Statement of
Additional Information
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THE LEGG MASON TAX EXEMPT TRUST, INC.
MONEY MARKET PORTFOLIO
Legg Mason Tax Exempt Trust, Inc. ("Corporation") is a money
market fund seeking to produce high current income exempt from federal
income tax, to preserve capital, and to maintain liquidity.
The Corporation offers a single portfolio, the Money Market
Portfolio ("Fund"). In attempting to achieve its objectives, the Fund's
investment adviser, Legg Mason Fund Adviser, Inc. ("Adviser"), invests
primarily in short-term, high-quality municipal obligations, the interest
on which is exempt from federal income tax and is not a tax preference
item for purposes of the federal alternative minimum tax ("TPI"). Shares
in the Fund are issued and redeemed at net asset value, without an initial
sales charge or redemption fee. The Fund attempts to maintain a stable
net asset value of $1.00 per share, although there can be no assurance
that it will always be able to do so.
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Fund's Prospectus, dated May 1,
1995, which has been filed with the Securities and Exchange Commission
("SEC"). A copy of the Prospectus is available without charge from the
Fund's distributor, Legg Mason Wood Walker, Incorporated ("Legg Mason")
(address and telephone numbers listed below).
Dated: May 1, 1995
Legg Mason Wood Walker,
Incorporated
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111 South Calvert Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
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Table of Contents
Page
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Additional Information About Investment Objectives,
Limitations, and Policies 2
Investment Limitations 5
Additional Purchase and Redemption Information 7
How the Fund's Yield Is Calculated 11
Additional Tax Information 13
Valuation of Shares 15
The Corporation's Directors and Officers 16
The Fund's Investment Adviser 21
The Fund's Distributor 22
Portfolio Transactions and Brokerage 23
The Corporation's Custodian and Transfer and Dividend-
Disbursing Agent 24
The Corporation's Legal Counsel 24
The Corporation's Independent Accountants 24
Financial Statements 24
Appendix A: Ratings of Securities A-1
No person has been authorized to give any information or to make
any representations not contained in the Prospectus or this Statement
of Additional Information in connection with the offering made by the
Prospectus and, if given or made, such information or representations
must not be relied upon as having been authorized by the Fund or its
distributor. The Prospectus and this Statement of Additional
Information does not constitute an offering by the Fund or by the
distributor in any jurisdiction in which such offering may not lawfully
be made.
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ADDITIONAL INFORMATION ABOUT INVESTMENT OBJECTIVES, LIMITATIONS, AND
POLICIES
The following information supplements the information concerning
the Fund's investment objectives, policies and limitations found in the
Prospectus. The Fund invests primarily in a diversified portfolio of
obligations issued by or on behalf of the states, territories and
possessions of the United States and the District of Columbia and their
political subdivisions, agencies, instrumentalities or authorities, the
interest on which, in the opinion of counsel to the issuers, is exempt
from federal income tax and the federal alternative minimum tax
("Municipal Obligations").
The Prospectus explains that the Fund, in selecting investments,
considers the ratings assigned securities by nationally recognized
statistical rating organizations ("NRSROs"), such as Moody's Investors
Service, Inc. ("Moody's") and Standard & Poor's Ratings Group ("S&P").
The ratings of NRSROs represent their opinion as to the quality of the
Municipal Obligations which they undertake to rate. It should be
emphasized, however, that ratings are general and are not absolute
standards of quality. Consequently, Municipal Obligations with the same
maturity, interest rate and rating may have different market prices. The
Appendix to this Statement of Additional Information contains information
concerning the ratings of Moody's and S&P and their significance. The
Fund considers each rating to include any modifiers, e.g., "+" or "-".
Municipal Obligations include "general obligation bonds," which
are secured by the issuer's pledge of its full faith and credit, including
its taxing power, and "revenue bonds," which are payable only from the
revenues derived from a particular facility or class of facilities or from
the proceeds of a special excise tax or other specific revenue source such
as the corporate user of the facility being financed. Industrial
development bonds and private activity bonds usually are revenue bonds and
are not payable from the unrestricted revenues of the issuer. The credit
quality of industrial development bonds and private activity bonds is
usually directly related to the credit standing of the corporate user of
the facilities. Municipal Obligations also include short-term tax
anticipation notes, bond anticipation notes, revenue anticipation notes
and other forms of short-term debt obligations. Such notes may be issued
with a short-term maturity in anticipation of the receipt of tax funds,
the proceeds of bond placements or other revenues.
Opinions relating to the validity of Municipal Obligations and to
the exemption of interest thereon from federal income tax and the
alternative minimum tax are rendered by bond counsel to the issuers at the
time of issuance. Neither the Fund nor the Adviser will independently
review the basis for such opinions.
An issuer's obligations under its Municipal Obligations are
subject to the provisions of bankruptcy, insolvency and other laws
affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Act, and laws that may be enacted by Congress or state
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legislatures extending the time for payment of principal or interest, or
both, or imposing other constraints upon enforcement of such obligations.
There is also the possibility that as a result of litigation or other
conditions the power or ability of issuers to meet their obligations for
the payment of interest and principal on their Municipal Obligations may
be materially and adversely affected.
From time to time, proposals have been introduced before Congress
for the purpose of restricting or eliminating the federal income tax
exemption for interest on Municipal Obligations. If other legislative
proposals further restricting, or eliminating, the exemption of Municipal
Obligations interest from federal income tax were enacted, the
availability of Municipal Obligations for investment by the Fund and the
value of its assets could be materially and adversely affected. In that
event, the Fund would re-evaluate its investment objectives and policies
and consider changes in its structure or possible dissolution.
When-Issued Securities
As stated in the Prospectus, the Fund may enter into commitments
to purchase new issues of municipal bonds on a when-issued basis.
Delivery of and payment for these securities normally takes place 7 to 45
days after the date of the commitment. Interest rates on when-issued
securities are normally fixed at the time of the commitment.
Consequently, increases in the market rate of interest between the
commitment date and settlement date may result in a market value for the
security on the settlement date that is less than its purchase price.
With regard to each such commitment agreement, the Fund maintains
in a segregated account with the custodian, commencing on the date of such
agreement, cash, U.S. government securities or other high-quality liquid
debt securities equal in value to the purchase price for the when-issued
securities due on the settlement date. The Fund makes when-issued
commitments only with the intention of actually acquiring the securities
subject thereto, but the Fund may sell these securities before the
settlement date if market conditions warrant. When payment is due for
when-issued securities, the Fund meets its obligations from then-available
cash flow, from the sale of securities or, although it would not normally
expect to do so, from the sale of the when-issued securities themselves
(which may have a market value greater or less than the Fund's payment
obligation). As the Prospectus states, commitments to purchase when-
issued securities will not exceed 25% of the Fund's total assets.
Stand-By Commitments
When the Fund exercises a stand-by commitment that it has
acquired from a dealer with respect to Municipal Obligations held by it,
the dealer normally pays to the Fund an amount equal to (1) the Fund's
acquisition cost of the Municipal Obligations (excluding any accrued
interest which the Fund paid on its acquisition), less any amortized
market premium or plus any amortized market or original issue discount
during the period the Fund owned the securities, plus (2) all interest
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accrued on the securities since the last interest payment date or the date
the securities were purchased by the Fund, whichever is later. The Fund's
right to exercise stand-by commitments is unconditional and unqualified
and exercisable by the Fund at any time prior to the underlying
securities' maturity.
