<PAGE> 1
LOGO
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
(Class A and Class B Shares)
This mutual fund (the "Fund") is designed to provide:
1. A professionally managed portfolio consisting primarily of income-
producing common stock, securities convertible thereto and debt
obligations of companies in the telephone industry; and
2. The objective of high current income as well as the secondary objective of
long-term capital growth without undue risk.
This Prospectus sets forth basic information that investors should know
about the Fund prior to investing and should be retained for future
reference. A Statement of Additional Information dated May 1, 1995 has been
filed with the Securities and Exchange Commission (the "SEC") and is hereby
incorporated by reference. It is available upon request and without charge by
calling the Fund at (800) 767-FLAG.
Shares of the Fund are available through Alex. Brown & Sons Incorporated
("Alex. Brown") as well as Participating Dealers and Shareholder Servicing
Agents. This Prospectus relates to Class A and Class B Shares of the Fund.
The separate classes provide investors with alternatives as to sales load and
Fund expenses. (See "How to Invest in the Fund.")
No person has been authorized to give any information or to make
representations not contained in this Prospectus in connection with any
offering made by this Prospectus and, if given or made, such information must
not be relied upon as having been authorized by the Fund or its distributor.
This Prospectus does not constitute an offering by the Fund or by its
distributor in any jurisdiction in which such offering may not lawfully be
made.
- -------------------------------------------------------------------------------
THE FUND'S SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK. THE SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER
GOVERNMENT AGENCY. INVESTMENT IN THE SHARES INVOLVES RISK, INCLUDING POSSIBLE
LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
The date of this Prospectus is May 1, 1995
<PAGE> 2
LOGO
<PAGE> 3
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
(Class A and Class B Shares)
135 East Baltimore Street
Baltimore, Maryland 21202
TABLE OF CONTENTS
------
<TABLE>
<CAPTION>
Page
<S> <C>
1. Fee Table .............................. 2
2. Financial Highlights ................... 3
3. Investment Program ..................... 6
4. Investment Restrictions ................ 8
5. How to Invest in the Fund .............. 8
6. How to Redeem Shares ................... 15
7. Telephone Transactions ................. 17
8. Dividends and Taxes .................... 18
9. Management of the Fund ................. 19
10. Investment Advisor and Sub-Advisor ..... 20
11. Distributor ............................ 22
12. Custodian, Transfer Agent, Accounting
Services ................................ 23
13. Performance Information ................ 23
14. General Information .................... 24
</TABLE>
1
<PAGE> 4
________________________________________________________________________________
1. FEE TABLE
................................................................................
SHAREHOLDER TRANSACTION EXPENSES:
<TABLE>
<CAPTION>
Class A Class B
Shares Shares
Initial Sales Deferred
Charge Sales Charge
Alternative Alternative
- -------------------------------------------------------------- ----------------- ----------------
<S> <C> <C>
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) ......................... 4.50%* None
Maximum Sales Charge Imposed on Reinvested Dividends ......... None None
Deferred Sales Charge (as a percentage of original purchase
price or redemption proceeds, whichever is lower) ........... None* 4.00%**
</TABLE>
ANNUAL FUND OPERATING EXPENSES (NET OF FEE WAIVERS):
(as a percentage of average net assets)
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Management Fees (net of fee waivers) .................... .45%*** .45%***
12b-1 Fees .............................................. .25% .75%
Other Expenses (including a .25% shareholder servicing
fee for Class B Shares) ................................ .22% .47%****
--------- ----------
Total Fund Operating Expenses (net of fee waivers) ...... .92%*** 1.67%***
========= ==========
</TABLE>
- -----------------------------------------------------------------------------
* Purchases of $1 million or more of Class A Shares are not subject to an
initial sales charge, however, a contingent deferred sales charge of
.50% will be imposed on such purchases in the event of redemption within
24 months following such purchase. (See "How to Invest in the Fund--
Offering Price.")
** A declining contingent deferred sales charge will be imposed on
redemptions of Class B Shares made within six years of purchase. Class B
Shares will automatically convert to Class A Shares six years after
purchase. (See "How to Invest in the Fund -- Class B Shares.")
*** Management Fees may be reduced voluntarily from time to time to increase
or preserve investment performance and the fees set forth in the fee
table are merely estimates of such reductions. Absent reductions,
Management Fees would be .52% of the Fund's average daily net assets and
Total Fund Operating Expenses would be .99% of the Class A Shares'
average daily net assets and 1.74% of the Class B Shares' average daily
net assets.
**** A portion of the shareholder servicing fee is allocated to member firms
of the National Association of Securities Dealers, Inc. and qualified
banks for continued personal service by such members to investors in
Class B Shares, such as responding to shareholder inquiries, quoting net
asset values, providing current marketing materials and attending to
other shareholder matters.
Example:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000
investment, assuming (1) 5% annual return and
(2) redemption at the end of each time period:* 1 Year 3 Years 5 Years 10 Years
- ------------------------........................ ---------- ----------- ----------- ------------
Class A Shares ................................ $54 $73 $ 95 $158
Class B Shares ................................ $57 $84 $115 $171**
---------- ----------- ----------- ------------
</TABLE>
* Absent fee waivers for the 1, 3, 5 and 10 year periods, expenses would be
$55, $76, $99 and $167, respectively, for the Class A Shares and $58, $86,
$119 and $180, respectively, for the Class B Shares.
** Expenses assume that Class B Shares are converted to Class A Shares at the
end of six years. Therefore, the expense figures assume six years of Class
B expenses and four years of Class A expenses.
2
<PAGE> 5
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
You would pay the following expenses on the
same investment, assuming no redemption:* ... 1 Year 3 Years 5 Years 10 Years
---------- ----------- ---------- ------------
Class B Shares .............................. $17 $54 $95 $171**
---------- ----------- ---------- ------------
</TABLE>
* Absent fee waivers for the 1, 3, 5 and 10 year periods, expenses for the
Class B Shares would be $18, $56, $99 and $180, respectively.
** Expenses assume that Class B Shares are converted to Class A Shares at the
end of six years. Therefore, the expense figures assume six years of Class
B expenses and four years of Class A expenses.
The Expenses and Example should not be considered a representation of
future expenses. Actual expenses may be greater or less than those shown.
The purpose of the foregoing table is to describe the various costs and
expenses that an investor in the Fund will bear directly and indirectly. A
person who purchases shares of either class through a financial institution
may be charged separate fees by the financial institution. (For more complete
descriptions of the various costs and expenses, see "How to Invest in the
Fund--Offering Price", "Investment Advisor and Sub-Advisor" and
"Distributor.") The Expenses and Example for the Class A Shares appearing in
the table above are based on the Fund's expenses for the Class A Shares for
the fiscal year ended December 31, 1994 which, net of fee waivers, were .92%
of the Class A Shares' average daily net assets. The Expenses and Example for
the Class B Shares, which have been offered since January 3, 1995, are based
on those for the Class A Shares plus the incremental 12b-1 and service fee
costs.
The rules of the SEC require that the maximum sales charge be reflected in
the above table. However, certain investors may qualify for reduced sales
charges or no sales charge at all. (See "How to Invest in the Fund--Class A
Shares.") Due to the continuous nature of Rule 12b-1 fees, long-term
shareholders of the Fund may pay more than the equivalent of the maximum
front-end sales charges permitted by the Rules of Fair Practice of the
National Association of Securities Dealers, Inc. ("NASD Rules").
________________________________________________________________________________
2. FINANCIAL HIGHLIGHTS
The financial highlights included in this table are a part of the Fund's
financial statements for the Class A Shares for the periods indicated and
have been audited by Coopers & Lybrand L.L.P., independent accountants. The
financial statements and financial highlights for the Class A Shares for the
year ended December 31, 1994 and the report thereon of Coopers & Lybrand
L.L.P. are included in the Statement of Additional Information. Additional
performance information for the Class A Shares is contained in the Fund's
Annual Report for the fiscal year ended December 31, 1994 which can be
obtained at no charge by calling the Fund at (800) 767- FLAG. The Fund
commenced offering the Class B Shares on January 3, 1995.
3
<PAGE> 6
(FOR A CLASS A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
---------------------------------------
1994 1993 1992
---------- ---------- ----------
<S> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 13.70 $12.20 $11.28
---------- ---------- ----------
Income from Investment Operations:
Net investment income 0.41 0.42 0.42
Net realized and unrealized
gain/(loss) on investments (1.27) 1.78 0.93
---------- ---------- ----------
Total from Investment Operations (0.86) 2.20 1.35
Less Distributions:
Dividends from net investment income
and short-term gains (0.44) (0.42) (0.42)
Distributions from net realized long-
term gains (0.10) (0.28) (0.01)
---------- ---------- ----------
Total Distributions (0.54) (0.70) (0.43)
---------- ---------- ----------
Net asset value at end of year $ 12.30 $13.70 $12.20
========== ========== ==========
Total Return ** (6.32)% 18.12% 12.35%
Ratios to Average Net Assets:
Expenses 0.92(2) 0.92%(2) 0.92%(2)
Net investment income 3.14(3) 3.12%(3) 3.81%(3)
Supplemental Data:
Net assets at end of year (000) $435,805 $469,163 $307,641
Portfolio turnover rate 23% 14% 6%
</TABLE>
4
<PAGE> 7
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------
1991 1990 1989*(1) 1988* 1987* 1986* 1985*
---------- ---------- ---------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of year $ 9.57 $10.98 $ 8.24 $ 7.50 $ 7.84 $ 8.02 $ 6.99
---------- ---------- ---------- ---------- --------- --------- ---------
Income from Investment Operations:
Net investment income 0.45 0.46 0.52 0.46 0.43 0.49 0.50
Net realized and unrealized
gain/(loss) on investments 1.74 (1.29) 3.38 0.97 (0.30) 1.42 1.39
---------- ---------- ---------- ---------- --------- --------- ---------
Total from Investment Operations 2.19 (0.83) 3.90 1.43 0.13 1.91 1.89
Less Distributions:
Dividends from net investment income
and short-term gains (0.46) (0.45) (0.52) (0.46) (0.42) (0.54) (0.54)
Distributions from net realized long-
term gains (0.02) (0.13) (0.64) (0.23) (0.05) (1.55) (0.32)
---------- ---------- ---------- ---------- --------- --------- ---------
Total Distributions (0.48) (0.58) (1.16) (0.69) (0.47) (2.09) (0.86)
---------- ---------- ---------- ---------- --------- --------- ---------
Net asset value at end of year $11.28 $ 9.57 $10.98 $ 8.24 $ 7.50 $ 7.84 $ 8.02
========== ========== ========== ========== ========= ========= =========
Total Return ** 23.08% (7.55%) 48.86% 19.90% 1.51% 24.81% 29.13%
Ratios to Average Net Assets:
Expenses 0.92%(2) 0.92%(2) 0.93%(2) 0.92% 0.88% 0.87% 0.95%
Net investment income 4.38%(3) 4.54%(3) 4.41%(3) 5.35% 5.37% 5.58% 6.93%
Supplemental Data:
Net assets at end of year (000) $238,571 $177,963 $162,449 $102,483 $94,650 $99,584 $85,863
Portfolio turnover rate 7% 2% 27% 11% 4% 30% 26%
</TABLE>
- ------
* Restated for two-for-one stock split, effected in the form of a stock
dividend to shareholders of record on October 27, 1989.
** Total return represents aggregate total return for the periods indicated
and does not reflect any applicable sales charges.
(1) Investment Company Capital Corp. became Investment Advisor to the Fund on
January 19, 1989.
(2) Without the waiver of advisory fees, the ratio of expenses to average net
assets would have been .99%, .98%, 1.07%, 1.17%, 1.13% and 1.07% for the
years ended December 31, 1994, 1993, 1992, 1991, 1990 and 1989,
respectively.
(3) Without the waiver of advisory fees, the ratio of net investment income
to average net assets would have been 3.07%, 3.06%, 3.66%, 4.13%, 4.32%
and 4.28% for the years ended December 31, 1994, 1993, 1992, 1991, 1990
and 1989, respectively.
5
<PAGE> 8
________________________________________________________________________________
3. INVESTMENT PROGRAM
................................................................................
INVESTMENT OBJECTIVE, POLICIES
AND RISK CONSIDERATIONS
The Fund's investment objective is to seek high current income and,
secondarily, long-term growth of capital without undue risk. In seeking this
objective, the Fund invests primarily in income-producing common stock,
securities convertible thereto and debt obligations of companies in the
telephone industry and, to a lesser degree, in other income-producing
securities (including debt obligations) of issuers in other industries. There
can be no assurance that the Fund's investment objective will be met.
Concentration in the telephone industry will subject the Fund to the risks
associated with that industry (e.g., regulatory and technological change) and
may result in greater fluctuation in the Fund's net asset value than is
experienced in less concentrated portfolios. In light of the relatively
limited number of telephone companies, the Fund will be non-diversified for
purposes of the Investment Company Act of 1940 (the "Investment Company
Act").
The Fund's investment advisors believe that investing in a portfolio of
securities of companies in the telephone industry affords an attractive
opportunity for achieving the Fund's investment objective. The telephone
industry comprises many well capitalized companies which have demonstrated
stable, profitable growth. Significant technological and regulatory changes
are currently stimulating new services while certain unit costs are
declining. The Fund's investment advisors believe that because the telephone
industry is a focal point in the development of the information age, both for
personal and for data communications, it provides new opportunities for
earnings and dividend growth. At the same time, these developments pose
challenges to companies in the telecommunications industry with attendant
risks. The Fund's investment objective may be changed only by the affirmative
vote of a majority of the outstanding shares of the Fund.
Under normal market conditions at least 65% of the Fund's total assets
will be invested in income-producing common stock, securities convertible
thereto and debt obligations of companies in the telephone industry. The Fund
may purchase American Depository Receipts ("ADRs"), which are U.S. exchange
listed interests in securities of foreign companies. ADRs include American
Depositary Shares and New York Shares and may be "sponsored" or
"unsponsored." Sponsored ADRs are established jointly by a depositary
6
<PAGE> 9
(typically a U.S. financial institution) and the underlying issuer, whereas
unsponsored ADRs may be established by a depositary without participation by the
underlying issuer. The Fund may invest some portion of its assets in other
income-producing securities, including money market instruments and other debt
obligations, of issuers in other industries, when doing so is deemed appropriate
in order to help the Fund achieve its investment objective. The circumstances
under which the Fund will invest in such securities include, but are not limited
to, occasions when telephone industry securities that satisfy the Fund's
criteria of stability and potential for long-term growth are not available.
Depending on the circumstances, the Fund may temporarily and for defensive
purposes invest up to 100% of its net assets in such other income-producing
securities.
In general, the Fund will invest in investment grade debt obligations that
are rated, at the time of purchase, BBB or higher by Standard and Poor's
Ratings Group ("S&P") or Baa or higher by Moody's Investors Service, Inc.
("Moody's"), or, if unrated, determined to be of comparable quality by the
Fund's investment advisors, under criteria approved by the Fund's Board of
Directors. Investment grade securities are generally thought to provide the
highest credit quality and the smallest risk of default, although securities
rated BBB by S&P or Baa by Moody's have speculative characteristics. The value
of debt securities changes as interest rates fluctuate. A decrease in interest
rates will generally result in an increase in the value of the securities while
an increase in interest rates will generally result in a decrease in the value
of the securities. Such changes in the value of portfolio securities will not
affect interest income from these securities but will be reflected in the
Fund's net asset value. In the event any security owned by the Fund is
downgraded, the Fund's investment advisors will review and take appropriate
action with regard to the security. Up to 10% of the Fund's assets may be
invested in lower quality debt obligations (securities rated BB or lower by
S&P or Ba or lower by Moody's). (See "Investments in Non-Investment Grade
Securities" below.)
______________________________________________________________________________
Investments in Non-Investment Grade Securities
Where deemed appropriate by the Fund's investment advisors, the Fund may
invest up to 10% of its total assets (measured at the time of the investment)
in lower quality debt obligations (securities rated BB or lower by S&P or Ba
or lower by Moody's and unrated securities of comparable quality). Securities
that were rated BBB/Baa or higher at the time of purchase but are subsequently
downgraded to BB/Ba or lower will be included in the 10% category. If such a
downgrade causes the 10% limit to be exceeded, the Fund will be precluded
from investing further in below investment grade debt obligations but will not
be automatically required to sell any such securities. The advisors will
review the situation and take appropriate action. Lower rated debt
obligations, also known as "junk bonds," are considered to be speculative and
involve greater risk of default or price changes due to changes in the issuer's
creditworthiness. Yields and market values of these bonds will fluctuate over
time reflecting changing interest rates and the market's perception of credit
quality and the outlook for economic growth. When economic conditions appear
to be deteriorating, lower rated bonds may decline in value, regardless of
prevailing interest rates. Accordingly, adverse economic developments,
including a recession or substantial period of rising interst rates, may
disrupt the high yield bond market, affecting both the value and liquidity of
such bonds. An economic downturn could adversely affect the ability of issuers
of such bonds to make payments of principal and interest to a greater extent
than issuers of higher rated bonds might be affected. Securities in the lowest
rating category that the Fund may purchase (securities rated C by either S&P or
Moody's) may present a particular risk of default, or may be in default or
arrears in the payment of principal and interest. The ratings categories of
S&P and Moody's are described more fully in the Appendix to the Statement of
Additional Information.
_____________________________________________________________________________
Investments in Repurchase Agreements
The Fund may enter into repurchase agreements with domestic banks or
broker-dealers deemed creditworthy under guidelines approved by the
Directors. A repurchase agreement is a short-term investment in which the
purchaser (i.e., the Fund) acquires ownership of a debt security, and the
seller agrees to repurchase the obligation at a future time and set price,
usually not more than 7 days from the date of purchase, thereby determining
the yield during the purchaser's holding period. The value of the underlying
securities will be at least equal at all times to the total amount of the
repurchase agreement obligation, including the interest factor. The
underlying securities, which in the case of the Fund will be securities of
the U.S. Government only, may have maturities exceeding one year. If the
seller defaulted on its obligation to repurchase the underlying instrument,
the Fund could experience loss due to delay in liquidating the collateral and
to adverse market action.
7
<PAGE> 10
_______________________________________________________________________________
Other Investments
The Fund has the right to lend portfolio securities to recognized
institutional borrowers on a fully collateralized basis. The Fund may also
write covered call options if each such option is traded on a national
securities exchange (and may purchase calls in related closing transactions).
To date the Fund has not lent portfolio securities.
________________________________________________________________________________
4. INVESTMENT RESTRICTIONS
The Fund's investment program is subject to a number of restrictions which
reflect both self-imposed standards and federal and state regulatory
limitations. The investment restrictions recited below are matters of
fundamental policy and may not be changed without the affirmative vote of a
majority of the outstanding shares of the Fund. Accordingly, the Fund will
not:
1) Invest less than 65% of the value of its total assets in the telephone
industry, except as described in this Prospectus (otherwise the Fund will
not concentrate more than 25% of its total assets in securities of issuers
in any industry);
2) Invest in the securities of any single issuer if, as a result, the Fund
would hold more than 10% of the outstanding voting securities of such
issuer; or
3) Borrow money except as a temporary measure for extraordinary or emergency
purposes and then only from banks and in an amount not exceeding 10% of
the value of the total assets of the Fund at the time of such borrowing,
provided that, while borrowings by the Fund equalling 5% or more of the
Fund's total assets are outstanding, the Fund will not purchase securities
for investment.
The Fund is subject to further investment restrictions that are set forth
in the Statement of Additional Information.
______________________________________________________________________________
5. HOW TO INVEST IN THE FUND
Class A Shares and Class B Shares may be purchased from Alex. Brown, 135
East Baltimore Street, Baltimore, Maryland 21202, through any securities
dealer which has entered into a dealer agreement with Alex. Brown
("Participating Dealers") or through any financial institution which has
entered into a Shareholder Servicing Agreement with the Fund ("Shareholder
Servicing Agents"). Shares of either class may also be purchased directly
from the Fund by completing the Application Form attached to this Prospectus
and returning it, together with payment of the purchase
8
<PAGE> 11
price, to the Fund at the address shown on the Application Form.
Participating Dealers or Shareholder Servicing Agents and their investment
representatives may receive different levels of compensation depending on
which class of shares they sell.
