As filed with the Securities and Exchange Commission on March 12, 2010
1933 Act File No. 333-164388
1940 Act File No. 811-21601
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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
x REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
x Amendment No. 8
PIMCO Income Strategy Fund II
(Exact Name of Registrant as Specified in Charter)
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3222
(Registrants Telephone Number, including Area Code))
Thomas J. Fuccillo, Esq.
c/o Allianz Global Investors Fund Management LLC
1345 Avenue of the Americas
New York, New York 10105
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
David C. Sullivan, Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
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, other than securities offered in connection with a dividend reinvestment plan, check the following box ¨ .
It is proposed that this filing will become effective (check appropriate box):
x | when declared effective pursuant to section 8(c). |
Calculation of Registration Fee Under the Securities Act of 1933
Title of Securities Being Registered |
Amount Being
Registered |
Proposed Maximum
Offering Price per Unit |
Proposed Maximum
Aggregate Offering Price 1 |
Amount of
Registration Fee |
||||
Common Shares, par value $0.00001 |
14,444,000 |
$9.84 |
$142,128,960 1 |
$10,133.80 2 |
||||
Rights to Subscribe for Common Shares |
18,519,000 Rights | None 3 | None | None | ||||
1 | Estimated solely for the purpose of calculating the registration fee as required by Rule 457(c) under the Securities Act of 1933, as amended, based upon the average of the high and low sales prices reported on the New York Stock Exchange consolidated reporting system of $9.84 on March 9, 2010. |
2 | A registration fee of $71.30 was previously paid in connection with the initial filing on January 19, 2010. |
3 | No separate consideration will be received by the Registrant for the Rights |
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 that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
The information in this preliminary 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 preliminary 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.
PRELIMINARY PROSPECTUS | SUBJECT TO COMPLETION | March 12, 2010 |
PIMCO Income Strategy Fund II
(formerly, PIMCO Floating Rate Strategy Fund)
[ · ] Common Shares
Issuable Upon Exercise of Rights to Subscribe for Such Shares
PIMCO Income Strategy Fund II (formerly, PIMCO Floating Rate Strategy Fund, the Fund) is a diversified closed-end management investment company. The Funds investment objective is to seek high current income, consistent with the preservation of capital.
The Fund is issuing transferable rights (Rights) to its common shareholders of record (Record Date Shareholders) as of 5:00 p.m., Eastern time, on March 24, 2010 (the Record Date), entitling the holders of those Rights to subscribe for up to an aggregate of [ · ] of the Funds common shares of beneficial interest (the Offer). Record Date Shareholders will receive one Right for each outstanding whole common share held on the Record Date. The Rights entitle their holders to purchase one new common share for every three Rights held (1-for-3). Any Record Date Shareholder who is issued fewer than three Rights may subscribe for one full common share in the offer. In addition, Record Date Shareholders who fully exercise their Rights (other than those Rights that cannot be exercised because they represent the right to acquire less than one common share) will be entitled to subscribe for additional common shares of the Fund that remain unsubscribed as a result of any unexercised Rights. This over-subscription privilege is subject to a number of limitations and subject to allotment.
The subscription price (the Subscription Price) will be determined based upon a formula equal to 90% of the average of the last reported sale prices of the Funds common shares on the NYSE on the Expiration Date (as defined below) and on each of the four preceding trading days (the Formula Price). If, however, the Formula Price is less than 80% of the Funds net asset value per common share on the Expiration Date, then the Subscription Price will be 80% of the Funds net asset value per common share on that day. The Offer will expire at 5:00 p.m., Eastern time, on April 23, 2010, unless extended as described in this prospectus (the Expiration Date).
Rights holders may not know the Subscription Price at the time of exercise and will be required initially to pay for both the common shares subscribed for pursuant to the primary subscription and, if eligible, any additional common shares subscribed for pursuant to the over-subscription privilege at the estimated Subscription Price of $[ · ] per common share and, except in limited circumstances, will not be able to rescind their subscription.
Exercising your Rights and investing in the Funds common shares involves a high degree of risk and may be considered speculative. Before exercising your Rights and investing in the Funds common shares, you should read the discussion of the material risks of investing in the Fund, including the risks of leverage and of investing in below investment grade/high yield securities, in Principal risks of the Fund. Certain of these risks are summarized in Prospectus summaryPrincipal Risks of the Fund.
You should read this prospectus, which contains important information about the Fund, before deciding whether to invest and retain it for future reference. A Statement of Additional Information, dated [ · ], 2010, containing additional information about the Fund has been filed with the Securities and Exchange Commission (the Commission) and is incorporated by reference in its entirety into this prospectus. You can review the table of contents of the Statement of Additional Information on page [ · ] of this prospectus. You may request a free copy of the Statement of Additional Information, request the Funds most recent annual and semiannual reports, request information about the Fund and make shareholder inquiries by calling (800)254-5197 or by writing to the Fund at c/o Allianz Global Investors Fund Management LLC, 1345 Avenue of the Americas, New York, New York 10105. You may also obtain a copy of the Statement of Additional Information (and other information regarding the Fund) from the
(continued on following page)
Commissions Public Reference Room in Washington, D.C. by calling (202) 551-8090. The Commission charges a fee for copies. The Funds most recent annual and semiannual reports are available, free of charge, on the Funds website (http://www.allianzinvestors.com). You can obtain the same information, free of charge, from the Commissions web site (http://www.sec.gov).
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined that this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
Per share | Total (1) | |||
Estimated subscription price (2) | $[ · ] | $[ · ] | ||
Estimated sales load (2)(3) | $[ · ] | $[ · ] | ||
Estimated offering expenses | $[ · ] | $[ · ] | ||
Estimated proceeds, after expenses, to the Fund (2) | $[ · ] | $[ · ] |
(footnotes on inside front cover)
UBS Investment Bank
(continued from previous page)
Record Date Shareholders who do not fully exercise their Rights will, upon completion of the Offer, own a smaller proportional interest in the Fund than they owned prior to the Offer. In addition, because the Subscription Price per common share may be less than the then current net asset value per common share, the completion of the Offer may result in an immediate dilution of the net asset value per common share for all existing common shareholders of the Fund. Such dilution is not currently determinable because it is not known how many common shares will be subscribed for, what the net asset value or market price of the common shares will be on the Expiration Date or what the Subscription Price will be. Such dilution could be substantial. If such dilution occurs, common shareholders will experience a decrease in the net asset value per common share held by them, irrespective of whether they exercise all or any portion of their Rights. The distribution to Record Date Shareholders of transferable Rights, which may themselves have intrinsic value, will afford such shareholders the potential of receiving cash payment upon the sale of the Rights, receipt of which may be viewed as partial compensation for the economic dilution of their interests. No assurance can be given that a market for the Rights will develop, or as to the value, if any, that the Rights will have. See The OfferInvestment Considerations and Dilution.
The Funds outstanding common shares are listed and trade on the New York Stock Exchange (NYSE) under the symbol PFN, as will the common shares offered for subscription in the Offer. The Rights are transferable and will be admitted for trading on the NYSE under the symbol PFN.RT throughout the term of the Offer, which may afford non-subscribing Record Date Shareholders the opportunity to sell their Rights for cash value. See The Offer for a complete discussion of the terms of the Offer.
If you have questions or need further information about the Offer, please write The Altman Group, the Funds information agent for the Offer, at 60 East 42nd Street, Suite 916, New York, NY 10165 or call (866) 207-3647.
The Fund seeks to achieve its investment objective by ordinarily investing in a diversified portfolio of floating- and/or fixed-rate debt instruments. The average portfolio duration of the Fund normally will be in a low to intermediate range ( i.e. , zero to eight years). The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys Investors Service, Inc. (Moodys) or below BBB- by either Standard & Poors, a division of The McGraw-Hill Companies (S&P), or Fitch, Inc. (Fitch)) or that are unrated but judged by the Funds sub-adviser, Pacific Investment Management Company LLC (PIMCO), to be of comparable quality, and also may invest without limit in investment grade securities. The Fund has the flexibility to allocate and re-allocate its assets in varying proportions among floating- and fixed-rate debt instruments as well as among investment grade and non-investment grade securities, and may choose to focus more heavily or exclusively on an asset class ( i.e. , floating or fixed; investment grade or non-investment grade) at any time and from time to time based on PIMCOs assessment of relative values, market conditions and other factors. The Fund is actively managed in accordance with PIMCOs top down short-term (cyclical) and longer-term (secular) economic outlook, using strategies that focus on credit quality analysis, broad market diversification among industries and sectors and other risk management techniques. See Investment objective and policiesInvestment Strategies for further description of these and other investment management techniques used by PIMCO for the Fund. The Fund may invest in issuers of any credit quality (including bonds in the lowest ratings categories and securities that are in default or the issuers of which are in bankruptcy) if PIMCO determines that the particular obligation offers an attractive yield relative to its risk profile. Debt securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal, and are commonly referred to as high yield securities or junk bonds. High yield securities are subject to greater risk of loss of principal and interest and may be less liquid than investment grade securities. The Fund normally invests predominantly in U.S. dollar-denominated debt securities, which may include those issued by foreign corporations or supranational government agencies. The Fund may invest up to 25% of its total assets in securities denominated in foreign currencies, and may invest up to 25% of its total assets in securities that are economically tied to emerging market countries. Various types of securities and other investments in which the Fund may invest are described under Portfolio contents in this prospectus. The Fund cannot assure you that it will achieve its investment objective.
The Funds common shares 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.
(footnotes from front cover)
(1) | Assumes that all Rights are exercised at the estimated Subscription Price. |
(2) | Estimated on the basis of 90% of the last reported sale price of a common share of the Fund on the NYSE on [ · ]. |
(3) | UBS Securities LLC will act as dealer manager for the Offer (the Dealer Manager). The Fund has agreed to pay the Dealer Manager a fee for its financial structuring and soliciting services equal to 3.50% of the Subscription Price per common share for each common share issued pursuant to the exercise of Rights and the over-subscription privilege. The Dealer Manager will reallow to broker-dealers in the selling group to be formed and managed by the Dealer Manager selling fees equal to 2.50% of the Subscription Price per common share for each common share issued pursuant to the exercise of Rights as a result of their selling efforts. In addition, the Dealer Manager will reallow to other broker-dealers that have executed and delivered a soliciting dealer agreement and have solicited the exercise of Rights solicitation fees equal to 0.50% of the Subscription Price per common share for each common share issued pursuant to the exercise of Rights as a result of their soliciting efforts, subject to a maximum fee based on the number of common shares held by each broker-dealer through The Depository Trust Company (DTC) on the Record Date. The fees and expenses of the Offer, including the Dealer Manager fee, will be borne by the Fund and indirectly by all of its common shareholders, including those who do not exercise their Rights. The Fund and Allianz Global Investors Fund Management LLC, the Funds investment manager, have each agreed to indemnify the Dealer Manager for losses arising out of certain liabilities, including liabilities under the Securities Act of 1933, as amended. |
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Anti-takeover provisions in the Agreement and Declaration of Trust |
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You should rely only on the information contained or incorporated by reference in this prospectus. The Fund has not, and the Dealer Manager has 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. The Fund is not, and the Dealer Manager is not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common shares of the Fund.
i
This is only a summary. This summary may not contain all of the information that you should consider before investing in the Fund. You should review the more detailed information contained in this prospectus and in the Statement of Additional Information, especially the information set forth under the heading Principal risks of the Fund.
The Fund |
PIMCO Income Strategy Fund II (formerly, PIMCO Floating Rate Strategy Fund) is a diversified closed-end management investment company. The Fund commenced investment operations on October 29, 2004, following the initial public offering of its common shares. Throughout this prospectus, PIMCO Income Strategy Fund II is referred to simply as the Fund. See The Fund. |
Purpose of the Offer |
The Board of Trustees of the Fund (the Board), Allianz Global Investors Fund Management LLC, the Funds investment manager (AGIFM or the Investment Manager), and Pacific Investment Management Company LLC, the Funds sub-adviser (PIMCO or the Sub-Adviser), have determined that it would be in the best interests of the Fund and its shareholders to increase the assets of the Fund, in order to more fully take advantage of current and prospective investment opportunities that reflect the Sub-Advisers views regarding the credit markets. Consistent with the changes to the Funds name and investment policies and guidelines that became effective on March 1, 2010 (see The Fund), the Board, the Investment Manager and the Sub-Adviser believe that there are more attractive opportunities in fixed rate securities. By increasing assets through the Offer, the Fund believes that it will be able to cost-efficiently shift a larger portion of the Funds investment allocations from floating rate assets (including floating rate loans) to fixed rate instruments, achieve greater portfolio diversification with respect to industries and issuers currently represented in the portfolio (including as an alternative to possibly selling existing holdings that have appreciated in value) and potentially enhance risk-adjusted returns, in pursuit of its investment objective of seeking high current income, consistent with the preservation of capital. The Offer is also intended to enhance the market liquidity of the Funds common shares, reduce the Funds expense ratio modestly (not taking into account interest expense) and provide common shareholders with the opportunity to buy additional common shares at a discounted price to then-current market value. |
The Offer may not be successful. The completion of the Offer may result in an immediate dilution of the net asset value per common share for all existing common shareholders of the Fund, including those who fully exercise their rights. See The OfferPurpose of the Offer.
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The Fund expects to declare a monthly common share dividend in April 2010. Such dividend will not be payable with respect to Shares that are issued pursuant to the Offer after the record date for such dividend.
The Fund will bear the expenses of the Offer and all such expenses will be borne indirectly by the Funds common shareholders, including those who do not exercise their Rights. These expenses include, but are not limited to, the dealer manager fee and reimbursement of dealer manager expenses, the expenses of preparing, printing and mailing the prospectus and Rights subscription materials for the Offer and the expenses of Fund counsel and the Funds independent registered public accounting firm in connection with the Offer.
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Subscription Price |
The subscription price for the Shares (the Subscription Price) will be determined based on a formula equal to 90% of the average of the last reported sale price of the Funds common shares on the New York Stock Exchange (the NYSE) on the Expiration Date and on each of the four preceding trading days (the Formula Price). If, however, the Formula Price is less than 80% of the Funds net asset value per common share on the Expiration Date, then the Subscription Price will be 80% of the Funds net asset value per common share on that day. Because the Expiration Date of the subscription period will be April 23, 2010 (unless the subscription period is extended), Rights holders may not know the Subscription Price at the time of exercise and will be required initially to pay for both the Shares subscribed for pursuant to the primary subscription and, if eligible, any additional Shares subscribed for pursuant to the over-subscription privilege at the estimated Subscription Price of $[ · ] per Share and, except in limited circumstances, will not be able to rescind their subscription. See The OfferSubscription Price. |
Over-Subscription Privilege |
Record Date Shareholders who exercise all the Rights issued to them (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) are entitled to subscribe for additional Shares at the same Subscription Price pursuant to the over-subscription privilege, subject to certain limitations and subject to allotment. If sufficient remaining Shares are available, all Record Date Shareholders over-subscription requests will be honored in full. Investors who are not Record Date Shareholders, but who otherwise acquire Rights pursuant to the Offer, are not entitled to subscribe for any Shares pursuant to the over-subscription privilege. To the extent sufficient Shares are not available to honor all over-subscription requests, unsubscribed Shares will be allocated pro rata among those Record Date Shareholders who over-subscribe based on the number of common shares of the Fund they owned on the Record Date. See The OfferOver-Subscription Privilege. |
Sale and Transferability of Rights |
The Rights will be admitted for trading on the NYSE under the symbol PFN.RT during the course of the Offer. Trading in the Rights on the NYSE may be conducted until the close of trading on the NYSE on the last business day prior to the Expiration Date. The Fund will use its best efforts to ensure that an adequate trading market for the Rights will exist, although there can be no assurance that a market for the Rights will develop. Assuming a market exists for the Rights, the Rights may be purchased and sold through usual brokerage channels or sold through the Subscription Agent (defined below). |
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Record Date Shareholders who do not wish to exercise any of the Rights issued to them pursuant to the Offer may instruct the Subscription Agent to sell any unexercised Rights through or to the Dealer Manager (as defined on the next page). Subscription certificates representing the Rights to be sold through or to the Dealer Manager must be received by the Subscription Agent by 5:00 p.m., Eastern time, on April 21, 2010 (or, if the subscription period is extended, by 5:00 p.m., Eastern time, two business days prior to the extended Expiration Date).
Alternatively, the Rights evidenced by a subscription certificate may be transferred until the Expiration Date in whole or in part by endorsing the subscription certificate for transfer in accordance with the accompanying instructions. See The OfferSale and Transferability of Rights.
Rights holders who have exercised their Rights will have no right to rescind their subscription after receipt by the Subscription Agent of the completed subscription certificate together with payment for Shares, except as described under The OfferNotice of Net Asset Value Decline.
Requirements for Foreign Shareholders |
Subscription certificates will not be mailed to Record Date Shareholders whose addresses are outside the United States (for these purposes, the United States includes the District of Columbia and the territories and possessions of the |
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United States) (Foreign Shareholders). The Subscription Agent will send a letter via regular mail to Foreign Shareholders to notify them of the Offer. The Rights of Foreign Shareholders will be held by the Subscription Agent for their accounts until instructions are received to exercise the Rights. If instructions have not been received by 5:00 p.m., Eastern time, on April 20, 2010, three business days prior to the Expiration Date (or, if the subscription period is extended, on or before three business days prior to the extended Expiration Date), the Rights of Foreign Shareholders will be transferred by the Subscription Agent to the Dealer Manager, who will either purchase the Rights or use its best efforts to sell the Rights. The net proceeds, if any, from sale of those Rights by or to the Dealer Manager will be remitted to these Foreign Shareholders. |
Prior to the expiration of the Offer, the Dealer Manager may independently offer for sale Shares it has acquired through purchasing and exercising the Rights, at prices it sets. Although the Dealer Manager may realize gains and losses in connection with purchases and sales of Shares, such offering of Shares is intended by the Dealer Manager to facilitate the Offer and any such gains or losses are not expected to be material to the Dealer Manager. The Dealer Managers fee for its financial structuring and soliciting services is independent of any gains or losses that may be realized by the Dealer Manager through the purchase and
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exercise of the Rights and the sale of Shares. See Distributions. |
The Investment Manager has retained its affiliate, PIMCO, as a sub-adviser to manage the Funds portfolio investments. See Sub-Adviser below.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660. Organized in 1971, PIMCO provides investment management and advisory services to private accounts of institutional and individual clients and to a number of open-end and closed-end investment companies. As of December 31, 2009, PIMCO had approximately $1 trillion in assets under management.
The Investment Manager (and not the Fund) pays a portion of the fees it receives to PIMCO in return for PIMCOs services.
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Subscription Agent |
The subscription agent for the Offer is The Colbent Corporation (the Subscription Agent). |
Information Agent |
The information agent for the Offer is The Altman Group (the Information Agent). If you have questions or need further information about the Offer, please write the Information Agent at [60 East 42nd Street, Suite 916, New York, NY 10165] or call (866) 207-3647. |
Listing |
The Funds outstanding common shares are listed and trade on the NYSE under the trading or ticker symbol PFN, as will the Shares offered for subscription in the Offer. The Rights are transferable and will be admitted for trading on the NYSE under the symbol PFN.RT during the course of the Offer. |
Use of Proceeds |
The net proceeds of the Offer will be invested in accordance with the Funds investment objective and investment strategies set forth below. Assuming current market conditions, the Fund estimates that the net proceeds of the Offer will be substantially invested in accordance with its investment objective and investment strategies within one to three months of the completion of the Offer. Pending such investment, it is anticipated that the proceeds of the Offer will be invested in short-term debt securities. Following the completion of the Offer, the Fund currently intends to increase the Funds leverage. See Use of leverage. |
Benefits to the Investment Manager and the Sub-Adviser |
The Investment Manager and the Sub-Adviser will benefit from the Offer, in part, because the investment management fee paid by the Fund to the Investment Manager and the subadvisory fee paid by the Investment Manager to the Sub-Adviser each are based on the Funds average weekly total managed assets, meaning the total assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding) minus accrued liabilities (other than liabilities representing borrowings). It is not possible to state precisely the amount of additional compensation the Investment Manager and the Sub-Adviser will receive as a result of the Offer because it is not known how many Shares of the Fund will be subscribed for and because the proceeds of the Offer will be invested in additional portfolio securities which will fluctuate in value. However, assuming (i) all Rights are exercised, (ii) the Funds average weekly net asset value during the twelve-month period beginning May 1, 2010 is $[ · ] per common share (the net asset value per common share on [ · ]) (iii) the Subscription Price is $[ · ] per Share (90% of the last reported sale price of the Funds common shares on [ · ]), and (iv) for purposes of this example, the Fund increases the amount of leverage it has outstanding (through the use of repurchase |
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agreements) while maintaining approximately the same percentage of total assets attributable to leverage, and after giving effect to the Dealer Manager fee and other estimated offering expenses, the Investment Manager and the Sub-Adviser would receive additional investment management fees and subadvisory fees of approximately $[ · ] and $[ · ], respectively, for the twelve-month period beginning May 1, 2010, and would continue to receive additional investment management fees and subadvisory fees, respectively, as a result of the Offer, based on the Funds average weekly total managed assets attributable to the Shares issued in the Offer and related additional leverage, thereafter. |
The Fund has the flexibility to allocate and to re-allocate its assets in varying proportions among floating- and fixed-rate debt instruments as well as among investment grade and non-investment grade securities, and may choose to focus more heavily or exclusively on an asset class ( i.e. , floating or fixed; investment grade or non-investment grade) at any time and from time to time based on PIMCOs assessment of relative values, market conditions and other factors.
Various types of securities and other instruments in which the Fund may invest are described under Portfolio contents below. The Fund cannot assure you that it will achieve its investment objective.
Investment Strategies |
The Fund is actively managed in accordance with PIMCOs top down short-term (cyclical) and longer-term (secular) economic outlook, using strategies that focus on credit quality analysis, broad market diversification among industries and sectors and other risk management techniques. In selecting investments for the Fund, PIMCO attempts to identify floating- and/or fixed-rate debt instruments that provide high current income through fundamental research, driven by independent credit analysis and proprietary analytical tools. Investment |
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decisions are based primarily on PIMCOs assessment of the issuers credit characteristics and the position of the particular security in the issuers capital structure, in light of PIMCOs outlook for particular industries, the economy and the market generally. At the same time, PIMCO may use a variety of techniques, such as credit default swaps, designed to control risk and to minimize the Funds exposure to issues that PIMCO believes are more likely to default or otherwise to depreciate in value over time and to detract from the Funds overall return to investors. The Fund cannot assure you that such securities will ultimately continue to pay current income or be paid in full at maturity.
Credit Quality. The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade or that are unrated but judged by PIMCO to be of comparable quality. The Fund may invest in issuers of any credit quality (including debt securities in the lowest ratings categories and securities that are in default or the issuers of which are in bankruptcy) if PIMCO determines that the particular security offers an attractive yield relative to its risk profile. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security or that are unrated but judged by PIMCO to be of comparable quality. Debt securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and to repay principal, and are commonly referred to as high yield securities or junk bonds. Debt securities in the lowest investment grade category also may be considered to posses some speculative characteristics by certain rating agencies. The Funds credit quality policies apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue.
Independent Credit Analysis. PIMCO relies heavily on its own analysis of the credit quality and risks associated with individual debt instruments considered for the Fund, rather than relying exclusively on rating agencies or third-party research. In the case of floating rate loans in which the Fund may invest (Floating Rate Loans), PIMCO analyzes and takes into account the legal/protective features associated with the securities (such as their position in the borrowers capital structure and any security through collateral) in assessing their credit characteristics. PIMCO has a devoted team of professionals that conducts
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fundamental credit research and analysis of individual issuers, industries and sectors and uses proprietary analytical tools (such as computer databases and Web-based applications) to assess and to monitor credit risk. The Funds portfolio manager utilizes this information in an attempt to manage credit risk and to identify issuers, industries or sectors that offer attractive yields relative to PIMCOs assessment of their credit characteristics. This aspect of PIMCOs capabilities is particularly important to the extent that the Fund focuses on Floating Rate Loans and/or below investment grade securities. PIMCOs ability to analyze Floating Rate Loans may be limited to the extent that the portfolio manager and analysts avoid the receipt of material, non-public information about the issuers of Floating Rate Loans. See Principal risks of the FundConfidential Information Access Risk.
Duration. The average portfolio duration of the Fund will normally be in a low to intermediate range ( i.e. , zero to eight years), although it may be longer at any time and from time to time based on PIMCOs assessment of market conditions and other factors. PIMCO may utilize certain strategies, including investments in structured notes or interest rate futures contracts or swap, cap, floor or collar transactions, for the purpose of reducing the interest rate sensitivity of the Funds portfolio, although there is no assurance that it will do so or that, if used, such strategies will be successful.
Portfolio Contents |
The Fund seeks to achieve its investment objective by ordinarily investing in a diversified portfolio of floating- and/or fixed-rate debt instruments. The Fund may invest a substantial portion of its floating-rate assets in Floating Rate Loans. Other floating rate debt instruments in which the Fund may invest include catastrophe and other event-linked bonds, bank capital securities, unsecured bank loans, corporate bonds and other debt securities, money market instruments and certain types of mortgage-backed and other asset-backed securities that pay interest at rates which adjust whenever a specified interest rate changes and/or reset on predetermined dates (such as the last day of a month or calendar quarter). The Fund also considers floating rate assets to include securities with durations of less than or equal to one year and fixed rate securities with respect to which the Fund has entered into derivative instruments to effectively convert the fixed rate interest payments into floating rate interest payments. The Fund also may invest in a wide variety of fixed-rate debt securities, including corporate bonds, convertible securities and mortgage-backed and other asset-backed securities issued on a public or private basis. The Fund may make use |
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of a variety of other instruments, including collateralized debt obligations, preferred shares, commercial paper, U.S. Government securities, zero-coupon and inflation-indexed bonds, real estate investment trusts (REITs), structured notes and other hybrid instruments and credit-linked trust certificates. Certain debt instruments, such as convertible bonds, also may include the right to participate in equity appreciation. The principal and/or interest rate on some debt instruments may be determined by reference to the performance of a benchmark asset or market, such as an index of securities, or the differential performance of two assets or markets, such as the level of exchange rates between the U.S. dollar and a foreign currency or currencies. |
The Fund may also hold common stocks and other equity securities from time to time, including those it has received through the conversion of a convertible security held by the Fund or in connection with the restructuring of a debt security. The Fund may invest in securities that have not been registered for public sale, including securities eligible for purchase and sale pursuant to Rule 144A under the Securities Act of 1933 and other securities issued in private placements. The Fund may also invest in securities of other investment companies, including exchange-traded funds (ETFs). The Fund may invest in securities of companies with small market capitalizations.
As noted above, the Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade, and may also invest without limit in investment grade securities.
The Fund expects to invest predominantly in U.S. dollar-denominated debt securities, which may include those issued by foreign corporations or supra-national government agencies. The Fund may invest up to 25% of its total assets in securities denominated in foreign currencies, including obligations of non-U.S. governments and their respective sub-divisions, agencies and government-sponsored enterprises. The Fund may invest up to 25% of its total assets in securities that are economically tied to emerging market countries.
The Fund may utilize various derivative strategies involving the purchase or sale of credit default swaps, total return swaps and other swap agreements, call and put options (including options on futures contracts), futures and forward contracts, short sales and other derivative instruments for investment purposes, leveraging purposes or in an attempt to hedge against market, interest rate, currency and other risks in the portfolio. The Fund may
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also seek to obtain market exposure to the securities in which it invests by entering into a series of purchase and sales contracts. |
The Fund may invest without limit in illiquid securities. Illiquidity is generally determined using the Securities and Exchange Commissions standard applicable to open-end investment companies ( i.e. , securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities). PIMCO will determine the liquidity of the Funds investments by reference to market conditions and contractual provisions.
The Fund cannot change its investment objective without the approval (a) of the holders of a majority of the outstanding common shares and any preferred shares (including the Funds currently outstanding auction market preferred shares (the Preferred Shares)) voting together as a single class, and (b) of the holders of a majority of the outstanding preferred shares (including the Preferred Shares) voting as a separate class. A majority of the outstanding shares (whether voting together as a single class or voting as a separate class) means (i) 67% or more of such shares present at a meeting, if the holders of more than 50% of those shares are present or represented by proxy, or (ii) more than 50% of such shares, whichever is less.
Upon PIMCOs recommendation, for temporary defensive purposes and in order to keep the Funds cash fully invested, the Fund may deviate from its investment objective and strategies and invest some or all of its total assets in investment grade debt securities, including high quality, short-term debt securities. The Fund may not achieve its investment objective when it does so.
Use of Leverage |
The Fund has utilized leverage since shortly after it began investment operations, including through the issuance of Preferred Shares. As of February 28, 2010, the aggregate dollar amount ( i.e. , liquidation preference) of the Funds outstanding Preferred Shares was $161 million, which then represented approximately 27% of the Funds total assets (including assets attributable to the Preferred Shares). Information regarding the terms and features of the Preferred Shares is provided under Description of capital structure in this prospectus. |
Following the Offer, the Fund currently intends to add leverage to its portfolio by utilizing reverse repurchase agreements, dollar rolls or other forms of borrowings, such as bank loans or commercial paper or other credit facilities
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(together Borrowings) in order to maintain approximately the total amount of leverage (as a percentage of the Funds total assets) that the Fund currently maintains. As of February 28, 2010, the Fund had reverse repurchase agreements outstanding representing approximately 5% of the Funds total assets (including the leverage obtained through the use of the instruments), such that the Funds total leverage attributable in the aggregate to Preferred Shares and Borrowings then represented approximately 32% of the Funds total assets. |
The Fund may also enter into transactions other than those noted above that may give rise to a form of leverage including, among others, credit default swap contracts, futures and forward contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions. Although it has no current intention to do so, the Fund may also determine to issue other preferred shares to add leverage to its portfolio.
Following completion of the Offer, the Fund intends to increase the amount of its leverage outstanding. The Fund intends to do so by engaging in additional Borrowings, including through the use of reverse repurchase agreements, in order to maintain approximately the Funds current leverage ratio as described above, taking into account the additional assets raised through the issuance of Shares in the Offer. The Fund may also add leverage through the use of credit default swaps and other derivative transactions and/or the other techniques noted above. There is no assurance, however, that the Fund will determine to add leverage following the Offer, as the Fund intends to utilize leverage opportunistically and may choose to increase or decrease its use of leverage over time and from time to time based on PIMCOs assessment of the yield curve environment, interest rate trends, market conditions and other factors. In this regard, the Fund may determine to increase its leverage ratio beyond current levels from time to time following the Offer. If the Fund determines to add leverage following the Offer, it is not possible to predict with accuracy the precise amount of leverage that would be added, in part, because it is not possible to predict the number of Shares that ultimately will be subscribed for in the Offer.
The Funds net assets attributable to its Preferred Shares and the net proceeds the Fund obtains from Borrowings or other forms of leverage will be invested in accordance with the Funds investment objective and policies as described in this
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prospectus. So long as the rate of return, net of applicable Fund expenses, on the debt obligations and other investments purchased by the Fund exceeds the dividend rates payable on the Preferred Shares together with the costs to the Fund of other forms of leverage it utilizes, the investment of the Funds net assets attributable to leverage will generate more income than will be needed to pay the costs of the leverage. If so, and all other things being equal, the excess may be used to pay higher dividends to holders of he Funds common shares (Common Shareholders) than if the Fund were not so leveraged. |
Regarding the expenses associated with the Funds leverage, the terms of the Preferred Shares provide that they would ordinarily pay dividends at a rate set at auctions held every seven days, subject to a maximum applicable rate calculated as a function of the Preferred Shares then-current rating and a reference interest rate. However, the weekly auctions for the Preferred Shares, as well as auctions for similar preferred shares of other closed-end funds across the U.S. industry, have failed since February 2008, and the dividend rates on the Preferred Shares since that time have been paid at the maximum applicable rate ( i.e. the greater of a multiple of or a spread plus a reference rate, which is the greater of the applicable LIBOR rate or the applicable Treasury Index Rate). The Fund expects that the Preferred Shares will continue to pay dividends at the maximum applicable rate for the foreseeable future and cannot predict whether or when the auction markets for the Preferred Shares may resume normal functioning. See Principal risks of the FundLeverage Risk, Principal risks of the FundAdditional Risks Associated with the Funds Preferred Shares and Description of capital structure for more information.
Leveraging is a speculative technique and there are special risks and costs involved. The Fund cannot assure you that its Preferred Shares and any Borrowings or other forms of leverage (such as the use of derivatives strategies) will result in a higher yield on your common shares. When leverage is used, the net asset value and market price of the common shares and the yield to Common Shareholders will be more volatile. See Principal risks of the FundLeverage Risk. In addition, dividend, interest and other expenses borne by the Fund with respect to its Preferred Shares and any Borrowings or other forms of leverage are borne entirely by the Common Shareholders (and not by the holders of Preferred Shares) and result in a reduction of the net asset value of the common shares. In addition, because the fees received by the Investment Manager and by PIMCO are based on the total managed assets of the Fund (including any
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assets attributable to any preferred shares and borrowings that may be outstanding), the Investment Manager and PIMCO have a financial incentive for the Fund to have Preferred Shares outstanding and to use certain other forms of leverage ( e.g. , reverse repurchase agreements and other Borrowings), which may create a conflict of interest between the Investment Manager and PIMCO, on the one hand, and the Common Shareholders, on the other hand. |
Under the Investment Company Act of 1940, as amended (the 1940 Act), the Fund is not permitted to issue preferred shares unless immediately after such issuance the value of the Funds total net assets is at least 200% of the liquidation value of the outstanding Preferred Shares and the newly issued preferred shares plus the aggregate amount of any senior securities of the Fund representing indebtedness ( i.e. , such liquidation value plus the aggregate amount of senior securities representing indebtedness may not exceed 50% of the Funds total net assets). 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 value of the Funds total net assets satisfies the above-referenced 200% coverage requirement.
The 1940 Act also generally prohibits the Fund from engaging in most forms of leverage other than preferred shares (including through the use of reverse repurchase agreements, dollar rolls, bank loans, commercial paper or other credit facilities, credit default swap contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions, to the extent that these instruments are not covered as described below) unless immediately after the issuance of the leverage the Fund has satisfied the asset coverage test with respect to senior securities representing indebtedness prescribed by the 1940 Act, i.e. , the value of the Funds total assets less liabilities (other than the leverage and other senior securities) is at least 300% of the principal amount of such leverage ( i.e. , effectively limiting the use of leverage through senior securities representing indebtedness to 33 1 / 3 % of the Funds total assets, including assets attributable to the leverage). The Fund is not permitted to declare any cash dividend or other distribution on common shares unless, at the time of such declaration, this 300% asset coverage requirement is satisfied. The Fund may (but is not required to) cover its commitments under derivatives and certain other instruments by the segregation of liquid assets or by entering into offsetting transactions or owning positions covering its obligations. For instance, the Fund may cover its position in a reverse repurchase agreement by segregating liquid assets
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at least equal in amount to its forward purchase commitment. To the extent that certain of these instruments are so covered, they will not be considered senior securities under the 1940 Act and therefore will not be subject to the 300% asset coverage requirement otherwise applicable to forms of leverage (other than preferred shares) used by the Fund. However, these transactions, even if covered, may represent a form of economic leverage and create special risks. The use of these forms of leverage increases the volatility of the Funds investment portfolio and could result in larger losses to Common Shareholders than if the strategies were not used. See Principal risks of the FundLeverage Risk. Failure to maintain certain asset coverage requirements could result in an event of default under certain Borrowings that may be used by the Fund. |
The Funds ability to utilize leverage is also limited by asset coverage requirements and other guidelines imposed by rating agencies (currently Moodys and Fitch) that provide ratings for the Preferred Shares, which may be more restrictive than the limitations imposed by the 1940 Act noted above. See Description of capital structure for more information.
The Fund also may borrow money in order to repurchase its shares or as a temporary measure for extraordinary or emergency purposes, including for the payment of dividends or the settlement of securities transactions which otherwise might require untimely dispositions of portfolio securities held by the Fund.
Principal Risks of the Fund |
The following is a summary of the principal risks associated with an investment in common shares of the Fund. Investors should also refer to Principal risks of the Fund in this prospectus and Investment Objective and Policies in the Statement of Additional Information for a more detailed explanation of these and other risks associated with investing in the Fund. |
Market Discount Risk . As with any stock, the price of the Funds common shares will fluctuate with market conditions and other factors. If common shares are sold, the price received may be more or less than the original investment. Net asset value of the Funds common shares will be reduced immediately following the Offer by expenses paid or reimbursed by the Fund in connection with the Offer. The completion of the Offer may result in an immediate dilution of the net asset value per common shares for all existing Common Shareholders, including those who fully exercise their Rights. The common shares are designed for long-term investors and should not be treated as trading vehicles. Common shares of closed-end
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management investment companies frequently trade at a discount from their net asset value. The Funds common shares may trade at a price that is less than the Subscription Price for Shares issued pursuant to the Offer. This risk may be greater for investors who sell their Shares relatively shortly after completion of the Offer. |
Market Risk . The market price of securities owned by the Fund may go up or down, sometimes rapidly or unpredictably. Securities may decline in value due to factors affecting securities markets generally or particular industries represented in the securities markets. The value of a security may decline due to general market conditions which are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. During a general downturn in the securities markets, multiple asset classes may decline in value simultaneously.
High Yield Risk . In general, lower rated debt securities carry a greater degree of risk that the issuer will lose its ability to make interest and principal payments, which could have a negative effect on the net asset value of the Funds common shares or common share dividends. The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys or below BBB- by either S&P or Fitch) or that are unrated but judged by PIMCO to be of comparable quality, including debt securities that are in default or the issuers of which are in bankruptcy. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security or that are unrated but judged by PIMCO to be of comparable quality. Securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal, and are commonly referred to as high yield securities or junk bonds. The prices of these lower grade bonds are generally more volatile and sensitive to actual or perceived negative developments, such as a decline in the issuers revenues or revenues of underlying borrowers or a general economic downturn, than are the prices of higher grade securities. Bonds in the lowest investment grade category also may be considered to possess some speculative characteristics by certain rating agencies.
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The Fund may purchase distressed securities that are in default or the issuers of which are in bankruptcy, which involve heightened risks. See Principal risks of the FundDistressed and Defaulted Securities Risk.
An economic downturn could severely affect the ability of issuers (particularly those that are highly leveraged) to service their debt obligations or to repay their obligations upon maturity. Lower-rated securities are generally less liquid than higher-rated securities, which may have an adverse effect on the Funds ability to dispose of a particular security. For example, under adverse market or economic conditions, the secondary market for below investment grade securities could contract further, independent of any specific adverse changes in the condition of a particular issuer, and certain securities in the Funds portfolio may become illiquid or less liquid. As a result, the Fund could find it more difficult to sell these securities or may be able to sell these securities only at prices lower than if such securities were widely traded. See Principal risks of the FundLiquidity Risk.
The Funds credit quality policies apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue. In determining whether to retain or sell such a security, PIMCO may consider such factors as PIMCOs assessment of the credit quality of the issuer of such security, the price at which such security could be sold and the rating, if any, assigned to such security by other rating agencies. Analysis of creditworthiness may be more complex for issuers of high yield securities than for issuers of higher quality debt securities.
Although Floating Rate Loans in which the Fund may invest will often be secured by collateral, there can be no assurance that liquidation of any such collateral would satisfy the borrowers obligation in the event of default or that such collateral could be readily liquidated. In the event of bankruptcy of a borrower, the Fund could experience delays or limitations in its ability to realize the benefits of any collateral securing a Floating Rate Loan. To the extent the Fund focuses on Floating Rate Loans or other below investment grade debt obligations, PIMCOs capabilities in analyzing credit quality and associated risks will be particularly important, and there can be no assurance that PIMCO will be successful in this regard. See Portfolio contentsHigh Yield Securities (Junk Bonds) for additional information. Due to the risks involved in
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investing in high yield securities, an investment in the Fund should be considered speculative. |
Distressed and Defaulted Securities Risk . As noted above, the Fund may invest in the debt securities of financially distressed issuers, including those that are in default or the issuers of which are in bankruptcy. Investments in the securities of financially distressed issuers involve substantial risks. These securities may present a substantial risk of default or may be in default at the time of investment. The Fund may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of principal or interest on its portfolio holdings. In any reorganization or liquidation proceeding relating to an investment, the Fund may lose its entire investment or may be required to accept cash or securities with a value less than its original investment. Among the risks inherent in investments in a troubled issuer is that it frequently may be difficult to obtain information as to the true financial condition of such issuer. PIMCOs judgments about the credit quality of the issuer and the relative value of its securities may prove to be wrong.
Credit Risk . Credit risk is the risk that one or more of the Funds investments in debt securities or other instruments will decline in price, or fail to pay interest, liquidation value or principal when due, because the issuer of the obligation or the issuer of a reference security experiences an actual or perceived decline in its financial status. In addition to the credit risks associated with high yield securities, the Fund could also lose money if the issuer of other debt obligations, or the counterparty to a derivatives contract, repurchase agreement, loan of portfolio securities or other obligation, is, or is perceived to be, unable or unwilling to make timely principal and/or interest payments, or to otherwise honor its obligations. The downgrade of the credit of a security held by the Fund may decrease its value. |
Interest Rate Risk . Generally, when market interest rates rise, the prices of debt obligations fall, and vice versa. Interest rate risk is the risk that debt obligations and other instruments in the Funds portfolio will decline in value because of increases in market interest rates. This risk may be particularly acute because market interest rates are currently at historically low levels. The prices of long-term debt obligations generally fluctuate more than prices of short-term debt obligations as interest rates change. Because the Fund will normally have a low to intermediate average portfolio duration ( i.e. , zero to eight years), the Funds common share net asset value and market price per common share will tend to fluctuate more in response to |
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changes in market interest rates than if the Fund invested mainly in short-term debt securities. During periods of rising interest rates, the average life of certain types of securities may be extended due to slower than expected payments. This may lock in a below market yield, increase the securitys duration and reduce the securitys value. In addition to directly affecting debt securities, rising interest rates may also have an adverse effect on the value of any equity securities held by the Fund. The Funds use of leverage, as described below, will tend to increase common share interest rate risk. PIMCO may utilize certain strategies, including investments in structured notes or interest rate futures contracts or swap, cap, floor or collar transactions, for the purpose of reducing the interest rate sensitivity of the Funds portfolio, although there is no assurance that it will do so or that, if used, such strategies will be successful. |
Investments in floating rate debt instruments, although generally less sensitive to interest rate changes than longer duration fixed rate instruments, may nevertheless decline in value in response to rising interest rates if, for example, the rates at which they pay interest do not rise as much, or as quickly, as market interest rates in general. Conversely, floating rate instruments will not generally increase in value if interest rates decline. Inverse floating rate debt securities may also exhibit greater price volatility than a fixed rate debt obligation with similar credit quality. To the extent the Fund holds floating rate instruments, a decrease (or, in the case of inverse floating rate securities, an increase) in market interest rates will adversely affect the income received from such securities and the net asset value of the Funds common shares.
Liquidity Risk . The Fund may invest without limit in illiquid securities ( i.e. , securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities). Illiquid securities may trade at a discount from comparable, more liquid investments, and may be subject to wide fluctuations in market value. Also, the Fund may not be able to dispose readily of illiquid securities when that would be beneficial at a favorable time or price or at prices approximating those at which the Fund currently values them. Further, the lack of an established secondary market for illiquid securities may make it more difficult to value such securities, which may negatively affect the price the Fund would receive upon disposition of such securities. Floating Rate Loans and various other securities in which the Fund may invest may not be registered with the Securities and Exchange Commission or any state securities
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commission and generally will not be listed on a national securities exchange. PIMCO will determine the liquidity of the Funds investments by reference to market conditions and contractual provisions. |
Leverage Risk . The Fund utilizes leverage on an ongoing basis for investment purposes, including through its outstanding Preferred Shares and also from time to time through the use of reverse repurchase agreements, other Borrowings and through other transactions noted below. As noted under Use of leverage, the Fund currently intends to add leverage to its portfolio following the offer in order to maintain approximately the total amount of leverage (as a percentage of the Funds total assets that the Fund currently maintains. See Use of leverage for details.
Leverage creates several major types of risks for Common Shareholders, including:
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the likelihood of greater volatility of net asset value and market price of common shares than a comparable portfolio without leverage; |
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the possibility either that common share dividends will fall if the costs of leverage rise, or that dividends paid on common shares will fluctuate because such costs vary over time; and |
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the effects of leverage in a declining market or a rising interest rate environment, as leverage is likely to cause a greater decline in the net asset value of the common shares than if the Fund were not leveraged and may result in a greater decline in the market value of the common shares. |
In addition to using Preferred Shares and Borrowings, the Fund may also enter into other transactions that may give rise to a form of leverage including, among others, credit default swap contracts, futures and forward contracts and other derivatives transactions, loans of portfolio securities, short sales and when issued, delayed delivery and forward commitment transactions. The Funds use of such transactions gives rise to associated leverage risks described herein, and may adversely affect the Funds income and distributions. The Fund may manage some of its derivative positions by segregating an amount of cash or liquid securities equal to the face value or the market value, as applicable, of those positions. The Fund also may offset derivatives positions against one another or against other assets to manage effective market exposure resulting from derivatives in its portfolio. To the extent that any offsetting positions do not behave in relation to one another as expected, the Fund may perform as if it is leveraged through use of these derivative strategies. See Use of leverage.
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The Funds use of leverage creates the opportunity for increased net income to Common Shareholders, but also creates special risks for Common Shareholders. There can be no assurance that the Funds leveraging strategies will be successful. Leverage is a speculative technique that may expose the Fund to greater risk and increased costs. The net proceeds the Fund obtains from its use of leverage are invested in accordance with the Funds investment objective and strategies as described in this prospectus. If the rate of return, net of applicable Fund expenses, on the investments purchased by the Fund exceeds the costs of such leverage to the Fund (including dividends, interest and other repayment obligations), then, all other things being equal, the use of such leverage by the Fund may allow the Fund to pay higher dividends to Common Shareholders than if the Fund were not so leveraged. If, however, the costs of leverage rise relative to the rate of return on the Funds portfolio, the interest and other costs to the Fund of leverage could exceed the rate of return on the investments held by the Fund, thereby reducing the return to Common Shareholders. Among other negative consequences, any decline in the net asset value of the Funds investments could result in the Fund being in danger of failing to meet its asset coverage requirements or of losing its Aaa rating (in the case of Moodys) or AAA rating (in the case of Fitch) on the Preferred Shares. In an extreme case, the Funds current investment income might not be sufficient to meet the dividend requirements on the Preferred Shares. In order to address these types of events, the Fund might need to liquidate investments in order to fund a redemption of some or all of the Preferred Shares. Liquidation at times of adverse economic conditions may result in a loss to the Fund. At other times, these liquidations may result in gain at the Fund level and thus in additional taxable distributions to Common Shareholders. See Tax matters for more information. The Preferred Shares have, and any Borrowings by the Fund or counterparties to the Funds other leveraging transactions, if any, would have, seniority over the Funds common shares.
Because the fees received by the Investment Manager and by PIMCO are based on the total managed assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding), the Investment Manager and PIMCO have a financial incentive for the Fund to have Preferred Shares outstanding and to use certain other forms of leverage ( e.g. , reverse repurchase agreements and other Borrowings), which may create a conflict of interest between the Investment Manager and PIMCO, on the one hand, and the Common Shareholders, on the other hand.
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Additional Risks Associated with the Funds Preferred Shares. Although the Preferred Shares ordinarily would pay dividends at rates set at periodic auctions, the weekly auctions for the Preferred Shares (and auctions for similar preferred shares across the U.S.) have failed since February 2008. The dividend rates on the Preferred Shares since that time have been paid, and the Fund expects that they will continue to be paid for the foreseeable future, at the maximum applicable rate, which is calculated using a reference interest rate. An increase in market interest rates generally, therefore, could increase substantially the dividend rate required to be paid by the Fund to the holders of Preferred Shares, which would reduce the funds available for distribution to Common Shareholders. It is possible that a substantial rise in interest rates could make the Funds continued use of Preferred Shares for leverage purposes less attractive than such use is currently considered to be. In such case, the Fund may elect to redeem all or some portion of the Preferred Shares outstanding, which may require it to dispose of investments at inopportune times and to incur losses on such dispositions. Such dispositions may adversely affect the Funds investment performance generally, and the resultant loss of leverage may materially and adversely affect the returns to Common Shareholders.
The Preferred Shares have complete priority over the common shares as to distribution of assets, and in the event of limited funds available for distribution to shareholders, it is possible that all of such funds would be paid to holders of Preferred Shares to the exclusion of Common Shareholders.
The Fund must satisfy certain asset coverage tests mandated by the rating agencies that rate the Preferred Shares. Failure by the Fund to maintain the required asset coverages (and to cure such failure in a timely manner) can require the Fund to redeem Preferred Shares, as discussed above. Moreover, the rating agency guidelines impose restrictions or limitations on the Funds use of certain financial instruments or investment techniques that the Fund might otherwise utilize in order to achieve its investment objective, which may adversely affect the Funds investment performance. The New Fitch Criteria (as defined in Description of capital structure) and related asset coverage requirements in various respects impose more stringent and limiting standards than the guidelines to which the Fund previously was subject. In this regard, the New Fitch Criteria may cause the Fund to invest in higher-quality assets, use derivatives transactions and related leverage to a lesser extent, maintain higher balances
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of highly liquid assets, and otherwise to invest the Funds assets differently than it otherwise would prefer, all or any of which could negatively affect the Funds investment performance, yield to Common Shareholders and common share net asset value and/or market price. Rating agency guidelines may be modified by the rating agencies in the future, and such modifications may make such guidelines substantially more restrictive, which could further negatively affect the Funds investment performance. |
Issuer Risk . The value of debt instruments may decline for a number of reasons that directly relate to the issuer, such as management performance, financial leverage and reduced demand for the issuers goods and services, as well as the historical and prospective earnings of the issuer and the value of its assets.
Smaller Company Risk . The general risks associated with debt instruments or equity securities are particularly pronounced for securities issued by companies with small market capitalizations. Small capitalization companies involve certain special risks. They are more likely than larger companies to have limited product lines, markets or financial resources, or to depend on a small, inexperienced management group. Securities of smaller companies may trade less frequently and in lesser volume than more widely held securities and their values may fluctuate more sharply than other securities. They may also have limited liquidity. These securities may therefore be more vulnerable to adverse developments than securities of larger companies, and the Fund may have difficulty purchasing or selling positions in securities of smaller companies at prevailing market prices. Also, there may be less publicly available information about smaller companies or less market interest in their securities as compared to larger companies. Companies with medium-sized market capitalizations may have risks similar to those of smaller companies.
Management Risk . The Fund is subject to management risk because it is an actively managed portfolio. PIMCO and the portfolio manager will apply investment techniques and risk analyses in making investment decisions for the Fund, but there can be no guarantee that these decisions will produce the desired results.
Convertible Securities Risk . Convertible securities generally offer lower interest or dividend yields than non-convertible debt securities of similar quality. The market values of convertible securities tend to decline as interest rates increase and, conversely, to increase as interest rates decline. However, a convertible securitys market value tends to reflect the market price of the common stock of
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the issuing company when that stock price approaches or is greater than the convertible securitys conversion price. The conversion price for these purposes is the predetermined price at which the convertible security could be exchanged for the associated stock. As the market price of the underlying common stock declines, the price of the convertible security tends to be influenced more by the yield of the convertible security. Thus, it may not decline in price to the same extent as the underlying common stock. In the event of a liquidation of the issuing company, holders of convertible securities would be paid before the companys common stockholders but after holders of any senior debt obligations of the company. Consequently, the issuers convertible securities generally entail less risk than its common stock but more risk than its debt obligations. |
The Fund may invest in synthetic convertible securities, which are created through a combination of separate securities that possess the two principal characteristics of a traditional convertible security; that is, an income-producing security (income-producing component) and the right to acquire an equity security (convertible component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments. The convertible component is achieved by purchasing warrants or options to buy common stock at a certain exercise price, or options on a stock index. The values of synthetic convertible securities will respond differently to market fluctuations than a traditional convertible security because a synthetic convertible is composed of two or more separate securities or instruments, each with its own market value. Synthetic convertible securities are also subject to the risks associated with derivatives. See Principal risks of the FundDerivatives Risk. In addition, if the value of the underlying common stock or the level of the index involved in the convertible element falls below the strike price of the warrant or option, the warrant or option may lose all value.
Preferred Securities Risk . In addition to equity securities risk (see Principal risks of the FundEquity Securities and Related Market Risk), credit risk (see Principal risks of the FundCredit Risk) and possibly high yield risk (see Principal risks of the FundHigh Yield Risk), investment in preferred stocks involves certain other risks. Certain preferred stocks contain provisions that allow an issuer under certain conditions to skip or defer distributions.
Preferred stocks often are subject to legal provisions that allow for redemption in the event of certain tax or legal
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changes or at the issuers call. In the event of redemption, the Fund may not be able to reinvest the proceeds at comparable rates of return. Preferred stocks are subordinated to bonds and other debt securities in an issuers capital structure in terms of priority for corporate income and liquidation payments, and therefore will be subject to greater credit risk than those debt securities. Preferred stocks may trade less frequently and in a more limited volume and may be subject to more abrupt or erratic price movements than many other securities, such as common stocks, corporate debt securities and U.S. Government securities.
If the Fund owns a preferred stock that is deferring its distribution, the Fund may be required to include the amount of the deferred distribution in its taxable income for tax purposes despite the fact that it does not currently receive such amount. In order to receive the special treatment accorded to regulated investment companies (RICs) and their shareholders under the Internal Revenue Code of 1986, as amended (the Code) and to avoid U.S. federal income and/or excise taxes at the Fund level, the Fund may be required to distribute this income to shareholders in the tax year in which the income is recognized (without a corresponding receipt of cash). Therefore, the Fund may be required to pay out as an income distribution in any such tax year an amount greater than the total amount of cash income the Fund actually received, and to sell portfolio securities, including at potentially disadvantageous times or prices, to obtain cash needed for these income distributions.
Foreign (Non-U.S.) Investment Risk . The Fund may invest some or all of its assets in U.S. dollar-denominated debt obligations of foreign issuers or supra-national government agencies. The Fund may invest up to 25% of its total assets in securities denominated in foreign currencies, including obligations of non-U.S. governments and their respective sub-divisions, agencies and government-sponsored enterprises. The Funds investments in foreign issuers and in securities denominated in foreign currencies involve special risks.
For example, the value of these investments may decline in response to unfavorable political and legal developments, unreliable or untimely information or economic and financial instability. Foreign securities may experience more rapid and extreme changes in value than investments in securities of U.S. issuers. The securities markets of many foreign countries are relatively small, with a limited number of companies representing a small number of industries. Issuers of foreign securities are usually not
26
subject to the same degree of regulation as U.S. issuers. Reporting, accounting and auditing standards of foreign countries differ, in some cases significantly, from U.S. standards. Also, nationalization, expropriation or other confiscation, currency blockage, political changes or diplomatic developments could adversely affect the Funds investments in foreign securities. In the event of nationalization, expropriation or other confiscation, the Fund could lose its entire investment in foreign securities. To the extent that the Fund invests a significant portion of its assets in a particular foreign country or a concentrated geographic area (such as Europe or Asia), the Fund will generally have more exposure to regional economic risks associated with foreign investments. Also, adverse conditions in a certain region can adversely affect securities from other countries whose economies appear to be unrelated. The costs of investing in foreign countries frequently are higher than the costs of investing in the United States. Additionally, investments in securities of foreign issuers generally will be denominated in foreign currencies, subjecting the Fund to foreign currency risk. See Principal risks of the FundForeign Currency Risk. |
Emerging Markets Risk . The Fund may invest up to 25% of its total assets in securities that are economically tied to emerging market countries. Foreign investment risk may be particularly high to the extent that the Fund invests in securities of issuers based in or securities denominated in the currencies of emerging market countries. Investing in securities of issuers based in underdeveloped emerging markets entails all of the risks of investing in securities of foreign issuers noted above, but to a heightened degree. These heightened risks include: (i) greater risks of expropriation, confiscatory taxation, nationalization and less social, political and economic stability; (ii) the smaller size of the market for such securities and a lower volume of trading, resulting in a lack of liquidity and in price volatility; (iii) certain national policies which may restrict the Funds investment opportunities, including restrictions on investing in issuers or industries deemed sensitive to relevant national interests and requirements that government approval be obtained prior to investment by foreign persons; (iv) certain national policies that may restrict the Funds repatriation of investment income, capital or the proceeds of sales of securities, including temporary restrictions on foreign capital remittances; (v) the lack of uniform accounting and auditing standards; (vi) less publicly available financial and other information regarding issuers; (vii) potential difficulties in enforcing contractual obligations; and (viii) higher rates of inflation,
27
higher interest rates and other economic concerns. The Fund may invest to a significant extent in emerging market securities that are issued in local currencies, subjecting the Fund to a greater degree of foreign currency risk. See Principal risks of the FundForeign Currency Risk. Also, investing in emerging market countries may entail purchases of securities of issuers that are insolvent, bankrupt, in default or otherwise of questionable ability to satisfy their payment obligations as they become due, subjecting the Fund to a greater amount of credit risk and/or high yield risk. See Principal risks of the FundCredit Risk and Principal Risks of the FundHigh Yield Risk. |
Foreign Currency Risk . The Funds common shares are priced in U.S. dollars and the distributions paid by the Fund to Common Shareholders are paid in U.S. dollars. However, a significant portion of the Funds assets may at any time be denominated in foreign (non-U.S.) currencies and income received by the Fund from many foreign debt obligations will be paid in foreign currencies. The Fund may also invest in or gain exposure to foreign currencies themselves for investment or hedging purposes. The Funds investments in or exposure to foreign currencies or in securities or instruments that trade, or receive revenues, in foreign currencies are subject to the risk that those currencies will decline in value relative to the U.S. dollar or, in the case of hedging positions (if utilized), that the U.S. dollar will decline in value relative to the currency being hedged. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including changes in interest rates, intervention (or the failure to intervene) by U.S. or foreign governments, central banks or supranational entities such as the International Monetary Fund, or by the imposition of currency controls or other political developments in the U.S. or abroad. These fluctuations may have a significant adverse effect on the value of the Funds portfolio and/or the level of Fund distributions made to Common Shareholders. As noted above, the Fund may (but is not required to) attempt to hedge some of its exposure to foreign currencies in order to reduce the risk of loss due to fluctuations in currency exchange rates relative to the U.S. dollar. There is no assurance, however, that these hedging strategies will be available or will be used by the Fund or, if used, that they will be successful.
