AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 12, 2005
SECURITIES ACT FILE NO. 333-128080
INVESTMENT COMPANY ACT FILE NO. 811-21485
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM N-2
(CHECK APPROPRIATE BOX OR BOXES)
[x] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[x] PRE-EFFECTIVE AMENDMENT NO. 1
[ ] POST-EFFECTIVE AMENDMENT NO.
AND/OR
[x] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[x] AMENDMENT NO. 10
-------------------
COHEN & STEERS
SELECT UTILITY FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
-------------------
757 THIRD AVENUE
NEW YORK, NEW YORK 10017
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 832-3232
ROBERT H. STEERS
COHEN & STEERS CAPITAL MANAGEMENT, INC.
757 THIRD AVENUE
NEW YORK, NEW YORK 10017
(212) 832-3232
(NAME AND ADDRESS OF AGENT FOR SERVICE)
-------------------
WITH COPIES TO:
SARAH E. COGAN, ESQ. LEONARD B. MACKEY, JR., ESQ.
SIMPSON THACHER & BARTLETT LLP CLIFFORD CHANCE US LLP
425 LEXINGTON AVENUE 31 WEST 52ND STREET
NEW YORK, NEW YORK 10017 NEW YORK, NY 10019
(212) 455-2000 (212) 878-8000
-------------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the effective date of this Registration Statement.
If any securities being registered on this form will be offered on a delayed
or continuous basis in reliance on Rule 415 under the Securities Act of 1933, as
amended, other than securities offered in connection with a dividend
reinvestment plan, check the following box. [ ]
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
=========================================================================================================================
PROPOSED PROPOSED
MAXIMUM MAXIMUM
TITLE OF SECURITIES AMOUNT BEING OFFERING PRICE AGGREGATE AMOUNT OF REGISTRATION
BEING REGISTERED REGISTERED(1) PER SHARE(1) OFFERING PRICE(1) FEE(1)(2)
-------------------------------------------------------------------------------------------------------------------------
Series TH7 Auction Market Preferred
Shares, par value $0.001............... 20 $25,000 $500,000 $58.85
=========================================================================================================================
(1) Estimated solely for the purpose of computing the registration fee pursuant
to Rule 457.
(2) Registration fees of $117.60 were paid on September 2, 2005.
-------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
================================================================================
COHEN & STEERS
SELECT UTILITY FUND, INC.
CROSS REFERENCE SHEET
PART A -- PROSPECTUS
ITEM IN PART A OF FORM N-2
SPECIFIED IN PROSPECTUS LOCATION IN PROSPECTUS
----------------------- ----------------------
Item 1. Outside Front Cover.................................. Cover Page
Item 2. Inside Front and Outside Back Cover Page............. Cover Page; Inside Front Cover
Page; Outside Back Cover Page
Item 3. Fee Table and Synopsis............................... Inapplicable
Item 4. Financial Highlights................................. Financial Highlights
Item 5. Plan of Distribution................................. Cover Page; Prospectus Summary;
Underwriting
Item 6. Selling Stockholders................................. Inapplicable
Item 7. Use of Proceeds...................................... Use of Proceeds; Investment
Objectives and Policies
Item 8. General Description of the Registrant................ Cover Page; Prospectus Summary;
The Fund; Investment Objectives
and Policies; Risks Factors; How
the Fund Manages Risk
Item 9. Management........................................... Prospectus Summary; Management of
the Fund; How the Fund Manages
Risk
Item 10. Capital Stock, Long-Term Debt, and Other
Securities......................................... Capitalization; Investment
Objectives and Policies; Use of
Leverage; U.S. Federal Taxation;
Description of AMPS; Description
of Common Shares
Item 11. Defaults and Arrears on Senior Securities............ Inapplicable
Item 12. Legal Proceedings.................................... Inapplicable
Item 13. Table of Contents of the Statement of Additional
Information........................................ Table of Contents of the Statement
of Additional Information
PART B -- STATEMENT OF ADDITIONAL INFORMATION
LOCATION IN STATEMENT
ITEMS IN PART B OF FORM N-2 OF ADDITIONAL INFORMATION
--------------------------- -------------------------
Item 14. Cover Page........................................... Cover Page
Item 15. Table of Contents.................................... Table of Contents
Item 16. General Information and History...................... General Information
Item 17. Investment Objective and Policies.................... Investment Objectives and
Policies; Additional Information
Regarding Fund Investments;
Investment Restrictions
Item 18. Management........................................... Management of the Fund;
Compensation of Directors and
Certain Officers
Item 19. Control Persons and Principal Holders of
Securities......................................... Management of the Fund
Item 20. Investment Advisory and Other Services............... Investment Advisory and Other
Services
Item 21. Portfolio Managers................................... Management of the Fund
Item 22. Brokerage Allocation and Other Practices............. Portfolio Transactions and
Brokerage; Determination of Net
Asset Value
Item 23. Tax Status........................................... U.S. Federal Taxation
Item 24. Financial Statements................................. Report of Independent Registered
Public Accounting Firm;
Financial Information
PART C -- OTHER INFORMATION
Items 25-33. have been answered in Part C of this Registration
Statement
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES
IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED , 2005
PROSPECTUS [COHEN & STEERS
SELECT UTILITY FUND LOGO]
$
COHEN & STEERS
SELECT UTILITY FUND, INC.
AUCTION MARKET PREFERRED SHARES ('AMPS')
SHARES, SERIES TH7
LIQUIDATION PREFERENCE $25,000 PER SHARE
-----------------
Cohen & Steers Select Utility Fund, Inc. (the 'Fund') is offering Series
TH7 Auction Market Preferred Shares. The shares are referred to in this
prospectus as 'AMPS.' The Fund is a non-diversified, closed-end management
investment company. Our investment objective is to achieve a high level of
after-tax total return through investment in utility securities. In pursuing
total return, the Fund equally emphasizes both current income, consisting
primarily of tax-advantaged dividend income, and capital appreciation.
(continued on following page)
INVESTING IN THE AMPS INVOLVES RISKS THAT ARE DESCRIBED IN THE 'RISK FACTORS'
SECTION BEGINNING ON PAGE 42 OF THIS PROSPECTUS. THE MINIMUM PURCHASE AMOUNT OF
THE AMPS IS $25,000.
-----------------
PER SHARE TOTAL
--------- -----
Public offering price....................................... $25,000 $
Sales load.................................................. $ $
Proceeds to the Fund(1)..................................... $ $
(1) Not including offering expenses payable by the Fund estimated to be $
The public offering price per share will be increased by the amount of
dividends, if any, that have accumulated from the date the AMPS are first
issued.
Neither the Securities and Exchange Commission nor any State Securities
Commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The underwriters are offering the AMPS subject to various conditions. The
AMPS will be ready for delivery in book-entry form only through the facilities
of the Depository Trust Company on or about , 2005.
-----------------
MERRILL LYNCH & CO.
DEUTSCHE BANK SECURITIES
UBS INVESTMENT BANK
WACHOVIA SECURITIES
-----------------
The date of this prospectus is , 2005.
(continued from previous page)
Portfolio Contents. Under normal market conditions, the Fund will invest at
least 80% of its managed assets in a portfolio of common stocks, preferred
stocks and other equity securities issued by companies engaged in the utility
industry ('utility companies'). Managed assets equal the net asset value of the
Fund's common shares plus the liquidation value of the AMPS and other
outstanding shares of preferred stock plus the principal amount of any
borrowings. In addition, under normal market conditions, the Fund may invest up
to 20% of its managed assets in preferred securities and other fixed income
securities issued by any type of company. The Fund also may invest up to 25% of
its managed assets in preferred securities and other fixed income securities
that at the time of the investment are rated below investment grade or that are
unrated but judged to be below investment grade by the Fund's Investment
Manager. These below investment grade quality securities are commonly referred
to as 'junk bonds' and are regarded as having predominantly speculative
characteristics with respect to the payment of interest and repayment of
principal. In addition, the Fund may invest up to 20% of its managed assets in
U.S. dollar-denominated securities of foreign issuers traded or listed on a U.S.
securities exchange or in the U.S. over-the-counter market.
There can be no assurance that the Fund will achieve its investment
objective. See 'Investment Objective and Policies' and 'Risk Factors.'
Investors in the AMPS will be entitled to receive cash dividends at an
annual rate that may vary for the successive dividend periods for the AMPS. The
AMPS have a liquidation preference of $25,000 per share, plus any accumulated,
unpaid dividends. The AMPS also have priority over the Fund's common shares as
to distribution of assets as described in this prospectus. See 'Description of
AMPS.' As of October , 2005, the Fund had outstanding 19,680 shares of six
other series of preferred stock: 3,400 of Series M7 AMPS, par value $.001 per
share (the 'Series M7 AMPS'), 3,400 of Series T7 AMPS, par value $.001 per share
(the 'Series T7 AMPS'), 3,400 of Series W7 AMPS, par value $.001 per share (the
'Series W7 AMPS'), 2,680 of Series T28 AMPS, par value $0.001 per share (the
'Series T28 AMPS'), 3,400 of Series TH28 AMPS, par value $.001 per share (the
'Series TH28 AMPS'), and 3,400 of Series F7 AMPS, par value $.001 per share (the
'Series F7 AMPS' and together with the Series M7 AMPS, Series T7 AMPS,
Series W7 AMPS, Series T28 AMPS and Series TH28 AMPS, the 'Outstanding AMPS').
The AMPS offered in this prospectus rank on a parity with the Series M7 AMPS,
Series T7 AMPS, Series W7 AMPS, Series T28 AMPS, Series TH28 AMPS and Series F7
AMPS with respect to dividends and liquidation preference. The AMPS have
priority over the Fund's common shares as to dividends and distribution of
assets as described in this prospectus. See 'Description of AMPS.' The dividend
rate for the initial dividend period will be % for the AMPS. The initial
dividend period is from the date of issuance through for the
AMPS. For subsequent dividend periods, the AMPS will pay dividends based on a
rate set at auction, usually held every 7 days. Prospective purchasers should
note: (1) a buy order (called a 'bid order') or sell order is a commitment to
buy or sell the AMPS based on the results of an auction and (2) purchases and
sales will be settled on the next business day after the auction. Investors may
only buy or sell the AMPS through an order placed at an auction or with or
through a broker-dealer in accordance with the procedures specified in this
prospectus. Broker-dealers are not required to maintain a secondary market in
the AMPS, and a secondary market may not provide you with liquidity. The Fund
may redeem the AMPS as described under 'Description of AMPS -- Redemption.'
The AMPS do not represent a deposit or obligation of, and are not guaranteed
or endorsed by, any bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board or any other government agency.
The AMPS will be senior to the Fund's outstanding Common Shares. The AMPS
are not listed on an exchange. The Fund's common shares are traded on the New
York Stock Exchange (the 'NYSE') under the symbol 'UTF.' It is a condition of
closing this offering that the AMPS be offered with the highest credit quality
rating from at least two of Standards & Poor's Rating Services, a division of
The McGraw-Hill Companies, Inc. ('S&P'), Moody's Investors Service, Inc.
('Moody's'), and Fitch Ratings ('Fitch').
This prospectus concisely sets forth information about the Fund you should
know before investing. You should read the prospectus before deciding whether to
invest and retain it for future reference. A Statement of Additional
Information, dated , 2005, as it may be supplemented (the 'SAI'),
containing additional information about the Fund, has been filed with the
Securities and Exchange Commission and is incorporated by reference in its
entirety into this prospectus. You may request a free copy of the SAI, the table
of contents of which is on page 83 of this Prospectus, annual and semi-annual
reports to shareholders when available, and other information about the Fund,
and make shareholder inquiries by calling (800) 437-9912, by writing to the Fund
or from the Fund's web site (http://cohenandsteers.com). You also may obtain a
copy (and other information regarding the Fund) from the Securities and Exchange
Commission's web site (http://www.sec.gov).
TABLE OF CONTENTS
PAGE
----
Prospectus Summary.......................................... 4
Financial Highlights........................................ 27
The Fund.................................................... 29
Use of Proceeds............................................. 29
Capitalization.............................................. 30
Investment Objective and Policies........................... 31
Use of Leverage............................................. 39
Risk Factors................................................ 42
How the Fund Manages Risk................................... 57
Management of the Fund...................................... 58
Description of AMPS......................................... 60
The Auction................................................. 68
Description of Common Shares................................ 72
Certain Provisions of the Charter and By-Laws............... 73
Conversion to Open-End Fund................................. 74
Repurchase of Common Shares................................. 75
U.S. Federal Taxation....................................... 75
Underwriting................................................ 81
Custodian, Auction Agent, Transfer Agent, Dividend Paying
Agent and Registrar....................................... 82
Legal Opinions.............................................. 82
Independent Registered Public Accounting Firm............... 82
Further Information......................................... 82
Table of Contents of the Statement of Additional
Information............................................... 83
-------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. WE AND THE UNDERWRITERS HAVE NOT AUTHORIZED ANY
OTHER PERSON TO PROVIDE YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU
WITH DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. WE AND
THE UNDERWRITERS ARE NOT MAKING AN OFFER TO SELL THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT
THE INFORMATION IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS
PROSPECTUS. OUR BUSINESS, FINANCIAL CONDITION AND PROSPECTS MAY HAVE CHANGED
SINCE THAT DATE.
3
PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of the information
that you should consider before investing in the AMPS. You should review the
more detailed information contained in this prospectus and in the SAI,
especially the information set forth under the heading 'Risk Factors.'
THE FUND..................................... Cohen & Steers Select Utility Fund, Inc. (the 'Fund')
is a recently organized, non-diversified, closed-end
management investment company. The Fund was organized
as a Maryland corporation on January 8, 2004 and is
registered under the Investment Company Act of 1940,
as amended (the '1940 Act'). The Fund commenced
investment operations on March 30, 2004, upon the
closing of an initial public offering of 41,250,000
Common Shares, par value $0.001 per share ('Common
Shares'). The Fund issued 3,400 of Series M7 AMPS,
3,400 of Series T7 AMPS, 3,400 of Series W7 AMPS,
3,400 of Series TH28 AMPS and 3,400 of Series F7 AMPS
on May 20, 2004. The Fund issued 2,680 of Series T28
AMPS on November 15, 2004. References to the
Outstanding AMPS refer to Taxable Auction Market
Preferred Shares. As of , 2005, the Fund
had Common Shares outstanding and net
assets, plus the liquidation value of the Outstanding
AMPS, of $ . The Fund's principal office is
located at 757 Third Avenue, New York, New York
10017, and its telephone number is (212) 832-3232.
THE OFFERING................................. The Fund is offering Series TH7 AMPS, par value
$0.001 per share (the 'AMPS'), at a purchase price of
$25,000 per share plus dividends, if any, that have
accumulated from the date the Fund first issues the
AMPS. The AMPS are offered through a group of
underwriters led by Merrill Lynch, Pierce, Fenner &
Smith Incorporated ('Merrill Lynch').
The AMPS entitle their holders to receive cash
dividends at an annual rate that may vary for the
successive dividend periods for the AMPS. In general,
except as described under ' -- Dividends and Dividend
Periods' below and 'Description of AMPS -- Dividends
and Dividend Periods,' the dividend period for the
AMPS will be 7 days. The auction agent will determine
the dividend rate for a particular period by an
auction conducted on the business day immediately
prior to the start of that rate period. See 'The
Auction.'
4
The AMPS are not listed on an exchange. Instead,
investors may buy or sell the AMPS in an auction by
submitting orders to broker-dealers that have entered
into an agreement with the auction agent and the
Fund.
Generally, investors in the AMPS will not receive
certificates representing ownership of their shares.
The securities depository (The Depository Trust
Company ('DTC') or any successor) or its nominee for
the account of the investor's broker-dealer will
maintain record ownership of the AMPS in book-entry
form. An investor's broker-dealer, in turn, will
maintain records of that investor's beneficial
ownership of the AMPS.
RATINGS...................................... The Fund will issue the AMPS only if such shares have
received the highest credit quality rating from at
least two of S&P, Moody's or Fitch. These ratings are
an assessment of the capacity and willingness of an
issuer to pay preferred stock obligations. The
ratings are not a recommendation to purchase, hold or
sell those shares inasmuch as the rating does not
comment as to the market price or suitability for a
particular investor. The ratings described above also
do not address the likelihood that an owner of AMPS
will be able to sell such shares in an auction or
otherwise. The ratings are based on current
information furnished to the rating agencies by the
Fund and the Investment Manager and information
obtained from other sources. The ratings may be
changed, suspended or withdrawn in the rating
agencies' discretion as a result of changes in, or
the unavailability of, such information. See
'Description of AMPS -- Rating Agency Guidelines.'
USE OF PROCEEDS.............................. The net proceeds of this offering will be invested in
accordance with the policies set forth under
'Investment Objective and Policies.' We estimate that
the net proceeds of this offering will be fully
invested in accordance with our investment objective
and policies within four months of the completion of
this offering.
The Fund intends to invest the proceeds of this
offering in securities of utility companies. Pending
such investment, those proceeds may be invested in
U.S. Government securities or high quality,
short-term money market instruments.
INVESTMENT OBJECTIVE AND POLICIES............ Our investment objective is to achieve a high level
of after-tax total return through investment in
utility securities. In pursuing total return, the
Fund equally
5
emphasizes both current income, consisting primarily
of tax-advantaged dividend income, and capital
appreciation. Our investment objective and certain
investment policies are considered fundamental and
may not be changed without stockholder approval. See
'Investment Objective and Policies.'
Under normal market conditions, the Fund seeks to
achieve its objective by investing at least 80% of
its managed assets in a portfolio of common stocks,
preferred stocks and other equity securities issued
by utility companies. The Fund currently invests
approximately % of its managed assets in common
stocks and approximately % of its managed assets
in preferred securities issued by utility companies.
These percentages will vary from time to time,
consistent with the Fund's investment objective and
policies. At any time, under normal circumstances, at
least 80% of the Fund's managed assets will be
invested in common stocks, preferred stocks and other
equity securities issued by utility companies.
Investment Strategies. In making investment decisions
with respect to common stocks and other equity
securities issued by utility companies, the
Investment Manager relies on a fundamental analysis
of each company. Securities are evaluated for their
potential to provide an attractive total return
through a combination of dividend yield and capital
appreciation. The Investment Manager reviews each
company's potential for success in light of general
economic and industry trends, as well as the
company's quality of management, financial condition,
business plan, industry and sector market position,
dividend payout ratio and corporate governance. The
Investment Manager utilizes a value-oriented
approach, and evaluates each company's valuation on
the basis of relative price/cash flow and
price/earnings multiples, earnings growth rate,
dividend yield and price/book value, among other
metrics.
In making investment decisions with respect to
preferred securities and other fixed income
securities, the Investment Manager seeks to select
securities that it believes are undervalued on the
basis of risk and return profiles. In making these
determinations, the Investment Manager evaluates the
fundamental characteristics of an issuer, including
an issuer's creditworthiness, and also takes into
account prevailing market factors. In analyzing
6
credit quality, the Investment Manager considers not
only fundamental analysis, but also an issuer's
corporate and capital structure and the placement of
the preferred or debt securities within that
structure. The Investment Manager also takes into
account other factors, such as call and other
structural features, event risk, the likely
directions of ratings and relative value versus other
income security classes, among others.
Securities Issued by Utility Companies. Under normal
market conditions, at least 80% of the Fund's managed
assets will be invested in common stocks, preferred
stocks and other equity securities issued by utility
companies. Substantially all of the securities issued
by utility companies in which the Fund intends to
invest are traded on a national securities exchange
or in the over-the-counter market. Utility companies
generally pay dividends on their equity securities
that qualify for the dividends received deduction
(the 'DRD') under Section 243 of the Internal Revenue
Code of 1986, as amended (the 'Code'), and are
considered 'qualified dividend income' eligible for
reduced rates of taxation. The DRD generally allows
corporations to deduct from their income 70% of
dividends received. Corporate stockholders are
generally permitted to claim a deduction with respect
to that portion of their distributions attributable
to amounts received by the Fund that qualify for the
DRD. Under current law, individuals will generally be
taxed at long-term capital gain rates on qualified
dividend income. The Fund generally can pass the tax
treatment of qualified dividend income it receives
through to stockholders, provided that holding period
and other requirements are met.
Utility companies derive at least 50% of their
revenues from, or have at least 50% of their assets
committed to, the:
generation, transmission, sale or distribution of
electric energy;
distribution, purification and treatment of water;
production, transmission or distribution of
natural gas; and
provision of communications services, including
cable television, satellite, microwave, radio,
telephone and other communications media.
7
Preferred Securities. The Fund may invest in
preferred securities issued by utility companies and
other types of issuers. There are two basic types of
preferred securities. The first, sometimes referred
to in this prospectus as traditional preferred
securities, consists of preferred stock issued by an
entity taxable as a corporation. Preferred stocks are
considered equity securities. The second basic type
is referred to in this prospectus as hybrid-preferred
securities. Hybrid-preferred securities are usually
issued by a trust or limited partnership and often
represent preferred interests in subordinated debt
instruments issued by a corporation for whose benefit
the trust or partnership was established.
Hybrid-preferred securities are considered debt
securities. Preferred securities pay fixed or
floating dividends to investors and have 'preference'
over common stock in the payment of dividends and the
liquidation of a company's assets. This means that a
company must pay dividends on preferred stock before
paying dividends on its common stock. Preferred
stockholders usually have no right to vote for
corporate directors or on other matters. The hybrid
preferred securities in which the Fund may invest do
not qualify for the DRD and are not expected to
provide significant benefits under the rules relating
to qualified dividend income. As a result, any
corporate stockholder who otherwise would qualify for
the DRD, and any individual stockholder who otherwise
would qualify to be taxed at long-term capital gain
rates on qualified dividend income, should assume
that none of the distributions the stockholder
receives from the Fund attributable to
hybrid-preferred securities will qualify for the DRD
or provide significant benefits under the rules
relating to qualified dividend income. Distributions
received from the Fund attributable to traditional
preferred securities, such as the preferred
securities of utility companies, generally would
qualify for the DRD as to any corporate stockholder
and would qualify to be taxed at long-term capital
gains rates as to any individual stockholder.
Debt Securities. The Fund may invest in debt
securities issued by utility companies and other
types of issuers. The Fund's investments in debt
securities may include investments in convertible
debt securities, convertible preferred securities,
U.S. dollar-denominated corporate debt securities
issued by domestic and non-U.S.
8
corporations and U.S. dollar-denominated government
debt securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities or a
non-U.S. Government or its agencies or
instrumentalities.
Lower Rated Securities. The Fund may invest up to 25%
of its managed assets in securities that at the time
of investment are rated below investment grade (below
Baa3 or BBB - ) by Moody's, S&P, Fitch or an
equivalent rating by a nationally recognized
statistical rating agency, or that are unrated but
judged to be below investment grade by the Fund's
Investment Manager. A security will not be considered
to be below investment grade quality if it is rated
within the four highest grades (Baa or BBB or better)
by Moody's, S&P, Fitch or an equivalent rating by a
nationally recognized statistical rating agency, or
is unrated but judged to be of comparable quality by
the Fund's Investment Manager. These below investment
grade quality securities are commonly referred to as
'junk bonds' and are regarded as having predominantly
speculative characteristics with respect to the
payment of interest and repayment of principal.
While the Fund does not currently intend to invest in
illiquid securities (i.e., securities that are not
readily marketable), it may invest up to 10% of its
managed assets in illiquid securities.
The Fund may invest up to 20% of its managed assets
in preferred securities and other fixed-income
securities that are not issued by utility companies.
The Fund also may invest up to 20% of its managed
assets in U.S. dollar-denominated securities of
foreign issuers traded or listed on a U.S. securities
exchange or the U.S. over-the-counter market.
The Fund will generally not invest more than 10% of
its managed assets in the securities of one issuer.
The Fund may engage in portfolio trading when
considered appropriate, but short-term trading will
not be used as the primary means of achieving the
Fund's investment objective.
There are no limits on portfolio turnover, and
investments may be sold without regard to length of
time held when, in the opinion of the Investment
Manager, investment considerations warrant such
action. A higher portfolio turnover rate results in
correspondingly greater brokerage commissions and
other
9
transactional expenses that are borne by the Fund.
High portfolio turnover may result in the realization
of net short-term capital gains by the Fund which,
when distributed to stockholders, will be taxable as
ordinary income.
Although not intended to be a significant element in
the Fund's investment strategy, from time to time the
Fund may use various other investment management
techniques that also involve certain risks and
special considerations including: engaging in
interest rate and credit derivatives transactions and
using options and financial futures.
There can be no assurance that the Fund's investment
objective will be achieved. See 'Investment Objective
and Policies.'
INVESTMENT MANAGER........................... Cohen & Steers Capital Management, Inc. (the
'Investment Manager') is the investment manager of
the Fund pursuant to an Investment Management
Agreement. The Investment Manager was formed in 1986,
and as of June 30, 2005 had approximately
$19.9 billion in assets under management. Its clients
include pension plans, endowment funds and mutual
funds, including some of the largest open-end and
closed-end real estate funds. The Investment Manager,
whose principal business address is 757 Third Avenue,
New York, New York 10017, is also responsible for
providing administrative services and assisting the
Fund with operational needs pursuant to an
Administration Agreement (the 'Adminstration
Agreement'). In accordance with the terms of the
Administration Agreement, the Fund has entered into
an agreement with State Street Bank and Trust
Company ('State Street Bank') to perform certain
administrative functions subject to the supervision
of the Investment Manager (the 'Sub-Administration
Agreement'). See 'Management of the Fund --
Administration and Sub-Administration Agreement.'
USE OF LEVERAGE.............................. The Fund may, but is not required to, use financial
leverage for investment purposes. In addition to
issuing the AMPS, the Fund may borrow money or issue
debt securities such as commercial paper or notes.
Any such borrowings will have seniority over the AMPS
and any other outstanding shares of preferred stock,
and payments to holders of the AMPS in liquidation or
10
otherwise will be subject to the prior payment of any
borrowings. Since the Investment Manager's fee is
based upon a percentage of the Fund's managed assets,
which include assets attributable to any outstanding
leverage, the investment management fee will be
higher if the Fund is leveraged and the Investment
Manager will have an incentive to be more aggressive
and leverage the Fund. See 'Use of Leverage.'
RISK FACTORS................................. Risk is inherent in all investing. Therefore, before
investing in the AMPS and the Fund you should
consider certain risks carefully. The primary risks
of investing in the AMPS are:
the Fund will not be permitted to declare
dividends or other distributions with respect to your
AMPS or redeem your AMPS unless the Fund meets
certain asset coverage requirements required by
the 1940 Act and the rating agencies;
if you try to sell your AMPS between auctions you
may not be able to sell any or all of your shares
or you may not be able to sell them for $25,000
per share or $25,000 per share plus accumulated
but unpaid dividends, if any, whether or not
earned or declared. If the Fund has designated a
special rate period, changes in interest rates
could affect the price you would receive if you
sold your shares in the secondary market. You may
transfer your shares outside of auctions only to
or through a broker-dealer that has entered into
an agreement with the auction agent and the Fund
or other person as the Fund permits;
if an auction fails, you may not be able to sell
some or all of your AMPS;
you may receive less than the price you paid for
your AMPS if you sell them outside of the auction,
especially when market interest rates are rising;
a rating agency could downgrade the rating
assigned to the AMPS, which could affect liquidity;
the Fund may be forced to redeem your AMPS to meet
regulatory or rating agency requirements or may
voluntarily redeem your shares in certain
circumstances;
restrictions imposed by the 1940 Act and by rating
agencies on the declaration and payment of
dividends to the holders of the Fund's Common
Shares and
11
AMPS and other outstanding shares of preferred
stock might impair the Fund's ability to maintain
its qualification as a regulated investment
company for Federal income tax purposes;
in certain circumstances, the Fund may not earn
sufficient income from its investments to pay
dividends on the AMPS;
the AMPS will be junior to any borrowings;
any borrowings may constitute a substantial lien
and burden on the AMPS by reason of its priority
claim against the income of the Fund and against
the net assets of the Fund in liquidation;
if the Fund leverages through borrowings, the Fund
may not be permitted to declare dividends or other
distributions with respect to the AMPS or purchase
the AMPS unless at the time thereof the Fund meets
certain asset coverage requirements and the
payments of principal and of interest on any such
borrowing are not in default;
the value of the Fund's investment portfolio may
decline, reducing the asset coverage for the AMPS;
and
if an issuer of a common stock in which the Fund
invests experiences financial difficulties or if
an issuer's preferred stock or debt security is
downgraded or defaults or if an issuer in which
the Fund invests is affected by other adverse
market factors, there may be a negative impact on
the income and/or asset value of the Fund's
investment portfolio. See 'Risk Factors -- Risks
of Investing in AMPS.'
In addition, although the offering of the AMPS is
conditioned upon receipt of the highest credit
quality rating from at least two of S&P, Moody's or
Fitch for the AMPS, there are additional risks
related to the investment policies of and an
investment in the Fund, such as:
Limited Operating History. We are a recently
organized, non-diversified, closed-end management
investment company with a limited operating history.
Investment Risk. An investment in the Fund is subject
to investment risk, including the possible loss of
the entire principal amount that you invest.
12
Stock Market Risk. Because prices of equity
securities fluctuate from day-to-day, the value of
our portfolio will vary based upon general market
conditions.
Interest Rate Risk. Interest rate risk is the risk
that fixed-income securities such as preferred and
debt securities, and to a lesser extent certain
utility company common shares, will decline in value
because of changes in market interest rates. When
market interest rates rise, the market value of such
securities generally will fall. The Fund's investment
in such securities means that the net asset value and
market price of the Common Shares may tend to decline
if market interest rates rise.
During periods of declining interest rates, an issuer
may be able to exercise an option to prepay principal
earlier than scheduled, which is generally known as
call or prepayment risk. If this occurs, the Fund may
be forced to reinvest in lower yielding securities.
This is known as reinvestment risk. Preferred and
debt securities frequently have call features that
allow the issuer to repurchase the security prior to
its stated maturity. An issuer may redeem an
obligation if the issuer can refinance the debt at a
lower cost due to declining interest rates or an
improvement in the credit standing of the issuer.
During periods of rising interest rates, the average
life of certain types of securities may be extended
because of slower than expected principal payments.
This may lock in a below market interest rate,
increase the security's duration and reduce the value
of the security. This is known as extension risk.
Market interest rates for investment grade
fixed-income securities in which the Fund will invest
have recently declined significantly below the recent
historical average rates for such securities. This
decline may have increased the risk that these rates
will rise in the future (which would cause the value
of the Fund's net assets to decline) and the degree
to which asset values may decline in such events;
however, historical interest rate levels are not
necessarily predictive of future interest rate
levels. See 'Risk Factors -- Interest Rate Risk.'
Credit Risk and Lower-Rated Securities Risk. Credit
risk is the risk that a security in the Fund's
portfolio will decline in price or the issuer will
fail to make dividend, interest or principal payments
when due because the issuer of the security
experiences a decline in its financial
13
status. Preferred securities normally are
subordinated to bonds and other debt instruments in a
company's capital structure, in terms of priority to
corporate income and claim to corporate assets, and
therefore will be subject to greater credit risk than
debt instruments. The Fund may invest up to 25%
(measured at the time of investment) of its managed
assets in securities that are rated below investment
grade. A security will be considered to be investment
grade if, at the time of the investment, such
security has a rating of 'BBB-' or higher by S&P,
'Baa3' or higher by Moody's or an equivalent rating
by a nationally recognized statistical rating agency
or, if unrated, such security is determined by the
Investment Manager to be of comparable quality.
Lower-rated securities, or equivalent unrated
securities, which are commonly known as 'junk bonds,'
generally involve greater volatility of price and
risk of loss of income and principal, and may be more
susceptible to real or perceived adverse economic and
competitive industry conditions than higher grade
securities. It is reasonable to expect that any
adverse economic conditions could disrupt the market
for lower-rated securities, have an adverse impact on
the value of those securities and adversely affect
the ability of the issuers of those securities to
repay principal and interest on those securities.
See 'Risk Factors -- Credit Risk and Lower-Rated
Securities Risk.'
Counterparty Risk. The Fund will be subject to credit
risk with respect to the counterparties to any
derivative contracts purchased by the Fund. If a
counterparty becomes bankrupt or otherwise fails to
perform its obligations under a derivative contract
due to financial difficulties, the Fund may
experience significant delays in obtaining any
recovery under the derivative contract in bankruptcy
or other reorganization proceeding. The Fund may
obtain only a limited recovery or may obtain no
recovery in such circumstances. See 'Risk
Factors -- Counterparty Risk.'
Auction Risk. The dividend rate for the AMPS normally
is set through an auction process. In the auction,
holders of AMPS may indicate the dividend rate at
which they would be willing to hold or sell their
AMPS or purchase additional AMPS. The auction also
provides liquidity for the sale of AMPS. An auction
fails if there are more AMPS offered for sale than
there are buyers. You may
14
not be able to sell your AMPS at an auction if the
auction fails. A holder of the AMPS therefore can be
given no assurance that there will be sufficient
clearing bids in any auction or that the holder will
be able to sell its AMPS in an auction. Also, if you
place bid orders (orders to retain AMPS) at an
auction only at a specified dividend rate, and that
rate exceeds the rate set at the auction, you will
not retain your AMPS. Additionally, if you buy AMPS
or elect to retain AMPS without specifying a dividend
rate below which you would not wish to buy or
continue to hold those AMPS, you could receive a
lower rate of return on your AMPS than the market
rate. Finally, the dividend periods for the AMPS may
be changed by the Fund, subject to certain conditions
and with notice to the holders of AMPS, which could
also affect the liquidity of your investment.
As noted above, if there are more AMPS offered for
sale than there are buyers for those AMPS in any
auction, the auction will fail and you may not be
able to sell some or all of your AMPS at that time.
The relative buying and selling interest of market
participants in your AMPS and in the auction rate
securities market as a whole will vary over time, and
such variations may be affected by, among other
things, news relating to the Fund, the attractiveness
of alternative investments, the perceived risk of
owning the security (whether related to credit,
liquidity or any other risk), the tax treatment
accorded the instruments, the accounting treatment
accorded auction rate securities, including recent
clarifications of U.S. generally accepted accounting
principles relating to the treatment of auction rate
securities, reactions to regulatory actions or press
reports, financial reporting cycles and market
sentiment generally. Shifts of demand in response to
any one or simultaneous particular events cannot be
predicted and may be short-lived or exist for longer
periods.
Securities and Exchange Commission Inquiries. Certain
of the underwriters have advised the Fund that those
underwriters and various other broker-dealers and
other firms that participate in the auction rate
securities market received letters from the staff of
the Securities and Exchange Commission last spring.
The letters requested that each of these firms
voluntarily conduct an investigation regarding
its respective practices
15
and procedures in that market. Pursuant to these
requests, each of those underwriters conducted its
own voluntary review and reported its findings to the
Securities and Exchange Commission staff. At the
Securities and Exchange Commission staff's request,
those underwriters are engaging in discussions with the
Securities and Exchange Commission staff that may lead
to a resolution of its inquiry. Neither those underwriters
nor the Fund can predict how such a resolution may
affect the market for the AMPS or the
auctions.
Special Risks of Securities Linked to the Utility
Industry. Since at least 80% of the Fund's managed
assets normally will be concentrated in common
stocks, preferred stocks and other equity securities
issued by utility companies, your investment in the
Fund will be significantly impacted by the
performance of this industry. The Fund's emphasis on
securities of utility issuers makes it more
susceptible to adverse conditions affecting such
industry than a fund that does not have its assets
invested to a similar degree in such issuers. Certain
segments of this industry and individual companies
within such segments may not perform as well as the
industry as a whole. Issuers in the utility industry
are subject to a variety of factors that may
adversely affect their business or operations,
including:
high interest costs in connection with capital
construction and improvement programs;
difficulty in raising capital in adequate amounts
on reasonable terms in periods of high inflation and
unsettled capital markets;
governmental regulation of rates charged to
customers;
costs associated with compliance with and changes
in environmental and other regulations;
effects of economic slowdowns and surplus
capacity;
increased competition from other providers of
utility services;
inexperience with and potential losses resulting
from a developing deregulatory environment;
costs associated with the reduced availability of
certain types of fuel, occasionally reduced
availability and high costs of natural gas for
resale, and the effects of energy conservation
policies;
effects of a national energy policy and lengthy
delays and greatly increased costs and other problems
16
associated with the design, construction,
licensing, regulation and operation of nuclear
facilities for electric generation, including,
among other considerations, the problems
associated with the use of radioactive materials
and the disposal of radioactive wastes;
technological innovations that may render existing
plants, equipment or products obsolete; and
potential impact of terrorist activities on the
utility industry and its customers and the impact of
natural or man-made disasters.
Issuers in the utility industry may be subject to
regulation by various governmental authorities and
may be affected by the imposition of special tariffs
and changes in tax laws, regulatory policies and
accounting standards. In addition, there are
substantial differences between the regulatory
practices and policies of various jurisdictions, and
any given regulatory agency may make major shifts in
policy from time to time. There is no assurance that
regulatory authorities will, in the future, grant
rate increases or that such increases will be
adequate to permit the payment of dividends on
preferred or common stocks. Prolonged changes in
climatic conditions can also have a significant
impact on both the revenues of an electric or gas
utility as well as its expenses. See 'Risk
Factors -- Special Risks of Securities Linked to the
Utility Industry.'
Special Risks Related to Preferred Securities
There are special risks associated with investing in
preferred securities, including:
deferral and omission of distributions;
subordination to bonds and other debt instruments
in the issuer's capital structure;
substantially less liquidity than many other
securities, such as common stocks or U.S. Government
securities;
limited voting rights with respect to the issuing
company; and
special redemption rights of the issuer.
In addition, the Financial Accounting Standards Board
currently is reviewing accounting guidelines relating
to hybrid-preferred securities. To the extent that a
change in the guidelines could adversely affect the
market for,
17
and availability of, these securities, the Fund may
be adversely affected.
From time to time, preferred securities, including
hybrid-preferred securities, have been, and may in
the future be, offered having features other than
those described herein. The Fund reserves the right
to invest in these securities if the Investment
Manager believes that doing so would be consistent
with the Fund's investment objective and policies.
Since the market for these instruments would be new,
the Fund may have difficulty disposing of them at a
suitable price and time. In addition to limited
liquidity, these instruments may present other risks,
such as high price volatility.
Moreover, companies principally engaged in financial
services are prominent issuers of preferred
securities and, therefore, the Fund may be
susceptible to adverse economic or regulatory
occurrences affecting that sector. See 'Risk
Factors -- Special Risks Related to Preferred
Securities.'
Foreign Securities Risks. Under normal market
conditions, the Fund may invest up to 20% of its
managed assets in U.S. dollar-denominated securities
of foreign issuers traded or listed on a U.S.
securities exchange or in the U.S. over-the-counter
market. Such investments involve certain risks not
involved in domestic investments. Certain foreign
countries may impose restrictions on the ability of
issuers of foreign securities to make payments of
principal and interest to investors located outside
the country, due to blockage of foreign currency
exchanges or otherwise. Generally, there is less
publicly available information about foreign
companies due to less rigorous disclosure or
accounting standards and regulatory practices. In
addition, the Fund will be subject to risks
associated with adverse political and economic
developments in foreign countries, which could cause
the Fund to lose money on its investments in foreign
securities. Typically, the Fund will not hold any
foreign securities of issuers in so-called 'emerging
markets' (or lesser developed countries), but to the
extent it does, the Fund will not invest more than
10% of its managed assets in such securities.
Investments in such securities are particularly
speculative. See 'Risk Factors -- Foreign Securities
Risk.'
18
Other Investment Management Techniques Risk. The Fund
may use various other investment management
techniques that also involve certain risks and
special considerations, including engaging in hedging
and risk management transactions, such as interest
rate transactions, options, futures, swaps and other
derivatives transactions. These strategic
transactions will be entered into to seek to manage
the risks of the Fund's portfolio of securities, but
may have the effect of limiting the gains from
favorable market movements. See 'Risk Factors --
Other Investment Management Techniques Risk.'
Convertible Securities Risk. Although to a lesser
extent than with nonconvertible fixed income
securities, the market value of convertible
securities tends to decline as interest rates
increase and, conversely, tends to increase as
interest rates decline. In addition, because of the
conversion feature, the market value of convertible
securities tends to vary with fluctuations in the
market value of the underlying common stock. A unique
feature of convertible securities is that as the
market price of the underlying common stock declines,
convertible securities tend to trade increasingly on
a yield basis, and so may not experience market value
declines to the same extent as the underlying common
stock. When the market price of the underlying common
stock increases, the prices of the convertible
securities tend to rise as a reflection of the value
of the underlying common stock. While no securities
investments are without risk, investments in
convertible securities generally entail less risk
than investments in common stock of the same issuer.
See 'Risk Factors -- Convertible Securities Risk.'
Common Stock Risk. While common stock has
historically generated higher average returns than
fixed income securities, common stock has also
experienced significantly more volatility in those
returns. An adverse event, such as an unfavorable
earnings report, may depress the value of common
stock held by the Fund. Also, the price of common
stock is sensitive to general movements in the stock
market. A drop in the stock market may depress the
price of common stock held by the Fund. See 'Risk
Factors -- Common Stock Risk.'
Tax Risk. The Fund's investment program and the tax
treatment of Fund distributions may be affected by
Internal Revenue Service ('IRS') interpretations of
the
19
Code and future changes in tax laws and regulations.
In particular, the provisions that currently apply to
the favorable tax treatment of qualified dividend
income are scheduled to expire on December 31, 2008
unless future legislation is passed to make the
provisions effective beyond this date. There can be
no assurance of what portion, if any, of the Fund's
distributions will be entitled to the lower tax rates
that apply to qualified dividend income. In addition,
the Fund may invest in preferred securities or
other securities the Federal income tax treatment
of which may not be clear or may be subject to
recharacterization by the IRS. It could be more
difficult for the Fund to comply with the tax
requirements applicable to regulated investment
companies if the tax characterization of the Fund's
investments or the tax treatment of the income from
such investments were successfully challenged by the
IRS. See 'Risk Factors -- Tax Risk.' See also 'U.S.
Federal Taxation.'
Restricted and Illiquid Securities Risk. The Fund may
invest, on an ongoing basis, in restricted securities
and other investments that may be illiquid. Illiquid
securities are securities that are not readily
marketable and may include some restricted
securities, which are securities that may not be
resold to the public without an effective
registration statement under the Securities Act of
1933, as amended (the 'Securities Act'), or, if they
are unregistered, may be sold only in a privately
negotiated transaction or pursuant to an exemption
from registration. Illiquid investments involve the
risk that the securities will not be able to be
sold at the time desired by the Fund or at prices
approximating the value at which the Fund is
carrying the securities on its books. See 'Risk
Factors -- Restricted and Illiquid Securities Risk.'
Interest Rate Transactions Risk. The Fund may enter
into a swap or cap transaction to attempt to protect
itself from increasing dividend or interest expenses
resulting from increasing short-term interest rates.
A decline in interest rates may result in a decline
in the value of the swap or cap, which may result in
a decline in the net asset value of the Fund. A
sudden and dramatic decline in interest rates may
result in a significant decline in the net asset
value of the Fund. See 'Risk Factors -- Interest Rate
Transactions Risk.'
20
Portfolio Turnover Risk. We may engage in portfolio
trading when considered appropriate. There are no
limits on the rate of portfolio turnover. A higher
turnover rate results in correspondingly greater
brokerage commissions and other transactional
expenses which are borne by the Fund. See 'Risk
Factors -- Portfolio Turnover Risk.'
Inflation Risk. Inflation risk is the risk that the
value of assets or income from investments will be
worth less in the future as inflation decreases the
value of money. As inflation increases, the real
value of the Common Shares and distributions can
decline and the dividend payments on the AMPS, if
any, or interest payments on any borrowings may
increase. See 'Risk Factors -- Inflation Risk.'
Non-Diversified Status. Because we, as a
non-diversified investment company, may invest in a
smaller number of individual issuers than a
diversified investment company, an investment in the
Fund presents greater risk to you than an investment
in a diversified company. We intend to comply with
the diversification requirements of the Code
applicable to regulated investment companies. See
'Risk Factors -- Non-Diversified Status.' See also
'U.S. Federal Taxation' in the SAI.
Anti-Takeover Provisions. Certain provisions of the
Fund's Articles of Incorporation (which, as hereafter
amended, restated or supplemented from time to time,
and together with the Articles Supplementary, is
referred to as the 'Charter'), and By-Laws could have
the effect of limiting the ability of other entities
or persons to acquire control of the Fund or to
change the Fund's structure. The provisions may also
have the effect of depriving you of an opportunity to
redeem your AMPS and may have the effect of
inhibiting conversion of the Fund to an open-end
investment company. See 'Risk Factors -- Anti-Takeover
Provisions.' See also 'Description of Common Shares'
and 'Certain Provisions of the Charter and By-Laws.'
Market Disruption Risk. The aftermath of the war
in Iraq and the continuing occupation of Iraq,
instability in the Middle East and terrorist attacks
in the United States and around the world have
resulted in recent market volatility and may have
long-term effects on the U.S. and worldwide financial
markets and may cause further economic uncertainties
in the United States and
21
worldwide. These events could also adversely affect
individual issuers and securities markets, interest
rates, auctions and auction participants, secondary
trading, ratings, credit risk, inflation, deflation
and other factors relating to the AMPS. The Fund does
not know how long the securities markets will
continue to be affected by these events and cannot
predict the effects of the occupation or similar
events in the future on the U.S. economy and
securities markets. See 'Risk Factors -- Market
Disruption Risk.'
Given the risks described above, an investment in the
AMPS may not be appropriate for all investors. You
should carefully consider your ability to assume
these risks before making an investment in the Fund.
For further discussion of the risks associated with
investing in the AMPS and the Fund, see 'Risk
Factors.'
DIVIDENDS AND RATE PERIODS................... The table below shows the dividend rate, the dividend
payment date and the number of days for the initial
rate period for the AMPS offered in this prospectus.
For subsequent rate periods, the AMPS will pay
dividends based on a rate set at auctions normally
held every 7 days. In most instances, dividends are
payable on the first business day following the end
of the rate period. The rate set at auction will not
exceed the applicable maximum rate.
The dividend payment date for special rate periods
will be set out in the notice designating a special
rate period. Dividends on the AMPS will be cumulative
from the date the AMPS are first issued and will be
paid out of legally available funds.
DIVIDEND
PAYMENT NUMBER OF
INITIAL DATE FOR DAYS OF
DIVIDEND INITIAL RATE INITIAL RATE
RATE PERIOD PERIOD
---- ------ ------
Series TH7 AMPS % , 2005
The Fund may, subject to certain conditions,
designate special rate periods of more than 7 days.
The Fund may not designate a special rate period
unless sufficient clearing bids were made in the most
recent auction for the AMPS. In addition, full
cumulative dividends, any amounts due with respect to
mandatory redemptions and any additional dividends
payable prior to such date must be paid in full. The
Fund also must have received
22
confirmation from any two of Moody's, S&P and Fitch or any
substitute rating agency that the proposed special rate period
will not adversely affect such agency's then- current rating
on the AMPS and the lead broker-dealer designated by
the Fund, initially, must not have objected to
declaration of a special rate period. See 'Description
of AMPS -- Dividends and Rate Periods,' 'Description of
AMPS -- Dividends and Rate Periods -- Designation of
Special Rate Periods' and 'The Auction.'
SECONDARY MARKET TRADING..................... Broker-dealers may, but are not obligated to,
maintain a secondary trading market in the AMPS
outside of auctions. There can be no assurance that a
secondary market will provide owners with liquidity.
You may transfer shares outside of auctions only to
or through a broker-dealer that has entered into an
agreement with the auction agent and the Fund, or
other persons as the Fund permits.
INTEREST RATE TRANSACTIONS................... In order to seek to reduce the interest rate risk
inherent in the Fund's capital structure and
underlying investments, the Fund may enter into
interest rate swap or cap transactions. The use of
interest rate swaps and caps is a highly specialized
activity that involves investment techniques and
risks different from those associated with ordinary
portfolio security transactions. In an interest rate
swap, the Fund would agree to pay to the other party
to the interest rate swap (which is known as the
'counterparty') a fixed rate payment in exchange for
the counterparty agreeing to pay to the Fund a
variable rate payment that is intended to approximate
the Fund's variable rate payment obligation on the
AMPS and any other outstanding shares of preferred
stock or any variable rate borrowing. The payment
obligations would be based on the notional amount of
the swap. In an interest rate cap, the Fund would pay
a premium to the counterparty to the interest rate
cap and, to the extent that a specified variable rate
index exceeds a predetermined fixed rate, would
receive from the counterparty payments of the
difference based on the notional amount of such cap.
If the counterparty to an interest rate swap or cap
defaults, the Fund would be obligated to make the
payments that it had intended to avoid. Depending on
the general state of short-term interest rates and
the returns on the Fund's portfolio securities at
that point in time, this could negatively impact the
Fund's ability to make dividend payments on
23
the AMPS and any other outstanding shares of
preferred stock.
In addition, at the time an interest rate swap or cap
transaction reaches its scheduled termination date,
there is a risk that the Fund will not be able to
obtain a replacement transaction or that the terms of
the replacement will not be as favorable as on the
expiring transaction. If this occurs, it could have a
negative impact on the Fund's ability to make
dividend payments on the AMPS. If the Fund fails to
maintain the required asset coverage on the AMPS and
any other outstanding shares of preferred stock or
fails to comply with other covenants, the Fund may be
required to redeem some or all of these shares. Such
redemption would likely result in the Fund seeking to
terminate early all or a portion of any swap or cap
transaction. Early termination of the swap could
result in a termination payment by or to the Fund.
Early termination of a cap could result in a
termination payment to the Fund. We would not enter
into interest rate swap or cap transactions having an
aggregate notional amount that exceeded the
outstanding amount of the AMPS and any other
outstanding shares of preferred stock. See 'How the
Fund Manages Risk -- Interest Rate Transactions' for
additional information.
ASSET MAINTENANCE............................ Under the Fund's Articles Supplementary for the AMPS,
which establishes and fixes the rights and
preferences of the AMPS (and the respective Articles
Supplementary for the Outstanding AMPS), the Fund
must maintain:
asset coverage of the AMPS (and the Outstanding
AMPS) as required by the rating agency or agencies
rating the AMPS (and the Outstanding AMPS); and
asset coverage of at least 200% with respect to
senior securities that are stock, including the AMPS
and the Outstanding AMPS.
In the event that the Fund does not maintain or cure
these coverage tests, some or all of the AMPS will be
subject to mandatory redemption. See 'Description of
AMPS -- Redemption.'
Based on the composition of the Fund's portfolio as
of , 2005, the asset coverage of the AMPS
(and the Outstanding AMPS) as measured pursuant to
the 1940 Act would be approximately % if the Fund
were to issue all of the AMPS offered in this
prospectus,
24
representing approximately % of the Fund's managed
assets (as defined below).
REDEMPTION................................... The Fund does not expect to and ordinarily will not
redeem the AMPS. However, under the Articles
Supplementary, it may be required to redeem the AMPS
in order, for example, to meet an asset coverage
ratio or to correct a failure to meet a rating agency
guideline in a timely manner. The Fund may also
voluntarily redeem the AMPS, without the consent of
holders of the AMPS, under certain conditions. See
'Description of AMPS -- Redemption.'
LIQUIDATION PREFERENCE....................... The liquidation preference (that is, the amount the
Fund must pay to holders of the AMPS if the Fund is
liquidated) for the AMPS will be $25,000 per share
plus accumulated but unpaid dividends, if any,
whether or not earned or declared.
VOTING RIGHTS................................ The 1940 Act requires that holders of the AMPS, and
the holders of any other series of preferred stock of
the Fund, voting together as a separate class, have
the right to:
elect at least two directors at all times; and
elect a majority of the directors if at any time
the Fund fails to pay dividends on the AMPS, or any
other series of preferred stock of the Fund, for
two full years and will continue to be so
represented until all dividends in arrears have
been paid or otherwise provided for.
The holders of the AMPS, and the holders of any other
series of preferred stock of the Fund, will vote as a
separate class or series on other matters as required
under the Fund's Charter, the 1940 Act and Maryland
law. On all other matters, holders of the AMPS will
vote together with the holders of Common Shares and
each share of any other series of preferred stock of
the Fund. Each Common Share, each share of the AMPS,
and each share of any other series of preferred stock
of the Fund is entitled to one vote per share.
FEDERAL INCOME TAXATION...................... The distributions with respect to the AMPS (other
than distributions in redemption of the AMPS subject
to Section 302(b) of the Code) will constitute
dividends to the extent of the Fund's current or
accumulated earnings and profits, as calculated for
Federal income tax purposes. Except in the case of
distributions of qualified dividend income and net
capital gains, such dividends
25
generally will be taxable as ordinary income to
holders. Provided that holding period and other
requirements are met by both the Fund and the holder
receiving distributions from the Fund, a portion of
each year's distributions may be eligible for the
dividends received deduction and the lower tax rates
that apply to qualified dividend income. The DRD
generally allows corporations to deduct from their
income 70% of dividends received. Under current law,
individuals will generally be taxed at long-term
capital gain rates on qualified dividend income.
Distributions of net capital gain that are designated
by the Fund as capital gain dividends will be treated
as long-term capital gains in the hands of holders
receiving such distributions. The IRS currently
requires that a regulated investment company that has
two or more classes of stock allocate to each such
class proportionate amounts of each type of its
income (such as ordinary income, capital gains,
dividends qualifying for the DRD, qualified dividend
income, interest-related dividends and short-term
capital gain dividends) based upon the percentage of
total dividends distributed to each class for the tax
year. Accordingly, the Fund intends each year to
allocate capital gain dividends, dividends qualifying
for the dividends received income, dividends derived
from qualified dividend income, interest-related
dividends and short-term capital gain dividends, if
any, among its Common Shares, the AMPS and the
Outstanding AMPS in proportion to the total dividends
paid to each class during or with respect to such
year. See 'U.S. Federal Taxation.'
CUSTODIAN, AUCTION AGENT, TRANSFER AGENT,
DIVIDEND PAYING AGENT AND REGISTRAR.......... State Street Bank and Trust Company acts as the
Fund's custodian. The Bank of New York will act as
auction agent, transfer agent, dividend paying agent
and registrar for the AMPS.
26
COHEN & STEERS
SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS
The following table includes selected data for a common share outstanding
throughout the periods presented. The information contained below under the
headings 'Per Share Operating Performance' and 'Ratios/Supplemental Data' for
the fiscal period ended December 31, 2004 has been audited by
PricewaterhouseCoopers LLP, the Fund's independent registered public accounting
firm, as stated in their report which is incorporated by reference into the SAI
dated , 2005. The table should be read in conjunction with the
Financial Statements and Notes thereto, which are incorporated by reference into
the SAI.
FOR THE FOR THE PERIOD
SIX MONTHS ENDED MARCH 30, 2004(a)
JUNE 30, 2005 THROUGH
(UNAUDITED) DECEMBER 31, 2004
PER SHARE OPERATING PERFORMANCE: ----------- -----------------
Net asset value per common share, beginning of period....... $22.38 $19.10
------ ------
Income from investment operations:
Net investment income(b)................................ 0.70 0.85
Net realized and unrealized gain on investments......... 2.29 3.36
------ ------
Total income from investment operations............. 2.99 4.21
------ ------
Less dividends and distributions to preferred shareholders
from:
Net investment income................................... (0.16) (0.12)
Net realized gain on investments........................ -- (0.00)(c)
------ ------
Total dividends and distributions to preferred
shareholders...................................... (0.16) (0.12)
------ ------
Total from investment operations applicable to
common shares..................................... 2.83 4.09
------ ------
Less: Offering costs charged to paid-in capital -- common
shares.................................................... -- (0.04)
Preferred share offering cost adjustment................ 0.01 --
Offering costs charged to paid-in capital -- preferred
shares................................................ -- (0.14)
Anti-dilutive effect of common share offering........... -- 0.05
------ ------
Total offering and organization costs............... 0.01 (0.13)
------ ------
Less dividends and distributions to common shareholders
from:
Net investment income................................... (0.56) (0.67)
Net realized gain on investments........................ -- (0.01)
Tax return on capital................................... -- (0.00)(c)
------ ------
Total dividends and distributions to common
shareholders...................................... (0.56) (0.68)
------ ------
Net increase in net asset value............................. 2.28 3.28
------ ------
Net asset value, per common share, end of period............ $24.66 $22.38
------ ------
------ ------
Market value, per common share, end of period............... $21.43 $19.82
------ ------
------ ------
Net asset value total return(d)............................. 13.25%(e) 21.57%(e)
------ ------
------ ------
Market value return(d)...................................... 11.12%(e) 2.82%(e)
------ ------
------ ------
27
SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS -- (CONTINUED)
FOR THE FOR THE PERIOD
SIX MONTHS ENDED MARCH 30, 2004(a)
JUNE 30, 2005 THROUGH
(UNAUDITED) DECEMBER 31, 2004
RATIOS/SUPPLEMENTAL DATA: ---------------- -----------------
Net assets applicable to common shares, end of period
(in millions)............................................. $1,068.3 $ 969.4
-------- --------
-------- --------
Ratio of expenses to average daily net assets applicable to
common shares (before expense reduction)(g)............... 1.59%(f) 1.51%(f)
-------- --------
-------- --------
Ratio of expenses to average daily net assets applicable to
common shares (net of expense reduction)(g)............... 1.29%(f) 1.22%(f)
-------- --------
-------- --------
Ratio of net investment income to average daily net
assets applicable to common shares (before expense
reduction)(g)............................................... 5.91%(f) 5.33%(f)
-------- --------
-------- --------
Ratio of net investment income to average daily net
assets applicable to common shares (net of expense
reduction)(g)............................................... 6.21%(f) 5.62%(f)
-------- --------
-------- --------
Ratio of expenses to average daily managed assets
(before expense reduction)(g,h)........................... 1.06%(f) 1.06%(f)
-------- --------
-------- --------
Ratio of expenses to average daily managed assets
(net of expense reduction)(g,h)........................... 0.86%(f) 0.86%(f)
-------- --------
-------- --------
Portfolio turnover rate..................................... 14.56%(e) 14.03%(e)
-------- --------
-------- --------
PREFERRED SHARES:
Liquidation value, end of period (in 000's)................. $492,000 $ 492,000
-------- --------
-------- --------
Total shares outstanding (in 000's)......................... 20 20
-------- --------
-------- --------
Asset coverage per share.................................... $ 79,285 $ 74,259
-------- --------
-------- --------
Liquidation preference per share............................ $ 25,000 $ 25,000
-------- --------
-------- --------
Average market value per share(i)........................... $ 25,000 $ 25,000
-------- --------
-------- --------
---------
(a) Commencement of operations.
