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STATEMENT OF ADDITIONAL INFORMATION
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FLAG INVESTORS MARYLAND INTERMEDIATE TAX-FREE INCOME FUND, INC.
One South Street
Baltimore, Maryland 21202
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THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A
PROSPECTUS. IT SHOULD BE READ IN CONJUNCTION WITH A
PROSPECTUS, WHICH MAY BE OBTAINED FROM ANY
PARTICIPATING DEALER OR SHAREHOLDER SERVICING AGENT
OR BY WRITING THE FUND, ONE SOUTH STREET, BALTIMORE,
MARYLAND 21202, OR BY CALLING (800) 767-FLAG.
Statement of Additional Information Dated: August 1, 1997,
as Supplemented through September 1, 1997
Relating to Prospectuses Dated: August 1, 1997, as supplemented through
September 1, 1997,
Relating to Flag Investors Class A Shares, Flag Investors Institutional Shares
and
Alex. Brown Capital Advisory & Trust Shares
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TABLE OF CONTENTS
Page
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1. General Information and History............................ 1
2. Investment Objectives and Policies......................... 1
3. Valuation of Shares and Redemption......................... 10
4. Federal Tax Treatment of Dividends and
Distributions............................................ 11
5. Management of the Fund..................................... 14
6. Investment Advisory and Other Services..................... 18
7. Distribution of Fund Shares................................ 19
8. Brokerage.................................................. 22
9. Capital Stock.............................................. 23
10. Semi-Annual Reports........................................ 24
11. Custodian, Transfer Agent and Accounting Services ......... 24
12. Independent Auditors ...................................... 25
13. Performance Information.................................... 25
14. Control Persons and Principal Holders of
Securities............................................... 28
15. Financial Statements....................................... 28
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1. GENERAL INFORMATION AND HISTORY
Flag Investors Maryland Intermediate Tax-Free Income Fund, Inc. (the
"Fund") is an open-end management investment company. Under the rules and
regulations of the Securities and Exchange Commission (the "SEC"), all mutual
funds are required to furnish prospective investors with certain information
concerning the activities of the company being considered for investment. The
Fund currently offers three classes of shares: Flag Investors Maryland
Intermediate Tax-Free Income Fund Class A Shares (the "Flag Investors Class A
Shares"), Flag Investors Maryland Intermediate Tax-Free Income Fund
Institutional Shares (the "Flag Investors Institutional Shares") and Alex. Brown
Capital Advisory & Trust Maryland Intermediate Tax-Free Income Shares (the
"ABCAT Shares") (collectively, the "Shares"). As used herein, the "Fund" refers
to Flag Investors Maryland Intermediate Tax-Free Income Fund, Inc., and specific
references to any class of the Fund's Shares will be made using the name of such
class. The Flag Investors Class A Shares were formerly known as the Flag
Investors Shares.
There are three separate prospectuses for the Fund's Shares: one for the
Flag Investors Class A Shares, one for the Flag Investors Institutional Shares
and one for the ABCAT Shares. Each prospectus contains important information
concerning the class of Shares offered thereby and the Fund and may be obtained
without charge from the Fund's Distributor (the "Distributor") or, with respect
to the Flag Investors Class A Shares and the Flag Investors Institutional
Shares, from Participating Dealers that offer shares to prospective investors.
Prospectuses for the Flag Investors Class A Shares may also be obtained from
Shareholder Servicing Agents. As used herein, the term "Prospectus" describes
information common to the prospectuses of the three classes of the Fund's
shares, unless the term "Prospectus" is modified by the appropriate class
designation. As used herein, the "Fund" refers to Flag Investors Maryland
Intermediate Tax-Free Income Fund, Inc. and specific references to any class of
the Fund's Shares will be made using the name of such class. Some of the
information required to be in this Statement of Additional Information is also
included in the Fund's current Prospectuses. To avoid unnecessary repetition,
references are made to related sections of the Prospectuses. In addition, the
Prospectuses and this Statement of Additional Information omit certain
information about the Fund and its business that is contained in the
Registration Statement respecting the Fund and its Shares filed with the SEC.
Copies of the Registration Statement as filed, including such omitted items, may
be obtained from the SEC by paying the charges prescribed under its rules and
regulations.
The Fund was incorporated under the laws of the State of Maryland on
July 23, 1993. The Fund filed a registration statement with the SEC registering
itself as an open-end, non-diversified management investment company under the
Investment Company Act of 1940, as amended (the "Investment Company Act"), and
its Shares under the Securities Act of 1933, as amended. The Fund commenced
offering the Flag Investors Class A Shares on October 1, 1993 and the Flag
Investors Institutional Shares on November 2, 1995. The ABCAT Shares have been
offered since January 10, 1997.
Under a license agreement dated October 1, 1993 between the Fund and
Alex. Brown & Sons Incorporated, Alex. Brown & Sons Incorporated (now BT
Alex-Brown Incorporated) licenses to the Fund the "Flag Investors" name and logo
but retains the rights to the name and logo, including the right to permit other
investment companies to use them.
2. INVESTMENT OBJECTIVES AND POLICIES
The Fund is designed to provide current income exempt from federal
income taxes and Maryland state and local income taxes consistent with
preservation of principal within an intermediate-term maturity structure. As
described in the Prospectus, the Fund will attempt to achieve its objective by
investing
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primarily in municipal obligations issued by the State of Maryland and its
political subdivisions, agencies or instrumentalities. There can be no assurance
that the Fund's investment objective will be achieved.
Municipal Obligations
Municipal obligations include debt securities issued by or on behalf of
states, territories and possessions of the United States and the District of
Columbia and their political subdivisions, agencies and instrumentalities, the
interest on which is exempt from federal income tax. For a discussion of
quality, maturity and other criteria the Fund applies in investing in municipal
obligations, see "Investment Objectives, Policies and Risk Considerations" in
the Prospectus.
Municipal obligations can be classified into three principal categories:
"general obligation bonds," "revenue bonds" and "notes." General obligation
bonds are secured by the issuer's pledge of its faith, credit and taxing power
for the payment of principal and interest. Revenue bonds are payable from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise or other specific revenue source,
but not from the general taxing power of the issuer. Revenue bonds include "tax
exempt industrial development bonds," i.e., bonds issued by or on behalf of
public authorities to obtain funds for privately-operated facilities. Tax-exempt
industrial development bonds do not generally carry the pledge of the credit of
the issuing municipality, but are generally guaranteed by the corporate entity
on whose behalf they are issued. Notes are short-term instruments used to
provide for short-term capital or operating needs. They are obligations of the
issuing municipalities or agencies and are sold in anticipation of a bond sale,
collection of taxes or receipt of other revenues.
Other Tax-Exempt Instruments
Other tax-exempt instruments which are permissible investments include
floating rate notes. Investments in such floating rate instruments will normally
involve industrial development or revenue bonds which provide that the rate of
interest is set as a specific percentage of a designated base rate (such as the
prime rate) at a major commercial bank, and that the Fund can demand payment of
the obligation at all times or at stipulated dates on short notice (not to
exceed 30 days) at par plus accrued interest. Such obligations are frequently
secured by letters of credit or other credit support arrangements provided by
banks. The quality of the underlying credit or of the bank, as the case may be,
must, in the opinion of the Fund's investment advisor (the "Advisor") be
comparable to the long-term bond or commercial paper ratings stated in the
Prospectus. The Advisor will monitor the earning power, cash flow and liquidity
ratios of the issuers of such instruments and the ability of an issuer of a
demand instrument to pay principal and interest on demand.
The Fund may also invest in municipal lease obligations or participation
certificates issued by government authorities or entities to finance the
acquisition or construction of a project or equipment. The certificates
represent participations in a lease or installment purchase contract relating to
such project or equipment. Although such municipal lease obligations do not
constitute general obligations of the issuer to which the issuer's unlimited
taxing power is pledged, lease obligations are frequently backed by the issuer's
covenant to budget for, appropriate and make the payments due under the lease
obligation; however, certain lease obligations contain "non-appropriation"
clauses which provide that the issuer has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. Although "non-appropriation" lease obligations
are secured by the leased property, disposition of the property in the event of
foreclosure might prove difficult. These securities are a type of financing that
has not yet developed the depth of marketability associated with more
conventional securities and may be illiquid. The Fund will not purchase such
lease obligations
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to the extent that it holds municipal lease obligations or illiquid securities
in an amount exceeding 10% of its net assets, except that, if the Advisor
determines that any municipal lease obligations are liquid pursuant to
guidelines adopted by the Board of Directors, such municipal lease obligations
shall not be included for purposes of calculating the foregoing limit. The
Advisor, in making this liquidity determination, will consider, among other
factors, the strength and nature of the secondary market for such obligations,
the prospect of its future marketability and whether such obligations are rated.
The Fund expects that it will purchase only rated municipal lease obligations.
Money Market Securities
From time to time the Fund may purchase taxable short-term securities.
These securities include direct obligations of the U.S. Government which consist
of bills, notes and bonds issued by the U.S. Treasury. Obligations issued by
agencies of the U.S. Government, while not direct obligations of the U.S.
Government, are either backed by the full faith and credit of the U.S. or are
guaranteed by the U.S. Treasury or supported by the issuing agencies' right to
borrow from the U.S. Treasury.
The obligations of U.S. commercial banks include certificates of
deposit, time deposits and bankers' acceptances. Certificates of deposit are
negotiable interest-bearing instruments with a specific maturity. Certificates
of deposit are issued by banks and savings and loan institutions in exchange for
the deposit of funds and normally can be traded in the secondary market, prior
to maturity. Time deposits are non-negotiable receipts issued by a bank in
exchange for the deposit of funds. Time deposits earn a specified rate of
interest over a definite period of time; however time deposits cannot be traded
in the secondary market. Bankers' acceptances are bills of exchange or time
drafts drawn on and accepted by a commercial bank. Bankers' acceptances are used
by corporations to finance the shipment and storage of goods and furnish dollar
exchanges. Maturities are generally six months or less.
The commercial paper which may be purchased includes variable amount
master demand notes which may or may not be backed by bank letters of credit.
These notes permit the investment of fluctuating amounts at varying market rates
of interest pursuant to direct arrangements between the Fund, as lender, and the
borrower. Such notes provide that the interest rate on the amount outstanding
varies on a daily, weekly or monthly basis depending upon a stated short-term
interest rate index. Both the lender and the borrower have the right to reduce
the amount of outstanding indebtedness at any time. There is no secondary market
for the notes. It is not generally contemplated that such instruments will be
traded. Variable or floating rate instruments bear interest at a rate which
varies with changes in market rates. The holder of an instrument with a demand
feature may tender the instrument back to the issuer at par prior to maturity. A
variable amount master demand note is issued pursuant to a written agreement
between the issuer and the holder, its amount may be increased by the holder or
decreased by the holder or issuer, it is payable on demand, and the rate of
interest varies based upon an agreed formula. The quality of the underlying
credit must, in the opinion of the Advisor, be equivalent to the ratings
applicable to permitted investments for the Fund. The Advisor will monitor on an
ongoing basis the earning power, cash flow, and liquidity ratios of the issuers
of such instruments and will similarly monitor the ability of an issuer of a
demand instrument to pay principal and interest on demand.