Derivatives Risk . Derivatives are financial contracts whose value depends on, or is derived from, the value of an underlying asset, reference rate or index (or relationship between two indexes). The Fund may invest in a variety of |
28
derivative instruments for hedging or risk management purposes or as part of its investment strategies, such as call and put options (including options on futures contracts), futures and forward contracts, swap agreements (including total return and credit-default swaps) and short sales. The Fund may also have exposure to derivatives, such as interest rate or credit default swaps, through investment in credit-linked trust certificates and other securities issued by special purpose or structured vehicles. The Fund may use derivatives as a substitute for taking a position in an underlying debt instrument or other asset and/or as part of a strategy designed to reduce exposure to other risks, such as interest rate or currency risk. The Fund also may use derivatives to add leverage to the portfolio. The Funds use of derivative instruments involves risks different from, and possibly greater than, the risks associated with investing directly in securities and other traditional investments. Derivatives are subject to a number of risks described elsewhere in this prospectus, such as liquidity risk, interest rate risk, issuer risk, credit risk, leveraging risk, counterparty risk, management risk and, if applicable, smaller company risk. They also involve the risk of mispricing or improper valuation, the risk of ambiguous documentation, and the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index. If the Fund invests in a derivative instrument, it could lose more than the principal amount invested. Also, suitable derivative transactions may not be available in all circumstances and there can be no assurance that the Fund will engage in these transactions to reduce exposure to other risks when that would be beneficial. In addition, the Fund is subject to certain restrictions or limitations on its use of derivative strategies imposed by Moodys and Fitch (or any rating agency that may in the future rate the Preferred Shares) in connection with their ratings of the Funds Preferred Shares. See Description of capital structure. The use of derivatives also may increase the amount and affect the character and/or timing of taxes payable by shareholders. |
Counterparty Risk . The Fund will be subject to credit risk with respect to the counterparties to the derivative contracts and other instruments entered into by the Fund or held by special purpose or structured vehicles in which the Fund invests. In the event that the Fund enters into a derivative transaction with a counterparty that subsequently becomes insolvent or becomes the subject of a bankruptcy case, the derivative transaction may be terminated in accordance with its terms and the Funds ability to realize its rights under the derivative instrument
29
and its ability to distribute the proceeds could be adversely affected. 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 a bankruptcy or other reorganization proceeding. The Fund may obtain only a limited recovery or may obtain no recovery in such circumstances. |
Mortgage-Related and Asset-Backed Securities Risk . Mortgage-related and other asset-backed securities often involve risks that are different from or more acute than risks associated with other types of debt instruments. For instance, these securities may be particularly sensitive to changes in prevailing interest rates. Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates, and may reduce the market value of the securities. This is known as extension risk. In addition, mortgage-related securities are subject to prepayment riskthe risk that borrowers may pay off their mortgages sooner than expected, particularly when interest rates decline. This can reduce the Funds returns because the Fund may have to reinvest that money at lower prevailing interest rates. For instance, the Fund may invest in stripped mortgage-backed securities with respect to which one class receives all of the interest from the mortgage assets (the interest-only, or IO class), while the other class receives all of the principal (the principal-only, or PO class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Funds yield to maturity from these investments.
The Funds investments in other asset-backed securities are subject to risks similar to those associated with mortgage-backed securities, as well as additional risks associated with their structure and the nature of the assets underlying the security and the servicing of those assets. For instance, certain collateralized debt obligations in which the Fund may invest are backed by pools of high-risk, below investment grade debt securities and may involve substantial credit and other risks. Further, due to their often complicated structures, various mortgage-related and asset-backed securities may be difficult to value and may constitute illiquid investments.
The value of mortgage-related and other asset-based securities may be substantially dependent on the servicing of the underlying asset pools, and are therefore subject to risks associated with the negligence by, or defalcation of,
30
their servicers. Furthermore, debtors may be entitled to the protection of a number of state and federal consumer credit laws with respect to these securities, which may give the debtor the right to avoid payment. |
Investments in mortgage-related securities may involve particularly high levels of risk under current market conditions. See Principal risks of the FundMortgage Market/Subprime Risk. See also Principal Risks of the FundRecent Economic Conditions Risk.
Mortgage Market/Subprime Risk . The residential mortgage market in the United States has experienced extreme difficulties over the past few years that may adversely affect the performance and market value of certain of the Funds mortgage-related investments. Delinquencies and losses on residential mortgage loans (especially subprime and second-lien mortgage loans) generally have increased during that period and may continue to increase, and a decline in or flattening of housing values (as has been experienced during that period and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have experienced serious financial difficulties or bankruptcy during that period. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
Government Entity Risk . As noted, the Fund may invest in mortgage-related and other debt securities issued or guaranteed by certain U.S. government agencies, instrumentalities and sponsored enterprises. Some U.S. Government securities, such as U.S. Treasury bills, notes and bonds, and securities guaranteed by the Government National Mortgage Association (GNMA), are supported by the full faith and credit of the United States; others, such as those of the Federal Home Loan Banks or the Federal Home Loan Mortgage Corporation (FHLMC), are supported by the right of the issuer to borrow from the U.S. Treasury; others, such as those of the Federal National Mortgage Association (FNMA), are supported by the discretionary authority of the U.S. Government to purchase
31
the agencys obligations; and still others, such as those of the Student Loan Marketing Association, are supported only by the credit of the instrumentality. Although U.S. Government-sponsored enterprises, such as the Federal Home Loan Banks, FHLMC, FNMA and the Student Loan Marketing Association may be chartered or sponsored by Congress, they are not funded by Congressional appropriations, and their securities are not issued by the U.S. Treasury or supported by the full faith and credit of the U.S. Government and involve increased credit risks. Certain governmental entities, including FNMA and FHLMC, have been subject to regulatory scrutiny regarding their accounting policies and practices and other concerns that may result in legislation, changes in regulatory oversight and/or other consequences that could adversely affect the credit quality, availability or investment character of securities issued by these entities. See Investment Objective and PoliciesMortgage-Related and Other Asset-Backed Securities in the Statement of Additional Information. |
Risk of Investing in REITs . Like other mortgage-related securities, REITs are subject to interest rate risk and prepayment risk. Investing in REITs also involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. An equity REIT may be affected by changes in the value of the underlying properties owned by the REIT. A mortgage REIT may be affected by changes in interest rates and the ability of the issuers of its portfolio mortgages to repay their obligations. REITs are dependent upon the skills of their managers and are not diversified. REITs are generally dependent upon maintaining cash flows to repay borrowings and to make distributions to shareholders and are subject to the risk of default by lessees or borrowers. REITs whose underlying assets are concentrated in properties used by a particular industry are also subject to risks associated with such industry.
REITs may have limited financial resources, may trade less frequently and in a limited volume and may be subject to more abrupt or erratic price movements than larger company securities. Historically, REITs have been more volatile in price than the larger capitalization stocks included in S&P 500 Composite Stock Index.
Valuation Risk . When market quotations are not readily available or are deemed to be unreliable, the Fund values its investments at fair value as determined in good faith pursuant to policies and procedures approved by the Board. See Net asset value. Fair value pricing may
32
require subjective determinations about the value of a security or other asset. As a result, there can be no assurance that fair value pricing will result in adjustments to the prices of securities or other assets, or that fair value pricing will reflect actual market value, and it is possible that the fair value determined for a security or other asset will be materially different from quoted or published prices, from the prices used by others for the same security or other asset and/or from the value that actually could be or is realized upon the sale of that security or other asset by the Fund. |
Focused Investment Risk . Although the Fund has a policy not to concentrate investments in any particular industry, it may (consistent with that policy) invest up to 25% of its assets in any particular industry. To the extent that the Fund focuses its investments in a particular industry, the net asset value of the common shares will be more susceptible to events or factors affecting companies in that industry. These may include, but are not limited to, governmental regulation, inflation, rising interest rates, cost increases in raw materials, fuel and other operating expenses, technological innovations that may render existing products and equipment obsolete, competition from new entrants, high research and development costs, increased costs associated with compliance with environmental or other regulation and other economic, market, political or other developments specific to that industry. Also, the Fund may have greater risk to the extent that it invests a substantial portion of its assets in companies in related sectors, which may share common characteristics, are often subject to similar business risks and regulatory burdens, and whose securities may react similarly to the types of events and factors described above. The Fund will also be subject to focused investment risks to the extent that it invests a substantial portion of its assets in a particular country or geographic region. See Principal risks of the FundForeign (Non-U.S.) Investment Risk, Principal risks of the FundEmerging Markets Risk and Principal risks of the FundForeign Currency Risk.
Reinvestment Risk . Reinvestment risk is the risk that income from the Funds portfolio will decline if and when the Fund invests the proceeds from prepaid, matured, traded or called debt obligations at market interest rates that are below the portfolios current earnings rate. For instance, during periods of declining interest rates, an issuer of debt obligations may exercise an option to redeem securities prior to maturity, forcing the Fund to invest in lower-yielding securities. The Fund also may choose to sell higher yielding portfolio securities and to purchase lower
33
yielding securities to achieve greater portfolio diversification, because the portfolio manager believes the current holdings are overvalued or for other investment-related reasons. A decline in income received by the Fund from its investments is likely to have a negative effect on the market price, net asset value and/or overall return of the Funds common shares. |
Short Sale Risk . The Fund may use short sales for investment and risk management purposes, including when PIMCO anticipates that the market price of securities will decline or will underperform relative to other securities held in the Funds portfolio. Short sales are transactions in which the Fund sells a security or other instrument (such as an option forward, futures or other derivative contract) that it does not own. Short exposure with respect to securities or market segments may also be achieved through the use of derivative instruments, such as futures on indices or swaps on individual securities. When the Fund engages in a short sale on a security, it must borrow the security sold short and deliver it to the counterparty. The Fund will ordinarily have to pay a fee or premium to borrow particular securities and be obligated to repay the lender of the security any dividends or interest that accrue on the security during the period of the loan. The amount of any gain from a short sale will be decreased, and the amount of any loss increased, by the amount of the premium, dividends, interest or expenses the Fund pays in connection with the short sale. Short sales expose the Fund to the risk that it will be required to cover its short position at a time when the securities have appreciated in value, thus resulting in a loss to the Fund. The Fund may, to the extent permitted by law, engage in short sales where it does not own or have the right to acquire the security (or basket of securities) sold short at no additional cost. The Funds loss on a short sale could theoretically be unlimited in a case where the Fund is unable, for whatever reason, to close out its short position. The use by the Fund of short sales in combination with long positions in its portfolio in an attempt to improve performance may not be successful and may result in greater losses or lower positive returns than if the Fund held only long positions. It is possible that the Funds long positions will decline in value at the same time that the value of the securities underlying its short positions increase, thereby increasing potential losses to the Fund. In addition, the Funds short selling strategies may limit its ability to fully benefit from increases in the relevant securities markets. Short selling also involves a form of financial leverage that may exaggerate any losses realized by the Fund. See Principal risks of the Fund
34
Leveraging Risk. Also, there is the risk that the counterparty to a short sale may fail to honor its contractual terms, causing a loss to a Fund. See Principal risks of the FundCounterparty Risk. To the extent a Fund seeks to obtain some or all of its short exposure by using derivative instruments instead of engaging directly in short sales on individual securities, it will be subject to many of the foregoing risks, as well as to those described under Principal Risks of the FundDerivatives Risk. |
Inflation/Deflation Risk . Inflation risk is the risk that the value of assets or income from the Funds investments will be worth less in the future as inflation decreases the value of payments at future dates. As inflation increases, the real value of the Funds portfolio could decline. Deflation risk is the risk that prices throughout the economy decline over time. Deflation may have an adverse effect on the creditworthiness of issuers and may make issuer default more likely, which may result in a decline in the value of the Funds portfolio. |
Confidential Information Access Risk . In managing the fund, PIMCO normally will seek to avoid the receipt by the portfolio manager and analysts of material, non-public information (Confidential Information) about the issuers of Floating Rate Loans, other bank loans and related investments being considered for acquisition by the Fund or held in the Funds portfolio. In many instances, issuers offer to furnish Confidential Information to prospective purchasers or holders of the issuers loans. In circumstances when the PIMCO portfolio manager and analysts do not receive Confidential Information from these issuers, the Fund may be disadvantaged in comparison to other bank loan investors, including with respect to the price the Fund pays or receives when it buys or sells a bank loan. Further, in situations when the Fund is asked, for example, to grant consents, waivers or amendments with respect to bank loans, PIMCOs ability to assess the desirability of such consents, waivers and amendments may be compromised.
Equity Securities and Related Market Risk . The Fund may hold common stocks and other equity securities from time to time, including those it has received through the conversion of a convertible security held by the Fund or in connection with the restructuring of a debt security. The market price of common stocks and other equity securities may go up or down, sometimes rapidly or unpredictably. Equity securities may decline in value due to factors affecting equity securities markets generally, particular industries represented in those markets, or the issuer itself. See Principal risks of the FundIssuer Risk. The values
35
of equity securities may decline due to general market conditions that are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. Debt securities are also subject to the market risks described above; however, equity securities generally have greater price volatility than bonds and other debt securities. |
Rule 144A Securities Risk . Rule 144A permits certain qualified institutional buyers, such as the Fund, to trade in privately placed securities that have not been registered for sale under the Securities Act.
Other Investment Companies Risk . The Fund may invest in securities of other open- or closed-end investment companies, including ETFs, to the extent that such investments are consistent with the Funds investment objective and policies and permissible under the 1940 Act. As a shareholder in an investment company, the Fund will bear its ratable share of that investment companys expenses, and would remain subject to payment of the Funds investment management fees and other expenses with respect to the assets so invested. Common Shareholders would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. In addition, these other investment companies may utilize leverage, in which case an investment would subject the Fund to additional risks associated with leverage. See Principal risks of the FundLeverage Risk.
Risk of Regulatory Changes . To the extent that legislation or state or federal bank or other regulators impose additional requirements or restrictions on the ability of certain financial institutions to make loans, particularly in connection with highly leveraged transactions, the availability of investments sought after by the Fund may be reduced. Further, such legislation or regulation could depress the market value of investments held by the Fund. Additionally, legislative, regulatory, or tax developments may affect the investment techniques available to PIMCO and the portfolio manager in connection with managing the Fund and may also adversely affect the ability of the Fund to achieve its investment objective.
Market Disruption and Geopolitical Risk . The wars with Iraq and Afghanistan, their aftermath and the occupations of Iraq and substantial military presence in Afghanistan are
36
likely to have a substantial effect on the U.S. and world economies and securities markets. The nature, scope and duration of the wars and the potential costs of rebuilding infrastructure cannot be predicted with any certainty. Terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001 closed some of the U.S. securities markets for a four-day period and similar future events cannot be ruled out. The war and occupation, terrorism and related geopolitical risks have led, and may in the future lead, to increased short-term market volatility and may have adverse long-term effects on U.S. and world economies and markets generally. Those events also could have an acute effect on individual issuers or related groups of issuers. These risks also could adversely affect individual issuers and securities markets, interest rates, secondary trading, ratings, credit risk, inflation, deflation and other factors relating to the Funds investments and the market value and net asset value of the common shares. |
Recent Economic Conditions Risk . The debt and equity capital markets in the United States have been negatively affected by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated market, among other things. These events, along with the deterioration of the housing market, the failure of major financial institutions and the resulting United States federal government actions have led to worsening general economic conditions, which have materially and adversely affected the broader financial and credit markets and have reduced the availability of debt and equity capital for the market as a whole and financial firms in particular. These developments may increase the volatility of the value of securities owned by the Fund and also may make it more difficult for the Fund to accurately value securities or to sell securities on a timely basis. These developments have adversely affected the broader economy, and may continue to do so, which in turn may adversely affect the ability of issuers of securities owned by the Fund to make payments of principal and interest when due, lead to lower credit ratings and increase defaults. Such developments could, in turn, reduce the value of securities owned by the Fund and adversely affect the net asset value and/or market value of the Funds common shares. In addition, the prolonged continuation or further deterioration of current market conditions could adversely affect the Funds portfolio.
The recent instability in the financial markets discussed above has led the U.S. government to take a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have
37
experienced extreme volatility, and in some cases a lack of liquidity. Federal, state, and other governments, their regulatory agencies, or self-regulatory organizations may take actions that affect the regulation of the instruments in which the Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of the Funds portfolio holdings and common shares. |
Legislation or regulation may also change the way in which the Fund itself is regulated. Such legislation or regulation could limit or preclude the Funds ability to achieve its investment objective.
Certain Affiliations |
Certain broker-dealers may be considered to be affiliated persons of the Fund, the Investment Manager and/or PIMCO due to their possible affiliations with Allianz SE, the ultimate parent of the Investment Manager and PIMCO. Absent an exemption from the Securities and Exchange Commission or other regulatory relief, the Fund is generally precluded from effecting certain principal transactions with affiliated brokers, and its ability to purchase securities being underwritten by an affiliated broker or a syndicate including an affiliated broker, or to utilize affiliated brokers for agency transactions, is subject to restrictions. This could limit the Funds ability to engage in securities transactions and take advantage of market opportunities. |
Anti-Takeover Provisions |
The Funds Agreement and Declaration of Trust, as amended and restated through the date hereof (the Declaration) includes provisions that could limit the ability of other entities or persons to acquire control of the Fund or to convert the Fund to open-end status. See Anti-takeover provisions in the Agreement and Declaration of Trust. These provisions in the Declaration could have the effect of depriving the Common Shareholders of opportunities to sell their common shares at a premium over the then-current market price of the common shares or at net asset value. |
38
The following table is intended to assist investors in understanding the fees and expenses (annualized) that an investor in common shares of the Fund would bear, directly or indirectly, as a result of the Offer being fully subscribed and the receipt of net proceeds from the Offer of approximately $124 million. If the Fund issues fewer Shares in the Offer and the net proceeds to the Fund are less, all other things being equal, the total annual expenses shown would increase. The table assumes that the Fund has Preferred Shares outstanding in an amount equal to 23% of the Funds total assets (taking into account such outstanding Preferred Shares), which reflects the percentage of the Funds total assets that would be represented by the amount of Preferred Shares outstanding as of February 28, 2010 and taking into account the additional assets to be raised in the Offer as estimated above. The table also assumes the use of additional leverage in the form of reverse repurchase agreements in an amount equal to 9% of the Funds total assets (including the amounts of leverage obtained through the use of such instruments), also taking into account the additional assets to be raised in the Offer as estimated above. The table assumes the use of leverage attributable to a combination of Preferred Shares and reverse repurchase agreements following the Offer in an amount equal to 32% of the Funds total assets (taking into account such Preferred Shares and amounts attributable to such reverse repurchase agreements), which reflects the percentage of the Funds total assets attributable to such leverage (although in different proportions as between Preferred Shares and reverse repurchase agreements) as of February 28, 2010. The extent of the Funds assets attributable to leverage following the Offer, and the Funds associated expenses, are likely to vary (perhaps significantly) from these assumptions.
Percentage of Subscription Price |
|||
Shareholder Transaction Expenses |
|||
Sales load |
3.50 | % 1 | |
Offering expenses borne by Common Shareholders |
0.27 | % 2 | |
Dividend reinvestment and cash purchase plan fees |
None 3 |
Percentage of Net Assets
Attributable to Common Shares |
|||
Annual Expenses |
|||
Management fees 4 |
1.08 | % | |
Dividend expense on Preferred Shares 5 |
0.46 | % | |
Interest expense on reverse repurchase agreements 6 |
0.08 | % | |
Other expenses 7 |
0.21 | % | |
Total annual expenses |
1.82 | % |
1. | The Dealer Manager will receive a fee for its financial structuring and soliciting services equal to 3.50% of the aggregate Subscription Price for Shares issued pursuant to the Offer. The Dealer Manager will reallow to broker-dealers in the selling group to be formed and managed by the Dealer Manager selling fees equal to 2.50% of the Subscription Price per Share for each Share issued pursuant to the Offer as a result of their selling efforts. In addition, the Dealer Manager will reallow to other broker-dealers that have executed and delivered a soliciting dealer agreement and have solicited the exercise of Rights solicitation fees equal to 0.50% of the Subscription Price per Share for each Share issued pursuant to the exercise of Rights as a result of their soliciting efforts, subject to a maximum fee based on the number of Shares held by each broker-dealer through The Depository Trust Company (DTC) on the Record Date. |
2. | The fees and expenses of the Offer will be borne by the Fund and indirectly by all of its Common Shareholders, including those who do not exercise their Rights. |
39
Summary of Fund expenses
3. | You may pay brokerage charges if you direct the plan agent to sell your common shares held in a dividend reinvestment account. You also may pay a pro rata share of brokerage commissions incurred in connection with your market purchases pursuant to the Funds dividend reinvestment plan. See Dividend reinvestment plan. |
4. | Management fees are charged to the Fund on the basis of total managed assets, but have been converted to a percentage in the table above of net assets attributable to common shares of the Fund for purposes of the presentation as follows: management fees, assuming no leverage attributable to Preferred Shares or Borrowings, divided by (one minus the percentage of the Funds total assets estimated to be attributable to outstanding Preferred Shares and reverse repurchase agreements following the Offer (32% of the Funds total assets, based on amounts of leverage outstanding as of February 28, 2010). |
5. | Assumes Preferred Shares outstanding in an amount equal to 23% of the Funds total assets (taking into account such outstanding Preferred Shares) at an annual dividend cost to the Fund of 1.48%, and assumes the Fund will continue to pay Preferred Share dividends at the maximum applicable rate called for under the Funds Bylaws due to the ongoing failure of auctions for the Preferred Shares. The actual dividend rate paid on the Preferred Shares will vary over time in accordance with variations in market interest rates. |
6. | Assumes the use of leverage in the form of reverse repurchase agreements representing 9% of the Funds total assets (including the amounts of leverage obtained through the use of such instruments) at an annual interest rate cost to the Fund of 0.60%. The actual amount of interest expense borne by the Fund will vary over time in accordance with the level of the Funds use of reverse repurchase agreements and/or other Borrowings and variations in market interest rates. Interest expense is required to be treated as an expense of the Fund for accounting purposes. Any associated income or gain (or losses) realized from leverage obtained through such instruments is not reflected in the Annual Expenses table above, but would be reflected in the Funds performance results. |
7. | Other expenses are estimated for the Funds current fiscal year ending July 31, 2010. |
EXAMPLE
The following example illustrates the expenses that you would pay on a $1,000 investment in common shares of the Fund (including the total sales load of $35 and the other estimated costs of this Offer to be borne by the Common Shareholders of $2.70), assuming (1) that the Funds net assets following the Offer do not increase or decrease, (2) that the Fund incurs total annual expenses of 1.82% of net assets attributable to common shares in years 1 through 10 (assuming outstanding Preferred Shares representing 23% of the Funds total assets and reverse repurchase agreements utilized equal to 9% of the Funds total assets) and (3) a 5% annual return: 1
1 Year | 3 Years | 5 Years | 10 Years | |||||||||
Total expenses incurred |
$ | 55 | $ | 93 | $ | 133 | $ | 243 |
1. | The example above should not be considered a representation of future expenses. Actual expenses may be higher or lower than those shown. The example assumes that the estimated Other expenses set forth in the Annual Expenses table are accurate and that all dividends and distributions are reinvested at net asset value. Actual expenses may be greater or less than those assumed. Moreover, the Funds actual rate of return may be greater or less than the hypothetical 5% annual return shown in the example. |
40
The information in the table below for the fiscal periods ended July 31, 2009, 2008, 2007 and 2006 and the fiscal period ended August 31, 2005 is derived from the Funds financial statements for the fiscal year ended July 31, 2009 audited by PricewaterhouseCoopers, LLP, whose report on such financial statements is contained in the Funds July 31, 2009 Annual Report and is incorporated by reference into the Statement of Additional Information. The information shown for the six months ended January 31, 2010 is unaudited.
Six Months Ended
January 31, |
Year Ended July 31, |
Eleven Months Ended
July 31, |
For the Period
October 29, 2004* through August 31, |
|||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Net asset value, beginning of year |
$ | 7.98 | $ | 14.16 | $ | 16.76 | $ | 18.76 | $ | 18.98 | $ | 19.10 | ** | |||||||||||
Investment Operations: |
||||||||||||||||||||||||
Net investment income |
0.61 | 1.44 | 1.81 | 2.06 | 1.64 | 0.88 | ||||||||||||||||||
Net realized and change in unrealized gain (loss) on investments, futures contracts, options written, swaps, unfunded loan commitments and foreign currency transactions |
1.87 | (6.40 | ) | (2.37 | ) | (1.34 | ) | | 0.31 | |||||||||||||||
Total from investment operations |
2.48 | (4.96 | ) | (0.56 | ) | (0.72 | ) | 1.64 | 1.19 | |||||||||||||||
Dividends and Distributions on Preferred Shares from: |
||||||||||||||||||||||||
Net investment income |
(0.03 | ) | (0.20 | ) | (0.52 | ) | (0.58 | ) | (0.45 | ) | (0.24 | ) | ||||||||||||
Net realized gains |
| | | (0.00 | ) | | | |||||||||||||||||
Total dividends and distributions on preferred shares |
(0.03 | ) | (0.20 | ) | (0.52 | ) | (0.58 | ) | (0.45 | ) | (0.24 | ) | ||||||||||||
Net increase (decrease) in net assets applicable to common shareholders resulting from investment operations |
2.45 | (5.16 | ) | (1.08 | ) | 0.14 | 1.19 | 0.95 | ||||||||||||||||
Dividends and Distributions to Common Shareholders from: |
||||||||||||||||||||||||
Net investment income |
(1.29 | ) | (1.02 | ) | (1.51 | ) | (1.72 | ) | (1.41 | ) | (0.91 | ) | ||||||||||||
Net realized gains |
| | | (0.42 | ) | | | |||||||||||||||||
Return of capital |
| | (0.01 | ) | | | | |||||||||||||||||
Total dividends and distributions to common shareholders |
(1.29 | ) | (1.02 | ) | (1.52 | ) | (2.14 | ) | (1.41 | ) | (0.91 | ) | ||||||||||||
41
Financial highlights
Six Months
Ended January 31, |
Year Ended July 31, |
Eleven Months
Ended July 31, |
For the Period
October 29, 2004* through August 31, |
|||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||
Capital Share Transactions: |
||||||||||||||||||||||||
Common stock offering costs charged to paid-in capital in excess of par |
| | | | | (0.03 | ) | |||||||||||||||||
Preferred shares offering costs/underwriting discounts charged to paid-in capital in excess of par |
| | | | | (0.13 | ) | |||||||||||||||||
Total capital share transactions |
| | | | | (0.16 | ) | |||||||||||||||||
Net asset value, end of period |
$ | 9.14 | $ | 7.98 | $ | 14.16 | $ | 16.76 | $ | 18.76 | $ | 18.98 | ||||||||||||
Market price, end of period |
$ | 9.87 | $ | 7.78 | $ | 12.80 | $ | 17.28 | $ | 18.87 | $ | 18.21 | ||||||||||||
Total Investment Return (1) |
44.43 | % | (29.85 | )% | (18.08 | )% | 2.73 | % | 11.77 | % | (4.39 | )% | ||||||||||||
Ratios/Supplemental Data: |
||||||||||||||||||||||||
Net assets applicable to common shareholders, end of period (000) |
$ | 395,365 | $ | 341,949 | $ | 604,632 | $ | 712,152 | $ | 782,371 | $ | 789,094 | ||||||||||||
Ratio of expenses to average net assets, including interest expense (2)(4) |
1.45 | % (5) | 2.08 | % (3) | 1.60 | % (3) | 1.48 | % (3) | 1.47 | % (3)(5) | 1.35 | % (3)(5) | ||||||||||||
Ratio of expenses to average net assets, excluding interest expense (2) |
1.41 | % (5) | 1.96 | % (3) | 1.60 | % (3) | 1.48 | % (3) | 1.47 | % (3)(5) | 1.35 | % (3)(5) | ||||||||||||
Ratio of net investment income to average net assets (2) |
13.38 | % (5) | 17.84 | % | 11.59 | % | 11.03 | % | 9.51 | % (5) | 5.57 | % (5) | ||||||||||||
Preferred shares asset coverage per share |
$ | 86,380 | $ | 78,091 | $ | 56,481 | $ | 62,069 | $ | 65,722 | $ | 66,084 | ||||||||||||
Portfolio turnover |
44 | % | 96 | % | 29 | % | 65 | % | 60 | % | 47 | % |
* | Commencement of operations. |
** | Initial public offering price of $20,00 per share less underwriting discount of $0.90 per share. |
42
Financial highlights
| Fiscal year end changed from August 31, to July 31. |
| Amount less than $0.005 per share. |
(1) | Total investment return is calculated assuming a purchase of common shares at the current market price on the first day and a sale of common shares at the current market price on the last day of each period reported. Dividends and distributions are assumed, for purposes of this calculation, to be reinvested at prices obtained under the Funds dividend reinvestment plan. Total investment return does not reflect brokerage commissions or sales charges. Total investment return for a period of less than one year is not annualized. |
(2) | Calculated on the basis of income and expenses applicable to both common shares and Preferred Shares relative to the average net assets attributable to common shares. |
(3) | Inclusive of expenses offset by custody credits earned on cash balances at the custodian bank. (See note 1(k) in the Notes to Financial Statements in the Funds July 31, 2009 Annual Report to Shareholders). |
(4) | Interest expense primarily relates to investments in reverse repurchase agreement transactions. |
(5) | Annualized. |
The following table sets forth certain unaudited information regarding the Funds outstanding Preferred Shares as of the end of each of the Funds fiscal years since inception.
1. | Asset Coverage per Preferred Share means the ratio that the value of the total assets of the Fund, less all liabilities and indebtedness not represented by Preferred Shares, bears to the aggregate of the involuntary liquidation preference of the Preferred Shares, expressed as a dollar amount per Preferred Shares. |
2. | Involuntary Liquidating Preference per Preferred Share means the amount to which a holder of Preferred Shares would be entitled upon the involuntary liquidation of the Fund in preference to the Common Shareholders, expressed as a dollar amount per Preferred Share. |
3. | The Preferred Shares have no readily ascertainable market value. As discussed herein under Use of leverage, auctions for the Preferred Shares have failed since February 2008, there is currently no active trading market for the Preferred Shares and the Fund is not able to reliably estimate their value in a third party market sale. |
4. | The Funds fiscal year end changed from August 31 to July 31. Information in this row is for the period from September 1, 2005 through July 31, 2006. |
5. | Information in this row is for the period from October 29, 2004 through August 31, 2005. |
43
PURPOSE OF THE OFFER
The Board of Trustees of the Fund (the Board), Allianz Global Investors Fund Management LLC, the Funds investment manager (AGIFM or the Investment Manager), and Pacific Investment Management Company LLC, the Funds sub-adviser (PIMCO or the Sub-Adviser), have determined that it would be in the best interests of the Fund and its shareholders to increase the assets of the Fund, in order to more fully take advantage of current and prospective investment opportunities that reflect PIMCOs views regarding the credit markets. Consistent with the changes to the Funds name and investment policies and guidelines that became effective on March 1, 2010 (see The Fund), the Board, the Investment Manager and PIMCO believe that there are more attractive opportunities in fixed rate securities. By increasing assets through the Offer, the Fund believes that it will be able to cost-efficiently shift a larger portion of the Funds investment allocations from floating rate assets (including senior floating rate bank loans) to fixed rate instruments, achieve greater portfolio diversification with respect to industries and issuers currently represented in the portfolio (including as an alternative to possibly selling existing holdings that have appreciated in value) and potentially enhance risk-adjusted returns, in pursuit of its investment objective of seeking high current income, consistent with the preservation of capital. The Offer is also intended to enhance the market liquidity of the Funds common shares, reduce the Funds expense ratio modestly (not taking into account interest expense) and provide common shareholders with the opportunity to buy additional common shares at a discounted price to then-current market value.
The Offer may not be successful. The completion of the Offer may result in an immediate dilution of the net asset value per common share for all existing Common Shareholders, including those who fully exercise their Rights.
IMPORTANT TERMS OF THE OFFER
The Fund is issuing transferable rights (Rights) to its Common Shareholders of record (Record Date Shareholders) as of 5:00 p.m., Eastern time, on March 24, 2010 (the Record Date), entitling the holders of those Rights to subscribe for up to an aggregate of [ · ] of the Funds common shares (the Shares) (the Offer). Record Date Shareholders will receive one Right for each outstanding whole common share of the Fund held on the Record Date. The Rights entitle their holders to purchase one new Share for every three Rights held (1-for-3). Fractional Shares will not be issued upon the exercise of Rights; accordingly, Rights may be exercised only in integer multiples of three, except that any Record Date Shareholder who is issued fewer than three Rights may subscribe, at the Subscription Price (defined below), for one full Share. Assuming the exercise of all Rights, the Offer will result in an approximately 33 1 / 3 % increase in the Funds common shares outstanding.
Record Date Shareholders who exercise all the Rights issued to them (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) are entitled to subscribe for additional Shares at the same Subscription Price pursuant to the over-subscription privilege, subject to certain limitations and subject to allotment. Investors who are not Record Date Shareholders, but who otherwise acquire Rights to purchase Shares pursuant to the Offer, are not entitled to subscribe for any Shares pursuant to the over-subscription privilege. See Over-Subscription Privilege below. The distribution to Record Date Shareholders of transferable Rights may afford non-participating Record Date Shareholders the opportunity to sell their Rights for some cash value, receipt of which may be viewed as partial compensation for any economic dilution of their interests resulting from the Offer.
The subscription period commences on March 24, 2010 and ends at 5:00 p.m., Eastern time, on April 23, 2010, unless otherwise extended (the Expiration Date).
44
The Offer
The Fund expects to declare a monthly dividend in April 2010. Such dividend will not be payable with respect to Shares that are issued pursuant to the Offer after the record date for such dividend.
For purposes of determining the maximum number of Shares a Rights holder may acquire pursuant to the Offer, broker-dealers, trust companies, banks or others whose shares are held of record by Cede & Co., the nominee for the Depository Trust Company (DTC), or by any other depository or nominee, will be deemed to be the holders of the Rights that are held by Cede & Co. or such other depository or nominee on their behalf.
The Rights are transferable and will be admitted for trading on the NYSE under the symbol PFN.RT during the course of the Offer. Trading in the Rights on the NYSE may be conducted until the close of trading on the NYSE on the last business day prior to the Expiration Date. See Sale and Transferability of Rights. The Shares, once issued, will be listed on the NYSE under the symbol PFN. The Rights will be evidenced by subscription certificates which will be mailed to Record Date Shareholders, except as discussed below under Requirements for Foreign Shareholders.
Rights may be exercised by filling in and signing the subscription certificate and mailing it in the envelope provided, or otherwise delivering the completed and signed subscription certificate to the Subscription Agent, together with payment at the estimated Subscription Price for the Shares. For a discussion of the method by which Rights may be exercised and Shares may be paid for, see Method for Exercising Rights and Payment for Shares.
The Fund has retained the Dealer Manager to provide the Fund with financial structuring and soliciting services relating to the Offer, including advice with respect to the structure, timing and terms of the Offer. In determining the structure of the Offer, the Board considered, among other things, using a fixed-pricing versus a variable pricing mechanism, the benefits and drawbacks of conducting a non-transferable versus a transferable rights offering, the anticipated effect on the Fund and its existing Common Shareholders if the Offer is not fully subscribed, the anticipated dilutive effects on the Fund and its existing Common Shareholder of the Offer and the experience of the Dealer Manager in conducting rights offerings. The Board also considered that the Investment Manager and the Sub-Adviser would benefit from the Offer because the investment management fee and the sub-advisory fee paid to them are based on the Funds total managed assets, which would increase as a result of the Offer. See Benefits to the Investment Manager and the Sub-Adviser.
IMPORTANT DATES TO REMEMBER
Record Date: |
March 24, 2010 | |
Subscription Period: |
March 24, 2010 through April 23, 2010 * | |
Final Date Rights Will Trade on NYSE: |
April 22, 2010 * | |
Expiration Date and Pricing Date: |
April 23, 2010 * | |
Payment for Shares Due or Notices of Guarantees of Delivery Due: |
April 23, 2010 * | |
Confirmation Mailed to Participants: |
April 30, 2010 * | |
Final Payment for Shares Due: |
May 14, 2010 * |
* | Unless the Offer is extended. |
| See Payment for Shares. |
SUBSCRIPTION PRICE
The subscription price for the Shares (the Subscription Price) will be determined based on a formula equal to 90% of the average of the last reported sale price of the Funds common shares on the New York Stock Exchange (the NYSE) on the Expiration Date and on each of the four preceding trading
45
The Offer
days (the Formula Price). If, however, the Formula Price is less than 80% of the net asset value per common share on the Expiration Date, then the Subscription Price will be 80% of the Funds net asset value per common share on the Expiration Date. In each case, net asset value will be calculated as of the close of trading on the NYSE on the applicable day.
Because the Expiration Date of the subscription period will be April 23, 2010 (unless the Fund extends the subscription period), Rights holders may not know the Subscription Price at the time of exercise and will be required initially to pay for both the Shares subscribed for pursuant to the primary subscription and, if eligible, any additional Shares subscribed for pursuant to the over-subscription privilege at the estimated Subscription Price of $[ · ] per Share. See Payment for Shares. A Rights holder will have no right to rescind his subscription after the Subscription Agent has received a completed subscription certificate together with payment for the Shares offered pursuant to the Offer, except as provided under Notice of Net Asset Value Decline. The Fund does not have the right to withdraw the Rights or to cancel the Offer after the Rights have been distributed.
The net asset value per share of the Funds common shares at the close of business on [ · ] (the last trading date prior to the date of this prospectus on which the Fund determined its net asset value) was $[ · ], and the last reported sale price of a common share on the NYSE on that day was $[ · ].
OVER-SUBSCRIPTION PRIVILEGE
Record Date Shareholders who exercise all the Rights issued to them (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) are entitled to subscribe for additional Shares at the same Subscription Price pursuant to the over-subscription privilege, subject to certain limitations and to allotment. If sufficient remaining Shares are available, all Record Date Shareholders over-subscription requests will be honored in full. Investors who are not Record Date Shareholders, but who otherwise acquire Rights pursuant to the Offer, are not entitled to subscribe for any Shares pursuant to the over-subscription privilege. To the extent sufficient Shares are not available to honor all over-subscription requests, unsubscribed Shares will be allocated pro rata among those Record Date Shareholders who over-subscribe based on the number of common shares of the Fund they owned on the Record Date. The allocation process may involve a series of allocations in order to ensure that the total number of Shares available for over-subscriptions is distributed on a pro rata basis.
Record Date Shareholders who are fully exercising their Rights during the subscription period should indicate, on the subscription certificate that they submit with respect to the exercise of the Rights issued to them, how many Shares they desire to acquire pursuant to the over-subscription privilege.
Banks, broker-dealers, trustees and other nominee holders of Rights will be required to certify to the Subscription Agent, before any over-subscription privilege may be exercised with respect to any particular beneficial owner, as to the aggregate number of Rights exercised during the subscription period and the number of Shares subscribed for pursuant to the over-subscription privilege by such beneficial owner, and that such beneficial owners primary subscription was exercised in full. Nominee holder over-subscription forms will be distributed to banks, brokers, trustees and other nominee holders of Rights with the subscription certificates.
The Fund will not offer or sell any Shares that are not subscribed for during the subscription period or pursuant to the over-subscription privilege.
The Fund has been advised that one or more of the officers or employees of the Sub-Adviser may exercise all of the Rights initially issued to them and may request additional Shares pursuant to the over-subscription privilege. An exercise of the over-subscription privilege by such persons will increase their proportionate voting power and share of the Funds assets.
46
The Offer
SALE AND TRANSFERABILITY OF RIGHTS
The Rights will be admitted for trading on the NYSE under the symbol PFN.RT during the course of the Offer. Trading in the Rights on the NYSE may be conducted until the close of trading on the NYSE on the last business day prior to the Expiration Date. The Fund will use its best efforts to ensure that an adequate trading market for the Rights will exist, although there can be no assurance that a market for the Rights will develop. Assuming a market exists for the Rights, the Rights may be purchased and sold through usual brokerage channels or sold through the Subscription Agent.
Sales through the Subscription Agent and the Dealer Manager. Record Date Shareholders who do not wish to exercise any of the Rights issued to them pursuant to the Offer may instruct the Subscription Agent to sell any unexercised Rights through or to the Dealer Manager. Subscription certificates representing the Rights to be sold through or to the Dealer Manager must be received by the Subscription Agent by 5:00 p.m., Eastern time, on April 21, 2010 (or, if the subscription period is extended, by 5:00 p.m., Eastern time, two business days prior to the extended Expiration Date). Upon the timely receipt by the Subscription Agent of appropriate instructions to sell Rights, the Subscription Agent will ask the Dealer Manager either to purchase them or to use its best efforts to complete their sale, and the Subscription Agent will remit the proceeds of the sale to the selling Rights holder. If the Rights are sold, sales of those Rights will be deemed to have been effected at the weighted average price received by the Dealer Manager on the day those Rights are sold. The sale price of any Rights sold to the Dealer Manager will be based upon the then-current market price for the Rights. The Dealer Manager will also attempt to sell all Rights that remain unclaimed as a result of subscription certificates being returned by the postal authorities to the Subscription Agent as undeliverable as of the fourth business day prior to the Expiration Date. The Subscription Agent will hold the proceeds from those sales for the benefit of those non-claiming shareholders until the proceeds are either claimed or revert to The Commonwealth of Massachusetts. There can be no assurance that the Dealer Manager will purchase or be able to complete the sale of any Rights, and neither the Fund nor the Dealer Manager have guaranteed any minimum sale price for the Rights. If a Record Date Shareholder does not utilize the services of the Subscription Agent and chooses to use another broker-dealer or other financial institution to sell Rights issued to that shareholder pursuant to the Offer, then the other broker-dealer or financial institution may charge a fee to sell the Rights.
Other Transfers. The Rights evidenced by a subscription certificate may be transferred in whole by endorsing the subscription certificate for transfer in accordance with the instructions accompanying the subscription certificate. A portion of the Rights evidenced by a single subscription certificate (but not fractional Rights) may be transferred by delivering to the Subscription Agent a subscription certificate properly endorsed for transfer, with instructions to register such portion of the Rights evidenced thereby in the name of the transferee and to issue a new subscription certificate to the transferee evidencing the transferred Rights. If this occurs, a new subscription certificate evidencing the balance of the Rights, if any, will be issued to the Record Date Shareholder or, if the Record Date Shareholder so instructs, to an additional transferee. The signature on the subscription certificate must correspond with the name as written upon the face of the subscription certificate in every particular, without alteration or enlargement, or any change. A signature guarantee must be provided by an eligible guarantor institution (as defined in Rule 17Ad-15 of the Securities Exchange Act of 1934 (the Exchange Act)).
Record Date Shareholders wishing to transfer all or a portion of their Rights should allow at least five business days prior to the Expiration Date for: (i) the transfer instructions to be received and processed by the Subscription Agent; (ii) a new subscription certificate to be issued and transmitted to the transferee or transferees with respect to transferred Rights and to the transferor with respect to retained Rights, if any; and (iii) the Rights evidenced by the new subscription certificate to be exercised or sold by
47
The Offer
the recipients of the subscription certificate. Neither the Fund nor the Subscription Agent or the Dealer Manager shall have any liability to a transferee or transferor of Rights if subscription certificates are not received in time for exercise or sale prior to the Expiration Date.
Except for the fees charged by the Information Agent, the Subscription Agent and the Dealer Manager (which are expected to be paid from the proceeds of the Offer by the Fund), all commissions, fees and other expenses (including brokerage commissions and transfer taxes) incurred or charged in connection with the purchase, sale or transfer of Rights will be for the account of the transferor of the Rights, and none of these commissions, fees or expenses will be paid by the Fund, the Information Agent, the Subscription Agent or the Dealer Manager. Shareholders who wish to purchase, sell, exercise or transfer Rights through a broker, bank or other party should first inquire about any fees and expenses that the shareholder will incur in connection with the transactions.
The Fund anticipates that the Rights will be eligible for transfer through, and that the exercise of the primary subscription and the over-subscription may be effected through, the facilities of DTC or the Subscription Agent until 5:00 p.m., Eastern time, on the Expiration Date.
METHOD FOR EXERCISING RIGHTS
Rights are evidenced by subscription certificates that will be mailed to Record Date Shareholders (except as described under Requirements for Foreign Shareholders below) or, if a shareholders shares are held by Cede & Co. or any other depository or nominee on their behalf, to Cede & Co. or the other depository or nominee. Rights may be exercised by completing and signing the subscription certificate and mailing it in the envelope provided, or otherwise delivering the completed and signed subscription certificate to the Subscription Agent, together with payment in full at the estimated Subscription Price for the Shares by the Expiration Date as described under Payment For Shares. Rights may also be exercised by contacting your broker, banker or trust company, which can arrange, on your behalf, to guarantee by the Expiration Date delivery of payment and of a properly completed and executed subscription certificate pursuant to a notice of guaranteed delivery by the close of business on the third business day after the Expiration Date. A fee may be charged for this service. Completed subscription certificates and payments must be received by the Subscription Agent by 5:00 p.m., Eastern time, on the Expiration Date (unless delivery of subscription certificate and payment is effected by means of a notice of guaranteed delivery as described below under Payment for Shares) at the offices of the Subscription Agent at the addresses set forth below under Subscription Agent. Fractional Shares will not be issued upon exercise of Rights.
Shareholders Who are Record Owners. Shareholders who are record owners of common shares can choose between either option set forth below under Payment For Shares. If time is of the essence, option (2) will permit delivery of the subscription certificate and payment after the Expiration Date.
Investors Whose Shares are Held by a Nominee. Shareholders whose common shares are held by a nominee, such as a broker, trustee or other intermediary, must contact that nominee to exercise their Rights. In that case, the nominee will complete the subscription certificate on behalf of the investor and arrange for proper payment by one of the methods set forth below under Payment For Shares.
Nominees. Nominees, such as brokers, trustees or depositories for securities, who hold common shares of the Fund for the account of others should notify the respective beneficial owners of such shares as soon as possible to ascertain those beneficial owners intentions and to obtain instructions with respect to the Rights. If the beneficial owner so instructs, the nominee should complete the subscription certificate and submit it to the Subscription Agent with the proper payment as described below under Payment For Shares.
48
The Offer
Banks, brokers, trustees and other nominee holders of Rights will be required to certify to the Subscription Agent, before any over-subscription privilege may be exercised with respect to any particular beneficial owner who is a Record Date Shareholder, as to the aggregate number of Rights exercised during the subscription period and the number of Shares subscribed for pursuant to the over-subscription privilege by the beneficial owner, and that the beneficial owner exercised all the Rights issued to it pursuant to the Offer.
REQUIREMENTS FOR FOREIGN SHAREHOLDERS
Subscription certificates will not be mailed to Record Date Shareholders whose addresses are outside the United States (for these purposes, the United States includes the District of Columbia and the territories and possessions of the United States) (Foreign Shareholders). The Subscription Agent will send a letter via regular mail to Foreign Shareholders to notify them of the Offer. The Rights of Foreign Shareholders will be held by the Subscription Agent for their accounts until instructions are received to exercise the Rights. If instructions have not been received by 5:00 p.m., Eastern time, on April 20, 2010, three business days prior to the Expiration Date (or, if the subscription period is extended, on or before three business days prior to the extended Expiration Date), the Rights of Foreign Shareholders will be transferred by the Subscription Agent to the Dealer Manager, who will either purchase the Rights or use its best efforts to sell the Rights. The net proceeds, if any, from sale of those Rights by or to the Dealer Manager will be remitted to those Foreign Shareholders.
DISTRIBUTION ARRANGEMENTS
UBS Securities LLC will act as Dealer Manager for this Offer. Under the terms and subject to the conditions contained in the Dealer Manager Agreement among the Dealer Manager, the Fund and the Investment Manager, the Dealer Manager will provide financial structuring services in connection with the Offer and will solicit the exercise of Rights and participation in the over-subscription privilege. The Fund has agreed to pay the Dealer Manager a fee for its financial structuring and soliciting services equal to 3.50% of the aggregate Subscription Price for the Shares issued pursuant to the exercise of Rights and the over-subscription privilege. The fees paid to the Dealer Manager and other expenses of the Offer will be borne by the Fund and indirectly by all of its Common Shareholders, including those who do not exercise the Rights.
The Dealer Manager will reallow a portion of its fees to other broker-dealers who have assisted in soliciting the exercise of Rights. The Dealer Manager will reallow to broker-dealers included in the selling group to be formed and managed by the Dealer Manager selling fees equal to 2.50% of the Subscription Price per share for each Share issued pursuant to the Offer as a result of their selling efforts. In addition, the Dealer Manager will reallow to other broker-dealers that have executed and delivered a soliciting dealer agreement and have solicited the exercise of Rights solicitation fees equal to 0.50% of the Subscription Price per share for each Share issued pursuant to exercise of Rights as a result of their soliciting efforts, subject to a maximum fee based on the number of Shares held by each broker-dealer through DTC on the Record Date. Fees will be paid to the broker-dealer designated on the applicable portion of the subscription certificates or, in the absence of such designation, to the Dealer Manager.
In addition to the fees noted above, the Fund also has agreed to reimburse the Dealer Manager for its reasonable expenses incurred in connection with its activities under the Dealer Manager Agreement in an amount up to $100,000.
The Fund and the Investment Manager have each agreed to indemnify the Dealer Manager for losses arising out of certain liabilities, including liabilities under the Securities Act. The Dealer Manager Agreement also provides that the Dealer Manager will not be subject to any liability to the Fund in rendering the services contemplated by the Dealer Manager Agreement except for any act of bad faith, willful misconduct or gross negligence of the Dealer Manager or reckless disregard by the Dealer Manager of its obligations and duties under the Dealer Manager Agreement.
49
The Offer
Prior to the expiration of the Offer, the Dealer Manager may independently offer for sale Shares it has acquired through purchasing and exercising the Rights, at prices it sets. Although the Dealer Manager may realize gains and losses in connection with purchases and sales of Shares, such offering of Shares is intended by the Dealer Manager to facilitate the Offer and any such gains or losses are not expected to be material to the Dealer Manager. The Dealer Managers fee for its financial structuring and soliciting services is independent of any gains or losses that may be realized by the Dealer Manager through the purchase and exercise of the Rights and the sale of Shares.
In the ordinary course of their businesses, the Dealer Manager and/or its affiliates may engage in investment banking or financial transactions with the Fund, the Investment Manager, the Sub-Adviser and their affiliates.
The principal business address of UBS Securities LLC is 299 Park Avenue, New York, New York 10171.
SUBSCRIPTION AGENT
The Colbent Corporation is the Subscription Agent for the Offer. The Subscription Agent will receive for its administrative, processing, invoicing and other services a fee estimated to be approximately $22,500, plus reimbursement for all out-of-pocket expenses related to the Offer. The fees and expenses of the Subscription Agent are included in the fees and expenses of the Offer and therefore will be borne by the Fund and indirectly by all Common Shareholders, including those who do not exercise their Rights. Questions regarding the subscription certificates should be directed by mail to The Colbent Corporation Rights Offering Attn: Corporate Actions P.O. Box 859208 Braintree, MA 02185-9208. Shareholders may also subscribe for the Offer by contacting their broker dealer, trust company, bank or other nominee.
Completed subscription certificates must be sent together with proper payment of the estimated Subscription Price for all Shares subscribed for in the primary subscription and the over-subscription privilege (for Record Date Shareholders) to the Subscription Agent by one of the methods described below. Alternatively, Rights holders may arrange for their financial institutions to send notices of guaranteed delivery by facsimile to DTC to be received by the Subscription Agent prior to 5:00 p.m., Eastern time, on the Expiration Date. Facsimiles should be confirmed by telephone at DTC. The Fund will accept only properly completed and executed subscription certificates actually received at any of the addresses listed below, prior to 5:00 p.m., Eastern time, on the Expiration Date or by the close of business on the third business day after the Expiration Date following timely receipt of a notice of guaranteed delivery. See Payment for Shares below.
Subscription Certificate Delivery Method | Address/Number | |
Notice of Guaranteed Delivery: |
Contact your broker-dealer, trust company, bank, or other nominee to notify the Fund of your intent to exercise the Rights. | |
First Class Mail Only: (No Overnight /Express Mail): |
The Colbent Corporation Rights Offering Attn: Corporate Actions P.O. Box 859208 Braintree, MA 02185-9208 |
|
Hand: |
The Colbent Corporation Rights Offering Attn: Corporate Actions 161 Bay State Road Braintree, MA 02184 |
|
Express Mail or Overnight Courier: |
The Colbent Corporation Rights Offering Attn: Corporate Actions 161 Bay State Road Braintree, MA 02184 |
50
The Offer
The Fund will honor only subscription certificates received by the Subscription Agent on or prior to the Expiration Date at one of the addresses listed above. Delivery to an address other than those listed above will not constitute good delivery.
INFORMATION AGENT
The Information Agent for the Offer is The Altman Group. If you have questions or need further information about the Offer, please write the Information Agent at 60 East 42nd Street Suite 916, New York, NY 10165 or call (866) 207-3647. Any questions or requests for assistance concerning the method of subscribing for Shares or additional copies of this prospectus or subscription certificates should be directed to the Information Agent. Shareholders may also contact their brokers or nominees for information with respect to the Offer.
The Information Agent will receive a fee estimated to be approximately $7,500 for its services, plus reimbursement for all out-of-pocket expenses related to the Offer. The fees and expenses of the Information Agent are included in the fees and expenses of the Offer and therefore will be borne by the Fund and indirectly by all of its Common Shareholders, including those who do not exercise their Rights.
EXPIRATION OF THE OFFER
The Offer will expire at 5:00 p.m., Eastern time, on April 23, 2010, unless the Fund extends the Expiration Date. Rights will expire on the Expiration Date and may not be exercised after that date. If the Fund extends the Expiration Date, the Fund will make an announcement as promptly as practicable. This announcement will be issued no later than 9:00 a.m., Eastern time, on the next business day following the previously scheduled Expiration Date. Without limiting the manner in which the Fund may choose to make this announcement, the Fund will not, unless otherwise required by law, have any obligation to publish, advertise or otherwise communicate this announcement other than by making a release to the Dow Jones News Service or any other means of public announcement as the Fund may deem proper.
PAYMENT FOR SHARES
Rights holders who wish to acquire Shares pursuant to the Offer may choose between the following methods of payment:
(1) | A Rights holder can send the properly completed and executed subscription certificate together with payment for the Shares subscribed for during the subscription period and, if eligible, for any additional Shares subscribed for pursuant to the over-subscription privilege to the Subscription Agent based upon an estimated Subscription Price of $[ · ] per Share. Subscription will be accepted when payment, together with the executed subscription certificate, is received by the Subscription Agent at one of the addresses set forth above; the payment and the properly completed and executed subscription certificate must be received by the Subscription Agent by 5:00 p.m., Eastern time, on the Expiration Date. The Subscription Agent will deposit all checks received by it for the purchase of Shares into a segregated interest-bearing account of the Fund (the interest from which will belong to the Fund) pending proration and distribution of Shares. A payment pursuant to this method must be in U.S. dollars by money order or check drawn on a bank located in the United States, must be payable to PIMCO Income Strategy Fund II and must accompany a properly completed and executed subscription certificate for such subscription to be accepted. |
(2) | Alternatively, a subscription will be accepted by the Subscription Agent if, by 5:00 p.m., Eastern time, on the Expiration Date, the Subscription Agent has received a notice of guaranteed delivery by facsimile (telecopy) or otherwise from a bank, a trust company or NYSE member guaranteeing |
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The Offer
delivery of (i) payment of the full Subscription Price for the Shares subscribed for during the subscription period and, if eligible, any additional Shares subscribed for pursuant to the over-subscription privilege and (ii) a properly completed and executed subscription certificate. The Subscription Agent will not honor a notice of guaranteed delivery unless a properly completed and executed subscription certificate and full payment for the Shares at the estimated subscription price are received by the Subscription Agent by the close of business on the third business day after the Expiration Date. |
On the confirmation date, which will be five business days following the Expiration Date, a confirmation will be sent by the Subscription Agent to each Rights holder exercising its Rights (or, if a Rights holders common shares are held by DTC or any other depository or nominee, to DTC and/or that other depository or nominee) showing (i) the number of Shares acquired during the subscription period, (ii) the number of Shares, if any, acquired pursuant to the over-subscription privilege, (iii) the per Share and total purchase price for the Shares and (iv) any additional amount payable to the Fund by the Rights holder or any excess to be refunded by the Fund to the Rights holder, in each case based on the Subscription Price as determined on the Expiration Date. If any Record Date Shareholder exercises its right to acquire Shares of the Fund pursuant to the over-subscription privilege, any excess payment which would otherwise be refunded to the Record Date Shareholder will be applied by the Fund toward payment for Shares acquired pursuant to exercise of the over-subscription privilege. Any additional payment required from a Rights holder must be received by the Subscription Agent within ten business days after the confirmation date (May 14, 2010, unless the Expiration Date is extended). Any excess payment to be refunded by the Fund to a Rights holder will be mailed by the Subscription Agent to such Rights holder as promptly as practicable. All payments by a Rights holder must be in U.S. dollars by money order or check drawn on a bank located in the United States and payable to PIMCO Income Strategy Fund II.
Whichever of the two methods described above is used, issuance and delivery of the Shares subscribed for are contingent upon actual payment for such Shares. No certificates will be issued or delivered with respect to Shares issued and sold in the Offer.
Rights holders who have exercised their Rights will have no right to rescind their subscription after receipt of the completed subscription certificate together with payment for Shares by the Subscription Agent, except as described under Notice of Net Asset Value Decline below.
If a Rights holder who acquires Shares during the subscription period or pursuant to the over-subscription privilege (for Record Date Shareholders) does not make payment of any amounts due by the Expiration Date or the date payment is due under a notice of guaranteed delivery, the Fund reserves the right to take any or all of the following actions through all appropriate means: (i) find other Record Date Shareholders for the subscribed and unpaid for Shares; (ii) apply any payment actually received by the Fund toward the purchase of the greatest whole number of Shares that could be acquired by the Rights holder upon exercise of such Rights acquired during the subscription period or pursuant to the over-subscription privilege; and/or (iii) exercise any and all other rights or remedies to which the Fund may be entitled, including, without limitation, the right to set off against payments actually received by it with respect to such subscribed Shares.