(b) Calculation based on average shares outstanding.
(c) Less than $0.005 per share.
(d) Total market value return is computed based upon the New York Stock Exchange
market price of the Fund's shares and excludes the effects of brokerage
commissions that would have been paid by investors. Dividends and
distributions, if any, are assumed for purposes of this calculation, to be
reinvested at prices obtained under the Fund's dividend reinvestment plan.
Total net asset value return measures the changes in value over the period
indicated, taking into account dividends as reinvested.
(e) Not annualized.
(f) Annualized.
(g) Ratios do not reflect dividend payments to preferred shareholders.
(h) Average daily managed assets represents net assets applicable to common
shares plus liquidation preference of preferred shares.
(i) Based on weekly prices.
28
THE FUND
The Fund is a non-diversified, closed-end management investment company. The
Fund was organized as a Maryland corporation on January 8, 2004, and is
registered as an investment company under the 1940 Act. The Fund issued an
aggregate of 41,250,000 Common Shares, par value $.001 per share, pursuant to
the initial public offering thereof and commenced its operations with the
closing of the initial public offering on March 30, 2004. On May 7, 2004, the
Fund issued 2,065,500 additional Common Shares, in connection with a partial
exercise by the underwriters of the over allotment option. On May 20, 2004, the
Fund issued 3,400 Series M7 AMPS, 3,400 Series T7 AMPS, 3,400 Series W7 AMPS,
3,400 Series TH28 AMPS and 3,400 Series F7 AMPS. On November 15, 2004, the Fund
issued 2,680 Series T28 AMPS. The Fund's Common Shares are traded on the NYSE
under the symbol 'UTF.' The Fund's principal office is located at 757 Third
Avenue, New York, New York 10017, and the Fund's telephone number is (212)
832-3232.
The following provides information about the Fund's outstanding shares as of
October 11, 2005:
AMOUNT HELD
AMOUNT BY THE FUND OR AMOUNT
TITLE OF CLASS AUTHORIZED FOR ITS ACCOUNT OUTSTANDING
-------------- ---------- --------------- -----------
Common Shares.................................. 99,980,320 0 43,320,750
Preferred Shares...............................
Series M7 AMPS............................. 3,400 0 3,400
Series T7 AMPS............................. 3,400 0 3,400
Series W7 AMPS............................. 3,400 0 3,400
Series TH28 AMPS........................... 3,400 0 3,400
Series F7 AMPS............................. 3,400 0 3,400
Series T28 AMPS............................ 2,680 0 2,680
Series TH7 AMPS............................ 0 0 0
USE OF PROCEEDS
The Fund estimates that the net proceeds of this offering of the AMPS, after
payment of the sales load and offering expenses, will be $ . The net
proceeds offering, together with the proceeds from our initial public offering,
will be invested in accordance with the policies set forth under 'Investment
Objective and Policies.' The Fund estimates that the net proceeds of this
offering will be fully invested in accordance with its investment objective and
policies within four months of the completion of this offering. Pending such
investment, the proceeds may be invested in U.S. Government securities or
high-quality, short-term money market instruments. See 'Investment Objective and
Policies.'
29
CAPITALIZATION (UNAUDITED)
The following table sets forth the unaudited capitalization of the Fund as
of , 2005, and as adjusted to give effect to the issuance of the AMPS
offered in this prospectus.
AS OF , 2005
-------------------------------
ACTUAL AS ADJUSTED
------ -----------
(UNAUDITED)
AS OF , 2005:
AMPS, $0.001 par value, $25,000 liquidation value;
19,680 shares authorized (3,400 Series M7
AMPS, 3,400 Series T7 AMPS, 2,680 Series T28
AMPS, 3,400 Series W7 AMPS, 3,400 Series TH28
AMPS and 3,400 Series F7 AMPS outstanding)
shares authorized after giving effect to the
issuance of shares of Series TH7 AMPS....... $ $
Common Shares, $.001 par value per share; As
of , 2005, shares authorized
(before giving effect to the issuance of
shares of Series TH7 AMPS) shares
outstanding..................................... $ $
Paid-in surplus................................... $ $
Distributions in excess of net investment
income.......................................... $ $
Accumulated net realized gain (loss) from
investment transactions.........................
Net unrealized appreciation (depreciation) of
investments..................................... $ $
Net assets applicable to common shares............ $ $
-------------- --------------
Net assets, plus liquidation preference of
Preferred Shares................................ $ $
-------------- --------------
-------------- --------------
As used in this prospectus, unless otherwise noted, the Fund's 'managed
assets' include assets of the Fund attributable to the AMPS and any other
oustanding shares of preferred stock, with no deduction for the liquidation
preference of such shares. For financial reporting purposes, however, the Fund
is required to deduct the liquidation preference of the AMPS and any other
outstanding shares of preferred stock from 'managed assets' so long as the AMPS
and any other outstanding shares of preferred stock have redemption features
that are not solely within the control of the Fund. In connection with the
rating of the AMPS and other outstanding shares of preferred stock, the Fund has
established various portfolio covenants to meet third-party rating agency
guidelines in its Charter. These covenants include, among other things,
investment diversification requirements and requirements that investments
included in the Fund's portfolio meet specific industry and credit quality
criteria. Market factors outside the Fund's control may affect its ability to
meet the criteria of third-party rating agencies set forth in the Fund's
portfolio covenants. If the Fund violates these covenants, it may be required to
cure the violation by redeeming all or a portion of the AMPS. For all regulatory
purposes, the Fund's AMPS will be treated as stock (rather than indebtedness).
30
INVESTMENT OBJECTIVE AND POLICIES
GENERAL
The Fund's investment objective is to seek a high level of after-tax total
return through investment in utility securities. In pursuing total return, the
Fund equally emphasizes both current income, consisting primarily of
tax-advantaged dividend income, and capital appreciation. The Fund is not
intended as a complete investment program. There can be no assurance that the
Fund will achieve its investment objective.
Under normal market conditions, the Fund invests at least 80% of its managed
assets in a portfolio of common stocks, preferred stocks and other equity
securities issued by utility companies. In addition, under normal market
conditions, the Fund may invest up to 20% of its managed assets in preferred
securities and other fixed income securities that are issued by any type of
company. The Fund also may invest up to 25% of its managed assets in preferred
securities and other fixed income securities that at the time of the investment
are rated below investment grade or that are unrated but judged to be below
investment grade by the Fund's Investment Manager. In addition, the Fund may
invest up to 20% of its managed assets in U.S. dollar-denominated securities of
foreign issuers traded or listed on a U.S. securities exchange or in the U.S.
over-the-counter market.
The Fund's concentration of its investments in the utility industry makes
the Fund more susceptible to adverse economic or regulatory occurrences
affecting that industry. See 'Risk Factors -- Special Risks of Securities Linked
to the Utility Industry.'
Although the Fund does not currently intend to invest in illiquid securities
(i.e., securities that are not readily marketable), it may invest up to 10% of
its managed assets in illiquid securities.
Under normal market conditions, the Fund seeks to achieve its objective by
investing in a portfolio of income producing securities issued by utility
companies. Substantially all of the securities issued by utility companies in
which the Fund intends to invest are traded on a national securities exchange or
in the over-the-counter market.
Utility companies generally pay dividends on their equity securities that
qualify for the DRD and for the benefits under the rules relating to qualified
dividend income. The DRD generally allows corporations to deduct 70% of the
income they receive from dividends that are paid out of earnings and profits of
the issuer. Under current law, individuals will generally be taxed at long-term
capital gain rates on qualified dividend income for taxable years beginning on
or before December 31, 2008. Corporate stockholders of a regulated investment
company like the Fund generally are permitted to claim a deduction with respect
to that portion of their distributions attributable to amounts received by the
regulated investment company that qualify for the DRD. Individual stockholders
of a regulated investment company like the Fund generally are permitted to treat
as qualified dividend income that portion of their distributions attributable to
qualified dividend income received by the regulated investment company.
A security will be considered investment grade quality if it is rated
'BBB-' or higher by S&P, 'Baa3' or higher by Moody's or an equivalent rating
by a nationally recognized statistical rating agency, or is unrated but judged
to be of comparable quality by the Investment Manager. Bonds of below investment
grade quality (BB/Ba or below) are commonly referred to as 'junk bonds.'
Securities of below investment grade quality are regarded as having
predominantly speculative characteristics with respect to the issuer's capacity
to pay interest and repay principal. The Fund's credit quality policies apply
only at the time a security is purchased, and the Fund is
31
not required to dispose of a security if a rating agency downgrades its
assessment of the credit characteristics of a particular issue. In determining
whether to retain or sell a security that a rating agency has downgraded, the
Investment Manager may consider such factors as its assessment of the credit
quality of the issuer of the security, the price at which the security could be
sold and the rating, if any, assigned to the security by other rating agencies.
Appendix A to the SAI contains a general description of Moody's and S&P's
ratings of securities.
The Fund's investment objective and certain other policies are fundamental
and may not be changed without the approval of the holders of a 'majority of the
outstanding' Common Shares and the AMPS (and the Outstanding AMPS) voting
together as a single class, and of the holders of a 'majority of the
outstanding' AMPS (and the Outstanding AMPS) voting together as a separate
class. When used with respect to particular shares of the Fund, a 'majority of
the outstanding' shares means (i) 67% or more of the shares present at a
meeting, if the holders of more than 50% of the shares are present or
represented by proxy, or (ii) more than 50% of the shares, whichever is less.
Unless otherwise indicated, the Fund's investment policies are not fundamental
and may be changed by the Board of Directors without the approval of
stockholders, although we have no current intention of doing so.
INVESTMENT STRATEGIES
In making investment decisions with respect to common stocks and other
equity securities issued by utility companies, the Investment Manager relies on
a fundamental analysis of each company. Securities are evaluated for their
potential to provide an attractive total return through a combination of
dividend yield and capital appreciation. The Investment Manager reviews each
company's potential for success in light of general economic and industry
trends, as well as the company's quality of management, financial condition,
business plan, industry and sector market position, dividend payout ratio and
corporate governance. The Investment Manager utilizes a value-oriented approach,
and evaluates each company's valuation on the basis of relative price/cash flow
and price/earnings multiples, earnings growth rate, dividend yield and
price/book value, among other metrics.
In making investment decisions with respect to preferred securities and
other fixed income securities, the Investment Manager seeks to select what it
believes are securities that are undervalued on the basis of risk and return
profiles. In making these determinations, the Investment Manager evaluates the
fundamental characteristics of an issuer, including an issuer's
creditworthiness, and also takes into account prevailing market factors. In
analyzing credit quality, the Investment Manager considers not only fundamental
analysis, but also an issuer's corporate and capital structure and the placement
of the preferred or debt securities within that structure. The Investment
Manager also takes into account other factors, such as call and other structural
features, event risk, the likely directions of ratings and relative value versus
other income security classes.
PORTFOLIO COMPOSITION
Our portfolio will be composed principally of the following investments. A
more detailed description of our investment policies and restrictions and more
detailed information about our portfolio investments are contained in the SAI.
32
The Fund currently invests approximately % of its managed assets in
common stocks and approximately % of its managed assets in preferred
securities issued by utility companies. These percentages may vary from time to
time, consistent with the Fund's investment objective. At any time, under normal
circumstances at least 80% of the Fund's managed assets will be invested in
equity securities issued by utility companies.
Securities Issued By Utility Companies. Under normal market conditions, at
least 80% of the Fund's managed assets will be invested in common stocks,
preferred stocks and other equity securities of utility companies. Utility
companies derive at least 50% of their revenues from, or have at least 50% of
their assets committed to, the:
generation, transmission, sale or distribution of electric energy;
distribution, purification and treatment of water;
production, transmission or distribution of natural gas; and
provision of communications services, including cable television,
satellite, microwave, radio, telephone and other communications media.
Substantially all of the securities issued by utility companies in which the
Fund intends to invest are traded on a national securities exchange or in the
over-the-counter market. Utility companies generally pay dividends on their
equity securities that qualify for the DRD and for the benefits under rules
relating to qualified dividend income. Corporate stockholders are generally
permitted to claim a deduction with respect to that portion of their
distributions attributable to amounts received by the Fund that qualify for the
DRD. The Fund generally can pass the tax treatment of qualified dividend income
it receives through to individual stockholders, provided that holding period and
other requirements are met.
Preferred Securities. The Fund may invest in preferred securities issued by
utility companies and other types of issuers. There are two basic types of
preferred securities. The first, sometimes referred to in this prospectus as
traditional preferred securities, consists of preferred stock issued by an
entity taxable as a corporation. Preferred stocks are considered equity
securities. The second is referred to in this prospectus as hybrid-preferred
securities. Hybrid-preferred securities are usually issued by a trust or limited
partnership and often represent preferred interests in subordinated debt
instruments issued by a corporation for whose benefit the trust or partnership
was established. Hybrid-preferred securities are considered debt securities.
Initially, the preferred securities component of the Fund will be comprised
primarily of hybrid-preferred securities.
Traditional Preferred Securities. Preferred securities pay fixed or floating
dividends to investors and have 'preference' over common stock in the payment of
dividends and the liquidation of a company's assets. This means that a company
must pay dividends on preferred stock before paying any dividends on its common
stock. In order to be payable, distributions on such preferred securities must
be declared by the issuer's board of directors. Income payments on typical
preferred securities currently outstanding are cumulative, causing dividends and
distributions to accumulate even if not declared by the board of directors or
otherwise made payable. In such a case, all accumulated dividends must be paid
before any dividend on the common stock can be paid. However, some traditional
preferred stocks are non-cumulative, in which case dividends do not accumulate
and need not ever be paid. A portion of the portfolio may include investments in
non-cumulative preferred securities, whereby the issuer does not have an
obligation to make up any arrearages to its stockholders. Should an issuer of a
non-cumulative preferred stock held by the Fund determine not to pay dividends
on such stock, the amount of dividends the Fund pays
33
may be adversely affected. There is no assurance that dividends or distributions
on the traditional preferred securities in which the Fund invests will be
declared or otherwise made payable. Preferred stockholders usually have no right
to vote for corporate directors or on other matters. Shares of traditional
preferred securities have a liquidation value that generally equals the original
purchase price at the date of issuance. The market value of preferred securities
may be affected by favorable and unfavorable changes impacting companies in the
utilities and financial services sectors, which are prominent issuers of
preferred securities, and by actual and anticipated changes in tax laws, such as
changes in corporate income tax rates. Because the claim on an issuer's earnings
represented by traditional preferred securities may become onerous when interest
rates fall below the rate payable on such securities, the issuer may redeem the
securities. Thus, in declining interest rate environments in particular, the
Fund's holdings of higher rate-paying fixed rate preferred securities may be
reduced and the Fund may be unable to acquire securities of comparable credit
quality paying comparable rates with the redemption proceeds.
Pursuant to the DRD, corporations may generally deduct 70% of the income
they receive from dividends on traditional preferred securities that are paid
out of earnings and profits of the issuer. Corporate stockholders of a regulated
investment company like the Fund generally are permitted to claim a deduction
with respect to that portion of their distributions attributable to amounts
received by the regulated investment company that qualify for the DRD.
Individuals will generally be taxed at long-term capital gain rates on qualified
dividend income for taxable years beginning on or before December 31, 2008.
Individual stockholders of a regulated investment company like the Fund
generally are permitted to treat as qualified dividend income that portion of
their distributions attributable to qualified dividend income received by the
regulated investment company.
Hybrid-Preferred Securities. Hybrid-preferred securities are a comparatively
new asset class. Hybrid-preferred securities are typically issued by
corporations, generally in the form of interest-bearing notes with preferred
securities characteristics, or by an affiliated business trust of a corporation,
generally in the form of beneficial interests in subordinated debentures or
similarly structured securities. The hybrid-preferred securities market consists
of both fixed and adjustable coupon rate securities that are either perpetual in
nature or have stated maturity dates.
Hybrid-preferred securities are typically junior and fully subordinated
liabilities of an issuer or the beneficiary of a guarantee that is junior and
fully subordinated to the other liabilities of the guarantor. In addition,
hybrid-preferred securities typically permit an issuer to defer the payment of
income for eighteen months or more without triggering an event of default.
Generally, the maximum deferral period is five years. Because of their
subordinated position in the capital structure of an issuer, the ability to
defer payments for extended periods of time without default consequences to the
issuer, and certain other features (such as restrictions on common dividend
payments by the issuer or ultimate guarantor when full cumulative payments on
the trust preferred securities have not been made), these hybrid-preferred
securities are often treated as close substitutes for traditional preferred
securities, both by issuers and investors. Hybrid-preferred securities have many
of the key characteristics of equity due to their subordinated position in an
issuer's capital structure and because their quality and value are heavily
dependent on the profitability of the issuer rather than on any legal claims to
specific assets or cash flows. Hybrid preferred securities include, but are not
limited to, trust originated preferred securities ('TOPRS'r''); monthly income
preferred securities ('MIPS'r''); quarterly income bond securities ('QUIBS'r'');
quarterly income debt securities ('QUIDS'r''); quarterly income preferred
securities
34
('QUIPS'sm''); corporate trust securities ('CORTS'r''); public income notes
('PINES'r''); and other hybrid-preferred securities.*
Hybrid-preferred securities are typically issued with a final maturity date,
although some are perpetual in nature. In certain instances, a final maturity
date may be extended and/or the final payment of principal may be deferred at
the issuer's option for a specified time without default. No redemption can
typically take place unless all cumulative payment obligations have been met,
although issuers may be able to engage in open-market repurchases without regard
to whether all payments have been paid.
Many hybrid-preferred securities are issued by trusts or other special
purpose entities established by operating companies and are not a direct
obligation of an operating company. At the time the trust or special purpose
entity sells such preferred securities to investors, it purchases debt of the
operating company (with terms comparable to those of the trust or special
purpose entity securities), which enables the operating company to deduct for
tax purposes the interest paid on the debt held by the trust or special purpose
entity. The trust or special purpose entity is generally required to be treated
as transparent for Federal income tax purposes such that the holders of the
trust preferred securities are treated as owning beneficial interests in the
underlying debt of the operating company. Accordingly, payments on the
hybrid-preferred securities are treated as interest rather than dividends for
Federal income tax purposes and, as such, are not eligible for the DRD or the
reduced rates of tax that apply to qualified dividend income. The trust or
special purpose entity in turn would be a holder of the operating company's debt
and would have priority with respect to the operating company's earnings and
profits over the operating company's common stockholders, but would typically be
subordinated to other classes of the operating company's debt. Typically a
preferred share has a rating that is slightly below that of its corresponding
operating company's senior debt securities.
Within the category of hybrid-preferred securities are senior debt
instruments that trade in the broader preferred securities market. These debt
instruments, which are sources of long-term capital for the issuers, have
structural features similar to preferred stock such as maturities ranging from
30 years to perpetuity, call features, exchange listings and the inclusion of
accrued interest in the trading price. Similar to other hybrid-preferred
securities, these debt instruments usually do not offer equity capital
treatment. CORTS'r' and PINES'r' are two examples of senior debt instruments
which are structured and trade as hybrid-preferred securities.
Financial Services Company Securities. Companies principally engaged in
financial services are prominent issuers of preferred securities. A company is
'principally engaged' in financial services if it derives at least 50% of its
consolidated revenues from providing financial services. Companies in the
financial services sector include commercial banks, industrial banks, savings
institutions, finance companies, diversified financial services companies,
investment banking firms, securities brokerage houses, investment advisory
companies, leasing companies, insurance companies and companies providing
similar services.
Debt Securities. The Fund may invest in debt securities issued by utility
companies and other types of issuers. The Fund's investments in debt securities
may include investments in convertible
---------
* TOPRS is a registered service mark owned by Merrill Lynch & Co., Inc. MIPS and
QUIDS are registered service marks and QUIPS is a service mark owned by
Goldman, Sachs & Co. QUIBS is a registered service mark owned by Morgan
Stanley. CORTS and PINES are registered service marks owned by Salomon Smith
Barney Inc.
35
debt securities, convertible preferred securities, U.S. dollar-denominated
corporate debt securities issued by domestic and non-U.S. corporations and U.S.
dollar-denominated government debt securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities or a non-U.S. Government or its
agencies or instrumentalities. Convertible securities are exchangeable for
common stock at a predetermined stock (the 'conversion price'). Depending upon
the relationship of the conversion price to the market value of the underlying
securities, convertible securities may trade more like common stock than debt
instruments.
Lower-Rated Securities. The Fund may invest up to 25% of its managed assets
in securities that at the time of investment are rated below investment grade
(below Baa3 or BBB-) by Moody's, S&P, Fitch or an equivalent rating by a
nationally recognized statistical rating agency or that are unrated but judged
to be below investment grade by the Fund's Investment Manager. A security will
not be considered to be below investment grade quality if it is rated within the
four highest grades (Baa or BBB or better) by Moody's, S&P, Fitch or an
equivalent rating by a nationally recognized statistical rating agency or is
unrated but judged to be of comparable quality by the Fund's Investment Manager.
These below investment grade quality securities are commonly referred to as
'junk bonds' and are regarded as having predominantly speculative
characteristics with respect to the payment of interest and repayment of
principal. Such securities may face major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. Lower grade
securities, though high yielding, are characterized by high risk. They may be
subject to certain risks with respect to the issuing entity and to greater
market fluctuations than certain lower yielding, higher rated securities. The
retail secondary market for lower grade securities may be less liquid than that
of higher rated securities; adverse conditions could make it difficult at times
for the Fund to sell certain of these securities or could result in lower prices
than those used in calculating the Fund's net asset value.
Foreign Securities. The Fund may invest up to 20% of its managed assets in
U.S. dollar-denominated securities of foreign issuers traded or listed on a U.S.
securities exchange or the U.S. over-the-counter market. The Fund may invest in
any region of the world and invest in companies operating in developed countries
such as Canada, Japan, Australia, New Zealand and most Western European
countries. The Fund does not intend to invest in companies based in emerging
markets such as the Far East, Latin America and Eastern Europe, but to the
extent it does, the Fund will not invest more than 10% of its managed assets in
such securities. The World Bank and other international agencies define emerging
markets based on such factors as trade initiatives, per capita income and level
of industrialization. For purposes of this 20% limitation, non-U.S. securities
include securities represented by American Depository Receipts. Dividend income
the Fund receives from foreign securities may not be eligible for the special
tax treatment applicable to qualified dividend income. However, dividend income
the Fund receives from securities of certain 'qualified foreign corporations'
(e.g., generally, foreign corporations incorporated in a possession of the
United States or in certain countries with a qualifying comprehensive tax treaty
with the United States, or the stock with respect to which such dividend is paid
is readily tradable on an established securities market in the United States,
but does not include a foreign corporation which for the taxable year of the
corporation in which the dividend was paid, or the preceding taxable year, is a
'passive foreign investment company,' as defined in the Code) will be eligible
for the special tax treatment applicable to qualified dividend income.
36
Preferred Securities and Other Fixed-Income Securities. The Fund may invest
up to 20% of its managed assets in preferred securities and other fixed-income
securities that are issued by any type of company.
Common Stocks. The Fund will invest in common stocks issued by utility
companies. Common stocks represent the residual ownership interest in the issuer
and holders of common stock are entitled to the income and increase in the value
of the assets and business of the issuer after all of its debt obligations and
obligations to preferred stockholders are satisfied. Common stocks generally
have voting rights. Common stocks fluctuate in price in response to many factors
including historical and prospective earnings of the issuer, the value of its
assets, general economic conditions, interest rates, investor perceptions and
market liquidity.
Other Investment Companies
The Fund may invest up to 10% of its managed assets in securities of other
open- or closed-end investment companies, including exchange traded funds, that
invest primarily in securities of the types in which the Fund may invest
directly. The Fund generally expects to invest in other investment companies
either during periods when it has large amounts of uninvested cash, such as the
period shortly after the Fund receives the proceeds of the offering of its
Common Shares, or during periods when there is a shortage of attractive
opportunities in the market. As a stockholder in an investment company, the Fund
would bear its ratable share of that investment company's expenses, and would
remain subject to payment of the Fund's advisory and other fees and expenses
with respect to assets so invested. Holders of Common Shares would therefore be
subject to duplicative expenses to the extent the Fund invests in other
investment companies. The Investment Manager will take expenses into account
when evaluating the investment merits of an investment in an investment company
relative to available bond investments. The securities of other investment
companies may also be leveraged and will therefore be subject to the same
leverage risks to which the Fund is subject. As described in the sections
entitled 'Use of Leverage,' the net asset value and market value of leveraged
shares will be more volatile and the yield to stockholders will tend to
fluctuate more than the yield generated by unleveraged shares. Investment
companies may have investment policies that differ from those of the Fund. In
addition, to the extent the Fund invests in other investment companies, the Fund
will be dependent upon the investment and research abilities of persons other
than the Investment Manager.
Illiquid Securities. While the Fund does not currently intend to invest in
illiquid securities (i.e., securities that are not readily marketable), it may
invest up to 10% of its managed assets in illiquid securities. For this purpose,
illiquid securities include, but are not limited to, restricted securities
(securities the disposition of which is restricted under the Federal securities
laws), securities that may only be resold pursuant to Rule 144A under the
Securities Act but that are deemed to be illiquid, and repurchase agreements
with maturities in excess of seven days. The Board of Directors or its delegate
has the ultimate authority to determine, to the extent permissible under the
Federal securities laws, which securities are liquid or illiquid for purposes of
this 10% limitation. The Board of Directors has delegated to the Investment
Manager the day-to-day determination of the illiquidity of any security held by
the Fund, although it has retained oversight and ultimate responsibility for
such determinations. Although no definitive liquidity criteria are used, the
Board and/or the Investment Manager will consider factors such as (i) the nature
of the market for a security (including the institutional private resale market;
the frequency of trades and quotes for the security; the number of dealers
willing to purchase or sell the
37
security; the amount of time normally needed to dispose of the security; and the
method of soliciting offers and the mechanics of transfer), (ii) the terms of
certain securities or other instruments allowing for the disposition to a third
party or the issuer thereof (e.g., certain repurchase obligations and demand
instruments) and (iii) other permissible relevant factors.
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act. Where registration is required, the Fund may be
obligated to pay all or part of the registration expenses and a considerable
period may elapse between the time of the decision to sell and the time the Fund
may be permitted to sell a security under an effective registration statement.
If, during such a period, adverse market conditions were to develop, the Fund
might obtain a less favorable price than that which prevailed when it decided to
sell. Illiquid securities will be priced at fair value as determined in good
faith by the Board of Directors or its delegate. If, through changes in the
market value of its portfolio securities, the Fund should be in a position where
more than 10% of the value of its managed assets is invested in illiquid
securities, including restricted securities that are not readily marketable, the
Fund will take such steps as the Board and/or the Investment Manager deem
advisable, if any, to protect liquidity.
Strategic Transactions. The Fund may, but is not required to, use various
strategic transactions described below to mitigate risks and to facilitate
portfolio management. Such strategic transactions are generally accepted under
modern portfolio management and are regularly used by many closed-end funds and
other institutional investors. Although the Investment Manager seeks to use the
practices to further the Fund's investment objective, no assurance can be given
that these practices will achieve this result.
The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on securities, equity,
fixed-income and interest rate indices, and other financial instruments,
purchase and sell financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors or collars or
credit transactions and credit default swaps. The Fund also may purchase
derivative instruments that combine features of these instruments. Collectively,
all of the above are referred to as 'Strategic Transactions.' The Fund generally
seeks to use Strategic Transactions as a portfolio management or hedging
technique to seek to protect against possible adverse changes in the market
value of securities held in or to be purchased for the Fund's portfolio, protect
the value of the Fund's portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate exposure of the Fund,
manage the effective maturity or duration of the Fund's portfolio, or establish
positions in the derivatives markets as a temporary substitute for purchasing or
selling particular securities. There is no limit on the amount of credit
derivative transactions that may be entered into by the Fund.
Strategic Transactions have risks, including the imperfect correlation
between the value of such instruments and the underlying assets, the possible
default of the other party to the transaction or illiquidity of the derivative
instruments. Furthermore, the ability to successfully use Strategic Transactions
depends on the Investment Manager's ability to predict pertinent market
movements, which cannot be assured. Thus, the use of Strategic Transactions may
result in losses greater than if they had not been used, may require the Fund to
sell or purchase portfolio securities at inopportune times or for prices other
than current market values, may limit the amount of appreciation the Fund can
realize on an investment, or may cause the Fund to hold a security that it might
otherwise sell. Additionally, amounts paid by the Fund as premiums and cash or
other
38
assets held in margin accounts with respect to Strategic Transactions are not
otherwise available to the Fund for investment purposes. A more complete
discussion of Strategic Transactions and their risks is contained in the Fund's
SAI.
The Fund also may enter into certain interest rate transactions that are
designed in part to reduce the risks inherent in the Fund's issuance of the
AMPS. See 'How the Fund Manages Risk -- Interest Rate Transactions.'
When-Issued and Delayed Delivery Transactions. The Fund may buy and sell
securities on a when-issued or delayed delivery basis, making payment or taking
delivery at a later date, normally within 15 to 45 days of the trade date. This
type of transaction may involve an element of risk because no interest accrues
on the securities prior to settlement and, because securities are subject to
market fluctuations, the value of the securities at time of delivery may be less
(or more) than cost. A separate account of the Fund will be established with its
custodian consisting of cash equivalents or liquid securities having a market
value at all times at least equal to the amount of the commitment.
Portfolio Turnover. The Fund may engage in portfolio trading when considered
appropriate, but short-term trading will not be used as the primary means of
achieving the Fund's investment objective. There are no limits on portfolio
turnover, and investments may be sold without regard to length of time held
when, in the opinion of the Investment Manager, investment considerations
warrant such action. A higher portfolio turnover rate results in correspondingly
greater brokerage commissions and other transactional expenses that are borne by
the Fund. High portfolio turnover may result in the realization of net
short-term capital gains by the Fund which, when distributed to stockholders,
will be taxable as ordinary income.
Defensive Position. When the Investment Manager believes that market or
general economic conditions justify a temporary defensive position, we may
deviate from our investment objective and invest all or any portion of our
assets in investment grade debt securities, without regard to whether the issuer
is a utility company. When and to the extent we assume a temporary defensive
position, we may not pursue or achieve our investment objective.
OTHER INVESTMENTS
The Fund's cash reserves, held to provide sufficient flexibility to take
advantage of new opportunities for investments and for other cash needs, will be
invested in money market instruments. Money market instruments in which we may
invest our cash reserves will generally consist of obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities and such
obligations which are subject to repurchase agreements and commercial paper. See
'Investment Objective and Policies' in the SAI.
USE OF LEVERAGE
The Fund may issue other preferred shares, in addition to the AMPS and the
Outstanding AMPS, or borrow or issue short-term debt securities to increase its
assets available for investment. The Fund is authorized to issue preferred
shares, borrow or issue debt obligations. Before issuing such preferred shares
to increase its assets available for investment, the Fund must have received
confirmation from Moody's and S&P or any substitute rating agency that the
proposed issuance will not adversely affect such rating agency's then-current
rating on the AMPS. The Fund must also comply with certain asset coverage
requirements under the 1940 Act. See 'Description of AMPS -- Rating Agency
Guidelines.' The Fund also may borrow money as a temporary measure
39
for extraordinary or emergency purposes, including the payment of dividends and
the settlement of securities transactions which otherwise might require untimely
dispositions of the Fund's holdings. When the Fund leverages its assets, the
fees paid to the Investment Manager for investment management services will be
higher than if the Fund did not borrow because the Investment Manager's fees are
calculated based on the Fund's managed assets, which includes the liquidation
preference of preferred shares, including the AMPS, or any outstanding
borrowings. Consequently, the Fund and the Investment Manager may have differing
interests in determining whether to leverage the Fund's assets.
The Fund's use of leverage is premised upon the expectation that the Fund's
preferred share dividends or borrowing cost will be lower than the return the
Fund achieves on its investments with the proceeds of the issuance of preferred
shares or borrowing. Such difference in return may result from the Fund's higher
credit rating or the short-term nature of its borrowing compared to the
long-term nature of its investments. Since the total assets of the Fund
(including the assets obtained from leverage) will be invested in the higher
yielding portfolio investments or portfolio investments with the potential for
capital appreciation, holders of Common Shares will be the beneficiaries of the
incremental return. Should the differential between the underlying assets and
cost of leverage narrow, the incremental return 'pick up' will be reduced.
Furthermore, if long-term rates rise or the Fund otherwise incurs losses on its
investments, the Fund's net asset value attributable to its Common Shares will
reflect the decline in the value of portfolio holdings resulting therefrom.
To the extent the income or capital appreciation derived from securities
purchased with funds received from leverage exceeds the cost of leverage, the
Fund's return to the holders of Common Shares will be greater than if leverage
had not been used. Conversely, if the income or capital appreciation from the
securities purchased with such funds is not sufficient to cover the cost of
leverage or if the Fund incurs capital losses, the return of the Fund to holders
of Common Shares will be less than if leverage had not been used. The Investment
Manager may determine to maintain the Fund's leveraged position if it expects
that the long-term benefits to the holders of Common Shares of maintaining the
leveraged position will outweigh the current reduced return. Capital raised
through the issuance of preferred shares or borrowing will be subject to
dividend payments or interest costs that may or may not exceed the income and
appreciation on the assets purchased. The Fund also may be required to maintain
minimum average balances in connection with borrowings or to pay a commitment or
other fee to maintain a line of credit; either of these requirements will
increase the cost of borrowing over the stated interest rate.
The Fund may be subject to certain restrictions on investments imposed by
guidelines of one or more nationally recognized rating organizations which may
issue ratings for the AMPS, other preferred shares or short-term debt
instruments issued by the Fund. These guidelines may impose asset coverage or
portfolio composition requirements that are more stringent than those imposed by
the 1940 Act. Certain types of borrowings may result in the Fund being subject
to covenants in credit agreements, including those relating to asset coverage,
borrowing base and portfolio composition requirements and additional covenants.
The Fund may also be required to pledge its assets to the lenders in connection
with certain types of borrowing. The Investment Manager does not anticipate that
these covenants or restrictions will adversely affect its ability to manage the
Fund's portfolio in accordance with the Fund's investment objective and
policies. Due to these covenants or restrictions, the Fund may be forced to
liquidate investments at times and at prices
40
that are not favorable to the Fund, or the Fund may be forced to forgo
investments that the Investment Manager otherwise views as favorable.
If and to the extent that the Fund employs leverage in addition to the AMPS
and the Outstanding AMPS will depend on many factors, the most important of
which are investment outlook, market conditions and interest rates.
41
RISK FACTORS
Risk is inherent in all investing. Before investing, you should consider
carefully the following risks that you assume when you invest in the AMPS.
RISKS OF INVESTING IN AMPS
Leverage Risk. The Fund uses financial leverage for investment purposes by
issuing preferred shares. It is currently anticipated that, taking into account
the AMPS being offered in this prospectus, the amount of leverage will represent
approximately 35% of the Fund's managed assets (as defined below).
The Fund's leveraged capital structure creates special risks not associated
with unleveraged funds having a similar investment objective and policies. These
include the possibility of higher volatility in the net asset value of the
Fund's Common Shares and the asset coverage of the AMPS and the Outstanding
AMPS. As long as the AMPS and the Outstanding AMPS are outstanding, the Fund
does not intend to utilize other forms of leverage.
Because the fees paid to the Investment Manager will be calculated on the
basis of the Fund's managed assets (which equals the aggregate net asset value
('NAV') of the Common Shares plus the liquidation preference of the AMPS and the
Outstanding AMPS), the fee will be higher when leverage is utilized, giving the
Investment Manager an incentive to utilize leverage.
Interest Rate Risk. The Fund issues preferred shares, such as the AMPS,
which pay dividends based on short-term interest rates. The Fund purchases
equity securities that pay dividends that are based on the performance of the
issuing companies. The Fund also may buy debt securities that pay interest based
on longer-term yields. These dividends and interest payments are typically,
although not always, higher than short-term interest rates. Long-term and
short-term interest rates, fluctuate. If short-term interest rates rise,
dividend rates on the AMPS may rise so that the amount of dividends to be paid
to stockholders of the AMPS exceeds the income from the portfolio securities.
Because income from the Fund's entire investment portfolio (not just the portion
of the portfolio purchased with the proceeds of the AMPS offering) is available
to pay dividends on the AMPS, dividend rates on the AMPS would need to greatly
exceed the Fund's net portfolio income before the Fund's ability to pay
dividends on the AMPS would be jeopardized. If long-term interest rates rise,
this could negatively impact the value of the Fund's investment portfolio,
reducing the amount of assets serving as asset coverage for the AMPS. The Fund
anticipates entering into interest rate swap or cap transactions with the intent
to reduce or eliminate the risk posed by an increase in short-term interest
rates. There is no guarantee that the Fund will engage in these transactions or
that these transactions will be successful in reducing or eliminating interest
rate risk. See 'How the Fund Manages Risk -- Interest Rate Transactions.'
Auction Risk. The dividend rate for the AMPS normally is set through an
auction process. In the auction, holders of AMPS may indicate the dividend rate
at which they would be willing to hold or sell their AMPS or purchase additional
AMPS. The auction also provides liquidity for the sale of AMPS. An auction fails
if there are more AMPS offered for sale than there are buyers. You may not be
able to sell your AMPS at an auction if the auction fails. A holder of the AMPS
therefore can be given no assurance that there will be sufficient clearing bids
in any auction or that the holder will be able to sell its AMPS in an auction.
Also, if you place bid orders (orders to retain AMPS) at an auction only at a
specified dividend rate, and that rate exceeds the rate set at the auction, you
will not retain your AMPS. Additionally, if you buy AMPS or elect to retain
42
AMPS without specifying a dividend rate below which you would not wish to buy or
continue to hold those AMPS, you could receive a lower rate of return on your
AMPS than the market rate. Finally, the dividend periods for the AMPS may be
changed by the Fund, subject to certain conditions with notice to the holders of
AMPS, which could also affect the liquidation of your investment. See
'Description of AMPS and 'The Auction -- Auction Procedures.
As noted above, if there are more auction rate securities offered for sale
than there are buyers for those auction rate securities in any auction, the
auction will fail and you may not be able to sell some or all of your auction
rate securities at that time. The relative buying and selling interest of market
participants in your auction rate securities and in the auction rate securities
market as a whole will vary over time, and such variations may be affected by,
among other things, news relating to the issuer, the attractiveness of
alternative investments, the perceived risk of owning the security (whether
related to credit, liquidity or any other risk), the tax treatment accorded the
instruments, the accounting treatment accorded auction rate securities,
including recent clarifications of U.S. generally accepted accounting principles
relating to the treatment of auction rate securities, reactions to regulatory
actions or press reports, financial reporting cycles and market sentiment
generally. Shifts of demand in response to any one or simultaneous particular
events cannot be predicted and may be short-lived or exist for longer periods.
Secondary Market Risk. If you try to sell your AMPS between auctions, you
may not be able to sell any or all of your shares, or you may not be able to
sell them for $25,000 per share or $25,000 per share plus accumulated but unpaid
dividends, if any, whether or not earned or declared. If the Fund has designated
a special rate period (a dividend period of more than days), changes in
interest rates could affect the price you would receive if you sold your shares
in the secondary market. You may transfer shares outside of auctions only to or
through a broker-dealer that has entered into an agreement with the auction
agent and the Fund or other person as the Fund permits. The Fund does not
anticipate imposing significant restrictions on transfers to other persons.
However, unless any such other person has entered into a relationship with a
broker-dealer that has entered into a broker-dealer agreement with the auction
agent, that person will not be able to submit bids at auctions with respect to
the AMPS. Broker-dealers that maintain a secondary trading market for the AMPS
are not required to maintain this market, and the Fund is not required to redeem
shares either if an auction or an attempted secondary market sale fails because
of a lack of buyers. The AMPS are not listed on a stock exchange or the National
Association of Securities Dealers Automated Quotations, Inc. ('NASDAQ') stock
market. If you sell your AMPS to a broker-dealer between auctions, you may
receive less than the price you paid for them, especially when market interest
rates have risen since the last auction and during a special rate period. In
addition, a broker-dealer may, in its own discretion, decide to sell the AMPS in
the secondary market to investors at any time and at any price, including at
prices equivalent to, below or above the liquidation preference of the AMPS.
Securities and Exchange Commission Inquiries. The underwriters have advised
the Fund that certain of the underwriters and various other broker-dealers and
other firms that participate in the auction rate securities market received
letters from the staff of the Securities and Exchange Commission last spring.
The letters requested that each of these firms voluntarily conduct an
investigation regarding its respective practices and procedures in that market.
Pursuant to these requests, each of those underwriters conducted its own
voluntary review and reported its findings to the Securities and Exchange
Commission staff. At the Securities and Exchange Commission staff's request,
those underwriters are engaging in discussions with the Securities and Exchange
Commission staff that may lead to a resolution of its inquiry. Neither those
underwriters nor the
43
Fund can predict how such a resolution may affect the market for the AMPS or
the auctions.
Ratings and Asset Coverage Risk. While it is a condition to the closing of
the offering that the AMPS receive the highest credit quality rating from at
least two of S&P, Moody's and Fitch, the ratings do not eliminate or necessarily
mitigate the risks of investing in the AMPS. In addition, Moody's, S&P, Fitch,
or another rating agency then rating the AMPS could downgrade the AMPS, which
may make your shares less liquid at an auction or in the secondary market. If a
rating agency downgrades the AMPS, the dividend rate on the AMPS will be the
applicable maximum rate based on the credit rating of the AMPS, which will be a
rate higher than is payable currently on the AMPS. See 'Description of
AMPS -- Rating Agency Guidelines' for a description of the asset maintenance
tests the Fund must meet. The Fund may not redeem AMPS if such a redemption
would cause the Fund to fail to meet regulatory or rating agency asset coverage
requirements, and the Fund may not declare, pay or set apart for payment any
dividend or other distribution if immediately thereafter the Fund would fail to
meet regulatory asset coverage requirements.
Portfolio Security Risk. Portfolio security risk is the risk that an issuer
of a security in which the Fund invests will not be able, in the case of common
stock, to make dividend distributions at the level forecast by the Fund's
Investment Manager, or that the issuer becomes unable to meet its obligation to
pay fixed dividends at the specified rate, in the case of preferred stock, or to
make interest and principal payments in the case of debt securities. Common
stock is not rated by rating agencies and it is incumbent on the Investment
Manager to select securities of utility companies that it believes have the
ability to pay dividends at the forecasted level. Preferred stock and debt
securities may be rated. The Fund may invest up to 25% of its total assets in
preferred stock or debt securities rated below investment grade (commonly known
as 'junk bonds') by S&P, Moody's or unrated securities considered to be of
comparable quality by the Investment Manager. In general, lower-rated securities
carry a greater degree of risk. If rating agencies lower their ratings of
securities held in the Fund's portfolio, the value of those securities could
decline, which would jeopardize the rating agencies' ratings of the AMPS. The
failure of a company to pay common stock or preferred stock dividends, or
interest payments, at forecasted or contractual rates, could have a negative
impact on the Fund's ability to pay dividends on the AMPS and could result in
the redemption of some or all of the AMPS.
Restrictions on Dividends and other Distributions. Restrictions imposed on
the declaration and payment of dividends or other distributions to the holders
of the Fund's Common Shares, the AMPS and the Outstanding AMPS, both by the 1940
Act and by requirements imposed by rating agencies, might impair the Fund's
ability to maintain its qualification as a regulated investment company for
Federal income tax purposes. While the Fund intends to redeem the AMPS and the
Outstanding AMPS to enable the Fund to distribute its income as required to
maintain its qualification as a regulated investment company under the Code,
there can be no assurance that such actions can be effected in time to meet the
Code requirements. See 'U.S. Federal Taxation.'
GENERAL RISKS OF INVESTING IN THE FUND
The Fund is a non-diversified, closed-end management investment company
designed primarily as a long-term investment and not as a trading vehicle. The
Fund is not intended to be a complete investment program and, due to the
uncertainty inherent in all investments, there can be no assurance that we will
achieve our investment objective.
44
LIMITED OPERATING HISTORY
The Fund is a recently organized, non-diversified, closed-end management
investment company with a limited operating history.
INVESTMENT RISK
An investment in the Fund is subject to investment risk, including the
possible loss of the entire amount that you invest.
STOCK MARKET RISK
Because prices of equity securities fluctuate from day-to-day, the value of
our portfolio will vary based upon general market conditions.
INTEREST RATE RISK
Interest rate risk is the risk that fixed-income securities such as
preferred and debt securities, and to a lesser extent dividend-paying common
stocks such as certain utility company common shares, will decline in value
because of changes in market interest rates. When market interest rates rise,
the market value of such securities generally will fall. The Fund's investment
in such securities means that the net asset value and market price of common
shares may tend to decline if market interest rates rise. Because investors
generally look to utility companies for a stream of income, the prices of
utility company shares may be more sensitive to changes in interest rates than
are other equity securities.
During periods of declining interest rates, an issuer may be able to
exercise an option to prepay principal earlier than scheduled which is generally
known as call or prepayment risk. If this occurs, the Fund may be forced to
reinvest in lower yielding securities. This is known as reinvestment risk.
Preferred and debt securities frequently have call features that allow the
issuer to repurchase the security prior to its stated maturity. An issuer may
redeem an obligation if the issuer can refinance the debt at a lower cost due to
declining interest rates or an improvement in the credit standing of the issuer.
During periods of rising interest rates, the average life of certain types of
securities may be extended because of slower than expected principal payments.
This may lock in a below market interest rate, increase the security's duration
and reduce the value of the security. This is known as extension risk. Market
interest rates for investment grade fixed-income securities in which the Fund
will invest have recently declined significantly below the recent historical
average rates for such securities. This decline may have increased the risk that
these rates will rise in the future (which would cause the value of the Fund's
net assets to decline) and the degree to which asset values may decline in such
events; however, historical interest rate levels are not necessarily predictive
of future interest rate levels.
CREDIT RISK AND LOWER-RATED SECURITIES RISK
Credit risk is the risk that a security in the Fund's portfolio will decline
in price or the issuer will fail to make dividend, interest or principal
payments when due because the issuer of the security experiences a decline in
its financial status. Preferred securities are subordinated to bonds and other
debt instruments in a company's capital structure, in terms of priority to
corporate income and claim to corporate assets, and therefore will be subject to
greater credit risk than debt instruments. The Fund may invest up to 25%
(measured at the time of investment) of its managed
45
assets in securities that are rated below investment grade. Securities rated
below investment grade are regarded as having predominately speculative
characteristics with respect to the issuer's capacity to pay interest and repay
principal, and these bonds are commonly referred to as 'junk bonds.' These
securities are subject to a greater risk of default. The prices of these lower
grade securities are more sensitive to negative developments, such as a decline
in the issuer's revenues or a general economic downturn, than are the prices of
higher grade securities. Lower grade securities tend to be less liquid than
investment grade securities. The market values of lower grade securities tend to
be more volatile than investment grade securities. A security will be considered
to be investment grade if, at the time of investment, such security has a rating
of 'BBB' or higher by S&P, 'Baa' or higher by Moody's or an equivalent rating by
a nationally recognized statistical rating agency, or, if unrated, such security
is determined by the Investment Manager to be of comparable quality.
Lower-rated securities, may be considered speculative with respect to the
issuer's continuing ability to make principal and interest payments. Analysis of
the creditworthiness of issuers of lower-rated securities may be more complex
than for issuers of higher quality debt securities, and our ability to achieve
our investment objective may, to the extent we are invested in lower-rated
securities, be more dependent upon such creditworthiness analysis than would be
the case if we were investing in higher quality securities. An issuer of these
securities has a currently identifiable vulnerability to default and the issuer
may be in default or there may be present elements of danger with respect to
principal or interest. We will not invest in securities which are in default at
the time of purchase.
Lower-rated securities, or equivalent unrated securities, which are commonly
known as 'junk bonds,' generally involve greater volatility of price and risk of
loss of income and principal and may be more susceptible to real or perceived
adverse economic and competitive industry conditions than higher grade
securities. The prices of lower-rated securities have been found to be less
sensitive to interest-rate changes than more highly rated investments, but more
sensitive to adverse economic downturns or individual corporate developments.
Yields on lower-rated securities will fluctuate if the issuer of lower-rated
securities defaults, and the Fund may incur additional expenses to seek
recovery.
The secondary markets in which lower-rated securities are traded may be less
liquid than the market for higher grade securities. Less liquidity in the
secondary trading markets could adversely affect the price at which we could
sell a particular lower-rated security when necessary to meet liquidity needs or
in response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, and could adversely affect and cause large
fluctuations in the net asset value of our shares. Adverse publicity and
investor perceptions may decrease the values and liquidity of high yield
securities.
It is reasonable to expect that any adverse economic conditions could
disrupt the market for lower-rated securities, have an adverse impact on the
value of those securities and adversely affect the ability of the issuers of
those securities to repay principal or interest on those securities. New laws
and proposed new laws may adversely impact the market for lower-rated
securities.
COUNTERPARTY RISK
The Fund will be subject to credit risk with respect to the counterparties
to any derivative contracts purchased by the Fund. If a counterparty becomes
bankrupt or otherwise fails to perform its obligations under a derivative
contract due to financial difficulties, the Fund may experience significant
delays in obtaining any recovery under the derivative contract in bankruptcy or
other
46
reorganization proceeding. The Fund may obtain only a limited recovery or may
obtain no recovery in such circumstances.
SPECIAL RISKS OF SECURITIES LINKED TO THE UTILITY INDUSTRY
Since at least 80% of the Fund's managed assets normally will be
concentrated in common stocks, preferred stocks and other equity securities
issued by utility companies, your investment in the Fund will be significantly
impacted by the performance of this industry. The Fund's emphasis on securities
of utility issuers makes it more susceptible to adverse economic, political or
regulatory occurrences affecting such issuers than a fund that does not have its
assets invested to a similar degree in such issuers. The utility industry
generally includes companies involved in providing products, services or
equipment for (i) the generation or distribution of electricity, gas or water,
(ii) telecommunications services or (iii) infrastructure operations, such as
airports, toll roads and municipal services. Certain segments of this industry
and individual companies within such segments may not perform as well as the
industry as a whole. Issuers in the utility industry are subject to a variety of
factors that may adversely affect their business or operations, including:
high interest costs in connection with capital construction and
improvement programs;
difficulty in raising capital in adequate amounts on reasonable terms in
periods of high inflation and unsettled capital markets;
governmental regulation of rates charged to customers;
costs associated with compliance with and changes in environmental and
other regulations;
effects of economic slowdowns and surplus capacity;
increased competition from other providers of utility services;
inexperience with and potential losses resulting from a developing
deregulatory environment;
costs associated with reduced availability of certain types of fuel,
occasionally reduced availability and high costs of natural gas for resale
and the effects of energy conservation policies, and the potential that
costs incurred by the utility, such as the cost of fuel, change more
rapidly than the rate the utility is permitted to charge its customers;
effects of a national energy policy and lengthy delays and greatly
increased costs and other problems associated with the design,
construction, licensing, regulation and operation of nuclear facilities
for electric generation, including, among other considerations, the
problems associated with the use of radioactive materials and the disposal
of radioactive wastes;
technological innovations that may render existing plants, equipment or
products obsolete; and
potential impact of terrorist activities on the utility industry and its
customers and the impact of natural or man-made disasters.
Issuers in the utility industry may be subject to regulation by various
governmental authorities in various jurisdictions and may be affected by the
imposition of special tariffs and changes in tax laws, regulatory policies and
accounting standards. Various regulatory regimes also impose limitations on the
percentage of the shares of a public utility held by a fund as an investment for
its clients. These limitations may unfavorably restrict the ability of the Fund
to make certain investments. Generally, prices charged by certain utilities are
regulated in the United States with the intention of protecting the public while
ensuring that the rate of return earned by such
47
companies is sufficient to allow them to attract capital in order to grow and
continue to provide appropriate services. There can be no assurance that such
pricing policies or rates of return will continue in the future. The nature of
regulation in the utility industry is evolving. Changes in regulation
increasingly allow participants in the utility industry to provide services and
products outside their traditional geographic areas and lines of business,
creating new areas of competition within such industries. The emergence of
competition may result in certain companies being forced to defend their core
businesses which may cause such companies to be less profitable.
In addition, there are substantial differences between the regulatory
practices and policies of various jurisdictions, and any given regulatory agency
may make major shifts in policy from time to time. There is no assurance that
regulatory authorities will, in the future, grant rate increases or that such
increases will be adequate to permit the payment of dividends on preferred or
common stocks. Additionally, existing and possible future regulatory legislation
may make it even more difficult for these utilities to obtain adequate relief.
Certain of the issuers of securities held in the Fund's portfolio may own or
operate nuclear generating facilities. Governmental authorities may from time to
time review existing policies and impose additional requirements governing the
licensing, construction and operation of nuclear power plants. Prolonged changes
in climatic conditions can also have a significant impact on both the revenues
of an electric and gas utility as well as its expenses.
The nature of regulation of the utility industries is evolving both in the
United States and in foreign countries. In recent years, changes in regulation
in the United States increasingly have allowed utility companies to provide
services and products outside their traditional geographic areas and lines of
business, creating new areas of competition within the industries. In some
instances, utility companies are operating on an unregulated basis. Because of
trends toward deregulation and the evolution of independent power producers as
well as new entrants to the field of telecommunications, non-regulated providers
of utility services have become a significant part of their respective
industries. The emergence of competition and deregulation may result in certain
utility companies being able to earn more than their traditional regulated rates
of return, while others may be forced to defend their core business from
increased competition and may be less profitable. Reduced profitability, as well
as new uses of funds (such as for expansion, operations or stock buybacks) could
result in cuts in dividend payout rates.
Foreign utility companies are also subject to regulation, although such
regulation may or may not be comparable to those in the United States. Foreign
utility companies may be more heavily regulated by their respective governments
than utilities in the United States and, as in the United States, generally are
required to seek government approval for rate increases. In addition, many
foreign utilities use fuels that may cause more pollution than those used in the
United States, which may require such utilities to invest in pollution control
equipment to meet any proposed pollution restrictions. Foreign regulatory
systems vary from country to country and may evolve in ways different from
regulation in the United States.
Investments in certain utility companies are also subject to certain
additional risks.
Electric. Electric utilities consist of companies that are engaged
principally in one of more of the following activities: the generation,
transmission, sale and distribution of electric energy, although many also
provide other energy-related services. In the past, electric utility companies,
in general, have been favorably affected by lower fuel and financing costs and
the full or near completion of major construction programs. In addition, many of
these companies have generated cash flows in excess of current operating
expenses and construction expenditures, permitting some
48
degree of diversification into unregulated businesses. Some electric utilities
have also taken advantage of the right to sell power outside of their
traditional geographic areas. Electric utility companies have historically been
subject to the risks associated with increases in fuel and other operating
costs, high interest costs on borrowings needed for capital construction
programs, costs associated with compliance with environmental and safety
regulations and changes in the regulatory climate. As interest rates declined,
many utilities refinanced high cost debt and in doing so improved their fixed
charges coverage. Regulators, however, lowered allowed rates of return as
interest rates declined and thereby caused the benefits of the rate declines to
be shared wholly or in part with customers.
The construction and operation of nuclear power facilities are subject to
increased scrutiny by, and evolving regulations of, the Nuclear Regulatory
Commission and state agencies having comparable jurisdiction. Increased scrutiny
might result in higher operating costs and higher capital expenditures, with the
risk that the regulators may disallow inclusion of these costs in rate
authorizations or the risk that a company may not be permitted to operate or
complete construction of a facility. In addition, operators of nuclear power
plants may be subject to significant costs for disposal of nuclear fuel and for
decommissioning such plants.
The rating agencies are taking a closer look at the business profile of
utilities. Ratings for companies are expected to be impacted to a greater extent
in the future by the division of their asset base. Electric utility companies
that focus more on the generation of electricity may be assigned less favorable
ratings as this business is expected to be competitive and the least regulated.
On the other hand, companies that focus on transmission and distribution which
is expected to be the least competitive and the more regulated part of the
business may see higher ratings given the greater predictability of cash flow.
Currently, several states are considering deregulation proposals, while
other states have already enacted enabling legislation. The introduction of
competition into the industry as a result of deregulation may result in lower
revenue, lower credit ratings, increased default risk and lower electric utility
security prices. Such increased competition may also cause long-term contracts,
which electric utilities previously entered into to buy power, to become
'stranded assets' which have no economic value. Any loss associated with such
contracts must be absorbed by ratepayers and investors. In addition, in
anticipation of increasing competition, some electric utilities have acquired
electric utilities overseas to diversify, enhance earnings and gain experience
in operating in a deregulated environment. In some instances, such acquisitions
have involved significant borrowings, which have burdened the acquirer's balance
sheet. There is no assurance that current deregulation proposals will be
adopted. However, deregulation in any form could significantly impact the
electric utilities industry.