Puts
The Fund may engage in put transactions. The Advisor has the authority
to purchase securities at a price which would result in a yield to maturity
lower than that generally offered by the seller at the time of purchase when the
Fund can simultaneously acquire the right to sell the securities back to the
seller, the issuer, or a third party (the "writer") at an agreed-upon price at
any time during a stated period or on a certain date. Such a right is generally
denoted as a "standby commitment" or a "put." The purpose of
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engaging in transactions involving puts is to maintain flexibility and liquidity
to permit the Fund to meet redemptions and remain as fully invested as possible
in municipal securities. The right to put the securities depends on the writer's
ability to pay for the securities at the time the put is exercised. The Fund
would limit its put transactions to institutions which the Advisor believes
present minimum credit risks, and the Advisor would use its best efforts
initially to determine and continue to monitor the financial strength of the
sellers of the options by evaluating their financial statements and such other
information as is available in the marketplace. It may, however, be difficult to
monitor the financial strength of the writers because adequate current financial
information may not be available. In the event that any writer is unable to
honor a put for financial reasons, the Fund would be a general creditor (i.e.,
on a parity with all other unsecured creditors) of the writer. Furthermore,
particular provisions of the contract between the Fund and the writer may excuse
the writer from repurchasing the securities; for example, a change in the
published rating of the underlying securities or any similar event that has an
adverse effect on the issuer's credit or a provision in the contract that the
put will not be exercised except in certain special cases, for example, to
maintain portfolio liquidity. The Fund could, however, at any time sell the
underlying portfolio security in the open market or wait until the portfolio
security matures, at which time it should realize the full par value of the
security.
The securities purchased subject to a put, may be sold to third persons
at any time, even though the put is outstanding, but the put itself, unless it
is an integral part of the security as originally issued, may not be marketable
or otherwise assignable. Therefore, the put would have value only to the Fund.
Sale of the securities to third parties or lapse of time with the put
unexercised may terminate the right to put the securities. Prior to the
expiration of any put option, the Fund could seek to negotiate terms for the
extension of such an option. If such a renewal cannot be negotiated on terms
satisfactory to the Fund, the Fund could, of course, sell the security. The
maturity of the underlying security will generally be different from that of the
put. There will be no limit to the percentage of portfolio securities that the
Fund may purchase subject to a put but the amount paid directly or indirectly
for premiums on all puts outstanding will not exceed 2% of the value of the
total assets of the Fund calculated immediately after any such put is acquired.
For the purpose of determining the "maturity" of securities purchased subject to
an option to put, and for the purpose of determining the dollar-weighted average
maturity of the Fund including such securities the Fund will consider
"maturity" to be the first date on which it has the right to demand payment from
the writer of the put although the final maturity of the security is later than
such date.
Futures Contracts and Options on Futures Contracts
The Fund may invest in futures contracts and related options including
futures contracts on fixed income securities and contracts based on municipal
bond or other financial indices.
The Fund may buy or sell financial futures contracts or purchase options
on such futures as a hedge against anticipated interest rate changes. A futures
contract sale creates an obligation by the Fund, as seller, to deliver the
specified type of financial instrument called for in the contract at a specified
future time for a specified price or, in "cash settlement" futures contracts, to
pay to (or receive from) the buyer in cash the difference between the price in
the futures contract and the market price of the instrument on the specified
date, if the market price is higher (or lower, as the case may be). Options on
futures contracts are similar to options on securities except that an option on
a futures contract gives the purchaser the right for the premium paid to assume
a position in a futures contract (a long position if the option is a call and a
short position if the option is a put).
The Fund's use of futures and options on futures will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission ("CFTC") with which
the Fund must comply in order not to be deemed a commodity pool
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operator within the meaning and intent of the Commodity Exchange Act and the
regulations promulgated thereunder.
Typically, an investment in a futures contract requires the Fund to
deposit with the applicable exchange or other specified financial intermediary
as security for its obligations an amount of cash or other specified debt
securities which initially is 1% to 5% of the face amount of the contract and
which thereafter fluctuates on a periodic basis as the value of the contract
fluctuates. An investment in options involves payment of a premium for the
option without any further obligation on the part of the Fund.
Under rules adopted by the Commodities Futures Trading Commission, the
Fund may enter into futures contracts and options thereon for both hedging and
non-hedging purposes, provided that not more than 5% of such Fund's total assets
at the time of entering the transaction are required as margin and option
premiums to secure obligations under such contracts relating to non-hedging
activities.
The variable degree of correlation between price movements of futures
contracts and price movements in the position being hedged creates the
possibility that losses on the hedge may be greater than gains in the value of
the Fund's position. In addition, futures and futures option markets may not be
liquid in all circumstances. As a result, in volatile markets, the Fund may not
be able to close out a transaction without incurring losses substantially
greater than the initial deposit. Although the contemplated use of these
contracts should tend to minimize the risk of loss due to a decline in the value
of the hedged position, at the same time they tend to limit any potential gain
which might result from an increase in the value of such position. The ability
of the Fund to hedge successfully will depend on the Advisor's ability to
forecast pertinent market movements, which cannot be assured. Finally, the daily
deposit requirements in futures contracts create an ongoing greater potential
financial risk than do options purchased by the Fund, where the exposure is
limited to the cost of the initial premium. Losses due to hedging transactions
will reduce net asset value. Income earned by the Fund from its hedging
activities generally will be treated as capital gains.
Other Investment Practices
In addition, the Fund may enter into repurchase agreements and make
purchases of when-issued securities as described below.
Repurchase Agreements. The Fund may enter into repurchase agreements
with financial institutions, such as banks and broker-dealers, deemed to be
creditworthy by the Fund's Board of Directors under criteria established with
the guidance of the Advisor. A repurchase agreement is a short-term investment
in which the purchaser (i.e., the Fund) acquires ownership of a debt security
and the seller agrees to repurchase the obligation at a future time and set
price, usually not more than seven days from the date of purchase, thereby
determining the yield during the purchaser's holding period. The value of
underlying securities will at least be equal at all times to the total amount of
the repurchase obligation, including the interest factor. The Fund makes payment
for such securities only upon physical delivery or evidence of book entry
transfer to the account of a custodian or bank acting as agent. The underlying
securities, which in the case of the Fund are securities of the U.S. Treasury
only, may have maturity dates exceeding one year. The Fund does not bear the
risk of a decline in value of the underlying securities unless the seller
defaults under its repurchase obligation. In the event of a bankruptcy or other
default of a seller of a repurchase agreement, the Fund could experience both
delays in liquidating the underlying securities and loss including (a) possible
decline in the value of the underlying security while the Fund seeks to enforce
its rights thereto, (b) possible subnormal levels of income and lack of access
to income during this period and (c) expenses of enforcing its rights.
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When-Issued Securities. The Fund may purchase debt obligations on a
when-issued basis, in which case delivery and payment normally take place within
45 days after the date of commitment to purchase. The Fund will make commitments
to purchase obligations on a when-issued basis only with the intention of
actually acquiring the securities, but may sell them before the settlement date.
The when-issued securities are subject to market fluctuation, and no interest
accrues to the purchaser during this period. The payment obligation and the
interest rate that will be received on the securities are each fixed at the time
the purchaser enters into the commitment. Purchasing obligations on a
when-issued basis is a form of leveraging and can involve a risk that the yields
available in the market when the delivery takes place may actually be higher
than those obtained in the transaction itself. In that case there could be an
unrealized loss at the time of delivery.
Segregated accounts will be established with the Fund's custodian and
will maintain liquid assets in an amount at least equal in value to the Fund's
commitments to purchase when-issued securities. If the value of these assets
declines, the Fund will place additional liquid assets in the account on a daily
basis so that the value of the assets in the account is equal to the amount of
such commitments.
Investment Restrictions
The Fund's investment program is subject to a number of investment
restrictions which reflect self- imposed standards as well as federal regulatory
limitations. The investment restrictions recited below are in addition to those
described in the Fund's Prospectus, and are matters of fundamental policy and
may not be changed without the affirmative vote of a majority of the outstanding
Shares. Accordingly, the Fund will not:
1. Borrow money except as a temporary measure to facilitate settlements
and for extraordinary or emergency purposes and then only from banks and in an
amount not exceeding 10% of the value of the total assets of the Fund at the
time of such borrowing, provided that, while borrowings by the Fund equaling 5%
or more of the Fund's total assets are outstanding, the Fund will not purchase
securities;
2. Invest in real estate or mortgages on real estate;
3. Purchase or sell commodities or commodities contracts, except that
the Fund may invest in financial futures and options thereon;
4. Act as an underwriter of securities within the meaning of the U.S.
federal securities laws except insofar as it might be deemed to be an
underwriter upon disposition of certain portfolio securities acquired within the
limitation on purchases of restricted securities;
5. Issue senior securities;
6. Make loans, except that the Fund may purchase or hold debt
instruments in accordance with its investment objectives and policies and may
make loans through the use of repurchase agreements;
7. Effect short sales of securities;
8. Purchase securities on margin (but the Fund may obtain such
short-term credits as may be necessary for the clearance of transactions); or
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9. Purchase participations or other direct interests in oil, gas or
other mineral exploration or development programs.
The following investment restriction may be changed by a vote of the
majority of the Board of Directors. The Fund will not:
1. Invest in shares of any other investment company registered under the
Investment Company Act, except as permitted by federal law.
Risk Factors Associated With a Maryland Portfolio
The Fund's concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition to
the State of Maryland and its agencies, there are 23 counties and 156
incorporated municipalities in Maryland (including Baltimore City), many of
which have outstanding debt. As described below, a number of Maryland public
authorities also issue debt.
Economy. The economy of the State of Maryland continues to demonstrate
relatively strong performance, with personal income well above the national
average. Total State employment was 2.73 million in April 1997 with the majority
of jobs in trade, service, and government sectors. The national recession caused
a loss of jobs in Maryland after employment levels peaked in mid-1990 but
employment levels began to recover in mid-1992. Unemployment was 4.4% in April
1997, compared to a national average of 4.8%. The State's population in 1996 was
approximately 5.07 million with 87% concentrated in the Baltimore-Washington
corridor.
Debt. The State of Maryland and its political subdivisions issue four
basic types of debt having varying degrees of credit risk: general obligation
bonds backed by the unlimited taxing power of the issuer, revenue bonds secured
by specific pledged taxes or revenue streams, conduit revenue bonds payable from
the repayment of certain loans to entities such as hospitals and universities
and tax-exempt lease obligations (including certificates of participation in the
same), the payments under which are subject to annual appropriation. In 1996,
$2.8 billion in state and local debt was issued in Maryland, with approximately
46% representing general obligation debt and 54% revenue bonds or lease-backed
debt.
