LEGG MASON
TAX EXEMPT TRUST, INC.
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A money market fund seeking to produce high current income exempt
from federal income tax, to preserve capital, and to maintain
liquidity.
PROSPECTUS May 1, 1999
[LOGO]
HOW TO INVEST SM
As with all mutual funds, the Securities and Exchange Commission has not passed
upon the adequacy of this prospectus, nor has it approved or disapproved these
securities. It is a criminal offense to state otherwise.
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TABLE OF CONTENTS
About the fund:
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1 Investment objective
3 Principal risks
5 Performance
6 Fees and expenses of the fund
7 Management
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About your investment:
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8 How to invest
9 How to sell your shares
10 Account policies
11 Services for investors
12 Dividends and taxes
13 Financial highlights
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LEGG MASON TAX EXEMPT TRUST, INC.
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INVESTMENT OBJECTIVE
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The fund seeks to produce high current income exempt from federal
income tax, to preserve capital, and to maintain liquidity. The fund
is a money market fund that seeks to maintain a constant net asset
value of $1.00 per share.
Strategy
To achieve its objective, the fund adheres to the following practices:
- it 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
- as a fundamental policy, except during defensive periods, it
maintains at least 80% of its assets invested in municipal
obligations that have remaining maturities of one year or
less or that are variable or floating rate demand notes.
Variable and floating rate securities are securities whose
interest rates change at specified intervals so they
approximate current market rates.
- it invests the balance of its assets in municipal obligations
that have remaining maturities of 397 days or less or that
are variable or floating rate demand notes
- it maintains a dollar-weighted average maturity of 90 days
or less
- it limits its investments to obligations which present
minimal credit risk in the opinion of the adviser and are
rated in one of the two highest short-term ratings categories
by at least two nationally recognized statistical rating
organizations ("NRSRO"), or one NRSRO if only rated by one.
If a security is unrated by any NRSRO, the adviser may
determine the security to be of comparable quality.
- it may invest, to a limited extent, in taxable short-term
money market instruments
Legg Mason Tax Exempt Trust 1
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The fund may invest in securities 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. These debt obligations generally are
issued to obtain funds for various public purposes, including
constructing a wide range of public facilities, refunding outstanding
obligations, obtaining funds for general operating expenses and making
loans to other public institutions and facilities. Municipal
obligations in which the fund may invest include, but are not limited
to:
- revenue bonds
- general obligation bonds
- industrial development bonds
- private activity bonds
- tax anticipation notes
- bond anticipation notes
- revenue anticipation notes
The fund does not intend to invest more than 25% of its net assets
in:
- municipal obligations whose issuers are in the same state;
- municipal obligations which are repayable out of revenue
streams generated from economically related projects or
facilities; or
- industrial development bonds or private activity bonds issued
by issuers in the same industries. For purposes of this
restriction, there is no limitation on investments in U.S.
Treasury bills or other obligations issued or guaranteed by
the U.S. Government or its agencies or instrumentalities.
The fund may, from time to time, take temporary defensive positions
that are inconsistent with the fund's principal investment strategies.
At such times, the fund may not achieve its investment objective.
2 Legg Mason Tax Exempt Trust
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PRINCIPAL RISKS
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An investment in the fund is not insured or guaranteed by the Federal
Deposit Insurance Corporation or any other government agency. Although
the fund seeks to maintain a net asset value of $1.00 per share, it is
possible to lose money by investing in the fund. There is no guarantee
that the fund will achieve its objective.
Additional risks of investing in this fund include:
Interest rate risk -
The possibility that the market prices of the fund's investments may
decline due to an increase in interest rates.
Credit risk -
The risk that any of the fund's holdings could have its credit rating
downgraded or could default. Credit ratings measure an issuer's
ability to make timely principal and interest payments. Credit ratings
are the opinions of the private companies (such as Standard & Poor's)
that rate companies or their securities; they are not guarantees.
The fund considers the "issuer" of a municipal obligation to be the
entity responsible for payment. Thus, the District of Columbia, each
state, each political subdivision, agency, instrumentality and
authority thereof, and each multi-state agency of which a state is a
member is a separate "issuer" as that term is used in this prospectus.
In certain circumstances, the non-government user of facilities
financed by industrial development bonds or private activity bonds is
considered to be the issuer.
Not all obligations of the U.S. Government, its agencies and
instrumentalities are backed by the full faith and credit of the
United States; some are backed only by the credit of the issuing
agency or instrumentality. 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. Accordingly, there may be some risk of default by the
issuer.
Other risks -
Current efforts to restructure the federal budget and the relationship
between the federal government and state and local governments may
adversely impact the financing of some issuers of municipal
securities. Some states and localities are experiencing substantial
deficits and may find it difficult for political or economic reasons
to increase taxes. Some local jurisdictions have invested heavily in
Legg Mason Tax Exempt Trust 3
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derivative instruments and may now hold portfolios of uncertain
valuation. Efforts are also under way that may result in a
restructuring of the federal income tax system. These developments
could reduce the value of all municipal securities, or the securities
of particular issuers.
The fund is not intended to be a balanced investment program and is
not designed for investors who are unable to benefit from tax-exempt
income. The fund is not appropriate for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations
in principal.
The fund is not an appropriate investment for "substantial users" of
certain facilities financed by industrial development or private
activity bonds or persons related to such "substantial users." For
more information, see the "Additional Tax Information" section in the
Statement of Additional Information.
Year 2000 -
Like other mutual funds (and most organizations around the world), the
fund could be adversely affected by computer problems related to the
year 2000. These could interfere with operations of the fund, its
administrator, distributor or adviser, and could impact municipal and
other issuers in which the fund invests.
While no one knows if these problems will have any impact on the fund
or on financial markets in general, the administrator and its
affiliates are taking steps to protect fund investors. These include
efforts to determine that the problem will not directly affect the
systems used by major service providers.
Whether these steps will be effective can only be known for certain in
the year 2000.