A stand-by commitment is not transferable by the Fund without the
underlying securities, although the Fund could sell the underlying
Municipal Obligations to a third party at any time. The Fund may pay for
stand-by commitments either separately in cash or by paying a higher price
for portfolio securities which are acquired subject to such a commitment
(thus reducing the yield to maturity otherwise available for the same
securities). The total amount paid in either manner for outstanding
stand-by commitments held by the Fund will not exceed 1/2 of 1% of the
Fund's total asset value calculated immediately after each stand-by
commitment is acquired. The Fund intends to enter into stand-by
commitments only with those banks, brokers and dealers that in the
Adviser's opinion present minimal credit risks.
The Fund intends to acquire stand-by commitments solely to
facilitate liquidity and does not intend to exercise its rights thereunder
for trading purposes. The acquisition of a stand-by commitment would not
ordinarily affect the valuation or assumed maturity of the underlying
Municipal Obligations, which will continue to be valued in accordance with
the amortized cost method. Stand-by commitments acquired by the Fund
would be valued at zero in determining net asset value. Where the Fund
paid directly or indirectly for a stand-by commitment, its cost would be
reflected as unrealized depreciation during the period the commitment is
held by the Fund. Stand-by commitments would not affect the average
weighted maturity of the assets of the Fund.
Variable Rate and Floating Rate Obligations
The Prospectus states that the Fund may invest in variable and
floating rate Municipal Obligations. A variable rate obligation differs
from an obligation with a fixed rate coupon, the value of which fluctuates
in inverse relation to interest rate changes. If interest rates decline
below the coupon rate, generally the value of a fixed rate obligation
increases and the obligation sells at a premium. Should interest rates
increase above the coupon rate, generally the value of a fixed rate
obligation decreases and the obligation sells at a discount. The
magnitude of such capital fluctuations is also a function of the period of
time remaining until the obligation matures. Short-term fixed rate
obligations are minimally affected by interest rate changes; the greater
the remaining period until maturity, the greater the fluctuation in value
of a fixed rate obligation is likely to be.
Variable rate obligation coupons are not fixed for the full term
of the obligation, but are adjusted periodically based upon changes in
prevailing interest rates. As a result, the value of variable rate
obligations is less affected by changes in interest rates. The more
frequently such obligations are adjusted, the less such obligations are
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affected by interest rate changes during the period between adjustments.
The value of a variable rate obligation, however, may fluctuate in
response to market factors and changes in the creditworthiness of the
issuer.
By investing in variable rate obligations, the Fund hopes to take
advantage of the normal yield curve function that usually results in
higher yields on longer-term investments. This policy also means that
should interest rates decline, the yield of the Fund will decline, and the
Fund and its shareholders will forgo the opportunity for capital
appreciation of its portfolio investments and of their shares. Should
interest rates increase, the yield of the Fund will increase, and the Fund
and its shareholders will diminish the risk of capital depreciation of its
portfolio investments and of their shares. There is no limitation on the
percentage of the Fund's assets that may be invested in variable rate
obligations. However, the Fund will limit the value of its investments in
any variable rate securities that are illiquid and in all other illiquid
securities to 10% or less of its total assets.
Floating rate obligations also are not fixed, but are adjusted as
specified benchmark interest rates change. In other respects, their
characteristics are similar to variable rate notes, as discussed
previously.
As stated in the Prospectus, the Fund may also invest in floating
rate and variable rate demand notes. A demand feature entitles the Fund
to receive the principal amount of the instrument from the issuer or a
third party (1) on no more than 30 days' notice or (2) at specified
intervals, not exceeding 397 days, and upon no more than 30 days' notice.
When the note is supported by an unconditional bank letter of credit
guaranteeing payment of the principal or both the principal and accrued
interest, the Adviser may take into consideration the creditworthiness of
the bank issuing the letter in making the investment decision.
The Board of Directors of the Corporation has approved
investments in floating rate and variable rate demand notes by the Fund
that comply with conditions established by the SEC, which, among other
things, permit such instruments to be deemed to have remaining maturities
of 397 days or less, notwithstanding that they may otherwise have a stated
maturity in excess of 397 days.
Repurchase Agreements
A repurchase agreement is an agreement under which U.S.
government obligations or other high-quality debt securities are acquired
by the Fund from a securities dealer or bank subject to resale at a
previously agreed-upon price and date. The resale price reflects an
agreed interest rate effective for the period the securities are held and
is unrelated to the interest rate provided by the securities. In these
transactions, the securities acquired by the Fund are held by the Fund's
custodian until resold and will be supplemented by additional collateral
if necessary to maintain a total value equal to or in excess of the value
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of the repurchase agreements. Repurchase agreements are usually for
periods of one week or less, but may be for longer periods. The Fund will
not enter into repurchase agreements of more than seven days duration if
more than 10% of its net assets would be invested in such agreements and
other illiquid investments. The Fund's income from repurchase agreements
is taxable as interest income.
To the extent that proceeds from the sale upon a default of the
obligation to repurchase were less than the repurchase price, the Fund
might suffer a loss. In addition, if bankruptcy proceedings are commenced
with respect to the seller of the security, realization upon the
collateral by the Fund could be delayed or limited. However, the Fund has
adopted standards for the parties with whom it will enter into repurchase
agreements that the Corporation's Board believes are reasonably designed
to assure that each party presents no serious risk of becoming involved in
bankruptcy proceedings within the time frame contemplated by the
repurchase agreement.
Trading Policies
In seeking increased income, the Fund may not always hold its
securities to maturity but may sell a security to buy another with a
higher yield because of short-term market movements. This may result in
high portfolio turnover. The Fund, however, does not anticipate incurring
significant brokerage expense in connection with this trading because the
transactions ordinarily are made directly with the issuer or a dealer on a
net price basis.
INVESTMENT LIMITATIONS
The Fund has adopted certain fundamental policies that can be
changed only by the vote of a majority of the outstanding voting
securities of the Fund. Under the 1940 Act, a "vote of a majority of the
outstanding voting securities" of the Fund means the affirmative vote of
the lesser of (1) more than 50% of the outstanding shares of the Fund or
(2) 67% or more of the shares present at a shareholders' meeting if more
than 50% of the outstanding shares are represented at the meeting in
person or by proxy. As a matter of fundamental policy, the Fund may not:
1. Borrow money, except for temporary purposes in an
aggregate amount not to exceed 10% of the value of the total assets of the
Fund; provided that borrowings in excess of 5% of such value will be only
from banks, and the Fund will not purchase portfolio securities while its
borrowings exceed 5% (interest paid on borrowed money would reduce income
to the Fund);
2. Underwrite the securities of other issuers except insofar
as the Fund may be deemed an underwriter under the Securities Act of 1933,
as amended, in disposing of a portfolio security;
3. Purchase common stocks, preferred stocks, warrants, or
other equity securities;
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4. Buy or hold any real estate other than municipal bonds
secured by real estate or interests therein;
5. Buy or hold any commodity or commodity futures contracts,
or any oil, gas or mineral exploration or development program;
6. Make loans, except loans of portfolio securities and
except to the extent the purchase of a portion of an issue of publicly
distributed notes, bonds or other evidences of indebtedness, the entry
into repurchase agreements, or deposits with banks and other financial
institutions may be considered loans;
7. Mortgage or pledge any of the Fund's assets, except to
the extent, up to a maximum of 10% of the value of its total assets,
necessary to secure borrowings permitted by paragraph 1;
8. Buy securities on "margin" or make "short" sales of
securities;
9. Write or purchase put or call options except to the
extent that securities subject to stand-by commitments may be purchased as
set forth under "Additional Information About Investment Objectives,
Limitations, and Policies," in this Statement of Additional Information;
10. Buy securities which have legal or contractual
restrictions on resale, if the purchase causes more than 10% of the Fund's
assets to be invested in illiquid securities and repurchase agreements
maturing in more than seven days;
11. Buy securities issued by any other investment company,
except in connection with a merger, consolidation, acquisition or
reorganization;
12. Invest more than 5% of its total assets in securities of
issuers which, including their predecessors, have been in operation for
less than three years; or
13. Purchase securities of any one issuer, other than
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, if immediately after such purchase more than 5% of the
Fund's total asset value would be invested in such issuer, except that up
to 25% of the Fund's total asset value may be invested without regard to
such 5% limitation.
