<PAGE> 1
Filed Pursuant to Rule 497(e) for
File Nos. 33-02610 and 811-04550
THE MAINSTAY FUNDS
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1999, AS SUPPLEMENTED JULY 19, 1999
- --------------------------------------------------------------------------------
This Statement of Additional Information supplements the information
contained in the Funds' Prospectus dated May 1, 1999, as amended or supplemented
from time to time (the "Prospectus"), and should be read in conjunction with the
Prospectus. The Prospectus is available without charge by writing to NYLIFE
Distributors Inc., (the "Distributor") 300 Interpace Parkway, Parsippany, NJ
07054 or by calling 1-800-MAINSTAY (1-800-624-6782). This Statement of
Additional Information, although not in itself a prospectus, is incorporated by
reference in and is made a part of the Prospectus.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in this
Statement of Additional Information or in the related Prospectus, in connection
with the offer contained herein, and, if given or made, such other information
or representations must not be relied upon as having been authorized by The
MainStay Funds or the Distributor. This Statement of Additional Information and
the related Prospectus do not constitute an offer by The MainStay Funds or by
the Distributor to sell or a solicitation of any offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is
unlawful to make such offer in such jurisdiction.
Shareholder inquiries should be made by writing directly to MainStay
Shareholder Services, Inc., P.O. Box 8401, Boston, Massachusetts 02266-8401, or
by calling 1-800-MAINSTAY. In addition, you can make inquiries through your
registered representative.
The financial statements of each of the Funds, except for the MAP Equity
Fund, including the Statements of Assets and Liabilities, the Portfolio of
Investments and the Statement of Operations for the year ended December 31,
1998, the Statement of Changes in Net Assets for the years ended December 31,
1998 and 1997, the Notes to the Financial Statements and the Reports of
Independent Accountants, all of which are included in the 1998 Annual Reports to
the Shareholders are hereby incorporated by reference into this Statement of
Additional Information.
In addition, the financial statements of the MAP-Equity Fund, the
predecessor of the MainStay MAP Equity Fund, including the Statement of Assets
and Liabilities, the Portfolio of Investments and the Statement of Operations
for the year ended December 31, 1998, the Statement of Changes in Net Assets for
the years ended December 31, 1998 and 1997, the Notes to the Financial
Statements and the Report of Independent Accountants, all of which are included
in the MAP-Equity Fund's 1998 Annual Report to the Shareholders are hereby
incorporated by reference into this Statement of Additional Information.
An audited financial statement for NYLIFE Inc., as of December 31, 1998, is
included in this Statement of Additional Information.
1
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
The MainStay Funds 5
Additional Information About Certain Funds 5
Blue Chip Growth Fund 5
Convertible Fund 6
Equity Index Fund 6
Global High Yield Fund 6
Government Fund 7
High Yield Corporate Bond Fund 7
International Bond Fund 8
International Equity Fund 8
MAP Equity Fund 9
Money Market Fund 9
Research Value Fund 11
Small Cap Value Fund 11
Strategic Income Fund 11
Strategic Value Fund 12
Tax Free Bond Fund 13
Total Return Fund 14
The Equity Index Fund Guarantee 14
How the Indexing Works 16
Risk Factors Affecting California Municipal Securities 17
Risk Factors Affecting New York Municipal Securities 24
Special Considerations Affecting Puerto Rico 34
Investment Practices and Instruments Common to Multiple Funds 37
Temporary Defensive Measures 37
Repurchase Agreements and Reverse Repurchase Agreements 38
Lending of Portfolio Securities 39
Cash Equivalents 39
Bank Obligations 40
Commercial Paper 40
U.S. Government Securities 40
Debt Securities 40
Convertible Securities 41
Arbitrage 42
Foreign Securities 42
Foreign Currency Transactions 43
Foreign Index-Linked Instruments 45
Brady Bonds 45
Municipal Securities 46
Industrial Development and Pollution Control Bonds 48
Variable Rate Demand Notes ("VRDNs") 49
</TABLE>
2
<PAGE> 3
<TABLE>
<S> <C>
Floating and Variable Rate Securities 49
Zero Coupon Bonds 50
Standby Commitments -- Obligations with Puts Attached 50
When-Issued Securities 50
Mortgage-Related and Other Asset-Backed Securities 51
Warrants 56
Short Sales Against the Box 56
Options on Securities 57
Options on Foreign Currencies 60
Securities Index Options 61
Futures Transactions 62
Swap Agreements 69
Loan Participation Interests 70
Real Estate Investment Trusts ("REITs") 71
Risks Associated with Debt Securities 71
Risks of Investing in High Yield Securities ("Junk Bonds") 72
Fundamental Investment Restrictions 72
Non-Fundamental Investment Restrictions 74
Trustees and Officers 77
The Manager, the Subadvisers and the Distributor 84
Management Agreement 84
Sub-Advisory Agreements 85
Distribution Agreement 89
Distribution Plans 90
Other Services 99
Expenses Borne by the Trust 100
Portfolio Transactions and Brokerage 100
Net Asset Value 104
Shareholder Investment Account 106
Shareholder Servicing Agent 106
Purchase, Redemption, Exchanges and Repurchase 106
How to Purchase Shares of the Funds 106
Alternative Sales Arrangements 108
Purchases at NAV 110
Reduced Sales Charges on Class A Shares 111
Letter of Intent ("LOI") 111
Contingent Deferred Sales Charge, Class A 111
Contingent Deferred Sales Charge, Class B 112
Contingent Deferred Sales Charge, Class C 113
Redemptions and Exchanges 114
Distributions in Kind 114
Suspension of Redemptions 115
Exchange Privileges 115
Distributions and Redemptions for Equity Index Fund 116
</TABLE>
3
<PAGE> 4
<TABLE>
<S> <C>
Tax-Deferred Retirement Plans 117
Cash or Deferred Profit Sharing Plans Under Section 401(k) for
Corporations and Self-Employed Individuals 117
Individual Retirement Account ("IRA") 117
403(b)(7) Tax Sheltered Account 118
General Information 118
Calculation of Performance Quotations 119
Tax Information 128
Taxation of the Funds 128
Character of Distributions to Shareholders -- General 129
Character of Distributions to Shareholders -- The Tax-Free Funds 130
Discount 130
Users of Bond-Financed Facilities 131
Taxation of Options, Futures and Similar Instruments 131
Passive Foreign Investment Companies 132
Foreign Currency Gains and Losses 132
Commodity Investments 133
Dispositions of Fund Shares 133
Tax Reporting Requirements 133
Foreign Taxes 134
State and Local Taxes - General 134
Explanation of Fund Distributions 135
Additional Information Regarding the Equity Index Fund 135
Additional Information Regarding the California Tax Free Fund and New
York Tax Free Fund 135
Annual Statements 136
General Information 136
Organization and Capitalization 137
General 137
Voting Rights 137
Shareholder and Trustee Liability 137
Registration Statement 137
Share Ownership of the Funds 138
Other Information 150
Independent Accountants 150
Transfer Agent 150
Custodians 150
Legal Counsel 151
Code of Ethics 151
Appendix A -- Description of Securities Ratings 152
NYLIFE Inc. and Subsidiaries -- Consolidated Financial Statements
December 31, 1998 and 1997 156
</TABLE>
4
<PAGE> 5
THE MAINSTAY FUNDS
The MainStay Funds (the "Trust") is an open-end management investment
company (or mutual fund) currently consisting of 23 separate investment
portfolios: Blue Chip Growth Fund, California Tax Free Fund, Capital
Appreciation Fund, Convertible Fund, Equity Income Fund, Equity Index Fund,
Global High Yield Fund, Government Fund, Growth Opportunities Fund, High Yield
Corporate Bond Fund, International Bond Fund, International Equity Fund, MAP
Equity Fund, Money Market Fund, New York Tax Free Fund, Research Value Fund,
Small Cap Growth Fund, Small Cap Value Fund, Strategic Income Fund, Strategic
Value Fund, Tax Free Bond Fund, Total Return Fund and Value Fund (individually
referred to as a "Fund" or, collectively, the "Funds"). MainStay Management,
Inc. (the "Manager") serves as the manager for the Funds and has entered into
Sub-Advisory Agreements with Monitor Capital Advisors, Inc. ("Monitor") with
respect to the Equity Index Fund; Gabelli Asset Management Company ("GAMCO")
with respect to the Blue Chip Growth Fund; John A. Levin & Co., Inc. ("John A.
Levin & Co.") with respect to the Research Value Fund; Dalton Greiner, Hartman,
Maher & Co. ("DGHM") with respect to the Small Cap Value Fund; Madison Square
Advisors, Inc. ("Madison Square Advisors") with respect to the Growth
Opportunities Fund; Markston International LLC ("Markston") with respect to the
MAP Equity Fund and MacKay-Shields Financial Corporation ("MacKay-Shields") with
respect to the remaining 17 Funds; MacKay-Shields, Monitor, GAMCO, John A. Levin
& Co., Dalton, Greiner, Madison Square Advisors and Markston are sometimes
jointly referred to as the "Subadvisers."
The Trust, formed January 9, 1986, is a Massachusetts business trust. Each
Fund, other than California Tax Free Fund, Equity Index Fund, International Bond
Fund, Global High Yield Fund, and New York Tax Free Fund, is a diversified fund
as defined by the Investment Company Act of 1940, as amended (the "1940 Act").
ADDITIONAL INFORMATION ABOUT CERTAIN FUNDS
The Prospectus discusses the investment objectives of the Funds and the
principal investment strategies to be employed in seeking to achieve those
objectives. This section contains supplemental information concerning certain of
the securities and other instruments in which the Funds may invest, the
principal investment strategies the Funds may utilize, and certain risks
involved with those strategies.
NONE OF THE FUNDS ALONE CONSTITUTES A COMPLETE INVESTMENT PROGRAM.
Investment decisions for each Fund are made independently from those of the
other accounts and investment companies that may be managed by a Subadviser.
However, if such other accounts or investment companies are prepared to invest
in, or desire to dispose of, securities in which a Fund invests at the same time
as another fund or another account managed by the same Subadviser, available
investments or opportunities for sales will be allocated equitably to each. In
some cases, this procedure may adversely affect the size of the position
obtained for or disposed of by a Fund or the price paid or received by a Fund.
BLUE CHIP GROWTH FUND
The Fund will generally invest in Blue Chip companies, with the Subadviser
selecting those securities which it perceives to be undervalued or to otherwise
have growth potential. Blue Chip companies are those which occupy (or in the
Subadviser's judgment have the potential to occupy) leading market positions
that are expected to be maintained or enhanced over time. Market leaders can be
identified within an industry as those companies which have: superior growth
prospects compared with other companies in the same industry; possession of
proprietary technology with the potential to bring about major changes within an
industry; and/or leading sales within an industry, or the potential to become a
market leader.
In addition, Blue Chip companies possess at least one of the following
attributes: faster earnings growth than its competitors and the market in
general; higher profit margins relative to its competitors; strong cash flow
relative to its competitors; and/or a balance sheet with relatively low debt and
a high return on equity relative to its competitors.
5
<PAGE> 6
The Fund's investments will usually be sold when they lose their perceived
value relative to other similar or alternative investments. Specific sources of
information used to select securities for the Fund include: general economic and
industry data provided by the U.S. government, various trade associations;
annual and quarterly reports and Form 10-Ks; and direct interviews with company
management. Research is directed towards locating stocks that are undervalued
relative to their future earnings potential.
CONVERTIBLE FUND
In selecting convertible securities for purchase or sale, the Subadviser
takes into account a variety of investment considerations, including credit
risk, projected interest return and the premium for the convertible security
relative to the underlying common stock. The Fund may sell short against the
box, among other reasons, to hedge against a possible market decline in the
value of the security owned or to enhance liquidity.
EQUITY INDEX FUND
When the Fund has cash reserves, the Fund may invest in S&P 500 Index
Futures, cash equivalents, U.S. government securities and repurchase agreements
with respect thereto. The Fund may also invest up to 25% of its total assets in
securities of issuers in one industry (unless the Index exceeds that
concentration) and lend up to 30% of its total assets to financial institutions.
The Fund seeks to provide investment results that correspond to the total
return performance of the S&P 500 Composite Stock Price Index. The Fund
regularly monitors how well its performance corresponds to that Index and seeks
to take corrective action whenever the correlation between the Fund's
performance and the Index is less than 0.95.
GLOBAL HIGH YIELD FUND
Investors should understand that international fixed income investments
involve more risk than comparable domestic securities, due, in part, to
fluctuating currency values.
In making investments for the foreign and emerging markets sectors of the
Fund, the Subadviser considers factors such as prospects for currency exchange
and interest rates, and inflation in each country, relative economic growth,
government policies influencing exchange rates and business conditions, and
credit quality of individual issuers. The Subadviser will also determine, using
good faith and judgement, (1) the percentage of the Fund's assets to be invested
in each emerging market; (2) currency exposure (asset allocation across
currencies); and (3) diversified security holdings within each market.
The Fund may invest in participation interests in loans. Such participation
interests, which may take the form of interests in, or assignments of, loans,
are acquired from banks which have made loans or are members of lending
syndicates. The Fund's investments in loan participation interests will be
subject to its limitation on investments in illiquid securities and, to the
extent applicable, its limitation on investments in securities rated below
investment grade.
To hedge the market value of securities held, proposed to be held or sold
or relating to foreign currency exchange rates, the Fund may enter into or
purchase securities or securities index options, foreign currency options, and
futures contracts and related options with respect to securities, indexes of
securities, or currencies. The Fund also may buy and sell currencies on a spot
or forward basis. Subject to compliance with applicable rules, futures contracts
and related options may be used for any legally permissible purpose, including
as a substitute for acquiring a basket of securities and to reduce transaction
costs. The Fund may also purchase and sell foreign exchange contracts and
foreign currency options for purposes of seeking to enhance portfolio returns
and manage portfolio risk more efficiently. The Fund is not obligated to use any
of these instruments, but its Subadviser may do so, when, in its discretion, it
believes it advisable.
6
<PAGE> 7
GOVERNMENT FUND
This Fund seeks to achieve its investment objective by investing primarily
in U.S. government securities, which include obligations issued or guaranteed by
the U.S. government or its agencies or instrumentalities which are supported by:
(i) the full faith and credit of the U.S. government (e.g., Government National
Mortgage Association ("GNMA") certificates); (ii) the right of the issuer to
borrow an amount limited to a specific line of credit from the U.S. government;
(iii) the credit of the instrumentality (e.g., bonds issued by the Federal
National Mortgage Association ("FNMA")); or (iv) the discretionary authority of
the U.S. government to purchase certain obligations of U.S. government agencies
or instrumentalities.
The agencies and instrumentalities that issue U.S. government securities
include, among others: Federal Land Banks, Farmers Home Administration, Central
Bank for Cooperatives, Federal Intermediate Credit Banks, Federal Farm Credit
Bank, Student Loan Marketing Association and U.S. Maritime Administration.
The Fund anticipates that a significant portion of its portfolio may
consist of Treasury bonds, GNMA mortgage-backed certificates and other U.S.
government securities representing ownership interests in mortgage pools, such
as securities issued by FNMA and the Federal Home Loan Mortgage Corporation
("FHLMC").
Although the mortgage loans in the pool underlying a GNMA certificate will
have maturities of up to 30 years, the actual average life of a GNMA certificate
typically will be substantially less because the mortgages will be subject to
normal principal amortization and may be prepaid prior to maturity.
The duration of the Fund's portfolio will be managed in light of current
and projected economic and market conditions and other factors considered
relevant by the Subadviser.
HIGH YIELD CORPORATE BOND FUND
This Fund seeks to maximize current income through investment in a
diversified portfolio of high yield debt securities. Capital appreciation is a
secondary objective; and will be sought only when consistent with the Fund's
primary objective. For example, capital appreciation may be sought by
lengthening the maturities of high yield debt securities held in the Fund's
portfolio during periods when the Subadviser expects interest rates to decline.
Since available yields and yield differentials vary over time, no specific
level of income or yield differential can ever be ensured.
Debt securities in which the Fund may invest include all types of debt
obligations of both domestic and foreign issuers, such as bonds, debentures,
notes, equipment lease certificates, equipment trust certificates, conditional
sales contracts, commercial paper and U.S. government securities (including
obligations, such as repurchase agreements, secured by such instruments).
The Fund may invest in participation interests in loans. Such participation
interests, which may take the form of interests in, or assignments of, loans,
are acquired from banks which have made loans or are members of lending
syndicates. The Fund's investments in loan participation interests will be
subject to its limitation on investments in illiquid securities and, to the
extent applicable, its limitation on investments in securities rated below
investment grade.
The Subadviser seeks to reduce risk through diversification, credit
analysis and attention to current developments and trends in both the economy
and financial markets. In addition, investments in foreign securities may serve
to provide further diversification.
7
<PAGE> 8
INTERNATIONAL BOND FUND
The International Bond Fund may be appropriate for investors who are
seeking competitive overall return commensurate with an acceptable level of risk
from an international portfolio of debt securities, but who also understand that
international fixed income investments involve more risk than comparable
domestic securities, due, in part, to fluctuating currency values. In making
investments for the Fund, the Subadviser considers factors such as prospects for
currency exchange and interest rates, and inflation in each country, relative
economic growth, government policies influencing exchange rates and business
conditions, and quality of individual issuers. The Subadviser will also
determine, using good faith and judgement, (1) country allocation; (2) currency
exposure (asset allocation across currencies); and (3) diversified security
holdings within each market.
To hedge the market value of securities held, proposed to be held or sold
or relating to foreign currency exchange rates, the Fund may enter into or
purchase securities or securities index options, foreign currency options, and
futures contracts and related options with respect to securities, indexes of
securities, or currencies. The Fund also may buy and sell currencies on a spot
or forward basis. Subject to compliance with applicable rules, futures contracts
and related options may be used for any legally permissible purpose, including
as a substitute for acquiring a basket of securities and to reduce transaction
costs. The Fund may also purchase and sell foreign exchange contracts and
foreign currency options for purposes of seeking to enhance portfolio returns or
to manage portfolio risk more efficiently. The Fund is not obligated to use any
of these instruments but may do so when the Subadviser, in its discretion,
believes it advisable.
Generally, the Fund's average maturity will be shorter when interest rates
worldwide or in a particular country are expected to rise, and longer when
interest rates are expected to fall. The Fund may use various techniques to
shorten or lengthen the dollar-weighted average maturity of its portfolio,
including transactions in futures and options on futures, interest rate swaps,
caps, floors and short sales against the box. The duration of the Fund's
portfolio will be managed in light of current and projected economic and market
conditions and other factors considered relevant by the Subadviser.
INTERNATIONAL EQUITY FUND
In making investments for the Fund, the Subadviser considers factors such
as prospects for currency exchange and interest rates, and inflation in each
country, relative economic growth, government policies influencing exchange
rates and business conditions, and quality of individual issuers. The Subadviser
will also determine, using good faith judgement, (1) country allocation; (2)
currency exposure (asset allocation across currencies); and (3) diversified
security holdings within each market. To hedge the market value of securities
held, proposed to be held or sold, or relating to foreign currency exchange
rates, the Fund may enter into or purchase securities or securities index
options, foreign currency options, and future contracts and related options with
respect to securities, indexes of securities or currencies. The Fund also may
buy and sell currencies on a spot or forward basis. Subject to compliance with
applicable rules, futures contracts and related options may be used for any
legally permissible purpose, including as a substitute for acquiring a basket of
securities and to reduce transaction costs. The Fund also may purchase
securities on a when-issued or forward commitment basis and engage in portfolio
securities lending. The Fund may use all of these techniques (1) in an effort to
manage cash flow and remain fully invested in the stock and currency markets,
instead of or in addition to buying and selling stocks and currencies, or (2) in
an effort to hedge against a decline in the value of securities or currencies
owned by it or an increase in the price of securities which it plans to
purchase. The Fund may also purchase and sell foreign currency exchange
contracts and foreign currency options for purposes of seeking to enhance
portfolio returns or to manage portfolio risk more efficiently. The Fund is not
obligated to use any of these instruments, but may do so when the Subadviser, in
its discretion, believes it advisable.
The International Equity Fund may invest in American Depositary Receipts
("ADRs") European Depositary Receipts ("EDRs"), Global Depositary Receipts
("GDRs"), International Depositary Receipts ("IDRs") or other similar securities
convertible into securities of foreign issuers. An ADR is a receipt typically
issued by a U.S. bank or trust company showing that you own a foreign security.
An EDR is a receipt typically issued by a European bank or trust company showing
that you own a foreign security. GDRs and IDRs are receipts typically issued by
global or international depositories showing that you own a foreign security.
8
<PAGE> 9
MAP EQUITY FUND
The Fund may invest in warrants. A warrant is a right which entitles its
holder, for a specified period of time, to acquire a specified number of shares
of common stock for a specified price per share. If the share price at the time
the warrant is exercised exceeds the total of the exercise price of the warrant
and its purchase price, the Fund experiences a gain to the extent this total is
exceeded by the share price. However, if the share price at the time the warrant
expires is less than the exercise price of the warrant, the Fund will suffer a
loss of the purchase price of the warrant.
The Fund restricts its investment in securities of foreign issuers to no
more than 10% of the value of the Fund's total net assets. Such securities may
be subject to additional federal taxes which would increase the cost of such
investments and may be subject to foreign government taxes which could reduce
the income yield on such securities.
In addition, the Fund may also buy "restricted" securities which cannot be
sold publicly until registered under the Securities Act of 1933. The Fund's
ability to dispose of investments in "restricted" securities at reasonable price
levels might be limited unless and until their registration under the Securities
Act of 1933 has been completed. The Fund will endeavor to have the issuing
company pay all the expenses of any such registration, but there is no assurance
that the Fund will not have to pay all or some of these expenses.
MONEY MARKET FUND
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars).
All of the assets of the Fund generally will be invested in obligations
which mature in 397 days or less and substantially all of these investments will
be held to maturity; however, securities collateralizing repurchase agreements
may have maturities in excess of 397 days. The Fund will, to the extent
feasible, make portfolio investments primarily in anticipation of, or in
response to, changing economic and money market conditions and trends. The
dollar-weighted average maturity of the Fund's portfolio may not exceed 90 days.
Consistent with the provisions of Rule 2a-7 under the 1940 Act ("Rule 2a-7"),
the Fund invests only in U.S. dollar-denominated money market instruments that
present minimal credit risk and, with respect to 95% of its total assets,
measured at the time of investment, that are of the highest quality. The
Subadviser shall determine whether a security presents minimal credit risk under
procedures adopted by the Fund's Board of Trustees. A money market instrument
will be considered to be of the highest quality (1) if rated in the highest
rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-1 by S&P's) by (i)
any two nationally recognized statistical rating organizations ("NRSROs") or,
(ii) if rated by only one NRSRO, by that NRSRO; (2) if issued by an issuer that
has received a short-term rating from an NRSRO with respect to a class of debt
obligations that is comparable in priority and security, and that is rated in
the highest rating category by (i) any two NRSRO's or, (ii) if rated by only one
NRSRO, by that NRSRO;(3) an unrated security that is of comparable quality to a
security in the highest rating category as determined by the Subadviser;(4)(i)
with respect to a security that is subject to any features that entitle the
holder, under certain circumstances, to receive the approximate amortized cost
of the underlying security or securities plus accrued interest ("Demand
Feature") or an obligation of a person other than the issuer of the security,
under certain circumstances, to undertake to pay the principal amount of the
underlying security plus interest ("Guarantee Obligation"), the Guarantee
Obligation has received a rating from an NRSRO or the Guarantee Obligation is
issued by a guarantor that has received a rating from an NRSRO with respect to a
class of debt obligations that is comparable in priority and security to the
Guarantee Obligation, with certain exceptions, and (ii) the issuer of the Demand
Feature or Guarantee Obligation, or another institution, has undertaken promptly
to notify the holder of the security in the event that the Demand Feature or
Guarantee Obligation is substituted with another Demand Feature or Guarantee
Obligation,(5) if it is a security issued by a money market fund registered with
the Securities and Exchange Commission ("SEC") under the 1940 Act; or (6) if it
is a government security as defined in Rule 2a-7. With respect to 5% of its
total assets, measured at the time of investment, the Fund may also invest in
money market instruments that are in the second-highest rating category for
short-term debt obligations (i.e., rated Aa or Prime-2 by Moody's or AA or A-2
by S&P).
9
<PAGE> 10
The Fund may not invest more than 5% of its total assets, measured at the
time of investment, in securities of any one issuer that are in the highest
rating category, except that the Fund may exceed this 5% limitation with respect
to 25% of its total assets for up to three business days after the purchase of
securities of any one issuer and except that this limitation shall not apply to
U.S. government securities or securities subject to certain Guarantee
Obligations. The Fund may not invest more than the greater of 1% of its total
assets or one million dollars, measured at the time of investment, in securities
of any one issuer that are in the second-highest rating category. Immediately
after the acquisition of any Demand Feature or Guarantee Obligation, the Fund,
with respect to 75% of its total assets, shall not have invested more than 10%
of its assets in securities issued by or subject to Demand Features or Guarantee
Obligations from the institution that issued the Demand Feature or Guarantee
Obligation, with certain exceptions. In addition, immediately after the
acquisition of any Demand Feature or Guarantee Obligation (or a security after
giving effect to the Demand Feature or Guarantee Obligation) that is a not
within the highest rating category by NRSROs, the Fund shall not have invested
more than 5% of its total assets in securities issued by or subject to Demand
Features or Guarantee Obligations from the institution that issued the Demand
Feature or Guarantee Obligation. In the event that an instrument acquired by the
Fund is downgraded or otherwise ceases to be of the quality that is eligible for
the Fund, the Subadviser, under procedures approved by the Board of Trustees,
shall promptly reassess whether such security presents minimal credit risk and
shall recommend to the Valuation Committee of the Board (the "Valuation
Committee") that the Fund take such action as it determines is in the best
interest of the Fund and its shareholders. The Valuation Committee, after
consideration of the recommendation of the Sub- Adviser and such other
information as it deems appropriate, shall cause the Fund to take such action as
it deems appropriate, and shall report promptly to the Board the action it has
taken and the reasons for such action.
Pursuant to the rule, the Fund uses the amortized cost method of valuing
its investments, which facilitates the maintenance of the Fund's per share net
asset value at $1.00. The amortized cost method, which is normally used to value
all of the Fund's portfolio securities, involves initially valuing a security at
its cost and thereafter amortizing to maturity any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument.
The Trustees have also established procedures designed to stabilize, to the
extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of the
Fund's portfolio by the Trustees, at such intervals as they deem appropriate, to
determine whether the Fund's net asset value calculated by using available
market quotations or market equivalents (the determination of value by reference
to interest rate levels, quotations of comparable securities and other factors)
deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Trustees. If such deviation
exceeds 1/2 of 1%, the Trustees will promptly consider what action, if any, will
be initiated. In the event the Trustees determine that a deviation exists which
may result in material dilution or other unfair results to investors or existing
shareholders, they will take such corrective action as they regard to be
necessary and appropriate, including the sale of portfolio instruments prior to
maturity to realize capital gains or losses or to shorten average portfolio
maturity; withholding part or all of dividends or payment of distributions from
capital or capital gains; redemptions of shares in kind; or establishing a net
asset value per share by using available market quotations or equivalents. In
addition, in order to stabilize the net asset value per share at $1.00, the
Trustees have the authority (1) to reduce or increase the number of shares
outstanding on a pro rata basis, and (2) to offset each shareholder's pro rata
portion of the deviation between the net asset value per share and $1.00 from
the shareholder's accrued dividend account or from future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset value
per share. Holdings of cash, on which no return is earned, would tend to lower
the yield on the Fund's shares.
10
<PAGE> 11
The Fund may also, consistent with the provisions of Rule 2a-7, invest in
securities with a face maturity of more than 397 days, provided that the
security is a variable or floating rate security that meets the guidelines of
Rule 2a-7 with respect to maturity.
RESEARCH VALUE FUND
Under normal market conditions, the Fund invests at least 80% of its total
assets in common stock and other securities having equity characteristics. For
hedging purposes, the Fund may use options on securities, stock index options,
and stock index futures and related options. These investments involve certain
risks. The Fund may also invest in debt securities, including U.S. Government
securities and corporate debt securities (such as bonds, notes and debentures).
Certain of the Fund's investments in debt securities will be obligations which,
at the time of purchase, are rated "A" or better by S&P or Moody's or, if
unrated, are of comparable quality as determined by the Subadviser.
However, the Fund may invest up to 5% of the value of its total assets in
non-convertible, non-investment grade debt securities (commonly known as "high
yield" or "junk" bonds). These investments involve certain risks. The Fund may
also invest in money market instruments, including repurchase agreements.
Investments in debt securities will generally be made to reduce the Fund's
equity exposure. During periods of high market valuations or adverse market
conditions or for liquidity purposes, all or any portion of the Fund's assets
may be invested temporarily in high quality debt securities or money market
instruments, or held as cash.
SMALL CAP VALUE FUND
It is expected that stock price performance for those firms that generate
cash flow substantially exceeding normal capital spending requirements generally
betters that of the equity market as a whole. At any given time, a large
percentage of the Fund's portfolio may consist of substantial free cash flow
generators. Sell decisions are driven by the Subadviser's proprietary
multifactor model or a change in fundamental expectations. Positions are
eliminated when price appreciation renders a sale rating based on the
Subadviser's valuation model. The Fund may invest up to 15% of net assets in
real estate investment trusts ("REITs").
STRATEGIC INCOME FUND
In managing the Fund, the Subadviser conducts a continuing review of yields
and other information derived from a data base which it maintains in managing
fixed-income portfolios. Fundamental economic cycle analysis, credit quality and
interest rate trends are among the principal factors considered by the
Subadviser in determining whether to increase or decrease the emphasis placed
upon a particular type of security or bond market sector within the Fund's
investment portfolio.
In making investment decisions with respect to maturity shifts, the
Subadviser takes into account a broad range of fundamental and technical
indicators. The Subadviser will alter the average maturity of the portfolio in
accordance with its judgment based on the research and other methods described
above.
In seeking a competitive overall return, capital appreciation may be sought
by lengthening the maturities of high yield debt securities held in the Fund's
portfolio during periods when the Subadviser expects interest rates to decline.
If the Subadviser is incorrect in its expectations of changes in interest rates,
or in its evaluation of the normal yield relationship between two securities,
the Fund's income, NAV and potential capital gains could decrease; or the
potential loss could increase. This and other factors may affect the income
available for distribution to shareholders.
Since available yields and yield differentials vary over time, no specific
level of income or yield differential can ever be ensured.
Debt securities in which the Fund may invest include all types of debt
obligations of both domestic and foreign issuers, such as bonds, debentures,
notes, equipment lease certificates, equipment trust certificates, conditional
sales
11
<PAGE> 12
contracts, commercial paper, foreign government securities and U.S. government
securities (including obligations, such as repurchase agreements, secured by
such instruments).
The Fund may invest up to 30% of its total assets in equity securities.
These may include capital notes, which are securities representing beneficial
interests in a trust for which the controlling common stock is owned by a bank
holding company. These beneficial interests are commonly issued as preferred
stock but may also be issued as other types of instruments. The trust owns
debentures issued by the bank holding company and issues the preferred stock to
investors.
In making investments in foreign securities the Subadviser will determine,
using good faith and judgement, (1) country allocation; (2) currency exposure
(asset allocation across currencies); and (3) diversified security holdings
within each market. The Subadviser may consider factors such as prospects for
currency exchange and interest rates and inflation in each country, relative
economic growth, government policies influencing exchange rates and business
conditions, and quality of individual issuers.
To hedge the market value of securities held, proposed to be held or sold
or relating to foreign currency exchange rates, the Fund may enter into or
purchase securities or securities index options, foreign currency options, and
futures contracts and related options with respect to securities, indexes of
securities, or currencies. The Fund also may buy and sell currencies on a spot
or forward basis. Subject to compliance with applicable rules, futures contracts
and related options may be used for any legally permissible purpose, including
as a substitute for acquiring a basket of securities and to reduce transaction
costs. The Fund may also purchase and sell foreign currency exchange contracts
for purposes of seeking to enhance portfolio returns and manage portfolio risk
more efficiently.
Generally, the average maturity of the foreign securities held by the Fund
will be shorter when interest rates worldwide or in a particular country are
expected to rise, and longer when interest rates are expected to fall. The Fund
may use various techniques to shorten or lengthen the dollar-weighted average
maturity of its portfolio, including transactions in futures and options on
futures, interest rate swaps, caps, floors and short sales against the box.
The duration of the Fund's portfolio will be managed in light of current
and projected economic and market conditions and other factors considered
relevant by the Subadviser.
The Subadviser seeks to reduce risk through diversification, credit
analysis and attention to current developments and trends in both the economy
and financial markets.
STRATEGIC VALUE FUND
In managing the Fund, the Subadviser conducts a rigorous, disciplined
valuation methodology to maximize the most appropriate investment levels among
the three asset classes. Fundamental economic analysis, risk and return
estimations, credit quality and interest rate trends are among the principal
factors considered by the Subadviser in determining whether to increase or
decrease the emphasis placed on a particular type of security or bond within the
Fund's investment portfolio. In the event that the Subadviser's analysis
indicates that the Fund should be fully invested in only one asset group, the
Subadviser will still adhere to the limitations on the amount of assets which
may be allocated to each of the three asset groups.
In analyzing different securities to assess their relative attractiveness,
the Subadviser's value investment process emphasizes such factors as low price
to earnings and price to cash flow ratios, financial strength and earnings
predictability. The Fund intends to purchase those securities which it believes
to be undervalued in the market relative to comparable securities based on the
foregoing analysis.
In assessing whether a stock is undervalued, the Subadviser considers,
among other factors, a company's financial strength and earnings predictability.
The Fund may provide some protection on the downside through its investment in
companies whose current stock prices reflect, in the Subadviser's opinion,
either unwarranted pessimism or unrecognized value.
12
<PAGE> 13
In selecting convertible securities for purchase or sale, the Subadviser
takes into account a variety of investment considerations, including credit
risk, projected interest return and the premium for the convertible security
relative to the underlying common stock.
In seeking a competitive overall return, capital appreciation may be sought
by lengthening the maturities of high yield debt securities held in the Fund's
portfolio during periods when the Subadviser expects interest rates to decline.
If the Subadviser is incorrect in its expectations of changes in interest rates,
or in its evaluation of the normal yield relationship between two securities,
the Fund's income, NAV and potential capital gains could decrease; or the
potential loss could increase. This and other factors may affect the income
available for distribution to shareholders.
Since available yields and yield differentials vary over time, no specific
level of income or yield differential can ever be ensured.
Debt securities in which the Fund may invest include all types of debt
obligations of both domestic and foreign issuers, such as bonds, debentures,
notes, equipment lease certificates, equipment trust certificates, conditional
sales contracts, commercial paper, foreign government securities and U.S.
government securities (including obligations, such as repurchase agreements,
secured by such instruments). For purposes of the Fund's investment policies,
the Fund considers preferred stock to be a debt obligation.
The Fund's investments may include capital notes, which are securities
representing beneficial interest in a trust for which the controlling common
stock is owned by a bank holding company. These beneficial interests are
commonly issued as preferred stock but may also be issued as other types of
instruments. The trust owns debentures issued by the bank holding company and
issues the preferred stock to investors.
In making investments in foreign securities the Subadviser will determine,
using good faith and judgement, (1) country allocation; (2) currency exposure
(asset allocation across currencies); and (3) diversified security holdings
within each market. The Subadviser may consider factors such as prospects for
currency exchange and interest rates, and inflation in each country, relative
economic growth, government policies influencing exchange rates and business
conditions, and quality of individual issuers.
To hedge the market value of securities held, proposed to be held or sold
or relating to foreign currency exchange rates, the Fund may enter into or
purchase securities or securities index options, foreign currency options, and
futures contracts and related options with respect to securities, indexes of
securities, or currencies. The Fund also may buy and sell currencies on a spot
or forward basis. Subject to compliance with applicable rules, futures contracts
and related options may be used for any legally permissible purpose, including
as a substitute for acquiring a basket of securities and to reduce transaction
costs. The Fund may also purchase and sell foreign exchange contracts and
foreign currency options for purposes of seeking to enhance portfolio returns or
to manage portfolio risk more efficiently.
TAX FREE BOND FUND
This Fund invests in obligations of states and their political subdivisions
and agencies, the interest from which is, in the opinion of the issuer's bond
counsel, exempt from regular federal income tax ("Municipal Bonds" or
"tax-exempt securities"). None of the Fund, the Subadviser nor counsel to the
Fund reviews such opinions or otherwise determines independently that the
interest on a security will be classified as tax-exempt interest.
Municipal Bonds are issued to obtain funds for various public purposes. The
interest on these obligations is generally exempt from regular federal income
tax in the hands of most investors. Because the Fund may hold high-grade
Municipal Bonds, the income earned on shares of the Fund may tend to be less
than it might be on a portfolio emphasizing lower quality securities.
Conversely, to the extent that the Fund holds lower quality securities, the risk
of default in the payment of principal or interest by the issuer of a portfolio
security is greater than if the Fund held only higher quality securities.
Although higher quality tax-exempt securities may produce lower yields, they are
generally more marketable. To protect the Fund's capital under adverse market
conditions, the Fund may from time to time
13
<PAGE> 14
purchase higher quality securities or taxable short-term investments with a
resultant decrease in yield or increase in the proportion of taxable income.
The Fund may sell a security at any time in order to improve the yield on
the Fund's portfolio. In buying and selling portfolio securities, the Fund seeks
to take advantage of market developments, yield disparities and variations in
the creditworthiness of issuers. The Fund will not engage in arbitrage
transactions.
The Fund may invest in Industrial Development and Pollution Control Bonds
and municipal lease obligations.
From time to time, the Fund may invest 25% or more of the value of its
total assets in Municipal Bonds that are related in such a way that an economic,
business, or political development or change affecting one such security could
also affect the other securities (for example, securities whose issuers are
located in the same state). The Fund may also invest 25% or more of the value of
its total assets in Industrial Development Bonds. Further, the Fund may acquire
all or part of privately negotiated loans made to tax-exempt borrowers. To the
extent that these private placements are not readily marketable, the Fund will
limit its investment in such securities (along with all other illiquid
securities) to no more than 10% of the value of its total assets. Because an
active trading market may not exist for such securities, the price that the Fund
may pay for these securities or receive on their resale may be lower than that
for similar securities with a more liquid market.
The duration of the Fund's portfolio will be managed in light of current
and projected economic and market conditions and other factors considered
relevant by the Subadviser.
TOTAL RETURN FUND
The Fund may invest in common stocks, convertible securities, warrants and
fixed-income securities, such as bonds, preferred stocks and other debt
obligations, including money market instruments. The Fund will also invest in
stocks and other equity securities which it believes to be undervalued based
upon factors such as ratios of market price to book value, estimated liquidating
value and projected cash flow.
The duration of the Fund's portfolio will be managed in light of current
and projected economic and market conditions and other factors considered
relevant by the Subadviser.
Although the Total Return Fund does not intend to seek short-term profits,
securities in its portfolio will be sold whenever the Subadviser believes it is
appropriate to do so without regard to the length of time the particular
security may have been held, subject to certain tax requirements for
qualification as a regulated investment company under the Internal Revenue Code
of 1986, as amended (the "Code"). A high turnover rate involves greater expenses
to the Fund and may increase the possibility of shareholders realizing taxable
capital gains. The Fund engages in portfolio trading if it believes a
transaction, net of costs (including custodian charges), will help in achieving
its investment objective.
THE EQUITY INDEX FUND GUARANTEE
NYLIFE Inc. ("NYLIFE"), a New York corporation and a wholly owned
subsidiary of New York Life Insurance Company ("New York Life"), will guarantee
unconditionally and irrevocably pursuant to a Guaranty Agreement between NYLIFE
and the Fund (the "Guarantee") that if, exactly 10 years from the date of
purchase (the "Guarantee Date"), the net asset value of a unit equal to the net
asset value of a Fund share when purchased, plus the value of all dividends and
distributions paid, including cumulative reinvested dividends and distributions
attributable to such share paid during that 10-year period ("Guaranteed Share"),
is less than the public offering price initially paid for the share ("Guaranteed
Amount"), NYLIFE will pay for disbursement to shareholders an amount equal to
the difference between the Guaranteed Amount for each such share and the net
asset value of each such Guaranteed Share outstanding and held by shareholders
as of the close of business on the Guarantee Date. There is no charge to the
Fund or its shareholders for the Guarantee.
14
<PAGE> 15
If, on a particular Guarantee Date, payments must be made under the terms
of the Guarantee, the terms of the Guarantee will obligate NYLIFE
unconditionally and irrevocably to pay to the Equity Index Fund's transfer and
dividend disbursing agent for the benefit of shareholders with that Guarantee
Date an amount equal to the difference between the Guaranteed Amount and net
asset value per each Guaranteed Share (as defined in the Prospectus)
outstanding. The Equity Index Fund's transfer and dividend disbursing agent will
forward the difference between the Guaranteed Amount and the net asset value
directly to each individual shareholder.
A Guaranteed Share (the unit to which the Guaranteed Amount will apply) is
not the same as a share of the Fund. Shareholders who redeem shares, or who
elect to receive dividends and distributions in cash, will own fewer units to
which the Guaranteed Amount applies (i.e., they will own fewer Guaranteed
Shares) and therefore will lose a portion of the benefit of the Guarantee with
respect to any such redemption or dividends or distributions received in cash.
NYLIFE will pay any amounts owing under the Guarantee to the Fund's
transfer and dividend disbursing agent on the fifth business day following a
Guarantee Date. A pro rata portion of any amounts so paid will then be forwarded
to each shareholder holding, as of the close of business on such date,
Guaranteed Shares with that Guarantee Date. If the Guarantee Date should fall on
a weekend or on a holiday, the Guarantee Date shall be the first business day
following the Guarantee Date. The Guarantee is intended to assure each owner of
Guaranteed Shares on a Guarantee Date that he or she will be able to recover, as
of the Guarantee Date, at a minimum, the Guaranteed Amount (with no adjustment
for inflation or the time value of money). The Guarantee will benefit any holder
of such Guaranteed Shares on the relevant Guarantee Date, who need not be the
original purchaser, and who, for example, may own such shares by gift or
inheritance.
Although the Equity Index Fund does not intend to pay dividends and
distributions in cash to shareholders (unless a shareholder elects to receive
payments in cash), such dividends and distributions which are reinvested will be
taxable to shareholders. See "Tax Information." The Guaranteed Amount does not
reflect any adjustment for the payment of taxes by a shareholder on dividends
and distributions received from the Equity Index Fund.
The obligations, if any, of NYLIFE under the Guarantee shall be discharged
when all required payments are made in full to the transfer and dividend
disbursing agent for the benefit of the shareholders or if the Equity Index
Fund's net asset value on a Guarantee Date is such that no amounts are payable
to shareholders under the terms of the Guarantee. Payment obligations under the
Guarantee will be solely the obligations of NYLIFE. Neither the Equity Index
Fund, New York Life, Monitor, NYLIFE Distributors, any of their affiliates nor
any other party is undertaking any obligation to the Equity Index Fund or its
shareholders with respect to the Guarantee.
Although the Guarantee has been arranged for by the Equity Index Fund and
is created under contract between the Equity Index Fund and NYLIFE, the Equity
Index Fund has no interest in, and specifically disclaims any interest in, the
proceeds payable under the Guarantee, which are payable solely to the
shareholders with a particular Guarantee Date. The designation of such
shareholders as the sole beneficiaries of the Guarantee may not be changed by
either the Equity Index Fund or such shareholders. The Guarantee is neither
transferable nor assignable by the Equity Index Fund or the shareholders it
benefits, nor may the Equity Index Fund or its shareholders cancel or waive
rights under the Guarantee. The Guarantee cannot be surrendered by either the
Fund or its shareholders for cash, except in the event that payment is made
pursuant to its terms. Neither the Equity Index Fund nor its shareholders may
use the Guarantee as a pledge for a loan, nor may the Equity Index Fund or its
shareholders obtain any loan from NYLIFE with respect to amounts that may be
payable pursuant to the Guarantee.
The foregoing is only a summary, and not a complete statement of the
principal terms of the Guarantee. Reference is made to the Guarantee, a specimen
copy of which has been filed as an exhibit to the Registration Statement. This
summary is subject thereto and qualified in its entirety by such reference.
If the Fund pays a dividend or distribution in cash to all Fund
shareholders, the amount of the distribution will reduce the Guaranteed Amount
with respect to each Guaranteed Share in the amount of such cash distribution.
Fund shares may
15
<PAGE> 16
be redeemed or exchanged by shareholders prior to their Guarantee Date. However,
any such redeemed or exchanged shares will lose the benefit of the Guarantee.
Following the Guarantee Date, the shares of the Equity Index Fund will be
subject to those risks normally associated with an investment in shares of a
mutual fund that invests in securities represented in the Index.
NYLIFE is a New York holding company incorporated on January 26, 1984.
Audited financial statements for NYLIFE for its most recent fiscal year ended
December 31, 1998, appear in this SAI.
New York Life is a mutual life insurance company. Payment obligations under
the Guarantee will be solely the obligations of NYLIFE. None of the Fund, New
York Life, Monitor, NYLIFE Distributors, NYLIFE Securities Inc., any of their
affiliates nor any other party is undertaking any obligation to the Fund or its
shareholders with respect to the Guarantee. New York Life is not obligated to
pay any claim under the Guarantee or to make additional capital contributions to
NYLIFE.
HOW THE INDEXING WORKS
The weightings of stocks in the Index are based on each stock's relative
total market capitalization (the stock's market price per share times the number
of shares outstanding). The Subadviser seeks to provide investment results which
mirror the performance of the Index. The Subadviser attempts to achieve this
objective by investing in all stocks in the Index in the same proportion as
their representation in the Index.
It is a reasonable expectation that there will be a close correlation
between the Fund's performance and that of the Index in both rising and falling
markets. The correlation between the performance of the Fund and the Index is
expected to be at least 0.95. A correlation of 1.00 would indicate perfect
correlation, which would be achieved when the Fund's NAV, including the value of
its dividend and capital gains distributions, increases or decreases in exact
proportion to changes in the Index. The Fund's correlation, however, may be
affected by, among other things, transaction costs, changes in either the
composition of the Index or number of shares outstanding for the components of
the Index, and the timing and amount of shareholder redemptions, if any.
"Standard & Poor's", "S&P 500", "S&P", "Standard & Poor's 500" and "500"
are trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use
by Monitor Capital Advisors, Inc. S&P does not sponsor, endorse, sell or promote
the Fund or represent the advisability of investing in the Fund.
The Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes no
representation or warranty, express or implied, to the owners of the Fund or any
member of the public regarding the advisability of investing in securities
generally or in the Fund particularly or the ability of the S&P 500 Index to
track general stock market performance. S&P's only relationship to Monitor is
the licensing of certain trademarks and trade names of S&P and of the S&P 500
Index which is determined, composed and calculated by S&P without regard to
Monitor or the Fund. S&P has no obligation to take the needs of Monitor or the
owners of the Fund into consideration in determining, composing or calculating
the S&P 500 Index. S&P is not responsible for and has not participated in the
determination of the prices and amount of the Fund or the timing of the issuance
or sale of the Fund or in the determination or calculation of the equation by
which the Fund is to be converted into cash. S&P has no obligation or liability
in connection with the administration, marketing or trading of the Fund.
S&P does not guarantee the accuracy and/or the completeness of the S&P 500
Index or any data included therein and S&P shall have no liability for any
errors, omissions, or interruptions therein. S&P makes no warranty, express or
implied, as to results to be obtained by Monitor, owners of the Fund, or any
other person or entity from the use of the S&P 500 Index or any data included
therein. S&P makes no express or implied warranties, and expressly disclaims all
warranties of merchantability or fitness for a particular purpose or use with
respect to the S&P 500 Index or any data included therein. Without limiting any
of the foregoing, in no event shall S&P have any liability for any special,
punitive, indirect, or consequential damages (including lost profits), even if
notified of the possibility of such damages.
16
<PAGE> 17
RISK FACTORS AFFECTING CALIFORNIA MUNICIPAL SECURITIES
The following information as to certain California State ("State") risk
factors is given to investors in view of the policy of the MainStay California
Tax Free Fund of concentrating its investments in California municipal issuers.
Such information constitutes only a brief discussion, does not purport to be a
complete description and is based on information from sources believed by the
Trust to be reliable, including official statements relating to securities
offerings of California and municipal issuers, and periodic publications by
national ratings organizations. Such information, however, has not been
independently verified by the Trust.
Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives, as discussed
below, could adversely affect the market values and marketability of, or result
in default of, existing obligations of the State. Obligations of the State or
local governments may also be affected by budgetary pressures affecting the
State and economic conditions in the State.
Certain of the California municipal securities in which the Fund may invest
may be obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's General Fund surplus are distributed to counties, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of the
State's General Fund will be distributed in the future to counties, cities and
their various entities, is unclear.
Certain of the California municipal securities may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, Proposition 13 added Article XIIIA to the
California Constitution. The effect of Article XIIIA is to limit ad valorem
taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
Legislation enacted by the California legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation. The apportionment of property taxes in fiscal
years after 1978-79 was revised pursuant to Statutes of 1979, Chapter 282, which
provides relief funds from State moneys beginning in fiscal year 1979-80 and is
designed to provide a permanent system for sharing State taxes and budget funds
with local agencies. Under Chapter 282, cities and counties receive more of the
remaining property tax revenues collected under Proposition 13 instead of direct
State aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief.
On November 8, 1986, California voters approved an initiative statute known
as "Proposition 62." This statute (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity; (ii)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction; (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed; (iv) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA of the California Constitution; (v) prohibits the imposition of
transaction taxes and sales taxes on the sale of real property by local
governments; (vi) requires that any tax imposed by a local government on or
after August 1, 1985 be ratified by a majority of the electorate within two
years of the adoption of the initiative or be terminated by November 15, 1988;
(vii) requires that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of tax revenue allocated
to such local government occur in an amount equal to the revenues received by
such entity attributable to the tax levied in violation of the initiative; and
(viii) permits these provisions to be amended exclusively by the voters of the
State of California. In September 1988, the California Court of Appeals held
that it was unconstitutional to require that local tax measures be submitted to
the electorate, as described in (vi) above.
17
<PAGE> 18
In September 1995, the California Supreme Court upheld the
constitutionality of Proposition 62, creating uncertainty as to the legality of
certain local taxes enacted by non-charter cities in California without voter
approval.
On November 5, 1996, voters approved Proposition 218, entitled the "Right
to Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions place limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges and
assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, assessments or charges through local initiatives. There are a number of
ambiguities concerning the Proposition and its impact on local governments and
their bonded debt which will require interpretation by the courts or the
Legislature. Proposition 218 does not affect the State or its ability to levy or
collect taxes.
The State is subject to an annual appropriations limit imposed by Article
XIIIB of the State Constitution (the "Appropriations Limit"). The Appropriations
Limit does not restrict appropriations to pay debt service on the bonds or other
voter-authorized bonds. Article XIIIB prohibits the State from spending
"appropriations subject to limitation" in excess of the Appropriations Limit.
"Appropriations subject to limitation," with respect to the State, are
authorizations to spend "proceeds of taxes," which consist of tax revenues, and
certain other funds, including proceeds from regulatory licenses, user charges
or other fees to the extent that such proceeds exceed "the cost reasonably borne
by that entity in providing the regulation, product or service," but "proceeds
of taxes" exclude most State subventions to local governments, tax refunds and
some benefit payments such as unemployment insurance. No limit is imposed on
appropriations of funds which are not "proceeds of taxes," such as reasonable
user charges or fees and certain other non-tax funds.
Not included in the Appropriations Limit are appropriations for the debt
service costs of bonds existing or authorized by January 1, 1979, or
subsequently authorized by the voters, appropriations required to comply with
mandates of courts or the federal government and, pursuant to Proposition 111,
appropriations for qualified capital outlay projects and appropriations of
revenues derived from any increase in gasoline taxes and motor vehicle weight
fees above January 1, 1990 levels, and appropriation of certain special taxes
imposed by initiative (e.g., increased cigarette and tobacco taxes enacted by
Proposition 99 in 1988). The Appropriations Limit may also be exceeded in cases
of emergency.
The State's Appropriations Limit in each year is based on the limit for the
prior year, adjusted annually for changes in State per capita personal income
and changes in population, and adjusted, when applicable, for any transfer of
financial responsibility of providing services to or from another unit of
government. The measurement of change in population is a blended average of
statewide overall population growth, and change in attendance at local school
and community college ("K-14") districts. As amended by Proposition 111, the
Appropriations Limit is tested over consecutive two-year periods. Any excess of
the aggregate "proceeds of taxes" received over such a two-year period above the
combined Appropriations Limits for those two years is divided equally between
transfers to K-14 districts and refunds to taxpayers.
The legislature enacted legislation to implement Article XIIIB which
defines certain terms used in Article XIIIB and sets forth the methods for
determining the Appropriations Limit. California Government Code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
On November 8, 1988, the State's voters approved Proposition 98, a combined
initiative constitutional amendment and statute called the "Classroom
Instructional Improvement and Accountability Act." Proposition 98 changed State
funding of public education below the university level and the operation of the
State Appropriations Limit, primarily by guaranteeing K-14 schools a minimum
share of General Fund revenues. Under Proposition 98 (as modified by Proposition
111, enacted on June 5, 1990), K-14 schools are guaranteed the greater of (a) in
general, a fixed percent of General Fund revenues ("Test 1"), (b) the amount
appropriated to K-14 schools in the prior year, adjusted for changes in the cost
of living (measured as in Article XIIIB by reference to State per capita
personal income) and enrollment ("Test 2"), or (c) a third test, which would
replace Test 2 in any year when the percentage growth in per capita General Fund
revenues from the prior year plus one half of one percent is less than the
percentage growth in State per capita personal
18
<PAGE> 19
income ("Test 3"). Under Test 3, schools would receive the amount appropriated
in the prior year adjusted for changes in enrollment and per capita General Fund
revenues, plus an additional small adjustment factor. If Test 3 is used in any
year, the difference between Test 3 and Test 2 would become a "credit" to
schools which would be the basis of payments in future years when per capita
General Fund revenue growth exceeds per capita personal income growth.
Legislation adopted prior to the end of the 1988-89 fiscal year, implementing
Proposition 98, determined the K-14 schools' funding guarantee under Test 1 to
be 40.3 percent of the General Fund tax revenues, based on 1986-87
appropriations. The percentage has been adjusted to approximately 35 percent to
account for a subsequent redirection of local property taxes, since such
redirection directly affects the share of General Fund revenues to schools.
Proposition 98 permits the legislature by two-thirds vote of both houses,
with the Governor's concurrence, to suspend the K-14 schools' minimum funding
formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIIIB limit to
K-14 schools.
During the recent recession, General Fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 entitlements, and also intended that the "extra" payments
would not be included in the Proposition 98 "base" for calculating future years'
entitlements. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,200 from Fiscal Year
1991-92 to Fiscal Year 1993-94. Per pupil funding from Proposition 98 sources
for the Fiscal Year 1999-00 is projected to be $5,944, an increase of
approximately $200 per pupil from the 1998-99 Fiscal Year, and an increase of
nearly $500 per pupil from the 1997-98 Fiscal Year.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off- budget loans. The settlement
of this case, finalized in July, 1996, provided, among other things, that both
the State and K-14 schools share in the repayment of prior years' emergency
loans to schools. Of the total $1.76 billion in loans, the State will repay $935
million by forgiveness of the amount owed, while schools will repay $825
million. The State share of the repayment will be reflected as an appropriation
above the current Proposition 98 base calculation. The schools' share of the
repayment will count as appropriations that count toward satisfying the
Proposition 98 guarantee, or from "below" the current base. Repayments are
spread over the eight-year period of 1994-95 through 2001-02 to mitigate any
adverse fiscal impact.
Substantially increased General Fund revenues, above initial budget
projections, in the fiscal year 1994-95 and thereafter have resulted or will
result in retroactive increases in Proposition 98 appropriations from subsequent
fiscal years' budgets. A significant amount of the "extra" Proposition 98 monies
in the last few years have been allocated to special programs. During the Fiscal
Year 1999-00, the most significant use of new K-12 Proposition 98 General Fund
is $365 million for the Governor's READ in Schools Initiative, which seeks to
improve reading skills, the quality of professional teaching, and school
accountability. The remaining funds are attributable to statutory growth
funding, cost-of-living adjustments, and deficit reduction funding for school
district county offices of education.
Certain California municipal securities in the Fund may be obligations that
are secured in whole or in part by a mortgage or deed of trust on real property.
Upon the default of a mortgage or deed of trust with respect to California real
property, the creditor's nonjudicial foreclosure rights under the power of sale
contained in the mortgage or deed of trust are subject to the constraints
imposed by California law upon transfers of title to real property by private
power of sale. During the three-month period beginning with the filing of a
formal notice of default, the debtor is entitled to reinstate the home mortgage
by making any overdue payments. Under standard loan servicing procedures, the
filing of the formal notice of default does not occur unless at least three full
monthly payments have become due and remain unpaid. The power of sale is
exercised by posting and publishing a notice of sale for at least 20 days after
expiration of the three-month reinstatement period. Therefore, the effective
minimum period for foreclosing on a mortgage could be in excess of seven months
after the initial default. Such time delays in collections could disrupt the
flow of revenues available to an issuer for the payment of debt service on the
outstanding obligations if such defaults occur with respect to a substantial
number of home mortgages or deeds of trust securing an issuer's obligations.
Certain California municipal securities in the Fund may be obligations that
finance the acquisition of single family home mortgages for low- and
moderate-income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to the California
statutory limitations described above applicable to
19
<PAGE> 20
obligations secured by real property. Under California anti-deficiency
legislation, there is no personal recourse against a mortgagor of a single
family residence purchased with the loan secured by the mortgage.
Under California law, mortgage loans secured by single family
owner-occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years of the term of the mortgage loan, and cannot in any
event exceed six months' advance interest on the amount prepaid in excess of 20%
of the original principal amount of the mortgage loan. This limitation could
affect the flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on the
Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties.
The possibility exists that another such earthquake could create a major
dislocation of the State economy.
Congress passed and the President signed (on August 22, 1996) the Personal
Responsibility and Work Opportunity Act of 1996 making a fundamental reform of
the current welfare system. Among many provisions, the Law includes: (i)
conversion of Aid to Families with Dependent Children from an entitlement
program to a block grant titled Temporary Assistance for Needy Families
("TANF"), with lifetime time limits on TANF recipients, work requirements and
other changes; (ii) provisions denying certain federal welfare and public
benefits to legal noncitizens, allowing states to elect to deny additional
benefits (including TANF) to legal noncitizens, and generally denying almost all
benefits to illegal immigrants; and (iii) changes in the Food Stamp program,
including reducing maximum benefits and imposing work requirements.
As part of the 1997-98 Budget Act legislative package, the Legislature and
Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent Children
("AFDC") and Greater Avenues to Independence ("GAIN") programs effective January
1, 1998. Consistent with the federal law, CalWORKs contains new time limits on
receipt of welfare aid, both lifetime as well as for any current period of aid.
The centerpiece of CalWORKs is the linkage of eligibility to work participation
requirements. Administration of the new Welfare-to-Work programs will be largely
at the county level, and counties are given financial incentives for success in
this program.
Although the long-term impact of the new federal Law and CalWORKs cannot be
determined until there has been more experience, the State does not presently
anticipate that these new programs will have an adverse financial impact on the
General Fund. Overall TANF grants from the federal government are expected to
equal or exceed the amounts the State would have received under the old AFDC
program.
Pressures on the State's budget in the late 1980's and early 1990's were
caused by a combination of external economic conditions (including a recession
which began in 1990) and growth of the largest General Fund Programs - K-14
education, health, welfare and corrections - at rates faster than the revenue
base. During this period, expenditures exceeded revenues in four out of six
years up to 1992-93, and the State accumulated and sustained a budget deficit
approaching $2.8 billion at its peak at June 30, 1993. Between the 1991-92 and
1994-95 Fiscal Years, each budget required multibillion dollar actions to bring
projected revenues and expenditures into balance, including significant cuts in
health and welfare program expenditures; transfers of program responsibilities
and funding from the State to local governments; transfer of about $3.6 billion
in annual local property tax revenues from other local governments to local
school districts, thereby reducing State funding for schools under Proposition
98; and revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration.
Despite these budget actions, the effects of the recession led to large,
unanticipated budget deficits. By the 1993-94 Fiscal Year, the accumulated
deficit was so large that it was impractical to retire it in one year, so a
two-year program was implemented, using the issuance of revenue anticipation
warrants to carry a portion of the deficit over the end of the
20
<PAGE> 21
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed" from
future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to adopt a budget for
the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the State to
carry out its normal annual cash flow borrowing to replenish its cash reserves,
the State Controller issued registered warrants to pay a variety of obligations
representing prior years' or continuing appropriations, and mandates from court
orders. Available funds were used to make constitutionally-mandated payments,
such as debt service on bonds and warrants. Between July 1 and September 4,
1992, when the budget was adopted, the State Controller issued a total of
approximately $3.8 billion of registered warrants.
For several fiscal years during the recession, the State was forced to rely
on external debt markets to meet its cash needs, as a succession of notes and
revenue anticipation warrants were issued in the period from June 1992 to July
1994, often needed to pay previously maturing notes or warrants. These
borrowings were used also in part to spread out the repayment of the accumulated
budget deficit over the end of a fiscal year, as noted earlier. The last and
largest of these borrowings was $4.0 billion of revenue anticipation warrants
which were issued in July, 1994 and matured on April 25, 1996.
The State's financial condition improved markedly during the 1995-96 and
1996-97 fiscal years, with a combination of better than expected revenues,
slowdown in growth of social welfare programs, and continued spending restraint
based on the actions taken in earlier years. The State's cash position also
improved, and no external deficit borrowing has occurred over the end of these
two fiscal years.
The economy grew strongly during these fiscal years, and as a result, the
General Fund took in substantially greater tax revenues (around $2.2 billion in
1995-96 and $1.6 billion in 1996-97) than were initially planned when the
budgets were enacted. These additional funds were largely directed to school
spending as mandated by Proposition 98, and to make up shortfalls from reduced
federal health and welfare aid. The accumulated budget deficit from the
recession years was finally eliminated.
At the end of the Legislative Session on September 13, 1997, the
Legislature passed and the Governor later signed several bills encompassing a
coordinated package of fiscal reforms, mostly to take effect after the 1997-98
Fiscal Year. Included in the package were a variety of phased-in tax cuts,
conformity with certain provisions of the federal tax reform law passed earlier
in the year, and reform of funding for county trial courts, with the State to
assume greater financial responsibility. The Department of Finance estimated
that the major impact of these fiscal reforms will occur in Fiscal Year 1998-99
and subsequent years.
The following are major features of the 1998-99 Budget Act:
1. The Budget reflected the largest single year tax cut reduction in
California history, amounting to approximately $1.4 billion in 1998-99. The
central element is a bill which provides for a phased-in reduction of Vehicle
Licensing Fee ("VLF"). Since the VLF is currently transferred to cities and
counties, the bill provides for the General Fund to replace the lost revenues.
Started on January 1, 1999, the VLF has been reduced by 25%, at a cost to the
General Fund of approximately $500 million in the 1998-99 Fiscal Year and about
$1 billion annually thereafter. In addition to the cut in VLF, the 1998-99
budget includes temporary and permanent increase in the personal income tax
dependent credit ($612 million General Fund cost in 1998-99, but less in future
years), a nonrefundable renters tax credit($133 million), and various targeted
business tax credits ($106 million).
21
<PAGE> 22
2. Proposition 98 funding for K-12 schools is increased by $2.2 billion in
General Fund moneys over the latest revised 1997-98 levels, over $1 billion
higher than the minimum Proposition 98 guarantee. Of the 1998-99 funds, major
new programs include money for instructional and library materials, deferred
maintenance, support for increasing the school year to 180 days and reduction of
class sizes in Grade 9. Overall, per-pupil spending for K-12 schools under
Proposition 98 is increased to $5,752, which is $478 over the 1997-98 level. The
Budget also includes $250 million as repayment of prior years' loans to schools,
as part of the settlement of the CTA v. Gould lawsuit.
3. Funding for higher education increased substantially above the actual
1997-98 level. General Fund support was increased by $339 million (15.6%) for
the University of California and $271 million (14.5%) for the California State
University system. In addition, Community Colleges increased by $182 million
(9.0%).
4. The Budget includes increased funding for health, welfare and social
services programs. A 4.9% grant increase was included in the basic welfare
grants, the first increase in those grants in 9 years. Future increase will
depend on sufficient General Fund revenue to trigger the phased costs in VLF
described above.
5. Funding for the judiciary and criminal justice programs increased by
about 15% over 1997-98, primarily to reflect increased state support for local
trial courts and rising prison population.
6. Various other highlights of the revised Budget included new funding for
resources projects, dedication of $240 million of General Fund moneys for
capital outlay projects, funding of a state employee salary increase, funding of
2,000 new Department of Transportation positions to accelerate transportation
construction projects, and funding of the Infrastructure and Economic
Development Bank ($50 million).
7. The State of California received approximately $167 million of federal
reimbursements to offset costs related to the incarceration of undocumented
alien felons for federal fiscal year 1997. The state anticipates receiving
approximately $173 million in federal reimbursements for federal fiscal year
1998.
The revised 1998-99 budget as reported in the 1999-00 Governor's Budget,
also reflects the latest estimated costs or savings as provided in various
pieces of legislation passed and signed after the 1998 Budget Act. Major budget
items include costs for the All-American Canal, state's share of purchase of
Headwaters Forest, and additional funds for state prisons and juvenile
facilities. The revised budget reflects $443 million reduction in the State's
obligation to contribute to STRS in 1998-99.
The Department of Finance released updated estimates for the 1998-99 Fiscal
Year on January 9, 1998 as part of the Governor's 1999-00 Fiscal Year Budget
Proposal. Total revenues and transfers are projected at $56.3 billion, down
approximately $600 million from the Budget Act projection. Expenditures for the
fiscal year are expected to rise approximately $1.0 billion above the original
Budget Act, to $58.3 billion. The balance in the budget reserve, the SFEU, is
projected to be $618 million at the end of the 1998-99 Fiscal Year, down
approximately $500 million from the Budget Act projection.
In January 1999, the Governor released his proposed budget for the 1999-00
Fiscal Year (the "Proposed Budget"). The Governor's Proposed Budget projects
total General Fund revenues and transfers of $60.3 billion, a $3.3 billion
increase over revised 1998-99 revenues. This includes anticipated initial
payments from the tobacco litigation settlement of about $560 million and
receipt of one-time revenue from sale of assets. Overall, the increase reflects
an underlying revenue growth rate of 4.7% based on economic trends, as well as
non-economic factors, such as the tobacco company litigation, that increases the
total revenue growth rate to 7.1%.
Total General Fund expenditures for 1999-00 are recommended at $60.5
billion, an increase of $2.7 billion above the revised 1998-99 level. The budget
gives highest priority to education, with Proposition 98 funding increasing by
almost 5%. The Governor's budget also proposed new education initiatives, such
as the READ
22
<PAGE> 23
in Schools Initiative. The proposed budget included a modest increase in higher
education funding, and an 8 percent increase in SSP payments (a State-funded
welfare program). The Governor assumed decreases in Medi-Cal and CalWORKS grant
cost as a result of decreasing caseloads. The Governor's Budget projects that
the budget reserve, the SFEU, will be $415 million at June 30, 2000, $200
million lower than the projected level at June 30, 1998. The Governor's Budget
projects Special Fund revenues of $15.2 billion, and Special Fund expenditures
of $15.7 billion, in the 1999-00 Fiscal Year. A total of $1.3 billion of bond
fund expenditures are also proposed.
At the end of the 1999-00 Fiscal Year, the Fund balance is projected to be
$895 million, comprised of $480 million in reserve for liquidation of
encumbrances and $415 in reserve for economic uncertainties.
