Rule 497(c)
Registration No. 33-25747
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TAX EXEMPT PROCEEDS FUND, INC.
600 Fifth Avenue, New York, NY 10020
(212) 830-5220
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STATEMENT OF ADDITIONAL INFORMATION
October 27, 2000
AS SUPPLEMENTED ON OCTOBER 31, 2000
RELATING TO THE TAX EXEMPT PROCEEDS FUND, INC.
PROSPECTUS DATED OCTOBER 27, 2000
This Statement of Additional Information (SAI) is not a Prospectus. The SAI
expands upon and supplements the information contained in the current Prospectus
of Tax Exempt Proceeds Fund, Inc. (the "Fund"), dated October 27, 2000, and
should be read in conjunction with the Fund's Prospectus.
A Prospectus may be obtained from any Participating Organization or by writing
or calling the Fund toll-free at 1-(800) 221-3079. The Financial Statements of
the Fund have been incorporated by reference to the Fund's Annual Report. The
section entitled "Purchase, Redemption and Pricing of Shares" has been
incorporated by reference to the Fund's Prospectus. The Annual Report is
available, without charge, upon request by calling the toll-free number
provided.
This Statement of Additional Information is incorporated by reference into the
Prospectus in its entirety.
Table of Contents
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Fund History........................................ 2 Capital Stock and Other Securities.............14
Description of the Fund and Its Investments and Purchase, Redemption and Pricing of Shares.....14
Risks............................................. 2 Taxation of the Fund...........................15
Management of the Fund...............................9 Underwriters...................................17
Control Persons and Principal Holders of Calculation of Performance Data................17
Securities........................................10 Financial Statements...........................18
Investment Advisory and Other Services..............10 Description of Ratings.........................19
Brokerage Allocation and Other Practices............13
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I. FUND HISTORY
The Fund was incorporated on November 18, 1988 in the state of Maryland.
II. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS
The Fund is a diversified, open-end, management investment company that is a
short-term, tax-exempt money market fund. The Fund's investment objectives are
to seek to provide its investors with high current interest income exempt from
Federal income taxes, preservation of capital and liquidity. No assurance can be
given that these objectives will be achieved.
The following discussion expands upon the description of the Fund's investment
objectives and policies in the Prospectus.
The Fund's assets will be invested primarily in short-term high quality,
tax-exempt fixed rate and variable rate obligations issued by or on behalf of
states and municipal governments and their authorities, agencies,
instrumentalities and political subdivisions ("Municipal Obligations") and in
participation certificates in such obligations purchased from banks, insurance
companies or other financial institutions, where such securities and
participation certificates therein meet this Federal income tax definition. The
Fund will not invest in Municipal Obligations the interest income on which may
be subject to the Federal individual alternative minimum tax.
The Fund will only invest in securities that would qualify an investment in the
Fund as an investment in "tax-exempt bonds" as defined in Section 150(a)(6) of
the Internal Revenue Code of 1986, as amended (the "Code") and amplified in
Treasury Department Regulations. Therefore, Fund shareholders that are
tax-exempt bond issuers are expected to be exempt from the arbitrage rebate
provisions of the Code with respect to income from the Fund.
The Fund seeks to maintain an investment portfolio with a dollar-weighted
average maturity of 90 days or less, and to value its investment portfolio at
amortized cost and maintain a net asset value of $1.00 per share. There can be
no assurance that this value will be maintained.
The Fund may hold uninvested cash reserves pending investment. The Fund's
investments may include "when-issued" Municipal Obligations and stand-by
commitments. The Fund may invest its assets in participation certificates issued
by banks in industrial revenue bonds (issued before August 8, 1986) and other
Municipal Obligations. In view of this possible investment in bank participation
certificates in Municipal Obligations, an investment in Fund shares should be
made with an understanding of the characteristics of the banking industry and
the risks which such an investment may entail. (See "Variable Rate Demand
Instruments and Participation Certificates" herein.)
The investment objectives of the Fund described above may not be changed unless
approved by the holders of a majority of the outstanding shares of the Fund. The
Fund's fundamental investment policies of investing in securities that would
qualify an investment in the Fund as a "tax-exempt bond" and of not investing in
securities, the interest income on which may be subject to the Federal
individual alternative minimum tax, may only be changed with the approval of 90%
of the Fund's outstanding shares. As used herein, the term "majority of the
outstanding shares" of the Fund means, respectively, the vote of the lesser of
(i) 67% or more of the shares of the Fund present at a meeting, if the holders
of more than 50% of the outstanding shares of the Fund are present or
represented by proxy or (ii) more than 50% of the outstanding shares of the
Fund.
The Fund may only purchase securities determined by the Fund's Board of
Directors to present minimal credit risks and that are Eligible Securities at
the time of acquisition. The term Eligible Securities means: (i) Municipal
Obligations with remaining maturities of 397 days or less and rated in the two
highest short-term rating categories by any two nationally recognized
statistical rating organizations ("NRSROs") or in such categories by the only
NRSRO that has rated the Municipal Obligations (collectively, the "Requisite
NRSROs"); (ii) Municipal Obligations which are subject to a Demand Feature or
Guarantee (as such terms are defined in Rule 2a-7 of the Investment Company Act
of 1940 (the "1940 Act")) and have received a rating from an NRSRO, or such
guarantor has received a rating from an NRSRO, with respect to a class of debt
obligations (or any debt obligation within that class) that is comparable in
priority and security to the Guarantee (unless, the guarantor, directly or
indirectly, controls, is controlled by or is under common control with the
issuer of the security subject to the Guarantee); and the issuer of the Demand
Feature or Guarantee, or another institution, has undertaken promptly to notify
the holder of the security in the event the Demand Feature or Guarantee is
substituted with another Demand Feature or Guarantee; or (iii) unrated Municipal
Obligations determined by the Fund's Board of Directors to be of comparable
quality. In addition, Municipal Obligations with remaining maturities of 397
days or less but that at the time of issuance were long-term securities (i.e.
with maturities greater than 366 days) are deemed unrated and may be purchased
if such has received a long-term rating from the Requisite NRSROs in one of the
three highest rating categories. Provided however, that such may not be
purchased if it (i) does not satisfy the rating requirements set forth in the
preceding sentence and (ii) has received a long-term rating from any NRSRO that
is not within the three highest long-term rating categories. A determination of
comparability by the Board of Directors is made on the basis of its credit
evaluation of the issuer, which may include an evaluation of a letter of
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credit, guarantee, insurance or other credit facility issued in support of the
Municipal Obligations or Participation Certificates. (See "Variable Rate Demand
Instruments and Participation Certificates" herein.) There are several
organizations that currently qualify as NRSROs including Standard & Poor's
Rating Services, a division of The McGraw-Hill Companies, ("S&P") and Moody's
Investors Service, Inc. ("Moody's"). The two highest ratings by S&P and Moody's
are "AAA" and "AA" by S&P in the case of long-term bonds and notes or "Aaa" and
"Aa" by Moody's in the case of bonds; "SP-1" and "SP-2" by S&P or "MIG-1" and
"MIG-2" by Moody's in the case of notes; "A-1" and "A-2" by S&P or "Prime-1" and
"Prime-2" by Moody's in the case of tax-exempt commercial paper. The highest
rating in the case of variable and floating demand notes is "VMIG-1" by Moody's
or "SP-1/AA" by S&P. Such instruments may produce a lower yield than would be
available from less highly rated instruments.
All investments by the Fund will mature or will be deemed to mature within 397
days or less from the date of acquisition and the average maturity of the Fund
portfolio (on a dollar-weighted basis) will be 90 days or less. The maturities
of variable rate demand instruments held in the Fund's portfolio will be deemed
to be the longer of the period required before the Fund is entitled to receive
payment of the principal amount of the instrument through demand, or the period
remaining until the next interest rate adjustment, although the stated
maturities may be in excess of 397 days. The maturity of a variable rate demand
instrument will be determined in the same manner for purposes of computing the
Fund's dollar-weighted average portfolio maturity.
The Fund has elected and intends to continue to qualify as a "regulated
investment company" under the Code. The Fund will be restricted in that at the
close of each quarter of the taxable year, at least 50% of the value of its
total assets must be represented by cash, government securities, regulated
investment company securities and other securities limited in respect of any one
issuer to not more than 5% in value of the total assets of the Fund and not more
than 10% of the outstanding voting securities of such issuer. In addition, at
the close of each quarter of its taxable year, not more than 25% in value of the
Fund's total assets may be invested in securities of one issuer other than
Government securities. The limitations described in this paragraph regarding
qualification as a "regulated investment company" are not fundamental policies
and may be revised to the extent applicable Federal income tax requirements are
revised. (See "Federal Income Taxes" herein.)
Description Of Municipal Obligations
As used herein, "Municipal Obligations" include the following as well as
"Variable Rate Demand Instruments and Participation Certificates":
1. Municipal Bonds with remaining maturities of 397 days or less that are
Eligible Securities at the time of acquisition. Municipal Bonds are debt
obligations of states, cities, counties, municipalities and municipal
agencies (all of which are generally referred to as "municipalities"). They
generally have a maturity at the time of issue of one year or more and are
issued to raise funds for various public purposes such as construction of a
wide range of public facilities, to refund outstanding obligations and to
obtain funds for institutions and facilities.