If a percentage restriction described above is complied with at
the time an investment is made, a later increase or decrease in percentage
resulting from a change in value of portfolio securities or in the amount
of net assets of the Fund will not be considered a violation of any of
those restrictions.
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Except as expressly stated otherwise, the policies and
limitations described in this Statement of Additional Information are not
fundamental and can be changed by vote of the Board of Directors.
The Corporation in the future may organize additional separate
investment portfolios, each of which will invest in particular types of
tax-exempt, interest-bearing securities and will have separate investment
objectives, policies and limitations.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Prospectus explains that the minimum initial investment in
the Fund is $1,000 and subsequent investments must be at least $100.
Purchases made through the Future First Systematic Investment Plan,
payroll deduction plans and plans involving automatic payment of funds
from financial institutions or automatic investment of dividends from
certain unit investment trusts are subject to no initial minimum and to a
minimum monthly investment of only $50.
Future First Systematic Investment Plan and Transfer of Funds from
Financial Institutions
When you purchase shares through the Future First Systematic
Investment Plan, Boston Financial Data Services ("BFDS"), the Fund's
transfer agent, will send a check each month to your bank for collection,
and the proceeds of the check will be used to buy shares of the Fund.
Legg Mason, the Fund's distributor, will send you a cumulative account
statement quarterly. The check will also be reflected on your regular
checking account statement. You may terminate the Future First Systematic
Investment Plan at any time without charge or penalty. Forms to enroll in
the Future First Systematic Investment Plan are available from any Legg
Mason or affiliated office.
You may also buy additional shares of the Fund through a plan
permitting transfers of funds from a financial institution. Certain
financial institutions may allow you, on a pre-authorized basis, to have
$50 or more automatically transferred monthly for investment in shares of
the Fund to:
Legg Mason Wood Walker, Incorporated
Funds Processing
P.O. Box 1476
Baltimore, Maryland 21203-1476
If your check is not honored by the institution it is drawn on,
you may be subject to extra charges in order to cover collection costs.
These charges may be deducted from your shareholder account.
Systematic Withdrawal Plan
You may also elect to make systematic withdrawals from your Fund
account of a minimum of $50 on a monthly basis if you own shares with a
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net asset value of $5,000 or more. The amounts paid to you each month are
obtained by redeeming sufficient shares from your account to provide the
withdrawal amount that you have specified. You may change the monthly
amount to be paid to you without charge not more than once a year by
notifying Legg Mason or the affiliate with which you have an account.
Redemptions will be made at the net asset value determined as of the close
of business of the New York Stock Exchange, Inc. ("Exchange") on the first
day of each month. If the Exchange is not open for business on that day,
the shares will be redeemed at the net asset value as determined as of the
close of regular trading of the Exchange on the preceding business day.
The check for the withdrawal payment will usually be mailed to you on the
next business day following redemption. If you elect to participate in
the Systematic Withdrawal Plan, dividends and distributions, if any, on
all shares in your Fund account must automatically be reinvested in Fund
shares. You may terminate the Systematic Withdrawal Plan at any time
without charge or penalty. The Fund, its transfer agent, Legg Mason and
its affiliates also reserve the right to modify or terminate the
Systematic Withdrawal Plan at any time.
Withdrawal payments are treated as a sale of shares rather than
as a dividend or capital gain distribution. To the extent periodic
withdrawals exceed reinvested dividends, if any, the amount of your
original investment will be correspondingly reduced.
The Fund will not knowingly accept purchase orders from you for
additional shares if you maintain a Systematic Withdrawal Plan unless your
purchase is equal to at least one year's scheduled withdrawals. In
addition, if you maintain a Systematic Withdrawal Plan, you may not make
periodic investments under the Future First Systematic Investment Plan.
Conversion to Federal Funds
A cash deposit made after the daily cashiering deadline of the
Legg Mason office in which the deposit is made will be credited to your
Legg Mason brokerage account ("Brokerage Account") on the next business
day following the day of deposit, and the resulting free credit balance
will be invested on the second business day following the day of receipt.
Legg Mason Premier Asset Management Account/VISA Account
Shareholders of the Fund who have cash or negotiable securities
(including Fund shares) valued at $20,000 or more in accounts with Legg
Mason may subscribe to Legg Mason's Premier Asset Management Account
("Premier"). This program provides a direct link between a shareholder's
Fund account and his or her Brokerage Account. Premier provides
shareholders with a convenient method to invest in the Fund through their
Brokerage Account, which includes automatic daily investment of free
credit balances of $100 or more and automatic weekly investment of free
credit balances of less than $100.
Premier is a comprehensive financial service which combines a
shareholder's Fund account, a preferred customer VISA Gold debit card, a
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Legg Mason Brokerage Account and unlimited checks with no minimum check
amount. Premier is offered as an exclusive preferred customer service for
shareholders of certain Legg Mason funds.
The VISA Gold debit card may be used to purchase merchandise or
services from merchants honoring VISA or to obtain cash advances (which a
bank may limit to $5,000 or less, per account per day) from any bank
honoring VISA.
Checks, VISA charges and cash advances are posted to the
shareholder's margin account and create automatic same-day redemptions if
shares are available in the Fund. If Fund shares have been exhausted, the
debits will remain in the margin account, reducing the cash available.
The shareholder will receive one consolidated monthly statement which
details all Fund transactions, securities activity, checkwriting activity
and VISA Gold purchases and cash advances.
BancOne Columbus ("BancOne"), 757 Carolyn Avenue, Columbus, Ohio
43271, is the Fund's agent for processing payment of VISA Gold debit card
charges and clearance of checks written on the Premier Account.
Shareholders are subject to BancOne's rules and regulations governing VISA
accounts, including the right of BancOne not to honor VISA drafts in
amounts exceeding the authorization limit of the shareholder's account at
the time the VISA draft is presented for payment. The authorization limit
is determined daily by taking the shareholder's Fund account balance and
subtracting (1) all shares purchased by other than federal funds wired
within 15 days; (2) all shares for which certificates have been issued;
and (3) any previously authorized VISA transaction.
PREFERRED CUSTOMER CARD SERVICES Unlike some other investment
programs which offer the VISA card privilege, Premier also includes
travel/accident insurance at no added cost when shareholders purchase
travel tickets with their Premier VISA Gold debit card. Coverage is
provided through VISA and extends up to $250,000.
If a VISA Gold debit card is lost or stolen, the shareholder
should report the loss immediately by contacting Legg Mason directly
between the hours of 8:30 a.m. and 5:00 p.m. eastern time, or BancOne
collect after hours at 1-614-248-4242. Those shareholders who subscribe
to the Premier VISA account privilege may be liable for the unauthorized
use of their VISA Gold debit card in amounts up to $50.
Legg Mason is responsible for all Premier VISA Gold debit card
inquiries as well as billing and account resolutions. Simply call Legg
Mason Premier Client Services directly between 8:30 a.m. and 5:00 p.m.
eastern time, at 1-800-253-0454 or 1-410-528-2066 with your account
inquiries.
