Morgan Grenfell SMALLCap Fund, Inc.
2,138,337 Shares of Common Stock
Issuable upon Exercise of
Rights to Subscribe for Such Shares
Morgan Grenfell SMALLCap Fund, Inc. (the "Fund") is issuing to its
shareholders of record as of the close of business on May 20, 1996 (the "Record
Date") non-transferable rights ("Rights") entitling the holders thereof to
subscribe for up to an aggregate of 2,138,337 shares of the Fund's Common Stock
(the "Shares"), at the rate of one Share of Common Stock for every three Rights
held (the "Offer"). Shareholders of record will receive one Right for each whole
share of Common Stock held on the Record Date. Shareholders who fully exercise
their Rights will be entitled to subscribe for additional Shares of Common Stock
pursuant to the Over-Subscription Privilege described herein. The Fund may
increase the number of Shares of Common Stock subject to subscription by up to
25% of the Shares, or an additional 534,584 Shares of Common Stock, for an
aggregate total of 2,672,921 Shares. Fractional Shares will not be issued upon
the exercise of Rights. The Rights are non-transferable and, therefore, may not
be purchased or sold. The Rights will not be admitted for trading on the New
York Stock Exchange (the "NYSE") or any other exchange. See "The Offer". THE
SUBSCRIPTION PRICE PER SHARE (THE "SUBSCRIPTION PRICE") WILL BE 95% OF THE LOWER
OF (i) THE AVERAGE OF THE LAST REPORTED SALE PRICES OF A SHARE OF THE FUND'S
COMMON STOCK ON THE NYSE ON THE DATE OF THE EXPIRATION OF THE OFFER (THE
"PRICING DATE") AND THE FOUR PRECEDING BUSINESS DAYS OR (ii) THE NET ASSET VALUE
PER SHARE AS OF THE CLOSE OF BUSINESS ON THE PRICING DATE.
The Fund first announced that the Fund was considering the Offer after the
close of trading on the NYSE on April 4, 1996. Shares of the Fund's outstanding
Common Stock trade on the NYSE under the symbol "MGC". Shares issued upon the
exercise of Rights and the Over- Subscription Privilege will be listed for
trading on the NYSE. The net asset values per share of the Fund's Common Stock
at the close of business on April 4, 1996 (the last trading date on which the
Fund calculated its net asset value prior to the announcement) and on May 17,
1996 (the last trading date on which the Fund calculated its net asset value
prior to the Record Date) were $12.74 and $14.15, respectively, and the last
reported sales price of a Share of the Fund's Common Stock on the NYSE on those
dates were $10.50 and $11.375, respectively.
THE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON JUNE 14, 1996
UNLESS EXTENDED AS DESCRIBED HEREIN (THE "EXPIRATION DATE").
The Fund is a diversified, closed-end management investment company whose
primary investment objective is long-term capital appreciation principally by
investment in equity and equity-related securities of U.S. companies. The Fund
seeks current income as a secondary investment objective. The Fund seeks to
achieve its primary investment objective by investing principally in common
stocks of small capitalization companies. For this purpose, small capitalization
companies are those ranked (at the time of investment) according to market
capitalization in the bottom 20% of all issuers listed or quoted on a national
securities exchange or market. Within this universe, the Fund focuses on
companies with market capitalizations of between $100 million and $1.6 billion.
See "Investment Objectives and Policies". No assurance can be given that the
Fund's investment objectives will be realized. While securities of small
capitalization companies may offer a greater capital appreciation potential than
investments in large-cap company securities, they may also present greater
risks. See "Special Risk Considerations".
This Prospectus sets forth concisely the information about the Fund that a
prospective investor ought to know before investing. Investors are advised to
read this Prospectus and retain it for future reference. A Statement of
Additional Information, dated May 17, 1996 (the "SAI"), containing additional
information about the Fund, has been filed with the Securities and Exchange
Commission (the "Commission") and is incorporated by reference in its entirety
into this Prospectus. A copy of the SAI, the table of contents of which appears
on page 25 of this Prospectus, may be obtained without charge by calling
Corporate Investor Communications, Inc., the Fund's Information Agent, at (800)
459-8562.
(Continued on the following page)
----------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
Estimated Estimated Sales Estimated Proceeds
Subscription Price (1) Load (2) to Fund (3) (4)
- ----------------- ---------------------------- ---------------------------- ------------------------------
<S> <C> <C> <C>
Per Share $10.81 $0.41 $10.40
Total Maximum (5) $23,115,423 $866,828 $22,248,595
</TABLE>
(Footnotes on the following page)
----------------------
PaineWebber Incorporated
----------------------
The date of this Prospectus is May 17, 1996.
<PAGE>
(Continued from the previous page)
Upon the completion of the Offer, shareholders who do not fully exercise
their Rights will own a smaller proportional interest in the Fund than they
owned prior to the Offer. In addition, because the Subscription Price per Share
will be less than the then current net asset value per share as of the Pricing
Date, the Offer will result in an immediate dilution of the net asset value per
share for all shareholders. Such dilution is not currently determinable because
it is not known how many Shares will be subscribed for, what the net asset value
or market price of the Common Stock will be on the Pricing Date or what the
Subscription Price will be, although the amount of such dilution could be
substantial. See "Special Risk Considerations". Except as described herein,
shareholders will have no right to rescind their subscriptions after receipt of
their payment for Shares by the Subscription Agent.
The Fund's Investment Manager is Morgan Grenfell Capital Management, Inc., a
U.S.-registered investment adviser. The Investment Manager is an indirect
wholly-owned subsidiary of Morgan Grenfell Asset Management Limited which is, in
turn, a direct wholly-owned subsidiary of Deutsche Morgan Grenfell Group PLC.
Deutsche Morgan Grenfell Group PLC is an indirect wholly-owned subsidiary of
Deutsche Bank AG, a commercial and investment banking group listed on stock
exchanges internationally. See "Management of the Fund". The address of the Fund
is 885 Third Avenue, New York, New York 10022, and its telephone number is (212)
230-2600. (Footnotes from the previous page)
----------------------
(1) Estimated on the basis of 95% of the Fund's last sales price on the NYSE
on May 17, 1996.
(2) In connection with the Offer, PaineWebber Incorporated (the "Dealer
Manager") and other broker-dealers soliciting the exercise of Rights will
receive solicitation fees equal to 2.50% of the Subscription Price per
Share for each Share issued pursuant to the exercise of such Rights and
the Over-Subscription Privilege. The Fund has also agreed to pay the
Dealer Manager a fee for financial advisory and marketing services in
connection with the Offer equal to 1.25% of the aggregate Subscription
Price for the Shares issued pursuant to the exercise of such Rights and
the Over-Subscription Privilege and the Fund and the Investment Manager
have agreed to indemnify the Dealer Manager against certain liabilities
under the Securities Act of 1933, as amended.
(3) Before deduction of offering expenses incurred by the Fund, estimated at
$400,000, including up to an aggregate of $100,000 to be paid to the
Dealer Manager as partial reimbursement of its expenses pursuant to the
Offer.
(4) The funds received by check prior to the final due date of this Offer
will be deposited into a segregated interest-bearing account (which
interest will be paid to the Fund) pending proration and distribution of
Shares.
(5) Assumes all Rights are exercised at the Estimated Subscription Price.
Pursuant to the Over-Subscription Privilege, the Fund may at the
discretion of the Board of Directors increase the number of Shares
subject to subscription by up to 25% of the Shares offered hereby. If the
Fund increases the number of Shares subject to subscription by 25%, the
total maximum Estimated Subscription Price (as hereinafter defined),
Estimated Sales Load and Estimated Proceeds to the Fund will be
$28,894,276, $1,083,535 and $27,810,741, respectively.
----------------------
2
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
<S> <C> <C>
Shareholder Transaction Expenses
Sales Load (as a percentage of the Subscription Price per Share) (1) 3.75%
Annual Expenses (as a percentage of net assets attributable to Common Stock)
Management Fees (2) 1.00%
Other Expenses (3) 0.44%
----
Total Annual Expenses 1.44%
======
</TABLE>
(1) The Dealer Manager and the other broker-dealers soliciting the exercise of
Rights will receive soliciting fees payable by the Fund equal to 2.50% of
the Subscription Price per Share for each Share issued pursuant to the
exercise of Rights and the Over-Subscription Privilege. The Fund has also
agreed to pay the Dealer Manager a fee for financial advisory and marketing
services in connection with the Offer equal to 1.25% of the aggregate
Subscription Price per Share for each Share issued pursuant to the exercise
of Rights and the Over-Subscription Privilege and to reimburse the Dealer
Manager for out-of-pocket expenses up to an aggregate of $100,000. These
fees will be borne by the Fund and indirectly by all of the Fund's
shareholders, including those who do not exercise their Rights.
(2) See "Management of the Fund--Investment Manager;--Management Agreement"
herein and "Expenses" and "Portfolio Transactions and Brokerage" in the SAI
for additional information.
(3) "Other Expenses" assume that (i) all of the Rights are exercised and (ii)
the Fund does not increase the number of shares subject to subscription
pursuant to the Over-Subscription Privilege. Other expenses for the fiscal
year ended December 31, 1995 were 0.51% as a percentage of average net
assets.
The foregoing fee table is intended to assist Fund investors in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. "Other Expenses" have been estimated for the current fiscal year.
Example
An investor would directly or indirectly pay the following expense on a $1,000
investment in the Fund, assuming a 5% annual return throughout the periods:
1 Year 3 Years 5 Years 10 Years
- ------- ------- ------- --------
$52 $81 $113 $203
This Example assumes that all dividends and other distributions are
reinvested at net asset value and that the 1.44% listed under Total Annual
Expenses remains the same in the years shown. The Example also reflects payment
of the 3.75% Sales Load on the entire $1,000 investment. The above tables and
the assumption in the Example of a 5% annual return are required by the
Securities and Exchange Commission (the "Commission") regulations applicable to
all investment companies; the assumed 5% annual return is not a prediction of,
and does not represent, the projected or actual performance of the Fund's
Shares. For a more complete description of certain of the Fund's costs and
expenses, see "Management of the Fund--Investment Management;--Management
Agreement" herein and "Expenses" and "Portfolio Transactions and Brokerage" in
the SAI.
This Example should not be considered a representation of future expenses,
and the Fund's actual expenses may be greater or less than those shown.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The table below sets forth certain specified information for a share of the
Fund's Common Stock outstanding throughout each period presented. This
information is derived from the financial and accounting records of the Fund.
The financial highlights for the eight fiscal years ended December 31, 1995 and
for the period ended December 31, 1987 have been audited by KPMG Peat Marwick
LLP, independent accountants, whose reports thereon were unqualified. The report
of independent accountants has been included in the SAI. This information should
be read in conjunction with the financial statements and notes thereto included
in the SAI.
<TABLE>
<CAPTION>
May 6, 1987
(commencement
Years Ended December 31, of operations)
through
December 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987
------- ------- ------- ------- ------- ------- ------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating
Performance:
Net asset value,
beginning of period $ 10.21 $11.85 $ 11.97 $12.30 $8.70 $10.80 $8.87 $7.45 $ 9.27
Net investment income
(expense) (0.00) (0.07) (0.08) (0.09) (0.10) (0.11) (0.11) (0.11) (0.16)
Net gain/(loss) on
securities (realized and
unrealized) 4.23 (0.34) 1.10 0.58 4.67 (1.34) 2.29 1.53 (1.66)
Total from investment
operations $ 4.23 $(0.41) $1.02 $0.49 $4.57 $(1.45) $ 2.18 $ 1.42 $(1.82)
Less dividends and
distributions:
Tax return of capital
distribution (2.13) (1.23) (1.14) (0.82) (0.97) (0.65) (0.25) -- --
Total dividends and
distributions $(2.13) $(1.23) $(1.14) $(0.82) $(0.97) $(0.65) $(0.25) $ 0.00 $ 0.00
Net asset value, end of
year $12.31 $10.21 $11.85 $11.97 $12.30 8.70 $10.80 8.87 $ 7.45
Market value per share,
end of year $12.625(1) $8.875 $10.875 $12.250 $12.875 $8.750 $9.625 $ 7.375 $6.000
Total Investment Return
(2):
Based on market value per
share +42.3% -7.1% -1.9% +1.5% +58.0% -2.2% +34.2% +22.9% -40.0%
Based on net asset value
per share +41.4% -3.5% +8.5% +4.0% +52.5% -13.4% +24.6% +19.1% -19.7%
Ratios to Average Net
Assets:
Expenses 1.51% 1.52% 1.39% 1.44% 1.79% 2.01% 2.13% 2.56% 4.32%*
Net investment income
(expense) (0.03%) (0.59%) (0.74%) (0.83%) (0.85%) (1.05%) (1.10%) (1.30%) (1.80%)*
Supplemental Data:
Net assets at end of year
(000 omitted) $74,402 $59,093 $67,321 $68,013 $64,461 $45,581 $54,136 $44,462 $37,316
Average net assets during
year (000 omitted) $72,202 $66,064 $69,048 $64,644 $58,900 $51,121 $50,522 $43,422 $44,062
Portfolio turnover 110% 105% 89% 89% 70% 75% 80% 83% 98%*
Total debt outstanding at
end of year (000 omitted) -0- -0- -0- -0- $1,060 $ 1,724 $ 2,324 $ 2,868 $ 3,360
Asset coverage per $1000
of debt (000 omitted) N/A N/A N/A N/A 60.8 $26.4 $23.3 $15.5 $ 11.1
</TABLE>
*Annualized.
(1) The Fund declared a $2.133 capital gain distribution payable to shareholders
of record on December 29, 1995. The dividend was paid on January 26, 1996
and the Fund's shares traded with the dividend until the ex-dividend date,
January 29, 1996.
(2) Total investment return based on market value per share reflects performance
of the Fund during each period measured against the actual market value per
share. Total investment return based on net asset value per share reflects
the effect of changes in net asset value resulting from the performance of
the Fund during each period measured against the Fund's net asset value.
Both calculations assume distributions, if any, were reinvested.
4
<PAGE>
THE OFFER
Purpose of the Offer
The Board of Directors of the Fund has determined that it would be in the best
interests of the Fund and its shareholders to increase the assets of the Fund
available for investment, thereby enabling the Fund to more fully take advantage
of investment opportunities consistent with the Fund's investment objectives.
The Fund's Board of Directors has voted unanimously to approve the terms of the
Offer as set forth in this Prospectus.
In reaching its decision, the Board of Directors considered, among other
things, advice by the Investment Manager that new funds would allow the Fund
additional flexibility to capitalize on available investment opportunities
without the necessity of having to sell existing portfolio securities that the
Investment Manager believes should be held. Although the Investment Manager
currently expects moderate growth in the U.S. economy, it believes attractive
investment opportunities exist in the market for small capitalization companies.
The Investment Manager believes that the growth prospects for small
capitalization companies are generally more dependent on individual company
developments (e.g. new products and services) than on the performance of the
overall economy. The Investment Manager also believes that valuations of many
small capitalization companies are attractive relative to their forecasted
earnings. Proceeds from the Offer will allow the Investment Manager to better
take advantage of such existing and future investment opportunities.
The Board of Directors also considered that the Offer would provide
shareholders with an opportunity to purchase additional shares of the Fund below
both its market price and net asset value. The Board of Directors also took into
account that a well-subscribed rights offering may result in certain economies
of scale which could in turn marginally reduce the Fund's expense ratio in
future years, and could increase the liquidity of the Fund's shares of the NYSE.
Finally, the Board of Directors considered that, because the Subscription Price
per Share will be less than the net asset value per share on the Pricing Date,
the Offer will result in dilution of the net asset value per share, but the
Board believes that the factors in favor of the Offer outweigh this dilution.
See "Special Risk Considerations--Dilution and Effects of Non-Participation in
the Offer."
The Fund's Investment Manager will benefit from the Offer because the
Investment Manager's fee is based on the weekly average net assets of the Fund.
It is not possible to state precisely the amount of additional compensation the
Investment Manager will receive as a result of the Offer because it is not known
how many Shares will be subscribed for and because the proceeds of the Offer
will be invested in additional portfolio securities, which will fluctuate in
value. See "Management of the Fund".
The Fund may, in the future and at its discretion, choose to make additional
rights offerings from time to time for a number of shares and on terms which may
or may not be similar to the Offer. Any such future rights offerings will be
made in accordance with the requirements of the Investment Company Act of 1940,
as amended (the "1940 Act").
Terms of the Offer
The Fund is issuing to holders of its common stock (the "Common Stock") of
record as of the close of business on May 20, 1996 (the "Record Date"),
non-transferable rights (the "Rights") to subscribe for an aggregate of
2,138,337 Shares (2,672,921 Shares if the Fund increases the number of shares
available by up to 25% in connection with the Over-Subscription Privilege). Each
shareholder is being issued one Right for each whole share of Common Stock owned
on the Record Date. The Rights entitle the holders thereof to subscribe for one
Share for every three Rights held (1 for 3). Fractional shares will not be
issued upon the exercise of Rights. Shareholders who receive or have remaining
fewer than three Rights will not be able to purchase a Share upon the exercise
of such Rights and will not be entitled to receive any cash in lieu thereof,
although such shareholders may subscribe for additional Shares pursuant to the
Over-Subscription Privilege. Rights may be exercised at any time during the
Subscription Period,
5
<PAGE>
which commences on May 20, 1996 and ends at 5:00 p.m. New York City time, on
June 14, 1996, unless extended by the Fund until 5:00 p.m., New York City time,
to a date not later than June 21, 1996 (such date, as it may be extended,
referred to herein as the "Expiration Date"). See "--Expiration of the Offer". A
shareholder's right to acquire during the Subscription Period at the
Subscription Price one additional Share for every three Rights held is
hereinafter referred to as the "Primary Subscription". The Rights are evidenced
by subscription certificates ("Subscription Certificates"), which will be mailed
to shareholders of record, except as discussed below under "Foreign
Restrictions".
Any shareholder who fully exercises all Rights issued to such shareholder in
the Primary Subscription will be entitled to subscribe for additional Shares at
the Subscription Price pursuant to the terms of the Over-Subscription Privilege,
as described below. Shares available, if any, pursuant to the Over-Subscription
Privilege are subject to allotment and may be subject to increase, as is more
fully discussed below under "Over-Subscription Privilege". For purposes of
determining the maximum number of Shares a shareholder may acquire pursuant to
the Offer, shareholders whose Shares are held of record by Cede & Co. Inc.
("Cede") or by any other depository or nominee will be deemed to be the holders
of the Rights that are issued to Cede or such other depository or nominee on
their behalf.
