Registration No. 33-10436
Rule 497(c)
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CALIFORNIA 600 FIFTH AVENUE
DAILY TAX FREE NEW YORK, NY 10020
INCOME FUND, INC. (212) 830-5220
PROSPECTUS
May 1, 1998
California Daily Tax Free Income Fund, Inc. (the "Fund") is an open-end
management investment company that is a short-term, tax-exempt, money market
fund whose investment objectives are to seek as high a level of current income
exempt from regular Federal income taxes and to the extent possible from
California income taxes, as is believed to be consistent with preservation of
capital, maintenance of liquidity and stability of principal. No assurance can
be given that those objectives will be achieved. The Fund offers two classes of
shares to the general public. The Class A shares of the Fund are subject to a
service fee pursuant to the Fund's Rule 12b-1 Distribution and Service Plan and
are sold through financial intermediaries who provide servicing to Class A
shareholders for which they receive compensation from the Manager and the
Distributor. The Class B shares of the Fund are not subject to a service fee and
either are sold directly to the public or are sold through financial
intermediaries that do not receive compensation from the Manager or the
Distributor. In all other respects, the Class A and Class B shares represent the
same interest in the income and assets of the Fund. The Fund is concentrated in
the securities issued by California or entities within California and the Fund
may invest a significant percentage of its assets in a single issuer. Therefore,
an investment in the Fund may be riskier than an investment in other types of
money market funds.
This Prospectus sets forth concisely the information a prospective investor
should know before investing in the Fund. A Statement of Additional information
about the Fund has been filed with the Securities and Exchange Commission (the
"SEC") and is available upon request and without charge by calling or writing
the Fund at the above address. The Statement of Additional Information bears the
same date as this Prospectus and is incorporated by reference into this
Prospectus in its entirety. The SEC maintains a website (http://www.sec.gov)
that contains the Statement of Additional Information and other reports and
information regarding the Fund which have been filed electronically with the
SEC.
Reich & Tang Asset Management L.P. is a registered investment adviser and acts
as investment manager of the Fund. Reich & Tang Distributors, Inc. acts as
distributor of the Fund's shares and is a registered broker-dealer and member of
the National Association of Securities Dealers, Inc.
An investment in the Fund is neither insured nor guaranteed by the U.S.
Government. The Fund intends to maintain a stable net asset value of $1.00 per
share although there can be no assurance that this value will be maintained.
Shares in the Fund are not deposits or obligations of, or guaranteed or endorsed
by, any bank, and the shares are not insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board, or any other agency.
This Prospectus should be read and retained by investors for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SEC OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SEC OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE. SHARES OF THE FUND ARE NOT BEING OFFERED VIA THE
INTERNET TO RESIDENTS OF PARTICULAR STATES.
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<S> <C> <C> <C> <C> <C> <C>
TABLE OF FEES AND EXPENSES
Annual Fund Operating Expenses
(as a percentage of average net assets) Class A Class B
Management Fees (After Fee Waiver) 0.26% 0.26%
12b-1 Fees 0.20% 0.00%
Other Expenses 0.41% 0.31%
Administration Fees 0.21% _____ 0.21% _____
Total Fund Operating Expenses 0.87% 0.57%
Example 1 year 3 years 5 years 10 years
- ------- ------ ------- ------- --------
You would pay the following on a $1,000
investment, assuming 5% annual return
(cumulative through the end of each year):
Class A $9 $28 $48 $107
Class B $6 $18 $32 $71
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The purpose of the above fee table is to assist an investor in understanding the
various costs and expenses that an investor in the Fund will bear directly or
indirectly. For a further discussion of these fees see "Management of the Fund"
and "Distribution and Service Plan" herein. The Manager has voluntarily waived a
portion of the management fees. Absent the fee waivers, the Management Fee would
have been .30%. The Total Fund Operating Expenses would have been .91% for Class
A shares and .61% for Class B shares, absent the respective fee waivers.
The figures reflected in this example should not be considered a representation
of past or future expenses. Actual expenses may be greater or lesser than those
shown above.
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FINANCIAL HIGHLIGHTS
The following financial highlights of California Daily Tax Free Income Fund,
Inc. have been audited by McGladrey & Pullen LLP, Independent Certified Public
Accountants, whose report thereon appears in the Statement of Additional
Information.
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CLASS A Year Ended December 31,
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Per Share Operating Performance:
(for a share outstanding throughout the period)
Net asset value, beginning of period...... $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ------ ----- ----- ----- ------ ------ ------ ------
Income from investment operations:
Net investment income.......... 0.028 0.027 0.032 0.024 0.021 0.023 0.038 0.051 0.056 0.046
Less distributions:
Dividends from net investment income (0.028) (0.027) (0.032) (0.024) (0.021) (0.023) (0.038) (0.051) (0.056) (0.046)
Net asset value, end of period. $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
Total Return................... 2.84% 2.76% 3.28% 2.45% 2.16% 2.35% 3.83% 5.18% 5.73% 4.70%
Ratios/Supplemental Data
Net assets, end of period (000) $182,653 $205,947 $171,808 $105,120 $117,260 $90,795 $83,525 $99,688 $98,923 $79,346
Ratios to average net assets:
Expenses..................... 0.82%+ 0.75%+(0) 0.67%+(0) 0.56%+ 0.35%+ 0.68%+ 0.74%+ 0.62%+ 0.62%+ 0.62%+
Net investment income........ 2.80%+ 2.73%+ 3.24%+ 2.40%+ 2.14%+ 2.34%+ 3.77%+ 5.05%+ 5.60%+ 4.59%+
Year October 9, 1996
Class B Ended (Commencement of Sales) to
December 31, 1997 December 31, 1996
----------------- -----------------
Per Share Operating Performance:
(for a share outstanding throughout the period)
Net asset value, beginning of period.... $ 1.00 $ 1.00
--------- ------
Income from investment operations:
Net investment income............... 0.030 0.004
Less distributions:
Dividends from net investment income (0.030) (0.004)
----- -----
Net asset value, end of period.......... $ 1.00 $1.00
====== =====
Total Return............................ 3.08% 3.08%*
Ratios/Supplemental Data
Net assets, end of period (000)......... $ 15,163 $ 3,436
Ratios to average net assets:
Expenses, net of fees waived.......... 0.58% 0.56%*++(0)
Net investment income................. 3.10% 3.09%*++
* Annualized
+ Net of management, administration and shareholder servicing fees waived
equivalent to .05%, .08%, .22%, .28%, .54%, .29%, .23%, .28%, .29% and .28%
of average net assets.
++ Net of management fees waived equivalent to .05% and .06% of average net
assets.
(0) Includes expense offsets equivalent to .01% of average net assets.
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INTRODUCTION
California Daily Tax Free Income Fund, Inc. (the "Fund") is an open-end
management investment company that is a short-term, tax-exempt money market fund
whose investment objectives are to seek as high a level of current income exempt
under current law, in the opinion of bond counsel to the issuer at the date of
issuance, from regular Federal income tax, and, to the extent possible, from
California income taxes, and as is believed to be consistent with preservation
of capital, maintenance of liquidity and stability of principal by investing
principally in short-term, high quality debt obligations of the State of
California, Puerto Rico and other U.S. territories, and their political
subdivisions as described under "Investment Objectives, Policies and Risks"
herein. The Fund also may invest in municipal securities of issuers located in
states other than California, the interest income on which will be, in the
opinion of bond counsel to the issuer at the date of issuance, exempt from
regular Federal income tax, but will be subject to California income taxes for
California residents. The Fund seeks to maintain an investment portfolio with a
dollar-weighted average maturity of 90 days or less, and to value its investment
portfolio at amortized cost and maintain a net asset value of $1.00 per share,
although there can be no assurance that this value will be maintained. The Fund
intends to invest all of its assets in tax-exempt obligations; however, it
reserves the right to invest up to 20% of the value of its total assets in
taxable obligations. This is a summary of the Fund's fundamental investment
policies which are set forth in full under "Investment Objectives, Policies and
Risks" herein and in the Statement of Additional Information and may not be
changed without approval of a majority of the Fund's outstanding shares. Of
course, no assurance can be given that these objectives will be achieved.
The Fund's investment advisor is Reich & Tang Asset Management L.P. (the
"Manager"), which is a registered investment advisor and which currently acts as
manager or administrator to seventeen other open-end management investment
companies. The Fund's shares are distributed through Reich & Tang Distributors,
Inc. (the "Distributor"), with whom the Fund has entered into a Distribution
Agreement and a Shareholder Servicing Agreement (with respect to Class A shares
of the Fund only) pursuant to the Fund's distribution and service plan adopted
under Rule 12b-1 of the Investment Company Act of 1940, as amended (the "1940
Act"). (See "Distribution and Service Plan" herein.)
On any day on which the New York Stock Exchange, Inc. is open for trading ("Fund
Business Day"), investors may, without charge by the Fund, purchase and redeem
shares of the Fund's common stock at their net asset value next determined after
receipt of the order. An investor's purchase order will be accepted after the
payment is converted into Federal Funds, and shares will be issued as of the
Fund's next net asset value determination which is made as of 12 noon on each
Fund Business Day. (See "How to Purchase and Redeem Shares" and "Net Asset
Value" herein.) Dividends from accumulated net income are declared by the Fund
on each Fund Business Day.
The Fund generally pays interest dividends monthly. Net capital gains, if any,
will be distributed at least annually, and in no event later than within 60 days
after the end of the Fund's fiscal year. All dividends and distributions of
capital gains are automatically invested in additional shares of the same Class
of the Fund unless a shareholder has elected by written notice to the Fund to
receive either of such distributions in cash. (See "Dividends and Distributions"
herein.)
The Fund intends that its investment portfolio may be concentrated in California
Municipal Obligations and Participation Certificates as defined herein. A
summary of special risk factors affecting the State of California is set forth
under "California Risk Factors" in the Statement of Additional Information.
Investment in the Portfolio should be made with an understanding of the risks
which an investment in California Municipal Obligations may entail. Payment of
interest and preservation of capital are dependent upon the continuing ability
of California issuers and/or obligors of state, municipal and public authority
debt obligations to meet their
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obligations thereunder. Investors should consider the greater risk of the
Portfolio's concentration versus the safety that comes with a less concentrated
investment portfolio.
The Fund's Board of Directors is authorized to divide the unissued shares into
separate series of stock, one for each of the Fund's separate investment
portfolios that may be created in the future.
INVESTMENT OBJECTIVES,
POLICIES AND RISKS
The Fund is an open-end management investment company that is a short-term,
tax-exempt money market fund whose investment objectives are to seek as high a
level of current income exempt from regular Federal income tax and, to the
extent possible, from California income taxes, as is believed to be consistent
with the preservation of capital, maintenance of liquidity and stability of
principal. There can be no assurance that the Fund will achieve its investment
objectives.
The Fund's assets will be invested primarily in high quality debt obligations
issued by or on behalf of the State of California, other states, territories and
possessions of the United States, and their authorities, agencies,
instrumentalities and political subdivisions, the interest on which is, in the
opinion of bond counsel at the date of issuance, currently exempt from regular
Federal income taxation ("Municipal Obligations") and in Participation
Certificates (which, in the opinion of Battle Fowler LLP, counsel to the Fund,
cause the Fund to be treated as the owner of the underlying Municipal
Obligations) in Municipal Obligations purchased from banks, insurance companies
or other financial institutions ("Participation Certificates"). Dividends paid
by the Fund which are "exempt-interest dividends" by virtue of being properly
designated by the Fund as derived from Municipal Obligations and Participation
Certificates will be exempt from regular Federal income tax provided the Fund
complies with Section 852(b)(5) of the Internal Revenue Code of 1986, as amended
(the "Code").
Although the Supreme Court has determined that Congress has the authority to
subject the interest on bonds such as the Municipal Obligations to Federal
income taxation, existing law excludes such interest from regular Federal income
tax. However, "exempt-interest dividends" may be subject to the Federal
alternative minimum tax. Securities, the interest income on which may be subject
to the Federal alternative minimum tax (including Participation Certificates in
such securities), together with securities, the interest income on which is
subject to regular Federal, state and local income tax, will not exceed 20% of
the value of the Fund's total assets. (See "Federal Income Taxes" herein.)
Exempt-interest dividends paid by the Fund correctly identified by the Fund as
derived from obligations issued by or on behalf of the State of California or
any California local governments, or their instrumentalities, authorities or
districts, and on obligations of the United States which pay interest excludable
from income under the Constitution or laws of the United States ("California
Municipal Obligations") will be exempt from the California Income Tax.
Exempt-interest dividends correctly identified by the Fund as derived from
obligations of Puerto Rico and the Virgin Islands, as well as any other types of
obligations the interest on which is exempt from California taxation
("Territorial Municipal Obligations") also may be exempt from the California
Income Tax provided the Fund complies with California law. (See "California
Income Taxes" herein.) To the extent suitable California Municipal Obligations
are not available for investment by the Fund, the Fund may purchase Municipal
Obligations issued by other states, their agencies and instrumentalities, the
dividends on which will be designated by the Fund as derived from interest
income which will be, in the opinion of bond counsel to the issuer at the date
of issuance, exempt from regular Federal income tax but will be subject to the
California Income Tax. However, except as a temporary defensive measure during
periods of adverse market conditions as determined by the Manager, the Fund will
invest at least 65% of its total assets in California Municipal Obligations,
although the exact amount of the Fund's assets invested in such securities will
vary from time to time. The Fund's investments may include "when-issued"
Municipal Obligations, stand-by commitments and taxable repurchase agreements.
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Although the Fund will attempt to invest 100% of its assets in Municipal
Obligations (excluding securities, the interest income on which may be subject
to the Federal alternative minimum tax) and in participation certificates in
Municipal Obligations, the Fund reserves the right to invest up to 20% of the
value of its total assets in securities, the interest income on which is subject
to Federal, state and local income tax, including securities, the interest
income on which may be subject to the Federal alternative minimum tax. The Fund
will invest more than 25% of its assets in participation certificates purchased
from banks in industrial revenue bonds and other California Municipal
Obligations. The investment objectives of the Fund described in this paragraph
may not be changed unless approved by the holders of a majority of the
outstanding shares of the Fund that would be affected by such a change. As used
in this Prospectus, the term "majority of the outstanding shares" of the Fund
means, respectively, the vote of the lesser of (i) 67% or more of the shares of
the Fund present at a meeting, if the holders of more than 50% of the
outstanding shares of the Fund are present or represented by proxy, or (ii) more
than 50% of the outstanding shares of the Fund.
The Fund may only purchase securities that have been determined by the Fund's
Board of Directors to present minimal credit risks and that are Eligible
Securities at the time of acquisition. The term Eligible Securities means: (i)
Municipal Obligations with remaining maturities of 397 days or less and rated in
the two highest short-term rating categories by any two nationally recognized
statistical rating organizations ("NRSROs") or in such categories by the only
NRSRO that has rated the Municipal Obligations (collectively, the "Requisite
NRSROs"); (ii) Municipal Obligations which are subject to a Demand Feature or
Guarantee (as such terms are defined in Rule 2a-7 of the 1940 Act) and which
have received a rating from an NRSRO, or such guarantor has received a rating
from an NRSRO, with respect to a class of debt obligations (or any debt
obligation within that class) that is comparable in priority and security to the
Guarantee (unless, the guarantor, directly or indirectly, controls, is
controlled by or is under common control with the issuer of the security subject
to the Guarantee); and the issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the security in the
event the Demand Feature or Guarantee is substituted with another Demand Feature
or Guarantee; and (iii) unrated Municipal Obligations determined by the Fund's
Board of Directors to be of comparable quality. In addition, Municipal
Obligations with remaining maturities of 397 days or less but that at the time
of issuance were long-term securities (i.e. with maturities greater than 366
days) are deemed unrated and may be purchased if such had received a long-term
rating from the Requisite NRSROs in one of the three highest rating categories.
Provided, however, that such may not be purchased if it (i) does not satisfy the
rating requirements set forth in the preceding sentence and (ii) has received a
long-term rating from any NRSRO that is not within the three highest long-term
rating categories. A determination of comparability by the Board of Directors is
made on the basis of its credit evaluation of the issuer, which may include an
evaluation of a letter of credit, guarantee, insurance or other credit facility
issued in support of the Municipal Obligations or Participation Certificates.
(See "Variable Rate Demand Instruments and Participation Certificates" in the
Statement of Additional Information.) While there are several organizations that
currently qualify as NRSROs, two examples of NRSROs are Standard & Poor's Rating
Services, a division of The McGraw-Hill Companies ("S&P") and Moody's Investors
Service, Inc. ("Moody's"). The two highest ratings by S&P and Moody's are "AAA"
and "AA" by S&P in the case of long-term bonds and notes or "Aaa" and "Aa" by
Moody's in the case of bonds; "SP-1" and "SP-2" by S&P or "MIG-1" and "MIG-2" by
Moody's in the case of notes; "A-1" and "A-2" by S&P or "Prime-1" and "Prime-2"
by Moody's in the case of tax-exempt commercial paper. The highest rating in the
case of variable and floating demand notes is "SP-1/AA" by S&P and "VMIG-1" by
Moody's. Such instruments may produce a lower yield than would be available from
less highly rated instruments.
Subsequent to its purchase by the Fund, the quality of an investment may cease
to be rated or its rating
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may be reduced such that the investment is no longer a First Tier Security or is
rated below the minimum required for purchase by the Fund. If this occurs, the
Board of Directors of the Fund shall promptly reassess whether the security
presents minimal credit risks and shall cause the Fund to take such action as
the Board of Directors determines is in the best interest of the Fund and its
shareholders. However, reassessment is not required if the security is disposed
of or matures within five business days of the Manager becoming aware of the new
rating and provided further that the Board of Directors is subsequently notified
of the Manager's actions. The term First Tier Security means any Eligible
Security that: (i) is a rated security that has received a short-term rating
from the Requisite NRSROs in the highest short-term rating category for debt
obligations; (ii) is an unrated security that is, as determined by the fund's
board of directors, to be of comparable quality; (iii) is a security issued by a
registered investment company that is a money market fund; or (iv) is a
government security.
In addition, in the event that a security (1) is in default, (2) ceases to be an
Eligible Security under Rule 2a-7, or (3) is determined to no longer present
minimal credit risks, or an event of insolvency occurs with respect to the
issuer of a portfolio security or the provider of any Demand Feature or
Guarantee, the Fund will dispose of the security absent a determination by the
Fund's Board of Directors that disposal of the security would not be in the best
interests of the Fund. In the event that a security is disposed of, such
disposal shall occur as soon as practicable, consistent with achieving an
orderly disposition by sale, exercise of any Demand Feature or otherwise. In the
event of a default with respect to a security which immediately before default
accounted for 1/2 of 1% or more of the Fund's total assets, the Fund shall
promptly notify the SEC of such fact and of the actions that the Fund intends to
take in response to the situation.
All investments by the Fund will mature or will be deemed to mature in 397 days
or less from the date of acquisition and the average maturity of the Fund
portfolio (on a dollar-weighted basis) will be 90 days or less. The maturities
of variable rate demand instruments held in the Fund's portfolio will be deemed
to be the longer of the period required before the Fund is entitled to receive
payment of the principal amount of the instrument through demand, or the period
remaining until the next interest rate adjustment, although the stated
maturities may be in excess of 397 days.
In view of the "concentration" of the Fund in Participation Certificates, which
may be secured by Guarantees, an investment in the Fund should be made with an
understanding of the characteristics of the banking industry and the risks which
such an investment may entail which include extensive governmental regulation,
changes in the availability and cost of capital funds, and general economic
conditions. (See "Variable Rate Demand Instruments and Participation
Certificates" in the Statement of Additional Information.) Banks are subject to
extensive governmental regulations which may limit both the amounts and types of
loans and other financial commitments which may be made and interest rates and
fees which may be charged. The profitability of this industry is largely
dependent upon the availability and cost of capital funds for the purpose of
financing lending operations under prevailing money market conditions. Also,
general economic conditions play an important part in the operations of this
industry and exposure to credit losses arising from possible financial
difficulties of borrowers might affect a bank's ability to meet its obligations
under a letter of credit. The Fund may invest 25% or more of the net assets of
any portfolio in securities that are related in such a way that an economic,
business or political development or change affecting one of the securities
would also affect the other securities including, for example, securities the
interest upon which is paid from revenues of similar type projects, or
securities the issuers of which are located in the same state.
The Fund has adopted the following fundamental investment restrictions which
apply to all portfolios and which may not be changed unless approved by a
majority of the outstanding shares of each series of the Fund's shares that
would be affected by such a change. The Fund is subject to further investment
restrictions that are set forth in the Statement of Additional Information. The
Fund may not:
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1. Borrow Money. This restriction shall not apply to borrowings from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests that might otherwise require the untimely disposition
of securities, in an amount up to 15% of the value of the Fund's total
assets (including the amount borrowed) valued at market less liabilities
(not including the amount borrowed) at the time the borrowing was made.
While borrowings exceed 5% of the value of the Fund's total assets, the
Fund will not make any investments.
Interest paid on borrowings will reduce net income.
2. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in
an amount up to 15% of the value of its total assets and only to secure
borrowings for temporary or emergency purposes.
3. Purchase securities subject to restrictions on disposition under the
Securities Act of 1933 ("restricted securities"), except the Fund may
purchase variable rate demand instruments which contain a demand feature.
The Fund will not invest in a repurchase agreement maturing in more than
seven days if any such investment together with securities that are not
readily marketable held by the Fund exceed 10% of the Fund's net assets.
4. Invest more than 25% of its assets in the securities of "issuers" in any
single industry, provided that the Fund may invest more than 25% of its
assets in bank Participation Certificates and there shall be no limitation
on the purchase of those Municipal Obligations and other obligations issued
or guaranteed by the United States government, its agencies or
instrumentalities. Immediately after the acquisition of any securities
subject to a Demand Feature or Guarantee (as such terms are defined in Rule
2a-7 of the Investment Company Act of 1940), with respect to 75% of the
total assets of the Fund, not more than 10% of the Fund's assets may be
invested in securities that are subject to a Guarantee or Demand Feature
from the same institution. However, the Fund may only invest more than 10%
of its assets in securities subject to a Guarantee or Demand Feature issued
by a non-controlled person.
5. Invest in securities of other investment companies, except the Fund may
purchase unit investment trust securities where such unit trusts meet the
investment objectives of the Fund and then only up to 5% of the Fund's net
assets, except as they may be acquired as part of a merger, consolidation
or acquisition of assets.
The Fund intends to continue to qualify as a "regulated investment company"
under Subchapter M of the Code. The Fund will be restricted in that at the close
of each quarter of the taxable year, at least 50% of the value of its total
assets must be represented by cash, government securities, investment company
securities and other securities limited in respect of any one issuer to not more
than 5% in value of the total assets of the Fund and to not more than 10% of the
outstanding voting securities of such issuer. In addition, at the close of each
quarter of its taxable year, not more than 25% in value of the Fund's total
assets may be invested in securities of one issuer other than government
securities. The limitations described in this paragraph regarding qualification
as a "regulated investment company" are not fundamental policies and may be
revised to the extent applicable Federal income tax requirements are revised.
(See "Federal Income Taxes" herein.)
The primary purpose of investing in a portfolio of California Municipal
Obligations is the special tax treatment accorded California resident individual
investors. Certain of the California Municipal Obligations rely in whole or in
part, directly or indirectly, on ad valorum property taxes as a source of
revenue which are and may become subject to constitutional and/or legislative
restrictions. Investment in the Fund should be made with an understanding of the
risks which an investment in California Municipal Obligations may entail.