AUTOMATIC PURCHASES OF FUND SHARES For shareholders
participating in the Premier program who sell shares held in their
Brokerage Account, any free credit balances of $100 or more resulting from
any such sale will automatically be invested in shares of the Fund on the
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same business day the proceeds of sale are credited to the Brokerage
Account. Free credit balances of less than $100 will be invested in Fund
shares weekly.
Free credit balances arising from sales of Brokerage Account
shares for cash (i.e., same-day settlement), redemption of debt
securities, dividend and interest payments and deposits will be invested
automatically in Fund shares on the next business day following the day
the transaction is credited to the Brokerage Account.
Fund shares will receive the next dividend declared following
purchase (normally 12:00 noon, eastern time, on the following business
day). A purchase order will not become effective until cash in the form
of federal funds is received by the Fund.
HOW TO OPEN A PREMIER ACCOUNT To subscribe to Premier services,
clients must contact Legg Mason to execute both a Premier Agreement with
Legg Mason and a VISA Account Application and Agreement with BancOne.
Legg Mason charges a fee for the Premier service, which is currently $85
per year for individuals and $100 per year for businesses and
corporations. Legg Mason reserves the right to alter or waive the
conditions upon which a Premier Account may be opened. Both Legg Mason
and BancOne reserve the right to terminate or modify any shareholder's
Premier services at their discretion.
Your may request Premier Account status by filling out the
Premier Asset Management Account Agreement and Check Application which can
be obtained from your investment executive. You will receive your VISA
Gold debit card (if applicable) from BancOne. The Premier VISA Gold debit
card may be used at over 8 million locations, including 23,000 ATMs, in 24
countries around the world. Premier checks will be sent to you directly.
There is no limit to the number of checks you may write against your
Premier account.
Shareholders should be aware that the various features of the
Premier program are intended to provide easy access to assets in their
accounts and that the Premier Account is not a bank account. Additional
information about the Premier program is available by calling your Legg
Mason or affiliated investment executive or Legg Mason's Premier Client
Services.
Other Information Regarding Redemption
The Fund reserves the right to modify or terminate the check,
wire, telephone or VISA Gold card redemption services described in the
Prospectus and this Statement of Additional Information at any time.
You may request the Fund's checkwriting service by sending a
written request to Legg Mason. State Street Bank and Trust Company
("State Street"), the Fund's custodian, will supply you with checks which
can be drawn on an account of the Fund maintained with State Street. When
honoring a check presented for payment, the Fund will cause State Street
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to redeem exactly enough full and fractional shares in your account to
cover the amount of the check. Cancelled checks will be returned to you.
Check redemption is subject to State Street's rules and
regulations governing checking accounts. Checks should not be used to
close a Fund account, because when the check is written you will not know
the exact value of the account, including accrued dividends, on the day
the check clears. Persons obtaining certificates for their shares may not
use the checkwriting service.
The date of payment for a redemption may not be postponed for
more than seven days, and the right of redemption may not be suspended
except (a) for any period during which the Exchange is closed (other than
for customary weekend and holiday closings), (b) when trading in markets
the Fund normally utilizes is restricted or an emergency, as defined by
rules and regulations of the SEC, exists, making disposal of the Fund's
investments or determination of its net asset value not reasonably
practicable, or (c) for such other periods as the SEC, by order, may
permit for protection of the Fund's shareholders. In the case of any such
suspension, you may either withdraw your request for redemption or receive
payment based upon the net asset value next determined after the
suspension is lifted.
The Fund further reserves the right, under certain conditions, to
honor any request or combination of requests for redemption from the same
shareholder in any 90-day period, totalling $250,000 or 1% of the net
assets of the Fund, whichever is less, by making payment in whole or in
part by securities valued in the same way as they would be valued for
purposes of computing the Fund's net asset value per share. If payment is
made in securities, a shareholder should expect to incur brokerage
expenses in converting those securities into cash and will be subject to
fluctuation in the market price of those securities until they are sold.
The Fund does not redeem "in kind" under normal circumstances, but would
do so where the Adviser determines that it would be in the best interests
of the shareholders as a whole.
Although the Fund may elect to redeem any shareholder account
with a current value of less than $500, the Fund will not redeem accounts
that fall below $500 solely as a result of a reduction in net asset value
per share.
HOW THE FUND'S YIELD IS CALCULATED
The current annualized yield for the Fund is based upon a seven-
day period and is computed by determining the net change in the value of a
hypothetical account in the Fund. The net change in the value of the
account includes the value of dividends and of additional shares purchased
with dividends, but does not include realized gains and losses or
unrealized appreciation and depreciation. In addition, the Fund may use a
compound effective annualized yield quotation which is calculated, as
prescribed by SEC regulations, by adding one to the base period return
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(calculated by dividing the Fund's net investment income for a seven-day
period ("Period"), by the average number of shares entitled to receive
dividends during the Period), raising the sum to a power equal to 365
divided by 7, and subtracting one.
The Fund's yield may fluctuate daily depending upon such factors
as the average maturity of its securities, changes in investments, changes
in interest rates and variations in operating expenses. Therefore,
current yield does not provide a basis for determining future yields. The
fact that the Fund's current yield will fluctuate and that shareholders'
principal is not guaranteed or insured should be considered in comparing
the Fund's yield with yields on fixed-yield investments, such as insured
savings certificates. In comparing the yield of the Fund to other
investment vehicles, consideration should be given to the investment
policies of each, including the types of investments owned, lengths of
maturities of the portfolio, the method used to compute the yield and
whether there are any special charges that may reduce the yield.
The Fund from time to time also may advertise its tax-equivalent
yield and tax-equivalent effective yield, based on a recently ended
thirty-day period. These quotations are calculated by dividing that
portion of the Fund's yield (or effective yield, as the case may be) that
is tax-exempt by 1 minus a stated income tax rate and adding the product
to that portion, if any, of the Fund's yield that is not tax-exempt.
Assuming a maximum tax rate of 39.6%, the Fund's tax-equivalent yield and
tax-equivalent effective yield for the thirty-day period ended December
31, 1994 were 5.35% and 5.43%, respectively.
Other Information
The Fund's performance data quoted in advertising and other
promotional materials ("Performance Advertisements") represent past
performance and are not intended to predict or indicate future results.
The return on an investment in the Fund will fluctuate. In Performance
Advertisements, the Fund may compare its taxable or tax-free yield with
data published by Lipper Analytical Services, Inc. for money funds
("Lipper"), CDA Investment Technologies, Inc. ("CDA"), IBC/Donoghue's
Money Market Fund Report ("Donoghue"), Wiesenberger Investment Companies
Service ("Wiesenberger") or Investment Company Data Inc. ("ICD"), or with
the performance of recognized stock and other indexes, including (but not
limited to) the Standard & Poor's 500 Composite Stock Price Index ("S&P
500"), the Dow Jones Industrial Average ("Dow Jones") and the Consumer
Price Index as published by the U.S. Department of Commerce. The Fund
also may refer in such materials to mutual fund performance rankings and
other data, such as comparative asset, expense and fee levels, published
by Lipper, CDA, Donoghue, Wiesenberger or ICD. Performance Advertisements
also may refer to discussions of the Fund and comparative mutual fund data
and ratings reported in independent periodicals, including (but not
limited to) THE WALL STREET JOURNAL, MONEY, FORBES, BUSINESS WEEK,
FINANCIAL WORLD, BARRON'S, THE NEW YORK TIMES and FORTUNE.
13
<PAGE>
The Fund may include discussions or illustrations of the effects
of compounding in performance advertisements. "Compounding" refers to the
fact that, if dividends or other distributions on an investment in the
Fund are reinvested in additional Fund shares, any future income or
capital appreciation of the Fund would increase the value, not only of the
original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been
paid in cash.