Total combined tax supported debt outstanding of the State, Baltimore
City and all of the counties, municipalities and special districts within
Maryland totaled $13.9 billion as of June 30, 1996. The State of Maryland had
$3.05 billion in general obligation bonds outstanding as of March 31, 1997.
General obligation debt of the State of Maryland is rated Aaa by Moody's, AAA by
Standard & Poor's Ratings Group and AAA by Fitch; there can be no assurance that
these ratings will continue. There is no general limit on state general
obligation bonds imposed by the State Constitution or laws; state general
obligation bonds are payable from ad valorem taxes and, under the State
Constitution, may not be issued unless the debt 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 has been paid. State and local general obligation debt on a per
capita basis and as a percentage of property values have increased by 24.7% and
16.4%, respectively, between fiscal years 1992 and 1996. Although the State may
borrow up to $100 million in short-term notes in anticipation of taxes and
revenues, the State has not made use of this authority.
Many agencies and instrumentalities of the State government are
authorized to borrow money under legislation which expressly provides that the
obligations shall not be deemed to constitute a debt or a pledge of the faith
and credit of the State. The Department of Transportation issues limited,
special obligations payable primarily from fixed-rate excise taxes and other
revenues related mainly to highway
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use, the amount of which is limited by the General Assembly to $1.074 billion
for fiscal year 1998 (ending June 30, 1998); the principal amount of such bonds
outstanding as of March 31, 1997 was $965.6 million. The Maryland Transportation
Authority, the Community Development Administration of the Department of Housing
and Community Development, the Maryland Stadium Authority, the Maryland
Environmental Service, the public educational institutions (which include the
University System of Maryland, Morgan State University and St. Mary's College of
Maryland, the Maryland Food Center Authority and the Maryland Water Quality
Financing Administration also have issued and have outstanding bonds, the
principal of and interest on which are payable solely from specified sources,
principally fees or loan payments generated from use of the facilities,
enterprises financed by the bonds, or other dedicated fees. None of these bonds
constitute debts or pledges of the faith and credit of the State. The issuers of
these obligations are subject to various economic risks and uncertainties, and
the credit quality of the securities issued by them may vary considerably from
that of the State's general obligation bonds. Total outstanding revenue and
enterprise debt of these State units at March 31, 1997 was approximately $3.6
billion.
Certain State agencies also execute capital lease or conditional
purchase agreements to finance certain facilities; all of the payments under
these arrangements are subject to annual appropriation by the State. In the
event that appropriations are not made, the State and its agencies may not be
held contractually liable for the lease payments. As of March 31, 1997, $140
million of lease and conditional purchase financings were outstanding.
In addition, the Maryland Health and Higher Educational Facilities
Authority, the Maryland Industrial Development Financing Authority, the
Northeast Maryland Waste Disposal Authority and the Maryland Economic
Development Corporation issue conduit revenue bonds, the proceeds of which are
lent to borrowers eligible under relevant State and federal law. These bonds are
payable solely from the loan payments made by the borrowers, and their credit
quality vary with the financial strengths of the respective borrowers.
Financial. To a large degree, the risk of the portfolio is dependent
upon the financial strength of the State of Maryland, its political subdivisions
and the obligors on conduit revenue bonds. The following discussion focuses only
on the recent budgets of the State of Maryland. The soundness of the State's
budget, however, may have little or no correlation to the financial strength (or
weakness) of a particular political subdivision or a particular obligor on
conduit revenue bonds.
During the fiscal years 1991 through 1993, the national recession and
weakened economy caused shortfalls in the State's budgeted revenues and
increases in demand for State services. During that period the State was forced
both to cut local aid and other State expenditures and to raise taxes. Showing
improvement from prior years, the State ended its fiscal years 1994, 1995 and
1996 with surpluses.
In April, 1996, the General Assembly approved a $14.6 billion 1997
fiscal year budget. The budget as enacted includes funds sufficient to meet all
fiscal year 1996 deficiencies and to meet all specific statutory funding
requirements; the budget incorporates $29 million in savings from revisions to
the State personnel system and reform to the welfare and Medicare programs. When
this budget was enacted, the State estimated that the General Fund surplus on a
budgetary basis at June 30, 1996 would be approximately $22.5 million, in
addition to which the State projected that there would be $490.4 million in the
Revenue Stabilization Account of the State Reserve Fund. The State currently
projects a General Fund balance on a budgetary basis of $144.5 million.
In April, 1997 the General Assembly approved a $15.4 billion 1998 fiscal
year budget. This budget (i) includes funds sufficient to meet all specific
statutory funding requirements; (ii) incorporates the first year of a five-year
phase-in of a 10% reduction in personal income taxes (estimated to reduce
revenues
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by $38.5 million in fiscal year 1998 and $450 million when fully phased in) and
certain reductions in sales taxes on certain manufacturing equipment (estimated
to reduce revenues by $38.6 million when the reductions are fully phased in
fiscal year 2001); and (iii) includes the first year's $30 million funding under
an agreement to provide additional funds totaling $230 million over a five-year
period to schools in the City of Baltimore and related grants to other
subdivisions totaling $32 million. When this budget was enacted, the State
estimated the General Fund surplus on a budgetary basis would be $28.2 million,
in addition to which the State projected that there would be a balance of $554
million in the Revenue Stabilization Account of the State Reserve Fund.
Other Maryland Issuers
Many local Maryland governments have also suffered from fiscal stress
and general declines in financial performance. Recessionary impacts have
resulted in downturns in real estate related receipts, declines in the growth of
income tax revenues, lower cash positions and reduced interest income. To
compensate for reductions in State aid to local governments, local governments
closed this gap by increasing property and other taxes, program cuts, and
curtailing pay raises. Certain counties in Maryland are subject to voter
approval limitations on property tax levy increases or on increases in
governmental spending which limits their flexibility in responding to external
changes. Various tax initiatives to reform existing tax structures in certain
counties were placed on the November 1992 election ballot and were adopted.
Future initiatives, if proposed and adopted, could create pressure on the
counties and other local governments and their ability to raise revenues. The
Fund cannot predict the impact of any such future tax limitations on debt
quality.
Many Maryland counties have established agencies with bond issuing
authority, such as housing authorities. Maryland municipalities also have the
power to issue conduit revenue bonds. Maryland local governments and their
authorities are subject to various risks and uncertainties, and the credit
quality of the bonds issued by them may vary considerably from that of State
general obligation bonds.
Sectors. Certain areas of potential investment concentration present
unique risks. In recent years, 6 to 12% of tax-exempt debt issues in Maryland
has been for public or non-profit health care institutions. A significant
portion of the Fund's assets may be invested in health care issues. Since 1983,
the hospital industry has been under significant pressure to reduce expenses and
limit length of stay, a phenomenon which has negatively affected the financial
health of many hospitals. While each issue is separately secured by the
individual hospital's revenues, third party reimbursement mechanisms for patient
care are common to the group. At the present time Maryland hospitals operate
under a system which reimburses hospitals according to a State administered set
of rates and charges rather than the Medicare Prospective Payment System for
Medicare payments. Since 1983, Maryland hospitals have operated below the
national average in terms of Medicare cost increases, allowing them to continue
operating under a Medicare waiver. However, under the terms of the Medicare
waiver, a retroactive adjustment could occur if certain performance standards
are not attained, and any loss of this waiver in the future may have an adverse
impact upon the credit quality of Maryland hospitals. Additionally, national
focus on health care reform and any resulting legislation may further impact the
financial condition of hospitals in Maryland and other states.
The Fund may from time to time invest in solid waste revenue bonds which
have exposure to environmental, technological and market risks which could
affect the security and value of the bonds. Such risks include construction
delay or shortfalls in construction funds due to increased regulation, and
market disruption and revenue variability due to recent court decisions and
legislative proposals.
-9-
<PAGE>
Investments in Puerto Rico
Although the Fund has no present intention to do so, from time to time,
the Fund may invest in obligations of the Commonwealth of Puerto Rico and its
public corporations exempt from federal and Maryland state and local income
taxes. These investments will not be considered Maryland municipal securities
for purposes of the Fund's policy to invest, under normal market conditions, 65%
of its assets in Maryland municipal securities. The majority of the
Commonwealth's debt is issued by ten public agencies that are responsible for
many of the island's public functions, such as water, wastewater, highways,
telecommunications, education, and public construction. As of May 31, 1995,
outstanding public sector debt issued by the Commonwealth and its public
corporations totaled $15.9 billion.
Investment in Puerto Rico obligations requires a careful assessment of
certain risk factors. These include reliance on substantial federal assistance
and favorable tax programs, above average levels of unemployment and low wealth
levels, and an economy vulnerable to adverse shifts in energy prices and U.S.
foreign trade/monetary policies. These risks are countered by strong security
provisions, a long history of timely debt repayment, and improved financial
practices.
3. VALUATION OF SHARES AND REDEMPTION
Valuation of Shares
The net asset value per Share is determined daily as of the close of the
New York Stock Exchange, which is ordinarily 4:00 p.m. (Eastern Time), on each
day on which the New York Stock Exchange is open for business (a "Business
Day"). The New York Stock Exchange is open for business on all weekdays except
for the following holidays: New Year's Day, Martin Luther King, Jr's. Birthday,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. The Fund reserves the right to suspend the
sale of Shares at any time.
Redemption
The Fund may suspend the right of redemption or postpone the date of
payment during any period when (a) trading on the New York Stock Exchange is
restricted by applicable rules and regulations of the SEC; (b) the New York
Stock Exchange is closed for other than customary weekend and holiday closings;
(c) the SEC has by order permitted such suspension; or (d) an emergency exists
as determined by the SEC so that valuation of the net assets of the Fund is not
reasonably practicable.
Under normal circumstances, the Fund will redeem Flag Investors Class A
Shares by check, Flag Investors Institutional Shares by wire transfer of funds
and ABCAT Shares by transfer of funds by, or at the direction of, Alex. Brown
Capital Advisory & Trust Company or an affiliate, as described in the Prospectus
relating to each class of Shares. However, if the Board of Directors determines
that it would be in the best interests of the remaining shareholders to make
payment of the redemption price in whole or in part by a distribution in kind of
securities from the portfolio of the Fund in lieu of cash, in conformity with
applicable rules of the SEC, the Fund will make such distributions in kind. If
Shares are redeemed in kind, the redeeming shareholder will incur brokerage
costs in later converting the assets into cash. The method of valuing portfolio
securities is described under "Valuation of Shares" and such valuation will be
made as of the same time the redemption price is determined. The Fund has
elected to be governed by Rule 18f-1 under the Investment Company Act pursuant
to which the Fund is obligated to redeem Shares solely in cash up to the lesser
of $250,000 or 1% of the net asset value of the Fund during any 90-day period
for any one shareholder.
-10-
<PAGE>
4. FEDERAL TAX TREATMENT OF DIVIDENDS AND DISTRIBUTIONS
The following is only a summary of certain additional tax considerations
generally affecting the Fund and its shareholders that are not described in the
Fund's Prospectus. No attempt is made to present a detailed explanation of the
tax treatment of the Fund or its shareholders and the discussion here and in the
Fund's Prospectus is not intended as a substitute for careful tax planning.
