<PAGE>
PROSPECTUS DECEMBER 1, 2000
PRUDENTIAL
SMALL COMPANY FUND, INC.
FUND TYPE Stock
OBJECTIVE Capital growth
BUILD ON THE ROCK
As with all mutual funds, the Securities and Exchange Commission has not
approved or disapproved the Fund's shares, nor has the SEC determined that this
prospectus is complete or accurate. It is a criminal offense to state otherwise.
[PRUDENTIAL LOGO]
<PAGE>
TABLE OF CONTENTS
-------------------------------------
<TABLE>
<S> <C>
1 RISK/RETURN SUMMARY
1 Investment Objective and Principal Strategies
1 Principal Risks
3 Evaluating Performance
4 Fees and Expenses
6 HOW THE FUND INVESTS
6 Investment Objective and Policies
7 Other Investments and Strategies
10 Investment Risks
13 HOW THE FUND IS MANAGED
13 Board of Directors
13 Manager
13 Investment Adviser
13 Portfolio Manager
14 Distributor
15 FUND DISTRIBUTIONS AND TAX ISSUES
15 Distributions
16 Tax Issues
17 If You Sell or Exchange Your Shares
19 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE FUND
19 How to Buy Shares
27 How to Sell Your Shares
31 How to Exchange Your Shares
33 Telephone Redemptions or Exchanges
34 FINANCIAL HIGHLIGHTS
34 Class A Shares
35 Class B Shares
36 Class C Shares
37 Class Z Shares
38 THE PRUDENTIAL MUTUAL FUND FAMILY
FOR MORE INFORMATION (Back Cover)
</TABLE>
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PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
RISK/RETURN SUMMARY
-------------------------------------
This section highlights key information about the PRUDENTIAL SMALL COMPANY FUND,
INC. (formerly, Prudential Small Company Value Fund, Inc.), which we refer to as
"the Fund." Additional information follows this summary.
INVESTMENT OBJECTIVE AND PRINCIPAL STRATEGIES
Our investment objective is CAPITAL GROWTH, which means we seek invest-
ments whose price will increase over time. We normally invest at least 65% of
our total assets in common stocks of small, less well-known U.S. companies that
the investment adviser believes are relatively undervalued.
We currently consider small companies to be those with a market
capitalization less than the largest market capitalization found in the Standard
& Poor's 600 SmallCap Index ($5,788 million as of October 31, 2000). The
portfolio is well-diversified and typically includes stocks representing all of
the sectors in the Index. In addition to common stocks, the Fund may invest in
equity-related securities including nonconvertible preferred stocks and
convertible securities.
While we make every effort to achieve our objective, we can't guarantee
success.
PRINCIPAL RISKS
Although we try to invest wisely, all investments involve risk. Since we invest
primarily in common stocks, there is the risk that the price of particular
equities we own could go down, or the value of the equity markets or a sector of
them could go down. Stock markets are volatile. The Fund's holdings can vary
significantly from broad market indexes and the performance of the Fund can
deviate from the performance of these indexes. Different parts of a market can
react differently to adverse issuer, market, regulatory, political and economic
developments.
-------------------------------------------------------------------
WE'RE BLEND INVESTORS
In deciding which stocks to buy, we use a blend of both value and growth styles.
We look for stocks of smaller, less well-known companies that we believe have
above average growth prospects but can be purchased at lower prices relative to
the company's earnings or whose growth prospects are underappreciated by the
market. This approach is often referred to as GARP, or "growth at a reasonable
price."
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1
<PAGE>
RISK/RETURN SUMMARY
------------------------------------------------
Generally, the stock prices of small companies vary more than the prices of
large company stocks. Small company stocks present above-average risks. This
means that when stock prices decline overall, the Fund may decline more than a
broad-based securities market index. Small companies usually offer a smaller
range of products and services than larger companies. They also may have limited
financial resources and may lack management depth.
Since our objective is capital growth, the companies that we invest in
generally may reinvest their earnings rather than distribute them to
shareholders. As a result, the Fund is not likely to receive significant
dividend income on its portfolio securities.
Like any mutual fund, an investment in the Fund could lose value, and you
could lose money. For more detailed information about the risks associated with
the Fund, see "How the Fund Invests--Investment Risks."
An investment in the Fund is not a bank deposit and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency.
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2 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
RISK/RETURN SUMMARY
------------------------------------------------
EVALUATING PERFORMANCE
A number of factors--including risk--can affect how the Fund performs. The
following bar chart shows the Fund's performance for the last 10 full calendar
years of operation. The bar chart and table demonstrate the risk of investing in
the Fund by showing how returns can change from year to year and by showing how
the Fund's average annual total returns compare with those of a stock index and
a group of similar mutual funds. Past performance does not mean that the Fund
will achieve similar results in the future. The Fund followed a "value" style of
investing until May 2000, when it adopted its current "blend" style.
ANNUAL RETURNS* (CLASS B SHARES)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
1990 -12.51%
1991 38.69%
1992 20.22%
1993 18.75%
1994 -3.86%
1995 23.31%
1996 22.97%
1997 32.64%
1998 -11.56%
1999 -7.08%
</TABLE>
BEST QUARTER: 38.70% (4th quarter of 1991) WORST QUARTER: -12.51% (4th quarter
of 1990)
* THESE ANNUAL RETURNS DO NOT INCLUDE SALES CHARGES. IF THE SALES CHARGES WERE
INCLUDED, THE ANNUAL RETURNS WOULD BE LOWER THAN THOSE SHOWN. THE TOTAL RETURN
OF THE CLASS B SHARES FROM 1-1-00 TO 9-30-00 WAS 14.88%.
AVERAGE ANNUAL RETURNS(1) (AS OF 12-31-99)
<TABLE>
<CAPTION>
1 YR 5 YRS 10 YRS SINCE INCEPTION
<S> <C> <C> <C> <C>
Class A shares -11.02% 10.27% N/A 11.47% (since 1-22-90)
Class B shares -12.08% 10.44% 10.66% 10.91% (since 11-13-80)
Class C shares -9.01% 10.35% N/A 9.71% (since 8-1-94)
Class Z shares -6.19% N/A N/A 8.32% (since 3-1-96)
Russell 2000(2) 15.36% 11.50% 17.01% N/A(2)
S&P SmallCap(3) 12.41% 17.05% 13.04% N/A(3)
Lipper Average(4) 20.66% 12.67% 15.86% N/A(4)
</TABLE>
1 THE FUND'S RETURNS ARE AFTER DEDUCTION OF SALES CHARGES AND EXPENSES.
WITHOUT THE DISTRIBUTION AND SERVICE (12b-1) FEE WAIVER FOR CLASS A SHARES,
THE RETURNS WOULD HAVE BEEN LOWER.
2 THE RUSSELL 2000 VALUE INDEX (RUSSELL 2000) IS AN UNMANAGED
CAPITAL-WEIGHTED INDEX OF THE SMALLEST 2,000 STOCKS AMONG THE LARGEST 3,000
EQUITY-CAPITALIZED U.S. CORPORATIONS AND REPRESENTS APPROXIMATELY 8% OF
THEIR AGGREGATE MARKET VALUE. THESE RETURNS DO NOT INCLUDE THE EFFECT OF
ANY SALES CHARGES OR OPERATING EXPENSES OF A MUTUAL FUND. THESE RETURNS
WOULD BE LOWER IF THEY INCLUDED THE EFFECT OF SALES CHARGES. RUSSELL 2000
RETURNS SINCE THE INCEPTION OF EACH CLASS ARE 14.25% FOR CLASS A, 13.44%
FOR CLASS B, 12.02% FOR CLASS C AND 10.01% FOR CLASS Z SHARES. THE
SECURITIES IN THE RUSSELL 2000 MAY BE VERY DIFFERENT FROM THOSE IN THE
FUND. SOURCE: LIPPER INC.
3 THE STANDARD & POOR'S SMALLCAP 600 INDEX (S&P SMALLCAP) -- AN UNMANAGED
CAPITAL-WEIGHTED INDEX OF 600 SMALLER COMPANY U.S. COMMON STOCKS THAT COVER
ALL INDUSTRY SECTORS--GIVES A BROAD LOOK AT HOW SMALL-CAP STOCK PRICES HAVE
PERFORMED. THESE RETURNS DO NOT INCLUDE THE EFFECT OF ANY SALES CHARGES.
THESE RETURNS WOULD BE LOWER IF THEY INCLUDED THE EFFECT OF ANY SALES
CHARGES. THE SECURITIES IN THE S&P SMALLCAP MAY BE VERY DIFFERENT FROM
THOSE IN THE FUND. S&P SMALLCAP RETURNS SINCE THE INCEPTION OF EACH CLASS
(OTHER THAN CLASS B, BECAUSE THE S&P SMALLCAP WAS NOT COMPILED IN 1980) ARE
14.27% FOR CLASS A, 16.40% FOR CLASS C AND 13.65% FOR CLASS Z SHARES.
SOURCE: LIPPER INC.
4 THE LIPPER AVERAGE IS BASED ON THE AVERAGE RETURN OF ALL MUTUAL FUNDS IN
THE LIPPER SMALL CAP VALUE FUNDS CATEGORY AND DOES NOT INCLUDE THE EFFECT
OF ANY SALES CHARGES. AGAIN, THESE RETURNS WOULD BE LOWER IF THEY INCLUDED
THE EFFECT OF SALES CHARGES. LIPPER RETURNS SINCE THE INCEPTION OF EACH
CLASS ARE 11.02% FOR CLASS A, 13.00% FOR CLASS B, 12.71% FOR CLASS C AND
11.33% FOR CLASS Z SHARES. SOURCE: LIPPER INC.
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3
<PAGE>
RISK/RETURN SUMMARY
------------------------------------------------
FEES AND EXPENSES
These tables show the sales charges, fees and expenses that you may pay if you
buy and hold shares of each share class of the Fund--Class A, B, C and Z. Each
share class has different sales charges--known as loads--and expenses, but
represents an investment in the same fund. Class Z shares are available only to
a limited group of investors. For more information about which share class may
be right for you, see "How to Buy, Sell and Exchange Shares of the Fund."
SHAREHOLDER FEES(1) (PAID DIRECTLY FROM YOUR INVESTMENT)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C>
Maximum sales charge (load) imposed on
purchases (as a percentage of offering
price) 5% None 1% None
Maximum deferred sales charge (load) (as a
percentage of the lower of original
purchase price or sale proceeds) None 5%(2) 1%(3) None
Maximum sales charge (load) imposed on
reinvested dividends and other
distributions None None None None
Redemption fees None None None None
Exchange fee None None None None
</TABLE>
ANNUAL FUND OPERATING EXPENSES (DEDUCTED FROM FUND ASSETS)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C>
Management fees .70% .70% .70% .70%
+ Distribution and service (12b-1) fees .30%(4) 1.00% 1.00% None
+ Other expenses .42% .42% .42% .42%
= Total annual Fund operating expenses 1.42% 2.12% 2.12% 1.12%
- Fee waiver .05% None None None
= NET ANNUAL FUND OPERATING EXPENSES 1.37%(4) 2.12% 2.12% 1.12%
</TABLE>
1 YOUR BROKER MAY CHARGE YOU A SEPARATE OR ADDITIONAL FEE FOR PURCHASES AND
SALES OF SHARES.
2 THE CONTINGENT DEFERRED SALES CHARGE (CDSC) FOR CLASS B SHARES DECREASES BY
1% ANNUALLY TO 1% IN THE FIFTH AND SIXTH YEARS AND 0% IN THE SEVENTH YEAR.
CLASS B SHARES CONVERT TO CLASS A SHARES APPROXIMATELY SEVEN YEARS AFTER
PURCHASE.
3 THE CDSC FOR CLASS C SHARES IS 1% FOR SHARES REDEEMED WITHIN 18 MONTHS OF
PURCHASE.
4 FOR THE FISCAL YEAR ENDING SEPTEMBER 30, 2001, THE DISTRIBUTOR OF THE FUND
HAS CONTRACTUALLY AGREED TO REDUCE ITS DISTRIBUTION AND SERVICE (12B-1)
FEES FOR CLASS A SHARES TO .25 OF 1% OF THE AVERAGE DAILY NET ASSETS OF THE
CLASS A SHARES.
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4 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
RISK/RETURN SUMMARY
------------------------------------------------
EXAMPLE
This example will help you compare the fees and expenses of the Fund's different
share classes and the cost of investing in the Fund with the cost of investing
in other mutual funds.
The example assumes that you invest $10,000 in the Fund for the time periods
indicated and then sell all of your shares at the end of those periods. The
example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same, except for the Distributor's
reduction of distribution and service (12b-1) fees for Class A shares during the
first year. Although your actual costs may be higher or lower, based on these
assumptions, your costs would be:
<TABLE>
<CAPTION>
1 YR 3 YRS 5 YRS 10 YRS
<S> <C> <C> <C> <C>
Class A shares $633 $922 $1,233 $2,113
Class B shares $715 $964 $1,239 $2,190
Class C shares $413 $757 $1,228 $2,527
Class Z shares $114 $356 $ 617 $1,363
</TABLE>
You would pay the following expenses on the same investment if you did not
sell your shares:
<TABLE>
<CAPTION>
1 YR 3 YRS 5 YRS 10 YRS
<S> <C> <C> <C> <C>
Class A shares $633 $922 $1,233 $2,113
Class B shares $215 $664 $1,139 $2,190
Class C shares $313 $757 $1,228 $2,527
Class Z shares $114 $356 $ 617 $1,363
</TABLE>
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5
<PAGE>
HOW THE FUND INVESTS
-------------------------------------
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is CAPITAL GROWTH. This means we seek
investments whose price will increase over time. While we make every effort to
achieve our objective, we can't guarantee success.
In pursuing our objective, we normally invest in COMMON STOCKS of SMALL,
LESS WELL-KNOWN U.S. COMPANIES that the investment adviser believes are
relatively undervalued. We currently consider small companies to be those with
market capitalizations of less than the largest market capitalization found in
the Standard & Poor's 600 SmallCap Index ($5,788 million at October 31, 2000).
Market capitalization is measured at the time of initial purchase so that
companies whose capitalization no longer meets this definition after purchase
continue to be considered small for purposes of achieving our investment
objective. We may change the kind of companies we consider small to reflect
industry norms.
In addition to common stocks, we invest in other equity-related securities,
including nonconvertible preferred stocks and convertible securities--like
bonds, corporate notes and preferred stock--that we can convert to the company's
common stock or some other equity security.
-------------------------------------------------------------------
OUR BLEND STRATEGY
We look for smaller, less well-known companies that we believe have above
average growth prospects and whose stocks appear undervalued relative to those
growth prospects or relative to the company's earnings. We build our portfolios
on a company by company basis using in-depth fundamental analysis, while
considering industry and sector weightings of the benschmark. Generally, we
consider selling a security for any of the following reasons: (1) if the
underlying trends in the company's industry or business change; (2) if the
company experiences a deterioration of fundamentals and its earnings prospects;
or (3) if the company's valuation, in our opinion, is too high relative to its
risks.
-------------------------------------------------------------------
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6 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
For more information, see "Investment Risks" below and the Statement of
Additional Information, "Description of the Fund, Its Investments and Risks."
The Statement of Additional Information--which we refer to as the SAI--contains
additional information about the Fund. To obtain a copy, see the back cover
page of this prospectus.
The Fund's investment objective is a fundamental policy that cannot be
changed without shareholder approval. The Board can change investment policies
that are not fundamental.
OTHER INVESTMENTS AND STRATEGIES
In addition to the principal strategies, we may use the following investment
strategies to try to increase the Fund's returns or protect its assets if market
conditions warrant.
OTHER EQUITY-RELATED SECURITIES
In addition to common stocks, nonconvertible preferred stocks and convertible
securities, other equity-related securities in which the Fund may invest include
warrants and rights that can be exercised to obtain stock; investments in
various types of business ventures, including partnerships and joint ventures;
real estate investment trusts; American Depositary Receipts (ADRs) and other
similar securities. Although the Fund invests primarily in common stocks of
small U.S. companies, we also can invest in equity-related securities of
U.S. companies of any size.
REAL ESTATE INVESTMENT TRUSTS
We may invest in the securities of real estate investment trusts known as REITS.
REITs are like corporations, except that they do not pay income taxes if they
meet certain IRS requirements. However, while REITs themselves do not pay income
taxes, the distributions they make to investors are taxable. REITs invest
primarily in real estate or real estate mortgages and distribute almost all of
their income--most of which comes from rents, mortgages and gains on sales of
property--to shareholders.
MONEY MARKET INSTRUMENTS
The Fund may temporarily hold cash or invest in high-quality money market
instruments pending investment of proceeds from new sales of Fund shares, during
periods of portfolio restructuring, or to meet ordinary daily cash
--------------------------------------------------------------------------------
7
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
needs subject to the policy of normally investing at least 65% of the Fund's
assets in common stocks. Money market instruments include commercial paper of
corporations; certificates of deposit, bankers' acceptances and other
obligations of domestic banks; short-term obligations issued or guaranteed by
the U.S. government, its agencies or instrumentalities; and cash.
REPURCHASE AGREEMENTS
The Fund also may use REPURCHASE AGREEMENTS, where a party agrees to sell a
security to the Fund and then repurchase it at an agreed-upon price at a stated
time. This creates a fixed return for the Fund and is, in effect, a loan by the
Fund. The Fund uses repurchase agreements for cash management purposes only.
TEMPORARY DEFENSIVE INVESTMENTS
In response to adverse market, economic or political conditions, we may
temporarily invest up to 100% of the Fund's assets in cash or high-quality MONEY
MARKET INSTRUMENTS. Investing heavily in these securities limits our ability to
achieve capital appreciation, but can help to preserve the Fund's assets when
the equity markets are unstable.
FOREIGN SECURITIES
The Fund can invest in equity-related securities and fixed-income obligations of
foreign issuers. We do not consider ADRs and other similar receipts or shares to
be foreign securities.
DERIVATIVE STRATEGIES
We may use various derivative strategies to try to improve the Fund's returns.
We may use hedging strategies to try to protect the Fund's assets. We cannot
guarantee that these strategies will work, that the instruments necessary to
implement these strategies will be available or that the Fund will not lose
money. Derivatives--such as futures, options, foreign currency forward contracts
and options on futures--involve costs and can be volatile. With derivatives, the
investment adviser tries to predict whether the underlying investment--a
security, market index, currency, interest rate or some other benchmark--will go
up or down at some future date. We may use derivatives to try to reduce risk or
to increase return consistent with the
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8 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
Fund's overall investment objective. The investment adviser will consider other
factors (such as cost) in deciding whether to employ any particular strategy or
use any particular instrument. Any derivatives we use may not match the Fund's
underlying holdings.
OPTIONS. The Fund may purchase and sell put and call options on securities and
currencies traded on U.S. or foreign securities exchanges or in the
over-the-counter market. An OPTION is the right to buy or sell securities in
exchange for a premium. The options may be on equity securities, stock indexes
and foreign currencies. The Fund will sell only covered options.
FUTURES CONTRACTS AND RELATED OPTIONS
FOREIGN CURRENCY FORWARD CONTRACTS. The Fund may purchase and sell futures
contracts and related options on stock indexes and foreign currencies. A FUTURES
CONTRACT is an agreement to buy or sell a set quantity of an underlying product
at a future date, or to make or receive a cash payment based on the value of a
securities index. The Fund also may enter into foreign currency forward
contracts to try to protect the value of its assets against future changes in
the level of foreign currency exchange rates. A FOREIGN CURRENCY FORWARD
CONTRACT is an obligation to buy or sell a given currency on a future date and
at a set price.
ADDITIONAL STRATEGIES
The Fund also follows certain policies when it BORROWS MONEY (the Fund can
borrow up to 20% of the value of its total assets) and HOLDS ILLIQUID SECURITIES
(the Fund may hold up to 15% of its net assets in illiquid securities, including
securities with legal or contractual restrictions, those without a readily
available market, and repurchase agreements with maturities longer than seven
days). The Fund is subject to certain investment restrictions that are
fundamental policies, which means they cannot be changed without shareholder
approval. For more information about these restrictions, see the SAI.
--------------------------------------------------------------------------------
9
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
INVESTMENT RISKS
As noted, all investments involve risk, and investing in the Fund is no
exception. Since the Fund's holdings can vary significantly from broad-based
securities market indexes, performance of the Fund can deviate from performance
of the indexes. This chart outlines the key risks and potential rewards of the
Fund's principal investments and certain other non-principal investments the
Fund may make. The investment types are listed in the order in which they
normally will be used by the portfolio manager. See, too, "Description of the
Fund, Its Investments and Risks" in the SAI.
INVESTMENT TYPE
<TABLE>
<CAPTION>
% OF FUND'S TOTAL ASSETS RISKS POTENTIAL REWARDS
<S> <C> <C>
-------------------------------------------------------------------------------------------------------
COMMON STOCKS OF SMALL -- Individual stocks could lose -- Historically, stocks have
U.S. COMPANIES value outperformed other investments
-- The equity markets could go over the long term
AT LEAST 65% down, resulting in a decline in -- Generally, economic growth means
value of the Fund's investments higher corporate profits, which
-- Stocks of small companies are leads to an increase in stock
more volatile and may decline prices, known as capital
more than those in the S&P 500 appreciation
Index -- Highly successful small
-- Small companies are more likely companies can outperform larger
to reinvest earnings and not ones
pay dividends
-- Changes in interest rates may
affect the securities of small
companies more than the
securities of larger companies
-- Changes in economic or political
conditions, both domestic and
international, may result in a
decline in value of the Fund's
investments
-------------------------------------------------------------------------------------------------------
COMMON STOCKS OF LARGER -- Similar risks to small U.S. -- Not as likely to lose value as
U.S. COMPANIES companies stocks of small companies
-- Companies that pay dividends may -- May be a source of dividend
UP TO 35%; USUALLY LESS not do so if they don't have income
THAN 10% profits or adequate cash flow
-------------------------------------------------------------------------------------------------------
</TABLE>
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10 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
INVESTMENT TYPE (CONT'D)
<TABLE>
<CAPTION>
% OF FUND'S TOTAL ASSETS RISKS POTENTIAL REWARDS
<S> <C> <C>
REAL ESTATE INVESTMENT -- Performance depends on the -- Real estate holdings can
TRUSTS (REITS) strength of real estate generate good returns from
markets, REIT management and rents, rising market values,
PERCENTAGE VARIES; property management, which can etc.
USUALLY LESS THAN 5% be affected by many factors, -- Greater diversification than
including national and regional direct ownership
economic conditions
-------------------------------------------------------------------------------------------------------
MONEY MARKET -- Limits potential for capital -- May preserve the Fund's assets
INSTRUMENTS appreciation
-- Credit risk--the risk that the
UP TO 100% ON A default of an issuer would
TEMPORARY BASIS leave the Fund with unpaid
interest or principal
-- Market risk--the risk that the
market value of an investment
may move up or down, sometimes
rapidly or unpredictably.
Market risk may affect an
industry, a sector, or the
market as a whole
-------------------------------------------------------------------------------------------------------
FOREIGN SECURITIES -- Foreign markets, economies and -- Investors can participate in
political systems may not be as foreign markets and companies
UP TO 15%; USUALLY LESS stable as in the U.S., operating in those markets
THAN 5% particularly those in -- May profit from changing value
developing countries of foreign currencies
-- Currency risk--changing values -- Opportunities for
of foreign currencies can cause diversification
losses
-- May be less liquid than U.S.
stocks and bonds
-- Differences in foreign laws,
accounting standards, public
information, custody and
settlement practices provide
less reliable information on
foreign investments and involve
more risk
-------------------------------------------------------------------------------------------------------
</TABLE>
--------------------------------------------------------------------------------
11
<PAGE>
HOW THE FUND INVESTS
------------------------------------------------
INVESTMENT TYPE (CONT'D)
<TABLE>
<CAPTION>
% OF FUND'S TOTAL ASSETS RISKS POTENTIAL REWARDS
<S> <C> <C>
---------------------------------------------------------------------------------------------------------
DERIVATIVES -- Derivatives such as futures, -- The Fund could make money and
options and foreign currency protect against losses if the
PERCENTAGE VARIES; forward contracts may not fully investment analysis proves
USUALLY LESS THAN 3% offset the underlying positions correct
and this could result in losses -- One way to manage the Fund's
to the Fund that would not have risk/return balance is by
otherwise occurred locking in the value of an
-- Derivatives used for risk investment ahead of time
management may not have the -- Hedges that correlate well with
intended effects and may result an underlying position can
in losses or missed reduce or eliminate investment
opportunities income or capital gains at low
-- The other party to a derivatives cost
contract could default
-- Derivatives that involve
leverage could magnify losses
-- Certain types of derivatives
involve costs to the Fund that
can reduce returns
---------------------------------------------------------------------------------------------------------
ILLIQUID SECURITIES -- May be difficult to value -- May offer a more attractive
precisely yield or potential for growth
UP TO 15% OF NET ASSETS; -- May be difficult to sell at the than more widely traded
USUALLY LESS THAN 3% time or price desired securities
---------------------------------------------------------------------------------------------------------
</TABLE>
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12 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW THE FUND IS MANAGED
-------------------------------------
BOARD OF DIRECTORS
The Board of Directors oversees the actions of the Manager, Investment Adviser
and Distributor and decides on general policies. The Board also oversees the
Fund's officers, who conduct and supervise the daily business operations of the
Fund.
MANAGER
PRUDENTIAL INVESTMENTS FUND MANAGEMENT LLC (PIFM)
GATEWAY CENTER THREE, 100 MULBERRY STREET
NEWARK, NJ 07102-4077
Under a management agreement with the Fund, PIFM manages the Fund's
investment operations and administers its business affairs. PIFM also is
responsible for supervising the Fund's investment adviser. For the fiscal year
ended September 30, 2000, the Fund paid PIFM management fees of .70 of 1% of the
Fund's average net assets.
PIFM and its predecessors have served as manager or administrator to
investment companies since 1987. As of October 31, 2000, PIFM served as the
manager to all 41 of the Prudential mutual funds, and as manager or
administrator to 22 closed-end investment companies, with aggregate assets of
approximately $77.7 billion.
INVESTMENT ADVISER
Jennison Associates LLC (Jennison) is the Fund's investment adviser and has
served as such since August 24, 2000. Its address is 466 Lexington Avenue, New
York, NY 10017. PIFM has responsibility for all investment advisory services,
supervises Jennison and pays Jennison for its services. As of October 31, 2000,
Jennison managed approximately $87 billion in assets. Jennison has served as an
investment adviser to investment companies since 1990. The Prudential Investment
Corporation (PI) served as investment adviser from the Fund's inception through
August 23, 2000. For the period January 1, 2000 through August 2000, PI was paid
at the same rate at which Jennison currently is being paid by PIFM.
PORTFOLIO MANAGER
The Fund has been managed by JOHN MULLMAN, CFA, since May 2000. Mr. Mullman is a
Senior Vice President of Jennison. Mr. Mullman has been
--------------------------------------------------------------------------------
13
<PAGE>
HOW THE FUND IS MANAGED
------------------------------------------------
employed with Prudential since 1987, most recently managing institutional
portfolios. He earned a B.A. from the College of The Holy Cross and an M.B.A.
from Yale University. He holds a Chartered Financial Analyst (CFA) designation.
DISTRIBUTOR
Prudential Investment Management Services LLC (PIMS) distributes the Fund's
shares under a Distribution Agreement with the Fund. The Fund has Distribution
and Service Plans under Rule 12b-1 of the Investment Company Act. Under the
Plans and the Distribution Agreement, PIMS pays the expenses of distributing the
Fund's Class A, B, C and Z shares and provides certain shareholder support
services. The Fund pays distribution and other fees to PIMS as compensation for
its services for each class of shares other than Class Z. These fees--known as
12b-1 fees--are shown in the "Fees and Expenses" tables.
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14 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
FUND DISTRIBUTIONS
AND TAX ISSUES
-------------------------------------
Investors who buy shares of the Fund should be aware of some important tax
issues. For example, the Fund distributes DIVIDENDS of ordinary income and any
realized net CAPITAL GAINS to shareholders. These distributions are subject to
taxes, unless you hold your shares in a 401(k) plan, an Individual Retirement
Account (IRA), or some other qualified or tax-deferred plan or account.
Dividends and distributions from the Fund also may be subject to state and local
income taxes.
Also, if you sell shares of the Fund for a profit, you may have to pay
capital gains taxes on the amount of your profit, again unless you hold your
shares in a qualified or tax-deferred plan or account.
The following briefly discusses some of the important federal tax issues you
should be aware of, but is not meant to be tax advice. For tax advice, please
speak with your tax adviser.
DISTRIBUTIONS
The Fund distributes DIVIDENDS of any net investment income to shareholders --
typically twice a year. For example, if the Fund owns ACME Corp. stock and the
stock pays a dividend, the Fund will pay out a portion of this dividend to its
shareholders, assuming the Fund's income is more than its costs and expenses.
The dividends you receive from the Fund will be taxed as ordinary income,
whether or not they are reinvested in the Fund.
The Fund also distributes realized net CAPITAL GAINS to shareholders--
typically once a year. Capital gains are generated when the Fund sells its
assets for a profit. For example, if the Fund bought 100 shares of ACME Corp.
stock for a total of $1,000 and more than one year later sold the shares for a
total of $1,500, the Fund has net long-term capital gains of $500, which it will
pass on to shareholders (assuming the Fund's total gains are greater than any
losses it may have). Capital gains are taxed differently depending on how long
the Fund holds the security--if a security is held more than one year before it
is sold, LONG-TERM capital gains are taxed at the rate of 20%, but if the
security is held one year or less, SHORT-TERM capital gains are taxed at
ordinary income rates of up to 39.6%. Different rates apply to corporate
shareholders.
For your convenience, Fund distributions of dividends and capital gains are
AUTOMATICALLY REINVESTED in the Fund without any sales charge. If you ask us to
pay the distributions in cash, we will send you a check if your account is with
the Transfer Agent. Otherwise, if your account is with a broker, you will
receive a credit to your account. Either way, the distributions
--------------------------------------------------------------------------------
15
<PAGE>
FUND DISTRIBUTIONS
AND TAX ISSUES
------------------------------------------------
may be subject to taxes, unless your shares are held in a qualified or
tax-deferred plan or account. For more information about automatic reinvestment
and other shareholder services, see "Step 4: Additional Shareholder Services" in
the next section.
TAX ISSUES
FORM 1099
Every year, you will receive a Form 1099, which reports the amount of dividends
and capital gains we distributed to you during the prior year. If you own shares
of the Fund as part of a qualified or tax-deferred plan or account, your taxes
are deferred, so you will not receive a Form 1099. However, you will receive a
Form 1099 when you take any distributions from your qualified or tax-deferred
plan or account.
Fund distributions are generally taxable to you in the calendar year they
are received, except when we declare certain dividends in the fourth quarter and
actually pay them in January of the following year. In such cases, the dividends
are treated as if they were paid on December 31 of the prior year. Corporate
shareholders generally are eligible for the 70% dividends-received deduction for
certain dividends.
WITHHOLDING TAXES
If federal tax law requires you to provide the Fund with your taxpayer
identification number and certifications as to your tax status, and you fail to
do this, or if you are otherwise subject to backup withholding, we will withhold
and pay to the U.S. Treasury 31% of your distributions and sale proceeds.
Dividends of net investment income and short-term capital gains paid to a
nonresident foreign shareholder generally will be subject to a U.S. withholding
tax of 30%. This rate may be lower, depending on any tax treaty the U.S. may
have with the shareholder's country.
IF YOU PURCHASE JUST BEFORE RECORD DATE
If you buy shares of the Fund just before the record date (the date that
determines who receives the distribution), that distribution will be paid to
you. As explained above, the distribution may be subject to income or capital
gains taxes. You may think you've done well since you bought shares one day and
soon thereafter received a distribution. That is not so because when dividends
are paid out, the value of each share of the Fund decreases
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16 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
FUND DISTRIBUTIONS
AND TAX ISSUES
------------------------------------------------
by the amount of the dividend to reflect the payout, although this may not be
apparent because the value of each share of the Fund also will be affected by
market changes, if any. The distribution you receive makes up for the decrease
in share value. However, the timing of your purchase does mean that part of your
investment came back to you as taxable income.
QUALIFIED AND TAX-DEFERRED RETIREMENT PLANS
Retirement plans and accounts allow you to defer paying taxes on investment
income and capital gains. Contributions to these plans may also be tax
deductible, although distributions from these plans generally are taxable. In
the case of Roth IRA accounts, contributions are not tax deductible, but
distributions from the plan may be tax free. Please contact your financial
adviser for information on a variety of Prudential mutual funds that are
suitable for retirement plans offered by Prudential.
IF YOU SELL OR EXCHANGE YOUR SHARES
If you sell any shares of the Fund for a profit, you have REALIZED A CAPITAL
GAIN, which is subject to tax, unless you hold shares in a qualified or tax-
deferred plan or account. The amount of tax you pay depends on how long you
owned your shares. If you sell shares of the Fund for a loss, you may have a
capital loss, which you may use to offset certain capital gains you have.
If you sell shares and realize a loss, you will not be permitted to use the
loss to the extent you replace the shares (including pursuant to the
reinvestment of a dividend) within a 61-day period (beginning 30 days before the
sale of the shares). If you acquire shares of the Fund and sell your shares
within 90 days, you may not be allowed to include certain charges incurred in
acquiring the shares for purposes of calculating gain or loss realized upon the
sale of the shares.
-------------------------------------------------------------------
RECEIPTS FROM SALE --> +$ CAPITAL GAIN
(taxes owed)
$ OR
--> -$ CAPITAL LOSS
(offset against gain)
-------------------------------------------------------------------
Exchanging your shares of the Fund for the shares of another Prudential
mutual fund is considered a sale for tax purposes. In other words, it's a
"taxable event." Therefore, if the shares you exchanged have
--------------------------------------------------------------------------------
17
<PAGE>
FUND DISTRIBUTIONS
AND TAX ISSUES
------------------------------------------------
increased in value since you purchased them, you have capital gains, which are
subject to the taxes described above.
Any gain or loss you may have from selling or exchanging Fund shares will
not be reported on Form 1099; however, proceeds from the sale or exchange will
be reported on Form 1099-B. Therefore, unless you hold your shares in a
qualified or tax-deferred plan or account, you or your financial adviser should
keep track of the dates on which you buy and sell--or exchange--Fund shares, as
well as the amount of any gain or loss on each transaction. For tax advice,
please see your tax adviser.
AUTOMATIC CONVERSION OF CLASS B SHARES
We have obtained a legal opinion that the conversion of Class B shares into
Class A shares--which happens automatically approximately seven years after
purchase--is not a "taxable event" because it does not involve an actual sale of
your Class B shares. This opinion, however, is not binding on the Internal
Revenue Service (IRS). For more information about the automatic conversion of
Class B shares, see "Class B Shares Convert to Class A Shares After
Approximately Seven Years" in the next section.
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18 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
-------------------------------------
HOW TO BUY SHARES
STEP 1: OPEN AN ACCOUNT
If you don't have an account with us or a securities firm that is permitted to
buy or sell shares of the Fund for you, call Prudential Mutual Fund Services LLC
(PMFS) at (800) 225-1852 or contact:
PRUDENTIAL MUTUAL FUND SERVICES LLC
ATTN: INVESTMENT SERVICES
P.O. BOX 8179
PHILADELPHIA, PA 19101
You may purchase shares by check or wire. We do not accept cash or money
orders. To purchase by wire, call the number above to obtain an application.
After PMFS receives your completed application, you will receive an account
number. We have the right to reject any purchase order (including an exchange
into the Fund) or suspend or modify the Fund's sale of its shares.
STEP 2: CHOOSE A SHARE CLASS
Individual investors can choose among Class A, Class B, Class C and Class Z
shares of the Fund, although Class Z shares are available only to a limited
group of investors.