The Fund may also compare its performance with the performance of
bank certificates of deposit ("CDs") as measured by the CDA Investment
Technologies, Inc., Certificate of Deposit Index and the Bank Rate Monitor
National Index. In comparing the Fund's performance to CD performance,
investors should keep in mind that bank CDs are insured in whole or in
part by an agency of the U.S. Government and offer fixed principal and
fixed or variable rates of interest, and that bank CD yields may vary
depending on the financial institution offering the CD and prevailing
interest rates. Fund shares not insured or guaranteed by the U.S.
Government or any agency thereof and returns thereon will fluctuate.
While the Fund seeks to maintain a stable net asset value of $1.00 per
share, there can be no assurance that it will be able to do so.
Fund advertisements may reference the history of the distributor
and its affiliates, and the education and experience of the portfolio
manager. Advertisements may also describe techniques the Adviser employs
in selecting among the sectors of the fixed-income market and adjusting
average portfolio maturity. In particular, the advertisements may focus on
the technique of "value investing." With value investing, the Adviser
invests in those securities it believes to be undervalued in relation to
the long-term earning power or asset value of their issuers. Securities
may be undervalued because of many factors, including market decline, poor
economic conditions, tax-loss selling, or actual or anticipated
unfavorable developments affecting the issuer of the security.
In advertising, the Fund may illustrate hypothetical investment
plans designed to help investors meet long-term financial goals, such as
saving for a child's college education or for retirement. Sources such as
the Internal Revenue Service, the Social Security Administration, the
Consumer Price Index and Chase Global Data and Research may supply data
concerning interest rates, college tuitions, the rate of inflation, Social
Security benefits, mortality statistics and other relevant information.
The Fund may use other recognized sources as they become available.
The Fund may use data prepared by Ibbotson Associates of Chicago,
Illinois ("Ibbotson") to compare the returns of various capital markets
and to show the value of a hypothetical investment in a capital market.
Ibbotson relies on different indices to calculate the performance of
common stocks, corporate and government bonds and Treasury bills.
The Fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is
14
<PAGE>
represented by the performance of an appropriate market index, such as the
S&P 500 and the performance of bonds is represented by a nationally
recognized bond index, such as the Lehman Brothers Long-Term Government
Bond Index.
The Fund may also include in advertising biographical information
on key investment and managerial personnel.
The Fund may discuss Legg Mason's tradition of service. Since
1899, Legg Mason and its affiliated companies have helped investors meet
their specific investment goals and have provided a full spectrum of
financial services. Legg Mason affiliates serve as investment advisors
for private accounts and mutual funds with assets of more than $17 billion
as of December 31, 1994.
ADDITIONAL TAX INFORMATION
Federal Tax
In order to continue to qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as
amended ("Code"), the Fund must distribute annually to its shareholders at
least 90% of the sum of its net interest income excludable from gross
income under section 103(a) of the Code plus its investment company
taxable income (generally, taxable net investment income plus net short-
term capital gain, if any) and must meet several additional requirements.
These requirements include the following: (1) the Fund must derive at
least 90% of its gross income each taxable year from dividends, interest,
payments with respect to securities loans, and gains from the sale or
other disposition of securities, or other income derived with respect to
its business of investing in securities; (2) the Fund must derive less
than 30% of its gross income each taxable year from the sale or other
disposition of securities held for less than three months; (3) at the
close of each quarter of the Fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities and other securities, with those other securities
limited, in respect of any one issuer, to an amount that does not exceed
5% of the value of the Fund's total assets; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its
total assets may be invested in the securities (other than U.S. government
securities) of any one issuer.
Tax-exempt interest attributable to certain "private activity
bonds" (including, if the Fund receives interest on such bonds, a
proportionate part of the exempt-interest dividends paid by the Fund) is a
TPI. Exempt-interest dividends received by a corporate shareholder also
may be indirectly subject to the alternative minimum tax, without regard
to whether the Fund's tax-exempt interest was attributable to those bonds.
Private activity bonds are issued by or on behalf of public authorities to
finance various privately operated facilities.
15
<PAGE>
To the extent the Fund invests in instruments that generate
taxable income, distributions of the interest earned thereon will be
taxable to the Fund's shareholders as ordinary income to the extent of the
Fund's earnings and profits. Moreover, if the Fund realizes capital gains
as a result of market transactions, any distributions of those gains will
be taxable to its shareholders.
If Fund shares are sold at a loss after being held for six months
or less, the loss will be disallowed to the extent of any exempt-interest
dividends received with respect to those shares.
Entities or persons who are "substantial users" (or persons
related to "substantial users") of facilities financed by industrial
development bonds or private activity bonds should consult their tax
advisers before purchasing Fund shares because, for users of certain of
these facilities, the interest on those bonds is not exempt from federal
income tax. For these purposes, a "substantial user" generally includes a
"non-exempt person" who regularly uses in trade or business a part of a
facility financed from the proceeds of industrial development bonds or
private activity bonds.
Up to 85% of social security and railroad retirement benefits may
be included in taxable income for recipients whose adjusted gross income
(including income from tax-exempt sources such as the Fund) plus 50% of
their benefits exceeds certain base amounts. Exempt-interest dividends
from the Fund still are tax-exempt to the extent described in the
Prospectus; they are only included in the calculation of whether a
recipient's income exceeds certain established amounts.
The Fund is required to withhold 31% of taxable dividends payable
to any individuals and certain other noncorporate shareholders who do not
provide the Fund with a certified taxpayer identification number or who
otherwise are subject to backup withholding.
The Fund will be subject to a nondeductible 4% excise tax to the
extent it fails to distribute by the end of any calendar year
substantially all of its taxable ordinary income for that year and capital
gain net income for the one-year period ending on October 31 of that year,
plus certain other amounts.
State and Local Income Tax
The exemption of certain interest income for federal income tax
purposes does not necessarily result in exemption thereof under the income
or other tax laws of any state or local taxing authority. A shareholder
may be exempt from state and local taxes on distributions of interest
income derived from obligations of the state and/or localities of the
state in which he or she is a resident, but generally will be taxed on
income derived from obligations of other jurisdictions. Shareholders
receive notification annually of the portion of the Fund's tax-exempt
income attributable to each state. Shareholders should consult their tax
16
<PAGE>
advisers about the tax status in their own states and localities of
distributions from the Fund.
VALUATION OF SHARES
The Fund attempts to stabilize the value of a share at $1.00.
Net asset value will not be calculated on days when the Exchange is
closed. The Exchange currently observes the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving and Christmas.
Use of the Amortized Cost Method
The directors have determined that the interests of shareholders
are best served by using the amortized cost method for determining the
value of portfolio instruments. Under this method, portfolio instruments
are valued at acquisition cost, adjusted for amortization of premium or
accumulation of discount, rather than at current market value. The Board
of Directors periodically assesses the appropriateness of this method of
valuation.
The Fund's use of the amortized cost method of valuing portfolio
instruments depends on its compliance with Rule 2a-7 under the Investment
Company Act of 1940 ("1940 Act"). Under that Rule, the directors must
establish procedures reasonably designed to stabilize the net asset value
per share, as computed for purposes of distribution and redemption, at
$1.00 per share, taking into account current market conditions and the
Fund's investment objective.
Under the Rule, the Fund is permitted to purchase instruments
which are subject to demand features or stand-by commitments. As defined
by the Rule, a demand feature entitles the Fund to receive the principal
amount of the instrument from the issuer or a third party (1) on no more
than 30 days' notice or (2) at specified intervals not exceeding 397 days
on no more than 30 days' notice. A stand-by commitment entitles the Fund
to achieve same-day settlement and to receive an exercise price equal to
the amortized cost of the underlying instrument plus accrued interest at
the time of exercise.