However, payment of interest and preservation of principal are dependent upon
the continuing ability of the California issuers and/or obligors of state,
municipal and public authority debt obligations to
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meet their obligations thereunder. Investors should consider the greater risk of
the Fund's concentration versus the safety that comes with a less concentrated
investment portfolio and should compare yields available on portfolios of
California issues with those of more diversified portfolios including
out-of-state issues before making an investment decision. The Fund's management
believes that by maintaining the Fund's investment portfolio in liquid,
short-term, high quality investments, including Participation Certificates and
other variable rate demand instruments that have high quality credit support
from banks, insurance companies or other financial institutions, the Fund is
largely insulated from the credit risks that may exist on long-term California
Municipal Obligations. For additional information, please refer to the Statement
of Additional Information.
MANAGEMENT OF THE FUND
The Fund's Board of Directors, which is responsible for the overall management
and supervision of the Fund, has employed the Manager to serve as investment
manager of the Fund. The Manager provides persons satisfactory to the Fund's
Board of Directors to serve as officers of the Fund. Such officers, as well as
certain other employees and directors of the Fund, may be directors or officers
of Reich & Tang Asset Management, Inc., the sole general partner of the Manager,
or employees of the Manager or its affiliates. Due to the services performed by
the Manager, the Fund currently has no employees and its officers are not
required to devote full-time to the affairs of the Fund. The Statement of
Additional Information contains general background information regarding each
director and principal officer of the Fund.
The Manager is a Delaware limited partnership with its principal office at 600
Fifth Avenue, New York New York 10020. As of March 31, 1998, the Manager was
investment manager, advisor or supervisor with respect to assets aggregating in
excess of $11.51 billion. The Manager acts as manager or administrator of
seventeen other registered investment companies and also advises pension trusts,
profit-sharing trusts and endowments.
Effective January 1, 1998, NEIC Operating Partnership, L.P. ("NEICOP") was the
limited partner and owner of a 99.5% interest in the Manager replacing New
England Investment Companies, L.P. ("NEICLP") as the limited partner and owner
of such interest in the Manager, due to a restructuring by New England
Investment Companies, Inc. ("NEIC"). Subsequently, effective March 31, 1998,
Nvest Companies, L.P. ("Nvest Companies") due to a change in name of NEICOP,
replaces NEICOP as the limited partner and owner of a 99.5% interest in the
Manager.
Reich & Tang Asset Management, Inc. (an indirect wholly-owned subsidiary of
Nvest Companies) is the sole general partner and owner of the remaining 0.5%
interest of the Manager. Nvest Corporation, a Massachusetts Corporation
(formerly known as New England Investment Companies, Inc.), serves as the
managing general partner of Nvest Companies.
Reich & Tang Asset Management, Inc. is an indirect subsidiary of Metropolitan
Life Insurance Company ("MetLife"). Also, MetLife directly and indirectly owns
approximately 47% of the outstanding partnership interests of Nvest Companies
and may be deemed a "controlling person" of the Manager. Reich & Tang, Inc.
owns, directly and indirectly, approximately 13% of the outstanding partnership
interests of Nvest Companies.
MetLife is a mutual life insurance company with assets of $297.6 billion at
December 31, 1996. It is the second largest life insurance company in the United
States in terms of total assets. MetLife provides a wide range of insurance and
investment products and services to individuals and groups and its the leader
among United States life insurance companies in terms of total life insurance in
force, which exceeded $1.6 trillion at December 31, 1996 for MetLife and its
insurance affiliates. MetLife and its affiliates provide insurance or other
financial services to approximately 36 million people worldwide.
Nvest is a holding company offering a broad array of investment styles across a
wide range of asset categories through thirteen subsidiaries, divisions and
affiliates offering a wide array of investment
9
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styles and products to institutional clients. Its business units, in addition to
the manager, include AEW Capital Management, L.P., Back Bay Advisors, L.P.,
Capital Growth Management, Limited Partnership, Greystone Partners, L.P., Harris
Associates, L.P., Jurika & Voyles, L.P., Loomis, Sayles & Company, L.P., New
England Funds, L.P., Nvest Associates, Inc., Snyder Capital Management, L.P.,
Vaughan, Nelson, Scarborough & McCullough, L.P., and Westpeak Investment
Advisors, L.P. These affiliates in the aggregate are investment advisors or
managers to 80 other registered investment companies.
The recent name change did not result in a change in control of the Manager and
has no impact upon the Manager's performance of its responsibilities and
obligations.
The Investment Management Contract has a term which extends to December 31, 1998
and may be continued in force thereafter for successive twelve-month periods
beginning each January 1, provided that such continuance is specifically
approved annually by majority vote of the Fund's outstanding voting securities
or by its Board of Directors, and in either case by a majority of the directors
who are not parties to the Investment Management Contract or interested persons
of any such party, by votes cast in person at a meeting called for the purpose
of voting on such matter.
Pursuant to the Investment Management Contract, the Manager manages the Fund's
portfolio of securities and makes decisions with respect to the purchase and
sale of investments, subject to the general control of the Board of Directors of
the Fund.
For its services under the Investment Management Contract, the Manager receives
from the Fund a fee equal to .30% per annum of the Fund's average daily net
assets (the "Management Fee") for managing the Fund's investment portfolio and
performing related services. In addition to its fees under the Investment
Management Contract, Reich & Tang Distributors, Inc., (the "Distributor"),
receives a fee equal to .20% per annum of the Fund's average daily net assets
under the Shareholder Servicing Agreement. The fees are accrued daily and paid
monthly. Investment management fees and operating expenses, which are
attributable to both classes of the Fund, will be allocated daily to each Class
share based on the percentage of outstanding shares at the end of the day.
Pursuant to the Administrative Services Contract for the Fund, the Manager
performs clerical, accounting supervision and office service functions for the
Fund and provides the Fund with personnel to (i) supervise the performance of
bookkeeping and related services by Investors Fiduciary Trust Company, the
Fund's bookkeeping agent, (ii) prepare reports to and filings with regulatory
authorities and (iii) perform such other services as the Fund may from time to
time request of the Manager. The personnel rendering such services may be
employees of the Manager or its affiliates. The Manager, at its discretion, may
voluntarily waive all or a portion of the administrative services fee. For its
services under the Administrative Services Contract, the Manager receives a fee
equal to .21% per annum of the Fund's average daily net assets. Any portion of
the total fees received by the Manager may be used to provide shareholder
services and for distribution of Fund shares. (See "Distribution and Service
Plan" herein.)
DESCRIPTION OF COMMON STOCK
The Fund was incorporated in Maryland on December 5, 1986. The authorized
capital stock of the Fund consists of twenty billion shares of stock having a
par value of one tenth of one cent ($.001) per share. The Fund's Board of
Directors is authorized to divide the unissued shares into separate series of
stock, each series representing a separate, additional investment portfolio.
Shares of all series will have identical voting rights, except where, by law,
certain matters must be approved by a majority of the shares of the affected
series. Each share of any series of shares when issued has equal dividend,
distribution, liquidation and voting rights within the series for which it was
issued, and each fractional share has those rights in proportion to the
percentage that the fractional share represents of a whole share. Generally, all
shares will be voted in the aggregate except if voting by Class is required by
law or the matter involved
10
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affects only one Class, in which case shares will be voted on separately by
Class. There are no conversion or preemptive rights in connection with any
shares of the Fund. All shares, when issued in accordance with the terms of the
offering, will be fully paid and nonassessable. Shares are redeemable at net
asset value, at the option of the shareholder. As of March 31, 1998 the amount
of shares owned by all officers and directors of the Fund, as a group, was less
than 1% of the outstanding shares of the Fund.
The Class A and Class B shares of the Fund, will represent an interest in the
same portfolio of investments and will have identical voting, dividend,
liquidation and other rights, preferences, powers, restrictions, limitations,
qualifications, designations and terms and conditions, except that: (i) the
Class A and Class B shares will have different class designations; (ii) only the
Class A shares will be assessed a service fee pursuant to the Rule 12b-1
Distribution and Service Plan of the Fund of .20% of the Fund's average daily
net assets; (iii) only the holders of the Class A shares would be entitled to
vote on matters pertaining to the Plan and any related agreements in accordance
with provisions of Rule 12b-1; and (iv) the exchange privilege will permit
shareholders to exchange their shares only for shares of the same class of an
Exchange Fund. Payments that are made under the Plans will be calculated and
charged daily to the appropriate class prior to determining daily net asset
value per share and dividends/distributions.
Under its Articles of Incorporation, the Fund has the right to redeem shares of
stock owned by any shareholder for cash, to the extent and at such times as the
Fund's Board of Directors determines to be necessary or appropriate to prevent
an undue concentration of stock ownership, which would cause the Fund to become
a "personal holding company" for Federal income tax purposes. In this regard,
the Fund may also exercise its right to reject purchase orders.
The shares of the Fund have non-cumulative voting rights, which means that the
holders of more than 50% of the shares outstanding, voting for the election of
directors, can elect 100% of the directors if the holders choose to do so, and,
in that event, the holders of the remaining shares will not be able to elect any
person or persons to the Board of Directors.
DIVIDENDS AND DISTRIBUTIONS
The Fund declares dividends equal to all its net investment income (excluding
capital gains and losses, if any, and amortization of market discount) on each
Fund Business Day and generally pays dividends monthly. There is no fixed
dividend rate. In computing these dividends, interest earned and expenses are
accrued daily.
Net realized capital gains, if any, are distributed at least annually and in no
event later than within 60 days after the end of the Fund's fiscal year.
All dividends and distributions of capital gains are automatically invested in
additional Fund shares of the same Class of shares immediately upon payment
thereof unless a shareholder has elected by written notice to the Fund to
receive either of such distributions in cash.
The Class A shares will bear the service fee under the Plan. As a result, the
net income of and the dividends payable to the Class A shares will be lower than
the net income of and dividends payable to the Class B shares of the Fund.
Dividends paid to each Class of shares of the Fund will, however, be declared
and paid on the same days at the same times and, except as noted with respect to
the service fees payable under the Plan, will be determined in the same manner
and paid in the same amounts.
HOW TO PURCHASE AND REDEEM SHARES
Investors who have accounts with Participating Organizations may invest in the
Fund through their Participating Organizations in accordance with the procedures
established by the Participating Organizations. Certain Participating
Organizations are compensated by the Distributor from its shareholder servicing
fee and by the Manager from its management fee for the performance of these
services. An investor who purchases shares through a Participating Organization
that receives payment from the Manager or the Distributor will
11
<PAGE>
become a Class A shareholder. (See "Investments Through Participating
Organizations" herein.) All other investors, and investors who have accounts
with Participating Organizations but who do not wish to invest in the Fund
through their Participating Organizations, may invest in the Fund directly as
Class B shareholders of the Fund and not receive the benefit of the servicing
functions performed by a Participating Organization. Class B shares may also be
offered to investors who purchase their shares through Participating
Organizations who do not receive compensation from the Distributor or the
Manager because they may not be legally permitted to receive such as
fiduciaries. The Manager pays the expenses incurred in the distribution of Class
B shares. Participating Organizations whose clients become Class B shareholders
will not receive compensation from the Manager or Distributor for the servicing
they may provide to their clients.. (See "Direct Purchase and Redemption
Procedures" herein.) With respect to both Classes of shares, the minimum initial
investment in the Fund by Participating Organizations is $1,000 which may be
satisfied by initial investments aggregating $1,000 by a Participating
Organization on behalf of customers whose initial investments are less than
$1,000. The minimum initial investment for securities brokers, financial
institutions and other industry professionals that are not Participating
Organizations is $1,000. The minimum initial investment for all other investors
is $5,000. Initial investments may be made in any amount in excess of the
applicable minimums. The minimum amount for subsequent investments is $100
unless the investor is a client of a Participating Organization whose clients
have made aggregate subsequent investments of $100.
The Fund sells and redeems its shares on a continuing basis at their net asset
value and does not impose a charge for either sales or redemptions. All
transactions in Fund shares are effected through the Fund's transfer agent,
which accepts orders for purchases and redemptions from Participating
Organizations and from investors directly.
In order to maximize earnings on its portfolio, the Fund normally has its assets
as fully invested as is practicable. Many securities in which the Fund invests
require immediate settlement in funds of Federal Reserve member banks on deposit
at a Federal Reserve Bank (commonly known as "Federal Funds"). Accordingly, the
Fund does not accept a subscription or invest an investor's payment in portfolio
securities until the payment has been converted into Federal Funds.
Shares will be issued as of the first determination of the Fund's net asset
value per share for each Class made after acceptance of the investor's purchase
order at the net asset value per share next determined after receipt of the
purchase order. Shares begin accruing income dividends on the day they are
purchased. The Fund reserves the right to reject any subscription for its
shares.
Shares are issued as of 12 noon, New York City time, on any Fund Business Day as
defined herein on which an order for the shares and accompanying Federal Funds
are received by the Fund's transfer agent before 12 noon. Orders accompanied by
Federal Funds and received after 12 noon, New York City time, on a Fund Business
Day will not result in share issuance until the following Fund Business Day.
Fund shares begin accruing income on the day the shares are issued to an
investor.
There is no redemption charge, no minimum period of investment, no minimum
amount for a redemption and no restriction on frequency of withdrawals. Proceeds
of redemptions are paid by check. Unless other instructions are given in proper
form to the Fund's transfer agent, a check for the proceeds of a redemption will
be sent to the shareholder's address of record. If a shareholder elects to
redeem all the shares of the Fund he owns, all dividends accrued to the date of
such redemption will be paid to the shareholder along with the proceeds of the
redemption.
The right of redemption may not be suspended or the date of payment upon
redemption postponed for more than seven days after the shares are tendered for
redemption, except for any period during which the New York Stock Exchange, Inc.
is closed (other than customary weekend and holiday closings) or during which
12
<PAGE>
the SEC determines that trading thereon is restricted, or for any period during
which an emergency (as determined by the SEC) exists as a result of which
disposal by the Fund of its portfolio securities is not reasonably practicable
or as a result of which it is not reasonably practicable for the Fund fairly to
determine the value of its net assets, or for such other period as the SEC may
by order permit for the protection of the shareholders of the Fund.
Redemption requests received by the Fund's transfer agent before 12 noon, New
York City time, on any Fund Business Day become effective at 12 noon that day.
Shares are not entitled to participate in dividends declared on the day a
redemption becomes effective. A redemption request received after 12 noon, New
York City time, on any Fund Business Day becomes effective on the next Fund
Business Day.
The Fund has reserved the right to redeem the shares of any shareholder if the
net asset value of all the remaining shares in the shareholder's or his
Participating Organization's account after a withdrawal is less than $500.
Written notice of a proposed mandatory redemption will be given at least 30 days
in advance to any shareholder whose account is to be redeemed or the Fund may
impose a monthly service charge of $10 on such accounts. For Participant
Investor accounts, notice of a proposed mandatory redemption will be given only
to the appropriate Participating Organization, and the Participating
Organization will be responsible for notifying the Participant Investor of the
proposed mandatory redemption. During the notice period a shareholder or
Participating Organization who receives such a notice may avoid mandatory
redemption by purchasing sufficient additional shares to increase the total net
asset value to the minimum amount and thereby avoid such mandatory redemption.
The redemption of shares may result in the investor's receipt of more or less
than he paid for his shares and, thus, is a taxable gain or loss to the
investor.
Investments Through
Participating Organizations
Participant Investors may, if they wish, invest in the Fund through the
Participating Organizations with which they have accounts. "Participating
Organizations" are securities brokers, banks and financial institutions or other
industry professionals or organizations which have entered into shareholder
servicing agreements with the Manager with respect to investment of their
customer accounts in the Fund. When instructed by its customer to purchase or
redeem Fund shares, the Participating Organization, on behalf of the customer,
transmits to the Fund's transfer agent a purchase or redemption order, and in
the case of a purchase order, payment for the shares being purchased.
Participating Organizations may confirm to their customers who are shareholders
in the Fund each purchase and redemption of Fund shares for the customers'
accounts. Also, Participating Organizations may send their customers periodic
account statements showing the total number of Fund shares owned by each
customer as of the statement closing date, purchases and redemptions of Fund
shares by each customer during the period covered by the statement and the
income earned by Fund shares of each customer during the statement period
(including dividends paid in cash or reinvested in additional Fund shares).
Participant Investors whose Participating Organizations have not undertaken to
provide such confirmations and statements will receive them from the Fund
directly.
Participating Organizations may charge Participant Investors a fee in connection
with their use of specialized purchase and redemption procedures offered to
Participant Investors by the Participating Organizations. In addition,
Participating Organizations offering purchase and redemption procedures similar
to those offered to shareholders who invest in the Fund directly may impose
charges, limitations, minimums and restrictions in addition to or different from
those applicable to shareholders who invest in the Fund directly. Accordingly,
the net yield to investors who invest through Participating Organizations may be
less than by investing in the Fund directly. A Participant Investor should read
this Prospectus in conjunction with the materials provided by the Participating
Organization describing the procedures under which
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<PAGE>
Fund shares may be purchased and redeemed through the Participating
Organization.
The Glass-Steagall Act limits the ability of a depository institution to become
an underwriter or distributor of securities. However, it is the Fund
management's position that banks are not prohibited from acting in other
capacities for investment companies, such as providing administrative and
shareholder account maintenance services and receiving compensation from the
Manager for providing such services. However, this is an unsettled area of the
law and if a determination contrary to the Fund management's position is made by
a bank regulatory agency or court concerning shareholder servicing and
administration payments to banks from the Manager, any such payments will be
terminated and any shares registered in the banks' names, for their underlying
customers, will be re-registered in the name of the customers at no cost to the
Fund or its shareholders. In addition, state securities laws on this issue may
differ from the interpretations of Federal law expressed herein and banks and
financial institutions may be required to register as dealers pursuant to state
law.
In the case of qualified Participating Organizations, orders received by the
Fund's transfer agent before 12 noon, New York City time, on a Fund Business
Day, without accompanying Federal Funds will result in the issuance of shares on
that day provided that the Federal Funds required in connection with the orders
are received by the Fund's transfer agent before 4:00 p.m., New York City time,
on that day. Orders for which Federal Funds are received after 4:00 p.m., New
York City time, will not result in share issuance until the following Fund
Business Day. Participating Organizations are responsible for instituting
procedures to insure that purchase orders by their respective clients are
processed expeditiously.
Direct Purchase and Redemption Procedures
The following purchase and redemption procedures apply to investors who wish to
invest in the Fund directly and not through Participating Organizations. These
investors may obtain a current Prospectus and the subscription order form
necessary to open an account by telephoning the Fund at the following numbers:
Within New York State 212-830-5220
Outside New York State (toll free) 800-221-3079
All shareholders, other than certain Participant Investors, will receive from
the Fund individual confirmations of each purchase and redemption of Fund shares
(other than draft check redemptions) and a monthly statement listing the total
number of Fund shares owned as of the statement closing date, purchase and
redemptions of Fund shares during the month covered by the statement and the
dividends paid on Fund shares of each shareholder during the statement period
(including dividends paid in cash or reinvested in additional Fund shares).
Certificates for Fund shares will not be issued to an investor.
Initial Purchases of Shares
Mail
Investors may send a check made payable to "California Daily Tax Free Income
Fund, Inc." along with a completed subscription order form to:
California Daily Tax Free Income Fund, Inc.
Reich & Tang Funds
600 Fifth Avenue - 8th Floor
New York, New York 10020
Checks are accepted subject to collection at full value in United States
currency. Payment by a check drawn on any member of the Federal Reserve System
can normally be converted into Federal Funds within two business days after
receipt of the check. Checks drawn on a non-member bank may take substantially
longer to convert into Federal Funds. An investor's subscription will not be
accepted until the Fund receives Federal Funds.
Bank Wire
To purchase shares of the Fund using the wire system for transmittal of money
among banks, an investor should first obtain a new account number by telephoning
the Fund at 212-830-5220 (within New York State) or at 800-221-3079 (outside New
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<PAGE>
York State) and then instruct a member commercial bank to wire money immediately
to:
Investors Fiduciary Trust Company
ABA #101003621
DDA #890752-953-8
For California Daily Tax Free Income Fund, Inc.
Account of (Investor's Name)
Fund Account #
SS #/Tax I.D. #
The investor should then promptly complete and mail the subscription order form.
Investors planning to wire funds should instruct their bank early in the day so
the wire transfer can be accomplished before 12 noon, New York City time, on the
same day. There may be a charge by the investor's bank for transmitting the
money by bank wire, and there also may be a charge for use of Federal Funds. The
Fund does not charge investors in the Fund for its receipt of wire transfers.
Payment in the form of a "bank wire" received prior to 12 noon, New York City
time, on a Fund Business Day will be treated as a Federal Funds payment received
on that day.
Personal Delivery
Deliver a check made payable to "California Daily Tax Free Income Fund, Inc."
along with a completed subscription order form to:
Reich & Tang Funds
600 Fifth Avenue - 9th Floor
New York, New York 10020
Electronic Funds Transfers (EFT),
Pre-authorized Credit
and Direct Deposit Privilege
You may purchase shares of the Fund (minimum of $100) by having salary, dividend
payments, interest payments or any other payments designated by you, or by
having federal salary, social security, or certain veteran's, military or other
payments from the federal government, automatically deposited into your Fund
account. You can also have money debited from your checking account. To enroll
in any one of these programs, you must file with the Fund a completed EFT
Application, Pre-authorized Credit Application, use a copy of a voided check or
a Direct Deposit Sign-Up Form for each type of payment that you desire to
include in the privilege. The appropriate form may be obtained from your broker
or the Fund. You may elect at any time to terminate your participation by
notifying in writing the appropriate depositing entity and/or federal agency.
Death or legal incapacity will automatically terminate your participation in the
privilege. Further, the Fund may terminate your participation upon 30 days'
notice to you.
Subsequent Purchases of Shares
Subsequent purchases can be made by personal delivery or by bank wire, as
indicated above or by mailing a check to:
California Daily Tax Free Income Fund, Inc.
Mutual Funds Group
P.O. Box 13232
Newark, New Jersey 07101-3232
There is a $100 minimum for subsequent purchases of shares. All payments should
clearly indicate the shareholder's account number.
Provided that the information on the subscription form on file with the Fund is
still applicable, a shareholder may reopen an account without filing a new
subscription order form at any time during the year the shareholder's account is
closed or during the following calendar year.
Redemption of Shares
A redemption is effected immediately following, and at a price determined in
accordance with, the next determination of net asset value per share of each
Class following receipt by the Fund's transfer agent of the redemption order
(and any supporting documentation which it may require). Normally, payment for
redeemed shares is made on the same Fund Business Day after the redemption is
effected, provided the redemption request is received prior to 12 noon, New York
City time and on the next Fund Business Day if the redemption request is
received after 12 noon, New York City time. However, redemption requests will
not be effected, unless the check (including a certified or cashiers check) used
for investment has been cleared for payment by the
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<PAGE>
investor's bank and converted into Federal Funds. A bank check will be
considered by the Fund to have cleared 15 days after it is deposited by the
Fund.
A shareholder's original subscription order form permits the shareholder to
redeem by written request and to elect one or more of the additional redemption
procedures described below. A shareholder may only change the instructions
indicated on his original subscription order form by transmitting a written
direction to the Fund's transfer agent. Requests to institute or change any of
the additional redemption procedures will require a signature guarantee. When a
signature guarantee is called for, the shareholder should have "Signature
Guaranteed" stamped under his signature and signed and guaranteed by an eligible
guarantor institution which includes a domestic bank, a domestic savings and
loan institution, a domestic credit union, a member bank of the Federal Reserve
System or a member firm of a national securities exchange, pursuant to the
Fund's transfer agent's standards and procedures.