The two principal classifications of Municipal Bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by
the issuer's pledge of its faith, credit and taxing power for the payment
of principal and interest. Issuers of general obligation bonds include
states, counties, cities, towns and other governmental units. The principal
of, and interest on revenue bonds are payable from the income of specific
projects or authorities and generally are not supported by the issuer's
general power to levy taxes. In some cases, revenues derived from specific
taxes are pledged to support payments on a revenue bond.
In addition, certain kinds of "private activity bonds" are issued by public
authorities to provide funding for various privately operated facilities
(hereinafter referred to as "industrial revenue bonds" or "IRBs"). Interest
on IRBs is generally exempt, with certain exceptions, from regular Federal
income tax pursuant to Section 103(a) of the Code, provided the issuer and
corporate obligor thereof continue to meet certain conditions. (See
"Federal Income Taxes" herein.) IRBs are, in most cases, revenue bonds and
generally do not constitute the pledge of the credit of the issuer of such
bonds. The payment of the principal and interest on IRBs usually depends
solely on the ability of the user of the facilities financed by the bonds,
or any guarantor of the bonds to meet its financial obligations and, in
certain instances, the pledge of real and personal property as security for
payment. If there is no established secondary market for the IRBs, the IRBs
or the Participation Certificates in IRBs purchased by the Fund will be
supported by letters of credit, guarantees or insurance that meet the
definition of Eligible Securities at the time of acquisition and provide
the demand feature which may be exercised by the Fund at any time to
provide liquidity. In accordance with Investment Restriction 7 herein, the
Fund is permitted to invest up to 10% of the portfolio in high quality,
short-term Municipal Obligations (including IRBs) meeting the definition of
Eligible Securities at the time of acquisition that may not be readily
marketable or have a liquidity feature. The Fund will not invest in IRBs
(issued after August 7, 1986) the interest income from which may be subject
to the Federal individual alternative minimum tax.
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In view of the investment of the Fund in IRBs issued before August 8, 1986
and participation interests therein secured by letters of credit or
Guarantees of banks, an investment in Fund shares should be made with an
understanding of the characteristics of the banking industry and the risks
which such an investment may entail. Banks are subject to extensive
governmental regulations which may limit both the amounts and types of
loans and other financial commitments which may be made and interest rates
and fees which may be charged. The profitability of this industry is
largely dependent upon the availability and cost of capital funds for the
purpose of financing lending operations under prevailing money market
conditions. Also, general economic conditions play an important part in the
operations of this industry and exposure to credit losses arising from
possible financial difficulties of borrowers might affect a bank's ability
to meet its obligations under a letter of credit.
2. Municipal Notes with remaining maturities of 397 days or less that are
Eligible Securities at the time of acquisition. The principal kinds of
Municipal Notes include tax anticipation notes, bond anticipation notes,
revenue anticipation notes and project notes. Notes sold in anticipation of
collection of taxes, a bond sale or receipt of other revenues are usually
general obligations of the issuing municipality or agency. Project notes
are issued by local agencies and are guaranteed by the United States
Department of Housing and Urban Development. Project notes are also secured
by the full faith and credit of the United States.
3. Municipal Commercial Paper that is an Eligible Security at the time of
acquisition. Issues of Municipal Commercial Paper typically represent very
short-term, unsecured, negotiable promissory notes. These obligations are
often issued to meet seasonal working capital needs of municipalities or to
provide interim construction financing. They are paid from general revenues
of municipalities or are refinanced with long-term debt. In most cases
Municipal Commercial Paper is backed by letters of credit, lending
agreements, note repurchase agreements or other credit facility agreements
offered by banks or other institutions which may be called upon in the
event of default by the issuer of the commercial paper.
4. Any other Federal tax-exempt obligations issued by or on behalf of states
and municipal governments and their authorities, agencies,
instrumentalities and political subdivisions, whose inclusion in the Fund
will be consistent with the Fund's investments and policies as described
under "Description of the Fund and Its Investments and Risks" herein and
under "Investment Objectives, Principal Investment Strategies and Related
Risks" in the Prospectus and that is permissible under Rule 2a-7 under the
1940 Act.
Subsequent to its purchase by the Fund, a rated Municipal Obligation may cease
to be rated or its rating may be reduced below the minimum required for purchase
by the Fund. If this occurs, the Board of Directors of the Fund shall promptly
reassess whether the Municipal Obligation presents minimal credit risks and
shall cause the Fund to take such action as the Board of Directors determines is
in the best interest of the Fund and its shareholders. However, reassessment is
not required if the Municipal Obligation is disposed of or matures within five
business days of the Manager becoming aware of the new rating and provided
further that the Board of Directors is subsequently notified of the Manager's
actions.
In addition, in the event that a Municipal Obligation (i) is in default, (ii)
ceases to be an Eligible Security under Rule 2a-7 of the 1940 Act or (iii) is
determined to no longer present minimal credit risks, or an event of insolvency
occurs with respect to the issues of a portfolio security or the provider of any
Demand Feature or Guarantee, the Fund will dispose of the security absent a
determination by the Fund's Board of Directors that disposal of the security
would not be in the best interests of the Fund. Disposal of the security shall
occur as soon as practicable consistent with achieving an orderly disposition by
sale, exercise of any demand feature or otherwise. In the event of a default
with respect to a security which immediately before default accounted for 1/2 of
1% or more of the Fund's total assets, the Fund shall promptly notify the SEC of
such fact and of the actions that the Fund intends to take in response to the
situation. Certain Municipal Obligations issued by instrumentalities of the
United States government are not backed by the full faith and credit of the
United States Treasury but only by the creditworthiness of the instrumentality.
The Fund's Board of Directors has determined that any Municipal Obligation that
depends directly, or indirectly through a government insurance program or other
Guarantee, on the full faith and credit of the United States government will be
considered to have a rating in the highest category. Where necessary to ensure
that the Municipal Obligations are Eligible Securities, or where the obligations
are not freely transferable, the Fund will require that the obligation to pay
the principal and accrued interest be backed by an unconditional irrevocable
bank letter of credit, a Guarantee, insurance or other comparable undertaking of
an approved financial institution that would qualify the investment as an
Eligible Security.
Variable Rate Demand Instruments and Participation Certificates
Variable rate demand instruments that the Fund will purchase are tax-exempt
Municipal Obligations. They provide for a periodic adjustment in the interest
rate paid on the instrument and permit the holder to demand payment of the
unpaid principal balance plus accrued interest at specified intervals upon a
specified number of days notice either from the issuer or by drawing on a bank
letter of credit, a guarantee or insurance issued with respect to such
instrument.
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The variable rate demand instruments in which the Fund may invest are payable on
demand on not more than thirty calendar days' notice and may be exercised at any
time or at specified intervals not exceeding 397 days depending upon the terms
of the instrument. Variable rate demand instruments that can not be disposed of
properly within seven days in the ordinary course of business are illiquid
securities. The terms of the instruments provide that interest rates are
adjustable at intervals ranging from daily to up to 397 days. The adjustments
are based upon the "prime rate"* of a bank or other appropriate interest rate
adjustment index as provided in the respective instruments. The Fund decides
which variable rate demand instruments it will purchase in accordance with
procedures prescribed by its Board of Directors to minimize credit risks. A fund
utilizing the amortized cost method of valuation under Rule 2a-7 of the 1940 Act
may purchase variable rate demand instruments only if (i) the instrument is
subject to an unconditional demand feature, exercisable by the Fund in the event
of a default in the payment of principal or interest on the underlying
securities, that is an Eligible Security or (ii) the instrument is not subject
to an unconditional demand feature but does qualify as an Eligible Security and
has a long-term rating by the Requisite NRSROs in one of the two highest rating
categories, or if unrated, is determined to be of comparable quality by the
Fund's Board of Directors. The Fund's Board of Directors may determine that an
unrated variable rate demand instrument meets the Fund's high quality criteria
if it is backed by a letter of credit or guarantee or is insured by an insurer
that meets the quality criteria for the Fund stated herein or on the basis of a
credit evaluation of the underlying obligor. If an instrument is ever not deemed
to be an Eligible Security, the Fund either will sell it in the market or
exercise the demand feature.