Multiple share classes let you choose a cost structure that better meets
your needs. With Class A shares, you pay the sales charge at the time of
purchase, but the operating expenses each year are lower than the expenses of
Class B and Class C shares. With Class B shares, you only pay a sales charge if
you sell your shares within six years (that is why it is called a Contingent
Deferred Sales Charge or CDSC), but the operating expenses each year are higher
than Class A share expenses. With Class C shares, you pay a 1% front-end sales
charge and a 1% CDSC if you sell within 18 months of purchase, but the operating
expenses are also higher than the expenses for Class A shares.
When choosing a share class, you should consider the following:
-- The amount of your investment
-- The length of time you expect to hold the shares and the impact of
the varying distribution fees
-- The different sales charges that apply to each share class--
Class A's front-end sales charge vs. Class B's CDSC vs. Class C's low
front-end sales charge and low CDSC
-- Whether you qualify for any reduction or waiver of sales charges
--------------------------------------------------------------------------------
19
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
-- The fact that Class B shares automatically convert to Class A shares
approximately seven years after purchase
-- Whether you qualify to purchase Class Z shares.
See "How to Sell Your Shares" for a description of the impact of CDSCs.
SHARE CLASS COMPARISON. Use this chart to help you compare the Fund's different
share classes. The discussion following this chart will tell you whether you are
entitled to a reduction or waiver of any sales charges.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C>
Minimum purchase $1,000 $1,000 $2,500 None
amount(1)
Minimum amount for $100 $100 $100 None
subsequent
purchases(1)
Maximum initial sales 5% of the None 1% of the None
charge public offering public offering
price price
Contingent Deferred None If sold during: 1% on sales None
Sales Charge (CDSC)(2) Year 1 5% made within
Year 2 4% 18 months of
Year 3 3% purchase(2)
Year 4 2%
Years 5/6 1%
Year 7 0%
Annual distribution and .30 of 1% 1% 1% None
service (12b-1) fees (.25 of 1%
shown as a percentage currently)
of average net
assets(3)
</TABLE>
1 THE MINIMUM INVESTMENT REQUIREMENTS DO NOT APPLY TO CERTAIN RETIREMENT AND
EMPLOYEE SAVINGS PLANS AND CUSTODIAL ACCOUNTS FOR MINORS. THE MINIMUM
INITIAL AND SUBSEQUENT INVESTMENT FOR PURCHASES MADE THROUGH THE AUTOMATIC
INVESTMENT PLAN IS $50. FOR MORE INFORMATION, SEE "ADDITIONAL SHAREHOLDER
SERVICES--AUTOMATIC INVESTMENT PLAN."
2 FOR MORE INFORMATION ABOUT THE CDSC AND HOW IT IS CALCULATED, SEE "HOW TO
SELL YOUR SHARES--CONTINGENT DEFERRED SALES CHARGE (CDSC)." CLASS C SHARES
BOUGHT BEFORE NOVEMBER 2, 1998, HAVE A 1% CDSC IF SOLD WITHIN ONE YEAR.
3 THESE DISTRIBUTION AND SERVICE FEES ARE PAID FROM THE FUND'S ASSETS ON A
CONTINUOUS BASIS. OVER TIME, THE FEES WILL INCREASE THE COST OF YOUR
INVESTMENT AND MAY COST YOU MORE THAN PAYING OTHER TYPES OF SALES CHARGES.
THE SERVICE FEE FOR CLASS A, CLASS B AND CLASS C SHARES IS .25 OF 1%. THE
DISTRIBUTION FEE FOR CLASS A SHARES IS LIMITED TO .30 OF 1% (INCLUDING THE
.25 OF 1% SERVICE FEE) AND IS .75 OF 1% FOR CLASS B AND CLASS C SHARES. FOR
THE FISCAL YEAR ENDING SEPTEMBER 30, 2001, THE DISTRIBUTOR OF THE FUND HAS
CONTRACTUALLY AGREED TO REDUCE ITS DISTRIBUTION AND SERVICE (12b-1) FEES
FOR CLASS A SHARES TO .25 OF 1% OF THE AVERAGE DAILY NET ASSETS OF THE
CLASS A SHARES.
-------------------------------------------------------------------
20 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
REDUCING OR WAIVING CLASS A'S INITIAL SALES CHARGE
The following describes the different ways investors can reduce or avoid
paying Class A's initial sales charge.
INCREASE THE AMOUNT OF YOUR INVESTMENT. You can reduce Class A's sales
charge by increasing the amount of your investment. This table shows how
the sales charge decreases as the amount of your investment increases.
<TABLE>
<CAPTION>
SALES CHARGE AS % OF SALES CHARGE AS % OF DEALER
AMOUNT OF PURCHASE OFFERING PRICE AMOUNT INVESTED REALLOWANCE
<S> <C> <C> <C>
Less than $25,000 5.00% 5.26% 4.75%
$25,000 to $49,999 4.50% 4.71% 4.25%
$50,000 to $99,999 4.00% 4.17% 3.75%
$100,000 to $249,999 3.25% 3.36% 3.00%
$250,000 to $499,999 2.50% 2.56% 2.40%
$500,000 to $999,999 2.00% 2.04% 1.90%
$1 million and above* None None None
</TABLE>
* IF YOU INVEST $1 MILLION OR MORE, YOU CAN BUY ONLY CLASS A SHARES, UNLESS
YOU QUALIFY TO BUY CLASS Z SHARES.
To satisfy the purchase amounts above, you can:
-- Invest with an eligible group of related investors
-- Buy Class A shares of two or more Prudential mutual funds at the same
time
-- Use your RIGHTS OF ACCUMULATION, which allow you to combine the
current value of Prudential mutual fund shares you already own with
the value of the shares you are purchasing for purposes of
determining the applicable sales charge (note: you must notify the
Transfer Agent if you qualify for Rights of Accumulation)
-- Sign a LETTER OF INTENT, stating in writing that you or an eligible
group of related investors will purchase a certain amount of shares
in the Fund and other Prudential mutual funds within 13 months.
The Distributor may reallow Class A's sales charge to dealers.
BENEFIT PLANS. Certain group retirement and savings plans may purchase Class A
shares without the initial sales charge if they meet the required
--------------------------------------------------------------------------------
21
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
minimum for amount of assets, average account balance or number of eligible
employees. For more information about these requirements, call Prudential at
(800) 353-2847.
MUTUAL FUND PROGRAMS. The initial sales charge will be waived for investors in
certain programs sponsored by broker-dealers, investment advisers and financial
planners who have agreements with Prudential Investments Advisory Group relating
to:
-- Mutual fund "wrap" or asset allocation programs where the sponsor
places Fund trades and charges its clients a management, consulting
or other fee for its services, or
-- Mutual fund "supermarket" programs where the sponsor links its
clients' accounts to a master account in the sponsor's name and the
sponsor charges a fee for its services.
Broker-dealers, investment advisers or financial planners sponsoring these
mutual fund programs may offer their clients more than one class of shares in
the Fund in connection with different pricing options for their programs.
Investors should consider carefully any separate transaction and other fees
charged by these programs in connection with investing in each available share
class before selecting a share class.
OTHER TYPES OF INVESTORS. Other investors pay no sales charge, including certain
officers, employees or agents of Prudential and its affiliates, the Prudential
mutual funds, the subadvisers of the Prudential mutual funds and registered
representatives and employees of brokers that have entered into a dealer
agreement with the Distributor. To qualify for a reduction or waiver of the
sales charge, you must notify the Transfer Agent or your broker at the time of
purchase. For more information, see the SAI, "Purchase, Redemption and Pricing
of Fund Shares--Reduction and Waiver of Initial Sales Charge--Class A Shares."
WAIVING CLASS C'S INITIAL SALES CHARGE
BENEFIT PLANS. Certain group retirement plans may purchase Class C shares
without the initial sales charge. For more information, call Prudential at
(800) 353-2847.
-------------------------------------------------------------------
22 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
INVESTMENT OF REDEMPTION PROCEEDS FROM OTHER INVESTMENT COMPANIES. The initial
sales charge will be waived for purchases of Class C shares if the purchase is
made with money from the redemption of shares of any unaffiliated investment
company, as long as the shares were not held in an account at Prudential
Securities Incorporated (Prudential Securities) or one of its affiliates. These
purchases must be made within 60 days of the redemption. To qualify for this
waiver, you must do one of the following:
-- Purchase your shares through an account at Prudential Securities,
-- Purchase your shares through an ADVANTAGE Account or an Investor
Account with Pruco Securities Corporation, or
-- Purchase your shares through another broker.
This waiver is not available to investors who purchase shares directly from
the Transfer Agent. If you are entitled to the waiver, you must notify either
the Transfer Agent or your broker, who may require any supporting documents they
consider appropriate.
QUALIFYING FOR CLASS Z SHARES
BENEFIT PLANS. Certain group retirement plans may purchase Class Z shares if
they meet the required minimum for amount of assets, average account balance or
number of eligible employees. For more information about these requirements,
call Prudential at (800) 353-2847.
MUTUAL FUND PROGRAMS. Class Z shares also can be purchased by participants in
any fee-based program or trust program sponsored by Prudential or an affiliate
that includes the Fund as an available option. Class Z shares also can be
purchased by investors in certain programs sponsored by broker-dealers,
investment advisers and financial planners who have agreements with Prudential
Investments Advisory Group relating to:
-- Mutual fund "wrap" or asset allocation programs where the sponsor
places Fund trades, links its clients' accounts to a master account
in the sponsor's name and charges its clients a management,
consulting or other fee for its services, or
-- Mutual fund "supermarket" programs where the sponsor links its
clients' accounts to a master account in the sponsor's name and the
sponsor charges a fee for its services.
--------------------------------------------------------------------------------
23
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
Broker-dealers, investment advisers or financial planners sponsoring these
mutual fund programs may offer their clients more than one class of shares in
the Fund in connection with different pricing options for their programs.
Investors should consider carefully any separate transaction and other fees
charged by these programs in connection with investing in each available share
class before selecting a share class.
OTHER TYPES OF INVESTORS. Class Z shares also can be purchased by any of the
following:
-- Certain participants in the MEDLEY Program (group variable annuity
contracts) sponsored by Prudential for whom Class Z shares of the
Prudential mutual funds are an available option,
-- Current and former Directors/Trustees of the Prudential mutual funds
(including the Fund), and
-- Prudential, with an investment of $10 million or more.
In connection with the sale of shares, the Manager, the Distributor or one
of their affiliates may pay brokers, financial advisers and other persons a
commission of up to 4% of the purchase price for Class B shares, up to 2% of the
purchase price for Class C shares and a finder's fee for Class A or Class Z
shares from their own resources based on a percentage of the net asset value of
shares sold or otherwise.
CLASS B SHARES CONVERT TO CLASS A SHARES AFTER APPROXIMATELY SEVEN YEARS
If you buy Class B shares and hold them for approximately seven years, we will
automatically convert them into Class A shares without charge. At that time, we
will also convert any Class B shares that you received with reinvested dividends
and other distributions. Since the 12b-1 fees for Class A shares are lower than
for Class B shares, converting to Class A shares lowers your Fund expenses.
When we do the conversion, you will get fewer Class A shares than the number
of converted Class B shares if the price of the Class A shares is higher than
the price of Class B shares. The total dollar value will be the same, so you
will not have lost any money by getting fewer Class A shares. We do the
conversions quarterly, not on the anniversary date of your purchase. For more
information, see the SAI, "Purchase, Redemption and Pricing of Fund
Shares--Conversion Feature--Class B Shares."
-------------------------------------------------------------------
24 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
STEP 3: UNDERSTANDING THE PRICE YOU'LL PAY
The price you pay for each share of the Fund is based on the share value. The
share value of a mutual fund--known as the NET ASSET VALUE or NAV--is determined
by a simple calculation: it's the total value of the Fund (assets minus
liabilities) divided by the total number of shares outstanding. For example, if
the value of the investments held by Fund XYZ (minus its liabilities) is $1,000
and there are 100 shares of Fund XYZ owned by shareholders, the price of one
share of the fund--or the NAV--is $10 ($1,000 divided by 100). Portfolio
securities are valued based upon market quotations or, if not readily available,
at fair value as determined in good faith under procedures established by the
Fund's Board. Most national newspapers report the NAVs of most mutual funds,
which allows investors to check the price of mutual funds daily.
We determine the NAV of our shares once each business day at 4:15 p.m. New
York time on days that the New York Stock Exchange (NYSE) is open for trading.
The NYSE is closed on most national holidays and Good Friday. Because the Fund
may invest in foreign securities, its NAV may change on days when you cannot buy
or sell shares. We do not determine the NAV on days when we have not received
any orders to purchase, sell or exchange Fund shares, or when changes in the
value of the Fund's portfolio do not materially affect the NAV.
WHAT PRICE WILL YOU PAY FOR SHARES OF THE FUND?
For Class A and Class C shares, you'll pay the public offering price, which is
the NAV next determined after we receive your order to purchase, plus an initial
sales charge (unless you're entitled to a waiver). For Class B and Class Z
shares, you will pay the NAV next determined after we receive your order to
purchase (remember, there are no up-front sales charges for these share
classes). Your broker may charge you a separate or additional fee for purchases
of shares.
-------------------------------------------------------------------
MUTUAL FUND SHARES
The NAV of mutual fund shares changes every day because the value of a fund's
portfolio changes constantly. For example, if Fund XYZ holds ACME Corp. stock in
its portfolio and the price of ACME stock goes up while the value of the fund's
other holdings remains the same and expenses don't change, the NAV of Fund XYZ
will increase.
-------------------------------------------------------------------
--------------------------------------------------------------------------------
25
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
STEP 4: ADDITIONAL SHAREHOLDER SERVICES
As a Fund shareholder, you can take advantage of the following services and
privileges:
AUTOMATIC REINVESTMENT. As we explained in the "Fund Distributions and Tax
Issues" section, the Fund pays out--or distributes--its net investment income
and capital gains to all shareholders. For your convenience, we will
automatically reinvest your distributions in the Fund at NAV without any sales
charge. If you want your distributions paid in cash, you can indicate this
preference on your application, notify your broker or notify the Transfer Agent
in writing (at the address below) at least five business days before the date we
determine who receives dividends.
PRUDENTIAL MUTUAL FUND SERVICES LLC
ATTN: ACCOUNT MAINTENANCE
P.O. BOX 8159
PHILADELPHIA, PA 19101
AUTOMATIC INVESTMENT PLAN. You can make regular purchases of the Fund for as
little as $50 by having the funds automatically withdrawn from your bank or
brokerage account at specified intervals.
RETIREMENT PLAN SERVICES. Prudential offers a wide variety of retirement plans
for individuals and institutions, including large and small businesses. For
information on IRAs, including Roth IRAs or SEP-IRAs for a one-person business,
please contact your financial adviser. If you are interested in opening a 401(k)
or other company-sponsored retirement plan (SIMPLES, SEP plans, Keoghs,
403(b) plans, pension and profit-sharing plans), your financial adviser will
help you determine which retirement plan best meets your needs. Complete
instructions about how to establish and maintain your plan and how to open
accounts for you and your employees will be included in the retirement plan kit
you receive in the mail.
-------------------------------------------------------------------
26 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
THE PRUTECTOR PROGRAM. Optional group term life insurance--which protects the
value of your Prudential mutual fund investment for your beneficiaries against
market declines--is available to investors who purchase their shares through
Prudential. Eligible investors who apply for PruTector coverage after the
initial 6-month enrollment period will need to provide satisfactory evidence of
insurability. This insurance is subject to other restrictions and is not
available in all states.
SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available that will
provide you with monthly, quarterly, semi-annual or annual redemption checks.
Remember, the sale of Class B and Class C shares may be subject to a CDSC.
REPORTS TO SHAREHOLDERS. Every year we will send you an annual report (along
with an updated prospectus) and a semi-annual report, which contain important
financial information about the Fund. To reduce Fund expenses, we will send one
annual shareholder report, one semi-annual shareholder report and one annual
prospectus per household, unless you instruct us or your broker otherwise.
HOW TO SELL YOUR SHARES
You can sell your shares of the Fund for cash (in the form of a check) at any
time, subject to certain restrictions.
When you sell shares of the Fund--also known as redeeming your shares--the
price you will receive will be the NAV next determined after the Transfer Agent,
the Distributor or your broker receives your order to sell. If your broker holds
your shares, your broker must receive your order to sell by 4:15 p.m. New York
time to process the sale on that day. Otherwise contact:
PRUDENTIAL MUTUAL FUND SERVICES LLC
ATTN: REDEMPTION SERVICES
P.O. BOX 8149
PHILADELPHIA, PA 19101
Generally, we will pay you for the shares that you sell within seven days
after the Transfer Agent, the Distributor or your broker receives your sell
--------------------------------------------------------------------------------
27
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
order. If you hold shares through a broker, payment will be credited to your
account. If you are selling shares you recently purchased with a check, we may
delay sending you the proceeds until your check clears, which can take up to 10
days from the purchase date. You can avoid delay if you purchase shares by wire,
certified check or cashier's check. Your broker may charge you a separate or
additional fee for sales of shares.
RESTRICTIONS ON SALES
There are certain times when you may not be able to sell shares of the Fund, or
when we may delay paying you the proceeds from a sale. As permitted by the
Securities and Exchange Commission, this may happen during unusual market
conditions or emergencies when the Fund can't determine the value of its assets
or sell its holdings. For more information, see the SAI, "Purchase, Redemption
and Pricing of Fund Shares--Sale of Shares."
If you are selling more than $100,000 of shares, you want the redemption
proceeds payable to or sent to someone or some place that is not in our records,
or you are a business or a trust and you hold your shares directly with the
Transfer Agent, you will need to have the signature on your sell order signature
guaranteed by an "eligible guarantor institution." An "eligible guarantor
institution" includes any bank, broker-dealer or credit union. For more
information, see the SAI, "Purchase, Redemption and Pricing of Fund Shares--Sale
of Shares--Signature Guarantee."
CONTINGENT DEFERRED SALES CHARGE (CDSC)
If you sell Class B shares within six years of purchase or Class C shares within
18 months of purchase (one year for Class C shares purchased before November 2,
1998), you will have to pay a CDSC. To keep the CDSC as low as possible, we will
sell amounts representing shares in the following order:
-- Amounts representing shares you purchased with reinvested dividends
and distributions
-- Amounts representing the increase in NAV above the total amount of
payments for shares made during the past six years for Class B shares
and 18 months for Class C shares (one year for Class C shares
purchased before November 2, 1998)
-------------------------------------------------------------------
28 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
-- Amounts representing the cost of shares held beyond the CDSC period
(six years for Class B shares and 18 months for Class C shares).
Since shares that fall into any of the categories listed above are not
subject to the CDSC, selling them first helps you to avoid--or at least
minimize--the CDSC.
Having sold the exempt shares first, if there are any remaining shares that
are subject to the CDSC, we will apply the CDSC to amounts representing the cost
of shares held for the longest period of time within the applicable CDSC period.
As we noted before in the "Share Class Comparison" chart, the CDSC for
Class B shares is 5% in the first year, 4% in the second, 3% in the third, 2% in
the fourth and 1% in the fifth and sixth years. The rate decreases on the first
day of the month following the anniversary date of your purchase, not on the
anniversary date itself. The CDSC is 1% for Class C shares--which is applied to
shares sold within 18 months of purchase (one year for Class C shares purchased
before November 2, 1998). For both Class B and Class C shares, the CDSC is
calculated based on the lesser of the original purchase price or the redemption
proceeds. For purposes of determining how long you've held your shares, all
purchases during the month are grouped together and considered to have been made
on the last day of the month.
The holding period for purposes of determining the applicable CDSC will be
calculated from the first day of the month after initial purchase, excluding any
time shares were held in a money market fund.
WAIVER OF THE CDSC--CLASS B SHARES
The CDSC will be waived if the Class B shares are sold:
-- After a shareholder is deceased or disabled (or, in the case of a
trust account, the death or disability of the grantor). This waiver
applies to individual shareholders, as well as shares held in joint
tenancy, provided the shares were purchased before the death or
disability
-- To provide for certain distributions--made without IRS penalty--from
a tax-deferred retirement plan, IRA or Section 403(b) custodial
account
-- On certain sales effected through a Systematic Withdrawal Plan.
--------------------------------------------------------------------------------
29
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
For more information on the above and other waivers, see the SAI, "Purchase,
Redemption and Pricing of Fund Shares--Waiver of Contingent Deferred Sales
Charge--Class B Shares."
WAIVER OF THE CDSC--CLASS C SHARES
BENEFIT PLANS. The CDSC will be waived for redemptions by certain group
retirement plans for which Prudential or brokers not affiliated with Prudential
provide administrative or recordkeeping services. The CDSC also will be waived
for certain redemptions by benefit plans sponsored by Prudential and its
affiliates. For more information, call Prudential at (800) 353-2847.
REDEMPTION IN KIND
If the sales of Fund shares you make during any 90-day period reach the lesser
of $250,000 or 1% of the value of the Fund's net assets, we can then give you
securities from the Fund's portfolio instead of cash. If you want to sell the
securities for cash, you would have to pay the costs charged by a broker.
SMALL ACCOUNTS
If you make a sale that reduces your account value to less than $500, we may
sell the rest of your shares (without charging any CDSC) and close your account.
We would do this to minimize the Fund's expenses paid by other shareholders. We
will give you 60 days' notice, during which time you can purchase additional
shares to avoid this action. This involuntary sale does not apply to
shareholders who own their shares as part of a 401(k) plan, an IRA or some other
qualified or tax-deferred plan or account.
90-DAY REPURCHASE PRIVILEGE
After you redeem your shares, you have a 90-day period during which you may
reinvest any of the redemption proceeds in shares of the same Fund and account
without paying an initial sales charge. Also, if you paid a CDSC when you
redeemed your shares, we will credit your new account with the appropriate
number of shares to reflect the amount of the CDSC you paid. In order to take
advantage of this one-time privilege, you must notify the Transfer Agent or your
broker at the time of the repurchase. See
-------------------------------------------------------------------
30 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
the SAI, "Purchase, Redemption and Pricing of Fund Shares--Sale of Shares."
RETIREMENT PLANS
To sell shares and receive a distribution from a retirement account, call your
broker or the Transfer Agent for a distribution request form. There are special
distribution and income tax withholding requirements for distributions from
retirement plans and you must submit a withholding form with your request to
avoid delay. If your retirement plan account is held for you by your employer or
plan trustee, you must arrange for the distribution request to be signed and
sent by the plan administrator or trustee. For additional information, see the
SAI.
HOW TO EXCHANGE YOUR SHARES
You can exchange your shares of the Fund for shares of the same class in certain
other Prudential mutual funds--including certain money market funds--if you
satisfy the minimum investment requirements. For example, you can exchange
Class A shares of the Fund for Class A shares of another Prudential mutual fund,
but you can't exchange Class A shares for Class B, Class C or Class Z shares.
Class B and Class C shares may not be exchanged into money market funds other
than Prudential Special Money Market Fund, Inc. After an exchange, at redemption
the CDSC will be calculated from the first day of the month after initial
purchase, excluding any time shares were held in a money market fund. We may
change the terms of the exchange privilege after giving you 60 days' notice.
If you hold shares through a broker, you must exchange shares through your
broker. Otherwise contact:
PRUDENTIAL MUTUAL FUND SERVICES LLC
ATTN: EXCHANGE PROCESSING
P.O. BOX 8157
PHILADELPHIA, PA 19101
There is no sales charge for such exchanges. However, if you exchange--and
then sell--Class B shares within approximately six years of your original
purchase, or Class C shares within 18 months of your original purchase, you must
still pay the applicable CDSC. If you have exchanged
--------------------------------------------------------------------------------
31
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
Class B or Class C shares into a money market fund, the time you hold the shares
in the money market account will not be counted in calculating the required
holding period for CDSC liability.
Remember, as we explained in the section entitled "Fund Distributions and
Tax Issues--If You Sell or Exchange Your Shares," exchanging shares is
considered a sale for tax purposes. Therefore, if the shares you exchange are
worth more than the amount that you paid for them, you may have to pay capital
gains tax. For additional information about exchanging shares, see the SAI,
"Shareholder Investment Account--Exchange Privilege."
If you own Class B or Class C shares and qualify to purchase Class A shares
without paying an initial sales charge, we will automatically exchange your
Class B or Class C shares which are not subject to a CDSC for Class A shares. We
make such exchanges on a quarterly basis if you qualify for this exchange
privilege. We have obtained a legal opinion that this exchange is not a "taxable
event" for federal income tax purposes. This opinion is not binding on the IRS.
FREQUENT TRADING
Frequent trading of Fund shares in response to short-term fluctuations in the
market--also known as "market timing"--may make it very difficult to manage the
Fund's investments. When market timing occurs, the Fund may have to sell
portfolio securities to have the cash necessary to redeem the market timer's
shares. This can happen at a time when it is not advantageous to sell any
securities, so the Fund's performance may be hurt. When large dollar amounts are
involved, market timing can also make it difficult to use long-term investment
strategies because we cannot predict how much cash the Fund will have to invest.
When, in our opinion, such activity would have a disruptive effect on portfolio
management, the Fund reserves the right to refuse purchase orders and exchanges
into the Fund by any person, group or commonly controlled account. The decision
may be based upon dollar amount, volume and frequency of trading. The Fund may
notify a market timer of rejection of an exchange or purchase order after the
day the order is placed. If the Fund allows a market timer to trade Fund shares,
it may require the market timer to enter into a written agreement to follow
certain procedures and limitations.
-------------------------------------------------------------------
32 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
HOW TO BUY, SELL AND
EXCHANGE SHARES OF THE FUND
------------------------------------------------
TELEPHONE REDEMPTIONS OR EXCHANGES
You may redeem or exchange your shares in any amount by calling the Fund at
(800) 225-1852. In order to redeem or exchange your shares by telephone, you
must call the Fund before 4:15 p.m. New York time. You will receive a redemption
or exchange amount based on that day's NAV.
The Fund's Transfer Agent will record your telephone instructions and
request specific account information before redeeming or exchanging shares. The
Fund will not be liable if it follows instructions that it reasonably believes
are made by the shareholder. If the Fund does not follow reasonable procedures,
it may be liable for losses due to unauthorized or fraudulent telephone
instructions.
In the event of drastic economic or market changes, you may have difficulty
in redeeming or exchanging your shares by telephone. If this occurs, you should
consider redeeming or exchanging your shares by mail or through your broker.
The telephone redemption or exchange privilege may be modified or terminated
at any time. If this occurs, you will receive a written notice from the Fund.
--------------------------------------------------------------------------------
33
<PAGE>
FINANCIAL HIGHLIGHTS
-------------------------------------
The financial highlights will help you evaluate the Fund's financial performance
for the past five years. The TOTAL RETURN in each chart represents the rate that
a shareholder earned on an investment in that share class of the Fund, assuming
reinvestment of all dividends and other distributions. The information is for
each share class for the periods indicated.
Review each chart with the financial statements and report of independent
accountants which appear in the annual report and the SAI and are available upon
request. Additional performance information for each share class is contained in
the annual report, which you can receive at no charge.
CLASS A SHARES
The financial highlights were audited by PricewaterhouseCoopers LLP, independent
accountants, whose report was unqualified.
CLASS A SHARES (FISCAL YEARS ENDED 9-30)
<TABLE>
<CAPTION>
PER SHARE OPERATING
PERFORMANCE 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $12.54 $13.79 $18.95 $15.30 $14.18
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) .01 (.01) -- .02 .04
Net realized and unrealized gain
(loss) on investment transactions 1.97 .29 (3.31) 6.06 1.75
TOTAL FROM INVESTMENT OPERATIONS 1.98 .28 (3.31) 6.08 1.79
-----------------------------------------------------------------
LESS DISTRIBUTIONS:
Distributions from net realized
gains -- (1.53) (1.85) (2.43) (.67)
NET ASSET VALUE, END OF YEAR $14.52 $12.54 $13.79 $18.95 $15.30
TOTAL RETURN(2) 15.70% 1.48% (18.90)% 45.92% 13.38%
-----------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
-----------------------------------------------------------------
NET ASSETS, END OF YEAR (000) $291,869 $319,779 $365,431 $412,980 $237,306
Average net assets (000) $284,681 $360,707 $443,189 $287,894 $223,091
RATIOS TO AVERAGE NET ASSETS:
Expenses, including distribution
and service (12b-1) fees(3) 1.37% 1.27% 1.17% 1.21% 1.24%
Expenses, excluding distribution
and service (12b-1) fees 1.12% 1.02% .92% .96% .99%
Net investment income (loss) .04% (.09)% -- .15% .33%
Portfolio turnover 92% 39% 36% 58% 53%
</TABLE>
1 CALCULATED BASED ON AVERAGE SHARES OUTSTANDING DURING THE YEAR.
2 TOTAL RETURN DOES NOT CONSIDER THE EFFECTS OF SALES LOADS. TOTAL RETURN IS
CALCULATED ASSUMING A PURCHASE OF SHARES ON THE FIRST DAY AND A SALE ON THE
LAST DAY OF EACH YEAR REPORTED AND INCLUDES REINVESTMENT OF DIVIDENDS AND
DISTRIBUTIONS.
3 THE DISTRIBUTOR OF THE FUND AGREED TO LIMIT ITS DISTRIBUTION FEES TO .25 OF
1% OF THE AVERAGE DAILY NET ASSETS OF THE CLASS A SHARES.
-------------------------------------------------------------------
34 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
FINANCIAL HIGHLIGHTS
------------------------------------------------
CLASS B SHARES
The financial highlights were audited by PricewaterhouseCoopers LLP, independent
accountants, whose report was unqualified.
CLASS B SHARES (FISCAL YEARS ENDED 9-30)
<TABLE>
<CAPTION>
PER SHARE OPERATING
PERFORMANCE 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $11.28 $12.63 $17.64 $14.49 $13.56
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (.08) (.10) (.12) (.09) (.06)
Net realized and unrealized gain
(loss) on investment transactions 1.77 .28 (3.04) 5.67 1.66
TOTAL FROM INVESTMENT OPERATIONS 1.69 .18 (3.16) 5.58 1.60
-------------------------------------------------------------------
LESS DISTRIBUTIONS:
Distributions from net realized
gains -- (1.53) (1.85) (2.43) (.67)
NET ASSET VALUE, END OF YEAR $12.97 $11.28 $12.63 $17.64 $14.49
TOTAL RETURN(2) 14.88% .74% (19.52)% 44.91% 12.56%
-------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
-------------------------------------------------------------------
NET ASSETS, END OF YEAR (000) $199,149 $335,013 $514,159 $645,579 $378,861
Average net assets (000) $250,061 $444,747 $678,462 $443,761 $355,636
RATIOS TO AVERAGE NET ASSETS:
Expenses, including distribution
and service (12b-1) fees 2.12% 2.02% 1.92% 1.96% 1.99%
Expenses, excluding distribution
and service (12b-1) fees 1.12% 1.02% .92% .96% .99%
Net investment loss (.69)% (.82)% (.75)% (.60)% (.42)%
Portfolio turnover 92% 39% 36% 58% 53%
</TABLE>
1 CALCULATED BASED ON AVERAGE SHARES OUTSTANDING DURING THE YEAR.
2 TOTAL RETURN DOES NOT CONSIDER THE EFFECTS OF SALES LOADS. TOTAL RETURN IS
CALCULATED ASSUMING A PURCHASE OF SHARES ON THE FIRST DAY AND A SALE ON THE
LAST DAY OF EACH YEAR REPORTED AND INCLUDES REINVESTMENT OF DIVIDENDS AND
DISTRIBUTIONS.
--------------------------------------------------------------------------------
35
<PAGE>
FINANCIAL HIGHLIGHTS
------------------------------------------------
CLASS C SHARES
The financial highlights were audited by PricewaterhouseCoopers LLP, independent
accountants, whose report was unqualified.
CLASS C SHARES (FISCAL YEARS ENDED 9-30)
<TABLE>
<CAPTION>
PER SHARE OPERATING
PERFORMANCE 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $11.28 $12.63 $17.64 $14.49 $13.56
INCOME FROM INVESTMENT OPERATIONS:
Net investment loss (.08) (.10) (.12) (.09) (.06)
Net realized and unrealized gain
(loss) on investment transactions 1.77 .28 (3.04) 5.67 1.66
TOTAL FROM INVESTMENT OPERATIONS 1.69 .18 (3.16) 5.58 1.60
------------------------------------------------------------------
LESS DISTRIBUTIONS:
Distributions from net realized
gains -- (1.53) (1.85) (2.43) (.67)
NET ASSET VALUE, END OF YEAR $12.97 $11.28 $12.63 $17.64 $14.49
TOTAL RETURN(2) 14.88% .74% (19.52)% 44.91% 12.56%
------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA 2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
------------------------------------------------------------------
NET ASSETS, END OF YEAR (000) $19,236 $25,207 $26,804 $22,049 $4,323
Average net assets (000) $20,159 $27,813 $29,259 $8,762 $2,786
RATIOS TO AVERAGE NET ASSETS:
Expenses, including distribution
and service (12b-1) fees 2.12% 2.02% 1.92% 1.96% 1.99%
Expenses, excluding distribution
and service (12b-1) fees 1.12% 1.02% .92% .96% .99%
Net investment loss (.70)% (.83)% (.75)% (.60)% (.42)%
Portfolio turnover 92% 39% 36% 58% 53%
</TABLE>
1 CALCULATED BASED ON AVERAGE SHARES OUTSTANDING DURING THE YEAR.
2 TOTAL RETURN DOES NOT CONSIDER THE EFFECTS OF SALES LOADS. TOTAL RETURN IS
CALCULATED ASSUMING A PURCHASE OF SHARES ON THE FIRST DAY AND A SALE ON THE
LAST DAY OF EACH YEAR REPORTED AND INCLUDES REINVESTMENT OF DIVIDENDS AND
DISTRIBUTIONS.
-------------------------------------------------------------------
36 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
FINANCIAL HIGHLIGHTS
------------------------------------------------
CLASS Z SHARES
The financial highlights were audited by PricewaterhouseCoopers LLP, independent
accountants, whose report was unqualified.
CLASS Z SHARES (FISCAL PERIODS ENDED 9-30)
<TABLE>
<CAPTION>
PER SHARE OPERATING
PERFORMANCE 2000(2) 1999(2) 1998(2) 1997(2) 1996(1),(2)
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF
PERIOD $12.70 $13.92 $19.04 $15.32 $13.69
INCOME FROM INVESTMENT OPERATIONS:
Net investment income .04 .02 .04 .06 .05
Net realized and unrealized gain
(loss) on investment transactions 2.00 .29 (3.31) 6.09 1.58
TOTAL FROM INVESTMENT OPERATIONS 2.04 .31 (3.27) 6.15 1.63
-----------------------------------------------------------------
LESS DISTRIBUTIONS:
Distributions from net realized
gains -- (1.53) (1.85) (2.43) --
NET ASSET VALUE, END OF PERIOD $14.74 $12.70 $13.92 $19.04 $15.32
TOTAL RETURN(3) 15.97% 1.70% (18.58)% 46.38% 11.91%
-----------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA 2000(2) 1999(2) 1998(2) 1997(2) 1996(1),(2)
-----------------------------------------------------------------
NET ASSETS, END OF PERIOD (000) $105,656 $105,355 $125,770 $151,215 $68,516
Average net assets (000) $98,623 $131,013 $154,623 $97,310 $66,228
RATIOS TO AVERAGE NET ASSETS:
Expenses 1.12% 1.02% .92% .96% .99%(4)
Net investment income .29% .16% .25% .40% .58%(4)
Portfolio turnover 92% 39% 36% 58% 53%
</TABLE>
1 INFORMATION SHOWN IS FOR THE PERIOD 3-1-96 (WHEN CLASS Z SHARES WERE FIRST
OFFERED) THROUGH 9-30-96.
