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Navigator Tax-Free Income Funds
Prospectus
July 31, 1995
Shares of Navigator Maryland Tax-Free Income Trust, Navigator
Pennsylvania Tax-Free Income Trust and Navigator Tax-Free Intermediate-
Term Income Trust (collectively referred to as "Navigator Shares")
represent separate classes (each a "Navigator Class") of interest in Legg
Mason Maryland Tax-Free Income Trust ("Maryland Tax-Free"), Legg Mason
Pennsylvania Tax-Free Income Trust ("Pennsylvania Tax-Free") and Legg
Mason Tax-Free Intermediate-Term Income Trust ("Tax-Free Intermediate")
(each separately referred to as a "Fund" and collectively referred to as
the "Funds"), respectively. Each Fund is a separate series of Legg Mason
Tax-Free Income Fund, ("Trust"), an open-end management investment
company.
The Navigator Classes of Shares, described in this Prospectus,
are currently offered for sale only to institutional clients of the
Fairfield Group, Inc. ("Fairfield") for investment of their own funds and
funds for which they act in a fiduciary capacity, to clients of Legg Mason
Trust Company ("Trust Company") for which Trust Company exercises
discretionary investment management responsibility (such institutional
investors are referred to collectively as "Institutional Clients" and
accounts of the customers with such Clients ("Customers") are referred to
collectively as "Customer Accounts"), to qualified retirement plans
managed on a discretionary basis and having net assets of at least $200
million, and to The Legg Mason Profit Sharing Plan and Trust. Navigator
Shares may not be purchased by individuals directly, but Institutional
Clients may purchase shares for Customer Accounts maintained for
individuals.
Mutual fund shares are not deposits or obligations of, or
guaranteed or endorsed by, any bank or other depository institution.
Shares are not insured by the FDIC, the Federal Reserve Board, or any
other agency, and are subject to investment risk, including the possible
loss of the principal amount invested.
This Prospectus sets forth concisely the information about the
Funds that a prospective investor ought to know before investing. It
should be read and retained for future reference. A Statement of
Additional Information about the Funds dated July 31, 1995 has been filed
with the Securities and Exchange Commission ("SEC") and, as amended or
supplemented from time to time, is incorporated herein by this reference.
The Statement of Additional Information is available without charge upon
request from the Funds' distributor, Legg Mason Wood Walker, Incorporated
("Legg Mason") (address and telephone numbers listed below).
Shares of Maryland Tax-Free are registered for sale to investors
only in the States of Maryland, Delaware, Florida, Pennsylvania, Texas,
Virginia, and Wyoming. Shares of Pennsylvania Tax-Free are registered for
sale to investors only in the States of Pennsylvania, Delaware, Florida,
Maryland, New York, Ohio, and Wyoming. These Funds are not being offered
for sale to investors in any other State.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
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PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Legg Mason Wood Walker, Incorporated
111 South Calvert Street, P.O. Box 1476
Baltimore, MD 21203-1476
410-539-0000 800-822-5544
Navigator Shares are sold and redeemed without any purchase or
redemption charge imposed by the Funds, although Institutional Clients may
charge their Customer Accounts for services provided in connection with
the purchase or redemption of shares. See "How to Purchase and Redeem
Shares." Each Fund pays management fees to Legg Mason Fund Adviser,
Inc., but Navigator Classes pay no distribution fees.
Maryland Tax-Free is a non-diversified, professionally managed
portfolio seeking a high level of current income exempt from federal and
Maryland state and local income taxes, consistent with prudent investment
risk and preservation of capital. In attempting to achieve the Fund's
objective, the Funds' investment adviser, Legg Mason Fund Adviser, Inc.
("Adviser"), invests primarily in debt instruments issued by or on behalf
of the State of Maryland, its political subdivisions, municipalities,
agencies, instrumentalities or public authorities, the interest on which,
in the opinion of counsel to the issuer, is exempt from federal and
Maryland state and local income taxes ("Maryland municipal obligations")
and which are investment grade, i.e., securities rated within the four
highest grades by Moody's Investors Service, Inc. ("Moody's") or Standard
& Poor's Ratings Group ("S&P") or, if unrated by Moody's or S&P, deemed by
the Adviser to be of comparable quality. Under normal circumstances, the
dollar-weighted average maturity of the Fund's portfolio is expected to be
between 12 and 24 years. The Fund also may engage in hedging transactions.
Pennsylvania Tax-Free is a non-diversified, professionally
managed portfolio seeking a high level of current income exempt from
federal income tax and Pennsylvania personal income tax, consistent with
prudent investment risk and preservation of capital. In attempting to
achieve the Fund's objective, the Adviser invests primarily in debt
instruments issued by or on behalf of the Commonwealth of Pennsylvania,
its political subdivisions, municipalities, agencies, instrumentalities or
public authorities, the interest on which, in the opinion of counsel to
the issuer, is exempt from federal income tax and Pennsylvania personal
income tax ("Pennsylvania municipal obligations") and which are investment
grade, i.e., securities rated within the four highest grades by Moody's,
S&P or, if unrated by Moody's or S&P, securities deemed by the Adviser to
be of comparable quality. The Fund's shares are exempt from Pennsylvania
county personal property tax to the extent that the Fund invests in
Pennsylvania municipal obligations. Under normal circumstances, the
dollar-weighted average maturity of the Fund's portfolio is expected to be
between 12 and 24 years. The Fund also may engage in hedging transactions.
Tax-Free Intermediate is a non-diversified, professionally
managed portfolio seeking a high level of current income exempt from
federal income tax, consistent with prudent investment risk. In attempting
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to achieve the Fund's objective, the Adviser invests primarily in debt
instruments issued by or on behalf of states, territories and possessions
of the United States, the District of Columbia and their respective
authorities, agencies, instrumentalities and political subdivisions, the
interest on which, in the opinion of counsel to the issuer, is exempt from
federal income tax and which are investment grade, i.e. securities rated
within the four highest grades by Moody's, S&P or Fitch Investors Service,
Inc. ("Fitch") or, if unrated by Moody's, S&P or Fitch ("unrated
securities"), deemed by the Adviser to be of comparable quality, while
maintaining an average dollar-weighted maturity of between 2 and 10 years.
The Fund also may engage in hedging transactions.
Expenses
The purpose of the following table is to assist an investor in
understanding the various costs and expenses that an investor in Navigator
Shares of a Fund will bear directly or indirectly. The expenses and fees
set forth in the table are based on estimated expenses for the initial
period of operations of the Navigator Classes.
Shareholder Transaction Expenses For Each Fund
Maximum sales charge on purchases or
reinvested dividends None
Redemption or exchange fees None
Annual Fund Operating Expenses -- Navigator Shares
(as a percentage of average net assets)
Maryland Pennsylvania Tax-Free
Tax-Free Tax-Free Intermediate
-------- ------------ ------------
Management fees A 0.21% 0.09% 0.16%
12b-1 fees None None None
Other expenses 0.14% 0.21% 0.24%
----- ----- -----
Total operating expenses A 0.35% 0.30% 0.40%
===== ===== =====
A Pursuant to a voluntary expense limitation, the Adviser has agreed to
waive the management fees and assume certain other expenses such that
total operating expenses relating to Navigator Shares (exclusive of taxes,
interest, brokerage fees and extraordinary expenses) will not exceed
annual rates of: 0.35% of average daily net assets of Maryland Tax-Free
until January 31, 1996 or until the Fund's net assets reach $200 million,
whichever occurs first; 0.30% of average daily net assets of Pennsylvania
Tax-Free until January 31, 1996 or until the Fund's net assets reach $125
million, whichever occurs first; and 0.40% of average daily net assets of
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Tax-Free Intermediate until January 31, 1996 or until the Fund's net
assets reach $100 million, whichever occurs first. In the absence of such
waivers, the expense ratios for Navigator Maryland Tax-Free, Pennsylvania
Tax-Free and Tax-Free Intermediate would be 0.69%, 0.76% and 0.79%,
respectively.
For further information concerning the expenses of each Fund,
please see "The Funds' Management and Investment Adviser" and "The Funds'
Distributor," page 25.
Example of Effect of Fund Expenses
The following example illustrates the expenses that you would pay
on a $1,000 investment in Navigator Shares over various time periods
assuming (1) a 5% annual rate of return and (2) redemption at the end of
each time period. As noted in the table above, the Funds charge no
redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Maryland Tax-Free $4 $11 $20 $44
Pennsylvania Tax-Free $3 $10 $17 $38
Tax-Free Intermediate $4 $13 $22 $51
This example assumes that all dividends and capital gain
distributions are reinvested and that the percentage amounts listed under
"Annual Fund Operating Expenses" remain the same over the time periods
shown. The above tables and the assumption in the example of a 5% annual
return are required by regulations of the SEC applicable to all mutual
funds. The assumed 5% annual return is not a prediction of, and does not
represent, the projected or actual performance of Navigator Shares of the
Funds. The above tables and example should not be considered a
representation of past or future expenses. Actual expenses may be greater
or less than those shown. The actual expenses attributable to Navigator
Shares will depend upon, among other things, the level of average net
assets, the levels of sales and redemptions of shares, the extent to which
Navigator Shares incur variable expenses, such as transfer agency costs,
and whether the Adviser reimburses all or a portion of a Fund's expenses.
Financial Highlights
Effective August 1, 1995, the Funds will commence the sale of
Navigator Shares. Navigator Shares pay no 12b-1 distribution fees. The
information below is for Primary Shares (the other class of shares
currently offered) and reflects 12b-1 fees paid by that class and not by
Navigator Shares.
The financial highlights tables that follow have been derived
from each Fund's financial statements which have been audited by Coopers &
Lybrand L.L.P., independent accountants. Each Fund's financial statements
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for the year ended March 31, 1995 and the report of Coopers & Lybrand
L.L.P. thereon are included in that Fund's annual report and are
incorporated by reference into the Statement of Additional Information.
The annual report for each Fund is available to shareholders without
charge by calling an investment executive at Fairfield or Legg Mason or
Legg Mason's Funds Marketing Department at 800-822-5544.
MARYLAND TAX-FREE
PRIMARY CLASS
Years Ended March 31,
---------------------
---- ---- ---- ------
1995 1994 1993 1992 A
---- ---- ---- ------
Per Share Operating
Performance:
Net asset value, $15.69 $15.97 $15.03 $14.70
beginning of period ------ ------ ------ ------
Net investment income B .828 .839 .877 .823
Net realized and
unrealized gain (loss) .180 (.275) .947 .333
on investments ----- ------ ----- -----
Total from investment 1.008 .564 1.824 1.156
operations ----- ---- ----- -----
Distributions to
shareholders from:
Net investment income (.828) (.839) (.877) (.823)
Net realized gain on
investments -- -- (.007) (.003)
In excess of net
realized gain on -- (.005) -- --
investments ----- ------ ----- -----
Net asset value, end of $15.87 $15.69 $15.97 $15.03
period ====== ====== ====== ======
Total return D 6.60% 3.51% 12.47% 8.04% C
Ratios/Supplemental Data:
Ratios to average net
assets:
Expenses B 0.54% 0.46% 0.40% 0.18% E
Net investment
income B 5.32% 5.10% 5.61% 5.91% E
Portfolio turnover rate 9.5% 6.6% -- 5.4% E
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Net assets, end of
period (in thousands) $142,314 $145,578 $128,566 $83,052
A For the period May 1, 1991 (commencement of operations) to March 31,
1992.
B Net of fees waived and reimbursements made by the Adviser in excess of
voluntary expense limitations as follows: all expenses until October
20, 1991; 0.25% until December 31, 1991; 0.35% until June 30, 1992;
0.40% until December 31, 1992; 0.45% until December 31, 1993; 0.50%
until June 30, 1994; and 0.60% until January 31, 1996.
C Not annualized. The annualized total return for the period would have
been 8.76%.
D Excluding sales charge.
E Annualized.
PENNSYLVANIA TAX-FREE
PRIMARY CLASS
Years Ended March 31,
---------------------
---- ---- ---- ------
1995 1994 1993 1992 A
---- ---- ---- ------
Per Share Operating
Performance:
Net asset value, $15.80 $16.03 $14.99 $14.70
beginning of period ------ ------- ------ ------
Net investment income B .85 .86 .91 .63
Net realized and
unrealized gain (loss) .22 (.23) 1.04 .29
on investments --- ----- ---- ---
Total from investment 1.07 .63 1.95 .92
operations ---- ---- ---- ----
Distributions to
shareholders from net (.85) (.86) (.91) (.63)
investment income ----- ----- ----- -----
Net asset value, end of $16.02 $15.80 $16.03 $14.99
period ====== ====== ====== ======
Total return D 7.03% 3.81% 13.31% 6.36% C
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Ratios/Supplemental Data:
Ratios to average net
assets:
Expenses B 0.49% 0.40% 0.32% 0.12% E
Net investment income
B 5.42% 5.16% 5.74% 5.91% E
Portfolio turnover rate 2.08% -- -- --
Net assets, end of
period (in thousands) $63,929 $62,904 $49,959 $28,873
A For the period August 1, 1991 (commencement of operations) to March 31,
1992.
B Net of fees waived and reimbursements made by the Adviser in excess of
voluntary expense limitations as follows: all expenses until November
30, 1991; 0.20% until March 31, 1992; 0.25% until June 30, 1992; 0.30%
until December 31, 1992; 0.35% until July 31, 1993; 0.40 until December
31, 1993; 0.45% until June 30, 1994; and 0.55% until January 31, 1996.
C Not annualized. The annualized total return for the period would have
been 9.55%.
D Excluding sales charge.
E Annualized.
TAX-FREE INTERMEDIATE
PRIMARY CLASS
Years Ended March 31,
---------------------
---- ---- ------
1995 1994 1993 A
---- ---- ------
Per Share Operating Performance:
Net asset value, beginning of $14.96 $15.06 $14.70
period ------ ------ ------
Net investment income B .72 .70 .28
Net realized and unrealized .10 (.09) .36
gain (loss) on investments ---- ----- ----
Total from investment .82 .61 .64
operations ---- ---- ----
Distributions to shareholders
from:
Net investment income (.72) (.70) (.28)
Net realized gain on -- (.01) --
investments ----- ----- -----
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Net asset value, end of period $15.06 $14.96 $15.06
====== ====== ======
Total return D 5.65% 3.99% 4.35% C
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses B 0.34% 0.30% 0.20% E
Net investment income B 4.83% 4.44% 4.71% E
Portfolio turnover rate 24.8% 6.63% --
Net assets, end of period
(in thousands) $48,837 $54,032 $37,138
A For the period November 9, 1992 (commencement of operations) to March
31, 1993.
B Net of fees waived and reimbursements made by the Adviser in excess of
voluntary expense limitations as follows: 0.20% until March 31, 1993;
0.30 until June 30, 1994; and 0.35% until January 31, 1996.
C Not annualized. The annualized total return for the period would have
been 11.10%.
D Excluding sales charge.
E Annualized.
Performance Information
From time to time each Fund may quote the total return of each class of
shares in advertisements or in reports or other communications to
shareholders. A mutual fund's total return is a measurement of the overall
change in value of an investment in the fund, including changes in share
price and assuming reinvestment of dividends and other distributions.
Cumulative total return shows the fund's performance over a specific
period of time. Average annual total return is the average annual
compounded return that would have produced the same cumulative total
return if the fund's performance had been constant over the entire period.
Average annual returns, which differ from actual year-to-year results,
tend to smooth out variations in a fund's returns.
Total returns of Primary Shares as of March 31, 1995 were as follows:
Cumulative Total Return
Maryland Pennsylvania Tax-Free
Tax-Free Tax-Free Intermediate
-------- ----------- ------------
One Year +3.70% +4.07% +3.50%
Life of Class +30.34 A +30.16 B +12.34 C
Average Annual Total Return
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Maryland Pennsylvania Tax-Free
Tax-Free Tax-Free Intermediate
-------- ------------ ------------
One Year +3.70% +4.07% +3.50%
Life of Class +7.00 A +7.45 B +4.99 C
A Inception of Maryland Tax-Free - May 1, 1991.
B Inception of Pennsylvania Tax-Free - August 1, 1991.
C Inception of Tax-Free Intermediate - November 9, 1992.
As of the date of this Prospectus, Navigator Shares have no
performance record. Because Navigator Shares have lower total expenses,
they will generally have a higher return than Primary Shares.
Each Fund also may advertise its yield or tax equivalent yield.
Yield reflects investment income net of expenses over a 30-day (or
one-month) period on a Fund share, expressed as an annualized percentage
of the maximum offering price per share at the end of the period. Tax
equivalent yield shows the taxable yield an investor would have to earn
before taxes to equal the Fund's tax-exempt yield. A tax equivalent yield
is calculated by dividing a Fund's tax-exempt yield by the result of one
minus a stated federal, state and local income tax rate. The effective
yield, although calculated similarly, will be slightly higher than the
yield because it assumes that income earned from the investment is
reinvested (i.e., the compounding effect of reinvestment). Yield
computations differ from other accounting methods and therefore may differ
from dividends actually paid or reported net income.
Total return and yield information reflect past performance and
are not predictions or guarantees of future results. Yields and total
returns of Primary Shares of the Funds would be lower if the Adviser and
Legg Mason had not waived a portion of the fees and reimbursed certain
expenses during the fiscal years 1992 through 1995. Investment return and
share price will fluctuate, and the value of your shares, when redeemed,
may be worth more or less than their original cost.
Further information about each Fund's performance is contained in
that Fund's Annual Report to Shareholders, which may be obtained without
charge by calling an investment executive at Fairfield or Legg Mason or
Legg Mason's Funds Marketing Department at 800-822-5544.
Who Should Invest
Maryland Tax-Free is designed for longer-term investors who are
able to benefit from income exempt from federal and Maryland state and
local income taxes. Pennsylvania Tax-Free is designed for longer-term
investors who are able to benefit from income exempt from federal income
tax and Pennsylvania personal income tax. Tax-Free Intermediate is
designed for intermediate-term investors who are able to benefit from
income exempt from federal income tax. The value of Navigator Shares can
generally be expected to fluctuate inversely with changes in interest
rates and, because of the potential negative impact of rising interest
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rates and other risks, the Funds would not be appropriate for investors
whose primary goal is stability of principal. Each Fund is not intended to
be a balanced investment program. Each Fund is not an appropriate
investment for "substantial users" of certain facilities financed by
industrial development or private activity bonds or related persons
thereof. See "Taxes-Federal Income Tax," page 21.
Investment Objectives and Policies
Each Fund's investment objective may not be changed without
shareholder approval; however, except as otherwise noted, the investment
policies of each Fund described below may be changed by the Trust's Board
of Trustees without a shareholder vote. There can be no assurance that
any Fund will achieve its investment objective.
Maryland Tax-Free's investment objective is to earn a high level
of current income exempt from federal and Maryland state and local income
taxes, consistent with prudent investment risk and preservation of
capital. The Fund seeks to achieve its investment objective by investing
primarily in debt instruments issued by or on behalf of the State of
Maryland, its political subdivisions, municipalities, agencies,
instrumentalities or public authorities, the interest on which, in the
opinion of counsel to the issuer, is exempt from federal and Maryland
state and local income taxes. As a fundamental policy, under normal
circumstances, the Fund will maintain at least 80% of its total assets in
Maryland municipal obligations, exclusive of any such obligations the
interest on which is a tax preference item for purposes of the federal
alternative minimum tax ("Tax Preference Item"). See "Temporary
Investments," page 12.
Pennsylvania Tax-Free's investment objective is to earn a high
level of current income exempt from federal income tax and Pennsylvania
personal income tax, consistent with prudent investment risk and
preservation of capital. The Fund seeks to achieve its investment
objective by investing primarily in debt instruments issued by or on
behalf of the Commonwealth of Pennsylvania, its political subdivisions,
municipalities, agencies, instrumentalities or public authorities, the
interest on which, in the opinion of counsel to the issuer, is exempt from
federal income tax and Pennsylvania personal income tax. As a fundamental
policy, under normal circumstances, the Fund will maintain at least 80% of
its total assets in Pennsylvania municipal obligations, exclusive of any
Tax Preference Items. See "Temporary Investments" page 12.
Tax-Free Intermediate's investment objective is to earn a high
level of current income exempt from federal income tax, consistent with
prudent investment risk. The Fund seeks to achieve its investment
objective by investing primarily in debt instruments issued by or on
behalf of states, territories and possessions of the United States, the
District of Columbia and their respective authorities, agencies,
instrumentalities and political subdivisions, the interest on which, in
the opinion of counsel to the issuer, is exempt from federal income tax
("municipal obligations"), while maintaining an average dollar-weighted
maturity of between 2 and 10 years. As a fundamental policy, under normal
circumstances, the Fund will maintain at least 80% of its total assets in
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municipal obligations exclusive of any Tax Preference Items. See
"Temporary Investments," page 12.
Maryland Tax-Free and Pennsylvania Tax-Free each invest in
securities that, in the opinion of the Adviser, present acceptable credit
risks and that, at the time of purchase, are rated:
"Baa" or higher by Moody's or "BBB" or higher by S&P in the case
of bonds;
"P1" or higher by Moody's or "A1" or higher by S&P in the case of
commercial paper;
"MIG-1" or higher by Moody's or "SP-1" or higher by S&P in the
case of notes; and
"VMIG-1" or higher by Moody's in the case of variable rate demand
notes.
Tax-Free Intermediate invests in securities that, in the opinion
of the Adviser, present acceptable credit risks and that, at the time of
purchase, are rated:
"Baa" or higher by Moody's, "BBB" or higher by S&P or Fitch in
the case of bonds;
"MIG-1" or higher by Moody's, "SP-1" or higher by S&P or "F-1" or
higher by Fitch in the case of notes;
"P1" or higher by Moody's, "A1" or higher by S&P or "F-1" or
higher by Fitch in the case of commercial paper; and
"VMIG-1" or higher by Moody's in the case of variable rate demand
notes.
Each Fund also invests in securities unrated by any of the above
services which are deemed by the Adviser to be of comparable quality.