4 Legg Mason Tax Exempt Trust
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PERFORMANCE
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The information below provides an indication of the risks of investing
in the fund by showing changes in the fund's performance from year to
year. Annual returns assume reinvestment of dividends. Historical
performance of the fund does not necessarily indicate what will happen
in the future.
YEAR BY YEAR TOTAL RETURN AS OF DECEMBER 31 OF EACH YEAR (%)
[GRAPHIC TABLE APPEARS HERE]
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
5.86 5.30 3.93 2.34 1.75 2.25 3.17 2.85 2.95 2.76
DURING THE PAST TEN YEARS:
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Quarter Ended Total Return
- --------------------- ------------------- --------------------
Best quarter: June 30, 1989 +1.56%
Worst quarter: March 31, 1993 +0.42%
</TABLE>
The fund's seven day yield as of December 31, 1998 was 2.83%. For the
fund's current yield, call toll-free 1-800-822-5544.
Average Annual Total Returns as of December 31, 1998:
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1 Year +2.75%
5 Years +2.80%
10 Years +3.31%
</TABLE>
Legg Mason Tax Exempt Trust 5
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FEES AND EXPENSES OF THE FUND
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The table below describes the fees and expenses you will incur as an
investor in the fund. Other expenses include transfer agency, custody,
professional and registration fees. The fund has no sales charge or
redemption fee, but is subject to a 12b-1 service fee.
The fees and expenses shown are based on expenses for the fiscal year
ended December 31, 1998 and are calculated as a percentage of average
net assets.
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Annual Fund Operating Expenses
(expenses that are deducted from fund assets)
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Management fees 0.50 %
Service (12b-1) fee 0.20%*
Other Expenses 0.12 %
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Total Annual Fund Operating Expenses 0.82%*
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* The Board has determined to limit the 12b-1 service fee to 0.10%
indefinitely. With this limitation, total annual fund operating
expenses are 0.72%.
Example
This example helps you compare the cost of investing in the fund with
the cost of investing in other mutual funds. Although your actual
costs may be higher or lower, you would pay the following expenses on
a $10,000 investment in the fund, assuming (1) a 5% return each year,
(2) the fund's operating expenses remain the same as shown in the
table above, and (3) you redeem all of your shares at the end of the
time periods shown. Actual returns may be higher or lower than 5% per
year.
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1 Year 3 Years 5 Years 10 Years
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$84 $ 262 $ 455 $ 1,014
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6 Legg Mason Tax Exempt Trust
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MANAGEMENT
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Adviser and Administrator:
Legg Mason Capital Management, Inc., 100 Light Street, Baltimore,
Maryland 21202, is the investment adviser for the fund. The adviser
directs the investments of the fund in accordance with its investment
objectives, policies and limitations. The adviser acts as investment
adviser to four investment company portfolios and to private accounts
for institutions and individuals with aggregate assets of $4.3 billion
as of March 31, 1999.
Legg Mason Fund Adviser, Inc., 100 Light Street, Baltimore, Maryland
21202, serves as the fund's administrator. The administrator manages
the affairs of the fund and provides the fund with office facilities
and personnel reasonably necessary for the operation of the fund. The
administrator acts as investment adviser or manager to twenty
investment company portfolios with aggregate assets of $18.1 billion
as of March 31, 1999.
For its services, the fund paid the adviser a fee equal to an annual
rate of 0.50% of the fund's average daily net assets for the fiscal
year ended December 31, 1998. The adviser paid the administrator a fee
equal to an annual rate of 0.05% of the fund's average daily net
assets.
Distributor of the fund's shares:
Legg Mason Wood Walker, Incorporated, 100 Light Street, Baltimore,
Maryland 21202, distributes the fund's shares. The fund has adopted a
plan that allows it to pay shareholder service fees for services
provided to shareholders not to exceed an annual rate of 0.20% of the
fund's average daily net assets. However, Legg Mason has agreed that
it will not request payment of more than 0.10% annually from the fund
indefinitely.
Because these fees are paid out of the fund's assets on an ongoing
basis, over time these fees will increase the cost of your investment
and may cost you more than paying other types of sales charges.
The distributor may enter into agreements with other brokers to sell
shares of the fund. The distributor pays these brokers up to 90% of
the service fee that it receives from the fund for those sales.
The adviser, administrator and distributor are wholly owned
subsidiaries of Legg Mason, Inc., a financial services holding
company.
Legg Mason Tax Exempt Trust 7
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HOW TO INVEST
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To open a regular account with the fund, contact a Legg Mason financial
advisor or other entity that has entered into an agreement with the fund's
distributor to sell shares of the Legg Mason family of funds. A Legg Mason
financial advisor will explain the shareholder services available from our
funds and answer any questions you may have. The minimum initial investment
for regular accounts is $1,000 and the minimum for each purchase of additional
shares is $500.
Once your account is open, you may use the following methods to add to your
account:
IN PERSON Give your financial advisor a check for $500 or more payable
to the fund
MAIL Mail your check, payable to the fund, for $500 or more to
your financial advisor
TELEPHONE Call your financial advisor to transfer available cash
OR WIRE balances in your brokerage account or to transfer money from
your bank directly to Legg Mason. Wire transfers may be
subject to a service charge by your bank.
FUTURE FIRST Contact your Legg Mason financial advisor to enroll in Legg
SYSTEMATIC Mason's Future First Systematic Investment Plan. Under this
INVESTMENT plan, you may arrange for automatic monthly investments in the
PLAN fund of $50 or more. The fund's transfer agent will transfer
funds monthly from your Legg Mason account or from your
checking account to purchase shares of the fund.
AUTOMATIC Arrangements may be made with some employers and financial
INVESTMENTS institutions for regular automatic monthly investments of $50
or more in shares of the fund. You may also reinvest dividends
from certain unit investment trusts in shares of the fund.