The variable rate demand instruments that the Fund may invest in include
Participation Certificates purchased by the Fund from banks, insurance companies
or other financial institutions in fixed or variable rate, tax-exempt Municipal
Obligations (expected to be concentrated in IRBs) owned by such institutions or
affiliated organizations. The Fund will not purchase Participation Certificates
in fixed rate tax-exempt Municipal Obligations without obtaining an opinion of
counsel that the Fund will be treated as the owner of an interest in the
underlying Municipal Obligations for Federal income tax purposes. A
participation certificate gives the Fund an undivided interest in the Municipal
Obligation in the proportion that the Fund's participation interest bears to the
total principal amount of the Municipal Obligation and provides the demand
repurchase feature described below. Where the institution issuing the
participation does not meet the Fund's eligibility criteria, the participation
is backed by an irrevocable letter of credit or guaranty of a bank (which may be
the bank issuing the participation certificate, a bank issuing a confirming
letter of credit to that of the issuing bank, or a bank serving as agent of the
issuing bank with respect to the possible repurchase of the certificate of
participation) or insurance policy of an insurance company that the Board of
Directors of the Fund has determined meets the prescribed quality standards for
the Fund. The Fund has the right to sell the participation certificate back to
the institution. Where applicable, the Fund can draw on the letter of credit or
insurance after no more than 30 days notice either at any time or at specified
intervals not exceeding 397 days (depending on the terms of the participation),
for all or any part of the full principal amount of the Fund's participation
interest in the security plus accrued interest. The Fund intends to exercise the
demand only (i) upon a default under the terms of the bond documents, (ii) as
needed to provide liquidity to the Fund in order to make redemptions of Fund
shares or (iii) to maintain a high quality investment portfolio. The
institutions issuing the participation certificates will retain a service and
letter of credit fee (where applicable) and a fee for providing the demand
repurchase feature, in an amount equal to the excess of the interest paid on the
instruments over the negotiated yield at which the participations were purchased
by the Fund. The total fees generally range from 5% to 15% of the applicable
prime rate or other interest rate index. With respect to insurance, the Fund
will attempt to have the issuer of the participation certificate bear the cost
of the insurance. However, the Fund retains the option to purchase insurance if
necessary, in which case the cost of insurance will be an expense of the Fund
subject to the expense limitation (see "Expense Limitation" herein). The Manager
has been instructed by the Fund's Board of Directors to continually monitor the
pricing, quality and liquidity of the variable rate demand instruments held by
the Fund, including the participation certificates, on the basis of published
financial information and reports of the rating agencies and other bank
analytical services to which the Fund may subscribe. Although these instruments
may be sold by the Fund, the Fund intends to hold them until maturity, except
under the circumstances stated above (see "Federal Income Taxes" herein).
While the value of the underlying variable rate demand instruments may change
with changes in interest rates generally, the variable rate nature of the
underlying variable rate demand instruments should minimize changes in value of
the instruments. Accordingly, as interest rates decrease or increase, the
potential for capital appreciation and the risk of potential capital
depreciation is less than would be the case with a portfolio of fixed income
securities. The portfolio may contain variable maximum rates set by state law,
which limit the degree to which interest on such variable rate demand
instruments may fluctuate; to the extent state law contains such limits,
increases or decreases in value may be somewhat greater than would be the case
without such limits. Additionally, the portfolio may contain
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* The prime rate is generally the rate charged by a bank to its most
creditworthy customers for short-term loans. The prime rate of a particular
bank may differ from other banks and will be the rate announced by each
bank on a particular day. Changes in the prime rate may occur with great
frequency and generally become effective on the date announced.
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variable rate demand participation certificates in fixed rate Municipal
Obligations. The fixed rate of interest on these Municipal Obligations will be a
ceiling on the variable rate of the participation certificate. In the event that
interest rates increase so that the variable rate exceeds the fixed rate on the
Municipal Obligations, the Municipal Obligations can no longer be valued at par
and may cause the Fund to take corrective action, including the elimination of
the instruments from the portfolio. Because the adjustment of interest rates on
the variable rate demand instruments is made in relation to movements of the
applicable banks' "prime rates", or other interest rate adjustment index, the
variable rate demand instruments are not comparable to long-term fixed rate
securities. Accordingly, interest rates on the variable rate demand instruments
may be higher or lower than current market rates for fixed rate obligations of
comparable quality with similar maturities.
Because of the variable rate nature of the instruments, the Fund's yield will
decline and its shareholders will forego the opportunity for capital
appreciation during periods when prevailing interest rates have declined. On the
other hand, during periods where prevailing interest rates have increased, the
Fund's yield will increase and its shareholders will have reduced risk of
capital depreciation.
For purposes of determining whether a variable rate demand instrument held by
the Fund matures within 397 days from the date of its acquisition, the maturity
of the instrument will be deemed to be the longer of (i) the period required
before the Fund is entitled to receive payment of the principal amount of the
instrument or (ii) the period remaining until the instrument's next interest
rate adjustment. The maturity of a variable rate demand instrument will be
determined in the same manner for purposes of computing the Fund's
dollar-weighted average portfolio maturity. If a variable rate demand instrument
ceases to be an Eligible Security it will be sold in the market or through
exercise of the repurchase demand feature to the issuer.
When-Issued Securities
New issues of certain Municipal Obligations frequently are offered on a
when-issued basis. The payment obligation and the interest rate that will be
received on these Municipal Obligations are each fixed at the time the buyer
enters into the commitment although delivery and payment of the Municipal
Obligations normally take place within 45 days after the date of the Fund's
commitment to purchase. Although the Fund will only make commitments to purchase
when-issued Municipal Obligations with the intention of actually acquiring them,
the Fund may sell these securities before the settlement date if deemed
advisable by the Manager.
Municipal Obligations purchased on a when-issued basis and the securities held
in the Fund's portfolio are subject to changes in value (both generally changing
in the same way; that is, both experiencing appreciation when interest rates
decline and depreciation when interest rates rise) based upon the public's
perception of the creditworthiness of the issuer and changes, real or
anticipated, in the level of interest rates. Purchasing Municipal Obligations on
a when-issued basis can involve a risk that the yields available in the market
when the delivery takes place may actually be higher or lower than those
obtained in the transaction itself. A separate account of the Fund consisting of
cash or liquid debt securities equal to the amount of the when-issued
commitments will be established at the Fund's custodian bank. For the purpose of
determining the adequacy of the securities in the account, the deposited
securities will be valued at market value. If the market or fair value of such
securities declines, additional cash or highly liquid securities will be placed
in the account daily so that the value of the account will equal the amount of
such commitments by the Fund. On the settlement date of the when-issued
securities, the Fund will meet its obligations from then-available cash flow,
sale of securities held in the separate account, sale of other securities or,
although it would not normally expect to do so, from sale of the when-issued
securities themselves (which may have a value greater or lesser than the Fund's
payment obligations). Sale of securities to meet such obligations may result in
the realization of capital gains or losses, which are not exempt from Federal
income tax.
Stand-by Commitments
When the Fund purchases Municipal Obligations, it may also acquire stand-by
commitments from banks and other financial institutions. Under a stand-by
commitment, a bank or broker-dealer agrees to purchase at the Fund's option a
specified Municipal Obligation at a specified price with same day settlement. A
stand-by commitment is the equivalent of a "put" option acquired by the Fund
with respect to a particular Municipal Obligation held in its portfolio.
The amount payable to the Fund upon its exercise of a stand-by commitment
normally would be (i) the acquisition cost of the Municipal Obligation
(excluding any accrued interest that the Fund paid on the acquisition), less any
amortized market premium or plus any amortized market or original issue discount
during the period the Fund owned the security, plus (ii) all interest accrued on
the security since the last interest payment date during the period the security
was owned by the Fund. Absent unusual circumstances relating to a change in
market value, the Fund would value the underlying Municipal Obligation at
amortized cost. Accordingly, the amount payable by a bank or dealer during the
time a stand-by commitment is exercisable would be substantially the same as the
market value of the underlying Municipal Obligation.
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The Fund's right to exercise a stand-by commitment would be unconditional and
unqualified. A stand-by commitment would not be transferable by the Fund,
although it could sell the underlying Municipal Obligation to a third party at
any time.
The Fund expects stand-by commitments to generally be available without the
payment of any direct or indirect consideration. However, if necessary and
advisable, the Fund may pay for stand-by commitments either separately in cash
or by paying a higher price for portfolio securities which are acquired subject
to such a commitment (thus reducing the yield to maturity otherwise available
for the same securities). The total amount paid in either manner for outstanding
stand-by commitments held in the Fund's portfolio will not exceed 1/2 of 1% of
the value of the Fund's total assets calculated immediately after the
acquisition of each stand-by commitment.
The Fund will enter into stand-by commitments only with banks and other
financial institutions that, in the Manager's opinion, present minimal credit
risks. If the issuer of the Municipal Obligation does not meet the eligibility
criteria, the issuer of the stand-by commitment will have received a rating
which meets the eligibility criteria or, if not rated, will present a minimal
risk of default as determined by the Board of Directors. The Fund's reliance
upon the credit of these banks and broker-dealers will be supported by the value
of the underlying Municipal Obligations held by the Fund that were subject to
the commitment.