Although demand features and stand-by commitments are techniques
that are defined as "puts" under the Rule, the Fund does not consider them
to be "puts" as that term is used in the Fund's investment limitations.
Demand features and stand-by commitments are features which enhance an
instrument's liquidity. The Fund's investment limitation which proscribes
puts is designed to prohibit the purchase and sale of put and call options
and is not designed to prohibit the Fund from using techniques which
enhance the liquidity of portfolio instruments.
Monitoring Procedures
The Fund's procedures include monitoring the relationship between
the amortized cost value per share and net asset value per share based
17
<PAGE>
upon available indications of market value. If there is a difference of
more than 0.5% between the two, the directors will take any steps they
consider appropriate (such as shortening the dollar-weighted average
portfolio maturity) to minimize any material dilution or other unfair
results arising from differences between the two methods of determining
net asset value.
Investment Restrictions
Rule 2a-7 requires the Fund, if it wishes to value its assets at
amortized cost, to limit its investments to instruments that, in the
opinion of the directors, present minimal credit risk and are rated in one
of the two highest short-term ratings categories by nationally recognized
statistical rating organizations or, if unrated, are determined to be of
comparable quality. The Rule requires the Fund to maintain a
dollar-weighted average portfolio maturity appropriate to the objective of
maintaining a stable net asset value of $1.00 per share and in any event
not more than 90 days. In addition, under the Rule, no instrument with a
remaining maturity (as defined in the Rule) of more than 397 days can be
purchased by the Fund, except that the Fund may hold securities with
maturities greater than 397 days as collateral for repurchase agreements
and other collateralized transactions of short duration. However, the
Rule permits the Fund to treat certain floating and variable rate demand
notes as having maturities of 397 days or less, even if the notes specify
a final repayment date more than 397 days in the future.
Should the disposition of a portfolio security result in a
dollar-weighted average portfolio maturity of more than 90 days, the Fund
will invest its available cash to reduce the average maturity to 90 days
or less as soon as possible.
It is the Fund's usual practice to hold portfolio securities to
maturity and realize par, unless the Adviser determines that sale or other
disposition is appropriate in light of the Fund's investment objective.
Under the amortized cost method of valuation, neither the amount of daily
income nor the net asset value is affected by any unrealized appreciation
or depreciation of the portfolio.
In periods of declining interest rates, the indicated daily yield
on shares of the Fund, computed by dividing the annualized daily income on
the Fund's investment portfolio by the net asset value computed as above,
may tend to be higher than a similar computation made by using a method of
valuation based upon market prices and estimates.
In periods of rising interest rates, the indicated daily yield on
shares of the Fund computed the same way may tend to be lower than a
similar computation made by using a method of calculation based upon
market prices and estimates.
18
<PAGE>
THE CORPORATION'S DIRECTORS AND OFFICERS
The Corporation's officers are responsible for the operation of
the Corporation under the direction of the Board of Directors. The
Corporation's officers and directors and their principal occupations
during the past five years are set forth below. An asterisk (*) indicates
those officers and/or directors who are "interested persons" of the
Corporation as defined in the 1940 Act, because of their relationship to
Legg Mason or the Adviser. The address of each officer and director is
111 South Calvert Street, Baltimore, Maryland 21202, unless otherwise
indicated.
JOHN F. CURLEY, JR.*, [55] Chairman of the Board and Director;
Vice Chairman and Director of Legg Mason Wood Walker, Inc. and Legg Mason,
Inc.; Director of Legg Mason Fund Adviser, Inc. and Western Asset
Management Company; Officer and/or Director of various other affiliates of
Legg Mason, Inc.; President and Director of three Legg Mason funds;
Chairman of the Board and Director of three Legg Mason funds; President
and/or Chairman of the Board and Trustee of two Legg Mason funds.
EDMUND J. CASHMAN, JR.*, [58] President and Director; Senior
Executive Vice President and Director of Legg Mason, Inc.; Officer and/or
Director of various other affiliates of Legg Mason, Inc.; Director of
Worldwide Value Fund, Inc.; Vice Chairman and Director of one Legg Mason
fund; President and Trustee of one Legg Mason fund.
RICHARD G. GILMORE, [67] Director; 5534 Chanteclaire, Sarasota,
Florida. Independent Consultant; Director of CSS Industries, Inc.
(diversified holding company whose subsidiaries are engaged in manufacture
and sale of decorative paper products, business forms, and specialty metal
packaging); Director of PECO Energy Company (formerly Philadelphia
Electric Company); Director of six Legg Mason funds; and Trustee of one
Legg Mason fund. Formerly: Senior Vice President and Chief Financial
Officer of Philadelphia Electric Company (now PECO Energy Company);
Executive Vice President and Treasurer, Girard Bank, and Vice President of
its parent holding company, the Girard Company; and Director of Finance,
City of Philadelphia.
CHARLES F. HAUGH, [69] Director; 14201 Laurel Park Drive, Laurel,
Maryland. Real Estate Developer and Investor; Chairman of Resource Realty
LLC (management of retail and office space); President and Director of
Resource Enterprises, Inc. (real estate brokerage); Partner in Greater
Laurel Health Park Ltd. Partnership (real estate investment and
development); Director of six Legg Mason funds; Trustee of two Legg Mason
funds.
ARNOLD L. LEHMAN, [51] Director; The Baltimore Museum of Art, Art
Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum of
Art; Director of six Legg Mason funds; Trustee of two Legg Mason funds.
JILL E. McGOVERN, [50] Director; 1500 Wilson Boulevard,
Arlington, Virginia. Chief Executive Officer of the Marrow Foundation;
19
<PAGE>
Director of six Legg Mason funds; Trustee of two Legg Mason funds.
Formerly: Executive Director of the Baltimore International Festival
(January, 1991 - March, 1993); and Senior Assistant to the President of
The Johns Hopkins University (1986-1991).
T. A. RODGERS, [60] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T.A. Rodgers & Associates (management consulting);
Director of six Legg Mason funds; Trustee of one Legg Mason fund.
Formerly: Director and Vice President of Corporate Development, Polk
Audio, Inc. (manufacturer of audio components).
The executive officers of the Corporation, other than those who
also serve as directors, are:
KATHI D. GLENN *, [30] Secretary and Assistant Treasurer;
Secretary and Assistant Treasurer of Legg Mason Special Investment Trust,
Inc. and Legg Mason Global Trust, Inc.; employee of Legg Mason.
MARIE K. KARPINSKI *, [46] Vice President and Treasurer;
Treasurer of Legg Mason Fund Adviser, Inc.; Vice President and Treasurer
of eight Legg Mason funds; Secretary/Treasurer of Worldwide Value Fund,
Inc.; Vice President of Legg Mason.
BLANCHE P. ROCHE *, [46] Assistant Vice President and Assistant
Secretary; Assistant Vice President and Assistant Secretary of seven Legg
Mason funds; employee of Legg Mason since 1991. Formerly: Manager of
Consumer financial services Primerica Corporation (1989-1991).
Officers and directors of the Corporation who are "interested
persons" of the Corporation, as defined in the 1940 Act, receive no salary
or fees from the Corporation. Directors who are not interested persons of
the Corporation receive a fee of $400 annually for serving as a director
and a fee of $400 for each meeting of the Board of Directors attended by
him or her. During the year ended December 31, 1994, the independent
directors as a group received a total of $10,000. On December 31, 1994,
the directors and officers of the Corporation beneficially owned, in the
aggregate, less than 1% of the Fund's outstanding shares.