2 CALCULATED BASED ON AVERAGE SHARES OUTSTANDING DURING THE PERIOD.
3 TOTAL RETURN DOES NOT CONSIDER THE EFFECTS OF SALES LOADS. TOTAL RETURN IS
CALCULATED ASSUMING A PURCHASE OF SHARES ON THE FIRST DAY AND A SALE ON THE
LAST DAY OF EACH YEAR REPORTED AND INCLUDES REINVESTMENT OF DIVIDENDS AND
DISTRIBUTIONS.
4 ANNUALIZED.
--------------------------------------------------------------------------------
37
<PAGE>
THE PRUDENTIAL MUTUAL FUND FAMILY
-------------------------------------
Prudential offers a broad range of mutual funds designed to meet your individual
needs. For information about these funds, contact your financial adviser or call
us at (800) 225-1852. Please read the prospectus carefully before you invest or
send money.
STOCK FUNDS
PRUDENTIAL EQUITY FUND, INC.
PRUDENTIAL INDEX SERIES FUND
PRUDENTIAL STOCK INDEX FUND
PRUDENTIAL REAL ESTATE SECURITIES FUND
PRUDENTIAL SECTOR FUNDS, INC.
PRUDENTIAL FINANCIAL SERVICES FUND
PRUDENTIAL HEALTH SCIENCES FUND
PRUDENTIAL TECHNOLOGY FUND
PRUDENTIAL UTILITY FUND
PRUDENTIAL SMALL COMPANY FUND, INC.
PRUDENTIAL TAX-MANAGED FUNDS
PRUDENTIAL TAX-MANAGED EQUITY FUND
PRUDENTIAL TAX-MANAGED SMALL-CAP FUND, INC.
PRUDENTIAL 20/20 FOCUS FUND
PRUDENTIAL U.S. EMERGING GROWTH FUND, INC.
PRUDENTIAL VALUE FUND
THE PRUDENTIAL INVESTMENT PORTFOLIOS, INC.
PRUDENTIAL JENNISON EQUITY OPPORTUNITY FUND
PRUDENTIAL JENNISON GROWTH FUND
NICHOLAS-APPLEGATE FUND, INC.
NICHOLAS-APPLEGATE GROWTH EQUITY FUND
TARGET FUNDS
LARGE CAPITALIZATION GROWTH FUND
LARGE CAPITALIZATION VALUE FUND
SMALL CAPITALIZATION GROWTH FUND
SMALL CAPITALIZATION VALUE FUND
ASSET ALLOCATION/BALANCED FUNDS
PRUDENTIAL DIVERSIFIED FUNDS
CONSERVATIVE GROWTH FUND
MODERATE GROWTH FUND
HIGH GROWTH FUND
THE PRUDENTIAL INVESTMENT PORTFOLIOS, INC.
PRUDENTIAL ACTIVE BALANCED FUND
GLOBAL FUNDS
GLOBAL STOCK FUNDS
PRUDENTIAL EUROPE GROWTH FUND, INC.
PRUDENTIAL NATURAL RESOURCES FUND, INC.
PRUDENTIAL PACIFIC GROWTH FUND, INC.
PRUDENTIAL WORLD FUND, INC.
PRUDENTIAL GLOBAL GROWTH FUND
PRUDENTIAL INTERNATIONAL VALUE FUND
PRUDENTIAL JENNISON INTERNATIONAL GROWTH FUND
GLOBAL UTILITY FUND, INC.
TARGET FUNDS
INTERNATIONAL EQUITY FUND
GLOBAL BOND FUND
PRUDENTIAL GLOBAL TOTAL RETURN FUND, INC.
-------------------------------------------------------------------
38 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
BOND FUNDS
TAXABLE BOND FUNDS
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
PRUDENTIAL HIGH YIELD FUND, INC.
PRUDENTIAL HIGH YIELD TOTAL RETURN FUND, INC.
PRUDENTIAL SHORT-TERM CORPORATE BOND FUND, INC.
INCOME PORTFOLIO
PRUDENTIAL TOTAL RETURN BOND FUND, INC.
TARGET FUNDS
TOTAL RETURN BOND FUND
TAX-EXEMPT BOND FUNDS
PRUDENTIAL CALIFORNIA MUNICIPAL FUND
CALIFORNIA SERIES
CALIFORNIA INCOME SERIES
PRUDENTIAL MUNICIPAL BOND FUND
HIGH INCOME SERIES
INSURED SERIES
PRUDENTIAL MUNICIPAL SERIES FUND
FLORIDA SERIES
NEW JERSEY SERIES
NEW YORK SERIES
PENNSYLVANIA SERIES
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
MONEY MARKET FUNDS
TAXABLE MONEY MARKET FUNDS
CASH ACCUMULATION TRUST
LIQUID ASSETS FUND
NATIONAL MONEY MARKET FUND
PRUDENTIAL GOVERNMENT SECURITIES TRUST
MONEY MARKET SERIES
U.S. TREASURY MONEY MARKET SERIES
PRUDENTIAL MONEYMART ASSETS, INC.
PRUDENTIAL SPECIAL MONEY MARKET FUND, INC.
MONEY MARKET SERIES
TAX-FREE MONEY MARKET FUNDS
PRUDENTIAL CALIFORNIA MUNICIPAL FUND
CALIFORNIA MONEY MARKET SERIES
PRUDENTIAL MUNICIPAL SERIES FUND
NEW JERSEY MONEY MARKET SERIES
NEW YORK MONEY MARKET SERIES
PRUDENTIAL TAX-FREE MONEY FUND, INC.
COMMAND FUNDS
COMMAND GOVERNMENT FUND
COMMAND MONEY FUND
COMMAND TAX-FREE FUND
INSTITUTIONAL MONEY MARKET FUND
PRUDENTIAL INSTITUTIONAL LIQUIDITY PORTFOLIO, INC.
INSTITUTIONAL MONEY MARKET SERIES
--------------------------------------------------------------------------------
39
<PAGE>
Notes
-------------------------------------------------------------------
40 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
Notes
--------------------------------------------------------------------------------
41
<PAGE>
Notes
-------------------------------------------------------------------
42 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
Notes
--------------------------------------------------------------------------------
43
<PAGE>
Notes
-------------------------------------------------------------------
44 PRUDENTIAL SMALL COMPANY FUND, INC. [LOGO] (800) 225-1852
<PAGE>
Notes
--------------------------------------------------------------------------------
45
<PAGE>
FOR MORE INFORMATION
Please read this prospectus before you invest in the Fund and keep it for future
reference. For information or shareholder questions contact
PRUDENTIAL MUTUAL FUND SERVICES LLC
P.O. BOX 8098
PHILADELPHIA, PA 19101
(800) 225-1852
(732) 482-7555 (Calling from outside the U.S.)
Outside Brokers should contact
PRUDENTIAL INVESTMENT MANAGEMENT
SERVICES LLC
P.O. BOX 8310
PHILADELPHIA, PA 19101
(800) 778-8769
Visit Prudential's website at
http://www.prudential.com
Additional information about the Fund can
be obtained without charge and can be
found in the following documents
STATEMENT OF ADDITIONAL INFORMATION (SAI)
(incorporated by reference into this prospectus)
ANNUAL REPORT
(contains a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance)
SEMI-ANNUAL REPORT
You can also obtain copies of Fund documents from the Securities and Exchange
Commission as follows
BY MAIL
Securities and Exchange Commission
Public Reference Section
Washington, DC 20549-0102
BY ELECTRONIC REQUEST
[email protected]
(The SEC charges a fee to copy documents.)
IN PERSON
Public Reference Room in Washington, DC
(For hours of operation, call
1-202-942-8090)
VIA THE INTERNET
on the EDGAR Database at
http://www.sec.gov
CUSIP Numbers NASDAQ Symbols
Class A 743968-10-9 PGOAX
Class B 743968-20-8 CHNDX
Class C 743968-30-7 PSCCX
Class Z 743968-40-6 PSCZX
Investment Company Act File No. 811-3084
MF109A
[RECYCLED LOGO]
Printed on Recycled Paper
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 1, 2000
Prudential Small Company Fund, Inc., formerly known as Prudential Small
Company Value Fund, Inc. (the Fund), is an open-end, diversified, management
investment company whose objective is capital growth. The Fund intends to invest
primarily in a carefully selected portfolio of common stocks, generally stocks
of small, less well known U.S. companies that typically have above average
growth prospects and valuations which, in the investment adviser's view, are
temporarily low relative to the companies' earnings, assets, cash flow,
price/book value and market value. The Fund's purchase and sale of put and call
options and related short-term trading may be considered speculative and may
result in higher risks and costs to the Fund. The Fund also may buy and sell
options on stocks, stock indexes and foreign currencies, foreign currency
forward contracts and futures contracts on stock indexes and foreign currencies
and options thereon in accordance with the limits described herein. There can be
no assurance that the Fund's investment objective will be achieved. See
"Description of the Fund, Its Investments and Risks."
The Fund's address is Gateway Center Three, 100 Mulberry Street, Newark, New
Jersey 07102-4077, and its telephone number is (800) 225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus, dated December 1, 2000. A copy
of the Prospectus may be obtained from the Fund upon request.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fund History.......................................... B-2
Description of the Fund, Its Investments and Risks.... B-2
Investment Restrictions............................... B-14
Management of the Fund................................ B-15
Control Persons and Principal Holders of Securities... B-18
Investment Advisory and Other Services................ B-19
Brokerage Allocation and Other Practices.............. B-23
Capital Shares, Other Securities and Organization..... B-25
Purchase, Redemption and Pricing of Fund Shares....... B-26
Shareholder Investment Account........................ B-35
Net Asset Value....................................... B-39
Performance Information............................... B-41
Taxes, Dividends and Distributions.................... B-43
Financial Statements.................................. B-47
Report of Independent Accountants..................... B-72
Appendix I -- General Investment Information.......... I-1
Appendix II -- Historical Performance Data............ II-1
</TABLE>
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MF109B
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FUND HISTORY
The Fund was established as a Maryland corporation on July 28, 1980. By an
amendment to the Fund's Articles of Incorporation filed with the Maryland
Secretary of State on June 10, 1996, the Fund's name was changed from Prudential
Growth Opportunity Fund, Inc. (originally, the Fund's name was Prudential-Bache
Growth Opportunity Fund, Inc.), to Prudential Small Companies Fund, Inc.
Effective May 30, 1997, the Fund's name was changed from Prudential Small
Companies Fund, Inc. to Prudential Small Company Value Fund, Inc. The Fund's
name was changed from Prudential Small Company Value Fund, Inc. to Prudential
Small Company Fund, Inc. effective May 30, 2000.
DESCRIPTION OF THE FUND, ITS INVESTMENTS AND RISKS
CLASSIFICATION. The Fund is an open-end, diversified, management investment
company.
INVESTMENT STRATEGIES, POLICIES AND RISKS. The Fund's investment objective
is capital growth. It attempts to achieve that objective by investing primarily
in a carefully selected portfolio of common stocks generally of small, less well
known U.S. companies that typically have above average growth prospects and
valuations which, in the Subadviser's view, are temporarily low relative to the
companies' earnings, assets, cash flow, price/book value and private market
value. This section describes the Fund's principal and non-principal investment
strategies and risks.
The Fund generally invests in common stocks of small companies, that is,
those with a market capitalization less than the largest market capitalization
found in the Standard & Poor's 600 SmallCap Index. Market capitalization is
measured at the time of initial purchase. The Fund may, however, invest in the
securities of any issuer without regard to its size or the market capitalization
of its common stock. Companies in which the Fund is likely to invest may have
limited product lines, markets or financial resources and may lack management
depth. The securities of these companies may have limited marketability and may
be subject to more abrupt or erratic market movements than securities of larger,
more established companies or the market averages in general. Investment income
is of incidental importance, and the Fund may invest in securities that do not
produce any income. There can be no assurance that the Fund's investment
objective will be achieved.
The Subadviser believes that, in seeking to attain capital appreciation, it
is important to attempt to minimize losses. Accordingly, the Subadviser will
attempt to anticipate periods when stock prices generally decline. When, in the
Subadviser's judgment, such a period is imminent, the Fund will take defensive
measures, such as investing all or part of the Fund's assets in money market
instruments during this period. The Fund may also engage in various derivative
transactions, such as the purchase and sale of options on stocks, stock indexes
and foreign currencies, the purchase and sale of foreign currency forward
contracts and futures contracts on stock indexes and foreign currencies and
options thereon to hedge its portfolio and to attempt to enhance return.
EQUITY-RELATED SECURITIES
The equity-related securities in which the Fund may invest include common
stocks, preferred stocks, securities convertible or exchangeable for common
stocks or preferred stocks, equity investments in partnerships, joint ventures,
other forms of non-corporate investments, American Depositary Receipts (ADRs),
American Depositary Shares (ADSs) and warrants and rights exercisable for equity
securities.
CONVERTIBLE SECURITIES. The Fund may invest in preferred stocks or debt
securities that either have warrants attached or are otherwise convertible into
common stocks. A convertible security is typically a corporate bond (or
preferred stock) that may be converted at a stated price within a specified
period of time into a specified number of shares of common stock of the same or
a different issuer. Convertible securities generally are senior to common stocks
in a corporation's capital structure but usually are subordinated to similar
non-convertible securities. While providing a fixed income stream (generally
higher in yield than the income derivable from a common stock but lower than
that afforded by a similar non-convertible security), a convertible security
also affords an investor the opportunity, through its conversion feature, to
participate in capital appreciation dependent upon a market price advance in the
convertible security's underlying common stock. Convertible securities also
include preferred stock, which is technically an equity security.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying common stock). A convertible security tends to increase in market
value when interest rates decline and tends to decrease in value when interest
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rates rise. However, the price of a convertible security also is influenced by
the market value of the security's underlying common stock. The price of a
convertible security tends to increase as the market value of the underlying
stock rises, whereas it tends to decrease as the market value of the underlying
stock declines. While no securities investment is without some risk, investments
in convertible securities generally entail less risk than investments in the
common stock of the same issuer.
AMERICAN DEPOSITARY RECEIPTS AND AMERICAN DEPOSITARY SHARES. ADRs and ADSs
are U.S. dollar-denominated certificates or shares issued by a United States
bank or trust company and represent the right to receive securities of a foreign
issuer deposited in a domestic bank or foreign branch of a United States bank
and traded on a United States exchange or in the over-the-counter market.
Generally, ADRs and ADSs are in registered form. There are no fees imposed on
the purchase or sale of ADRs and ADSs when purchased from the issuing bank or
trust company in the initial underwriting, although the issuing bank or trust
company may impose charges for the collection of dividends and the conversion of
ADRs and ADSs into the underlying securities. Investment in ADRs and ADSs has
certain advantages over direct investment in the underlying foreign securities
since: (1) ADRs and ADSs are denominated in U.S. dollars, registered
domestically, easily transferable, and market quotations are readily available
for them; and (2) issuers whose securities are represented by ADRs and ADSs
usually are subject to auditing, accounting, and financial reporting standards
comparable to those of domestic issuers.
WARRANTS AND RIGHTS. A warrant gives its holder the right to subscribe by a
specified date to a stated number of shares of stock of the issuer at a fixed
price. Warrants tend to be more volatile than the underlying stock, and if, at a
warrant's expiration date the stock is trading at a price below the price set in
the warrant, the warrant will expire worthless. Conversely, if at the expiration
date, the underlying stock is trading at a price higher than the price set in
the warrant, the Fund can acquire the stock at a price below its market value.
Rights are similar to warrants but normally have a shorter duration and are
distributed directly by the issuer to shareholders. Rights and warrants have no
voting rights, receive no dividends and have no rights with respect to the
corporation issuing them.
REAL ESTATE INVESTMENT TRUSTS. The Fund may invest in securities of real
estate investment trusts or REITs. Unlike corporations, REITs do not have to pay
income taxes if they meet certain requirements of the Internal Revenue Code of
1986, as amended (Internal Revenue Code). To qualify, a REIT must distribute at
least 95% of its taxable income to its shareholders and receive at least 75% of
that income from rents, mortgages and sales of property. REITs offer investors
greater liquidity and diversification than direct ownership of a handful of
properties, as well as greater income potential than an investment in common
stocks. Like any investment in real estate, though, a REIT's performance depends
on several factors, such as its ability to find tenants for its properties, to
renew leases and to finance property purchases and renovations.
FOREIGN SECURITIES
The Fund may invest up to 15% of its total assets in foreign equity and debt
securities. For purposes of this limitation, ADRs and ADSs are not deemed to be
foreign securities. In many instances, foreign securities may provide higher
yields but may be subject to greater fluctuations in price than securities of
domestic issuers which have similar maturities or quality.
Investing in securities of foreign companies and countries involves certain
considerations and risks that are not typically associated with investing in
U.S. government securities and securities of domestic companies. There may be
less publicly available information about a foreign issuer than a domestic one,
and foreign companies are not generally subject to uniform accounting, auditing
and financial standards and requirements comparable to those applicable to U.S.
companies. There may also be less government supervision and regulation of
foreign securities exchanges, brokers and listed companies than exists in the
United States. Interest and dividends paid by foreign issuers may be subject to
withholding and other foreign taxes, which may decrease the net return on such
investments as compared to dividends and interest paid to the Fund by domestic
companies or the U.S. government. There may be the possibility of
expropriations, seizure or nationalization of foreign deposits, confiscatory
taxation, political, economic or social instability or diplomatic developments
that could affect assets of the Fund held in foreign countries. Finally, the
establishment of exchange controls or other foreign governmental laws or
restrictions could adversely affect the payment of obligations.
To the extent the Fund's currency exchange transactions do not fully protect
the Fund against adverse changes in currency exchange rates, decreases in the
value of currencies of the foreign countries in which the Fund will invest
relative to the U.S. dollar will result in a corresponding decrease in the U.S.
dollar value of the Fund's assets denominated in those currencies (and possibly
a corresponding increase in the amount of securities required to be liquidated
to meet distribution requirements).
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Conversely, increases in the value of currencies of the foreign countries in
which the Fund invests relative to the U.S. dollar will result in a
corresponding increase in the U.S. dollar value of the Fund's assets (and
possibly a corresponding decrease in the amount of securities to be liquidated).
There may be less publicly available information about foreign companies and
governments compared to reports and ratings published about U.S. companies.
Foreign securities markets have substantially less volume than the New York
Stock Exchange and securities of some foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. Brokerage commissions and
other transaction costs on foreign securities exchanges are generally higher
than in the United States.
RISK FACTORS AND SPECIAL CONSIDERATIONS OF INVESTING IN EURO-DENOMINATED
SECURITIES
On January 1, 1999, 11 of the 15 member states of the European Monetary
Union introduced the "euro" as a common currency. During a three-year
transitional period, the euro will coexist with each member state's national
currency. By July 1, 2002, the euro is expected to become the sole legal tender
of the member states. During the transition period, the Fund will treat the euro
as a separate currency from the national currency of any member state.
The adoption by the member states of the euro will eliminate the substantial
currency risk among member states and will likely affect the investment process
and considerations of the Fund's investment adviser. To the extent the Fund
holds non-U.S. dollar-denominated securities, including those denominated in the
euro, the Fund will still be subject to currency risk due to fluctuations in
those currencies as compared to the U.S. dollar.
The medium- to long-term impact of the introduction of the euro in member
states cannot be determined with certainty at this time. In addition to the
effects described above, it is likely that more general long-term ramifications
can be expected, such as changes in economic environment and changes in behavior
of investors, all of which will impact the Fund's investments.
RISK MANAGEMENT AND RETURN ENHANCEMENT STRATEGIES
The Fund also may engage in various portfolio strategies, including using
derivatives, to seek to reduce certain risks of its investments and to attempt
to enhance return but not for speculation. These strategies currently include
the use of options on stocks, stock indexes and foreign currencies. The Fund
also may purchase futures contracts on foreign currencies and stock indexes and
options thereon. The Fund's ability to use these strategies may be limited by
various factors, such as market conditions, regulatory limits and tax
considerations and there can be no assurance that any of these strategies will
succeed. The Fund, and thus its investors, may lose money through any
unsuccessful use of these strategies. If new financial products and risk
management techniques are developed, the Fund may use them to the extent
consistent with its investment objective and policies.
LIMITATIONS ON PURCHASE AND SALE OF STOCK OPTIONS, OPTIONS ON STOCK INDEXES AND
STOCK INDEX FUTURES
CALL OPTIONS ON STOCK. The Fund may, from time to time, write (that is,
sell) call options on its portfolio securities. The Fund may only write call
options which are "covered," meaning that the Fund (1) owns an offsetting
position in the underlying security or (2) segregates cash or other liquid
assets in an amount equal to or greater than its obligation under the option.
Under the first circumstance, the Fund's losses are limited because it owns the
underlying position; under the second circumstance, in the case of a written
call option, the Fund's losses are potentially unlimited. There is no limitation
on the amount of call options the Fund may write. In addition, the Fund will not
permit the call to become uncovered prior to the expiration of the option or
termination through a closing purchase transaction as described below. The Fund
may write put and call options to generate additional income through the receipt
of premiums, purchase put options in an effort to protect the value of
securities that it owns against a decline in market value and purchase call
options in an effort to protect against an increase in the price of securities
(or currencies) it intends to purchase. The Fund may also purchase put and call
options to offset previously written put and call options of the same series.
A call option on equity securities gives the purchaser, in exchange for a
premium paid, the right for a specified period of time to purchase the
securities subject to the option at a specified price (the "exercise price" or
"strike price"). The writer of a call option, in return for the premium, has the
obligation, upon exercise of the option, to deliver, depending upon the terms of
the option contract, the underlying securities to the purchaser upon receipt of
the exercise price. The Fund's obligation to deliver the
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underlying security against payment of the exercise price would terminate either
upon expiration of the option or earlier if the Fund were to effect a "closing
purchase transaction" through the purchase of an equivalent option on an
exchange. There can be no assurance that a closing purchase transaction can be
effected.
In order to write a call option on an exchange, the Fund is required to
comply with the rules of The Options Clearing Corporation and the various
exchanges with respect to collateral requirements. The Fund may not purchase
call options except in connection with a closing purchase transaction. It is
possible that the cost of effecting a closing purchase transaction may be
greater than the premium received by the Fund for writing the option.
Generally, the Subadviser intends to write listed covered call options
during periods when it anticipates declines in the market values of portfolio
securities because the premiums received may offset to some extent the decline
in the Fund's net asset value (NAV) occasioned by such declines in market value.
Except as part of the "sell discipline" described below, the Subadviser will
generally not write listed covered call options when it anticipates that the
market values of the Fund's portfolio securities will increase.
One reason for the Fund to write call options is as part of a "sell
discipline." If the Subadviser decides that a portfolio security would be
overvalued and should be sold at a certain price higher than the current price,
the Fund could write an option on the stock at the higher price. Should the
stock subsequently reach that price and the option be exercised, the Fund would,
in effect, have increased the selling price of that stock, which it would have
sold at that price in any event, by the amount of the premium. In the event the
market price of the stock declined and the option were not exercised, the
premium would offset all or some portion of the decline. It is possible that the
price of the stock could increase beyond the exercise price; in that event, the
Fund would forego the opportunity to sell the stock at that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
Subadviser, the market price of a stock is overvalued and it should be sold, the
Fund may elect to write a call option with an exercise price substantially below
the current market price. As long as the value of the underlying security
remains above the exercise price during the term of the option, the option will,
in all probability, be exercised, in which case the Fund will be required to
sell the stock at the exercise price. If the sum of the premium and the exercise
price exceeds the market price of the stock at the time the call option is
written, the Fund would, in effect, have increased the selling price of the
stock. The Fund would not write a call option in these circumstances if the sum
of the premium and the exercise price were less than the current market price of
the stock.
PUT OPTIONS ON STOCK. The Fund also may write listed put options. A put
option on equity securities gives the purchaser, in return for a premium, the
right, for a specified period of time, to sell the securities subject to the
option to the writer of the put at the specified exercise price. The writer of
the put option, in return for the premium, has the obligation, upon exercise of
the option, to acquire the securities underlying the option at the exercise
price. The Fund as the writer of a put option might, therefore, be obligated to
purchase underlying securities for more than their current market price.
Writing listed put options is a useful portfolio investment strategy when
the Fund has cash or other reserves available for investment as a result of
sales of Fund shares or, more importantly, because the Subadviser believes a
more defensive and less fully invested position is desirable in light of market
conditions. If the Fund wishes to invest its cash or reserves in a particular
security at a price lower than current market value, it may write a put option
on that security at an exercise price which reflects the lower price it is
willing to pay. The buyer of the put option generally will not exercise the
option unless the market price of the underlying security declines to a price
near or below the exercise price. If the Fund writes a listed put, the price of
the underlying stock declines and the option is exercised, the premium, net of
transaction charges, will reduce the purchase price paid by the Fund for the
stock. The price of the stock may decline by an amount in excess of the premium,
in which event the Fund would have foregone an opportunity to purchase the stock
at a lower price.
If, prior to the exercise of a put option, the Subadviser determines that it
no longer wishes to invest in the stock on which the put option had been
written, the Fund may be able to effect a closing purchase transaction on an
exchange by purchasing a put option of the same series as the one which it has
previously written. The cost of effecting a closing purchase transaction may be
greater than the premium received on writing the put option and there is no
guarantee that a closing purchase transaction can be effected.
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At the time a put option is written, the Fund will be required to segregate
until the put is exercised or has expired, with its custodian, State Street Bank
and Trust Company (the Custodian), cash or other liquid assets, marked-to-market
daily, equal in value to the amount the Fund will be obligated to pay upon
exercise of the put option.
STOCK INDEX OPTIONS. Except as described below, the Fund will write call
options on indexes only if on such date it holds a portfolio of stocks at least
equal to the value of the index times the multiplier times the number of
contracts. When the Fund writes a call option on a broadly-based stock market
index, the Fund will segregate or pledge to a broker as collateral for the
option, cash or other liquid assets, marked-to-market daily, with a market value
at the time the option is written of not less than 100% of the current index
value times the multiplier times the number of contracts.
If the Fund has written an option on an industry or market segment index, it
will segregate with the Fund's Custodian or pledge to a broker as collateral for
the option, at least ten "qualified securities," which are securities of an
issuer in such industry or market segment, with a market value at the time the
option is written of not less than 100% of the current index value times the
multiplier times the number of contracts. Those securities will include stocks
which represent at least 50% of the weighting of the industry or market segment
index and will represent at least 50% of the Fund's holdings in that industry or
market segment. No individual security will represent more than 25% of the
amount so segregated or pledged. If at the close of business on any day the
market value of such qualified securities so segregated or pledged falls below
100% of the current index value times the multiplier times the number of
contracts, the Fund will segregate or pledge an amount in cash or other liquid
assets equal in value to the difference. In addition, when the Fund writes a
call on an index which is in-the-money at the time the call is written, the Fund
will segregate with the Custodian or pledge to the broker as collateral cash or
other liquid assets, marked-to-market daily, equal in value to the amount by
which the call is in-the-money times the multiplier times the number of
contracts. Any amount segregated pursuant to the foregoing sentence may be
applied to the Fund's obligation to segregate additional amounts in the event
that the market value of the qualified securities falls below 100% of the
current index value times the multiplier times the number of contracts. A
"qualified security" is an equity security that is listed on a national
securities exchange or listed on the National Association of Securities Dealers
Automated Quotation System against which the Fund has not written a stock call
option and which has not been hedged by the Fund by the sale of stock index
futures. However, if the Fund holds a call on the same index as the call written
where the exercise price of the call held is equal to or less than the exercise
price of the call written or greater than the exercise price of the call written
if the difference is segregated by the Fund in cash or other liquid assets with
the Fund's Custodian, it will not be subject to the requirements described in
this paragraph.
STOCK INDEX FUTURES. The Fund will engage in transactions in stock index
futures contracts as a hedge against changes resulting from market conditions in
the values of securities which are held in the Fund's portfolio or which it
intends to purchase. The Fund will engage in those transactions when they are
economically appropriate for the reduction of risks inherent in the ongoing
management of the Fund or for return enhancement. The Fund may not purchase or
sell stock index futures if, immediately thereafter, more than one-third of its
net assets would be hedged and, in addition, except as described above in the
case of a call written and held on the same index, will write call options on
indices or sell stock index futures only if the amount resulting from the
multiplication of the then current level of the index (or indexes) upon which
the option or future contract(s) is based, the applicable multiplier(s), and the
number of futures or options contracts which would be outstanding, would not
exceed one-third of the value of the Fund's net assets. In instances involving
the purchase of stock index futures contracts by the Fund, an amount of cash or
other liquid assets, marked-to-market daily, having a value equal to the market
value of the futures contracts, will be segregated with the Fund's Custodian, a
futures commissions merchant, and/or in a margin account with a broker to
collateralize the position and thereby insure that the use of such futures is
unleveraged.
Under regulations of the Commodity Exchange Act, investment companies
registered under the Investment Company Act of 1940, as amended (the Investment
Company Act), are exempt from the definition of "commodity pool operator,"
provided all of the Fund's commodity futures or commodity options transactions
constitute BONA FIDE hedging transactions within the meaning of the regulations
of the Commodity Futures Trading Commission (CFTC). The Fund will use stock
index futures and options on futures as described herein in a manner consistent
with this requirement.
RISKS OF TRANSACTIONS IN STOCK OPTIONS. Writing options involves the risk
that there will be no market in which to effect a closing transaction. An option
position may be closed out only on an exchange which provides a secondary market
for an option of the same series. Although the Fund will generally write only
those options for which there appears to be an active secondary market, there is
no assurance that a liquid secondary market on an exchange will exist for any
particular option, or at any particular time, and for some options no secondary
market on an exchange may exist. If the Fund, as a covered call option writer,
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is unable to effect a closing purchase transaction in a secondary market, it
will not be able to sell the underlying security until the option expires or it
delivers the underlying security upon exercise. The Fund, and thus its
investors, may lose money if the Fund is unsuccessful in its use of these
strategies.
RISKS OF OPTIONS ON INDEXES. The Fund's purchase and sale of options on
indexes will be subject to risks described above under "Risks of Transactions in
Stock Options." In addition, the distinctive characteristics of options on
indexes create certain risks that are not present with stock options.
Because the value of an index option depends upon movements in the level of
the index rather than the price of a particular stock, whether the Fund will
realize a gain or loss on the purchase or sale of an option on an index depends
upon movements in the level of stock prices in the stock market generally or in
an industry or market segment rather than movements in the price of a particular
stock. Accordingly, successful use by the Fund of options on indexes would be
subject to the Subadviser's ability to predict correctly movements in the
direction of the stock market generally or of a particular industry. This
requires different skills and techniques than predicting changes in the price of
individual stocks.
Index prices may be distorted if trading of certain stocks included in the
index is interrupted. Trading in the index options also may be interrupted in
certain circumstances, such as if trading were halted in a substantial number of
securities included in the index. If this occurred, the Fund would not be able
to close out options that it had purchased or written and, if restrictions on
exercise were imposed, may be unable to exercise an option it holds, which could
result in substantial losses to the Fund. It is the Fund's policy to purchase or
write options only on indexes that include a number of stocks sufficient to
minimize the likelihood of a trading halt in the index.
Although the markets for certain index option contracts have developed
rapidly, the markets for other index options are still relatively illiquid. The
ability to establish and close out positions on those options will be subject to
the development and maintenance of a liquid secondary market. It is not certain
that this market will develop in all index option contracts. The Fund will not
purchase or sell any index option contract unless and until, in the Subadviser's
opinion, the market for those options has developed sufficiently that the risk
in connection with those transactions is no greater than the risk in connection
with options on stocks.
SPECIAL RISKS OF WRITING CALLS ON INDEXES. Because exercises of index
options are settled in cash, a call writer like the Fund cannot determine the
amount of its settlement obligations in advance and, unlike call writing on
specific stocks, cannot provide in advance for, or cover, its potential
settlement obligations by acquiring and holding the underlying securities.
However, the Fund will write call options on indices only under the
circumstances described above under "Limitations on Purchase and Sale of Stock
Options, Options on Stock Indexes and Stock Index Futures."
Price movements in the Fund's portfolio probably will not correlate
precisely with movements in the level of the index and, therefore, the Fund
bears the risk that the price of the securities held by the Fund may not
increase as much as the index. In that event, the Fund would bear a loss on the
call that is not completely offset by movements in the price of the Fund's
portfolio. It also is possible that the index may rise when the Fund's portfolio
of stocks does not rise. If this occurred, the Fund would experience a loss on
the call that is not offset by an increase in the value of its portfolio and
might also experience a loss in its portfolio. However, because the value of a
diversified portfolio will, over time, tend to move in the same direction as the
market, movements in the value of the Fund in the opposite direction as the
market would be likely to occur for only a short period or to a small degree.
Unless the Fund has other liquid assets which are sufficient to satisfy the
exercise of a call, the Fund would be required to liquidate portfolio securities
in order to satisfy the exercise. Because an exercise must be settled within
hours after receiving the notice of exercise, if the Fund fails to anticipate an
exercise, it may have to borrow (in amounts not exceeding 20% of the Fund's
total assets) pending settlement of the sale of securities in its portfolio and
would incur interest charges thereon.
When the Fund has written a call, there also is a risk that the market may
decline between the time the Fund has a call exercised against it, at a price
which is fixed as of the closing level of the index on the date of exercise, and
the time the Fund is able to sell stocks in its portfolio. As with stock
options, the Fund will not learn that an index option has been exercised until
the day following the exercise date but, unlike a call on stock where the Fund
would be able to deliver the underlying securities in settlement, the Fund may
have to sell part of its stock portfolio in order to make settlement in cash,
and the price of those securities might decline before they can be sold. This
timing risk makes certain strategies involving more than one option
substantially more risky with index options than with stock options. For
example, even if an index call that the Fund has written is
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"covered" by an index call held by the Fund with the same strike price, the Fund
will bear the risk that the level of the index may decline between the close of
trading on the date the exercise notice is filed with the clearing corporation
and the close of trading on the date the Fund exercises the call it holds or the
time the Fund sells the call, which in either case would occur no earlier than
the day following the day the exercise notice was filed.
SPECIAL RISKS OF PURCHASING PUTS AND CALLS ON INDEXES. If the Fund holds an
index option and exercises it before final determination of the closing index
value for that day, it runs the risk that the level of the underlying index may
change before closing. If such a change causes the exercised option to fall
out-of-the-money, the Fund will be required to pay the difference between the
closing index value and the exercise price of the option (times the applicable
multiple) to the assigned writer. Although the Fund may be able to minimize this
risk by withholding exercise instructions until just before the daily cut off
time or by selling rather than exercising an option when the index level is
close to the exercise price, it may not be possible to eliminate this risk
entirely because the cut off times for index options may be earlier than those
fixed for other types of options and may occur before definitive closing index
values are announced.
ADDITIONAL RISKS OF PURCHASING OTC OPTIONS. Purchase and sale of OTC
options subject the Fund to risks not present with exchange traded options. OTC
options also are subject to certain additional risks. It is not possible to
effect a closing transaction in OTC options in the same manner as listed options
because a clearing corporation is not interposed between the buyer and seller of
the option. In order to terminate the obligation represented by an OTC option,
the holder must agree to the termination of the OTC option and may be unable or
unwilling to do so on terms acceptable to the writer. In any event, a
cancellation, if agreed to, may require the writer to pay a premium to the
counterparty. Although it does not eliminate counterparty risk, the Fund may be
able to eliminate the market risk of an option it has written by writing or
purchasing an offsetting position with the same or another counterparty.
However, the Fund would remain exposed to each counterparty's credit risk on the
call or put option until such option is exercised or expires. There is no
guarantee that the Fund will be able to write put or call options, as the case
may be, that will effectively offset an existing position.