Call your financial advisor or another entity offering the fund for sale with
any questions regarding the investment options above.
Certain investment methods may be subject to lower minimum initial and
additional investments.
Investments made through entities other than Legg Mason may be subject to
transaction fees or other purchase conditions established by those entities.
You should consult their program literature for further information.
Purchase orders received in federal funds form, by either your Legg
Mason financial advisor or the entity offering the fund, on any day that the
New York Stock Exchange is open, will be processed as follows:
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Shares will be purchased at the
If the purchase order is net asset value next determined Such shares will begin to
received on earn dividends on the
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before 12:00 noon, Eastern time same day same day
12:00 noon or after, but before
4:00 p.m., Eastern time same day next day
after 4:00 p.m., Eastern time next day next day
</TABLE>
If you do not make payment in federal funds, your order will be processed when
payment is converted into federal funds, which is usually completed in two
days, but may take up to ten days. Most bank wires are federal funds.
8 Legg Mason Tax Exempt Trust
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HOW TO SELL YOUR SHARES
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Redemptions made through entities other than Legg Mason may be subject to
transaction fees or other conditions imposed by those entities. Your should
consult their program literature for further information.
<TABLE>
<S> <C>
ANY OF THE FOLLOWING METHODS MAY BE USED TO SELL YOUR SHARES:
TELEPHONE Call your Legg Mason financial advisor or entity offering
the fund and request a redemption of $100 or more.
Proceeds will be credited to your brokerage account or a
check will be sent to you, at your direction, at no charge
to you. Wire requests will be subject to a fee of $18. Be
sure that your financial advisor has your bank account
information on file. Unless you specify that you do not
wish to have telephone redemption privileges, you may be
held responsible for any fraudulent telephone order. The
fund will follow reasonable procedures to ensure the
validity of any telephone redemption request, such as
requesting identifying information from callers or
employing identification numbers.
CHECKWRITING The fund offers a free checkwriting service. You may write
checks to anyone in amounts of $250 or more. The fund's
transfer agent will redeem sufficient shares from your
account to pay the checks. You will continue to earn
dividends on your shares until the check clears at the
transfer agent. Please do not use your checks to close
your account.
MAIL Send a letter to the fund requesting redemption of your
shares. The letter should be signed by all of the owners
of the account. Redemption requests for shares valued at
$10,000 or more or when proceeds are to be paid to someone
other than the accountholder will require a signature
guarantee. You may obtain a signature guarantee from most
banks or securities dealers.
SECURITIES LEGG Mason has special redemption procedures for investors who
PURCHASES AT wish to purchase stocks, bonds or other securities at Legg
LEGG MASON Mason. Once you've placed an order for securities, and
have not indicated any other payment method, fund shares
will be redeemed on the settlement date for the amount
due. Fund shares may also be redeemed to cover debit
balances in your brokerage account.
</TABLE>
Your order will be processed promptly and you will generally receive the
proceeds within a week. Fund shares will be sold at the next net asset value
calculated after your redemption request is received by your Legg Mason
financial advisor or another entity.
Redemptions of shares that were recently purchased by check or acquired
through reinvestment of dividends on such shares may be delayed for up to 10
days from the purchase date in order to allow for the check to clear.
Additional documentation may be required from corporations, executors,
partnerships, administrators, trustees or custodians. The fund reserves the
right to redeem shares in kind.
Legg Mason Tax Exempt Trust 9
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ACCOUNT POLICIES
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To calculate the fund's share price, the fund's assets are valued and
totaled, liabilities are subtracted, and the resulting net assets are
divided by the number of shares outstanding. The fund seeks to
maintain a share price of $1.00 per share. The fund is priced twice a
day, as of 12:00 noon, Eastern time, and at the close of the New York
Stock Exchange (normally 4:00 p.m., Eastern time), on every day the
exchange is open. Like most other money market funds, the fund
normally values its investments using the amortized cost method.
Fund shares may not be held in, or transferred to, an account with any
firm that does not have an agreement with Legg Mason.
If your account falls below $500, the fund may ask you to increase
your balance. If, after 60 days, your account is still below $500, the
fund may close your account and send you the proceeds.
The fund reserves the right to:
- reject any order for shares or suspend the offering of
shares for a period of time
- change its minimum investment amounts
- delay sending out redemption proceeds for up to seven days.
This generally applies only in cases of very large
redemptions, excessive trading or during unusual market
conditions. The fund may delay redemptions beyond seven days,
or suspend redemptions, only as permitted by the SEC.
10 Legg Mason Tax Exempt Trust
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SERVICES FOR INVESTORS
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For further information regarding any of the services below, please
contact your financial advisor or other entity offering the fund for
sale.
Account Statements:
Legg Mason or the entity through which you invest will send you
account statements monthly unless there has been no activity in the
account, in which case you will receive a quarterly statement. Legg
Mason will send you statements quarterly if you participate in the
Future First Systematic Investment Plan or if you purchase shares
through automatic investments.
Systematic Withdrawal Plan:
If you are purchasing or already own shares with a net asset value of
$5,000 or more, you may elect to make systematic withdrawals from the
fund. The minimum amount for each withdrawal is $50.
Premier Account Status:
Legg Mason offers a Premier Asset Management Account, which combines
your fund account, a preferred customer VISA Gold debit card, a Legg
Mason brokerage account with margin borrowing availability and
unlimited checks with no minimum check amount. Other services include
automatic transfer of free credit balances in your brokerage account
to your fund account and automatic redemption of fund shares to offset
debit balances in your brokerage account. Legg Mason charges an annual
fee for the Premier Account, which is currently $85 for individuals
and $100 for corporations and businesses.
Exchange Privilege:
Fund shares may be exchanged for shares of any of the other Legg Mason
funds, provided these funds are eligible for sale in your state of
residence. You can request an exchange in writing or by phone. Be sure
to read the current prospectus for any fund into which you are
exchanging.