Following deregulation of the energy markets in certain states, a number of
companies have engaged in energy trading and incurred substantial losses.
Certain of these energy trading businesses have been accused of employing
improper accounting practices and have been required to make significant
restatements of their financial results. In addition, several energy companies
have been accused of attempting to manipulate the price and availability of
energy in certain states.
Telecommunications. The telecommunications industry today includes both
traditional telephone companies with a history of broad market coverage and
highly regulated businesses, and cable companies, which began as small, lightly
regulated businesses focused on limited markets. Today these two historically
different businesses are converging in an industry which is trending toward
49
larger, competitive, national and international markets with an emphasis on
deregulation. Companies that distribute telephone services and provide access to
the telephone networks still comprise the greatest portion of this segment, but
non-regulated activities such as cellular telephone services, paging, data
processing, equipment retailing, computer software and hardware services are
becoming increasingly significant components as well. The presence of
unregulated companies in this industry and the entry of traditional telephone
companies into unregulated or less regulated businesses provide significant
investment opportunities with companies which may increase their earnings at
faster rates than had been allowed in traditional regulated businesses. Still,
increasing competition, technological innovations and other structural changes
could adversely affect the profitability of such utilities and the growth rate
of their dividends. Given mergers, certain marketing tests currently underway
and proposed legislation and enforcement changes, it is likely that both
traditional telephone companies and cable companies will soon provide a greatly
expanded range of utility services, including two-way video and informational
services to both residential, corporate and governmental customers.
In February 1996, the Telecommunications Act of 1996 (the 'Act') became law.
The Act removed regulatory restrictions on entry that prevented local and
long-distance telephone companies and cable television companies from competing
against one another. The Act also removed most cable rate controls and allows
broadcasters to own more radio and television stations. Litigation concerning
the constitutionality of certain major provisions of the Act has slowed the
implementation of such provisions.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to energy
prices. In the recent decade, gas utility companies have been adversely affected
by disruptions in the oil industry and have also been affected by increased
concentration and competition. Prolonged changes in climatic conditions can also
have a significant impact on both the revenues and expenses of a gas utility.
Water. Water supply utilities are companies that collect, purify, distribute
and sell water. In the United States and around the world the industry is highly
fragmented because most of the water utilities are owned by local authorities.
Companies in this industry are generally mature and are experiencing little or
no per capita volume growth.
There can be no assurance that the positive developments noted above,
including those relating to privatization and changing regulation, will occur or
that risk factors other than those noted above will not develop in the future.
SPECIAL RISKS RELATED TO PREFERRED SECURITIES
There are special risks associated with investing in preferred securities,
including:
Deferral and Omission. Preferred securities may include provisions that
permit the issuer, at its discretion, to defer or omit distributions for a
stated period without any adverse consequences to the issuer. If the Fund owns a
preferred security that is deferring or omitting its distributions, the Fund may
be required to report income for tax purposes although it has not yet received
such income.
50
Subordination. Preferred securities are generally subordinated to bonds and
other debt instruments in a company's capital structure in terms of having
priority to corporate income and liquidation payments, and therefore will be
subject to greater credit risk than more senior debt instruments.
Liquidity. Preferred securities may be substantially less liquid than many
other securities, such as common stocks or U.S. Government securities.
Limited Voting Rights. Generally, traditional preferred securities offer no
voting rights with respect to the issuing company unless preferred dividends
have been in arrears for a specified number of periods, at which time the
preferred security holders may elect a number of directors to the issuer's
board. Generally, once all the arrearages have been paid, the preferred security
holders no longer have voting rights. Hybrid-preferred security holders
generally have no voting rights.
Special Redemption Rights. In certain varying circumstances, an issuer of
preferred securities may redeem the securities prior to a specified date. For
instance, for certain types of preferred securities, a redemption may be
triggered by a change in Federal income tax or securities laws. As with call
provisions, a redemption by the issuer may negatively impact the return of the
security held by the Fund.
Supply of Hybrid-Preferred Securities. The Financial Accounting Standards
Board currently is reviewing accounting guidelines relating to hybrid-preferred
securities. To the extent that a change in the guidelines could adversely affect
the market for, and availability of, these securities, the Fund may be adversely
affected. The recently enacted legislation that reduced the Federal income tax
rates on dividends may also adversely impact the market and supply of
hybrid-preferred securities if the issuance of such securities becomes less
attractive to issuers.
New Types of Securities. From time to time, preferred securities, including
hybrid-preferred securities, have been, and may in the future be, offered having
features other than those described herein. The Fund reserves the right to
invest in these securities if the Investment Manager believes that doing so
would be consistent with the Fund's investment objective and policies. Since the
market for these instruments would be new, the Fund may have difficulty
disposing of them at a suitable price and time. In addition to limited
liquidity, these instruments may present other risks, such as high price
volatility.
Financial Services. Companies principally engaged in financial services are
prominent issuers of preferred securities and, therefore, the Fund may be
susceptible to adverse economic or regulatory occurrences affecting that sector.
Investing in the financial services sector includes the following risks:
regulatory actions -- financial services companies may suffer a setback if
regulators change the rules under which they operate;
changes in interest rates -- unstable interest rates can have a
disproportionate effect on the financial services sector;
concentration of loans -- financial services companies whose securities
the Fund may purchase may themselves have concentrated portfolios, such as
a high level of loans to real estate developers, which makes them
vulnerable to economic conditions that affect that sector; and
competition -- financial services companies have been affected by
increased competition, which could adversely affect the profitability or
viability of such companies.
51
FOREIGN SECURITIES RISKS
Under normal market conditions, the Fund may invest up to 20% of its managed
assets in U.S. dollar-denominated securities of foreign issuers traded or listed
on a U.S. securities exchange or the U.S. over-the-counter market ('Foreign
Securities'). Typically, the Fund will not hold any Foreign Securities of
issuers in so-called 'emerging markets' (or lesser developed countries), but to
the extent it does, the Fund will not invest more than 10% of its managed assets
in such securities. Investments in such securities are particularly speculative.
Investing in Foreign Securities involves certain risks not involved in domestic
investments, including, but not limited to:
future foreign economic, financial, political and social developments;
different legal systems;
the possible imposition of exchange controls or other foreign governmental
laws or restrictions;
less governmental supervision;
regulation changes;
changes in currency exchange rates;
less publicly available information about companies due to less rigorous
disclosure or accounting standards or regulatory practices;
high and volatile rates of inflation;
fluctuating interest rates; and
different accounting, auditing and financial record-keeping standards and
requirements.
Dividend income the Fund receives from Foreign Securities may not be
eligible for the special tax treatment applicable to qualified dividend income.
However, dividend income the Fund receives from securities of certain 'qualified
foreign corporations' (e.g., generally, foreign corporations incorporated in a
possession of the United States or in certain countries with a qualifying
comprehensive tax treaty with the United States, or the stock with respect to
which such dividend is paid is readily tradable on an established securities
market in the United States, but does not include a foreign corporation which
for the taxable year of the corporation in which the dividend was paid, or the
preceding taxable year, is a 'passive foreign investment company,' as defined in
the Code) will be eligible for the special tax treatment applicable to qualified
dividend income.
Investments in Foreign Securities, especially in emerging market countries,
will expose the Fund to the direct or indirect consequences of political, social
or economic changes in the countries that issue the securities or in which the
issuers are located. Certain countries in which the Fund may invest, especially
emerging market countries, have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. Many of these countries are
also characterized by political uncertainty and instability. The cost of
servicing external debt will generally be adversely affected by rising
international interest rates because many external debt obligations bear
interest at rates which are adjusted based upon international interest rates. In
addition, with respect to certain foreign countries, there is a risk of:
the possibility of expropriation of assets;
confiscatory taxation;
difficulty in obtaining or enforcing a court judgment;
52
economic, political or social instability; and
diplomatic developments that could affect investments in those countries.
In addition, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as:
growth of gross domestic product;
rates of inflation;
capital reinvestment;
resources;
self-sufficiency; and
balance of payments position.
In addition, certain investments in Foreign Securities also may be subject
to foreign withholding taxes.
Investing in securities of companies in emerging markets may entail special
risks relating to potential political and economic instability and the risks of
expropriation, nationalization, confiscation or the imposition of restrictions
on foreign investment, the lack of hedging instruments, and on repatriation of
capital invested. Emerging securities markets are substantially smaller, less
developed, less liquid and more volatile than the major securities markets. The
limited size of emerging securities markets and limited trading value compared
to the volume of trading in U.S. securities could cause prices to be erratic for
reasons apart from factors that affect the quality of the securities. For
example, limited market size may cause prices to be unduly influenced by traders
who control large positions. Adverse publicity and investors' perceptions,
whether or not based on fundamental analysis, may decrease the value and
liquidity of portfolio securities, especially in these markets. Many emerging
market countries have experienced substantial, and in some periods extremely
high, rates of inflation for many years. Inflation and rapid fluctuations in
inflation rates and corresponding currency devaluations have had and may
continue to have negative effects on the economies and securities markets of
certain emerging market countries. Typically, the Fund will not hold any Foreign
Securities of emerging market issuers, and, if it does, such securities will not
comprise more than 10% of the Fund's managed assets.
As a result of these potential risks, the Investment Manager may determine
that, notwithstanding otherwise favorable investment criteria, it may not be
practicable or appropriate to invest in a particular country. The Fund may
invest in countries in which foreign investors, including the Investment
Manager, have had no or limited prior experience.
OTHER INVESTMENT MANAGEMENT TECHNIQUES RISK
The Fund may use various other investment management techniques that also
involve certain risks and special considerations, including engaging in hedging
and risk management transactions, such as interest rate transactions, options,
futures, swaps and other derivatives transactions. Strategic Transactions will
be entered into to seek to manage the risks of the Fund's portfolio of
securities, but may have the effect of limiting the gains from favorable market
movements. Strategic Transactions involve risks, including (1) that the loss on
the Strategic Transaction position may be larger than the gain in the portfolio
position being hedged and (2) that the derivative instruments used in Strategic
Transactions may not be liquid and may require the Fund to pay additional
amounts of money. Successful use of Strategic Transactions depends on the
Investment
53
Manager's ability to predict correctly market movements, which, of course,
cannot be assured. Losses on Strategic Transactions may reduce the Fund's net
asset value and its ability to pay dividends if they are not offset by gains on
the portfolio positions being hedged. The Fund may also lend the securities it
owns to others, which allows the Fund the opportunity to earn additional income.
Although the Fund will require the borrower of the securities to post collateral
for the loan and the terms of the loan will require that the Fund be able to
reacquire the loaned securities if certain events occur, the Fund is still
subject to the risk that the borrower of the securities may default, which could
result in the Fund losing money, which would result in a decline in the Fund's
net asset value. The Fund may also purchase securities for delayed settlement.
This means that the Fund is generally obligated to purchase the securities at a
future date for a set purchase price, regardless of whether the value of the
securities is more or less than the purchase price at the time of settlement.
CONVERTIBLE SECURITIES RISK
Although to a lesser extent than with non-convertible fixed-income
securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stock. A unique feature of convertible securities is that
as the market price of the underlying common stock declines, convertible
securities tend to trade increasingly on a yield basis, and so may not
experience market value declines to the same extent as the underlying common
stock. When the market price of the underlying common stock increases, the
prices of the convertible securities tend to rise as a reflection of the value
of the underlying common stock. While no securities investments are without
risk, investments in convertible securities generally entail less risk than
investments in common stock of the same issuer.
COMMON STOCK RISK
While common stock has historically generated higher average returns than
fixed income securities, common stock has also experienced significantly more
volatility in those returns. An adverse event, such as an unfavorable earnings
report, may depress the value of common stock held by the Fund. Also, the price
of common stock is sensitive to general movements in the stock market. A drop in
the stock market may depress the price of common stock held by the Fund.
TAX RISK
The Fund's investment program and the tax treatment of Fund distributions
may be affected by IRS interpretations of the Code and future changes in tax
laws and regulations. In particular, the provisions that currently apply to the
favorable tax treatment of qualified dividend income are scheduled to expire on
December 31, 2008 unless future legislation is passed to make the provisions
effective beyond this date. There can be no assurance of what portion, if any,
of the Fund's distributions will be entitled to the lower tax rates that apply
to qualified dividend income. In addition, the Fund may invest in preferred
securities or other securities the Federal income tax treatment of which may not
be clear or may be subject to recharacterization by the IRS. It could be more
difficult for the Fund to comply with the tax requirements applicable to
regulated investment companies if the tax characterization of the Fund's
investments or the tax treatment of
54
the income from such investments were successfully challenged by the IRS. See
'U.S. Federal Taxation.'
RESTRICTED AND ILLIQUID SECURITIES RISK
The Fund may invest, on an ongoing basis, in restricted securities and other
investments that may be illiquid. Illiquid securities are securities that are
not readily marketable and may include some restricted securities, which are
securities that may not be resold to the public without an effective
registration statement under the Securities Act or, if they are unregistered,
may be sold only in a privately negotiated transaction or pursuant to an
exemption from registration. Illiquid investments involve the risk that the
securities will not be able to be sold at the time desired by the Fund or at
prices approximating the value at which the Fund is carrying the securities on
its books.
INTEREST RATE TRANSACTIONS RISK
The Fund may enter into a swap or cap transaction to attempt to protect
itself from increasing dividend or interest expenses resulting from increasing
short-term interest rates. A decline in interest rates may result in a decline
in the value of the swap or cap which may result in a decline in the net asset
value of the Fund. A sudden and dramatic decline in interest rates may result in
a significant decline in the net asset value of the Fund. See 'How The Fund
Manages Risks -- Interest Rate Transactions.'
PORTFOLIO TURNOVER RISK
We may engage in portfolio trading when considered appropriate, but
short-term trading will not be used as the primary means of achieving the Fund's
investment objective. Although we cannot accurately predict our portfolio
turnover rate, it is not expected to exceed 100% under normal circumstances.
There are no limits on the rate of portfolio turnover, and investments may be
sold without regard to length of time held when, in the opinion of the
Investment Manager, investment considerations warrant such action. A higher
turnover rate results in correspondingly greater brokerage commissions and other
transactional expenses which are borne by the Fund. High portfolio turnover may
result in the realization of net short-term capital gains by the Fund which,
when distributed to stockholders, will be taxable as ordinary income. See 'U.S.
Federal Taxation.'
INFLATION RISK
Inflation risk is the risk that the value of assets or income from
investment will be worth less in the future as inflation decreases the value of
money. As inflation increases, the real value of the Common Shares and
distributions can decline and the dividend payments on the AMPS, if any, or
interest payments on any borrowings may increase. In addition, during any
periods of rising inflation, dividend rates on the AMPS would likely increase,
which would tend to further reduce returns to holders of Common Shares.
55
NON-DIVERSIFIED STATUS
The Fund is classified as a 'non-diversified' investment company under the
1940 Act, which means we are not limited by the 1940 Act in the proportion of
our assets that may be invested in the securities of a single issuer. However,
we intend to conduct our operations so as to qualify as a regulated investment
company for purposes of the Code, which generally will relieve the Fund of any
liability for Federal income tax to the extent our earnings are distributed to
stockholders. See 'U.S. Federal Taxation' in the SAI. To so qualify, among other
requirements, we will limit our investments so that, at the close of each
quarter of the taxable year, (i) not more than 25% of the value of our total
assets will be invested in the securities (other than U.S. Government securities
or the securities of other regulated investment companies) of a single issuer,
or two or more issuers which the Fund controls and are engaged in the same,
similar or related trades or businesses and (ii) at least 50% of the value of
our total assets will be invested in cash and cash items, U.S. Government
securities, securities of other regulated investment companies and other
securities; provided, however, that with respect to such other securities, not
more than 5% of the value of our total assets will be invested in the securities
of a single issuer and we will not own more than 10% of the outstanding voting
securities of a single issuer. In addition, at the close of each quarter, no
more than 25% of the value of our total assets may be invested in the securities
of one or more 'qualified publicly traded partnerships,' as defined in the Code.
Because we, as a non-diversified investment company, may invest in a smaller
number of individual issuers than a diversified investment company, an
investment in the Fund presents greater risk to you than an investment in a
diversified company. The Fund intends to comply with the diversification
requirements of the Code applicable to regulated investment companies.
ANTI-TAKEOVER PROVISIONS
Certain provisions of the Fund's Charter and By-Laws could have the effect
of limiting the ability of other entities or persons to acquire control of the
Fund or to change the Fund's structure. The provisions may also have the effect
of depriving stockholders of an opportunity to redeem their AMPS. These include
provisions for staggered terms of office for Directors, super-majority voting
requirements for merger, consolidation, liquidation, termination and asset sale
transactions, amendments to the Charter and conversion to open-end status. See
'Description of Common Shares' and 'Certain Provisions of the Charter and
By-Laws.'
MARKET DISRUPTION RISK
The aftermath of the war in Iraq and the continuing occupation of Iraq,
instability in the Middle East and terrorist attacks in the United States and
around the world have resulted in recent market volatility and may have
long-term effects on the U.S. and worldwide financial markets and may cause
further economic uncertainties in the United States and worldwide. These events
could also adversely affect individual issuers and securities markets, interest
rates, auctions and auction participants, secondary trading, ratings, credit
risk, inflation, deflation and other factors relating to the AMPS. The Fund does
not know how long the securities markets will continue to be affected by these
events and cannot predict the effects of the occupation or similar events in the
future on the U.S. economy and securities markets.
56
HOW THE FUND MANAGES RISK
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit
investment risk. These limitations are fundamental and may not be changed
without the approval of the holders of a majority, as defined in the 1940 Act,
of the outstanding Common Shares, the AMPS and the Outstanding AMPS voting
together as a single class, and the approval of the holders of a majority, as
defined in the 1940 Act, of the outstanding AMPS and the Outstanding AMPS voting
together as a separate class. Among other restrictions, the Fund may not invest
more than 25% of its managed assets in securities of issuers in any one industry
except for the utility industry.
The Fund may become subject to guidelines that are more limiting than its
investment restrictions in order to obtain and maintain ratings from nationally
recognized rating agencies on the AMPS. The Fund does not anticipate that such
guidelines would have a material adverse effect on the Fund's Common
Stockholders or the Fund's ability to achieve its investment objective. See
'Investment Restrictions' in the SAI for a complete list of the fundamental and
non-fundamental investment policies of the Fund.
INTEREST RATE TRANSACTIONS
In order to seek to reduce the interest rate risk inherent in the Fund's
capital structure and underlying investments, the Fund may enter into interest
rate swap or cap transactions. In an interest rate swap, the Fund would agree to
pay to the other party to the interest rate swap (which is known as the
'counterparty') a fixed rate payment in exchange for the counterparty agreeing
to pay the Fund a variable rate payment that is intended to approximate the
Fund's variable rate payment obligation on the AMPS, any other outstanding
shares of preferred stock or any variable rate borrowing. The payment obligation
would be based on the notional amount of the swap. In an interest rate cap, the
Fund would pay a premium to the counterparty to the interest rate swap and to
the extent that a specified variable rate index exceeds a predetermined fixed
rate, would receive from the counterparty payments of the difference based on
the notional amount of such cap. If the counter-party to an interest rate swap
or cap defaults, the Fund would not be able to use the anticipated net receipts
under the swap or cap to offset the dividend payments on the Fund's outstanding
shares of preferred stock, including the AMPS or rate of interest on borrowings.
Depending on the general state of short-term interest rates at that point in
time, such default could negatively impact the Fund's ability to make dividend
payments on the Fund's outstanding shares of preferred stock, including the
AMPS. In addition, at the time an interest rate swap or cap transaction reaches
its scheduled termination date, there is a risk that the Fund will not be able
to obtain a replacement transaction or that the terms of the replacement will
not be as favorable as on the expiring transaction. If this occurs, it could
have a negative impact on the Fund's ability to make dividend payments on the
AMPS.
To the extent there is a decline in the interest rates, the value of the
interest rate swap or cap could decline, resulting in a decline in the asset
coverage for the AMPS. A sudden and dramatic decline in the interest rates may
result in a significant decline in the asset coverage. Under the terms of the
AMPS, if the Fund fails to maintain the required asset coverage on the
outstanding AMPS or fails to comply with other covenants, the Fund may be
required to redeem some or all of the AMPS.
57
The Fund may choose or be required to redeem some or all of the AMPS or
prepay any borrowings. This redemption or prepayment would likely result in the
Fund seeking to terminate early all or a portion of any swap or cap transaction.
Such early termination of a swap could result in termination payment by or to
the Fund. An early termination of a cap could result in a termination payment to
the Fund.
The Fund will usually enter into swaps or caps on a net basis; that is, the
two payment streams will be netted out in a cash settlement on the payment date
or dates specified in the instrument, with the Fund receiving or paying, as the
case may be, only the net amount of the two payments. The Fund intends to
maintain in a segregated account with its custodian cash or liquid securities
having a value at least equal to the Fund's net payment obligations under any
swap transaction marked to market daily. The Fund would not enter into interest
rate swap or cap transactions having a notional amount that exceeded the
outstanding amount of the Fund's leverage. The Fund will monitor any interest
rate swap or cap transactions with a view to ensuring that it remains in
compliance with applicable tax requirements.
MANAGEMENT OF THE FUND
The business and affairs of the Fund are managed under the direction of the
Board of Directors. The Directors approve all significant agreements between the
Fund and persons or companies furnishing services to it, including the Fund's
agreement with its Investment Manager, administrator, custodian and transfer
agent. The management of the Fund's day-to-day operations is delegated to its
officers, the Investment Manager and the Fund's administrator, subject always to
the investment objective and policies of the Fund and to the general supervision
of the Directors. The names and business addresses of the Directors and officers
of the Fund and their principal occupations and other affiliations during the
past five years are set forth under 'Management of the Fund' in the SAI.
INVESTMENT MANAGER
Cohen & Steers Capital Management, Inc., with offices located at 757 Third
Avenue, New York, New York 10017, has been retained to provide investment advice
to and, in general, to conduct the management and investment program of, the
Fund under the overall supervision and control of the directors of the Fund. The
Investment Manager was formed in 1986 and had approximately $19.9 billion of
assets under management as of June 30, 2005. Its current clients include pension
plans, endowment funds, mutual funds and registered investment companies,
including each of the open-end and closed-end Cohen & Steers funds. The
Investment Manager is a wholly owned subsidiary of Cohen & Steers, Inc., a
publicly traded company whose common stock is listed on the New York Stock
Exchange under the symbol 'CNS.'
INVESTMENT MANAGEMENT AGREEMENT
Under its Investment Management Agreement with the Fund, the Investment
Manager furnishes a continuous investment program for the Fund's portfolio,
makes the day-to-day investment decisions for the Fund, and generally manages
the Fund's investments in accordance with the stated policies of the Fund,
subject to the general supervision of the Board of Directors of the Fund. The
Investment Manager also performs certain administrative services for the Fund
and provides persons satisfactory to the Directors of the Fund to serve as
officers of the Fund.
58
Such officers, as well as certain other employees and Directors of the Fund, may
be directors, officers or employees of the Investment Manager.
For its services under the Investment Management Agreement, the Fund will
pay the Investment Manager a monthly management fee computed at the annual rate
of .85% of average daily managed assets (i.e., the net asset value of the Common
Shares plus the liquidation preference of the AMPS and all other outstanding
shares of preferred stock). In addition to the monthly management fee, the Fund
pays all other costs and expenses of its operations, including compensation of
its Directors, custodian, transfer agency and dividend disbursing expenses,
legal fees, expenses of independent accountants, expenses of issuing and
repurchasing shares, expenses of preparing, printing and distributing
stockholder reports, notices, proxy statements and reports to governmental
agencies, and taxes, if any. The Investment Manager has contractually agreed to
waive a portion of its investment management fee in the amount of .20% of
average daily total managed assets for the first five years of the Fund's
operations, .15% of average daily managed assets in year six, .10% of average
daily managed assets in year seven and .05% of average daily managed assets in
year eight. When the Fund is utilizing leverage, the fees paid to the Investment
Manager for investment advisory and management services will be higher than if
the Fund did not utilize leverage because the fees paid will be calculated based
on the Fund's managed assets, which includes the liquidation preference of the
AMPS and all other outstanding shares of preferred stock for leverage.
The Fund's portfolio managers who are primarily responsible for the day to
day management of the Fund's portfolio are:
Robert S. Becker -- Mr. Becker joined Cohen & Steers Capital Management,
Inc., the Fund's Investment Manager, as a Senior Vice President in December
2003. Mr. Becker is the director of the Cohen & Steers utility investment
team and is a portfolio manager of certain other Cohen & Steers funds. Prior
to joining Cohen & Steers, Mr. Becker was a co-portfolio manager of the
Franklin Utilities Fund at Franklin Templeton Investments. Mr. Becker has
previously held positions in equity research for the utility sector at
Salomon Smith Barney and Scudder, Stevens and Clark.
William F. Scapell -- Mr. Scapell joined Cohen & Steers Capital
Management, Inc., the Fund's Investment Manager, as a Senior Vice President
in February 2003. Mr. Scapell is the director of the Cohen & Steers fixed
income investment team and is a portfolio manager of certain other Cohen &
Steers funds. Prior to joining Cohen & Steers, Mr. Scapell was a director in
the fixed income research department of Merrill Lynch & Co., Inc., where he
was also its chief strategist for preferred securities. Before joining
Merrill Lynch's research department, Mr. Scapell worked in Merrill Lynch
Treasury with a focus on balance sheet management. Prior to working for
Merrill Lynch, Mr. Scapell was employed at the Federal Reserve Bank of New
York in both bank supervision and monetary policy roles. Mr. Scapell is a
Chartered Financial Analyst.
See 'Compensation of Directors and Certain Officers' and 'Investment
Advisory and Other Services' in the SAI for further information about the Fund's
portfolio managers' compensation, other accounts managed by the portfolio
managers and the portfolio managers' ownership of securities in the Fund.
59
ADMINISTRATION AND SUB-ADMINISTRATION AGREEMENT
Under its Administration Agreement with the Fund, the Investment Manager
will have responsibility for providing administrative services and assisting the
Fund with operational needs, including providing administrative services
necessary for the operations of the Fund and furnishing office space and
facilities required for conducting the business of the Fund.
In accordance with the Administration Agreement and with the approval of the
Board of Directors of the Fund, the Fund has entered into an agreement with
State Street Bank as sub-administrator under a fund accounting and
administration agreement (the 'Sub-Administration Agreement'). Under the
Sub-Administration Agreement, State Street Bank has assumed responsibility for
certain fund administration services.
Under the Administration Agreement, the Fund pays the Investment Manager an
amount equal to, on an annual basis, .06% of the Fund's average daily managed
assets up to $1 billion, .04% of the Fund's average daily managed assets in
excess of $1 billion up to $1.5 billion and .02% of the Fund's average daily
managed assets in excess of $1.5 billion. Under the Sub-Administration
agreement, the Fund pays State Street Bank a monthly administration fee. The
sub-administration fee paid by the Fund to State Street Bank is computed on the
basis of the average daily managed assets (including the liquidation value of
the AMPS and any other shares of outstanding preferred stock) in the Fund at an
annual rate equal to .03% of the first $2.2 billion in assets, .02% of the next
$2.2 billion and .01% of assets in excess of $4.4 billion, with a minimum fee of
$120,000. The aggregate fee paid by the Fund and the other funds advised by the
Investment Manager to State Street Bank is computed by multiplying the total
number of funds by each break point in the above schedule in order to determine
the aggregate break points to be used in calculating the total fee paid by the
Cohen & Steers family of funds (i.e., six funds at $200.0 million or $1.2
billion at .04%, etc.). The Fund is then responsible for its pro rata amount of
the aggregate administration fee. State Street Bank also serves as the Fund's
custodian and The Bank of New York has been retained to serve as the Fund's
auction agent, transfer agent, dividend paying agent and registrar for the
Fund's AMPS. See 'Custodian, Auction Agent, Transfer Agent, Dividend Paying
Agent and Registrar.'
DESCRIPTION OF AMPS
The following is a brief description of the terms of the AMPS. For the
complete terms of the AMPS, please refer to the detailed description of the AMPS
in the Fund's Articles Supplementary attached as Appendix B to the SAI.
GENERAL
Under its Charter, the Fund is authorized to issue shares of preferred
stock, with rights as determined by the Board of Directors, without the approval
of the holders of Common Shares. The AMPS will have a liquidation preference of
$25,000 per share, plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared). The AMPS will rank on a parity with the
Outstanding AMPS, and with shares of any other series of preferred stock of the
Fund, as to the payment of dividends and the distribution of assets upon
liquidation. The AMPS carry one vote per share on all matters on which such
shares are entitled to vote. The AMPS, when issued by the Fund and paid for
pursuant to the terms of this prospectus, will be fully paid and non-assessable
and will have no preemptive, exchange or conversion rights. Any AMPS
60
repurchased or redeemed by the Fund will be classified as authorized and
unissued AMPS. The Board of Directors may by resolution classify or reclassify
any authorized and unissued AMPS from time to time by setting or changing the
preferences, rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption of such shares. The AMPS
will not be subject to any sinking fund, but will be subject to mandatory
redemption under certain circumstances described below.
DIVIDENDS AND RATE PERIODS
General. The following is a general description of dividends and rate
periods for the AMPS. The initial rate period for the AMPS will be days and
the dividend rate for this period will be %. Subsequent rate periods will be
7 days, and the dividend rate will be determined by auction. The Fund, subject
to certain conditions, may change the length of subsequent rate periods by
designating them as special rate periods. See 'Designation of Special Rate
Periods' below.
Dividend Payment Dates. Dividends on the AMPS will be payable, when, as and
if declared by the Board, out of legally available funds in accordance with the
Fund's Charter and applicable law. Dividend periods generally will begin on the
first business day after an auction. If dividends are payable on a day that is
not a business day, then dividends will generally be payable on the next day if
such day is a business day, or as otherwise specified in the Articles
Supplementary.
If a dividend payment date is not a business day because the NYSE is closed
for business for more than three consecutive business days due to an act of God,
natural disaster, act of war, civil or military disturbance, act of terrorism,
sabotage, riots or a loss or malfunction of utilities or communications
services, or the dividend payable on such date cannot be paid for any such
reason, then:
the dividend payment date for the affected dividend period will be the
next business day on which the Fund and its paying agent, if any, are able
to cause the dividend to be paid using their reasonable best efforts;
the affected dividend period will end on the day it would have ended had
such event not occurred and the dividend payment date had remained the
scheduled date; and
the next dividend period will begin and end on the dates on which it would
have begun and ended had such event not occurred and the dividend payment
date remained the scheduled date.
Dividends will be paid through DTC on each dividend payment date. The
dividend payment date will normally be the first business day after the dividend
period ends. DTC, in accordance with its current procedures, is expected to
distribute dividends received from the auction agent in same-day funds on each
dividend payment date to agent members (members of DTC that will act on behalf
of existing or potential holders of the AMPS). These agent members are in turn
expected to distribute such dividends to the persons for whom they are acting as
agents. Each of the current broker-dealers has indicated to the Fund that
dividend payments will be available in same-day funds on each dividend payment
date to customers that use a broker-dealer or a broker-dealer's designee as
agent member.
Calculation of Dividend Payment. The Fund computes the dividends per share
payable on the AMPS by multiplying the applicable rate in effect by a fraction.
The numerator of this fraction will normally be the number of days in the rate
period and the denominator will normally be 360. This rate is then multiplied by
$25,000 to arrive at the dividends per share.
61
Dividends on the AMPS will accumulate from the date of their original issue,
which is , 2005. For each dividend payment period after the initial
rate period, the dividend will be the dividend rate determined at auction. The
dividend rate that results from an auction will not be greater than the maximum
rate described below.
The maximum applicable rate for any regular period will be the higher of (as
set forth in the table below) the applicable percentage of the Reference Rate or
the applicable spread plus the Reference Rate. The Reference Rate is the
applicable LIBOR Rate (for a dividend period or a special dividend period of
fewer than 365 days), or the applicable Treasury Index Rate (for a special
dividend period of 365 days or more). In the case of a special rate period, the
maximum applicable rate will be specified by the Fund in the notice of the
special rate period for such dividend payment period. The applicable percentage
or applicable spread is determined on the day that a notice of a special rate
period is delivered if the notice specifies a maximum applicable rate for a
special rate period. The applicable percentage or applicable spread will be
determined based on the lower of the credit rating or ratings assigned to the
AMPS by Moody's and S&P. If Moody's or S&P or both shall not make such rating
available, the rate shall be determined by reference to equivalent ratings
issued by a substitute rating agency.
CREDIT RATINGS APPLICABLE
-------------- PERCENTAGE OF APPLICABLE
MOODY'S S&P REFERENCE RATE: SPREAD
------- --- --------------- ------
Aaa AAA 125% 125 bps
Aa3 to Aa1 AA - to AA+ 150% 150 bps
A3 to A1 A - to A+ 200% 200 bps
Baa3 to Baa1 BBB - to BBB+ 250% 250 bps
Ba1 and below BB+ and below 300% 300 bps
Assuming the Fund maintains an Aaa/AAA rating on the AMPS, the practical
effect of the different methods used to calculate the Maximum Applicable Rate is
shown in the table below:
MAXIMUM METHOD USED
MAXIMUM APPLICABLE APPLICABLE RATE TO DETERMINE
RATE USING THE USING THE THE MAXIMUM
REFERENCE RATE APPLICABLE PERCENTAGE APPLICABLE SPREAD APPLICABLE RATE
-------------- --------------------- ----------------- ---------------
1% 1.25% 2.25% Spread
2% 2.50% 3.25% Spread
3% 3.75% 4.25% Spread
4% 5.00% 5.25% Spread
5% 6.25% 6.25% Either
6% 7.50% 7.25% Percentage
The Applicable Percentage and Applicable Spread as so determined will be
further subject to upward but not downward adjustment in the discretion of the
Board of Directors after consultation with the broker-dealers, provided that
immediately following any such increase the Fund would be in compliance with the
Preferred Shares Basic Maintenance Amount (as defined in this prospectus under
'Rating Agency Guidelines' below). The Fund will take all reasonable action
necessary to enable either Moody's or S&P to provide a rating for the AMPS. If
neither Moody's nor S&P will make such a rating available, the Fund will select
another rating agency to act as a substitute rating agency.
62
On or prior to each dividend payment date, the Fund is required to deposit
with the auction agent sufficient funds for the payment of declared dividends.
The failure to make such deposit, subject to applicable cure periods, will
result in a default period during which no auction will be held. The Fund does
not intend to establish any reserves for the payment of dividends.
Restriction on Dividends and Other Distributions. While any of the AMPS are
outstanding, the Fund generally may not declare, pay or set apart for payment,
any dividend or other distribution in respect of its Common Shares (other than
in additional shares of common stock or rights to purchase common stock) or
repurchase any of its Common Shares (except by conversion into or exchange for
shares of the Fund ranking junior to the AMPS as to the payment of dividends and
the distribution of assets upon liquidation) unless each of the following
conditions have been satisfied:
In the case of the Moody's coverage requirements, immediately after such
transaction, the aggregate Moody's Coverage Value (i.e., the aggregate
value of the Fund's portfolio discounted according to Moody's criteria)
would be equal to or greater than the Preferred Shares Basic Maintenance
Amount (i.e., the amount necessary to pay all outstanding obligations of
the Fund with respect to the AMPS, any preferred stock outstanding,
expenses for the next 90 days and any other liabilities of the Fund) (see
'Rating Agency Guidelines' below);
In the case of S&P's coverage requirements, immediately after such
transaction, the Aggregate S&P value (i.e., the aggregate value of the
Fund's portfolio discounted according to S&P criteria) would be equal to
or greater than the Preferred Shares Basic Maintenance Amount.
Immediately after such transaction, the 1940 Act Preferred Shares Asset
Coverage (as defined in this prospectus under 'Rating Agency Guidelines'
below) is met;
Full cumulative dividends on the AMPS due on or prior to the date of the
transaction have been declared and paid or shall have been declared and
sufficient funds for the payment thereof deposited with the auction agent;
and
The Fund has redeemed the full number of AMPS required to be redeemed by
any provision for mandatory redemption contained in the Articles
Supplementary.
The Fund generally will not declare, pay or set apart for payment any
dividend on any shares of the Fund ranking as to the payment of dividends on a
parity with the AMPS unless the Fund has declared and paid or contemporaneously
declares and pays full cumulative dividends on the AMPS through its most recent
dividend payment date. However, when the Fund has not paid dividends in full on
the AMPS through the most recent dividend payment date or upon any shares of the
Fund ranking, as to the payment of dividends, on a parity with the AMPS through
their most recent respective dividend payment dates, the amount of dividends
declared per share on the AMPS and such other class or series of shares will in
all cases bear to each other the same ratio that accumulated dividends per share
on the AMPS and such other class or series of shares bear to each other.
Designation of Special Rate Periods. The Fund may, in certain situations,
declare a special rate period. Prior to declaring a special rate period, the
Fund will give notice (a 'notice of special rate period') to the auction agent
and to each broker-dealer. The notice will state that the next succeeding rate
period for the AMPS will be a number of days as specified in such notice. The
63
Fund may not designate a special rate period unless sufficient clearing bids
were made in the most recent auction. In addition, full cumulative dividends,
any amounts due with respect to mandatory redemptions and any additional
dividends payable prior to such date must be paid in full or deposited with the
auction agent. The Fund also must have received confirmation from Moody's and
S&P or any substitute rating agency that the proposed special rate period will
not adversely affect such agency's then-current rating on the AMPS and the lead
broker-dealer designated by the Fund, initially Merrill Lynch, must not have
objected to declaration of a special rate period. A notice of special rate
period also will specify whether the shares of the AMPS will be subject to
optional redemption during such special rate period and, if so, the redemption,
premium, if any, required to be paid by the Fund in connection with such
optional redemption.
VOTING RIGHTS
Except as noted below, the Fund's Common Shares and the AMPS (and the
Outstanding AMPS) have equal voting rights of one vote per share and vote
together as a single class. In elections of directors, the holders of the AMPS
(and the Outstanding AMPS), as a separate class, vote to elect two directors,
and the holders of the Common Shares and holders of AMPS (and the Outstanding
AMPS) vote together as a single class to elect the remaining directors. In
addition, during any period ('Voting Period') in which the Fund has not paid
dividends on the AMPS (and the Outstanding AMPS) in an amount equal to two full
years dividends, the holders of the AMPS (and the Outstanding AMPS), voting
together as a single class, are entitled to elect (in addition to the two
directors set forth above) the smallest number of additional directors as is
necessary to ensure that a majority of the directors has been elected by the
holders of the AMPS (and the Outstanding AMPS). The holders of the AMPS (and
the Outstanding AMPS) will continue to have these rights until all dividends in
arrears have been paid or otherwise provided for.
In an instance when the Fund has not paid dividends as set forth in the
immediately preceding paragraph, the terms of office of all persons who are
directors of the Fund at the time of the commencement of a Voting Period will
continue, notwithstanding the election by the holders of the AMPS (together with
the Outstanding AMPS) of the number of directors that such holders are entitled
to elect. The persons elected by the holders of the AMPS (and the Outstanding
AMPS), together with the incumbent directors, will constitute the duly elected
directors of the Fund. When all dividends in arrears on the AMPS (and the
Outstanding AMPS) have been paid or provided for, the terms of office of the
additional directors elected by the holders of the AMPS (and the Outstanding
AMPS) will terminate.
So long as any of the AMPS (and the Outstanding AMPS) are outstanding, the
Fund will not, without the affirmative vote of the holders of a majority of the
outstanding AMPS (and the Outstanding AMPS), (i) institute any proceedings to be
adjudicated bankrupt or insolvent, or consent to the institution of bankruptcy
or insolvency proceedings against it, or file a petition seeking or consenting
to reorganization or relief under any applicable federal or state law relating
to bankruptcy or insolvency, or consent to the appointment of a receiver,
liquidator, assignee, trustee, sequestrator (or other similar official) of the
Fund or a substantial part of its property, or make any assignment for the
benefit of creditors, or, except as may be required by applicable law, admit in
writing its inability to pay its debts generally as they become due or take any
corporate
64
action in furtherance of any such action; (ii) create, incur or suffer to exist,
or agree to create, incur or suffer to exist, or consent to cause or permit in
the future (upon the happening of a contingency or otherwise) the creation,
incurrence or existence of any material lien, mortgage, pledge, charge, security
interest, security agreement, conditional sale or trust receipt or other
material encumbrance of any kind upon any of the Fund's assets as a whole,
except (A) liens the validity of which are being contested in good faith by
appropriate proceedings, (B) liens for taxes that are not then due and payable
or that can be paid thereafter without penalty, (C) liens, pledges, charges,
security interests, security agreements or other encumbrances arising in
connection with any indebtedness senior to the AMPS (and the Outstanding AMPS),
(D) liens, pledges, charges, security interests, security agreements or other
encumbrances arising in connection with any indebtedness permitted under clause
(iii) below and (E) liens to secure payment for services rendered including,
without limitation, services rendered by the Fund's Paying Agent and the auction
agent; or (iii) create, authorize, issue, incur or suffer to exist any
indebtedness for borrowed money or any direct or indirect guarantee of such
indebtedness for borrowed money, except the Fund may borrow as may be permitted
by the Fund's investment restrictions; provided, however, that transfers of
assets by the Fund subject to an obligation to repurchase will not be deemed to
be indebtedness for purposes of this provision to the extent that after any such
transaction the Fund has eligible assets with an aggregate discounted value at
least equal to the Preferred Shares Basic Maintenance Amount as of the
immediately preceding valuation date.
In addition, the affirmative vote of the holders of a majority, as defined
in the 1940 Act, of the outstanding AMPS (together with the Outstanding AMPS)
shall be required to approve any plan of reorganization (as such term is used in
the 1940 Act) adversely affecting such shares or any action requiring a vote of
security holders of the Fund under Section 13(a) of the 1940 Act, including,
among other things, changes in the Fund's investment restrictions described
under 'Investment Restrictions' in the SAI and changes in the Fund's
subclassification as a closed-end investment company.
The affirmative vote of the holders of a majority, as defined in the 1940
Act, of the outstanding shares of preferred stock of any series, voting
separately from any other series, will be required with respect to any matter
that materially and adversely affects the rights, preferences, or powers of that
series in a manner different from that of other series or classes of the Fund's
shares of capital stock. For purposes of the foregoing, no matter will be deemed
to adversely affect any right, preference or power unless such matter (i) alters
or abolishes any preferential right of such series; (ii) creates, alters or
abolishes any right in respect of redemption of such series; or (iii) creates or
alters (other than to abolish) any restriction on transfer applicable to such
series. The vote of holders of any series described in this paragraph will in
each case be in addition to a separate vote of the requisite percentage of
Common Shares and/or preferred stock necessary to authorize the action in
question.
The Common Shares and the AMPS (and the Outstanding AMPS) also will vote
separately to the extent otherwise required under Maryland law or the 1940 Act
as in effect from time to time. The class votes of holders of the AMPS (and the
Outstanding AMPS) described above will in each case be in addition to any
separate vote of the requisite percentage of Common Shares and the AMPS (and the
Outstanding AMPS), voting together as a single class, necessary to authorize the
action in question.
65
For purpose of any right of the holders of the AMPS to vote on any matter,
whether the right is created by the Charter, by statute or otherwise, a holder
of AMPS is not entitled to vote and the AMPS will not be deemed to be
outstanding for the purpose of voting or determining the number of the AMPS
required to constitute a quorum, if prior to or concurrently with a
determination of the AMPS entitled to vote or of the AMPS deemed outstanding for
quorum purposes, as the case may be, a notice of redemption was given in respect
of those AMPS and sufficient Deposit Securities (as defined in the SAI) for the
redemption of those AMPS were deposited.
RATING AGENCY GUIDELINES
The Fund is required under S&P and Moody's guidelines to maintain assets
having in the aggregate a discounted value at least equal to the Preferred
Shares Basic Maintenance Amount (as defined below). S&P and Moody's have each
established separate guidelines for determining discounted value. To the extent
any particular portfolio holding does not satisfy the applicable rating agency's
guidelines, all or a portion of such holding's value will not be included in the
calculation of discounted value (as defined by the rating agency). The S&P and
Moody's guidelines also impose certain diversification requirements on the
Fund's overall portfolio. The 'Preferred Shares Basic Maintenance Amount'
includes the sum of (i) the aggregate liquidation preference of the AMPS (and
the Outstanding AMPS) then outstanding (plus accrued and projected dividends),
(ii) the total principal of any senior debt, (iii) certain Fund expenses and
(iv) certain other current liabilities.
The Fund also is required under rating agency guidelines to maintain, with
respect to the AMPS, as of the last business day of each month in which the AMPS
are outstanding, asset coverage of at least 200% with respect to senior
securities that are shares of the Fund, including the AMPS (or such other asset
coverage as may in the future be specified in or under the 1940 Act as the
minimum asset coverage for senior securities that are shares of a closed-end
investment company as a condition of declaring dividends on its Common Shares)
('1940 Act Preferred Shares Asset Coverage'). S&P and Moody's have agreed that
the auditors must certify once per year the asset coverage test. Based on the
Fund's assets and liabilities as of , 2005 and assuming the issuance
of all the AMPS offered hereby and the use of the proceeds as intended, the 1940
Act Preferred Shares Asset Coverage with respect to the AMPS (and the
Outstanding AMPS) would be computed as follows:
Value of Fund assets less liabilities $
not constituting senior securities = ------------ = %
------------------------------------------- $
Senior securities representing indebtedness
plus liquidation value of the AMPS
If the Fund does not timely cure a failure to maintain (1) a discounted
value of its portfolio equal to the Preferred Shares Basic Maintenance Amount or
(2) the 1940 Act Preferred Shares Asset Coverage, in each case in accordance
with the requirements of the rating agency or agencies then rating the AMPS, the
Fund will be required to redeem the AMPS as described below under
' -- Redemption.'
The Fund may, but is not required to, adopt any modifications to the
guidelines that may hereafter be established by S&P or Moody's. Failure to adopt
any such modifications, however,
66
may result in a change or a withdrawal of the ratings altogether. In addition,
any rating agency providing a rating for the AMPS may, at any time, change or
withdraw any such rating. The Board of Directors may, without stockholder
approval, amend, alter, add to or repeal any or all of the definitions and
related provisions that have been adopted by the Fund pursuant to the rating
agency guidelines in the event the Fund receives written confirmation from S&P
or Moody's, or both, as appropriate, that any such change would not impair the
ratings then assigned by S&P and Moody's to the AMPS.
As described by S&P and Moody's, the AMPS rating is an assessment of the
capacity and willingness of the Fund to pay AMPS' obligations. The ratings on
the AMPS are not recommendations to purchase, hold or sell the AMPS, inasmuch as
the ratings do not comment as to market price or suitability for a particular
investor. The rating agency guidelines also do not address the likelihood that
an owner of the AMPS will be able to sell such shares in an auction or
otherwise. The ratings are based on current information furnished to S&P and
Moody's by the Fund and the Investment Manager and information obtained from
other sources. The ratings may be changed, suspended or withdrawn as a result of
changes in, or the unavailability of, such information.
The rating agency guidelines will apply to the AMPS only so long as such
rating agency is rating these shares. The Fund will pay fees to S&P and Moody's
for rating the AMPS.
REDEMPTION
Mandatory Redemption. If the Fund does not timely cure a failure to (1)
maintain a discounted value of its portfolio equal to the Preferred Shares Basic
Maintenance Amount, (2) maintain the 1940 Act Preferred Shares Asset Coverage or
(3) file a required certificate related to asset coverage on time, the AMPS will
be subject to mandatory redemption out of funds legally available therefor in
accordance with the Articles Supplementary and applicable law, at the redemption
price of $25,000 per share plus an amount equal to accumulated but unpaid
dividends thereon (whether or not earned or declared) to (but not including) the
date fixed for redemption. Any such redemption will be limited to the number of
AMPS necessary to restore the required discounted value or the 1940 Act
Preferred Shares Asset Coverage, as the case may be.
In determining the number of AMPS required to be redeemed in accordance with
the foregoing, the Fund will allocate the number of shares required to be
redeemed to satisfy the Preferred Shares Basic Maintenance Amount or the 1940
Act Preferred Shares Asset Coverage, as the case may be, pro rata among the AMPS
of the Fund and any other preferred stock of the Fund, subject to redemption or
retirement. If fewer than all outstanding shares of any series are, as a result,
to be redeemed, the Fund may redeem such shares by lot or other method that it
deems fair and equitable.
Optional Redemption. To the extent permitted under the 1940 Act and Maryland
law, the Fund at its option may without the consent of the holders of the AMPS,
redeem AMPS having a dividend period of one year or less, in whole or in part,
on the business day after the last day of such dividend period upon not less
than 15 calendar days and not more than 40 calendar days prior notice. The
optional redemption price per share will be $25,000 per share, plus an amount
equal to accumulated but unpaid dividends thereon (whether or not earned or
declared) to the date fixed for redemption. AMPS having a dividend period of
more than one year are redeemable at the option of the Fund, in whole or in
part, prior to the end of the relevant dividend period,
67
subject to any specific redemption provisions, which may include the payment of
redemption premiums to the extent required under any applicable specific
redemption provisions. The Fund will not make any optional redemption unless,
after giving effect thereto, (i) the Fund has available certain deposit
securities with maturities or tender dates not later than the day preceding the
applicable redemption date and having a value not less than the amount
(including any applicable premium) due to holders of the AMPS by reason of the
redemption of the AMPS on such date fixed for the redemption and (ii) the Fund
has eligible assets with an aggregate discounted value at least equal to the
Preferred Shares Basic Maintenance Amount.
Notwithstanding the foregoing, AMPS may not be redeemed at the option of the
Fund unless all dividends in arrears on the outstanding AMPS, and any other
outstanding shares of preferred stock, have been or are being contemporaneously
paid or set aside for payment. This would not prevent the lawful purchase or
exchange offer for AMPS made on the same terms to holders of all outstanding
shares of preferred stock.
LIQUIDATION
Subject to the rights of holders of any series or class or classes of shares
ranking on a parity with AMPS with respect to the distribution of assets upon
liquidation of the Fund, upon a liquidation of the Fund, whether voluntary or
involuntary, the holders of AMPS then outstanding will be entitled to receive
and to be paid out of the assets of the Fund available for distribution to its
stockholders, before any payment or distribution is made on the Common Shares,
an amount equal to the liquidation preference with respect to such shares
($25,000 per share), plus an amount equal to all dividends thereon (whether or
not earned or declared by the Fund, but excluding the interest thereon)
accumulated but unpaid to and including the date of final distribution in same-
day funds in connection with the liquidation of the Fund. After the payment to
the holders of AMPS of the full preferential amounts provided for as described
herein, the holders of AMPS as such will have no right or claim to any of the
remaining assets of the Fund.
Neither the sale of all or substantially all the property or business of the
Fund, nor the merger or consolidation of the Fund into or with any other entity
nor the merger or consolidation of any other entity into or with the Fund, will
be a liquidation, whether voluntary or involuntary, for the purposes of the
foregoing paragraph.
THE AUCTION
GENERAL
The Articles Supplementary provide that, except as otherwise described in
this prospectus, the applicable rate for the AMPS for each rate period after the
initial rate period will be the rate that results from an auction conducted as
set forth in the Articles Supplementary and summarized below. In such an
auction, persons determine to hold or offer to sell or, based on dividend rates
bid by them, offer to purchase or sell the AMPS. See the Articles Supplementary
for a more complete description of the auction process.
Auction Agency Agreement. The Fund will enter into an auction agency
agreement with the auction agent (initially, The Bank of New York) which
provides, among other things, that the auction agent will follow the auction
procedures to determine the applicable rate for the AMPS, so long as the
applicable rate for the AMPS is to be based on the results of an auction.
68
The auction agent may terminate the auction agency agreement upon notice to
the Fund no earlier than 60 days after the delivery of such notice. If the
auction agent should resign, the Fund will use its best efforts to enter into an
agreement with a successor auction agent containing substantially the same terms
and conditions as the auction agency agreement. The Fund may remove the auction
agent provided that, prior to such removal, the Fund has entered into such an
agreement with a successor auction agent.
Broker-Dealer Agreements. Each auction requires the participation of one or
more broker-dealers. The auction agent will enter into agreements with several
broker-dealers selected by the Fund, which provide for the participation of
those broker-dealers in auctions for the AMPS.
The auction agent will pay to each broker-dealer after each auction from
funds provided by the Fund, a service charge at the annual rate of 1/4 of 1% of
the liquidation preference ($25,000 per share) of the AMPS held by a
broker-dealer's customer upon settlement in an auction. For any special rate
period, the service charge will be determined by mutual consent of the Fund and
any such broker-dealer or broker-dealers and will be based upon a selling
concession that would be applicable to an underwriting of fixed or variable rate
preferred shares with a similar final maturity or variable rate dividend period,
respectively, at the commencement of the dividend period with respect to such
auction. For purposes of the foregoing, the AMPS will be placed by a
broker-dealer if such shares were (i) the subject of hold orders deemed to have
been made by beneficial owners that were acquired by such beneficial owners
through such broker-dealer or (ii) the subject of the following orders submitted
by such broker-dealer: (A) a submitted bid of a Beneficial Owner that resulted
in such Beneficial Owner continuing to hold such shares as a result of the
auction, (B) a submitted bid of a potential Beneficial Owner that resulted in
such potential Beneficial Owner purchasing such shares as a result of the
auction or (C) a submitted hold order. A broker-dealer may share a portion of
any such fees with non-participating broker-dealers that submit orders to the
broker-dealer for an auction that are placed by that broker-dealer in such
auction.
AUCTION PROCEDURES
Prior to the submission deadline on each auction date for the AMPS, each
customer of a broker-dealer who is listed on the records of that broker-dealer
(or, if applicable, the auction agent) as a beneficial owner of AMPS may submit
the following types of orders with respect to AMPS to that broker-dealer:
1. Hold Order -- indicating its desire to hold AMPS without regard to the
applicable rate for the next rate period.
2. Bid -- indicating its desire to purchase or hold the indicated number of
AMPS at $25,000 per share if the applicable rate for shares of such
series for the next rate period is not less than the rate or spread
specified in the bid and which shall be deemed an irrevocable offer to
sell AMPS at $25,000 per share if the applicable rate for shares of such
series for the next rate period is less than the rate or spread specified
in the bid.
3. Sell Order -- indicating its desire to sell AMPS at $25,000 per share
without regard to the applicable rate for shares of such series for the
next rate period.
A beneficial owner of AMPS may submit different types of orders to its
broker-dealer with respect to AMPS then held by the beneficial owner. A
beneficial owner that submits a bid to its broker-dealer having a rate higher
than the maximum applicable rate on the auction date will be
69
treated as having submitted a sell order to its broker-dealer. A beneficial
owner that fails to submit an order to its broker-dealer will ordinarily be
deemed to have submitted a hold order to its broker-dealer. However, if a
beneficial owner fails to submit an order for some or all of its shares to its
broker-dealer for an auction relating to a rate period of more than 91 days,
such beneficial owner will be deemed to have submitted a sell order for such
shares to its broker-dealer. A sell order constitutes an irrevocable offer to
sell the AMPS subject to the sell order. A beneficial owner that offers to
become the beneficial owner of additional AMPS is, for the purposes of such
offer, a potential holder as discussed below.
A potential holder is either a customer of a broker-dealer that is not a
beneficial owner of AMPS but that wishes to purchase AMPS or a beneficial owner
that wishes to purchase additional AMPS. A potential holder may submit bids to
its broker-dealer in which it offers to purchase AMPS at $25,000 per share if
the applicable rate for the next rate period is not less than the rate specified
in such bid. A bid placed by a potential holder specifying a rate higher than
the maximum applicable rate on the auction date will not be accepted.
The broker-dealers in turn will submit the orders of their respective
customers who are beneficial owners and potential holders to the auction agent.
However, neither the Fund nor the auction agent will be responsible for a
broker-dealer's failure to comply with these procedures. Any order placed with
the auction agent by a broker-dealer as or on behalf of an existing holder or a
potential holder will be treated the same way as an order placed with a
broker-dealer by a beneficial owner or potential holder. Similarly, any failure
by a broker-dealer to submit to the auction agent an order for any AMPS held by
it or customers who are beneficial owners will be treated as a beneficial
owner's failure to submit to its broker-dealer an order in respect of AMPS held
by it. A broker-dealer may also submit orders to the auction agent for its own
account as an existing holder or potential holder, provided it is not an
affiliate of the Fund. If a broker-dealer submits an order for its own account
in any auction, it may have knowledge of orders placed through it in that
auction and therefore have an advantage over other bidders, but such
broker-dealer would not have knowledge of orders submitted by other
broker-dealers in that auction. As a result of bidding by the broker-dealer in
an auction, the auction rate may be higher or lower than the rate that would
have prevailed had the broker-dealer not bid.
There are sufficient clearing bids in an auction if the number of shares
subject to bids submitted or deemed submitted to the auction agent by
broker-dealers for potential holders with rates or spreads equal to or lower
than the maximum applicable rate is at least equal to the number of AMPS subject
to sell orders submitted or deemed submitted to the auction agent by
broker-dealers for existing holders. If there are sufficient clearing bids, the
applicable rate for the AMPS for the next succeeding rate period thereof will be
the lowest rate specified in the submitted bids which, taking into account such
rate and all lower rates bid by broker-dealers as or on behalf of existing
holders and potential holders, would result in existing holders and potential
holders owning the AMPS available for purchase in the auction.