The bond ratings noted above are considered "investment grade" by
the respective rating agencies. A rating of a municipal obligation
represents the rating agency's opinion regarding its quality and is not a
guarantee of quality. Moody's considers that bonds rated in its fourth
highest category (i.e., Baa) have speculative characteristics; changes in
economic conditions or other circumstances are more likely to lead to a
weakened capacity for the issuers of such securities to make principal and
interest payments than is the case for higher rated bonds. In the event
the rating on an issue held in a Fund's portfolio is changed by Moody's,
S&P or (with respect to Tax-Free Intermediate) Fitch, such change will be
considered by the Adviser in its evaluation of the overall investment
merits of that security. If, as a result of any downgradings by Moody's,
S&P or (with respect to Tax-Free Intermediate) Fitch or, for unrated
securities, any determinations by the Adviser that securities are no
longer of comparable quality to investment grade securities, more than 5%
of a Fund's total assets are represented by securities rated below
investment grade or the equivalent, the Adviser will, as soon as
practicable consistent with achieving an orderly disposition of the
securities, sell such holdings until they represent 5% or less of the
Fund's total assets. A discussion of the ratings outlined above is
included in the Statement of Additional Information.
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In addition to the agency ratings, there are other criteria which
will be used by the Adviser in selecting securities for a portfolio.
Consideration will be given to the maturity and duration of each bond as
well as its effect on the overall average maturity and duration of the
portfolio. Analysis of the current and historical yield spreads is done to
determine the relative value in any bond considered for purchase. The
coupon level and call features also figure in the decision on the relative
merits of an investment. Consideration is also given to the type of bond--
whether it is a general obligation or a revenue bond. In addition to this
examination of bond characteristics, significant effort is devoted to
analysis of the creditworthiness of the bond issuer at the time of
purchase and on an ongoing basis.
Each Fund is permitted to invest in municipal securities of any
maturity. The maturities of a Fund's portfolio securities will reflect the
Adviser's judgment concerning current and future market conditions as well
as other factors, such as the Fund's liquidity needs. Under normal
circumstances, the dollar-weighted average maturities of Maryland Tax-
Free's and Pennsylvania Tax-Free's portfolios are expected to be between
12 and 24 years and the dollar-weighted average maturity of Tax-Free
Intermediate's portfolio is expected to be between 2 and 10 years.
Each Fund does not expect its portfolio turnover rate to exceed
90% per year.
Municipal Obligations
Municipal obligations include obligations issued to obtain funds
for various public purposes, including constructing a wide range of public
facilities, such as bridges, highways, housing, hospitals, mass
transportation, schools and streets. Other public purposes for which
municipal obligations may be issued include the refunding of outstanding
obligations, the obtaining of funds for general operating expenses and the
making of loans to other public institutions and facilities. In addition,
certain types of industrial development bonds ("IDBs") and private
activity bonds ("PABs") are issued by or on behalf of public authorities
to finance various privately operated facilities, including certain
pollution control facilities, convention or trade show facilities, and
airport, mass transit, port or parking facilities. Interest on certain
tax-exempt PABs will constitute a Tax Preference Item. Accordingly, under
normal circumstances, each Fund's investment in obligations, the interest
on which is such an item, including PABs, will be limited to a maximum of
20% of its total assets.
Municipal obligations also include short-term tax anticipation
notes, bond anticipation notes, revenue anticipation notes and other forms
of short-term debt obligations. Such notes may be issued with a short-term
maturity in anticipation of the receipt of tax payments, the proceeds of
bond placements or other revenues.
Municipal obligations also include municipal lease obligations.
These obligations, which are issued by state and local governments to
acquire land, equipment and facilities, typically are not fully backed by
the municipality's credit, and, if funds are not appropriated for the
following year's lease payments, a lease may terminate, with the
possibility of default on the lease obligation and significant loss to a
Fund. Certificates of Participation are participations in municipal lease
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obligations or installment sales contracts. Each certificate represents a
proportionate interest in or right to the lease purchase payments made.
The two principal classifications of municipal obligations are
"general obligation" and "revenue" bonds. "General obligation" bonds are
secured by the issuer's pledge of its faith, credit and taxing power.
"Revenue" bonds are payable only from the revenues derived from a
particular facility or class of facilities or from the proceeds of a
special excise tax or other specific revenue source such as the corporate
user of the facility being financed. IDBs and PABs are usually revenue
bonds and are not payable from the unrestricted revenues of the issuer.
The credit quality of IDBs and PABs is usually directly related to the
credit standing of the corporate user of the facilities.
Temporary Investments
During unusual market conditions, including if, in the Adviser's
opinion, there are insufficient suitable Maryland municipal obligations
(with respect to Maryland Tax-Free), Pennsylvania municipal obligations
(with respect to Pennsylvania Tax-Free) or municipal obligations (with
respect to Tax-Free Intermediate) available that pay interest that is not
a Tax Preference Item, a Fund temporarily may invest more than 20% of its
total assets in municipal obligations the interest on which is exempt from
federal income tax but is such an item (with respect to Tax-Free
Intermediate) and/or is subject to Maryland state and local income taxes
(with respect to Maryland Tax-Free) and/or is subject to Pennsylvania
personal income tax (with respect to Pennsylvania Tax-Free). Each Fund
expects that under normal circumstances it will maintain needed liquidity
through the purchase of short-term municipal securities. However, for
liquidity purposes, or pending the investment of the proceeds of the sale
of shares, a Fund temporarily may invest in taxable short-term investments
consisting of: obligations of the U.S. Government, its agencies and
instrumentalities; certificates of deposit and bankers' acceptances of
U.S. domestic banks with assets of one billion dollars or more; commercial
paper or other corporate notes of high quality; and any of such items
subject to short-term repurchase agreements. Each Fund may invest without
limit in such instruments for temporary, defensive purposes, when in the
Adviser's opinion, no suitable municipal securities are available. No more
than 10% of a Fund's net assets will be invested in repurchase agreements
maturing in more than seven days and other illiquid securities. Interest
earned from such taxable investments will be taxable to investors as
ordinary income when distributed to them.
As a fundamental policy, each Fund may borrow money solely for
temporary purposes from banks or by engaging in reverse repurchase
agreements in an amount up to 10% of the value of its total assets;
however, borrowings by a Fund in excess of 5% of the value of a Fund's
total assets may be made only from banks.
Yield and Risk Factors
Yield
The yield of a municipal obligation is dependent on a variety of
factors, including general municipal securities market conditions, general
fixed-income market conditions, the financial condition of the issuer, the
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size of the particular offering, the maturity of the obligation, the
credit quality and rating of the issue and expectations regarding changes
in income tax rates.
Interest Rate Risk
If general market interest rates increase, the prices of
municipal obligations ordinarily will decrease. In a market of decreasing
interest rates, the opposite generally will be true. Although longer-term
bonds generally offer higher yields than shorter-term bonds, their prices
are more sensitive to changes in interest rates than bonds with shorter
maturities. Under normal circumstances, the dollar-weighted average
maturities of Maryland Tax-Free's and Pennsylvania Tax-Free's portfolios
are expected to be 12-24 years and the dollar-weighted average maturity of
Tax-Free Intermediate's portfolio is expected to be 2-10 years. Therefore,
the value of a Fund's portfolio securities, and hence of that Fund's
shares, will be more sensitive to changes in interest rates and will
fluctuate more than the value of a portfolio of shorter-term municipal
obligations.
For Maryland Tax-Free:
Changes in economic conditions in or governmental policies of the
state of Maryland could have a significant impact on the performance of
the Fund. For example, services (including mining), wholesale and retail
trade, government, and manufacturing (primarily printing and publishing,
food and kindred products, instruments and related products, electronic
equipment, industrial machinery and transportation equipment) are the
leading areas of employment in the State of Maryland. In contrast to the
nation as a whole, more people in Maryland are employed in government than
in manufacturing. The relatively high concentration of governmental
employment in Maryland makes the state potentially vulnerable to any
decreases in federal, including military, and state governmental spending.
In recent years, finance, insurance, and real estate were large
contributors to the gross state product. The outlook for those sectors is
subject to question given disclosures indicating continuing financial
weakness in major banking and insurance companies having their corporate
headquarters in Maryland and the general regional decline in real estate
activity and values.
The Fund may invest in certain municipal obligations with unique
risks. These include, but are not limited to, securities issued by
hospitals and other health care providers. The hospital industry
throughout the nation has been subjected to pressure to reduce expenses
and to limit lengths of stay. That pressure may adversely affect the
financial health of some hospitals.
An expanded discussion of certain investment considerations
relating to debt obligations of Maryland and its political subdivisions is
contained in the Statement of Additional Information.
For Pennsylvania Tax-Free:
Changes in economic conditions in, or governmental policies of,
the Commonwealth of Pennsylvania could have a significant impact on the
performance of the Fund. For example, Pennsylvania's continued dependence
on manufacturing, mining and steel has made Pennsylvania vulnerable to
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cyclical industry fluctuations, foreign imports and environmental
concerns. However, growth in the service and trade sectors has helped
diversify Pennsylvania's economy and reduce its unemployment rate below
the national average. Changes in local economic conditions or local
governmental policies within Pennsylvania, which can vary substantially by
region, could also have a significant impact on the performance of
municipal obligations held by the Fund. The City of Philadelphia, for
example, recently experienced severe financial problems which impaired its
ability to borrow money and adversely affected the ratings of its
obligations and their marketability. While the Fund may invest in
obligations that are secured by obligors other than Pennsylvania or its
political subdivisions (such as hospitals, universities, corporate
obligors and corporate credit and liquidity providers) and obligations
limited to specific revenue pledges (such as sewer authority bonds), the
creditworthiness of these obligors may be partly dependent on the
creditworthiness of Pennsylvania or its municipal authorities.
An expanded discussion of certain investment considerations
relating to debt obligations of Pennsylvania and its political
subdivisions is contained in the Statement of Additional Information.
Concentration
Each Fund may invest 25% or more of its total assets in a
particular segment of the municipal securities market, such as hospital
revenue bonds, housing agency bonds, IDBs or airport bonds, or in
securities the interest on which is paid from revenues of a similar type
of project. In such circumstances, economic, business, political or other
changes affecting one issue of bonds (such as proposed legislation
affecting healthcare or the financing of a project, shortages or price
increases of needed materials, or declining markets or needs for the
projects) would most likely affect other bonds in the same segment,
thereby potentially increasing market risk. As a result, each Fund is
subject to greater risk than other funds that do not follow this practice.
Non-Diversification
Each Fund has registered as a "non-diversified" investment
company. Therefore, the percentage of Fund assets invested in any single
issuer is not limited by the Investment Company Act of 1940 ("1940 Act").
However, each Fund intends to continue to qualify as a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as
amended ("Code"). To qualify as a RIC, a Fund generally must meet the
following diversification requirements at the close of each quarter of its
taxable year: (1) at least 50% of the value of its total assets must
consist of cash, securities of the U.S. Government and other RICs and
holdings of other securities, which, with respect to any one issuer, do
not have a value greater than 5% of the value of the Fund's total assets;
and (2) no more than 25% of the value of its total assets may be invested
in the securities of a single issuer. For these purposes, the term
"issuer" does not include the U.S. Government or other RICs. To the extent
that a Fund's assets are invested in the obligations of a limited number
of issuers, the value of that Fund's shares will be more susceptible to
any single economic, political or regulatory occurrence affecting one or
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more of those issuers than the shares of a diversified investment company
would be.
Other Risks
Current efforts to restructure the federal budget and the
relationship between the federal government and state and local
governments may impact the financing of some issuers of municipal
securities. Some states and localities are experiencing substantial
deficits and may find it difficult for political or economic reasons to
increase taxes. Some local jurisdictions have invested heavily in
derivative instruments and may now hold portfolios of uncertain valuation.
Each of these factors may affect the ability of an issuer of municipal
securities to meet its obligations. Efforts by Congress to restructure
the federal income tax system could adversely affect the value of
municipal securities.
Investment Techniques
Each Fund may employ the investment techniques described below,
among others. Use of certain of these techniques may give rise to taxable
income.
When-Issued Securities
Each Fund may enter into commitments to purchase municipal
obligations or other securities on a when-issued basis. A Fund may
purchase when-issued securities because such securities are often the most
efficiently priced and have the best liquidity in the bond market. As with
the purchase of any security, when a Fund purchases securities on a
when-issued basis, it assumes the risks of ownership at the time of
purchase, not at the time of receipt. However, the Fund does not have to
pay for the obligations until they are delivered to it, normally 15 to 45
days later. To meet that payment obligation, the Fund will set aside cash
or marketable high-quality debt securities equal to the payment that will
be due. Depending on market conditions, a Fund's when-issued purchases
could cause its share value to be more volatile, because they may increase
the amount by which the Fund's total assets, including the value of the
when-issued securities held by it, exceed the Fund's net assets. Each Fund
does not expect that its commitment to purchase when-issued securities
will at any time exceed, in the aggregate, 25% of total assets.
Callable Bonds
Callable municipal bonds are municipal bonds which carry a
provision permitting the issuer to redeem the bonds prior to their
maturity dates at a specified price which typically reflects a premium
over the bonds' original issue price. If the proceeds of a bond owned by a
Fund called under circumstances favorable to the issuer are reinvested,
the result may be a lower overall yield on such proceeds upon reinvestment
because of lower prevailing interest rates. If the purchase price of such
bonds included a premium related to the appreciated value of the bonds,
some or all of that premium may not be recovered by bondholders, such as
the Funds, depending on the price at which such bonds were redeemed.
Each callable bond is "marked-to-market" daily based on the
bond's call date so that the call of some or all of a Fund's callable
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bonds is not expected to have a material impact on that Fund's net asset
value. In light of the previously described pricing policies and because
each Fund follows certain amortization procedures required by the Internal
Revenue Service, each Fund does not expect to suffer any material adverse
impact in connection with a call of bonds purchased at a premium.
Notwithstanding such policies, however, as with any investment strategy,
there is no guarantee that a call may not have a more substantial impact
than anticipated.
Stand-By Commitments
Each Fund may acquire "stand-by commitments" with respect to its
investments in municipal obligations. A stand-by commitment is a put (that
is, the right to sell the underlying security within a specified period of
time at a specified exercise price) that may be sold, transferred or
assigned only with the underlying security. Under a stand-by commitment, a
broker, dealer or bank agrees to purchase, at the Fund's option, specified
municipal obligations at a specified price. The total amount paid for
outstanding stand-by commitments held by a Fund will not exceed 25% of
that Fund's total assets calculated immediately after each stand-by
commitment is acquired.
Securities Lending, Zero Coupon and Deferred Interest Bonds
Each Fund may engage in securities lending and may invest in zero
coupon and deferred interest bonds. However, each Fund does not currently
intend to loan securities with a value exceeding 5% of its total assets or
to invest more than 5% of its total assets in zero coupon and deferred
interest bonds. Any income from securities lending would be taxable when
distributed to shareholders. For further information concerning securities
lending, zero coupon and deferred interest bonds, see the Statement of
Additional Information.
Variable Rate and Floating Rate Obligations
Each Fund may invest in variable rate municipal obligations and
notes. Variable rate obligations have a yield that is adjusted
periodically based upon market conditions.
Each Fund may also invest in floating rate and variable rate
demand notes. Demand notes provide that the holder may demand payment of
the note at its par value plus accrued interest. The notes may be
supported by an unconditional bank letter of credit guaranteeing payment
of the principal or both the principal and accrued interest. Floating rate
demand notes have an interest rate related to a known lending rate, such
as the prime rate, and are automatically adjusted when such rate changes.
With respect to Maryland Tax-Free and Pennsylvania Tax-Free, such
securities often react to changes in market interest rates in a manner
similar to shorter-term securities that mature at the time of the next
interest rate reset for the variable or floating rate instrument. With
respect to Tax-Free Intermediate, in calculating its dollar-weighted
average maturity, the Fund may determine the maturity of a variable or
floating rate note according to the interest rate reset date, or the date
principal can be recovered on demand, rather than the date of ultimate
maturity.
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Futures and Option Strategies
To protect against the effect of adverse changes in interest
rates, each Fund may purchase and sell interest rate futures contracts and
options on securities indexes, and may purchase put options on interest
rate futures contracts and debt securities (practices known as "hedging").
A Fund may purchase put options on interest rate futures contracts or sell
interest rate futures contracts (that is, enter into a futures contract to
sell the underlying security) to attempt to reduce the risk of
fluctuations in its share value. A Fund may purchase an interest rate
futures contract (that is, enter into a futures contract to purchase the
underlying security) to attempt to establish more definitely the return on
securities the Fund intends to purchase. No Fund may use these instruments
for speculation or leverage. In addition, a Fund's ability to use these
strategies may be limited by market conditions, regulatory limits and tax
considerations.
Each Fund may seek to enhance its income by writing (selling)
covered call options and covered put options. A Fund may write puts and
calls only on a covered basis, which means, in the case of calls, that the
Fund will own the underlying instrument while the call is outstanding and,
in the case of puts, that the Fund will have cash, U.S. government
securities or other high-grade, liquid debt instruments in a segregated
account in an amount not less than the exercise price while the put is
outstanding. Any gains from futures and options transactions would be
taxable.
The success of a Fund's strategies in reducing risks depends on
many factors, the most significant of which is the Adviser's ability to
predict market interest rate changes correctly, which differs from its
ability to select portfolio securities. In addition, a hedge could be
unsuccessful if the changes in the value of its futures contract or option
positions do not correlate to the changes in the value of the Fund's
investments. It is also possible that a Fund may be unable to purchase or
sell a portfolio security at a time that otherwise would be favorable for
it to do so, or that a Fund may need to sell a portfolio security at a
disadvantageous time, due to the need for the Fund to maintain "cover" or
to segregate securities in connection with hedging transactions. Because
the markets for futures and options are not always liquid, a Fund may be
unable to close out or liquidate its hedged position and may be locked in
during a market decline. The Adviser attempts to minimize the possible
negative effects of these factors through careful selection and monitoring
of each Fund's futures and options positions. The Adviser is of the
opinion that a Fund's investment in futures transactions will not have a
material adverse effect on that Fund's liquidity or ability to honor
redemptions.
The purchase and sale of options and futures contracts involve
risks different from those involved with direct investments in securities,
and also require different skills from the Adviser in managing the
portfolios. While utilization of options, futures contracts and similar
instruments may be advantageous to a Fund, if the Adviser is not
successful in employing such instruments in managing a Fund's investments
or in predicting interest rate changes, that Fund's performance will be
worse than if the Fund did not use such instruments. In addition, a Fund
will pay commissions and other costs in connection with such investments,
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<PAGE>
which may increase that Fund's expenses and reduce its yield. A more
complete discussion of the possible risks involved in transactions in
options and futures contracts is contained in the Statement of Additional
Information.
Each Fund's current policy is to limit options and futures
transactions to those described above. Each Fund currently does not intend
to (i) purchase put and call options having a value in excess of 5% of its
total assets or (ii) write options on portfolio securities having
aggregate exercise prices exceeding 25% of its net assets. Normally,
options will be written, if at all, on those portfolio securities which
the Adviser does not expect to have significant short-term capital
appreciation.
Investment Limitations
Each Fund has adopted certain fundamental limitations that, like
its investment objective, can be changed only by the vote of a majority of
the outstanding voting securities of that Fund. For these purposes, a
"vote of a majority of the outstanding voting securities" of a Fund means
the affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Fund, or (2) 67% or more of the shares present at a
shareholders' meeting if more than 50% of the outstanding shares are
represented in person or by proxy. These investment limitations are set
forth under "Additional Information About Investment Limitations and
Policies" in the Statement of Additional Information. Other Fund policies,
unless described as fundamental, can be changed by the Board of Trustees.
How to Purchase and Redeem Shares
Institutional Clients of Fairfield Group, Inc. may purchase
Navigator Shares from Fairfield, the principal offices of which are
located at 200 Gibraltar Road, Horsham, Pennsylvania 19044. Other
investors eligible to purchase Navigator Shares may purchase them through
a brokerage account with Legg Mason. (Legg Mason and Fairfield are wholly
owned subsidiaries of Legg Mason, Inc., a financial services holding
company.)
Purchase of Shares
The minimum investment is $50,000 for the initial purchase of
Navigator Shares of each Fund and $100 for each subsequent investment.
Each Fund may change these minimum amounts at its discretion.
Institutional Clients may set different minimums for their Customers'
investments in accounts invested in Navigator Shares.
Share purchases will be processed at the net asset value next
determined after Legg Mason or Fairfield has received your order; payment
must be made within three business days to the selling organization.
Orders received by Legg Mason or Fairfield before the close of business of
the New York Stock Exchange ("Exchange") (normally 4:00 p.m. Eastern time)
("close of the Exchange") on any day the Exchange is open will be executed
at the net asset value determined as of the close of the Exchange on that
day. Orders received by Legg Mason or Fairfield after the close of the
Exchange or on days the Exchange is closed will be executed at the net
asset value determined as of the close of the Exchange on the next day the
Exchange is open. See "How Net Asset Value is Determined" on page 20.
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Each Fund reserves the right to reject any order for its shares, to
suspend the offering of shares for a period of time, or to waive any
minimum investment requirements.
In addition to Institutional Clients purchasing shares directly
from Fairfield, Navigator Shares may be purchased through procedures
established by Fairfield in connection with requirements of Customer
Accounts of various Institutional Clients.
No sales charge is imposed by any of the Funds in connection with
the purchase of Navigator Shares. Depending upon the terms of a
particular Customer Account, however, Institutional Clients may charge
their Customers fees for automatic investment and other cash management
services provided in connection with investments in the Funds.
Information concerning these services and any applicable charges will be
provided by the Institutional Clients. This Prospectus should be read by
Customers in connection with any such information received from the
Institutional Clients. Any such fees, charges or other requirements
imposed by an Institutional Client upon its Customers will be in addition
to the fees and requirements described in this Prospectus.
Redemption of Shares
Shares may ordinarily be redeemed by a shareholder via telephone,
in accordance with the procedures described below. However, Customers of
Institutional Clients wishing to redeem shares held in Customer Accounts
at the Institution may redeem only in accordance with instructions and
limitations pertaining to their Account at the Institution.