The following discussion of certain federal income tax consequences is
based on the Internal Revenue Code of 1986, as amended (the "Code") and the
regulations issued thereunder as in effect on the date of this Statement of
Additional Information. New legislation, as well as administrative changes or
court decisions, may significantly change the conclusions expressed herein, and
may have a retroactive effect with respect to the transactions contemplated
herein.
The Fund expects to qualify as a regulated investment company under
Subchapter M of the Code. However, to qualify as a regulated investment company
for any taxable year, the Fund must derive at least 90% of its gross income
from dividends, interest, certain payments with respect to securities loans and
gains from the sale or other disposition of stock, securities or foreign
currencies and other income (including, but not limited to gains from options,
futures or forward contracts) derived with respect to its business of investing
in such stock, securities or currencies (the "Income Requirement").
In addition, at the close of each quarter of the Fund's taxable year, at
least 50% of the value of its assets must consist of cash and cash items, U.S.
government securities, securities of other regulated investment companies, and
securities of other issuers (as to which the Fund has not invested more than 5%
of the value of its total assets in securities of such issuer and as to which
the Fund does not hold more than 10% of the outstanding voting securities of
such issuer), and no more than 25% of the value of its total assets may be
invested in the securities of any one issuer (other than U.S. government
securities and securities of other regulated investment companies), or in two or
more issuers which the Fund controls and which are engaged in the same or
similar trades or businesses or related trades or businesses (the "Asset
Diversification Test"). Generally, the Fund will not lose its status as a
regulated investment company if it fails to meet the Asset Diversification Test
solely as a result of a fluctuation in value of portfolio assets not
attributable to a purchase.
Under Subchapter M, the Fund is exempt from federal income tax on its
taxable net investment income and net capital gains which it distributes to
shareholders, provided generally that it distributes at least 90% of its
investment company taxable income (net investment income and the excess of net
short-term capital gains over net long-term capital loss) for the year (the
"Distribution Requirement") and complies with the other requirements of the Code
described above. The Distribution Requirement for any year may be waived if a
regulated investment company establishes to the satisfaction of the Internal
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<PAGE>
Revenue Service that it is unable to satisfy the Distribution Requirement by
reason of distributions previously made for the purpose of avoiding liability
for federal excise tax (discussed below).
As noted in the Prospectus, exempt-interest dividends are excludable
from a shareholder's gross income for regular federal income tax purposes.
Exempt-interest dividends may nevertheless be subject to the alternative minimum
tax (the "Alternative Minimum Tax") imposed by Section 55 of the Code or the
environmental tax (the "Environmental Tax") imposed by Section 59A of the Code.
The Alternative Minimum Tax is imposed at rates up to 28% in the case of
non-corporate taxpayers and at the rate of 20% in the case of corporate
taxpayers, to the extent it exceeds the taxpayer's regular tax liability. The
Environmental Tax is imposed at the rate of 0.12% and applies only to corporate
taxpayers. The Alternative Minimum Tax and the Environmental Tax may be imposed
in two circumstances. First, exempt-interest dividends derived from certain
"private activity bonds" issued after August 7, 1986, will generally be an item
of tax preference for both corporate and non-corporate taxpayers. Second,
exempt- interest dividends, regardless of when the bonds from which they are
derived were issued or whether they are derived from private activity bonds,
will be included in the corporation's "adjusted current earnings," as defined in
Section 56(g) of the Code, in calculating the corporation's alternative minimum
taxable income for purposes of determining the Alternative Minimum Tax and the
Environmental Tax.
For purposes of the Distribution Requirement (as well as for other
purposes), the Fund will be required to treat as interest income any recognized
market discount on debt obligations which it holds. Generally, market discount
is the amount by which the stated redemption price of a bond exceeds the amount
paid by a purchaser of the bond (most common where the value of a bond decreases
after original issue as a result of a decline in the creditworthiness of the
issuer or an increase in prevailing interest rates). Generally, upon the
disposition of a bond bearing market discount or receipt of any principal
payment with respect to such a bond, market discount is recognized by treating a
portion of the proceeds as interest income. The application of these rules (and
the rules regarding original issue discount) to debt obligations held by the
Fund could affect (i) the amount and timing of distributions to shareholders and
(ii) the ability of the Fund to satisfy the Distribution Requirement.
If capital gain distributions have been made with respect to Shares that
are sold at a loss after being held for six months or less, then the loss is
treated as a long-term capital loss to the extent of the capital gain
distributions. Any gain or loss recognized on a sale or redemption of Shares of
the Fund by a shareholder who is not a dealer in securities will generally be
treated as a long-term capital gain or loss if the Shares have been held for
more than eighteen months, mid-term capital gain if the shares are held for
more than twelve months, but not more than eighteen months and otherwise will be
generally treated as a short-term capital gain or loss. Any loss recognized by a
shareholder upon the sale or redemption of Shares of the Fund held for six
months or less, however, will be disallowed to the extent of any exempt-interest
dividends received by the shareholder with respect to such Shares. If Shares on
which a net capital gain distribution has been received are subsequently sold or
redeemed and such Shares have been held for six months or less, any loss
recognized will be treated as a long-term capital loss to the extent of the
long-term capital gain distribution.
The deduction otherwise allowable to property and casualty insurance
companies for "losses incurred" will be reduced by an amount equal to a portion
of exempt-interest dividends received or accrued during any taxable year.
Foreign corporations engaged in a trade or business in the United States will be
subject to a "branch profits tax" on their "dividend equivalent amount" for the
taxable year, which will include exempt-interest dividends. Certain Subchapter S
corporations may also be subject to taxes on their "passive investment income,"
which could include exempt-interest dividends. Individuals whose "modified
income" exceeds a base amount will be subject to federal income tax in a portion
of their social security or railroad retirement benefits. Modified income
currently includes adjusted gross income, one-half of social security or
railroad retirement benefits and tax-exempt interest, including exempt-interest
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<PAGE>
dividends paid by the Fund. Individuals whose modified income exceeds certain
base amounts are required to include in gross income up to 85% of their social
security or railroad retirement benefits. Further, the Fund may not be an
appropriate investment for persons who are "substantial users" of facilities
financed by industrial development bonds or are "related persons" to such users.
A "substantial user" is defined generally to include certain persons who
regularly use a facility in their trade or business. Such persons should consult
their tax advisor before investing in the Fund.
Issuers of bonds purchased by the Fund (or the beneficiary of such
bonds) may have made certain representations or covenants in connection with the
issuance of such bonds to satisfy certain requirements of the Code that must be
satisfied subsequent to the issuance of such bonds. Shareholders should be aware
that exempt-interest dividends may become subject to federal income taxation
retroactively to the date of issuance of the bonds to which such dividends are
attributable if such representations are determined to have been inaccurate or
if the issuers (or the beneficiary) of the bonds fail to comply with certain
covenants made at that time.
If for any taxable year, the Fund does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to shareholders, and
such distributions will generally be taxable as ordinary dividends to the extent
of the Fund's current and accumulated earnings and profits. However, in the case
of corporate shareholders, such distributions will generally be eligible for the
70% dividends received deduction for "qualifying dividends."
The Fund will be required in certain cases to withhold and remit to the
United States Treasury 31% of distributions payable to any shareholder who (1)
has provided the Fund either an incorrect tax identification number or no number
at all, (2) who is subject to backup withholding by the Internal Revenue Service
for failure to properly report payments of interest or dividends, or (3) who has
failed to certify to the Fund that such shareholder is not subject to backup
withholding.
The Fund will provide a statement annually to shareholders as to the
federal tax status of distributions paid (or deemed to be paid) by the Fund
during the year.
The Code imposes a nondeductible 4% excise tax on regulated investment
companies that do not distribute in each calendar year an amount equal to 98% of
their ordinary income for the calendar year plus 98% of their capital gains net
income for the one-year period ending on October 31 of such calendar year. The
balance of such income must be distributed during the next calendar year. For
the foregoing purposes, an investment company is treated as having distributed
any amount on which it is subject to income tax for any taxable year ending in
such calendar year.
The Fund intends to make sufficient distributions of its ordinary income
and capital gains net income prior to the end of each calendar year to avoid
liability for excise tax. However, the Fund may in certain circumstances be
required to liquidate portfolio investments in order to make sufficient
distributions to avoid excise tax liability, and, in addition, the liquidation
of such investments in such circumstances may affect the ability of the Fund to
satisfy the Short-Short Gain Test.
Rules of state and local taxation of dividend and capital gains
distributions from regulated investment companies often differ from the rules
for federal income taxation described above. Shareholders are urged to consult
their tax advisors as to the consequences of these and other state and local tax
rules affecting an investment in the Fund and also as to the application of the
rules set forth above to a shareholder's particular circumstances.
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<PAGE>
5. MANAGEMENT OF THE FUND
Directors and Officers
The Directors and executive officers of the Fund, their respective dates
of birth and their principal occupations during the last five years are set
forth below. Unless otherwise indicated, the address of each Director and
executive officer is One South Street, Baltimore, Maryland 21202.
*RICHARD T. HALE, Chairman and Director (7/17/45
Managing Director, BT Alex. Brown Incorporated; Director and
President, Investment Company Capital Corp. (registered
investment advisor); Chartered Financial Analyst.
*TRUMAN T. SEMANS, Director (10/27/27)
Managing Director, BT Alex. Brown Incorporated; Director,
Investment Company Capital Corp. (registered investment
advisor); Formerly, Vice Chairman, Alex. Brown & Sons
Incorporated now BT Alex. Brown Incorporated.
JAMES J. CUNNANE, Director (3/11/38)
CBC Capital, 264 Carlyle Lake Drive, St. Louis, Missouri 63141.
Managing Director, CBC Capital (merchant banking), 1993-Present;
Formerly, Senior Vice-President and Chief Financial Officer,
General Dynamics Corporation (defense), 1989-1993 and Director,
The Arch Fund (registered investment companies).
JOHN F. KROEGER, Director (8/11/24)
37 Pippins Way, Morristown, New Jersey 07960. Director/Trustee,
AIM Funds (registered investment companies); Formerly,
Consultant, Wendell & Stockel Associates, Inc. (consulting firm)
and General Manager, Shell Oil Company.
LOUIS E. LEVY, Director (11/16/32)
26 Farmstead Road, Short Hills, New Jersey 07078. Director,
Kimberly-Clark Corporation (personal consumer products) and
Household International (banking and finance); Chairman of the
Quality Control Inquiry Committee, American Institute of
Certified Public Accountants; Formerly, Trustee, Merrill Lynch
Funds for Institutions, 1991-1993, Adjunct Professor, Columbia
University-Graduate School of Business, 1991-1992 and Partner,
KPMG Peat Marwick, retired 1990.
EUGENE J. McDONALD, Director (7/14/32)
Duke Management Company, Erwin Square, Suite 1000, 2200 West
Main Street, Durham, North Carolina 27705. President, Duke
Management Company (investments); Executive Vice President, Duke
University (education, research and health care); Director,
Central Carolina Bank & Trust (banking), Key Funds (registered
investment companies), and AMBAC Treasurers Trust (registered
investment companies) and DP Mann Holdings (insurance).