On February 16, 1999, the Legislative Analyst released a report on the
1999-00 Governor's Budget (the "LAO Report"). The LAO Report was based in part
on actual revenues received in December, 1998 and January, 1999, which had not
been available when the Governor's Budget was prepared. These revenues were
higher than had been predicted in the Governor's Budget, apparently reflecting
stronger than expected economic activity in the nation and the State. The LAO
report projected that General Fund revenues in 1998-99 could be as much as $750
million higher than predicted in the Governor's Budget, and 1999-00 revenues
could be $550 million above the Governor's Budget.
The Governor's Budget includes a proposal to implement changes in law to
make "mid-course corrections" in the State budget if ongoing revenues fall short
of projects during fiscal year or expenditures increase significantly. The
proposals include two components: restoring authority for the Director of
Finance to reduce expenditures in certain circumstances and an automatic
"trigger" mechanism that would produce spending cuts if certain conditions were
met. These proposals will require legislative action.
On December 6, 1994, Orange County, California (the "County"), together
with its pooled investment funds (the "Funds") filed for protection under
Chapter 9 of the federal Bankruptcy Code, after reports that the Funds had
suffered significant market losses in their investments, causing a liquidity
crisis for the Funds and the County. More than 200 other public entities, most
of which, but not all, are located in the County, were also depositors in the
Funds. The bankruptcy filing stemmed from approximately $1.7 billion in losses
suffered by the County's investment pool due to investments in high risk
"derivative" securities. On June 12, 1996, it emerged from bankruptcy after the
successful sale of $880 million in municipal bonds allowed the County to pay off
the last of its creditors. On January 7, 1997, the County returned to the
municipal bond market with a $136 million bond issue maturing in 13 years at an
insured yield of 7.23%.
The State is a party to numerous legal proceedings, many of which normally
recur in governmental operations. In addition, the State is involved in certain
other legal proceedings which, if decided against the State, may require the
State to make significant future expenditures or may impair future revenue
sources.
The Bonds have received ratings of "Aa3" by Moody's Investors Service, "A+"
by Standard & Poor's, a division of The McGraw-Hill Companies and "AA-" by Fitch
ICBA, Inc. An explanation of the significance and status of such credit ratings
may be obtained from the rating agencies furnishing the same. There is no
assurance that such ratings will continue for any given period of time or that
they will not be revised or withdrawn entirely by any such rating agencies, if
in their respective judgments, circumstances so warrant. A revision or
withdrawal of any such credit rating could have an effect on the market price of
the Bonds. After the Bonds are rated, the State Treasurer intends to provide
appropriate periodic credit information to the bond rating agencies to assist in
maintaining the ratings on the Bonds.
The State's reliance on information technology in every aspect of its
operations has made Year 2000-related ("Y2K") information technology ("IT")
issues a high priority for the State. The Department of Information Technology
("DOIT"), an independent office reporting directly to the Governor, is
responsible for ensuring the State's information technology processes are fully
functional before the year 2000. The DOIT has created a Year 2000 Task Force and
a California 2000 Office to establish statewide policy requirements; to gather,
coordinate, and share information; and to
23
<PAGE> 24
monitor statewide progress. In December 1996, the DOIT began requiring
departments to report on Y2K activities and currently requires departmental
monthly reporting of Y2K status. The DOIT has emphasized to departments that
efforts should be focused on applications that support mission-critical business
practices.
The State Treasurer's Office reports that as of December 31, 1998, its
systems for bond payments were fully Y2K compliant. The State Controller's
Office reported that it had completed the necessary Y2K remediation projects for
the State fiscal and accounting system by December 31, 1998, consistent with the
Governor's Executive Order. The final steps of testing will be completed during
1999. Both offices are actively working with the outside entities with whom they
interface to ensure that they are also compliant.
Although substantial progress has been made toward the goal of Y2K
compliance, the task is very large and will likely encounter unexpected
difficulties. The State cannot predict whether all mission critical systems will
be ready and tested by late 1999 or what the impact failure of any particular IT
system(s) or of outside interfaces with IT systems might have.
RISK FACTORS AFFECTING NEW YORK MUNICIPAL SECURITIES
The following information as to certain New York State ("State") and New
York City ("City") risk factors is given to investors in view of the policy of
the MainStay New York Tax Free Fund of concentrating its investments in New York
municipal issuers. Such information constitutes only a brief discussion, does
not purport to be a complete description and is based on information from
sources believed by the Trust to be reliable, including official statements
relating to securities offerings of New York and municipal issuers, and periodic
publications by national ratings organizations. Such information, however, has
not been independently verified by the Trust.
There are a number of methods by which the State itself may incur debt. The
State may issue general obligation bonds. Under the State Constitution, the
State may not, with limited exceptions for emergencies, undertake long-term
general obligation borrowing (i.e., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
Legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State. With the exception of general obligation housing bonds
(which must be paid in equal annual installments or installments that result in
substantially level or declining debt service payments, within 50 years after
issuance, commencing no more than three years after issuance), general
obligation bonds must be paid in equal annual installments or installments that
result in substantially level or declining debt service payments, within 40
years after issuance, beginning not more than one year after issuance of such
bonds.
The State may undertake short-term borrowings without voter approval (i) in
anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes ("TRANs"), and (ii) in anticipation of the receipt of
proceeds from the sale of duly authorized but unissued general obligation bonds,
by issuing bond anticipation notes ("BANs"). TRANs must mature within one year
from their dates of issuance and may not be refunded or refinanced beyond such
period. However, since 1990 the State's ability to issue TRANs has been limited
due to enactment of the fiscal reform program which created LGAC, a public
benefit corporation empowered to issue long-term obligations to fund certain
payments to local governments that had been traditionally funded through the
State's annual seasonal borrowing. BANs may only be issued for the purposes and
within the amounts for which bonds may be issued pursuant to voter
authorizations. Such BANs must be paid from the proceeds of the sale of bonds in
anticipation of which they were issued or from other sources within two years of
the date of issuance or, in the case of BANs for housing purposes, within five
years of the date of issuance. In order to provide flexibility within these
maximum term limits, the State has utilized the BANs authorization to conduct a
commercial paper program to fund disbursements eligible for general obligation
bond financing.
Pursuant to specific constitutional authorization, the State may also
directly guarantee certain public authority obligations. The State Constitution
provides for the State guarantee of the repayment of certain borrowings for
designated projects of the New York State Thruway Authority, the Job Development
Authority and the Port Authority
24
<PAGE> 25
of New York and New Jersey. The State has never been called upon to make any
direct payments pursuant to such guarantees. State guaranteed bonds of the Port
Authority of New York and New Jersey were fully retired on December 31, 1996.
State guaranteed bonds issued by the Thruway Authority were fully retired on
July 1, 1995.
In February 1997, the Job Development Authority ("JDA") issued
approximately $85 million of State guaranteed bonds to refinance certain of its
outstanding bonds and notes in order to restructure and improve JDA's capital
finances. Due to concerns regarding the economic viability of its programs,
JDA's loan and loan guarantee activities were suspended in 1995. JDA recently
resumed its lending activities under a revised set of lending programs and
underwriting guidelines. As a result of the structural imbalances in JDA's
capital structure, and defaults in its loan portfolio and loan guarantee program
incurred between 1991 and 1996, JDA would have experienced a debt service cash
flow shortfall had it not completed the 1997 refinancing. JDA anticipates that
it will transact additional refinancings in 1999, 2000 and 2003 to complete its
long-term plan of finance and further alleviate cash flow imbalances which are
likely to occur in future years. The State does not anticipate that it will be
called upon to make any payments pursuant to the State guarantee in the 1998-99
fiscal year.
Payments of debt service on State general obligation and State-guaranteed
bonds and notes are legally enforceable obligations of the State.
The State employs additional long-term financing mechanisms, lease-purchase
and contractual obligation financings, which involve obligations of public
authorities or municipalities that are State supported but not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment, and expect to meet their debt service requirements
through the receipt of rental or other contractual agreement by the State to
make payments to a public authority, municipality or other entity, the State's
obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a financing
arrangement with LGAC to restructure the way the State makes certain local aid
payments.
The State also participates in the issuance of certificates of
participation ("COPs") in a pool of leases entered into by the State's Office of
General Services on behalf of several State departments and agencies interested
in acquiring operational equipment or in certain cases, real property.
Legislation enacted in 1986 established restrictions upon and centralized State
control, through the Comptroller and the Director of the Budget, over the
issuance of COPs representing the State's contractual obligation, subject to
annual appropriation by the Legislature and availability of money, to make
installment or lease-purchase payments for the State's acquisition of such
equipment or real property.
The State has never defaulted on any of its general obligation indebtedness
or its obligations under lease purchase or contractual-obligation financing
arrangements and has never been called upon to make any direct payments pursuant
to its guarantees.
The fiscal stability of the State is related in part to the fiscal
stability of its public authorities. For the purposes of this Annual Information
Statement, public authorities refer to public benefit corporations, created
pursuant to State law, other than local authorities. Public authorities are not
subject to the constitutional restrictions on the incurrence of debt which apply
to the State itself and may issue bonds and notes within the amounts and
restrictions set forth in legislative authorization. The State's access to the
public credit markets could be impaired and the market price of its outstanding
debt may be materially and adversely affected if any of its public authorities
were to default on their respective obligations.
In 1990, as part of a State fiscal reform program, legislation was enacted
creating LGAC. The legislation authorized LGAC to issue its bonds and notes in
an amount to yield net proceeds not in excess of $4.7 billion (exclusive of
certain refunding bonds). Over a period of years, the issuance of these
long-term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also dedicated revenues equal to one-quarter of the four cent State
sales and use tax to pay
25
<PAGE> 26
debt service on these bonds. The legislation also imposed a cap on the annual
seasonal borrowing of the State at $4.7 billion, less net proceeds of bonds
issued by LGAC and bonds issued to provide for capitalized interest, except in
cases where the Governor and the legislative leaders have certified the need for
additional borrowing and provided a schedule for reducing it to the cap. If
borrowing above the cap is thus permitted in any fiscal year, it is required by
law to be reduced to the cap by the fourth fiscal year after the limit was first
exceeded. This provision capping the seasonal borrowing was included as a
covenant with LGAC's bondholders in the resolution authorizing such bonds.
As of June 1995, LGAC had issued bonds and notes to provide net proceeds of
$4.7 billion, completing the program. The impact of LGAC's borrowing, as well as
other changes in revenue and spending patterns, is that the State has been able
to meet its cash flow needs throughout the fiscal year without relying on
short-term seasonal borrowings.
The State's 1998-99 enacted budget includes several new multi-year tax
reduction initiatives, including acceleration of State-funded property and local
income tax relief for senior citizens under the School Tax Relief Program
("STAR"), expansion of the child care income-tax credit for middle-income
families, a phased-in reduction of the general business tax, and reduction of
several other taxes and fees, including an accelerated phase-out of assessments
on medical providers. The enacted budget also provides for significant increases
in spending for public schools, special education programs, and for the State
and City university systems. It also allocates $50 million for a new Debt
Reduction Reserve Fund ("DRRF") that may eventually be used to pay debt service
costs on or to prepay outstanding State-supported bonds.
The 1998-99 State Financial Plan projects a closing balance in the General
Fund of $799 million that is comprised of a balance of $473 million in the Tax
Stabilization Reserve Fund ("TSRF"), a balance of $226 million in the Community
Projects Fund ("CPF"), and a balance of $100 million in the Contingency Reserve
Fund ("CRF"). The TSRF can be used in the event of an unanticipated General Fund
cash operating deficit, as provided under the State Constitution and State
Finance Law. The CPF is used to finance various legislative and executive
initiatives. The CRF provides resources to help finance any extraordinary
litigation costs during the fiscal year.
The transfer of a portion of the surplus recorded in 1997-98 to 1998-99
exaggerates the "real" growth in State receipts from year to year by depressing
reported 1997-98 figures and inflating 1998-99 projections. Conversely, the
incremental cost of tax reductions newly effective in 1998-99 and the impact of
statutes earmarking certain tax receipts to other funds work to depress apparent
growth below the underlying growth in receipts attributable to expansion of the
State's economy. On an adjusted basis, State tax revenues in 1998-99 fiscal year
are projected to grow at approximately 7.5%, following an adjusted growth
roughly nine percent in the 1997-98 fiscal year.
The State's current fiscal year began on April 1, 1999 and ends on March
31, 2000 and is referred to herein as the State's 1999-00 fiscal year. This
section of the AIS reflects estimates of receipts and disbursements for the
State's 1999-00 fiscal year as formulated in the Financial Plan released on
February 9, 1999, and as supplemented on February 18, 1999. Additional
information on the State's finances will be released in quarterly updates to the
Financial Plan. Information on the State's Capital Program and Financing Plan
for the 1999-00 through 2002-03 fiscal years was released on or before July 30,
1999. The update to the State's financial projections based upon Generally
Accepted Accounting Principles (GAAP) will be released on or before September 1,
1999.
Many complex political, social and economic forces influence the State's
economy and finances, which may in turn affect the State's Financial Plan. These
forces may affect the State unpredictably from fiscal year to fiscal year and
are influenced by governments, institutions, and organizations that are not
subject to the State's control. The State Financial Plan is also necessarily
based upon forecasts of national and State economic activity. Economic forecasts
have frequently failed to predict accurately the timing and magnitude of changes
in the national and the State economies. The Division of Budget believes that
its projections of receipts and disbursements relating to the current State
Financial Plan, and the assumptions on which they are based, are reasonable.
26
<PAGE> 27
Total General Fund receipts in 1999-00 are projected to be $38.81 billion,
an increase of over $2 billion from the current estimate of $36.78 billion in
1998-99. This total includes $34.80 billion in tax receipts, $1.28 billion in
miscellaneous receipts, and $1.93 billion in transfers from other funds.
The personal income tax is imposed on the income of individuals, estates
and trusts and is based on federal definitions of income and deductions. This
tax continues to account for over half of the State's General Fund receipts
base. Net personal income tax collections are projected to reach $22.88 billion,
nearly $2.77 billion above the 1998-99 collection total. The projected annual
growth is in part due to the net impact of refund reserve transactions which
will increase reported collections by over $1.77 billion, as partially offset by
the diversion of slightly over $1.22 billion in income tax receipts to the STAR
fund to finance the school tax reduction program. The STAR program was enacted
in 1997 to increase the State share of school funding and reduce residential
school taxes. Adjusted for these transactions, the growth in net income tax
receipts is roughly $1.7 billion, an increase of over 9%. This growth is largely
a function of over 5.3% growth in income tax liability projected for 1999 as
well as the impact of the 1998 tax year settlement on 1998-99 net collections.
User taxes and fees are comprised of three-quarters of the State four
percent sales and use tax (the balance, one percent, flows to support Local
Government Assistance Corporation ("LGAC") debt service requirements),
cigarette, alcoholic beverage, container, and auto rental taxes, and a portion
of the motor fuel excise levies. Also included in this category are receipts
from the motor vehicle registration fees and alcoholic beverage license fees. A
portion of the motor fuel tax and motor vehicle registration fees and all of the
highway use tax are earmarked for dedicated transportation funds.
Receipts from user taxes and fees are projected to total $7.17 billion, a
decrease of $76 million from reported collections in the prior year. The sales
tax component of this category accounts for approximately 80% of projected
receipts, and is projected to increase by 4.4% in the 1999-00 fiscal year. The
yields of most of the excise taxes in this category show a long-term declining
trend, particularly cigarette and alcoholic beverage taxes. These General Fund
declines were exacerbated in 1998-99 by revenue losses from scheduled and
enacted tax reductions, and by an increase in earmarking of motor vehicle
registration fees to the Dedication Highway and Bridge Trust Fund.
Business taxes include franchise taxes based generally on net income of
general business, bank and insurance corporations, as well as
gross-receipts-based taxes on utilities and gallonage-based petroleum business
taxes. Beginning in 1994, a percent surcharge on these levies began to be phased
out and, for most taxpayers, there is no surcharge liability for taxable periods
ending in 1997 and thereafter.
Total business tax collections in 1999-00 are now projected to be $4.56
billion, $241 million less than received in the prior fiscal year. The category
includes receipts from the largely income-based levies on general business
corporations, banks and insurance companies, gross receipts taxes on energy and
telecommunication service providers and a per-gallon imposition on petroleum
business. The year-over-year decline in projected receipts in this category is
largely attributable to utility-tax rate cuts and the Power for Jobs tax
reduction program for energy providers, and the scheduled additional diversion
of General Fund petroleum business and utility tax receipts to other funds. In
addition, profit growth is also expected to slow in 1999.
Other taxes include estate, gift and real estate transfer taxes, a tax on
gains from the sale or transfer certain real estate (this tax was repealed in
1996), a pari-mutuel tax and other minor levies. They are now projected to total
$980 million - $119 million below last year's amount. The expected decline in
collections from this category is a result of the ongoing effect of enacted tax
cuts, and the elimination of the real property gains tax collections.
Miscellaneous receipts include investment income, abandoned property
receipts, medical provider assessments, minor federal grants, receipts from
public authorities, and certain other license and fee revenues. Total
miscellaneous receipts are projected to reach $1.24 billion, down $292 million
from the prior year, reflecting the growing effects of the phase-out of the
medical provider assessments.
27
<PAGE> 28
Transfers from other funds to the General Fund consist primarily of tax
revenues in excess of debt one percent sales tax used to support payments to
LGAC. Transfers from other funds are expected to total $1.93 billion, or $20
million less than total receipts from this category during 1998-99. Total
transfers of sales taxes in excess of LGAC debt service requirements are
expected to increase by approximately $43 million, while transfers from all
other funds are expected to fall by $20 million, primarily reflecting lower
receipts from real estate transfer taxes.
General Fund disbursements in 1999-00, including transfers to support
capital projects, debt service and other funds, are estimated at $37.14 billion.
This represents an increase of $528 million or 1.4% percent from 1998-99. Nearly
one-half of the growth is for educational purposes, reflecting increased support
for public schools, special education programs and the State and City university
systems. The remaining increase is primarily for Medicaid, mental hygiene, and
other health and social welfare programs, including children and family
services. The 1999-00 Financial Plan also includes funds for the current
negotiated salary increases for State employees, as well as increased transfers
for debt service.
Grants to Local Governments is the largest category of General Fund
disbursements, comprising approximately 67% of all General Funding
disbursements, and includes financial assistance to local governments and
not-for-profit corporations, as well as entitlement benefits to individuals. The
1999-00 Financial Plan projects spending of $24.81 billion in this category, an
decrease of $86 million or -0.4% over the prior year, in part due to a $175
million decline in proposed spending for legislative initiatives. The largest
annual decreases are for education, Medicaid, other health and social welfare
programs, and community projects grants.
State operations spending reflects the administrative costs of operating
the State's agencies, including the prison system, mental hygiene institutions,
the State University system (SUNY), the Legislature, and the court system.
Personal service costs account for approximately 73% of spending in this
category. Since January 1995, the State's workforce has been reduced by about
10% and is projected to remain at its current level of approximately 191,200
persons in 1999-00.
State operations spending is projected at $6.89 billion, an increase of
$243 million or 3.7% the prior year. This increase is primarily due to the
annualized costs of collective bargaining agreements for 1998-99, the costs of
staffing a new State prison facility, the loss of federal receipts that would
otherwise lower General Fund spending in mental hygiene programs, and an
increase in the Legislative and Judiciary budgets.
Disbursements in General State charges are estimated at $2.32 billion, an
increase of $32 million from the prior year.
Debt service paid from the General Fund reflects debt service on short-term
obligations of the State, and includes only interest costs on the State's
commercial paper program. The 1999-00 debt service estimate is $11 million,
reflecting relative stability in short-term interest rates. The State's
short-term TRAN borrowing program was eliminated in 1995.
Transfers to other funds from the General Fund are made primarily to
finance certain portions of State capital projects spending and debt service on
long-term bonds where these costs are not funded from other sources. Transfers
in support of debt service are projected at $3.08 billion in 1999-00, an
increase of $299 million from 1998-99. The increase reflects the
reclassification of SUNY community debt from local assistance accounts. The
balance reflects the costs of prior borrowings and costs connected to the Debt
Reduction Reserve Fund. The Fund may be used, subject to enactment of new
appropriations, to pay the debt service costs on or to prepay State-supported
bonds. Transfers in support of capital projects provide General Fund support for
projects not otherwise financed through bond proceeds, dedicated taxes and other
revenues, or federal grants. These transfers are projected at $439 million for
1999-00. Remaining transfer's from the General Fund to other funds are estimated
to decline $71 million in 1999-00 to $350 million. This decline is primarily the
net impact of one-time transfers in 1998-99 to the Lottery and Oil Spill Funds.
28
<PAGE> 29
Special Revenue Funds are used to account for the proceeds of specific
revenue sources such as federal grants that are legally restricted, either by
the Legislature or outside parties, to expenditures for specified purposes.
Total disbursements for programs supported by Special Revenue Funds are
projected at $30.54 billion, an increase of $537 million or 1.8% from 1998-99.
Federal grants account for approximately three-quarters of all spending in the
Special Revenue fund type. Disbursements from federal funds are estimated at
$21.93 billion, an increase of $222 million or 1.0%. The single largest program
in this fund group is Medicaid, which is projected at $13.55 billion, a decrease
of $578 million below last year. Federal support for welfare programs is
projected at $1.69 billion, a decrease of $259 million from 1998-99, due largely
to declining case loads. The remaining growth in federal funds is primarily due
to (1) education spending, projected at $1.86 billion in 1999-00, an increase of
$170 million from 1998-99; and (2) the Child Health Plus program, estimated at
$278 million in 1999-00, an increase of $96 million from last year. This program
will expand health insurance coverage to children of indigent families.
State special revenue spending is projected to be $8.61 billion, an
increase of $315 million or 3.8% from last year's levels. Most of this projected
increase in spending is due to the $638 million increase in the STAR program, as
well as $42 million increase for the State share of the new Child Health Plus
program.
Capital Projects Funds account for the financial resources used in the
acquisition, construction, or rehabilitation of major State capital facilities,
and for capital assistance grants to certain local governments or public
authorities. This fund type consists of the Capital Projects Fund, which is
supported by tax receipts transferred from the General Fund, and various other
capital funds established to distinguish specific capital construction purposes
supported by other revenues.
Capital Projects Funds spending in fiscal year 1999-00 is projected at
$4.39 billion, an increase of $184 million from last year. The major components
of this expected growth are transportation and environmental programs, including
continued increased spending for 1996 Clean Water/Clean Air Bond Act projects
and higher projected disbursements from the Environmental Protection Fund
("EPF"). Another significant component of this projected increase is in the area
of public protection, primarily for facility rehabilitation and construction of
additional prison capacity. The capital spending plan also includes
approximately $272 million for maintenance, preservation, and improvement
projects at existing SUNY and CUNY facilities.
Spending for capital projects is financed with cash or bond proceeds. Cash
resources include pay-as-you-go State resources and Federal grants. Bond
resources include proceeds from the sale of bonds, including voter-approved
General Obligation bonds or public authority bonds.
The Governor's debt reduction measures lower the State's dependence on debt
by ensuring that a larger and growing share of the State's essential capital
investments are financed with pay-as-you-go resources. The prudent financing of
capital needs with cash resources ensures that less than one-half of 46% of
capital spending in 1999-00 will be financed with debt while State pay-as-you-go
resources and Federal grants will support the majority of 54% of capital costs.
Total cash resources are comprised of State pay-as-you-go and Federal
grants, and will finance 54 percent of 1999-00 capital spending. The percentage
of the Capital Plan financed with pay-as-you-go resources in 1999-00 will
represent 22% of total projected capital spending, an increase of 4% over last
year's Plan estimate. Approximately 32% of the State's total spending for
capital projects is expected to be supported by Federal grants, mainly for
transportation and environmental purposes. Primarily as a result of the new
Federal Highway Act, TEA-21, spending supported by Federal grants in 1999-00
will increase by $272 million, or 24%, from the 1998-99 enacted Capital Plan.
Bonds will also be used as a resource for capital spending. Approximately
$316 million, or 7% of projected 1999-00 capital spending will be supported by
the Clean Water/Clean Air Environmental Bond Act approved by the voters in 1996.
These projects will continue to protect the environment and the health and
safety of all New Yorkers. Efforts to shift the financing of capital projects
from bonds to cash resources will significantly reduce the share of 1999-00
capital spending projected to be financed with authority bond proceeds from last
year's projection of 46% to 39%. In
29
<PAGE> 30
1999-00, $1.7 billion of total capital spending, primarily in the areas of
transportation, corrections, mental hygiene and higher education programs will
be reimbursed by authority bond proceeds.
In the 1999-00 Fiscal Year, the State projects a closing balance in the
General Fund of $2.63 billion, comprised of a balance of $1.79 billion in the
reduction reserves, $473 million in the TSRF, and $100 million in the CRF.
The Division of the Budget projects budget gaps of $1.11 billion in 2000-01
and $2.08 billion in 2001-02. These estimates assume that the Legislature will
enact the 1999-00 Executive Budget and accompanying legislation in its entirety.
The gaps also include $500 million in unspecified annual spending efficiencies,
which is comparable to the Governor's Executive Budget assumptions in previous
fiscal years. Future Financial Plans are also likely to count on savings from
efficiencies, workforce management efforts, aggressive efforts to maximize
federal and other non-General Fund resources, and other efforts to control State
spending. Nearly all the actions proposed by the Governor to balance the 1999-00
Financial Plan recur and grow in value in future years. The Division of the
Budget projects that, if the projected budget gap for 2000-01 is closed with
recurring actions, the 2001-02 budget gap would be reduced to $963 million under
current projections.
The Executive Budget assumes the use of $1.79 billion tax reduction reserve
to offset the incremental loss in tax receipts resulting from previously enacted
and proposed tax reductions beginning in 2000-01. The Financial Plan currently
assumes that $589 million of the reserves (about one-third of the amount
available) will be applied in 2000-01, with the remaining $1.2 billion used in
2001-02. The State may alter how it apportions the reserves across the three
years of the projection period.
The Governor is required by law to propose a balanced budget each year and
will propose steps necessary to address any potential remaining budget gaps in
subsequent budgets. The Division of the Budget estimates that the State has
closed projected budget gaps of $5.0 billion, $3.9 billion and $2.3 billion in
its 1995-96, 1996-97 and 1997-98 fiscal years, respectively, and ended each of
thee years with a cash surplus.
The Division of the Budget believes that the economic assumptions and
projections of receipts and disbursements accompanying the 1999-00 Executive
Budget are reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
by entities, such as the federal government, that are outside the State's
control. Because of the uncertainty and unpredictability of changes in these
factors, their impact cannot be fully included in the assumptions underlying the
State's projections. For example, there can be no assurance that the Legislature
will enact the Governor's proposals or that the State's actions will be
sufficient to preserve budgetary balance or to align recurring receipts and
disbursements in either 1999-00 or in future fiscal years.
Uncertainties with regard to the economy present the largest potential risk
to future budget balance in New York State. This risk includes either a
financial market or broader economic "correction" during the period, a risk
heightened by the relatively lengthy expansions currently underway. The
securities industry is more important to the New York economy than the national
economy, and a significant deterioration in stock market performance could
ultimately produce adverse changes in wage and employment levels. In addition, a
normal "forecast error" of one percentage point in the expected growth rate
could cumulatively raise or lower receipts by over $1 billion by the last year
of the 1999 through 2001 projection period. On the other hand, the national or
State economy may continue to perform better than projected, which could produce
beneficial short-term results in State receipts.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. These factors can be
very complex, may vary from fiscal year to fiscal year, and are frequently the
result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. Because of the uncertainty and
unpredictability of these factors, their impact cannot, as a practical matter,
be included in the assumptions underlying the State's projections at this time.
30
<PAGE> 31
The State Financial Plan is based upon forecasts of national and State
economic activity developed through both internal analysis and review of State
and national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. Economic forecasts have frequently failed
to predict accurately the timing and magnitude of changes in the national and
the State economies. Many uncertainties exist in forecasts of both the national
and State economies, including consumer attitudes toward spending, the extent of
corporate and governmental restructuring, the condition of the financial sector,
federal fiscal and monetary policies, the level of interest rates, and the
condition of the world economy, which could have an adverse effect on the State.
There can be no assurance that the State economy will not experience results in
the current fiscal year that are worse than predicted, with corresponding
material and adverse effects on the State's projections of receipts and
disbursements.
Projections of total State receipts in the Financial Plan are based on the
State tax structure n effect during the fiscal year and on assumptions relating
to basic economic factors and their historical relationships to State tax
receipts. In preparing projections of State receipts, economic forecasts
relating to personal income, wages, consumption, profits and employment have
been particularly important. The projection of receipts from most tax or revenue
sources is generally made by estimating the change in yield of such tax or
revenue source caused by economic and other factors, rather than by estimating
the total yield of such tax or revenue source from its estimated tax base. The
forecasting methodology, however, ensures that State fiscal year collection
estimates for taxes that are based on a computation of annual liability, such as
the business and personal income taxes, are consistent with estimates of total
liability under such taxes.
Projections of total State disbursements are based on assumptions relating
to economic and demographic factors, levels of disbursements for various
services provided by local governments (where the cost is partially reimbursed
by the State), and the results of various administrative and statutory
mechanisms in controlling disbursements for State operations. Factors that may
affect the level of disbursements in the fiscal year include uncertainties
relating to the economy of the nation and the State, the policies of the federal
government, and changes in the demand for and use of State services.
An additional risk to the State Financial Plan arises from the potential
impact of certain litigation and of federal disallowances now pending against
the State, which could adversely affect the State's projections of receipts and
disbursements. The State Financial Plan assumes no significant litigation or
federal disallowance or other federal actions that could affect State finances,
but has significant reserves in the event of such an action.
The Division of the Budget believes that its projections of receipts and
disbursements relating to the current State Financial Plan, and the assumptions
on which they are based, are reasonable. Actual results, however, could differ
materially and adversely from the projections set fort herein. In the past the
State has taken management actions to address potential Financial Plan
shortfalls, and DOB believes it could take similar actions should variances
occur in its projections for the current fiscal year.
Despite recent budgetary surpluses recorded by the State, actions affecting
the level of receipts and disbursements, the relative strength of the State and
regional economy, and actions by the federal government have helped to create
projected structural budget gaps for the State. These gaps result from a
significant disparity between recurring revenues and the costs of maintaining or
increasing the level of support for State programs. To address a potential
imbalance in any given fiscal year, the State would be required to take actions
to increase receipts and/or reduce disbursements as it enacts the budget for
that year, and, under the State Constitution, the Governor is required to
propose a balanced budget each year. There can be no assurance, however, that
the Legislature will enact the Governor's proposals or that the State's actions
will be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years. For example,
the fiscal effects of tax reductions adopted in the last several fiscal years
are projected to grow more substantially beyond the 1999-00 fiscal year, with
the incremental annual cost of all currently enacted tax reductions estimated at
over $4 billion by the time they are fully effective in State fiscal year
2002-03. These actions will place pressure on future budget balance in New York
State.
31
<PAGE> 32
New York State is currently addressing "Year 2000" data processing
compliance issues. The Year 2000 compliance issue ("Y2K") arises because most
computer software programs allocate two digits to the data field for "year" on
the assumption that the first two digits will be "19". Such programs will thus
interpret the year 2000 as the year 1900 absent reprogramming. Y2K could impact
both the ability to enter data into computer programs and the ability of such
programs to correctly process data. There can be no guarantee, however, that all
of the State's mission-critical and high-priority computer systems will be Year
2000 compliant and that there will not be an adverse impact upon State
operations or State finances as a result.
Constitutional challenges to State laws have limited the amount of taxes
which political subdivisions can impose on real property. In 1979, the State's
highest court declared unconstitutional a State law allowing localities and
school districts to impose a special increase in real estate property taxes in
order to raise funds for pensions and other uses. Additional court actions have
been brought against the State, certain agencies and municipalities relating to
financing, the amount of real estate tax, the use of tax revenues and other
matters.
An additional risk to the 1999-00 State Financial Plan arises from the
potential impact of certain litigation now pending against the State, which
could produce adverse effects on the State's projections of receipts and
disbursements.
Certain litigation pending against the State, its subdivisions and their
officers and employees could have a substantial and long-term adverse effect on
State finances. The State is a party to numerous legal proceedings, many of
which normally recur in governmental operations. Because of the prospective
nature of these proceedings, no estimate of the potential loss can be made.
The State is a defendant in numerous legal proceedings pertaining to
matters incidental to the performance of routine governmental operations. Such
litigation includes, but is not limited to, claims asserted against the State
arising from alleged torts, alleged breaches of contracts, condemnation
proceedings and other alleged violations of State and Federal laws.
Included in the State's outstanding litigation are a number of cases
challenging the legality or the adequacy of a variety of significant social
welfare programs primarily involving the State's Medicaid and mental health
programs. Adverse judgments in these matters generally could result in
injunctive relief coupled with prospective changes in patient care which could
require substantial increased financing of the litigated programs in the future.
Because of the prospective nature of these matters, no provision for this
potential exposure has been made in the accompanying general purpose financial
statements.
Actions commenced by several Indian nations claim that significant amounts
of land were unconstitutionally taken from the Indians in violation of various
treaties and agreements during the eighteenth and nineteenth centuries. The
claimants seek recovery of approximately six million acres and as well as
compensatory and punitive damages.
In addition, the State is party to other claims and litigation which its
legal counsel has advised are not probable of adverse court decisions. Although
the amounts of potential losses, if any, are not presently determinable, it is
the State's opinion that its ultimate liability in these cases is not expected
to have a material adverse effect on the State's financial position.
The national economy has maintained a robust rate of growth during the past
six quarters as the expansion, which is well into its seventh year, continues.
Since early 1992, approximately 16-1/2 million jobs have been added nationally.
The State economy has also continued to expand, but growth remains somewhat
slower than in the nation. Although the State has added over 400,000 jobs since
late 1992, employment growth in the State has been hindered during recent years
by significant cutbacks in the computer and instrument manufacturing, utility,
defense, and banking industries. Government downsizing has also moderated these
job gains.
The fiscal health of the State may also be affected by the fiscal health of
New York City ("City"), which continues to receive significant financial
assistance from the State. State aid contributes to the City's ability to
balance its budget and
32
<PAGE> 33
meet its cash requirements. The State may also be affected by the ability of the
City and certain entities issuing debt for the benefit of the City to market
their securities successfully in the public credit markets.
The City has achieved balanced operating results for each of its fiscal
years since 1981 as measured by the GAAP standards in force at that time. The
City prepares a four-year financial plan ("Financial Plan") annually and updates
it periodically, and prepares a comprehensive annual financial report describing
its most recent fiscal year each October.
Certain localities outside New York City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The cities of Yonkers and Troy continue to
operate under State-ordered control agencies. The potential impact on the State
of any future requests by localities for additional oversight or financial
assistance is not included in the projections of the State's receipts and
disbursements for the State's 1999-00 fiscal year.
Eighteen municipalities received extraordinary assistance during the 1996
legislative session through $50 million in special appropriations targeted for
distressed cities, and 28 municipalities received more than $32 million in
targeted unrestricted aid in the 1997-98 budget. Both of these emergency aid
packages were largely continued through the 1998-99 budget. The State also
dispersed an additional $21 million among all cities, towns and villages after
enacting a 3.9% increase in General Purpose State Aid in 1997-98 and continued
this increase in 1998-99.
The 1998-99 budget included an additional $29.4 million in unrestricted aid
targeted to 57 municipalities across the State. Other assistance for
municipalities with special needs totaled more than $25.6 million. Twelve
upstate cities will receive $24.2 million in one-time assistance from a cash
flow acceleration of State aid.
The appropriation and allocation of general purpose local government aid
among localities, including New York City, is currently the subject of
investigation by a State commission. While the distribution of general purpose
local government aid was originally based on a statutory formula, in recent
years both the total amount appropriated and the amounts appropriated to
localities have been determined by the Legislature. A State commission was
established to study the distribution and amounts of general purpose local
government aid and recommend a new formula by June 30, 1999, which may change
the way aid is allocated.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. In 1996, the total indebtedness of all localities in
the State other than New York City was approximately $20.0 billion. A small
portion (approximately $77.2 million) of that indebtedness represented borrowing
to finance budgetary deficits and was issued pursuant to enabling State
legislation. State law requires the Comptroller to review and make
recommendations concerning the budgets of those local government units other
than New York City that are authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding.
Twenty-one localities had outstanding indebtedness for deficit financing at the
close of their fiscal year ending in 1996.
Like the State, local governments must respond to changing political,
economic and financial influences over which they have little or no control.
Such changes may adversely affect the financial condition of certain local
governments. For example, the federal government may reduce (or in some cases
eliminate) federal funding of some local programs which, in turn, may require
local governments to fund these expenditures from their own resources. It is
also possible that the State, New York City, or any of their respective public
authorities may suffer serious financial difficulties that could jeopardize
local access to the public credit markets, which may adversely affect the
marketability of notes and bonds issued by localities within the State.
Localities may also face unanticipated problems resulting from certain pending
litigation, judicial decisions and long-range economic trends. Other large-scale
potential problems, such as declining urban populations, increasing
expenditures, and the loss of skilled manufacturing jobs, may also adversely
affect localities and necessitate State assistance.
Moody's Investors Service, Inc. ("Moody's") has given the Series 1999A
Tax-Exempt Bonds and the 1999B Taxable Bonds a rating of "A2" and Standard &
Poor's Ratings Group ("S&P") has given the Bonds a rating of "A."
33
<PAGE> 34
Ratings reflect only the respective views of such organizations, and an
explanation of the significance of such ratings must be obtained from the rating
agency furnishing the same. There is no assurance that a particular rating will
continue for any given period of time or that any such rating will not be
revised downward or withdrawn entirely if, in the judgment of the agency
originally establishing the rating, circumstances so warrant. A downward
revision or withdrawal of such ratings, or either of them, may have an effect on
the market price of the Bonds.
SPECIAL CONSIDERATIONS AFFECTING PUERTO RICO
The following highlights some of the more significant financial trends and
problems affecting the Commonwealth of Puerto Rico (the "Commonwealth" or
"Puerto Rico") and is based on information drawn from official statements and
prospectuses relating to the securities offerings of Puerto Rico and its
agencies and instrumentalities. Such information, however, has not been
independently verified by the Trust.
The Government of Puerto Rico has established programs directed at
developing the manufacturing and service sectors (with emphasis on the tourism
industry) of the economy and expanding and modernizing the island's
infrastructure. Domestic and foreign investment has been stimulated by selective
tax exemption, development loans, and other financial and tax incentives.
Infrastructure expansion and modernization have been to a large extent financed
by bonds and notes issues by the Commonwealth, its public corporations and
municipalities. Economic progress has been aided by significant increases in the
levels of education and occupational skills of the island's population.
The economy of Puerto Rico is fully integrated with that of the United
States mainland. During fiscal 1997, approximately 88% of Puerto Rico's exports
went to the United States mainland, which was also the source of approximately
62% of Puerto Rico's imports. In fiscal 1997, Puerto Rico experienced a $2.7
billion positive adjusted merchandise trade balance.
The dominant sectors of the Puerto Rico economy are manufacturing and
services. The manufacturing sector has experienced a basis change over the years
as a result of increased emphasis on higher wage, high technology industries,
such as pharmaceuticals, electronics, computers, microprocessors, professional
and scientific instruments, and certain high technology machinery and equipment.
The services sector, including finance, insurance, real estate, wholesale and
retail trade, and hotel and related services, also plays a major role in
economy. It rates second only to manufacturing in contribution to the gross
domestic product and leads all sectors in providing employment.
Puerto Rico's more than decade-long economic expansion continued throughout
the five-year period from fiscal 1993 through fiscal 1997. Almost every sector
of the economy participated and record levels of employment were achieved.
Factors behind this expansion included government-sponsored economic development
programs, periodic declines in the exchange value of the United States dollar,
increases in the level of federal transfers, and the relatively low cost of
borrowing.
Gross product in fiscal 1993 was $25.1 ($24.5 billion in 1992 prices) and
gross product in fiscal 1997 was $32.1 billion ($27.7 billion in 1992 prices).
This represents an increase in gross product of 27.7% from fiscal 1993 to 1997
(13.0% in 1992 prices).
Since fiscal 1985, personal income, both aggregate and per capita, has
increased consistently each fiscal year. In fiscal 1997, aggregate personal
income was $32.1 billion ($30.0 billion in 1992 prices) and personal income per
capita was $8,509 ($7,957 in 1992 prices). The difference in the statistics of
1992 prices for gross product and personal income is attributable to the
difference in the price deflators used for each.
Personal income includes transfer payments to individuals in Puerto Rico
under various social programs. Total federal payments to Puerto Rico, which
include transfers to local government entities and expenditures of federal
agencies in Puerto Rico, in addition to federal transfer payments to
individuals, are lower on a per capita basis in Puerto Rico than in any state.
Transfer payments to individuals in fiscal 1997 were $7.3 billion, of which $5.2
billion, or
34
<PAGE> 35
71.6%, represented entitlements to individuals who had previously performed
services or made contributions under programs such as Social Security, Veteran's
Benefits, Medicare and U.S. Civil Service retirement pensions.
According to the Labor Department's Household Employment Survey, during
fiscal 1998, total employment increased 0.8% over fiscal 1997. Total monthly
employment averaged 1,137,400 during the fiscal 1998, compared to 1,128,500 in
fiscal 1997. The seasonally adjusted unemployment rate for September 1998 was
13.5%.
The Planning Board's gross product forecast for fiscal 1999, made in
February 1998, projected an increase of 2.7% over fiscal 1998.
Puerto Rico has a diversified economy with the manufacturing and services
sectors comprising the principal sectors. Manufacturing is the largest sector in
terms of a gross domestic product. According to the Planning Board's estimates,
in fiscal 1997 manufacturing generated $19.8 billion, or 41.2%, of gross
domestic product and accounted for 14.4% of total employment; as compared with
fiscal 1996, when it generated $19.0 billion, or 42.0%, of gross domestic
product and accounted for 14.4% of total employment. Manufacturing in Puerto
Rico is now more diversified than during the earlier phases of its industrial
development and includes several industries less prone to business cycles. In
the last two decades, industrial development has tended to be more capital
intensive and more dependent on skilled labor. This gradual shift in emphasis is
best exemplified by the heavy investment in the pharmaceutical, scientific
instruments, computer, microprocessor, medical product and electrical product
industries over the last decade. One of the factors assisting the development of
the manufacturing sector has been the tax incentives offered by the federal and
Puerto Rico governments. Federal legislation enacted in 1996, however, which
amended Internal Revenue Code Section 936, phased out the federal tax incentives
during a 10-year period.
For many years, United States companies operating in Puerto Rico enjoyed a
special tax credit that was available under Section 936 of the Code. Originally,
the credit provided an effective 100% federal tax exemption for operating and
qualifying investment income from Puerto Rico sources. Amendments to Section 936
made in 1993 instituted two alternative methods for calculating the credit and
limited the amount of the credit that a qualifying company could claim. These
limitations area based on a percentage of qualifying income and on qualifying
expenditures on wages, other wage related benefit and qualifying expenditures.
As a result of amendments incorporated in the Small Business Job Protection Act
of 1996 enacted by the United States Congress and signed into law by President
Clinton on August 20, 1996, the tax credit is now being phased out over a
ten-year period for existing claimants and is no longer available for
corporations that establish operations in Puerto Rico after October 13, 1995
(including existing Section 936 Corporations to the extent substantially new
operations are established in Puerto Rico), the 1996 Amendments also moved the
credit based on the economic activity limitation to Section 30A of the Code and
phased it out over 10 years. In addition, the 1996 Amendments eliminated the
credit previously available for income derived from certain qualified
investments in Puerto Rico.
During 1997, Governor Rossello proposed to Congress the enactment of a new
permanent federal incentive program similar to what is now provided under
Section 30A. Such program would provide U.S. companies a tax credit based on
qualifying wages paid and other wage related expenses, such as fringe benefits,
as well as depreciation expenses for certain tangible assets and research and
development expenses. Under the Governor's proposal, the credit granted to
qualifying companies would continue to effect until Puerto Rico shows, among
other things, substantial economic improvements in terms of certain economic
parameters. The fiscal 1998 budget submitted by President Clinton to Congress in
February 1997 included a proposal to modify Section 30A to (i) extend the
availability of the Section 30A Credit indefinitely, (ii) make it available to
companies establishing operations in Puerto Rico after October 13, 1995, and
(iii) eliminate the income cap. Although said proposal was not included in the
final fiscal 1998 federal budget, President Clinton's fiscal 1999 budget
submitted to Congress again included these modifications to Section 30A. While
the Government of Puerto Rico plans to continue lobbying for this proposal, it
is not possible at this time to predict whether the Section 30A Credit will be
modified.
35
<PAGE> 36
It is not possible at this time to determine the long-term effect on the
Puerto Rico economy of the enactment of the 1996 Amendments. The Government of
Puerto does not believe there will be short-term or medium-term material adverse
effects on Puerto Rico's economy as a result of the enactment of the 1996
Amendment. The Government incentive programs to safeguard Puerto Rico's
competitive position.
Section 2 of Article VI of the Constitution of Puerto Rico provides that
direct obligations of the Commonwealth evidenced by full faith and credit bonds
or notes shall not be issued if the amount of the principal of and interest on
such bonds and notes and on all such bonds and notes theretofore issued which is
payable in any fiscal year, together with any amount paid by the Commonwealth in
the preceding fiscal year on account of bonds or notes guaranteed by the
Commonwealth, exceeds 15% of the average annual revenues raised under the
provisions of Commonwealth legislations and covered into the Treasury of Puerto
Rico in the two fiscal years proceeding the then current fiscal year. Section 2
of Article VI does not limit the amount of debt that the Commonwealth may
guarantee so long as the 15% limitation is not exceeded. Internal revenues
consist principally of income taxes, property taxes and excise taxes. Certain
revenues, such as federal excise taxes on offshore shipments of alcoholic
beverages and tobacco products and customs duties, which are collected by the
United States Government and returned to the Treasury of Puerto Rico, and motor
vehicle fuel taxes and license fees, which are allocated to the Highway
Authority, are not included as internal revenues for the purpose of calculating
the debt limit, although they may be available for the payment of debt service.
On February 26, 1997 legislation was introduced in the U.S. House of
Representatives proposing a mechanism to settle permanently the political
relationship between Puerto Rico and the United States, either through full
self-government (e.g., statehood or independence, including, as an alternative,
free association via a bilateral treaty) or continued commonwealth status. Under
the proposed legislation, failure to settle on full self-government after
completion of the referenda process provided therein would result in retention
of the current commonwealth status. On March 19, 1997, similar legislation was
introduced in the U.S. Senate. On March 4, 1998, the U.S. House of
Representatives voted in favor of the Political Status Act. The Senate, however,
has failed to act upon the Political Status Act and is not expected to consider
this measure prior to the end of the current session.
Pursuant to legislation approved by the Commonwealth Legislature, a
referendum will be held in Puerto Rico on December 13, 1998 in which the voters
will express their preference among four political status options. Two of the
options represent statehood and independence. The other two options describe
statuses which are based on a political relationship with the United States
providing varying degrees of sovereignty over local, national and international
matters. In connection with this referendum, the U.S. Senate adopted Senate
Resolution 279 in which it expressed the sense of the Senate supporting and
recognizing the right of United States citizens residing in Puerto Rico to
express their views regarding their future political status through a
referendum.
On September 21, 1998, Puerto Rico suffered the direct impact of Hurricane
Georges. The hurricane caused extensive damage throughout the island, with the
most serious damage occurring in the central mountain region. The island was
declared an emergency zone by President Clinton, thus making it eligible for
emergency assistance from the Federal Emergency Management Agency ("FEMA"). Most
losses to government and private property are expected to be covered by private
insurance, FEMA emergency aid and local government assistance programs.
It is expected that the hurricane will have a moderate short term negative
impact on the economy. Unemployment figures may increase during the second
quarter of fiscal year 1999 while the local economy recovers from the effects of
the hurricane. The receipt of FEMA funds and private insurance proceeds and the
corresponding increase in capital investment resulting from restoration
activities is expected to counteract the negative impact of the slowdown in
production activity. It is expected that the island will receive more than $3
billion from FEMA assistance and private insurance proceeds. This infusion is
expected to generate increased economic activity similar to what the island
experienced in the months after Hurricane Hugo and Hurricane Hortense in 1989
and 1996, respectively.
Governor Rossello's administration has developed and is implementing a new
economic development program which is based on the premise that the private
sector should provide the primary impetus for economic development and growth.
This new program, referred to as the New Economic Model, promotes changing the
role of the
36
<PAGE> 37
government from one of a provider of most basic services, to that of a
facilitator for private sector initiatives, and encourages private sector
investment by reducing government-imposed regulatory constraints.
The New Economic Model contemplates the development of initiatives that
will foster private investment in, and private management of, sectors that are
served more efficiently and effectively by private enterprise. The New Economic
Model also seeks to identify and promote those areas in which Puerto Rico can
compete more effectively in the global markets. In this regard, tourism has been
targeted as a priority because of its potential for job creation and increased
contribution to the gross product stemming from Puerto Rico's natural
competitive advantage. The New Economic Model also seeks to reduce the size of
government's direct contribution to gross domestic product. As part of this
goal, the Government has transferred certain governmental operations and sold a
number of its assets to private parties. One of the goals of the Rossello
administration is to change Puerto Rico's public health care system from one in
which the government provides: (i) free health services to low income
individuals through public health facilities owned and administered by the
government to one in which all medical services are provided by the private
sector; and (ii) the government provides comprehensive health insurance coverage
for qualifying (generally low-income) Puerto Rico residents.
Computer applications could fail or create erroneous results at or during
the year 2000. The extent of the potential impact of the Year 2000 Problem is
not yet known, and if not timely corrected, it could affect the global economy.
The Commonwealth does not anticipate that the transition to the twenty first
century will have any material impact on its ability to continue providing
governmental services. Each department, agency and instrumentality of the
Commonwealth has implemented a program intended to assess and remedy the Year
2000 Problem in its respective unit. In addition, each such unit has been
directed to seek assurances from service providers that they are taking all
necessary steps to ensure that their computer systems will accurately reflect
the Year 2000 and to continue to monitor the situation. However, in the event
the Commonwealth or other such organizations are not Year 2000 compliant, the
Commonwealth may face material adverse consequences with respect to its revenues
and operations.
On January 22, 1996, the U.S. District Court in Puerto Rico consolidated
all cases against the Commonwealth related to the complaints filed in 1979 by
the inmates of the correctional facilities in Puerto Rico. The Court ruled a
permanent order requiring the Commonwealth to comply with the requirement of the
minimum fixed living space per inmate. In the opinion of management, based on
advice of their legal counsel, this order will limit the imposition of further
fines and the fines already paid together with the accrued liability the general
long-term debt account group, (which amount to approximately $200 million at
June 30, 1997) shall be sufficient to carry out the Court's requirement.
Moody's and S&P have given the Bonds ratings of Baa1 and A, respectively.
These ratings do not reflect the MBIA Bond Insurance Policy or the Ambac Bond
Insurance Policy. Moody's and Standard and Poor's have given the Insured Bonds
ratings of Aaa and AAA, respectively. Ratings reflect only the respective views
of the rating agencies and an explanation of the significance of each rating may
be obtained only from the respective rating agency. There is no assurance that
such ratings will remain in effect for any given period of time or that they
will not be revised downward or withdrawn entirely by either or both of such
rating agencies, if in the judgment of either or both, circumstances so warrant.
INVESTMENT PRACTICES AND INSTRUMENTS
COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices or invest in the
following instruments to the extent permitted in the Prospectus and elsewhere in
this SAI.
TEMPORARY DEFENSIVE MEASURES
In times of unusual or adverse market conditions - for temporary defensive
purposes - each fund, except for the Equity Index Fund, may invest without limit
in cash and cash equivalents. See "Cash Equivalents."
37
<PAGE> 38
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
The Funds may enter into repurchase agreements with member banks of the
Federal Reserve System or member firms of the National Association of Securities
Dealers, Inc. that meet the repurchase agreement creditworthiness guidelines
established by the Trustees. In addition, the Global High Yield Fund,
International Bond and International Equity Funds may enter into domestic or
foreign repurchase agreements with certain sellers deemed to be creditworthy
pursuant to guidelines adopted by the Trustees.
A repurchase agreement, which provides a means for a Fund to earn income on
uninvested cash for periods as short as overnight, is an arrangement under which
the purchaser (i.e., the Fund) purchases a security, usually in the form of a
debt obligation (the "Obligation") and the seller agrees, at the time of sale,
to repurchase the Obligation at a specified time (usually not more than a week
in the case of the Equity Index Fund, California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond Fund) and price. Repurchase agreements with foreign
banks may be available with respect to government securities of the particular
foreign jurisdiction. The custody of the Obligation will be maintained by a
custodian appointed by the Fund. The Fund attempts to assure that the value of
the purchased securities, including any accrued interest, will at all times
exceed the value of the repurchase agreement. The repurchase price may be higher
than the purchase price, the difference being income to the Fund, or the
purchase and repurchase prices may be the same, with interest at a stated rate
due to the Fund together with the repurchase price upon repurchase. In either
case, the income to the Fund is unrelated to the interest rate on the Obligation
subject to the repurchase agreement.
The income on repurchase agreements may be subject to federal and state
income taxes when distributed by a Fund as a dividend to shareholders. Subject
to applicable limitations, the Tax Free Bond Fund and California and New York
Tax Free Funds will enter into repurchase agreements as a means of earning
income on their cash reserves when, in the judgment of the Subadviser,
shareholders would benefit more from receiving taxable income thereon than from
earning no income or tax-free income at a lower rate on such reserves.
For purposes of the Investment Company Act of 1940, as amended (the "1940
Act"), a repurchase agreement has been deemed to be a loan from the Fund to the
seller of the Obligation. It is not clear whether a court would consider the
Obligation purchased by the Fund subject to a repurchase agreement as being
owned by the Fund or as being collateral for a loan by the Fund to the seller.
In the event of the commencement of bankruptcy or insolvency proceedings with
respect to the seller of the Obligation before repurchase of the Obligation
under a repurchase agreement, the Fund may encounter delays and incur costs
before being able to sell the security. Delays may involve loss of interest or
decline in price of the Obligation. If the court characterizes the transaction
as a loan and the Fund has not perfected a security interest in the Obligation,
the Fund may be required to return the Obligation to the seller's estate and be
treated as an unsecured creditor of the seller. As an unsecured creditor, the
Fund would be at risk of losing some or all of the principal and income involved
in the transaction. As with any unsecured debt instrument purchased for the
Funds, the Subadvisers seek to minimize the risk of loss from repurchase
agreements by analyzing the creditworthiness of the obligor, in this case the
seller of the Obligation. Apart from the risk of bankruptcy or insolvency
proceedings, there is also the risk that the seller may fail to repurchase the
security. However, if the market value of the Obligation subject to the
repurchase agreement becomes less than the repurchase price (including accrued
interest), the Fund will direct the seller of the Obligation to deliver
additional securities so that the market value of all securities subject to the
repurchase agreement equals or exceeds the repurchase price.
The Strategic Income Fund, Strategic Value Fund, California Tax Free Fund,
New York Tax Free Fund, Blue Chip Growth Fund, Research Value Fund, Small Cap
Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income Fund
and Global High Yield Fund may enter into reverse repurchase agreements with
banks or broker-dealers, which involve the sale of a security by a Fund and its
agreement to repurchase the instrument at a specified time and price. Each Fund
will maintain a segregated account consisting of liquid assets to cover its
obligations under reverse repurchase agreements. Each of the California Tax Free
Fund and New York Tax Free Fund will limit its investments in reverse repurchase
agreements and other borrowing to no more than 10% of its total assets. The
Strategic Income Fund, Strategic Value Fund, Blue Chip Growth Fund, Research
Value Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth
Fund, Equity Income Fund and Global High Yield Fund will each limit
38
<PAGE> 39
its investments in reverse repurchase agreements to no more than 5% of its total
assets. The use of reverse repurchase agreements by a Fund creates leverage
which increases a Fund's investment risk. If the income and gains on securities
purchased with the proceeds of reverse repurchase agreements exceed the cost of
the agreements, the Fund's earnings or net asset value will increase faster than
otherwise would be the case; conversely, if the income and gains fail to exceed
the costs, earnings or net asset value would decline faster than otherwise would
be the case.
The Trustees have reviewed and approved certain sellers who they believe to
be creditworthy and have authorized the named Funds to enter into repurchase
agreements with such sellers. If the other party to a repurchase agreement were
to become bankrupt, a Fund could experience delays in recovering its investment
or losses.
LENDING OF PORTFOLIO SECURITIES
In accordance with guidelines adopted by the Board of Trustees, each Fund
may seek to increase its income by lending portfolio securities. Under present
regulatory policies, such loans may be made to institutions, such as
broker-dealers, and would be required to be secured continuously by collateral
in cash or U.S. government securities maintained on a current basis at an amount
at least equal to 100% of the current market value of the securities loaned. The
Fund would have the right to call a loan and obtain the securities loaned at any
time generally on less than five days' notice. For the duration of a loan, the
Fund would continue to receive the equivalent of the interest or dividends paid
by the issuer on the securities loaned and would also receive compensation from
the investment of the collateral. The Fund would not, however, have the right to
vote any securities having voting rights during the existence of the loan, but
the Fund would call the loan in anticipation of an important vote to be taken
among holders of the securities or of the giving or withholding of their consent
on a material matter affecting the investment. The Trust, on behalf of certain
of the Funds, has entered into an agency agreement with Merrill Lynch Portfolio
Services, Inc. which acts as the Funds' agent in making loans of portfolio
securities and short-term money market investments of the cash collateral
received, under the supervision and control of the Funds' Subadvisers.
As with other extensions of credit, there are risks of delay in recovery
of, or even loss of rights in, the collateral should the borrower of the
securities fail financially or breach its agreement with a Fund. However, the
loans would be made only to firms deemed by the Subadviser to be creditworthy
and approved by the Board, and when, in the judgment of the Subadviser, the
consideration which can be earned currently from securities loans of this type
justifies the attendant risk. If a Subadviser determines to make securities
loans, it is intended that the value of securities loaned will not exceed 33% of
the value of the total assets of the lending Fund. Under the guidelines adopted
by the Board of Trustees, a Fund may not enter into a lending agreement with a
counterparty which would cause the Fund to have loans outstanding to that
counterparty for securities having a value greater than 5% of the Fund's total
assets.
CASH EQUIVALENTS
Each of the Funds may invest in cash or cash equivalents, which include, but are
not limited to: short-term obligations issued or guaranteed as to interest and
principal by the U.S. Government or any agency or instrumentality
thereof(including repurchase agreements collateralized by such securities);
obligations of banks (certificates of deposit, bankers' acceptances and time
deposits) which at the date of investment have capital, surplus, and undivided
profits (as of the date of their most recently published financial statements)
in excess of $100,000,000, and obligations of other banks or savings and loan
associations if such obligations are federally insured; commercial paper (as
described in this SAI) short-term corporate obligations which at the date of
investment are rated AA or better by S&P or Aa or better by Moody's; and other
debt instruments not specifically described above if such instruments are deemed
by the Subadviser to be of comparable high quality and liquidity. In addition,
the Global High Yield, International Equity and International Bond Funds may
hold foreign cash and cash equivalents.
39
<PAGE> 40
BANK OBLIGATIONS
Time deposits are nonnegotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate. Time
deposits which may be held by the Funds will not benefit from insurance from the
Bank Insurance Fund or the Savings Association Insurance Fund administered by
the Federal Deposit Insurance Corporation.
Certificates of deposit are certificates evidencing the obligation of a
bank to repay funds deposited with it for a specified period of time.
Bankers' acceptances are credit instruments evidencing the obligation of a
bank to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity.
Investments in the obligations of banks are deemed to be "cash equivalents"
if, at the date of investment, the banks have capital surplus and individual
profits (as of the date of their most recently published financials) in excess
of $100,000,000, or if, with respect to the obligations of other banks and
savings and loan associations, such obligations are federally insured. The
Equity Index Fund will not be subject to the above restriction to the extent it
invests in bank obligations of United States banks (including foreign branches)
which have more than $1 billion in total assets at the time of investment and
are members of the Federal Reserve System or are examined by the Comptroller of
the Currency or whose deposits are insured by the Federal Deposit Insurance
Corporation. The Equity Index Fund also may invest in certificates of deposit of
savings and loan associations (federally or state chartered and federally
insured) having total assets in excess of $1 billion.
COMMERCIAL PAPER
Each Fund may invest in commercial paper if it is rated at the time of
investment Prime-1 by Moody's or A-1 by S&P, or, if not rated by Moody's or S&P,
if the Fund's Subadviser determines that the commercial paper is of comparable
quality. In addition, each Fund may invest up to 5% of its total assets in
commercial paper if rated in the second highest rating category by a nationally
recognized statistical rating organization, such as S&P or Moody's, or, if
unrated, if the Fund's Subadviser determines that the commercial paper is of
comparable quality. Commercial paper represents short-term unsecured promissory
notes issued by banks or bank holding companies, corporations and finance
companies.
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities include various U.S. Treasury securities, which differ only in
their interest rates, maturities and times of issuance. Treasury bills have
initial maturities of one year or less; Treasury notes have initial maturities
of one to 10 years; and Treasury bonds generally have initial maturities of
greater than ten years. Some obligations issued or guaranteed by U.S. government
agencies and instrumentalities, for example, Government National Mortgage
Association ("GNMA") pass-through certificates, are supported by the full faith
and credit of the U.S. Treasury; others, such as those of the Federal Home Loan
Banks, by the right of the issuer to borrow from the Treasury; others, such as
those issued by the Federal National Mortgage Association ("FNMA"), by the
discretionary authority of the U.S. government to purchase certain obligations
of the agency or instrumentality; and others, such as those issued by the
Student Loan Marketing Association, only by the credit of the agency or
instrumentality. While the U.S. government provides financial support to such
U.S. government-sponsored agencies or instrumentalities, no assurance can be
given that it will always do so, and it is not so obligated by law. See
"Mortgage-Related and Other Asset-Backed Securities."
DEBT SECURITIES
Debt securities may have fixed, variable or floating (including inverse
floating) rates of interest. To the extent that a Fund invests in debt
securities, it will be subject to certain risks. The value of the debt
securities held by a Fund, and
40
<PAGE> 41
thus the NAV of the shares of a Fund, generally will fluctuate depending on a
number of factors, including, among others, changes in the perceived
creditworthiness of the issuers of those securities, movements in interest
rates, the maturity of a Fund's investments, changes in relative values of the
currencies in which a Fund's investments are denominated relative to the U.S.
dollar, and the extent to which a Fund hedges its interest rate, credit and
currency exchange rate risks. Generally, a rise in interest rates will reduce
the value of fixed income securities held by a Fund, and a decline in interest
rates will increase the value of fixed income securities held by a Fund.
CONVERTIBLE SECURITIES
The Capital Appreciation Fund, Convertible Fund, High Yield Corporate Bond
Fund, International Bond Fund, International Equity Fund, Strategic Income Fund,
Strategic Value Fund, Total Return Fund, Value Fund, Blue Chip Growth Fund,
Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap
Growth Fund, Equity Income Fund, MAP Equity Fund and Global High Yield Fund may
invest in securities convertible into common stock or the cash value of a single
equity security or a basket or index of equity securities. Such investments may
be made, for example, if the Subadviser believes that a company's convertible
securities are undervalued in the market. Convertible securities eligible for
inclusion in the Funds' portfolios include convertible bonds, convertible
preferred stocks, warrants or notes or other instruments that may be exchanged
for cash payable in an amount that is linked to the value of a particular
security, basket of securities, index or indices of securities or currencies.
Convertible securities, until converted, have the same general
characteristics as other fixed income securities insofar as they generally
provide a stable stream of income with generally higher yields than those of
equity securities of the same or similar issuers. By permitting the holder to
exchange his investment for common stock or the cash value of a security or a
basket or index of securities, convertible securities may also enable the
investor to benefit from increases in the market price of the underlying
securities. Therefore, convertible securities generally offer lower interest or
dividend yields than non-convertible securities of similar quality.
As with all fixed income securities, the market value of convertible
securities tends to decline as interest rates increase and, conversely, tends to
increase as interest rates decline. The unique feature of the convertible
security is that as the market price of the underlying common stock declines, a
convertible security tends to trade increasingly on a yield basis, and so may
not experience market value declines to the same extent as the underlying common
stock. When the market price of the underlying common stock increases, the price
of a convertible security increasingly reflects the value of the underlying
common stock and may rise accordingly. While no securities investment is without
some risk, investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
Holders of fixed income securities (including convertible securities) have
a claim on the assets of the issuer prior to the holders of common stock in case
of liquidation. However, convertible securities are typically subordinated to
similar non-convertible securities of the same issuer.
Accordingly, convertible securities have unique investment characteristics
because (i) they have relatively high yields as compared to common stocks, (ii)
they have defensive characteristics since they provide a fixed return even if
the market price of the underlying common stock declines, and (iii) they provide
the potential for capital appreciation if the market price of the underlying
common stock increases.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the charter provision or indenture pursuant to
which the convertible security is issued. If a convertible security held by a
Fund is called for redemption, the Fund will be required to surrender the
security for redemption, convert it into the underlying common stock or cash or
sell it to a third party.
41
<PAGE> 42
ARBITRAGE
Each Fund, except the California Tax Free Fund, Equity Index Fund,
International Bond Fund, International Equity Fund, MAP Equity Fund, New York
Tax Free Fund and Tax Free Bond Fund, may sell in one market a security which it
owns and simultaneously purchase the same security in another market, or it may
buy a security in one market and simultaneously sell it in another market, in
order to take advantage of differences between the prices of the security in the
different markets. The Funds do not actively engage in arbitrage. Such
transactions may be entered into only with respect to debt securities and will
occur only in a dealer's market where the buying and selling dealers involved
confirm their prices to the Fund at the time of the transaction, thus
eliminating any risk to the assets of a Fund. Such transactions, which involve
costs to a Fund, may be limited by the requirements imposed on each Fund to
qualify as a "regulated investment company" under the Code.
FOREIGN SECURITIES
Except for the California Tax Free Fund, Government Fund, New York Tax Free
Fund and Tax Free Bond Fund, each Fund may invest in U.S. dollar-denominated and
non-dollar-denominated foreign debt and equity securities and in certificates of
deposit issued by foreign banks and foreign branches of U.S. banks. Under
current SEC rules relating to the use of the amortized cost method of portfolio
securities valuation, the Money Market Fund is restricted to purchasing U.S.
dollar-denominated securities, but it is not otherwise precluded from purchasing
securities of foreign issuers.
Investors should carefully consider the appropriateness of foreign
investing in light of their financial objectives and goals. While foreign
markets may present unique investment opportunities, foreign investing involves
risks not associated with domestic investing. Securities denominated in foreign
currencies may gain or lose value as a result of fluctuating currency exchange
rates. Securities markets in other countries are not always as efficient as
those in the U.S. and are sometimes less liquid and more volatile. Other risks
involved in investing in the securities of foreign issuers include differences
in accounting, auditing and financial reporting standards; limited publicly
available information; the difficulty of assessing economic trends in foreign
countries; generally higher commission rates on foreign portfolio transactions;
the possibility of nationalization, expropriation or confiscatory taxation;
adverse changes in investment or exchange control regulations (which may include
suspension of the ability to transfer currency from a country); government
interference, including government ownership of companies in certain sectors,
wage and price controls, or imposition of trade barriers and other protectionist
measures; difficulties in invoking legal process abroad and enforcing
contractual obligations; political, social or economic instability which could
affect U.S. investments in foreign countries; and potential restrictions on the
flow of international capital. Additionally, foreign securities and dividends
and interest payable on those securities may be subject to foreign taxes,
including foreign withholding taxes, and other foreign taxes may apply with
respect to securities transactions. Additional costs associated with an
investment in foreign securities may include higher transaction, custody and
foreign currency conversion costs. In the event of litigation relating to a
portfolio investment, the Funds may encounter substantial difficulties in
obtaining and enforcing judgments against non-U.S. resident individuals and
companies.
Investment in emerging market countries presents risks in greater degree
than, and in addition to, those presented by investment in foreign issuers in
general. Developing countries have economic structures that are less mature.