OTC options are issued in privately negotiated transactions exempt from
registration under the Securities Act of 1933, as amended (Securities Act), and,
as a result, are generally subject to substantial legal and contractual
limitations on sale. As a result, there is no secondary market for OTC options
and the staff of the Securities and Exchange Commission (the Commission) has
taken the position that OTC options held by an investment company, as well as
securities used to cover OTC options written by one, are illiquid securities,
unless the Fund and its counterparty have provided for the Fund at its option to
unwind the option. Such provisions ordinarily involve the payment by the Fund to
the counterparty to compensate it for the economic loss caused by an early
termination. In the absence of a negotiated unwind provision, the Fund may be
unable to terminate its obligation under a written option or to enter into an
offsetting transaction eliminating its market risk.
There currently are legal and regulatory limitations on the Fund's purchase
or sale of OTC options. These limitations are not fundamental policies of the
Fund and the Fund's obligation to comply with them could be changed without
approval of the Fund's shareholders in the event of modification or elimination
of those laws or regulations in the future.
There can be no assurance that the Fund's use of OTC options will be
successful and the Fund may incur losses in connection with the purchase and
sale of OTC options.
RISKS OF OPTIONS ON FOREIGN CURRENCIES
The Fund may purchase and write put and call options on foreign currencies
traded on securities exchanges or boards of trade (foreign and domestic) for
hedging purposes in a manner similar to that in which foreign currency forward
contracts and futures contracts on foreign currencies will be employed. Options
on foreign currencies are similar to options on stock, except that the Fund has
the right to take or make delivery of a specified amount of foreign currency,
rather than stock.
The Fund may purchase and write options to hedge the Fund's portfolio
securities denominated in foreign currencies. If there is a decline in the
dollar value of a foreign currency in which the Fund's portfolio securities are
denominated, the dollar value of such securities will decline even though the
foreign currency value remains the same. To hedge against the decline of the
foreign currency, the Fund may purchase put options on that foreign currency. If
the value of the foreign currency declines, the gain realized on the put option
would offset, in whole or in part, the adverse effect such decline would have on
the value of the portfolio securities. Alternatively, the Fund may write a call
option on the foreign currency. If the value of the foreign currency declines,
the option would not be exercised and the decline in the value of the portfolio
securities denominated in that foreign currency would be offset in part by the
premium the Fund received for the option.
B-8
<PAGE>
If, on the other hand, the Subadviser anticipates purchasing a foreign
security and also anticipates a rise in the value of that foreign currency
(thereby increasing the cost of such security), the Fund may purchase call
options on the foreign currency. The purchase of such options could offset, at
least partially, the effects of the adverse movements of the exchange rates.
Alternatively, the Fund could write a put option on the currency and, if the
exchange rates move as anticipated, the option would expire unexercised.
Because there are two currencies involved, developments in either or both
countries can affect the values of options on foreign currencies. Risks include
those described above under "Foreign Securities," including government actions
affecting currency valuation and the movements of currencies from one country to
another. The quantities of currency underlying option contracts represent odd
lots in a market dominated by transactions between banks; this can mean extra
transaction costs upon exercise. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
RISKS RELATED TO FOREIGN CURRENCY FORWARD CONTRACTS
A foreign currency forward contract involves an obligation to purchase or
sell a specific currency at a future date, which may be any fixed number of days
from the date of the contract agreed upon by the parties, at a price set at the
time of the contract. These contracts are traded in the interbank market
conducted directly between currency traders (typically large commercial banks)
and their customers. A forward contract generally has no deposit requirements
and commissions are charged for such trades.
The Fund's dealings in forward contracts will be limited to hedging
involving either specific transactions or portfolio positions. Transaction
hedging is the purchase or sale of a forward contract with respect to specific
receivables or payables of the Fund generally arising in connection with the
purchase or sale of its portfolio securities and accruals of interest or
dividends receivable and Fund expenses. Position hedging is the sale of a
foreign currency with respect to portfolio security positions denominated or
quoted in that currency or in a different currency (cross hedge). Although there
are no limits on the number of forward contracts that the Fund may enter into,
the Fund may not position hedge (including cross hedges) with respect to a
particular currency for an amount greater than the aggregate market value
(determined at the time of making any sale of forward currency) of the
securities being hedged. The Fund may not use forward contracts to generate
income, although the use of those contracts may incidentally generate income.
The Fund will not speculate in forward contracts.
The Fund may enter into foreign currency forward contracts in several
circumstances. When the Fund enters into a contract for the purchase or sale of
a security denominated in a foreign currency, or when the Fund anticipates the
receipt in a foreign currency of dividends or interest payments on a security
that it holds, the Fund may desire to "lock-in" the U.S. dollar price of the
security or the U.S. dollar equivalent of such dividend or interest payment, as
the case may be. By entering into a forward contract for a fixed amount of
dollars, for the purchase or sale of the amount of foreign currency involved in
the underlying transactions, the Fund may be able to protect itself against a
possible loss resulting from an adverse change in the relationship between the
U.S. dollar and the foreign currency during the period between the date on which
the security is purchased or sold, or on which the dividend or interest payment
is declared, and the date on which such payments are made or received.
Additionally, when the Subadviser believes that the currency of a particular
foreign country may suffer a substantial decline against the U.S. dollar, the
Fund may enter into a forward contract for a fixed amount of dollars, to sell
the amount of foreign currency approximating the value of some or all of the
Fund's portfolio securities denominated in such foreign currency. The precise
matching of the forward contract amounts and the value of the securities
involved will not generally be possible since the future value of securities in
foreign currencies will change as a consequence of market movements in the value
of those securities between the date on which the forward contract is entered
into and the date it matures. The projection of short-term currency market
movement is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain. If the Fund enters into a position hedging
transaction, the transaction will be "covered" by the position being hedged, or
the Fund's Custodian will segregate cash or other liquid assets in an amount
equal to the value of the Fund's total assets committed to the consummation of
such forward contracts (less the value of the "covering" positions, if any). The
assets segregated will be marked-to-market daily, and if the value of the assets
segregated declines, additional cash or other liquid assets will be placed in
the account so that the value of the account will, at all times, equal the
amount of the Fund's net commitment with respect to such contract. The Fund's
ability to enter into foreign currency forward contracts may be limited by
certain requirements for qualification as a regulated investment company under
the Internal Revenue Code. See "Taxes, Dividends and Distributions."
B-9
<PAGE>
The Fund generally will not enter into a forward contract with a term of
greater than one year. At the maturity of a forward contract, the Fund may
either sell the portfolio security and make delivery of the foreign currency, or
it may retain the security and terminate its contractual obligation to deliver
the foreign currency by purchasing an "offsetting" contract with the same
currency trader obligating it to purchase, on the same maturity date, the same
amount of the foreign currency.
It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the forward contract.
Accordingly, if a decision is made to sell the security and make delivery of the
foreign currency and if the market value of the security is less than the amount
of foreign currency that the Fund is obligated to deliver, then it would be
necessary for the Fund to purchase additional foreign currency on the spot
market (and bear the expense of such purchase).
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. Should forward contract prices decline
during the period between the Fund's entering into a forward contract for the
sale of a foreign currency and the date it enters into an offsetting contract
for the purchase of the foreign currency, the Fund will realize a gain to the
extent that the price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward contract prices increase,
the Fund will suffer a loss to the extent that the price of the currency it has
agreed to purchase exceeds the price of the currency it has agreed to sell.
The Fund's dealing in foreign currency forward contracts generally will be
limited to the transactions described above. Of course, the Fund is not required
to enter into such transactions with regard to its foreign currency-denominated
securities. It also should be recognized that this method of protecting the
value of the Fund's portfolio securities against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices of the
securities that are unrelated to exchange rates. Additionally, although such
contracts tend to minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time they tend to limit any potential gain which
might result should the value of such currency increase.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend physically to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors should
be aware of the costs of currency conversion. Although foreign exchange dealers
do not charge a fee for conversion, they do realize a profit based on the
difference (the spread) between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS
The Fund may purchase and sell financial futures contracts and options
thereon which are traded on a commodities exchange or board of trade to reduce
certain risks of its investments and to attempt to enhance return in accordance
with regulations of the CFTC. The Fund, and thus its investors, may lose money
through any unsuccessful use of these strategies. These futures contracts and
related options will be on stock indexes and foreign currencies. A futures
contract is an agreement to purchase or sell an agreed amount of securities or
currencies at a set price for delivery in the future. A stock index futures
contract is an agreement to purchase or sell cash equal to a specific dollar
amount times the difference between the value of a specific stock index at the
close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of the underlying stocks in the index is
made. The Fund may purchase and sell futures contracts or related options as a
hedge against changes in market conditions.
There are several risks in connection with the use of futures contracts as a
hedging device. Due to the imperfect correlation between the price of futures
contracts and movements in the prices of equity securities or a currency or
group of currencies, the price of a futures contract may move more or less than
the price of the equity securities or currencies being hedged. Therefore, a
contract forecast of equity prices, currency rates, market trends or
international political trends by the Subadviser may still not result in a
successful hedging transaction. The use of these instruments will hedge only the
currency risks associated with investments in foreign securities, not market
risk.
Although the Fund will purchase or sell futures contracts only on exchanges
where there appears to be an adequate secondary market, there is no assurance
that a liquid secondary market on an exchange will exist for any particular
contract or at any particular time. Accordingly, there can be no assurance that
it will be possible, at any particular time, to close a futures position. In the
event the Fund could not close a futures position and the value of such position
declined, the Fund would be required to continue to make daily cash payments of
variation margin. However, in the event a futures contract has been used to
B-10
<PAGE>
hedge portfolio securities, such securities will not be sold until the futures
contract can be terminated. In such circumstances, an increase in the price of
the securities, if any, may partially or completely offset losses on the futures
contract. However, there is no guarantee that the price movements of the
securities will, in fact, correlate with the price movements in the futures
contracts and thus provide an offset to losses on a futures contract.
Futures contracts and related options are generally subject to segregation
requirements of the Commission and coverage requirements of the CFTC. If the
Fund does not hold the security or currency underlying the futures contract, the
Fund will be required to segregate on an ongoing basis with its Custodian cash
or other liquid assets in an amount at least equal to the Fund's obligations
with respect to such futures contracts. The Fund may place and maintain cash,
securities and similar investments with a futures commissions merchant in
amounts necessary to effect the Fund's transactions in exchange traded futures
contracts and options thereon, provided certain conditions are satisfied. The
Fund may also enter into futures or related options contracts for income
enhancement and risk management purposes if the aggregate initial margin and
option premiums do not exceed 5% of the liquidation value of the Fund's total
assets.
Successful use of futures contracts by the Fund also is subject to the
ability of the Subadviser to predict correctly movements in the direction of
markets and other factors affecting equity securities and currencies generally.
For example, if the Fund has hedged against the possibility of an increase in
the price of securities in its portfolio and the price of those securities
increases instead, the Fund will lose part or all of the benefit of the
increased value of its securities because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Fund has insufficient
cash to meet daily variation margin requirements, it may need to sell securities
to meet such requirements. Such sales of securities may be, but will not
necessarily be, at increased prices which reflect the rising market. The Fund
may have to sell securities at a time when it is disadvantageous to do so.
The hours of trading of futures contracts may not conform to the hours
during which the Fund may trade the underlying securities. To the extent that
the futures markets close before the securities markets, significant price and
rate movements can take place in the securities markets that cannot be reflected
in the futures markets. Certain futures exchanges or boards of trade have
established daily limits on the amount that the price of futures contracts or
related options may vary, either up or down, from the previous day's settlement
price. These daily limits may restrict the Fund's ability to purchase or sell
certain futures contracts or related options on any particular day.
RISKS OF RISK MANAGEMENT AND RETURN ENHANCEMENT STRATEGIES
Participation in the options or futures market and in currency exchange
transactions involves investment risks and transaction costs to which the Fund
would not be subject absent the use of these strategies. The Fund, and thus its
investors, may lose money through any unsuccessful use of these strategies. If
the Subadviser's predictions of movements in the direction of the securities or
foreign currency markets are inaccurate, the adverse consequences to the Fund
may leave the Fund in a worse position than if such strategies were not used.
Risks inherent in the use of these strategies include: (1) dependence on the
Subadviser's ability to predict correctly movements in the direction of
securities prices and currency markets; (2) imperfect correlation between the
price of options and futures contracts and options thereon and movements in the
prices of the securities or currencies being hedged; (3) the fact that skills
needed to use these strategies are different from those needed to select
portfolio securities; (4) the possible absence of a liquid secondary market for
any particular instrument at any time; (5) the risk that the counterparty may be
unable to complete the transaction; and (6) the possible inability of the Fund
to purchase or sell a portfolio security at a time that otherwise would be
favorable for it to do so, or the possible need for the Fund to sell a portfolio
security at a disadvantageous time, due to the need for the Fund to maintain
"cover" or to segregate assets in connection with hedging transactions.
SEGREGATED ASSETS
The Fund will segregate with its Custodian cash, U.S. government securities,
equity securities (including foreign securities), debt securities or other
liquid, unencumbered assets equal in value to its obligations in respect of
potentially leveraged transactions. These include forward contracts, when-issued
and delayed delivery securities, futures contracts, written options and options
on futures contracts (unless otherwise covered). If collateralized or otherwise
covered, in accordance with Commission guidelines, these will not be deemed to
be senior securities. The assets segregated will be marked-to-market daily.
B-11
<PAGE>
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements whereby the seller of a
security agrees to repurchase that security from the Fund at a mutually
agreed-upon time and price. The period of maturity usually is quite short,
possibly overnight or a few days, although it may extend over a number of
months. The resale price is in excess of the purchase price, reflecting an
agreed-upon rate of return effective for the period of time the Fund's money is
invested in the security. The Fund's repurchase agreements will at all times be
fully collateralized in an amount at least equal to the resale price. The
instruments held as collateral are valued daily, and if the value of the
instruments declines, the Fund will require additional collateral. If the seller
defaults and the value of the collateral securing the repurchase agreement
declines, the Fund may incur a loss. The Fund participates in a joint repurchase
account with other investment companies managed by the Manager, pursuant to an
order of the Commission.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
The Fund may purchase or sell securities on a when-issued or delayed
delivery basis. When-issued or delayed delivery transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future in order to secure what is considered to be an advantageous
price and yield to the Fund at the time of entering into the transaction. The
Fund's Custodian will segregate cash or other liquid assets having a value equal
to or greater than the Fund's purchase commitments; the Custodian will likewise
segregate securities sold on a delayed delivery basis. The securities so
purchased are subject to market fluctuation and no interest accrues to the
purchaser during the period between purchase and settlement. At the time of
delivery of the securities the value may be more or less than the purchase price
and an increase in the percentage of the Fund's assets committed to the purchase
of securities on a when-issued or delayed delivery basis may increase the
volatility of the Fund's NAV.
BORROWING
The Fund may borrow up to 20% of the value of its total assets (calculated
when the loan is made) from banks for temporary, emergency or extraordinary
purposes or for the clearance of transactions. The Fund may pledge up to 20% of
its total assets to secure these borrowings. However, the Fund will not purchase
portfolio securities when borrowings exceed 5% of the value of the Fund's total
assets.
SHORT SALES AGAINST-THE-BOX
The Fund may make short sales of securities or maintain a short position,
provided that at all times when a short position is open the Fund owns an equal
amount of such securities (or securities convertible into or exchangeable for
such securities of the same issuer) as the securities sold short (a short sale
against-the-box). No more than 25% of the Fund's net assets (determined at the
time of the short sale) may be subject to such sales.
ILLIQUID SECURITIES
The Fund may not hold more than 15% of its net assets in illiquid
securities. If the Fund were to exceed this limit, the investment adviser would
take prompt action to reduce the Fund's holdings in illiquid securities to no
more than 15% of its net assets, as required by applicable law. Illiquid
securities include repurchase agreements that have a maturity of longer than
seven days, securities with legal or contractual restrictions on resale
(restricted securities) and securities that are not readily marketable in
securities markets (either within or outside of the United States). Repurchase
agreements subject to demand are deemed to have a maturity equal to the
applicable notice period.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities that are otherwise not readily
marketable and repurchase agreements having a maturity of longer than seven
days. Securities that have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Mutual funds do not
typically hold a significant amount of these restricted or other illiquid
securities because of the potential for delays on resale and uncertainty in
valuation. Limitations on resale may have an adverse effect on the marketability
of portfolio securities and a mutual fund might be unable to dispose of
restricted or other illiquid securities promptly or at reasonable prices and
might thereby experience difficulty satisfying redemptions within seven days. A
mutual fund also might have to register such restricted securities to dispose of
them resulting in additional expense and delay. Adverse market conditions could
impede such a public offering of securities.
B-12
<PAGE>
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Subadviser anticipates that the market for
certain restricted securities such as institutional commercial paper and foreign
securities will expand further as a result of this regulation and the
development of automated systems for the trading, clearance and settlement of
unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market are treated as liquid only when deemed liquid under procedures
established by the Board of Directors. The Fund's investment in Rule 144A
securities could have the effect of increasing illiquidity to the extent that
qualified institutional buyers become, for a limited time, uninterested in
purchasing Rule 144A securities. The Subadviser will monitor the liquidity of
such restricted securities subject to the supervision of the Board of Directors.
In reaching liquidity decisions, the Subadviser will consider, among others, the
following factors: (1) the frequency of trades and quotes for the security;
(2) the number of dealers wishing to purchase or sell the security and the
number of other potential purchasers; (3) dealer undertakings to make a market
in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (a) it must be rated in one of the two
highest rating categories by at least two nationally recognized statistical
rating organizations (NRSRO), or if only one NRSRO rates the securities, by that
NRSRO, or, if unrated, be of comparable quality in the view of the Subadviser;
and (b) it must not be "traded flat" (that is, without accrued interest) or in
default as to principal or interest.
The staff of the Commission has taken the position that purchased
over-the-counter options and the assets used as "cover" for written
over-the-counter options are illiquid securities unless the Fund and the
counterparty have provided for the Fund, at the Fund's election, to unwind the
over-the-counter option. The exercise of such an option ordinarily would involve
the payment by the Fund of an amount designed to reflect the counterparty's
economic loss from an early termination, but does allow the Fund to treat the
assets used as "cover" as "liquid."
SECURITIES OF OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its total assets in shares of other
investment companies. Generally, the Fund does not intend to invest more than 5%
of its total assets in such securities. To the extent the Fund does invest in
securities of other investment companies, shareholders may be subject to
duplicate management and advisory fees.
TEMPORARY DEFENSIVE STRATEGY AND SHORT-TERM INVESTMENTS
When adverse market or economic conditions dictate a defensive strategy, the
Fund may temporarily invest without limit in money market instruments, including
commercial paper of U.S. corporations, certificates of deposit, bankers'
acceptances and other obligations of domestic banks, and obligations issued or
guaranteed by the U.S. government, its agencies or its instrumentalities. Money
market instruments typically have a maturity of one year or less as measured
from the date of purchase.
The Fund also may temporarily hold cash or invest in money market
instruments pending investment of proceeds from new sales of Fund shares or
during periods of portfolio restructuring.
PORTFOLIO TURNOVER
The Fund anticipates that its annual portfolio turnover rate will not exceed
100% in normal circumstances. For the years ended September 30, 2000 and 1999,
the Fund's portfolio turnover rate was 92% and 39%, respectively. The portfolio
turnover rate generally is the percentage computed by dividing the lesser of
portfolio purchases or sales (excluding all securities, including options, whose
maturities or expiration date at acquisition were one year or less) by the
monthly average value of such portfolio securities. High portfolio turnover
(100% or more) involves correspondingly greater brokerage commissions and other
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<PAGE>
transaction costs, which are borne directly by the Fund. In addition, high
portfolio turnover may also mean that a proportionately greater amount of
distributions to shareholders will be taxed as ordinary income rather than
long-term capital gains compared to investment companies with lower portfolio
turnover. See "Brokerage Allocation and Other Practices" and "Taxes, Dividends
and Distributions."
INVESTMENT RESTRICTIONS
The following restrictions are fundamental policies. Fundamental policies
are those that cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities. A "majority of the Fund's
outstanding voting securities," when used in this Statement of Additional
Information, means the lesser of (1) 67% of the voting shares represented at a
meeting at which more than 50% of the outstanding voting shares are present in
person or represented by proxy or (2) more than 50% of the outstanding voting
shares.
The Fund may not:
(1) With respect to 75% of the Fund's total assets, invest more than 5% of
the value of its total assets in the securities of any one issuer (other than
obligations issued or guaranteed by the United States government, its agencies
or instrumentalities). It is the current policy (but not a fundamental policy)
of the Fund not to invest more than 5% of the value of its total assets in
securities of any one issuer.
(2) Purchase more than 10% of the outstanding voting securities of any one
issuer.
(3) Invest more than 25% of the value of its total assets in securities of
issuers in any one industry. This restriction does not apply to obligations
issued or guaranteed by the United States government or its agencies or
instrumentalities.
(4) Purchase or sell real estate or interests therein, although the Fund may
purchase securities of issuers which engage in real estate operations and
securities which are secured by real estate or interests therein.
(5) Purchase or sell commodities or commodity futures contracts, except that
transactions in foreign currency financial futures contracts and forward
contracts and related options are not considered to be transactions in
commodities or commodity contracts.
(6) Purchase oil, gas or other mineral leases, rights or royalty contracts
or exploration or development programs, except that the Fund may invest in the
securities of companies which operate, invest in or sponsor such programs.
(7) Purchase securities of other investment companies, except by purchases
in the open market involving only customary brokerage commissions and as a
result of which not more than 10% of its total assets (determined at the time of
investment) would be invested in such securities or except in connection with a
merger, consolidation, reorganization or acquisition of assets.
(8) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 20% of the value of the total assets (calculated when
the loan is made) for temporary, extraordinary or emergency purposes or for the
clearance of transactions. The Fund may pledge up to 20% of the value of its
total assets to secure such borrowings. Secured borrowings may take the form of
reverse repurchase agreements, pursuant to which the Fund would sell portfolio
securities for cash and simultaneously agree to repurchase them at a specified
date for the same amount of cash plus an interest component. For purposes of
this restriction, obligations of the Fund to Directors pursuant to deferred
compensation arrangements, the purchase and sale of securities on a when-issued
or delayed delivery basis, the purchase and sale of foreign currency forward
contracts and financial futures contracts and related options and collateral
arrangements with respect to margins for financial futures contracts and with
respect to options are not deemed to be the issuance of a senior security or a
pledge of assets.
(9) Make loans of money or securities, except by the purchase of debt
obligations in which the Fund may invest consistently with its investment
objective and policies or by investment in repurchase agreements.
(10) Make short sales of securities except short sales against-the-box.
(11) Purchase securities on margin, except for such short-term loans as are
necessary for the clearance of purchases of portfolio securities. (For the
purpose of this restriction, the deposit or payment by the Fund of initial or
maintenance margin in connection with financial futures contracts is not
considered the purchase of a security on margin.)
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(12) Engage in the underwriting of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act, in disposing of a
portfolio security.
(13) Invest for the purpose of exercising control or management of any other
issuer.
Whenever any fundamental investment policy or investment restriction states
a maximum percentage of the Fund's assets, it is intended that if the percentage
limitation is met at the time the investment is made, a later change in
percentage resulting from changing total or net asset values will not be
considered a violation of such policy. However, in the event that the Fund's
asset coverage for borrowings falls below 300%, the Fund will take prompt action
to reduce its borrowings, as required by applicable law.
MANAGEMENT OF THE FUND
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS** (AGE) WITH FUND DURING PAST FIVE YEARS
------------------------ --------- ----------------------
<S> <C> <C>
Saul K. Fenster (67) Director President (since December 1978) of New Jersey
Institute of Technology; Commissioner (since
1998) of the Middle States Association,
Commission on Higher Education; member (since
1985) of the New Jersey Commission on Science
and Technology; formerly a director or trustee
(1987-1999) of the New Jersey State Chamber of
Commerce, Society of Manufacturing Engineering
Education Foundation, the Research and
Development Council of New Jersey, Prosperity
New Jersey, Inc., the Edison Partnership,
National Action Council for Minorities in
Engineering and IDT Corporation.
Delayne Dedrick Gold (63) Director Marketing and Management Consultant.
*Robert F. Gunia (53) Vice President and Executive Vice President and Chief
Director Administrative Officer (since June 1999) of
Prudential Investments; Executive Vice
President and Treasurer (since December 1996)
of Prudential Investments Fund Management LLC
(PIFM); President (since April 1999) of
Prudential Investment Management Services LLC
(PIMS); formerly Senior Vice President (March
1987-May 1999) of Prudential Securities
Incorporated (Prudential Securities), Corporate
Vice President (September 1997-March 1999) of
The Prudential Insurance Company of America
(Prudential) and Chief Administrative Officer
(July 1990-September 1996), Director (January
1989-September 1996) and Executive Vice
President, Treasurer and Chief Financial
Officer (June 1987-September 1996) of
Prudential Mutual Fund Management, Inc.
Douglas H. McCorkindale (61) Director Chairman (since June 2000) and President (since
September 1997) of Gannett Co. Inc. (publishing
and media); formerly Vice Chairman (March
1984-May 2000) of Gannett Co. Inc.; Director of
Gannett Co. Inc., Global Crossing Ltd. and
Continental Airlines, Inc.
</TABLE>
B-15
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS** (AGE) WITH FUND DURING PAST FIVE YEARS
------------------------ --------- ----------------------
<S> <C> <C>
W. Scott McDonald, Jr. (63) Director Vice President (since 1997) of Kaludis
Consulting Group, Inc., a Sallie Mae company
serving higher education; formerly Principal
(1995-1997) of Scott McDonald & Associates,
Chief Operating Officer (1991-1995) of
Fairleigh Dickinson University, Executive Vice
President and Chief Operating Officer
(1975-1991) of Drew University, Interim
President (1988-1990) of Drew University, and a
founding director of School, College and
University Underwriters Ltd.
Thomas T. Mooney (58) Director President of the Greater Rochester Metro Chamber
of Commerce; former Rochester City Manager;
former Deputy Monroe County Executive; Trustee
of Center for Governmental Research, Inc.;
Director of Blue Cross of Rochester, Monroe
County Water Authority and Executive Service
Corps of Rochester.
Stephen P. Munn (58) Director Chairman (since January 1994), Director and
President (since 1988) and Chief Executive
Officer (1988-December 1993) of Carlisle
Companies Incorporated.
*David R. Odenath, Jr. (43) President and Director Officer in Charge, President, Chief Executive
Officer and Chief Operating Officer (since June
1999), PIFM; Senior Vice President (since June
1999), Prudential; formerly Senior Vice
President (August 1993-May 1999), PaineWebber
Group Inc.
Richard A. Redeker (57) Director Formerly President, Chief Executive Officer and
Director (October 1993-September 1996) of
Prudential Mutual Fund Management, Inc.,
Executive Vice President, Director and Member
of the Operating Committee (October
1993-September 1996) of Prudential Securities,
Director (October 1993-September 1996) of
Prudential Securities Group, Inc., Executive
Vice President (January 1994-September 1996) of
The Prudential Investment Corporation, Director
(January 1994-September 1996) of Prudential
Mutual Fund Distributors, Inc. and Prudential
Mutual Fund Services, Inc. and Senior Executive
Vice President and Director (September
1978-September 1993) of Kemper Financial
Services, Inc.
*Judy A. Rice (52) Director Executive Vice President (since 1999) of
Prudential Investments; Executive Vice
President (since 1999) of PIFM; formerly
various positions to Senior Vice President
(1992-1999) of Prudential Securities; various
positions to Managing Director (1975-1992) of
Shearson Lehman Advisors; Governor of the Money
Management Institute and Member of the
Prudential Securities Operating Council and the
National Association for Variable Annuities.
Robin B. Smith (60) Director Chairman and Chief Executive Officer (since
August 1996); formerly President and Chief
Executive Officer (January 1989-August 1996)
and President and Chief Operating Officer
(September 1981-December 1988) of Publishers
Clearing House; Director of BellSouth
Corporation, Texaco Inc., Springs Industries
Inc. and Kmart Corporation.
</TABLE>
B-16
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS** (AGE) WITH FUND DURING PAST FIVE YEARS
------------------------ --------- ----------------------
<S> <C> <C>
Louis A. Weil, III (59) Director Formerly, Chairman (January 1999-July 2000),
President and Chief Executive Officer (January
1996-July 2000) and Director (September
1991-July 2000) of Central Newspapers, Inc.,
Chairman of the Board (January 1996-July 2000),
Publisher and Chief Executive Officer (August
1991-December 1995) of Phoenix Newspapers,
Inc., Publisher (May 1989-March 1991) of Time
Magazine, President, Publisher & Chief
Executive Officer (February 1986-August 1989)
of The Detroit News and member of the Advisory
Board, Chase Manhattan Bank-Westchester.
Clay T. Whitehead (62) Director President of National Exchange Inc. (new
business development firm) (since May 1983).
Grace C. Torres (41) Treasurer and Principal First Vice President (since December 1996) of
Financial and PIFM; First Vice President (March
Accounting Officer 1994-September 1996) of Prudential Securities;
formerly First Vice President (March
1994-September 1996) of Prudential Mutual Fund
Management, Inc.
Marguerite E. H. Morrison (44) Secretary Department Vice President and Chief Legal
Officer (since August 2000) of the Mutual Funds
Law Division of Prudential; Vice President and
Associate General Counsel (since December 1996)
of PIFM; formerly Vice President and Associate
General Counsel (September 1987-September 1996)
of Prudential Securities; Vice President and
Associate General Counsel (June 1991-September
1996) of Prudential Mutual Fund Management,
Inc.
William V. Healey (47) Assistant Secretrary Vice President and Associate General Counsel
(since August 1998) of Prudential and Chief
Legal Officer of Prudential Investments;
Director (since June 1999), ICI Mutual
Insurance Company; formerly Associate General
Counsel of The Dreyfus Corporation (Dreyfus), a
subsidiary of Mellon Bank, N.A. (Mellon Bank),
and an officer and/or director of various
affiliates of Mellon Bank and Dreyfus.
Jonathan D. Shain (42) Assistant Secretary Assistant General Counsel (since August 1998) of
Prudential; formerly Attorney with Fleet Bank,
N.A. (January 1997-July 1998) an Associate
Counsel (August 1994-January 1997) of New York
Life Insurance Company.
</TABLE>
------------
* "Interested" Director, as defined in the Investment Company Act, by reason of
an affiliation with Prudential Securities, Prudential or PIFM.
** The address of the Directors and officers is c/o Prudential Investments Fund
Management LLC, Gateway Center Three, 100 Mulberry Street, Newark, New Jersey
07102-4077.
The Fund has Directors who, in addition to overseeing the actions of the
Fund's Manager, Subadviser and Distributor, decide upon matters of general
policy. The Directors also review the actions of the Fund's officers who conduct
and supervise the daily business operations of the Fund.
The Board of Directors has adopted a retirement policy which calls for the
retirement of Directors on December 31 of the year in which they reach the age
of 75.
B-17
<PAGE>
Pursuant to the Management Agreement with the Fund, the Manager pays all
compensation of officers and employees of the Fund as well as the fees and
expenses of all Directors of the Fund who are affiliated persons of the Manager.
The Fund currently pays each of its Directors who is not an affiliated person of
the Manager annual compensation of $2,675, in addition to certain out-of-pocket
expenses. The amount of annual compensation paid to each Director may change as
a result of the introduction of additional funds on the boards of which the
Director will be asked to serve.
Directors may receive their Director's fees pursuant to a deferred fee
agreement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of such Director's fee which accrues interest at a rate
equivalent to the prevailing rate applicable to 90-day U.S. Treasury Bills at
the beginning of each calendar quarter or, pursuant to a Commission exemptive
order, at the daily rate of return of any Prudential mutual fund. Payment of the
interest so accrued is also deferred and accruals become payable at the option
of the Director. The Fund's obligation to make payments of deferred Directors'
fees, together with interest thereon, is a general obligation of the Fund.
The following table sets forth the aggregate compensation paid by the Fund
for the fiscal year ended September 30, 2000 to the Directors who are not
affiliated with the Manager and the aggregate compensation paid to such
Directors for service on the Fund's board and that of all other funds managed by
the Manager (Fund Complex) for the calendar year ended December 31, 1999.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM FUND
AGGREGATE AND FUND
COMPENSATION COMPLEX PAID
NAME OF DIRECTOR FROM FUND TO DIRECTORS
--------------------------------------- ------------ ---------------
<S> <C> <C>
Edward D. Beach@ $2,675 $142,500(43/70)*
Saul K. Fenster@@ -- $ 35,000(5/21)*
Delayne Dedrick Gold $2,675 $144,500(43/70)*
Robert F. Gunia+ -- None
Douglas H. McCorkindale** $2,675 $ 80,000(24/49)*
W. Scott McDonald, Jr.@@ -- $ 35,000(5/21)*
Thomas T. Mooney** $2,675 $129,500(35/75)*
Stephen P. Munn $2,675 $ 62,250(29/53)*
David R. Odenath, Jr.+ -- None
Richard A. Redeker $2,675 $ 95,000(29/53)*
Judy A. Rice+ -- None
Robin B. Smith** $2,675 $ 96,000(32/44)*
Louis A. Weil, III $2,675 $ 96,000(29/53)*
Clay T. Whitehead $2,675 $ 77,000(38/66)*
</TABLE>
------------------------
* Indicates number of funds/portfolios in Fund Complex (including the Fund)
to which aggregate compensation relates.
** Total compensation from all of the funds in the Fund Complex for the
calendar year ended December 31, 1999, includes amounts deferred at the
election of Directors under the funds' deferred compensation plans.
Including accrued interest, total compensation amounted to $97,915,
$135,101 and $156,477 for Douglas H. McCorkindale, Thomas T. Mooney and
Robin B. Smith, respectively.
+ Interested Directors do not receive compensation from the Fund or any other
fund in the Fund Complex.
@ Mr. Beach retired on December 31, 1999.
@@ Messrs. Fenster and McDonald joined the Board in August 2000.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
Directors of the Fund are eligible to purchase Class Z shares of the Fund,
which are sold without either an initial sales charge or contingent deferred
sales charge to a limited group of investors.
As of November 10, 2000, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding common stock of the Fund.
B-18
<PAGE>
As of November 10, 2000, the following shareholders owned 5% of the
outstanding shares of any class of the Fund: Prudential Trust Co. FBO BPA
International, Inc., 270 Madison Avenue, New York, NY 10016 held 316,539
Class C shares (21% of the outstanding Class C shares), Prudential Defined
Contribution Services, attn. John Surdy, FBO PRU - NON - Trust Accounts,
30 Scranton Office Park, Moosic, PA 18507 held 965,965 Class Z shares (14% of
the outstanding Class Z shares) and Prudential Trust Company, FBO PRU - DC -
Trust Accounts, attn. John Surdy, 30 Scranton Office Park, Moosic, PA 18507 held
1,805,199 Class Z shares (26% of the outstanding Class Z shares).
As of November 10, 2000, Prudential Securities was the record holder for
other beneficial owners of 9,101,936 Class A shares (or 45% of the outstanding
Class A shares), 8,029,188 Class B shares (or 54% of the outstanding Class B
shares), 661,398 Class C shares (or 44% of the outstanding Class C shares), and
519,922 Class Z shares (or 7.5% of the outstanding Class Z shares) of the Fund.
In the event of any meetings of shareholders, Prudential Securities will
forward, or cause the forwarding of, proxy materials to the beneficial owners
for which it is the record holder.
INVESTMENT ADVISORY AND OTHER SERVICES
MANAGER AND INVESTMENT ADVISER
The Manager of the Fund is Prudential Investments Fund Management LLC
(formerly, Prudential Mutual Fund Management LLC), Gateway Center Three, 100
Mulberry Street, Newark, New Jersey 07102-4077. The Manager serves as manager to
all of the other open-end management investment companies that, together with
the Fund, comprise the Prudential mutual funds. See "How the Fund is
Managed--Manager" in the Prospectus. As of October 31, 2000, the Manager managed
and/or administered open-end and closed-end management investment companies with
assets of approximately $77.7 billion. According to the Investment Company
Institute, as of June 30, 2000, the Prudential mutual funds were the 22nd
largest family of mutual funds in the United States.
