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497(c) File Nos. 33-5819 and 811-5034
Prospectus September 14, 1998
CitiFunds(SM) California Tax Free Income Portfolio
This Prospectus describes CitiFundsSM California Tax Free Income Portfolio, a
non-diversified mutual fund. Citibank, N.A. is the investment manager.
This Prospectus concisely sets forth information about the Fund that a
prospective investor should know before investing. A Statement of Additional
Information dated the date of this Prospectus (and incorporated by reference
in this Prospectus) has been filed with the Securities and Exchange
Commission. Copies of the Statement of Additional Information may be obtained
without charge, and further inquiries about the Fund may be made, by contacting
the investor's Service Agent or by calling 1-800-625-4554. The Statement of
Additional Information and other related materials are available on the SEC's
Internet web site (http://www.sec.gov).
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Remember that shares of the Fund:
o ARE NOT INSURED BY THE FDIC OR ANY OTHER AGENCY;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, CITIBANK OR
ANY OF ITS AFFILIATES;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL
AMOUNT INVESTED.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
INVESTORS SHOULD READ THIS PROSPECTUS AND RETAIN IT FOR FUTURE REFERENCE.
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TABLE OF CONTENTS
Prospectus Summary 3
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Expense Summary 5
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Investment Information 6
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Risk Considerations 8
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Valuation of Shares 10
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Purchases 10
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Exchanges 11
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Redemptions 11
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Dividends and Distributions 12
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Management 12
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Tax Matters 15
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Performance Information 16
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General Information 17
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Appendix -- Permitted Investments and Investment Practices 20
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PROSPECTUS SUMMARY
See the body of the Prospectus for more information on the topics discussed in
this summary.
THE FUND: This Prospectus describes CitiFundsSM California Tax Free Income
Portfolio.
INVESTMENT OBJECTIVE AND POLICIES: The Fund's investment objective is to
generate high levels of current income exempt from federal and California State
personal income taxes and preserve the value of its shareholders' investment.
The Fund invests primarily in municipal obligations that pay interest that is
exempt from federal income taxes.
INVESTMENT MANAGER AND DISTRIBUTOR: Citibank, N.A. ("Citibank" or the
"Manager"), a wholly-owned subsidiary of Citicorp, is the investment manager.
Citibank and its affiliates manage more than $88 billion in assets worldwide.
CFBDS, Inc. ("CFBDS" or the "Distributor") is the distributor of shares of the
Fund. See "Management."
PURCHASES AND REDEMPTIONS: Investors may purchase and redeem shares of the
Fund through a Service Agent on any day the New York Stock Exchange is open
for trading. See "Purchases" and "Redemptions."
PRICING: Shares of the Fund are purchased and redeemed at net asset value,
without a sales load or redemption fees. Shares are subject to a fee of up to
0.25% per annum of the Fund's average daily net assets for distribution, sales
and marketing and shareholder services. See "Purchases" and "Management --
Distribution Arrangements."
EXCHANGES: Shares may be exchanged for shares of the CitiSelect(R) Portfolios
and certain other CitiFunds. See "Exchanges."
DIVIDENDS: Dividends, if any, are declared daily and paid monthly. Net capital
gains, if any, are distributed annually. See "Dividends and Distributions."
REINVESTMENT: All dividends and capital gains distributions may be received
either in cash or in Fund shares at net asset value. See "Dividends and
Distributions."
WHO SHOULD INVEST: The Fund is designed for investors seeking current income
that is exempt from federal and California State personal income taxes.
Investors should be willing to accept fluctuation in the price of shares of the
Fund and to bear the increased risk of an investment portfolio that is
concentrated in obligations of the State of California and its political
subdivisions.
RISK FACTORS: There can be no assurance that the Fund will achieve its
investment objective. The Fund's net asset value will fluctuate based on changes
in the values of the underlying portfolio securities. As a result, an investor's
shares may be worth more or less at redemption than at the time of purchase.
The value of fixed income securities, including municipal obligations, generally
goes down when interest rates go up, and vice versa. Changes in interest rates
will generally cause bigger changes in the prices of longer-term securities than
in the prices of shorter-term securities.
Prices of fixed income securities also fluctuate based on changes in the actual
and perceived creditworthiness of issuers. The prices of lower rated securities
often fluctuate more than those of higher rated securities. Also, it is possible
that some issuers will be unable to make required payments on fixed income
securities held by the Fund.
The Fund is a non-diversified mutual fund, which means that it may invest a
relatively high percentage of its assets in the obligations of a limited number
of issuers. The Fund's investments are, under normal circumstances, concentrated
in municipal obligations of California issuers. As a result, the Fund is more
susceptible than more diversified funds to any single economic, political or
regulatory occurrence, and the Fund is particularly susceptible to occurrences
affecting California issuers.
Certain investment practices may also entail special risks. Investors should
read "Risk Considerations" for more information about risk factors.
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EXPENSE SUMMARY
The following table summarizes estimated shareholder transaction and annual
operating expenses for shares of the Fund. For more information on costs and
expenses, see "Management" -- page 12 and "General Information -- Expenses" --
page 18.*
CITIFUNDS
CALIFORNIA
TAX FREE
INCOME
PORTFOLIO
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SHAREHOLDER TRANSACTION EXPENSES NONE
ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS):
Management Fees(1) 0.50%
12b-1 Fees (including service fees)(2) 0.25%
Other Expenses (after fee waivers and reimbursements)(3) 0.05%
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Total Fund Operating Expenses (after fee waivers
and reimbursements)(3) 0.80%
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* This table is intended to assist investors in understanding the various
costs and expenses that a shareholder of the Fund will bear, either
directly or indirectly. The table shows the fees paid to various service
providers after giving effect to expected voluntary partial fee waivers
and reimbursements. There can be no assurance that the fee waivers and
reimbursements reflected in the table will continue at these levels.
Because the Fund is newly organized, the information in the expense table
and the example below is estimated for the current fiscal year.
(1) A combined fee for investment advisory and administrative services.
(2) 12b-1 distribution fees include asset-based sales charges. Long-term
shareholders in the Fund could pay more in sales charges than the economic
equivalent of the maximum front-end sales charges permitted by the National
Association of Securities Dealers, Inc.
(3) Absent fee waivers and reimbursements, other operating expenses and total
fund operating expenses would be 0.83% and 1.58%, respectively.
EXAMPLE: A shareholder would pay the following expenses on a $1,000
investment, assuming a 5% annual return and redemption at the end of each
period indicated below:
ONE THREE
YEAR YEARS
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CITIFUNDS CALIFORNIA TAX FREE INCOME PORTFOLIO $8 $26
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The Example assumes that all dividends are reinvested and reflects certain
voluntary fee waivers and reimbursements. Absent these fee waivers and
reimbursements, the amounts in the example would be $16 and $50, respectively.
The assumption of a 5% annual return is required by the Securities and Exchange
Commission for all mutual funds, and is not a prediction of the Fund's future
performance. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES OF THE FUND. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE
SHOWN.
INVESTMENT INFORMATION
INVESTMENT OBJECTIVE: The investment objective of the Fund is to generate high
levels of current income exempt from federal and California State personal
income taxes and preserve the value of its shareholders' investment.
The investment objective of the Fund may be changed by its Trustees without
approval by the Fund's shareholders, but shareholders will be given written
notice at least 30 days before any change is implemented. Of course, there can
be no assurance that the Fund will achieve its investment objective.
INVESTMENT POLICIES: The Fund seeks its objective by investing in debt
securities consisting primarily of obligations issued by state and municipal
governments and by other qualifying issuers ("Municipal Obligations") that pay
interest that is exempt from federal income taxes including the federal
alternative minimum tax. Under normal circumstances, at least 80% of the Fund's
net assets will be invested in Municipal Obligations and at least 65% of the
Fund's total assets will be invested in Municipal Obligations the interest on
which is exempt from both federal and California personal income taxes
("California Municipal Obligations"). California Municipal Obligations include
Municipal Obligations of the State of California and its political subdivisions,
Puerto Rico, other U.S. territories and their political subdivisions and other
qualifying issuers.
The Fund may invest in Municipal Obligations paying interest that is exempt from
federal income taxes but subject to California State personal income taxes. The
Fund may also invest in short-term debt securities that pay interest that is
subject to federal and California State personal income taxes, including those
issued by companies, the U.S. Government or agencies of the U.S. Government.
Except during periods of unusual economic or market conditions or except for
temporary defensive purposes or liquidity, no more than 20% of the Fund's net
assets will be invested in debt securities that pay interest subject to federal
income tax.
Municipal Obligations include municipal bonds, notes and commercial paper issued
by the states, territories and possessions of the United States (including the
District of Columbia) and their political subdivisions, agencies and
instrumentalities, and obligations of other qualifying issuers. The Fund may
invest both in "general obligation" bonds, which are backed by the full faith,
credit and taxing power of the issuer, and in "revenue" bonds, which are payable
only from the revenues generated by a specific project or from another specific
revenue source. Municipal Obligations also include participations in municipal
leases.
The Fund will invest only in cash and in debt securities that either (i) carry
at least a Baa rating from Moody's Investors Service, Inc., or a BBB rating from
Standard & Poor's Ratings Group, or are considered by the Manager to be of
equivalent quality, (ii) are issued or guaranteed by the U.S. Government or one
of its agencies or instrumentalities, or (iii) are obligations (including
certificates of deposit, bankers' acceptances and repurchase agreements) of
banks with at least $1 billion of assets.
Securities rated Baa or BBB, while considered "investment grade," have
speculative characteristics. Changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make principal
and interest payments on securities rated Baa or BBB than is the case for higher
grade securities. Investors should review Appendix B to the Statement of
Additional Information for a description of credit ratings.
Under normal market conditions, the Fund intends that the weighted average
maturity of securities held by the Fund will be in a long-term range (between 10
and 30 years). For strategic purposes, however, the Fund may invest so that the
weighted average maturity of securities held by the Fund is under 10 years.
While long-term debt securities tend to generate a higher rate of current income
than short-term debt securities, the prices of long-term debt securities
generally fluctuate more in response to interest rate changes and other factors
than the prices of short-term debt securities. Therefore, investors in the Fund
should be willing to accept fluctuation in the price of shares of the Fund.
CERTAIN ADDITIONAL INVESTMENT POLICIES:
Temporary Investments. During periods of unusual economic or market conditions
or for temporary defensive purposes or liquidity, the Fund may invest without
limit in cash and in U.S. dollar-denominated high quality money market and
short-term instruments. These investments may result in a lower yield than would
be available from investments with a lower quality or longer term and the
interest on these investments may be subject to tax.
Other Permitted Investments. For more information regarding the Fund's permitted
investments and investment practices, see the Appendix -- Permitted Investments
and Investment Practices on page 20. The Fund will not necessarily invest or
engage in each of the investments and investment practices in the Appendix but
reserves the right to do so.
Investment Restrictions. The Statement of Additional Information contains a list
of specific investment restrictions which govern the investment policies of the
Fund, including a limitation that the Fund may borrow money from banks in an
amount not to exceed 1/3 of the Fund's net assets for extraordinary or emergency
purposes (e.g., to meet redemption requests). Except as otherwise indicated, the
Fund's investment objective and policies may be changed without shareholder
approval. If a percentage or rating restriction (other than a restriction as to
borrowing) is adhered to at the time an investment is made, a later change in
percentage or rating resulting from changes in the Fund's securities will not be
a violation of policy.
Portfolio Turnover. Securities of the Fund will be sold whenever the Manager
believes it is appropriate to do so in light of the Fund's investment objective,
without regard to the length of time a particular security may have been held.
The annual portfolio turnover rate is not expected to exceed 100% during the
current fiscal year. The amount of transaction costs and realization of taxable
capital gains will tend to increase as the level of portfolio activity
increases.
Brokerage Transactions. The primary consideration in placing the Fund's 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.
RISK CONSIDERATIONS
The risks of investing in the Fund vary depending upon the nature of the
securities held, and the investment practices employed, on its behalf. Certain
of these risks are described below.
Changes in Net Asset Value. The Fund's net asset value will fluctuate based on
changes in the values of the underlying portfolio securities. This means that an
investor's shares may be worth more or less at redemption than at the time of
purchase.
Interest Rate Risk. The value of fixed income securities, including Municipal
Obligations, generally goes down when interest rates go up, and vice versa.
Furthermore, the value of fixed income securities may vary based on anticipated
or potential changes in interest rates. Changes in interest rates will generally
cause bigger changes in the prices of longer-term securities than in the prices
of shorter-term securities.
Credit Risk. Prices of fixed income securities fluctuate based on changes in the
actual and perceived creditworthiness of issuers. The prices of lower rated
securities often fluctuate more than those of higher rated securities. It is
possible that some issuers will be unable to make required payments on fixed
income securities held by the Fund.
"Revenue" Obligations. The Fund may invest in Municipal Obligations that are
payable only from the revenues generated from a specific project or from another
specific revenue source. The Fund may invest more than 25% of its assets in (i)
industrial revenue bonds issued to finance industrial projects, and (ii)
Municipal Obligations issued to finance housing, electrical utilities and
hospitals (although the Fund may not invest more than 25% of its assets at any
time in debt securities financing any one of housing, electrical utilities, or
hospitals, considered as three separate categories). Projects may suffer
construction delays, increased costs or reduced revenues as a result of
political, regulatory, economic and other factors. As a result projects may not
generate sufficient revenues to pay principal and interest on Municipal
Obligations held by the Fund.
Non-Diversified Fund. The Fund is a non-diversified mutual fund. This means that
it is not subject to any statutory restrictions under the Investment Company Act
of 1940 limiting the investment of its assets in one or relatively few issuers
(although certain diversification requirements are imposed by the Internal
Revenue Code). Since the Fund may invest a relatively high percentage of its
assets in the obligations of a limited number of issuers, the value of shares of
the Fund may be more susceptible to any single economic, political or regulatory
occurrence. The Fund is particularly susceptible to occurrences affecting
California issuers. The Fund also may invest 25% or more of its assets in
securities the issuers of which are located in the same state or the interest on
which is paid from revenues of similar type projects or that are otherwise
related in such a way that a single economic, business or political development
or change affecting one of the securities would also affect other securities.
Investors should consider the greater risk inherent in these policies when
compared with more diversified mutual funds.
California Securities. The Fund's investments are, under normal circumstances,
concentrated in California Municipal Obligations. Payment of interest and
principal of these securities is dependent on the continuing ability of issuers
in California to meet their obligations.
Investors in the Fund should consider carefully the special risks inherent in
investing in California Municipal Obligations. The State of California and other
issuers of California Municipal Obligations have experienced severe financial
difficulties. From 1990-1993, the State suffered through a severe recession, the
worst since the 1930's, heavily influenced by large cutbacks in the
defense/aerospace industries and military base closures and a major drop in real
estate construction. In December 1994, Orange County, California and its pooled
investment funds filed for protection under the federal Bankruptcy Code. Orange
County's financial difficulties could continue to adversely affect other issuers
and issuers of California Municipal Obligations. Since the start of 1994,
California's economy has been recovering and growing steadily stronger, to the
point where the State's economic growth is outpacing the rest of the nation.
However, the effects of the Asian economic turmoil are just beginning to be felt
in the U.S., and the earnings of some of the State's leading high technology and
other firms have been adversely affected. Latin American markets also are
experiencing economic turmoil, and U.S. issuers, including those in California,
may be adversely affected. After having been downgraded in 1994 as the result of
the financial difficulties of the State of California, the credit ratings of
certain of the State's obligations have been upgraded by certain rating
agencies. There can be no assurance that the State's economic growth will
continue or that credit ratings on obligations of the State of California and
other California Municipal Obligations will not be downgraded again.
Many of the Fund's Municipal Obligations are likely to be obligations of
California governmental issuers which rely in whole or in part, directly or
indirectly, on real property taxes as a source of revenue. "Proposition
Thirteen" and similar California constitutional and statutory amendments and
initiatives in recent years have restricted the ability of California taxing
entities to increase real property tax revenues. Other initiative measures
approved by California voters in recent years, through limiting various other
taxes, have resulted in a substantial reduction in state revenues. Decreased
state revenues may result in reductions in allocations of state revenues to
local governments. Investors in this Fund should consider the greater risks
inherent in the Fund's concentration in these securities when compared with the
safety that comes with a less geographically concentrated investment portfolio.
Further information is set forth in the Statement of Additional Information.
Investment Practices. Certain of the investment practices employed for the
Fund may entail certain risks. These risks are in addition to risks described
above and are described in the Appendix. See the Appendix -- Permitted
Investments and Investment Practices on page 20.
VALUATION OF SHARES
Net asset value per share of the Fund is determined each day the New York Stock
Exchange is open for trading (a "Business Day"). This determination is made once
each day as of the close of regular trading on the Exchange (normally 4:00 p.m.
Eastern time) by adding the market value of all securities and other assets of
the Fund, then subtracting the Fund's liabilities, and then dividing the result
by the number of the Fund's outstanding shares. The net asset value per share is
effective for orders received and accepted by the Transfer Agent prior to its
calculation.
Portfolio securities and other assets are valued primarily on the basis of
market quotations, or if quotations are not available, by a method believed to
accurately reflect fair value.
PURCHASES
Shares of the Fund are offered continuously and may be purchased on any Business
Day at the public offering price. The public offering price is the net asset
value next determined after an order is transmitted to and accepted by the
Transfer Agent. The Fund and the Transfer Agent reserve the right to reject any
purchase order and to suspend the offering of Fund shares for a period of time.
Shares may be purchased through certain financial institutions (which may
include banks), securities dealers and other industry professionals (called
Service Agents) that have entered into service agreements with the Distributor.