The method of delivery of completed subscription certificates and payment of the Subscription Price to the Subscription Agent will be at the election and risk of exercising Rights holders, but if sent by mail it is recommended that such forms and payments be sent by registered mail, properly insured, with return receipt requested, and that a sufficient number of days be allowed to ensure delivery to the Subscription Agent and clearance of payment by 5:00 p.m., Eastern time, on the Expiration Date. Because uncertified personal checks may take at least five business days to clear, exercising Rights holders are strongly urged to pay, or arrange for payment, by means of certified or cashiers check or money order.
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The Offer
All questions concerning the timeliness, validity, form and eligibility of any exercise of Rights will be determined by the Fund, which determinations will be final and binding. The Fund, in its sole discretion, may waive any defect or irregularity, or permit a defect or irregularity to be corrected within such time as it may determine, or reject the purported exercise of any Right. Subscriptions will not be deemed to have been received or accepted until substantially all irregularities have been waived or cured within such time as the Fund determines in its sole discretion. The Fund will not be under any duty to give notification of any defect or irregularity in connection with the submission of subscription certificates or incur any liability for failure to give such notification.
NOTICE OF NET ASSET VALUE DECLINE
The Fund has, pursuant to the Securities and Exchange Commissions regulatory requirements, undertaken to suspend the Offer until the Fund amends this prospectus if after March 17, 2010, the effective date of the Funds Registration Statement, the Funds net asset value declines more than 10% from the Funds net asset value as of that date. In that event, the Expiration Date will be extended and the Fund will notify Record Date Shareholders of any such decline and permit Rights holders to cancel their exercise of Rights.
DELIVERY OF SHARES
Participants in the Funds dividend reinvestment plan (the Plan) will have any Shares acquired pursuant to the Offer credited to their shareholder dividend reinvestment accounts in the Plan. Common Shareholders whose shares are held of record by DTC or by any other depository or nominee on their behalf or their broker-dealers behalf will have any Shares acquired during the subscription period credited to the account of DTC or other depository or nominee. No certificates will be issued or delivered with respect to Shares issued and sold in the Offer.
U.S. FEDERAL INCOME TAX CONSEQUENCES
The following is a general summary of the material U.S. federal income tax consequences of the Offer under the provisions of the Internal Revenue Code of 1986, as amended (the Code), Treasury regulations promulgated thereunder (Treasury regulations), and other applicable authorities in effect as of the date of this prospectus that are generally applicable to Record Date Shareholders and other Rights holders who are United States persons within the meaning of the Code, and does not address any foreign, state, local or other tax consequences. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative or judicial action. Record Date Shareholders and other Rights holders should consult their tax advisors regarding the tax consequences, including U.S. federal, state, local, foreign or other tax consequences, relevant to their particular circumstances.
The Fund believes that the value of a Right will not be includible in the income of a Record Date Shareholder at the time the Right is issued, and the Fund will not report to the Internal Revenue Service (IRS) that a Record Date Shareholder has income as a result of the issuance of the Right; however, there is no guidance directly on point concerning certain aspects of the Offer. The remainder of this discussion assumes that the receipt of the Rights by Record Date Shareholders will not be a taxable event for U.S. federal income tax purposes.
The basis of a Right issued to a Record Date Shareholder will be zero, and the basis of the common share with respect to which the Right was issued (the Old Common Share) will remain unchanged, except that the Record Date Shareholder must allocate the basis of the Old Common Share and the Right in proportion to their respective fair market values on the date of distribution if (i) either (a) the fair market value of the Right on the date of distribution is at least 15% of the fair market value of the Old Common Share on that date, or (b) the Record Date Shareholder affirmatively elects (in the manner set out in
53
The Offer
Treasury regulations) to allocate to the Right a portion of the basis of the Old Common Share and (ii) the Right does not expire unexercised in the hands of the Record Date Shareholder ( i.e. , the Record Date Shareholder either exercises or sells the Right following its issuance).
No loss will be recognized by a Record Date Shareholder if a Right distributed to such Record Date Shareholder expires unexercised in the hands of such Record Date Shareholder.
The basis of a Right purchased in the market will generally be its purchase price. If a Right that has been purchased in the market expires unexercised, the holder will recognize a loss equal to the basis of the Right.
Any gain or loss on the sale of a Right or, in the case of Rights purchased in the market, any loss from a Right that expires unexercised, will be a capital gain or loss if the Right is held as a capital asset (which in the case of Rights issued to Record Date Shareholders will depend on whether the Old Common Share is held as a capital asset), and will be a long-term capital gain or loss if the holding period of the Right exceeds (or is deemed to exceed) one year. The deductibility of capital losses is subject to limitation. The holding period of a Right issued to a Record Date Shareholder will include the holding period of the Old Common Share.
No gain or loss will be recognized by a Rights holder upon the exercise of a Right, and the basis of any Share acquired upon exercise of the Right (the New Common Share) will equal the sum of the basis, if any, of the Right and the Subscription Price for the New Common Share. When a Rights holder exercises a Right, the Rights holders holding period in the New Common Shares does not include the time during which the Rights holder held the unexercised Right; the holding period for the New Common Shares will begin no later than the date following the date of exercise of the Right.
EMPLOYEE PLAN CONSIDERATIONS
Shareholders whose shares are in employee benefit plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) or Section 4975 of the Code (including corporate savings and 401(k) plans, Keogh or H.R. 10 plans of self-employed individuals and individual retirement accounts) (each a Plan) should be aware that additional contributions of cash to the Plan (other than rollover contributions or trustee-to-trustee transfers from other Plans) in order to exercise Rights would be treated as contributions to such Plan and, when taken together with contributions previously made, may result in, among other things, excise taxes for excess or nondeductible contributions. In the case of Plans qualified under Section 401(a) of the Code and certain other retirement plans, additional cash contributions could cause the maximum contribution limitations of Section 415 of the Code or other qualification rules to be violated. In addition, there may be other adverse tax and ERISA consequences if Rights are sold or transferred by a Plan.
Plans also should be aware that if they borrow in order to finance their exercise of Rights, they may become subject to the tax on unrelated business taxable income (UBTI) under Section 511 of the Code. If any portion of an individual retirement account (IRA) is used as security for a loan, the portion so used also is treated as distributed to the IRA depositor.
ERISA contains fiduciary responsibility requirements, and ERISA and the Code contain prohibited transaction rules that may affect the exercise or transfer of Rights. Due to the complexity of these rules and the penalties for noncompliance, fiduciaries of Plans and other retirement plans should consult with their counsel and other advisors regarding the consequences of their exercise or transfer of Rights under ERISA and the Code.
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The Offer
BENEFITS TO THE INVESTMENT MANAGER AND THE SUB-ADVISER
The Investment Manager and the Sub-Adviser will benefit from the Offer, in part, because the investment management fee paid by the Fund to the Investment Manager and the subadvisory fee paid by the Investment Manager to the Sub-Adviser are based on the Funds average weekly total managed assets. It is not possible to state precisely the amount of additional compensation the Investment Manager and the Sub-Adviser will receive as a result of the Offer because it is not known how many Shares of the Fund will be subscribed for and because the proceeds of the Offer will be invested in additional portfolio securities which will fluctuate in value. However, assuming (i) all Rights are exercised, (ii) the Funds average weekly net asset value during the twelve-month period beginning May 1, 2010 is $[ · ] per common share (the net asset value per common share on [ · ]) (iii) the Subscription Price is $[ · ] per Share (90% of the last reported sale price of the Funds common shares on [ · ]), and (iv) for purposes of this example, the Fund increases the amount of leverage outstanding (through the use of repurchase agreements) while maintaining approximately the same percentage of total assets attributable to leverage, and after giving effect to Dealer Manager fee and other estimated offering expenses, the Investment Manager and the Sub-Adviser would receive additional investment management fees and subadvisory fees of approximately $[ · ] and $[ · ], respectively, for the twelve-month period beginning May 1, 2010, and would continue to receive additional investment management fees and subadvisory fees, respectively, as a result of the Offer, based on the Funds average weekly total managed assets attributable to the Shares issued in the Offer and related additional leverage, thereafter.
INVESTMENT CONSIDERATIONS AND DILUTION
Upon completion of the Offer, Common Shareholders who do not exercise their Rights fully will own a smaller proportional interest in the Fund than would be the case if the Offer had not been made. In addition, because the Subscription Price per Share may be less than the Funds net asset value per common share, the Offer may result in a dilution of the Funds net asset value per common share for all Common Shareholders, irrespective of whether they exercise all or any portion of their Rights. Although it is not possible to state precisely the amount of such a decrease in value, because it is not known at this time what the Subscription Price will be, what the net asset value per common share will be at the Expiration Date or what proportion of Shares will be subscribed for, the dilution could be substantial. For example, assuming that all Rights are exercised, that the Funds net asset value on the Expiration Date is $[ · ] per common share (the net asset value per common share on [ · ]), and that the Subscription Price is $[ · ] per Share (90% of the last reported sale price of the Funds common shares on [ · ]), the Funds net asset value per common share on this date would be reduced by approximately $[ · ] per common share, after giving affect to Dealer Manager fee and other estimated offering expenses, estimated at $[ · ], payable by the Fund. Record Date Shareholders will experience a decrease in the net asset value per common share held by them, irrespective of whether they exercise all or any portion of their Rights. The distribution of transferable Rights, which may themselves have value, will afford non-participating Common Shareholders the potential of receiving a cash payment upon the sale of the Rights, receipt of which may be viewed as partial compensation for the economic dilution of their interests, although there can be no assurance that a market for the Rights will develop.
55
The net proceeds of the Offer will be invested in accordance with the Funds investment objective and investment strategies set forth below. Assuming current market conditions, the Fund estimates that the net proceeds of the Offer will be substantially invested in accordance with its investment objective and investment strategies within one to three months of the completion of the Offer. Pending such investment, it is anticipated that the proceeds of the Offer will be invested in short-term debt securities. Following the completion of the Offer, the Fund intends to increase the Funds leverage. See Use of leverage.
The Fund is a diversified closed-end management investment company. The Fund was organized as a Massachusetts business trust on June 30, 2004, pursuant to an Agreement and Declaration of Trust governed by the laws of The Commonwealth of Massachusetts. The Fund commenced investment operations on October 29, 2004, following the initial public offering of its common shares. The Funds principal office is located at 1345 Avenue of the Americas, New York, New York 10105 and its telephone number is (800) 254-5197.
Effective March 1, 2010, the Fund changed its name from PIMCO Floating Rate Strategy Fund to its current name, PIMCO Income Strategy Fund II, and rescinded its prior policy to normally invest at least 80% of its net assets (plus any borrowings for investment purposes) in floating rate assets. The Fund also recently revised various of its investment guidelines and strategies (including those relating to average portfolio duration, investments in below investment grade securities and exposure to emerging market securities) to those reflected in this prospectus. In this regard, the Funds investments and performance results under its new policies, guidelines and strategies are likely to differ, and perhaps substantially, from those it has made and achieved in the past.
Investment objective and policies
INVESTMENT OBJECTIVE
The Funds investment objective is to seek high current income, consistent with the preservation of capital. The Fund seeks to achieve its investment objective by ordinarily investing in a diversified portfolio of floating- and/or fixed-rate debt instruments. The average portfolio duration of the Fund normally will be in a low to intermediate range ( i.e. , zero to eight years). The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys or below BBB- by either S&P or Fitch) or that are unrated but judged by PIMCO to be of comparable quality, and also may invest without limit in investment grade securities.
The Fund has the flexibility to allocate and to re-allocate its assets in varying proportions among floating- and fixed-rate debt instruments as well as among investment grade and non-investment grade securities, and may choose to focus more heavily or exclusively on an asset class ( i.e. , floating or fixed; investment grade or non-investment grade) at any time and from time to time based on PIMCOs assessment of relative values, market conditions and other factors.
Various types of securities and other instruments in which the Fund may invest are described under Portfolio contents below. The Fund cannot assure you that it will achieve its investment objective.
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Investment objective and policies
INVESTMENT STRATEGIES
The Fund is actively managed in accordance with PIMCOs top down short-term (cyclical) and longer-term (secular) economic outlook, using strategies that focus on credit quality analysis, broad market diversification among industries and sectors and other risk management techniques. In selecting investments for the Fund, PIMCO attempts to identify floating- and/or fixed-rate debt instruments that provide high current income through fundamental research, driven by independent credit analysis and proprietary analytical tools. Investment decisions are based primarily on PIMCOs assessment of the issuers credit characteristics and the position of the particular security in the issuers capital structure, in light of PIMCOs outlook for particular industries, the economy and the market generally. At the same time, PIMCO may use a variety of techniques, such as credit default swaps, designed to control risk and to minimize the Funds exposure to issues that PIMCO believes are more likely to default or otherwise to depreciate in value over time and to detract from the Funds overall return to investors. The Fund cannot assure you that such securities will ultimately continue to pay current income or be paid in full at maturity.
Credit Quality. The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade or that are unrated but judged by PIMCO to be of comparable quality. The Fund may invest in issuers of any credit quality (including debt securities in the lowest ratings categories and securities that are in default or the issuers of which are in bankruptcy) if PIMCO determines that the particular security offers an attractive yield relative to its risk profile. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security or that are unrated but judged by PIMCO to be of comparable quality. Debt securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and to repay principal, and are commonly referred to as high yield securities or junk bonds. Debt securities in the lowest investment grade category also may be considered to posses some speculative characteristics by certain rating agencies. The Funds credit quality policies apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue.
Independent Credit Analysis. PIMCO relies heavily on its own analysis of the credit quality and risks associated with individual debt instruments considered for the Fund, rather than relying exclusively on rating agencies or third-party research. In the case of Floating Rate Loans, PIMCO analyzes and takes into account the legal/protective features associated with the securities (such as their position in the borrowers capital structure and any security through collateral) in assessing their credit characteristics. PIMCO has a devoted team of professionals that conducts fundamental credit research and analysis of individual issuers, industries and sectors and uses proprietary analytical tools (such as computer databases and Web-based applications) to assess and to monitor credit risk. The Funds portfolio manager utilizes this information in an attempt to manage credit risk and to identify issuers, industries or sectors that offer attractive yields relative to PIMCOs assessment of their credit characteristics. This aspect of PIMCOs capabilities is particularly important to the extent that the Fund focuses on Floating Rate Loans and/or below investment grade securities. PIMCOs ability to analyze Floating Rate Loans may be limited to the extent that the portfolio manager and analysts avoid the receipt of material, non-public information about the issuers of Floating Rate Loans. See Principal risks of the FundConfidential Information Access Risk.
Duration. The average portfolio duration of the Fund will normally be in a low to intermediate range ( i.e. , zero to eight years), although it may be longer at any time and from time to time based on PIMCOs assessment of market conditions and other factors. PIMCO may utilize certain strategies, including investments in structured notes or interest rate futures contracts or swap, cap, floor or collar
57
Investment objective and policies
transactions, for the purpose of reducing the interest rate sensitivity of the Funds portfolio, although there is no assurance that it will do so or that such strategies will be successful.
Duration is a measure of the expected life of a debt security that is used to determine the sensitivity of the securitys price to changes in interest rates. The longer a securitys duration, the more sensitive it will be to changes in interest rates. For example, the market price of a bond with a duration of two years would be expected to decline 2% if interest rates were to rise 1%. Conversely, the market price of the same bond would be expected to increase 2% if interest rates were to fall 1%. The market price of a bond with a duration of four years would be expected to increase or decline twice as much as the market price of a bond with a two-year duration. The maturity of a security, another commonly used measure of price sensitivity, measures only the time until final payment is due, whereas duration takes into account the pattern of all payments of interest and principal on a security over time, including how these payments are affected by prepayments and by changes in interest rates, as well as the time until an interest rate on a security is reset (in the case of variable rate securities).
The Fund seeks to achieve its investment objective by ordinarily investing in a diversified portfolio of floating- and/or fixed-rate debt instruments. The Fund may invest a substantial portion of its floating-rate assets in Floating Rate Loans. Other floating rate debt instruments in which the Fund may invest include catastrophe and other event-linked bonds, bank capital securities, unsecured bank loans, corporate bonds and other debt securities, money market instruments and certain types of mortgage-backed and other asset-backed securities that pay interest at rates which adjust whenever a specified interest rate changes and/or reset on predetermined dates (such as the last day of a month or calendar quarter). The Fund also considers floating rate assets to include securities with durations of less than or equal to one year and fixed rate securities with respect to which the Fund has entered into derivative instruments to effectively convert the fixed rate interest payments into floating rate interest payments. The Fund also may invest in a wide variety of fixed-rate debt securities, including corporate bonds, convertible securities and mortgage-backed and other asset-backed securities issued on a public or private basis. The Fund may make use of a variety of other instruments, including collateralized debt obligations, preferred shares, commercial paper, U.S. Government securities, zero-coupon and inflation-indexed bonds, real estate investment trusts (REITs), structured notes and other hybrid instruments and credit-linked trust certificates. Certain debt instruments, such as convertible bonds, also may include the right to participate in equity appreciation. The principal and/or interest rate on some debt instruments may be determined by reference to the performance of a benchmark asset or market, such as an index of securities, or the differential performance of two assets or markets, such as the level of exchange rates between the U.S. dollar and a foreign currency or currencies.
The Fund may also hold common stocks and other equity securities from time to time, including those it has received through the conversion of a convertible security held by the Fund or in connection with the restructuring of a debt security. The Fund may invest in securities that have not been registered for public sale, including securities eligible for purchase and sale pursuant to Rule 144A under the Securities Act of 1933 and other securities issued in private placements. The Fund may also invest in securities of other investment companies, including exchange-traded funds (ETFs). The Fund may invest in securities of companies with small market capitalizations.
As noted above, the Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade, and may also invest without limit in investment grade securities.
The Fund expects to invest predominantly in U.S. dollar-denominated debt securities, which may include those issued by foreign corporations or supra-national government agencies. The Fund may invest up to
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Portfolio contents
25% of its total assets in Securities denominated in foreign currencies, including obligations of non-U.S. governments and their respective sub-divisions, agencies and government-sponsored enterprises. The Fund may invest up to 25% of its total assets in securities that are economically tied to emerging market countries.
The Fund may utilize various derivative strategies involving the purchase or sale of credit default swaps, total return swaps and other swap agreements, call and put options (including options on futures contracts), futures and forward contracts, short sales and other derivative instruments for investment purposes, leveraging purposes or in an attempt to hedge against market, interest rate, currency and other risks in the portfolio. The Fund may also seek to obtain market exposure to the securities in which it invests by entering into a series of purchase and sales contracts.
The Fund may invest without limit in illiquid securities. Illiquidity is generally determined using the Securities and Exchange Commissions standard applicable to open-end investment companies ( i.e. , securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities).
The Fund cannot change its investment objective without the approval (a) of the holders of a majority of the outstanding common shares and any preferred shares (including the Preferred Shares) voting together as a single class, and (b) of the holders of a majority of the outstanding preferred shares (including the Preferred Shares) voting as a separate class. A majority of the outstanding shares (whether voting together as a single class or voting as a separate class) means (i) 67% or more of such shares present at a meeting, if the holders of more than 50% of those shares are present or represented by proxy, or (ii) more than 50% of such shares, whichever is less.
Upon PIMCOs recommendation, for temporary defensive purposes and in order to keep the Funds cash fully invested, the Fund may deviate from its investment objective and strategies and invest some or all of its total assets in investment grade debt securities, including high quality, short-term debt securities. The Fund may not achieve its investment objective when it does so.
The following provides information regarding certain types of securities and other instruments in which the Fund ordinarily may invest. Additional information regarding these and other instruments and investment techniques that may be used by the Fund is provided under Investment Objective and Policies in the Statement of Additional Information.
HIGH YIELD SECURITIES (JUNK BONDS)
The Fund may invest without limit in debt securities that are rated below investment grade (below Baa by Moodys or below BBB by either S&P or Fitch) or unrated but judged by PIMCO to be of comparable quality. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security, or unrated but judged by PIMCO to be of comparable quality. These securities are commonly referred to as high yield securities or junk bonds. High yield securities involve a greater degree of risk (in particular, a greater risk of default) than and special risks in addition to the risks associated with investment grade debt obligations. While offering a greater potential opportunity for capital appreciation and higher yields, high yield securities typically entail greater potential price volatility and may be less liquid than higher-rated securities. High yield securities may be regarded as predominantly speculative with respect to the issuers continuing ability to make timely principal and interest payments. They also may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-rated securities. Debt securities in the lowest investment grade category also may be considered to possess some speculative characteristics by certain ratings agencies.
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Portfolio contents
The market values of high yield securities tend to reflect individual developments of the issuer to a greater extent than do higher-quality securities, which tend to react mainly to fluctuations in the general level of interest rates. In addition, lower-quality debt securities tend to be more sensitive to general economic conditions. Certain emerging market governments that issue high yield securities in which the Fund may invest are among the largest debtors to commercial banks, foreign governments and supranational organizations, such as the World Bank, and may not be able or willing to make principal and/or interest payments as they come due.
Floating Rate Loans, many of which are high yield securities, generally tend to have more favorable recovery rates than most other types of loans. Although Floating Rate Loans in which the Fund may invest will often be secured by collateral, there can be no assurance that liquidation of such collateral would satisfy the borrowers obligation in the event of default or that such collateral could be readily liquidated.
Credit Ratings and Unrated Securities . Rating agencies are private services that provide ratings of the credit quality of debt obligations. Appendix A to this prospectus describes the various ratings assigned to debt obligations by Moodys, S&P and Fitch. As noted in Appendix A, Moodys, S&P and Fitch may modify their ratings of securities to show relative standing within a rating category, with the addition of numerical modifiers (1, 2 or 3) in the case of Moodys, and with the addition of a plus (+) or minus (-) sign in the case of S&P and Fitch. The Fund may purchase a security, regardless of any rating modification, provided the security is rated at or above the Funds minimum rating category. For example, the Fund may purchase a security rated Caa3 by Moodys, CCC- by S&P or CCC- by Fitch, provided that the Fund is permitted to purchase securities rated Caa/CCC. Ratings assigned by a rating agency are not absolute standards of credit quality and do not evaluate market risks. Rating agencies may fail to make timely changes in credit ratings and an issuers current financial condition may be better or worse than a rating indicates. The Fund will not necessarily sell a security when its rating is reduced below its rating at the time of purchase. PIMCO does not rely solely on credit ratings, and develops its own analysis of issuer credit quality. The ratings of a debt security may change over time. Moodys, S&P and Fitch monitor and evaluate the ratings assigned to securities on an ongoing basis. As a result, debt instruments held by the Fund could receive a higher rating (which would tend to increase their value) or a lower rating (which would tend to decrease their value) during the period in which they are held by the Fund.
The Fund may purchase unrated securities (which are not rated by a rating agency) if PIMCO determines that the securities are of comparable quality to rated securities that the Fund may purchase. Unrated securities may be less liquid than comparable rated securities and involve the risk that PIMCO may not accurately evaluate the securitys comparative credit rating. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher-quality debt obligations. The Funds success in achieving its investment objective may depend more heavily on PIMCOs credit analysis to the extent that the Fund invests in below investment grade quality and unrated securities.
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate instruments are instruments that pay interest at rates which adjust whenever a specified interest rate changes and/or which reset on predetermined dates (such as the last day of a month or calendar quarter). In addition to Floating Rate Loans, variable and floating rate instruments may include, without limitation, instruments such as catastrophe and other event-linked bonds, bank capital securities, unsecured bank loans, corporate bonds, money market instruments and certain types of mortgage-backed and other asset-backed securities. Due to their variable or floating rate features, these instruments will generally pay higher levels of income in a rising interest rate environment and lower levels of income as interest rates decline. For the same reason, the market value of a variable or floating
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Portfolio contents
rate instrument is generally expected to have less sensitivity to fluctuations in market interest rates than a fixed-rate instrument, although the value of a variable or floating rate instrument may nonetheless decline as interest rates rise and due to other factors, such as changes in credit quality.
The Fund also may engage in credit spread trades. A credit spread trade is an investment position relating to a difference in the prices or interest rates of two bonds or other securities, where the value of the investment position is determined by changes in the difference between such prices or interest rates, as the case may be, of the respective securities. The Fund may also invest in inverse floating rate debt instruments (inverse floaters). An inverse floater may exhibit greater price volatility than a fixed rate obligation of similar credit quality.
FLOATING RATE AND OTHER BANK LOANS
The Fund may invest in fixed- and floating-rate loans issued by banks (including, among others, Floating Rate Loans, delayed funding loans and revolving credit facilities). Loan interests may take the form of direct interests acquired during a primary distribution and may also take the form of assignments of, novations of or participations in a bank loan acquired in secondary markets.
As noted, the Fund may purchase assignments of bank loans from lenders. The purchaser of an assignment typically succeeds to all the rights and obligations under the loan agreement with the same rights and obligations as the assigning lender. Assignments may, however, be arranged through private negotiations between potential assignees and potential assignors, and the rights and obligations acquired by the purchaser of an assignment may differ from, and be more limited than, those held by the assigning lender.
The Fund may also invest in participations in bank loans. Participations by the Fund in a lenders portion of a bank loan typically will result in the Fund having a contractual relationship only with such lender, not with the borrower. As a result, the Fund may have the right to receive payments of principal, interest and any fees to which it is entitled only from the lender selling the participation and only upon receipt by such lender of such payments from the borrower. In connection with purchasing participations, the Fund generally will have no right to enforce compliance by the borrower with the terms of the loan agreement, nor any rights with respect to any funds acquired by other lenders through set-off against the borrower, and the Fund may not directly benefit from any collateral supporting the loan in which it has purchased the participation. As a result, the Fund may assume the credit risk of both the borrower and the lender selling the participation.
The Floating Rate Loans in which the Fund may invest typically pay interest at rates that are re-determined periodically on the basis of a floating base lending rate (such as the LIBOR Rate) plus a premium. Although Floating Rate Loans are typically of below investment grade quality ( i.e. , high yield securities), they tend to have more favorable recovery rates than other types of below investment grade quality debt obligations. Floating Rate Loans may hold a senior position in the capital structure of a borrower and are often secured with collateral. A Floating Rate Loan is typically originated, negotiated and structured by a U.S. or foreign commercial bank, insurance company, finance company or other financial institution (the Agent) for a lending syndicate of financial institutions (Lenders). The Agent typically administers and enforces the Floating Rate Loan on behalf of the other Lenders in the syndicate. In addition, an institution, typically but not always the Agent, holds any collateral on behalf of the Lenders. A financial institutions employment as an Agent might be terminated in the event that it fails to observe a requisite standard of care or becomes insolvent. A successor Agent would generally be appointed to replace the terminated Agent, and assets held by the Agent under the loan agreement would likely remain available to holders of such indebtedness. However, if assets held by the Agent for the benefit of the Fund were determined to be subject to the claims of the Agents general creditors, the Fund might incur certain costs and delays in realizing payment on a loan or loan participation and could suffer
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a loss of principal and/or interest. In situations involving other interposed financial institutions ( e.g. , an insurance company or government agency) similar risks may arise.
Purchasers of Floating Rate Loans and other forms of direct indebtedness depend primarily upon the creditworthiness of the corporate or other borrower for payment of principal and interest. If the Fund does not receive scheduled interest or principal payments on such indebtedness, the net asset value, market price and/or yield of the common shares could be adversely affected. Floating Rate Loans that are fully secured may offer the Fund more protection than an unsecured loan in the event of non-payment of scheduled interest or principal. However, there is no assurance that the liquidation of any collateral from a secured Floating Rate Loan would satisfy the borrowers obligation, or that such collateral could be liquidated. Also, the Fund may invest in Floating Rate Loans that are unsecured.
Floating Rate Loans and interests in other bank loans may not be readily marketable and may be subject to restrictions on resale. In some cases, negotiations involved in disposing of indebtedness may require weeks to complete. Consequently, some indebtedness may be difficult or impossible to dispose of readily at what PIMCO believes to be a fair price.
Floating Rate Loans usually require, in addition to scheduled payments of interest and principal, the prepayment of the Floating Rate Loan from free cash flow. The degree to which borrowers prepay Floating Rate Loans, whether as a contractual requirement or at their election, may be affected by general business conditions, the financial condition of the borrower and competitive conditions among lenders, among others. As such, prepayments cannot be predicted with accuracy. Upon a prepayment, either in part or in full, the actual outstanding debt on which the Fund derives interest income will be reduced. However, the Fund may receive both a prepayment penalty fee from the prepaying borrower and a facility fee upon the purchase of a new Floating Rate Loan with the proceeds from the prepayment of the former. The effect of prepayments on the Funds performance may be mitigated by the receipt of prepayment fees and the Funds ability to reinvest prepayments in other Floating Rate Loans that have similar or identical yields.
DELAYED FUNDING LOANS AND REVOLVING CREDIT FACILITIES
As noted above under Floating Rate and Other Bank Loans, the Fund may enter into, or acquire participations in, delayed funding loans and revolving credit facilities, in which a bank or other lender agrees to make loans up to a maximum amount upon demand by the borrower during a specified term. These commitments may have the effect of requiring the Fund to increase its investment in a company at a time when it might not be desirable to do so (including at a time when the companys financial condition makes it unlikely that such amounts will be repaid). Delayed funding loans and revolving credit facilities are subject to credit, interest rate and liquidity risk and the risks of being a lender.
BANK CAPITAL SECURITIES AND BANK OBLIGATIONS
The Fund may invest in bank capital securities. Bank capital securities are issued by banks to help fulfill their regulatory capital requirements. There are three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. Bank capital is generally, but not always, of investment grade quality. Upper Tier II securities are commonly thought of as hybrids of debt and preferred stock. Upper Tier II securities are often perpetual (with no maturity date), callable and have a cumulative interest deferral feature. This means that under certain conditions, the issuer bank can withhold payment of interest until a later date. However, such deferred interest payments generally earn interest. Tier I securities often take the form of trust preferred securities.
The Fund may also invest in other bank obligations including certificates of deposit, bankers acceptances and fixed time deposits. Certificates of deposit are negotiable certificates that are issued against funds deposited in a commercial bank for a definite period of time and that earn a specified return. Bankers
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acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Fixed time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. There are generally no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is generally no market for such deposits. The Fund may also hold funds on deposit with its custodian bank in an interest-bearing account for temporary purposes.
BONDS
The Fund may invest in a wide variety of bonds of varying maturities issued by U.S. and foreign corporations and other business entities, governments and municipalities and other issuers. Bonds are fixed or variable/floating rate debt obligations, including bills, notes, debentures, money market instruments and similar instruments and securities. Bonds generally are used by corporations as well as governments and other issuers to borrow money from investors. The issuer pays the investor a fixed or variable rate of interest and normally must repay the amount borrowed on or before maturity. Certain bonds are perpetual in that they have no maturity date.
COMMERCIAL PAPER
Commercial paper represents short-term unsecured promissory notes issued in bearer form by corporations such as banks or bank holding companies and finance companies. The rate of return on commercial paper may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies.
PREFERRED SECURITIES
Preferred securities represent an equity interest in a company that generally entitles the holder to receive, in preference to the holders of other stocks such as common stocks, dividends and a fixed share of the proceeds resulting from liquidation of the company. Unlike common stocks, preferred stocks usually do not have voting rights. Preferred stocks in some instances are convertible into common stock. Some preferred stocks also entitle their holders to receive additional liquidation proceeds on the same basis as holders of a companys common stock, and thus also represent an ownership interest in the company. Some preferred stocks offer a fixed rate of return with no maturity date. Because they never mature, these preferred stocks act like long-term bonds, can be more volatile than other types of preferred stocks and may have heightened sensitivity to changes in interest rates. Other preferred stocks have a variable dividend, generally determined on a quarterly or other periodic basis, either according to a formula based upon a specified premium or discount to the yield on particular U.S. Treasury securities or based on an auction process, involving bids submitted by holders and prospective purchasers of such stocks. Although they are equity securities, preferred securities have certain characteristics of both debt securities and common stock. They are like debt securities in that their stated income is generally contractually fixed. They are like common stocks in that they do not have rights to precipitate bankruptcy proceedings or collection activities in the event of missed payments. Furthermore, preferred securities have many of the key characteristics of equity due to their subordinated position in an issuers 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. Because preferred securities represent an equity ownership interest in a company, their value usually will react more strongly than bonds and other debt instruments to actual or perceived changes in a companys financial condition or prospects, or to fluctuations in the equity markets.
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In order to be payable, dividends on preferred securities must be declared by the issuers board of directors. In addition, distributions on preferred securities may be subject to deferral and thus may not be automatically payable. Income payments on some preferred securities are cumulative, causing dividends and distributions to accrue even if they are not declared by the board of directors of the issuer or otherwise made payable. Other preferred securities are non-cumulative, meaning that skipped dividends and distributions do not continue to accrue. There is no assurance that dividends on preferred securities in which the Fund invests will be declared or otherwise made payable.
Preferred securities have a liquidation value that generally equals their original purchase price at the date of issuance. The market values of preferred securities may be affected by favorable and unfavorable changes impacting the issuers industries or sectors. They may also be affected by actual and anticipated changes or ambiguities in the tax status of the security and by actual and anticipated changes or ambiguities in tax laws, such as changes in corporate and individual income tax rates or the characterization of dividends as tax-advantaged. The dividend paid on the preferred securities in which the Fund may invest might not be eligible for tax-advantaged qualified dividend treatment. See Tax matters. Because the claim on an issuers earnings represented by preferred securities may become disproportionately large when interest rates fall below the rate payable on the securities or for other reasons, the issuer may redeem preferred securities, generally after an initial period of call protection in which the security is not redeemable. Thus, in declining interest rate environments in particular, any holdings of the Fund of higher dividend-paying preferred securities may be reduced and the Fund may be unable to acquire securities paying comparable rates with the redemption proceeds.
CONVERTIBLE SECURITIES AND SYNTHETIC CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are debt securities that may be converted at either a stated price or stated rate into underlying shares of common stock. Convertible securities have general characteristics similar to both debt securities and equity securities. Although to a lesser extent than with debt obligations, 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 stocks and, therefore, also will react to variations in the general market for equity securities.
Convertible securities are investments that provide for a stable stream of income with generally higher yields than common stocks. There can be no assurance of current income because the issuers of the convertible securities may default on their obligations. Convertible securities, however, generally offer lower interest or dividend yields than non-convertible debt securities of similar credit quality because of the potential for equity-related capital appreciation. A convertible security, in addition to providing current income, offers the potential for capital appreciation through the conversion feature, which enables the holder to benefit from increases in the market price of the underlying common stock.
The Fund may invest in synthetic convertible securities, which are created through a combination of separate securities that possess the two principal characteristics of a traditional convertible security, that is, an income-producing security (income-producing component) and the right to acquire an equity security (convertible component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments. The convertible component is achieved by purchasing warrants or options to buy common stock at a certain exercise price, or options on a stock index. The Fund may also purchase synthetic securities created by other parties, typically investment banks, including convertible structured notes. The income-producing and convertible components of a synthetic convertible security may be issued separately by different issuers and at different times. The values of synthetic convertible securities will
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respond differently to market fluctuations than a traditional convertible security because a synthetic convertible is composed of two or more separate securities or instruments, each with its own market value. Synthetic convertible securities are also subject to the risks associated with derivatives. See Principal risks of the FundDerivatives Risk. In addition, if the value of the underlying common stock or the level of the index involved in the convertible element falls below the strike price of the warrant or option, the warrant or option may lose all value.
ZERO-COUPON BONDS, STEP-UPS AND PAYMENT-IN-KIND SECURITIES
Zero-coupon bonds pay interest only at maturity rather than at intervals during the life of the security. Like zero-coupon bonds, step up bonds pay no interest initially but eventually begin to pay a coupon rate prior to maturity, which rate may increase at stated intervals during the life of the security. Payment-in-kind securities (PIKs) are debt obligations that pay interest in the form of other debt obligations, instead of in cash. Each of these instruments is normally issued and traded at a deep discount from face value. Zero-coupon bonds, step-ups and PIKs allow an issuer to avoid or delay the need to generate cash to meet current interest payments and, as a result, may involve greater credit risk than bonds that pay interest currently or in cash. The Fund would be required to distribute the income on these instruments as it accrues, even though the Fund will not receive the income on a current basis or in cash. Thus, the Fund may have to sell other investments, including when it may not be advisable to do so, to make income distributions to its shareholders.
FOREIGN (NON-U.S.) INVESTMENTS
The Fund may invest some or all of its assets in U.S. dollar-denominated debt obligations of foreign issuers or supranational government agencies. The Fund may invest up to 25% of its total assets in securities denominated in foreign currencies, including sovereign debt issued by foreign developed and emerging market governments and their respective sub-divisions, agencies or instrumentalities, government sponsored enterprises and supranational government entities. Supranational entities include international organizations that are organized or supported by one or more government entities to promote economic reconstruction or development and by international banking institutions and related governmental agencies. As a holder of sovereign debt, the Fund may be requested to participate in the rescheduling of such debt and to extend further loans to governmental entities. In addition, there are generally no bankruptcy proceedings similar to those in the United States by which defaulted sovereign debt may be collected. Investing in foreign securities involves special risks and considerations not typically associated with investing in U.S. securities. See Principal risks of the FundForeign (Non-U.S.) Investment Risk.
The Fund may invest in Brady Bonds, which are securities created through the exchange of existing commercial bank loans to sovereign entities for new obligations in connection with a debt restructuring. Investments in Brady Bonds may be viewed as speculative. Brady Bonds acquired by the Fund may be subject to restructuring arrangements or to requests for new credit, which may cause the Fund to realize a loss of interest or principal on any of its portfolio holdings.
The foreign securities in which the Fund may invest include Eurodollar obligations and Yankee Dollar obligations. Eurodollar obligations are U.S. dollar-denominated certificates of deposit and time deposits issued outside the U.S. capital markets by foreign branches of U.S. banks and by foreign banks. Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations are generally subject to the same risks that apply to domestic debt issues, notably credit risk, interest rate risk, market risk and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee Dollar) obligations are subject to certain sovereign risks. One such risk is the possibility that a sovereign country might prevent capital, in the form of U.S. dollars,
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from flowing across its borders. Other risks include adverse political and economic developments; the extent and quality of government regulation of financial markets and institutions; the imposition of foreign withholding taxes; and the expropriation or nationalization of foreign issuers.
EMERGING MARKET SECURITIES
The Fund may invest up to 25% of its total assets in the securities that are economically tied to emerging market countries. A security is considered to be economically tied to an emerging market country if the issuer or guarantor of the security is organized under the laws of the country or if the currency of settlement of the security is a currency of the emerging market country. PIMCO has broad discretion to identify countries that it considers to qualify as emerging securities markets. In making investments in emerging market securities, the Fund emphasizes countries with relatively low gross national product per capita and with the potential for rapid economic growth. Emerging market countries are generally located in Asia, Africa, the Middle East, Latin America and Eastern Europe. PIMCO will select emerging market country and currency composition based on its evaluation of relative interest rates, inflation rates, exchange rates, monetary and fiscal policies, trade and current account balances and any other specific factors it believes to be relevant.
Investments in emerging market securities involve a greater degree of risk than, and special risks in addition to the risks associated with, investments in domestic securities or in securities of foreign, developed countries. See Principal risks of the FundEmerging Markets Risk.
FOREIGN CURRENCIES AND RELATED TRANSACTIONS
The Funds common shares are priced in U.S. dollars and the distributions paid by the Fund to Common Shareholders are paid in U.S. dollars. However, a significant portion of the Funds assets may be denominated in foreign (non-U.S.) currencies and that income received by the Fund from many foreign debt obligations will be paid in foreign currencies. The Fund also may invest in or gain exposure to foreign currencies themselves for investment or hedging purposes. The Funds investments in securities that trade in, or receive revenues in, foreign currencies will be subject to currency risk, which is the risk that fluctuations in the exchange rates between the U.S. dollar and foreign currencies may negatively affect any investment. See Principal risks of the FundForeign Currency Risk. The Fund may (but is not required to) hedge some or all of its exposure to foreign currencies through the use of derivative strategies. For instance, the Fund may enter into forward foreign currency exchange contracts, and may buy and sell foreign currency futures contracts and options on foreign currencies and foreign currency futures. A forward foreign currency exchange contract, which involves an obligation to purchase or sell a specific currency at a future date at a price set at the time of the contract, reduces the Funds exposure to changes in the value of the currency it will deliver and increases its exposure to changes in the value of the currency it will receive for the duration of the contract. The effect on the value of the Fund is similar to selling securities denominated in one currency and purchasing securities denominated in another currency. Contracts to sell foreign currency would limit any potential gain which might be realized by the Fund if the value of the hedged currency increases. The Fund may enter into these contracts to hedge against foreign exchange risk arising from the Funds investment or anticipated investment in securities denominated in foreign currencies. Suitable hedging transactions may not be available in all circumstances and there can be no assurance that the Fund will engage in such transactions at any given time or from time to time when they would be beneficial. Although PIMCO has the flexibility to engage in such transactions for the Fund, it may determine not to do so or to do so only in unusual circumstances or market conditions. Also, these transactions may not be successful and may eliminate any chance for the Fund to benefit from favorable fluctuations in relevant foreign currencies.
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The Fund may also use derivatives contracts for purposes of increasing exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one currency to another. To the extent that it does so, the Fund will be subject to the additional risk that the relative value of currencies will be different than anticipated by PIMCO.
Please see Investment Objective and PoliciesNon-U.S. Securities, Investment Objective and PoliciesForeign Currency Transactions and Investment Objective and PoliciesForeign Currency Exchange-Related Securities in the Statement of Additional Information for a more detailed description of the types of foreign investments and foreign currency transactions in which the Fund may invest and their related risks.
DERIVATIVES
The Fund may, but is not required to, use a variety of derivative instruments for both investment and risk management purposes. The Fund also expects from time to time to use various derivatives transactions to add leverage to its portfolio. See Use of leverage. Generally, derivatives are financial contracts whose value depends upon, or is derived from, the value of an underlying asset, reference rate or index, and may relate to, among others, individual debt instruments, interest rates, currencies or currency exchange rates, commodities, and related indexes. Examples of derivative instruments that the Fund may use include credit default swaps, total return swaps and other swap agreements, call and put options (including options on futures contracts), futures and forward contracts and short sales. The Funds use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investment directly in securities and other more traditional investments. See Principal risks of the FundDerivatives Risk. Certain types of derivative instruments that the Fund may utilize are described elsewhere in this section, including those described under Certain Interest Rate Transactions, Credit Default Swaps and Structured Notes and Related Instruments. Please see Investment Objective and PoliciesDerivative Instruments in the Statement of Additional Information for additional information about these and other derivative instruments that the Fund may use and the risks associated with such instruments. There is no assurance that these derivative strategies will be available at any time or that PIMCO will determine to use them for the Fund or, if used, that the strategies will be successful. In addition, the Fund may be limited in its use of derivatives by guidelines imposed by the rating agencies (currently Fitch and Moodys) that issue ratings for the Preferred Shares.
CREDIT DEFAULT SWAPS
The Fund may enter into credit default swap contracts for both investment and risk management purposes, as well as to add leverage to the Funds portfolio. A credit default swap agreement may have as reference obligations one or more securities that are not currently held by the Fund. The protection buyer in a credit default contract is generally obligated to pay the protection seller an upfront or a periodic stream of payments over the term of the contract provided that no credit event, such as a default, on a reference obligation has occurred. If a credit event occurs, the seller generally must pay the buyer the par value (full notional value) of the swap in exchange for an equal face amount of deliverable obligations of the reference entity described in the swap, or the seller may be required to deliver the related net cash amount, if the swap is cash settled. The Fund may be either the buyer or seller in the transaction. If the Fund is a buyer and no credit event occurs, the Fund may recover nothing if the swap is held through its termination date. However, if a credit event occurs, the buyer generally may elect to receive the full notional value of the swap in exchange for an equal face amount of deliverable obligations of the reference entity whose value may have significantly decreased. As a seller, the Fund generally receives an upfront payment or a fixed rate of income throughout the term of the swap
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provided that there is no credit event. As the seller, the Fund would effectively add leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap.
The spread of a credit default swap is the annual amount the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount. When spreads rise, market perceived credit risk rises and when spreads fall, market perceived credit risk falls. Wider credit spreads and decreasing market values, when compared to the notional amount of the swap, represent a deterioration of the referenced entitys credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. For credit default swap agreements on asset-backed securities and credit indices, the quoted market prices and resulting values, as well as the annual payment rate, serve as an indication of the current status of the payment/performance risk.
Credit default swap agreements involve greater risks than if the Fund had invested in the reference obligation directly since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risk. The Fund will enter into credit default swap agreements only with counterparties that meet certain standards of creditworthiness. A buyer generally also will lose its investment and recover nothing should no credit event occur and the swap is held to its termination date. If a credit event were to occur, the value of any deliverable obligation received by the seller, coupled with the upfront or periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. The Funds obligations under a credit default swap agreement will be accrued daily (offset against any amounts owing to the Fund). In connection with credit default swaps in which the Fund is the buyer, the Fund will segregate or earmark cash or liquid assets or enter into certain offsetting positions, with a value at least equal to the Funds exposure (any accrued but unpaid net amounts owed by the Fund to any counterparty), on a marked-to-market basis. In connection with credit default swaps in which the Fund is the seller, the Fund will segregate or earmark cash or assets determined to be liquid by PIMCO in accordance with procedures established by the Board, or enter into offsetting positions, with a value at least equal to the full notional amount of the swap (minus any amounts owed to the Fund). Such segregation or earmarking will ensure that the Fund has assets available to satisfy its obligations with respect to the transaction and will limit any potential leveraging of the Funds portfolio. Such segregation or earmarking will not limit the Funds exposure to loss.
HYBRID INSTRUMENTS
A hybrid instrument is a type of potentially high-risk derivative that combines a traditional stock, bond or commodity with an option or forward contract. Generally, the principal amount, amount payable upon maturity or redemption, or interest rate of a hybrid is tied (positively or negatively) to the price of some commodity, currency or securities index or another interest rate or some other economic factor (each a benchmark). The interest rate or (unlike most fixed income securities) the principal amount payable at maturity of a hybrid security may be increased or decreased, depending on changes in the value of the benchmark. An example of a hybrid could be a bond issued by an oil company that pays a small base level of interest with additional interest that accrues in correlation to the extent to which oil prices exceed a certain predetermined level. Such a hybrid instrument would be a combination of a bond and a call option on oil.
Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management, and increased total return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These
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benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal amount and pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes a Fund to the credit risk of the issuer of the hybrids. These risks may cause significant fluctuations in the net asset value of the Funds common shares if the Fund invests in hybrid instruments.
Certain hybrid instruments may provide exposure to the commodities markets. These are derivative securities with one or more commodity-linked components that have payment features similar to commodity futures contracts, commodity options or similar instruments. Commodity-linked hybrid instruments may be either equity or debt securities, leveraged or unleveraged, and are considered hybrid instruments because they have both security and commodity-like characteristics. A portion of the value of these instruments may be derived from the value of a commodity, futures contract, index or other economic variable.
Certain issuers of structured products such as hybrid instruments may be deemed to be investment companies as defined in the 1940 Act. As a result, the Funds investments in these products may be subject to limits applicable to investments in investment companies and may be subject to restrictions contained in the 1940 Act.
STRUCTURED NOTES AND RELATED INSTRUMENTS
The Fund may invest in structured notes and other related instruments, which are privately negotiated debt obligations in which the principal and/or interest is determined by reference to the performance of a benchmark asset, market or interest rate (an embedded index), such as selected securities, an index of securities or specified interest rates, or the differential performance of two assets or markets, such as indexes reflecting bonds. Structured instruments may be issued by corporations, including banks, as well as by governmental agencies. Structured instruments frequently are assembled in the form of medium-term notes, but a variety of forms are available and may be used in particular circumstances. The terms of such structured instruments normally provide that their principal and/or interest payments are to be adjusted upwards or downwards to reflect changes in the embedded index while the structured instruments are outstanding. As a result, the interest and/or principal payments that may be made on a structured product may vary widely, depending on a variety of factors, including the volatility of the embedded index and the effect of changes in the embedded index on principal and/or interest payments. The rate of return on structured notes may be determined by applying a multiplier to the performance or differential performance of the referenced index(es) or other asset(s). Application of a multiplier involves leverage that will serve to magnify the potential for gain and the risk of loss.
The Fund may use structured instruments for investment purposes and also for risk management purposes, such as to reduce the duration and interest rate sensitivity of the Funds portfolio, and for leveraging purposes. While structured instruments may offer the potential for a favorable rate of return from time to time, they also entail certain risks. Structured instruments may be less liquid than other debt securities, and the price of structured instruments may be more volatile. In some cases, depending on the terms of the embedded index, a structured instrument may provide that the principal and/or interest payments may be adjusted below zero. Structured instruments also may involve significant credit risk and risk of default by the counterparty. Structured instruments may also be illiquid. Like other sophisticated strategies, the Funds use of structured instruments may not work as intended. If the value of the embedded index changes in a manner other than that expected by PIMCO, principal and/or interest payments received on the structured instrument may be substantially less than expected. Also, if PIMCO
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uses structured instruments to reduce the duration of the Funds portfolio, this may limit the Funds return when having a longer duration would be beneficial (for instance, when interest rates decline).
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
The Fund may invest in mortgage-related or other asset-backed securities. Mortgage-related securities include mortgage pass-through securities, collateralized mortgage obligations (CMOs), commercial mortgage-backed securities (CMBSs), mortgage dollar rolls, CMO residuals, adjustable rate mortgage-backed securities (ARMBSs), stripped mortgage-backed securities (SMBSs) and other securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property.
Mortgage Pass-Through Securities . Interests in pools of mortgage-related securities differ from other forms of debt securities, which normally provide for periodic payment of interest in fixed amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment which consists of both interest and principal payments. In effect, these payments are a pass-through of the monthly payments made by the individual borrowers on their residential or commercial mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of principal resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs which may be incurred. Some mortgage-related securities (such as securities issued by the Government National Mortgage Association (GNMA)) are described as modified pass-through. These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at the scheduled payment dates regardless of whether or not the mortgagor actually makes the payment.
The rate of pre-payments on underlying mortgages will affect the price and volatility of a mortgage-related security, and may have the effect of shortening or extending the effective duration of the security relative to what was anticipated at the time of purchase. To the extent that unanticipated rates of pre-payment on underlying mortgages increase the effective duration of a mortgage-related security, the volatility of such security can be expected to increase. The residential mortgage market in the United States recently has experienced difficulties that may adversely affect the performance and market value of mortgage-related investments. Delinquencies and losses on residential mortgage loans (especially subprime and second-lien mortgage loans) generally have increased recently and may continue to increase, and a decline in or flattening of housing values (as has recently been experienced and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have recently experienced serious financial difficulties or bankruptcy. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
The principal governmental guarantor of mortgage-related securities is GNMA. GNMA is a wholly owned United States Government corporation within the Department of Housing and Urban Development. GNMA is authorized to guarantee, with the full faith and credit of the United States Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of mortgages insured by the Federal Housing Administration (the FHA), or guaranteed by the Department of Veterans Affairs (the VA). Government-related guarantors ( i.e. , not backed by the full
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faith and credit of the United States Government) include the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). FNMA is a government-sponsored corporation the common stock of which is owned entirely by private stockholders. FNMA purchases conventional ( i.e. , not insured or guaranteed by any government agency) residential mortgages from a list of approved seller/servicers which include state and federally chartered savings and loan associations, mutual savings banks, commercial banks and credit unions and mortgage bankers. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA, but are not backed by the full faith and credit of the United States Government. FHLMC was created by Congress in 1970 for the purpose of increasing the availability of mortgage credit for residential housing. It is a government-sponsored corporation formerly owned by the twelve Federal Home Loan Banks but the common stock of which is now owned entirely by private stockholders. FHLMC issues Participation Certificates (PCs), which are pass-through securities, each representing an undivided interest in a pool of residential mortgages. FHLMC guarantees the timely payment of interest and ultimate collection of principal, but PCs are not backed by the full faith and credit of the United States Government.
On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed FNMA and FHLMC into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. FNMA and FHLMC continue to operate as going concerns while in conservatorship, and each remains liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. For more information regarding the mechanics and effects of such conservatorships, see Investment Objective and PoliciesMortgage-Related and Other Asset-Backed Securities in the Statement of Additional Information.
Commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market issuers also create pass-through pools of conventional residential mortgage loans. Such issuers may be the originators and/or servicers of the underlying mortgage loans as well as the guarantors of the mortgage-related securities. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government or agency guarantees of payments in the former pools. However, timely payment of interest and principal of these pools may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit, which may be issued by governmental entities or private insurers. Such insurance and guarantees and the creditworthiness of the issuers thereof will be considered in determining whether a mortgage-related security meets the Funds investment quality standards. There can be no assurance that the private insurers or guarantors can meet their obligations under the insurance policies or guarantee arrangements. The Fund may buy mortgage-related securities without insurance or guarantees if, through an examination of the loan experience and practices of the originators/servicers and poolers, PIMCO determines that the securities meet the Funds quality standards. Securities issued by certain private organizations may not be readily marketable.
Collateralized Mortgage Obligations . A CMO is a debt obligation of a legal entity that is collateralized by mortgages and divided into classes. Similar to a bond, interest and prepaid principal is paid, in most cases, on a monthly basis. CMOs may be collateralized by whole mortgage loans or private mortgage bonds, but are more typically collateralized by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA, and their income streams. CMOs are structured into multiple classes, often referred to as tranches, with each class bearing a different stated maturity and entitled to a different schedule for payments of principal and interest, including pre-payments. Actual maturity and average life will depend upon the pre-payment experience of the collateral. In the case of certain CMOs (known as sequential pay CMOs), payments of principal received from the pool of underlying
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mortgages, including pre-payments, are applied to the classes of CMOs in the order of their respective final distribution dates. Thus, no payment of principal will be made to any class of sequential pay CMOs until all other classes having an earlier final distribution date have been paid in full. CMOs may be less liquid and may exhibit greater price volatility than other types of mortgage- or asset-backed securities.
Commercial Mortgage-Backed Securities . CMBSs include securities that reflect an interest in, and are secured by, mortgage loans on commercial real property. Many of the risks of investing in commercial mortgage-backed securities reflect the risks of investing in the real estate securing the underlying mortgage loans. These risks reflect the effects of local and other economic conditions on real estate markets, the ability of tenants to make loan payments, and the ability of a property to attract and retain tenants. Commercial mortgage-backed securities may be less liquid and exhibit greater price volatility than other types of mortgage- or asset-backed securities.
Mortgage Dollar Rolls . A mortgage dollar roll is similar to a reverse repurchase agreement in certain respects. In a dollar roll transaction, the Fund sells a mortgage-related security to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A dollar roll can be viewed, like a reverse repurchase agreement, as a collateralized borrowing in which the Fund pledges a mortgage-related security to a dealer to obtain cash. However, unlike reverse repurchase agreements, the dealer with which the Fund enters into a dollar roll transaction is not obligated to return the same securities as those originally sold by the Fund, but only securities which are substantially identical. To be considered substantially identical, the securities returned to the Fund generally must: (1) be collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market yields (and therefore price); and (6) satisfy good delivery requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within 2.5% of the initial amount delivered.
CMO Residuals . CMO residuals are mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing. The cash flow generated by the mortgage assets underlying a series of CMOs is applied first to make required payments of principal and interest on the CMOs and second to pay the related administrative expenses and any management fee of the issuer. The residual in a CMO structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related CMO residual represents income and/or a return of capital. The amount of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the pre-payment experience on the mortgage assets. In particular, the yield to maturity on CMO residuals is extremely sensitive to pre-payments on the related underlying mortgage assets, in the same manner as an interest-only (IO) class of stripped mortgage-backed securities (described below). In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. As described below with respect to stripped mortgage-backed securities, in certain circumstances the Fund may fail to recoup fully its initial investment in a CMO residual. CMO residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. Transactions in CMO residuals are generally completed only after careful review of the characteristics of the securities in question. In addition, CMO residuals may, or pursuant to an exemption therefrom, may not have been registered under the Securities Act of 1933, as amended (the 1933 Act). CMO residuals, whether or not registered under the 1933 Act, may be subject to certain restrictions on transferability.
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Adjustable Rate Mortgage-Backed Securities . ARMBSs have interest rates that reset at periodic intervals. Acquiring ARMBSs permits the Fund to participate in increases in prevailing current interest rates through periodic adjustments in the coupons of mortgages underlying the pool on which ARMBSs are based. Such ARMBSs generally have higher current yield and lower price fluctuations than is the case with more traditional fixed income debt securities of comparable rating and maturity. In addition, when prepayments of principal are made on the underlying mortgages during periods of rising interest rates, the Fund can reinvest the proceeds of such prepayments at rates higher than those at which they were previously invested. Mortgages underlying most ARMBSs, however, have limits on the allowable annual or lifetime increases that can be made in the interest rate that the mortgagor pays. Therefore, if current interest rates rise above such limits over the period of the limitation, the Fund, when holding an ARMBS, does not benefit from further increases in interest rates. Moreover, when interest rates are in excess of coupon rates ( i.e. , the rates being paid by mortgagors) of the mortgages, ARMBSs behave more like fixed income securities and less like adjustable rate securities and are subject to the risks associated with fixed income securities. In addition, during periods of rising interest rates, increases in the coupon rate of adjustable rate mortgages generally lag current market interest rates slightly, thereby creating the potential for capital depreciation on such securities.
Stripped Mortgage-Backed Securities . SMBSs are derivative multi-class mortgage securities. SMBSs may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing. SMBSs are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the IO class), while the other class will receive all of the principal (the principal-only or PO class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including pre-payments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Funds yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated pre-payments of principal, the Fund may fail to recoup some or all of its initial investment in these securities even if the security is in one of the highest rating categories.
Collateralized Debt Obligations . The Fund may invest in collateralized debt obligations (CDOs), which include collateralized bond obligations (CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. CBOs and CLOs are types of asset-backed securities. A CBO is a trust which is backed by a diversified pool of high risk, below investment grade fixed income securities. A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and foreign senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans. CDOs may charge management fees and administrative expenses. For both CBOs and CLOs, the cash flows from the trust are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the equity tranche which bears the bulk of defaults from the bonds or loans in the trust and serves to protect the other, more senior tranches from default in all but the most severe circumstances. Since it is partially protected from defaults, a senior tranche from a CBO trust or CLO trust typically have higher ratings and lower yields than their underlying securities, and can be rated investment grade. Despite the protection from the equity tranche, CBO or CLO tranches can experience substantial losses due to actual defaults, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults, as well as aversion to CBO or CLO securities as a class. The risks of an investment in a CDO depend largely on the type of the collateral securities and the class of the
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CDO in which the Fund invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus, are not registered under the securities laws. As a result, investments in CDOs may be characterized by the Fund as illiquid securities, however, an active dealer market may exist for CDOs allowing a CDO to qualify for Rule 144A transactions. In addition to the normal risks associated with fixed income securities discussed elsewhere in this Statement of Additional Information and the Funds Prospectuses (e.g., interest rate risk and default risk), CDOs carry additional risks including, but are not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the quality of the collateral may decline in value or default; (iii) the Funds may invest in CDOs that are subordinate to other classes; and (iv) the complex structure of the security may not be fully understood at the time of investment and may produce disputes with the issuer or unexpected investment results.