Over-Subscription Privilege
To the extent shareholders do not exercise all of the Rights issued to them,
any underlying Shares represented by such Rights will be offered by means of the
Over-Subscription Privilege to the shareholders who have exercised all the
Rights issued to them and who wish to acquire more than the number of Shares to
which they are entitled. Only Shareholders who exercise all the Rights issued to
them may indicate, on the Subscription Certificate, which they submit with
respect to the exercise of the Rights issued to them, how many Shares they
desire to purchase pursuant to the Over-Subscription Privilege. If sufficient
Shares remain after completion of the Primary Subscription, all
over-subscription requests will be honored in full. If sufficient Shares are not
available to honor all over-subscription requests, the Fund may, at the
discretion of the Board of Directors, issue shares of Common Stock up to an
additional 25% of the Shares available pursuant to the Offer, or 534,584
additional Shares of Common Stock in order to cover such over-subscription
requests. Regardless of whether the Fund issues additional Shares pursuant to
the Offer and to the extent Shares are not available to honor all over-
subscription requests, the available Shares will be allocated among those who
over-subscribe based on the number of Shares owned by them in the Fund on the
Record Date. The allocation process may involve a series of allocations in order
to assure that the total number of Shares available for over-subscription is
distributed on a pro rata basis. The Fund will not offer to sell in connection
with the Offer any Shares that are not subscribed for pursuant to the Primary
Subscription or the Over-Subscription Privilege.
Subscription Price
The Subscription Price for the Shares to be issued pursuant to the Offer will
be 95% of the lower of (i) the average of the last reported sale prices of a
share of the Fund's Common Stock on the NYSE on the date of the expiration of
the Offer (the "Pricing Date") and the four preceding business days or (ii) the
net asset value per share as of the close of business on the Pricing Date. For
example, if the average of the last reported sales price on the NYSE on the
Pricing Date and the four preceding business days of a share of the Fund's
Common Stock is $11.00, and the net asset value per share on the Pricing Date is
$10.00, the Subscription Price will be $9.50 (95% of $10.00). If, however, the
average of the last reported sales prices on the NYSE on the Pricing Date and
the four preceding business days is $11.00, and the net asset value per share on
the Pricing Date is $12.00, the Subscription Price will be $10.45 (95% of
$11.00).
The Fund first announced that the Fund was contemplating the Offer after the
close of trading on the NYSE on April 4, 1996 and announced the terms of the
Offer after the close of trading on May 8, 1996. The net asset value per share
of Common Stock at the close of business on April 4, 1996 (the last trading date
on which the Fund calculated its net asset value per share prior to the
announcement),
6
<PAGE>
May 3, 1996 (the last trading date on which the Fund calculated its net asset
value per share prior to the announcement of the terms) and on May 17, 1996 (the
last trading date on which the Fund calculated its net asset value prior to the
Record Date) was $12.74, $13.56 and $14.15, respectively, and the last reported
sales price of a share of the Fund's Common Stock on the NYSE on those dates was
$10.50, $11.125 and $11.375, respectively.
Non-Transferability of Rights
The Rights are non-transferable and, therefore, may not be purchased or sold.
The Rights will not be listed for trading on the NYSE or any other exchange.
However, the additional Shares of Common Stock to be issued upon the exercise of
the Rights and the Over-Subscription Privilege will be listed for trading on the
NYSE, subject to notice of official issuance.
Expiration of the Offer
The Offer will expire at 5:00 p.m., New York City time, on June 14, 1996,
unless extended by the Fund until 5:00 p.m., New York City time, to a date or
dates not later than June 21, 1996. The Rights will expire on the Expiration
Date and thereafter may not be exercised. Since the Expiration Date and the
Pricing Date will be the same date, shareholders who decide to acquire Shares in
the Primary Subscription or pursuant to the Over-Subscription Privilege will not
know when they make such decision the purchase price of such Shares. Any
extension of the Offer will be followed as promptly as practicable by
announcement thereof. Such announcement shall be issued no later than 9:00 a.m.,
New York City time, on the next business day following the previously scheduled
Expiration Date. Without limiting the manner in which the Fund may choose to
make such announcement, the Fund will not, unless otherwise required by law,
have any obligation to publish, advertise or otherwise communicate any such
announcement other than by making a release to the Dow Jones News Service or
such other means of announcement as the Fund deems appropriate.
Method of Exercise of Rights
Rights are evidenced by subscription certificates ("Subscription
Certificates") which will be mailed to shareholders or, if a shareholder's
shares of Common Stock are held by Cede or any other depository or nominee on
their behalf, to Cede or such depository or nominee. Rights may be exercised by
filling in completely and signing the Subscription Certificate which accompanies
this Prospectus and mailing it in the envelope provided, or otherwise delivering
the completed and signed Subscription Certificate to the Subscription Agent,
together with payment in full for the Shares at the estimated Subscription Price
(the "Estimated Subscription Price") as described below under "Payment for
Shares". Rights may also be exercised by a shareholder contacting his or her
broker, banker or trust company, which can arrange, on his or her behalf, to
guarantee delivery of payment (using a "Notice of Guaranteed Delivery") and of a
properly completed and executed Subscription Certificate. A fee may be charged
for this service. Since fractional Shares will not be issued, and shareholders
who receive or who have remaining, fewer than three Rights will not be entitled
to purchase a Share upon the exercise of such Rights but will be able to request
additional Shares pursuant to the terms of the Offer applicable to the
Over-Subscription Privilege. Completed Subscription Certificates must be
received by the Subscription Agent prior to 5:00 p.m., New York City time, on
the Expiration Date (unless the guaranteed delivery procedures are complied with
as described below under "Payment for Shares") at the offices of the
Subscription Agent at the address set forth below.
Shareholders who Are Record Owners. Shareholders who are record owners can
choose between either option set forth under "Payment for Shares" below. If time
is of the essence, option (2), under "Payment for Shares" below, will permit
delivery of the Subscription Certificate and payment after the Expiration Date.
Shareholders whose Shares Are Held By A Nominee. Shareholders whose shares
are held by a nominee, such as a broker or trustee, must contact such nominee
to exercise their Rights. In that case,
7
<PAGE>
the nominee will complete the Subscription Certificate on behalf of the investor
and arrange for proper payment by one of the methods set forth under "Payment
for Shares" below.
Nominees. Nominees who hold shares of Common Stock for the account of others
must notify the beneficial owners of such shares as soon as possible to
ascertain such beneficial owners' intentions and to obtain instructions with
respect to the Rights. If the beneficial owner so instructs, the nominee should
complete the Subscription Certificate and submit it to the Subscription Agent
with the proper payment described under "Payment for Shares" below.
Foreign Restrictions
Record Date shareholders whose record addresses are outside the United States
(for these purposes the United States includes its territories and possessions
and the District of Columbia) will receive written notice of the Offer; however
Subscription Certificates will not be mailed to such shareholders. The Rights to
which those Subscription Certificates relate will be held by the Subscription
Agent for such foreign Record Date shareholders' accounts until instructions are
received to exercise the Rights. If no such instructions are received by the
Expiration Date, such rights will expire.
Subscription Agent
The Subscription Agent is The Bank of New York, which will receive for its
administrative, processing, invoicing and other services as subscription agent,
a fee estimated to be approximately $35,000 including reimbursement for all
out-of-pocket expenses related to the Offer. Questions regarding the
Subscription Certificates should be directed to The Bank of New York, Tender &
Exchange Department, P.O. Box 11248, Church Street Station, New York, New York
10286-1248, (800) 507-9357 (toll free); shareholders may also consult their
brokers or nominees. Signed Subscription Certificates must be sent, together
with payment at the Estimated Subscription Price for all Shares subscribed in
the Primary Subscription and Over-Subscription Privilege by one of the methods
described below, prior to 5:00 p.m., New York City time, on the Expiration Date.
Alternatively, if using a Notice of Guaranteed Delivery, the Notice of
Guaranteed Delivery (see "Method of Exercise of Rights" above) may also be sent
by facsimile to (212) 815-6213, with the originals to be sent promptly
thereafter by one of the methods described below. Facsimiles should be confirmed
by telephone to (800) 507-9357.
(1) BY FIRST CLASS MAIL OR EXPRESS MAIL:
The Bank of New York
Attention: Tender & Exchange Department
P.O. Box 11248
Church Street Station
New York, New York 10286-1248
(2) BY HAND OR OVERNIGHT COURIER:
The Bank of New York
Attention: Tender & Exchange Department
101 Barclay Street
Receive and Deliver Window
New York, New York 10286
(3) BY FACSIMILE (TELECOPIER), with the original Subscription
Certificate to be sent by one of the methods described above:
(212) 815-6213
Confirm by telephone (800) 507-9357
Delivery to an address other than one of the addresses listed above will
not constitute valid delivery.
8
<PAGE>
Information Agent
Any questions or requests for assistance may be directed to the Information
Agent at its telephone number and address listed below:
The Information Agent for the Offer is:
Corporate
Investor Communications, Inc.
111 Commerce Road
Carlstadt, New Jersey 07072-8017
Toll Free: (800) 459-8562
or
Call Collect: (212) 896-1900
Shareholders may also contact their brokers or nominees for information with
respect to the Offer.
The Information Agent will receive a fee estimated to be approximately
$40,000 including reimbursement for all out-of-pocket expenses related to the
Offer.
Payment for Shares
Shareholders who acquire Shares in the Primary Subscription and pursuant to
the Over-Subscription Privilege may choose between the following methods of
payment:
(1) A shareholder can send the Subscription Certificate together with payment
for the Shares acquired in the Primary Subscription and for additional Shares
subscribed for pursuant to the Over-Subscription Privilege to the Subscription
Agent. Payment should be calculated on the basis of the Estimated Subscription
Price of $10.81 per Share for all Shares requested. To be accepted, such
payment, together with the executed Subscription Certificate, must be received
by the Subscription Agent at one of the Subscription Agent's offices at the
addresses set forth above prior to 5:00 p.m., New York City time, on the
Expiration Date. The Subscription Agent will deposit all checks and money orders
received by it prior to the final payment date into a segregated
interest-bearing account (which interest will be paid to the Fund) pending
proration and distribution of Shares. A PAYMENT PURSUANT TO THIS METHOD MUST BE
IN UNITED STATES DOLLARS BY MONEY ORDER OR CHECK DRAWN ON A BANK LOCATED IN THE
UNITED STATES, MUST BE PAYABLE TO MORGAN GRENFELL SMALLCAP FUND, INC. AND MUST
ACCOMPANY A COMPLETED SUBSCRIPTION CERTIFICATE FOR SUCH SUBSCRIPTION CERTIFICATE
TO BE ACCEPTED. BECAUSE UNCERTIFIED PERSONAL CHECKS MAY TAKE AT LEAST FIVE
BUSINESS DAYS TO CLEAR AND, MAY AT THE DISCRETION OF THE FUND, NOT BE ACCEPTED
IF NOT CLEARED PRIOR TO THE EXPIRATION DATE, SHAREHOLDERS ARE ENCOURAGED TO PAY,
OR ARRANGE FOR PAYMENT, BY MEANS OF A CERTIFIED OR CASHIER'S CHECK OR MONEY
ORDER.
(2) Alternatively, a subscription will be accepted by the Subscription Agent
if, prior to 5:00 p.m., New York City time, on the Expiration Date, the
Subscription Agent has received a Notice of Guaranteed Delivery by facsimile
(telecopy) or otherwise from a bank, a trust company, or a NYSE member
guaranteeing delivery of (i) payment of the Estimated Subscription Price of
$10.81 per share for the Shares subscribed for in the Primary Subscription and
for any additional Shares subscribed for pursuant to the Over-Subscription
Privilege, and (ii) a properly completed and executed Subscription Certificate.
The Subscription Agent will not honor a Notice of Guaranteed Delivery unless a
properly completed and executed Subscription Certificate together with full
payment is received by the Subscription Agent by the close of business on the
third business day after the Expiration Date (June 19, 1996, unless the Offer is
extended).
Within eight business days following the Expiration Date (June 26, 1996),
unless the Offer is extended (the "Confirmation Date"), a confirmation will be
sent by the Subscription Agent to each subscribing shareholder (or, if the
shareholder's shares of Common Stock are held by Cede or any other depository or
nominee, to Cede or such depository or nominee), showing (i) the number of
Shares
9
<PAGE>
acquired pursuant to the Primary Subscription, (ii) the number of Shares, if
any, acquired pursuant to the Over-Subscription Privilege, (iii) the per Share
and total purchase price of the Shares, and (iv) any additional amount payable
by such shareholder to the Fund or any excess to be refunded by the Fund to such
shareholder, in each case based on the Subscription Price as determined on the
Pricing Date. If any shareholder exercises his right to acquire Shares pursuant
to the Over-Subscription Privilege, any such excess payment which would
otherwise be refunded to the shareholder will be applied by the Fund toward
payment for additional Shares acquired pursuant to exercise of the
Over-Subscription Privilege. Any additional payment required from a shareholder
must be received by the Subscription Agent within ten business days after the
Confirmation Date (July 11, 1996, unless the Offer is extended). Any excess
payment to be refunded by the Fund to a shareholder will be mailed by the
Subscription Agent to such shareholder as promptly as possible. All payments by
a shareholder must be in United States dollars by money order or check drawn on
a bank located in the United States of America and payable to MORGAN GRENFELL
SMALLCAP FUND, INC.
The Subscription Agent will deposit all checks received by it prior to the
final date into a segregated interest-bearing account (which interest will
accrue to the benefit of the Fund) pending distribution of the Shares.
Whichever of the two methods described above is used, issuance and delivery
of certificates for the Shares purchased are subject to collection of checks and
actual payment pursuant to any Notice of Guaranteed Delivery.
Shareholders will have no right to rescind their subscription after receipt
of their payment for Shares by the Subscription Agent, except as provided below
under "Notice of Net Asset Value Decline".
If a Shareholder who acquires Shares pursuant to the Primary Subscription or
Over-Subscription Privilege does not make payment of any additional amounts due
by the tenth Business Day after the Confirmation Date, the Fund reserves the
right to take any or all of the following actions: (i) sell such subscribed and
unpaid-for Shares to other shareholders, (ii) apply any payment actually
received by it toward the purchase of the greatest whole number of Shares which
could be acquired by such holder upon exercise of the Primary Subscription or
Over-Subscription Privilege, or (iii) exercise any and all other rights or
remedies to which it may be entitled.
THE METHOD OF DELIVERY OF SUBSCRIPTION CERTIFICATES AND PAYMENT OF THE
SUBSCRIPTION PRICE TO THE FUND WILL BE AT THE ELECTION AND RISK OF THE RIGHTS
HOLDERS, BUT IF SENT BY MAIL IT IS RECOMMENDED THAT SUCH CERTIFICATES AND
PAYMENT BE SENT BY REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT
REQUESTED, AND THAT A SUFFICIENT NUMBER OF DAYS BE ALLOWED TO ENSURE DELIVERY TO
THE FUND AND CLEARANCE OF PAYMENT PRIOR TO 5:00 P.M., NEW YORK CITY TIME, ON THE
EXPIRATION DATE. BECAUSE UNCERTIFIED PERSONAL CHECKS MAY TAKE AT LEAST FIVE
BUSINESS DAYS TO CLEAR AND, MAY AT THE DISCRETION OF THE FUND, NOT BE ACCEPTED
IF NOT CLEARED PRIOR TO THE EXPIRATION DATE, YOU ARE STRONGLY ENCOURAGED TO PAY,
OR ARRANGE FOR PAYMENT, BY MEANS OF CERTIFIED OR CASHIER'S CHECK OR MONEY ORDER.
All questions concerning the timeliness, validity, form and eligibility of
any exercise of Rights will be determined by the Fund, whose determinations will
be final and binding. The Fund in its sole discretion may waive any defect or
irregularity, or permit a defect or irregularity to be corrected within such
time as it may determine, or reject the purported exercise of any Right.
Subscriptions will not be deemed to have been received or accepted until all
irregularities have been waived or cured within such time as the Fund determines
in its sole discretion. The Fund will not be under any duty to give notification
of any defect or irregularity in connection with the submission of Subscription
Certificates or incur any liability for failure to give such notification.
10
<PAGE>
Notice of Net Asset Value Decline
The Fund has, pursuant to the Commission's regulatory requirements,
undertaken to suspend the Offer until it amends this Prospectus if,
subsequent to May 15, 1996, the effective date of the Fund's Registration
Statement, the Fund's net asset value declines more than 10% from its net asset
value as of that date. Accordingly, the Fund will notify shareholders of any
such decline and thereby permit them to cancel their exercise of Rights prior to
the extended expiration date as defined herein.
Delivery of Share Certificates
Stock certificates for all Shares acquired in the Primary Subscription will be
mailed promptly after the expiration of the Offer and full payment for the
subscribed Shares has been received and cleared. Certificates representing
Shares acquired pursuant to the Over-Subscription Privilege will be mailed as
soon as practicable after full payment has been received and cleared and all
allocations have been effected. Participants in the Fund's Dividend Reinvestment
Plan (the "Plan") will have any Shares acquired in the Primary Subscription and
pursuant to the Over-Subscription Privilege credited to their shareholder
dividend reinvestment accounts in the Plan. Participants in the Plan wishing to
exercise Rights for the shares of Common Stock held in their accounts in the
Plan must exercise them in accordance with the procedures set forth above. Stock
certificates will be issued for Shares credited to Plan accounts. Shareholders
whose shares of Common Stock are held of record by Cede or by any other
depository or nominee on their behalf or their broker-dealers' behalf will have
any Shares acquired in the Primary Subscription credited to the account of Cede
or such other depository or nominee. Shares acquired pursuant to the
Over-Subscription Privilege will be certificated and stock certificates
representing such Shares will be sent directly to Cede or such other depository
or nominee.
Federal Income Tax Consequences
The U.S. Federal income tax consequences to holders of Common Stock with
respect to the Offer will be as follows:
The distribution of Rights will not result in taxable income to a shareholder
nor will the Rights holder recognize gain or loss as a result of the exercise of
the Rights.
If the fair market value of the Rights as of the date of their distribution
equals or exceeds 15% of the fair market value of the Common Stock with respect
to which they are distributed, a U.S. shareholder's basis in such Common Stock
must be allocated between such Common Stock and the Rights in proportion to
their respective fair market values on the date of distribution. If the fair
market value of the Rights as of the date of their distribution is less than 15%
of the fair market value of the Common Stock with respect to which they are
distributed, however, a U.S. shareholder's basis in such Common Stock will
remain unchanged and the basis in such Rights will be zero, unless such U.S.
shareholder affirmatively and irrevocably elects (in a statement attached to
such shareholder's U.S. Federal income tax return for the year in which the
Rights are received) to allocate the basis in the Common Stock between such
Common Stock and the Rights in proportion to their respective fair market values
on the date of distribution.
If the Right is exercised by the holder of Common Stock, the basis of the
Common Stock received will equal the sum of the basis, if any, allocated to the
Right and the Subscription Price; and the holding period of the Common Stock
acquired upon such exercise will begin on the date the Right is exercised.
If Rights issued to a U.S. shareholder expire without being sold or
exercised, no basis will be allocated to said Rights, and such shareholder will
not recognize any gain or loss for U.S. Federal income tax purposes upon such
expiration.
The foregoing is only a general summary of the applicable U.S. Federal income
tax law and does not include any state, local or foreign tax consequences of the
Offer. Such applicable U.S. Federal income tax law is subject to change by
legislative or administrative action. Shareholders should consult their tax
advisers concerning the tax consequences of the Offer. See "Taxation" herein and
in the SAI.