Service Agents may receive fees from the Distributor and/or the Fund. See
"Management -- Distribution Arrangements." Investors should contact their
Service Agents for information on purchases. Each Service Agent may establish
its own terms, conditions and charges with respect to services it offers to its
customers. Charges for these services may include fixed annual fees and account
maintenance fees. The effect of any such fees will be to reduce the net return
on the investment of customers of that Service Agent. Each Service Agent has
agreed to transmit to its customers who are shareholders of the Fund appropriate
prior written disclosure of any fees that it may charge them directly. Each
Service Agent is responsible for transmitting promptly orders of its customers.
From time to time the Distributor may make payments for distribution and/or
shareholder servicing activities out of its past profits and other sources
available to it. The Distributor also may make payments for marketing,
promotional or related expenses to dealers who engage in marketing efforts on
behalf of the Fund. The amounts of these payments will be determined by the
Distributor in its sole discretion and may vary among different dealers. Similar
payments may also be made by Citibank under similar arrangements.
EXCHANGES
Shares may be exchanged for shares of the CitiSelect Portfolios and certain
other CitiFunds, or may be acquired through an exchange of shares of those
funds.
Shareholders must place exchange orders through the Transfer Agent or, if they
are customers of a Service Agent, through their Service Agent, and may do so by
telephone if their account applications so permit. For more information on
telephone transactions see "Redemptions." All exchanges will be effected based
on the relative net asset values per share next determined after the exchange
order is received and accepted by the Transfer Agent. See "Valuation of Shares."
Shares of the Fund may be exchanged only after payment in federal funds for the
shares has been received by the Transfer Agent.
This exchange privilege may be modified or terminated at any time, upon at least
60 days' notice when such notice is required by Securities and Exchange
Commission rules, and is available only in those jurisdictions where such
exchanges legally may be made. See the Statement of Additional Information for
further details. An exchange is treated as a sale of the shares exchanged and
could result in taxable gain or loss to the shareholder making the exchange.
REDEMPTIONS
Fund shares may be redeemed at their net asset value next determined after a
redemption request in proper form is received by the Transfer Agent. Each
Service Agent is responsible for the prompt transmission of redemption orders to
the Fund on behalf of its customers. A Service Agent may establish requirements
or procedures regarding submission of redemption requests by its customers that
are different from those described below. Investors should consult their Service
Agents for details. A redemption is treated as a sale of the shares redeemed and
could result in taxable gain or loss to the shareholder making the redemption.
Redemptions by Mail. Shareholders may redeem Fund shares by sending written
instructions in proper form (as determined by the Transfer Agent or a
shareholder's Service Agent) to the Transfer Agent or, if shareholders are
customers of a Service Agent, their Service Agent. Shareholders are responsible
for ensuring that a request for redemption is in proper form.
Redemptions by Telephone. Shareholders may redeem or exchange Fund shares by
telephone, if their account applications so permit, by calling the Transfer
Agent or, if they are customers of a Service Agent, their Service Agent. During
periods of drastic economic or market changes or severe weather or other
emergencies, shareholders may experience difficulties implementing a telephone
exchange or redemption. In such an event, another method of instruction, such as
a written request sent via an overnight delivery service, should be considered.
The Fund, the Transfer Agent and each Service Agent will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine.
These procedures may include recording of the telephone instructions and
verification of a caller's identity by asking for his or her name, address,
telephone number, Social Security number, and account number. If these or other
reasonable procedures are not followed, the Fund, the Transfer Agent or the
Service Agent may be liable for any losses to a shareholder due to unauthorized
or fraudulent instructions. Otherwise, the shareholder will bear all risk of
loss relating to a redemption or exchange by telephone.
Payment of Redemptions. The proceeds of a redemption are paid in federal funds
normally on the next Business Day, but in any event within seven days. If a
shareholder requests redemption of shares which were purchased recently, the
Fund may delay payment until it is assured that good payment has been received.
In the case of purchases by check, this can take up to ten days. See
"Determination of Net Asset Value; Valuation of Securities; Additional
Redemption Information" in the Statement of Additional Information regarding the
Fund's right to pay the redemption price in kind with securities (instead of
cash).
Questions about redemption requirements should be referred to the Transfer Agent
or, for customers of a Service Agent, their Service Agent. The right of any
shareholder to receive payment with respect to any redemption may be suspended
or the payment of the redemption price postponed during any period in which the
New York Stock Exchange is closed (other than weekends or holidays) or trading
on the Exchange is restricted or if an emergency exists.
DIVIDENDS AND DISTRIBUTIONS
Substantially all of the Fund's net income from dividends and interest, if any,
is declared daily and paid to its shareholders of record as a dividend monthly,
on or about the last day of each month.
The Fund's net realized short-term and long-term capital gains, if any, will be
distributed to the Fund's shareholders at least annually, in December. The Fund
may also make additional distributions to its shareholders to the extent
necessary to avoid the application of the 4% non-deductible excise tax on
certain undistributed income and net capital gains of mutual funds.
A shareholder may elect to receive dividends and capital gains distributions in
either cash or additional shares of the Fund issued at net asset value.
MANAGEMENT
TRUSTEES AND OFFICERS: The Fund is supervised by the Board of Trustees of
CitiFunds Tax Free Income Trust. A majority of the Trustees are not affiliated
with Citibank. More information on the Trustees and officers of the Fund appears
under "Management" in the Statement of Additional Information.
INVESTMENT MANAGER: Citibank offers a wide range of banking and investment
services to customers across the United States and throughout the world, and has
been managing money since 1822. Its portfolio managers are responsible for
investing in money market, equity and fixed income securities. Citibank and its
affiliates manage more than $88 billion in assets worldwide. Citibank is a
wholly-owned subsidiary of Citicorp. Citibank also serves as investment adviser
to other registered investment companies. Citibank's address is 153 East 53rd
Street, New York 10043. Citicorp recently announced its intention to merge with
Travelers Group, Inc. Completion of the merger is subject to the satisfaction of
certain conditions.
Subject to policies set by the Trustees, Citibank is responsible for overall
management of the Fund pursuant to a Management Agreement with the Fund.
Citibank also provides certain administrative services to the Fund. These
administrative services include providing general office facilities and
supervising the overall administration of the Fund. Pursuant to a sub-
administrative services agreement with Citibank, the Distributor performs such
sub-administrative duties for the Fund as from time to time are agreed upon by
Citibank and the Distributor. The Distributor's compensation as
sub-administrator is paid by Citibank.
John C. Mooney, a Vice President of Citibank, is the manager of the Fund. Mr.
Mooney is a Senior Portfolio Manager responsible for managing tax-exempt fixed
income funds. He is also part of the team responsible for fixed-income strategy,
research and trading. Prior to joining Citibank in 1997, Mr. Mooney served as a
tax-exempt portfolio manager at SunAmerica for over three years and also served
as a tax-exempt portfolio manager at First Investors for three years. His prior
experience also includes positions at Alliance Capital Management L.P. and The
Boston Company.
The Fund currently does not employ an investment subadviser, but in the future
the Fund may do so. Citibank would be responsible for recommending the hiring,
termination or replacement of any subadviser and for supervising and monitoring
the subadviser's performance. Certain CitiFunds have applied for exemptive
relief from the Securities and Exchange Commission which would permit them to
employ subadvisers without shareholder approval. The requested exemptive relief
also would permit the terms of sub-advisory agreements to be changed, and the
employment of subadvisers to be continued after events that would otherwise
cause an automatic termination of a sub-advisory agreement, in each case without
shareholder approval if those changes or continuation are approved by the fund's
Board of Trustees. There is no assurance that the SEC will grant the requested
relief; however, if the requested relief is granted, the Fund also would be
permitted to employ subadvisers without shareholder approval, subject to
compliance with certain conditions. If the Fund adds or changes a subadviser,
this Prospectus would be revised and shareholders notified.
MANAGEMENT FEES. For its services under the Management Agreement, Citibank
receives fees, which are accrued daily and paid monthly, of 0.50% of the Fund's
average daily net assets on an annualized basis for the Fund's then-current
fiscal year. Citibank may voluntarily agree to waive a portion of its management
fees.
BANKING RELATIONSHIPS. Citibank and its affiliates may have deposit, loan and
other relationships with the issuers of securities purchased on behalf of the
Fund, including outstanding loans to such issuers which may be repaid in whole
or in part with the proceeds of securities so purchased. Citibank has informed
the Fund that, in making its investment decisions, it does not obtain or use
material inside information in the possession of any division or department of
Citibank or in the possession of any affiliate of Citibank.
BANK REGULATORY MATTERS. The Glass-Steagall Act prohibits certain financial
institutions, such as Citibank, from underwriting securities of open-end
investment companies, such as the Fund. Citibank believes that its services
under the Management Agreement and the activities performed by it or its
affiliates as Service Agents are not underwriting and are consistent with the
Glass-Steagall Act and other relevant federal and state laws. However, there is
no controlling precedent regarding the performance of the combination of
investment advisory, shareholder servicing and administrative activities by
banks. State laws on this issue may differ from applicable federal law, and
banks and financial institutions may be required to register as dealers pursuant
to state securities laws. Changes in either federal or state statutes or
regulations, or in their interpretations, could prevent Citibank or its
affiliates from continuing to perform these services. If Citibank or its
affiliates were to be prevented from acting as the Manager or a Service Agent,
the Fund would seek alternative means for obtaining these services. The Fund
does not expect that shareholders would suffer any adverse financial
consequences as a result of any such occurrence.
TRANSFER AGENT, CUSTODIAN AND FUND ACCOUNTANT: State Street Bank and Trust
Company acts as transfer agent, dividend disbursing agent and custodian for the
Fund. Securities may be held by a sub-custodian bank approved by the Trustees.
State Street also provides fund accounting services and calculates the daily net
asset value for the Fund. The principal business address of State Street is 225
Franklin Street, Boston, MA 02110.
DISTRIBUTION ARRANGEMENTS: CFBDS, 21 Milk Street, 5\t/\h/ Floor, Boston, MA
02109 (telephone: (617) 423-1679), is the distributor of the Fund's shares.
Under a Service Plan which has been adopted in accordance with Rule 12b-1 under
the 1940 Act, the Fund may pay monthly fees at an annual rate not to exceed
0.25% of the average daily net assets of the Fund. These fees may be used to
make payments to the Distributor for distribution services and to Service Agents
and others as compensation for the sale of shares of the Fund, for advertising,
marketing or other promotional activity, and for preparation, printing and
distribution of prospectuses, statements of additional information and reports
for recipients other than regulators and existing shareholders. The Fund also
may make payments to the Distributor, Service Agents and others for providing
personal service or the maintenance of shareholder accounts. In those states
where CFBDS is not a registered broker-dealer, shares of the Fund are sold
through Signature Broker-Dealer Services, Inc., as dealer.
The amounts paid by the Distributor to each Service Agent and other recipient
may vary based upon certain factors, including, among other things, the levels
of sales of Fund shares and/or shareholder services provided by the Service
Agent.
The Fund and the Distributor provide to the Trustees quarterly a written report
of amounts expended pursuant to the Service Plan and the purposes for which the
expenditures were made.
During the period they are in effect, the Service Plan and related Distribution
Agreement obligate the Fund to pay fees to the Distributor, Service Agents and
others as compensation for their services, not as reimbursement for specific
expenses incurred. Thus, even if these entities' expenses exceed the fees
provided for under the Service Plan, the Fund will not be obligated to pay more
than those fees and, if their expenses are less than the fees paid to them, they
will realize a profit. The Fund will pay the fees to the Distributor, Service
Agents and others until the Service Plan or Distribution Agreement is terminated
or not renewed. In that event, the Distributor's or Service Agent's expenses in
excess of fees received or accrued through the termination date will be the
Distributor's or Service Agent's sole responsibility and not obligations of the
Fund.
TAX MATTERS
This discussion of taxes is for general information only. Investors should
consult their own tax advisers about their particular situations.
FEDERAL INCOME TAXES: The Fund intends to meet the requirements of the Internal
Revenue Code applicable to regulated investment companies so that it will not be
liable for any federal income or excise taxes.
The Fund expects that most of its net income will be attributable to tax-exempt
Municipal Obligations, and, as a result, most of the Fund's dividends to
shareholders will be excludable from shareholders' gross income. However, the
Fund may invest from time to time in taxable securities, and certain Fund
dividends may be subject to the federal alternative minimum tax. Distributions
of capital gains on the sale or other disposition of Fund investments are also
taxable to Fund shareholders. Generally, distributions of net short-term capital
gains will be taxed as ordinary income, and distributions of net capital gains
(i.e., the excess of net long-term capital gains over net short-term capital
losses) will be taxed as such regardless of how long the shares of the Fund have
been held. Dividends and distributions are treated in the same manner for
federal tax purposes whether they are paid in cash or as additional shares.
Any gains realized by a shareholder on the sale or redemption of Fund shares are
subject to tax. If Fund shares are redeemed after tax-exempt income has accrued
but not yet been declared as a dividend, the portion of redemption proceeds
representing that income may be taxed as a capital gain even though it would
have been tax-exempt if it had been declared as a dividend prior to redemption.
In addition, any short-term capital loss realized upon the redemption of Fund
shares within six months of their purchase is disallowed to the extent of any
dividends of tax-exempt income received during that period. Fund dividends of
tax-exempt income are taken into account in determining the amount of a
shareholder's social security and railroad retirement benefits that may be
subject to federal income tax. No deduction may be claimed for interest on
indebtedness incurred or carried for the purpose of purchasing or holding Fund
shares. Investors who are, or are related to, "substantial users" of facilities
financed by private activity bonds should consult their tax advisers before
buying Fund shares.
By January 31 of each year, the Fund will notify its shareholders of the amount
and tax status of distributions paid to shareholders for the preceding year.
STATE AND LOCAL TAXES: California Taxes. Under existing California law, as long
as at the end of each quarter of the Fund's fiscal year the Fund continues to
qualify for the special federal income tax treatment afforded regulated
investment companies and at least 50% of the value of the Fund's assets consist
of California Municipal Obligations, shareholders of the Fund will be able to
exclude from income, for California State personal income tax purposes,
dividends received from the Fund which are derived from income (less related
expenses) from the California Municipal Obligations of the Fund. These dividends
must be designated as such by the Fund by written notice to shareholders within
60 days after the close of the fiscal year.
The foregoing description is a general, abbreviated summary that relates solely
to the taxation of shareholders subject to California State personal income tax.
Accordingly, potential investors, including, in particular, investors who may be
subject to California corporate franchise tax or California corporate income
tax, should consult with their own tax advisers.
PERFORMANCE INFORMATION
Fund performance may be quoted in advertising, shareholder reports and other
communications in terms of yield, effective yield, tax equivalent yield, total
rate of return or tax equivalent total rate of return. All performance
information is historical and is not intended to indicate future performance.
Yields and total rates of return fluctuate in response to market conditions and
other factors, and the value of the Fund's shares when redeemed may be more or
less than their original cost.
The Fund may provide its period and average annualized "total rates of return"
and "tax equivalent total rates of return." The "total rate of return" refers to
the change in the value of an investment in the Fund over a stated period,
reflects any change in net asset value per share and is compounded to include
the value of any shares purchased with any dividends or capital gains declared
during such period. Period total rates of return may be "annualized." An
"annualized" total rate of return assumes that the period total rate of return
is generated over a one-year period. The "tax equivalent total rate of return"
refers to the total rate of return that a fully taxable mutual fund would have
to generate in order to produce an after-tax total rate of return equivalent to
that of the Fund. The use of a tax equivalent total rate of return allows
investors to compare the total rates of return of the Fund, the dividends from
which are expected to be mostly exempt from federal income taxes and from
California State personal income taxes, with the total rates of return of funds
the dividends from which are not so tax-exempt.
The Fund may provide annualized "yield," "effective yield" and "tax equivalent
yield" quotations. The "yield" of the Fund refers to the income generated by an
investment in the Fund over a 30-day or one month period (which period is stated
in any such advertisement or communication). This income is then annualized;
that is, the amount of income generated by the investment over that period is
assumed to be generated each month over a one-year period and is shown as a
percentage of the public offering price on the last day of that period. The
"effective yield" is calculated similarly, but when annualized the income earned
by the investment during that 30-day or one month period is assumed to be
reinvested. The effective yield is slightly higher than the yield because of the
compounding effect of this assumed reinvestment. The "tax equivalent yield"
refers to the yield that a fully taxable fund would have to generate in order to
produce an after-tax yield equivalent to that of the Fund. The use of a tax
equivalent yield allows investors to compare the yield of the Fund, the
dividends from which are expected to be mostly exempt from federal income taxes
and from California State personal income taxes, with yields of funds the
dividends from which are not so tax exempt. A "yield" quotation, unlike a total
rate of return quotation, does not reflect changes in net asset value.
Of course, any fees charged by a shareholder's Service Agent will reduce that
shareholder's net return on his or her investment. See the Statement of
Additional Information for more information concerning the calculation of yield
and total rate of return quotations for the Fund.
GENERAL INFORMATION
ORGANIZATION: The Fund is a series of CitiFunds Tax Free Income Trust, a
Massachusetts business trust that was organized on May 27, 1986. The Trust is
also an open-end management investment company registered under the 1940 Act.
Prior to March 2, 1998 CitiFunds Tax Free Income Trust was called Landmark Tax
Free Income Funds.
The Fund is a non-diversified mutual fund, which means that it is not limited by
the 1940 Act in the proportion of its assets that may be invested in the
obligations of a single issuer. The Fund intends, however, to comply with
diversification requirements imposed on mutual funds by the Internal Revenue
Code.
Under Massachusetts law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for the trust's
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both
inadequate insurance existed and the trust itself was unable to meet its
obligations.
INVESTMENT STRUCTURE: The Fund currently invests directly in securities.
However, in the future, the Fund may invest in securities indirectly through one
or more investment companies, to the extent permitted by applicable law.
Shareholder approval is not needed to change the Fund's investment structure.
VOTING AND OTHER RIGHTS: CitiFunds Tax Free Income Trust may issue an unlimited
number of shares, may create new series of shares and may divide shares in each
series into classes. Each share of the Fund gives the shareholder one vote in
Trustee elections and other matters submitted to shareholders for vote. All
shares of each series of CitiFunds Tax Free Income Trust have equal voting
rights except that, in matters affecting only a particular series or class, only
shares of that particular series or class are entitled to vote.