Fairfield clients can make telephone redemption requests by
calling Fairfield at 1-800-441-3885. Legg Mason clients should call their
investment executives or Legg Mason Funds Processing at 1-800-822-5544.
Callers should have available the number of shares (or dollar amount) to
be redeemed and their account number.
Orders for redemption received by Legg Mason or Fairfield before
the close of the Exchange, on any day when the Exchange is open, will be
transmitted to Boston Financial Data Services ("BFDS"), transfer agent for
the Funds, for redemption at the net asset value per share determined as
of the close of the Exchange on that day. Requests for redemption received
by Legg Mason or Fairfield after the close of the Exchange will be
executed at the net asset value determined as of the close of the Exchange
on its next trading day. A redemption request received by Legg Mason or
Fairfield may be treated as a request for repurchase and, if it is
accepted by Legg Mason, your shares will be purchased at the net asset
value per share determined as of the next close of the Exchange.
Shareholders may have their telephone redemption requests paid by
a direct wire to a domestic commercial bank account previously designated
by the shareholder, or mailed to the name and address in which the
shareholder's account is registered with the respective Fund. Such
payments will normally be transmitted on the next business day following
receipt of a valid request for redemption. However, each Fund reserves the
right to take up to seven days to make payment upon redemption if, in the
judgment of the Adviser, that Fund could be adversely affected by
immediate payment. (The Statement of Additional Information describes
several other circumstances in which the date of payment may be postponed
or the right of redemption suspended.) The proceeds of redemption or
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repurchase may be more or less than the original cost. If the shares to be
redeemed or repurchased were paid for by check (including certified or
cashier's checks) within 15 business days of the redemption or repurchase
request, the proceeds may not be disbursed unless that Fund can be
reasonably assured that the check has been collected.
None of the Funds will be responsible for the authenticity of
redemption instructions received by telephone, provided it follows
reasonable procedures to identify the caller. Each Fund may request
identifying information from callers or employ identification numbers.
Each Fund may be liable for losses due to unauthorized or fraudulent
instructions if it does not follow reasonable procedures. Telephone
redemption privileges are available automatically to all shareholders
unless certificates have been issued. Shareholders who do not wish to have
telephone redemption privileges should call their investment executive for
further instructions.
Because of the relatively high cost of maintaining small
accounts, each Fund may elect to close any account with a current value of
less than $500 by redeeming all of the shares in the account and mailing
the proceeds to the investor. However, no Fund will redeem accounts that
fall below $500 solely as a result of a reduction in net asset value per
share. If a Fund elects to redeem the shares in an account, the investor
will be notified that the account is below $500 and will be allowed 60
days in which to make an additional investment in order to avoid having
the account closed.
How Shareholder Accounts are Maintained
A shareholder account is established automatically for each
investor. Any shares the investor purchases or receives as a dividend or
other distribution will be credited directly to the account at the time of
purchase or receipt. No certificates are issued unless the shareholder
specifically requests them in writing. Shareholders who elect to receive
certificates can redeem their shares only by mail. Certificates will be
issued in full shares only. No certificates will be issued for shares of
any Fund prior to 15 business days after purchase of such shares by check
unless that Fund can be reasonably assured during that period that payment
for the purchase of such shares has been collected. Fund shares may not
be held in, or transferred to, an account with any brokerage firm other
than Fairfield, Legg Mason or their affiliates.
Every shareholder of record will receive a confirmation of each
new share transaction with that holder's respective Fund, which will also
show the total number of shares being held in safekeeping by the Fund's
transfer agent for the account of the shareholder.
Navigator Shares sold to Institutional Clients acting in a
fiduciary, advisory, custodial, or other similar capacity on behalf of
persons maintaining Customer Accounts at Institutional Clients will
normally be held of record by the Institutional Clients. Therefore, in
the context of Institutional Clients, references in this Prospectus to
shareholders mean the Institutional Clients rather than their Customers.
Institutional Clients purchasing or holding Navigator Shares on behalf of
their Customers are responsible for the transmission of purchase and
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redemption orders (and the delivery of funds) to each Fund on a timely
basis.
How Net Asset Value is Determined
Net asset value per Navigator Share of each Fund is determined
daily as of the close of the Exchange, on every day that the Exchange is
open, by subtracting the liabilities attributable to Navigator Shares from
the total assets attributable to such shares and dividing the result by
the number of Navigator Shares outstanding. Securities owned by each Fund
for which market quotations are readily available are valued at current
market value. In the absence of readily available market quotations,
securities are valued based upon appraisals received from an independent
pricing service using a computerized matrix system or based upon
appraisals derived from information concerning the security or similar
securities received from recognized dealers in those securities. Other
securities are valued at fair value as determined by, or under the
supervision of, the Board of Trustees of the Trust. Pursuant to guidelines
established by the Board of Trustees, the fair value of debt securities
with remaining maturities of 60 days or less shall be their amortized
cost, unless conditions otherwise indicate.
Dividends and Other Distributions
Dividends from net investment income of each Fund are declared
daily and paid monthly. Shareholders begin to earn dividends on their
Navigator Shares as of the settlement date, which is normally the third
business day after their orders are placed with their Legg Mason or
affiliated investment executive. Each Fund also distributes to
shareholders substantially all net capital gain (the excess of net
long-term capital gain over net short-term capital loss) after the end of
the taxable year in which the gain is realized. A second distribution of
net capital gain may be necessary in some years to avoid imposition of the
excise tax described under the heading "Additional Tax Information" in the
Statement of Additional Information. Shareholders may elect to:
1. Receive both dividends and capital gain distributions in
Navigator Shares of the distributing Fund;
2. Receive dividends in cash and capital gain distributions in
Navigator Shares of the distributing Fund;
3. Receive dividends in Navigator Shares of the distributing Fund
and capital gain distributions in cash; or
4. Receive both dividends and capital gain distributions in cash.
In certain cases, shareholders may reinvest dividends and capital
gain distributions in the corresponding class of shares of another
Navigator fund. A shareholder should contact his or her investment
executive for additional information about this option. Qualified
retirement plans that obtained Navigator Shares through exchange generally
receive dividends and capital gain distributions in additional shares.
If no election is made, both dividends and capital gain
distributions will be credited to the Institutional Client's account in
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Navigator Shares at the net asset value of the shares determined as of the
close of the Exchange on the reinvestment date. Shares received pursuant
to any of the first three (reinvestment) elections above also will be
credited to the account at that net asset value. If an investor elects to
receive dividends or capital gain distributions in cash, a check will be
sent. Investors purchasing through Fairfield may elect at any time to
change the distribution option by notifying the applicable Fund in writing
at: [insert complete Fund name], c/o Fairfield Group, Inc., 200 Gibraltar
Road, Horsham, Pennsylvania 19044. Those purchasing through Legg Mason
should write to: [insert complete Fund name], c/o Legg Mason Funds
Processing, P.O. Box 1476, Baltimore, Maryland, 21203-1476. An election
must be received at least 10 days before the record date in order to be
effective for dividends and capital gain distributions paid to
shareholders as of that date.
Taxes
Federal Income Tax
Each Fund intends to continue to qualify for treatment as a RIC
under the Code. If a Fund so qualifies and, at the close of each quarter
of its taxable year, at least 50% of the value of its total assets
consists of certain obligations the interest on which is excludable from
gross income under Section 103(a) of the Code, that Fund may pay
"exempt-interest" dividends to its shareholders. Those dividends
constitute the portion of the aggregate dividends (excluding capital gain
distributions), as designated by the Fund, equal to the excess of the
excludable interest over certain amounts disallowed as deductions.
Exempt-interest dividends are excludable from a shareholder's gross
income; however, the amount of such dividends must be reported on the
recipient's federal income tax return.
If and to the extent a Fund receives interest on certain PABs, a
proportionate part of the exempt-interest dividends paid by the Fund will
be treated as a Tax Preference Item. In addition, exempt-interest
dividends received by a corporate shareholder may be indirectly subject to
the federal alternative minimum tax without regard to whether the Fund's
tax-exempt interest is attributable to PABs.
To the extent dividends are derived from taxable income from
temporary investments, from net short-term capital gain or from the use of
certain investment techniques described in "Investment Objective and
Policies," page 9, they are taxable to shareholders as ordinary income
(whether paid in cash or reinvested in Fund shares). No portion of those
dividends will qualify for the corporate dividends-received deduction.
Distributions derived from net capital gain, if any, are taxable to
shareholders as long-term capital gain regardless of the length of time
they have held their Fund shares (and irrespective of whether those
distributions are paid in cash or reinvested in Fund shares).
Interest on indebtedness incurred or continued by a shareholder
in order to purchase or carry Fund shares generally is not deductible.
Persons who are "substantial users" (or related persons) of facilities
financed by IDBs or PABs should consult their tax advisers before
purchasing shares of a Fund because, for users of certain of these
facilities, the interest on those bonds is not exempt from federal income
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tax. For these purposes, a "substantial user" includes a non-exempt person
who regularly uses in trade or business a part of a facility financed from
the proceeds of IDBs or PABs.
A redemption of Fund shares may result in taxable gain or loss to
the redeeming shareholder, depending on whether the redemption proceeds
are more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of any other Navigator fund
generally will have similar tax consequences. In addition, if Fund shares
are purchased within 30 days before or after redeeming Fund shares at a
loss, all or part of that loss will not be deductible and instead will
increase the basis of the newly purchased shares.
For Maryland Tax-Free:
Maryland Taxes
Dividends paid by Maryland Tax-Free to Maryland residents
attributable to interest received or capital gains recognized by the Fund
on Maryland municipal obligations are exempt from Maryland state and local
income taxes. Distributions attributable to interest received or capital
gains recognized by the Fund on certain U.S. government obligations also
are exempt from Maryland state and local income taxes. Distributions
attributable to the Fund's other income or gains, generally are subject to
these taxes.
Interest on indebtedness incurred by a shareholder to purchase or
carry Fund shares generally is not deductible for purposes of either
Maryland state or local income tax. Fund shares held by an individual are
not subject to the Maryland personal property tax. Fund shares held by a
corporation also are not subject to the Maryland personal property tax.
Subject to a three year phase-in period, dividends paid by the Fund with
respect to Maryland municipal obligations and profits realized on the sale
or exchange of such obligations are not subject to the Maryland Franchise
Tax imposed on "financial institutions" and measured by net earnings.
In the case of individuals, Maryland imposes an income tax on Tax
Preference Items. Interest paid on certain PABs is a Tax Preference Item.
Accordingly, if the Fund holds such bonds, 50% of the interest thereon in
excess of a threshold amount is taxable by Maryland.
For Pennsylvania Tax-Free:
Pennsylvania Taxes
Individual shareholders of Pennsylvania Tax-Free who are
otherwise subject to the Pennsylvania personal income tax will not be
subject to that tax on distributions by the Fund that are attributable to
interest on Pennsylvania municipal obligations. Distributions attributable
to most other sources, including gains, will not be exempt from
Pennsylvania personal income tax.
Navigator Shares that are held by individual shareholders who are
Pennsylvania residents will be exempt from the Pennsylvania county
personal property tax to the extent that the Fund's portfolio consists of
Pennsylvania municipal obligations on the annual assessment date.
Nonresidents of Pennsylvania are not subject to this tax. Corporations are
not subject to any of these personal property taxes. For shareholders who
are residents of the City of Philadelphia, distributions of interest
derived from Pennsylvania municipal obligations are not taxable for
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purposes of the Philadelphia School District investment net income tax,
provided that the Fund reports to its shareholders the percentage of
Pennsylvania municipal obligations held by it for the year. The Fund will
report such percentage to its shareholders.
Distributions of interest, but not gains, realized on
Pennsylvania municipal obligations are not subject to the Pennsylvania
corporate net income tax. The Pennsylvania Department of Revenue also
takes the position that shares of funds similar to the Fund are not
considered exempt assets of a corporation for the purposes of determining
its capital stock value subject to Pennsylvania capital stock and
franchise taxes.
General
Shareholders receive information after the close of each year
concerning the tax status of all dividends and capital gain distributions
for their Fund(s). Each Fund is required to withhold 31% of all taxable
dividends, capital gain distributions and redemption proceeds payable to
any individuals and certain other noncorporate shareholders who do not
provide the Fund with a certified taxpayer identification number. Each
Fund also is required to withhold 31% of all taxable dividends and capital
gain distributions payable to such shareholders who otherwise are subject
to backup withholding. Dividends derived from interest on Maryland
municipal obligations may not be exempt from taxation under the laws of
states other than Maryland. Dividends derived from interest on
Pennsylvania municipal obligations may not be exempt from taxation under
the laws of states other than Pennsylvania.
The foregoing is only a summary of some of the important federal
income tax, Maryland income tax, Pennsylvania and certain local income tax
considerations generally affecting the respective Funds and their
shareholders; see the Statement of Additional Information for a further
discussion. In addition to those considerations, which are applicable to
any investment in the Funds, there may be other federal, state or local
tax considerations applicable to a particular investor. Prospective
shareholders are urged to consult their tax advisers with respect to the
effects of this investment on their own tax situations.
Shareholder Services
Confirmations and Reports
Shareholders will receive from Legg Mason a confirmation after
each transaction involving Navigator Shares (except a reinvestment of
dividends and capital gain distributions). An account statement will be
sent to each shareholder monthly unless there has been no activity in the
account, in which case an account statement will be sent quarterly.
Reports will be sent by each Fund to its shareholders at least
semiannually showing its portfolio and other information; the annual
report for each Fund will contain financial statements audited by its
independent accountants.
Confirmations for purchases and redemptions of Navigator Shares
made by Institutional Clients acting in a fiduciary, advisory, custodial,
or other similar capacity on behalf of persons maintaining Customer
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Accounts at Institutional Clients will be sent to the Institutional
Client. Beneficial ownership of shares by Customer Accounts will be
recorded by the Institutional Client and reflected in the regular account
statements provided by them to their customers.
Shareholder inquiries should be addressed to: [insert complete
Fund name], c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland 21203-1476," or c/o "Fairfield Group, Inc., 200 Gibraltar Road,
Horsham, Pennsylvania 19044."
Exchange Privilege
Holders of Navigator Shares are entitled to exchange them for
Navigator Shares of the following funds, provided the shares to be
acquired are eligible for sale under applicable state securities laws:
Navigator Money Market Fund, Inc. -- Prime Obligations Portfolio
A money market fund seeking to provide as high a level of current
interest income as is consistent with liquidity and relative stability of
principal.
Navigator Tax-Free Money Market Fund, Inc.
A money market fund seeking to provide its shareholders with as
high a level of current interest income that is exempt from federal income
taxes as is consistent with liquidity and relative stability of principal.
Navigator Value Trust
A mutual fund seeking long-term growth of capital.
Navigator Total Return Trust
A mutual fund seeking capital appreciation and current income in
order to achieve an attractive total investment return consistent with
reasonable risk.
Navigator Special Investment Trust
A mutual fund seeking capital appreciation by investing
principally in issuers with market capitalizations of less than $2.5
billion.
Navigator American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Navigator U.S. Government Intermediate-Term Portfolio
A mutual fund seeking high current income consistent with prudent
investment risk and liquidity needs, primarily by investing in debt
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, while maintaining an average dollar-weighted maturity
of between three and ten years.
Navigator Maryland Tax-Free Income Trust
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A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Navigator Pennsylvania Tax-Free Income Trust
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Navigator Tax-Free Intermediate-Term Income Trust
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current
income consistent with stability of principal.
Investments by exchange into other Navigator funds are made at
the per share net asset value next determined on the same business day as
redemption of the Fund shares you wish to exchange. To obtain further
information concerning the exchange privilege and prospectuses of other
Navigator funds, or to make an exchange, please contact your investment
executive. To effect an exchange by telephone, please call your investment
executive with the information described in the section "How to Purchase
and Redeem Shares," page 17. The other factors relating to telephone
redemptions described in that section apply also to telephone exchanges.
Please read the prospectus for the other fund(s) carefully before you
invest by exchange. Each Fund reserves the right to modify or terminate
its exchange privilege upon 60 days' notice to shareholders. There is no
assurance the money market funds will be able to maintain a $1.00 share
price. None of the funds is insured or guaranteed by the U.S. Government.
The Funds' Management and Investment Adviser
Board of Directors
The business and affairs of each Fund are managed under the
direction of the Board of Trustees of the Trust.
Adviser
Pursuant to separate advisory agreements with each Fund (each an
"Advisory Agreement"), which were approved by the Trust's Board of
Trustees, the Adviser, a wholly owned subsidiary of Legg Mason, Inc.,
serves as each Fund's investment adviser. The Adviser administers and acts
as the portfolio manager for each Fund and is responsible for the actual
investment management of the Funds, including the responsibility for
making investment decisions and placing orders to buy, sell or hold a
particular security. Each Fund pays the Adviser, pursuant to the Advisory
Agreement, a management fee equal to an annual rate of 0.55% of each
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Fund's average daily net assets attributable to Navigator Shares. Each
Fund pays all its other expenses which are not assumed by the Adviser.
Pursuant to a voluntary expense limitation, the Adviser has
agreed to waive the management fee and assume certain other expenses
relating to Navigator Shares (exclusive of taxes, interest, brokerage fees
and extraordinary expenses) in excess of: 0.35% (annualized) of average
daily net assets of Maryland Tax-Free until January 31, 1996 or until the
Fund's net assets reach $200 million, whichever occurs first; 0.30%
(annualized) of average daily net assets of Pennsylvania Tax-Free until
January 31, 1996 or until the Fund's net assets reach $125 million,
whichever occurs first; and 0.40% (annualized) of average daily net assets
of Tax-Free Intermediate until January 31, 1996 or until the Fund's net
assets reach $100 million.
The Adviser acts as investment adviser, manager or consultant to
sixteen investment company portfolios which had aggregate assets under
management of approximately $4.4 billion as of May 31, 1995. The
Adviser's address is 111 South Calvert Street, Baltimore, Maryland 21202.
Victoria M. Schwatka has been primarily responsible for the
day-to-day management of the Fund since its inception. Ms. Schwatka is a
portfolio manager and Senior Vice-President of Legg Mason's Fixed Income
Group. Ms. Schwatka has been employed by Legg Mason since June, 1986.
The Funds' Distributor
Legg Mason is the distributor of the Funds' shares pursuant to a
separate Underwriting Agreement with each Fund. Each Underwriting
Agreement obligates Legg Mason to pay certain expenses in connection with
the offering of shares of the Funds, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at each
respective Fund's expense, and for any supplementary sales literature and
advertising costs. Legg Mason also assists BFDS with certain of its duties
as transfer agent; for the year ended March 31, 1995, Legg Mason received
from BFDS $19,111, $9,300 and $6,059 for performing such services in
connection with Maryland Tax-Free, Pennsylvania Tax-Free and Tax-Free
Intermediate, respectively.
Fairfield Group, Inc., a wholly owned subsidiary of Legg Mason,
Inc., is a registered broker-dealer with principal offices located at 200
Gibraltar Road, Horsham, Pennsylvania 19044. Fairfield may sell
Navigator Shares pursuant to a Dealer Agreement with the Funds'
distributor, Legg Mason. Neither Fairfield nor Legg Mason receives
compensation from the Funds for selling Navigator Shares.
The Chairman, President and Treasurer of the Trust are employed
by Legg Mason.
Description of the Trust and Its Shares
The Trust was established as a Massachusetts business trust under
a Declaration of Trust dated November 21, 1990. The Declaration of Trust
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authorizes the Trust to issue an unlimited number of shares and to create
additional series, each of which may issue separate classes of shares.
Three series of the Trust currently are being offered. Each series of the
Trust currently offers two Classes of Shares -- Class Y (known as
"Navigator Shares") and Class A (known as "Primary Shares"). The two
Classes represent interests in the same pool of assets. A separate vote
is taken by a Class of Shares of a Fund if a matter affects just that
Class of Shares. Each Class of Shares may bear certain differing Class-
specific expenses. Salespersons and others entitled to receive
compensation for selling or servicing Fund Shares may receive more with
respect to one Class than another.
The initial and subsequent investment minimums for Primary Shares
are $1,000 and $100, respectively. Investments in Primary Shares may be
made through a Legg Mason or affiliated investment executive, through the
Future First Systematic Investment Plan or through automatic investment
arrangements. For information about Primary Shares, call 800-822-5544.
Holders of Primary Shares bear distribution and service fees
under Rule 12b-1 at the rate of 0.25% of the net assets attributable to
Primary Shares. Investors in Primary Shares may elect to receive
dividends and/or capital gain distributions in cash through the receipt of
a check or a credit to their Legg Mason account. The per share net asset
value of Navigator Shares of each Fund, and dividends and distributions
(if any) paid to Navigator shareholders, are generally expected to be
higher than those of Primary Shares of the Funds, because of the lower
expenses attributable to Navigator Shares. Primary Shares of each Fund
may be exchanged for the corresponding class of shares of other Legg Mason
funds. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
sales charge, determined on the same business day as redemption of the
fund shares the investors in Primary Shares wish to redeem.
The Board of Trustees of the Trust does not anticipate that there
will be any conflicts among the interests of the holders of the different
classes of Fund shares. On an ongoing basis, the Board will consider
whether any such conflict exists and, if so, take appropriate action.
Shareholders of the Funds are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Funds are fully paid and nonassessable and
have no preemptive or conversion rights.
Shareholders' meetings will not be held except where the
Investment Company Act of 1940 requires a shareholder vote on certain
matters (including the election of trustees, approval of an advisory
contract, and approval of a plan of distribution pursuant to Rule 12b-1).
The Trust will call a special meeting of the shareholders at the request
of 10% or more of the shares entitled to vote; shareholders wishing to
call such a meeting should submit a written request to their respective
Fund at 111 South Calvert Street, Baltimore, Maryland 21202, stating the
purpose of the proposed meeting and the matters to be acted upon.