Written Requests
Shareholders may make a redemption in any amount by sending a written request to
the Fund, accompanied by any certificate that may have been previously issued to
the shareholder, addressed to:
California Daily Tax Free Income Fund, Inc.
Reich & Tang Funds
600 Fifth Avenue - 8th Floor
New York, New York 10020
All previously issued certificates submitted for redemption must be endorsed by
the shareholder and all written requests for redemption must be signed by the
shareholder, in each case with signature guaranteed. Normally the redemption
proceeds are paid by check and mailed to the shareholder of record.
Checks
By making the appropriate election on their subscription order form,
shareholders may request a supply of checks which may be used to effect
redemptions from the Class of shares in the Fund in which they invest. The
checks, which will be issued in the shareholder's name, are drawn on a special
account maintained by the Fund with the agent bank. Checks may be drawn in any
amount of $250 or more. When a check is presented to the Fund's agent bank, it
instructs the Fund's transfer agent to redeem a sufficient number of full and
fractional shares in the shareholder's account to cover the amount of the check.
The use of a check to make a withdrawal enables a shareholder in the Fund to
receive dividends on the shares to be redeemed up to the Fund Business Day on
which the check clears. Checks provided by the Fund may not be certified. Fund
shares purchased by check may not be redeemed for up to 15 days following the
date of purchase.
There is no charge to the shareholder for checks provided by the Fund. The Fund
reserves the right to impose a charge or impose a different minimum check amount
in the future, if the Board of Directors determines that doing so is in the best
interests of the Fund and its shareholders.
Shareholders electing the checking option are subject to the procedures, rules
and regulations of the Fund's agent bank. Checks drawn on a jointly owned
account may, at the shareholder's election, require only one signature. Checks
in amounts exceeding the value of the shareholder's account at the time the
check is presented for payment will not be honored. Since the dollar value of
the account changes daily, the total value of the account may not be determined
in advance and the account may not be entirely redeemed by check. In addition,
the Fund reserves the right to charge the shareholder's account a fee of up to
$20 for checks not honored as a result of an insufficient account value, a check
deemed not negotiable because it has been held longer than six months, an
unsigned check and a post-dated check. The Fund reserves the right to terminate
or modify the check redemption procedure at any time or to impose additional
fees following notification to the Fund's shareholders.
Investors wishing to avail themselves of this method of redemption should elect
it on their subscription order form. Individuals and joint tenants are not
required to furnish any supporting documentation. Corporations and other
entities making this election,
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<PAGE>
however, are required to furnish a certified resolution or other evidence of
authorization in accordance with the Fund's normal practices. Appropriate
authorization forms will be sent by the Fund or its agents to corporations and
other shareholders who select this option. As soon as the authorization forms
are filed in good order, the Fund will provide the shareholder with a supply of
checks. This checking service may be terminated or modified at any time.
Telephone
The Fund accepts telephone requests for redemption from shareholders who elect
this option. The proceeds of a telephone redemption may be sent to the
shareholders at their addresses or, if in excess of $1,000, to their bank
accounts, both as set forth in the subscription order form or in a subsequent
written authorization. The Fund may accept telephone redemption instructions
from any person with respect to accounts of shareholders who elect this service
and thus such shareholders risk possible loss of principal and interest in the
event of a telephone redemption not authorized by them. The Fund will employ
reasonable procedures to confirm that telephone redemption instructions are
genuine, and will require that shareholders electing such option provide a form
of personal identification. The failure by the Fund to employ such procedures
may cause the Fund to be liable for the losses incurred by investors due to
telephone redemptions based upon unauthorized or fraudulent instructions.
A shareholder making a telephone withdrawal should call the Fund at
212-830-5220; outside New York State at 800-221-3079, and state (i) the name of
the shareholder appearing on the Fund's records, (ii) the shareholder's account
number with the Fund, (iii) the amount to be withdrawn, (iv) whether such amount
is to be forwarded to the shareholder's designated bank account or address and
(v) the name of the person requesting the redemption. Usually the proceeds are
sent to the designated bank account or address on the same Fund Business Day the
redemption is effected, provided the redemption request is received before 12
noon, New York City time and on the next Fund Business Day if the redemption
request is received after 12 noon, New York City time. The Fund reserves the
right to terminate or modify the telephone redemption service in whole or in
part at any time and will notify shareholders accordingly.
Exchange Privilege
Shareholders of the Fund are entitled to exchange some or all of their Class of
shares in the Fund for shares of the same Class of certain other investment
companies which retain Reich & Tang Asset Management L.P. as investment advisor
and which participate in the exchange privilege program with the Fund. If only
one Class of shares is available in a particular exchange Fund, the shareholder
of the Fund is entitled to exchange their shares for the shares available in
that exchange Fund. Currently the exchange privilege program has been
established between the Fund and Connecticut Daily Tax Free Income Fund, Inc.,
Daily Tax Free Income Fund, Inc., Florida Daily Municipal Income Fund, Michigan
Daily Tax Free Income Fund, Inc., New Jersey Daily Municipal Income Fund, Inc.,
New York Daily Tax Free Income Fund, Inc., North Carolina Daily Municipal Income
Fund, Inc., Pennsylvania Daily Municipal Income Fund, Reich & Tang Equity Fund,
Inc. and Short Term Income Fund, Inc. In the future, the exchange privilege
program may be extended to other investment companies which retain Reich & Tang
Asset Management L.P. as investment advisor, manager or administrator. An
exchange of shares in the Fund pursuant to the exchange privilege is, in effect,
a redemption of Fund shares (at net asset value) followed by the purchase of
shares of the investment company into which the exchange is made (at net asset
value) and may result in a shareholder realizing a taxable gain or loss for
Federal income tax purposes.
There is no charge for the exchange privilege or limitation as to frequency of
exchange. The minimum amount for an exchange is $1,000, except that shareholders
who are establishing a new account with an investment company through the
exchange privilege must ensure that a sufficient number of shares are exchanged
to meet the minimum initial investment required for the
17
<PAGE>
investment company into which the exchange is being made. Each Class of shares
is exchanged at its respective net asset value.
The exchange privilege provides shareholders of the Fund with a convenient
method to shift their investment among different investment companies when they
feel such a shift is desirable. The exchange privilege is available to
shareholders resident in any state in which shares of the investment company
being acquired may legally be sold. Shares of the same Class may be exchanged
only between investment company accounts registered in identical names. Before
making an exchange, the investor should review the current prospectus of the
investment company into which the exchange is to be made. Prospectuses may be
obtained by contacting the Distributor at the address or telephone number set
forth on the cover page of this Prospectus.
Instructions for exchanges may be made by sending a signature guaranteed written
request to:
California Daily Tax Free Income Fund, Inc.
Reich & Tang Funds
600 Fifth Avenue - 8th Floor
New York, New York 10020
or, for shareholders who have elected that option, by telephoning the Fund at
212-830-5220; outside New York State at 800-221-3079. The Fund reserves the
right to reject any exchange request and may modify or terminate the exchange
privilege at any time and will notify the shareholders accordingly.
Specified Amount Automatic Withdrawal Plan
Shareholders may elect to withdraw shares and receive payment from the Fund of a
specified amount of $50 or more automatically on a monthly basis in an amount
approved and confirmed by the Manager. A specified amount plan payment is made
by the Fund generally on the 23rd day of each month. Whenever such 23rd day of a
month is not a Fund Business Day, the payment date is the Fund Business Day
preceding the 23rd day of the month. In order to make a payment, a number of
shares equal in aggregate net asset value to the payment amount are redeemed at
their net asset value on the Fund Business Day immediately preceding the date of
payment. To the extent that the redemptions to make plan payments exceed the
number of shares purchased through reinvestment of dividends and distributions,
the redemptions reduce the number of shares purchased on original investment,
and may ultimately liquidate a shareholder's investment.
The election to receive automatic withdrawal payments may be made at the time of
the original subscription by so indicating on the subscription order form. The
election may also be made, changed or terminated at any later time by the
participant. Because the withdrawal plan involves the redemption of Fund shares,
such withdrawals may constitute taxable events to the shareholder, but the Fund
does not expect that there will be any realizable capital gains.
DISTRIBUTION AND SERVICE PLAN
Pursuant to Rule 12b-1 under the 1940 Act, the SEC has required that an
investment company which bears any direct or indirect expense of distributing
its shares must do so only in accordance with a plan permitted by Rule 12b-1.
The Fund's Board of Directors has adopted a distribution and service plan (the
"Plan") and, pursuant to the Plan, the Fund and Reich & Tang Distributors, Inc.
(the "Distributor") have entered into a Distribution Agreement and a Shareholder
Servicing Agreement (with respect to Class A shares of the Fund only).
Under the Distribution Agreement, the Distributor, for nominal consideration and
as agent for the Fund, will solicit orders for the purchase of the Fund's
shares, provided that any subscriptions and orders will not be binding on the
Fund until accepted by the Fund as principal.
Under the Shareholder Servicing Agreement, the Distributor receives with respect
only to the Class A shares a service fee equal to .20% per annum of the Class A
shares' average daily net assets (the "Shareholder Servicing Fee") for providing
personal shareholders services and for the maintenance of shareholder accounts.
The fee is accrued daily and paid monthly and any portion of the fee may be
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<PAGE>
deemed to be used by the Distributor for payments to Participating Organizations
with respect to their provision of such services to their clients or customers
who are shareholders of the Class A shares of the Fund. The Class B shareholders
will not receive the benefit of such services from Participating Organizations
and, therefore, will not be assessed a Shareholder Servicing Fee.
The Plan and the Shareholder Servicing Agreement provide that, in addition to
the Shareholder Servicing Fee, the Fund will pay for (i) telecommunications
expenses, including the cost of dedicated lines and CRT terminals, incurred by
the Manager and Distributor in carrying out their obligations under the
Shareholder Servicing Agreement with respect to Class A shares and (ii)
preparing, printing and delivering the Fund's prospectus to existing
shareholders of the Fund and preparing and printing subscription application
forms for shareholder accounts.
The Plan provides that the Manager may make payments from time to time from its
own resources, which may include the Management Fee and past profits for the
following purposes: (i) to defray the costs of, and to compensate others,
including Participating Organizations with whom the Distributor has entered into
written agreements, for performing shareholder servicing and related
administrative functions on behalf of the Class A shares of the Fund and (ii) to
compensate certain Participating Organizations for providing assistance in
distributing the Class A shares of the Fund. The Distributor may also make
payments from time to time from its own resources, which may include the
Shareholder Servicing Fee and past profits, for the purposes enumerated in (i)
above. The Distributor, in its sole discretion, will determine the amount of
such payments made pursuant to the Plan, provided that such payments will not
increase the amount which the Fund is required to pay to the Manager and the
Distributor for any fiscal year under either the Investment Management Contract
in effect for that year or the Shareholder Servicing Agreement in effect for
that year.
For the fiscal year ended December 31, 1997, the total amount spent pursuant to
the Plan for Class A shares was .42% of the average daily net assets of the
Fund, of which .20% of the average daily net assets was paid by the Fund to the
Distributor, pursuant to the Shareholder Servicing Agreement and an amount
representing .22% was paid by the Manager (which may be deemed an indirect
payment by the Fund). Of the total amount paid by the Manager, $890,593 was
utilized for Broker assistance payments, $9,497 for compensation to sales
personnel, $5,961 for travel and expenses, $8,672 for Prospectus printing, and
$397 on miscellaneous expenses.
FEDERAL INCOME TAXES
The Fund has elected to qualify under the Code as a regulated investment company
that distributes "exempt-interest dividends" as defined in the Code. The Fund's
policy is to distribute as dividends each year 100% (and in no event less than
90%) of its tax-exempt interest income, net of certain deductions, and its
investment company taxable income (if any). If distributions are made in this
manner, dividends designated as derived from the interest earned on Municipal
Obligations are "exempt-interest dividends" and are not subject to regular
Federal income tax, although as described below, such "exempt-interest
dividends" may be subject to Federal alternative minimum tax. Dividends paid
from taxable income, if any, and distributions of any realized short-term
capital gains (whether from tax-exempt or taxable obligations) are taxable to
shareholders as ordinary income for Federal income tax purposes, whether
received in cash or reinvested in additional shares of the Fund. Although it is
not intended, it is possible that the Fund may realize short-term or long-term
capital gains or losses. The Fund will inform shareholders of the amount and
nature of its income and gains in a written notice mailed to shareholders not
later than 60 days after the close of the Fund's taxable year. For Social
Security recipients, interest on tax-exempt bonds, including "exempt-interest
dividends" paid by the Fund, is to be added to adjusted gross income for
purposes of computing the amount of Social Security benefits includable in gross
income. Further, corporations will be required to include in alternative minimum
taxable income 75% of the amount by which their adjusted current earnings
19
<PAGE>
(including generally, tax-exempt interest) exceeds their alternative minimum
taxable income (determined without this item). In addition, in certain cases
Subchapter S corporations with accumulated earnings and profits from Subchapter
C years will be subject to a tax on "passive investment income," including
tax-exempt interest. Although the Fund intends to maintain a $1.00 per share net
asset value, a Shareholder may realize a taxable gain or loss upon the
disposition of shares.
Interest on certain "private activity bonds" (generally, a bond issue in which
more than 10% of the proceeds are used for a non-governmental trade or business
and which meets the private security or payment test, or a bond issue which
meets the private loan financing test) issued after August 7, 1986 will
constitute an item of tax preference subject to the individual alternative
minimum tax.
With respect to variable rate demand instruments, including Participation
Certificates therein, the Fund is relying on the opinion of Battle Fowler LLP,
counsel to the Fund, that it will be treated for Federal income tax purposes as
the owner of the underlying Municipal Obligations and the interest thereon will
be tax-exempt from Federal income taxes to the Fund to the same extent as
interest on the underlying Municipal Obligations. Counsel has pointed out that
the Internal Revenue Service has announced that it will not ordinarily issue
advance rulings on the question of the ownership of securities or participation
interests therein subject to a put and could reach a conclusion different from
that reached by counsel. (See "Federal Income Taxes" in the Statement of
Additional Information.)
In South Carolina v. Baker, the U.S. Supreme Court held that the Federal
government may constitutionally require states to register bonds they issue and
may subject the interest on such bonds to Federal tax if not registered, and the
Court further held that there is no constitutional prohibition against the
Federal government's taxing the interest earned on state or other municipal
bonds. The Supreme Court decision affirms the authority of the Federal
government to regulate and control bonds such as the Municipal Obligations and
to tax such bonds in the future. The decision does not, however, affect the
current exemption from taxation of the interest earned on the Municipal
Obligations in accordance with Section 103 of the Code.
CALIFORNIA INCOME TAXES
The designation of all or a portion of a dividend paid by the Fund as an
"exempt-interest dividend" under the Code does not necessarily result in the
exemption of such amount from tax under the laws of any state or local taxing
authority. Under California law, at the end of each quarter of its tax year, at
least 50% of the "value" of the Fund's assets must consist of obligations which,
when held by an individual, the interest thereon exempt from taxation by the
State of California. Assuming compliance with this requirement and the
limitation as to the amount of "exempt-interest dividends" described below with
respect to dividends treated for Federal income tax purposes as exempt-interest
dividends that are paid by the Fund to a California resident individual
shareholder, in the opinion of LeBoeuf, Lamb, Greene & MacRae, LLP, special
California tax counsel to the Fund, amounts correctly designated as derived from
California Municipal Obligations received by the Fund will not be subject to the
California Income Tax. Amounts correctly designated as derived from Territorial
Municipal Obligations will not be subject to the California Income Tax as long
as the interest on such obligations, when held by an individual, is exempt from
California taxation.
California law, however, limits the amount that may be designated as
"exempt-interest dividends." With respect to the Fund's taxable year, if the
aggregate amount designated as an exempt-interest dividend is greater than the
excess of (i) the amount of interest it received which, if held by an
individual, was exempt from taxation by California, over (ii) the amounts that,
if the Fund were treated as an individual, would be disallowed as deductions for
expenses related to exempt income under California or Federal law, the portion
of the distribution designated an "exempt-interest dividend" that will be
allowed shall be only that proportion of the designated amount that the excess
bears to the designated amount.
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<PAGE>
Exempt-interest dividends which are not derived from California Municipal
Obligations and any other dividends of the Fund which do not qualify as
"exempt-interest dividends" under California law will be includible in a
California resident's tax base for purposes of the California Income Tax.
Shareholders are urged to consult their tax advisors with respect to the
treatment of distributions from the Fund in their own states and localities.
GENERAL INFORMATION
The Fund was incorporated under the laws of the State of Maryland on December 5,
1986 and it is registered with the SEC as a non-diversified, open-end management
investment company.
The Fund prepares semi-annual unaudited and annual audited reports which include
a list of investment securities held by the Fund and which are sent to
shareholders.
As a general matter, the Fund will not hold annual or other meetings of the
Fund's shareholders. This is because the By-laws of the Fund provide for annual
meetings only (a) for the election of directors, (b) for approval of the revised
investment advisory contracts with respect to a particular class or series of
stock, (c) for approval of revisions to the Fund's distribution agreement with
respect to a particular class or series of stock, and (d) upon the written
request of shareholders entitled to cast not less than 25% of all the votes
entitled to be cast at such meeting. Annual and other meetings may be required
with respect to such additional matters relating to the Fund as may be required
by the 1940 Act, including the removal of Fund director(s) and communication
among shareholders, any registration of the Fund with the SEC or any state, or
as the Directors may consider necessary or desirable. Each Director serves until
the next meeting of the shareholders called for the purpose of considering the
election or reelection of such Director or of a successor to such Director, and
until the election and qualification of his or her successor, elected at such a
meeting, or until such Director sooner dies, resigns, retires or is removed by
the vote of the shareholders.
As the year 2000 approaches, an issue has emerged regarding how existing
application software programs and operating systems can accommodate this date
value. Failure to adequately address this issue could have potentially serious
repercussions. The Manager is in the process of working with the Fund's service
providers to prepare for the year 2000. Based on information currently
available, the Manager does not expect that the Fund will incur significant
operating expenses or be required to incur material costs to be year 2000
compliant. Although the Manager does not anticipate that the year 2000 issue
will have a material impact of the Fund's ability to provide service at current
levels, there can be no assurance that steps taken in preparation for the year
2000 will be sufficient to avoid an adverse impact on the Fund.
For further information with respect to the Fund and the shares offered hereby,
reference is made to the Fund's registration statement filed with the SEC,
including the exhibits thereto. The Registration Statement and the exhibits
thereto may be examined at the Commission and copies thereof may be obtained
upon payment of certain duplicating fees.
NET ASSET VALUE
The net asset value of the Fund's shares is determined as of 12 noon, New York
City time, on each Fund Business Day. Fund Business Day means weekdays (Monday
through Friday) except customary business holidays and Good Friday. It is
computed by dividing the value of the Fund's net assets (i.e., the value of its
securities and other assets less its liabilities, including expenses payable or
accrued but excluding capital stock and surplus) by the total number of shares
outstanding.
The Fund's portfolio securities are valued at their amortized cost in compliance
with the provisions of Rule 2a-7 under the 1940 Act. Amortized cost valuation
involves valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, except that if fluctuating
interest rates cause the market value of the Fund's portfolio to deviate more
than 1/2 of 1% from the value determined on the basis of amortized
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<PAGE>
cost, the Board of Directors will consider whether any action should be
initiated. Although the amortized cost method provides certainty in valuation,
it may result in periods during which the value of an instrument is higher or
lower than the price an investment company would receive if the instrument were
sold. The Fund intends to maintain a stable net asset value at $1.00 per share
although there can be no assurance that this will be achieved.
CUSTODIAN AND TRANSFER AGENT
Investors Fiduciary Trust Company, 801 Pennsylvania, Kansas City, Missouri 64105
is custodian for the Fund's cash and securities. Reich & Tang Services, Inc.,
600 Fifth Avenue, New York, New York 10020, is the transfer agent and dividend
agent for the shares of the Fund. The Fund's custodian and transfer agent do not
assist in, and are not responsible for, investment decisions involving assets of
the Fund.
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<PAGE>
Table of Contents CALIFORNIA
Table of Fees and Expenses..........................2 DAILY TAX
Financial Highlights................................3 FREE INCOME
Introduction........................................4 FUND, INC.
Investment Objectives, Policies and Risks...........5
Management of the Fund..............................9
Description of Common Stock........................10
Dividends and Distributions........................11
How to Purchase and Redeem Shares..................11
Investments Through
Participating Organizations.....................13
Direct Purchase and Redemption Procedures..........14
Initial Purchases of Shares........................14 PROSPECTUS
Electronic Funds Transfers (EFT), May 1, 1998
Pre-authorized Credit and
Direct Deposit Privilege........................15
Subsequent Purchases of Shares.....................15
Redemption of Shares...............................15
Exchange Privilege.................................17
Specified Amount Automatic Withdrawal Plan.........18
Distribution and Service Plan......................18
Federal Income Taxes...............................19
California Income Taxes............................20
General Information................................21
Net Asset..........................................21
Custodian and Transfer Agent.......................22
<PAGE>
===============================================================================
600 Fifth Avenue, New York, NY 10020
(212) 830-5220
CALIFORNIA
DAILY TAX FREE
INCOME FUND, INC.
===============================================================================
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1998
This Statement of Additional Information, although not in itself a Prospectus,
expands upon and supplements the information contained in the current Prospectus
of California Daily Tax Free Income Fund, Inc. (the "Fund"), dated May 1, 1998
and should be read in conjunction with the Prospectus. The Fund's Prospectus may
be obtained, without charge, from any Participating Organization or by writing
or calling the Fund. This Statement of Additional Information is incorporated by
reference into the Prospectus in its entirety.
Table of Contents
- -------------------------------------------------------------------------------
Investment Objectives, Policies and Risks...2 Manager........................17
Description of Municipal Obligations........3 Expense Limitation..........19
Variable Rate Demand Instruments Management of the Fund.........19
and Participation Certificates..........5 Compensation Table..........21
When-Issued Securities....................7 Counsel and Auditors...........21
Stand-by Commitments......................7 Distribution and Service Plan..21
Taxable Securities..........................8 Description of Common Stock....23
Repurchase Agreements.....................8 Federal Income Taxes...........24
California Risk Factors.....................9 California Income Taxes........25
Investment Restrictions....................14 Custodian and Transfer Agent ..26
Portfolio Transactions.....................15 Financial Statements...........26
How to Purchase and Redeem Shares..........16 Description of Ratings.........27
Net Asset Value............................16 Tax Equivalent Yield Tables....28
Yield Quotations...........................16
- -------------------------------------------------------------------------------
<PAGE>
INVESTMENT OBJECTIVES, POLICIES AND RISKS
As stated in the Prospectus, the Fund is a non-diversified, open-end management
investment company that is a short-term, tax-exempt money market fund. The
Fund's investment objectives are to seek as high a level of current income,
exempt from Federal tax and, to the extent possible, California income taxes
(the "California Income Tax"), as is believed to be consistent with preservation
of capital, maintenance of liquidity and stability of principal. No assurance
can be given that these objectives will be achieved. The following discussion
expands upon the description of the Fund's investment objectives, policies and
risks in the Prospectus.