If there are not sufficient clearing bids, the applicable rate for the next
rate period will be the maximum applicable rate on the auction date. However, if
the Fund has declared a special rate period and there not sufficient clearing
bids, the applicable rate for the next rate period will be the same as during
the current rate period. If there are not sufficient clearing bids, beneficial
owners of AMPS that have submitted or are deemed to have submitted sell orders
may not be able to sell in the auction all shares subject to such sell orders.
If all of the outstanding AMPS are the subject of submitted hold orders, then
the rate period following the auction will
70
automatically be the same length as the preceding rate period and the applicable
rate for the next rate period will be 90% of the Reference Rate.
A broker-dealer may also bid in an auction in order to prevent what would
otherwise be (i) a failed auction, (ii) an 'all-hold' auction or (iii) an
applicable rate that the broker-dealer believes, in its sole discretion, does
not reflect the market for the AMPS at the time of the auction. A broker-dealer
may, but is not obligated to, advise beneficial owners of AMPS that the
applicable rate that would apply in an 'all-hold' auction may be lower than
would apply if beneficial owners submit bids, and such advice, if given, may
facilitate the submission of bids by beneficial owners that would avoid the
occurrence of an 'all-hold' auction.
The auction procedures include a pro rata allocation of shares for purchase
and sale, which may result in an existing holder continuing to hold or selling,
or a potential holder purchasing, a number of AMPS that is different than the
number of shares specified in its order. To the extent the allocation procedures
have that result, broker-dealers that have designated themselves as existing
holders or potential holders in respect of customer orders will be required to
make appropriate pro rata allocations among their respective customers.
Settlement of purchases and sales will be made on the next business day
(which is also a dividend payment date) after the auction date through DTC.
Purchasers will make payment through their agent members in same-day funds to
DTC against delivery to their respective agent members. DTC will make payment to
the sellers' agent members in accordance with DTC's normal procedures, which now
provide for payment against delivery by their agent members in same-day funds.
The auctions for the AMPS will normally be held every 7 days, and each
subsequent rate period will normally begin on the following business day.
The first auction for the AMPS will be held on , 2005, the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during the special rate periods, auctions for the
AMPS normally will be held every 7 days, and each subsequent dividend period
normally will begin on the following business day.
The following is a simplified example of how a typical auction works. Assume
that the Fund has 1,000 outstanding AMPS and three current holders. The three
current holders and three potential holders submit orders through broker-dealers
at the auction:
Current Holder A...... Owns 500 shares, wants to sell Bid order of 4.1% rate for all
all 500 shares if auction rate 500 Shares
is less than 4.1%
Current Holder B...... Owns 300 shares, wants to hold Hold order -- will take the
auction rate
Current Holder C...... Owns 200 shares, wants to sell Bid order of 3.9% rate for all
all 200 shares if auction rate 200 shares
is less than 3.9%
Potential Holder D.... Wants to buy 200 shares Places order to buy at or
above 4.0%
Potential Holder E.... Wants to buy 300 shares Places order to buy at or
above 3.9%
Potential Holder F.... Wants to buy 200 shares Places order to buy at or
above 4.1%
71
The lowest dividend rate that will result in all 1,000 AMPS continuing to be
held is 4.0% (the offer by D). Therefore, the dividend rate will be 4.0%.
Current holders B and C will continue to own their shares. Current holder A will
sell its shares because A's dividend rate bid was higher than the dividend rate.
Potential holder D will buy 200 shares and potential holder E will buy 300
shares because their bid rates were at or below the dividend rate. Potential
holder F will not buy any shares because its bid rate was above the dividend
rate.
SECONDARY MARKET TRADING AND TRANSFER OF AMPS
The underwriters are not required to make a market in the AMPS. The
broker-dealers (including the underwriters) may maintain a secondary trading
market for AMPS outside of auctions, but they are not required to do so. There
can be no assurance that a secondary trading market for AMPS will develop or, if
it does develop, that it will provide owners with liquidity of investment. The
AMPS will not be registered on any stock exchange or on the NASDAQ market.
Investors who purchase AMPS in an auction for a special rate period should note
that because the dividend rate on such shares will be fixed for the length of
that dividend period, the value of such shares may fluctuate in response to the
changes in interest rates, and may be more or less than their original cost if
sold on the open market in advance of the next auction thereof, depending on
market conditions. In addition, a broker-dealer may, in its own discretion,
decide to sell AMPS in the secondary market to investors at any time and at any
price, including at prices equivalent to, below or above the liquidation
preference of the AMPS.
You may sell, transfer, or otherwise dispose of AMPS only in whole shares
and only
pursuant to a bid or sell order placed with the auction agent in
accordance with the auction procedures;
to a broker-dealer; or
to such other persons as may be permitted by the Fund; provided, however,
that (i) if you hold your AMPS in the name of a broker-dealer, a sale or
transfer of your AMPS to that broker-dealer, or to another customer of
that broker-dealer, will not be considered a sale or transfer for purposes
of the foregoing if that broker-dealer remains the existing holder of the
AMPS immediately after the transaction; and (ii) in the case of all
transfers, other than through an auction, the broker-dealer (or other
person, if the Fund permits) receiving the transfer will advise the
auction agent of the transfer.
A further description of the auction procedures can be found in the Articles
Supplementary.
DESCRIPTION OF COMMON SHARES
The Fund is authorized to issue shares of Common Shares, par value
$.001 per share. Common Shares are fully paid and non-assessable when issued and
have no preemptive, conversion, exchange or redemption rights. Each Common Share
has equal voting, dividend, distribution and liquidation rights. Whenever the
AMPS and the shares of the Outstanding AMPS are outstanding, holders of Common
Shares will not be entitled to receive any distributions from the Fund unless
all accrued dividends on the AMPS and the shares of the Outstanding AMPS have
been paid, and unless the applicable asset coverage requirements under the 1940
Act would be at least 200% after giving effect to the distribution.
72
Under the rules of the NYSE applicable to listed companies, the Fund is
required to hold an annual meeting of stockholders each year.
CERTAIN PROVISIONS OF THE CHARTER AND BY-LAWS
The Fund has provisions in its Charter and By-Laws that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund, to cause it to engage in certain transactions or to modify its
structure. The Board of Directors has been divided into three classes. At the
annual meeting of stockholders in each year, the term of one class will expire
and directors will be elected to serve in that class for terms of three years.
This provision could delay for up to two years the replacement of a majority of
the Board of Directors. A director may be removed from office only for cause and
only by a vote of the holders of at least 75% of the outstanding shares of the
Fund entitled to vote on the matter.
The affirmative vote of at least 75% of the entire Board of Directors is
required to authorize the conversion of the Fund from a closed-end to an
open-end investment company. Such conversion also requires the affirmative vote
of the holders of at least 75% of Common Shares and the AMPS (and the
Outstanding AMPS) outstanding at the time, voting together as a single class,
unless it is approved by a vote of at least 75% of the Continuing Directors (as
defined below), in which event such conversion requires the approval of the
holders of a majority of the votes entitled to be cast thereon by the
stockholders of the Fund. A 'Continuing Director' is any member of the Board of
Directors of the Fund who (i) is not a person or affiliate of a person who
enters or proposes to enter into a Business Combination (as defined below) with
the Fund (an 'Interested Party') and (ii) who has been a member of the Board of
Directors of the Fund for a period of at least 12 months, or has been a member
of the Board of Directors since the Fund's initial public offering of Common
Shares, or is a successor of a Continuing Director who is unaffiliated with an
Interested Party and is recommended to succeed a Continuing Director by a
majority of the Continuing Directors then on the Board of Directors of the Fund.
The affirmative vote of at least 75% of the entire Board of Directors and at
least 75% of the holders of Common Shares and the AMPS (and the Outstanding
AMPS) outstanding at the time, voting together as a single class, will be
required to amend the Charter to change any of the provisions in this paragraph
and the preceding paragraph.
The affirmative votes of at least 75% of the entire Board of Directors and
the holders of at least (i) 80% of the votes entitled to be cast thereon by the
stockholders of the Fund and (ii) in the case of a Business Combination (as
defined below), 66 2/3% of Common Shares and the AMPS (and the Outstanding AMPS)
outstanding at the time, voting together as a single class, other than votes
held by an Interested Party who is (or whose affiliate is) a party to a Business
Combination (as defined below) or an affiliate or associate of the Interested
Party, are required to authorize any of the following transactions:
(i) merger, consolidation or statutory share exchange of the Fund with
or into any other entity;
(ii) issuance or transfer by the Fund (in one or a series of
transactions in any 12-month period) of any securities of the Fund to any
person or entity for cash, securities or other property (or combination
thereof) having an aggregate fair market value of $1,000,000 or more,
excluding (a) issuances or transfers of debt securities of the Fund, (b)
sales of securities of the Fund in connection with a public offering, (c)
issuances of securities of the Fund
73
pursuant to a dividend reinvestment plan adopted by the Fund, (d) issuances
of securities of the Fund upon the exercise of any stock subscription rights
distributed by the Fund and (e) portfolio transactions effected by the Fund
in the ordinary course of business;
(iii) sale, lease, exchange, mortgage, pledge, transfer or other
disposition by the Fund (in one or a series of transactions in any 12 month
period) to or with any person or entity of any assets of the Fund having an
aggregate fair market value of $1,000,000 or more except for portfolio
transactions (including pledges of portfolio securities in connection with
borrowings) effected by the Fund in the ordinary course of its business
(transactions within clauses (i), (ii) and (iii) above being known
individually as a 'Business Combination');
(iv) any voluntary liquidation or dissolution of the Fund or an
amendment to the Fund's Charter to terminate the Fund's existence; or
(v) any stockholder proposal as to specific investment decisions made or
to be made with respect to the Fund's assets as to which stockholder
approval is required under Federal or Maryland law.
However, the stockholder vote described above will not be required with
respect to the foregoing transactions (other than those set forth in (v) above)
if they are approved by a vote of at least 75% of the Continuing Directors (as
defined above). In that case, if Maryland law requires stockholder approval, the
affirmative vote of a majority of votes entitled to be cast thereon shall be
required and if Maryland law does not require stockholder approval, no
shareholder approval will be required. The Fund's By-Laws contain provisions the
effect of which is to prevent matters, including nominations of directors, from
being considered at a stockholders' meeting where the Fund has not received
notice of the matters generally at least 90 but no more than 120 days prior to
the first anniversary of the preceding year's annual meeting.
These provisions are in addition to any special voting rights granted to the
holders of the AMPS in the Charter. See 'Description of AMPS -- Voting Rights.'
The Board of Directors has determined that the foregoing voting requirements,
which are generally greater than the minimum requirements under Maryland law and
the 1940 Act, are in the best interest of the Fund's stockholders generally.
Reference is made to the Charter and By-Laws of the Fund, on file with the
Securities and Exchange Commission, for the full text of these provisions. These
provisions could have the effect of depriving stockholders of an opportunity to
sell their shares at a premium over prevailing market prices by discouraging a
third party from seeking to obtain control of the Fund in a tender offer or
similar transaction. In the opinion of the Investment Manager, however, these
provisions offer several possible advantages. They may require persons seeking
control of a Fund to negotiate with its management regarding the price to be
paid for the shares required to obtain such control, they promote continuity and
stability and they enhance the Fund's ability to pursue long-term strategies
that are consistent with its investment objective.
CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and it may be converted to an
open-end investment company at any time by a vote of the outstanding shares. See
'Description of AMPS -- Voting Rights' and 'Certain Provisions of the Charter
and By-Laws' for a discussion of voting requirements applicable to conversion of
the Fund to an open-end investment company. If the Fund converted to an open-end
investment company, it would be required to redeem all the
74
AMPS (and the Outstanding AMPS) then outstanding (requiring in turn that it
liquidate a portion of its investment portfolio) and the Common Shares would no
longer be listed on the NYSE. Conversion to open-end status could also require
the Fund to modify certain investment restrictions and policies. Stockholders of
an open-end investment company may require the company to redeem their shares at
any time (except in certain circumstances as authorized by or permitted under
the 1940 Act) at their net asset value, less such redemption charge, if any, as
might be in effect at the time of redemption. In order to avoid maintaining
large cash positions or liquidating favorable investments to meet redemptions,
open-end investment companies typically engage in a continuous offering of their
shares. Open-end investment companies are thus subject to periodic asset
in-flows and out-flows that can complicate portfolio management. The Board of
Directors may at any time propose conversion of the Fund to open-end status,
depending upon its judgment regarding the advisability of such action in light
of circumstances then prevailing. The Board of Directors believes, however, that
the closed-end structure is desirable in light of the Fund's investment
objective and policies and it is currently not likely that the Board of
Directors would vote to convert the Fund to an open-end fund.
REPURCHASE OF COMMON SHARES
Common shares of closed-end investment companies often trade at a discount
to net asset value, and the Fund's Common Shares may also trade at a discount to
their net asset value, although it is possible that they may trade at a premium
above net asset value. The market price of the Fund's Common Shares will be
determined by such factors as relative demand for and supply of the Common
Shares in the market, the Fund's net asset value, general market and economic
conditions and other factors beyond the control of the Fund. Although holders of
Common Shares will not have the right to redeem the Common Shares, the Fund may
take action to repurchase Common Shares in the open market or make tender offers
for its Common Shares at net asset value.
The acquisition of Common Shares by the Fund will decrease the total assets
of the Fund and, therefore, have the effect of increasing the Fund's expense
ratio and may adversely affect the ability of the Fund to achieve its investment
objective. Furthermore, the acquisition of Common Shares by the Fund, may
require the Fund to redeem the AMPS in order to maintain certain asset coverage
requirements. To the extent the Fund may need to liquidate investments to fund
repurchase of Common Shares, this may result in portfolio turnover which will
result in additional expenses being borne by the Fund. The Board of Directors
currently considers the following factors to be relevant to a potential decision
to repurchase Common Shares: the extent and duration of the discount, the
liquidity of the Fund's portfolio, the impact of any action on the Fund or its
stockholders and market considerations. Any share repurchases or tender offers
will be made in accordance with the requirements of the Securities Exchange Act
of 1934, as amended, and the 1940 Act. See 'U.S. Federal Taxation' for a
description of the potential tax consequences of a repurchase of Common Shares.
U.S. FEDERAL TAXATION
The following discussion offers only a brief outline of the U.S. Federal
income tax consequences of investing in the Fund and is based on the U.S.
Federal tax laws in effect on the date hereof. Such tax laws are subject to
change by legislative, judicial or administrative action,
75
possibly with retroactive effect. Investors should consult their own tax
advisers for more detailed information and for information regarding the impact
of state, local and foreign taxes on an investment in the Fund.
U.S. FEDERAL INCOME TAX TREATMENT OF THE FUND
The Fund has elected to be treated as, and intends to qualify annually as, a
regulated investment company (a 'RIC') under Subchapter M of the Code. To
qualify, the Fund must, among other things, (a) (i) derive in each taxable year
at least 90% of its gross income from: (a) dividends, interest, payments with
respect to certain securities loans, and gains from the sale or other
disposition of stock, securities or foreign currencies, or other income
(including but not limited to gain from options, futures and forward contracts)
derived with respect to its business of investing in such stock, securities or
foreign currencies; and (b) net income derived from interests in certain
publicly traded partnerships that are treated as partnerships for U.S. federal
income tax purposes and that derive less than 90% of their gross income from the
items described in (a) above (each a 'Qualified Publicly Traded Partnership');
and (ii) diversify its holdings so that, at the end of each quarter of each
taxable year: (a) at least 50% of the value of the Fund's total assets is
represented by (I) cash and cash items, U.S. government securities, the
securities of other regulated investment companies and (II) other securities,
with such other securities limited, in respect of any one issuer, to an amount
not greater than 5% of the value of the Fund's total assets and not more than
10% of the outstanding voting securities of such issuer and (b) not more than
25% of the value of the Fund's total assets is invested in the securities (other
than U.S. government securities and the securities of other RICs) of (I) any one
issuer, (II) any two or more issuers that the Fund controls and that are
determined to be engaged in the same or similar trades or businesses or related
trades or businesses or (III) any one or more Qualified Publicly Traded
Partnerships.
For each taxable year that the Fund otherwise qualifies as a RIC, it will
not be subject to U.S. Federal income tax on that part of its investment company
taxable income (as that term is defined in the Code, but determined without
regard to any deduction for dividends paid) and net capital gain (the excess of
net long-term capital gain over net short-term capital loss) that it distributes
to its stockholders, if it distributes at least 90% of the sum of its investment
company taxable income and any net tax-exempt interest income for that year (the
'Distribution Requirement'). The Fund intends to make sufficient distributions
of its investment company taxable income each taxable year to meet the
Distribution Requirement. If the Fund failed to qualify for treatment as a RIC
for any taxable year or failed to satisfy the Distribution Requirement in any
taxable year, (a) it would be taxed as an ordinary corporation on the full
amount of its taxable income for that year without being able to deduct the
distributions it makes to its stockholders, and (b) its stockholders would treat
any such distributions, including distributions of net capital gain, as ordinary
dividends to the extent of the Fund's current and accumulated earnings and
profits. Such distributions generally would be eligible (i) for the DRD
available to corporate stockholders and (ii) for treatment as qualified dividend
income in the case of individual stockholders.
The Fund also currently intends to distribute all realized net capital gain
annually. If, however, the Board of Directors determines for any taxable year to
retain all or a portion of the Fund's net capital gain, that decision will not
affect the Fund's ability to qualify for treatment as a RIC, but
76
will subject the Fund to a maximum tax rate of 35% of the amount retained. In
that event, the Fund expects to designate the retained amount as undistributed
capital gains in a notice to its stockholders, who (i) will be required to
include their proportionate shares of the undistributed amount in their gross
income as long-term capital gain, and (ii) will be entitled to credit their
proportionate shares of the 35% tax paid by the Fund against their U.S. Federal
income tax liabilities. For U.S. Federal income tax purposes, the tax basis of
shares owned by a Fund stockholder will be increased by an amount equal to 65%
of the amount of undistributed capital gains included in the stockholder's gross
income.
The Fund will be subject to a nondeductible 4% excise tax to the extent it
fails to distribute by the end of any calendar year an amount at least equal to
the sum of (i) 98% of its ordinary income for that year (ii) 98% of its capital
gain net income for the one-year period ending on October 31 of that calendar
year, unless the Fund elects to use a calendar year and (iii) any ordinary
income and capital gains for previous years that were not distributed during
those years and on which the Fund paid no U.S. federal income tax. For this and
other purposes, a distribution will be treated as paid by the Fund and received
by the stockholders on December 31 if it is declared by the Fund in October,
November or December of such year, made payable to stockholders of record on a
date in such a month and paid by the Fund during January of the following year.
Any such distribution thus will be taxable to stockholders whose taxable year is
the calendar year in the year the distribution is declared, rather than the year
in which the distribution is received. To prevent application of the excise tax,
the Fund intends to make its distributions in accordance with the calendar year
distribution requirement.
U.S. FEDERAL INCOME TAX TREATMENT OF HOLDERS OF AMPS
Based in part on the lack of any present intention on the part of the Fund
to redeem or purchase the AMPS at any time in the future, the Fund believes that
under present law the AMPS will constitute stock of the Fund and distributions
with respect to the AMPS (other than distributions in redemption of the AMPS
that are treated as exchanges of stock under Section 302(b) of the Code) thus
will constitute dividends to the extent of the Fund's current or accumulated
earnings and profits as calculated for U.S. Federal income tax purposes. Such
dividends generally will be taxable as ordinary income to holders (other than
distributions of qualified dividend income and capital gain dividends, as
described below). If a portion of the Fund's income consists of qualifying
dividends paid by U.S. corporations (other than REITs), a portion of the
dividends paid by the Fund to corporate stockholders, if properly designated,
may qualify for the DRD. In addition, for taxable years beginning on or before
December 31, 2008, distributions of investment income designated by the Fund as
derived from qualified dividend income will be taxed in the hands of individuals
at the rates applicable to long-term capital gain, provided holding period and
other requirements are met by both the Fund and the stockholder. Specifically, a
dividend paid by the Fund to a stockholder will not be treated as qualified
dividend income of the stockholder (1) if the dividend is received with respect
to any share held for fewer than 61 days during the 121-day period beginning on
the date which is 60 days before the date on which such share becomes
ex-dividend with respect to such dividend, (2) to the extent that the recipient
is under an obligation (whether pursuant to a short sale or otherwise) to make
related payments with respect to positions in substantially similar or related
property or (3) if the recipient elects to have the dividend treated as
investment income for purposes of the limitation on deductibility of investment
interest. Qualified dividend income is, in general, dividend income
77
from taxable domestic corporations and certain 'qualified foreign corporations'
(e.g., generally, foreign corporations incorporated in a possession of the
United States or in certain countries with a qualifying comprehensive tax treaty
with the United States, or the stock of which and with respect to which such
dividend is paid is readily tradable on an established securities market in the
United States), but does not include a foreign corporation which for the taxable
year of the corporation in which the dividend was paid, or the preceding taxable
year, is a 'passive foreign investment company,' as defined in the Code.
Dividend income that the Fund receives from utility companies will generally be
treated as qualified dividend income, although there can be no assurance in this
regard. The foregoing discussion relies in part on a published ruling of the IRS
stating that certain preferred stock similar in many material respects to the
AMPS represents equity (and the following discussion assumes such treatment will
apply). It is possible, however, that the IRS might take a contrary position
asserting, for example, that the AMPS constitute debt of the Fund. If this
position were upheld, the discussion of the treatment of distributions above
would not apply. Instead, distributions by the Fund to holders of AMPS would
constitute interest, whether or not such distributions exceeded the earnings and
profits of the Fund, would be included in full in the income of the recipient
and would be taxed as ordinary income.
Distributions of net capital gain that are designated by the Fund as capital
gain dividends will be treated as long-term capital gains in the hands of
holders regardless of the holders' respective holding periods for their AMPS.
Long-term capital gain rates for individuals have been temporarily reduced to
15% (with lower rates for individuals in the 10% and 15% rate brackets) for
taxable years beginning on or before December 31, 2008. Distributions, if any,
in excess of the Fund's current and accumulated earnings and profits will first
reduce the adjusted tax basis of a stockholder's shares and, after that basis
has been reduced to zero, will constitute a capital gain to the stockholder
(assuming the shares are held as a capital asset). The IRS currently requires
that a regulated investment company that has two or more classes of stock
allocate to each such class proportionate amounts of each type of its income
(such as ordinary income, capital gains, dividends qualifying for the DRD,
qualified dividend income, interest-related dividends and short-term capital
gain dividends) based upon the percentage of total dividends paid out of current
or accumulated earnings and profits to each class for the tax year. Accordingly,
the Fund intends each year to allocate capital gain dividends, dividends
qualifying for the DRD, dividends derived from qualified dividend income,
interest-related dividends and short-term capital gain dividends, if any,
between its Common Shares, the Outstanding AMPS and the AMPS in proportion to
the total dividends paid out of current or accumulated earnings and profits to
each class with respect to such tax year. Distributions in excess of the Fund's
current and accumulated earnings and profits, if any, however, will not be
allocated proportionately among the Common Shares and the AMPS (and the
Outstanding AMPS). Since the Fund's current and accumulated earnings and profits
will first be used to pay dividends on the AMPS (and the Outstanding AMPS),
distributions in excess of such earnings and profits, if any, will be made
disproportionately to holders of Common Shares.
Stockholders will be notified annually as to the U.S. federal tax status of
distributions.
SALE OF SHARES
The sale or other disposition of the AMPS generally will be a taxable
transaction for U.S. Federal income tax purposes. Selling holders of the AMPS
generally will recognize gain or loss in
78
an amount equal to the difference between the amount of cash and the fair market
value of any property received in exchange therefor and their respective bases
in such AMPS. If the AMPS are held as a capital asset, the gain or loss
generally will be a capital gain or loss. Similarly, a redemption (including a
redemption resulting from liquidation of the Fund), if any, of the AMPS by the
Fund generally will give rise to capital gain or loss if the holder does not own
(and is not regarded under certain tax law rules of constructive ownership as
owning) any shares of Common Shares in the Fund and provided that the redemption
proceeds do not represent declared but unpaid dividends.
Generally, a holder's gain or loss will be a long-term gain or loss if the
shares have been held for more than one year. Capital gains of individuals are
generally taxed at a maximum rate of tax of 15% (with lower rates applying to
taxpayers in the 10% and 15% rate brackets) for taxable years beginning on or
before December 31, 2008 (after which time the maximum rate will increase to
20%). However, any loss realized upon a taxable disposition of the AMPS held for
six months or less will be treated as a long-term capital loss to the extent of
any capital gain dividends received by the holder (or amounts credited to the
holder as undistributed capital gains) with respect to such shares. Also, any
loss realized upon a taxable disposition of the AMPS may be disallowed if other
substantially identical shares are acquired within a 61-day period beginning 30
days before and ending 30 days after the date the original shares are disposed
of. If disallowed, the loss will be reflected by an upward adjustment to the
basis of the shares acquired. Capital losses may be subject to other limitations
imposed by the Code.
BACKUP WITHHOLDING
The Fund may be required to withhold, for U.S. Federal income taxes, a
portion of all taxable dividends and redemption proceeds payable to stockholders
who fail to provide the Fund with their correct taxpayer identification numbers
or who otherwise fail to make required certifications, or if the Fund or a
Series stockholder has been notified by the IRS that such stockholder is subject
to backup withholding. Corporate stockholders and other stockholders specified
in the Code and the Treasury regulations promulgated thereunder are exempt from
such backup withholding. Backup withholding is not an additional tax. Any
amounts withheld will be allowed as a refund or a credit against the
stockholder's Federal income tax liability if the appropriate information is
provided to the IRS.
OTHER TAXATION
Foreign stockholders, including stockholders who are nonresident aliens, may
be subject to U.S. withholding tax on certain distributions at a rate of 30% or
such lower rates as may be prescribed by any applicable treaty. Under the
American Jobs Creation Act of 2004 (the 'Act'), U.S. source withholding taxes
are no longer imposed on dividends paid by RICs to the extent the dividends are
designated as 'interest-related dividends' or 'short-term capital gain
dividends.' Under this exemption, interest-related dividends and short-term
capital gain dividends generally represent distributions of U.S. source interest
or short-term capital gains that would not have been subject to U.S. withholding
tax at the source if they had been received directly by a foreign person, and
that satisfy certain other requirements. In addition, the Act provides that
distributions attributable to gains from U.S. real property interests (including
certain U.S. real property holding corporations) will generally cause the
foreign stockholder to be treated as recognizing such gain as
79
income effectively connected to a trade or business within the United States.
Foreign stockholders would thus generally be taxed at the same rates applicable
to U.S. stockholders, subject to a special alternative minimum tax in the case
of nonresident alien individuals. Also, such gain may be subject to a 30% branch
profits tax in the hands of a foreign stockholder that is a corporation. Such
distributions may be subject to U.S. withholding tax and will generally give
rise to an obligation on the part of the foreign stockholder to file a U.S.
federal income tax return. These rules apply to dividends with respect to
taxable years of RICs beginning after December 31, 2004 and before January 1,
2008. Investors are advised to consult their own tax advisers with respect to
the application to their own circumstances of the above-described general
taxation rules and with respect to the state, local, foreign and other tax
consequences to them of an investment in the AMPS.
FURTHER INFORMATION
The SAI summarizes further Federal income tax considerations that may apply
to the Fund and its stockholders and may qualify the considerations discussed
herein.
Fund distributions also may be subject to state and local taxes. You should
consult with your own tax adviser regarding the particular consequences of
investing in the Fund.
80
UNDERWRITING
Subject to the terms and conditions stated in the purchase agreement dated
, 2005, each underwriter named below, for which Merrill
Lynch, Pierce, Fenner & Smith Incorporated is acting as representative, has
severally agreed to purchase, and the Fund has agreed to sell to such
underwriter, the number of AMPS set forth opposite the name of such underwriter.
NUMBER OF
UNDERWRITER AMPS
----------- ----
Merrill Lynch, Pierce, Fenner & Smith
Incorporated....................................
Deutsche Bank Securities Inc................................
UBS Securities LLC..........................................
Wachovia Capital Markets, LLC...............................
...............................
---------
Total...........................................
---------
---------
The purchase agreement provides that the obligations of the underwriters to
purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to certain other conditions, including
without limitation, the receipt by the underwriters of customary closing
certificates, opinions and other documents and the receipt by the Fund of the
highest credit quality rating on the AMPS from Moody's and S&P, as of the time
of the offering. The underwriters are obligated to purchase all the AMPS sold if
they purchase any of the AMPS. In the purchase agreement, the Fund and the
Investment Manager have agreed to indemnify the underwriters against certain
liabilities, including liabilities arising under the Securities Act or to
contribute to payments the underwriters may be required to make for any of those
liabilities.
The underwriters propose to initially offer some of the AMPS directly to the
public at the public offering price set forth on the cover page of this
prospectus and some of the AMPS to certain dealers at the public offering price
less a concession not to exceed $ per share. The sales load the Fund will pay
of $250 per share is equal to 1% of the initial offering price of the AMPS.
After this offering, the underwriters may change the public offering price and
the concession. Investors must pay for any AMPS purchased on or before
, 2005.
The Fund anticipates that the underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions and that the
underwriters, or their affiliates, may act as counterparties in connection with
the interest rate transactions described above after they have ceased to be
underwriters. The underwriters are active underwriters of, and dealers in,
securities and act as market makers in a number of such securities, and
therefore can be expected to engage in portfolio transactions with, and perform
services for, the Fund.
The underwriters have advised the Fund that certain of the underwriters and
various other broker-dealers and other firms that participate in the auction
rate securities market received letters from the staff of the Securities and
Exchange Commission last spring. The letters requested that each of those firms
voluntarily conduct an investigation regarding its respective practices and
procedures in that market. Pursuant to these requests, each of those
underwriters conducted its own voluntary review and reported its findings
to the Securities and Exchange Commission staff. At the Securities and Exchange
Commission staff's request, those underwriters are engaging in discussions with
the Securities and Exchange Commission staff that may lead to a resolution of
its inquiry. Neither those underwriters nor the Fund can predict how such a
resolution may affect the market for the AMPS or the auctions.
The Fund anticipates that the underwriters or their respective affiliates
may, from time to time, act in auctions as broker-dealers and receive fees as
set forth under 'The Auction' and in the SAI.
81
The principal business address of Merrill Lynch, Pierce, Fenner & Smith
Incorporated is 4 World Financial Center, New York, New York 10080.
The settlement date for the purchase of the AMPS will be , 2005,
as agreed upon by the underwriters, the Fund and the Investment Manager pursuant
to Rule 15c6-1 under the Securities Exchange Act of 1934.
CUSTODIAN, AUCTION AGENT, TRANSFER
AGENT, DIVIDEND PAYING AGENT AND REGISTRAR
The Bank of New York, whose address is 101 Barclay Street, Floor 7W, New
York, New York 10286, will act as auction agent, transfer agent, dividend paying
agent and registrar for the AMPS. State Street Bank, whose principal business
address is 225 Franklin Street, Boston, Massachusetts 02110, has been retained
to act as custodian of the Fund's investments. Neither The Bank of New York nor
State Street Bank has any part in deciding the Fund's investment policies or
which securities are to be purchased or sold for the Fund's portfolio.
LEGAL OPINIONS
The validity of the shares offered hereby is being passed on for the Fund by
Simpson Thacher & Bartlett LLP, New York, New York, and certain other legal
matters will be passed on for the underwriters by Clifford Chance US LLP, New
York, New York. Venable LLP will opine on certain matters pertaining to Maryland
law. Simpson Thacher & Bartlett LLP and Clifford Chance US LLP may rely as to
certain matters of Maryland law on the opinion of Venable LLP.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The financial statements of the Fund for the period from March 30, 2004
through December 31, 2004 have been audited by PricewaterhouseCoopers LLP,
independent registered public accounting firm, as set forth in their report
given upon the authority of said firm as experts in auditing and accounting. The
address of PricewaterhouseCoopers LLP is 300 Madison Avenue, New York, New York
10017.
FURTHER INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and is required to file reports, proxy
statements and other information with the Securities and Exchange Commission.
These documents can be inspected and copied for a fee at the Securities and
Exchange Commission's public reference room, 100 F Street, N.E., Room 1580,
Washington, D.C. 20549. Reports, proxy statements, and other information
about the Fund can be inspected at the offices of the NYSE.
This prospectus does not contain all of the information in the Fund's
registration statement, including amendments, exhibits, and schedules.
Statements in this prospectus about the contents of any contract or other
document are not necessarily complete and in each instance reference is made to
the copy of the contract or other document filed as an exhibit to the
registration statement, each such statement being qualified in all respects by
this reference.
Additional information about the Fund and AMPS can be found in the Fund's
Registration Statement (including amendments, exhibits, and schedules) on Form
N-2 filed with the Securities and Exchange Commission. The Fund's SAI contains
additional information about the Fund and is incorporated by reference into
(which means it is considered to be a part of) this prospectus. The Securities
and Exchange Commission maintains a web site (http://www.sec.gov) that contains
the Fund's Registration Statement, the SAI, other documents incorporated by
reference, and other information the Fund has filed electronically with the
Securities and Exchange Commission, including proxy statements and reports filed
under the Securities Exchange Act of 1934. Additional information may be found
on the Internet at http://cohenandsteers.com.
82
TABLE OF CONTENTS OF THE STATEMENT OF ADDITIONAL INFORMATION
General Information......................................... 3
Investment Objective and Policies, Additional Information
Regarding Fund Investments................................ 3
Investment Restrictions..................................... 10
Management of the Fund...................................... 12
Compensation of Directors and Certain Officers.............. 19
Investment Advisory and Other Services...................... 21
Portfolio Transactions and Brokerage........................ 31
Determination of Net Asset Value............................ 32
Additional Information Concerning the Auctions for AMPS..... 33
S&P and Moody's Guidelines.................................. 35
U.S. Federal Taxation....................................... 46
Performance Data and Index Returns.......................... 52
Experts..................................................... 53
Report of Independent Registered Public Accounting Firm..... 54
Financial Information....................................... 55
Appendix A: Ratings of Investments.......................... A-1
Appendix B: Articles Supplementary.......................... B-1
83
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
$
COHEN & STEERS
SELECT UTILITY FUND, INC.
AUCTION MARKET PREFERRED SHARES ('AMPS')
SHARES, SERIES TH7
LIQUIDATION PREFERENCE $25,000 PER SHARE
-----------------
PROSPECTUS
-----------------
MERRILL LYNCH & CO.
DEUTSCHE BANK SECURITIES
UBS INVESTMENT BANK
WACHOVIA SECURITIES
, 2005
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SUBJECT TO COMPLETION, DATED , 2005
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT COMPLETE
AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
STATEMENT OF ADDITIONAL INFORMATION IS NOT AN OFFER TO SELL THESE SECURITIES AND
IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER
OR SALE IS NOT PERMITTED.
[COHEN & STEERS
SELECT UTILITY FUND LOGO]
757 THIRD AVENUE
NEW YORK, NEW YORK 10017
(800) 437-9912
--------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
Auction Market Preferred Shares ('AMPS')
Shares, Series TH7
, 2005
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS, BUT SHOULD BE
READ IN CONJUNCTION WITH THE PROSPECTUS OF COHEN & STEERS SELECT UTILITY FUND,
INC., DATED , 2005, AS SUPPLEMENTED FROM TIME TO TIME (THE
'PROSPECTUS').
THIS STATEMENT OF ADDITIONAL INFORMATION DOES NOT INCLUDE ALL INFORMATION
THAT A PROSPECTIVE INVESTOR SHOULD CONSIDER BEFORE PURCHASING AMPS IN THIS
OFFERING, AND INVESTORS SHOULD OBTAIN AND READ THE PROSPECTUS PRIOR TO
PURCHASING AMPS.
THIS STATEMENT OF ADDITIONAL INFORMATION IS INCORPORATED BY REFERENCE IN ITS
ENTIRETY INTO THE PROSPECTUS. COPIES OF THE STATEMENT OF ADDITIONAL INFORMATION
AND PROSPECTUS MAY BE OBTAINED FREE OF CHARGE BY WRITING OR CALLING THE ADDRESS
OR PHONE NUMBER SHOWN ABOVE.
Capitalized terms used in this Statement of Additional Information have the
meanings assigned to them in the Prospectus or in this Statement of Additional
Information, including the appendices.
--------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
----
General Information......................................... 3
Investment Objective and Policies, Additional Information
Regarding Fund Investments................................ 3
Investment Restrictions..................................... 10
Management of the Fund...................................... 12
Compensation of Directors and Certain Officers.............. 19
Investment Advisory and Other Services...................... 21
Portfolio Transactions and Brokerage........................ 31
Determination of Net Asset Value............................ 32
Additional Information Concerning the Auctions for AMPS..... 33
S&P and Moody's Guidelines.................................. 35
U.S. Federal Taxation....................................... 46
Performance Data and Index Returns.......................... 52
Experts..................................................... 53
Report of Independent Registered Public Accounting Firm..... 54
Financial Information....................................... 55
Appendix A: Ratings of Investments.......................... A-1
Appendix B: Articles Supplementary.......................... B-1
2
GENERAL INFORMATION
The Fund is a non-diversified, closed-end management investment company
registered under the Investment Company Act of 1940 (the '1940 Act'). Cohen &
Steers Capital Management, Inc. (the 'Investment Manager') serves as the Fund's
investment manager. The Fund's investment objective is to achieve a high level
of after-tax total return through investment in utility securities. No assurance
can be given that the Fund will achieve its investment objective.
STATEMENT OF ADDITIONAL INFORMATION
Cohen & Steers Select Utility Fund, Inc. (the 'Fund') is a non-diversified,
closed-end management investment company organized as a Maryland corporation on
January 8, 2004. Much of the information contained in this Statement of
Additional Information expands on subjects discussed in the Prospectus. Defined
terms used herein have the same meanings as in the Prospectus. No investment in
the shares of the Fund should be made without first reading the Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
ADDITIONAL INFORMATION REGARDING FUND INVESTMENTS
The following descriptions supplement the descriptions of the principal
investment objective, strategies and risks as set forth in the Prospectus.
Except as otherwise provided, the Fund's investment policies are not fundamental
and may be changed by the Board of Directors of the Fund without the approval of
the stockholders; however, the Fund will not change its non-fundamental
investment policies without written notice to stockholders.
INVESTMENTS IN UTILITY COMPANIES
Under normal market conditions, we will invest at least 80% of our managed
assets in common stocks, preferred stocks and other equity securities of
companies engaged in the utility industry ('utility companies'). Utility
companies derive at least 50% of their revenues from, or have at least 50% of
their assets committed to, the:
generation, transmission, sale or distribution of electric energy;
distribution, purification and treatment of water;
production, transmission or distribution of natural gas; and
provision of communications services, including cable television,
satellite, microwave, radio, telephone and other communications media
PREFERRED SECURITIES
The Fund may invest in preferred securities issued by utility companies and
other types of companies. The taxable preferred securities (as defined in the
next paragraph) in which the Fund may invest do not qualify for the dividends
received deduction (the 'DRD') under Section 243 of the Internal Revenue Code of
1986, as amended (the 'Code') and are not expected to provide significant
benefits under the rules relating to 'qualified dividend income.' The DRD
generally allows corporations to deduct from their income 70% of dividends
received. Under current law, individuals will generally be taxed at long-term
capital gain rates on qualified dividend income. Accordingly, any corporate
stockholder who otherwise would qualify for the DRD, and any individual
stockholder who otherwise would qualify to be taxed at long-term capital gain
rates on qualified dividend income, should assume that none of the distributions
the stockholder receives from the Fund attributable to taxable preferred
securities will qualify for the DRD or provide significant benefits under the
rules relating to qualified dividend income.
There are two basic types of preferred securities: traditional preferred
securities and hybrid-preferred securities. When used in this SAI, taxable
preferred securities refer generally to hybrid-preferred securities as well as
certain types of traditional preferred securities that are not eligible for the
DRD (and are not expected to provide significant benefits under the rules
relating to
3
qualified dividend income), such as preferred securities issued by real estate
investment trusts ('REITs').
Traditional Preferred Securities. Traditional preferred securities pay fixed
or adjustable rate dividends to investors, and have a 'preference' over common
stock in the payment of dividends and the liquidation of a company's assets.
This means that a company must pay dividends on preferred stock before paying
any dividends on its common stock. In order to be payable, distributions on
preferred securities must be declared by the issuer's board of directors. Income
payments on typical preferred securities currently outstanding are cumulative,
causing dividends and distributions to accrue even if not declared by the board
of directors or otherwise made payable. There is no assurance that dividends or
distributions on the preferred securities in which the Fund invests will be
declared or otherwise made payable. Preferred stockholders usually have no right
to vote for corporate directors or on other matters. Shares of preferred
securities have a liquidation value that generally equals the original purchase
price at the date of issuance. The market value of preferred securities may be
affected by favorable and unfavorable changes impacting companies in the
utilities, real estate and financial services sectors, which are prominent
issuers of preferred securities, and by actual and anticipated changes in tax
laws, such as changes in corporate income tax rates, the rates applicable to
qualified dividend income and the DRD. Because the claim on an issuer's earnings
represented by preferred securities may become onerous when interest rates fall
below the rate payable on such securities, the issuer may redeem the securities.
Thus, in declining interest rate environments in particular, the Fund's holdings
of higher rate-paying fixed rate preferred securities may be reduced and the
Fund would be unable to acquire securities paying comparable rates with the
redemption proceeds.
Hybrid-Preferred Securities. The hybrid-preferred securities market is
divided into the '$25 par' and the 'institutional' segments. The $25 par segment
is typified by securities that are listed on the New York Stock Exchange, trade
and are quoted 'flat,' (i.e., without accrued dividend income) and are typically
callable at par value five years after their original issuance date. The
institutional segment is typified by $1,000 par value securities that are not
exchange-listed, trade and are quoted on an 'accrued income' basis, and
typically have a minimum of ten years of call protection (at premium prices)
from the date of their original issuance.
Hybrid-preferred securities are treated in a similar fashion to traditional
preferred securities by several regulatory agencies, including the Federal
Reserve Bank, and by credit rating agencies, for various purposes, such as the
assignment of minimum capital ratios, over-collateralization rates and
diversification limits.
Within the category of hybrid-preferred securities are senior debt
instruments that trade in the broader preferred securities market. These debt
instruments, which are sources of long-term capital for the issuers, have
structural features similar to preferred stock such as maturities ranging from
30 years to perpetuity, call features, exchange listings and the inclusion of
accrued interest in the trading price. Similar to other hybrid-preferred
securities, these debt instruments usually do not offer equity capital
treatment. CORTS'r' and PINES'r' are two examples of senior debt instruments
which are structured and trade as hybrid-preferred securities.
See 'Investment Objective and Policies -- Portfolio
Composition -- Hybrid-Preferred Securities' in the Fund's Prospectus for a
general description of hybrid-preferred securities.
SHORT-TERM FIXED INCOME SECURITIES
For temporary defensive purposes or to keep cash on hand fully invested, and
following the offering pending investment in securities that meet the Fund's
investment objective, the Fund may invest up to 100% of its total assets in cash
equivalents and short-term fixed income securities. Short-term fixed income
investments are defined to include, without limitation, the following:
(1) U.S. Government securities, including bills, notes and bonds differing
as to maturity and rates of interest that are either issued or
guaranteed by the U.S. Treasury or by U.S. Government agencies or
instrumentalities. U.S. Government securities include securities issued
by (a) the Federal Housing Administration, Farmers Home Administration,
Export-Import Bank of the United States, Small Business Administration,
and Government
4
National Mortgage Association, whose securities are supported by the
full faith and credit of the United States; (b) the Federal Home Loan
Banks, Federal Intermediate Credit Banks, and Tennessee Valley
Authority, whose securities are supported by the right of the agency to
borrow from the U.S. Treasury; (c) the Federal National Mortgage
Association, whose securities are supported by the discretionary
authority of the U.S. Government to purchase certain obligations of the
agency or instrumentality; and (d) the Student Loan Marketing
Association, whose securities are supported only by its credit. While
the U.S. Government provides financial support to such U.S.
Government-sponsored agencies or instrumentalities, no assurance can be
given that it always will do so since it is not so obligated by law. The
U.S. Government, its agencies and instrumentalities do not guarantee the
market value of their securities. Consequently, the value of such
securities may fluctuate.
(2) Certificates of deposit issued against funds deposited in a bank or a
savings and loan association. Such certificates are for a definite
period of time, earn a specified rate of return, and are normally
negotiable. The issuer of a certificate of deposit agrees to pay the
amount deposited plus interest to the bearer of the certificate on the
date specified thereon. Certificates of deposit purchased by the Fund
may not be fully insured by the Federal Deposit Insurance Corporation.
(3) Repurchase agreements, which involve purchases of debt securities. At
the time the Fund purchases securities pursuant to a repurchase
agreement, it simultaneously agrees to resell and redeliver such
securities to the seller, who also simultaneously agrees to buy back the
securities at a fixed price and time. This assures a predetermined yield
for the Fund during its holding period, since the resale price is always
greater than the purchase price and reflects an agreed-upon market rate.
Such actions afford an opportunity for the Fund to invest temporarily
available cash. The Fund may enter into repurchase agreements only with
respect to obligations of the U.S. Government, its agencies or
instrumentalities; certificates of deposit; or bankers' acceptances in
which the Fund may invest. Repurchase agreements may be considered loans
to the seller, collateralized by the underlying securities. The risk to
the Fund is limited to the ability of the seller to pay the agreed-upon
sum on the repurchase date; in the event of default, the repurchase
agreement provides that the Fund is entitled to sell the underlying
collateral. If the value of the collateral declines after the agreement
is entered into, and if the seller defaults under a repurchase agreement
when the value of the underlying collateral is less than the repurchase
price, the Fund could incur a loss of both principal and interest. The
Investment Manager monitors the value of the collateral at the time the
action is entered into and at all times during the term of the
repurchase agreement. The Investment Manager does so in an effort to
determine that the value of the collateral always equals or exceeds the
agreed-upon repurchase price to be paid to the Fund. If the seller were
to be subject to a Federal bankruptcy proceeding, the ability of the
Fund to liquidate the collateral could be delayed or impaired because of
certain provisions of the bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured promissory
notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes
are direct lending arrangements between the Fund and a corporation.
There is no secondary market for such notes. However, they are
redeemable by the Fund at any time.
The Investment Manager will consider the financial condition of the
corporation (e.g., earning power, cash flow and other liquidity ratios) and will
continuously monitor the corporation's ability to meet all of its financial
obligations, because the Fund's liquidity might be impaired if the corporation
were unable to pay principal and interest on demand. Investments in commercial
paper will be limited to commercial paper rated in the two highest categories by
a major rating agency or are unrated but determined to be of comparable quality
by the Investment Manager and which mature within one year of the date of
purchase or carry a variable or floating rate of interest.
5
LOWER RATED SECURITIES
The Fund may invest up to 25% of its managed assets (measured at the time of
purchase) in securities rated below investment grade, such as those rated below
Baa3 or BBB - by Moody's and S&P, respectively, or securities comparably rated
by other rating agencies or in unrated securities determined by the Investment
Manager to be below investment grade. Securities rated Ba by Moody's are judged
to have speculative elements; their future cannot be considered as well assured
and often the protection of interest and principle payments may be very
moderate. Securities rated BB by S&P are regarded as having predominantly
speculative characteristics and, while such obligations have less near-term
vulnerability to default than other speculative grade debt, they face major
ongoing uncertainties or exposure to adverse business, financial or economic
conditions which could lead to inadequate capacity to meet timely interest and
principal payments.
Lower grade securities, though high yielding, are characterized by high
risk. They may be subject to certain risks with respect to the issuing entity
and to greater market fluctuations than certain lower yielding, higher rated
securities. The retail secondary market for lower grade securities may be less
liquid than that of higher rated securities; adverse conditions could make it
difficult at times for the Fund to sell certain securities or could result in
lower prices than those used in calculating the Fund's net asset value.
The prices of debt securities generally are inversely related to interest
rate changes; however, the price volatility caused by fluctuating interest rates
of securities also is inversely related to the coupons of such securities.
Accordingly, below investment grade securities may be relatively less sensitive
to interest rate changes than higher quality securities of comparable maturity
because of their higher coupon. This higher coupon is what the investor receives
in return for bearing greater credit risk. The higher credit risk associated
with below investment grade securities potentially can have a greater effect on
the value of such securities than may be the case with higher quality issues of
comparable maturity.
Lower grade securities may be particularly susceptible to economic
downturns. It is likely that an economic recession could severely disrupt the
market for such securities and may have an adverse impact on the value of such
securities. In addition, it is likely that any such economic downturn could
adversely affect the ability of the issuers of such securities to repay
principle and pay interest thereon and increase the incidence of default for
such securities.
The ratings of Moody's, S&P and other rating agencies represent their
opinions as to the quality of the obligations that they undertake to rate.
Ratings are relative and subjective and, although ratings may be useful in
evaluating the safety of interest and principle payments, they do not evaluate
the market value risk of such obligations. Although these ratings may be an
initial criterion for selection of portfolio investments, the Investment Manager
also will independently evaluate these securities and the ability for the
issuers of such securities to pay interest and principal. To the extent that the
Fund invests in lower grade securities that have not been rated by a rating
agency, the Fund's ability to achieve its investment objective will be more
dependent on the Fund's credit analysis than would be the case when the Fund
invests in rated securities.
STRATEGIC TRANSACTIONS
Consistent with its investment objective and policies as set forth herein,
the Fund may also enter into certain hedging and risk management transactions.
In particular, the Fund may purchase and sell futures contracts and options
thereon exchange-listed and over-the-counter put and call options on securities
and financial indices and may enter into various interest rate transactions
(collectively, 'Strategic Transactions'). Strategic Transactions may be used to
attempt to protect against possible changes in the market value of the Fund's
portfolio resulting from fluctuations in the securities markets and changes in
interest rates, to protect the Fund's unrealized gains in the value of its
portfolio securities, to facilitate the sale of such securities for investment
purposes or to establish a position in the securities markets as a temporary
substitute for purchasing particular securities. Any or all of these techniques
may be used at any time. There is no particular strategy that requires use of
one technique rather than another. Use of any Strategic Transaction is a
function of market conditions. The Strategic Transactions that the Fund may use
are described
6
below. The ability of the Fund to hedge successfully will depend on the
Investment Manager's ability to predict pertinent market movements, which cannot
be assured.
Interest Rate Transactions. Among the Strategic Transactions into which the
Fund may enter are interest rate swaps and the purchase or sale of interest rate
caps and floors. The Fund expects to enter into the transactions primarily to
preserve a return or spread on a particular investment or portion of its
portfolio as a duration management technique or to protect against any increase
in the price of securities the Fund anticipates purchasing at a later date or,
as discussed in the Prospectus, to hedge against increased Fund Preferred Share
dividend rates or increases in the Fund's cost of borrowing. For a more complete
discussion of interest rate transactions, see the section entitled 'How the Fund
Manages Risks -- Interest Rate Transactions' in the Prospectus.
Futures Contracts and Options on Futures Contracts. In connection with its
hedging and other risk management strategies, the Fund may also enter into
contracts for the purchase or sale for future delivery ('future contracts') of
debt securities, aggregates of debt securities, financial indices, and U.S.
Government debt securities or options on the foregoing to hedge the value of its
portfolio securities that might result from a change in interest rates or market
movements. The Fund's futures transactions will be entered into for traditional
hedging purposes -- i.e., futures contracts will be sold to protect against a
decline in the price of securities that the Fund owns, or futures contracts will
be purchased to protect the Fund against an increase in the price of securities
it intends to purchase. There is, however, no limit on the amount of the Fund's
assets that can be put at risk through the use of futures contracts and options
thereon and the value of the Fund's futures contracts and options thereon may
equal or exceed 100% of the Fund's total asssets.
The Fund is operated by persons who have claimed exclusions from the
definition of the term 'commodity pool operator' under the Commodity Exchange
Act and, therefore, are not subject to registration or regulation as commodity
pool operators under the Act.
Credit Derivatives. The Fund may engage in credit derivative transactions.
There are two broad categories of credit derivatives: default price risk
derivatives and market spread derivatives. Default price risk derivatives are
linked to the price of reference securities or loans after a default by the
issuer or borrower, respectively. Market spread derivatives are based on the
risk that changes in market factors, such as credit spreads, can cause a decline
in the value of a security, loan or index. There are three basic transactional
forms for credit derivatives: swaps, options and structured instruments. The use
of credit derivatives is a highly specialized activity that involves strategies
and risks different from those associated with ordinary portfolio security
transactions. If incorrect in its forecasts of default risks, market spreads or
other applicable factors, the investment performance of the Fund would diminish
compared with what it would have been if these techniques were not used.
Moreover, even if it is correct in its forecasts, there is a risk that a credit
derivative position may correlate imperfectly with the price of the asset or
liability being hedged. There is no limit on the amount of credit derivative
transactions that may be entered into by the Fund. The Fund's risk of loss in a
credit derivative transaction varies with the form of the transaction. For
example, if the Fund purchases a default option on a security, and if no default
occurs with respect to the security, the Fund's loss is limited to the premium
it paid for the default option. In contrast, if there is a default by the
grantor of a default option, the Fund's loss will include both the premium that
it paid for the option and the decline in value of the underlying security that
the default option hedged.
Calls on Securities, Indices and Futures Contracts. In order to enhance
income or reduce fluctuations in net asset value, the Fund may sell or purchase
call options ('calls') on securities, futures contracts and indices based upon
the prices of debt securities that are traded on U.S. securities exchanges and
to the over-the-counter markets. A call option gives the purchaser of the option
the right to buy, and obligates the seller to sell, the underlying security,
futures contract or index at the exercise price at any time or at a specified
time during the option period. All such calls sold by the Fund must be 'covered'
as long as the call is outstanding (i.e., the Fund must own the instrument
subject to the call or other securities or assets acceptable for applicable
segregation and coverage requirements). A call sold by the Fund exposes the Fund
during the
7
term of the option to possible loss of opportunity to realize appreciation in
the market price of the underlying security, index or futures contract and may
require the Fund to hold an instrument that it might otherwise have sold. The
purchase of a call gives the Fund the right to buy the underlying instrument or
index at a fixed price. Calls on futures contracts on securities written by the
Fund must also be covered by assets or instruments acceptable under applicable
segregation and coverage requirement.
Puts on Securities, Indices and Futures Contracts. As with calls, the Fund
may purchase put options ('puts') on securities (whether or not it holds such
securities in its portfolio). For the same purposes, the Fund may also sell puts
on securities, financial indices and puts on futures contracts on securities if
the Fund's contingent obligations on such puts are secured by segregated assets
consisting of cash or liquid securities having a value not less than the
exercise price. The Fund will not sell puts if, as a result, more than 50% of
the Fund's assets would be required to cover its potential obligation under its
hedging and other investment transactions. In selling puts, there is a risk that
the Fund may be required to buy the underlying instrument or index at higher
than the current market price.
The principal risks relating to the use of futures and other Strategic
Transitions are: (i) less than perfect correlation between the prices of the
hedging instrument and the market value of the securities in the Fund's
portfolio; (ii) possible lack of a liquid secondary market for closing out a
position in such instruments; (iii) losses resulting from interest rate or other
market movements not anticipated by the Investment Manager; and (iv) the
obligation to meet additional variation margin or other payment requirements.
Certain provisions of the Code may restrict or affect the ability of the
Fund to engage in Strategic Transactions. See 'U.S. Federal Taxation.'
OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its managed assets in securities of other
open- or closed-end investment companies, including exchange traded funds, that
invest primarily in securities of the types in which the Fund may invest
directly. The Fund generally expects to invest in other investment companies
either during periods when it has large amounts of uninvested cash, such as the
period shortly after the Fund receives the proceeds of the offering of its
Common Shares, or during periods when there is a shortage of attractive
opportunities in the market. As a stockholder in an investment company, the Fund
would bear its ratable share of that investment company's expenses, and would
remain subject to payment of the Fund's advisory and other fees and expenses
with respect to assets so invested. Holders of Common Shares would therefore be
subject to duplicative expenses to the extent the Fund invests in other
investment companies. The Investment Manager will take expenses into account
when evaluating the investment merits of an investment in an investment company
relative to available bond investments. The securities of other investment
companies may also be leveraged and will therefore be subject to the same
leverage risks to which the Fund is subject. As described in the Prospectus in
the section entitled 'Use of Leverage,' the net asset value and market value of
leveraged shares will be more volatile and the yield to stockholders will tend
to fluctuate more than the yield generated by unleveraged shares. Investment
companies may have investment policies that differ from those of the Fund. In
addition, to the extent the Fund invests in other investment companies, the Fund
will be dependent upon the investment and research abilities of persons other
than the Investment Manager.
RESTRICTED AND ILLIQUID SECURITIES
When purchasing securities that have not been registered under the
Securities Act, and are not readily marketable, the Fund will endeavor, to the
extent practicable, to obtain the right to registration at the expense of the
issuer. Generally, there will be a lapse of time between the Fund's decision to
sell any such security and the registration of the security permitting sale.
During any such period, the price of the securities will be subject to market
fluctuations. In addition, the Fund may not be able to readily dispose of such
securities at prices that approximate those at which the Fund could sell such
securities if they were more widely traded and, as a result of such
8
illiquidity, the Fund may have to sell other investments or engage in borrowing
transactions if necessary to raise cash to meet its obligations.