Each Fund acknowledges that it is solely responsible for the
information or any lack of information about it in this joint Prospectus
and in the joint Statement of Additional Information, and no other Fund is
responsible therefor. There is a possibility that one Fund might be
deemed liable for misstatements or omissions regarding another Fund in
this Prospectus or in the joint Statement of Additional Information;
however, the Funds deem this possibility slight.
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Table of Contents
Page
Expenses 3
Financial Highlights 5
Performance Information 8
Investment Objectives and Policies 10
How to Purchase and Redeem Shares 17
How Shareholder Accounts are Maintained 19
How Net Asset Value is Determined 20
Dividends and Other Distributions 20
Taxes 21
Shareholder Services 23
The Funds' Management and Investment Adviser 25
The Funds' Distributor 25
Description of the Trust and Its Shares 26
Addresses
Distributor:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410-539-0000 800-822-5544
Authorized Dealer:
Fairfield Group, Inc.
200 Gibraltar Road
Horsham, PA 19044
Transfer and Shareholder Servicing Agent:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
Counsel:
Kirkpatrick & Lockhart LLP
1800 M Street, N.W., Washington, DC 20036
Independent Accountants:
Coopers & Lybrand L.L.P.
217 East Redwood Street, Baltimore, Maryland 21202
No person has been authorized to give any information or to
make any representations not contained in this Prospectus or
the Statement of Additional Information in connection with
the offering made by the Prospectus and, if given or made,
such information or representations must not be relied upon
as having been authorized by the Trust or its distributor.
The Prospectus does not constitute an offering by the Trust
or by the principal underwriter in any jurisdiction in which
such offering may not lawfully be made.
<PAGE>
THE LEGG MASON TAX-FREE INCOME FUND:
Legg Mason Maryland Tax-Free Income Trust
Legg Mason Pennsylvania Tax-Free Income Trust
Legg Mason Tax-Free Intermediate-Term Income Trust
PRIMARY SHARES
NAVIGATOR SHARES
STATEMENT OF ADDITIONAL INFORMATION
The Legg Mason Tax-Free Income Fund ("Trust") is an open-end
investment company which currently has three separate investment series.
Legg Mason Maryland Tax-Free Income Trust ("Maryland Tax-Free Fund")
seeks a high level of current income exempt from federal and Maryland
state and local income taxes, consistent with prudent investment risk and
preservation of capital. In attempting to achieve the Maryland Tax-Free
Fund's objective, the Fund's investment adviser, Legg Mason Fund Adviser,
Inc. ("Adviser"), invests primarily in debt instruments issued by or on
behalf of the state of Maryland, its political subdivisions,
municipalities, agencies, instrumentalities or public authorities, the
interest on which, in the opinion of counsel to the issuer, is exempt from
federal and Maryland state and local income tax ("Maryland municipal
obligations") and which are investment grade.
Legg Mason Pennsylvania Tax-Free Income Trust ("Pennsylvania Tax-Free
Fund") seeks a high level of current income exempt from federal income tax
and Pennsylvania personal income tax, consistent with prudent investment
risk and preservation of capital. In attempting to achieve the
Pennsylvania Tax-Free Fund's objective, the Adviser invests primarily in
debt instruments issued by or on behalf of the Commonwealth of
Pennsylvania, its political subdivisions, municipalities, agencies,
instrumentalities or public authorities, the interest on which, in the
opinion of counsel to the issuer, is exempt from federal income tax and
Pennsylvania personal income tax ("Pennsylvania municipal obligations")
and which are investment grade.
Legg Mason Tax-Free Intermediate-Term Income Trust ("Tax-Free
Intermediate Fund") seeks a high level of current income exempt from
federal income tax, consistent with prudent investment risk and
preservation of capital. In attempting to achieve the Tax-Free
Intermediate Fund's objective, the Adviser invests primarily in debt
instruments issued by or on behalf of states, territories and possessions
of the United States, the District of Columbia and their respective
authorities, agencies, instrumentalities and political subdivisions, the
interest on which, in the opinion of counsel to the issuer, is exempt from
federal income tax ("municipal obligations") and which are investment
grade.
Under normal circumstances, each Fund's investment in obligations the
interest on which is a tax preference item for purposes of the federal
alternative minimum tax ("Tax Preference Item") will be limited to a
maximum of 20% of its total assets.
<PAGE>
Shares of Navigator Maryland Tax-Free Fund, Navigator Pennsylvania
Tax-Free Fund and Navigator Tax-Free Intermediate Fund (collectively
referred to as "Navigator Shares") represent interests in the Funds that
are currently offered for sale only to institutional clients of the
Fairfield Group, Inc. ("Fairfield") for investment of their own funds and
funds for which they act in a fiduciary capacity, to clients of Legg Mason
Trust Company ("Trust Company") for which Trust Company exercises
discretionary investment management responsibility (such institutional
investors are referred to collectively as "Institutional Clients" and
accounts of the customers with such Clients ("Customers") are referred to
collectively as "Customer Accounts"), to qualified retirement plans
managed on a discretionary basis and having net assets of at least $200
million, and to The Legg Mason Profit Sharing Plan and Trust. The
Navigator Class of Shares of each Fund may not be purchased by individuals
directly, but Institutional Clients may purchase shares for Customer
Accounts maintained for individuals.
The Primary Class of shares of Legg Mason Maryland Tax-Free Fund,
Legg Mason Pennsylvania Tax-Free Fund and Legg Mason Tax-Free Intermediate
Fund (collectively referred to as "Primary Shares") is offered for sale to
all other investors and may be purchased directly by individuals. The
Primary Class of shares of Legg Mason Maryland Tax-Free Fund and Legg
Mason Pennsylvania Tax-Free Fund are sold with a front-end sales charge.
The front-end sales charge is waived for all purchases of Primary Shares
of the Legg Mason Tax-Free Intermediate Fund through January 31 , 1996.
Navigator Shares are sold and redeemed without any purchase or
redemption charge imposed by the Funds, although Institutions may charge
their Customer Accounts for services provided in connection with the
purchase or redemption of Navigator Shares. The Funds pay management fees
to Legg Mason Fund Adviser, Inc. Primary Shares pay a 12b-1 distribution
fee, but Navigator Shares pay no distribution fees. See "The Fund's
Distributor."
Mutual fund shares are not deposits or obligations of, or guaranteed
or endorsed by, any bank or other depository institution. Shares are not
insured by the FDIC, the Federal Reserve Board, or any other agency, and
are subject to investment risk, including the possible loss of the
principal amount invested.
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectuses for Primary Shares and
Navigator Shares of the Maryland Tax-Free Fund, the Pennsylvania Tax-Free
Fund and the Tax-Free Intermediate Fund (each individually a "Fund" and
collectively "Funds"), each dated July 31, 1995, as appropriate, which
have been filed with the Securities and Exchange Commission ("SEC").
Copies of the Funds' Prospectuses are available without charge from the
Funds at (410) 539-0000.
Dated: July 31, 1995
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Legg Mason Wood Walker
Incorporated
________________________________________________________________________
111 South Calvert Street
P.O. Box 1476Baltimore, Maryland 21203-1476
(410) 539-0000 (800) 822-5544
This Statement of Additional Information is not authorized for use
unless preceded or accompanied by a Prospectus.
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<PAGE>
ADDITIONAL INFORMATION ABOUT INVESTMENT
LIMITATIONS AND POLICIES
In addition to the investment objectives described in the
Prospectuses, each Fund has adopted certain fundamental investment
limitations that cannot be changed except by a vote of the shareholders of
that Fund. The following are each Fund's fundamental investment
limitations set forth in their entirety. Each Fund may not:
1. Borrow money, except from banks or through reverse repurchase
agreements for temporary purposes in an aggregate amount not to exceed 10%
of the value of the total assets of the Fund; provided that borrowings,
including reverse repurchase agreements, in excess of 5% of such value
will be only from banks (although not a fundamental policy subject to
shareholder approval, the Fund will not purchase securities if borrowings,
including reverse repurchase agreements, exceed 5% of its total assets);
2. Issue bonds or any other class of securities preferred over
shares of the Fund in respect of the Fund's assets or earnings, provided
that the Trust may issue separate series of shares in accordance with its
Declaration of Trust;
3. Underwrite the securities of other issuers except insofar as the
Fund may be deemed an underwriter under the Securities Act of 1933, as
amended, in disposing of a portfolio security;
4. Buy or hold any real estate other than municipal bonds secured
by real estate or interests therein;
5. Purchase or sell any commodities or commodities contracts,
except that the Fund may purchase or sell interest rate futures contracts,
options on securities indexes and options on interest rate futures
contracts;
6. Purchase or sell any oil, gas or mineral exploration or
development programs;
7. Make loans, except loans of portfolio securities and except to
the extent the purchase of a portion of an issue of publicly distributed
notes, bonds or other evidences of indebtedness, the entry into repurchase
agreements, or deposits with banks and other financial institutions may be
considered loans;
8. Buy securities on "margin," except for short-term credits
necessary for clearance of portfolio transactions and except that the Fund
may make margin deposits in connection with the use of interest rate
futures contracts and options on interest rate futures contracts;
9. Make short sales of securities or maintain a short position,
except that the Fund may (a) make short sales and maintain short positions
in connection with its use of options, futures contracts and options on
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<PAGE>
futures contracts and (b) sell short "against the box" (although not a
fundamental policy, the Fund does not intend to make short sales in excess
of 5% of its assets during the coming year);
The foregoing investment limitations cannot be changed without the
affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Fund or (2) 67% or more of the shares present at a
shareholders' meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy.
As a non-fundamental investment limitation (which may be changed by
the vote of the Trust's Board of Trustees without shareholder approval),
each Fund will not:
1. Invest more than 10% of its net assets in illiquid securities, a
term which means securities that cannot be disposed of within seven days
in the normal course of business at approximately the amount at which the
Fund has valued the securities and includes, among other things,
repurchase agreements maturing in more than seven days;
2. Invest 25% or more of its total assets in the securities of
issuers in any one industry, provided that this limitation does not apply
to (a) obligations issued or guaranteed by the U.S. government or its
agencies or instrumentalities or repurchase agreements thereon; (b)
Pennsylvania municipal obligations for the Pennsylvania Tax-Free Fund and
Maryland municipal obligations for the Maryland Tax-Free Fund; and (c)
municipal obligations for the Tax-Free Intermediate Fund. For the purpose
of this restriction, industrial development bonds issued by non-
governmental users will not be considered municipal obligations; or
3. Invest in oil, gas or other mineral leases or in real estate
limited partnership interests.
In addition, the Pennsylvania Tax-Free Fund will not purchase the
securities of other open-end investment companies, except in connection
with a merger, consolidation, reorganization or acquisition of assets.
If any percentage restriction is adhered to at the time of an
investment or transaction, a later increase or decrease in percentage
resulting from a change in value of portfolio securities or amount of
total assets of a Fund will not be considered a violation of any of the
foregoing fundamental or non-fundamental limitations.
Unless otherwise specified, the policies and limitations set forth in
this Statement of Additional Information are non-fundamental and can be
changed without a shareholder vote. Each Fund anticipates being as fully
invested as practicable in municipal obligations; however, there may be
occasions when, as a result of maturities of portfolio securities, or
sales of a Fund's shares, or in order to meet anticipated redemption
requests, a Fund may hold cash which is not earning income.
Municipal Obligations
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The municipal obligations in which each Fund may invest include
municipal leases and participation interests therein. These obligations,
which may take the form of a lease, an installment purchase or a
conditional sales contract, are issued by state and local governments and
authorities to acquire land and a wide variety of equipment and
facilities, such as fire and sanitation vehicles, telecommunications
equipment and other capital assets. Rather than holding such obligations
directly, a Fund may purchase a participation interest in a municipal
lease obligation from a bank or other third party. A participation
interest gives a Fund a specified, undivided pro-rata interest in the
total amount of the obligation.
Municipal lease obligations have risks distinct from those associated
with general obligation or revenue bonds. State constitutions and
statutes set forth requirements that states or municipalities must meet to
incur debt. These may include voter referenda, interest rate limits or
public sale requirements. Leases, installment purchase or conditional
sale contracts (which normally provide for title to the leased asset to
pass to the governmental issuer) have evolved as a means for governmental
issuers to acquire property and equipment without meeting their
constitutional and statutory requirements for the issuance of debt. The
debt-issuance limitations are deemed inapplicable because of the inclusion
in many leases and contracts of "non-appropriation" clauses providing that
the governmental user has no obligation to make future payments under the
lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis.
In determining the liquidity of a municipal lease obligation, the
Adviser will distinguish between simple or direct municipal leases and
municipal lease-backed securities, the latter of which may take the form
of a lease-backed revenue bond or other investment structure using a
municipal lease-purchase agreement as its base. While the former may
present special liquidity issues, the latter are based on a well
established method of securing payment of a municipal obligation. A
Fund's investment in municipal lease obligations and participation
interests therein will be treated as illiquid unless the Adviser
determines, pursuant to guidelines established by the Board of Directors,
that the security could be disposed of within seven days in the normal
course of business at approximately the amount at which the Fund has
valued the security.
The municipal obligations in which each Fund may invest also include
zero coupon bonds and deferred interest bonds, although each Fund
currently does not intend to invest more than 5% of the value of its total
assets in such instruments during the coming year. Zero coupon and
deferred interest bonds are debt obligations which are issued at a
significant discount from face value. Like other municipal securities,
the price can also reflect a premium or discount to par reflecting the
market's judgment as to the issuer's creditworthiness, the interest rate
or other similar factors. The discount approximates the total amount of
interest the bonds will accrue and compound over the period until maturity
or the first interest payment date at a rate of interest reflecting the
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<PAGE>
market rate of the security at the time of issuance. While zero coupon
bonds do not require the periodic payment of interest, deferred interest
bonds provide for a period of delay before the regular payment of interest
begins. Such instruments benefit the issuer by mitigating its need for
cash to meet debt service, but also require a higher rate of return to
attract investors who are willing to defer receipt of such cash. Such
instruments may experience greater volatility in market value than debt
obligations which make regular payments of interest. Each Fund will
accrue income on such investments for accounting purposes, which is
distributable to shareholders.
An issuer's obligations under its municipal obligations are subject
to the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of creditors, such as the Federal Bankruptcy Act, and
laws that may be enacted by Congress or state legislatures extending the
time for payment of principal or interest, or both, or imposing other
constraints upon enforcement of such obligations. There is also the
possibility that as a result of litigation or other conditions the power
or ability of issuers to meet their obligations for the payment of
interest and principal on their municipal obligations may be materially
and adversely affected.
Opinions relating to the validity of municipal obligations, to the
exemption of interest thereon from federal income tax, Maryland state and
local income taxes and Pennsylvania personal income tax, and to the lack
of treatment of that interest as a Tax Preference Item, respectively, are
rendered by counsel to the issuers at the time of issuance. Neither the
Funds nor the Adviser will independently review the basis for such
opinions.
The United States Supreme Court has held that Congress may subject
the interest on municipal obligations to federal income tax. It can be
expected that, as in the past, proposals will be introduced before
Congress for the purpose of restricting or eliminating the federal income
tax exemption for interest on municipal obligations. Proposals also may
be introduced in state legislatures which could affect the state tax
treatment of the Maryland, Pennsylvania and Intermediate-Term Tax-Free
Funds' distributions. If any such proposals were enacted, the availability
of municipal obligations for investment by the Funds and the value of
their assets could be materially and adversely affected. In such event,
each Fund would re-evaluate its investment objective and policies and
consider changes in its structure or possible dissolution.
When-Issued Securities
Delivery of and payment for when-issued securities normally take
place 15 to 45 days after the date of the commitment. Interest rates on
when-issued securities are normally fixed at the time of the commitment.
Consequently, increases in the market rate of interest between the
commitment date and settlement date may result in a market value for the
security on the settlement date that is less than its purchase price.
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<PAGE>
With regard to each such commitment, a Fund maintains in a segregated
account with the custodian, commencing on the date of such commitment,
cash, U.S. government securities or other high-quality liquid debt
securities equal in value to the purchase price for the when-issued
securities due on the settlement date. Each Fund only makes when-issued
commitments with the intention of actually acquiring the securities
subject thereto, but a Fund may sell these securities before the
settlement date if market conditions warrant. When payment is due for
when-issued securities, a Fund meets its obligations from then-available
cash flow, from the sale of securities or, although it would not normally
expect to do so, from the sale of the when-issued securities themselves
(which may have a market value greater or less than the Fund's payment
obligation). The purchase of when-issued securities may affect a Fund's
share price in a manner similar to the use of borrowing.
Callable Bonds
Callable bonds generally have call-protection (that is, a period of
time during which the bonds may not be called) which usually lasts for 7
to 10 years from the date of issue, after which time such bonds may be
redeemed by the issuer. An issuer may generally be expected to call its
bonds, or a portion of them, during periods of declining interest rates,
when borrowings may be replaced at lower rates than those obtained in
prior years. If interest rates decline as the call-protection on callable
bonds expires, there is an increased likelihood that a number of such
bonds may in fact be redeemed by the issuers.
Stand-By Commitments
When a Fund exercises a stand-by commitment that it has acquired from
a dealer with respect to municipal obligations held by it, the dealer
normally pays the Fund an amount equal to (1) the Fund's acquisition cost
of the municipal obligations (excluding any accrued interest which the
Fund paid on its acquisition) less any amortized market premium or plus
any amortized market or original issue discount during the period the Fund
owned the securities, plus (2) all interest accrued on the securities
since the last interest payment date or the date the securities were
purchased by the Fund, whichever is later. The Fund's right to exercise
stand-by commitments is unconditional and unqualified and exercisable by
the Fund at any time prior to the underlying securities' maturity.
A stand-by commitment is not transferable by a Fund without the
underlying securities, although the Fund could sell the underlying
municipal obligations to a third party at any time. 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). Each Fund intends to enter into stand-by commitments only
with those banks, brokers and dealers that in the Adviser's opinion
present minimal credit risks.
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Each Fund intends to acquire stand-by commitments solely to
facilitate liquidity and does not intend to exercise its rights thereunder
for trading purposes. The acquisition of a stand-by commitment would not
ordinarily affect the valuation or assumed maturity of the underlying
municipal obligations. Stand-by commitments would not affect the average
weighted maturity of the assets of a Fund.
Variable Rate and Floating Rate Obligations
A variable rate obligation differs from an obligation with a fixed
rate coupon, the value of which fluctuates in inverse relation to interest
rate changes. If interest rates decline below the coupon rate, generally
the value of a fixed rate obligation increases and the obligation sells at
a premium. Should interest rates increase above the coupon rate,
generally the value of a fixed rate obligation decreases and the
obligation sells at a discount. The magnitude of such capital
fluctuations is also a function of the period of time remaining until the
obligation matures. Short-term fixed rate obligations are minimally
affected by interest rate changes; the greater the remaining period until
maturity, the greater the fluctuation in value of a fixed rate obligation
is likely to be.
Variable rate obligation coupons are not fixed for the full term of
the obligation, but are adjusted periodically based upon changes in
prevailing interest rates. As a result, the value of variable rate
obligations is less affected by changes in interest rates. The more
frequently such obligations are adjusted, the less such obligations are
affected by interest rate changes during the period between adjustments.
The value of a variable rate obligation, however, may fluctuate in
response to market factors and changes in the creditworthiness of the
issuer.
By investing in variable rate obligations, a Fund hopes to take
advantage of the normal yield curve function that usually results in
higher yields on longer-term investments. This policy also means that
should interest rates decline, the yield of the Fund will decline, and the
Fund and its shareholders will forego the opportunity for, respectively,
capital appreciation of its portfolio investments and of their shares.
Should interest rates increase, the yield of the Fund will increase, and
the Fund and its shareholders will diminish the risk of, respectively,
capital depreciation of its portfolio investments and of their shares.
There is no limitation on the percentage of a Fund's assets that may be
invested in variable rate obligations. However, each Fund will limit the
value of its investments in any variable rate securities that are illiquid
and in all other illiquid securities to 10% or less of its net assets.
Floating rate obligations also are not fixed, but are adjusted as
specified benchmark interest rates change. In other respects, their
characteristics are similar to variable rate notes, as discussed above.
Yield Factors and Ratings
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Standard & Poor's Ratings Group ("S&P"), Moody's Investors Service,
Inc. ("Moody's") and Fitch Investors Service, Inc. ("Fitch") are private
services that provide ratings of the credit quality of obligations. A
description of the ratings assigned to obligations by Moody's, S&P and
Fitch is included in Appendix A. A Fund may consider these ratings in
determining whether to purchase, sell or hold a security. The ratings
represent Moody's, S&P's and Fitch's opinions as to the quality of the
obligations which they undertake to rate. Ratings are general and are not
absolute standards of quality. Consequently, obligations with the same
maturity, interest rate and rating may have different market prices. In
addition to ratings assigned to individual bond issues, the Adviser will
analyze interest rate trends and developments that may affect individual
issuers, including factors such as liquidity, profitability and asset
quality. Credit rating agencies attempt to evaluate the safety of
principal and interest payments and do not evaluate the risks of
fluctuations in market value. Also, rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that
an issuer's current financial condition may be better or worse than the
rating indicates.
Securities Lending
A Fund may lend portfolio securities to dealers in municipal
securities, brokers or dealers in corporate or government securities,
banks or other recognized institutional borrowers of securities, provided
that cash or equivalent collateral, equal to at least 100% of the market
value of the securities loaned, is continuously maintained by the borrower
with the Fund. During the time portfolio securities are on loan, the
borrower will pay the Fund an amount equivalent to any dividends or
interest paid on such securities, and the Fund may invest the cash
collateral and earn income, or it may receive an agreed upon amount of
taxable interest income from the borrower who has delivered equivalent
collateral. These loans are subject to termination at the option of the
Fund or the borrower. The Fund may pay reasonable administrative and
custodial fees in connection with a loan and may pay a negotiated portion
of the interest earned on the cash or equivalent collateral to the
borrower or placing broker. The Funds do not have the right to vote
securities on loan, but each Fund would terminate the loan and regain the
right to vote if that were considered important with respect to the
investment. Because interest from securities lending is taxable, each
Fund presently does not intend to loan more than 5% of its portfolio
securities at any given time.