11
<PAGE>
Employee Plan Considerations
Shareholders that are employee benefit plans subject to the Employee
Retirement Income Security Act of 1974, as amended ("ERISA") (including
corporate savings and 401(k) plans), Keough or H.R. 10 plans of self-employed
individuals and Individual Retirement Accounts ("IRAs") (collectively, "Plans")
should be aware that additional contributions of cash to the Plan (other than
rollover contributions or trustee-to-trustee transfers from other Plans) in
order to exercise Rights would be treated as Plan contributions and, when taken
together with contributions previously made, may subject a Plan, among other
things, to excise taxes for excess or nondeductible contributions. In the case
of Plans qualified under Section 401(a) of the Code, additional cash
contributions could cause the maximum contribution limitations of Section 415 of
the Code or other qualification rules to be violated. Permitted contributions to
IRAs are subject to annual maximums (generally equal to the lesser of 100% of an
individual's earned income or $2,000, but up to $2,250 for an individual and his
or her non-earning spouse). The deductibility of such contributions may be
reduced or eliminated for particular shareholders, depending upon their income
levels and other factors. Other types of Plans are subject to different
contribution limitations and other restrictions concerning which shareholders
should consult their own tax advisers.
ERISA contains fiduciary responsibility requirements, and ERISA and the Code
contain prohibited transaction rules, that may impact the exercise of Rights.
Due to the complexity of these rules and the penalties for noncompliance, Plans
should consult with their counsel regarding the consequences of their exercise
of Rights under ERISA and the Code.
Dilution and Effect of Non-Participation in the Offer
Upon the completion of the Offer, shareholders who do not exercise their
Rights fully will own a smaller proportional interest in the Fund than would be
the case if the Offer had not been made. In addition, because the Subscription
Price of each Share will be less than the net asset value per share of the
Fund's Common Stock as of the Pricing Date, the Offer will result in a dilution
of the net asset value per share for all shareholders, which will
disproportionately affect shareholders who do not exercise their Rights in full.
Although it is not possible to state precisely the amount of such decrease in
net asset value because it is not known at the date of this Prospectus how many
Shares will be subscribed for, or what the Subscription Price will be, such
dilution may be substantial. For example, assuming all of the Shares are sold at
the Estimated Subscription Price and after deducting all expenses related to the
issuance of the Shares, the Fund's net asset value per share on May 17, 1996
would be reduced by approximately $0.98 or 6.9% (or, in the event that all of
the Rights are exercised and the Fund increases the number of Shares subject to
subscription by 25% pursuant to the Over-Subscription Privilege, by
approximately $1.14 or 8.1%). See "Special Risk Considerations--Dilution and
Effect of Non-Participation in the Offer".
Important Dates to Remember
<TABLE>
<CAPTION>
Event Date
- --------------------------------------------------------- ------------------------------
<S> <C>
Record Date May 20, 1996
Subscription Period May 20, 1996--June 14, 1996*
Expiration Date and Pricing Date June 14, 1996*
Subscription Certificates and Payment for Shares Due+ June 14, 1996*
Notice of Guaranteed Delivery Due+ June 14, 1996*
Payment of Guarantees of Delivery Due June 19, 1996*
Confirmation to Participants June 26, 1996*
Final Payment for Shares July 11, 1996*
</TABLE>
* Unless the Offer is extended to a date not later than June 21, 1996.
+ A shareholder exercising Rights must deliver by the Expiration Date either (i)
the Subscription Certificate together with payment or (ii) a Notice of
Guaranteed Delivery.
12
<PAGE>
THE FUND
Morgan Grenfell SMALLCap Fund, Inc., incorporated in Maryland on January 16,
1987, is a diversified, closed-end management investment company registered
under the 1940 Act. The Fund seeks, as a primary investment objective, long-term
capital appreciation principally by investing in equity and equity-related
securities of U.S. companies. The Fund also seeks current income as a secondary
investment objective. See "Investment Objectives and Policies". No assurance can
be given that the Fund's investment objectives will be realized.
The Fund's Investment Manager is Morgan Grenfell Capital Management, Inc., an
indirect U.S. subsidiary of London based Deutsche Morgan Grenfell Group PLC
("Deutsche Morgan Grenfell"). Duetsche Morgan Grenfell is an indirect
wholly-owned subsidiary of Deutsche Bank AG, and is responsible for Deutsche
Bank Group's institutional investment management activities worldwide. The
Investment Manager is registered with the Commission under the Investment
Advisers Act of 1940. Such registration does not involve supervision or approval
by the Commission of investment advice rendered by the Investment Manager. See
"Management of the Fund".
The Fund completed an initial public offering of 5,000,000 shares of its
Common Stock in May 1987. The net proceeds to the Fund from such offering were
approximately $46,375,000. As of May 17, 1996, the net assets of the Fund were
$90,745,731 and, since inception, the Fund had paid or declared dividends and
capital gains distributions aggregating $40,564,602. The increase in the Fund's
net assets since inception is attributable primarily to appreciation in the
value of its portfolio securities.
USE OF PROCEEDS
If all of the Rights are exercised in full and assuming a Subscription Price
of $10.81 per share (95% of the last reported sale price per share on the NYSE
on May 17, 1996), the net proceeds to the Fund would be approximately
$21,848,595, after deducting expenses payable by the Fund, including the fees
and expenses of the Dealer Manager and soliciting broker-dealers and other
offering expenses estimated to total $400,000. If the Fund increases the number
of Shares subject to subscription by up to 534,584 Shares, in order to satisfy
over-subscription requests, the additional net proceeds will be approximately
$5,562,146. However, there can be no assurance that all Rights will be exercised
in full, and the Subscription Price will not be determined until the close of
business on the Expiration Date. The Fund anticipates that the net proceeds of
the Offer will be fully invested in investments conforming to the Fund's
investment objectives and policies within six months from the Expiration Date.
Pending such investment, the proceeds will be invested in cash or cash
equivalent short-term obligations including, but not limited to, U.S. Government
obligations, certificates of deposit, commercial paper and short-term notes.
13
<PAGE>
MARKET PRICE AND NET ASSET VALUE INFORMATION
Shares of the Fund's Common Stock, $0.01 par value, are listed on the NYSE
under the symbol "MGC". The following table sets forth for the Common Stock for
the calendar quarters indicated: (i) the per share high and low net asset
values, (ii) the per share high and low market prices on the NYSE, (iii) the
premium (discount) to net asset value, and (iv) the volume of trading on the
NYSE.
<TABLE>
<CAPTION>
Premium/
(Discount) Volume of
Net Asset Market Prices to Net Asset Trading
Value (1) Value (1)
-------------- ---------------- --------------- (in
Common Stock High Low High Low High Low shares)
- ---------------------- ----- ----- ------ ------ ------ ----- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
1994
First Quarter $12.65 $11.55 $11.625 $ 9.875 (15.0)% (2.7)% 810,400
Second Quarter 11.70 10.50 10.250 9.250 (15.5) (8.3) 514,600
Third Quarter 11.78 10.69 10.000 9.125 (18.0) (12.4) 681,100
Fourth Quarter 11.89 9.79 9.750 8.500 (18.4) (12.4) 824,600
1995
First Quarter 11.17 10.13 9.250 8.625 (19.0) (10.3) 820,400
Second Quarter 12.24 11.02 10.625 9.125 (18.6) (12.5) 787,300
Third Quarter 14.07 12.52 12.500 10.375 (18.7) (11.2) 1,027,000
Fourth Quarter 14.45 13.42 12.625 11.250 (17.4) (11.4) 669,500
1996
First Quarter 13.99 12.02 13.00 10.125 (16.3) (5.0) 1,671,100
Second Quarter
(through
May 17, 1996) 14.15 12.58 11.625 10.500 (19.6) (15.5) 651,000
</TABLE>
(1) As reported by the NYSE.
Since the Fund's inception in May 1987, the Fund's Common Stock has generally
traded at a discount to net asset value. Officers of the Fund cannot determine
the reason for the Fund's Common Stock trading at a premium or discount to net
asset value, nor can they predict whether the Fund's Common Stock will trade in
the future at a premium or discount to net asset value and if so, the level of
such premium or discount. Shares of closed end investment companies frequently
trade at a discount from net asset value.
On May 17, 1996, the net asset value per share of Common Stock was $14.15 and
the last reported sales price was $11.375, representing a discount from net
asset value per share of 19.6%.
INVESTMENT OBJECTIVES AND POLICIES
Investment Objectives
The Fund's primary investment objective is to seek long-term capital
appreciation by investing principally in equity and equity-related securities of
U.S. companies. The Fund seeks current income as a secondary investment
objective. There is no assurance that the Fund will achieve its investment
objectives. The Fund's primary investment objective may not be changed without
the approval of a majority of the Fund's outstanding securities. As used in this
Prospectus, the term "majority of the Fund's outstanding voting securities"
means the lesser of either (i) 67% of the shares represented at a shareholders
meeting at which the holders of more than 50% of the outstanding shares are
present in person or by proxy, or (ii) more than 50% of the outstanding shares.
Except as indicated under "Investment Restrictions" in the SAI, the Fund does
not consider its other policies, including its secondary investment objective of
current income, to be fundamental, and such policies may be changed by the Board
of Directors without shareholder approval.
14
<PAGE>
Investment Policies
The Fund's investments are made principally in publicly traded securities of
small capitalization companies in a variety of industries. The Fund primarily
invests in securities of U.S. issuers. Equity and equity-related securities
include common stocks, preferred stocks and securities convertible into or
exchangeable for such equity securities. For purposes of the Fund's investment
policies, small capitalization companies are those ranked (at the time of
investment) according to market capitalization in the bottom 20% of all issuers
listed or quoted on a national securities exchange or market. Within this
universe, the Fund focuses on companies with market capitalizations of between
$100 million and $1.6 billion. At December 31, 1995, the median market
capitalization of companies held in the Fund was $684 million.
Investments in equity securities of small capitalized companies generally
involve both the opportunity for greater rewards and more risk than an
investment in common stocks of larger, better-known companies. The Investment
Manager believes that greater opportunities for superior returns exist from
investments in small capitalization companies. These issuers are not as
well-known to the general public, may have less investor following, and,
therefore, may provide opportunities for investment gains due to the relative
inefficiencies in this sector of the marketplace.
The Fund seeks to invest in small capitalization companies the earnings of
which are expected by the Investment Manager to grow faster than both inflation
and the economy in general and where the Investment Manager believes that such
growth potential has not yet been fully reflected in the market price. In
seeking such investments, the Investment Manager considers a variety of factors
including quality of management, a leading or dominant position in a major
product line, a sound financial position, and a relatively high rate of return
on invested capital so that future growth can be financed from internal sources.
The Fund may also invest in companies which offer the possibility of
accelerating earnings growth because of management changes, new products or
structural changes in the economy.
When, in the opinion of the Investment Manager, temporary defensive positions
are warranted by market or economic conditions, the Fund may invest all or a
portion of its assets in cash or cash equivalent short-term obligations
including, but not limited to, U.S. Government obligations, certificates of
deposit, commercial paper and short-term notes.
The Fund may also engage in other investment practices, such as borrowing,
repurchase agreements, hedging instruments and lending of its portfolio
securities. See "Special Risk Considerations" herein and "Investment Objectives
and Policies" in the SAI.
SPECIAL RISK CONSIDERATIONS
The following discusses certain matters that should be considered, among
others, in connection with the Offer.
Dilution and Effect of Non-Participation in the Offer
Because the Subscription Price will be less than the net asset value per
share of Common Stock on the Pricing Date (and the Fund will incur expenses in
connection with the Offer), the net asset value, on a per share basis, of the
Common Stock outstanding prior to the Offer will be reduced as a result of the
Offer and the number of Shares outstanding after the Offer will increase by a
greater percentage than the increase in the size of the Fund's assets. It is not
possible to state precisely the amount of such decrease in net asset value per
share because it is not known at this time what the Subscription Price will be,
what the net asset value per share will be on the Expiration Date or what
proportion of the Shares will be subscribed for; however, such decrease may be
substantial. For example, assuming (i) all Rights are exercised, (ii) the Fund's
net asset value on the Expiration Date is $14.15 per share (the net asset value
per share on May 17, 1996), and (iii) the Subscription Price is $10.81 per share
(95% of the last reported sale price per share on the NYSE on May 17, 1996),
then the Fund's net asset value per share would be reduced by approximately
$0.98 per share or 6.9%. Record Date shareholders will experience a
15
<PAGE>
decrease in the net asset value per share held by them, irrespective of whether
they exercise all or any portion of their Rights. Moreover, Record Date
shareholders who do not fully exercise their Rights will, at the completion of
the Offer, own a smaller proportional interest in the Fund than they owned prior
to the Offer.
Small Capitalization Companies
The Fund invests principally in smaller, lesser-known companies which the
Investment Manager believes offer greater growth potential than larger, more
mature, better-known companies. Investing in the securities of these companies,
however, also involves greater risk and the possibility of greater portfolio
price volatility. Among the reasons for the greater price volatility of these
small companies and less seasoned stocks are the less certain growth prospects
of smaller firms, the lower degree of liquidity in the markets for such stocks
and the greater sensitivity of small companies to changing economic conditions
in their geographic region. For example, securities of these companies involve
higher investment risk than that normally associated with larger companies due
to the greater business risks of small size and limited product lines, markets,
distribution channels and financial and managerial resources.
Repurchase Agreements
The Fund may enter into repurchase agreements. In a repurchase agreement, the
Fund buys a security subject to the right and obligation to sell it back to the
other party at the same price plus accrued interest. The counterparty furnishes
collateral at least equal in value or market price to its repurchase
obligations. If the other party or "seller" defaults, the Fund might suffer a
loss to the extent that the proceeds from the sale of the underlying securities
and other collateral held by the Fund in connection with the repurchase
agreement are less than the repurchase prices. In addition, in the event of
bankruptcy of the seller or failure of the seller to repurchase the securities
as agreed, the Fund could suffer losses, including loss of interest or principal
of the security and costs associated with delays and enforcement of the
repurchase agreement. The Fund enters into repurchase agreements only with
financial institutions deemed to present minimal risk of bankruptcy during the
term of the agreement based on guidelines established and periodically reviewed
by the Fund's Board of Directors. Not more than 10% of the Fund's net assets
will be invested in repurchase agreements maturing in more than seven days.
Leverage and Borrowing
The Fund is authorized to borrow money in amounts of up to 15% of the value
of its total assets at the time of such borrowings. Borrowings by the Fund
create an opportunity for greater capital appreciation with respect to the
Fund's investment portfolio, but at the same time such borrowing is speculative
in that it will increase the Fund's exposure to capital risk. In addition,
borrowed funds are subject to interest costs that may offset or exceed the
return earned on the borrowed funds. The Fund has not had any outstanding
borrowing since the year ended December 31, 1991.
Certain Investment Strategies
The Fund has no current intention to enter into transactions in options and
futures and has not employed such instruments in the portfolio management of the
Fund since its inception. However, the Fund retains the authority, without
shareholder approval, to use options and futures transactions to increase total
return or to hedge against a decline in the value of securities owned by it or
an increase in the price of securities which it plans to purchase. The use of
options and futures is a highly specialized activity which involves investment
risks and portfolio management skills that are different from those associated
with investments in equity securities. Use of these instruments to seek to
increase total return involves the risk of loss, which may be substantial, if
the Investment Manager is incorrect in its expectation of change in securities
prices. The successful use of options and futures also depends upon the ability
of the Investment Manager to anticipate future price fluctuations and the degree
of correlation between the hedging instrument and securities prices. If the
Investment Manager is incorrect in its
16
<PAGE>
expectation of securities prices or the correlation between these prices and the
value of the hedging instrument, the Fund's investment performance will be less
favorable than it would have been in the absence of the hedging transaction.
Entering into transactions in options and futures also involves additional
expenses for the Fund. See "Investment Objectives and Policies" in the SAI for
additional information concerning options and futures strategies.
Lending of Portfolio Securities
Consistent with applicable regulatory requirements, the Fund, in order to
generate additional income in accordance with its secondary investment
objective, may lend its portfolio securities (principally to broker-dealers,
except the Investment Manager's affiliates, or institutional investors) where
such loans are callable at any time and are continuously secured by collateral
(cash or U.S. Government Securities) at least equal to the current market value
of the securities loaned. The Investment Manager believes the risk of loss on
such transactions is slight because, if a borrower were to default for any
reason, the collateral should satisfy the obligation. The Fund will, as a
fundamental policy, limit such lending to not more than 30% of the value of its
total assets.
Portfolio Turnover
It is estimated that, under normal circumstances, the portfolio turnover
rate of the Fund will not exceed 150%. A high rate of portfolio turnover
(i.e., 100% or higher) will result in correspondingly higher transaction costs
to the Fund, increase the likelihood of realizing net short-term capital gains
(distributions from which are taxable to shareholders as ordinary income) and,
under some circumstances, make it more difficult for the Fund to qualify as a
regulated investment company under the Code. See "Financial Highlights" for the
Fund's portfolio turnover since inception.
Unrealized Appreciation
As of April 30, 1996, there was approximately $19,930,298 or approximately
$3.08 per share of net unrealized appreciation in the Fund's net assets of
approximately $87,781,000; if realized and distributed, or deemed distributed,
such gains would, in general, be taxable to shareholders, including holders at
that time of Shares acquired upon the exercise of Rights. See "Taxation".
Anti-takeover Provisions
The Fund has provisions in its Articles of Incorporation and By-Laws that
are intended to have the effect of limiting the ability of other entities
or persons to acquire control of the Fund, to cause it to engage in certain
transactions or to modify its structure. The Board of Directors is divided into
three classes. At the annual meeting of shareholders each year, the term of one
class will expire and directors will be elected to serve in that class for terms
of three years. This provision could delay for up to two years the replacement
of a majority of the Board of Directors.
These provisions could have the effect of depriving shareholders of an
opportunity to sell their shares at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. See "Common Stock--Special Voting
Provisions".
Discount to Net Asset Value
Since the Fund's commencement of investment operations in May 1987, the
Fund's shares have generally traded in the market at a discount from net
asset value. Officers of the Fund cannot determine the reason why the Fund's
Common Stock has traded at a discount from net asset value, nor can they predict
whether the Fund's Common Stock will in the future trade at a premium to or
discount from net asset value and if so, the level of such premium or discount.
Shares of closed-end investment companies frequently trade at a discount from
net asset value. The risk of the Common Stock trading at a discount is a risk
separate from a decline in the Fund's net asset value. See "Market and Net Asset
Value Information" herein and "Net Asset Value" in the SAI.
17
<PAGE>
MANAGEMENT OF THE FUND
Board of Directors
The management of the Fund, including general supervision of the duties
performed by the Investment Manager under the Investment Management Agreement
(as defined herein), is the responsibility of its Board of Directors. For
certain information regarding the Directors and officers of the Fund, see
"Management--Directors and Officers" in the SAI.
One of the Directors of the Fund resides outside the United States, and
substantially all the assets of this Director are located outside the United
States. It may not be possible, therefore, for investors to effect service of
process within the United States upon this Director or to enforce against him,
in United States courts or foreign courts, judgments obtained in United States
courts predicated upon the civil liability provisions of the federal securities
laws of the United States or the laws of the State of Maryland. In addition, it
is not certain that a foreign court would enforce, in original actions or in
actions to enforce judgments obtained in the United States, liabilities against
this Director predicated solely upon the Federal securities laws.