Furthermore, developing countries have less stable political systems and may
have high inflation, rapidly changing interest and currency exchange rates, and
their securities markets are substantially less developed. The economies of
developing countries generally are heavily dependent upon international trade,
and, accordingly, have been and may continue to be adversely affected by
barriers, exchange controls, managed adjustments in relative currency values and
other protectionist measures in the countries with which they trade. These
economies also have been and may continue to be adversely affected by economic
conditions in the countries with which they trade.
ADRs (sponsored or unsponsored) are receipts typically issued by a U.S.
bank or trust company evidencing ownership of the underlying foreign securities.
Most ADRs are traded on a U.S. stock exchange. Issuers of unsponsored ADRs are
not contractually obligated to disclose material information in the U.S. and,
therefore, there may
42
<PAGE> 43
not be a correlation between such information and the market value of the
unsponsored ADR. European Depositary Receipts and International Depositary
Receipts are receipts typically issued by a European bank or trust company
evidencing ownership of the underlying foreign securities. Global Depositary
Receipts are receipts issued by either a U.S. or non-U.S. banking institution
evidencing ownership of the underlying foreign securities.
FOREIGN CURRENCY TRANSACTIONS
Many of the foreign securities in which the Funds invest will be
denominated in foreign currencies. Changes in foreign exchange rates will affect
the value of securities denominated or quoted in foreign currencies. Exchange
rate movements can be large and can endure for extended periods of time,
affecting either favorably or unfavorably the value of the Funds' assets.
However, each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond Fund, may seek to increase its return by trading in foreign
currencies. In addition, to the extent a Fund invests in foreign securities, it
may enter into foreign currency forward contracts in order to protect against
uncertainty in the level of future foreign currency exchange rates. Each of
these Funds may enter into contracts to purchase foreign currencies to protect
against an anticipated rise in the U.S. dollar price of securities it intends to
purchase and may enter into contracts to sell foreign currencies to protect
against the decline in value of its foreign currency-denominated portfolio
securities due to a decline in the value of the foreign currencies against the
U.S. dollar. In addition, a Fund may use one currency (or a basket of
currencies) to hedge against adverse changes in the value of another currency
(or a basket of currencies) when exchange rates between the two currencies are
correlated.
Foreign currency transactions in which the Funds may engage include foreign
currency forward contracts, currency exchange transactions on a spot (i.e.,
cash) basis, put and call options on foreign currencies and foreign exchange
futures contracts. A foreign currency forward exchange contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days (usually less than one year) from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
A forward contract generally has no deposit requirement, and no commissions are
charged at any stage for trades. Although foreign exchange dealers do not charge
a fee for conversion, they do realize a profit based on the difference (the
spread) between the price at which they are buying and selling various
currencies.
Normally, consideration of fair value exchange rates will be incorporated
in a longer term investment decision made with regard to overall diversification
strategies. However, each Subadviser believes that it is important to have the
flexibility to enter into such forward contracts when it determines that the
best interest of a Fund will be served by entering into such a contract. Set
forth below are examples of some circumstances in which a Fund might employ a
foreign currency transaction. When a Fund enters into, or anticipates entering
into, a contract for the purchase or sale of a security denominated in a foreign
currency, it may desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale, for a fixed amount of
U.S. dollars, of the amount of foreign currency involved in the underlying
security transaction, a Fund will be able to insulate itself from a possible
loss resulting from a change in the relationship between the U.S. dollar and the
subject foreign currency during the period between the date on which the
security is purchased or sold and the date on which payment is made or received,
although a Fund would also forego any gain it might have realized had rates
moved in the opposite direction. This technique is sometimes referred to as a
"settlement" hedge or "transaction" hedge.
Another example is when the Subadviser believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, it may enter into a forward contract to sell, for a fixed amount of
dollars, the amount of foreign currency approximating the value of some or all
of a Fund's portfolio securities denominated in such foreign currency. Such a
hedge (sometimes referred to as a "position" hedge) will tend to offset both
positive and negative currency fluctuations, but will not offset changes in
security values caused by other factors. The Fund also may hedge the same
position by using another currency (or a basket of currencies) expected to
perform in a manner substantially similar to the hedged currency ("proxy"
hedge). The precise matching of the forward contract amounts and the value of
the securities involved will not generally be possible since the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the
43
<PAGE> 44
forward contract is entered into and the date it matures. With respect to
positions that constitute "transaction" or "position" hedges (including "proxy"
hedges), a Fund will not enter into forward contracts to sell currency or
maintain a net exposure to such contracts if the consummation of such contracts
would obligate the Fund to deliver an amount of foreign currency in excess of
the value of the Fund's portfolio securities or other assets denominated in that
currency (or the related currency, in the case of a "proxy" hedge).
A Fund may also enter into forward contracts to shift its investment
exposure from one currency into another currency that is expected to perform
inversely with respect to the hedged currency relative to the U.S. dollar. This
type of strategy, sometimes known as a "cross-currency" hedge, will tend to
reduce or eliminate exposure to the currency that is sold, and increase exposure
to the currency that is purchased, much as if the Fund had sold a security
denominated in one currency and purchased an equivalent security denominated in
another. "Cross-currency" hedges protect against losses resulting from a decline
in the hedged currency, but will cause the Fund to assume the risk of
fluctuations in the value of the currency it purchases.
A Fund may also purchase or sell currencies to profit from changing
exchange rates based upon the Subadviser's assessment of likely exchange rate
movements. These transactions will not necessarily hedge existing or anticipated
holdings of foreign securities and may result in a loss if the Subadviser's
currency assessment is incorrect.
At the consummation of the forward contract, a Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by purchasing an offsetting contract obligating it
to purchase at the same maturity date the same amount of such foreign currency.
If a Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If a Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract. When a Fund has sold a foreign currency, a similar
process would be followed at the consummation of the forward contract.
Of course, a Fund is not required to enter into such transactions with
regard to its foreign currency-denominated securities and will not do so unless
deemed appropriate by the Subadviser. A Fund generally will not enter into a
forward contract with a term of greater than one year.
In cases of transactions which constitute "transaction" or "settlement"
hedges or "position" hedges (including "proxy" hedges) or "cross-currency"
hedges that involve purchase and sale of two different foreign currencies
directly through the same foreign currency contract, a Fund may deem its forward
currency hedge position to be covered by underlying Fund portfolio securities or
may establish a Segregated Account with its custodian in an amount equal to the
value of the Fund's total assets committed to the consummation of the subject
hedge. The Segregated Account will consist of liquid assets. In the case of
"anticipatory" hedges and "cross-currency" hedges that involve the purchase and
sale of two different foreign currencies indirectly through separate forward
currency contracts, the Fund will establish a Segregated Account with its
custodian as described above. In the event a Fund establishes a Segregated
Account, the Fund will mark-to-market the value of the assets in the Segregated
Account. If the value of the liquid assets placed in the Segregated Account
declines, additional liquid assets will be placed in the account by the Fund on
a daily basis so that the value of the account will equal the amount of the
Fund's commitments with respect to such contracts.
It should be realized that the use forward contracts to protect the value
of a Fund's portfolio securities against a decline in the value of a currency
does not eliminate fluctuations in the underlying prices of the securities. It
simply establishes a rate of exchange which can be achieved at some future point
in time. It also reduces any potential gain which may have otherwise occurred
had the currency value increased above the settlement price of the contract.
The Subadvisers believe active currency management can be employed as an
overall portfolio risk management tool. For example, in their view, foreign
currency management can provide overall portfolio risk diversification when
combined with a portfolio of foreign securities, and the market risks of
investing in specific foreign markets can at
44
<PAGE> 45
times be reduced by currency strategies which may not involve the currency in
which the foreign security is denominated.
The Funds cannot assure that their use of forward contracts will always be
successful. Successful use of forward contracts depends on the investment
manager's skill in analyzing and predicting relative currency values. Forward
contracts alter a Fund's exposure to currencies and could result in losses to
the Fund if currencies do not perform as the Subadviser anticipates. A Fund may
also incur significant costs when converting assets from one currency to
another. Contracts to sell a foreign currency would limit any potential gain
which might be realized by a Fund if the value of the hedged currency increases.
A Fund's foreign currency transactions may be limited by the requirements
of Subchapter M of the Code for qualification as a regulated investment company.
FOREIGN INDEX-LINKED INSTRUMENTS
As part of its investment program, and to maintain greater flexibility, the
International Bond Fund, International Equity Fund, Strategic Income Fund and
Global High Yield Fund may, subject to compliance with each Fund's limitations
applicable to its investment in debt securities, invest in instruments which
have the investment characteristics of particular securities, securities
indexes, futures contracts or currencies. Such instruments may take a variety of
forms, such as debt instruments with interest or principal payments determined
by reference to the value of a currency or commodity at a future point in time.
For example, a Fund may, subject to compliance with its respective limitations
applicable to its investment in debt securities, invest in instruments issued by
the U.S. or a foreign government or by private issuers that return principal
and/or pay interest to investors in amounts which are linked to the level of a
particular foreign index ("foreign index-linked instruments"). Foreign
index-linked instruments have the investment characteristics of particular
securities, securities indexes, futures contracts or currencies. Such
instruments may take a variety of forms, such as debt instruments with interest
or principal payments determined by reference to the value of a currency or
commodity at a future point in time.
A foreign index may be based upon the exchange rate of a particular
currency or currencies or the differential between two currencies, or the level
of interest rates in a particular country or countries, or the differential in
interest rates between particular countries. In the case of foreign index-
linked instruments linking the interest component to a foreign index, the amount
of interest payable will adjust periodically in response to changes in the level
of the foreign index during the term of the foreign index-linked instrument. The
risks of such investments would reflect the risks of investing in the index or
other instrument the performance of which determines the return for the
instrument. Tax considerations may limit the Funds' ability to invest in foreign
index-linked instruments.
BRADY BONDS
Each of the Convertible Fund, Global High Yield Fund, High Yield Corporate
Bond Fund, International Bond Fund, Strategic Income Fund, Strategic Value Fund
and Total Return Fund may invest a portion of its assets in Brady Bonds, which
are securities created through the exchange of existing commercial bank loans to
sovereign entities for new obligations in connection with debt restructurings.
Brady bonds are not considered U.S. government securities.
Brady Bonds may be collateralized or uncollateralized and are issued in
various currencies (primarily the U.S. dollar). U.S. dollar-denominated,
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S.
Treasury zero coupon bonds having the same maturity as the Brady Bonds. Interest
payments on these Brady Bonds generally are collateralized on a one-year or
longer rolling-forward basis by cash or securities in an amount that, in the
case of fixed rate bonds, is equal to at least one year of interest payments or,
in the case of floating rate bonds, initially is equal to at least one year's
interest payments based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
"value recovery payments" in certain circumstances, which in effect constitute
supplemental interest payments but generally are not collateralized. Brady Bonds
are often viewed as having three or four valuation
45
<PAGE> 46
components: (i) the collateralized repayment of principal at final maturity;
(ii) the collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk").
Brady Bonds involve various risk factors, including the history of defaults
with respect to commercial bank loans by public and private entities of
countries issuing Brady Bonds. Investments in Brady Bonds are to be viewed as
speculative. There can be no assurance that Brady Bonds in which the Fund may
invest will not be subject to restructuring arrangements or to requests for new
credit, which may cause the Fund to suffer a loss of interest or principal on
any of its holdings.
MUNICIPAL SECURITIES
Municipal securities generally are understood to include debt obligations
issued by, or on behalf of, states, territories and possessions of the United
States and their political subdivisions, agencies and instrumentalities and the
District of Columbia, to obtain funds for various public purposes, including
construction of a wide range of public facilities, refunding of outstanding
obligations, payment of general operating expenses and extensions of loans to
public institutions and facilities. The yields on municipal securities depend
upon a variety of factors, including general economic and monetary conditions,
general money market conditions, general conditions of the municipal securities
market, the financial condition of the issuer, the size of a particular
offering, the maturity of the obligations offered and the rating of the issue or
issues. Municipal securities also may be subject to the provisions of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the Federal Bankruptcy Code, and laws, if any, which may be
enacted by Congress or state legislatures extending the time for payment of
principal or interest, or both, or imposing other constraints upon enforcement
of such obligations or upon the ability of municipalities to levy taxes. There
is also the possibility that, as a result of litigation or other conditions, the
power or ability of any one or more issuers to pay, when due, the principal of,
and interest on, its or their municipal securities may be materially and
adversely affected.
Tax Anticipation Notes are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues,
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes are issued in expectation of receipt of other
kinds of revenue, such as federal revenues. They, also, are usually general
obligations of the issuer.
Bond Anticipation Notes are normally issued to provide interim financial
assistance until long-term financing can be arranged. The long-term bonds then
provide funds for the repayment of the notes.
Construction Loan Notes are sold to provide construction financing for
specific projects. After successful completion and acceptance, many projects
receive permanent financing through the FHA under the FNMA or GNMA.
Project Notes are instruments sold by the Department of Housing and Urban
Development ("HUD") but issued by a state or local housing agency to provide
financing for a variety of programs. They are backed by the full faith and
credit of the U.S. government, and generally carry a term of one year or less.
Short-Term Discount Notes (tax-exempt commercial paper) are short-term (365
days or less) promissory notes issued by municipalities to supplement their cash
flow.
Municipal Bonds, which meet longer-term capital needs and generally have
maturities of more than one year when issued, have two principal
classifications: general obligation bonds and revenue bonds. Issuers of general
obligation bonds include states, counties, cities, towns and regional districts.
The proceeds of these obligations are used to fund a wide range of public
projects, including construction or improvement of schools, highways and roads,
and water and sewer systems. The basic security behind general obligation bonds
is the issuer's pledge of its full faith, credit and
46
<PAGE> 47
taxing power for the payment of principal and interest. The taxes that can be
levied for the payment of debt service may be limited or unlimited as to the
rate or amount of special assessments.
A revenue bond is not secured by the full faith, credit and taxing power of
an issuer. Rather, the principal security for a revenue bond is generally the
net revenue derived from a particular facility, group of facilities or, in some
cases, the proceeds of a special excise or other specific revenue source.
Revenue bonds are issued to finance a wide variety of capital projects,
including: electric, gas, water, and sewer systems; highways, bridges, and
tunnels; port and airport facilities; colleges and universities; and hospitals.
Although the principal security behind these bonds may vary, many provide
additional security in the form of a debt service reserve fund which may be used
to make principal and interest payments on the issuer's obligations. Housing
finance authorities have a wide range of security and credit enhancement
guarantees available to them, including partially or fully insured mortgages,
rent subsidized and/or collateralized mortgages, and/or the net revenues from
housing or other public projects. Some authorities are provided further security
in the form of a state's assurance (although without obligation) to make up
deficiencies in the debt service reserve fund.
An entire issue of Municipal Securities may be purchased by one or a small
number of institutional investors such as the Funds. Thus, the issue may not be
said to be publicly offered. Unlike securities which must be registered under
the Securities Act of 1933 prior to offer and sale, unless an exemption from
such registration is available, Municipal Securities which are not publicly
offered may nevertheless be readily marketable. A secondary market may exist for
Municipal Securities which were not publicly offered initially.
The Tax Free Bond Fund may invest more than 25% of its total assets in
Municipal Securities the issuers of which are located in the same state and may
invest more than 25% of its total assets in Municipal Securities the security of
which is derived from any one of the following categories: hospitals and health
facilities; turnpikes and toll roads; ports and airports; colleges and
universities; public housing authorities; general obligations of states and
localities; lease rental obligations of states and local authorities; state and
local housing finance authorities; municipal utilities systems; bonds that are
secured or backed by the Treasury or other U.S. government guaranteed
securities; or industrial development and pollution control bonds. There could
be economic, business or political developments which might affect all Municipal
Securities of a similar type. However, the Fund believes that the most important
consideration affecting risk is the quality of Municipal Securities.
The Tax Free Bond Fund and California and New York Tax Free Funds may
engage in short-term trading (selling securities held for brief periods of time,
usually less than three months) if the Subadviser believes that such
transactions, net of costs including taxes, if any, would improve the overall
return on its portfolio. The needs of different classes of lenders and borrowers
and their changing preferences and circumstances have in the past caused market
dislocations unrelated to fundamental creditworthiness and trends in interest
rates which have presented market trading opportunities. There can be no
assurance that such dislocations will occur in the future or that the Fund will
be able to take advantage of them.
There are, in addition, a variety of hybrid and special types of municipal
obligations, such as municipal lease obligations, as well as numerous
differences in the security of Municipal Securities both within and between the
two principal classifications described above. Municipal lease obligations are
municipal securities that may be supported by a lease or an installment purchase
contract issued by state and local government authorities to acquire funds to
obtain the use of a wide variety of equipment and facilities such as fire and
sanitation vehicles, computer equipment and other capital assets. These
obligations, which may be secured or unsecured, are not general obligations and
have evolved to make it possible for state and local governments to obtain the
use of property and equipment without meeting constitutional and statutory
requirements for the issuance of debt. Thus, municipal lease obligations have
special risks not normally associated with Municipal Securities. These
obligations frequently contain "non-appropriation" clauses that provide that the
governmental issuer of the obligation has no obligation to make future payments
under the lease or contract unless money is appropriated for such purposes by
the legislative body on a yearly or other periodic basis. In addition to the
"nonappropriation" risk, many municipal lease obligations have not yet developed
the depth of marketability associated with Municipal Bonds; moreover, although
the obligations may be secured by the leased
47
<PAGE> 48
equipment, the disposition of the equipment in the event of foreclosure might
prove difficult. For the purpose of each Fund's investment restrictions, the
identification of the "issuer" of Municipal Securities which are not General
Obligation Bonds is made by the Subadviser on the basis of the characteristics
of the Municipal Securities as described above, the most significant of which is
the source of funds for the payment of principal of and interest on such
Securities.
In order to limit certain of these risks, the California Tax Free Fund, New
York Tax Free Fund and Tax Free Bond Fund will not invest more than 10% (15% in
the case of the Strategic Income Fund) of its total assets in municipal lease
obligations that are illiquid (along with all other illiquid securities). The
liquidity of municipal lease obligations purchased by the Funds will be
determined pursuant to guidelines approved by the Board of Trustees. Factors
considered in making such determinations may include: the frequency of trades
and quotes for the obligation; the number of dealers willing to purchase or sell
the security and the number of other potential buyers; the willingness of
dealers to undertake to make a market in the security; the nature of marketplace
trades; the obligation's rating; and, if the security is unrated, the factors
generally considered by a rating agency.
There may be other types of municipal securities that become available
which are similar to the foregoing described municipal securities in which each
Fund may invest.
INCOME LEVEL AND CREDIT RISK. Municipal obligations are subject to the
provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the Federal Bankruptcy Code, and laws, if any,
which may be enacted by Congress or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations or upon municipalities to levy taxes. There is
also the possibility that as a result of litigation or other conditions, the
power or ability of any one or more issuers to pay, when due, principal or
interest on its or their municipal obligations may be materially affected.
Although the Funds' quality standards are designed to minimize the credit risk
of investing in Municipal Securities, that risk cannot be entirely eliminated.
TAX CONSIDERATIONS. With respect to the California Tax Free Fund, New York
Tax Free Fund and Tax Free Bond Fund, income derived by a Fund from taxable
investments, including but not limited to securities lending transactions,
repurchase transactions, options and futures transactions, and investments in
commercial paper, bankers' acceptances and certificates of deposit will be
taxable for federal, state and local income tax purposes when distributed to
shareholders. Income derived by a Fund from interest on direct obligations of
the U.S. government will be taxable for federal income tax purposes when
distributed to shareholders but, provided that the Fund meets the requirements
of state law and properly designates distributions to shareholders, such
distributions may be excludable from income for state personal income tax
purposes. A portion of original issue discount relating to stripped Municipal
Securities and their coupons may also be treated as taxable income under certain
circumstances.
The Tax Reform Act of 1986 ("TRA") limited the types and volume of
Municipal Securities qualifying for the federal income tax exemption for
interest, and the Code treats tax-exempt interest on certain Municipal
Securities as a tax preference item included in the alternative minimum tax base
for corporate and noncorporate shareholders. In addition, all tax-exempt
interest may result in or increase a corporation's liability under the corporate
alternative minimum tax, because a portion of the difference between corporate
"adjusted current earnings" and alternative minimum taxable income is treated as
a tax preference item. Further, an issuer's failure to comply with the detailed
and numerous requirements imposed by the Code after bonds have been issued may
cause the retroactive revocation of the tax-exempt status of certain Municipal
Securities after their issuance. The Funds intend to monitor developments in the
municipal bond market to determine whether any defensive action should be taken.
INDUSTRIAL DEVELOPMENT AND POLLUTION CONTROL BONDS
Industrial Development Bonds which pay tax-exempt interest are, in most
cases, revenue bonds and are issued by, or on behalf of, public authorities to
raise money to finance various privately operated facilities for business,
manufacturing, housing, sports, and pollution control. These bonds are also used
to finance public facilities such as
48
<PAGE> 49
airports, mass transit systems, ports, and parking. The payment of the principal
and interest on such bonds is solely dependent on the ability of the facility's
user to meet its financial obligations and the pledge, if any, of the real and
personal property so financed as security for such payments. These bonds are
generally not secured by the taxing power of the municipality but are secured by
the revenues of the authority derived from payments by the industrial user.
Industrial Development and Pollution Control Bonds, although nominally
issued by municipal authorities, are generally not secured by the taxing power
of the municipality but are secured by the revenues of the authority derived
from payments by the industrial user. Industrial Development Bonds issued after
the effective date of the TRA, as well as certain other bonds, are now
classified as "private activity bonds." Some, but not all, private activity
bonds issued after that date qualify to pay tax-exempt interest.
VARIABLE RATE DEMAND NOTES ("VRDNS")
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may invest in tax-exempt obligations which contain a floating or variable
interest rate adjustment formula and an unconditional right of demand to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period prior to specified dates, generally at 30, 60, 90, 180 or 365-day
intervals. The interest rates are adjustable at various intervals to the
prevailing market rate for similar investments, such adjustment formula being
calculated to maintain the market value of the VRDN at approximately the par
value of the VRDN on the adjustment date. The adjustments are typically based
upon the prime rate of a bank or some other appropriate interest rate adjustment
index.
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may also invest in VRDNs in the form of participation interests ("Participating
VRDNs") in variable rate tax-exempt obligations held by a financial institution,
typically a commercial bank ("Institution"). Participating VRDNs provide a Fund
with a specified undivided interest (up to 100%) of the underlying obligation
and the right to demand payment of the unpaid principal balance plus accrued
interest on the Participating VRDNs from the Institution upon a specified number
of days' notice, not to exceed seven days. In addition, the Participating VRDN
is backed up by an irrevocable letter of credit or guaranty of the Institution.
A Fund has an undivided interest in the underlying obligation and thus
participates on the same basis as the Institution in such obligation, except
that the Institution typically retains fees out of the interest paid or the
obligation for servicing the obligation, providing the letter of credit and
issuing the repurchase commitment.
FLOATING AND VARIABLE RATE SECURITIES
Floating and variable rate securities provide for a periodic adjustment in
the interest rate paid on the obligations. The terms of such obligations must
provide that interest rates are adjusted periodically based upon an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be based
on an event, such as a change in the prime rate.
The interest rate on a floating rate debt instrument ("floater") is a
variable rate which is tied to another interest rate, such as a money-market
index or Treasury bill rate. The interest rate on a floater resets periodically,
typically every six months. While, because of the interest rate reset feature,
floaters provide the Funds with a certain degree of protection against rises in
interest rates, the Funds will participate in any declines in interest rates as
well. To be an eligible investment for the Money Market Fund, there must be a
reasonable expectation that, at any time until the final maturity for the
floater or the period remaining until the principal amount can be recovered
through demand, the market value of a floater will approximate its amortized
cost.
The interest rate on a leveraged inverse floating rate debt instrument
("inverse floater") resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values. Accordingly, the
duration of an inverse floater may exceed its stated final maturity. Certain
inverse
49
<PAGE> 50
floaters may be deemed to be illiquid securities for purposes of the Funds'
limitations on investments in such securities. The Money Market Fund may not
invest in inverse floaters.
ZERO COUPON BONDS
The Funds, except the Equity Index Fund and MAP Equity Fund, may purchase
zero coupon bonds, which are debt obligations issued without any requirement for
the periodic payment of interest. Zero coupon bonds are issued at a significant
discount from face value. The discount approximates the total amount of interest
the bonds would accrue and compound over the period until maturity at a rate of
interest reflecting market rate at the time of issuance. Because interest on
zero coupon obligations is not paid to the Fund on a current basis but is, in
effect, compounded, the value of the securities of this type is subject to
greater fluctuations in response to changing interest rates than the value of
debt obligations which distribute income regularly. Zero coupon bonds tend to be
subject to greater market risk than interest paying securities of similar
maturities. The discount represents income, a portion of which the Funds must
accrue and distribute every year even though a Fund receives no payment on the
investment in that year. Zero coupon bonds tend to be more volatile than
conventional debt securities.
STANDBY COMMITMENTS -- OBLIGATIONS WITH PUTS ATTACHED
The California Tax Free Fund, New York Tax Free Fund, Strategic Income Fund
and Tax Free Bond Fund may purchase municipal securities together with the right
to resell the securities to the seller at an agreed-upon price or yield within a
specified period prior to the maturity date of the securities. Although it is
not a put option in the usual sense, such a right to resell is commonly known as
a "put" and is also referred to as a "standby commitment." Each of these Funds
may pay for a standby commitment either separately, in cash, or in the form of a
higher price for the securities which are acquired subject to the standby
commitment, thus increasing the cost of securities and reducing the yield
otherwise available from the same security. The Subadviser understands that the
Internal Revenue Service (the "IRS") has issued a revenue ruling to the effect
that, under specified circumstances, a registered investment company will be the
owner of tax-exempt municipal obligations acquired subject to a put option. The
IRS has also issued private letter rulings to certain taxpayers (which do not
serve as precedent for other taxpayers) to the effect that tax-exempt interest
received by a regulated investment company with respect to such obligations will
be tax-exempt in the hands of the company and may be distributed to its
shareholders as exempt-interest dividends. The IRS has subsequently announced
that it will not ordinarily issue advance ruling letters as to the identity of
the true owner of property in cases involving the sale of securities or
participation interests therein if the purchaser has the right to cause the
security, or the participation interest therein, to be purchased by either the
seller or a third party. Each of these Funds intends to take the position that
it is the owner of any municipal obligations acquired subject to a standby
commitment and that tax-exempt interest earned with respect to such municipal
obligations will be tax-exempt in its hands; however, no assurance can be given
that this position would prevail if challenged. In addition, there is no
assurance that standby commitments will be available to a Fund, nor has the
California Tax Free Fund, New York Tax Free Fund or Tax Free Bond Fund assumed
that such commitments would continue to be available under all market
conditions.
A standby commitment may not be used to affect a Fund's valuation of the
municipal security underlying the commitment. Any consideration paid by a Fund
for the standby commitment, whether paid in cash or by paying a premium for the
underlying security, which increases the cost of the security and reduces the
yield otherwise available from the same security, will be accounted for by the
Fund as unrealized depreciation until the standby commitment is exercised or has
expired.
WHEN-ISSUED SECURITIES
Each Fund may from time to time purchase securities on a "when-issued"
basis. Debt securities, including municipal securities, are often issued in this
manner. The price of such securities, which may be expressed in yield terms, is
fixed at the time a commitment to purchase is made, but delivery of and payment
for the when-issued securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase (60 days for municipal
bonds and notes). During the period between purchase and settlement, no payment
is made by the Fund and
50
<PAGE> 51
no interest accrues to the Fund. To the extent that assets of a Fund are held
in cash pending the settlement of a purchase of securities, that Fund would
earn no income; however, it is the Trust's intention that each Fund will be
fully invested to the extent practicable and subject to the policies stated
herein. Although when-issued securities may be sold prior to the settlement
date, the Trust intends to purchase such securities with the purpose of
actually acquiring them unless a sale appears desirable for investment reasons.
The transactions are entered into in order to secure what is considered to
be an advantageous price and yield to a Fund and not for purposes of leveraging
the Fund's assets. However, a Fund will not accrue any income on these
securities prior to delivery. The value of when-issued securities may vary prior
to and after delivery depending on market conditions and changes in interest
rate levels. There is a risk that a party with whom a Fund has entered into such
transactions will not perform its commitment, which could result in a gain or
loss to the Fund.
At the time the Trust makes the commitment on behalf of a Fund to purchase
a security on a when-issued basis, it will record the transaction and reflect
the amount due and the value of the security in determining the Fund's net asset
value. The market value of the when-issued security may be more or less than the
purchase price payable at the settlement date. The Funds do not believe that a
Fund's net asset value or income will be exposed to additional risk by the
purchase of securities on a when-issued basis. Each Fund will establish a
segregated account in which it will maintain liquid assets at least equal in
value to commitments for when-issued securities. Such segregated securities
either will mature or, if necessary, be sold on or before the settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
Each Fund may buy mortgage-related securities. Mortgage-related securities
are interests in pools of residential or commercial mortgage loans or leases,
including mortgage loans made by savings and loan institutions, mortgage
bankers, commercial banks and others. Pools of mortgage loans are assembled as
securities for sale to investors by various governmental, government-related and
private organizations (see "Mortgage Pass-Through Securities"). The Funds, to
the extent permitted in the Prospectus, may also invest in debt securities
which are secured with collateral consisting of mortgage-related securities
(see "Collateralized Mortgage Obligations"), and in other types of mortgage-
related securities. Like other fixed-income securities, when interest rates
rise, the value of a mortgage-related security generally will decline; however,
when interest rates are declining, the value of a mortgage-related security
with prepayment features may not increase as much as other fixed-income
securities.
MORTGAGE PASS-THROUGH SECURITIES. Mortgage pass-through securities, which
are securities interests in pools of mortgage-related securities, differ from
other forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Additional payments are caused by repayments of principal
resulting from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Some mortgage-related
securities (such as securities issued by GNMA) are described as "modified
pass-through." These securities entitle the holder to receive all interest and
principal payments owed on the mortgage pool, net of certain fees, at the
scheduled payment dates regardless of whether or not the mortgagor actually
makes the payment. Some mortgage pass-through certificates may include
securities backed by adjustable-rate mortgages which bear interest at a rate
that will be adjusted periodically.
Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to sale of the underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose a Fund to a lower rate of return upon reinvestment of principal. Also, if
a security subject to prepayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
51
<PAGE> 52
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. government (in the case of securities
guaranteed by GNMA); or guaranteed by agencies or instrumentalities of the U.S.
government (in the case of securities guaranteed by FNMA or FHLMC, which are
supported only by the discretionary authority of the U.S. government to purchase
the agency's obligations).
The principal governmental guarantor of mortgage-related securities is the
GNMA. GNMA is a wholly owned U.S. government corporation within the U.S.
Department of Housing and Urban Development. GNMA is authorized to guarantee,
with the full faith and credit of the U.S. government, the timely payment of
principal and interest on securities issued by institutions approved by GNMA
(such as savings and loan institutions, commercial banks and mortgage bankers)
and backed by pools of Federal Housing Administration ("FHA")-insured or
Veterans Administration-guaranteed mortgages.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development
and acts as a government instrumentality under authority granted by Congress.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. government. FNMA is authorized to borrow from the U.S. Treasury to
meet its obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a
government-sponsored corporation and acts as a government instrumentality under
authority granted by Congress. FHLMC was formerly owned by the twelve Federal
Home Loan Banks and is now owned entirely by private stockholders. FHLMC issues
Participation Certificates ("PCS") which represent interests in conventional
mortgages from FHLMC's national portfolio. FHLMC guarantees the timely payment
of interest and collection of principal, but PCS are not backed by the full
faith and credit of the U.S. government.
If either fixed or variable rate pass-through securities issued by the U.S.
government or its agencies or instrumentalities are developed in the future, the
Funds reserve the right to invest in them.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Such issuers may,
in addition, be the originators and/or servicers of the underlying mortgage
loans as well as the guarantors of the mortgage-related securities. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. Such insurance and guarantees and the creditworthiness of the
issuers thereof will be considered in determining whether a mortgage-related
security meets a Fund's investment quality standards. There can be no assurance
that the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. A Fund may buy mortgage-related
securities without insurance or guarantees if, through an examination of the
loan experience and practices of the originator/servicers and poolers, the
Fund's Subadviser determines that the securities meet the Fund's quality
standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. The mortgage-related
securities in which the Funds may invest may be: (i) privately issued securities
which are collateralized by pools of mortgages in which each mortgage is
guaranteed as to payment of principal and interest by an agency or
instrumentality of the U.S. government; (ii) privately issued securities which
are collateralized by pools of mortgages in which payment of principal and
interest is
52
<PAGE> 53
guaranteed by the issuer and such guarantee is collateralized by U.S. government
securities; and (iii) other privately issued securities in which the proceeds of
the issuance are invested in mortgage-backed securities and payment of the
principal and interest is supported by the credit of an agency or
instrumentality of the U.S. government.
The MAP Equity Fund, California Tax Free Fund, New York Tax Free Fund and
Equity Index Fund, however, may not invest in non-government mortgage
pass-through securities. Although the market for such securities is becoming
increasingly liquid, securities issued by certain private organizations may not
be readily marketable. No Fund will purchase mortgage-related securities or any
other assets which, in the opinion of the Fund's Subadviser, are illiquid if, as
a result, more than 10% of the value of the Fund's total assets will be illiquid
(15% in the case of the Blue Chip Growth, Equity Income, Global High Yield,
Growth Opportunities, International Equity, International Bond, MAP Equity,
Research Value, Small Cap Growth, Small Cap Value, Strategic Income and
Strategic Value Funds).
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. As with bonds,
interest and prepaid principal is paid, in most cases, semiannually. CMOs may be
collateralized by whole mortgage loans, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering
are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third-party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The Series A, B, and C Bonds
all bear current interest. Interest on the Series Z Bond is accrued and added to
principal and a like amount is paid as principal on the Series A, B or C Bond
currently being paid off. When the Series A, B and C Bonds are paid in full,
interest and principal on the Series Z Bond begins to be paid currently. With
some CMOs, the issuer serves as a conduit to allow loan originators (primarily
builders or savings and loan associations) to borrow against their loan
portfolios.
The eligible Funds will not invest in any privately issued CMOs that do not
meet the requirements of Rule 3a-7 under the 1940 Act if, as a result of such
investment, more than 5% of a Fund's net assets would be invested in any one
such CMO, more than 10% of the Fund's net assets would be invested in such CMOs
and other investment company securities in the aggregate, or the Fund would hold
more than 3% of any outstanding issue of such CMOs.
FHLMC COLLATERALIZED MORTGAGE OBLIGATIONS. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCS, payments of principal and interest on the CMOs are made
semiannually, as opposed to monthly. The amount of principal payable on each
semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payment of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's minimum
sinking fund requirement, the rate at which principal of the CMOs is actually
repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
53
<PAGE> 54
If collection of principal (including prepayments) on the mortgage loans
during any semiannual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC PCS. FHLMC has the right to substitute collateral in the event
of delinquencies and/or defaults.
OTHER MORTGAGE-RELATED SECURITIES. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals or stripped mortgage-backed
securities, and may be structured in classes with rights to receive varying
proportions of principal and interest. Other mortgage-related securities may be
equity or debt securities issued by agencies or instrumentalities of the U.S.
government or by private originators of, or investors in, mortgage loans,
including savings and loan associations, homebuilders, mortgage banks,
commercial banks, investment banks, partnerships, trusts and special purpose
entities of the foregoing.
The Funds' Subadvisers expect that governmental, government-related or
private entities may create mortgage loan pools and other mortgage-related
securities offering mortgage pass-through and mortgage-collateralized
investments in addition to those described above. The mortgages underlying these
securities may include alternative mortgage instruments, that is, mortgage
instruments whose principal or interest payments may vary or whose terms to
maturity may differ from customary long-term fixed rate mortgages. As new types
of mortgage-related securities are developed and offered to investors, a Fund's
Subadviser will, consistent with the Fund's investment objectives, policies and
quality standards, consider making investments in such new types of
mortgage-related securities.
CMO RESIDUALS. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-backed securities. See "Stripped
Mortgage-Backed Securities." In addition, if a series of a CMO includes a class
that bears interest at an adjustable rate, the yield to maturity on the related
CMO residual will also be extremely sensitive to changes in the level of the
index upon which interest rate adjustments are based. As described below with
respect to stripped mortgage-backed securities, in certain circumstances, a
portfolio may fail to recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may or, pursuant to an exemption therefrom, may not have
been registered under the Securities Act of 1933, as amended. CMO residuals,
whether or not registered under such Act, may be subject to certain restrictions
on transferability, and may be deemed "illiquid" and subject to a Fund's
limitations on investment in illiquid securities.
Under certain circumstances, a Fund's investment in residual interests in
"real estate mortgage investment conduits" ("REMICs") may cause shareholders of
that Fund to be deemed to have taxable income in addition to their Fund
dividends and distributions and such income may not be eligible to be reduced
for tax purposes by certain deductible
54
<PAGE> 55
amounts, including net operating loss deductions. In addition, in some cases,
the Fund may be required to pay taxes on certain amounts deemed to be earned
from a REMIC residual. Prospective investors may wish to consult their tax
advisors regarding REMIC residual investments by a Fund.
CMOs and REMICs may offer a higher yield than U.S. government securities,
but they may also be subject to greater price fluctuation and credit risk. In
addition, CMOs and REMICs typically will be issued in a variety of classes or
series, which have different maturities and are retired in sequence. Privately
issued CMOs and REMICs are not government securities nor are they supported in
any way by any governmental agency or instrumentality. In the event of a default
by an issuer of a CMO or a REMIC, there is no assurance that the collateral
securing such CMO or REMIC will be sufficient to pay principal and interest. It
is possible that there will be limited opportunities for trading CMOs and REMICs
in the over-the-counter market, the depth and liquidity of which will vary from
time to time. Holders of "residual" interests in REMICs (including the Fund)
could be required to recognize potential phantom income, as could shareholders
(including unrelated business taxable income for tax-exempt shareholders) of
funds that hold such interests. The Fund will consider this rule in determining
whether to invest in residual interests.
STRIPPED MORTGAGE-BACKED SECURITIES. Stripped mortgage-backed securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the principal-only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on a Fund's yield to maturity from these securities. If the underlying
mortgage assets experience greater than anticipated prepayments of principal, a
Fund may fail to fully recoup its initial investment in these securities even if
the security is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, these securities may be deemed "illiquid" and
subject to a Fund's limitations on investment in illiquid securities.
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES. As is the case with other
fixed-income securities, when interest rates rise, the value of a
mortgage-related security generally will decline; however, when interest rates
are declining, the value of mortgage-related securities with prepayment features
may not increase as much as other fixed income securities. The value of some
mortgage-backed securities in which the Funds may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Funds, the ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of a Subadviser to forecast
interest rates and other economic factors correctly. If a Subadviser incorrectly
forecasts such factors and has taken a position in mortgage-backed securities
that is or becomes contrary to prevailing market trends, the Funds could be
exposed to the risk of a loss.
Investment in mortgage-backed securities poses several risks, including
prepayment, market, and credit risk. Prepayment risk reflects the chance that
borrowers may prepay their mortgages faster than expected, thereby affecting the
investment's average life and perhaps its yield. Whether or not a mortgage loan
is prepaid is almost entirely controlled by the borrower. Borrowers are most
likely to exercise their prepayment options at a time when it is least
advantageous to investors, generally prepaying mortgages as interest rates fall,
and slowing payments as interest rates
55
<PAGE> 56
rise. Besides the effect of prevailing interest rates, the rate of prepayment
and refinancing of mortgages may also be affected by home value appreciation,
ease of the refinancing process and local economic conditions.
Market risk reflects the chance that the price of the security may
fluctuate over time. The price of mortgage-backed securities may be particularly
sensitive to prevailing interest rates, the length of time the security is
expected to be outstanding, and the liquidity of the issue. In a period of
unstable interest rates, there may be decreased demand for certain types of
mortgage-backed securities, and a Fund invested in such securities and wishing
to sell them may find it difficult to find a buyer, which may in turn decrease
the price at which they may be sold.
Credit risk reflects the chance that a Fund may not receive all or part of
its principal because the issuer or credit enhancer has defaulted on its
obligations. Obligations issued by U.S. government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. government. The performance of private
label mortgage-backed securities, issued by private institutions, is based on
the financial health of those institutions.
OTHER ASSET-BACKED SECURITIES. The Funds' Subadvisers expect that other
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future. Several types of asset-backed securities have already
been offered to investors, including Certificates for Automobile ReceivablesSM
("CARSSM"). CARSSM represent undivided fractional interests in a trust ("trust")
whose assets consist of a pool of motor vehicle retail installment sales
contracts and security interests in the vehicles securing the contracts.
Payments of principal and interest on CARSSM are passed-through monthly to
certificate holders, and are guaranteed up to certain amounts and for a certain
time period by a letter of credit issued by a financial institution unaffiliated
with the trustee or originator of the trust. An investor's return on CARSSM may
be affected by early prepayment of principal on the underlying vehicle sales
contracts. If the letter of credit is exhausted, the trust may be prevented from
realizing the full amount due on a sales contract because of state law
requirements and restrictions relating to foreclosure sales of vehicles and the
obtaining of deficiency judgments following such sales or because of
depreciation, damage or loss of a vehicle, the application of Federal and state
bankruptcy and insolvency laws, or other factors. As a result, certificate
holders may experience delays in payments or losses if the letter of credit is
exhausted.
If consistent with a Fund's investment objective and policies, and, in the
case of the Money Market Fund, the requirements of Rule 2a-7, a Fund also may
invest in other types of asset-backed securities. Certain asset-backed
securities may present the same types of risks that may be associated with
mortgage-backed securities.
WARRANTS
The holder of a warrant has the right to purchase a given number of shares
of a particular issuer at a specified price until expiration of the warrant.
Such investments can provide a greater potential for profit or loss than an
equivalent investment in the underlying security. Prices of warrants do not
necessarily move in tandem with the prices of the underlying securities, and are
speculative investments. Warrants pay no dividends and confer no rights other
than a purchase option. If a warrant is not exercised by the date of its
expiration, the Fund will lose its entire investment in such warrant.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a Fund sells through a broker a
security it does not own in anticipation of a possible decline in market price.
A short sale "against the box" is a short sale in which, at the time of the
short sale, a Fund owns or has the right to obtain securities equivalent in kind
and amount. Each of the Funds will only enter into short sales against the box.
A Fund may enter into a short sale against the box among other reasons, to hedge
against a possible market decline in the value of the security owned by the
Fund. If the value of a security sold short against the box increases, the Fund
would suffer a loss when it purchases or delivers to the selling broker the
security sold short. The proceeds of the short sale are retained by the broker
pursuant to applicable margin rules. In addition, the Fund may segregate assets,
equal in value to 50% of the value of the short sale, in a special account with
the Fund's
56
<PAGE> 57
custodian. The segregated assets are pledged to the broker pursuant to
applicable margin rules. If a broker with which the Fund has open short sales,
were to become bankrupt, a Fund could experience losses or delays in recovering
gains on short sales. The Funds will only enter into short sales against the box
with brokers the Subadvisers believe are creditworthy. Short sales against the
box will be limited to no more than 25% of a Fund's total assets. The MAP Equity
Fund may not enter into short sales against the box.
OPTIONS ON SECURITIES
WRITING CALL OPTIONS. Each Fund, except the MAP Equity Fund and the Money
Market Fund, may sell ("write") covered call options on its portfolio securities
in an attempt to enhance investment performance. A call option sold by a Fund is
a short-term contract, having a duration of nine months or less, which gives the
purchaser of the option the right to buy, and imposes on the writer of the
option--in return for a premium received--the obligation to sell, the underlying
security at the exercise price upon the exercise of the option at any time prior
to the expiration date, regardless of the market price of the security during
the option period. A call option may be covered by, among other things, the
writer's owning the underlying security throughout the option period, or by
holding, on a share-for-share basis, a call on the same security as the call
written, where the exercise price of the call held is equal to or less than the
price of the call written, or greater than the exercise price of a call written
if the difference is maintained by the Fund in liquid assets in a segregated
account with its custodian.
A Fund will write covered call options both to reduce the risks associated
with certain of its investments and to increase total investment return through
the receipt of premiums. In return for the premium income, the Fund will give up
the opportunity to profit from an increase in the market price of the underlying
security above the exercise price so long as its obligations under the contract
continue, except insofar as the premium represents a profit. Moreover, in
writing the call option, the Fund will retain the risk of loss should the price
of the security decline, which loss the premium is intended to offset in whole
or in part. A Fund, in writing "American Style" call options, must assume that
the call may be exercised at any time prior to the expiration of its obligations
as a writer, and that in such circumstances the net proceeds realized from the
sale of the underlying securities pursuant to the call may be substantially
below the prevailing market price. In contrast, "European Style" options may
only be exercised on the expiration date of the option. Covered call options and
the securities underlying such options will be listed on national securities
exchanges, except for certain transactions in options on debt securities and
foreign securities.
During the option period, the covered call writer has, in return for the
premium received on the option, given up the opportunity to profit from a price
increase in the underlying securities above the exercise price, but, as long as
its obligation as a writer continues, has retained the risk of loss should the
price of the underlying security decline.
A Fund may protect itself from further losses due to a decline in value of
the underlying security or from the loss of ability to profit from appreciation
by buying an identical option, in which case the purchase cost may offset the
premium. In order to do this, the Fund makes a "closing purchase
transaction"--the purchase of a call option on the same security with the same
exercise price and expiration date as the covered call option which it has
previously written on any particular security. The Fund will realize a gain or
loss from a closing purchase transaction if the amount paid to purchase a call
option in a closing transaction is less or more than the amount received from
the sale of the covered call option. Also, because increases in the market price
of a call option will generally reflect increases in the market price of the
underlying security, any loss resulting from the closing out of a call option is
likely to be offset in whole or in part by unrealized appreciation of the
underlying security owned by the Fund. When a security is to be sold from the
Fund's portfolio, the Fund will first effect a closing purchase transaction so
as to close out any existing covered call option on that security or otherwise
cover the existing call option.
A closing purchase transaction may be made only on a national or foreign
securities exchange (an "Exchange") which provides a secondary market for an
option with the same exercise price and expiration date, except as discussed
below. There is no assurance that a liquid secondary market on an Exchange or
otherwise will exist for any particular option, or at any particular time, and
for some options no secondary market on an Exchange or otherwise may exist. If a
Fund is unable to effect a closing purchase transaction involving an
exchange-traded option, the Fund will not sell the
57
<PAGE> 58
underlying security until the option expires, or the Fund otherwise covers the
existing option portion or the Fund delivers the underlying security upon
exercise. Once an option writer has received an exercise notice, it cannot
effect a closing purchase transaction in order to terminate its obligation under
the option and must deliver or purchase the underlying securities at the
exercise price. Over-the-counter options differ from exchange-traded options in
that they are two-party contracts with price and other terms negotiated between
buyer and seller, and generally do not have as much market liquidity as
exchange-traded options. Therefore, a closing purchase transaction for an
over-the-counter option may in many cases only be made with the other party to
the option.
Each Fund pays brokerage commissions and dealer spreads in connection with
writing covered call options and effecting closing purchase transactions, as
well as for purchases and sales of underlying securities. The writing of covered
call options could result in significant increases in a Fund's portfolio
turnover rate, especially during periods when market prices of the underlying
securities appreciate. Subject to the limitation that all call and put option
writing transactions be covered, the Funds may, to the extent determined
appropriate by the Subadviser, engage without limitation in the writing of
options on U.S. government securities. Subject to the limitation that all call
and put option writing transactions be covered, and limitations imposed on
regulated investment companies under Federal tax law, the International Bond
Fund, International Equity Fund and Global High Yield Fund may, to the extent
determined appropriate by the Subadviser, engage without limitation in the
writing of options on their portfolio securities.
WRITING PUT OPTIONS. Each Fund, except the Money Market Fund and the MAP
Equity Fund, may also write covered put options. A put option is a short-term
contract which gives the purchaser of the put option, in return for a premium,
the right to sell the underlying security to the seller of the option at a
specified price during the term of the option. Put options written by a Fund are
agreements by a Fund, for a premium received by the Fund, to purchase specified
securities at a specified price if the option is exercised during the option
period. A put option written by a Fund is "covered" if the Fund maintains liquid
assets with a value equal to the exercise price in a segregated account with its
custodian. A put option is also "covered" if the Fund holds on a share-for-share
basis a put on the same security as the put written, where the exercise price of
the put held is equal to or greater than the exercise price of the put written,
or less than the exercise price of the put written if the difference is
maintained by the Fund in liquid assets in a segregated account with its
custodian.
The premium which the Funds receive from writing a put option will reflect,
among other things, the current market price of the underlying security, the
relationship of the exercise price to such market price, the historical price
volatility of the underlying security, the option period, supply and demand and
interest rates.
A covered put writer assumes the risk that the market price for the
underlying security will fall below the exercise price, in which case the writer
could be required to purchase the security at a higher price than the
then-current market price of the security. In both cases, the writer has no
control over the time when it may be required to fulfill its obligation as a
writer of the option.
The Funds may effect a closing purchase transaction to realize a profit on
an outstanding put option or to prevent an outstanding put option from being
exercised.
If a Fund is able to enter into a closing purchase transaction, the Fund
will realize a profit or loss from such transaction if the cost of such
transaction is less or more than the premium received from the writing of the
option respectively. After writing a put option, the Fund may incur a loss equal
to the difference between the exercise price of the option and the sum of the
market value of the underlying security plus the premium received from the sale
of the option.
In addition, the Funds may also write straddles (combinations of covered
puts and calls on the same underlying security). The extent to which the Funds
may write covered put and call options and enter into so-called "straddle"
transactions involving put or call options may be limited by the requirements of
the Code for qualification as a regulated investment company and the Trust's
intention that each Fund qualify as such. Subject to the limitation that all
58
<PAGE> 59
call and put option writing transactions be covered, the Funds may, to the
extent determined appropriate by the Subadvisers, engage without limitation in
the writing of options on U.S. government securities.
PURCHASING OPTIONS. Each Fund, except Money Market Fund and the Tax Free
Bond Fund, may purchase put or call options which are traded on an Exchange or
in the over-the-counter market. Options traded in the over-the-counter market
may not be as actively traded as those listed on an Exchange. Accordingly, it
may be more difficult to value such options and to be assured that they can be
closed out at any time. The Funds will engage in such transactions only with
firms the Subadvisers deem to be of sufficient creditworthiness so as to
minimize these risks.
The Funds may purchase put options on securities to protect their holdings
in an underlying or related security against a substantial decline in market
value. Securities are considered related if their price movements generally
correlate with one another. The purchase of put options on securities held in
the portfolio or related to such securities will enable a Fund to preserve, at
least partially, unrealized gains occurring prior to the purchase of the option
on a portfolio security without actually selling the security. In addition, the
Fund will continue to receive interest or dividend income on the security. The
put options purchased by the Fund may include, but are not limited to,
"protective puts" in which the security to be sold is identical or substantially
identical to a security already held by the Fund or to a security which the Fund
has the right to purchase. The Fund would ordinarily recognize a gain if the
value of the securities decreased during the option period below the exercise
price sufficiently to cover the premium. The Fund would recognize a loss if the
value of the securities remained above the difference between the exercise price
and the premium.
The Funds may also purchase call options on securities the Funds intend to
purchase to protect against substantial increases in prices of such securities
pending their ability to invest in an orderly manner in such securities. The
purchase of a call option would entitle the Fund, in exchange for the premium
paid, to purchase a security at a specified price upon exercise of the option
during the option period. The Fund would ordinarily realize a gain if the value
of the securities increased during the option period above the exercise price
sufficiently to cover the premium. The Fund would have a loss if the value of
the securities remained below the sum of the premium and the exercise price
during the option period. In order to terminate an option position, the Funds
may sell put or call options identical to those previously purchased, which
could result in a net gain or loss depending on whether the amount received on
the sale is more or less than the premium and other transaction costs paid on
the put or call option when it was purchased.
MARRIED PUTS. Each Fund, except the Equity Index Fund, MAP Equity Fund,
Money Market Fund and Tax Free Bond Fund, may engage in a strategy known as
"married puts." This strategy is most typically used when the Fund owns a
particular common stock or security convertible into common stock and wishes to
effect a short sale against the box (see "Short Sales Against the Box") but for
various reasons is unable to do so. The Fund may then enter into a series of
stock and related option transactions to achieve the economic equivalent of a
short sale against the box. To implement this trading strategy, the Fund will
simultaneously execute with the same broker a purchase of shares of the common
stock and an "in the money" over-the-counter put option to sell the common stock
to the broker and generally will write an over-the-counter "out of the money"
call option in the same stock with the same exercise price as the put option.
The options are linked and may not be exercised, transferred or terminated
independently of the other.
Holding the put option places the Fund in a position to profit on the
decline in price of the security just as it would by effecting a short sale and
to, thereby, hedge against possible losses in the value of a security or
convertible security held by the Fund. The writer of the put option may require
that the Fund write a call option, which would enable the broker to profit in
the event the price of the stock rises above the exercise price of the call
option (see "Writing Call Options" above). In the event the stock price were to
increase above the strike or exercise price of the option, the Fund would suffer
a loss unless it first terminated the call by exercising the put.
SPECIAL RISKS ASSOCIATED WITH OPTIONS ON SECURITIES. Exchange markets in
some securities options are a relatively new and untested concept, and it is
impossible to predict the amount of trading interest that may exist in such
options. The same types of risk apply to over-the-counter trading in options.
There can be no assurance that viable markets will develop or continue in the
United States or abroad.
59
<PAGE> 60
A Fund's purpose in selling covered options is to realize greater income
than would be realized on portfolio securities transactions alone. A Fund may
forego the benefits of appreciation on securities sold pursuant to call options,
or pay a higher price for securities acquired pursuant to put options written by
the Fund. If a put or call option purchased by a Fund is not sold when it has
remaining value, and if the market price of the underlying security, in the case
of a put, remains equal to or greater than the exercise price, or, in the case
of a call, remains less than or equal to the exercise price, the Fund will not
be able to exercise profitably the option and will lose its entire investment in
the option. Also, the price of a put or call option purchased to hedge against
price movements in a related security may move more or less than the price of
the related security. The Capital Appreciation Fund, Convertible Fund,
Government Fund, High Yield Corporate Bond Fund, Money Market Fund, Total Return
Fund and Value Fund will not purchase a put or call option if, as a result, the
amount of premiums paid for all put and call options then outstanding would
exceed 10% of the value of the Fund's total assets.
The Fund would ordinarily realize a gain if the value of the securities
increased during the option period above the exercise price sufficiently to
cover the premium. The Fund would have a loss if the value of the securities
remained below the sum of the premium paid and the exercise price during the
option period. The ability of a Fund to successfully utilize options may depend
in part upon the ability of the Subadviser to forecast interest rates and other
economic factors correctly.
The hours of trading for options on securities may not conform to the hours
during which the underlying securities are traded. To the extent that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the options markets.
OPTIONS ON FOREIGN CURRENCIES
Each Fund, except the California Tax Free Fund, the Equity Index Fund, the
Government Fund, the MAP Equity Fund, the Money Market Fund, the New York Tax
Free Fund and the Tax Free Bond Fund, may, to the extent that it invests in
foreign securities, purchase and write options on foreign currencies. A Fund may
use foreign currency options contracts for various reasons, including: to manage
its exposure to changes in currency exchange rates; as an efficient means of
adjusting its overall exposure to certain currencies; or in an effort to enhance
its return through exposure to a foreign currency.
A Fund may, for example, purchase and write put and call options on foreign
currencies for the purpose of protecting against declines in the dollar value of
foreign portfolio securities and against increases in the U.S. dollar cost of
foreign securities to be acquired. A Fund may also use foreign currency options
to protect against potential losses in positions denominated in one foreign
currency against another foreign currency in which the Fund's assets are or may
be denominated. For example, a decline in the dollar value of a foreign currency
in which portfolio securities are denominated will reduce the dollar value of
such securities, even if their value in the foreign currency remains constant.
In order to protect against such declines in the value of portfolio securities,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the market value of such currency,
resulting in a gain that may offset, in whole or in part, the negative effect of
currency depreciation on the value of the Fund's securities denominated in that
currency.
Conversely, if a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of such
securities, a Fund may purchase call options on such currency. If the value of
such currency does increase, the purchase of such call options would enable the
Fund to purchase currency for a fixed amount of dollars which is less than the
market value of such currency, resulting in a gain that may offset, at least
partially, the effect of any currency-related increase in the price of
securities the Fund intends to acquire. As in the case of other types of options
transactions, however, the benefit a Fund derives from purchasing foreign
currency options will be reduced by the amount of the premium and related
transaction costs. In addition, if currency exchange rates do not move in the
direction or to the extent anticipated, a Fund could sustain losses on
transactions in foreign currency options which would deprive it of a portion or
all of the benefits of advantageous changes in such rates.
60
<PAGE> 61
If a Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the diminution in value of portfolio securities will be offset by
the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency option
will constitute only a partial hedge up to the amount of the premium, and only
if rates move in the expected direction. If unanticipated exchange rate
fluctuations occur, the option may be exercised and a Fund would be required to
purchase or sell the underlying currency at a loss which may not be fully offset
by the amount of the premium. As a result of writing options on foreign
currencies, a Fund also may be required to forego all or a portion of the
benefits which might otherwise have been obtained from favorable movements in
currency exchange rates.
A call option written on foreign currency by a Fund is "covered" if that
Fund owns the underlying foreign currency subject to the call or securities
denominated in that currency or has an absolute and immediate right to acquire
that foreign currency without additional cash consideration (or for additional
cash consideration held in a segregated account by its custodian) upon
conversion or exchange of other foreign currency held in its portfolio. A call
option is also covered if a Fund holds a call on the same foreign currency for
the same principal amount as the call written where the exercise price of the
call held (a) is equal to or less than the exercise price of the call written or
(b) is greater than the exercise price of the call written if the amount of the
difference is maintained by a Fund in liquid assets in a segregated account with
its custodian.
Options on foreign currencies to be written or purchased by a Fund will be
traded on U.S. and foreign exchanges or over-the-counter. Exchange-traded
options generally settle in cash, whereas options traded over-the counter may
settle in cash or result in delivery of the underlying currency upon exercise of
the option. As with other kinds of options transactions, however, the writing of
an option on foreign currency will constitute only a partial hedge up to the
amount of the premium received and a Fund could be required to purchase or sell
foreign currencies at disadvantageous exchange rates, thereby incurring losses.
The purchase of an option on foreign currency may constitute an effective hedge
against exchange rate fluctuations, although, in the event of rate movements
adverse to a Fund's position, a Fund may forfeit the entire amount of the
premium plus related transaction costs.
A Fund also may use foreign currency options to protect against potential
losses in positions denominated in one foreign currency against another foreign
currency.
There can be no assurance that a liquid market will exist when a Fund seeks
to close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, a Fund may be unable to close
out a position.
Currency options traded on U.S. or other exchanges may be subject to
position limits which may limit the ability of a Fund to reduce foreign currency
risk using such options. Over-the- counter options differ from traded options in
that they are two- party contracts with price and other terms negotiated between
buyer and seller and generally do not have as much market liquidity as
exchanged-traded options. Foreign currency exchange-traded options generally
settle in cash, whereas options traded over-the-counter may settle in cash or
result in delivery of the underlying currency upon exercise of the option.
SECURITIES INDEX OPTIONS
The Funds, except the MAP Equity Fund, may purchase call and put options on
securities indexes (only call options on the S&P 500 Composite Price Index in
the case of the Equity Index Fund) for the purpose of hedging against the risk
of unfavorable price movements which may adversely affect the value of a Fund's
securities. The Equity Index
61
<PAGE> 62
Fund may purchase call options on the S&P 500 Index to protect against increases
in the prices of securities underlying the Index that the Equity Index Fund
intends to purchase pending its ability to invest in such securities in an
orderly manner.
Unlike a securities option, which gives the holder the right to purchase or
sell specified securities at a specified price, an option on a securities index
gives the holder the right to receive a cash "exercise settlement amount" equal
to (i) the difference between the value of the underlying securities index on
the exercise date and the exercise price of the option, multiplied by (ii) a
fixed "index multiplier." In exchange for undertaking the obligation to make
such a cash payment, the writer of the securities index option receives a
premium.
A securities index fluctuates with changes in the market values of the
securities included in the index. For example, some securities index options are
based on a broad market index such as the S&P 500 Composite Price Index or the
NYSE Composite Index, or a narrower market index such as the S&P 100 Index.
Indexes may also be based on an industry or market segment such as the AMEX Oil
and Gas Index or the Computer and Business Equipment Index. Options on stock
indexes are traded on the following exchanges, among others: The Chicago Board
Options Exchange, New York Stock Exchange, and American Stock Exchange.
The effectiveness of hedging through the purchase of securities index
options will depend upon the extent to which price movements in the portion of
the securities portfolio being hedged correlate with price movements in the
selected securities index. Perfect correlation is not possible because the
securities held or to be acquired by a Fund will not exactly match the
securities represented in the securities indexes on which options are based. In
addition, the purchase of securities index options involves essentially the same
risks as the purchase of options on futures contracts. The principal risk is
that the premium and transaction costs paid by a Fund in purchasing an option
will be lost as a result of unanticipated movements in prices of the securities
comprising the securities index on which the option is based. Gains or losses on
a Fund's transactions in securities index options depend on price movements in
the securities market generally (or, for narrow market indexes, in a particular
industry or segment of the market) rather than the price movements of individual
securities held by a Fund. In this respect, purchasing a securities index put
(or call) option is analogous to the purchase of a put (or call) on a securities
index futures contract.
A Fund may sell securities index options prior to expiration in order to
close out its positions in securities index options which it has purchased. A
Fund may also allow options to expire unexercised.
FUTURES TRANSACTIONS
The California Tax Free Fund, Convertible Fund, Equity Income Fund, Global
High Yield Fund, Government Fund, High Yield Corporate Bond Fund, International
Bond Fund, International Equity Fund, New York Tax Free Fund, Strategic Income
Fund, Strategic Value Fund, Tax Free Bond Fund and Total Return Fund may
purchase and sell futures contracts on debt securities and on indexes of debt
securities in order to attempt to protect against the effects of adverse changes
in interest rates, to lengthen or shorten the average maturity or duration of a
Fund's portfolio and for other appropriate risk management and investment
purposes. For example, a Fund may purchase futures contracts as a substitute for
the purchase of longer-term debt securities to lengthen the average duration of
a Fund's portfolio of fixed-income securities. The Government Fund may enter
into futures contracts and purchase and write options on futures, which are not
U.S. government securities, in order to attempt to hedge against changes in
interest rates and to seek current income. Such futures contracts would obligate
the Fund to make or take delivery of certain debt securities or an amount of
cash upon expiration of the futures contract, although most futures positions
typically are closed out through an offsetting transaction prior to expiration.
The Capital Appreciation Fund, Convertible Fund, Equity Index Fund,
International Equity Fund, Strategic Income Fund, Strategic Value Fund, Total
Return Fund, Value Fund, Blue Chip Growth Fund, Research Value Fund, Small Cap
Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income
Fund, MAP Equity Fund and Global High Yield Fund may purchase and sell stock
index futures to hedge the equity portion of those Funds' securities portfolios
with regard to market (systematic) risk (involving the market's assessment of
overall economic prospects), as
62
<PAGE> 63
distinguished from stock-specific risk (involving the market's evaluation of the
merits of the issuer of a particular security) or to gain market exposure to
that portion of the market represented by the futures contract. These Funds, and
the International Bond Fund, may also purchase and sell other futures when
deemed appropriate, in order to hedge the equity or non-equity portions of their
portfolios. In addition, each Fund, except the California Tax Free Fund, Equity
Index Fund, Government Fund, Money Market Fund, New York Tax Free Fund and Tax
Free Bond Fund may, to the extent it invests in foreign securities, enter into
contracts for the future delivery of foreign currencies to hedge against changes
in currency exchange rates. Each of the Funds may also purchase and write put
and call options on futures contracts of the type into which such Fund is
authorized to enter and may engage in related closing transactions. In the
United States, all such futures on debt securities, debt index futures, stock
index futures, foreign currency futures and related options will be traded on
exchanges that are regulated by the Commodity Futures Trading Commission
("CFTC"). Subject to compliance with applicable CFTC rules, the Funds also may
enter into futures contracts traded on foreign futures exchanges such as
Frankfurt, Tokyo, London or Paris as long as trading on foreign futures
exchanges does not subject a Fund to risks that are materially greater than the
risks associated with trading on U.S. exchanges. The International Bond Fund,
International Equity Fund, Blue Chip Growth Fund, Research Value Fund, Small Cap
Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income Fund
and Global High Yield Fund are not limited to the above-listed exchanges.
A futures contract is an agreement to buy or sell a security or currency
(or to deliver a final cash settlement price in the case of a contract relating
to an index or otherwise not calling for physical delivery at the end of trading
in the contracts), for a set price at a future date. When interest rates are
changing and portfolio values are falling, futures contracts can offset a
decline in the value of a Fund's current portfolio securities. When interest
rates are changing and portfolio values are rising, the purchase of futures
contracts can secure better effective rates or purchase prices for the Fund than
might later be available in the market when the Fund makes anticipated
purchases. In the United States, futures contracts are traded on boards of trade
which have been designated "contract markets" by the CFTC. Futures contracts
trade on these markets through an "open outcry" auction on the exchange floor.
Currently, there are futures contracts based on a variety of instruments,
indexes and currencies, including long-term U.S. Treasury bonds, Treasury notes,
GNMA certificates, three-month U.S. Treasury bills, three-month domestic bank
certificates of deposit, a municipal bond index and various stock indexes.
When a purchase or sale of a futures contract is made by a Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of liquid assets ("initial margin") as a partial guarantee of
its performance under the contract. The margin required for a futures contract
is set by the exchange on which the contract is traded and may be modified
during the term of the contract. The initial margin is in the nature of a
performance bond or good faith deposit on the futures contract which is returned
to the Fund upon termination of the contract assuming all contractual
obligations have been satisfied. Each Fund expects to earn interest income on
its initial margin deposits. A futures contract held by a Fund is valued daily
at the official settlement price of the exchange on which it is traded. Each
day, as the value of the security, currency or index fluctuates, the Fund pays
or receives cash, called "variation margin," equal to the daily change in value
of the futures contract. This process is known as "marking-to-market." Variation
margin does not represent a borrowing or loan by a Fund but is instead a
settlement between the Fund and the broker of the amount one would owe the other
if the futures contract expired. In computing daily net asset value, each Fund
will mark-to-market its open futures positions. Moreover, each Fund will
maintain sufficient liquid assets to cover its obligations under open futures
contracts.
A Fund is also required to deposit and maintain margin with respect to put
and call options on futures contracts written by it. Such margin deposits will
vary depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund.
Positions taken in the futures markets are not normally held until delivery
or final cash settlement is required, but are instead liquidated through
offsetting transactions which may result in a gain or a loss. While futures
positions taken by a Fund will usually be liquidated in this manner, the Fund
may instead make or take delivery of underlying securities or currencies
whenever it appears economically advantageous to the Fund to do so. A clearing
organization associated with the exchange on which futures are traded assumes
responsibility for closing-out transactions and guarantees that as
63
<PAGE> 64
between the clearing members of an exchange, the sale and purchase obligations
will be performed with regard to all positions that remain open at the
termination of the contract.
FUTURES ON DEBT SECURITIES. A futures contract on a debt security is a
binding contractual commitment which, if held to maturity, will result in an
obligation to make or accept delivery, during a particular future month, of
securities having a standardized face value and rate of return. By purchasing
futures on debt securities--assuming a "long" position--a Fund will legally
obligate itself to accept the future delivery of the underlying security and pay
the agreed-upon price. By selling futures on debt securities--assuming a "short"
position--it will legally obligate itself to make the future delivery of the
security against payment of the agreed-upon price. Open futures positions on
debt securities will be valued at the most recent settlement price, unless such
price does not appear to the Subadvisers to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Trustees.
Hedging by use of futures on debt securities seeks to establish, more
certainly than would otherwise be possible, the effective rate of return on
portfolio securities. A Fund may, for example, take a "short" position in the
futures market by selling contracts for the future delivery of debt securities
held by the Fund (or securities having characteristics similar to those held by
the Fund) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position.