At any meeting of shareholders of the Fund, a Service Agent may vote any shares
of which it is the holder of record and for which it does not receive voting
instructions proportionately in accordance with the instructions it receives for
all other shares of which that Service Agent is the holder of record.
As a Massachusetts business trust, CitiFunds Tax Free Income Trust is not
required to hold annual shareholder meetings. Shareholder approval will usually
be sought only for changes in the Fund's fundamental investment restrictions and
for the election of Trustees under certain circumstances. Trustees may be
removed by shareholders under certain circumstances. Each share of the Fund is
entitled to participate equally in dividends and other distributions and the
proceeds of any liquidation of the Fund.
Certificates: The Fund's Transfer Agent maintains a share register for
shareholders of record. Share certificates are not issued.
EXPENSES: In addition to amounts payable under the Management Agreement and
Service Plan, the Fund is responsible for its own expenses, including, among
other things, the costs of securities transactions, the compensation of Trustees
that are not affiliated with Citibank or the Distributor, government fees,
taxes, accounting and legal fees, expenses of communicating with shareholders,
interest expense, and insurance premiums.
All fee waivers and reimbursements are voluntary and may be reduced or
terminated at any time.
YEAR 2000: The Fund could be adversely affected if the computer systems used by
the Fund or its service providers are not programmed to accurately process
information on or after January 1, 2000. The Fund, and its service providers,
are making efforts to resolve any potential Year 2000 issues. While it is likely
that these efforts will be successful, the failure to implement any necessary
modifications to computer systems used by the Fund or its service providers
could result in an adverse impact on the Fund. The Fund could also be adversely
affected if the issuers in which the Fund invests do not solve their Year 2000
problems.
COUNSEL AND INDEPENDENT AUDITORS: Bingham Dana LLP, 150 Federal Street, Boston,
MA 02110, is counsel for the Fund. Deloitte & Touche LLP, 125 Summer Street,
Boston, MA 02110, are the independent auditors for the Fund.
- ------------------------------------------------------------------------------
The Statement of Additional Information dated the date hereof contains more
detailed information about the Fund, including information related to (i)
investment policies and restrictions, (ii) the Trustees, officers and investment
manager, (iii) securities transactions, (iv) the Fund's shares, including rights
and liabilities of shareholders, (v) the method used to calculate performance
information and (vi) the determination of net asset value.
No person has been authorized to give any information or make any
representations not contained in this Prospectus or the Statement of Additional
Information in connection with the offering made by this Prospectus and, if
given or made, such information or representations must not be relied upon as
having been authorized by the Fund or its distributor. This Prospectus does not
constitute an offering by the Fund or its distributor in any jurisdiction in
which such offering may not lawfully be made.
<PAGE>
APPENDIX
PERMITTED INVESTMENTS AND INVESTMENT PRACTICES
Municipal Bonds. Municipal bonds are debt obligations of states, cities,
municipalities, municipal agencies and authorities and other qualifying issuers
which generally have a maturity at the time of issue of one year or more and
which are issued to raise funds for various public purposes, such as
construction of a wide range of public facilities, refunding outstanding
obligations or obtaining funds for institutions and facilities. The two
principal classifications of municipal bonds are "general obligation" and
"revenue" bonds. General obligation bonds are secured by the issuer's pledge of
its full faith, credit and taxing power for the payment of principal and
interest. The principal of and interest on revenue bonds are payable from the
income of specific projects or authorities and generally are not supported by
the issuer's general power to levy taxes. In some cases, revenues derived from
specific taxes are pledged to support payments on a revenue bond. In addition,
certain kinds of private activity bonds ("PABs") are issued by or on behalf of
public authorities to provide funding for various privately operated industrial
facilities, such as warehouse, office, plant and store facilities and
environmental and pollution control facilities. PABs are, in most cases, revenue
bonds. The payment of the principal and interest on PABs usually depends solely
on the ability of the user of the facilities financed by the bonds or other
guarantor to meet its financial obligations and, in certain instances, the
pledge of real and personal property as security for payment. Many PABs may not
be readily marketable; however, the PABs or the participation certificates in
PABs purchased by the Fund may have liquidity because they generally will be
supported by demand features to "high quality" banks, insurance companies or
other financial institutions.
Municipal Notes. There are four major varieties of state and municipal notes:
Tax and Revenue Anticipation Notes ("TRANs"); Tax Anticipation Notes ("TANs");
Revenue Anticipation Notes ("RANs"); and Bond Anticipation Notes ("BANs").
TRANs, TANs and RANs are issued by states, municipalities and other tax-exempt
issuers to finance short-term cash needs or, occasionally, to finance
construction. Most TRANs, TANs and RANs are general obligations of the issuing
entity payable from taxes or designated revenues, respectively, expected to be
received within the related fiscal period. BANs are issued with the expectation
that principal and interest of the maturing notes will be paid out of proceeds
from notes or bonds to be issued concurrently or at a later date. BANs are
issued most frequently by both general obligation and revenue bond issuers
usually to finance such items as land acquisition, facility acquisition and/or
construction and capital improvement projects.
Participations in Municipal Leases. Participations in municipal leases are
undivided interests in a portion of a lease or installment purchase issued by a
state or local government to acquire equipment of facilities. Municipal leases
frequently have special risks not normally associated with general obligation
bonds or revenue bonds. Many leases include "non-appropriation" clauses that
provide that the governmental issuer has no obligation to make future payments
under the lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis. Although the
obligations will be secured by the leased equipment or facilities, the
disposition of the property in the event of non-appropriation or foreclosure
might, in some cases, prove difficult.
Variable Rate Instruments and Participation Interests. Variable rate instruments
provide for a periodic adjustment in the interest rate paid on the instrument
and usually permit the holder to receive payment of principal and accrued
interest upon a specified number of day's notice. The Fund may invest in
participation interests in Municipal Obligations owned by a bank, insurance
company or other financial institution or affiliated organization
("Participation Interests"). A variable rate instrument or a Participation
Interest may be backed by an irrevocable letter of credit or guarantee of, or a
right to put to, a bank, or an insurance policy of an insurance company. See
"Stand-by Commitments." Purchase of a Participation Interest may involve the
risk that the Fund will not be deemed to be the owner of the underlying
Municipal Obligation for purposes of the ability to claim tax exemption of
interest paid on that Municipal Obligation. If interest rates rise or fall, the
rates payable on variable rate instruments will generally be readjusted. As a
result variable rate instruments do not offer the same opportunity for capital
appreciation or loss as fixed rate instruments.
Stand-by Commitments. When the Fund purchases Municipal Obligations it may also
acquire stand-by commitments from banks or broker-dealers with respect to the
Municipal Obligations. Under a stand-by commitment, a bank or broker-dealer
agrees to purchase at the Fund's option a specified Municipal Obligation at a
specified price. A stand-by commitment is the equivalent of a "put" option with
respect to a particular Municipal Obligation. The Fund intends to acquire
stand-by commitments solely to facilitate liquidity. Standby commitments are
subject to certain risks, which include the ability of the issuer of the
commitment to pay for the Municipal Obligations at the time the commitment is
exercised, the fact that the commitment is not marketable, and the fact that the
maturity of the underlying security will generally be different from that of the
commitment. In some cases it may not be possible to exercise rights under a
stand-by commitment when the underlying Municipal Obligation is in default.
Repurchase Agreements. The Fund may enter into repurchase agreements in order to
earn a return on temporarily available cash. Repurchase agreements are
transactions in which an institution sells the Fund a security at one price,
subject to the Fund's obligation to resell and the selling institution's
obligation to repurchase that security at a higher price normally within a seven
day period. There may be delays and risks of loss if the seller is unable to
meet its obligation to repurchase. Repurchase agreements may involve Municipal
Obligations and other securities.
Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreements. Reverse repurchase agreements involve the sale of securities held by
the Fund and the agreement by the Fund to repurchase the securities at an
agreed-upon price, date and interest payment. When the Fund enters into reverse
repurchase transactions, securities of a dollar amount equal in value to the
securities subject to the agreement will be maintained in a segregated account
with the Fund's custodian. The segregation of assets could impair the Fund's
ability to meet its current obligations or impede investment management if a
large portion of the Fund's assets are involved. Reverse repurchase agreements
are considered to be a form of borrowing.
Lending of Portfolio Securities. Consistent with applicable regulatory
requirements and in order to generate additional income, the Fund may lend its
portfolio securities to broker-dealers and other institutional borrowers. Such
loans must be callable at any time and continuously secured by collateral (cash
or U.S. Government securities) in an amount not less than the market value,
determined daily, of the securities loaned. It is intended that the value of
securities loaned by the Fund would not exceed 30% of the Fund's total assets.
In the event of the bankruptcy of the other party to a securities loan, a
repurchase agreement or a reverse repurchase agreement, the Fund could
experience delays in recovering either the securities or cash. To the extent
that, in the meantime, the value of the securities loaned or sold has increased
or the value of the securities purchased has decreased, the Fund could
experience a loss.
Rule 144A Securities. The Fund may purchase restricted securities that are not
registered for sale to the general public. If the Manager determines that there
is a dealer or institutional market in the securities, the securities will not
be treated as illiquid for purposes of the Fund's investment limitations. The
Trustees will review these determinations. These securities are known as "Rule
144A securities," because they are traded under SEC Rule 144A among qualified
institutional buyers. Institutional trading in Rule 144A securities is
relatively new, and the liquidity of these investments could be impaired if
trading in Rule 144A securities does not develop or to the extent qualified
institutional buyers become, for a time, uninterested in purchasing Rule 144A
securities.
Private Placements and Illiquid Investments. The Fund may invest up to 10% of
its net assets in securities for which there is no readily available market.
These illiquid securities may include privately placed restricted securities for
which no institutional market exists. The absence of a trading market can make
it difficult to ascertain a market value for illiquid investments. Disposing of
illiquid investments may involve time-consuming negotiation and legal expenses,
and it may be difficult or impossible for the Fund to sell them promptly at an
acceptable price.
Commercial Paper. The Fund may invest in commercial paper, which is unsecured
debt of corporations usually maturing in 270 days or less from its date of
issuance.
"When-Issued" Securities. In order to ensure the availability of suitable
securities, the Fund may purchase securities on a "when-issued" or on a "forward
delivery" basis, which means that the securities would be delivered to the Fund
at a future date beyond customary settlement time. Under normal circumstances,
the Fund takes delivery of the securities. In general, the Fund does not pay for
the securities until received and does not start earning interest until the
contractual settlement date. While awaiting delivery of the securities, the Fund
establishes a segregated account consisting of cash, cash equivalents or high
quality debt securities equal to the amount of the Fund's commitments to
purchase "when-issued" securities. An increase in the percentage of the Fund's
assets committed to the purchase of securities on a "when-issued" basis may
increase the volatility of its net asset value.
Other Investment Companies. Subject to applicable statutory and regulatory
limitations, assets of the Fund may be invested in shares of other investment
companies.
Futures Contracts. The Fund may use financial futures in order to protect itself
from fluctuations in interest rates (sometimes called "hedging") without
actually buying or selling debt securities, or to manage the effective maturity
or duration of fixed-income securities in the Fund's portfolio in an effort to
reduce potential losses or enhance potential gain. Futures contracts provide for
the future sale by one party and purchase by another party of a specified amount
of a security at a specified future time and price, or for making payment of a
cash settlement based on changes in the value of a security or an index of
securities. Because the value of a futures contract changes based on the price
of the underlying security, futures contracts are commonly referred to as
"derivatives." Futures contracts are a generally accepted part of modern
portfolio management and are regularly utilized by many mutual funds and other
institutional investors. The futures contracts that may be purchased by the Fund
are standardized contracts traded on commodities exchanges or boards of trade.
When the Fund purchases or sells a futures contract, it is required to make an
initial margin deposit. Although the amount may vary, initial margin can be as
low as 1% or less of the face amount of the contract. Additional margin may be
required as the contract fluctuates in value. Since the amount of margin is
relatively small compared to the value of the securities covered by a futures
contract, the potential for gain or loss on a futures contract is much greater
than the amount of the Fund's initial margin deposit. The Fund does not
currently intend to enter into a futures contract if, as a result, the initial
margin deposits on all of the Fund's futures contracts would exceed
approximately 5% of the Fund's net assets. Also, the Fund intends to limit its
futures contracts so that the value of the securities covered by its futures
contracts would not generally exceed 50% of the Fund's total assets other than
its futures contracts and to segregate sufficient assets to meet its obligations
under outstanding futures contracts. In any event, the Fund will not invest in
futures contracts to the extent that the investment would be inconsistent with
the Fund's investment policies which provide that, under normal circumstances,
the Fund will invest at least 80% of its assets in tax-exempt Municipal
Obligations.
The ability of the Fund to utilize futures contracts successfully will depend on
the Manager's ability to predict interest rate movements, which cannot be
assured. In addition to general risks associated with any investment, the use of
futures contracts entails the risk that, to the extent the Manager's view as to
interest rate movements is incorrect, the use of futures contracts, even for
hedging purposes, could result in losses greater than if they had not been used.
This could happen, for example, if there is a poor correlation between price
movements of futures contracts and price movements in the Fund's related
portfolio position. Also, although the Fund will purchase only standardized
futures traded on regulated exchanges, the futures markets may not be liquid in
all circumstances. As a result, in certain markets, the Fund might not be able
to close out a transaction without incurring substantial losses, if at all. When
futures contracts are used for hedging, even if they are successful in
minimizing the risk of loss due to a decline in the value of the hedged
position, at the same time they limit any potential gain which might result from
an increase in value of such position.
The use of futures contracts potentially exposes the Fund to the effects of
"leveraging," which occurs when futures are used so that the Fund's exposure to
the market is greater than it would have been if the Fund had invested directly
in the underlying securities. "Leveraging" increases the Fund's potential for
both gain and loss. As noted above, the Fund intends to adhere to certain
policies relating to the use of futures contracts, which should have the effect
of limiting the amount of leverage by the Fund. The use of futures contracts may
increase the amount of taxable income of the Fund and may affect in other ways
the amount, timing and character of the Fund's income for tax purposes, as more
fully discussed in the section entitled "Certain Additional Tax Matters" in the
Statement of Additional Information.
The use of futures by the Fund and some of their risks are described more fully
in the Statement of Additional Information.
Short Sales "Against the Box." In a short sale, the Fund sells a borrowed
security and has a corresponding obligation to the lender to return the
identical security. The Fund may engage in short sales only if at the time of
the short sale it owns or has the right to obtain, at no additional cost, an
equal amount of the security being sold short. This investment technique is
known as a short sale "against the box." The Fund may make a short sale as a
hedge, when it believes that the value of a security owned by the Fund (or a
security convertible or exchangeable for such security) may decline. Not more
than 40% of the Fund's total assets would be involved in short sales "against
the box."
CFP/CAT 1198 [recycle symbol] Printed on recycled paper
<PAGE>
497(c) File Nos. 33-5819 and 811-5034
Statement of
Additional Information
September 14, 1998
CITIFUNDS(SM) CALIFORNIA TAX FREE INCOME PORTFOLIO
CitiFunds(SM) California Tax Free Income Portfolio (the "Fund") is a series
of CitiFunds Tax Free Income Trust (the "Trust"). The address and telephone
number of the Trust are 21 Milk Street, 5\t/\h/ Floor, Boston, Massachusetts
02109, (617) 423-1679.
FUND SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED BY, CITIBANK,
N.A. OR ANY OF ITS AFFILIATES, ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER AGENCY, AND INVOLVE INVESTMENT RISKS, INCLUDING
POSSIBLE LOSS OF PRINCIPAL AMOUNT INVESTED.
Table of Contents Page
- ----------------- ----
1. The Trust ........................................................... 2
2. Investment Objective and Policies ................................... 2
3. Description of Permitted Investments and Investment Practices ....... 2
4. Investment Restrictions ............................................. 6
5. Performance Information ............................................. 7
6. Determination of Net Asset Value; Valuation of Securities;
Additional Redemption Information ................................. 8
7. Management .......................................................... 9
8. Portfolio Transactions .............................................. 13
9. Description of Shares, Voting Rights and Liabilities ................ 14
10. Certain Additional Tax Matters ...................................... 15
11. Independent Accountants and Financial Statements .................... 16
Appendix A -- Description of Municipal Obligations ...................... 17
Appendix B -- Description of Securities Ratings ......................... 19
Appendix C -- Additional Information Concerning California
Municipal Obligations ..................................... 23
This Statement of Additional Information sets forth information which may be
of interest to investors but which is not necessarily included in the Fund's
Prospectus dated September 14, 1998. This Statement of Additional Information
should be read in conjunction with the Prospectus, copies of which may be
obtained by an investor without charge by calling 1-800-625-4554.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND IS
AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR
ACCOMPANIED BY AN EFFECTIVE PROSPECTUS.
<PAGE>
1. THE TRUST
CitiFunds Tax Free Income Trust (the "Trust") is an open-end management
investment company which was organized as a business trust under the laws of the
Commonwealth of Massachusetts on May 27, 1986. The Trust was called Landmark New
York Tax Free Income Fund until its name was changed to Landmark Tax Free Income
Funds effective October 21, 1993. Effective March 2, 1998, the Trust's name was
changed to CitiFunds Tax Free Income Trust. This Statement of Additional
Information describes CitiFunds California Tax Free Income Portfolio (the
"Fund"), which is a non-diversified separate series of the Trust. References in
this Statement of Additional Information to the "Prospectus" are to the Fund's
Prospectus dated September 14, 1998.
Citibank, N.A. ("Citibank" or the "Manager") is the manager of the Fund.
Citibank manages the investments of the Fund from day to day in accordance with
the Fund's investment objective and policies. The selection of investments for
the Fund and the way they are managed depend on the conditions and trends in the
economy and the financial marketplaces.