There is currently no fee for exchanges; however, you may be subject
to a sales charge when exchanging into a fund that has one. In
addition, an exchange of the fund's shares will be treated as a sale
of the shares and any gain on the transaction may be subject to tax.
The fund reserves the right to:
- terminate or limit the exchange privilege of any shareholder
who makes more than four exchanges from the fund in one
calendar year
- terminate or modify the exchange privilege after 60 days'
notice to shareholders
Legg Mason Tax Exempt Trust 11
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DIVIDENDS AND TAXES
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The fund declares dividends from its net investment income daily and
pays them monthly. Your dividends will be automatically reinvested in
additional shares of the fund. If you wish to receive dividends in
cash, you must notify the fund at least 10 days before the next
dividend is to be paid. If the postal or other delivery service is
unable to deliver your check, your distribution option will
automatically be converted to having all dividends and other
distributions reinvested in fund shares. No interest will accrue on
amounts represented by uncashed distribution or redemption checks. You
may request that your dividends be reinvested in shares of another
Legg Mason fund.
The fund does not expect to realize any capital gain or loss; however,
if the fund realizes any net short-term capital gains, it will pay
them at least once every twelve months.
Any dividends paid to shareholders will be "exempt-interest" dividends
if, at the close of each quarter of its taxable year, at least 50% of
the value of its total assets consists of certain obligations the
interest on which is excludable from gross income for federal income
tax purposes. Exempt-interest dividends are excludable from a
shareholder's gross income; however, the amount of such dividends must
be reported on the recipient's federal income tax return.
Fund distributions of any net short-term capital gains are taxable to
most investors (other than certain tax-exempt investors) whether
received in cash or reinvested in additional shares of the fund.
Generally, those distributions will be taxable as ordinary income.
Dividends derived from interest on municipal obligations may not be
exempt from income taxation under state or local law. A tax statement
is sent to each investor at the end of each year detailing the tax
status of your distributions.
The fund will withhold 31% of all taxable dividends payable to
individuals and certain other non-corporate shareholders who do not
provide the fund with a valid taxpayer identification number or who
are otherwise subject to backup withholding.
Because each investor's tax situation is different, please consult
your tax advisor about federal, state and local tax considerations.
12 Legg Mason Tax Exempt Trust
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FINANCIAL HIGHLIGHTS
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The financial highlights table is intended to help you understand the fund's
financial performance for the past 5 years. Total return represents the rate
that an investor would have earned (or lost) on an investment in the fund,
assuming reinvestment of all dividends and distributions. This information has
been audited by the fund's independent accountants, PricewaterhouseCoopers LLP,
whose report, along with the fund's financial statements, is incorporated by
reference into the Statement of Additional Information (see back cover) and is
included in the annual report. The annual report is available upon request by
calling toll-free 1-800-822-5544.
<TABLE>
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998 1997 1996 1995 1994
- ------------------------------------ ------- ------- ------- ------- -------
The following information reflects financial results for a single share of the fund:
Net asset value,
beginning of year $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- --------
Income from investment operations:
Net investment income .0271 .0292 .0282 .0313 .0223
Distributions:
Dividends from net investment
income (.0271) (.0292) (.0282) (.0313) (.0223)
--------- --------- --------- --------- ---------
Net asset value, end of year $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
========= ========= ========= ========= =========
Total return 2.75 % 2.95 % 2.85 % 3.17 % 2.25 %
Ratios/Supplemental Data:
Ratio of total expenses to average
net assets(a) .72 % .73 % .64 % .66 % --
Ratio of net expenses to average
net assets(b) .71 % .72 % .64 % .65 % .65 %
Ratio of net investment income to
average net assets 2.71 % 2.92 % 2.82 % 3.14 % 2.23 %
Net assets, end of year
(in thousands) $ 330,134 $ 307,371 $ 278,492 $ 224,656 $ 222,490
</TABLE>
(a) This ratio reflects total expenses before compensating balance credits.
Previously, the credits were included in this ratio.
(b) This ratio reflects expenses net of compensating balance credits.
Legg Mason Tax Exempt Trust 13
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LEGG MASON
TAX EXEMPT TRUST, INC.
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The following additional information about the fund is available upon
request and without charge:
Statement of Additional Information (SAI) - the SAI is filed with the
Securities and Exchange Commission (SEC) and is incorporated by
reference into (is considered part of) the prospectus. The SAI provides
additional details about the fund and its policies.
Annual and Semiannual Reports - additional information about the fund's
investments is available in the fund's annual and semiannual reports to
shareholders. These reports provide detailed information about the
fund's portfolio holdings and operating results.
To request the SAI or any reports to shareholders, or to obtain
more information:
- call toll-free 1-800-822-5544
- visit us on the Internet via http://www.leggmason.com
- write to us at: Legg Mason Wood Walker, Incorporated
100 Light Street, P.O. Box 1476
Baltimore, Maryland 21203-1476
Information about the fund, including the SAI, can be reviewed and
copied at the SEC's public reference room in Washington, DC (phone
1-800-SEC-0330). Reports and other information about the fund are
available on the SEC's Internet site at http://www.sec.gov. Investors
may also write to: SEC, Public Reference Section, Washington, DC
20549-6009. A fee will be charged for making copies.
LMF-015 SEC file number: 811-3526
<PAGE>
THE LEGG MASON TAX EXEMPT TRUST, INC.
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1999
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the fund's Prospectus dated May 1, 1999, which has
been filed with the Securities and Exchange Commission ("SEC"). The fund's
annual report is incorporated by reference into this Statement of Additional
Information. A copy of either the Prospectus or the annual report is available
without charge by writing to or calling the fund's distributor, Legg Mason Wood
Walker, Incorporated ("Legg Mason") (address and telephone numbers listed
below).