On other occasions, a Fund may take a "long" position by purchasing futures
on debt securities. This would be done, for example, when the Fund intends to
purchase particular securities and it has the necessary cash, but expects the
rate of return available in the securities markets at that time to be less
favorable than rates currently available in the futures markets. If the
anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Fund of purchasing
the securities will be offset, at least to some extent, by the rise in the value
of the futures position taken in anticipation of the subsequent securities
purchase. A Fund may also purchase futures contracts as a substitute for the
purchase of longer-term securities to lengthen the average duration of the
Fund's portfolio.
The Fund could accomplish similar results by selling securities with long
maturities and investing in securities with short maturities when interest rates
are expected to increase or by buying securities with long maturities and
selling securities with short maturities when interest rates are expected to
decline. However, by using futures contracts as a risk management technique,
given the greater liquidity in the futures market than in the cash market, it
may be possible to accomplish the same result more easily and more quickly.
Depending upon the types of futures contracts that are available to hedge a
Fund's portfolio of securities or portion of a portfolio, perfect correlation
between that Fund's futures positions and portfolio positions may be difficult
to achieve. Futures contracts do not exist for all types of securities and
markets for futures contracts that do exist may, for a variety of reasons, be
illiquid at particular times when a Fund might wish to buy or sell a futures
contract.
SECURITIES INDEX FUTURES. A securities index futures contract does not
require the physical delivery of securities, but merely provides for profits and
losses resulting from changes in the market value of the contract to be credited
or debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures positions are simply closed out. Changes in
the market value of a particular stock index futures contract reflect changes in
the specified index of equity securities on which the contract is based. A stock
index is designed to reflect overall price trends in the market for equity
securities.
Stock index futures may be used to hedge the equity portion of a Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Funds may enter into stock index futures to the
extent that they have equity securities in their portfolios. Similarly, the
Funds may enter into futures on debt securities indexes (including the municipal
bond index) to the extent they have debt securities in their portfolios. By
establishing an appropriate "short" position in securities index futures, a Fund
may seek to protect the value of its portfolio against an overall decline in the
market for securities. Alternatively, in anticipation of a generally rising
market, a Fund can seek
64
<PAGE> 65
to avoid losing the benefit of apparently low current prices by establishing a
"long" position in securities index futures and later liquidating that position
as particular securities are in fact acquired. To the extent that these hedging
strategies are successful, the Fund will be affected to a lesser degree by
adverse overall market price movements, unrelated to the merits of specific
portfolio securities, than would otherwise be the case. A Fund may also purchase
futures on debt securities or indexes as a substitute for the purchase of
longer-term debt securities to lengthen the average duration of the Fund's debt
portfolio or to gain exposure to particular markets represented by the index.
The Funds do not intend to use U.S. stock index futures to hedge positions
in securities of non-U.S. companies.
CURRENCY FUTURES. A sale of a currency futures contract creates an
obligation by a Fund, as seller, to deliver the amount of currency called for in
the contract at a specified future time for a specified price. A purchase of a
currency futures contract creates an obligation by a Fund, as purchaser, to take
delivery of an amount of currency at a specified future time at a specified
price. A Fund may sell a currency futures contract if the Subadviser anticipates
that exchange rates for a particular currency will fall, as a hedge against a
decline in the value of the Fund's securities denominated in such currency. If
the Subadviser anticipates that exchange rates will rise, the Fund may purchase
a currency futures contract to protect against an increase in the price of
securities denominated in a particular currency the Fund intends to purchase.
Although the terms of currency futures contracts specify actual delivery or
receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. To offset a currency futures contract sold by a Fund, the Fund
purchases a currency futures contract for the same aggregate amount of currency
and delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is immediately paid the difference. Similarly, to close out a
currency futures contract purchased by the Fund, the Fund sells a currency
futures contract. If the offsetting sale price exceeds the purchase price, the
Fund realizes a gain, and if the offsetting sale price is less than the purchase
price, the Fund realizes a loss.
A risk in employing currency futures contracts to protect against the price
volatility of portfolio securities denominated in a particular currency is that
changes in currency exchange rates or in the value of the futures position may
correlate imperfectly with changes in the cash prices of a Fund's securities.
The degree of correlation may be distorted by the fact that the currency futures
market may be dominated by short-term traders seeking to profit from changes in
exchange rates. This would reduce the value of such contracts for hedging
purposes over a short-term period. Such distortions are generally minor and
would diminish as the contract approached maturity.
Another risk is that the Subadviser could be incorrect in its expectation
as to the direction or extent of various exchange rate movements or the time
span within which the movements take place.
OPTIONS ON FUTURES. For bona fide hedging and other appropriate risk
management purposes, the Funds also may purchase and write call and put options
on futures contracts which are traded on exchanges that are licensed and
regulated by the CFTC for the purpose of options trading, or, subject to
applicable CFTC rules, on foreign exchanges. A "call" option on a futures
contract gives the purchaser the right, in return for the premium paid, to
purchase a futures contract (assume a "long" position) at a specified exercise
price at any time before the option expires. A "put" option gives the purchaser
the right, in return for the premium paid, to sell a futures contract (assume a
"short" position), for a specified exercise price at any time before the option
expires.
Upon the exercise of a "call," the writer of the option is obligated to
sell the futures contract (to deliver a "long" position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a "put,"
the writer of the option is obligated to purchase the futures contract (deliver
a "short" position to the option holder) at the option exercise price, which
will presumably be higher than the current market price of the contract in the
futures market. When an entity exercises an option and assumes a "long" futures
position, in the case of a "call," or a "short" futures position, in the case of
a "put," its gain will be credited to its futures margin account, while the loss
suffered by the writer of the option will be debited to its account. However, as
with the trading of futures, most participants in the options markets do not
seek to realize their gains or losses by exercise of their option rights.
Instead, the writer or holder of an option will usually realize a gain or
65
<PAGE> 66
loss by buying or selling an offsetting option at a market price that will
reflect an increase or a decrease from the premium originally paid.
Options on futures contracts can be used by a Fund to hedge substantially
the same risks and for the same duration and risk management purposes as might
be addressed or served by the direct purchase or sale of the underlying futures
contracts. If the Fund purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself.
The purchase of put options on futures contracts is a means of hedging a
Fund's portfolio against the risk of rising interest rates, declining securities
prices or declining exchange rates for a particular currency. The purchase of a
call option on a futures contract represents a means of hedging against a market
advance affecting securities prices or currency exchange rates when the Fund is
not fully invested or of lengthening the average maturity or duration of a
Fund's portfolio. Depending on the pricing of the option compared to either the
futures contract upon which it is based or upon the price of the underlying
securities or currencies, it may or may not be less risky than ownership of the
futures contract or underlying securities or currencies.
In contrast to a futures transaction, in which only transaction costs are
involved, benefits received in an option transaction will be reduced by the
amount of the premium paid as well as by transaction costs. In the event of an
adverse market movement, however, the Fund will not be subject to a risk of loss
on the option transaction beyond the price of the premium it paid plus its
transaction costs, and may consequently benefit from a favorable movement in the
value of its portfolio securities or the currencies in which such securities are
denominated that would have been more completely offset if the hedge had been
effected through the use of futures.
If a Fund writes options on futures contracts, the Fund will receive a
premium but will assume a risk of adverse movement in the price of the
underlying futures contract comparable to that involved in holding a futures
position. If the option is not exercised, the Fund will realize a gain in the
amount of the premium, which may partially offset unfavorable changes in the
value of securities held by or to be acquired for the Fund. If the option is
exercised, the Fund will incur a loss in the option transaction, which will be
reduced by the amount of the premium it has received, but which may partially
offset favorable changes in the value of its portfolio securities or the
currencies in which such securities are denominated.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the underlying securities or the currencies in
which such securities are denominated. If the futures price at expiration is
below the exercise price, the Fund will retain the full amount of the option
premium, which provides a partial hedge against any decline that may have
occurred in the Fund's holdings of securities or the currencies in which such
securities are denominated.
The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if the Fund writes a put option on
a futures contract on debt securities related to securities that the Fund
expects to acquire and the market price of such securities increases, the net
cost to a Fund of the debt securities acquired by it will be reduced by the
amount of the option premium received. Of course, if market prices have
declined, the Fund's purchase price upon exercise may be greater than the price
at which the debt securities might be purchased in the securities market.
While the holder or writer of an option on a futures contract may normally
terminate its position by selling or purchasing an offsetting option of the same
series, a Fund's ability to establish and close out options positions at fairly
established prices will be subject to the maintenance of a liquid market. The
Funds will not purchase or write options on futures contracts unless the market
for such options has sufficient liquidity such that the risks associated with
such options transactions are not at unacceptable levels.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND OPTIONS ON
FUTURES CONTRACTS. A Fund will only enter into futures contracts or related
options which are standardized and traded on a U.S. or foreign exchange or board
66
<PAGE> 67
of trade, or similar entity, or quoted on an automatic quotation system. The
Funds will not enter futures contracts for which the aggregate contract amounts
exceed 100% of the Fund's net assets. In addition, with respect to positions in
futures and related options that do not constitute bona fide hedging positions,
a Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's total assets. A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise price. A put
option is "in-the-money" if the exercise price exceeds the value of the futures
contract that is the subject of the option.
When purchasing a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amounts deposited with a futures commission merchant as margin, are equal to the
market value of the futures contract. Alternatively, the Fund may "cover" its
position by purchasing a put option on the same futures contract with a strike
price as high or higher than the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) liquid assets that, when added to the
amount deposited with a futures commission merchant as margin, are equal to the
market value of the instruments underlying the contract. Alternatively, the Fund
may "cover" its position by owning the instruments underlying the contract (or,
in the case of an index futures contract, a portfolio with a volatility
substantially similar to that of the index on which the futures contract is
based), or by holding a call option permitting the Fund to purchase the same
futures contract at a price no higher than the price of the contract written by
the Fund (or at a higher price if the difference is maintained in liquid assets
with the Fund's custodian).
When selling a call option on a futures contract, a Fund will maintain with
its custodian (and mark-to-market on a daily basis) liquid assets that, when
added to the amounts deposited with a futures commission merchant as margin,
equal the total market value of the futures contract underlying the call option.
Alternatively, the Fund may cover its position by entering into a long position
in the same futures contract at a price no higher than the strike price of the
call option, by owning the instruments underlying the futures contract, or by
holding a separate call option permitting the Fund to purchase the same futures
contract at a price not higher than the strike price of the call option sold by
the Fund.
When selling a put option on a futures contract, a Fund will maintain with
its custodian (and mark-to-market on a daily basis) liquid assets that equal the
purchase price of the futures contract, less any margin on deposit.
Alternatively, the Fund may cover the position either by entering into a short
position in the same futures contract, or by owning a separate put option
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
The requirements for qualification as a regulated investment company also
may limit the extent to which a Fund may enter into futures, futures options or
forward contracts. See "Tax Information."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. There can be no assurance that hedging strategies using futures will
be successful. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract, which in some cases may
be unlimited. There can be no guarantee that there will be a correlation between
price movements in the hedging vehicle and in the Fund's securities being
hedged. An incorrect correlation could result in a loss on both the hedged
securities or currencies and the hedging vehicle so that the portfolio return
might have been better had hedging not been attempted. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or
67
<PAGE> 68
unexpected interest rate trends. It is also possible that, when a Fund has sold
stock index futures to hedge its portfolio against a decline in the market, the
market may advance while the value of the particular securities held in the
Fund's portfolio may decline. If this occurred, the Fund would incur a loss on
the futures contracts and also experience a decline in the value of its
portfolio securities.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when a
Fund seeks to close out a futures or a futures option position. If no liquid
market exists, the Fund would remain obligated to meet margin requirements until
the position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist. Lack of a liquid market for any reason may prevent the Fund
from liquidating an unfavorable position and the Fund would remain obligated to
meet margin requirements until the position is closed.
In addition to the risks that apply to all options transactions, there are
several special risks relating to options on futures contracts. The ability to
establish and close out positions in such options will be subject to the
development and maintenance of a liquid market in the options. It is not certain
that such a market will develop. Although the Funds generally will purchase only
those options and futures contracts for which there appears to be an active
market, there is no assurance that a liquid market on an exchange will exist for
any particular option or futures contract at any particular time. In the event
no such market exists for particular options, it might not be possible to effect
closing transactions in such options with the result that a Fund would have to
exercise options it has purchased in order to realize any profit and would be
less able to limit its exposure to losses on options it has written.
Many of the contracts discussed above are relatively new instruments
without a significant trading history. As a result, there can be no assurance
that an active secondary market will develop or continue to exist. If the price
of a futures contract changes more than the price of the securities or
currencies, the Fund will experience either a loss or a gain on the futures
contracts which will not be completely offset by changes in the price of the
securities or currencies which are the subject of the hedge. In addition, it is
not possible to hedge fully or perfectly against currency fluctuations affecting
the value of securities denominated in foreign currencies because the value of
such securities is likely to fluctuate as a result of independent factors not
related to currency fluctuations.
ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS, OPTIONS ON
FUTURES CONTRACTS, AND FOREIGN CURRENCY. Options on securities, futures
contracts, options on futures contracts, currencies and options on currencies
may be traded on foreign exchanges. Such transactions may not be regulated as
effectively as similar transactions in the United States; may not involve a
clearing mechanism and related guarantees; and are subject to the risk of
governmental actions affecting trading in, or the prices of, foreign securities.
The value of such positions also could be adversely affected by (i) other
complex foreign political, legal and economic factors, (ii) delays in a
availability than in the United States of data on which to make trading
decisions, (iii) delays in a Fund's ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States, and (v) lesser trading
volume.
68
<PAGE> 69
SWAP AGREEMENTS
The International Bond Fund, International Equity Fund, Strategic Value
Fund, Strategic Income Fund, Blue Chip Growth Fund, Research Value Fund, Small
Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income
Fund and Global High Yield Fund may enter into interest rate, index and currency
exchange rate swap agreements for purposes of attempting to obtain a particular
desired return at a lower cost to the Fund than if the Fund had invested
directly in an instrument that yielded that desired return or for other
portfolio management purposes. Swap agreements are two party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross returns to be
exchanged or "swapped" between the parties are calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. The
"notional amount" of the swap agreement is only a fictive basis on which to
calculate the obligations which the parties to a swap agreement have agreed to
exchange. Most Swap Agreements entered into by the Fund would calculate the
obligations of the parties to the agreements on a "net" basis. Consequently, a
Fund's obligations (or rights) under a swap agreement will generally be equal
only to the net amount to be paid or received under the agreement based on the
relative values of the positions held by each party to the agreement (the "net
amount"). A Fund's obligations under a swap agreement will be accrued daily
(offset against any amounts owing to the Fund) and any accrued but unpaid net
amounts owed to a swap counterparty will be covered by the maintenance of a
segregated account consisting of liquid assets to avoid any potential leveraging
of the Fund's portfolio. A Fund will not enter into a swap agreement with any
single party if the net amount owed or to be received under existing contracts
with that party would exceed 5% of the Fund's total assets.
Commonly used swap agreements include interest rate caps, under which, in
return for a premium, one party agrees to make payments to the other to the
extent that interest rates exceed a specified rate, or "cap"; interest rate
floors, under which, in return for a premium, one party agrees to make payments
to the other to the extent that interest rates fall below a specified level, or
"floor"; and interest rate collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself against interest
rate movements exceeding given minimum or maximum levels.
Whether a Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the Sub- Adviser's ability correctly to
predict whether certain types of investments are likely to produce greater
returns than other investments. Because they are two party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, a Fund bears the risk of loss of the amount
expected to be received under a swap agreement in the event of the default or
bankruptcy of a swap agreement counterparty. The Subadviser will cause a Fund to
enter into swap agreements only with counterparties that would be eligible for
consideration as repurchase agreement counterparties under the Fund's repurchase
agreement guidelines. Certain restrictions imposed on the Funds by the Code may
limit the Funds' ability to use swap agreements. The swaps market is a
relatively new market and is largely unregulated. It is possible that
developments in the swaps market, including potential government regulation,
could adversely affect a Fund's ability to terminate existing swap agreements or
to realize amounts to be received under such agreements.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the CFTC.
To qualify for this exemption, a swap agreement must be entered into by
"eligible participants," which include the following, provided the participants'
total assets exceed established levels: a bank or trust company, savings
association or credit union, insurance company, investment company subject to
regulation under the 1940 Act, commodity pool, corporation, partnership,
proprietorship, organization, trust or other entity, employee benefit plan,
governmental entity, broker-dealer, futures commission merchant, natural person,
or regulated foreign person. To be eligible, natural persons and most other
entities must have total assets exceeding $10 million; commodity pools and
employee benefit plans must have assets exceeding $5 million. In addition, an
eligible swap transaction must meet three conditions. First, the swap agreement
may not be part of a fungible class of agreements that are standardized as to
their material economic terms. Second, the creditworthiness of parties with
actual or potential obligations under the
69
<PAGE> 70
swap agreement must be a material consideration in entering into or determining
the terms of the swap agreement, including pricing, cost or credit enhancement
terms. Third, swap agreements may not be entered into and traded on or through a
multilateral transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option transactions under the CEA or its regulations. The Policy
Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
LOAN PARTICIPATION INTERESTS
The Funds may invest in participation interests in loans. A Fund's
investment in loan participation interests may take the form of participation
interests in, assignments of or novations of a corporate loan ("Participation
Interests"). The Participation Interests may be acquired from an agent bank,
co-lenders or other holders of Participation Interests ("Participants"). In a
novation, a Fund would assume all of the rights of the lender in a corporate
loan, including the right to receive payments of principal and interest and
other amounts directly from the borrower and to enforce its rights as a lender
directly against the borrower. As an alternative, a Fund may purchase an
assignment of all or a portion of a lender's interest in a corporate loan, in
which case, a Fund may be required generally to rely on the assigning lender to
demand payment and enforce its rights against the borrower, but would otherwise
be entitled to all of such lender's rights in the corporate loan. A Fund also
may purchase a Participation Interest in a portion of the rights of a lender in
a corporate loan. In such a case, a Fund will be entitled to receive payments of
principal, interest and fees, if any, but generally will not be entitled to
enforce its rights directly against the agent bank or the borrower; rather the
Fund must rely on the lending institution for that purpose. A Fund will not act
as an agent bank, a guarantor or sole negotiator of a structure with respect to
a corporate loan.
In a typical corporate loan involving the sale of Participation Interests,
the agent bank administers the terms of the corporate loan agreement and is
responsible for the collection of principal and interest and fee payments to the
credit of all lenders which are parties to the corporate loan agreement. The
agent bank in such cases will be qualified under the 1940 Act to serve as a
custodian for a registered investment company such as the Trust. A Fund
generally will rely on the agent bank or an intermediate Participant to collect
its portion of the payments on the corporate loan. The agent bank monitors the
value of the collateral and, if the value of the collateral declines, may take
certain action, including accelerating the corporate loan, giving the borrower
an opportunity to provide additional collateral or seeking other protection for
the benefit of the Participants in the corporate loan, depending on the terms of
the corporate loan agreement. Furthermore, unless under the terms of a
participation agreement a Fund has direct recourse against the borrower (which
is unlikely), a Fund will rely on the agent bank to use appropriate creditor
remedies against the borrower. The agent bank also is responsible for monitoring
compliance with covenants contained in the corporate loan agreement and for
notifying holders of corporate loans of any failures of compliance. Typically,
under corporate loan agreements, the agent bank is given broad discretion in
enforcing the corporate loan agreement, and is obligated to use only the same
care it would use in the management of its own property. For these services, the
borrower compensates the agent bank. Such compensation may include special fees
paid on structuring and funding the corporate loan and other fees paid on a
continuing basis.
A financial institution's employment as an agent bank may be terminated in
the event that it fails to observe the requisite standard of care or becomes
insolvent, or has a receiver, conservator, or similar official appointed for it
by the appropriate bank regulatory authority or becomes a debtor in a bankruptcy
proceeding. A successor agent bank generally will be appointed to replace the
terminated bank, and assets held by the agent bank under the corporate loan
agreement should remain available to holders of corporate loans. If, however,
assets held by the agent bank for the benefit of a Fund were determined by an
appropriate regulatory authority or court to be subject to the claims of the
agent bank's general or secured creditors, the Fund might incur certain costs
and delays in realizing payment on a
70
<PAGE> 71
corporate loan, or suffer a loss of principal and/or interest. In situations
involving intermediate Participants similar risks may arise.
When a Fund acts as co-lender in connection with a participation interest
or when a Fund acquires a Participation Interest the terms of which provide that
a Fund will be in privity of contract with the corporate borrower, the Fund will
have direct recourse against the borrower in the event the borrower fails to pay
scheduled principal and interest. In all other cases, the Fund will look to the
agent bank to enforce appropriate credit remedies against the borrower. In
acquiring Participation Interests a Fund's Subadviser will conduct analysis and
evaluation of the financial condition of each such co-lender and participant to
ensure that the Participation Interest meets the Fund's qualitative standards.
There is a risk that there may not be a readily available market for loan
Participation Interests and, in some cases, this could result in a Fund
disposing of such securities at a substantial discount from face value or
holding such security until maturity. When a Fund is required to rely upon a
lending institution to pay the Fund principal, interest, and other amounts
received by the lending institution for the loan participation, the Fund will
treat both the borrower and the lending institution as an "issuer" of the loan
participation for purposes of certain investment restrictions pertaining to the
diversification and concentration of the Fund's portfolio. The Funds consider
Participation Interests not subject to puts to be illiquid.
The principal credit risk associated with acquiring Participation Interests
from a co-lender or another Participant is the credit risk associated with the
underlying corporate borrower. A Fund may incur additional credit risk, however,
when it is in the position of participant rather than a co-lender because the
Fund must assume the risk of insolvency of the co-lender from which the
Participation Interest was acquired and that of any person interpositioned
between the Fund and the co-lender.
REAL ESTATE INVESTMENT TRUSTS ("REITS")
REITs are pooled investment vehicles that invest primarily in either real
estate or real estate-related loans. The Fund will not invest in real estate
directly, but only in securities issued by real estate companies. However, to
the extent the Fund invests in REITs, the Fund is also subject to the risks
associated with the direct ownership of real estate. These risks include:
declines in the value of real estate; risks related to general and local
economic conditions; possible lack of availability of mortgage funds;
overbuilding; extended vacancies of properties; increased competition; increases
in property taxes and operating expenses; changes in zoning laws; losses due to
costs resulting from the clean-up of environmental problems; liability to third
parties for damages resulting from environmental problems; casualty or
condemnation losses; limitations on rents; changes in neighborhood values and
the appeal of properties to tenants; and changes in interest rates. Thus, the
value of the Fund's shares may change at different rates compared to the value
of shares of a mutual fund with investments in a mix of different industries.
REITs are dependent upon management skills and generally may not be
diversified. REITs are also subject to heavy cash flow dependency, defaults by
borrowers and self-liquidation. In addition, REITs could possibly fail to
qualify for tax free pass-through of income under the Internal Revenue Code, or
to maintain their exemptions from registration under the Investment Company Act
of 1940, as amended. The above factors may also adversely affect a borrower's or
a lessee's ability to meet its obligations to the REIT. In the event of a
default by a borrower or lessee, the REIT may experience delays in enforcing its
rights as a mortgagee or lessor and may incur substantial costs associated with
protecting its investments. In addition, even the larger REITs in the industry
tend to be small to medium-sized companies in relation to the equity markets as
a whole. Accordingly, REIT shares can be more volatile than--and at times will
perform differently from--large-capitalization stocks such as those found in the
Dow Jones Industrial Average. In addition, because smaller-capitalization stocks
are typically less liquid than large-capitalization stocks, REIT shares may
sometimes experience greater share-price fluctuations than the stocks of larger
companies.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be subject to
certain risks. The value of the debt securities held by a Fund, and thus the net
asset value of the shares of beneficial interest of the Fund, generally will
fluctuate
71
<PAGE> 72
depending on a number of factors, including, among others, changes in the
perceived creditworthiness of the issuers of those securities, movements in
interest rates, the average maturity of the Fund's investments, changes in the
relative values of the currencies in which the Fund's investments are
denominated relative to the U.S. dollar, and the extent to which the Fund hedges
its interest rate, credit and currency exchange rate risks. Generally, a rise in
interest rates will reduce the value of fixed income securities held by a Fund,
and a decline in interest rates will increase the value of fixed income
securities held by a Fund. Longer term debt securities generally pay higher
interest rates than do shorter term debt securities but also may experience
greater price volatility as interest rates change.
Since shares of the Funds represent an investment in securities with
fluctuating market prices, the value of shares of each Fund will vary as the
aggregate value of the Funds' portfolio securities increases or decreases.
Moreover, the value of lower rated debt securities that a Fund purchases may
fluctuate more than the value of higher rated debt securities. Lower rated debt
securities generally carry greater risk that the issuer will default on the
payment of interest and principal. Lower rated fixed income securities generally
tend to reflect short-term corporate and market developments to a greater extent
than higher rated securities which react primarily to fluctuations in the
general level of interest rates. Changes in the value of securities subsequent
to their acquisition will not affect cash income or yields to maturity to the
Funds but will be reflected in the net asset value of the Funds' shares.
Corporate debt securities may bear fixed, contingent, or variable rates of
interest and may involve equity features, such as conversion or exchange rights
or warrants for the acquisition of stock of the same or a different issuer,
participations based on revenues, sales or profits, or the purchase of common
stock in a unit transaction (where corporate debt securities and common stock
are offered as a unit).
When and if available, debt securities may be purchased at a discount from
face value. From time to time, each Fund may purchase securities not paying
interest or dividends at the time acquired if, in the opinion of the Subadviser,
such securities have the potential for future income (or capital appreciation,
if any).
RISKS OF INVESTING IN HIGH YIELD SECURITIES ("JUNK BONDS")
High yield bonds may be more susceptible to real or perceived adverse
economic and competitive industry conditions than higher grade bonds. The prices
of high yield bonds have been found to be less sensitive to interest-rate
changes than more highly rated investments, but more sensitive to adverse
economic downturns or individual corporate developments. A projection of an
economic downturn or of a period of rising interest rates, for example, could
cause a decline in high yield bond prices because the advent of a recession
could lessen the ability of a highly leveraged company to make principal and
interest payments on its debt securities.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly traded market.
Legislation designed to limit the use of high yield bonds in corporate
transactions may have a material adverse effect on a Fund's net asset value and
investment practices. In addition, there may be special tax considerations
associated with investing in high yield bonds structured as zero coupon or
payment-in-kind securities. A Fund records the interest on these securities
annually as income even though it receives no cash interest until the security's
maturity or payment date. Also, distributions on account of such interest
generally will be taxable to shareholders even if the Fund does not distribute
cash to them. Therefore, in order to pay taxes on this interest, shareholders
may have to redeem some of their shares to pay the tax or the Fund may have to
sell some of its assets to reduce the Fund's assets and may thereby increase its
expense ratio and decrease its rate of return.
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Funds' investment restrictions set forth below are fundamental policies
of each Fund; i.e., they may not be changed with respect to a Fund without a
majority vote of the outstanding shares of that Fund, as defined in the 1940
Act. Except for those investment policies of a Fund specifically identified as
fundamental in the Prospectus and this
72
<PAGE> 73
Statement of Additional Information, all other investment policies and practices
described may be changed by the Board of Trustees without the approval of
shareholders.
Unless otherwise indicated, all of the percentage limitations below, and in
the investment restrictions recited in the Prospectus, apply to each Fund on an
individual basis, and apply only at the time a transaction is entered into.
Accordingly, if a percentage restriction is adhered to at time of investment, a
later increase or decrease in the percentage which results from a relative
change in values or from a change in a Fund's net assets will not be considered
a violation. With respect to investment in illiquid securities, a Fund will
consider taking measures to reduce the holdings of illiquid securities if they
exceed the percentage limitation as a result of changes in the values of the
securities as if liquid securities have become illiquid.
EACH FUND MAY NOT:
1. With respect to 75% of each Fund's total assets invest more than 5% of
the value of the total assets of a Fund in the securities of any one issuer,
except U.S. government securities, or purchase the securities of any issuer if
such purchase would cause more than 10% of the voting securities of such issuer
to be held by a Fund. This restriction does not apply to the California Tax Free
Fund, Equity Index Fund, International Bond Fund, New York Tax Free Fund and
Global High Yield Fund.
2. Borrow money except from banks on a temporary basis for extraordinary or
emergency purposes, including the meeting of redemption requests, or by engaging
in reverse repurchase agreements or comparable portfolio transactions provided
that these Funds maintain asset coverage of at least 300% for all such
borrowings, and no purchases of securities will be made while such borrowings
exceed 5% of the value of the Fund's total assets (10% in the case of the
California Tax Free Fund and New York Tax Free Fund).
3. Purchase securities (or with respect to the California Tax Free Fund,
New York Tax Free Fund, and Tax Free Bond Fund purchase (i) Pollution Control
and Industrial Development Bonds or (ii) securities the interest from which is
not exempt from regular federal income tax) if such purchase would cause 25% or
more in the aggregate of the market value of the total assets of a Fund to be
invested in the securities of one or more issuers having their principal
business activities in the same industry, provided that there is no limitation
in respect to investments in U.S. government securities or, with respect to each
Fund except Strategic Value Fund, investments in repurchase agreements with
respect thereto (for the purposes of this restriction, telephone companies are
considered to be a separate industry from gas or electric utilities, and wholly
owned finance companies are considered to be in the industry of their parents if
their activities are primarily related to financing the activities of the
parents) except that (a) the above limitation does not apply to the Equity Index
Fund to the extent that the Standard & Poor's 500 Composite Stock Price Index is
so concentrated; (b) up to 40% of the High Yield Corporate Bond Fund's,
Strategic Income Fund's and Strategic Value Fund's total assets, taken at market
value, may be invested in each of the electric utility and telephone industries,
but each Fund will not invest 25% or more in either of those industries unless
yields available for four consecutive weeks in the four highest rating
categories on new issue bonds in such industry (issue size of $50 million or
more) have averaged in excess of 105% of yields of new issue long-term
industrial bonds similarly rated (issue size of $50 million or more); (c) 25% or
more of the market value of the total assets of the Money Market Fund will be
invested in the securities of banks and bank holding companies, including
certificates of deposit and bankers' acceptances; and (d) at such time that the
1940 Act is amended to permit a registered investment company to elect to be
"periodically industry concentrated" (i.e., a fund that does not concentrate its
investments in a particular industry would be permitted, but not required, to
invest 25% or more of its total assets in a particular industry) the Funds elect
to be so classified and the foregoing limitation shall no longer apply with
respect to the Funds. With respect to the California Tax Free Fund and New York
Tax Free Fund, private activity bonds ultimately payable by companies within the
same industry are treated as if they were issued by issuers in the same industry
for purposes of this restriction.
4. Purchase or sell real estate (excluding securities secured by real
estate or interests therein or issued by companies that invest in or deal in
real estate) or, in the case of the California Tax Free Fund and New York Tax
Free Fund, real estate investment trust securities; commodities and commodity
contracts. The Trust reserves the freedom of
73
<PAGE> 74
action to hold and to sell real estate acquired for any Fund as a result of the
ownership of securities. Purchases and sales of foreign currencies on a spot
basis and forward foreign currency exchange contracts, options on currency,
futures contracts on currencies (or securities, with respect to the MAP Equity
Fund, Blue Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund, Global High Yield
Fund and Strategic Value Fund) or securities indices and options on such futures
contracts are not deemed to be an investment in a prohibited commodity or
commodity contract for the purpose of this restriction.
5. Make loans to other persons, except loans of portfolio securities (in
the case of the California Tax Free Fund and New York Tax Free Fund, in an
amount not to exceed 10% of the value of each Fund's total assets in accordance
with applicable guidelines approved by the Board of Trustees and 30% in the case
of the Equity Index Fund). The purchase of debt obligations (and bankers'
acceptances and commercial paper in the case of the Equity Index Fund) and the
entry into repurchase agreements in accordance with a Fund's investment
objectives and policies are not deemed to be loans for this purpose.
6. Act as an underwriter of securities issued by others, except to the
extent that a Fund may be considered an underwriter within the meaning of the
1933 Act, as amended, in the disposition of portfolio securities.
7. Issue senior securities, except to the extent permitted under the
Investment Company Act of 1940.
The following fundamental investment restriction is applicable to the Tax Free
Bond Fund only. The Tax Free Bond Fund must:
1. Invest at least 80% of the Fund's net assets in securities the interest
on which is exempt from regular federal income tax, except that the Fund may
temporarily invest more than 20% of its net assets in securities the interest
income on which may be subject to regular federal income tax.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the Trust's fundamental investment restrictions, the
Trustees of the Trust have voluntarily adopted certain policies and restrictions
which are observed in the conduct of the affairs of the Funds. These represent
intentions of the Trustees based upon current circumstances. They differ from
fundamental investment policies in that the following additional investment
restrictions may be changed or amended by action of the Trustees without
requiring prior notice to or approval of shareholders.
Unless otherwise indicated, all percentage limitations apply to each Fund
on an individual basis, and apply only at the time a transaction is entered
into. Accordingly, if a percentage restriction is adhered to at the time of
investment, a later increase or decrease in the percentage which results from a
relative change in values or from a change in a Fund's net assets will not be
considered a violation.
The following are non-fundamental restrictions of the Capital Appreciation
Fund, Convertible Fund, Government Fund, High Yield Corporate Bond Fund, Money
Market Fund, Tax Free Bond Fund, Total Return Fund and Value Fund. Each of these
Funds may not:
(a) purchase from or sell portfolio securities of a Fund to any of the
officers or Trustees of the Trust, its investment advisers, its principal
underwriter or the officers, or directors of its Subadvisers or principal
underwriter;
(b) invest more than 10% of the net assets of a Fund (taken at market
value at the time of the investment) in "illiquid securities," illiquid
securities being defined to include securities subject to legal or
contractual restrictions on resale (other than restricted securities
eligible for resale pursuant to Rule 144A or Section 4(1) under the
Securities Act of 1933 determined to be liquid pursuant to guidelines
adopted by the Board), repurchase agreements maturing in more than seven
days, certain options traded over the counter that a Fund has written,
74
<PAGE> 75
securities for which market quotations are not available, or other
securities which legally or in the opinion of the Subadviser are deemed
illiquid;
(c) purchase the securities of other investment companies, except to
the extent permitted by the 1940 Act or in connection with merger,
consolidation, acquisition or reorganization;
(d) invest in other companies for the purpose of exercising control or
management;
(e) purchase securities on margin except in connection with arbitrage
transactions or make short sales, unless by virtue of its ownership of
other securities, it has the right to obtain securities equivalent in kind
and amount to the securities sold, except that the Trust may obtain such
short-term credits as may be necessary for the clearance of purchases and
sales of securities and in connection with transactions involving forward
foreign currency exchange contracts;
(f) purchase or sell any put or call options or any combination
thereof, except that the Trust may purchase and sell or write (i) options
on any futures contracts into which it may enter, (ii) put and call options
on currencies, securities indexes and covered put and call options on
securities, and (iii) may also engage in closing purchase transactions with
respect to any put and call option position it has entered into; and except
that the Government Fund may not write any covered put options on U.S.
government securities if, as a result, more than 50% of its total assets
(taken at current value) would be subject to put options written by such
Fund;
(g) purchase, with respect to the Government Fund, any call option,
long futures contract or long option on a futures contract if, at the date
of purchase, realized net losses from such transactions during the fiscal
year to date exceed 5% of such Fund's average net assets during such
period;
(h) as an operating policy, each of the High Yield Corporate Bond and
Strategic Income Funds may not invest more than 15% of its net assets in
securities rated lower than B by Moody's or S&P;
(i) as an operating policy, the Convertible Fund may not invest more
than 5% of its total assets in securities that are rated less than B by
Moody's or S&P; or are unrated but judged by the subadviser to be of
comparable quality; or
(j) as an operating policy, the Total Return Fund may not invest more
than 5% of its net assets in securities rated below investment grade. Up
to 20% of the Total Return Fund's debt securities may be rated below A but
must be rated at least Ba (Moody's) or BB (S&P), or, if unrated, judged by
the subadviser to be of comparable quality.
The following are non-fundamental restrictions of the California Tax
Free Fund, Equity Index Fund and New York Tax Free Fund:
(a) A Fund may not purchase the securities of other investment
companies except to the extent permitted by the 1940 Act or in connection
with a merger, consolidation or reorganization.
(b) The Funds may not invest more than 10% of the net assets of a Fund
(taken at market value at the time of the investment) in "illiquid
securities," illiquid securities being defined to include securities
subject to legal or contractual restrictions on resale (other than
restricted securities eligible for resale pursuant to Rule 144A or Section
4(1) under the Securities Act of 1933 determined to be liquid pursuant to
guidelines adopted by the Board).
(c) A Fund may not invest in other companies for the purpose of
exercising control or management.
(d) A Fund may not purchase securities on margin, except in connection
with arbitrage transactions, or make short sales, unless it owns the
securities sold short or it has the right to obtain securities equivalent
in kind and amount to the securities sold, except that the Trust may obtain
such short-term credits as may be necessary for the clearance of purchases
and sales of securities. (This restriction has no application to
transactions in futures, options and foreign currency exchange contracts).
The following are non-fundamental restrictions of the International Bond
Fund, International Equity Fund, Strategic Income Fund and Strategic Value Fund:
(a) As an operating policy, a Fund may not sell securities short,
except for covered short sales or unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, futures and forward contracts are
deemed not to constitute short sales of securities.
75
<PAGE> 76
(b) As an operating policy, a Fund may not purchase securities on
margin, except that the Fund may obtain such short-term credits as are
necessary for the clearance of transactions, and provided that margin
payments in connection with futures contracts and options on futures
contracts shall not constitute the purchase of securities on margin. This
restriction is not applicable to the Strategic Income Fund.
(c) As an operating policy, a Fund may not invest in securities which
are not readily marketable, or the disposition of which is restricted under
federal securities laws (collectively, "illiquid securities"), other than
Rule 144A securities or Section 4(2) commercial paper determined to be
liquid pursuant to guidelines adopted by the Trust's Board of Trustees if,
as a result, more than 15% of the Fund's net assets would be invested in
illiquid securities. A Fund may not invest more than 15% of its net assets
in repurchase agreements providing for settlement in more than seven days,
or in other instruments which for regulatory purposes or in the
Subadviser's opinion may be deemed to be illiquid, such as a certain
portion of options traded in the over-the-counter market, and securities
being used to cover options a Fund has written.
(d) As an operating policy, a Fund may not purchase the securities of
other investment companies, except to the extent permitted by the 1940 Act
or in connection with a merger, consolidation, acquisition or
reorganization.
The following are non-fundamental restrictions of the MAP Equity Fund, Blue
Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund:
(a) As an operating policy, a Fund may not sell securities short, except
for covered short sales or unless it owns or has the right to obtain securities
equivalent in kind and amount to the securities sold short, and provided that
transactions in options, futures and forward contracts are deemed not to
constitute short sales of securities.
(b) As an operating policy, a Fund may not purchase securities on margin,
except that the Fund may obtain such short-term credits as are necessary for the
clearance of transactions, and provided that margin payments in connection with
futures contracts and options on futures contracts shall not constitute the
purchase of securities on margin.
(c) As an operating policy, a Fund may not invest in securities which are
not readily marketable, or the disposition of which is restricted under federal
securities laws (collectively, "illiquid securities"), other than Rule 144A
securities and Section 4(2) commercial paper determined to be liquid pursuant to
guidelines adopted by the Trust's Board of Trustees if, as a result, more than
15% of the Fund's net assets would be invested in illiquid securities. A Fund
may not invest more than 15% of its net assets in repurchase agreements
providing for settlement in more than seven days, or in other instruments which
for regulatory purposes or in the Subadviser's opinion may be deemed to be
illiquid, such as a certain portion of options traded in the over-the-counter
market, and securities being used to cover options a Fund has written.
(d) As an operating policy, a Fund may not purchase the securities of other
investment companies except to the permitted by the 1940 Act in connection with
a merger, consolidated, acquisition, or reorganization;
(e) As an operating policy, the Blue Chip Growth Fund may not invest more
than 10% of its total assets in securities of non-U.S. issuers.
"Value" for the purposes of all investment restrictions shall mean the
value used in determining a Fund's net asset value.
In addition, though not a fundamental policy, the California Tax Free and
New York Tax Free Funds will not sell securities short, except that each Fund
reserves the right to sell securities short "against the box."
In addition, though not a fundamental policy, the Equity Index Fund may not
engage in arbitrage transactions, nor may it purchase warrants (excluding those
acquired by the Equity Index Fund in units or attached to securities), nor will
the Equity Index Fund sell securities short or buy on margin, except that the
Fund reserves the right to sell securities short "against the box."
76
<PAGE> 77
The Trustees have the ultimate responsibility for determining whether
specific securities are liquid or illiquid. The Trustees have delegated the
function of making day-to-day determinations of liquidity to the Subadvisers,
pursuant to guidelines approved by the Trustees.
Each Subadviser takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by a Fund is liquid,
including at least the following:
(i) the frequency and size of trades and quotes for the Rule 144A security
relative to the size of the Fund's holding;
(ii) the number of dealers willing to purchase or sell the 144A security
and the number of other potential purchasers;
(iii) dealer undertakings to make a market in the 144A security; and
(iv) the nature of the 144A security and the nature of the market for the
144A security (i.e., the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer).
To the extent that the market for a Rule 144A security changes, a Rule 144A
security originally determined to be liquid upon purchase may be determined to
be illiquid.
To make the determination that an issue of 4(2) commercial paper is liquid,
a Subadviser must conclude that the following conditions have been met:
(a) the 4(2) commercial paper is not traded flat or in default as to
principal or interest;
(b) the 4(2) commercial paper is rated:
(i) in one of the two highest rating categories by at least two nationally
recognized statistical rating organizations ("NRSROs");or
(ii) if only one NRSRO rates the security, the 4(2) commercial paper is
rated in one of the two highest rating categories by that NRSRO; or
(iii) if the security is unrated, the Subadviser has determined that the
security is of equivalent quality based on factors commonly used by rating
agencies; and
(c) there is a viable trading market for the specific security, taking into
account all relevant factors (e.g., whether the security is the subject of a
commercial paper program that is administered by an issuing and paying agent
bank and for which there exists a dealer willing to make a market in the
security, the size of trades relative to the size of the Fund's holding or
whether the 4(2) commercial paper is administered by a direct issuer pursuant to
a direct placement program).
TRUSTEES AND OFFICERS
The Board of Trustees oversees the Funds, the Manager and the Subadvisers.
Information pertaining to the Trustees and officers of the Trust is set forth
below. Trustees deemed to be "interested persons" of the Trust for purposes of
the 1940 Act are indicated by an asterisk.
77
<PAGE> 78
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S) POSITION(S)
- ----------------------- -----------
NAME, ADDRESS AND AGE WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------- -------------------
<S> <C> <C>
Richard M. Kernan,Jr.* Chairman and Director of MainStay VP Series
51 Madison Avenue Trustee Fund, Inc. From January 1987 to
New York, NY 10010 present; Chairman of the board
Age: 58 and Chief Executive Officer of
MainStay VP Series Fund, Inc.
From August 1989 to present;
Executive Vice President and
Chief Investment Officer of New
York Life Insurance Company from
March 1995 to present; Executive
Vice President prior thereto;
Member of the Board of Directors
of New York Life Insurance Company
from November 1996 to present and
Chairman of the Investment Committee
from January 1997 to present; and
Director, MacKay Shields Financial
Corporation, 1988 to present; and
Director, Express Scripts, 1992-present.
Stephen C. Roussin* President, Chief Director and Chairperson, MainStay
51 Madison Avenue Executive Officer Institutional Funds, Inc., 1997
New York, NY 10010 and Trustee to present; Senior Vice President,
Age: 35 New York Life Insurance Company,
1997 to present; Senior Vice President,
Smith Barney, 1994 to 1997; and Division
Sales Manager, Prudential Securities, 1989
to 1994.
Mark Gordon* Trustee Senior Vice President, New York Life Insurance
51 Madison Avenue Company, 1998-present; President, NYLIFE
New York, NY 10010 Distributors Inc., 1998-present; Senior Vice
Age: 45 President, Seligman Financial Services,
1995-1998, Senior Vice President, Directors of
Investments, AG Edwards, 1994-1995.
</TABLE>
78
<PAGE> 79
<TABLE>
<S> <C> <C>
Harry G. Hohn* Trustee Retired Chairman and Chief Executive Officer,
51 Madison Avenue New York Life Insurance Company; Chairman
New York, NY 10010 of the Board and Chief Executive Officer,
Age: 67 New York Life Insurance Company, 1990 to 1997;
Vice Chairman of the Board, New York Life
Insurance Company, 1986 to 1990; Director,
New York Life Insurance Company, 1985 to
present; Chairman of the Board, American Council
of Insurance, 1994 to 1995; Chairman of the
Board, Life Insurance Council of New York, 1996
to 1997; Director, Million Dollar Roundtable
Foundation, 1996 to 1997; Director, Insurance
Marketplace Standards Association, 1996 to 1997;
Director, Witco Corporation, 1989 to present;
Member, International Advisory Board of Credit
Commercial de France, 1995 to present; and a
Life Fellow of the American Bar Foundation.
Edward J. Hogan Trustee Rear Admiral U.S. Navy (Retired); Independent
Box 2321 Management Consultant, 1992 to 1997.
Sun Valley, ID 83353
Age: 66
Nancy Maginnes Kissinger Member, Council of Rockefeller University,
Henderson Road New York, NY, 1991 to present; Trustee,
South Kent, CT 06785 Rockefeller University, 1995 to present;
Age: 65 Trustee Trustee, Animal Medical Center, 1993 to present;
and Trustee, The Masters School, 1994 to present;
Member, Board of Overseers, Rockefeller Institute
of Government, Albany, NY, 1983- 1992 (Board
dissolved).
</TABLE>
79
<PAGE> 80
<TABLE>
<S> <C> <C>
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984 to
426 C Street, N.E. present; Managing Director, The Life Services
Washington, D.C. 20002 Trust, 1998 to present; President, Employee
Age: 51 Health Programs, 1990 to present; Vice Chairman,
TheraCom Inc., 1994 to present; Director, Harvard
University, Pollin Institute, 1995 to present;
Director, PeacePac, 1994 to present; Commissioner,
State of Maryland, Higher Education Commission,
1995 to present; Vice Chairman, National
Organization on Fetal Alcohol Syndrome, 1993 to
present; Chief Executive Officer, Medical Crisis
Systems, 1997 to present; and Board Member,
Hollings Cancer Center, Medical University of
South Carolina, 1993 to present; Member, UNICEF
National Board, 1993 to present; Member, UNICEF
National Board, 1993 to present.
John B. McGuckian Trustee Chairman of the Board, Ulster Television plc,
Ardverna 1990 to present; Director, Ulster Television
Cloughmills plc, 1970 to present; Chairman of the Board,
Northern Ireland Tedcastle Holding Ltd. (energy), 1995 to
BT4 49NL present; Director, Cooneen Textiles Ltd. (clothing
Age: 59 manufacturer), 1967 to present; Director Allied
Irish Banks plc, 1977 to present; Director,
First Trust Bank, 1991 to present; Director, Unidare
plc (engineering), 1986 to present; Director,
Irish Continental Group plc (ferry operations),
1988 to present; Director, Harbour Group Ltd.
(management company), 1980 to present; Chairman,
Industrial Development Board, 1990 to 1997; and
Chairman of Senate and Senior Pro-Chancellor, Queen's
University, 1986 to present.
</TABLE>
80
<PAGE> 81
<TABLE>
<S> <C> <C>
Donald E. Nickelson Trustee Vice Chairman, Harbour Group Industries, Inc., 1991
1701 Highway A-1-A to present; Director, PaineWebber Group, 1980 to
Suite 218 1993; President, PaineWebber Group, 1988 to 1990;
Vero Beach, FL 32963 Chairman of the Board, Paine Webber Properties,
Age: 66 1985 to 1989; Director, Harbour Group, 1986 to
present; Director, Sugen, Inc., 1992 to present;
Chairman of the Board, Omniquip International, Inc.,
1996 to present; Director, Carey Diversified, L.L.C.,
January 1,1998 to present.
Donald K. Ross* Trustee Retired Chairman and Chief Executive Officer, New York
953 Cherokee Lane Life Insurance Company; Director, New York Life
Franklin Lakes, NJ 07417 Insurance Company, 1978 to 1996; President, New York
Age: 73 Life Insurance Company, 1986 to 1990; Chairman of the
Board, New York Insurance Company, 1981 to 1990; New
York Life Insurance Company, 1981 to 1990; Director,
MacKay-Shields Financial Corporation, 1984 to present;
and Trustee, Consolidated Edison Company of New York,
Inc., 1976 to 1998.
Richard S. Trutanic Trustee Managing Director, The Somerset Group (financial
1155 Connecticut Ave. N.W. advisory firm), 1990 to present; Chief Executive Officer
Suite 400 and President, Americap L.L.C. (Financial Advisory
Washington, DC 20036 Firm), 1997 to present; Senior Vice President,
Age: 46 Washington National Investment Corporation (financial
advisory firm), 1985 to 1990; Director, Allin
Communications Corporation, 1996 to 1997; and Director
and Member of Executive Committee, Southern Net, Inc.,
1986 to 1990.
</TABLE>
81
<PAGE> 82
<TABLE>
<S> <C> <C>
Jefferson C. Boyce Senior Vice Chairman, Monitor Capital Advisors, Inc., 1977 to present;
51 Madison Avenue President Senior Vice President, MainStay Institutional Funds Inc.,
New York, NY 10010 1998 to present; Senior Vice President, New York Life
Age: 40 Insurance Company, 1994 to present; Director, NYLIFE
Distributors Inc., 1993 to present; and chief
Administrative Officer, Pensin, Mutual Funds,
Structured Finance, Corporate Quality, Human
Resources and Employees' health Departments, New
York Life Insurance company, 1992 to 1994.
Anthony W. Polis Vice President and Chief Vice President, New York Life Insurance Company, 1988 to
51 Madison Avenue Financial Company present; Director, Vice President and Chief Financial
New York, NY 10010 Officer, NYLIFE Securities Inc., 1988 to present; Vice
Age: 54 President and Chief Financial Officer, NYLIFE Distributors
Inc., 1993 to present; Treasurer, MainStay Institutional
Funds Inc., 1990 to present; Treasurer, MainStay VP Series
Fund, Inc., 1993 to present; Assistant Treasurer, MainStay
VP Series Fund, Inc., 1992 to 1993; Vice President and
Treasurer, Eclipse Financial Asset Trust, 1992 to present;
Vice President and Chief Financial Officer, Eagle Strategies
Corp. (registered investment adviser), 1993 to present.
Patrick J. Farrell Vice President Vice President, New York Life Insurance Company, 1996 to
51 Madison Avenue present; Assistant Treasurer, Member of the Dividend
New York, NY 10010 Committee, The MainStay Funds, 1998 to present.
Age: 39
</TABLE>
82
<PAGE> 83
<TABLE>
<S> <C> <C>
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance Company, 1995 to
51 Madison Avenue present; Vice President -- Tax, New York Life Insurance
New York, NY 10010 Company, 1986 to 1995; Tax Vice President, NYLIFE Securities
Age: 48 Inc., 1987 to present; Tax Vice President, NAFCO, Inc., 1990
to present; Tax Vice President, NYLIFE Depositary Inc., 1990
to present; Tax Vice President, NYLIFE Inc., 1990 to
present; Tax Vice President, NYLIFE Insurance Company of
Arizona, 1990 to present; Tax Vice President, NYLIFE Realty
Inc., 1991 to present; Tax Vice President, NYLICO Inc., 1991
to present; Tax Vice President, New York Life Fund Inc.,
1991 to present; Tax Vice President, New York Life
International Investment, Inc., 1991 to present; Tax Vice
President, NYLIFE Equity Inc., 1991 to present; Tax Vice
President, NYLIFE Funding Inc., 1991 to present; Tax Vice
President, NYLCO Inc., 1991 to present; Tax Vice President,
MainStay VP Series Fund, Inc., 1991 to present; Tax Vice
President, CNP Realty, 1991 to present; Tax Vice President,
New York Life MainStay Institutional Funds Inc., 1992 to
present; Tax Vice President, NYLIFE Distributors, Inc.,
1993 to present; Vice President Assistant Controller,
New York Life.
</TABLE>
- -----------------------
*Messrs. Ross, Roussin, Gordon, Hohn and Kernan are deemed to be "interested
persons" of the Trust as that term is defined in the 1940 Act.
As indicated in the above table, certain Trustees and officers also hold
positions with MacKay-Shields, Monitor, New York Life Insurance Company, NYLIFE
Securities Inc. and/or NYLIFE Distributors Inc.
Effective August 1, 1998, the Independent Trustees of the Trust receive
from the Trust an annual retainer of $45,000 and a fee of $2,000 for each Board
of Trustees meeting and for each Board committee meeting attended and are
reimbursed for all out-of-pocket expenses related to attendance at such
meetings. Trustees who are affiliated with New York Life Insurance Company do
not receive compensation from the Trust.
For the fiscal year ended December 31, 1998, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment advisers as the Trust or
an investment adviser that is an affiliated person of one of the Trust's
investment advisers:
83
<PAGE> 84
<TABLE>
<CAPTION>
Aggregate Total Compensation From
Name of Compensation Registrant
Trustee from the Trust Paid to Trustees
- ------- -------------- ----------------
<S> <C> <C>
Edward J. Hogan $48,250 $48,250
Nancy M. Kissinger 48,250 48,250
Terry L. Lierman 48,250 48,250
Donald E. Nickelson 52,250 52,250
Richard S. Trutanic 48,250 48,250
John B. McGuckian 48,250 48,250
</TABLE>
As of April 1, 1999, the Trustees and officers of the Trust as a group
owned less than 1% of the outstanding shares of any class of beneficial interest
of each of the Funds.
THE MANAGER, THE SUBADVISERS AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds, MainStay Management,
Inc. (the "Manager"), subject to the supervision of the Trustees of the Trust
and in conformity with the stated policies of the Funds, administers the Funds'
business affairs and has investment advisory responsibilities. MainStay
Management, Inc is a direct subsidiary of NYLIFE Inc. which is a direct
subsidiary of New York Life Insurance Company.
The Trustees, including the Independent Trustees, approved the Management
Agreement with respect to the Funds then in operation, as well as the Strategic
Value Fund, at an in-person meeting held July 28, 1997. On April 27, 1998, the
Trustees approved the Management Agreement with respect to the Blue Chip Growth
Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund,
Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund, and
approved the continuation of the Agreement with respect to the other Funds. On
March 15, 1999, the Trustees approved the Management Agreement with respect to
the MAP Equity Fund. On October 24, 1997, the shareholders of each of the Funds
other than the Strategic Value Fund approved the Management Agreement. The
Management Agreement for the Strategic Value Fund was approved by the Fund's
sole shareholder on October 21, 1997. On May 29, 1998, the sole initial
shareholder of Blue Chip Growth Fund, Research Value Fund, Small Cap Value
Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and
Global High Yield Fund approved the Management Agreement with respect to those
Funds. It is anticipated that the sole initial shareholder of the MAP Equity
Fund will approve the Management Agreement on June 8, 1999. The Management
Agreement will remain in effect for two years following its effective date, and
will continue in effect thereafter only if such continuance is specifically
approved at least annually by the Trustees or by vote of a majority of the
outstanding voting securities of each of the Funds (as defined in the 1940 Act
and the rules thereunder) and, in either case, by a majority of the Trustees
who are not "interested persons" of the Trust or the Manager (as the term is
defined in the 1940 Act).
The Manager has authorized any of its directors, officers and employees who
have been elected or appointed as Trustees or officers of the Trust to serve in
the capacities in which they have been elected or appointed.
The Management Agreement provides that the Manager shall not be liable to a
Fund for any error or judgment by the Manager or for any loss sustained by a
Fund except in the case of the Manager's willful misfeasance, bad faith, gross
negligence or reckless disregard of duty. The Management Agreement also provides
that it shall terminate automatically if assigned and that it may be terminated
without penalty by either party upon no more than 60 days' nor less than 30
days' written notice.
In connection with its administration of the business affairs of each of
the Funds, and except as indicated in the Prospectus under the heading "Manager,
Subadvisers and Distributor," the Manager bears the following expenses:
(a) the salaries and expenses of all personnel of the Trust and the
Manager, except the fees and expenses of Trustees not affiliated with the
Manager or a Subadviser;
84
<PAGE> 85
(b) the fees to be paid to the Subadvisers pursuant to the Sub-Advisory
Agreements; and
(c) all expenses incurred by the Manager in connection with administering
the ordinary course of the Funds' business, other than those assumed by the
Trust.
SUB-ADVISORY AGREEMENTS
Pursuant to the Sub-Advisory Agreements between the Manager and Monitor
Capital Advisors, Inc. ("Monitor") with respect to the Equity Index Fund;
between the Manager and Gabelli Asset Management ("GAMCO") with respect to the
Blue Chip Growth Fund; between the Manager and John A. Levin & Co., Inc. ("John
A. Levin & Co.") with respect to the Research Value Fund; between the Manager
and Dalton Greiner, Hartman, Maher & C. ("DGHM") with respect to the Small Cap
Value Fund; between the Manager and Madison Square Advisors, Inc. ("Madison
Square Advisors") with respect to the Growth Opportunities Fund; between the
Manager and Markston International LLC ("Markston") with respect to the MAP
Equity Fund; and between the Manager and MacKay Shields Financial Corporation
("MacKay-Shields") with respect to the remaining 17 Funds (each a "Subadviser"
and collectively the "Subadvisers"); each of the Subadvisers, subject to the
supervision of the Trustees of the Trust the Manager in conformity with the
stated policies of each of the Funds and the Trust, manage the Funds'
portfolios, including the purchase, retention, disposition and loan of
securities. As compensation for services, the Manager, not the Funds, pays the
Fund's Subadvisers a monthly fee calculated on the basis of each Fund's average
daily net assets during the preceding month at the following annual rates:
<TABLE>
<CAPTION>
Annual Rate
<S> <C>
Blue Chip Growth Fund 0.50%(1)
California Tax Free Fund 0.25%(2)
Capital Appreciation Fund 0.36%(2)
Convertible Fund 0.36%(2)
Equity Income Fund 0.35%(2)
Equity Index Fund 0.10%
Global High Yield Fund 0.35%(2)
Government Fund 0.30%(2)
Growth Opportunities Fund 0.35%
High Yield Corporate Bond Fund 0.30%(2)
International Bond Fund 0.45%(2)(3)
International Equity Fund 0.60%(2)
MAP Equity Fund 0.45%(4)
Money Market Fund 0.25%(2)(5)
New York Tax Free Fund 0.25%(2)
Research Value Fund 0.425%(6)
Small Cap Growth Fund 0.50%(2)
Small Cap Value Fund 0.50%(7)
Strategic Income Fund 0.30%(2)
Strategic Value Fund 0.375%(2)
Tax Free Bond Fund 0.30%(2)
Total Return Fund 0.32%(2)
Value Fund 0.36%(2)(8)
</TABLE>
- -------------------
(1) Up to $500 million. For the period June 1, 1998 to May 31, 2001, only 0.40%
on assets over $500 million, to be reviewed prior to June 1, 2001.
(2) To the extent that the Manager has agreed to voluntarily waive all or a
portions of its fee or reimburse expenses or has established fee
breakpoints, the Subadviser has voluntarily agreed to do so
proportionately.
(3) The Subadviser has voluntarily agreed to waive a portion of its fee until
such time as the International Bond Fund reaches $50 million in net assets.
(4) Up to $250 million; 0.40% from $250 million to $500 million; and 0.35% in
excess of $500 million.
(5) Up to $300 million; 0.225% from $300 million to $700 million; 0.20% from
$700 million to $1.0 billion; and 0.175% in excess of $1.0 billion.
85
<PAGE> 86
(6) Up to $250 million; 0.3825% from $250 million to $500 million; and 0.34% in
excess of $500 million.
(7) Up to $250 million; 0.45% from $250 million to $500 million; and 0.40% in
excess of $500 million.
(8) Up to $200 million; 0.325% from $200 million to $500 million; and 0.25% in
excess of $500 million.
The Trustees, including the Independent Trustees, approved the Sub-Advisory
Agreements with MacKay-Shields and Monitor with respect to the Funds then in
operation, as well as the Strategic Value Fund, at an in-person meeting held
July 28, 1997. On April 27, 1998, the Trustees approved the Sub-Advisory
Agreement with GAMCO on behalf of the Blue Chip Growth Fund, the Sub-Advisory
Agreement with John A. Levin & Co. on behalf of the Research Value Fund, the
Sub-Advisory Agreement with DGHM on behalf of the Small Cap Value Fund, the
Sub-Advisory Agreements with Madison Square Advisors on behalf of the Growth
Opportunities Fund, and the Sub-Advisory Agreement with MacKay-Shields on
behalf of Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund.
On that date, the Trustees also approved the continuation of the Sub-Advisory
Agreements previously approved for the other funds. On March 15, 1999, the
Trustees approved the Sub-Advisory Agreement with Markston on behalf of the MAP
Equity Fund. On October 24, 1997, the shareholders of each of the Funds other
than the Strategic Value Fund approved the Sub-Advisory Agreements with
MacKay-Shields and Monitor. The Sub-Advisory Agreement with respect to the
Strategic Value Fund was approved by that Fund's sole shareholder on October
21, 1998. On May 29, 1998 the sole initial shareholder of Blue Chip Growth
Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund,
Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund approved
the Sub-Advisory Agreements with respect to those Funds. It is anticipated that
the sole initial shareholder of the MAP Equity Fund will approve the
Sub-Advisory Agreement on June 8, 1999. The Sub-Advisory Agreements will remain
in effect for two years following their effective dates, and will continue in
effect thereafter only if such continuance is specifically approved at least
annually by the Trustees or by vote of a majority of the outstanding voting
securities of each of the Funds (as defined in the 1940 Act and the rules
thereunder) and, in either case, by a majority of the Trustees who are not
"interested persons" of the Trust, the Manager, or any Subadviser (as the term
is defined in the 1940 Act).
The Subadvisers have authorized any of their directors, officers and
employees who have been elected or appointed as Trustees or officers of the
Trust to serve in the capacities in which they have been elected or appointed.
In connection with the services they render, the Subadvisers bear the salaries
and expenses of all of their personnel.
The Sub-Advisory Agreements provide that the Subadvisers shall not be
liable to a Fund for any error of judgment by a Subadviser or for any loss
suffered by a Fund except in the case of the Subadviser's willful misfeasance,
bad faith, gross negligence or reckless disregard of duty. The Sub-Advisory
Agreements also provide that they shall terminate automatically if assigned and
that they may be terminated without penalty by either party upon no more than 60
days' nor less than 30 days' written notice.
For fiscal year ended December 31, 1998 and the period from October 27,
1997 through December 31, 1997, the amount of the Management fee paid and waived
and/or reimbursed by each Fund; the amount of the Sub-Advisory fee paid by the
Manager from the Management fee; and the amount of the Sub-Advisory fee waived
and/or reimbursed were as follows (the Blue Chip Growth Fund, Research Value
Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund,
Equity Income Fund and Global High Yield Fund had not commenced operations as of
December 31, 1997):
86
<PAGE> 87
<TABLE>
<CAPTION>
YEAR ENDED 12/31/98 SUB-ADVISORY
MANAGEMENT FEE WAIVED
MANAGEMENT FEE WAIVED SUB-ADVISORY AND/OR
FUND FEE PAID* AND/OR REIMBURSED FEE PAID* REIMBURSED
- ---- ---------- ----------------- --------- ----------
<S> <C> <C> <C> <C>
Blue Chip Growth Fund $189,170 $ - $94,585 $ -
California Tax Free Fund 92,717 45,570 46,359 22,785
Capital Appreciation Fund 13,345,757 4,592,655 6,672,879 3,296,327
Convertible Fund 6,025,907 - 3,012,954 -
Equity Income Fund 49,143 - 24,572 -
Equity Index Fund+ 2,866,599 172,008 607,721 -
Global High Yield Fund 28,467 11,387 14,234 5,693
Government Fund 3,741,658 - 1,870,829 -
Growth Opportunities Fund 70,044 - 35,022 -
High Yield Corporate Bond Fund 20,579,090 1,598,099 10,289,545 799,049
International Bond Fund 134,025 100,518 83,766 67,012
International Equity Fund 906,887 - 544,132 -
Money Market Fund 1,189,726 1,107,346 594,863 553,673
New York Tax Free Fund 35,333 70,678 17,667 35,339
Research Value Fund 61,472 - 30,736 -
Small Cap Growth Fund 136,799 - 68,400 -
Small Cap Value Fund 95,249 - 47,625 -
Strategic Income Fund++ 424,136 30,927 212,068 15,463
Strategic Value Fund 382,133 - 191,067 -
Tax Free Bond Fund 2,904,883 - 1,452,442 -
Total Return Fund 8,761,932 371,167 4,380,966 185,583
Value Fund 8,378,478 - 4,189,239 -
</TABLE>
* After expense reimbursement or waiver.
+ Effective April 1, 1998, the Equity Index Fund's expense cap was terminated.
++ Effective February 28, 1998, the Strategic Income Fund's expense cap was
terminated.
10/27/97 - 12/31/97
<TABLE>
<CAPTION>
MANAGEMENT SUB-ADVISORY
FEE WAIVED FEE WAIVED
MANAGEMENT AND/OR SUB-ADVISORY AND/OR
FUND FEE PAID* REIMBURSED FEE PAID* REIMBURSED
- ------------------------------ ---------- ----------- --------- ----------
<S> <C> <C> <C> <C>
California Tax Free Fund $ 22,562 $ -- $ 11,281 $ --
Capital Appreciation Fund 1,996,154 -- 998,077 --
Convertible Fund 1,210,730 -- 605,365 --
Equity Index Fund+ 149,354 223,441 74,559 --
Government Fund 712,902 -- 356,451 --
High Yield Corporate Bond Fund 3,590,202 -- 1,795,101 --
International Bond Fund 24,178 18,134 15,111 12,089
International Equity Fund 145,829 -- 87,497 --
Money Market Fund 165,694 205,316 82,847 102,658
New York Tax Free Fund 11,863 5,413 5,932 2,707
Strategic Income Fund++ -- 74,218 -- 37,109
Strategic Value Fund++ 23,276 -- 11,638 --
Tax Free Bond Fund 533,914 -- 266,957 --
Total Return Fund 1,431,434 -- 715,717 --
Value Fund 1,479,934 -- 739,967 --
</TABLE>
* After expense reimbursement or waiver.
+ The Equity Index Fund's expense limitation was terminated April 1, 1998.
87
<PAGE> 88
++ The Strategic Income Fund commenced operations on February 28, 1997.
Effective February 28, 1998, the Fund's expense cap was terminated. The
Strategic Value Fund commenced operations on October 21, 1997.