The Board of Trustees of the Trust provides broad supervision over the
affairs of the Fund. Shares of the Fund are continuously sold by CFBDS, Inc.,
the Fund's distributor ("CFBDS" or the "Distributor"). Shares of the Fund are
sold at net asset value. CFBDS may receive distribution fees from the Fund
pursuant to a Service Plan adopted in accordance with Rule 12b-1 under the
Investment Company Act of 1940, as amended (the "1940 Act").
2. INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to generate high levels of current
income exempt from federal and California State personal income taxes and
preserve the value of its shareholders' investment. The Fund invests primarily
in municipal obligations that pay interest that is exempt from federal income
taxes.
The investment objective of the Fund may be changed without approval by the
Fund's shareholders, but shareholders will be given written notice at least 30
days before any change is implemented. Of course, there can be no assurance that
the Fund will achieve its investment objective.
As a fundamental policy, the Trust seeks to achieve the investment objective
of the Fund by investing at least 80% of its net assets under normal conditions
in municipal bonds and notes and other debt instruments the interest on which is
exempt from federal income taxes. These obligations are issued primarily by the
State of California, its political subdivisions, municipalities, agencies,
instrumentalities or public authorities.
The Fund's investment policies are described in "Investment Information --
Investment Policies" in the Prospectus.
3. DESCRIPTION OF PERMITTED INVESTMENTS AND INVESTMENT PRACTICES
The following supplements the information contained in the Prospectus
concerning the investment objectives, policies and techniques of the Fund. For a
general discussion of Municipal Obligations and the risks associated with
investment therein, see Appendix A to this Statement of Additional Information.
In determining the tax status of interest on Municipal Obligations, the Manager
relies on opinions of bond counsel who may be counsel to the issuer.
FUTURES CONTRACTS
A futures contract is an agreement between two parties for the purchase or
sale for future delivery of securities or for the payment or acceptance of a
cash settlement based upon changes in the value of the securities or of an index
of securities. A "sale" of a futures contract means the acquisition of a
contractual obligation to deliver the securities called for by the contract at a
specified price, or to make or accept the cash settlement called for by the
contract, on a specified date. A "purchase" of a futures contract means the
acquisition of a contractual obligation to acquire the securities called for by
the contract at a specified price, or to make or accept the cash settlement
called for by the contract, on a specified date. Futures contracts have been
designed by exchanges which have been designated "contract markets" by the
Commodity Futures Trading Commission ("CFTC") and must be executed through a
futures commission merchant, or brokerage firm, which is a member of the
relevant contract market. Futures contracts trade on these markets, and the
exchanges, through their clearing organizations, guarantee that the contracts
will be performed as between the clearing members of the exchange.
While futures contracts based on debt securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are very seldom
made. Generally, a futures contract is terminated by entering into an offsetting
transaction. Brokerage fees will be incurred when the Fund purchases or sells a
futures contract. At the same time such a purchase or sale is made, the Fund
must provide cash or securities as a deposit ("initial deposit") known as
"margin." The initial deposit required will vary, but may be as low as 1% or
less of a contract's face value. Daily thereafter, the futures contract is
valued through a process known as "marking to market," and the Fund may receive
or be required to pay additional "variation margin" as the futures contract
becomes more or less valuable. At the time of delivery of securities pursuant to
such a contract, adjustments are made to recognize differences in value arising
from the delivery of securities with a different interest rate than the specific
security that provides the standard for the contract. In some (but not many)
cases, securities called for by a futures contract may not have been issued when
the contract was entered into.
The Fund may purchase or sell futures contracts to attempt to protect the
Fund from fluctuations in interest rates, or to manage the effective maturity or
duration of the Fund's portfolio in an effort to reduce potential losses or
enhance potential gain, without actually buying or selling debt securities. For
example, if interest rates were expected to increase, the Fund might enter into
futures contracts for the sale of debt securities. Such a sale would have much
the same effect as if the Fund sold bonds that it owned, or as if the Fund sold
longer-term bonds and purchased shorter-term bonds. If interest rates did
increase, the value of the Fund's debt securities would decline, but the value
of the futures contracts would increase, thereby keeping the net asset value of
the Fund from declining as much as it otherwise would have. Similar results
could be accomplished by selling bonds, or by selling bonds with longer
maturities and investing in bonds with shorter maturities. However, by using
futures contracts, the Fund avoids having to sell its securities.
Similarly, when it is expected that interest rates may decline, the Fund
might enter into futures contracts for the purchase of debt securities. Such a
transaction would be intended to have much the same effect as if the Fund
purchased bonds, or as if the Fund sold shorter-term bonds and purchased
longer-term bonds. If interest rates did decline, the value of the futures
contracts would increase.
Although the use of futures for hedging should tend to minimize the risk of
loss due to a decline in the value of the hedged position (e.g., if the Fund
sells a futures contract to protect against losses in the debt securities held
by the Fund), at the same time the futures contracts limit any potential gain
which might result from an increase in value of a hedged position.
In addition, the ability effectively to hedge all or a portion of the Fund's
investments through transactions in futures contracts depends on the degree to
which movements in the value of the debt securities underlying such contracts
correlate with movements in the value of the Fund's securities. If the security
underlying a futures contract is different than the security being hedged, they
may not move to the same extent or in the same direction. In that event, the
Fund's hedging strategy might not be successful and the Fund could sustain
losses on these hedging transactions which would not be offset by gains on the
Fund's other investments or, alternatively, the gains on the hedging transaction
might not be sufficient to offset losses on the Fund's other investments. It is
also possible that there may be a negative correlation between the security
underlying a futures contract and the securities being hedged, which could
result in losses both on the hedging transaction and the securities. In these
and other instances, the Fund's overall return could be less than if the hedging
transactions had not been undertaken. Similarly, where the Fund enters into
futures transactions other than for hedging purposes, the effectiveness of its
strategy may be affected by lack of correlation between changes in the value of
the futures contracts and changes in value of the securities which the Fund
would otherwise buy and sell.
The ordinary spreads between prices in the cash and futures markets, due to
differences in the nature of those markets, are subject to distortions. First,
all participants in the futures market are subject to initial deposit and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close out futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, there is the potential that the liquidity of the
futures market may be lacking. Prior to expiration, a futures contract may be
terminated only by entering into a closing purchase or sale transaction, which
requires a secondary market on the contract market on which the futures
contracts was originally entered into. While the Fund will establish a futures
position only if there appears to be a liquid secondary market therefor, there
can be no assurance that such a market will exist for any particular futures
contract at any specific time. In that event, it may not be possible to close
out a position held by the Fund, which could require the Fund to purchase or
sell the instrument underlying the futures contract or to meet ongoing variation
margin requirements. The inability to close out futures positions also could
have an adverse impact on the ability effectively to use futures transactions
for hedging or other purposes.
The liquidity of a secondary market in a futures contract may be adversely
affected by "daily price fluctuation limits" established by the exchanges, which
limit the amount of fluctuation in the price of a futures contract during a
single trading day and prohibit trading beyond such limits once they have been
reached. The trading of futures contracts also is subject to the risk of trading
halts, suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal trading activity, which could at times make it difficult
or impossible to liquidate existing positions or to recover excess variation
margin payments.
Investments in futures contracts also entail the risk that if the Manager's
investment judgment about the general direction of interest rates is incorrect,
the Fund's overall performance may be poorer than if any such contract had not
been entered into. For example, if the Fund hedged against the possibility of an
increase in interest rates which would adversely affect the price of the Fund's
bonds and interest rates decrease instead, part or all of the benefit of the
increased value of the Fund's bonds which were hedged will be lost because the
Fund will have offsetting losses in its futures positions. Similarly, if the
Fund purchases futures contracts expecting a decrease in interest rates and
interest rates instead increased, the Fund will have losses in its futures
positions which will increase the amount of the losses on the securities in its
portfolio which will also decline in value because of the increase in interest
rates. In addition, in such situations, if the Fund has insufficient cash, the
Fund may have to sell bonds from its investments to meet daily variation margin
requirements, possibly at a time when it may be disadvantageous to do so.
Each contract market on which futures contracts are traded has established a
number of limitations governing the maximum number of positions which may be
held by a trader, whether acting alone or in concert with others. The Manager
does not believe that these trading and position limits would have an adverse
impact on the Fund's strategies involving futures.
CFTC regulations require compliance with certain limitations in order to
assure that the Fund is not deemed to be a "commodity pool" under such
regulations. In particular, CFTC regulations prohibit the Fund from purchasing
or selling futures contracts (other than for bona fide hedging transactions) if,
immediately thereafter, the sum of the amount of initial margin required to
establish the Fund's non-hedging futures positions would exceed 5% of the Fund's
net assets.
The Fund will comply with this CFTC requirement, and the Fund currently
intends to adhere to the additional policies described below. First, an amount
of cash or cash equivalents will be maintained by the Fund in a segregated
account with the Fund's custodian so that the amount so segregated, plus the
initial margin held on deposit, will be approximately equal to the amount
necessary to satisfy the Fund's obligations under the futures contract. The
second is that the Fund will not enter into a futures contract if immediately
thereafter the amount of initial margin deposits on all the futures contracts
held by the Fund would exceed approximately 5% of the net assets of the Fund.
The third is that the aggregate market value of the futures contracts held by
the Fund not generally exceed 50% of the market value of the Fund's total assets
other than its futures contracts. For purposes of this third policy, "market
value" of a futures contract is deemed to be the amount obtained by multiplying
the number of units covered by the futures contract times the per unit price of
the securities covered by that contract. Finally, the Fund will not invest in
futures contracts to the extent that such investment would be inconsistent with
the Fund's investment policies which provide that, under normal circumstances,
the Fund will invest at least 80% of its net assets in Municipal Obligations
exempt from federal income taxes including the federal alternative minimum tax.
The use of futures contracts may increase the amount of taxable income of
the Fund and may affect the amount, timing and character of the Fund's income
for tax purposes, as more fully discussed herein in the section entitled
"Certain Additional Tax Matters."
WHEN-ISSUED SECURITIES
The Fund may purchase securities on a "when-issued" or on a "forward
delivery" basis. It is expected that, under normal circumstances, the Fund would
take delivery of such securities. When the Fund commits to purchase a security
on a "when-issued" or on a "forward delivery" basis, it sets up procedures
consistent with Securities and Exchange Commission ("SEC") policies. Since those
policies currently require that an amount of the Fund's assets equal to the
amount of the purchase be held aside or segregated to be used to pay for the
commitment, the Fund expects always to have cash, cash equivalents, or high
quality debt securities sufficient to cover any commitments or to limit any
potential risk. However, even though the Fund does not intend to make such
purchases for speculative purposes and intends to adhere to the provisions of
SEC policies, purchases of securities on such bases may involve more risk than
other types of purchases. For example, the Fund may have to sell assets which
have been set aside in order to meet redemptions. Also, if the Manager
determines it is advisable as a matter of investment strategy to sell the
"when-issued" or "forward delivery" securities, the Fund would be required to
meet its obligations from the then available cash flow or the sale of
securities, or, although it would not normally expect to do so, from the sale of
the "when-issued" or "forward delivery" securities themselves (which may have a
value greater or less than the Fund's payment obligation).
FLOATING AND VARIABLE RATE OBLIGATIONS
The Fund may invest in floating and variable rate obligations. Floating or
variable rate obligations bear interest at rates that are not fixed, but vary
with changes in specified market rates or indices, such as the prime rate, and
at specified intervals. Certain of the floating or variable rate obligations
that may be purchased by the Fund may carry a demand feature that would permit
the holder to tender them back to the issuer at par value prior to maturity.
Such obligations include variable rate master demand notes, which are unsecured
instruments issued pursuant to an agreement between the issuer and the holder
that permit the indebtedness thereunder to vary and provide for periodic
adjustments in the interest rate. The Fund will limit its purchases of floating
and variable rate obligations to those of the same quality as it otherwise is
allowed to purchase. The Fund will monitor on an ongoing basis the ability of an
issuer of a demand instrument to pay principal and interest on demand. Some of
the demand instruments purchased by the Fund are not traded in a secondary
market and derive their liquidity solely from the ability of the holder to
demand repayment from the issuer or third party providing credit support. If a
demand instrument is not traded in a secondary market, the Fund will nonetheless
treat the instrument as "readily marketable" for the purposes of its investment
restriction limiting investments in illiquid securities unless the demand
feature has a notice period of more than seven days in which case the instrument
will be characterized as "not readily marketable" and therefore illiquid. The
Fund's right to obtain payment at par on a demand instrument could be affected
by events occurring between the date the Fund elects to demand payment and the
date payment is due that may affect the ability of the issuer of the instrument
or third party providing credit support to make payment when due, except when
such demand instruments permit same day settlement. To facilitate settlement,
these same day demand instruments may be held in book entry form at a bank other
than the Fund's custodian subject to a sub-custodian agreement approved by the
Fund between that bank and the Fund's custodian.
PARTICIPATION INTERESTS
The Trust may purchase from banks on behalf of the Fund participation
interests in all or part of specific holdings of Municipal Obligations. The
Trust has the right to sell the participation interest back to the bank and draw
on the letter of credit or guarantee for all or any part of the full principal
amount of the participation interest in the security, plus accrued interest. In
some cases, these rights may not be exercisable in the event of a default on the
underlying Municipal Obligations; in these cases, the underlying Municipal
Obligations must meet the Fund's credit standards at the time of purchase of the
participation interests. Each participation interest is backed by an irrevocable
letter of credit or guarantee of the selling bank. Participation interests will
only be purchased if in the opinion of counsel interest income on such interests
will be tax-exempt when distributed as dividends to shareholders of the Fund.
Participation interests include municipal lease obligations which are deemed to
be illiquid unless otherwise determined by the Board of Trustees.
LENDING OF SECURITIES
Consistent with applicable regulatory requirements and in order to generate
income, the Fund may lend its securities to broker-dealers and other
institutional borrowers. Such loans will usually be made only to member banks of
the U.S. Federal Reserve System and to member firms of the New York Stock
Exchange (and subsidiaries thereof). Loans of securities would be secured
continuously by collateral in cash, cash equivalents or U.S. Treasury
obligations maintained on a current basis at an amount at least equal to the
market value of the securities loaned. The cash collateral would be invested in
high quality short-term instruments. Either party has the right to terminate a
loan at any time on customary industry settlement notice (which will not usually
exceed three business days). During the existence 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 with respect to cash collateral would also
receive compensation based on investment of the collateral (subject to a rebate
payable to the borrower). When the borrower provides the Fund with collateral
consisting of U.S. Treasury obligations, the borrower is also obligated to pay
the Fund a fee for use of the borrowed securities. The Fund would not, however,
have the right to vote any securities having voting rights during the existence
of the loan, but 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. As with other extensions
of credit, there are risks of delay in recovery or even loss of rights in the
collateral should the borrower fail financially. However, the loans would be
made only to entities deemed by the Manager to be of good standing, and when, in
the judgment of the Manager, the consideration which can be earned currently
from loans of this type justifies the attendant risk. In addition, the Fund
could suffer loss if the borrower terminates the loan and the Fund is forced to
liquidate the investments in order to return the cash collateral to the buyer.
If the Manager determines to make loans, it is not intended that the value of
the securities loaned by the Fund would exceed 30% of the value of its total
assets.
RULE 144A SECURITIES
The Fund may purchase securities that are not registered ("Rule 144A
securities") under the Securities Act of 1933 (the "Securities Act"), but can be
offered and sold to "qualified institutional buyers" under Rule 144A under the
Securities Act. However, the Fund will not invest more than 10% of its net
assets in illiquid investments, which include securities for which there is no
readily available market, securities subject to contractual restrictions on
resale and Rule 144A securities, unless the Trustees of the Trust determine,
based on the trading markets for a specific Rule 144A security, that it is
liquid. The Trustees have adopted guidelines and delegated to the Manager the
daily function of determining and monitoring liquidity of Rule 144A securities.
The Trustees, however, retain oversight and are ultimately responsible for the
determinations.
Since it is not possible to predict with assurance exactly how the market
for Rule 144A securities will develop, the Trustees will carefully monitor the
Fund's investments in Rule 144A securities, focusing on such factors, among
others, as valuation, liquidity and availability of information. The liquidity
of investments in Rule 144A securities could be impaired if trading in Rule 144A
securities does not develop or if qualified institutional buyers become for a
time uninterested in purchasing Rule 144A securities.
SPECIAL FACTORS AFFECTING CALIFORNIA
The Trust intends to invest a high proportion of the Fund's assets in
Municipal Obligations of the State of California and its political subdivisions,
municipalities, agencies, instrumentalities and public authorities. Payment of
interest and preservation of principal is dependent upon the continuing ability
of California issuers and/or obligors of state, municipal and public authority
debt obligations to meet their obligations thereunder.
The fiscal stability of the State of California is related, at least in
part, to the fiscal stability of its localities and authorities. Various State
agencies, authorities and localities have issued large amounts of bonds and
notes either guaranteed or supported by the State through lease-purchase
arrangements, other contractual arrangements or moral obligation provisions.
While debt service is normally paid out of revenues generated by projects of
such State agencies, authorities and localities, the State has had to provide
special assistance in recent years, in some cases of a recurring nature, to
enable such agencies, authorities and localities to meet their financial
obligations and, in some cases, to prevent or cure defaults. To the extent State
agencies and local governments require State assistance to meet their financial
obligations, the ability of the State to meet its own obligations as they become
due or to obtain additional financing could be adversely affected.
For further information concerning California Municipal Obligations, see
Appendix C to this Statement of Additional Information. The summary set forth
above and in Appendix C is included for purposes of providing a general
description of California credit and financial conditions. This summary is based
on information from statements, including preliminary statements, of issuers of
California Municipal Obligations and does not purport to be complete. The Trust
is not responsible for the accuracy or timeliness of this information.