REBECCA W. RIMEL, Director (4/10/51)
The Pew Charitable Trusts, One Commerce Square, 2005 Market
Street, Suite 1700, Philadelphia, Pennsylvania 19103. President
and Chief Executive Officer, The Pew Charitable Trusts; Director
and Executive Vice President, The Glenmede Trust Company;
Formerly, Executive Director, The Pew Charitable Trusts.
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<PAGE>
CARL W. VOGT, Esq., Director (4/20/36)
Fulbright & Jaworski L.L.P., 801 Pennsylvania Avenue, N.W.,
Washington, D.C. 20004- 2604. Senior Partner, Fulbright &
Jaworski L.L.P. (law); Director, Yellow Corporation (trucking);
Formerly, Chairman and Member, National Transportation Safety
Board; Director, National Railroad Passenger Corporation
(Amtrak) and Member, Aviation System Capacity Advisory Committee
(Federal Aviation Administration).
HARRY WOOLF, President (8/12/23)
Institute for Advanced Study, South Olden Lane, Princeton, New
Jersey 08540. Professor- at-Large Emeritus, Institute for
Advanced Study; Director, ATL and Spacelabs Medical Corp.
(medical equipment) and Family Health International (non-profit
research and education); Director, Research America (non-profit
medical research); Formerly, Trustee, Reed College (education);
Trustee, Rockefeller Foundation; and Director, Merrill Lynch
Cluster C Funds (registered investment companies).
JOSEPH A. FINELLI, Treasurer (1/24/57)
Vice President, BT Alex. Brown Incorporated and Vice President,
Investment Company Capital Corp. (registered investment
advisor), September 1995-Present; Formerly, Vice President and
Treasurer, The Delaware Group of Funds (mutual funds) and Vice
President, Delaware Management Company, Inc. (investments),
1980-August 1995.
AMY M. OLMERT, Secretary (5/14/63)
Vice President, BT Alex. Brown Incorporated, June, 1997-Present.
Formerly, Senior Manager, Coopers & Lybrand, LLP, September,
1988-June, 1997.
LAURIE D. COLLIDGE, Assistant Secretary (1/1/66)
Asset Management Department, BT Alex. Brown Incorporated,
1991-Present.
- ---------------
* Messrs. Hale and Semans are Directors who are "interested persons," as
defined in the Investment Company Act.
Directors and officers of the Fund are also directors and officers of
some or all of the other investment companies managed, administered, advised or
distributed by BT Alex. Brown or its affiliates. There are currently 13 funds in
the Flag Investors/ISI Funds and BT Alex. Brown Cash Reserve Fund, Inc. fund
complex (the "Fund Complex"). Mr. Semans serves as Chairman of five funds and as
a Director of six other funds in the Fund Complex. Mr. Hale serves as Chairman
of four funds and Director of eleven other funds in the Fund Complex. Messrs.
Cunnane, Kroeger, Levy, and McDonald serve as Directors of each fund in the Fund
Complex. Mr. Woolf serves as President of seven Funds in the Fund Complex. Ms.
Rimel and Mr. Vogt serve as Director of eleven funds in the Fund Complex. Ms.
Olmert serves as Secretary, Mr. Finelli serves as Treasurer and Ms. Collidge
serves as Assistant Secretary, respectively, of each fund in the Fund Complex.
Some of the Directors of the Fund are customers of, and have had normal
brokerage transactions with, BT Alex. Brown in the ordinary course of business.
All such transactions were made on substantially the same terms as those
prevailing at the time for comparable transactions with unrelated persons.
Additional transactions may be expected to take place in the future.
With the exception of the Fund's President, officers of the Fund receive
no direct remuneration in such capacity from the Fund. Officers and Directors of
the Fund who are officers or directors of BT Alex. Brown may be considered to
have received remuneration indirectly. As
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<PAGE>
compensation for his services as President, Mr. Woolf receives an annual fee
from all Flag Investors Funds for which he serves as President and from the BT
Alex. Brown Cash Reserve Fund, Inc. As compensation for his or her services as
Director, each Director who is not an "interested person" of the Fund (as
defined in the Investment Company Act) (a "Non-Interested Director"), receives
an aggregate annual fee (plus reimbursement for reasonable out-of-pocket
expenses incurred in connection with his or her attendance at Board and
committee meetings) from all Flag Investors/ISI Funds and BT Alex. Brown Cash
Reserve Fund, Inc. for which he or she serves. In addition, the Chairman of the
Fund Complex's Audit Committee receives an aggregate annual fee from the Fund
Complex. Payment of such fees and expenses are allocated among all such funds
described above in direct proportion to their relative net assets. For the
fiscal year ended March 31, 1997, Non-Interested Directors' fees attributable to
the assets of the Fund totaled approximately $1,511.
The following table shows aggregate compensation payable to each of the
Fund's Directors by the Fund and the Fund Complex, respectively, and pension or
retirement benefits accrued as part of Fund expenses in the fiscal year ended
March 31, 1997.
<TABLE>
<CAPTION>
COMPENSATION TABLE
- ------------------------------------------------------------------------------------------------------------------------------
Name of Person, Aggregate Compensation From Pension or Retirement Total Compensation from the Fund and
Position the Fund Payable to Directors Benefits Accrued as Part Fund Complex Payable to Directors for
for the Fiscal Year Ended of Fund Expenses the Fiscal Year Ended March 31, 1997
March 31, 1997
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Richard T. Hale (1) $0 $0 $0
Chairman and Director
Truman T. Semans (1) $0 $0 $0
Director
James J. Cunnane $156(2) (3) $39,000 for service on 12
Director Boards in the Fund Complex
John F. Kroeger $196(2) (3) $49,000 for service on 12
Director Boards in the Fund Complex
Louis E. Levy $156(2) (3) $39,000 for service on 12
Director Boards in the Fund Complex
Eugene J. McDonald $156(2) (3) $39,000 for service on 12
Director Boards in the Fund Complex
Rebecca W. Rimel $178(2) (3) $39,000 for service on 10
Director Boards in the Fund Complex (5)
Carl W. Vogt, Esq. $0 (4) (3) $39,000 for service on 9
Director Boards in the Fund Complex (5)
Harry Woolf (6) $116(2) (3) $29,250 for service on 12
Director Boards in the Fund Complex
</TABLE>
- -----------------------------
(1) A Director who is an "interested person" as defined in the Investment
Company Act.
(2) None of this amount has been deferred pursuant to a deferred compensation
plan.
(3) The Fund Complex has adopted a retirement plan for eligible Directors, as
described below. The actuarially computed pension expense for the year
ended March 31, 1997 was approximately $950.
(4) Mr. Vogt was elected Director to the Fund on August 14, 1997.
(5) Ms. Rimel receives proportionately higher compensation from each fund for
which she serves as a Director.
(6) Retired as Director of the Fund on December 31, 1996 and was appointed
President of the Fund on September 1, 1997.
The Fund Complex has adopted a retirement plan (the "Retirement Plan")
for Directors who are not employees of the Fund, the Fund's Advisor or their
respective affiliates (the "Participants"). After
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<PAGE>
completion of six years of service, each Participant will be entitled to receive
an annual retirement benefit equal to a percentage of the fee earned by such
Participant in his or her last year of service. Upon retirement, each
Participant will receive annually 10% of such fee for each year that he or she
served after completion of the first five years, up to a maximum annual benefit
of 50% of the fee earned by such participant in his or her last year of service.
The fee will be paid quarterly, for life, by each Fund for which he or she
serves. The Retirement Plan is unfunded and unvested. Mr. Kroeger has qualified
but has not received benefits. The Fund has two Participants, a Director who
retired effective December 31, 1994 and a Director who retired effective
December 31, 1996, who have qualified for the Retirement Plan by serving
thirteen and fourteen years, respectively, as Directors in the Fund Complex, and
each of whom will be paid a quarterly fee of $4,875 by the Fund Complex for the
rest of his life. Another Participant, who retired on January 31, 1996 and died
on June 2, 1996 was paid fees of $8,090 by the Fund Complex under the Retirement
Plan in the fiscal year ended March 31, 1997. Such fees are allocated to each
fund in the Fund Complex based upon the relative net assets of such fund to the
Fund Complex.
Set forth in the table below are the estimated annual benefits payable
to a Participant upon retirement assuming various years of service and payment
of a percentage of the fee earned by such Participant in his or her last year of
service, as described above. The approximate credited years of service at March
31, 1997 are as follows: for Mr. Cunnane, 2 years; for Mr. Kroeger, 14 years;
for Mr. Levy, 2 years; for Mr. McDonald, 4 years; for Mr. Vogt, 1 year and for
Ms. Rimel, 1 year, respectively.
<TABLE>
<CAPTION>
Years of Service Estimated Annual Benefits Payable By Fund Complex Upon Retirement
- ---------------- -----------------------------------------------------------------
Chairman of Audit Committee Other Participants
--------------------------- ------------------
<S> <C> <C>
6 years $4,900 $3,900
7 years $9,800 $7,800
8 years $14,700 $11,700
9 years $19,600 $15,600
10 years or more $24,500 $19,500
</TABLE>
Any Director who receives fees from the Fund is permitted to defer a
minimum of 50%, or up to all, of his or her annual compensation pursuant to a
Deferred Compensation Plan. Messrs. Cunnane, Kroeger, Levy, McDonald and Vogt
and Ms. Rimel have each executed a Deferred Compensation Agreement. Currently,
the deferring Directors may select various Flag Investors and BT Alex. Brown
Cash Reserve Funds in which all or part of their deferral account shall be
deemed to be invested. Distributions from the deferring Directors' deferral
accounts will be paid in cash, in generally equal quarterly installments over a
period of ten years.
Code of Ethics
The Board of Directors of the Fund has adopted a Code of Ethics
pursuant to Rule 17j-1 under the Investment Company Act. The Code of Ethics
applies to the personal investing activities of all directors and officers of
the Fund, as well as to designated officers, directors and employees of the
Advisor and the Distributor. As described below, the Code of Ethics imposes
significant restrictions on the Advisor's investment personnel, including the
portfolio managers and employees who execute or help execute a portfolio
manager's decisions or who obtain contemporaneous information regarding the
purchase or sale of a security by the Fund.
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<PAGE>
The Code of Ethics requires that covered employees of the Advisor,
certain directors or officers and all Fund Directors who are "interested
persons," preclear personal securities investments (with certain exceptions,
such as non-volitional purchases or purchases which are part of an automatic
dividend reinvestment plan). The preclearance requirement and associated
procedures are designed to identify any substantive prohibition or limitation
applicable to the proposed investment. The substantive restrictions applicable
to investment personnel include a ban on acquiring any securities in an initial
public offering, a prohibition from profiting on short-term trading in
securities and preclearance of the acquisition of securities in private
placements. Furthermore, the Code of Ethics provides for trading "blackout
periods" that prohibit trading by investment personnel and certain other
employees within periods of trading by the Fund in the same security. Officers,
directors and employees of the Advisor and the Distributor may comply with codes
of ethics instituted by those entities so long as they contain similar
requirements and restrictions.