In previous years, prior to a change in management structure, each
applicable or existing Fund paid an advisory fee directly to MacKay-Shields or
Monitor. For the period from January 1,1997 through October 26, 1997 and the
fiscal year ended December 31, 1996, the amount of the advisory fee paid and
waived and/or reimbursed, by each Fund to MacKay-Shields or Monitor was as
follows:
<TABLE>
<CAPTION>
PERIOD ENDED 10/26/97 YEAR ENDED 12/31/96
--------------------- -------------------
ADVISORY ADVISORY
FEE FEE
ADVISORY WAIVED ADVISORY WAIVED
FEE AND/OR FEE AND/OR
REIMBURSED PAID* REIMBURSED PAID* REIMBURSED
-------- ---------- ------- ----------
<S> <C> <C> <C> <C>
California Tax Free Fund $ 44,678 $ 2,589 $ 45,307 $ 11,228
Capital Appreciation Fund 3,934,494 -- 3,429,258 --
Convertible Fund 2,710,393 -- 2,444,000 --
Equity Index Fund 256,066 -- 163,785 --
Government Fund 1,760,807 -- 2,643,801 --
High Yield Corporate Bond Fund 6,921,965 -- 5,816,110 --
International Bond Fund 65,696 52,556 68,489 54,933
International Equity Fund 384,003 -- 342,100 --
Money Market Fund 407,638 396,862 397,071 473,155
New York Tax Free Fund 25,025 13,579 29,457 19,911
Strategic Income Fund+ 61,282 40,291 N/A N/A
Strategic Value Fund+ N/A N/A N/A N/A
Tax Free Bond Fund 1,217,473 -- 1,579,820 --
Total Return Fund 3,025,045 -- 3,087,111 --
Value Fund 2,976,469 -- 2,682,642
</TABLE>
+ The Strategic Income Fund commenced operations on February 28, 1997. The
Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
In previous years, prior to a change in management structure, each
applicable or existing Fund paid an administrative fee directly to NYLIFE
Distributors Inc. as administrator. For the period from January 1, 1997 through
October 26, 1997 and the fiscal year ended December 31, 1996, the amount of the
administration fees paid and waived and/or reimbursed by each Fund was as
follows:
88
<PAGE> 89
<TABLE>
<CAPTION>
PERIOD ENDED 10/26/97 YEAR ENDED 12/31/96
--------------------- -------------------
ADMINISTRA-
TION FEE ADMINISTRATION
ADMINISTRA WAIVED ADMINISTRA- FEE WAIVED
TION FEE AND/OR TION FEE AND/OR
REIMBURSED PAID* REIMBURSED PAID* REIMBURSED
---------- ---- ---------- ---- ----------
<S> <C> <C> <C> <C>
California Tax Free Fund $44,678 $2,589 $ 45,307 $11,228
Capital Appreciation Fund 3,934,494 -- 3,429,258 --
Convertible Fund 2,710,393 -- 2,444,000 --
Equity Index Fund 605,767 418,496 365,118 290,022
Government Fund 1,760,807 -- 2,643,801 --
High Yield Corporate Bond Fund 6,921,965 -- 5,816,110 --
International Bond Fund 39,417 26,278 41,100 27,467
International Equity Fund 256,002 -- 228,066 --
Money Market Fund 407,638 396,862 397,071 473,155
New York Tax Free Fund 25,025 13,579 29,457 19,911
Strategic Income Fund+ 61,282 40,291 N/A N/A
Strategic Value Fund+ N/A N/A N/A N/A
Tax Free Bond Fund 1,217,473 -- 1,579,820 --
Total Return Fund 3,025,045 -- 3,087,111 --
Value Fund 2,976,469 -- 2,682,642 --
</TABLE>
+ The Strategic Income Fund commenced operations on February 28, 1997. The
Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
DISTRIBUTION AGREEMENT
NYLIFE Distributors Inc. serves as the Trust's distributor and principal
underwriter (the "Distributor")pursuant to a Distribution Agreement dated
January 1, 1994. NYLIFE Securities Inc. ("NYLIFE Securities") sells shares of
the Funds pursuant to a dealer agreement with the Distributor. The Distributor
and other broker-dealers will pay commissions to salesmen as well as the cost
of printing and mailing prospectuses to potential investors and of any
advertising incurred by them in connection with their distribution of Trust
shares. In addition, the Distributor will pay for a variety of account
maintenance and personal services to shareholders after the sale. The
Distributor is not obligated to sell any specific amount of the Trust's shares.
The Distributor receives sales loads and distribution plan payments.
The Trust anticipates making a continuous offering of its shares, although
it reserves the right to suspend or terminate such offering at any time with
respect to any Fund or class or group of Funds or classes. The Distribution
Agreement was most recently approved by the Board of Trustees, including a
majority of the Trustees who are not "interested persons" (as the term is
defined in the 1940 Act) of the Trust or the Distributor nor have any direct or
indirect financial interest in the operation of the distribution plan or in any
related agreement (the "Independent Trustees") at a meeting held on October 25,
1993. The Distribution Agreement for the International Bond Fund and the
International Equity Fund was approved by the Trustees, including a majority of
the Independent Trustees, at a meeting held on July 25, 1994. The Distribution
Agreement for the Strategic Income Fund was approved by the Trustees, including
a majority of the Independent Trustees at a meeting held on January 27, 1997.
The Distribution Agreement for the Strategic Value Fund was approved by the
Trustees, including a majority of the Independent Trustees, at a meeting held on
July 28, 1997. The Distribution Agreement for the Blue Chip Growth Fund,
Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap
Growth Fund, Equity Income Fund and Global High Yield Fund was approved by the
Trustees, including a majority of the Independent Trustees, on April 27, 1998.
On that date, Distribution Agreements for the other Funds were reapproved by the
Trustees, including a majority of the Independent Trustees. The Distribution
Agreement for the MAP Equity Fund was approved by the Trustees, including a
majority of the Independent Trustees, at a meeting held on March 15, 1999.
89
<PAGE> 90
After an initial two-year period, the Distribution Agreements are subject
to annual approval by the Board of Trustees. The Distribution Agreements are
terminable with respect to a Fund at any time, without payment of a penalty, by
vote of a majority of the Trust's Trustees who are not "interested persons" (as
defined in the 1940 Act) of the Trust, upon 60 days' written notice to the
Distributor, or by vote of a majority of the outstanding voting securities of
that Fund, upon 60 days' written notice to the Trust. The Distribution
Agreements will terminate in the event of their assignment.
First Priority Investment Corporation acted as distributor to the MAP -
Equity Fund until April 30, 1999 pursuant to a Distributor's Agreement. During
the fiscal years ended December 31, 1996, 1997 and 1998, the company received
$22,754, $37,552 and $162,627, respectively, for its services as distributors.
DISTRIBUTION PLANS
Each of the Funds (except the Money Market Fund and the Equity Index Fund,
which does not offer Class B or Class C shares) has adopted separate plans of
distribution pursuant to Rule 12b-1 under the 1940 Act for each class of shares
of each Fund (the "Class A Plans," the "Class B Plans," the "Class C Plans" and,
collectively, the "Plans"). Under the Plans, a class of shares of a Fund pays
distribution and/or service fees to the Distributor as compensation for
distribution and/or service activities related to that class of shares and its
shareholders. Because these fees are paid out of a Fund's assets on an on-going
basis, over time these fees will increase the cost of an investment and may cost
a shareholder more than paying other types of sales charges. Each Plan provides
that the distribution and/or service fees are payable to the Distributor
regardless of the amounts actually expended by the Distributor. Authorized
distribution expenses include the Distributor's interest expense and profit. The
Distributor anticipates that its actual expenditures will substantially exceed
the distribution fee received by it during the early years of the operation of a
Plan. For example, the Distributor will advance to dealers who sell Class B
shares of the Funds an amount equal to 4% of the aggregate net asset value of
the shares sold. Dealers meeting certain criteria established by the
Distributor, which may be changed from time to time, may receive additional
compensation. In addition, with respect to Class A and Class B shares, the
Distributor may pay dealers an ongoing annual service fee equal to 0.25% of the
aggregate net asset value of shares held by investors serviced by the dealer.
The Distributor will advance to dealers who sell Class C shares of the
Funds an amount equal to 1% of the aggregate net asset value of the shares sold.
In addition, the Distributor may make payments quarterly to dealers in an
amount up to 1.00% (0.50% for the California Tax Free, New York Tax Free and
Tax Free Bond Funds) on an annualized basis of the average net asset value of
the Class C shares which are attributable to shareholders for whom the dealers
are designated as dealers of record.
In later years, its expenditures may be less than the distribution fee,
thus enabling the Distributor to realize a profit in those years.
If the Plans for the Funds are terminated, the Funds will owe no payments
to the Distributor other than fees accrued but unpaid on the termination date.
Plans may be terminated only by specific action of the Board of Trustees or
shareholders.
Plan revenues may be used to reimburse third parties which provide various
services to shareholders who are participants in various retirement plans. These
services include aggregating and processing purchase and redemption orders for
participant shareholders, processing dividend payments, forwarding shareholder
communications, and recordkeeping. Persons selling or servicing different
classes of shares of the Funds may receive different compensation with respect
to one particular class of shares as opposed to another in the same Fund. The
Distributor, at its expense, also may from time to time provide additional
promotional incentives to dealers who sell Fund shares.
Under the Class A Plans, Class A shares of each Fund pay the Distributor a
monthly fee at the annual rate of 0.25% of the average daily net assets of each
Fund's Class A shares for distribution or service activities, as designated by
the Distributor.
As noted above, the Class B shares of each Fund (except the Money Market
Fund and the Equity Index Fund, which does not offer Class B shares) also have
adopted Rule 12b-1 distribution plans.
Under the current Class B plans, each Fund's Class B shares pay a monthly
distribution fee to the Distributor at the annual rate of 0.75% (0.25% in the
case of the California Tax Free Fund, New York Tax Free Fund and the Tax Free
Bond Fund) of the average daily net assets attributable to the Fund's Class B
shares. Pursuant to the Class B Plan, the Class B shares also pay a service fee
to the Distributor at the annual rate of 0.25% of the average daily net assets
of the Funds' Class B shares.
90
<PAGE> 91
The Class C shares of each Fund (except the Money Market Fund and the
Equity Index Fund, which does not offer Class C shares) also have adopted Rule
12b-1 distribution plans.
Under the Class C plans, each Fund's Class C shares pay a monthly
distribution fee to the Distributor at the annual rate of 0.75% (0.50% in the
case of the California Tax Free Fund, New York Tax Free Fund and the Tax Free
Bond Fund) of the average daily net assets attributable to the Fund's Class C
shares. Pursuant to the Class C Plans, the Class C shares also pay a service fee
to the Distributor at the annual rate of 0.25% of the average daily net assets
of the Funds' Class C shares.
Each Plan shall continue in effect from year to year, provided such
continuance is approved annually by a vote of the Trustees in the manner
described above. No Plan may be amended to increase materially the amount to be
spent for the services described therein without approval of the shareholders of
the affected class of shares of a Fund, and all material amendments of each Plan
must also be approved by the Trustees in the manner described above. Each Plan
may be terminated at any time, without payment of any penalty, by vote of a
majority of the Independent Trustees, or by a vote of a majority of the
outstanding voting securities of the affected Fund (as defined in the 1940 Act)
on not more than 30 days' written notice to any other party to the Plan. So long
as any Plan is in effect, the selection and nomination of Trustees who are not
such interested persons has been committed to those Trustees who are not such
interested persons. The Trustees have determined that, in their judgment, there
is a reasonable likelihood that each Plan will benefit the respective Fund and
its shareholders. Pursuant to the Class A, Class B and Class C Plans, the
Distributor shall provide the Trust for review by the Trustees, and the Trustees
shall review at least quarterly, a written report of the amounts expended under
each Plan and the purpose for which such expenditures were made. In the
Trustees' quarterly review of each Plan, they will consider its continued
appropriateness and the level of compensation provided therein.
Pursuant to a rule of the National Association of Securities Dealers, Inc.,
the amount which a Fund may pay for distribution expenses, excluding service
fees, is limited to 6.25% of the gross sales of the Fund's shares since
inception of the Fund's Plan, plus interest at the prime rate plus 1% per annum
(less any contingent deferred sales charges paid by shareholders to the
Distributor or distribution fee (other than service fees) paid by the Funds to
the Distributor).
For the fiscal year ended December 31, 1998, the Funds paid distribution
and service fees pursuant to the Class A, Class B and Class C Plans as follows
(Class C shares were not offered prior to September 1, 1998):
91
<PAGE> 92
<TABLE>
<CAPTION>
AMOUNT OF FEE AMOUNT OF FEE AMOUNT OF FEE
PURSUANT TO PURSUANT TO PURSUANT TO
CLASS A PLAN CLASS B PLAN CLASS C PLANS +
------------ ------------ ---------------
<S> <C> <C> <C>
Blue Chip Growth Fund......................... $ 19,546 $ 110,695 $ 255
California Tax Free Fund...................... 46,921 44,446 --
Capital Appreciation Fund..................... 713,699 22,059,032 1,492
Convertible Fund.............................. 140,235 7,808,334 1
Equity Income Fund............................ 13,799 15,005 2
Equity Index Fund............................. 1,519,304 N/A N/A
Global High Yield Fund........................ 11,488 10,923 12
Government Fund............................... 47,334 6,046,833 180
Growth Opportunities Fund..................... 15,350 38,662 1
High Yield Corporate Bond Fund................ 678,256 34,240,975 11,916
International Bond Fund....................... 35,903 191,552 1
International Equity Fund..................... 50,725 704,194 14
Money Market Fund............................. N/A N/A N/A
New York Tax Free Fund........................ 36,654 32,688 --
Research Value Fund........................... 13,506 17,849 360
Small Cap Growth Fund......................... 17,741 16,833 2
Small Cap Value Fund.......................... 14,989 34,743 458
Strategic Income Fund......................... 49,104 561,856 36
Strategic Value Fund.......................... 43,224 336,436 177
Tax Free Bond Fund............................ 38,079 2,344,632 4
Total Return Fund............................. 319,120 12,993,818 295
Value Fund.................................... 330,584 13,654,812 170
</TABLE>
- -----------------------
+ The Class C Plans became effective September 1, 1998.
For the fiscal year ended December 31, 1998, 1997 and 1996, NYLIFE
Distributors retained the following amounts in sales charges for sales of Class
A shares of the Funds:
92
<PAGE> 93
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------- --------- --------
<S> <C> <C> <C>
Blue Chip Growth Fund..................... $18,599
California Tax Free Fund.................. 5,765 $ 6,958 $ 35,009
Capital Appreciation Fund................. 249,244 201,562 1,430,417
Convertible Fund.......................... 10,796 39,646 903,782
Equity Income Fund........................ 2,531 -- --
Equity Index Fund......................... 547,315 329,059 1,968,993
Global High Yield Fund.................... 766 -- --
Government Fund+.......................... 16,947 5,803 96,545
Growth Opportunities Fund................. 3,564 -- --
High Yield Corporate Bond Fund 335,190 308,282 1,413,313
International Bond Fund................... 2,626 5,235 54,586
International Equity Fund................. 11,418 121,009 91,571
Money Market Fund......................... N/A N/A N/A
New York Tax Free Fund.................... 3,909 2,297 22,774
Research Value Fund....................... 2,903 -- --
Small Cap Growth Fund..................... 9,699 -- --
Small Cap Value Fund...................... 7,842 -- --
Strategic Income Fund..................... 16,088 14,008 N/A
Strategic Value Fund...................... 20,954 344 N/A
Tax Free Bond Fund........................ 5,062 5,710 51,345
Total Return Fund......................... 67,358 50,232 334,470
Value Fund+............................... 90,483 112,844 574,807
</TABLE>
93
<PAGE> 94
For the fiscal years ended December 31, 1998, 1997 and 1996, contingent
deferred sales charges were paid by investors on the redemption of Class B
shares of each Fund, as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Blue Chip Growth Fund..................... $9,233
California Tax Free Fund.................. 14,309 $ 3,586 $ 2,008
Capital Appreciation Fund................. 2,052,866 1,485,899 966,555
Convertible Fund.......................... 1,760,525 1,466,588 852,359
Equity Income Fund........................ 169
Equity Index Fund......................... N/A N/A N/A
Global High Yield Fund.................... 1,244
Government Fund........................... 535,272 788,647 952,234
Growth Opportunities Fund................. 1,935
High Yield Corporate Bond Fund 4,333,277 2,684,352 1,482,294
International Bond Fund................... 36,901 31,152 27,332
International Equity Fund................. 102,712 88,010 48,979
Money Market Fund+........................ 892,546 779,844 640,623
New York Tax Free Fund.................... 13,598 2,531 2,810
Research Value Fund....................... 1,171 -- --
Small Cap Growth Fund..................... 4,526 -- --
Small Cap Value Fund...................... 3,797 -- --
Strategic Income Fund++................... 76,399 11,479 N/A
Strategic Value Fund++.................... 86,652 -- N/A
Tax Free Bond Fund........................ 350,238 492,542 605,386
Total Return Fund......................... 908,734 871,336 745,382
Value Fund................................ 1,412,491 996,052 712,915
</TABLE>
- ----------
+ The amount shown represents proceeds from contingent deferred sales charges
which were assessed on redemptions of shares which had previously been
exchanged from other Funds into the Money Market Fund.
++ The Strategic Income Fund commenced operations on February 28, 1997. The
Strategic Value Fund commenced operations on October 21, 1997.
94
<PAGE> 95
For the period from September 1, 1998 (commencement of Class C operations)
through December 31, 1998, contingent deferred sales charges were paid by
investors on the redemption of Class C shares of each Fund, as follows:
<TABLE>
<CAPTION>
PERIOD ENDED
DECEMBER 31, 1998
-----------------
<S> <C>
Blue Chip Growth Fund............................ --
California Tax Free Fund......................... --
Capital Appreciation Fund........................ --
Convertible Fund................................. 82
Equity Income Fund............................... --
Equity Index Fund................................ N/A
Global High Yield Fund........................... 20
Government Fund.................................. --
Growth Opportunities Fund........................ --
High Yield Corporate Bond Fund --
International Bond Fund.......................... 1,170
International Equity Fund........................ --
Money Market Fund+............................... --
New York Tax Free Fund........................... --
Research Value Fund.............................. --
Small Cap Growth Fund............................ --
Small Cap Value Fund............................. --
Strategic Income Fund............................ --
Strategic Value Fund............................. 150
Tax Free Bond Fund............................... --
Total Return Fund................................ --
Value Fund....................................... --
</TABLE>
For the fiscal year ended December 31, 1998, it is estimated that the
following amounts were spent on compensation to dealers with respect to the
Class A shares of each Fund: Blue Chip Growth Fund spent $123,528; California
Tax Free Fund spent $41,072; Capital Appreciation Fund spent $1,611,424;
Convertible Fund spent $63,513; Equity Income spent $17,479; Equity Index Fund
spent $5,385,422; Global High Yield Fund spent $5,867; Government Fund spent
$128,915; Growth Opportunities Fund spent $25,740; High Yield Corporate Bond
Fund spent $1,900,188; International Bond Fund spent $25,864; International
Equity Fund spent $400,314; New York Tax Free Fund spent $26,929; Research Value
Fund spent $22,102; Small Cap Growth Fund spent $65,297; Small Cap Value Fund
spent $56,716; Strategic Income Fund spent $111,494; Strategic Value Fund spent
$152,675 Tax Free Bond Fund spent $39,218; Total Return Fund spent $454,543; and
Value Fund spent $611,010.
For the fiscal year ended December 31, 1998, it is estimated that the
following amounts were spent for distribution-related activities with respect to
the Class A shares of each Fund:
95
<PAGE> 96
<TABLE>
<CAPTION>
Printing and
Mailing
Prospectuses To Compensation To Compensation
Sales Material and Other than Current Distribution To Sales
Advertising Shareholders Personnel Personnel
----------- ------------ --------- ---------
<S> <C> <C> <C> <C>
Capital Appreciation
Fund $21,178 $94,212 $464,440 $268,190
Value Fund 7,419 44,970 171,693 88,877
Convertible Fund 757 18,772 19,090 12,709
High Yield Corp. Fund 21,820 90,843 440,276 289,332
Government Fund 3,295 5,864 36,481 34,264
Tax Free Bond Fund 950 4,986 23,127 11,336
Total Return Fund 7,968 41,949 131,652 88,810
California Tax Free Fund 206 6,131 13,209 8,489
New York Tax Free Fund 594 4,818 6,796 6,217
International Bond Fund 86 4,653 4,891 2,393
International Equity
Fund 1,048 6,786 23,613 13,203
Strategic Income Fund 1,927 6,370 22,252 19,338
Strategic Value Fund 1,653 5,919 31,308 17,396
Equity Index Fund 64,075 202,189 1,281,066 745,639
Blue Chip Growth Fund 1,429 2,781 36,703 25,275
Research Value Fund 291 2,211 5,664 4,183
Small Cap Value Fund 324 2,392 16,264 10,288
Growth Opportunity Fund 439 2,396 6,437 5,715
Small Cap Growth Fund 804 2,776 18,268 14,100
Equity Income Fund 202 2,190 4,784 3,497
Global High Yield (7) 2,002 1,894 950
==============================================================================================================
Total 136,459 555,211 2,759,910 1,670,202
==============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Approximate
Total Amount
Spent By NYLife
Sales Distributors With
Distribution Respect to Each
Other Costs Fund
----- ----- ----
<S> <C> <C> <C>
Capital Appreciation
Fund $371,753 $2,533,006 $3,752,779
Value Fund 126,056 1,029,602 1,468,618
Convertible Fund 14,152 215,031 280,511
High Yield Corp. Fund 398,940 2,726,374 3,967,585
Government Fund 36,167 199,823 315,895
Tax Free Bond Fund 18,989 119,410 178,798
Total Return Fund 118,232 852,280 1,240,890
California Tax Free Fund 9,124 93,961 131,120
New York Tax Free Fund 9,114 77,719 105,259
International Bond Fund 2,992 60,743 75,759
International Equity
Fund 17,816 139,598 202,064
Strategic Income Fund 23,921 137,017 210,825
Strategic Value Fund 22,131 175,972 254,381
Equity Index Fund 1,160,171 7,096,672 10,549,813
Blue Chip Growth Fund 33,524 148,154 247,867
Research Value Fund 5,298 22,727 40,374
Small Cap Value Fund 13,693 64,303 107,263
Growth Opportunity Fund 8,603 32,909 56,498
Small Cap Growth Fund 19,662 82,615 138,225
Equity Income Fund 4,506 20,238 35,417
Global High Yield 1,071 154,908 160,818
====================================================================================
Total 2,415,917 15,983,060 23,520,758
====================================================================================
</TABLE>
Total differences due to inherent Lotus rounding.
96
<PAGE> 97
For the fiscal year ended December 31, 1998, it is estimated that the
following amounts were spent for distribution-related activities with respect to
the Class B shares of each Fund:*
<TABLE>
<CAPTION>
Printing and
Mailing
Prospectuses To Compensation To Compensation
Sales Material and Other than Current Distribution To Sales
Advertising Shareholders Personnel Personnel
----------- ------------ --------- ---------
<S> <C> <C> <C> <C>
Capital Appreciation
Fund $172,099 $570,147 $3,141,208 $1,269,325
Value Fund 71,239 363,935 1,520,706 549,114
Convertible Fund 10,133 204,341 215,104 80,486
High Yield Corp. Fund 199,002 889,581 4,337,271 1,774,831
Government Fund 18,518 152,599 325,350 143,968
Tax Free Bond Fund 12,530 119,187 257,784 106,559
Total Return Fund 70,719 334,039 1,256,208 498,199
California Tax Free Fund 1,539 2,226 34,245 13,169
New York Tax Free Fund 2,112 1,620 23,513 11,895
International Bond Fund 969 4,854 20,221 8,005
International Equity
Fund 5,416 18,410 108,532 42,045
Strategic Income Fund 8,754 14,208 180,968 71,095
Strategic Value Fund 10,013 9,103 243,741 83,789
Blue Chip Growth Fund* 8,489 2,154 150,470 70,659
Research Value Fund 567 414 19,481 8,495
Small Cap Value Fund* 2,528 814 60,650 26,290
Growth Opportunity Fund* 2,622 781 43,063 21,965
Small Cap Growth Fund* 5,257 1,375 98,322 44,350
Equity Income Fund* 767 346 17,600 8,196
Global High Yield Fund* 411 291 12,821 5,146
============================================================================================================
Total 603,685 2,690,424 12,067,256 4,837,580
============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Approximate Total
Amount Spent By NYLife
Sales Distributors With
Distribution Respect to
Other Costs Each Fund
----- ----- ---------
<S> <C> <C> <C>
Capital Appreciation
Fund $2,781,395 $14,808,885 $22,743,059
Value Fund 1,182,239 7,500,431 11,187,664
Convertible Fund 176,529 1,331,775 2,018,367
High Yield Corp. Fund 4,012,878 24,964,419 36,177,983
Government Fund 313,635 1,939,142 2,893,212
Tax Free Bond Fund 236,221 1,502,168 2,234,449
Total Return Fund 1,100,809 6,175,841 9,435,813
California Tax Free Fund 27,467 150,254 228,900
New York Tax Free Fund 27,281 109,791 176,213
International Bond Fund 19,086 100,170 153,306
International Equity
Fund 93,935 494,340 762,677
Strategic Income Fund 151,479 855,934 1,282,438
Strategic Value Fund 175,052 1,129,775 1,651,473
Blue Chip Growth Fund* 174,977 622,252 1,029,003
Research Value Fund 20,717 87,583 137,256
Small Cap Value Fund* 62,467 251,367 404,115
Growth Opportunity Fund* 57,671 200,417 326,519
Small Cap Growth Fund* 110,312 401,278 660,893
Equity Income Fund* 21,615 78,570 127,093
Global High Yield Fund* 12,666 51,804 83,138
=====================================================================================
Total 10,758,428 62,756,196 93,713,569
=====================================================================================
</TABLE>
Total differences due to inherent Lotus rounding.
* Commenced operations on June 1, 1998.
97
<PAGE> 98
For the period September 1, 1998 (commencement of operations--Class C
shares) through December 31, 1998, it is estimated that the following amounts
were spent for distribution-related activities with respect to the Class C
shares of each Fund:*
<TABLE>
<CAPTION>
Printing and
Mailing
Prospectuses
Sales Material To Other than Compensation Compensation
and Current To Distribution To Sales
Advertising Shareholders Personnel Personnel
----------- ------------ --------- ---------
<S> <C> <C> <C> <C>
Capital Appreciation
Fund 522 543 3,119 2,422
Value Fund 5 39 175 83
Convertible Fund 0 1 2 1
High Yield Corp. Fund 2,442 6,199 21,135 14,359
Government Fund 18 25 231 138
Tax Free Bond Fund 0 6 10 5
Total Return Fund 111 155 691 532
California Tax Free Fund 0 0 0 0
New York Tax Free Fund 0 0 0 0
International Bond Fund 0 0 0 0
International Equity
Fund 3 3 22 16
Strategic Income Fund 23 (3) 101 89
Strategic Value Fund 26 20 215 140
Blue Chip Growth Fund 41 54 268 202
Research Value Fund 25 91 276 176
Small Cap Value Fund 56 98 387 277
Growth Opportunity Fund 0 0 0 0
Small Cap Growth Fund 0 (0) 1 1
Equity Income Fund 0 0 0 0
Global High Yield Fund 1 13 35 13
==============================================================================================================
Total 3,272 7,243 26,669 18,453
==============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Approximate Total
Amount Spent By
NYLife
Sales Distributors With
Distribution Respect to
Other Costs Each Fund
----- ----- ---------
<S> <C> <C> <C>
Capital Appreciation
Fund 5,153 13,899 25,658
Value Fund 182 782 1,267
Convertible Fund 2 10 16
High Yield Corp. Fund 30,285 96,263 170,683
Government Fund 310 942 1,664
Tax Free Bond Fund 10 50 83
Total Return Fund 1,125 3,107 5,722
California Tax Free Fund 0 0 0
New York Tax Free Fund 0 0 0
International Bond Fund 0 0 0
International Equity
Fund 36 94 174
Strategic Income Fund 192 425 826
Strategic Value Fund 304 953 1,658
Blue Chip Growth Fund 430 1,190 2,185
Research Value Fund 372 1,240 2,179
Small Cap Value Fund 576 1,831 3,224
Growth Opportunity Fund 0 0 0
Small Cap Growth Fund 1 3 6
Equity Income Fund 0 0 0
Global High Yield Fund 25 193 279
=======================================================================================
Total 39,004 120,982 215,622
=======================================================================================
</TABLE>
Total differences due to inherent Lotus rounding.
98
<PAGE> 99
OTHER SERVICES
Pursuant to an Accounting Agreement with the Trust, dated October 24,
1997, the Manager performs certain bookkeeping and pricing services for the
Funds. Each Fund will bear an allocable portion of the cost of providing these
services to the Trust.
For the fiscal year ended December 31, 1998 and the period from October
27, 1997 through December 31, 1997, the amount of recordkeeping fees paid to
the Manager by each Fund was as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998 10/27/97 - 12/31/97
--------------------- ----------------------
<S> <C> <C>
Blue Chip Growth Fund................ 8,769
California Tax Free Fund............. 8,531 N/A
Capital Appreciation Fund............ 275,485 41,466
Convertible Fund..................... 110,412 21,595
Equity Income Fund................... 7,133
Equity Index Fund.................... 61,548 N/A
Global High Yield Fund............... 7,000
Government Fund...................... 88,839 16,639
Growth Opportunities Fund............ 7,133
High Yield Corporate Bond
Fund............................. 395,788 68,994
International Bond Fund.............. 14,829 2,608
International Equity Fund............ 33,255 5,460
Money Market Fund.................... 74,315 12,407
New York Tax Free Fund............... 8,000 N/A
Research Value Fund.................. 7,133 --
Small Cap Growth Fund................ 7,280 --
Small Cap Value Fund................. 7,133 --
Strategic Income Fund................ 28,380 4,701
Strategic Value Fund................. 20,585 2,323
Tax Free Bond Fund................... 75,715 13,665
Total Return Fund.................... 169,320 28,016
Value Fund........................... 176,604 31,142
</TABLE>
For the period January 1, 1997 through October 26, 1997 and the fiscal
year ended December 31, 1996, the amount of recordkeeping fee paid to NYLIFE
Distributors, the previous Accounting Agent, by each Fund was as follows:
<TABLE>
<CAPTION>
PERIOD YEAR ENDED
1/1/97 - 10/26/97 DECEMBER 31,
----------------- ------------
1996
----
<S> <C> <C>
California Tax Free Fund............................................ $N/A $ N/A
Capital Appreciation Fund........................................... 164,868 145,721
Convertible Fund.................................................... 108,332 81,568
Equity Index Fund................................................... N/A N/A
Government Fund..................................................... 80,879 114,622
High Yield Corporate Bond Fund...................................... 270,515 233,333
International Bond Fund............................................. 11,358 12,511
International Equity Fund........................................... 24,683 22,075
</TABLE>
99
<PAGE> 100
<TABLE>
<S> <C> <C>
Money Market Fund................................................... 54,915 62,593
New York Tax Free Fund.............................................. N/A N/A
Strategic Income Fund +............................................. 13,624 N/A
Strategic Value Fund +.............................................. N/A N/A
Tax Free Bond Fund.................................................. 60,703 80,430
Total Return Fund................................................... 119,962 126,154
Value Fund.......................................................... 125,541 16,985
</TABLE>
----------------
+ The Strategic Income Fund commenced operations on February 28, 1997. The
Strategic Value Fund commenced operation on October 21, 1997.
In addition, each Fund may reimburse NYLIFE Securities, NYLIFE
Distributors and MainStay Shareholder Services for the cost of certain
correspondence to shareholders and the establishment of shareholder accounts.
EXPENSES BORNE BY THE TRUST
Except for the expenses to be paid by the Manager as described in the
Prospectus, the Trust, on behalf of each Fund, is responsible under its
Management Agreement for the payment of expenses related to each Fund's
operations, including (i) the fees payable to the Manager, (ii) the fees and
expenses of Trustees who are not affiliated with the Manager or Subadvisers,
(iii) certain fees and expenses of the Trust's Custodians and Transfer Agent,
(iv) the charges and expenses of the Trust's legal counsel and independent
accountants, (v) brokers' commissions and any issue or transfer taxes
chargeable to the Trust, on behalf of a Fund, in connection with its
securities transactions, (vi) the fees of any trade association of which a
Fund or the Trust is a member, (vii) the cost of share certificates
representing shares of a Fund, (viii) reimbursement of a portion of the
organization expenses of a Fund and the fees and expenses involved in
registering and maintaining registration of the Trust and of its shares with
the SEC and registering the Trust as a broker or dealer and qualifying its
shares under state securities laws, including the preparation and printing of
the Trust's registration statements and prospectuses for such purposes, (ix)
allocable communications expenses with respect to investor services and all
expenses of shareholders' and Trustees' meetings and preparing, printing and
mailing prospectuses and reports to shareholders, (x) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of a Fund's business, (xi) any expenses assumed by the Fund
pursuant to its plan of distribution, (xii) all taxes and business fees
payable by a Fund to federal, state or other governmental agencies, and (xiii)
costs associated with the pricing of the Funds' shares. Fees and expenses of
legal counsel, registering shares, holding meetings and communicating with
shareholders include an allocable portion of the cost of maintaining an
internal legal and compliance department.
Certain of the Funds have entered into a committed line of credit with
The Bank of New York as agent, and various other lenders from whom a Fund may
borrow up to 5% of its net assets in order to honor redemptions. The credit
facility is expected to be utilized in periods when the Funds experience
unusually large redemption requests. A mutual fund is considered to be using
leverage whenever it borrows an amount more than 5% of its assets. None of the
Funds intend to borrow for the purpose of purchasing securities using the
credit facility or any other source of borrowed funds.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected
by brokers, and the Funds pay a brokerage commission for this service. In
transactions on stock exchanges in the United States, these commissions are
negotiated, whereas on many foreign stock exchanges these commissions are
fixed. In the over-the-counter markets, securities (i.e., municipal bonds,
other debt securities and some equity securities) are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a
profit to the dealer. Transactions in certain over-the-counter securities also
may be effected on an agency basis, when the total price paid (including
commission) is equal to or better than the best total prices available from
other sources. In underwritten offerings, securities are usually purchased at
a fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On
occasion, certain money market instruments may be purchased directly from an
issuer, in which case no commissions or discounts are paid.
100
<PAGE> 101
Regarding the California Tax Free Fund and New York Tax Free Fund, newly
issued securities normally are purchased directly from the issuer or from an
underwriter acting as principal. Other purchases and sales usually are placed
with those dealers from which it appears that the best price or execution will
be obtained; those dealers may be acting as either agents or principals. The
purchase price paid by a Fund to underwriters of newly issued securities
usually includes a concession paid by the issuer to the underwriter, and
purchases of after-market securities from dealers normally are executed at a
price between the bid and asked prices.
The primary consideration in placing portfolio security transactions with
broker-dealers for execution is to obtain and maintain the availability of
execution at the most favorable prices and in the most effective manner
possible. The Subadviser attempts to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of the Fund and its
other clients on the basis of the broker-dealers' professional capability, the
value and quality of their brokerage services and the level of their brokerage
commissions. Consistent with the foregoing primary considerations, the Conduct
Rules of the NASD and such other policies as the Trustees may determine, the
Subadvisers may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' portfolio transactions.
NYLIFE Securities (the "Affiliated Broker") may act as broker for the
Funds. In order for the Affiliated Broker to effect any portfolio transactions
for the Funds on an exchange, the commissions, fees or other remuneration
received by the Affiliated Broker must be reasonable and fair compared to the
commissions, fees or other remuneration paid to other brokers in connection
with comparable transactions involving similar securities being purchased or
sold on an exchange during a comparable period of time. This standard would
allow the Affiliated Broker to receive no more than the remuneration which
would be expected to be received by an unaffiliated broker in a commensurate
arms-length transaction. The Funds will not deal with the Affiliated Broker in
any portfolio transaction in which the Affiliated Broker acts as principal.
Under each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Subadviser may cause a
Fund to pay a broker-dealer (except the Affiliated Broker) which provides
brokerage and research services to the Subadviser an amount of commission for
effecting a securities transaction for a Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Subadviser
determines in good faith that the greater commission is reasonable in relation
to the value of the brokerage and research services provided by the executing
broker-dealer viewed in terms of either a particular transaction or the
Subadviser's overall responsibilities to the Trust or to its other clients.
The term "brokerage and research services" includes advice as to the value of
securities, the advisability of investing in, purchasing, or selling
securities, and the availability of securities or of purchasers or sellers of
securities; furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and the
performance of accounts; and effecting securities transactions and performing
functions incidental thereto such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment of
the Subadvisers, be reasonable in relation to the value of the brokerage
services provided, commissions exceeding those which another broker might
charge may be paid to broker-dealers (except the Affiliated Broker) who were
selected to execute transactions on behalf of the Trust and the Subadvisers'
other clients in part for providing advice as to the availability of
securities or of purchasers or sellers of securities and services in effecting
securities transactions and performing functions incidental thereto such as
clearance and settlement.
Broker-dealers may be willing to furnish statistical, research and other
factual information or services ("Research") to the Subadvisers for no
consideration other than brokerage or underwriting commissions. Research
provided by brokers is used for the benefit of all of the Subadvisers' clients
and not solely or necessarily for the benefit of the Trust. The Subadvisers'
investment management personnel attempt to evaluate the quality of Research
provided by brokers. Results of this effort are sometimes used by the
Subadvisers as a consideration in the selection of brokers to execute
portfolio transactions.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of another Fund or one or more of the
other clients of the Subadvisers. Investment decisions for a Fund and for the
Subadvisers' other clients are made with a view to achieving their respective
investment objectives. It may develop that a particular security is bought or
sold for only one client even though it might be held by, or bought or sold
for, other clients. Likewise, a
101
<PAGE> 102
particular security may be bought for one or more clients when one or more
other clients are selling that same security. Some simultaneous transactions
are inevitable when several clients receive investment advice from the same
investment adviser, particularly when the same security is suitable for the
investment objectives of more than one client. When two or more clients are
simultaneously engaged in the purchase or sale of the same security, the
securities are allocated among clients in a manner believed to be equitable to
each. It is recognized that in some cases this system could have a detrimental
effect on the price or volume of the security in a particular transaction as
far as a Fund is concerned. The Trust believes that over time its ability to
participate in volume transactions will produce better executions for the
Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to the
Subadvisers will not be reduced as a consequence of the Subadvisers' receipt
of brokerage and research services. To the extent a Fund's portfolio
transactions are used to obtain such services, the brokerage commissions paid
by the Fund will exceed those that might otherwise be paid, by an amount which
cannot be clearly determined. Such services would be useful and of value to
the Subadvisers in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Subadvisers in carrying out their obligations to the
Funds.
For the fiscal years ended December 31, 1998, 1997 and 1996, each of the
following Funds paid brokerage commissions as follows:
<TABLE>
<CAPTION>
Total Brokerage Commissions Paid
--------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996
------------- ------------- -------------
<S> <C> <C> <C>
Blue Chip Growth Fund $ 52,673 $ $
Capital Appreciation Fund 1,418,340 1,349,716 $ 882,877
Convertible Fund 2,933,036 1,728,411 1,952,991
Equity Income Fund 40,578
Equity Index Fund 199,806 24,704 63,111
Global High Yield Fund --
Government Fund -- 1,719 20,809
Growth Opportunities Fund 28,756
High Yield Corporate Bond
Fund 1,730,356 1,297,005 1,187,150
International Equity Fund 230,372 239,373 215,696
Research Value Fund 27,977
Small Cap Growth Fund 43,448
Small Cap Value Fund 60,955
Strategic Income Fund+ 2,531 11,739 N/A
Strategic Value Fund+ 237,599 21,314 N/A
Total Return Fund 496,313 609,009 339,858
Value Fund 2,776,378 2,347,711 1,354,707
</TABLE>
<TABLE>
<CAPTION>
Total Brokerage Commissions
Paid to Affiliated Persons
--------------------------
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996
------------- ------------- -------------
<S> <C> <C> <C>
Blue Chip Growth Fund $ $ $
Capital Appreciation Fund $--- $ --- $ ---
Convertible Fund --- --- ---
Equity Income Fund
Equity Index Fund --- --- ---
Global High Yield Fund
Government Fund --- --- ---
Growth Opportunities Fund
High Yield Corporate Bond ---
Fund ---
International Equity Fund --- --- ---
Research Value Fund
Small Cap Growth Fund
Small Cap Value Fund
Strategic Income Fund+ --- --- N/A
Strategic Value Fund+ --- --- N/A
Total Return Fund --- --- ---
Value Fund --- ---
</TABLE>
102
<PAGE> 103
<TABLE>
<CAPTION>
TOTAL AMOUNT OF TRANSACTIONS
WHERE COMMISSIONS PAID
--------------------------------------------------------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
----------------------- ------------------- -----------------------
<S> <C> <C> <C>
Blue Chip Growth Fund $ 59,586,318
Capital Appreciation Fund 1,150,491,675 $987,618,526 $ 571,478,397
Convertible Fund 2,129,442,319 1,608,359,897 1,296,465,108
Equity Income Fund 60,556,859
Equity Index Fund 211,986,359 21,111,250 64,348,135
Government Fund --- 12,111,250 275,083,720
Growth Opportunities Fund 23,105,426
High Yield Corporate Bond
Fund 644,381,301 1,451,737,826 2,471,387,854
International Equity Fund 84,406,014 60,462,344 49,098,906
Research Value Fund 24,199,572
Small Cap Growth Fund 18,719,435
Small Cap Value Fund 26,176,292
Strategic Income Fund+ 1,122,044 41,537,454 N/A
Strategic Value Fund+ 147,090,662 12,723,841 N/A
Total Return Fund 403,031,223 459,057,404 271,187,968
Value Fund 2,147,864,794 1,523,756,743 848,170,710
</TABLE>
<TABLE>
<CAPTION>
TOTAL BROKERAGE
COMMISSIONS PAID
TO BROKERS THAT
PROVIDED RESEARCH
-----------------
YEAR ENDED
DECEMBER 31, 1998
-----------------
<S> <C>
Blue Chip Growth Fund
Capital Appreciation Fund $ ---
Convertible Fund 287,964
Equity Income Fund 995,049
Equity Index Fund 28,690
Government Fund 163,805
Growth Opportunities Fund ---
High Yield Corporate Bond
Fund 285,948
International Equity Fund 2,096
Research Value Fund 8,201
Small Cap Growth Fund 14,024
Small Cap Value Fund 28,638
Strategic Income Fund+ 300
Strategic Value Fund+ 124,871
Total Return Fund 130,137
Value Fund 693,561
</TABLE>
+ The Strategic Income Fund commenced operations on February 28, 1997 and the
Strategic Value Fund commenced operations on October 21, 1997.
The California Tax Free Fund, Global High Yield Fund, International Bond
Fund, Money Market Fund, New York Tax Free Fund and Tax Free Bond Fund paid no
brokerage commissions during the fiscal years ended December 31, 1998, 1997 and
1996.
For the fiscal years ended December 31, 1996, 1997 and 1998, The MAP -
Equity Fund (predecessor to the MAP Equity Fund) paid total brokerage
commissions of $48,782 in 1996 (on portfolio transactions amounting to
$52,030,342), of which approximately 41% was paid to brokers that provided
research; $61,779.48 in 1997 (on portfolio transactions amounting to
$84,698,287), of which approximately 24.3% was paid to brokers that provided
research; and $44,996.83 in 1998 (on portfolio transactions amounting to
$63,342,288), of which approximately 37.9% was paid to brokers that provided
research.
As of December 31, 1998, Blue Chip Growth Fund held common stock of Charles
Schwab Corp. valued at $716,391 and common stock of Merrill Lynch & Co, Inc.
valued at $480,600; Capital Appreciation Fund held commercial paper of Salomon
Smith Barney Holdings Inc. valued at $23,587,347 and commercial paper of
American Express Credit Corp., valued at $14,990,247; Convertible Fund held
preferred stock of Merrill Lynch & Co., Inc., 7.25%, valued at $16,680,550, and
6.25%, valued at $921,500; Equity Index Fund held common stock of American
Express Co. valued at $3,613,822, common stock of Bear Stearns Cos. Inc. valued
at $335,740, common stock of Lehman Brothers Holdings Inc. valued at $398,281,
common stock of Merrill Lynch & Co., Inc. valued at $1,850,977 and common stock
of Charles Schwab Corp. valued at $1,774,289; Government Fund held
collateralized mortgage obligations of Merrill Lynch Mortgage Investors, Inc.,
7.2778%, due 6/15/21, valued at $5,323,846; Morgan Stanley Capital I, 6.01%, due
11/15/30, valued at $2,911,156; DLJ Commercial Mortgage Corp., 6.24%, due
11/12/31, valued at $5,739,109; and Asset-Backed Securities of Morgan Stanley
Aircraft Finance, 5.7455%, due 3/15/23, valued at $8,087,534; Growth
Opportunities Fund held commercial paper of MetLife Funding Inc. valued at
$299,444. High Yield Corporate Bond Fund held commercial paper of American
Express Credit Corp. valued at $14,990,250; International Equity Fund held
common stock of Nomura Securities, Ltd. valued at $209,592; Money Market Fund
held commercial paper of American Express Credit Corp. valued at $11,911,878,
commercial paper of Goldman Sachs Group L.P. valued at $14,027,944, commercial
paper of Merrill
103
<PAGE> 104
Lynch & Co., Inc. valued at $13,929,079, commercial paper of Morgan Stanley,
Dean Witter, Discover & Co. valued at $20,368,422, commercial paper of
Prudential Finance (Jersey) Ltd. valued at $14,912,482, commercial paper of
Prudential Funding Corp. valued at $9,942,975, commercial paper of Salomon Smith
Barney Holdings Inc. valued at $18,973,495, medium-term notes of Goldman Sachs
Group L.P. 5.25%, due 3/26/99, valued at $7,500,000 and medium-term notes of
Merrill Lynch & Co., Inc. 5.20%, due 3/17/99, valued at $6,400,669; Small Cap
Growth Fund held commercial paper of American Express Credit Corp. valued at
$903,969; Strategic Income Fund held long-term bonds of Equitable Companies,
Inc., 7.00%, due 4/1/28, valued at $115,064, collateralized mortgage obligations
of Merrill Lynch Mortgage Investors, Inc. 7.2778% due 6/15/21, valued at
$158,476, collateralized mortgage obligations of Morgan Stanley Capital I,
6.01%, due 11/15/30, valued at $100,385, and DLJ Commercial Mortgage Corp.,
6.24%, due 11/12/31, valued at $183,488; and Total Return Fund held medium-term
notes of Sears Roebuck Acceptance Corp., 6.36%, due 12/4/01, valued at
$3,573,150, collateralized mortgage obligations of DLJ Commercial Mortgage
Corp., 6.24%, due 11/12/31, valued at $3,348,663, collateralized mortgage
obligations of Merrill Lynch Mortgage Investors, Inc., 7.2778%, due 6/15/21,
valued at $4,622,928, collateralized mortgage obligations of Morgan Stanley
Capital I, 6.01%, due 11/15/30, valued at $2,409,233, commercial paper of
American Express Credit Corp. valued at $4,914,395, commercial paper of Salomon
Smith Barney Inc., valued at $9,970,557, and asset-backed securities of Morgan
Stanley Aircraft Finance, 5.7455%, due 3/15/23, valued at $5,160,936.
A Fund's portfolio turnover rate is calculated by dividing the lesser of
sales or purchases of portfolio securities by the average monthly value of the
Fund's portfolio securities. For purposes of this calculation, portfolio
securities will exclude purchases and sales of debt securities having a maturity
at the date of purchase of one year or less.
The turnover rate for a Fund will vary from year-to-year and depending on
market conditions, turnover could be greater in periods of unusual market
movement and volatility. A higher turnover rate generally would result in
greater brokerage commissions, particularly in the case of equity oriented
Funds, or other transactional expenses which must be borne, directly or
indirectly, by the Fund and, ultimately, by the Fund's shareholders. High
portfolio turnover may also result in the realization of an increase in net
short-term capital gains by the Fund which, when distributed to non-tax exempt
shareholders, will be treated as dividends (ordinary income).
NET ASSET VALUE
The Trust determines the net asset value per share of each class of each
Fund on each day the New York Stock Exchange is open for trading. Net asset
value per share is calculated as of the close of the first session of the New
York Stock Exchange (currently 4:00 p.m., New York time) for each class of
shares of each Fund (except the Money Market Fund, which is determined at noon),
by dividing the current market value (amortized cost, in the case of the Money
market Fund) of the total assets attributable to that class, by the total number
of outstanding shares of that class.
Portfolio securities of the Money Market Fund are valued at their amortized
cost, which does not take into account unrealized securities gains or losses.
This method involves initially valuing on instrument at its cost and thereafter
assuming a constant amortization to maturity of any premium paid or discount
received. While this method provides certainty in valuation, it may result in
periods during which value, as determined by amortized cost, is higher or lower
than the price the Money Market Fund would receive if it sold the instrument.
During periods of declining interest rates, the quoted yield on shares of the
Money Market Fund may tend to be higher than a like computation made by a fund
with identical investments utilizing a method of valuation based upon market
prices and estimates of market prices for all of its portfolio instruments.
Thus, if the use of amortized cost by the Money Market Fund resulted in a lower
aggregate portfolio value on a particular day, a prospective investor in the
Money Market Fund would be able to obtain a somewhat higher yield if he or she
purchased shares of the Money Market Fund on that day, than would result from
investment in a fund utilizing solely market values, and existing investors in
the Money Market Fund would receive less investment income. The converse would
apply in a period of rising interest rates.
Portfolio securities of each of the other Funds are valued (a) by
appraising common and preferred stocks which are traded on the New York Stock
Exchange at the last sale price of the first session on that day or, if no sale
occurs, at the mean between the closing bid price and asked price; (b) by
appraising other common and preferred stocks as nearly as possible in the manner
described in clause (a) if traded on any other exchange, including the National
Association of Securities Dealers National Market System and foreign securities
exchanges; (c) by appraising over-the-counter common
104
<PAGE> 105
and preferred stocks quoted on the National Association of Securities Dealers
NASDAQ system (but not listed on the National Market System) at the closing bid
price supplied through such system; (d) by appraising over-the-counter common
and preferred stocks not quoted on the NASDAQ system and securities listed or
traded on certain foreign exchanges whose operations are similar to the U.S.
over-the-counter market at prices supplied by a pricing agent selected by a
Fund's Subadviser if the prices are deemed by the Subadviser to be
representative of market values at the close of the first session of the New
York Stock Exchange; (e) by appraising debt securities at prices supplied by a
pricing agent selected by the Subadviser, which prices reflect
broker-dealer-supplied valuations and electronic data processing techniques
and/or matrix pricing if those prices are deemed by a Fund's Subadviser to be
representative of market values at the close of the first session of the New
York Stock Exchange; (f) by appraising exchange-traded options and futures
contracts at the last posted settlement price on the market where any such
option or futures contract is principally traded; and (g) by appraising all
other securities and other assets, including over-the-counter common and
preferred stocks not quoted on the NASDAQ system, securities listed or traded on
foreign exchanges whose operations are similar to the U.S. over-the-counter
market and debt securities for which prices are supplied by a pricing agent but
are not deemed by a Fund's Subadviser to be representative of market values, but
excluding money market instruments with a remaining maturity of 60 days or less
and including restricted securities and securities for which no market quotation
is available, at fair value in accordance with procedures approved by and
determined in good faith by the Trustees, although the actual calculations may
be done by others. Money market instruments held by the Funds with a remaining
maturity of 60 days or less are valued by the amortized cost method unless such
method does not represent fair value. Forward foreign currency exchange
contracts held by the Funds are valued at their respective fair market values
determined on the basis of the mean between the last current bid and asked
prices based on dealer or exchange quotations.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is being determined at the close of the
exchange representing the principal market for such securities. The value of all
assets and liabilities expressed in foreign currencies will be converted into
U.S. dollar values at the mean between the buying and selling rates of such
currencies against U.S. dollars last quoted by any major bank or broker-dealer.
If such quotations are not available, the rate of exchange will be determined in
accordance with policies established by the Trustees. For financial accounting
purposes, the Trust recognizes dividend income and other distributions on the
ex-dividend date, except that certain dividends from foreign securities are
recognized as soon as the Trust is informed after the ex-dividend date.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of business
on each business day in New York (i.e., a day on which the New York Stock
Exchange is open for trading). In addition, European or Far Eastern securities
trading generally in a particular country or countries may not take place on all
business days in New York. Furthermore, trading takes place in Japanese markets
on certain Saturdays and in various foreign markets on days which are not
business days in New York and on which the Funds' net asset values are not
calculated. Such calculation of net asset value does not take place
contemporaneously with the determination of the prices of the majority of the
portfolio securities used in such calculation.
Events affecting the values of portfolio securities that occur between the
time their prices are determined and the close of the New York Stock Exchange
generally will not be reflected in the Funds' calculation of net asset values.
However, a Subadviser, in consultation with the Manager, may, in its judgement,
determine that an adjustment to a Fund's net asset value should be made because
intervening events have caused the Fund's net asset value to be materially
inaccurate.
Because the Guarantee regarding the Equity Index Fund is payable to
shareholders directly (and not payable to the Equity Index Fund), and because it
represents only a contingent liability of New York Life Inc. rather than an
agreement to pay a definite amount on the Guarantee Date, the Trustees believe
that the Guarantee should have no impact in determining
the Equity Index Fund's net asset value.
The proceeds received by each Fund for each issue or sale of its shares,
and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to such Fund and constitute the underlying assets of that Fund. The underlying
assets of each Fund will be segregated on the books of account, and will be
charged with the liabilities in respect to such Fund and with a share of the
general liabilities of the Trust. Expenses with respect to any two or more Funds
will be allocated in proportion to the net asset values of the respective Funds
except where allocations of direct expenses can otherwise be fairly made.
105
<PAGE> 106
To the extent that any newly organized fund or class of shares receives, on
or before December 31, any seed capital, the net asset value of such fund(s) or
class(es) will be calculated as of December 31.
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in the
Funds, under which a record of the shares of each Fund held is maintained by the
Transfer Agent. If a share certificate is desired, it must be requested in
writing for each transaction. There is no charge to the investor for issuance of
a certificate. Whenever a transaction takes place in a Fund (other than the
Money Market Fund), the shareholder will be mailed a confirmation showing the
transaction. Shareholders will be sent a quarterly statement showing the status
of the Account. In addition, shareholders will be sent a monthly statement for
each month in which a transaction occurs.
SHAREHOLDER SERVICING AGENT
The Funds may pay shareholder service fees, directly or indirectly to
various entities (shareholders service agents) that provide services to
shareholders. These may include broker-dealers, advisers, administrative service
forms, banks and other financial institutions. The Glass-Steagall Act prohibits
national banks from engaging in the business of underwriting, selling or
distributing securities. There is currently no precedent prohibiting banks from
performing shareholder servicing and recordkeeping functions. Changes in federal
or state statutes and regulations pertaining to the permissible activities of
banks and their affiliates or subsidiaries, as well as further judicial or
administrative decisions or interpretations of those provisions, could prevent a
bank from continuing to perform all or a part of such services. If a bank were
prohibited from so acting, the Trustees would consider what actions, if any,
would be necessary to continue to provide efficient and effective shareholder
services. It is not expected that shareholders would suffer any adverse
financial consequences as a result of any of these occurrences.
PURCHASE, REDEMPTION, EXCHANGES AND REPURCHASE
HOW TO PURCHASE SHARES OF THE FUNDS
GENERAL INFORMATION
The three classes of shares each represent an interest in the same
portfolio of investments of each Fund, have the same rights and are identical in
all respects, except that, to the extent applicable, each class bears its own
service and distribution expenses and may bear incremental transfer agency costs
resulting from such sales arrangement. Each class of each Fund has exclusive
voting rights with respect to provisions of the Rule 12b-1 plan for such class
of a Fund pursuant to which its distribution and service fees are paid, and each
class has similar exchange privileges. The net income attributable to Class B
and Class C shares and the dividends payable on Class B and Class C shares will
be reduced by the amount of the higher Rule 12b-1 fee and incremental expenses
associated with such class. Likewise, the NAV of the Class B and Class C shares
generally will be reduced by such class specific expenses (to the extent the
Fund has undistributed net income) and investment performance of Class B and
Class C shares will be less competitive than that of Class A shares. For
additional information on the features of Class A, Class B and Class C shares,
see "Alternative Sales Arrangements."
BY MAIL
Initial purchases of shares of the Funds should be made by mailing the
completed application form to the investor's Registered Representative. Shares
of any Fund, except the Money Market Fund, may be purchased at the NAV per share
plus any applicable sales charge next determined after receipt in good order of
the purchase order by that Fund plus any applicable sales charge. In the case of
the Money Market Fund (which seeks to maintain a constant net asset value of
$1.00 per share), the share purchase is effected as of the NAV next determined
after receipt in good order of the purchase order by MSS.
106
<PAGE> 107
BY TELEPHONE
For all Funds, other than the Money Market Fund, an investor may make an
initial investment by having his or her Registered Representative telephone MSS
between 8:00 AM and 6:00 PM, Eastern time, on any day the New York Stock
Exchange is open. The purchase will be effected at the NAV per share plus any
applicable sales charge next determined following receipt of the telephone order
as described above. An application and payment must be received in good order by
MSS within three business days. All telephone calls are recorded to protect
shareholders and MSS. For a description of certain limitations on the liability
of the Funds and MSS for transactions effected by telephone, see "Know How to
Sell and Exchange Shares."
BY WIRE
An investor may open an account and invest by wire by having his or her
Registered Representative telephone MSS between 8:00 AM and 6:00 PM, Eastern
time, to obtain an account number and instructions. For both initial and
subsequent investments, federal funds should be wired to:
State Street Bank and Trust Company
225 Franklin Street
Boston, Massachusetts 02110
ABA No.: 011 0000 28 Attn.: Custody and Shareholder Services
For Credit: MainStay________________Fund-Class______
Shareholder Account No.____________________________
Shareholder Registration ____________________________
DDA Account Number 99029415
An application must be received by MSS within three business days.
The investor's bank may charge the investor a fee for the wire.
To make a purchase effective the same day, the Registered Representative must
call MSS by 12:00 noon Eastern time, and federal funds must be received by the
Shareholder Servicing Agent before 4:00 PM Eastern time.
Wiring money to the Trust will reduce the time a shareholder must wait
before redeeming or exchanging shares because, when a shareholder purchases by
check or by ACH payment, the Trust may withhold payment for up to 10 days
from the date the check is received.
ADDITIONAL INVESTMENTS
Additional investments in a Fund may be made at any time by mailing a check
payable to The MainStay Funds, P.O. Box 8401, Boston, Massachusetts 02266-8401.
The shareholder's account number and the name of the Fund and class of shares
must be included with each investment. Purchases will be effected at the NAV per
share plus any applicable sales charge as described above.
SYSTEMATIC INVESTMENT PLANS
The Trust's officers may waive the initial and subsequent investment
minimums for certain purchases when they deem it appropriate, including, but
not limited to, purchases by certain qualified retirement plans, New York Life
employee and agent investment plans, investments resulting from distributions
by other New York Life products and NYLIFE Distributors products, and purchases
by certain individual participants.
Investors whose bank is a member of the Automated Clearing House ("ACH")
may purchase shares of a Fund through AutoInvest. AutoInvest facilitates
investments by using electronic debits, authorized by the shareholder, to a
checking or savings account, for share purchases. When the authorization is
accepted (usually within two weeks of receipt) a shareholder may purchase shares
by calling MSS, toll free at 1-800-MAINSTAY (between 8:00 AM and 4:00 PM,
Eastern time). The investment will be effected at the NAV per share next
determined after receipt in good order of the
107
<PAGE> 108
order, plus any applicable sales charge, and normally will be credited to the
shareholder's Fund account within two business days thereafter. Shareholders
whose bank is an ACH member also may use AutoInvest to automatically purchase
shares of a Fund on a scheduled basis by electronic debit for an account
designated by the shareholder on an application form. The initial investment
must be in accordance with the investment amounts previously mentioned.
Subsequent minimum investments are $50 monthly, $100 quarterly, $250
semiannually, or $500 annually. The investment day may be any day from the first
through the twenty-eighth of the respective month. Redemption proceeds from Fund
shares purchased by AutoInvest may not be paid until 10 days or more after the
purchase date. Fund shares may not be redeemed by AutoInvest.
OTHER INFORMATION
Investors may, subject to the approval of the Trust, the Distributor, the
Manager and the Subadviser to the particular Fund, purchase shares of a Fund
with liquid securities that are eligible for purchase by that Fund and that have
a value that is readily ascertainable. These transactions will be effected only
if the Subadviser intends to retain the security in the Fund as an investment.
The Trust reserves the right to amend or terminate this practice at any time. An
investor must call MAINSTAY at 1- 800-MAINSTAY before sending any securities.
An investor in certain qualified retirement plans may open an account with
a minimum investment of a lesser amount when permitted under such qualified
retirement plan. The Trust and the Distributor reserve the right to redeem
shares of any shareholder who has failed to provide the Trust with a certified
Taxpayer I.D. number or such other tax-related certifications as the Trust may
require. A notice of redemption, sent by first class mail to the shareholder's
address of record, will fix a date not less than 30 days after the mailing date,
and shares will be redeemed at the NAV determined as of the close of business on
that date unless a certified Taxpayer I.D. number (or such other information as
the Trust has requested) has been provided.
ALTERNATIVE SALES ARRANGEMENTS
INITIAL SALES CHARGE ALTERNATIVE CLASS A SHARES
The sales charge on Class A shares of the Funds is a variable percentage
of the public offering price depending upon the investment orientation of the
Fund and the amount of the sale.
The sales charge applicable to an investment in Class A shares of the Blue
Chip Growth Fund, Capital Appreciation Fund, Convertible Fund, Equity Income
Fund, Growth Opportunities Fund, International Equity Fund, MAP Equity Fund,
Research Value Fund, Small Cap Growth Fund, Small Cap Value Fund, Strategic
Value Fund, Total Return Fund and Value Fund will be determined according to
the following table:
<TABLE>
<CAPTION>
SALES CHARGE AS SALES CHARGE AS A PERCENTAGE OF OFFERING PRICE:
A PERCENTAGE OF:
NET RETAINED
AMOUNT OF OFFERING AMOUNT RETAINED BY THE
PURCHASE PRICE INVESTED BY DEALER DISTRIBUTOR
- -------- ----- -------- --------- -----------
<S> <C> <C> <C> <C>
Less than $50,000 5.50% 5.82% 4.75% 0.75%
$50,000 to $99,999 4.50% 4.71% 4.00% 0.50%
$100,000 to 3.50% 3.63% 3.00% 0.50%
$249,999
$250,000 to 2.50% 2.56% 2.00% 0.50%
$499,999
$500,000 to 2.00% 2.04% 1.75% 0.25%
$999,999
$1,000,000 or
more* None None See Below* None
</TABLE>
108
<PAGE> 109
The sales charge applicable to an investment in Class A shares of the
California Tax Free Fund, Global High Yield Fund, Government Fund, High Yield
Corporate Bond Fund, International Bond Fund, New York Tax Free Fund, Strategic
Income Fund and Tax Free Bond Fund will be determined according to the following
table:
<TABLE>
<CAPTION>
SALES CHARGE AS SALES CHARGE AS A PERCENTAGE OF OFFERING PRICE:
A PERCENTAGE OF:
NET RETAINED
AMOUNT OF OFFERING AMOUNT RETAINED BY THE
PURCHASE PRICE INVESTED BY DEALER DISTRIBUTOR
- -------- ----- -------- --------- -----------
<S> <C> <C> <C> <C>
Less than $100,000 4.50% 4.71% 4.00% 0.50%
$100,000 to 3.50% 3.63% 3.00% 0.50%
$249,999
$250,000 to 2.50% 2.56% 2.00% 0.50%
$499,999
$500,000 to 2.00% 2.04% 1.75% 0.25%
$999,999
$1,000,000 or
more* None None See Below* None
</TABLE>
The sales charge for Class A Shares of the Equity Index Fund will be
determined according to the following table:
<TABLE>
<CAPTION>
SALES CHARGE AS SALES CHARGE AS A PERCENTAGE OF OFFERING PRICE:
A PERCENTAGE OF:
NET RETAINED
AMOUNT OF OFFERING AMOUNT RETAINED BY THE
PURCHASE PRICE INVESTED BY DEALER DISTRIBUTOR
- -------- ----- -------- --------- -----------
<S> <C> <C> <C> <C>
Less than $100,000 3.00% 3.09% 2.75% 0.25%
$100,000 to 2.50% 2.56% 2.25% 0.25%
$249,999
$250,000 to 2.00% 2.04% 1.75% 0.25%
$499,999
$500,000 to 1.50% 1.52% 1.25% 0.25%
$999,999
$1,000,000 or
more* None None See Below* None
</TABLE>
- --------------
*No sales charge applies on investments of $1 million or more, but a contingent
deferred sales charge of 1% is imposed on certain redemptions of such shares
within one year of the date of purchase. See "Reduced Sales Charges on Class A
Shares -- Contingent Deferred Sales Charge, Class A."
Although an investor will not pay an initial sales charge on investments of
$1,000,000 or more, the Distributor may pay, from its own resources, a
commission to dealers on such investments. In such cases, the dealer will
receive a commission of 1.00% on the portion of a sale from $1,000,000 to
$2,999,999, 0.50% of any portion from $3,000,000 to $4,999,999 and 0.40% on any
portion of $5,000,000 or more. Effective, January 1, 1999, commissions will be
calculated on a calendar year basis. Such commission will be paid only on those
purchases that were not previously subject to a front-end sales charge and
dealer concession.
The Distributor may allow the full sales charge to be retained by dealers.
The amount retained may be changed from time to time. The Distributor, at its
expense, also may from time to time provide additional promotional incentives to
dealers who sell Fund shares. A selected dealer who receives a reallowance in
excess of 90% of such a sales charge may be deemed to be an "underwriter" under
the 1933 Act.
Set forth below is an example of the method of computing the offering price
of Class A shares of the Equity Index Fund. The example assumes a purchase
109
<PAGE> 110
of Class A shares of the Fund aggregating less than $100,000 subject to the
schedule of sales charges set forth above at a price based upon the net asset
value of Class A shares of the Fund on December 31, 1998.
Net Asset Value per Class A Share $39.47
at December 31, 1998
Per Share Sales Charge - 3.00%
of offering price (3.09% of net asset value per share)
$1.22
Class A Per Share Offering Price to the Public $40.69
The sales charge applicable to an investment in Class A shares of the California
Tax Free Fund, Global High Yield Fund, Government Fund, High Yield Corporate
Bond Fund, International Bond Fund, New York Tax Free Fund, Strategic Income
Fund and Tax Free Bond Fund will be 4.50% of the offering price per share (4.71%
of the net asset value per share). Set forth below is an example of the method
of commuting the offering price of the Class A shares of these Funds. The
example assumes a purchase of Class A shares of the California Tax Free Fund
aggregating less than $1,000,000 at a price based upon the net asset value of
Class A shares of the California Tax Free Fund on December 31, 1998. The
offering price of shares of each of the other listed Funds can be calculated
using the same method.
Net Asset Value per Class A Share at December 31, 1998 $9.98
Per Share Sales Charge - 4.50% of offering price (4.71% of net 0.47
asset value per share)
Class A Per Share Offering Price to the Public $10.45
The sales charge applicable to an investment in Class A shares of the Blue Chip
Growth Fund, Capital Appreciation Fund, Convertible Fund, Equity Income Fund,
Growth Opportunities Fund, International Equity Fund, MAP Equity Fund, Research
Value Fund, Small Cap Value Fund, Strategic Value Fund, Total Return Fund and
Value Fund will be 5.50% of the offering price per share (5.82% of net asset
value per share). Set forth below is an example of the method of computing the
offering price of the Class A shares of the Funds. The example assumes a
purchase of Class A shares of the Blue Chip Growth Fund aggregating less than
$1,000,000 at a price based upon the net asset value of Class A shares of the
Blue Chip Growth Fund on December 31, 1998. The offering price of the Class A
shares of each of the other listed Funds can be calculated using the same
method.
Net Asset Value per Class A Share at December 31, 1998 $11.64
Per Share Sales Charge - 5.50% of offering price (5.82% of net 0.68
asset value per share)
Class A Per Share Offering Price to the Public $12.32
PURCHASES AT NAV
A Fund's Class A shares may be purchased at NAV, without payment of any
sales charge, by its Trustees, New York Life and its subsidiaries and their
employees, officers, directors or agents (and immediate family members);
employees and clients (and immediate family members) of John A. Levin & Co.
("Levin") and Dalton, Greiner, Hartman, Maher & Co. ("DGHM"); employees (and
immediate family members) of Gabelli Asset Management Company and Markston
Investment Management LLC; and investors who are recommended by Levin or DGHM
to invest in the MainStay funds managed by Levin or DGHM, respectively. Also,
any employee or Registered Representative of an authorized broker-dealer (and
immediate family members) may purchase a Fund's shares at NAV without payment
of any sales charge.