Asset-Backed Securities . Asset-backed securities (ABS) are bonds backed by pools of loans or other receivables. ABS are created from many types of assets, including auto loans, credit card receivables, home equity loans, and student loans. ABS are issued through special purpose vehicles that are bankruptcy remote from the issuer of the collateral. The credit quality of an ABS transaction depends on the performance of the underlying assets. To protect ABS investors from the possibility that some borrowers could miss payments or even default on their loans, ABS include various forms of credit enhancement. Some ABS, particularly home equity loan transactions, are subject to interest-rate risk and prepayment risk. A change in interest can affect the pace of payments on the underlying loans, which in turn, affects total return on the securities. ABS also carry credit or default risk. If many borrowers on the underlying loans default, losses could exceed the credit enhancement level and result in losses to investors in an ABS transaction. Finally, ABS have structure risk due to a unique characteristic known as early amortization, or early payout, risk. Built into the structure of most ABS are triggers for early payout, designed to protect investors from losses. These triggers are unique to each transaction and can include: a big rise in defaults on the underlying loans, a sharp drop in the credit enhancement level, or even the bankruptcy of the originator. Once early amortization begins, all incoming loan payments are used to pay investors as quickly as possible.
Please see Investment Objective and PoliciesMortgage-Related and Other Asset-Backed Securities in the Statement of Additional Information and Principal risks of the FundMortgage-Related and Asset-Backed Securities Risk in this prospectus for a more detailed description of the types of mortgage-related and other asset-backed securities in which the Fund may invest and their related risks.
REAL ESTATE INVESTMENT TRUSTS (REITS)
The Fund may invest in REITs. REITs primarily invest in income-producing real estate or real estate related loans or interests. REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets directly in real property and derive income primarily from the collection of rents. Equity REITs can also realize capital gains by selling properties that have appreciated in value. Mortgage REITs invest the majority of their assets in real estate mortgages and derive income from the collection of interest payments. REITs are not taxed on income distributed to shareholders provided they comply with the applicable requirements of the Code. The Fund will indirectly bear its proportionate share of any management and other expenses paid by REITs in which it invests in addition to the expenses paid by the Fund. The Fund may invest in equity or debt securities issued by REITs. Debt securities issued by REITs are, for the most part, general and unsecured obligations and are subject to risks associated with REITs. Please see Investment Objective and PoliciesReal Estate Securities and Related Derivatives in the Statement of Additional Information for a more detailed description of these instruments.
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CERTAIN INTEREST RATE TRANSACTIONS
In order to reduce the interest rate risk inherent in the Funds underlying investments and capital structure, the Fund may (but is not required to) enter into interest rate swap transactions. Interest rate swaps generally involve an agreement with the swap counterparty to pay a fixed or variable rate payment in exchange for the counterparty paying the Fund the other type of payment stream ( i.e. , variable or fixed). The payment obligation would be based on the notional amount of the swap. Other forms of interest rate swap agreements in which the Fund may invest include interest rate caps, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or cap; interest rate floors, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates fall below a specified rate, or floor; and interest rate collars, under which a party sells a cap and purchases a floor or vice versa in an attempt to protect itself against interest rate movements exceeding given minimum or maximum levels. The Fund may (but is not required to) use interest rate swap transactions with the intent to reduce or eliminate the risk that an increase in short-term interest rates could pose for the performance of the common shares as a result of leverage, and also may use these instruments for other hedging or investment purposes. Any termination of an interest rate swap transaction could result in a termination payment by or to the Fund.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS
The Fund may use reverse repurchase agreements or dollar rolls in order to add leverage to the portfolio in addition to (or as a substitute for) leverage obtained through the Preferred Shares. Under a reverse repurchase agreement, the Fund would sell securities to a bank or broker dealer and agree to repurchase the securities at a mutually agreed future date and price. A dollar roll is similar to a reverse repurchase agreement except that the counterparty with which the Fund enters into a dollar roll transaction is not obligated to return the same securities as those originally sold by the Fund but only securities that are substantially identical. See Mortgage-Related and other Asset-Backed SecuritiesMortgage Dollar Rolls. Generally, the effect of a reverse repurchase agreement or dollar roll transaction is that the Fund can recover and reinvest all or most of the cash invested in the portfolio securities involved during the term of the agreement and still be entitled to the returns associated with those portfolio securitiesthereby resulting in a transaction similar to a borrowing and giving rise to leverage for the Fund. The Fund will incur interest expense as a cost of utilizing reverse repurchase agreements and mortgage dollar rolls. In the event the buyer of securities under a reverse repurchase agreement or dollar roll files for bankruptcy or becomes insolvent, the Funds use of the proceeds of the agreement may be restricted pending a determination by the other party, or its trustee or receiver, whether to enforce the Funds obligation to repurchase the securities.
Unless the Fund covers its positions in reverse repurchase agreements or dollar rolls (by segregating liquid assets at least equal in amount to the forward purchase commitment), its obligations under such instruments will be subject to the Funds limitations on borrowings. See Use of leverage.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements, in which the Fund purchases a security from a bank or broker-dealer and the bank or broker-dealer agrees to repurchase the security at the Funds cost plus interest within a specified time. If the party agreeing to repurchase should default, the Fund will seek to sell the securities which it holds. This could involve transaction costs or delays in addition to a loss on the securities if their value should fall below their repurchase price. Repurchase agreements maturing in more than seven days are considered to be illiquid securities.
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U.S. GOVERNMENT SECURITIES
U.S. Government securities are obligations of and, in certain cases, guaranteed by, the U.S. Government, its agencies or instrumentalities. The U.S. Government does not guarantee the net asset value of the Funds shares. Some U.S. Government securities, such as Treasury bills, notes and bonds, and securities guaranteed by GNMA, are supported by the full faith and credit of the United States; others, such as those of the Federal Home Loan Banks, are supported by the right of the issuer to borrow from the U.S. Department of the Treasury (the U.S. Treasury); others, such as those of FNMA, are supported by the discretionary authority of the U.S. Government to purchase the agencys obligations; and still others, such as those of the Student Loan Marketing Association, are supported only by the credit of the instrumentality. U.S. Government securities may include zero coupon securities, which do not distribute interest on a current basis and tend to be subject to greater risk than interest-paying securities of similar maturities.
MUNICIPAL BONDS
Municipal Bonds share the attributes of debt/fixed income securities in general, but are generally issued by states, municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies or authorities. The municipal bonds which the Fund may purchase include general obligation bonds and limited obligation bonds (or revenue bonds), including industrial development bonds issued pursuant to former federal tax law. General obligation bonds are obligations involving the credit of an issuer possessing taxing power and are payable from such issuers general revenues and not from any particular source. Limited obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Tax exempt private activity bonds and industrial development bonds generally are also limited obligation bonds and thus are not payable from the issuers general revenues. The credit and quality of private activity bonds and industrial development bonds are usually related to the credit of the corporate user of the facilities. Payment of interest on and repayment of principal of such bonds is the responsibility of the corporate user (and/or any guarantor).
The Fund may invest in pre-refunded municipal bonds. Pre-refunded municipal bonds are tax-exempt bonds that have been refunded to a call date prior to the final maturity of principal, or, in the case of pre-refunded municipal bonds commonly referred to as escrowed-to-maturity bonds, to the final maturity of principal, and remain outstanding in the municipal market. The payment of principal and interest of the pre-refunded municipal bonds held by the Fund is funded from securities in a designated escrow account that holds U.S. Treasury securities or other obligations of the U.S. Government (including its agencies and instrumentalities (Agency Securities)). While still tax-exempt, pre-refunded municipal bonds usually will bear a Aaa rating (if a re-rating has been requested and paid for) because they are backed by U.S. Treasury securities or Agency Securities. As the payment of principal and interest is generated from securities held in an escrow account established by the municipality and an independent escrow agent, the pledge of the municipality has been fulfilled and the original pledge of revenue by the municipality is no longer in place. The escrow account securities pledged to pay the principal and interest of the pre-refunded municipal bond do not guarantee the price movement of the bond before maturity. Issuers of municipal bonds refund in advance of maturity the outstanding higher cost debt and issue new, lower cost debt, placing the proceeds of the lower cost issuance into an escrow account to pre-refund the older, higher cost debt. Investment in pre-refunded municipal bonds held by the Fund may subject the Fund to interest rate risk and market risk. In addition, while a secondary market exists for pre-refunded municipal bonds, if the Fund sells pre-refunded municipal bonds prior to maturity, the price received may be more or less than the original cost, depending on market conditions at the time of sale.
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The Fund may invest in Build America Bonds, which are taxable municipal bonds with federal subsidies for a portion of the issuers borrowing costs. Build America Bonds offer an alternative form of financing to the state and local governments whose primary means for accessing the capital markets has been through the issuance of tax-exempt municipal bonds. Build America Bonds are issued through the Build America Bond program, which was created as part of the American Recovery and Reinvestment Act of 2009 (the Act). The objective of the program is to reduce the borrowing costs of state and local governments. Pursuant to the Act, issuers can elect to receive the federal subsidies on Build America Bonds in one of two forms: (i) direct payments from the U.S. Treasury and the IRS to the issuer over the life of the bond in an amount generally equal to 35% (or 45% in the case of Recovery Zone Economic Development Bonds) of the total coupon interest payable by the issuer to its bondholders (direct pay Build America Bonds) or (ii) a federal tax credit, which is passed along directly to bondholders, generally in an amount equal to 35% of the total coupon interest payable by the issuer to the bondholders (tax credit Build America Bonds). Issuance of Build America Bonds will cease on December 31, 2010 unless the relevant provisions of the Act are extended. In the event that the Build America Bond program is not extended, the Build America Bonds outstanding at such time will continue to be eligible for the federal interest rate subsidy, which continues for the life of the Build America Bonds.
The Fund may invest in municipal lease obligations. A lease is not a full faith and credit obligation of the issuer and is usually backed only by the borrowing governments unsecured pledge to make annual appropriations for lease payments. There have been challenges to the legality of lease financing in numerous states, and, from time to time, certain municipalities have considered not appropriating money for lease payments. In deciding whether to purchase a lease obligation, the Fund will assess the financial condition of the borrower, the merits of the project, the level of public support for the project, and the legislative history of lease financing in the state. These securities may be less readily marketable than other municipal securities.
The Fund may seek to enhance its yield through the purchase of private placements. These securities are sold through private negotiations, usually to institutions or mutual funds, and may have resale restrictions. Their yields are usually higher than comparable public securities to compensate the investor for their limited marketability.
Some longer-term municipal bonds give the investor the right to put or sell the security at par (face value) within a specified number of days following the investors requestusually one to seven days. This demand feature enhances a securitys liquidity by shortening its effective maturity and enables it to trade at a price equal to or very close to par. If a demand feature terminates prior to being exercised, the Fund would hold the longer-term security, which could experience substantially more volatility.
The Fund may invest in municipal warrants, which are essentially call options on municipal bonds. In exchange for a premium, municipal warrants give the purchaser the right, but not the obligation, to purchase a municipal bond in the future. The Fund may purchase a warrant to lock in forward supply in an environment in which the current issuance of bonds is sharply reduced. Like options, warrants may expire worthless and they may have reduced liquidity.
The Fund may invest in municipal bonds with credit enhancements such as letters of credit, municipal bond insurance and Standby Bond Purchase Agreements (SBPAs). Letters of credit are issued by a third party, usually a bank, to enhance liquidity and ensure repayment of principal and any accrued interest if the underlying municipal bond should default. Municipal bond insurance, which is usually purchased by the bond issuer from a private, nongovernmental insurance company, provides an unconditional and irrevocable guarantee that the insured bonds principal and interest will be paid when due. Insurance does not guarantee the price of the bond. The credit rating of an insured bond reflects the credit rating of the insurer, based on its claims-paying ability. The obligation of a municipal bond insurance company to pay a claim extends over the life of each insured bond. Although defaults on insured municipal bonds
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have been low to date and municipal bond insurers have met their claims, there is no assurance this will continue. A higher-than expected default rate could strain the insurers loss reserves and adversely affect its ability to pay claims to bondholders. Because a significant portion of insured municipal bonds that have been issued and are outstanding is insured by a small number of insurance companies, not all of which have the highest credit rating, an event involving one or more of these insurance companies, such as a credit rating downgrade, could have a significant adverse effect on the value of the municipal bonds insured by that insurance company and on the municipal bond markets as a whole. An SBPA is a liquidity facility provided to pay the purchase price of bonds that cannot be re-marketed. The obligation of the liquidity provider (usually a bank) is only to advance funds to purchase tendered bonds that cannot be remarketed and does not cover principal or interest under any other circumstances. The liquidity providers obligations under the SBPA are usually subject to numerous conditions, including the continued creditworthiness of the underlying borrower.
RESIDUAL INTEREST BONDS
The Fund may invest in residual interest bonds (sometimes referred to as inverse floaters) (RIBs), which brokers create by depositing a municipal bond in a trust. The trust in turn issues a variable rate security and RIBs. The interest rate for the variable rate security is determined by an index or an auction process held approximately every 7 to 35 days, while the RIB holder receives the balance of the income from the underlying municipal bond less an auction fee. The market prices of RIBs may be highly sensitive to changes in market rates and may decrease significantly when market rates increase. In a transaction in which the Fund purchases a RIB from a trust, and the underlying municipal bond was held by the Fund prior to being deposited into the trust, for financial reporting purposes the Fund treats the transaction as a secured borrowing for financial reporting purposes. As a result, the Fund will incur a non-cash interest expense with respect to interest paid by the trust on the variable rate securities, and will recognize additional interest income in an amount directly corresponding to the non-cash interest expense. Therefore, the Funds net asset value per common share and performance are not affected by the non-cash interest expense. This accounting treatment does not apply to RIBs acquired by the Fund when the Fund did not previously own the underlying municipal bond.
WHEN ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase securities which it is eligible to purchase on a when-issued basis, may purchase and sell such securities for delayed delivery and may make contracts to purchase such securities for a fixed price at a future date beyond normal settlement time (forward commitments). When-issued transactions, delayed delivery purchases and forward commitments involve a risk of loss if the value of the securities declines prior to the settlement date. The risk is in addition to the risk that the Funds other assets will decline in value. Therefore, these transactions may result in a form of leverage and increase the Funds overall investment exposure. Typically, no income accrues on securities the Fund has committed to purchase prior to the time delivery of the securities is made, although the Fund may earn income on securities it has segregated to cover these positions. When the Fund has sold a security on a when-issued, delayed delivery, or forward commitment basis, the Fund does not participate in future gains or losses with respect to the security. If the other party to a transaction fails to pay for the securities, the Fund could suffer a loss. Additionally, when selling a security on a when-issued, delayed delivery, or forward commitment basis without owning the security, the Fund will incur a loss if the securitys price appreciates in value such that the securitys price is above the agreed upon price on the settlement date.
INFLATION-INDEXED BONDS
Inflation-indexed bonds (other than municipal inflation-indexed bonds and certain corporate inflation-indexed bonds) are fixed income securities whose principal value is periodically adjusted according to the
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rate of inflation. If the index measuring inflation falls, the principal value of inflation indexed bonds (other than municipal inflation indexed bonds and certain corporate inflation-indexed bonds) will be adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury inflation-indexed bonds. For bonds that do not provide a similar guarantee, the adjusted principal value of the bond repaid at maturity may be less than the original principal. With regard to municipal inflation-indexed bonds and certain corporate inflation-indexed bonds, the inflation adjustment is reflected in the semi-annual coupon payment. As a result, the principal value of municipal inflation-indexed bonds and such corporate inflation-indexed bonds does not adjust according to the rate of inflation.
The value of inflation-indexed bonds is expected to change in response to changes in real interest rates. Real interest rates are tied to the relationship between nominal interest rates and the rate of inflation. If nominal interest rates increase at a faster rate than inflation, real interest rates may rise, leading to a decrease in value of inflation-indexed bonds. Any increase in the principal amount of an inflation-indexed bond will be considered taxable ordinary income, even though investors do not receive their principal until maturity. See Tax matters.
EVENT-LINKED INSTRUMENTS
The Fund may obtain event-linked exposure by investing in event-linked bonds or event-linked swaps or by implementing event-linked strategies. Event-linked exposure results in gains or losses that typically are contingent, or formulaically related to defined trigger events. Examples of trigger events include hurricanes, earthquakes, weather-related phenomena or statistics relating to such events. Some event-linked bonds are commonly referred to as catastrophe bonds. If a trigger event occurs, the Fund may lose a portion or its entire principal invested in the bond or notional amount on a swap. Event-linked exposure often provides for an extension of maturity to process and audit loss claims where a trigger event has, or possibly has, occurred. An extension of maturity may increase volatility. Event-linked exposure may also expose the Fund to certain other risks including credit risk, counterparty risk, adverse regulatory or jurisdictional interpretations and adverse tax consequences. Event-linked exposures may also be subject to liquidity risk.
CREDIT-LINKED TRUST CERTIFICATES
The Fund may invest in credit-linked trust certificates, which are investments in a limited purpose trust or other vehicle formed under state law which, in turn, invests in a basket of derivative instruments, such as credit default swaps, interest rate swaps and other securities, in order to provide exposure to the high yield or another debt securities market. Like an investment in a bond, investments in credit-linked trust certificates represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end of the term of the certificate. However, these payments are conditioned on the trusts receipt of payments from, and the trusts potential obligations to, the counterparties to the derivative instruments and other securities in which the trust invests. For instance, the trust may sell one or more credit default swaps, under which the trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default occurs, the stream of payments may stop and the trust would be obligated to pay to the counterparty the par (or other agreed upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that the Fund would receive as an investor in the trust. The Funds investments in these instruments are indirectly subject to the risks associated with derivative instruments, including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk. It is expected that the trusts that issue credit-linked trust certificates will constitute private investment companies,
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exempt from registration under the 1940 Act. Therefore, the certificates will not be subject to applicable investment limitations and other regulation imposed by the 1940 Act (although the Fund will remain subject to such limitations and regulation, including with respect to its investments in the certificates). Although the trusts are typically private investment companies, they generally are not actively managed such as a hedge fund might be. It also is expected that the certificates will be exempt from registration under the Securities Act. Accordingly, there may be no established trading market for the certificates and they may constitute illiquid investments. See Principal risks of the FundLiquidity Risk. If market quotations are not readily available for the certificates, they will be valued by the Fund at fair value as determined by the Board or persons acting at its direction. See Net asset value. The Fund may lose its entire investment in a credit-linked trust certificate.
COMMON STOCKS AND OTHER EQUITY SECURITIES
The Fund may from time to time invest in or hold common stocks and other equity securities, including upon conversion of convertible securities held by the Fund or in connection with the restructuring of a debt security. For instance, in connection with the restructuring of a debt instrument, either outside of bankruptcy court or in the context of bankruptcy court proceedings, the Fund may determine or be required to accept equity securities in exchange for all or a portion of the debt instrument. Depending upon, among other things, PIMCOs evaluation of the potential value of such securities in relation to the price that could be obtained by the Fund at any given time upon sale thereof, the Fund may determine to hold these equity securities in its portfolio.
Although common stocks and other equity securities have historically generated higher average returns than debt securities over the long term, they also have experienced significantly more volatility in those returns and in certain years have significantly underperformed relative to debt securities. An adverse event, such as an unfavorable earnings report, may depress the value of a particular equity security held by the Fund. Also, prices of common stocks and other equity securities are sensitive to general movements in the equity markets and a decline in those markets may depress the prices of the equity securities held by the Fund. The prices of equity securities fluctuate for many different reasons, including changes in investors perceptions of the financial condition of an issuer or the general condition of the relevant stock market or when political or economic events affecting the issuer occur. In addition, prices of equity securities may be particularly sensitive to rising interest rates, as the cost of capital rises and borrowing costs increase.
OTHER INVESTMENT COMPANIES
The Fund may invest in securities of other open- or closed-end investment companies, including exchange traded funds (ETFs), to the extent that such investments are consistent with the Funds investment objective, strategies and policies and permissible under the 1940 Act. The Fund may invest in other investment companies to gain broad market or sector exposure, including during periods when it has large amounts of uninvested cash (such as the period shortly after the Fund receives the proceeds of the Offer) or when PIMCO believes share prices of other investment companies offer attractive values. The Fund may invest in investment companies that are advised by the Investment Manager, PIMCO or their affiliates to the extent permitted by applicable law and/or pursuant to exemptive relief from the Securities and Exchange Commission. As a shareholder in an investment company, the Fund will bear its ratable share of that investment companys expenses and would remain subject to payment of the Funds management fees and other expenses with respect to assets so invested. Common Shareholders would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. The securities of other investment companies may be leveraged, in which case the net asset value and/or market value of the investment companys shares will be more volatile than unleveraged investments. See Principal risks of the FundLeverage Risk.
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SHORT SALES
A short sale is a transaction in which the Fund sells an instrument that it does not own in anticipation that the market price will decline. The Fund may use short sales for investment purposes or for hedging and risk management purposes. The Fund may also take short positions with respect to the performance of securities, indexes, interest rates, currencies and other assets or markets through the use of derivative or forward instruments. When the Fund engages in a short sale of a security, it must borrow the security sold short and deliver it to the counterparty. The Fund may have to pay a fee to borrow particular securities and would often be obligated to pay over any payments received on such borrowed securities. The Funds obligation to replace the borrowed security will be secured by collateral deposited with the lender, which is usually a broker-dealer, and/or with the Funds custodian. The Fund may not receive any payments (including interest) on its collateral. Short sales expose the Fund to the risk that it will be required to cover its short position at a time when the securities have appreciated in value, thus resulting in a loss to the Fund. The Fund may engage in so-called naked short sales where it does not own or have the immediate right to acquire the security sold short at no additional cost, in which case the Funds losses theoretically could be unlimited. If the price of the security sold short increases between the time of the short sale and the time that the Fund replaces the borrowed security, the Fund will incur a loss; conversely, if the price declines, the Fund will realize a capital gain. Any gain will be decreased, and any loss increased, by the transaction costs described above. The successful use of short selling may be adversely affected by imperfect correlation between movements in the price of the security sold short and securities being hedged if the short is being used for hedging purposes. See Derivatives. The Fund may engage in short selling to the extent permitted by the 1940 Act and the rules and interpretations thereunder and other federal securities laws. To the extent the Fund engages in short selling in foreign (non-U.S.) jurisdictions, the Fund will do so to the extent permitted by the laws and regulations of such jurisdiction.
LENDING OF PORTFOLIO SECURITIES
For the purpose of achieving income, the Fund may lend its portfolio securities to brokers, dealers and other financial institutions provided a number of conditions are satisfied, including that the loan is fully collateralized. See Investment Objective and PoliciesSecurities Loans in the Statement of Additional Information for details. When the Fund lends portfolio securities, its investment performance will continue to reflect changes in the value of the securities loaned. The Fund will also receive a fee or interest on the collateral. Securities lending involves the risk of loss of rights in the collateral or delay in recovery of the collateral if the borrower fails to return the security loaned or becomes insolvent, or the risk of loss due to the investment performance of the collateral. The Fund may pay lending fees to the party arranging the loan.
Please see Investment Objective and Policies in the Statement of Additional Information for additional information regarding the investments of the Fund and their related risks.
PORTFOLIO TURNOVER
The length of time the Fund has held a particular security is not generally a consideration in investment decisions. A change in the securities held by the Fund is known as portfolio turnover. The Fund may engage in frequent and active trading of portfolio securities to achieve its investment objective, particularly during periods of volatile market movements. High portfolio turnover ( e.g., over 100%) involves correspondingly greater expenses to the Fund, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestments in other securities. Such sales may also result in realization of taxable capital gains, including short-term capital gains (which are generally taxed at ordinary income tax rates). The trading costs and tax effects associated with portfolio
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turnover may adversely affect a Funds performance. Please see Financial highlights for the Funds historic portfolio turnover rates.
The Fund has utilized leverage since shortly after it began investment operations, including through the issuance of Preferred Shares. As of February 28, 2010, the aggregate dollar amount ( i.e. , liquidation preference) of the Funds outstanding Preferred Shares was $161 million, which then represented approximately 27% of the Funds total assets (including assets attributable to the Preferred Shares). Information regarding the terms and features of the Preferred Shares is provided under Description of capital structure in this prospectus.
Following the offer, the Fund intends to add leverage to its portfolio by utilizing reverse repurchase agreements, dollar rolls or other forms of borrowings, such as bank loans or commercial paper or other credit facilities (collectively, Borrowings in order to maintain approximately the total amount of leverage (as a percentage of the Funds total assets) that the Fund currently maintains). As of February 28, 2010, the Fund had reverse repurchase agreements outstanding representing approximately 5% of the Funds total assets (including the leverage obtained through the use of the instruments), such that the Funds total leverage attributable in the aggregate to Preferred Shares and Borrowings then represented approximately 32% of the Funds total assets (including assets attributable to the Preferred Shares and leverage obtained through such instruments).
The Fund may also enter into transactions other than those noted above that may give rise to a form of leverage including, among others, credit default swap contracts, futures and forward contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions. Although it has no current intention to do so, the Fund may also determine to issue other preferred shares to add leverage to its portfolio.
Following completion of the Offer, the Fund currently intends to increase the amount of its leverage outstanding. The Fund intends to do so by engaging in additional Borrowings, including through the use of reverse repurchase agreements, in order to maintain the Funds desired leverage ratio at that time, taking into account the additional assets raised through the issuance of Shares in the Offer. The Fund may also add leverage through the use of credit default swaps and other derivative transactions and/or the other techniques noted above. There is no assurance, however, that the Fund will determine to add leverage following the Offer, as the Fund intends to utilize leverage opportunistically and may choose to increase or decrease its use of leverage over time and from time to time based on PIMCOs assessment of the yield curve environment, interest rate trends, market conditions and other factors. In addition, if the Fund determines to add leverage following the Offer, it is not possible to predict with accuracy the precise amount of leverage that would be added, in part, because it is not possible to predict the number of Shares that ultimately will be subscribed for in the Offer.
The Funds net assets attributable to its Preferred Shares and the net proceeds the Fund obtains from Borrowings or other forms of leverage will be invested in accordance with the Funds investment objective and policies as described in this prospectus. So long as the rate of return, net of applicable Fund expenses, on the debt obligations and other investments purchased by the Fund exceeds the dividend rates payable on the Preferred Shares together with the costs to the Fund of other forms of leverage it utilizes, the investment of the Funds net assets attributable to leverage will generate more income than will be needed to pay the costs of the leverage. If so, the excess may be used to pay higher dividends to Common Shareholders than if the Fund were not so leveraged.
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Use of leverage
Regarding the expenses associated with the Funds leverage, the terms of the Preferred Shares provide that they would ordinarily pay dividends at a rate set at auctions held every seven days, subject to a maximum applicable rate calculated as a function of the Preferred Shares then-current rating and a reference interest rate. However, the weekly auctions for the Preferred Shares, as well as auctions for similar preferred shares of other closed-end funds across the U.S. industry, have failed since February 2008, and the dividend rates on the Preferred Shares since that time have been paid at the maximum applicable rate. The Fund expects that the Preferred Shares will continue to pay dividends at the maximum applicable rate for the foreseeable future and cannot predict whether or when the auction markets for the Preferred Shares may resume normal functioning. See Principal risks of the FundLeverage Risk and Description of capital structure for more information.
Leveraging is a speculative technique and there are special risks and costs involved. The Fund cannot assure you that its Preferred Shares and any Borrowings or other forms of leverage (such as the use of derivatives strategies) will result in a higher yield on your common shares. When leverage is used, the net asset value and market price of the common shares and the yield to Common Shareholders will be more volatile. See Principal risks of the FundLeverage Risk. In addition, dividend, interest and other expenses borne by the Fund with respect to its Preferred Shares and any Borrowings or other forms of leverage are borne entirely by the Common Shareholders (and not by the holders of Preferred Shares) and result in a reduction of the net asset value of the common shares. In addition, because the fees received by the Investment Manager and by PIMCO are based on the total managed assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding), the Investment Manager and PIMCO have a financial incentive for the Fund to have Preferred Shares outstanding and to use certain other forms of leverage ( e.g. , reverse repurchase agreements and other Borrowings), which may create a conflict of interest between the Investment Manager and PIMCO, on the one hand, and the Common Shareholders, on the other hand.
Under the 1940 Act, the Fund is not permitted to issue preferred shares unless immediately after such issuance the value of the Funds total net assets is at least 200% of the liquidation value of the outstanding Preferred Shares and the newly issued preferred shares plus the aggregate amount of any senior securities of the Fund representing indebtedness ( i.e. , such liquidation value plus the aggregate amount of senior securities representing indebtedness may not exceed 50% of the Funds total net assets). 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 value of the Funds total net assets satisfies the above-referenced 200% coverage requirement.
The 1940 Act also generally prohibits the Fund from engaging in most forms of leverage other than preferred shares (including through the use of reverse repurchase agreements, dollar rolls, bank loans, commercial paper or other credit facilities, credit default swap contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions, to the extent that these instruments are not covered as described below) unless immediately after the issuance of the leverage the Fund has satisfied the asset coverage test with respect to senior securities representing indebtedness prescribed by the 1940 Act, i.e. , the value of the Funds total assets less liabilities (other than the leverage and other senior securities) is at least 300% of the principal amount of such leverage ( i.e. , effectively limiting the use of leverage through senior securities representing indebtedness to 33 1 / 3 % of the Funds total assets, including assets attributable to the leverage). The Fund is not permitted to declare any cash dividend or other distribution on common shares unless, at the time of such declaration, this 300% asset coverage test is satisfied. The Fund may (but is not required to) cover its commitments under derivatives and certain other instruments by the segregation of liquid assets or by entering into offsetting transactions or owning positions covering its obligations. For instance, the Fund may cover its position in a reverse repurchase agreement by segregating liquid assets at least equal in amount to its forward purchase commitment. To the extent that certain of these instruments are so covered, they will not be considered senior securities under the
83
Use of leverage
1940 Act and therefore will not be subject to the 300% asset coverage requirement otherwise applicable to forms of leverage (other than preferred shares) used by the Fund. However, these transactions, even if covered, may represent a form of economic leverage and create special risks. The use of these forms of additional leverage increases the volatility of the Funds investment portfolio and could result in larger losses to Common Shareholders than if the strategies were not used. See Principal risks of the FundLeverage Risk. Failure to maintain certain asset coverage requirements could result in an event of default under certain Borrowings that may be used by the Fund.
The Funds ability to utilize leverage is also limited by asset coverage requirements and other guidelines imposed by rating agencies (currently Moodys and Fitch) that provide ratings for the Preferred Shares, which may be more restrictive than the limitations imposed by the 1940 Act noted above. See Description of capital structure for more information.
The Fund also may borrow money in order to repurchase its shares or as a temporary measure for extraordinary or emergency purposes, including for the payment of dividends or the settlement of securities transactions which otherwise might require untimely dispositions of portfolio securities held by the Fund.
EFFECTS OF LEVERAGE
Assuming that the Preferred Shares and Borrowings used by the Fund will represent approximately 32% of the Funds total assets after the Expiration Date and pay dividends or incur interest expense at a combined average annual rate of [ · ]% (based on Preferred Share dividend rates and market interest rates as of the date of this prospectus), the income generated by the Funds portfolio (net of expenses) would have to exceed [ · ]% in order to cover such dividend payments or interest expense. Of course, these numbers are merely estimates, used for illustration. The amount of leverage used by the Fund as well as actual Preferred Share dividend rates and interest expenses on Borrowings used by the Fund, if any, will vary.
The following table is furnished in response to requirements of the Securities and Exchange Commission. It is designed to illustrate the effect of leverage on common share total return, assuming investment portfolio total returns (consisting of income and changes in the value of investments held in the Funds portfolio) of -10%, -5%, 0%, 5% and 10%. These assumed investment portfolio returns are hypothetical figures and are not necessarily indicative of the investment portfolio returns experienced or expected to be experienced by the Fund. The table further assumes the Fund has Preferred Shares outstanding and is utilizing Borrowings representing, collectively, approximately 32% of the Funds total assets and a combined average Preferred Share dividend rate and interest expense of [ · ]%.
Assumed Return on Portfolio (Net of Expenses) |
(10.00 | )% | (5.00 | )% | 0 | % | 5 | % | 10 | % | |||||
Corresponding Return to Common Shareholders |
[ · | ]% | [ · | ]% | [ · | ]% | [ · | ]% | [ · | ]% |
Common share total return is composed of two elementsthe common share dividends paid by the Fund (the amount of which is largely determined by the net investment income of the Fund after paying dividends on Preferred Shares and expenses on other forms of leverage) and gains or losses on the value of the securities and other instruments the Fund owns. As required by Securities and Exchange Commission rules, the table assumes that the Fund is more likely to suffer capital losses than to enjoy capital appreciation. For example, to assume a total return of 0%, the Fund must assume that the interest it receives on its investments is entirely offset by losses in the value of those investments.
Any benefits of additional leverage used by the Fund following the Offer cannot be fully achieved until the proceeds resulting from the use of leverage have been received by the Fund and invested in accordance with the Funds investment objective and policies. As noted above, the Funds willingness to use additional leverage, and the extent to which leverage is used at any time, will depend on many factors, including PIMCOs assessment of the yield curve environment, interest rate trends, market conditions and other factors.
84
The net asset value of the common shares will fluctuate with and be affected by, among other things, the following principal risks of the Fund: market discount risk, high yield risk, credit risk, interest rate risk, distressed and defaulted securities risk, liquidity risk, leverage risk, issuer risk, smaller company risk, management risk, convertible securities risk, preferred securities risk, foreign (non-U.S.) investment risk, emerging markets risk, foreign currency risk, derivatives risk, counterparty risk, mortgage-related and asset-backed securities risk, mortgage market/subprime risk, risk of investing in REITs, valuation risk, focused investment risk, reinvestment risk, inflation/deflation risk, confidential information access risk, equity securities and related market risk, Rule 144A securities risk, other investment companies risk, risk of regulatory changes and market disruption and geopolitical risk. These and other risks are summarized below.
MARKET DISCOUNT RISK
As with any stock, the price of the Funds common shares will fluctuate with market conditions and other factors. If common shares are sold, the price received may be more or less than the original investment. Net asset value of the Funds common shares will be reduced immediately following the Offer by expenses paid or reimbursed by the Fund in connection with the Offer. The completion of the Offer may result in an immediate dilution of the net asset value per common shares for all existing Common Shareholders, including those who fully exercise their Rights. The common shares are designed for long-term investors and should not be treated as trading vehicles. Common shares of closed-end management investment companies frequently trade at a discount from their net asset value. The Funds common shares may trade at a price that is less than the Subscription Price for Shares issued pursuant to the Offer. This risk may be greater for investors who sell their Shares relatively shortly after completion of the Offer.
MARKET RISK
The market price of securities owned by the Fund may go up or down, sometimes rapidly or unpredictably. Securities may decline in value due to factors affecting securities markets generally or particular industries represented in the securities markets. The value of a security may decline due to general market conditions which are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. During a general downturn in the securities markets, multiple asset classes may decline in value simultaneously.
HIGH YIELD RISK
In general, lower rated debt securities carry a greater degree of risk that the issuer will lose its ability to make interest and principal payments, which could have a negative effect on the net asset value of the Funds common shares or common share dividends. The Fund may invest without limit in debt securities that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys or below BBB- by either S&P or Fitch) or that are unrated but judged by PIMCO to be of comparable quality, including debt securities that are in default or the issuers of which are in bankruptcy. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security or that are unrated but judged by PIMCO to be of comparable quality. Securities of below investment grade quality are regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal, and are commonly referred to
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Principal risks of the Fund
as high yield securities or junk bonds. The prices of these lower grade bonds are generally more volatile and sensitive to actual or perceived negative developments, such as a decline in the issuers revenues or revenues of underlying borrowers or a general economic downturn, than are the prices of higher grade securities. Bonds in the lowest investment grade category also may be considered to possess some speculative characteristics by certain rating agencies.
The Fund may purchase distressed securities that are in default or the issuers of which are in bankruptcy, which involve heightened risks. See Distressed and Defaulted Securities Risk.
An economic downturn could severely affect the ability of issuers (particularly those that are highly leveraged) to service their debt obligations or to repay their obligations upon maturity. Lower-rated securities are generally less liquid than higher-rated securities, which may have an adverse effect on the Funds ability to dispose of a particular security. For example, under adverse market or economic conditions, the secondary market for below investment grade securities could contract further, independent of any specific adverse changes in the condition of a particular issuer, and certain securities in the Funds portfolio may become illiquid or less liquid. As a result, the Fund could find it more difficult to sell these securities or may be able to sell these securities only at prices lower than if such securities were widely traded. See Liquidity Risk.
The Funds credit quality policies apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue. In determining whether to retain or sell such a security, PIMCO may consider such factors as PIMCOs assessment of the credit quality of the issuer of such security, the price at which such security could be sold and the rating, if any, assigned to such security by other rating agencies. Analysis of creditworthiness may be more complex for issuers of high yield securities than for issuers of higher quality debt securities.
Although Floating Rate Loans in which the Fund may invest will often be secured by collateral, there can be no assurance that liquidation of any such collateral would satisfy the borrowers obligation in the event of default or that such collateral could be readily liquidated. In the event of bankruptcy of a borrower, the Fund could experience delays or limitations in its ability to realize the benefits of any collateral securing a Floating Rate Loan. To the extent the Fund focuses on Floating Rate Loans or other below investment grade debt obligations, PIMCOs capabilities in analyzing credit quality and associated risks will be particularly important, and there can be no assurance that PIMCO will be successful in this regard. See Portfolio contentsHigh Yield Securities (Junk Bonds) for additional information. Due to the risks involved in investing in high yield securities, an investment in the Fund should be considered speculative.
DISTRESSED AND DEFAULTED SECURITIES RISK
As noted above, the Fund may invest in the debt securities of financially distressed issuers, including those that are in default or the issuers of which are in bankruptcy. Investments in the securities of financially distressed issuers involve substantial risks. These securities may present a substantial risk of default or may be in default at the time of investment. The Fund may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of principal or interest on its portfolio holdings. In any reorganization or liquidation proceeding relating to an investment, the Fund may lose its entire investment or may be required to accept cash or securities with a value less than its original investment. Among the risks inherent in investments in a troubled issuer is that it frequently may be difficult to obtain information as to the true financial condition of such issuer. PIMCOs judgments about the credit quality of the issuer and the relative value of its securities may prove to be wrong.
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Principal risks of the Fund
CREDIT RISK
Credit risk is the risk that one or more of the Funds investments in debt securities or other instruments will decline in price, or fail to pay interest, liquidation value or principal when due, because the issuer of the obligation or the issuer of a reference security experiences an actual or perceived decline in its financial status. In addition to the credit risks associated with high yield securities, the Fund could also lose money if the issuer of other debt obligations, or the counterparty to a derivatives contract, repurchase agreement, loan of portfolio securities or other obligation, is, or is perceived to be, unable or unwilling to make timely principal and/or interest payments, or to otherwise honor its obligations. The downgrade of a security may further decrease its value.
INTEREST RATE RISK
Generally, when market interest rates rise, the prices of debt obligations fall, and vice versa. Interest rate risk is the risk that debt obligations and other instruments in the Funds portfolio will decline in value because of increases in market interest rates. This risk may be particularly acute because market interest rates are currently at historically low levels. The prices of long-term debt obligations generally fluctuate more than prices of short-term debt obligations as interest rates change. Because the Fund will normally have a low to intermediate average portfolio duration ( i.e. , zero to eight years), the common share net asset value and market price per common share will tend to fluctuate more in response to changes in market interest rates than if the Fund invested mainly in short-term debt securities. During periods of rising interest rates, the average life of certain types of securities may be extended due to slower than expected payments. This may lock in a below market yield, increase the securitys duration and reduce the securitys value. In addition to directly affecting debt securities, rising interest rates may also have an adverse effect on the value of any equity securities held by the Fund. The Funds use of leverage, as described below, will tend to increase common share interest rate risk. PIMCO may utilize certain strategies, including investments in structured notes or interest rate futures contracts or swap, cap, floor or collar transactions, for the purpose of reducing the interest rate sensitivity of the Funds portfolio, although there is no assurance that it will do so or that such strategies will be successful.
Investments in floating rate debt instruments, although generally less sensitive to interest rate changes than longer duration fixed rate instruments, may nevertheless decline in value in response to rising interest rates if, for example, the rates at which they pay interest do not rise as much, or as quickly, as market interest rates in general. Conversely, floating rate instruments will not generally increase in value if interest rates decline. Inverse floating rate debt securities may also exhibit greater price volatility than a fixed rate debt obligation with similar credit quality. To the extent the Fund holds floating rate instruments, a decrease (or, in the case of inverse floating rate securities, an increase) in market interest rates will adversely affect the income received from such securities and the net asset value of the common shares.
LIQUIDITY RISK
The Fund may invest without limit in illiquid securities (i.e. , securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities). Illiquid securities may trade at a discount from comparable, more liquid investments, and may be subject to wide fluctuations in market value. Also, the Fund may not be able to dispose readily of illiquid securities when that would be beneficial at a favorable time or price or at prices approximating those at which the Fund currently values them. Further, the lack of an established secondary market for illiquid securities may make it more difficult to value such securities, which may negatively affect the price the Fund would receive upon disposition of such securities. Floating Rate Loans and various other securities in which the Fund may invest may not be registered with the Securities and Exchange
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Principal risks of the Fund
Commission or any state securities commission and generally will not be listed on a national securities exchange. PIMCO will determine the liquidity of the Funds investments by reference to market conditions and contractual provisions.
LEVERAGE RISK
The Fund utilizes leverage on an ongoing basis for investment purposes, including through its outstanding Preferred Shares and also from time to time through the use of reverse repurchase agreements, other Borrowings and through other transactions noted below. See Use of leverage for details.
Leverage creates several major types of risks for Common Shareholders, including:
· |
the likelihood of greater volatility of net asset value and market price of common shares than a comparable portfolio without leverage; |
· |
the possibility either that common share dividends will fall if the costs of leverage rise, or that dividends paid on common shares will fluctuate because such costs vary over time; and |
· |
the effects of leverage in a declining market or a rising interest rate environment, as leverage is likely to cause a greater decline in the net asset value of the common shares than if the Fund were not leveraged and may result in a greater decline in the market value of the common shares. |
In addition to using Preferred Shares and Borrowings, the Fund may also enter into other transactions that may give rise to a form of leverage including, among others, credit default swap contracts, futures and forward contracts and other derivatives transactions, loans of portfolio securities, short sales and when issued, delayed delivery and forward commitment transactions. The Funds use of such transactions gives rise to associated leverage risks described herein, and may adversely affect the Funds income and distributions. The Fund may manage some of its derivative positions by segregating an amount of cash or liquid securities equal to the face value or the market value, as applicable, of those positions. The Fund also may offset derivatives positions against one another or against other assets to manage effective market exposure resulting from derivatives in its portfolio. To the extent that any offsetting positions do not behave in relation to one another as expected, the Fund may perform as if it is leveraged through use of these derivative strategies. See Use of leverage.
The Funds use of leverage creates the opportunity for increased net income to Common Shareholders, but also creates special risks for Common Shareholders. There can be no assurance that the Funds leveraging strategies will be successful. Leverage is a speculative technique that may expose the Fund to greater risk and increased costs. The net proceeds the Fund obtains from its use of leverage are invested in accordance with the Funds investment objective and strategies as described in this prospectus. If the rate of return, net of applicable Fund expenses, on the investments purchased by the Fund exceeds the costs of such leverage to the Fund (including dividends, interest and other repayment obligations), then, all other things being equal, the use of such leverage by the Fund may allow the Fund to pay higher dividends to Common Shareholders than if the Fund were not so leveraged. If, however, the costs of leverage rise relative to the rate of return on the Funds portfolio, the interest and other costs to the Fund of leverage could exceed the rate of return on the investments held by the Fund, thereby reducing the return to Common Shareholders. Among other negative consequences, any decline in the net asset value of the Funds investments could result in the Fund being in danger of failing to meet its asset coverage requirements or of losing its Aaa rating (in the case of Moodys) or AAA rating (in the case of Fitch) on the Preferred Shares. In an extreme case, the Funds current investment income might not be sufficient to meet the dividend requirements on the Preferred Shares. In order to these types of events, the Fund might need to liquidate investments in order to fund a redemption of some or all of the Preferred Shares. Liquidation at times of adverse economic conditions may result in a loss to the Fund. At other times,
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Principal risks of the Fund
these liquidations may result in gain at the Fund level and thus in additional taxable distributions to Common Shareholders. See Tax matters for more information. The Preferred Shares have, and any Borrowings by the Fund or counterparties to the Funds other leveraging transactions, if any, would have, seniority over the Funds common shares.
Because the fees received by the Investment Manager and by PIMCO are based on the total managed assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding), the Investment Manager and PIMCO have a financial incentive for the Fund to have Preferred Shares outstanding and to use certain other forms of leverage ( e.g. , reverse repurchase agreements and other Borrowings), which may create a conflict of interest between the Investment Manager and PIMCO, on the one hand, and the Common Shareholders, on the other hand.
ADDITIONAL RISKS ASSOCIATED WITH THE FUNDS PREFERRED SHARES
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ISSUER RISK
The value of debt instruments may decline for a number of reasons that directly relate to the issuer, such as management performance, financial leverage and reduced demand for the issuers goods and services, as well as the historical and prospective earnings of the issuer and the value of its assets.
SMALLER COMPANY RISK
The general risks associated with debt instruments or equity securities are particularly pronounced for securities issued by companies with small market capitalizations. Small capitalization companies involve certain special risks. They are more likely than larger companies to have limited product lines, markets or financial resources, or to depend on a small, inexperienced management group. Securities of smaller companies may trade less frequently and in lesser volume than more widely held securities and their values may fluctuate more sharply than other securities. They may also have limited liquidity. These securities may therefore be more vulnerable to adverse developments than securities of larger companies, and the Fund may have difficulty purchasing or selling positions in securities of smaller companies at prevailing market prices. Also, there may be less publicly available information about smaller companies or less market interest in their securities as compared to larger companies. Companies with medium-sized market capitalizations may have risks similar to those of smaller companies.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively managed portfolio. PIMCO and the portfolio manager will apply investment techniques and risk analyses in making investment decisions for the Fund, but there can be no guarantee that these decisions will produce the desired results.
CONVERTIBLE SECURITIES RISK
Convertible securities generally offer lower interest or dividend yields than non-convertible debt securities of similar quality. The market values of convertible securities tend to decline as interest rates increase and, conversely, to increase as interest rates decline. However, a convertible securitys market value tends to reflect the market price of the common stock of the issuing company when that stock price approaches or is greater than the convertible securitys conversion price. The conversion price for these purposes is the predetermined price at which the convertible security could be exchanged for the associated stock. As the market price of the underlying common stock declines, the price of the convertible security tends to be influenced more by the yield of the convertible security. Thus, it may not
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Principal risks of the Fund
decline in price to the same extent as the underlying common stock. In the event of a liquidation of the issuing company, holders of convertible securities would be paid before the companys common stockholders but after holders of any senior debt obligations of the company. Consequently, the issuers convertible securities generally entail less risk than its common stock but more risk than its debt obligations.
The Fund may invest in synthetic convertible securities, which are created through a combination of separate securities that possess the two principal characteristics of a traditional convertible security; that is, an income-producing security (income-producing component) and the right to acquire an equity security (convertible component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments. The convertible component is achieved by purchasing warrants or options to buy common stock at a certain exercise price, or options on a stock index. The values of synthetic convertible securities will respond differently to market fluctuations than a traditional convertible security because a synthetic convertible is composed of two or more separate securities or instruments, each with its own market value. Synthetic convertible securities are also subject to the risks associated with derivatives. See Principal risks of the FundDerivatives Risk. In addition, if the value of the underlying common stock or the level of the index involved in the convertible element falls below the strike price of the warrant or option, the warrant or option may lose all value.
PREFERRED SECURITIES RISK
In addition to equity securities risk (see Equity Securities and Related Market Risk), credit risk (see Credit Risk) and possibly high yield risk (see High Yield Risk), investment in preferred stocks involves certain other risks. Certain preferred stocks contain provisions that allow an issuer under certain conditions to skip or defer distributions. If the Fund owns a preferred stock that is deferring its distribution, the Fund may be required to include the amount of the deferred distribution in its taxable income for tax purposes despite the fact that it does not currently receive such amount. In order to receive the special treatment accorded to regulated investment companies (RICs) and their shareholders under the Internal Revenue Code of 1986, as amended (the Code) and to avoid U.S. federal income and/or excise taxes at the Fund level, the Fund may be required to distribute this income to shareholders in the tax year in which the income is recognized (without a corresponding receipt of cash). Therefore, the Fund may be required to pay out as an income distribution in any such tax year an amount greater than the total amount of cash income the Fund actually received, and to sell portfolio securities, including at potentially disadvantageous times or prices, to obtain cash needed for these income distributions. Preferred stocks often are subject to legal provisions that allow for redemption in the event of certain tax or legal changes or at the issuers call. In the event of redemption, the Fund may not be able to reinvest the proceeds at comparable rates of return. Preferred stocks are subordinated to bonds and other debt securities in an issuers capital structure in terms of priority for corporate income and liquidation payments, and therefore will be subject to greater credit risk than those debt securities. Preferred stocks may trade less frequently and in a more limited volume and may be subject to more abrupt or erratic price movements than many other securities, such as common stocks, corporate debt securities and U.S. Government securities.
FOREIGN (NON-U.S.) INVESTMENT RISK
The Fund may invest some or all of its assets in U.S. dollar-denominated debt obligations of foreign issuers or supra-national government agencies. The Fund may invest up to 25% of its total assets in securities denominated in foreign currencies, including obligations of non-U.S. governments and their respective sub-divisions, agencies and government-sponsored enterprises. The Funds investments in foreign issuers and in securities denominated in foreign currencies involve special risks.
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Principal risks of the Fund
For example, the value of these investments may decline in response to unfavorable political and legal developments, unreliable or untimely information or economic and financial instability. Foreign securities may experience more rapid and extreme changes in value than investments in securities of U.S. issuers. The securities markets of many foreign countries are relatively small, with a limited number of companies representing a small number of industries. Issuers of foreign securities are usually not subject to the same degree of regulation as U.S. issuers. Reporting, accounting and auditing standards of foreign countries differ, in some cases significantly, from U.S. standards. Also, nationalization, expropriation or other confiscation, currency blockage, political changes or diplomatic developments could adversely affect the Funds investments in foreign securities. In the event of nationalization, expropriation or other confiscation, the Fund could lose its entire investment in foreign securities. To the extent that the Fund invests a significant portion of its assets in a particular foreign country or a concentrated geographic area (such as Europe or Asia), the Fund will generally have more exposure to regional economic risks associated with foreign investments. Also, adverse conditions in a certain region can adversely affect securities from other countries whose economies appear to be unrelated. The costs of investing in foreign countries frequently are higher than the costs of investing in the United States. Additionally, investments in securities of foreign issuers generally will be denominated in foreign currencies, subjecting the Fund to foreign currency risk. See Foreign Currency Risk.
EMERGING MARKETS RISK
The Fund may invest up to 25% of its total assets in securities that are economically tied to emerging market countries. Foreign investment risk may be particularly high to the extent that the Fund invests in securities of issuers based in or securities denominated in the currencies of emerging market countries. Investing in securities of issuers based in underdeveloped emerging markets entails all of the risks of investing in securities of foreign issuers noted above, but to a heightened degree. These heightened risks include: (i) greater risks of expropriation, confiscatory taxation, nationalization and less social, political and economic stability; (ii) the smaller size of the market for such securities and a lower volume of trading, resulting in a lack of liquidity and in price volatility; (iii) certain national policies which may restrict the Funds investment opportunities, including restrictions on investing in issuers or industries deemed sensitive to relevant national interests and requirements that government approval be obtained prior to investment by foreign persons; (iv) certain national policies that may restrict the Funds repatriation of investment income, capital or the proceeds of sales of securities, including temporary restrictions on foreign capital remittances; (v) the lack of uniform accounting and auditing standards; (vi) less publicly available financial and other information regarding issuers; (vii) potential difficulties in enforcing contractual obligations; and (viii) higher rates of inflation, higher interest rates and other economic concerns. The Fund may invest to a significant extent in emerging market securities that are issued in local currencies, subjecting the Fund to a greater degree of foreign currency risk. See Foreign Currency Risk. Also, investing in emerging market countries may entail purchases of securities of issuers that are insolvent, bankrupt, in default or otherwise of questionable ability to satisfy their payment obligations as they become due, subjecting the Fund to a greater amount of credit risk and/or high yield risk. See Credit Risk and High Yield Risk.
FOREIGN CURRENCY RISK
The Funds common shares are priced in U.S. dollars and the distributions paid by the Fund to Common Shareholders are paid in U.S. dollars. However, a significant portion of the Funds assets may at any time be denominated in foreign (non-U.S.) currencies and income received by the Fund from many foreign debt obligations will be paid in foreign currencies. The Fund may also invest in or gain exposure to foreign currencies themselves for investment or hedging purposes. The Funds investments in or exposure to foreign currencies or in securities or instruments that trade, or receive revenues, in foreign currencies
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Principal risks of the Fund
are subject to the risk that those currencies will decline in value relative to the U.S. dollar or, in the case of hedging positions (if utilized), that the U.S. dollar will decline in value relative to the currency being hedged. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including changes in interest rates, intervention (or the failure to intervene) by U.S. or foreign governments, central banks or supranational entities such as the International Monetary Fund, or by the imposition of currency controls or other political developments in the U.S. or abroad. These fluctuations may have a significant adverse effect on the value of the Funds portfolio and/or the level of Fund distributions made to Common Shareholders. As noted above, the Fund may (but is not required to) attempt to hedge some of its exposure to foreign currencies in order to reduce the risk of loss due to fluctuations in currency exchange rates relative to the U.S. dollar. There is no assurance, however, that these hedging strategies will be available or will be used by the Fund or, if used, that they will be successful.
DERIVATIVES RISK
Derivatives are financial contracts whose value depends on, or is derived from, the value of an underlying asset, reference rate or index (or relationship between two indexes). The Fund may invest in a variety of derivative instruments for hedging or risk management purposes or as part of its investment strategies, such as options contracts (including options on futures contracts), futures contracts, swap agreements (including total return and credit-default swaps) and short sales. The Fund may also have exposure to derivatives, such as interest rate or credit default swaps, through investment in credit-linked trust certificates and other securities issued by special purpose or structured vehicles. The Fund may use derivatives as a substitute for taking a position in an underlying debt instrument or other asset and/or as part of a strategy designed to reduce exposure to other risks, such as interest rate or currency risk. The Fund also may use derivatives to add leverage to the portfolio. The Funds use of derivative instruments involves risks different from, and possibly greater than, the risks associated with investing directly in securities and other traditional investments. Derivatives are subject to a number of risks described elsewhere in this prospectus, such as liquidity risk, interest rate risk, issuer risk, credit risk, leveraging risk, counterparty risk, management risk and, if applicable, smaller company risk. They also involve the risk of mispricing or improper valuation, the risk of ambiguous documentation, and the risk that changes in the value of the derivative may not correlate perfectly with the underlying asset, rate or index. If the Fund invests in a derivative instrument, it could lose more than the principal amount invested. Also, suitable derivative transactions may not be available in all circumstances and there can be no assurance that the Fund will engage in these transactions to reduce exposure to other risks when that would be beneficial. In addition, the Fund is subject to certain restrictions or limitations on its use of derivative strategies imposed by Moodys and Fitch (or any rating agency that may in the future rate the Preferred Shares) in connection with their ratings of the Funds Preferred Shares. See Description of capital structure. The use of derivatives also may increase the amount of and affect the character and/or timing of taxes payable by shareholders.
COUNTERPARTY RISK
The Fund will be subject to credit risk with respect to the counterparties to the derivative contracts and other instruments entered into by the Fund or held by special purpose or structured vehicles in which the Fund invests. In the event that the Fund enters into a derivative transaction with a counterparty that subsequently becomes insolvent or becomes the subject of a bankruptcy case, the derivative transaction may be terminated in accordance with its terms and the Funds ability to realize its rights under the derivative instrument and its ability to distribute the proceeds could be adversely affected. 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
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Principal risks of the Fund
the derivative contract in a bankruptcy or other reorganization proceeding. The Fund may obtain only a limited recovery or may obtain no recovery in such circumstances.
MORTGAGE-RELATED AND ASSET-BACKED SECURITIES RISK
Mortgage-related and other asset-backed securities often involve risks that are different from or more acute than risks associated with other types of debt instruments. For instance, these securities may be particularly sensitive to changes in prevailing interest rates. Rising interest rates tend to extend the duration of mortgage-related securities, making them more sensitive to changes in interest rates, and may reduce the market value of the securities. This is known as extension risk. In addition, mortgage-related securities are subject to prepayment riskthe risk that borrowers may pay off their mortgages sooner than expected, particularly when interest rates decline. This can reduce the Funds returns because the Fund may have to reinvest that money at lower prevailing interest rates. For instance, the Fund may invest in stripped mortgage-backed securities with respect to which one class receives all of the interest from the mortgage assets (the interest-only, or IO class), while the other class receives all of the principal (the principal-only, or PO class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including prepayments) on the underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Funds yield to maturity from these investments. The Funds investments in other asset-backed securities are subject to risks similar to those associated with mortgage-backed securities, as well as additional risks associated with their structure and the nature of the assets underlying the security and the servicing of those assets. For instance, certain collateralized debt obligations in which the Fund may invest are backed by pools of high-risk, below investment grade debt securities and may involve substantial credit and other risks. Further, due to their often complicated structures, various mortgage-related and particularly asset-backed securities may be difficult to value and may constitute illiquid investments.
Investments in mortgage-related securities may involve particularly high levels of risk under current market conditions. See Mortgage Market/Subprime Risk.