4. INVESTMENT RESTRICTIONS
The Trust, on behalf of the Fund, has adopted the following policies which
cannot be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities (which, as used in this Statement of
Additional Information, means the lesser of (i) more than 50% of the outstanding
voting securities of the Fund, or (ii) 67% or more of the outstanding voting
securities of the Fund present at a meeting at which holders of more than 50% of
the Fund's outstanding voting securities are represented in person or by proxy).
The term "voting securities" as used in this paragraph has the same meaning as
in the 1940 Act.
The Fund may not:
(1) Borrow money, except that as a temporary measure for extraordinary
or emergency purposes it may borrow in an amount not to exceed 1/3 of the
current value of its net assets, including the amount borrowed or purchase
any securities at any time at which borrowings exceed 5% of the total assets
of the Fund, taken at market value. It is intended that the Fund would
borrow money only from banks and only to accommodate requests for the
repurchase of shares of the Fund while effecting an orderly liquidation of
portfolio securities.
(2) Underwrite securities issued by other persons except that all or any
portion of the assets of the Fund may be invested in one or more investment
companies, to the extent not prohibited by the 1940 Act, the rules and
regulations thereunder, and exemptive orders granted under such Act, and
except insofar as the Fund may technically be deemed an underwriter under
the Securities Act in selling a security.
(3) Make loans to other persons except (a) through the lending of its
portfolio securities and provided that any such loans not exceed 30% of the
Fund's total assets (taken at market value), (b) through the use of
repurchase agreements or fixed time deposits or the purchase of short-term
obligations, or (c) by purchasing all or a portion of an issue of debt
securities of types commonly distributed privately to financial
institutions. The purchase of short-term commercial paper or a portion of an
issue of debt securities which is part of an issue to the public shall not
be considered the making of a loan.
(4) Purchase or sell real estate (including limited partnership
interests but excluding securities secured by real estate or interests
therein), interests in oil, gas or mineral leases, commodities or commodity
contracts in the ordinary course of business (the foregoing shall not be
deemed to preclude the Fund from purchasing or selling futures contracts or
options thereon, and the Fund reserves the freedom of action to hold and to
sell real estate acquired as a result of the ownership of securities by the
Fund).
(5) Concentrate its investments in any particular industry, but if it is
deemed appropriate for the achievement of the Fund's investment objective,
up to 25% of its assets, at market value at the time of each investment, may
be invested in any one industry, except that positions in futures contracts
shall not be subject to this restriction.
(6) Issue any senior security (as that term is defined in the 1940 Act)
if such issuance is specifically prohibited by the 1940 Act or the rules and
regulations promulgated thereunder.
For purposes of the investment restrictions described above, the issuer of a
tax-exempt security is deemed to be the entity (public or private) ultimately
responsible for the payment of the principal of and interest on the security.
For purposes of restriction (5) above, industries such as telecommunications,
electric utilities and gas utilities will be treated as separate industries.
As an operating policy, the Fund will not invest more than 10% of its net
assets in securities for which there is no readily available market. This policy
is not fundamental and may be changed without shareholder approval.
If a percentage restriction on investment or utilization of assets set forth
above or referred to in the Prospectus is adhered to at the time an investment
is made or assets are so utilized, a later change in percentage resulting from
changes in the value of the securities held for the Fund is not considered a
violation of policy. This policy does not apply to securities for which there is
no readily available market. With respect to such securities the Fund will take
action to reduce its holdings.
5. PERFORMANCE INFORMATION
A total rate of return quotation for the Fund is calculated for any period
by (a) dividing (i) the sum of the net asset value per share on the last day of
the period and the net asset value per share on the last day of the period of
shares purchasable with dividends and capital gains distributions declared
during such period with respect to a share held at the beginning of such period
and with respect to shares purchased with such dividends and capital gains
distributions, by (ii) the public offering price per share on the first day of
such period, and (b) subtracting 1 from the result. Any annualized total rate of
return quotation is calculated by (x) adding 1 to the period total rate of
return quotation calculated above, (y) raising such sum to a power which is
equal to 365 divided by the number of days in such period, and (z) subtracting 1
from the result.
Any current yield quotation of the Fund consists of an annualized historical
yield, carried at least to the nearest hundredth of one percent, based on a 30
calendar day or one month period and is calculated by (a) raising to the sixth
power the sum of 1 plus the quotient obtained by dividing the Fund's net
investment income earned during the period by the product of the average daily
number of shares outstanding during the period that were entitled to receive
dividends and the public offering price per share on the last day of the period,
(b) subtracting 1 from the result, and (c) multiplying the result by 2.
Any tax equivalent yield quotation of the Fund is calculated as follows: If
the entire current yield quotation for such period is tax-exempt, the tax
equivalent yield would be the current yield quotation divided by 1 minus a
stated income tax rate or rates. If a portion of the current yield quotation is
not tax-exempt, the tax equivalent yield would be the sum of (a) that portion of
the yield which is tax-exempt divided by 1 minus a stated income tax rate or
rates, and (b) the portion of the yield which is not tax-exempt.
Comparative performance information may be used from time to time in
advertising shares of the Fund, including data from Lipper Analytical Services,
Inc. and other industry sources and publications. From time to time the Fund may
compare its performance against inflation with the performance of other
instruments against inflation, such as FDIC-insured bank money market accounts.
In addition, advertising for the Fund may indicate that investors should
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 the Fund may refer to or discuss current or past economic or
financial conditions, developments and events.
From time to time, the Fund may use hypothetical tax equivalent yields or
charts in its advertising. These hypothetical yields or charts will be used for
illustrative purposes only and are not indicative of the Fund's past or future
performance.
6. DETERMINATION OF NET ASSET VALUE; VALUATION OF SECURITIES;
ADDITIONAL REDEMPTION INFORMATION
The net asset value per share of the Fund is determined each day during
which the New York Stock Exchange is open for trading ("Business Day"). As of
the date of this Statement of Additional Information, the Exchange is open for
trading every weekday except for the following holidays (or the days on which
they are observed): New Year's Day, Martin Luther King Jr. Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. This determination is made once each day as of the close of
regular trading on the Exchange (normally 4:00 p.m. Eastern time) by adding the
market value of all securities and other assets of the Fund, then subtracting
the liabilities of the Fund, and then dividing the result by the number of
outstanding shares of the Fund. The net asset value per share is effective for
orders received and accepted by the Transfer Agent prior to its calculation.
Bonds and other fixed income securities (other than short-term obligations)
held for the Fund are valued on the basis of valuations furnished by a pricing
service, use of which has been approved by the Board of Trustees. In making such
valuations, the pricing service utilizes both dealer-supplied valuations and
electronic data processing techniques which take into account appropriate
factors such as institutional-size trading in similar groups of securities,
yield, quality, coupon rate, maturity, type of issue, trading characteristics
and other market data, without exclusive reliance upon quoted prices or exchange
or over-the-counter prices, since such valuations are believed to reflect more
accurately the fair value of such securities. Short-term obligations (maturing
in 60 days or less) are valued at amortized cost, which constitutes fair value
as determined by the Board of Trustees. Futures contracts are normally valued at
the settlement price on the exchange on which they are traded. Securities for
which there are no such valuations are valued at fair value as determined in
good faith by or at the direction of the Board of Trustees.
Interest income on long-term obligations held for the Fund is determined on
the basis of interest accrued plus amortization of "original issue discount"
(generally, the difference between issue price and stated redemption price at
maturity) and premiums (generally, the excess of purchase price over stated
redemption price at maturity). Interest income on short-term obligations is
determined on the basis of interest accrued less amortization of any premiums.
Subject to compliance with applicable regulations, the Trust has reserved
the right to pay the redemption or repurchase price of shares of the Fund,
either totally or partially, by a distribution in kind of readily marketable
securities (instead of cash). The securities so distributed would be valued at
the same amount as that assigned to them in calculating the net asset value for
the shares being sold. If a holder of shares received a distribution in kind,
such holder could incur brokerage or other charges in converting the securities
to cash.
The Trust may suspend the right of redemption or postpone the date of
payment for shares of the Fund more than seven days during any period when (a)
trading in the markets the Fund normally utilizes is restricted, or an
emergency, as defined by the rules and regulations of the SEC, exists making
disposal of the Fund's investments or determination of its net asset value not
reasonably practicable; (b) the New York Stock Exchange is closed (other than
customary weekend and holiday closings); or (c) the SEC has by order permitted
such suspension.
7. MANAGEMENT
The Trustees and officers of the Trust, their ages and their principal
occupations during at least the past five years are set forth below. Their
titles may have varied during that period. Asterisks indicate that those
Trustees and officers are "interested persons" (as defined in the 1940 Act) of
the Trust. Unless otherwise indicated below, the address of each Trustee and
officer is 21 Milk Street, 5th Floor, Boston, Massachusetts 02109.
TRUSTEES
ELLIOTT J. BERV; 55 -- Chairman and Director, Catalyst, Inc. (Management
Consultants) (since June 1992); President, Chief Operating Officer and
Director, Deven International, Inc. (International Consultants) (June 1991 to
June 1992); President and Director, Elliott J. Berv & Associates (Management
Consultants) (since May 1984). His address is 15 Stornoway Drive, Cumberland
Foreside, Maine.
PHILIP W. COOLIDGE*; 47 -- President of the Trust; Chief Executive Officer and
President, Signature Financial Group, Inc. and CFBDS.
MARK T. FINN; 55 -- President and Director, Delta Financial, Inc. (since June
1983); Chairman of the Board and Chief Executive Officer, FX 500 Ltd.
(Commodity Trading Advisory Firm) (since April 1990); Director, Vantage
Consulting Group, Inc. (since October 1988). His address is 3500 Pacific
Avenue, P.O. Box 539, Virginia Beach, Virginia.
RILEY C. GILLEY; 72 -- Vice President and General Counsel, Corporate Property
Investors (November 1988 to December 1991); Partner, Breed, Abbott & Morgan
(Attorneys) (retired, December 1987). His address is 4041 Gulf Shore Boulevard
North, Naples, Florida.
DIANA R. HARRINGTON; 58 -- Professor, Babson College (since September 1993);
Visiting Professor, Kellogg Graduate School of Management, Northwestern
University (September 1992 to September 1993); Professor, Darden Graduate School
of Business, University of Virginia (September 1978 to September 1993); Trustee,
The Highland Family of Funds (March 1997 to March 1998). Her address is 120
Goulding Street, Holliston, Massachusetts.
SUSAN B. KERLEY; 47 -- President, Global Research Associates, Inc. (Investment
Research) (since August 1990); Manager, Rockefeller & Co. (March 1988 to July
1990); Trustee, Mainstay Institutional Funds (since December 1990). Her
address is P.O. Box 9572, New Haven, Connecticut.
C. OSCAR MORONG, JR.; 63 -- Chairman of the Board of Trustees of the Trust;
Managing Director, Morong Capital Management (since February 1993); Senior Vice
President and Investment Manager, CREF Investments, Teachers Insurance & Annuity
Association (retired, January 1993); Director, Indonesia Fund; Director, MAS
Funds. His address is 1385 Outlook Drive West, Mountainside, New
Jersey.
WALTER E. ROBB, III; 72 -- President, Benchmark Consulting Group, Inc. (since
1991); Principal, Robb Associates (Corporate Financial Advisors) (since 1978);
President, Benchmark Advisors, Inc. (Corporate Financial Advisors)(since
1989); Trustee of certain registered investment companies in the MFS Family of
Funds. His address is 35 Farm Road, Sherborn, Massachusetts.
E. KIRBY WARREN; 64 -- Professor of Management, Graduate School of Business,
Columbia University (since 1987); Samuel Bronfman Professor of Democratic
Business Enterprise (1978 to 1987). His address is Columbia University, Graduate
School of Business, 725 Uris Hall, New York, New York.
WILLIAM S. WOODS, JR.; 78 -- Vice President-Investments, Sun Company, Inc.
(retired, April 1984). His address is 35 Colwick Road, Cherry Hill, New
Jersey.
OFFICERS OF THE TRUST
PHILIP W. COOLIDGE*; 47 -- President of the Trust; Chief Executive Officer and
President, Signature Financial Group, Inc. and CFBDS.
CHRISTINE A. DRAPEAU*; 28 -- Assistant Secretary and Assistant Treasurer of
Trust; Assistant Vice President, Signature Financial Group, Inc. (since January
1996); Paralegal and Compliance Officer, various financial companies (July 1992
to January 1996); Graduate Student, Bentley College (prior to December 1994).
TAMIE EBANKS-CUNNINGHAM*; 25 -- Assistant Secretary of the Trust; Office
Manager, Signature Financial Group (Cayman) Ltd. (Since April 1995);
Administrator, Cayman Islands Primary School (prior to April 1995). Her address
is P.O. Box 2494, Elizabethan Square, George Town, Grand Cayman, Cayman Islands,
B.W.I.
JOHN R. ELDER*; 50 -- Treasurer of the Trust; Vice President, Signature
Financial Group, Inc. (since April 1995); Treasurer, CFBDS (since April 1995);
Treasurer, Phoenix Family of Mutual Funds (Phoenix Home Life Mutual Insurance
Company) (1983 to March 1995).
LINDA T. GIBSON*; 33 -- Secretary of the Trust; Vice President, Signature
Financial Group, Inc. (since May 1992); Assistant Secretary, CFBDS (since
October 1992).
JOAN R. GULINELLO*; 42 -- Assistant Secretary and Assistant Treasurer of the
Trust; Vice President, Signature Financial Group, Inc. (since October 1993);
Secretary, CFBDS (since October 1995); Vice President and Assistant General
Counsel, Massachusetts Financial Services Company (prior to October 1993).
JAMES E. HOOLAHAN*; 51 -- Vice President, Assistant Secretary and Assistant
Treasurer of the Trust; Senior Vice President, Signature Financial Group, Inc.
SUSAN JAKUBOSKI*; 34 -- Vice President, Assistant Treasurer and Assistant
Secretary of the Trust (since August 1994); Vice President, Signature Financial
Group (Cayman) Ltd. (since August 1994); Fund Compliance Administrator, Concord
Financial Group (November 1990 to August 1994). Her address is Suite 193, 12
Church Street, Hamilton HM 11, Bermuda.
MOLLY S. MUGLER*; 46 -- Assistant Secretary and Assistant Treasurer of the
Trust; Vice President, Signature Financial Group, Inc.; Assistant Secretary,
CFBDS.
CLAIR TOMALIN*; 29 -- Assistant Secretary of the Trust; Office Manager,
Signature Financial Group (Europe) Limited (since 1993). Her address is 117
Charterhouse Street, London ECIM 6AA.
SHARON M. WHITSON*; 50 -- Assistant Secretary and Assistant Treasurer of the
Trust; Assistant Vice President, Signature Financial Group, Inc.
JULIE J. WYETZNER*; 39 -- Vice President, Assistant Secretary and Assistant
Treasurer of the Trust; Vice President, Signature Financial Group, Inc.
The Trustees and officers of the Trust also hold comparable positions with
certain other funds for which CFBDS, Signature Financial Group, Inc., or their
affiliates serve as distributor, administrator or sub-administrator.
The following table shows estimated Trustee compensation for the period
indicated:
<TABLE>
<CAPTION>
TRUSTEE COMPENSATION TABLE
TOTAL
PENSION OR COMPENSATION FROM
RETIREMENT BENEFITS THE TRUST
AGGREGATE ACCRUED AS ESTIMATED ANNUAL AND FUND COMPLEX
COMPENSATION PART OF FUND BENEFITS UPON PAID TO
TRUSTEE FROM THE FUND(1) EXPENSES RETIREMENT TRUSTEES(1)(2)
- ------- ---------------- ------------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Elliott J. Berv $889 None None $57,000
Philip W. Coolidge $ 0 None None $ 0
Mark T. Finn $888 None None $54,000
Riley C. Gilley $891 None None $50,000
Diana R. Harrington $896 None None $57,000
Susan B. Kerley $892 None None $59,000
C. Oscar Morong, Jr. $900 None None $70,000
Walter E. Robb, III $889 None None $56,000
E. Kirby Warren $892 None None $50,000
William S. Woods, Jr. $896 None None $58,000
</TABLE>
(1) Information is estimated for the fiscal year ending December 31, 1998.
(2) As of the date of this Statement of Additional Information, Messrs. Berv,
Coolidge, Finn, Gilley, Morong, Robb, Warren and Woods, and Mses. Harrington
and Kerley are Trustees of 26, 47, 26, 30, 41, 29, 25, 24, 26, and 26 funds
and portfolios, respectively, in the family of open-end registered
investment companies advised or managed by Citibank.
As of the date of this Statement of Additional Information, there are no
outstanding shares of the Fund.
The Trust's Declaration of Trust provides that the Trust will indemnify its
Trustees and officers against liabilities and expenses incurred in connection
with litigation in which they may be involved because of their offices with the
Trust unless, as to liability to the Trust or its investors, it is finally
adjudicated that they engaged in willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in their offices, or
unless with respect to any other matter it is finally adjudicated that they did
not act in good faith in the reasonable belief that their actions were in the
best interests of the Trust. In the case of settlement, such indemnification
will not be provided unless it has been determined by a court or other body
approving the settlement or other disposition, or by a reasonable determination,
based upon a review of readily available facts, by vote of a majority of
disinterested Trustees of the Trust, or in a written opinion of independent
counsel, that such officers or Trustees have not engaged in willful misfeasance,
bad faith, gross negligence or reckless disregard of their duties.
MANAGER
Citibank manages the assets of the Fund and provides certain administrative
services to the Trust pursuant to a management agreement (the "Management
Agreement"). Subject to such policies as the Board of Trustees of the Trust may
determine, Citibank manages the securities of the Fund and makes investment
decisions for the Fund. Citibank furnishes at its own expense all services,
facilities and personnel necessary in connection with managing the Fund's
investments and effecting securities transactions for the Fund. The Management
Agreement with the Trust provides that Citibank may delegate the daily
management of the securities of the Fund to one or more subadvisers. The
Management Agreement with the Trust will continue in effect until August 7,
2000, and thereafter as long as such continuance is specifically approved at
least annually by the Board of Trustees of the Trust or by a vote of a majority
of the outstanding voting securities of the Fund, and, in either case, by a
majority of the Trustees of the Trust who are not parties to the Management
Agreement or interested persons of any such party, at a meeting called for the
purpose of voting on the Management Agreement.