110
<PAGE> 111
In addition, the Trust will treat Class A share purchases of Funds, other
than the Money Market Fund, in an amount less than $1,000,000 by defined
contribution plans, other than 403(b) plans, that are sponsored by employers
with 50 or more employees as if such purchases were equal to an amount more than
$1,000,000 but less than $2,999,999. Such purchases by defined contribution
plans may be subject to a contingent deferred sales charge of 1% on shares
redeemed within one year of the date of purchase. See "Reduced Sales Charges on
Class A Shares-Contingent Deferred Sales Charge, Class A."
Class A shares of the Funds also may be purchased at net asset value,
without payment of any sales charge, through broker-dealers, investment advisers
and other financial institutions which have entered into a supplemental
agreement with the Distributor which (i) includes a requirement that such shares
be sold for the benefit of clients participating in a "wrap account" or similar
program under which clients pay a fee to the broker-dealer, investment adviser
or other financial institution or (ii) provides for certain employee benefit
plans to be made available to their clients.
REDUCED SALES CHARGES ON CLASS A SHARES
The sales charge varies with the size of the purchase and reduced charges
apply to the aggregate of purchases of a Fund made at one time by any "Qualified
Purchaser," which term includes (i) an individual and his/her spouse and their
children under the age of 21; and (ii) any other organized group of persons,
whether incorporated or not, which is itself a shareholder of the Fund,
including group retirement and benefit plans (other than IRAs and non-Erisa
403(b) plans) whether incorporated or not, provided the organization has been in
existence for at least six months and has some purpose other than the purchase
at a discount of redeemable securities of a registered investment company.
LETTER OF INTENT ("LOI")
Qualified Purchasers may obtain reduced sales charges by signing an LOI.
The LOI is a nonbinding obligation on the Qualified Purchaser to purchase the
full amount indicated in the LOI. The sales charge is based on the total amount
invested during a 24-month period. A 90-day back-dated period can be used to
include earlier purchases; the 24-month period would then begin on the date of
the first purchase during the 90-day period. For more information, call your
Registered Representative or MainStay at 1-800-MAINSTAY.
On the initial purchase, if required (or, on subsequent purchases if
necessary), 5% of the dollar amount specified in the LOI will be held in escrow
by the Transfer Agent in shares registered in the shareholder's name in order to
assure payment of the proper sales charge. If total purchases pursuant to the
LOI (less any dispositions and exclusive of any distribution on such shares
automatically reinvested) are less than the amount specified, the investor will
be requested to remit to the Distributor an amount equal to the difference
between the sales charge paid and the sales charge applicable to the aggregate
purchases actually made. If not remitted within 20 days after written request,
an appropriate number of escrowed shares will be redeemed in order to realize
the difference.
CONTINGENT DEFERRED SALES CHARGE, CLASS A
In order to recover commissions paid to dealers on qualified investments of
$1 million or more, a contingent deferred sales charge of 1% may be imposed on
redemptions of such investments made within one year of the date of
purchase.
Class A shares that are redeemed will not be subject to a contingent
deferred sales charge, however, to the extent that the value of such shares
represents: (1) capital appreciation of Fund assets; (2) reinvestment of
dividends or capital gains distributions; (3) Class A shares redeemed more than
one year after their purchase; (4) withdrawals from qualified retirement plans
and nonqualified deferred compensation plans resulting from separation of
service, loans, hardship withdrawals, death, disability, QDROs and excess
contributions pursuant to applicable IRS rules; and Required Minimum
Distributions at age 70 1/2 for IRA and 403(b)(7) TSA participants; (5)
transfers within a retirement plan where the proceeds of the redemption are
invested in any guaranteed investment contract written by New York Life or any
of its affiliates; transfers to products offered within a retirement plan which
uses New York Life Benefit Services, Inc. or TRAC- 2000 as the recordkeeper; as
well as participant transfers or rollovers from a retirement plan to a MainStay
IRA; or (6) redemptions, under the Systematic Withdrawal Plan, used to pay
scheduled monthly premiums on insurance policies issued
111
<PAGE> 112
by New York Life or an affiliate. Class A shares of a Fund that are purchased
without a front-end sales charge may be exchanged for Class A shares of another
Fund without the imposition of a contingent deferred sales charge, although,
upon redemption, contingent deferred sales charges may apply to the Class A
shares that were acquired through an exchange.
The contingent deferred sales charge will be applicable to amounts
invested pursuant to a right of accumulation or an LOI to the extent that (a) a
front-end sales charge was not paid at the time of the purchase and (b) any
shares so purchased are redeemed within one year of the date of purchase.
For federal income tax purposes, the amount of the contingent deferred
sales charge generally will reduce the gain or increase the loss, as the case
may be, recognized upon redemption.
CONTINGENT DEFERRED SALES CHARGE CLASS B SHARES
A contingent deferred sales charge will be imposed on redemptions of Class
B shares of the Funds, in accordance with the table below, at the time of any
redemption by a shareholder which reduces the current value of the shareholder's
Class B account in any Fund to an amount which is lower than the amount of all
payments by the shareholder for the purchase of Class B shares in that Fund
during the preceding six years. However, no such charge will be imposed to the
extent that the aggregate net asset value of the Class B shares redeemed does
not exceed (a) the current aggregate net asset value of Class B shares of that
Fund purchased more than six years prior to the redemption, plus (b) the current
aggregate net asset value of Class B shares of that Fund purchased through
reinvestment of dividends or distributions, plus (c) increases in the net asset
value of the investor's Class B shares of that Fund above the total amount of
payments for the purchase of Class B shares of that Fund made during the
preceding six years.
Proceeds from the contingent deferred sales charge are paid to, and are
used in whole or in part by, the Distributor to defray its expenses of providing
distribution related services to the Funds in connection with the sale of the
Class B shares, such as the payment of compensation to selected dealers and
agents. The combination of the contingent deferred sales charge and the
distribution fee facilitates the ability of the Fund to sell the Class B shares
without a sales charge being deducted at the time of purchase.
The amount of the contingent deferred sales charge, if any, paid by a
redeeming shareholder will vary depending on the number of years from the time
of payment for the purchase of Class B shares of any Fund (other than the Money
Market Fund) until the time of redemption of such shares. Solely for purposes of
determining the number of years from the time of payment for the purchase of
shares, all payments during a month will be 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 as a Percentage
Year Since Purchase of Amount Redeemed
Payment Made Subject to the Charge
- ----------------------------------------------------------------------------------------------------
<S> <C>
First 5.0%
Second 4.0%
Third 3.0%
Fourth 2.0%
Fifth 2.0%
Sixth 1.0%
Thereafter None
</TABLE>
In determining the rate of any applicable contingent deferred sales charge,
it will be assumed that a redemption is made of shares held by the shareholder
for the longest period of time. This will result in any such charge being
imposed at the
112
<PAGE> 113
lowest possible rate. For federal income tax purposes, the amount of the
contingent deferred sales charge generally will reduce the gain or increase the
loss, as the case may be, recognized on the redemption or repurchase of shares.
The contingent deferred sales charge will be waived in connection with the
following redemptions: (i) withdrawals from qualified retirement plans and
nonqualified deferred compensation plans resulting from separation of service,
loans, hardship withdrawals, QDROs and excess contributions pursuant to
applicable IRS rules; and Required Minimum Distributions at age 70 1/2 for IRA
and 403(b) TSA participants; (ii) withdrawals related to the termination of a
retirement plan where no successor plan has been established; (iii) transfers
within a retirement plan where the proceeds of the redemption are invested in
any guaranteed investment contract written by New York Life or any of its
affiliates, transfers to products offered within a retirement plan which uses
New York Life Benefit Services, Inc. as the recordkeeper; as well as participant
transfers or rollovers from a retirement plan to a MainStay IRA; (iv) required
distributions by charitable trusts under Section 664 of the Code; (v)
redemptions following the death of the shareholder or the beneficiary of a
living revocable trust or within one year following the disability of a
shareholder occurring subsequent to the purchase of shares; (vi) redemptions
under the Systematic Withdrawal Plan used to pay scheduled monthly premiums on
insurance policies issued by New York Life or an affiliate; (vii) continuing,
periodic monthly or quarterly withdrawals, under the Systematic Withdrawal Plan,
up to an annual total of 10% of the value of a shareholder's Class B shares in a
Fund; (viii) redemptions by New York Life or any of its affiliates or by
accounts managed by New York Life or any of its affiliates; (ix) redemptions
effected by registered investment companies by virtue of transactions with a
Fund; and (x) redemptions by shareholders of shares purchased with the proceeds
of a settlement payment made in connection with the liquidation and dissolution
of a limited partnership sponsored by New York Life or one of its affiliates.
The contingent deferred sales charge is waived on such sales or redemptions to
promote goodwill and because the sales effort, if any, involved in making such
sales is negligible.
ADDITIONAL CDSC WAIVERS APPLICABLE TO ACCOUNTS ESTABLISHED BEFORE
JANUARY 1, 1998. In addition to the categories outlined above, the CDSC will be
waived in connection with the following redemptions of Class B shares by
accounts established before January 1, 1998: (i) withdrawals from IRS qualified
and nonqualified retirement plans, individual retirement accounts, tax sheltered
accounts, and deferred compensation plans, where such withdrawals are permitted
under the terms of the plan or account (e.g., attainment of age 59 1/2,
separation from service, death, disability, loans, hardships, withdrawals of
excess contributions pursuant to applicable IRS rules, withdrawals based on life
expectancy under applicable IRS rules); (ii) preretirement transfers or
rollovers within a retirement plan where the proceeds of the redemption are
invested in proprietary products offered or distributed by New York Life or its
affiliates; (iii) living revocable trusts on the death of the beneficiary; (iv)
redemptions made within one year following the death or disability or a
shareholder; (v) redemptions by directors, Trustees, officers and employees (and
immediate family members) of the Trust and of New York Life and its affiliates
where no commissions have been paid; (vi) redemptions by employees of any dealer
which has a soliciting dealer agreement with the Distributor, and by any trust,
pension, profit-sharing or benefit plan for the benefit of such persons where no
commissions have been paid; (vii) redemptions by tax-exempt employee benefit
plans resulting from the adoption or promulgation of any law or regulation;
(viii) redemptions by any state, country or city, or any instrumentality,
department, authority or agency thereof and by trust companies and bank trust
departments; and (ix) transfers to (a) other funding vehicles sponsored or
distributed by New York Life or an affiliated company, or (b) guaranteed
investment contracts, regardless of the sponsor, within a retirement plan.
Shareholders should notify MainStay Shareholder Services, the Funds'
transfer agent, at the time of requesting such redemptions that they are
eligible for a waiver of the contingent deferred sales charge. Class B shares
upon which the contingent deferred sales charge may be waived may not be resold,
except to the Trust. Shareholders who are making withdrawals from retirement
plans and accounts or other tax-sheltered or tax-deferred accounts should
consult their tax advisers regarding the tax consequences of such withdrawals.
CONTINGENT DEFERRED SALES CHARGE, CLASS C
A contingent deferred sales charge of 1% of the net asset value of Class C
shares will be imposed on redemptions of Class C shares of the Funds at the time
of any redemption by a shareholder which reduces the current value of the
shareholder's Class C account in any Fund to an amount which is lower than the
amount of all payments by the shareholder for the purchase of Class C shares in
that Fund during the preceding one year. However, no such charge will be imposed
to the extent that the net asset value of the Class C shares redeemed does not
exceed (a) the current aggregate net asset value
113
<PAGE> 114
of Class C shares of that Fund purchased more than one year prior to the
redemption, plus (b) the current aggregate net asset value of Class C shares of
that Fund purchased through reinvestment of dividends, or distributions, plus
(c) increases in the net asset value of the investor's Class C shares of that
Fund above the total amount of payments for the purchase of Class C shares of
that Fund made during the preceding one year.
Proceeds from the contingent deferred sales charge are paid to, and are
used in whole or in part by, the Distributor to defray its expenses related to
providing distribution related services to the Funds in connection with the sale
of the Class C shares, such as the payment of compensation to selected dealers
and agents. The combination of the contingent deferred sales charge and the
distribution fee facilitates the ability of the Fund to sell the Class C shares
without a sales charge being deducted at the time of purchase.
REDEMPTIONS AND EXCHANGES
Shares may be redeemed directly from a Fund or through your Registered
Representative. Shares redeemed will be valued at the NAV per share next
determined after MSS receives the redemption request in "good order." "Good
order" with respect to a redemption request generally means that for
certificated shares, a stock power or certificate must be endorsed, and for
uncertificated shares a letter must be signed, by the record owner(s) exactly as
the shares are registered and the signature(s) must be guaranteed by an eligible
guarantor institution. In cases where redemption is requested by a corporation,
partnership, trust, fiduciary or any other person other than the record owner,
written evidence of authority acceptable to MSS must be submitted before the
redemption request will be accepted. The signature guarantee may be waived on a
redemption of $100,000 or less which is payable to the shareholder(s) of record
and mailed to the address of record, or under such other circumstances as the
Trust may allow. Send your written request to The MainStay Funds, P.O. Box 8401,
Boston, MA 02266-8401.
Upon the redemption of shares the redeeming Fund will make payment in cash,
except as described below, of the net asset value of the shares next determined
after such redemption request was received, less any applicable contingent
deferred sales charge. There will be no redemption, however, during any period
in which the right of redemption is suspended or date of payment is postponed
because the New York Stock Exchange is closed or trading on such Exchange is
restricted or the SEC deems an emergency to exist.
The value of the shares redeemed from a Fund may be more or less than the
shareholder's cost, depending on portfolio performance during the period the
shareholder owned the shares.
REDEMPTION BY CHECK
The Money Market Fund and State Street Bank and Trust Company (the "Bank")
each reserve the right at any time to suspend the procedure permitting
redemption by check and intend to do so in the event that federal legislation or
regulations impose reserve requirements or other restrictions deemed by the
Trustees to be adverse to the interest of other shareholders of the Money Market
Fund. Shareholders who arrange to have checkwriting privileges will be subject
to the rules and regulations of the Bank pertaining to this checkwriting
privilege as amended from time to time. The applicable rules and regulations
will be made available by the Bank upon request when a shareholder establishes
checkwriting privileges.
SYSTEMATIC WITHDRAWAL PLAN
Dividends and capital gains distributions on shares held under the
Systematic Withdrawal Plan are reinvested in additional full and fractional
shares of the same Fund at NAV. MSS acts as agent for the shareholder in
redeeming sufficient full and fractional shares to provide the amount of the
systematic withdrawal payment and any contingent deferred sales charge, if
applicable.
DISTRIBUTIONS IN KIND
The Trust has agreed to redeem shares of each Fund 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. The Trust reserves the right to pay other
redemptions,
114
<PAGE> 115
either total or partial, by a distribution in kind of securities (instead of
cash) from the applicable Fund's portfolio. The securities distributed in such
a distribution would be valued at the same value as that assigned to them in
calculating the NAV of the shares being redeemed. If a shareholder receives a
distribution in kind, he or she should expect to incur transaction costs when
he or she converts the securities to cash.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of any Fund and may
postpone payment for any period: (i) during which the New York Stock Exchange is
closed other than customary weekend and holiday closings or during which trading
on the New York Stock Exchange is restricted; (ii) when the SEC determines that
a state of emergency exists which may make payment or transfer not reasonably
practicable; (iii) as the SEC may by order permit for the protection of the
security holders of the Trust; or (iv) at any other time when the Trust may,
under applicable laws and regulations, suspend payment on the redemption or
repurchase of its shares.
EXCHANGE PRIVILEGES
Exchanges will be based upon each Fund's NAV per share next computed
following receipt of a properly executed exchange request.
Subject to the conditions and limitations described herein, Class A, Class
B and Class C shares of a Fund may be exchanged for shares of an identical class
of a MainStay Fund registered in the state of residence of the investor or where
an exemption from registration is available and only with respect to Funds that
are available for sale to new investors.
In addition, an exchange privilege between Class A shares of the Funds and
MainStay Equity Index Fund is offered. Any exchanges between a Fund and MainStay
Equity Index Fund will be subject to the conditions applicable to Class A share
exchanges described herein, as well as any applicable minimum investment
requirements. No exchange privilege between Class B or Class C shares of the
Funds and MainStay Equity Index Fund is offered.
INVESTORS SHOULD READ THE PROSPECTUS CAREFULLY BEFORE THEY PLACE AN
EXCHANGE REQUEST.
Generally, shareholders may exchange their Class A shares of a Fund for
Class A shares of another MainStay Fund, without the imposition of a sales
charge. Any such exchanges will be based upon each Fund's NAV per share next
computed following receipt of a properly executed exchange request. However,
where a shareholder seeks to exchange Class A shares of the Money Market Fund
for Class A shares of another MainStay Fund which are subject to a front-end
sales charge, the applicable sales charge will be imposed on the exchange,
unless the shareholder has previously paid a sales charge with respect to such
shares.
Class B and Class C shares of a Fund may be exchanged for the same class of
shares of another MainStay Fund at the NAV next computed following receipt of a
properly executed exchange request, without the payment of a contingent deferred
sales charge; the sales charge will be assessed, if applicable, when the
shareholder redeems his or her shares without a corresponding purchase of shares
of another MainStay Fund. However, where a shareholder previously exchanged his
or her Class B or Class C shares into the Money Market Fund from another
MainStay Fund, the applicable contingent deferred sales charge will be assessed
when the shares are redeemed from the Money Market Fund even though the Money
Market Fund does not otherwise assess a contingent deferred sales charge on
redemptions. Class B and Class C shares of a Fund acquired as a result of
subsequent investments, except reinvested dividends and distributions, will be
subject to the contingent deferred sales charge when ultimately redeemed or
repurchased without purchasing shares of another MainStay Fund.
Exchanges may only be made with respect to Funds registered in the state of
residence of the investor or where an exemption from registration is available
and only with respect to Funds that are available for sale to new investors. An
exchange may be made by either writing to MSS at the following address: The
MainStay Funds, P.O. Box 8401, Boston, Massachusetts 02266-8401, or by calling
MSS at 1-800-MAINSTAY (8:00 AM to 6:00 PM Eastern time).
115
<PAGE> 116
In times when the volume of telephone exchanges is heavy, additional phone
lines will be added by MSS. However, in times of very large economic or market
changes, the telephone exchange privilege may be difficult to implement. When
calling MSS to make a telephone exchange, shareholders should have available
their account number and Social Security or Taxpayer I.D. numbers. Under the
telephone exchange privilege, shares may only be exchanged among accounts with
identical names, addresses and Social Security or Taxpayer I.D. numbers. Shares
may be transferred among accounts with different names, addresses and Social
Security or Taxpayer I.D. numbers only if the exchange request is in writing and
is received in "good order." If the dealer permits, the dealer representative of
record may initiate telephone exchanges on behalf of a shareholder, unless the
shareholder notifies the Fund in writing not to permit such exchanges.
It is the policy of The MainStay Funds to discourage frequent trading by
shareholders among the Funds in response to market fluctuations. Accordingly, in
order to maintain a stable asset base in each Fund and to reduce administrative
expenses borne by each Fund, except for systematic exchanges, exchanges
processed via MainStay's automated system and as to certain accounts for which
tracking data is not available, after five exchanges per calendar year, a $10
fee will be imposed on each trade date on which a shareholder makes an exchange
and additional exchange requests may be denied.
For purposes of determining the length of time a shareholder owned Class B
or Class C shares prior to redemption or repurchase in order to determine the
applicable contingent deferred sales charge, if any, shares will be deemed to
have been held from the date of purchase of the shares, regardless of exchanges
into other Funds. For federal income tax purposes, an exchange is treated as a
sale on which an investor may realize a gain or loss. See "Understand the Tax
Consequences" for information concerning the federal income tax treatment of a
disposition of shares. All exchanges are subject to the minimum investment
requirements of the Funds involved. The exchange privilege may be modified or
withdrawn at any time upon prior notice.
DISTRIBUTIONS AND REDEMPTIONS FOR EQUITY INDEX FUND
For the Equity Index Fund, Distributions will be paid in additional shares
based on the NAV at the close of business on the payment date of the
distribution, unless the shareholder elects to receive such distributions in
cash. Receipt of dividends in cash by a shareholder will have the effect of
reducing the number of Guaranteed Shares held by that shareholder, and,
therefore, the value of the Guarantee to that shareholder. If, however, the Fund
pays a dividend in cash to all shareholders for the purpose of assuring the
Fund's compliance with applicable provisions of the Code, any such amounts paid
in cash will reduce the Guaranteed Amount applicable to each Guaranteed Share in
the amount of the dividend paid.
For shareholder convenience in monitor the number and value of a
shareholder's Guaranteed Shares, the Fund currently intends, through reverse
share splits, to combine any additional shares received by a shareholder as
dividends and distributions from the Fund with each originally purchased share
of the Fund to which such dividends and distributions relate, so that a
Guaranteed Share of the Fund will mean a single share of the Fund as purchased
and include in its NAV the value of all dividends and distributions attributable
to such originally purchased share and paid up to that point in time. Following
a reverse share split, a shareholder who has elected to reinvest dividends and
distributions from the Fund will hold the same number of Guaranteed Shares in
the Fund as the shareholder held prior to the reverse share split, but each
share will have a higher NAV (reflecting the added value of the dividends paid).
Shareholders who elect to receive their dividends and distributions from the
Fund in cash will, following a reverse share split, own fewer Guaranteed Shares
of the Fund, but those shares will have the same higher per share NAV as all
other Fund shares. IN EITHER CASE, THE OVERALL VALUE OF A SHAREHOLDER'S
INVESTMENT IN THE FUND WILL BE UNAFFECTED BY A REVERSE SHARE SPLIT. If reverse
share splits are not authorized, a Guaranteed Share shall mean, on a given date,
that number of shares of the Fund that a shareholder would hold on that date if
he had bought a single share and then held it, plus all shares issued as
dividends and distributions attributable to such share through the Guarantee
Date. This single share and all other shares issued through the reinvestment of
any dividends and distributions attributable to such share will be treated as a
single unit to which the Guaranteed Amount will apply as described above for a
Guaranteed Share. Shareholders who elect to receive dividends and distributions
in cash would hold fewer shares of the Fund and, consequently, fewer units as to
which the Guaranteed Amount would apply. Equity Index Fund shares may be
redeemed by shareholders prior to their Guaranteed Date. However, any such
redeemed shares will lose the benefit of the Guarantee.
116
<PAGE> 117
Within seven days after acceptance of a redemption request, the Equity
Index Fund is required to make payment of the NAV of the shares on the date the
order was received in proper form, except that where a request is made at least
30 days prior to a dividend or distribution record date to redeem the dividend
shares immediately upon issuance (to effectively receive the dividend in cash),
redemption and payment will occur at that time.
TAX-DEFERRED RETIREMENT PLANS
CASH OR DEFERRED PROFIT SHARING PLANS UNDER SECTION 401(K) FOR CORPORATIONS AND
SELF-EMPLOYED INDIVIDUALS
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased as an investment under a
specimen cash or deferred profit sharing plan intended to qualify under Section
401(k) of the Code (a "401(k) Plan") adopted by a corporation, a self-employed
individual (including sole proprietors and partnerships), or other organization.
All Funds, except the California Tax Free Fund, New York Tax Free Fund and Tax
Free Bond Fund, may be used as funding vehicles for qualified retirement plans
including 401(k) plans, which may be administered by third-party administrator
organizations. NYLIFE Distributors does not sponsor or administer such qualified
plans at this time.
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased as an underlying investment
for an IRA made available by NYLIFE Distributors. Three types of IRAs are
available -- a traditional IRA, the Roth IRA and the Education IRA.
An individual may contribute as much as $2,000 of his or her earned income
to a traditional IRA. A married individual filing a joint return may also
contribute to a traditional IRA for a nonworking spouse. The maximum deduction
allowed for a contribution to a spousal IRA is the lesser of (i) $2,000 or (ii)
the sum of (a) the compensation includible in the working spouse's gross income
plus (b) any compensation includible in the gross income of the nonworking
spouse, reduced by the amount of the deduction taken by the working spouse. The
maximum deduction for an IRA contribution by a married couple is $4,000.
An individual who has not attained age 70-1/2 may make a contribution to a
traditional IRA which is deductible for federal income tax purposes. For the
1999 tax year, a contribution is deductible only if the individual (and his or
her spouse, if applicable) has an adjusted gross income below a certain level
($51,000 for married individuals filing a joint return, with a phase-out of the
deduction for adjusted gross income between $51,000 and $61,000; $31,000 for a
single individual, with a phase-out for adjusted gross income between $31,000
and $41,000). These phase-out limits will gradually increase, eventually
reaching $50,000 - $60,000 for single filers in 2005 and thereafter (and
reaching $80,000 - $100,000 if married filing jointly in 2007 and thereafter).
In addition, a married individual may make a deductible IRA contribution even
though the individual's spouse is an active participant in a qualified
employer's retirement plan, subject to a phase-out for adjusted gross income
between $150,000 - $160,000 ($0-$10,000 for non-participant spouses filing a
separate return). However, an individual not permitted to make a deductible
contribution to an IRA may nonetheless make nondeductible contributions up to
the maximum contribution limit for that year. The deductibility of IRA
contributions under state law varies from state to state.
Distributions from IRAs (to the extent they are not treated as a tax-free
return of nondeductible contributions) are taxable under federal income tax laws
as ordinary income. There are special rules for determining how withdrawals are
to be taxed if an IRA contains both deductible and nondeductible amounts. In
general, all traditional IRAs are aggregated and treated as one IRA, all
withdrawals are treated as one withdrawal, and then a proportionate amount of
the withdrawal will be deemed to be made from nondeductible contributions;
amounts treated as a return of nondeductible contributions will not be taxable.
Certain early withdrawals are subject to an additional penalty tax. However,
there are exceptions for certain withdrawals, including: withdrawals up to a
total of $10,000 for qualified first-time homebuyer expenses or withdrawals used
to pay "qualified higher education expenses" of the taxpayer or his or her
spouse, child or grandchild. There are also special rules governing when IRA
distributions must begin and the minimum amount of such distributions; failure
to comply with these rules can result in the imposition of an excise tax.
117
<PAGE> 118
Roth IRAs. Roth IRAs are a form of individual retirement account which
feature nondeductible contributions that may be made even after the individual
attains the age of 70-1/2. In certain cases, distributions from a Roth IRA may
be tax free. The Roth IRA, like the traditional IRA, is subject to a $2,000
($4,000 for a married couple) contribution limit (taking into account both Roth
IRA and traditional IRA contributions). The maximum contribution that can be
made is phased-out for taxpayers with adjusted gross income between $95,000 and
$110,000 ($150,000 - $160,000 if married filing jointly). If the Roth IRA has
been in effect for five years, and distributions are (1) made on or after the
individual attains the age of 59-1/2; (2) made after the individual's death; (3)
attributable to disability; or (4) used for "qualified first-time home buyer
expenses," they are not taxable. If these requirements are not met,
distributions are treated first as a return of contributions and then as taxable
earnings. Taxable distributions may be subject to the same excise tax described
above with respect to traditional IRAs. All Roth IRAs, like traditional IRAs,
are treated as one IRA for this purpose. Unlike the traditional IRA, Roth IRAs
are not subject to minimum distribution requirements during the account owner's
lifetime. However, the amount in a Roth IRA is subject to required distribution
rules after the death of the account owner.
Education IRAs. A taxpayer may make non-deductible contributions of up to
$500 per year per beneficiary to an Education IRA. Contributions cannot be made
after the beneficiary becomes 18 years old. The maximum contribution is phased
out for taxpayers with adjusted gross income between $95,000 and $110,000
($150,000 - $160,000 if married filing jointly). Earnings are tax-deferred until
a distribution is made. If a distribution does not exceed the beneficiary's
"qualified higher education expenses" for the year, no part of the distribution
is taxable. If part of a distribution is taxable, a penalty tax will generally
apply as well. Any balance remaining in an Education IRA when the beneficiary
becomes 30 years old must be distributed and any earnings will be taxable and
subject to a penalty tax upon distribution.
All income and capital gains deriving from IRA investments in the Fund are
reinvested and compounded tax-deferred until distributed from the IRA. The
combination of annual contributions to a traditional IRA, which may be
deductible, and tax-deferred compounding can lead to substantial retirement
savings. Similarly, the combination of tax free distributions from a Roth IRA or
Education IRA combined with tax-deferred compounded earnings on IRA investments
can lead to substantial retirement and/or education savings.
403(b)(7) TAX SHELTERED ACCOUNT
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased as the underlying investment
for tax sheltered custodial accounts (403(b)(7) TSA plans) made available by
NYLIFE Distributors. In general, employees of tax-exempt organizations described
in Section 501(c)(3) of the Code (such as hospitals, churches, religious,
scientific, or literary organizations and educational institutions) or a public
school system are eligible to participate in a 403(b)(7) TSA plan.
GENERAL INFORMATION
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be a permitted investment under profit
sharing, pension, and other retirement plans, IRAs, and tax-deferred annuities
other than those offered by the Fund depending on the provisions of the relevant
plan. Third-party administrative services, available for some corporate plans,
may limit or delay the processing of transactions.
The custodial agreements and forms provided by the Funds' Custodian and
Transfer Agent designate New York Life Trust Company as custodian for IRAs and
403(b)(7) TSA plans (unless another trustee or custodian is designated by the
individual or group establishing the plan) and contain specific information
about the plans. Each plan provides that dividends and distributions will be
reinvested automatically. For further details with respect to any plan,
including fees charged by New York Life Trust Company, tax consequences and
redemption information, see the specific documents for that plan.
The federal tax laws applicable to retirement plans, IRAs and 403(b)(7) TSA
plans are extremely complex and change from time to time. Therefore, an investor
should consult with his or her own professional tax adviser before establishing
any of the tax-deferred retirement plans described above.
118
<PAGE> 119
CALCULATION OF PERFORMANCE QUOTATIONS
From time to time, quotations of the Money Market Fund's "yield" and
"effective yield" may be included in advertisements or communications to
shareholders. These performance figures are calculated in the following manner:
A. Yield -- the net annualized yield based on a specified
seven-calendar day period calculated at simple interest rates. Yield is
calculated by determining the net change, exclusive of capital changes, in
the value of a hypothetical preexisting account having a balance of one
share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the
difference by the value of the account at the beginning of the base period
to obtain the base period return. The yield is annualized by multiplying
the base period return by 365/7. The yield figure is stated to the nearest
hundredth of one percent. The yield of the Class A, Class B and Class C
shares of the Money Market Fund for the seven-day period ended December 31,
1998 was 4.53%, 4.53% and 4.53%, respectively.
B. Effective Yield -- the net annualized yield for a specified
seven-calendar day period assuming a reinvestment of dividends
(compounding). Effective yield is calculated by the same method as yield
except the yield figure is compounded by adding one, raising the sum to a
power equal to 365 divided by 7, and subtracting one from the result,
according to the following formula: Effective Yield = [(Base Period Return
+ 1) 365/7] - 1. The effective yield of the Class A, Class B and Class C
shares of the Money Market Fund for the seven-day period ended December 31,
1998 was 4.63%, 4.63% and 4.63%, respectively.
The yield and effective yield of the Money Market Fund reflect the
reduction of certain fees otherwise payable and voluntary expense
limitations. Had there been no reduction of fees or expense limitations,
the yield and effective yield of the Money Market Fund would have been
4.50% and 4.60%, respectively, for Class A shares, 4.50% and 4.60%,
respectively, for Class B shares and 4.50% and 4.60%, respectively, for
Class C shares for the seven-day period ended December 31, 1998.
As described above, yield and effective yield are based on historical
earnings and are not intended to indicate future performance. The "effective
yield" will be slightly higher than the "yield" because of the compounding
effect of the assumed reinvestment of dividends. Yield and effective yield will
vary based on changes in market conditions and the level
of expenses.
From time to time a Fund, other than the Money Market Fund, may publish its
yield and/or average annual total return in advertisements and communications to
shareholders. Total return and yield are computed separately for Class A and
Class B shares. The average annual total return of each Fund is determined for a
particular period by calculating the actual dollar amount of the investment
return on a $1,000 investment in the Fund made at the maximum public offering
price at the beginning of the period, and then calculating the annual compounded
rate of return which would produce that amount. Total return for a period of one
year is equal to the actual return of the Fund during that period and reflects
fee waivers and reimbursements in effect for each period. This calculation
assumes a complete redemption of the investment and the deduction of the maximum
contingent deferred sales charge at the end of the period in the case of Class B
shares. In the case of Class A shares, the calculation assumes the maximum sales
charge is deducted from the initial $1,000 purchase order. It also assumes that
all dividends and distributions are reinvested at net asset value on the
reinvestment dates during the period. The performance information shown below
for the period ended December 31, 1998 provides performance figures for both
Class A and Class B shares of the Funds, except in the case of the Equity Index
Fund which offers only one class of shares, Class A shares.
In considering any average annual total return quotation, investors should
remember that the maximum initial sales charge reflected in each quotation for
Class A shares is a one-time fee which will have its greatest impact during the
early stages of an investor's investment in the Fund. The actual performance of
your investment will be affected less by this charge the longer you retain your
investment in the Fund.
Quotations of each Fund's average annual total return will be calculated
according to the following SEC formula:
n
P(1+T) = ERV
119
<PAGE> 120
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10- year
periods at the end of the 1, 5, or 10-year periods (or
fractional portion thereof)
Each Fund may quote total rates of return in addition to its average annual
total return. Such quotations are computed in the same manner as the average
annual compounded rate, except that such quotations will be based on a Fund's
actual return for a specified period as opposed to its average return over 1, 5,
and 10-year periods. In considering any total rate of return quotation,
investors should remember that the maximum initial sales charge reflected in
each quotation for Class A shares is a one-time fee which will have its greatest
impact during the early stages of an investor's investment in the Fund. The
actual performance of your investment will be affected less by this charge the
longer you retain your investment in the Fund.
The average annual total returns of the Class A shares of the following
Funds for the 1-year and, as applicable, 5-year and 10-year periods ended
December 31, 1998 and the period from inception to December 31, 1998 were as
follows:*
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98 12/31/98 12/31/98 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund....................... -- -- -- 10.00% 6/1/98
California Tax Free Fund.................... 0.59% 4.23% -- 6.00% 10/1/91
Capital Appreciation Fund (b)............... 31.59% 21.08% 21.95% 16.64% 5/1/86
Convertible Fund (b)........................ (4.34)% 7.83% 11.74% 9.27% 5/1/86
Equity Income Fund.......................... -- -- -- (1.71)% 6/1/98
Equity Index Fund........................... 23.86% 22.25% -- 19.02% 12/20/90
Global High Yield Fund...................... -- -- -- (20.14)% 6/1/98
Government Fund (b)......................... 3.44% 5.41% 6.88% 6.68% 5/1/86
Growth Opportunities Fund................... -- -- -- 12.08% 6/1/98
High Yield Corporate
Bond Fund (b)............................. (2.52)% 9.21% 10.28% 9.80% 5/1/86
International Bond Fund (b)................. 6.59% -- -- 9.36% 9/13/94
International Equity Fund (b)............... 13.56% -- -- 7.04% 9/13/94
New York Tax Free Fund...................... 0.64% 4.43% -- 6.22% 10/1/91
Research Value Fund......................... -- -- -- (2.67)% 6/1/98
Small Cap Growth Fund....................... -- -- -- (0.68)% 6/1/98
Small Cap Value Fund........................ -- -- -- (14.67)% 6/1/98
Strategic Income Fund....................... 0.44% -- -- 3.80% 2/28/97
Strategic Value Fund........................ (5.01)% -- -- (0.93)% 10/22/97
Tax Free Bond Fund (b)...................... 0.26% 4.13% 6.21% 6.10% 5/1/86
Total Return Fund (b)....................... 19.95% 15.06% 14.33% 13.74% 12/29/87
Value Fund (b).............................. (12.50)% 10.79% 13.82% 10.95% 5/1/86
</TABLE>
- --------------
* Assumes the deduction of the maximum applicable initial sales charge.
(a) From inception to 12/31/98.
(b) Performance figures for the Funds' Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class B shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on differences
in their expense structures.
120
<PAGE> 121
The average annual total returns of the Class B shares of the following
Funds for the 1-year and, as applicable, 5-year and 10-year periods ended
December 31, 1998, and the period from inception to December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98* 12/31/98* 12/31/98* Return(a) Date
---- --------- --------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund........... -- -- -- 11.00% 6/1/98
California Tax Free Fund........ 0.07% 4.63% -- 6.52% 10/1/91
Capital Appreciation Fund....... 33.15% 21.71% 22.36% 16.95% 5/1/86
Convertible Fund................ (4.47)% 8.22% 12.09% 9.54% 5/1/86
Equity Income Fund.............. -- -- -- (1.44)% 6/1/98
Global High Yield Fund.......... -- -- -- (20.98)% 6/1/98
Government Fund 2.52% 5.52% 7.10% 6.85% 5/1/86
Growth Opportunities Fund....... -- -- -- 13.00% 6/1/98
High Yield Corporate
Bond Fund..................... (3.69)% 9.40% 10.52% 9.99% 5/1/86
International Bond Fund......... 5.79% -- -- 9.51% 9/13/94
International Equity Fund....... 14.34% -- -- 7.33% 9/13/94
New York Tax Free Fund.......... 0.00% 4.85% -- 6.75% 10/1/91
Research Value Fund............. -- -- -- (2.50)% 6/1/98
Small Cap Growth Fund........... -- -- -- (0.40)% 6/1/98
Small Cap Value Fund............ -- -- -- (14.50)% 6/1/98
Strategic Income Fund........... (0.65)% -- -- 3.55% 2/28/97
Strategic Value Fund............ (5.26)% -- -- (0.20)% 10/22/97
Tax Free Bond Fund.............. (0.17)% 4.60% 6.62% 6.42% 5/1/86
Total Return Fund............... 20.96)% 15.62% 14.72% 14.09% 12/29/87
Value Fund...................... (12.69)% 11.25% 14.19% 11.24% 5/1/86
</TABLE>
- --------------
* Assumes a complete redemption at the end of each year and the deduction of the
maximum applicable contingent deferred sales charge.
(a) From inception to 12/31/98.
(b) Performance figures for the Funds' Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class A shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on differences
in their expense structures.
121
<PAGE> 122
The average annual total returns of the Class C shares of the following
Funds for the 1-year and, as applicable, 5-year and 10-year periods ended
December 31, 1998, and the period from inception to December 31, 1998 were as
follows:*
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98* 12/31/98* 12/31/98* Return(a) Date
---- --------- --------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund............ -- -- -- 15.00% 6/1/98
California Tax Free Fund......... 4.07% 4.97% -- 6.52% 10/1/91
Capital Appreciation Fund........ 37.15% 21.89% 22.36% 16.95% 5/1/86
Convertible Fund................. (0.47)% 8.51% 12.09% 9.54% 5/1/86
Equity Income Fund............... -- -- -- 2.56% 6/1/98
Global High Yield Fund........... -- -- -- 17.65% 6/1/98
Government Fund.................. 6.52% 5.84% 7.10% 6.85% 5/1/86
Growth Opportunities Fund........ -- -- -- 17.00% 6/1/98
High Yield Corporate
Bond Fund...................... 0.31% 9.68% 10.52% 9.99% 5/1/86
International Bond Fund.......... 9.79% -- -- 9.85% 9/13/94
International Equity Fund........ 18.34% -- -- 7.70% 9/13/94
New York Tax Free Fund........... 4.00% 5.18% -- 6.75% 10/1/91
Research Value Fund.............. -- -- -- 1.50% 6/1/98
Small Cap Growth Fund............ -- -- -- 3.60% 6/1/98
Small Cap Value Fund............. -- -- -- (10.90)% 6/1/98
Strategic Income Fund............ 3.35% -- -- 5.05% 2/28/97
Strategic Value Fund............. 1.27% -- -- 3.15% 10/22/97
Tax Free Bond Fund............... 3.83% 4.93% 6.62% 6.42% 5/1/86
Total Return Fund................ 24.96% 15.84% 14.72% 14.09% 12/29/87
Value Fund....................... (9.01)% 11.51% 14.19% 11.24% 5/1/86
</TABLE>
- --------------
* Assumes a complete redemption at the end of each year and the deduction of the
maximum applicable contingent deferred sales charge. Performance figures for the
Funds' Class C shares, first offered to the public on September 1, 1998, include
the historical performance of the Funds' Class B shares for the period from
inception through August 31, 1998 Performance data for the two classes after
this date vary based on differences in their expense structures.
(a) From inception to 12/31/98.
122
<PAGE> 123
The average annual total returns of the Class A shares of the following
Funds for the 1-year and as applicable, 5-year and 10-year periods ended
December 31, 1998, and the period from inception to December 31, 1998, without
deducting the applicable initial sales charge is as follows:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98 12/31/98 12/31/98 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund............ -- -- -- 16.40% 6/1/98
California Tax Free Fund......... 5.33% 5.19% -- 6.67% 10/1/91
Capital Appreciation Fund (b).... 39.24% 22.45% 22.64% 17.16% 5/1/86
Convertible Fund(b).............. 1.23% 9.06% 12.38% 9.76% 5/1/86
Equity Income Fund............... -- -- -- 4.01% 6/1/98
Equity Index Fund................ 27.69% 23.00% -- 19.47% 12/20/90
Global High Yield Fund........... -- -- -- (16.38)% 6/1/98
Government Fund(b)............... 8.32% 6.39% 7.38% 7.07% 5/1/86
Growth Opportunities Fund........ -- -- -- 18.60% 6/1/98
High Yield Corporate
Bond Fund (b).................. 2.07% 10.22% 10.79% 10.20% 5/1/86
International Bond Fund (b)...... 11.61% -- -- 10.54% 9/13/94
International Equity Fund (b).... 20.17% -- -- 8.45% 9/13/94
New York Tax Free Fund........... 5.38% 5.40% -- 6.90% 10/1/91
Research Value Fund.............. -- -- -- 3.00% 6/1/98
Small Cap Growth Fund............ -- -- -- 5.10% 6/1/98
Small Cap Value Fund............. -- -- -- (9.70)% 6/1/98
Strategic Income Fund............ 5.17% -- -- 6.43% 2/28/97
Strategic Value Fund............. 0.52% -- -- 3.89% 10/22/97
Tax Free Bond Fund (b)........... 4.98% 5.09% 6.70% 6.48% 5/1/86
Total Return Fund (b)............ 26.93% 16.37% 14.98% 14.33% 12/29/87
Value Fund (b)................... (7.41)% 12.05% 14.47% 11.45% 5/1/86
</TABLE>
- --------------
(a) From inception to 12/31/98.
(b) Performance figures for the Funds' Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class B shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on differences
in their expense structures.
123
<PAGE> 124
The average annual total returns of the Class B shares of the following
Funds for the 1-year and as applicable, 5-year and 10-year periods ended
December 31, 1998, and the period from inception to December 31, 1998, without
deducting the applicable contingent deferred sales charge is as follows:*
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98 12/31/98 12/31/98 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund............ -- -- -- 16.00% 6/1/98
California Tax Free Fund......... 5.07% 4.97% -- 6.52% 10/1/91
Capital Appreciation Fund........ 38.15% 21.89% 22.36% 16.95% 5/1/86
Convertible Fund................. 0.53% 8.51% 12.09% 9.54% 5/1/86
Equity Income Fund............... -- -- -- 3.56% 6/1/98
Global High Yield Fund........... -- -- -- (16.82)% 6/1/98
Government Fund.................. 7.52% 5.84% 7.10% 6.85% 5/1/86
Growth Opportunities Fund........ -- -- -- 18.00% 6/1/98
High Yield Corporate
Bond Fund...................... 1.31% 9.68% 10.52% 9.99% 5/1/86
International Bond Fund.......... 10.79% -- -- 9.85% 9/13/94
International Equity Fund........ 19.34% -- -- 7.70% 9/13/94
New York Tax Free Fund........... 5.00% 5.18% -- 6.75% 10/1/91
Research Value Fund.............. -- -- -- 2.50% 6/1/98
Small Cap Growth Fund............ -- -- -- 4.60% 6/1/98
Small Cap Value Fund............. -- -- -- (10.00)% 6/1/98
Strategic Income Fund............ 4.35% -- -- 5.65% 2/28/97
Strategic Value Fund............. (0.27)% -- -- 3.15% 10/22/97
Tax Free Bond Fund............... 4.83% 4.93% 6.62% 6.42% 5/1/86
Total Return Fund................ 25.96% 15.84% 14.72% 14.09% 12/29/87
Value Fund....................... (8.09)% 11.51% 14.19% 11.24% 5/1/86
</TABLE>
--------------
(a) From inception to 12/31/98.
124
<PAGE> 125
The average annual total returns of the Class C shares of the
following Funds for the 1-year and as applicable, 5-year and 10-year
periods ended December 31, 1998, and the period from inception to December
31, 1998, without deducting the applicable contingent deferred sales charge
is as follows:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/98* 12/31/98* 12/31/98* Return(a) Date
---- --------- --------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
Blue Chip Growth Fund......... -- -- -- 16.00% 6/1/98
California Tax Free Fund...... 5.07% 4.97% -- 6.52% 10/1/91
Capital Appreciation Fund..... 38.15% 21.89% 22.36% 16.95% 5/1/86
Convertible Fund.............. 0.53% 8.51% 12.09% 9.54% 5/1/86
Equity Income Fund............ -- -- -- 3.56% 6/1/98
Global High Yield Fund........ -- -- -- (16.82)% 6/1/98
Government Fund............... 7.52% 5.84% 7.10% 6.85% 5/1/86
Growth Opportunities Fund..... -- -- -- 18.00% 6/1/98
High Yield Corporate..........
Bond Fund 1.31% 9.68% 10.52% 9.99% 5/1/86
International Bond Fund....... 10.79% -- -- 9.85% 9/13/94
International Equity Fund..... 19.34% -- -- 7.70% 9/13/94
New York Tax Free Fund........ 5.00% 5.18% -- 6.75% 10/1/91
Research Value Fund........... -- -- -- 2.50% 6/1/98
Small Cap Growth Fund......... -- -- -- 4.60% 6/1/98
Small Cap Value Fund.......... -- -- -- (10.00)% 6/1/98
Strategic Income Fund......... 4.35% -- -- 5.65% 2/28/97
Strategic Value Fund.......... (0.27)% -- -- 3.15% 10/22/97
Tax Free Bond Fund............ 4.83% 4.93% 6.62% 6.42% 5/1/86
Total Return Fund............. 25.96% 15.84% 14.72% 14.09% 12/29/87
Value Fund.................... (8.09)% 11.51% 14.19% 11.24% 5/1/86
</TABLE>
- --------------
(a) From inception to 12/31/98.
(*) Performance figures for the Funds' Class C shares, first offered to the
public on September 1, 1998, include the historical performance of the Funds'
Class B shares for the period from inception through August 31, 1998.
Performance data for the two classes after this date vary based on differences
in their expense structures.
The performance data quoted represents historical performance and 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.
The yield of each Fund, except the Money Market Fund, is computed by
dividing its net investment income (determined in accordance with the following
SEC formula) earned during a recent 30-day period by the product of the average
daily number of shares outstanding and entitled to receive dividends during the
period and the maximum offering price per share
125
<PAGE> 126
on the last day of the period. The results are compounded on a bond equivalent
(semiannual) basis and then they are annualized. Yield will be calculated using
the following SEC formula:
6
Yield = 2[(a-b +1) -1]
--------
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
This yield figure does not reflect the deduction of any contingent deferred
sales charges which are imposed upon certain redemptions at the rates set forth
under "Redemptions and Repurchases" in the Prospectus.
For the 30-day period ended December 31, 1998, the yield of each of the
following Funds was:
<TABLE>
<CAPTION>
30-Day
Period Ended
December 31,
Fund Class A 1998 Class B Class C
---- ------- ------------ -------
<S> <C> <C> <C>
California Tax Free Fund.................................... 4.17 4.10 4.10
Government Fund............................................. 4.46 3.92 3.92
High Yield Corporate Bond Fund.............................. 8.08 7.69 7.69
International Bond Fund..................................... 3.48 2.89 2.89
New York Tax Free Fund...................................... 4.45 4.39 4.39
Tax Free Bond Fund.......................................... 4.13 4.07 4.07
Strategic Income Fund....................................... 5.16 4.64 4.64
</TABLE>
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may publish its tax equivalent yield in advertisements and communications to
shareholders. The tax equivalent yield is calculated by determining the rate of
return that would have to be achieved on a fully taxable investment to produce
the after-tax equivalent of the Fund's yield, assuming certain tax brackets for
a Fund shareholder.
The table below illustrates the taxable yield equivalent to a tax-free
yield of 5.50%.*+
<TABLE>
<CAPTION>
To Equal a 5.50% Tax
If Free Return, a Taxable
Your Federal Investment Would Have to
Marginal Tax Earn Without Fee Reduction
Rate is: or Expense Limit
--------------- ---------------------
<S> <C> <C>
15.00% 6.47%
28.00% 7.64%
31.00% 7.97%
36.00% 8.59%
39.60% 9.11%
</TABLE>
- --------------------
* This table reflects application of the regular Federal income tax only; other
taxes may be applicable with respect to a particular shareholder. Such taxes
could change the information shown. Tax rates are subject to change. Investors
in the
126
<PAGE> 127
California and New York Tax Free Funds should in particular note that the chart
does not reflect any state and local taxes that may be deductible in computing
Federal income tax liability.
+ This table is for illustrative purposes only; investors should consult their
tax advisers with respect to the tax implications of an investment in a Fund
that invests primarily in securities, the interest on which is exempt from
regular Federal income tax.
A Fund may also include its current dividend rate in its prospectus, in
supplemental sales literature, or in communications to shareholders. The current
dividend rate of each Fund for a particular period is calculated by annualizing
total distributions per share from net investment income (including equalization
credits, excluding realized short-term capital gains and premiums from writing
options) during this period and dividing this amount by the maximum offering
price per share on the last day of the period. The current dividend rate does
not reflect all components of a Fund's performance including (i) realized and
unrealized capital gains and losses, which are reflected in calculations of a
Fund's total return, or (ii) the amortized discount and premium on debt
obligations in income using the current market value of the obligations, as is
currently required for yield calculations. In addition, the current dividend
rate does not take into account the imposition of any contingent deferred sales
charge on the redemption of Fund shares. Any performance figure which does not
take into account the contingent deferred sales charge would be reduced to the
extent such charge is imposed upon a redemption.
Investors should note that the investment results of a Fund will fluctuate
over time, and any presentation of a Fund's yield, current dividend rate, total
return or tax-equivalent yield of any prior period should not be considered as
a representation of what an investment may earn or what an investor's yield,
current dividend rate, total return or tax-equivalent yield may be in any
future period.
In addition, advertising for a Fund may indicate that investors may
consider diversifying their investment portfolios in order to seek protection of
the value of their assets against inflation. From time to time, advertising
materials for a Fund may refer to or discuss current or past business,
political, economic or financial conditions, including events as they relate to
those conditions, such as any U.S. monetary or fiscal policies and the current
rate of inflation. In addition, from time to time, advertising materials for a
Fund may include information concerning retirement and investing for retirement
and may refer to the approximate number of then-current Fund shareholders,
shareholder accounts and Fund assets.
From time to time, advertising and sales literature for a Fund may discuss
the investment philosophy, personnel and assets under management of the Fund's
Manager and Subadviser, and other pertinent facts relating to the management of
the Fund by the Sub- Adviser.
From time to time any of the Funds may publish an indication of its past
performance as measured by independent sources such as Lipper Analytical
Services, Incorporated, Weisenberger Investment Companies Service, Donoghue's
Money Fund Report, Spot Market Prices, Barron's, BusinessWeek, Kiplinger's
Personal Finance, Financial World, Forbes, Money, Morningstar, Personal
Investor, Sylvia Porter's Personal Finance, and The Wall Street Journal.
In addition, performance information for a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i) unmanaged
indexes, such as the Standard & Poor's 500 Composite Stock Price Index, the
Salomon Brothers Broad Investment Grade Bond Index, the Morgan Stanley Capital
International indexes, the Dow Jones Industrial Average, Donoghue Money Market
Institutional Averages, the Merrill Lynch 1 to 3 Year Treasury Index, the
Salomon Brothers World Government Benchmark Bond Index, the Salomon Brothers
non-U.S. Dollar World Government Bond Index, the Lehman Brothers Municipal Bond
Index and the Lehman Brothers Government Corporate Index; (ii) other groups of
mutual funds tracked by Morningstar Inc. or Lipper Analytical Services, widely
used independent research firms which rank mutual funds by overall performance,
investment objectives and assets, or tracked by other services, companies,
publications or persons who rank mutual funds on overall performance or other
criteria; and (iii) the Consumer Price Index (measure for inflation) and other
measures of the performance of the economy to assess the real rate of return
from an investment in the Funds. Advertisements for a Fund may also include
general information about the performance of unmanaged indexes with investment
parameters similar to the Fund's. Unmanaged indexes may assume the reinvestment
of dividends but generally do not reflect deductions for administrative and
management costs and expenses.
127
<PAGE> 128
From time to time, advertisements for the Funds may include general
information about the services and products offered by the Funds, MainStay
Institutional Funds Inc. and New York Life Insurance Company and its
subsidiaries. For example, such advertisements may include statistical
information about those entities including, but not limited to, the number of
current shareholder accounts, the amount of assets under management, sales
information, the distribution channels through which the entities' products are
available, marketing efforts and statements about this information by the
entities' officers, directors and employees.
TAX INFORMATION
TAXATION OF THE FUNDS
The following summarizes certain federal income tax considerations
generally affecting the Funds and their stockholders. No attempt is made to
present a detailed explanation of the tax treatment of the Funds or their
stockholders, and the discussion here is not intended as a substitute for
careful tax planning. The discussion is based upon provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), the regulations promulgated
thereunder, and judicial and administrative ruling authorities, all of which are
subject to change, which change may be retroactive. Prospective investors should
consult their own tax advisors with regard to the federal tax consequences of
the purchase, ownership, and disposition of Fund shares, as well as the tax
consequences arising under the laws of any state, foreign country, or other
taxing jurisdiction.
Each Fund intends to be treated as a regulated investment company ("RIC")
under Subchapter M of the Code. To qualify as a regulated investment company,
each Fund must, among other things: (i) derive in each taxable year at least 90%
of its gross income from dividends, interest, payments with respect to certain
securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with respect to its
business of investing in such stock, securities, or currencies ("Qualifying
Income Test"); (ii) diversify its holdings so that, at the end of each quarter
of the taxable year, (a) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, U.S. Government securities, the securities
of other regulated investment companies, and other securities, with such other
securities of any one issuer limited for the purposes of this calculation to an
amount not greater than 5% of the value of the Fund's total assets and 10% of
the outstanding voting securities of such issuer, and (b) not more than 25% of
the value of its total assets is invested in the securities on any one issuer
(other than U.S. Government securities or the securities of other regulated
investment companies), or of two or more issuers which the Fund controls (as
that term is defined in the relevant provisions of the Code) and which are
determined to be engaged in the same or similar trades or businesses or related
trades or businesses; and (iii) distribute at least 90% of the sum of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of any net long-term capital
losses) and its net tax-exempt interest each taxable year. The Treasury
Department is authorized to promulgate regulations under which foreign currency
gains would constitute qualifying income for purposes of the Qualifying Income
Test only if such gains are directly related to investing in securities (or
options and futures with respect to securities). To date, no such regulations
have been issued.
Certain requirements relating to the qualification of a Fund as regulated
investment company may limit the extent to which a Fund will be able to engage
in certain investment practices, including transactions in futures contracts and
other types of derivative securities transactions. In addition, if a Fund were
unable to dispose of portfolio securities due to settlement problems relating to
foreign investments or due to the holding of illiquid securities, the Fund's
ability to qualify as a regulated investment company might be affected.
A Fund qualifying as a regulated investment company generally will not be
subject to U.S. federal income tax on its investment company taxable income and
net capital gains (any net long-term capital gains in excess of the net
short-term capital losses), if any, that it distributes to shareholders. Each
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and any net capital gains.
Generally, regulated investment companies, like the Fund, must distribute
amounts on a timely basis in accordance with a calendar year distribution
requirement in order to avoid a nondeductible 4% excise tax. Generally, to avoid
the tax, a regulated investment company must distribute during each calendar
year, (i) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (ii) at least 98% of its capital
gains in excess of its capital
128
<PAGE> 129
losses (adjusted for certain ordinary losses) for the 12-month period ending on
October 31 of the calendar year, and (iii) all ordinary income and capital gains
for previous years that were not distributed during such years. To avoid
application of the excise tax, each Fund intends to make its distributions in
accordance with the calendar year distribution requirement. A distribution is
treated as paid on December 31 of the calendar year if it is declared by a Fund
in October, November or December of that year to shareholders of record on a
date in such a month and paid by the Fund during January of the following
calendar year. Such distributions are taxable to shareholders in the calendar
year in which the distributions are declared, rather than the calendar year in
which the distributions are received.
Provided that a Fund qualifies as a regulated investment company, under the
Code, it generally will not be subject to any excise or income taxes in
Massachusetts. A Fund's investments, if any, in REMIC residual interests (as
explained previously in this SAI) or in Passive Foreign Investment Companies, as
explained below, may cause the Fund to become liable for certain taxes.
Investors that are tax-exempt organizations should carefully consider whether
distributions of a Fund's earnings will be subject to tax in their hands.
Certain of the Funds have received a ruling from the IRS to the effect that
differing distributions between the classes of its shares will not result in a
Fund's dividends and other distributions being regarded as "preferential
dividends" under the Code. Generally, a preferential dividend is a dividend
which a Fund cannot treat as having been distributed for purposes of (i)
determining whether the Fund qualifies as a regulated investment company for
federal tax purposes, and (ii) determining the Fund's tax liability.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming a Fund qualifies as a RIC, distributions of taxable net investment
income and net short-term capital gains in excess of net long-term capital
losses will be treated as ordinary income in the hands of shareholders.
If a Fund's investment income is derived exclusively from sources (such as
interest) other than dividends, no portion of such distributions will be
eligible for the dividends-received deduction available to corporations. If a
portion of a Fund's net investment income is derived from dividends from
domestic corporations, then a portion of such distributions may be eligible for
the corporate dividends-received deduction. The dividends-received deduction is
reduced to the extent shares of a Fund are treated as debt-financed under the
Code and is generally eliminated unless such shares are deemed to have been held
for more than 45 days. The 45-day holding period must occur during the 90-day
period beginning 45 days before the date on which the shares become ex-dividend.
In the case of dividends on certain preferred stock, the holding period
requirement is 90 days during a 180-day period. In addition, the entire dividend
(including the deducted portion) is includable in the corporate shareholder's
alternative minimum taxable income. Finally, if such dividends are large enough
to constitute "extraordinary dividends" under Section 1059 of the Code and the
applicable holding period requirements are not met, the shareholder's basis in
its shares could be reduced by all or a portion of the amount of the dividends
that qualifies for the dividends-received deduction.
Distributions of a fund's net capital gain, whether received in cash or
reinvested in Fund shares, will generally be taxable to shareholders as
long-term capital gains, regardless of how long a Shareholder has held the
Fund's Shares. Net capital gains from assets held for one year or less will be
taxed as ordinary income.
Any loss realized upon the redemption of shares within six months from the
date of their purchase will be treated as a long-term capital loss to the extent
of any capital gain dividends received with respect to such shares during that
six-month period. A loss realized upon a redemption of shares of a Fund within
30 days before or after a purchase of shares of the same Fund (whether by
reinvestment of distributions or otherwise) may be disallowed in whole or in
part.
If any net long-term capital gains in excess of net short-term capital
losses are retained by a Fund for reinvestment, requiring federal income taxes
to be paid thereon by that Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such capital
gains will be taxable to the shareholders. Shareholders will be able to claim
their proportionate share of the federal income taxes paid by the Fund on such
gains as a credit against their own federal income tax liabilities and will be
entitled to increase the adjusted tax basis of the relevant Fund shares by the
difference between their pro-rata share of such gains and their tax credit.
129
<PAGE> 130
Except for distributions by the Money Market Fund, distributions by a Fund
result in a reduction in the net asset value of a Fund's shares. Should a
distribution reduce the net asset value below a shareholder's cost basis, such
distribution nevertheless would generally be taxable to the shareholder (except
to the extent the distribution is an exempt interest dividend as described
below) as ordinary income or capital gain as described above, even though, from
an investment standpoint, it may constitute a partial return of investment. In
particular, investors should be careful to consider the tax implications of
buying shares just prior to a distribution. The price of shares purchased at
that time includes the amount of the forthcoming distribution. Those investors
purchasing shares just prior to a distribution will then receive a partial
return of their investment upon such distribution, which may nevertheless be
taxable to them.
Distributions of taxable net investment income and net realized capital
gains will be taxable as described above, whether received in shares or in cash.
Any distributions that are not from a Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or, in
some cases, as capital gain. Shareholders electing to receive distributions in
the form of additional shares will have a cost basis for federal income tax
purposes in each share so received equal to the net asset value of such share on
the reinvestment date.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- THE TAX-FREE FUNDS
The Code permits the character of tax-exempt interest distributed by a
regulated investment company to "flow through" as tax-exempt interest to its
shareholders, provided that 50% or more of the value of its assets at the end of
each quarter of its taxable year is invested in state, municipal or other
obligations the interest on which is exempt under Section 103(a) of the Code.
Each of the California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund (collectively, the "Tax Free Funds") intend to satisfy the 50% requirement
to permit their distributions of tax-exempt interest to be treated as such for
regular Federal income tax purposes in the hands of their shareholders.
Exempt-interest dividends must be taken into account by individual shareholders
in determining whether their total incomes are large enough to result in
taxation of up to 85% of their social security benefits and certain railroad
retirement benefits. None of the income distributions of the Tax Free Funds will
be eligible for the deduction for dividends received by corporations.
Although a significant portion of the distributions by the Tax Free Funds
generally is expected to be exempt from federal taxes, each of these Funds may
under certain circumstances invest in obligations the interest from which is
fully taxable, or, although exempt from the regular federal income tax, is
subject to the alternative minimum tax. Similarly, gains from the sale or
exchange of obligations the interest on which is exempt from regular Federal
income tax will constitute taxable income to those Funds. In addition, a sale of
shares in such Fund (including a redemption of such shares and an exchange of
shares between two mutual funds) will be a taxable event, and may result in a
taxable gain or loss to a shareholder. Accordingly, it is possible that a
significant portion of the distributions of these Funds will constitute taxable
rather than tax-exempt income in the hands of a shareholder. Furthermore,
investors should be aware that tax laws may change, and issuers may fail to
follow applicable laws, causing a tax-exempt item to become taxable.
Exempt-interest dividends from the Tax Free Funds; ordinary dividends from
the Tax Free Funds, if any; capital gains distributions from the Tax Free Funds
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes. However, the portion of a distribution of
the Funds' tax-exempt income that is attributable to state and municipal
securities issued within the shareholder's own state may not be subject, at
least in some states, to state or local taxes.
Distributions derived from interest on certain private activity bonds which
is exempt from regular federal income tax are treated as a tax preference item
and may subject individual or corporate shareholders to liability (or increased
liability) for the alternative minimum tax. In addition, because a portion of
the difference between adjusted current earnings, as defined in the Code, and
alternative minimum taxable income is an addition to the alternative minimum tax
base, all distributions derived from interest which is exempt from regular
federal income tax are included in adjusted current earnings and may subject
corporate shareholders to or increase their liability for the alternative
minimum tax.
DISCOUNT
Certain of the bonds purchased by the Funds, such as zero coupon bonds, may
be treated as bonds that were originally issued at a discount. Original issue
discount represents interest for federal income tax purposes and can generally
be defined
130
<PAGE> 131
as the difference between the price at which a security was issued (or the price
at which it was deemed issued for federal income tax purposes) and its stated
redemption price at maturity. Original issue discount is treated for federal
income tax purposes as income earned by a Fund over the term of the bond, and
therefore is subject to the distribution requirements of the Code. The annual
amount of income earned on such a bond by a Fund generally is determined on the
basis of a constant yield to maturity which takes into account the semiannual
compounding of accrued interest.
In addition, some of the bonds may be purchased by a Fund at a discount
which exceeds the original issue discount on such bonds, if any. This additional
discount represents market discount for federal income tax purposes. The gain
realized on the disposition of any bond having market discount generally will be
treated as taxable ordinary income to the extent it does not exceed the accrued
market discount on such bond (unless a Fund elects to include market discount in
income in tax years to which it is attributable). Realized accrued market
discount on obligations that pay tax-exempt interest is nonetheless taxable.
Generally, market discount accrues on a daily basis for each day the bond is
held by a Fund at a constant rate over the time remaining to the bond's
maturity. In the case of any debt security having a fixed maturity date of not
more than one year from date of issue, the gain realized on disposition will be
treated as short-term capital gain.
USERS OF BOND-FINANCED FACILITIES
Section 147(a) of the Code prohibits exemption from taxation of interest on
certain governmental obligations to persons who are "substantial users" (or
persons related thereto) of facilities financed thereby. No investigation as to
the users of the facilities financed by bonds in the portfolios of the Tax Free
Funds has been made by these Funds. Persons who may be "substantial users" (or
"related persons" of substantial users) of facilities financed by private
activity bonds should consult their tax advisers before purchasing shares of a
Fund since the acquisition of shares of the Tax Free Bond Fund, California Tax
Free Fund or New York Tax Free Fund may result in adverse tax consequences to
them.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered into
by a Fund will be classified as "Section 1256 contracts." Generally, gains or
losses on Section 1256 contracts are considered 60% long-term and 40% short-term
capital gains or losses ("60/40"). Also, certain Section 1256 contracts held by
a Fund are "marked-to-market" at the times required pursuant to the Code with
the result that unrealized gains or losses are treated as though they were
realized. The resulting gain or loss generally is treated as 60/40 gain or loss,
except for foreign currency gain or loss on such contracts, which generally is
ordinary in character.
Distribution of Fund gains from hedging transactions will be taxable to
shareholders. Generally, hedging transactions and certain other transactions in
options, futures and forward contracts undertaken by a Fund may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by a Fund. In addition, losses realized
by a Fund on positions that are part of a straddle may be deferred under the
straddle rules rather than being taken into account in the taxable year in which
such losses are realized.
Furthermore, certain transactions (including options, futures contracts,
notional principal contracts, short sales and short sales against the box) with
respect to an "appreciated position" in certain financial instruments may be
deemed a constructive sale of the appreciated position, requiring the immediate
recognition of gain as if the appreciated position were sold. Because only a few
regulations implementing the straddle rules have been promulgated, and
regulations relating to constructive sales of appreciated positions have yet to
be promulgated, the tax consequences of transactions in options, futures and
forward contracts to a Fund are not entirely clear. The hedging transactions in
which a Fund engages may increase the amount of short-term capital gain realized
by a Fund which is taxed as ordinary income when distributed to shareholders.
A Fund may make one or more of the elections available under the Code which
are applicable to straddles. If a Fund makes any of the elections, the amount,
character and timing of the recognition of gains or losses from the affected
straddle positions will be determined under rules that vary according to the
election(s) made. The rules applicable under certain of the elections may
accelerate the recognition of gains or losses from the affected straddle
positions.
131
<PAGE> 132
Because application of the straddle rules may affect the character of gains
or losses, defer losses and/or accelerate the recognition of gains or losses
from the affected straddle positions, the amount which must be distributed to
shareholders and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a Fund that did not engage in such hedging transactions.
The diversification requirements applicable to a Fund's status as a
regulated investment company may limit the extent to which a Fund will be able
to engage in transactions in options, futures contracts or forward contracts.
Regarding the Tax Free Bond Fund, the California Tax Free Fund and New York
Tax Free Fund, gains from certain transactions, including, for example,
transactions in options, futures, and other instruments, and from obligations
the interest on which is not exempt from Federal income tax, will be taxable
income to those Funds.
The International Bond Fund, International Equity Fund, Strategic Value
Fund and Strategic Income Fund may engage in swap transactions. The tax
treatment of swap agreements is not entirely clear in certain respects.
Accordingly, while the Funds intend to account for such transactions in a manner
they deem to be appropriate, the IRS might challenge such treatment. If such a
challenge were successful, status of a Fund as a regulated investment company
might be affected. The Funds intend to monitor developments in this area.