Reverse Repurchase Agreements
A reverse repurchase agreement is a portfolio management technique in
which a Fund temporarily transfers possession of a portfolio instrument to
another person, such as a financial institution or broker-dealer, in
return for cash. At the same time, the Fund agrees to repurchase the
instrument at an agreed upon time (normally within seven days) and price,
including interest payment. A Fund may engage in reverse repurchase
agreements as a means of raising cash to satisfy redemption requests or
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for other temporary or emergency purposes without the necessity of selling
portfolio instruments. A Fund may also engage in reverse repurchase
agreements in order to reinvest the proceeds in other securities or
repurchase agreements. Such a use of reverse repurchase agreements would
constitute a form of leverage.
When a Fund reinvests the proceeds of a reverse repurchase agreement
in other securities, any fluctuations in the market value of either the
securities transferred to another party or the securities in which the
proceeds are invested would affect the market value of the Fund's assets.
As a result, such transactions could increase fluctuation in the Fund's
net asset value. If a Fund reinvests the proceeds of the agreement at a
rate lower than the cost of the agreement, engaging in the agreement will
lower the Fund's yield. While engaging in reverse repurchase agreements,
each Fund will maintain cash, U.S. government securities or other high-
grade, liquid debt securities in a segregated account at its custodian
bank with a value at least equal to the Fund's obligation under the
agreements.
The ability of a Fund to engage in reverse repurchase agreements is
subject to the Fund's fundamental investment limitation concerning
borrowing described above.
Repurchase Agreements
A repurchase agreement is an agreement under which U.S. government
obligations or other high-quality debt securities are acquired by a Fund
from a securities dealer or bank subject to resale at a previously agreed-
upon price and date. The resale price reflects an agreed interest rate
effective for the period the securities are held and is unrelated to the
interest rate provided by the securities. In these transactions, the
securities acquired by the Fund are held by its custodian until resold and
will be supplemented by additional collateral if necessary to maintain a
total value equal to or in excess of the value of the repurchase
agreements. Repurchase agreements are usually for periods of one week or
less, but may be for longer periods. Each Fund will not enter into
repurchase agreements of more than seven days duration if more than 10% of
its net assets would be invested in such agreements and other illiquid
investments. A Fund's income from repurchase agreements is taxable
income.
To the extent that proceeds from the sale upon a default of the
obligation to repurchase were less than the repurchase price, a Fund might
suffer a loss. In addition, if bankruptcy proceedings are commenced with
respect to the seller of the securities, realization upon the collateral
by the Fund could be delayed or limited, during which time the value of
the Fund's collateral might decline. However, each Fund has adopted
standards for the parties with whom it will enter into repurchase
agreements that the Trust's Board of Trustees believes are reasonably
designed to assure that each party presents no serious risk of becoming
involved in bankruptcy proceedings within the time frame contemplated by
the repurchase agreement.
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Interest Rate Futures Contracts
Interest rate futures contracts, which are traded on commodity
futures exchanges, provide for the sale by one party and the purchase by
another party of a specified type and amount of financial instruments (or
an index of financial instruments) at a specified future date. Interest
rate futures contracts currently exist covering such financial instruments
as U.S. Treasury bonds, notes and bills, Government National Mortgage
Association certificates, bank certificates of deposit and 90-day
commercial paper. An interest rate futures contract may be held until the
underlying instrument is delivered and paid for on the delivery date, but
most contracts are closed out before then by taking an offsetting position
on a futures exchange.
A Fund may purchase an interest rate futures contract (that is, enter
into a futures contract to purchase an underlying financial instrument)
when it intends to purchase fixed income securities but has not yet done
so. This strategy is sometimes called an anticipatory hedge. This
strategy is intended to minimize the effects of an increase in the price
of the securities the Fund intends to purchase (but may also reduce the
effects of a decrease in price), because the value of the futures contract
would be expected to rise and fall in the same direction as the price of
the securities the Fund intends to purchase. The Fund could purchase the
intended securities either by holding the contract until delivery and
receiving the financial instrument underlying the futures contract, or by
purchasing the securities directly and closing out the futures contract
position. If the Fund no longer wished to purchase the securities, it
would close out the futures contract before delivery.
A Fund may sell a futures contract (that is, enter into a futures
contract to sell an underlying financial instrument) to offset price
changes of securities it already owns. This strategy is intended to
minimize any price changes in the securities the Fund owns (whether
increases or decreases) caused by interest rate changes, because the value
of the futures contract would be expected to move in the opposite
direction from the value of the securities owned by the Fund. The Funds
do not expect ordinarily to hold futures contracts they have sold until
delivery or to use securities they own to satisfy delivery requirements.
Instead, each Fund expects to close out such contracts before the delivery
date.
The prices of interest rate futures contracts depend primarily on the
value of the instruments on which they are based, the price changes of
which, in turn, primarily reflect changes in current interest rates.
Because there are a limited number of types of interest rate futures
contracts, it is likely that the standardized futures contracts available
to a Fund will not exactly match the securities the Fund wishes to hedge
or intends to purchase, and consequently will not provide a perfect hedge
against all price fluctuation. Because fixed income instruments all
respond similarly to changes in interest rates, however, a futures
contract, the underlying instrument of which differs from the securities
the Fund wishes to hedge or intends to purchase, may still provide
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protection against changes in interest rate levels. To compensate for
differences in historical volatility between positions a Fund wishes to
hedge and the standardized futures contracts available to it, the Fund may
purchase or sell futures contracts with a greater or lesser value than the
securities it wishes to hedge or intends to purchase.
Futures Trading
If a Fund does not wish to hold a futures contract position until the
underlying instrument is delivered and paid for on the delivery date, it
may attempt to close out the contract by entering into an offsetting
position on a futures exchange that provides a secondary market for the
contract. A futures contract is closed out by entering into an opposite
position in an identical futures contract (for example, by purchasing a
contract on the same instrument and with the same delivery date as a
contract the Fund had sold) at the current price as determined on the
futures exchange. A Fund's gain or loss on closing out a futures contract
depends on the difference between the price at which the Fund entered into
the contract and the price at which the contract is closed out.
Transaction costs in opening and closing futures contracts must also be
taken into account. There can be no assurance that a Fund will be able to
offset a futures position at the time it wishes to, or at a price that is
advantageous. If a Fund were unable to enter into an offsetting position
in a futures contract, it might have to continue to hold the contract
until the delivery date, in which case it would continue to bear the risk
of price fluctuation in the contract until the underlying instrument was
delivered and paid for.
At the time a Fund enters into an interest rate futures contract, it
is required to deposit with its custodian, in the name of the futures
broker (known as a futures commission merchant, or "FCM"), a percentage of
the contract's value. This amount, which is known as initial margin,
generally equals 5% or less of the value of the futures contract. Initial
margin is in the nature of a good faith deposit or performance bond, and
is returned to the Fund when the futures position is terminated, after all
contractual obligations have been satisfied. Futures margin does not
represent a borrowing by a Fund, unlike margin extended by a securities
broker, and depositing initial margin in connection with futures positions
does not constitute purchasing securities on margin for the purposes of a
Fund's investment limitations. Initial margin may be maintained either in
cash or other liquid, high-quality debt securities such as U.S. government
securities.
As the contract's value fluctuates, payments known as variation
margin or maintenance margin are made to or received from the FCM. If the
contract's value moves against the Fund (i.e., the Fund's futures position
declines in value), the Fund may be required to make payments to the FCM,
and, conversely, the Fund may be entitled to receive payments from the FCM
if the value of its futures position increases. This process is known as
marking-to- market and takes place on a daily basis.
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In addition to initial margin deposits, the Fund will instruct its
custodian to segregate additional cash and liquid, high-grade debt
securities to cover its obligations under futures contracts it has
purchased. The value of the assets held in the segregated account will be
equal to the daily market value of all outstanding futures contracts
purchased by the Fund, less the amount deposited as initial margin. When
the Fund has sold futures contracts to hedge securities it owns, it will
not sell those securities (or lend to another party) while the contracts
are outstanding, unless it substitutes other similar securities for the
securities sold or lent. The Fund will not sell futures contracts with a
value exceeding the value of securities it owns, except that the Fund may
do so to the extent necessary to adjust for differences in historical
volatility between the securities owned and the contracts used as a hedge.
Risks of Interest Rate Future Contracts
By purchasing an interest rate futures contract, the Fund in effect
becomes exposed to price fluctuations resulting from changes in interest
rates, and by selling a futures contract the Fund neutralizes those
fluctuations. If interest rates fall, the Fund would expect to profit
from an increase in the value of the instrument underlying a futures
contract it had purchased, and if interest rates rise, the Fund would
expect to offset the resulting decline in the value of the securities it
owns by profits in a futures contract it has sold. If interest rates move
in the direction opposite that which was contemplated at the time of
purchase, however, the Fund's positions in futures contracts could have a
negative effect on the Fund's net asset value. If interest rates rise
when the Fund has purchased futures contracts, the Fund could suffer a
loss in its futures positions. Similarly, if interest rates fall, losses
in a futures contract a Fund has sold could negate gains on securities the
Fund owns, or could result in a net loss to the Fund. In this sense,
successful use of interest rate futures contracts by a Fund will depend on
the Adviser's ability to hedge the Fund in the correct way at the
appropriate time.
Other than the risk that interest rates will not move as expected,
the primary risk in employing interest rate futures contracts is that the
market value of the futures contracts may not move in concert with the
value of the securities the Fund wishes to hedge or intends to purchase.
This may result from differences between the instrument underlying the
futures contracts and the securities the Fund wishes to hedge or intends
to purchase, as would be the case, for example, if the Fund hedged U.S.
Treasury bonds by selling futures contracts on U.S. Treasury notes.
Even if the securities which are the objects of a hedge are identical
to those underlying the futures contract, there may not be perfect price
correlation between the two. Although the value of interest rate futures
contracts is primarily determined by the price of the underlying financial
instruments, the value of interest rate futures contracts is also affected
by other factors, such as current and anticipated short-term and long-term
interest rates, the time remaining until expiration of the futures
contract, and conditions in the futures markets, which may not affect the
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current market price of the underlying financial instruments in the same
way. In addition, futures exchanges establish daily price limits for
interest rate futures contracts, and may halt trading in the contracts if
their prices move upward and downward more than a specified daily limit on
a given day. This could distort the relationship between the price of the
underlying instrument and the futures contract, and could prevent prompt
liquidation of unfavorable futures positions. The value of a futures
contract may also move differently from the price of the underlying
financial instrument because of inherent differences between the futures
and securities markets, including variations in speculative demand for
futures contracts and for debt securities, the differing margin
requirements for futures contracts and debt securities, and possible
differences in liquidity between the two markets.
Put Options on Interest Rate Futures Contracts
Purchasing a put option on an interest rate futures contract gives a
Fund the right to assume a seller's position in the contract at a
specified exercise price at any time up to the option's expiration date.
In return for this right, the Fund pays the current market price for the
option (known as the option premium), as determined on the commodity
futures exchange where the option is traded.
A Fund may purchase put options on interest rate futures contracts to
hedge against a decline in the market value of securities the Fund owns.
Because a put option is based on a contract to sell a financial instrument
at a certain price, its value will tend to move in the opposite direction
from the price of the financial instrument underlying the futures
contract; that is, the put option's value will tend to rise when prices
fall, and fall when prices rise. By purchasing a put option on an
interest rate futures contract, the Fund would attempt to offset potential
depreciation of securities it owns by appreciation of the put option.
This strategy is similar to selling the underlying futures contract
directly.
A Fund's position in a put option on an interest rate futures
contract may be terminated either by exercising the option (and assuming a
seller's position in the underlying futures contract at the option's
exercise price) or by closing out the option at the current price as
determined on the futures exchange. If the put option is not exercised or
closed out before its expiration date, the entire premium paid would be
lost by the Fund. A Fund could profit from exercising a put option if the
current market value of the underlying futures contract were less than the
sum of the exercise price of the put option and the premium paid for the
option because the Fund would, in effect, be selling the futures contract
at a price higher than the current market price. A Fund could also profit
from closing out a put option if the current market price of the option is
greater than the premium the Fund paid for the option. Transaction costs
must also be taken into account in these calculations. A Fund may close
out an option it had purchased by selling an identical option (that is, an
option on the same futures contract, with the same exercise price and
expiration date) in a closing transaction on a futures exchange that
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provides a secondary market for the option. A Fund is not required to
make futures margin payments when it purchases an option on an interest
rate futures contract.
Compared to the purchase or sale of an interest rate futures
contract, the purchase of a put option on an interest rate futures
contract involves a smaller potential risk to the Fund, because the
maximum amount at risk is the premium paid for the option (plus related
transaction costs). If prices of debt securities remain stable, however,
purchasing a put option may involve a greater probability of loss than
selling a futures contract, even though the amount of the potential loss
is limited. The Adviser will consider the different risk and reward
characteristics of options and futures contracts when selecting hedging
instruments.
Risks of Transactions in Options on Interest Rate Futures Contracts
Options on interest rate futures contracts are subject to risks
similar to those described above with respect to interest rate futures
contracts. These risks include the risk that the Adviser may not hedge a
Fund in the correct way at the appropriate time, the risk of imperfect
price correlation between the option and the securities being hedged, and
the risk that there may not be an active secondary market for the option.
There is also a risk of imperfect price correlation between the option and
the underlying futures contract.
Although the Adviser will purchase and write only those options for
which there appears to be a liquid secondary market, there can be no
assurance that such a market will exist for any particular option at any
particular time. If there were no liquid secondary market for a
particular option, a Fund might have to exercise an option it had
purchased in order to realize any profit, and might continue to be
obligated under an option it had written until the option expired or was
exercised.
Options Writing on Debt Securities
A Fund may from time to time write (sell) covered call options and
covered put options on certain of its portfolio securities. When it
writes a covered call option, a Fund obligates itself to sell the
underlying security to the purchaser of the option at a fixed price if the
purchaser exercises the option during the option period. A call is
"covered" if the Fund owns the optioned securities or, in the case of
options on certain U.S. government securities, the Fund maintains with its
custodian in a segregated account cash, U.S. government securities or
other high-grade, liquid debt securities with a value sufficient to meet
its obligations under the call. When a Fund writes a call option, it
receives a premium from the purchaser. During the option period, the Fund
foregoes the opportunity to profit from any increase in the market price
of the security above the exercise price of the option, but retains the
risk that the price of the security may decline.
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<PAGE>
A Fund may also write covered put options. When a Fund writes a put
option, it receives a premium and gives the purchaser of the put the right
to sell the underlying security to the Fund at the exercise price at any
time during the option period. A put is "covered" if a Fund maintains
cash, U.S. government securities or other high-grade, liquid debt
securities with a value equal to the exercise price in a segregated
account. The risk in writing puts is that the market price of the
underlying security may decline below the exercise price (less the
premiums received).
A Fund may seek to terminate its obligations as a writer of a put or
call option prior to its expiration by entering into a "closing purchase
transaction." A closing purchase transaction is the purchase of an option
covering the same underlying security and having the same exercise price
and expiration date as an option previously written by the Fund on which
it wishes to terminate its obligation.
Risks of Writing Options on Debt Securities
When a Fund writes an option, it assumes the risk of fluctuations in
the value of the underlying security in return for a fixed premium and
must be prepared to satisfy exercise of the option at any time until the
expiration date. The writing of options could also result in an increase
in the Fund's turnover rate, particularly in periods of appreciation in
the market price of the underlying securities. In addition, writing
options on portfolio securities involves a number of other risks,
including the risk that the Adviser may not correctly predict interest
rate movements and the risk that there may not be a liquid secondary
market for the option, as a result of which the Fund might be unable to
effect a closing transaction.
If a Fund is unable to close out an option it has written, it must
continue to bear the risks associated with the option, and must continue
to hold cash or securities to cover the option until the option is
exercised or expires. A Fund may engage in options on securities which
are not traded on national exchanges ("unlisted options"). Because
unlisted options may be closed out only with the other party to the option
transaction, it may be more difficult to close out unlisted options than
listed options.
Regulatory Notification of Futures and Options Strategies
The Trust has filed on behalf of the Funds a notice of eligibility
for exclusion from the definition of the term "commodity pool operator"
with the Commodity Futures Trading Commission ("CFTC") and the National
Futures Association, which regulate trading in the futures markets. Under
regulations adopted by the CFTC, futures contracts and related options may
be used by a Fund (a) for hedging purposes, without quantitative limits,
and (b) for other purposes to the extent that the amount of margin deposit
on all such non-hedging futures contracts owned by the Fund, together with
the amount of premiums paid by the Fund on all such non-hedging options
held on futures contracts, does not exceed 5% of the market value of the
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Fund's net assets. Each Fund will not purchase futures contracts or
related options if as a result more than 25% of the Fund's total assets
would be so invested. These limits on the Fund's investments in futures
contracts are not fundamental and may be changed by the Board of Trustees
as regulatory agencies permit. Each Fund will not modify these limits to
increase its permissible futures and related options activities without
supplying additional information in a supplement to a current Prospectus
or Statement of Additional Information that has been distributed or made
available to the Fund's shareholders.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Each Fund offers two classes of shares, known as Primary Shares and
Navigator Shares. Primary Shares are available from Legg Mason and
certain of its affiliates. Navigator Shares are currently offered for
sale only to Institutional Clients, to clients of Trust Company, for which
Trust Company exercises discretionary investment management
responsibility, to qualified retirement plans managed on a discretionary
basis and having net assets of at least $200 million, and to The Legg
Mason Profit Sharing Plan and Trust. Navigator Shares may not be
purchased by individuals directly, but Institutional Clients may purchase
shares for Customer Accounts maintained for individuals. Primary Shares
are available to all other investors.
Future First Systematic Investment Plan
If you invest in Primary Shares, the Prospectus for those shares
explains that you may buy additional Primary Shares through the Future
First Systematic Investment Plan. Under this plan you may arrange for
automatic monthly investments in Primary Shares of $50 or more by
authorizing Boston Financial Data Services ("BFDS"), the Funds' transfer
agent, to prepare a check each month drawn on your checking account. Each
month the transfer agent will send a check to your bank for collection,
and the proceeds of the check will be used to buy Primary Shares of the
Fund you selected at the per share net asset value determined on the day
the check is sent to your bank. An account statement will be sent to you
quarterly. You may terminate the Future First Systematic Investment Plan
at any time without charge or penalty. Forms to enroll in the Future
First Systematic Investment Plan are available from any Legg Mason or
affiliated office.
Purchases by Check
In making purchases of shares by check, you should be aware that
checks drawn on a member bank of the Federal Reserve System will normally
be converted to federal funds and used to purchase shares within two
business days of receipt by Legg Mason Wood Walker, Incorporated ("Legg
Mason") or its affiliate. Legg Mason is closed on the days that the New
York Stock Exchange ("Exchange") is closed, which are listed under
"Valuation of Fund Shares" on page 24. Checks drawn on banks that are not
members of the Federal Reserve System may take up to nine business days to
be converted.
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Letter of Intention -- (Primary Shares)
Through a Letter of Intention ("LOI") you may pay the lower sales
charge on the dollar amount of Primary Shares currently being purchased
plus the dollar amount of any purchases you intend to make during the next
thirteen months of shares of this and other Legg Mason funds sold with an
initial sales charge. To take advantage of an LOI you should indicate the
total amount you intend to purchase over the thirteen-month period on the
form available from your Legg Mason or affiliated investment executive.
Holdings acquired up to 90 days before the LOI is filed will be counted
toward completion of the LOI and will be entitled to a retroactive
downward adjustment of the initial sales charge providing that you bring
the prior purchase(s) to the attention of your Legg Mason or affiliated
investment executive at the time the LOI is filed. The minimum investment
under an LOI is $50,000 for the Maryland, Pennsylvania and Intermediate
Tax-Free Funds. Signing an LOI does not obligate you to purchase the full
amount indicated, but you must complete the intended purchase to obtain
the reduced sales charge. The front-end sales charge is waived for all
purchases of Primary Shares of the Tax-Free Intermediate Fund made through
January 31, 1996.
If the total amount of shares purchased at the end of the eleventh
month does not equal the amount stated in the LOI, you will be notified in
writing by Legg Mason of the amount purchased to date, the amount required
to complete the LOI and the expiration date. If the total purchases
indicated on the LOI are not made within the thirteen-month period, your
account will be charged with the difference between the reduced LOI sales
charge and the sales charge applicable to the purchases actually made.
The first purchase under an LOI must be at least 2.5% of the intended LOI
purchases for the Maryland and Pennsylvania Tax-Free Funds and 1% for the
Tax-Free Intermediate Fund. Shares with a value equal to 2.5% for the
Maryland and Pennsylvania Tax-Free Funds and 1% for the Tax-Free
Intermediate Fund, of the intended LOI purchases will be held in escrow
during the thirteen-month period (registered in your name) to assure such
necessary payment. These escrowed shares may not be exchanged for shares
of other Legg Mason funds.
Right of Accumulation -- (Primary Shares)
Under the Right of Accumulation, the current value of your existing
Primary Shares in Legg Mason funds sold with an initial sales charge may
be combined with the amount of your current purchase in determining the
sales charge for the current purchase. In determining both the current
value of existing shares and the amount of the current purchase, Primary
Shares held or purchased by the investor's spouse, and/or children under
the age of 21, may be included. In order to receive a reduced sales
charge for the current purchase, you must remind your Legg Mason or
affiliated investment executive of your share balance in Legg Mason funds
sold with initial sales charges at the time of the current purchase.
Reinstatement Privilege --(Primary Shares)
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<PAGE>
As described in the Prospectus, shareholders who have redeemed their
Primary Shares may reinstate their Fund account without a sales charge by
notifying their Legg Mason or affiliated investment executive of such
desire and placing an order for the amount to be purchased within 90 days
after the date of redemption. The reinstatement will be made at the net
asset value per share next computed after the Notice of Reinstatement and
order are received by Legg Mason's Funds Processing department. The
amount of a purchase under this reinstatement privilege cannot exceed the
amount of the redemption proceeds. Gain on a redemption is taxable
regardless of whether the reinstatement privilege is exercised; however, a
loss arising out of a redemption will not be deductible to the extent the
reinstatement privilege is exercised within 30 days after redemption, and
an adjustment will be made to the shareholder's tax basis for shares
acquired pursuant to the reinstatement privilege.