The Fund intends to acquire stand-by commitments solely to facilitate portfolio
liquidity and does not intend to exercise its rights thereunder for trading
purposes. The purpose of this practice is to permit the Fund to be fully
invested in securities the interest on which is exempt from Federal income tax
while preserving the necessary liquidity to purchase securities on a when-issued
basis, to meet unusually large redemptions and to purchase at a later date
securities other than those subject to the stand-by commitment. The acquisition
of a stand-by commitment would not affect the valuation or assumed maturity of
the underlying Municipal Obligations which will continue to be valued in
accordance with the amortized cost method. Stand-by commitments acquired by the
Fund will be valued at zero in determining net asset value. In those cases in
which the Fund pays directly or indirectly for a stand-by commitment, its cost
will be reflected as unrealized depreciation for the period during which the
commitment is held by the Fund. Stand-by commitments will not affect the
dollar-weighted average maturity of the Fund's portfolio. The maturity of a
security subject to a stand-by commitment is longer than the stand-by repurchase
date.
The stand-by commitments the Fund may enter into are subject to certain risks.
These include the ability of the issuer of the commitment to pay for the
securities at the time the commitment is exercised, the fact that the commitment
is not marketable by the Fund, and that the maturity of the underlying security
will generally be different from that of the commitment.
In addition, the Fund may apply to the Internal Revenue Service for a ruling, or
seek from its counsel an opinion, that interest on Municipal Obligations subject
to stand-by commitments will be exempt from Federal income taxation (see
"Federal Income Taxes" herein). In the absence of a favorable tax ruling or
opinion of counsel, the Fund will not engage in the purchase of securities
subject to stand-by commitments.
Investment Restrictions
The Fund has adopted the following fundamental investment restrictions which may
not be changed unless approved by a majority of the outstanding shares of the
Fund; except that fundamental investment restriction number 2 below may only be
changed with the approval of 90% of the outstanding shares of the Fund. The Fund
may not:
1. Make portfolio investments other than as described under "Description of
the Fund and Its Investments and Risks."
2. Purchase any security (i) the interest income on which may be subject to the
Federal individual alternative minimum tax or (ii) that would disqualify an
investment in the Fund as an investment in "tax-exempt bonds" as defined in
Section 150(a) (6) of the Code.
3. Borrow money. This restriction shall not apply to borrowings from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests that might otherwise require the untimely disposition of
securities, in an amount up to 15% of the value of the Fund's total assets
(including the amount borrowed) valued at market less liabilities (not
including the amount borrowed) at the time the borrowing was made. While
borrowings exceed 5% of the value of the Fund's total assets, the Fund will
not make any investments. Interest paid on borrowings will reduce net
income.
4. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in an
amount up to 15% of the value of its total assets and only to secure
borrowings for temporary or emergency purposes.
5. Sell securities short or purchase securities on margin, or engage in the
purchase and sale of put, call, straddle or spread options or in writing
such options, except to the extent that securities subject to a demand
obligation and
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<PAGE>
stand-by commitments may be purchased as set forth under "Description of
the Fund and Its Investments and Risks."
6. Underwrite the securities of other issuers, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
7. Purchase securities subject to restrictions on disposition under the
Securities Act of 1933 ("restricted securities"). The Fund will not invest
more than 10% of the Fund's total net assets in securities that are not
readily marketable (including participation certificates and variable rate
demand instruments with a right to demand payment on more than 7 days
notice).
8. Purchase or sell real estate, real estate investment trust securities,
commodities or commodity contracts, or oil and gas interests, but this
shall not prevent the Fund from investing in Municipal Obligations secured
by real estate or interests in real estate.
9. Make loans to others.
10. Invest more than 5% of the value of its total assets in the securities of
issuers where the entity providing the revenues from which the issue is to
be paid has a record, including predecessors, of fewer than three years of
continuous operation, except obligations issued or guaranteed by the United
States Government, its agencies or instrumentalities.
11. Invest more than 5% of its assets in the obligations of any one issuer
except for securities backed by the United States Government, or its
agencies or instrumentalities, which may be purchased without limitation,
and except to the extent that investment restriction 13 permits a single
bank to issue its letters of credit covering up to 10% of the total assets
of the Fund.
12. Purchase more than 10% of all outstanding voting securities of any one
issuer or invest in companies for the purpose of exercising control.
13. Invest more than 25% of its assets in the securities of "issuers" in any
single industry, provided that the Fund may invest more than 25% of its net
assets in IRBs bonds and that there shall be no limitation on the purchase
of those Municipal Obligations and other obligations issued or guaranteed
by the United States Government, its agencies or instrumentalities. When
the assets and revenues of an agency, authority, instrumentality or other
political subdivision are separate from those of the government creating
the issuing entity and a security is backed only by the assets and revenues
of the entity, the entity would be deemed to be the sole issuer of the
security. Similarly, in the case of an IRB, if that bond is backed only by
the assets and revenues of the non-governmental user, then such
non-governmental user would be deemed to be the sole issuer. If, however,
in either case, the creating government or some other entity, such as an
insurance company or other corporate obligor, guarantees a security or a
bank issues a letter of credit, such a guarantee or letter of credit would
be considered a separate security and would be treated as an issue of such
government, other entity or bank. Immediately after the acquisition of any
securities subject to a Demand Feature or Guarantee (as such terms are
defined in Rule 2a-7 under the Investment Company Act of 1940), with
respect to 75% of the total assets of the Fund, not more than 10% of the
Fund's assets may be invested in securities that are subject to a Guarantee
or Demand Feature from the same institution. However, the Fund may only
invest more than 10% of its assets in securities subject to a Guarantee or
Demand Feature issued by a Non-Controlled Person (as such terms are defined
in Rule 2a-7).
14. Invest in securities of other investment companies except (i) the Fund may
purchase unit investment trust securities where such unit investment trust
meets the investment objectives of the Fund and then only up to 5% of the
Fund's net assets except as they may be acquired as part of a merger,
consolidation or acquisition of assets and (ii) as permitted by Section
12(d) of the 1940 Act.
15. Issue senior securities, except insofar as the Fund may be deemed to have
issued a senior security in connection with any permitted borrowing.
If a percentage restriction is adhered to at the time of an investment, a later
increase or decrease in percentage resulting from a change in values of
portfolio securities or in the amount of the Fund's assets will not constitute a
violation of such restriction.
III. MANAGEMENT OF THE FUND
The Fund's Board of Directors, which is responsible for the overall management
and supervision of the Fund, employs Reich & Tang Asset Management L.P. (the
"Manager") to serve as investment manager of the Fund. The Manager provides
persons satisfactory to the Fund's Board of Directors to serve as officers of
the Fund. Such officers, as well as certain other employees and directors of the
Fund, may be directors or officers of Reich & Tang Asset Management,
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<PAGE>
Inc., the sole general partner of the Manager or employees of the Manager or its
affiliates. Due to the services performed by the Manager, the Fund currently has
no employees and its officers are not required to devote their full-time to the
affairs of the Fund.
The directors and officers of the Fund and their principal occupations during
the past five years are set forth below. Unless otherwise specified, the address
of each of the following persons is 600 Fifth Avenue, New York, New York 10020.
Mr. Duff may be deemed an "interested person" of the Fund, as defined in the
1940 Act, on the basis of his affiliation with the Manager.
Marian R. Chertow, 45 - Director of the Fund, is Director, Industrial
Governmental Management Program, School of Forestry and Environmental Studies at
Yale University since July 1991. Her address is 35 Huntington Street, New Haven,
Connecticut 06511.
John C. Richmond, 76 - Director of the Fund, was Deputy Treasurer - Debt
Management for the State of Connecticut from March 1975 until his retirement in
June 1987. His address is 69 Valley Brook Road, Centerville, Massachusetts
02632. Glenn S. Klocko, 45 - Director of the Fund, Comptroller, City of Bristol,
Connecticut Director since May 1998. Formerly Director of Finance, Town of Avon,
Connecticut from May 1988 to May 1998. Mr. Klocko was Deputy Controller, Town of
Wallingford, Connecticut from 1985 to 1988. His address is 111 North Main
Street, Bristol, Connecticut 06010.
Catherine S. Boone, 56 - Director of the Fund, Deputy Assistant Treasurer, State
of Connecticut, Office of the Treasurer from March 1995. Ms. Boone was Interim
Assistant Treasurer, State of Connecticut, Office of the Treasurer from January
1995 to March 1995. Her address is 55 Elm Street, Hartford, Connecticut 06106.
Howard G. Rifkin, 50 - Director of the Fund, Deputy Treasurer, State of
Connecticut, Office of the Treasurer since January 1999. Mr. Rifkin was Deputy
Secretary, State of Connecticut, Office of the Treasurer from January 1997 to
January 1999 and Associate Professor and Director, Institute of Public Service,
University of Connecticut from 1995 to 1997.
Steven W. Duff, 46 - President and Chief Executive Officer of the Fund, has been
President of the Mutual Funds Division of the Manager since September 1994. Mr.
Duff is also President and a Director/Trustee of 13 other funds in the Reich &
Tang Fund Complex, Director of Pax World Money Market Fund, Inc., President of
Back Bay Funds, Inc., and Executive Vice President of Delafield Fund, Inc.