The Fund's assets will be invested primarily in high quality debt obligations
issued by or on behalf of the State of California, other states, territories and
possessions of the United States and their authorities, agencies,
instrumentalities and political subdivisions, the interest on which is, in the
opinion of bond counsel to the issuer at the date of issuance, currently exempt
from regular Federal income taxation ("Municipal Obligations") and in
Participation Certificates (which, in the opinion of Battle Fowler LLP, counsel
to the Fund, cause the Fund to be treated as the owner of the underlying
Municipal Obligations) in Municipal Obligations purchased from banks, insurance
companies or other financial institutions ("Participation Certificates").
Dividends paid by the Fund which are "exempt-interest dividends" by virtue of
being properly designated by the Fund as derived from Municipal Obligations and
Participation Certificates will be exempt from regular Federal income tax
provided the Fund complies with Section 852(b)(5) of Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"). Although the Supreme
Court has determined that Congress has the authority to subject the interest on
bonds such as the Municipal Obligations to Federal income taxation, existing law
exempts such interest from regular Federal income tax. However, "exempt-interest
dividends" may be subject to the Federal alternative minimum tax.
Securities, the interest income on which may be subject to the Federal
alternative minimum tax (including Participation Certificates in such
securities), together with securities, the interest income on which is subject
to regular Federal, state and local income tax, will not exceed 20% of the value
of the Fund's total assets. (See "Federal Income Taxes" herein.) Exempt-interest
dividends paid by the Fund correctly identified by the Fund as derived from
obligations issued by or on behalf of the State of California or any California
local governments, or their instrumentalities, authorities or districts and on
obligations of the United States which pay interest excludable under the
Constitution or laws of the United States ("California Municipal Obligations")
will be exempt from the California Income Tax. Exempt-interest dividends
correctly identified by the Fund as derived from obligations of Puerto Rico and
the Virgin Islands, as well as any other types of obligations that California is
prohibited from taxing under the Constitution, the laws of the United States of
America or the California Constitution ("Territorial Municipal Obligations")
also may be exempt from California Income Tax provided the Fund complies with
California laws. (See "California Income Taxes" herein.) To the extent suitable
California Municipal Obligations are not available for investment by the Fund,
the Fund may purchase Municipal Obligations issued by other states, their
agencies and instrumentalities, the dividends on which will be designated by the
Fund as derived from interest income which will be, in the opinion of bond
counsel to the issuer at the date of issuance, exempt from Federal income tax
but will be subject to the California Income Tax. Except as a temporary
defensive measure during periods of adverse market conditions as determined by
the Manager, the Fund will invest at least 65% of its assets in California
Municipal Obligations, although the exact amount of the Fund's assets invested
in such securities will vary from time to time. The Fund seeks to maintain an
investment portfolio with a dollar-weighted average maturity of 90 days or less
and to value its investment portfolio at amortized cost and maintain a net asset
value at $1.00 per share for each Class. There can be no assurance that this
value will be maintained. The Fund may hold uninvested cash reserves pending
investment. The Fund's investments may include "when-issued" Municipal
Obligations, stand-by commitments and taxable repurchase agreements.
Although the Fund will attempt to invest 100% of its assets in Municipal
Obligations (excluding securities, the interest income on which may be subject
to the Federal alternative minimum tax) and in Participation Certificates, the
Fund reserves the right to invest up to 20% of the value of its total assets in
securities, the interest income on which is subject to Federal, state and local
income tax, including securities, the interest income on which may be subject to
the Federal alternative minimum tax. The Fund will invest more than 25% of its
assets in Participation Certificates purchased from banks in industrial revenue
bonds and other California Municipal Obligations. In view of this
"concentration" in Participation Certificates in California Municipal
Obligations, an investment in Fund shares should be made with an understanding
of the characteristics of the banking industry and the risks which such an
investment may entail. (See "Variable Rate Demand Instruments and Participation
Certificates" herein.) The investment objectives of the Fund described in this
paragraph may not be changed unless approved by the holders of a majority of the
outstanding shares of the Fund that would be affected by such a change. As used
herein, the term "majority of the outstanding shares" of the Fund means,
respectively, the vote of the lesser of (i) 67% or more of the shares of the
Fund present at a meeting, if the holders of more than 50% of the outstanding
shares of the Fund are present or represented by proxy or (ii) more than 50% of
the outstanding shares of the Fund.
2
<PAGE>
The Fund may only purchase securities that have been determined by the Fund's
Board of Directors to present minimal credit risks and that are Eligible
Securities at the time of acquisition. The term Eligible Securities means (i)
Municipal Obligations with remaining maturities of 397 days or less and rated in
the two highest short-term rating categories by any two nationally recognized
statistical rating organizations ("NRSROs") or in such categories by the only
NRSRO that has rated the Municipal Obligations (collectively, the "Requisite
NRSROs") (acquisition in the latter situation must also be ratified by the Board
of Directors); (ii) Municipal Obligations which are subject to a Demand Feature
or Guarantee (as such terms are defined in Rule 2a-7 of the 1940 Act) and which
have received a rating from an NRSRO or such guarantor has received a rating
from an NRSRO with respect to a class of debt obligations (or any debt
obligation within that class) that is comparable in priority and security to the
Guarantee (unless, the guarantor, directly or indirectly, controls, is
controlled by or is under common control with the issuer or the security subject
to the Guarantee); and the issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the security in the
event the Demand Feature or Guarantee is substituted with another Demand Feature
or Guarantee; and (iii) unrated Municipal Obligations determined by the Fund's
Board of Directors to be of comparable quality. In addition, Municipal
Obligations with remaining maturities of 397 days or less but that at the time
of issuance were long-term securities (i.e. with maturities greater than 366
days) are deemed unrated and may be purchased if such had received a long-term
rating from the Requisite NRSROs in one of the three highest rating categories.
Provided, however, that such may not be purchased if it (i) does not satisfy the
rating requirements set forth in the preceding sentence and (ii) has received a
long-term rating from any NRSRO that is not within the three highest long-term
rating categories. A determination of comparability by the Board of Directors is
made on the basis of its credit evaluation of the issuer, which may include an
evaluation of a letter of credit, Guarantee, insurance or other credit facility
issued in support of the Municipal Obligations or Participation Certificates.
(See "Variable Rate Demand Instruments and Participation Certificates " herein.)
While there are several organizations that currently qualify as NRSROs, two
examples of NRSROs are Standard & Poor's Rating Services, a division of the
McGraw-Hill Companies ("S&P") and Moody's Investors Service, Inc. ("Moody's").
The two highest ratings by S&P and Moody's are "AAA" and "AA" by S&P in the case
of long-term bonds and "Aaa" and "Aa" by Moody's in the case of bonds; "MIG-1"
and "MIG-2" by Moody's in the case of notes; "A-1" and "A-2" by S&P or "Prime-1"
and "Prime-2" by Moody's in the case of tax-exempt commercial paper. Such
instruments may produce a lower yield than would be available from less highly
rated instruments. The Fund's Board of Trustees has determined that Municipal
Obligations which are backed by the credit of the Federal Government will be
considered to have a rating equivalent to Moody's "Aaa". (See "Description of
Ratings" herein.) The highest rating in the case of variable and floating demand
notes is "SP-1/AA" by S&P or "VMIG-1" by Moody's. Such instruments may produce a
lower yield than would be available from less highly rated instruments. The
Fund's Board of Directors has determined that obligations which are backed by
the credit of the Federal government (the interest on which is not exempt from
Federal income taxation) will be considered to have a rating equivalent to
Moody's "Aaa". (See "Description of Ratings" herein.)
All investments by the Fund will mature or will be deemed to mature in 397 days
or less from the date of acquisition and the average maturity of the Fund
portfolio (on a dollar-weighted basis) will be 90 days or less. The maturities
of variable rate demand instruments held in the Fund's portfolio will be deemed
to be the longer of the period required before the Fund is entitled to receive
payment of the principal amount of the instrument through demand, or the period
remaining until the next interest rate adjustment, although the stated
maturities may be in excess of 397 days.
With respect to 75% of its total assets, the Fund shall invest not more than 5%
of its total assets in Municipal Obligations or Participation Certificates
issued by a single issuer. Provided, however, the Fund shall not invest more
than 5% of its total assets in Municipal Obligations or Participation
Certificates issued by a single issuer, unless Municipal Obligations are First
Tier Securities.
The concentration in Municipal Obligations and Participation Certificates may
present greater risks than in the case of a more diversified company. The Fund
intends to continue to qualify as a "regulated investment company" under
Subchapter M of the Code. The Fund will be restricted in that at the close of
each quarter of the taxable year, at least 50% of the value of its total assets
must be represented by cash, government securities, investment company
securities and other securities limited in respect of any one issuer to not more
than 5% in value of the total assets of the Fund and to not more than 10% of the
outstanding voting securities of such issuer. In addition, at the close of each
quarter of its taxable year, not more than 25% in value of the Fund's total
assets may be invested in securities of one issuer other than Government
securities. The limitations described in this paragraph regarding qualification
as a "regulated investment company" are not fundamental policies and may be
revised to the extent applicable Federal income tax requirements are revised.
(See "Federal Income Taxes" herein.)
DESCRIPTION OF MUNICIPAL OBLIGATIONS
As used in the Prospectus, "Municipal Obligations" include the following as well
as "Variable Rate Demand Instruments and Participation Certificates" discussed
herein.
3
<PAGE>
1. Municipal Bonds with remaining maturities of 397 days or less that are
Eligible Securities at the time of acquisition.
Municipal Bonds are debt obligations of states, cities, counties, municipalities
and municipal agencies (all of which are generally referred to as
"municipalities") 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, to refund outstanding
obligations and to obtain 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 faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds include states, counties, cities, towns and
other governmental units. 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" are issued by public
authorities to provide funding for various privately operated industrial
facilities (hereinafter referred to as "industrial revenue bonds" or "IRBs").
Interest on the IRBs is generally exempt, with certain exceptions, from Federal
income tax pursuant to Section 103(a) of the Code, provided the issuer and
corporate obligor thereof continue to meet certain conditions. (See "Federal
Income Taxes" herein.) IRBs are, in most cases, revenue bonds and do not
generally constitute the pledge of the credit of the issuer of such bonds. The
payment of the principal and interest on IRBs 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. If there is no established
secondary market for the IRBs, the IRBs or the Participation Certificates in
IRBs purchased by the Fund will be supported by letters of credit, Guarantees or
insurance that meet the definition of Eligible Securities at the time of
acquisition as stated herein and provide the Demand Feature which may be
exercised by the Fund at any time to provide liquidity. Shareholders should note
that the Fund may invest in IRBs acquired in transactions involving a
Participating Organization. In accordance with investment restriction 6 herein,
the Fund is permitted to invest up to 10% of the portfolio in high quality,
short-term Municipal Obligations (including IRBs) meeting the definition of
Eligible Securities at the time of acquisition that may not be readily
marketable or have a liquidity feature.
2. Municipal Notes with remaining maturities of 397 days or less that are
Eligible Securities at the time of acquisition. The principal kinds of Municipal
Notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes and project notes. Notes sold in anticipation of collection
of taxes, a bond sale or receipt of other revenues are usually general
obligations of the issuing municipality or agency. Project notes are issued by
local agencies and are guaranteed by the United States Department of Housing and
Urban Development. Project notes are also secured by the full faith and credit
of the United States. The Fund's investments may be concentrated in Municipal
Notes of California issuers.
3. Municipal Commercial Paper that is an Eligible Security at the time of
acquisition. Issues of Municipal Commercial Paper typically represent very
short-term, unsecured, negotiable promissory notes. These obligations are often
issued to meet 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
Commercial Paper is backed by letters of credit, lending agreements, note
repurchase agreements or other credit facility agreements offered by banks or
other institutions which may be called upon in the event of default by the
issuer of the commercial paper.
4. Municipal Leases, which may take the form of a lease or an installment
purchase or conditional sale contract, are issued by state and local governments
and authorities to acquire a wide variety of equipment and facilities such as
fire and sanitation vehicles, telecommunications equipment and other capital
assets. Municipal Leases frequently have special risks not normally associated
with general obligation or revenue bonds. Leases and installment purchase or
conditional sale contracts (which normally provide for title to the leased asset
to pass eventually to the governmental issuer) have evolved as a means for
governmental issuers to acquire property and equipment without meeting the
constitutional and statutory requirements for the issuance of debt. The
debt-issuance limitations of many state constitutions and statutes are deemed to
be inapplicable because of the inclusion in many leases or contracts of
"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. To reduce this risk, the Fund will only purchase Municipal
Leases subject to a non-appropriation clause where the payment of principal and
accrued interest is backed by an unconditional, irrevocable letter of credit, a
guarantee, insurance or other comparable undertaking of an approved financial
institution. These types of municipal leases may be considered illiquid and
subject to the 10% limitation of investments in illiquid securities set forth
under "Investment Restrictions" contained herein. The Board of Directors may
adopt guidelines and delegate to the Manager the daily function of determining
and monitoring the liquidity of municipal leases. In making such determination,
the Board and the Manager may consider such factors as the frequency of trades
for the obligation, the number of dealers
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willing to purchase or sell the obligations and the number of other potential
buyers and the nature of the marketplace for the obligations, including the time
needed to dispose of the obligations and the method of soliciting offers. If the
Board determines that any municipal leases are illiquid, such lease will be
subject to the 10% limitation on investments in illiquid securities.
5. Any other Federal tax exempt, and to the extent possible, California Income
Tax exempt obligations issued by or on behalf of states and municipal
governments and their authorities, agencies, instrumentalities and political
subdivisions, whose inclusion in the Fund would be consistent with the Fund's
"Investment Objectives, Policies and Risks" and permissible under Rule 2a-7
under the 1940 Act.
Subsequent to its purchase by the Fund, a rated Municipal Obligation may cease
to be rated or its rating may be reduced such that the investment is no longer a
First Tier Security or is rated below the minimum required for purchase by the
Fund. If this occurs, the Board of Directors of the Fund shall promptly reassess
whether the Municipal Obligation presents minimal credit risks and shall cause
the Fund to take such action as the Board of Directors determines is in the best
interest of the Fund and its shareholders. However, reassessment is not required
if the Municipal Obligation is disposed of or matures within five business days
of the Manager becoming aware of the new rating and provided further that the
Board of Directors is subsequently notified of the Manager's actions.
In addition, in the event that a Municipal Obligation (1) is in default, (2)
ceases to be an Eligible Security, or (3) there is a determination that it no
longer presents minimal credit risks, or an event of insolvency occurs with
respect to the issuer of a portfolio security or the provider of any Demand
Feature or Guarantee, the Fund will dispose of the Municipal Obligation absent a
determination by the Fund's Board of Directors that disposal of the Municipal
Obligation would not be in the best interests of the Fund. In the event that the
Municipal Obligation is disposed of it shall be disposed of as soon as
practicable consistent with achieving an orderly disposition by sale, exercise
of any Demand Feature or otherwise. In the event of a default with respect to a
Municipal Obligation which immediately before default accounted for 1/2 of 1% or
more of the Fund's total assets, the Fund shall promptly notify the Securities
and Exchange Commission (the "SEC") of such fact and of the actions that the
Fund intends to take in response to the situation. Certain Municipal Obligations
issued by instrumentalities of the United States Government are not backed by
the full faith and credit of the United States Treasury but only by the
creditworthiness of the instrumentality. Where necessary to ensure that the
Municipal Obligations are Eligible Securities, or where the obligations are not
freely transferable, the Fund will require that the obligation to pay the
principal and accrued interest be backed by a Guarantee that would qualify the
investment as an Eligible Security.
Variable Rate Demand Instruments and Participation Certificates
Variable rate demand instruments that the Fund will purchase are tax-exempt
Municipal Obligations that provide for a periodic adjustment in the interest
rate paid on the instrument and permit the holder to demand payment of the
unpaid principal balance plus accrued interest at specified intervals upon a
specified number of days' notice either from the issuer or by drawing on a bank
letter of credit, a Guarantee or insurance issued with respect to such
instrument.
The variable rate demand instruments in which the Fund may invest are payable on
demand on not more than thirty calendar days' notice and may be exercised at any
time or at specified intervals not exceeding 397 days depending upon the terms
of the instrument. The terms of the instruments provide that interest rates are
adjustable at intervals ranging from daily to up to 397 days and the adjustments
are based upon the "prime rate"* of a bank or other appropriate interest rate
adjustment index as provided in the respective instruments. The Fund will decide
which variable rate demand instruments it will purchase in accordance with
procedures prescribed by its Board of Directors to minimize credit risks. A fund
utilizing the amortized cost method of valuation under Rule 2a-7 of the 1940 Act
may only purchase variable rate demand instruments only if (i) the instrument is
subject to an unconditional Demand Feature, exercisable by the Fund in the event
of default in the payment of principal or interest on the underlying securities,
that is an Eligible Security or (ii) the instrument is not subject to an
unconditional Demand Feature but does qualify as an Eligible Security and has a
long-term rating by the Requisite NRSROs in one of the two highest rating
categories, or, if unrated, is determined to be of comparable quality by the
Fund's Board of Directors. The Fund's Board of Directors may determine that an
unrated variable rate demand instrument meets the Fund's quality criteria if it
is backed by a letter of credit or guarantee or is insured by an insurer that
meets the quality criteria for the Fund stated herein or on the basis of a
credit evaluation of the underlying obligor. If an instrument is ever not deemed
to be an Eligible Security, the Fund either will sell it in the market or
exercise the Demand Feature.
The variable rate demand instruments that the Fund may invest in include
Participation Certificates purchased by the Fund from banks, insurance companies
or other financial institutions in fixed or variable rate, tax-exempt Municipal
- --------------------------------------------------------------------------------
* The "prime rate" is generally the rate charged by a bank to its most
creditworthy customers for short-term loans. The prime rate is a particular bank
may differ from other banks and will be the rate announced by each bank on a
particular day. Changes in the prime rate may occur with great frequency and
generally become effective on the date announced.
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Obligations (expected to be concentrated in IRBs) owned by such institutions or
affiliated organizations. The Fund will not purchase Participation Certificates
in fixed rate tax-exempt Municipal Obligations without obtaining an opinion of
counsel that the Fund will be treated as the owner thereof for Federal income
tax purposes. A Participation Certificate gives the Fund an undivided interest
in the Municipal Obligation in the proportion that the Fund's participation
interest bears to the total principal amount of the Municipal Obligation and
provides the demand repurchase feature described below. Where the institution
issuing the participation does not meet the Fund's eligibility criteria, the
participation is backed by an irrevocable letter of credit or guaranty of a bank
(which may be the bank issuing the Participation Certificate, a bank issuing a
confirming letter of credit to that of the issuing bank, or a bank serving as
agent of the issuing bank with respect to the possible repurchase of the
certificate of participation) or insurance policy of an insurance company that
the Board of Directors of the Fund has determined meets the prescribed quality
standards for the Fund. The Fund has the right to sell the Participation
Certificate back to the institution and, where applicable, draw on the letter of
credit or insurance after no more than 30 days' notice either at any time or at
specified intervals not exceeding 397 days (depending on the terms of the
participation), for all or any part of the full principal amount of the Fund's
participation interest in the security, plus accrued interest. The Fund intends
to exercise the demand only (1) upon a default under the terms of the bond
documents, (2) as needed to provide liquidity to the Fund in order to make
redemptions of Fund shares or (3) to maintain a high quality investment
portfolio. The institutions issuing the Participation Certificates will retain a
service and letter of credit fee (where applicable) and a fee for providing the
demand repurchase feature, in an amount equal to the excess of the interest paid
on the instruments over the negotiated yield at which the participations were
purchased by the Fund. The total fees generally range from 5% to 15% of the
applicable prime rate or other interest rate index. With respect to insurance,
the Fund will attempt to have the issuer of the Participation Certificate bear
the cost of the insurance, although the Fund retains the option to purchase
insurance if necessary, in which case the cost of insurance will be an expense
of the Fund subject to the expense limitation. (See "Expense Limitation"
herein.) The Manager has been instructed by the Fund's Board of Directors to
continually monitor the pricing, quality and liquidity of the variable rate
demand instruments held by the Fund, including the Participation Certificates,
on the basis of published financial information and reports of the rating
agencies and other bank analytical services to which the Fund may subscribe.
Although these instruments may be sold by the Fund, the Fund intends to hold
them until maturity, except under the circumstances stated above. (See "Federal
Income Taxes" herein.)
In view of the potential "concentration" of the Fund in Participation
Certificates in California Municipal Obligations, which may be secured by bank
letters of credit or Guarantees, an investment in the Fund should be made with
an understanding of the characteristics of the banking industry and the risks
which such an investment may entail. Banks are subject to extensive governmental
regulations which may limit both the amounts and types of loans and other
financial commitments which may be made and interest rates and fees which may be
charged. The profitability of this industry is largely dependent upon the
availability and cost of capital funds for the purpose of financing lending
operations under prevailing money market conditions. Also, general economic
conditions play an important part in the operations of this industry and
exposure to credit losses arising from possible financial difficulties of
borrowers might affect a bank's ability to meet its obligations under a letter
of credit. The Fund may invest 25% or more of the net assets of any portfolio in
securities that are related in such a way that an economic, business or
political development or change affecting one of the securities would also
affect the other securities including, for example, securities the interest upon
which is paid from revenues of similar type projects, or securities the issuers
of which are located in the same state. The recent period has seen wide
fluctuations in interest rates, particularly "prime rates" charged by banks.
While the value of the underlying variable rate demand instruments may change
with changes in interest rates generally, the variable rate nature of the
underlying variable rate demand instruments should minimize changes in value of
the instruments. Accordingly, as interest rates decrease or increase, the
potential for capital appreciation and the risk of potential capital
depreciation is less than would be the case with a portfolio of fixed income
securities. The portfolio may contain variable rate demand instruments on which
stated minimum or maximum rates, or maximum rates set by state law, which limit
the degree to which interest on such variable rate demand instruments may
fluctuate; to the extent state law contains such limits, increases or decreases
in value may be somewhat greater than would be the case without such limits.
Additionally, the portfolio may contain variable rate demand Participation
Certificates in fixed rate Municipal Obligations. The fixed rate of interest on
these Municipal Obligations will be a ceiling on the variable rate of the
participation certificate. In the event that interest rates increased so that
the variable rate exceeded the fixed rate on the Municipal Obligations, the
Municipal Obligations could no longer be valued at par and may cause the Fund to
take corrective action, including the elimination of the instruments from the
portfolio. Because the adjustment of interest rates on the variable rate demand
instruments is made in relation to movements of the applicable banks' "prime
rates", or other interest rate adjustment index, the variable rate demand
instruments are not comparable to long-term fixed rate securities. Accordingly,
interest rates on the variable rate demand instruments may be higher or lower
than current market rates for fixed rate obligations of comparable quality with
similar maturities.
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Because of the variable rate nature of the instruments, the Fund's yield will
decline and its shareholders will forego the opportunity for capital
appreciation during periods when prevailing interest rates have declined. On the
other hand, during periods where prevailing interest rates have increased, the
Fund's yield will increase and its shareholders will have reduced risk of
capital depreciation.
For purposes of determining whether a variable rate demand instrument held by
the Fund matures within 397 days from the date of its acquisition, the maturity
of the instrument will be deemed to be the longer of (1) the period required
before the Fund is entitled to receive payment of the principal amount of the
instrument or (2) the period remaining until the instrument's next interest rate
adjustment. The maturity of a variable rate demand instrument will be determined
in the same manner for purposes of computing the Fund's dollar-weighted average
portfolio maturity. If a variable rate demand instrument ceases to be an
Eligible Security, it will be sold in the market or through exercise of the
repurchase Demand Feature to the issuer.