Citibank provides the Trust with general office facilities and supervises
the overall administration of the Trust, including, among other
responsibilities, the negotiation of contracts and fees with, and the monitoring
of performance and billings of, the Trust's independent contractors and agents;
the preparation and filing of all documents required for compliance by the Trust
with applicable laws and regulations; and arranging for the maintenance of books
and records of the Trust. Trustees, officers, and investors in the Trust are or
may be or may become interested in Citibank, as directors, officers, employees,
or otherwise and directors, officers and employees of Citibank are or may become
similarly interested in the Trust.
The Management Agreement provides that Citibank may render services to
others. The Management Agreement is terminable without penalty on not more than
60 days' nor less than 30 days' written notice by the Trust when authorized
either by a vote of a majority of the outstanding voting securities of the Fund
or by a vote of a majority of the Board of Trustees of the Trust, or by Citibank
on not more than 60 days' nor less than 30 days' written notice, and will
automatically terminate in the event of its assignment. The Management Agreement
with the Trust provides that neither Citibank nor its personnel shall be liable
for any error of judgment or mistake of law or for any loss arising out of any
investment or for any act or omission in the execution of security transactions
for the Fund, except for willful misfeasance, bad faith or gross negligence or
reckless disregard of its or their obligations and duties under the Management
Agreement with the Trust.
The Prospectus contains a description of the fees payable to Citibank for
services under the Management Agreement. Citibank may reimburse the Fund for or
waive all or a portion of its management fees.
Pursuant to a sub-administrative services agreement with Citibank, CFBDS
performs such sub-administrative duties for the Trust as from time to time are
agreed upon by Citibank and CFBDS. For performing such sub-administrative
services, CFBDS receives compensation as from time to time is agreed upon by
Citibank, not in excess of the amount paid to Citibank for its services under
the Management Agreement with the Trust. All such compensation is paid by
Citibank.
DISTRIBUTOR
CFBDS, 21 Milk Street, 5th Floor, Boston, Massachusetts 02109, serves as the
Distributor of the Fund's shares pursuant to a Distribution Agreement with the
Trust (the "Distribution Agreement"). Unless otherwise terminated the
Distribution Agreement will continue from year to year upon annual approval by
the Trust's Board of Trustees, or by the vote of a majority of the outstanding
voting securities of the Fund and by the vote of a majority of the Board of
Trustees of the Trust who are not parties to the Distribution Agreement or
interested persons of any party to the Distribution Agreement, cast in person at
a meeting called for the purpose of voting on such approval. The Distribution
Agreement will terminate in the event of its assignment, as defined in the 1940
Act.
Under a Service Plan for shares of the Fund (the "Service Plan") which has
been adopted in accordance with Rule 12b-1 under the 1940 Act, the Fund may pay
monthly fees at an annual rate not to exceed 0.25% of the average daily net
assets of the Fund. Such fees may be used to make payments to the Distributor
for distribution services, to securities dealers and other industry
professionals (called Service Agents) that have entered into service agreements
with the Distributor and others in respect of the sale of shares of the Fund,
and to other parties in respect of the sale of shares of the Fund, and to make
payments for advertising, marketing or other promotional activity, and payments
for preparation, printing, and distribution of prospectuses, statements of
additional information and reports for recipients other than regulators and
existing shareholders. The Fund also may make payments to the Distributor,
Service Agents and others for providing personal service or the maintenance of
shareholder accounts. The Fund and the Distributor provide to the Trustees
quarterly a written report of amounts expended pursuant to Service Plan and the
purposes for which the expenditures were made.
The Service Plan obligates the Fund to pay fees to the Distributor, Service
Agents and others as compensation for their services, not as reimbursement for
specific expenses incurred. Thus, even if their expenses exceed the fees
provided for by the Service Plan for the Fund, the Fund will not be obligated to
pay more than those fees and, if their expenses are less than the fees paid to
them, they will realize a profit. The Fund will pay the fees to the Distributor,
Service Agents and others until the Service Plan or Distribution Agreement is
terminated or not renewed. In that event, the Distributor's or Service Agent's
expenses in excess of fees received or accrued through the termination date will
be the Distributor's or Service Agent's sole responsibility and not obligations
of the Fund. In their annual consideration of the continuation of the Service
Plan for each of the series of the Trust, the Trustees will review the Service
Plan and the expenses for each series separately.
From time to time the Distributor may make payments for distribution out of
its past profits or any other sources available to it.
The Service Plan continues in effect if such continuance is specifically
approved at least annually by a vote of both a majority of the Trust's Trustees
and a majority of the Trustees who are not "interested persons" of the Trust and
who have no direct or indirect financial interest in the operation of the
Service Plan or in any agreement related to the Plan (for purposes of this
paragraph "Qualified Trustees"). The Service Plan requires that the Trust and
the Distributor provide to the Board of Trustees, and the Board of Trustees
review, at least quarterly, a written report of the amounts expended (and the
purposes therefor) under the Service Plan. The Service Plan further provides
that the selection and nomination of the Qualified Trustees is committed to the
discretion of the disinterested Trustees (as defined in the 1940 Act) then in
office. The Service Plan may be terminated with respect to the Fund at any time
by a vote of a majority of the Trust's Qualified Trustees or by a vote of a
majority of the outstanding voting securities of the Fund. The Service Plan may
not be amended to increase materially the amount of the Fund's permitted
expenses thereunder without the approval of a majority of the outstanding
securities of the Fund and may not be materially amended in any case without a
vote of a majority of both the Trustees and Qualified Trustees. The Distributor
will preserve copies of any plan, agreement or report made pursuant to the
Service Plan for a period of not less than six years, and for the first two
years the Distributor will preserve such copies in an easily accessible place.
As contemplated by the Service Plan, CFBDS acts as the agent of the Trust in
connection with the offering of shares of the Fund pursuant to the Distribution
Agreement. The Fund's Prospectus contains a description of fees payable to the
Distributor under the Distribution Agreement.
The Distributor may enter into agreements with Service Agents and may pay
compensation to such Service Agents for accounts for which the Service Agents
are holders of record. Payments may be made to the Service Agents out of the
distribution fees received by the Distributor and out of the Distributor's past
profits or any other source available to it.
TRANSFER AGENT, CUSTODIAN AND FUND ACCOUNTANT
The Trust has entered into a Transfer Agency and Service Agreement with
State Street Bank and Trust Company ("State Street") pursuant to which State
Street acts as transfer agent for the Fund. The Trust also has entered into a
Custodian Agreement and a Fund Accounting Agreement with State Street, pursuant
to which custodial and fund accounting services, respectively, are provided for
the Fund. See "Transfer Agent, Custodian and Fund Accountant" in the Prospectus
for additional information.
The principal business address of State Street is 225 Franklin Street,
Boston, Massachusetts 02110.
AUDITORS
Deloitte & Touche LLP are the independent accountants for the Trust,
providing audit services and assistance and consultation with respect to the
preparation of filings with the SEC. The address of Deloitte & Touche LLP is 125
Summer Street, Boston, Massachusetts 02110.
COUNSEL
Bingham Dana LLP, 150 Federal Street, Boston, Massachusetts 02110, acts as
counsel for the Trust.
8. PORTFOLIO TRANSACTIONS
The Trust trades securities for the Fund if it believes that a transaction
net of costs (including custodian charges) will help achieve the Fund's
investment objective. Changes in the Fund's investments are made without regard
to the length of time a security has been held, or whether a sale would result
in the recognition of a profit or loss. Therefore, the rate of turnover is not a
limiting factor when changes are appropriate. Specific decisions to purchase or
sell securities for the Fund are made by a portfolio manager who is an employee
of Citibank and who is appointed and supervised by its senior officers. The
portfolio manager may serve other clients of Citibank in a similar capacity.
The primary consideration in placing portfolio securities 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. Citibank attempts to achieve this result by selecting broker-dealers
to execute transactions on behalf of the Fund and other clients of Citibank on
the basis of their professional capability, the value and quality of their
brokerage services, and the level of their brokerage commissions. In the case of
securities traded in the over-the-counter market (where no stated commissions
are paid but the prices include a dealer's markup or markdown), Citibank
normally seeks to deal directly with the primary market makers, unless in its
opinion, best execution is available elsewhere. In the case of securities
purchased from underwriters, the cost of such securities generally includes a
fixed underwriting commission or concession. From time to time, soliciting
dealer fees are available to Citibank on the tender of the Fund's securities in
so-called tender or exchange offers. Such soliciting dealer fees are in effect
recaptured for the Fund by Citibank. At present no other recapture arrangements
are in effect.
Under the Management Agreement, in connection with the selection of such
brokers or dealers and the placing of such orders, Citibank is directed to seek
for the Fund in its best judgment, prompt execution in an effective manner at
the most favorable price. Subject to this requirement of seeking the most
favorable price, securities may be bought from or sold to broker-dealers who
have furnished statistical, research and other information or services to
Citibank or the Fund, subject to any applicable laws, rules and regulations.
The management fee that the Fund pays to Citibank will not be reduced as a
consequence of Citibank's receipt of brokerage and research services. While such
services are not expected to reduce the expenses of Citibank, Citibank would,
through the use of the services, avoid the additional expenses which would be
incurred if it should attempt to develop comparable information through its own
staff or obtain such services independently.
In certain instances there may be securities that are suitable as an
investment for the Fund as well as for one or more of Citibank's other clients.
Investment decisions for the Fund and for Citibank's 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 particular
security may be bought for one or more clients when one or more clients are
selling the 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 adversely affect the price of or the size of the
position obtainable in a security for the Fund. When purchases or sales of the
same security for the Fund and for other portfolios managed by Citibank occur
contemporaneously, the purchase or sale orders may be aggregated in order to
obtain any price advantages available to large volume purchases or sales.
9. DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES
The Trust's Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares of beneficial interest (without par value)
of each series and to divide or combine the shares of any series into a greater
or lesser number of shares of that series without thereby changing the
proportionate beneficial interests in that series and to divide such series into
classes. The Trust has reserved the right to create and issue additional series
and classes of shares. Each share of the Fund represents an equal proportionate
interest in the Fund with each other share. Shares of each series of the Trust
participate equally in the earnings, dividends and distribution of net assets of
the particular series upon liquidation or dissolution. Shares of each series are
entitled to vote separately to approve advisory agreements or changes in
investment policy, but shares of all series may vote together in the election or
selection of Trustees and accountants for the Trust. In matters affecting only a
particular series or class only shares of that particular series or class are
entitled to vote.
Shareholders are entitled to one vote for each share held on matters on
which they are entitled to vote. Shareholders in the Trust do not have
cumulative voting rights, and shareholders owning more than 50% of the
outstanding shares of the Trust may elect all of the Trustees of the Trust if
they choose to do so and in such event the other shareholders in the Trust would
not be able to elect any Trustee. The Trust is not required to hold, and has no
present intention of holding, annual meetings of shareholders but the Trust will
hold special meetings of shareholders when in the judgment of the Trustees it is
necessary or desirable to submit matters for a shareholder vote. Shareholders
have, under certain circumstances (e.g., upon the application and submission of
certain specified documents to the Trustees by a specified number of
shareholders), the right to communicate with other shareholders in connection
with requesting a meeting of shareholders for the purpose of removing one or
more Trustees. Shareholders also have under certain circumstances the right to
remove one or more Trustees without a meeting by a declaration in writing by a
specified number of shareholders. No material amendment may be made to the
Trust's Declaration of Trust without the affirmative vote of the holders of a
majority of the outstanding shares of each series affected by the amendment.
(See "Investment Restrictions.")
The Trust may enter into a merger or consolidation, or sell all or
substantially all of its assets (or all or substantially all of the assets
belonging to any series of the Trust), if approved by a vote of the holders of
two-thirds of the Trust's outstanding shares, voting as a single class, or of
the affected series of the Trust, as the case may be, except that if the
Trustees of the Trust recommend such sale of assets, merger or consolidation,
the approval by vote of the holders of a majority of the Trust's or the affected
series' outstanding shares would be sufficient. The Trust or any series of the
Trust, as the case may be, may be terminated (i) by a vote of a majority of the
outstanding voting securities of the Trust or the affected series or (ii) by the
Trustees by written notice to the shareholders of the Trust or the affected
series. If not so terminated, the Trust will continue indefinitely.
Share certificates will not be issued.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a business trust
may, under certain circumstances, be held personally liable as partners for its
obligations and liabilities. However, the Declaration of Trust of the Trust
contains an express disclaimer of shareholder liability for acts or obligations
of the Trust and provides for indemnification and reimbursement of expenses out
of Trust property for any shareholder held personally liable for the obligations
of the Trust. The Declaration of Trust of the Trust also provides that the Trust
may maintain appropriate insurance (e.g., fidelity bonding and errors and
omissions insurance) for the protection of the Trust, its shareholders,
Trustees, officers, employees and agents covering possible tort and other
liabilities. Thus, the risk of a shareholder incurring financial loss on account
of shareholder liability is limited to circumstances in which both inadequate
insurance existed and the Trust itself was unable to meet its obligations.
The Trust's Declaration of Trust further provides that obligations of the
Trust are not binding upon the Trustees individually but only upon the property
of the Trust and that the Trustees will not be liable for any action or failure
to act, but nothing in the Declaration of Trust of the 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.
10. CERTAIN ADDITIONAL TAX MATTERS
The Fund has elected to be treated, and intends to qualify each year, as a
"regulated investment company" under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"), by meeting all applicable requirements of
Subchapter M, including requirements as to the nature of the Fund's gross
income, the amount of Fund distributions (as a percentage of both the Fund's
income and its tax-exempt income), and the composition of the Fund's portfolio
assets. Provided all such requirements are met and all of the Fund's net
investment income and realized capital gains are distributed to shareholders in
accordance with the timing requirements imposed by the Code, no federal income
or excise taxes generally will be required to be paid by the Fund. If the Fund
should fail to qualify as a "regulated investment company" for any year, the
Fund would incur a regular corporate federal income tax upon its taxable income
and Fund distributions would generally be taxable as ordinary dividend income to
shareholders.
The portion of the Fund's distributions of net investment income that is
attributable to interest from tax-exempt securities will be designated by the
Fund as an "exempt-interest dividend" under the Code and will generally be
exempt from federal income tax in the hands of shareholders so long as at least
50% of the total value of the Fund's assets consists of tax-exempt securities at
the close of each quarter of the Fund's taxable year. Distributions of
tax-exempt interest earned from certain securities may, however, be treated as
an item of tax preference for shareholders under the federal alternative minimum
tax, and all exempt-interest dividends may increase a corporate shareholder's
alternative minimum tax. Unless the Fund provides shareholders with actual
monthly percentage breakdowns, the percentage of income designated as tax-exempt
will be applied uniformly to all distributions by the Fund of net investment
income made during each fiscal year of the Fund and may differ from the
percentage of distributions consisting of tax-exempt interest in any particular
month. Shareholders are required to report exempt-interest dividends received
from the Fund on their federal income tax returns.
Shareholders of the Fund will generally have to pay federal income taxes on
the balance of the Fund's distributions of net investment income and on any
distributions from net short-term capital gains, whether the distributions are
made in cash or in additional shares. Distributions of net capital gains (i.e.,
the excess of net long-term capital gains over net short-term capital losses),
whether made in cash or in additional shares, are taxable to shareholders as
long-term capital gains without regard to the length of time the shareholders
have held their shares. Because the Fund expects to earn primarily interest
income, it is expected that no Fund dividends will qualify for the dividends
received deduction for corporations.
Any Fund dividend that is declared in October, November or December of any
calendar year, that is payable to shareholders of record in such a month, and
that is paid the following January will be treated as if received by the
shareholders on December 31 of the year in which the dividend is declared. Any
Fund distribution will have the effect of reducing the per share net asset value
of shares in the Fund by the amount of the distribution. Shareholders purchasing
shares shortly before the record date of any distribution other than an
exempt-interest dividend may thus pay the full price for the shares and then
effectively receive a portion of the purchase price back as a taxable
distribution.
In general, any gain or loss realized upon a taxable disposition of shares
of the Fund by a shareholder that holds such shares as a capital asset will be
treated as long-term capital gain or loss if the shares have been held for more
than twelve months and otherwise as a short-term capital gain or loss. However,
any loss realized upon a redemption of shares in the Fund held for six months or
less will be disallowed to the extent of any exempt-interest dividends received
with respect to those shares. If not disallowed, any such loss will be treated
as a long-term capital loss to the extent of any distributions of net capital
gain made with respect to those shares. Any loss realized upon a disposition of
shares may also be disallowed under rules relating to wash sales.
The Fund's current dividend and accounting policies will affect the amount,
timing, and character of distributions to shareholders. Any investment in
certain securities purchased at a market discount will cause the Fund to
recognize income prior to the receipt of cash payments with respect to those
securities. In order to distribute this income and avoid a tax, the Trust may be
required to liquidate securities of the Fund that it might otherwise have
continued to hold and thereby potentially cause the Fund to realize additional
taxable gain or loss.
The Fund's transactions in short sales "against the box" and futures
contracts, if any, will be subject to special tax rules that may affect the
amount, timing, and character of Fund income and distributions to holders of
beneficial interests. For example, certain positions held by the Trust on behalf
of the Fund on the last business day of each taxable year will be marked to
market (i.e., treated as if closed out) on that day, and any gain or loss
associated with the positions will be treated as 60% long-term and 40%
short-term capital gain or loss. Certain positions held by the Trust on behalf
of the Fund that substantially diminish its risk of loss with respect to other
positions in its portfolio may constitute straddles, and may be subject to
special tax rules that would cause deferral of Fund losses, adjustments in the
holding periods of securities held by the Trust on behalf of the Fund and
conversion of short-term into long-term capital losses. Certain tax elections
exist for straddles which may alter the effects of these rules. The Trust will
limit its investment activities in short sales and futures contracts on behalf
of the Fund to the extent necessary to meet the requirements of Subchapter M of
the Code.