Redemption Services
Each Fund reserves the right to modify or terminate the wire or
telephone redemption services described in its Prospectus at any time.
The date of payment for redemption may not be postponed for more than
seven days, and the right of redemption may not be suspended, except (a)
for any periods during which the Exchange is closed (other than for
customary weekend and holiday closings), (b) when trading in markets a
Fund normally utilizes is restricted or an emergency, as defined by rules
and regulations of the SEC, exists, making disposal of the Fund's
investments or determination of its net asset value not reasonably
practicable, or (c) for such other periods as the SEC, by order, may
permit for protection of a Fund's shareholders. In the case of any such
suspension, you may either withdraw your request for redemption or receive
payment based upon the net asset value next determined after the
suspension is lifted.
Each Fund reserves the right under certain conditions to honor any
request for redemption, or combination of requests from the same
shareholder in any 90-day period, totaling $250,000 or 1% of the net
assets of the Fund, whichever is less, by making payment in whole or in
part by securities valued in the same way as they would be valued for
purposes of computing each Fund's net asset value per share. Any such
redemption payments shall be made with portfolio securities that are
readily marketable. If payment is made in securities, a shareholder
generally will incur brokerage expenses in converting those securities
into cash and will be subject to fluctuation in the market price of those
securities until they are sold. The Funds do not redeem in kind under
normal circumstances, but would do so where the Adviser determines that it
would be in the best interests of the shareholders as a whole. Although
each Fund may elect to redeem any shareholder account with a current value
of less than $500, a Fund will not redeem accounts that fall below $500
solely as a result of a reduction in net asset value per share.
- 20 -
<PAGE>
SPECIAL FACTORS AFFECTING MARYLAND AND PENNSYLVANIA
Overview
The following only highlights some of the more significant financial
trends and problems and is based on information drawn from official
statements and prospectuses relating to securities offerings of the states
of the United States, the State of Maryland and the Commonwealth of
Pennsylvania, their agencies and instrumentalities, as available on the
date of this Statement of Additional Information. The Funds assume no
obligation to update this information.
State and Local Income Tax
The exemption of certain interest income for federal income tax
purposes does not necessarily result in exemption thereof under the income
or other tax laws of any state or local taxing authority. A shareholder
may be exempt from state and local taxes on dividends attributable to
interest income derived from obligations of the state and municipalities
or other localities of the state in which he or she is a resident, but
generally will be taxed on dividends attributable to interest income
derived from obligations of other jurisdictions. Shareholders receive
notification annually of the portion of each Fund's tax-exempt income
attributable to each state. Shareholders should consult their tax
advisers about the tax status in their own states and localities of
distributions from each Fund.
Because the Maryland Tax-Free Fund and the Pennsylvania Tax-Free Fund
each concentrates its investments in a specific state, there are risks
associated with investment in each such Fund which would not exist if
those Funds' investments were more widely diversified. These risks
include the possible enactment of new legislation in the applicable state
which could affect Maryland or Pennsylvania municipal obligations,
economic factors which could affect these obligations and varying levels
of supply and demand for Maryland or Pennsylvania municipal obligations.
Maryland Tax-Free Fund
State Debt The Maryland Constitution prohibits the contracting of
State general obligation debt unless it is authorized by a law levying an
annual tax or taxes sufficient to pay the debt service within 15 years and
prohibiting the repeal of the tax or taxes or their use for another
purpose until the debt is paid. As a uniform practice, each separate
enabling act which authorizes the issuance of general obligation bonds for
a given object or purpose has specifically levied and directed the
collection of an ad valorem property tax on all taxable property in the
State. The Board of Public Works is directed by law to fix by May 1 of
each year the precise rate of such tax necessary to produce revenue
sufficient for debt service requirements of the next fiscal year, which
begins July 1. However, the taxes levied need not be collected if or to
the extent that funds sufficient for debt service requirements in the next
fiscal year have been appropriated in the annual State budget.
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<PAGE>
Accordingly, the Board, in annually fixing the rate of property tax after
the end of the regular legislative session in April, takes account of
appropriations of general funds for debt service.
There is no general debt limit imposed by the Maryland Constitution
or public general laws, but a special committee created by statute
annually submits to the Governor an estimate of the maximum amount of new
general obligation debt that prudently may be authorized. Although the
committee's responsibilities are advisory only, the Governor is required
to give due consideration to the committee's findings in preparing a
preliminary allocation of new general debt authorization for the ensuing
fiscal year. The continuation of the credit ratings on State debt is
dependent upon several economic and political factors, including the
ability to continue to fund a substantial portion of the debt service on
general obligation debt from general fund revenues in the annual State
budget or to raise the rate of State property tax levies, and the ability
to maintain the amount of authorized debt within the range of
affordability.
Consolidated Transportation Bonds are limited obligations issued by
the Maryland Department of Transportation, the principal of which must be
paid within 15 years from the date of issue, for highway, port, transit,
rail or aviation facilities or any combination of such facilities. Debt
service on Consolidated Transportation Bonds is payable from those
portions of the excise tax on each gallon of motor vehicle fuel and the
motor vehicle titling tax, all mandatory motor vehicle registration fees,
motor carrier fees, and the corporate income tax as are credited to the
Maryland Department of Transportation, plus all departmental operating
revenues and receipts. Holders of such bonds are not entitled to look to
other sources for payment.
The Maryland Transportation Authority operates certain highway,
bridge and tunnel toll facilities in the State. The tolls and other
revenues received from these facilities are pledged as security for
revenue bonds of the Authority issued under, and secured by, a trust
agreement between the Authority and a corporate trustee.
Certain other instrumentalities of the State government are
authorized to borrow money under legislation which expressly provides that
the loan obligations shall not be deemed to constitute a debt or a pledge
of the faith and credit of the State. The Community Development
Administration of the Department of Housing and Community Development,
higher educational institutions (including St. Mary's College of Maryland,
the University of Maryland System, and Morgan State University), the
Maryland Transportation Authority, the Maryland Water Quality Financing
Administration, and the Maryland Environmental Service have issued and
have outstanding bonds of this type. The principal of and interest on
bonds issued by these bodies are payable solely from various sources,
principally fees generated from use of the facilities or enterprises
financed by the bonds.
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<PAGE>
The Port of Baltimore is one of the larger foreign trade ports in the
United States and in the world and a significant factor in Maryland's
economy. Total cargo tonnage at the Port declined from 30,682,730 in 1982
to 25,129,171 in 1993. The Port handles both high value general cargo,
including containers and automobiles, as well as bulk cargo such as coal
and grain. The value of the tonnage handled increased from $14.2 billion
in 1982 to $17.2 billion in 1993. The ability of the Port to sustain and
improve its volume and value of cargos is dependent, in part, upon
national and worldwide economic conditions.
The Maryland Stadium Authority is responsible for financing and
directing the acquisition and construction of one or more new professional
sports facilities in Maryland. Currently, the Authority operates Oriole
Park at Camden Yards, which opened in 1992. In connection with the
construction of that facility, the Authority issued $155 million in notes
and bonds. Those notes and bonds, as well as any future financing for a
football stadium, are lease-backed revenue obligations, the payment of
which is secured by, among other things, an assignment of revenues
received under a lease of the sports facilities from the Stadium Authority
to the State. The Stadium Authority also has been assigned responsibility
for constructing an expansion of the Convention Center in Baltimore. The
Convention Center expansion is expected to cost $155 million and will be
financed through a combination of funding from Baltimore City, Stadium
Authority revenue bonds, and State general obligation bonds.
The State has financed and expects to continue to finance the
construction and acquisition of various facilities through conditional
purchase, sale-leaseback, and similar transactions. All of the lease
payments under these arrangements are subject to annual appropriation by
the Maryland General Assembly. In the event that appropriations are not
made, the State may not be held contractually liable for the payments.
Local Subdivision Debt The counties and incorporated
municipalities in Maryland issue general obligation debt for general
governmental purposes. The general obligation debt of the counties and
incorporated municipalities is generally supported by ad valorem taxes on
real estate, tangible personal property and intangible personal property
subject to taxation. The issuer typically pledges its full faith and
credit and unlimited taxing power to the prompt payment of the maturing
principal and interest on the general obligation debt and to the levy and
collection of the ad valorem taxes as and when such taxes become necessary
in order to provide sufficient funds to meet the debt service
requirements. The amount of debt which may be authorized may in some
cases be limited by the requirement that it not exceed a stated percentage
of the assessable base upon which such taxes are levied.
Other Risk Factors The manufacturing sector of Maryland's economy,
which historically has been a significant element of the State's economic
health, has experienced severe financial pressures and an overall
contraction in recent years. This is due in part to the reduction in
defense-related contracts and grants, which has had an adverse impact that
is substantial and is believed to be disproportionately large compared
- 23 -
<PAGE>
with the impact on most other states. The State has endeavored to promote
economic growth in other areas, such as financial services, health care
and high technology. Whether the State can successfully make the
transition from an economy reliant on heavy industries to one based on
service and science-oriented businesses is uncertain. Moreover, future
economic difficulties in the service sector and high technology industries
being promoted by Maryland could have an adverse impact on the finances of
the State and its subdivisions, and could adversely affect the market
value of the Bonds in the Maryland Trust or the ability of the respective
obligors to make payments of interest and principal due on such Bonds.
The State and its subdivisions, and their respective officers and
employees, are defendants in numerous legal proceedings, including alleged
tort and breaches of contract and other alleged violations of laws.
Although adverse decisions in these matters could require extraordinary
appropriations not budgeted for, in the opinion of the Attorney General of
Maryland, the legal proceedings are not likely to have a material adverse
effect on the State's financial position.
Pennsylvania Tax-Free Fund
State Debt Pennsylvania may incur debt to rehabilitate areas
affected by disaster, debt approved by the electorate, debt for certain
capital projects (such as highways, public improvements, transportation
assistance, flood control, redevelopment assistance, site development and
industrial development) and tax anticipation debt payable in the fiscal
year of issuance. Pennsylvania had outstanding general obligation debt of
$5,075.8 million at June 30, 1994. Pennsylvania is not permitted to fund
deficits between fiscal years with any form of debt. All year-end deficit
balances must be funded within the succeeding fiscal year's budget. At
May 9, 1995, all outstanding general obligation bonds of Pennsylvania were
rated AA- by S&P and A1 by Moody's (see Appendix A). There can be no
assurance that the current ratings will remain in effect in the future.
The Pennsylvania Tax-Free Fund assumes no obligation to update this rating
information. Over the five-year period ending June 30, 2000, Pennsylvania
has projected that it will issue bonds totaling $2,195.2 million and
retire bonded debt in the principal amount of $2,328.8 million.
Certain agencies created by Pennsylvania have statutory authorization
to incur debt for which Pennsylvania appropriations to pay debt service
thereon is not required. As of December 31, 1994, total combined debt
outstanding for these agencies was $6,549.9 million. The debt of these
agencies is supported by assets of, or revenues derived from, the various
projects financed and is not an obligation of Pennsylvania. Some of these
agencies, however, are indirectly dependent on Pennsylvania
appropriations. The only obligations of agencies in Pennsylvania that
bear a moral obligation of Pennsylvania are those issued by the
Pennsylvania Housing Finance Agency ("PHFA"), a state-created agency which
provides housing for lower and moderate income families, and The Hospitals
and Higher Education Facilities Authority of Philadelphia ("Hospital
Authority"), an agency created by the City of Philadelphia to acquire and
prepare various sites for use as intermediate care facilities for the
- 24 -
<PAGE>
mentally retarded. As of December 31, 1994, PHFA has $2,300.0 million of
revenue bonds and notes outstanding.
Local Government Debt Numerous local government units in
Pennsylvania issue general obligations (i.e., backed by taxing power)
debt, including counties, cities, boroughs, townships and school
districts. School district obligations are supported indirectly by
Pennsylvania. The issuance of non-electoral general obligation debt is
limited by constitutional and statutory provisions. Electoral debt, i.e.,
that approved by the voters, is unlimited. In addition, local government
units and municipal and other authorities may issue revenue obligations
that are supported by the revenues generated from particular projects or
enterprises. Examples include municipal authorities (frequently operating
water and sewer systems), municipal authorities formed to issue
obligations benefiting hospitals and educational institutions, and
industrial development authorities, whose obligations benefit industrial
or commercial occupants. In some cases, sewer or water revenue
obligations are guaranteed by taxing bodies and have the credit
characteristics of general obligation debt.
Other Factors Pennsylvania historically has been identified as a
heavy industry state, although that reputation has changed with the
decline of the coal, steel and railroad industries and the resulting
diversification of Pennsylvania's industrial composition. The major new
sources of growth are in the service sector, including trade, medical and
health services, educational and financial institutions. Manufacturing
has fallen behind both the services sector and the trade sector as the
largest single source of employment in Pennsylvania. Between 1988 and
1993, employment in Pennsylvania has grown each year at a rate slightly in
excess of the growth in employment in the mid-Atlantic region, but less
than that of the U.S. as a whole, during the same period. Pennsylvania's
average unemployment rate for the years 1988, 1989 and 1990 remained
slightly below the nation's annual average unemployment rate, and
Pennsylvania's average annual unemployment rate for the years 1991, 1992
and 1993 remained slightly above the nation's annual average unemployment
rate. The unadjusted unemployment rate for both Pennsylvania and United
States for May, 1995 was 5.7%. The population of Pennsylvania, 12.096
million people in 1994 according to the U.S. Bureau of the Census,
represents a slight increase from the 1985 estimate of 11.772 million.
Per capita income in Pennsylvania was $21,352 for calendar year 1993,
slightly above the per capita income of the United States of $20,817.
Pennsylvania's General Fund, which receives all tax receipts and most
other revenues and through which debt service on all general obligations
of Pennsylvania are made, closed fiscal years ended June 30, 1992, 1993
and 1994 with fund balances of $87,455 million, $698,945 million and
$892,940 million, respectively.
ADDITIONAL TAX INFORMATION
The following is a general summary of certain federal tax
considerations affecting each Fund and its shareholders. Investors are
urged to consult their own tax advisers for more detailed information
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<PAGE>
regarding any federal, state or local taxes that may be applicable to
them.
General
For federal tax purposes, each Fund is treated as a separate
corporation. In order to continue to qualify for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended ("Code"), a Fund must distribute annually to its
shareholders at least 90% of the sum of its net interest income excludable
from gross income under section 103(a) of the Code plus its investment
company taxable income (generally, taxable net investment income plus net
short-term capital gain, if any) ("Distribution Requirement") and must
meet several additional requirements. With respect to each Fund, these
requirements include the following: (1) the Fund must derive at least 90%
of its gross income each taxable year from dividends, interest, payments
with respect to securities loans and gains from the sale or other
disposition of securities, or other income (including gains from options
and futures contracts) derived with respect to its business of investing
in securities ("Income Requirement"); (2) the Fund must derive less than
30% of its gross income each taxable year from the sale or other
disposition of securities, options or futures contracts held for less than
three months ("Short-Short Limitation"); (3) at the close of each quarter
of the Fund's taxable year, at least 50% of the value of its total assets
must be represented by cash and cash items, U.S. government securities,
securities of other RICs and other securities, with those other securities
limited, in respect of any one issuer, to an amount that does not exceed
5% of the value of the Fund's total assets; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its
total assets may be invested in the securities (other than U.S. government
securities or the securities of other RICs) of any one issuer.
Dividends paid by a Fund will qualify as "exempt-interest dividends"
(as defined in each Prospectus), and thus will be excludable from gross
income by its shareholders, if the Fund satisfies the additional
requirement that, at the close of each quarter of the Fund's taxable year,
at least 50% of the value of its total assets consists of securities the
interest on which is excludable from gross income under section 103(a) of
the Code; each Fund intends to continue to satisfy this requirement. The
portion of each dividend excludable from a Fund's shareholder's gross
income may not exceed the Fund's net tax-exempt income.
To the extent a Fund invests in instruments that generate taxable
income, distributions of the interest earned thereon will be taxable to
the Fund's shareholders as ordinary income to the extent of its earnings
and profits. Moreover, if a Fund realizes capital gains as a result of
market transactions, any distributions of those gains will be taxable to
its shareholders.
If Fund shares are sold at a loss after being held for six months or
less, the loss will be disallowed to the extent of the amount of any
exempt-interest dividends received with respect to those shares, and any
- 26 -
<PAGE>
portion of the loss that is not disallowed will be treated as long-term,
instead of short-term, capital loss to the extent of any capital gain
distributions received with respect thereto.
Up to 85% of social security and railroad settlement benefits may be
included in taxable income for recipients whose adjusted gross income
(including income from tax-exempt sources such as a Fund) plus 50% of
their benefits exceeds certain base amounts. Exempt-interest dividends
from a Fund still are tax-exempt to the extent described in each
Prospectus; they are only included in the calculation of whether a
recipient's income exceeds the established amounts.
A Fund will be subject to a nondeductible 4% excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain
net income for the one-year period ending on October 31 of that year, plus
certain other amounts. For this and other purposes, dividends or capital
gain distributions declared by a Fund in December of any year and payable
to shareholders of record on a date in that month will be deemed to have
been paid by the Fund and received by the shareholders on December 31 if
the distributions are paid by the Fund during the following January.
Accordingly, those distributions will be reportable by shareholders for
the year in which that December 31 falls.
A Fund may purchase zero coupon municipal obligations or other
municipal obligations issued with original issue discount. As the holder
of those securities, a Fund must include in its income the original issue
discount that accrues during the taxable year, even if the Fund receives
no corresponding payment on the securities during the year. Because each
Fund annually must distribute substantially all of its income, including
tax-exempt income, to satisfy the Distribution Requirement, it may be
required in a particular year to distribute as a dividend an amount that
is greater than the total amount of cash it actually receives. Those
distributions will be made from the Fund's cash assets or from the
proceeds of sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those dispositions, which would
increase or decrease its investment company taxable income and/or net
capital gain (the excess of net long-term capital gain over net short-term
capital loss). In addition, any such gains may be realized on the
disposition of securities held for less than three months. Because of the
Short-Short Limitation, any such gains would reduce the Fund's ability to
sell other securities (and options or futures) held for less than three
months that it might wish to sell in the ordinary course of its portfolio
management.
Shortly after the end of each year, each Fund mails to each
shareholder a statement setting forth the federal income tax status of all
distributions made during the year. Shareholders may be subject to state
and local taxes on distributions from a Fund, except for Maryland and
Pennsylvania residents to the extent described in the Prospectuses for the
Maryland and Pennsylvania Tax-Free Funds. Shareholders should consult
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<PAGE>
their tax advisers regarding specific questions relating to federal, state
and local taxes.
Issues Related to Hedging Instruments
The use of hedging instruments, such as writing (selling) and
purchasing options and futures contracts, involves complex rules that will
determine for income tax purposes the character and timing of recognition
of the gains and losses a Fund realizes in connection therewith.
Income from transactions in options and futures contracts derived by
a Fund with respect to its business of investing in securities will be
taxable and will qualify as permissible income under the Income
Requirement. However, income from the disposition of options and futures
contracts will be subject to the Short-Short Limitation if they are held
for less than three months.
VALUATION OF FUND SHARES
Net asset value of a Fund share is determined daily for each class as
of the close of the Exchange, on every day that the Exchange is open, by
dividing the value of the total assets attributable to that class, less
liabilities attributable to that class, by the number of shares of that
class outstanding. Pricing will not be done on days when the Exchange is
closed. The Exchange currently observes the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving, and Christmas. When market quotations are
readily available, portfolio securities are valued based upon market
quotations, provided such quotations adequately reflect, in the Adviser's
judgment, the fair value of the security. For valuation purposes, the
market quotation shall be the mean of the most recent bid and asked prices
quoted by the dealers. Where such market quotations are not readily
available, securities are valued based upon appraisals received from an
independent pricing service using a computerized matrix system or based
upon appraisals derived from information concerning the security or
similar securities received from recognized dealers in those securities.
The methods used by the pricing service and the quality of the valuations
so established are reviewed by the Adviser under the general supervision
of the Trust's Board of Trustees. The amortized cost method of valuation
is used with respect to obligations with 60 days or less remaining to
maturity unless the Adviser determines that this does not represent fair
value. All other assets are valued at fair value as determined in good
faith by or under the direction of the Trust's Board of Trustees.
Premiums received on the sale of put and call options are included in each
Fund's net asset value, and the current market value of options sold by a
Fund will be subtracted from its net assets.
PERFORMANCE INFORMATION
The following tables show the value, as of the end of each fiscal
year, of a hypothetical investment of $10,000 made in each Fund at that
Fund's respective commencement of operations (Primary Shares). Each table
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<PAGE>
assumes that all dividends and capital gain distributions are reinvested
in the respective Fund. Each table includes the effect of all charges and
fees applicable to Primary Shares the respective Fund has paid. (There
are no redemption fees.) The tables do not include the effect of any
income tax that an investor would have to pay on distributions.
For the Maryland Tax-Free Fund:
<TABLE>
<CAPTION>
<C> <C>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
<s: Through Reinvestment of Reinvestment of <C>
Fiscal Year Capital Gain Distributions Income Dividends Total Value
1992* $ 9,942 $ 561 $10,503
1993 10,569 1,244 11,813
1994 10,395 1,832 12,227
1995 10,507 2,527 13,034
</TABLE>
* May 1, 1991 (commencement of operations) to March 31, 1992.
If the investor had not reinvested dividends and capital gain
distributions, the total value of the hypothetical investment as of March
31, 1995 would have been $10,496, and the investor would have received a
total of $2,538 in distributions. If the Adviser had not waived or
reimbursed certain Fund expenses in each of the fiscal years, returns
would have been lower.