The Class A and Class B alternatives permit an investor to choose the
method of purchasing shares that is more beneficial given the amount of the
purchase, the length of time the investor expects to hold the shares, and
other circumstances. Investors should consider whether, during the
anticipated life of their investment in the Fund, the combination of sales
charge and distribution fee on Class A Shares is more favorable than the
combination of distribution/service fees and contingent deferred sales charge
on Class B Shares. In almost all cases, investors planning to purchase
$100,000 or more of Fund shares will pay lower aggregate charges and expenses
by purchasing Class A Shares. Accordingly, the Fund will not accept purchases
for Class B Shares in excess of $100,000 per account. (See "Fee Table.")
The minimum initial investment in shares of either class is $2,000, except
that the minimum initial investment for shareholders of any other Flag
Investors fund or class is $500 and the minimum initial investment for
participants in the Fund's Automatic Investing Plan is $250. Each subsequent
investment must be at least $100 per class, except that the minimum
subsequent investment under the Fund's Automatic Investing Plan is $250 for
quarterly investments and $100 for monthly investments. (See "Purchases
Through Automatic Investing Plan" below.) There is no minimum investment
requirement for qualified retirement plans (i.e., 401(k) plans or pension and
profit sharing plans). IRA accounts are, however, subject to the $2,000
minimum initial investment requirement. There is no minimum investment
requirement for spousal IRA accounts. Orders for purchases of shares are
accepted on any day on which the New York Stock Exchange is open for business
("Business Day"). The Fund reserves the right to suspend the sale of shares
at any time at the discretion of Alex. Brown and the Fund's investment
advisors. Purchase orders for shares will be executed at a per share purchase
price equal to the net asset value next determined after receipt of the
purchase order plus any applicable front-end sales charge (the "Offering
Price") on the date such net asset value is determined (the "Purchase Date").
Purchases made directly from the Fund must be accompanied by payment of the
purchase price. Purchases made through Alex. Brown or a Participating Dealer
or Shareholder Servicing Agent must be in accordance with such entity's
payment procedures. Alex. Brown may, in its sole discretion, refuse to accept
any purchase order.
The net asset value per share is determined once daily as of the close of
the New York Stock Exchange, which is ordinarily 4:00 p.m. (Eastern
9
<PAGE> 12
Time), on each Business Day. Net asset value per share of a class is
calculated by valuing all assets held by the Fund, deducting liabilities
attributable to all shares and any liabilities attributable to the specific
class, and dividing the resulting amount by the number of then outstanding
shares of the class. For this purpose, portfolio securities will be given
their market value where feasible. If a portfolio security is traded on a
national exchange or on an automated dealer quotation system, such as NASDAQ,
on the valuation date, the last quoted sale price will generally be used.
Options are valued at the last reported sale price, or if no sales are
reported, at the average of the last reported bid and asked prices.
Securities or other assets for which market quotations are not readily
available are valued at their fair value as determined in good faith under
procedures established from time to time and monitored by the Fund's Board of
Directors. Debt obligations with maturities of 60 days or less will be valued
at amortized cost, which constitutes fair value as determined by the Fund's
Board of Directors. Because of differences between the classes of shares in
distribution fees, the net asset value per share of the classes will differ
at times.
................................................................................
OFFERING PRICE
Shares may be purchased from Alex. Brown, Participating Dealers or
Shareholder Servicing Agents at the Offering Price which for Class A Shares
includes a sales charge which is calculated as a percentage of the Offering
Price and for Class B Shares is net asset value.
................................................................................
CLASS A SHARES
The sales charge on Class A Shares, which decreases as the amount of
purchase increases, is shown below:
<TABLE>
<CAPTION>
Sales Charge Dealer
as % of Retention
------------------------------
Offering Net Amount as % of
Amount of Purchase Price Invested Offering Price
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $ 50,000 ..... 4.50% 4.71% 4.00%
$ 50,000 - $ 99,999 ..... 3.50% 3.63% 3.00%
$100,000 - $249,999 ..... 2.50% 2.56% 2.00%
$250,000 - $499,999 ..... 2.00% 2.04% 1.50%
$500,000 - $999,999 ..... 1.50% 1.52% 1.25%
$1,000,000 and over ..... None* None* None*
- --------------------------------------------------------------------------------
</TABLE>
* Purchases of $1 million or more may be subject to a contingent deferred
sales charge. (See below.) Alex. Brown may make payments to dealers in the
amount of .50% of the Offering Price.
A shareholder who purchases additional Class A Shares may obtain reduced
sales charges, as set forth in the table above, through a right of
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<PAGE> 13
accumulation. In addition, an investor may obtain reduced sales charges as
set forth above through a right of accumulation of purchases of Class A
Shares and purchases of shares of other Flag Investors funds with the same
sales charge and purchases of shares of Flag Investors Intermediate-Term
Income Fund, Inc. and Flag Investors Maryland Intermediate Tax Free Income
Fund, Inc. (the "Intermediate Funds"). The applicable sales charge will be
determined based on the total of (a) the shareholder's current purchase plus
(b) an amount equal to the then current net asset value or cost, whichever is
higher, of all Class A Shares and of all Flag Investors shares described
above and any Flag Investors Class D shares held by the shareholder. To
obtain the reduced sales charge through a right of accumulation, the
shareholder must provide Alex. Brown, either directly or through a
Participating Dealer or Shareholder Servicing Agent, as applicable, with
sufficient information to verify that the shareholder has such a right. The
Fund may amend or terminate this right of accumulation at any time as to
subsequent purchases.
The term "purchase" refers to an individual purchase by a single
purchaser, or to concurrent purchases, which will be aggregated, by a
purchaser, the purchaser's spouse and their children under the age of 21
years purchasing shares for their own account.
An investor may also obtain the reduced sales charges shown above by
executing a written Letter of Intent which states the investor's intention to
invest not less than $50,000 within a 13-month period in Class A Shares. Each
purchase of shares under a Letter of Intent will be made at the Offering
Price applicable at the time of such purchase to the full amount indicated on
the Letter of Intent. A Letter of Intent is not a binding obligation upon the
investor to purchase the full amount indicated. The minimum initial
investment under a Letter of Intent is 5% of the full amount. Shares
purchased with the first 5% of the full amount will be held in escrow (while
remaining registered in the name of the investor) to secure payment of the
higher sales charge applicable to the shares actually purchased if the full
amount indicated is not invested. Such escrowed shares will be involuntarily
redeemed to pay the additional sales charge, if necessary. When the full
amount indicated has been purchased, the escrowed shares will be released. An
investor who wishes to enter into a Letter of Intent in conjunction with an
investment in Class A Shares may do so by completing the appropriate section
of the Application Form attached to this Prospectus.
No sales charge will be payable at the time of purchase on investments of
$1 million or more of Class A Shares. However, a contingent deferred sales
charge will be imposed on such investments in the event of a redemption
within 24 months following the purchase, at the rate of .50% on the
11
<PAGE> 14
lesser of the value of the shares redeemed or the total cost of such shares.
No contingent deferred sales charge will be imposed on purchases of $3
million or more of Class A Shares redeemed within 24 months of purchase if
the Participating Dealer and Alex. Brown have entered into an agreement under
which the Participating Dealer agrees to return any payments received on the
sale of such shares. In determining whether a contingent deferred sales
charge is payable, and, if so, the amount of the charge, it is assumed that
shares not subject to such charge are the first redeemed followed by other
shares held for the longest period of time.
Class A Shares may also be purchased through a Systematic Purchase Plan.
An investor who wishes to take advantage of such a plan should contact Alex.
Brown or a Participating Dealer or Shareholder Servicing Agent.
The Fund may sell Class A Shares at net asset value (without sales charge)
to the following: (i) banks, bank trust departments, registered investment
advisory companies, financial planners and broker-dealers purchasing shares
on behalf of their fiduciary and advisory clients, provided such clients have
paid an account management fee for these services; (ii) qualified retirement
plans; (iii) participants in a Flag Investors fund payroll savings plan
program; (iv) investors who have redeemed Class A Shares, or shares of any
other mutual fund in the Flag Investors family of funds with the same sales
charges, or who have redeemed shares of the Intermediate Funds which they had
held for at least 24 months prior to redemption, in an amount that is not
more than the total redemption proceeds, provided that the purchase is within
90 days after the redemption; and (v) current or retired Directors of the
Fund and directors and employees (and their immediate families) of Alex.
Brown, Participating Dealers and their respective affiliates.
................................................................................
CLASS B SHARES
No sales charge will be payable at the time of purchase of Class B Shares.
However, a contingent deferred sales charge will be imposed on certain Class
B Shares redeemed within six years of purchase. The charge is assessed on an
amount equal to the lesser of the then-current market value of the Class B
Shares redeemed or the total cost of such shares. Accordingly, the contingent
deferred sales charge will not be applied to dollar amounts representing an
increase in the net asset values above the initial purchase price of the
shares being redeemed. In addition, no charge is assessed on redemptions of
Class B Shares derived from reinvestment of dividends or capital gains
distributions.
12
<PAGE> 15
In determining whether the contingent deferred sales charge is applicable
to a redemption, the calculation is made in the manner that results in the
lowest possible rate. Therefore, it is assumed that the redemption is first
of any Class B Shares in the shareholder's account that represent reinvested
dividends and distributions and second of Class B Shares held the longest
during the six year period. The amount of the contingent deferred sales
charge, if any, will vary depending on the number of years from the time of
payment for the purchase of Class B Shares until the redemption of such
shares (the "holding period"). For purposes of determining this holding
period, all payments during a month are aggregated and deemed to have been
made on the first day of the month. The following table sets forth the rates
of the contingent deferred sales charge.
<TABLE>
<CAPTION>
Contingent Deferred Sales Charge
Year Since Purchase (as a percentage of the dollar amount
Payment was Made subject to charge)
- ----------------------- ----------------------------------------
<S> <C>
First ................. 4.0%
Second ................ 4.0%
Third ................. 3.0%
Fourth ................ 3.0%
Fifth ................. 2.0%
Sixth ................. 1.0%
Thereafter ............ None*
----------------------------------------
</TABLE>
* As described more fully below, Class B Shares automatically convert to
Class A Shares six years after the beginning of the calendar month in which
the purchase order is accepted.
Waiver of Contingent Deferred Sales Charge. The contingent deferred sales
charge will be waived on the redemption of Class B Shares (i) following the
death or initial determination of disability (as defined in the Internal
Revenue Code of 1986, as amended) of a shareholder; or (ii) to the extent
that the redemption represents a minimum required distribution from an
individual retirement account or other retirement plan to a shareholder who
has attained the age of 70 1/2 . The waiver with respect to (i) above is only
applicable in cases where the shareholder account is registered (a) in the
name of an individual person, (b) as a joint tenancy with rights of
survivorship, (c) as community property or (d) in the name of a minor child
under the Uniform Gifts or Uniform Transfers to Minors Act. A shareholder, or
his or her representative, must notify the Fund's transfer agent (the
"Transfer Agent") prior to the time of redemption if such circumstances exist
and the shareholder is eligible for this waiver. For information on the
imposition and waiver of the contingent deferred sales charge, contact the
Transfer Agent at (800) 553-8080.
Automatic Conversion to Class A Shares. Six years after the beginning of
the calendar month in which the purchase order for Class B Shares is
13
<PAGE> 16
accepted, such Class B Shares will automatically convert to Class A Shares
and will no longer be subject to the higher distribution and service fees.
Such conversion will be on the basis of the relative net asset values of the
two classes, without the imposition of any sales load, fee or other charge.
The conversion is not a taxable event to the shareholder.
For purposes of conversion to Class A Shares, shares received as dividends
and other distributions paid on Class B Shares in the shareholder's account
will be considered to be held in a separate sub-account. Each time any Class
B Shares in the shareholder's account (other than those in the sub-account)
convert to Class A Shares, an equal pro rata portion of the Class B Shares in
the sub-account will also convert to Class A Shares.
Class B Shares may also be purchased through a Systematic Purchase Plan.
An investor who wishes to take advantage of such a plan should contact Alex.
Brown or a Participating Dealer or Shareholder Servicing Agent.
..............................................................................
PURCHASES BY EXCHANGE
As permitted pursuant to any rule, regulation or order promulgated by the
SEC, shareholders of other Flag Investors funds may exchange their shares of
those funds for an equal dollar amount of Fund shares of the same class.
Except as provided below, shares issued pursuant to this offer will not be
subject to the sales charges described above or any other charge.
Shareholders of the Intermediate Funds may exchange into Class A Shares upon
payment of the difference in sales charges, as applicable, except that the
exchange will be made at net asset value if the shares of such funds have
been held for more than 24 months. Shareholders of Flag Investors Cash
Reserve Prime Class A Shares may exchange into Class A Shares upon payment of
the difference in sales charges, as applicable, or into Class B Shares at net
asset value, subject to any applicable contingent deferred sales charge.
When a shareholder acquires Fund shares through an exchange from another
fund in the Flag Investors family of funds, the Fund will combine the period
for which the original shares were held prior to the exchange with the
holding period of the shares acquired in the exchange for purposes of
determining what, if any, contingent deferred sales charge is applicable upon
a redemption of any such shares.
The net asset value of shares purchased and redeemed in an exchange
request received on a Business Day will be determined on the same day,
provided that the exchange request is received prior to 4:00 p.m. (Eastern
Time). Exchange requests received after 4:00 p.m. (Eastern Time) will be
effected on the next Business Day.
14
<PAGE> 17
Shareholders of any mutual fund not affiliated with the Fund, who have
paid a sales charge may exchange shares of such fund for an equal dollar
amount of Class A Shares by submitting to Alex. Brown or a Participating
Dealer the proceeds of the redemption of such shares, together with evidence
of the payment of a sales charge and the source of such proceeds. Shares
issued pursuant to this offer will not be subject to the sales charge
described above or any other charge.
The exchange privilege with respect to other Flag Investors funds may also
be exercised by telephone. (See "Telephone Transactions" below.)
The exchange privilege may be exercised only in those states where the
class of shares of such other funds may legally be sold. Investors should
receive and read the applicable prospectus prior to tendering shares for
exchange. The Fund may modify or terminate this offer of exchange at any time
on 60 days' prior written notice to shareholders.
................................................................................
PURCHASES THROUGH AUTOMATIC INVESTING PLAN
Shareholders may purchase either Class A Shares or Class B Shares
regularly by means of an Automatic Investing Plan with a pre-authorized check
drawn on their checking accounts. Under this plan, the shareholder may elect
to have a specified amount invested monthly or quarterly in either Class A
Shares or Class B Shares. The amount specified by the shareholder will be
withdrawn from the shareholder's checking account using the pre-authorized
check. This amount will be invested in the class of shares selected by the
shareholder at the applicable Offering Price determined on the date the
amount is available for investment. Participation in the Automatic Investing
Plan may be discontinued either by the Fund or the shareholder upon 30 days'
prior written notice to the other party. A shareholder who wishes to enroll
in the Automatic Investing Plan or who wishes to obtain additional purchase
information may do so by completing the appropriate section of the
Application Form attached to this Prospectus.
________________________________________________________________________________
6. HOW TO REDEEM SHARES
Shareholders may redeem all or part of their investments on any Business
Day by transmitting a redemption order through Alex. Brown, a Participating
Dealer, a Shareholder Servicing Agent or by regular or express mail to the
Transfer Agent. Shareholders may also redeem shares of either class by
telephone (in amounts up to $50,000). (See "Telephone Transactions" below.) A
redemption order is effected at the net asset value per share (reduced by any
applicable contingent deferred sales charge) next determined after receipt of
15
<PAGE> 18
the order (or, if stock certificates have been issued for the shares to be
redeemed, after the tender of the stock certificates for redemption). Redemption
orders received after 4:00 p.m. (Eastern Time) will be effected at the net asset
value next determined on the following Business Day. Payment for redeemed shares
will be made by check and will be mailed within seven days after receipt of a
duly authorized telephone redemption request or of a redemption order fully
completed and, as applicable, accompanied by the documents described below:
1) A letter of instructions, specifying the shareholder's account number with
a Participating Dealer, if applicable, and the number of shares or dollar
amount to be redeemed, signed by all owners of the shares in the exact
names in which their account is maintained;
2) For redemptions in excess of $50,000, a guarantee of the signature of each
registered owner by a member of the Federal Deposit Insurance Corporation,
a trust company, broker, dealer, credit union (if authorized under state
law), securities exchange or association, clearing agency or savings
association;
3) If shares are held in certificate form, stock certificates either properly
endorsed or accompanied by a duly executed stock power for shares to be
redeemed; and
4) Any additional documents required for redemption by corporations,
partnerships, trusts or fiduciaries.
Dividends payable up to the date of redemption of shares will be paid on
the next dividend payable date. If all of the shares in a shareholder's
account have been redeemed on a dividend payable date, the dividend will be
remitted by check to the shareholder.
The Fund has the power, under its Articles of Incorporation, to redeem
shareholder accounts amounting to less than $500 (as a result of redemptions)
upon 60 days' notice.
................................................................................
SYSTEMATIC WITHDRAWAL PLAN
Shareholders who hold Class A Shares or Class B Shares having a value of
$10,000 or more may arrange to have a portion of their shares redeemed
monthly or quarterly under the Fund's Systematic Withdrawal Plan. Such
payments are drawn from income dividends, and to the extent necessary, from
share redemptions (which would be a return of principal and, if reflecting a
gain, would be taxable). If redemptions continue, a shareholder's account may
eventually be exhausted. Because share purchases include a sales charge that
16
<PAGE> 19
will not be recovered at the time of redemption, a shareholder should not have a
withdrawal plan in effect at the same time he is making recurring purchases of
shares. In addition, Class B Shares may be subject to a contingent deferred
sales charge upon redemption. (See "How to Invest in the Fund -- Class B
Shares.") A shareholder who wishes to participate in the Fund's Systematic
Withdrawal Plan may do so by completing the appropriate section of the
Application Form attached to this Prospectus.
________________________________________________________________________________
7. TELEPHONE TRANSACTIONS
Shareholders may exercise the exchange privilege with respect to other
Flag Investors funds, or redeem shares of either class in amounts up to
$50,000, by notifying the Transfer Agent by telephone at (800) 553-8080 on
any Business Day between the hours of 8:30 a.m. and 5:30 p.m. (Eastern Time)
or by regular or express mail at its address listed under "Custodian,
Transfer Agent, Accounting Services." Telephone transaction privileges are
automatic. Shareholders may specifically request that no telephone
redemptions or exchanges be accepted for their accounts. This election may be
made on the Application Form or at any time thereafter by completing and
returning appropriate documentation supplied by the Transfer Agent.
A telephone exchange or redemption placed by 4:00 p.m. (Eastern Time) or
the close of the New York Stock Exchange, whichever is earlier, is effective
that day. Telephone orders placed after 4:00 p.m. (Eastern Time) will be
effected at the net asset value (less any applicable contingent deferred
sales charge on redemptions) as next determined on the following Business
Day.
The Fund and the Transfer Agent will employ reasonable procedures to
confirm that instructions communicated by telephone are genuine. These
procedures include requiring the investor to provide certain personal
identification information at the time an account is opened and prior to
effecting each transaction requested by telephone. In addition, all telephone
transaction requests will be recorded and investors may be required to
provide additional telecopied instructions of such transaction requests. The
Fund or the Transfer Agent may be liable for any losses due to unauthorized
or fraudulent telephone instructions if either of them does not employ these
procedures. Neither the Fund nor the Transfer Agent will be responsible for
any loss, liability, cost or expense for following instructions received by
telephone that either of them reasonably believes to be genuine. During
periods of extreme economic or market changes, shareholders may experience
difficulty in effecting telephone transactions. In such event, requests should
17
<PAGE> 20
be made by regular or express mail. Shares held in certificate form may not be
exchanged or redeemed by telephone. (See "How to Invest in the Fund -- Purchases
by Exchange" and "How to Redeem Shares.")
________________________________________________________________________________
8. DIVIDENDS AND TAXES
................................................................................
DIVIDENDS AND DISTRIBUTIONS
The Fund's policy is to distribute to shareholders substantially all of
its taxable net investment income in the form of monthly dividends. The Fund
will attempt to pay dividends that are consistent in amount with its taxable
net investment company income and reserves the right, with the approval of
the Directors, to pay dividends that constitute a return of capital which
could cause a decrease in a shareholder's tax basis in shares. The Fund
normally will distribute to shareholders any net capital gains on an annual
basis.
Unless the shareholder elects otherwise, all income and capital gains
distributions will be reinvested in additional Fund shares at net asset
value. Shareholders may elect to terminate automatic reinvestment by giving
written notice to the Transfer Agent (see "Custodian, Transfer Agent,
Accounting Services"), either directly or through any Participating Dealer or
Shareholder Servicing Agent, at least five days before the next date on which
dividends or distributions will be paid.