The Fund may purchase certain securities eligible for resale to qualified
institutional buyers as contemplated by Rule 144A under the Securities Act
('Rule 144A Securities'). Rule 144A provides an exemption from the registration
requirements of the Securities Act for the resale of certain restricted
securities to certain qualified institutional buyers. One effect of Rule 144A is
that certain restricted securities may be considered liquid, though no assurance
can be given that a liquid market for Rule 144A Securities will develop or be
maintained. However, where a substantial market of qualified institutional
buyers has developed for certain unregistered securities purchased by the Fund
pursuant to Rule 144A, the Fund intends to treat such securities as liquid
securities in accordance with procedures approved by the Fund's Board of
Directors. Because it is not possible to predict with assurance how the market
for Rule 144A Securities will develop, the Fund's Board of Directors has
directed the Investment Manager to monitor carefully the Fund's investments in
such securities with particular regard to trading activity, availability of
reliable price information and other relevant information. To the extent that,
for a period of time, qualified institutional buyers cease purchasing restricted
securities pursuant to Rule 144A, the Fund's investing in such securities may
have the effect of increasing the level of illiquidity in its investment
portfolio during such period.
WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES
The Fund may purchase securities on a 'when-issued' basis and may purchase
or sell securities on a 'forward commitment' basis in order to acquire the
security or to hedge against anticipated changes in interest rates and prices.
When such transactions are negotiated, the price, which is generally expressed
in yield terms, is fixed at the time the commitment is made, but delivery and
payment for the securities take place at a later date. When-issued securities
and forward commitments may be sold prior to the settlement date, but the Fund
will enter into when-issued and forward commitments only with the intention of
actually receiving or delivering the securities, as the case may be. If the Fund
disposes of the right to acquire a when-issued security prior to its acquisition
or disposes of its right to deliver or receive against a forward commitment, it
might incur a gain or loss. At the time the Fund enters into a transaction on a
when-issued or forward commitment basis, it will designate on its books and
records cash or liquid debt securities equal to at least the value of the
when-issued or forward commitment securities. The value of these assets will be
monitored daily to ensure that their marked to market value will at all times
equal or exceed the corresponding obligations of the Fund. There is always a
risk that the securities may not be delivered and that the Fund may incur a
loss. Settlements in the ordinary course, which may take substantially more than
three business days, are not treated by the Fund as when-issued or forward
commitment transactions and accordingly are not subject to the foregoing
restrictions.
Securities purchased on a forward commitment or when-issued basis are
subject to changes in value (generally changing in the same way, i.e.,
appreciating when interest rates decline and depreciating when interest rates
rise) based upon the public's perception of the creditworthiness of the issuer
and changes, actual or anticipated, in the level of interest rates. Securities
purchased with a forward commitment or when-issued basis may expose the Fund to
risks because they may experience such fluctuations prior to their actual
delivery. Purchasing securities on a when-issued basis can involve the
additional risks that the yield available in the market when the delivery takes
place actually may be higher than that obtained in the transaction itself.
Purchasing securities on a forward commitment or when-issued basis when the Fund
is fully invested may result in greater potential fluctuation in the value of
the Fund's net assets and its net asset value per share.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements with respect to its
portfolio investments subject to the investment restrictions set forth herein.
Reverse repurchase agreements involve the sale of securities held by the Fund
with an agreement by the Fund to repurchase the
9
securities at an agreed upon price, date and interest payment. The use by the
Fund of reverse repurchase agreements involves many of the same risks of
leverage described under 'Use of Leverage,' since the proceeds derived from such
reverse repurchase agreements may be invested in additional securities. At the
time the Fund enters into a reverse repurchase agreement, it may designate on
its books and records, liquid instruments having a value not less than the
repurchase price (including accrued interest). If the Fund designates liquid
instruments on its books and records, a reverse repurchase agreement will not be
considered a borrowing by the Fund; however, under circumstances in which the
Fund does not designate liquid instruments on its books and records, such
reverse repurchase agreement will be considered a borrowing for the purpose of
the Fund's limitation on borrowings. Reverse repurchase agreements involve the
risk that the market value of the securities acquired in connection with the
reverse repurchase agreement may decline below the price of the securities the
Fund has sold but is obligated to repurchase. Also, reverse repurchase
agreements involve the risk that the market value of the securities retained in
lieu of sale by the Fund in connection with the reverse repurchase agreement may
decline in price.
If the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision. Also, the Fund would bear the risk of loss to the extent that the
proceeds of the reverse repurchase agreement are less than the value of the
securities subject to such agreement.
CASH RESERVES
The Fund's cash reserves, held to provide sufficient flexibility to take
advantage of new opportunities for investments and for other cash needs, will be
invested in money market instruments.
Money market instruments in which the Fund may invest its cash reserves will
generally consist of obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities and such obligations which are subject to
repurchase agreements. Repurchase agreements may be entered into with member
banks of the Federal Reserve System or 'primary dealers' (as designated by the
Federal Reserve Bank of New York) in U.S. Government securities. Other
acceptable money market instruments include commercial paper rated by any
nationally recognized rating agency, such as Moody's or S&P, certificates of
deposit, bankers' acceptances issued by domestic banks having total assets in
excess of one billion dollars, and money market mutual funds.
In entering into a repurchase agreement for the Fund, the Investment Manager
will evaluate and monitor the creditworthiness of the vendor. In the event that
a vendor should default on its repurchase obligation, the Fund might suffer a
loss to the extent that the proceeds from the sale of the collateral were less
than the repurchase price. If the vendor becomes bankrupt, the Fund might be
delayed, or may incur costs or possible losses of principal and income, in
selling the collateral.
INVESTMENT RESTRICTIONS
The investment objective and the general investment policies and investment
techniques of the Fund are described in the Prospectus. The Fund has also
adopted certain investment restrictions limiting the following activities except
as specifically authorized:
The Fund may not:
1. Issue senior securities (including borrowing money for other than
temporary purposes) except in conformity with the limits set forth in the
1940 Act; or pledge its assets other than to secure such issuances or
borrowings or in connection with permitted investment strategies; provided
that, notwithstanding the foregoing, the Fund may borrow up to an additional
5% of its total assets for temporary purposes;
10
2. Act as an underwriter of securities issued by other persons, except
insofar as the Fund may be deemed an underwriter in connection with the
disposition of securities;
3. Purchase or sell real estate, mortgages on real estate or
commodities, except that the Fund may invest in securities of companies that
deal in real estate or are engaged in the real estate business, including
REITs, and securities secured by real estate or interests therein and the
Fund may hold and sell real estate or mortgages on real estate acquired
through default, liquidation, or other distributions of an interest in real
estate as a result of the Fund's ownership of such securities;
4. Purchase or sell commodities or commodity futures contracts, except
that the Fund may invest in financial futures contracts, options thereon and
such similar instruments;
5. Make loans to other persons except through the lending of securities
held by it (but not to exceed a value of one-third of total assets), through
the use of repurchase agreements, and by the purchase of debt securities;
6. Invest more than 25% of its managed assets in securities of issuers
in any one industry other than the utility industry, with at least 25% of
the Fund's managed assets being invested in the utility industry; provided,
however, that such limitation shall not apply to obligations issued or
guaranteed by the United States Government or by its agencies or
instrumentalities;
7. Purchase preferred securities and other fixed income securities
rated below investment grade and unrated securities of comparable quality,
if, as a result, more than 25% of the Fund's managed assets would then be
invested in such securities;
8. Acquire or retain securities of any investment company, except that
the Fund may (a) acquire securities of investment companies up to the limits
permitted by Section 12(d)(1) of the 1940 Act, or any exemption granted
under the 1940 Act and (b) acquire securities of any investment company as
part of a merger, consolidation or similar transaction;
9. Invest in oil, gas or other mineral exploration programs,
development programs or leases, except that the Fund may purchase securities
of companies engaging in whole or in part in such activities;
10. Pledge, mortgage or hypothecate its assets except in connection with
permitted borrowings; or
11. Purchase securities on margin, except short-term credits as are
necessary for the purchase and sale of securities.
The investment restrictions numbered 1 through 6 in this Statement of
Additional Information have been adopted as fundamental policies of the Fund.
Under the 1940 Act, a fundamental policy may not be changed without the approval
of a 'majority of the outstanding' Common Shares, the AMPS and any other shares
of outstanding preferred stock voting together as a single class, and the
holders of a 'majority of the outstanding' AMPS (and the Outstanding AMPS)
voting together as a separate class. When used with respect to particular shares
of the Fund, a 'majority of the outstanding' shares means of (i) 67% or more of
the shares present at a meeting, if the holders of more than 50% of the shares
are present or represented by proxy, or (ii) more than 50% of the shares,
whichever is less. Investment restrictions numbered 7 through 11 above are
non-fundamental and may be changed at any time by vote of a majority of the
Board of Directors.
Under the 1940 Act, the Fund is not permitted to issue preferred shares
unless immediately after the issuance, the Fund's asset coverage with respect to
such preferred shares is at least 200%. The Fund's asset coverage with respect
to preferred shares is measured as the ratio that the Fund's total assets, less
liabilities and indebtedness not represented by senior securities, bears to the
aggregate amount of senior securities representing indebtedness of the Fund plus
the aggregate of the liquidation value of the Fund's outstanding preferred
shares (such ratio, 'Preferred Shares Asset Coverage'). In addition, the Fund is
not permitted to declare any cash dividend or other distribution on its Common
Shares unless, at the time of such declaration, the Fund's Preferred Shares
Asset Coverage is at least 200%. The Fund intends, to the extent possible, to
purchase or
11
redeem the AMPS and any other shares of outstanding preferred stock from time to
time to the extent necessary in order to maintain a Preferred Shares Asset
Coverage of at least 200%. If the Fund has AMPS and any other shares of
outstanding preferred stock, two of the Fund's Directors will be elected by the
holders of the AMPS and any other shares of outstanding preferred stock, voting
separately as a class. The remaining Directors of the Fund will be elected by
holders of Common Shares, AMPS and any other shares of outstanding preferred
stock voting together as a single class. In the event the Fund failed to pay
dividends on the AMPS and any other shares of outstanding preferred stock for
two years, holders of the AMPS and any other shares of outstanding preferred
stock, voting together as a single class, would be entitled to elect a majority
of the Directors of the Fund.
Under the 1940 Act, the Fund generally is not permitted to borrow unless
immediately after the borrowing, the Fund's asset coverage related to such
borrowings is at least 300%. The Fund's asset coverage with respect to
indebtedness is the ratio that the Fund's total assets, less liabilities and
indebtedness not represented by senior securities, bears to the aggregate amount
of senior securities representing indebtedness of the Fund (such ratio,
'Indebtedness Asset Coverage'). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on its Common Shares unless, at
the time of such declaration, the Fund's Indebtedness Asset Coverage is at least
300% of such principal amount. If the Fund borrows, the Fund intends, to the
extent possible, to prepay all or a portion of the principal amount of the
borrowing to the extent necessary in order to maintain the required asset
coverage. Failure to maintain certain asset coverage requirements could result
in an event of default and entitle the debt holders to elect a majority of the
board of directors.
MANAGEMENT OF THE FUND
The business and affairs of the Fund are managed under the direction of the
Board of Directors. The Directors approve all significant agreements between the
Fund and persons or companies furnishing services to it, including the Fund's
agreements with its Investment Manager, administrator, custodian and transfer
agent. The management of the Fund's day-to-day operations is delegated to its
officers, the Investment Manager and the Fund's administrator, subject always to
the investment objective and policies of the Fund and to the general supervision
of the Directors. As of October 11, 2005, the Directors and officers as a group
beneficially owned, directly or indirectly, less than 1% of the outstanding
shares of the Fund.
Basic information about the identity and experience of each Director and
officer is set forth in the charts below. Each such Director is also a director
of each of the closed-end and open-end investment companies advised by the
Investment Manager.
The Directors of the Fund, their addresses, their ages, the length of time
served, their principal occupations for at least the past five years, the number
of portfolios they oversee within the Fund complex, and other directorships held
by the Director are set forth below.
12
NUMBER OF
FUNDS WITHIN
PRINCIPAL FUND
OCCUPATION COMPLEX
DURING PAST OVERSEEN BY
5 YEARS DIRECTOR
POSITION HELD TERM OF (INCLUDING OTHER (INCLUDING LENGTH OF
NAME, ADDRESS AND AGE WITH FUND OFFICE DIRECTORSHIPS HELD) THE FUND) TIME SERVED
--------------------- --------- ------ ------------------- --------- -----------
INTERESTED DIRECTORS
Robert H. Steers ........ Director, 2006 Co-Chairman and 17 Since
757 Third Avenue Co-Chairman Co-Chief Executive Inception
New York, New York of the Board Officer of Cohen &
Age: 52 Steers Capital
Management, Inc.,
the Fund's
Investment Manager.
Prior thereto,
Chairman of the
Investment Manager.
Martin Cohen* ........... Director, 2007 Co-Chairman and 17 Since
757 Third Avenue Co-Chairman Co-Chief Executive Inception
New York, New York of the Board Officer of Cohen &
Age: 56 Steers Capital
Management, Inc.,
the Fund's
Investment Manager.
DISINTERESTED DIRECTORS
Bonnie Cohen* ........... Director 2008 Private Consultant. 17 Since
1824 Phelps Place, N.W. Prior thereto, Inception
Washington, D.C. Undersecretary of
Age: 62 State, United
States Department
of State. Director
of Wellsford Real
Properties, Inc.
George Grossman ......... Director 2006 Attorney-at-law. 17 Since
17 Elm Place Inception
Rye, New York
Age: 51
(table continued on next page)
13
(table continued from previous page)
NUMBER OF
FUNDS WITHIN
PRINCIPAL FUND
OCCUPATION COMPLEX
DURING PAST OVERSEEN BY
5 YEARS DIRECTOR
POSITION HELD TERM OF (INCLUDING OTHER (INCLUDING LENGTH OF
NAME, ADDRESS AND AGE WITH FUND OFFICE DIRECTORSHIPS HELD) THE FUND) TIME SERVED
--------------------- --------- ------ ------------------- --------- -----------
Richard E. Kroon ........ Director 2008 Board Member of 17 Since
328 Newman Springs Rd. Finlay Enterprises, November
Red Bank, New Jersey Inc. (operator of 2004
Age: 63 department store
fine jewelry leased
departments) and
several private
companies; member
of Investment
Subcommittee,
Monmouth
University; Retired
Chairman and
Managing Partner of
the Sprout Group
venture capital
funds, then an
affiliate of
Donald, Lufkin &
Jenrette Securities
Corporation, and
former Chairman of
the National
Venture Capital
Association.
Richard J. Norman ....... Director 2007 Private Investor. 17 Since
7520 Hackamore Drive President of the Inception
Potomac, Maryland Board of Directors
Age: 62 of Maryland Public
Television, Board
Member of the
Salvation Army;
Prior thereto,
Investment
Representative of
Morgan Stanley Dean
Witter.
(table continued on next page)
14
(table continued from previous page)
NUMBER OF
FUNDS WITHIN
PRINCIPAL FUND
OCCUPATION COMPLEX
DURING PAST OVERSEEN BY
5 YEARS DIRECTOR
POSITION HELD TERM OF (INCLUDING OTHER (INCLUDING LENGTH OF
NAME, ADDRESS AND AGE WITH FUND OFFICE DIRECTORSHIPS HELD) THE FUND) TIME SERVED
--------------------- --------- ------ ------------------- --------- -----------
Frank K. Ross ........... Director 2007 Professor of 17 Since
10130 Darmuid Accounting, Howard March 2004
Green Drive University; Board
Potomac, Maryland member of Pepco
Age: 62 Holdings, Inc.
(electric utility).
Formerly,
Midatlantic Area
Managing Partner
for Audit and Risk
Advisory Services
at KPMG LLP and
Managing Partner of
its Washington DC
Office.
Willard H. Smith Jr. .... Director 2008 Board member of 17 Since
7231 Encelia Drive Essex Property Inception
La Jolla, California Trust Inc.,
Age: 68 Highwoods
Properties, Inc.,
Realty Income
Corporation and
Crest Net Lease,
Inc. Managing
Director at Merrill
Lynch & Co., Equity
Capital Markets
Division from 1983
to 1995.
C. Edward Ward, Jr. ..... Director 2008 Member of the Board 17 Since
788 Columbus Avenue, Apt. of Trustees of November
7G Manhattan College, 2004
New York, New York Riverdale, New
Age: 59 York. Formerly head
of closed-end fund
listings for the
New York Stock
Exchange.
---------
* Martin Cohen & Bonnie Cohen are unrelated.
15
The officers of the Fund, their addresses, their ages, and their principal
occupations for at least the past five years are set forth below.
POSITION(S)
HELD WITH
NAME, ADDRESS AND AGE FUND PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
------------------------------ ------------------- -------------------------------------------
Joseph M. Harvey ............. Vice President President of Cohen & Steers Capital
757 Third Avenue Management, Inc., the Fund's Investment
New York, New York Manager, since 2003. Prior thereto, he was
Age: 41 Senior Vice President and Director of
Investment Research of the Fund's
Investment Manager.
Robert S. Becker ............. Vice President Senior Vice President of Cohen & Steers
757 Third Avenue Capital Management, Inc. since December
New York, New York 2003. Prior thereto, he was a co-portfolio
Age: 36 manager of the Franklin Utilities Fund at
Franklin Templeton Investments. Mr. Becker
has previously held positions in equity
research for the utility sector at Salomon
Smith Barney and Scudder, Stevens and
Clark.
William F. Scapell ........... Vice President Senior Vice President of Cohen & Steers
757 Third Avenue Capital Management, Inc., the Fund's
New York, New York Investment Manager, since February 2003.
Age: 38 Prior thereto, he was the chief strategist
for preferred securities at Merrill Lynch &
Co.
Adam M. Derechin ............. President and Chief Chief Operating Officer of Cohen & Steers
757 Third Avenue Executive Officer Capital Management, Inc., the Fund's
New York, New York Investment Manager, since August, 2003.
Age: 41 Prior thereto, he was Senior Vice President
of the Fund's Investment Manager since
1998.
Lawrence B. Stoller .......... Secretary Senior Vice President and General Counsel
757 Third Avenue of Cohen & Steers Capital Management, Inc.,
New York, New York the Fund's Investment Manager, since 1999.
Age: 42 Prior to that, Associate General Counsel,
Neuberger Berman Management, Inc. (money
manager); and Assistant General Counsel,
The Dreyfus Corporation (money manager).
Jay J. Chen .................. Treasurer Senior Vice President of the Advisor since
757 Third Avenue 2003 and prior to that, Vice President of
New York, NY the Advisor.
Age: 42
John E. McLean ............... Chief Compliance Vice President and Associate General
757 Third Avenue Officer and Counsel of Cohen & Steers Capital
New York, NY Assistant Secretary Management since September 2003. Prior to
Age: 34 that, Vice President, Law & Regulation,
J. & W. Seligman & Co. Incorporated (money
manager); and Associate, Battle Fowler LLP
(law firm).
16
The following table provides information concerning the dollar range of the
Fund's equity securities owned by each Director and the aggregate dollar range
of securities owned in the Cohen & Steers Fund Complex.
AGGREGATE DOLLAR
RANGE OF EQUITY
DOLLAR RANGE OF SECURITIES IN THE
EQUITY SECURITIES IN COHEN & STEERS FUND
THE FUND AS OF COMPLEX AS OF
NOVEMBER 1, 2004 NOVEMBER 1, 2004
---------------- ----------------
Bonnie Cohen........................................... none over $100,000
Martin Cohen........................................... none over $100,000
George Grossman........................................ none over $100,000
Richard E. Kroon....................................... $1 - $10,000 $10,001 - $50,000
Richard J. Norman...................................... none over $100,000
Frank K. Ross*......................................... none over $100,000
Willard H. Smith, Jr................................... over $100,000 over $100,000
Robert H. Steers....................................... none over $100,000
C. Edward Ward, Jr..................................... $1 - $10,000 $10,001 - $50,000
---------
* Because Mr. Ross is a Director of Pepco Holdings, Inc., he is prohibited from
purchasing shares of this Fund.
Conflicts of Interest. No Director who is not an 'interested person' of the
Fund as defined in the 1940 Act, and no immediate family members, owns any
securities issued by the Investment Manager, or any person or entity (other than
the Fund) directly or indirectly controlling, controlled by, or under common
control with the Investment Manager. Solely as a result of his ownership of
securities of one of the underwriters, Mr. Smith is technically an 'interested
person' of the Fund as defined in the 1940 Act until after completion of this
offering of the AMPS. After the completion of this offering, he will be a
non-interested Director.
BOARD'S ROLE IN FUND GOVERNANCE
Committees. The Fund's Board of Directors has four standing committees of
the Board, the Audit Committee, the Nominating Committee, the Contract Review
Committee and the Governance Committee. The Directors serving on each Committee
are not 'interested persons' of the Fund, as defined in the 1940 Act, and
otherwise satisfy the applicable standards for independence of a committee
member of an investment company issuer under the federal securities laws and
under applicable listing standards of the New York Stock Exchange. The members
of the Nominating and Contract Review Committees are Ms. Cohen and
Messrs. Kroon, Grossman, Norman, Ross, Smith and Ward. The members of the
Governance Committee are Messrs. Norman, Ward, and Smith. The members of the
Audit Committee are Ms. Cohen and Messrs. Ross, Kroon and Grossman.
The main function of the Audit Committee is to oversee the Fund's accounting
and financial reporting policies and practices and its internal controls,
including by assisting with the Board's oversight of the integrity of the Fund's
financial statements, the Fund's compliance with legal and regulatory
requirements, the selection, retention, qualifications and independence of the
Fund's independent registered public accounting firm, and the performance of the
Fund's internal control systems and independent registered public accounting
firm. The Audit Committee met three times in the year ended December 31, 2004
and operates pursuant to a written charter adopted by the Board.
The main functions of the Nominating Committee are to identify individuals
qualified to become members of the Board of Directors in the event that a
position is vacated or created, to select the director nominees for the next
annual meeting of stockholders and to set any necessary standards or
qualifications for service on the Board of Directors. The Nominating Committee
will consider nominees properly recommended by the Funds' stockholders.
Stockholders who wish to recommend a nominee should send nominations that
include, among other things, biographical data and the qualifications of the
proposed nominee to the Fund's Secretary. The Nominating Committee met twice
in the year ended December 31, 2004 and operates pursuant to a written charter
adopted by the Board.
17
The main functions of the Contract Review Committee are to make
recommendations to the Board of Directors after reviewing management and other
contracts that the Fund has with the Investment Manager and to select third
parties to provide evaluative reports and other information regarding the
services provided by the Investment Manager to the Board. The Contract Review
Committee met twice in the year ended December 31, 2004 and operates pursuant
to a written charter adopted by the Board.
The main function of the Governance Committee is to assist the Board in the
oversight of appropriate and effective governance of the Fund. The Governance
Committee will oversee, among other things, the structure and composition of the
Board committees, the size of the Board and the compensation of independent
directors for service on the Board and any Board committee. The Governance
Committee did not meet in the year ended December 31, 2004. It operates
pursuant to a written charter adopted by the Board in September 2004.
Approval of Investment Management Agreement. The Board of Directors of the
Fund including a majority of the Directors who are not parties to the fund's
Investment Management Agreement, or interested persons of any such party
('Independent Directors'), has the responsibility under the 1940 Act to approve
the Fund's Investment Management Agreement for its initial two-year term and its
continuation annually thereafter at a meeting of the Board called for the
purpose of voting on the approval or continuation. The Investment Management
Agreement for the Fund was discussed at a meeting held on March 2, 2004 and was
unanimously approved for an initial two-year term by the Fund's Board, including
the Independent Directors. The Independent Directors were represented by
independent counsel who assisted them in their deliberations.
In considering whether to approve the Fund's Investment Management
Agreement, the Board reviewed the materials provided by the Investment Manager
and Fund counsel, which included, among other things, fee and expense
information of funds with investment objectives and policies similar to those of
the Fund, prepared by the Investment Manager, information regarding the past
performance of funds managed by the Investment Manager, and memoranda outlining
the legal duties of the Board. The Board considered factors relating to both the
selection of the investment managers and the approval of the management fee when
reviewing the Investment Management Agreement. In particular, the Board
considered the following:
(i) The nature, extent and quality of services to be provided by the
Investment Manager: The Directors reviewed the services that the Investment
Manager would provide to the Fund, including, but not limited to, generally
managing the Fund's investments in accordance with the stated policies of
the Fund. The Directors also discussed with officers and portfolio managers
of the Fund the amount of the time the Investment Manager would dedicate to
the Fund and the type of transactions that would be done on behalf of the
Fund.
The Board determined that the services proposed for the Fund by the
Investment Manager would be similar to those already being provided for
other closed-end funds by the Investment Manager. The Board noted that the
services proposed for the Fund by the Investment Manager would be different
and distinct from existing funds, but determined that the Investment
Manager's experience in the securities markets would provide the background
and expertise to further the Fund's objective. They also took into
consideration the favorable history, reputation and background of the
Investment Manager's portfolio managers, finding that these would likely
have an impact on the success of the Fund. Lastly, the Directors noted the
Investment Manager's ability to attract quality and experienced personnel
and its continuing effort to expand its capabilities particularly with
respect to the Fund. The Directors concluded that the proposed services of
the Investment Manager to the Fund compared favorably to services provided
by the Investment Manager for other funds and accounts in both nature and
quality.
(ii) Investment performance of the Fund and the Investment Manager:
Because the Fund was newly formed, the Directors did not consider the
investment performance of the Fund. The Directors reviewed the Investment
Manager's performance for other closed-end funds. In particular, the
Directors noted that the Investment Manager managed several funds that were
outperforming the indices and their competitors. The Directors recognized
that past performance is not an indicator of future performance, but found
that the Investment Manager had the necessary expertise to manage the Fund
and that the Investment Manager was committed to hiring additional
investment personnel in connection with its management efforts
18
for the Fund. The Directors determined that the Investment Manager would be
an appropriate investment manager for the Fund.
(iii) Cost of the services to be provided and profits to be realized by
the Investment Manager from the relationship with the Fund: Next, the
Directors considered the anticipated cost of the services provided by the
Investment Manager. Under the Investment Management Agreement, the Fund
would pay the Investment Manager a monthly management fee computed at the
annual rate of 0.85% of the average daily managed assets of the Fund. The
Directors also considered the fact that the Investment Manager has agreed to
reimburse a portion of its investment management fees through March 31,
2013.
In reviewing the proposed investment management fee, the Directors
considered the management fees of other comparable, closed-end equity income
funds, noting that the Fund's proposed management fee was in line with those
funds. The total management fee, represented by the management fee plus the
administration fee, for the Fund also would be in line with the average of
the other comparable funds' fees. The Directors concluded that the Fund's
investment management fee for the initial term of the contract was projected
to compare favorably to the average investment management fee charged to
competitive funds with similar investments. The Directors did not consider
the profitability of the Fund, since the Fund was newly formed with no
operating history.
(iv) The extent to which economies of scale would be realized as the
Fund grows and whether fee levels would reflect such economies of scale: The
Directors did not believe at this time that the Fund would experience any
economies of scale. If the Fund were to grow, the Directors would reevaluate
this issue.
(v) Comparison of services to be rendered and fees to be paid to those
under other investment management contracts, such as contracts of the same
and other investment managers or other clients: As discussed above in (i)
and (iii), the Directors compared both the services to be rendered and the
fees to paid under the Investment Management Agreement to other contracts of
the Investment Manager and to contracts of other investment managers to
registered investment companies investing in similar securities. The
Directors determined that the proposed services and fees were comparable to
those being offered under the other contracts by the Investment Manager and
other investment managers.
The Directors then took into consideration other benefits to be derived by
the Investment Manager in connection with the Investment Management Agreement,
noting particularly the research and related services, within the meaning of
Section 28(e) of the Securities Exchange Act of 1934, as amended, that the
Investment Manager would be eligible to receive by allocating the Fund's
brokerage transactions. The Directors also noted the administrative services
provided under the Administration Agreement by the Investment Manager for the
Fund such as operational services and furnishing office space and facilities for
the Fund, and providing persons satisfactory to the Board to serve as officers
of the Fund, noting that these services were beneficial to the Fund.
For these reasons, the Board, including the Independent Directors,
unanimously approved the Investment Management Agreement.
COMPENSATION OF DIRECTORS AND CERTAIN OFFICERS
The following table sets forth estimated information regarding compensation
expected to be paid to Directors by the Fund for the current fiscal year ending
December 31, 2005 and the aggregate compensation paid by the fund complex of
which the Fund is a part for the fiscal year ended December 31, 2004. Officers
of the Fund and Directors who are interested persons of the Fund do not receive
any compensation from the Fund or any other fund in the fund complex which is a
U.S. registered investment company. Each of the other Directors is paid an
annual retainer of $4,500, and a fee of $500 for each meeting attended and is
reimbursed for the expenses of attendance at such meetings. Additionally, the
Audit Committee Chairman is paid $10,000 per year in the aggregate for his
service as Chairman of the Audit Committee of the Fund and of all
19
of the other Cohen & Steers funds and the lead Director and each other committee
chairman is paid $5,000 per year in the aggregate for their work in connection
with the Fund and all of the other Cohen & Steers funds. These additional
amounts are not reflected in the table. In the column headed `Total Compensation
from Fund Complex Paid to Directors,' the compensation paid to each Director
represents the aggregate amount paid to the Director by the Fund and the 17
other funds that each Director serves in the fund complex. The Directors do not
receive any pension or retirement benefits from the fund complex.
TOTAL
COMPENSATION
AGGREGATE FROM FUND
COMPENSATION COMPLEX PAID TO
NAME OF PERSON, POSITION OF FUND DIRECTORS FROM FUND DIRECTORS
------------------------------------------ --------- ---------
Bonnie Cohen,(1)(3) Director................................ $6,500 $85,625
Martin Cohen,* Director and Co-Chairman..................... $ 0 $ 0
George Grossman,(1)(3) Director............................. $6,500 $85,625
Richard E. Kroon,(1)(3),'DD' Director....................... $6,500 $25,000
Richard J. Norman,(1)(2) Director........................... $6,500 $85,625
Frank K. Ross,(1)(3) Director............................... $6,500 $71,000
Willard H. Smith, Jr.,(1)(2) Director....................... $6,500 $85,625
Robert H. Steers,* Director and Co-Chairman................. $ 0 $ 0
C. Edward Ward, Jr.,(1)(2),'DD' Director.................... $6,500 $25,500
---------
(1) Member of the Nominating Committee and Contract Review Committee.
(2) Member of the Governance Committee.
(3) Member of the Audit Committee.
* 'Interested person,' as defined in the 1940 Act, of the Fund because of
affiliation with Cohen & Steers Capital Management, Inc., the Fund's
Investment Manager.
'DD' Each of Richard E. Kroon and C. Edward Ward, Jr. was elected as a Director
by the Fund's Board of Directors effective November 3, 2004.
20
PRINCIPAL STOCKHOLDERS
To the knowledge of the Fund, as of , 2005, no current director
of the Fund owned 1% or more of the outstanding Common Shares, and the officers
and directors of the Fund owned, as a group, less than 1% of the Common Shares.
As of , 2005, no person to the knowledge of the Fund, owned
beneficially more than 5% of the outstanding Common Shares. As of ,
2005, CEDE & Co. c/o Depository Trust Company, Box 20, New York, New York was
the record owner of % of the outstanding Common Shares.
INVESTMENT ADVISORY AND OTHER SERVICES
THE INVESTMENT MANAGER
Cohen & Steers Capital Management, Inc., with offices located at 757 Third
Avenue, New York, New York 10017, is the Investment Manager to the Fund. The
Investment Manager, a registered investment adviser, was formed in 1986 and is a
wholly owned subsidiary of Cohen & Steers, Inc., a publicly traded company whose
common stock is listed on the NYSE under the symbol 'CNS.' Its current clients
include pension plans of leading corporations, endowment funds and mutual funds,
including each of the open-end and closed-end Cohen & Steers funds. The
Investment Manager is a wholly owned subsidiary of Cohen & Steers, Inc., a
publicly traded company whose common stock is listed on the New York Stock
Exchange under the symbol 'CNS.'
Pursuant to the Investment Management Agreement, the Investment Manager
furnishes a continuous investment program for the Fund's portfolio, makes the
day-to-day investment decisions for the Fund, executes the purchase and sale
orders for the portfolio transactions of the Fund and generally manages the
Fund's investments in accordance with the stated policies of the Fund, subject
to the general supervision of the Board of Directors of the Fund.
Under the Investment Management Agreement, the Fund pays the Investment
Manager a monthly management fee computed at the annual rate of .85% of the
average daily value of the managed assets (which equals the net asset value of
the Common Shares, including the liquidation preference on any AMPS and other
outstanding shares of preferred stock, plus the principal amount of any
borrowings used for leverage) of the Fund. The Investment Manager has
contractually agreed to waive a portion of its investment management fee in the
amount of .20% of average daily total managed assets for the first five years of
the Fund's operations (through March 31, 2009), and in declining amounts for
each of the three years thereafter (through March 31, 2012).
The Investment Manager also provides the Fund with such personnel as the
Fund may from time to time request for the performance of clerical, accounting
and other office services, such as coordinating matters with the
sub-administrator, the transfer agent and the custodian. The personnel rendering
these services, who may act as officers of the Fund, may be employees of the
Investment Manager or its affiliates. These services are provided at no
additional cost to the Fund. The Fund does not pay any additional amounts for
services performed by officers of the Investment Manager or its affiliates.
PORTFOLIO MANAGER
Accounts Managed. The Fund's portfolio managers (each referred to as a
'portfolio manager') are listed below. Each portfolio manager manages other
investment companies and/or investment vehicles and accounts in addition to the
Fund. The following tables show, as of , 2005, the number of accounts
each portfolio manager managed in each of the listed categories and the total
assets in the accounts managed within each category. The Investment Manager does
not receive performance-based fees with respect to any of the registered
investment companies, other pooled investment vehicles or other accounts that it
manages.
21
ROBERT BECKER
NUMBER OF TOTAL ASSETS OF
ALL ACCOUNTS ALL ACCOUNTS
------------ ------------
Registered Investment Companies............................. $
Other Pooled Investment Vehicles............................
Other Accounts..............................................
WILLIAM F. SCAPELL
NUMBER OF TOTAL ASSETS OF
ALL ACCOUNTS ALL ACCOUNTS
------------ ------------
Registered Investment Companies............................. -- --
Other Pooled Investment Vehicles............................ -- --
Other Accounts.............................................. -- --
Share Ownership. The following table indicates the dollar range of
securities of the Fund owned by the Fund's portfolio managers as of
, 2005:
DOLLAR RANGE OF SECURITIES OWNED
--------------------------------
Robert Becker.............................................
William F. Scapell........................................
Conflicts of Interest. It is possible that conflicts of interest may arise
in connection with the portfolio managers' management of the Fund's investments
on the one hand and the investments of other accounts or vehicles for which the
portfolio managers are responsible on the other. For example, the portfolio
managers may have conflicts of interest in allocating management time, resources
and investment opportunities among the Fund and the other accounts or vehicles
they advise. In addition, due to differences in the investment strategies or
restrictions among the Fund and the other accounts, the portfolio managers may
take action with respect to another account that differs from the action taken
with respect to the Fund. In some cases, another account managed by a portfolio
manager may provide more revenue to the Investment Manager. While this may
appear to create additional conflicts of interest for the portfolio managers in
the allocation of management time, resources and investment opportunities, the
Investment Manager strives to ensure that the portfolio managers endeavor to
exercise their discretion in a manner that is equitable to all interested
persons. In this regard, in the absence of specific account-related impediments
(such as client-imposed restrictions or lack of available cash), it is the
policy of the Advisor to allocate investment ideas pro rata to all accounts with
the same primary investment objective.
Investment Manager Compensation Structure. Compensation of the Investment
Manager's portfolio managers and other investment professionals has three
primary components: (1) a base salary, (2) an annual cash bonus and (3) annual
stock-based compensation consisting generally of restricted stock units of the
Investment Manager's parent, Cohen & Steers, Inc. ('CNS'). The Investment
Manager's investment professionals, including the portfolio manager, also
receive certain retirement, insurance and other benefits that are broadly
available to all of its employees. Compensation of the Investment Manager's
investment professionals is reviewed primarily on an annual basis. Cash bonuses,
stock-based compensation awards, and adjustments in base salary are typically
paid or put into effect at or around the December 31st fiscal year-end of CNS.
This compensation structure has been in place since the initial public offering
of common stock of CNS in 2004.
Method to Determine Compensation. The Investment Manager compensates its
portfolio managers based primarily on the scale and complexity of their
portfolio responsibilities and the total return performance of funds and
accounts managed by the portfolio manager versus appropriate peer groups or
benchmarks. The Investment Manager uses a variety of benchmarks to evaluate the
portfolio managers' performance for compensation purposes, including the S&P
1500 Utilities Index with respect to Mr. Becker and the Merrill Lynch Fixed Rate
Preferred Index with
22
respect to Mr. Scapell. In evaluating the performance of a portfolio manager,
primary emphasis is normally placed on one- and three-year performance, with
secondary consideration of performance over longer periods of time. Performance
is evaluated on a pre-tax and pre-expense basis. In addition to rankings within
peer groups of funds and benchmarks and on the basis of absolute performance,
consideration may also be given to risk-adjusted performance. For managers
responsible for multiple funds and accounts, investment performance is evaluated
on an aggregate basis. The Investment Manager does not have any funds or
accounts with performance-based advisory fees. Portfolio managers are also
evaluated on the basis of their success in managing their dedicated team of
analysts. Base compensation for portfolio managers of the Investment Manager
varies in line with the portfolio manager's seniority and position with the
firm.
The compensation of portfolio managers with other job responsibilities (such
as acting as an executive officer of the firm and supervising various
departments within the firm) will include consideration of the scope of such
responsibilities and the portfolio managers' performance in meeting them. The
Investment Manager seeks to compensate portfolio managers commensurate with
their responsibilities and performance, and competitive with other firms within
the investment management industry. The Investment Manager participates in
investment-industry compensation surveys and utilizes survey data as a factor in
determining salary, bonus and stock-based compensation levels for portfolio
managers and other investment professionals. Salaries, bonuses and stock-based
compensation are also influenced by the operating performance of the Investment
Manager and CNS. The overall annual cash bonus pool is based on a substantially
fixed percentage of pre-bonus operating income. While the salaries of the
Investment Manager's portfolio managers do not fluctuate significantly from year
to year, cash bonuses and stock-based compensation may fluctuate significantly
from year to year, based on changes in manager performance and other factors as
described herein. For a high performing portfolio manager, cash bonuses and
stock-based compensation generally are a substantial portion of total
compensation.
ADMINISTRATIVE SERVICES
Pursuant to an Administration Agreement, the Investment Manager also
performs certain administrative and accounting functions for the Fund, including
(i) providing office space, telephone, office equipment and supplies for the
Fund; (ii) paying compensation of the Fund's officers for services rendered as
such; (iii) authorizing expenditures and approving bills for payment on behalf
of the Fund; (iv) supervising preparation of the periodic updating of the Fund's
registration statement, including the Prospectus and Statement of Additional
Information, for the purpose of filings with the Securities and Exchange
Commission and state securities administrators and monitoring and maintaining
the effectiveness of such filings, as appropriate; (v) supervising preparation
of periodic reports to the Fund's stockholders and filing of these reports with
the Securities and Exchange Commission, Forms N-SAR filed with the Securities
and Exchange Commission, notices of dividends, capital gains distributions and
tax credits, and attending to routine correspondence and other communications
with individual stockholders; (vi) supervising the daily pricing of the Fund's
investment portfolio and the publication of the net asset value of the Fund's
shares, earnings reports and other financial data; (vii) monitoring
relationships with organizations providing services to the Company, including
the Custodian, Transfer Agent and printers; (viii) providing trading desk
facilities for the Fund; (ix) supervising compliance by the Fund with
record-keeping requirements under the Act and regulations thereunder,
maintaining books and records for the Fund (other than those maintained by the
Custodian and Transfer Agent) and preparing and filing of tax reports other than
the Fund's income tax returns; and (x) providing executive, clerical and
secretarial help needed to carry out these responsibilities. Under the
Administration Agreement, the Fund pays the Investment Manager an amount equal
to, on an annual basis, .06% of the Fund's average daily managed assets up to $1
billion, .04% of the Fund's average daily managed assets in excess of $1 billion
up to $1.5 billion and .02% of the Fund's average daily managed assets in excess
of $1.5 billion.
In accordance with the terms of the Administration Agreement and with the
approval of the Fund's Board of Directors, the Investment Manager has caused the
Fund to retain State Street
23
Bank and Trust Company ('State Street Bank') as sub-administrator under a fund
accounting and administration agreement (the 'Sub-Administration Agreement').
Under the Sub-Administration Agreement, State Street Bank has assumed
responsibility for performing certain of the foregoing administrative functions,
including (i) determining the Fund's net asset value and preparing these figures
for publication; (ii) maintaining certain of the Fund's books and records that
are not maintained by the Investment Manager, custodian or transfer agent;
(iii) preparing financial information for the Fund's income tax returns, proxy
statements, stockholders reports, and Securities and Exchange Commission
filings; and (iv) responding to stockholder inquiries.
Under the terms of the Sub-Administration Agreement, the Fund pays State
Street Bank a monthly sub-administration fee. The sub-administration fee paid by
the Fund to State Street Bank is computed on the basis of the average daily
managed assets (which equals the net asset value of the Common Shares, including
the liquidation preference on any AMPS and other outstanding shares of preferred
stock, plus the principal amount of any borrowings used for leverage) in the
Fund at an annual rate equal to .03% of the first $2.2 billion in assets, .02%
of the next $2.2 billion and .01% of assets in excess of $4.4 billion, with a
minimum fee of $120,000. The aggregate fee paid by the Fund and the other funds
advised by the Investment Manager to State Street Bank is computed by
multiplying the total number of funds by each break point in the above schedule
in order to determine the aggregate break points to be used in calculating the
total fee paid by the Cohen & Steers family of funds (i.e., six funds at $200
million or $1.2 billion at .030%, etc.). The Fund is then responsible for its
pro rata amount of the aggregate administration fee.
The Investment Manager remains responsible for monitoring and overseeing the
performance by State Street Bank, and EquiServe Trust Company, NA, as custodian
and transfer and disbursing agent, of their obligations to the Fund under their
respective agreements with the Fund, subject to the overall authority of the
Fund's Board of Directors.
CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT
State Street Bank, which has its principal business office at 225 Franklin
Street, Boston, MA 02110, has been retained to act as custodian of the Fund's
investments and EquiServe Trust Company, NA, which has its principal business
office at 150 Royall Street, Canton, MA 02021, as the Fund's transfer and
dividend disbursing agent for the Fund's Common Shares. Neither State Street nor
EquiServe has any part in deciding the Fund's investment policies or which
securities are to be purchased or sold for the Fund's portfolio. The Depository
Trust Company ('DTC') will act as securities depository for the AMPS. The Bank
of New York, whose principal place of business is 101 Barclay Street, Floor 7W,
New York, New York 10286, will act as auction agent, transfer agent, dividend
paying agent and registrar for the AMPS.
CODE OF ETHICS
The Fund and Investment Manager have adopted codes of ethics in compliance
with Rule 17j-1 under the 1940 Act. The codes of ethics of the Fund and the
Investment Manager, among other things, prohibit management personnel from
investing in REITs and real estate securities, prohibit purchases in an initial
public offering and require pre-approval for investments in utility securities,
any Cohen & Steers closed-end fund and in private placements. The Fund's
Independent Directors are prohibited from purchasing or selling any security if
they knew or reasonably should have known at the time of the transaction that,
within the most recent 15 days, the security is being or has been considered for
purchase or sale by the Fund, or is being purchased or sold by the Fund.
PRIVACY POLICY
The Fund is committed to maintaining the privacy of its stockholders and to
safeguarding their nonpublic personal information. The following information is
provided to help you
24
understand what personal information the Fund collects, how we protect that
information, and why in certain cases we may share this information with others.
The Fund does not receive any nonpublic personal information relating to the
stockholders who purchase shares through an intermediary that acts as the record
owner of the shares. In the case of stockholders who are record owners of the
Fund, we receive nonpublic personal information on account applications or other
forms. With respect to these stockholders, the Fund also has access to specific
information regarding their transactions in the Fund.
The Fund does not disclose any nonpublic personal information about its
stockholders or former stockholders to anyone, except as permitted by law or as
is necessary to service stockholder accounts. The Fund restricts access to
nonpublic personal information about its stockholders to Cohen & Steers
employees with a legitimate business need for the information.
PROXY VOTING
The Fund's Board of Directors has delegated to the Investment Manager the
responsibility for voting proxies on behalf of the Fund, and has determined that
proxies with respect to the Fund's portfolio companies shall be voted in
accordance with Cohen & Steers Capital Management, Inc.'s Statement of Policies
and Procedures Regarding the Voting of Securities (the 'Proxy Voting Policies
and Procedures'). The following is a summary of the Proxy Voting Policies and
Procedures.
Voting rights are an important component of corporate governance. The
Investment Manager has three overall objectives in exercising voting rights:
A. Responsibility. The Investment Manager shall seek to ensure that
there is an effective means in place to hold companies accountable for their
actions. While management must be accountable to its board, the board must
be accountable to a company's stockholders. Although accountability can be
promoted in a variety of ways, protecting stockholder voting rights may be
among our most important tools.
B. Rationalizing Management and Stockholder Concerns. The Investment
Manager seeks to ensure that the interests of a company's management and
board are aligned with those of the company's stockholders. In this respect,
compensation must be structured to reward the creation of stockholder value.
C. Stockholder Communication. Since companies are owned by their
stockholders, the Investment Manager seeks to ensure that management
effectively communicates with its owners about the company's business
operations and financial performance. It is only with effective
communication that stockholders will be able to assess the performance of
management and to make informed decisions on when to buy, sell or hold a
company's securities.
In exercising voting rights, the Investment Manager shall conduct itself in
accordance with the general principles set forth below.
1. The ability to exercise a voting right with respect to a security is
a valuable right and, therefore, must be viewed as part of the asset itself.
2. In exercising voting rights, the Investment Manager shall engage in a
careful evaluation of issues that may materially affect the rights of
stockholders and the value of the security.
3. Consistent with general fiduciary principles, the exercise of voting
rights shall always be conducted with reasonable care, prudence and
diligence.
4. In exercising voting rights on behalf of clients, the Investment
Manager conduct itself in the same manner as if it were the constructive
owner of the securities.
5. To the extent reasonably possible, the Investment Manager shall
participate in each stockholder voting opportunity.
6. Voting rights shall not automatically be exercised in favor of
management-supported proposals.
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7. The Investment Manager, and its officers and employees, shall never
accept any item of value in consideration of a favorable proxy voting
decision.
Set forth below are general guidelines that the Investment Manager shall
follow in exercising proxy voting rights:
Prudence. In making a proxy voting decision, the Investment Manager
shall give appropriate consideration to all relevant facts and
circumstances, including the value of the securities to be voted and the
likely effect any vote may have on that value. Since voting rights must be
exercised on the basis of an informed judgment, investigation shall be a
critical initial step.
Third Party Views. While the Investment Manager may consider the views
of third parties, it shall never base a proxy voting decision solely on the
opinion of a third party. Rather, decisions shall be based on a reasonable
and good faith determination as to how best to maximize stockholder value.
Stockholder Value. Just as the decision whether to purchase or sell a
security is a matter of judgment, determining whether a specific proxy
resolution will increase the market value of a security is a matter of
judgment as to which informed parties may differ. In determining how a proxy
vote may affect the economic value of a security, the Investment Manager
shall consider both short-term and long-term views about a company's
business and prospects, especially in light of our projected holding period
on the stock (e.g., the Investment Manager may discount long-term views on a
short-term holding).
Set forth below are guidelines as to how specific proxy voting issues shall
be analyzed and assessed. While these guidelines will provide a framework for
the Investment Manager's decision making process, the mechanical application of
these guidelines can never address all proxy voting decisions. When new issues
arise or old issues present nuances not encountered before, the Investment
Manager must be guided by its reasonable judgment to vote in a manner that the
Investment Manager deems to be in the best interests of the Fund and its
stockholders.
STOCK-BASED COMPENSATION
Approval of Plans or Plan Amendments. By their nature, compensation plans
must be evaluated on a case-by-case basis. As a general matter, the Investment
Manager always favors compensation plans that align the interests of management
and stockholders. The Investment Manager generally approves compensation plans
under the following conditions:
10% Rule. The dilution effect of the newly authorized shares, plus the
shares reserved for issuance in connection with all other stock related
plans, generally should not exceed 10%.
Exercise Price. The minimum exercise price of stock options should be at
least equal to the market price of the stock on the date of grant.
Plan Amendments. Compensation plans should not be materially amended
without stockholder approval.
Non-Employee Directors. Awards to non-employee directors should not be
subject to management discretion, but rather should be made under
non-discretionary grants specified by the terms of the plan.
Repricing/Replacement of Underwater Options. Stock options generally
should not be re-priced, and never should be re-priced without stockholder
approval. In addition, companies should not issue new options, with a lower
strike price, to make up for previously issued options that are
substantially underwater. The Investment Manager will vote against the
election of any slate of directors that, to its knowledge, has authorized a
company to re-price or replace underwater options during the most recent
year without stockholder approval.
Reload/Evergreen Features. The Investment Manager will generally vote
against plans that enable the issuance of reload options and that provide an
automatic share replenishment ('evergreen') feature.
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Measures to Increase Executive Long-Term Stock Ownership. The Investment
Manager supports measures to increase the long-term stock ownership by a
company's executives. These include requiring senior executives to hold a
minimum amount of stock in a company (often expressed as a percentage of
annual compensation), requiring stock acquired through option exercise to be
held for a certain minimum amount of time, and issuing restricted stock
awards instead of options. In this respect, the Investment Manager supports
the expensing of option grants because it removes the incentive of a company
to issue options in lieu of restricted stock. The Investment Manager also
supports employee stock purchase plans, although the Investment Manager
generally believes the discounted purchase price should be at least 85% of
the current market price.
Vesting. Restricted stock awards normally should vest over at least a
two-year period.
Other Stock Awards. Stock awards other than stock options and restricted
stock awards should be granted in lieu of salary or a cash bonus, and the
number of shares awarded should be reasonable.
CHANGE OF CONTROL ISSUES
While the Investment Manager recognizes that a takeover attempt can be a
significant distraction for the board and management to deal with, the simple
fact is that the possibility of a corporate takeover keeps management focused on
maximizing stockholder value. As a result, the Investment Manager opposes
measures that are designed to prevent or obstruct corporate takeovers because
they can entrench current management. The following are the Investment Manager's
guidelines on change of control issues:
Stockholder Rights Plans. The Investment Manager acknowledges that there
are arguments for and against stockholder rights plans, also known as
'poison pills.' Companies should put their case for rights plans to
stockholders. The Investment Manager generally votes against any directors
who, without stockholder approval, to our knowledge have instituted a new
poison pill plan, extended an existing plan, or adopted a new plan upon the
expiration of an existing plan during the past year.
Golden Parachutes. The Investment Manager opposes the use of accelerated
employment contracts that result in cash grants of greater than three times
annual compensation (salary and bonus) in the event of termination of
employment following a change in control of a company. In general, the
guidelines call for voting against 'golden parachute' plans because they
impede potential takeovers that stockholders should be free to consider. The
Investment Manager generally withholds votes at the next stockholder meeting
for directors who to its knowledge approved golden parachutes.
Approval of Mergers. The Investment Manager votes against proposals that
require a super-majority of stockholders to approve a merger or other
significant business combination. The Investment Manager supports proposals
that seek to lower super-majority voting requirements.
ROUTINE ISSUES
Director Nominees in a Non-Contested Election. The Investment Manager
generally votes in favor of management proposals on director nominees.
Director Nominees in a Contested Election. By definition, this type of board
candidate or slate runs for the purpose of seeking a significant change in
corporate policy or control. Therefore, the economic impact of the vote in favor
of or in opposition to that director or slate must be analyzed using a higher
standard normally applied to changes in control. Criteria for evaluating
director nominees as a group or individually should include: performance;
compensation, corporate governance provisions and takeover activity; criminal
activity; attendance at meetings; investment in the company; interlocking
directorships; inside, outside and independent directors; whether the chairman
and CEO titles are held by the same person; number of other board seats; and
other
27
experience. It is impossible to have a general policy regarding director
nominees in a contested election.
Board Composition. The Investment Manager supports the election of a board
that consists of at least a majority of independent directors. The Investment
Manager generally withholds support for non-independent directors who serve on a
company's audit, compensation and/or nominating committees. The Investment
Manager also generally withholds support for director candidates who have not
attended a sufficient number of board or committee meetings to effectively
discharge their duties as directors.
Classified Boards. Because a classified board structure prevents
stockholders from electing a full slate of directors at annual meetings, the
Investment Manager generally votes against classified boards. The Investment
Manager votes in favor of stockholder proposals to declassify a board of
directors unless a company's charter or governing corporate law allows
stockholders, by written consent, to remove a majority of directors at any time,
with or without cause.
Barriers to Stockholder Action. The Investment Manager votes to support
proposals that lower the barriers to stockholder action. This includes the right
of stockholders to call a meeting and the right of stockholders to act by
written consent.
Cumulative Voting. Having the ability to cumulate votes for the election of
directors -- that is, cast more than one vote for a director about whom they
feel strongly -- generally increases stockholders' rights to effect change in
the management of a corporation. The Investment Manager therefore generally
supports proposals to adopt cumulative voting.
Ratification of Auditors. Votes generally are cast in favor of proposals to
ratify an independent auditor, unless there is a reason to believe the auditing
firm is no longer performing its required duties or there are exigent
circumstances requiring the Investment Manager to vote against the approval of
the recommended auditor. For example, the Investment Manager's general policy is
to vote against an independent auditor that receives more than 50% of its total
fees from a company for non-audit services.
STOCK RELATED ITEMS
Increase Additional Common Stock. The Investment Manager's guidelines
generally call for approval of increases in authorized shares, provided that the
increase is not greater than three times the number of shares outstanding and
reserved for issuance (including shares reserved for stock-related plans and
securities convertible into common stock, but not shares reserved for any poison
pill plan).
Votes generally are cast in favor of proposals to authorize additional
shares of stock except where the proposal:
1. creates blank check preferred stock; or
2. establishes classes of stock with superior voting rights.
Blank Check Preferred Stock. Votes generally are cast in opposition to
management proposals authorizing the creation of new classes of preferred stock
with unspecific voting, conversion, distribution and other rights, and
management proposals to increase the number of authorized blank check preferred
shares. The Investment Manager may vote in favor of this type of proposal when
it receives assurances to its reasonable satisfaction that (i) the preferred
stock was authorized by the board for the use of legitimate capital formation
purposes and not for anti-takeover purposes, and (ii) no preferred stock will be
issued with voting power that is disproportionate to the economic interests of
the preferred stock. These representations should be made either in the proxy
statement or in a separate letter from the company to the Investment Manager.
Preemptive Rights. Votes are cast in favor of stockholder proposals
restoring limited preemptive rights.
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Dual Class Capitalizations. Because classes of common stock with unequal
voting rights limit the rights of certain stockholders, the Investment Manager
votes against adoption of a dual or multiple class capitalization structure.
SOCIAL ISSUES
The Investment Manager believes that it is the responsibility of the board
and management to run a company on a daily basis. With this in mind, in the
absence of unusual circumstances, the Investment Manager does not believe that
stockholders should be involved in determining how a company should address
broad social and policy issues. As a result, the Investment Manager generally
votes against these types of proposals, which are generally initiated by
stockholders, unless the Investment Manager believes the proposal has
significant economic implications.
OTHER SITUATIONS
No set of guidelines can anticipate all situations that may arise. The
Investment Manager's portfolio managers and analysts will be expected to analyze
proxy proposals in an effort to gauge the impact of a proposal on the financial
prospects of a company, and vote accordingly. These policies are intended to
provide guidelines for voting. They are not, however, hard and fast rules
because corporate governance issues are so varied.
PROXY VOTING PROCEDURES
The Investment Manager maintains a record of all voting decisions for the
period required by applicable laws. In each case in which the Investment Manager
votes contrary to the stated policies set forth in these guidelines, the record
shall indicate the reason for such a vote.
The Investment Committee of the Investment Manager shall have responsibility
for voting proxies, under the supervision of the Director of Research. The
Director of Research's designee (the 'Designee') shall be responsible for
ensuring that the Investment Committee is aware of all upcoming proxy voting
opportunities. The Designee shall ensure that proxy votes are properly recorded
and that the requisite information regarding each proxy voting opportunity is
maintained. The Investment Manager's General Counsel shall have overall
responsibility for ensuring that the Investment Manager complies with all proxy
voting requirements and procedures.
RECORDKEEPING
The Designee shall be responsible for recording and maintaining the
following information with respect to each proxy voted by the Investment
Manager:
Name of the company
Ticker symbol
CUSIP number
Stockholder meeting date
Brief identification of each matter voted upon
Whether the matter was proposed by management or a stockholder
Whether the Investment Manager voted on the matter
If the Investment Manager voted, then how the Investment Manager voted
Whether the Investment Manager voted with or against management
The Investment Manager's General Counsel shall be responsible for
maintaining and updating the Policies and Procedures, and for maintaining any
records of written client requests for proxy voting information and documents
that were prepared by the Investment Manager and were deemed material to making
a voting decision or that memorialized the basis for the decision.
The Investment Manager shall rely on the Securities and Exchange
Commission's EDGAR filing system with respect to the requirement to maintain
proxy materials regarding client securities.
29
CONFLICTS OF INTEREST
There may be situations in which the Investment Manager may face a conflict
between its interests and those of its clients or fund stockholders. Potential
conflicts are most likely to fall into three general categories:
Business Relationships. This type of conflict would occur if the
Investment Manager or an affiliate has a substantial business relationship
with the company or a proponent of a proxy proposal relating to the company
(such as an employee group) such that failure to vote in favor of management
(or the proponent) could harm the relationship of the Investment Manager or
its affiliate with the company or proponent. In the context of the
Investment Manager, this could occur if an affiliate of the Investment
Manager has a material business relationship with a company that the
Investment Manager has invested in on behalf of the Fund, and the Investment
Manager is encouraged to vote in favor of management as an inducement to
acquire or maintain the affiliate's relationship.