When-Issued Securities
New issues of certain Municipal Obligations frequently are offered on a
when-issued basis. The payment obligation and the interest rate that will be
received on these Municipal Obligations are each fixed at the time the buyer
enters into the commitment although delivery and payment of the Municipal
Obligations normally take place within 45 days after the date of the Fund's
commitment to purchase. Although the Fund will only make commitments to purchase
when-issued Municipal Obligations with the intention of actually acquiring them,
the Fund may sell these securities before the settlement date if deemed
advisable by the Manager.
Municipal Obligations purchased on a when-issued basis and the securities held
in the Fund's portfolio are subject to changes in value (both generally changing
in the same way, that is, both experiencing appreciation when interest rates
decline and depreciation when interest rates rise) based upon the public's
perception of the credit worthiness of the issuer and changes, real or
anticipated, in the level of interest rates. Purchasing Municipal Obligations on
a when-issued basis can involve a risk that the yields available in the market
when the delivery takes place may actually be higher or lower than those
obtained in the transaction itself. A separate account of the Fund consisting of
cash or liquid debt securities equal to the amount of the when-issued
commitments will be established at the Fund's custodian bank. For the purpose of
determining the adequacy of the securities in the account, the deposited
securities will be valued at market value. If the market or fair value of such
securities declines, additional cash or highly liquid securities will be placed
in the account daily so that the value of the account will equal the amount of
such commitments by the Fund. On the settlement date of the when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of securities held in the separate account, sale of other securities or,
although it would not normally expect to do so, from sale of the when-issued
securities themselves (which may have a value greater or lesser than the Fund's
payment obligations). Sale of securities to meet such obligations may result in
the realization of capital gains or losses, which are not exempt from Federal
income tax.
Stand-by Commitments
When the Fund purchases Municipal Obligations it may also acquire stand-by
commitments from banks and other financial institutions with respect to such
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 with same day settlement. A stand-by commitment is the
equivalent of a "put" option acquired by the Fund with respect to a particular
Municipal Obligation held in its portfolio.
The amount payable to the Fund upon its exercise of a stand-by commitment
normally would be (1) the acquisition cost of the Municipal Obligation
(excluding any accrued interest that the Fund paid on the acquisition), less any
amortized market premium or plus any amortized market or original issue discount
during the period the Fund owned the security, plus (2) all interest accrued on
the security since the last interest payment date during the period the security
was owned by the Fund. Absent unusual circumstances relating to a change in
market value, the Fund would value the underlying Municipal Obligation at
amortized cost. Accordingly, the amount payable by a bank or dealer during the
time a stand-by commitment is exercisable would be substantially the same as the
market value of the underlying Municipal Obligation.
The Fund's right to exercise a stand-by commitment would be unconditional and
unqualified. A stand-by commitment would not be transferable by the Fund,
although it could sell the underlying Municipal Obligation to a third party at
any time.
The Fund expects that stand-by commitments generally will be available without
the payment of any direct or indirect consideration. However, if necessary and
advisable, the Fund may pay for stand-by commitments either separately in cash
or by paying a higher price for portfolio securities which are acquired subject
to such a commitment (thus reducing the yield to maturity otherwise available
for the same securities). The total amount paid in either manner for outstanding
7
<PAGE>
stand-by commitments held in the Fund's portfolio would not exceed 1/2 of 1% of
the value of the Fund's total assets calculated immediately after each stand-by
commitment was acquired.
The Fund would enter into stand-by commitments only with banks and other
financial institutions that, in the Manager's opinion, present minimal credit
risks and, where the issuer of the Municipal Obligation does not meet the
eligibility criteria, only where the issuer of the stand-by commitment has
received a rating which meets the eligibility criteria or, if not rated,
presents a minimal risk of default as determined by the Board of Directors. The
Fund's reliance upon the credit of these banks and broker-dealers would be
supported by the value of the underlying Municipal Obligations held by the Fund
that were subject to the commitment.
The Fund intends to acquire stand-by commitments solely to facilitate portfolio
liquidity and does not intend to exercise its rights thereunder for trading
purposes. The purpose of this practice is to permit the Fund to be fully
invested in securities the interest on which is exempt from Federal income taxes
while preserving the necessary liquidity to purchase securities on a when-issued
basis, to meet unusually large redemptions and to purchase at a later date
securities other than those subject to the stand-by commitment.
The acquisition of a stand-by commitment would not affect the valuation or
assumed maturity of the underlying Municipal Obligations which will continue to
be valued in accordance with the amortized cost method. Stand-by commitments
acquired by the Fund would be valued at zero in determining net asset value. In
those cases in which the Fund paid directly or indirectly for a stand-by
commitment, its cost would be reflected as unrealized depreciation for the
period during which the commitment is held by the Fund. Stand-by commitments
would not affect the dollar-weighted average maturity of the Fund's portfolio.
The maturity of a security subject to a stand-by commitment is longer than the
stand-by repurchase date.
The stand-by commitments that the Fund may enter into are subject to certain
risks, which include the ability of the issuer of the commitment to pay for the
securities at the time the commitment is exercised, the fact that the commitment
is not marketable by the Fund, and that the maturity of the underlying security
will generally be different from that of the commitment.
In addition, the Fund may apply to the Internal Revenue Service for a ruling, or
seek from its counsel an opinion, that interest on Municipal Obligations subject
to stand-by commitments will be exempt from Federal income taxation. (See
"Federal Income Taxes" herein.) In the absence of a favorable tax ruling or
opinion of counsel, the Fund will not engage in the purchase of securities
subject to stand-by commitments.
TAXABLE SECURITIES
Although the Fund will attempt to invest 100% of its net assets in tax-exempt
Municipal Obligations, the Fund may invest up to 20% of the value of its total
assets in securities of the kind described below, the interest income on which
is subject to Federal income tax, under any one or more of the following
circumstances: (a) pending investment of proceeds of sales of Fund shares or of
portfolio securities, (b) pending settlement of purchases of portfolio
securities, (c) to maintain liquidity for the purpose of meeting anticipated
redemptions and (d) with regard to (5) below, if the Manager believes that such
investments are in the best interests of the investors in the Fund. In addition,
the Fund may temporarily invest more than 20% in such taxable securities when,
in the opinion of the Manager, it is advisable to do so because of adverse
market conditions affecting the market for Municipal Obligations. The kinds of
taxable securities in which the Fund may invest are limited to the following
short-term, fixed-income securities (maturing in 397 days or less from the time
of purchase): (1) obligations of the United States Government or its agencies,
instrumentalities or authorities; (2) commercial paper meeting the definition of
Eligible Securities at the time of acquisition; (3) certificates of deposit of
domestic banks with assets of $1 billion or more; (4) repurchase agreements with
respect to any Municipal Obligations or other securities which the Fund is
permitted to own; and (5) Municipal Obligations, the interest income on which
may be subject to the Federal alternative minimum tax. (See "Federal Income
Taxes" herein.)
Repurchase Agreements
The Fund may invest in instruments subject to repurchase agreements with
securities dealers or member banks of the Federal Reserve System. Under the
terms of a typical repurchase agreement, the Fund would acquire an underlying
debt instrument for a relatively short period (usually not more than one week)
subject to an obligation of the seller to repurchase and the Fund to resell the
instrument at a fixed price and time, thereby determining the yield during the
Fund's holding period. This results in a fixed rate of return insulated from
market fluctuations during such period. A repurchase agreement is subject to the
risk that the seller may fail to repurchase the security. Repurchase agreements
may be deemed to be loans under the 1940 Act. All repurchase agreements entered
into by the Fund shall be fully collateralized at all times during the period of
the agreement in that the value of the underlying security shall be at least
equal to the amount of the loan, including the accrued interest thereon, and the
Fund or its custodian shall have possession of the collateral, which the Fund's
Board believes will give it a valid, perfected security interest in the
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<PAGE>
collateral. In the event of default by the seller under a repurchase agreement
construed to be a collateralized loan, the underlying securities are not owned
by the Fund but only constitute collateral for the seller's obligation to pay
the repurchase price. Therefore, the Fund may suffer time delays and incur costs
in connection with the disposition of the collateral. The Fund's Board believes
that the collateral underlying repurchase agreements may be more susceptible to
claims of the seller's creditors than would be the case with securities owned by
the Fund. It is expected that repurchase agreements will give rise to income
which will not qualify as tax-exempt income when distributed by the Fund. The
Fund will not invest in a repurchase agreement maturing in more than seven days
if any such investment together with illiquid securities held by the Fund exceed
10% of the Fund's net assets. (See Investment Restriction Number 6 herein.)
Repurchase agreements are subject to the same risks described herein for
stand-by commitments.
CALIFORNIA RISK FACTORS
Certain of the California Municipal Obligations in the Fund may be bonds or
other types of obligations which rely in whole or in part, directly or
indirectly, on ad valorem real property taxes as a source of revenue. Over the
past several years, California voters have approved amendments to the California
Constitution which establish certain limitations on the powers of municipalities
to impose and collect ad valorem taxes on real property which, in turn, restrict
the ability of municipalities to service their debt or lease obligations from
such taxes.
Article XIII A of the State Constitution
Section 1(a) of Article XIII A of the State Constitution limits the maximum ad
valorem tax on real property to 1% of full cash value (as defined in Section 2
of Article XIII A), to be collected by the counties and apportioned according to
law. Section 1(b) of Article XIII A provides that the 1% limitation does not
apply to ad valorem taxes to pay interest or redemption charges on (1)
indebtedness approved by the voters prior to December 1, 1978 or (2) any bonded
indebtedness for the acquisition or improvement of real property approved on or
after December 1, 1978, by two-thirds of the votes cast by the voters voting on
the indebtedness. Section 2 of Article XIII A defines "full cash value" to mean
"the country assessor's valuation of real property as shown on the 1975/76 tax
bill under full cash value or, thereafter, the appraised value of real property
when purchased, newly constructed, or a change in ownership has occurred after
the 1975 assessment." The full cash value may be adjusted annually to reflect
inflation at a rate not to exceed 2% per year, or to reflect a reduction in the
consumer price index or comparable data for the area under taxing jurisdiction
or reduced in the event of declining property value caused by substantial
damage, destruction or other factors. Legislation enacted by the State
Legislature to implement Article XIII A provides that notwithstanding any other
law, local agencies may not levy any ad valorem property tax except to pay debt
service in indebtedness approved by the voters as described above.
The voters of the State subsequently approved various measures which further
amended Article XIII A. One such amendment generally provides that the purchase
or transfer of (i) real property between spouses or (ii) the principal residence
and the first $1,000,000 of the full cash value of other real property between
parents and children, do not constitute a "purchase" or "change of ownership"
triggering reassessment under Article XIII A. This amendment could serve to
reduce the property tax revenues of California counties. Other amendments
permitted the State Legislature to allow persons over 55 or "severely disabled
homeowners" who sell their residence and buy or build another of equal or lesser
value within two years in the same county, to transfer the old residence's
assessed value to the new residence.
In the November 1990 election, the voters approved the amendment of Article XIII
A to permit the State Legislature to exclude from the definition of "new
construction" seismic retrofitting improvements or improvements utilizing
earthquake hazard mitigation technologies constructed or installed in existing
buildings after November 6, 1990.
Article XIII A has also been amended to permit reduction of the "full cash
value" base in the event of declining property values caused by damage,
destruction or other factors and provided that there would be no increase in the
"full cash value" base in the event or reconstruction of property damaged or
destroyed in a disaster.
Article XIII B of the State Constitution
Article XIII B of the State Constitution limits the annual appropriations of the
State and any city, county, school district, authority or other political
subdivision of the State to the level of appropriations for the prior fiscal
year, as adjusted for changes in the cost of living, population and services for
which the fiscal responsibility is shifted to or from the governmental entity.
The "base year" for establishing this appropriation limit is fiscal year
1978/79, and the limit is adjusted annually to reflect changes in population,
consumer prices and certain increases or decreases in the cost of services
provided by these public agencies.
Appropriations of an entity of local government subject to Article XIII B
include generally authorizations to expend during a fiscal year the proceeds of
taxes levied by or for the entity and the proceeds of State subventions,
exclusive of certain State subventions, refunds of taxes, and benefit payments
from retirement, unemployment insurance and
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disability insurance funds. "Proceeds of taxes" include, but are not limited to,
all tax revenues, most State subventions and the proceeds to the local
government entity from (i) regulatory licenses, user charges, and user fees to
the extent that such proceeds exceed the cost reasonably borne by such entity
and (ii) the investment of tax revenues. Article XIII B provides that if a
governmental entity's revenues in any year exceed the amounts permitted to be
spent, the excess must be returned by revising tax rates or fee schedules over
the subsequent two years.
Article XIII B does not limit the appropriation of moneys to pay debt service on
indebtedness existing or authorized as of June 1, 1979, or for bonded
indebtedness approved thereafter by a vote of the electors of the issuing entity
at an election held for that purpose. Furthermore, in 1990, Article XIII B was
amended to exclude from the appropriations limit "all qualified capital outlay
projects, as defined by the Legislature" from proceeds of taxes. The Legislature
has defined "qualified capital outlay project" to mean a fixed asset (including
land and construction) with a useful life of 10 or more years and a value which
equals or exceeds $100,000.
Articles XIIIC and XIIID of the State Constitution
On November 5, 1996, the voters of the State approved an initiative known
variously as the "Right to Vote on Taxes Act" and "Proposition 218" (hereafter,
"Proposition 218"). This initiative became effective on November 6, 1996 as to
certain matters and will become effective on July 1, 1997 as to others.
Proposition 218 added Articles XIIIC and XIIID to the State Constitution, which,
taken together, will affect the ability of California public agencies to levy or
continue to collect general and special taxes, special assessments and
"property-related fees and charges," as described below. These provisions could
materially adversely affect the financial condition of the California public
agencies. In particular, Proposition 218 potentially reduces the ability of such
public agencies to increase their revenues through taxes, assessments and fees,
which could have an adverse impact, in turn, on the ability of their General
Fund to support their payment obligations.
Under Article XIIIC, all new local taxes must be submitted to the registered
voters within the levying public agency before they may become effective.
"General taxes," being taxes imposed for general governmental purposes of an
agency, require a simple majority vote; "special taxes," being those imposed for
a specified purpose, require a two-thirds vote. Proposition 218 also contains a
retroactive provision which prohibits the continuation of any general tax
levied, extended or increased by a public agency following December 31, 1994,
unless approved by a majority vote at an election conducted within two years
following the initiative's effective date of November 6, 1996. Accordingly,
Proposition 218 will likely exert a downward pressure on the ability of
California public agencies to impose taxes and to collect other forms of
revenues, including assessments and property-related fees and charges.
To the extent that Proposition 218's long-term effects include the elimination
of alternative revenue sources or the repeal of taxes, assessments, fees or
charges through taxpayer initiatives, California public agencies may be required
to curtail municipal services or to use moneys to replace such lost revenues. It
is not possible to predict at present the precise financial impact of
Proposition 218 on California public agencies in this regard. A substantial
erosion of other revenue sources over time could have a material adverse effect
upon the ability of California public agencies to meet their financial
obligations. Proposition 218, however, has no effect upon the ability of those
California public agencies authorized to pursue voter approval of a general
obligation bond issue or a Mello-Roos Community Facilities District bond issue
in the future, both of which are already subject to a 2/3 vote, although certain
procedures and burdens of proof may be altered slightly. It is not possible to
predict the nature of any future challenges to Proposition 218 or the extent to
which, if any, Proposition 218 may be held to be unconstitutional. The
interpretation and application of Proposition 218 will ultimately be determined
by the courts with respect to a number of the matters discussed above, and it is
not possible at this time to predict with certainty the outcome of such
determination.
Article XIIID governs the authorization for special assessments made by public
agencies to pay for municipal services, including street lighting and park and
playground maintenance. The Article defines "assessments" as any levy or charge
upon real property for a special benefit to be conferred on that real property.
Under Article XIIID, unless (a) a registered voter election had been held prior
to November 6, 1996, or (b) an election is conducted prior to July 1, 1997
according to the procedures set forth in Proposition 218, existing annual
maintenance assessments (but not assessments supporting debt service on bonds
issued prior to November 6, 1996) will expire. Following Proposition 218,
California public agencies may be far less likely to initiate proceedings for
the formation of new assessment districts in the future. Formation proceedings
are made more difficult, more time-consuming and more expensive by Article
XIIID.
The new Article XIIID also places restrictions on the imposition and collection
of "fees" and "charges," being "any levy other than an ad valorem tax, a special
tax or an assessment, imposed upon a parcel or upon a person as an incident of
property ownership, constituting a user fee or charge for a property related
service." Fees and charges in this category (hereafter, "Fees and Charges") may,
if they do not otherwise violate the provisions of Proposition 218 set forth in
clauses (a) through (e) below, continue to be collected by public agencies until
action is taken to increase them; increases are treated as new Fees and Charges
under Proposition 218. The Article also specifically excludes from its
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scope fees and charges for the provision of electric or gas service, whether or
not "property-related." Article XIIID requires that all Fees and Charges,
whether preexisting, newly imposed or increased, conform to its provisions. It
prohibits the imposition of Fees and Charges that (a) generate revenues
exceeding actual amounts required to provide the stated service; (b) are
diverted from supporting the service for which they are imposed to another
purpose of the agency; (c) with respect to any parcel or person, exceed the
proportional costs of the service attributable to that parcel; (d) are imposed
for a service not actually used by, or immediately available to, the owner of
the parcel being charged; or (e) are used to support general governmental
services, such as police, fire or library services, where substantially the same
service is available to the public at large without surcharge. No Fee or Charge
may be imposed or increased by a local agency unless, first, written notice is
given to the owner of record of each parcel that would be affected by the Fee or
Charge, second, the agency conducts a public hearing upon the proposed
imposition or increase; and, last, written protests against the imposition of
the Fee or Charge received by the agency do not represent a majority of the
owners of affected parcels. Thereafter, Fees and Charges fall into two
subcategories: (1) those for water, sewer and refuse collection services may be
imposed in accordance with the above restrictions by action of the governing
body of the public agency; and (2) all others may be imposed only upon, at the
option of the public agency, (A) a majority approval of the property owners
subject to the Fees and Charges; or (B) a 2/3 vote of the general electorate
residing in the affected area.
Article XIIIC also specifically grants initiative powers to taxpayers with
respect to taxes, assessments and fees and charges. Voters within any public
agency could, following the imposition or increase of any type of levy, even one
confirmed by a majority of 2/3 vote, commence proceedings to repeal, reduce or
prohibit the future imposition or increase of such levy by the public agency.
Under the various provisions of Proposition 218, it is unclear whether the terms
"assessment, "fee" and "charge" are intended to have the same meanings in
Article XIIIC as they are ascribed in Article XIIID. If the Article XIIID
definitions are not held to apply to Article XIIIC, the initiative power could
potentially apply to revenue sources which currently constitute a substantial
portion of an agency's general fund revenues.
Court Challenges to Article XIII A
The United States Supreme Court recently struck down as a violation of equal
protection certain property tax assessment practices in West Virginia, which had
resulted in vastly different assessments of similar properties. Since Article
XIII A provides that property may only be reassessed up to 2% per year, except
upon change of ownership or new construction, recent purchasers may pay
substantially higher property taxes than long-time owners of comparable property
in a community. The Supreme Court in the West Virginia case expressly declined
to comment in any way on the constitutionality of Article XIII A.
Based on this United States Supreme Court decision, however, property owners in
California brought three suits challenging the acquisition value assessment
provisions to Article XIII A. The State Courts of Appeal upheld Article XIII A
in two cases in December 1990 and in the third case in April 1991. On February
28, 1991, the California Supreme Court declined to hear the appeals of the two
cases decided in December 1990. The United States Supreme Court agreed on June
3, 1991 to hear the appeal of the case, R.H. Macy & Co., Inc. v. Contra Costa
County, California. R.H. Macy & Co. subsequently determined to withdraw its
petition for review. In February 1992, the United States Supreme Court heard the
second case, Nordlinger v. Hahn. On June 18, 1992, the United States Supreme
Court affirmed the State Court of Appeals decision in Nordlinger and upheld the
constitutionality of Article XIII A.
Statutory Spending Limitations
Proposition 62 was adopted by the voters at the November 4, 1986, general
election and (a) requires that any new or higher taxes for general governmental
purposes imposed by local governmental entities be approved by a two-thirds vote
of the governmental entity's legislative body and by a majority vote of the
voters of the governmental entity voting in an election on the tax, (b) requires
that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local government entity be approved by a
two-thirds vote of the voters of the governmental entity voting in an election
on the tax, (c) restricts the use of revenues from a special tax to the purposes
or for the services for which the special tax was imposed, (d) prohibits the
imposition of ad valorem taxes on real property by local governmental entities
except as permitted by Article XIIIA of the California Constitution, (d)
prohibits the imposition of transaction taxes and sales taxes on the sale of
real property by local governmental entities, and (f) requires that any tax
imposed by a local governmental entity on or after August 1, 1985, be ratified
by a majority vote of the voters voting in an election on the tax within two
years of the adoption of the initiative or be terminated by November 15, 1988.
On September 28, 1995, the California Supreme Court affirmed the lower court
decision in Santa Clara County Local Transportation Authority v. Guardino (the
"Santa Clara Case"). The action held invalid a half-cent sales tax to be levied
by the Santa Clara County Local Transportation Authority because it was approved
by a majority but not two-thirds of the voters in Santa Clara County voting on
the tax. The California Supreme Court decided the tax was invalid under
Proposition 62, a statutory initiative adopted at the November 4, 1986 election
that (a) requires that any new or higher taxes for general governmental purposes
imposed by local governmental entities be approved by a majority vote of the
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voters of the governmental entity voting in an election on the tax, (b) requires
that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters of the governmental entity voting in an election
on the tax, (c) restricts the use of revenues from a special tax to the purposes
or for the service for which the special tax was imposed, (d) prohibits the
imposition of ad valorem taxes on real property by local governmental entities
except as permitted by Article XIIIA of the California Constitution, (e)
prohibits the imposition of transaction taxes and sales taxes on the sale of
real property by local governmental entities, (f) required that any tax imposed
by a local governmental entity on or after August 1, 1985 be ratified by a
majority vote of the voters voting in an election on the tax within two years of
November 5, 1986 or be terminated by November 15, 1988 and (g) requires a
reduction of ad valorem property taxes allocable to the jurisdiction imposing a
tax not in compliance with its provisions equal to one dollar for each dollar of
revenue attributable to the invalid tax, for each year that the tax is
collected.
In deciding the Santa Clara case on Proposition 62 grounds, the Court
disapproved the decision in City of Woodlake v. Logan ("Woodlake"), where the
Court of Appeal had held portions of Proposition 62 unconstitutional as a
referendum on taxes prohibited by the California Constitution. The California
Supreme Court determined that the voter approval requirement of Proposition 62
is a condition precedent to the enactment of each tax statute to which it
applies, while referendum refers to a process invoked only after a statute has
been enacted. Numerous taxes to which Proposition 62 would apply were imposed or
increased without any voter approval in reliance on Woodlake. The Court noted as
apparently distinguishable, but did not confirm, the decision in City of
Westminster v. County of Orange, that held unconstitutional the section of
Proposition 62 requiring voter approval of taxes imposed during the "window
period" of August 1, 1985 until November 5, 1986. Proposition 62 as an
initiative statute does not have the same level of authority as a constitutional
initiative, but is akin to legislation adopted by the State Legislature.