LEGG MASON WOOD WALKER,
INCORPORATED
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100 Light Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
<PAGE>
TABLE OF CONTENTS
Page
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Investment Strategies and Risks 3
Fund Policies 6
Management of the Fund 8
Investment Advisory Agreement 10
The Fund's Distributor 11
Additional Tax Information 12
Additional Purchase and Redemption Information 13
Valuation of Shares 17
How the Fund's Yield Is Calculated 18
Portfolio Transactions and Brokerage 20
Description of the Fund and its Shares 20
The Fund's Custodian and Transfer and Dividend
Disbursing Agent 21
The Fund's Legal Counsel 21
The Fund's Independent Accountants 21
Financial Statements 21
Appendix A: Ratings of Securities A-1
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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 do 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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INVESTMENT STRATEGIES AND RISKS
The fund is an open-end, diversified management investment company. The
fund seeks to produce high current income exempt from federal income tax, to
preserve capital, and to maintain liquidity. The fund normally invests
substantially all of its assets 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 is not a tax
preference item for purposes of the federal alternative minimum tax ("TPI")
("Municipal Obligations").
The Prospectus explains that the fund, in selecting investments,
considers the ratings assigned to securities by nationally recognized
statistical rating organizations ("NRSROs"), such as Moody's Investors Service,
Inc. ("Moody's") and Standard & Poor's ("S&P"). The ratings of NRSROs represent
their opinions 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, to the
exemption of interest thereon from federal income tax, and to that interest's
not being a TPI 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 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 litigation or other
conditions may materially and adversely affect the power or ability of issuers
to meet their obligations for the payment of interest and principal on their
Municipal Obligations.
From time to time, Congress has considered proposals that would
restrict or eliminate the federal income tax exemption for interest on Municipal
Obligations. If Congress enacted such a proposal, 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.
- 3 -
<PAGE>
WHEN-ISSUED SECURITIES
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 take 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. The fund
will not earn income on these securities until they are delivered.
Commencing on the date of such commitment agreement, the fund maintains
in a segregated account, cash or appropriate liquid 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 to such a commitment, 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). Commitments to purchase when-issued securities will not exceed, in
the aggregate, 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 its investments in Municipal Obligations, the dealer
normally pays 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 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 will be valued at zero in determining
net asset value. Where the fund paid directly or indirectly for a stand-by
commitment, its cost will be reflected as unrealized depreciation during the
period the commitment is held by the fund. Stand-by commitments will not affect
the average weighted maturity of the assets of the fund. The fund will establish
a segregated account with its custodian for each stand-by commitment.
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, generally the
value of a fixed rate
- 4 -
<PAGE>
obligation increases and the obligation sells at a premium. Should interest
rates increase, 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 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,
however, 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 net 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. The note may be supported by an
unconditional bank letter of credit guaranteeing payment of the principal or
both the principal and accrued interest. The adviser, as permitted by the SEC,
may take into consideration the creditworthiness of the bank issuing the letter
in making the investment decision. A change in the credit quality of the bank
backing a variable rate or floating rate demand note could result in a loss to
the fund and affect its share price. The SEC permits some instruments to be
deemed to have remaining maturities of 397 days or less, notwithstanding that
the date on which final payment is due may be in excess of 397 days.
TEMPORARY INVESTMENTS
From time to time for liquidity purposes or pending the investment of
the proceeds of the sale of shares, the fund may invest up to 20% of its net
assets in: obligations of the U.S. Government, its agencies and
instrumentalities; certificates of deposit and bankers' acceptances of U.S.
domestic banks with assets of one billion dollars or more; commercial paper or
other corporate notes of high grade quality; and any of such items subject to
short-term repurchase agreements. Interest earned from such taxable investments
will be taxable to investors as ordinary income when distributed to them. For
temporary defensive purposes, the fund may invest up to 100% of its assets in
U.S. government securities and other taxable short-term instruments.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement under which Municipal
obligations, 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
- 5 -
<PAGE>
securities. In these transactions, the securities acquired by the fund are held
by a custodian bank until resold and will be supplemented by additional
collateral if necessary to maintain a total value equal to or in excess of the
value of the repurchase agreement. 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.
The fund may suffer a loss to the extent that proceeds from the sale
upon a default of the obligation to repurchase are less than the repurchase
price. 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 fund'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
expenses in connection with this trading, because the transactions ordinarily
are made directly with the issuer or a dealer on a net price basis.
FUND POLICIES
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 Investment Company Act of 1940 ("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;
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;
- 6 -
<PAGE>
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;
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;
14. Issue senior securities, except as permitted by the 1940 Act;
15. Purchase any security if, as a result of that purchase, 25% or more
of its total assets would be invested in securities having their principal
business activities in the same industry, except that this limitation does not
apply to securities issued or guaranteed by the U.S. government, its agencies or
instrumentalities. State or local governments or subdivisions thereof are not
considered members of any industry for purposes of this 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 the 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. For purposes of fundamental policy #15, the fund considers the
"issuer" of an obligation of any state or local government or subdivision
thereof to be the entity responsible for payment.
Although demand features and stand-by commitments are techniques that
are defined as "puts" under Rule 2a-7 of the 1940 Act, 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.
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.
- 7 -
<PAGE>
MANAGEMENT OF THE FUND
The fund's officers are responsible for the operation of the fund under
the direction of the Board of Directors. The officers and directors of the fund,
their dates of birth 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 fund as defined in the 1940 Act, because of
their relationship to Legg Mason or the adviser. The address of each officer and
director is 100 Light Street Baltimore, Maryland 21202, unless otherwise
indicated.
JOHN F. CURLEY, JR.*, [07/24/39] Chairman of the Board and Director;
Retired Vice Chairman and Director of Legg Mason Wood Walker, Inc. and 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. Formerly: Director of Legg Mason Fund
Adviser, Inc., and Western Asset Management Company (each a registered
investment adviser); Officer and/or Director of various other affiliates of Legg
Mason, Inc.
EDMUND J. CASHMAN, JR.*, [08/31/36] 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.; Trustee of Bartlett
Capital Trust; Vice Chairman and Director of one Legg Mason fund; President and
Trustee of one Legg Mason fund.