Molly Flewharty, 49 - Vice President of the Fund, has been Vice President of the
Mutual Funds Division of the Manager since September 1993. Ms. Flewharty is also
Vice President of 16 other funds in the Reich & Tang Fund Complex.
Bernadette N. Finn, 52 - Secretary of the Fund, has been Vice President of the
Mutual Funds Division of the Manager since September 1993. Ms. Finn is also
Secretary of 12 other funds in the Reich & Tang Fund Complex, and a Vice
President and Secretary of 4 funds in the Reich & Tang Fund Complex.
Richard De Sanctis, 44 - Treasurer of the Fund, has been Assistant Treasurer of
NEIC since September 1993. Mr. De Sanctis is also Treasurer of 15 other funds in
the Reich & Tang Fund Complex and is Vice President and Treasurer of Cortland
Trust, Inc.
Rosanne Holtzer, 36 - Assistant Treasurer of the Fund, has been Vice President
of the Mutual Funds division of the Manager since December 1997. Ms. Holtzer was
formerly Manager of Fund Accounting for the Manager with which she was
associated with from June 1986. Ms. Holtzer is also Assistant Treasurer of 16
other funds in the Reich & Tang Fund Complex.
9
<PAGE>
Directors of the Fund not affiliated with the Manager receive from the Fund (1)
an annual retainer of $1000 and a fee of $375 for each Board of Directors
meeting attended and are reimbursed for all out-of-pocket expenses relating to
attendance at such meetings. See "Compensation Table".
COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Aggregate Pension or Retirement Estimated Annual Total Compensation from Fund and
Name of Person, Compensation from the Benefits Accrued as Part Benefits upon Fund Complex Paid to
Position Fund(1) of Fund Expenses Retirement Directors(1)(2)
Marian R. Chertow,
Director $2,500 0 0 $2,500 (1 Fund)
John C. Richmond,
Director $2,500 0 0 $2,500 (1 Fund)
Glenn S. Klocko,
Director $2,500 0 0 $2,500 (1 Fund)
Catherine S. Boone,
Director $0 0 0 $0 (1 Fund)
Howard G. Rifkin,
Director $0 0 0 $0 (1 Fund)
</TABLE>
(1) The Directors are paid by the Manager from its Management Fee.
(2) The total compensation paid to such persons for the fiscal year ending June
30, 2000. The parenthetical number represents the number of investment
companies (including the Fund) from which such person receives compensation
that are considered part of the same Fund complex as the Fund, because,
among other things, they have a common investment adviser.
IV. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
On September 30, 2000 there were 233,942,267 shares of common stock outstanding.
As of September 30, 2000, the amount of shares owned by all officers and
directors of the Fund, as a group, was less than 1% of the outstanding shares.
Set forth below is certain information as to persons who owned 5% or more of the
Fund's outstanding shares as of September 30, 2000:
Percentage of Nature of
Name and Address Ownership Ownership
State of Connecticut
Inter-Agency/Intra-Agency GRTS 1169
55 Elm Street
Hartford, CT 06106-1764
Attn: C. Boone 16.67% Beneficial
State of CT, Office of the Treasurer
Local Bridge Program #6301
55 Elm Street
Hartford, CT 06106-1764 11.41% Beneficial
V. INVESTMENT ADVISORY AND OTHER SERVICES
The Investment Manager for the Fund is Reich & Tang Asset Management L.P., a
Delaware limited partnership with principal offices at 600 Fifth Avenue, New
York, New York 10020. The Manager was as of September 30, 2000, investment
manager, adviser, or supervisor with respect to assets aggregating in excess of
$13.5 billion. In addition to the Fund, the Manager acts as investment manager
and administrator of eighteen other investment companies and also advises
pension trusts, profit-sharing trusts and endowments.
10
<PAGE>
Nvest Companies, L.P. (Nvest Companies) is the limited partner and owner of a
99.5% interest in the Manager. Reich & Tang Asset Management, Inc. (RTAM) is the
sole general partner and owner of the remaining 0.5% interest of the Manager, as
well as being an indirect wholly-owned subsidiary of Nvest Companies. Nvest
Companies is a publicly traded company of which approximately 13% of its
outstanding partnership interests is owned, directly and indirectly, by Reich &
Tang, Inc.
CDC Asset Management ("CDC AM"), the investment management arm of France's
Caisse des Depots Group, has completed its acquisition of Nvest, L.P. and Nvest
Companies. As a result, CDC AM owns, directly or indirectly, a controlling
interest in the Manager. CDC AM is 60% owned by CDC Finance, a wholly-owned
subsidiary of Caisse des depots et Consignations ("CDC"). Founded in 1816, CDC
is a major diversified financial institution. In addition to its 60% ownership
of CDC AM through CDC Finance, CDC owns 40% of CNP Assurances, the leading
French insurance company, which itself owns 20% of CDC AM. CDC also owns 35% of
Caisse National des Caisses d'Epargne, which also owns 20% of CDC AM. CDC is
100% owned by the French state.
Nvest Companies is a holding company offering a broad array of investment styles
across a wide range of asset categories through seventeen subsidiaries,
divisions and affiliates offering a wide array of investment styles and products
to institutional clients. Its business units, in addition to the Manager,
include AEW Capital Management, L.P., Back Bay Advisors, L.P.; Capital Growth
Management Limited Partnerships; Greystone Partners, L.P.; Harris Associates,
L.P.; Jurika & Voyles, L.P.; Kobrick Funds, LLP, Loomis, Sayles & Company, L.P.;
New England Funds, L.P.; Nvest Associates, Inc.; Snyder Capital Management,
L.P.; Vaughan, Nelson, Scarborough & McCullough, L.P.; and Westpeak Investment
Advisors, L.P. These affiliates in the aggregate are investment advisors or
managers to more than 80 other registered investment companies.
The Nvest-CDC AM transaction involved a change of ownership of Nvest Companies,
which may be deemed to have caused a "change of control" of the Manager, even
though operations did not change as a result. As required by the 1940 Act, the
Fund's shareholders approved a new Investment Management Contract for the Fund
to assure that there was no interruption in the services that the Manager
provides to the Fund. The new Investment Management Contract was approved by the
shareholders on October 10, 2000 and is effective as of October 30, 2000.
On July 31, 2000, the Board of Directors, including a majority of the directors
who are not interested persons (as defined in the 1940 Act) of the Fund or the
Manager, approved the Investment Management Contract for an initial term of two
years, extending to September 30, 2000. The contract may be continued in force
after the initial term for successive twelve-month periods beginning each
October 1, provided that such continuance is specifically approved annually by a
majority vote of the Fund's outstanding voting securities or by its Board of
Directors, and in either case by a majority of the directors who are not parties
to the Investment Management Contract or interested persons of any such party,
by votes cast in person at a meeting called for the purpose of voting on such
matter.
Pursuant to the Investment Management Contract, the Manager manages the Fund's
portfolio of securities and makes decisions with respect to the purchase and
sale of investments, subject to the general control of the Board of Directors of
the Fund.
The Manager provides persons satisfactory to the Board of Directors of the Fund
to serve as officers of the Fund. Such officers, as well as certain other
employees and directors of the Fund, may be directors or officers of Reich &
Tang Asset Management, Inc., the sole general partner of the Manager, or
employees of the Manager or its affiliates.
The Investment Management Contract is terminable without penalty by the Fund on
sixty days' written notice when authorized either by majority vote of its
outstanding voting shares or by a vote of a majority of its Board of Directors,
or by the Manager on sixty days written notice, and will automatically terminate
in the event of its assignment. The Investment Management Contract provides that
in the absence of willful misfeasance, bad faith or gross negligence on the part
of the Manager, or of reckless disregard of its obligations thereunder, the
Manager shall not be liable for any action or failure to act in accordance with
its duties thereunder.
For its services under the Investment Management Contract, the Manager receives
from the Fund a fee equal to .40% per annum of the Fund's average daily net
assets up to $250 million, .35% per annum of the average net assets between $250
million and $500 million and .30% per annum of the average daily net assets over
$500
11
<PAGE>
million for managing the Fund's investment portfolio and performing related
administrative and clerical services. The Investment Management Contract also
provides that the Manager will bear the cost of, or reimburse the Fund for, all
other expenses of the Fund. Therefore, the fees payable under the Investment
Management Contract will be the only expenses of the Fund. The fees are accrued
daily and paid monthly. Any portion of the total fees received by the Manager
may be used by the Manager to provide shareholder and administrative services.
Pursuant to the Investment Management Contract for the fiscal years ended June
30, 2000, June 30, 1999, and June 30, 1998, the Manager received investment
management fees aggregating $833,233, $774,901, and $817,240 respectively.