Investment Manager
Morgan Grenfell Capital Management, Inc., 885 Third Avenue, New York, New
York, acts as Investment Manager to the Fund. The Investment Manager is
registered as an investment adviser with the Commission and provides a full
range of investment advisory services to institutional clients. The Investment
Manager is an indirect wholly-owned subsidiary of Morgan Grenfell Asset
Management Limited ("MGAM"), which is a wholly-owned subsidiary of Deutsche
Morgan Grenfell Group PLC. Deutsche Morgan Grenfell Group PLC is an indirect
wholly-owned subsidiary of Deutsche Bank AG, a commercial and investment banking
group. As of April 30, 1996, the Investment Manager managed approximately $8.1
billion in assets.
Subject to the supervision of the Fund's Board of Directors, the Investment
Manager manages the Fund's investments in accordance with the Fund's investment
objectives, policies and restrictions and makes investment decisions on behalf
of the Fund, including the selection of, and placing of orders with, brokers and
dealers to execute portfolio transactions on behalf of the Fund. The Fund pays
the Investment Manager a fee at the annual rate of 1.00% of the Fund's average
weekly net assets and payable at the end of each calendar month. For the fiscal
years ended December 31, 1995, 1994 and 1993, the fees under the management
agreement (the "Management Agreement") with the Fund amounted to $743,088,
$660,746 and $688,489, respectively. The fees payable by the Fund are higher
than those paid by most other U.S. investment companies due to the greater
efforts and extra research that are required to manage investments in small
capitalization companies but are similar to other funds with similar investment
objectives.
Morgan Grenfell Incorporated, Cyrus J. Lawrence Incorporated or any other
brokerage affiliate (the "Brokerage Affiliate") may act as a broker for the
Fund. In order for the Brokerage Affiliate to effect any portfolio transactions
for the Fund, the commissions, fees or other remuneration received by the
Brokerage Affiliate must be reasonable and fair compared to the commissions,
fees or other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on an exchange
during a comparable period of time. The Fund will not deal with a Brokerage
Affiliate in any portfolio transaction in which the Brokerage Affiliate acts as
principal. However, Brokerage Affiliates may serve as the Fund's broker in
transactions conducted on an exchange or over-the-counter transactions conducted
on an agency basis.
Portfolio Manager
The Fund is managed by a team of three experienced portfolio managers,
Robert Kern, Audrey M.T. Jones and David A. Baratta, and a dedicated
trader, Michael Murphy, who develops execution strategies. Mr. Kern and Ms.
Jones have served as members of the Fund's portfolio management team since the
18
<PAGE>
Fund's inception. Mr. Baratta joined the team in September 1994. Mr. Kern has
been in the investment advisory business since 1965 (with the Investment
Manager since 1986) and has managed investments in small capitalization
companies since 1970. Ms. Jones has been employed by the Investment Manager
as a portfolio manager since 1986. Prior to joining the Investment Manager in
1993, Mr. Baratta worked as a portfolio manager for AIG Global Investors and
Shearson Lehman Asset Management. Mr. Murphy is a senior equity trader with
the Investment Manager. Prior to joining the Investment Manager in 1987, Mr.
Murphy was a partner at Alex Brown, where he specialized in small cap equity
trading. Effective May 10, 1996, Gerald M. Frey, who previously served as a
portfolio manager of the Fund, no longer serves in that capacity.
Management Agreement
The Management Agreement sets forth the services to be provided by and the
fees to be paid to each party, as described above. The Investment Manager
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Fund in connection with matters to which the Management
Agreement relates, except a loss resulting from willful misfeasance, bad faith
or gross negligence in the performance of its duties or by reason of reckless
disregard of its duties and obligations under the Management Agreement.
The services of the Investment Manager to the Fund are not deemed to be
exclusive, and the Investment Manager or any affiliate thereof may provide
similar services to other investment companies and other clients or engage in
other activities.
The Fund pays all of its own expenses, other than those expressly assumed by
the Investment Manager or an affiliate. The expenses payable by the Fund
include, without limitation, organization and offering expenses; fees and
expenses incurred in connection with membership in investment company
organizations; custodian and transfer agent fees; legal, auditing and accounting
expenses; costs of preparing, printing and distributing its proxy statements,
shareholder reports and notices; the costs and/or fees incident to director and
shareholder meetings; Federal and state registration fees; stock exchange
listing fees and expenses; taxes or governmental fees; non-affiliated directors'
fees; interest on its borrowings; brokerage commissions; the cost of preparing
share certificates and the cost of issue, sale and repurchase of its shares;
payment for portfolio pricing services; and any extraordinary expenses of a
non-recurring nature. The Fund will also be required to repay borrowings by it.
The Management Agreement remains in effect provided that such continuance is
specifically approved at least annually by the Board of Directors or by vote of
a majority of the Fund's outstanding voting securities and, in either case, by a
majority of the Directors who are not parties to the Management Agreement or
interested persons of any such party. The Management Agreement terminates
automatically if it is assigned and may be terminated without penalty by vote of
a majority of the Fund's outstanding voting securities or by either party on not
more than 60 days' nor less than 30 days' written notice.
The Management Agreement provides that the Fund may use the name "Morgan
Grenfell" only so long as the Management Agreement or any extension, renewal or
amendment thereof remains in effect. If the Management Agreement is no longer in
effect, the Fund is obligated (to the extent it lawfully can) to cease using
such name or any other name indicating that it is advised by or otherwise
connected with the Investment Manager. In addition, the Investment Manager may
grant the non-exclusive right to use the name "Morgan Grenfell" to any other
entity, including any other investment company of which the Investment Manager
or any of its affiliates is the investment manager.
19
<PAGE>
DIVIDENDS AND DISTRIBUTIONS; DIVIDEND REINVESTMENT PLAN
History of Dividend Payments
The following table shows dividends per share paid by the Fund to its
shareholders since its inception:
<TABLE>
<CAPTION>
Payable Date Source Amount
- ---------------- ------------ -------
<S> <C> <C>
February 1, 1990 Capital Gains $0.250
December 31, 1990 Capital Gains 0.6500
January 31, 1992 Capital Gains 0.9700
December 31, 1992 Cash 0.8205
January 24, 1994 Capital Gains 1.137
January 20, 1995 Capital Gains 1.227
January 26, 1996 Capital Gains 2.133
</TABLE>
The Fund distributes to shareholders, at least annually, all or substantially
all of its net investment income and net realized capital gains. Pursuant to the
Dividend Reinvestment Plan (the "Plan"), all distributions to participants in
the Plan will be automatically reinvested by The Bank of New York (the "Bank"),
as Plan Agent, in Fund shares pursuant to the Plan. Shareholders will be deemed
to participate in the Plan unless (i) they elect to receive all distributions
from net investment income in cash, or (ii) they elect not to receive all
capital gain distributions in the form of a stock dividend and they further make
no election to receive such distributions in cash. Each registered shareholder
will receive from the Plan Agent an authorization card to be signed and returned
if the shareholder elects to receive distributions from net investment income in
cash or elects not to receive capital gain distributions in the form of a stock
dividend. Shareholders who do not participate in the Plan will receive all
distributions in cash paid by check in U.S. dollars mailed directly to the
shareholder by the Bank, as dividend paying agent. In the case of any
distribution to participants in the Plan, the Board of Directors may elect to
pay such distribution in shares of the Fund's Common Stock. For the fiscal year
ended December 31, 1995, the Fund paid distributions from long-term capital
gains of $0.9953 per share and dividends taxable as ordinary income equal to
$1.1377 per share out of ordinary income. In connection with such dividend,
426,804 shares of Common Stock were issued by the Fund in accordance with the
Plan.
The Plan Agent serves as agent for the shareholders in administering the
Plan. If the directors of the Fund declare a dividend, participants in the Plan
will receive stock in the Fund valued, as described below, depending upon the
market price or net asset value determined at the time of purchase (generally
the payable date of the dividend). Whenever market price equals or exceeds net
asset value at the time shares are valued for the purpose of determining the
number of shares equivalent to the cash dividend or distribution, participants
will be issued shares of the Fund at a price equal to the greater of net asset
value or 95% of the then current market price of the Fund's shares. If net asset
value determined as at the time of purchase exceeds the market price of Fund
shares at such time, or if the Fund should declare a dividend or other
distribution payable only in cash (i.e., if the Board of Directors should
preclude reinvestment at net asset value), the Plan Agent will, as agent for the
participants, buy Fund shares in the open market, on the NYSE or elsewhere, for
the participants' accounts. If, before the Plan Agent has completed its
purchases, the market price exceeds the net asset value of a Fund share, the
average per share purchase price paid by the Plan Agent may exceed the net asset
value of the Fund's shares, resulting in the acquisition of fewer shares than if
the dividend or distribution had been paid in shares issued by the Fund.
The Plan Agent maintains all shareholder accounts in the Plan and furnishes
written confirmations of all transactions in the account, including information
needed by shareholders for personal and tax records. Shares in the account of
each Plan participant are held by the Plan Agent in non-certificated form in the
name of the participant, and each shareholder's proxy will include those shares
purchased pursuant to the Plan.
20
<PAGE>
In the case of shareholders, such as banks, brokers or nominees, that hold
shares for others who are the beneficial owners, the Plan Agent administers the
Plan on the basis of the number of shares certified from time to time by the
shareholder as representing the total amount registered in the shareholder's
name and held for the account of beneficial owners who are to participate in the
Plan.
There is no charge to participants for reinvesting dividends or capital gains
distributions. The Plan Agent's fees for the handling of reinvestment of
dividends and distributions will be paid by the Fund. There will be no brokerage
charges with respect to shares issued directly by the Fund as a result of
dividends or capital gains distributions payable either in shares or in cash.
However, each participant will pay a pro rata share of brokerage commissions
incurred with respect to the Plan Agent's open market purchases in connection
with the reinvestment of dividends or capital gains distributions.
The automatic reinvestment of dividends and distributions will not relieve
participants of any U.S. income tax that may be payable on such dividends or
distributions.
The Fund reserves the right to amend or to terminate the Plan. There is no
direct service charge to participants in the Plan; however, the Fund reserves
the right to amend the Plan to include a service charge payable by the
participants. All correspondence concerning the Plan should be directed to the
Plan Agent at The Bank of New York, Dividend Reinvestment Department, P.O. 1958,
Newark, New Jersey 07101-9774.
COMMON STOCK
The authorized capital stock of the Fund consists of 150,000,000 shares of
Common Stock, US $0.01 par value, of which 6,415,013 were outstanding as of May
17, 1996. The Shares when issued, will be fully paid and nonassessable. All
shares of Common Stock are equal as to dividends, assets and voting privileges
and have no conversion, preemptive or exchange rights. In the event of
liquidation, each share of Common Stock is entitled to its proportion of the
Fund's assets after payment of debts and expenses. Shareholders are entitled to
one vote per share. All voting rights for directors are non-cumulative, which
means that the holders of more than 50% of the shares of common stock can elect
100% of the directors if they choose to do so, and, in such event, the holders
of the remaining shares of common stock will not be able to elect any directors.
The Fund's outstanding Common Stock is, and the Shares offered hereby will be,
listed on the NYSE. The symbol of the Fund's Common Stock on the NYSE is MGC.
The Fund has no present intention of offering additional shares beyond this
Offering, except that additional shares may be issued under the Dividend
Reinvestment Plan. See "Dividends and Distributions; Dividend Reinvestment
Plan". Other offerings of its Common Stock, if made, will require approval of
the Fund's Board of Directors. Any additional offering will be subject to the
requirements of the 1940 Act that shares may not be sold at a price below the
then current net asset value (exclusive of underwriting discounts and
commissions) except in connection with an offering to existing shareholders or
with the consent of a majority of the Fund's outstanding shares.
Special Voting Provisions
The Fund has provisions in its Articles of Incorporation and By-Laws that
are intended to have the effect of limiting the ability of other entities
or persons to acquire control of the Fund, to cause it to engage in certain
transactions or to modify its structure. The Board of Directors is divided into
three classes. At the annual meeting of shareholders each year, the term of one
class will expire and directors will be elected to serve in that class for terms
of three years. This provision could delay for up to two years the replacement
of a majority of the Board of Directors.
The affirmative vote of the holders of three-quarters of the shares of the
Fund is required to authorize any of the following transactions:
(i) a merger or consolidation of the Fund with or into any other
corporation;
(ii) the issuance of any securities of the Fund to any person or entity
for cash;
21
<PAGE>
(iii) the sale, lease or exchange of all or any substantial part of the Fund's
assets to any entity or person (except assets having an aggregate fair market
value of less than $1,000,000); or
(iv) the sale, lease or exchange to the Fund in exchange for securities of
the Fund of any assets of any entity or person (except assets having an
aggregate fair market value of less than $1,000,000);
if such corporation, person or entity is directly, or indirectly through
affiliates, the beneficial owner of 5% or more of the outstanding shares of the
Fund. However, such three-quarter vote will not be required with respect to the
foregoing transactions where the Board of Directors in accordance with the
Fund's Articles of Incorporation approves the transaction. Reference is made to
the Articles of Incorporation and By-Laws of the Fund, on file with the
Commission, for the full text of these provisions. See "Further Information."
The Fund's Articles of Incorporation also authorizes a class of capital stock
consisting of 20,000,000 shares of Series Preferred Stock, $.01 par value, which
would have such voting powers, designations, preferences, and relative,
participating, optional, conversion or other special rights, and such
qualifications, limitations or restrictions, as the Board of Directors may
designate for each series thereof issued by vote of the Board of Directors from
time to time. The authorization of preferred stock enhances the Fund's
flexibility in connection with possible future actions. The authorized but
unissued shares of Preferred Stock could be used to make more difficult a change
in control of the Fund. Under certain circumstances, such shares could be used
to create voting impediments or to deter persons seeking to effect a takeover or
otherwise gain control of the Fund. Such shares could be sold in public or
private transactions to purchasers who might side with the Board of Directors in
opposing a takeover bid which the Board of Directors determines not to be in the
best interests of the Fund and its stockholders. In addition, the Board of
Directors could authorize holders of a series of Preferred Stock to vote, either
separately as a class or with the holders of common stock, on any merger, sale
or exchange of assets by the Fund or any other extraordinary corporate
transaction. On the other hand, the issuance of a series of Preferred Stock
could increase the likelihood of such an extraordinary transaction if the
holders of such shares deemed it to be desirable. The issuance of a series of
Preferred Stock may adversely affect the ability of the holders of shares of
common stock to control the Fund and may have an adverse effect on the
marketability of the Fund's shares.
These provisions could have the effect of depriving shareholders of an
opportunity to sell their shares at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. The Board of Directors has determined that
the foregoing voting requirements, which are generally greater than the minimum
requirements under Maryland law and the 1940 Act, are in the best interests of
shareholders generally.
TAXATION
Federal Taxation of the Fund and its Distributions
The Fund has qualified and elected to be treated, and intends to continue to
qualify and be treated, as a regulated investment company under the Internal
Revenue Code of 1986, as amended (the "Code"). The Fund intends to distribute
all or substantially all its investment company taxable income (all taxable
income and realized capital gains other than the excess of net long-term capital
gain over net short-term capital loss, reduced by deductible expenses) and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss) each year, thereby avoiding the imposition on the Fund of Federal
income and excise taxes on such distributed income and gain. Such distributions
from investment company taxable income and net capital gain will be taxable as
ordinary income and long-term capital gains, respectively, to shareholders of
the Fund who are subject to tax. Shareholders that are not subject to tax on
their income generally will not be required to pay tax on amounts distributed to
them. Notwithstanding the above, the Fund may decide to retain all or part of
any net capital gain for reinvestment. After the end of each taxable year, the
Fund will notify shareholders of the Federal income tax status of any
distributions, or deemed distributions, made by the Fund during such year. For a
discussion of certain income tax consequences to shareholders of the Fund, see
"Taxation" in the SAI.
22
<PAGE>
Federal Income Tax Consequences Relating to the Offer
The following discussion describes certain United States Federal income tax
consequences of the Offer generally applicable to citizens or residents of the
United States and U.S. trusts, estates, corporations and any other person who
would be subject to U.S. Federal income tax upon the sale or exchange of Common
Stock acquired upon the exercise of Rights ("U.S. Shareholders"). This summary
is intended to be descriptive only and does not purport to be a complete
analysis or listing of all potential tax effects relevant to the ownership of
Rights or Common Stock. Additionally, this summary does not specifically address
the U.S. Federal income tax consequences that might be relevant to holders of
Rights or Common Stock entitled to special treatment under the U.S. Federal
income tax laws, such as individual retirement accounts and other tax deferred
accounts, financial institutions, life insurance companies and tax-exempt
organizations, and does not discuss the effect of state, local and other tax
laws. Further, this summary is based on interpretations of existing law as of
the date of this Prospectus as contained in the Code, applicable current and
proposed Treasury Regulations, judicial decisions and published administrative
positions of the Internal Revenue Service, all of which are subject to change
either prospectively or retroactively.
U.S. Shareholders who receive Rights pursuant to the Offer will not
recognize taxable income for U.S. Federal income tax purposes upon their
receipt of the Rights.
If the fair market value of the Rights as of the date of their distribution
equals or exceeds 15% of the fair market value of the Common Stock with respect
to which they are distributed, a U.S. Shareholder's basis in such Common Stock
must be allocated between such Common Stock and the Rights in proportion to
their respective fair market values on the date of distribution. If the fair
market value of the Rights as of the date of their distribution is less than 15%
of the fair market value of the Common Stock with respect to which they are
distributed, however, a U.S. Shareholder's basis in such Common Stock will
remain unchanged and the basis in such Rights will be zero, unless such U.S.
Shareholder affirmatively and irrevocably elects (in a statement attached to his
or its U.S. Federal income tax return for the year in which the Rights are
received) to allocate the basis in the Common Stock between such Common Stock
and the Rights in proportion to their respective fair market values on the date
of distribution.
A U.S. Shareholder who exercises Rights will not recognize any gain or loss
for U.S. Federal income tax purposes upon the exercise. The basis of the newly
acquired Common Stock will then be equal to the sum of the Subscription Price
paid for the Common Stock and the basis, if any, allocated to the Rights in the
manner described in the immediately preceding paragraph.
If Rights issued to a U.S. Shareholder expire without being sold or
exercised, no basis will be allocated to such Rights, and such Shareholder will
not recognize any gain or loss for U.S. Federal income tax purposes upon such
expiration.
Upon a U.S. Shareholder's sale or exchange of Common Stock acquired upon the
exercise of Rights, such Shareholder will recognize gain or loss measured by the
difference between the proceeds of the sale or exchange and the basis of such
Common Stock. If the U.S. Shareholder holds Common Stock as a capital asset, any
gain or loss realized upon its sale or exchange will generally be treated as a
long-term or short-term capital gain or loss, depending on the length of the
U.S. Shareholder's holding period for such Common Stock. However, any loss
recognized upon the sale or exchange of shares of Common Stock with a tax
holding period of 6 months or less may be treated as a long-term capital loss to
the extent of any distribution of net capital gain with respect to such shares,
and losses on certain sales or exchanges may be disallowed under wash sale
rules. The holding period for Common Stock acquired upon the exercise of Rights
will begin on the date of exercise of the Rights.