PIFM is a wholly-owned subsidiary of PIFM HoldCo, Inc., which is a
wholly-owned subsidiary of Prudential Asset Management Holding Company, which is
a wholly-owned subsidiary of Prudential. Prudential Mutual Fund Services LLC
(the Transfer Agent), an affiliate of the Manager, serves as the transfer agent
and dividend distribution agent for the Prudential mutual funds and, in
addition, provides customer service, recordkeeping and management and
administration services to qualified plans.
Pursuant to the Management Agreement with the Fund (the Management
Agreement), the Manager, subject to the supervision of the Fund's Board of
Directors and in conformity with the stated policies of the Fund, manages both
the investment operations of the Fund and the composition of the Fund's
portfolio, including the purchase, retention, disposition and loan of
securities. In connection therewith, the Manager is obligated to keep certain
books and records of the Fund. PIFM has hired Jennison Associates LLC (Jennison,
the investment adviser or the Subadviser), to provide subadvisory services to
the Fund. The Manager also administers the Fund's corporate affairs and, in
connection therewith, furnishes the Fund with office facilities, together with
those ordinary clerical and bookkeeping services which are not being furnished
by the Fund's Custodian and the Transfer Agent. The services of the Manager for
the Fund are not exclusive under the terms of the Management Agreement and the
Manager is free to, and does, render management services to others.
For its services, the Manager receives, pursuant to the Management
Agreement, a fee at an annual rate of .70 of 1% of the Fund's average daily net
assets. The fee is computed daily and payable monthly. The Management Agreement
also provides that, in the event the expenses of the Fund (including the fees of
the Manager, but excluding interest, taxes, brokerage commissions, distribution
fees and litigation and indemnification expenses and other extraordinary
expenses not incurred in the ordinary course of the Fund's business) for any
fiscal year exceed the lowest applicable annual expense limitation established
and enforced pursuant to the statutes or regulations of any jurisdiction in
which the Fund's shares are qualified for offer and sale, the compensation due
to the Manager will be reduced by the amount of such excess. Reductions in
excess of the total compensation payable to the Manager will be paid by the
Manager to the Fund. No jurisdiction currently limits the Fund's expenses.
In connection with its management of the corporate affairs of the Fund, the
Manager bears the following expenses:
(a) the salaries and expenses of all of its and the Fund's personnel except
the fees and expenses of Directors who are not affiliated persons of the
Manager;
B-19
<PAGE>
(b) all expenses incurred by the Manager or by the Fund in connection with
managing the ordinary course of the Fund's business, other than those assumed by
the Fund as described below; and
(c) the costs and expenses payable to the Subadviser, pursuant to the
subadvisory agreement between the Manager and the Subadviser (the Subadvisory
Agreement).
Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (1) the fees payable to the Manager, (2) the
fees and expenses of Directors who are not affiliated persons of the Manager or
the Subadviser, (3) the fees and certain expenses of the Custodian and Transfer
Agent, including the cost of providing records to the Manager in connection with
its obligation of maintaining required records of the Fund and of pricing the
Fund's shares, (4) the charges and expenses of legal counsel and independent
accountants for the Fund, (5) brokerage commissions and any issue or transfer
taxes chargeable to the Fund in connection with its securities transactions,
(6) all taxes and corporate fees payable by the Fund to governmental agencies,
(7) the fees of any trade associations of which the Fund may be a member,
(8) the cost of stock certificates representing shares of the Fund, (9) the cost
of fidelity and liability insurance, (10) the fees and expenses involved in
registering and maintaining registration of the Fund and of its shares with the
Commission and the states, including the preparation and printing of the Fund's
registration statements and prospectuses for such purposes, (11) allocable
communications expenses with respect to investor services and all expenses of
shareholders' and Directors' meetings and of preparing, printing and mailing
reports, proxy statements and prospectuses to shareholders in the amount
necessary for distribution to the shareholders, (12) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Fund's business, and (13) distribution fees.
The Management Agreement provides that the Manager will not be liable for
any error of judgment or for any loss suffered by the Fund in connection with
the matters to which the Management Agreement relates, except a loss resulting
from willful misfeasance, bad faith, gross negligence or reckless disregard of
duty. The Management Agreement provides that it will terminate automatically if
assigned (as defined in the Investment Company Act), and that it may be
terminated without penalty by either party upon not more than 60 days' nor less
than 30 days' written notice. The Management Agreement will continue in effect
for a period of more than two years from the date of execution only so long as
such continuance is specifically approved at least annually in conformity with
the Investment Company Act.
For the fiscal years ended September 30, 2000, 1999 and 1998, the Fund
incurred management fees of $4,574,665, $6,749,959 and $9,138,728, respectively.
PIFM has entered into an interim Subadvisory Agreement with Jennison, a
wholly-owned subsidiary of the Prudential Investment Corporation (PI). Jennison
furnishes investment advisory services in connection with the management of the
Fund. In connection therewith, Jennison is obligated to keep certain books and
records of the Fund. The Manager continues to have responsibility for all
investment advisory services pursuant to the Management Agreement and supervises
the Subadviser's performance of such services. PI was the Fund's subadviser
until August 23, 2000, and was reimbursed by the Manager for the reasonable
costs and expenses it incurred in furnishing investment advisory services.
Effective January 1, 2000, PI was paid by PIFM at the annual rate of .455 of 1%
of the Fund's average daily net assets. Jennison will be paid at this rate only
upon shareholder approval of a new Subadvisory Agreement. If shareholders do not
approve the new Subadvisory Agreement, Jennison will receive the lesser of the
subadvisory fees paid into escrow under the interim Subadvisory Agreement, plus
interest, or the costs incurred by Jennison in performing the interim
Subadvisory Agreement, plus interest.
If a new Subadvisory Agreement is approved by shareholders as described
above, it will provide that it will terminate in the event of its assignment (as
defined in the Investment Company Act) or upon the termination of the Management
Agreement. The interim Subadvisory Agreement will continue in effect for a
period of up to 150 days from its effectiveness on August 24, 2000 until a new
Subadvisory Agreement is approved by a majority of the Fund's outstanding voting
securities.
PRINCIPAL UNDERWRITER, DISTRIBUTOR AND RULE 12b-1 PLANS
Prudential Investment Management Services LLC (the Distributor), Gateway
Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, acts as the
distributor of shares of the Fund. See "How the Fund is Managed--Distributor" in
the Prospectus.
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively, the Plans) adopted by the Fund
under Rule 12b-1 under the Investment Company Act and a distribution agreement
(the
B-20
<PAGE>
Distribution Agreement), the Distributor incurs the expense of distributing the
Fund's Class A, Class B and Class C shares. The Distributor also incurs the
expenses of distributing the Fund's Class Z shares under the Distribution
Agreement, none of which are paid for or reimbursed by the Fund.
The expenses incurred under the Plans include commissions and account
servicing fees paid to, or on account of, brokers or financial institutions
which have entered into agreements with the Distributor, advertising expenses,
the cost of printing and mailing prospectuses to potential investors and
indirect and overhead costs of the Distributor associated with the sale of Fund
shares, including lease, utility, communications and sales promotion expenses.
Under the Plans, the Fund is obligated to pay distribution and/or service
fees to the Distributor as compensation for its distribution and service
activities, not as reimbursement for specific expenses incurred. If the
Distributor's expenses exceed its distribution and service fees, the Fund will
not be obligated to pay any additional expenses. If the Distributor's expenses
are less than such distribution and service fees, it will retain its full fees
and realize a profit.
The distribution and/or service fees may also be used by the Distributor to
compensate on a continuing basis brokers in consideration for the distribution,
marketing, administrative and other services and activities provided by brokers
with respect to the promotion of the sale of the Fund's shares and the
maintenance of related shareholder accounts.
CLASS A PLAN. Under the Class A Plan, the Fund may pay the Distributor for
its distribution-related expenses with respect to Class A shares at an annual
rate of up to .30 of 1% of the average daily net assets of the Class A shares.
The Class A Plan provides that (1) up to .25 of 1% of the average daily net
assets of the Class A shares may be used to pay for personal service and/or the
maintenance of shareholder accounts (service fee) and (2) total distribution
fees (including the service fee of .25 of 1%) may not exceed .30 of 1% of the
average daily net assets of the Class A shares. The Distributor has
contractually agreed to limit its distribution-related fees payable under the
Class A Plan to .25 of 1% of the average daily net assets of the Class A shares
for the fiscal year ending September 30, 2001 and contractually limited its
distribution-related fees for the fiscal year ended September 30, 2000 to .25 of
1% of the average daily net assets of the Class A shares.
For the fiscal year ended September 30, 2000, the Distributor received
payments of $711,702 under the Class A Plan and spent approximately $711,702 in
distributing the Fund's shares. This amount was primarily expended for payment
of account servicing fees to financial advisers and other persons who sell
Class A shares. For the fiscal year ended September 30, 2000, the Distributor
also received approximately $94,600 in initial sales charges.
CLASS B PLAN AND CLASS C PLANS. Under the Class B and Class C Plans, the
Fund pays the Distributor for its distribution-related expenses with respect to
Class B and Class C shares at an annual rate of 1% of the average daily net
assets of each of the Class B and Class C shares. The Class B and Class C Plans
provide for the payment to the Distributor of (1) an asset-based sales charge of
.75 of 1% of the average daily net assets of each of the Class B and Class C
shares, respectively, and (2) a service fee of .25 of 1% of the average daily
net assets of each of the Class B and Class C shares. The service fee is used to
pay for personal service and/or the maintenance of shareholder accounts. The
Distributor also receives contingent deferred sales charges from certain
redeeming shareholders and, with respect to Class C shares, an initial sales
charge.
CLASS B PLAN. For the fiscal year ended September 30, 2000, the Distributor
received $2,500,608 from the Fund under the Class B Plan and spent approximately
$1,309,900 in distributing the Class B shares. It is estimated that of the
latter amount, approximately 2.3% ($30,000) was spent on printing and mailing of
prospectuses to other than current shareholders; 25.0% ($327,200) was spent on
compensation to broker-dealers for commissions to its representatives and other
expenses, including an allocation on account of overhead and other branch office
distribution-related expenses, incurred for distribution of Class B shares; and
72.7% ($952,700) was spent on the aggregate of (1) payments of commissions and
account servicing fees to financial advisers (49.8% or $652,200) and (2) an
allocation on account of overhead and other branch office distribution-related
expenses (22.9% or $300,500). The term "overhead and other branch office
distribution-related expenses" represents (a) the expenses of operating
Prudential Securities' and Pruco Securities Corporation's (Prusec's) branch
offices in connection with the sale of Fund shares, including lease costs, the
salaries and employee benefits of operations and sales support personnel,
utility costs, communications costs and the costs of stationery and supplies,
(b) the costs of client sales seminars, (c) expenses of mutual fund sales
coordinators to promote the sale of Fund shares and (d) other incidental
expenses relating to branch promotion of Fund sales.
B-21
<PAGE>
The Distributor also receives the proceeds of contingent deferred sales
charges paid by investors upon certain redemptions of Class B shares. For the
fiscal year ended September 30, 2000, the Distributor received approximately
$919,700 in contingent deferred sales charges attributable to Class B shares.
CLASS C PLAN. For the fiscal year ended September 30, 2000, the Distributor
received $201,593 from the Fund under the Class C Plan and spent approximately
$189,400 in distributing the Fund's Class C shares. It is estimated that of the
latter amount, approximately 1.2% ($2,200) was spent on printing and mailing of
prospectuses to other than current shareholders; 0.8% ($1,600) was spent on
compensation to broker-dealers for commissions to representatives and other
expenses, including an allocation on account of overhead and other branch office
distribution-related expenses, incurred for distribution of Class C shares; and
98.0% ($185,600) was spent on the aggregate of (1) commission credits to
Prudential Securities branch offices, for payments of commissions and account
servicing fees to financial advisers (93.2% or $176,600) and (2) an allocation
on account of overhead and other branch office distribution-related expenses
(4.8% or $9,000).
The Distributor also receives an initial sales charge and the proceeds of
contingent deferred sales charges paid by investors upon certain redemptions of
Class C shares. For the fiscal year ended September 30, 2000, the Distributor
received approximately $19,100 in contingent deferred sales charges attributable
to Class C shares. For the fiscal year ended September 30, 2000, the Distributor
also received approximately $15,600 in initial sales charges attributable to
Class C shares.
Distribution expenses attributable to the sale of Class A, Class B or
Class C shares of the Fund will be allocated to each such class based upon the
ratio of sales of each such class to the sales of Class A, Class B and Class C
shares of the Fund other than expenses allocable to a particular class. The
distribution fee and sales charge of one class will not be used to subsidize the
sale of another class.
The Class A, Class B and Class C Plans continue in effect from year to year,
provided that each such continuance is approved at least annually by a vote of
the Board of Directors, including a majority vote of the Directors who are not
interested persons of the Fund and who have no direct or indirect financial
interest in the Class A, Class B and Class C Plan or in any agreement related to
the Plans (the Rule 12b-1 Directors), cast in person at a meeting called for the
purpose of voting on such continuance. The Plans may each be terminated at any
time, without penalty, by the vote of a majority of the Rule 12b-1 Directors or
by the vote of the holders of a majority of the outstanding shares of the
applicable class on not more than 30 days' written notice to any other party to
the Plans. The Plans may not be amended to increase materially the amounts to be
spent for the services described therein without approval by the shareholders of
the applicable class (by both Class A and Class B shareholders, voting
separately, in the case of material amendments to the Class A Plan), and all
material amendments are required to be approved by the Board of Directors in the
manner described above. Each Plan will automatically terminate in the event of
its assignment. The Fund will not be contractually obligated to pay expenses
incurred under any Plan if it is terminated or not continued.
Pursuant to each Plan, the Board of Directors will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of the Fund by the Distributor. The report will include an itemization
of the distribution expenses and the purposes of such expenditures. In addition,
as long as the Plans remain in effect, the selection and nomination of the
Rule 12b-1 Directors shall be committed to the Rule 12b-1 Directors.
Pursuant to the Distribution Agreement, the Fund has agreed to indemnify the
Distributor to the extent permitted by applicable law against certain
liabilities under federal securities laws.
In addition to distribution and service fees paid by the Fund under the
Class A, Class B and Class C Plans, the Manager (or one of its affiliates) may
make payments to dealers (including Prudential Securities) and other persons who
distribute shares of the Fund (including Class Z shares). Such payments may be
calculated by reference to the net asset value of shares sold by such persons or
otherwise.
FEE WAIVERS/SUBSIDIES
The Manager may from time to time waive all or a portion of its management
fee and subsidize all or a portion of the operating expenses of the Fund. In
addition, the Distributor has contractually agreed to waive a portion of its
distribution fees for the Class A shares as described above. Fee waivers and
subsidies will increase the Fund's total return.
B-22
<PAGE>
NASD MAXIMUM SALES CHARGE RULE
Pursuant to rules of the NASD, the Distributor is required to limit
aggregate initial sales charges, deferred sales charges and asset-based sales
charges to 6.25% of total gross sales of each class of shares. Interest charges
on unreimbursed distribution expenses equal to the prime rate plus one percent
per annum may be added to the 6.25% limitation. Sales from the reinvestment of
dividends and distributions are not included in the calculation of the 6.25%
limitation. The annual asset-based sales charge of the Fund may not exceed .75
of 1% per class. The 6.25% limitation applies to each class of the Fund rather
than on a per shareholder basis. If aggregate sales charges were to exceed 6.25%
of total gross sales of any class, all sales charges on shares of that class
would be suspended.
OTHER SERVICE PROVIDERS
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as Custodian for the portfolio securities of the
Fund and cash and in that capacity maintains certain financial and accounting
books and records pursuant to an agreement with the Fund. Subcustodians provide
custodial services for the Fund's foreign assets held outside the United States.
Prudential Mutual Fund Services LLC (PMFS), 194 Wood Avenue South, Iselin,
New Jersey 08830, serves as the Transfer and Dividend Disbursing Agent of the
Fund. PMFS is a wholly-owned subsidiary of PIFM. PMFS provides customary
transfer agency services to the Fund, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, payment of dividends and distributions and related
functions. For these services, PMFS receives an annual fee per shareholder
account of $10.00, a new account set-up fee for each manually established
account of $2.00 and a monthly inactive zero balance account fee per shareholder
account of $.20. PMFS is also reimbursed for its out-of-pocket expenses,
including but not limited to postage, stationery, printing, allocable
communication expenses and other costs.
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as the Fund's independent accountants, and in that capacity audits
the annual financial statements of the Fund.
CODES OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics. In
addition, the Manager, Subadviser and Distributor have each adopted a Code of
Ethics (the Codes). The Codes permit personnel subject to the Codes to invest in
securities, including securities that may be purchased or held by the Fund.
However, the protective provisions of the Codes prohibit certain investments and
limit such personnel from making investments during periods when the Fund is
making such investments. The Codes are on public file with, and are available
from, the Commission.
BROKERAGE ALLOCATION AND OTHER PRACTICES
The Manager is responsible for decisions to buy and sell securities, options
on securities and futures contracts for the Fund, the selection of brokers,
dealers and futures commission merchants to effect the transactions and the
negotiation of brokerage commissions, if any. For purposes of this section, the
term "Manager" includes the Subadviser. Purchases and sales of securities or
futures contracts on a securities exchange or board of trade are effected
through brokers or futures commission merchants who charge a commission for
their services. On foreign securities exchanges, commissions may be fixed.
Orders may be directed to any broker or futures commission merchant, including,
to the extent and in the manner permitted by applicable law, Prudential
Securities and its affiliates. Brokerage commissions on United States
securities, options and futures exchanges or boards of trade are subject to
negotiation between the Manager and the broker or futures commission merchant.
In the over-the-counter markets, securities are generally traded on a "net"
basis with dealers acting as principal for their own accounts without a stated
commission, although the price of the security usually includes a profit to the
dealer. In underwritten offerings, securities are purchased at a fixed price
which includes an amount of compensation to the underwriter, generally referred
to as the underwriter's concession or discount. On occasion, certain money
market instruments may be purchased directly from an issuer, in which case no
commissions or discounts are paid. The Fund will not deal with Prudential
Securities in any transaction in which Prudential Securities (or any affiliate)
acts as principal. Thus it will not deal in over-the-counter securities with
Prudential Securities acting as market maker, and it will not execute a
negotiated trade with Prudential Securities if execution involves Prudential
Securities acting as principal with respect to any part of the Fund's order.
B-23
<PAGE>
In placing orders for portfolio securities or futures contracts of the Fund,
the Manager's overriding objective is to obtain the best possible combination of
favorable price and efficient execution. The Manager seeks to effect each
transaction at a price and commission that provides the most favorable total
cost or proceeds reasonably attainable in the circumstances. The factors that
the Manager may consider in selecting a particular broker, dealer or futures
commission merchant (firms) are the Manager's knowledge of negotiated commission
rates currently available and other current transaction costs; the nature of the
portfolio transaction; the size of the transaction; the desired timing of the
trade; the activity existing and expected in the market for the particular
transaction; confidentiality; the execution, clearance and settlement
capabilities of the firms; the availability of research and research related
services provided through such firms; the Manager's knowledge of the financial
stability of the firms; the Manager's knowledge of actual or apparent
operational problems of firms; and the amount of capital, if any, that would be
contributed by firms executing the transaction. Given these factors, the Fund
may pay transaction costs in excess of that which another firm might have
charged for effecting the same transaction.
When the Manager selects a firm that executes orders or is a party to
portfolio transactions, relevant factors taken into consideration are whether
that firm has furnished research and research products and/or services, such as
research reports, research compilations, statistical and economic data, computer
data bases, quotation equipment and services, research oriented computer
software, hardware and services, reports concerning the performance of accounts,
valuations of securities, investment related periodicals, investment seminars
and other economic services and consultants. Such services are used in
connection with some or all of the Manager's investment activities; some of such
services, obtained in connection with the execution of transactions for one
investment account, may be used in managing other accounts, and not all of these
services may be used in connection with the Fund.
The Manager maintains an internal allocation procedure to identity those
firms who have provided it with research and research related products and/or
services, and the amount that was provided, and to endeavor to direct sufficient
commissions to them to ensure the continued receipt of those services that the
Manager believes provides a benefit to the Fund and its other clients. The
Manager makes a good faith determination that the research and/or service is
reasonable in light of the type of service provided and the price and execution
of the related portfolio transactions.
When the Manager deems the purchase or sale of equities to be in the best
interests of the Fund or its other clients, including Prudential, the Manager
may, but is under no obligation to, aggregate the transactions in order to
obtain the most favorable price or lower brokerage commissions and efficient
execution. In such event, allocation of the transactions, as well as the
expenses incurred in the transaction, will be made by the Manager in the manner
it considers to be most equitable and consistent with its fiduciary obligations
to its clients.
The allocation of orders among firms and the commission rates paid are
reviewed periodically by the Fund's Board of Directors. Portfolio securities may
not be purchased from any underwriting or selling syndicate of which Prudential
Securities or any affiliate, during the existence of the syndicate, is a
principal underwriter (as defined in the Investment Company Act), except in
accordance with rules of the Commission. This limitation, in the opinion of the
Fund, will not significantly affect the Fund's ability to pursue its present
investment objective. However, in the future in other circumstances, the Fund
may be at a disadvantage because of this limitation in comparison to other funds
with similar objectives but not subject to such limitations.
Subject to the above considerations, the Manager may use Prudential
Securities as a securities broker or futures commission merchant for the Fund.
In order for Prudential Securities (or any affiliate) to effect any portfolio
transactions for the Fund, the commissions, fees or other remuneration received
by Prudential Securities (or any affiliate) must be reasonable and fair compared
to the commissions, fees or other remuneration paid to other firms or futures
commission merchants in connection with comparable transactions involving
similar securities or futures being purchased or sold on an exchange or board of
trade during a comparable period of time. This standard would allow Prudential
Securities (or any affiliate) to receive no more than the remuneration which
would be expected to be received by an unaffiliated firm or futures commission
merchant in a commensurate arm's-length transaction. Furthermore, the Board of
Directors of the Fund, including a majority of the non-interested Directors, has
adopted procedures which are reasonably designed to provide that any
commissions, fees or other remuneration paid to Prudential Securities (or any
affiliate) are consistent with the foregoing standard. In accordance with
Section 11(a) of the Securities Exchange Act of 1934, Prudential Securities may
not retain compensation for effecting transactions on a national securities
exchange for the Fund unless the Fund has expressly authorized the retention of
such compensation. Prudential Securities must furnish to the Fund at least
annually a statement setting forth the total amount of all
B-24
<PAGE>
compensation retained by Prudential Securities from transactions effected for
the Fund during the applicable period. Brokerage and futures transactions with
Prudential Securities (or any affiliate) also are subject to such fiduciary
standards as may be imposed upon Prudential Securities (or such affiliate) by
applicable law.
The table presented below shows certain information regarding the payment of
commissions by the Fund, including the amount of such commissions paid to
Prudential Securities for the three-year period ended September 30, 2000.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
2000 1999 1998
---------- ---------- ----------
<S> <C> <C> <C>
Total brokerage commissions paid by the Fund................ $2,682,638 $2,516,963 $1,812,871
Total brokerage commissions paid to Prudential Securities... $ 12,515 $ 5,118 $ 2,049
Percentage of total brokerage commissions paid to Prudential
Securities................................................. .47% .20% .11%
</TABLE>
Of the total brokerage commissions paid by the Fund for the fiscal year
ended September 30, 2000, $324,685 (8.41% of gross brokerage transactions) was
paid to firms which provided research, statistical or other services provided to
the Manager on behalf of the Fund. The Manager has not separately identified a
portion of such brokerage commissions as applicable to the provision of such
research, statistical or other services.
The Fund is required to disclose its holdings of securities of its regular
brokers and dealers (as defined under Rule 10b-1 of the Investment Company Act)
and their parents at September 30, 2000. As of September 30, 2000, the Fund held
securities of Bear Stearns & Co. Inc., Credit Suisse First Boston Corp., Salomon
Smith Barney, Inc., and UBS Warburg, Inc., in the amount of $5,141,497,
$3,427,665, $1,679,384 and $5,141,497, respectively.
CAPITAL SHARES, OTHER SECURITIES AND ORGANIZATION
The Fund is authorized to issue 1 billion shares of common stock, $.01 par
value per share divided into four classes, designated Class A, Class B, Class C
and Class Z shares. Class A, Class B, Class C and Class Z shares each consist of
250 million authorized shares. Each class of common stock represents an interest
in the same assets of the Fund and is identical in all respects except that
(1) each class is subject to different sales charges and distribution and/or
service fees (except for Class Z shares, which are not subject to any sales
charges and distribution and/or service fees), which may affect performance,
(2) each class has exclusive voting rights on any matter submitted to
shareholders that relates solely to its arrangement and has separate voting
rights on any matter submitted to shareholders in which the interests of one
class differ from the interests of any other class, (3) each class has a
different exchange privilege, (4) only Class B shares have a conversion feature
and (5) Class Z shares are offered exclusively for sale to a limited group of
investors. In accordance with the Fund's Articles of Incorporation, the
Directors may authorize the creation of additional series and classes within
such series, with such preferences, privileges, limitations and voting and
dividend rights as the Directors may determine. The voting rights of the
shareholders of a series or class can be modified only by the majority vote of
shareholders of that series or class.
Shares of the Fund, when issued, are fully paid, nonassessable, fully
transferable and redeemable at the option of the holder. Shares are also
redeemable at the option of the Fund under certain circumstances. Each share of
each class is equal as to earnings, assets and voting privileges, except as
noted above, and each class of shares (with the exception of Class Z shares,
which are not subject to any distribution or service fees) bears the expenses
related to the distribution of its shares. Except for the conversion feature
applicable to the Class B shares, there are no conversion, preemptive or other
subscription rights. In the event of liquidation, each share of the Fund is
entitled to its portion of all of the Fund's assets after all debt and expenses
of the Fund have been paid. Since Class B and Class C shares generally bear
higher distribution expenses than Class A shares, the liquidation proceeds to
shareholders of those classes are likely to be lower than to Class A
shareholders and to Class Z shareholders, whose shares are not subject to any
distribution and/or service fees.
The Fund does not intend to hold annual meetings of shareholders unless
otherwise required by law. The Fund will not be required to hold meetings of
shareholders unless, for example, the election of Directors is required to be
acted on by shareholders under the Investment Company Act. Shareholders have
certain rights, including the right to call a meeting upon the vote of 10% of
the Fund's outstanding shares for the purpose of voting on the removal of one or
more Directors or to transact any other business.
Under the Articles of Incorporation, the Directors may authorize the
creation of additional series of shares (the proceeds of which would be invested
in separate, independently managed portfolios with distinct investment
objectives and policies and share purchase, redemption and net asset value
procedures) with such preferences, privileges, limitations and voting and
B-25
<PAGE>
dividend rights as the Directors may determine. All consideration received by
the Fund for shares of any additional series, and all assets in which such
consideration is invested, would belong to that series (subject only to the
rights of creditors of that series) and would be subject to the liabilities
related thereto. Under the Investment Company Act, shareholders of any
additional series of shares would normally have to approve the adoption of any
advisory contract relating to such series and of any changes in the investment
policies related therein. The Directors do not intend to authorize the creation
of additional series at the present time.
The Directors have the power to alter the number and the terms of office of
the Directors and they may at any time lengthen their own terms or make their
terms of unlimited duration and appoint their own successors, provided that
always at least a majority of the Directors have been elected by the
shareholders of the Fund. The voting rights of shareholders are not cumulative,
so that holders of more than 50 percent of the shares voting can, if they
choose, elect all Directors being selected, while the holders of the remaining
shares would be unable to elect any Directors.
PURCHASE, REDEMPTION AND PRICING OF FUND SHARES
Shares of the Fund may be purchased at a price equal to the next determined
NAV per share plus a sales charge which, at the election of the investor, may be
imposed either (1) at the time of purchase (Class A or Class C shares) or
(2) on a deferred basis (Class B or Class C shares). Class Z shares of the Fund
are offered to a limited group of investors at NAV without any sales charges.
PURCHASE BY WIRE
For an initial purchase of shares of the Fund by wire, you must complete an
application and telephone PMFS to receive an account number at (800) 225-1852
(toll-free). The following information will be requested: your name, address,
tax identification number, fund and class election, dividend distribution
election, amount being wired and wiring bank. Instructions should then be given
by you to your bank to transfer funds by wire to State Street Bank and Trust
Company (State Street), Boston, Massachusetts, Custody and Shareholder Services
Division, Attention: Prudential Small Company Fund, Inc., specifying on the wire
the account number assigned by PMFS and your name and identifying the class in
which you are investing (Class A, Class B, Class C or Class Z shares).
If you arrange for receipt by State Street of Federal Funds prior to the
calculation of NAV (4:15 P.M., New York time) on a business day, you may
purchase shares of the Fund as of that day.
In making a subsequent purchase order by wire, you should wire State Street
directly and should be sure that the wire specifies Prudential Small Company
Fund, Inc., Class A, Class B, Class C or Class Z shares and your name and
individual account number. It is not necessary to call PMFS to make subsequent
purchase orders utilizing Federal Funds. The minimum amount which may be
invested by wire is $1,000.
ISSUANCE OF FUND SHARES FOR SECURITIES
Transactions involving the issuance of Fund shares for securities (rather
than cash) will be limited to: (1) reorganizations, (2) statutory mergers, or
(3) other acquisitions of portfolio securities that (a) meet the investment
objective and policies of the Fund, (b) are liquid and not subject to
restrictions on resale, (c) have a value that is readily ascertainable via
listing on or trading in a recognized United States or international exchange of
market, and (d) are approved by the Fund's investment adviser.
B-26
<PAGE>
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares are sold at a maximum sales charge of 5%, Class C*
shares are sold with a 1% sales charge, and Class B* and Class Z shares are sold
at NAV. Using the Fund's NAV at September 30, 2000, the maximum offering price
of the Fund's shares is as follows:
<TABLE>
<S> <C>
CLASS A
Net asset value and redemption price per Class A share...... $14.52
Maximum sales charge (5% of offering price)................. .76
------
Maximum offering price to public............................ $15.28
======
CLASS B
Net asset value, offering price and redemption price per
Class B share*............................................. $12.97
======
CLASS C
Net asset value, offering price and redemption price per
Class C share*............................................. $12.97
Sales charge (1% of offering price)......................... .13
------
Offering price to public.................................... $13.10
======
CLASS Z
Net asset value, offering price and redemption price per
Class Z share.............................................. $14.74
======
--------------------
* Class B and Class C shares are subject to a
contingent deferred sales charge on certain
redemptions.
</TABLE>
SELECTING A PURCHASE ALTERNATIVE
The following is provided to assist you in determining which method of
purchase best suits your individual circumstances and is based on current fees
and expenses being charged to the Fund:
If you intend to hold your investment in a Fund for less than 4 years and do
not qualify for a reduced sales charge on Class A shares, since Class A shares
are subject to an initial sales charge of 5% and Class B shares are subject to a
CDSC of 5% which declines to zero over a 6 year period, you should consider
purchasing Class C shares over either Class A or Class B shares.
If you intend to hold your investment for longer than 4 years, but less than
5 years, and do not qualify for a reduced sales charge on Class A shares, you
should consider purchasing Class B or Class C shares over Class A shares. This
is because the initial sales charge plus the cumulative annual
distribution-related fee on Class A shares would exceed those of the Class B and
Class C shares if you redeem your investment during this time period. In
addition, more of your money would be invested initially in the case of Class C
shares, because of the relatively low initial sales charge, and all of your
money would be invested initially in the case of Class B shares, which are sold
at NAV.
If you intend to hold your investment for longer than 5 years, you should
consider purchasing Class A shares over either Class B or Class C shares. This
is because the maximum sales charge plus the cumulative annual
distribution-related fee on Class A shares would be less than those of the
Class B and Class C shares.
If you qualify for a reduced sales charge on Class A shares, it may be more
advantageous for you to purchase Class A shares over either Class B or Class C
shares regardless of how long you intend to hold your investment. However,
unlike Class B shares, you would not have all of your money invested initially
because the sales charge on Class A shares is deducted at the time of purchase.
If you do not qualify for a reduced sales charge on Class A shares and you
purchase Class B or Class C shares, you would have to hold your investment for
more than 6 years in the case of Class B shares and for more than 5 years in the
case of Class C shares for the higher cumulative annual distribution-related fee
on those shares plus, in the case of Class C shares, the 1% initial sales charge
to exceed the initial sales charge plus the cumulative annual
distribution-related fees on Class A shares. This does not take into account the
time value of money, which further reduces the impact of the higher Class B or
Class C distribution-related fee on the investment, fluctuations in NAV, the
effect of the return on the investment over this period of time or redemptions
when the CDSC is applicable.
B-27
<PAGE>
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
BENEFIT PLANS. Certain group retirement and savings plans may purchase
Class A shares without the initial sales charge if they meet the required
minimum for amount of assets, average account balance or number of eligible
employees. For more information about these requirements, call Prudential at
(800) 353-2847.
OTHER WAIVERS. In addition, Class A shares may be purchased at NAV, without
the initial sales charge, through the Distributor or the Transfer Agent, by:
- Officers of the Prudential mutual funds (including the Fund)
- Employees of the Distributor, Prudential Securities, the Manager and their
subsidiaries and members of the families of such persons who maintain an
"employee related" account at Prudential Securities or the Transfer Agent
- Employees of subadvisers of the Prudential mutual funds provided that
purchases at NAV are permitted by such person's employer
- Prudential, employees and special agents of Prudential and its
subsidiaries and all persons who have retired directly from active service
with Prudential or one of its subsidiaries
- Members of the Board of Directors of Prudential
- Real estate brokers, agents and employees of real estate brokerage
companies affiliated with The Prudential Real Estate Affiliates who
maintain an account at Prudential Securities, Prusec or with the Transfer
Agent
- Registered representatives and employees of brokers who have entered into
a selected dealer agreement with the Distributor provided that purchases at
NAV are permitted by such person's employer
- Investors who have a business relationship with a financial adviser who
joined Prudential Securities from another investment firm, provided that
(1) the purchase is made within 180 days of the commencement of the
financial adviser's employment at Prudential Securities, or within one year
in the case of Benefit Plans, (2) the purchase is made with proceeds of a
redemption of shares of any open-end non-money market fund sponsored by the
financial adviser's previous employer (other than a fund which imposes a
distribution or service fee of .25 of 1% or less) and (3) the financial
adviser served as the client's broker on the previous purchase
- Investors in Individual Retirement Accounts, provided the purchase is made
in a directed rollover to such Individual Retirement Account or with the
proceeds of a tax-free rollover of assets from a Benefit Plan for which
Prudential provides administrative or recordkeeping services and further
provided that such purchase is made within 60 days of receipt of the
Benefit Plan distribution
- Orders placed by broker-dealers, investment advisers or financial planners
who have entered into an agreement with the Distributor, who place trades
for their own accounts or the accounts of their clients and who charge a
management, consulting or other fee for their services (for example, mutual
fund "wrap" or asset allocation programs) and
- Orders placed by clients of broker-dealers, investment advisers or
financial planners who place trades for customer accounts if the accounts
are linked to the master account of such broker-dealer, investment adviser
or financial planner and the broker-dealer, investment adviser or financial
planner charges the clients a separate fee for its services (for example,
mutual fund "supermarket" programs).
Broker-dealers, investment advisers or financial planners sponsoring
fee-based programs (such as mutual fund "wrap" or asset allocation programs and
mutual fund "supermarket" programs) may offer their clients more than one class
of shares in the Fund in connection with different pricing options for their
programs. Investors should consider carefully any separate transaction and other
fees charged by these programs in connection with investing in each available
share class before selecting a share class.