................................................................................
TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS
The following is only a general summary of certain federal income tax
considerations affecting the Fund and the shareholders. No attempt is made to
present a detailed explanation of the tax treatment of the Fund or the
shareholders, and the discussion here is not intended as a substitute for
careful tax planning.
The following summary is based on current tax laws and regulations, which
may be changed by legislative, judicial, or administrative action. The
Statement of Additional Information sets forth further information with
respect to taxes.
The Fund has elected to be and has been taxed as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended.
As long as the Fund qualifies for this tax treatment, the Fund will be
relieved of federal income tax on amounts distributed to shareholders, but
18
<PAGE> 21
shareholders, unless otherwise exempt, generally will be subject to income tax
on the amounts so distributed, regardless of whether such distributions are paid
in cash or reinvested in additional shares.
Distributions from the Fund out of net capital gains (the excess of net
long-term capital gains over net short-term capital losses), if any, will be
taxed to shareholders as long-term capital gains regardless of the length of
time a shareholder has held the shares. All other income distributions will
be taxed to shareholders as ordinary income. Corporate shareholders may be
entitled to the dividends received deduction on a portion of dividends
received from the Fund. Shareholders will be advised annually as to the tax
status of all distributions.
The sale, exchange or redemption of shares is a taxable event to the
shareholder.
Ordinarily, shareholders will include all dividends declared by the Fund
in income in the year of payment. However, dividends declared payable to
shareholders of record in December of one year, but paid in January of the
following year, will be deemed for tax purposes to have been received by the
shareholders and paid by the Fund on December 31 of the year in which the
dividends were declared.
The Fund intends to make sufficient distributions of its ordinary income
and capital gain net income prior to the end of each calendar year to avoid
liability for federal excise tax.
Shareholders are advised to consult with their tax advisors concerning the
application of the rules described above to their particular circumstances
and the application of state and local taxes to an investment in the Fund.
________________________________________________________________________________
9. MANAGEMENT OF THE FUND
The overall business and affairs of the Fund are managed by its Board of
Directors. The Board approves all significant agreements between the Fund and
persons or companies furnishing services to the Fund, including the Fund's
agreements with its investment advisor, sub-advisor, distributor, custodian
and transfer agent. The day-to-day operations of the Fund are delegated to
the Fund's officers, to the Fund's investment advisor, Investment Company
Capital Corp. ("ICC"), to its sub-advisor, Alex. Brown Investment Management
("ABIM"), and to the Fund's distributor, Alex. Brown. Three Directors and all
of the officers of the Fund are officers or employees of ICC, ABIM or Alex.
Brown. The other Directors of the Fund have no affiliation with ICC, ABIM or
Alex. Brown.
19
<PAGE> 22
The Fund's Directors and officers are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
*W. James Price Chairman Bruce E. Behrens President
*Robert S. Killebrew, Jr. Director J. Dorsey Brown, III Executive Vice President
*Truman T. Semans Director Richard T. Hale Vice President
James J. Cunnane Director Hobart C. Buppert, II Vice President
N. Bruce Hannay Director Lee S. Owen Vice President
John F. Kroeger Director Edward J. Veilleux Vice President
Louis E. Levy Director Gary V. Fearnow Vice President
Eugene J. McDonald Director Brian C. Nelson Vice President and Secretary
Harry Woolf Director Diana M. Ellis Treasurer
Laurie D. DePrine Assistant Secretary
</TABLE>
- ------
*Messrs. Price, Killebrew and Semans are Directors who are "interested
persons" of the Fund within the meaning of Section 2(a)(19) under the
Investment Company Act.
________________________________________________________________________________
10. INVESTMENT ADVISOR AND SUB-ADVISOR
ICC is the Fund's investment advisor and ABIM is the Fund's sub-advisor.
ICC is also the investment advisor to, and Alex. Brown acts as distributor
for other mutual funds in the Flag Investors family of funds and Alex. Brown
Cash Reserve Fund, Inc., which funds had approximately $3.4 billion of net
assets as of December 31, 1994. ABIM is a registered investment advisor with
approximately $3.0 billion under management as of December 31, 1994.
Pursuant to the terms of the Investment Advisory Agreement, ICC supervises
and manages all of the Fund's operations. Under the Investment Advisory and
Sub-Advisory Agreements, ICC delegates to ABIM certain of its duties,
provided that ICC continues to supervise the performance of ABIM and report
thereon to the Fund's Board of Directors. Pursuant to the terms of the
Sub-Advisory Agreement, ABIM is responsible for decisions to buy and sell
securities for the Fund, for broker-dealer selection, and for negotiation of
commission rates under standards established and periodically reviewed by the
Board of Directors. The Board has established procedures under which ABIM may
allocate transactions to Alex. Brown, provided that compensation to Alex.
Brown on each transaction is reasonable and fair compared to the commission,
fee or other remuneration received or to be received by other broker-dealers
in connection with comparable transactions involving similar securities
during a comparable period of time. In addition, consistent with NASD Rules,
and subject to seeking the most favorable price and execution available and
such other policies as the Board may determine, ABIM may consider services in
connection with the sale of shares as a factor in the selection of
broker-dealers to execute portfolio transactions for the Fund.
20
<PAGE> 23
As compensation for its services for the fiscal year ended December 31,
1994, ICC received from the Fund a fee (net of fee waivers) equal to .45% of
the Fund's average daily net assets and, for the same period, ICC paid ABIM a
sub-advisory fee equal to .31% of the Fund's average daily net assets.
ICC is a wholly-owned subsidiary of Alex. Brown, the Fund's distributor.
Buppert, Behrens & Owen, Inc., a company organized and owned by three
employees of ABIM, owns a 49% limited partnership interest and a 1% general
partnership interest in ABIM. Alex. Brown owns a 1% general partnership
interest in ABIM and Alex. Brown Incorporated owns the remaining 49% limited
partnership interest. The address of both ICC and ABIM is 135 East Baltimore
Street, Baltimore, Maryland 21202.
ICC also serves as the Fund's transfer and dividend disbursing agent and
provides accounting services to the Fund. (See "Custodian, Transfer Agent,
Accounting Services.")
................................................................................
PORTFOLIO MANAGERS
Messrs. Bruce E. Behrens, the Fund's President, and Hobart C. Buppert, II,
a Vice President of the Fund, have shared primary responsibility for managing
the Fund's assets since inception.
Bruce E. Behrens -- 27 Years Investment Experience
Mr. Behrens has been a Vice President of ABIM since 1981. Prior to joining
ABIM, Mr. Behrens was a Senior Vice President and Principal of Corbyn
Associates from 1978 to 1981 and a Vice President at Investment Counselors of
Maryland from 1972 to 1978. Prior thereto, he was a Security Analyst at
Citibank from 1968 to 1972. Mr. Behrens received his B.A. from Denison
University in 1966 and an M.B.A. from the University of Michigan in 1968. He
is a member and past President of the Baltimore Security Analysts Society and
a member of the Financial Analysts Federation.
Hobart C. Buppert, II -- 23 Years Investment Experience
Mr. Buppert has been a Vice President of ABIM since 1980. Prior to joining
ABIM, Mr. Buppert worked as a Portfolio Manager for T. Rowe Price Associates
from 1976 to 1980 and as a Portfolio Manager and Research Analyst for the
Equitable Trust Company from 1972 to 1976. Mr. Buppert received his B.A and
M.B.A. degrees from Loyola College in 1970 and 1974. He is a member of the
Baltimore Security Analysts Society and the Financial Analysts Federation.
21
<PAGE> 24
________________________________________________________________________________
11. DISTRIBUTOR
Alex. Brown acts as distributor of the Class A Shares and the Class B
Shares. Alex. Brown is an investment banking firm which offers a broad range
of investment services to individual, institutional, corporate and municipal
clients. It is a wholly-owned subsidiary of Alex. Brown Incorporated which
has engaged directly and through subsidiaries and affiliates in the
investment business since 1800. Alex. Brown is a member of the New York Stock
Exchange and other leading securities exchanges. Headquartered in Baltimore,
Maryland, Alex. Brown has offices throughout the United States and, through
subsidiaries, maintains offices in London, England, Geneva, Switzerland and
Tokyo, Japan.
The Fund has adopted two separate Distribution Agreements and related
Plans of Distribution, one with respect to the Class A Shares and one with
respect to the Class B Shares (the "Plans") pursuant to Rule 12b-1 under the
Investment Company Act. In addition, the Fund may enter into Shareholder
Servicing Agreements with certain financial institutions, such as banks, to
act as Shareholder Servicing Agents, pursuant to which Alex. Brown will
allocate a portion of its distribution fee as compensation for such financial
institutions' ongoing shareholder services. Such financial institutions may
impose separate fees in connection with these services and investors should
review this Prospectus in conjunction with any such institution's fee
schedule. In addition, financial institutions may be required to register as
dealers pursuant to state securities laws. Amounts allocated to Participating
Dealers and Shareholder Servicing Agents may not exceed amounts payable to
Alex. Brown under the Plans with respect to shares held by or on behalf of
customers of such entity.
As compensation for providing distribution services for the Class A Shares
for the fiscal year ended December 31, 1994, Alex. Brown received a fee equal
to .25% of the average daily net assets of the Class A Shares.
Under the Class B Plan, Alex. Brown will receive an annual distribution
fee, paid monthly, equal to .75% of the Class B Shares' average daily net
assets. In addition, Alex. Brown will receive an annual shareholder servicing
fee, paid monthly, equal to .25% of the Class B Shares' average daily net
assets. The distribution fee will be used to compensate Alex. Brown for its
services and expenses in distributing the Class B Shares. The shareholder
servicing fee will be used to compensate Alex. Brown, Participating Dealers
and Shareholder Servicing Agents for services provided and expenses incurred
in maintaining shareholder accounts, responding to shareholder inquiries and
providing information on their investments.
22
<PAGE> 25
Payments under the Plans are made as described above regardless of Alex.
Brown's actual cost of providing distribution services and may be used to pay
Alex. Brown's overhead expenses. If the cost of providing distribution
services to the Fund in connection with the sale of the Class A Shares is
less than .25% of the average daily net assets invested in Class A Shares or
in connection with the sale of the Class B Shares is less than .75% of the
average daily net assets invested in Class B Shares for any period, the
unexpended portion of the distribution fees may be retained as profit by
Alex. Brown. Alex. Brown will from time to time and from its own resources
pay or allow additional discounts or promotional incentives in the form of
cash or other compensation (including merchandise or travel) to Participating
Dealers.
The address of Alex. Brown is 135 East Baltimore Street, Baltimore,
Maryland 21202.
________________________________________________________________________________
12. CUSTODIAN, TRANSFER AGENT, ACCOUNTING SERVICES
PNC Bank, National Association ("PNC Bank"), a national banking
association with offices at Airport Business Park, 200 Stevens Drive, Lester,
Pennsylvania 19113, acts as custodian of the Fund's assets. Investment
Company Capital Corp., 135 East Baltimore Street, Baltimore, Maryland 21202
(telephone: (800) 553-8080), is the Fund's transfer and dividend disbursing
agent and provides accounting services to the Fund. As compensation for
providing accounting services to the Fund for the fiscal year ended December
31, 1994, ICC received a fee equal to .02% of the Fund's average daily net
assets. (See the Statement of Additional Information.) ICC also serves as the
Fund's investment advisor.
________________________________________________________________________________
13. PERFORMANCE INFORMATION
From time to time, the Fund may advertise its performance, including
comparisons to other mutual funds with similar investment objectives and to
stock or other relevant indices. All such advertisements will show the
average annual total return, net of the Fund's maximum sales charge imposed
on Class A Shares or including the contingent deferred sales charge imposed
on Class B Shares redeemed at the end of the specified period covered by the
total return figure, over one, five and ten year periods or, if such periods
have not yet elapsed, shorter periods corresponding to the life of the Fund.
Such total return quotations will be computed by finding the average annual
compounded rates of return over such periods that would equate an assumed
23
<PAGE> 26
initial investment of $1,000 to the ending redeemable value, net of the maximum
sales charge and other fees, according to the required standardized calculation.
The standardized calculation is required by the SEC to provide consistency and
comparability in investment company advertising and is not equivalent to a yield
calculation. If the Fund compares its performance to other funds or to relevant
indices, the Fund's performance will be stated in the same terms in which such
comparative data and indices are stated, which is normally total return rather
than yield. For these purposes, the performance of the Fund, as well as the
performance of such investment companies or indices, may not reflect sales
charges, which, if reflected, would reduce performance results.
The performance of the Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. and Morningstar,
Inc., independent services which monitor the performance of mutual funds. The
performance of the Fund may also be compared to the Lehman Government
Corporate Bond Index, the Consumer Price Index, the return on 90 day U.S.
Treasury bills, the Standard & Poor's 500 Stock Index and the Dow Jones
Industrial Average. The Fund may also use total return performance data as
reported in the following national financial and industry publications that
monitor the performance of mutual funds: Money Magazine, Forbes, Business
Week, Barrons, Investor's Daily, IBC/Donoghue's Money Fund Report and The
Wall Street Journal.
Performance will fluctuate, and any statement of performance should not be
considered as representative of the future performance of the Fund.
Shareholders should remember that performance is generally a function of the
type and quality of instruments held by the Fund, operating expenses and
market conditions. Any fees charged by banks with respect to customer
accounts through which shares may be purchased, although not included in
calculations of performance, will reduce performance results.
Although expenses for Class B Shares may be higher than those for Class A
Shares, the performance of Class B Shares may be higher than the performance
of Class A Shares after giving effect to the impact of the sales charges and
distribution/service fees applicable to each class of shares.
________________________________________________________________________________
14. GENERAL INFORMATION
................................................................................
CAPITAL SHARES
The Fund is a Maryland corporation, authorized to issue 70 million shares
of capital stock, with a par value of $.001 per share. Shares of the
24
<PAGE> 27
Fund have equal rights with respect to voting. Voting rights are not
cumulative, so the holders of more than 50% of the outstanding shares voting
together for election of Directors may elect all the members of the Board of
Directors of the Fund. In the event of liquidation or dissolution of the
Fund, each share would be entitled to its portion of the Fund's assets after
all debts and expenses have been paid.
The Board of Directors is authorized to establish additional "series" of
shares of capital stock, each of which would evidence interests in a separate
portfolio of securities, and separate classes of each series of the Fund. The
Shares offered by this Prospectus have been designated: Flag Investors
Telephone Income Fund Class A Shares and Flag Investors Telephone Income Fund
Class B Shares. The Board has no present intention of establishing any
additional series of the Fund but the Fund does have another class of shares
in addition to the Shares offered hereby, "Flag Investors Telephone Income
Fund Class D Shares," which are not currently being offered. Different
classes of the Fund may be offered to certain investors and holders of such
shares may be entitled to certain exchange privileges not offered to Class A
or Class B Shares. All classes of the Fund share a common investment
objective, portfolio of investments and advisory fee, but the classes may
have different distribution/service fees or sales load structures.
................................................................................
ANNUAL MEETINGS
The Fund does not expect to hold annual meetings of shareholders, but
special meetings of shareholders may be held under certain circumstances.
Shareholders of the Fund retain the right, under certain circumstances, to
request that a meeting of shareholders be held for the purpose of considering
the removal of a Director from office, and if such a request is made, the
Fund will assist with shareholder communications in connection with the
meeting.
...............................................................................
REPORTS
The Fund furnishes shareholders with quarterly reports containing
information about the Fund and its operations, including a list of
investments held in the Fund's portfolio and financial statements. The annual
financial statements are audited by the Fund's independent accountants,
Coopers & Lybrand L.L.P.
...............................................................................
FUND COUNSEL
Morgan, Lewis & Bockius serves as counsel to the Fund.
25
<PAGE> 28
...............................................................................
SHAREHOLDER INQUIRIES
Shareholders with inquiries concerning their shares should contact Alex.
Brown at (800) 767-FLAG, the Transfer Agent at (800) 553-8080, or a
Participating Dealer or Shareholder Servicing Agent, as appropriate.
26
<PAGE> 29
LOGO
<PAGE> 30
FLAG INVESTORS TELEPHONE INCOME FUND, INC.
NEW ACCOUNT APPLICATION
- -----------------------------------------------------------------------------
Make check payable to "Flag Investors Telephone Income
Fund, Inc." and mail with this application to:
Flag Investors Funds
P.O. Box 419426
Kansas City, MO 64141-6426
Attn: Flag Investors Telephone Income Fund, Inc.
For assistance in completing this application please call: 1-800-553-8080
8:30 a.m. to 5:30 p.m., Eastern Time, Monday-Friday
To open an IRA account, call 1-800-767-3524 to request an IRA application
I wish to purchase the following class of shares of the Fund, in the amount
indicated below: Please check the applicable box and indicate amount
of purchase.
/ / Class A Shares (4.5% maximum initial charge)
in the amount of $____________________
/ / Class B Shares (4.0% maximum contingent deferred sales charge)
in the amount of $____________________
The minimum initial purchase is $2,000, except that the minimum initial purchase
for shareholders of any other Flag Investors Fund or class is $500 and the
minimum initial purchase for participants in the Fund's Automatic Investing Plan
is $250 per class. Each subsequent purchase requires a $100 minimum per class,
except that the minimum subsequent purchase under the Fund's Automatic Investing
Plan is $250 for quarterly purchases and $100 for monthly purchases. The maximum
investment in Class B Shares is $100,000 per account. The Fund reserves the
right not to accept checks for more than $50,000 that are not certified or bank
checks.
- -----------------------------------------------------------------------------
YOUR ACCOUNT REGISTRATION (PLEASE PRINT)
Existing Account No., if any: _____________________________________
INDIVIDUAL OR JOINT TENANT
- -----------------------------------------------------------------------------
First Name Initial Last Name
- -----------------------------------------------------------------------------
Social Security Number
- -----------------------------------------------------------------------------
Joint Tenant Initial Last Name
CORPORATIONS, TRUSTS, PARTNERSHIPS, ETC.
- -----------------------------------------------------------------
Name of Corporation, Trust or Partnership
- ------------------------------- ------------------------------
Tax ID Number Date of Trust
- -----------------------------------------------------------------
Name of Trustees (If to be included in the Registration)
- -----------------------------------------------------------------
For the Benefit of
GIFTS TO MINORS
- -----------------------------------------------------------------------------
Custodian's Name (only one allowed by law)
- -----------------------------------------------------------------------------
Minor's Name (only one)
- -----------------------------------------------------------------------------
Social Security Number of Minor
under the ____________________ Uniform Gifts to Minors Act
State of Residence
YOUR MAILING ADDRESS
- -----------------------------------------------------------------------------
Street
- -----------------------------------------------------------------------------
City State Zip
( )
- -----------------------------------------------------------------------------
Daytime Phone
______________________________________________________________________________
<PAGE> 31
LETTER OF INTENT (CLASS A SHARES ONLY) (OPTIONAL)
[ ] I agree to the Letter of Intent and Escrow Agreement set forth in the
accompanying prospectus. Although I am not obligated to do so, I intend to
invest over a 13-month period in Class A Shares, as shown below, in an
aggregate amount at least equal to:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Class A Shares: | | $50,000 | | $100,000 | | $250,000 | | $500,000 | | $1,000,000
</TABLE>
________________________________________________________________________________
RIGHT OF ACCUMULATION (OPTIONAL)
[ ] I already own shares of the Flag Investors Fund(s) set forth below (except
Class B shares) to be applied for a reduced sales charge. List the Account
numbers of other Flag Investors Funds that you or your immediate family (spouse
and children under 21) already own that qualify for reduced sales charges.
Fund Name Account No. Owner's Name Relationship
--------- ----------- ------------ ------------
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
<PAGE> 32
DISTRIBUTION OPTIONS
Please check appropriate boxes. If none of the options is elected, all
distributions will be reinvested in additional shares of the same class of
the Fund at no sales charge.
Income Dividends
[ ] Reinvested in additional shares
[ ] Paid in Cash
Capital Gains
[ ] Reinvested in additional shares
[ ] Paid in Cash
- -----------------------------------------------------------------------------
AUTOMATIC INVESTING PLAN (OPTIONAL)
[ ] I authorize you as Agent for the Automatic Investing Plan to
automatically invest $_______ in Class A Shares or $_______ in Class B Shares
for me, on a monthly or quarterly basis, on or about the 20th of each month
or if quarterly, the 20th of January, April, July and October, and to draw a
bank draft in payment of the investment against my checking account. (Bank
drafts may be drawn on commercial banks only.)