For the Pennsylvania Tax-Free Fund:
<TABLE>
<CAPTION>
<C> <C>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
<S> Through Reinvestment of Reinvestment of <C>
Fiscal Year Capital Gain Distributions Income Dividends Total Value
1992* $10,192 $ 437 $10,629
1993 10,602 1,113 11,715
1994 10,450 1,711 12,161
- 29 -
<PAGE>
1995 10,595 2,421 13,016
- 30 -
<PAGE>
</TABLE>
* August 1, 1991 (commencement of operations) to March 31, 1992.
If the investor had not reinvested dividends and capital gain
distributions, the total value of the hypothetical investment as of March
31, 1995 would have been $10,595, and the investor would have received a
total of $2,145 in distributions. If the Adviser had not waived or
reimbursed certain Fund expenses in each of the fiscal years, returns
would have been lower.
For the Tax-Free Intermediate Fund:
<TABLE>
<CAPTION>
<C> <C>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
<S> Through Reinvestment of Reinvestment of <C>
Fiscal Year Capital Gain Distributions Income Dividends Total Value
1993* $10,040 $ 186 $10,226
1994 9,980 640 10,620
1995 10,047 1,187 11,234
</TABLE>
* November 9, 1992 (commencement of operations) to March 31, 1993.
If the investor had not reinvested dividends and capital gain
distributions, the total value of the hypothetical investment as of March
31, 1995 would have been $10,040, and the investor would have received a
total of $1,130 in distributions. If the Adviser had not waived or
reimbursed certain Fund expenses in each fiscal year, returns would have
been lower.
Total Return Calculations Average annual total return quotes used in
each Fund's advertising and other promotional materials ("Performance
Advertisements") are calculated according to the following formula:
n
P(1+T) = ERV
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<PAGE>
where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated at
least to the last day of the most recent quarter prior to submission of
the Performance Advertisements for publication. Total return, or "T" in
the formula above, is computed by finding the average annual change in the
value of an initial $1,000 investment over the period. In calculating the
ending redeemable value, the Maryland Tax-Free and Pennsylvania Tax-Free's
maximum 2.75% initial sales charge or the Tax-Free Intermediate's maximum
2.00% initial sales charge is deducted from the initial $1,000 payment and
all dividends and capital gain distributions by a Fund are assumed to have
been reinvested at net asset value on the reinvestment dates during the
period. Cumulative and average annual returns for the year ended March
31, 1995 are contained in each Fund's prospectus. The front-end sales
charge is waived for all purchases of Primary Shares of the Tax-Free
Intermediate Fund made through January 31, 1996.
Yield. Yield figures used in each Fund's Performance Advertisements
are calculated by dividing the Fund's net investment income for a 30-day
period ("Period"), by the average number of shares entitled to receive
dividends during the Period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the maximum offering
price per share at the end of the Period. Yield quotations are calculated
according to the following formula:
6
YIELD = 2[(a-b + 1) ]/cd - 1
where: a = dividends and interest earned during the Period
b = expenses accrued for the Period (net of
reimbursements)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends
d = the maximum offering price per share on the last day
of the Period.
Except as noted below, in determining net investment income earned
during the Period (variable "a" in the above formula), each Fund
calculates interest earned on each debt obligation held by it during the
Period by (1) computing the obligation's yield to maturity based on the
market value of the obligation (including actual accrued interest) on the
last business day of the Period or, if the obligation was purchased during
the Period, the purchase price plus accrued interest and (2) dividing the
yield to maturity by 360, and multiplying the resulting quotient by the
market value of the obligation (including actual accrued interest). Once
interest earned is calculated in this fashion for each debt obligation
held by a Fund, interest earned during the Period is then determined by
totalling the interest earned on all debt obligations. For purposes of
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<PAGE>
these calculations, the maturity of an obligation with one or more call
provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
Tax-exempt yield is calculated according to the same formula except
that a = interest exempt from federal income tax earned during the Period.
This tax-exempt yield is then translated into tax equivalent yield
according to the following formula:
TAX EQUIVALENT YIELD = ( E ) = t
-------
l - p
E = tax-exempt yield
p = stated income tax rate
t = taxable yield
From time to time, the Maryland Tax-Free Fund may also illustrate the
effect of tax equivalent yields using information such as that set forth
below:
<TABLE>
<CAPTION>
<C>
Combined <C>
<S> federal, A taxable yield of
Adjusted Gross Income Maryland and 5.0% 5.5% 6.0% 6.5% 7.0%
Single Return Joint Return local taxes (1) is equivalent to a tax-exempt yield of
Not over $23,350 Not over $39,000 23% 3.85% 4.24% 4.62% 5.01% 5.39%
$23,350 to $56,550 $39,000 to $94,250 36% 3.20 3.52 3.84 4.16 4.48
$56,550 to $117,950 $94,250 to $143,600 39% 3.05 3.36 3.66 3.97 4.27
$117,950 to $256,500 $143,600 to $256,500 44% 2.80 3.08 3.36 3.64 3.92
Over $256,500 Over $256,500 47.6% 2.62 2.88 3.14 3.41 3.67
</TABLE>
(1) Based on 1995 tax rates using a state rate of 5% and a local tax rate
of 60% of the 5% state rate, or 3%. the rate limits for high income
taxpayers have been eliminated for tax years after 12/31/94.
From time to time, the Pennsylvania Tax-Free Fund may also illustrate
the effect of tax equivalent yields using information such as that set
forth below:
<TABLE>
<CAPTION>
- 33 -
<PAGE>
<C>
Combined <C>
<S> federal and A taxable yield of
Adjusted Gross Income Pennsylvania 5.0% 5.5% 6.0% 6.5% 7.0%
Single Return Joint Return taxes (1) is equivalent to a tax-exempt yield of
Not over $22,750 Not over $38,000 17.8% 4.11% 4.52% 4.93% 5.34% 5.75%
$22,750 to $55,100 $38,000 to $91,850 30.8% 3.46 3.81 4.15 4.50 4.84
$55,100 to $115,000 $91,850 to $140,000 33.8% 3.31 3.64 3.97 4.30 4.63
$115,000 to $250,000 $140,000 to $250,000 38.9% 3.06 3.36 3.67 3.97 4.28
Over $250,000 Over $250,000 42.4% 2.88 3.17 3.46 3.74 4.03
</TABLE>
(1) Based on 1995 tax rates.
From time to time, the Tax-Free Intermediate Fund may also illustrate
the effect of tax equivalent yields using information such as that set
forth below:
<TABLE>
<CAPTION>
<C>
<S> A taxable yield of
Adjusted Gross Income <C> 5.0% 5.5% 6.0% 6.5% 7.0%
Single Return Joint Return Federal Tax(1) is equivalent to a tax-exempt yield of
Not over $22,750 Not over $38,000 15% 4.25% 4.68% 5.10% 5.53% 5.95%
$22,750 to $55,100 $38,000 to $91,850 28% 3.60 3.96 4.32 4.68 5.04
$55,100 to $115,000 $91,850 to $140,000 31% 3.45 3.80 4.14 4.49 4.83
$115,000 to $250,000 $140,000 to $250,000 36% 3.20 3.52 3.84 4.16 4.48
Over $250,000 Over $250,000 39.6% 3.02 3.32 3.62 3.93 4.23
</TABLE>
(1) Based on 1995 tax rates.
For the 30-day period ended March 31, 1995, the Maryland Tax-Free
Fund's yield and tax equivalent yield (assuming a 23% combined tax rate)
were 5.26% and 6.83%, respectively. The Pennsylvania Tax-Free Fund's
yield and tax equivalent yield (assuming an 17.8% combined tax rate) for
the same period were 5.17% and 6.29%, respectively. The Tax-Free
Intermediate Fund's yield and tax equivalent yield (assuming a 15% tax
rate) for the same period were 4.84% and 5.69%, respectively.
Other Information From time to time, in reports and promotional
literature, each class of shares of a Fund's performance may be compared
to indices of broad groups of managed and unmanaged securities considered
to be representative of or similar to Fund portfolio holdings such as the
Bond Buyer 20, Lipper General Purpose Municipal Bond Average, Lipper
- 34 -
<PAGE>
Maryland State Municipal Bond Fund Average (Maryland Tax-Free Fund only)
and Shearson Lehman/American Express Municipal Bond Index. Securities
indices may take no account of the cost of investing or of any tax
consequences of distributions. The Funds may invest in securities not
included in the indices to which they make such comparisons.
A Fund may also cite rankings and ratings and compare the return of a
class with data published by Lipper Analytical Services, Inc. ("Lipper"),
CDA Investment Technologies, Inc., Wiesenberger Investment Company
Services, Value Line, Morningstar, and other services or publications that
monitor, compare and/or rank the performance of investment companies. A
Fund may also refer in such materials to mutual fund performance rankings,
ratings and comparisons with funds having similar investment objectives
and other mutual funds reported periodically in national financial
publications such as MONEY Magazine, FORBES, BUSINESS WEEK and BARRON's.
A Fund may compare the investment return of a class to the return on
certificates of deposit and other forms of bank deposits, and may quote
from organizations that track the rates offered on such deposits. Bank
deposits are insured by an agency of the federal government up to
specified limits. In contrast, Fund shares are not insured, the value of
Fund shares may fluctuate, and an investor's shares, when redeemed, may be
worth more or less than the investor originally paid for them. Unlike the
interest paid on a certificate of deposit, which remains at a specified
rate for a specified period of time, the return of each class of shares
will vary.
In advertising, the Fund may illustrate hypothetical investment plans
designed to help investors meet long-term financial goals, such as saving
for a child's college education or for retirement. Sources such as the
Internal Revenue Service, the Social Security Administration, the Consumer
Price Index and Chase Global Data and Research may supply data concerning
interest rates, college tuitions, the rate of inflation, Social Security
benefits, mortality statistics and other relevant information. The Fund
may use other recognized sources as they become available.
The Fund may use data prepared by Ibbotson Associates of Chicago,
Illinois ("Ibbotson") to compare the returns of various capital markets
and to show the value of a hypothetical investment in a capital market.
Ibbotson relies on different indices to calculate the performance of
common stocks, corporate and government bonds and Treasury bills.
The Fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is
represented by the performance of an appropriate market index, such as the
S&P 500 and the performance of bonds is represented by a nationally
recognized bond index, such as the Lehman Brothers Long-Term Government
Bond Index.
The Fund may also include in advertising biographical information on
key investment and managerial personnel.
- 35 -
<PAGE>
The Fund may advertise examples of the potential benefits of periodic
investment plans, such as dollar cost averaging, a long-term investment
technique designed to lower average cost per share. Under such a plan, an
investor invests in a mutual fund at regular intervals a fixed dollar
amount, thereby purchasing more shares when prices are low and fewer
shares when prices are high. Although such a plan does not guarantee
profit or guard against loss in declining markets, the average cost per
share could be lower than if a fixed number of shares were purchased at
the same intervals. Investors should consider their ability to purchase
shares through low price levels.
The Fund may discuss Legg Mason's tradition of service. Since 1899,
Legg Mason and its affiliated companies have helped investors meet their
specific investment goals and have provided a full spectrum of financial
services. Legg Mason affiliates serve as investment advisers for private
accounts and mutual funds with assets of more than $17 billion as of March
31, 1995.
THE TRUST'S TRUSTEES AND OFFICERS
The Trust's officers are responsible for the operation of the Trust
under the direction of the Board of Trustees. The officers and trustees
and their principal occupations during the past five years are set forth
below. An asterisk (*) indicates those officers and/or trustees who are
"interested persons" of the Trust as defined by the 1940 Act. The
business address of each officer and director is 111 South Calvert Street,
Baltimore, Maryland, unless otherwise indicated.
JOHN F. CURLEY [56], JR.*, Chairman of the Board and Trustee; Vice
Chairman and Director of Legg Mason, Inc. and Legg Mason Wood Walker,
Inc.; Director of Legg Mason Fund Adviser, Inc. and Western Asset
Management Company; Officer and/or Director of various other affiliates of
Legg Mason, Inc.; President and Director of three Legg Mason funds;
Chairman of the Board, President and Trustee of one Legg Mason fund;
Chairman of the Board and Director of four Legg Mason funds.
EDMUND J. CASHMAN, JR.* [58], President and Trustee; Senior Executive
Vice President and Director of Legg Mason, Inc.; Officer and/or Director
of various other affiliates of Legg Mason, Inc.; President and Director
of one Legg Mason fund; Director of Worldwide Value Fund, Inc.
RICHARD G. GILMORE [68], Trustee; 948 Kennett Way, West Chester,
Pennsylvania. Independent Consultant. Director of CSS Industries, Inc.
(diversified holding company whose subsidiaries are engaged in manufacture
and sale of decorative paper products, business forms, and specialty metal
packaging); Director of PECO Energy Company (formerly Philadelphia
Electric Company); Director of six Legg Mason funds; and Trustee of one
Legg Mason fund. Formerly: Senior Vice President and Chief Financial
Officer of Philadelphia Electric Company (now PECO Energy Company);
- 36 -
<PAGE>
Executive Vice President and Treasurer, Girard Bank, and Vice President of
its parent holding company, the Girard Company; and Director of Finance,
City of Philadelphia.
CHARLES F. HAUGH [69], Trustee; 14201 Laurel Park Drive, Suite 104,
Laurel, Maryland. Real Estate Developer and Investor; President and
Director of Resource Enterprises, Inc. (real estate brokerage); Chairman
of Resource Realty LLC (management of retail and office space); Partner in
Greater Laurel Health Park Ltd. Partnership (real estate investment and
development); Director of six Legg Mason funds; and Trustee of two Legg
Mason funds.
ARNOLD L. LEHMAN [51], Trustee; The Baltimore Museum of Art, Art
Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum of
Art; Director of six Legg Mason funds; Trustee of two Legg Mason funds.
JILL E. McGOVERN [50], Trustee; 1500 Wilson Boulevard, Arlington,
Virginia. Chief Executive of the Marrow Foundation. Director of six Legg
Mason funds; Trustee of two Legg Mason funds. Formerly: Executive Director
of the Baltimore International Festival (January 1991 - March 1993); and
Senior Assistant to the President of The Johns Hopkins University (1986-
1991).
T. A. RODGERS [60], Trustee; 2901 Boston Street, Baltimore, Maryland.
Principal, T. A. Rodgers & Associates (management consulting); Director of
six Legg Mason funds; Trustee of one Legg Mason fund. Formerly: Director
and Vice President of Corporate Development, Polk Audio, Inc.
(manufacturer of audio components).
EDWARD A. TABER, III* [51], Trustee; Executive Vice President of
Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Vice Chairman and
Director of Legg Mason Fund Adviser, Inc.; Director of three Legg Mason
funds; President and Director of two Legg Mason funds; Trustee of one Legg
Mason fund; Vice President of Worldwide Value Fund, Inc. Formerly:
Executive Vice President of T. Rowe Price-Fleming International, Inc.
(1986-1992) and Director of the Taxable Fixed Income Division at T. Rowe
Price Associates, Inc. (1973-1992).
The executive officers of the Trust, other than those who also serve
as Trustees, are:
MARIE K. KARPINSKI* [46], Vice President and Treasurer; Treasurer of
Legg Mason Fund Adviser, Inc.; Vice President and Treasurer of eight Legg
Mason funds; and Secretary/Treasurer of Worldwide Value Fund, Inc.; Vice
President of Legg Mason.
SUSAN T. LIND* [53], Secretary; Assistant Treasurer and Secretary of
one Legg Mason fund; Assistant Secretary of Worldwide Value Fund, Inc.;
employee of Legg Mason.
BLANCHE P. ROCHE* [46], Assistant Secretary and Assistant Vice
President; Assistant Secretary and Assistant Vice President of seven Legg
- 37 -
<PAGE>
Mason funds; employee of Legg Mason since 1991. Formerly: Manager of
Consumer Financial Services, Primerica Corporation (1989-1991).
Officers and Trustees of the Trust who are "interested persons"
thereof receive no salary or fees from the Trust. Independent Trustees of
the Trust receive a fee of $400 annually for serving as a trustee and a
fee of $400 for each meeting of the Board of Trustees attended by him or
her.
The Nominating Committee of the Board of Trustees is responsible for
the selection and nomination of disinterested trustees. The Committee is
composed of Messrs. Gilmore, Haugh, Lehman and Rodgers and Dr. McGovern.
On May 31, 1995, the trustees and officers of the Trust owned, in the
aggregate, less than 1% of the outstanding shares of the Maryland Tax-Free
Fund, the Pennsylvania Tax-Free Fund and the Tax-Free Intermediate Fund.
The following table provides certain information relating to the
compensation of the Trust's trustees for the fiscal year ended March 31,
1995.
- 38 -
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
<C> <C>
<S> <C> Pension or <C> Total Compensation
Aggregate Retirement Benefits Estimated Annual From Trust and Fund
Name of Person and Compensation Accrued as Part of Benefits Upon Complex Paid to
Position From the Trust* Funds' Expenses Retirement Trustees**
John F. Curley, Jr.
-
Chairman of the None N/A N/A None
Board and Trustee
Edward A. Taber,
III - None N/A N/A None
Trustee
Edmund J. Cashman,
Jr.- President and None N/A N/A None
Trustee
Marie K.
Karpinski - None N/A N/A None
Vice President and
Treasurer
Richard G.
Gilmore - $2,000 N/A N/A $21,600
Trustee
Charles F. Haugh -
Trustee $2,000 N/A N/A $23,600
Arnold L. Lehman -
Trustee $2,000 N/A N/A $23,600
Jill E. McGovern -
Trustee $2,000 N/A N/A $23,600
T. A. Rodgers -
Trustee $2,000 N/A N/A $21,600
</TABLE>
* Represents fees paid to each director during the fiscal year ended
March 31, 1995.
** Represents aggregate compensation paid to each director during the
calendar year ended December 31, 1994.
THE FUNDS' INVESTMENT ADVISER
- 39 -
<PAGE>
The Adviser, a Maryland corporation, is located at 111 South Calvert
Street, Baltimore, Maryland 21202. The Adviser is a wholly owned
subsidiary of Legg Mason, Inc., which also is the parent of Legg Mason
Wood Walker, Incorporated. The Adviser serves as each Fund's investment
adviser and manager under an Investment Advisory and Management Agreement
("Advisory Agreement") dated March 25, 1991. Continuation of the
Agreement was most recently approved by the Board of Trustees on October
21, 1994. The Advisory Agreement provides that, subject to overall
direction by the Board of Trustees, the Adviser manages the investment and
other affairs of each Fund. The Adviser is responsible for managing each
Fund consistent with the Funds' investment objectives and policies
described in their Prospectuses and this Statement of Additional
Information. The Adviser also is obligated to (a) furnish each Fund with
office space and executive and other personnel necessary for the
operations of the Fund; (b) supervise all aspects of each Fund's
operations; (c) bear the expense of certain informational and purchase and
redemption services to each Fund's shareholders; (d) arrange, but not pay
for, the periodic updating of prospectuses, proxy material, tax returns
and reports to shareholders and state and federal regulatory agencies; and
(e) report regularly to the Trust's officers and trustees. The Adviser
and its affiliates pay all the compensation of trustees and officers of
the Trust who are employees of the Adviser. Each Fund pays all its other
expenses which are not expressly assumed by the Adviser. These expenses
include, among others, interest expense, taxes, auditing and accounting
fees, distribution fees, if any, fees and expenses of the independent
trustees of the Trust, brokerage fees and commissions, expenses of
preparing prospectuses and of printing and distributing prospectuses
annually to existing shareholders, custodian charges, transfer agency
fees, legal expenses, insurance expenses, association membership dues,
governmental fees, expenses of registering and qualifying Fund shares for
sale under federal and state law, and the expense of reports to
shareholders, shareholders' meetings and proxy solicitations. Each Fund
also pays the expenses for maintenance of its financial books and records,
including computation of the Fund's daily net asset value per share and
dividends. Each Fund is also liable for such nonrecurring expenses as may
arise, including litigation to which the Fund may be a party. Each Fund
also may have an obligation to indemnify the trustees and officers of the
Trust with respect to any such litigation.
Under the Advisory Agreement, the Adviser will not be liable for any
error of judgment or mistake of law or for any loss suffered by a Fund in
connection with the performance of the Advisory Agreement, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from willful misfeasance,
bad faith or gross negligence on its part in the performance of its duties
or from reckless disregard by it of its obligations or duties thereunder.
With respect to each Fund, the Advisory Agreement terminates
automatically upon assignment. It also is terminable at any time without
penalty by vote of the Trust's Board of Trustees, by vote of a majority of
each Fund's outstanding voting securities, or by the Adviser, on not less
than 60 days' notice to the other party to the Agreement and may be
- 40 -
<PAGE>
terminated immediately upon the mutual written consent of both parties to
the Agreement.
As explained in the Prospectus, the Adviser receives for its services
a fee, calculated daily and payable monthly, at an annual rate of 0.55% of
the average daily net assets of each Fund. The Adviser has agreed to
waive its fees and reimburse each Fund if and to the extent its expenses
(exclusive of taxes, interest, brokerage and extraordinary expenses)
exceed during any month annual rates of each Fund's average daily net
assets for such month, or certain asset levels, whichever occurs first, in
accordance with the following schedules:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Rate Expiration Date Asset Level
________ _________________ -------------
For the Maryland Tax-Free Fund:
Primary Shares:
0.60% January 31, 1996 $200 million
0.55% December 31, 1994 $200 million
0.50% June 30, 1994 $200 million
0.45% December 31, 1993 $175 million
0.40% December 31, 1992 $150 million
Navigator Shares:
0.35% January 31, 1996 $200 million
For the Pennsylvania Tax-Free Fund:
Primary Shares:
0.55% January 31, 1996 $125 million
0.50% December 31, 1994 $125 million
0.45% June 30, 1994 $125 million
0.40% December 31, 1993 $100 million
0.35% July 31, 1993 $100 million
Navigator Shares:
0.30% January 31, 1996 $125 million
For the Tax-Free Intermediate Fund:
Primary Shares:
0.65% January 31, 1996 $100 million
0.35% December 31, 1994 $100 million
0.30% June 30, 1994 $100 million
0.30% December 31, 1993 $ 75 million
0.20% March 31, 1993 $ 75 million
Navigator Shares:
0.40% January 31, 1996 $100 million
- 41 -
<PAGE>
</TABLE>
For the years ended March 31, 1995 and 1994, the Maryland Tax-Free
Fund paid advisory fees of $778,739 and $806,670 (prior to fees waived of
$569,982 and $707,590), respectively, and for the year ended March 31,
1993, the Adviser waived all advisory fees for the Fund. For the year
ended March 31, 1995, 1994 and 1993, the Fund paid advisory fees of
$342,774, $327,975 and $215,075 (prior to fees waived of $326,376,
$327,975 and $215,075), respectively, for the Pennsylvania Tax-Free Fund.