For an investor to obtain any reduction or waiver of the initial sales
charges, at the time of the sale either the Transfer Agent must be notified
directly by the investor or the Distributor must be notified by the broker
facilitating the transaction that the sale qualifies for the reduced or waived
sales charge. The reduction or waiver will be granted subject to confirmation of
your entitlement. No initial sales charges are imposed upon Class A shares
acquired upon the reinvestment of dividends and distributions.
B-28
<PAGE>
COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential mutual funds, the purchases
may be combined to take advantage of the reduced sales charges applicable to
larger purchases. See the table of breakpoints under "How to Buy, Sell and
Exchange Shares of the Fund--How to Buy Shares--Reducing or Waiving Class A's
Initial Sales Charge" in the Prospectus.
An eligible group of related Fund investors includes any combination of the
following:
- An individual
- The individual's spouse, their children and their parents
- The individual's and spouse's Individual Retirement Account (IRA)
- Any company controlled by the individual (a person, entity or group that
holds 25% or more of the outstanding voting securities of a corporation
will be deemed to control the corporation, and a partnership will be deemed
to be controlled by each of its general partners)
- A trust created by the individual, the beneficiaries of which are the
individual, his or her spouse, parents or children
- A Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account
created by the individual or the individual's spouse and
- One or more employee benefit plans of a company controlled by an
individual.
Also, an eligible group of related Fund investors may include an employer
(or group of related employers) and one or more qualified retirement plans of
such employer or employers (an employer controlling, controlled by or under
common control with another employer is deemed related to that employer).
The Transfer Agent, the Distributor or your broker must be notified at the
time of purchase that the investor is entitled to a reduced sales charge. The
reduced sales charges will be granted subject to confirmation of the investor's
holdings. The Combined Purchase and Cumulative Purchase Privilege does not apply
to individual participants in any retirement or group plans.
LETTERS OF INTENT. Reduced sales charges also are available to investors
(or an eligible group of related investors) who enter into a written Letter of
Intent providing for the purchase, within a thirteen-month period, of shares of
the Fund and shares of other Prudential mutual funds (Investment Letter of
Intent). Retirement and group plans no longer qualify to purchase Class A shares
at NAV by entering into a Letter of Intent.
For purposes of the Investment Letter of Intent, all shares of the Fund and
shares of other Prudential mutual funds (excluding money market funds other than
those acquired pursuant to the exchange privilege) which were previously
purchased and are still owned are also included in determining the applicable
reduction. However, the value of shares held directly with the Transfer Agent or
its affiliates and through your broker will not be aggregated to determine the
reduced sales charge.
An Investment Letter of Intent permits a purchaser to establish a total
investment goal to be achieved by any number of investments over a
thirteen-month period. Each investment made during the period will receive the
reduced sales charge applicable to the amount represented by the goal, as if it
were a single investment. Escrowed Class A shares totaling 5% of the dollar
amount of the Letter of Intent will be held by the Transfer Agent in the name of
the investor. The effective date of an Investment Letter of Intent may be
back-dated up to 90 days, in order that any investments made during this 90-day
period, valued at the investor's cost, can be applied to the fulfillment of the
Letter of Intent goal.
The Investment Letter of Intent does not obligate the investor to purchase,
nor the Fund to sell, the indicated amount. In the event the Letter of Intent
goal is not satisfied within the thirteen-month period, the investor is required
to pay the difference between the sales charge otherwise applicable to the
purchases made during this period and sales charge actually paid. Such payment
may be made directly to the Distributor or, if not paid, the Distributor will
liquidate sufficient escrowed shares to obtain such difference. If the goal is
exceeded in an amount which qualifies for a lower sales charge, a price
adjustment is made by refunding to the investor the amount of excess sales
charge, if any, paid during the thirteen-month period. Investors electing to
purchase Class A shares of the Fund pursuant to a letter of intent should
carefully read such letter of intent.
B-29
<PAGE>
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charge will be granted
subject to confirmation of the investor's holdings. Letters of Intent are not
available to individual participants in any retirement or group plans.
CLASS B SHARES
The offering price of Class B shares for investors choosing one of the
deferred sales charge alternatives is the NAV next determined following receipt
of an order in proper form by the Transfer Agent, your broker or the
Distributor. Although there is no sales charge imposed at the time of purchase,
redemptions of Class B shares may be subject to a CDSC. See "Sale of Shares--
Contingent Deferred Sales Charge" below.
The Distributor will pay, from its own resources, sales commissions of up to
4% of the purchase price of Class B shares to brokers, financial advisers and
other persons who sell Class B shares at the time of sale. This facilitates the
ability of the Fund to sell the Class B shares without an initial sales charge
being deducted at the time of purchase. The Distributor anticipates that it will
recoup its advancement of sales commissions from the combination of the CDSC and
the distribution fee.
CLASS C SHARES
The offering price of Class C shares is the next determined NAV plus a 1%
sales charge. In connection with the sale of Class C shares, the Distributor
will pay, from its own resources, brokers, financial advisers and other persons
which distribute Class C shares a sales commission of up to 2% of the purchase
price at the time of the sale.
WAIVER OF INITIAL SALES CHARGE--CLASS C SHARES
BENEFIT PLANS. Certain group retirement plans may purchase Class C shares
without the initial sales charge. For more information, call Prudential at
(800) 353-2847.
INVESTMENT OF REDEMPTION PROCEEDS FROM OTHER INVESTMENT
COMPANIES. Investors may purchase Class C shares at NAV, without the initial
sales charge, with the proceeds from the redemption of shares of any
unaffiliated registered investment company which were not held through an
account with any Prudential affiliate. Such purchases must be made within
60 days of the redemption. Investors eligible for this waiver include:
(1) investors purchasing shares through an account at Prudential Securities;
(2) investors purchasing shares through an ADVANTAGE Account or an Investor
Account with Prusec; and (3) investors purchasing shares through other brokers.
This waiver is not available to investors who purchase shares directly from the
Transfer Agent. You must notify the Transfer Agent directly or through your
broker if you are entitled to this waiver and provide the Transfer Agent with
such supporting documents as it may deem appropriate.
CLASS Z SHARES
BENEFIT PLANS. Certain group retirement plans may purchase Class Z shares
if they meet the required minimum for amount of assets, average account balance
or number of eligible employees. For more information about these requirements,
call Prudential at (800) 353-2847.
MUTUAL FUND PROGRAMS. Class Z shares also can be purchased by participants
in any fee-based program or trust program sponsored by Prudential or an
affiliate that includes the Fund as an available option. Class Z shares also can
be purchased by investors in certain programs sponsored by broker-dealers,
investment advisers and financial planners who have agreements with Prudential
Investments Advisory Group relating to:
- Mutual fund "wrap" or asset allocation programs where the sponsor places
Fund trades, links its clients' accounts to a master account in the
sponsor's name and charges its clients a management, consulting or other
fee for its services, or
- Mutual fund "supermarket" programs where the sponsor links its clients'
accounts to a master account in the sponsor's name and the sponsor charges
a fee for its services.
Broker-dealers, investment advisers or financial planners sponsoring these
mutual fund programs may offer their clients more than one class of shares in
the Fund in connection with different pricing options for their programs.
Investors should consider carefully any separate transaction and other fees
charged by these programs in connection with investing in each available share
class before selecting a share class.
B-30
<PAGE>
OTHER TYPES OF INVESTORS. Class Z shares also are available for purchase by
the following categories of investors:
- Certain participants in the MEDLEY Program (group variable annuity
contracts) sponsored by Prudential for whom Class Z shares of the
Prudential mutual funds are an available option
- Current and former Directors/Trustees of the Prudential mutual funds
(including the Fund) or
- Prudential, with an investment of $10 million or more.
In connection with the sale of Class Z shares, the Manager, the Distributor
or one of their affiliates may pay brokers, financial advisers and other persons
which distribute shares a finder's fee, from its own resources, based on a
percentage of the net asset value of shares sold by such persons.
RIGHTS OF ACCUMULATION
Reduced sales charges also are available through rights of accumulation,
under which an investor or an eligible group of related investors, as described
above under "Combined Purchase and Cumulative Purchase Privilege," may aggregate
the value of their existing holdings of shares of the Fund and shares of other
Prudential mutual funds (excluding money market funds other than those acquired
pursuant to the exchange privilege) to determine the reduced sales charge.
Rights of accumulation may be applied across the classes of shares of the
Prudential mutual funds. However, the value of shares held directly with the
Transfer Agent and through your broker will not be aggregated to determine the
reduced sales charge. The value of existing holdings for purposes of determining
the reduced sales charge is calculated using the maximum offering price (NAV
plus maximum sales charge) as of the previous business day.
The Distributor or the Transfer Agent must be notified at the time of
purchase that the investor is entitled to a reduced sales charge. The reduced
sales charge will be granted subject to confirmation of the investor's holdings.
Rights of accumulation are not available to individual participants in any
retirement or group plans.
SALE OF SHARES
You can redeem your shares at any time for cash at the NAV next determined
after the redemption request is received in proper form (in accordance with
procedures established by the Transfer Agent in connection with investors'
accounts) by the Transfer Agent, the Distributor or your broker. In certain
cases, however, redemption proceeds will be reduced by the amount of any
applicable CDSC, as described below. See "Contingent Deferred Sales Charge"
below. If you are redeeming your shares through a broker, your broker must
receive your sell order before the Fund computes its NAV for that day (that is,
4:15 p.m., New York time) in order to receive that day's NAV. Your broker will
be responsible for furnishing all necessary documentation to the Distributor and
may charge you for its services in connection with redeeming shares of the Fund.
If you hold shares of the Fund through Prudential Securities, you must
redeem your shares through Prudential Securities. Please contact your Prudential
Securities financial adviser.
If you hold shares in non-certificate form, a written request for redemption
signed by you exactly as the account is registered is required. If you hold
certificates, the certificates must be received by the Transfer Agent, the
Distributor or your broker in order for the redemption request to be processed.
If redemption is requested by a corporation, partnership, trust or fiduciary,
written evidence of authority acceptable to the Transfer Agent must be submitted
before such request will be accepted. All correspondence and documents
concerning redemptions should be sent to the Fund in care of its Transfer Agent,
Prudential Mutual Fund Services LLC, Attention: Redemption Services, P.O. Box
8149, Philadelphia, Pennsylvania 19101, the Distributor, or to your broker.
SIGNATURE GUARANTEE. If the proceeds of the redemption (1) exceed $100,000,
(2) are to be paid to a person other than the record owner, (3) are to be sent
to an address other than the address on the Transfer Agent's records, or (4) are
to be paid to a corporation, partnership, trust or fiduciary, and your shares
are held directly with the Transfer Agent, the signature(s) on the redemption
request and on the certificates, if any, or stock power must be guaranteed by an
"eligible guarantor institution." An "eligible guarantor institution" includes
any bank, broker, dealer or credit union. The Transfer Agent reserves the right
to request additional information from, and make reasonable inquiries of, any
eligible guarantor institution. For clients of Prusec, a signature guarantee may
be obtained from the agency or office manager of most Prudential Insurance and
Financial Services or Preferred
B-31
<PAGE>
Services offices. In the case of redemptions from a PruArray Plan, if the
proceeds of the redemption are invested in another investment option of the plan
in the name of the record holder and at the same address as reflected in the
Transfer Agent's records, a signature guarantee is not required.
Payment for shares presented for redemption will be made by check within
seven days after receipt by the Transfer Agent, the Distributor or your broker
of the certificate and/or written request, except as indicated below. If you
hold shares through a broker, payment for shares presented for redemption will
be credited to your account at your broker, unless you indicate otherwise. Such
payment may be postponed or the right of redemption suspended at times (1) when
the New York Stock Exchange is closed for other than customary weekends and
holidays, (2) when trading on such Exchange is restricted, (3) when an emergency
exists as a result of which disposal by the Fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the Fund
fairly to determine the value of its net assets, or (4) during any other period
when the Commission, by order, so permits; provided that applicable rules and
regulations of the Commission shall govern as to whether the conditions
prescribed in (2), (3) or (4) exist.
REDEMPTION IN KIND. If the Board of Directors determines that it would be
detrimental to the best interests of the remaining shareholders of the Fund to
make payment wholly or partly in cash, the Fund may pay the redemption price in
whole or in part by a distribution in kind of securities from the investment
portfolio of the Fund, in lieu of cash, in conformity with applicable rules of
the Commission. Securities will be readily marketable and will be valued in the
same manner as in a regular redemption. If your shares are redeemed in kind, you
would incur transaction costs in converting the assets into cash. The Fund,
however, has elected to be governed by Rule 18f-1 under the Investment Company
Act, under which the Fund is obligated to redeem shares solely in cash up to the
lesser of $250,000 or 1% of the NAV of the Fund during any 90-day period for any
one shareholder.
INVOLUNTARY REDEMPTION. In order to reduce expenses of the Fund, the Board
of Directors may redeem all of the shares of any shareholder, other than a
shareholder which is an IRA or other tax-deferred retirement plan, whose account
has a net asset value of less than $500 due to a redemption. The Fund will give
such shareholders 60 days' prior written notice in which to purchase sufficient
additional shares to avoid such redemption. No CDSC will be imposed on any such
involuntary redemption.
90-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not
previously exercised the repurchase privilege, you may reinvest any portion or
all of the proceeds of such redemption in shares of the same Fund at the NAV
next determined after the order is received, which must be within 90 days after
the date of the redemption. Any CDSC paid in connection with such redemption
will be credited (in shares) to your account. (If less than a full repurchase is
made, the credit will be on a PRO RATA basis.) You must notify the Transfer
Agent, either directly or through the Distributor or your broker, at the time
the repurchase privilege is exercised to adjust your account for the CDSC you
previously paid. Thereafter, any redemptions will be subject to the CDSC
applicable at the time of the redemption. See "Contingent Deferred Sales Charge"
below. Exercise of the repurchase privilege will generally not affect federal
tax treatment of any gain realized upon redemption. However, if the redemption
was made within a 30 day period of the repurchase and if the redemption resulted
in a loss, some or all of the loss, depending on the amount reinvested, may not
be allowed for federal income tax purposes.
CONTINGENT DEFERRED SALES CHARGE
Redemptions of Class B shares will be subject to a contingent deferred sales
charge or CDSC declining from 5% to zero over a six-year period. Class C shares
redeemed within 18 months of purchase (one year in the case of shares purchased
before November 2, 1998) will be subject to a 1% CDSC. The CDSC will be deducted
from the redemption proceeds and reduce the amount paid to you. The CDSC will be
imposed on any redemption by you which reduces the current value of your
Class B or Class C shares to an amount which is lower than the amount of all
payments by you for shares during the preceding six years, in the case of
Class B shares, and 18 months, in the case of Class C shares (one year for
Class C shares purchased before November 2, 1998). A CDSC will be applied on the
lesser of the original purchase price or the current value of the shares being
redeemed. Increases in the value of your shares or shares acquired through
reinvestment of dividends or distributions are not subject to a CDSC. The amount
of any CDSC will be paid to and retained by the Distributor.
The amount of the CDSC, if any, will vary depending on the number of years
from the time of payment for the purchase of shares until the time of redemption
of such shares. Solely for purposes of determining the number of years from the
time of any payment for the purchase of shares, all payments during a month will
be aggregated and deemed to have been made on the last day of the month. The
CDSC will be calculated from the first day of the month after the initial
purchase, excluding the time shares were held in a money market fund.
B-32
<PAGE>
The following table sets forth the rates of the CDSC applicable to
redemption of Class B shares:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES
CHARGE AS A PERCENTAGE
YEAR SINCE PURCHASE OF DOLLARS INVESTED OR
PAYMENT MADE REDEMPTION PROCEEDS
------------ -------------------------
<S> <C>
First....................................................... 5.0%
Second...................................................... 4.0%
Third....................................................... 3.0%
Fourth...................................................... 2.0%
Fifth....................................................... 1.0%
Sixth....................................................... 1.0%
Seventh..................................................... None
</TABLE>
In determining whether a CDSC is applicable to a redemption, the calculation
will be made in a manner that results in the lowest possible rate. It will be
assumed that the redemption is made first of amounts representing shares
acquired pursuant to the reinvestment of dividends and distributions; then of
amounts representing the increase in NAV above the total amount of payments for
the purchase of Class B shares made during the preceding six years (five years
for Class B shares purchased prior to January 22, 1990) and 18 months for
Class C shares (one year for Class C shares bought before November 2, 1998);
then of amounts representing the cost of shares held beyond the applicable CDSC
period; then of amounts representing the cost of Class B shares acquired prior
to July 1, 1985; and finally, of amounts representing the cost of shares held
for the longest period of time within the applicable CDSC period.
For example, assume you purchased 100 Class B shares at $10 per share for a
cost of $1,000. Subsequently, you acquired 5 additional Class B shares through
dividend reinvestment. During the second year after the purchase you decide to
redeem $500 of your investment. Assuming at the time of the redemption the NAV
had appreciated to $12 per share, the value of your Class B shares would be
$1,260 (105 shares at $12 per share). The CDSC would not be applied to the value
of the reinvested dividend shares and the amount which represents appreciation
($260). Therefore, $240 of the $500 redemption proceeds ($500 minus $260) would
be charged at a rate of 4% (the applicable rate in the second year after
purchase) for a total CDSC of $9.60.
For federal income tax purposes, the amount of the CDSC will reduce the
gain, or increase the loss, as the case may be, on the amount recognized on the
redemption of shares.
WAIVER OF CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES. The CDSC will
be waived in the case of a redemption following the death or disability of a
shareholder or, in the case of a trust account, following the death or
disability of the grantor. The waiver is available for total or partial
redemptions of shares owned by a person, either individually or in joint
tenancy, at the time of death or initial determination of disability, provided
that the shares were purchased prior to death or disability.
The CDSC also will be waived in the case of a total or partial redemption in
connection with certain distributions made without penalty under the Internal
Revenue Code from a tax-deferred retirement plan, an IRA or Section 403(b)
custodial account. For more information, call Prudential at (800) 353-2847.
Finally, the CDSC will be waived to the extent that the proceeds from shares
redeemed are invested in Prudential mutual funds, The Guaranteed Investment
Account, the Guaranteed Insulated Separate Account or units of The Stable Value
Fund.
SYSTEMATIC WITHDRAWAL PLAN. The CDSC will be waived (or reduced) on certain
redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12% of
the total dollar amount subject to the CDSC may be redeemed without charge. The
Transfer Agent will calculate the total amount available for this waiver
annually on the anniversary date of your purchase. The CDSC will be waived (or
reduced) on redemptions until this threshold 12% is reached.
In addition, the CDSC will be waived on redemptions of shares held by
Directors of the Fund.
B-33
<PAGE>
You must notify the Fund's Transfer Agent either directly or through your
broker at the time of redemption, that you are entitled to waiver of the CDSC
and provide the Transfer Agent with such supporting documentation as it may deem
appropriate. The waiver will be granted subject to confirmation of your
entitlement. In connection with these waivers, the Transfer Agent will require
you to submit the supporting documentation set forth below.
<TABLE>
<CAPTION>
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
<S> <C>
Death A copy of the shareholder's death certificate or,
in the case of a trust, a copy of the grantor's
death certificate, plus a copy of the trust
agreement identifying the grantor.
Disability--An individual will be A copy of the Social Security Administration award
considered disabled if he or she is letter or a letter from a physician on the
unable to engage in any substantial physician's letterhead stating that the shareholder
gainful activity by reason of any (or, in the case of a trust, the grantor (a copy of
medically determinable physical or the trust agreement identifying the grantor will be
mental impairment which can be expected required as well)) is permanently disabled. The
to result in death or to be of letter must also indicate the date of disability.
long-continued and indefinite duration.
Distribution from an IRA or A copy of the distribution form from the custodial
403(b) Custodial Account firm indicating (1) the date of birth of the
shareholder and (2) that the shareholder is over
age 59 and is taking a normal distribution--signed
by the shareholder.
Distribution from Retirement Plan A letter signed by the plan administrator/trustee
indicating the reason for the distribution.
Excess Contributions A letter from the shareholder (for an IRA) or the
plan administrator/ trustee on company letterhead
indicating the amount of the excess and whether or
not taxes have been paid.
</TABLE>
The Transfer Agent reserves the right to request such additional documents
as it may deem appropriate.
WAIVER OF CONTINGENT DEFERRED SALES CHARGE--CLASS C SHARES
BENEFIT PLANS. The CDSC will be waived for redemptions by certain group
retirement plans for which Prudential or brokers not affiliated with Prudential
provide administrative or recordkeeping services. The CDSC also will be waived
for certain redemptions by benefit plans sponsored by Prudential and its
affiliates. For more information, call Prudential at (800) 353-2847.
CONVERSION FEATURE--CLASS B SHARES
Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. Conversions will be effected at
relative net asset value without the imposition of any additional sales charge.
Since the Fund tracks amounts paid rather than the number of shares bought
on each purchase of Class B shares, the number of Class B shares eligible to
convert to Class A shares (excluding shares acquired through the automatic
reinvestment of dividends and other distributions)(the Eligible Shares) will be
determined on each conversion date in accordance with the following formula:
(1) the ratio of (a) the amounts paid for Class B shares purchased at least
seven years prior to the conversion date to (b) the total amount paid for all
Class B shares purchased and then held in your account (2) multiplied by the
total number of Class B shares purchased and then held in your account. Each
time any Eligible Shares in your account convert to Class A shares, all shares
or amounts representing Class B shares then in your account that were acquired
through the automatic reinvestment of dividends and other distributions will
convert to Class A shares.
For purposes of determining the number of Eligible Shares, if the Class B
shares in your account on any conversion date are the result of multiple
purchases at different net asset values per share, the number of Eligible Shares
calculated as described above will generally be either more or less than the
number of shares actually purchased approximately seven years before such
conversion date. For example, if 100 shares were initially purchased at $10 per
share (for a total of $1,000) and a second purchase of 100 shares was
subsequently made at $11 per share (for a total of $1,100), 95.24 shares would
convert
B-34
<PAGE>
approximately seven years from the initial purchase (that is, $1,000 divided by
$2,100 (47.62%), multiplied by 200 shares equals 95.24 shares). The Manager
reserves the right to modify the formula for determining the number of Eligible
Shares in the future as it deems appropriate on notice to shareholders.
Since annual distribution-related fees are lower for Class A shares than
Class B shares, the per share NAV of the Class A shares may be higher than that
of the Class B shares at the time of conversion. Thus, although the aggregate
dollar value will be the same, you may receive fewer Class A shares than
Class B shares converted.
For purposes of calculating the applicable holding period for conversions,
all payments for Class B shares during a month will be deemed to have been made
on the last day of the month, or for Class B shares acquired through exchange,
or a series of exchanges, on the last day of the month in which the original
payment for purchases of such Class B shares was made. For Class B shares
previously exchanged for shares of a money market fund, the time period during
which such shares were held in the money market fund will be excluded. For
example, Class B shares held in a money market fund for one year would not
convert to Class A shares until approximately eight years from purchase. For
purposes of measuring the time period during which shares are held in a money
market fund, exchanges will be deemed to have been made on the last day of the
month. Class B shares acquired through exchange will convert to Class A shares
after expiration of the conversion period applicable to the original purchase of
such shares.
The conversion feature may be subject to the continuing availability of
opinions of counsel or rulings of the Internal Revenue Service (1) that the
dividends and other distributions paid on Class A, Class B, Class C and Class Z
shares will not constitute "preferential dividends" under the Internal Revenue
Code and (2) that the conversion of shares does not constitute a taxable event.
The conversion of Class B shares into Class A shares may be suspended if such
opinions or rulings are no longer available. If conversions are suspended,
Class B shares of the Fund will continue to be subject, possibly indefinitely,
to their higher annual distribution and service fee.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which the shares are held for the
investor by the Transfer Agent. If a stock certificate is desired, it must be
requested in writing for each transaction. Certificates are issued only for full
shares and may be redeposited in the Account at any time. There is no charge to
the investor for issuance of a certificate. The Fund makes available to the
shareholders the following privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund at net asset
value per share. An investor may direct the Transfer Agent in writing not less
than five full business days prior to the record date to have subsequent
dividends and/or distributions sent in cash rather than reinvested. In the case
of recently purchased shares for which registration instructions have not been
received on the record date, cash payment will be made directly to the broker.
Any shareholder who receives dividends or distributions in cash may subsequently
reinvest any such dividend or distribution at NAV by returning the check or the
proceeds to the Transfer Agent within 30 days after the payment date. The
reinvestment will be made at the NAV per share next determined after receipt of
the check by the Transfer Agent. Shares purchased with reinvested dividends
and/or distributions will not be subject to any CDSC upon redemption.
EXCHANGE PRIVILEGE
The Fund makes available to its shareholders the privilege of exchanging
their shares of the Fund for shares of certain other Prudential mutual funds,
including one or more specified money market funds, subject in each case to the
minimum investment requirements of such funds. Shares of such other Prudential
mutual funds may also be exchanged for shares of the Fund. All exchanges are
made on the basis of the relative NAV next determined after receipt of an order
in proper form. An exchange will be treated as a redemption and purchase for tax
purposes. Shares may be exchanged for shares of another fund only if shares of
such fund may legally be sold under applicable state laws. For retirement and
group plans having a limited menu of Prudential mutual funds, the exchange
privilege is available for those funds eligible for investment in the particular
program.
It is contemplated that the exchange privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
B-35
<PAGE>
In order to exchange shares by telephone, you must authorize telephone
exchanges on your initial application form or by written notice to the Transfer
Agent and hold shares in non-certificate form. Thereafter, you may call the Fund
at (800) 225-1852 to execute a telephone exchange of shares, on weekdays, except
holidays, between the hours of 8:00 A.M. and 6:00 P.M., New York time. For your
protection and to prevent fraudulent exchanges, your telephone call will be
recorded and you will be asked to provide your personal identification number. A
written confirmation of the exchange transaction will be sent to you. Neither
the Fund nor its agents will be liable for any loss, liability or cost which
results from acting upon instructions reasonably believed to be genuine under
the foregoing procedures. All exchanges will be made on the basis of the
relative NAV of the two funds next determined after the request is received in
good order.
If you hold shares through Prudential Securities, you must exchange your
shares by contacting your Prudential Securities financial adviser.
If you hold certificates, the certificates must be returned in order for the
shares to be exchanged.
You may also exchange shares by mail by writing to Prudential Mutual Fund
Services LLC, Attention: Exchange Processing, P.O. Box 8157, Philadelphia, PA
19101.
In periods of severe market or economic conditions the telephone exchange of
shares may be difficult to implement and you should make exchanges by mail by
writing to Prudential Mutual Fund Services LLC, at the address noted above.
CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential mutual funds and shares of the money
market funds specified below. No fee or sales load will be imposed upon the
exchange. Shareholders of money market funds who acquired such shares upon
exchange of Class A shares may use the exchange privilege only to acquire
Class A shares of the Prudential mutual funds participating in the exchange
privilege.
The following money market funds participate in the Class A exchange
privilege:
Prudential California Municipal Fund
(California Money Market Series)
Prudential Government Securities Trust
(Money Market Series)
(U.S. Treasury Money Market Series)
Prudential Municipal Series Fund
(New Jersey Money Market Series)
(New York Money Market Series)
Prudential MoneyMart Assets, Inc. (Class A shares)
Prudential Tax-Free Money Fund, Inc.
CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B
shares and Class C shares of the Fund for Class B and Class C shares of certain
other Prudential mutual funds and shares of Prudential Special Money Market
Fund, Inc. No CDSC will be payable upon such exchange, but a CDSC may be payable
upon the redemption of the Class B and Class C shares acquired as a result of an
exchange. The applicable sales charge will be that imposed by the fund in which
shares were initially purchased and the purchase date will be deemed to be the
first day of the month after the initial purchase, rather than the date of the
exchange.
Class B and Class C shares of the Fund may also be exchanged for shares of
Prudential Special Money Market Fund, Inc. without imposition of any CDSC at the
time of exchange. Upon subsequent redemption from such money market fund or
after re-exchange into the Fund, such shares will be subject to the CDSC
calculated without regard to the time such shares were held in the money market
fund. In order to minimize the period of time in which shares are subject to a
CDSC, shares exchanged out of the money market fund will be exchanged on the
basis of their remaining holding periods, with the longest remaining holding
periods being transferred first. In measuring the time period shares are held in
a money market fund and "tolled" for purposes of calculating the CDSC holding
period, exchanges are deemed to have been made on the last day of the month.
Thus, if shares are exchanged into the Fund from a money market fund during the
month (and are held in the Fund at the end of the month), the entire month will
be included in the CDSC holding period. Conversely, if shares are exchanged into
a money market fund prior to the last
B-36
<PAGE>
day of the month (and are held in the money market fund on the last day of the
month), the entire month will be excluded from the CDSC holding period. For
purposes of calculating the seven year holding period applicable to the Class B
conversion feature, the time period during which Class B shares were held in a
money market fund will be excluded.
At any time after acquiring shares of other funds participating in the
Class B or Class C exchange privilege, a shareholder may again exchange those
shares (and any reinvested dividends and distributions) for Class B or Class C
shares of the Fund, respectively, without subjecting such shares to any CDSC.
Shares of any fund participating in the Class B or Class C exchange privilege
that were acquired through reinvestment of dividends or distributions may be
exchanged for Class B or Class C shares of other funds, respectively, without
being subject to any CDSC.
CLASS Z. Class Z shares may be exchanged for Class Z shares of other
Prudential mutual funds.
SPECIAL EXCHANGE PRIVILEGES. A special exchange privilege is available for
shareholders who qualify to purchase Class A shares at NAV and for shareholders
who qualify to purchase Class Z shares. Under this exchange privilege, amounts
representing any Class B and Class C shares which are not subject to a CDSC held
in such a shareholder's account will be automatically exchanged for Class A
shares for shareholders who qualify to purchase Class A shares at NAV on a
quarterly basis, unless the shareholder elects otherwise.
Shareholders who qualify to purchase Class Z shares will have their Class B
and Class C shares which are not subject to a CDSC and their Class A shares
exchanged for Class Z shares on a quarterly basis. Eligibility for this exchange
privilege will be calculated on the business day prior to the date of the
exchange. Amounts representing Class B or Class C shares which are not subject
to a CDSC include the following: (1) amounts representing Class B or Class C
shares acquired pursuant to the automatic reinvestment of dividends and
distributions, (2) amounts representing the increase in the NAV above the total
amount of payments for the purchase of Class B or Class C shares and
(3) amounts representing Class B or Class C shares held beyond the applicable
CDSC period. Class B and Class C shareholders must notify the Transfer Agent
either directly or through Prudential Securities, Prusec or another broker that
they are eligible for this special exchange privilege.
Participants in any fee-based program for which the Fund is an available
option will have their Class A shares, if any, exchanged for Class Z shares when
they elect to have those assets become a part of the fee-based program. Upon
leaving the program (whether voluntarily or not), such Class Z shares (and, to
the extent provided for in the program, Class Z shares acquired through
participation in the program) will be exchanged for Class A shares at NAV.
Similarly, participants in Prudential Securities' 401(k) Plan for which the
Fund's Class Z shares are an available option and who wish to transfer their
Class Z shares out of the Prudential Securities 401(k) Plan following separation
from service (that is, voluntary or involuntary termination of employment or
retirement) will have their Class Z shares exchanged for Class A shares at NAV.
Additional details about the exchange privilege and prospectuses for each of
the Prudential mutual funds are available from the Fund's Transfer Agent, the
Distributor or your broker. The exchange privilege may be modified, terminated
or suspended on 60 days' notice, and any fund, including the Fund, or the
Distributor, has the right to reject any exchange application relating to such
fund's shares.
DOLLAR COST AVERAGING
Dollar cost averaging is a method of accumulating shares by investing a
fixed amount of dollars in shares at set intervals. An investor buys more shares
when the price is low and fewer shares when the price is high. The average cost
per share is lower than it would be if a constant number of shares were bought
at set intervals.
Dollar cost averaging may be used, for example, to plan for retirement, to
save for a major expenditure, such as the purchase of a home, or to finance a
college education. The cost of a year's education at a four-year college today
averages around $14,000 at a private college and around $6,000 at a public
university. Assuming these costs increase at a rate of 7% a
B-37
<PAGE>
year, as has been projected, for the freshman class of 2011, the cost of four
years at a private college could reach $210,000 and over $90,000 at a public
university.(1)
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals.(2)
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
-------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
25 Years............................................. $ 105 $ 158 $ 210 $ 263
20 Years............................................. 170 255 340 424
15 Years............................................. 289 433 578 722
10 Years............................................. 547 820 1,093 1,366
5 Years............................................. 1,361 2,041 2,721 3,402
See "Automatic Investment Plan."
</TABLE>
------------------------
(1)Source information concerning the costs of education at public and
private universities is available from The College Board Annual Survey of
Colleges, 1993. Average costs for private institutions include tuition, fees,
room and board for the 1993-1994 academic year.
(2)The chart assumes an effective rate of return of 8% (assuming monthly
compounding). This example is for illustrative purposes only and is not intended
to reflect the performance of an investment in shares of the Fund. The
investment return and principal value of an investment will fluctuate so that an
investor's shares when redeemed may be worth more or less than their original
cost.
AUTOMATIC INVESTMENT PLAN (AIP)
Under AIP, an investor may arrange to have a fixed amount automatically
invested in shares of the Fund monthly by authorizing his or her bank account or
brokerage account (including a Prudential Securities Command Account) to be
debited to invest specified dollar amounts in shares of the Fund. The investor's
bank must be a member of the Automatic Clearing House System. Share certificates
are not issued to AIP participants.
Further information about this program and an application form can be
obtained from the Transfer Agent, the Distributor or your broker.
SYSTEMATIC WITHDRAWAL PLAN
A systematic withdrawal plan is available to shareholders through the
Distributor, the Transfer Agent or your broker. The withdrawal plan provides for
monthly, quarterly, semi-annual or annual redemption checks in any amount,
except as provided below, up to the value of the shares in the shareholder's
account. Withdrawals of Class B or Class C shares may be subject to a CDSC.
In the case of shares held through the Transfer Agent (1) a $10,000 minimum
account value applies, (2) withdrawals may not be for less than $100 and
(3) the shareholder must elect to have all dividends and/or distributions
automatically reinvested in additional full and fractional shares at NAV on
shares held under this plan.
The Distributor, the Transfer Agent or your broker acts as an agent for the
shareholder in redeeming sufficient full and fractional shares to provide the
amount of the systematic withdrawal payment. The systematic withdrawal plan may
be terminated at any time, and Prudential Securities reserves the right to
initiate a fee of up to $5 per withdrawal, upon 30 days' written notice to the
shareholder.
Withdrawal payments should not be considered as dividends, yield or income.
If systematic withdrawals continuously exceed reinvested dividends and
distributions, the shareholder's original investment will be correspondingly
reduced and ultimately exhausted.
Furthermore, each withdrawal constitutes a redemption of shares, and any
gain or loss realized must generally be recognized for federal income tax
purposes. In addition, withdrawals made concurrently with purchases of
additional shares are inadvisable because of the sales charge applicable to
(1) the purchase of Class A shares and (2) the redemption of Class B and
Class C shares. Each shareholder should consult his or her own tax adviser with
regard to the tax consequences of the systematic withdrawal plan, particularly
if used in connection with a retirement plan.
B-38
<PAGE>
TAX-DEFERRED RETIREMENT PLANS
Various tax-deferred retirement plans, including a 401(k) plan,
self-directed individual retirement accounts and "tax-sheltered accounts" under
Section 403(b)(7) of the Internal Revenue Code are available through Prudential
Securities. These plans are for use by both self-employed individuals and
corporate employers. These plans permit either self-direction of accounts by
participants, or a pooled account arrangement. Information regarding the
establishment of these plans, the administration, custodial fees and other
details is available from the Distributor or the Transfer Agent.
Investors who are considering the adoption of such a plan should consult
with their own legal counsel or tax adviser with respect to the establishment
and maintenance of any such plan.