Personal Relationships. The Investment Manager or an affiliate could
have a personal relationship with other proponents of proxy proposals,
participants in proxy contests, corporate directors or director nominees.
Familial Relationships. The Investment Manager or an affiliate could
have a familial relationship relating to a company (e.g., spouse or other
relative who serves as a director or nominee of a public company).
The next step is to identify if a conflict is material. A material matter is
one that is reasonably likely to be viewed as important by the average
stockholder. Materiality will be judged under a two-step approach:
Financial Based Materiality. The Investment Manager presumes a conflict
to be non-material unless it involves at least $500,000.
Non-Financial Based Materiality. Non-financial based materiality would
impact the members of the Investment Manager's Investment Committee, who are
responsible for making proxy voting decisions.
Finally, if a material conflict exists, the Investment Manager shall vote in
accordance with the advice of a proxy voting service.
The Investment Manager's General Counsel shall have responsibility for
supervising and monitoring conflicts of interest in the proxy voting process
according to the following process:
Identifying Conflicts. The Investment Manager is responsible for
monitoring the relationships of the Investment Manager's affiliates for
purposes of the Investment Manager's Inside Information Policy and
Procedures. The General Counsel (or his designee) maintains a watch list and
a restricted list. The Investment Manager's Investment Committee is unaware
of the content of the watch list and therefore it is only those companies on
the restricted list, which is made known to everyone at the Investment
Manager, for which potential concerns might arise. When a company is placed
on the restricted list, the General Counsel (or his designee) shall promptly
inquire of the Designee as to whether there is a pending proxy voting
opportunity with respect to that company, and continue to inquire on a
weekly basis until such time as the company is no longer included on the
restricted list. When there is a proxy voting opportunity with respect to a
company that has been placed on the restricted list, the General Counsel
shall inform the Investment Committee that no proxy vote is to be submitted
for that company until the general counsel completes the conflicts analysis.
For purposes of monitoring personal or familial relationships, the
general counsel (or his designee) shall receive on at least an annual basis
from each member of the Investment Manager's Investment Committee written
disclosure of any personal or familial relationships with public company
directors that could raise potential conflict of interest concerns.
Investment Committee members also shall agree in writing to advise if (i)
there are material changes to any previously furnished information, (ii) a
person with whom a personal or familial relationship exists is subsequently
nominated as a director or (iii) a personal or
30
familial relationship exists with any proponent of a proxy proposal or a
participant in a proxy contest.
Identifying Materiality. The General Counsel (or his designee) shall be
responsible for determining whether a conflict is material. He shall
evaluate financial based materiality in terms of both actual and potential
fees to be received. Non-financial based items impacting a member of the
Investment Committee shall be presumed to be material.
Communication with Investment Committee; Voting of Proxy -- If the
General Counsel determines that the relationship between the Investment
Manager's affiliate and a company is financially material, he shall
communicate that information to the members of the Investment Manager's
Investment Committee and instruct them, and the Designee, that the
Investment Manager will vote its proxy based on the advice of a consulting
firm engaged by the Investment Manager. Any personal or familial
relationship, or any other business relationship, that exists between a
company and any member of the Investment Committee shall be presumed to be
material, in which case the Investment Manager again will vote its proxy
based on the advice of a consulting firm engaged by the Investment Manager.
The fact that a member of the Investment Committee personally owns
securities issued by a company will not disqualify the Investment Manager
from voting common stock issued by that company, since the member's personal
and professional interests will be aligned.
In cases in which the Investment Manager will vote its proxy based on the
advice of a consulting firm, the General Counsel (or his designee) shall be
responsible for ensuring that the Designee votes proxies in this manner. The
General Counsel will maintain a written record of each instance when a conflict
arises and how the conflict is resolved (e.g., whether the conflict is judged to
be material, the basis on which the materiality decision is made and how the
proxy is voted).
The Fund is required to file Form N-PX, with its complete proxy voting
record for the 12 months ended June 30th, no later than August 31st of each
year. The Fund's Form N-PX filing for the twelve months ended June 30, 2005 is
available (i) without charge, upon request, by calling the Fund toll-free at
(800) 437-9912 and (ii) on the Securities and Exchange Commission's website
(http://www.sec.gov).
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Directors, decisions to buy and sell
securities for the Fund and negotiation of its brokerage commission rates are
made by the Investment Manager. Transactions on U.S. stock exchanges involve the
payment by the Fund of negotiated brokerage commissions. There is generally no
stated commission in the case of securities traded in the over-the-counter
market but the price paid by the Fund usually includes an undisclosed dealer
commission or markup. In certain instances, the Fund may make purchases of
underwritten or agency placed issues at prices which include underwriting or
placement fees.
In selecting a broker to execute each particular transaction, the Investment
Manager will take the following into consideration: the best net price
available; the reliability, integrity and financial condition of the broker; the
size and difficulty in executing the order; and the value of the expected
contribution of the broker to the investment performance of the Fund on a
continuing basis. Accordingly, the cost of the brokerage commissions to the Fund
in any transaction may be greater than that available from other brokers if the
difference is reasonably justified by other aspects of the portfolio execution
services offered. Subject to such policies and procedures as the Directors may
determine, the Investment Manager shall not be deemed to have acted unlawfully
or to have breached any duty solely by reason of its having caused the Fund to
pay a broker that provides research services to the Investment Manager an amount
of commission for effecting a portfolio investment transaction in excess of the
amount of commission another broker would have charged for effecting that
transaction, if the Investment Manager determines in good faith that the Fund
received best execution viewed in terms of either that particular transaction or
the Investment Manager's ongoing responsibilities with respect to the Fund.
31
In addition, the Investment Manager may receive research services from a
broker in connection with initiating portfolio transactions for the Fund. While
it is not the Investment Manager's policy to 'pay up' for these research
services, the Investment Manager shall not be deemed to have acted unlawfully or
to have breached any duty solely by reason of its having caused the Fund to pay
a broker an amount of commission for effecting a portfolio investment
transaction in excess of the amount of commission another broker would have
charged solely for execution services for that transaction if the Investment
Manager determines in good faith that the commission was reasonable in relation
to the value of the research service provided viewed in terms of either that
particular transaction or the Investment Manager's ongoing responsibilities with
respect to the Fund.
Research and investment information is provided by these and other brokers
at no cost to the Investment Manager and is available for the benefit of other
accounts advised by the Investment Manager and its affiliates, and not all of
the information will be used in connection with the Fund. While this information
may be useful in varying degrees and may tend to reduce the Investment Manager's
expenses, it is not possible to estimate its value and in the opinion of the
Investment Manager it does not reduce the Investment Manager's expenses in a
determinable amount. The extent to which the Investment Manager makes use of
statistical, research and other services furnished by brokers is considered by
the Investment Manager in the allocation of brokerage business but there is no
formula by which such business is allocated. The Investment Manager does so in
accordance with its judgment of the best interests of the Fund and its
stockholders. The Investment Manager may also take into account payments made by
brokers effecting transactions for the Fund to other persons on behalf of the
Fund for services provided to it for which it would be obligated to pay (such as
custodial and professional fees).
DETERMINATION OF NET ASSET VALUE
The Fund determines the net asset value of its Common Shares daily, as of
the close of trading on the New York Stock Exchange (currently 4:00 p.m. New
York time). Net asset value is computed by dividing the value of all assets of
the Fund (including accrued interest and dividends), less all liabilities
(including accrued expenses, the liquidation preference of the AMPS and the
Outstanding AMPS, and dividends declared but unpaid), by the total number of
Common Shares outstanding. Any swap transaction that the Fund enters into may,
depending on the applicable interest rate environment, have a positive or
negative value for purposes of calculating net asset value. Any cap transaction
that the Fund enters into may, depending on the applicable interest rate
environment, have no value or a positive value. In addition, accrued payments to
the Fund under such transactions will be assets of the Fund and accrued payments
by the Fund will be liabilities of the Fund.
For purposes of determining the net asset value of the Fund, readily
marketable portfolio securities listed on the New York Stock Exchange are
valued, except as indicated below, at the last sale price reflected on the
consolidated tape at the close of the New York Stock Exchange on the business
day as of which such value is being determined. If there has been no sale on
such day, the securities are valued at the mean of the closing bid and asked
prices on such day. If no bid or asked prices are quoted on such day, then the
security is valued by such method as the Board of Directors shall determine in
good faith to reflect its fair market value. Readily marketable securities not
listed on the New York Stock Exchange but listed on other domestic or foreign
securities exchanges or admitted to trading on the National Association of
Securities Dealers Automated Quotations, Inc. ('NASDAQ') National List are
valued in a like manner (NASDAQ traded securities are valued at the NASDAQ
official closing price). Portfolio securities traded on more than one securities
exchange are valued at the last sale price on the business day as of which such
value is being determined as reflected on the tape at the close of the exchange
representing the principal market for such securities.
Readily marketable securities traded in the over-the-counter market,
including listed securities whose primary market is believed by the Investment
Manager to be over-the-counter, but excluding securities admitted to trading on
the NASDAQ National List, are valued at the mean of the
32
current bid and asked prices as reported by NASDAQ or, in the case of securities
not quoted by NASDAQ, the National Quotation Bureau or such other comparable
source as the Directors deem appropriate to reflect their fair market value.
However, certain fixed-income securities may be valued on the basis of prices
provided by a pricing service when such prices are believed by the Board of
Directors to reflect the fair market value of such securities. The prices
provided by a pricing service take into account institutional size trading in
similar groups of securities and any developments related to specific
securities. Where securities are traded on more than one exchange and also
over-the-counter, the securities will generally be valued using the quotations
the Board of Directors believes reflect most closely the value of such
securities.
Any securities for which market quotations are not readily available shall
be valued in accordance with procedures approved by the Board of Directors.
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR AMPS
GENERAL
Securities Depository. DTC will act as the Securities Depository with
respect to the AMPS. One certificate for all of the AMPS will be registered in
the name of Cede & Co., as nominee of the Securities Depository. Such
certificate will bear a legend to the effect that such certificate is issued
subject to the provisions restricting transfers of shares of the AMPS contained
in the Articles Supplementary. The Fund will also issue stop-transfer
instructions to the transfer agent for the AMPS. Prior to the commencement of
the right of holders of the AMPS (and the Outstanding AMPS) to elect a majority
of the Fund's Directors, as described under 'Description of AMPS -- Voting
Rights' in the Prospectus, Cede & Co. will be the holder of record of the AMPS
and owners of such shares will not be entitled to receive certificates
representing their ownership interest in such shares.
DTC, a New York-chartered limited purpose trust company, performs services
for its participants, some of whom (and/or their representatives) own DTC. DTC
maintains lists of its participants and will maintain the positions (ownership
interests) held by each such participant in shares of the AMPS, whether for its
own account or as a nominee for another person.
CONCERNING THE AUCTION AGENT
The auction agent will act as agent for the Fund in connection with
Auctions. In the absence of willful misconduct or gross negligence on its part,
the auction agent will not be liable for any action taken, suffered, or omitted
or for any error of judgment made by it in the performance of its duties under
the auction agency agreement between the Fund and the auction agent and will not
be liable for any error of judgment made in good faith unless the auction agent
was grossly negligent in ascertaining the pertinent facts.
The auction agent may conclusively rely upon, as evidence of the identities
of the holders of the AMPS, the auction agent's registry of holders, and the
results of auctions and notices from any broker-dealer (or other person, if
permitted by the Fund) with respect to transfers described under 'The
Auction-Secondary Market Trading and Transfers of AMPS' in the Prospectus and
notices from the Fund. The auction agent is not required to accept any such
notice for an auction unless it is received by the auction agent by 3:00 p.m.,
New York City time, on the business day preceding such Auction.
The auction agent may terminate its auction agency agreement with the Fund
upon notice to the Fund on a date no earlier than 60 days after such notice. If
the auction agent should resign, the Fund will use its best efforts to enter
into an agreement with a successor auction agent containing substantially the
same terms and conditions as the auction agency agreement. The Fund may remove
the auction agent provided that prior to such removal the Fund shall have
entered into such an agreement with a successor auction agent.
33
BROKER-DEALERS
The auction agent after each auction for the AMPS will pay to each
broker-dealer, from funds provided by the Fund, a service charge at the annual
rate of 1/4 of 1% in the case of any auction immediately preceding the dividend
period of less than one year, or a percentage agreed to by the Fund and the
broker-dealer in the case of any auction immediately preceding a dividend period
of one year or longer, of the purchase price of the AMPS placed by such
broker-dealer at such auction. For the purposes of the preceding sentence, the
AMPS will be placed by a broker-dealer if such shares were (a) the subject of
hold orders deemed to have been submitted to the auction agent by the
broker-dealer and were acquired by such broker-dealer for its customers who are
beneficial owners or (b) the subject of an order submitted by such broker-dealer
that is (i) a submitted bid of an existing holder that resulted in the existing
holder continuing to hold such shares as a result of the auction or (ii) a
submitted bid of a potential bidder that resulted in the potential holder
purchasing such shares as a result of the auction or (iii) a valid hold order.
The Fund may request the auction agent to terminate one or more
broker-dealer agreements at any time, provided that at least one broker-dealer
agreement is in effect after such termination.
The broker-dealer agreement provides that a broker-dealer (other than an
affiliate of the Fund) may submit orders in auctions for its own account, unless
the Fund notifies all broker-dealers that they may no longer do so, in which
case broker-dealers may continue to submit hold orders and sell orders for their
own accounts. Any broker-dealer that is an affiliate of the Fund may submit
orders in auctions, but only if such orders are not for its own account. If a
broker-dealer submits an order for its own account in any auction, it might have
an advantage over other bidders because it would have knowledge of all orders
submitted by it in that auction; such broker-dealer, however, would not have
knowledge of orders submitted by other broker-dealers in that auction.
34
S&P AND MOODY'S GUIDELINES
The descriptions of the S&P and Moody's Guidelines contained in this SAI do
not purport to be complete and are subject to and qualified in their entireties
by reference to the Articles Supplementary. A copy of the Articles Supplementary
is filed as an exhibit to the registration statement of which the Prospectus and
this SAI are a part and may be inspected, and copies thereof may be obtained, as
described under 'Further Information' in the Prospectus.
The composition of the Fund's portfolio reflects guidelines (referred to
herein as the 'Rating Agency Guidelines') established by S&P and Moody's in
connection with the Fund's receipt of a rating of 'AAA' and 'Aaa' from S&P and
Moody's, respectively, for the AMPS. These Rating Agency Guidelines relate,
among other things, to industry and credit quality characteristics of issuers
and diversification requirements and specify various Discount Factors for
different types of securities (with the level of discount greater as the rating
of a security becomes lower). Under the Rating Agency Guidelines, certain types
of securities in which the Fund may otherwise invest consistent with its
investment strategy are not eligible for inclusion in the calculation of the
Discounted Value of the Fund's portfolio. Such instruments include, for example,
private placements (other than Rule 144A Securities) and other securities not
within the investment guidelines. Accordingly, although the Fund reserves the
right to invest in such securities to the extent set forth herein, they have not
and it is anticipated that they will not constitute a significant portion of the
Fund's portfolio.
The Rating Agency Guidelines require that the Fund maintain assets having an
aggregate Discounted Value, determined on the basis of the Guidelines, greater
than the aggregate liquidation preference of the AMPS (and the Outstanding AMPS)
plus specified liabilities, payment obligations and other amounts, as of
periodic Valuation Dates. The Rating Agency Guidelines also require the Fund to
maintain asset coverage for the AMPS (and the Outstanding AMPS) on a
non-discounted basis of at least 200% as of the end of each month, and the 1940
Act requires this asset coverage as a condition to paying dividends or other
distributions on Common Shares. S&P and Moody's have agreed that the auditors
must certify once per year the asset coverage test on a date randomly selected
by the auditor. The effect of compliance with the Rating Agency Guidelines may
be to cause the Fund to invest in higher quality assets and/or to maintain
relatively substantial balances of highly liquid assets or to restrict the
Fund's ability to make certain investments that would otherwise be deemed
potentially desirable by the Investment Manager, including private placements of
other than Rule 144A Securities (as defined herein). The Rating Agency
Guidelines are subject to change from time to time with the consent of the
relevant rating agency and would not apply if the Fund in the future elected not
to use investment leverage consisting of senior securities rated by one or more
rating agencies, although other similar arrangements might apply with respect to
other senior securities that the Fund may issue.
The Fund intends to maintain, at specified times, a Discounted Value for its
portfolio at least equal to the amount specified by each rating agency (the
'Preferred Shares Basic Maintenance Amount'). S&P and Moody's have each
established separate guidelines for determining Discounted Value. To the extent
any particular portfolio holding does not satisfy the applicable Rating Agency's
Guidelines, all or a portion of such holding's value will not be included in the
calculation of Discounted Value (as defined by such rating agency).
The Rating Agency Guidelines do not impose any limitations on the percentage
of Fund assets that may be invested in holdings not eligible for inclusion in
the calculation of the Discounted Value of the Fund's portfolio. The amount of
such assets included in the portfolio at any time may vary depending upon the
rating, diversification and other characteristics of the assets included in the
portfolio which are eligible for inclusion in the Discounted Value of the
portfolio under the Rating Agency Guidelines.
As described by S&P, a preferred stock rating of AAA indicates strong asset
protection, conservative balance sheet ratios and positive indications of
continued protection of preferred dividend requirements. An S&P or Moody's
credit rating of preferred stock does not address the likelihood that a resale
mechanism (e.g., the Auction) will be successful. As described by Moody's, an
issue of preferred stock which is rated 'Aaa' is considered to be top-quality
preferred stock
35
with good asset protection and the least risk of dividend impairment within the
universe of preferred stocks.
Ratings are not recommendations to purchase, hold or sell AMPS, inasmuch as
the rating does not comment as to market price or suitability for a particular
investor. The rating is based on current information furnished to S&P and
Moody's by the Fund and obtained by S&P and Moody's from other sources. The
rating may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information.
S&P GUIDELINES
Under the S&P guidelines, the Fund is required to maintain specified
discounted asset values for its portfolio representing the Preferred Shares
Basic Maintenance Amount (as defined below). To the extent any particular
portfolio holding does not meet the applicable guidelines, it is not included
for purposes of calculating the Discounted Value of the Fund's portfolio, and,
among the requirements, the amount of such assets included in the portfolio at
any time, if any, may vary depending upon the credit quality (and related
Discounted Value) of the Fund's eligible assets at such time.
The Preferred Shares Basic Maintenance Amount includes the sum of (1)
$25,000 times the number of AMPS (and the Outstanding AMPS) then outstanding and
(2) certain accrued and projected payment obligations of the Fund. Upon any
failure to maintain the required Discounted Value, the Fund would seek to alter
the composition of its portfolio to reestablish required asset coverage within
the specified ten Business Day cure period, thereby incurring additional
transaction costs and possible losses and/or gains on dispositions of portfolio
securities. To the extent any such failure is not cured in a timely manner, the
holders of the AMPS will acquire certain rights. See 'Description of
AMPS -- Asset Maintenance.' 'Business Day,' as used in the Prospectus and this
SAI, means each Monday, Tuesday, Wednesday, Thursday and Friday that is a day on
which the NYSE is open for trading and that is not a day on which banks in New
York City are authorized or required by law or executive order to close.
With respect to an S&P Eligible Asset specified below, the following
applicable number is the S&P Discount Factor (used to determine the Discounted
Value of any S&P Eligible Asset) provided that the S&P Exposure Period is 20
Business Days or less:
(a) Types of S&P Eligible Assets
DISCOUNT FACTOR FOR
TYPE OF S&P ELIGIBLE ASSET AAA RATING
-------------------------- ----------
Common Stock 168%
DRD Eligible Preferred Stock with a senior or preferred
stock rating of at least BBB- 228%
REIT and Non-DRD eligible Preferred Stock with a senior or
preferred stock rating of at least BBB- 155%
DRD Eligible Preferred Stock with a senior or preferred
stock rating below BBB- 233%
REIT and non-DRD Eligible Preferred Stock with a senior or
preferred stock rating below BBB- 160%
Un-rated DRD Eligible Preferred Stock 238%
Un-rated Non-DRD Eligible and un-rated REIT Preferred Stock 165%
Convertible bonds rated AAA to AAA- 148%
Convertible bonds rated AA+ to AA- 155%
Convertible bonds rated A+ to A- 162%
Convertible bonds rated BBB+ to BBB- 168%
Convertible bonds rated BB+ to BB- 175%
Convertible bonds rated B+ to B- 182%
Convertible bonds rated CCC+ to CCC- 189%
U.S. Short-Term Money Market Investments with maturities of
180 days or less 104%
36
DISCOUNT FACTOR FOR
TYPE OF S&P ELIGIBLE ASSET AAA RATING
-------------------------- ----------
U.S. Short-Term Money Market Investments with maturities of
between 181 and 360 days 113%
U.S. Government Obligations (52 week Treasury Bills) 102%
U.S. Government Obligations (Two-Year Treasury Notes) 104%
U.S. Government Obligations (Five-Year Treasury Notes) 110%
U.S. Government Obligations (Ten-Year Treasury Notes) 117%
U.S. Government Obligations (Thirty-Year Treasury Bonds) 130%
Agency Mortgage Collateral (Fixed 15-Year) 129%
Agency Mortgage Collateral (Fixed 30-Year) 132%
Agency Mortgage Collateral (ARM 1/1) 122%
Agency Mortgage Collateral (ARM 3/1) 123%
Agency Mortgage Collateral (ARM 5/1) 123%
Agency Mortgage Collateral (ARM 10/1) 123%
Mortgage Pass-Through Fixed (15 Year) 131%
Mortgage Pass-Through Fixed (30 Year) 134%
Debt securities of REIT's and other real estate
companies according to the following corporate bond
schedule
Corporate Bonds rated at least AAA 110%
Corporate Bonds rated at least AA+ 111%
Corporate Bonds rated at least AA 113%
Corporate Bonds rated at least AA- 115%
Corporate Bonds rated at least A+ 116%
Corporate Bonds rated at least A 117%
Corporate Bonds rated at least A- 118%
Corporate Bonds rated at least BBB+ 120%
Corporate Bonds rated at least BBB 122%
Corporate Bonds rated at least BBB- 124%
Corporate Bonds rated at least BB+ 129%
Corporate Bonds rated at least BB 135%
Corporate Bonds rated at least BB- 142%
Corporate Bonds rated at least B+ 156%
Corporate Bonds rated at least B 169%
Corporate Bonds rated at least B- 184%
Corporate Bonds rated at least CCC+ 202%
Corporate Bonds rated at least CCC 252%
Corporate Bonds rated at least CCC- 350%
Master Limited Partnership 625%
Cash and Cash Equivalents 100%
(b) Interest rate swaps entered into according to International Swap Dealers
Association ('ISDA') standards if
(i) the counterparty to the swap transaction has a short-term rating of
A-1 or equivalent by S&P or, if the counterparty does not have a short-term
rating, the counterparty's senior unsecured long-term debt rating is A- ,
or equivalent by S&P, or higher.
(ii) the original aggregate notional amount of the interest rate swap
transaction or transactions is not to be greater than the liquidation
preference of the Series.
(iii) The interest rate swap transaction will be marked-to-market weekly
by the swap counterparty.
(iv) If the Fund fails to maintain an aggregate discounted value at
least equal to the basic maintenance amount on two consecutive valuation
dates then the agreement will terminate immediately.
(v) For the purpose of calculating the asset coverage test 90% of any
positive mark-to-market valuation of the Fund's rights will be eligible
assets. 100% of any negative mark-to-
37
market valuation of the Fund's rights will be included in the calculation of
the Preferred Shares Basic Maintenance Amount.
(vi) The Fund must maintain liquid assets with a value at least equal to
the net amount of the excess, if any, of the Fund's obligations over its
entitlement with respect to each swap. For caps/floors, must maintain liquid
assets with a value at least equal to the Fund's obligations with respect to
such caps or floors.
(c) Cash and Cash Equivalents
(i) Cash and Cash Equivalents and demand deposits in an 'A-1+' rated
institution are valued at 100%. 'A-1+' rated commercial paper, with
maturities no greater than 30 days and held instead of cash until maturity,
is valued at 100%. Securities with next-day maturities invested in 'A-1+'
rated institutions are considered cash equivalents and are valued at 100%.
Securities maturing in 181 to 360 calendar days are valued at 114.2%.
(ii) The S&P Discount Factor for shares of unrated Money Market Funds
affiliated with the Fund used as 'sweep' vehicles will be 110%. Money Market
Funds rated 'AAAm' will be discounted at the appropriate level as dictated
by the exposure period. No S&P Discount Factor will be applied to Money
Market Funds rated AAAm by S&P with effective next day maturities.
'S&P Eligible Assets' will mean:
(A) Deposit Securities;
(B) U.S. Government Obligations and U.S. Government Agencies;
(C) Corporate Indebtedness. Evidences of indebtedness other than Deposit
Securities, U.S. Government Obligations and Municipal Obligations that are
not convertible into or exchangeable or exercisable for stock of a
corporation (except to the extent of ten percent (10%) in the case of a
share exchange or tender offer) ('Other Debt') and that satisfy all of the
following conditions:
(1) be no more than 10% of total assets may be below a S&P rating of
BBB- , or comparable Moody's or Fitch rating, or unrated;
(2) the remaining term to maturity of such Other Debt will not exceed
fifty (50) years;
(3) such Other Debt must provide for periodic interest payments in
cash over the life of the security;
(4) no more than 10% of the issuers of such evidences of indebtedness
do not file periodic financial statements with the Commission;
(5) which, in the aggregate, have an average duration of not more
than 12 years.
(D) Convertible Corporate Indebtedness. Evidences of indebtedness other
than Deposit Securities, U.S. Government Obligations and Municipal
Obligations that are convertible into or exchangeable or exercisable for
stock of a corporation and that satisfy all of the following conditions:
(1) such evidence of indebtedness is rated at least CCC by S&P; and
(2) if such evidence of indebtedness is rated BBB or lower by S&P,
the market capitalization of the issuer of such evidence of indebtedness
is at least $100 million;
(E) Agency Mortgage Collateral. Certificates guaranteed by U.S.
Government Agencies (as defined below) (e.g., FNMA, GNMA and FHLMC) for
timely payment of interest and full and ultimate payment of principal.
Agency Mortgage Collateral also evidence undivided interests in pools of
level-payment, fixed, variable, or adjustable rate, fully amortizing loans
that are secured by first liens on one- to four-family residences
residential properties (or in the case of Plan B FHLMC certificates, five or
more units primarily designed for residential use) ('Agency Mortgage
Collateral'). Agency Mortgage Collateral the following conditions apply:
38
(1) For GNMA certificates backed by pools of graduated payment
mortgages, levels are 20 points above established levels;
(2) Qualifying 'large pool' FNMA mortgage-backed securities and FHLMC
participation certificates are acceptable as eligible collateral. The
eligible fixed-rate programs include FNMA MegaPools, FNMA Majors, FHLMC
Multilender Swaps, and FHLMC Giant certificates. Eligible adjustable rate
mortgage ('ARMs') programs include nonconvertible FNMA ARM MegaPools and
FHLMC weighted average coupon ARM certificates. Eligible FHLMC Giant
programs exclude interest-only and principal only stripped securities;
(3) FNMA certificates backed by multifamily ARMs pegged to the 11th
District Cost of Funds Index are acceptable as eligible collateral at 5
points above established levels; and
(4) Multiclass REMICs issued by FNMA and FHLMC are acceptable as
eligible collateral at the collateral levels established for CMOs.
(F) Mortgage Pass-Through Certificates. Publicly issued instruments
maintaining at least a AA- ratings by S&P. Certificates evidence
proportional, undivided interests in pools of whole residential mortgage
loans. Pass-through certificates backed by pools of convertible ARMs are
acceptable as eligible collateral at 5 points above the levels established
for pass-through certificates backed by fixed or non-convertible ARM pools.
(G) Preferred Stocks. Preferred stocks that satisfy all of the following
conditions:
1. The preferred stock issue has a senior rating from S&P, or the
preferred issue must be rated. In the case of Yankee preferred stock, the
issuer should have a S&P senior rating of at least 'BBB- ', or the
preferred issue must be rated at least 'BBB- '.
2. The issuer -- or if the issuer is a special purpose corporation,
its parent -- is listed on either the New York Stock Exchange, the
American Stock Exchange or NASDAQ if the traded par amount is less than
$1,000. If the traded par amount is $1,000 or more exchange listing is
not required.
3. The collateral pays cash dividends denominated in U.S. dollars.
4. Private placement 144A with registration rights are eligible
assets.
5. The minimum market capitalization of eligible issuers is US$100
million.
Restrictions for floating-rate preferred stock:
1. Holdings must be limited to stock with a dividend period of
less than or equal to 49 days, except for a new issue, where the
first dividend period may be up to 64 days.
2. The floating-rate preferred stock may not have been subject to
a failed auction.
Restrictions for adjustable -- or auction-rate preferred stock:
1. The total fair market value of adjustable-rate preferred stock
held in the portfolio may not exceed 10% of eligible assets.
Concentration Limits:
1. Total issuer exposure in preferred stock of any one issuer is
limited to 10% of the fair market value of eligible assets.
2. Preferred stock rated below B- (including non-rated preferred
stock) and preferred stock with a market cap of less than US$100
million are limited to no more than 15% of the fair market value of
the eligible assets.
3. Add 5 points to over-collateralization level for issuers with
a senior rating or preferred stock rating of less than BBB- .
4. Add 10 point to over-collateralization level of issuers with
no senior rating, preferred stock rating or dividend history.
39
(H) Common stocks of Utility Companies that satisfy all of the following
conditions:
1. The issuer can hold no more than the average monthly trading
volume over the past year.
2. Each stock must have a minimum market capitalization of at least
$100 million.
3. Restricted stocks (144a securities) or any pink sheet stocks
(generally, stocks that are not carried in daily over-the-counter
newspaper listings) are ineligible.
4. The issuer may not hold any equity unless it has been listed on an
exchange or traded for more than one year and one quarter, or 15 months
(eligible stock exchanges are the New York Stock Exchange, American Stock
Exchange, Philadelphia Stock Exchange, Boston Stock Exchange, Washington
Stock Exchange, Midwest Stock Exchange, Pacific Stock Exchange, NASDAQ,
and National Market Quotations).
5. The collateral is owned by the fund, or the trustee or collateral
agent has a first perfected priority security interest in the collateral.
(for S&P's perfection of Security Interest Criteria, see Legal Criteria
For Structured Finance Transactions, April 2002).
Note:
Add 20 points to the overcollateralization level for common stock
that do not meet the requirement of item number 4 above.
Receivables due within five business days of a valuation will be
treated as cash and are valued at 100%.
Receivables that are due in more than five business days of a
valuation date qualify as a Standard & Poor's-eligible asset at a
value no greater than the settlement price discounted at the
applicable credit rating and/or exposure period discount factor.
Escrow Bonds may comprise 100% of the Fund's S&P Eligible Assets. Bonds
that are legally defeased and secured by direct U.S. Government Obligations
are not required to meet any minimum issuance size requirement. Bonds that
are economically defeased or secured by other U.S. Agency paper must meet
the minimum issuance size requirement for the Fund described above. Bonds
initially rated or rerated as an escrow bond by another Rating Agency are
limited to 50% of the Fund's S&P Eligible Assets, and carry one full rating
lower than the equivalent S&P rating for purposes of determining the
applicable discount factors. Bonds economically defeased and either
initially rated or rerated by S&P or another Rating Agency are assigned that
same rating level as its debt issuer, and will remain in its original
industry category unless it can be demonstrated that a legal defeasance has
occurred.
With respect to the above, the Fund portfolio must consist of no less
than 20 issues representing no less than 10 industries as determined by the
S&P Industry Classifications and S&P Real Estate Industry/Property sectors.
For industry concentration, the following sectors represent distinct
industry classifications: electric-distribution, electric-integrated,
natural gas-distribution, natural gas-integrated and unregulated utilities.
For purposes of determining the discount factors applicable to
collateral not rated by S&P, the collateral will carry an S&P rating one
full rating level lower than the equivalent S&P rating.
'S&P Exposure Period' will mean the sum of (i) that number of days from
the last Valuation Date on which the Fund's Discounted Value of S&P Eligible
Assets were greater than the Preferred Shares Basic Maintenance Amount to
the Valuation Date on which the Fund's Discounted Value of S&P Eligible
Assets failed to exceed the Preferred Shares Basic Maintenance Amount, (ii)
the maximum number of days following a Valuation Date that the Fund has
under this Statement to cure any failure to maintain a Discounted Value of
S&P Eligible Assets at least equal to the Preferred Shares Basic Maintenance
Amount, and
(iii) the maximum number of days the Fund has to effect a mandatory
redemption under Section 3(a)(ii) of Part I of the Articles Supplementary.
40
MOODY'S GUIDELINES
For purposes of calculating the Discounted Value of the Fund's portfolio
under current Moody's guidelines, the fair market value of portfolio securities
eligible for consideration under such guidelines ('Moody's Eligible Assets')
must be discounted by certain discount factors set forth below ('Moody's
Discount Factors'). The Discounted Value of a portfolio security under Moody's
guidelines is the Market Value thereof, determined as specified by Moody's,
divided by the Moody's Discount Factor. The Moody's Discount Factor with respect
to securities other than those described below will be the percentage provided
in writing by Moody's.
The following Discount Factors apply to portfolio holdings as described
below, subject to diversification, issuer size and other requirements, in order
to constitute Moody's Eligible Assets includable within the calculation of
Discounted Value:
(a) Preferred Stock and Common Stock:
DISCOUNT
FACTOR(1)(2)(3)
---------------
Common stock and common stock of foreign issuers for which
ADRs are traded:
Large Cap (4)........................................... 200%
Mid Cap (4)............................................. 205%
Small Cap (4)........................................... 220%
Common stock of foreign issuers (in existence for at least
five years) for which no ADRs are traded.................. 400%
Preferred stock of REITs:
with Senior Implied Moody's (or S&P or Fitch) rating.... 154%
without Senior Implied Moody's (or S&P or Fitch)
rating................................................ 208%
Preferred stock of Other Real Estate Companies:
with Senior Implied Moody's (or S&P or Fitch) rating.... 208%
without Senior Implied Moody's (or S&P or Fitch)
rating................................................ 250%
Preferred Securities of non-real estate companies including
DRD eligible preferred securities (5)(6):
(A) for taxable preferred securities issued by a
utility, industrial, financial issuer or other
non-real estate related issuers with Moody's or
equivalent S&P or Fitch ratings:.................... Aaa 150%
Aa 155%
A 160%
Baa 165%
Ba 196%
B 216%
<= B, NR 250%
(B) for DRD eligible preferred securities issued by a
utility, industrial, financial issuer, or other
non-real estate related issuers
(i) Investment grade................................ 165%
(ii) non-investment grade........................... 216%
(C) for auction rate preferred securities............... 350%
---------
(1) A Discount Factor of 260% will be applied to those assets in a single
Moody's Utility Sub-Industry Classification which exceed 50% of Moody's
Eligible Assets but are not greater than 75% of Moody's Eligible Assets.
(2) A Discount Factor of 250% will be applied if dividends on such securities
have not been paid consistently (either quarterly or annually) over the
previous three years, or for such shorter time period that such securities
have been outstanding.
(3) A Discount Factor of 250% will be applied if the market capitalization
(including common stock and preferred stock) of a real estate issuer is
below $500 million.
(4) Market cap for Large-cap stocks are $10 billion and up, Mid-cap stocks range
between $2 billion and $10 billion, and Small-cap stocks are $2 billion and
below.
(5) Applies to preferred securities which have a minimum issue size of $50
million.
(6) Non-real estate eligible preferred securities will be issued by investment
grade companies having a senior unsecured debt rating that is Baa3 or higher
by Moody's or BBB- by S&P or Fitch and pay dividends in U.S. Dollars or
Euros. The market value of eligible non-cumulative preferred issues are
subject to standard preferred stock discount factors multiplied by a factor
of 1.10.
41
(b) Debt securities (1):
The percentage determined by reference to the rating on such asset with
reference to the remaining term to maturity of such asset, in accordance
with the table set forth below.
TERMS OF MATURITY OF DEBT SECURITY(1) Aaa Aa A Baa Ba B UNRATED
------------------------------------- --- -- - --- -- - -------
1 year or less..................... 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than
1 year).......................... 115% 118% 122% 125% 146% 160% 250%
3 years or less (but longer than
2 years)......................... 120% 123% 127% 131% 153% 168% 250%
4 years or less (but longer than
3 years)......................... 126% 129% 133% 138% 161% 176% 250%
5 years or less (but longer than
4 years)......................... 132% 135% 139% 144% 168% 185% 250%
7 years or less (but longer than
5 years)......................... 139% 143% 147% 152% 179% 197% 250%
10 years or less (but longer than
7 years)......................... 145% 150% 155% 160% 189% 208% 250%
15 years or less (but longer than
10 years)........................ 150% 155% 160% 165% 196% 216% 250%
20 years or less (but longer than
15 years)........................ 150% 155% 160% 165% 196% 228% 250%
30 years or less (but longer than
20 years)........................ 150% 155% 160% 165% 196% 229% 250%
Greater than 30 years.............. 165% 173% 181% 189% 205% 240% 250%
---------
(1) The Moody's Discount Factors for debt securities will also be applied to any
interest rate swap or cap, in which case the rating of the counterparty will
determine the appropriate rating category.
(c) U.S. Treasury Securities and U.S. Treasury Strips (as defined by
Moody's):
U.S. TREASURY SECURITIES
REMAINING TERM TO MATURITY DISCOUNT FACTOR U.S. TREASURY STRIPS
-------------------------- --------------- --------------------
1 year or less...................................... 107% 107%
2 years or less (but longer than 1 year)............ 113% 115%
3 years or less (but longer than 2 years)........... 118% 121%
4 years or less (but longer than 3 years)........... 123% 128%
5 years or less (but longer than 4 years)........... 128% 135%
7 years or less (but longer than 5 years)........... 135% 147%
10 years or less (but longer than 7 years)........... 141% 163%
15 years or less (but longer than 10 years).......... 146% 191%
20 years or less (but longer than 15 years).......... 154% 218%
30 years or less (but longer than 20 years).......... 154% 244%
(d) Short-Term Instruments and Cash.
The Moody's Discount Factor applied to Moody's Eligible Assets that are
short term money instruments (as defined by Moody's) will be (i) 100%, so long
as such portfolio securities mature or have a demand feature at par exercisable
within 49 days of the relevant valuation date, (ii) 102%, so long as such
portfolio securities mature or have a demand feature at par not exercisable
within 49 days of the relevant valuation date, and (iii) 125%, if such
securities are not rated by Moody's, so long as such portfolio securities are
rated at least A-1 by S&P and mature or have a demand feature at par exercisable
within 49 days of the relevant valuation date. A Moody's Discount Factor of 100%
will be applied to cash.
(e) Rule 144A Debt or Preferred Securities:
The Moody's Discount Factor applied to Rule 144A debt or preferred
securities will be
42
(i) 130% of the Moody's Discount Factor, which would apply if the
securities have registration rights under the Securities Act after 365 days,
and
(ii) 120% of the Moody's Discount Factor if the securities have
registration rights within 365 days of calculation of the Basic Maintenance
Amount.
(f) Convertible Securities:
MOODY'S RATING CATEGORY
INDUSTRY CATEGORY Aaa Aa A Baa Ba B NR
----------------- --- -- - --- -- - --
Utility.............. 162% 167% 172% 188% 195% 199% 300%
Industrial........... 256% 261% 266% 282% 290% 293% 300%
Financial............ 233% 238% 243% 259% 265% 270% 300%
Transportation....... 250% 265% 275% 285% 290% 295% 300%
Ratings assigned by S&P or Fitch are generally accepted by Moody's at face
value. However, adjustments to face value may be made to particular categories
of credits for which the S&P and/or Fitch rating does not seem to approximate a
Moody's rating equivalent.
'Moody's Eligible Assets' means the following:
(i) Common stocks: (i) (A) which are traded on a nationally recognized
stock exchange or in the over-the-counter market, (B) if cash dividend
paying, pay cash dividends in U.S. dollars and (C) which may be sold without
restriction by the Fund; provided, however, that (y) common stock which,
while a Moody's Eligible Asset owned by the Fund, ceases paying any regular
cash dividend will no longer be considered a Moody's Eligible Asset until 71
days after the date of the announcement of such cessation, unless the issuer
of the common stock has senior debt securities rated at least A3 by Moody's
and (z) the aggregate Market Value of the Fund's holdings of the common
stock of any issuer in excess of 4% in the case of utility common stock and
6% in the case of non-utility common stock of the aggregate Market Value of
the Fund's holdings shall not be Moody's Eligible Assets, (ii) which are
securities denominated in any currency other than the U.S. dollar or
securities of issuers formed under the laws of jurisdictions other than the
United States, its states and the District of Columbia for which there are
ADRs or their equivalents which are traded in the United States on exchanges
or over-the-counter and are issued by banks formed under the laws of the
United States, its states or the District of Columbia or (iii) which are
securities of issuers formed under the laws of jurisdictions other than the
United States (and in existence for at least five years) for which no ADRs
are traded; provided, however, that the aggregate Market Value of the Fund's
holdings of securities denominated in currencies other than the U.S. dollar
and ADRs in excess of (A) 6% of the aggregate Market Value of the
outstanding shares of common stock of such issuer thereof or (B) in excess
of 10% of the Market Value of the Fund's Moody's Eligible Assets with
respect to issuers formed under the laws of any single such non-U.S.
jurisdiction other than Australia, Belgium, Canada, Denmark, Finland,
France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand,
Norway, Spain, Sweden, Switzerland and the United Kingdom, shall not be a
Moody's Eligible Asset;
(ii) Corporate debt securities if: (A) such securities provide for the
periodic payment of interest in cash in U.S. dollars or euros, except that
such securities that do not pay interest in U.S. dollars or euros shall be
considered Moody's Eligible Assets if they are rated by Moody's, S&P or
Fitch; (B) such securities have been registered under the 1933 Act or are
restricted as to resale under federal securities laws but are eligible for
resale pursuant to Rule 144A under the 1933 Act as determined by the Fund's
investment manager or portfolio manager acting pursuant to procedures
approved by the Board of Directors, except that such securities that are not
subject to U.S. federal securities laws shall be considered Moody's Eligible
Assets if they are publicly traded; and (C) such securities are not subject
to extended settlement.
43
(iii) Preferred stocks if: (A) such securities provide for the periodic
payment of dividends thereon in cash in U.S. dollars or euros and do not
provide for conversion or exchange into, or have warrants attached entitling
the holder to receive, equity capital at any time over the respective lives
of such securities, (B) the issuer of such a preferred stock has common
stock listed on either the New York Stock Exchange or the American Stock
Exchange or other Moody's approved exchanges, (C) the issuer of such a
preferred stock has a senior debt rating from Moody's of Baa3 or higher
(D) such preferred stock has paid consistent cash dividends in U.S. dollars
or euros over the last three years or has a minimum rating of A1 (if the
issuer of such preferred stock has other preferred issues outstanding that
have been paying dividends consistently for the last three years, then a
preferred stock without such a dividend history would also be eligible). In
addition, the preferred stocks must have the following diversification
requirements: (X) the preferred stock issue must be greater than $50 million
and (Y) the minimum holding by the Fund of each issue of preferred stock is
$500,000. In addition, preferred stocks issued by transportation companies
will not be considered Moody's Eligible Assets;
(iv) Convertible securities (including convertible preferred stock),
provided that: (A) the issuer of common stock must have a Moody's senior
unsecured debt of Caa or better, or a rating of CCC or better by S&P or
Fitch Ratings, (B) the common stocks must be traded on the New York Stock
Exchange, the American Stock Exchange, or the NASDAQ, (C) dividends must be
paid in U.S. dollars, (D) the portfolio of convertible bonds must be
diversified as set forth in the table set forth below, (E) the Fund shall
not hold shares exceeding the average weekly trading volume during the
preceding month and (F) synthetic convertibles are excluded from asset
eligibility;
(v) Preferred stock or any debt security of REITs or real estate
companies;
(vi) Unrated debt securities issued by an issuer which:
(A) has not filed for bankruptcy within the past three years
(B) is current on all principal and interest on its fixed income
obligations;
(C) is current on all preferred stock dividends;
(D) possesses a current, unqualified auditor's report without
qualified, explanatory language; and
(E) in the aggregate taken together with securities rated B by
Moody's, or comparable by S&P or Fitch, and below do not exceed 10% of
the discounted Moody's Eligible Assets;
(vii) Interest rate swaps entered into according to International Swap
Dealers Association ('ISDA') standards if
(A) the counterparty to the swap transaction has a short-term rating
of not less than P-1 by Moody's or A-1 by S&P or, if the counterparty
does not have a short-term rating, the counterparty's senior unsecured
long-term debt rating is A3 or higher by Moody's or A- or higher by S&P
or Fitch;
(B) the original aggregate notional amount of the interest rate swap
transaction or transactions is not to be greater than the liquidation
preference of the Series outstanding;
(C) the interest rate swap transaction will be marked-to-market
daily;
(D) an interest rate swap that is in-the-money is discounted at the
counterparty's corporate debt rating for the maturity of the swap for
purposes of calculating Moody's Eligible Assets; and
(E) an interest rate swap that is out-of-the money includes that
negative mark-to-market amount as indebtedness for purposes of
calculating the Preferred Shares Basic Maintenance amount.
44
(viii) U.S. Treasury Securities and Treasury Strips (as defined by
Moody's);
(ix) Short-Term Money Market Instruments so long as
(A) such securities are rated at least P-1,
(B) in the case of demand deposits, time deposits and overnight
funds, the supporting entity is rated at least A2, or
(C) in all other cases, the supporting entity (1) is rated A2 and the
security matures within one month, (2) is rated A1 and the security
matures within three months or (3) is rated at least Aa3 and the security
matures within six months; provided, however, that for purposes of this
definition, such instruments (other than commercial paper rated by S&P
and not rated by Moody's) need not meet any otherwise applicable Moody's
rating criteria.
(x) Cash including, for this purpose, interest and dividends due on
assets rated
(A) Baa3 or higher by Moody's if the payment date is within five
Business Days of the Valuation Date,
(B) A2 or higher if the payment date is within thirty days of the
Valuation Date, and
(C) A1 or higher if the payment date is within 90 days of the
relevant valuation date and receivables for Moody's Eligible Assets sold
if the receivable is due within five Business Days of the Valuation Date,
and if the trades which generated such receivables are (1) settled
through clearing house firms with respect to which the Fund has received
prior written authorization from Moody's or (2) with counterparties
having a Moody's long-term debt rating of at least Baa3 or (3) with
counterparties having a Moody's Short-Term Money Market Instrument rating
of at least P-1.
The Fund's investment in preferred stock, common stock, corporate evidences
of indebtedness and convertible corporate evidences of indebtedness shall not be
treated as Moody's Eligible Assets except to the extent they satisfy the
following diversification requirements (utilizing Moody's Industry and
Sub-industry Categories) with respect to the Market Value of the Fund's
holdings:
ISSUER:
NON-UTILITY MAXIMUM UTILITY MAXIMUM SINGLE
MOODY'S RATING (1)(2) SINGLE ISSUER(3)(4) ISSUER(3)(4)
---------------------------------------------- ------------------- ----------------------
Aaa........................................... 100% 100%
Aa............................................ 20% 20%
A............................................. 10% 10%
CS/CB, 'Baa', Baa(5).......................... 6% 4%
Ba............................................ 4% 4%
B1/B2......................................... 3% 3%
B3 or below................................... 2% 2%
INDUSTRY AND STATE:
NON-UTILITY UTILITY MAXIMUM
MAXIMUM SINGLE SINGLE SUB- UTILITY MAXIMUM
MOODY'S RATING(1) INDUSTRY(3) INDUSTRY(3)(6) SINGLE STATE(3)
------------------------------------- -------------- --------------- ---------------
Aaa.................................. 100% 100% 100%
Aa................................... 60% 60% 20%
A.................................... 40% 50% 10%(8)
CS/CB, 'Baa', Baa(5)................. 20% 50%(7) 7%(8)
Ba................................... 12% 12% 0%
B1/B2................................ 8% 8% 0%
B3 or below.......................... 5% 5% 0%
---------
(1) Ratings assigned by S&P or Fitch are generally accepted by Moody's at face
value. However, adjustments to face value may be made to particular
categories of credits for which the S&P and/or Fitch rating does not seem to
approximate a Moody's rating equivalent.
(footnotes continued on next page)
45
(footnotes continued from previous page)
(2) Corporate evidences of indebtedness from issues ranging $50,000,000 to
$100,000,000 are limited to 20% of Moody's Eligible Assets.
(3) The referenced percentages represent maximum cumulative totals only for the
related Moody's rating category and each lower Moody's rating category.
(4) Issuers subject to common ownership of 25% or more are considered as one
name.
(5) CS/CB refers to common stock and convertible corporate evidences of
indebtedness, which are diversified independently from the rating level.
(6) In the case of utility common stock, utility preferred stock, utility
evidences of indebtedness and utility convertible evidences of indebtedness,
the definition of industry refers to sub-industries (electric, water, hydro
power, gas, diversified). Investments in other sub-industries are eligible
only to the extent that the combined sum represents a percentage position of
the Moody's Eligible Assets less than or equal to the percentage limits in
the diversification tables above.
(7) For common stock assets, utility sub-industry assets above 50% and below 75%
will be discounted at 260%.
(8) Such percentage shall be 15% in the case of utilities regulated by
California, New York and Texas.
See the Articles Supplementary of the Fund for further detail on the above
Moody's Rating Agency Guidelines and for a description of Moody's Eligible
Assets.
The foregoing Rating Agency Guidelines are subject to change from time to
time. The Fund may, but it is not required to, adopt any such change. Nationally
recognized rating agencies other than S&P and Moody's may also from time to time
rate the AMPS; any nationally recognized rating agency providing a rating for
the AMPS may, at any time, change or withdraw any such rating.
U.S. FEDERAL TAXATION
The following is only a summary of certain U.S. Federal income tax
considerations generally affecting the Fund and its stockholders. No attempt is
made to present a detailed explanation of the tax treatment of the Fund or its
stockholders, and the following discussion is not intended as a substitute for
careful tax planning. Stockholders should consult with their own tax advisers
regarding the specific federal, state, local, foreign and other tax consequences
of investing in the Fund.
TAXATION OF THE FUND
The Fund has elected to be taxed as, and intends to qualify annually as, a
regulated investment company under Subchapter M of the Code. As a regulated
investment company, the Fund generally is not subject to U.S. Federal income tax
on the portion of its investment company taxable income (as that term is defined
in the Code, but determined without regard to any deduction for dividends paid)
and net capital gain (i.e., the excess of net long-term capital gain over net
short-term capital loss) that it distributes to stockholders, provided that it
distributes at least 90% of the sum of its investment company taxable income and
any net tax-exempt interest income for the taxable year (the 'Distribution
Requirement'), and satisfies certain other requirements of the Code that are
described below. The Fund intends to make sufficient distributions of its
investment company taxable income each taxable year to meet the Distribution
Requirement.
In addition to satisfying the Distribution Requirement, a regulated
investment company must (i) derive in each taxable year at least 90% of its
gross income from: (a) dividends, interest, payments with respect to certain
securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income (including but not limited to
gain from options, futures and forward contracts) derived with respect to its
business of investing in such stock, securities or foreign currencies; and
(b) net income derived from interests in certain publicly traded partnerships
that are treated as partnerships for U.S. federal income tax purposes and that
derive less than 90% of their gross income from the items described in (a) above
(each a 'Qualified Publicly Traded Partnership'); and (ii) diversify its
holdings so that, at the end of each
46
quarter of each taxable year: (a) at least 50% of the value of the Fund's total
assets is represented by (I) cash and cash items, U.S. government securities,
the securities of other regulated investment companies and (II) other
securities, with such other securities limited, in respect of any one issuer, to
an amount not greater than 5% of the value of the Fund's total assets and not
more than 10% of the outstanding voting securities of such issuer and (b) not
more than 25% of the value of the Fund's total assets is invested in the
securities (other than U.S. government securities and the securities of other
regulated investment companies) of (I) any one issuer, (II) any two or more
issuers that the Fund controls and that are determined to be engaged in the same
or similar trades or businesses or related trades or businesses or (III) any one
or more Qualified Publicly Traded Partnerships.
Upon any failure to meet the asset coverage requirements of the 1940 Act,
the Fund will be required (i) to suspend distributions to holders of Common
Shares, and (ii) under certain circumstances to partially redeem the AMPS in
order to maintain or restore the requisite asset coverage, either of which could
prevent the Fund from making distributions required to qualify as a regulated
investment company for U.S. Federal income tax purposes and to avoid the excise
taxes discussed below. Depending on the size of the Fund's assets relative to
its outstanding senior securities, under certain circumstances redemption of the
AMPS might restore asset coverage. If asset coverage were restored, the Fund
would again be able to pay dividends and depending on the circumstances, could
requalify or avoid disqualification as a regulated investment company and avoid
the excise taxes discussed below.
If for any taxable year the Fund does not qualify as a regulated investment
company or satisfy the Distribution Requirement, all of its taxable income
(including its net capital gain) will be subject to U.S. Federal income tax at
regular corporate rates without any deduction for distributions to stockholders,
and such distributions will be taxable as ordinary dividends to the extent of
the Fund's current and accumulated earnings and profits. Such distributions
generally will be eligible (i) for the DRD in the case of corporate stockholders
and (ii) for treatment as qualified dividend income in the case of individual
stockholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated investment company
that fails to distribute in a calendar year an amount equal to the sum of
(1) 98% of its ordinary taxable income for the calendar year, (2) 98% of its
capital gain net income (i.e., capital gains in excess of capital losses) for
the one-year period ended on October 31 of such calendar year, unless the Fund
elects to use a calendar year, and (3) any ordinary taxable income and capital
gain net income for previous years that was not distributed or taxed to the
regulated investment company during those years. A distribution will be treated
as paid on December 31 of the current calendar year if it is declared by the
Fund in October, November or December with a record date in such a month and
paid by the Fund during January of the following calendar year. Such
distributions will be taxed to stockholders in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received. To prevent the application of the excise tax, the
Fund intends to make its distributions in accordance with the calendar year
distribution requirement.
DISTRIBUTIONS
Based in part on the lack of any present intention on the part of the Fund
to redeem or purchase the AMPS at any time in the future, the Fund believes that
under present law the AMPS will constitute stock of the Fund and distributions
with respect to the AMPS (other than distributions in redemption of the AMPS
that are treated as exchanges of stock under Section 302(b) of the Code) thus
will constitute dividends to the extent of the Fund's current or accumulated
earnings and profits as calculated for U.S. Federal income tax purposes. Such
dividends generally will be taxable as ordinary income to holders (other than
distributions of qualified dividend income and capital gain dividends, as
described below). If a portion of the Fund's income consists of qualifying
dividends paid by U.S. corporations (other than REITs), a portion of the
dividends paid by the Fund to corporate stockholders, if properly designated,
may
47
qualify for the DRD. In addition, for taxable years beginning on or before
December 31, 2008, distributions of investment income designated by the Fund as
derived from qualified dividend income will be taxed in the hands of individuals
at the rates applicable to long-term capital gain, provided holding period and
other requirements are met by both the Fund and the stockholder. Specifically, a
dividend paid by the Fund to a stockholder will not be treated as qualified
dividend income of the stockholder (1) if the dividend is received with respect
to any share held for fewer than 61 days during the 121-day period beginning on
the date which is 60 days before the date on which such share becomes
ex-dividend with respect to such dividend, (2) to the extent that the recipient
is under an obligation (whether pursuant to a short sale or otherwise) to make
related payments with respect to positions in substantially similar or related
property, or (3) if the recipient elects to have the dividend treated as
investment income for purposes of the limitation on deductibility of investment
interest. Dividend income that the Fund receives from utility companies will
generally be treated as qualified dividend income, although there can be no
assurance in this regard. The foregoing discussion relies in part on a published
ruling of the IRS stating that certain preferred stock similar in many material
respects to the AMPS represents equity (and the following discussion assumes
such treatment will apply). It is possible, however, that the IRS might take a
contrary position asserting, for example, that the AMPS constitute debt of the
Fund. If this position were upheld, the discussion of the treatment of
distributions above would not apply. Instead, distributions by the Fund to
holders of AMPS would constitute interest, whether or not such distributions
exceeded the earnings and profits of the Fund, would be included in full in the
income of the recipient and would be taxed as ordinary income.
The Fund may either retain or distribute to stockholders its net capital
gain for each taxable year. The Fund currently intends to distribute any such
amounts. If net capital gain is distributed and designated as a capital gain
dividend, it generally will be taxable to individual stockholders at long-term
capital gains rates regardless of the length of time the stockholders have held
their shares. Conversely, if the Fund elects to retain its net capital gain, the
Fund will be taxed thereon (except to the extent of any available capital loss
carryovers) at the applicable corporate tax rate. In such event, it is expected
that the Fund also will elect to treat such gain as having been distributed to
stockholders. As a result, each stockholder will be required to report his or
her pro rata share of such gain on his or her tax return as long-term capital
gain, will be entitled to claim a tax credit for his or her pro rata share of
tax paid by the Fund on the gain, and will increase the tax basis for his or her
shares by an amount equal to the deemed distribution less the tax credit.