MORTGAGE MARKET/SUBPRIME RISK
The residential mortgage market in the United States has experienced difficulties over the past few years that may adversely affect the performance and market value of certain of the Funds mortgage-related investments. Delinquencies and losses on residential mortgage loans (especially subprime and second-lien mortgage loans) generally have increased during that period and may continue to increase, and a decline in or flattening of housing values (as has been experienced during that period and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have experienced serious financial difficulties or bankruptcy during that period. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
GOVERNMENT ENTITY RISK
As noted, the Fund may invest in mortgage-related and other debt securities issued or guaranteed by certain U.S. government agencies, instrumentalities and sponsored enterprises. Some U.S. Government securities, such as Treasury bills, notes and bonds, and securities guaranteed by the Government
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Principal risks of the Fund
National Mortgage Association (GNMA), are supported by the full faith and credit of the United States; others, such as those of the Federal Home Loan Banks or the Federal Home Loan Mortgage Corporation (FHLMC), are supported by the right of the issuer to borrow from the U.S. Treasury; others, such as those of the Federal National Mortgage Association (FNMA), are supported by the discretionary authority of the U.S. Government to purchase the agencys obligations; and still others, such as those of the Student Loan Marketing Association, are supported only by the credit of the instrumentality. Although U.S. Government-sponsored enterprises, such as the Federal Home Loan Banks, FHLMC, FNMA and the Student Loan Marketing Association may be chartered or sponsored by Congress, they are not funded by Congressional appropriations, and their securities are not issued by the U.S. Treasury or supported by the full faith and credit of the U.S. Government and involve increased credit risks. Certain governmental entities, including FNMA and FHLMC, have been subject to regulatory scrutiny regarding their accounting policies and practices and other concerns that may result in legislation, changes in regulatory oversight and/or other consequences that could adversely affect the credit quality, availability or investment character of securities issued by these entities. See Investment Objective and PoliciesMortgage-Related and Other Asset-Backed Securities in the Statement of Additional Information.
RISK OF INVESTING IN REITS
Like other mortgage-related securities, REITs are subject to interest rate risk and prepayment risk. Investing in REITs also involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. An equity REIT may be affected by changes in the value of the underlying properties owned by the REIT. A mortgage REIT may be affected by changes in interest rates and the ability of the issuers of its portfolio mortgages to repay their obligations. REITs are dependent upon the skills of their managers and are not diversified. REITs are generally dependent upon maintaining cash flows to repay borrowings and to make distributions to shareholders and are subject to the risk of default by lessees or borrowers. REITs whose underlying assets are concentrated in properties used by a particular industry are also subject to risks associated with such industry.
REITs may have limited financial resources, may trade less frequently and in a limited volume and may be subject to more abrupt or erratic price movements than larger company securities. Historically, REITs have been more volatile in price than the larger capitalization stocks included in S&P 500 Composite Stock Index.
VALUATION RISK
When market quotations are not readily available or are deemed to be unreliable, the Fund values its investments at fair value as determined in good faith pursuant to policies and procedures approved by the Board. See Net asset value. Fair value pricing may require subjective determinations about the value of a security or other asset. As a result, there can be no assurance that fair value pricing will result in adjustments to the prices of securities or other assets, or that fair value pricing will reflect actual market value, and it is possible that the fair value determined for a security or other asset will be materially different from quoted or published prices, from the prices used by others for the same security or other asset and/or from the value that actually could be or is realized upon the sale of that security or other asset by the Fund.
FOCUSED INVESTMENT RISK
Although the Fund has a policy not to concentrate investments in any particular industry, it may (consistent with that policy) invest up to 25% of its assets in any particular industry. To the extent that the Fund focuses its investments in a particular industry, the net asset value of the common shares will be
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Principal risks of the Fund
more susceptible to events or factors affecting companies in that industry. These may include, but are not limited to, governmental regulation, inflation, rising interest rates, cost increases in raw materials, fuel and other operating expenses, technological innovations that may render existing products and equipment obsolete, competition from new entrants, high research and development costs, increased costs associated with compliance with environmental or other regulation and other economic, market, political or other developments specific to that industry. Also, the Fund may have greater risk to the extent that it invests a substantial portion of its assets in companies in related sectors, which may share common characteristics, are often subject to similar business risks and regulatory burdens, and whose securities may react similarly to the types of events and factors described above. The Fund will also be subject to focused investment risks to the extent that it invests a substantial portion of its assets in a particular country or geographic region. See Foreign (Non-U.S.) Investment Risk, Emerging Markets Risk and Foreign Currency Risk.
REINVESTMENT RISK
Reinvestment risk is the risk that income from the Funds portfolio will decline if and when the Fund invests the proceeds from prepaid, matured, traded or called debt obligations at market interest rates that are below the portfolios current earnings rate. For instance, during periods of declining interest rates, an issuer of debt obligations may exercise an option to redeem securities prior to maturity, forcing the Fund to invest in lower-yielding securities. The Fund also may choose to sell higher yielding portfolio securities and to purchase lower yielding securities to achieve greater portfolio diversification, because the portfolio manager believes the current holdings are overvalued or for other investment-related reasons. A decline in income received by the Fund from its investments is likely to have a negative effect on the market price, net asset value and/or overall return of the Funds common shares.
SHORT SALE RISK
A short sale involves the sale by the Fund of a security that it does not own with the hope of purchasing the same security at a later date at a lower price. The Fund may also enter into a short position through a forward commitment or a short derivative position through a futures contract or swap agreement. If the price of the security or derivative has increased during this time, then the Fund will incur a loss equal to the increase in price from the time that the short sale was entered into plus any premiums and interest paid to the third party. Therefore, short sales involve the risk that losses may be exaggerated, potentially losing more money than the actual cost of the investment. Also, there is the risk that the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund.
INFLATION/DEFLATION RISK
Inflation risk is the risk that the value of assets or income from the Funds investments will be worth less in the future as inflation decreases the value of payments at future dates. As inflation increases, the real value of the Funds portfolio could decline. Deflation risk is the risk that prices throughout the economy decline over time. Deflation may have an adverse effect on the creditworthiness of issuers and may make issuer default more likely, which may result in a decline in the value of the Funds portfolio.
CONFIDENTIAL INFORMATION ACCESS RISK
In managing the fund, PIMCO normally will seek to avoid the receipt by the portfolio manager and analysts of material, non-public information (Confidential Information) about the issuers of Floating Rate Loans, other bank loans and related investments being considered for acquisition by the Fund or held in the Funds portfolio. In many instances, issuers offer to furnish Confidential Information to prospective purchasers or holders of the issuers loans. In circumstances when the PIMCO portfolio
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Principal risks of the Fund
manager and analysts do not receive Confidential Information from these issuers, the Fund may be disadvantaged in comparison to other bank loan investors, including with respect to the price the Fund pays or receives when it buys or sells a bank loan. Further, in situations when the Fund is asked, for example, to grant consents, waivers or amendments with respect to bank loans, PIMCOs ability to assess the desirability of such consents, waivers and amendments may be compromised.
EQUITY SECURITIES AND RELATED MARKET RISK
The Fund may hold common stocks and other equity securities from time to time, including those it has received through the conversion of a convertible security held by the Fund or in connection with the restructuring of a debt security. The market price of common stocks and other equity securities may go up or down, sometimes rapidly or unpredictably. Equity securities may decline in value due to factors affecting equity securities markets generally, particular industries represented in those markets, or the issuer itself. See Issuer Risk. The values of equity securities may decline due to general market conditions that are not specifically related to a particular company, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors which affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. Debt securities are also subject to the market risks described above; however, equity securities generally have greater price volatility than bonds and other debt securities.
RULE 144A SECURITIES RISK
Rule 144A permits certain qualified institutional buyers, such as the Fund, to trade in privately placed securities that have not been registered for sale under the Securities Act.
OTHER INVESTMENT COMPANIES RISK
The Fund may invest in securities of other open- or closed-end investment companies, including ETFs, to the extent that such investments are consistent with the Funds investment objective and policies and permissible under the 1940 Act. As a shareholder in an investment company, the Fund will bear its ratable share of that investment companys expenses, and would remain subject to payment of the Funds investment management fees with respect to the assets so invested. Common Shareholders would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. In addition, these other investment companies may utilize leverage, in which case an investment would subject the Fund to additional risks associated with leverage. See Leverage Risk.
RISK OF REGULATORY CHANGES
To the extent that legislation or state or federal bank or other regulators impose additional requirements or restrictions on the ability of certain financial institutions to make loans, particularly in connection with highly leveraged transactions, the availability of investments sought after by the Fund may be reduced. Further, such legislation or regulation could depress the market value of investments held by the Fund. Additionally, legislative, regulatory, or tax developments may affect the investment techniques available to PIMCO and the Funds portfolio manager in connection with managing the Fund and may also adversely affect the ability of the Fund to achieve its investment objective.
MARKET DISRUPTION AND GEOPOLITICAL RISK
The wars with Iraq and Afghanistan, their aftermath and the occupations of Iraq and substantial military presence in Afghanistan are likely to have a substantial effect on the U.S. and world economies and securities markets. The nature, scope and duration of the wars and the potential costs of rebuilding
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Principal risks of the Fund
infrastructure cannot be predicted with any certainty. Terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001 closed some of the U.S. securities markets for a four-day period and similar future events cannot be ruled out. The war and occupation, terrorism and related geopolitical risks have led, and may in the future lead, to increased short-term market volatility and may have adverse long-term effects on U.S. and world economies and markets generally. Those events also could have an acute effect on individual issuers or related groups of issuers. These risks also could adversely affect individual issuers and securities markets, interest rates, secondary trading, ratings, credit risk, inflation, deflation and other factors relating to the Funds investments and the market value and net asset value of the common shares.
RECENT ECONOMIC CONDITIONS RISK
The debt and equity capital markets in the United States have been negatively affected by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated market, among other things. These events, along with the deterioration of the housing market, the failure of major financial institutions and the resulting United States federal government actions have led to worsening general economic conditions, which have materially and adversely affected the broader financial and credit markets and have reduced the availability of debt and equity capital for the market as a whole and financial firms in particular. These developments may increase the volatility of the value of securities owned by the Fund and also may make it more difficult for the Fund to accurately value securities or to sell securities on a timely basis. These developments have adversely affected the broader economy, and may continue to do so, which in turn may adversely affect the ability of issuers of securities owned by the Fund to make payments of principal and interest when due, lead to lower credit ratings and increase defaults. Such developments could, in turn, reduce the value of securities owned by the Fund and adversely affect the net asset value of the Fund. In addition, the prolonged continuation or further deterioration of current market conditions could adversely affect the Funds portfolio.
The recent instability in the financial markets discussed above has led the U.S. government to take a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Federal, state, and other governments, their regulatory agencies, or self-regulatory organizations may take actions that affect the regulation of the instruments in which the Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of the Funds portfolio holdings.
Legislation or regulation may also change the way in which the Fund itself is regulated. Such legislation or regulation could limit or preclude the Funds ability to achieve its investment objective.
CERTAIN AFFILIATIONS
Certain broker-dealers may be considered to be affiliated persons of the Fund, the Investment Manager and/or PIMCO due to their possible affiliations with Allianz SE, the ultimate parent of the Investment Manager and PIMCO. Absent an exemption from the Securities and Exchange Commission or other regulatory relief, the Fund is generally precluded from effecting certain principal transactions with affiliated brokers, and its ability to purchase securities being underwritten by an affiliated broker or a syndicate including an affiliated broker, or to utilize affiliated brokers for agency transactions, is subject to restrictions. This could limit the Funds ability to engage in securities transactions and take advantage of market opportunities.
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Principal risks of the Fund
ANTI-TAKEOVER PROVISIONS
The Funds Declaration includes provisions that could limit the ability of other entities or persons to acquire control of the Fund or to convert the Fund to open-end status. See Anti-takeover provisions in the Agreement and Declaration of Trust. These provisions in the Declaration could have the effect of depriving the Common Shareholders of opportunities to sell their common shares at a premium over the then-current market price of the common shares or at net asset value.
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit investment risk and to maintain portfolio diversification. These limitations (two of which are listed below) are fundamental and may not be changed without the approval of the holders of a majority of the outstanding common shares and Preferred Shares voting together as a single class, and the approval of the holders of a majority of the Preferred Shares voting as a separate class. The Fund may not:
· |
concentrate its investments in a particular industry, as that term is used in the 1940 Act and as interpreted, modified, or otherwise permitted by regulatory authority having jurisdiction, from time to time; or |
· |
with respect to 75% of the Funds total assets, purchase the securities of any issuer, except securities issued or guaranteed by the U.S. Government or any of its agencies or instrumentalities or securities of other investment companies, if, as a result, (i) more than 5% of the Funds total assets would be invested in the securities of that issuer, or (ii) the Fund would hold more than 10% of the outstanding voting securities of that issuer. |
The Fund would be deemed to concentrate its investments in a particular industry if it invested more than 25% of its total assets in that industry. The Funds industry concentration policy does not preclude it from focusing investments in issuers in a group of related industrial sectors (such as different types of utilities). The Fund interprets its industry concentration policy to apply to direct investments in the securities of issuers in a particular industry, as defined by the Fund. For purposes of this restriction, a foreign government is considered to be an industry. Currency positions are not considered to be an investment in a foreign government for industry concentration purposes. Mortgage-backed securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities are not subject to the Funds industry concentration restrictions, by virtue of the exclusion from that test available to all U.S. Government securities. Similarly, municipal bonds issued by states, municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies and authorities are not subject to the Funds industry concentration restrictions.
The Fund is subject to additional guidelines in order to obtain and maintain ratings on the Preferred Shares of Aaa from Moodys and AAA from Fitch and may become subject to additional guidelines in the future. See Description of capital structure in this Prospectus and Investment Objective and Policies and Investment Restrictions in the SAI for information about these guidelines and a complete list of the fundamental investment policies of the Fund.
HEDGING AND RELATED STRATEGIES
The Fund may (but is not required to) use various investment strategies designed to limit the risk of price fluctuations of its portfolio securities and to preserve capital. For instance, the Fund may purchase credit default swap contracts for the purpose of hedging the Funds credit exposure to certain issuers and,
98
How the Fund manages risk
thereby, decreasing its exposure to credit risk, and it may invest in structured notes or interest rate futures contracts or swap, cap, floor or collar transactions, for the purpose of reducing the interest rate sensitivity of the Funds portfolio and, thereby, decreasing the Funds exposure to interest rate risk. See Portfolio contentsCredit Default Swaps, Portfolio contentsStructured Notes and Related Instruments and Portfolio contentsCertain Interest Rate Transactions in this prospectus. The Fund may also (but is not required to) seek to hedge some or all of its exposure to foreign currencies, including through the use of derivative strategies, to protect against future fluctuations in foreign currencies in relation to the U.S. dollar. See Portfolio contentsForeign Currencies and Related Transactions. Other hedging strategies that the Fund may use include: financial futures contracts; short sales; other types of swap agreements or options thereon; options on financial futures; and options based on either an index or individual debt securities whose prices, PIMCO believes, correlate with the prices of the Funds investments. Income earned by the Fund from its hedging and related transactions may be subject to one or more special U.S. federal income tax rules that can affect the amount, timing and/or character of distributions to shareholders. For instance, income earned by the Fund from its foreign currency hedging activities, if any, may give rise to ordinary income that, to the extent not offset by losses from such activities, will be distributed to shareholders and taxable at ordinary income rates. Therefore, these foreign currency hedging activities can increase the amount of distributions taxable to shareholders as ordinary income. See Tax matters. There is no assurance that these hedging strategies will be available at any time or that PIMCO will determine to use them for the Fund or, if used, that the strategies will be successful. PIMCO may determine not to engage in hedging strategies or to do so only in unusual circumstances or market conditions. In addition, the Fund is subject to certain restrictions on its use of hedging strategies imposed by guidelines of Fitch and/or Moodys with respect to their ratings on the Preferred Shares.
99
TRUSTEES AND OFFICERS
The Board is responsible for the management of the Fund, including supervision of the duties performed by the Investment Manager and PIMCO. There are currently seven Trustees of the Fund, one of whom is treated by the Fund as an interested person (as defined in the 1940 Act). The names and business addresses of the Trustees 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.
The Investment Manager serves as the investment manager of the Fund. Subject to the supervision of the Board, the Investment Manager is responsible for managing, either directly or through others selected by it, the investment activities of the Fund and the Funds business affairs and other administrative matters. The Investment Manager is located at 1345 Avenue of the Americas, New York, New York 10105.
Organized in 2000, the Investment Manager provides investment management and advisory services to a number of closed-end and open-end investment company clients. The Investment Manager is a wholly-owned indirect subsidiary of Allianz SE, a publicly-traded European insurance and financial services company. As of December 31, 2009, the Investment Manager and its investment management affiliates had approximately $1.7 trillion in assets under management.
The Investment Manager has retained its affiliate, PIMCO, as a sub-adviser to manage the Funds portfolio investments. See Sub-Adviser below. The Investment Manager may retain affiliates to provide various administrative and other services required by the Fund.
SUB-ADVISER
PIMCO, an affiliate of the Investment Manager, serves as the sub-adviser for the Fund, pursuant to a portfolio management agreement between the Investment Manager and PIMCO. Subject to this agreement and to the supervision of the Investment Manager, PIMCO has full investment discretion and makes all determinations with respect to the investment of the Funds assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660. Organized in 1971, PIMCO provides investment management and advisory services to private accounts of institutional and individual clients and to a number of open-end and closed-end investment companies. As of December 31, 2009, PIMCO had approximately $1 trillion in assets under management.
The Investment Manager (and not the Fund) will pay a portion of the fees it receives under the Investment Management Agreement to PIMCO in return for PIMCOs services. The fee is paid monthly at the annual rate of 0.55% of the Funds average weekly total managed assets, provided, however, that the amounts payable for each month shall be reduced by the amount of all fees, if any, payable by the Investment Manager to the underwriters of the Funds initial public offering of common shares for such month (such that the Investment Manager retains from its investment management fee, on an annual basis, .05% of the Funds average weekly total managed assets, after having paid PIMCO and such underwriters).
The following individual has primary responsibility for the day-to-day portfolio management of the Fund.
Portfolio Manager | Since | Title | Recent Professional Experience | |||
William H. Gross |
December 2009 | Managing Director and Co-Chief Investment Officer of PIMCO | Managing Director, Co-Chief Investment Officer and a founding partner of PIMCO. Mr. Gross has been associated with PIMCO since 1971. |
100
Management of the Fund
The Statement of Additional Information provides additional information about portfolio manager compensation, other accounts managed by the portfolio manager and the portfolio managers ownership of securities in the Fund.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Investment Manager and the Fund (the Investment Management Agreement), the Fund has agreed to pay the Investment Manager an annual fee, payable monthly, in an amount equal to 0.75% of the Funds average weekly total managed assets, for the services and facilities it provides. Total managed assets means the total assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding) minus accrued liabilities (other than liabilities representing borrowings). For purposes of calculating total managed assets, the liquidation preference of any Preferred Shares outstanding is not considered a liability. With respect to any reverse repurchase agreement or similar transaction, total managed assets include any proceeds from the sale of an asset of the Fund to a counterparty in such a transaction, in addition to the value of the underlying asset as of the relevant measuring date.
In addition to the fees of the Investment Manager, the Fund pays all other costs and expenses of its operations, including compensation of its trustees (other than those affiliated with the Investment Manager), custodial expenses, shareholder servicing expenses, transfer agency, sub-transfer agency and dividend disbursing expenses, legal fees, expenses of independent auditors, expenses of preparing, printing and distributing prospectuses, shareholder reports, notices, proxy statements and reports to governmental agencies, and taxes, if any.
Because the fees received by the Investment Manager and PIMCO are based on the total managed assets of the Fund (including any assets attributable to any preferred shares and borrowings that may be outstanding), the fees will be higher when leverage is utilized and the Investment Manager and PIMCO therefore have a financial incentive for the Fund to utilize leverage, which may create a conflict of interest between the Investment Manager and PIMCO, on the one hand, and the Funds Common Shareholders, on the other hand.
A discussion regarding the basis for the Boards continuation of the Funds Investment Management Agreement and Portfolio Manager agreement is available in the Funds annual report to shareholders for the fiscal year ended July 31, 2009.
REGULATORY AND LITIGATION MATTERS
In June and September 2004, the Investment Manager and certain of its affiliates (including PEA Capital LLC (PEA) and Allianz Global Investors Distributors LLC), agreed to settle, without admitting or denying the allegations, claims brought by the Securities and Exchange Commission and the New Jersey Attorney General alleging violations of federal and state securities laws with respect to certain open-end funds for which the Investment Manager serves as investment adviser. The settlements related to an alleged market timing arrangement in certain open-end funds formerly sub-advised by PEA. The Investment Manager and its affiliates agreed to pay a total of $68 million to settle the claims. In addition to monetary payments, the settling parties agreed to undertake certain corporate governance, compliance and disclosure reforms related to market timing, and consented to cease and desist orders and censures. Subsequent to these events, PEA deregistered as an investment adviser and dissolved. None of the settlements alleged that any inappropriate activity took place with respect to the Fund.
Since February 2004, the Investment Manager and certain of its affiliates and their employees have been named as defendants in a number of pending lawsuits concerning market timing which allege the same or similar conduct underlying the regulatory settlements discussed above. The market timing lawsuits
101
Management of the Fund
have been consolidated in a multi-district litigation proceeding in the U.S. District Court for the District of Maryland. Any potential resolution of these matters may include, but not be limited to judgments or settlements for damages against the Investment Manager or its affiliates or related injunctions.
PIMCO and PIMCO Funds, a series of mutual funds managed by PIMCO, are the subject of a lawsuit in the Northern District of Illinois Eastern Division, in which the complaint alleges that the plaintiffs each purchased and sold a 10-year Treasury note futures contract and suffered damages from an alleged shortage when PIMCO held both physical and futures positions in 10-year Treasury notes for its client accounts in violation of the federal Commodity Exchange Act provisions on market manipulation. In July 2007, the District Court granted class certification of a class consisting of those persons who purchased futures contracts to offset short positions between May 9, 2005 and June 30, 2005. PIMCO believes the complaint is without merit and PIMCO and PIMCO Funds intend to vigorously defend against this action. The outcome of this action cannot be predicted at this time.
The Investment Manager and the Sub-Adviser believe that these matters are not likely to have a material adverse effect on the Fund or on their ability to perform their respective investment advisory activities relating to the Fund.
The foregoing speaks only as of the date of this prospectus. While there may be additional litigation or regulatory developments in connection with the matters discussed above, the foregoing disclosure of litigation and regulatory matters will be updated only if those developments are material.
The net asset value per share (NAV) of the Funds common shares is determined by dividing the total value of the Funds portfolio investments and other assets, less any liabilities and the liquidation preference of Preferred Shares, by the total number of common shares outstanding. Fund shares are valued as of a particular time (the Valuation Time) on each day (Business Day) that the New York Stock Exchange is open for trading. The Valuation Time is ordinarily at the close of regular trading on the New York Stock Exchange (normally 4:00 p.m., Eastern time) (the NYSE Close). In unusual circumstances, the Board may determine that the Valuation Time shall be as of 4:00 p.m., Eastern time, notwithstanding an earlier, unscheduled close or halt of trading on the New York Stock Exchange.
For purposes of calculating NAV, the Funds investments for which market quotations are readily available are valued at market value. Market values for various types of securities and other instruments are determined on the basis of closing prices or last sales prices on an exchange or other market, or based on quotes or other market information obtained from quotation reporting systems, established market makers or pricing services. Short-term investments having a maturity of 60 days or less are generally valued at amortized cost.
If market quotations are not readily available (including in cases where available market quotations are deemed to be unreliable), the Funds investments will be valued at fair value as determined in good faith pursuant to policies and procedures approved by the Board. Fair value pricing may require subjective determinations about the value of a security or other asset, and fair values used to determine the Funds NAV may differ from quoted or published prices, or from prices that are used by others, for the same investments. Also, the use of fair value pricing may not always result in adjustments to the prices of securities or other assets held by the Fund.
The Fund may determine that market quotations are not readily available due to events relating to a single issuer ( e.g. , corporate actions or announcements) or events relating to multiple issuers ( e.g. , governmental actions or natural disasters). The Fund may determine the fair value of investments based on information provided by pricing services and other third-party vendors, which may recommend fair value prices or
102
Net asset value
adjustments with reference to other securities, indices or assets. In considering whether fair value pricing is required and in determining fair values, the Fund may, among other things, consider significant events (which may be considered to include changes in the value of U.S. securities or securities indices) that occur after the close of the relevant market and before the Valuation Time. The Fund may use modeling tools provided by third-party vendors to determine fair values of certain non-U.S. securities.
For purposes of calculating NAV, the Fund normally uses pricing data for domestic equity securities received shortly after the NYSE Close and does not normally take into account trading, clearances or settlements that take place after the NYSE Close. Domestic fixed income and non-U.S. securities are normally priced using data reflecting the earlier closing of the principal markets for those securities, subject to possible fair value adjustments. Information that becomes known to the Fund or its agents after NAV has been calculated on a particular day will not generally be used to retroactively adjust the price of a security or NAV determined earlier that day.
Investments initially valued in currencies other than the U.S. dollar are converted to U.S. dollars using exchange rates obtained from pricing services. As a result, NAV of the Funds shares may be affected by changes in the value of currencies in relation to the U.S. dollar. The value of investments traded in markets outside the United States or denominated in currencies other than the U.S. dollar may be affected significantly on a day that the New York Stock Exchange is closed. The calculation of the Funds NAV may not take place contemporaneously with the determination of the prices of non-U.S. securities used in NAV calculations.
In unusual circumstances, instead of valuing securities in the usual manner, the Fund may value securities at fair value as determined in good faith by the Board, generally based upon recommendations provided by the Investment Manager or PIMCO. Fair valuation also may be required due to material events that occur after the close of the relevant market but prior to the NYSE Close.
The Fund intends to make regular monthly cash distributions to Common Shareholders at rates which may vary based upon the performance of the Fund and income accrual. Distributions can be made only from net investment income after paying any accrued dividends to holders of Preferred Shares. The dividend rate that the Fund pays on its common shares will depend on a number of factors, including variable rates of interest which may be received on the Funds portfolio, the level of dividends payable on the Preferred Shares and the expenses of any other leveraging transactions utilized by the Fund. Because some or all of the debt instruments held by the Fund may be floating rate assets, the amount of the Funds monthly distributions to Common Shareholders may vary over time with fluctuations in market interest rates. The net income of the Fund consists of all income paid or accrued on portfolio assets less all expenses of the Fund. Expenses of the Fund are accrued each day. Over time, substantially all the net investment income of the Fund will be distributed. At least annually, the Fund also intends to distribute to Common Shareholders their pro rata shares of any available net capital gains. Although it does not now intend to do so, the Board may change the Funds dividend policy and the amount or timing of the distributions based on a number of factors, including the amount of the Funds undistributed net investment income and historical and projected investment income and the amount of the expenses and dividend rates on any outstanding Preferred Shares.
To permit the Fund to maintain a more stable relationship between its monthly distributions and the variable rates of interest it may receive on its investment portfolio, the Fund may initially distribute less than the entire amount of net investment income earned in a particular period. The undistributed net investment income would be available to supplement future distributions. As a result, the distributions paid by the Fund for any particular monthly period may be more or less than the amount of net
103
Distributions
investment income actually earned by the Fund during the period. Undistributed net investment income will be added to the Funds net asset value and, correspondingly, distributions from undistributed net investment income will be deducted from the Funds net asset value. Unless Common Shareholders elect to receive distributions in cash, all distributions to Common Shareholders will be automatically reinvested in additional common shares under the Funds Dividend Reinvestment Plan.
Pursuant to the Funds Dividend Reinvestment Plan (the Plan), all Common Shareholders whose shares are registered in their own names will have all dividends, including any capital gain dividends, reinvested automatically in additional common shares by PNC Global Investment Servicing Inc., as agent for the Common Shareholders (the Plan Agent), unless the shareholder elects to receive cash. An election to receive cash may be revoked or reinstated at the option of the shareholder. In the case of record shareholders such as banks, brokers or other nominees that hold common shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of common shares certified from time to time by the record shareholder as representing the total amount registered in such shareholders name and held for the account of beneficial owners who are to participate in the Plan. Shareholders whose shares are held in the name of a bank, broker or nominee should contact the bank, broker or nominee for details. Such shareholders may not be able to transfer their shares to another bank or broker and continue to participate in the Plan. All distributions to investors who elect not to participate in the Plan (or whose broker or nominee elects not to participate on the investors behalf) will be paid in cash by check mailed, in the case of direct shareholders, to the record holder by PNC Global Investment Servicing Inc., as the Funds dividend disbursement agent.
Unless you elect (or your broker or nominee elects) not to participate in the Plan, the number of common shares you will receive with respect to a common share dividend will be determined as follows:
(1) | If on the payment date the net asset value of the common shares is equal to or less than the market price per common share plus estimated brokerage commissions that would be incurred upon the purchase of common shares on the open market, the Fund will issue new common shares at the greater of (i) the net asset value per common share on the payment date or (ii) 95% of the market price per common share on the payment date; or |
(2) | If on the payment date the net asset value of the common shares is greater than the market price per common share plus estimated brokerage commissions that would be incurred upon the purchase of common shares on the open market, the Plan Agent will receive the dividend or distribution in cash and will purchase common shares in the open market, on the New York Stock Exchange or elsewhere, for the participants accounts. It is possible that the market price for the common shares may increase before the Plan Agent has completed its purchases. Therefore, the average purchase price per share paid by the Plan Agent may exceed the market price on the payment date, resulting in the purchase of fewer shares than if the dividend or distribution had been paid in common shares issued by the Fund. The Plan Agent will use all dividends and distributions received in cash to purchase common shares in the open market on or shortly after the payment date, but in no event later than the ex-dividend date for the next distribution. Interest will not be paid on any uninvested cash payments. |
You may withdraw from the Plan at any time by giving written notice to the Plan Agent. If you withdraw or the Plan is terminated, you will receive common shares for each whole share in your account under the Plan and you will receive a cash payment for any fraction of a share in your account. If you wish, the Plan Agent will sell your common shares and send you the proceeds, minus brokerage commissions.
104
Dividend reinvestment plan
The Plan Agent maintains all shareholders accounts in the Plan and gives written confirmation of all transactions in the accounts, including information you may need for tax records. The Plan Agent will also furnish each person who buys common shares with written instructions detailing the procedures for electing not to participate in the Plan and to instead receive distributions in cash. Common shares in your account will be held by the Plan Agent in non-certificated form. Any proxy you receive will include all common shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions in common shares. However, all participants will pay a pro rata share of brokerage commissions incurred by the Plan Agent when it makes open market purchases.
Automatically reinvested dividends and distributions are taxed in the same manner as cash dividends and distributions. See Tax matters.
The Fund and the Plan Agent reserve the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. Additional information about the Plan may be obtained from PNC Global Investment Servicing Inc., P.O. Box 43027, Providence, Rhode Island 02940-3027, telephone number (800) 254-5197.
Description of capital structure
The following is a brief description of the capital structure of the Fund. This description does not purport to be complete and is subject to and qualified in its entirety by reference to the Funds Agreement and Declaration of Trust, as amended and restated through the date hereof (the Declaration) and Bylaws, as amended and restated through the date hereof (the Bylaws). The Funds Declaration and Bylaws are each exhibits to the registration statement of which this prospectus is a part.
The Fund is an unincorporated voluntary association with transferable shares of beneficial interest (commonly referred to as a Massachusetts business trust) established under the laws of The Commonwealth of Massachusetts by the Funds Declaration. The Declaration provides that the Trustees of the Fund may authorize separate classes of shares of beneficial interest. Preferred shares (such as the Preferred Shares) may be issued in one or more series, with such par value and with such rights as determined by the Board, by action of the Board without the approval of the Common Shareholders. The following table shows, for each class of authorized securities of the Fund, the amount of (i) shares authorized and (ii) shares outstanding, each as of February 28, 2010.
Title of Class | Amount Authorized | Amount Outstanding | ||
Common Shares |
Unlimited | 43,261,106 | ||
Preferred Shares |
||||
Series M |
3,840 | 1,288 | ||
Series T |
3,840 | 1,288 | ||
Series W |
3,840 | 1,288 | ||
Series TH |
3,840 | 1,288 | ||
Series F |
3,840 | 1,288 |
The common shares of the Fund commenced trading on the NYSE on October 27, 2004 under the trading or ticker symbol PFN. As of the close of trading on the NYSE on [ · ], the net asset value per common share was $[ · ], and the closing price per common share on the NYSE was $[ · ].
Common Shareholders are entitled to share equally in dividends declared by the Board payable to Common Shareholders and in the net assets of the Fund available for distribution to Common
105
Description of capital structure
Shareholders after payment of the preferential amounts payable to holders of Preferred Shares and any other outstanding preferred shares of beneficial interest. See Preferred Share Dividends below. Neither Common Shareholders nor holders of preferred shares (including the Preferred Shares) have preemptive or conversion rights or have the right to cause the Fund to redeem their shares. Upon liquidation of the Fund, after paying or adequately providing for the payment of all liabilities of the Fund and the liquidation preference with respect to any outstanding preferred shares (including the Preferred Shares), and upon receipt of such releases, indemnities and refunding agreements as they deem necessary for their protection, the Trustees may distribute the remaining assets of the Fund among the Funds Common Shareholders. See Liquidation Preference below.
For so long as any Preferred Shares are outstanding, the Fund generally may not declare, pay or set apart for payment any dividend or other distribution (other than a dividend or distribution paid in shares of additional common shares or rights to purchase common shares or other shares ranking junior to the Preferred Shares as to dividends or upon liquidation) in respect of common shares or any other shares of the Fund ranking junior to or on a parity with the Preferred Shares as to dividends or upon liquidation, or call for redemption, redeem, purchase or otherwise acquire for consideration any common shares or any other such junior shares (except by conversion into or exchange for shares of beneficial interest of the Fund ranking junior to Preferred Shares as to dividends and upon liquidation) or any such parity shares (except by conversion into or exchange for shares of beneficial interest of the Fund ranking junior to or on a parity with Preferred Shares as to dividends and upon liquidation), unless and only if: (i) immediately after such transaction, the Fund would satisfy both Moodys Ratings Agency Preferred Shares Asset Coverage and Fitch Ratings Agency Preferred Shares Asset Coverage, and 1940 Act Preferred Shares Asset Coverage would be satisfied (each as defined and described under Rating Agency Guidelines and Asset Coverage below); (ii) full cumulative dividends on the Preferred Shares 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 for the Preferred Shares; and (iii) the Fund has redeemed the full number of Preferred Shares required to be redeemed by any provision for mandatory redemption contained in the Funds Bylaws. See Preferred Shares Redemption below. The Fund expects that similar restrictions would apply to any other classes of preferred shares that the Fund might choose to issue in the future. In addition, if the Fund has outstanding any senior security representing indebtedness, the 1940 Act also prohibits the Fund from declaring any dividend or distribution on the Funds common shares (other than a dividend or distribution paid in shares of additional common shares) unless such senior securities representing indebtedness have at the time of the declaration asset coverage of at least 300% after deducting the amount of such dividend or distribution. See Use of leverage.
Shareholders of each class are entitled to one vote for each share held. Common Shareholders will vote with the holders of any outstanding Preferred Shares or other preferred shares as a single class on each matter submitted to a vote of holders of common shares, except as otherwise provided by the Declaration, the Bylaws or applicable law. Except as otherwise provided by the Declaration, the Bylaws or applicable law, holders of Preferred Shares, voting as a separate class, are entitled to elect two of the Funds Trustees. The remaining Trustees will be elected by Common Shareholders and holders of Preferred Shares, voting together as a single class. In the unlikely event that two full years of accrued dividends are unpaid on the Preferred Shares, the holders of all outstanding Preferred Shares, voting as a separate class, will be entitled to elect a majority of the Funds Trustees until all dividends in arrears have been paid or declared and set apart for payment.
The Fund will send unaudited reports at least semiannually and audited financial statements annually to all of its shareholders.
106
Description of capital structure
ADDITIONAL INFORMATION REGARDING THE PREFERRED SHARES
The Fund initially issued Preferred Shares in five series (Series M, Series T, Series W, Series TH and Series F) in December 2004, in the amount of 3,840 shares per series. The Preferred Shares have a par value of $0.00001 and liquidation value of $25,000 per share. The Preferred Shares have various rights determined by action of the Board without the approval of Common Shareholders, most of which are specified in Article 11 of the Funds Bylaws. The Fund voluntarily redeemed a total of 12,760 shares of each series of its outstanding Preferred Shares in December 2008, March 2009 and April 2009, such that the Fund currently has a total of 6,440 Preferred Shares outstanding (1,288 shares per series), with a total liquidation value of $161,000,000.
Under the 1940 Act, the Fund is permitted to have outstanding more than one series of preferred shares of beneficial interest as long as no single series has priority over another series as to the distribution of assets of the Fund or the payment of dividends. Neither Common Shareholders nor holders of Preferred Shares have preemptive rights to purchase any Preferred Shares or any other preferred shares that might be issued by the Fund.
PREFERRED SHARE DIVIDENDS
The Preferred Shares have complete priority over the common shares as to distribution of assets. The terms of the Preferred Shares provide that they would ordinarily pay dividends at a rate set at auctions held every seven days, normally payable on the first business day following the end of the rate period, subject to a maximum applicable rate calculated as a function of the Preferred Shares then-current ratings and a reference interest rate as described below. However, the weekly auctions for the Preferred Shares, as well as auctions for similar preferred shares of other closed-end funds across the U.S. industry, have failed since February 2008, and the dividend rates on the Preferred Shares since that time have been paid at the maximum applicable rate. The Fund expects that the Preferred Shares will continue to pay dividends at the maximum applicable rate for the foreseeable future and cannot predict whether or when the auction markets for the Preferred Shares may resume normal functioning.
As noted, the maximum applicable rate for each series of Preferred Shares depends on the credit ratings assigned to such shares (currently by Fitch and Moodys) and on the duration of the rate period. The maximum applicable rate for any regular rate period ( i.e. , any rate period other than a non-payment period) will be the higher of the applicable percentage of the reference rate, or the applicable spread plus the reference rate. The reference rate is the applicable LIBOR Rate (as defined below) (for a rate period of fewer than 365 days) or the Treasury Index Rate (as defined below) (for a rate period of 365 days or more). The applicable percentage and applicable spread for any regular rate period will generally be determined based on the credit ratings assigned to the Preferred Shares by Fitch and Moodys on the auction date for such period (as set forth in the table below).
Moodys Credit
Rating |
Fitch Credit
Rating |
Applicable Percentage |
Applicable
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 |
For these purposes, the LIBOR Rate is the applicable London Inter-Bank Offered Rate for deposits in U.S. dollars for the period most closely approximating the applicable rate period for a series of Preferred Shares (ordinarily 7 days), and the Treasury Index Rate is the average yield to maturity for certain U.S. Treasury securities having substantially the same length to maturity as the applicable rate period for a series of Preferred Shares.
107
Description of capital structure
RATING AGENCY GUIDELINES AND ASSET COVERAGE
The Fund is required to satisfy various asset maintenance requirements with respect to its Preferred Shares under the terms of the Bylaws, which are summarized below.
1940 Act Preferred Shares Asset Coverage. The Fund is required under the Bylaws to maintain, with respect to the Preferred Shares, as of the last business day of each month in which any Preferred Shares are outstanding, 1940 Act Preferred Shares Asset Coverage (as defined below) of at least 200% with respect to senior securities that are equity securities, including the Preferred Shares. If the Fund fails to maintain 1940 Act Preferred Shares Asset Coverage and such failure is not cured as of the last business day of the following month (the 1940 Act Cure Date), the Fund will be required under certain circumstances to redeem certain of the Preferred Shares. See Preferred Shares Redemption below.
The 1940 Act Preferred Shares Asset Coverage with respect to the Funds currently outstanding Preferred Shares as of February 28, 2010 was as follows:
Value of the Funds total assets
less all liabilities
|
= | 347% | ||
Senior securities representing indebtedness
|
Ratings Agency Preferred Shares Asset Coverage. In connection with the Funds receipt of ratings of Aaa from Moodys and AAA from Fitch with respect to the Preferred Shares, the Fund is required under the Bylaws to satisfy separate asset coverage tests specific to each rating agency (with respect to each ratings agency, Ratings Agency Preferred Shares Asset Coverage).
Moodys Ratings Agency Preferred Shares Asset Coverage. Satisfaction of Moodys Ratings Agency Preferred Shares Asset Coverage generally requires the Fund to have eligible assets having in the aggregate a discounted value equal to or in excess of a Preferred Shares Basic Maintenance Amount. Generally, the Preferred Shares Basic Maintenance Amount includes the sum of (a) the aggregate liquidation preference of the Funds preferred shares then outstanding (including the Preferred Shares) and (b) certain accrued and projected payment obligations of the Fund, including without limitation any accrued and projected dividends on its preferred shares then outstanding (including the Preferred Shares).
Article 11 of the Funds Bylaws includes Moodys-specific guidelines for calculating discounted value for purposes of determining whether the Moodys Ratings Agency Preferred Shares Asset Coverage test is satisfied. These guidelines specify discount factors that the Fund must apply to various types of securities in its portfolio for purposes of calculating whether the discounted value of the Funds eligible assets is at least equal to the Preferred Shares Basic Maintenance Amount (with the level of discount generally becoming greater as the credit quality of a security becomes lower). In addition, under the Moodys guidelines, certain types of securities (including securities in which the Fund may otherwise invest) are not eligible for inclusion in the calculation of the discounted value of the Funds portfolio. Such ineligible securities may include, for example, certain privately placed debt securities (other than Rule 144A securities) and debt securities of certain non-U.S. issuers. The Moodys guidelines for calculating discounted value do not impose any limitations on the percentage of the Funds assets that may be invested in ineligible assets, and the amount of ineligible assets included in the Funds portfolio at any time may vary depending upon the rating, diversification and other characteristics of the Moodys eligible assets included in the portfolio.
Fitch Ratings Agency Preferred Shares Asset Coverage. Until recently, the ratings agency asset coverage criteria relating to Fitchs ratings of the Preferred Shares were substantially similar in structure to the Moodys-related requirements summarized above. Like the Moodys requirements, the Fitch asset coverage requirements were premised on the Fund having eligible assets with an aggregate discounted
108
Description of capital structure
value equal to or in excess of the Preferred Share Basis Maintenance Amount. The asset coverage requirements of the two ratings agencies differed in that each rating agency had different guidelines for calculating discounted value and for determining whether a particular asset was an eligible asset for these purposes.
Effective March 1, 2010, the Funds Board adopted amended and restated Bylaws which incorporate substantially revised and updated Preferred Shares ratings criteria issued by Fitch with respect to its ratings on debt and preferred stock issued by closed-end investment companies (the New Fitch Criteria). The New Fitch Criteria are attached as Exhibit 1 to the Funds Bylaws and are incorporated therein by reference.
Generally, the New Fitch Criteria include two separate asset coverage tests which differ from the single Preferred Share Basis Maintenance Amount test currently applicable to Moodys ratings of the Preferred Shares and previously to Fitchs ratings. Under the New Fitch Criteria, the Fund must satisfy both a Fitch Total Overcollateralization Test (Fitch Total OC) and a Fitch Net Overcollateralization Test (Fitch Net OC), in each case to be consistent with a AAA rating from Fitch, to satisfy Fitch Ratings Agency Preferred Shares Asset Coverage.
The New Fitch Criteria define Fitch Total OC and Fitch Net OC as follows:
Fitch Total OC |
= |
Total Net Discounted Assets at MV*
|
||
Fitch Rated Liability + Other Liabilities Pari Passu and Senior to Rated Liability |
* | Total net discounted assets at market value (MV) equal total portfolio assets at MV and accrued income, including assets held as collateral for other Fund liabilities, less current liabilities that settle in 10 days that are not part of a rolling leverage strategy (such as to-be-announced (TBA) securities, futures, forwards, among others), then discounted pursuant to the Fitch discount factors specified in the New Fitch Criteria. |
Fitch Net OC |
= |
Available Net Discounted Assets*
|
||
Fitch Rated Liability + Other Liabilities That Are Pari Passu |
* | Available net discounted assets equals total portfolio assets at MV and accrued income minus all assets that are either held as collateral for other Fund liabilities and/or subject to a first claim of a senior liability in the capital structure minus current liabilities that settle in 10 days that are not part of a rolling leverage strategy (such as TBA security rolls, futures, forwards, among others), then discounted pursuant to the Fitch discount factors specified in the New Fitch Criteria. |
Under the Funds Bylaws, Fitch Ratings Agency Preferred Shares Asset Coverage is satisfied if, as of a particular date or time, the Fund has sufficient asset coverage with respect to the Preferred Shares such that the Fund satisfies both the (i) Fitch Total OC test and the (ii) Fitch Net OC test as of such date or time. The Fitch Total OC test and the Fitch Net OC test are satisfied if the Fund has Fitch Total OC or Fitch Net OC, as the case may be, in excess of one-hundred percent (100%) pursuant to the applicable formula above.
Other key components of the New Fitch Criteria as cited by Fitch include, among others, updated asset discount factors (used in part to calculate Fitch Total OC and Fitch Net OC), changes to issuer and industry diversification and concentration thresholds and guidelines and inclusion of leverage and derivatives when calculating asset coverage for purposes of determining Fitch Ratings Agency Preferred Shares Asset Coverage.
In the event the Fund does not timely cure a failure to maintain (a) Moodys Ratings Agency Preferred Shares Asset Coverage or Fitch Ratings Agency Preferred Shares Asset Coverage (as applicable) or (b) 1940 Act Preferred Shares Asset Coverage, in each case in accordance with the requirements of the rating agency or agencies then rating the Preferred Shares, the Fund will be required to redeem Preferred Shares as described under Preferred Shares RedemptionMandatory Redemption below.
109
Description of capital structure
In addition to the requirements described above, the rating agency guidelines impose restrictions or limitations on the Funds use of certain financial instruments or investment techniques that the Fund might otherwise utilize in order to obtain and maintain a rating from Moodys and Fitch on the Preferred Shares. It is not currently anticipated that these guidelines will materially impede PIMCO from managing the Funds portfolio in accordance with the Funds investment objective and policies. However, it should be noted that the New Fitch Criteria and related asset coverage requirements to which the Fund recently became subject are different in material respects from the Fitch-related asset coverage requirements to which the Fund was subject prior to March 1, 2010, and in various respects impose more stringent and limiting standards than the prior Fitch guidelines and/or the Moodys guidelines summarized above. In this regard, the New Fitch Criteria may cause the Fund to invest in higher-quality assets, use derivatives transactions and related leverage to a lesser extent, maintain higher balances of highly liquid assets, and otherwise invest the Funds assets differently than it has in the past under the prior Fitch guidelines, which could negatively impact the Funds investment performance, yield to common shareholders and common share net asset value and/or market price.
The Fund may, but is not required to, adopt any modifications to the guidelines that may be established by Moodys and/or Fitch with respect to their ratings of the Preferred Shares. Failure to adopt any such modifications, however, may result in a reduction in the ratings described above or a withdrawal of ratings altogether. In addition, any rating agency providing a rating for the Preferred Shares may, at any time, change or withdraw any such rating. The Trustees may, without shareholder approval, amend, alter or repeal various 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 Moodys or Fitch (or any substitute rating agency) that any such amendment, alteration or repeal would not impair the rating then assigned by the rating agency to the Preferred Shares.
The ratings of the Preferred Shares are based on current information furnished to Moodys and Fitch by the Fund, the Manager and/or PIMCO or 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 Funds common shares have not been rated by a nationally recognized statistical rating organization. A rating agencys guidelines will apply to the Preferred Shares only so long as the rating agency is rating the shares. The Fund pays certain fees to Moodys and Fitch for rating the Preferred Shares.
The foregoing description of the rating agency guidelines and asset coverage requirements applicable to the Preferred Shares is intended only as a summary and is qualified in its entirety by reference to the actual terms of Article 11 and other relevant provisions of the Funds Bylaws and Exhibit 1 thereto (which includes the New Fitch Criteria).
LIQUIDATION PREFERENCE
Subject to the rights of holders of any series or class or classes of shares ranking on a parity with Preferred Shares 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 Preferred Shares then outstanding will be entitled to receive and to be paid, out of the assets of the Fund available for distribution to its shareholders, before any payment or distribution will be made on the Funds common shares or any other class of shares of the Fund ranking junior in right of payment upon liquidation to the Preferred Shares, an amount equal to the liquidation preference with respect to such Preferred 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 (but not including) the date of final distribution in same-day funds in connection with the liquidation of the Fund. If such assets of the Fund are insufficient to make the full liquidation payment on outstanding Preferred Shares and liquidation payments on any other outstanding class or series of preferred shares of the Fund ranking on
110
Description of capital structure
parity with the Preferred Shares as to payment upon liquidation, then such assets will be distributed among the holders of Preferred Shares and the holders of shares of such other class or series ratably in proportion to the respective preferential amounts to which they are entitled. After the payment to the holders of Preferred Shares of the full preferential amounts provided for as described herein, the holders of Preferred Shares as such will have no right or claim to any of the remaining assets of the Fund. For these purposes, a liquidation of the Fund does not include the sale of all or any portion of the assets of the Fund; or the merger, consolidation or statutory share exchange of the Fund into or with any trust or other entity.
As used in this prospectus, unless otherwise noted, the Funds net assets include assets of the Fund attributable to any outstanding Preferred Shares, with no deduction for the liquidation preference of the Preferred Shares. Solely for financial reporting purposes, however, the Fund is required to exclude the liquidation preference of Preferred Shares from net assets, so long as the Preferred Shares have redemption features that are not solely within the control of the Fund. For all regulatory and tax purposes, the Funds Preferred Shares will be treated as stock (rather than indebtedness).
PREFERRED SHARES REDEMPTION
Mandatory Redemption. As noted above, the Fund is required under the Bylaws to maintain (a) both Moodys Ratings Agency Preferred Shares Asset Coverage and Fitch Ratings Agency Preferred Shares Asset Coverage and (b) 1940 Act Preferred Shares Asset Coverage. Eligible portfolio securities for the purposes of (a) above will be determined from time to time by the rating agency then rating the Preferred Shares. If the Fund fails to maintain such asset coverage amounts and does not timely cure such failure in accordance with the Bylaws, the Fund would be required to redeem all or a portion of the Preferred Shares. This mandatory redemption would take place on a date that the Trustees specify out of legally available funds in accordance with the Declaration, the Bylaws and applicable law, at the redemption price of $25,000 per share, plus accumulated but unpaid dividends (whether or not earned or declared) to (but not including) the date fixed for redemption. In determining the number of Preferred Shares required to be redeemed in accordance with the foregoing, the Fund would redeem the lesser of (a) the minimum number of Preferred Shares necessary to satisfy the applicable Ratings Agency Preferred Shares Asset Coverage or 1940 Act Preferred Shares Asset Coverage, as the case may be, and (b) the maximum number of Preferred Shares and any other preferred shares of the Fund subject to redemption or retirement that can be redeemed out of funds expected to be legally available therefor at the time of redemption, and in any case will redeem such Preferred Shares pro rata among the Preferred Shares and any other preferred shares of the Fund subject to redemption or retirement. The mandatory redemption will be limited to the number of Preferred Shares and any other preferred shares necessary to restore the required Ratings Agency Preferred Shares Asset Coverage or 1940 Act Preferred Shares Asset Coverage, as the case may be.
Optional Redemption. To the extent permitted under the 1940 Act and under Massachusetts law, upon giving notice of redemption, as provided below, the Fund, at its option, may redeem Preferred Shares, in whole or in part, out of funds legally available therefore, at the Optional Redemption Price per share on any dividend payment date; provided that no Preferred Shares may be redeemed at the option of the Fund during (a) the initial rate period with respect to the Preferred Shares or (b) a non-call period to which such shares are subject. Optional Redemption Price means $25,000 per Preferred Shares plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) to (but not including) the date fixed for redemption plus the applicable redemption premium, if any. The Fund has the authority to redeem the Preferred Shares for any reason and may redeem all or part of the outstanding Preferred Shares if it anticipates that the Funds leveraged capital structure will result, for a significant period of time, in a lower rate of return to Common Shareholders than that obtainable if the Common Shares were not so leveraged.
111
Description of capital structure
Although the Preferred Shares are subject to redemption under certain circumstances as described above, unlike the shares of an open-end mutual fund, the Preferred Shares may not be redeemed at a shareholders option at net asset value.
Market and net asset value information
The Funds common shares are listed on the NYSE under the trading or ticker symbol PFN. The Funds common shares commenced trading on the NYSE in October 2004. The Fund cannot predict whether its common shares will trade in the future at a premium or discount to net asset value. The conduct of the Offer and the issuance of additional common shares pursuant to the Offer may have an adverse effect on prices in the secondary market for the Funds common shares by increasing the number of shares available, which may put downward pressure on the market price for the common shares. Record Date Shareholders who do not fully exercise their Rights will, upon completion of the Offer, own a smaller proportional interest in the Fund than they owned prior to the Offer. In addition, because the Subscription Price per common share may be less than the then current net asset value per common share, the completion of the Offer may result in an immediate dilution of the net asset value per common share for all existing Common Shareholders. Such dilution is not currently determinable because it is not known how many common shares will be subscribed for, what the net asset value or market price of the common shares will be on the Expiration Date or what the Subscription Price will be. Such dilution could be substantial. If such dilution occurs, Common Shareholders will experience a decrease in the net asset value per common share held by them, irrespective of whether they exercise all or any portion of their Rights.
The following table sets forth, for each of the periods indicated, the high and low closing market prices of the Funds common shares on the NYSE, the high and low net asset value per common share and the high and low premium/discount to net asset value per common share. See Net asset value for information as to how the Funds net asset value is determined.
Common Share
Market price |
Common Share
Net asset value |
Premium (discount) as
|
||||||||||||||||
Quarter | High | Low | High | Low | High | Low | ||||||||||||
Quarter ended Oct. 31, 2007 |
$ | 17.77 | $ | 15.49 | $ | 17.55 | $ | 16.76 | 2.08 | % | -4.82 | % | ||||||
Quarter ended Jan. 31, 2008 |
$ | 16.86 | $ | 14.75 | $ | 17.28 | $ | 15.38 | -1.24 | % | -10.82 | % | ||||||
Quarter ended Apr. 30, 2008 |
$ | 15.19 | $ | 12.18 | $ | 15.07 | $ | 13.48 | 4.35 | % | -9.30 | % | ||||||
Quarter ended Jul. 31, 2008 |
$ | 14.68 | $ | 12.09 | $ | 15.14 | $ | 14.09 | -3.60 | % | -11.10 | % | ||||||
Quarter ended Oct. 31, 2008 |
$ | 12.99 | $ | 6.73 | $ | 14.11 | $ | 8.44 | -7.23 | % | -23.94 | % | ||||||
Quarter ended Jan. 31, 2009 |
$ | 8.11 | $ | 4.75 | $ | 8.47 | $ | 6.07 | 18.12 | % | -23.95 | % | ||||||
Quarter ended Apr. 30, 2009 |
$ | 6.68 | $ | 3.33 | $ | 6.14 | $ | 4.24 | 8.33 | % | -10.30 | % | ||||||
Quarter ended Jul. 31, 2009 |
$ | 7.78 | $ | 5.59 | $ | 7.98 | $ | 5.93 | -0.93 | % | -8.67 | % | ||||||
Quarter ended Oct. 31, 2009 |
$ | 9.91 | $ | 8.04 | $ | 9.37 | $ | 8.07 | 8.66 | % | -2.99 | % | ||||||
Quarter ended Jan. 31, 2010 |
$ | 10.78 | $ | 9.29 | $ | 9.67 | $ | 8.70 | 16.88 | % | -0.32 | % |
112
Anti-takeover provisions in the Agreement and Declaration of Trust
The Declaration and the Bylaws include provisions that could limit the ability of other entities or persons to acquire control of the Fund or to convert the Fund to open-end status. The Funds Trustees are divided into three classes. At each annual meeting of shareholders, the term of one class expires and each Trustee elected to that class holds office for a term of three years. The classification of the Board in this manner could delay for an additional year the replacement of a majority of the Board. In addition, the Declaration provides that a Trustee may be removed only for cause and only (i) by action of at least seventy-five percent (75%) of the outstanding shares of the classes or series of shares entitled to vote for the election of such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining Trustees.
As described below, the Declaration grants special approval rights with respect to certain matters to members of the Board who qualify as Continuing Trustees, which term means a Trustee who either (i) has been a member of the Board for a period of at least thirty-six months (or since the commencement of the Funds operations, if less than thirty-six months) or (ii) was nominated to serve as a member of the Board by a majority of the Continuing Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least seventy-five percent (75%) of the Board and holders of at least seventy-five percent (75%) of the Funds shares (including common and preferred shares of beneficial interest) to authorize certain Fund transactions not in the ordinary course of business, including a merger or consolidation, issuance or transfer by the Fund of the Funds shares (except as may be pursuant to a public offering, the Funds dividend reinvestment plan or upon exercise of any stock subscription rights), a sale, transfer or other disposition of Fund assets, or any shareholder proposal regarding specific investment decisions, unless the transaction is authorized by both a majority of the Trustees and seventy-five percent (75%) of the Continuing Trustees (in which case no shareholder authorization would be required by the Declaration, but may be required in certain cases under the 1940 Act). The Declaration also requires the affirmative vote or consent of holders of at least seventy-five percent (75%) of each class of the Funds shares entitled to vote on the matter to authorize a conversion of the Fund from a closed-end to an open-end investment company, unless the conversion is authorized by both a majority of the Trustees and seventy-five percent (75%) of the Continuing Trustees (in which case shareholders would have only the minimum voting rights required by the 1940 Act with respect to the conversion). Also, the Declaration provides that the Fund may be terminated at any time by vote or consent of at least seventy-five percent (75%) of the Funds shares or, alternatively, by vote or consent of both a majority of the Trustees and seventy-five percent (75%) of the Continuing Trustees. See Anti-Takeover and Other Provisions in the Declaration of Trust in the SAI for a more detailed summary of these provisions.
The Trustees may from time to time grant other voting rights to shareholders with respect to these and other matters in the Funds Bylaws, certain of which are required by the 1940 Act. For example, the Bylaws grant holders of Preferred Shares and any other preferred shares special voting rights with respect to certain matters described in the preceding paragraph.