TAX-DEFERRED RETIREMENT ACCOUNTS
INDIVIDUAL RETIREMENT ACCOUNTS. An individual retirement account (IRA)
permits the deferral of federal income tax on income earned in the account until
the earnings are withdrawn. The following chart represents a comparison of the
earnings in a personal savings account with those in an IRA, assuming a $2,000
annual contribution, an 8% rate of return and a 39.6% federal income tax bracket
and shows how much more retirement income can accumulate within an IRA as
opposed to a taxable individual savings account.
<TABLE>
<CAPTION>
TAX-DEFERRED COMPOUNDING(1)
CONTRIBUTIONS PERSONAL
MADE OVER: SAVINGS IRA
------------- -------- --------
<S> <C> <C>
10 years................ $ 26,165 $ 31,291
15 years................ 44,675 58,649
20 years................ 68,109 98,846
25 years................ 97,780 157,909
30 years................ 135,346 244,692
</TABLE>
------------------------
(1) The chart is for illustrative purposes only and does not represent the
performance of the Fund or any specific investment. It shows taxable versus
tax-deferred compounding for the periods and on the terms indicated. Earnings in
a traditional IRA account will be subject to tax when withdrawn from the
account. Distributions from a Roth IRA which meet the conditions required under
the Internal Revenue Code will not be subject to tax upon withdrawal from the
account.
MUTUAL FUND PROGRAMS
From time to time, the Fund may be included in a mutual fund program with
other Prudential mutual funds. Under such a program, a group of portfolios will
be selected and thereafter marketed collectively. Typically, these programs are
created with an investment theme, such as, to seek greater diversification,
protection from interest rate movements or access to different management
styles. In the event such a program is instituted, there may be a minimum
investment requirement for the program as a whole. The Fund may waive or reduce
the minimum initial investment requirements in connection with such a program.
The mutual funds in the program may be purchased individually or as part of
a program. Since the allocation of portfolios included in the program may not be
appropriate for all investors, investors should consult their financial advisor
concerning the appropriate blend of portfolios for them. If investors elect to
purchase the individual mutual funds that constitute the program in an
investment ratio different from that offered by the program, the standard
minimum investment requirements for the individual mutual funds will apply.
NET ASSET VALUE
The Fund's net asset value or NAV is determined by subtracting its
liabilities from the value of its assets and dividing the remainder by the
number of shares outstanding. The Fund will compute its NAV at 4:15 P.M., New
York time, on each day the New York Stock Exchange is open for trading except on
days on which no orders to purchase, sell or redeem Fund shares have been
received or days on which changes in the value of the Fund's portfolio
securities do not affect NAV. In the event the New York Stock Exchange closes
early on any business day, the NAV of the Fund's shares shall be determined at a
time between such
B-39
<PAGE>
closing and 4:15 P.M., New York time. The New York Stock Exchange is closed on
the following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.
Under the Investment Company Act, the Board of Directors is responsible for
determining in good faith the fair value of securities of the Fund. In
accordance with procedures adopted by the Board of Directors, the value of
investments listed on a securities exchange and NASDAQ National Market System
securities (other than options on stock and stock indexes) are valued at the
last sales price on the day of valuation or, if there was no sale on such day,
the mean between the last bid and asked prices on such day or at the last bid
price on such day in the absence of an asked price. Corporate bonds (other than
convertible debt securities) and U.S. government securities that are actively
traded in the over-the-counter market, including listed securities for which the
primary market is believed by the Manager in consultation with the Subadviser to
be over-the-counter, are valued on the basis of valuations provided by an
independent pricing agent or more than one principal market maker which uses
information with respect to transactions in bonds, quotations from bond dealers,
agency ratings, market transactions in comparable securities and various
relationships between securities in determining value. Convertible debt
securities that are actively traded in the over-the-counter market, including
listed securities for which the primary market is believed by the Manager in
consultation with the Subadviser to be over-the-counter, are valued at the mean
between the last reported bid and asked prices (or the last bid price in the
absence of an asked price) provided by more than one principal market maker (if
available, otherwise a primary market dealer). Options on stock and stock
indexes traded on an exchange are valued at the last sale price on such exchange
or, if there was no such sale on such day, at the mean between the most recently
quoted bid and asked prices on the respective exchange or at the last bid price
on such day in the absence of an asked price and futures contracts and options
thereon are valued at their last sales prices as of the close of trading on the
applicable commodities exchange or board of trade or, if there was no sale on
the applicable commodities exchange or board of trade on such day, at the mean
between the most recently quoted bid and asked prices on such exchange or board
of trade or at the last bid price on such day in the absence of an asked price.
Quotations of foreign securities in a foreign currency are converted to U.S.
dollar equivalents at the current rate obtained from a recognized bank, dealer
or independent service on the day of valuation, and forward currency exchange
contracts are valued at the current cost of covering or offsetting such
contracts. Should an extraordinary event, which is likely to affect the value of
the security, occur after the close of an exchange on which a portfolio security
is traded, such security will be valued at fair value considering factors
determined in good faith by the investment adviser under procedures established
by and under the general supervision of the Fund's Board of Directors.
Securities or other assets for which reliable market quotations are not
readily available, or for which the pricing agent or principal market maker does
not provide a valuation or methodology or provides a valuation or methodology
that, in the judgment of the Manager or Subadviser (or Valuation Committee or
Board of Directors) does not represent fair value, are valued by the Valuation
Committee or Board, in consultation with the Manager or Subadviser, including
its portfolio managers, traders and its research and credit analysts and legal
and compliance personnel, on the basis of the following factors: nature of any
restrictions on disposition of the securities, assessment of the general
liquidity/illiquidity of the securities, the issuer's financial condition and
the markets in which it does business, the cost of the security, the size of the
holding and the capitalization of the issuer, any available analyst, media or
other reports of information deemed reliable by the Manager or Subadviser
regarding the issuer or the markets or industry in which it operates,
consistency with valuation of similar securities held by other Prudential funds,
transactions in comparable securities, relationships among various securities
and such other factors as may be determined by the Manager, the investment
adviser, Board of Directors or Valuation Committee to materially affect the
value of the security. Short-term debt securities are valued at cost, with
interest accrued or discount amortized to the date of maturity, if their
original maturity was 60 days or less, unless this is determined by the Board of
Directors not to represent fair value. Short-term securities with remaining
maturities of 60 days or more, for which market quotations are readily
available, are valued at their current market quotations as supplied by an
independent pricing agent or principal market maker.
Although the legal rights of each class of shares are substantially
identical, the different expenses borne by each class will result in different
NAVs. The NAV of Class B and Class C shares will generally be lower than the NAV
of Class A or Class Z shares as a result of the larger distribution-related fee
to which Class B and Class C shares are subject. The NAV of Class Z shares will
generally be higher than the NAV of Class A, Class B or Class C shares as a
result of the fact that Class Z shares are not subject to any distribution
and/or service fee. It is expected however that the NAV per share of the four
classes will tend to converge immediately after the recording of dividends, if
any, which will differ by approximately the amount of the distribution and/or
service fee expense accrual differential among the classes.
B-40
<PAGE>
PERFORMANCE INFORMATION
AVERAGE ANNUAL TOTAL RETURN. The Fund may from time to time advertise its
average annual total return. Average annual total return is determined
separately for Class A, Class B, Class C and Class Z shares.
Average annual total return is computed according to the following formula:
P(1+T)to the power of n = ERV
Where: P = a hypothetical initial payment of $1000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value at the end of the 1, 5 or 10 year periods
(or fractional portion thereof) of a hypothetical $1000 investment
made at the beginning of the 1, 5 or 10 year periods.
Average annual total return takes into account any applicable initial or
contingent deferred sales charges but does not take into account any federal or
state income taxes that may be payable upon redemption.
Below are the average annual total returns for the Fund's share classes for
the periods ended September 30, 2000.
<TABLE>
<CAPTION>
1 YEAR 5 YRS 10 YRS SINCE INCEPTION
-------------- -------- -------- ------------------
<S> <C> <C> <C> <C>
Class A.............................. 9.91% 8.40% 14.62% 12.13% (1/22/90)
Class B.............................. 9.88% 8.58% 14.33% 11.25% (11/13/80)
Class C.............................. 12.73% 8.51% N/A 10.96% (8/1/94)
Class Z.............................. 15.97% N/A N/A 10.39% (3/1/96)
</TABLE>
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B,
Class C and Class Z shares.
Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed according to the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1000.
ERV = ending redeemable value at the end of the 1, 5, or 10 year
periods (or fractional portion thereof) of a hypothetical $1000
investment made at the beginning of the 1, 5 or 10 year
periods.
Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
Below are the aggregate total returns for the Fund's share classes for the
periods ended September 30, 2000.
<TABLE>
<CAPTION>
1 YEAR 5 YRS 10 YRS SINCE INCEPTION
-------------- -------- -------- ------------------
<S> <C> <C> <C> <C>
Class A............................ 15.70% 57.53% 311.98% 257.91% (1/22/90)
Class B............................ 14.88% 51.93% 281.59% 732.92% (11/13/80)
Class C............................ 14.88% 51.93% N/A 91.84% (8/1/94)
Class Z............................ 15.97% N/A N/A 57.30% (3/1/96)
</TABLE>
B-41
<PAGE>
The Fund may include comparative performance information in advertising or
marketing the Fund's shares. Such performance information may include data from
Lipper Inc., Morningstar Publications, Inc. and other industry publications,
business periodicals and market indexes. Set forth below is a chart which
compares the performance of different types of investments over the long-term
and the rate of inflation.(1)
ADVERTISING. Advertising materials for the Fund may include biographical
information relating to its portfolio manager(s), and may include or refer to
commentary by the Fund's manager(s) concerning investment style, investment
discipline, asset growth, current or past business experience, business
capabilities, political, economic or financial conditions and other matters of
general interest to investors. Advertising materials for the Fund also may
include mention of The Prudential Insurance Company of America, its affiliates
and subsidiaries, and reference the assets, products and services of those
entities.
From time to time, advertising materials for the Fund may include
information concerning retirement and investing for retirement, may refer to the
approximate number of Fund shareholders and may refer to Lipper rankings or
Morningstar ratings, other related analysis supporting those ratings, other
industry publications, business periodicals and market indexes. In addition,
advertising materials may reference studies or analyses performed by the Manager
or its affiliates. Advertising materials for sector funds, funds that focus on
market capitalizations, index funds and international/global funds may discuss
the potential benefits and risks of that investment style. Advertising materials
for fixed income funds may discuss the benefits and risks of investing in the
bond market including discussions of credit quality, duration and maturity.
Set forth below is a chart which compares the performance of different types
of investments over the long term and the rate of inflation.(1)
PERFORMANCE COMPARISON OF DIFFERENT TYPES OF INVESTMENTS
OVER THE LONG TERM (12/31/25 - 12/31/99)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C> <C> <C>
Common Stocks Long-Term Gov't. Bonds Inflation
11.4% 5.1% 3.1%
</TABLE>
------------
(1)Source: Ibbotson Associates. All rights reserved. Common stock returns are
based on the Standard & Poor's 500 Composite Stock Price Index, a
market-weighted, unmanaged index of 500 common stocks in a variety of
industry sectors. It is a commonly used indicator of broad stock
price movements. This chart is for illustrative purposes only and is
not intended to represent the performance of any particular
investment or fund. Investors cannot invest directly in an index.
Past performance is not a guarantee of future results.
B-42
<PAGE>
TAXES, DIVIDENDS AND DISTRIBUTIONS
The Fund is qualified, intends to remain qualified, and has elected to be
treated as a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986, as amended (the "Code"). This relieves the Fund (but not
its shareholders) from paying federal income tax on income and capital gains
which are distributed to shareholders, and permits net capital gains of the Fund
(that is, the excess of net long-term capital gains over net short-term capital
losses) to be treated as long-term capital gains of the shareholders, regardless
of how long shareholders have held their shares in the Fund. The Fund expects to
pay dividends of net investment income, if any, semi-annually. The Board of
Directors of the Fund will determine at least once a year whether to distribute
any net capital gains of the Fund. In determining amounts of capital gains to be
distributed, any capital loss carryforwards from prior years will offset capital
gains. Distributions will be paid in additional Fund shares based on the net
asset value at the close of business on the record date, unless the shareholder
elects in writing not less than five full business days prior to the record date
to receive such distributions in cash.
Qualification of the Fund as a regulated investment company under the Code
requires, among other things, that (a) the Fund derive at least 90% of its
annual gross income (without reduction for losses from the sale or other
disposition of securities or foreign currencies) from dividends, interest,
payments with respect to securities loans and gains from the sale or other
disposition of securities or options thereon or foreign currencies, or other
income (including but not limited to gains from options, futures or forward
contracts) derived with respect to its business of investing in such securities
or currencies; (b) the Fund diversify its holdings so that, at the end of each
quarter of the taxable year, (1) at least 50% of the value of the Fund's assets
is represented by cash, U.S. government securities and other securities limited
in respect of any one issuer to an amount not greater than 5% of the value of
the Fund's assets and 10% of the outstanding voting securities of such issuer,
and (2) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. government securities); and (c)
the Fund distribute to its shareholders at least 90% of its net investment
income and net short-term capital gains (that is, the excess of net short-term
capital gains over net long-term capital losses) in each year. A 4%
nondeductible excise tax will be imposed on the Fund to the extent the Fund does
not meet certain minimum distribution requirements by the end of each calendar
year. For this purpose, any income or gain retained by the Fund which is subject
to tax will be considered to have been distributed by year-end. In addition,
dividends declared in October, November and December payable to shareholders of
record on a specified date in October, November and December and paid in the
following January will be treated as having been paid by the Fund and received
by each shareholder in such prior year. Under this rule, therefore, a
shareholder may be taxed in one year on dividends or distributions actually
received in January of the following year. (The Fund intends to make timely
distributions of the Fund's income in compliance with these requirements. As a
result, it is expected that the Fund will not be subjected to the excise tax.)
Gains or losses on sales of securities by the Fund generally will be treated
as long-term capital gains or losses if the securities have been held by it for
more than one year, except in certain cases where the Fund acquires a put or
writes a call thereon or otherwise holds an offsetting position with respect to
the securities. Other gains or losses on the sale of securities will be
short-term capital gains or losses. Gains and losses on the sale, lapse or other
termination of options on securities will be treated as gains and losses from
the sale of securities. If an option written by the Fund lapses or is terminated
through a closing transaction, such as a repurchase by the Fund of the option
from its holder, the Fund generally will realize a short-term capital gain or
loss. If securities are sold by the Fund pursuant to the exercise of a call
option written by it, the Fund will include the premium received in the sales
proceeds of the securities delivered in determining the amount of gain or loss
on the sale. If securities are purchased by the Fund pursuant to the exercise of
a put option written by it, the Fund will subtract the premium received from its
cost basis in the securities purchased. Certain transactions of the Fund may be
subject to wash sale, short sale, constructive sale, straddle and
anti-conversion provisions of the Code which may, among other things, require
the Fund to defer recognition of losses. In addition, debt securities acquired
by the Fund may be subject to original issue discount and market discount rules
which, respectively, may cause the Fund to accrue income in advance of the
receipt of cash with respect to interest or cause gains to be treated as
ordinary income.
Certain futures contracts and certain listed options (referred to as Section
1256 contracts) held by the Fund will be required to be "marked to market" for
federal income tax purposes, that is, treated as having been sold at their fair
market value on the last day of the Fund's taxable year. Except with respect to
certain foreign currency forward contracts, 60% of any gain or loss recognized
on these deemed sales and on actual dispositions will be treated as long-term
capital gain or loss, and the remainder will be treated as short-term capital
gain or loss. Under the "straddle" rules, the Fund may be required to defer the
recognition of
B-43
<PAGE>
losses on securities and options and futures contracts to the extent of any
unrecognized gain on offsetting positions held by the Fund. Other special rules
may apply to positions held as part of a straddle; in particular, the
deductibility of interest or other charges incurred to purchase or carry such
positions will be subject to limitations.
Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within
the 61-day period beginning 30 days before the disposition of shares. Shares
purchased pursuant to the reinvestment of a dividend or distribution will
constitute a replacement of shares.
A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes of
calculating gain or loss realized upon a sale or exchange of shares of the Fund.
The per share dividends on Class B and Class C shares, if any, will be lower
than the per share dividends on Class A or Class Z shares as a result of the
higher distribution-related fee applicable with the Class B and Class C shares
and lower on Class A shares in relation to Class Z shares. The per share
distributions of net capital gains, if any, will be paid in the same amount for
Class A, Class B, Class C and Class Z shares. See "Net Asset Value."
Shareholders electing to receive dividends and distributions in the form of
additional shares will have a cost basis for federal income tax purposes in each
share so received equal to the NAV of a share of the Fund on the reinvestment
date.
Any dividends or distributions paid shortly after a purchase by an investor
may have the effect of reducing the per share net asset value of the investor's
shares by the per share amount of the dividends or distributions. Furthermore,
such dividends or distributions, although in effect a return of capital, are
subject to federal income taxes. In addition, dividends and capital gain
distributions may also be subject to state and local income taxes. Therefore,
prior to purchasing shares of the Fund, the investor should carefully consider
the impact of dividends or capital gains distributions which are expected to be
or have been announced.
Dividends of net investment income and distributions of net short-term
capital gains paid to a shareholder (including a shareholder acting as a nominee
or fiduciary) who is a nonresident alien individual, a foreign corporation or a
foreign partnership (foreign shareholder) are subject to a 30% (or lower treaty
rate) withholding tax upon the gross amount of the dividends unless the
dividends are effectively connected with a U.S. trade or business conducted by
the foreign shareholder. Net capital gain distributions paid to a foreign
shareholder are generally not subject to withholding tax. A foreign shareholder
will, however, be required to pay U.S. income tax on any dividends and capital
gain distributions which are effectively connected with a U.S. trade or business
of the foreign shareholder. Foreign shareholders are advised to consult their
own tax advisors with respect to the particular tax consequences to them of an
investment in the Fund.
Dividends received by corporate shareholders are eligible for a
dividends-received deduction of 70% to the extent a Fund's income is derived
from qualified dividends received by the Fund from domestic corporations.
Dividends attributable to foreign corporations, interest income, capital and
currency gain, gain or loss from Section 1256 contracts (described above), and
income from certain other sources will not constitute qualified dividends.
Individual shareholders are not eligible for the dividends-received deduction.
The Fund may, from time to time, invest in Passive Foreign Investment
Companies (PFICs). A PFIC is a foreign corporation that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. If the Fund acquires and holds stock in a PFIC
beyond the end of the year of its acquisition, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on the
stock or on any gain from disposition of the stock (collectively, PFIC income),
plus interest thereon, even if the Fund distributes the PFIC income as a taxable
dividend to its shareholders. The balance of the PFIC income will be included in
the Fund's investment company taxable income and, accordingly, will not be
taxable to it to the extent that income is distributed to its shareholders. The
Fund may make a "mark-to-market" election with respect to any marketable stock
it holds of a PFIC. If the election is in effect, at the end of the Fund's
taxable year the Fund will recognize the amount of gains, if any, as ordinary
income with respect to PFIC stock. No loss will be recognized on PFIC stock,
except to the extent of gains recognized in prior years. Alternatively, the
Fund, if it meets certain requirements, may elect to treat any PFIC in which it
invests as a "qualified electing fund," in which case, in lieu of the foregoing
tax and interest obligation, the Fund will be required to include in income each
year its PRO RATA share of the qualified electing fund's annual ordinary
earnings and net capital gain, even if they are not distributed to the Fund;
those amounts would be subject to the distribution requirements applicable to
the Fund described above.
B-44
<PAGE>
Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time the Fund accrues interest or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time the Fund actually collects such receivables or pays such
liabilities are treated as ordinary income or ordinary loss. Similarly, gains or
losses on forward foreign currency exchange contracts or dispositions of debt
securities denominated in a foreign currency attributable to fluctuations in the
value of the foreign currency between the date of acquisition of the security
and the date of disposition also may be treated as ordinary gain or loss. These
gains or losses, referred to under the Code as "Section 988" gains or losses,
increase or decrease the amount of the Fund's investment company taxable income
available to be distributed to its shareholders as ordinary income, rather than
increasing or decreasing the amount of the Fund's net capital gain. If Section
988 losses exceed other investment company taxable income during a taxable year,
the Fund would not be able to make any ordinary dividend distributions, or
distributions made before the losses were realized would be recharacterized as a
return of capital to shareholders, rather than as an ordinary dividend, thereby
reducing each shareholder's basis in his or her Fund shares.
Income received by the Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or eliminate
such taxes. It is impossible to determine in advance the effective rate of
foreign tax to which the Fund will be subject, since the amount of the Fund's
assets to be invested in various countries is not known. The Fund does not
expect to meet the requirements of the Code for "passing-through" to its
shareholders any foreign income taxes paid.
Shareholders are advised to consult their own tax advisors with respect to
the federal, state, and local tax consequences resulting from their investment
in the Fund.
B-45
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
B-46
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
<C> <S> <C>
------------------------------------------------------------------------------------------
LONG-TERM INVESTMENTS 97.5%
COMMON STOCKS 97.5%
-------------------------------------------------------------------------------------
AEROSPACE/DEFENSE 0.6%
116,750 REMEC, Inc. $ 3,436,828
-------------------------------------------------------------------------------------
APPAREL 3.5%
287,100 G & K Services, Inc., Class A 8,056,744
348,100 Pacific Sunwear of California, Inc.(a) 6,526,875
664,900 Phillips-Van Heusen Corp. 6,856,781
--------------
21,440,400
-------------------------------------------------------------------------------------
APPLIANCES & HOME FURNISHINGS 1.8%
625,500 Applica, Inc.(a) 3,870,281
433,500 Furniture Brands International, Inc.(a) 7,206,938
--------------
11,077,219
-------------------------------------------------------------------------------------
AUTOMOTIVE 1.6%
140,100 Borg-Warner Automotive, Inc. 4,640,812
187,800 Dura Automotive Systems, Inc.(a) 1,734,216
357,100 Tower Automotive, Inc.(a) 3,347,813
--------------
9,722,841
-------------------------------------------------------------------------------------
Banking 2.8%
212,500 Astoria Financial Corp. 8,207,813
431,600 Banknorth Group, Inc. 7,714,850
65,500 Boston Private Financial, Inc. 1,080,750
--------------
17,003,413
-------------------------------------------------------------------------------------
CHEMICALS 2.7%
460,200 Arch Chemicals Inc. 8,398,650
579,700 Crompton Corp. 4,565,137
124,700 Lilly Industries, Inc., Class A 3,678,650
--------------
16,642,437
-------------------------------------------------------------------------------------
COMMERCIAL SERVICES 1.7%
204,200 Bright Horizons Family Solutions, Inc.(a) 5,219,863
420,900 NCO Group, Inc.(a) 4,998,188
--------------
10,218,051
</TABLE>
See Notes to Financial Statements
B-47
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
<C> <S> <C>
-----------------------------------------------------------------------------------------
COMPUTER SOFTWARE & SERVICES 4.6%
184,700 Allscripts, Inc.(a) $ 2,608,888
120,000 Hyperion Software Corp.(a) 3,105,000
253,200 Networks Associates, Inc. 5,728,650
160,500 PC-Tel, Inc.(a) 3,731,625
139,100 Safeguard Scientifics, Inc.(a) 2,773,306
257,800 USinternetworking, Inc.(a) 1,720,009
661,000 Visual Networks, Inc.(a) 4,337,812
487,900 X-Rite, Inc. 4,269,125
--------------
28,274,415
-------------------------------------------------------------------------------------
CONSULTING 1.3%
179,500 Braun Consulting, Inc.(a) 3,556,344
218,300 Jupiter Media Metrix, Inc.(a) 3,479,156
258,200 U.S. Interactive, Inc.(a) 653,569
--------------
7,689,069
-------------------------------------------------------------------------------------
CONTAINERS & PACKAGING 0.4%
217,900 Pactiv Corp.(a) 2,437,756
-------------------------------------------------------------------------------------
DATA PROCESSING/MANAGEMENT 2.0%
150,800 Acxiom Corp.(a) 4,787,900
345,900 American Management Systems, Inc.(a) 5,945,156
45,800 CSG Systems International, Inc.(a) 1,328,200
--------------
12,061,256
-------------------------------------------------------------------------------------
DENTAL SUPPLIES 1.7%
163,900 DENTSPLY International, Inc. 5,726,256
208,100 Sybron International Corp.(a) 4,994,400
--------------
10,720,656
-------------------------------------------------------------------------------------
DISTRIBUTION/WHOLESALERS 1.6%
1,222,100 Brightpoint, Inc.(a) 6,148,691
92,500 Tech Data Corp.(a) 3,954,375
--------------
10,103,066
-------------------------------------------------------------------------------------
ELECTRICAL UTILITIES 1.7%
552,500 El Paso Electric Co.(a) 7,607,925
</TABLE>
See Notes to Financial Statements
B-48
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
------------------------------------------------------------------------------------------
<C> <S> <C>
78,000 H Power Corp.(a) $ 2,608,125
--------------
10,216,050
-------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 1.3%
339,500 Belden, Inc. 8,020,688
-------------------------------------------------------------------------------------
ELECTRONICS 8.6%
172,200 ANADIGICS, Inc.(a) 3,809,925
128,600 APW Ltd.(a) 6,269,250
113,300 Axcelis Technologies, Inc.(a) 1,345,438
104,000 Electro Scientific Industries, Inc.(a) 3,653,000
168,300 Integrated Silicon Solution, Inc.(a) 2,387,756
67,100 Intersil Holding Corp.(a) 3,346,612
62,600 Manufacturers Services Ltd.(a) 743,375
205,800 Oak Technology, Inc.(a) 5,633,775
299,300 Photronics, Inc.(a) 6,528,481
306,900 Power Integrations, Inc.(a) 4,277,419
70,500 SIPEX Corp.(a) 2,965,406
152,500 Three-Five Systems, Inc.(a) 4,460,625
64,100 TTM Technologies, Inc.(a) 1,506,350
157,100 Varian Semiconductor Associates, Inc.(a) 5,881,431
--------------
52,808,843
-------------------------------------------------------------------------------------
ENTERTAINMENT 3.9%
182,400 Harrah's Entertainment, Inc.(a) 5,016,000
704,000 Imax Corp.(a) 11,924,000
344,500 Speedway Motorsports, Inc. 7,169,906
--------------
24,109,906
-------------------------------------------------------------------------------------
FINANCIAL SERVICES 0.9%
276,900 Allied Capital Corp. 5,745,675
-------------------------------------------------------------------------------------
FOODS 5.4%
669,333 SUPERVALU, Inc. 10,081,828
121,300 Suiza Foods Corp.(a) 6,148,394
207,200 United Natural Foods, Inc.(a) 2,564,100
265,400 Whole Foods Market, Inc.(a) 14,248,662
--------------
33,042,984
</TABLE>
See Notes to Financial Statements
B-49
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
------------------------------------------------------------------------------------------
<C> <S> <C>
HEALTH SERVICES 4.4%
207,700 AmeriSource Health Corp.(a) $ 9,761,900
487,000 Hooper Holmes, Inc. 4,631,370
244,300 Omnicare, Inc 3,939,337
459,600 Renal Care Group, Inc.(a) 8,560,050
--------------
26,892,657
-------------------------------------------------------------------------------------
HOSPITAL MANAGEMENT 2.3%
570,000 Quorum Health Group, Inc.(a) 7,410,000
237,900 Triad Hospitals, Inc.(a) 6,988,312
--------------
14,398,312
-------------------------------------------------------------------------------------
INSURANCE 5.7%
224,027 Amerus Group Co. 5,768,695
221,600 Enhance Financial Services Group, Inc. 2,880,800
226,900 Everest Re Group, Ltd. 11,231,550
274,652 Reinsurance Group of America, Inc. 9,406,831
132,600 StanCorp Financial Group, Inc. 5,668,650
--------------
34,956,526
-------------------------------------------------------------------------------------
LEISURE 1.5%
419,500 Aztar Corp.(a) 6,449,813
180,300 Cheap Tickets, Inc.(a) 1,870,613
52,800 Steiner Leisure Ltd.(a) 1,181,400
--------------
9,501,826
-------------------------------------------------------------------------------------
MEDIA 3.0%
332,500 A. H. Belo Corp., Class A 6,130,469
209,200 Emmis Communications Corp. 5,177,700
188,600 Entravision Communications Corp., Class A(a) 3,276,925
369,600 Sinclair Broadcast Group, Inc., Class A(a) 4,042,500
--------------
18,627,594
-------------------------------------------------------------------------------------
MEDICAL PRODUCTS 1.6%
10,400 Cubist Pharmaceuticals, Inc.(a) 541,450
142,200 Genaissance Pharmaceuticals, Inc.(a) 2,941,763
82,900 Endocare, Inc.(a) 1,637,275
186,800 Mylan Laboratories, Inc. 5,031,925
--------------
10,152,413
</TABLE>
See Notes to Financial Statements
B-50
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
------------------------------------------------------------------------------------------
<C> <S> <C>
MISCELLANEOUS INDUSTRIAL 6.0%
225,100 Advanced Lighting Technologies, Inc.(a) $ 2,785,613
245,850 Clarcor, Inc. 4,794,075
164,800 Graco, Inc. 5,314,800
305,600 Pentair, Inc. 8,174,800
241,935 Robbins & Myers, Inc. 5,715,714
193,200 Roper Industries, Inc. 6,411,825
148,200 Valspar Corp. 3,407,118
--------------
36,603,945
-------------------------------------------------------------------------------------
OIL & GAS EXPLORATION/PRODUCTION 4.4%
76,200 Bellwether Exploration Co.(a) 585,788
130,600 Cabot Oil & Gas Corp., Class A 2,660,975
100,595 Devon Energy Corp. 6,050,771
167,800 Louis Dreyfus Natural Gas Corp.(a) 6,649,075
140,000 Marine Drilling Companies, Inc.(a) 3,998,750
6,900 Newfield Exploration Co.(a) 322,144
291,300 St. Mary Land & Exploration Co. 6,718,106
--------------
26,985,609
-------------------------------------------------------------------------------------
PHOTOGRAPHY 0.3%
80,800 Concord Camera Corp.(a) 2,070,500
-------------------------------------------------------------------------------------
PRINTING 0.2%
328,900 Mail-Well, Inc.(a) 1,459,494
-------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT TRUST 1.3%
172,700 Kilroy Realty Corp.(a) 4,608,931
123,400 Liberty Property Trust 3,393,500
--------------
8,002,431
-------------------------------------------------------------------------------------
RESTAURANTS 2.1%
311,900 CBRL Group, Inc. 4,483,562
285,500 Consolidated Products, Inc.(a) 2,284,000
208,500 Jack in the Box, Inc.(a) 4,469,719
168,400 Ruby Tuesday, Inc. 1,894,500
--------------
13,131,781
</TABLE>
See Notes to Financial Statements
B-51
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
------------------------------------------------------------------------------------------
<C> <S> <C>
RETAIL 5.4%
271,900 Casey's General Stores, Inc. $ 3,534,700
174,100 Claire's Stores, Inc. 3,133,800
336,000 Consolidated Stores Corp.(a) 4,536,000
649,000 Hollywood Entertainment Corp.(a) 4,826,938
389,800 Pier 1 Imports, Inc. 5,286,662
395,800 Ross Stores, Inc. 5,689,625
592,300 Stein Mart, Inc.(a) 6,404,244
--------------
33,411,969
-------------------------------------------------------------------------------------
STEEL 1.3%
304,100 Maverick Tube Corp.(a) 8,191,694
-------------------------------------------------------------------------------------
TELECOMMUNICATIONS 8.1%
55,800 AirGate Pcs, Inc.(a) 2,504,025
115,900 Carrier Access Corp.(a) 2,296,269
28,900 Clarent Corp.(a) 1,137,938
70,200 Clearnet Communications Inc.(a) 3,110,737
260,200 CommScope, Inc.(a) 6,374,900
180,400 DMC Stratex Networks, Inc.(a) 2,897,675
31,000 Glenayre Technologies, Inc.(a) 337,125
447,000 NorthPoint Communications Group, Inc.(a) 3,967,125
133,800 Rural Cellular Corp.(a) 9,115,125
290,200 UbiquiTel, Inc.(a) 2,611,800
171,600 US Unwired, Inc.(a) 1,635,562
115,700 Vyyo, Inc.(a) 3,471,000
291,000 Western Wireless Corp.(a) 10,366,875
--------------
49,826,156
-------------------------------------------------------------------------------------
WASTE MANAGEMENT 1.8%
582,700 Republic Services, Inc., Class A(a) 7,647,937
139,000 Waste Connections, Inc.(a) 3,561,875
--------------
11,209,812
--------------
Total long-term investments (cost $559,285,118) 600,194,272
</TABLE>
See Notes to Financial Statements
B-52
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Portfolio of Investments as of September 30, 2000 Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES DESCRIPTION VALUE (NOTE 1)
------------------------------------------------------------------------------------------
<C> <S> <C>
SHORT-TERM INVESTMENTS 3.2%
PRINCIPAL AMOUNT
(000)
$ 19,916 Joint Repurchase Agreement Account,
6.50%, 10/2/00 (cost $19,916,000; Note 5) 19,916,000
--------------
TOTAL INVESTMENTS 100.7%
(COST $579,201,118; NOTE 4) 620,110,272
Liabilities in excess of other assets (0.7%) (4,199,582)
--------------
NET ASSETS 100% $ 615,910,690
--------------
--------------
</TABLE>
------------------------------
(a) Non-income producing security.