Unitary Property
AB 454 (Chapter 921, Statutes of 1987), amending Section 98.9 of the California
Revenue and Taxation Code, provides that revenues derived from most utility
property (e.g., pipelines in more than one county, regulated railways, and
telephone, electric and gas utility companies) assessed by the State Board of
Equalization (referred to in the statute as "Unitary Property"), is based on a
uniform rate within each county and allocated as follows: (1) each jurisdiction
will receive up to 102 percent of its prior year State-assessed revenues; and
(2) if county-wide revenues generated from Unitary Property are less than the
previous year's revenues or greater than 102% of the previous year's revenues,
each jurisdiction will share the burden of the shortfall or excess revenues by a
specified formula. This provision applies to all Unitary Property except
railroads, whose valuation will continue to be allocated to individual tax rate
areas.
The provisions of AB 454 do not constitute an elimination of the assessment of
any State-assessed properties nor a revision of the methods of assessing
utilities by the State Board of Equalization. Generally, AB 454 allows valuation
growth or decline of Unitary Property to be shared by all jurisdictions in a
county.
Changes in Law
In addition, there can be no assurance that the California electorate will not
at some future time adopt additional initiatives or that the Legislature will
not enact legislation that will amend the laws or the Constitution of the State
of California.
1995-96 Budget
The following are the principal features of the 1995-96 Budget Act:
1. Proposition 98 funding for schools and community colleges was originally
budgeted to increase by about $1.0 billion (General Fund) and $1.2 billion total
above revised 1994-95 levels. Because of higher than projected revenues in
1994-95, an additional $543 million ($91 per K-12 ADA) was appropriated to the
1994-95 Proposition 98 entitlement. A large part of this is a block grant of
about $54 per pupil for any one time purpose. For the first time in several
years, a full 2.7% cost of living allowance was funded. The budget compromise
anticipated the settlement date of the CTA v. Gould litigation which challenged
the validity of certain off-budget loans
In anticipation of the settlement of such litigation, the 1995-96 Governors'
Budget indicated that, with revenues even higher that projected, Proposition 98
apportionments will exceed the amounts originally budgeted, reaching a level of
$4,500 per ADA.
2. Cuts in health and welfare costs totaling about $0.9 billion. Some of these
cuts (totaling about $500 million) required federal legislative or
administrative approval, which were still pending as of February, 1996.
3. A 3.5% increase in funding for the University of California ($90 million
General Fund) and the California State University systems ($24 million General
Fund), with no increases in student fees.
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4. The 1995-96 Governor's Budget, as updated by the 1996-97 Governor's Budget
dated January 10, 1996, assumed receipt of $494 million in new federal aid for
incarceration and health costs of illegal immigrants, above commitments
already made by the federal government.
5. General Fund support for the Department of Corrections was increased by about
8% over the prior year, reflecting estimates of increased prison population, but
funding is less than proposed in the 1995 Governor's Budget.
The 1996-97 Budget
The following were the principal features of the 1996-1997 Budget Act:
1. Proposition 98 funding for schools and community college districts increased
by almost $1.6 billion (General Fund) and $1.65 billion total above revised
1995-96 level periods. Almost half of this money was budgeted to fund class-size
reduction in kindergarten and grades 1-3.
2. Proposed cuts in health an welfare totaling $660 million. All of these cuts
required federal law changes (including welfare reform), federal waivers, or
federal budget appropriations in order to be achieved. The 1996-97 Budget Act
assumes approval/action by October, 1996, with the savings to be achieved
beginning in November, 1996. The 1996-97 Budget Act was based on continuation of
previously approved assistance levels for Aid to Families with Dependent
Children and other health and welfare programs, which had been reduced in prior
years, including suspension of State authorized cost of living increases.
3. A 4.9 percent increase in funding for the University of California ($130
million General Fund) and the California State University system ($101 General
Fund), with no increases in student fees, maintaining the second year of the
Governor's four-year "Compact" with the State's higher education units.
4. General Fund support for the Department of Corrections was increased by about
7 percent over the prior year, reflecting estimates of increased prison
population.
5. With respect to aid local governments, the principal new programs included in
the 1996-97 Budget Act are $100 million in grants to cities and counties for law
enforcement purposes, and budgeted $50 million for competitive grants to local
governments for programs to combat juvenile crime.
The 1996-97 Budget Act did not contain any tax increases. As noted, there was a
reduction in corporate taxes. In addition, the Legislature approved for another
one-year suspension of the Renters Tax Credit, saving $520 million in
expenditures.
State of California Financial Condition
The 1997-98 Budget
On January 9, 1997, Governor Wilson announced his proposed 1997-98 State budget
detailing plans to cut welfare, increase education spending and provide certain
tax cuts to businesses and banks. The total spending plan in the amount of
approximately $66.6 billion represents an increase of approximately 4% from the
1996-97 State Budget, with an increase in the State's General Fund to
approximately $50.3 billion.
The Governor announced a proposal to restructure the State's welfare system,
placing strict time limits on the provision of assistance and introducing
penalties, and included a plan to increase spending for elementary and secondary
schools.
On August 11, 1997, the State Legislature approved a 1997-98 State Budget of
approximately $68 billion which included approximately $32 billion for public
schools, an increase of approximately $4 billion over the prior year. The Budget
also included approximately $100 million for local law enforcement and
approximately $75 million in spending to subsidize hospitals that care for large
numbers of uninsured patients, as well as approximately $40 million for legal
immigrants and an increase of approximately $223 million in welfare spending,
including job training. The education portion of the State Budget approved by
the Legislature of 1997-98 included approximately $850 million to expand the
class-size reduction program and full statutory funding of the Revenue Limit
COLA comprising a 2.65% COLA, consistent with the May Revision. Revenue Limit
Equalization is as funded in the amount of approximately $261 million for the
school district revenue limit equalization for 1996-97.
The final State Budget was signed by the Governor on August 18, 1997 after using
his line-item veto authority to veto, with reservation until an acceptable
school testing bill is passed, a significant amount of education funding from
the State Budget approved by the Legislature. Vetoes which would be restored if
a testing bill acceptable to the Governor is passed include approximately
$955,000 in Department of Education spending, and approximately $900 million in
local assistance. Vetoes not relating to the testing issue, but which need
legislation in order to restore the vetoed funds, included more than $20 million
in Department of Education spending. The final State Budget also provided
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approximately $377 million for child care programs administered by the
Department of Education and the Department of Social Services, approximately
$160 million for welfare-to-work programs, approximately $25 million in adult
education funding and approximately $50 million to California community
colleges, approximately $100 million to cities and counties to enhance local law
enforcement, approximately $55 million in federal funds to local governments for
the construction of detention facilities and approximately $1.2 billion in
deferred general fun contributions to the Public Employees Retirement System.
The final State Budget did not include the Governor's proposed 10% tax cut for
bank and corporations.
Proposed 1998-99 Budget. In 1997, California experienced employment growth
exceeding 3 percent-approximately 400,000 new jobs-and income rose by more than
7 percent. The State's unemployment rate fell during 1997 to a low of 5.8
percent in November. In fiscal year 1996-97, the State's General Fund
collections grew by over 6 percent to reach $49.2 billion, and revenue for the
1997-98 and 1998-99 fiscal years is expected to reach $52.9 billion and $55.4
billion respectively. This represents an annual growth of $3.7 billion (7.5
percent) for 1997-98 and $2.5 billion (4.7 percent) for 1998-99.
The 1998-99 Governor's Budget provides $50 million in General Fund and $200
million in a proposed bond issue to capitalize the Infrastructure and
Development Bank, which will provide capital to local governments to help
businesses locate and expand in California, and $3 million for the small
business loan guarantee program. The Budget also includes an Early Childhood
Development Initiative, which is designed to improve the health and development
of children from birth to age three and provides additional funds for anti-gang
programs and for the apprehension of sexual predators. The Budget proposes an
approximately $7 billion investment plan to maintain and build the State's
system of schools, water supply, prisons, natural resources, and other
infrastructure.
In addition, the Budget includes approximately $40 billion to be devoted to
California's 999 school districts and 58 county offices of education, resulting
on estimated total per-pupil expenditures from all sources of $6,6,20 in fiscal
year 1997-98 and $6,749 in 1998-99. Projected state revenues will contribute to
a 7 percent increase in Proposition 98 General Fund support for K-12 education
in 1998-99. This level of resources results in K-12 Proposition 98 per-pupil
expenditures of $5,636 in 1998-99, up from $5,114 in 1996-97 and $5,414 in
1997-98. In addition, approximately $350 million has been allocated to lengthen
the school year to 180 days while maintaining sufficient funds for staff
development days. The State Budget includes a 2.22% COLA for revenue limit,
special education, and child development in an amount of $657.4 million which
includes school district and county office education apportionments ($470.6
million), summer school ($4.0 million), special education ($57.8 million), child
development ($14.6 million), class size reduction ($33.6 million), and
categorical program COLA and growth ($73.7 million); enrollment growth funding
of $564.5 million; class size reduction funding in the amount of $547 billion
for all pupils in grades K-3 at $818 per pupil; and approximately $2 billion in
state bonds for the 1998 election and $2.0 billion for each two years thereafter
in 2000, 2002 and 2004 and an additional $135 million for deferred maintenance
to be matched locally.
Future Budgets. It cannot be predicted what actions will be taken in the future
by the State Legislature and the Governor to deal with changing State of
California revenues and expenditures. The California state budget will also be
affected by national and state economic conditions and other factors which
cannot be predicted.
California's General Obligation Bonds are currently rated "A" by S&P, "A-1" by
Moody's and "A" by Fitch.
There can be no assurance that general economic difficulties or the financial
circumstances of California or its towns, cities and special districts will not
adversely affect the market volume or rating of the California Municipal
Obligations or the ability of the obligors to pay debt service on the California
Municipal Obligations.
INVESTMENT RESTRICTIONS
The Fund has adopted the following fundamental investment restrictions which
apply to all portfolios and which may not be changed unless approved by a
majority of the outstanding shares of each series of the Fund's shares that
would be affected by such a change. The Fund may not:
1. Make portfolio investments other than as described under "Investment
Objectives, Policies and Risks" or any other form of Federal tax-exempt
investment which meets the Fund's high quality criteria, as determined by the
Board of Directors and which is consistent with the Fund's objectives and
policies.
2. Borrow Money. This restriction shall not apply to borrowings from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests that might otherwise require the untimely disposition of
securities, in an amount up to 15% of the value of the Fund's total assets
(including the amount borrowed) valued at market less liabilities (not including
the amount borrowed) at the time the borrowing was made. While borrowings exceed
5% of the value of the Fund's total assets, the Fund will not make any
investments. Interest paid on borrowings will reduce net income.
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3. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in an
amount up to 15% of the value of its total assets and only to secure borrowings
for temporary or emergency purposes.
4. Sell securities short or purchase securities on margin, or engage in the
purchase and sale of put, call, straddle or spread options or in writing such
options, except to the extent that securities subject to a demand obligation and
stand-by commitments may be purchased as set forth under "Investment Objectives,
Policies and Risks" herein.
5. Underwrite the securities of other issuers, except insofar as the Fund may be
deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
6. Purchase securities subject to restrictions on disposition under the
Securities Act of 1933 ("restricted securities"), except the Fund may purchase
variable rate demand instruments which contain a Demand Feature. The Fund will
not invest in a repurchase agreement maturing in more than seven days if any
such investment together with securities that are not readily marketable held by
the Fund exceed 10% of the Fund's net assets.
7. Purchase or sell real estate, real estate investment trust securities,
commodities or commodity contracts, or oil and gas interests, but this shall not
prevent the Fund from investing in Municipal Obligations secured by real estate
or interests in real estate.
8. Make loans to others, except through the purchase of portfolio investments,
including repurchase agreements, as described under "Investment Objectives,
Policies and Risks" herein.
9. Purchase more than 10% of all outstanding voting securities of any one issuer
or invest in companies for the purpose of exercising control.
10. Invest more than 25% of its assets in the securities of "issuers" in any
single industry, provided that the Fund may invest more than 25% of its assets
in bank Participation Certificates and there shall be no limitation on the
purchase of those Municipal Obligations and other obligations issued or
guaranteed by the United States Government, its agencies or instrumentalities.
When the assets and revenues of an agency, authority, instrumentality or other
political subdivision are separate from those of the government creating the
issuing entity and a security is backed only by the assets and revenues of the
entity, the entity would be deemed to be the sole issuer of the security.
Similarly, in the case of an industrial revenue bond, if that bond is backed
only by the assets and revenues of the non-governmental user, then such
non-governmental user would be deemed to be the sole issuer. If, however, in
either case, the creating government or some other entity, such as an insurance
company or other corporate obligor, guarantees a security or a bank issues a
letter of credit, such a Guarantee or letter of credit would be considered a
separate security and would be treated as an issue of such government, other
entity or bank. Immediately after the acquisition of any securities subject to a
Demand Feature or Guarantee (as such terms are defined in Rule 2a-7 under the
Investment Company Act of 1940), with respect to 75% of the total assets of the
Fund, not more than 10% of the Fund's assets may be invested in securities that
are subject to a Guarantee or Demand Feature from the same institution. However,
the Fund may only invest more than 10% of its assets in securities subject to a
Guarantee or Demand Feature issued by a non-controlled person.
11. Invest in securities of other investment companies, except the Fund may
purchase unit investment trust securities where such unit trusts meet the
investment objectives of the Fund and then only up to 5% of the Fund's net
assets, except as they may be acquired as part of a merger, consolidation or
acquisition of assets.
12. Issue senior securities, except insofar as the Fund may be deemed to have
issued a senior security in connection with any permitted borrowing.
If a percentage restriction is adhered to at the time of an investment, a later
increase or decrease in percentage resulting from a change in values of
portfolio securities or in the amount of the Fund's assets will not constitute a
violation of such restriction.
PORTFOLIO TRANSACTIONS
The Fund's purchases and sales of portfolio securities usually are principal
transactions. Portfolio securities are normally purchased directly from the
issuer, from banks and financial institutions or from an underwriter or market
maker for the securities. There usually are no brokerage commissions paid for
such purchases. The Fund has paid no brokerage commissions since its formation.
Any transaction for which the Fund pays a brokerage commission will be effected
at the best price and execution available. Purchases from underwriters of
portfolio securities include a commission or concession paid by the issuer to
the underwriter, and purchases from dealers serving as market makers include the
spread between the bid and asked price. The Fund purchases Participation
Certificates in variable rate Municipal Obligations with a Demand Feature from
banks or other financial institutions at a negotiated yield to the Fund based on
the applicable interest rate adjustment index for the security. The interest
received by the Fund is net of a fee
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charged by the issuing institution for servicing the underlying obligation and
issuing the participation certificate, letter of credit, Guarantee or insurance
and providing the demand repurchase feature.
Allocation of transactions, including their frequency, to various dealers is
determined by the Manager in its best judgment and in a manner deemed in the
best interest of shareholders of the Fund rather than by any formula. The
primary consideration is prompt execution of orders in an effective manner at
the most favorable price. No preference in purchasing portfolio securities will
be given to banks or dealers that are Participating Organizations.
Investment decisions for the Fund will be made independently from those for any
other investment companies or accounts that may be or become managed by the
Manager or its affiliates. If, however, the Fund and other investment companies
or accounts managed by the Manager are simultaneously engaged in the purchase or
sale of the same security, the transactions may be averaged as to price and
allocated equitably to each account. In some cases, this policy might adversely
affect the price paid or received by the Fund or the size of the position
obtainable for the Fund. In addition, when purchases or sales of the same
security for the Fund and for other investment companies managed by the Manager
occur contemporaneously, the purchase or sale orders may be aggregated in order
to obtain any price advantage available to large denomination purchasers or
sellers.
No portfolio transactions are executed with the Manager or its affiliates acting
as principal. In addition, the Fund will not buy bankers' acceptances,
certificates of deposit or commercial paper from the Manager or its affiliates.
HOW TO PURCHASE AND REDEEM SHARES
The material relating to the purchase and redemption of shares in the Prospectus
is herein incorporated by reference.
NET ASSET VALUE
The Fund does not determine net asset value per share on the following holidays:
New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas.
The net asset value of the Fund's shares is determined as of 12 noon, New York
City time, on each Fund Business Day. It is computed by dividing the value of
the Fund's net assets (i.e., the value of its securities and other assets less
its liabilities, including expenses payable or accrued but excluding capital
stock and surplus) by the total number of shares outstanding.
The Fund's portfolio securities are valued at their amortized cost in compliance
with the provisions of Rule 2a-7 under the 1940 Act. Amortized cost valuation
involves valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, except that if fluctuating
interest rates cause the market value of the Fund's portfolio to deviate more
than 1/2 of 1% from the value determined on the basis of amortized cost, the
Board of Directors will consider whether any action should be initiated, as
described in the following paragraph. Although the amortized cost method
provides certainty in valuation, it may result in periods during which the value
of an instrument is higher or lower than the price an investment company would
receive if the instrument were sold.
The Fund's Board of Directors has established procedures to stabilize the Fund's
net asset value at $1.00 per share of each Class. These procedures include a
review of the extent of any deviation of net asset value per share, based on
available market rates, from the Fund's $1.00 amortized cost per share of each
Class. Should that deviation exceed 1/2 of 1%, the Board will consider whether
any action should be initiated to eliminate or reduce material dilution or other
unfair results to shareholders. Such action may include redemption of shares in
kind, selling portfolio securities prior to maturity, reducing or withholding
dividends and utilizing a net asset value per share as determined by using
available market quotations. The Fund will maintain a dollar-weighted average
portfolio maturity of 90 days or less, will not purchase any instrument with a
remaining maturity greater than 397 days, will limit portfolio investments,
including repurchase agreements, to those United States dollar-denominated
instruments that the Fund's Board of Directors determines present minimal credit
risks, and will comply with certain reporting and record keeping procedures. The
Fund has also established procedures to ensure compliance with the requirement
that portfolio securities are Eligible Securities. (See "Investment Objectives,
Policies and Risks" herein.)
YIELD QUOTATIONS
The Fund calculates a seven-day yield quotation using a standard method
prescribed by the rules of the SEC. Under that method, the Fund's yield figure,
which is based on a chosen seven-day period, is computed as follows: the Fund's
return for the seven-day period (which is obtained by dividing the net change in
the value of a hypothetical account having a balance of one share at the
beginning of the period by the value of such account at the beginning of the
period (expected to always be $1.00) is multiplied by (365/7) with the resulting
annualized figure carried to the nearest hundredth of one percent). For purposes
of the foregoing computation, the determination of the net change in account
value during the seven-day period reflects (i) dividends declared on the
original share and on any additional shares, including the value of any
additional shares purchased with dividends paid on the original share and (ii)
fees charged to
16
<PAGE>
all shareholder accounts. Realized capital gains or losses and unrealized
appreciation or depreciation of the Fund's portfolio securities are not included
in the computation. Therefore annualized yields may be different from effective
yields quoted for the same period.
The Fund's "effective yield" for each Class is obtained by adjusting its
"current yield" to give effect to the compounding nature of the Fund's
portfolio, as follows: the unannualized base period return is compounded and
brought out to the nearest one hundredth of one percent by adding one to the
base period return, raising the sum to a power equal to 365 divided by 7, and
subtracting one from the result, i.e., effective yield = (base period return +
1)365/7 - 1.
Although published yield information is useful to investors in reviewing the
Fund's performance, investors should be aware that the Fund's yield fluctuates
from day to day. The Fund's yield for any given period is not an indication, or
representation by the Fund, of future yields or rates of return on the Fund's
shares, and may not provide a basis for comparison with bank deposits or other
investments that pay a fixed yield for a stated period of time. Investors who
purchase the Fund's shares directly may realize a higher yield than Participant
Investors because they will not be subject to any fees or charges that may be
imposed by Participating Organizations.
The Fund may from time to time advertise its tax equivalent yield. The tax
equivalent yield for each Class is computed based upon a 30-day (or one month)
period ended on the date of the most recent balance sheet included in this
Statement of Additional Information, computed by dividing that portion of the
yield of the Fund (as computed pursuant to the formulae previously discussed)
which is tax-exempt by one minus a stated income tax rate and Fund may also
fluctuate daily and does not provide a basis for determining future yields.
adding the product to that portion, if any, of the yield of the Fund that is not
tax-exempt. The tax equivalent yield for the Fund may also fluctuate daily and
does not provide a basis for determining future yields.
The Fund may from time to time advertise a taxable equivalent yield table which
shows the yield that an investor would need to receive from a taxable investment
in order to equal a tax-free yield from the Fund. (See "Taxable Equivalent Yield
Table" herein.)
The Fund's Class A shares yield for the seven-day period ended March 31, 1998
was 2.74% which is equivalent to an effective yield of 2.78%. The Fund's Class B
shares yield for the seven-day period ended March 31, 1998 was 3.05% which is
equivalent to an effective yield of 3.09%.
MANAGER
The investment manager for the Fund is Reich & Tang Asset Management L.P., a
Delaware limited partnership with principal offices at 600 Fifth Avenue, New
York, New York 10020 (the "Manager"). The Manager was at March 31, 1998,
investment manager, advisor or supervisor with respect to assets aggregating in
excess of $11.51 billion. In addition to the Fund, the Manager acts as
investment manager and administrator of seventeen other investment companies and
also advises pension trusts, profit-sharing trusts and endowments.
Effective January 1, 1998, NEIC Operating Partnership, L.P. ("NEICOP") was the
limited partner and owner of a 99.5% interest in the Manager replacing New
England Investment Companies, L.P. ("NEICLP") as the limited partner and owner
of such interest in the Manager due to a restructuring by New England Investment
Companies, Inc. ("NEIC"). Subsequently, effective March 31, 1998, Nvest
Companies, L.P. ("Nvest Companies") due to a change in name of NEICOP, replaces
NEICOP as the limited partner and owner of a 99.5% interest in the Manager.
Reich & Tang Asset Management, Inc. (an indirect wholly-owned subsidiary of
Nvest Companies) is the sole general partner and owner of the remaining 0.5%
interest of the Manager. Nvest Corporation, a Massachusetts Corporation
(formerly known as New England Investment Companies, Inc.), serves as the
managing general partner of Nvest Companies.
Reich & Tang Asset Management, Inc. is an indirect subsidiary of Metropolitan
Life Insurance Company ("MetLife"). Also, MetLife directly and indirectly owns
approximately 47% of the outstanding partnership interests of Nvest Companies
and may be deemed a "controlling person" of the Manager. Reich & Tang, Inc.
owns, directly and indirectly, approximately 13% of the outstanding partnership
interests of Nvest Companies.
MetLife is a mutual life insurance company with assets of $297.6 billion at
December 31, 1996. It is the second largest life insurance company in the United
States in terms of total assets. MetLife provides a wide range of insurance and
investment products and services to individuals and groups and its the leader
among United States life insurance companies in terms of total life insurance in
force, which exceeded $1.6 trillion at December 31, 1996 for MetLife and its
insurance affiliates. MetLife and its affiliates provide insurance or other
financial services to approximately 36 million people worldwide.
Nvest is a holding company offering a broad array of investment styles across a
wide range of asset categories through thirteen subsidiaries, divisions and
affiliates offering a wide array of investment styles and products to
institutional
17
<PAGE>
clients. Its business units, in addition to the manager, include AEW Capital
Management, L.P., Back Bay Advisors, L.P., Capital Growth Management, Limited
Partnership, Greystone Partners, L.P., Harris Associates, L.P., Jurika & Voyles,
L.P., Loomis, Sayles & Company, L.P., New England Funds, L.P., Nvest Associates,
Inc., Snyder Capital Management, L.P., Vaughan, Nelson, Scarborough &
McCullough, L.P., and Westpeak Investment Advisors, L.P. These affiliates in the
aggregate are investment advisors or managers to 80 other registered investment
companies.