Expense Limitation
The Manager has agreed, pursuant to the Investment Management Contract, (See
"Distribution and Service Plan" herein), to reimburse the Fund for its expenses
(exclusive of interest, taxes, brokerage and extraordinary expenses) which in
any year exceed the limits on investment company expenses prescribed by any
state in which the Fund's shares are qualified for sale. For the purpose of this
obligation to reimburse expenses, the Fund's annual expenses are estimated and
accrued daily, and any appropriate estimated payments are made to it on a
monthly basis. Subject to the obligations of the Manager to reimburse the Fund
for its excess expenses as described above, the Fund has, under the Investment
Management Contract, confirmed its obligation for payment of all its other
expenses (except for the Management fee payable to the Manager under the
Investment Management Contract). This includes all operating expenses, taxes,
brokerage fees and commissions, commitment fees, certain insurance premiums,
interest charges and expenses of the custodian, transfer agent and dividend
disbursing agent's fees, telecommunications expenses, auditing and legal
expenses, bookkeeping agent fees, costs of forming the corporation and
maintaining corporate existence, compensation of directors, officers and
employees of the Fund and costs of other personnel performing services for the
Fund who are not officers of the Manager or its affiliates, costs of investor
services, shareholders' reports and corporate meetings, SEC registration fees
and expenses, state securities laws registration fees and expenses, expenses of
preparing and printing the Fund's Prospectus for delivery to existing
shareholders and of printing application forms for shareholder accounts.
The Fund may from time to time hire its own employees or contract to have
management services performed by third parties as discussed herein. The
management of the Fund intends to do so whenever it appears advantageous to the
Fund. The Fund's expenses for employees and for such services are among the
expenses borne by the Manager.
Distribution And Service Plan
The Fund's distributor is Reich & Tang Distributors, Inc. (the "Distributor"), a
Delaware corporation with principal offices at 600 Fifth Avenue, New York, New
York 10020. Pursuant to Rule 12b-1 under the 1940 Act, the SEC has required that
an investment company which bears any direct or indirect expense of distributing
its shares must do so only in accordance with a plan permitted by the Rule. The
Fund's Board of Directors has adopted a distribution and service plan (the
"Plan") and, pursuant to the Plan, the Fund has entered into a Distribution
Agreement with the Distributor, as distributor of the Fund's shares.
There are no fees or expenses chargeable to the Fund under the Plan. The Fund's
Board of Directors has adopted the Plan in case certain expenses of the Fund are
deemed to constitute indirect payment by the Fund for distribution expenses. If
a payment of fees under the Investment Management Contract by the Fund to the
Manager should be deemed to be indirect financing by the Fund of the
distribution of its shares, such payments are authorized by the Plan.
Under the Distribution Agreement, the Distributor, for nominal consideration
(i.e., $1.00) and as agent for the Fund, will solicit orders for the purchase of
the Fund's shares, provided that any subscriptions and orders will not be
binding on the Fund until accepted by the Fund as principal. This consideration
of $1.00 per year is also subject to the Manager's expense reimbursement
obligation and, therefore, will not be an expense borne by the Fund. The shares
of the Fund will be offered primarily to entities that are issuers of tax-exempt
state and local bonds, such as states and municipalities and their authorities,
agencies, instrumentalities and subdivisions.
The Plan provides that the Manager may make payments from time to time from its
own resources, which may include the management fee, and past profits for the
following purposes: (i) to defray the costs of, and to compensate others with
whom the Distributor has entered into written agreements for performing
shareholder servicing and related administrative functions on behalf of the
Fund, (ii) to compensate certain organizations for providing assistance in
distributing the Fund's shares, and (iii) to pay the costs of printing and
distributing the Fund's Prospectus to prospective investors, and to defray the
cost of the preparation and printing of brochures
12
<PAGE>
and other promotional materials, mailings to prospective shareholders,
advertising, and other promotional activities, including the salaries and/or
commissions of sales personnel in connection with the distribution of the Fund's
shares. The Distributor determines the amount of such payments made pursuant to
the Plan, provided that such payments will not increase the amount which the
Fund is required to pay to the Manager or the Distributor for any fiscal year
under the Investment Management Contract or the Shareholder Servicing Agreement
in effect for that year.
In accordance with the Rule, the Plan provides that all written agreements
relating to the Plan entered into between either the Fund or the Distributor and
other organizations must be in a form satisfactory to the Fund's Board of
Directors. In addition, the Plan requires the Fund and the Distributor to
prepare, at least quarterly, written reports setting forth all amounts expended
for distribution purposes by the Fund and the Distributor pursuant to the Plan
and identifying the distribution activities for which those expenditures were
made.
The Plan was most recently approved by the Board of Directors on December 2,
1999 and will remain in effect until December 31, 2000. Thereafter it may
continue in effect for successive annual periods commencing January 1, provided
it is approved by a majority of the shareholders or by the Board of Directors,
including a majority of directors who are not interested persons of the Fund and
who have no direct or indirect interest in the operation of the Plan or in the
agreements related to the Plan. The Plan further provides that it may not be
amended to increase materially the costs which may be spent by the Fund for
distribution pursuant to the Plan without shareholder approval, and the other
material amendments must be approved by the directors in the manner described in
the preceding sentence. The Plan may be terminated at any time by a vote of a
majority of the disinterested directors of the Fund or the Fund's shareholders.
Custodian and Transfer Agent
State Street Kansas City, 801 Pennsylvania, Kansas City, Missouri 64105, is
custodian for the Fund's cash and securities. Reich & Tang Services, Inc., an
affiliate of the Fund's Manager, located at 600 Fifth Avenue, New York, NY
10020, is transfer agent and dividend agent for the shares of the Fund. The
custodian and transfer agent do not assist in, and are not responsible for
investment decisions involving assets of the Fund.
Counsel and Auditors
Legal matters in connection with the issuance of shares of stock of the Fund are
passed upon by Paul, Hastings, Janosky & Walker LLP, 399 Park Avenue, New York,
New York 10022.
Deloitte & Touche, LLP, Two World Financial Center, New York, New York 10281,
independent certified public accountants, have been selected as auditors for the
Fund.
VI. BROKERAGE ALLOCATION AND OTHER PRACTICES
The Fund's purchases and sales of portfolio securities usually are principal
transactions. Portfolio securities are normally purchased directly from the
issuer, from banks and financial institutions or from an underwriter or market
maker for the securities. There usually are no brokerage commissions paid for
such purchases. The Fund has paid no brokerage commissions since its formation.
Any transaction for which the Fund pays a brokerage commission will be effected
at the best price and execution available. Thus, the Fund will select a broker
for such a transaction based upon which broker can effect the trade at the best
price and execution available. Purchases from underwriters of portfolio
securities include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers include the
spread between the bid and asked price. The Fund purchases participation
certificates in variable rate Municipal Obligations with a demand feature from
banks or other financial institutions at a negotiated yield to the Fund based on
the applicable interest rate adjustment index for the security. The interest
received by the Fund is net of a fee charged by the issuing institution for
servicing the underlying obligation and issuing the participation certificate,
letter of credit, guarantee or insurance and providing the demand repurchase
feature.
Allocation of transactions, including their frequency, to various dealers is
determined by the Manager in its best judgment and in a manner deemed in the
best interest of shareholders of the Fund rather than by any formula. The
primary consideration is prompt execution of orders in an effective manner at
the most favorable price.
Investment decisions for the Fund are made independently from those for any
other investment companies or accounts that may be or become managed by the
Manager or its affiliates. If, however, the Fund and other investment companies
or accounts managed by the Manager are simultaneously engaged in the purchase or
sale of the same security, the transactions may be averaged as to price and
allocated equitably to each account. In some cases, this policy might adversely
affect the price paid or received by the Fund or the size of the position
obtainable for the Fund. In addition, when purchases or sales of the same
security for the Fund and for other
13
<PAGE>
investment companies managed by the Manager occur contemporaneously, the
purchase or sale orders may be aggregated in order to obtain any price advantage
available to large denomination purchasers or sellers.
No portfolio transactions are executed with the Manager or its affiliates acting
as principal.
VII. CAPITAL STOCK AND OTHER SECURITIES
The authorized capital stock of the Fund consists of twenty billion shares of
stock having a par value of one tenth of one cent ($.001) per share. Each share
when issued has equal dividend, distribution and liquidation rights. Each
fractional share has those rights in proportion to the percentage that the
fractional share represents of a whole share. There are no conversion or
preemptive rights in connection with any shares of the Fund. All shares, when
issued in accordance with the terms of the offering, will be fully paid and
nonassessable. Shares are redeemable at net asset value, at the option of the
shareholder.
Under its amended Articles of Incorporation, the Fund has the right to redeem
for cash shares of stock owned by any shareholder to the extent and at such
times as the Fund's Board of Directors determines to be necessary or appropriate
to prevent an undue concentration of stock ownership which will cause the Fund
to become a "personal holding company" for Federal income tax purposes. In this
regard, the Fund may also exercise its right to reject purchase orders.