Long-term capital gain rates for individuals have been temporarily reduced
to 15% (with lower rates for individuals in the 10% and 15% rate brackets) for
taxable years beginning on or before December 31, 2008.
Distributions by the Fund in excess of the Fund's current and accumulated
earnings and profits will be treated as a return of capital to the extent of
(and in reduction of) the stockholder's tax basis in his or her shares; any such
return of capital distributions in excess of the stockholder's tax basis will be
treated as gain from the sale of his or her shares, as discussed below.
If the NAV at the time a stockholder purchases shares of the Fund reflects
undistributed income or gain, distributions of such amounts will be taxable to
the stockholder in the manner described above, even though such distributions
economically constitute a return of capital to the stockholder.
The IRS currently requires that a regulated investment company that has two
or more classes of stock allocate to each such class proportionate amounts of
each type of its income (such as ordinary income, capital gains, dividends
qualifying for the DRD, qualified dividend income, interest-related dividends
and short-term capital gain dividends) based upon the percentage of total
dividends paid out of current or accumulated earnings and profits to each class
for the tax year. Accordingly, the Fund intends each year to allocate capital
gain dividends, dividends qualifying for the DRD, dividends derived from
qualified dividend income, interest-related dividends and short-term capital
gain dividends, if any, between its Common Shares, the AMPS and the Outstanding
AMPS in proportion to the total dividends paid out of current or accumulated
48
earnings and profits to each class with respect to such tax year. Distributions
in excess of the Fund's current and accumulated earnings and profits, if any,
however, will not be allocated proportionately among the Common Shares, the AMPS
and the Outstanding AMPS. Since the Fund's current and accumulated earnings and
profits will first be used to pay dividends on the AMPS and the Outstanding
AMPS, distributions in excess of such earnings and profits, if any, will be made
disproportionately to holders of Common Shares.
SALE OF SHARES
A stockholder generally will recognize gain or loss on the sale or exchange
of shares of the Fund in an amount equal to the difference between the amount of
cash and the fair market value of any property received on the sale and the
stockholder's adjusted tax basis in the shares. In general, any such gain or
loss will be considered capital gain or loss if the shares are held as capital
assets, and gain or loss will be long-term or short-term, depending upon the
stockholder's holding period for the shares. Generally, a stockholder's gain or
loss will be a long-term gain or loss if the shares have been held for more than
one year. However, any capital loss arising from the sale of shares held for six
months or less will be treated as a long-term capital loss to the extent of any
capital gain dividends received by the stockholder (or amounts credited to the
stockholder as undistributed capital gains) with respect to such shares. Also,
any loss realized on a sale or exchange of shares will be disallowed to the
extent the shares disposed of are replaced with other substantially identical
shares within a period of 61 days beginning 30 days before and ending 30 days
after the shares are disposed of. In such case, the tax basis of the acquired
shares will be adjusted to reflect the disallowed loss. The ability to otherwise
deduct capital losses may be subject to other limitations imposed by the Code.
NATURE OF FUND'S INVESTMENTS
Certain of the Fund's investment practices are subject to special and
complex U.S. Federal income tax provisions that may, among other things,
(i) disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited),
(iv) cause the Fund to recognize income or gain without a corresponding receipt
of cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur, (vi) adversely alter the characterization of
certain complex financial transactions and (vii) produce income that will not
qualify as good income under the 90% annual gross income test described above.
The Fund will monitor its transactions and may make certain tax elections in
order to mitigate the effect of these provisions.
ORIGINAL ISSUE DISCOUNT SECURITIES
Investments by the Fund in zero coupon or other discount securities will
result in income to the Fund equal to a portion of the excess of the face value
of the securities over their issue price (the 'original issue discount') each
year that the securities are held, even though the Fund receives no cash
interest payments. This income is included in determining the amount of income
which the Fund must distribute to maintain its status as a regulated investment
company and to avoid the payment of Federal income tax and the 4% excise tax.
Because such income may not be matched by a corresponding cash distribution to
the Fund, the Fund may be required to borrow money or dispose of other
securities to be able to make distributions to its stockholders.
INVESTMENT IN REAL ESTATE INVESTMENT TRUSTS
The Fund may invest in REITs that hold residual interests in real estate
mortgage investment conduits ('REMICs'). Under Treasury regulations that have
not yet been issued, but may apply retroactively, a portion of the Fund's income
from a REIT that is attributable to the REIT's residual interest in a REMIC
(referred to in the Code as an 'excess inclusion') will be subject to U.S.
Federal income tax in all events. These regulations are also expected to provide
that excess inclusion income of a regulated investment company, such as the
Fund, will be allocated to
49
stockholders of the regulated investment company in proportion to the dividends
received by such stockholders, with the same consequences as if the stockholders
held the related REMIC residual interest directly. In general, excess inclusion
income allocated to stockholders (i) cannot be offset by net operating losses
(subject to a limited exception for certain thrift institutions), (ii) will
constitute unrelated business taxable income to entities (including a qualified
pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or
other tax-exempt entity) subject to tax on unrelated business income, thereby
potentially requiring such an entity that is allocated excess inclusion income,
and otherwise might not be required to file a tax return, to file a tax return
and pay tax on such income, and (iii) in the case of a foreign stockholder, will
not qualify for any reduction in U.S. Federal withholding tax. In addition, if
at any time during any taxable year a 'disqualified organization' (as defined in
the Code) is a record holder of a share in a regulated investment company, then
the regulated investment company will be subject to a tax equal to that portion
of its excess inclusion income for the taxable year that is allocable to the
disqualified organization, multiplied by the highest U.S. Federal income tax
rate imposed on corporations. The Investment Manager does not intend on behalf
of the Fund to invest in REITs, a substantial portion of the assets of which
consists of residual interests in REMICs.
INVESTMENTS IN SECURITIES OF UNCERTAIN TAX CHARACTER
The Fund may invest in preferred securities or other securities the U.S.
Federal income tax treatment of which may not be clear or may be subject to
recharacterization by the IRS. To the extent the tax treatment of such
securities or the income from such securities differs from the tax treatment
expected by the Fund, it could affect the timing or character of income
recognized by the Fund, requiring the Fund to purchase or sell securities, or
otherwise change its portfolio, in order to comply with the tax rules applicable
to regulated investment companies under the Code.
BORROWINGS
If the Fund utilizes leverage through borrowing, it may be restricted by
loan covenants with respect to the declaration of, and payment of, dividends in
certain circumstances. Limits on the Fund's payments of dividends may prevent
the Fund from meeting the distribution requirements, described above, and may,
therefore, jeopardize the Fund's qualification for taxation as a regulated
investment company and possibly subject the Fund to the 4% excise tax. The Fund
will endeavor to avoid restrictions on its ability to make dividend payments.
INVESTMENT IN NON-U.S. SECURITIES
The Fund's investment in non-U.S. securities may be subject to non-U.S.
withholding taxes. In that case, the Fund's yield on those securities would be
decreased. Stockholders will generally not be entitled to claim a credit or
deduction with respect to foreign taxes paid by the Fund.
In addition, if the Fund acquires an equity interest in certain foreign
corporations that receive at least 75% of their annual gross income from passive
sources (such as interest, dividends, certain rents and royalties or capital
gains) or that hold at least 50% of their assets in investments producing such
passive income ('passive foreign investment companies'), the Fund could be
subject to U.S. Federal income tax and additional interest charges on gains and
certain distributions with respect to those equity interests, even if all the
income or gain is timely distributed to its stockholders. The Fund will not be
able to pass through to its stockholders any credit or deduction for such taxes.
An election would generally be available to ameliorate these adverse tax
consequences, but any such election could require the Fund to recognize taxable
income or gain without the concurrent receipt of cash. These investments could
also result in the treatment of capital gains as ordinary income. The Fund
intends to manage its holdings to limit the tax liability from these
investments.
BACKUP WITHHOLDING
If a stockholder fails to furnish a correct taxpayer identification number
or fails to make required certifications or has been notified by the IRS that
the stockholder is subject to 'backup withholding,' the stockholder may be
subject to a 'backup withholding' tax with respect to
50
(1) taxable dividends and (2) the proceeds of any sales or repurchases of AMPS.
An individual's taxpayer identification number is generally his or her social
security number. Corporate stockholders and other stockholders specified in the
Code or the Treasury regulations promulgated thereunder are exempt from backup
withholding. Backup withholding is not an additional tax and any amounts
withheld will be allowed as a refund or a credit against a taxpayer's U.S.
Federal income tax liability if the appropriate information is provided to the
IRS.
FOREIGN STOCKHOLDERS
U.S. taxation of a stockholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ('foreign stockholder') as defined in the Code, depends
on whether the income of the Fund is 'effectively connected' with a U.S. trade
or business carried on by the stockholder.
Income Not Effectively Connected. If the income from the Fund is not
'effectively connected' with a U.S. trade or business carried on by the foreign
stockholder, distributions of investment company taxable income, including any
dividends designated as qualified dividend income, will generally be subject to
a U.S. tax of 30% (or lower treaty rate, except in the case of any excess
inclusion income allocated to the stockholder (see 'U.S. Federal
Taxation -- Investments in Real Estate Investment Trusts' above)), which tax is
generally withheld from such distributions. Under the American Jobs Creation Act
of 2004 (the 'Act'), U.S. source withholding taxes are no longer imposed on
dividends paid by regulated investment companies to the extent the dividends are
designated as 'interest-related dividends' or 'short-term capital gain
dividends.' Under this exemption, interest-related dividends and short-term
capital gain dividends generally represent distributions of U.S. source interest
or short-term capital gains that would not have been subject to U.S. withholding
tax at the source if they had been received directly by a foreign person, and
that satisfy certain other requirements. The exemption applies to dividends with
respect to taxable years of regulated investment companies beginning before
January 1, 2008.
Capital gain dividends and any amounts retained by the Fund which are
designated as undistributed capital gains will generally not be subject to U.S.
Federal withholding tax at the rate of 30% (or lower treaty rate) unless the
foreign stockholder is a nonresident alien individual and is physically present
in the United States for more than 182 days during the taxable year and meets
certain other requirements. However, this 30% tax on capital gains of
nonresident alien individuals who are physically present in the United States
for more than the 182 day period only applies in exceptional cases because any
individual present in the United States for more than 182 days during the
taxable year is generally treated as a resident for U.S. income tax purposes; in
that case, he or she would generally be subject to U.S. Federal income tax on
his or her worldwide income at the graduated rates applicable to U.S. citizens,
rather than the 30% U.S. Federal withholding tax. In the case of a foreign
stockholder who is a nonresident alien individual, the Fund may be required to
backup withhold U.S. Federal income tax on distributions of net capital gain
unless the foreign stockholder certifies his or her non-U.S. status under
penalties of perjury or otherwise establishes an exemption. See 'U.S. Federal
Taxation -- Backup Withholding' above. Under the Act, capital gains
distributions attributable to gains from U.S. real property interests (including
certain U.S. real property holding corporations and which may include certain
REITs and certain REIT capital gain dividends) will generally cause the foreign
stockholder to be treated as recognizing such gain as income effectively
connected to a trade or business within the United States. Foreign stockholders
would thus generally be taxed at the same rates applicable to U.S. stockholders,
subject to a special alternative minimum tax in the case of nonresident alien
individuals. Also, such gain may be subject to a 30% branch profits tax in the
hands of a foreign stockholder that is a corporation. Such distributions may be
subject to U.S. withholding tax and will generally give rise to an obligation on
the part of the foreign stockholder to file a U.S. federal income tax return.
This provision generally would apply to distributions with respect to taxable
years of regulated investment companies beginning before January 1, 2008. Any
gain that a foreign stockholder realizes upon the sale or exchange of such
stockholder's shares of the Fund will ordinarily be exempt from U.S. Federal
withholding tax unless the stockholder is a nonresident alien individual, the
gain is U.S. source income and such stockholder is physically present in the
51
United States for more than 182 days during the taxable year and meets certain
other requirements.
Income Effectively Connected. If the income from the Fund is 'effectively
connected' with a U.S. trade or business carried on by a foreign stockholder,
then distributions of investment company taxable income and capital gain
dividends, any amounts retained by the Fund which are designated as
undistributed capital gains and any gains realized upon the sale or exchange of
shares of the Fund will generally be subject to U.S. Federal income tax at the
graduated rates applicable to U.S. citizens, residents and domestic
corporations. Foreign corporate stockholders may also be subject to the branch
profits tax imposed by the Code.
The tax consequences to a foreign stockholder entitled to claim the benefits
of an applicable tax treaty may differ from those described herein. Foreign
stockholders are advised to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in the Fund.
TAX SHELTER REPORTING REGULATIONS
Under Treasury regulations, if a stockholder recognizes a loss with respect
to shares of $2 million or more for an individual stockholder or $10 million or
more for a corporate stockholder in any single taxable year (or a greater loss
over a combination of years), the stockholder must file with the IRS a
disclosure statement on Form 8886. Direct stockholders of portfolio securities
are in many cases excepted from this reporting requirement, but under current
guidance, stockholders of a regulated investment company are not excepted.
Future guidance may extend the current exception from this reporting requirement
to stockholders of most or all regulated investment companies. The fact that a
loss is reportable under these regulations does not affect the legal
determination of whether the taxpayer's treatment of the loss is proper.
Stockholders should consult their tax advisors to determine the applicability of
these regulations in light of their individual circumstances.
EFFECT OF FUTURE LEGISLATION; OTHER TAX CONSIDERATIONS
The foregoing general discussion of U.S. Federal income tax consequences is
based on the Code and the Treasury regulations issued thereunder as in effect on
the date of this SAI. Future legislative or administrative changes or court
decisions may significantly change the conclusions expressed herein, and any
such changes or decisions may have a retroactive effect with respect to the
transactions and considerations discussed herein.
Distributions to stockholders also may be subject to state, local and
foreign taxes, depending upon each stockholder's particular situation.
Stockholders are urged to consult their tax advisers as to the particular
consequences to them of an investment in the Fund.
PERFORMANCE DATA AND INDEX RETURNS
From time to time, the Fund may quote the Fund's total return, aggregate
total return or yield in advertisements or in reports and other communications
to stockholders. The Fund's performance will vary depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investors comparing the Fund's
performance with that of other investment companies should give consideration to
the quality and maturity of the respective investment companies' portfolio
securities.
AVERAGE ANNUAL TOTAL RETURN
The Fund's 'average annual total return' figures described in the Prospectus
are computed according to a formula prescribed by the Securities and Exchange
Commission. The formula can be expressed as follows:
52
P(1 + T)'pp'n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000 investment
made at the beginning of a 1-, 5-, or 10-year period at the
end of a 1-, 5-, or 10-year period (or fractional portion
thereof), assuming reinvestment of all dividends and
distributions.
YIELD
Quotations of yield for the Fund will be based on all investment income per
share earned during a particular 30-day period (including dividends and
interest), less expenses accrued during the period ('net investment income') and
are computed by dividing net investment income by the maximum offering price per
share on the last day of the period, according to the following formula:
a-b
= --------------------
2[(cd + 1)'pp'6 - 1]
Where: a = dividends and interest earned during the period,
b = expenses accrued for the period (net of reimbursements),
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends, and
d = the maximum offering price per share on the last day of the
period.
In reports or other communications to stockholders of the Fund or in
advertising materials, the Fund may compare its performance with that of
(i) other investment companies listed in the rankings prepared by Lipper
Analytical Services, Inc., publications such as Barrons, Business Week, Forbes,
Fortune, Institutional Investor, Kiplinger's Personal Finance, Money,
Morningstar Mutual Fund Values, The New York Times, The Wall Street Journal and
USA Today or other industry or financial publications or (ii) the Standard and
Poor's Index of 500 Stocks, the Dow Jones Industrial Average, Dow Jones Utility
Index, the Salomon Brothers Broad Investment Grade Bond Index (BIG), Morgan
Stanley Capital International Europe Australia Far East (MSCI EAFE) Index, the
NASDAQ Composite Index, and other relevant indices and industry publications.
The Fund may also compare the historical volatility of its portfolio to the
volatility of such indices during the 30 same time periods. (Volatility is a
generally accepted barometer of the market risk associated with a portfolio of
securities and is generally measured in comparison to the stock market as a
whole -- the beta -- or in absolute terms -- the standard deviation.)
Marketing materials for the Fund may make reference to other closed-end
investment companies for which the Investment Manager serves as investment
adviser. The past performance of any other Cohen & Steers Fund is not a
guarantee of future performance for the Fund.
EXPERTS
PricewaterhouseCoopers LLP has been appointed as the independent registered
public accounting firm for the Fund. The audited financial statements for the
period from March 30, 2004 through December 31, 2004 included in this Statement
of Additional Information have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent registered public accounting firm, given
on the authority of said firm as experts in auditing and accounting.
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Cohen & Steers Select Utility Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Cohen & Steers Select Utility Fund,
Inc. (the 'Fund') at December 31, 2004, and the results of its operations, the
changes in its net assets and the financial highlights for the period March 30,
2004 (commencement of operations) through December 31, 2004, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements and financial highlights (hereafter referred to as
'financial statements') are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these financial statements in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit, which included confirmation of securities at December 31, 2004 by
correspondence with the custodian and brokers, provides a reasonable basis for
our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 21, 2005
54
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2004
DIVIDEND
NUMBER VALUE YIELD
OF SHARES (NOTE 1) (UNAUDITED)(a)
--------- -------------- --------------
Common Stock 119.71%(b)
Utilities 119.71%
Electric -- Integrated 90.76%
Ameren Corp................................... 1,424,500 $ 71,424,430 5.07%
American Electric Power Co.................... 409,000 14,045,060 4.08
Cinergy Corp.................................. 1,559,000 64,901,170 4.52
Cleco Corp.................................... 246,700 4,998,142 4.44
DTE Energy Co................................. 1,302,300 56,168,199 4.78
Dominion Resources............................ 414,600 28,085,004 3.93
Duke Energy Corp.............................. 2,471,100 62,592,963 4.34
E.ON AG (ADR)................................. 298,000 27,118,000 3.09
Entergy Corp.................................. 696,350 47,066,296 3.20
Exelon Corp................................... 1,435,464 63,260,898 3.63
FirstEnergy Corp.............................. 928,100 36,669,231 4.18
FPL Group..................................... 478,500 35,767,875 3.64
Hawaiian Electric Industries.................. 1,280,100 37,314,915 4.25
NiSource...................................... 339,000 7,722,420 4.04
PPL Corp...................................... 387,000 20,619,360 3.08
Pacific Gas & Electric Co..................... 25,600 667,520 3.64
Pinnacle West Capital Corp.................... 1,086,000 48,229,260 4.28
Progress Energy............................... 808,450 36,574,278 5.22
Public Service Enterprise Group............... 811,400 42,006,178 4.25
Puget Energy.................................. 476,000 11,757,200 4.05
SCANA Corp.................................... 203,700 8,025,780 3.71
Scottish Power plc (ADR)...................... 342,000 10,656,720 4.11
Southern Co................................... 2,134,600 71,551,792 4.27
TXU Corp...................................... 495,000 31,957,200 3.49
Xcel Energy................................... 2,230,000 40,586,000 4.56
--------------
879,765,891
--------------
Electric -- Distribution 14.83%
Consolidated Edison........................... 1,289,500 56,415,625 5.17
Energy East Corp.............................. 379,700 10,130,396 4.12
National Grid Transco plc (ADR)............... 701,300 33,655,387 4.44
NSTAR......................................... 197,000 10,693,160 4.09
Pepco Holdings................................ 1,542,500 32,886,100 4.69
--------------
143,780,668
--------------
Gas -- Distribution 4.60%
AGL Resources................................. 261,000 8,675,640 3.49
Atmos Energy Corp............................. 460,500 12,594,675 4.53
Sempra Energy................................. 213,000 7,812,840 2.73
Vectren Corp.................................. 579,867 15,540,435 4.40
--------------
44,623,590
--------------
---------
(a) Dividend yield is computed by dividing the security's current annual
dividend rate by the last sale price on the principal exchange, or market,
on which such security trades. The dividend yield has not been audited.
(b) Percentages indicated are based on the net assets applicable to common
shares of the fund.
See accompanying notes to financial statements.
55
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
DECEMBER 31, 2004
DIVIDEND
NUMBER VALUE YIELD
OF SHARES (NOTE 1) (UNAUDITED)
---------- -------------- -----------
Gas -- Integrated 9.52%
Equitable Resources.......................... 777,300 $ 47,151,018 2.51%
KeySpan Corp................................. 1,144,800 45,162,360 4.61
--------------
92,313,378
--------------
Total Utilities.............................. 1,160,483,527
--------------
Total Common Stock
(Identified cost -- $1,019,996,874).... 1,160,483,527
--------------
Preferred Securities -- $25 Par Value 19.28%
Agricultural Chemicals 0.04%
Agrium, 8.00% (COPrS)........................ 16,700 428,021 7.80
--------------
Bank 0.58%
Chevy Chase Bank, 8.00%, Series C............ 87,100 2,525,900 6.90
First Republic Bank, 6.70% Series A.......... 118,700 3,098,070 6.44
--------------
5,623,970
--------------
Bank -- Foreign 0.12%
Northern Rock, 8.00%, Series................. 45,000 1,129,050 7.97
--------------
Insurance 0.11%
RenaissanceRE Holdings Ltd., 6.08%,
Series C................................... 46,100 1,100,407 6.37
--------------
Media 0.60%
Cable Televison 0.48%
Shaw Communications, 8.45%, Series A
(COPrS).................................... 85,553 2,160,213 8.36
Shaw Communications, 8.50%, Series B
(COPrS).................................... 99,600 2,529,840 8.39
--------------
4,690,053
--------------
Diversified Services 0.12%
Liberty Media Corp., 8.75% (CBTCS)........... 22,100 602,004 8.04
Liberty Media Corp., 8.75% (PPLUS)........... 20,700 565,317 8.02
--------------
1,167,321
--------------
Total Media.................................. 5,857,374
--------------
Real Estate 15.82%
Diversified 2.35%
Bedford Property Investors, 7.625%,
Series B................................... 205,350 5,254,907 7.46
Forest City Enterprises, 7.375%, Class A..... 80,800 2,057,976 7.22
iStar Financial, 7.875%, Series E............ 270,700 7,103,168 7.51
iStar Financial, 7.80%, Series F............. 132,000 3,432,000 7.50
iStar Financial, 7.50%, Series I............. 113,940 2,906,609 7.37
Lexington Corporate Properties Trust,
8.05%, Series B............................ 75,000 1,993,500 7.56
--------------
22,748,160
--------------
Health Care 2.25%
Health Care REIT, 7.875%, Series D........... 72,550 1,885,575 7.58
Health Care REIT, 7.625%, Series F........... 218,800 5,524,700 7.56
LTC Properties, 8.00%, Series F.............. 547,713 14,432,238 7.59
--------------
21,842,513
--------------
See accompanying notes to financial statements.
56
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
DECEMBER 31, 2004
DIVIDEND
NUMBER VALUE YIELD
OF SHARES (NOTE 1) (UNAUDITED)
---------- -------------- ------------
Hotel 1.41%
Ashford Hospitality Trust, 8.55%,
Series A................................... 155,600 $ 4,030,040 8.26%
Equity Inns, 8.75%, Series B................. 75,900 1,999,965 8.31
Host Marriott Corp., 8.875%, Series E........ 100,000 2,777,500 7.99
Innkeepers USA, 8.00%, Series C.............. 189,400 4,877,050 7.77
--------------
13,684,555
--------------
Office 4.85%
Alexandria Real Estate Equities, 8.375%,
Series C................................... 514,000 13,605,580 7.90
Brandywine Realty Trust, 7.50%, Series C..... 75,819 1,934,901 7.37
Corporate Office Properties Trust, 8.00%,
Series G................................... 38,486 1,019,879 7.55
CRT Properties, 8.50%, Series A.............. 35,335 930,371 8.09
Highwoods Properties, 8.00%, Series B........ 26,435 669,599 7.90
Highwoods Properties, 8.00%, Series D........ 33,058 832,070 7.95
Maguire Properties, 7.625%, Series A......... 495,626 12,688,026 7.46
SL Green Realty Corp., 7.625%, Series C...... 247,000 6,335,550 7.45
SL Green Realty Corp., 7.875%, Series D...... 347,333 9,013,291 7.59
--------------
47,029,267
--------------
Office/Industrial 1.02%
PS Business Parks, 7.00%, Series H........... 75,700 1,876,603 7.06
PS Business Parks, 6.875%, Series I.......... 54,950 1,357,265 6.96
PS Business Parks, 7.95%, Series K........... 252,000 6,652,800 7.54
--------------
9,886,668
--------------
Residential -- Apartment 0.23%
Apartment Investment & Management Co., 8.00%,
Series V................................... 87,000 2,207,190 7.88
--------------
Shopping Center 2.48%
Community Center 1.83%
Cedar Shopping Centers, 8.875%, Series A..... 260,000 6,858,800 8.42
Developers Diversified Realty Corp.,
7.375%, Series H........................... 25,000 647,750 7.10
Developers Diversified Realty Corp.,
7.50%, Series I............................ 302,000 7,821,800 7.26
Kramont Realty Trust, 8.25%, Series E........ 22,300 561,960 8.17
Saul Centers, 8.00%, Series A................ 67,500 1,805,625 7.48
--------------
17,695,935
--------------
Regional Mall 0.65%
CBL & Associates Properties, 7.75%,
Series C................................... 126,931 3,335,747 7.38
Mills Corp., 9.00%, Series C................. 43,300 1,203,740 8.09
Mills Corp., 8.75%, Series E................. 40,700 1,154,252 7.72
Taubman Centers, 8.00%, Series G............. 25,000 648,750 7.71
--------------
6,342,489
--------------
Total Shopping Center........................ 24,038,424
--------------
See accompanying notes to financial statements.
57
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
DECEMBER 31, 2004
DIVIDEND
NUMBER VALUE YIELD
OF SHARES (NOTE 1) (UNAUDITED)
---------- -------------- ------------
Specialty 1.23%
Capital Automotive REIT, 6.75%............... 125,000 $ 3,125,000 7.32%
Capital Automotive REIT, 7.50%, Series A..... 95,102 2,444,121 6.76
Capital Automotive REIT, 8.00%, Series B..... 240,400 6,311,702 7.62
--------------
11,880,823
--------------
Total Real Estate............................ 153,317,600
--------------
Utilities 2.01%
Electric -- Integrated 1.37%
Pacific Gas and Electric Co., 6.57%.......... 240,833 6,237,575 6.62
Southern California Edison Co., 7.23%,
Series A................................... 70,000 7,035,000 7.19
--------------
13,272,575
--------------
Gas -- Distribution 0.64%
Southern Union Co., 7.55%, Series C.......... 222,500 6,218,875 6.76
--------------
Total Utilities.............................. 19,491,450
--------------
Total Preferred Securities -- $25 Par
Value (Identified cost -- $177,777,426) 186,947,872
--------------
Preferred Securities -- Capital Trust 5.25%
Diversified Financial Services 1.62%
Old Mutual Capital Funding, 8.00%,
due 5/29/49 (Eurobond)..................... 14,850,000 15,713,067 7.56
--------------
Electric -- Integrated 1.41%
DPL Capital Trust II, 8.125%, due 9/1/31..... 3,000,000 3,413,694 7.14
Duquesne Light Co., 6.50%, Series H.......... 194,900 10,295,592 6.15
--------------
13,709,286
--------------
Food 0.94%
Dairy Products 0.74%
Dairy Farmers of America, 7.875%, 144A(a).... 70,000 7,139,174 7.73
--------------
Flour and Grain 0.20%
Gruma S.A., 7.75%, due 12/29/49, 144A........ 2,000,000 1,942,910 7.98
--------------
Total Food................................... 9,082,084
--------------
Insurance -- Multi-Line 0.86%
AFC Capital Trust I, 8.207%, due 2/3/27,
Series B................................... 8,000,000 8,349,384 7.87
--------------
Oil -- Exploration and Production 0.42%
Pemex Project Funding Master Trust, 7.75%,
due 9/29/49................................ 4,000,000 4,033,436 7.69
--------------
Total Preferred Securities -- Capital
Trust (Identified cost -- $49,640,296). 50,887,257
--------------
---------
(a) The fund prices this security at fair value using procedures approved by the
fund's board of directors.
See accompanying notes to financial statements.
58
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
DECEMBER 31, 2004
PRINCIPAL VALUE
AMOUNT (NOTE 1)
----------- -----------
Corporate Bond 5.25%
Automotive 1.37%
Delphi Corp., 7.125%, due 5/1/29............... $ 2,000,000 $ 1,885,596
Ford Motor Co., 9.215%, due 9/15/21............ 5,000,000 5,773,765
General Motors Corp., 9.40%, due 7/15/21....... 5,000,000 5,657,780
-----------
13,317,141
-----------
Cable Television 1.30%
Cablevision Systems New York Group, 8.00%,
due 4/15/12, 144A............................ 4,500,000 4,826,250
CSC Holdings, 7.875%, due 2/15/18.............. 2,500,000 2,712,500
Rogers Cable, 8.75%, due 5/01/32............... 4,500,000 5,017,500
-----------
12,556,250
-----------
Cellular Telecommunications 0.15%
Rogers Wireless Communications, 7.50%,
due 3/15/15, 144A............................ 1,400,000 1,484,000
-----------
Finance -- Auto Loan 0.21%
General Motors Acceptance Corp., 8.00%,
due 11/1/31.................................. 2,000,000 2,061,524
-----------
Insurance 0.76%
Liberty Mutual Insurance, 7.697%,
due 10/15/97................................. 7,000,000 7,353,850
-----------
Medical -- Hospitals 0.87%
Columbia/HCA, 8.36%, due 4/15/24............... 3,000,000 3,284,541
Columbia/HCA, 7.69%, due 6/15/25............... 4,000,000 4,110,308
Columbia/HCA, 7.75%, due 7/15/36............... 1,000,000 1,014,810
-----------
8,409,659
-----------
Telephone -- Integrated 0.59%
Citizens Communications Co., 9.00%, due
8/15/31...................................... 5,000,000 5,737,500
-----------
Total Corporate Bond
(Identified cost -- $49,518,140)......... 50,919,924
-----------
Commercial Paper 1.11%
State Street Corp., 1.70%, due 1/03/05
(Identified cost -- $10,744,985)............. 10,746,000 10,744,985
-----------
See accompanying notes to financial statements.
59
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
DECEMBER 31, 2004
VALUE
(NOTE 1)
--------------
Total Investments
(Identified cost -- $1,307,677,721)..... 150.60% $1,459,983,565
Other Assets in Excess of Liabilities..... 0.15% 1,429,174
Liquidation Value of Auction Market
Preferred Shares: Series M7, Series T7,
Series W7, Series TH28, Series F7
(Equivalent to $25,000 per share based
on 3,400 shares outstanding per class)
and Series T28 (Equivalent to $25,000
per share based on 2,680 shares
outstanding) ........................... (50.75)% (492,000,000)
------- --------------
Net Assets Applicable to Common Shares
(Equivalent to $22.38 per share based on
43,320,750 shares of capital stock
outstanding) ........................... 100.00% $ 969,412,739
------ --------------
------ --------------
GLOSSARY OF PORTFOLIO ABBREVIATIONS
--------------------------------------------------------------------------------
ADR American Depository Receipt.
CBTCS Corporate Backed Trust Certificates.
COPrS Canadian Origin Preferred Securities.
PPLUS Preferred Plus Trust.
--------------------------------------------------------------------------------
See accompanying notes to financial statements.
60
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2004
Assets:
Investments in securities, at value (Identified
cost -- $1,307,677,721) (Note 1)...................... $1,459,983,565
Dividends and interest receivable....................... 5,796,721
Other assets............................................ 41,986
--------------
Total Assets........................................ 1,465,822,272
--------------
Liabilities:
Unrealized depreciation on interest rate swap
transactions (Notes 1 and 6).......................... 1,919,926
Payable to investment manager........................... 793,953
Payable for dividends declared on common shares......... 592,390
Payable for dividends declared on preferred shares...... 507,202
Payable for preferred offering costs.................... 329,374
Payable to administrator................................ 65,800
Payable to custodian.................................... 7,823
Payable for directors fees.............................. 4,012
Other liabilities....................................... 189,053
--------------
Total Liabilities................................... 4,409,533
--------------
Liquidation Value of Preferred Shares:
Auction market preferred shares, Series M7, ($25,000
liquidation value, $0.001 par value, 3,400 shares
issued and outstanding) (Notes 1 and 5)............... 85,000,000
Auction market preferred shares, Series T7, ($25,000
liquidation value, $0.001 par value, 3,400 shares
issued and outstanding) (Notes 1 and 5)............... 85,000,000
Auction market preferred shares, Series T28, ($25,000
liquidation value, $0.001 par value, 2,680 shares
issued and outstanding) (Notes 1 and 5)............... 67,000,000
Auction market preferred shares, Series W7, ($25,000
liquidation value, $0.001 par value, 3,400 shares
issued and outstanding) (Notes 1 and 5)............... 85,000,000
Auction market preferred shares, Series TH28, ($25,000
liquidation value, $0.001 par value, 3,400 shares
issued and outstanding) (Notes 1 and 5)............... 85,000,000
Auction market preferred shares, Series F7, ($25,000
liquidation value, $0.001 par value, 3,400 shares
issued and outstanding) (Notes 1 and 5)............... 85,000,000
--------------
492,000,000
--------------
Total Net Assets Applicable to Common Shares................ $ 969,412,739
--------------
--------------
Total Net Assets Applicable to Common Shares consist of:
Common stock ($0.001 par value, 43,320,750 shares issued
and outstanding) (Notes 1 and 5)...................... $ 819,612,324
Distribution in excess of net investment income......... (315,065)
Accumulated net realized loss on investments............ (270,438)
Net unrealized appreciation on investments and interest
rate swap transactions................................ 150,385,918
--------------
$ 969,412,739
--------------
--------------
Net Asset Value per Common Share:
($969,412,739[div]43,320,750 shares outstanding)........ $ 22.38
--------------
--------------
Market Price Per Common Share............................... $ 19.82
--------------
--------------
Market Price Premium/(Discount) to Net Asset Value Per
Common Share.............................................. (11.44)%
--------------
--------------
See accompanying notes to financial statements.
61
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED MARCH 30, 2004(a) THROUGH DECEMBER 31, 2004
Investment Income (Note 1):
Dividend income (net of $42,567 of foreign withholding
tax).................................................. $ 40,067,248
Interest income......................................... 3,993,634
------------
Total Income........................................ 44,060,882
------------
Expenses:
Investment management fees (Note 2)..................... 7,767,088
Administration fees (Note 2)............................ 658,684
Preferred remarketing fee............................... 677,478
Professional fees....................................... 147,605
Reports to shareholders................................. 142,012
Custodian fees and expenses............................. 111,783
Directors' fees and expenses (Note 2)................... 44,201
Transfer agent fees and expenses........................ 14,921
Miscellaneous........................................... 148,527
------------
Total Expenses...................................... 9,712,299
------------
Reduction of Expenses (Note 2).......................... (1,827,550)
------------
Net Expenses........................................ 7,884,749
------------
Net Investment Income....................................... 36,176,133
------------
Net Realized and Unrealized Gain/(Loss) on Investments
(Note 1):
Net realized gain on investments........................ 488,760
Net realized loss on interest rate swap transactions.... (2,598,585)
Net change in unrealized appreciation on investments.... 152,305,844
Net change in unrealized depreciation on interest rate
swap transactions..................................... (1,919,926)
------------
Net realized and unrealized gain/(loss) on
investments....................................... 148,276,093
------------
Net Increase Resulting from Operations.................. 184,452,226
Less Dividends and Distributions to Preferred Shareholders
from:
Net Investment Income and net realized gains on
investments........................................... (5,240,938)
------------
Net Increase in Net Assets from Operations Applicable to
Common Shares............................................. $.179,211,288
------------
------------
---------
(a) Commencement of Operations.
See accompanying notes to financial statements.
62
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS APPLICABLE TO COMMON SHARES
FOR THE PERIOD
MARCH 30, 2004(a)
THROUGH
DECEMBER 31, 2004
-----------------
Change in Net Assets Applicable to Common Shares:
From Operations:
Net investment income............................... $ 36,176,133
Net realized loss on investments and interest rate
swap transactions................................. (2,109,825)
Net change in unrealized appreciation on investments
and interest rate swap transactions............... 150,385,918
------------
Net increase resulting from operations.......... 184,452,226
------------
Less Dividends and Distributions to Preferred
Shareholders from:
Net investment income............................... (5,135,684)
Net realized gain on investments.................... (105,254)
------------
Total dividends and distributions to preferred
shareholders.................................. (5,240,938)
------------
Net increase in net assets from operations
applicable to common shares....................... 179,211,288
------------
Less Dividends and Distributions to Common Shareholders
from:
Net investment income............................... (28,756,928)
Net realized gain on investments.................... (653,945)
Tax return of capital............................... (47,237)
------------
Total dividends and distributions to common
shareholders.................................. (29,458,110)
------------
Capital Stock Transactions (Note 5):
Increase in net assets from common share
transactions...................................... 825,593,430
Decrease in net assets from underwriting commissions
and offering expenses from issuance of preferred
shares............................................ (6,034,144)
------------
Net increase in net assets from capital stock
transactions.................................. 819,559,286
------------
Total increase in net assets applicable to
commmon shares................................ 969,312,464
------------
Net Assets Applicable to Common Shares:
Beginning of period................................. 100,275
------------
End of period(b).................................... $969,412,739
------------
------------
---------
(a) Commencement of Operations.
(b) Includes distribution in excess of net investment income of $315,065 at
December 31, 2004.
See accompanying notes to financial statements.
63
COHEN & STEERS SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS
The following table includes selected data for a common share outstanding
throughout the period and other performance information derived from the
financial statements. It should be read in conjunction with the financial
statements and notes thereto.
FOR THE PERIOD
MARCH 30, 2004(a)
THROUGH
DECEMBER 31, 2004
------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value per common share, beginning of period....... $ 19.10
--------
Income from investment operations:
Net investment income................................... 0.85(b)
Net realized and unrealized gain on investments......... 3.36
--------
Total income from investment operations........... 4.21
--------
Less dividends and distributions to preferred shareholders
from:
Net investment income................................... (0.12)
Net realized gain on investments........................ (0.00)(c)
--------
Total dividends and distributions to preferred
shareholders.................................... (0.12)
--------
Total from investment operations applicable to
common shares................................... 4.09
--------
Less Offering costs charged to paid-in capital -- common
shares............................................... (0.04)
Offering costs charged to paid-in capital -- preferred
shares............................................... (0.14)
Anti-dilutive effect of common share offering.......... 0.05
--------
Total offering and organization costs............. (0.13)
--------
Less dividends and distributions to common shareholders
from:
Net investment income.................................. (0.67)
Net realized gain on investments....................... (0.01)
Tax return of capital.................................. (0.00)(c)
--------
Total dividends and distributions to common
shareholders.................................... (0.68)
--------
Net increase in net asset value............................. 3.28
--------
Net asset value, per common share, end of period............ $ 22.38
--------
--------
Market value, per common share, end of period............... $ 19.82
--------
--------
Net asset value total return(d)............................. 21.57%(e)
--------
--------
Market value return(d)...................................... 2.82%(e)
--------
--------
---------
(a) Commencement of operations.
(b) Calculation based on average shares outstanding.
(c) Less than $.005 per share.
(d) Total market value return is computed based upon the New York Stock Exchange
market price of the fund's shares and excludes the effects of brokerage
commissions. Dividends and distributions, if any, are assumed for purposes
of this calculation, to be reinvested at prices obtained under the fund's
dividend reinvestment plan. Total net asset value return measures the
changes in value over the period indicated, taking into account dividends as
reinvested.
(e) Not annualized.
See accompanying notes to financial statements.
64
COHEN & STEERS SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS -- (CONTINUED)
FOR THE PERIOD
MARCH 30, 2004(a)
THROUGH
DECEMBER 31, 2004
------------------
RATIOS/SUPPLEMENTAL DATA:
Net assets applicable to common shares, end of period
(in millions)............................................. $ 969.4
--------
--------
Ratio of expenses to average daily net assets applicable to
common shares (before expense reduction)(b)............... 1.51%(c)
--------
--------
Ratio of expenses to average daily net assets applicable to
common shares (net of expense reduction)(b)............... 1.22%(c)
--------
--------
Ratio of net investment income to average daily net assets
applicable to common shares (before expense reduction)(b). 5.33%(c)
--------
--------
Ratio of net investment income to average daily net assets
applicable to common shares (net of expense reduction)(b). 5.62%(c)
--------
--------
Ratio of expenses to average daily managed assets (before
expense reduction)(b,e)................................... 1.06%(c)
--------
--------
Ratio of expenses to average daily managed assets (net of
expense reduction)(b,e)................................... 0.86%(c)
--------
--------
Portfolio turnover rate..................................... 14.03%(d)
--------
--------
PREFERRED SHARES:
Liquidation value, end of period (in 000's)................. $492,000
--------
--------
Total shares outstanding (in 000's)......................... 20
--------
--------
Asset coverage per share.................................... $ 74,259
--------
--------
Liquidation preference per share............................ $ 25,000
--------
--------
Average market value per share(f)........................... $ 25,000
--------
--------
---------
(a) Commencement of operations.
(b) Ratios do not reflect dividend payments to preferred shareholders.
(c) Annualized.
(d) Not annualized.
(e) Average daily managed assets represents net assets applicable to common
shares plus liquidation preference of preferred shares.
(f) Based on weekly prices.
See accompanying notes to financial statements.
65
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Cohen & Steers Select Utility Fund, Inc. (the fund) was incorporated under
the laws of the State of Maryland on January 8, 2004 and is registered under the
Investment Company Act of 1940, as amended, as a closed-end, nondiversified
management investment company. The fund had no operations until March 3, 2004
when it sold 5,250 shares of common stock for $100,275 to Cohen & Steers Capital
Management, Inc. (the investment manager). Investment operations commenced on
March 30, 2004.
The following is a summary of significant accounting policies consistently
followed by the fund in the preparation of its financial statements. The
policies are in conformity with accounting principles generally accepted in the
United States of America (GAAP). The preparation of the financial statements in
accordance with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
Portfolio Valuation: Investments in securities that are listed on the New
York Stock Exchange are valued, except as indicated below, at the last sale
price reflected at the close of the New York Stock Exchange on the business day
as of which such value is being determined. If there has been no sale on such
day, the securities are valued at the mean of the closing bid and asked prices
for the day or, if no asked price is available, at the bid price. If no bid or
asked prices are quoted on such day, then the security is valued by such method
as the board of directors shall determine in good faith to reflect its fair
market value.
Securities not listed on the New York Stock Exchange but listed on other
domestic or foreign securities exchanges or admitted to trading on the National
Association of Securities Dealers Automated Quotations, Inc. (Nasdaq) national
market system are valued in a similar manner. Securities traded on more than one
securities exchange are valued at the last sale price on the business day as of
which such value is being determined as reflected on the tape at the close of
the exchange representing the principal market for such securities.
Readily marketable securities traded in the over-the-counter market,
including listed securities whose primary market is believed by the investment
manager to be over-the-counter, but excluding securities admitted to trading on
the Nasdaq national list, are valued at the official closing prices as reported
by Nasdaq, the National Quotations Bureau or such other comparable sources as
the board of directors deems appropriate to reflect their fair market value. If
there has been no sale on such day, the securities are valued at the mean of the
closing bid and asked prices for the day or, if no asked price is available, at
the bid price. However, certain fixed-income securities may be valued on the
basis of prices provided by a pricing service when such prices are believed by
the board of directors to reflect the fair market value of such securities.
Where securities are traded on more than one exchange and also over-the-counter,
the securities will generally be valued using the quotations the board of
directors believes reflect most closely the value of such securities.
Short-term debt securities, which have a maturity of 60 days or less, are
valued at amortized cost which approximates value.
Any securities for which market quotations are not readily available shall
be valued in accordance with the procedures approved by the board of directors.
Security Transactions and Investment Income: Security transactions are
recorded on trade date. Realized gains and losses on investments sold are
recorded on the basis of identified cost. Interest income is recorded on the
accrual basis. Dividend income is recorded on the ex-dividend date. The fund
records distributions received in excess of income from underlying investments
as a reduction of cost of investments and/or realized gain. Such amounts are
based on estimates if actual amounts are not available, and actual amounts of
income, realized gain and return of capital may differ from the estimated
amounts. The fund adjusts the estimated amounts of the components of
66
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
distributions (and, consequently, its net investment income) as an increase to
unrealized appreciation/(depreciation) and realized gain/(loss) on investments
as necessary once the issuers provide information about the actual composition
of the distributions.
Interest Rate Swaps: The fund uses interest rate swaps in connection with
the sale of taxable auction market preferred shares. The interest rate swaps are
intended to reduce or eliminate the effect that an increase in short-term
interest rates could have on the performance of the fund's common shares as a
result of the floating rate structure of preferred shares. In these interest
rate swaps, the fund agrees to pay the other party to the interest rate swap
(which is known as the counterparty) a fixed rate payment in exchange for the
counterparty agreeing to pay the fund a variable rate payment that is intended
to approximate the fund's variable rate payment obligation on the auction market
preferred shares. The payment obligation is based on the notional amount of the
swap. Depending on the state of interest rates in general, the use of interest
rate swaps could enhance or harm the overall performance of the common shares.
The market value of interest rate swaps is based on pricing models that consider
the time value of money, volatility, the current market and contractual prices
of the underlying financial instrument. Unrealized gains are reported as an
asset and unrealized losses are reported as a liability on the Statement of
Assets and Liabilities. The change in value of swaps, including the accrual of
periodic amounts of interest to be paid or received on swaps is reported as
unrealized gains or losses in the Statement of Operations. A realized gain or
loss is recorded upon payment or receipt of a periodic payment or termination of
swap agreements. Swap agreements involve, to varying degrees, elements of market
and counterparty risk, and exposure to loss in excess of the related amounts
reflected in the Statement of Assets and Liabilities.
Dividends and Distributions to Shareholders: Dividends from net investment
income are declared and paid to common shareholders monthly. Dividends to
shareholders are recorded on the ex-dividend date. A portion of the fund's
distributions may consist of amounts derived from nontaxable components of the
dividends from the fund's portfolio investments. Net realized capital gains,
unless offset by any available capital loss carryforward, are distributed to
shareholders annually.
Dividends from net investment income and capital gain distributions are
determined in accordance with U.S. federal income tax regulations which may
differ from GAAP.
Series M7, Series T7, Series W7, and Series F7 preferred shares pay
dividends based on a variable interest rate set at auctions, normally held every
seven days. Dividends for Series M7, Series T7, Series W7, and Series F7
preferred shares are accrued for the subsequent seven day period on the auction
date. In most instances, dividends are payable every seven days, on the first
business day following the end of the dividend period.
Series T28 and Series TH28 preferred shares pay dividends based on a
variable interest rate set at auctions, normally held every 28 days. Dividends
for Series T28 and Series TH28 preferred shares are accrued for the subsequent
28 day period on the auction date. In most instances, dividends are payable
every 28 days, on the first business day following the end of the dividend
period.
Federal Income Taxes: It is the policy of the fund to qualify as a regulated
investment company, if such qualification is in the best interest of the
shareholders, by complying with the requirements of Subchapter M of the Internal
Revenue Code applicable to regulated investment companies, and by distributing
substantially all of its taxable earnings to its shareholders. Accordingly, no
provision for federal income or excise tax is necessary.
NOTE 2. INVESTMENT MANAGEMENT FEES, ADMINISTRATION FEES AND OTHER TRANSACTIONS
WITH AFFILIATES
Investment Management Fees: Cohen & Steers Capital Management, Inc. (the
investment manager) serves as the investment manager to the fund, pursuant to an
investment management
67
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
agreement (the management agreement). The investment manager furnishes a
continuous investment program for the fund's portfolio, makes the day-to-day
investment decisions for the fund and generally manages the fund's investments
in accordance with the stated polices of the fund, subject to the general
supervision of the board of directors of the fund. The investment manager also
performs certain administrative services for the fund.
For the services under the management agreement, the fund pays the
investment manager a monthly management fee, computed daily and payable monthly
at an annual rate of 0.85% of the fund's average daily managed asset value.
Managed asset value is the net asset value of the common shares plus the
liquidation preference of the preferred shares. For the period March 30, 2004
(commencement of operations) through December 31, 2004, the fund incurred
investment management fees of $7,767,088.
The investment manager has contractually agreed to waive its investment
management fee in the amount of 0.20% of average daily managed asset value for
the first five years of the fund's operations, 0.15% of average daily managed
asset value in year six, 0.10% of average daily managed asset value in year
seven, and 0.05% of average daily managed asset value in year eight. As long as
this expense cap continues, it may lower the fund's expenses and increase its
total return. For the period March 30, 2004 (commencement of operations) through
December 31, 2004, the investment manager waived management fees of $1,827,550.
Administration Fees: Pursuant to an administration agreement, the investment
manager also performs certain administrative and accounting functions for the
fund and receives a fee equal to, on an annual basis, 0.06% of the fund's
average daily managed assets up to $1 billion, 0.04% of the fund's average daily
managed assets in excess of $1 billion up to $1.5 billion and 0.02% of the
fund's average daily managed assets in excess of $1.5 billion. For the period
March 30, 2004 (commencement of operations) through December 31, 2004, the fund
incurred $516,876 in administration fees.
Director's Fees: Certain directors and officers of the fund are also
directors, officers and/or employees of the investment manager. None of the
directors and officers so affiliated received compensation for their services.
For the period March 30, 2004 (commencement of operations) through December 31,
2004, fees and related expenses accrued for nonaffiliated directors totaled
$44,201.
Other: During the period, the fund may have purchased securities in which an
affiliate of the investment manager served as placement agent for the issuer.
NOTE 3. PURCHASES AND SALES OF SECURITIES
Purchases and sales of securities, excluding short-term investments, for the
period March 30, 2004 (commencement of operations) through December 31, 2004,
totaled $1,452,690,699 and $155,475,801, respectively.
NOTE 4. INCOME TAXES
The fund had a return of capital of $47,237 (less than $.005 per common
share) period March 30, 2004 (commencement of operations) through December 31,
2004 which has been deducted from paid-in capital. Short-term capital gains are
reflected in the financial statements as realized gains on investments but are
typically treated as ordinary income for tax purposes.
68
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
For the period March 30, 2004 (commencement of operations) through
December 31, 2004 the dividends and distributions to shareholders are
characterized for tax purposes as follows:
FOR THE PERIOD
MARCH 30, 2004
(COMMENCEMENT OF
OPERATIONS) THROUGH
DECEMBER 31, 2004
-----------------
Preferred shareholders:
Ordinary income......................................... $ 5,160,311(a)
Long-term capital gains................................. 80,627
-----------
Total dividends and distributions to preferred
shareholders...................................... $ 5,240,938
-----------
-----------
Common shareholders:
Ordinary income......................................... $28,909,936
Long-term capital gains................................. 500,937
Tax return of capital................................... 47,237
-----------
Total dividends and distributions to common
shareholders...................................... $29,458,110
-----------
-----------
---------
(a) Under federal income tax rules, the tax character of $507,202 will be
determined based upon 2005 earnings and profits.
At December 31, 2004, the cost of investments and net unrealized
appreciation for federal income tax purposes were as follows:
Aggregate cost.............................................. $1,307,948,160
--------------
--------------
Gross unrealized appreciation............................... $ 152,658,320
Gross unrealized depreciation............................... (622,915)
--------------
Net unrealized appreciation on investments.................. 152,035,405
Net unrealized depreciation on interest rate swap
Transactions.............................................. (1,727,788)
--------------
Net unrealized appreciation................................. $ 150,307,617
--------------
--------------
Differences between book and tax basis unrealized appreciation are primarily
due to wash sales on portfolio securities and differing treatment of swap
income/expense.
Net investment income and net realized gains differ for financial statement
and tax purposes primarily due to differing treatments of interest rate swap
payments and wash sales on portfolio securities. To the extent such differences
are permanent in nature, such amounts are reclassified within the capital
accounts. During the period March 30, 2004 (commencement of operations) through
December 31, 2004 the fund decreased undistributed net investment income by
$2,598,586 and increased accumulated net realized gain on investments by
$2,598,586, relating primarily to differing treatment of interest rate swap
income/expense.
For the year ended December 31, 2004, the fund did not have any
undistributed ordinary income or capital gains.
NOTE 5. CAPITAL STOCK
On March 26, 2004, the fund completed the initial public offering of
41,250,000 shares of common stock. Proceeds paid to the fund amounted to
$786,225,000 after deduction of underwriting commissions and offering expenses
of $38,775,000.
On May 7, 2004, the fund completed a subsequent offering of 2,065,500 shares
of common stock. Proceeds paid to the fund amounted to $39,368,430 after
deduction of underwriting commissions and offering expenses of $1,941,570.
69
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
During the period March 30, 2004 (commencement of operations) through
December 31, 2004, the fund issued no shares of common stock for the
reinvestment of dividends. At December 31, 2004, Cohen & Steers Capital
Management, Inc. owned approximately 5,400 shares.
On May 20, 2004, the fund issued 3,400 auction market preferred shares,
Series M7 (par value $0.001), 3,400 auction market preferred shares, Series T7
(par value $0.001), 3,400 auction market preferred shares, Series W7 (par value
$0.001), 3,400 auction market preferred shares, Series F7 (par value $0.001),
and 3,400 auction market preferred shares, Series TH28 (par value $0.001)
(together referred to as preferred shares). Proceeds paid to the fund amounted
to $420,017,152 after deduction of underwriting commissions and offering
expenses of $4,982,848. These issues have received a 'AAA/Aaa' rating from
Standard & Poor's and Moody's.
On November 15, 2004, the fund issued 2,680 auction market preferred shares,
Series T28 (par value $0.001). Proceeds paid to the fund amounted to $65,948,704
after deduction of underwriting commissions and offering expenses of $1,051,296.
This issue has received a 'AAA/Aaa' rating from Standard & Poor's and Moody's.
Preferred shares are senior to the fund's common shares and will rank on a
parity with shares of any other series of preferred shares, and with shares of
any other series of preferred stock of the fund, as to the payment of dividends
and the distribution of assets upon liquidation. If the fund does not timely
cure a failure to (1) maintain a discounted value of its portfolio equal to the
preferred shares basic maintenance amount, (2) maintain the 1940 Act preferred
shares asset coverage, or (3) file a required certificate related to asset
coverage on time, all of the forgoing as defined in the articles supplementary
of the fund, the preferred shares will be subject to a mandatory redemption at
the redemption price of $25,000 per share plus an amount equal to accumulated
but unpaid dividends thereon to the date fixed for redemption. To the extent
permitted under the 1940 Act and Maryland Law, the fund at its option may
without consent of the holders of preferred shares, redeem preferred shares
having a dividend period of one year or less, in whole, or in part, on the
business day after the last day of such dividend period upon not less than 15
calendar days and not more than 40 calendar days prior to notice. The optional
redemption price is $25,000 per share plus an amount equal to accumulated but
unpaid dividends thereon to the date fixed for redemption.
The fund's common shares and preferred shares have equal voting rights of
one vote per share and vote together as a single class. In addition, the
affirmative vote of a majority of the holders as defined in the 1940 Act, of the
outstanding preferred shares shall be required to (1) approve any plan of
reorganization that would adversely affect the taxable auction market preferred
shares and (2) any matter that materially and adversely affects the rights,
preferences, or powers of that series.
70
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. INVESTMENTS IN INTEREST RATE SWAPS
The fund has entered into interest rate swap agreements with UBS AG, Royal
Bank of Canada, and Merrill Lynch Derivative Products AG. Under the agreements
the fund receives a floating rate of interest and pays a respective fixed rate
of interest on the notional values of the swaps. Details of the swaps at
December 31, 2004 are as follows:
FLOATING RATE(a)
NOTIONAL (RATE RESET UNREALIZED
COUNTERPARTY AMOUNT FIXED RATE MONTHLY) TERMINATION DATE (DEPRECIATION)
-------------------------- ----------- ---------- -------- ---------------- --------------
Merrill Lynch Derivative
Products AG............. $40,000,000 3.8225% 2.2800% June 2, 2008 $ (266,178)
Merrill Lynch Derivative
Products AG............. $35,000,000 4.0850% 2.4175% May 27, 2009 (371,397)
Merrill Lynch Derivative
Products AG............. $40,000,000 3.9950% 2.3400% July 7, 2009 (288,213)
Royal Bank of Canada...... $35,000,000 3.8900% 2.4100% May 19, 2008 (289,091)
Royal Bank of Canada...... $30,000,000 4.0775% 2.2800% June 1, 2009 (349,861)
UBS AG.................... $32,500,000 3.9775% 2.4100% June 17, 2008 (355,186)
-----------
$(1,919,926)
-----------
-----------
---------
(a) Based on LIBOR (London Interbank Offered Rate). Represents rates in effect
at December 31, 2004.