For the years ended March 31, 1995, 1994 and the period November 9, 1992
(commencement of operations) to March 31, 1993, the Adviser waived all
advisory fees for the Tax-Free Intermediate Fund.
Under the Advisory Agreement, each Fund has the non-exclusive right
to use the name "Legg Mason" until that Agreement is terminated or until
the right is withdrawn in writing by the Adviser.
To mitigate the possibility that a Fund will be affected by personal
trading of employees, the Trust and the Adviser have adopted policies that
restrict securities trading in the personal accounts of portfolio managers
and others who normally come into advance possession of information on
portfolio transactions. These policies comply, in all material respects,
with the recommendations of the Investment Company Institute.
THE FUNDS' DISTRIBUTOR
Legg Mason acts as distributor of each Fund's shares pursuant to an
Underwriting Agreement with the Trust. The Underwriting Agreement
obligates Legg Mason to promote the sale of Fund shares and to pay certain
expenses in connection with its distribution efforts, including expenses
for the printing and distribution of prospectuses and periodic reports
used in connection with the offering to prospective investors (after the
prospectuses and reports have been prepared, set in type and mailed to
existing shareholders at the Fund's expense) and for supplementary sales
literature and advertising costs.
Fairfield Group, Inc., a wholly owned subsidiary of Legg Mason, Inc.,
with principal offices at 200 Gibraltar Road, Horsham, Pennsylvania, may
act as a dealer for Navigator Shares pursuant to a Dealer Agreement with
Legg Mason. Neither Legg Mason nor Fairfield receives any compensation
from the Funds for its activities in selling Navigator Shares.
Each Fund has adopted a Distribution and Shareholder Services Plan
("Plan") which, among other things, permits each Fund to pay Legg Mason
fees for its services related to sales and distribution of Primary Shares
and the provision of ongoing services to Primary Class shareholders.
Payments are made only from assets attributable to Primary Shares. Under
the Plan, the aggregate fees may not exceed an annual rate of 0.25% of the
Fund's average daily net assets attributable to Primary Shares.
Distribution activities for which such payments may be made include, but
are not limited to, compensation to persons who engage in or support
- 42 -
<PAGE>
distribution and redemption of shares, printing of prospectuses and
reports for persons other than existing shareholders, advertising,
preparation and distribution of sales literature, overhead, travel and
telephone expenses, all with respect to Primary Shares only. Legg Mason
may pay all or a portion of the fees to its investment executives. The
Plan has been amended, effective July 1, 1993, to make clear that, of the
aggregate 0.25% fees, 0.125% is paid for distribution services and 0.125%
is paid for ongoing services to shareholders. The amendments also specify
that the Fund may not pay more in distribution fees than 6.25% of total
new gross assets, plus interest, as specified in the Rules of Fair
Practice of the National Association of Securities Dealers, Inc. ("NASD").
Continuation of the Plan was most recently approved on October 21,
1994 by the Board of Trustees of the Trust, including a majority of the
trustees who are not "interested persons" of the Trust as that term is
defined in the 1940 Act and who have no direct or indirect financial
interest in the operation of the Plan or the Underwriting Agreement ("12b-
1 Trustees"). In approving the continuance of the Plan, in accordance
with the requirements of Rule 12b-1, the trustees determined that there
was a reasonable likelihood that the Plan would benefit each Fund and
their Primary Class shareholders. The trustees considered, among other
things, the extent to which the potential benefits of the Plan to each
Fund's Primary Class shareholders outweighed the costs of the Plan; the
likelihood that the Plan would succeed in producing such potential
benefits; the merits of certain possible alternatives to the Plan; and the
extent to which the retention of assets and additional sales of each
Fund's Primary Shares would be likely to maintain or increase the amount
of compensation paid by a Fund to its Adviser.
In considering the costs of the Plan, the trustees gave particular
attention to the fact that any payments made by a Fund to Legg Mason under
the Plan would increase the Fund's level of expenses in the amount of such
payments. Further, the trustees recognized that the Adviser would earn
greater management fees if a Fund's assets were increased, because such
fees are calculated as a percentage of the Fund's assets and thus would
increase if net assets increase. The trustees further recognized that
there can be no assurance that any of the potential benefits described
below would be achieved if the Plan were implemented.
Among the potential benefits of the Plan, the trustees noted that the
payment of commissions and service fees to Legg Mason and its investment
executives could motivate them to improve their sales efforts with respect
to each Fund's Primary Shares and to maintain and enhance the level of
services they provide to the Funds' Primary Class shareholders. These
efforts, in turn, could lead to increased sales and reduced redemptions,
eventually enabling a Fund to achieve economies of scale and lower per
share operating expenses. Any reduction in such expenses would serve to
offset, in whole or in part, the additional expenses incurred by a Fund in
connection with the Plan. Furthermore, the investment management of a
Fund could be enhanced, as net inflows of cash from new sales might enable
its portfolio manager to take advantage of attractive investment
opportunities, and reduced redemptions could eliminate the potential need
- 43 -
<PAGE>
to liquidate attractive securities positions in order to raise the funds
necessary to meet the redemption requests.
As compensation for its services and expenses, Legg Mason receives
from each Fund an annual distribution fee equivalent to 0.125% of its
average daily net assets attributable to Primary Shares and a service fee
equivalent to 0.125% of its average daily net assets attributable to
Primary Shares in accordance with the Plan. The distribution and service
fees are calculated daily and payable monthly. Legg Mason has voluntarily
agreed to waive its fees and reimburse each Fund if and to the extent its
expenses (exclusive of taxes, interest, brokerage and extraordinary
expenses) exceed during any month annual rates of each Fund's average
daily net assets attributable to Primary Shares for such month, or certain
asset levels, whichever occurs first, in accordance with the schedules
described previously.
For the years ended March 31, 1995, 1994 and 1993, the Maryland Tax-
Free Fund paid distribution and service fees of $353,972, $366,668 and
$195,240, respectively, to Legg Mason. For the years ended March 31, 1995
and 1994, the Pennsylvania Tax-Free Fund paid distribution and service
fees of $155,806 and $98,689, respectively and for the year ended March
31, 1993, Legg Mason waived all distribution and service fees for the
Fund. For the year ended March 31, 1995, the Tax-Free Intermediate Fund
paid distribution and service fees of $49,798 and for the year ended March
31, 1994 and the period November 9, 1992 (commencement of operations) to
March 31, 1993, Legg Mason waived all distribution and service fees for
the Tax-Free Intermediate Fund.
The Plan will continue in effect only so long as it is approved at
least annually by the vote of a majority of the Board of Trustees,
including a majority of the 12b-1 Trustees, cast in person at a meeting
called for the purpose of voting on the Plan. The Plan may be terminated
with respect to a Fund by a vote of a majority of 12b-1 Trustees or by
vote of a majority of the outstanding voting securities of Primary Shares
of the Funds. Any change in the Plan that would materially increase the
distribution costs to a Fund requires shareholder approval; otherwise, the
Plan may be amended by the trustees, including a majority of the 12b-1
Trustees.
In accordance with Rule 12b-1, the Plan provides that Legg Mason will
submit to the Trust's Board of Trustees, and the trustees will review at
least quarterly, a written report of any amounts expended pursuant to the
Plan and the purposes for which expenditures were made. In addition, as
long as the Plan is in effect, the selection and nomination of the
Independent Trustees will be committed to the discretion of such
Independent Trustees.
For the year ended March 31, 1995, Legg Mason incurred the following
expenses:
<TABLE>
<CAPTION>
- 44 -
<PAGE>
<C> <C> <C>
<S> Maryland Pennsylvania Tax-Free
Tax-Free Tax-Free Intermediate
Fund Fund Fund
Compensation to sales
personnel $160,000 $ 70,000 $ 58,000
Advertising 91,000 87,000 182,000
Printing and mailing of
prospectuses to prospective
shareholders 26,000 31,000 31,000
Other 260,000 250,000 212,000
Total expenses $537,000 $438,000 $483,000
</TABLE>
The foregoing are estimated and do not include all expenses fairly
allocable to Legg Mason's or its affiliates' efforts to distribute each
Fund's Primary Shares.
Initial sales charges on purchases of shares of the Funds are paid to
Legg Mason. For the year ended March 31, 1995, Legg Mason received
$475,000 from sales of the Maryland Tax-Free Fund, $117,000 from sales of
the Pennsylvania Tax-Free Fund and $102,000 from sales of the Tax-Free
Intermediate Fund. For the year ended March 31, 1994, Legg Mason received
$992,000 from sales of the Maryland Tax-Free Fund, $471,000 from sales of
the Pennsylvania Tax-Free Fund and $530,000 from sales of the Tax-Free
Intermediate Fund. For the year ended March 31, 1993, Legg Mason received
$1,251,000 from sales of the Maryland Tax-Free Fund and $573,000 from
sales of the Pennsylvania Tax-Free Fund. For the period November 9, 1992
(commencement of operations) to March 31, 1993, Legg Mason received
$622,000 from sales of the Tax-Free Intermediate Fund. Initial sales
charges are waived on purchases of Primary Shares of the Tax-Free
Intermediate Fund made through January 31, 1996.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Under each Advisory Agreement, the Adviser is responsible for the
execution of portfolio transactions. Corporate, municipal and government
debt securities are generally traded on the over-the-counter ("OTC")
market on a "net" basis without a stated commission, through dealers
acting for their own account and not as brokers. Prices paid to a dealer
in debt securities will generally include a "spread," which is the
difference between the price at which the dealer is willing to purchase
and sell the specific security at the time, and includes the dealer's
normal profit. Some portfolio transactions may be executed through
brokers acting as agent. In selecting brokers or dealers, the Adviser
must seek the most favorable price (including the applicable dealer
- 45 -
<PAGE>
spread) and execution for such transactions, subject to the possible
payment as described below of higher brokerage commissions to brokers who
provide research and analysis. The Funds may not always pay the lowest
commission or spread available. Rather, in placing orders on behalf of a
Fund, the Adviser also takes into account such factors as size of the
order, difficulty of execution, efficiency of the executing broker's
facilities (including the services described below) and any risk assumed
by the executing broker.
Consistent with the policy of most favorable price and execution, the
Adviser may give consideration to research, statistical and other services
furnished by brokers or dealers to the Adviser for its use, may place
orders with brokers who provide supplemental investment and market
research and securities and economic analysis, and may pay to these
brokers a higher brokerage commission than may be charged by other
brokers. Such research and analysis may be useful to the Adviser in
connection with services to clients other than the Funds. The Adviser's
fee is not reduced by reason of its receiving such brokerage and research
services.
Although the Funds do not expect to purchase securities on a
commission basis, the Funds may use Legg Mason to effect agency
transactions in listed securities at commission rates and under
circumstances consistent with the policy of best execution. Commissions
paid to Legg Mason will not exceed "usual and customary brokerage
commissions." Rule 17e-1 under the 1940 Act defines "usual and customary"
commissions to include amounts which are "reasonable and fair compared to
the commission, fee or other remuneration received by other brokers in
connection with comparable transactions involving similar securities being
purchased or sold on a securities exchange during a comparable period of
time." In the OTC market, the Funds generally will deal with responsible
primary market makers unless a more favorable execution can otherwise be
obtained.
Except as permitted by SEC rules or orders, the Funds may not buy
securities from, or sell securities to, Legg Mason or its affiliated
persons as principal. The Trust's Board of Trustees has adopted
procedures in conformity with Rule 10f-3 under the 1940 Act whereby each
Fund may purchase securities that are offered in certain underwritings in
which Legg Mason or any of its affiliated persons is a participant. These
procedures, among other things, limit a Fund's investment in the amount of
securities of any class of securities offered in an underwriting in which
Legg Mason or any of its affiliated persons is a participant so that: (i)
the Fund together with all other registered investment companies advised
by the Adviser, may not purchase more than 4% of the principal amount of
the offering of such class or $500,000 in principal amount, whichever is
greater, but in no event greater than 10% of the principal amount of the
offering; and (ii) the consideration to be paid by the Fund in purchasing
the securities being offered may not exceed 3% of the total assets of the
Fund. In addition, a Fund may not purchase securities during the
existence of an underwriting if Legg Mason is the sole underwriter of
those securities. Because Legg Mason is a principal underwriter of
- 46 -
<PAGE>
municipal obligations, the Funds may be precluded from purchasing certain
new issues of municipal securities or may be permitted to make only
limited investments therein.
Section 11(a) of the Securities Exchange Act of 1934 prohibits Legg
Mason from executing transactions on an exchange for its affiliates, such
as the Funds, unless the affiliate expressly consents by written contract.
The Advisory Agreement expressly provides such consent.
Investment decisions for each Fund are made independently from those
of other funds and accounts advised by the Adviser. However, the same
security may be held in the portfolios of more than one fund or account.
When two or more accounts simultaneously engage in the purchase or sale of
the same security, the prices and amounts will be equitably allocated to
each account. In some cases, this procedure may adversely affect the
price or quantity of the security available to a particular Fund. In
other cases, however, Fund's ability to participate in large-volume
transactions may produce better executions and prices.
Portfolio Turnover
The portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. Short-term securities are excluded
from the calculation. Each Fund's portfolio turnover rate may vary from
year to year, depending on market conditions. A high turnover rate (100%
or more) will involve correspondingly greater transaction costs, which
will be borne directly by a Fund. It may also change the character of
capital gains, if any, realized by a Fund and would affect dividends paid
to shareholders because short-term capital gains are taxable as ordinary
income. For the years ended March 31, 1995 and 1994, the Maryland Tax-
Free Fund's portfolio turnover rates were 9.5% and 6.6%, respectively.
For the years ended March 31, 1995 and 1994, the Pennsylvania Tax-Free
Fund's portfolio turnover rates were 2.08% and -0-, respectively. For the
years ended March 31, 1995 and 1994, the Tax-Free Intermediate Fund's
portfolio turnover rates were 24.8% and 6.6%, respectively.
THE TRUST'S CUSTODIAN AND
TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston
Massachusetts, serves as custodian of the Funds' assets. BFDS, P.O. Box
953, Boston, Massachusetts 02103 serves as transfer and dividend-
disbursing agent and administrator of various shareholder services. Legg
Mason also assists BFDS with certain of its duties as transfer agent, for
which BFDS pays Legg Mason a fee. Each Fund reserves the right, upon 60
days' written notice, to make other charges to investors to cover
administrative costs.
OTHER INFORMATION
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<PAGE>
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of each Fund
could, under certain circumstances, be held personally liable for the
obligations of that Fund and of the other Funds. However, the Trust's
Declaration of Trust disclaims shareholder liability for acts or
obligations of the Trust or the Funds and requires that notice of such
disclaimer be given in each note, bond, contract, instrument, certificate
or undertaking made or issued by the trustees or by any officers or
officer by or on behalf of the Trust, a Fund, the trustees or any of them
in connection with the Trust. The Declaration of Trust provides for
indemnification from each Fund's property for all losses and expenses of
any Fund shareholder held personally liable for the obligations of that
Fund. Thus, the risk of a shareholder's incurring financial loss on
account of shareholder liability is limited to circumstances in which a
Fund itself would be unable to meet its obligations, a possibility which
the Adviser believes is remote and not material. Upon payment of any
liability incurred by a Fund shareholder solely by reason of being or
having been a shareholder, the shareholder paying such liability will be
entitled to reimbursement from the general assets of that Fund. The
trustees intend to conduct the operations of each Fund in such a way as to
avoid, as far as possible, ultimate liability of the shareholders for
liabilities of each Fund.
THE TRUST'S LEGAL COUNSEL
Kirkpatrick & Lockhart LLP, 1800 M Street, N.W., Washington, D.C.
20036, serves as counsel to the Trust.
THE TRUST'S INDEPENDENT ACCOUNTANTS
Coopers & Lybrand, 217 L.L.P. East Redwood Street, Baltimore,
Maryland 21202, have been selected by the Trustees to serve as the Trust's
independent accountants.
FINANCIAL STATEMENTS
The Statements of Net Assets as of March 31, 1995; the Statements of
Operations for the year ended March 31, 1995; the Statements of Changes in
Net Assets for the years ended March 31, 1995 and 1994; the Financial
Highlights for the periods presented, the Notes to Financial Statements
and the Reports of the Independent Accountants, for each Fund, all of
which are included in the respective annual reports of the Legg Mason
Maryland Tax-Free Income Trust, the Legg Mason Pennsylvania Tax-Free
Income Trust and the Legg Mason Tax-Free Intermediate-Term Income Trust
for the year ended March 31, 1995, are hereby incorporated by reference in
this Statement of Additional Information.
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<PAGE>
APPENDIX A
RATINGS OF SECURITIES
1. Description of Moody's Investors Service, Inc. ("Moody's") Ratings
Municipal Bonds
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
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,
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make long-term risks appear somewhat
larger than in Aaa securities.
A--Bonds which are rated A possess many favorable investment
attributes and are to be considered upper medium-grade obligations.
Factors giving security to principal and interest are considered adequate
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa--Bonds which are rated Baa are considered medium-grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Municipal Notes
Moody's ratings for state and municipal notes and other short-term
obligations are designated Moody's Investment Grade ("MIG") and for
variable rated demand obligations are designated Variable Moody's
Investment Grade ("VMIG"). This distinction is in recognition of the
differences between short-term credit risk and long-term credit risk.
Notes bearing the designation MIG-1 or VMIG-1 are of the best quality,
enjoying strong protection from established cash flows for their servicing
or from established and broad-based access to the market for refinancing,
or both.
A - 1
<PAGE>
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B. The modifier 1 indicates that the
security ranks in the higher end of its generic rating, the modifier 2
indicates a mid-range rating; the modifier 3 indicates that the issue
ranks in the lower end of its generic rating.
Commercial Paper
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered in assigning commercial paper
ratings are the following: (1) evaluation of the management of the
issuer; (2) economic evaluation of the issuer's industry or industries and
an appraisal of speculative-type risks which may be inherent in certain
areas; (3) evaluation of the issuer's products in relation to competition
and customer acceptance; (4) liquidity; (5) amount and quality of long-
term debt; (6) trend of earnings over a period of ten years; (7) financial
strength of a parent company and the relationships which exist with the
issuer; and (8) recognition by the management of obligations which may be
present or may arise as a result of public interest questions and
preparations to meet such obligations. Relative strength or weakness of
the above factors determines whether the issuer's commercial paper is
rated Prime-1, -2, or -3.
2. Description of Standard & Poor's Ratings Group ("S&P")
Municipal Bonds
AAA--This is the highest rating assigned by S&P to an obligation
and indicates an extremely strong capacity to pay principal and interest.
AA--Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority
of instances they differ from AAA issues only in small degree.
A--Bonds rated A have a strong capacity to pay principal and
interest, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions.
BBB--Bonds which are rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally exhibit
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
principal and interest for bonds in this category than for bonds in the A
category.
Municipal Notes
Municipal notes with maturities of three years or less are usually
given note ratings (designated SP-1, -2, or -3) by S&P to distinguish more
clearly the credit quality of notes as compared to bonds. Notes rated SP-
1 have a very strong or strong capacity to pay principal and interest.
A - 2
<PAGE>
Those issues determined to possess overwhelming safety characteristics are
given the designation SP-1+.
Commercial Paper
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 and 2 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 are 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 the
issues designated "A-1".
3. Description of Fitch Investors Service, Inc. ("Fitch") Ratings
Investment Grade Bonds
AAA--Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonable foreseeable events.
AA--Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA". Because
bonds rated in the "AAA" and "AA" categories are not significantly
vulnerable to foreseeable future developments, short-term debt of these
issuers is generally rated "F-1+".
A--Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse change in
economic conditions and circumstances than bonds with higher ratings.
BBB--Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
Plus (+) Minus (-)--Plus and minus signs are used with a rating
symbol to indicate the relative position of a credit within the rating
category. Plus and minus signs, however, are not used in the "AAA"
category.
A - 3
<PAGE>
Short-term Ratings
F-1+--Exceptionally Strong Credit Quality. Issues assigned this
rating are regarded as having the strongest degree of assurance for timely
payment.
F-1--Very Strong Credit Quality. Issues assigned this rating reflect
assurance of timely payment only slightly less in degree than issues
rated"F-1+".
F-2--Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the margin of
safety is not as great as for issues assigned "F-1+" and "F-1" ratings.
F-3-- Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payments is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
A - 4
<PAGE>
LEGG MASON TAX-FREE INCOME FUND
Table of Contents
<TABLE>
<CAPTION>
<S> <C>
Page
_____
Additional Information About 3
Investment Limitations and Policies
Additional Purchase and Redemption 15
Information
Special Factors Affecting Maryland and 18
Pennsylvania
Additional Tax Information 22
Valuation of Fund Shares 24
Performance Information 24
The Trust's Trustees and Officers 29
The Funds' Investment Adviser 33
The Funds' Distributor 35
Portfolio Transactions and Brokerage 38
The Trust's Custodian and Transfer and 39
Dividend-Disbursing Agent
Other Information 40
The Trust's Legal Counsel 40
The Trust's Independent Accountants 40
Financial Statements 40
Appendix A: Ratings of Securities A-1
</TABLE>
No person has been authorized to give any information or to make any
representations not contained in the Prospectuses or this Statement of
Additional Information in connection with the offering made by the
Prospectuses and, if given or made, such information or representations
must not be relied upon as having been authorized by a Fund or its
distributor. The Prospectuses and this Statement of Additional
Information do not constitute an offering by any Fund or by its
A - 5
<PAGE>
distributor in any jurisdiction in which such offering may not lawfully be
made.
A - 6