Minimum Initial Investment: $250 per class
Subsequent Investments (check one):
[ ] Monthly ($100 minimum per class)
[ ] Quarterly ($250 minimum per class)
- -----------------------------------------------------------------------------
Bank Name
- -----------------------------------------------------------------------------
Existing Flag Investors Fund Account No., if any
Please attach a voided check.
- -----------------------------------------------------------------------------
Depositor's Signature Date
- -----------------------------------------------------------------------------
Depositor's Signature Date
(if joint acct., both must sign)
- -----------------------------------------------------------------------------
SYSTEMATIC WITHDRAWAL PLAN (OPTIONAL)
[ ] Beginning the month of _______, 19__ please send me checks on a
monthly or quarterly basis, as indicated below, in the amount of (complete as
applicable) $______ from Class A Shares and/or $______ from Class B Shares
that I own, payable to the account registration address as shown above.
(Participation requires minimum account value of $10,000 per class.)
Frequency (check one):
[ ] Monthly
[ ] Quarterly (January, April, July and October)
______________________________________________________________________________
TELEPHONE TRANSACTIONS
I understand that I will automatically have telephone redemption privileges
(for amounts up to $50,000) and telephone exchange privileges (with respect
to other Flag Investors Funds) unless I mark one or both of the boxes below:
No, I/We do not want
[ ] Telephone redemption privileges
[ ] Telephone exchange privileges
Redemptions effected by telephone will be mailed to the address of record. If
you would prefer redemptions mailed to a pre-designated bank account, please
provide the following information:
Bank: ___________________________ Bank Account No: ___________________
Address: ___________________________ Bank Account Name: ___________________
________________________________________________________________________________
<PAGE> 33
SIGNATURE AND TAXPAYER CERTIFICATION
I have received a copy of the Fund's prospectus dated May 1, 1995. Unless the
box below is checked, I certify under penalties of perjury, (1) that the
number shown on this form is my correct taxpayer identification number and
(2) that I am not subject to backup withholding as a result of a failure to
report all interest or dividends, or the Internal Revenue Service has
notified me that I am no longer subject to backup withholding. [ ] Check here
if you are subject to backup withholding.
If a non-resident alien, please indicate country of residence:
- -----------------------------------------------------------------------------
I acknowledge that the telephone redemption and exchange privileges are
automatic and will be effected as described in the Fund's current prospectus
(see "Telephone Transactions"). I also acknowledge that I may bear the risk
of loss in the event of fraudulent use of such privileges. If I do not want
telephone redemption or exchange privileges, I have so indicated on this
Application.
- -----------------------------------------------------------------------------
Signature Date
- -----------------------------------------------------------------------------
Signature (if joint acct., both must sign) Date
- -----------------------------------------------------------------------------
For Dealer Use Only
Dealer's Name: ___________________ Dealer Code: _________________________
Dealer's Address: ___________________ Branch Code: _________________________
____________________
Representative: ____________________ Rep. No. _________________________
<PAGE> 34
STATEMENT OF ADDITIONAL INFORMATION
____________________________________________
FLAG INVESTORS TELEPHONE INCOME FUND, INC.
(Class A and Class B Shares)
135 E. Baltimore Street
Baltimore, Maryland 21202
____________________________________________
THIS STATEMENT OF ADDITIONAL INFORMATION IS
NOT A PROSPECTUS. IT SHOULD BE READ IN
CONJUNCTION WITH A PROSPECTUS, WHICH MAY BE
OBTAINED FROM ANY PARTICIPATING DEALER OR
SHAREHOLDER SERVICING AGENT OR BY WRITING
OR CALLING ALEX. BROWN & SONS INCORPORATED,
135 EAST BALTIMORE ST., BALTIMORE, MARYLAND
21202, (800) 767-FLAG.
Statement of Additional Information Dated: May 1, 1995
Relating to the Prospectus Dated: May 1, 1995
<PAGE> 35
TABLE OF CONTENTS
Page
----
1. General Information and History............................... 1
2. Investment Objectives and Policies............................ 2
3. Valuation of Shares and Redemption............................ 6
4. Federal Tax Treatment of Dividends and Distributions.......... 7
5. Management of the Fund........................................ 10
6. Investment Advisory and other Services........................ 14
7. Distribution of Fund Shares................................... 16
8. Brokerage..................................................... 19
9. Capital Stock................................................. 20
10. Quarterly Reports............................................. 21
11. Custodian, Transfer Agent, Accounting Services................ 21
12. Independent Accountants....................................... 22
13. Performance Information....................................... 22
14. Control Persons and Principal Holders of Securities........... 24
15. Financial Statements.......................................... 24
<PAGE> 36
1. GENERAL INFORMATION AND HISTORY
Flag Investors Telephone Income Fund, Inc. (the "Fund") is an
open-end management investment company that was originally designed to provide
both convenience and professional investment management to shareholders of
the former American Telephone and Telegraph Company ("AT&T") after AT&T's
divestiture and reorganization in January 1984.
Under the rules and regulations of the Securities and Exchange
Commission (the "SEC"), all mutual funds are required to furnish prospective
investors with certain information concerning the activities of the company
being considered for investment. The Fund currently offers two classes of
shares: Flag Investors Telephone Income Fund Class A Shares and Flag
Investors Telephone Income Fund Class B Shares. As used herein, the "Fund"
refers to Flag Investors Telephone Income Fund, Inc. and specific references
to either class of the Fund's shares will be made using the name of such
class. Important information concerning the Fund is included in the Fund's
Prospectus which may be obtained without charge from Alex. Brown & Sons
Incorporated ("Alex. Brown"), 135 East Baltimore Street, Baltimore, Maryland
21202 (telephone (800) 767-FLAG) or from Participating Dealers that offer
shares of the respective classes of the Fund ("Shares") to prospective
investors. Prospectuses may also be obtained from Shareholder Servicing
Agents. Some of the information required to be in this Statement of
Additional Information is also included in the Fund's current Prospectus. To
avoid unnecessary repetition, references are made to related sections of the
Prospectus. In addition, the Prospectus and this Statement of Additional
Information omit certain information about the Fund and its business that is
contained in the Registration Statement respecting the Fund and its Shares
filed with the SEC. Copies of the Registration Statement as filed, including
such omitted items, may be obtained from the SEC by paying the charges
prescribed under its rules and regulations.
The Fund was organized as a Maryland corporation on October 18,
1983. Shares of the Fund were sold by Alex. Brown and other broker-dealers
in an offering that commenced on December 7, 1983. On January 18, 1984, the
Fund effected a tax-free exchange of five of its Shares for each share of
AT&T common stock that had previously been transmitted to the Fund by
exchanging shareholders. The Fund collected the distributed shares of the
regional telephone companies created by AT&T's divestiture and undertook an
investment program consistent with the Fund's investment objectives. (See
Prospectus - "Investment Program"). On May 20, 1985, the Fund reorganized as
a Massachusetts business trust and on January 19, 1989, it reorganized as a
Maryland corporation pursuant to an Agreement and Plan of Reorganization and
Liquidation approved by shareholders on December 6, 1988. The Fund commenced
offering the Flag Investors Telephone Income Fund Class B Shares on January
3, 1995.
For the period from April 6, 1993 through November 18, 1994, the
Fund offered another class of shares: Flag Investors Telephone Income Fund
Class D Shares, which were known at the time as Flag Investors Telephone
Income Fund Class B Shares and were reclassified as Flag Investors Telephone
Income Fund Class D Shares on November 18, 1994. Shares of that class are
not currently being offered although shares remain outstanding.
Under a license agreement dated January 19, 1989 between the Fund
and Alex. Brown Incorporated, Alex. Brown Incorporated licenses to the Fund
the "Flag Investors" name and logo but retains rights to that name and logo,
including the right to permit other investment companies to use them.
1
<PAGE> 37
2. INVESTMENT OBJECTIVES AND POLICIES
The Fund has the investment objective of seeking high current
income and, secondarily, long-term capital growth without undue risk through
investment primarily in income-producing common stock, securities convertible
thereto and debt obligations of companies in the telephone industry. The
Fund's investment advisor, Investment Company Capital Corp. ("ICC") and sub-
advisor, Alex. Brown Investment Management ("ABIM"), collectively, (the
"Advisors") believe that investing in a portfolio of securities of companies
in the telephone industry affords an attractive opportunity for achieving
this investment objective. There can be no assurance, however, that the
Fund's investment objective will be achieved. The Fund was rated the
number-two equity income fund by Lipper Analytical Services, Inc. for the
ten-year period ended December 31, 1994. Morningstar Mutual Fund Advisory
Services assigned the Fund a four star rating as of December 31, 1994.
The Fund may also invest under certain circumstances, described in
the Prospectus, in income-producing securities (including debt obligations)
of issuers in other industries and may enter into repurchase agreements, may
loan portfolio securities, and may write covered call options. In general, the
Fund will invest in investment grade debt obligations that are rated at the
time of purchase, BBB or higher by Standard & Poor's Ratings Group ("S&P") or
Baa or higher by Moody's Investors Service, Inc. ("Moody's"). Up to 10% of the
Fund's assets may be invested in lower quality debt obligations (securities
rated BB or lower by S&P or Ba or lower by Moody's). (See "Below Investment
Grade Securities" below.) The ratings categories of S&P and Moody's
are described more fully in Appendix A.
Below Investment Grade Securities
The Fund may purchase debt obligations that carry ratings lower
than those assigned to investment grade bonds by Moody's or S&P,or that are
unrated if such bonds, in the Advisors' judgment, meet the quality criteria
established by the Board of Directors. These bonds are generally known as
"junk bonds." These securities may trade at substantial discounts from their
face values. Accordingly, if the Fund is successful in meeting its objectives,
investors may receive a total return consisting not only of income dividends
but, to a lesser extent, capital gain distributions. Appendix A to this
Statement of Additional Information sets forth a description of the S&P and
Moody's rating categories, which indicate the rating agency's opinion as to
the probability of timely payment of interest and principal. These ratings
range in descending order of quality from AAA to D (though the Fund will not
purchase securities rated, at the time of purchase, below C), in the case of
S&P, and from Aaa to C, in the case of Moody's. Generally, securities which
are rated lower than BBB by S&P or Baa by Moody's are described as below
investment grade. Securities rated lower than investment grade may be of a
predominantly speculative character and their future cannot be considered
well-assured. The issuer's ability to make timely payments of principal and
interest may be subject to material contingencies. Securities in the lowest
rating categories may be unable to make timely interest or principal payments
and may be in default and in arrears in interest and principal payments.
The following summarizes the Moody's and S&P definitions for
speculative grade debt obligations in which the Fund may invest. Bonds which
are rated Ba by Moody's are judged to have speculative elements; their future
cannot be considered well-assured; and protection of principal and interest is
moderate and not well safeguarded. Bonds rated B lack characteristics of a
desirable investment and the assurance of interest or principal payments may
be small. Caa rated bonds are of poor standing and may be in default or may
have elements of danger with respect to principal or interest. Bonds rated Ca
represent obligations which are speculative in a high degree and are often in
default or have other marked shortcomings. Bonds rated C are the lowest rated
class of bonds and can be regarded as having extremely poor prospects of ever
attainig any real investment standing. In the case of S&P, BB rated bonds have
less near-term vulnerability to default than B or CCC rated securities but
face major ongoing uncertainties which may lead to inadequate capacity to pay
interest or principal. B rated bonds have a greater vulnerability to default
than BB rated bonds and the ability to pay interest or principal will likely
be impaired by adverse business conditions. CCC rated bonds have a currently
identifiable vulnerability to default and, without favorable business
conditions, will be unable to repay interest and principal. C rated bonds are
income bonds on which no interest is being paid.
2
<PAGE> 38
Ratings of S&P and Moody's represent their opinions of the quality of
bonds and other debt securities they undertake to rate at the time of issuance.
However, these ratings are not absolute standards of quality and may not reflect
changes in an issuer's creditworthiness. Accordingly, the Advisors do not
rely exclusively on ratings issued by S&P or Moody's in selecting portfolio
securities but supplement such ratings with independent and ongoing review of
credit quality. In addition, the total return the Fund may earn from investments
in high yield securities will be significantly affected not only by credit
quality but by fluctuations in the markets in which such securities are traded.
Accordingly, selection and supervision by the Advisors of investments in
lower rated securities involves continuous analysis of individual issuers,
general business conditions, activities in the high yield bond market and
other factors. The analysis of issuers may include, among other things,
historic and current financial conditions, strength of management,
responsiveness to business conditions, credit standing and current and
anticipated results of operations. Analysis of general business conditions
and other factors may include anticipated changes in economic activity in
interest rates, the availability of new investment opportunities and the
economic outlook for specific industries.
Investing in higher yield, lower rated bonds entails substantially
greater risk than investing in investment grade bonds, including not only
credit risk, but potentially greater market volatility and lower liquidity.
Yields and market values of high yield bonds will fluctuate over time,
reflecting not only changing interest rates but the bond market's perception
of credit quality and the outlook for economic growth. When economic conditions
appear to be deteriorating, lower rated bonds may decline in value due to
heightened concern over credit quality, regardless of prevailing interest
rates. In adverse economic conditions, the liquidity of the secondary market
for junk bonds may be significantly reduced. In addition, adverse economic
developments could disrupt the high yield market, affecting both price and
liquidity, and could also affect the ability of issuers to repay principal
and interest, thereby leading to a default rate higher than has been the case
historically. Even under normal conditions, the market for junk bonds may be
less liquid than the market for investment grade corporate bonds. There are
fewer securities dealers in the high yield market and purchasers of high
yield bonds are concentrated among a smaller group of securities dealers and
institutional investors. In periods of reduced market liquidity, the market for
junk bonds may become more volatile and there may be significant disparities
in the prices quoted for high yield securities by various dealers. Under
conditions of increased volatility and reduced liquidity, it would become
more difficult for the Fund to value its portfolio securities accurately
because there might be less reliable, objective data available.
Finally, prices for high yield bonds may be affected by legislative
and regulatory developments. For example, from time to time, Congress has
considered legislation to restrict or eliminate the corporate tax deduction
for interest payments or to regulate corporate restructurings such as
takeovers, mergers or leveraged buyouts. Such legislation may significantly
depress the prices of outstanding high yield bonds.
Repurchase Agreements
The Fund may enter into repurchase agreements with domestic banks or
broker-dealers deemed to be creditworthy by ICC and ABIM, under guidelines
approved by the Board of Directors. A repurchase agreement is a short-term
investment in which the purchaser (i.e., the Fund) acquires ownership of a debt
security and the seller agrees to repurchase the obligation at a future time and
set price, usually not more than seven days from the date of purchase, thereby
determining the yield during the purchaser's holding period. The value of
underlying securities will be at least equal at all times to the total amount of
the repurchase obligation, including the interest factor. The Fund makes payment
for such securities only upon physical delivery or evidence of book entry
transfer to the account of a custodian, sub-custodian, or bank acting as agent.
The underlying securities, which in the case of the Fund are securities of the
U.S. Government only, may have maturity dates exceeding one year. The Fund does
not bear the risk of a decline in value of the underlying securities unless the
seller defaults under its repurchase obligation. In the event of a bankruptcy or
other default of a seller of a repurchase agreement, the Fund could experience
both delays in liquidating the underlying securities and loss including: (a)
possible decline in the value of the underlying security during the period in
which the Fund seeks to enforce its rights thereto, (b) possible subnormal
levels of income and lack of access to income during this period, and (c)
expenses of enforcing its rights.
3
<PAGE> 39
Lending of Portfolio Securities
The Fund may lend portfolio securities to Board-approved brokers or
dealers in corporate or government securities, banks or other recognized
institutional borrowers of securities, provided that the borrower maintains
cash or equivalent collateral or a letter of credit in the Fund's favor of
not less than 100% of the market value of the securities loaned by marking to
market daily. While the portfolio securities are on loan, the Fund receives
from the borrower an amount equal to any dividend or interest paid on such
securities. The Fund may invest the cash collateral to generate additional
income or it may by agreement with the borrower receive interest income from
the borrower. Either the Fund or the borrower may terminate the loan at any
time. The Fund may pay reasonable administrative and custodial fees in
connection with a loan and may agree to pay a portion of interest generated
on the Fund's investment of the cash or equivalent collateral to the borrower
or placing broker. The Fund has no current intention of lending more than 5%
of its portfolio securities.
Covered Call Options
In an attempt to earn additional income, and as a means of
protecting the Fund's assets against market declines, the Fund may, to a
limited extent, write covered call option contracts on certain of its
securities and purchase call options for the purpose of terminating its
outstanding obligations with respect to securities upon which call option
contracts have been written.
When the Fund writes a call option on securities which it owns, it
gives the purchaser of the option the right to buy the securities at the
price specified in the option (the "Exercise Price") at any time prior to the
expiration of the option. In the strategy to be employed by the Fund, the
Exercise Price, plus the option premium paid by the purchaser, is almost
always greater than the market price of the underlying security at the time
the option is written. If any option is exercised, the Fund will realize the
long-term or short-term gain or loss from the sale of the underlying security
and the proceeds of the sale will be increased by the net premium originally
received. By writing a covered option, the Fund may forego, in exchange for
the net premium, the opportunity to profit from an increase in value of the
underlying security above the Exercise Price. Thus, options will be written
when ICC and ABIM believe the security should be held for the long term but
expects no appreciation or only moderate appreciation within the option
period. The Fund also may write covered options on securities that have a
current value above the original purchase price but which, if then sold,
would not normally qualify for a long-term capital gains treatment. Such
activities will normally take place during periods when market volatility is
expected to be high.
Only call options which are traded on a national securities
exchange will be written. Call options are issued by the Options Clearing
Corporation, which also serves as the clearing house for transactions with
respect to options. The price of a call option is paid to the writer without
refund on expiration or exercise, and no portion of the price is retained by
The Options Clearing Corporation or the exchanges listed above. Writers and
purchasers of options pay the transaction costs, which may include
commissions charged or incurred in connection with such option transactions.
The Fund may write options contracts on its securities up to an
amount not in excess of 20% of the value of its net assets at the time such
options are written. The Fund will not sell the securities against which
options have been written (uncover the options) until after the option period
has expired, the option has been exercised or a closing purchase has been
executed.
Call options may be purchased by the Fund, but only to terminate an
obligation as a writer of a call option. This is accomplished by making a
closing purchase transaction, that is, the purchase of a call option on the
same security with the same Exercise Price and expiration date as specified
in the call option which had been written previously. A closing purchase
transaction with respect to calls traded on a national securities exchange
has the effect of extinguishing the obligation of a writer. Although the
cost to the Fund of such a transaction may be greater than the net premium
received by the Fund upon writing the original option, the Directors believe
that it is appropriate for the Fund to have the ability to make closing
purchase transactions in order to prevent its portfolio securities from being
purchased pursuant to the exercise of a call. ICC and ABIM may also permit
the call option to be exercised. A profit or loss from a closing purchase
transaction will be realized depending on whether the amount paid to purchase
a call to close a position is less or more than the amount received from
writing the call. A profit or loss from an option exercised will be realized
depending upon whether the cost of the stock sold through the exercise, minus
the premium received on the option, is less or more than the proceeds of the
exercise.
4
<PAGE> 40
Investment Restrictions
The Fund's investment program is subject to a number of investment
restrictions which reflect self-imposed standards as well as federal and
state regulatory limitations. The investment restrictions recited below are
in addition to those described in the Fund's Prospectus, and are matters of
fundamental policy and may not be changed without the affirmative vote of a
majority of the outstanding Shares. The percentage limitations contained in
these restrictions apply at the time of purchase of securities. Accordingly,
the Fund will not:
1. Invest in real estate or mortgages on real estate;
2. Purchase or sell commodities or commodities contracts;
3. Borrow in order to increase income; however, the Fund may
borrow on a temporary basis amounts up to 10% of its assets to facilitate
redemption requests which might otherwise require untimely disposition of
portfolio securities. The Fund will not purchase additional securities when
borrowings exceed 5% of its total assets;
4. Act as an underwriter of securities within the meaning of the
U.S. federal securities laws except insofar as it might be deemed to be an
underwriter upon disposition of certain portfolio securities acquired within
the limitation on purchases of restricted securities;
5. Issue senior securities;
6. Make loans, except that the Fund may purchase or hold debt
instruments in accordance with its investment objectives and policies, and
may loan portfolio securities and enter into repurchase agreements as
described in this Registration Statement;
7. Effect short sales of securities;
8. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of transactions);
9. Purchase participations or other interests in oil, gas or
other mineral exploration or development programs; or
10. Invest more than 10% of the value of its net assets in
illiquid securities (as defined under federal and state securities laws),
including repurchase agreements with remaining maturities in excess of seven
days.