The Commonwealth of Pennsylvania-Pennvest, Finance Building, Room
126, Harrisburg, PA 17120, owned of record and beneficially 11.69% of the
Corporation's outstanding shares as of February 28, 1995.
The Nominating Committee of the Board of Directors is responsible
for the selection and nomination of disinterested directors. The
Committee is composed of Messrs. Haugh, Gilmore, Lehman, Rodgers and Dr.
McGovern, each of whom is a disinterested director as that term is defined
in the 1940 Act.
The following table provides certain information relating to the
compensation of the Corporation's directors for the fiscal year ended
December 31, 1994.
20
<PAGE>
<TABLE>
<CAPTION>
COMPENSATION TABLE
------------------
<C>
<C> <C> <C>
Pension or
<S> Retirement Total
Aggregate Benefits Estimated Compensation
Compen- Accrued as Annual From
sation Part of Benefits Corporation
From Corpora- Upon and Fund
Name of Person and Corpo- tion's Retire- Complex Paid
Position ration* Expenses ment to Directors**
John F. Curley, Jr. -
Chairman of the Board
and Director None N/A N/A None
Edmund J. Cashman,
Jr. -
Vice Chairman and None N/A N/A None
Director
Marie K. Karpinski -
Vice President and
Treasurer None N/A N/A None
Richard G. Gilmore -
Director $2,000 N/A N/A $21,600
Charles F. Haugh -
Director $2,000 N/A N/A $23,600
Arnold L. Lehman -
Director $2,000 N/A N/A $23,600
Jill E. McGovern -
Director $2,000 N/A N/A $23,600
T. A. Rodgers -
Director $2,000 N/A N/A $21,600
</TABLE>
* Represents fees paid to each director during the fiscal year
ended December 31, 1994.
** Represents aggregate compensation paid to each director during
the calendar year ended December 31, 1994.
21
<PAGE>
THE FUND'S INVESTMENT ADVISER
The Adviser, located at 111 South Calvert Street, Baltimore, Maryland
21202, is a wholly owned subsidiary of Legg Mason, Inc., which also is the
parent of Legg Mason . The Adviser serves as the Fund's investment
adviser and manager under an Investment Advisory and Management Agreement
("Advisory Agreement") dated July 1, 1983 that was most recently approved
by the Corporation's Board of Directors, including a majority of the
directors who are not "interested persons" of the Fund or the Adviser, on
October 21, 1994. The Advisory Agreement provides that, subject to
overall direction by the Board of Directors, the Adviser manages the
investment and other affairs of the Fund. The Adviser is responsible for
managing the Fund consistent with the Fund's investment objectives and
policies described in the Prospectus and this Statement of Additional
Information. The Adviser also is obligated to (a) furnish the Fund with
office space and executive and other personnel necessary for the
operations of the Fund; (b) supervise all aspects of the Fund's
operations; (c) bear the expense of certain informational and purchase and
redemption services to Fund shareholders; (d) arrange, but not pay for,
the periodic updating of prospectuses, proxy material, tax returns and
reports to shareholders and state and federal regulatory agencies; and (e)
report regularly to the Corporation's officers and directors. The Adviser
and its affiliates pay all the compensation of directors and officers of
the Corporation who are employees of the Adviser. The Fund is obligated
to pay all its other expenses which are not assumed by the Adviser. These
expenses include, among others, interest expense, taxes, auditing and
accounting fees, distribution fees, if any, fees and expenses of the
independent directors of the Corporation, brokerage fees and commissions,
expenses of preparing prospectuses and of printing and distributing
prospectuses annually to existing shareholders, custodian charges,
transfer agency fees, legal expenses, insurance expenses, association
membership dues, governmental fees, expenses of registering and qualifying
Fund shares for sale under federal and state law, and the expense of
reports to shareholders, shareholders' meetings and proxy solicitations.
The Fund is also obligated to pay the expenses for maintenance of its
financial books and records, including computation of the Fund's daily net
asset value per share and dividends. The Fund is also liable for such
nonrecurring expenses as may arise, including litigation to which the Fund
may be a party. The Corporation may have an obligation to indemnify its
directors and officers with respect to any litigation.
Under the Advisory Agreement, the Adviser will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund
in connection with the performance of the Advisory Agreement, except a
loss resulting from a breach of fiduciary duty with respect to the receipt
of compensation for services or a loss resulting from willful misfeasance,
bad faith or gross negligence on its part in the performance of its duties
or from reckless disregard by it of its obligations or duties thereunder.
As explained in the Prospectus, the Adviser receives for its services
a fee, calculated daily and payable monthly, at an annual rate of 0.50% of
the average daily net assets of the Fund. For the years ended December
22
<PAGE>
31, 1994, 1993 and 1992, fees of $1,224,832, $877,564 and $911,216,
respectively, were paid to the Adviser by the Fund.
The Advisory Agreement terminates automatically upon assignment and is
terminable at any time without penalty by vote of the Fund's Board of
Directors, by vote of a majority of the Fund's outstanding voting
securities, or by the Adviser, on not less than 60 days' notice to the
Fund and may be terminated immediately upon the mutual written consent of
the Adviser and the Fund.
Certain states impose limitations on the annual expenses of investment
companies such as the Fund. The most restrictive annual expense
limitation requires that the Adviser reimburse the Fund for certain
expenses,including the advisory fees received by it (but excluding
expenses for interest, taxes, distribution fees, brokerage fees and
commissions and certain extraordinary charges, such as litigation
expenses) in any fiscal year in which the Fund's expenses exceed 2.5% of
the first $30 million, 2% of the next $70 million and 1.5% of the balance
over $100 million of average daily net assets. The Fund may suspend sales
in a state at its option in order to be subject to a less stringent
requirement. In such a case, shareholders and others in that state could
not purchase new shares of the Fund, but such shareholders could continue
to have dividends and other distributions on their existing Fund shares
automatically reinvested in additional shares and credited to their
accounts, unless prohibited by applicable state law. No reimbursement
pursuant to state expense limitations has been required since the Fund's
inception in 1983.
Under the Advisory Agreement, the Fund has the non-exclusive right to
use the name "Legg Mason" until that Agreement is terminated or until the
right is withdrawn in writing by the Adviser.
To mitigate the possibility that the Fund will be affected by personal
trading of employees, the Corporation and the Adviser have adopted
policies that restrict securities trading in the personal accounts of
portfolio managers and others who normally come into advance possession of
information on portfolio transactions. These policies comply, in all
material respects, with the recommendations of the Investment Company
Institute.
THE FUND'S DISTRIBUTOR
Legg Mason acts as distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to promote the sale of Fund shares and to pay certain
expenses in connection with its distribution efforts, including the
printing and distribution of prospectuses and periodic reports used in
connection with the offering to prospective investors (after the
prospectuses and reports have been prepared, set in type and mailed to
existing shareholders at the Fund's expense) and for supplementary sales
literature and advertising costs.
23
<PAGE>
The Fund has adopted a Distribution and Shareholder Services Plan
("Plan"), pursuant to which the directors in their sole discretion may
authorize the Fund to pay Legg Mason a fee for its distribution and
shareholder services not to exceed an annual rate of 0.20% of the Fund's
average daily net assets. Legg Mason has no present intention of
requesting such a fee, but may do so in the future. Any such payments
would be limited in accordance with the rules of the National Association
of Securities Dealers, Inc. Legg Mason may also receive payments for
shareholder services from the Adviser out of fees paid to the Adviser, its
past profits or any other source of funds available to it.