A U.S. Shareholder may be subject to backup withholding at the rate of 31%
with respect to gross proceeds from the sale or exchange of Common Stock unless
such U.S. Shareholder (a) is a corporation or comes within certain other exempt
categories and, when required, demonstrates and/or certifies this fact, or (b)
provides a correct taxpayer identification number, along with certain required
certifications,
23
<PAGE>
and otherwise complies with applicable requirements of the backup withholding
rules. U.S. Shareholders who choose to transfer their Common Stock and who do
not provide the appropriate withholding agent with their correct taxpayer
identification number in the manner required may be subject to penalties imposed
by the Internal Revenue Service. Any amount withheld under these rules is not an
additional tax; it will be creditable against the U.S.
Shareholder's U.S. Federal income tax liability.
This summary is not intended to be, nor should it be, construed as legal or
tax advice to any current holder of Common Stock. Further, because the U.S.
Federal income tax consequences of the Offer may vary depending upon the
particular circumstances of each shareholder of the Fund and other facts, and
because this summary is not exhaustive of all possible U.S. Federal income tax
considerations (such as situations involving taxpayers who are dealers in
securities or whose functional currency is not the U.S. dollar), the Fund's
shareholders are urged to consult their own tax advisors to determine the U.S.
Federal income tax consequences to them of the Offer and their ownership of
Rights and Common Stock. In addition, such shareholders are urged to consult
their own tax advisors in determining the U.S. state and local tax consequences
to them of the Offer and such ownership. See "Taxation" in the SAI.
DISTRIBUTION ARRANGEMENTS
PaineWebber Incorporated, 1285 Avenue of the Americas, New York, New York,
will act as the Dealer Manager for the Offer. Under the terms and subject to the
conditions contained in the Dealer Manager Agreement dated the date hereof, the
Dealer Manager will provide financial advisory and marketing services, in
connection with the Offer and will solicit the exercise of Rights and the Over-
Subscription Privilege by Record Date shareholders. The Offer is not contingent
upon any number of Rights being exercised. The Fund has agreed to pay the Dealer
Manager a fee for financial advisory and marketing services equal to 1.25% of
the aggregate Subscription Price for Shares issued pursuant to the exercise of
such Rights or the Over-Subscription Privilege and to pay broker-dealers,
including the Dealer Manager, fees for its solicitation efforts (the
"Solicitation Fees") of 2.50% of the Subscription Price for each Share issued
pursuant to the exercise of such Rights or the Over-Subscription Privilege
solicited by such broker-dealers. Solicitation Fees will be paid to the
broker-dealer designated on the applicable portion of the Subscription
Certificates or, in the absence of such designation, to the Dealer Manager.
In addition, the Fund has agreed to reimburse the Dealer Manager up to an
aggregate of $100,000 for their reasonable expenses incurred in connection with
the Offer. The Fund and the Investment Manager have agreed to indemnify the
Dealer Manager or contribute to losses arising out of certain liabilities
including liabilities under the Securities Act. The Dealer Manager Agreement
also provides that the Dealer Manager will not be subject to any liability to
the Fund in rendering the services contemplated by the Agreement except for any
act of bad faith, willful misconduct, or gross negligence of the Dealer Manager
or reckless disregard by the Dealer Manager of its obligations and duties under
the Agreement.
The Fund has agreed not to offer or sell, or enter into any agreement to sell,
any equity or equity related securities of the Fund or securities convertible
into such securities for a period of 180 days after the date of the Dealer
Manager Agreement without the prior consent of PaineWebber Incorporated, as
Dealer Manager, except for the Shares and Common Stock issued in reinvestment of
dividends or distributions.
CUSTODIAN, DIVIDEND PAYING AGENT, TRANSFER AGENT AND REGISTRAR
The Bank of New York, P.O. 11002, Church Street Station, New York, New York
10277, will act as the Fund's custodian, dividend paying agent, transfer agent
and registrar.
EXPERTS
The financial statements at December 31, 1995, and the financial highlights
included in this Prospectus have been so included in reliance on the report of
KPMG Peat Marwick LLP, New York, New York, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
24
<PAGE>
LEGAL MATTERS
The validity of the Shares will be passed on for the Fund by Piper & Marbury
L.L.P., Baltimore, Maryland. Certain legal matters will be passed on for the
Fund by Hale and Dorr, Boston, Massachusetts and for the Dealer Manager by
Skadden, Arps, Slate, Meagher & Flom, Chicago, Illinois.
FURTHER INFORMATION
Further information concerning these securities and the Fund may be found in
the Registration Statement, of which this Prospectus and the SAI incorporated by
reference herein constitute a part, on file with the Commission. Financial
statements of the Fund for fiscal years ended December 31, 1994 and December 31,
1995 are included in the Fund's annual reports to shareholders for such years,
copies of which are on file with and may be inspected at the Commission as
indicated below.
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and the 1940 Act, and in
accordance therewith files reports and other information with the Commission.
Such reports and other information can be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street,
Washington, D.C. 20549 and the Commission's regional offices at 7 World Trade
Center, Suite 1300, New York, New York 10048 and 500 West Madison, Chicago,
Illinois 60661. Copies of such material can be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, Washington, D.C. 20549
at prescribed rates. Such reports and other information concerning the Fund may
also be inspected at the offices of the NYSE.
TABLE OF CONTENT
OF
STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<CAPTION>
Page
-------
<S> <C>
Investment Objectives and Policies 2
Investment Restrictions 10
Management 13
Expenses 15
Portfolio Transactions and Brokerage 16
Net Asset Value 19
Taxation 19
Financial Statements F-1
Report of Independent Accountants F-12
</TABLE>
25
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<PAGE>
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<PAGE>
No person has been authorized to give any information or to make any
representations in connection with this offering other than those contained in
this Prospectus and, if given or made, such other information and
representations must not be relied upon as having been authorized by the Fund,
the Investment Manager or the Dealer Manager. Neither the delivery of this
Prospectus nor any sale made hereunder shall, under any circumstances, create
any implication that there has been no change in the affairs of the Fund since
the date hereof or that the information contained herein is correct as of any
time subsequent to its date. However, if any material change occurs while this
Prospectus is required by law to be delivered, this Prospectus will be amended
or supplemented accordingly. This Prospectus does not constitute an offer to
sell or a solicitation of an offer to buy any securities other than the Shares
offered by the Prospectus, nor does it constitute an offer to sell or an offer
to buy the Shares by anyone in any jurisdiction in which such offer or
solicitation is not authorized or in which the person making such an offer or
solicitation is not qualified to do so or to any person to whom it is unlawful
to make such offer or solicitation.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
-------
<S> <C>
Fund Expenses 3
Financial Highlights 4
The Offer 5
The Fund 13
Use of Proceeds 13
Market Price and Net Asset Value Information 14
Investment Objectives and Policies 14
Special Risk Considerations. 15
Management of the Fund 18
Dividends and Distributions;
Dividend Reinvestment Plan 20
Common Stock 21
Taxation 22
Distribution Arrangements 24
Custodian, Dividend Paying Agent, Transfer
Agent and Registrar 24
Experts 24
Legal Matters 25
Further Information 25
Table of Contents of Statement of Additional
Information 25
</TABLE>
Morgan Grenfell
SMALLCap Fund, Inc.
2,138,337 Shares of
Common Stock Issuable
Upon Exercise of
Rights to Subscribe
for Such Shares of
Common Stock
P R O S P E C T U S
PaineWebber Incorporated
May 17, 1996
<PAGE>
MORGAN GRENFELL SMALLCAP FUND, INC.
---------------------
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information ("SAI") is not a
prospectus and should be read in conjunction with the Prospectus, dated
May 17, 1996 (the "Prospectus"). This SAI does not include all
information that a prospective investor should consider before
purchasing shares of the Fund and investors should obtain and read the
Prospectus prior to purchasing shares. A copy of the Prospectus may be
obtained without charge by calling the Fund's Information Agent,
Corporate Investor Communications, Inc. at (800) 459-8562. This SAI
incorporates by reference the entire Prospectus. Defined terms used
herein shall have the same meaning as provided in the Prospectus. The
date of this SAI is May 17, 1996.
---------------
TABLE OF CONTENTS
Page
Investment Objectives and Policies................. 2
Investment Restrictions............................ 10
Management......................................... 13
Expenses........................................... 15
Portfolio Transactions and Brokerage............... 16
Net Asset Value.................................... 19
Taxation........................................... 19
Financial Statements............................... F-1
Report of Independent Accountants.................. F-12
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to seek long-term
capital appreciation by investing principally in equity and
equity-related securities of U.S. companies. The Fund seeks current
income as a secondary investment objective. There is no assurance that
the Fund will achieve its investment objectives. See "Investment
Objectives and Policies" in the Prospectus.
The following describes certain investment strategies in which the
Investment Manager may engage, on behalf of the Fund, each of which may
involve certain special risks.
Options
Written Options. The Fund may write (sell) covered put and call
options on equity and fixed income securities and enter into related
closing transactions. The Fund may receive fees (referred to as
"premiums") for granting the rights evidenced by the options. However,
in return for the premium for a written call option, the Fund assumes
certain risks. For example, in the case of a written call option, the
Fund forfeits the right to any appreciation in the underlying security
in excess of the exercise price while the option is outstanding. A put
option gives to its purchaser the right to compel the Fund to purchase
an underlying security from the option holder at the specified price at
any time during the option period. In contrast, a call option written
by the Fund gives to its purchaser the right to compel the Fund to sell
an underlying security to the option holder at a specified price at any
time during the option period. Upon the exercise of a put option
written by the Fund, the Fund may suffer a loss equal to the difference
between the price at which the Fund is required to purchase the
underlying security and its market value at the time of the option
exercise, less the premium received for writing the option. All options
written by the Fund are covered. In the case of a call option, this
means that the Fund will own the securities subject to the option or an
offsetting call option as long as the written option is outstanding, or
will have the absolute and immediate right to acquire other securities
that are the same as those subject to the written option. In the case
of a put option, this means that the Fund will deposit cash or high
grade liquid debt obligations in a segregated account with the
custodian with a value at least equal to the exercise price of the put
option.
Purchased Options. The Fund may also purchase put and call options
on securities. A put option entitles the Fund to sell, and a call
option entitles the Fund to buy, a specified security at a specified
price during the term of the option. The advantage to the purchaser of
a call option is that it may hedge against an
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increase in the price of portfolio securities it ultimately wishes to
buy. The advantage to the purchaser of a put option is that it may
hedge against a decrease in the price of portfolio securities it
ultimately wishes to sell.
The Fund may enter into closing transactions in order to offset an
open option position prior to exercise or expiration by selling an
option it has purchased or by entering into an offsetting option. If
the Fund cannot effect closing transactions, it may have to retain a
security in its portfolio it would otherwise sell, or deliver a
security it would otherwise retain.
The Fund may purchase and sell options traded on U.S. exchanges
and, to the extent permitted by law, options traded over-the-counter
("OTC"). The Fund will treat over-the-counter options and their cover
as illiquid. There can be no assurance that a liquid secondary market
will exist for any particular option. Over-the-counter options also
involve the risk that a counterparty will fail to meet its obligation
under the option.
Stock Index Options
The Fund may purchase and write exchange-listed put and call
options on stock indices to hedge against risks of market-wide price
movements. A stock index measures the movement of a certain group of
stocks by assigning relative values to the common stocks included in
the index. Examples of well-known stock indices are the Standard &
Poor's Index of 500 Common Stocks and the Wilshire 5000 Index. Options
on stock indices are similar to options on securities. However, because
options on stock indices do not involve the delivery of an underlying
security, the option represents the holder's right to obtain from the
writer in cash a fixed multiple of the amount by which the exercise
price exceeds (in the case of a put) or is less than (in the case of a
call) the closing value of the underlying index on the exercise date.
When the Fund writes an option on a stock index, it will cover the
option by depositing cash or high grade liquid debt obligations or a
combination of both in an amount equal to the market value of the
option, in a segregated account, which will be marked to market daily,
with the Fund's custodian, and will maintain the account while the
option is open. Alternatively, and only in the case of a written call
option on a stock index, the Fund may cover the written option by
owning an offsetting call option.
There are several risks associated with transactions in options on
securities or securities indices. For example, there are significant
differences between the securities markets and the
-3-
<PAGE>
corresponding options markets that could result in imperfect
correlations, causing a given option transaction not to achieve its
objectives. In addition, a liquid secondary market for particular
options, whether traded OTC or on a U.S. securities exchange may be
absent for reasons which include the following: there may be
insufficient trading interest in certain options; restrictions may be
imposed by an exchange on opening transactions or closing transactions
or both; trading halts, suspensions or other restrictions may be
imposed with respect to particular classes or series of options or
underlying securities; unusual or unforeseen circumstances may
interrupt normal operations on an exchange; the facilities of an
exchange or the Options Clearing Corporation ("OCC") may not at all
times be adequate to handle current trading volume; or one or more
exchanges could, for economic or other reasons, decide or be compelled
at some future date to discontinue the trading of options (or a
particular class or series of options), in which event the secondary
market on that exchange (or in that class or series of options) would
cease to exist, although outstanding options that had been issued by
the OCC as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
Futures Contracts and Options on Futures Contracts
When deemed advisable by the Investment Manager, the Fund may
enter into futures contracts and purchase and write options on futures
contracts to seek to increase total return or to hedge against changes
in interest rates or securities prices. The Fund may purchase and sell
financial futures contracts, including stock index futures, and
purchase and write related options. The Fund may engage in futures and
related options transactions for hedging and non-hedging purposes as
defined in regulations of the Commodity Futures Trading Commission. The
Fund will not enter into futures contracts or options thereon for
non-hedging purposes, if immediately thereafter, the aggregate initial
margin and premiums required to establish non-hedging positions in
futures contracts and options on futures will exceed 5% of the net
asset value of the Fund's portfolio, after taking into account
unrealized profits and losses on any such positions and excluding the
amount by which such options were in-the-money at the time of purchase.
Transactions in futures contracts and options on futures involve
brokerage costs, require margin deposits and, in the case of contracts
and options obligating the Fund to purchase securities, require the
Fund to segregate cash or high grade liquid debt obligations with a
value equal to the amount of the Fund's obligations.
Futures Contracts. A futures contract may generally be
described as an agreement between two parties to buy and sell a
particular financial instrument for an agreed price during a
-4-
<PAGE>
designated month (or to deliver the final cash settlement price, in the
case of a contract relating to an index or otherwise not calling for
physical delivery at the end of trading in the contract). Futures
contracts obligate the long or short holder to take or make delivery of
a specified quantity of a commodity or financial instrument, such as a
security or the cash value of a securities index, during a specified
future period at a specified price.
When interest rates are rising or securities prices are falling,
the Fund can seek to offset a decline in the value of its current
portfolio securities through the sale of futures contracts. When
interest rates are falling or securities prices are rising, the Fund,
through the purchase of futures contracts, can attempt to secure better
rates or prices than might later be available in the market when it
effects anticipated purchases.
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting transactions
which may result in a profit or a loss. While futures contracts on
securities will usually be liquidated in this manner, the Fund may
instead make, or take, delivery of the underlying securities whenever
it appears economically advantageous to do so. A clearing corporation
associated with the exchange on which futures on securities are traded
guarantees that, if still open, the sale or purchase will be performed
on the settlement date.
Hedging Strategies. Hedging, by use of futures contracts, seeks to
establish with more certainty the effective price and rate of return on
portfolio securities and securities that the Fund proposes to acquire.
The Fund may, for example, take a "short" position in the futures
market by selling futures contracts in order to hedge against an
anticipated rise in interest rates or a decline in market prices that
would adversely affect the value of the Fund's portfolio securities.
Such futures contracts may include contracts for the future delivery of
securities held by the Fund or securities with characteristics similar
to those of the Fund's portfolio securities. If, in the opinion of the
Investment Manager, there is a sufficient degree of correlation between
price trends for the Fund's portfolio securities and futures contracts
based on other financial instruments, securities indices or other
indices, the Fund may also enter into such futures contracts as part of
its hedging strategy. Although under some circumstances prices of
securities in the Fund's portfolio may be more or less volatile than
prices of such futures contracts, the Investment Manager will attempt
to estimate the extent of this volatility difference based on
historical patterns and compensate for any such differential by having
the Fund enter into a greater or lesser number of futures
-5-
<PAGE>
contracts or by attempting to achieve only a partial hedge against
price changes affecting the Fund's securities portfolio. When hedging
of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in
the value of the futures position. On the other hand, any unanticipated
appreciation in the value of the Fund's portfolio securities would be
substantially offset by a decline in the value of the futures position
On other occasions, the Fund may take a "long" position by
purchasing futures contracts. This would be done, for example, when the
Fund anticipates the subsequent purchase of particular securities when
it has the necessary cash, but expects the prices then available in the
applicable market to be less favorable than prices that are currently
available.
Options on Futures Contracts. The acquisition of put and call
options on futures contracts will give the Fund the right (but not the
obligation) for a specified price to sell or to purchase, respectively,
the underlying futures contract at any time during the option period.
As the purchaser of an option on a futures contract, the Fund obtains
the benefit of the futures position if prices move in a favorable
direction but limits its risk of loss in the event of an unfavorable
price movement to the loss of the premium and transaction costs.
The writing of a call option on a futures contract generates a
premium which may partially offset a decline in the value of the Fund's
assets. By writing a call option, the Fund becomes obligated, in
exchange for the premium, to sell a futures contract (if the option is
exercised), which may have a value higher than the exercise price.
Conversely, the writing of a put option on a futures contract generates
a premium which may partially offset an increase in the price of
securities that the Fund intends to purchase. However, the Fund becomes
obligated to purchase a futures contract (if the option is exercised)
which may have a value lower than the exercise price. Thus, the loss
incurred by the Fund in writing options on futures is potentially
unlimited and may exceed the amount of the premium received. The Fund
will incur transaction costs in connection with the writing of options
on futures.
The holder or writer of an option on a futures contract may
terminate its position by selling or purchasing an offsetting option on
the same series. There is no guarantee that such closing transactions
can be effected. The Fund's ability to establish and close out
positions on such options will be subject to the development and
maintenance of a liquid market.
-6-
<PAGE>
The Fund may use options on futures contracts solely for bona fide
hedging or other non-hedging purposes as described below.
Other Considerations. The Fund will engage in futures and related
options transactions only for bona fide hedging or non-hedging
purposes as permitted by Commodities Futures Trading Commission
("CFTC") regulations which permit principals of an investment company
registered under the 1940 Act to engage in such transactions without
registering as commodity pool operators. The Fund will determine that
the price fluctuations in the futures contracts and options on futures
used by it for hedging purposes are substantially related to price
fluctuations in securities or instruments held by the Fund or
securities or instruments which it expects to purchase. Except as
stated below, the Fund's futures transactions will be entered into for
traditional hedging purposes -- i.e., futures contracts will be sold to
protect against a decline in the price of securities that the Fund owns
or futures contracts will be purchased to protect the Fund against an
increase in the price of securities that the Fund intends to purchase.