6. INVESTMENT ADVISORY AND OTHER SERVICES
On August 14, 1997, the shareholders of the Fund approved an Investment
Advisory Agreement between the Fund and Investment Company Capital Corp. ("ICC"
or the "Advisor"). ICC is an indirect subsidiary of Bankers Trust New York
Corporation. ICC is also the investment advisor to BT Alex. Brown Cash Reserve
Fund, Inc., Flag Investors Telephone Income Fund, Inc., Flag Investors Value
Builder Fund, Inc., Flag Investors International Fund, Inc., Flag Investors
Emerging Growth Fund, Inc., Flag Investors Short-Intermediate Income Fund, Inc.
(formerly Flag Investors Intermediate-Term Income Fund, Inc.), Flag Investors
Real Estate Securities Fund, Inc. and Flag Investors Equity Partners Fund, Inc.
Prior to August 14, 1997, ICC provided investment advisory services to the Fund
pursuant to an agreement dated October 1, 1993 for the same compensation and on
substantially the same terms as the current Investment Advisory Agreement.
Under the Investment Advisory Agreement, ICC is responsible for
obtaining and evaluating economic, statistical and financial information to
formulate and implement investment policies for the Fund. Any investment program
undertaken by ICC will at all times be subject to policies and control of the
Fund's Board of Directors. ICC will provide the Fund with office space for
managing its affairs, with the services of required executive personnel, subject
to applicable banking regulations, and with certain clerical and bookkeeping
services and facilities. These services are provided by ICC without
reimbursement by the Fund for any costs. ICC shall not be liable to the Fund or
its shareholders for any act or omission by ICC or any losses sustained by the
Fund or its shareholders, except in the case of willful misfeasance, bad faith,
gross negligence, or reckless disregard of duty. As compensation for its
services, ICC receives an annual fee from the Fund, payable monthly, at the
annual rate of .35% of the Fund's average daily net assets. ICC has voluntarily
agreed to reduce its annual fee, if necessary, or to make payments to the Fund
to the extent required so that the Fund's annual expenses do not exceed .70% of
the Flag Investors Class A Shares' average daily net assets and .45% of the Flag
Investors Institutional Shares' and the ABCAT Shares' respective average daily
net assets. The services of ICC to the Fund are not exclusive and ICC is free to
render similar services to others.
The Investment Advisory Agreement has an initial term of two years and
will continue in effect from year to year thereafter if such continuance is
specifically approved at least annually by the Fund's Board of Directors,
including a majority of the Non-Interested Directors who have no direct or
indirect financial interest in such agreement, by votes cast in person at a
meeting called for such purpose, or by a vote of a majority of the outstanding
Shares (as defined under "Capital Stock"). The Investment Advisory Agreement was
initially approved by the Fund's Board of Directors on June 17, 1997. The Fund
or ICC may terminate the Investment Advisory Agreement on sixty days' written
notice without
-18-
<PAGE>
penalty. The Investment Advisory Agreement will terminate automatically in the
event of assignment (as defined in the Investment Company Act). For the fiscal
years ended March 31, 1997, March 31, 1996 and March 31, 1995, ICC waived all
advisory fees ($79,698, $51,908 and $45,630, respectively). In addition, for the
same period, ICC reimbursed the Fund for other expenses aggregating $64,880,
$87,047 and $90,867, respectively. Absent such waivers and reimbursements, the
Fund's total operating expenses would have been 1.34%, 1.69% and 1.85%,
respectively, of the Flag Investors Class A Shares' average daily net assets for
the fiscal years ended March 31, 1997, March 31, 1996 and March 31, 1995. For
the fiscal year ended March 31, 1997 and the period ended March 31, 1996, total
operating expenses would have been 1.09% and 1.30% (annualized), respectively,
of the Flag Investors Institutional Shares' average daily net assets.
In addition to its services as investment advisor, ICC also provides
accounting services to the Fund and serves as the Fund's transfer and dividend
disbursing agent. (See "Custodian, Transfer Agent and Accounting Services.")
7. DISTRIBUTION OF FUND SHARES
ICC Distributors, Inc. ("ICC Distributors" or the "Distributor") serves
as the distributor of each class of the Fund's Shares pursuant to a Distribution
Agreement dated September 1, 1997 ("Distribution Agreement"). Prior to September
1, 1997, Alex. Brown & Sons Incorporated ("Alex. Brown") served as the Fund's
distributor pursuant to three separate agreements each with the same rates of
compensation and substantially the same terms as the Distribution Agreement.
The Distribution Agreement provides that ICC Distributors has the
exclusive right to distribute Shares of the Fund either directly or through
other broker-dealers and further provides that ICC Distributors will: (a)
solicit and receive orders for the purchase of Flag Investors Class A Shares;
(b) accept or reject such orders on behalf of the Fund in accordance with the
Fund's currently effective Prospectuses and transmit such orders as are accepted
to the Fund's transfer agent as promptly as possible; (c) receive requests for
redemptions and transmit such redemption requests to the Fund's transfer agent
as promptly as possible; and (d) respond to inquiries from shareholders
concerning the status of their accounts and the operations of the Fund; (e)
maintain such accounts, books and records as may be required by law or be deemed
appropriate by the Board of Directors; and (f) take all actions necessary to
carry into effect the distribution of the Shares. ICC Distributors has not
undertaken to sell any specific number of Shares. The Distribution Agreement
further provides that, in connection with the distribution of Shares, ICC
Distributors will be responsible for all of the promotional expenses. The
services provided by ICC Distributors to the Fund are not exclusive, and ICC
Distributors is free to provide similar services to others. ICC Distributors
shall not be liable to the Fund or its shareholders for any act or omission by
ICC Distributors or any losses sustained by the Fund or its shareholders except
in the case of willful misfeasance, bad faith, gross negligence or reckless
disregard of duty. The Distribution Agreement further provides that the Fund and
ICC Distributors will mutually indemnify each other for losses relating to the
disclosures in the Fund's registration statement.
The Distribution Agreement was approved by the Fund's Board of
Directors on August 4, 1997. The Agreement has an initial term of two years and
will remain in effect from year to year thereafter if specifically approved at
least annually by the Fund's Board of Directors and by the affirmative vote of a
majority of the Non-Interested Directors by votes cast at a meeting called for
such purpose. The Agreement may be terminated at any time upon sixty days'
written notice, without penalty, by the vote of a majority of the Fund's
Non-Interested Directors or by a vote of the outstanding shares of the class (as
defined under Capital Stock). The Distribution Agreement and any
Sub-Distribution Agreement shall automatically terminate in the event of
assignment.
-19-
<PAGE>
With respect to the Flag Investors Class A Shares and Flag Investors
Institutional Shares, ICC Distributors and certain broker-dealers
("Participating Dealers") have entered into Sub-Distribution Agreements under
which such Participating Dealers have agreed to process investor purchase and
redemption orders and respond to inquiries from shareholders concerning the
status of their accounts and the operations of the Fund. It is not currently
anticipated that ICC Distributors will enter into Sub-Distribution Agreements
for the ABCAT Shares.
As compensation for providing distribution services for the Flag
Investors Class A Shares as described above, ICC Distributors receives an annual
fee, paid monthly, equal to .25% of the average daily net assets of the Flag
Investors Class A Shares. ICC Distributors expects to allocate most of its
annual fee to its investment representatives and up to all of its fee to
Participating Dealers. For the fiscal years ended March 31, 1997, March 31, 1996
and March 31, 1995, Alex. Brown, formerly the Fund's Distributor, received
distribution fees of $29,887, $32,318, and $32,593, respectively. ICC
Distributors receives no compensation for distributing the Flag Investors
Institutional Shares or the ABCAT Shares.
Pursuant to Rule 12b-1 under the Investment Company Act, which provides
that investment companies may pay distribution expenses, directly or indirectly,
only pursuant to a plan adopted by the investment company's board of directors
and approved by its shareholders, the Fund has adopted a Plan of Distribution
for the Flag Investors Class A Shares ("Flag Investors Class A Distribution
Plan"). Under the Flag Investors Class A Plan, the Fund pays a fee to ICC
Distributors for distribution and other shareholder servicing assistance as set
forth in the Distribution Agreement, and ICC Distributors is authorized to make
payments out of its fee to participating broker-dealers.
In approving the Flag Investors Class A Plan, the Directors concluded,
in the exercise of reasonable business judgment, that there was a reasonable
likelihood that the Flag Investors Class A Plan would benefit the Fund and its
shareholders. The Flag Investors Class A Plan will be renewed only if the
Directors make a similar determination in each subsequent year. The Flag
Investors Class A Plan may not be amended to increase materially the fee to be
paid pursuant to the Flag Investors Class A Distribution Agreement without the
approval of the shareholders of the Fund. The Flag Investors Class A Plan may be
terminated at any time and the Flag Investors Class A Distribution Agreement may
be terminated at any time upon sixty days' notice, in either case without
penalty, by the vote of a majority of the Fund's Non-Interested Directors or by
a vote of a majority of the outstanding Flag Investors Class A Shares (as
defined under "Capital Stock"). Any Sub-Distribution Agreement may be terminated
in the same manner at any time. The Flag Investors Class A Distribution
Agreement and any Sub-Distribution Agreement shall automatically terminate in
the event of assignment.
During the continuance of the Flag Investors Class A Plan, the Fund's
Board of Directors will be provided for their review, at least quarterly, a
written report concerning the payments made under the Flag Investors Class A
Plan to ICC Distributors pursuant to the Flag Investors Class A Distribution
Agreement and to broker-dealers pursuant to Sub-Distribution Agreements. Such
reports will be made by the persons authorized to make such payments. In
addition, during the continuance of the Flag Investors Class A Plan, the
selection and nomination of the Fund's Non-Interested Directors will be
committed to the discretion of the Non-Interested Directors then in office.
For the fiscal year ended March 31, 1997, the Fund paid $29,887 to
Alex. Brown, formerly the Fund's distributor, pursuant to the Flag Investors
Class A Plan. Alex. Brown, in turn, paid the distribution-related expenses of
the Fund including one or more of the following: advertising expenses; printing
and
-20-
<PAGE>
mailing of prospectuses to other than current shareholders; compensation to
dealers and sales personnel; and interest, carrying or other financing charges.
In addition, with respect to the Flag Investors Class A Shares, the
Fund may enter into Shareholder Servicing Agreements with certain financial
institutions, such as banks, to act as Shareholder Servicing Agents, pursuant to
which ICC Distributors will allocate a portion of its distribution fee as
compensation for such financial institutions' ongoing shareholder services.