Any payments authorized under the Plan and the purpose of such
payments must be reviewed at least quarterly by the Board of Directors and
adjusted if appropriate. Activities for which such payments may be made
include, but are not limited to, compensation to persons who engage in or
support distribution and redemption of shares, printing of prospectuses
and reports for persons other than existing shareholders, advertising,
preparation and distribution of sales literature, overhead, travel and
telephone expenses.
As required by Rule 12b-1 under the 1940 Act, the Plan was most
recently approved by the Board of Directors, including a majority of the
directors who are not "interested persons" of the Fund and who have no
direct or indirect financial interest in the operation of the Plan or in
the Underwriting Agreement ("12b-1 directors"), on October 21, 1994. The
Plan was also approved by vote of a majority of the outstanding shares of
the Fund on July 20, 1984. In approving and continuing the Plan, in
accordance with the requirements of Rule 12b-1, the directors considered
various factors, including the amount of the distribution fee, and
determined that there is a reasonable likelihood that the Plan will
benefit the Fund and its shareholders.
The Plan continues in effect only so long as it is approved at least
annually by the vote of a majority of the Board of Directors, including
the 12b-1 directors, cast at a meeting called for the purpose of voting
on the Plan. The Plan may be terminated by vote of a majority of the 12b-
1 directors or by a vote of a majority of the outstanding voting
securities of the Fund (as defined in the 1940 Act). Any change in the
Plan that would materially increase the distribution cost to the Fund
requires shareholder approval; otherwise, the Plan may be amended by the
directors, including a majority of the 12b-1 directors.
In accordance with Rule 12b-1, the Plan provides that Legg Mason will
give to the Corporation's Board of Directors, and the directors will
review at least quarterly, a written report of any amounts expended
pursuant to the Plan and the purposes for which expenditures were made.
In addition, so long as the Plan is in effect, the selection and
nomination of the 12b-1 directors will be committed to the discretion of
such 12b-1 directors.
24
<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisory Agreement authorizes the Adviser (subject to the overall
direction of the Corporation's Board of Directors) to select brokers and
dealers to execute purchases and sales of the Fund's portfolio securities.
It directs the Adviser to use its best efforts to obtain the best
available price and most favorable execution with respect to all
transactions for the Fund. The Adviser undertakes to execute each
transaction at a price and commission that provides the most favorable
total cost or proceeds reasonably obtainable under the circumstances. The
Fund's portfolio securities are generally purchased either directly from
the issuer or from dealers who specialize in municipal bonds and money
market instruments. To the extent that the execution and price offered by
more than one dealer are comparable, the Adviser may, at its discretion,
effect transactions in portfolio securities with dealers who provide the
Fund with research, advice or other services. Since the commencement of
operations on July 14, 1983, the Fund has incurred no brokerage
commissions.
Portfolio securities are not purchased from or sold to the Adviser or
Legg Mason or any "affiliated person" (as defined in the 1940 Act)
thereof, except in accordance with SEC rules or actions. The
Corporation's Board of Directors has adopted procedures in conformity with
Rule 10f-3 under the 1940 Act whereby the Fund may purchase securities
that are offered in underwritings in which Legg Mason or other affiliated
persons are participants, though no such purchases have occurred since
commencement of operations.
THE CORPORATION'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105
serves as custodian of the Fund's assets. Boston Financial Data Services,
P.O. Box 953, Boston, MA 02103 serves as transfer and dividend-disbursing
agent for the Fund and administrator of various shareholder services.
THE CORPORATION'S LEGAL COUNSEL
Kirkpatrick & Lockhart LLP, 1800 M Street, N.W., Washington, D.C.,
20036, serves as counsel to the Corporation.
THE CORPORATION'S INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 East Redwood Street, Baltimore, MD
21202, are the Corporation's independent accountants.
FINANCIAL STATEMENTS
The Fund's Statement of Net Assets as of December 31, 1994; the
Statement of Operations for the year ended December 31, 1994; the
Statement of Changes in Net Assets for the years ended December 31, 1994
and 1993; the Financial Highlights for the periods presented; the Notes to
Financial Statements; and the Report of Independent Accountants, each of
25
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which is included in the Annual Report to Shareholders of the Fund dated
December 31, 1994, are hereby incorporated by reference in this Statement
of Additional Information.
26
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APPENDIX A
RATINGS OF SECURITIES
1. Description of Moody's Investors Service, Inc. ("Moody's") Ratings
Municipal Bonds which are rated Aaa by Moody's are judged to be of
the best quality. They carry the smallest degree of investment risk and
are generally referred to as "gilt edge." Interest payments are protected
by a large or by an exceptionally stable margin and principal is secure.
While the various protective elements are likely to change, such changes
as can be visualized are most unlikely to impair the fundamentally strong
position of such issues. Bonds rated Aa are judged to be of high quality
by all standards. Together with the Aaa group they comprise what are
generally known as high-grade bonds. They are rated lower than the best
bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make long-term
risks appear somewhat larger than in Aaa securities.
Municipal Notes Moody's ratings for state and municipal notes and
other short-term obligations are designated Moody's Investment Grade
("MIG") and for variable rate demand obligations are designated Variable
Moody's Investment Grade ("VMIG"). This distinction is in recognition of
the differences between short-term credit risk and long-term credit risk.
Notes bearing the designation MIG-1 or VMIG-1 are of the best quality,
enjoying strong protection from established cash flows for their servicing
or from established and broad-based access to the market for refinancing,
or both. Notes bearing the designation MIG-2 or VMIG-2 are judged to be
of high quality, with margins of protection ample although not so large as
in the preceding group.
Commercial Paper The ratings Prime-1 and Prime-2 are the two highest
commercial paper ratings assigned by Moody's. Among the factors
considered in assigning ratings are the following: (1) evaluation of the
management of the issuer; (2) economic evaluation of the issuer's industry
or industries and an appraisal of speculative-type risks which may be
inherent in certain areas; (3) evaluation of the issuer's products in
relation to competition and customer acceptance; (4) liquidity; (5) amount
and quality of long-term debt; (6) trend of earnings over a period of ten
years; (7) financial strength of a parent company and the relationships
which exist with the issuer; and (8) recognition by the management of
obligations which may be present or may arise as a result of public
interest questions and preparations to meet such obligations. Relative
strength or weakness of the above factors determines whether the issuer's
commercial paper is rated Prime-1, -2, or -3.
2. Description of Standard & Poor's Ratings Group ("S&P")
Municipal Bonds rated AAA by S&P are the highest grade obligations.
This rating indicates an extremely strong capacity to pay principal and
interest. Bonds rated AA also qualify as high-quality debt obligations.
A-1
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Capacity to pay principal and interest is very strong, and in the majority
of instances they differ from AAA issues only in small degree.
Municipal Notes Municipal notes with maturities of three years or
less are usually given note ratings (designated SP-1, -2, or -3) by S&P to
distinguish more clearly the credit quality of notes as compared to bonds.
Notes rated SP-1 have a very strong or strong capacity to pay principal
and interest. Those issues determined to possess overwhelming safety
characteristics are given the designation SP-1+.
Commercial Paper Commercial paper rated A (highest quality) by S&P
has the following characteristics: liquidity ratios are adequate to meet
cash requirements and long-term senior debt is rated "A" or better,
although in some cases "BBB" credits may be allowed; the issuer has access
to at least two additional channels of borrowing; basic earnings and cash
flow have an upward trend with allowance made for unusual circumstances;
typically, the issuer's industry is well established and the issuer has a
strong position within the industry; the reliability and quality of
management are unquestioned. The relative strength or weakness of the
above factors determines whether the issuer's commercial paper is rated A-
1 or A-2.
A-2
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