The overall effect of these provisions is to render more difficult the accomplishment of a merger or the assumption of control by a third party. These provisions also provide, however, the advantage of potentially requiring persons seeking control of the Fund to negotiate with its management regarding the price to be paid and facilitating the continuity of the Funds investment objective and policies. The provisions of the Declaration and Bylaws described above could have the effect of discouraging a third party from seeking to obtain control of the Fund in a tender offer or similar transaction. The Board of the Fund has considered the foregoing anti-takeover provisions and concluded that they are in the best interests of the Fund and its shareholders.
113
Anti-takeover provisions in the Agreement and Declaration of Trust
The foregoing is intended only as a summary and is qualified in its entirety by reference to the full text of the Declaration and the Bylaws, both of which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration contains an express disclaimer of shareholder liability for debts or obligations of the Fund and requires that notice of such limited liability be given in each agreement, obligation or instrument entered into or executed by the Fund or the Trustees. The Declaration further provides for indemnification out of the assets and property of the Fund for all loss and expense of any shareholder held personally liable for the obligations of the Fund. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund would be unable to meet its obligations. The Fund believes that the likelihood of such circumstances is remote.
Repurchase of common shares; conversion to open-end fund
The Fund is a closed-end investment company and as such holders of its common shares do not have the right to cause the Fund to redeem their shares. Instead, the common shares trade in the open market at a price that is a function of several factors, including dividend levels, net asset value, call protection, portfolio credit quality, relative demand for and supply of such shares in the market, general market and economic conditions, conditions affecting individual issuers and other factors. Shares of a closed-end investment company may frequently trade at prices lower than net asset value. The Funds Board regularly monitors the relationship between the market price and net asset value of the common shares. If the common shares were to trade at a substantial discount to net asset value for an extended period of time, the Board may consider the repurchase of its common shares on the open market or in private transactions, the making of a tender offer for such shares, or the conversion of the Fund to an open-end investment company. The Fund cannot assure you that its Board will decide to take or propose any of these actions, or that share repurchases or tender offers will actually reduce market discount.
If the Fund were to convert to an open-end company, it would be required to redeem all Preferred Shares and other preferred shares 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. In contrast to a closed-end investment company, shareholders 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 under the 1940 Act) at their net asset value, less any redemption charge that is in effect at the time of redemption. In addition, if the Fund were to convert to an open-end company, it would not be able to invest more than 15% of its net assets in illiquid securities, which may necessitate a substantial repositioning of the Funds investment portfolio, which may in turn generate substantial transaction costs, which would be borne by Common Shareholders, and may adversely affect Fund performance and Fund dividends.
Before deciding whether to take any action to convert the Fund to an open-end investment company, the Board would consider all relevant factors, including the extent and duration of the discount, the liquidity of the Funds portfolio, the impact of any action that might be taken on the Fund or its shareholders, and market considerations. Based on these considerations, even if the Funds common shares should trade at a discount, the Board may determine that, in the interest of the Fund and its shareholders, no action should be taken. See the Statement of Additional Information under Repurchase of Common Shares; Conversion to Open-End Fund for a further discussion of possible action to reduce or to eliminate such discount to net asset value.
114
U.S. FEDERAL INCOME TAX MATTERS
The following discussion of U.S. federal income tax matters is based on the advice of Ropes & Gray LLP, counsel to the Fund, and is a general summary of some of the important U.S. federal income tax considerations affecting the Fund and its Common Shareholders that are United States persons within the meaning of the Code, and does not address any state, local, foreign or other tax consequences. It reflects provisions of the Code, existing Treasury regulations, rulings published by the Internal Revenue Service (the IRS), and other applicable authority, as of the date of this prospectus. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative or judicial interpretations. This summary does not purport to be a complete description of the U.S. federal income tax considerations applicable to an investment in common shares of the Fund. For example, we have not described certain tax considerations that may be relevant to certain types of holders subject to special treatment under the U.S. federal income tax laws, including shareholders subject to the U.S. federal alternative minimum tax, insurance companies, tax-exempt organizations, pension plans and trusts, RICs, dealers in securities, shareholders holding Fund shares through tax-advantaged accounts (such as 401(k) plans or IRAs), financial institutions, and shareholders holding common shares as part of a hedge, straddle, or conversion transaction. This summary assumes that investors hold common shares as capital assets (within the meaning of the Code). Your investment in the Fund may have other tax implications. Please consult your tax advisor about U.S. federal, state, local, foreign or other tax laws applicable to you, as tax matters are very complex and the tax consequences to an investor of an investment in the Funds common shares will depend on the facts of his, her or its particular situation. For more information, including a summary of certain tax consequences of investing in common shares of the Fund for non-U.S. persons, see the Statement of Additional Information.
The Fund has elected to be treated as a regulated investment company (a RIC) under Subchapter M of the Code and intends each year to qualify and to be eligible to be treated as such. If the Fund so qualifies and satisfies certain distribution requirements, the Fund will not be subject to U.S. federal income tax on income distributed in a timely manner to its shareholders in the form of dividends or capital gain distributions.
To satisfy the distribution requirement applicable to RICs, amounts paid as dividends by the Fund to its shareholders, including holders of its Preferred Shares, must qualify for the dividends-paid deduction. In certain circumstances, the IRS could take the position that dividends paid on the Preferred Shares constitute preferential dividends under Section 562(c) of the Code, and thus do not qualify for the dividends-paid deduction. The Fund believes this position, if asserted, would be unlikely to prevail.
As described in Use of leverage and Description of capital structure above, if at any time when Preferred Shares are outstanding the Fund does not meet applicable asset coverage or other requirements, it will be required to suspend distributions to Common Shareholders until the requisite asset coverage is restored or other relevant requirements are met. Any such suspension may cause the Fund to pay a 4% excise tax (imposed on RICs that fail to distribute for a given calendar year, generally, at least 98% of their net investment income and capital gain net income) and U.S. federal income tax on undistributed income or gains, and may, in certain circumstances, prevent the Fund from qualifying for treatment as RIC. The Fund may redeem or purchase Preferred Shares in an effort to comply with the distribution requirement applicable to RICs and to avoid income or excise taxes or otherwise as part of a mandatory or optional redemption of Preferred Shares (see Description of capital structure above). The Fund may have to dispose of portfolio securities to generate cash for such redemptions, which may result in transaction expenses and gain at the Fund level and in further taxable distributions to Common Shareholders.
115
Tax matters
Subject to the considerations discussed immediately above, the Fund intends to distribute at least annually to its Common Shareholders all or substantially all of its investment company taxable income, generally defined in the Code as taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses), its net tax-exempt interest (if any), and its net capital gain (that is, the excess of net long-term capital gains over net short-term capital losses. Any taxable income including any net capital gain retained by the Fund will be subject to tax at the Fund level at regular corporate rates. In the case of net capital gain, the Fund is permitted to designate the retained amount as undistributed capital gains in a notice to its shareholders who would then, in turn, be (i) required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amount, and (ii) entitled to credit their proportionate shares of the tax paid by the Fund on such undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds on a properly-filed U.S. tax return to the extent the credit exceeds such liabilities. If the Fund makes this designation, for U.S. federal income tax purposes, the tax basis of the shares owned by a shareholder of the Fund would be increased by an amount equal under current law to the difference between the amount of undistributed capital gains included in the shareholders gross income under clause (i) of the preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence. The Fund is not required to, and there can be no assurance the Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year. To the extent that the Fund retains any net capital gain, it may be required to liquidate portfolio securities that it might otherwise have continued to hold (possibly at times or prices when it might not be advantageous to do so) in order to generate the cash to pay the tax on the amount retained.
For federal income tax purposes, distributions of net investment company taxable income are generally taxable to shareholders as ordinary income. Taxes on distributions of net capital gain are determined by how long the Fund owned the investments that generated such capital gain, rather than how long a shareholder has owned his or her shares. In general, the Fund will recognize long-term capital gain or loss on investments it has owned for more than one year, and short-term capital gain or loss on investments it has owned for one year or less. Therefore, distributions of net long-term capital gains (as reduced by any net short-term capital losses) that are properly designated by the Fund as capital gain dividends generally are taxable to shareholders as long-term capital gains. Long-term capital gain rates applicable to individuals have been temporarily reducedin general, to 15% with a 0% rate applying to taxpayers in the 10% and 15% bracketsfor taxable years beginning before January 1, 2011. It is currently unclear whether Congress will extend, change or eliminate this special rate to or for tax years beginning on or after January 1, 2011. Distributions of net short-term capital gains (as reduced by any net long-term capital losses) are generally taxable to shareholders as ordinary income.
Distributions in excess of the Funds current and accumulated earnings and profits are treated as returns of capital to the extent of the shareholders basis in its shares and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders tax basis in its shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of its shares. Where one or more such distributions occur in any taxable year of the Fund, the available earnings and profits will be allocated first to the distributions made to the holders of Preferred Shares, and only thereafter to distributions made to holders of common shares. As a result, in such a case, the holders of Preferred Shares will receive a disproportionate share of the distributions treated as dividends, and the Common Shareholders will receive a disproportionate share of the distributions treated as a return of capital.
Distributions are taxable to a shareholder whether the shareholder receives them in cash or reinvests them in additional common shares through the Funds Dividend Reinvestment Plan. Distributions are taxable to a shareholder even if they are paid from income or gains earned by the Fund before a shareholders investment (and thus were reflected in the price the shareholder paid). Shareholders will be notified annually as to the U.S. federal tax status of Fund distributions.
116
Tax matters
Any gain resulting from the sale or exchange of common shares generally will be taxable as capital gain.
For taxable years beginning before January 1, 2011, distributions of investment income designated by the Fund as derived from qualified dividend income are taxed in the hands of individuals at the rates applicable to long-term capital gain, provided holding period and other requirements are met at both the shareholder and Fund level. See the Statement of Additional Information for a description of these requirements. It is currently unclear whether Congress will extend, change or eliminate this provision to or for tax years beginning on or after January 1, 2011. Ordinary dividends representing distributions from interest income and short-term capital gains cannot be designated as qualified dividend income and will not qualify for the reduced rates. Therefore, the Fund does not expect a significant portion of Fund distributions to be derived from qualified dividend income.
From time to time, a substantial portion of the Funds investments in loans and other debt obligations could be treated as having market discount and/or original issue discount (OID) for U.S. federal income tax purposes, which, in some cases, could be significant and could cause the Fund to recognize income in respect of these investments before, or without receiving, cash representing such income. If so, the Fund could be required to pay out as an income distribution each year an amount which is greater than the total amount of cash interest the Fund actually received. As a result, the Fund could be required at times to, among other things, liquidate other investments (including at potentially disadvantageous times or prices) in order to satisfy its distribution requirements and/or to avoid incurring Fund-level U.S. federal income or excise taxes. If the Fund liquidates portfolio securities to raise cash, the Fund may realize gain or loss on such liquidations; in the event the Fund realizes net long-term or short-term capital gains from such liquidation transactions, its shareholders may receive larger capital gain or ordinary dividends, respectively, than they would in the absence of such transactions.
The interest paid on municipal bonds is generally exempt from U.S. federal income tax. However, because the Fund does not expect to be eligible to pay exempt-interest dividends to its shareholders under the Code, any distribution received by Fund shareholders that is attributable to the interest received by the Fund on its municipal bond holdings is taxable to shareholders. In addition, any gains realized by the Fund on the sale or exchange of municipal bonds generally are taxable to shareholders when distributed to them by the Fund.
Investments in debt obligations that are at risk of or in default present special tax issues for the Fund. Tax rules are not entirely clear about issues such as whether or to what extent the Fund should recognize market discount on a debt obligation, when the Fund may cease to accrue interest, OID or market discount, when and to what extent the Fund may take deductions for bad debts or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by the Fund when, as and if it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a RIC and does not become subject to U.S. federal income or excise tax.
Generally, the Funds transactions in derivative instruments ( e.g. , options, structured notes, futures contracts, swap agreements and forward contracts), short sales, as well as any of its other hedging and related activities more generally, may be subject to one or more special and complex U.S. federal income tax rules ( e.g. , notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short sale rules), the effect of which may be, among other things, to accelerate the recognition of income to the Fund, to defer losses to the Fund, to cause adjustments in the holding periods of the Funds securities, to convert lower taxed long-term capital gains or qualified dividend income into higher taxed short-term capital gains or ordinary income and to convert short-term capital losses into long-term capital losses. These rules, therefore, could affect the amount, timing and/or character of distributions to shareholders of the Fund.
117
Tax matters
The Funds transactions in foreign currencies, foreign currency-denominated debt obligations and certain foreign currency options, futures contracts and forward contracts (and similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Such ordinary income treatment may accelerate the Funds distributions to shareholders and increase the distributions taxed to shareholders as ordinary income. Losses from such positions may lead to a return of capital to Fund shareholders.
Income received by the Fund from sources within foreign countries may be subject to withholding and other taxes imposed by such countries, in which case, the Funds yield on the securities giving rise to such income would be decreased. Tax treaties between certain countries and the U.S. may reduce or eliminate such taxes. If more than 50% of the Funds assets at its year end consist of the securities of foreign corporations, the Fund may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata portion of qualified taxes paid by the Fund to foreign countries in respect of foreign securities the Fund has held for at least the minimum period specified in the Code. See the Statement of Additional Information for additional requirements to obtain such credits.
Under current law, the backup withholding rate is 28% for amounts paid through 2010 and will be 31% for amounts paid after December 31, 2010, unless Congress enacts tax legislation providing otherwise. The Fund may be required to apply backup withholding to taxable distributions or redemption proceeds payable to a shareholder including, for example, distributions paid to any individual shareholder who fails to properly furnish the Fund with a correct taxpayer identification number, who has under-reported dividend or interest income, or who fails to certify to the Fund that he or she is not subject to such withholding. Please see the Statement of Additional Information for additional information about backup withholding.
This section relates only to the U.S. federal income tax consequences of investing in common shares of the Fund; the consequences under other tax laws may differ. You should consult your tax advisor as to the possible application of foreign, state, local or other income tax laws to Fund dividends and capital distributions as well as possible estate tax consequences to foreign shareholders. Please see Tax Matters in the Statement of Additional Information for additional information regarding the tax aspects of investing in common shares of the Fund.
The custodian of the assets of the Fund is State Street Bank and Trust Co., 801 Pennsylvania Avenue, Kansas City, Missouri 64105. The custodian performs custodial and fund accounting services.
PNC Global Investment Servicing, P.O. Box 43027, Providence, Rhode Island 02940, serves as the Funds transfer agent, registrar, dividend paying agent and redemption agent for its common shares.
Independent registered public accounting firm
PricewaterhouseCoopers LLP, 300 Madison Avenue, New York, New York 10017, serves as independent registered public accounting firm for the Fund. PricewaterhouseCoopers LLP provides audit services, tax and other audit related services to the Fund.
Certain legal matters in connection with the common shares will be passed upon for the Fund by Ropes & Gray LLP, Boston Massachusetts, and certain other legal matters will be passed on for the Dealer Manager by Skadden, Arps, Slate, Meagher & Flom LLP, Chicago, Illinois.
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TABLE OF CONTENTS FOR STATEMENT OF ADDITIONAL INFORMATION
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DESCRIPTION OF SECURITIES RATINGS
The Funds investments may range in quality from securities rated in the lowest category to securities rated in the highest category (as rated by Moodys, S&P or Fitch or, if unrated, determined by PIMCO to be of comparable quality). The percentage of the Funds assets invested in securities in a particular rating category will vary. The following terms are generally used to described the credit quality of fixed income securities:
High Quality Debt Securities are those rated in one of the two highest rating categories (the highest category for commercial paper) or, if unrated, deemed comparable by PIMCO.
Investment Grade Debt Securities are those rated in one of the four highest rating categories or, if unrated deemed comparable by PIMCO.
Below Investment Grade, High Yield Securities (Junk Bonds) are those rated lower than Baa by Moodys or BBB by S&P or Fitch and comparable securities. They are considered predominantly speculative with respect to the issuers ability to repay principal and interest.
The following is a description of Moodys, S&Ps and Fitchs rating categories applicable to fixed income securities.
Moodys Long-Term Ratings: Bonds and Preferred Stock
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as gilt edge. Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present that make the long-term risks appear somewhat larger than with Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium-grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations ( i.e. , they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class.
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B: Bonds which are rated B generally lack characteristics of a desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing.
Moodys applies numerical modifiers, 1, 2, and 3 in each generic rating classified from Aa through Caa in its corporate bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category.
Corporate Short-Term Debt Ratings
Moodys short-term debt ratings are opinions of the ability of issuers to repay punctually senior debt obligations which have an original maturity not exceeding one year. Obligations relying upon support mechanisms such as letters of credit and bonds of indemnity are excluded unless explicitly rated.
Moodys employs the following three designations, all judged to be investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: 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; and well-established access to a range of financial markets and assured sources of alternate liquidity.
PRIME-2: 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.
PRIME-3: 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.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime rating categories.
Short-Term Municipal Bond Ratings
There are three rating categories for short-term municipal bonds that define an investment grade situation, which are listed below. In the case of variable rate demand obligations (VRDOs), a two-component rating is assigned. The first element represents an evaluation of the degree of risk associated with scheduled principal and interest payments, and the other represents an evaluation of the
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degree of risk associated with the demand feature. The short-term rating assigned to the demand feature of VRDOs is designated as VMIG. When either the long- or short-term aspect of a VRDO is not rated, that piece is designated NR, e.g. , Aaa/NR or NR/VMIG 1. MIG ratings terminate at the retirement of the obligation while VMIG rating expiration will be a function of each issues specific structural or credit features.
MIG 1/VMIG 1: This designation denotes superior quality. There is present strong protection by established cash flows, superior liquidity support or demonstrated broad-based access to the market for refinancing.
MIG 2/VMIG 2: This designation denotes strong quality. Margins of protection are ample although not so large as in the preceding group.
MIG 3/VMIG 3: This designation denotes acceptable quality. All security elements are accounted for but there is lacking the undeniable strength of the preceding grades. Liquidity and cash flow protection may be narrow and market access for refinancing is likely to be less well established.
SG: This designation denotes speculative quality. Debt instruments in this category lack margins of protection.
Standard & Poors Ratings Services
Corporate and Municipal Bond Ratings
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on the following considerations:
· |
Likelihood of paymentcapacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation; |
· |
Nature of and provisions of the obligation; |
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Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights. |
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
Investment Grade
AAA: Debt rated AAA has the highest rating assigned by S&P. Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions, or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher-rated categories.
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Speculative Grade
Debt rated BB, B, CCC, CC, and C is regarded as having predominantly speculative characteristics with respect to capacity to pay interest and repay principal. BB indicates the least degree of speculation and C the highest. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major exposures to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other speculative issues. However, it faces 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. The BB rating category is also used for debt subordinated to senior debt that is assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has the capacity to meet interest payments and principal repayments. Adverse business, financial, or economic conditions will likely impair capacity or willingness to pay interest and repay principal. The B rating category is also used for debt subordinated to senior debt that is assigned an actual or implied BB or BB- rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default and is dependent upon favorable business, financial, and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal. The CCC rating category is also used for debt subordinated to senior debt that is assigned an actual or implied B or B- rating.
CC: The rating CC is typically applied to debt subordinated to senior debt that is assigned an actual or implied CCC rating.
C: The rating C is typically applied to debt subordinated to senior debt that is assigned an actual or implied CCC debt rating. The C rating may be used to cover a situation where a bankruptcy petition has been filed, but debt service payments are continued.
CI: The rating CI is reserved for income bonds on which no interest is being paid.
D: Debt rated D is in payment default. The D rating category is used when interest payments or principal payments are not made on the date due even if the applicable grace period has not expired, unless S&P believes that such payments will be made during such grace period. The D rating will also be used upon the filing of a bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.
Provisional ratings: The letter p indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. The investor should exercise his own judgment with respect to such likelihood and risk.
N.R.: Not rated.
Debt obligations of issuers outside the United States and its territories are rated on the same basis as domestic corporate and municipal issues. The ratings measure the creditworthiness of the obligor but do not take into account currency exchange and related uncertainties.
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Commercial Paper Rating Definitions
An S&P commercial paper rating is a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into several categories, ranging from A for the highest quality obligations to D for the lowest. These categories are as follows:
A-1: This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation.
A-2: Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1.
A-3: Issues carrying this designation have adequate capacity for timely payment. They are, however, more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations.
B: Issues rated B are regarded as having only speculative capacity for timely payment.
C: This rating is assigned to short-term debt obligations with a doubtful capacity for payment.
D: Debt rated D is in payment default. The D rating category is used when interest payments or principal payments are not made on the date due, even if the applicable grace period has not expired, unless S&P believes that such payments will be made during such grace period.
A commercial paper rating is not a recommendation to purchase, sell or hold a security inasmuch as it does not comment as to market price or suitability for a particular investor. The ratings are based on current information furnished to S&P by the issuer or obtained from other sources it considers reliable. S&P does not perform an audit in connection with any rating and may, on occasion, rely on unaudited financial information. The ratings may be changed, suspended, or withdrawn as a result of changes in or unavailability of such information.
Active Qualifiers (currently applied and/or outstanding)
i: This subscript is used for issues in which the credit factors, terms, or both, that determine the likelihood of receipt of payment of interest are different from the credit factors, terms or both that determine the likelihood of receipt of principal on the obligation. The i subscript indicates that the rating addresses the interest portion of the obligation only. The i subscript will always be used in conjunction with the p subscript, which addresses likelihood of receipt of principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
L: Ratings qualified with L apply only to amounts invested up to federal deposit insurance limits.
P: This subscript is used for issues in which the credit factors, the terms, or both, that determine the likelihood of receipt of payment of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The p subscript indicates that the rating addresses the principal portion of the obligation only. The p subscript will always be used in conjunction with the i subscript, which addresses likelihood of receipt of interest. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
pi: Ratings with a pi subscript are based on an analysis of an issuers published financial information, as well as additional information in the public domain. They do not, however, reflect in-depth meetings with an issuers management and are therefore based on less comprehensive information than ratings without a pi subscript. Ratings with a pi subscript are reviewed annually based on a new years financial statements, but may be reviewed on an interim basis if a major event occurs that may affect the issuers credit quality.
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pr: The letters pr indicate that the rating is provisional. A provisional rating assumes the successful completion of the project financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful, timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of or the risk of default upon failure of such completion. The investor should exercise his own judgment with respect to such likelihood and risk.
Preliminary: Preliminary ratings are assigned to issues, including financial programs, in the following circumstances.
· |
Preliminary ratings may be assigned to obligations, most commonly structured and project finance issues, pending receipt of final documentation and legal opinions. Assignment of a final rating is conditional on the receipt and approval by Standard & Poors of appropriate documentation. Changes in the information provided to Standard & Poors could result in the assignment of a different rating. In addition, Standard & Poors reserves the right not to issue a final rating. |
· |
Preliminary ratings are assigned to Rule 415 Shelf Registrations. As specific issues, with defined terms, are offered from the master registration, a final rating may be assigned to them in accordance with Standard & Poors policies. The final rating may differ from the preliminary rating. |
t: This symbol indicates termination structures that are designed to honor their contracts to full maturity or, should certain events occur, to terminate and cash settle all their contracts before their final maturity date.
Unsolicited: Unsolicited ratings are those credit ratings assigned at the initiative of Standard & Poors and not at the request of the issuer or its agents.
Inactive Qualifiers (no longer applied or outstanding)
*: This symbol indicated continuance of the ratings is contingent upon Standard & Poors receipt of an executed copy of the escrow agreement or closing documentation confirming investments and cash flows. Discontinued use in August 1998.
c: This qualifier was used to provide additional information to investors that the bank may terminate its obligation to purchase tendered bonds if the long-term credit rating of the issuer is below an investment-grade level and/or the issuers bonds are deemed taxable. Discontinued use in January 2001.
q: A q subscript indicates that the rating is based solely on quantitative analysis of publicly available information. Discontinued use in April 2001.
r: The r modifier was assigned to securities containing extraordinary risks, particularly market risks, that are not covered in the credit rating. The absence of an r modifier should not be taken as an indication that an obligation will not exhibit extraordinary non-credit related risks. Standard & Poors discontinued the use of the r modifier for most obligations in June 2000 and for the balance of obligations (mainly structured finance transactions) in November 2002.
Local Currency and Foreign Currency Risks: Country risk considerations are a standard part of Standard & Poors analysis for credit ratings on any issuer or issue. Currency of repayment is a key factor in this analysis. An obligors capacity to repay foreign currency obligations may be lower than its capacity to repay obligations in its local currency due to the sovereign governments own relatively lower capacity to repay external versus domestic debt. These sovereign risk considerations are incorporated in the debt ratings assigned to specific issues. Foreign currency issuer ratings are also distinguished from local currency issuer ratings to identify those instances where sovereign risks make them different for the same issuer.
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Fitch, Inc.
A brief description of the applicable Fitch ratings symbols and meanings (as published by Fitch) follows:
Long-Term Credit Ratings
Investment Grade
AAA: Highest credit quality. AAA ratings denote the lowest expectation of credit risk. They are assigned only in case of exceptionally strong capacity for timely payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events.
AA: Very high credit quality. AA ratings denote a very low expectation of credit risk. They indicate very strong capacity for timely payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events.
A: High credit quality. A ratings denote a low expectation of credit risk. The capacity for timely payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. BBB ratings indicate that there is currently a low expectation of credit risk. The capacity for timely payment of financial commitments is considered adequate, but adverse changes in circumstances and in economic conditions are more likely to impair this capacity. This is the lowest investment-grade category.
Speculative Grade
BB: Speculative. BB ratings indicate that there is a possibility of credit risk developing, particularly as the result of adverse economic change over time; however, business or financial alternatives may be available to allow financial commitments to be met. Securities rated in this category are not investment grade.
B: Highly speculative. B ratings indicate that significant credit risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment.
CCC, CC, C: High default risk. Default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic developments. A CC rating indicates that default of some kind appears probable. C ratings signal imminent default.
DDD, DD, D: Default. The ratings of obligations in this category are based on their prospects for achieving partial or full recovery in a reorganization or liquidation of the obligor. While expected recovery values are highly speculative and cannot be estimated with any precision, the following serve as general guidelines. DDD obligations have the highest potential for recovery, around 90%-100% of outstanding amounts and accrued interest. DD indicates potential recoveries in the range of 50%-90%, and D the lowest recovery potential, i.e. , below 50%. Entities rated in this category have defaulted on some or all of their obligations. Entities rated DDD have the highest prospect for resumption of performance or continued operation with or without a formal reorganization process. Entities rated DD and D are generally undergoing a formal reorganization or liquidation process; those rated DD are likely to satisfy a higher portion of their outstanding obligations, while entities rated D have a poor prospect for repaying all obligations.
Recovery Ratings
Recovery Ratings are assigned to selected individual securities and obligations. These currently are published for most individual obligations of corporate issuers with IDRs in the B rating category and below, and for selected structured finance obligations in low speculative grade.
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Among the factors that affect recovery rates for securities are the collateral, the seniority relative to other obligations in the capital structure (where appropriate), and the expected value of the company or underlying collateral in distress.
The Recovery Rating scale is based upon the expected relative recovery characteristics of an obligation upon the curing of a default, emergence from insolvency or following the liquidation or termination of the obligor or its associated collateral. For structured finance, Recovery Ratings are designed to estimate recoveries on a forwardlooking basis while taking into account the time value of money.
Recovery Ratings are an ordinal scale and do not attempt to precisely predict a given level of recovery. As a guideline in developing the rating assessments, the agency employs broad theoretical recovery bands in its ratings approach based on historical averages, but actual recoveries for a given security may deviate materially from historical averages.
RR1: Outstanding recovery prospects given default . RR1 rated securities have characteristics consistent with securities historically recovering 91%-100% of current principal and related interest.
RR2: Superior recovery prospects given default. RR2 rated securities have characteristics consistent with securities historically recovering 71%-90% of current principal and related interest.
RR3: Good recovery prospects given default. RR3 rated securities have characteristics consistent with securities historically recovering 51%-70% of current principal and related interest. Prospectus A-5
RR4: Average recovery prospects given default. RR4 rated securities have characteristics consistent with securities historically recovering 31%-50% of current principal and related interest.
RR5: Below average recovery prospects given default. RR5 rated securities have characteristics consistent with securities historically recovering 11%-30% of current principal and related interest.
RR6: Poor recovery prospects given default. RR6 rated securities have characteristics consistent with securities historically recovering 0%-10% of current principal and related interest.
Short-Term Credit Ratings
A short-term rating has a time horizon of less than 12 months for most obligations, or up to three years for U.S. public finance securities, and thus places greater emphasis on the liquidity necessary to meet financial commitments in a timely manner.
F1: Highest credit quality. Indicates the strongest capacity for timely payment of financial commitments; may have an added + to denote any exceptionally strong credit feature.
F2: Good credit quality. A satisfactory capacity for timely payment of financial commitments, but the margin of safety is not as great as in the case of the higher ratings.
F3: Fair credit quality. The capacity for timely payment of financial commitments is adequate; however, near-term adverse changes could result in a reduction to non-investment grade.
B: Speculative. Minimal capacity for timely payment of financial commitments, plus vulnerability to near-term adverse changes in financial and economic conditions.
C: High default risk. Default is a real possibility. Capacity for meeting financial commitments is solely reliant upon a sustained, favorable business and economic environment.
D: Default. Denotes actual or imminent payment default.
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+ or - may be appended to a rating to denote relative status within major rating categories. Such suffixes are not added to the AAA long-term rating category, to categories below CCC, or to short-term ratings other than F1.
NR indicates that Fitch does not rate the issuer or issue in question.
Withdrawn: A rating is withdrawn when Fitch deems the amount of information available to be inadequate for rating purposes, or when an obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify investors that there is a reasonable probability of a rating change and the likely direction of such change. These are designated as Positive, indicating a potential upgrade, Negative, for a potential downgrade, or Evolving, if ratings may be raised, lowered or maintained. Rating Watch is typically resolved over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to move over a one to two year period. Outlooks may be positive, stable, or negative. A positive or negative Rating Outlook does not imply a rating change is inevitable. Similarly, companies whose outlooks are stable could be downgraded before an outlook moves to positive or negative if circumstances warrant such an action. Occasionally, Fitch may be unable to identify the fundamental trend. In these cases, the Rating Outlook may be described as evolving.
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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.
Subject to Completion Dated March 12, 2010
PIMCO INCOME STRATEGY FUND II
(formerly, PIMCO Floating Rate Strategy Fund)
Statement of Additional Information
[ ], 2010
PIMCO Income Strategy Fund II (formerly, PIMCO Floating Rate Strategy Fund) (the Fund) is a diversified, closed-end management investment company. Allianz Global Investors Fund Management LLC (the Investment Manager) serves as investment manager to the Fund, and has retained Pacific Investment Management Company LLC (PIMCO or the Sub-Adviser) to serve as sub-adviser to the Fund.
This Statement of Additional Information relating to the offering of transferable rights to subscribe for common shares of the Fund (the Offer) is not a prospectus, and should be read in conjunction with the Funds prospectus dated [ ], 2010 (the Prospectus). This Statement of Additional Information does not include all information that a prospectus investor should consider before investing in the Fund, and investors should obtain and read the Prospectus prior to investing in the Fund. A copy of the Prospectus may be obtained without charge by calling (800)254-5197. You may also obtain a copy of the Prospectus on the Web site of the Securities and Exchange Commission (the SEC) at http://www.sec.gov. Capitalized terms used but not defined in this Statement of Additional Information have the meanings ascribed to them in the Prospectus.
1
2
The Fund was organized as a Massachusetts business trust on June 30, 2004 under the name PIMCO Floating Rate Strategy Fund. Effective March 1, 2010, the Fund changed its name from PIMCO Floating Rate Strategy Fund to its current name, PIMCO Income Strategy Fund II, and rescinded its prior policy to normally invest at least 80% of its net assets (plus any borrowings for investment purposes) in floating rate assets. The Fund also recently revised various of its investment guidelines and strategies (including those relating to average portfolio duration, investments in below investment grade securities and exposure to emerging market securities) to those reflected in the Prospectus. Prior to commencing operations on October 29, 2004, the Fund had no operations other than matters relating to its organization and registration as a diversified, closed-end management investment company registered under the Investment Company Act of 1940, as amended (the 1940 Act).
The net proceeds of the Offer will be invested in accordance with the Funds investment objective and investment strategies as set forth in the Prospectus. Assuming current market conditions, the Fund estimates that the net proceeds of the Offer will be substantially invested in accordance with its investment objective and investment strategies within one to three months of the completion of the Offer. Pending such investment, it is anticipated that the proceeds of the Offer will be invested in short-term debt securities. Following completion of the Offer, the Fund intends to add leverage in order to maintain approximately the same total amount of leverage (as a percentage of the Funds total assets) as the Fund currently maintains. See Use of leverage in the Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund are described in the Prospectus. Additional information concerning the characteristics of certain of the Funds investments is set forth below.
High Yield Securities (Junk Bonds)
The Fund may invest without limit in debt instruments that are, at the time of purchase, rated below investment grade (below Baa3 by Moodys Investors Service, Inc. (Moodys), below BBB- by either Standard & Poors, a division of the McGraw Hill Companies (S&P), or Fitch, Inc. (Fitch Ratings)), or unrated but judged by PIMCO to be of comparable quality. These securities are sometimes referred to as high yield securities or junk bonds. The Fund will not invest more than 20% of its total assets in securities that are, at the time of purchase, rated CCC/Caa or lower by each agency rating the security or that are unrated but judged by PIMCO to be of comparable quality.
Some of the floating rate loans (Floating Rate Loans) in which the Fund may invest will be high yield securities. See Floating Rate Loans.
3
Investments in high yield securities generally provide greater income and increased opportunity for capital appreciation than investments in higher quality securities, but they also typically entail greater price volatility and principal and income risk, including the possibility of issuer default and bankruptcy. High yield securities are regarded as predominantly speculative with respect to the issuers continuing ability to meet principal and interest payments. Debt securities in the lowest investment grade category also may be considered to possess some speculative characteristics by certain rating agencies. In addition, analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher quality securities.
High yield securities may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade securities. A projection of an economic downturn or of a period of rising interest rates, for example, could cause a decline in high yield security prices because the advent of a recession could lessen the ability of an issuer to make principal and interest payments on its debt obligations. If an issuer of high yield securities defaults, in addition to risking non-payment of all or a portion of interest and principal, the Fund may incur additional expenses to seek recovery. The market prices of high yield securities structured as zero-coupon, step-up or payment-in-kind securities will normally be affected to a greater extent by interest rate changes, and therefore tend to be more volatile than the prices of securities that pay interest currently and in cash. PIMCO seeks to reduce these risks through prudent diversification with respect to industries and issuers, independent and fundamental credit analysis and an emphasis on top-down macroeconomic analysis focused on the developments of structural changes in both the economy and financial markets.
The secondary market on which high yield securities are traded may be less liquid than the market for investment grade securities. Less liquidity in the secondary trading market could adversely affect the price at which the Fund could sell a high yield security, and could adversely affect the net asset value of the shares. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may decrease the values and liquidity of high yield securities, especially in a thinly-traded market. When secondary markets for high yield securities are less liquid than the market for investment grade securities, it may be more difficult to value the lower rated securities because such valuation may require more research, and elements of judgment may play a greater role in the valuation because there is less reliable, objective data available. During periods of thin trading in these markets, the spread between bid and asked prices is likely to increase significantly and the Fund may have greater difficulty selling its portfolio securities. The Fund will be more dependent on PIMCOs research and analysis when investing in high yield securities. PIMCO seeks to minimize the risks of investing through in-depth credit analysis and attention to current developments in interest rates and market conditions.
A general description of the ratings of securities by Moodys, S&P and Fitch Ratings is set forth in Appendix A to the Prospectus. The ratings of Moodys, S&P, and Fitch Ratings represent their opinions as to the quality of the securities they rate. It should be emphasized, however, that ratings are general and are not absolute standards of quality. Consequently, debt obligations with the same maturity, coupon and rating may have different yields while obligations with the same maturity and coupon with different ratings may have the same yield. For these reasons, the use of credit ratings as the sole method of evaluating high yield securities can involve certain risks. For example, credit ratings evaluate the safety of principal and interest payments, not the market value risk of high yield securities. Also, credit rating agencies may fail to change credit ratings in a timely fashion to reflect events since the security was last rated. PIMCO does not rely solely on credit ratings when selecting securities for the Fund, and develops its own independent analysis of issuer credit quality.
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The Funds credit quality policies apply only at the time a security is purchased, and the Fund is not required to dispose of a security in the event that a rating agency or PIMCO downgrades its assessment of the credit characteristics of a particular issue. In determining whether to retain or sell such a security, PIMCO may consider such factors as PIMCOs assessment of the credit quality of the issuer of such security, the price at which such security could be sold and the rating, if any, assigned to such security by other rating agencies. However, analysis of creditworthiness may be more complex for issuers of Floating Rate Loans and other high yield securities than for issuers of higher quality debt securities.
Floating Rate Debt Instruments
The Fund may invest in floating rate debt instruments, including Floating Rate Loans (described in more detail below). Floating rate debt instruments are debt instruments that pay interest at rates that adjust whenever a specified interest rate changes, float at a fixed margin above a generally recognized base lending rate and/or reset or are redetermined ( e.g. , pursuant to an auction) on specified dates (such as the last day of a month or calendar quarter). These floating rate debt instruments may include, in addition to Floating Rate Loans, instruments such as catastrophe bonds, bank capital securities, unsecured bank loans, corporate bonds, money market instruments and certain types of mortgage-backed and other asset-backed securities. Due to their floating rate features, these instruments will generally pay higher levels of income in a rising interest rate environment and lower levels of income as interest rates decline. For the same reason, the market value of a floating rate debt instrument is generally expected to have less sensitivity to fluctuations in market interest rates than a fixed-rate debt instrument, although the value of a floating rate instrument may nonetheless decline as interest rates rise and due to other factors, such as changes in credit quality. The Fund also may invest in inverse floating rate debt instruments (inverse floaters). The interest rate on an inverse floater resets in the opposite direction from the market rate of interest to which the inverse floater is indexed. An inverse floating rate security may exhibit greater price volatility than a fixed rate obligation of similar credit quality.
Floating Rate Loans
The Fund may invest in Floating Rate Loans. Floating Rate Loans include floating rate loans and institutionally traded floating rate debt obligations issued by asset-backed pools and other issues, and interests therein. Loan interests generally take the form of direct interests acquired during a primary distribution and may also take the form of assignments of, novations of, or participations in a Floating Rate Loan acquired in secondary markets. Loan interests may be acquired from U.S. or non-U.S. commercial banks, insurance companies, finance companies or other financial institutions who have made loans or are members of a lending syndicate or from other holders of loan interests.
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Floating Rate Loans typically pay interest at rates which are re-determined periodically on the basis of a floating base lending rate (such as the London Inter-Bank Offered Rate, LIBOR) plus a premium. Although Floating Rate Loans are typically of below investment grade quality, they tend to have more favorable recovery rates than other types of below investment grade quality debt obligations. Floating Rate Loans generally may hold a senior position in the capital structure of a borrower and are often secured with collateral. A Floating Rate Loan is typically originated, negotiated and structured by a U.S. or non-U.S. commercial bank, insurance company, finance company or other financial institution (the Agent) for a lending syndicate of financial institutions (Lenders). The Agent typically administers and enforces the Floating Rate Loan on behalf of the other Lenders in the syndicate. In addition, an institution, typically but not always the Agent, holds any collateral on behalf of the Lenders.
The Fund may purchase assignments and participations in commercial loans, as well as debtor-in-possession loans. Such indebtedness may be secured or unsecured. Loan participations typically represent direct participations in a loan to a corporate borrower, and generally are offered by banks or other financial institutions or lending syndicates. The Fund may participate in such syndications, or can buy part of a loan, becoming a part lender. When purchasing loan participations, the Fund assumes the credit risk associated with the corporate or other borrower and may assume the credit risk associated with an interposed bank or other financial intermediary. The participation interests in which the Fund intends to invest may not be rated by any nationally recognized rating service.
Unless, under the terms of the loan or other indebtedness (such as may be the case in an assignment), the Fund has direct recourse against the borrower, the Fund may have to rely on the Agent or other financial intermediary to apply appropriate credit remedies against a borrower.
Purchasers of loans and other forms of direct indebtedness depend primarily upon the creditworthiness of the corporate or other borrower for payment of principal and interest. If the Fund does not receive scheduled interest or principal payments on such indebtedness, the Funds share price and yield could be adversely affected. Floating Rate Loans that are fully secured offer the Fund more protection than an unsecured loan in the event of non-payment of scheduled interest or principal. However, there is no assurance that the liquidation of collateral from a secured Floating Rate Loan would satisfy the borrowers obligation, or that such collateral could be liquidated.
The Fund may invest in loan participations with credit quality comparable to that of many issuers of its other debt securities investments. Indebtedness of companies whose creditworthiness is poor involves substantially greater risks, and may be highly speculative.
Some companies may never pay off their indebtedness, or may pay only a small fraction of the amount owed. Consequently, when investing in indebtedness of companies with poor credit, the Fund bears a substantial risk of losing the entire amount invested.
Loans and other types of direct indebtedness may not be readily marketable and may be subject to restrictions on resale. In some cases, negotiations involved in disposing of indebtedness may require weeks to complete. Consequently, some indebtedness may be difficult or impossible to dispose of readily at what PIMCO believes to be a fair price. In addition, valuation of illiquid
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indebtedness involves a greater degree of judgment in determining the Funds net asset value than if that value were based on available market quotations. At the same time, many loan interests are actively traded among certain financial institutions and considered to be liquid. PIMCO will determine the liquidity of the Funds investments by reference to market conditions and contractual provisions. Investments in loan participations are considered to be debt obligations for purposes of the Funds investment restriction relating to the lending of funds or assets.
Investments in loans through a direct assignment of the financial institutions interests with respect to the loan may involve additional risks to the Fund. For example, if a loan is foreclosed, the Fund could become part owner of any collateral, and would bear the costs and liabilities associated with owning and disposing of the collateral. In addition, it is conceivable that, under emerging legal theories of lender liability, the Fund could be held liable as co-lender. It is unclear whether loans and other forms of direct indebtedness offer securities law protections against fraud and misrepresentation. In the absence of definitive regulatory guidance, the Fund relies on PIMCOs research in an attempt to avoid situations where fraud or misrepresentations could adversely affect the Fund.
From time to time, PIMCO and its affiliates may borrow money from various banks in connection with their business activities. Such banks may also sell Floating Rate Loans to or acquire them from the Fund or may be intermediate participants with respect to Floating Rate Loans in which the Fund owns interests. Such banks may also act as Agents for Floating Rate Loans held by the Fund.
Lending Fees. In the process of buying, selling and holding Floating Rate Loans, the Fund may receive and/or pay certain fees. These fees are in addition to interest payments received and may include facility fees, commitment fees, commissions and prepayment penalty fees. When the Fund buys a Floating Rate Loan it may receive a facility fee and when it sells a Floating Rate Loan it may pay a facility fee. On an ongoing basis, the Fund may receive a commitment fee based on the undrawn portion of the underlying line of credit portion of the Floating Rate Loan. In certain circumstances, the Fund may receive a prepayment penalty fee upon the prepayment of a Floating Rate Loan by a borrower. Other fees received by the Fund may include covenant waiver fees and covenant modification fees.
Borrower Covenants. A borrower under a Floating Rate Loan typically must comply with various restrictive covenants contained in a loan agreement or note purchase agreement between the borrower and the Lender or lending syndicate (the Loan Agreement). Such covenants, in addition to requiring the scheduled payment of interest and principal, may include restrictions on dividend payments and other distributions to stockholders, provisions requiring the borrower to maintain specific minimum financial ratios and limits on total debt. In addition, the Loan Agreement may contain a covenant requiring the borrower to prepay the Floating Rate Loan with any free cash flow. Free cash flow is generally defined as net cash flow after scheduled debt service payments and permitted capital expenditures, and includes the proceeds from asset dispositions or sales of securities. A breach of a covenant which is not waived by the Agent, or by the lenders directly, as the case may be, is normally an event of acceleration; i.e. , the Agent, or the lenders directly, as the case may be, has the right to call the outstanding Floating Rate Loan. The typical practice of an Agent or a Lender in relying exclusively or primarily on reports from the borrower
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may involve a risk of fraud by the borrower. In the case of a Floating Rate Loan in the form of a participation, the agreement between the buyer and seller may limit the rights of the holder of a Floating Rate Loan to vote on certain changes which may be made to the Loan Agreement, such as waiving a breach of a covenant. However, the holder of the participation will, in almost all cases, have the right to vote on certain fundamental issues such as changes in principal amount, payment dates and interest rate.
Administration of Loans. In a typical Floating Rate Loan, the Agent administers the terms of the Loan Agreement. In such cases, the Agent is normally responsible for the collection of principal and interest payments from the borrower and the apportionment of these payments to the credit of all institutions which are parties to the Loan Agreement. The Fund will generally rely upon the Agent or an intermediate participant to receive and forward to the Fund its portion of the principal and interest payments on the Floating Rate Loan. Furthermore, unless under the terms of a participation agreement the Fund has direct recourse against the borrower, the Fund will rely on the Agent and the other members of the lending syndicate to use appropriate credit remedies against the borrower. The Agent is typically responsible for monitoring compliance with covenants contained in the Loan Agreement based upon reports prepared by the borrower. The seller of the Floating Rate Loan usually does, but is often not obligated to, notify holders of Floating Rate Loans of any failures of compliance. The Agent may monitor the value of the collateral, if any, and if the value of such collateral declines, may accelerate the Floating Rate Loan, may give the borrower an opportunity to provide additional collateral or may seek other protection for the benefit of the participants in the Floating Rate Loan. The Agent is compensated by the borrower for providing these services under a Loan Agreement, and such compensation may include special fees paid upon structuring and funding the Floating Rate Loan and other fees paid on a continuing basis. With respect to Floating Rate Loans for which the Agent does not perform such administrative and enforcement functions, PIMCO will perform such tasks on behalf of the Fund, although a collateral bank will typically hold any collateral on behalf of the Fund and the other lenders pursuant to the applicable Loan Agreement.
A financial institutions appointment as Agent may usually be terminated in the event that it fails to observe the requisite standard of care or becomes insolvent, enters Federal Deposit Insurance Corporation (FDIC) receivership, or, if not FDIC insured, enters into bankruptcy proceedings. A successor Agent would generally be appointed to replace the terminated Agent, and assets held by the Agent under the Loan Agreement should remain available to holders of Floating Rate Loans. However, if assets held by the Agent for the benefit of the Fund were determined to be subject to the claims of the Agents general creditors, the Fund might incur certain costs and delays in realizing payment on a Floating Rate Loan, or suffer a loss of principal and/or interest. In situations involving other intermediate participants similar risks may arise.
Prepayments. Floating Rate Loans usually require, in addition to scheduled payments of interest and principal, the prepayment of the Floating Rate Loan from free cash flow, as defined above. The degree to which borrowers prepay Floating Rate Loans, whether as a contractual requirement or at their election, may be affected by general business conditions, the financial condition of the borrower and competitive conditions among lenders, among others. As such, prepayments cannot be predicted with accuracy. Upon a prepayment, either in part or in full, the actual outstanding debt on which the Fund derives interest income will be reduced. However, the Fund may receive both a prepayment penalty fee from the prepaying borrower and a facility fee upon the purchase of a new Floating Rate Loan with the proceeds from the prepayment of the former.
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Bridge Financings . The Fund may acquire interests in Floating Rate Loans which are designed to provide temporary or bridge financing to a borrower pending the sale of identified assets or the arrangement of longer-term loans or the issuance and sale of debt obligations. The Fund may also invest in Floating Rate Loans of borrowers who have obtained bridge loans from other parties. A borrowers use of bridge loans involves a risk that the borrower may be unable to locate permanent financing to replace the bridge loan, which may impair the borrowers perceived creditworthiness.
Secured Floating Rate Loans. To the extent that the collateral, if any, securing a Floating Rate Loan consists of the stock of the borrowers subsidiaries or other affiliates, the Fund will be subject to the risk that this stock will decline in value. Such a decline, whether as a result of bankruptcy proceedings or otherwise, could cause the Floating Rate Loan to be undercollateralized or unsecured. In most credit agreements there is no formal requirement to pledge additional collateral. In addition, the Fund may invest in Floating Rate Loans guaranteed by, or fully secured by assets of, shareholders or owners, even if the Floating Rate Loans are not otherwise collateralized by assets of the borrower. There may be temporary periods when the principal asset held by a borrower is the stock of a related company, which may not legally be pledged to secure a secured Floating Rate Loan. On occasions when such stock cannot be pledged, the secured Floating Rate Loan will be temporarily unsecured until the stock can be pledged or is exchanged for or replaced by other assets, which will be pledged as security for such Floating Rate Loan. However, the borrowers ability to dispose of such securities, other than in connection with such pledge or replacement, will be strictly limited for the protection of the holders of secured Floating Rate Loans.
If a borrower becomes involved in bankruptcy proceedings, a court may invalidate the Funds security interest in any loan collateral or subordinate the Funds rights under a secured Floating Rate Loan to the interests of the borrowers unsecured creditors. Such action by a court could be based, for example, on a fraudulent conveyance claim to the effect that the borrower did not receive fair consideration for granting the security interest in the loan collateral to the Fund. For secured Floating Rate Loans made in connection with a highly leveraged transaction, consideration for granting a security interest may be deemed inadequate if the proceeds of such loan were not received or retained by the borrower, but were instead paid to other persons, such as shareholders of the borrower, in an amount which left the borrower insolvent or without sufficient working capital. There are also other events, such as the failure to perfect a security interest due to faulty documentation or faulty official filings, which could lead to the invalidation of the Funds security interest in any loan collateral. If the Funds security interest in loan collateral is invalidated or a secured Floating Rate Loan is subordinated to other debt of a borrower in bankruptcy or other proceedings, it is unlikely that the Fund would be able to recover the full amount of the principal and interest due on the secured Floating Rate Loan.
The Fund may also invest in Floating Rate Loans that are not secured by collateral or otherwise.
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Distressed Securities
Securities in which the Fund invests may be subject to significant risk of an issuers inability to meet principal and interest payments on the obligations and also may be subject to price volatility due to such factors as market perception of the creditworthiness of an issuer and general market liquidity. If PIMCOs evaluation of the anticipated outcome of an investment situation should prove incorrect, such Fund investments could experience a loss.
Bonds
The Fund may invest in a variety of bonds and related debt obligations of varying maturities issued by U.S. and non-U.S. corporations, banks and other business entities. Bonds include bills, notes, debentures, money market instruments and similar instruments and securities, and are generally used by corporations and other issuers to borrow money from investors for such purposes as working capital or capital expenditures. The issuer pays the investor a variable or fixed rate of interest and normally must repay the amount borrowed on or before maturity. Certain bonds are perpetual in that they have no maturity date.
The Funds investments in bonds are often subject to a number of risks described in the Prospectus and/or elaborated upon elsewhere in this section of the Statement of Additional Information, including credit risk, high yield risk, interest rate risk, issuer risk, foreign (non-U.S.) investment risk, inflation risk, liquidity risk, smaller company risk and management risk.
Event-Linked Exposure
The Fund may obtain event-linked exposure by investing in event-linked bonds or event-linked swaps, or may implement event-linked strategies. Event-linked exposure results in gains that typically are contingent on the nonoccurrence of a specific trigger event, such as a hurricane, earthquake or other physical or weather-related phenomena. Some event-linked bonds are commonly referred to as catastrophe bonds. They may be issued by government agencies, insurance companies, reinsurers, special purpose corporations or other on-shore or off-shore entities (such special purpose entities are created to accomplish a narrow and well-defined objective, such as the issuance of a note in connection with a reinsurance transaction). If a trigger event causes losses exceeding a specific amount in the geographic region and time period specified in a bond, the Fund may lose a portion or all of its principal invested in the bond. If no trigger event occurs, the Fund will recover its principal plus interest. For some event-linked bonds, the trigger event or losses may be based on company-wide losses, index-portfolio losses, industry indices or readings of scientific instruments rather than specified actual losses. Often the event-linked bonds provide for extensions of maturity that are mandatory, or optional at the discretion of the issuer, in order to process and audit loss claims in those cases where a trigger event has, or possibly has, occurred. An extension of maturity may increase volatility. In addition to the specified trigger events, event-linked bonds also may expose the Fund to certain unanticipated risks including but not limited to issuer risk, credit risk, counterparty risk, adverse regulatory or jurisdictional interpretations and adverse tax consequences.
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Event-linked bonds are a relatively new type of financial instrument. As such, there is no significant trading history for many of these bonds, and there can be no assurance that a liquid market in these bonds will develop. Lack of a liquid market may impose the risk of higher transaction costs and the possibility that the Fund may be forced to liquidate positions when it would not be advantageous to do so. Event-linked bonds are typically rated.
Inflation-Indexed Bonds
The Fund may invest in inflation-indexed bonds, which are debt obligations whose principal value is periodically adjusted according to the rate of inflation. Two structures are common. The U.S. Treasury and some other issuers utilize a structure that accrues inflation into the principal value of the bond. Many other issuers pay out the Consumer Price Index accruals as part of a semiannual coupon.
Inflation-indexed bonds issued by the U.S. Treasury have maturities of approximately five, ten or thirty years, although it is possible that securities with other maturities will be issued in the future. The U.S. Treasury securities pay interest on a semi-annual basis equal to a fixed percentage of the inflation-adjusted principal amount. For example, if the Fund purchased an inflation-indexed bond with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5% semi-annually), and the rate of inflation over the first six months was 1%, the mid-year par value of the bond would be $1,010 and the first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If inflation during the second half of the year resulted in the whole years inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and the second semi-annual interest payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal value of inflation-indexed bonds will be adjusted downward, and consequently the interest payable on these securities (calculated with respect to a smaller principal amount) will be reduced. Repayment of the original bond principal upon maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury inflation-indexed bonds, even during a period of deflation. However, the current market value of the bonds is not guaranteed and will fluctuate. The Fund may also invest in other inflation-related bonds which may or may not provide a similar guarantee. If a guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal amount.
The value of inflation-indexed bonds is expected to change in response to changes in real interest rates. Real interest rates in turn are tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if the rate of inflation rises at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-indexed bonds. In contrast, if nominal interest rates increase at a faster rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-indexed bonds.
While these securities are expected to provide protection from long-term inflationary trends, short-term increases in inflation may lead to a decline in value. If interest rates rise due to reasons other than inflation (for example, due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the bonds inflation measure.
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The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer Price Index for Urban Consumers (CPI-U), which is calculated monthly by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. Inflation-indexed bonds issued by a non-U.S. government are generally adjusted to reflect a comparable inflation index calculated by that government. There can be no assurance that the CPI-U or any non-U.S. inflation index will accurately measure the real rate of inflation in the prices of goods and services. Moreover, there can be no assurance that the rate of inflation in a non-U.S. country will be correlated to the rate of inflation in the United States.
For federal income tax purposes, any increase in the principal amount of an inflation-indexed bond will be original issue discount which is taxable as ordinary income in the year accrued, even though investors do not receive their principal, including any increases thereto, until maturity. See Tax MattersOriginal Issue Discount and Payment-in-Kind Securities.
Mortgage-Related and Other Asset-Backed Securities
The Fund may invest in mortgage-related securities, and may also invest in other asset-backed securities (whether or not related to mortgage loans) that are offered to investors currently or in the future. Mortgage-related securities are interests in pools of residential or commercial mortgage loans, including mortgage loans made by savings and loan institutions, mortgage bankers, commercial banks and others. Pools of mortgage loans are assembled as securities for sale to investors by various governmental, government-related and private organizations. The value of some mortgage-related or asset-backed securities in which the Fund invests may be particularly sensitive to changes in prevailing interest rates, and, like other debt securities, the ability of the Fund to successfully utilize these instruments may depend in part upon the ability of PIMCO to forecast certain macro-economic factors correctly. See Mortgage Pass-Through Securities below. Certain debt obligations are also secured with collateral consisting of mortgage-related securities. See Collateralized Mortgage Obligations (CMOs) below.
The mortgage-related securities in which the Fund may invest may pay variable or fixed rates of interest.
Through investments in mortgage-related securities, including those that are issued by private issuers, the Fund may have some exposure to subprime loans as well as to the mortgage and credit markets generally. Private issuers include commercial banks, savings associations, mortgage companies, investment banking firms, finance companies and special purpose finance entities (called special purpose vehicles or SPVs) and other entities that acquire and package mortgage loans for resale as mortgage-related securities.
In addition, mortgage-related securities that are issued by private issuers are not subject to the underwriting requirements for the underlying mortgages that are applicable to those mortgage-related securities that have a government or government-sponsored entity guarantee. As a result,
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the mortgage loans underlying private mortgage-related securities may, and frequently do, have less favorable collateral, credit risk or other underwriting characteristics than government or government-sponsored mortgage-related securities and have wider variances in a number of terms including interest rate, term, size, purpose and borrower characteristics. Privately issued pools more frequently include second mortgages, high loan-to-value mortgages and manufactured housing loans. The coupon rates and maturities of the underlying mortgage loans in a private-label mortgage-related securities pool may vary to a greater extent than those included in a government guaranteed pool, and the pool may include subprime mortgage loans. Subprime loans refer to loans made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their loans. For these reasons, the loans underlying these securities have had in many cases higher default rates than those loans that meet government underwriting requirements.
The risk of non-payment is greater for mortgage-related securities that are backed by mortgage pools that contain subprime loans, but a level of risk exists for all loans. Market factors adversely affecting mortgage loan repayments may include a general economic turndown, high unemployment, a general slowdown in the real estate market, a drop in the market prices of real estate, or an increase in interest rates resulting in higher mortgage payments by holders of adjustable rate mortgages.
Mortgage Pass-Through Securities. Mortgage pass-through securities are securities representing interests in pools of mortgage loans secured by residential or commercial real property. Interests in pools of mortgage-related securities differ from other forms of debt obligations, which normally provide for periodic payment of interest in fixed or variable amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment which consists of both interest and principal payments. In effect, these payments are a pass-through of the monthly payments made by the individual borrowers on their residential or commercial mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments are caused by repayments of principal resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs which may be incurred. Some mortgage-related securities (such as securities issued by the Government National Mortgage Association (GNMA)) are described as modified pass-through. These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at the scheduled payment dates regardless of whether or not the mortgagor actually makes the payment.