PASSIVE FOREIGN INVESTMENT COMPANIES
Certain of the Funds may invest in shares of foreign corporations which may
be classified under the Code as passive foreign investment companies ("PFICs").
In general, a foreign corporation is classified as a PFIC if at least one-half
of its assets constitute investment-type assets or 75% or more of its gross
income is investment-type income. If a Fund receives a so-called "excess
distribution" with respect to PFIC stock, the Fund itself may be subject to a
tax on a portion of the excess distribution, whether or not the corresponding
income is distributed by the Fund to Shareholders. In general, under the PFIC
rules, an excess distribution is treated as having been realized ratably over
the period during which the Fund held the PFIC shares. The Fund itself will be
subject to tax on the portion, if any, of an excess distribution that is so
allocated to prior Fund taxable years and an interest factor will be added to
the tax, as if the tax had been payable in such prior taxable years. Certain
distributions from a PFIC as well as gain from the sale of PFIC shares are
treated as excess distributions. Excess distributions are characterized as
ordinary income even though, absent application of the PFIC rules, certain
excess distributions might have been classified as capital gain.
A Fund may be eligible to elect alternative tax treatment with respect to
PFIC shares. Under an election that currently is available in some
circumstances, a Fund generally would be required to include in its gross income
its share of the earnings of a PFIC on a current basis, regardless of whether
distributions are received from the PFIC in a given year. If this election were
made, the special rules, discussed above, relating to the taxation of excess
distributions, would not apply. Alternatively, a Fund may elect to mark to
market its PFIC shares at the end of each taxable year, with the result that
unrealized gains are treated as though they were realized and reported as
ordinary income. Any mark-to-market losses and any loss from an actual
disposition of PFIC Shares would be deductible as ordinary losses to the extent
of any net mark-to-market gains included in income in prior years.
Because the application of the PFIC rules may affect, among other things,
the character of gains, the amount of gain or loss and the timing of the
recognition of income with respect to PFIC shares, as well as subject the Fund
itself to tax on certain income from PFIC shares, the amount that must be
distributed to shareholders, and which will be taxed to shareholders as ordinary
income or long-term capital gain, may be increased or decreased substantially as
compared to a Fund that did not invest in PFIC shares.
FOREIGN CURRENCY GAINS AND LOSSES
Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time a Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time a Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on the
disposition of debt securities denominated in a foreign currency and on the
disposition of certain options, futures, forward and other contracts, gain or
loss attributable to fluctuations in the value of foreign currency between the
132
<PAGE> 133
date of acquisition of the security or contract and the date of disposition also
are treated as ordinary gain or loss. These gains or losses, referred to under
the Code as "Section 988" gains or losses, may increase or decrease the amount
of a Fund's net investment income to be distributed to its shareholders. If
Section 988 losses exceed other investment company taxable income (which
includes, among other items, dividends, interest and the excess, if any, of net
short-term capital gains over net long-term capital losses) during the taxable
year, a Fund would not be able to make any ordinary dividend distributions, and
distributions made before the losses were realized would be recharacterized as a
return of capital to shareholders or, in some cases, as capital gain, rather
than as an ordinary dividend.
COMMODITY INVESTMENTS
A regulated investment company is required under the Code to derive at
least 90% of its gross income from certain qualifying sources. Qualifying income
includes, inter alia, interest, dividends, and gain from the sale of stock or
securities, but it does not include gain from the sale of commodities such as
gold and other precious metals.
DISPOSITIONS OF FUND SHARES
Upon redemption, sale or exchange of shares of a Fund, a shareholder will
realize a taxable gain or loss, depending on whether the gross proceeds are more
or less than the shareholder's tax basis for the shares. Such gain or loss
generally will be a capital gain or loss if the shares of a Fund were capital
assets in the hands of the shareholder, and generally will be taxable to
shareholders as long-term capital gains if the shares had been held for more
than one year. A loss realized by a shareholder on the redemption, sale or
exchange of shares of a Fund with respect to which capital gain dividends have
been paid will, to the extent of such capital gain dividends, be treated as
long-term capital loss if such shares have been held by the shareholder for six
months or less at the time of their disposition. Furthermore, a loss realized by
a shareholder on the redemption, sale or exchange of shares of a Fund with
respect to which exempt-interest dividends have been paid will, to the extent of
such exempt-interest dividends, be disallowed if such shares have been held by
the shareholder for six months or less at the time of their disposition. A loss
realized on a redemption, sale or exchange also will be disallowed to the extent
the shares disposed of are replaced (whether through reinvestment of
distributions, or otherwise) within a period of 61 days beginning 30 days before
and ending 30 days after the shares are disposed of. In such a case, the basis
of the shares acquired will be adjusted to reflect the disallowed loss.
Shareholders should be aware that redeeming shares of a Fund after
tax-exempt interest has been accrued by the Fund but before that income has been
declared as a dividend may be disadvantageous. This is because the gain, if any,
on the redemption will be taxable, even though such gains may be attributable in
part to the accrued tax-exempt interest which, if distributed to the shareholder
as a dividend rather than as redemption proceeds, might have qualified as an
exempt-interest dividend.
Under certain circumstances, the sales charge incurred in acquiring shares
of either Fund may not be taken into account in determining the gain or loss on
the disposition of those shares. This rule applies where shares of a Fund are
exchanged within 90 days after the date they were purchased and new shares are
acquired without a sales charge or at a reduced sales charge pursuant to a right
acquired upon the initial purchase of shares. In that case, the gain or loss
recognized on the exchange will be determined by excluding from the tax basis of
the shares exchanged all or a portion of the sales charge incurred in acquiring
those shares. The portion of the sales charge affected by this rule will be
treated as a sales charge paid for the new shares and will be reflected in their
basis.
If reverse stock splits are done, a share may have a split holding period
reflecting the fact that part of the share represents a reinvested dividend or
distribution.
TAX REPORTING REQUIREMENTS
All distributions, whether received in shares or cash, must be reported by
each shareholder on his or her federal income tax return. Shareholders are also
required to report tax-exempt interest. Dividends declared and payable to
shareholders of record on a specified date in October, November or December, if
any, will be deemed to have been received by shareholders on December 31 if paid
during January of the following year. Redemptions of shares, including exchanges
for shares of another Fund, may result in tax consequences (gain or loss) to the
shareholder and generally are also subject to
133
<PAGE> 134
these reporting requirements. Each shareholder should consult his or her own tax
adviser to determine the tax status of a Fund distribution in his or her own
state and locality (or foreign country).
Under the federal income tax law, a Fund will be required to report to the
IRS all distributions of income (other than exempt-interest dividends) and
capital gains as well as gross proceeds from the redemption or exchange of Fund
shares (other than shares of the Money Market Fund), except in the case of
certain exempt shareholders. Under the backup withholding provisions of Section
3406 of the Code, all such taxable distributions and proceeds from the
redemption or exchange of a Fund's shares may be subject to withholding of
federal income tax at the rate of 31% in the case of nonexempt shareholders who
fail to furnish a Fund with their taxpayer identification number and with
required certifications regarding their status under the federal income tax law
or if the IRS or a broker notifies a Fund that the number furnished by the
shareholder is incorrect. In addition, both the Fund and the shareholder are
potentially subject to a $50 penalty imposed by the IRS if a correct, certified
taxpayer identification number is not furnished and used on required information
returns.
If the withholding provisions are applicable, any such distributions and
proceeds, whether taken in cash or reinvested in shares, will be reduced by the
amounts required to be withheld. Backup withholding is not an additional tax and
any amounts withheld are creditable against the shareholder's U.S. Federal tax
liability. Investors may wish to consult their tax advisers about the
applicability of the backup withholding provisions.
FOREIGN TAXES
Investment income and gains received by a Fund from sources outside the
United States may be subject to foreign taxes which were paid or withheld at the
source. The payment of such taxes will reduce the amount of dividends and
distributions paid to the Funds' stockholders. Since the percentage of each
Fund's total assets (with the exception of the International Bond Fund and
International Equity Fund) which will be invested in foreign stocks and
securities will not be more than 50%, any foreign tax credits or deductions
associated with such foreign taxes will not be available for use by its
shareholders. The effective rate of foreign taxes to which a Fund will be
subject depends on the specific countries in which each Fund's assets will be
invested and the extent of the assets invested in each such country and,
therefore, cannot be determined in advance.
The International Bond Fund and the International Equity Fund may qualify
for and make the election permitted under Section 853 of the Code so that
shareholders will be able to claim a credit or deduction on their federal income
tax returns for, and will be required to treat as part of the amounts
distributed to them, their pro rata portion of qualified taxes paid by the Fund
to foreign countries (which taxes relate primarily to investment income). The
U.S. shareholders of either of these Funds may claim a foreign tax credit or
deduction by reason of the Fund's election under Section 853 of the Code,
provided that more than 50% of the value of the total assets of the Fund at the
close of the taxable year consists of securities of foreign corporations. The
foreign tax credit and deduction available to shareholders is subject to certain
limitations imposed by the Code. Also, under Section 63 of the Code, no
deduction for foreign taxes may be claimed by shareholders who do not itemize
deductions on their federal income tax returns, although any such shareholder
may claim a credit for foreign taxes and in any event will be treated as having
taxable income in respect to the shareholder's pro rata share of foreign taxes
paid by the Fund. It should also be noted that a tax-exempt shareholder, like
other shareholders, will be required to treat as part of the amounts distributed
its pro rata portion of the income taxes paid by the Fund to foreign countries.
However, that income will generally be exempt from taxation by virtue of such
shareholder's tax-exempt status, and such a shareholder will not be entitled to
either a tax credit or a deduction with respect to such income. The foreign tax
credit generally may offset only up to 90% of the alternative minimum tax in any
given year. Foreign taxes generally are not deductible in computing alternative
minimum taxable income.
STATE AND LOCAL TAXES - GENERAL
The state and local tax treatment of distributions received from a Fund and
any special tax considerations associated with foreign investments of a Fund
should be examined by shareholders with regard to their own tax situations.
Shareholders of the Tax Free Bond Fund, the California Tax Free Fund and
New York Tax Free Fund may be subject to state and local taxes on distributions
from the Fund, including distributions which are exempt from federal income
taxes. Some states exempt from the state personal income tax distributions from
a Fund derived from interest on obligations issued
134
<PAGE> 135
by the U.S. government or by such state or its municipalities or political
subdivisions. Each investor should consult his or her own tax adviser to
determine the tax status of distributions from the Funds in his or her own state
and locality.
Opinions relating to the validity of municipal securities and the exemption
of interest thereon from federal income tax are rendered by bond counsel to the
issuers. The Tax Free Bond Fund, California Tax Free Fund and New York Tax Free
Fund, the Subadviser and its affiliates, and the Funds' counsel make no review
of proceedings relating to the issuance of state or municipal securities or the
bases of such opinions.
Due to the lack of adequate supply of certain types of tax-exempt
obligations, and other reasons, various instruments are being marketed which are
not "pure" state and local obligations, but which are thought to generate
interest excludable from taxable income under Code section 103. While a Fund may
invest in such instruments, it does not guarantee the tax-exempt status of the
income earned thereon or from any other investment. Thus, for example, were a
Fund to invest in an instrument thought to give rise to tax-exempt interest but
such interest ultimately were determined to be taxable, the Fund might have
invested more than 20% of its assets in taxable instruments. In addition, it is
possible in such circumstances that a Fund will not have met the 50% investment
threshold, described above, necessary for it to pay exempt-interest dividends.
EXPLANATION OF FUND DISTRIBUTIONS
Each distribution is accompanied by a brief explanation of the form and
character of the distribution. In January of each year, each Fund will issue to
each shareholder a statement of the federal income tax status of all
distributions, including, in the case of the Tax Free Bond Fund, the California
Tax Free Fund and New York Tax Free Fund, a statement of the percentage of the
prior calendar year's distributions which the Fund has designated as tax-exempt,
the percentage of such tax-exempt distributions treated as a tax-preference item
for purposes of the alternative minimum tax, and in, the case of the Tax Free
Bond Fund, the source on a state-by-state basis of all distributions.
ADDITIONAL INFORMATION REGARDING THE EQUITY INDEX FUND
If Shareholders receive distributions of amounts paid pursuant to the
Guarantee, such distributions from the Fund may not be eligible for the
dividends-received deduction available to corporations.
In addition, although not considered likely, it is possible that
shareholders could be regarded for tax purposes as receiving a constructive
distribution(s) (which could be taxable) from the Fund to the extent that the
Guarantee is deemed to have value.
It is anticipated that capital gain or loss from the disposition of shares
will be eligible for treatment as long-term or short-term capital gain or loss
depending upon the shareholder's actual holding period for the shares. Investors
should be aware that, under IRS regulations, as a result of the Guarantee, a
shareholder's holding period for Fund shares might be deemed not to commence
until the Guarantee is paid or expires. In that event, the capital gain or loss
on the disposition of Fund shares would be short-term capital gain or loss until
such time as the shares have been held continuously by the shareholder for the
requisite long-term holding period (currently more than one year for Federal
income tax purposes) after the expiration or payment of the Guarantee. The
holding period for shares received from reinvestment of dividends and
distributions will commence no earlier than the reinvestment date but could be
delayed as described previously in this paragraph as a result of the Guarantee.
ADDITIONAL INFORMATION REGARDING THE CALIFORNIA TAX FREE FUND AND NEW YORK TAX
FREE FUND
Under California law, a mutual fund which qualifies as a regulated
investment company must have at least 50% of its total assets in obligations
exempt from California personal income tax at the end of each quarter of its
taxable year in order to be eligible to pay dividends which will be exempt from
California personal income tax. Generally, shareholders who are California
residents will not incur California personal income tax on the amount of
exempt-interest dividends received by them from the California Tax Free Fund and
derived from California state and local issues, whether taken in cash or
reinvested in additional shares. However, other taxes, such as the franchise tax
may apply. Shareholders will normally be
135
<PAGE> 136
subject to California personal income tax on dividends paid from interest income
derived from taxable securities and from securities issued by states other than
California and its subsidiaries and on distributions of capital gains.
Deductions for interest on indebtedness incurred or continued by a
shareholder to purchase or carry shares of the Fund may be disallowed in whole
or in part for California personal income tax purposes.
Exempt-interest dividends paid by the New York Tax Free Fund from interest
on qualifying New York bonds generally are exempt from New York State and New
York City personal income taxes, but not corporate franchise taxes. Dividends
and distributions of the Fund derived from taxable income and capital gains are
not exempt from New York State and New York City taxes. Deductions for interest
on indebtedness incurred or continued by a shareholder to purchase or carry
shares of the Fund may be disallowed in whole or in part for New York State or
New York City personal income tax purposes.
Dividends from the California Tax Free Fund or New York Tax Free Fund
(including exempt-interest dividends), capital gains distributions from a Fund,
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes (as well as Federal taxes). However, the
portion of a distribution of a Fund's tax-exempt income that is attributable to
state and municipal securities issued within the shareholder's own state
generally will not be subject to state or local taxes. Individuals are often
exempt from state and local personal income taxes on distributions of tax-exempt
interest income derived from obligations of issuers located in the state in
which they reside when these distributions are received directly from these
issuers, but are usually subject to such taxes on income derived from
obligations of issuers located in other jurisdictions. Shareholders are urged to
consult their tax advisers with specific reference to their own federal, state
and local tax situations.
ANNUAL STATEMENTS
Each shareholder of the California Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
California state personal income tax status of his or her dividends and
distributions from the Fund for the prior calendar year. Any dividends
attributable to interest on municipal obligations that are not California
municipal securities will be taxable as ordinary dividends for California state
personal income tax purposes even if such dividends are excluded from gross
income for federal income tax purposes. These statements will also designate the
amount of exempt-interest dividends that is a specific preference item for
purposes of the federal individual and corporate alternative minimum taxes. Each
shareholder also will receive, if appropriate, various written notices after the
close of the Fund's prior taxable year as to the federal income tax status of
his or her dividends and distributions which were received from the Fund during
the Fund's prior taxable year. Shareholders should consult their tax advisers as
to any other state and local taxes that may apply to these dividends and
distributions. The dollar amount of dividends excluded or exempt from federal
income taxation or California state personal income taxation, if any, will vary
for each shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
Each shareholder of the New York Tax Free Fund will be sent after the close
of the calendar year an annual statement as to the federal income tax and New
York State and New York City personal income tax status of his or her dividends
and distributions from the Fund for the prior calendar year. These statements
will also designate the amount of exempt-interest dividends that is a specified
preference item for purposes of the federal individual and corporate alternative
minimum taxes. Each shareholder also will receive, if appropriate, various
written notices after the close of the Fund's prior taxable year as to the
federal income tax status of his or her dividends and distributions which were
received from the Fund during the Fund's prior taxable year. Shareholders should
consult their tax advisers as to any other state and local taxes that may apply
to these dividends and distributions. The dollar amounts of dividends excluded
or exempt from federal income taxation or New York State and City personal
income taxation and the dollar amount subject to federal income taxation or New
York State and City personal income taxation, if any, will vary for each
shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
GENERAL INFORMATION
The foregoing discussion generally relates to U.S. federal income tax law
as applicable to U.S. persons (i.e., U.S. citizens and residents and U.S.
domestic corporations, partnerships, trusts and estates). Each shareholder who
is not a U.S. person should consult his or her tax adviser regarding the U.S.
and non-U.S. tax consequences of ownership of shares of a
136
<PAGE> 137
Fund, including the possibility that such a shareholder may be subject to a U.S.
withholding tax at a rate of 30% (or at a lower rate under an applicable U.S.
income tax treaty) on amounts constituting ordinary income to him or her.
ORGANIZATION AND CAPITALIZATION
GENERAL
The Funds are separate series of an open-end investment company, The
MainStay Funds ("Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Tax Free Bond Fund was originally formed as the MacKay-Shields MainStay Tax Free
Bond Fund pursuant to a Declaration of Trust on January 9, 1986 and became a
series of the Trust pursuant to a reorganization which occurred on May 29, 1987.
The Total Return Fund commenced operations on December 29, 1987. The Equity
Index Fund commenced operations on December 20, 1990. The California Tax Free
Fund and New York Tax Free Fund commenced operations on October 1, 1991. The
International Bond Fund and International Equity Fund commenced operations on
September 13, 1994. The Strategic Income Fund and Strategic Value Fund commenced
operations on February 28 and October 22, 1997, respectively. The Blue Chip
Growth Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities
Fund, Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund
commenced operations on June 1, 1998. The MAP Equity Fund was originally formed
as the Mutual Benefit Fund, a Delaware corporation. The Fund was renamed the
MAP-Equity Fund in 1995. If the current shareholders of the MAP-Equity Fund
approve an Agreement and Plan of Reorganization at their June 3, 1999 meeting,
the Map-Equity Fund will be reorganized as the MainStay MAP Equity Fund on the
effective date of the reorganization. The organizational expenses of each Fund
(except the MAP Equity Fund) will be amortized and deferred over a period not to
exceed 60 months. The Declaration of Trust and By-laws authorize the Trustees to
establish additional series or "Funds" as well as additional classes of shares.
VOTING RIGHTS
Shares entitle their holders to one vote per share; however, separate votes
will be taken by each Fund or class on matters affecting an individual Fund or a
particular class of shares issued by a Fund. Shares have noncumulative voting
rights, which means that holders of more than 50% of the shares voting for the
election of Trustees can elect all Trustees and, in such event, the holders of
the remaining shares voting for the election of Trustees will not be able to
elect any person or persons as Trustees. Shares have no preemptive or
subscription rights and are transferable.
SHAREHOLDER AND TRUSTEE LIABILITY
Under Massachusetts law, shareholders of such a trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. The Declaration of Trust contains an express disclaimer of shareholder
liability for acts or obligations of the Trust. Notice of such disclaimer will
normally be given in each agreement, obligation or instrument entered into or
executed by the Trust or the Trustees. The Declaration of Trust provides for
indemnification by the relevant Fund for any loss suffered by a shareholder as a
result of an obligation of the Fund. The Declaration of Trust also provides that
the Trust shall, upon request, assume the defense of any claim made against any
shareholder for any act or obligation of the Trust and satisfy any judgment
thereon. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a Fund would be
unable to meet its obligations. The Trustees believe that, in view of the above,
the risk of personal liability of shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he or she
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his or
her office.
REGISTRATION STATEMENT
This Statement of Additional Information and the Prospectus do not
contain all the information included in the Company's registration statement
filed with the SEC under the Securities Act of 1933 with respect t the
securities offered
137
<PAGE> 138
hereby, certain portions of which have been omitted pursuant to the rules and
regulations of the SEC. The registration statement, including the exhibits filed
therewith, may be examined at the offices of the SEC in Washington, D.C.
Statements contained herein and in the Prospectus as to the contents
of any contract or other documents referred to are not necessarily complete,
and, in each instance, reference is made to the copy of such contract or other
documents filed as an exhibit to the registration statement, each such statement
being qualified in all respects by such reference.
SHARE OWNERSHIP OF THE FUNDS
The following table sets forth information concerning beneficial and record
ownership, as of April 5, 1999, of the Funds' shares by each person who
beneficially or of record owned more than 5% of the voting securities of any
Fund:
<TABLE>
<CAPTION>
Shares Percentage
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares
Owned
- --------------------------- ---------------------------------------------------- ---------------------------------------
<S> <C> <C> <C>
New York Helen Ostreicher 6.80% 103,381.4250
Tax Free Fund Agnes Zitter
Class A 1 Lakeside Dr East
Lawrence NY 11559-1718
New York NYLIFE Distributors Inc. 32.84% 499,488.3950
Tax Free Fund c/o George Daoust
Class A PO Box 421
Parsippany NJ 07054-0421
Equity Index New York Life Trust Company 7.98% 1,876,320.9250
Fund Client Accounts
Class A 51 Madison Avenue, Rm 117A
New York, NY 10010-1603
Blue Chip Growth Fund Merrill Lynch Pierce Fenner & Smith 11.18% 6,597.6630
Class C Inc. - For the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Blue Chip Growth Fund Salomon Smith Barney Inc. 8.50% 5,016.5020
Class C 00112017839
333 West 34th Street- 3rd Floor
New York, NY 10001-2483
Blue Chip Growth Fund Salomon Smith Barney Inc. 5.38% 3,172.0860
Class C 00117964110
333 West 34th Street- 3rd Floor
New York, NY 10001-2483
Blue Chip Growth Fund Smith Barney Inc. 6.44% 3,797.2650
Class C 00117968794
333 West 34th Street- 3rd Floor
New York, NY 10001-2483
</TABLE>
138
<PAGE> 139
<TABLE>
<S> <C> <C> <C>
Blue Chip Growth Fund Salomon Smith Barney Inc. 8.46% 4,991.9480
Class C 00117964459
333 West 34th Street- 3rd Floor
New York, NY 10001-2483
Blue Chip Growth Fund Salomon Smith Barney Inc. 8.65% 5,100.4860
Class C 00117968814
333 West 34th Street- 3rd Floor
New York, NY 10001-2483
Equity Income New York Life Insurance Company 89.50% 906,648.6490
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Equity Income Fund Boston Financial Data Services 8.83% 5.4820
Class C Corp Actions Audit Acct# 1 FD 121
MainStay Equity Income C
2 Heritage Drive - 8th Fl
North Quincy, MA 02171-2144
Equity Income Fund Boston Financial Data Services 8.96% 5.5640
Class C Corp Actions Audit Acct# 2 FD 121
MainStay Equity Income C
2 Heritage Drive - 8th Fl
North Quincy, MA 02171-2144
Equity Income Fund Boston Financial Data Services 8.41% 5.2230
Class C Operations Audit Account 121/3
MainStay Equity Income C
2 Heritage Drive - 8th Fl
North Quincy, MA 02171-2144
Equity Income Fund Boston Financial Data Services 8.92% 5.5350
Class C Corp Actions Audit Acct# 4 FD 121
MainStay Equity Income C
2 Heritage Drive - 8th Fl
North Quincy, MA 02171-2144
Equity Income Fund Alana D. Glover Revocable Living 47.02% 29.1930
Class C Trust DTD 11/20/97
Alana D. Glover TTEe
13 W. Frederick Street
Walkersville, MD 21793-8207
Equity Income Fund NYLIFE Distributors Inc. 17.85% 11.0830
Class C Attn: George Dacust - CVP
260 Cherry Hill Road
Parsippany, NJ 07054-1108
Research Value New York Life Insurance Company 86.63% 900,000
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
</TABLE>
139
<PAGE> 140
<TABLE>
<S> <C> <C> <C>
Research Value New York Life Insurance Company 18.22% 100,000
Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Research Value Fund Merrill Lynch Pierce Fenner & Smith 31.67% 11,468.7880
Class C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East
3rd fl
Jacksonville, FL 32246-6484
Research Value Fund Salomon Smith Barney Inc. 12.18% 4,411.2200
Class C 00112003921
333 West 34th Street - 3rd Fl
New York, NY 10001-2483
Research Value Fund Salomon Smith Barney Inc. 8.87% 3,213.2420
Class C 00112014971
333 West 34th Street - 3rd Fl
New York, NY 10001-2483
Research Value Fund Salomon Smith Barney Inc. 20.44% 7,400.1950
Class C 00112017839
333 West 34th Street - 3rd Fl
New York, NY 10001-2483
Research Value Fund Salomon Smith Barney Inc. 15.34% 5,553.9910
Class C 00150351046
333 West 34th Street - 3rd Fl
New York, NY 10001-2483
Equity Income New York Insurance Company 18.22% 100,739.4790
Fund Attn Jean Hoysradt
Class B New York, NY 10010-1603
Capital New York Life Trust Company 22.76% 1,984,622.2700
Appreciation Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
Capital Appreciation Merrill Lynch Pierce Fenner & Smith 25.52% 35,391.2470
Fund C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Value Fund New York Life Trust Company 23.35% 1,424,988.6270
Class A Client Accounts
51 Madison Avenue Rm 117A
New York NY 10010-1603
</TABLE>
140
<PAGE> 141
<TABLE>
<S> <C> <C> <C>
Value Fund Merrill Lynch Pierce Fenner & Smith 29.59% 2,030.2690
Class C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Value Fund Salomon Smith Barney Inc. 34.72% 2,381.7330
Class C 00112003921
333 West 34th St - 3rd Fl
New York, NY 10001-2483
Value Fund Salomon Smith Barney Inc. 8.34% 572.4400
Class C 00121763819
333 West 34th St - 3rd Fl
New York, NY 10001-2483
Value Fund Donaldson Lufkin Jenrette 14.23% 976.4900
Class C Securities Corporation Inc.
P. O. Box 2052
Jersey City, NJ 07303-2052
Value Fund Jacqueline A. Leger 8.84% 606.3690
Class C Lynn Albert Leger JTWROS
53 Morse Ave.
Lewiston, ME 04240-3441
Convertible Fund Boston Financial Data Service Corp. 7.38% 8.5110
Class C Actions Dept.
Audit Acct 2 Fund #192
MainStay Convertible Fund C
2 Heritage Drive - 8th Floor
North Quincy, MA 02171-2144
Convertible Fund Merrill Lynch Pierce Fenner & Smith 34.43% 39.7240
Class C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Convertible Fund Andrea L. Rhoades 40.22% 46.4020
Class C 3450 Andrews Drive #101
Pleasanton, CA 94588-3024
Convertible Fund NYLIFE Distributors Inc. 7.41% 8.5460
Class C Attn: George Daoust - CVP
260 Cherry Hill Road
Parsippany, NJ 07054-1108
</TABLE>
141
<PAGE> 142
<TABLE>
<S> <C> <C> <C>
Government Fund Merrill Lynch Pierce Fenner & Smith 7.96% 257,892
Class A Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Government New York Life Trust Company 22.81% 738,586.9220
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
Government Fund Merrill Lynch Pierce Fenner & Smith 63.30% 7,168.3710
Class C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Government Fund Salomon Smith Barney Inc. 24.23% 2,744.0180
Class C 00114606397
333 West 34th Street - 3rd Floor
New York, NY 10001-2483
Government Fund Salomon Smith Barney Inc. 5.36% 606.8400
Class C 00114606408
333 West 34th Street - 3rd Floor
New York, NY 10001-2483
Government Fund Salomon Smith Barney Inc. 6.79% 768.3220
Class C 00107862531
333 West 34th Street - 3rd Floor
New York, NY 10001-2483
Growth Opportunities Fund Boston Financial Data Services 16.35% 5.2800
Class C Corp Actions Audit Acct # 1 FD 311
2 Heritage Drive, 8th Fl
North Quincy, MA 02171-2144
Growth Opportunities Fund Boston Financial Data Services 16.35% 5.2800
Class C Corp Actions Audit Acct # 2 FD 311
2 Heritage Drive, 8th Fl
North Quincy, MA 02171-2144
Growth Opportunities Fund Boston Financial Data Services 15.39% 4.9700
Class C Corp Actions Audit Account 311/3
2 Heritage Drive, 8th Fl
North Quincy, MA 02171-2144
Growth Opportunities Fund Boston Financial Data Services 16.05% 5.1810
Class C Corp Actions Audit Acct # 4 FD 311
2 Heritage Drive, 8th Fl
North Quincy, MA 02171-2144
</TABLE>
142
<PAGE> 143
<TABLE>
<S> <C> <C> <C>
Growth Opportunities Fund NYLIFE Distributors Inc. 32.74% 10.5710
Class C Attn: George Daoust - CVP
260 Cherry Hill Road
Parsippany, NJ 07054-1108
Tax Free Schmitt Family Trust 9.31% 191,741.5830
Bond Fund Dtd 9-13-91
Class A A James S Schmitt & Don L Waters
& Kim Schmitt Fogarty TTEES PO
PO Box 1566
Savannah GA 31402-1566
Tax Free Michael N. Marks 8.59% 176,954.1490
Bond Fund PO Box 529
Class A Pottsboro TX 75076-0529
Tax Free David Katzin 5.06% 104,218.3620
Bond Fund 6301 N. 44th Street
Class A Paradise Valley, AZ 85253-3919
Tax Free Shirley J. Schatz 14.42% 297,029.7030
Bond Fund Larry L. Schatz JT Ten
Class A TDD Registration on file
7518 Lillys Lane
Villa Ridge, MO 63089-2781
Tax Free Ellen Lajuan Pesnoff 5.22% 107,502.3040
Bond Fund 1593 Marshall St., Apt. 23
Class A Cameron, LA 70631-4930
Tax Free Salomon Smith Barney Inc. 94.41% 499.8690
Bond Fund 00114606408
Class C 333 West 34th St - 3rd Floor
New York, NY 10001-2483
Money Market New York Life Trust Company 7.97% 10,231,764.0100
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
High Yield Corporate Bond Merrill Lynch Pierce Fenner & Smith 19.85% 596,496.5400
Class C Inc - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Money Market Fund Louis M. Carrick 17.45% 31,500.0000
Class C Lynn A. Carrick JT Wros
110 N. Oliver Ave.
Zelienople, PA 16063-1338
</TABLE>
143
<PAGE> 144
<TABLE>
<S> <C> <C> <C>
Money Market Fund Helen A. Oliverio 13.69% 24,707.7300
Class C 100 S. High St.
Zelienople, PA 16063-1317
Money Market Fund Jennings R. Graham 8.31% 15,000.000
Class C Geraldine G. Graham JT Wros
3694 Doume Way
Clermont, FL 34711-6957
Money Market Fund Nancy A. Smith 5.55% 10,019.9300
Class C 735 University Dr.
Menlo Park, CA 94025-4913
Money Market Fund Leroy A. Andrews 9.80% 17,697.0000
Class C Barbara J. Andrews JT Wros
337 Star Grille Rd.
Butler, PA 16003-8202
Money Market Fund Danielle L. Kolling 5.54% 10,000.000
Class C 213 S. Pittsburgh St., Apt. 3
Zelienople, PA 16063-1233
Money Market Fund PaineWebber For the Benefit of 24.11% 43,515.6400
Class C PaineWebber CDN FBO
Craig Knudsen
P. O. Box 3321
Weehawken, NJ 07087-8154
International Defined Benefit Pension Trust of 5.11% 74,304.6560
Bond Fund FMCNA
Class A c/o The Free Methodist Foundation
PO Box 580
8050 Spring Arbor Road
Strong Arbor MI 49283-0580
International Bond Fund Dean Witter Reynolds Incorporated 5.79% 777,411.0670
Class A Michael Jordon
Attn: Curtis POL238299768
International NYLIFE Distributors 53.50% 777,411.0670
Bond Fund Attn George Daoust
Class A 260 Cherry Hill Rd
Parsippany NJ 07054-1108
International Bond Fund Dorothy W. Brown 92.60% 2,819.7380
Class C Terry A. Brown
1208 N. I St.
Tacoma, WA 98403-2117
International Bond Fund Richard Flinn 6.42% 195.5400
Class C Caren Flinn JT Wros
11199 N. Maple
Haydon Lake, ID 83835-9612
</TABLE>
144
<PAGE> 145
<TABLE>
<S> <C> <C> <C>
International New York Life Trust Company 5.09% 98,182.9240
Equity Fund Clients Accounts
Class A New York NY 10010-1603
International NYLIFE Distributors 32.39% 625,089.8280
Equity Fund Attn George Daoust
Class A 260 Cherry Hill Rd
Parsippany NJ 07054-1108
International Equity Fund Salomon Smith Barney Inc. 15.31% 1,615.0080
Class C D0112014971
333 West 34th St - 3rd floor
New York, NY 10001-2483
International Equity Fund Salomon Smith Barney Inc. 35.26% 3,719.4130
Class C D0112017839
333 West 34th St - 3rd floor
New York, NY 10001-2483
International Equity Fund Salomon Smith Barney Inc. 28.18% 2,973.3110
Class C 00150351046
333 West 34th St - 3rd floor
New York, NY 10001-2483
Total Return New York Life Trust Company 49.37% 3,414,613.8650
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
Total Return Fund Paul Koeing Inc. 13.48% 7,729.6210
Class C Paul Koeing TTEE
Angelia Charon Sanchez TTEE
P. O. Box 1238
Mesilla Park, NM 88047-1238
Total Return Fund A G Edwards & Sons Inc. C/F 6.37% 3,653.7190
Class C Dowene W. Gregory
Rollover IRA Account
744 Cole Ranch Rd
Olivenhain, CA 92024-6611
Total Return Fund Salomon Smith Barney Inc. 6.21% 3,562.4860
Class C 00154657858
333 West 34th St - 3rd floor
New York, NY 10001-2483
Total Return Fund Salomon Smith Barney Inc. 9.66% 5,539.0030
Class C 00154655894
333 West 34th St - 3rd floor
New York, NY 10001-2483
Strategic Income James C. Calano 5.12% 111,751.7270
Fund 200 Boulder View Lane
Class A Boulder CO 80304-0491
</TABLE>
145
<PAGE> 146
<TABLE>
<S> <C> <C> <C>
Strategic Income Fund New York Life Ins. General Account 32.18% 702,286.4480
Class A Attn Richard Schwartz
260 Cherry Hill Rd
Parsippany NJ 07054-1187
Strategic Income Fund Barbara D. Boga 25.33% 9,834.2390
Class C 1114 Skyline Dr.
Medford, OR 97504-8584
Strategic Income Fund Thomas J. Finn 26.09% 10,127.8930
Class C Sara B. Finn
P. O. Box 569
Guerneville, CA 95446-0569
Strategic Income Fund Dain Rauscher Custodian 8.13% 3,155.9910
Class C Robert L. Manor
A/C #1741-1273
Individual Retirement Account
4155 S. Pine Street
Superior, WI 54880-8483
Strategic Income Fund Salomon Smith Barney Inc. 23.22% 9,015.5910
Class C 00112014416
333 West 34th St - 3rd floor
New York, NY 10001-2483
Strategic Value Fund New York Life Insurance 56.64% 930,642.899
Class A Company
Attn: Richard Schwartz
260 Cherry Hill Rd.
Parsippany, NJ 07054-1187
Strategic Value Fund Merrill Lynch Pierce Fenner & Smith 65.24% 5,878.3290
Class C Inc. - for the sole benefit of its
customers
Attn: Fund Administration 97T98
4800 Deer lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Strategic Value Fund Salomon Smith Barney Inc. 28.93% 2,606.3610
Class C 00144363011
333 West 34th St - 3rd floor
New York, NY 10001-2483
Blue Chip New York Life Insurance Company 42.02% 900,000
Growth Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Global High New York Life Insurance Company 96.66% 900,000
Yield Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
</TABLE>
146
<PAGE> 147
<TABLE>
<S> <C> <C> <C>
Global High New York Life Insurance Company 28.98% 100,000
Yield Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Global High Ettinger Family Trust 5.97% 20,587.3220
Yield Fund Dated 05-16-1993
Class B S. Ettinger & J. Gross TTEES
115 Nottingham Drive
Watchung, NJ 07060-6139
Global High Donaldson Lufkin Jenrette 6.34% 21,885.6270
Yield Fund Securities Corporation Inc.
Class B P. O. Box 2052
Jersey City, NJ 07303-2052
Global High Boston Financial Data Services 8.68% 15.8370
Yield Fund Corp Actions Aduti Acct# 4FD 802
Class C MainStay Global High Yield C
2 Heritage Drive - 8th FL
North Quincy, MA 02171-2144
Global High Richard Flinn 71.75% 130.9770
Yield Fund Caren Flinn JT Wros
Class C 11199 N. Maple
Haydon Lake, ID 83835-9612
Global High NYLIFE Distributors Inc. 7.79% 14.2140
Yield Fund Attn: George Daoust - CVP
Class C 260 Cherry Hill Road
Parsippany, NJ 07054-1108
Growth Opportunities New York Life Insurance Company 71.49% 900,000
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Growth Opportunities New York Life Insurance Company 5.17% 100,000
Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Small Cap New York Life Insurance Company 61.20% 900,000
Value Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Small Cap New York Life Insurance Company 7.59% 100,000
Value Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
</TABLE>
147
<PAGE> 148
<TABLE>
<S> <C> <C> <C>
Small Cap Merrill Lynch Pierce Fenner & Smith 27.74% 8,238.9390
Value Fund Inc - for the sole benefit of its
Class C customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
Small Cap Smith Moore & Co. IRA Custodian 5.88% 1,744.7310
Value Fund A/C Gary R. Johnson
Class C 400 Locust St
Saint Louis, MO 63102-2064
Small Cap Legg Mason Wood Walker Inc. 10.93% 3,246.7530
Value Fund 382-00717-14
Class C P. O. Box 1476
Baltimore, MD 21203-1476
Small Cap Donaldson Lufkin Jenrette 5.91% 1,756.4400
Value Fund Securities Corporation Inc.
Class C P. O. Box 2052
Jersey City, NJ 07303-2052
Small Cap Raymond James & Assoc Inc. CSDN 6.14% 1,824.4010
Value Fund Jerry L. Dinsdale IRA
Class C 12294 NE 37th
Bellevue, WA 98005-1211
Small Cap New York Life Insurance Company 55.29% 900,000
Growth Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Small Cap Merrill Lynch Pierce Fenner & Smith 98.05% 3,129.4970
Growth Fund Inc - for the sole benefit of its
Class C customers
Attn: Fund Administration 97T98
4800 Deer Lake Drive East 3rd Fl
Jacksonville, FL 32246-6484
California Tax Jaroth II LLC 5.99% 105,646.2340
Free Fund Michael Zumbo TTEE
Class A Thomas Keane TTEE
14472 Wicks Blvd
San Leandro CA 94577-6712
California Tax NYLIFE Distributors Inc. 15.36% 271,121.2630
Free Fund c/o George Daoust
Class A PO Box 421
Parsippany NJ 07054-0421
Strategic Income NYLIFE Distributors Inc. 8.74% 579,505.9570
Fund Attn George Daoust
Class B 300 Interpace Parkway
Parsippany NJ 07054-1100
</TABLE>
148
<PAGE> 149
<TABLE>
<S> <C> <C> <C>
New York Tax Felice Brand 5.94% 50,607.9020
Free Fund 156 Wright Ave
Class B Deer Park, NY 11729-2224
New York Tax Henry Sheiman Irrevocable Trust 6.14% 52,330.0030
Free Fund Dtd 03/06/97
Class B Robert Sheiman TTEE
David Brown TTEE
411 Theodore Fremd Ave Ste 3
Rye, NY 10580-1411
New York Tax Dominick Carelli 6.55% 55,867.4320
Free Fund 29 Beattie Rd
Class B Washingtonville, NY 10992-1018
New York Tax Boston Financial Data Services 19.77% 4.9550
Free Fund Corp Actions Audit Account #1 199
Class C MainStay New York Tax Free C
2 Heritage Drive - 8th Floor
North Quincy, MA 02171-2144
New York Tax Boston Financial Data Services 20.42% 5.1190
Free Fund Corp Actions Audit Account #2- 199
Class C MainStay New York Tax Free C
2 Heritage Drive - 8th Floor
North Quincy, MA 02171-2144
New York Tax Boston Financial Data Services 19.01% 4.7660
Free Fund Operations Audit Account 199/3
Class C MainStay Funds-5th Floor
2 Heritage Drive - 8th Floor
North Quincy, MA 02171-2144
New York Tax NYLIFE Distributors Inc. 40.80% 10.2260
Free Fund Attn: George Daoust - CVP
Class C 260 Cherry Hill Road
Parsippany, NJ 07054-1108
California Tax William J & Elinor G. Potikian 6.78% 83,446.9820
Free Fund Family Revocable Trust
Class B Dtd 8-17-93
Jacinda Potikian TTEE
4475 N College
Fresno CA 93704-3806
California Tax Attn Mutual Funds Dept. 5.51% 67,907.4450
Free Fund BNC Securities Inc.
Class B FAO 40278915
One Commerce Square
2005 Market Street Suite 1200
Philadelphia, PA 19103-7084
</TABLE>
149
<PAGE> 150
<TABLE>
<S> <C> <C> <C>
California Tax Thomas J. Finn 82.71% 9,807.7240
Free Fund Sara B. Finn
Class C P. O. Box 569
Guerneville, CA 95446-0569
California Tax Nancy A. Smith 17.08% 2,025.3660
Free Fund 735 University Dr.
Class C Menlo Park, CA 94025-4913
</TABLE>
(1) This information, not being within the knowledge of the Trust, has been
furnished by each of the above persons. Beneficial ownership is as
defined under Section 13(d) of the Securities Exchange Act of 1934.
Fractional Shares have been omitted.
(2) Mr. George Daoust, in connection with his position with NYLIFE
Distributors, has the power to vote all of the shares shown in the above
table owned by NYLIFE Distributors. Mr. Daoust disclaims beneficial
ownership of such shares.
NYLIFE Distributors Inc. is a corporation organized under the laws of
Delaware. NYLIFE Distributors Inc. is a wholly owned subsidiary of NYLIFE Inc.,
and an indirect wholly owned subsidiary of New York Life Insurance Company.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York, 10036, has been selected as independent accountants of the Trust. The
Funds' Annual Reports, which are incorporated by reference in this SAI, have
been so incorporated in reliance on the reports of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
TRANSFER AGENT
MainStay Shareholder Services, Inc. ("MSS"), an affiliate of the Manager,
serves as the transfer agent and dividend disbursing agent for each of the
Funds. MSS has its principal office and place of business at 260 Cherry Hill
Road, Parsippany, New Jersey. Pursuant to its Transfer Agency and Service
Agreement dated April 28, 1997 with the Trust, MSS provides transfer agency
services, such as the receipt of purchase and redemption orders, the receipt of
dividend reinvestment instructions, the preparation and transmission of dividend
payments and the maintenance of various records of accounts. The Funds pay MSS
fees in the form of per account charges, as well as out-of-pocket expenses and
advances incurred by MSS. MSS has entered into a Sub-Transfer Agency and Service
Agreement with Boston Financial Data Services, Inc. ("BFDS") located at 2
Heritage Drive, North Quincy, Massachusetts 02171 and pays to BFDS per account,
and transaction fees and out-of-pocket expenses for performing certain transfer
agency and shareholder recordkeeping services.
CUSTODIANS
The Bank of New York ("BONY") serves as custodian for the Equity Index
Fund, California Tax Free Fund, New York Tax Free Fund, International Equity
Fund, International Bond Fund, Strategic Income Fund, Strategic Value Fund, Blue
Chip Growth Fund, Equity Income Fund, Global High Yield Fund, Growth
Opportunities fund, Research Value Fund, Small Cap Growth Fund, Small Cap Value
Fund and the MAP Equity Fund. The Trust has also appointed BONY as its foreign
custody manager with respect to certain securities held outside of the United
States. BONY has its principal office at 48 Wall Street, New York, New York
10286.
State Street Bank and Trust Company ("State Street") serves as custodian
for the other MainStay Funds, including the Capital Appreciation Fund,
Convertible Fund, Total Return Fund, Value Fund, Government Fund, High Yield
Corporate Bond Fund, Tax Free Fund, and Money Market Fund. State Street has its
principal office at 225 Franklin Street, Boston, Massachusetts.
150
<PAGE> 151
LEGAL COUNSEL
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006,
passes upon certain legal matters in connection with the shares offered by the
Trust, and also acts as counsel to the Trust.
CODE OF ETHICS
The Trust has adopted a Code of Ethics governing personal trading
activities of all Trustees, officers of the Trust and persons who, in connection
with their regular functions, play a role in the recommendation of any purchase
or sale of a security by the Trust or obtain information pertaining to such
purchase or sale or who have the power to influence the management or policies
of the Trust or the Manager or a Subadviser unless such power is the result of
their position with the Trust or Manager or Subadviser. Such persons are
generally required to preclear all security transactions with the Trust's
Compliance Officer or his designee and to report all transactions on a regular
basis. The Trust has developed procedures for administration of the Code. The
Subadvisers that are unaffiliated with New York Life Insurance Company have
adopted their own Codes of Ethics to govern the personal trading activities of
their personnel.
151
<PAGE> 152
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
- -----------------------------------------------------------------
MOODY'S INVESTORS SERVICE, INC.
- -----------------------------------------------------------------
Corporate and Municipal Bond Ratings Aaa: Bonds which are rated Aaa are judged
to be of the best quality. They carry the smallest degree of investment risk and
are generally referred to as "gilt edged." Interest payments are protected by a
large or by an exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of such
issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
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.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through Caa. The modifier 1 indicates that the issue ranks in
the higher end of its generic rating category; the modifier 2 indicates a
midrange ranking; and the modifier 3 indicates that the issue ranks in the lower
end of its generic rating category.
Advance refunded issues that are secured by escrowed funds held in cash, held in
trust, reinvested in direct noncallable United States government obligations or
noncallable obligations unconditionally guaranteed by the U.S. government are
identified with a hatchmark (#) symbol, i.e., #Aaa.
Moody's assigns conditional ratings to bonds for which the security depends upon
the completion of some act or the fulfillment of some condition. These are bonds
secured by: (a) earnings of projects under construction; (b) earnings of
projects unseasoned in operating experience; (c) rentals that begin when
facilities are completed; or (d) payments to which
152
<PAGE> 153
some other limiting condition attaches. The parenthetical rating denotes
probable credit stature upon completion of construction or elimination of basis
of condition, e.g., Con.(Baa).
Municipal Short-Term Loan Ratings
MIG 1/VMIG 1: This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing.
MIG 2/VMIG 2: This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 3/VMIG 3: This designation denotes favorable quality. All security elements
are accounted for but there is lacking the undeniable strength of the preceding
grades. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
MIG 4/VMIG 4: This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
SG: This designation denotes speculative quality. Debt instruments in this
category lack margins of protection.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations which have an original maturity not exceeding
one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
STANDARD & POOR'S
- ------------------------------------------------------------------
Corporate and Municipal Long-Term Debt Ratings
Investment Grade
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong. AA: Debt rated AA differs from the highest rated issues only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
153
<PAGE> 154
A: Debt rated A is somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than debt in higher rated categories.
However, the obligor's capacity to meet its financial commitment on the
obligation is still strong.
BBB: Debt rated BBB exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity of the obligor to meet its financial commitment on the
obligation.
Speculative Grade
Debt rated BB, B, CCC, CC, and C is regarded as having significant speculative
characteristics with respect to capacity to pay interest and repay principal. BB
indicates the least degree of speculation and C the highest. While such debt
will likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse conditions.
BB: Debt rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial or economic conditions which could lead to the obligor's
inadequate capacity to meet its financial commitment on the obligation.
B: Debt rated B is more vulnerable to nonpayment than obligations rated BB, but
the obligor currently has the capacity to meet its financial commitment on the
obligation. Adverse business, financial or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation.
CCC: Debt rated CCC is currently vulnerable to nonpayment and is dependent upon
favorable business, financial and economic conditions for the obligor. In the
event of adverse business, financial or economic conditions, the obligor is not
likely to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: The C rating may be used to cover a situation where a bankruptcy petition has
been filed or a similar action has been taken, but debt service payments are
continued.
D: Debt rated D is in payment default. The D rating category is used when
payments on an obligation are not made on the date due even if the applicable
grace period has not expired, unless S&P believes that such payments will be
made during such grace period. The D rating will also be used upon the filing of
a bankruptcy petition, or the taking of similar action, if debt service payments
are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Debt obligations of issuers outside the United States and its territories are
rated on the same basis as domestic corporate and municipal issues. The ratings
measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Short-Term Rating Definitions
A-1: A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign(+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2: A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
154
<PAGE> 155
A-3: A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B: A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated 'C' is currently vulnerable to nonpayment and
is dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The 'D'
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
155
<PAGE> 156
AUDITED FINANCIAL STATEMENT FOR NYLIFE INC.
NYLIFE INC. AND SUBSIDIARIES
(AFFILIATES OF NEW YORK LIFE
INSURANCE COMPANY)
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
156
<PAGE> 157
PRICEWATERHOUSECOOPERS
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York NY 10036
Telephone (212) 596 8000
Facsimile (212) 596 8910
REPORT OF INDEPENDENT ACCOUNTANTS
March 19, 1999
To the Board of Directors and
Stockholder of NYLIFE Inc.
We have audited the accompanying statutory basis consolidated statement of
financial position of NYLIFE Inc. and its subsidiaries (affiliates of New York
Life Insurance Company) as of December 31, 1998 and 1997, and the related
statutory basis consolidated statements of operations, of changes in
stockholder's equity and of cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements 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 are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As described in Note 2, these financial statements were prepared in conformity
with accounting practices prescribed or permitted by the New York State
Insurance Department for valuing companies owned by an insurer, which is a
comprehensive basis of accounting other than generally accepted accounting
principles. The effects on the financial statements of the variances between
such practices and generally accepted accounting principles are described in
Note 2.
157
<PAGE> 158
To the Board of Directors and
Stockholder of NYLIFE Inc.
Page 2
March 19,1999
In our opinion, except for the effects of the matters described in the preceding
paragraph, the financial statements referred to above present fairly, in all
material respects, the financial position of NYLIFE Inc. and its subsidiaries at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Also, in our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of NYLIFE Inc. and its
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, on the basis of the accounting described in Note 2.
/s/ PricewaterhouseCoopers LLP
158
<PAGE> 159
NYLIFE INC. AND SUBSIDIARIES
(affiliates of New York Life Insurance Company)
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
(in thousands)
ASSETS
Investments:
<S> <C> <C>
Common stocks $7,083 $26,130
Bonds:
Available for sale 3,968 241,697
Held to maturity 4,119 4,119
Insurance operations 70,065 50,253
Real estate - 11,359
MainStay funds at fair value 35,622 41,665
Security alarm monitoring contracts held for sale - 34,180
Other investments 29,353 66,034
Cash and cash equivalents 362,644 401,565
Short-term investments 25 57,959
Premiums and accounts receivable less allowance for doubtful
accounts of $18,074 and $6,374, respectively 472,310 569,108
Interest and other receivables 21,628 36,805
Deferred distribution costs (net of accumulated amortization
of $432,076 and $296,341, respectively) 226,756 268,470
Statutory valuation of subsidiary in excess of GAAP net equity 549,363 200,247
Fixed assets (net of accumulated depreciation of $43,976 and
$84,445, respectively) 103,451 80,355
Income taxes receivable - 10,961
Receivable from New York Life Insurance Company 1,315,849 500,686
Goodwill 274,955 40,183
Other assets 157,111 83,775
---------- ----------
Total assets $3,634,302 $2,725,551
========== ==========
LIABILITIES and STOCKHOLDER'S EQUITY
Accrued claims payable $339,992 $341,594
Policy and claim reserves - accident and health - 133,412
Policy and claim reserves - life 87,319 94,825
Participating policyholder liability 4,292 14,866
Payable to New York Life Insurance Company 14,889 48,204
Dividend payable to New York Life Insurance Company 373,924 -
Accrued expenses and other payables 210,310 202,642
Payable on reinsurance assumed - 39,608
Medical group risk sharing and unearned premiums - 71,424
Income taxes payable 5,084 -
Notes payable 1,271,202 577,930
Net deferred tax liability 41,192 79,019
Other liabilities 152,836 69,888
---------- ----------
Total liabilities 2,501,040 1,673,412
---------- ----------
Minority interest 128,428 111,901
Stockholder's equity:
Commonstock, par value $.10 per share (20,000 shares authorized, 3,850
shares issued and outstanding) and
additional paid-in capital 857,696 1,043,108
Accumulated deficit (404,787) (306,938)
Investment valuation account 549,363 200,247
Net unrealized gains on available for sale investments (net of
taxes of $96 and $886, respectively) 111 1,383
Cumulative translation adjustment 2,451 2,438
---------- ----------
Total stockholder's equity 1,004,834 940,238
---------- ----------
Total liabilities and stockholder's equity $3,634,302 $2,725,551
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
159
<PAGE> 160
NYLIFE INC. AND SUBSIDIARIES
(affiliates of New York Life Insurance Company)
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Years ended December 31,
--------------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Income:
<S> <C> <C> <C>
Premium revenue - net of reinsurance $1,426,882 $ 2,792,678 2,363,286
Premiums (ceded) assumed on reinsurance settlement (569,687) - 478,149
Fee income 3,078,365 1,392,649 925,671
Interest and dividend income 82,632 57,108 56,846
Commission income 146,661 113,590 95,858
Net realized and unrealized losses on investments (19,409) (6,462) (2,869)
Net realized gain on sale of interest in subsidiaries 696,818 19,932 121,741
Equity in loss of affiliates (2,519) (2,551) (699)
Gain on issuance of additional shares by public subsidiary 921 2,411 27,835
Other income 13,128 38,341 11,871
---------- ----------- ----------
Total income 4,853,792 4,407,696 4,077,689
========== =========== ==========
Expenses:
HMO claims and capitation costs 1,054,552 1,738,512 1,350,743
Health, disability and death benefit costs 170,000 618,663 551,816
Cost of prescription sales 2,449,592 1,015,982 621,652
Administrative charge from New York Life
Insurance Company 86,446 65,385 62,631
Employee compensation 292,337 368,939 339,974
Reserve transfer on reinsurance (ceded) assumed (569,687) - 478,149
Increase in policy reserves - life 24,500 21,829 11,746
Depreciation and amortization 205,617 120,238 112,642
Impairment of intangible asset - 4,381 28,830
Interest 55,362 14,558 15,594
Professional fees 58,909 35,138 37,938
Selling expenses 166,619 166,632 123,413
Rent expense 26,978 36,575 34,943
Administrative and other expenses 197,039 184,442 152,272
---------- ----------- ----------
Total expenses 4,218,264 4,391,274 3,922,343
---------- ----------- ----------
Net income before income taxes and minority interest 635,528 16,422 155,346
Net income tax expense 302,867 21,929 76,325
---------- ----------- ----------
Net income (loss) before minority interest 332,661 (5,507) 79,021
Minority interest 14,799 18,288 14,188
---------- ----------- ----------
Net income (loss) $317,862 $(23,795) $64,833
========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
160
<PAGE> 161
NYLIFE INC. AND SUBSIDIARIES
(affiliates of New York Life Insurance Company)
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
For the years ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Common Net Unrealized
Stock & Gains (Losses)
Additional Investment on Available
Paid-In Accumulated Valuation for Sale
Capital Deficit Account Investments
- -------------------------------------------------- ----------------- ------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 $946,546 $(240,623) $406,834 $19,099
Effect of business combination (Note 1) -- (88,130) -- (17,375)
Capital contributions 168,325 -- -- --
Return of capital (47,950) -- -- --
Change in prior year's retained earnings -- (7,102) -- --
Cumulative translation adjustment -- -- --
Statutory valuation of subsidiary in
excess of GAAP net equity -- -- (307,307) --
Other equity adjustments -- 205 -- --
Net unrealized losses on available for
sale investments -- -- -- (2,939)
Net income -- 64,833 -- --
---------- ------------ ----------- --------
Balance at December 31, 1996 1,066,921 (270,817) 99,527 (1,215)
Capital contributions 101,087 -- -- --
Return of capital (124,900) -- -- --
Cumulative translation adjustment -- -- -- --
Statutory valuation of subsidiary in
excess of GAAP net equity -- -- 100,720 --
Other equity adjustments -- (12,326) -- --
Net unrealized gains on available for
sale investments -- -- -- 2,598
Net loss -- (23,795) -- --
----------- ------------ ----------- --------
Balance at December 31, 1997 1,043,108 (306,938) 200,247 1,383
Capital contributions 100,145 -- -- --
Return of capital (285,557) -- -- --
Dividends -- (373,924) -- --
Cumulative translation adjustment -- -- -- --
Statutory valuation of subsidiary in
excess of GAAP net equity -- -- 349,116 --
Other equity adjustments -- (41,787) -- --
Net unrealized losses on available for
sale investments -- -- -- (1,272)
Net income -- 317,862 -- --
----------- ------------ ----------- --------
Balanced at December 31, 1998 $857,696 $(404,787) $549,363 $111
=========== ============ =========== ========
</TABLE>
<TABLE>
<CAPTION>
Cumulative Total
Translation Stockholder's
Adjustment Equity
- -------------------------------------------------- ----------------- -----------------------
<S> <C> <C>
Balance at December 31, 1995 $1,123 $1,132,979
Effect of business combination (Note 1) -- (105,505)
Capital contributions -- 168,325
Return of capital -- (47,950)
Change in prior year's retained earnings -- (7,102)
Cumulative translation adjustment 2,727 2,727
Statutory valuation of subsidiary in
excess of GAAP net equity -- (307,307)
Other equity adjustments -- 205
Net unrealized losses on available for
sale investments -- (2,939)
Net income -- 64,833
--------- ---------
Balance at December 31, 1996 3,850 898,266
Capital contributions -- 101,087
Return of capital -- (124,900)
Cumulative translation adjustment (1,412) (1,412)
Statutory valuation of subsidiary in
excess of GAAP net equity -- 100,720
Other equity adjustments -- (12,326)
Net unrealized gains on available for
sale investments -- 2,598
Net loss -- (23,795)
--------- -----------
Balance at December 31, 1997 2,438 940,238
Capital contributions -- 100,145
Return of capital -- (285,557)
Dividends -- (373,924)
Cumulative translation adjustment 13 13
Statutory valuation of subsidiary in
excess of GAAP net equity -- 349,116
Other equity adjustments -- (41,787)
Net unrealized losses on available for
sale investments -- (1,272)
Net income -- 317,862
--------- ------------
Balanced at December 31, 1998 $2,451 $1,004,834
========= ==========
</TABLE>
161
<PAGE> 162
NYLIFE INC. AND SUBSIDIARIES
(affiliates of New York Life Insurance Company)
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years ended December 31.
--------------------------------
Cash flow from operating activities 1998 1997 1996
----------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Cash flow from operating activities:
Net income (loss) $ 317,862 $ (23,795) $ 64,833
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 205,617 120,238 112,642
Impairment of intangible assets - 4,381 28,830
Insurance reserves 24,500 21,829 11,748
Net realized gain on sale of interest in subsidiaries (696,818) (19,932) (121,741)
Net realized and unrealized losses on investments 19,409 6,462 2,869
Equity in loss of affiliates 2,519 2,551 699
Provision for deferred income tax expense (730) 13,609 87,297
Minority interest 14,799 18,288 14,188
Gain on issuance of additional shares by public subsidiary (921) (2,411) (27,835)
Other 9,997 3,821 11,083
Change in assets and liabilities, net of changes resulting from
acquisitions or sales of subsidiaries:
Premiums and accounts receivable 78,185 (91,791) (206,586)
Interest and other receivables (8,302) 22,609 (67,897)
Deferred distribution costs and other assets (138,751) (107,471) (141,565)
Accrued expenses and other payables 5,114 171,002 170,509
Net (receivable) payable to New York Life
Insurance Company (463,035) 467 30,499
Policy and claim reserves (132,124) 11,029 143,096
Net income taxes payable (receivable) 16,305 1,604 (58,597)
Other liabilities 84,327 (13,285) 345
Net assets of dissolved subsidiaries - 66,553 (192,223)
----------- ----------- -----------
Net cash (used in) provided by operating activities (662,047) 205,758 (137,806)
Cash flow from investing activities:
Capital expenditures (45,363) (38,826) (51,446)
Proceeds from sale of investments 289,655 214,642 209,383
Purchase of investments (164,007) (165,089) (283,947)
Purchase of receivable from New York Life (1,252,023) (615,307) -
Proceeds from sale of subsidiaries, net of cash
sold and closing costs 851,332 2,766 138,497
Acquisition of subsidiaries, net of cash acquired (460,137) - (14,843)
Payments received on receivable from New York Life 884,728 115,526 -
Payments received on investments 2,537 8,693 45,653
Other 4,603 (1,045) 3,552
----------- ----------- -----------
Net cash provided by (used in) investing activities $ 111,325 $ (478,640) $ 46,849
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
162
<PAGE> 163
NYLIFE INC. AND SUBSIDIARIES
(affiliates of New York Life Insurance Company)
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
<TABLE>
<CAPTION>
For the Years ended December 31.
--------------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Cash flow from financing activities:
<S> <C> <C> <C>
Capital contributions $97,534 $95,471 $97,784
Dividends paid - - (35,250)
Borrowings net of repayments under line of credit agreements - (97,446) 53,378
Payments applied against capital leases - (527) (779)
Proceeds from issuance of debt 7,286,530 615,374 -
Principal repayment of debt (6,592,397) (122,839) (12,536)
Return of capital distribution (276,237) (124,900) -
Proceeds from issuance of shares by public subsidiary - - 52,592
Other (2,256) 2,124 (52,839)
----------- ---------- ----------
Net cash provided by financing activities 513,174 367,257 102,350
----------- ---------- ----------
Effect of exchange rates on cash (1,373) (3,042) 3,158
----------- ---------- ----------
Net (decrease) increase in cash and cash equivalents (38,921) 91,333 14,551
Cash and cash equivalents at beginning of period 401,565 310,232 295,681
----------- ---------- ----------
Cash and cash equivalents at end of period $362,644 $401,565 $310,232
=========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid (received) during the year for:
Income taxes $298,158 $(11,776) $50,245
----------- ---------- ----------
Interest expense $47,492 $10,998 $ 15,075
----------- ---------- ----------
Supplemental disclosure of non-cash financing activities:
Net capital contributions $(6,709) $5,613 $22,598
----------- ---------- ----------
Dividends declared but not paid $373,924 $ - $ -
----------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
163
<PAGE> 164
NYLIFE INC. AND SUBSIDIARIES
(AFFILIATES OF NEW YORK LIFE INSURANCE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE I - ORGANIZATION AND DESCRIPTION OF BUSINESS
The accompanying financial statements reflect the consolidation of NYLIFE Inc.
("NYLIFE Inc." or the "Company"), a wholly-owned subsidiary of New York Life
Insurance Company ("New York Life"), and its subsidiaries, each of which is
wholly-owned, except as noted:
Aegis Technologies, Inc. ("Aegis")
Avanti Corporate Health Systems Inc. ("Avanti")
Eagle Strategies Corp. ("Eagle")
Greystone Realty Corporation ('Greystone") (Discontinued in 1998)
MacKay-Shields Financial Corporation ("MacKay-Shields")
Madison Square Advisors, Inc. ("MSA")
MainStay Management, Inc. ("MainStay Management")
MainStay Shareholder Services Inc. ("MSSI")
Monitor Capital Advisors, Inc. ("Monitor Capital")
MSC Holding, Inc. ("MSC"), 85% owned
New York Life Benefit Services, Inc. ("Benefit Services")
New York Life Capital Corporation ("Capital Corp.")
New York Life International, Inc. ("International, Inc.")*
New York Life International Investment, Inc. ("NYL International")
NYL Management Limited
New York Life Irrevocable Trust of 1996 ("Trust")
New York Life Settlement Corporation ("NYLSET")
New York Life Trust Company ("NYL Trust")
New York Life UK Limited ("NYLUK")*
NYLCare NC Holdings, Inc. ("NC Holdings") (Discontinued in 1998)
NYLIFE Administration Corp. ("NYLACOR")
NYLIFE Depositary Corporation ("Depositary")
NYLIFE Distributors Inc. ("NYLIFE Distributors")
NYLIFE Equity Inc. ("NYLIFE Equity")(Dissolved in 1997)
NYLIFE Funding Inc. ("NYLIFE Funding")(Dissolved in 1998)
NYLIFE HealthCare Management Inc. ("NYLIFE HealthCare")
NYLCare Health Plans ("NYLCare")(Discontinued in 1998)
New York Life and Health Insurance Company ("NYLHIC")(Discontinued in
1998)*
Express Scripts Inc. ("ESI"), 45% owned
NYLIFE Realty Inc. ("NYLIFE Realty")(Dissolved in 1997)
NYLIFE Refinery Inc. ("NYLIFE Refinery")
NYLIFE Resources Inc. ("NYLIFE Resources")(Dissolved in 1998)
NYLIFE Securities Inc. ("NYLIFE Securities")
NYLIFE SFD Holding, Inc. ("SFD Holding")
Auto Funding II, LP ("Auto Funding")
NYLIFE Structured Asset Management Company, Ltd. ("SAMCO")
NYLINK Insurance Agency Corporation ("NYLINK")
NYLTemps Inc. ("NYLTemps")
WellPath of Arizona Reinsurance Company ("WellPath") (Discontinued in 1998)
* Denotes Life Insurance Operations
1
<PAGE> 165
NYLIFE Inc., through its subsidiaries, offers insurance products in certain
international markets; pharmacy benefit management services; investment
management, mutual fund, and pension products and services; securities brokerage
and the ability to raise capital. Until July 15, 1998, the Company offered
health insurance and managed care through NYLCare, which was sold to
Aetna, Inc. ("Aetna") (See Note 5).
International operations are conducted primarily through International, Inc.,
which markets life insurance and related products and services through joint
ventures and equity investments in Hong Kong, Korea, Indonesia, Mexico and
Argentina.
Pharmacy benefit management services are conducted through ESI, which markets
mail order prescriptions and provides pharmacy claims processing services.
Asset management operations primarily consist of institutional asset management
and mutual fund related products and services offered through MacKay-Shields,
Monitor Capital and MSA. Mutual fund distribution and administration services
are conducted through NYLIFE Distributors, MSSI and MainStay Management. Pension
and 401(k) products and related administrative and trust services are offered
through Benefit Services and NYL Trust.
Securities brokerage is conducted through NYLIFE Securities, whose operations
consist of the distribution of mutual fund products (including the MainStay
Funds through a soliciting dealer agreement with NYLIFE Distributors) and
registered products through New York Life's career agency force.
Capital raising operations are conducted through Capital Corp. which issues
commercial paper and borrows from other sources for the purpose of making loans
to New York Life and its affiliates.
BUSINESS COMBINATIONS:
NYLCare was established on January 1, 1996 when New York Life combined certain
of its existing group life and health indemnity insurance operations with those
of Sanus Corp. Health Systems, an indirect wholly-owned managed care subsidiary
of New York Life, and renamed the company. Concurrently, New York Life also
transferred its ownership in New York Life and Health Insurance Company
(NYLHIC), a wholly-owned life insurance subsidiary, to NYLCare.
Also on January 1, 1996, NYLHIC entered into a modified coinsurance agreement
through which it had assumed the risk on 90% of New York Life's group life and
health indemnity insurance business. Under the terms of the modified coinsurance
agreement, NYLHIC assumed the risk for group life and health policies issued by
New York Life; however, New York Life retained the reserves and related assets.