As evidence of this hedging intent, the Fund expects that, on 75% or
more of the occasions on which it takes a long futures or option
position (involving the purchase of futures contracts), the Fund will
have purchased, or will be in the process of purchasing, equivalent
amounts of related securities in the cash market at the time when the
futures or option position is closed out. However, in particular cases,
when it is economically advantageous for the Fund to do so, a long
futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
As an alternative to compliance with the bona fide hedging
definition, a CFTC regulation permits the Fund to elect to comply with
a different test under which the aggregate initial margin and premiums
required to establish non-hedging positions in futures contracts and
options on futures will not exceed 5% of the net asset value of the
Fund's portfolio, after taking into account unrealized profits and
losses on any such positions and excluding the amount by which such
options were in-the-money at the time of purchase.
Limitations and Risks Associated With Transactions In Options,
Futures Contracts and Options on Futures Contracts
The Fund's options and futures transactions involve (1) liquidity
risk that contractual positions cannot be easily closed out in the
event of market changes or generally in the absence of a liquid
secondary market, (2) correlation risk that changes in the value of
hedging positions may not match the securities market fluctuations
intended to be hedged, and (3) market risk that an incorrect prediction
of securities prices
-7-
<PAGE>
by the Investment Manager may cause the Fund to perform worse than if
such positions had not been taken. The ability to terminate
over-the-counter options is more limited than with exchange traded
options and may involve the risk that the counterparty to the option
will not fulfill its obligations. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii) restrictions may
be imposed by an exchange on opening or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed
with respect to particular classes or series of options; (iv) unusual
or unforeseen circumstances may interrupt normal operations on an
exchange; (v) the facilities of an exchange or the Options Clearing
Corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in
which event the secondary market on that exchange (or in that class or
series of options) would cease to exist, although outstanding options
on that exchange, if any, that had been issued by the Options Clearing
Corporation as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
In accordance with a position taken by the Commission, the Fund
will limit its investments in illiquid securities to 10% of the Fund's
net assets. The Fund will treat over-the-counter options and the assets
used to cover such options as illiquid securities subject to this
limitation, except that, with respect to options written with primary
dealers in U.S. Government securities pursuant to an agreement
requiring a closing purchase transaction at a formula price, the amount
of the illiquid securities may be calculated with reference to the
formula price.
Options and futures transactions are highly specialized activities
which involve investment techniques and risks that are different from
those associated with ordinary portfolio transactions. Gains and losses
on investments in options and futures depend on the Investment
Manager's ability to predict the direction of stock prices and other
economic factors. The loss that may be incurred by the Fund in entering
into futures contracts and written options thereon is potentially
unlimited. There is no assurance that higher than anticipated trading
activity or other unforeseen events might not, at times, render certain
facilities of an options clearing entity or other entity performing the
regulatory and liquidity functions of an options clearing entity
inadequate, and thereby result in the institution by an exchange of
special procedures which may interfere with the timely execution of
customers' orders. Most futures exchanges limit the amount of
fluctuation permitted in a futures contract's
-8-
<PAGE>
prices during a single trading day. Once the limit has been reached no
further trades may be made that day at a price beyond the limit. The
price limit will not limit potential losses, and may in fact prevent
the prompt liquidation of futures positions, ultimately resulting in
further losses.
Except as set forth above under "Futures Contracts and Options on
Futures Contracts", there is no limit on the percentage of the Fund's
assets that may be at risk with respect to futures contracts and
related options. The Fund may not invest more than 25% of its total
assets in purchased protective put options nor more than 5% of its
total assets in purchased options other than protective put options.
The Fund's transactions in options, futures contracts and options on
futures contracts may be limited by the requirements for qualification
of the Fund as a regulated investment company for tax purposes. See
"TAXATION," below. Options, futures contracts and options on futures
contracts are derivative instruments.
Foreign Securities
The Fund intends to limit its investments in foreign securities to
less than 5% of the Fund's total assets during the current fiscal year.
Investments in foreign securities may offer potential benefits not
available from investments solely in U.S. dollar-denominated domestic
issuers. Such benefits may include the opportunity to invest in foreign
issuers that appear, in the opinion of the Investment Manager, to offer
better opportunity for long-term growth of capital and income than
investments in U.S. securities, the opportunity to invest in foreign
countries with economic policies or business cycles different from
those of the United States and the opportunity to reduce fluctuations
in portfolio value by taking advantage of foreign stock markets that do
not necessarily move in a manner parallel to U.S. markets.
Investing in foreign securities involves certain special
considerations which are not typically associated with investing in
U.S. dollar-denominated securities of U.S. issuers. Investments in
foreign securities may involve currencies of foreign countries.
Currency exchange rates may fluctuate significantly over short periods
of time. Since foreign issuers are generally not subject to uniform
accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to U.S. companies, there
may be less publicly available information about a foreign company than
about a U.S. company. Volume and liquidity in most foreign securities
markets are less than in the United States and securities of many
foreign companies are less liquid and more
-9-
<PAGE>
volatile than securities of comparable U.S. companies. Fixed
commissions on foreign securities exchanges are generally higher than
negotiated commissions on U.S. exchanges, although the Fund endeavors
to achieve the most favorable net results on its portfolio
transactions. There is generally less government supervision and
regulation of foreign securities exchanges, brokers, dealers and listed
and unlisted companies than in the United States. Foreign markets also
have different clearance and settlement procedures, and in certain
markets there have been times when settlements have been unable to keep
pace with the volume of securities transactions, making it difficult to
conduct such transactions.
Convertible Securities
The Fund intends to limit its investments in convertible
securities to less than 5% of the Fund's total assets during the
current fiscal year.
Convertible securities may include corporate notes or preferred
stock but are ordinarily long-term debt obligations of the issuer
convertible at a stated exchange rate into common stock of the issuer.
As with all fixed income securities, the market value of convertible
securities tends to decline as interest rates increase and, conversely,
to increase as interest rates decline. Convertible securities generally
offer lower interest or dividend yields than non-convertible securities
of similar quality. However, when the market price of the common stock
underlying a convertible security exceeds the conversion price, the
price of the convertible security tends to reflect the value of the
underlying common stock. As the market price of the underlying common
stock declines, the convertible security tends to trade increasingly on
a yield basis, and thus may not decline in price to the same extent as
the underlying common stock. Convertible securities rank senior to
common stocks in an issuer's capital structure and are consequently of
higher quality and entail less risk than the issuer's common stock.
However, the extent to which such risk is reduced depends in large
measure upon the degree to which the convertible security sells above
its value as a fixed income security. In evaluating a convertible
security, the Investment Manager will give primary emphasis to the
attractiveness of the underlying common stock.
INVESTMENT RESTRICTIONS
The Fund has adopted the following fundamental policies which
cannot be changed without the approval of the holders of a majority of
its shares (as defined under "Investment Objectives and Policies" in
the Prospectus). The Fund may not:
-10-
<PAGE>
(1) Borrow money on a secured or unsecured basis for any purpose
of the Fund in an aggregate amount exceeding 15% of the value of the
Fund's total assets at the time of any such borrowing (exclusive of all
obligations on amounts held as collateral for securities loaned to
other persons to the extent that such obligations are secured by assets
of at least equivalent value).
(2) Pledge, mortgage or hypothecate its assets, except to secure
indebtedness permitted by paragraph (1) above. The deposit in escrow of
securities in connection with the writing of put and call options,
collateralized loans of securities and collateral arrangements with
respect to margin for futures contracts are not deemed to be pledges or
hypothecations for this purpose.
(3) Act as an underwriter of securities of other issuers, except
to the extent that, in connection with the disposition of portfolio
securities, the Fund may be deemed to be an underwriter for purposes of
the Securities Act of 1933.
(4) Purchase or sell real estate or any interest therein, except
that the Fund may invest in securities issued or guaranteed by
corporate or governmental entities secured by real estate or interests
therein, such as mortgage pass-throughs and collateralized mortgage
obligations, or issued by companies that invest in real estate or
interests therein.
(5) Make loans to other persons except for loans of portfolio
securities (up to 30% of total assets) as described under "Investment
Objectives and Policies -- Lending of Portfolio Securities" in the
Prospectus and except through the use of repurchase agreements, the
purchase of commercial paper or the purchase of all or a portion of an
issue of debt securities in accordance with its investment objectives,
policies and restrictions, and provided that not more than 10% of the
Fund's assets will be invested in repurchase agreements maturing in
more than seven days.
(6) Invest in commodities or in commodity contracts, except that
it may enter into futures contracts on financial instruments and
options on such futures contracts subject to regulations of the
Commodity Futures Trading Commission.
(7) Purchase securities on margin, or make short sales of
securities, except for the use of short-term credit necessary for the
clearance of purchases and sales of portfolio securities, but it may
make margin deposits in connection with transactions in options,
futures and options on futures.
(8) Purchase the securities of issuers conducting their
principal business activity in the same industry (other than
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<PAGE>
securities issued or guaranteed by the United States, its agencies and
instrumentalities) if, immediately after such purchase, the value of
its investments in such industry would comprise 25% or more of the
value of its total assets taken at market value at the time of each
investment.
(9) Purchase securities of any one issuer, if
(a) more than 5% of the Fund's total assets taken at market
value would at the time of purchase be invested in the securities
of such issuer, except that such restriction does not apply to
securities issued or guaranteed by the United States Government or
its agencies or instrumentalities or corporations sponsored
thereby, and except that up to 25% of the Fund's total assets may
be invested without regard to this limitation; or
(b) such purchase would at the time result in more than 10%
of the outstanding voting securities of such issuer being held by
the Fund, except that up to 25% of the Fund's total assets may be
invested without regard to this limitation.
(10) Invest in securities of another registered investment
company, except in connection with a merger, consolidation, acquisition
or reorganization.
(11) Purchase any security, including any repurchase agreement
maturing in more than seven days, which is subject to legal or
contractual delays in or restrictions on resale, or which is not
readily marketable, if more than 10% of the net assets of the Fund,
taken at market value, would be invested in such securities.
(12) Invest for the purpose of exercising control over or
management of any company.
(13) Issue senior securities except pursuant to Section 18 of the
Investment Company Act of 1940, and, except that the Fund may borrow
money subject to investment restriction 1.
If a percentage restriction on investment or utilization of assets
as set forth above is adhered to at the time an investment is made, a
later change in percentage resulting from a change in the market values
of the Fund's assets will not be considered a violation of the
restriction (except for restriction 1).
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<PAGE>
MANAGEMENT
Directors and Officers
The names and addresses of the directors and officers of the Fund
are set forth below, together with their positions and their principal
occupations during the past five years and, in the case of the
directors, their positions with certain other organizations and
companies.
Name, Age Positions With Principal Occupations
and Address the Fund During Past 5 Years
Michael Bullock* Chairman and Director Director, Chairman and
20 Finsbury Circus Chief Investment Officer,
London, EC2M 1NB Morgan Grenfell
England Investment Services,
Age 44 Ltd.; Managing Director,
Morgan Grenfell Asset
Management Ltd.;
Director, Morgan Grenfell
Capital Management Inc.
Robert E. Kern, Jr.* President and Director Executive Vice President
885 Third Avenue and Director, Morgan
New York, NY 10022 Grenfell Capital
Age 60 Management, Inc.
(September, 1986 to
present)
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<PAGE>
Name, Age Positions With Principal Occupations
and Address the Fund During Past 5 Years
Robert E. Greeley Director Chairman, Page Mill Asset
Page Mill Asset Management (June 1985 to
Management Present); Manager
433 California Street Corporate Investments,
Suite 900 Hewlett-Packard Company
San Francisco, CA (March, 1979 to June
94104 1991); Director, Pacific
Age 64 Horizon Funds, Time
Horizon Funds
Joseph J. Incandela Director Partner/Managing
Thomas H. Lee Company Director, Thomas H. Lee
75 State Street Co.
Boston, MA 02109
Age 49
Richard D. Wood Director Consultant (October, 1994
27 Hidden Valley to present); Chairman and
Monrovia, CA 91016 President, Optical
Age 56 Radiation Corporation
(1969 to October 1994)
Audrey M.T. Jones* Vice President Senior Director, Morgan
885 Third Avenue Grenfell Capital
New York, NY 10022 Management Inc.
Age 49
Mark G. Arthus* Secretary and Director of
885 Third Avenue Treasurer Administration and
New York, NY 10022 Compliance, Morgan
Age 39 Grenfell Capital
Management, Inc. (July
1992 to present); Vice
President, Compliance,
Citibank, N.A. (August
1985 to July 1992)
* Indicates a person who is an "interested person" of the Fund,
as defined in the 1940 Act.
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<PAGE>
As of April 30, 1996, the Directors and officers of the Fund
beneficially owned 51,985 shares (0.80%) of Common Stock of the Fund.
The following table sets forth the aggregate compensation paid by
the Fund to the Directors for the fiscal year ended December 31, 1995.
Compensation Table
Pension or Total
Retirement Estimated Compensation
Aggregate Benefits As Annual From Fund
Compensation Part of Fund Benefits Complex Paid
Name and Position From Fund Expenses Retirement to Director*
Michael Bullock $0 $0 $0 $0
Robert E. Kern, Jr. $0 $0 $0 $0
Robert E. Greeley $10,000 $0 $0 $10,000
Joseph J. Incandela $10,000 $0 $0 $10,000
Richard D. Wood $10,000 $0 $0 $10,000
* None of the Directors receives any compensation from any other investment
company managed by or affiliated with the Investment Manager.
Executive Compensation
No current or former employees, officers or directors received
remuneration in excess of $60,000 in the last fiscal year for service
in all their respective capacities.
EXPENSES
The Fund's annual operating expenses are higher than those of most
other investment companies of comparable size because the management
fees and other operating expenses reflect the costs associated with an
investment company investing in small capitalization companies. For the
fiscal years ended December 31, 1995, 1994 and 1993, the Fund's
expenses amounted to $1,086,817, $1,004,524 and $957,761, respectively.
Expenses of the Offer will be charged to capital. The Fund's
annual expense ratio was 1.51%, 1.52% and 1.39% of the Fund's net
assets for the fiscal years ended December 31, 1995, 1994 and 1993,
respectively.
-15-
<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the general supervision of the Board of Directors, the
Investment Manager makes decisions with respect to and places orders
for all purchases and sales of portfolio securities for the Fund. In
executing portfolio transactions, the Investment Manager seeks to
obtain the best net results for the Fund, taking into account such
factors as price (including the applicable brokerage commission or
dealer spread), size of the order, difficulty of execution and
operational facilities of the firm involved. Commission rates, being a
component of price, are considered together with such factors.
Commissions on transactions on U.S. securities exchanges are subject to
negotiation. Where transactions are effected in the over-the-counter
market or third market, the Fund deals with the primary market makers
unless a more favorable result is obtainable elsewhere. Fixed income
securities purchased or sold on behalf of the Fund normally will be
traded in the over-the-counter market on a net basis (i.e. without a
commission) through dealers acting for their own account and not as
brokers or otherwise through transactions directly with the issuer of
the instrument. Some fixed income securities are purchased and sold on
an exchange or in over-the-counter transactions conducted on an agency
basis involving a commission.
Pursuant to the Investment Management Agreement, the Investment
Manager agrees to select broker-dealers in accordance with guidelines
established by the Fund's Board of Directors from time to time and in
accordance with Section 28(e) of the Securities Exchange Act of 1934,
as amended. In assessing the terms available for any transaction, the
Investment Manager shall consider all factors it deems relevant,
including the breadth of the market in the security, the price of the
security, the financial condition and execution capability of the
broker-dealer, and the reasonableness of the commission, if any, both
for the specific transaction and on a continuing basis. In addition,
the Investment Management Agreement authorizes the Investment Manager,
subject to the periodic review of the Fund's Board of Directors, to
cause the Fund to pay a broker-dealer which furnishes brokerage and
research services a higher commission than that which might be charged
by another broker-dealer for effecting the same transaction, provided
that the Investment Manager determines in good faith that such
commission is reasonable in relation to the value of the brokerage and
research services provided by such broker-dealer, viewed in terms of
either the particular transaction or the overall responsibilities of
the Investment Manager to the Fund. Such brokerage and research
services may consist of pricing information, reports and statistics on
specific companies or industries, general summaries of groups of bonds
and
-16-
<PAGE>
their comparative earnings and yields, or broad overviews of the
securities markets and the economy.
Supplemental research information utilized by the Investment
Manager is in addition to, and not in lieu of, services required to be
performed by the Investment Manager and does not reduce the advisory
fees payable to the Investment Manager. The Directors will periodically
review the commissions paid by the Fund to consider whether the
commissions paid over representative periods of time appear to be
reasonable in relation to the benefits inuring to the Fund. It is
possible that certain of the supplemental research or other services
received will primarily benefit one or more other investment companies
or other accounts of the Investment Manager for which investment
discretion is exercised. Conversely, a Fund may be the primary
beneficiary of the research or services received as a result of
portfolio transactions effected for such other account or investment
company. During the fiscal period ended December 31, 1995, the
Investment Manager did not, pursuant to any agreement or understanding
with a broker or otherwise through an internal allocation procedure,
direct any Fund's brokerage transactions to a broker because of
research services provided by such broker.
Investment decisions for each Fund and for other investment
accounts managed by the Investment Manager are made independently of
each other in the light of differing conditions. However, the same
investment decision may be made for two or more of such accounts.
Purchases or sales are then averaged as to price and allocated as to
amount in a manner deemed equitable to each such account. While in some
cases this practice could have a detrimental effect on the price or
value of the security as far as a Fund is concerned, in other cases it
is believed to be beneficial to a Fund. To the extent permitted by law,
the Investment Manager may aggregate the securities to be sold or
purchased for a Fund with those to be sold or purchased for other
investment companies or accounts in executing transactions.
Pursuant to procedures determined by the Directors and subject to
the general policies of the Fund and Section 17(e) of the 1940 Act, the
Investment Manager may place securities transactions with brokers with
whom it is affiliated ("Affiliated Brokers").
Section 17(e) of the 1940 Act limits to "the usual and customary
broker's commission" the amount which can be paid by the Fund to an
Affiliated Broker acting as broker in connection with transactions
effected on a securities exchange. The Board, including a majority of
the Directors who are not "interested persons" of the Fund or the
Investment Manager, has adopted procedures designed to comply with the
requirements of Section
-17-
<PAGE>
17(e) of the 1940 Act and Rule 17e-1 promulgated thereunder to ensure
that the broker's commission is "reasonable and fair compared to the
commission, fee or other remuneration received by other brokers in
connection with comparable transactions involving similar securities
being purchased or sold on a securities exchange during a comparable
period of time...."
A transaction would not be placed with an Affiliated Broker if a
Fund would have to pay a commission rate less favorable than their
contemporaneous charges for comparable transactions for their other
most favored, but unaffiliated, customers except for accounts for which
they act as a clearing broker, and any of their customers determined,
by a majority of the Directors who are not "interested persons" of the
Fund or the Investment Manager, not to be comparable to the Fund. With
regard to comparable customers, in isolated situations, subject to the
approval of a majority of the Directors who are not "interested
persons" of the Fund or the Investment Manager, exceptions may be made.
Since the Investment Manager, as investment adviser to the Fund, has
the obligation to provide management, which includes elements of
research and related skills, such research and related skills will not
be used by them as a basis for negotiating commissions at a rate higher
than that determined in accordance with the above criteria. The Fund
will not engage in principal transactions with Affiliated Brokers. When
appropriate, however, orders for the account of the Fund placed by
Affiliated Brokers are combined with orders of their respective
clients, in order to obtain a more favorable commission rate. When the
same security is purchased for two or more funds or customers on the
same day, each fund or customer pays the average price and commissions
paid are allocated in direct proportion to the number of shares
purchased.