The following are investment restrictions that may be changed by a
vote of the majority of the Board of Directors. The Fund will not:
1. Purchase any securities of unseasoned issuers which have been
in operation directly or through predecessors for less than three years;
5
<PAGE> 41
2. Invest in shares of any other investment company registered
under the Investment Company Act of 1940, other than in connection with a
merger, consolidation, reorganization or acquisition of assets;
3. Purchase or retain the securities of any issuer if to the
knowledge of the Fund any officer or Director of the Fund or its investment
advisor owns beneficially more than .5% of the outstanding securities of such
issuer and together they own beneficially more than 5% of the securities of
such issuer;
4. Invest in companies for the purpose of exercising management
or control;
5. Invest in puts or calls or any combination thereof, except
that the Fund may write covered call options and may enter into related
closing transactions in accordance with its investment objectives and
policies; or
6. Invest in warrants if as a result more than 2% of the value of
the Fund's net assets would be invested in warrants which are not listed on a
recognized stock exchange, or more than 5% of the Fund's net assets would be
invested in warrants regardless of whether listed on such exchange.
7. Invest in real estate limited partnerships or oil, gas or
mineral leases.
3. VALUATION OF SHARES AND REDEMPTION
Valuation of Shares
The net asset value per Share is determined once daily as of 4:00
p.m. (Eastern Time) each day on which the New York Stock Exchange is open for
business ("Business Day"). The New York Stock Exchange is open for business
on all weekdays except for the following holidays: New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
For the purpose of determining the price at which Shares are
redeemed, the net asset value per Share is calculated by valuing all
securities held by the Fund, deducting the Fund's actual and accrued
liabilities (including liability for dividends declared), and dividing the
resulting amount by the number of outstanding Shares. To determine the net
asset value per Share of either class, the net asset value calculated as
described above will be further adjusted to reflect the pro rata portion of
income and expenses attributable to that class. For this purpose, portfolio
securities will be given their market value where feasible. If a portfolio
security is traded on a national securities exchange or on an automated
dealer quotation system, such as NASDAQ, on the valuation date, the last
quoted sale price will generally be used. Options are valued at the last
reported sale price, or if no sales are reported at the average of the last
reported bid and asked prices. Securities or other assets for which market
quotations are not readily available are valued by appraisal at their fair
value so determined in good faith by ICC and ABIM under procedures
established and monitored by the Board of Directors. Short-term obligations
with maturities of 60 days or less will be valued at amortized cost, which
constitutes fair value as determined by the Directors.
6
<PAGE> 42
Redemption
The Fund may suspend the right of redemption or postpone the date
of payment during any period when (a) trading on the New York Stock Exchange
is restricted by applicable rules and regulations of the SEC; (b) the New
York Stock Exchange is closed for other than customary weekend and holiday
closings; (c) the SEC has by order permitted such suspension; or (d) an
emergency exists as determined by the SEC so that valuation of the net assets
of the Fund is not reasonably practicable.
Under normal circumstances, the Fund will redeem Shares by check as
described in the Prospectus. However, if the Board of Directors determines
that it would be in the best interests of the remaining shareholders of the
Fund to make payment of the redemption price in whole or in part by a
distribution in kind of readily marketable securities from the portfolio of
the Fund in lieu of cash, in conformity with applicable rules of the SEC, the
Fund will make such distributions in kind. If Shares are redeemed in kind,
the redeeming shareholder will incur brokerage costs in later converting the
assets into cash. The method of valuing portfolio securities is described
under "Valuation of Shares," and such valuation will be made as of the same
time the redemption price is determined. The Fund, however, has elected to
be governed by Rule 18f-1 under the Investment Company Act of 1940, as
amended (the "1940 Act") pursuant to which the Fund is obligated to redeem
Shares solely in cash up to the lesser of $250,000 or 1% of the net asset
value of the Fund during any 90-day period for any one shareholder.
4. FEDERAL TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS
The following discussion of federal income tax consequences is
based on the Internal Revenue Code of 1986, as amended (the "Code") and the
regulations issued thereunder as in effect on the date of this Statement of
Additional Information. New legislation, as well as administrative changes
or court decisions, may significantly change the conclusions expressed
herein, and may have a retroactive effect with respect to the transactions
contemplated herein.
The following is only a summary of certain additional tax
considerations generally affecting the Fund and its shareholders that are not
described in the Fund's Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the Fund or its shareholders, and the
discussion here and in the Fund's Prospectus is not intended as a substitute
for careful tax planning.
Qualification as a Regulated Investment Company
The Fund has elected to be, and has been, taxed as a regulated
investment company ("RIC") under Subchapter M of the Code. However, in order
to qualify as a RIC for any taxable year, the Fund must generally derive at
least 90% of its gross income from dividends, interest, certain payments with
respect to securities loans, and gains from the sale or other disposition of
stock, securities, or foreign currencies and other income (including, but not
limited to gains from options, futures or forward contracts) derived with
respect to its business of investing in stocks, securities or currencies (the
"Income Requirement"). In addition, the Fund generally must derive less than
30% of its gross income from gains on the sale or other disposition of
certain investments held for less than three months, including stock or
securities (as defined in Section 2(a)(36) of the 1940 Act); foreign
currencies (or options, futures, or forward contracts on foreign currencies)
that are not directly related to the Fund's principal business of investing
in stock or securities (or options and futures with respect to stocks or
7
<PAGE> 43
securities); and options, futures or forward contracts (other than options,
futures,or forward contracts on foreign currencies) (the "Short-Short Gain
Test").
To the extent that the Fund is able and chooses to identify and
designate offsetting positions (e.g., options that the Fund has written and
the securities covered by such options) as "hedges," increases and decreases
in the value of such positions will be netted for the purposes of determining
whether the Short-Short Gain Test has been satisfied. The Short-Short Gain
Test will not prevent the Fund from disposing of investments at a loss, since
the recognition of a loss before the expiration of the three-month holding
period is disregarded.
In addition, at the close of each quarter of the Fund's taxable
year, at least 50% of the value of its total assets must consist of cash and
cash items, U.S. government securities, securities of other RICs, and
securities of other issuers (as to which the Fund has not invested more than
5% of the value of its total assets in securities of any such issuer and as
to which the Fund does not hold more than 10% of the outstanding voting
securities of any such issuer), and no more than 25% of the value of its
total assets may be invested in the securities of any one issuer (other than
U.S. government securities and securities of other RICs), or in two or more
issuers which the Fund controls and which are engaged in the same, similar or
related trades or businesses (the "Asset Diversification Test"). The Fund
will not lose its status as a RIC if it fails to meet the Asset
Diversification Test solely as a result of a fluctuation in value of
portfolio assets not attributable to a purchase. The Fund may curtail its
investments in certain securities where the application thereto of the Asset
Diversification Test is uncertain.
Under Subchapter M, the Fund is exempt from federal income tax on
its net investment income and capital gains which it distributes to
shareholders, provided that it distributes at least 90% of its investment
company taxable income (net investment income and the excess of net short
term capital gains over net long term capital losses) for the year (the
"Distribution Requirement") and complies with the other requirements of the
Code described above. The Distribution Requirement for any year may be
waived if a RIC establishes to the satisfaction of the Internal Revenue
Service that it is unable to satisfy the Distribution Requirement by reason
of distributions previously made for the purpose of avoiding liability for
federal excise tax.
Although the Fund intends to distribute substantially all of its
net investment income and capital gains for any taxable year, the Fund will
be subject to federal income taxation to the extent any such income or gains
are not distributed.
If for any taxable year, the Fund does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at
regular corporate income tax rates without any deduction for distributions to
shareholders, and all such distributions generally will be taxable to
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be
eligible for the 70% dividends received deduction for corporate shareholders.
Fund Distributions
Distributions of investment company taxable income will be taxable
to shareholders as ordinary income, regardless of whether such distributions
are paid in cash or are reinvested in additional Shares. The Fund
anticipates that it will distribute substantially all of its investment
company taxable income for each taxable year.
8
<PAGE> 44
The Fund may either retain or distribute to shareholders its excess
of net long-term capital gains over net short-term capital losses ("net
capital gain") for each taxable year. However, the Fund expects to
distribute substantially all of its net capital gains each year. If such
gains are distributed as a capital gains distribution, they are taxable to
shareholders as long-term capital gains, regardless of the length of time the
shareholder has held the Shares, whether or not such gains were recognized by
the Fund prior to the date on which a shareholder acquired Fund Shares and
whether or not the distribution was paid in cash or reinvested in Shares.
Conversely, if the Fund elects to retain its net capital gains, it will be
taxed thereon (except to the extent of any available capital loss carryovers)
at the applicable corporate capital gains tax rate. In this event, it is
expected that the Fund also will elect to have shareholders treated as having
received a distribution of such gains, with the result that shareholders will
be required to report such gains on their returns as long-term capital gains,
will receive a tax credit for their allocable share of capital gains tax paid
by the Fund on the gains, and will increase the tax basis for their Shares by
an amount equal to 65% of such gains.
Generally, gain or loss on the sale or exchange of a Share will be
a capital gain or loss which will be long-term if the Share has been held for
more than one year and otherwise will be short-term. However, a shareholder
who realizes a loss on the sale, exchange or redemption of a Share held for
six months or less and has previously received a capital gains distribution
with respect to the Share (or has included in income any undistributed net
capital gains of the Fund with respect to such Share) must treat the loss as
a long-term capital loss to the extent of the amount of the prior capital
gains distribution (or any undistributed net capital gains of the Fund with
respect to such Share which have been included in the shareholder's income).
In addition, any loss realized on a sale or other disposition of Shares will
be disallowed to the extent an investor repurchases (or enters into a
contract or option to repurchase) Shares within a period of 61 days
(beginning 30 days before and ending 30 days after the disposition of the
Shares). Investors should particularly note that this loss disallowance rule
will apply to Shares received through the reinvestment of dividends during
the 61-day period.
Investors should be careful to consider the tax implications of
purchasing Shares just prior to the ex-dividend date of any ordinary income
dividend or capital gains distribution. Those purchasing just prior to an
ordinary income dividend or capital gains distribution will be taxable on the
entire amount of the dividend or distribution received, even though the net
asset value per Share on the date of such purchase may have reflected the
amount of such forthcoming dividend or distribution.
In the case of corporate shareholders, Fund distributions (other
than capital gains distributions) generally qualify for the 70% dividends
received deduction to the extent of the gross amount of certain qualifying
dividends received by the Fund for the year. Generally, a dividend will be
treated as a qualifying dividend if it has been received from a domestic
corporation. For purposes of the alternative minimum tax and the
environmental tax, corporate shareholders generally will be required to take
the full amount of any dividend received from the Fund into account in
determining their adjusted current earnings for purposes of computing
"alternative minimum taxable income."
The Fund will be required in certain cases to withhold and remit to
the United States Treasury 31% of distributions payable to any shareholder
who (1) has provided either an incorrect taxpayer identification number or no
number at all, (2) is subject to backup withholding by the Service for
failure to properly report the receipt of interest or dividend income, or (3)
who has failed to certify to the Fund that such shareholder is not subject to
backup withholding.
9
<PAGE> 45
The Fund will provide a statement annually to shareholders as to
the federal income tax status of distributions paid (or deemed to be paid) by
the Fund during the year.
Federal Excise Tax; Miscellaneous Considerations
The Code imposes a nondeductible 4% federal excise tax on RICs that
do not distribute in each calendar year an amount equal to 98% of their
ordinary income for the calendar year plus 98% of their capital gain net
income (the excess of long and short-term capital gain over long and short-
term capital loss) for the one-year period ending on October 31 of such
calendar year. The excise tax is imposed on the undistributed part of this
required distribution. In addition, the balance of such income must be
distributed during the next calendar year to avoid liability for the excise
tax in that year. For the foregoing purposes, an investment company is
treated as having distributed any amount on which it is subject to income tax
for any taxable year ending in such calendar year.
The Fund intends to make sufficient distributions of its ordinary
income and capital gain net income prior to the end of each calendar year to
avoid liability for excise tax. However, investors should note that in
certain circumstances the Fund may be required to liquidate portfolio
investments in order to make sufficient distributions to avoid excise tax
liability, and in addition, that the liquidation of investments in such
circumstances may affect the ability of the Fund to satisfy the Short-Short
Gain Test.
Rules of state and local taxation of dividend and capital gains
distributions from regulated investment companies often differ from the rules
for federal income taxation described above. Shareholders are urged to
consult their tax advisers as to the consequences of these and other state
and local tax rules affecting investment in the Fund.
5. MANAGEMENT OF THE FUND
Directors and Officers
The Directors and executive officers of the Fund and their
principal occupations during the last five years are set forth below. Unless
otherwise indicated, the address of each Director and executive officer is
135 East Baltimore Street, Baltimore, Maryland 21202.
*W. JAMES PRICE, Chairman and Director
6885 North Ocean Boulevard, Apartment #306, Ocean Ridge, Florida 33435-
3343. Director, Boca Research, Inc. (computer peripherals); Formerly,
Managing Director, Alex. Brown & Sons Incorporated; Director, CSX
Corporation (transportation and natural resources company), and PHH
Corporation (business services).
*ROBERT S. KILLEBREW, JR., Director
Managing Director, Alex. Brown & Sons Incorporated, 1974 - Present;
Senior Portfolio Manager, Brown Asset Management; Certified Financial
Analyst.
*TRUMAN T. SEMANS, Director
Managing Director, Alex. Brown & Sons Incorporated; Formerly, Vice
Chairman, Alex. Brown Incorporated.
10
<PAGE> 46
JAMES J. CUNNANE, Director
CBC Capital, 264 Carlyle Lake Drive, St. Louis, Missouri 63141.
Managing Director, CBC Capital (merchant banking), 1993-Present;
Formerly, Senior Vice President and Chief Financial Officer, General
Dynamics Corporation (defense), 1989-1993 and Director, The Arch Fund
(mutual fund).
N. BRUCE HANNAY, Director
201 Condon Lane, Port Ludlow, Washington 98365. Director, Plenum
Publishing Corp.; Formerly, Director, Rohm & Haas Company (diversified
chemicals) and General Signal Corp. (control equipment & systems) and
Consultant, SRI International (nonprofit consulting organization).
JOHN F. KROEGER, Director
P.O. Box 464, 24875 Swan Road-Martingham, St. Michaels, Maryland 21663.
Director/Trustee, AIM Funds; Formerly, Consultant, Wendell & Stockel
Associates, Inc. (consulting firm) and General Manager, Shell Oil
Company.
LOUIS E. LEVY, Director
26 Farmstead Road, Short Hills, New Jersey 07078. Director, Kimberly-
Clark Corporation (personal consumer products) and Household
International (banking and finance); Chairman of the Quality Control
Inquiry Committee, American Institute of Certified Public Accountants;
Formerly, Trustee, Merrill Lynch Funds for Institutions, 1991-1993;
Adjunct Professor, Columbia University-Graduate School of Business,
1991-1992; Partner, KPMG Peat Marwick, retired 1990.
EUGENE J. MCDONALD, Director
Duke Management Company, Erwin Square, Suite 1000, 2200 West Main
Street, Durham, North Carolina 27705. President, Duke Management
Company (investments); Executive Vice President, Duke University
(education, research and health care).
HARRY WOOLF, Director
Institute for Advanced Study, South Olden Lane, Princeton, New Jersey
08540. Professor-at-Large Emeritus, Institute for Advanced Study;
Director, Merrill Lynch Cluster C Funds (registered investment
companies), ATL and Spacelabs Medical Corp. (medical equipment) and
Family Health International (nonprofit research and education); Trustee,
Reed College (education); Formerly, Trustee, Rockefeller Foundation.
BRUCE E. BEHRENS, President
Vice President and Portfolio Manager, Alex. Brown Investment Management
(registered investment advisor); Vice President and Treasurer, Buppert,
Behrens & Owen, Inc.
J. DORSEY BROWN, III, Executive Vice President
Managing Director, Alex. Brown & Sons Incorporated; Chief Executive
Officer and Formerly, General Partner, Alex. Brown Investment
Management.
RICHARD T. HALE, Vice President
Managing Director, Alex. Brown & Sons Incorporated; Chartered Financial
Analyst.
11
<PAGE> 47
HOBART C. BUPPERT, Vice President
Vice President and Portfolio Manager, Alex. Brown Investment Management
(registered investment advisor) 1984 - Present; President, Buppert,
Behrens & Owen, Inc., 1987 - Present.
LEE S. OWEN, Vice President
Portfolio Manager, Alex. Brown Investment Management (registered
investment advisor); Vice President and Secretary, Buppert, Behrens &
Owen, Inc.
EDWARD J. VEILLEUX, Vice President
Principal, Alex. Brown & Sons Incorporated; President, Investment
Company Capital Corp. (registered investment advisor); Vice President,
Armata Financial Corp. (registered broker-dealer).
GARY V. FEARNOW, Vice President
Managing Director, Alex. Brown & Sons Incorporated; Manager, Special
Products Department, Alex. Brown & Sons Incorporated.
BRIAN C. NELSON, Vice President and Secretary
Vice President, Alex. Brown & Sons Incorporated, Investment Company
Capital Corp. (registered investment advisor) and Armata Financial Corp.
(registered broker-dealer).
DIANA M. ELLIS, Treasurer
Manager, Portfolio Accounting Department, Investment Company Capital
Corp. (registered investment advisor); Mutual Fund Accounting
Department, Alex. Brown & Sons Incorporated, 1991 - Present; Formerly,
Accounting Manager, Downtown Press Inc. (printer), 1987-1991.
LAURIE D. DePRINE, Assistant Secretary
Asset Management Department, Alex. Brown & Sons Incorporated, 1991
- Present; Prior thereto, Student, 1989-1991.
___________________
* A Director who is an "interested person," as defined in the 1940 Act.
Directors and officers of the Fund are also directors and officers
of some or all of the other investment companies managed, administered,
advised or distributed by Alex. Brown or its affiliates. There are currently
13 funds in the Flag Investors/ISI Funds and Alex. Brown Cash Reserve Fund,
Inc. fund complex (the "Fund Complex"). Mr. Price serves as a Director of
eight funds in the Fund Complex and Mr. Semans serves as a Director of seven
funds in the Fund Complex. Mr. Killebrew serves as Director of one fund and
President and Director of another fund in the Fund Complex. Messrs. Cunnane,
Hannay, Kroeger, Levy, McDonald and Woolf serve as Directors of each fund in
the Fund Complex. Mr. Hale serves as President and Director of one fund,
Vice President of one fund and as a Director of 11 other funds in the Fund
Complex. Mr. Behrens serves as President of one fund and Vice President of
two funds in the Fund Complex. Mr. Brown serves as President of one fund and
Vice President of two funds in the Fund Complex. Mr. Buppert serves as Vice
President of three funds in the Fund Complex and Mr. Owen serves as President
of one fund and Vice President of two funds in the Fund Complex. Mr. Fearnow
serves as Vice President of 11 funds in the Fund Complex. Mr. Veilleux
serves as Executive Vice President of one fund and as Vice President of 12
12
<PAGE> 48
funds in the Fund Complex. Mr. Nelson, Ms. Ellis, and Ms. DePrine serve as
Vice President and Secretary, Treasurer and Assistant Secretary,
respectively, of each of the funds in the Fund Complex.
Some of the Directors of the Fund are customers of, and have had
normal brokerage transactions with, Alex. Brown in the ordinary course of
business. All such transactions were made on substantially the same terms as
those prevailing at the time for comparable transactions with unrelated
persons. Additional transactions may be expected to take place in the
future.
Officers of the Fund receive no direct remuneration in such
capacity from the Fund. Officers and Directors of the Fund who are officers
or directors of Alex. Brown or Alex. Brown Incorporated may be considered to
have received remuneration indirectly. As compensation for his services as
director, each Director who is not an "interested person" of the Fund (as
defined in the 1940 Act) (a "Non-Interested Director") receives an aggregate
annual fee (plus reimbursement for reasonable out-of-pocket expenses incurred
in connection with his attendance at board and committee meetings) from all
Flag Investors/ISI Funds and Alex. Brown Cash Reserve Fund, Inc., for which
he serves. Payment of such fees and expenses is allocated among all such
funds described above in direct proportion to their relative net assets. For
the fiscal year ended December 31, 1994, Non-Interested Directors' fees
attributable to the assets of the Fund totalled $26,689.