The recent name change did not result in a change in control of the Manager and
has no impact upon the Manager's performance of its responsibilities and
obligations.
The Investment Management Contract has a term which extends to December 31,
1998, and may be continued in force thereafter for successive twelve-month
periods beginning each January 1, provided that such continuance is specifically
approved annually by majority vote of the Fund's outstanding voting securities
or by its Board of Directors, and in either case by a majority of the directors
who are not parties to the Investment Management Contract or interested persons
of any such party, by votes cast in person at a meeting called for the purpose
of voting on such matter.
Pursuant to the Investment Management Contract, the Manager manages the Fund's
portfolio of securities and makes decisions with respect to the purchase and
sale of investments, subject to the general control of the Board of Directors of
the Fund. The Manager provides persons satisfactory to the Board of Directors of
the Fund to serve as officers of the Fund. Such officers, as well as certain
other employees and directors of the Fund, may be directors or officers of Reich
& Tang Asset Management, Inc., or employees of the Manager or its affiliates.
The Investment Management Contract is terminable without penalty by the Fund on
sixty days' written notice when authorized either by majority vote of its
outstanding voting shares or by a vote of a majority of its Board of Directors,
or by the Manager on sixty days' written notice, and will automatically
terminate in the event of its assignment. The Investment Management Contract
provides that in the absence of willful misfeasance, bad faith or gross
negligence on the part of the Manager, or of reckless disregard of its
obligations thereunder, the Manager shall not be liable for any action or
failure to act in accordance with its duties thereunder.
For its services under the Investment Management Contract, the Manager receives
from the Fund a fee equal to .30% per annum of the Fund's average daily net
assets (the "Management Fee") for managing the Fund's investment portfolio and
performing related administrative and clerical services. The fees are accrued
daily and paid monthly. Any portion of the total fees received by the Manager
may be used by the Manager to provide shareholder and administrative services.
(See "Distribution and Service Plan" herein.) For the Fund's fiscal years ended
December 31, 1995, 1996 and 1997 the fees payable to the Manager under the
Investment Management Contract were $321,501, $589,504 and $693,398
respectively, of which $0, $27,514 and $124,425 respectively, was voluntarily
waived, therefore, the Manager actually received $321,501, $561,990 and $568,973
respectively for such years. The Manager may waive its rights to any portion of
the management fee and may use any portion of the management fee for purposes of
shareholder and administrative services and distribution of the Fund's shares.
Investment management fees and operating expenses which are attributable to both
Classes of the Fund will be allocated daily to each Class based on the
percentage of outstanding shares at the end of the day. Additional shareholder
services provided by Participating Organizations to Class A shareholders
pursuant to the Plan shall be compensated by the Distributor from its
shareholder servicing fee, the Manager from its management fee and the Fund
itself. Expenses incurred in the distribution of Class B shares and the
servicing of Class B shares shall be paid by the Manager.
Pursuant to the Administrative Services Contract with the Fund, the Manager
performs clerical, accounting, office service and related functions for the Fund
and provides the Fund with personnel to (i) supervise the performance of
accounting and related services by Investors Fiduciary Trust Company, the Fund's
bookkeeping or recordkeeping agent, (ii) prepare reports to and filings with
regulatory authorities and (iii) perform such other services as the Fund may
from time to time request of the Manager. The personnel rendering such services
may be employees of the Manager, of its affiliates or of other organizations.
The Manager, at its discretion, may voluntarily waive all or a portion of the
administrative services fee. For its services under the Administrative Services
Contract, the Manager receives a fee equal to .21% per annum of the Fund's
average daily net assets. For the Fund's fiscal year ended December 31, 1995,
the fee payable to the Manager under the Administrative Services Contract was
$215,873, of which $22,133 was voluntarily waived. For the Fund's fiscal year
ended December 31, 1996, the amount payable to the Manager under the
Administrative Services Contract was $412,653, $2,832 of which was waived. For
the Fund's fiscal year ended December 31, 1997, the fee payable to the Manager
under the Administrative Services Contract was $485,378, none of which was
waived. Any portion of the total fees received by the Manager may be used to
provide shareholder services and for distribution of Fund shares. (See
"Distribution and Service Plan" herein.)
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<PAGE>
Expense Limitation
The Manager has agreed to reimburse the Fund for its expenses (exclusive of
interest, taxes, brokerage, and extraordinary expenses) which in any year exceed
the limits on investment company expenses prescribed by any state in which the
Fund's shares are qualified for sale. For the purpose of this obligation to
reimburse expenses, the Fund's annual expenses are estimated and accrued daily,
and any appropriate estimated payments are made to it on a monthly basis.
Subject to the obligations of the Manager to reimburse the Fund for its excess
expenses as described above, the Fund has, under the Management Contract,
confirmed its obligation for payment of all its other expenses, including taxes,
brokerage fees and commissions, commitment fees, certain insurance premiums,
interest charges and expenses of the custodian, transfer agent and dividend
disbursing agent's fees, telecommunications expenses, auditing and legal
expenses, costs of forming the corporation and maintaining corporate existence,
compensation of directors, officers and employees of the Fund and costs of other
personnel performing services for the Fund who are not officers of the general
partner of the Manager or its affiliates, costs of investor services,
shareholders' reports and corporate meetings, SEC registration fees and
expenses, state securities laws registration fees and expenses, expenses of
preparing and printing the Fund's prospectus for delivery to existing
shareholders and of printing application forms for shareholder accounts, and the
fees payable to the Manager under the Investment Management Contract. As a
result of the passage of the National Securities Markets Improvement Act of
1996, all state expense limitations have been eliminated at this time.
The Fund may from time to time hire its own employees or contract to have
management services performed by third parties (including Participating
Organizations) as discussed herein, and the management of the Fund intends to do
so whenever it appears advantageous to the Fund. The Fund's expenses for
employees and for such services are among the expenses subject to the expense
limitation described above.
MANAGEMENT OF THE FUND
The directors and officers of the Fund and their principal occupations during
the past five years are set forth below. The address of each such person, unless
otherwise indicated, is 600 Fifth Avenue, New York, New York 10020. Mr. Duff may
be deemed an "interested person" of the Fund, as defined in the 1940 Act, on the
basis of his affiliation with the Manager.
Steven W. Duff, 44 - President and Director of the Fund, has been President of
Mutual Funds division of the Manager since September 1994. Mr. Duff was formerly
Director of Mutual Fund Administration at NationsBank which he was associated
with from June 1981 to August 1994. Mr. Duff is President and a Director of Back
Bay Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc., Cortland Trust,
Inc., Daily Tax Free Income Fund, Inc., Michigan Daily Tax Free Income Fund,
Inc., New Jersey Daily Municipal Income Fund, Inc., New York Daily Tax Free
Income Fund, Inc., North Carolina Daily Municipal Income Fund, Inc., Short Term
Income Fund, Inc. and Virginia Daily Municipal Income Fund, Inc., President and
a Trustee of Florida Daily Municipal Income Fund, Institutional Daily Income
Fund and Pennsylvania Daily Municipal Income Fund, President of Cortland Trust,
Inc., Executive Vice President of Reich & Tang Equity Fund, Inc., President and
Chief Executive Officer of Tax Exempt Proceeds Fund, Inc. and Director of Pax
World Money Market Fund, Inc.
Dr. W. Giles Mellon, 67 - Director of the Fund, has been Professor of Business
Administration in the Graduate School of Management, Rutgers University with
which he has been associated since 1966. His address is Rutgers University
Graduate School of Management, 180 University Avenue, Newark, New Jersey 07102.
Dr. Mellon is also a Director of Back Bay Funds, Inc., Connecticut Daily Tax
Free Income Fund, Inc., Daily Tax Free Income Fund, Inc., Delafield Fund, Inc.,
Michigan Daily Tax Free Income Fund, Inc., New Jersey Daily Municipal Income
Fund, Inc., North Carolina Daily Municipal Income Fund, Inc., Reich & Tang
Equity Fund, Inc., Pax World Money Market Fund, Inc., Short Term Income Fund,
Inc. and Virginia Daily Municipal Income Fund, Inc. and a Trustee of Florida
Daily Municipal Income Fund, Institutional Daily Income Fund and Pennsylvania
Daily Municipal Income Fund.
Robert Straniere, 57 - Director of the Fund, has been a member of the New York
State Assembly and a partner with the Straniere & Straniere Law Firm since 1981.
His address is 182 Rose Avenue, Staten Island, New York 10306. Mr. Straniere is
also a Director of Back Bay Funds, Inc., Connecticut Daily Tax Free Income Fund,
Inc., Daily Tax Free Income Fund, Inc., Delafield Fund, Inc., LifeCycle Funds,
Inc., Michigan Daily Tax Free Income Fund, Inc., New Jersey Daily Municipal
Income Fund, Inc., New York Daily Tax Free Income Fund, Inc., North Carolina
Daily Municipal Income Fund, Inc., Reich & Tang Equity Fund, Inc., Pax World
Money Market Fund, Inc., Short Term Income Fund, Inc. and Virginia Daily
Municipal Income Fund, Inc. and a Trustee of Florida Daily Municipal Income
Fund, Institutional Daily Income Fund and Pennsylvania Daily Municipal Income
Fund.
Dr. Yung Wong, 59 - Director of the Fund, was Director of Shaw Investment
Management (UK) Limited from 1994 to October 1995 and formerly General Partner
of Abacus Partners Limited Partnership (a general partner of a venture capital
investment firm) since 1984. His address is 29 Alden Road, Greenwich,
Connecticut 06831. Dr. Wong is a
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<PAGE>
Director of Republic Telecom Systems Corporation (provider of telecommunications
equipment) since January 1989 and of TelWatch, Inc. (provider of network
management software) since August 1989. Dr. Wong is also a Director of Back Bay
Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc., Daily Tax Free Income
Fund, Inc., Delafield Fund, Inc., Michigan Daily Tax Free Income Fund, Inc., New
Jersey Daily Municipal Income Fund, Inc., New York Daily Tax Free Income Fund,
Inc., North Carolina Daily Municipal Income Fund, Inc., Reich & Tang Equity
Fund, Inc., Pax World Money Market Fund, Inc., Short Term Income Fund, Inc. and
Virginia Daily Municipal Income Fund, Inc. and a Trustee of Florida Daily
Municipal Income Fund, Institutional Daily Income Fund and Pennsylvania Daily
Municipal Income Fund.
Molly Flewharty, 47 - Vice President of the Fund, has been Vice President of the
Mutual Funds division of the Manager since September 1993. Ms. Flewharty was
formerly Vice President of Reich & Tang, Inc. which she was associated with from
December 1977 to September 1993. Ms. Flewharty is also Vice President of Back
Bay Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc., Cortland Trust,
Inc., Daily Tax Free Income Fund, Inc., Delafield Fund, Inc., Florida Daily
Municipal Income Fund, Institutional Daily Income Fund, Michigan Daily Tax Free
Income Fund, Inc., New Jersey Daily Municipal Income Fund, Inc., New York Daily
Tax Free Income Fund, Inc., North Carolina Daily Municipal Income Fund, Inc.,
Pennsylvania Daily Municipal Income Fund, Reich and Tang Equity Fund, Inc., Pax
World Money Market Fund, Inc., Short Term Income Fund, Inc., Tax Exempt Proceeds
Fund, Inc. and Virginia Daily Municipal Income Fund, Inc.
Lesley M. Jones, 50 - Vice President of the Fund, has been Senior Vice President
of the Mutual Funds division of the Manager since September 1993. Ms. Jones was
formerly Senior Vice President of Reich & Tang, Inc. which she was associated
with from April 1973 to September 1993. Ms. Jones is also Vice President of Back
Bay Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc., Daily Tax Free
Income Fund, Inc., Delafield Fund, Inc., Florida Daily Municipal Income Fund,
Institutional Daily Income Fund, Michigan Daily Tax Free Income Fund, Inc., New
Jersey Municipal Income Fund, Inc., New York Daily Tax Free Income Fund, Inc.,
North Carolina Daily Municipal Income Fund, Inc., Pennsylvania Daily Municipal
Income Fund, Reich & Tang Equity Fund, Inc., Pax World Money Market Fund, Inc.,
Short Term Income Fund, Inc. and Virginia Daily Municipal Income Fund, Inc.
Dana E. Messina, 41 - Vice President of the Fund, has been Executive Vice
President of the Mutual Funds division of the Manager since January 1995 and was
Vice President from September 1993 to January 1995. Ms. Messina was formerly
Vice President of Reich & Tang, Inc. which she was associated with from December
1980 to September 1993. Ms. Messina is also Vice President of Back Bay Funds,
Inc., Connecticut Daily Tax Free Income Fund, Inc., Cortland Trust, Inc., Daily
Tax Free Income Fund, Inc., Delafield Fund, Inc., Florida Daily Municipal Income
Fund, Institutional Daily Income Fund, Michigan Daily Tax Free Income Fund,
Inc., New Jersey Daily Municipal Income Fund, Inc., New York Daily Tax Free
Income Fund, Inc., North Carolina Daily Municipal Income Fund, Inc.,
Pennsylvania Daily Municipal Income Fund, Reich & Tang Equity Fund, Inc., Pax
World Money Market Fund, Inc., Short Term Income Fund, Inc., Tax Exempt Proceeds
Fund, Inc. and Virginia Daily Municipal Income Fund, Inc.
Bernadette N. Finn, 50 - Secretary of the Fund, has been Vice President of the
Mutual Funds division of the Manager since September 1993. Ms. Finn was formerly
Vice President and Assistant Secretary of Reich & Tang, Inc. which she was
associated with from September 1970 to September 1993. Ms. Finn is also
Secretary of Back Bay Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc.,
Cortland Trust, Inc., Daily Tax Free Income Fund, Inc., Florida Daily Municipal
Income Fund, Michigan Daily Tax Free Income Fund, Inc., New Jersey Daily
Municipal Income Fund, Inc., New York Daily Tax Free Income Fund, Inc., North
Carolina Daily Municipal Income Fund, Inc., Pennsylvania Daily Municipal Income
Fund, Tax Exempt Proceeds Fund, Inc. and Virginia Daily Municipal Income Fund,
Inc., Vice President and Secretary of Delafield Fund, Inc., Institutional Daily
Income Fund, Reich & Tang Equity Fund, Inc., Pax World Money Market Fund, Inc.
and Short Term Income Fund, Inc.
Richard De Sanctis, 41 - Treasurer of the Fund, has been Vice President and
Treasurer of the Manager since September 1993. Mr. De Sanctis was formerly
Controller of Reich & Tang, Inc. from January 1991 to September 1993.. He is
also Treasurer of Back Bay Funds, Inc., Connecticut Daily Tax Free Income Fund,
Inc., Daily Tax Free Income Fund, Inc., Delafield Fund, Inc., Florida Daily
Municipal Income Fund, Institutional Daily Income Fund, Michigan Daily Tax Free
Income Fund, Inc., New Jersey Daily Municipal Income Fund, Inc., New York Daily
Tax Free Income Fund, Inc., North Carolina Daily Municipal Income Fund, Inc.,
Pennsylvania Daily Municipal Income Fund, Reich & Tang Equity Fund, Inc., Pax
World Money Market Fund, Inc., Short Term Income Fund, Inc., Tax Exempt Proceeds
Fund, Inc. and Virginia Daily Municipal Income Fund, Inc. and is Vice President
and Treasurer of Cortland Trust, Inc.
Rosanne Holtzer, 33 - Assistant Treasurer of the Fund, has been Vice President
of the Mutual Funds division of the Manager since December 1997. Ms. Holtzer was
formerly Manager of Fund Accounting for the Manager with which she was
associated with from June 1986. She is also Assistant Treasurer of Back Bay
Funds, Inc., Connecticut Daily Tax Free Income Fund, Inc., Daily Tax Free Income
Fund, Inc., Delafield Fund, Inc., Florida Daily Municipal Income Fund,
Institutional Daily Income Fund, Michigan Daily Tax Free Income Fund, Inc., New
Jersey Daily Municipal Income
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Fund, Inc., New York Daily Tax Free Income Fund, Inc., North Carolina Daily
Municipal Income Fund, Inc., Pax World Money Market Fund, Inc., Pennsylvania
Daily Municipal Income Fund, Reich & Tang Equity Fund, Inc., Short Term Income
Fund, Inc., and Virginia Daily Municipal Income Fund, Inc. and is Vice President
and Assistant Treasurer of Cortland Trust, Inc.
The Fund paid an aggregate remuneration of $9,000 to its directors with respect
to the period ended December 31, 1997, all of which consisted of aggregate
directors' fees paid to the three disinterested directors, pursuant to the terms
of the Investment Management Contract. (See "Manager" herein.) See Compensation
Table below.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Compensation Table
(2) ((3) (4) (5)
Name of Person, Aggregate Compensation Pension or Retirement Estimated Annual Total Compensation from
Position from Registrant for Benefits Accrued as Part Benefits upon Retirement Fund and Fund Complex
Fiscal Year of Fund Expenses Paid to Directors *
W. Giles Mellon, 0 0 $52,000 (13 Funds)
Director $3,000.00
Robert Straniere, 0 0 $52,000 (13 Funds)
Director $3,000.00
Yung Wong, 0 0
Director $3,000.00 $52,000 (13 Funds)
* The total compensation paid to such persons by the Fund and Fund Complex for
the fiscal year ending December 31, 1997 (and, with respect to certain of the
funds in the Fund Complex, estimated to be paid during the fiscal year ending
December 31, 1997). The parenthetical number represents the number of investment
companies (including the Fund) from which such person receives compensation that
are considered part of the same Fund complex as the Fund, because, among other
things, they have a common investment advisor.
</TABLE>
Counsel and Auditors
Legal matters in connection with the issuance of shares of stock of the Fund are
passed upon by Battle Fowler LLP, 75 East 55th Street, New York, New York 10022.
Matters in connection with California law are passed upon by LeBoeuf, Lamb,
Greene & MacRae LLP, 725 South Figueroa Street, Los Angeles, California 90017.
McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New York 10017, independent
certified public accountants, have been selected as auditors for the Fund.
DISTRIBUTION AND SERVICE PLAN
Pursuant to Rule 12b-1 (the "Rule") under the 1940 Act, the SEC has required
that an investment company which bears any direct or indirect expense of
distributing its shares must do so only in accordance with a plan permitted by
the Rule. The Fund's Board of Directors has adopted a distribution and service
plan (the "Plan") and, pursuant to the Plan, the Fund and the Manager have
entered into a Distribution Agreement and a Shareholder Servicing Agreement
(with respect to Class A shares only) with Reich & Tang Distributors, Inc. (the
"Distributor") as distributor of the Fund's shares.
Effective October 3, 1996 a majority of the Fund's Board of Directors, including
independent directors, approved the creation of a second class of shares of the
Fund's outstanding common stock. In furtherance of this action, the Board of
Directors has reclassified the common stock of the Fund into Class A and Class B
shares. The Class A shares will be offered to investors who desire certain
additional shareholder services from Participating Organizations that are
compensated by the Fund's Manager and Distributor for such services.
Under the Shareholder Servicing Agreement (with respect to Class A shares only),
the Distributor receives from the Fund a service fee equal to .20% per annum of
the Fund's average daily net assets of Class A shares (the "Shareholder
Servicing Fee") for providing personal shareholder services and for the
maintenance of shareholder accounts. The fee is accrued daily and paid monthly
and any portion of the fee may be deemed to be used by the Distributor for
purposes of distribution of the Fund's Class A shares only and for payments to
Participating
21
<PAGE>
Organizations with respect to servicing their clients or customers who are Class
A shareholders of the Fund. The Class B shareholders will not receive the
benefit of such services from Participating Organizations and, therefore, will
not be assessed a Shareholder Servicing Fee.
Under the Distribution Agreement, the Distributor, for nominal consideration and
as agent for the Fund, will solicit orders for the purchase of the Fund's
shares, provided that any subscriptions and orders will not be binding on the
Fund until accepted by the Fund as principal.
The Plan and the Shareholder Servicing Agreement provide that, in addition to
the Shareholder Servicing Fee, the Fund will pay for (i) telecommunications
expenses including the cost of dedicated lines and CRT terminals, incurred by
the Manager and Distributor in carrying out their obligations under the
Shareholder Servicing Agreement with respect to Class A shares only, and (ii)
preparing, printing and delivering the Fund's prospectus to existing
shareholders of the Fund and preparing and printing subscription application
forms for shareholder accounts, brochures and other promotional materials and of
delivering the prospectuses and materials to prospective shareholders of the
Fund.
The Plan provides that the Manager may make payments from time to time from
their own resources, which may include the Management Fee and past profits for
the following purposes: (i) to defray the costs of, and to compensate others,
including Participating Organizations with whom the Distributor has entered into
written agreements, for, performing shareholder servicing and related
administrative functions on behalf of the Class A shares of the Fund; (ii) to
compensate certain Participating Organizations for providing assistance in
distributing the Fund's Class A shares; and (iii) to pay the costs of printing
and distributing the Fund's prospectus to prospective investors and to defray
the cost of the preparation and printing of brochures and other promotional
materials, mailings to prospective shareholders, advertising, and other
promotional activities, including the salaries and/or commissions of sales
personnel in connection with the distribution of the Fund's shares. The
Distributor may also make payments from time to time from its own resources,
which include the Shareholder Servicing Fee with respect to Class A shares and
past profits, for the purposes enumerated in (i) above. The Distributor, in its
sole discretion, will determine the amount of such payments made pursuant to the
Plan, provided that such payments will not increase the amount which the Fund is
required to pay to the Manager and Distributor for any fiscal year under either
the Investment Management Contract or the Shareholder Servicing Agreement in
effect for that year.
In accordance with Rule 12b-1, the Plan provides that all written agreements
relating to the Plan entered into between either the Fund or the Distributor and
Participating Organizations or other organizations must be in a form
satisfactory to the Fund's Board of Directors. In addition, the Plan requires
the Fund and the Distributor to prepare, at least quarterly, written reports
setting forth all amounts expended for distribution purposes by the Fund and the
Distributor pursuant to the Plan and identifying the distribution activities for
which those expenditures were made.
The following applies only to Class A shares of the Fund. For the Fund's fiscal
year ended December 31, 1997 the amount payable to the Distributor under the
Distribution Plan and Shareholder Servicing Agreement adopted thereunder
pursuant to the Rule under the 1940 Act, totaled $440,891, none of which was
voluntarily waived by the Distributor. During the same period, the Manager and
Distributor made payments under the Plan totaling $915,120, of which $890,593
was to or on behalf of Participating Organizations. For the Fund's fiscal year
ended December 31, 1996 the amount payable to the Distributor under the
Distribution Plan and Shareholder Servicing Agreement adopted thereunder
pursuant to the Rule under the 1940 Act, totaled $392,125, of which $130,068 was
voluntarily waived by the Distributor. During the same period, the Manager and
Distributor made payments under the Plan totaling $710,185, of which $685,199
was to or on behalf of Participating Organizations. For the Fund's fiscal year
ended December 31, 1995, the amount payable to the Distributor under the
Distribution Plan and Shareholder Servicing Agreement totaled $214,334, all of
which was voluntarily waived by the Distributor. During the same period, the
Manager and Distributor made payments under the Plan totaling $389,175, of which
$358,227 was to or on behalf of Participating Organizations. The excess of such
payments over the total payments the Manager and Distributor received from the
Fund under the Plan represent distribution expenses funded by the Manager from
its own resources including the Management Fee.