71
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS
JUNE 30, 2005 (UNAUDITED)
NUMBER VALUE DIVIDEND
OF SHARES (NOTE 1) YIELD(a)
---------- -------------- ------------
Common Stock 118.88%
Utilities 116.34%
Electric -- Integrated 92.02%
Ameren Corp.................................. 1,247,400 $ 68,981,220 4.59%
American Electric Power Co................... 384,000 14,158,080 3.80
CINergy Corp................................. 1,176,300 52,721,766 4.28
Cleco Corp................................... 246,700 5,321,319 4.17
DPL.......................................... 359,700 9,873,765 3.50
DTE Energy Co................................ 1,003,500 46,933,695 4.40
Dominion Resources........................... 434,600 31,895,294 3.65
Duke Energy Corp............................. 2,539,100 75,487,443 4.17
E.ON AG (ADR)................................ 719,000 21,289,590 3.17
Edison International......................... 1,353,000 54,864,150 2.47
Enel S.P.A., (ADR)........................... 151,100 6,559,251 4.98
Entergy Corp................................. 696,350 52,609,243 2.86
Exelon Corp.................................. 1,435,464 73,682,367 3.12
FirstEnergy Corp............................. 478,100 23,001,391 3.43
FPL Group.................................... 1,167,000 49,084,020 3.38
Hawaiian Electric Industries................. 516,700 13,852,727 4.63
NiSource..................................... 339,000 8,383,470 3.72
PG&E Corp.................................... 1,519,000 57,023,260 3.20
PPL Corp..................................... 497,000 29,511,860 3.10
Pacific Gas & Electric Co.................... 25,600 668,800 6.74
Pinnacle West Capital Corp................... 812,600 36,120,070 4.27
Progress Energy.............................. 423,750 19,170,450 5.22
Public Service Enterprise Group.............. 811,400 49,349,348 3.68
Puget Energy................................. 166,000 3,881,080 4.28
SCANA Corp................................... 303,500 12,962,485 3.65
Scottish Power PLC (ADR)..................... 342,000 12,175,200 3.60
Southern Co.b................................ 1,952,500 67,693,175 4.30
TXU Corp..................................... 495,000 41,129,550 2.71
Xcel Energy.................................. 2,290,000 44,700,800 4.41
--------------
983,084,869
--------------
Electric -- Distribution 12.95%
Consolidated Edison.......................... 1,024,200 47,973,528 4.87
Energy East Corp............................. 224,700 6,511,806 3.80
National Grid Transco PLC (ADR).............. 701,300 34,202,401 4.37
NSTAR........................................ 515,239 15,884,818 3.76
Pepco Holdings............................... 1,409,200 33,736,248 4.18
--------------
138,308,801
--------------
Gas -- Distribution 3.63%
AGL Resources................................ 311,000 12,020,150 3.21
Atmos Energy Corp............................ 210,500 6,062,400 4.31
Sempra Energy................................ 213,000 8,799,030 2.81
Vectren Corp................................. 413,867 11,890,399 4.11
--------------
38,771,979
--------------
See accompanying notes to financial statements.
72
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
JUNE 30, 2005 (UNAUDITED)
NUMBER VALUE DIVIDEND
OF SHARES (NOTE 1) YIELD(a)
---------- -------------- ------------
Gas -- Integrated 7.74%
Equitable Resources.......................... 777,300 $ 52,856,400 2.47%
KeySpan Corp................................. 732,400 29,808,680 4.47
--------------
82,665,080
--------------
Total Utilities.............................. 1,242,830,729
--------------
Utility -- Foreign 1.27%
Electric -- Integrated
RWE AG(c).................................... 150,000 9,632,336 2.82
Scottish and Southern Energyc................ 217,900 3,943,218 2.98
--------------
13,575,554
--------------
Telecommunication Services 1.18%
FairPoint Communications..................... 780,000 12,597,000 9.29
--------------
Transport -- Marine 0.09%
Teekay LNG Partners LP....................... 35,400 998,280 5.85
--------------
Total Common Stock
(Identified cost -- $1,030,208,388).... 1,270,001,563
--------------
Preferred Securities -- $25 Par Value 17.01%
Bank 0.51%
Chevy Chase Bank, 8.00%, Series C............ 87,100 2,430,090 7.17
First Republic Bank, 6.70% Series A.......... 118,700 3,044,655 6.55
--------------
5,474,745
--------------
Bank -- Foreign 0.11%
Northern Rock, 8.00% Series.................. 45,000 1,128,600 7.97
--------------
Insurance 0.10%
RenaissanceRE Holdings Ltd., 6.08%,
Series C................................... 46,100 1,108,705 6.32
--------------
Media 0.34%
Liberty Media Corp., 8.75% (CBTCS)........... 22,100 582,335 8.31
Liberty Media Corp., 8.75% (PPLUS)........... 20,700 546,480 8.30
Shaw Communications, 8.50%, Series B (COPrS). 99,600 2,510,916 8.45
--------------
3,639,731
--------------
Real Estate 15.00%
Diversified 2.35%
Bedford Property Investors, 7.625%,
Series B................................... 205,350 5,186,114 7.56
Colonial Properties Trust, 7.62%, Series E... 49,500 1,212,750 7.80
Digital Realty Trust, 8.50%, Series A........ 56,000 1,451,240 8.22
Forest City Enterprises, 7.375%, Class A..... 80,800 2,064,440 7.20
iStar Financial, 7.875%, Series E............ 270,700 6,980,000 7.64
iStar Financial, 7.80%, Series F............. 132,000 3,379,200 7.62
iStar Financial, 7.50%, Series I............. 113,940 2,862,173 7.48
Lexington Corporate Properties Trust,
8.05%, Series B............................ 75,000 1,976,250 7.63
--------------
25,112,167
--------------
See accompanying notes to financial statements.
73
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
JUNE 30, 2005 (UNAUDITED)
NUMBER VALUE DIVIDEND
OF SHARES (NOTE 1) YIELD(a)
---------- -------------- ------------
Health Care 2.00%
Health Care REIT, 7.875%, Series D........... 72,550 $ 1,863,084 7.67%
Health Care REIT, 7.625%, Series F........... 218,800 5,529,076 7.56
LTC Properties, 8.00%, Series F.............. 547,713 14,007,760 7.82
--------------
21,399,920
--------------
Hotel 1.28%
Ashford Hospitality Trust, 8.55%, Series A... 156,500 4,088,563 8.19
Equity Inns, 8.75%, Series B................. 75,900 1,984,785 8.37
Host Marriott Corp., 8.875%, Series E........ 100,000 2,750,000 8.07
Innkeepers USA, 8.00%, Series C.............. 189,400 4,842,958 7.82
--------------
13,666,306
--------------
Office 4.36%
Alexandria Real Estate Equities, 8.375%,
Series C................................... 514,000 13,564,460 7.92
Brandywine Realty Trust, 7.50%, Series C..... 75,819 1,899,266 7.50
Corporate Office Properties Trust, 8.00%,
Series G................................... 38,486 994,863 7.74
CRT Properties, 8.50%, Sereis A.............. 35,335 873,128 8.62
Highwoods Properties, 8.00%, Series B........ 26,435 664,840 7.95
Highwoods Properties, 8.00%, Series D........ 33,058 831,409 7.95
Maguire Properties, 7.625%, Series A......... 495,626 12,529,425 7.56
SL Green Realty Corp., 7.625%, Series C...... 247,000 6,323,200 7.46
SL Green Realty Corp., 7.875%, Series D...... 347,333 8,909,091 7.68
--------------
46,589,682
--------------
Office/Industrial 0.92%
PS Business Parks, 7.00%, Series H........... 75,700 1,862,220 7.11
PS Business Parks, 6.875%, Series I.......... 54,950 1,346,275 7.02
PS Business Parks, 7.95%, Series K........... 252,000 6,577,200 7.62
--------------
9,785,695
--------------
Residential -- Apartment 0.68%
Apartment Investment & Management Co.,
7.75%, Series U............................ 30,000 753,000 7.85
Apartment Investment & Management Co.,
8.00%, Series V............................ 87,000 2,209,800 7.87
Apartment Investment & Management Co.,
7.875%, Series Y........................... 93,000 2,334,300 7.73
Hovnanian Enterprises, 7.625% Series......... 80,000 2,000,000 7.64
--------------
7,297,100
--------------
See accompanying notes to financial statements.
74
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
JUNE 30, 2005 (UNAUDITED)
NUMBER VALUE DIVIDEND
OF SHARES (NOTE 1) YIELD(a)
---------- -------------- ------------
Shopping Center 2.30%
Community Center 1.70%
Cedar Shopping Centers, 8.875%, Series A..... 300,000 $ 8,010,000 8.31%
Developers Diversified Realty Corp.,
7.375%, Series H........................... 25,000 633,500 7.26
Developers Diversified Realty Corp.,
7.50%, Series I............................ 302,000 7,731,200 7.34
Saul Centers, 8.00%, Series A................ 67,500 1,767,825 7.64
--------------
18,142,525
--------------
Regional Mall 0.60%
CBL & Associates Properties, 7.75%,
Series C................................... 126,931 3,484,256 7.07
Mills Corp., 9.00%, Series C................. 43,300 1,167,585 8.34
Mills Corp., 8.75%, Series E................. 40,700 1,102,970 8.08
Taubman Centers, 8.00%, Series G............. 25,000 641,250 7.80
--------------
6,396,061
--------------
Total Shopping Center........................ 24,538,586
--------------
Specialty 1.11%
Capital Automotive REIT, 6.75%............... 125,000 3,155,000 6.70
Capital Automotive REIT, 7.50%, Series A..... 95,102 2,415,590 7.40
Capital Automotive REIT, 8.00%, Series B..... 240,400 6,310,500 7.62
--------------
11,881,090
--------------
Total Real Estate............................ 160,270,546
--------------
Utilities 0.95%
Electric -- Integrated 0.40%
Sierra Pacific Power, 7.80%, Series 1........ 169,038 4,259,757 7.74
--------------
Gas -- Distribution 0.55%
Southern Union Co., 7.55%, Series C.......... 222,500 5,918,500 7.11
--------------
Total Utilities.............................. 10,178,257
--------------
Total Preferred Securities -- $25 Par
Value (Identified cost -- $174,512,809) 181,800,584
--------------
Preferred Securities -- Capital Trust 6.61%
Diversified Financial Services 1.47%
Old Mutual Capital Funding, 8.00%,
due 5/29/49 (Eurobond)..................... 14,850,000 15,728,244 7.55
--------------
Electric -- Integrated 1.28%
DPL Capital Trust II, 8.125%, due 9/1/31..... 3,000,000 3,551,754 6.87
Duquesne Light Co., 6.50% Series H........... 194,900 10,154,290 6.24
--------------
13,706,044
--------------
Food 1.02%
Dairy Farmers of America, 7.875%, 144A(c,d).. 70,000 6,908,825 7.98
Gruma S.A., 7.75%, due 12/29/49, 144A(c,d)... 4,000,000 3,909,100 7.93
--------------
10,817,925
--------------
See accompanying notes to financial statements.
75
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
JUNE 30, 2005 (UNAUDITED)
NUMBER VALUE DIVIDEND
OF SHARES (NOTE 1) YIELD(a)
---------- -------------- ------------
Insurance -- Multi-Line 1.58%
AFC Capital Trust I, 8.207%, due 2/3/27,
Series B................................... 8,000,000 $ 9,107,056 7.21%
Liberty Mutual Insurance, 7.697%, due
10/15/97................................... 7,000,000 7,755,426 6.95
--------------
16,862,482
--------------
Medical -- Hospitals 0.69%
Columbia/HCA, 7.50%, due 11/15/95............ 7,545,000 7,367,806 7.68
--------------
Oil -- Exploration and Production 0.38%
Pemex Project Funding Master Trust,
7.75%, due 9/29/49......................... 4,000,000 4,048,084 7.66
--------------
Retail 0.19%
JC Penney Co., 7.625%, due 3/1/97............ 2,000,000 2,000,000 7.63
--------------
Total Preferred Securities -- Capital
Trust (Identified cost -- $72,994,933). 70,530,585
--------------
PRINCIPAL
AMOUNT
-----------
Corporate Bond 3.11%
Media 1.47%
Cablevision Systems Corp., 8.00%, due
4/15/12.................................... $ 4,500,000 4,432,500
CSC Holdings, 7.875%, due 2/15/18............ 1,500,000 1,485,000
Liberty Media Corp., 8.25%, due 2/1/30....... 4,000,000 3,989,580
Rogers Cable, 8.75%, due 5/01/32............. 5,100,000 5,814,000
--------------
15,721,080
--------------
Cellular Telecommunications 0.14%
Rogers Wireless Communications,
7.50%, due 3/15/15, 144A(d)................ 1,400,000 1,529,500
--------------
Medical -- Hospitals 0.41%
Columbia/HCA, 8.36%, due 4/15/24............. 3,000,000 3,370,035
Columbia/HCA, 7.75%, due 7/15/36............. 1,000,000 1,070,375
--------------
4,440,410
--------------
Special Purpose Entity 0.25%
Valor Telecom Enterprise, 7.75%, due
02/15/15(c)................................ 2,750,000 2,634,156
--------------
Telephone -- Integrated 0.84%
Citizens Communications Co., 9.00%,
due 8/15/31................................ 8,700,000 8,961,000
--------------
Total Corporate Bond
(Identified cost -- $28,740,714)....... 33,286,146
--------------
Commercial Paper 0.22%
New Center Asset Trust, 2.20%, due 07/01/05
(Identified cost -- $2,300,000)............ 2,300,000 2,300,000
--------------
Total Investments (Identified cost --
$1,308,756,844)......................... 145.83% 1,557,918,878
Other Assets in Excess of Liabilities..... 0.22% 2,410,520
Liquidation Value of Auction Market
Preferred Shares........................ (46.05)% (492,000,000)
------ --------------
Net Assets Applicable to Common Shares
(Equivalent to $24.66 per share based on
43,320,750 shares of capital stock
outstanding)............................ 100.00% $1,068,329,398
------ --------------
------ --------------
See accompanying notes to financial statements.
76
COHEN & STEERS SELECT UTILITY FUND, INC.
SCHEDULE OF INVESTMENTS -- (CONTINUED)
JUNE 30, 2005 (UNAUDITED)
Note: Percentages indicated are based on the net assets applicable to common
shares of the fund.
(a) Dividend yield is computed by dividing the security's current annual
dividend rate by its value on June 30, 2005. The current dividend rate
does not reflect any potential reclassifications to capital gain or
return of capital.
(b) 120,000 shares segregated as collateral for interest rate swap transactions.
(c) Fair valued security. Aggregate holdings equal 2.53% of net assets
applicable to common shares.
(d) Resale is restricted to qualified institutional investors. Aggregate
holdings equal 1.16% of net assets applicable to common shares.
GLOSSARY OF PORTFOLIO ABBREVIATIONS
--------------------------------------------------------------------------
ADR American Depositary Receipt.
COPrS Canadian Origin Preferred Securities.
CBTCS Corporate Backed Trust Certificates.
PPLUS Preferred Plus Trust.
--------------------------------------------------------------------------
See accompanying notes to financial statements.
77
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 2005 (UNAUDITED)
Assets:
Investments in securities, at value (Identified
cost -- $1,308,756,844) (Note 1)...................... $1,557,918,878
Dividends and interest receivable....................... 7,649,025
Unrealized appreciation on interest rate swap
transactions (Notes 1 and 6).......................... 171,643
Other assets............................................ 34,272
--------------
Total Assets........................................ 1,565,773,818
--------------
Liabilities:
Payable for investment securities purchased............. 1,997,346
Unrealized depreciation on interest rate swap
transactions (Notes 1 and 6).......................... 1,035,118
Payable to investment manager........................... 817,989
Payable for dividends declared on common shares......... 627,897
Payable for dividends declared on preferred shares...... 614,789
Payable to administrator................................ 66,262
Payable for directors fees.............................. 6,738
Other liabilities....................................... 278,281
--------------
Total Liabilities................................... 5,444,420
--------------
Liquidation Value of Preferred Shares:
Auction market preferred shares, Series M7, ($25,000
liquidation value,
$0.001 par value, 3,400 shares issued and outstanding)
(Notes 1 and 5)....................................... 85,000,000
Auction market preferred shares, Series T7, ($25,000
liquidation value,
$0.001 par value, 3,400 shares issued and outstanding)
(Notes 1 and 5)....................................... 85,000,000
Auction market preferred shares, Series T28, ($25,000
liquidation value,
$0.001 par value, 2,680 shares issued and outstanding)
(Notes 1 and 5)....................................... 67,000,000
Auction market preferred shares, Series W7, ($25,000
liquidation value,
$0.001 par value, 3,400 shares issued and outstanding)
(Notes 1 and 5)....................................... 85,000,000
Auction market preferred shares, Series TH28, ($25,000
liquidation value,
$0.001 par value, 3,400 shares issued and outstanding)
(Notes 1 and 5)....................................... 85,000,000
Auction market preferred shares, Series F7, ($25,000
liquidation value,
$0.001 par value, 3,400 shares issued and outstanding)
(Notes 1 and 5)....................................... 85,000,000
--------------
492,000,000
--------------
Total Net Assets Applicable to Common Shares................ $1,068,329,398
--------------
--------------
Total Net Assets Applicable to Common Shares consist of:
Common stock ($0.001 par value, 43,320,750 shares issued
and outstanding)...................................... $ 819,922,546
Dividends in excess of net investment income............ (1,056,415)
Accumulated undistributed net realized gain............. 1,165,464
Net unrealized appreciation............................. 248,297,803
--------------
$1,068,329,398
--------------
--------------
Net Asset Value Per Common Share:
($1,068,329,398[div]43,320,750 shares outstanding)...... $ 24.66
--------------
--------------
Market Price Per Common Share............................... $ 21.43
--------------
--------------
Market Price Discount to Net Asset Value Per Common Share... (13.10)%
--------------
--------------
See accompanying notes to financial statements.
78
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED)
Investment Income (Note 1):
Dividend income (net of $333,623 of foreign withholding
tax).................................................. $ 33,486,388
Interest income......................................... 3,225,206
------------
Total Income........................................ 36,711,594
------------
Expenses:
Investment management fees (Note 2)..................... 6,237,506
Preferred remarketing fee............................... 609,641
Administration fees (Note 2)............................ 490,653
Reports to shareholders................................. 162,412
Professional fees....................................... 104,128
Custodian fees and expenses............................. 63,285
Directors' fees and expenses (Note 2)................... 26,228
Transfer agent fees and expenses........................ 5,430
Miscellaneous........................................... 74,042
------------
Total Expenses...................................... 7,773,325
Reduction of Expenses (Note 2).......................... (1,467,648)
------------
Net Expenses........................................ 6,305,677
------------
Net Investment Income....................................... 30,405,917
------------
Net Realized and Unrealized Gain (Loss) on Investments (Note
1):
Net realized gain on investments........................ 2,721,408
Net realized loss on foreign currency tranactions....... (14,703)
Net realized loss on interest rate swap transactions.... (1,270,803)
Net change in unrealized appreciation on investments.... 96,856,190
Net change in unrealized depreciation on foreign
currency translations................................. (756)
Net change in unrealized appreciation on interest rate
swap transactions..................................... 1,056,451
------------
Net realized and unrealized gain on investments..... 99,347,787
------------
Net Increase Resulting from Operations.................. 129,753,704
------------
Less Dividends and Distributions to Preferred Shareholders
from
Net Investment Income..................................... (7,104,251)
------------
Net Increase in Net Assets from Operations Applicable to
Common Shares............................................. $122,649,453
------------
------------
See accompanying notes to financial statements.
79
COHEN & STEERS SELECT UTILITY FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS APPLICABLE TO COMMON SHARES
(UNAUDITED)
FOR THE PERIOD
FOR THE MARCH 30, 2004(a)
SIX MONTHS ENDED THROUGH
JUNE 30, 2005 DECEMBER 31, 2004
---------------- -----------------
Change in Net Assets Applicable to Common Shares:
From Operations:
Net investment income............................... $ 30,405,917 $ 36,176,133
Net realized gain (loss)............................ 1,435,902 (2,109,825)
Net change in unrealized appreciation............... 97,911,885 150,385,918
-------------- ------------
Net increase resulting from operations.......... 129,753,704 184,452,226
-------------- ------------
Less Dividends and Distributions to Preferred
Shareholders from:
Net investment income............................... (7,104,251) (5,135,684)
Net realized gain on investments.................... -- (105,254)
-------------- ------------
Total dividends and distributions to preferred
shareholders.................................. (7,104,251) (5,240,938)
-------------- ------------
Net increase in net assets from operations
applicable to common shares....................... 122,649,453 179,211,288
-------------- ------------
Less Dividends and Distributions to Common Shareholders
from:
Net investment income............................... (24,043,016) (28,756,928)
Net realized gain on investments.................... -- (653,945)
Tax return of capital............................... -- (47,237)
-------------- ------------
Total dividends and distributions to common
shareholders.................................. (24,043,016) (29,458,110)
-------------- ------------
Capital Stock Transactions (Note 5):
Increase in net assets from common share
transactions...................................... -- 825,593,430
Increase in net assets from preferred share offering
cost adjustment................................... 310,222 --
Decrease in net assets from underwriting commissions
and offering expenses from issuance of preferred
shares............................................ -- (6,034,144)
-------------- ------------
Net increase in net assets from capital stock
transactions.................................. 310,222 819,559,286
-------------- ------------
Total increase in net assets applicable to
common shares................................. 98,916,659 969,312,464
-------------- ------------
Net Assets Applicable to Common Shares:
Beginning of period..................................... 969,412,739 100,275
-------------- ------------
End of period(b)........................................ $1,068,329,398 $969,412,739
-------------- ------------
-------------- ------------
---------
(a) Commencement of operations.
(b) Includes dividends in excess of net investment income of $1,056,415 and
$315,065, respectively.
See accompanying notes to financial statements.
80
COHEN & STEERS SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS (UNAUDITED)
The following table includes selected data for a common share outstanding
throughout each period and other performance information derived from the
financial statements. It should be read in conjunction with the financial
statements and notes thereto.
FOR THE PERIOD
FOR THE MARCH 30, 2004(a)
SIX MONTHS ENDED THROUGH
JUNE 30, 2005 DECEMBER 31, 2004
PER SHARE OPERATING PERFORMANCE: ------------- -----------------
Net asset value per common share, beginning of period....... $22.38 $19.10
------ ------
Income from investment operations:
Net investment income(b)................................ 0.70 0.85
Net realized and unrealized gain on investments......... 2.29 3.36
------ ------
Total income from investment operations............. 2.99 4.21
------ ------
Less dividends and distributions to preferred shareholders
from:
Net investment income................................... (0.16) (0.12)
Net realized gain on investments........................ -- (0.00)(c)
------ ------
Total dividends and distributions to preferred
shareholders...................................... (0.16) (0.12)
------ ------
Total from investment operations applicable to
common shares..................................... 2.83 4.09
------ ------
Less: Offering costs charged to paid-in capital -- common
shares.................................................... -- (0.04)
Preferred share offering cost adjustment................ 0.01 --
Offering costs charged to paid-in capital -- preferred
shares................................................ -- (0.14)
Anti-dilutive effect of common share offering........... -- 0.05
------ ------
Total offering and organization costs............... 0.01 (0.13)
------ ------
Less dividends and distributions to common shareholders
from:
Net investment income................................... (0.56) (0.67)
Net realized gain on investments........................ -- (0.01)
Tax return on capital................................... -- (0.00)c
------ ------
Total dividends and distributions to common
shareholders...................................... (0.56) (0.68)
------ ------
Net increase in net asset value............................. 2.28 3.28
------ ------
Net asset value, per common share, end of period............ $24.66 $22.38
------ ------
------ ------
Market value, per common share, end of period............... $21.43 $19.82
------ ------
------ ------
Net asset value total return(d)............................. 13.25%(e) 21.57%(e)
------ ------
------ ------
Market value return(d)...................................... 11.12%(e) 2.82%(e)
------ ------
------ ------
See accompanying notes to financial statements.
81
COHEN & STEERS SELECT UTILITY FUND, INC.
FINANCIAL HIGHLIGHTS (UNAUDITED) -- (CONTINUED)
FOR THE PERIOD
FOR THE MARCH 30, 2004(a)
SIX MONTHS ENDED THROUGH
JUNE 30, 2005 DECEMBER 31, 2004
RATIOS/SUPPLEMENTAL DATA: ---------------- -----------------
Net assets applicable to common shares, end of period
(in millions)............................................. $1,068.3 $ 969.4
-------- --------
-------- --------
Ratio of expenses to average daily net assets applicable to
common shares (before expense reduction)(g)............... 1.59%(f) 1.51%(f)
-------- --------
-------- --------
Ratio of expenses to average daily net assets applicable to
common shares (net of expense reduction)(g)............... 1.29%(f) 1.22%(f)
-------- --------
-------- --------
Ratio of net investment income to average daily net assets
applicable to common shares (before expense reduction)(g). 5.91%(f) 5.33%(f)
-------- --------
-------- --------
Ratio of net investment income to average daily net assets
applicable to common shares (net of expense reduction)(g). 6.21%(f) 5.62%(f)
-------- --------
-------- --------
Ratio of expenses to average daily managed assets (before
expense reduction)(g,h)................................... 1.06%(f) 1.06%(f)
-------- --------
-------- --------
Ratio of expenses to average daily managed assets (net of
expense reduction)(g,h)................................... 0.86%(f) 0.86%(f)
-------- --------
-------- --------
Portfolio turnover rate..................................... 14.56%(e) 14.03%(e)
-------- --------
-------- --------
PREFERRED SHARES:
Liquidation value, end of period (in 000's)................. 492,000 492,000
-------- --------
-------- --------
Total shares outstanding (in 000's)......................... 20 20
-------- --------
-------- --------
Asset coverage per share.................................... $ 79,285 $ 74,259
-------- --------
-------- --------
Liquidation preference per share............................ $ 25,000 $ 25,000
-------- --------
-------- --------
Average market value per share(i)........................... $ 25,000 $ 25,000
-------- --------
-------- --------
---------
(a) Commencement of operations.
(b) Calculation based on average shares outstanding.
(c) Less than $0.005 per share.
(d) Total market value return is computed based upon the New York Stock Exchange
market price of the fund's shares and excludes the effects of brokerage
commissions. Dividends and distributions, if any, are assumed for purposes
of this calculation, to be reinvested at prices obtained under the fund's
dividend reinvestment plan. Total net asset value return measures the
changes in value over the period indicated, taking into account dividends as
reinvested.
(e) Not annualized.
(f) Annualized.
(g) Ratios do not reflect dividend payments to preferred shareholders.
(h) Average daily managed assets represents net assets applicable to common
shares plus liquidation preference of preferred shares.
(i) Based on weekly prices.
See accompanying notes to financial statements.
82
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Cohen & Steers Select Utility Fund, Inc. (the fund) was incorporated under
the laws of the State of Maryland on January 8, 2004 and is registered under the
Investment Company Act of 1940, as amended, as a nondiversified closed-end
management investment company. The fund's investment objective is a high level
of after-tax total return. The fund had no operations until March 3, 2004 when
it sold 5,250 shares of common stock for $100,275 to Cohen & Steers Capital
Management, Inc. (the investment manager). Investment operations commenced on
March 30, 2004.
The following is a summary of significant accounting policies consistently
followed by the fund in the preparation of its financial statements. The
policies are in conformity with accounting principles generally accepted in the
United States of America (GAAP). The preparation of the financial statements in
accordance with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
Portfolio Valuation: Investments in securities that are listed on the New
York Stock Exchange are valued, except as indicated below, at the last sale
price reflected at the close of the New York Stock Exchange on the business day
as of which such value is being determined. If there has been no sale on such
day, the securities are valued at the mean of the closing bid and asked prices
for the day or, if no asked price is available, at the bid price.
Securities not listed on the New York Stock Exchange but listed on other
domestic or foreign securities exchanges or admitted to trading on the National
Association of Securities Dealers Automated Quotations, Inc. (Nasdaq) national
market system are valued in a similar manner. Securities traded on more than one
securities exchange are valued at the last sale price on the business day as of
which such value is being determined as reflected on the tape at the close of
the exchange representing the principal market for such securities.
Readily marketable securities traded in the over-the-counter market,
including listed securities whose primary market is believed by Cohen & Steers
Capital Management, Inc. to be over-the-counter, but excluding securities
admitted to trading on the Nasdaq National List, are valued at the official
closing prices as reported by Nasdaq, the National Quotation Bureau, or such
other comparable sources as the Board of Directors deem appropriate to reflect
their fair market value. If there has been no sale on such day, the securities
are valued at the mean of the closing bid and asked prices for the day, or if no
asked price is available, at the bid price. However, certain fixed-income
securities may be valued on the basis of prices provided by a pricing service
when such prices are believed by the board of directors to reflect the fair
market value of such securities. Where securities are traded on more than one
exchange and also over-the-counter, the securities will generally be valued
using the quotations the Board of Directors believes most closely reflect the
value of such securities.
Securities for which market prices are unavailable will be valued at fair
value pursuant to procedures approved by the fund's board of directors.
Circumstances in which market prices may be unavailable include, but are not
limited to, when trading in a security is suspended, the exchange on which the
security is traded is subject to an unscheduled close or disruption or material
events occur after the close of the exchange on which the security is
principally traded. In these circumstances, the fund determines fair value in a
manner that fairly reflects the market value of the security on the valuation
date based on consideration of any information or factors it deems appropriate.
These may include recent transactions in comparable securities, information
relating to the specific security and developments in the markets.
The fund's use of fair value pricing may cause the net asset value of fund
shares to differ from the net asset value that would be calculated using market
quotations. Fair value pricing
83
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
involves subjective judgments and it is possible that the fair value determined
for a security may be materially different than the value that could be realized
upon the sale of that security.
To the extent the fund holds securities that are primarily listed on foreign
exchanges that trade on weekends or days when the fund does not price its
shares, the value of the securities held in the fund may change on days when you
will not be able to purchase or redeem fund shares.
Short-term debt securities, which have a maturity date of 60 days or less,
are valued at amortized cost, which approximates value.
Security Transactions and Investment Income: Security transactions are
recorded on trade date. Realized gains and losses on investments sold are
recorded on the basis of identified cost. Interest income is recorded on the
accrual basis. Dividend income is recorded on the ex-dividend date. The fund
records distributions received in excess of income from underlying investments
as a reduction of cost of investments and/or realized gain. Such amounts are
based on estimates if actual amounts are not available, and actual amounts of
income, realized gain and return of capital may differ from the estimated
amounts. The fund adjusts the estimated amounts of the components of
distributions (and consequently its net investment income) as an increase to
unrealized appreciation/(depreciation) and realized gain/(loss) on investments
as necessary once the issuers provide information about the actual composition
of the distributions.
Foreign Currency Translation and Forward Foreign Currency Contracts: The
books and records of the fund are maintained in U.S. dollars as follows: (1) the
foreign currency market value of investment securities, other assets and
liabilities and forward foreign currency contracts (forward contracts) are
translated at the exchange rates prevailing at the end of the period; and (2)
purchases, sales, income and expenses are translated at the exchange rates
prevailing on the respective dates of such transactions. The resultant exchange
gains and losses are recorded as realized and unrealized gain/loss on foreign
exchange transactions. Pursuant to U.S. federal income tax regulations, certain
foreign exchange gains/losses included in realized and unrealized gain/loss are
included in or are a reduction of ordinary income for federal income tax
purposes. The fund does not isolate that portion of the results of operations
arising as a result of changes in the foreign exchange rates from the changes in
the market prices of the securities. Forward contracts are valued daily at the
appropriate exchange rates. The resultant unrealized exchange gains and losses
are recorded as unrealized foreign currency gain or loss. The fund records
realized gains or losses on delivery of the currency or at the time the forward
contract is extinguished (compensated) by entering into a closing transaction
prior to delivery.
Foreign Securities: The fund may directly purchase securities of foreign
issuers. Investing in securities of foreign issuers involves special risks not
typically associated with investing in securities of U.S. issuers. The risks
include possible revaluation of currencies, the ability to repatriate funds,
less complete financial information about companies and possible future adverse
political and economic developments. Moreover, securities of many foreign
issuers and their markets may be less liquid and their prices more volatile than
those of securities of comparable U.S. issuers.
Interest Rate Swaps: The fund uses interest rate swaps in connection with
the sale of preferred shares. The interest rate swaps are intended to reduce or
eliminate the risk that an increase in short-term interest rates could have on
the performance of the fund's common shares as a result of the floating rate
structure of the preferred shares. In these interest rate swaps, the fund agrees
to pay the other party to the interest rate swap (which is known as the
counterparty) a fixed rate payment in exchange for the counterparty agreeing to
pay the fund a variable rate payment that is intended to approximate the fund's
variable rate payment obligation on the preferred shares. The payment obligation
is based on the notional amount of the swap. Depending on the state of interest
rates in general, the use of interest rate swaps could enhance or harm the
overall performance of the common shares. The market value of interest rate
swaps is based on pricing
84
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
models that consider the time value of money, volatility, the current market and
contractual prices of the underlying financial instrument. Unrealized gains are
reported as an asset and unrealized losses are reported as a liability on the
Statement of Assets and Liabilities. The change in value of swaps, including the
accrual of periodic amounts of interest to be paid or received on swaps, is
reported as unrealized gains or losses in the Statement of Operations. A
realized gain or loss is recorded upon payment or receipt of a periodic payment
or termination of swap agreements. Swap agreements involve, to varying degrees,
elements of market and counterparty risk, and exposure to loss in excess of the
related amounts reflected in the Statement of Assets and Liabilities.
Dividends and Distributions to Shareholders: Dividends from net investment
income are declared and paid to common shareholders monthly. Dividends and
distributions to shareholders are recorded on the ex-dividend date.
Distributions paid by the fund are subject to recharacterization for tax
purposes. Based upon the results of operations for the six months ended
June 30, 2005, the investment manager considers it likely that a portion of the
dividends will be reclassified to return of capital and distributions of net
realized capital gains upon the final determination of the fund's taxable income
for the year. Net realized capital gains, unless offset by any available capital
loss carryforward, are distributed to shareholders annually.
Dividends from net investment income and capital gain distributions are
determined in accordance with U.S. federal income tax regulations which may
differ from GAAP.
Series M7, Series T7, Series W7 and Series F7 preferred shares pay dividends
based on a variable interest rate set at auctions, normally held every seven
days. The dividends are declared and recorded for the subsequent seven day
period on the auction date. In most instances, dividends are payable every seven
days, on the first business day following the end of the dividend period.
Series T28 and Series TH28 preferred shares pay dividends based on a
variable interest rate set at auctions, normally held every 28 days. The
dividends are declared and recorded for the subsequent 28 day period on the
auction date. In most instances, dividends are payable every 28 days, on the
first business day following the end of the dividend period.
Federal Income Taxes: It is the policy of the fund to qualify as a regulated
investment company, if such qualification is in the best interest of the
shareholders, by complying with the requirements of Subchapter M of the Internal
Revenue Code applicable to regulated investment companies, and by distributing
substantially all of its taxable earnings to its shareholders. Accordingly, no
provision for federal income or excise tax is necessary.
NOTE 2. INVESTMENT MANAGEMENT FEES, ADMINISTRATION FEES AND OTHER TRANSACTIONS
WITH AFFILIATES
Investment Management Fees: Cohen & Steers Capital Management, Inc. (the
investment manager) serves as the fund's investment manager pursuant to an
investment management agreement (the management agreement). Under the terms of
the management agreement, the investment manager provides the fund with
day-to-day investment decisions and generally manages the fund's investments in
accordance with the stated polices of the fund, subject to the supervision of
the Board of Directors.
For the services under the management agreement, the fund pays the
investment manager a management fee, accrued daily and paid monthly at an annual
rate of 0.85% of the fund's average daily managed asset value. Managed asset
value is the net asset value of the common shares plus the liquidation
preference of the preferred shares.
The investment manager has contractually agreed to waive its investment
management fee in the amount of 0.20% of average daily managed asset value for
the first five years of the fund's
85
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
operations, 0.15% of average daily managed asset value in year six, 0.10% of
average daily managed asset value in year seven and 0.05% of average daily
managed asset value in year eight.
Administration Fees: The fund has entered into an administration agreement
with the investment manager under which the investment manager performs certain
administrative functions for the fund and receives a fee, accrued daily and paid
monthly at the annual rate of 0.06% of the fund's average daily managed assets
up to $1 billion, 0.04% of the fund's average daily managed assets in excess of
$1 billion up to $1.5 billion and 0.02% of the fund's average daily managed
assets in excess of $1.5 billion. For the six months ended June 30, 2005, the
fund incurred $392,708 in administration fees.
Director's Fees: Certain directors and officers of the fund are also
directors, officers and/or employees of the investment manager. None of the
directors and officers so affiliated received compensation from the fund for
their services.
NOTE 3. PURCHASES AND SALES OF SECURITIES
Purchases and sales of securities, excluding short-term investments, for the
six months ended June 30, 2005 totaled $222,993,509 and $215,271,108,
respectively.
NOTE 4. INCOME TAX INFORMATION
At June 30, 2005, the cost of investments and net unrealized appreciation
for federal income tax purposes were as follows:
Aggregate cost.............................................. $1,308,756,846
--------------
--------------
Gross unrealized appreciation............................... $ 253,686,251
Gross unrealized depreciation............................... (4,524,973)
--------------
Net unrealized appreciation on investments.................. 249,161,278
Net unrealized depreciation on interest rate swap
transactions.............................................. (863,475)
--------------
Net unrealized appreciation................................. $ 248,297,803
--------------
--------------
NOTE 5. CAPITAL STOCK
The fund is authorized to issue 100 million shares of common stock at a par
value of $0.001 per share.
During the six months ended June 30, 2005 the fund issued no shares of
common stock for the reinvestment of dividends.
The fund's articles of incorporation authorize the issuance of fund
preferred shares, par value $0.001 per share, in one or more classes or series,
with rights as determined by the Board of Directors, by action of the Board of
Directors without the approval of the common shareholders.
During the six months ended June 30, 2005, a $310,222 adjustment was
credited to common stock for preferred offering costs.
On March 26, 2004, the fund completed the initial public offering of
41,250,000 shares of common stock. Proceeds paid to the fund amounted to
$786,225,000 after deduction of underwriting commissions and offering expenses
of $38,775,000.
On May 7, 2004, the fund completed a subsequent offering of 2,065,500 shares
of common stock. Proceeds paid to the fund amounted to $39,368,430 after
deduction of underwriting commissions and offering expenses of $1,941,570.
On May 20, 2004, the fund issued 3,400 auction market preferred shares,
Series M7 (par value $0.001), 3,400 auction market preferred shares, Series T7
(par value $0.001), 3,400 auction market
86
COHEN & STEERS SELECT UTILITY FUND, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
preferred shares, Series W7 (par value $0.001), 3,400 auction market preferred
shares, Series F7 (par value $0.001), and 3,400 auction market preferred shares,
Series TH28 (par value $0.001) (together referred to as preferred shares).
Proceeds paid to the fund amounted to $420,017,152 after deduction of
underwriting commissions and offering expenses of $4,982,848. These issues have
received a 'AAA/Aaa' rating from Standard & Poor's and Moody's.
On November 15, 2004, the fund issued 2,680 auction market preferred shares,
Series T28 (par value $0.001). Proceeds paid to the fund amounted to $65,948,704
after deduction of underwriting commissions and offering expenses of $1,051,296.
This issue has received a 'AAA/Aaa' rating from Standard & Poor's and Moody's.
Preferred shares are senior to the fund's common shares and will rank on a
parity with shares of any other series of preferred shares, and with shares of
any other series of preferred stock of the fund, as to the payment of dividends
and the distribution of assets upon liquidation. If the fund does not timely
cure a failure to (1) maintain a discounted value of its portfolio equal to the
preferred shares basic maintenance amount, (2) maintain the 1940 Act preferred
shares asset coverage, or (3) file a required certificate related to asset
coverage on time, the preferred shares will be subject to a mandatory redemption
at the redemption price of $25,000 per share plus an amount equal to accumulated
but unpaid dividends thereon to the date fixed for redemption. To the extent
permitted under the 1940 Act and Maryland Law, the fund at its option may
without consent of the holders of preferred shares, redeem preferred shares
having a dividend period of one year or less, in whole, or in part, on the
business day after the last day of such dividend period upon not less than 15
calendar days and not more than 40 calendar days prior to notice The optional
redemption price is $25,000 per share plus an amount equal to accumulated but
unpaid dividends thereon to the date fixed for redemption.
The fund's common shares and preferred shares have equal voting rights of
one vote per share and vote together as a single class. In addition, the
affirmative vote of the holders of a majority, as defined in the 1940 Act, of
the outstanding preferred shares shall be required to (1) approve any plan of
reorganization that would adversely affect the preferred shares and (2) approve
any matter that materially and adversely affects the rights, preferences, or
powers of that series.
NOTE 6. INVESTMENTS IN INTEREST RATE SWAPS
Interest rate swaps at June 30, 2005:
FLOATING RATE(a) UNREALIZED
NOTIONAL (RATE RESET TERMINATION APPRECIATION/
COUNTERPARTY AMOUNT FIXED RATE MONTHLY) DATE (DEPRECIATION)
----------------------------- ----------- ---------- -------- ---- --------------
Merrill Lynch Derivative
Products AG................ $40,000,000 3.8225% 3.111% June 2, 2008 $ 128,212
Merrill Lynch Derivative
Products AG................ $35,000,000 4.0850% 3.314% May 27, 2009 (106,843)
Merrill Lynch Derivative
Products AG................ $40,000,000 3.9950% 3.160% July 7, 2009 (1,326)
Royal Bank of Canada......... $35,000,000 3.8900% 3.260% May 19, 2008 43,431
Royal Bank of Canada......... $30,000,000 4.0775% 3.111% June 1, 2009 (116,582)
UBS AG....................... $32,500,000 3.9775% 3.240% June 17, 2008 (41,723)
UBS AG....................... $25,000,000 4.5500% 3.150% April 4, 2010 (596,290)
UBS AG....................... $32,000,000 4.1530% 3.314% May 26, 2010 (172,354)
-----------
$ (863,475)
-----------
-----------
---------
(a) Based on LIBOR (London Interbank Offered Rate). Represents rates in effect
at June 30, 2005.
87
APPENDIX A
RATINGS OF INVESTMENTS
Description of certain ratings assigned by S&P and Moody's:
S&P
LONG-TERM
'AAA' -- An obligation rated 'AAA' has the highest rating assigned by S&P.
The obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
'AA' -- An obligation rated 'AA' differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
'A' -- An obligation rated 'A' is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
'BBB' -- An obligation rated 'BBB' exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
'BB,' 'B,' 'CCC,' 'CC,' and 'C' -- Obligations rated 'BB,' 'B,' 'CCC,' 'CC,'
and 'C' are regarded as having significant speculative characteristics. 'BB'
indicates the least degree of speculation and 'C' the highest. While such
obligations will likely have some quality and protective characteristics, these
may be outweighed by large uncertainties or major exposures to adverse
conditions.
'BB' -- An obligation rated 'BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
'B' -- An obligation rated 'B' is more vulnerable to nonpayment than
obligations rated 'BB,' but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
'CCC' -- An obligation rated 'CCC' is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
'CC' -- An obligation rated 'CC' is currently highly vulnerable to
nonpayment.
'C' -- A subordinated debt or preferred stock obligation rated 'C' is
currently highly vulnerable to nonpayment. The 'C' rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action taken,
but payments on this obligation are being continued. A 'C' also will be assigned
to a preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
'D' -- An obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation 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 or the taking of a similar action
if payments on an obligation are jeopardized.
'r' -- The symbol 'r' is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or volatility of
expected returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or
A-1
commodities; obligations exposed to severe prepayment risk -- such as
interest-only or principal-only mortgage securities; and obligations with
unusually risky interest terms, such as inverse floaters.
'N.R.' -- The designation 'N.R.' indicates that no rating has been
requested, that there is insufficient information on which to base a rating, or
that S&P does not rate a particular obligation as a matter of policy.
Note: The ratings from 'AA' to 'CCC' may be modified by the addition of a
plus (+) or minus (-) sign designation to show relative standing within the
major rating categories.
SHORT-TERM
'A-1' -- A short-term obligation rated 'A-1' is rated in the highest
category by S&P. The obligor's capacity to meet its financial commitment on the
obligation is strong. Within this category, certain obligations are given a plus
sign (+) designation. This indicates that the obligor's capacity to meet its
financial commitment on these obligations is extremely strong.
'A-2' -- A short-term obligation rated 'A-2' is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
'A-3' -- A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
'B' -- A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet is
financial commitment on the obligation.
'C' -- A short-term obligation rated 'C' is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation.
'D' -- A short-term obligation rated 'D' is in payment default. The 'D'
rating category is used when payments on an obligation 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 or the taking of a similar
action if payments on an obligation are jeopardized.
MOODY'S
LONG-TERM
'Aaa' -- Bonds 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 by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
'Aa' -- Bonds rated 'Aa' are judged to be of high quality by all standards.
Together with the 'Aaa' group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in 'Aaa' securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than the 'Aaa'
securities.
'A' -- Bonds 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.
A-2
'Baa' -- Bonds 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 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
characterizes bonds in this class.
'B' -- Bonds 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 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 rated 'Ca' represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
'C' -- Bonds 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.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from 'Aa' through 'Caa'. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
PRIME RATING SYSTEM (SHORT-TERM)
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics:
Leading market positions in well-established industries.
High rates of return on funds employed.
Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability for
repayment of senior short-term debt obligations. This will normally be evidenced
by many of the characteristics cited above but to a lesser degree. Earnings
trends and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
A-3
APPENDIX B
ARTICLES SUPPLEMENTARY
[TO BE UPDATED]
B-1
PART C
OTHER INFORMATION
ITEM 25. FINANCIAL STATEMENTS AND EXHIBITS
1) Financial Statements
Part A -- Financial Highlights for the period March 30, 2004 through December 31, 2004 (audited)
-- Financial Highlights for the six months ended June 30, 2005 (unaudited)
Part B -- Report of Independent Registered Public Accounting Firm
-- Schedule of Investments, as of December 31, 2004 (audited)
-- Statement of Assets and Liabilities, as of December 31, 2004 (audited)
-- Statement of Operations, for the period March 30, 2004 through December 31, 2004
(audited)
-- Statement of Changes in Net Assets Applicable to Common Shares, for the period
March 30, 2004 through December 31, 2004 (audited)
-- Financial Highlights for the period March 30, 2004 through December 31, 2004 (audited)
-- Notes to Financial Statements (audited)
-- Schedule of Investments, as of June 30, 2005 (unaudited)
-- Statement of Assets and Liabilities, as of June 30, 2005 (unaudited)
-- Statement of Operations, for the six months ended June 30, 2005 (unaudited)
-- Statement of Changes in Net Assets Applicable to Common Shares, for the six months
ended June 30, 2005 (unaudited)
-- Financial Highlights for the period March 30, 2004 through December 31, 2004 (audited)
and for the six months ended June 30, 2005 (unaudited)
-- Notes to Financial Statements (unaudited)
All other financial statements, schedules and historical financial
information are omitted because the conditions requiring their filing do not
exist.
2) Exhibits
(a) -- Articles of Incorporation(1)
(b) -- By-Laws(1)
(c) -- Not Applicable
(d) -- (i) Form of Articles Supplementary creating Series TH7
Auction Market Preferred Shares**
-- (ii) The Specimen Certificate for Series TH7 Auction
Market Preferred Shares**
(e) -- Form of Dividend Reinvestment Plan(2)
(f) -- Not Applicable
(g) -- (i) Form of Investment Management Agreement(3)
-- (ii) Not Applicable
(h) -- Form of Purchase Agreement**
(i) -- Not Applicable
(j) -- Form of Custodian Agreement(2)
(k) -- (i) Form of Transfer Agency, Registrar and Dividend
Disbursing Agency Agreement(2)
-- (ii) Form of Administration Agreement between the Fund
and the Investment Manager(3)
-- (iii) Form of Administration Agreement between the Fund
and State Street Bank and Trust Company(3)
-- (iv) Form of Auction Agency Agreement between the Fund
and the Bank of New York**
-- (v) Form of Master Broker-Dealer Agreement**
(l) -- (i) Opinion and Consent of Simpson Thacher & Bartlett LLP**
-- (ii) Opinion and Consent of Venable LLP**
(m) -- Not Applicable
C-1
(n) -- Consent of Independent Registered Public Accounting Firm*
(o) -- Not Applicable
(p) -- Not Applicable
(q) -- Not Applicable
(r) -- (i) Code of Ethics of the Fund(2)
-- (ii) Code of Ethics of Investment Manager(2)
(s) -- (i) Powers of Attorney, except for the Powers of Attorney
for Richard E. Kroon and C. Edward Ward, Jr.(2)
-- (ii) Powers of Attorney for Richard E. Kroon and C. Edward Ward, Jr.(4)
(1) Incorporated by reference to Fund's Registration Statement
(File Nos. 333-111820 and 811-21485), filed January 9, 2004.
(2) Incorporated by reference to Amendment No. 2 to the Fund's Registration
Statement (File Nos. 333-111820 and 811-21485), filed February 24, 2004.
(3) Incorporated by reference to Amendment No. 3 to the Fund's Registration
Statement (File Nos. 333-111820 and 811-21485), filed March 15, 2004.
(4) Incorporated by reference to Amendment No. 1 to the Fund's Registration
Statement (File Nos. 333-119279 and 811-21485), filed November 8, 2004.
* Filed herewith.
** To be filed by subsequent amendment.
ITEM 26. MARKETING ARRANGEMENTS
See Exhibit 2(h).
ITEM 27. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses to be incurred in
connection with the offering described in this registration statement:
SEC Registration fees....................................... $
Printing and engraving expenses*............................
Auditing fees and expenses*.................................
Legal fees and expenses*....................................
S&P and Moody's Initial Costs...............................
Miscellaneous*..............................................
--------
Total*.................................................. $
--------
--------
---------
* Estimated.
ITEM 28. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
None.
ITEM 29. NUMBER OF HOLDERS OF SECURITIES
Set forth below is the number of record holders as of 2005, of
each class of securities of the Registrant:
NUMBER OF
TITLE OF CLASS RECORD HOLDERS
-------------- --------------
Common Shares...............................................
Series M7 AMPS, par value $.001 per share...................
Series T7 AMPS, par value $.001 per share...................
Series T28 AMPS, par value $.001 per share..................
Series W7 AMPS, par value $.001 per share...................
Series TH28 AMPS, par value $.001 per share.................
Series F7 AMPS, par value $.001 per share...................
Series TH7 AMPS, par value $.001 per share..................
C-2
ITEM 30. INDEMNIFICATION
It is the Registrant's policy to indemnify its directors, officers,
employees and other agents to the maximum extent permitted by Section 2-418 of
the General Corporation Law of the State of Maryland as set forth in Article
NINTH of Registrant's Articles of Incorporation, and Article VIII of the
Registrant's By-Laws. The liability of the Registrant's directors and officers
is dealt with in Article NINTH of Registrant's Articles of Incorporation. The
liability of Cohen & Steers Capital Management, Inc., the Registrant's
investment manager (the 'Investment Manager'), for any loss suffered by the
Registrant or its stockholders is set forth in Section 5 of the Investment
Management Agreement.
The Registrant has agreed to indemnify the Underwriters of the Registrant's
AMPS to the extent set forth in Exhibit 2(h).
Insofar as indemnification for liabilities under the Securities Act of
1933 may be permitted to the directors and officers, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in such Act and is
therefore unenforceable. If a claim for indemnification against such liabilities
under the Securities Act of 1933 (other than for expenses incurred in a
successful defense) is asserted against the Company by the directors or officers
in connection with the shares, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question of whether such indemnification by it
is against public policy as expressed in such Act and will be governed by the
final adjudication of such issue.
ITEM 31. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT MANAGER
The descriptions of the Investment Manager under the caption 'Management of
the Fund' in the Prospectus and in the Statement of Additional Information,
respectively, constituting Parts A and B, respectively, of this registration
statement are incorporated by reference herein.
The following is a list of the Directors and Officers of the Investment
Manager. None of the persons listed below has had other business connections of
a substantial nature during the past two fiscal years.
NAME TITLE
---- -----
Robert H. Steers....................... Co-Chairman and Co-Chief Executive Officer, Director
Martin Cohen........................... Co-Chairman and Co-Chief Executive Officer, Director
Joseph M. Harvey....................... President
Adam Derechin.......................... Chief Operating Officer
John J. McCombe........................ Executive Vice President
Douglas R. Bond........................ Executive Vice President
James S. Corl.......................... Executive Vice President
Lawrence B. Stoller.................... Executive Vice President and General Counsel
Matthew S. Stadler..................... Executive Vice President and Chief Financial Officer
William F. Scapell..................... Senior Vice President, Director of Fixed Income
Investments
Robert Becker.......................... Senior Vice President
William J. Frischling.................. Senior Vice President
Jay J. Chen............................ Senior Vice President
Victor M. Gomez........................ Senior Vice President -- Chief Accounting Officer
Richard E. Helm........................ Senior Vice President
Anthony Dotro.......................... Vice President
Mark Freed............................. Vice President
Robert Tisler.......................... Vice President
Norbert Berrios........................ Vice President
Terrance R. Ober....................... Vice President
Thomas Bohjalian....................... Vice President
David Oakes............................ Vice President
Hoyt Peters............................ Vice President
(continued on next page)
C-3
(continued from previous page)
NAME TITLE
---- -----
John McLean............................ Vice President and Associate General Counsel
Salvatore Rappa........................ Vice President and Associate General Counsel
Blair Lewis............................ Vice President
Scott Collins.......................... Vice President
John Cheigh............................ Vice President
Derek Cheung........................... Vice President
Sandra Morgan.......................... Vice President
Ben Morton............................. Vice President
Pascal van Garderen.................... Vice President
Elaine Zaharis-Nikas................... Vice President
Frank Zukowski......................... Vice President
Cohen & Steers Capital Management, Inc. acts as Investment Manager of, in
addition to the Registrant, the following registered investment companies:
Cohen & Steers Advantage Income Realty Fund, Inc.
Cohen & Steers Dividend Majors Fund, Inc.
Cohen & Steers Institutional Realty Shares, Inc.
Cohen & Steers International Realty Fund, Inc.
Cohen & Steers Realty Income Fund, Inc.
Cohen & Steers Premium Income Realty Fund, Inc.
Cohen & Steers Quality Income Realty Fund, Inc.
Cohen & Steers Realty Shares, Inc.
Cohen & Steers REIT and Preferred Income Fund, Inc.
Cohen & Steers REIT and Utility Income Fund, Inc.
Cohen & Steers Total Return Realty Fund, Inc.
Cohen & Steers Realty Focus Fund, Inc.
Cohen & Steers Utility Fund, Inc.
Cohen & Steers VIF Realty Fund, Inc.
Cohen & Steers Worldwide Realty Income Fund, Inc.
American Skandia Trust -- AST Cohen & Steers Realty Portfolio
ITEM 32. LOCATION OF ACCOUNTS AND RECORDS
The majority of the accounts, books and other documents required to be
maintained by Section 31(a) of the Investment Company Act of 1940, as amended
and the Rules thereunder will be maintained as follows: journals, ledgers,
securities records and other original records will be maintained principally at
the offices of the Registrant's Administrator and Custodian, State Street Bank
and Trust Company. All other records so required to be maintained will be
maintained at the offices of Cohen & Steers Capital Management, Inc., 757 Third
Avenue, New York, New York 10017.
ITEM 33. MANAGEMENT SERVICES
Not applicable.
ITEM 34. UNDERTAKINGS
(1) Registrant undertakes to suspend the offering of shares until the
prospectus is amended, if subsequent to the effective date of this registration
statement, its net asset value declines more than ten percent from its net asset
value as of the effective date of the registration statement or its net asset
value increases to an amount greater than its net proceeds as stated in the
prospectus.
(2) Not applicable.
C-4
(3) Not applicable.
(4) Not applicable.
(5) Registrant undertakes that, for the purpose of determining any liability
under the Securities Act, the information omitted from the form of prospectus
filed as part of the registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant pursuant to Rule
497(h) will be deemed to be a part of the registration statement as of the time
it was declared effective.
Registrant undertakes that, for the purpose of determining any liability
under the Securities Act, each post-effective amendment that contains a form of
prospectus will be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
will be deemed to be the initial bona fide offering thereof.
(6) Registrant undertakes to send by first-class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
C-5
SIGNATURES
Pursuant to the requirements of the Securities Act and the 1940 Act, the
Registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York
and the State of New York, on the 12th day of October 2005.
COHEN & STEERS SELECT UTILITY FUND, INC.
By: /s/ ADAM M. DERECHIN
....................................
ADAM M. DERECHIN
PRESIDENT
Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed below by the following persons in the
capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
By: /s/ ADAM M. DERECHIN President and Chief Executive Officer October 12, 2005
...................................... (Principal Executive Officer)
(ADAM M. DERECHIN)
By: /s/ JAY J. CHEN Treasurer (Principal Financial and October 12, 2005
...................................... Accounting Officer)
(JAY J. CHEN)
By: /s/ MARTIN COHEN Director and Co-Chairman October 12, 2005
......................................
(MARTIN COHEN)
By: /s/ ROBERT H. STEERS Director and Co-Chairman October 12, 2005
......................................
(ROBERT H. STEERS)
* Director October 12, 2005
.........................................
(BONNIE COHEN)
* Director October 12, 2005
.........................................
(GEORGE GROSSMAN)
* Director October 12, 2005
.........................................
(RICHARD E. KROON)
* Director October 12, 2005
.........................................
(RICHARD J. NORMAN)
* Director October 12, 2005
.........................................
(FRANK K. ROSS)
* Director October 12, 2005
.........................................
(WILLARD H. SMITH, JR.)
* Director October 12, 2005
.........................................
(C. EDWARD WARD, JR.)
*By: /s/ MARTIN COHEN
.....................................
MARTIN COHEN
ATTORNEY-IN-FACT**
---------
**Powers of Attorney were previously filed.
C-6
STATEMENT OF DIFFERENCES
The registered trademark symbol shall be expressed as.................... 'r'
The service mark symbol shall be expressed as............................ 'sm'
The double dagger symbol shall be expressed as........................... 'DD'
The division sign shall be expressed as.................................. [div]
Characters normally expressed as superscript shall be preceded by........ 'pp'