This modified coinsurance agreement was terminated on March 31, 1998.
For purposes of these financial statements, the combination has been treated as
a transaction between entities under common control and, accordingly,
stockholder's equity has been restated to reflect an increase of $105,505,000 as
of December 31, 1995.
On July 15, 1998, NYLCare was sold to Aetna (see Note 5).
2
<PAGE> 166
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING:
The accompanying statutory basis consolidated financial statements have been
prepared on the basis of accounting practices prescribed or permitted by the New
York State Insurance Department for valuing common stocks of subsidiaries (New
York statutory basis of accounting), which is a comprehensive basis of
accounting other than generally accepted accounting principles ("GAAP").
For non-insurance subsidiaries, New York accepts GAAP net equity as a valuation
basis, with certain adjustments for goodwill amortization. Goodwill arising from
the purchase of non-insurance subsidiaries is amortized over a period not to
exceed ten years. Under GAAP, this goodwill would be amortized over a period of
15 to 30 years. In 1993, New York Life received authorization from the New York
State Insurance Department to adopt approximate market value (subject to certain
liquidity adjustments) as the carrying value for its investment in Express
Scripts Inc., a publicly traded 45% owned subsidiary of NYLIFE HealthCare. This
practice is not recognized under GAAP.
The New York statutory basis of accounting for life insurance subsidiaries
varies from those prepared under GAAP primarily as follows: (1) the costs
relating to acquiring business, principally commissions and certain policy
issuance expenses, are charged to income in the year incurred, whereas under
GAAP, they would be deferred and amortized over the periods benefited; (2)
policy reserves are based on different assumptions than under GAAP and dividends
on participating policies are provided when approved by the Board of Directors,
whereas under GAAP, they are provided when credited to the policies; (3) policy
reserves are recorded net of reinsurance, whereas under GAAP, such amounts are
reported gross; (4) the excess of purchase price over statutory net assets
acquired is charged to stockholder's equity in the year of acquisition, whereas
under GAAP, an intangible asset is established and amortized over its useful
life; (5) investments in bonds are generally carried at amortized cost, whereas
under GAAP, investments in bonds which are considered available for sale or held
for trading are generally carried at market value, with changes in market value
charged against equity or reflected in earnings; (6) certain assets are
considered 'non-admitted and excluded from the statement of financial position,
whereas they are included under GAAP; (7) joint ventures and minority stock
investments are stated at the value of their underlying statutory net assets,
whereas under GAAP, such investments are stated on the equity basis; (8);
deferred federal income taxes are not provided for as they are under GAAP; and
(9) the results of discontinued operations are consolidated in each applicable
financial statement, whereas under GAAP, they are segregated from continuing
operations and reflected as discontinued operations in each financial statement.
The approximate effects on the financial statements of the variances between the
practices described in the preceding paragraphs and generally accepted
accounting principles are as follows: a decrease in net income of $73,000,000,
$4,000,000 and $17,000,000 for the years ending December 31, 1998, 1997 and
1996, respectively, a decrease in total assets of $479,000,000 and $122,000,000
at December 31, 1998 and 1997, respectively, and a decrease in stockholder's
equity of $490,000,000 and $123,000,000 as of December 31, 1998 and 1997,
respectively. The components comprising the differences in net income are
detailed in the chart on the following page (in thousands):
3
<PAGE> 167
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
GAAP Income before Discontinued Operations $(135,275) $116 $68,280
Discontinued Operations 380,137 (27,911) (20,447)
--------- --------- --------
GAAP Net Income 244,862 (27,795) 47,833
--------- --------- --------
Gain on Sale of NYLCare 66,000 - -
Goodwill Adjustments 9,000 1,000 1,000
Other Adjustment (2,000) 3,000 16,000
--------- --------- --------
Statutory Net Income $317,862 $(23,795) $64,833
========= ========= =======
</TABLE>
The consolidated statement of operations reflects the activities of purchased
subsidiaries from the acquisition date through the respective year-end date.
Intercompany accounts and transactions have been eliminated.
OTHER COMPREHENSIVE INCOME:
The following chart summarizes the components which would be included as other
comprehensive income:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
GAAP Net Income $244,862 $(27,795) $47,833
Cumulative translation adjustment 13 (1,412) 2,727
Net unrealized (losses) gains on
available for sale investments (1,272) 2,598 (2,939)
--------- --------- -------
Other Comprehensive Income $243,603 $(26,609) $47,621
========= ========= =======
</TABLE>
INVESTMENTS:
Short-term investments consist of commercial paper and are carried at cost which
approximates fair value. Common stocks are stated at market value. Bonds, other
than those associated with insurance operations, are either classified as held
to maturity and are reported at amortized cost or classified as available for
sale and are reported at estimated fair value, with unrealized gains and losses
reported as a separate component of stockholder's equity, net of deferred tax.
The investment in the MainStay Funds is recorded at fair value and is held by
MacKay-Shields and MainStay Management, investment advisors; MainStay
Shareholder Services, a transfer agent; and NYLIFE Securities and NYLIFE
Distributors, broker-dealers. In accordance with specialized accounting
practices for broker-dealers, unrealized gains and losses are included in net
income. Real estate is recorded at the lower of cost or fair value. Alarm
monitoring contracts are recorded at the lower of cost or fair value less cost
to sell. Investments in limited partnerships are generally accounted for under
the equity method of accounting. Under this method, net earnings or losses are
included in net income.
FAIR VALUES OF FINANCIAL INSTRUMENTS:
Fair values of various assets and liabilities are included throughout the notes
to financial statements. Specifically, fair value disclosure of bonds, real
estate and the investment in the MainStay Funds is reported in Note 6 and fair
value disclosure of notes payable is reported in Note 9. Fair values of bonds
and the investment in the MainStay Funds are based on published or quoted
market values, respectively.
4
<PAGE> 168
CASH AND CASH EQUIVALENTS:
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and have original maturities of three
months or less. The carrying value of cash and cash equivalents approximates
fair value.
ACCOUNTS RECEIVABLE:
The carrying value of accounts receivable approximates fair value.
DEFERRED DISTRIBUTION COSTS:
Deferred distribution costs relate to commission expenses and certain other
costs related to the distribution of MainStay Funds which have a contingent
deferred sales charge, and are deferred and amortized over a six year period on
a straight-line basis, adjusted for related contingent deferred sales charge
income earned.
FIXED ASSETS:
Fixed assets are recorded at cost and are depreciated over the estimated useful
lives of the assets, generally 3 to 10 years, using the double-declining balance
and straight-line methods of depreciation.
GOODWILL:
Goodwill represents the cost in excess of the value assigned to net assets
acquired in connection with acquisitions and is being amortized over 10 years,
unless deemed to be impaired, in which case it is written off to the extent
considered unrecoverable (see Note 4).
DERIVATIVE FINANCIAL INSTRUMENTS:
The Company, through its investment in ESI, has entered into an interest rate
swap agreement in order to manage exposure to interest rate risk (see Note 9).
ESI does not hold or issue derivative financial instruments for trading
purposes. The interest rate swap is designated as a hedge of ESI's variable
interest rate payments. Amounts received or paid are accrued as interest
receivable or payable and as interest income or expense. The fair value of
interest rate swap agreements is based on market prices. The fair value
represents the estimated amount ESI would receive or pay to terminate the
agreements taking into consideration current interest rates.
In June 1998, the Financial Accounting Standards Board ("the FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"). The Statement requires all
derivatives be recognized as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. In addition, the
Statement specifies the accounting for changes in the fair value of a derivative
based on the intended use of the derivative and the resulting designation. FAS
133 is effective for fiscal years beginning after June 15, 1999. ESI's present
interest rate swap would be considered a cash flow hedge. Accordingly, the
change in the fair value of the swap would be reported on the balance sheet as
an asset or liability. The corresponding unrealized gain or loss representing
the effective portion of the hedge will be initially recognized in stockholder's
equity, and subsequently any changes in unrealized gain or loss from the initial
measurement date will be recognized in earnings concurrent with the interest
expense on ESI's underlying variable rate debt. If ESI had adopted FAS 133 as of
December 31, 1998, ESI would record the unrealized loss of $7,209,000 as a
liability and reduction in stockholder's equity.
5
<PAGE> 169
POLICY AND CLAIM RESERVES:
Policy reserves are computed utilizing mortality tables and interest assumptions
which are consistent with the local statutory requirements of each respective
subsidiary and are considered to be sufficient to provide for contractual
benefits.
PARTICIPATING POLICYHOLDER LIABILITY:
The liability for participating policyholders consists principally of dividends
accrued as of the statement date. The allocation of dividends is determined by
means of formulas which reflect the relative contribution of each group of
policies to the results of operations.
ACCRUED EXPENSES AND OTHER PAYABLES:
The carrying value of accrued expenses and other payables approximates fair
value.
MEDICAL GROUPS' RISK SHARING:
NYLCare compensates primary care physicians on a capitation basis. NYLCare has
in place an incentive program whereby primary care physicians are eligible to
receive a bonus based on quality and cost utilization criteria. An accrual is
made for the estimate of the amount of bonus which will be paid to medical care
providers based upon quality cost utilization criteria.
NYLCare also has risk contracts with provider groups covering certain medical
services. To the extent medical expenses differ from budget, NYLCare and the
providers share any savings or deficit as defined in the contracts.
INCOME TAXES:
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109. Under this method, deferred tax assets and
liabilities are recognized for the expected future tax consequences/benefits,
utilizing current tax rates, of temporary differences between the carrying
amounts and the tax bases of assets and liabilities.
FOREIGN CURRENCY TRANSLATION:
Assets and liabilities denominated in foreign currency have been translated into
U.S. dollars at the respective year-end exchange rates. Operating results are
translated at the average exchange rates for the year. Foreign currency
translation gains and losses are credited or charged directly to the Cumulative
Translation Adjustment ("CTA") account in stockholder's equity. The change in
the CTA account is due to the current year effect of the translation adjustment.
Foreign currency transaction gains and losses are included in net income.
PREMIUM REVENUE RECOGNITION:
Premium revenue, net of reinsurance, for indemnity and managed health care and
other ancillary coverage is recorded as income over the premium paying period of
the policies. Revenue on premiums collected in advance is deferred.
6
<PAGE> 170
FEE INCOME:
Revenues from dispensing prescription and non-prescription medical products from
ESI's mail service pharmacies are recorded upon shipment. Revenue from sales of
prescription drugs by pharmacies in ESI's nationwide network and pharmacy claims
processing revenues are recognized when the claims are processed. When ESI has
an independent contractual obligation to pay its network pharmacy providers for
benefits provided to members of its clients pharmacy benefit plans, ESI includes
payments from plan sponsors for these benefits as prescription sales. Fees and
payments to these pharmacy providers are included as cost of prescription sales.
If ESI is only administering the plan sponsors' network pharmacy contracts, ESI
records fees derived from ESI's contracts with plan sponsors as net revenue.
Through its subsidiaries, the Company receives fees for services provided under
agreements with its clients. The Company accrues fee income when earned.
Consulting and management fees are recognized in income as services are
rendered. Additionally, the Company derives monitoring revenues from customer
payments for alarm monitoring services. The Company recognizes revenue as the
monitoring services are provided.
CLAIMS, BENEFITS AND CAPITATION COSTS:
Claims and benefits include estimates of payments to be made on individual
claims for medical and ancillary services and for death benefits. The cost of
claims incurred but not reported is estimated using actuarial techniques based
on current membership statistics, current utilization and historical claims data
and trends. These estimates are continually reviewed and revised as changes in
these factors occur and revisions are reflected in the current year's statement
of income. Capitation costs represent monthly charges paid to participating
physicians as compensation for providing continuing medical care.
COST OF PRESCRIPTION SALES:
Costs of prescription sales include product costs, pharmacy claims payments and
other direct costs associated with dispensing prescription and non-prescription
medical products and claims processing operations, offset by fees received from
pharmaceutical manufacturers in connection with ESI's drug purchasing and
formulary management programs.
RECLASSIFICATIONS:
Certain 1997 and 1996 amounts in the consolidated financial statements and
accompanying notes have been reclassified to conform with the 1998 presentation.
These reclassifications had no effect on net earnings or stockholders equity as
previously reported.
NOTE 3 - BUSINESS RISKS AND UNCERTAINTIES
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
7
<PAGE> 171
During 1993, New York Life received authorization from the New York State
Insurance Department to adopt approximate market value (subject to certain
liquidity adjustments) as the carrying value for its investment in ESI.
Accordingly, the Company recorded adjustments of $549,363,000 and $200,247,000
for the statutory valuation of ESI in excess of its GAAP net equity at December
31, 1998 and 1997, respectively. These adjustments are included as a component
of stockholder's equity. Based upon the market value of ESI's common stock at
March 15, 1999, the amount of the statutory valuation of the subsidiary in
excess of GAAP net equity was approximately $659,197,000. A significant decline
in the value of this stock could have an adverse effect on the Company's
stockholder's equity.
As providers of life and health insurance products, the operating results of
certain subsidiaries in any given period depend upon estimates of policy
reserves required to provide for future policyholder benefits. The development
of policy reserves for the products of these companies requires management to
make estimates and assumptions regarding mortality, morbidity, healthcare costs,
lapses, expense and investment experience. Such estimates, including provisions
for incurred but not reported claims, are primarily based on historical
experience and, at times, the specific requirements of local insurance
regulators. Actual results could differ materially from these estimates.
Management monitors actual experience, and, where circumstances warrant, revises
its assumptions and the related estimates of policy reserves and claim
liabilities.
As substantially all of the net assets of International, Inc.'s subsidiaries and
NYLUK are held in foreign countries, there is a potential for adverse impact on
net assets arising from economic and political changes in these countries.
See Note 14 for description of specific commitments and contingencies.
NOTE 4 - IMPAIRMENTS
DEFERRED DISTRIBUTION COSTS
In October of 1998, NYLIFE Distributors amortized an additional $52,648,000 of
deferred 12b- I distribution costs in order to more appropriately align the
deferred asset with the anticipated recoverable sales charges. This adjustment
was necessitated in part, by the occurrence of significant redemptions which
qualified for waiver of otherwise payable contingent deferred sales charges.
COMMON STOCK
On December 31, 1997, NYCare sold its 100% stock interest in Avanti Health
Systems of Texas, Inc. to FPA Medical Management, Inc. ("FPA"). NYLCare received
approximately 1,402,000 shares of FPA common stock with a market value of
$26,115,000 (see Note 5).
During the third quarter of 1998, FPA entered into bankruptcy proceedings. In
accordance with Statement of Financial Accounting Standard No. 115, the Company
determined that a provision for other than temporary impairment was required on
its investment in FPA and recorded a pre-tax realized loss of $26,115,000.
8
<PAGE> 172
LONG LIVED ASSETS
In accordance with Statement of Financial Accounting Standard No. 121 ("SFAS
121"), "Accounting for the Impairment of Long- lived Assets and for Long Lived
Assets to be Disposed Of", the following NYLIFE Inc. subsidiaries established
impairment reserves:
SFD HOLDING
Auto Funding II L.P. is a limited partnership formed for the purpose
of investing in a series of trusts (NAFCO Auto Trusts) consisting of
prime and non prime automobile loans. During the third quarter of
1998, Auto Funding II recorded a realized loss for its remaining
investments in the Trusts totaling approximately $6,700,000 before
taxes. In addition, during the fourth quarter of 1998, Auto Funding
II took an $11,500,000 pre-tax realized loss relating to the
anticipated exercise of its option to prepay the Investor
Certificateholders in NAFCO Auto Trusts-2, 3 and B. The write-offs
were necessitated by the continued unpredictability of the
underlying collateral in each of the Trusts. Going forward, Auto
Funding II will record all cash receipts from the Trusts as income
in the period received.
In 1997, Auto Funding II recorded a realized loss on its investment
in trusts of $4,600,000 and recorded a loss on related capitalized
costs associated with the investment of $2,600,000.
NYLIFE REFINERY
NYLIFE Refinery, Inc. determined that adverse market and operating
conditions and independent market value quotes were sufficient
indicators of a potential impairment for its investment in Refinery
Holding Corporation. As a result, NYLIFE Refinery recorded a pretax
realized loss of $6,010,000 and $17,219,000 on its investment in
limited partnerships for the years ended December 31, 1998 and 1997,
respectively.
BENEFIT SERVICES
In 1997, Benefit Services determined that projected operating losses
were indicators of potential impairment. These operating losses
indicated that a write-down of the goodwill related to the purchase
of this subsidiary was required. As a result, $4,381,000 of goodwill
that arose from the purchase of Benefit Services was written off in
1997.
NYLCARE
In 1996, NYLCare determined that continuing operating losses of
certain subsidiaries which perform administrative services for
physician groups, were indicators of potential impairment. Based
upon the estimated undiscounted cash flows anticipated from these
subsidiaries it was determined that a write-down of the goodwill
related to these subsidiaries was required. As a result of the
above, approximately $28,830,000 of goodwill and other intangibles
was written off in 1996.
NOTE 5 - ACQUISITIONS AND DISPOSITIONS
SALE OF NYLCARE
Through July 15, 1998, the Company offered health insurance and managed care
products which were sold to Aetna. The sale included the stock of the Company's
wholly owned healthcare subsidiary, NYLCare, including NYLHIC, a downstream
subsidiary of NYLCare. The sales price of $1,070,000,000 resulted in an
after-tax gain of $438,654,000.
9
<PAGE> 173
The following is summarized financial information of NYLCare included in the
consolidated statement of Financial Position and Statement of Operations (in
thousands).
<TABLE>
<CAPTION>
STATEMENT OF FINANCIAL POSITION 1998 1997
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ - $195,498
Premiums and accounts receivable - 331,727
Investments - 263,801
Fixed assets - 47,265
Other assets - 91,902
--------- ---------
Total assets - 930,193
Liabilities
Accrued HMO claims payable - 210,813
Policy & claims reserves - 153,513
Accrued expenses & other payables - 111,139
Other liabilities - 136,069
--------- -------
Total liabilities - 611,534
Net assets included in stockholder's equity $ - $318,659
======== ========
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues
Premium income $1,379,507 $2,765,107 $2,321,310
Premium (ceded) assumed on reinsurance settlement (569,687) - 478,149
Fee income 30,744 78,930 71,719
Other income 33,762 59,737 39,061
---------- ----------- -----------
Total revenue 874,326 2,903,774 2,910,239
Expenses
HMO claims and capitation costs 1,054,552 1,819,722 1,418,529
Health, disability and death benefit costs 159,092 630,661 554,865
Reserve transfer on reinsurance (ceded) assumed (569,687) - 478,149
Employee compensation 144,749 257,736 240,364
Selling, administrative and other expenses 71,172 232,259 239,436
--------- ---------- ----------
Total expenses 859,878 2,940,378 2,931,343
-------- ----------- ----------
Gain (loss) before income taxes 14,448 (36,604) (21,104)
Federal income tax expense (benefit) 7,452 (8,756) (743)
Minority interest 70 63 86
---------- ----------- ----------
Net income (loss) $6,926 $(27,911) $(20,447)
-========= =========== ==========
</TABLE>
10
<PAGE> 174
NYLIFE HEALTHCARE
On April 1, 1998, ESI acquired all of the outstanding capital stock of Value
Health, Inc. and Managed Prescriptions Network, Inc. (Collectively, the
"Acquired Entities") from Columbia/HCA HealthCare Corporation ("Columbia") for
approximately $460,000,000 in cash (which includes transaction costs and
executive management severance costs of approximately $15,000,000), of which
approximately $360,000,000 was obtained through a five year bank credit facility
and the remainder from ESI's cash balances and short term investments. At
closing, the Acquired Entities owned various subsidiaries that now or formerly
conducted a PBM business, commonly known as "ValueRx".
The acquisition has been accounted for using the purchase method of accounting
and the results of operations of the Acquired Entities have been included in the
consolidated financial statements since April 1, 1998. The purchase price has
been preliminarily allocated based on the estimated fair values of net assets
acquired at the date of the acquisition. The excess of purchase price over
tangible net assets acquired was originally allocated to other intangible assets
consisting of customer contracts and non-compete agreements in the amount of
$57,653,000, included in other assets, and goodwill in the amount of
$289,863,000, both of which are being amortized using the straight-line method
over 10 years. In conjunction with the acquisition, the Acquired Entities and
their subsidiaries retained the following liabilities (in thousands):
Fair value of assets acquired $656,488
Cash paid for the capital stock (460,137)
Liabilities retained $196,351
========
The following unaudited pro forma information presents a summary of combined
results of operations of NYLIFE Inc. and the Acquired Entities as if the
acquisition had occurred at the beginning of the period presented, along with
certain pro forma adjustments to give effect to amortization of goodwill, other
intangible assets, interest expense on acquisition debt and other adjustments.
The pro forma financial information is not necessarily indicative of the results
of operations as they would have been had the transaction been effected on the
assumed dates. Included in the pro forma information are integration costs
incurred by ESI that are being reported within selling, general and
administrative expenses in the statement of operations (in thousands).
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997
---- ----
<S> <C> <C>
Net revenues $5,263,720 $6,054,968
Net income (loss) 318,012 (23,537)
</TABLE>
On December 31, 1997, NYLCare sold its 100% stock interest in Avanti Health
Systems of Texas, Inc., its physician practice management company located in
Texas. NYLCare received approximately 1,402,000 shares of FPA Medical
Management, Inc. common stock with a market value of $26,115,000. NYLCare has
recorded a gain of $19,454,000 after adjusting for the costs related to the
sale.
In 1997, NYLCare sold substantially all of the operating assets and certain
liabilities of Avanti of the District, Inc., its physician management practice
company located principally in Maryland. NYLCare received $2,766,000 in cash,
resulting in a gain on the
sale of $478,000.
11
<PAGE> 175
In April 1996, ESI completed a public offering of 1,150,000 shares of Class A
common stock and received $52,592,000 in net proceeds. NYLIFE HealthCare
recognized a pre-tax gain of $27,835,000, representing the difference between
NYLIFE HealthCare s interest in the net assets of ESI immediately after the
public offering and the historical book value of its investment in ESI. As part
of the same stock offering, NYLIFE HealthCare converted 2,990,000 shares of ESI
Class B Common Stock to Class A Common Stock. Net proceeds from the sale totaled
$138,497,000 and a pre-tax gain of approximately $121,741,000 was recognized. As
a result of these transactions, NYLIFE HealthCare's ownership of ESI decreased
from 70% to 46% and its voting stock from 96% to 90%. Additional issuance of
shares in 1997 and 1998 reduced NYLIFE HealthCare's ownership to 45% and its
voting stock to 89%.
During 1996 and 1995, NYLIFE Inc. paid $7,076,000 and $10,800,000, respectively,
to the three original Founders of NYLIFE HealthCare to purchase their remaining
NYLIFE HealthCare shares in accordance with their Termination, Severance and
Stock Buyback Agreements. Subsequent to the purchase of these shares, NYLIFE's
ownership of NYLIFE HealthCare increased to 100%.
INTERNATIONAL, INC.
Effective December 31, 1998, International Inc. sold all of its common stock in
Bermuda to outside investors for consideration amounting to $3,812,000. The
assets, liabilities, premiums and net loss of Bermuda as of December 31, 1998
and 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Assets $15,963 $12,364
Liabilities $14,061 $11,795
Premiums $ 3,608 $ 8,945
Net loss $ 721 $ 2,325
</TABLE>
NYLUK
In March 1998, NYLUK contributed $9,909,000 to Life Assurance Holding
Corporation Limited ("LAHC"), a UK holding company in which NYLUK has an equity
interest, to fund the acquisition of GAN Life Holdings. As a result of
disproportionate contributions by other investors, NYLUK's interest in LAHC was
reduced from 31.25% to 22.8%. Accounting practices prescribed or permitted by
the New York State Insurance Department require the excess of purchase price
over statutory net assets acquired to be charged directly to stockholder's
equity. In accordance with this guidance, NYLUK reduced its investment in LAHC
by $43,960,000 following the purchase of GAN Life Holdings.
NYLIFE FUNDING/NYLIFE RESOURCES
On February 28, 1998, the Board of Directors of NYLIFE Funding and NYLIFE
Resources Inc. approved plans to voluntarily dissolve these companies. During
1998, NYLIFE Funding and NYLIFE Resources have had no present operations and
have returned capital to NYLIFE Inc. totaling $4,100,000 and $2,018,000,
respectively.
GREYSTONE
In January 1998, management of the company decided to transfer the asset and
property management functions performed by Greystone to New York Life and
liquidated Greystone. As a result, all third party management agreements have
been terminated and Greystone has incurred various expenses including employee
severance and office closure expenses.
12
<PAGE> 176
MSA
On November 13, 1997, MSA was created to act as investment advisors over three
New York Life separate accounts. MSA was funded with a $25,000 subscription
receivable. A $25,000 cash contribution was made in January of 1998.
MAINSTAY MANAGEMENT
On August 22, 1997, MainStay Management was created to oversee the portfolio
management services provided by MacKay- Shields, Monitor Capital, MSA, and New
York Life and for managing the MainStay Funds business affairs. MainStay
Management was funded with a $1,000,000 cash contribution and $1,210,000 of
furniture and equipment.
MSSI
On March 4, 1997, MSSI was created to assume certain shareholder servicing
functions previously handled by NYLIFE Distributors. MSSI was funded with a
$2,000,000 cash contribution and $912,000 of furniture and equipment.
MSC
During 1995, the assets of the Health and Investment Divisions of MSC were sold
to Meritech, a subsidiary of Summit Technologies and Melson Technologies, an
indirect subsidiary of Aegon Insurance, respectively. Meritech purchased the
Health Division assets for approximately $750,000 which included contracts,
licenses, equipment and various receivables. Melson Technologies purchased the
Investment Division assets for a purchase price contingent upon the amount of
licencing fees the buyers receive over the next 10 years relating to the SMS
Investment System. $1,000,000 of the purchase price is guaranteed, and will be
received within 5 years or within 1 year after the assets were sold. In 1997,
the assets were sold to SS&C Technologies, activating the acceleration clause.
As of December 1998, $75,000 has been received. The remaining $925,000
receivable is expected to be settled in 1999. A total gain of approximately
$1,695,000 was recognized on these transactions.
NYLINK
NYLINK was incorporated in Delaware in November 1996. NYLINK commenced
operations in 1998 and its activities primarily consist of the facilitation of
the sale of non-proprietary insurance products by New York Life registered
representatives.
NYL MANAGEMENT LTD.
On June 18, 1996, Quorum Capital Management Ltd. ("Quorum") transferred its
assets and business operations to Westdeutsche LandesBank (West LB) for
approximately $1,125,000. A gain of approximately $969,000 was recognized on
this transaction. Quorum subsequently changed its name to NYL Management Ltd.
and substantially ceased on-going operations.
AEGIS
In December 1995, the Aegis Board of Directors approved a plan to close the
business and dissolve Aegis in the event a suitable buyer could not be found. On
March 5, 1996, the decision to dissolve Aegis and its subsidiary, Personal
Financial Assistant Financial Centers was announced. The assets were liquidated
and a loss of $5,420,000 was recognized. Aegis is expected to be
formally dissolved in 1999.
13
<PAGE> 177
OTHER
In 1995, New York Life, NYLIFE Inc., and certain other affiliated and
unaffiliated entities, entered into a Stipulation of Settlement (the "Settlement
Agreement") of a class action lawsuit related to the sale of units in, and the
operation of, the Company's proprietary limited partnership programs. In
connection with the Settlement Agreement, New York Life announced a plan to
dissolve the partnership programs ("the Plan"), contingent upon the consent of
the Limited Partnership Investors (the "Investors"). In 1995, NYLIFE Inc.
recorded a provision of $137,000,000 to reflect the estimated costs of
dissolving the partnership operations and certain claims in connection
therewith, including settlement of the class action lawsuit. Both the Settlement
Agreement and the Plan were approved during 1996. Final settlement costs totaled
$121,000,000 and, as a result, a corresponding $16,000,000 pre-tax gain was
recorded in 1997 and is included in other income.
Pursuant to the Plan, NYLIFE Equity and NYLIFE Realty, as liquidators,
finalized the process of winding up the partnership programs. All of the
property interests of the partnership programs were sold prior to September 30,
1997. As of September 30, 1997, pursuant to the Settlement Agreement, NYLIFE
Inc. advanced $173,000,000 to the Investors and paid $35,652,000 to other
unaffiliated entities for costs of the liquidation, primarily from the proceeds
from a $200,000,000 line of credit with New York Life. In addition, NYLIFE Inc.
recovered $87,723,000 from the liquidation of the partnership programs.
NYLIFE Equity and NYLIFE Realty were dissolved on September 30, 1997, whereby
each entity disbursed its remaining funds and transferred its net assets to
NYLIFE Inc. Closing returns of capital totaled $8,888,000 and $2,579,000 for
NYLIFE Equity and NYLIFE Realty, respectively.
NOTE 6 - INVESTMENTS
COMMON STOCK:
At December 31, 1998 and 1997, the distribution of unrealized gains on common
stock was as follows (in thousands):
<TABLE>
<CAPTION>
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---- ----- ------ ----------
<S> <C> <C> <C> <C>
1998 $6,397 $686 $- $7,083
====== ==== == ======
1997 $26,126 $4 $- $26,130
======= == == =======
</TABLE>
14
<PAGE> 178
BONDS:
At December 31, 1998, the maturity distribution of bonds was as follows (in
thousands):
<TABLE>
<CAPTION>
Insurance
Available for Sale Held to Maturity Operations
------------------ ---------------- ----------
Amortized Estimated Amortized Estimated Statement Estimated
Cost Fair Value Cost Fair Value Value Fair Value
--------- ---------- --------- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C>
Due in one year or less $ 1,499 $1,503 $ -- $ -- $2,752 $2,758
Due in years two through five 1,147 1,165 -- -- 30,731 30,813
Due in years six through ten -- -- -- -- 22,160 22,824
Due after ten years 1,291 1,300 4,119 5,007 14,422 15,109
----- ----- ----- ----- ------ ------
Total $ 3,937 $3,968 $4,119 $5,007 $70,065 $71,504
======= ====== ====== ====== ======= =======
</TABLE>
At December 31, 1998 and 1997, the distribution of unrealized gains and losses
on bonds was as follows (in thousands):
DECEMBER 31, 1998
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Estimated
Available for Sale Cost Gains Losses Fair Value
- ------------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Governmental Agencies $ 3,937 $ 31 $ - $ 3,968
======= ==== === =======
Amortized Unrealized Unrealized Estimated
Held to Maturity Cost Gains Losses Fair Value
- ---------------- --------- ---------- ---------- ----------
U.S. Treasury and other
U.S. Governmental Agencies $ 4,119 $ 888 $ - $ 5,007
======= ===== === =======
Statement Unrealized Unrealized Estimated
Value Gains Losses Fair Value
--------- ---------- ---------- ----------
Insurance Operations:
U.S. Treasury $ 7,231 $ -- $ 55 $ 7,176
Foreign Governments 26,211 1,530 12 27,729
Corporate 36,623 133 157 36,599
Other -- -- -- --
--------- ---------- -------- ----------
Total $70,065 $1,663 $224 $71,504
======= ====== ==== =======
</TABLE>
15
<PAGE> 179
DECEMBER 31, 1997
<TABLE>
<CAPTION>
Available for Sale Amortized Unrealized Unrealized Estimated
- ------------------ Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Governmental Agencies $ 85,691 $ 785 $ 81 $ 86,395
Commercial paper and Corporate notes 149,456 1,819 258 151,017
Other 4,057 -- -- 4,057
Certificates of deposit 228 -- -- 228
--------- ----------- -------- ------------
Total $239,432 $2,604 $ 339 $241,697
======== ====== ===== ========
Held to Maturity Amortized Unrealized Unrealized Estimated
- ---------------- Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
U.S. Treasury and other $ 4,119 $ 495 $ -- $4,614
======= ===== ==== ======
U.S. Governmental Agencies
Insurance Operations Amortized Unrealized Unrealized Estimated
- -------------------- Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
U.S. Treasury $ 548 $ -- $ 11 $ 537
Foreign Governments 16,520 1,809 12 18,317
Corporate 19,738 2,000 231 21,507
Other 13,447 289 4 13,732
-------- -------- ------- --------
Total $50,253 $4,098 $258 $54,093
======= ====== ==== =======
</TABLE>
Proceeds from investments in bonds sold, matured, or repaid were $162,850,000,
$82,038,000, and $182,786,000, for 1998, 1997 and 1996, respectively. Realized
gains from investments in bonds sold, matured, or repaid were $7,578,000, $0,
and $705,000 for 1998, 1997 and 1996, respectively, and realized losses were
$88,000, $89,000, and $12,000 for 1998, 1997 and 1996, respectively.
There were no restricted securities as of December 31, 1998. Investment in bonds
included $83,401,000 of restricted securities on deposit to meet solvency
requirements of various insurance departments, for 1997.
REAL ESTATE:
On January 8, 1998, NYLUK sold its freehold land and buildings and its finance
lease, including the property under the finance lease, to Windsor Life Assurance
Company Limited (which is 22.8% indirectly owned by NYLUK through its investment
in LAHC) resulting in no gain.
At December 31, 1997, real estate totaled $11,359,000.
During 1997 NYLIFE Funding sold its remaining three properties and recorded a
realized loss of $9,526,000. During 1996, NYLIFE Funding foreclosed on two
delinquent mortgage loans and transferred them at their appraisal value to real
estate recording a realized gain of $773,000.
16
<PAGE> 180
MAINSTAY FUNDS:
At December 31, 1998 the total investment in the MainStay Funds includes
investments in individual funds as follows (in thousands):
<TABLE>
<CAPTION>
Fund Cost Fair Value
- ----------------------------- ---- ----------
<S> <C> <C>
California Tax Free $2,830 $2,806
Capital Appreciation 176 350
Convertible 109 130
Corporate Bond 89 91
Equity Index 135 386
Institutional Growth 272 388
International Equity 6,303 7,692
International Bond 7,822 8,242
High Yield Corporate Bond 119 128
Short-Term Bond 4,134 4,014
New York Tax Free 5,200 5,137
Strategic Income/Value 5,700 5,533
Total Return 76 135
Value 681 590
------- -------
Total 1998 $33,646 $35,622
======= =======
Total 1997 $41,557 $41,665
======= =======
</TABLE>
SECURITY ALARM CONTRACTS:
All of SAMCO's security alarm monitoring contracts were sold during 1998
resulting in a pre-tax gain of $16,600,000. The carrying amount of security
alarm monitoring contracts held for sale as of December 31, 1997 includes
Contracts collateralizing Series A, B, and C Notes (see Note 9) as follows (in
thousands):
<TABLE>
<CAPTION>
1997
----
<S> <C>
Series A $ 7,821
Series B 3,374
Series C 22,985
--------
Total $34,180
</TABLE>
Prior to the reclassification of the Contracts as held for sale effective
December 30, 1996, the Contracts were being amortized over an estimated life of
12 years, as adjusted for lapsed Contracts. Amortization expense for the period
January 1, 1996 to December 30, 1996 for Series A, B and C Contracts was
$9,924,000.
TIME DEPOSITS:
Time deposits, included in cash and cash equivalents, at December 31, 1998 and
1997, amounted to $6,077,000 and $5,625,000, respectively.
OTHER INVESTMENTS:
Other investments include interests in limited partnerships which consist
primarily of an oil refinery and oil and gas producing properties valued at
$5,574,000 and $13,117,000 at December 31, 1998 and 1997, respectively. The 1998
and 1997 values include a pre-tax impairment loss of $6,010,000 and $17,219,000,
respectively, in accordance with SFAS 121 (see Note 4).
17
<PAGE> 181
NOTE 7 - FIXED ASSETS
At December 31, 1998 and 1997, fixed assets, at cost, are comprised of the
following (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Furniture $ 21,903 $29,571
Equipment 47,017 51,124
Computer hardware 14,171 44,260
Computer software 38,270 18,326
Leasehold improvements 19,342 17,901
Other 6,724 3,618
----- -----
147,427 164,800
Less accumulated depreciation and amortization 43,976 84,445
------ ------
Total $103,451 $80,355
======== =======
</TABLE>
NOTE 8 - POLICY AND CLAIM RESERVES
On January 1, 1996, in accordance with the terms of the initial settlement of
the modified coinsurance agreement, New York Life transferred $478,149,000 to
NYLHIC representing reserves and an equal amount of premiums on existing
business. NYLHIC immediately retransferred the reserves back to New York Life.
As a result of the above transactions, NYLHIC recorded premiums assumed and an
increase in reserves on the initial settlement of $478,149,000 in the statement
of operations.
The modified coinsurance reserve retained by New York Life related to the
reinsured group life and health indemnity business was $568,105,000 at December
31, 1997. The liability for unpaid group health indemnity claims incurred in the
year ended December 31, 1997 related to prior years was immaterial.
On March 31, 1998, in connection with the sale of NYLCare (Note 5), the modified
coinsurance agreement with New York Life was terminated. In accordance with the
terms of the final settlement, NYLHIC transferred $569,687,000 to New York Life
representing reserves and an equal amount of premiums on existing business. As a
result of the above transaction, NYLHIC recorded premiums ceded and a decrease
in reserves on the final settlement of $569,687,000 in the statement of
operations.
NOTE 9 - NOTES PAYABLE
Notes payable, generally carried at the unpaid principal balance, consisted of
the following at December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Short-term notes payable $ 865,906 $500,708
International-Loan from Windsor Life - 5,075
Series A and B, Floating Rate Secured Five Year Notes - 16,216
Series C 9% Fixed Rate Secured Five Year Notes 20,578 24,548
Loans payable to New York Life 24,704 29,474
Bank borrowings and revolving line of credit with financial institutions 306,000 -
Other (including current portion) 54,014 1,909
---------- --------
Total $1,271,202 $577,930
========== ========
</TABLE>
The carrying value of notes payable approximates fair value.
18
<PAGE> 182
Short-term notes payable consist of Capital Corp's debt balance at December 31,
1998 and 1997. The weighted average cost of short-term notes payable was
approximately 5.19% and 5.75% at December 31, 1998 and 1997, respectively.
The Series A and B Floating Rate Secured Five Year Notes matured on February 17,
1998 and August 17, 1998, respectively. All outstanding principal and accrued
interest was paid from the proceeds on the sale in February 1998 and August 1998
of the security alarm monitoring contracts and related assets, which constituted
the collateral securing these notes.
The $20,578,000 of Series C 9% Fixed Rate Secured Five Year Notes were secured
by Series C alarm monitoring contracts, which were sold on December 17, 1998. A
portion of the proceeds of the sale were used to purchase United States
Government Obligations with an aggregate value sufficient to pay principal and
interest to the Series C noteholders on the remaining distribution dates of
February 16, May 17, and August 16, 1999. Under Section 7.1(b) of the Indenture,
upon the aforesaid deposit and satisfaction of certain other conditions, the
Company is entitled to be relieved of its obligations under the Series C Notes,
the Indenture and the Security Agreement. (See Note 17)
On November 1, 1993, SFD Holding entered into a loan agreement with New York
Life. The agreement allows SFD Holding to borrow money pursuant to one or more
master notes (individually, a "Master Note," collectively, "Master Notes"), each
of which will not exceed one year in maturity and for amounts, in aggregate, not
to exceed $35,000,000 at any one time. Interest on any Master Note borrowing
accrues at the rate which is the annual simple interest equivalent (computed on
the actual daily principal balance based on a 360 day year of twelve 30-day
months) of 225 basis points above the one month London Interbank Offered Rates
("LIBOR") published in the Wall Street Journal on the 15th day of the preceding
calendar month (or if such day is not a day on which such newspaper is
published, the next succeeding day of such publication). In 1995, the loan
agreement between SFD Holding and New York Life was amended to accommodate the
acquisition of prime auto loans. The amendment provides for the following: (i)
an increase in the maximum borrowings to $70,000,000, (ii) an interest rate of
200 basis points above the one month LIBOR for borrowings related to prime auto
loan acquisitions, and (iii) a change in the monthly interest payment date to
the 20th of each month. During 1998, 1997 and 1996, SFD Holding made interest
payments totaling $2,183,000, $2,396,000 and $2,805,000, respectively, to New
York Life pursuant to the Master Notes. At December 31, 1998, 1997 and 1996, the
amounts outstanding under the Master Note are $24,704,000, $29,474,000 and
$22,089,000, respectively. Accrued interest at December 31, 1998 and 1997 is
$160,000 and $203,000, respectively.
In January 1995, NYLIFE Inc. entered into a credit agreement, expiring January
1, 1999, with New York Life whereby NYLIFE Inc. can borrow up to an aggregate
principal amount of $200,000,000 at any one time. This agreement and any loans
made shall be automatically extended and renewed for additional one year
periods, unless either NYLIFE Inc. or New York Life notifies the other to
terminate the agreement. At December 31, 1998 and 1997 there was no outstanding
principal under this agreement. Interest expense amounted to $8,000, $1,847,000
and $2,598,000 in 1998, 1997 and 1996, respectively.
Along with New York Life, Capital Corp. is party to a credit agreement with a
consortium of banks. On August 5th, 1998, the Company's lines of credit were
increased and extended. The new credit agreement consists of a $300,000,000, 364
day revolving credit facility ("Facility A"), and a $700,000,000, 5 year
revolving credit facility ("Facility B"). Annual facility fees are .04% and
.06%, for Facility A and B, respectively, and borrowing rates are capped at
spreads of .16% and .14% over LIBOR, respectively. In addition, the credit
agreement contains various covenants pertaining to allowable activities of
Capital Corp. Neither Capital Corp. nor New York Life have utilized the credit
facility to date.
19
<PAGE> 183
On April 1, 1998, ESI entered into a $440,000,000 credit facility with a bank
syndicated by Bankers Trust Company, consisting of a $360,000,000 term loan
facility and an $80,000,000 revolving loan facility. The credit facility expires
on April 15, 2003 and is guaranteed by certain ESI domestic subsidiaries and
secured by pledges of 100% (or, in the case of foreign subsidiaries 65%) of the
capital stock of those subsidiaries. The provision of this loan requires
quarterly interest payments and, beginning in April 1999, semiannual principal
payments. The current rate is passed on a spread ("Credit Rate Spread") over
several LIBOR or base rate options, depending upon ESI's ratio of earnings
before interest, taxes, depreciation and amortization to debt ("Leverage
Ratio"). At December 31, 1998, the interest rate was 6.0625%, representing a
credit rate spread of 0.75% over the three month LIBOR rate. The credit facility
contains covenants that limit the indebtedness ESI may incur and the amount of
annual capital expenditures. The covenants also establish a minimum interest
coverage ratio, a maximum leverage ratio, and a minimum consolidated net worth.
At December 31, 1998, ESI was in compliance with all covenants. In addition, ESI
is required to pay an annual fee depending on the leverage ratio, payable in
quarterly installments, on the unused portion of the revolving loan. The
commitment fee was 22.5 basis points at December 31, 1998. There were no
borrowings at December 31, 1998 under the revolving loan facility. The carrying
amount of ESI's term loan facility approximates fair value.
In conjunction with the credit facility and as part of ESI's policy to manage
interest rate risk, ESI entered into an interest rate swap agreement ("swap")
with The First National Bank of Chicago, a subsidiary of Bank One Corporation,
on April 3, 1998. At December 31, 1998, the swap had a notional principal amount
of $360,000,000. Under the terms of the swap, ESI agrees to receive a floating
rate or interest on the amount of the term loan facility based on a three month
LIBOR rate in exchange for payment of a fixed rate of interest of 5.88% per
annum. The notional principal amount of the swap amortizes in equal amounts with
the principal balance of the term loan facility. As a result, ESI has, in
effect, converted its variable rate term debt to fixed rate debt at 5.88% per
annum for the entire term of the term loan facility, plus the Credit Rate
Spread.
The following represents the schedule of current maturities for the term loan
facility as of December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31, Principal Repayment
----------------------- -------------------
<S> <C> <C>
$54,000
1999 72,000
2000 90,000
2001 96,000
2002 48,000
------
2003 $360,000
</TABLE>
Prior to April 1, 1998, ESI maintained a $25,000,000 unsecured line of credit
with Mercantile Bank National Association which was terminated upon the
consummation of The Bankers' Trust credit facility. Additionally, ESI allowed
another line of credit in the amount of $25,000,000 to lapse on October 31,
1997. At December 31, 1997, ESI had no outstanding borrowings under this
agreement, nor did it borrow any amounts under these agreements during 1997.
20
<PAGE> 184
NOTE 10 - REINSURANCE
MODIFIED COINSURANCE:
In 1996, NYLHIC entered into a modified coinsurance agreement with New York
Life, whereby 90% of New York Life's group life and health indemnity insurance
business was reinsured with NYLHIC. On March 31, 1998, the reinsurance agreement
with New York Life was terminated. For the three years ended December 31, 1998,
1997 and 1996, NYLHIC recorded the following activity under the reinsurance
agreement (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Premiums and fees assumed $177,826 $739,854 $613,632
Benefits 159,099 603,814 507,055
Commission and expense allowance 32,752 140,022 142,725
Modco reserve adjustment (2,859) 35,602 (13,135)
</TABLE>
Settlement on the net amount due is made 90 days after the end of each quarter.
Accordingly, at December 31, 1997 and 1996, NYLHIC recorded the following
amounts representing fourth quarter activity under the reinsurance agreement (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Deferred and uncollected premiums and fees $ - $183,970 $191,922
Claims payable - (143,206) (143,096)
Commission and expense allowances payable - (34,762) (34,191)
Dividends due and unpaid - (11,613) (27,777)
Payable on reinsurance assumed - (39,608) (26,507)
</TABLE>
OTHER REINSURANCE:
Certain subsidiaries enter into reinsurance agreements in the normal course of
their insurance business. Reinsurance on certain individual lives is ceded to
reduce the risk on any one life. These subsidiaries remain liable for the
reinsurance ceded, if the reinsurer fails to meet its obligations. Premiums
ceded by these subsidiaries for the years ended December 31, 1998, 1997 and 1996
in connection with reinsurance agreements totaled $30,307,000, $28,616,000 and
$29,434,000, respectively. Policy reserves are recorded net of reinsurance
receivables of $974,000 and $8,434,000 at December 31, 1998 and 1997,
respectively.
NOTE 11 - RELATED PARTY TRANSACTIONS
NYLIFE and several of its subsidiaries are party to a service agreement with New
York Life, whereby New York Life provides services to NYLIFE and such
subsidiaries, including office space, legal, accounting, administrative,
personnel and other services for which NYLIFE and its subsidiaries are billed.
NYLIFE and its subsidiaries are charged for these services based upon (a) actual
costs incurred, where they are separately identifiable and (b) allocation of
costs incurred by New York Life developed through analyses of time spent on
matters relating to NYLIFE and its subsidiaries.
21
<PAGE> 185
Investment management fees of $72,620,000, $54,017,000, and $40,864,000, were
received from New York Life and certain of its affiliates during the years ended
December 31, 1998, 1997 and 1996, respectively.
Certain subsidiaries earned premiums and fees related to health care services
provided to New York Life of approximately $9,910,000, $15,526,000, and
$14,447,000 in 1998, 1997 and 1996, respectively.
NYLACOR has an agreement with New York Life, whereby all the expenses incurred
by New York Life sales agents to market the New York Life long term care product
are paid by NYLACOR and reimbursed by New York Life. These expenses and the
associated reimbursements for the years ended December 31, 1998, 1997 and 1996,
totaled $2,968,000, $6,200,000, and $5,859,000, respectively.
As a distributor of mutual funds, NYLIFE Distributors has entered into
agreements with the MainStay Funds, pursuant to Rule 12b-1 under the Investment
Act of 1940, to compensate it for the distribution expenses it incurs. Although
the plans are required to be approved annually by the Trustees of the Funds, the
management of NYLIFE Distributors believes that such annual approval will
continue indefinitely. Distribution fee income for 1998, 1997 and 1996, was
$75,376,000, $49,248,000 and $36,826,000, respectively. At December 31, 1998 and
1997 receivables from the MainStay Funds approximated $10,486,000 and
$10,153,000, respectively for distribution, services and administration fees.
NYLIFE Securities earned commission revenue of approximately $117,446,000,
$85,690,000 and $61,438,000 on transactions with affiliates during 1998, 1997
and 1996, respectively.
On July 15, 1998, the Company entered into a loan agreement with New York Life,
whereby the net proceeds from the sale of NYLCare would be retained by New York
Life until the Company declared a return of capital or paid a dividend. During
1998, the Company received interest income in connection with this loan of
$13,387,000 from New York Life. On November 30, 1998, the Company returned
capital of $276,238,000 and declared a dividend (payable on January 4, 1999) of
$373,924,000. (The Company declared a dividend under Section 510 of the New York
State Business Corporation Law, which states that a company may declare a
dividend as long as its net assets exceed its stated capital, defined as the par
value of common stock outstanding). At December 31, 1998, the amount due from
New York Life as a result of the NYLCare sale is $447,356,000.
On October 1, 1997, Capital Corp. entered into a credit agreement (amended
August 5, 1998) with New York Life, whereby Capital Corp. has agreed to make
loans to New York Life in an aggregate principal amount at any time outstanding
of up to but not exceeding $1,000,000,000. This agreement and any loans made
shall be automatically extended and renewed for additional one year periods,
unless either Capital Corp. or New York Life notifies the other to terminate the
Agreement. At December 31, 1998 and 1997, loans to New York Life were
$867,077,000 and $499,781,000, respectively. During 1998 and 1997, New York Life
made interest payments totaling $28,335,000 and $1,443,000, respectively.
Interest receivable at December 31, 1998 and 1997 totaled $3,697,000 and
$2,422,000, respectively.
As of October 27, 1997, MainStay Management began to serve as Manager to each of
the MainStay Retail Funds and, as of November 22, 1997, as Manager to each of
the Institutional Funds (collectively, the "Funds") pursuant to a Management
Agreement with the Funds. MainStay Management assumed responsibility for
oversight of the portfolio management services provided by the Subadvisers
(MacKay-Shields, MSA, Monitor Capital and New York Life) and for managing the
Funds' business affairs, which includes furnishing the Funds with office
facilities and providing ordinary clerical, recordkeeping and bookkeeping
services. As Manager of the Funds, MainStay Management receives a fee which
ranges between .50% and 1.00% of the average daily net assets of affiliated
funds.
22
<PAGE> 186
Management fees for 1998 and 1997 were $96,016,000 and $14,109,000,
respectively. As the Accounting Service Agent, MainStay Management receives a
separate fee which generally is less than .05% per Fund on an annual basis. Such
fees for 1998 and 1997, were $1,593,000 and $249,000, respectively.
MSSI is the transfer agent and shareholder servicing agent for The MainStay
Funds. MSSI provides shareholder services and acts as the transfer agent for the
Fund's authorized and issued shares of beneficial interest, dividend disbursing
agent and agent in connection with any accumulation, letter of intent or similar
purchase plans provided to shareholders of record to the Fund and set out in the
Prospectus and Statement of Additional Information. For performance of transfer
agent and servicing duties, the Fund agrees to pay MSSI an annual maintenance
fee for each shareholder account. Transfer agent fees earned by the Company
amounted to $23,934,000 and $9,935,000 during 1998 and 1997, respectively.
Greystone had a non-interest bearing intercompany payable of $1,538,000 at
October 31, 1997. During 1998, Greystone paid a total of $1,138,000 to New York
Life. In connection with the New York Life decision to liquidate Greystone (see
Note 5) the remaining $400,000 balance was forgiven by New York Life and is
included in net income. During 1997, NYLIFE Funding received cash of $6,701,000
for transferring a mortgage loan (with the same statement value) to New York
Life Insurance and Annuity Corporation, a wholly-owned subsidiary of New York
Life. The cash in this transaction was used to return capital of $6,700,000 to
New York Life.
NOTE 12 - FOREIGN OPERATIONS
NYLIFE subsidiaries conduct insurance and investment management operations in
the United Kingdom, Argentina, Bermuda (sold on December 31, 1998), Hong Kong,
Japan, Korea, Indonesia and Mexico. The assets, liabilities, and net income of
these foreign operations at December 31, 1998 and 1997 and for the years then
ended are as follows (in thousands):
<TABLE>
<CAPTION>
Consolidated Subsidiaries:
- --------------------------
1998 1997
---- ----
<S> <C> <C>
Assets $143,432 $151,690
Liabilities 215,962 128,442
Revenue 53,729 39,639
Net Loss (103,243) (20,225)
Non-consolidated Subsidiaries
- -----------------------------
1998 1997
---- ----
Assets $10,733,053 $4,165,310
Liabilities 10,220,584 4,000,338
Revenue 802,846 371,226
Net Income (Loss) 83,631 (2,816)
</TABLE>
The cumulative translation adjustments for 1998, 1997 and 1996 are $2,451,000,
$2,438,000 and $3,850,000, respectively.
Dividend income earned by NYLUK, a wholly owned subsidiary of NYLIFE Inc., on
its investment in LAHC was $0, $5,136,000 and $3,673,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
23
<PAGE> 187
The Company, through its investment in NYLUK, became subject to sales practice
regulation and remediation in the United Kingdom with respect to the sale of
personal pension plans between April 29, 1988 and June 30, 1994.
As part of NYLUK's sale of its common stock of Windsor Life Assurance Company to
LAHC in 1994, NYLUK became party to a Warranty and Indemnity Deed (guaranteed by
NYLIFE Inc) which indemnified the outside investors against liabilities, costs
and expenses with regard to specified matters, including the sale of personal
pension plans between 1988 and 1994. In August, 1998, the Financial Service
Authority and the Personal Investment Authority issued a joint policy statement
on the next phase of the pension sales practices review and redress program. The
extension of this review and redress program will lead to additional claims
against NYLUK for the expenses incurred in connection with the extension of this
program. Based on this policy statement, NYLUK established $91,845,000 of
reserves in 1998, bringing the total reserve established to $122,734,000.
Through December 31, 1998, $15,009,000 in claims have been paid, reducing the
reserve reflected on the balance sheet to $107,725,000.
NOTE 13 - INCOME TAXES
NYLIFE Inc. and its 80% or more owned domestic subsidiaries are members of an
affiliated group which joins in the filing of a consolidated federal income tax
return with New York Life. The consolidated income tax provision or benefit is
allocated among the members of the group in accordance with a tax allocation
agreement. The tax allocation agreement provides that each member of the group
is allocated its share of the consolidated tax provision or benefit determined
generally on a separate return basis, but may, where applicable, recognize the
tax benefits of net operating losses or capital losses utilizable in the
consolidated group. Estimated payments for taxes are made between the members of
the consolidated group during the year. State, local, and foreign tax returns
are filed separately. The income tax receivable included $2,493,000 and
$5,983,000 due from New York Life as of December 31, 1998 and 1997,
respectively, pursuant to the tax allocation agreement.
The components of income tax expense (benefit) for each year are as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current
Federal $271,672 $(4,621) $(20,135)
State 31,391 12,471 8,973
Foreign 534 470 190
--------- -------- ---------
Total Current 303,597 8,320 (10,972)
--------- -------- ---------
Deferred
Federal (3,923) 13,230 86,686
State 3,193 379 611
Total Deferred (730) 13,609 87,297
--------- -------- ---------
Total $302,867 $21,929 $76,325
========= ======== =========
</TABLE>
24
<PAGE> 188
Total income tax expense (benefit) is different from the amount computed using
the statutory federal tax rate of 35% in 1998, 1997 and 1996 for the following
reasons (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Income tax expense (benefit) at statutory rate $222,435 $5,748 $ 54,371
Tax exempt investment income and capital gains (157) (174) (216)
State and local taxes, net of federal income tax benefit 22,480 8,353 6,256
Amortization of goodwill 3,683 4,055 6,155
Net foreign taxes 534 470 183
Equity in non-consolidated affiliates (23) (186) 160
Non-deductible losses with respect to foreign operations 34,365 6,445 6,636
Undistributed earnings of subsidiaries 2,030 1,596 1,237
Issuance of additional shares by public subsidiary - - 2,689
Subsidiary loan write-off - (4,598) -
Provision to return reconciliation (48) 1,323 217
Gain on sale of NYLCare 11,860 - -
Other 5,708 (1,103) (1,363)
-------- ------- -------
Total income tax expense (benefit) $302,867 $21,929 $76,325
======== ======= =======
</TABLE>
The net deferred tax liability at December 31, 1998 and 1997, respectively is
attributable to the following temporary differences (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax asset:
Non-deductible reserves $ 9,487 $ 11,879
Net operating losses - 4,445
Deferred compensation 4,208 12,122
Investments in affiliates and partnerships 4,660 2,087
Leasehold improvements - 1,182
Deferred rent 283 2,190
Depreciation 7,708 819
Unrealized investment losses 7 84
Employee benefits - 5,418
Modified coinsurance reserves - 1,215
Accrued expenses-ESI 34,170 512
Other 2,042 1,446
-------- --------
Gross deferred tax asset 62,565 43,399
Deferred tax liability:
Deferred distribution costs (79,709) (93,965)
Unrealized appreciation of subsidiary (10,008) (9,685)
Investments in affiliates and partnerships - (98)
Depreciation (178) (1,715)
Undistributed earnings of ESI (12,322) (10,484)
Unrealized investment gains - (802)
Other (1,223) (636)
----------- ------------
Gross deferred tax liability (103,440) (117,385)
Valuation allowance (317) (5,033)
----------- ------------
Net deferred tax liability $(41,192) $(79,019)
========= =========
</TABLE>
The valuation allowance principally relates to net operating loss limitations.
25
<PAGE> 189
NOTE 14 - COMMITMENTS AND CONTINGENCIES
LEASES:
The subsidiaries lease office space, a telephone system, and certain computer
and office equipment under agreements with various expiration dates. The leases
contain provisions for payment of real estate taxes, building maintenance,
electricity and other escalations.
Future minimum lease payments under noncancelable operating leases with original
or remaining lease terms in excess of one year at December 31, 1998, are as
follows (in thousands):
<TABLE>
<CAPTION>
Operating Leases
----------------
<S> <C>
1999 $11,596
2000 12,388
2001 12,241
2002 11,661
2003 11,021
2004 & thereafter 67,497
---------
Total 126,404
---------
Less future sublease rental receipts 11,331
---------
Total $115,073
=========
</TABLE>
Assets recorded under capital leases and the related accumulated depreciation
are listed below. Amortization of these assets is included in depreciation and
amortization expense (in thousands):
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
Assets recorded under leases $513 $14,091
Accumulated depreciation (328) (2,223)
----- -------
Total $185 $11,868
==== =======
</TABLE>
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
approximately $26,978,000, $36,575,000 and $34,943,000, respectively.
Windsor Construction Company Limited, a wholly owned subsidiary of NYLUK,
entered into two contracts with Balfour Beatty Limited on January 11, 1994, for
the construction of phases II and III of NYLUK s head office development in the
United Kingdom amounting to $3,945,000 for Phase II and $4,190,000 for Phase
Ill. The contract for Phase II began on January 8, 1998, and the contract for
Phase III must begin by December 31, 1999. On January 8, 1998, Windsor
Construction Company Limited transferred its assets in course of construction
and the related contracts to Windsor Limited Life Assurance Company.
OTHER:
During 1990, NYLIFE Inc. entered into an agreement to provide a guarantee for
the benefit of the shareholders of the MainStay Equity Index Fund. The guarantee
provides that if, after ten years from date of purchase, the net asset value,
with all dividend and capital gains distributions reinvested, is less than the
original offering price, NYLIFE Inc. will reimburse the shareholders for their
loss of principal and restore the net asset value to the original offering
price, including the return of any front-end sales charge. If shares are
redeemed prior to or after the one day guarantee date, the investor loses the
benefit of the guarantee with respect to those shares.
26
<PAGE> 190
The Company and its subsidiaries are defendants in various legal actions arising
from its operations. Most of these actions seek substantial or unspecified
compensatory and punitive damages. The Company is also from time to time
involved as a party in various governmental, administrative and investigative
proceedings and inquiries. Given the uncertain nature of litigation and
regulatory inquiries, the outcome of the above and other actions pending against
the Company cannot be predicted. The Company nevertheless believes that the
ultimate outcome of all pending litigation should not have a material adverse
effect on the Company's financial position; however, it is possible that
settlements or adverse determinations in one or more actions or other
proceedings in the future could have a material adverse effect on the Company's
operating results for a given year.
NYLIFE Inc. along with NYLIFE Securities and NYLIFE Distributors have a support
agreement whereby NYLIFE Inc. has agreed to absorb any liability which may be
allocated to NYLIFE Securities and NYLIFE Distributors as a result of a lawsuit
alleging misappropriation of funds by a New York Life agent. At December 31,
1998 plaintiffs were seeking $122,500,000 in compensatory and punitive damages.
At this time, neither the probability of loss nor the amount of the plaintiffs
recovery, if any, can be estimated.
Additionally, certain subsidiaries are subject to minimum net worth restrictions
pursuant to regulatory requirements and the terms of limited partnership and
debt agreements. At December 31, 1998 and 1997, the net worth of these
subsidiaries exceeded the related requirements.
For the year ended December 31, 1998, approximately 56% of ESI s pharmaceutical
purchases were through one wholesaler. ESI believes that other alternative
sources are readily available.
NYLIFE Inc. has a support agreement to provide additional capital to SFD
Holding, which has a net capital deficiency as a result of accumulated losses,
as needed to allow SFD Holding to fund its liabilities in an orderly fashion.
NOTE 15 - EMPLOYEE BENEFIT PLANS
LONG TERM PERFORMANCE PLAN:
MacKay-Shields adopted Long-Term Performance Plans ("the Plans") in 1988 and
1995. These Plans associated with the grant awards are calculated based upon the
attainment of specific goals as set forth in each Plan.
Payments under the 1988 Plan commenced in 1996 and extend through 2000. In
accordance with the provisions of the 1988 Plan, participants are also entitled
to income on the unpaid amount of their award. For certain individuals, a
portion of this amount may be adjusted based upon the investment performance of
certain registered investment companies managed by MacKay-Shields. In 1998, 1997
and 1996, respectively, MacKay-Shields recorded dividend and interest income in
the amount of $332,000, $1,018,000 and $1,678,000 on the cash and investments
segregated to fund the Plan obligation.
Awards under the 1995 Plan are based on cumulative growth during the 1995 to
1997 time period, and are payable commencing in 1999 and extending through 2001.
An accrual of $3,903,000 was recorded as a liability based on results for the
three year period 1995 to 1997. The Plans are long-term in nature and require
participants to enter into multi-year employment contracts.
27
<PAGE> 191
EMPLOYEE STOCK PURCHASE PLAN:
In December, 1998, ESI's Board of Directors approved an employee stock purchase
plan, effective March 1, 1999, that qualifies under Section 423 of the Internal
Revenue Code and permits all employees, excluding certain management level
employees, to purchase shares of ESI's Class A Common Stock. Participating
employees may elect to contribute up to 10% of their salary to purchase common
stock at the end of each six month participation period at a purchase price
equal to 85% of the fair market value of the common stock at the end of the
participation period. Class A Common Stock reserved for future employee
purchases under the plan was 250,000 shares at December 31, 1998.
DEFERRED COMPENSATION PLAN:
In December, 1998, the Compensation Committee of ESI's Board of Directors
approved a non-qualified deferred compensation plan (the "Executive Deferred
Compensation Plan"), effective January 1, 1999, that provides benefits payable
to eligible key employees at retirement, termination or death. Benefit payments
are funded by a combination of contributions from participants and ESI.
Participants become fully vested in ESI contributions on the third anniversary
of the end of the plan year for which the contribution is credited to their
account. For 1999, the annual ESI contribution will be equal to 6% of each
participant's total annual compensation, with 25% being invested in ESI's Class
A common stock and the remaining being allocated to a variety of investment
options. As a result of the implementation, ESI accrued as compensation expense
$797,000 in 1998 as a past service contribution which is equal to 8% of each
participant's total annual cash compensation for the period of the participant's
past service with ESI in a senior executive capacity.
OTHER:
Certain subsidiaries sponsor defined contribution retirement, 401(k) and profit
sharing plans for employees. Contributions to these plans during 1998, 1997 and
1996, totaled $6,103,000, $9,294,000 and $9,011,000, respectively.
NOTE 16 - ACCOUNTING FOR STOCK-BASED COMPENSATION
NON EMPLOYEE AGREEMENTS:
On December 31, 1995, ESI entered into a ten-year corporate alliance with
Premier Purchasing Partners, L.P. (American Healthcare Systems Purchasing
Partners, L.P., the "Partnership"), an affiliate of Premier, Inc. ("Premier").
Under the terms of the transaction, ESI is Premier's preferred vendor of
pharmacy benefit management services to Premier's shareholder systems and their
managed care affiliates and will issue shares of its Class A Common Stock as an
administrative fee to the Partnership based on the attainment of certain
benchmarks, principally related to the number of members receiving ESI pharmacy
benefit management services under the arrangement, and to the achievement of
certain joint purchasing goals. In accordance with the terms of the agreement,
ESI issued 454,546 shares of Class A Stock to Premier in May 1996, and may be
required to issue up to an additional 4,500,000 shares to the Partnership over a
period up to the first five years of the agreement if the Partnership exceeds
all benchmarks. The shares issued were valued at $11,250,000 and are being
amortized over the then remaining term of the agreement. Amortization expense
amounted to $1,164,000, $1,164,000 and $776,000 in 1998, 1997 and 1996,
respectively. Except for certain exemptions from registration under the
Securities Act of 1933, as amended (the "1933 Act"), any shares issued to the
Partnership cannot be traded until they have been registered under the 1933 Act
and any applicable state securities laws. No stock was issued in 1998 and 1997.
28
<PAGE> 192
EMPLOYEE STOCK-OPTIONS:
ESI accounts for employee stock options in accordance with Accounting Principles
Board No. 25 (APB 25), "Accounting for Stock Issued to Employees." Under APB 25,
ESI applies the intrinsic value method of accounting and, therefore, does not
recognize compensation expense for options granted, because options are only
granted at a price equal to market value at the time of grant. SFAS 123
prescribes the recognition of compensation expense based on the fair value of
options determined on the grant date. However, SFAS 123 grants an exception that
allows companies currently applying APB 25 to continue using that method. ESI
has, therefore, elected to continue applying the intrinsic value method under
APB 25.
NOTE 17 - SUBSEQUENT EVENTS
ESI
On February 9, 1999, ESI announced that it had executed a definitive agreement
to purchase Diversified Pharmaceuticals Services, Inc. (DPS), a wholly-owned
subsidiary of SmithKline Beecham Plc. Under the terms of the agreement, ESI will
pay cash in the amount of $700,000,000 for the stock of DPS. ESI expects to
finance the purchase through a $1,100,000,000 bank credit facility consisting of
an $800,000,000 term facility and a $300,000,000 revolving credit facility. In
addition, ESI has secured bridge financing in the amount of $150,000,000 to
facilitate closing. The loan proceeds will be used towards the $700,000,000
purchase price and acquisition related costs, and will also be used to refinance
ESI's existing $360,000,000 bank credit facility (see Note 5) and provide for
working capital needs, if any. ESI expects to issue $350,000,000 in Class A
Common Stock through an offering. Net proceeds from the offering will be used to
retire the $150,000,000 bridge facility and a portion of the $800,000,000 term
facility. The acquisition will be accounted for under the purchase method of
accounting and is subject to customary closing conditions including required
governmental approvals and consummation and funding of the bank credit facility.
ESI anticipates the transaction will close in the second quarter of 1999.
Should the transaction close and ESI refinance its existing $360,000,000 bank
credit facility, the remaining unamortized deferred financing fees will be
expensed and no material gain or loss for early extinguishment of debt is
anticipated. ESI anticipates maintaining its existing interest rate swap in
place to hedge the future variable interest rate payments on $360,000,000 of the
new $1,100,000,000 bank credit facility.
SFD HOLDING
On February 16, 1999, SAMCO distributed $2,103,000 to the Series C Noteholders,
reducing the outstanding principal amount of the Series C Notes to $18,965,000.
On March 19, 1999, SAMCO obtained a release of the lien on the Security
Agreement as required by Section 7.1(b) of the Indenture and was therefore
relieved of its obligations under the Series C Notes, the Indenture and the
Security Agreement.
29