The Fund will withhold tax payments at the rate of 30% (or any lower rate
permitted under an applicable treaty) on taxable dividends and other payments
subject to withholding taxes that are made to persons who are not citizens or
residents of the United States. Any amounts overwithheld may be recovered by
such persons by filing a claim for refund with the U.S. Internal Revenue Service
within the time period appropriate to such claims. Distributions received from
the Fund by non-U.S. persons also may be subject to tax under the laws of their
own jurisdictions.
The account application asks each new shareholder to certify that the
shareholder's Social Security or taxpayer identification number is correct and
that the shareholder is not subject to 31% backup withholding for failing to
report income to the IRS. If a shareholder (including non-U.S. persons) fails to
provide this information, or is otherwise subject to backup withholding, the
Fund may be required to withhold tax at the rate of 31% on certain distributions
and redemption proceeds paid to that shareholder. Backup withholding will not,
however, be applied to payments that have been subject to 30% withholding.
11. INDEPENDENT ACCOUNTANTS AND FINANCIAL STATEMENTS
The Fund is newly organized and has not yet issued financial statements.
<PAGE>
APPENDIX A
DESCRIPTION OF MUNICIPAL OBLIGATIONS
Municipal Obligations include bonds, notes and commercial paper issued by or
on behalf of states, territories and possessions of the United States and the
District of Columbia and their political subdivisions, agencies or
instrumentalities, the interest on which is exempt from federal income taxes
(without regard to whether the interest thereon is also exempt from the personal
income taxes of any state). Municipal Obligation bonds are issued to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as bridges, highways, housing, hospitals, mass
transportation, schools, streets and water and sewer works. Other public
purposes for which Municipal Obligation bonds may be issued include refunding
outstanding obligations, obtaining funds for general operating expenses, and
obtaining funds to loan to other public institutions and facilities. In
addition, certain types of industrial development bonds are issued by or on
behalf of public authorities to obtain funds to provide privately-operated
housing facilities, industrial facilities, sports facilities, convention or
trade show facilities, airport, mass transit, port or parking facilities, air or
water pollution control facilities, hazardous waste treatment or disposal
facilities, and certain local facilities for water supply, gas, electricity or
sewage or solid waste disposal. Such obligations are included within the term
Municipal Obligations if the interest paid thereon qualifies as exempt from
federal income tax. Other types of industrial development bonds, the proceeds of
which are used for the construction, equipment, repair or improvement of
privately operated industrial or commercial facilities, may constitute Municipal
Obligations, although the current federal tax laws place substantial limitations
on the size of such issues.
The two principal classifications of Municipal Obligation bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its good faith, credit and taxing power for the payment of
principal and interest. The payment of the principal of and interest on such
bonds may be dependent upon an appropriation by the issuer's legislative body.
The characteristics and enforcement of general obligation bonds vary according
to the law applicable to the particular issuer. Revenue bonds are payable only
from the revenues derived from a particular facility or class of facilities or,
in some cases, from the proceeds of a special excise or other specific revenue
source. Industrial development bonds which are Municipal Obligations are in most
cases revenue bonds and do not generally constitute the pledge of the credit of
the issuer of such bonds. There are, of course, variations in the security of
Municipal Obligations, both within a particular classification and between
classifications, depending on numerous factors.
Municipal Obligation notes generally are used to provide for short-term
capital needs and generally have maturities of one year or less. Municipal
Obligation notes include:
1. Tax Anticipation Notes. Tax Anticipation Notes are issued to finance
operational needs of municipalities. Generally, they are issued in anticipation
of the receipt of various tax revenues, such as property, income, sales, use and
business taxes.
2. Revenue Anticipation Notes. Revenue Anticipation Notes are issued in
expectation of receipt of dedicated revenues, such as state aid or federal
revenues available under federal revenue sharing programs.
3. Tax and Revenue Anticipation Notes. Tax and Revenue Anticipation Notes are
issued by a state or municipality to fund its day-to-day operations and certain
local assistance payments to its municipalities and school districts. Such Notes
are issued in anticipation of the receipt of various taxes and revenues, such as
personal income taxes, business taxes and user taxes and fees.
4. Bond Anticipation Notes. Bond Anticipation Notes are issued to provide
interim financing until long-term bond financing can be arranged. Long-term
bonds or renewal Bond Anticipation Notes provide the money for the repayment of
the Notes.
Issues of commercial paper typically represent short-term, unsecured,
negotiable promissory notes. These obligations are issued by agencies of state
and local governments to finance seasonal working capital needs of
municipalities or to provide interim construction financing and are paid from
general revenues of municipalities or are refinanced with long-term debt. In
most cases, Municipal Obligation commercial paper is backed by letters of
credit, lending agreements, note repurchase agreements or other credit facility
agreements offered by banks or other institutions.
The yields on Municipal Obligations are dependent on a variety of factors,
including general market conditions, supply and demand and general conditions of
the Municipal Obligation market, size of a particular offering, the maturity of
the obligation and rating (if any) of the issue. The ratings of Moody's
Investors Service, Inc., Standard & Poor's Ratings Group and FITCH IBCA, Inc.
represent their opinions as to the quality of various Municipal Obligations. It
should be emphasized, however, that ratings are not absolute standards of
quality. Consequently, Municipal Obligations with the same maturity, coupon and
rating may have different yields while Municipal Obligations of the same
maturity and coupon with different ratings may have the same yield.
<PAGE>
APPENDIX B
DESCRIPTION OF SECURITIES RATINGS
The ratings of Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Ratings Group ("S&P") and FITCH IBCA, Inc. ("Fitch") represent their
opinions as to the quality of various debt securities. It should be emphasized,
however, that ratings are not absolute standards of quality. Consequently, debt
securities with the same maturity, coupon and rating may have different yields
while debt securities of the same maturity and coupon with different ratings may
have the same yield. The ratings below are as described by the rating agencies.
Ratings are generally given to securities at the time of issuance. While the
rating agencies may from time to time revise such ratings, they undertake no
obligation to do so.
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S
FOUR HIGHEST 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 generally are 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 risk appear somewhat larger than in 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.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from Aa through Baa. The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that general rating category.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP'S
FOUR HIGHEST BOND RATINGS
AAA: An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
AA: An obligation rated AA differs from the highest rated obligations only in
small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: An obligation rated A is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB: An obligation 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.
Plus (+) or Minus (-): The ratings from AA to BBB may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF FITCH IBCA, INC.'S
FOUR HIGHEST INTERNATIONAL LONG-TERM CREDIT RATINGS
When assigning ratings, Fitch considers the historical and prospective
financial condition, quality of management, and the operating performance of the
issuer and of any guarantor, any special features of a specific issue or
guarantee, the issue's relationship to other obligations of the issuer, as well
as developments in the economic and political environment that might affect the
issuer's financial strength and credit quality.
Variable rate demand obligations and other securities which contain a demand
feature will have a dual rating, such as "AAA/F1+." The first rating denotes
long-term ability to make principal and interest payments. The second rating
denotes ability to meet a demand feature in full and on time.
AAA: Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in the case of exceptionally strong
capacity for timely payment of financial commitments. This capacity is highly
unlikely to be adversely affected by foreseeable events.
AA: Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of
financial commitments. This capacity is not significantly vulnerable to
foreseeable events.
A: High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. "BBB" ratings indicate that there is currently a low
expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and
in economic conditions are more likely to impair this capacity. This is the
lowest investment-grade category.
"+" OR "-" may be appended to a rating to denote relative status within major
rating categories. Such suffixes are not added to the "AAA" long-term category.
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S
TWO HIGHEST RATINGS OF STATE AND MUNICIPAL NOTES
Moody's ratings for state and municipal short-term obligations are
designated Moody's Investment Grade ("MIG"). Issues or the features associated
with MIG or VMIG ratings are identified by date of issue, date of maturity or
maturities or rating expiration date and description to distinguish each rating
from other ratings. Each rating designation is unique with no implication as to
any other similar issue of the same obligor. MIG ratings terminate at the
retirement of the obligation while VMIG rating expiration will be a function of
each issue's specific structural or credit features.
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.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP'S
TWO HIGHEST RATINGS OF STATE AND MUNICIPAL NOTES
An S&P note rating reflects the liquidity factors and market-access risks
unique to notes. Notes maturing in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating. The following criteria will be used in making that
assessment:
-- Amortization schedule -- the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
-- Source of payment -- the more the issue depends on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1: Strong capacity to pay principal and interest. Issues determined to
possess very strong characteristics are given a plus (+) designation.
SP-2: Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the term of the
notes.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP'S
RATINGS OF TAX-EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all debt issues that have a put option or
demand feature as part of their structure.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols for the put option (for
example, "AAA/A-1+"). With short-term demand debt, note rating symbols are used
with the commercial paper rating symbols (for example, "SP-1+ /A-1+").
DESCRIPTION OF FITCH IBCA, INC.'S
TWO HIGHEST INTERNATIONAL SHORT-TERM CREDIT RATINGS
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
F1: Highest credit quality. Indicates the strongest capacity for timely payment
of financial commitments; may have an added "+" to denote any exceptionally
strong credit feature.
F2: Good credit quality. A satisfactory capacity for timely payment of financial
commitments, but the margin of safety is not as great as in the case of the
higher ratings.
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC.'S
TWO HIGHEST SHORT-TERM DEBT RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations are an original
maturity not exceeding one year, unless explicitly noted.
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: (1) leading
market positions in well-established industries; (2) high rates of return on
funds employed; (3) conservative capitalization structure with moderate reliance
on debt and ample asset protection; (4) broad margins in earnings coverage of
fixed financial charges and high internal cash generation; and (5)
well-established access to a range of financial markets and assured sources of
alternate liquidity.
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.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP'S
TWO HIGHEST COMMERCIAL PAPER RATINGS
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
A-1: A short-term obligation rated A-1 is rated in the highest category by S&P.
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
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.
<PAGE>
APPENDIX C
ADDITIONAL INFORMATION CONCERNING
CALIFORNIA MUNICIPAL OBLIGATIONS
The following information is a summary of special factors affecting
investments in California Municipal Obligations from the preliminary official
statement of the State of California dated September 25, 1998. The sources of
payment for such obligations and the marketability thereof may be affected by
financial or other difficulties experienced by the State of California (the
"State") and certain of its municipalities and public authorities. The summary
does not purport to be a complete description and is current as of the date of
the information statement. CitiFunds California Tax Free Income Portfolio is not
responsible for the accuracy or timeliness of this information.
RECENT DEVELOPMENTS
California's economy, the largest among the 50 states and one of the largest
in the world, has major components in high technology, trade, entertainment,
agriculture, manufacturing, tourism, construction and services. Since 1994,
California's economy has been performing strongly after suffering a deep
recession between 1990-94. However, recent global economic events have begun to
adversely affect the earnings of corporate issuers in California. California
could experience economic difficulties again.
Moody's, Standard and Poor's and Fitch assigned their municipal bond ratings
of A1, A+ and AA-, respectively, to the State's general obligation bonds. Each
such rating reflects only the views of the respective rating agency, and an
explanation of the significance of such rating may be obtained from such rating
agency. 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 such
rating agency if, in the judgment of such rating agency, circumstances so
warrant. A downward revision or withdrawal of any such rating may have an
adverse effect on the market price of the State's general obligation bonds.
CONSTITUTIONAL LIMITS ON SPENDING AND TAXES
STATE APPROPRIATIONS LIMIT
The State is subject to an annual appropriations limit imposed by Article
XIII B of the State Constitution (the "Appropriations Limit"). The
Appropriations Limit does not restrict appropriations to pay debt service on
voter-authorized bonds.
Article XIII B 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, appropriations for qualified
capital outlay projects, 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., cigarette
and tobacco taxes). 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. The Appropriations Limit is tested
over consecutive two-year periods. Any excess of the aggregate "proceeds of
taxes" received over such 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 has enacted legislation to implement Article XIII B which
defines certain terms used in Article XIII B 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.
PROPOSITION 98
On November 8, 1988, voters of the State 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, which was 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 XIII B 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 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. However, that
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 XIII B 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 payments in one year as a "loan" from future years'
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.
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, provides, 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 years 1994-95 and thereafter have resulted or will
result in retroactive increases in Proposition 98 appropriations from subsequent
fiscal years' budgets. Because of the State's increasing revenues, per-pupil
funding at the K-12 level has increased by about 36% from the level in place
from 1991-92 through 1993-94, and is estimated at about $5,695 per ADA in
1998-99. A significant amount of the "extra" Proposition 98 monies in the last
few years have been allocated to special programs, most particularly an
initiative to allow each classroom from grades K-3 to have no more than 20
pupils by the end of the 1997-98 school year. There are also new initiatives for
reading skills and to upgrade technology in high schools.
SOURCES OF TAX REVENUE
The following is a summary of the State's major revenue sources.
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 1997, and
reform of funding for county trial courts, with the State to assume greater
financial responsibility. The Department of Finance estimates that the major
impact of these fiscal reforms will occur in Fiscal Year 1998-99 and subsequent
years.
PERSONAL INCOME TAX
The California personal income tax, which in 1997-98 contributed about 50
percent of General Fund revenues, is closely modeled after the federal income
tax law. It is imposed on net taxable income (gross income less exclusions and
deductions). The tax is progressive with rates ranging from 1 to 9.3 percent.
Personal, dependent, and other credits are allowed against the gross tax
liability. In addition, taxpayers may be subject to an alternative minimum tax
("AMT") which is much like the federal AMT.
The personal income tax is adjusted annually by the change in the consumer
price index to prevent taxpayers from being pushed into higher tax brackets
without a real increase in income.
SALES TAX
The sales tax is imposed upon retailers for the privilege of selling
tangible personal property in California. Sales tax accounted for about 32
percent of General Fund revenue in 1997-98. Most retail sales and leases are
subject to the tax. However, exemptions have been provided for certain
essentials such as food for home consumption, prescription drugs, gas delivered
through mains and electricity. Other exemptions provide relief for a variety of
sales ranging from custom computer software to aircraft.
Currently, 0.25 percent of the State tax rate may be terminated upon
certification by the Director of Finance that the balance in the budget reserve
for two consecutive years will exceed 4 percent of General Fund revenues. The
0.25 percent rate can be reinstated if the Director of Finance subsequently
determines that the reserve will not exceed 4 percent of General Fund revenues.
BANK AND CORPORATION TAX
Bank and corporation tax revenues, which comprised about 11 percent of
General Fund revenue in 1997-98, are derived from the following taxes:
1. The franchise tax and the corporate income tax are levied at a 8.84
percent rate on profits. The former is imposed on corporations for the
privilege of doing business in California, while the latter is imposed on
corporations that derive income from California sources but are not
sufficiently present to be classified as doing business in the State.
2. Banks and other financial corporations are subject to the franchise
tax plus an additional tax at the rate of 2.0 percent on their net income.
This additional tax is in lieu of personal property taxes and business
license taxes.
3. The alternative minimum tax ("AMT") is similar to that in federal
law. In general, the AMT is based on a higher level of net income computed
by adding back certain tax preferences. This tax is imposed at a rate of
6.65 percent.
4. Sub-Chapter S corporations are taxed at 1.5 percent of profits.
INSURANCE TAX
The majority of insurance written in California is subject to a 2.35 percent
gross premium tax. For insurers, this premium tax takes the place of all other
State and local taxes except those on real property and motor vehicles.
Exceptions to the 2.35 percent rate are certain pension and profit-sharing plans
which are taxed at the lesser rate of 0.5 percent, surplus lines and nonadmitted
insurance at 3 percent and ocean marine insurers at 5 percent of underwriting
profits. Insurance taxes comprised approximately 2.3 percent of General Fund
revenues in 1997-98.
In December 1996, the California Earthquake Authority (CEA) was authorized
to start selling homeowners' earthquake insurance. Earthquake policies written
through the CEA are exempt from the gross premiums tax.
OTHER TAXES
Other General Fund major taxes and licenses include: Estate, Inheritance and
Gift Taxes, Cigarette Taxes, Alcoholic Beverage Taxes, Horse Racing Revenues and
trailer coach license fees. These other sources totaled approximately 2.4
percent of General Fund revenues in the 1997-98 Fiscal Year.
SPECIAL FUND REVENUES
The California Constitution, codes and statutes specify the uses of certain
revenue. Such receipts are accounted for in various Special Funds. In general,
Special Fund revenues comprise three categories of income:
1. Receipts from tax levies which are allocated to specified functions,
such as motor vehicle taxes and fees and certain taxes on tobacco products.
2. Charges for special services to specific functions, including such
items as business and professional license fees.
3. Rental royalties and other receipts designated for particular
purposes (for example, oil and gas royalties).
Motor vehicle related taxes and fees accounted for about 59 percent of all
Special Fund revenue in 1996-97. Principal sources of this income are motor
vehicle fuel taxes, registration and weight fees and vehicle license fees.
During the 1997-98 Fiscal Year, $8.3 billion was derived from the ownership or
operation of motor vehicles. About $4.5 billion of this revenue was returned to
local governments. The remainder was available for various State programs
related to transportation and services to vehicle owners. These amounts include
the additional fees and taxes derived from the passage of Proposition 111 in
June 1990.
Chapter 322, Statutes of 1988, reduced vehicle license fees by 25 percent
beginning January 1, 1999. In addition, this percentage reduction could be
increased in annual stages up to a maximum of 67.5 percent in 2003 depending on
whether future General Fund revenues reach specified target levels. Vehicle
license fees, over and above the costs of collection and refunds authorized by
law, are constitutionally defined local revenues. A continuous appropriation
from the General Fund will replace the vehicle license fee revenue that local
governments would otherwise lose due to the fee reductions. If in any year the
Legislature fails to appropriate enough funds to fully offset the
then-applicable vehicle license fee reduction, the fee may be increased to
assure that local governments are not disadvantaged. Therefore, the amount of
revenue going to local governments will remain the same as under prior law.