The Plan was most recently approved on October 16, 1997 by the Board of
Directors and shall continue until December 31, 1998, including a majority of
the directors who are not interested persons (as defined in the 1940 Act) of the
Fund or the Manager. The Plan provides that it may continue in effect for
successive annual periods provided it is approved by the Class A shareholders or
by the Board of Directors, including a majority of directors who are not
interested persons of the Fund and who have no direct or indirect interest in
the operation of the Plan or in the agreements related to the Plan. The Plan was
approved by a majority of the shareholders of the Fund at their annual meeting
held on August 31, 1988. The Plan further provides that it may not be amended to
increase materially the costs which may be spent by the Fund for distribution
pursuant to the Plan without shareholder approval, and the other material
amendments must be approved by the directors in the manner described in the
preceding sentence. The Plan may be terminated at any time by a vote of a
majority of the disinterested directors of the Fund or the Fund's Class A
shareholders.
22
<PAGE>
DESCRIPTION OF COMMON STOCK
The authorized capital stock of the Fund, which was incorporated on December 5,
1986 in Maryland, consists of twenty billion shares of stock having a par value
of one tenth of one cent ($.001) per share. Shares will generally be voted in
the aggregate except in instances as disclosed below when class voting is
applicable. There are no conversion or preemptive rights in connection with any
shares of the Fund. All shares, when issued in accordance with the terms of the
offering, will be fully paid and nonassessable. Shares are redeemable at net
asset value, at the option of the shareholder. The Fund is subdivided into two
classes of stock, Class A and Class B. Each share, regardless of class, will
represent an interest in the same portfolio of investments and will have
identical voting, dividend, liquidation and other rights, preferences, powers,
restrictions, limitations, qualifications, designations and terms and
conditions, except that: (i) the Class A and Class B shares will have different
class designations; (ii) only the Class A shares will be assessed a service fee
pursuant to the Rule 12b-1 Distribution and Service Plan of the Fund of .25% of
the Fund's average daily net assets; (iii) only the holders of the Class A
shares would be entitled to vote on matters pertaining to the Plan and any
related agreements in accordance with provisions of Rule 12b-1; and (iv) the
exchange privilege will permit shareholders to exchange their shares only for
shares of the same class of an Exchange Fund. Payments that are made under the
Plans will be calculated and charged daily to the appropriate class prior to
determining daily net asset value per share and dividends/distributions. A
fractional share has those rights in proportion to the percentage that the
fractional share represents of a whole share.
On March 31, 1998, there were 201,733,638 shares of the Fund's Class A shares
outstanding, and 28,088,257 Class B shares outstanding. As of March 31, 1998,
the amount of shares owned by all officers and directors of the Fund as a group
was less than 1% of the outstanding shares of the Fund. Set forth below is
certain information as to persons who owned 5% or more of the Fund's outstanding
common stock as of March 31, 1998.
Nature of
Name and Address % of Shares Ownership
Class A
M. L. Stern & Co., Inc., as Agent 37.13% Record
8350 Wilshire Blvd.
Beverly Hills, CA 90211
National Financial Services Corp. 15.02% Record
200 Liberty Street
New York, NY 10281
DST Systems 9.42% Record
Attn: Eric Doran
210 W. 10th Street - 8th Floor
Kansas City, MO 64105-1614
Neuberger & Berman, as Agent 5.81% Record
Attn: Steve Gallo
55 Water Street - 27th Floor
New York, NY 10041-0001
Class B
Lewco Securities Corp. 62.55% Record
2 Broadway
New York, NY 10004
Under its Articles of Incorporation the Fund has the right to redeem shares of
stock owned by any shareholder for cash, to the extent and at such times as the
Fund's Board of Directors determines to be necessary or appropriate to prevent
an undue concentration of stock ownership which would cause the Fund to become a
"personal holding company" for Federal income tax purposes. In this regard, the
Fund may also exercise its right to reject purchase orders.
The shares of the Fund have non-cumulative voting rights, which means that the
holders of more than 50% of the shares outstanding voting for the election of
directors can elect 100% of the directors if the holders choose to do so and, in
that event, the holders of the remaining shares will not be able to elect any
person or persons to the Board of Directors.
As a general matter, the Fund will not hold annual or other meetings of the
Fund's shareholders. This is because the By-laws of the Fund provide for annual
meetings only (a) for the election of directors, (b) for approval of the Fund's
revised investment advisory contracts with respect to a particular class or
series of stock, (c) for approval of revisions to
23
<PAGE>
the Fund's distribution agreement with respect to a particular class or series
of stock and (d) upon the written request of shareholders entitled to cast not
less than 25% of all the votes entitled to be cast at such meeting. Annual and
other meetings may be required with respect to such additional matters relating
to the Fund as may be required by the 1940 Act, including the removal of Fund
director(s) and communication among shareholders, any registration of the Fund
with the SEC or any state, or as the Directors may consider necessary or
desirable. Each Director serves until the next meeting of shareholders called
for the purpose of considering the election or reelection of such Director or of
a successor to such Director, and until the election and qualification of his or
her successor, elected at such meeting, or until such Director sooner dies,
resigns, retires or is removed by the vote of the shareholders.
FEDERAL INCOME TAXES
The Fund has elected to qualify under the Code and under California law as a
"regulated investment company" that distributes "exempt-interest dividends". The
Fund intends to continue to qualify for regulated investment company status, so
long as such qualification is in the best interests of its shareholders. Such
qualification relieves the Fund of liability for Federal income taxes to the
extent its earnings are distributed in accordance with the applicable provisions
of the Code.
The Fund's policy is to distribute as dividends each year 100% and in no event
less than 90% of its tax-exempt interest income, net of certain deductions.
Exempt-interest dividends, as defined in the Code, are dividends or any part
thereof (other than capital gain dividends) paid by the Fund that are
attributable to interest on obligations, the interest on which is exempt from
regular Federal income tax, and designated by the Fund as exempt-interest
dividends in a written notice mailed to the Fund's shareholders not later than
60 days after the close of its taxable year. The percentage of the total
dividends paid by the Fund during any taxable year that qualifies as
exempt-interest dividends will be the same for all shareholders receiving
dividends during the year.
Exempt-interest dividends are to be treated by the Fund's shareholders as items
of interest excludable from their gross income under Section 103(a) of the Code.
If a shareholder receives an exempt-interest dividend with respect to any share
and such share has been held for six months or less, then any loss on the sale
or exchange of such share will be disallowed to the extent of the amount of such
exempt-interest dividend. The Code provides that interest on indebtedness
incurred, or continued, to purchase or carry certain tax-exempt securities such
as shares of the Fund is not deductible. Therefore, among other consequences, a
certain proportion of interest on indebtedness incurred, or continued, to
purchase or carry securities on margin may not be deductible during the period
an investor holds shares of the Fund. For Social Security recipients, interest
on tax-exempt bonds, including exempt-interest dividends paid by the Fund, is to
be added to adjusted gross income for purposes of computing the amount of Social
Security benefits includable in gross income. The amount of such interest
received will have to be disclosed on the shareholders' Federal income tax
returns. Taxpayers other than corporations are required to include as an item of
tax preference for purposes of the Federal alternative minimum tax all
tax-exempt interest on "private activity" bonds (generally, a bond issue in
which more than 10% of the proceeds are used in a non-governmental trade or
business) (other than qualified Section 501(c)(3) bonds) issued after August 7,
1986. Thus, this provision will apply to the portion of the exempt-interest
dividends from the Fund's assets, if any, that are attributable to such
post-August 7, 1986 private activity bonds, if any of such bonds are acquired by
the Fund. Corporations are required to increase their alternative minimum
taxable income by 75% of the amount by which the adjusted current earnings
(which will include tax-exempt interest) of the corporation exceeds the
alternative minimum taxable income (determined without this provision). In
addition, in certain cases, Subchapter S corporations with accumulated earnings
and profits from Subchapter C years are subject to a minimum tax on excess
"passive investment income" which includes tax-exempt interest. A shareholder is
advised to consult his tax advisor with respect to whether exempt-interest
dividends retain the exclusion under Section 103(a) of the Code if such
shareholder would be treated as a "substantial user" or "related person" under
Section 147(a) of the Code with respect to some or all of the "private activity
bonds", if any, held by the Fund.
Although it is not intended, it is possible that the Fund may realize short-term
or long-term capital gains or losses from its portfolio transactions. The Fund
may also realize short-term or long-term capital gains upon the maturity or
disposition of securities acquired at discounts resulting from market
fluctuations. Short-term capital gains will be taxable to shareholders as
ordinary income when they are distributed. Any net capital gains (the excess of
its net realized long-term capital gain over its net realized short-term capital
loss) will be distributed annually to the Fund's shareholders. The Fund will
have no tax liability with respect to distributed net capital gains and the
distributions will be taxable to shareholders as long-term capital gains
regardless of how long the shareholders have held Fund shares. However, Fund
shareholders who at the time of such a net capital gain distribution have not
held their Fund shares for more than six months, and who subsequently dispose of
those shares at a loss, will be required to treat such loss as a long-term
capital loss to the extent of such net capital gain distribution. Distributions
of net capital gain will be designated as a capital gain dividend in a written
notice mailed to the Fund's shareholders not later than 60 days after the close
of the Fund's taxable year. Capital gains realized by corporations are generally
taxed at the same rate as ordinary income.
24
<PAGE>
However, capital gains dividends are taxable at a maximum rate of 28% to
non-corporate shareholders if the Fund's holding period is more than 12 months
and 20% if the Fund's holding period is more than 18 months, without regard to
the length of time shares have been held by the holder. Corresponding maximum
rate and holding period rules apply with respect to capital gains realized by a
holder on the disposition of shares.
The Fund intends to distribute at least 90% of its investment company taxable
income (taxable income subject to certain adjustments exclusive of the excess of
its net long-term capital gain over its net short-term capital loss) for each
taxable year. The Fund will be subject to Federal income tax on any
undistributed investment company taxable income. To the extent such income is
distributed it will be taxable to shareholders as ordinary income. Expenses paid
or incurred by the Fund will be allocated between tax-exempt and taxable income
in the same proportion as the amount of the Fund's tax-exempt income bears to
the total of such exempt income and its gross income (excluding from gross
income the excess of capital gains over capital losses). If the Fund does not
distribute at least 98% of its ordinary income and 98% of its capital gain net
income for a taxable year, the Fund will be subject to a 4% excise tax on the
excess of such amounts over the amounts actually distributed.
The Fund generally is required to withhold 31% of taxable interest or dividend
payments or proceeds from the redemption of shares of the Fund if a shareholder
fails to provide the Fund with a current taxpayer identification number.
Dividends and distributions to shareholders will be treated in the same manner
for Federal income tax purposes whether received in cash or reinvested in
additional shares of the Fund.
With respect to the variable rate demand instruments, including Participation
Certificates therein, the Fund has obtained and is relying on the opinion of
Battle Fowler LLP, counsel to the Fund, that it will be treated for Federal
income tax purposes as the owner of the underlying Municipal Obligations and the
interest thereon will be exempt from regular federal income taxes to the Fund to
the same extent as interest on the underlying municipal obligations. Counsel has
pointed out that the Internal Revenue Service has announced that it will not
ordinarily issue advance rulings on the question of ownership of securities or
participation interests therein subject to a put, and as a result could reach a
conclusion different from that reached by counsel.
The Code provides that the interest on indebtedness incurred or continued to
purchase or carry shares of the Fund is not deductible. Therefore, among other
consequences, a certain proportion of interest on indebtedness incurred, or
continued to purchase or carry securities may not be deductible during the
period an investor holds shares of the Fund. P.L. 99-514 expands the application
of this rule as it applies to financial institutions, effective with respect to
Fund shares acquired after December 31, 1986. The Clinton Administration's
Revenue Proposals for fiscal years 1999 would extend this provision to all
financial intermediaries effective for taxable years beginning after the date of
enactment with respect to obligations acquired on or after the date of first
committee action.
From time to time, proposals have been introduced before Congress to restrict or
eliminate the Federal income tax exemption for interest on Municipal
Obligations. If such a proposal were introduced and enacted in the future, the
ability of the Fund to pay exempt-interest dividends would be adversely affected
and the Fund would re-evaluate its investment objective and policies and
consider changes in the structure.
In South Carolina v. Baker, the U.S. Supreme Court held that the Federal
government may constitutionally require states to register bonds they issue and
may subject the interest on such bonds to Federal tax if not registered, and
that there is no constitutional prohibition against the Federal government's
taxing the interest earned on state or other municipal bonds. The Supreme Court
decision affirms the authority of the Federal government to regulate and control
bonds such as the Municipal Obligations and to tax such bonds in the future. The
decision does not, however, affect the current exemption from taxation of the
interest earned on the Municipal Obligations in accordance with Section 103 of
the Code.
CALIFORNIA INCOME TAXES
The designation of all or a portion of a dividend paid by the Fund as an
"exempt-interest dividend" under the Code does not necessarily result in the
exemption of such amount from tax under the laws of any state or local taxing
authority. Under California law, at the end of each quarter of its tax year, at
least 50% of the "value" of the Fund's assets must consist of obligations which,
when held by an individual, the interest therefrom is exempt from taxation by
the State of California under the Constitution or laws of the State of
California or the United States. Assuming compliance with this requirement, with
respect to dividends treated for Federal income tax purposes as exempt-interest
dividends that are paid by the Fund to a California resident individual
shareholder, in the opinion of LeBoeuf, Lamb, Greene & MacRae LLP, special
California tax counsel to the Fund, amounts correctly designated as derived from
California Municipal Obligations received by the Fund will not be subject to the
California Income Tax. Amounts correctly designated as derived from Territorial
Municipal Obligations and which bear interest exempt from taxation by the State
of California, as described above, also will not be subject to the California
Income Tax. In the past, the California Franchise Tax
25
<PAGE>
Board has taken the position that dividends derived from Federal obligations are
includable in a California resident's tax base for purposes of the California
Income Tax. Legislation was enacted, however, to clarify treatment as
"exempt-interest dividends".
California also taxes capital gain dividends distributed to shareholders at
ordinary income rates. No tax is imposed on undistributed amounts unless the
shareholder has the option of receiving cash or additional shares.
Exempt-interest dividends which are not derived from California Municipal
Obligations and any other dividends of the Fund which do not qualify as
"exempt-interest dividends" under California law will be includable in a
California resident's tax base for purposes of the California Income Tax.
Shareholders are urged to consult their tax advisors with respect to the
treatment of distributions from the Fund in their own states and localities.
CUSTODIAN AND TRANSFER AGENT
Investors Fiduciary Trust Company, 801 Pennsylvania, Kansas City, Missouri 64105
is custodian for its cash and securities. Reich & Tang Services, Inc., 600 Fifth
Avenue, New York, New York 10020 is transfer agent and dividend disbursing agent
for the shares of the Fund. The custodian and transfer agent do not assist in,
and are not responsible for, investment decisions involving assets of the Fund.
FINANCIAL STATEMENTS
The audited financial statements for the Fund and the report of McGladrey &
Pullen thereon for the fiscal year ended December 31, 1997 are herein
incorporated by reference to the Fund's Annual Report. The Annual Report is
available upon request and without charge.
26
<PAGE>
DESCRIPTION OF RATINGS*
Description of Moody's Investors Service, Inc.'s two highest municipal bond
ratings:
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities, or fluctuation of protective elements
may be of greater amplitude, or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
Con. (...) - Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operating experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Description of Moody's Investors Service, Inc.'s two highest ratings of state
and municipal notes and other short-term loans:
Moody's ratings for state and municipal notes and other short-term loans will be
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing, while various factors of the first importance in bond risk
are of lesser importance in the short run. Symbols used will be as follows:
MIG-1 - Loans bearing this designation are of the best quality, enjoying strong
protection from established cash flows of funds for their servicing or from
established and broad-based access to the market for refinancing, or both.
MIG-2 - Loans bearing this designation are of high quality, with margins of
protection ample although not so large as in the preceding group.
Description of Standard & Poor's Rating Services two highest debt ratings:
AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
Plus ( + ) or Minus ( - ): The AA rating may be modified by the addition of a
plus or minus sign to show relative standing within the AA rating category.
Provisional Ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood of,
or the risk of default upon failure of, such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.
S&P does not provide ratings for state and municipal notes.
Description of Standard & Poor's Rating Services two highest commercial paper
ratings:
Issues assigned this highest rating are regarded as having the greatest capacity
for timely payment. Issues in this category are delineated with the numbers 1, 2
and 3 to indicate the relative degree of safety.
A-1 - This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics will be denoted with a plus (+) sign
designation.
A-2 - Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues designated
A-1.
Description of Moody's Investors Service, Inc.'s two highest commercial paper
ratings:
Moody's employs the following designations, both judged to be investment grade,
to indicate the relative repayment capacity of rated issues: Prime-1, highest
quality; Prime-2, higher quality.
- --------------------------------------------------------------------------------
* As described by the rating agencies
27
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------------------
CORPORATE TAXABLE EQUIVALENT YIELD TABLE
- -------------------------------------------------------------------------------------------------------------------------
1. If Your Corporate Taxable Income Bracket Is . . .
- --------------------------------------------------------------------------------------------------------------------------
Corporate $0- $50,001- $75,001- $100,001- $335,001- $10,000,001- $15,000,001- $18,333,334
Return 50,000 75,000 100,000 335,000 10,000,000 15,000,000 18,333,333 and over
- --------------------------------------------------------------------------------------------------------------------------
2. Then Your Combined Income Tax Bracket Is. . .
- --------------------------------------------------------------------------------------------------------------------------
Federal
Tax 15.00% 25.00% 34.00% 39.00% 34.00% 35.00% 38.00% 35.00%
Rate
- --- ------------ ------------ ------------- --------------- -------------- --------------- ---------------- --------------
State
Tax 8.84% 8.84% 8.84% 8.84% 8.84% 8.84% 8.84% 8.84%
Rate
- --- ------------ ------------ ------------- --------------- -------------- --------------- ---------------- --------------
Combined
Marginal
Tax 22.51% 31.63% 39.83% 44.39% 39.83% 40.75% 43.48% 40.75%
Rate
- --------------------------------------------------------------------------------------------------------------------------
3. Now Compare Your Tax Free Income Yields With Taxable Income Yields
- --------------------------------------------------------------------------------------------------------------------------
Tax Equivalent Taxable Investment Yield
Exempt Requires to Match Tax Exempt Yield
Yield
- --------------------------------------------------------------------------------------------------------------------------
2.00% 2.58% 2.93% 3.32% 3.60% 3.32% 3.38% 3.54% 3.38%
- --------------------------------------------------------------------------------------------------------------------------
2.50% 3.23% 3.66% 4.16% 4.50% 4.16% 4.22% 4.42% 4.22%
- --------------------------------------------------------------------------------------------------------------------------
3.00% 3.87% 4.39% 4.99% 5.39% 4.99% 5.06% 5.31% 5.06%
- --------------------------------------------------------------------------------------------------------------------------
3.50% 4.52% 5.12% 5.82% 6.29% 5.82% 5.91% 6.19% 5.91%
- --------------------------------------------------------------------------------------------------------------------------
4.00% 5.16% 5.85% 6.65% 7.19% 6.65% 6.75% 7.08% 6.75%
- --------------------------------------------------------------------------------------------------------------------------
4.50% 5.81% 6.58% 7.48% 8.09% 7.48% 7.59% 7.96% 7.59%
- --------------------------------------------------------------------------------------------------------------------------
5.00% 6.45% 7.31% 8.31% 8.99% 8.31% 8.44% 8.85% 8.44%
- --------------------------------------------------------------------------------------------------------------------------
5.50% 7.10% 8.04% 9.14% 9.28% 9.14% 9.28% 9.73% 9.28%
- --------------------------------------------------------------------------------------------------------------------------
6.00% 7.74% 8.78% 9.97% 10.79% 9.97% 10.13% 10.62% 10.13%
- --------------------------------------------------------------------------------------------------------------------------
6.50% 8.39% 9.51% 10.80% 11.69% 10.80% 10.97% 11.50% 10.97%
- --------------------------------------------------------------------------------------------------------------------------
7.00% 9.03% 10.24% 11.63% 12.59% 11.63% 11.81% 12.39% 11.81%
- --------------------------------------------------------------------------------------------------------------------------
To use this chart, find the applicable level of taxable income based on your tax
filing status in section one. Then read down to section two to determine your
combined tax bracket and, in section three, to see the equivalent taxable yields
for each of the tax free income yields given.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
INDIVIDUAL TAX EQUIVALENT YIELD TABLE
- -------------------------------------------------------------------------------------------------------------------
1. If Your Taxable Income Bracket Is . . .
- -------------------------------------------------------------------------------------------------------------------
Single $0- $25,351- $26,046- $32,917- $61,401- $128,101- $278,451
Return 25,350 26,045 32,916 61,400 128,100 278,450 and over
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
Joint $0- $42,351- $52,091- $65,833- $102,301- $155,951- $278,451
Return 42,350 52,090 65,832 102,300 155,950 278,450 and over
- -------------------------------------------------------------------------------------------------------------------
2. Then Your Combined Income Tax Bracket Is . . .
- -------------------------------------------------------------------------------------------------------------------
Federal
Tax 15.00% 28.00% 28.00% 28.00% 31.00% 36.00% 39.60%
Rate
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
State
Tax 6.00% 6.00% 8.00% 9.30% 9.30% 9.30% 9.30%
Rate
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
Combined
Marginal 20.10% 32.32% 33.76% 34.70% 37.42% 41.95% 45.22%
Tax
Rate
- -------------------------------------------------------------------------------------------------------------------
3. Now Compare Your Tax Free Income Yields With Taxable Income Yields
- -------------------------------------------------------------------------------------------------------------------
Tax Equivalent Taxable Investment Yield
Exempt Requires to Match Tax Exempt Yield
Yield
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
2.00% 2.50% 2.96% 3.02% 3.06% 3.20% 3.45% 3.65%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
2.50% 3.13% 3.69% 3.77% 3.83% 3.99% 4.31% 4.56%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
3.00% 3.75% 4.43% 4.53% 4.59% 4.79% 5.17% 5.48%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
3.50% 4.38% 5.17% 5.28% 5.36% 5.59% 6.03% 6.39%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
4.00% 5.01% 5.91% 6.04% 6.13% 6.39% 6.89% 7.30%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
4.50% 5.63% 6.65% 6.79% 6.89% 7.19% 7.75% 8.21%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
5.00% 6.26% 7.39% 7.55% 7.66% 7.99% 8.61% 9.13%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
5.50% 6.88% 8.13% 8.30% 8.42% 8.79% 9.47% 10.04%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
6.00% 7.51% 8.87% 9.06% 9.19% 9.59% 10.34% 10.95%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
6.50% 8.14% 9.60% 9.81% 9.95% 10.39% 11.20% 11.87%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
7.00% 8.76% 10.34% 10.57% 10.72% 11.19% 12.06% 12.78%
- -------- -------------- -------------- -------------- -------------- -------------- --------------- ---------------
To use this chart, find the applicable level of taxable income based on your tax
filing status in section one. Then read down to section two to determine your
combined tax bracket and, in section three, to see the equivalent taxable yields
for each of the tax free income yields given.
</TABLE>
29