Although banking laws and regulations prohibit banks from distributing
shares of open-end investment companies such as the Fund, according to
interpretations by various bank regulatory authorities, financial institutions
are not prohibited from acting in other capacities for investment companies,
such as the shareholder servicing capacities described above. Should future
legislative, judicial or administrative action prohibit or restrict the
activities of the Shareholder Servicing Agents in connection with the
Shareholder Servicing Agreements, the Fund may be required to alter materially
or discontinue its arrangements with the Shareholder Servicing Agents. Such
financial institutions may impose separate fees in connection with these
services and investors should review the Prospectus and this Statement of
Additional Information in conjunction with any such institution's fee schedule.
Under the Flag Investors Class A Plan, amounts allocated to
Participating Dealers and Shareholder Servicing Agents may not exceed amounts
payable to ICC Distributors under the Flag Investors Class A Plan. Payments
under the Flag Investors Class A Plan are made as described above regardless of
ICC Distributors' actual cost of providing distribution services and may be
used to pay ICC Distributors' overhead expenses. If the cost of providing
distribution services to the Fund in connection with the sale of the Flag
Investors Class A Shares is less than .25% of the Fund's average daily net
assets for any period, the unexpended portion of the distribution fee may be
retained by ICC Distributors. The Flag Investors Class A Plan does not provide
for any charges to the Fund for excess amounts expended by ICC Distributors and,
if the Flag Investors Class A Plan is terminated in accordance with its terms,
the obligation of the Fund to make payments to ICC Distributors pursuant to the
Flag Investors Class A Plan will cease and the Fund will not be required to make
any payments past the date the Distribution Agreement terminates.
General Information
The Fund will pay all costs associated with its organization and
registration under the Securities Act of 1933 and the Investment Company Act.
Except as described elsewhere, the Fund pays or causes to be paid all continuing
expenses of the Fund, including, without limitation: investment advisory and
distribution fees; the charges and expenses of any registrar, any custodian or
depository appointed by the Fund for the safekeeping of cash, portfolio
securities and other property, and any transfer, dividend or accounting agent or
agents appointed by the Fund; brokers' commissions chargeable to the Fund in
connection with portfolio securities transactions to which the Fund is a party;
all taxes, including securities issuance and transfer taxes, and fees payable by
the Fund to federal, state or other governmental agencies; the costs and
expenses of engraving or printing of certificates representing Shares; all costs
and expenses in connection with the registration and maintenance of registration
of the Fund and its Shares with the SEC and various states and other
jurisdictions (including filing fees, legal fees and disbursements of counsel);
the costs and expenses of printing, including typesetting and distributing
prospectuses and statements of additional information of the Fund and
supplements thereto to the Fund's
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<PAGE>
shareholders; all expenses of shareholders' and Directors' meetings and of
preparing, printing and mailing proxy statements and reports to shareholders;
fees and travel expenses of Directors and Director members of any advisory board
or committee; all expenses incident to the payment of any dividend,
distribution, withdrawal or redemption, whether in Shares or in cash; charges
and expenses of any outside service used for pricing of the Shares; fees and
expenses of legal counsel, including counsel to the Non-Interested Directors,
and of independent auditors, in connection with any matter relating to the Fund;
a portion of membership dues of industry associations; interest payable on Fund
borrowings; postage; insurance premiums on property or personnel (including
officers and Directors) of the Fund which inure to its benefit; extraordinary
expenses (including, but not limited to, legal claims and liabilities and
litigation costs and any indemnification related thereto); and all other charges
and costs of the Fund's operation unless otherwise explicitly assumed by ICC or
the Distributor.
The address of ICC Distributors is P.O. Box 7558, Portland, Maine 04101.
8. BROKERAGE
ICC is responsible for decisions to buy and sell securities for the
Fund, for the broker-dealer selection and for negotiation of commission rates.
Purchases and sales of securities on a securities exchange are effected through
broker-dealers who charge a commission for their services. ICC may direct
purchase and sale orders to any broker-dealer, including, to the extent and in
the manner permitted by applicable law, its affiliates, and ICC Distributors.
In over-the-counter transactions, orders are placed directly with a
principal market maker and such purchases normally include a mark up over the
bid to the broker-dealer based on the spread between the bid and asked price for
the security. Purchases from underwriters of portfolio securities include a
commission or concession paid by the issuer to the underwriter. On occasion,
certain money market instruments may be purchased directly from an issuer
without payment of a commission or concession. The Fund will not deal with the
Advisor or its affiliates in any transaction in which the Advisor or its
affiliates acts as a principal; that is, an order will not be placed with the
Advisor or its affiliates if execution of the trade involves the Advisor or its
affiliates serving as a principal with respect to any part of the Fund's order,
nor will the Fund buy or sell over-the-counter securities with the Advisor or
its affiliates acting as market maker.
If the Advisor or its affiliates is participating in an underwriting or
selling group, the Fund may not buy portfolio securities from the group except
in accordance with rules of the SEC. The Fund believes that the limitation will
not affect its ability to carry out its present investment objective.
ICC's primary consideration in effecting securities transactions is to
obtain best price and execution of orders on an overall basis. As described
below, however, ICC may, in its discretion, effect brokerage transactions with
broker-dealers that furnish statistical, research or other information or
services which are deemed by ICC to be beneficial to the Fund's investment
program. Certain research services furnished by broker-dealers may be useful to
ICC with clients other than the Fund. Similarly, any research services received
by ICC through placement of portfolio transactions of other clients may be of
value to ICC in fulfilling its obligations to the Fund. No specific value can be
determined for research and statistical services furnished without cost to ICC
by a broker-dealer. ICC is of the opinion that because the material must be
analyzed and reviewed by its staff, its receipt does not tend to reduce
expenses, but may be beneficial in supplementing ICC's research and analysis.
Therefore, it may tend to benefit the Fund by improving ICC's investment advice.
ICC's policy is to pay a broker-dealer higher commissions for particular
transactions than might be charged if a different broker-dealer had been chosen
when, in ICC's opinion, this policy furthers the overall objective of obtaining
best price and execution. Subject to periodic
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<PAGE>
review by the Fund's Board of Directors, ICC is also authorized to pay
broker-dealers other than BT Alex. Brown higher commissions on brokerage
transactions for the Fund in order to secure research and investment services
described above. The allocation of orders among broker-dealers and the
commission rates paid by the Fund will be reviewed periodically by the Board of
Directors.
Subject to the above considerations, the Board of Directors has
authorized the Fund to effect portfolio transactions, on an agency basis,
through the Advisor or its affiliates. At the time of such authorization certain
policies and procedures incorporating the standards of Rule 17e-1 under the
Investment Company Act which requires that the commissions paid the Advisor or
its affiliates must be "reasonable and fair compared to the commission, fee or
other remuneration received or to be received by other brokers in connection
with comparable transactions involving similar securities during a comparable
period of time." Rule 17e-1 also contains requirements for the review of such
transactions by the Board of Directors and requires ICC to furnish reports and
to maintain records in connection with such reviews. For the fiscal year ended
March 31, 1997, the Fund paid no brokerage commissions to Alex. Brown & Sons
Incorporated, predecessor to BT Alex. Brown.
ICC manages other investment accounts. It is possible that, at times,
identical securities will be acceptable for the Fund and one or more of such
other accounts; however, the position of each account in the securities of the
same issuer may vary and the length of time that each account may choose to hold
its investment in such securities may likewise vary. The timing and amount of
purchase by each account will also be determined by its cash position. If the
purchase or sale of securities consistent with the investment policies of the
Fund or one or more of these accounts is considered at or about the same time,
transactions in such securities will be allocated among the accounts in a manner
deemed equitable by ICC. ICC may combine such transactions, in accordance with
applicable laws and regulations, in order to obtain the best net price and most
favorable execution. Such simultaneous transactions, however, could adversely
affect the ability of the Fund to obtain or dispose of the full amount of a
security which it seeks to purchase or sell.
During the fiscal year ended March 31, 1997, Alex. Brown directed no
transactions to broker-dealers and paid no related commissions to broker dealers
because of research services provided.
The Fund is required to identify any securities of its "regular brokers
or dealers" (as such term is defined in the Investment Company Act) which the
Fund has acquired during its most recent fiscal year. As of March 31, 1997, the
Fund held a 6.25% repurchase agreement issued by Goldman Sachs & Co. which was
valued at $293,000.
9. CAPITAL STOCK
The Fund is authorized to issue 40 million Shares of common stock, par
value $.001 per share. The Board of Directors may increase or decrease the
number of authorized Shares without shareholder approval.
The Fund's Articles of Incorporation provide for the establishment of
separate series and separate classes of Shares by the Directors at any time
without shareholder approval. The Fund currently has one Series and the Board
has designated four classes of shares: Flag Investors Maryland Intermediate Tax-
Free Income Fund Class A Shares, Flag Investors Maryland Intermediate Tax-Free
Income Fund Class B Shares, Flag Investors Maryland Intermediate Tax-Free Income
Fund Institutional Shares and Alex. Brown Capital Advisory & Trust Maryland
Intermediate Tax-Free Income Shares. The Flag Investors Institutional Shares are
offered only to certain eligible institutions and to clients of investment
advisory affiliates of
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<PAGE>
Alex. Brown. The ABCAT Shares are offered only to clients of Alex. Brown Capital
Advisory & Trust Company and its affiliates. The Flag Investors Class B Shares
are not currently being offered. Shares of the Fund, regardless of series or
class would have equal rights with respect to voting, except that with respect
to any matter affecting the rights of the holders of a particular series or
class, the holders of each series or class would vote separately. In general,
each series would be managed separately and shareholders of each series would
have an undivided interest in the net assets of that series. For tax purposes,
the series would be treated as separate entities. Generally, each class of
Shares would be identical to every other class in a particular series and
expenses of the Fund (other than 12b-1 and any applicable service fees) would be
prorated between all classes of a series based upon the relative net assets of
each class. Any matters affecting any class exclusively will be voted on by the
holders of such class.
Shareholders of the Fund do not have cumulative voting rights, and
therefore the holders of more than 50% of the outstanding Shares voting together
for election of Directors may elect all the members of the Board of Directors of
the Fund. In such event, the remaining holders cannot elect any members of the
Board of Directors of the Fund. There are no preemptive, conversion or exchange
rights applicable to any of the Shares. The issued and outstanding Shares are
fully paid and non-assessable. In the event of liquidation or dissolution of the
Fund, each Share is entitled to its portion of the Fund's assets (or the assets
allocated to a separate series of shares if there is more than one series) after
all debts and expenses have been paid.
As used in this Statement of Additional Information the term "majority
of the outstanding Shares" means the vote of the lesser of (i) 67% or more of
the Shares present at a meeting, if the holders of more than 50% of the
outstanding Shares are present or represented by proxy, or (ii) more than 50% of
the outstanding Shares.
10. SEMI-ANNUAL REPORTS
The Fund furnishes shareholders with semi-annual reports containing
information about the Fund and its operations, including a list of investments
held in the Fund's portfolio and financial statements. The annual financial
statements are audited by the Fund's independent auditors.