Affiliated Brokers furnish to the Fund at least annually a
statement setting forth the total amount of all compensation retained
by them or any associated person of them in connection with effecting
transactions for the account of the Fund, and the Board reviews and
approves all the Fund's portfolio transactions on a quarterly basis and
the compensation received by Affiliated Brokers in connection
therewith. During the fiscal years ended December 31, 1993, 1994 and
1995, the Fund paid no brokerage commissions to Affiliated Brokers.
Affiliated Brokers do not knowingly participate in commissions
paid by the Fund to other brokers or dealers and do not seek or
knowingly receive any reciprocal business as the result of the payment
of such commissions. In the event that an Affiliated Broker learns at
any time that it has knowingly received reciprocal business, it will so
inform the Board.
-18-
<PAGE>
For the fiscal years ended December 31, 1995, 1994 and 1993, the
Fund paid brokerage commissions in the amount of $739,100, $628,300 and
$706,900, respectively.
NET ASSET VALUE
The net asset value of a share of the Fund is determined as of the
close of the last business day of the NYSE in each week by dividing the
value of the Fund's assets (including dividends accrued but not
collected), less its liabilities (including accrued expenses but
excluding capital and surplus), by the number of shares of the Fund
outstanding. The net asset value will be made available for
publication.
Portfolio securities (including options) listed on an exchange and
over-the-counter securities (including options) quoted on the NASDAQ
system are valued on the basis of the last sale on the date as of which
the valuation is made, or, lacking any sales, at the current bid
prices. Over-the-counter securities not quoted on the NASDAQ system are
valued on the basis of the mean between the current bid and asked
prices on that exchange on which they are traded. Securities for which
reliable quotations are not readily available are valued at fair value,
as determined in good faith and pursuant to procedures established by
the Directors. Short-term investments with remaining maturities of 60
days or less are valued at amortized cost, unless the Board of
Directors determines that this does not represent fair value.
The outstanding shares of Common Stock are, and the Shares will
be, listed on the NYSE. The Fund's Common Stock has traded primarily at
a discount to net asset value since May 1987. Shares of closed-end
investment companies frequently trade at a discount from net asset
value. The officers of the Fund cannot predict whether the Fund's
Common Stock will trade in the future at a premium or a discount to net
asset value, and if so, the level of such premium or discount.
TAXATION
The following is a summary of the principal U.S. federal income,
and certain state and local, tax considerations regarding the purchase,
ownership and disposition of shares of the Fund. The summary does not
address special tax rules applicable to certain classes of investors,
such as tax-exempt entities, insurance companies and financial
institutions. Each prospective shareholder is urged to consult his own
tax adviser with respect to the specific federal, state, local and
foreign tax consequences of investing in the Fund. The summary is based
on the laws in effect on the date of this SAI, which are subject to
change.
-19-
<PAGE>
General
The Fund has elected to be treated, has qualified and intends to
continue to qualify for each taxable year, as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code").
Qualification of the Fund as a regulated investment company under
the Code requires, among other things, that (a) the Fund derive at
least 90% of its annual gross income from dividends, interest, payments
with respect to securities loans and gains from the sale or other
disposition of stocks or securities, or other income (including but not
limited to gains from options or futures contracts) derived with
respect to its business of investing in such stock or securities (the
"90% gross income test"); (b) the Fund derive less than 30% of its
annual gross income from the sale or other disposition of stock,
securities, options or futures contracts, any of which was held for
less than three months (the "short-short test"); and (c) the Fund
diversify its holdings so that, at the close of each quarter of its
taxable year, (i) at least 50% of the market value of the Fund's total
(gross) assets is comprised of cash, cash items, United States ("U.S.")
Government securities, securities of other regulated investment
companies and other securities limited in respect of any one issuer to
an amount not greater in value than 5% of the value of the Fund's total
(gross) assets and to not more than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of
its total (gross) assets is invested in the securities of any one
issuer (other than U.S. Government securities and securities of other
regulated investment companies) or two or more issuers controlled by
the Fund and engaged in the same, similar or related trades or
business.
If the Fund complies with such provisions, then in any taxable
year for which the Fund distributes, in accordance with the Code's
timing requirements, at least 90% of its "investment company taxable
income" (which includes, among other things, dividends, interest,
accrued original issue discount and recognized market discount income,
income from securities lending, and any net short-term capital gain in
excess of net long-term capital loss and is reduced by deductible
expenses) and at least 90% of the excess of its gross tax-exempt
interest income, if any, over certain disallowed deductions, the Fund
(but not its shareholders) will be relieved of federal income tax on
any income of the Fund, including long-term capital gains, distributed
to shareholders in accordance with the Code's requirements. However, if
the Fund retains any investment company taxable income or "net capital
gain" (the excess of net long-term capital gain over net short-term
capital loss), it will be subject to a tax at regular corporate rates
on the amount retained.
-20-
<PAGE>
If the Fund retains any net capital gain, the Fund may designate
the retained amount as undistributed capital gains in a notice to its
shareholders who, if subject to U.S. federal income tax on long-term
capital gains, (i) will be required to include in income for federal
income tax purposes, as long-term capital gain, their shares of such
undistributed amount, and (ii) will be entitled to credit their
proportionate shares of the tax paid by the Fund against their U.S.
federal income tax liabilities, if any, and to claim refunds to the
extent the credit exceeds such liabilities. For U.S. federal income tax
purposes, the tax basis of shares owned by a shareholder of the Fund
will be increased by an amount equal under current law to 65% of the
amount of undistributed net capital gain included in the shareholder's
gross income. The Fund intends to distribute at least annually to its
shareholders all or substantially all of its investment company taxable
income and to distribute annually, or retain and designate as described
in this paragraph, its net capital gain. If for any taxable year the
Fund fails to distribute at least 90% of its investment company taxable
income or otherwise does not qualify as a regulated investment company,
it will be taxed on all of its investment company taxable income and
net capital gain at corporate rates, and its distributions to
shareholders will be taxable as ordinary dividends to the extent of its
current and accumulated earnings and profits.
In order to avoid a 4% federal excise tax, the Fund must
distribute (or be deemed to have distributed) by December 31 of each
calender year at least 98% of its taxable ordinary income for such
year, at least 98% of the excess of its capital gains over its capital
losses (generally computed on the basis of the one-year period ending
on October 31 of such year), and all taxable ordinary income and the
excess of capital gains over capital losses for the previous year that
were not distributed for such year and on which the Fund did not pay
federal income tax. For federal income tax purposes, dividends declared
by the Fund in October, November or December to shareholders of record
on a specified date in such a month and paid during January of the
following year are treated as if they were paid by the Fund and
received by such shareholders on December 31 of the year declared.
For federal income tax purposes, the Fund is permitted to carry
forward a net capital loss in any year to offset its own net capital
gains, if any, during the eight years following the year of the loss.
Gains and losses on the sale, lapse, or other termination of
options and futures contracts entered into by the Fund will generally
be treated as capital gain and losses. Certain of the futures contracts
and options held by the Fund will be required to be "marked-to-market"
for federal income tax purposes, that is,
-21-
<PAGE>
treated as having been sold at their fair market value on the last day
of the Fund's taxable year. These provisions may require the Fund to
recognize gains without a concurrent receipt of cash. Any gain or loss
recognized on actual or deemed sales of futures contracts or options
that are subject to the mark to market rules will be treated as 60%
long-term capital gain or loss and 40% short-term capital gain or loss.
As a result of certain hedging transactions entered into by the Fund,
the Fund may be required to defer the recognition of losses on futures
contracts and options or underlying securities to the extent of any
unrecognized gains on related positions held by the Fund and the
characterization of gains or losses as long-term or short-term may be
changed. The tax provisions described above applicable to options and
futures contracts may affect the amount, timing and character of the
Fund's distributions to shareholders. The short-short test described
above may limit the Fund's ability to use options and futures
transactions. Certain tax elections may be available to the Fund to
mitigate some of the unfavorable consequences described in this
paragraph.
The Fund's investments, if any, in securities bearing original
issue discount or, if the Fund elects to include market discount in
income currently, market discount, will generally cause it to realize
income prior to the receipt of cash payments with respect to these
securities. The mark to market rules applicable to certain options and
futures contracts, as described above, may also require that net gains
be recognized without a concurrent receipt of cash. In order to obtain
cash to distribute this income or gains, maintain its qualification as
a regulated investment company, and avoid federal income or excise
taxes, the Fund may be required to liquidate portfolio securities that
it might otherwise have continued to hold.
Taxable U.S. Shareholders - Distributions
For U.S. federal income tax purposes, distributions by the Fund,
whether reinvested in additional shares or paid in cash, generally will
be taxable to shareholders who are subject to tax.
Distributions from the Fund's investment company taxable income
will be taxable as ordinary income. Distributions to corporate
shareholders designated as derived from the Fund's dividend income that
would be eligible for the dividends received deduction if the Fund were
not a regulated investment company will be eligible, subject to certain
holding period and debt-financing restrictions, for the 70% dividends
received deduction for corporations. The entire dividend, including the
deducted amount, is considered in determining the excess, if any, of a
corporate shareholder's adjusted current earnings over its alternative
-22-
<PAGE>
minimum taxable income, which may increase its liability for the
federal alternative minimum tax, and the dividend may, if it is treated
as an "extraordinary dividend" under the Code, reduce such
shareholder's tax basis in its shares of the Fund. Capital gain
dividends (i.e., dividends from net capital gain) if properly
designated as such in a written notice to shareholders mailed not later
than 60 days after the Fund's taxable year closes, will be taxed to
shareholders as long-term capital gain regardless of how long shares
have been held by shareholders, but are not eligible for the dividends
received deduction. Distributions, if any, that are in excess of the
Fund's current and accumulated earnings and profits, as computed for
federal income tax purposes, will first reduce a shareholder's tax
basis in his or her shares and, after such basis is reduced to zero,
will constitute capital gains to a shareholder who holds his or her
shares as capital assets.
All distributions, whether received in shares or in cash, as well
as sales and exchanges of Fund shares, must be reported by each
shareholder who is required to file a U.S. federal income tax return.
With respect to distributions paid in cash or, for shareholders
participating in the Dividend Reinvestment Plan (the "Plan"),
reinvested in shares purchased in the open market, the amount of the
distribution for tax purposes is the amount of cash distributed or
allocated to the shareholder. In the case of shares purchased on the
open market, a participating shareholder's tax basis in each share
received is its cost. With respect to distributions issued in shares of
the Fund, the amount of the distribution for tax purposes is the fair
market value of the issued shares on the payment date, and the
difference between such fair market value and the amount of cash the
shareholder would otherwise have received may be treated as a return of
capital. In the case of shares issued by the Fund, the shareholder's
tax basis in each share received is its fair market value on the
payment date, adjusted by any amount treated as a return of capital to
the shareholder.
Distributions by the Fund result in a reduction in the net asset
value of the Fund's shares and may also reduce their market value.
Should a distribution reduce the net asset value or market value below
a shareholder's cost basis, such distribution (to the extent paid from
the Fund's current or accumulated earnings and profits) would
nevertheless be taxable to the shareholder as ordinary income or
capital gain as described above even though, from an investment
standpoint, it may constitute a partial return of capital. In
particular, investors should be careful to consider the tax
implications of buying shares just prior to a distribution. Since the
market price of shares purchased at that time may include the amount of
any forthcoming distribution,
-23-
<PAGE>
investors purchasing shares just prior to a distribution will in effect
receive a return of a portion of their investment in the form of a
distribution which nevertheless will be taxable to them.
Different tax treatment, including penalties on certain excess
contributions and deferrals, certain pre-retirement and post-retirement
distributions, and certain prohibited transactions is accorded to
accounts maintained as qualified retirement plans. Shareholders should
consult their tax advisers for more information.
Taxable U.S. Shareholders - Sale of Shares
When a shareholder's shares are sold, exchanged or otherwise
disposed of, the shareholder will generally recognize gain or loss
equal to the difference between the shareholder's adjusted tax basis in
the shares and the cash, or fair market value of any property,
received. Assuming the shareholder holds the shares as a capital asset
at the time of such sale or other disposition, such gain or loss should
be capital in character, and long-term if the shareholder has a tax
holding period for the shares of more than one year, otherwise (except
as described in the next sentence) short-term. However, any loss
realized on the sale, exchange or other disposition of Fund shares with
a tax holding period of six months or less will be treated as a
long-term capital loss to the extent of any capital gain dividend
received with respect to such shares. Additionally, any loss realized
on a sale or other disposition of shares of the Fund may be disallowed
under "wash sale" rules to the extent the shares disposed of are
replaced with other shares of the Fund within a period of 61 days
beginning 30 days before and ending 30 days after the shares are
disposed of, such as pursuant to a dividend reinvestment under the Plan
in shares of the Fund. If disallowed, the loss will be reflected in an
adjustment to the basis of the shares acquired.
Backup Withholding
The Fund will be required to report to the Internal Revenue
Service all distributions, as well as gross proceeds from the sale or
exchange of Fund shares with respect to which the Fund is a payor (such
as pursuant to a tender offer), except in the case of certain exempt
recipients, i.e., corporations and certain other investors to which
distributions are exempt from the information reporting provisions of
the Code. Under the backup withholding provisions of Code Section 3406
and applicable Treasury regulations, all such reportable distributions
and proceeds may be subject to backup withholding of federal income tax
at the rate of 31% in the case of nonexempt shareholders who fail to
furnish the
-24-
<PAGE>
Fund with their correct taxpayer identification number and with certain
required certifications or if the Internal Revenue Service or a broker
notifies the Fund that the number furnished by the shareholder is
incorrect or that the shareholder is subject to backup withholding as a
result of failure to report interest or dividend income. The Fund may
refuse to accept any subscription that does not contain any required
taxpayer identification number or certification that the number
provided is correct. If the backup withholding provisions are
applicable, any such distributions and proceeds, whether taken in cash
or reinvested in shares, will be reduced by the amounts required to be
withheld. Any amounts withheld may be credited against a shareholder's
U.S. federal income tax liability. Investors should consult their tax
advisers about the applicability of the backup withholding provisions.
Non-U.S. Shareholders
The foregoing discussion relates solely to U.S. federal
income tax law as it applies to "U.S. persons" (i.e., U.S.
citizens or residents and U.S. domestic corporations,
partnerships, trust or estates) subject to tax under such law.
Dividends of investment company taxable income distributed by the
Fund to a shareholder who is not a U.S. person will be subject to
U.S. withholding tax at the rate of 30% (or a lower rate provided
by an applicable tax treaty) unless the dividends are effectively
connected with a U.S. trade or business of the shareholder, in
which case the dividends will be subject to tax on a net income
basis at the graduated rates applicable to U.S. individuals or
domestic corporations. Distributions of net capital gain,
including amounts retained by the Fund which are designated as
undistributed capital gains, to a non-U.S. shareholder will not be
subject to U.S. income or withholding tax unless the distributions
are effectively connected with the shareholder's trade or business
in the U.S. or, in the case of a shareholder who is a nonresident
alien individual, the shareholder is present in the U.S. for 183
days or more during the taxable year and certain other conditions
are met.
Any gain realized by a shareholder who is not a U.S. person upon a
sale or other disposition of shares of the Fund will not be subject to
U.S. federal income or withholding tax unless the gain is effectively
connected with the shareholder's trade or business in the U.S., or in
the case of a shareholder who is a nonresident alien individual, the
shareholder is present in the U.S. for 183 days or more during the
taxable year and certain other conditions are met. Non-U.S. persons who
fail to furnish the Fund with an IRS Form W-8 or acceptable substitute
Form W-8 may be subject to backup withholding at the rate of 31% on
capital gain dividends
-25-
<PAGE>
and the proceeds of certain sales of their shares with respect to
which the Fund is a payor (such as pursuant to a tender offer).
Investors who are not U.S. persons should consult their tax
advisers about the U.S. and non-U.S. tax consequences of ownership
of shares of, and receipt of distributions from, the Fund.
State and Local Taxes
The Fund may be subject to state or local taxes in jurisdictions
in which the Fund may be deemed to be doing business. In addition, in
those states or localities which have income tax laws, the treatment of
the Fund and its shareholders under such laws may differ from their
treatment under federal income tax laws, and investment in the Fund may
have tax consequences for shareholders different from those of a direct
investment in the Fund's portfolio securities. Shareholders should
consult their own tax advisers concerning these matters.
-26-
<PAGE>
FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
<PAGE>
SCHEUDLE OF INVESTMENTS
-----------------------
December 31, 1995
-----------------
<TABLE>
<CAPTION>
COMMON STOCKS: 89.3%
----------------------------------
MARKET
TECHNOLOGY: 21.2% BUSINESS FOCUS SHARES VALUE
---------------------------------- ---------------------------- ------- -------------
<S> <C> <C> <C>
* MEMC Electronic Materials Inc. Silicon Wafer Manufacturer 66,600 $ 2,172,825
* Dionex Corp. Analytical Instruments 31,000 1,759,250
Adobe Systems Inc. Applications Software 25,000 1,550,000
* Micrel Inc. Analog Semiconductors 75,000 1,462,500
* Computervision Corp. Computer-Aided Design
Systems 94,700 1,456,013
* Platinum Technology System Software Products 71,600 1,315,650
* Ceridian Corp. Human Resource Services 30,000 1,237,500
Linear Technology Corp. Advanced Linear Circuits 28,000 1,099,000
* Xilinx Inc. Field Programmable Gate
Arrays 35,000 1,067,500
* Synopsys Inc. CAE Software 25,200 957,600
* Progress Software Corp. Database Software 23,000 862,500
* Geoworks System & Application
Software 40,800 775,200
* Mercury Interactive Corp. Computer Software 40,700 742,775
* FTP Software Inc. Internetworking Software 24,000 696,000
* Discreet Logic Inc. Computer Software 25,500 637,500
* Rational Software Corp. Computer Software 21,400 478,825
* Integrated Process Equip. Inc. Semiconductor Equipment 17,000 399,500
-------------
$ 18,670,138
CONSUMER: 15.0%
----------------------------------
* Staples Inc. Office Products
Superstores 55,050 $ 1,341,844
* Department 56 Inc. Specialty Giftware 34,000 1,304,750
* Garden Ridge Corp. Specialty Home Accessories 29,000 1,123,750
* Nine West Group Inc. Women's Footwear Retailer 26,800 1,005,000
* Blyth Industries Inc. Candles and Accessories 30,200 890,900
Family Dollar Stores Discount Stores 63,650 875,187
Lancaster Colony Corp. Consumer Products 19,400 722,650
* Damark International Inc. General Merchandise 91,450 685,875
* Mohawk Industries Inc. Carpet Manufacturer 43,800 684,375
Leggett & Platt Inc. Furniture Components 25,500 618,375
* Stations Casinos Inc. Multi-Jurisdictional
Gaming 40,000 585,000
* Micro Warehouse Inc. Computer Direct Marketer 13,400 579,550
* West Marine Inc. Boating Supplies Retailer 18,500 578,125
* Daka International Inc. Restaurants 19,700 541,750
* Sonic Corp. Drive-In Restaurants 27,000 513,000
* PetsMart Inc. Pet Supplies Superstores 15,650 485,150
* Micros Systems Inc. Electronic Information
Systems 9,300 458,025
* Global Direct Mail Corp. Computer/Office Prod.