The rate of prepayments on underlying mortgages will affect the price and volatility of a mortgage-related security, and may have the effect of shortening or extending the effective duration of the security relative to what was anticipated at the time of purchase. Early repayment of principal on some mortgage-related securities (arising from prepayments of principal due to the sale of the underlying property, refinancing, or foreclosure, net of fees and costs which may be incurred) may expose the Fund to a lower rate of return upon reinvestment of principal. Also, if a security subject to prepayment has been purchased at a premium, the value of the premium would be lost in the event of prepayment. Like other fixed-rate debt obligations, when interest rates rise, the value of a fixed-rate mortgage-related security generally will decline; however, when interest rates are declining, the value of fixed-rate mortgage-related securities with
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prepayment features may not increase as much as other debt obligations. Adjustable rate mortgage-related and other asset-backed securities are also subject to some interest rate risk. For example, because interest rates on most adjustable rate mortgage- and other asset-backed securities only reset periodically ( e.g. , monthly or quarterly), changes in prevailing interest rates (and particularly sudden and significant changes) can be expected to cause some fluctuations in the market value of these securities, including declines in value as interest rates rise. In addition, to the extent that unanticipated rates of prepayment on underlying mortgages increase the effective maturity of a mortgage-related security, the volatility of such security can be expected to increase.
The residential mortgage market in the United States recently has experienced difficulties that may adversely affect the performance and market value of certain of the Funds mortgage-related investments. Delinquencies and losses on residential mortgage loans (especially subprime and second-lien mortgage loans) generally have increased recently and may continue to increase, and a decline in or flattening of housing values (as has recently been experienced and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have recently experienced serious financial difficulties or bankruptcy. Owing largely to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.
Payment of principal and interest on some mortgage pass-through securities (but not the market value of the securities themselves) may be guaranteed by the full faith and credit of the U.S. Government (in the case of securities guaranteed by GNMA) or guaranteed by agencies or instrumentalities of the U.S. Government (in the case of securities guaranteed by the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). The principal governmental guarantor of mortgage-related securities is GNMA. GNMA is a wholly-owned U.S. Government corporation within the Department of Housing and Urban Development. GNMA is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by institutions approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of mortgages insured by the Federal Housing Administration (the FHA), or guaranteed by the Department of Veterans Affairs (the VA).
Government-related guarantors ( i.e. , not backed by the full faith and credit of the U.S. Government) include the FNMA and the FHLMC. FNMA was, until recently, a government-sponsored corporation owned entirely by private stockholders and subject to general regulation by the Department of Housing and Urban Development and the Office of Federal Housing Enterprise Oversight. As described below under U.S. Government Securities, FNMA is now under conservatorship by the FHFA. FNMA primarily purchases conventional ( i.e. , not insured or guaranteed by any government agency) residential mortgages from a list of approved
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seller/servicers, which includes state and federally chartered savings and loan associations, mutual savings banks, commercial banks, and credit unions and mortgage bankers, although it may purchase other types of mortgages as well. Pass-through securities issued by FNMA are guaranteed as to timely payment of principal and interest by FNMA but are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agencys obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the availability of mortgage credit for residential housing. It was, until recently, a government-sponsored corporation formerly owned by the twelve Federal Home Loan Banks and then owned entirely by private stockholders. As described above under Government Securities, FHLMC is now under in conservatorship by the FHFA. FHLMC issues Participation Certificates (PCs) which represent interests in conventional mortgages from FHLMCs national portfolio. FHLMC guarantees the timely payment of interest and ultimate collection of principal, but PCs are not backed by the full faith and credit of the U.S. Government. Instead, they are supported only by the discretionary authority of the U.S. Government to purchase the agencys obligations.
On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed FNMA and FHLMC into conservatorship. As the conservator, FHFA succeeded to all rights, titles, powers and privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. FHFA selected a new chief executive officer and chairman of the board of directors for each of FNMA and FHLMC.
On September 7, 2008, the U.S. Treasury announced three additional steps taken by it in connection with the conservatorship. First, the U.S. Treasury entered into a Senior Preferred Stock Purchase Agreement with each of FNMA and FHLMC pursuant to which the U.S. Treasury will purchase up to an aggregate of $100 billion of each of FNMA and FHLMC to maintain a positive net worth in each enterprise. This agreement contains various covenants that severely limit each enterprises operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprises senior preferred stock and warrants to purchase 79.9% of each enterprises common stock. Second, the U.S. Treasury announced the creation of a new secured lending facility which is available to each of FNMA and FHLMC as a liquidity backstop. Third, the U.S. Treasury announced the creation of a temporary program to purchase mortgage-backed securities issued by each of FNMA and FHLMC. On February 18, 2009, the U.S. Treasury announced that it was doubling the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasurys obligations under the Senior Preferred Stock Program are for an indefinite period of time for a maximum amount of $200 billion per enterprise. Both the liquidity backstop and the mortgage-backed securities purchase program expired December 31, 2009.
FNMA and FHLMC are continuing to operate as going concerns while in conservatorship and each remain liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. The liquidity backstop and the Senior Preferred Stock Purchase Agreement are both intended to enhance each of FNMAs and FHLMCs ability to meet its obligations.
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Under the Federal Housing Finance Regulatory Reform Act of 2008 (the Reform Act), which was included as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by FNMA or FHLMC prior to FHFAs appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly administration of FNMAs or FHLMCs affairs. The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver.
FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of FNMA or FHLMC because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for FNMA or FHLMC, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of FNMAs or FHLMCs assets available therefor.
In the event of repudiation, the payments of interest to holders of FNMA or FHLMC mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such mortgage-backed securities are not made by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders.
Further, in its capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of FNMA or FHLMC without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as conservator or receiver, were to transfer any such guaranty obligation to another party, holders of FNMA or FHLMC mortgage-backed securities would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party.
In addition, certain rights provided to holders of mortgage-backed securities issued by FNMA and FHLMC under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or any future receivership. The operative documents for FNMA and FHLMC mortgage backed securities may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided) that upon the occurrence of an event of default on the part of FNMA or FHLMC, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right to replace FNMA or FHLMC as trustee if the requisite percentage of mortgage-backed securities holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has been appointed. The Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which FNMA or FHLMC is a party, or obtain possession of or exercise control over any property of FNMA or FHLMC, or affect any contractual rights of FNMA or FHLMC, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days following the appointment of FHFA as conservator or receiver, respectively.
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Commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market issuers also create pass-through pools of conventional residential mortgage loans. Such issuers may, in addition, be the originators and/or servicers of the underlying mortgage loans as well as the guarantors of the mortgage-related securities. Pools created by such non-governmental issuers generally offer a higher rate of interest than government and government-related pools because there are no direct or indirect government or agency guarantees of payments in such pools. However, timely payment of interest and principal of these pools may be supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance and letters of credit. The insurance and guarantees are issued by governmental entities, private insurers and the mortgage poolers. There can be no assurance that the private insurers or guarantors can meet their obligations under the insurance policies or guarantee arrangements. Securities issued by certain private organizations may not be readily marketable.
Mortgage-related securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities, are not subject to the Funds industry concentration restriction (see Investment Restrictions) by virtue of the exclusion from that restriction available to all U.S. Government securities. The assets underlying such securities may be represented by a portfolio of first lien residential mortgages (including both whole mortgage loans and mortgage participation interests) or portfolios of mortgage pass-through securities issued or guaranteed by GNMA, FNMA or FHLMC. Mortgage loans underlying a mortgage-related security may in turn be insured or guaranteed by the FHA or the VA. In the case of private issue mortgage-related securities whose underlying assets are neither U.S. Government securities nor U.S. Government insured mortgages, to the extent that real properties securing such assets may be located in the same geographical region, the security may be subject to a greater risk of default than other comparable securities in the event of adverse economic, political or business developments that may affect such region and, ultimately, the ability of residential homeowners to make payments of principal and interest on the underlying mortgages.
Collateralized Mortgage Obligations (CMOs). A CMO is a hybrid between a mortgage-backed bond and a mortgage pass-through security. Similar to a bond, interest and prepaid principal is paid, in most cases, semi-annually or on a monthly basis. CMOs may be collateralized by whole mortgage loans, but are more typically collateralized by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or FNMA, and their income streams.
CMOs are structured into multiple classes, often referred to as tranches, with each class bearing a different stated maturity and entitled to a different schedule for payments of principal and interest, including prepayments. Actual maturity and average life will depend upon the prepayment experience of the collateral. CMOs provide for a modified form of call protection through a de facto breakdown of the underlying pool of mortgages according to how quickly the loans are repaid. Monthly payment of principal received from the pool of underlying mortgages,
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including prepayments, is first returned to investors holding the shortest maturity class. Investors holding the longer maturity classes receive principal only after the first class has been retired. An investor is partially guarded against a sooner than desired return of principal because of the sequential payments.
In a typical CMO transaction, a corporation (issuer) issues multiple series ( e.g. , A, B, C, Z) of CMO bonds (the Bonds). Proceeds of the Bond offering are used to purchase mortgages or mortgage pass-through certificates (the Collateral). The Collateral is pledged to a third party trustee as security for the Bonds. Principal and interest payments from the Collateral are used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B and C Bonds all bear current interest. Interest on the Series Z Bond is accrued and added to principal and a like amount is paid as principal on the Series A, B or C Bond currently being paid off. When the Series A, B and C Bonds are paid in full, interest and principal on the Series Z Bond begin to be paid currently. With some CMOs, the issuer serves as a conduit to allow loan originators (primarily builders or savings and loan associations) to borrow against their loan portfolios. CMOs may be less liquid and may exhibit greater price volatility than other types of mortgage- or asset-backed securities.
CMOs that are issued or guaranteed by the U.S. Government or by any of its agencies or instrumentalities will be considered U.S. Government securities by the Fund, while other CMOs, even if collateralized by U.S. Government securities, will have the same status as other privately issued securities for purposes of applying the Funds diversification tests.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations of FHLMC issued in multiple classes having different maturity dates which are secured by the pledge of a pool of conventional mortgage loans purchased by FHLMC. Payments of principal and interest on the CMOs are made semi-annually, as opposed to monthly. The amount of principal payable on each semi-annual payment date is determined in accordance with FHLMCs mandatory sinking fund schedule, which in turn, is equal to approximately 100% of FHA prepayment experience applied to the mortgage collateral pool. All sinking fund payments in the CMOs are allocated to the retirement of the individual classes of bonds in the order of their stated maturities. Payments of principal on the mortgage loans in the collateral pool in excess of the amount of FHLMCs minimum sinking fund obligation for any payment date are paid to the holders of the CMOs as additional sinking fund payments. Because of the pass-through nature of all principal payments received on the collateral pool in excess of FHLMCs minimum sinking fund requirement, the rate at which principal of the CMOs is actually repaid is likely to be such that each class of bonds will be retired in advance of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans during any semi-annual payment period is not sufficient to meet FHLMCs minimum sinking fund obligation on the next sinking fund payment date, FHLMC agrees to make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in the event of delinquencies and/or defaults.
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Commercial Mortgage-Backed Securities. Commercial mortgage-backed securities include securities that reflect an interest in, and are secured by, mortgage loans on commercial real property. Many of the risks of investing in commercial mortgage-backed securities reflect the risks of investing in the real estate securing the underlying mortgage loans. These risks reflect the effects of local and other economic conditions on real estate markets, the ability of tenants to make loan payments, and the ability of a property to attract and retain tenants. Commercial mortgage-backed securities may be less liquid and exhibit greater price volatility than other types of mortgage- or asset-backed securities.
CMO Residuals. CMO residuals are mortgage securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is applied first to make required payments of principal and interest on the CMOs and second to pay the related administrative expenses of the issuer. The residual in a CMO structure generally represents the interest in any excess cash flow remaining after making the foregoing payments. Each payment of such excess cash flow to a holder of the related CMO residual represents income and/or a return of capital. The amount of residual cash flow resulting from a CMO will depend on, among other things, the characteristics of the mortgage assets, the coupon rate of each class of CMO, prevailing interest rates, the amount of administrative expenses and the prepayment experience on the mortgage assets. In particular, the yield to maturity on CMO residuals is extremely sensitive to prepayments on the related underlying mortgage assets. In addition, if a series of a CMO includes a class that bears interest at an adjustable rate, the yield to maturity on the related CMO residual will also be extremely sensitive to changes in the level of the index upon which interest rate adjustments are based. The Fund may fail to recoup some or all of its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors through several investment banking firms acting as brokers or dealers. The CMO residual market has developed fairly recently and CMO residuals currently may not have the liquidity of other more established securities trading in other markets. CMO residuals may, or pursuant to an exemption therefrom, may not, have been registered under the Securities Act of 1933, as amended (the 1933 Act). CMO residuals, whether or not registered under the 1933 Act, may be subject to certain restrictions on transferability, and may be deemed illiquid. As used in this Statement of Additional Information, the term CMO residual does not include residual interests in real estate mortgage investment conduits.
Adjustable Rate Mortgage Backed Securities. Adjustable rate mortgage-backed securities (ARMBSs) have interest rates that reset at periodic intervals. Acquiring ARMBSs permits the Fund to participate in increases in prevailing current interest rates through periodic adjustments in the coupons of mortgages underlying the pool on which ARMBSs are based. Such ARMBSs generally have higher current yield and lower price fluctuations than is the case with more traditional fixed income debt securities of comparable rating and maturity. In addition, when prepayments of principal are made on the underlying mortgages during periods of rising interest
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rates, the Fund can reinvest the proceeds of such prepayments at rates higher than those at which they were previously invested. Mortgages underlying most ARMBSs, however, have limits on the allowable annual or lifetime increases that can be made in the interest rate that the mortgagor pays. Therefore, if current interest rates rise above such limits over the period of the limitation, the Fund if holding an ARMBS does not benefit from further increases in interest rates. Moreover, when interest rates are in excess of coupon rates ( i.e. , the rates being paid by mortgagors) of the mortgages, ARMBSs behave more like fixed income securities and less like adjustable rate securities and are subject to the risks associated with fixed income securities. In addition, during periods of rising interest rates, increases in the coupon rate of adjustable rate mortgages generally lag current market interest rates slightly, thereby creating the potential for capital depreciation on such securities.
Stripped Mortgage-Backed Securities . SMBS are derivative multi-class mortgage securities. SMBS may be issued by agencies or instrumentalities of the U.S. Government, or by private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage banks, commercial banks, investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different proportions of the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class receiving some of the interest and most of the principal from the mortgage assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the IO class), while the other class will receive all of the principal (the principal-only or PO class). The yield to maturity on an IO class is extremely sensitive to the rate of principal payments (including pre-payments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on the Funds yield to maturity from these securities. If the underlying mortgage assets experience greater than anticipated pre-payments of principal, the Fund may fail to recoup some or all of its initial investment in these securities even if the security is in one of the highest rating categories.
Other Mortgage-Related Securities. Other mortgage-related securities include securities other than those described above that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property, including CMO residuals and stripped mortgage-backed securities. Other mortgage-related securities may be equity or debt securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks, partnerships, trusts and special purpose entities of the foregoing.
Asset-Backed Securities. The Fund may invest in, or have exposure to, asset-backed securities, which are securities that represent a participation in, or are secured by and payable from, a stream of payments generated by particular assets, most often a pool or pools of similar assets ( e.g. , trade receivables). The credit quality of these securities depends primarily upon the quality of the underlying assets and the level of credit support and/or enhancement provided.
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The underlying assets ( e.g. , loans) are subject to prepayments which shorten the securities weighted average maturity and may lower their return. If the credit support or enhancement is exhausted, losses or delays in payment may result if the required payments of principal and interest are not made. The value of these securities also may change because of changes in the markets perception of the creditworthiness of the servicing agent for the pool, the originator of the pool, or the financial institution or trust providing the credit support or enhancement. Typically, there is no perfected security interest in the collateral that relates to the financial assets that support asset-backed securities. Asset-backed securities have many of the same characteristics and risks as the mortgage backed securities described above.
The Fund may purchase or have exposure to commercial paper, including asset-backed commercial paper (ABCP), that is issued by structured investment vehicles or other conduits. These conduits may be sponsored by mortgage companies, investment banking firms, finance companies, hedge funds, private equity firms and special purpose finance entities. ABCP typically refers to a short-term debt security, the payment of which is supported by cash flows from underlying assets, or one or more liquidity or credit support providers, or both. Assets backing ABCP include credit card, car loan and other consumer receivables and home or commercial mortgages, including subprime mortgages. The repayment of ABCP issued by a conduit depends primarily on the cash collections received from the conduits underlying asset portfolio and the conduits ability to issue new ABCP. Therefore, there could be losses to the Fund if investing in ABCP in the event of credit or market value deterioration in the conduits underlying portfolio, mismatches in the timing of the cash flows of the underlying asset interests and the repayment obligations of maturing ABCP, or the conduits inability to issue new ABCP. To protect investors from these risks, ABCP programs may be structured with various protections, such as credit enhancement, liquidity support, and commercial paper stop-issuance and wind-down triggers. However there can be no guarantee that these protections will be sufficient to prevent losses to investors in ABCP. Some ABCP programs provide for an extension of the maturity date of the ABCP if, on the related maturity date, the conduit is unable to access sufficient liquidity through the issue of additional ABCP. This may delay the sale of the underlying collateral and the Fund may incur a loss if the value of the collateral deteriorates during the extension period. Alternatively, if collateral for ABCP deteriorates in value, the collateral may be required to be sold at inopportune times or at prices insufficient to repay the principal and interest on the ABCP. ABCP programs may provide for the issuance of subordinated notes as an additional form of credit enhancement. The subordinated notes are typically of a lower credit quality and have a higher risk of default. To the extent the Fund purchases these subordinated notes, it will have a higher likelihood of loss than investors in the senior notes.
Collateralized Debt Obligations. The Fund may invest in Collateralized Debt Obligations (CDOs), which include collateralized bond obligations (CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. CBOs and CLOs are types of asset-backed securities. A CBO is a trust which is backed by a diversified pool of high risk, below investment grade fixed income securities. A CLO is a trust typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent unrated loans. CDOs may charge management fees and administrative expenses.
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For both CBOs and CLOs, the cash flows from the trust are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the residual or equity tranche which bears the bulk of defaults from the bonds or loans in the trust and serves to protect the other, more senior tranches from default in all but the most severe circumstances. Since it is partially protected from defaults, a senior tranche from a CBO trust or CLO trust typically has higher ratings and lower yields than underlying securities, and can be rated investment grade. Despite the protection from the equity tranche, CBO or CLO tranches can experience substantial losses due to actual defaults, downgrades of the underlying collateral by rating agencies, forced liquidation of the collateral pool due to a failure of coverage tests, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults, as well as aversion to CBO or CLO securities as a class. Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash), which involves continued exposure to default risk with respect to such payments.
The risks of an investment in a CDO depend largely on the type of the collateral securities and the class of the CDO in which the Fund invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus, are not registered under the securities laws. As a result, investments in CDOs may be characterized by the Fund as illiquid securities; however, an active dealer market may exist for CDOs allowing a CDO to qualify for Rule 144A transactions. In addition to the normal risks associated with debt instruments discussed elsewhere in this Statement of Additional Information and the Prospectus ( e.g. , interest rate risk and default risk), CDOs carry additional risks that include, but are not limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization (NRSRO); (iii) the Fund may invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) risk of forced fire sale liquidation due to technical defaults such as coverage test failures; and (viii) the CDOs manager may perform poorly.
Other Asset-Backed Securities. Other asset-backed securities (unrelated to mortgage loans) will be offered to investors in the future and may be purchased by the Fund. Several types of asset-backed securities have already been offered to investors, including Enhanced Equipment Trust Certificates (EETCs) and Certificates for Automobile Receivables SM (CARS SM ).
Although any entity may issue EETCs, to date, U.S. airlines are the primary issuers. An airline EETC is an obligation secured directly by aircraft or aircraft engines as collateral. Airline EETCs generally have credit enhancement in the form of over-collateralization and cross-subordination ( i.e. , multiple tranches and multiple aircraft as collateral). They also generally have a dedicated liquidity facility provided by a third-party insurer to insure that coupon payments are made on a
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timely basis until collateral is liquidated in the event of a default by the lessor of the collateral. Aircraft EETCs issued by registered U.S. carriers also benefit from a special section of the U.S. Bankruptcy Code, which allows the aircraft to be sold by the trust holding the collateral to repay note holders without participating in bankruptcy proceedings. EETCs tend to be less liquid than bonds.
CARS SM represent undivided fractional interests in a trust whose assets consist of a pool of motor vehicle retail installment sales contracts and security interests in the vehicles securing the contracts. Payments of principal and interest on CARS SM are passed through monthly to certificate holders, and are guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution unaffiliated with the trustee or originator of the trust. An investors return on CARS SM may be affected by early prepayment of principal on the underlying vehicle sales contracts. If the letter of credit is exhausted, the trust may be prevented from realizing the full amount due on a sales contract because of state law requirements and restrictions relating to foreclosure sales of vehicles and the obtaining of deficiency judgments following such sales or because of depreciation, damage or loss of a vehicle, the application of federal and state bankruptcy and insolvency laws, or other factors. As a result, certificate holders may experience delays in payments or losses if the letter of credit is exhausted.
Consistent with the Funds investment objective and policies, PIMCO also may invest in other types of asset-backed securities. Other asset-backed securities may be collateralized by the fees earned by service providers. The value of asset-backed securities may be substantially dependent on the servicing of the underlying asset pools and are therefore subject to risks associated with the negligence by, or defalcation of, their servicers. In certain circumstances, the mishandling of related documentation may also affect the rights of the security holders in and to the underlying collateral. The insolvency of entities that generate receivables or that utilize the assets may result in added costs and delays in addition to losses associated with a decline in the value of the underlying assets.
Investors should note that Congress from time to time may consider actions that would limit or remove the explicit or implicit guarantee of the payment of principal and/or interest on many types of asset-backed securities. Any such action would likely adversely impact the value of such securities.
Real Estate Securities and Related Derivatives
The Fund may gain exposure to the real estate sector by investing in real estate-linked derivatives, real estate investment trusts (REITs) and common, preferred and convertible securities of issuers in real estate-related industries. Each of these types of investments is subject to risks similar to those associated with direct ownership of real estate, including loss to casualty or condemnation, increases in property taxes and operating expenses, zoning law amendments, changes in interest rates, overbuilding and increased competition, variations in market value and possible environmental liabilities.
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REITs are pooled investment vehicles that own, and typically operate, income-producing real estate. If a REIT meets certain requirements, including distributing to shareholders annually substantially all of its taxable income (other than net capital gains), then it is not taxed on the income distributed to shareholders. REITs are subject to management fees and other expenses, and so the Fund would bear its proportionate share of the costs of the REITs operations.
There are three general categories of REITs: Equity REITs, Mortgage REITs and Hybrid REITs. Equity REITs invest primarily in direct fee ownership or leasehold ownership of real property; they derive most of their income from rents. Mortgage REITs invest mostly in mortgages on real estate, which may secure construction, development or long-term loans, and the main source of their income is mortgage interest payments. Hybrid REITs hold both ownership and mortgage interests in real estate.
Along with the risks common to different types of real estate-related securities, REITs, no matter the type, involve additional risk factors. These include poor performance by the REITs manager, changes to the tax laws, and failure by the REIT to qualify for tax-free distribution of income or exemption under the 1940 Act. Furthermore, REITs are not diversified and are heavily dependent on cash flow.
Bank Capital Securities and Obligations
The Fund may invest in bank capital securities. Bank capital securities are issued by banks to help fulfill their regulatory capital requirements. There are three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. Bank capital is generally, but not always, of investment grade quality. Upper Tier II securities are commonly thought of as hybrids of debt and preferred stock. Upper Tier II securities are often perpetual (with no maturity date), callable and have a cumulative interest deferral feature. This means that under certain conditions, the issuer bank can withhold payment of interest until a later date. However, such deferred interest payments generally earn interest. Tier I securities often take the form of trust preferred securities.
The Fund may also invest in other bank obligations including certificates of deposit, bankers acceptances and fixed time deposits. Certificates of deposit are negotiable certificates that are issued against funds deposited in a commercial bank for a definite period of time and that earn a specified return. Bankers acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Fixed time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. There are generally no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is generally no market for such deposits. The Fund may also hold funds on deposit with its custodian bank in an interest-bearing account for temporary purposes.
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Delayed Funding Loans and Revolving Credit Facilities
The Fund may enter into, or acquire participations in, delayed funding loans and revolving credit facilities. Delayed funding loans and revolving credit facilities are borrowing arrangements in which the lender agrees to make loans up to a maximum amount upon demand by the borrower during a specified term. A revolving credit facility differs from a delayed funding loan in that as the borrower repays the loan, an amount equal to the repayment may be borrowed again during the term of the revolving credit facility. Delayed funding loans and revolving credit facilities usually provide for floating or variable rates of interest. These commitments may have the effect of requiring the Fund to increase its investment in a company at a time when it might not otherwise be desirable to do so (including a time when the companys financial condition makes it unlikely that such amounts will be repaid).
The Fund may invest in delayed funding loans and revolving credit facilities with credit quality comparable to that of issuers of its securities investments. Delayed funding loans and revolving credit facilities may be subject to restrictions on transfer, and only limited opportunities may exist to resell such instruments. As a result, the Fund may be unable to sell such investments at an opportune time or may have to resell them at less than fair market value. Delayed funding loans and revolving credit facilities are considered to be debt obligations for the purposes of the Funds investment restriction relating to the lending of funds or assets by the Fund.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in bearer form by corporations such as banks or bank holding companies and finance companies. The Fund may invest in commercial paper of any credit quality consistent with the Funds investment objective and policies, including unrated commercial paper for which PIMCO has made a credit quality assessment. See Appendix A to the Prospectus for a description of the ratings assigned by Moodys, S&P and Fitch Ratings to commercial paper. The rate of return on commercial paper may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities. The U.S. Government does not guarantee the net asset value of the Funds shares. Some U.S. Government securities, such as Treasury bills, notes and bonds, and securities guaranteed by the GNMA, are supported by the full faith and credit of the United States; others, such as those of the Federal Home Loan Banks, are supported by the right of the issuer to borrow from the U.S. Treasury; others, such as those of the FNMA, are supported by the discretionary authority of the U.S. Government to purchase the agencys obligations; and still others, such as those of the Student Loan Marketing Association, are supported only by the credit of the instrumentality.
U.S. Government securities include securities that have no coupons, or have been stripped of their unmatured interest coupons, individual interest coupons from such securities that trade separately, and evidences of receipt of such securities. Such securities may pay no cash income, and are purchased at a deep discount from their value at maturity. See Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities. Custodial receipts issued in connection with so-called trademark zero-coupon securities, such as CATs and TIGRs, are not issued by the U.S.
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Treasury, and are therefore not U.S. Government securities, although the underlying bond represented by such receipt is a debt obligation of the U.S. Treasury. Other zero-coupon Treasury securities ( e.g. , STRIPs and CUBEs) are direct obligations of the U.S. Government.
Preferred Stock
Preferred stock represents an equity interest in a company that generally entitles the holder to receive, in preference to the holders of other stocks such as common stocks, dividends and a fixed share of the proceeds resulting from a liquidation of the company. Some preferred stocks also entitle their holders to receive additional liquidation proceeds on the same basis as holders of a companys common stock, and thus also represent an ownership interest in that company. The Fund may invest in preferred stocks that pay variable or fixed rates of return. The value of a companys preferred stock may fall as a result of factors relating directly to that companys products or services. A preferred stocks value may also fall because of factors affecting not just the company, but companies in the same industry or in a number of different industries, such as increases in production costs. The value of preferred stock may also be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a companys preferred stock generally pays dividends only after the company makes required payments to holders of its bonds and other debt. For this reason, the value of the preferred stock will usually react more strongly than bonds and other debt to actual or perceived changes in the companys financial condition or prospects. Preferred stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies.
Adjustable Rate and Auction Preferred Stocks. Typically, the dividend rate on an adjustable rate preferred stock is determined prospectively each quarter by applying an adjustment formula established at the time of issuance of the stock. Although adjustment formulas vary among issues, they typically involve a fixed premium or discount relative to rates on specified debt securities issued by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed premium or discount adjustment relative to the highest base yield of three specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year Treasury note and the 20-year Treasury bond. The premium or discount adjustment to be added to or subtracted from this highest U.S. Treasury base rate yield is fixed at the time of issue and cannot be changed without the approval of the holders of the stock. The dividend rate on other preferred stocks in which the Fund may invest, commonly known as auction preferred stocks, is adjusted at intervals that may be more frequent than quarterly, such as every 49 days, based on bids submitted by holders and prospective purchasers of such stocks and may be subject to stated maximum and minimum dividend rates. The issues of most adjustable rate and auction preferred stocks currently outstanding are perpetual, but are redeemable after a specified date at the option of the issuer. Certain issues supported by the credit of a high-rated financial institution provide for mandatory redemption prior to expiration of the credit arrangement. No redemption can occur if full cumulative dividends are not paid. Although the dividend rates on adjustable and auction preferred stocks are generally adjusted or reset frequently, the market values of these preferred stocks may still fluctuate in response to changes in interest rates. Market values of adjustable preferred stocks also may substantially fluctuate if interest rates increase or decrease once the maximum or minimum dividend rate for a particular stock is approached. Auctions for U.S.
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auction preferred stocks have failed since early 2008, and the dividend rates payable on such preferred shares since that time typically have been paid at their maximum applicable rate (typically a function of a reference rate of interest). The Fund expects that auction preferred stocks will continue to pay dividends at their maximum applicable rate for the foreseeable future and cannot predict whether or when the auction markets for auction preferred stocks may resume normal functioning.
Fixed Rate Preferred Stocks. Some fixed rate preferred stocks in which the Fund may invest, known as perpetual preferred stocks, offer a fixed return with no maturity date. Because they never mature, perpetual preferred stocks act like long-term bonds, can be more volatile than other types of preferred stocks that have a maturity date and may have heightened sensitivity to changes in interest rates. The Fund may also invest in sinking fund preferred stocks. These preferred stocks also offer a fixed return, but have a maturity date and are retired or redeemed on a predetermined schedule. The shorter duration of sinking fund preferred stocks makes them perform somewhat like intermediate-term bonds and they typically have lower yields than perpetual preferred stocks.
Common Stock
Common stock generally takes the form of shares in a corporation. The value of a companys stock may fall as a result of factors directly relating to that company, such as decisions made by its management or lower demand for the companys products or services. A stocks value also may fall because of factors affecting not just the company, but also companies in the same industry or in a number of different industries, such as increases in production costs. The value of a companys stock also may be affected by changes in financial markets that are relatively unrelated to the company or its industry, such as changes in interest rates or currency exchange rates. In addition, a companys stock generally pays dividends only after the company invests in its own business and makes required payments to holders of its bonds, other debt and preferred stock. For this reason, the value of a companys stock will usually react more strongly than its bonds, other debt and preferred stock to actual or perceived changes in the companys financial condition or prospects. Stocks of smaller companies may be more vulnerable to adverse developments than those of larger companies. Stocks of companies that the portfolio managers believe are fast-growing may trade at a higher multiple of current earnings than other stocks. The value of such stocks may be more sensitive to changes in current or expected earnings than the values of other stocks.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon securities are debt obligations that do not entitle the holder to any periodic payments of interest either for the entire life of the obligation or for an initial period after the issuance of the obligations. Like zero-coupon bonds, step-up bonds pay no interest initially but eventually begin to pay a coupon rate prior to maturity, which rate may increase at stated intervals during the life of the security. Payment-in-kind securities (PIKs) pay dividends or interest in the form of additional securities of the issuer, rather than in cash. Each of these instruments is typically issued and traded at a deep discount from its face amount. The amount of the discount varies depending on such factors as the time remaining until maturity of the
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securities, prevailing interest rates, the liquidity of the security and the perceived credit quality of the issuer. The market prices of zero-coupon bonds, step-ups and PIKs generally are more volatile than the market prices of debt instruments that pay interest currently and in cash and are likely to respond to changes in interest rates to a greater degree than do other types of securities having similar maturities and credit quality.
In order to satisfy a requirement for qualification as a regulated investment company under the Internal Revenue Code of 1986, as amended (the Code), an investment company, such as the Fund, must distribute each year at least 90% of its net investment income, including the original issue discount accrued on zero-coupon bonds, step-ups and PIKs. Because the Fund will not, on a current basis, receive cash payments from the issuer of these securities in respect of any accrued original issue discount, in some years, the Fund may have to sell other portfolio holdings in order to obtain cash to satisfy the distribution requirements under the Code even though investment considerations might otherwise make it undesirable for the Fund to sell securities at such time. Under many market conditions, investments in zero-coupon bonds, step-ups and PIKs may be illiquid, making it difficult for the Fund to dispose of them or determine their current value.
Convertible Securities and Synthetic Convertible Securities
A convertible security is a bond, debenture, note, preferred stock, or other security that entitles the holder to acquire common stock or other equity securities of the same or a different issuer. A convertible security generally entitles the holder to receive interest paid or accrued until the convertible security matures or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to non-convertible debt or preferred securities, as applicable.
Convertible securities rank senior to common stock in a corporations capital structure and, therefore, generally entail less risk than the corporations common stock, although the extent to which such risk is reduced depends in large measure upon the degree to which the convertible security sells above its value as a fixed income security. Convertible securities are subordinate in rank to any senior debt obligations of the issuer, and, therefore, an issuers convertible securities entail more risk than its debt obligations. Convertible securities generally offer lower interest or dividend yields than non-convertible debt securities of similar credit quality because of the potential for capital appreciation. In addition, convertible securities are often lower-rated securities.
Because of the conversion feature, the price of the convertible security will normally fluctuate in some proportion to changes in the price of the underlying asset, and as such is subject to risks relating to the activities of the issuer and/or general market and economic conditions. The income component of a convertible security may tend to cushion the security against declines in the price of the underlying asset. However, the income component of convertible securities causes fluctuations based upon changes in interest rates and the credit quality of the issuer.
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If the convertible securitys conversion value, which is the market value of the underlying common stock that would be obtained upon the conversion of the convertible security, is substantially below the investment value, which is the value of a convertible security viewed without regard to its conversion feature ( i.e. , strictly on the basis of its yield), the price of the convertible security is governed principally by its investment value. If the conversion value of a convertible security increases to a point that approximates or exceeds its investment value, the value of the security will be principally influenced by its conversion value. A convertible security will sell at a premium over its conversion value to the extent investors place value on the right to acquire the underlying common stock while holding an income-producing security.
A convertible security may be subject to redemption at the option of the issuer at a predetermined price. If a convertible security held by the Fund is called for redemption, the Fund would be required to permit the issuer to redeem the security and convert it to underlying common stock, or would sell the convertible security to a third party, which may have an adverse effect on the Funds ability to achieve its investment objective.
A third party or PIMCO also may create a synthetic convertible security by combining separate securities that possess the two principal characteristics of a traditional convertible security, i.e. , an income-producing security (income producing component) and the right to acquire an equity security (convertible component). The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments, which may be represented by derivative instruments. The convertible component is achieved by investing in securities or instruments such as warrants or options to buy common stock at a certain exercise price, or options on a stock index. Unlike a traditional convertible security, which is a single security having a single market value, a synthetic convertible comprises two or more separate securities, each with its own market value.
Therefore, the market value of a synthetic convertible security is the sum of the values of its income-producing component and its convertible component. For this reason, the values of a synthetic convertible security and a traditional convertible security may respond differently to market fluctuations.
More flexibility is possible in the assembly of a synthetic convertible security than in the purchase of a convertible security. Although synthetic convertible securities may be selected where the two components are issued by a single issuer, thus making the synthetic convertible security similar to the traditional convertible security, the character of a synthetic convertible security allows the combination of components representing distinct issuers, when PIMCO believes that such a combination may better achieve the Funds investment objective. A synthetic convertible security also is a more flexible investment in that its two components may be purchased separately. For example, the Fund may purchase a warrant for inclusion in a synthetic convertible security but temporarily hold short-term investments while postponing the purchase of a corresponding bond pending development of more favorable market conditions.
A holder of a synthetic convertible security faces the risk of a decline in the price of the security or the level of the index involved in the convertible component, causing a decline in the value of the security or instrument, such as a call option or warrant, purchased to create the synthetic convertible security. Should the price of the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the call option or warrant would be lost.
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Because a synthetic convertible security includes the income-producing component as well, the holder of a synthetic convertible security also faces the risk that interest rates will rise, causing a decline in the value of the income-producing instrument.
The Fund also may purchase synthetic convertible securities created by other parties, including convertible structured notes. Convertible structured notes are income-producing debentures linked to equity, and are typically issued by investment banks. Convertible structured notes have the attributes of a convertible security; however, the investment bank that issues the convertible note, rather than the issuer of the underlying common stock into which the note is convertible, assumes credit risk associated with the underlying investment, and the Fund in turn assumes credit risk associated with the convertible note.
Municipal Bonds
The Fund may invest in municipal bonds which pay interest that, in the opinion of bond counsel to the issuer (or on the basis of other authority believed by PIMCO to be reliable), is exempt from federal income taxes (municipal bonds), although dividends that the Fund pays that are attributable to such interest will not be tax-exempt to shareholders of the Fund.
Municipal bonds share the attributes of debt obligations in general, but are generally issued by states, municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies or authorities. The municipal bonds that the Fund may purchase include general obligation bonds and limited obligation bonds (or revenue bonds), including industrial development bonds issued pursuant to former federal tax law. General obligation bonds are obligations involving the credit of an issuer possessing taxing power and are payable from such issuers general revenues and not from any particular source. Limited obligation bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Tax-exempt private activity bonds and industrial development bonds generally are also revenue bonds and thus are not payable from the issuers general revenues. The credit and quality of private activity bonds and industrial development bonds are usually related to the credit of the user of the facilities. Payment of interest on and repayment of principal of such bonds is the responsibility of the user (and/or any guarantor).
Municipal bonds are subject to credit and market risk. Generally, prices of higher quality issues tend to fluctuate less with changes in market interest rates than prices of lower quality issues and prices of longer maturity issues tend to fluctuate more than prices of shorter maturity issues. Prices and yields on municipal bonds are dependent on a variety of factors, including general money-market conditions, the financial condition of the issuer, general conditions of the municipal bond market, the size of a particular offering, the maturity of the obligation and the rating of the issue. A number of these factors, including the ratings of particular issues, are subject to change from time to time. Information about the financial condition of an issuer of municipal bonds may not be as extensive as that which is made available by corporations whose securities are publicly traded. Obligations of issuers of municipal bonds are subject to the provisions of bankruptcy, insolvency and other laws, such as the Federal Bankruptcy Reform Act of 1978, affecting the rights and remedies of creditors. Congress or state legislatures may seek
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to extend the time for payment of principal or interest, or both, or to impose other constraints upon enforcement of such obligations. There is also the possibility that as a result of litigation or other conditions, the power or ability of issuers to meet their obligations for the payment of interest and principal on their municipal bonds may be materially affected or their obligations may be found to be invalid or unenforceable.
The Fund may also invest in residual interest municipal bonds (RIBS) whose interest rates bear an inverse relationship to the interest rate on another security or the value of an index. RIBS are created by dividing the income stream provided by the underlying bonds to create two securities, one short-term and one long-term. The interest rate on the short-term component is reset by an index or auction process normally every seven to 35 days. After income is paid on the short-term securities at current rates, the residual income from the underlying bond(s) goes to the long-term securities. Therefore, rising short-term interest rates result in lower income for the longer-term portion, and vice versa. The longer-term bonds can be very volatile and may be less liquid than other municipal bonds of comparable maturity. An investment in RIBS typically will involve greater risk than an investment in a fixed rate bond. Because increases in the interest rate on the other security or index reduce the residual interest paid on a RIB, the value of a RIB is generally more volatile than that of a fixed rate bond. RIBS have interest rate adjustment formulas that generally reduce or, in the extreme, eliminate the interest paid to the Fund when short-term interest rates rise, and increase the interest paid to the Fund when short-term interest rates fall. RIBS have varying degrees of liquidity that approximate the liquidity of the underlying bond(s), and the market price for these securities is volatile. These securities generally will underperform the market of fixed rate bonds in a rising interest rate environment, but tend to outperform the market of fixed rate bonds when interest rates decline or remain relatively stable. Although volatile, RIBS typically offer the potential for yields exceeding the yields available on fixed rate bonds with comparable credit quality, coupon, call provisions and maturity. The Fund may also invest in RIBS for the purpose of increasing the Funds leverage. Should short-term and long-term interest rates rise, the combination of the Funds investment in RIBS and its use of other forms of leverage (including through the issuance of preferred shares or the use of other derivative instruments) likely will adversely affect the Funds net asset value per share and income, distributions and total returns to shareholders. Trusts in which RIBS may be held could be terminated, in which case the residual bond holder would take possession of the underlying bond(s) on an unleveraged basis.
The Fund may invest in Build America Bonds, which are taxable municipal bonds with federal subsidies for a portion of the issuers borrowing costs. Build America Bonds offer an alternative form of financing to the state and local governments whose primary means for accessing the capital markets has been through the issuance of tax-exempt municipal bonds. Build America Bonds are issued through the Build America Bond program, which was created as part of the American Recovery and Reinvestment Act of 2009 (the Act). The objective of the program is to reduce the borrowing costs of state and local governments. Pursuant to the Act, issuers can elect to receive the federal subsidies on Build America Bonds in one of two forms: (i) in the form of direct payments from the U.S. Treasury and the IRS to the issuer over the life of the bond in an amount generally equal to 35% (or 45% in the case of Recovery Zone Economic Development Bonds) of the total coupon interest payable by the issuer to its bondholders (direct pay Build America Bonds) or (ii) in the form of a federal tax credit, which is passed along directly to bondholders, generally in an amount equal to 35% of the total coupon interest payable by the issuer to the bondholders (tax credit Build America Bonds). See Tax Matters for information on the tax consequences of the Funds investments in Build America Bonds.
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Issuance of Build America Bonds will cease on December 31, 2010 unless the relevant provisions of the Act are extended. In the event that the Build America Bond program is not extended, the Build America Bonds outstanding at such time will continue to be eligible for the federal interest rate subsidy, which continues for the life of the Build America Bonds; however, no bonds issued following expiration of the Build America Bond program will be eligible for the federal tax subsidies (either in the form of direct payments to the issuers or as federal tax credits passed along to bondholders). The current administration has recently proposed to extend the Build America Bond program; however, as of the date of this Statement of Additional Information, it is unclear whether and in what form this proposal might be enacted by Congress.
Non-U.S. Securities
The Fund may invest some or all of its assets in U.S. dollar-denominated debt obligations of corporate and other non-U. S. issuers, including obligations of non-U.S. banks, non-U.S. governments or their subdivisions, agencies and instrumentalities, international agencies and supra-national government entities and other issuers. The Fund may invest up to 25% of its total assets in securities denominated in currencies other than the U.S. dollar.
The non-U.S. securities in which the Fund may invest include Eurodollar obligations and Yankee Dollar obligations. Eurodollar obligations are U.S. dollar-denominated certificates of deposit and time deposits issued outside the U.S. capital markets by non-U.S. branches of U.S. banks and by non-U.S. banks. Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the U.S. capital markets by non-U.S. banks. Eurodollar and Yankee Dollar obligations are generally subject to the same risks that apply to domestic debt issues, notably credit risk, market risk and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee Dollar) obligations are subject to certain sovereign risks. One such risk is the possibility that a sovereign country might prevent capital, in the form of U.S. dollars, from flowing across its borders. Other risks include adverse political and economic developments; the extent and quality of government regulation of financial markets and institutions; the imposition of non-U.S. withholding taxes; and the expropriation or nationalization of non-U.S. issuers.
The Fund may invest in American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) or Global Depositary Receipts (GDRs). ADRs are U.S. dollar-denominated receipts issued generally by domestic banks and represent the deposit with the bank of a security of a non-U.S. issuer. EDRs are foreign currency-denominated receipts similar to ADRs and are issued and traded in Europe, and are publicly traded on exchanges or over-the-counter in the United States. GDRs may be offered privately in the United States and also trade in public or private markets in other countries. ADRs, EDRs and GDRs may be issued as sponsored or unsponsored programs. In sponsored programs, an issuer has made arrangements to have its securities trade in the form of ADRs, EDRs or GDRs. In unsponsored programs, the issuer may not be directly involved in the creation of the program. Although regulatory requirements with respect to sponsored and unsponsored programs are generally similar, in some cases it may be easier to obtain financial information from an issuer that has participated in the creation of a sponsored program.
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The Fund may invest in Brady Bonds. Brady Bonds are securities created through the exchange of existing commercial bank loans to sovereign entities for new obligations in connection with debt restructurings under a debt restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the Brady Plan). Brady Plan debt restructurings have been implemented in a number of countries, including: Argentina, Bolivia, Brazil, Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger, Nigeria, Panama, Peru, the Philippines, Poland, Uruguay and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in various currencies (primarily the U.S. dollar) and are actively traded in the over-the-counter secondary market. Brady Bonds are not considered to be U.S. Government securities. U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate par bonds or floating rate discount bonds, are generally collateralized in full as to principal by U.S. Treasury zero-coupon bonds having the same maturity as the Brady Bonds. Interest payments on these Brady Bonds generally are collateralized on a one-year or longer rolling-forward basis by cash or securities in an amount that, in the case of fixed rate bonds, is equal to at least one year of interest payments or, in the case of floating rate bonds, initially is equal to at least one years interest payments based on the applicable interest rate at that time and is adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to value recovery payments in certain circumstances, which in effect constitute supplemental interest payments but generally are not collateralized. Brady Bonds are often viewed as having three or four valuation components: (i) the collateralized repayment of principal at final maturity; (ii) the collateralized interest payments; (iii) the uncollateralized interest payments; and (iv) any uncollateralized repayment of principal at maturity (the uncollateralized amounts constitute the residual risk).
Most Mexican Brady Bonds issued to date have principal repayments at final maturity fully collateralized by U.S. Treasury zero-coupon bonds (or comparable collateral denominated in other currencies) and interest coupon payments collateralized on an 18-month rolling-forward basis by funds held in escrow by an agent for the bondholders. A significant portion of the Venezuelan Brady Bonds and the Argentine Brady Bonds issued to date have repayments at final maturity collateralized by U.S. Treasury zero-coupon bonds (or comparable collateral denominated in other currencies) and/or interest coupon payments collateralized on a 14-month (for Venezuela) or 12-month (for Argentina) rolling-forward basis by securities held by the Federal Reserve Bank of New York as collateral agent.
Brady Bonds involve various risk factors including residual risk and the history of defaults with respect to commercial bank loans by public and private entities of countries issuing Brady Bonds. There can be no assurance that Brady Bonds in which the Fund may invest will not be subject to restructuring arrangements or to requests for new credit, which may cause the Fund to suffer a loss of interest or principal on any of its holdings.
Investing in the securities of non-U.S. issuers involves special risks and considerations not typically associated with investing in U.S. companies. These include: differences in accounting; auditing and financial reporting standards; generally higher commission rates on non-U.S. portfolio transactions; the possibility of expropriation or confiscatory taxation; adverse changes in investment or exchange control regulations (which may include suspension of the ability to
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transfer currency from a country); political instability which can affect U.S. investments in non-U.S. countries; and potential restrictions on the flow of international capital. In addition, non-U.S. securities and dividends and interest payable on those securities may be subject to non-U.S. taxes, including taxes withheld from payments on those securities. Non-U.S. securities often trade with less frequency and volume than domestic securities and therefore may exhibit greater price volatility. Changes in foreign exchange rates will affect the value of those securities which are denominated or quoted in currencies other than the U.S. dollar. The currencies of non-U.S. countries may experience significant declines against the U.S. dollar, and devaluation may occur subsequent to investments in these currencies by the Fund.
Emerging Market Securities. The Fund may invest up to 25% of its total assets in securities or instruments that are economically tied to emerging market countries. PIMCO generally considers an instrument to be economically tied to an emerging market country if the issuer or guarantor is a government of an emerging market country (or any political subdivision, agency, authority or instrumentality of such government), if the issuer or guarantor is organized under the laws of an emerging market country, or if the currency of settlement of the security is a currency of an emerging market country. With respect to derivative instruments, PIMCO generally considers such instruments to be economically tied to emerging market countries if the underlying assets are currencies of emerging market countries (or baskets or indexes of such currencies), or instruments or securities that are issued or guaranteed by governments of emerging market countries or by entities organized under the laws of emerging market countries. PIMCO has broad discretion to identify countries that it considers to qualify as emerging markets. In exercising such discretion, PIMCO generally will consider a country to be an emerging market country if it is classified as an emerging or developing economy by any supranational organization such as the World Bank or the United Nations, or related entities, or if the country is considered an emerging market country for purposes of constructing emerging markets indices.
Investment risk may be particularly high to the extent that the Fund invests in instruments economically tied to emerging market countries. These securities may present market, credit, currency, liquidity, legal, political and other risks different from, or greater than, the risks of investing in developed countries. The Fund may invest in emerging markets that may be in the process of opening to trans-national investment, which may increase these risks. Risks particular to emerging market countries include, but are not limited to, the following risks:
General Emerging Market Risk. The securities markets of countries in which the Fund may invest may be relatively small, with a limited number of companies representing a small number of industries. Additionally, issuers in countries in which the Fund may invest may not be subject to a high degree of regulation and the financial institutions with which the Fund may trade may not possess the same degree of financial sophistication, creditworthiness or resources as those in developed markets. Furthermore, the legal infrastructure and accounting, auditing and reporting standards in certain countries in which the Fund may invest may not provide the same degree of investor protection or information to investors as would generally apply in major securities markets.
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Nationalization, expropriation or confiscatory taxation, currency blockage, political changes or diplomatic developments could adversely affect the Funds investments in a foreign country. In the event of nationalization, expropriation or other confiscation, the Fund could lose its entire investment in that country. Adverse conditions in a certain region can adversely affect securities of other countries whose economies appear to be unrelated. To the extent that the Fund invests a significant portion of assets in a concentrated geographic area, the Fund will generally have more exposure to regional economic risks associated with those investments.
Restrictions on Foreign Investment. A number of emerging securities markets restrict foreign investment to varying degrees. Furthermore, repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some countries. While the Fund will only invest in markets where these restrictions are considered acceptable, new or additional repatriation or other restrictions might be imposed subsequent to the Funds investment. If such restrictions were to be imposed subsequent to the Funds investment in the securities markets of a particular country, the Funds response might include, among other things, applying to the appropriate authorities for a waiver of the restrictions or engaging in transactions in other markets designed to offset the risks of decline in that country. Such restrictions will be considered in relation to the Funds liquidity needs and all other acceptable positive and negative factors. Some emerging markets limit foreign investment, which may decrease returns relative to domestic investors. The Fund may seek exceptions to those restrictions. If those restrictions are present and cannot be avoided by the Fund, the Funds returns may be lower.
Settlement Risks. Settlement systems in emerging markets may be less well organized than in developed markets. Supervisory authorities may also be unable to apply standards comparable with those in developed markets. Thus there may be risks that settlement may be delayed and that cash or securities belonging to the Fund may be in jeopardy because of failures of or defects in the systems. In particular, market practice may require that payment be made prior to receipt of the security which is being purchased or that delivery of a security must be made before payment is received. In such cases, default by a broker or bank through whom the relevant transaction is effected might result in a loss being suffered by the Fund. The Fund will seek, where possible, to use counterparties whose financial status is such that this risk is reduced. However, there can be no certainty that the Fund will be successful in eliminating or reducing this risk, particularly as counterparties operating in developing countries frequently lack the substance, capitalization and/or financial resources of those in developed countries.
There may also be a danger that, because of uncertainties in the operation of settlement systems in individual markets, competing claims may arise in respect of securities held by or to be transferred to the Fund. Furthermore, compensation schemes may be non-existent, limited or inadequate to meet the Funds claims in any of these events.
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Counterparty Risk. Trading in the securities of developing markets presents additional credit and financial risks. The Fund may have limited access to, or there may be a limited number of, potential counterparties that trade in the securities of emerging market issuers. Governmental regulations may restrict potential counterparties to certain financial institutions located or operating in the particular emerging market. Potential counterparties may not possess, adopt or implement creditworthiness standards, financial reporting standards or legal and contractual protections similar to those in developed markets. Currency hedging techniques may not be available or may be limited. The Fund may not be able to reduce or mitigate risks related to trading with emerging market counterparties. The Fund will seek, where possible, to use counterparties whose financial status is such that the risk of default is reduced, but the risk of losses resulting from default is still possible.
Government in the Private Sector. Government involvement in the private sector varies in degree among the emerging markets in which the Fund may invest. Such involvement may, in some cases, include government ownership of companies in certain sectors, wage and price controls or imposition of trade barriers and other protectionist measures. With respect to any developing country, there is no guarantee that some future economic or political crisis will not lead to price controls, forced mergers of companies, expropriation, or creation of government monopolies, to the possible detriment of the Funds investment in that country.
Litigation. The Fund may encounter substantial difficulties in obtaining and enforcing judgments against individuals and companies located in certain developing countries. It may be difficult or impossible to obtain or enforce legislation or remedies against governments, their agencies and sponsored entities.
Fraudulent Securities. It is possible, particularly in markets in developing countries, that purported securities in which the Fund invests may subsequently be found to be fraudulent and as a consequence the Fund could suffer losses.
Taxation. The local taxation of income and capital gains accruing to non-residents varies among developing countries and, in some cases, is comparatively high. In addition, developing countries typically have less well-defined tax laws and procedures and such laws may permit retroactive taxation so that the Fund could in the future become subject to local tax liabilities that had not been anticipated in conducting its investment activities or valuing its assets. The Fund will seek to reduce these risks by careful management of assets. However, there can be no assurance that these efforts will be successful.
Political Risks/Risks of Conflicts. Recently, various countries have seen significant internal conflicts and in some cases, civil wars may have had an adverse impact on the securities markets of the countries concerned. In addition, the occurrence of new disturbances due to acts of war or other political developments cannot be excluded. Apparently stable systems may experience periods of disruption or improbable reversals of policy. Nationalization, expropriation or confiscatory taxation, currency blockage, political changes, government regulation, political, regulatory or social instability or uncertainty or diplomatic developments could adversely affect the Funds investments. The transformation from a centrally planned, socialist economy to a more market
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oriented economy has also resulted in many economic and social disruptions and distortions. Moreover, there can be no assurance that the economic, regulatory and political initiatives necessary to achieve and sustain such a transformation will continue or, if such initiatives continue and are sustained, that they will be successful or that such initiatives will continue to benefit foreign (or non-national) investors. Certain instruments, such as inflation index instruments, may depend upon measures compiled by governments (or entities under their influence) which are also the obligors.
Sovereign Debt. The Fund may invest in sovereign debt issued by non-U.S. developed and emerging market governments and their respective sub-divisions, agencies or instrumentalities, government sponsored enterprises and supra-national government entities. Supra-national entities include international organizations that are organized or supported by one or more government entities to promote economic reconstruction or development and by international banking institutions and related governmental agencies. Investment in sovereign debt can involve a high degree of risk. The governmental entity that controls the repayment of sovereign debt may not be able or willing to repay the principal and/or interest when due in accordance with the terms of the debt. A governmental entitys willingness or ability to repay principal and interest due in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, the governmental entitys policy toward the International Monetary Fund, and the political constraints to which a governmental entity may be subject. Governmental entities may also depend on expected disbursements from non-U.S. governments, multilateral agencies and others to reduce principal and interest arrearages on their debt. The commitment on the part of these governments, agencies and others to make such disbursements may be conditioned on a governmental entitys implementation of economic reforms and/or economic performance and the timely service of such debtors obligations. Failure to implement such reforms, achieve such levels of economic performance or repay principal or interest when due may result in the cancellation of such third parties commitments to lend funds to the governmental entity, which may further impair such debtors ability or willingness to service its debts in a timely manner. Consequently, governmental entities may default on their sovereign debt. Holders of sovereign debt (including the Fund) may be requested to participate in the rescheduling of such debt and to extend further loans to governmental entities. There is no bankruptcy proceeding by which sovereign debt on which governmental entities have defaulted may be collected in whole or in part.
The Funds investments in foreign currency-denominated debt obligations and hedging activities will likely produce a difference between its book income and its taxable income. This difference may cause a portion of the Funds income distributions to constitute returns of capital for tax purposes or require the Fund to make distributions exceeding book income to qualify as a regulated investment company for federal income tax purposes.
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Foreign Currency Transactions
Subject to the limitations discussed above and in the Prospectus, the Fund also may purchase and sell foreign currency options and foreign currency futures contracts and related options (see Derivative Instruments below), and may engage in foreign currency transactions either on a spot (cash) basis at the rate prevailing in the currency exchange market at the time or through forward foreign currency exchange contracts (forwards) with terms generally of less than one year. The Fund may (but is not required to) engage in these transactions in order to protect against uncertainty in the level of future foreign exchange rates in the purchase and sale of securities. The Fund may also use foreign currency options and foreign currency forward contracts to increase exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one country to another. Suitable currency hedging transactions may not be available in all circumstances and PIMCO may decide not to use hedging transactions that are available.
A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts may be bought or sold to protect the Fund against a possible loss resulting from an adverse change in the relationship between foreign currencies and the U.S. dollar or to increase exposure to a particular foreign currency. Although forwards are intended to minimize the risk of loss due to a decline in the value of the hedged currencies, at the same time, they tend to limit any potential gain which might result should the value of such currencies increase. Forwards will be used primarily to adjust the foreign exchange exposure of the Fund, and the Fund might be expected to enter into such contracts under the following circumstances:
Lock In. When PIMCO desires to lock in the U.S. dollar price on the purchase or sale of a security denominated in a foreign currency.
Cross Hedge. If a particular currency is expected to decrease against another currency, the Fund may sell the currency expected to decrease and purchase a currency that is expected to increase against the currency sold in an amount approximately equal to some or all of the Funds portfolio holdings denominated in the currency sold.
Direct Hedge. If PIMCO wants to eliminate substantially all of the risk of owning a particular currency, and/or if PIMCO believes that the Fund can benefit from price appreciation in a given countrys debt obligations but does not want to hold the currency, it may employ a direct hedge back into the U.S. dollar. In either case, the Fund would enter into a forward contract to sell the currency in which a portfolio security is denominated and purchase U.S. dollars at an exchange rate established at the time it initiated a contract. The cost of the direct hedge transaction may offset most, if not all, of the yield advantage offered by the non-U.S. security, but the Fund would hope to benefit from an increase (if any) in the value of the debt obligation.
Proxy Hedge. PIMCO might choose to use a proxy hedge, which may be less costly than a direct hedge. In this case, the Fund, having purchased a security, will sell a currency whose value is believed to be closely linked to the currency in which the security is denominated. Interest rates prevailing in the country whose currency was sold would be expected to be close to those in the United States and lower than those of securities denominated in the currency of the original holding. This type of hedging entails greater risk than a direct hedge because it is dependent on a stable relationship between the two currencies paired as proxies and the relationships can be very unstable at times.