See Notes to Financial Statements
B-53
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Statement of Assets and Liabilities
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
<S> <C>
----------------------------------------------------------------------------------------
ASSETS
Investments, at value (cost $579,201,118) $620,110,272
Receivable for investments sold 17,144,416
Receivable for Fund shares sold 973,161
Dividends and interest receivable 260,984
Prepaid expenses 12,759
------------------
TOTAL ASSETS 638,501,592
------------------
LIABILITIES
Bank overdraft 36,647
Payable for investments purchased 14,671,474
Payable for Fund shares reacquired 6,489,859
Accrued expenses 773,681
Management fee payable 368,465
Distribution fee payable 250,776
------------------
TOTAL LIABILITIES 22,590,902
------------------
NET ASSETS $615,910,690
------------------
------------------
Net assets were comprised of:
Common stock, at par $ 441,000
Paid-in capital in excess of par 615,065,591
------------------
615,506,591
Accumulated net realized loss on investments (40,505,055)
Net unrealized appreciation/depreciation on investments 40,909,154
------------------
Net assets, September 30, 2000 $615,910,690
------------------
------------------
</TABLE>
See Notes to Financial Statements
B-54
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Statement of Assets and Liabilities Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
----------------------------------------------------------------------------------------
<S> <C>
Class A:
Net asset value and redemption price per share
($291,869,026 DIVIDED BY 20,096,572 shares of
common stock issued and outstanding) $14.52
Maximum sales charge (5% of offering price) .76
------------------
Maximum offering price to public $15.28
------------------
------------------
Class B:
Net asset value, offering price and redemption price per
share
($199,149,269 DIVIDED BY 15,354,526 shares of
common stock issued and outstanding) $12.97
------------------
------------------
Class C:
Net asset value and redemption price per share
($19,236,242 DIVIDED BY 1,483,143 shares of common
stock issued and outstanding) $12.97
Sales charge (1% of offering price) .13
------------------
Offering price to public $13.10
------------------
------------------
Class Z:
Net asset value, offering price and redemption price per
share
($105,656,153 DIVIDED BY 7,165,794 shares of common
stock issued and outstanding) $14.74
------------------
------------------
</TABLE>
See Notes to Financial Statements
B-55
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Statement of Operations
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR
ENDED
SEPTEMBER 30, 2000
<S> <C>
----------------------------------------------------------------------------------------
NET INVESTMENT LOSS
Income
Dividends (net of foreign withholding taxes of $11,096) $ 6,654,757
Interest 2,614,035
------------------
TOTAL INCOME 9,268,792
------------------
Expenses
Management fee 4,574,665
Distribution fee--Class A 711,702
Distribution fee--Class B 2,500,608
Distribution fee--Class C 201,593
Transfer agent's fees and expenses 2,145,000
Reports to shareholders 275,000
Custodian's fees and expenses 130,000
Registration fees 85,000
Legal fees and expenses 47,000
Audit fees 25,000
Directors' fees and expenses 20,400
Miscellaneous 19,234
------------------
TOTAL EXPENSES 10,735,202
------------------
Net investment loss (1,466,410)
------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized loss on investment transactions (30,404,991)
Net change in unrealized appreciation/depreciation on
investments 114,018,267
------------------
Net gain on investments 83,613,276
------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 82,146,866
------------------
------------------
</TABLE>
See Notes to Financial Statements
B-56
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Statement of Changes in Net Assets
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------------------
2000 1999
<S> <C> <C>
-----------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net investment loss $ (1,466,410) $ (3,984,439)
Net realized gain (loss) on investment
transactions (30,404,991) 6,018,074
Net change in unrealized
appreciation/depreciation on
investments 114,018,267 13,126,457
-------------- ------------------
Net increase in net assets resulting from
operations 82,146,866 15,160,092
-------------- ------------------
DISTRIBUTIONS FROM NET REALIZED GAINS ON
INVESTMENT TRANSACTIONS (NOTE 1)
Class A -- (41,109,661)
Class B -- (62,450,536)
Class C -- (3,389,932)
Class Z -- (14,727,094)
-------------- ------------------
-- (121,677,223)
-------------- ------------------
FUND SHARE TRANSACTIONS (NOTE 6)
(NET OF SHARE CONVERSIONS)
Net proceeds from shares sold 465,954,260 556,701,257
Net asset value of shares issued to
shareholders in reinvestment of
distributions -- 117,928,503
Cost of shares reacquired (717,545,426) (814,921,695)
-------------- ------------------
Net decrease in net assets from Fund
share transactions (251,591,166) (140,291,935)
-------------- ------------------
Total decrease (169,444,300) (246,809,066)
NET ASSETS
Beginning of year 785,354,990 1,032,164,056
-------------- ------------------
End of year $ 615,910,690 $ 785,354,990
-------------- ------------------
-------------- ------------------
</TABLE>
See Notes to Financial Statements
B-57
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements
--------------------------------------------------------------------------------
Prudential Small Company Fund, Inc. (formerly known as Prudential Small
Company Value, Inc.) is registered under the Investment Company Act of 1940 as a
diversified, open-end management investment company. The investment objective of
the Fund is to achieve capital growth by investing in a carefully selected
portfolio of common stocks. Investment income is of incidental importance, and
the Fund may invest in securities which do not produce any income.
NOTE 1. ACCOUNTING POLICIES
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements.
SECURITIES VALUATIONS: Investments traded on a national securities
exchange are valued at the last reported sales price on the primary exchange on
which they are traded. Securities traded in the over-the-counter market
(including securities listed on exchanges whose primary market is believed to be
over-the-counter) and listed securities for which no sale was reported on that
date are valued at the mean between the last reported bid and asked prices. Any
security for which a reliable market quotation is unavailable is valued at fair
value as determined in good faith by or under the direction of the Fund's Board
of Directors. Short-term securities which mature in more than 60 days are valued
based upon current market quotations. Short-term securities which mature in 60
days or less are valued at amortized cost.
REPURCHASE AGREEMENTS: In connection with transactions in repurchase
agreements with U.S. financial institutions, it is the Fund's policy that its
custodian or designated subcustodians, as the case may be under triparty
repurchase agreements, take possession of the underlying collateral securities,
the value of which exceeds the principal amount of the repurchase transaction,
including accrued interest. To the extent that any repurchase transaction
exceeds one business day, the value of the collateral is market-to-market on a
daily basis to ensure the adequacy of the collateral. If the seller defaults and
the value of the collateral declines or if bankruptcy proceedings are commenced
with respect to the seller of the security, realization of the collateral by the
Fund may be delayed or limited.
All securities are valued as of 4:15 p.m., New York time.
SECURITIES TRANSACTIONS AND NET INVESTMENT INCOME: Securities transactions
are recorded on the trade date. Realized gains and losses on sales of
investments are calculated on the identified cost basis. Dividend income is
recorded on the ex-dividend date; interest income is recorded on the accrual
basis. Expenses are recorded on the accrual basis which may require the use of
certain estimates by management.
B-58
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements
--------------------------------------------------------------------------------
Net investment income (loss), other than distribution fees, and unrealized
and realized gains or losses are allocated daily to each class of shares of the
Fund based upon the relative proportion of net assets of each class at the
beginning of the day.
TAXES: It is the Fund's policy to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable net income to its shareholders. Therefore, no
federal income tax provision is required.
Withholding taxes on foreign dividends have been provided for in
accordance with the Fund's understanding of the applicable country's tax rules
and rates.
DIVIDENDS AND DISTRIBUTIONS: The Fund expects to pay dividends of net
investment income, if any, semi-annually and make distributions at least
annually of any net capital gains. Dividends and distributions are recorded on
the ex-dividend date.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles.
RECLASSIFICATION OF CAPITAL ACCOUNTS: The Fund accounts and reports for
distributions to shareholders in accordance with the American Institute of
Certified Public Accountants Statement of Position 93-2: Determination,
Disclosure, and Financial Statement Presentation of Income, Capital Gain, and
Return of Capital Distributions by Investment Companies. The effect of applying
this statement was to increase undistributed net income by $1,466,410 and
decrease paid-in capital by $1,466,410 due to the Fund experiencing net
operating losses. Net investment income, net realized gains and net assets were
not affected by this change.
NOTE 2. AGREEMENTS
The Fund has a management agreement with Prudential Investments Fund Management
LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PIFM has entered into a Subadvisory Agreement with The Prudential
Investment Corporation ('PIC'). The subadvisory agreement provides that PIC will
furnish investment advisory services in connection with the management of the
Fund. In connection therewith, PIC is obligated to keep certain books and
records of the Fund. PIFM continues to have responsibility for all investment
advisory services pursuant to the management agreement and supervises PIC's
performance of such services. PIFM pays for the services of PIC, the cost of
compensation of officers of the Fund, occupancy and certain clerical and
bookkeeping costs of the Fund. The Fund bears all other costs and expenses.
The management fee paid to PIFM is computed daily and payable monthly, at
an annual rate of .70 of 1% of the Fund's average daily net assets.
B-59
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements Cont'd.
--------------------------------------------------------------------------------
Effective January 1, 2000, the subadvisory fee paid to PIC by PIFM is
computed daily and payable monthly at an annual rate of .455 of 1% of the
average daily net assets of the Fund. Prior to January 1, 2000, PIC was
reimbursed by PIFM for reasonable costs and expenses incurred in furnishing
investment advisory services. The change in the subadvisory fee structure has no
impact on the management fee charged to the Fund or its shareholders.
The Fund has a distribution agreement with Prudential Investment
Management Services LLC ('PIMS'), which acts as the distributor of the Class A,
Class B, Class C and Class Z shares of the Fund. The Fund compensates PIMS for
distributing and servicing the Fund's Class A, Class B and Class C shares,
pursuant to plans of distribution, (the 'Class A, B and C Plans'), regardless of
expenses actually incurred by them. The distribution fees are accrued daily and
payable monthly. No distribution or service fees are paid to PIMS as distributor
of the Class Z shares of the Fund.
Pursuant to the Class A, B and C Plans, the Fund compensates PIMS for
distribution-related activities at an annual rate of up to .30 of 1%, 1% and 1%,
of the average daily net assets of the Class A, B and C shares, respectively.
Such expenses were .25 of 1%, 1% and 1% of the average daily net assets of the
Class A, Class B and Class C shares, respectively, for the year ended September
30, 2000.
PIMS has advised the Fund that it received approximately $94,600 and
$15,600 in front-end sales charges resulting from sales of Class A and Class C
shares during the year ended September 30, 2000. From these fees, PIMS paid such
sales charges to affiliated broker-dealers, which in turn paid commissions to
salespersons and incurred other distribution costs.
PIMS has advised the Fund that for the year ended September 30, 2000, it
received approximately $919,700 and $19,100 in contingent deferred sales charges
imposed upon certain redemptions by Class B and Class C shareholders,
respectively.
PIFM, PIMS and PIC are indirect, wholly owned subsidiaries of The
Prudential Insurance Company of America ('Prudential').
The Fund, along with other affiliated registered investment companies (the
'Funds'), entered into a syndicated credit agreement ('SCA') with an
unaffiliated lender. The maximum commitment under the SCA is $1 billion.
Interest on any such borrowings will be at market rates. The purpose of the
agreement is to serve as an alternative source of funding for capital share
redemptions. The Funds pay a commitment fee at an annual rate of .080 of 1% of
the unused portion of the credit facility. The commitment fee is accrued and
paid quarterly on a pro rata basis by the Funds. The expiration date of the SCA
is March 9, 2001. Prior to March 9, 2000, the commitment fee was .065 of
B-60
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements
--------------------------------------------------------------------------------
1% of the unused portion of the credit facility. The Fund did not borrow any
amounts pursuant to the SCA during the year ended September 30, 2000.
NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES
Prudential Mutual Fund Services LLC ('PMFS'), a wholly owned subsidiary of PIFM,
serves as the Fund's transfer agent. During the year ended September 30, 2000,
the Fund incurred fees of approximately $1,561,400 for the services of PMFS. As
of September 30, 2000, approximately $59,500 of such fees were due to PMFS.
Transfer agent fees and expenses in the Statement of Operations include certain
out-of-pocket expenses paid to nonaffliates.
For the year ended September 30, 2000, PSI earned approximately $12,515 in
brokerage commissions from portfolio transactions executed on behalf of the
Fund.
NOTE 4. PORTFOLIO SECURITIES
Purchases and sales of investment securities, other than short-term investments,
for the fiscal year ended September 30, 2000 were $570,923,472 and $781,404,201,
respectively.
The cost basis of investments for federal income tax purposes as of
September 30, 2000 was $580,244,959 and, accordingly, net unrealized
appreciation for federal income tax purposes was $39,865,313 (gross unrealized
appreciation--$106,459,109 gross unrealized depreciation--$66,593,796).
The Fund had a capital loss carryforward as of September 30, 2000, of
$28,204,000 which expires in 2008. Accordingly, no capital gains distributions
are expected to be paid to shareholders until future net gains have been
realized in excess of such amounts.
The Fund will elect, for United States federal income tax purposes, to
treat net short-term capital losses of $11,258,000 incurred in the eleven months
ended September 30, 2000 as having been incurred in the following fiscal year.
NOTE 5. JOINT REPURCHASE AGREEMENT ACCOUNT
The Fund, along with other affiliated registered investment companies, transfers
uninvested cash balances into a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. As of September 30, 2000, the
Fund had a 1.7% undivided interest in the joint account. The undivided interest
for the Fund represents $19,916,000 in principal amount. As of such date, each
repurchase agreement in the joint account and the collateral therefore were as
follows:
B-61
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements Cont'd.
--------------------------------------------------------------------------------
Bear, Stearns & Co., Inc., 6.51%, in the principal amount of $300,000,000,
repurchase price $300,162,750, due 10/2/00. The value of the collateral
including accrued interest was $307,686,775.
Chase Securities, Inc., 6.45%, in the principal amount of $264,084,000,
repurchase price $264,225,945, due 10/2/00. The value of the collateral
including accrued interest was $269,373,200.
Credit Suisse First Boston Corp., 6.54%, in the principal amount of
$200,000,000, repurchase price $200,109,000, due 10/2/00. The value of the
collateral including accrued interest was $206,853,792.
Salomon Smith Barney, Inc., 6.45%, in the principal amount of $97,990,000,
repurchase price $98,042,670, due 10/2/00. The value of the collateral including
accrued interest was $102,042,316.
UBS Warburg, Inc., 6.52%, in the principal amount of $300,000,000,
repurchase price $300,163,000, due 10/2/00. The value of the collateral
including accrued interest was $306,002,065.
NOTE 6. CAPITAL
The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are
sold with a front-end sales charge of up to to 5%. Class B shares are sold with
a contingent deferred sales charge which declines from 5% to zero depending on
the period of time the shares are held. Class C shares are sold with a front-end
sales charge of 1% and a contingent deferred sales charge of 1% during the first
18 months. Class B shares will automatically convert to Class A shares on a
quarterly basis approximately seven years after purchase. A special exchange
privilege is also available for shareholders who qualify to purchase Class A
shares at net asset value. Class Z shares are not subject to any sales or
redemption charge and are offered exclusively for sale to a limited group of
investors.
There are 1 billion shares of common stock authorized $.01 par value per
share, divided into four classes, designated Class A, Class B, Class C and Class
Z common stock. Class A, Class B, Class C and Class Z shares each consist of 250
million authorized shares.
Transactions in shares of common stock for the years ended September 30,
2000 and September 30, 1999 were as follows:
<TABLE>
<CAPTION>
CLASS A SHARES AMOUNT
---------------------------------------------------------- ----------- -------------
<S> <C> <C>
Year ended September 30, 2000:
Shares sold 22,953,145 $ 301,249,492
Shares reacquired (32,082,541) (416,908,818)
----------- -------------
Net decrease in shares outstanding before conversion (9,129,396) (115,659,326)
Shares issued upon conversion from Class B 3,732,291 50,187,179
----------- -------------
Net increase (decrease) in shares outstanding (5,397,105) $ (65,472,147)
----------- -------------
----------- -------------
</TABLE>
B-62
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Notes to Financial Statements
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A SHARES AMOUNT
---------------------------------------------------------- ----------- -------------
<S> <C> <C>
Year ended September 30, 1999:
Shares sold 21,652,787 $ 283,748,336
Shares issued in reinvestment of distributions 2,977,458 39,600,186
Shares reacquired (28,149,832) (366,651,014
----------- -------------
Net increase (decrease) in shares outstanding before
conversion (3,519,587) (43,302,492)
Shares issued upon conversion from Class B 2,514,601 32,509,648
----------- -------------
Net increase (decrease) in shares outstanding (1,004,986) $ (10,792,844)
----------- -------------
----------- -------------
<CAPTION>
CLASS B
----------------------------------------------------------
<S> <C> <C>
Year ended September 30, 2000:
Shares sold 6,431,353 $ 75,343,368
Shares reacquired (16,597,815) (189,752,213)
----------- -------------
Net increase (decrease) in shares outstanding before
conversion (10,166,462) (114,408,845)
Shares reacquired upon conversion into Class A (4,167,176) (50,187,179)
----------- -------------
Net increase (decrease) in shares outstanding (14,333,638) $(164,596,024)
----------- -------------
----------- -------------
Year ended September 30, 1999:
Shares sold 12,427,779 $ 148,785,336
Shares issued in reinvestment of distributions 5,000,512 60,256,172
Shares reacquired (25,651,226 (300,425,348)
----------- -------------
Net decrease in shares outstanding before conversion (8,222,935) (91,383,840)
Shares reacquired upon conversion into Class A (2,785,771) (32,509,648)
----------- -------------
Net increase (decrease) in shares outstanding (11,008,706) $(123,893,488)
----------- -------------
----------- -------------
<CAPTION>
CLASS C
----------------------------------------------------------
<S> <C> <C>
Year ended September 30, 2000:
Shares sold 2,565,702 $ 31,632,503
Shares reacquired (3,316,355) (39,899,580)
----------- -------------
Net increase (decrease) in shares outstanding (750,653) $ (8,267,077)
----------- -------------
----------- -------------
Year ended September 30, 1999:
Shares sold 1,537,225 $ 18,451,563
Shares issued in reinvestment of distributions 278,300 3,353,512
Shares reacquired (1,703,303) (19,969,646)
----------- -------------
Net increase (decrease) in shares outstanding 112,222 $ 1,835,429
----------- -------------
----------- -------------
<CAPTION>
CLASS Z
----------------------------------------------------------
<S> <C> <C>
Year ended September 30, 2000:
Shares sold 4,253,732 $ 57,728,897
Shares reacquired (5,382,396) (70,984,815)
----------- -------------
Net increase (decrease) in shares outstanding (1,128,664) $ (13,255,918)
----------- -------------
----------- -------------
Year ended September 30, 1999:
Shares sold 7,908,673 $ 105,716,022
Shares issued in reinvestment of distributions 1,095,136 14,718,633
Shares reacquired (9,747,471) (127,875,687)
----------- -------------
Net increase (decrease) in shares outstanding (743,662) $ (7,441,032)
----------- -------------
----------- -------------
</TABLE>
B-63
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
------------------
YEAR ENDED
SEPTEMBER 30, 2000
----------------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE(a):
NET ASSET VALUE, BEGINNING OF YEAR $ 12.54
----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income (loss) .01
Net realized and unrealized gain (loss) on investment
transactions 1.97
----------
Total from investment operations 1.98
----------
LESS DISTRIBUTIONS
Distributions from net realized gains --
----------
Net asset value, end of year $ 14.52
----------
----------
TOTAL RETURN(b): 15.70%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000) $291,869
Average net assets (000) $284,681
Ratios to average net assets:
Expenses, including distribution fees and service
(12b-1) fees 1.37%
Expenses, excluding distribution fees and service
(12b-1) fees 1.12%
Net investment income (loss) .04%
For Class A, B, C and Z shares:
Portfolio turnover rate 92%
</TABLE>
------------------------------
(a) Calculated based upon average shares outstanding during the year.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
See Notes to Financial Statements
B-64
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
-------------------------------------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
$ 13.79 $ 18.95 $ 15.30 $ 14.18
---------------- ---------------- ---------------- ----------------
(.01) -- .02 .04
.29 (3.31) 6.06 1.75
---------------- ---------------- ---------------- ----------------
.28 (3.31) 6.08 1.79
---------------- ---------------- ---------------- ----------------
(1.53) (1.85) (2.43) (.67)
---------------- ---------------- ---------------- ----------------
$ 12.54 $ 13.79 $ 18.95 $ 15.30
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
1.48% (18.90)% 45.92% 13.38%
$319,779 $365,431 $412,980 $237,306
$360,707 $443,189 $287,894 $223,091
1.27% 1.17% 1.21% 1.24%
1.02% .92% .96% .99%
(.09)% -- .15% .33%
39% 36% 58% 53%
</TABLE>
See Notes to Financial Statements
B-65
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
------------------
YEAR ENDED
SEPTEMBER 30, 2000
----------------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE(a):
NET ASSET VALUE, BEGINNING OF YEAR $ 11.28
----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income (loss) (.08)
Net realized and unrealized gain (loss) on investment
transactions 1.77
----------
Total from investment operations 1.69
----------
LESS DISTRIBUTIONS
Distributions from net realized gains --
----------
Net asset value, end of year $ 12.97
----------
----------
TOTAL RETURN(b): 14.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000) $199,149
Average net assets (000) $250,061
Ratios to average net assets:
Expenses, including distribution fees and service
(12b-1) fees 2.12%
Expenses, excluding distribution fees and service
(12b-1) fees 1.12%
Net investment income (loss) (0.69)%
</TABLE>
------------------------------
(a) Calculated based upon average shares outstanding during the year.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
See Notes to Financial Statements
B-66
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
$ 12.63 $ 17.64 $ 14.49 $ 13.56
---------------- ---------------- ---------------- ----------------
(.10) (.12) (.09) (.06)
.28 (3.04) 5.67 1.66
---------------- ---------------- ---------------- ----------------
.18 (3.16) 5.58 1.60
---------------- ---------------- ---------------- ----------------
(1.53) (1.85) (2.43) (.67)
---------------- ---------------- ---------------- ----------------
$ 11.28 $ 12.63 $ 17.64 $ 14.49
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
.74% (19.52)% 44.91% 12.56%
$335,013 $514,159 $645,579 $378,861
$444,747 $678,462 $443,761 $355,636
2.02% 1.92% 1.96% 1.99%
1.02% .92% .96% .99%
(.82)% (.75)% (.60)% (.42)%
</TABLE>
See Notes to Financial Statements
B-67
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C
------------------
YEAR ENDED
SEPTEMBER 30, 2000
----------------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE(a):
NET ASSET VALUE, BEGINNING OF YEAR $ 11.28
--------
INCOME FROM INVESTMENT OPERATIONS
Net investment income (loss) (.08)
Net realized and unrealized gain (loss) on investment
transactions 1.77
--------
Total from investment operations 1.69
--------
LESS DISTRIBUTIONS
Distributions from net realized gains --
--------
Net asset value, end of year $ 12.97
--------
--------
TOTAL RETURN(b): 14.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000) $ 19,236
Average net assets (000) $ 20,159
Ratios to average net assets:
Expenses, including distribution fees and service
(12b-1) fees 2.12%
Expenses, excluding distribution fees and service
(12b-1) fees 1.12%
Net investment loss (.70)%
</TABLE>
------------------------------
(a) Calculated based upon average shares outstanding during the year.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
See Notes to Financial Statements
B-68
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C
-------------------------------------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------------------------------------------------------------------------
<S> <C> <C> <C>
$ 12.63 $ 17.64 $ 14.49 $ 13.56
-------- -------- -------- --------
(.10) (.12) (.09) (.06)
.28 (3.04) 5.67 1.66
-------- -------- -------- --------
.18 (3.16) 5.58 1.60
-------- -------- -------- --------
(1.53) (1.85) (2.43) (.67)
-------- -------- -------- --------
$ 11.28 $ 12.63 $ 17.64 $ 14.49
-------- -------- -------- --------
-------- -------- -------- --------
0.74% (19.52)% 44.91% 12.56%
$ 25,207 $ 26,804 $ 22,049 $ 4,323
$ 27,813 $ 29,259 $ 8,762 $ 2,786
2.02% 1.92% 1.96% 1.99%
1.02% .92% .96% .99%
(.83)% (.75)% (.60)% (.42)%
</TABLE>
See Notes to Financial Statements
B-69
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS Z
------------------
YEAR ENDED
SEPTEMBER 30, 2000
----------------------------------------------------------------------------------------
<S> <C>
PER SHARE OPERATING PERFORMANCE(a):
NET ASSET VALUE, BEGINNING OF PERIOD $ 12.70
----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income .04
Net realized and unrealized gain (loss) on investment
transactions 2.00
----------
Total from investment operations 2.04
----------
LESS DISTRIBUTIONS
Distributions from net realized gains --
----------
Net asset value, end of period $ 14.74
----------
----------
TOTAL RETURN(b): 15.97%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000) $105,656
Average net assets (000) $ 98,623
Ratios to average net assets:
Expenses, including distribution fees and service
(12b-1) fees 1.12%
Expenses, excluding distribution fees and service
(12b-1) fees 1.12%
Net investment income .29%
</TABLE>
------------------------------
(a) Calculated based upon average shares outstanding during the period.
(b) Total return is calculated assuming a purchase of shares on the first day
and a sale on the last day of each period reported and includes reinvestment
of dividends and distributions. Total returns for periods less than a full
year are not annualized.
(c) Annualized.
(d) Commencement of offering of Class Z shares.
See Notes to Financial Statements
B-70
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Financial Highlights Cont'd.
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS Z
------------------------------------------------------------------------------------------
YEAR ENDED SEPTEMBER 30, MARCH 1, 1996(d)
---------------------------------------------------------- THROUGH
1999 1998 1997 SEPTEMBER 30, 1996
------------------------------------------------------------------------------------------
<S> <C> <C> <C>
$ 13.92 $ 19.04 $ 15.32 $ 13.69
---------------- ---------------- ---------------- ----------
.02 .04 .06 .05
.29 (3.31) 6.09 1.58
---------------- ---------------- ---------------- ----------
.31 (3.27) 6.15 1.63
---------------- ---------------- ---------------- ----------
(1.53) (1.85) (2.43) --
---------------- ---------------- ---------------- ----------
$ 12.70 $ 13.92 $ 19.04 $ 15.32
---------------- ---------------- ---------------- ----------
---------------- ---------------- ---------------- ----------
1.70% (18.58)% 46.38% 11.91%
$105,355 $125,770 $151,215 $ 68,516
$131,013 $154,623 $ 97,310 $ 66,228
1.02% .92% .96% .99%(c)
1.02% .92% .96% .99%(c)
.16% .25% .40% .58%(c)
</TABLE>
See Notes to Financial Statements
B-71
<PAGE>
PRUDENTIAL SMALL COMPANY FUND, INC.
--------------------------------------------------------------------------------
Report of Independent Accountants
--------------------------------------------------------------------------------
The Shareholders and Board of Directors of
Prudential Small Company Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential Small Company Fund, Inc.
(the 'Fund') (formerly Prudential Small Company Value Fund, Inc.) at September
30, 2000, the results of its operations for the year then ended, the changes in
its net assets for each of the two years in the period then ended and the
financial highlights for each of the periods presented, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements and financial highlights (hereafter referred to as
'financial statements') are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with auditing standards generally accepted in the United States of America,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at September 30, 2000 by correspondence with the
custodian and brokers, provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York
November 22, 2000
B-72
<PAGE>
APPENDIX I--GENERAL INVESTMENT INFORMATION
The following terms are used in mutual fund investing.
ASSET ALLOCATION
Asset allocation is a technique for reducing risk, providing balance. Asset
allocation among different types of securities within an overall investment
portfolio helps to reduce risk and to potentially provide stable returns, while
enabling investors to work toward their financial goal(s). Asset allocation is
also a strategy to gain exposure to better performing asset classes while
maintaining investment in other asset classes.
DIVERSIFICATION
Diversification is a time-honored technique for reducing risk, providing
"balance" to an overall portfolio and potentially achieving more stable returns.
Owning a portfolio of securities mitigates the individual risks (and returns) of
any one security. Additionally, diversification among types of securities
reduces the risks (and general returns) of any one type of security.
DURATION
Debt securities have varying levels of sensitivity to interest rates. As
interest rates fluctuate, the value of a bond (or a bond portfolio) will
increase or decrease. Longer term bonds are generally more sensitive to changes
in interest rates. When interest rates fall, bond prices generally rise.
Conversely, when interest rates rise, bond prices generally fall.
Duration is an approximation of the price sensitivity of a bond (or a bond
portfolio) to interest rate changes. It measures the weighted average maturity
of a bond's (or a bond portfolio's) cash flows, that is, principal and interest
rate payments. Duration is expressed as a measure of time in years--the longer
the duration of a bond (or a bond portfolio), the greater the impact of interest
rate changes on the bond's (or the bond portfolio's) price. Duration differs
from effective maturity in that duration takes into account call provisions,
coupon rates and other factors. Duration measures interest rate risk only and
not other risks, such as credit risk and, in the case of non-U.S. dollar
denominated securities, currency risk. Effective maturity measures the final
maturity dates of a bond (or a bond portfolio).
MARKET TIMING
Market timing--buying securities when prices are low and selling them when
prices are relatively higher--may not work for many investors because it is
impossible to predict with certainty how the price of a security will fluctuate.
However, owning a security for a long period of time may help investors offset
short-term price volatility and realize positive returns.
POWER OF COMPOUNDING
Over time, the compounding of returns can significantly impact investment
returns. Compounding is the effect of continuous investment on long-term
investment results, by which the proceeds of capital appreciation (and income
distributions, if elected) are reinvested to contribute to the overall growth of
assets. The long-term investment results of compounding may be greater than that
of an equivalent initial investment in which the proceeds of capital
appreciation and income distributions are taken in cash.
STANDARD DEVIATION
Standard deviation is an absolute (non-relative) measure of volatility
which, for a mutual fund, depicts how widely the returns varied over a certain
period of time. When a fund has a high standard deviation, its range of
performance has been very wide, implying greater volatility potential. Standard
deviation is only one of several measures of a fund's volatility.
I-1
<PAGE>
APPENDIX II--HISTORICAL PERFORMANCE DATA
The historical performance data contained in this Appendix relies on data
obtained from statistical services, reports and other services believed by the
Manager to be reliable. The information has not been independently verified by
the Manager.
This chart shows the long-term performance of various asset classes and the rate
of inflation.
VALUE OF $1.00 INVESTED ON 1/1/1926 THROUGH 12/31/1999
<TABLE>
<CAPTION>
<S> <C>
Small Stocks $6,640.79
Common Stocks $2,845.63
Long-Term Bonds $ 40.22
Treasury Bills $ 15.64
Inflation $ 9.40
</TABLE>
Source: Ibbotson Associates. Used with permission. This chart is for
illustrative purposes only and is not indicative of the past, present, or future
performance of any asset class or any Prudential mutual fund.
Generally, stock returns are due to capital appreciation and reinvesting any
gains. Bond returns are due mainly to reinvesting interest. Also, stock prices
usually are more volatile than bond prices over the long-term. Small stock
returns for 1926-1980 are those of stocks comprising the 5th quintile of the New
York Stock Exchange. Thereafter, returns are those of the Dimensional Fund
Advisors (DFA) Small Company Fund. Common stock returns are based on the S&P 500
Composite Stock Price Index, a market-weighted, unmanaged index of 500 stocks
(currently) in a variety of industries. It is often used as a broad measure of
stock market performance.
Long-term government bond returns are measured using a constant one-bond
portfolio with a maturity of roughly 20 years. Treasury bill returns are for a
one-month bill. Treasuries are guaranteed by the government as to the timely
payment of principal and interest; equities are not. Inflation is measured by
the consumer price index (CPI).
II-1
<PAGE>
Set forth below is historical performance data relating to various sectors
of the fixed-income securities markets. The chart shows the historical total
returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds,
U.S. high yield bonds and world government bonds on an annual basis from 1989
through 1999. The total returns of the indexes include accrued interest, plus
the price changes (gains or losses) of the underlying securities during the
period mentioned. The data is provided to illustrate the varying historical
total returns and investors should not consider this performance data as an
indication of the future performance of the Fund or of any sector in which the
Fund invests.
All information relies on data obtained from statistical services, reports
and other services believed by the Manager to be reliable. Such information has
not been verified. The figures do not reflect the operating expenses and fees of
a mutual fund. See "Risk/Return Summary--Fees and Expenses" in the prospectus.
The net effect of the deduction of the operating expenses of a mutual fund on
these historical total returns, including the compounded effect over time, could
be substantial.
HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS
<TABLE>
<CAPTION>
'89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. GOVERNMENT TREASURY BONDS(1) 14.4 % 8.5 % 15.3% 7.2% 10.7% (3.4)% 18.4% 2.7% 9.6 % 10.0% (2.56)%
--------------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT MORTGAGE SECURITIES(2) 15.4 % 10.7 % 15.7% 7.0% 6.8% (1.6)% 16.8% 5.4% 9.5 % 7.0% 1.86 %
--------------------------------------------------------------------------------------------------------------------------------
U.S. INVESTMENT GRADE CORPORATE
BONDS(3) 14.1 % 7.1 % 18.5% 8.7% 12.2% (3.9)% 22.3% 3.3% 10.2 % 8.6% (1.96)%
--------------------------------------------------------------------------------------------------------------------------------
U.S. HIGH YIELD CORPORATE BONDS(4) 0.8 % (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2% 11.4% 12.8 % 1.6% 2.39 %
--------------------------------------------------------------------------------------------------------------------------------
WORLD GOVERNMENT BONDS(5) (3.4)% 15.3% 16.2% 4.8% 15.1% 6.0 % 19.6% 4.1% (4.3)% 5.3% (5.07)%
--------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------
DIFFERENCE BETWEEN HIGHEST
AND LOWEST RETURN PERCENT 18.8 24.9 30.9 11.0 10.3 9.9 5.5 8.7 17.12 8.4 7.46
</TABLE>
(1) LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over
150 public issues of the U.S. Treasury having maturities of at least one
year.
(2) LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that
includes over 600 15- and 30-year fixed-rate mortgage-backed securities of
the Government National Mortgage Association (GNMA), Federal National
Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation
(FHLMC).
(3) LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate,
nonconvertible investment-grade bonds. All bonds are U.S. dollar-
denominated issues and include debt issued or guaranteed by foreign
sovereign governments, municipalities, governmental agencies or
international agencies. All bonds in the index have maturities of at least
one year. Source: Lipper Inc.
(4) LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over
750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by
Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or
Fitch Investors Service). All bonds in the index have maturities of at least
one year.
(5) SALOMON SMITH BARNEY BROTHERS WORLD GOVERNMENT INDEX (NON U.S.) includes
over 800 bonds issued by various foreign governments or agencies, excluding
those in the U.S., but including those in Japan, Germany, France, the U.K.,
Canada, Italy, Australia, Belgium, Denmark, the Netherlands, Spain, Sweden,
and Austria. All bonds in the index have maturities of at least one year.
II-2
<PAGE>
This chart illustrates the performance of major
world stock markets for the period from 1985
through December 31, 1999. It does not represent the
performance of any Prudential mutual fund.
TOTAL RETURNS OF MAJOR WORLD STOCK MARKETS 12/31/85 - 12/31/99 (IN U.S. DOLLARS)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Sweden 22.70%
Hong Kong 20.37%
Spain 20.11%
Netherland 18.63%
Belgium 18.41%
France 17.69%
USA 17.39%
UK 16.41%
Europe 16.28%
Switzerland 15.58%
Sing/Mlysia 15.07%
Denmark 14.72%
Germany 13.29%
Australia 11.68%
Italy 11.39%
Canada 11.10%
Japan 9.59%
Norway 8.91%
Austria 7.09%
</TABLE>
Source: Morgan Stanley Capital International (MSCI) and
Lipper, Inc. as of 12/31/99. Used with permission.
Morgan Stanley Country indexes are unmanaged indexes which
include those stocks making up the largest two-thirds of each
country's total stock market capitalization. Returns reflect the
reinvestment of all distributions. This chart is for illustrative
purposes only and is not indicative of the past, present or
future performance of any specific investment. Investors
cannot invest directly in stock indexes.
This chart shows the growth of a hypothetical
$10,000 investment made in the stocks representing
the S&P 500 stock index with and without reinvested
dividends.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C> <C>
Capital Appreciation
Capital Appreciation only
and Reinvesting
Dividends
1969
1973
1977
1981
1985
1989
1993
1997
1999 $474,094 $159,957
</TABLE>
Source: Lipper Inc. Used with permission. All rights reserved.
This chart is used for illustrative purposes only and is not intended to
represent the past, present or future performance of any Prudential Mutual Fund.
Common stock total return is based on the Standard & Poor's 500 Composite Stock
Price Index, a market-value-weighted index made up of 500 of the largest stocks
in the U.S. based upon their stock market value. Investors cannot invest
directly in indexes.
II-3
<PAGE>
---------------------------------------------------------
WORLD STOCK MARKET CAPITALIZATION BY REGION
WORLD TOTAL: $20.7 TRILLION
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
U.S. 49.00%
Europe 32.50%
Pacific
Basin 16.40%
Canada 2.10%
</TABLE>
Source: Morgan Stanley Capital International, December 31, 1999.
Used with permission. This chart represents the capitalization of
major world stock markets as measured by the Morgan Stanley
Capital International (MSCI) World Index. The total market
capitalization is based on the value of approximately 1577 companies in 22
countries (representing approximately 60% of the aggregate
market value of the stock exchanges). This chart is for illustrative
purposes only and does not represent the allocation of any
Prudential mutual fund.
This chart below shows the historical volatility of general
interest rates as measured by the long U.S. Treasury Bond.
LONG U.S. TREASURY BOND YIELD IN PERCENT
(1926-1999)
[CHART]
YEAR-END
Source: Ibbotson Associates. Used with permission. All rights reserved.
This chart illustrates the historical yield of the long-term U.S. Treasury
Bond from 1926-1999. Yields represent that of an annually renewed one-bond
portfolio with a remaining maturity of approximately 20 years. This chart
is for illustrative purposes only and should not be construed to represent
the yields of any Prudential mutual fund.
II-4