The shares of the Fund have non-cumulative voting rights, which means that the
holders of more than 50% of the shares outstanding voting for the election of
directors can elect 100% of the directors if the holders choose to do so. In
that event, the holders of the remaining shares will not be able to elect any
person or persons to the Board of Directors. The Fund's By-laws provide that the
holders of one-third of the outstanding shares of the Fund present at the
meeting in person or proxy will constitute a quorum for the transaction of
business at a meeting, except that the Articles of Incorporation provide that a
meeting to consider an amendment to the Fund's fundamental investment policies
of investing in securities that would qualify an investment in the Fund as a
"tax-exempt bond" and of not investing in securities the interest income on
which may be subject to the Federal individual alternative minimum tax, 90% of
the outstanding shares of the Fund effected by the proposal must be present in
person or by proxy to constitute a quorum for this purpose. Unless specifically
requested by an investor, the Fund will not issue certificates evidencing Fund
shares.
As a general matter, the Fund will not hold annual or other meetings of the
Fund's shareholders. The By-laws of the Fund provide for annual or special
meetings only for (i) the election (or re-election) of directors, (ii) approval
of the revised investment advisory contracts with respect to a particular class
or series of stock, (iii) ratification of the selection of independent public
accountants, (iv) approval of the Fund's distribution agreement with respect to
a particular class or series of stock, and (v) upon the written request of
shareholders entitled to cast not less than 25% of all the votes entitled to be
cast at such meeting. Annual and other meetings may be required with respect to
such additional matters relating to the Fund as may be required by the 1940 Act,
including the removal of Fund director(s) and communication among shareholders,
any registration of the Fund with the SEC or any state, or as the Directors may
consider necessary or desirable. Each Director serves until his successor is
elected and qualified.
VIII. PURCHASE, REDEMPTION AND PRICING OF SHARES
The material relating to the purchase, redemption and pricing of shares in the
Prospectus is hereby incorporated by reference.
Net Asset Value
The Fund does not determine net asset value per share on any day in which the
New York Stock Exchange is closed for trading. Those days include: New Year's
Day, Martin Luther King Jr. Day, President's Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving and Christmas.
The net asset value of the Fund's shares is determined as of 12 noon, New York
City time, on each Fund Business Day. The net asset value is computed by
dividing the value of the Fund's net assets (i.e., the value of its securities
and other assets less its liabilities, including expenses payable or accrued but
excluding capital stock and surplus) by the total number of shares outstanding.
The Fund's portfolio securities are valued at their amortized cost in compliance
with the provisions of Rule 2a-7 under the 1940 Act. Amortized cost valuation
involves valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium. If fluctuating interest
rates cause the market value of the Fund's portfolio to deviate more than 1/2 of
1% from the value determined on the basis of amortized cost, the Board of
Directors will consider whether any action should be initiated, as described in
the following
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<PAGE>
paragraph. Although the amortized cost method provides certainty
in valuation, it may result in periods during which the value of an instrument
is higher or lower than the price an investment company would receive if the
instrument were sold.
The Fund's Board of Directors has established procedures to stabilize the Fund's
net asset value at $1.00 per share. These procedures include a review of the
extent of any deviation of net asset value per share, based on available market
rates, from the Fund's $1.00 amortized cost per share. Should that deviation
exceed 1/2 of 1%, the Board will consider whether any action should be initiated
to eliminate or reduce material dilution or other unfair results to
shareholders. Such action may include redemption of shares in kind, selling
portfolio securities prior to maturity, reducing or withholding dividends and
utilizing a net asset value per share as determined by using available market
quotations. The Fund will maintain a dollar-weighted average portfolio maturity
of 90 days or less, will not purchase any instrument with a remaining maturity
greater than 397 days, will limit portfolio investments, including repurchase
agreements, to those United States dollar-denominated instruments that the
Fund's Board of Directors determines present minimal credit risks, and will
comply with certain reporting and record keeping procedures. The Fund has also
established procedures to ensure compliance with the requirement that portfolio
securities are Eligible Securities. (See "Description of the Fund and Its
Investments and Risks" herein.)
IX. TAXATION OF THE FUND
Federal Income Taxes
The Fund has elected and has qualified in the past under the Code, to qualify as
a "regulated investment company" that distributes "exempt-interest dividends."
The Fund intends to continue to qualify for regulated investment company status
so long as such qualification is in the best interests of its shareholders. Such
qualification relieves the Fund of liability for Federal income taxes to the
extent its earnings are distributed in accordance with the applicable provisions
of the Code.
The Fund's policy is to distribute as dividends each year 100% and in no event
less than 90% of its tax-exempt interest income, net of certain deductions.
Dividends paid by the Fund that are attributable to interest on obligations, the
interest on which is exempt from regular Federal income tax, and are designated
by the Fund as exempt-interest dividends in a written notice mailed to the
Fund's shareholders not later than 60 days after the close of its taxable year
are defined by the Code as "exempt interest dividends." The percentage of the
total dividends paid by the Fund during any taxable year that qualifies as
exempt-interest dividends will be the same for all shareholders receiving
dividends during the year.
Exempt-interest dividends are treated as items of interest excludable from gross
income by the Fund's shareholders under the Code although the amount of that
interest will have to be disclosed by the shareholder on its Federal tax return.
A shareholder should consult its tax advisors with respect to whether
exempt-interest dividends retain the exclusion under the Code if the shareholder
would be treated as a "substantial user" or "related person" under the Code with
respect to some or all of any "private activity" bonds held by the Fund. If a
shareholder receives an exempt-interest dividend with respect to any share that
it has held for six months or less, then any loss on the sale or exchange of
such share will be disallowed to the extent of the amount of such
exempt-interest dividend. For shareholders that are Social Security recipients,
interest on tax-exempt bonds, including exempt-interest dividends paid by the
Fund, is to be added to the shareholder's adjusted gross income for purposes of
computing the amount of social security benefits includible in their gross
income. Corporations are required to increase their alternative minimum taxable
income for purposes of calculating their alternative minimum tax liability by
75% of the amount by which the adjusted current earnings (which will include
tax-exempt interest) of the corporation exceeds the alternative minimum taxable
income (determined without this item). In addition, in certain cases, Subchapter
S corporations with accumulated earnings and profits from Subchapter C years are
subject to a minimum tax on excess "passive investment income" which includes
tax-exempt interest.
If an issuer of a tax-exempt bond invests the proceeds of the bond issue in any
"tax-exempt bond", the income on which is not an item of tax preference
includible in the Federal alternative minimum tax computation for individual
taxpayers, such issuer is not subject to the rebate provisions of Code Section
148 with respect to the income from such bonds. The rebate provisions would
require an issuer that invests bond proceeds in "higher yielding investments"
(other than in "tax-exempt bonds") to rebate a portion of the income from such
investments in order for the bond interest to remain tax-exempt to the bond
holders. The term "tax-exempt bond" means any bond the interest on which is
excluded from gross income. Regulations provide that for purposes of the
arbitrage rebate provision of Section 148, the term "tax-exempt bond" includes
an interest in a regulated investment company to the extent that at least 95% of
the income from the regulated investment company is interest excludable from
gross income under Section 103 of the Code. The Fund intends to comply with all
requirements that must be satisfied in order for an investment in its shares to
be treated as a "tax-exempt bond" and will invest only in tax-
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exempt bonds the interest from which, in the opinion of bond counsel at the date
of issuance is excludable from gross income under Section 103 of the Code and is
not subject to the Federal individual alternative minimum tax provisions. If the
Fund does not comply with all requirements that must be satisfied in order for
an investment in its shares to be treated as a "tax-exempt bond" for arbitrage
purposes, issuers who invest in the Fund will be subject to the rebate
provisions of Code Section 148 with respect to income from the Fund.
Although not intended, it is possible that the Fund may realize short-term or
long-term capital gains or losses from its portfolio transactions. The Fund may
also realize market discount income, or short-term or long-term capital gains
upon the maturity or disposition of securities acquired at discounts resulting
from market fluctuations. Accrued market discount income and short-term capital
gains will be taxable to shareholders as ordinary income when they are
distributed. Any net capital gains (the excess of net realized long-term capital
gain from sales of assets with a holding period of more than twelve months over
net realized short-term capital loss) will be distributed annually to the Fund's
shareholders. The Fund will have no tax liability with respect to distributed
net capital gains, and the distributions will be taxable to shareholders as
long-term capital gains regardless of how long the shareholders have held Fund
shares. However, Fund shareholders who at the time of such a net capital gain
distribution have not held their Fund shares for more than 6 months, and who
subsequently dispose of those shares at a loss, will be required to treat such
loss as a long-term capital loss to the extent of the net capital gain
distribution. Distributions of net capital gain will be designated as a "capital
gain dividend" in a written notice mailed to the Fund's shareholders not later
than 45 days after the close of the Fund's taxable year. Capital gains realized
by corporations are generally taxed at the same rate as ordinary income.
However, long-term capital gains are generally taxable at a maximum rate of 20%
to non-corporate shareholders instead of the regular maximum tax rate of 39.6%.
Corresponding maximum rate and holding period rules apply with respect to
capital gains realized by a holder on the disposition of shares.
The Fund also intends to distribute at least 90% of its investment company
taxable income (taxable income including short term capital gain but subject to
certain adjustments, exclusive of the excess of its net long-term capital gain
over its net short-term capital loss) for each taxable year. This distribution
will be taxable to shareholders as ordinary income. The Fund will be subject to
Federal income tax on any undistributed investment company taxable income.