RICHARD G. GILMORE, [06/09/27] Director; 948 Kennett Way, West Chester,
Pennsylvania. Independent Consultant. Director of CSS Industries, Inc.
(diversified holding company 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/Trustee of all
Legg Mason funds. 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 (bank holding company) and Director of Finance, City
of Philadelphia.
ARNOLD L. LEHMAN, [07/18/44] Director; 200 Eastern Parkway, Brooklyn,
New York. Director of the Brooklyn Museum of Art; Director/Trustee of all Legg
Mason funds. Formerly: Director of the Baltimore Museum of Art.
JILL E. McGOVERN, [08/29/44] Director; 400 Seventh St., NW, Washington,
DC. Chief Executive Officer of the Marrow Foundation; Director/Trustee of all
Legg Mason funds. Formerly: Executive Director of the Baltimore International
Festival (January 1991 - March 1993); Senior Assistant to the President of The
Johns Hopkins University (1986-1991).
T. A. RODGERS, [10/22/34] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T. A. Rodgers & Associates (management consulting);
Director/Trustee of all Legg Mason funds. Formerly: Director and Vice President
of Corporate Development, Polk Audio, Inc. (manufacturer of audio components)
(1991-1992).
The executive officers of the Corporation, other than those who also
serve as directors, are:
KATHI D. BAIR *, [12/15/64] Secretary and Assistant Treasurer;
Secretary and Assistant Treasurer/Secretary/Assistant Secretary of the Legg
Mason funds; employee of Legg Mason.
SHANE HUGHES *, [4/24/68] Assistant Secretary; employee of Legg Mason
since May 1997. Formerly: Senior Associate of C. W. Amos and Co. (a regional
public accounting firm)
MARIE K. KARPINSKI *, [01/01/49] Vice President and Treasurer;
Treasurer of Legg Mason Fund Adviser, Inc.; Vice President and Treasurer of the
Legg Mason funds; Vice President of Legg Mason.
- 8 -
<PAGE>
Officers and directors of the fund who are "interested persons" of the
Corporation, as defined in the 1940 Act, receive no salary or fees from the
fund. Directors who are not interested persons of the Corporation receive an
annual retainer and a per meeting fee based on the average net assets of the
fund at December 31 of the previous year.
On April 1, 1999, 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 14.55% of the
Corporation's outstanding shares as of February 16, 1999.
The Nominating Committee of the Board of Directors is responsible for
the selection and nomination of disinterested directors. The Committee is
composed of Messrs. 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, 1998. None of the Legg Mason funds has any retirement plan for its
directors.
<TABLE>
<CAPTION>
<S> <C> <C>
================================================================================================================
TOTAL COMPENSATION FROM FUND AND
AGGREGATE COMPENSATION FROM FUND* FUND COMPLEX PAID TO DIRECTORS**
NAME OF PERSON AND POSITION
- ---------------------------------------- ------------------------------------ ----------------------------------
John F. Curley, Jr. -
Chairman of the Board and Director None None
- ---------------------------------------- ------------------------------------ ----------------------------------
Edmund J. Cashman, Jr.
President and Director None None
- ---------------------------------------- ------------------------------------ ----------------------------------
Richard G. Gilmore -
Director $2,480 $35,100
- ---------------------------------------- ------------------------------------ ----------------------------------
Charles F. Haugh -
Director (A) $1,819 $25,800
- ---------------------------------------- ------------------------------------ ----------------------------------
Arnold L. Lehman -
Director $2,154 $30,600
- ---------------------------------------- ------------------------------------ ----------------------------------
Jill E. McGovern -
Director $2,480 $35,100
- ---------------------------------------- ------------------------------------ ----------------------------------
T. A. Rodgers -
Director $2,480 $35,100
================================================================================================================
</TABLE>
A Mr. Haugh retired as a director in September 1998.
* Represents fees paid to each director during the fiscal year ended
December 31, 1998.
** Represents aggregate compensation paid to each director during the
calendar year ended December 31, 1998. There are eleven open-end
investment companies in the Legg Mason Complex (with a total of twenty
funds).
- 9 -
<PAGE>
INVESTMENT ADVISORY AGREEMENT
Legg Mason Capital Management, Inc., located at 100 Light Street,
Baltimore, Maryland 21202, is a wholly owned subsidiary of Legg Mason, Inc. The
Adviser serves as the fund's investment adviser under an Investment Advisory and
Management Agreement ("Advisory Agreement") dated July 1, 1983 that was most
recently approved by the fund's Board of Directors, including a majority of the
directors who are not "interested persons" of the fund or the Adviser, on
November 13, 1998. Effective January 1, 1998, the Advisory Agreement was
transferred to the Adviser; prior to that date, Legg Mason Fund Adviser, Inc.,
("LMFA") a wholly owned subsidiary of Legg Mason, Inc., served as the fund's
investment adviser and manager under the Advisory Agreement. 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 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, 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 existing 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 that the
Adviser may be liable for 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.
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 year ended December 31, 1998, the fund paid the Adviser fees
of $1,670,147. For the years ended December 31, 1997 and 1996, the fund paid
LMFA fees of $1,582,075, and $1,373,646, respectively.
The Advisory Agreement terminates automatically upon assignment and is
terminable at any time without penalty by vote of the Corporation'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.
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.
Pursuant to an agreement with the Adviser ("Administration Agreement"),
LMFA serves as the fund's administrator whereby it 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
- 10 -
<PAGE>
the Corporation's officers and directors. The Adviser pays LMFA, pursuant to the
Administration Agreement, a fee equal to an annual rate of 0.05% of the fund's
average daily net assets.
Under the Administration Agreement, LMFA will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Adviser or
the fund in connection with the performance of the Administration Agreement,
except that LMFA may be liable for 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 obligation
or duties thereunder.