COMPENSATION TABLE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Name of Person, Position Aggregate Compensation From the Fund Total Compensation From the Fund
in the Fiscal Year Ended December 31, and Fund Complex Paid to Directors
1994 in the Fiscal Year Ended December
31, 1994
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
*W. James Price, Chairman $0 $0
*Robert S. Killebrew, Jr., Director and President $0 $0
*Truman T. Semans, Director $0 $0
**James J. Cunnane, Director $0** $0**
N. Bruce Hannay, Director $5,037(1) $39,000 for service on 11
Boards(2) in the Fund Complex
John F. Kroeger, Director $5,541 $42,900 for service on 11
Boards(2) in the Fund Complex
***Louis E. Levy, Director $1,307*** $9,750 for service on 11
Boards(2) in the Fund Complex
Eugene J. McDonald, Director $5,037(1) $39,000 for service on 11
Boards(2) in the Fund Complex
Harry Woolf, Director $5,037(1) $39,000 for service on 11
Boards(2) in the Fund Complex
</TABLE>
- ------------
* A Director who is an "interested person" as defined in the Investment
Company Act.
** Elected to the Board on December 14, 1994.
*** Elected to the Board on June 17, 1994.
(1) $1,216 of this amount has been deferred pursuant to a deferred
compensation plan.
(2) Two additional funds in the Fund Complex commenced operations after
December 31, 1994.
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<PAGE> 49
The Fund Complex has adopted a Retirement Plan (the "Retirement
Plan") for Directors who are not employees of the Fund, the Fund's Advisor or
their respective affiliates (the "Participants"). After completion of five
years of service, each Participant will be entitled to receive an annual
retirement benefit equal to a percentage of the fee earned by him in his last
year of service. Upon retirement, each Participant will receive annually 10%
of such fee for each year that he served after completion of the first five
years, up to a maximum annual benefit of 50% of the fee earned by him in his
last year of service. The fee will be paid quarterly, for life, by each Fund
for which he serves. The Retirement Plan is unfunded and unvested. Messrs.
Hannay, Kroeger and Woolf have qualified but have not received benefits, and
no such benefits are being accrued for them since they have not yet retired.
The Fund has one Participant, a Director who retired effective December 31,
1994, who has qualified for the Retirement Plan and who will be paid a
quarterly fee of $4,875 by the Fund Complex for the rest of his life. Such
fee is allocated to each fund in the Fund Complex based upon the relative net
assets of such fund to the Fund Complex.
Beginning in December, 1994, any Director who receives fees from the
Fund is permitted to defer a minimum of 50%, or up to all, of his annual
compensation pursuant to a Deferred Compensation Plan.
Code of Ethics
The Board of Directors of the Fund has adopted a Code of Ethics
pursuant to Rule 17j-1 under the Investment Company Act. The Code of Ethics
significantly restricts the personal investing activities of all employees of
ICC and the directors and officers of Alex. Brown. As described below, the
Code of Ethics imposes additional, more onerous, restrictions on the Fund's
investment personnel, including the portfolio managers and employees who
execute or help execute a portfolio manager's decisions or who obtain
contemporaneous information regarding the purchase or sale of a security by
the Fund.
The Code of Ethics requires that all employees of ICC, any director
or officer of Alex. Brown, and all Non-Interested Directors, preclear any
personal securities investments (with limited exceptions, such as non-
volitional purchases or purchases which are part of an automatic dividend
reinvestment plan). The preclearance requirement and associated procedures
are designed to identify any substantive prohibition or limitation applicable
to the proposed investment. The substantive restrictions applicable to
investment personnel include a ban on acquiring any securities in an initial
public offering, a prohibition from profiting on short-term trading in
securities and preclearance of the acquisition of securities in private
placements. Furthermore, the Code of Ethics provides for trading "blackout
periods" that prohibit trading by investment personnel and certain other
employees within periods of trading by the Fund in the same security.
6. INVESTMENT ADVISORY AND OTHER SERVICES
On December 6, 1988, the shareholders of the Fund approved an
Investment Advisory Agreement between the Fund and ICC and a Sub-Advisory
Agreement among the Fund, ICC and ABIM, both of which contracts are described
in greater detail below. ICC, the investment advisor, is a wholly owned
subsidiary of Alex Brown, the Fund's distributor. ICC is also the investment
advisor to Flag Investors Value Builder Fund, Inc. and Flag Investors Equity
Partners Fund, Inc. (for which funds ABIM serves as the sub-advisor), Alex.
Brown Cash Reserve Fund, Inc., Flag Investors International Fund, Inc., Flag
Investors Emerging Growth Fund, Inc., Flag Investors Quality Growth Fund,
Inc., Flag Investors Intermediate-Term Income Fund, Inc., Flag Investors
Maryland Intermediate Tax Free Income Fund, Inc. and Flag Investors Real
Estate Securities Fund, Inc., which are also distributed by Alex. Brown.
Prior to January 19, 1989, ABIM served as the Fund's investment advisor
14
<PAGE> 50
pursuant to investment advisory agreements dated May 16, 1985 and September
17, 1987. Buppert, Behrens & Owen, Inc., a company organized and owned by
three employees of ABIM, owns a 49% limited partnership interest and a 1%
general partnership interest in ABIM. Alex. Brown holds a 1% general
partnership interest in ABIM and Alex. Brown Incorporated owns the remaining
49% limited partnership interest. ABIM is a registered investment advisor
and has under management as of December 31, 1994 approximately $3.0 billion,
including the assets of the Fund and the assets of ABIM's other clients.
Under the Investment Advisory Agreement, ICC obtains and evaluates
economic, statistical and financial information to formulate and implement
investment policies for the Fund. ICC has delegated this responsibility to
ABIM. Any investment program undertaken by ICC or ABIM will at all times be
subject to policies and control of the Fund's Board of Directors. ICC will
provide the Fund with office space for managing its affairs, with the
services of required executive personnel and with certain clerical and
bookkeeping services and facilities. These services are provided by ICC
without reimbursement by the Fund for any costs. Neither ICC nor ABIM shall
be liable to the Fund or its shareholders for any act or omission by ICC or
ABIM or any losses sustained by the Fund or its shareholders except in the
case of willful misfeasance, bad faith, gross negligence, or reckless
disregard of duty. The services of ICC and ABIM to the Fund are not
exclusive and ICC and ABIM are free to render similar services to others.
As compensation for its services, ICC is entitled to receive a fee
from the Fund, calculated daily and paid monthly, at the annual rate of .65%
of the first $100 million of the Fund's average daily net assets, .55% of the
Fund's average daily net assets exceeding $100 million but not exceeding $200
million, .50% of the Fund's average daily net assets exceeding $200 million
but not exceeding $300 million, and .45% of the Fund's average daily net
assets exceeding $300 million. As compensation for its services, ABIM is
entitled to receive a fee from ICC, payable from its advisory fee, calculated
daily and paid monthly, at the annual rate of .40% of the first $100 million
of the Fund's average daily net assets, .35% of the Fund's average daily net
assets exceeding $100 million but not exceeding $200 million, .30% of the
Fund's average daily net assets exceeding $200 million but not exceeding $300
million, and .25% of the Fund's average daily net assets over $300 million.
ICC has agreed to reduce its aggregate fees on a monthly basis for
any fiscal year to the extent required so that the amount of the ordinary
expenses of the Fund (excluding brokerage commissions, interest, taxes and
extraordinary expenses such as legal claims, liabilities, litigation costs
and indemnification related thereto) paid or incurred by the Fund for such
fiscal year does not exceed the expense limitations applicable to the Fund
imposed by the securities laws or regulations of the states in which the
Fund's Shares are registered or qualified for sale as such limitations may be
raised or lowered from time to time. Currently, the most restrictive of such
expense limitations requires ICC to reduce its fees to the extent required so
that ordinary expenses of the Fund (excluding brokerage commissions,
interest, taxes, and extraordinary expenses such as legal claims,
liabilities, litigation costs and indemnification related thereto) do not
exceed 2.5% of the first $30 million of the Fund's average daily net assets,
2.0% of the next $70 million of the Fund's average daily net assets and 1.5%
of the Fund's average daily net assets in excess of $100 million. In
addition, if required to do so by any applicable state securities laws or
regulations, ICC will reimburse the Fund to the extent required to prevent
the expense limitations of any state law or regulation from being exceeded.
ABIM has agreed to reduce its aggregate fees for any fiscal year in an amount
proportionate to the amount by which ICC's fees may be reduced as described
above.
Each of the Investment Advisory Agreement and the Sub-Advisory
Agreement has an initial term of two years and will continue in effect from
year to year thereafter if such continuance is specifically approved at least
annually by the Fund's Board of Directors, including a majority of the Non-
Interested Directors who have no direct or indirect financial interest in
such agreements, by votes cast in person at a meeting called for such
15
<PAGE> 51
purpose, and by a vote of a majority of the outstanding Shares. The
Investment Advisory Agreement and the Sub-Advisory Agreement were most
recently approved by the Board of Directors in the foregoing manner on
September 22, 1994. The Fund or ICC may terminate the Investment Advisory
Agreement on sixty days' written notice without penalty. The Investment
Advisory Agreement will terminate automatically in the event of assignment.
The Sub-Advisory Agreement has similar termination provisions. For the
fiscal years ended December 31, 1994, December 31, 1993 and December 31,
1992, the Fund paid ICC fees (net of fee waivers) of $2,244,515, $1,892,883
and $1,148,254, respectively, and ICC paid ABIM from the fees it received,
fees in the amount of $1,533,375, $1,289,934 and $927,674, respectively.
Absent such fee waivers, the Class A Shares' Total Operating Expenses would
have been .99%, .98% and 1.07%, respectively, of its average net assets.
Absent such fee waivers, for the year ended December 31, 1994 and for the
period from April 6, 1993 through December 31, 1993, the Class D Shares'
Total Operating Expenses would have been 1.34% and 1.31%, respectively, of
its average net assets.
ICC also serves as the Fund's transfer and dividend disbursing agent
and provides accounting services to the Fund. See "Custodian, Transfer
Agent, Accounting Services."
7. DISTRIBUTION OF FUND SHARES
The Distribution Agreements provide that Alex. Brown has the
exclusive right to distribute the related class of Flag Investors Telephone
Income Fund Shares either directly or through other broker-dealers and
further provide that Alex. Brown will: (a) solicit and receive orders for the
purchase of Shares, (b) accept or reject such orders on behalf of the Fund in
accordance with the Fund's currently effective prospectus and transmit such
orders as are accepted to the Fund's transfer agent as promptly as possible,
(c) receive requests for redemptions and transmit such redemption requests to
the Fund's transfer agent as promptly as possible, and (d) respond to
inquiries from shareholders concerning the status of their accounts and the
operations of the Fund. Alex. Brown has not undertaken to sell any specific
number of Shares. The Distribution Agreements further provide that, in
connection with the distribution of Shares, Alex. Brown will be responsible
for all of the promotional expenses. The services provided by Alex. Brown to
the Fund are not exclusive, and Alex. Brown is free to provide similar
services to others. Alex. Brown shall not be liable to the Fund or its
shareholders for any act or omission by Alex. Brown or any losses sustained
by the Fund or its shareholders except in the case of willful misfeasance,
bad faith, gross negligence or reckless disregard of duty.
Alex. Brown and certain broker-dealers have entered into Sub-
Distribution Agreements as more fully described below.
As compensation for providing distribution services as described
above, the Fund will pay Alex. Brown for the Flag Investors Class A Shares,
an annual fee, paid monthly equal to .25% of the average daily net assets of
the Class A Shares. As compensation for providing distribution services as
described above for the Flag Investors Class B Shares, the Fund will pay
Alex. Brown, on a monthly basis, an annual fee equal to .75% of the average
daily net assets of the Class B Shares. Alex. Brown expects to allocate most
of its annual fees to its investment representatives and broker-dealers who
enter into Sub-Distribution Agreements with Alex. Brown ("Participating
Dealers") under which such broker-dealers have agreed to process investor
purchase and redemption orders and respond to inquiries from Fund
shareholders concerning the status of their accounts and the operations of
the Fund. As compensation for providing distribution services for the Class
A Shares in the fiscal years ended December 31, 1994, December 31, 1993 and
December 31, 1992, Alex. Brown received from the Fund aggregate commissions
and fees in the amount of $1,155,931, $973,525 and $669,725, respectively.
For the same periods, Alex. Brown paid from the fees it received $470,275,
16
<PAGE> 52
$259,204 and $203,176 to its investment representatives as compensation and
$652,516, $485,886 and $274,218 to Participating Dealers as compensation.
In addition, with respect to the Class B Shares, the Fund will pay
Alex. Brown a shareholder servicing fee at an annual rate of .25% of the
average daily net assets of the Class B Shares. (See the Prospectus.)
For the period April 6, 1993 through November 18, 1994 the Fund
offered the Flag Investors Telephone Income Fund Class D Shares of the Fund
(which were known at such time as the Flag Investors Telephone Income Fund
Class B Shares.) As compensation for providing distribution services for the
Class D Shares for the period from January 1, 1994 through November 18, 1994
and from April 6, 1993 through December 31, 1993, Alex. Brown received from
the Fund aggregate commissions and fees in the amount of $185,856 and $39,490
and paid from such fees it received $6,785 and $0 to its investment
representatives as compensation and $20,377 and $0 to Participating Dealers
as compensation.
Pursuant to Rule 12b-1 under the 1940 Act, which provides that
investment companies may pay distribution expenses, directly or indirectly,
only pursuant to a plan adopted by the investment company's board of
directors and approved by its shareholders, the Fund has adopted a Plan of
Distribution for each of its classes of Shares (the "Plans"). Under the
Plans, the Fund pays a fee to Alex. Brown for distribution and other
shareholder servicing assistance as set forth in the Distribution Agreements,
and Alex. Brown is authorized to make payments out of its fees to its
investment representatives and to participating broker-dealers. Each
Distribution Agreement has an initial term of two years. The Distribution
Agreements and the Plans encompassed therein will remain in effect from year
to year as specifically approved (a) at least annually by the Fund's Board of
Directors and (b) by the affirmative vote of a majority of the Non-Interested
Directors, by votes cast in person at a meeting called for such purpose. The
Distribution Agreements including the Plans and forms of Sub-Distribution
Agreements, were most recently approved by the Fund's Board of Directors,
including a majority of the Non-Interested Directors, on September 22, 1994.
In approving the Plans, the Directors concluded, in the exercise of
reasonable business judgment, that there was a reasonable likelihood that the
Plans would benefit the Fund and its shareholders. The Plans will be renewed
only if the Directors make a similar determination in each subsequent year.
The Plans may not be amended to increase materially the fee to be paid
pursuant to the Distribution Agreements without the approval of the
shareholders of the Fund. The Plans may be terminated at any time and the
Distribution Agreements may be terminated at any time upon sixty days'
notice, in either case without penalty, by the vote of a majority of the
Fund's Non-Interested Directors or by a vote of a majority of the outstanding
class of Shares (as defined under "Capital Stock"). Any Sub-Distribution
Agreement may be terminated in the same manner at any time. The Distribution
Agreements and any Sub-Distribution Agreements shall automatically terminate
in the event of assignment.
During the continuance of the Plans, the Fund's Board of Directors
will be provided for their review, at least quarterly, a written report
concerning the payments made under the Plans to Alex. Brown pursuant to the
Distribution Agreements and to broker-dealers pursuant to Sub-Distribution
Agreements. Such reports shall be made by the persons authorized to make
such payments. In addition, during the continuance of the Plans, the
selection and nomination of the Fund's Non-Interested Directors shall be
committed to the discretion of the Non-Interested Directors then in office.
In addition, the Fund may enter into Shareholder Servicing Agreements
with certain financial institutions, such as banks, to act as Shareholder
Servicing Agents, pursuant to which Alex. Brown will allocate a portion of
17
<PAGE> 53
its distribution fee as compensation for such financial institutions' ongoing
shareholder services. Although banking laws and regulations prohibit banks
from distributing shares of open-end investment companies such as the Fund,
according to interpretations by various bank regulatory authorities,
financial institutions are not prohibited from acting in other capacities for
investment companies, such as the shareholder servicing capacities described
above. Should future legislative, judicial or administrative action prohibit
or restrict the activities of the Shareholder Servicing Agents in connection
with the Shareholder Servicing Agreements, the Fund may be required to alter
materially or discontinue its arrangements with the Shareholder Servicing
Agents. Such financial institutions may impose separate fees in connection
with these services and investors should review the Prospectus and this
Statement of Additional Information in conjunction with any such
institution's fee schedule. In addition, state securities laws on this issue
may differ from the interpretations of federal law expressed herein, and
banks and financial institutions may be required to register as dealers
pursuant to state law.
Under the Plans, amounts allocated to Participating Dealers and
Shareholder Servicing Agents may not exceed amounts payable to Alex. Brown
under the Plans. Payments under the Plan are made as described above
regardless of Alex. Brown's actual cost of providing distribution services
and may be used to pay Alex. Brown's overhead expenses. If the cost of
providing distribution services to the Fund in connection with the sale of
the Class A Shares is less than .25% of the Class A Shares' average daily net
assets for any period or in connection with the sale of the Class B Shares is
less than .75% of the Class B Shares' average daily net assets for any
period, the unexpended portion of the distribution fee may be retained by
Alex. Brown. The Plans do not provide for any charges to the Fund for excess
amounts expended by Alex. Brown and, if either Plan is terminated in
accordance with its terms, the obligation of the Fund to make payments to
Alex. Brown pursuant to the Plan will cease and the Fund will not be required
to make any payments past the date the related Distribution Agreement
terminates.
Except as described elsewhere, the Fund pays or causes to be paid all
continuing expenses of the Fund, including, without limitation: investment
advisory and distribution fees; the charges and expenses of any registrar,
any custodian or depository appointed by the Fund for the safekeeping of
cash, portfolio securities and other property, and any transfer, dividend or
accounting agent or agents appointed by the Fund; brokers' commissions
chargeable to the Fund in connection with portfolio securities transactions
to which the Fund is a party; all taxes, including securities issuance and
transfer taxes, and fees payable by the Fund to Federal, state or other
governmental agencies; the costs and expenses of engraving or printing of
certificates representing Shares; all costs and expenses in connection with
the registration and maintenance of registration of the Fund and its Shares
with the SEC and various states and other jurisdictions (including filing
fees, legal fees and disbursements of counsel); the costs and expenses of
printing, including typesetting and distributing prospectuses and statements
of additional information of the Fund and supplements thereto to the Fund's
shareholders; all expenses of shareholders' and Directors' meetings and of
preparing, printing and mailing proxy statements and reports to shareholders;
fees and travel expenses of Directors and Director members of any advisory
board or committee; all expenses incident to the payment of any dividend,
distribution, withdrawal or redemption, whether in Shares or in cash; charges
and expenses of any outside service used for pricing of the Shares; fees and
expenses of legal counsel, including counsel to the Non-Interested Directors,
and of independent certified public accountants, in connection with any
matter relating to the Fund; membership dues of industry associations;
interest payable on Fund borrowings; postage; insurance premiums on property
or personnel (including Officers and Directors) of the Fund which inure to
its benefit; extraordinary expenses (including, but not limited to, legal
claims and liabilities and litigation costs and any indemnification related
thereto); and all other charges and costs of the Fund's operation unless
otherwise explicitly assumed by Alex. Brown, ICC or ABIM.
18
<PAGE> 54
The address of Alex. Brown is 135 East Baltimore Street, Baltimore,
Maryland 21202.
8. BROKERAGE
ABIM is responsible for decisions to buy and sell securities for the
Fund, for the broker-dealer selection and for negotiation of commission
rates, subject to the supervision of ICC. Purchases and sales of securities
on a securities exchange are effected through broker-dealers who charge a
commission for their services. Brokerage commissions are subject to
negotiation between ABIM and the broker-dealers. ABIM may direct purchase
and sale orders to any broker-dealer, including, to the extent and in the
manner permitted by applicable law, Alex. Brown.