On November 8, 1988, voters approved Proposition 99, which imposed, as of
January 1, 1989, an additional 25 cents per pack excise tax on cigarettes, and a
new, equivalent excise tax on other tobacco products. The initiative requires
that funds from this tax be allocated to anti-tobacco education and research and
indigent health services, and environmental and recreation programs. Legislation
enacted in 1993 added an additional 2 cents per pack excise tax for the purpose
of funding breast cancer research.
PRIOR FISCAL YEARS' FINANCIAL RESULTS
FISCAL YEARS PRIOR TO 1995-96
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 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.
1995-96 AND 1997-98 FISCAL YEARS
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
three 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. The Department of Finance estimates that
the State's budget reserve totaled $639.8 million as of June 30, 1997 and $1.782
billion at June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contained a large increase
in funding for K-14 education under Proposition 98, reflecting strong
revenues which exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending was allocated to prior fiscal years. Funds
were provided to fully pay for the cost-of-living-increase component of
Proposition 98, and to extend the class size reduction and reading
initiatives.
2. The Budget Act reflects the $1.228 billion to satisfy a court
judgment in a lawsuit regarding payments to the State pension fund, and
brought funding of the State's pension contribution back to the quarterly
basis which existed prior to the deferral actions which were invalidated by
the courts.
3. Funding from the General Fund for the University of California and
California State University has increased by about 6 percent ($121 million
and $107 million, respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels, adjusted for caseload changes.
5. Health and welfare costs were contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the
new CalWORKs program.
6. Unlike prior years, this Budget Act did not depend on uncertain
federal budget actions. About $300 million in federal funds, already
included in the federal Fiscal Year 1997 and 1998 budgets, was included in
the Budget Act, to offset incarceration costs for illegal aliens.
7. The Budget Act contains no tax increases, and no tax reductions. The
Renters Tax Credit was suspended for another year, saving approximately $500
million.
CURRENT STATE BUDGET
The discussion below of the 1998-99 Fiscal Year budget is based on estimates
and projections of revenues and expenditures for the current and upcoming fiscal
years and must not be construed as statements of fact. These estimates and
projections are based upon various assumptions as of the adoption of the budget,
which may be affected by numerous factors, including future economic conditions
in the State and the nation, and there can be no assurance that the estimates
will be achieved. See "Economic Considerations" below.
1998-99 FISCAL YEAR BUDGET
When the Governor released his proposed 1998-99 Fiscal Year Budget on
January 9, 1998, he projected General Fund revenues for the 1998-99 Fiscal Year
of $55.4 billion, and proposed expenditures in the same amount. By the time the
Governor released the May Revision to the 1998-99 Budget ("May Revision") on May
14, 1998, the Administration projected that revenues for the 1997-98 and 1998-99
Fiscal Years combined would be more than $4.2 billion higher than was projected
in January. The Governor proposed that most of this increased revenue be
dedicated to fund a 75% cut in the Vehicle License Fee ("VLF").
The Legislature passed the 1998-99 Budget Bill on August 11, 1998, and the
Governor signed it on August 21, 1998. Some 33 companion bills necessary to
implement the budget were also signed. In signing the Budget Bill, the Governor
used his line-item veto power to reduce expenditures by $1.360 billion from the
General Fund, and $160 million from Special Funds. Of this total, the Governor
indicated that about $250 million of vetoed funds were "set aside" to fund
programs for education. Vetoed items included education funds, salary increases
and many individual resources and capital projects.
The 1998-99 Budget Act is based on projected General Fund revenues and
transfers of $57.0 billion (after giving effect to various tax reductions
enacted in 1997 and 1998), a 4.2% increase from the revised 1997-98 figures.
Special Fund revenues were estimated at $14.3 billion. The revenue projections
were based on the May Revision. Economic problems overseas since that time may
affect the May Revision projections.
After giving effect to the Governor's vetoes, the Budget Act provides
authority for expenditures of $57.3 billion from the General Fund (a 7.3%
increase from 1997-98), $14.7 billion from Special Funds, and $3.4 billion from
bond funds. The Budget Act projects a balance in the SFEU at June 30, 1999 (but
without including the "set aside" veto amount) of $1.255 billion, a little more
than 2% of General Fund revenues. The Budget Act assumes the State carry out its
normal intra-year cash flow borrowing in the amount of $1.7 billion of revenue
anticipation notes, which are expected to be issued by early October.
The most significant feature of the 1998-99 budget was agreement on a total
of $1.4 billion of tax cuts. The central element is a bill which provides for a
phased-in reduction of the VLF. Since the VLF is currently transferred to cities
and counties, the bill provides for the General Fund to replace the lost
revenues. Starting on January 1, 1999, the VLF will be 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 both 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
credit ($133 million), and various targeted business tax credits ($106 million).
About half of the business tax credits will only become effective if Proposition
7, an initiative measure which includes various tax credits, is rejected by the
voters on the November 3, 1998 ballot.
Other significant elements of the 1998-99 Budget Act are as follows:
1. Proposition 98 funding for K-12 schools is increased by $1.7 billion
in General Fund moneys over revised 1997-98 levels, about $300 million
higher than the minimum Proposition 98 guaranty. An additional $600 million
was appropriated to "settle up" prior years' Proposition 98 entitlements,
and was primarily devoted to one-time uses such as block grants, deferred
maintenance, and computer and laboratory equipment. Of the 1998-99 funds,
major new programs include money for instructional and library materials,
deferred maintenance, and computer and laboratory equipment. 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. The Governor held $250
million of education funds which were vetoed as set-aside for enactment of
additional reforms. Overall, per- pupil spending for K-12 schools under
Proposition 98 is increased to $5,695, more than one-third higher than the
level in the last recession year of 1993-94. 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.
2. Funding for higher eduction increased substantially above the level
called for in the Governor's four-year compact. General Fund support was
increased by $340 million ($15.6%) for the University of California and $267
million (14.1%) for the California State University system. In addition,
Community Colleges received a $300 million (6.6%) increase under Proposition
98.
3. 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 increases will
depend on sufficient General Fund revenue to trigger the phased cuts in VLF
described above.
4. Funding for the judiciary and criminal justice programs increased by
about 11% over 1997-98, primarily to reflect increased State support for
local trial courts and rising prison population.
5. Various other highlights of the Budget included new funding for
resources projects, dedication of $376 million of General Fund moneys for
capital outlay projects, funding of a 3% State employee salary increase,
funding of 2,000 new Department of Transportation positions to accelerate
transporation construction projects, and funding of the Infrastructure and
Economic Development Bank ($50 million).
6. 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 $195 million in federal reimbursements
for federal fiscal year 1998.
After the Budget Act was signed, and prior to the close of the Legislative
session on August 31, 1998, the Legislature passed a variety of fiscal bills.
The Governor will have until September 30, 1998 to sign or veto these bills. The
Governor has previously indicated his support for several bills containing new
spending, including $235 million for certain water system improvements in
Southern California, and $245 million for the State share of the purchase of
environmentally sensitive forest lands. The Legislature passed bills totaling at
least $105 million for education programs which were part of the Governor's $250
million veto "set-aside." The Legislature also passed a bill which reduces by
about $570 million the State's obligation to contribute to the State Teachers'
Retirement System. On a net basis, most of these various bills on the 1998-99
Budget will not be known until after September 30.
ECONOMIC CONSIDERATIONS
In the Governor's Budget released on January 9, 1998, and the May revision
to the 1998-99 Governor's Budget, released May 13, 1998, the Department of
Finance projected that the California economy will continue to show robust
growth through 1998, although at a slightly slower pace than in 1997. The
economic expansion has been marked by strong growth in high technology business
services (including computer software), construction, computers and electric
components. The Asian economic crisis which began in late 1997 was expected to
have some dampening effects on the State's economy, which was included in the
May Revision forecasts. However, during the summer of 1998, the soaring trade
deficit, continuing weakness in Asia, initial signs of economic weakness in
Canada and Latin America, which have been California's largest trading partners,
and the fall in stock prices worldwide all suggest that the May Revision
forecasts may be too optimistic, particularly for 1999. Other impacts of the
international situation may help California, such as the reduction in long-term
interest rates.
LITIGATION
The State is a party to numerous legal proceedings, many of which normally
occur in governmental operations. Following are some of the more significant
lawsuits against the State:
Northern California 1997 Flood Litigation: In January of 1997, California
experienced major flooding in six different areas with current estimates of
property damage to be approximately $1.6 to $2 billion. To date, one lawsuit has
been filed by 500 homeowners, but more lawsuits are expected. Exposure from all
of the anticipated cases arising from these floods could total approximately $2
billion.
The primary government is a defendant in several related cases, mainly
California Ambulance Association v. Shalala et al., in which the plaintiffs are
seeking action to compel the Department of Health Services to pay Part B
ambulance and physician services copayments under the Medicare and Medicaid
Acts. Should the plaintiffs prevail, the liability for retroactive payments is
estimated to be $490 million, and the liability for future payments can be in
excess of $130 million annually. The General Fund and the federal government
will share the liability equally. A judgment was entered for plaintiffs. The
Ninth Circuit Court of Appeals, however, reversed the trial court's decision.
Plaintiffs filed a petition for certiorari at the United States Supreme Court,
which the State opposed. The petition is currently pending at the Supreme Court.
The primary government is a defendant in Ceridian Corporation v. Franchise
Tax Board, a suit which challenges the validity of two sections of the
California Tax laws. The first relates to deduction from corporate taxes for
dividends received from insurance companies to the extent the insurance
companies have California activities. The second relates to corporate deduction
of dividends to the extent the earnings of the dividend paying corporation have
already been included in the measure of their California tax. If both sections
of the California Tax law are invalidated, and all dividends become deductible,
then the General fund can become liable for approximately $200-$250 million
annually. A judgment was entered for plaintiff in August 1998. The State will
appeal.
The primary government is involved in a lawsuit, Thomas Hayes v. Commission
on State Mandates, related to state-mandated costs. The action involves an
appeal by the Director of Finance from a 1984 decision by the State Board of
Control (now succeeded by the Commission on State Mandates (COSM)). The Board of
Control decided in favor of local school districts' claims for reimbursement for
special education programs for handicapped students. The case was then brought
to the trial court by the primary government and later remanded to the COSM for
redetermination. The COSM has since expanded the claim to include supplemental
claims filed by seven other educational institutions; the issuance of a final
consolidated decision is anticipated sometime in early 1998. To date, the
Legislature has not appropriated funds. The liability to the primary government,
if all potentially eligible school districts pursue timely claims, has been
estimated by the Department of Finance at more than $1 billion. The Commission
on State Mandates is now expected to issue a final consolidated decision in late
1998.
The primary government is involved in a lawsuit related to contamination at
the Stringfellow toxic waste site. In United States, People of the State of
California v. J.B. Stringfellow, Jr., et al., the primary government is seeking
recovery for past costs of cleanup of the site, a declaration that the
defendants are jointly and severally liable for future costs, and an injunction
ordering completion of the cleanup. However, the defendants have filed a
counterclaim against the primary government for alleged negligent acts. Because
the primary government is the present owner of the site, the primary government
may be found liable. Present estimates of the cleanup range from $300 million to
$800 million.
The primary government is a defendant in a coordinated action involving
3,000 plaintiffs seeking recovery for damages caused by the Yuba River flood of
February 1986. The trial court has found liability in inverse condemnation and
awarded damages of $500,000 to a sample of plaintiffs. The primary government's
potential liability to the remaining plaintiffs ranges from $800 million to $1.5
billion. An appeal has been filed.
The primary government is a defendant in California State Employees
Association v. Wilson, where the petitioners are challenging several budget
appropriations in the 1994 and 1995 Budget Acts. The appropriations mandate the
transfer of funds from the State Highway Account, within the special revenue
funds, to the General Fund to reimburse the General Fund for debt service costs
on the rail bond measures. The petitioners contend that the transfers violate
the bond acts themselves and are requesting the monies be returned. The loss to
the primary government's General Fund could be up to $227 million. In February
1998, the Court of Appeal in California State Employees Association v. Wilson,
modified, then affirmed, a judgment in favor of the plaintiffs invalidating the
transfer of $12,290,000 from the State Highway Account to the General Fund.
In a similar case, Professional Engineers in California Government v.
Wilson, the petitioners are challenging several appropriations in the 1993,
1994, and 1995 Budget Acts. The appropriations mandate the transfer of
approximately $262 million from the State Highway Account, within the special
revenue funds, and $113 million from the Motor Vehicle Account, within the
special revenue funds, to the General Fund and appropriate approximately $6
million from the State Highway Account to fund a highway-grade crossing program
administered by the Public Utilities Commission. Petitioners contend that the
transfers violate several constitutional provisions and request that the moneys
be returned to the State Highway Account and Motor Vehicle Account.
The primary government is a defendant in Just Say No To Tobacco Dough
Campaign v. State of California, where the petitioners challenge the
appropriation of approximately $166 million of Proposition 99 funds in Cigarette
and Tobacco Products Surtax Fund for years ended June 30, 1990, through June 30,
1995, for programs which were allegedly not health education or tobacco-related
disease research. If the primary government loses, the General Fund and funds
from other sources would be used to reimburse the Cigarette and Tobacco Products
Surtax Fund, an agency fund, for approximately $166 million.
The primary government is a defendant in the case of Kurt Hathaway, et al.
v. Wilson, et al., where the plaintiffs are challenging the legality of various
budget action transfers and appropriations from particular special funds for
years ended June 30, 1995, and June 30, 1996. The plaintiffs allege that the
transfers and appropriations are contrary to the substantive law establishing
the funds and providing the interest accruals to the fund, violate the single
subject requirement of the State Constitution and is an invalid "special law".
Plaintiffs seek to have monies totaling approximately $335 million returned to
the special funds. The plaintiffs and the State reached a settlement which
resolved all the issues presented in the case. Pursuant to the settlement,
judgment was entered in August 1998, requiring the State to return $19,427,000
from the General Fund to one special fund.
The primary government is a defendant in two related cases, Beno vs.
Sullivan (Beno) and Welch vs. Anderson (Welch), concerning reductions in Aid to
Families with Dependent Children (AFDC) grant payments. In the Beno case,
plaintiffs seek to invalidate AFDC grant reductions, and in the Welch case
plaintiffs contend that AFDC grant reductions are not authorized by state law.
The Beno case concerns the total grant reductions while the Welch case concerns
the period of time the State did not have a waiver for those reductions. The
primary government's potential liability for retroactive AFDC grant reductions
is estimated at $831 million if the plaintiffs are awarded the full amount in
both cases. In July 1998, the parties entered into a settlement agreement in
which the State agreed to pay $42 million in return for plaintiffs' agreement to
dismiss both actions.
The University of California and the special purpose authorities, which are
discretely presented component units, are contingently liable in connection with
claims and contracts, including those currently in litigation, arising in the
normal course of their activities. The outcome of such matters are not expected
to have a material effect on the financial statements.
In the case of Board of Administration, California Public Employees'
Retirement System et al. v. Pete Wilson, Governor, et al., plaintiffs challenged
the constitutionality of legislation which deferred payment of the State's
employer contribution to the Public Employees' Retirement System beginning in
Fiscal Year 1992-93. On January 11, 1995, the Sacramento County Superior Court
entered a judgment finding that the legislation unconstitutionally impaired the
vested contract rights of PERS members. The judgment provides for issuance of a
writ of mandate directing State defendants to disregard the provisions of the
legislation, to implement the statute governing employer contributions that
existed before the changes in the legislation found to be unconstitutional and
to transfer to PERS the contributions that were unpaid to date. On February 19,
1997, the State Court of Appeal affirmed the decision of the Superior Court, and
the Supreme Court subsequently refused to hear the case, making the Court of
Appeals' ruling final.
On July 30, 1997, the Controller transferred $1.228 billion from the General
Fund to PERS in repayment of the principal amount determined to have been
improperly deferred. Subsequent State payments to PERS will be made on a
quarterly basis. On July 7, 1998, pursuant to Chapter 94, Statutes of 1998, the
State paid PERS $332.7 million for the accrued interest on the judgment and
interest on the unpaid accrued interest amount.
On June 24, 1998, plaintiffs in Howard Jarvis Taxpayers Association et al.
v. Kathleen Connell filed a complaint for certain declaratory and injunctive
relief challenging the authority of the State Controller to make payments from
the State Treasury in the absence of a state budget. On July 21, 1998, the trial
court issued a preliminary injunction prohibiting the State Controller from
paying moneys from the State Treasury for fiscal year 1998-99, with certain
limited exceptions, in the absence of a state budget. The preliminary
injunction, among other things, prohibited the State Controller from making any
payments pursuant to any continuing appropriation.
On July 22 and 27, 1998, various employee unions which had intervened in the
case appealed the trial court's preliminary injunction and asked the Court of
Appeal to stay the preliminary injunction pending the Court of Appeal's decision
on the merits of the appeal. On August 5, 1998, the Court of Appeal denied the
plaintiff's request to reconsider the stay. Also on July 22, 1998, the State
Controller asked the California Supreme Court to immediately stay the trial
court's prelimiary injunction and to overrule the order granting the preliminary
injunction on the merits. On July 29, 1998, the Supreme Court transferred the
State Controller's request to the Court of Appeal. The matters are now pending
before the Court of Appeal.
In Jordan v. Department of Motor Vehicles, plaintiff challenged the validity
and constitutionality of the State's smog impact fee and requested a refund of
the fee. In October 1997, the trial court ruled in favor of plaintiff and, in
addition, ordered the State to provide refunds to all persons who paid the smog
impact fee from three years before the filing of the lawsuit in 1995 to the
present. Plaintiff asserts that the total amount required to be refunded will
exceed $350 million. The State has appealed.