To mitigate the possibility that the fund will be affected by personal
trading of employees, the fund, the Adviser and LMFA 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 Wood Walker, Incorporated, 100 Light Street, Baltimore,
Maryland 21202, is 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 any compensation to its Financial
Advisors, 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.
The Board of Directors of the Corporation has adopted a Distribution
and Shareholder Services Plan ("Plan") pursuant to Rule 12b-1 under the 1940
Act. The Plan provides that as compensation for Legg Mason's ongoing services to
investors in the fund and/or its activities and expenses related to the sale and
distribution of shares, the fund may pay Legg Mason a fee at an annual rate of
up to 0.20% of its average daily net assets. However, Legg Mason has agreed that
it will not request payment of more than 0.10% annually from the fund
indefinitely. The fee is computed daily and paid monthly. The fees received by
Legg Mason during any year may be more or less than its costs of providing
distribution and shareholder services for the fund. For the years ended December
31, 1998, and 1997 the fund paid Legg Mason $334,029and $309,363 for service
fees.
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 November 13, 1998. In accordance with the
requirements of Rule 12b-1, the directors considered various factors in
approving and continuing the Plan, including the amount of the fee, and
determined that there is a reasonable likelihood that the Plan will benefit the
fund and its shareholders. The directors noted that, to the extent the Plan
results in additional sales of fund shares, the Plan may enable the fund to
achieve economies of scale that could reduce expenses and to minimize the
prospects that the fund will experience net redemptions and the accompanying
disruption of portfolio management.
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 a
majority of 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
- 11 -
<PAGE>
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 disinterested directors
will be committed to the discretion of such disinterested directors.
For the year ended December 31, 1998, Legg Mason incurred the following expenses
with respect to the fund:
--------------------------------------------------------------------
Compensation to financial advisors $ 229,000
--------------------------------------------------------------------
Printing and mailing of prospectuses to 149,000
prospective shareholders
--------------------------------------------------------------------
Advertising $69,000
--------------------------------------------------------------------
Other $537,000
--------------------------------------------------------------------
Total $984,000
--------------------------------------------------------------------
The amounts in "Other" reflect the allocation of certain items of
overhead, using assumption believed by Legg Mason to be reasonable.
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) 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 (3) 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. If the fund failed to
qualify for treatment as a RIC for any taxable year, (i) it would be taxed at
corporate rates on the full amount of its taxable income for that year without
being able to deduct the distributions it makes to its shareholders and (ii) the
shareholders would treat all those distributions, including distributions that
otherwise would be "exempt-interest dividends" as described in the Prospectus,
as taxable dividends (that is, ordinary income) to the extent of the fund's
earnings and profits. In addition, the fund could be required to recognize
unrealized gains, pay substantial taxes and interest, and make substantial
distributions before requalifying for RIC treatment.
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If the fund receives tax-exempt interest attributable to certain
"private activity bonds," a proportionate part of the exempt-interest dividends
paid by the fund will be 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.
If 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.
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. 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 are still
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 substantially all of its taxable ordinary income by the
end of the calendar 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 of such income 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 advisers about the tax status in their own
states and localities of distributions from the fund.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Shares are sold at their net asset value without a sales charge on days
the New York Stock Exchange ("Exchange") is open for business. The procedure for
purchasing shares of the fund is explained in the Prospectus under "How to
Invest".
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CONVERSION TO FEDERAL FUNDS
It is the fund's policy to be as fully invested as possible so that
maximum interest may be earned. To this end, all payments from shareholders must
be in federal funds or be converted into federal funds. This conversion must be
made before shares are purchased. Legg Mason or Boston Financial Data Services
("BFDS") acts as the shareholders' agent in depositing checks and converting
them to federal funds, normally within two to nine business days of receipt of
checks.
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.
REDEMPTION BY WIRE
The fund redeems shares at the next computed net asset value after Legg
Mason receives the redemption request. Redemption procedures are explained in
the Prospectus under "How to Sell Your Shares". When payment for shares is in
the form of federal funds, the 10-day potential delay described in the
Prospectus does not apply.
REDEMPTION IN KIND
The fund reserves the right, under certain conditions, to honor any
request for a redemption, or combination of requests from the same shareholder
in any 90-day period, totaling $250,000 or 1% of the net assets of the fund,
whichever is less, by making payment in whole or in part in 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
the market price of those securities will be subject to fluctuation 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.
FUTURE FIRST SYSTEMATIC INVESTMENT PLAN AND TRANSFER OF FUNDS FROM FINANCIAL
INSTITUTIONS
When you purchase shares through the Future First Systematic Investment
Plan, BFDS, the fund's transfer agent, will transfer funds from your Legg Mason
account or from your checking account to be used to buy shares of the fund. Legg
Mason, the fund's distributor, will send an account statement quarterly. The
transfer also will be reflected on your Legg Mason account statement or your
regular checking account statement. You may terminate the Future First
Systematic Investment Plan at any time without charge or penalty.
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:
Boston Financial Data Services, Inc.
2 Heritage Drive
North Quincy, MA 02171
Attn: Legg Mason Funds
If the investor's check is not honored by the institution on which it
is drawn, the investor may be subject to extra charges in order to cover
collection costs. These charges may be deducted from the investor's account.
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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 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 the 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 determined as of the close 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 on all shares in your fund account
must be automatically 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. If the periodic withdrawals exceed reinvested dividends and
distributions, the amount of your original investment will be correspondingly
reduced.
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 Accounts, 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 Legg
Mason Brokerage Account and unlimited checkwriting 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, check writing 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 within 15 days by other
than federal funds wired; (2) all shares for which certificates have been
issued; and (3) any previously authorized VISA transaction.
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<PAGE>
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., 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 in a single account resulting from any such sale
will automatically be invested in shares of the fund on the 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 cash 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.
You may request Premier Account status by filling out the Premier Asset
Management Account Agreement and Check Application which can be obtained from
your financial advisor. 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 on 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 financial advisor 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.