In over-the-counter transactions, orders are placed directly with a
principal market maker and such purchases normally include a mark up over the
bid to the broker-dealer based on the spread between the bid and asked price
for the security. Purchases from underwriters of portfolio securities
include a commission or concession paid by the issuer to the underwriter. On
occasion, certain money market instruments may be purchased directly from an
issuer without payment of a commission or concession. The Fund will not deal
with Alex. Brown in any transaction in which Alex. Brown acts as a principal;
that is, an order will not be placed with Alex. Brown if execution of the
trade involves Alex. Brown serving as a principal with respect to any part of
the Fund's order, nor will the Fund buy or sell over-the-counter securities
with Alex. Brown acting as market maker.
If Alex. Brown is participating in an underwriting or selling group,
the Fund may not buy portfolio securities from the group except in accordance
with rules of the SEC. The Fund believes that the limitation will not affect
its ability to carry out its present investment objective.
ABIM's primary consideration in effecting securities transactions is
to obtain best price and execution of orders on an overall basis. As
described below, however, ABIM may, in its discretion, effect transactions
with dealers that furnish statistical, research or other information or
services which are deemed by ABIM to be beneficial to the Fund's investment
program. Certain research services furnished by broker-dealers may be useful
to ABIM with clients other than the Fund. Similarly, any research services
received by ABIM through placement of portfolio transactions of other clients
may be of value to ABIM in fulfilling its obligations to the Fund. No
specific value can be determined for research and statistical services
furnished without cost to ABIM by a broker-dealer. ABIM is of the opinion
that because the material must be analyzed and reviewed by its staff, its
receipt does not tend to reduce expenses, but may be beneficial in
supplementing ABIM's research and analysis. Therefore, it may tend to
benefit the Fund by improving ABIM's investment advice. ABIM's policy is to
pay a broker-dealer higher commissions for particular transactions than might
be charged if a different broker-dealer had been chosen when, in ABIM's
opinion, this policy furthers the overall objective of obtaining best price
and execution. Subject to periodic review by the Fund's Board of Directors,
ABIM is also authorized to pay broker-dealers other than Alex. Brown higher
commissions on brokerage transactions for the Fund in order to secure
research and investment services described above. The allocation of orders
among broker-dealers and the commission rates paid by the Fund will be
reviewed periodically by the Board.
Subject to the above considerations, the Board of Directors has
authorized the Fund to effect portfolio transactions, on an agency basis,
through Alex. Brown. At the time of such authorization the Board adopted
certain policies and procedures incorporating the standards of Rule 17e-1
under the 1940 Act which requires that the commissions paid Alex. Brown must
be "reasonable and fair compared to the commission, fee or other remuneration
received or to be received by other brokers in connection with comparable
transactions involving similar securities during a comparable period of
time." Rule 17e-1 also contains requirements for the review of such
19
<PAGE> 55
transactions by the Board of Directors and requires ICC and ABIM to furnish
reports and to maintain records in connection with such reviews. The
Distribution Agreement between Alex. Brown and the Fund does not provide for
any reduction in the distribution fee to be received by Alex. Brown from the
Fund as a result of profits resulting from brokerage commissions on
transactions of the Fund effected through Alex. Brown.
ABIM manages other investment accounts. It is possible that, at
times, identical securities will be acceptable for the Fund and one or more
of such other accounts; however, the position of each account in the
securities of the same issuer may vary and the length of time that each
account may choose to hold its investment in such securities may likewise
vary. The timing and amount of purchase by each account will also be
determined by its cash position. If the purchase or sale of securities
consistent with the investment policies of the Fund or one or more of these
accounts is considered at or about the same time, transactions in such
securities will be allocated among the accounts in a manner deemed equitable
by ABIM. ABIM may combine such transactions, in accordance with applicable
laws and regulations, in order to obtain the best net price and most
favorable execution. Such simultaneous transactions, however, could
adversely affect the ability of the Fund to obtain or dispose of the full
amount of a security which it seeks to purchase or sell.
During the fiscal years ended December 31, 1994, December 31, 1993
and December 31, 1992, Alex. Brown directed $208,696,174, $119,892,648 and
$48,436,059, respectively, of transactions to broker-dealers and paid
$254,895, $257,703 and $43,610, respectively, to broker-dealers in related
commissions because of research services provided. In the fiscal years ended
December 31, 1994, December 31, 1993 and December 31, 1992, the Fund paid
Alex. Brown brokerage commissions in the aggregate amount of $7,000, $5,600
and $5,810, which represented 2.7%, 2.2% and 11.8% of the Fund's aggregate
brokerage commissions for the respective periods and which were paid on
transactions that represented 1.8%, 2.3% and 10.2% of the aggregate dollar
amount of transactions that incurred commissions paid by the Fund during the
respective periods. The Fund is required to identify any securities of its
"regular brokers or dealers" (as such term is defined in the Investment
Company Act) which the Fund has acquired during its most recent fiscal year.
As of December 31, 1994, the Fund held a 5.50% repurchase agreement issued by
Goldman Sachs & Co. valued at $9,742,000. Goldman Sachs & Co. is a "regular
broker or dealer" of the Fund.
9. CAPITAL STOCK
Under the Fund's Articles of Incorporation, the Fund has 70 million
authorized Shares of common stock, with a par value of $.001 per share. The
Board of Directors may increase or decrease the number of authorized Shares
without shareholder approval. On October 11, 1989, the Fund declared a two
for one stock dividend payable to shareholders of record on October 27, 1989.
The Fund's Articles of Incorporation provide for the establishment of
separate series and separate classes of Shares by the Directors at any time.
The Fund currently has one Series and the Board has designated three classes
of Shares: Flag Investors Telephone Income Fund Class A Shares, Flag
Investors Telephone Fund Class B Shares and Flag Investors Telephone Income
Fund Class D Shares. The Flag Investors Telephone Income Fund Class D Shares
are not currently being offered. In the event separate series are
established, all Shares of the Fund, regardless of series or class, would
have equal rights with respect to voting, except that with respect to any
matter affecting the rights of the holders of a particular series or class,
the holders of each series or class would vote separately. In general, each
such series would be managed separately and shareholders of each series would
have an undivided interest in the net assets of that series. For tax
purposes, the series would be treated as separate entities. Generally, each
class of Shares issued by a particular series would be identical to every
other class and expenses of the Fund (other than 12b-1 fees) are prorated
20
<PAGE> 56
between all classes of a series based upon the relative net assets of each
class. Any matters affecting any class exclusively would be voted on by the
holders of such class.
Shareholders of the Fund do not have cumulative voting rights, and
therefore the holders of more than 50% of the outstanding Shares voting
together for election of Directors may elect all the members of the Board of
Directors of the Fund. In such event, the remaining holders cannot elect any
members of the Board of Directors of the Fund. There are no preemptive,
conversion or exchange rights applicable to any of the Shares. The issued
and outstanding Shares are fully paid and non-assessable. In the event of
liquidation or dissolution of the Fund, each Share is entitled to its portion
of the Fund's assets (or the assets allocated to a separate series of shares
if there is more than one series) after all debts and expenses have been
paid.
As used in this Statement of Additional Information, the term
"majority of the outstanding shares" means the vote of the lesser of (i) 67%
or more of the shares present at a meeting, if the holders of more than 50%
of the outstanding shares are present or represented by proxy, or (ii) more
than 50% of the outstanding shares.
10. QUARTERLY REPORTS
The Fund furnishes shareholders with quarterly reports containing
information about the Fund and its operations, including a list of
investments held in the Fund's portfolio and financial statements.
11. CUSTODIAN, TRANSFER AGENT, ACCOUNTING SERVICES
PNC Bank, National Association ("PNC Bank"), Airport Business Park,
200 Stevens Drive, Lester, Pennsylvania 19113, has been retained to act as
custodian of the Fund's investments. PNC Bank receives such compensation
from the Fund for its services as Custodian as may be agreed to from time to
time by PNC Bank and the Fund. Investment Company Capital Corp., 135 East
Baltimore Street, Baltimore, Maryland 21202, has been retained to act as
transfer and dividend disbursing agent, effective March 1, 1994. As
compensation for providing these services, the Fund pays ICC up to $10.50 per
account, plus reimbursement for out of pocket expenses incurred in connection
therewith. For the period from March 1, 1994 through December 31, 1994, such
fees totalled $471,565. Prior to March 1, 1994, PFPC provided these services.
ICC also provides certain accounting services to the Fund under a
Master Services Agreement effective January 1, 1994, between the Fund and
ICC. These services were previously provided by Alex. Brown. As
compensation for these services, ICC will receive an annual fee, calculated
daily and paid monthly as shown below. These fees are the same as those paid
to Alex. Brown under the prior accounting services agreement.
Average Net Assets Incremental Accounting Services Fee
------------------ -----------------------------------
$ 0- $ 10,000,000 $13,000(fixed fee)
$ 10,000,000- $ 20,000,000 .100%
$ 20,000,000- $ 30,000,000 .080%
$ 30,000,000- $ 40,000,000 .060%
$ 40,000,000- $ 50,000,000 .050%
$ 50,000,000- $ 60,000,000 .040%
$ 60,000,000- $ 70,000,000 .030%
$ 70,000,000- $ 100,000,000 .020%
$100,000,000- $ 500,000,000 .015%
$500,000,000- $1,000,000,000 .005%
over $1,000,000,000 .001%
21
<PAGE> 57
In addition, the Fund will reimburse ICC for the following out of
pocket expenses incurred in connection with ICC's provision of accounting
services under the Master Services Agreement: express delivery services,
independent pricing and storage.
ICC also serves as the Fund's investment advisor.
As compensation for providing accounting services for the fiscal
year ended December 31, 1994, ICC received fees of $113,842.
12. INDEPENDENT ACCOUNTANTS
The annual financial statements of the Fund are audited by Coopers &
Lybrand L.L.P. whose report thereon appears elsewhere herein, and have been
included herein in reliance upon the report of such firm of accountants given
on their authority as experts in accounting and auditing. Coopers & Lybrand
L.L.P. has offices at 2400 Eleven Penn Center, Philadelphia, Pennsylvania
19103.
13. PERFORMANCE INFORMATION
For purposes of quoting and comparing the performance of the Fund to
that of other open-end diversified management investment companies and to
stock or other relevant indices in advertisements or in certain reports to
shareholders, performance will be stated in terms of total return rather than
in terms of yield. The total return quotations, under the rules of the SEC,
must be calculated according to the following formula:
n
P(I + T) = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)
ERV = ending redeemable value at the end of the 1, 5,
or 10 year periods (or fractional portion
thereof) of a hypothetical $1,000 payment made at
the beginning of the 1, 5 or 10 year periods.
Under the foregoing formula, the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication, and
will cover one, five, and ten year periods or a shorter period dating from
the effectiveness of the Fund's registration statement or the date the Fund
(or a class or series) commenced operations (provided such date is subsequent
to the date the registration statement became effective). In calculating the
ending redeemable value, the maximum sales load (for the Flag Investors
22
<PAGE> 58
Telephone Income Fund Class A Shares 4.5% and for the Flag Investors
Telephone Income Fund Class B Shares, 4.0% for the one year period, 2.0% for
the five year period and no sales charge thereafter) is deducted from the
initial $1,000 payment and all dividends and distributions by the Fund are
assumed to have been reinvested at net asset value as described in the
prospectus on the reinvestment dates during the period. "T" in the formula
above is calculated by finding the average annual compounded rate of return
over the period that would equate an assumed initial payment of $1,000 to the
ending redeemable value. Any sales loads that might in the future be made
applicable at the time to reinvestments would be included as would any
recurring account charges that might be imposed by the Fund.
The Fund may also from time to time include in such advertising total
return figures that are not calculated according to the formula set forth
above in order to compare more accurately the Fund's performance with other
measures of investment return. For example, in comparing the Fund's total
return with data published by Lipper Analytical Services, Inc., CDA
Investment Technologies, Inc. or Morningstar Inc., or with the performance of
the Shearson Lehman Government Corporate Bond Index, the Consumer Price
Index, the return on 90 day U.S. Treasury bills, the Standard and Poor's 500
Stock Index or the Dow Industrial Average, the Fund calculates its aggregate
and average annual total return for the specified periods of time by assuming
the investment of $10,000 in Shares and assuming the reinvestment of each
dividend or other distribution at net asset value on the reinvestment date.
For this alternative computation, the Fund assumes that the $10,000 invested
in Shares is net of all sales charges (as distinguished from the computation
required by the SEC where the $1,000 payment is reduced by sales charges
before being invested in Shares). The Fund will, however, disclose the
maximum sales charges and will also disclose that the performance data do not
reflect sales charges and that inclusion of sales charges would reduce the
performance quoted. Such alternative total return information will be given
no greater prominence in such advertising than the information prescribed
under SEC rules, and all advertisements containing performance data will
include a legend disclosing that such performance data represent past
performance and that the investment return and principal value of an
investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost.
Calculated according to the SEC rules, for the one year period ended
December 31, 1994, the ending redeemable value of a hypothetical $1,000
payment for the Flag Investors Class A Shares was $895 resulting in an annual
total return for such class equal to -10.54%. For the five year period ended
December 31, 1994, the ending redeemable value of a hypothetical $1,000
payment for the Flag Investors Class A Shares was $1,351, resulting in an
average annual total return for such class of 6.20%. For the ten year period
ended December 31, 1994, the ending redeemable value of a hypothetical $1,000
payment for the Flag Investors Class A Shares was $3,944, resulting in an
average annual total return for such class equal to 14.71%.
Calculated according to SEC rules for the one year period ended
December 31, 1994, the ending redeemable value of a hypothetical $1,000
payment for the Flag Investors Class D Shares was $915, resulting in an
annual total return for such shares equal to -8.48%. For the period from
April 6, 1993 (commencement of operations of such class) to the end of the
Fund's fiscal year on December 31, 1994, the ending redeemable value of a
hypothetical $1,000 payment for the Flag Investors Class D Shares was $989,
resulting in an average annual total return for such shares equal to -0.66%.
Calculated according to the alternative computation, which assumes no
sales charges and reinvestment of all distributions, for the one year period
ended December 31, 1994, the ending redeemable value of a hypothetical
$10,000 investment in Flag Investors Class A Shares was $9,368, resulting in
an average total return equal to -6.3%. For the five-year period ended
December 31, 1994, the ending redeemable value of a hypothetical $10,000
investment in Flag Investors Class A Shares was $14,146, resulting in a total
return equal to 41.5% and an average annual total return equal to 7.2%. For
23
<PAGE> 59
the ten year period ended December 31, 1994, the ending redeemable value of a
hypothetical $10,000 investment in Flag Investors Class A Shares was $41,303
resulting in a total return equal to 313.0% and an average annual total
return equal to 15.2%.
Calculated according to the alternative computation for the one year
period ended December 31, 1994, the ending redeemable value of a hypothetical
$10,000 investment in Flag Investors Class D Shares was $9,387, resulting in
an average total return equal to -6.1%. For the period from April 6, 1993
(commencement of operations of such class) to December 31, 1994, the ending
redeemable value of a hypothetical $10,000 investment in Flag Investors Class
D Shares was $10,139, resulting in an average annual total return for such
class equal to 0.8%.
The Flag Investors Class B Shares were not offered in any period ended
December 31, 1994.
The Fund's annual portfolio turnover rate (the lesser of the value of
the purchases or sales for the year divided by the average monthly market
value of the portfolio during the year, excluding U.S. Government and short-
term securities) may vary from year to year, as well as within a year,
depending on market conditions. The Fund's portfolio turnover rates in
fiscal years 1994 and 1993 were 23% and 14%, respectively. The Fund expects
its portfolio turnover rate not to exceed 50% in the fiscal year ending
December 31, 1995.
14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of April 11, 1995, to Fund management's knowledge, the following
persons held beneficially or of record 5% or more of the Fund's outstanding
of any class:
Alex. Brown & Sons Incorporated, 135 E. Baltimore Street, Baltimore,
Maryland, owned of record 27.2% of the Fund's outstanding Class A Shares,
42.3% of the Fund's Class B Shares and 36.3% of the Funds Class D Shares. On
such date Alex. Brown owned beneficially less than 1% of the Fund's shares of
any class.
As of April 11, 1995, the Directors and officers as a group owned less
than 1% of the Fund's total outstanding shares.
15. FINANCIAL STATEMENTS
See next page.
24
<PAGE> 60
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Net Assets December 31, 1994
<TABLE>
<CAPTION>
PERCENT SHARES/ PERCENT
VALUE OF NET PAR VALUE OF NET
SHARES SECURITY (NOTE A) ASSETS (000) SECURITY (NOTE A) ASSETS
<C> <S> <C> <C> <C> <C> <C> <C>
</TABLE>
<TABLE>
<C> <S> <C> <C>
TELEPHONE INDUSTRY -- 71.4%
COMMON STOCK -- 66.1%
220,408 AirTouch Communications
Inc.* $ 6,419,383 1.4 %
709,224 American Telephone &
Telegraph Co. 35,638,506 7.6
266,000 Ameritech Corp. 10,739,750 2.3
400,000 BCE Inc. 12,850,000 2.7
262,008 Bell Atlantic Corp. 13,034,898 2.8
85,482 BellSouth Corp. 4,626,713 1.0
123,100 British Telecommuni-
cations PLC ADR 7,401,388 1.6
320,500 BroadBand Technologies* 9,775,250 2.1
115,000 Cellstar Corp.* 2,601,875 0.6
402,100 Cincinnati Bell Inc. 6,835,700 1.5
150,000 Compania Telefonica
National de
Espana ADS 5,268,750 1.1
200,000 DSC Communications Corp.* 7,175,000 1.5
812,320 GTE Corp. 24,674,220 5.3
165,000 Hong Kong Telecommu-
nications Ltd. ADR 3,155,625 0.7
39,600 LCI International Inc.* 1,059,300 0.2
490,000 MCI Communications Corp. 9,003,750 1.9
160,000 MFS Communications* 5,240,000 1.1
300,000 Mobile Telecommu-
nications 5,850,000 1.2
310,000 Motorola Inc. 17,941,250 3.8
140,000 NEXTEL Communications
Inc.* 2,012,500 0.4
210,612 NYNEX Corp. 7,739,991 1.7
200,000 Octel Communica-
tions Corp.* 4,150,000 0.9
56,000 Orbital Sciences Corp.* 1,078,000 0.2
COMMON STOCK -- (CONTINUED)
675,408 Pacific Telesis Group $ 19,249,128 4.1%
375,000 QUALCOMM Inc.* 9,000,000 1.9
416,200 Rochester
Telephone Corp. 8,792,225 1.9
97,000 Southern New England
Telecommunications
Corp. 3,116,125 0.7
659,106 Southwestern Bell Corp. 26,611,405 5.7
125,000 Sprint Corp. 3,453,125 0.7
200,000 Telefonos de Mexico
SA ADS 8,200,000 1.8
100,000 Telular Corp.* 625,000 0.1
560,408 U.S. West Inc. 19,964,535 4.3
174,000 Vodafone Group PLC ADR 5,850,750 1.3
TOTAL COMMON STOCK
(Cost $240,603,068) 309,134,142 66.1
CONVERTIBLE PREFERRED STOCK -- 1.9%
70,000 First Chicago Corp.