11. CUSTODIAN, TRANSFER AGENT AND ACCOUNTING SERVICES
PNC Bank, National Association ("PNC Bank"), with offices at Airport
Business Park, 200 Stevens Drive, Lester, Pennsylvania, 19113, has been retained
to act as Custodian of the Fund's investments. PNC Bank receives such
compensation from the Fund for its services as Custodian as may be agreed to
from time to time by PNC Bank and the Fund. Investment Company Capital Corp.,
One South Street, Baltimore, Maryland 21202, serves as transfer and dividend
disbursing agent and provides certain accounting services to the Fund under a
Master Services Agreement between the Fund and ICC. As compensation for
providing dividend and transfer agency services, the Fund pays ICC up to $12.83
per account per year, plus reimbursement for out-of-pocket expenses incurred in
connection therewith. ICC, as the Fund's Transfer Agent, has received fees for
the fiscal year ended March 31, 1997 which totaled $11,297. The Fund's Board of
Directors has approved Bankers Trust Company, a subsidiary of Bankers Trust New
York Corporation and an affiliate of the Fund, 130 Liberty Street, New York, New
York 10006 as custodian to the Fund. Currently, it is anticipated that Bankers
Trust Company will provide custodial services to the Fund effective September
22, 1997.
ICC also provides certain accounting services to the Fund. As
compensation for providing accounting services, ICC receives an annual fee,
calculated daily and paid monthly, as shown below.
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<PAGE>
<TABLE>
<CAPTION>
Average Daily Net Assets Incremental Annual Accounting Fees
------------------------ ----------------------------------
<S> <C>
$ 0 - $ 10,000,000 $13,000(fixed fee)
$ 10,000,001 - $ 20,000,000 .100%
$ 20,000,001 - $ 30,000,000 .080%
$ 30,000,001 - $ 40,000,000 .060%
$ 40,000,001 - $ 50,000,000 .050%
$ 50,000,001 - $ 60,000,000 .040%
$ 60,000,001 - $ 70,000,000 .030%
$ 70,000,001 - $ 100,000,000 .020%
$100,000,001 - $ 500,000,000 .015%
$500,000,001 - $1,000,000,000 .005%
over $1,000,000,000 .001%
</TABLE>
In addition, the Fund will reimburse ICC for the following
out-of-pocket expenses incurred in connection with provision of ICC's accounting
services under the Master Services Agreement: express delivery service,
independent pricing and storage.
For the fiscal year ended March 31, 1997, ICC received accounting fees
of $25,202.
12. INDEPENDENT AUDITORS
The annual financial statements of the Fund are audited by Deloitte &
Touche LLP.
13. PERFORMANCE INFORMATION
For purposes of quoting and comparing the performance of the Fund to
that of other open-end non-diversified management investment companies and to
stock or other relevant indices or averages in advertisements or in certain
reports to shareholders, performance will generally be stated both in terms of
total return and in terms of yield. However, the Fund may also from time to time
state the performance of the Fund solely in terms of total return.
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<PAGE>
Total Return Calculations
The total return quotations, under the rules of the SEC, must be
calculated according to the following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1-, 5- or 10-)
ERV = ending redeemable value at the end of the 1-, 5-, or
10-year periods (or fractional portion thereof) of a
hypothetical $1,000 payment made at the beginning of
the 1-, 5- or 10-year periods.
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and will cover one-,
five-, and ten-year periods or a shorter period dating from the effectiveness of
the Fund's registration statement (or the later commencement of operations of a
Series or class). During its first year of operations, the Fund may, in lieu of
annualizing its total return, use an aggregate total return calculated in the
same manner. In calculating the ending redeemable value, the maximum sales load
(1.50% for the Flag Investors Class A Shares) is deducted from the initial
$1,000 payment and all dividends and distributions by the Fund are assumed to
have been reinvested at net asset value as described in the Prospectus on the
reinvestment dates during the period. "T" in the formula above is calculated by
finding the average annual compounded rate of return over the period that would
equate an assumed initial payment of $1,000 to the ending redeemable value. Any
sales loads that might in the future be made applicable at the time to
reinvestments would be included as would any recurring account charges that
might be imposed by the Fund. The Flag Investors Institutional Shares and the
ABCAT Shares are sold without a sales load.
Calculated according to SEC rules, the ending redeemable value and
average annual total return of a hypothetical $1,000 payment for the period
ended March 31, 1997 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
One-Year Period Ended Since Inception
March 31, 1997
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Ending Average Ending Average
Redeemable Annual Total Redeemable Annual Total
Class Value Return Value Return
- --------------------------------------------------------------------------------------------------------------------
Class A $1024.91 4.05% $1118.37 3.25%
October 1, 1993*
- --------------------------------------------------------------------------------------------------------------------
Institutional $1042.68 4.27% $1054.81 3.86%
November 2, 1995*
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
One-Year Period Ended Since Inception
March 31, 1997
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Ending Average Ending Average
Redeemable Annual Total Redeemable Annual Total
Class Value Return Value Return
- --------------------------------------------------------------------------------------------------------------------
ABCAT
January 10, 1997* N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
- -----------
* Inception Date
The Fund may also from time to time include in such advertising total
return figures that are not calculated according to the formula set forth above
to compare more accurately the Fund's performance with other measures of
investment return. For example, in comparing the Fund's total return with data
published by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc.
or Morningstar Inc., the Fund calculates its aggregate and average annual total
return for the specified periods of time by assuming the investment of $10,000
in Shares and assuming the reinvestment of each dividend or other distribution
at net asset value on the reinvestment date. For this alternative computation,
the Fund assumes that the $10,000 invested in Shares is net of all sales charges
(as distinguished from the computation required by the SEC where the $1,000
payment is reduced by sales charges before being invested in Shares). The Fund
will, however, disclose the maximum sales charges and will also disclose that
the performance data do not reflect sales charges and that inclusion of sales
charges would reduce the performance quoted. Such alternative total return
information will be given no greater prominence in such advertising than the
information prescribed under SEC rules, and all advertisements containing
performance data will include a legend disclosing that such performance data
represent past performance and that the investment return and principal value of
an investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost.
Yield Calculations
The Fund's yield for the 30-day period ended March 31, 1997 was 4.24%
for the Flag Investors Class A Shares and 4.55% for the Flag Investors
Institutional Shares and was computed in the manner discussed below. The yield
of the Fund is calculated by dividing the net investment income per Share earned
by the Fund during a 30-day (or one month) period by the maximum offering price
per share on the last day of the period and annualizing the result on a
semiannual basis by adding one to the quotient, raising the sum to the power of
six, subtracting one from the result and then doubling the difference. The
Fund's yield calculations assume a maximum sales charge of 1.50% for the Flag
Investors Class A Shares and no sales charge for the Flag Investors
Institutional Shares or the ABCAT Shares. The Fund's net investment income per
Share earned during the period is based on the average daily number of Shares
outstanding during the period entitled to receive dividends and includes
dividends and interest earned during the period minus expenses accrued for the
period, net of reimbursements.
The Fund may also advertise a "tax-equivalent yield", which is
calculated by determining the rate of the return that would have to be achieved
on a fully taxable investment to produce the after-tax equivalent of the Fund's
yield, assuming certain tax brackets for a shareholder. The Fund's
tax-equivalent yield for the 30-day period ended March 31, 1997, for a
shareholder in the 31% bracket, was
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<PAGE>
6.14% for the Flag Investors Class A Shares and 6.59% for the Flag Investors
Institutional Shares.
Except as noted below, for the purpose of determining net investment
income earned during the period, interest earned on debt obligations held by the
Fund is calculated by computing the yield to maturity of each obligation based
on the market value of the obligation (including actual accrued interest) at the
close of business on the last business day of each month, or, with respect to
obligations purchased during the month, based on the purchase price (plus actual
accrued interest), dividing the result by 360 and multiplying the quotient by
the market value of the obligation (including actual accrued interest) in order
to determine the interest income on the obligation for each day of the
subsequent month that the obligation is held by the Fund. For purposes of this
calculation, it is assumed that each month contains 30 days. The maturity of an
obligation with a call provision is the next call date on which the obligation
reasonably may be expected to be called or, if none, the maturity date.
Undeclared earned income will be subtracted from the net asset value
per share. Undeclared earned income is net investment income which, at the end
of the base period, has not been declared as a dividend, but is reasonably
expected to be and is declared as a dividend shortly thereafter.
The Fund's annual portfolio turnover rate (the lesser of the value of
the purchases or sales for the year divided by the average monthly market value
of the portfolio during the year, excluding U.S. Government securities and
securities with maturities of one year or less) may vary from year to year, as
well as within a year, depending on market conditions. For the fiscal years
ended March 31, 1997 and March 31, 1996, the Fund's portfolio turnover rate was
33.18% and 8.79, respectively. A high level of portfolio turnover may generate
relatively high transaction costs and may increase the amount of taxes payable
by the Fund's shareholders.
14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of July 23, 1997, the following persons owned of record or
beneficially 5% or more of the Fund's total outstanding Shares:
Alex. Brown & Sons Incorporated* 11.46%
FBO 250-10788-16
P.O. Box 1346
Baltimore, MD 21203
As of July 23, 1997, to Fund management's knowledge, Directors and
officers as a group owned less than 1% of the Fund's total outstanding Shares.
* As of July 23, 1997, to Fund management's knowledge, Alex. Brown &
Sons, Incorporated owned beneficially less than 5% of such Shares.
15. FINANCIAL STATEMENTS
See next page.
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APPENDIX A
BOND AND COMMERCIAL PAPER RATINGS
Standard & Poor's Commercial Paper Ratings
S & P - Commercial paper rated A-1+ or A-1 by S&P has the
following characteristics. Liquidity ratios are adequate to meet cash
requirements. Long-term senior debt is rated "A" or better, although in some
cases "BBB" credits may be allowed. The issuer has access to at least two
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry. The
reliability and quality of management is unquestioned. Relative strength or
weakness of the above factors determines whether the issuer's commercial paper
is rated A-1, A-2 or A-3.
Moody's Commercial Paper Ratings
Moody's - The rating Prime-1 (P-1) is the highest commercial
paper rating assigned by Moody's. Among the factors considered by Moody's in
assigning 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 relationship which exists 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. These
factors are all considered in determining whether the commercial paper is rated
P-1, P-2 or P-3.
CORPORATE BOND RATINGS
Standard & Poor's Bond Ratings
AAA -- The highest rating assigned by Standard & Poor's. Capacity
to pay interest and repay principal is extremely strong.
AA -- Very strong capacity to pay interest and repay principal
and differs from the highest rated issues only in small degree.
A -- Strong capacity to pay interest and repay principal although
it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB -- Regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, and CC and C -- Regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least
A-1
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degree of speculation and C the highest. While such debt will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major exposures to adverse conditions.
D -- In default. The D rating category is used when interest
payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
Moody's Bond Ratings
Aaa -- Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt edged." 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 or the
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risk appear somewhat larger
than the Aaa securities.
A -- Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium-grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment some time in the
future.
Baa -- Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterize bonds in this class.
B -- Bonds which are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa -- Bonds which are rated Caa are of poor standing. Such
issues may be in default or there may be present elements of danger with respect
to principal or interest.
Ca -- Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
A-2