Marketer 8,000 220,000
-------------
$ 13,213,306
</TABLE>
F-1
<PAGE>
<TABLE>
<CAPTION>
MARKET
ENERGY: 11.7% BUSINESS FOCUS SHARES VALUE
---------------------------------- ------------------------------- ------ -----------
<S> <C> <C> <C>
Tidewater Inc. Marine Support Vessels 70,000 $ 2,205,000
Devon Energy Corp. Oil & Gas Producer 58,500 1,491,750
* BJ Services Co. Stimulation & Pumping Services 45,000 1,305,000
* Triton Energy Corp. Oil & Gas Producer 18,000 1,032,750
* United Meridian Corp. Oil & Gas Producer 46,500 807,937
Camco International Inc. Oil Field Services & Equipment 28,500 798,000
Diamond Shamrock Inc. Refiner and Marketer 30,500 789,188
* Benton Oil & Gas Co. Oil & Gas Producer 52,000 780,000
Parker & Parsley Pete Co. Oil & Gas Producer 25,000 550,000
* Coda Energy Inc. Oil & Gas Producer 68,000 505,750
-----------
$10,265,375
CREDIT SENSITIVE: 11.2%
----------------------------------
* Dime Bancorp Inc. New York Savings Bank 138,500 $ 1,610,063
Baybanks Inc. Massachusetts Bank 15,000 1,473,750
* Glendale Fed Bank Fed Svgs California Savings & Loan 59,750 1,045,625
Lennar Corp. Residential & Commer. Builders 40,000 1,005,000
* Credit Acceptance Corp. Auto Financing 48,300 1,002,225
Long Island Bancorp Inc. New York Savings Bank 29,000 764,875
Peoples Heritage Finanacial Group Maine Savings Bank 27,000 614,250
Amresco Inc. Real Estate Financial Services 47,500 605,625
Paine Webber Group Inc. Financial Broker 29,250 585,000
* Triangle Pacific Corp. Flooring & Kitchen Cabinets 31,000 530,875
* First Bell Bancorp Inc. Pennsylvania Savings Bank 30,000 401,250
* HFNC Financial Corp. North Carolina Savings & Loan 14,000 183,750
-----------
$ 9,822,288
HEALTH CARE: 10.7%
---------------------------------
* Phycor Inc. Physician Practice Management Co. 66,675 $ 3,371,255
* Community Health Systems Inc. Hospital Management Company 38,600 1,375,125
* Henry Schein Inc. Healthcare Products Distributor 23,500 693,250
* American Oncology Inc. Physician Practice Management Co. 14,000 680,750
* Gensia Pharmaceuticals Inc. Pharmaceuticals 102,500 538,125
* Perseptive Biosystems Inc. Analytical Instruments 62,500 531,250
* ImmuLogic Pharmaceutical Corp. Pharmaceuticals 25,000 481,250
* Uromed Corp. Urological Devices 35,500 457,063
* Agouron Pharmaceuticals Inc. Pharmaceuticals 13,500 442,125
* Gilead Sciences Inc. Pharmaceuticals 13,500 432,000
* IDX Systems Corp. Health Care Information Systems 10,800 375,300
* Sun Healthcare Group Inc. Health Care Services 2,000 27,000
-----------
$ 9,404,493
</TABLE>
F-2
<PAGE>
<TABLE>
<CAPTION>
MARKET
SERVICE COMPANIES: 10.6% BUSINESS FOCUS SHARES VALUE
- ------------------------------- ---------------------------- ------ -----------
<S> <C> <C> <C>
Delta & Pine Land Co. Largest Cotton Seed Company 68,133 $ 2,503,887
* Paging Network Inc. Paging Services 96,500 2,352,188
New England Business Service Business Forms 80,100 1,742,175
* Daisytek International Corp. Non-Paper Office Supplies 30,500 937,875
* Vanguard Cellular Systems Cellular Telephone Service 35,800 724,950
* BISYS Group Inc. Information Processing
System 16,000 492,000
National Data Corp. Information Processing
System 12,500 309,375
* Corestaff Inc. Temporary/Contract
Personnel 8,000 292,000
-----------
$ 9,354,450
PROCESS INDUSTRIES: 5.2%
- ------------------------------
Riverwood International Paperboard Packaging
Corp. Systems 50,000 $ 956,250
Rayonier Inc. Forest Products & Specialty
Pulp 27,500 917,812
P.H. Glatfelter Co. Paper Manufacturer 50,000 856,250
Potlatch Corp. Forest Products 19,000 760,000
Bowater Inc. Newsprint and Paper
Producer 20,000 710,000
Rock-Tenn Co. Paperboard Recycling 21,000 341,250
-----------
$ 4,541,562
TRANSPORTATION: 2.1%
- ------------------------------
TNT Freightways Corp. Regional Trucker 53,900 $ 1,084,737
Atlantic Southeast Airlines Air Carrier 19,800 425,700
* American Freightways Corp. Regional Trucker 28,000 290,500
* Western Pacific Airlines
Inc. Airline 3,000 50,250
-----------
$ 1,851,187
CAPITAL GOODS: 1.6%
- ------------------------------
Furon Co. Engineered Components 72,700 $ 1,454,000
-----------
$ 1,454,000
TOTAL COMMON STOCKS (cost $58,904,597) $78,576,799
COMMERCIAL PAPER: 10.7%
- ------------------------------
Associates Corp. 5.754% due
1/2/96 $ 9,366,000
- ------------------------------ -----------
TOTAL: 100% (cost 68,270,597) $87,942,799
===========
</TABLE>
* Non-income producing security.
See accompanying notes to financial statements
F-3
<PAGE>
- -------------------------------------------------------------------------------
Statement of Assets and Liabilities
December 31, 1995
- -------------------------------------------------------------------------------
Assets:
Investments in securities at market value,
cost $68,270,597 (Note 1) $87,942,799
Receivables
Dividends and interest 24,812
-----------
Total assets $87,967,611
Liabilities:
Dividend payable $12,888,514
Payable for investment securities purchased 358,513
Accrued expenses 241,009
Due to custodian 77,881
-----------
Total liabilities $13,565,917
Net assets $74,401,694
===========
Net assets:
Common stock, $0.01 par value; 6,042,435 shares
issued; 150,000,000 shares authorized $ 60,424
Capital in excess of par value 53,503,539
Net unrealized appreciation of investments 19,672,203
Undistributed net capital gains 1,165,528
-----------
Net assets $74,401,694
===========
Net asset value per share as of the close of
business on December 31, 1995 $ 12.31
===========
See accompanying notes to financial statements
F-4
<PAGE>
- -------------------------------------------------------------------------------
Statement of Operations
For the Year Ended December 31, 1995
- -------------------------------------------------------------------------------
Investment income:
Interest $ 643,504
Cash dividends 407,245
Miscellaneous income 14,736
-----------
$ 1,065,485
Expenses:
Investment advisory fees (Note 2) $ 743,088
Custodian and transfer agent fees 99,956
Professional fees 69,934
Shareholder communications 61,999
Directors' fees 52,002
Insurance 31,912
Registration and listing fees 20,947
Miscellaneous 6,979
-----------
$ 1,086,817
Net investment expense $ (21,332)
Realized and unrealized gain/(loss) on investments:
Proceeds from sales $79,312,314
Less-cost of securities sold 65,323,084
-----------
Net realized gain on investments $13,989,230
Unrealized appreciation:
Beginning of year $ 8,092,049
End of year 19,672,203
-----------
Net increase in unrealized appreciation on
investments $11,580,154
-----------
Net realized and unrealized gain on investments $25,569,384
-----------
Net increase in net assets resulting
from operations $25,548,052
===========
See accompanying notes to financial statements
F-5
<PAGE>
- -------------------------------------------------------------------------------
Statement of Changes in Net Assets
For the Years Ended December 31, 1995 and 1994
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994
------------ ------------
<S> <C> <C>
Increase (decrease) in net assets resulting from
operations:
Net investment expense $ (21,332) $ (389,775)
Net realized gain on investments 13,989,230 7,888,625
Net change in unrealized appreciation 11,580,154 (9,866,262)
------------ ------------
Net increase in net assets resulting from operations $ 25,548,052 $ (2,367,412)
Distributions from net realized gains (12,888,514) (7,096,506)
Share transactions 2,648,895 1,235,783
------------ ------------
Increase/(Decrease) in net assets $ 15,308,433 $ (8,228,135)
Net assets:
Beginning of year 59,093,261 67,321,396
------------ ------------
End of year $ 4,401,694 $ 59,093,261
============ ============
</TABLE>
See accompanying notes to financial statements
F-6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
December 31, 1995 and 1994
1. Significant Accounting Policies
Morgan Grenfell SMALLCap Fund, Inc. (the "Fund") was organized as a
Maryland corporation on January 16, 1987 and is registered under the
Investment Company Act of 1940, as amended, as a closed-end, diversified
management investment company. The Fund commenced operations on May 6, 1987.
The following is a summary of the significant accounting policies
consistently followed by the Fund in the preparation of its financial
statements. The policies are in conformity with generally accepted accounting
principles.
Portfolio valuation: Securities listed on an exchange and over-the-counter
securities quoted on the NASDAQ system are valued on the basis of the last
sale price on the last business day of the year. Over-the-counter securities
not quoted on the NASDAQ system are valued on the basis of the average bid
and asked prices on that date. Commercial paper is carried at cost, which
approximates market.
Securities transactions and investment income: Securities transactions are
recorded on a trade date basis. Dividend income is recorded on the
ex-dividend date and interest income is recorded on the accrual basis.
Realized gains and losses from securities transactions are recorded on the
basis of identified cost.
Federal income taxes: It is the policy of the Fund to qualify as a
regulated investment company by complying with provisions available to
certain investment companies, as defined in applicable sections of the
Internal Revenue Code, and to make distributions of income and securities
profits (after application of net capital loss carryovers) sufficient to
relieve it from all, or substantially all, Federal income taxes.
2. Investment Advisory Fee and Other Transactions with Affiliates
The Fund pays advisory fees for investment and advisory services to Morgan
Grenfell Capital Management Inc. ("MGCM"), a wholly-owned subsidiary of
Morgan Grenfell PLC. Under the terms of the investment advisory agreement,
the management fee is calculated at an annual rate of one percent of the
Fund's average daily net assets.
Certain individuals who are officers or directors, or both, of the Fund
are also officers or directors, or both, of MGCM.
F-7
<PAGE>
3. Capital Share Transactions
On April 29, 1987, the Fund issued 10,782 shares to MGCM for $100,003.
Subsequent to a public offering, the Fund issued 5,000,000 additional shares
on May 6, 1987 for net proceeds of $46,375,000 after deducting underwriting
discounts of $3,625,000. Arrangements were made to borrow from MGCM an amount
equal to the underwriting discount so that at the conclusion of the offering,
the Fund had available for investment an amount equal to the gross proceeds
of the offering. Initial registration fees amounting to $57,407 were charged
against paid in capital at the time of issuance of these shares.
During 1995, 1994, 1992 and 1990 the Fund issued 256,925, 103,447, 441,639
and 229,642 shares, respectively, under the dividend reinvestment plan.
4. Investment Transactions
The aggregate cost of securities purchased and the aggregate proceeds of
securities sold during the year ended December 31, 1995, excluding short-term
investments, were $69,533,278 and $79,312,314, respectively. At December 31,
1995, the cost of investments for Federal income tax purposes was
substantially the same as the cost for financial reporting purposes.
5. Dividend Reinvestment Plan
Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all
dividends from net investment income and/or all capital gain distributions
will be reinvested by The Bank of New York, as agent for shareholders in
administering the Plan (the "Plan Agent"), in additional shares of the Fund.
Registered shareholders are deemed to participate in the Plan unless they
elect to receive all dividends from net investment income and/or all capital
gains distributions in the form of cash. Each registered shareholder at the
time of purchase will receive from the Plan Agent an authorization card to be
signed and returned if the shareholder elects to receive distributions from
net investment income in cash or elects not to receive capital gain
distributions in the form of a stock dividend. Shareholders whose shares are
held in the name of a broker or nominee or shareholders transferring such an
account to a new broker should contact such broker or nominee to elect to
participate in the Plan or to receive their distributions in cash.
Participating shareholders will receive dividends from net investment
income and/or all capital gain distributions in additional shares issued by
the Fund if the shares are trading at a premium; i.e., the net asset value
("NAV") is less than the then-current market price. In such event, the number
of additional shares to be issued by the Fund will be determined by valuing
such shares at the higher of (i) their net asset value or (ii) 95% of the
market price. If shares of the Fund are trading at a discount; i.e., the NAV
exceeds the then-current market price, the Plan Agent will, as agent for the
participants, apply such dividends or distributions to purchase shares in the
open market, on the New York Stock Exchange or elsewhere, for the
participants' accounts. In such case, the price of the shares to each
participating shareholder will be the average market price at which such
shares were purchased under the direction of the Plan Agent. There will be no
brokerage charges for shares directly issued by the Fund; however, brokerage
commissions incurred on open market purchases will be borne pro rata by each
participant. There is no direct service charge to participants in the Plan;
the fees of the Plan Agent will be borne by the Fund. However, the Fund
reserves the right to amend the Plan to include such a charge payable by the
participants or for other reasons.
F-8
<PAGE>
5. Dividend Reinvestment Plan - continued
Participants in the Plan may elect to withdraw from the Plan at any time
upon written notice to the Plan Agent and thereby elect to receive all
distributions from net investment income in cash and/or all capital gain
distributions either in the form of a stock dividend or in cash. The written
notice will not be effective with respect to distributions made within seven
days of its receipt by the Plan Agent. If notice is received after a record
date, a shareholder's request will be completed after the determination of
shares for that dividend has been credited to the shareholder's account.
Dividends and capital gain distributions are taxable whether paid in cash or
reinvested in additional shares, and the reinvestment of dividends and
capital gain distributions will not relieve participants of liability for any
U.S. income tax that may be payable (or required to be withheld) on such
dividends or distributions. Additional information about the Plan is
available by calling the Plan Agent's Shareholder Relations Department at
1-800-432-8224.
F-9
<PAGE>
SUPPLEMENTARY INFORMATION
Financial Highlights
Contained below is per-share operating performance data for a share of common
stock outstanding, total investment return, ratios to average net assets, and
other supplemental data for the eight years ended December 31, 1995, and for
the period May 6, 1987 (commencement of operations) through December 31,
1987. This information has been derived from information provided in the
financial statements and market price data for the Fund's shares.
Years Ended December 31
-----------------------------------------
1995 1994 1993
----------- ----------- -----------
PER SHARE OPERATING PERFORMANCE:
Net asset value,
beginning of period $ 10.21 $ 11.85 $ 11.97
Net investment income
(expense) (0.00) (0.07) (0.08)
Net gain/(loss) on securities
(realized and unrealized) 4.23 (0.34) 1.10
----------- ----------- -----------
Total from investment operations $ 4.23 $ (0.41) $ 1.02
Less dividends and distributions:
Tax return
of capital distribution (2.13) (1.23) (1.14)
----------- ----------- -----------
Total dividends and distributions $ (2.13) $ (1.23) $ (1.14)
----------- ----------- -----------
Net asset value, end of year $ 12.31 $ 10.21 $ 11.85
=========== =========== ===========
Market value per share, $ 12.625(1) $ 8.875 $ 10.875
end of year
TOTAL INVESTMENT RETURN:
Based on market value per share +42.3% -7.1% -1.9%
Based on net asset value per
share +41.4% -3.5% +8.5%
RATIOS TO AVERAGE NET ASSETS:
Expenses 1.51% 1.52% 1.39%
Net investment income
(expense) (0.03%) (0.59%) (0.74%)
SUPPLEMENTAL DATA:
Net assets at end of year
(000 omitted) $ 74,402 $ 59,093 $ 67,321
Average net assets during year
(000 omitted) $ 72,202 $ 66,064 $ 69,048
Portfolio turnover 110% 105% 89%
Total debt outstanding at end
of year (000 omitted) -0- -0- -0-
Asset coverage per $1000 of debt
(000 omitted) N/A N/A N/A
*Annualized.
(1) The Fund declared a $2.133 capital gain distribution payable to
shareholders of record on December 29, 1995. The dividend was paid on January
26, 1996 and the Fund's shares traded with the dividend until the ex-dividend
date, January 29, 1996.
F-10
<PAGE>
Years Ended December 31 May 6, 1987
(commencement of
- --------------------------------------------------------------- operations)
1992 1991 1990 1989 1988 through 12/31/87
- ------- ------- ------- ------- ------- -------
$ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45 $ 9.27
(0.09) (0.10) (0.11) (0.11) (0.11) (0.16)
0.58 4.67 (1.34) 2.29 1.53 (1.66)
- ------- ------- ------- ------- ------- -------
$ 0.49 $ 4.57 $ (1.45) $ 2.18 $ 1.42 $ (1.82)
(0.82) (0.97) (0.65) (0.25) -- --
- ------- ------- ------- ------- ------- -------
$ (0.82) $ (0.97) $ (0.65) $ (0.25) $ 0.00 $ 0.00
- ------- ------- ------- ------- ------- -------
$ 11.97 $ 12.30 $ 8.70 $ 10.80 $ 8.87 $ 7.45
======= ======= ======= ======= ======= =======
$12.250 $12.875 $ 8.750 $ 9.625 $ 7.375 $ 6.000
+1.5% +58.0% -2.2% +34.2% +22.9% -40.0%
+4.0% +52.5% -13.4% +24.6% +19.1% -19.7%
1.44% 1.79% 2.01% 2.13% 2.56% 4.32%*
(0.83%) (0.85%) (1.05%) (1.10%) (1.30%) (1.80%)*
$68,013 $64,461 $45,581 $54,136 $44,462 $37,316
$64,644 $58,900 $51,121 $50,522 $43,422 $44,062
89% 70% 75% 80% 83% 98%*
-0- $ 1,060 $ 1,724 $ 2,324 $ 2,868 $ 3,360
N/A $ 60.8 $ 26.4 $ 23.3 $ 15.5 $ 11.1
F-11
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders
Morgan Grenfell SMALLCap Fund, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the schedule of investments, of Morgan Grenfell SMALLCap Fund, Inc.
as of December 31, 1995, and the related statement of operations for the year
then ended, the statement of changes in net assets for each of the years in
the two-year period ended December 31, 1995, and the financial highlights for
each of the years in the eight-year period ended December 31, 1995 and for
the period May 6, 1987 (commencement of operations) through December 31,
1987. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures include confirmation of
securities owned as of December 31, 1995, by correspondence with the
custodian and brokers. An audit also includes assessing the accounting
principles used, and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Morgan Grenfell SMALLCap Fund, Inc., as of December 31, 1995, the result of
its operations for the year then ended, changes in net assets for each of the
years in the two-year period ended December 31, 1995 and the financial
highlights for each of the years in the eight-year period ended December 31,
1995, and for the period May 6, 1987 (commencement of operations) through
December 31, 1987, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
New York, New York
January 31, 1996