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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 to redeem exactly enough full and
fractional shares from your account to cover the amount of the check. Canceled
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 total value of the
account, including accrued dividends, on the day the check clears. Persons who
obtained 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 (1) for any
periods during which the Exchange is closed, (2) 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 (3) for such
other periods as the SEC by regulation or 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.
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.
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, Martin Luther King's
Birthday, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving and Christmas.
USE OF THE AMORTIZED COST METHOD
The Board of Directors has 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 depends on its compliance
with Rule 2a-7 under the 1940 Act. Under that Rule, the Board of Directors must
establish procedures reasonably designed to stabilize the net asset value at
$1.00 per share, as computed for purposes of distribution and redemption, taking
into account current market conditions and the fund's investment objective.
MONITORING PROCEDURES
The fund's procedures include monitoring the relationship between the
amortized cost value per share and net asset value per share based upon
available indications of market value. If there is a difference of more than
0.5% between the two, the Board of Directors will take any steps it considers
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.
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INVESTMENT RESTRICTIONS
Rule 2a-7 requires the fund to limit its investments to instruments
that, in the opinion of the Board of Directors or its delegate, present minimal
credit risk and are rated in one of the two highest short-term ratings
categories by a requisite number of nationally recognized statistical rating
organizations or, if unrated (as defined in the Rule), 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.
The fund usually holds portfolio securities to maturity and realizes
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, which is 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.
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 (calculated as described
above), 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 fund from time to time also may advertise its tax-equivalent yield
and tax-equivalent effective yield, based on a recently ended seven-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 seven-day period
ended December 31, 1998 were 4.68% and 4.75%, respectively.
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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.
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 will 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 will increase more quickly than if
dividends or other distributions were 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 are not insured or guaranteed
by the U.S. Government or any agency thereof and returns on such shares 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. The
fund may also include in advertising biographical information on key investment
and managerial personnel. 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
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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 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 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 to private accounts
and mutual funds with approximately $89 billion in assets as of March 31, 1999.
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 without a
stated commission, either directly from the issuer or from dealers who
specialize in municipal bonds and money market instruments. Prices paid to a
dealer generally include a "spread," which is the difference between the price
at which the dealer is willing to purchase and sell the specific security at the
time, and includes the dealer's normal profit. 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.
Investment decisions for the fund are made independently from those of
other funds and accounts advised by the Adviser. However, the same security may
be held in the portfolios of more than one fund or account. When two or more
accounts simultaneously engage in the purchase or sale of the same security, the
prices and amounts will be equitably allocated to each account. In some cases,
this procedure may adversely affect the price or quantity of the security
available to a particular account. In other cases, however, an account's ability
to participate in large-volume transactions may produce better executions and
prices.
DESCRIPTION OF THE FUND AND ITS SHARES
The fund is a diversified, open-end management investment company which
was incorporated in Maryland on July 26, 1982. The fund is authorized to issue
multiple series of capital stock, each with a par value of $.001 per share, at
the discretion of the Board of Directors. To date, the directors have authorized
the issuance of only one series: shares in the fund. Each share in the fund is
entitled to one vote for the election of directors and any other matter
submitted to a shareholder vote. Fractional shares
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have fractional voting rights. Voting rights are not cumulative. All shares in
the fund are fully paid and nonassessable and have no preemptive or conversion
rights.
Shareholder meetings will not be held except where the Investment
Company Act of 1940 requires a shareholder vote on certain matters (including
the election of directors, approval of an advisory contract, and certain
amendments to the plan of distribution pursuant to Rule 12b-1). The fund will
call a special meeting of the shareholders at the request of 10% or more of the
shares entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the fund at 100 Light Street, Baltimore, Maryland
21202, stating the purpose of the proposed meeting and the matters to be acted
upon.
THE FUND'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 FUND'S LEGAL COUNSEL
Kirkpatrick & Lockhart LLP, 1800 Massachusetts Avenue, N.W.,
Washington, D.C., 20036-1800, serves as counsel to the Corporation.
THE FUND'S INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 250 W. Pratt Street, Baltimore, MD 21201,
is the fund's independent accountants.
FINANCIAL STATEMENTS
The fund's Statement of Net Assets as of December 31, 1998; the
Statement of Operations for the year ended December 31, 1998; the Statement of
Changes in Net Assets for the years ended December 31, 1998 and 1997; the
Financial Highlights for the periods presented; the Notes to Financial
Statements; and the Report of Independent Accountants, each of which is included
in the Annual Report to Shareholders of the fund dated December 31, 1998, are
hereby incorporated by reference in this Statement of Additional Information.
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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 short-term
obligations are designated Moody's Investment Grade ("MIG") and for variable
rate demand obligations are designated Variable Moody's Investment Grade
("VMIG"). The rating MIG recognizes the differences between short-term credit
risk and long-term credit risk, while VMIG differentiates variable rate demand
obligations to reflect such characteristics as payment upon periodic demand
rather than fixed maturity dates and payment relying on external liquidity.
Notes bearing the designation MIG-1 or VMIG-1 are of the best quality, enjoying
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing. 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) leading market positions in
well-established industries; (2) high rates of return on funds employed; (3)
conservative capitalization structure with moderate reliance on debt and ample
asset protection; (4) broad margins in earnings coverage of fixed financial
charges and high internal cash generation; and (5) well-established access to a
range of financial markets and assured sources of alternate liquidity. 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 ("S&P") RATINGS
MUNICIPAL BONDS rated AAA by S&P are the highest grade obligations.
This rating indicates an extremely strong capacity to pay interest and repay
principal. Bonds rated AA have a very strong capacity to pay interest and repay
principal and 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 The highest commercial paper rating assigned by S&P,
A-1, indicates that the degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
given the designation A-1+. Commercial paper rated A-2 has a satisfactory
capacity for timely payment. However, the relative degree of safety is not as
high for issues designated A-1.
A- 1