Expenses paid or incurred by the Fund will be allocated between tax-exempt and
taxable income in the same proportion as the amount of the Fund's tax-exempt
income bears to the total of such exempt income and its gross income (excluding
from gross income the excess of capital gains over capital losses). If the Fund
does not distribute at least 98% of its ordinary income and 98% of its capital
gain net income for a taxable year, the Fund will be subject to a nondeductible
4% excise tax on the excess of such amounts over the amounts actually
distributed.
If a shareholder (other than a corporation) fails to provide the Fund with a
current taxpayer identification number, the Fund is generally required to
withhold 31% of taxable dividend payments and proceeds from the redemption of
shares of the Fund.
Dividends and distributions to shareholders will be treated in the same manner
for Federal income tax purposes whether received in cash or reinvested in
additional shares of the Fund.
With respect to the variable rate demand instruments, including participation
certificates therein, the Fund should be treated for Federal income tax purposes
as the owner of an interest in the underlying Municipal Obligations and the
interest thereon will be exempt from Federal income taxes to the Fund to the
same extent as interest on the underlying Municipal Obligation. However, the
Internal Revenue Service has announced that it will not ordinarily issue advance
rulings on the question of ownership of securities or participation interests
therein subject to a put and as a result, the Internal Revenue Service could
reach a conclusion different from that described herein.
The United States Supreme Court held that there is no constitutional prohibition
against the Federal government's taxing the interest earned on state or other
municipal bonds. The Supreme Court decision affirms the authority of the Federal
government to regulate and control bonds such as Municipal Obligations and to
tax such bonds in the future. The decision does not, however, affect the current
exemption from regular income taxation of the interest earned on the Municipal
Obligations.
The exemption for Federal income tax purposes of dividends derived from interest
on Municipal Obligations does not necessarily result in an exemption under the
income or other tax laws of any state or local taxing authority. Shareholders of
the Fund may be exempt from state and local taxes on distributions of tax-exempt
interest income derived from obligations of the state and/or municipalities of
the state in which they may reside but may be subject to tax on income derived
from obligations of other jurisdictions. Shareholders are advised to consult
with their tax advisers concerning the application of state and local taxes to
investments in the Portfolio, which may differ from the Federal income tax
consequences described above.
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X. UNDERWRITERS
The Fund sells and redeems its shares on a continuing basis at their net asset
value and does not impose a sales charge. The Distributor does not receive an
underwriting commission. In effecting sales of Fund shares under the
Distribution Agreement, the Distributor, for nominal consideration (i.e., $1.00)
and as agent for the Fund, will solicit orders for the purchase of the Fund's
shares, provided that any subscriptions and orders will not be binding on the
Fund until accepted by the Fund as principal.
The Glass-Steagall Act and other applicable laws and regulations prohibit banks
and other depository institutions from engaging in the business of underwriting,
selling or distributing most types of securities. On November 16, 1999,
President Clinton signed the Gramm-Leach-Bliley Act, repealing certain
provisions of the Glass-Steagall Act which have restricted affiliation between
banks and securities firms and amending the Bank Holding Company Act thereby
removing restrictions on banks and insurance companies. The new legislation
grants banks new authority to conduct certain authorized activity through
financial subsidiaries. In the opinion of the Manager, however, based on the
advice of counsel, these laws and regulations do not prohibit such depository
institutions from providing other services for investment companies such as the
shareholder servicing and related administrative functions referred to above.
The Fund's Board of Directors will consider appropriate modifications to the
Fund's operations, including discontinuance of any payments then being made
under the Plan to banks and other depository institutions, in the event of any
future change in such laws or regulations which may affect the ability of such
institutions to provide the above-mentioned services. It is not anticipated that
the discontinuance of payments to such an institution would result in loss to
shareholders or change in the Fund's net asset value. In addition, state
securities laws on this issue may differ from the interpretations of Federal law
expressed herein and banks and financial institutions may be required to
register ad dealers pursuant to state law.
XI. CALCULATION OF PERFORMANCE DATA
The Fund calculates a seven-day yield quotation using a standard method
prescribed by the rules of the SEC. Under that method, the Fund's yield figure,
which is based on a chosen seven-day period, is computed as follows: the Fund's
return for the seven-day period is obtained by dividing the net change in the
value of a hypothetical account having a balance of one share at the beginning
of the period by the value of such account at the beginning of the period
(expected to always be $1.00). This is multiplied by (365/7) with the resulting
annualized figure carried to the nearest hundredth of one percent. For purposes
of the foregoing computation, the determination of the net change in account
value during the seven-day period reflects (i) dividends declared on the
original share and on any additional shares, including the value of any
additional shares purchased with dividends paid on the original share, and (ii)
fees charged to all shareholder accounts. Realized capital gains or losses and
unrealized appreciation or depreciation of the Fund's portfolio securities are
not included in the computation. Therefore, annualized yields may be different
from effective yields quoted for the same period.
The Fund's "effective yield" is obtained by adjusting its "current yield" to
give effect to the compounding nature of the Fund's portfolio, as follows: the
unannualized base period return is compounded and brought out to the nearest one
hundredth of one percent by adding one to the base period return, raising the
sum to a power equal to 365 divided by 7, and subtracting one from the result,
i.e., effective yield = [(base period return + 1)365/7] - 1.
Although published yield information is useful to investors in reviewing the
Fund's performance, investors should be aware that the Fund's yield fluctuates
from day to day. The Fund's yield for any given period is not an indication, or
representation by the Fund, of future yields or rates of return on the Fund's
shares, and may not provide a basis for comparison with bank deposits or other
investments that pay a fixed yield for a stated period of time.
The Fund may from time to time advertise its tax equivalent current yield. The
tax equivalent yield is computed based upon a 30-day (or one month) period ended
on the date of the most recent balance sheet included in this Statement of
Additional Information. It is computed by dividing that portion of the yield of
the Fund (as computed pursuant to the formulae previously discussed) which is
tax-exempt by one minus a stated income tax rate and adding the quotient to that
portion, if any, of the yield of the Fund that is not tax-exempt. The tax
equivalent yield for the Fund may also fluctuate daily and does not provide a
basis for determining future yields.
The Fund may from time to time advertise a tax equivalent effective yield table
which shows the yield that an investor needs to receive from a taxable
investment in order to equal a tax-free yield from the Fund. This is calculated
by dividing that portion of the Fund's effective yield that is tax-exempt by 1
minus a stated income tax rate and adding the quotient to that portion, if any,
of the Fund's effective yield that is not tax-exempt.
The Fund's yield for the seven day period ended June 30, 2000 was 4.06% which is
equivalent to an effective yield of 4.14%.
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XII. FINANCIAL STATEMENTS
The audited financial statements for the Fund for the fiscal year ended June 30,
2000 and the report therein of Deloitte & Touche , LLP, are herein incorporated
by reference to the Fund's Annual Report. The Annual Report is available upon
request and without charge.
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DESCRIPTION OF RATINGS*
Description of Moody's Investors Service, Inc.'s Two Highest Municipal Bond
Ratings:
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities, or fluctuation of protective elements
may be of greater amplitude, or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
Con. ( c): Bonds for which the security depends upon the completion of some act
or the fulfillment of some condition are rated conditionally. These are bonds
secured by (i) earnings of projects under construction, (ii) earnings of
projects unseasoned in operating experience, (iii) rentals which begin when
facilities are completed, or (iv) payments to which some other limiting
condition attaches. Parenthetical rating denotes probable credit stature upon
completion of construction or elimination of basis of condition.
Description of Moody's Investors Service, Inc.'s Two Highest Ratings of State
and Municipal Notes and Other Short-Term Loans:
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing, while various factors of the first importance in bond risk
are of lesser importance in the short run. Symbols used are as follows:
MIG-1: Loans bearing this designation are of the best quality, enjoying strong
protection from established cash flows of funds for their servicing or from
established and broad-based access to the market for refinancing, or both.
MIG-2: Loans bearing this designation are of high quality, with margins of
protection ample although not so large as in the preceding group.
Description of Standard & Poor's Rating Services Two Highest Debt Ratings:
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the highest rated issues only to a small degree.
Plus ( + ) or Minus ( - ): The AA rating may be modified by the addition of a
plus or minus sign to show relative standing within the AA rating category.
Provisional Ratings: The letter "p" indicates the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood of,
or the risk of default upon failure of, such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.
Standard & Poor's does not provide ratings for state and municipal notes.
Description of Standard & Poor's Rating Services Two Highest Commercial Paper
Ratings:
A: Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety.
A-1: This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics will be denoted with a plus (+) sign
designation.
A-2: Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high as for issues
designated A-1.
Description of Moody's Investors Service, Inc.'s Two Highest Commercial Paper
Ratings:
Moody's employs the following designations, both judged to be investment grade,
to indicate the relative repayment capacity of rated issues: Prime-1, highest
quality; Prime-2, higher quality.
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