(NEXTEL),
5.5% Cvt Pfd 1,225,000 0.3
207,800 LCI International Inc.,
5% Cvt Pfd 7,480,800 1.6
TOTAL CONVERTIBLE
PREFERRED STOCK
(Cost $8,865,649) 8,705,800 1.9
CORPORATE BONDS -- 3.4%
MCI Communications Corp.:
$5,000 Deb, 6.25%, 3/23/99 4,668,750 1.0
3,000 Deb, 7.50%, 8/20/04 2,835,000 0.6
1,000 Orbital Sciences Corp.,
6.75%, 3/1/03 1,345,000 0.3
</TABLE>
25
<PAGE> 61
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Net Assets (CONTINUED) December 31, 1994
<TABLE>
<CAPTION>
SHARES/ PERCENT
PAR VALUE OF NET
(000) SECURITY (NOTE A) ASSETS
<C> <S> <C> <C>
</TABLE>
<TABLE>
<C> <S> <C> <C>
CORPORATE BONDS (CONTINUED)
Tele-Communications, Inc.:
$2,500 9.25%, 4/15/02 $ 2,562,500 0.6 %
5,000 7.25%, 8/1/05 4,368,750 0.9
TOTAL CORPORATE BONDS
(Cost $16,756,526) 15,780,000 3.4
TOTAL TELEPHONE INDUSTRY
(Cost $266,225,243) 333,619,942 71.4
NON-TELEPHONE INDUSTRY -- 26.7%
COMMON STOCK -- 17.5%
426,900 Alexander Haagen
Properties 6,296,775 1.3
255,100 Burnham Pacific
Properties Inc. 3,252,525 0.7
342,956 Conseco Inc. 14,789,977 3.2
179,600 DeBartolo Realty
Corporation 2,694,000 0.6
175,000 Eastman Kodak Co. 8,356,250 1.8
109,000 General Growth
Properties 2,466,125 0.5
38,000 Long Island Lighting 584,250 0.1
145,000 Meditrust SBI 4,386,250 0.9
200,000 Nationwide Health
Properties Inc. 7,150,000 1.5
200,000 Philip Morris Cos., Inc. 11,500,000 2.5
150,000 Unicom 3,600,000 0.8
70,000 Wells Fargo & Co. 10,150,000 2.2
67,600 Xerox Corp. 6,692,400 1.4
TOTAL COMMON STOCK
(Cost $64,102,531) 81,918,552 17.5
CONVERTIBLE PREFERRED STOCK -- 4.7%
246,000 American Express,
6.25% Cvt Pfd 10,485,750 2.2
100,000 Conseco Inc., 6.5%
Series D Cvt Pfd 4,075,000 0.9
</TABLE>
26
<PAGE> 62
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Net Assets (CONTINUED) December 31, 1994
<TABLE>
<CAPTION>
SHARES/ PERCENT
PAR VALUE OF NET
(000) SECURITY (NOTE A) ASSETS
<C> <C> <C> <C>
CONVERTIBLE PREFERRED STOCK (CONTINUED)
75,000 Delta Air Lines Inc.,
$3.50 Cvt Pfd $ 3,281,250 0.7 %
90,800 Rouse Co., Series A
$3.25 Cvt Pfd* 4,403,800 0.9
TOTAL CONVERTIBLE
PREFERRED STOCK
(Cost $22,312,007) 22,245,800 4.7
CORPORATE BONDS -- 4.5%
$2,800 Bankers Life
Holding Corp., Deb,
13.00%, 11/1/02 3,122,000 0.7
3,500 Conseco Inc., Deb,
8.125%, 2/15/03 3,115,000 0.7
5,000 Eckerd Corp., Deb,
9.25%, 2/15/04 4,925,000 1.0
Host Marriott:
783 10.50%, 5/1/06 780,064 0.2
3,134 10.375%, 6/15/11 3,137,917 0.7
2,000 National Health
Investors, Cvt Deb,
10.00%, 10/17/06 2,600,000 0.6
2,000 Philip Morris Cos.,
Inc.,
Deb, 8.75%, 12/1/96 2,027,500 0.4
1,700 Rohr Industries, Cvt
Deb, 7.00%, 10/1/12 1,164,500 0.2
TOTAL CORPORATE BONDS
(Cost $20,035,462) 20,871,981 4.5
TOTAL NON-TELEPHONE
INDUSTRY
(Cost $106,450,000) 125,036,333 26.7
</TABLE>
27
<PAGE> 63
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Net Assets (CONCLUDED) December 31, 1994
<TABLE>
<CAPTION>
PERCENT
PAR VALUE OF NET
(000) SECURITY (NOTE A) ASSETS
<C> <S> <C> <C>
</TABLE>
<TABLE>
<C> <S> <C> <C>
REPURCHASE AGREEMENT -- 2.1%
$9,742 GOLDMAN SACHS & CO.
5.50%
Dated 12/30/94, to be
repurchased on 1/3/95,
collateralized by U.S.
Treasury Strips with
a market value of
$9,937,050
(Cost $9,742,000)...... $ 9,742,000 2.1 %
TOTAL INVESTMENTS
IN SECURITIES
(Cost $382,417,243)**.. 468,398,275 100.2
LIABILITIES IN EXCESS
OF OTHER ASSETS,
NET.................. (897,288) (0.2)
NET ASSETS............. $467,500,987 100.0 %
</TABLE>
<TABLE>
VALUE
(NOTE A)
<S> <C>
NET ASSET VALUE AND REDEMPTION VALUE PER:
CLASS A SHARE
($435,805,101 (division symbol) 35,432,180 shares
outstanding).............................. $12.30
CLASS D SHARE
($31,695,886 (division symbol) 2,576,705 shares
outstanding).............................. $12.30(dagger symbol)
MAXIMUM OFFERING PRICE PER:
CLASS A SHARE:
($12.30 (division symbol) .955)............................... $12.88
</TABLE>
* Non-income producing security.
** Aggregate cost for federal tax purposes was $378,563,289.
(dagger symbol) Redemption value is $12.18 after 1.00% contingent deferred
sales charge.
See accompanying Notes to Financial Statements.
28
<PAGE> 64
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Operations For the Year Ended December 31, 1994
<TABLE>
<CAPTION>
<S> <C>
INVESTMENT INCOME (NOTE A):
Dividends...................................................................................... $ 16,200,624
Interest....................................................................................... 4,054,972
Less: Foreign taxes withheld................................................................. (241,534)
Total income................................................................................. 20,014,062
EXPENSES:
Investment advisory fee (Note B)............................................................... 2,570,073
Distribution fees (Note B)..................................................................... 1,341,787
Transfer agent fees (Note B)................................................................... 552,810
Accounting fee (Note B)........................................................................ 113,842
Printing and postage........................................................................... 88,301
Custodian fee.................................................................................. 82,834
Registration fees.............................................................................. 66,093
Legal.......................................................................................... 51,307
Audit.......................................................................................... 28,035
Directors' fees................................................................................ 26,689
Miscellaneous.................................................................................. 26,340
Insurance...................................................................................... 24,081
Total expenses............................................................................... 4,972,192
Less: Fees waived (Note B)..................................................................... (325,558)
Net expenses................................................................................. 4,646,634
Net investment income.......................................................................... 15,367,428
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain from security transactions................................................... 4,980,639*
Net unrealized depreciation of investments..................................................... (52,606,757)
Net loss on investments...................................................................... (47,626,118)
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS................................................ $(32,258,690)
</TABLE>
* Net realized gain for federal tax purposes was $4,981,641.
See accompanying Notes to Financial Statements.
29
<PAGE> 65
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
<S> <C> <C>
1994 1993
</TABLE>
<TABLE>
<S> <C> <C>
INCREASE/(DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income........................................... $ 15,367,428 $ 12,327,199
Net gain from security transactions............................. 4,980,639 10,612,037
Net unrealized appreciation/(depreciation) of investments....... (52,606,757) 36,368,795
Net increase/(decrease) in net assets resulting from
operations.................................................... (32,258,690) 59,308,031
DIVIDENDS TO SHAREHOLDERS FROM:
Net investment income:
Class A Shares................................................ (14,498,099) (12,146,167)
Class D Shares................................................ (869,329) (181,032)
Net realized short-term gains:
Class A Shares................................................ (1,380,369) (109,857)
Class D Shares................................................ (207,441) (50,853)
Net realized long-term gains:
Class A Shares................................................ (3,302,412) (9,392,077)
Class D Shares................................................ (243,429) (427,915)
Total distributions............................................. (20,501,079) (22,307,901)
CAPITAL SHARE TRANSACTIONS (NOTE C):
Proceeds from sale of shares.................................... 74,463,764 177,220,746
Value of shares issued in reinvestment of dividends............. 14,926,479 16,085,675
Cost of shares repurchased...................................... (61,773,728) (45,303,418)
Increase in net assets derived from capital share
transactions.................................................. 27,616,515 148,003,003
Total increase/(decrease) in net assets......................... (25,143,254) 185,003,133
NET ASSETS:
Beginning of year............................................... 492,644,241 307,641,108
End of year..................................................... $467,500,987 $492,644,241
</TABLE>
See accompanying Notes to Financial Statements.
30
<PAGE> 66
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Financial Highlights -- Class A Shares
(FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1994 1993 1992 1991 1990
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value at beginning of year....... $13.70 $12.20 $11.28 $ 9.57 $10.98
INCOME FROM INVESTMENT OPERATIONS:
Net investment income...................... 0.41 0.42 0.42 0.45 0.46
Net realized and unrealized gain/(loss) on
investments............................. (1.27) 1.78 0.93 1.74 (1.29)
Total from Investment Operations........... (0.86) 2.20 1.35 2.19 (0.83)
LESS DISTRIBUTIONS:
Dividends from net investment income and
short-term gains........................ (0.44) (0.42) (0.42) (0.46) (0.45)
Distributions from net realized long-term
gains................................... (0.10) (0.28) (0.01) (0.02) (0.13)
Total Distributions........................ (0.54) (0.70) (0.43) (0.48) (0.58)
Net asset value at end of year............. $12.30 $13.70 $12.20 $11.28 $ 9.57
TOTAL RETURN................................. (6.32)% 18.12% 12.35% 23.08% (7.55)%
RATIOS TO AVERAGE NET ASSETS:
Expenses 1................................. 0.92% 0.92% 0.92% 0.92% 0.92%
Net investment income 2.................... 3.14% 3.12% 3.81% 4.38% 4.54%
SUPPLEMENTAL DATA:
Net assets at end of year (000)............ $435,805 $469,163 $307,641 $238,571 $177,963
Portfolio turnover rate.................... 23% 14% 6% 7% 2%
</TABLE>
1 Without the waiver of advisory fees (Note B), the ratio of expenses to average
net assets would have been .99%, .98%, 1.07%, 1.17% and 1.13% for the years
ended December 31, 1994, 1993, 1992, 1991 and 1990, respectively.
2 Without the waiver of advisory fees (Note B), the ratio of net investment
income to average net assets would have been 3.07%, 3.06%, 3.66%, 4.13% and
4.32% for the years ended December 31, 1994, 1993, 1992, 1991 and 1990,
respectively.
31
<PAGE> 67
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Financial Highlights -- Class D Shares
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
FOR THE
PERIOD APRIL
FOR THE YEAR 6, 1993*
ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1994 1993
PER SHARE OPERATING
PERFORMANCE:
Net asset value at
beginning of period..... $13.67 $13.21
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income..... 0.37 0.25
Net realized and
unrealized gain/(loss)
on investments.......... (1.20) 0.80
Total from Investment
Operations.............. (0.83) 1.05
LESS DISTRIBUTIONS:
Dividends from net
investment income
and short-term gains.... (0.42) (0.31)
Distribution in excess of
net investment income... (0.02) --
Distributions from net
realized long-term
gains................... (0.10) (0.28)
Total Distributions....... (0.54) (0.59)
Net asset value at end of
period...................... $12.30 $13.67
TOTAL RETURN................ (6.13)% 8.01%
RATIOS TO AVERAGE NET
ASSETS:
Expenses 1................ 1.27% 1.27%**
Net investment income 2... 2.81% 2.73%**
SUPPLEMENTAL DATA:
Net assets at end of
period (000).............. $ 31,696 $ 23,481
Portfolio turnover rate... 23% 14%
* Commencement of Operations.
** Annualized.
1 Without the waiver of advisory fees (Note B), the ratio of expenses to average
net assets would have been 1.34% and 1.31% for the year ended December 31,
1994 and the period ended December 31, 1993, respectively.
2 Without the waiver of advisory fees (Note B), the ratio of net investment
income to average net assets would have been 2.74% and 1.98% for the year
ended December 31, 1994 and the period ended December 31, 1993, respectively.
See accompanying Notes to Financial Statements.
32
<PAGE> 68
Notes to Financial Statements
A. SIGNIFICANT ACCOUNTING POLICIES - Flag Investors Telephone Income Fund, Inc.
(the "Fund") is organized as a Maryland corporation and commenced operations
on January 18, 1984 (the exchange date) when investors received five shares
of the Fund in a tax-free exchange for each share of American Telephone &
Telegraph Company (AT&T), with rights to the divested Bell regional operating
companies attached. The Fund is registered under the Investment Company Act
of 1940, as amended, as an open-end, management investment company. On April
6, 1993, the Fund began offering Class D shares (formerly Class B shares).
The Class A and Class D Shares each have different sales loads and
distribution fees. On November 18, 1994, Class D Shares were no longer
available for sale, however existing shareholders may reinvest their
dividends. On January 3, 1995, the Fund began offering Class B Shares. Class
B Shares have no initial sales charge but are subject to a contingent
deferred sales charge on certain shares redeemed within six years of
purchase. Significant accounting policies are as follows:
SECURITY VALUATION - Portfolio securities which are listed on a National
Securities Exchange are valued on the basis of their last sale price or, in
the absence of recorded sales, at the average of readily available closing
bid and asked prices. Unlisted securities held by the Fund are valued at the
average of the quoted bid and asked prices in the over-the-counter market.
Short-term obligations with maturities of 60 days or less are valued at
amortized cost.
REPURCHASE AGREEMENTS - The Fund may agree to purchase money market
instruments subject to the seller's agreement to repurchase them at an agreed
upon date and price. The seller, under a repurchase agreement, will be
required on a daily basis to maintain the value of the securities subject
33
<PAGE> 69
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Notes to Financial Statements (CONTINUED)
to the agreement at not less than the repurchase price. The agreement is
conditioned upon the collateral being deposited under the Federal Reserve
book entry system.
FEDERAL INCOME TAXES - No provision is made for federal income taxes as it is
the Fund's intention to continue to qualify as a regulated investment company
and to continue to make requisite distributions to the shareholders which
will be sufficient to relieve it from all or substantially all federal income
and excise taxes. The Fund's policy is to distribute to shareholders
substantially all of its taxable net investment income and net realized
capital gains.
At December 31, 1994, for federal income tax purposes, the Fund deferred
post-October losses of approximately $322,000.
OTHER - Security transactions are accounted for on the trade date and the
cost of investments sold is determined by use of the specific identification
method for both financial reporting and income tax purposes. Cost for
financial reporting purposes includes the value of the securities received in
the exchange. For income tax purposes, the tax cost is the basis of the AT&T
shares in the hands of the exchanging AT&T shareholders at the date of
exchange. Interest income is recorded on an accrual basis; dividend income is
recorded on the ex-dividend date.
B. INVESTMENT ADVISORY FEES, TRANSACTIONS WITH AFFILIATES AND OTHER FEES -
Investment Company Capital Corp. ("ICC"), a subsidiary of Alex. Brown & Sons
Incorporated ("Alex. Brown"), is the Fund's investment advisor and Alex.
Brown Investment Management ("ABIM") is the Fund's sub-advisor. As
compensation for its advisory services, ICC receives from the Fund an annual
fee, calculated daily and paid monthly, at the annual rate of .65% of the
first $100 million of the Fund's average daily net assets; .55% of the Fund's
average daily net assets in excess of $100 million but not exceeding $200
million; .50% of the Fund's average daily net assets in excess of $200
million but not exceeding $300 million; and .45% of the Fund's average daily
net assets in excess of $300 million.
As compensation for its sub-advisory services, ABIM receives a fee from ICC,
payable from its advisory fee, calculated daily and paid monthly, at an
annual rate of .40% of the first $100 million of the Fund's average daily net
assets; .35% of the Fund's average daily net assets in excess of $100 million
but not exceeding $200 million; .30% of the Fund's average daily net assets
exceeding $200 million but not exceeding $300 million; and .25% of the Fund's
average daily net assets over $300 million.
ICC has agreed to reduce its aggregate fees so that ordinary expenses of the
Fund for any fiscal year do not exceed .92% of average daily net assets of
Class A Shares and 1.27% of Class D Shares. For the year ended December 31,
1994, ICC voluntarily waived $325,558 in fees.
As compensation for its transfer agent services, ICC receives from the Fund a
per account fee, calculated and paid monthly. ICC received $471,565 for
transfer agent services for the period March 1, 1994 through December 31,
1994. Prior to March 1, 1994, PFPC, Inc. provided these services.
As compensation for its accounting services, ICC receives from the Fund an
annual fee, calculated daily and paid monthly, based upon the Fund's average
daily net assets. ICC received $113,842 for accounting services for the year
ended December 31, 1994.
As compensation for providing distribution services, Alex. Brown receives
from the Fund an annual fee, calculated daily and paid monthly, at an
34
<PAGE> 70
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Notes to Financial Statements (CONTINUED)
annual rate equal to .25% of the Fund's average daily net assets of Class A
Shares and .60% of Class D Shares. For the year ended December 31, 1994,
distribution fees aggregated $1,341,787 of which $1,155,931 and $185,856 were
attributable to Flag Investors Class A and Flag Investors Class D Shares,
respectively. Alex Brown received $7,000 in commissions on security
transactions from the Fund for the year ended December 31, 1994.
C. CAPITAL SHARE TRANSACTIONS - The Fund is authorized to issue up to 70 million
shares of capital stock, par value $.001 per share, all of which are shares
designated as common stock. Transactions in shares of the Fund were as
follows:
Class A Shares
For the Year Ended
December 31,
1994 1993
Shares sold............ 4,615,066 11,247,223
Shares issued to
shareholders on
reinvestment of
dividends............ 1,088,372 1,141,915
Shares redeemed........ (4,517,710) (3,352,254)
Net increase
in shares
outstanding.......... 1,185,728 9,036,884
Proceeds from sale of
shares............... $ 60,821,115 $153,622,897
Value of reinvested
dividends............ 13,849,565 15,548,274
Cost of shares
redeemed............. (58,534,367) (45,128,175)
Net increase from
capital share
transactions......... $ 16,136,313 $124,042,996
Class D Shares
For the
For the Period Ended
Year Ended April 6, 1993*
December 31, to
1994 December 31, 1993
Shares sold................. 1,028,832 1,690,880
Shares issued to
shareholders on
reinvestment of
dividends................. 84,910 39,061
Shares redeemed............. (254,327) (12,651)
Net increase in shares
outstanding............... 859,415 1,717,290
Proceeds from sale of
shares.................... $13,642,649 $23,597,849
Value of reinvested
dividends................. 1,076,914 537,401
Cost of shares redeemed..... (3,239,361) (175,243)
Net increase from capital
share transactions........ $11,480,202 $23,960,007
* Commencement of operations.
D. INVESTMENT TRANSACTIONS - Purchases and sales of investment securities, other
than short-term obligations and U.S. government securities, aggregated
$148,797,078 and $101,816,091, respectively, for the year ended December 31,
1994. Sales of U.S. government obligations aggregated $9,971,875.
At December 31, 1994, aggregate gross unrealized appreciation for all
securities in which there is an excess of market value over tax cost was
$104,953,086 and aggregate gross unrealized depreciation for all securities
in which there is an excess of tax cost over market value was $15,118,100.
35
<PAGE> 71
FLAG INVESTORS
TELEPHONE INCOME FUND, INC.
Notes to Financial Statements
(CONCLUDED)
E. NET ASSETS - At December 31, 1994, net assets consisted of:
Paid-in capital:
Flag Investors Class A Shares......... $345,742,771
Flag Investors Class D Shares......... 35,440,209
Undistributed net realized gain
from security transactions.......... 336,975
Unrealized appreciation of
investments......................... 85,981,032
$467,500,987
Report of Independent Accountants
To the Shareholders and Directors of
Flag Investors Telephone Income Fund, Inc.
We have audited the accompanying statement of net assets of Flag Investors
Telephone Income Fund, Inc. as of December 31, 1994, and the related statement
of operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended and the financial highlights
for each of the respective periods presented. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of investments owned as of
December 31, 1994 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Flag
Investors Telephone Income Fund, Inc. as of December 31, 1994, the results of
its operations for the year then ended, the changes in its net assets and its
financial highlights for each of the respective periods in conformity with
generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Baltimore, Maryland
January 27, 1995
36
<PAGE> 72
APPENDIX A
CORPORATE BOND RATINGS
Standard & Poor's Bond Ratings
AAA
Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA
Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A
Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB
Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Although it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for debt in this category than in higher rated categories.
BB, B, CCC, CC
Debt rated BB, B, CCC, and CC is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates that
lowest degree of speculation and CC the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties of major risk exposure to adverse
conditions.
C
The rating C is reserved for income bonds on which no interest is
being paid.
D
Debt rated D is in default, and payment of interest and/or repayment
of principal is in arrears.
A-1
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Moody's Bond Ratings
Aaa
Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be anticipated are most unlikely to
impair the fundamentally strong position of such issues.
Aa
Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as "high grade" bonds. They are rated lower than the Aaa bonds because
margins of protection may not be as large as in the case of Aaa securities,
or the fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks appear
somewhat larger than in Aaa securities.
A
Bonds which are rated A possess many favorable investment attributes
and are considered upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa
Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba
Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterize bonds in this class.
B
Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may
be small.
Caa
Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to
principal or interest.
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Ca
Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C
Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
A-3
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