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Costs of Hedging. When the Fund purchases a non-U.S. bond with a higher interest rate than is available on U.S. bonds of a similar maturity, the additional yield on the non-U.S. bond could be substantially reduced or lost if the Fund were to enter into a direct hedge by selling the foreign currency and purchasing the U.S. dollar. This is what is known as the cost of hedging. Proxy hedging attempts to reduce this cost through an indirect hedge back to the U.S. dollar.
It is important to note that hedging costs are treated as capital transactions and are not, therefore, deducted from the Funds dividend distribution and are not reflected in its yield. Instead such costs will, over time, be reflected in the Funds net asset value per share.
The forecasting of currency market movement is extremely difficult, and whether any hedging strategy will be successful is highly uncertain. Moreover, it is impossible to forecast with precision the market value of portfolio securities at the expiration of a foreign currency forward contract. Accordingly, the Fund may be required to buy or sell additional currency on the spot market (and bear the expense of such transaction) if PIMCOs predictions regarding the movement of foreign currency or securities markets prove inaccurate. In addition, the use of cross-hedging transactions may involve special risks, and may leave the Fund in a less advantageous position than if such a hedge had not been established. Because foreign currency forward contracts are privately negotiated transactions, there can be no assurance that the Fund will have flexibility to roll-over a foreign currency forward contract upon its expiration if it desires to do so. Additionally, there can be no assurance that the other party to the contract will perform its services thereunder.
The Fund may hold a portion of its assets in bank deposits denominated in foreign currencies, so as to facilitate investment in foreign securities as well as to protect against currency fluctuations and the need to convert such assets into U.S. dollars (thereby also reducing transaction costs). To the extent these monies are converted back into U.S. dollars, the value of the assets so maintained will be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations.
Tax Consequences of Hedging. Income earned by the Fund from its foreign currency hedging activities, if any, may give rise to ordinary income that, to the extent there is no offset by losses from such activities, will be distributed to shareholders and taxable at ordinary income rates. In addition, under applicable tax law, the Funds foreign currency hedging activities may result in the application of, among other rules, the mark-to-market and straddle provisions of the Code. These provisions could affect the amount, timing and/or character of distributions to Fund shareholders. See Tax Matters.
Among the risks of utilizing foreign currencies and related transactions is the risk that the relative value of currencies will be different than anticipated by PIMCO. The Fund may segregate liquid assets to cover forward currency contracts entered into for non-hedging purposes. If the Fund does not segregate liquid assets in such manner, then the Funds foreign currency contracts will be considered senior securities evidencing indebtedness for purpose of the 1940 Act.
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Foreign Currency Exchange-Related Securities
Foreign Currency Warrants. Foreign currency warrants, such as Currency Exchange Warrants SM (CEWs SM ), are warrants that entitle their holders to receive from their issuer an amount of cash (generally, for warrants issued in the United States, in U.S. dollars) that is calculated pursuant to a predetermined formula and based on the exchange rate between a specified foreign currency and the U.S. dollar as of the exercise date of the warrant. Foreign currency warrants generally are exercisable upon their issuance and expire as of a specific date and time. Foreign currency warrants have been issued in connection with U.S. dollar-denominated debt offerings by major issuers in an attempt to reduce the foreign currency exchange risk that, from the point of view of the prospective purchasers of the securities, is inherent in the international debt obligation marketplace. Foreign currency warrants may attempt to reduce the foreign exchange risk assumed by purchasers of a security by, for example, providing for a supplement payment in the event that the U.S. dollar depreciates against the value of a major foreign currency such as the Japanese yen. The formula used to determine the amount payable upon exercise of a foreign currency warrant may make the warrant worthless unless the applicable foreign currency exchange rate moves in a particular direction ( e.g. , unless the U.S. dollar appreciates or depreciates against the particular foreign currency to which the warrant is linked or indexed). Foreign currency warrants are severable from the debt obligations with which they may be offered, and may be listed on exchanges. Foreign currency warrants may be exercisable only in certain minimum amounts, and an investor wishing to exercise warrants who possesses less than the minimum number required for exercise may be required either to sell the warrants or to purchase additional warrants, thereby incurring additional transaction costs. In the case of any exercise of warrants, there may be a time delay between the time a holder of warrants gives instructions to exercise and the time the exchange rate relating to exercise is determined, during which time the exchange rate could change significantly, thereby affecting both the market and cash settlement values of the warrants being exercised. The expiration date of the warrants may be accelerated if the warrants should be delisted from an exchange or if their trading should be suspended permanently, which would result in the loss of any remaining time values of the warrants ( i.e. , the difference between the current market value and the exercise value of the warrants), and, if the warrants were out-of-the-money, in a total loss of the purchase price of the warrants. Warrants are generally unsecured obligations of their issuers and are not standardized foreign currency options issued by the Options Clearing Corporation (OCC). Unlike foreign currency options issued by the OCC, the terms of foreign exchange warrants generally will not be amended in the event of government or regulatory actions affecting exchange rates or in the event of the imposition of other regulatory controls affecting the international currency markets. The initial public offering price of foreign currency warrants is generally considerably in excess of the price that a commercial user of foreign currencies might pay in the interbank market for a comparable option involving significantly larger amounts of foreign currencies. Foreign currency warrants are subject to significant foreign exchange risk, including risks arising from complex political or economic factors.
Principal Exchange Rate Linked Securities. Principal exchange rate linked securities (PERLs SM ) are debt obligations the principal on which is payable at maturity in an amount that may vary based on the exchange rate between the U.S. dollar and a particular foreign currency at or about that time. The return on standard principal exchange rate linked securities is
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enhanced if the foreign currency to which the security is linked appreciates against the U.S. dollar, and is adversely affected by increases in the foreign exchange value of the U.S. dollar; reverse principal exchange rate linked securities are like standard securities, except that their return is enhanced by increases in the value of the U.S. dollar and adversely impacted by increases in the value of foreign currency. Interest payments on the securities are generally made in U.S. dollars at rates that reflect the degree of foreign currency risk assumed or given up by the purchaser of the notes ( i.e. , at relatively higher interest rates if the purchaser has assumed some of the foreign exchange risk, or relatively lower interest rates if the issuer has assumed some of the foreign exchange risk, based on the expectations of the current market). Principal exchange rate linked securities may in limited cases be subject to acceleration of maturity (generally, not without the consent of the holders of the securities), which may have an adverse impact on the value of the principal payment to be made at maturity.
Performance Indexed Paper. Performance indexed paper (PIPs SM ) is U.S. dollar-denominated commercial paper the yield of which is linked to certain foreign exchange rate movements. The yield to the investor on performance indexed paper is established at maturity as a function of spot exchange rates between the U.S. dollar and a designated currency as of or about that time (generally, the index maturity two days prior to maturity). The yield to the investor will be within a range stipulated at the time of purchase of the obligation, generally with a guaranteed minimum rate of return that is below, and a potential maximum rate of return that is above, market yields on U.S. dollar-denominated commercial paper, with both the minimum and maximum rates of return on the investment corresponding to the minimum and maximum values of the spot exchange rate two business days prior to maturity.
Derivative Instruments
The Fund may, but is not required to, use a variety of derivative instruments for hedging or risk management purposes or as part of its investment strategies.
Generally, derivatives are financial contracts whose value depends upon, or is derived from, the value of an underlying asset, reference rate or index, and may relate to individual debt instruments, interest rates, currencies or currency exchange rates, commodities or related indexes. The Fund may use derivatives to gain exposure to fixed rate or floating rate high yield securities and other securities in which the Fund may invest (including pending investment of the proceeds of this offering). Examples of derivative instruments that the Fund may use include, but are not limited to, options contracts, futures contracts, options on futures contracts, swap agreements (including total return and credit default swaps) and short sales. The Fund may also engage in credit spread trades. A credit spread trade is an investment position relating to a difference in the prices or interest rates of two bonds or other securities, where the value of the investment position is determined by changes in the difference between such prices or interest rates, as the case may be, of the respective securities. The Fund may also have exposure to derivatives, such as interest rate or credit-default swaps, through investment in credit-linked trust certificates and other securities issued by special purpose or structured vehicles. The Fund may also use derivatives to add leverage to the portfolio. If other types of financial instruments, including other types of options, futures contracts or futures options are traded in the future, the Fund may also use those instruments, provided that their use is consistent with the Funds investment objective and policies.
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Like the other investments of the Fund, the ability of the Fund to successfully utilize derivative instruments may depend in part upon the ability of PIMCO to assess the issuers credit characteristics and other macro-economic factors correctly. If PIMCO incorrectly forecasts such factors and has taken positions in derivative instruments contrary to prevailing market trends, the Fund could lose money.
The Fund might not employ any of the strategies described below, and no assurance can be given that any strategy used will succeed. If PIMCO incorrectly forecasts market values or other economic factors in utilizing a derivatives strategy for the Fund, the Fund might have been in a better position if it had not entered into the transaction at all. Also, suitable derivative transactions may not be available in all circumstances. The use of these strategies involves certain special risks, including a possible imperfect correlation, or even no correlation, between price movements of derivative instruments and price movements of related investments. While some strategies involving derivative instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in related investments or otherwise, due to the possible inability of the Fund to purchase or sell a portfolio security at a time that otherwise would be favorable or the possible need to sell a portfolio security at a disadvantageous time because the Fund is required to maintain asset coverage or offsetting positions in connection with transactions in derivative instruments, and the possible inability of the Fund to close out or to liquidate its derivatives positions. The Funds use of derivatives could affect the amount, timing and/or character of distributions to shareholders. See Tax Matters below.
Options on Securities and Indexes. The Fund may purchase and sell put and call options on securities or indexes in standardized contracts traded on domestic or other securities exchanges, boards of trade, or similar entities, or quoted on NASDAQ or on an over-the-counter market, and agreements, sometimes called cash puts, which may accompany the purchase of a new issue of debt obligations from a dealer.
An option on a security (or an index) is a contract that gives the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option (or the cash value of the index) at a specified exercise price at any time during the term of the option. The writer of an option on a security has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price or to pay the exercise price upon delivery of the underlying security. Upon exercise, the writer of an option on an index is obligated to pay the difference between the cash value of the index and the exercise price multiplied by the specified multiplier for the index option. (An index is designed to reflect features of a particular securities market, a specific group of financial instruments or securities, or certain economic indicators.)
The Fund may (but is not required to) cover its obligations when it writes call options or put options. In the case of a call option on a debt obligation or other security, the option is covered if the Fund owns the security underlying the call or has an absolute and immediate right to acquire
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that security without additional cash consideration (or, if additional cash consideration is required, cash or other liquid assets, in such amount are segregated by its custodian) upon conversion or exchange of other securities held by the Fund.
A call option on a security is also covered if the Fund does not hold the underlying security or have the right to acquire it, but the Fund segregates liquid assets in an amount equal to the contract value of the position (minus any collateral deposited with a broker-dealer), on a mark-to-market basis (a so-called naked call option).
For a call option on an index, the option is covered if the Fund maintains with its custodian liquid assets in an amount equal to the contract value of the index. A call option is also covered if the Fund holds a call on the same index or security as the call written where the exercise price of the call held is (i) equal to or less than the exercise price of the call written, or (ii) greater than the exercise price of the call written, provided the difference is maintained by the Fund in segregated liquid assets. A put option on a security or an index is covered if the Fund segregates liquid assets equal to the exercise price. A put option is also covered if the Fund holds a put on the same security or index as the put written where the exercise price of the put held is (i) equal to or greater than the exercise price of the put written, or (ii) less than the exercise price of the put written, provided the difference is maintained by the Fund in segregated liquid assets. Obligations under written call and put options so covered will not be construed to be senior securities for purposes of the Funds investment restrictions concerning senior securities and borrowings.
If an option written by the Fund expires unexercised, the Fund realizes on the expiration date a capital gain equal to the premium the Fund received at the time the option was written. If an option purchased by the Fund expires unexercised, the Fund realizes a capital loss equal to the premium paid. Prior to the earlier of exercise or expiration, an exchange-traded option may be closed out by an offsetting purchase or sale of an option of the same series (type, exchange, underlying security or index, exercise price, and expiration). There can be no assurance, however, that a closing purchase or sale transaction can be effected when the Fund desires.
The Fund may sell put or call options it has previously purchased, which could result in a net gain or loss depending on whether the amount realized on the sale is more or less than the premium and other transaction costs paid on the put or call option which is sold. Prior to exercise or expiration, an option may be closed out by an offsetting purchase or sale of an option of the same series. The Fund will realize a capital gain from a closing purchase transaction if the cost of the closing option is less than the premium received from writing the option, or, if it is more, the Fund will realize a capital loss. If the premium received from a closing sale transaction is more than the premium paid to purchase the option, the Fund will realize a capital gain or, if it is less, the Fund will realize a capital loss. The principal factors affecting the market value of a put or a call option include supply and demand, interest rates, the current market price of the underlying security or index in relation to the exercise price of the option, the volatility of the underlying security or index and the time remaining until the expiration date.
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The premium paid for a put or call option purchased by the Fund is an asset of the Fund. The premium received for an option written by the Fund is recorded as a deferred credit. The value of an option purchased or written is marked to market daily and is valued at the closing price on the exchange on which it is traded or, if not traded on an exchange or no closing price is available, at the mean between the last bid and asked prices.
The Fund may write straddles (covered or uncovered) consisting of a combination of a call and a put written on the same underlying security. A straddle will be covered when sufficient assets are deposited to meet the Funds immediate obligations. The Fund may use the same liquid assets to cover both the call and put options where the exercise price of the call and put are the same, or the exercise price of the call is higher than that of the put. In such cases, the Fund will also segregate liquid assets equivalent to the amount, if any, by which the put is in the money.
Risks Associated with Options on Securities and Indexes. There are several risks associated with transactions in options on securities and on indexes. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve the intended result. A decision as to whether, when and how to use options involves the exercise of skill and judgment, and even a well-conceived transaction may be unsuccessful because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the premium on the option, given up the opportunity to profit from a price increase in the underlying security above the exercise price, but, as long as its obligation as a writer continues, has retained the risk of loss should the price of the underlying security decline. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price. If a put or call option purchased by the Fund is not sold when it has remaining value, and if the market price of the underlying security remains equal to or greater than the exercise price (in the case of a put), or remains less than or equal to the exercise price (in the case of a call), the Fund will lose its entire investment in the option. Also, where a put or call option on a particular security is purchased to hedge against price movements in a related security, the price of the put or call option may move more or less than the price of the related security.
There can be no assurance that a liquid market will exist when the Fund seeks to close out an option position. If the Fund were unable to close out an option that it had purchased on a security or index, it would have to exercise the option in order to realize any profit or the option may expire worthless. If the Fund were unable to close out a call option that it had written on a security held in its portfolio, it would not be able to sell the underlying security unless the option expired without exercise. As the writer of a call option on an individual security held in its portfolio, the Fund forgoes, during the options life, the opportunity to profit from increases in the market value of the security or index position covering the call option above the sum of the premium and the exercise price of the call.
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If trading were suspended in an option purchased by the Fund, the Fund would not be able to close out the option. If restrictions on exercise were imposed, the Fund might be unable to exercise an option it has purchased. Except to the extent that a call option on an index written by the Fund is covered by an option on the same index purchased by the Fund, movements in the index may result in a loss to the Fund; however, such losses may be mitigated by changes in the value of the Funds securities during the period the option was outstanding.
Foreign Currency Options. The Fund may buy or sell put and call options on foreign currencies for investment purposes or as a hedge against changes in the value of the U.S. dollar (or another currency) in relation to a foreign currency in which the Funds securities may be denominated. The Fund may buy or sell put and call options on foreign currencies either on exchanges or in the over-the-counter market. A put option on a foreign currency gives the purchaser of the option the right to sell a foreign currency at the exercise price until the option expires. A call option on a foreign currency gives the purchaser of the option the right to purchase the currency at the exercise price until the option expires. Currency options traded on U.S. or other exchanges may be subject to position limits which may limit the ability of the Fund to reduce foreign currency risk using such options.
Futures Contracts and Options on Futures Contracts. The Fund may invest in futures contracts and options thereon (futures options), including interest rates, securities indexes, debt obligations (to the extent they are available) and U.S. Government and agency securities, as well as purchase put and call options on such futures contracts.
Generally, a futures contract provides for the future sale by one party and purchase by another party of a specified quantity of the security or other financial instrument at a specified price and time. A futures contract on an index is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to the difference between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally written. Although the value of an index might be a function of the value of certain specified securities, physical delivery of these securities is not always made. A public market exists in futures contracts covering a number of indexes as well as financial instruments, including, without limitation: U.S. Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S. Treasury bills; 90-day commercial paper; bank certificates of deposit; Eurodollar certificates of deposit; the Australian dollar; the Canadian dollar; the British pound; the Japanese yen; the Swiss franc; the Mexican peso; and certain multinational currencies, such as the euro. It is expected that other futures contracts will be developed and traded in the future.
The Fund may purchase and write call and put futures options. Futures options possess many of the same characteristics as options on securities and indexes (discussed above). A futures option gives the holder the right, in return for the premium paid, to assume a long position (call) or short position (put) in a futures contract at a specified exercise price at any time during the period of the option. Upon exercise of a call option, the holder acquires a long position in the futures contract and the writer is assigned the opposite short position. In the case of a put option, the opposite is true.
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The Fund may enter into futures contracts and futures options that are standardized and traded on a U.S. or other exchange, board of trade, or similar entity, or quoted on an automated quotation system, and the Fund may also enter into OTC options on futures contracts.
When a purchase or sale of a futures contract is made by the Fund, the Fund is required to deposit with its custodian (or broker, if legally permitted) a specified amount of liquid assets (initial margin). The margin required for a futures contract is set by the exchange on which the contract is traded and may be modified during the term of the contract. The initial margin is in the nature of a performance bond or good faith deposit on the futures contract that is returned to the Fund upon termination of the contract, assuming all contractual obligations have been satisfied. The Fund expects to earn taxable interest income on its initial margin deposits. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called variation margin, equal to the daily change in value of the futures contract. This process is known as marking to market. Variation margin does not represent a borrowing or loan by the Fund but is instead a settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing daily net asset value, the Fund will mark to market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to put and call options on futures contracts written by it. Such margin deposits will vary depending on the nature of the underlying futures contract (and the related initial margin requirements), the current market value of the option, and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the underlying securities, generally these obligations are closed out prior to delivery by offsetting purchases or sales of matching futures contracts (involving the same exchange, underlying security or index, and delivery month). If an offsetting purchase price is less than the original sale price, the Fund realizes a capital gain, or if it is more, the Fund realizes a capital loss. Conversely, if an offsetting sale price is more than the original purchase price, the Fund realizes a capital gain, or if it is less, the Fund realizes a capital loss. The transaction costs must also be included in these calculations.
The Fund may write straddles (covered or uncovered) consisting of a call and a put written on the same underlying futures contract. A straddle will be covered when sufficient assets are deposited to meet the Funds immediate obligations. The Fund may use the same liquid assets to cover both the call and put options where the exercise price of the call and put are the same, or the exercise price of the call is higher than that of the put. In such cases, the Fund will also segregate liquid assets equivalent to the amount, if any, by which the put is in the money.
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The Fund is operated by a person who has claimed an exclusion from the definition of the term commodity pool operator under the Commodity Exchange Act (the CEA), and, therefore, such person is not subject to registration or regulation as a pool operator under the CEA.
Limitations on Use of Futures and Futures Options. When purchasing a futures contract, the Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that, when added to the amounts deposited with a futures commission merchant as margin, are equal to the market value of the futures contract. Alternatively, the Fund may cover its position by purchasing a put option on the same futures contract with a strike price as high as or higher than the price of the contract held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that are equal to the market value of the instruments underlying the contract. Alternatively, the Fund may cover its position by owning the instruments underlying the contract (or, in the case of an index futures contract, a portfolio with a volatility substantially similar to that of the index on which the futures contract is based), or by holding a call option permitting the Fund to purchase the same futures contract at a price no higher than the price of the contract written by the Fund (or at a higher price if the difference is maintained in liquid assets with the Funds custodian).
With respect to futures contracts that are not legally required to cash settle, the Fund may cover the open position by setting aside or earmarking liquid assets in an amount equal to the market value of the futures contract. With respect to futures that are required to cash settle, however, the Fund is permitted to set aside or earmark liquid assets in an amount equal to the Funds daily marked to market (net) obligation, if any, (in other words, the Funds daily net liability, if any) rather than the market value of the futures contract. By setting aside or earmarking assets equal to only its net obligation under cash-settled futures, the Fund will have the ability to utilize these contracts to a greater extent than if the Fund were required to segregate or earmark assets equal to the full market value of the futures contract.
When selling a call option on a futures contract, the Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that, when added to the amounts deposited with a futures commission merchant as margin, equal the total market value of the futures contract underlying the call option. Alternatively, the Fund may cover its position by entering into a long position in the same futures contract at a price no higher than the strike price of the call option, by owning the instruments underlying the futures contract, or by holding a separate call option permitting the Fund to purchase the same futures contract at a price not higher than the strike price of the call option sold by the Fund, or by taking other offsetting positions.
When selling a put option on a futures contract, the Fund will maintain with its custodian (and mark to market on a daily basis) liquid assets that equal the purchase price of the futures contract, less any margin on deposit. Alternatively, the Fund may cover the position either by
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entering into a short position in the same futures contract, or by owning a separate put option permitting it to sell the same futures contract so long as the strike price of the purchased put option is the same as or higher than the strike price of the put option sold by the Fund, or by taking other offsetting positions.
To the extent that securities with maturities greater than one year are used to segregate liquid assets to cover the Funds obligations under futures contracts and related options, such use will not eliminate the leverage risk arising from such use, which may tend to exaggerate the effect on net asset value of any increase or decrease in the market value of the Funds portfolio, and may require liquidation of portfolio positions when it is not advantageous to do so. If the Fund does not segregate liquid assets in such manner, then such securities will be considered senior securities evidencing indebtedness for purposes of the 1940 Act.
The requirements for qualification as a regulated investment company also may limit the extent to which the Fund may enter into futures, futures options or forward contracts. See Tax Matters.
Risks Associated with Futures and Futures Options. There are several risks associated with the use of futures contracts and futures options. A purchase or sale of a futures contract may result in losses in excess of the amount invested in the futures contract. There can be no guarantee that there will be a correlation between price movements in the hedging vehicle and in the Fund securities being hedged. In addition, there are significant differences between the securities and futures markets that could result in an imperfect correlation between the markets, causing a given hedge not to achieve its objective. The degree of imperfection of correlation depends on circumstances such as variations in speculative market demand for futures and futures options on securities, including technical influences in futures trading and futures options, and differences between the financial instruments being hedged and the instruments underlying the standard contracts available for trading in such respects as interest rate levels, maturities, and creditworthiness of issuers. A decision as to whether, when and how to hedge involves the exercise of skill and judgment, and even a well-conceived hedge may be unsuccessful to some degree because of market behavior or unexpected interest rate trends.
Futures contracts on U.S. Government securities historically have reacted to an increase or decrease in interest rates in a manner similar to that in which the underlying U.S. Government securities reacted. To the extent, however, that the Fund enters into such futures contracts, the value of such futures will not vary in direct proportion to the value of the Funds holdings of debt obligations. Thus, the anticipated spread between the price of the futures contract and the hedged security may be distorted due to differences in the nature of the markets. The spread also may be distorted by differences in initial and variation margin requirements, the liquidity of such markets and the participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain futures contract prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous days settlement price at the end of the current trading session. Once the daily limit has been reached in a futures contract subject to the limit, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price movements during a particular trading day and therefore does not limit potential losses because the limit may work to prevent the liquidation of unfavorable positions. For example, futures prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of positions and subjecting some holders of futures contracts to substantial losses.
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There can be no assurance that a liquid market will exist at a time when the Fund seeks to close out a futures contract or a futures option position, and the Fund would remain obligated to meet margin requirements until the position is closed. As a result, there can be no assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts, Options on Futures Contracts and Forward Currency Exchange Contracts and Options Thereon. Options on securities or indexes, futures contracts, options on futures contracts, and options on currencies may be traded on foreign exchanges. Such transactions may not be regulated as effectively as similar transactions in the United States, may not involve a clearing mechanism and related guarantees, and are subject to the risk of governmental actions affecting trading in, or the prices of, non-U.S. securities. Some foreign exchanges may be principal markets so that no common clearing facility exists and a trader may look only to the broker for performance of the contract. The value of such positions also could be adversely affected by (i) other complex non-U.S. political, legal and economic factors, (ii) lesser availability than in the United States of data on which to make trading decisions, (iii) delays in the Funds ability to act upon economic events occurring in non-U.S. markets during non-business hours in the United States, (iv) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States and (v) lesser trading volume. In addition, unless the Fund hedges against fluctuations in the exchange rate between the U.S. dollar and the currencies in which trading is done on non-U.S. exchanges, any profits that the Fund might realize in trading could be eliminated by adverse changes in the exchange rate, or the Fund could suffer losses as a result of those changes. The Funds use of such instruments may cause the Fund to pay higher amounts of distributions that are taxable to shareholders at ordinary income tax rates than if the Fund had not used such instruments.
Swap Agreements and Options on Swap Agreements. The Fund may enter into total return swap agreements, credit default swap agreements and other swap agreements made with respect to interest rates, currencies, indexes of securities and other assets or measures of risk or return. These transactions are entered into in an attempt to obtain a particular return when it is considered desirable to do so, possibly at a lower cost to the Fund than if the Fund had invested directly in an instrument that yielded that desired return.
Swap agreements are two-party contracts entered into primarily by institutional investors for periods ranging from a few weeks to more than one year. Swap agreements are individually negotiated and structured to include exposure to a variety of types of investments or market factors. In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments or instruments, which may be adjusted for an interest factor. The gross returns to be exchanged or swapped between the parties are generally calculated with respect to a notional amount, i.e. , the return on or increase in value of a particular dollar amount invested at a particular interest rate or in a basket of securities representing a particular index.
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Forms of swap agreements include interest rate caps, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates exceed a specified rate, or cap; interest rate floors, under which, in return for a premium, one party agrees to make payments to the other to the extent that interest rates fall below a specified rate, or floor; and interest rate collars, under which a party sells a cap and purchases a floor or vice versa in an attempt to protect itself against interest rate movements exceeding given minimum or maximum levels. The Fund may use interest rate caps, floors and collars to a substantial degree in connection with its leveraging strategies. See Certain Interest Rate Transactions below and Portfolio ContentsCertain Interest Rate Transactions in the Prospectus.
The Fund may also enter into options on swap agreements (swaptions). A swaption is a contract that gives a counterparty the right (but not the obligation) to enter into a new swap agreement or to shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. The Fund may write (sell) and purchase put and call swaptions.
Most swap agreements entered into by the Fund would calculate the obligations of the parties to the agreement on a net basis. Consequently, the Funds current obligations (or rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement based on the relative values of the positions held by each party to the agreement (the net amount). The Funds current obligations under a swap agreement will be accrued daily (offset against any amounts owed to the Fund). The Fund may (but is not required to) cover any accrued but unpaid net amounts owed to a swap counterparty through the segregation of liquid assets. Obligations under swap agreements so covered will not be construed to be senior securities for purposes of the Funds investment restriction concerning senior securities and borrowings.
Whether the Funds use of swap agreements or swap options will be successful in furthering its investment objective will depend on PIMCOs ability to predict correctly whether certain types of investments are likely to produce greater returns than other investments. Moreover, the Fund bears the risk of loss of the amount expected to be received under a swap agreement in the event of the default or bankruptcy of a swap agreement counterparty. The Fund will enter into swap agreements only with counterparties that meet certain standards of creditworthiness. Certain restrictions imposed on the Fund by the Internal Revenue Code may limit the Funds ability to use swap agreements. The swaps market is largely unregulated. It is possible that developments in the swaps market, including potential government regulation, could adversely affect the Funds ability to terminate existing swap agreements or to realize amounts to be received under such agreements.
Swaps are highly specialized instruments that require investment techniques, risk analyses, and tax planning different from those associated with traditional investments. The use of a swap requires an understanding not only of the referenced asset, reference rate, or index but also of the swap itself, without the benefit of observing the performance of the swap under all possible market conditions. Because they are two party contracts that may be subject to contractual restrictions on transferability and termination, swap agreements may be illiquid. To the extent that a swap is not liquid, it may not be possible to initiate a transaction or liquidate a position at an advantageous time or price, which may result in significant losses.
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Like most other investments, swap agreements are subject to the risk that the market value of the instrument will change in a way detrimental to the Funds interest. The Fund bears the risk that PIMCO will not accurately forecast future market trends or the values of assets, reference rates, indexes, or other economic factors in establishing swap positions for the Fund. If PIMCO attempts to use a swap as a hedge against, or as a substitute for, a portfolio investment, the Fund will be exposed to the risk that the swap will have or will develop imperfect or no correlation with the portfolio investment. This could cause substantial losses for the Fund. While hedging strategies involving swap instruments can reduce the risk of loss, they can also reduce the opportunity for gain or even result in losses by offsetting favorable price movements in other Fund investments. Many swaps are complex and often valued subjectively.
Certain swap agreements are exempt from most provisions of the Commodity Exchange Act (CEA) and, therefore, are not regulated as futures or commodity option transactions under the CEA, pursuant to regulations approved by the CFTC. To qualify for this exemption, a swap agreement must be entered into by eligible participants, which includes the following, provided the participants total assets exceed established levels: a bank or trust company, savings association or credit union, insurance company, investment company subject to regulation under the 1940 Act, commodity pool, corporation, partnership, proprietorship, organization, trust or other entity, employee benefit plan, governmental entity, broker-dealer, futures commission merchant, natural person or regulated foreign person. To be eligible, natural persons and most other entities must have total assets exceeding $10 million; commodity pools and employee benefit plans must have assets exceeding $5 million. In addition, an eligible swap transaction must meet three conditions. First, the swap agreement may not be part of a fungible class of agreements that are standardized as to their material economic terms. Second, the creditworthiness of parties with actual or potential obligations under the swap agreement must be a material consideration in entering into or determining the terms of the swap agreement, including pricing, cost or credit enhancement terms. Third, swap agreements may not be entered into and traded on or through a multilateral transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on existing exclusions for swaps, such as the Policy Statement issued in July 1989 which recognized a safe harbor for swap transactions from regulation as futures or commodity option transactions under the CEA or its regulations. The Policy Statement applies to swap transactions settled in cash that (1) have individually tailored terms, (2) lack exchange-style offset and the use of a clearing organization or margin system, (3) are undertaken in conjunction with a line of business, and (4) are not marketed to the public.
Risk of Potential Government Regulation of Derivatives . It is possible that government regulation of various types of derivative instruments, including futures and swap agreements, may limit or prevent the Fund from using such instruments as a part of its investment strategy, and could ultimately prevent the Fund from being able to achieve its investment objective. In 2008, multiple committees of the U.S. Congress held hearings investigating the rise in energy
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and agricultural prices and the role that the futures market and swap market participants may have played in this phenomenon. The CFTC is also investigating allegations of price manipulation in certain commodity markets. Some Members of Congress have introduced legislation that would impose limits on the maximum position that could be held by a single trader in energy-related contracts and would subject certain commodity- or energy-related swap agreements to new forms of regulation that could create barriers to commodity-related investment activity. While none of this regulatory or legislative activity has a direct, immediate effect upon the Fund, it is not possible to predict the course of future legislation or regulation in this area. It is possible that if these or similar measures were to become law, they could potentially limit or completely restrict the ability of the Fund to use these instruments as a part of its investment strategy. Limits or restrictions applicable to the counterparties with which the Fund engages in derivative transactions could also prevent the Fund from using these instruments.
Credit Default Swaps
The Fund may enter into credit default swap contracts for both investment and risk management purposes. As the seller in a credit default swap contract, the Fund would be required to pay the par (or other agreed-upon) value of a referenced debt obligation to the counterparty in the event of a default by a third party, such as a U.S. or non-U.S. issuer, on the debt obligation. In return, the Fund would receive from the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default occurs, the Fund would keep the stream of payments and would have no payment obligations. As the seller, the Fund would effectively add leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap.
The spread of a credit default swap is the annual amount the protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount. When spreads rise, market perceived credit risk rises and when spreads fall, market perceived credit risk falls. Wider credit spreads and decreasing market values, when compared to the notional amount of the swap, represent a deterioration of the referenced entitys credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. For credit default swap agreements on asset-backed securities and credit indices, the quoted market prices and resulting values, as well as the annual payment rate, serve as an indication of the current status of the payment/performance risk.
Credit default swap agreements involve greater risks than if the Fund had invested in the reference obligation directly since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risk. The Fund will enter into credit default swap agreements only with counterparties that meet certain standards of creditworthiness. A buyer generally also will lose its investment and recover nothing should no credit event occur and the swap is held to its termination date. If a credit event were to occur, the value of any deliverable obligation received by the seller, coupled with the upfront or periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. The Funds obligations under a credit default swap agreement will be accrued daily (offset against any amounts owing to the Fund). In connection with credit default
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swaps in which the Fund is the buyer or the seller, the Fund may segregate or earmark cash or liquid assets or enter into certain offsetting positions, with a value at least equal to the Funds exposure (any accrued but unpaid net amounts owed by the Fund to any counterparty), on a marked-to-market basis (when the Fund is the buyer), or the full notional amount of the swap (minus any amounts owed to the Fund) (when the Fund is the seller). If the Fund does not segregate cash or liquid assets in such manner, then the Funds credit default swaps will be considered senior securities evidencing indebtedness for purposes of the 1940 Act.
In January 2009, the SEC issued temporary rules to allow for clearinghouses to facilitate certain credit default swap transactions between one or more counterparties. A clearinghouse may act as the intermediary, or central counterparty, in credit default swap transactions, reducing the risk of a counterparty defaulting on a transaction while providing a central location for regulators to view traders positions and prices. The use of a clearinghouse for credit default swaps is voluntary and the temporary rules are in effect from January 22, 2009 until November 30, 2010. In March 2009 the SEC approved exemptions to allow the CME Group, Inc. and InterContinental, Inc. to operate a clearinghouse for credit default swaps. Similarly, dealers of credit-default swaps in Europe agreed in February 2009 to use a clearinghouse in the European Union to guarantee derivatives. In response to these developments, in March 2009 the Financial Industry Regulatory Authority (FINRA) proposed a pilot program imposing margin rules for credit default swap transactions executed by a registered broker-dealer and cleared by the CME Group, Inc. or other central counterparty platforms. FINRA speculates that the creation of CDS central counterparties will result in an increasing volume of CDS transactions being handled through broker-dealers instead of through affiliated entities of investment banks as in the past. FINRAs pilot program is set to expire November 30, 2010.
Credit-Linked Trust Certificates
The Fund may invest in credit-linked trust certificates, which are investments in a limited purpose trust or other vehicle formed under state law which, in turn, invests in a basket of derivative instruments, such as credit default swaps, interest rate swaps and other securities, in order to provide exposure to the high yield or another fixed income market. For instance, the Fund may invest in credit-linked trust certificates as a cash management tool in order to gain exposure to the high yield markets and/or to remain fully invested when more traditional income-producing securities are not available, including during the period when the net proceeds of this offering and any future offering are being invested.
Like an investment in a bond, investments in these credit-linked trust certificates represent the right to receive periodic income payments (in the form of distributions) and payment of principal at the end of the term of the certificate. However, these payments are conditioned on the trusts receipt of payments from, and the trusts potential obligations to, the counterparties to the derivative instruments and other securities in which the trust invests. For instance, the trust may sell one or more credit default swaps, under which the trust would receive a stream of payments over the term of the swap agreements provided that no event of default has occurred with respect to the referenced debt obligation upon which the swap is based. If a default occurs, the stream of payments may stop and the trust would be obligated to pay to the counterparty the par (or other
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agreed upon value) of the referenced debt obligation. This, in turn, would reduce the amount of income and principal that the Fund would receive as an investor in the trust. Please see Investment Objective and PoliciesCredit Default Swaps in this Statement of Additional Information for additional information about credit default swaps. The Funds investments in these instruments are indirectly subject to the risks associated with derivative instruments, including, among others, credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk and management risk. It is expected that the trusts which issue credit-linked trust certificates will constitute private investment companies, exempt from registration under the 1940 Act. Therefore, the certificates will be subject to the risks described under Other Investment Companies below, and will not be subject to applicable investment limitations and other regulation imposed by the 1940 Act (although the Fund will remain subject to such limitations and regulation, including with respect to its investments in the certificates). Although the trusts are typically private investment companies, they are generally not actively managed such as a hedge fund might be. It is also expected that the certificates will be exempt from registration under the 1933 Act. Accordingly, there may be no established trading market for the certificates and they may constitute illiquid investments. See Principal Risks of the FundLiquidity Risk in the Prospectus. If market quotations are not readily available for the certificates, they will be valued by the Fund at fair value as determined by the Board of Trustees or persons acting at its direction. See Net asset value in the Prospectus.
Hybrid Instruments
A hybrid instrument is a type of potentially high-risk derivative that combines a traditional stock, bond, or commodity with an option or forward contract. Generally, the principal amount, amount payable upon maturity or redemption, or interest rate of a hybrid is tied (positively or negatively) to the price of some commodity, currency or securities index or another interest rate or some other economic factor (each a benchmark). The interest rate or (unlike most fixed income securities) the principal amount payable at maturity of a hybrid security may be increased or decreased, depending on changes in the value of the benchmark. An example of a hybrid could be a bond issued by an oil company that pays a small base level of interest with additional interest that accrues in correlation to the extent to which oil prices exceed a certain predetermined level. Such a hybrid instrument would be a combination of a bond and a call option on oil.
Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management and increased total return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal amount and pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes the Fund to the credit risk of the issuer of the hybrids. These risks may cause significant fluctuations in the net asset value of the Fund.
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Certain hybrid instruments may provide exposure to the commodities markets. These are derivative securities with one or more commodity-linked components that have payment features similar to commodity futures contracts, commodity options, or similar instruments. Commodity-linked hybrid instruments may be either equity or debt securities, leveraged or unleveraged, and are considered hybrid instruments because they have both security and commodity-like characteristics. A portion of the value of these instruments may be derived from the value of a commodity, futures contract, index or other economic variable.
Certain issuers of structured products such as hybrid instruments may be deemed to be investment companies, as defined in the 1940 Act. As a result, the Funds investments in these products may be subject to limits applicable to investments in investment companies and may be subject to restrictions contained in the 1940 Act.
Structured Notes and Indexed Securities . Structured notes are derivative debt instruments, the interest rate or principal of which is determined by an unrelated indicator (for example, a currency, security, commodity or index thereof). The terms of the instrument may be structured by the purchaser and the borrower issuing the note. Indexed securities may include structured notes as well as securities other than debt securities, the interest rate or principal of which is determined by an unrelated indicator. Indexed securities may include a multiplier that multiplies the indexed element by a specified factor and, therefore, the value of such securities may be very volatile. The terms of structured notes and indexed securities may provide that in certain circumstances no principal is due at maturity, which may result in a loss of invested capital. Structured notes and indexed securities may be positively or negatively indexed, so that appreciation of the unrelated indicator may produce an increase or a decrease in the interest rate or the value of the structured note or indexed security at maturity may be calculated as a specified multiple of the change in the value of the unrelated indicator. Therefore, the value of such notes and securities may be very volatile. Structured notes and indexed securities may entail a greater degree of market risk than other types of debt securities because the investor bears the risk of the unrelated indicator. Structured notes or indexed securities also may be more volatile, less liquid, and more difficult to accurately price than less complex securities and instruments or more traditional debt securities. PIMCO analyzes these notes and securities in its overall assessment of the effective duration of the Funds holdings in an effort to monitor the Funds interest rate risk.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically similar transactions in order to add leverage to the portfolio or for hedging or cash management purposes. A reverse repurchase agreement involves the sale of a portfolio-eligible security by the Fund, coupled with its agreement to repurchase the instrument at a specified time and price. Under a reverse repurchase agreement, the Fund continues to receive any principal and interest payments on the underlying security during the term of the agreement. Reverse repurchase agreements involve leverage risk and the risk that the market value of securities retained by the Fund may decline below the repurchase price of the securities sold by the Fund which it is obligated to repurchase. The Fund may segregate liquid assets
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equal (on a daily mark-to-market basis) to its obligations under reverse repurchase agreements. To the extent that positions in reverse repurchase agreements are not so covered, such transactions would be subject to the Funds limitations on borrowings, which would restrict the aggregate amount of such transactions (plus any other borrowings) to one-third of the Funds total assets and among other things, cause such securities to be deemed senior securities evidencing indebtedness for purposes of the 1940 Act.
The Fund also may effect simultaneous purchase and sale transactions that are known as sale-buybacks. A sale-buyback is similar to a reverse repurchase agreement, except that in a sale-buyback, the counterparty who purchases the security is entitled to receive any principal or interest payments made on the underlying security pending settlement of the Funds repurchase of the underlying security.
Mortgage Dollar Rolls
A mortgage dollar roll is similar to a reverse repurchase agreement in certain respects. In a dollar roll transaction, the Fund sells a mortgage-related security, such as a security issued by GNMA, to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A dollar roll can be viewed, like a reverse repurchase agreement, as a collateralized borrowing in which the Fund pledges a mortgage-related security to a dealer to obtain cash. However, unlike reverse repurchase agreements, the dealer with which the Fund enters into a dollar roll transaction is not obligated to return the same securities as those originally sold by the Fund, but only securities which are substantially identical. To be considered substantially identical, the securities returned to the Fund generally must: (1) be collateralized by the same types of underlying mortgages; (2) be issued by the same agency and be part of the same program; (3) have a similar original stated maturity; (4) have identical net coupon rates; (5) have similar market yields (and therefore price); and (6) satisfy good delivery requirements, meaning that the aggregate principal amounts of the securities delivered and received back must be within 2.5% of the initial amount delivered.
As with reverse repurchase agreements, to the extent that positions in dollar roll agreements are not covered by segregated liquid assets at least equal to the amount of any forward purchase commitment, such transactions would be subject to the Funds restrictions on borrowings. Furthermore, because dollar roll transactions may be for terms ranging between one and six months, dollar roll transactions may be deemed illiquid.
Repurchase Agreements
The Fund may enter into repurchase agreements with domestic commercial banks or registered broker/dealers. A repurchase agreement is a contract under which the Fund would acquire a security for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the Fund to resell such security at a fixed time and price (representing the Funds cost plus interest). In the case of repurchase agreements with broker-dealers, the value of the underlying securities (or collateral) will be at least equal at all times to the total amount of the repurchase obligation, including the interest factor. The Fund bears a risk of loss in the event that the other party to a repurchase agreement defaults on its obligations and the Fund is delayed or prevented from exercising its rights to dispose of the collateral securities. This risk includes the risk of procedural costs or delays in addition to a loss on the securities if their value should fall below their repurchase price. PIMCO will monitor the creditworthiness of the counterparties.
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When-Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase or sell securities on a when-issued, delayed delivery, or forward commitment basis. When such purchases are outstanding, the Fund may segregate liquid assets, in an amount sufficient to meet the purchase price. Typically, no income accrues on securities the Fund has committed to purchase prior to the time delivery of the securities is made, although the Fund may earn income on securities it has segregated. If the Fund does not segregate liquid assets in such manner, then such securities will be considered senior securities evidencing indebtedness for purposes of the 1940 Act.
When purchasing a security on a when-issued, delayed delivery, or forward commitment basis, the Fund assumes the rights and risks of ownership of the security, including the risk of price and yield fluctuations, and takes such fluctuations into account when determining its net asset value. Because the Fund is not required to pay for the security until the delivery date, these risks are in addition to the risks associated with the Funds other investments. If the other party to a transaction fails to deliver the securities, the Fund could miss a favorable price or yield opportunity. If the Fund remains substantially fully invested at a time when when-issued, delayed delivery, or forward commitment purchases are outstanding, the purchases may result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery, or forward commitment basis, the Fund does not participate in future gains or losses with respect to the security. If the other party to a transaction fails to pay for the securities, the Fund could suffer a loss. Additionally, when selling a security on a when-issued, delayed delivery, or forward commitment basis without owning the security, the Fund will incur a loss if the securitys price appreciates in value such that the securitys price is above the agreed upon price on the settlement date.
The Fund may dispose of or renegotiate a transaction after it is entered into, and may sell when-issued, delayed delivery or forward commitment securities before the settlement date, which may result in a capital gain or loss. There is no percentage limitation on the extent to which the Fund may purchase or sell securities on a when-issued, delayed delivery, or forward commitment basis.
Borrowing
The Fund may borrow money to the extent permitted under the 1940 Act as interpreted, modified or otherwise permitted by regulatory authority having jurisdiction, from time to time. The Fund may from time to time borrow money to add leverage to the portfolio. The Fund may also borrow money for temporary administrative purposes.
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Under the 1940 Act, the Fund is not permitted to issue preferred shares unless immediately after such issuance the value of the Funds total net assets is at least 200% of the liquidation value of the Funds currently outstanding auction market preferred shares (the Preferred Shares) and the newly issued preferred shares plus the aggregate amount of any senior securities of the Fund representing indebtedness ( i.e. , such liquidation value plus the aggregate amount of senior securities representing indebtedness may not exceed 50% of the Funds total net assets). In addition, the Fund is not permitted to declare any cash dividend or other distribution on its common shares of beneficial interest (the Common Shares) unless, at the time of such declaration, the value of the Funds total net assets satisfies the above-referenced 200% coverage requirement.
The 1940 Act also generally prohibits the Fund from engaging in most forms of leverage other than preferred shares (including through the use of reverse repurchase agreements, dollar rolls, bank loans, commercial paper or other credit facilities, credit default swap contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions, to the extent that these instruments are not covered as described below) unless immediately after the issuance of the leverage the Fund has satisfied the asset coverage test with respect to senior securities representing indebtedness prescribed by the 1940 Act, i.e. , the value of the Funds total assets less liabilities (other than the leverage and other senior securities) is at least 300% of the principal amount of such leverage ( i.e. , effectively limiting the use of leverage through senior securities representing indebtedness to 33 1 / 3 % of the Funds total assets, including assets attributable to the leverage). The Fund is not permitted to declare any cash dividend or other distribution on its Common Shares unless, at the time of such declaration, this 300% asset coverage test is satisfied. The Fund may (but is not required to) cover its commitments under these instruments by the segregation of liquid assets or by entering into offsetting transactions or owning positions covering its obligations. For instance, the Fund may cover its position in a reverse repurchase agreement by segregating liquid assets at least equal in amount to its forward purchase commitment. To the extent that certain of these instruments are so covered, they will not be considered senior securities under the 1940 Act and therefore will not be subject to the 300% asset coverage requirement otherwise applicable to forms of leverage (other than preferred shares) used by the Fund. However, these transactions, even if covered, may represent a form of economic leverage and create special risks. The use of these forms of additional leverage increases the volatility of the Funds investment portfolio and could result in larger losses to Common Shareholders than if the strategies were not used. Failure to maintain certain asset coverage requirements could result in an event of default under certain Borrowings that may be used by the Fund. Failure to pay dividends on the Preferred Shares for a certain period of time could result in an event of default and entitle the holders of Preferred Shares (the Preferred Shareholders) and holders of any other senior securities of the Fund to elect a majority of the Trustees of the Fund.
The Fund may also enter into transactions other than those noted above that may give rise to a form of leverage including, among others, credit default swap contracts, futures and forward contracts and other derivative transactions, loans of portfolio securities, short sales and when-issued, delayed delivery and forward commitment transactions. Although it has no current intention to do so, the Fund may also determine to issue other preferred shares to add leverage to its portfolio. See Principal risks of the FundLeverage Risk in the Prospectus.
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As described above, the Fund will may, under certain circumstances, cover its commitment under these instruments by the segregation of liquid assets, equal in value to the amount of the Funds commitment, or by entering into offsetting transactions or owning positions covering its obligations. In such cases, the instruments will not be considered senior securities under the 1940 Act for purposes of the asset coverage requirements otherwise applicable to borrowings by the Fund or the Funds issuance of Preferred Shares. Borrowing will tend to exaggerate the effect on net asset value of any increase or decrease in the market value of the Funds portfolio. Money borrowed will be subject to interest costs which may or may not be recovered by appreciation of the securities purchased. The Fund also may be required to maintain minimum average balances in connection with such borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate.
Short Sales
The Fund may make short sales of securities as part of its overall portfolio management strategies involving the use of derivative instruments and to offset potential declines in long positions in similar securities. A short sale is a transaction in which the Fund sells a security it does not own in anticipation that the market price of that security will decline.
When the Fund makes a short sale, it must borrow the security sold short and deliver it to the broker-dealer through which it made the short sale as collateral for its obligation to deliver the security upon conclusion of the sale. The Fund may have to pay a fee to borrow particular securities and is often obligated to pay over any accrued interest and dividends on such borrowed securities.
If the price of the security sold short increases between the time of the short sale and the time that the Fund replaces the borrowed security, the Fund will incur a loss; conversely, if the price declines, the Fund will realize a capital gain. Any gain will be decreased, and any loss increased, by the transaction costs described above. The successful use of short selling may be adversely affected by imperfect correlation between movements in the price of the security sold short and the securities being hedged.
To the extent the Fund engages in short sales, it will provide collateral to the broker-dealer and (except in the case of short sales against the box) may maintain additional asset coverage in the form of segregated or earmarked liquid assets equal to the current market value of the securities sold short, or may ensure that such positions are covered by offsetting positions, until the Fund replaces the borrowed security. If the Fund does not segregate liquid assets in such manner, then such securities will be considered senior securities evidencing indebtedness for purpose of the 1940 Act. A short sale is against the box to the extent that the Fund contemporaneously owns, or has the right to obtain at no added cost, securities identical to those sold short. The Fund will engage in short selling to the extent permitted by the federal securities laws and rules and interpretations thereunder. To the extent the Fund engages in short selling in foreign (non-U.S.) jurisdictions, the Fund will do so to the extent permitted by the laws and regulations of such jurisdiction.
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Illiquid Securities
The Fund may invest without limit in illiquid securities (determined using the Securities and Exchange Commissions standard applicable to open-end investment companies, that is, securities that cannot be disposed of within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities). Illiquid securities are considered to include, among other things, written over-the-counter options, securities or other liquid assets being used as cover for such options, repurchase agreements with maturities in excess of seven days, certain loan participation interests, fixed time deposits which are not subject to prepayment or provide for withdrawal penalties upon prepayment (other than overnight deposits), and certain other securities whose disposition is restricted under the federal securities laws.
Illiquid securities may include privately placed securities, which are sold directly to a small number of investors, usually institutions. Unlike public offerings, such securities are not registered under the federal securities laws. Although certain of these securities may be readily sold, others may be illiquid, and their sale may involve substantial delays and additional costs.
Portfolio Trading and Turnover Rate
A change in the securities held by the Fund is known as portfolio turnover. PIMCO manages the Fund without regard generally to restrictions on portfolio turnover. Trading in fixed income securities does not generally involve the payment of brokerage commissions, but does involve indirect transaction costs. The use of futures contracts may involve the payment of commissions to futures commission merchants. High portfolio turnover (e.g., greater than 100%) involves correspondingly greater expenses to the Fund, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestments in other securities. The higher the rate of portfolio turnover of the Fund, the higher these transaction costs borne by the Fund generally will be. Such sales may result in realization of taxable capital gains (including short-term capital gains which are generally taxed to shareholders at ordinary income tax rates).
The portfolio turnover rate of the Fund is calculated by dividing (a) the lesser of purchases or sales of portfolio securities for the particular fiscal year by (b) the monthly average of the value of the portfolio securities owned by the Fund during the particular fiscal year. In calculating the rate of portfolio turnover, there is excluded from both (a) and (b) all securities, including options, whose maturities or expiration dates at the time of acquisition were one year or less. Proceeds from short sales and assets used to cover short positions undertaken are included in the amounts of securities sold and purchased, respectively, during the year.
For the fiscal year ended July 31, 2008, the Funds portfolio turnover rate was 29%. For the fiscal year ended July 31, 2009, the Funds portfolio turnover rate was 96%. This increase resulted from PIMCOs efforts to deleverage the Fund and to improve the overall quality of the Funds portfolio in light of economic conditions prevailing at the time.
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Warrants to Purchase Securities
The Fund may invest in warrants to purchase debt securities. Debt obligations with warrants attached to purchase equity securities have many characteristics of convertible bonds and their prices may, to some degree, reflect the performance of the underlying stock. Debt obligations also may be issued with warrants attached to purchase additional debt securities at the same coupon rate. A decline in interest rates would permit the Fund to buy additional bonds at the favorable rate or to sell the warrants at a profit. If interest rates rise, the warrants would generally expire with no value.
Other Investment Companies
The Fund may invest in securities of open- or closed-end investment companies, including exchange-traded funds (ETFs), to the extent that such investments are consistent with the Funds investment objective and policies and permissible under the 1940 Act.
In general, under the 1940 Act, an investment company such as the Fund may not (i) own more than 3% of the outstanding voting securities of any one registered investment company, (ii) invest more than 5% of its total assets in the securities of any single registered investment company or (iii) invest more than 10% of its total assets in securities of other registered investment companies.
The Fund may 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 and offering, during periods when there is a shortage of attractive variable rate and other debt instruments available in the market, or when PIMCO believes share prices of other investment companies offer attractive values. The Fund may invest in investment companies that are advised by PIMCO or its affiliates to the extent permitted by applicable law and/or pursuant to exemptive relief from the SEC.
As a shareholder in an investment company, the Fund will bear its ratable share of that investment companys expenses and would remain subject to payment of the Funds management fees with respect to assets so invested. Holders of the Funds Common Shares would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. PIMCO will take expenses into account when evaluating the investment merits of an investment in an investment company relative to available debt instruments. In addition, the securities of other investment companies may also be leveraged and will therefore be subject to the same leverage risks described in the Prospectus and herein. As described in the Prospectus in the section entitled Principal Risks of the FundLeverage Risk, the net asset value and market value of leveraged shares will be more volatile and the yield to shareholders will tend to fluctuate more than the yield generated by unleveraged shares.
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Securities Loans
Subject to the Funds Investment Restrictions listed below, the Fund may make secured loans of its portfolio securities to brokers, dealers and other financial institutions amounting to no more than one-third of its total assets. The risks in lending portfolio securities, as with other extensions of credit, consist of possible delay in recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. However, such loans will be made only to broker-dealers that are believed by PIMCO to be of relatively high credit standing. Securities loans are made to broker-dealers pursuant to agreements requiring that loans be continuously secured by collateral consisting of U.S. Government securities, cash or cash equivalents (negotiable certificates of deposit, bankers acceptances or letters of credit) maintained on a daily mark-to-market basis in an amount at least equal at all times to the market value of the securities lent. The borrower pays to the Fund, as the lender, an amount equal to any dividends or interest received on the securities lent. The Fund may invest the cash collateral received in interest-bearing, short-term securities or receive a fee from the borrower. In the case of cash collateral, the Fund typically pays a rebate to the lender. Although voting rights or rights to consent with respect to the loaned securities pass to the borrower, the Fund, as the lender, retains the right to call the loans and obtain the return of the securities loaned at any time on reasonable notice, and it will do so in order that the securities may be voted by the Fund if the holders of such securities are asked to vote upon or consent to matters materially affecting the investment. The Fund may also call such loans in order to sell the securities involved. When engaged in securities lending, the Funds performance will continue to reflect changes in the value of the securities loaned and will also reflect the receipt of either interest, through investment of cash collateral by the Fund in permissible investments, or a fee, if the collateral is U.S. Government securities.
Participation on Creditors Committees
The Fund may from time to time participate on committees formed by creditors to negotiate with the management of financially troubled issuers of securities held by the Fund. Such participation may subject the Fund to expenses such as legal fees and may make the Fund an insider of the issuer for purposes of the federal securities laws, and therefore may restrict the Funds ability to trade in or acquire additional positions in a particular security when it might otherwise desire to do so. Participation by the Fund on such committees also may expose the Fund to potential liabilities under the federal bankruptcy laws or other laws governing the rights of creditors and debtors. The Fund would participate on such committees only when PIMCO believes that such participation is necessary or desirable to enforce the Funds rights as a creditor or to protect the value of securities held by the Fund.
Short-Term Investments / Temporary Defensive Strategies
Upon PIMCOs recommendation, for temporary defensive purposes and in order to keep the Funds cash fully invested, including the period during which the net proceeds of the offering are being invested, the Fund may invest up to 100% of its net assets in investment grade debt securities, including high quality, short-term debt instruments, credit-linked trust certificates and/or index futures contracts or similar derivative instruments. Such investments may prevent the Fund from achieving its investment objective.
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Government Intervention in Financial Markets
Recent instability in the financial markets has led the U.S. Government to take a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Federal, state, and other governments, their regulatory agencies, or self regulatory organizations may take actions that affect the regulation of the instruments in which the Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Legislation or regulation may also change the way in which the Fund itself is regulated. Such legislation or regulation could limit or preclude the Funds ability to achieve its investment objective.
Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of the Funds portfolio holdings. Furthermore, volatile financial markets can expose the Fund to greater market and liquidity risk and potential difficulty in valuing portfolio instruments held by the Fund. The Fund has established procedures to assess the liquidity of portfolio holdings and to value instruments for which market prices may not be readily available. PIMCO will monitor developments and seek to manage the Fund in a manner consistent with achieving the Funds investment objective, but there can be no assurance that it will be successful in doing so.
Except as described below, the Fund, as a fundamental policy, may not, without the approval of the holders of a majority of the outstanding Common Shares and any outstanding preferred shares of beneficial interest (including Preferred Shares) voting together as a single class, and of the holders of a majority of any outstanding preferred shares of beneficial interest (including Preferred Shares) voting as a separate class:
(1) | Concentrate its investments in a particular industry, as that term is used in the 1940 Act, and as interpreted, modified, or otherwise permitted by regulatory authority having jurisdiction, from time to time. |
(2) | With respect to 75% of the Funds total assets, purchase the securities of any issuer, except securities issued or guaranteed by the U.S. Government or any of its agencies or instrumentalities or securities issued by other investment companies, if, as a result, (i) more than 5% of the Funds total assets would be invested in the securities of that issuer, or (ii) the Fund would hold more than 10% of the outstanding voting securities of that issuer. |
(3) | Purchase or sell real estate, although it may purchase securities secured by real estate or interests therein, or securities issued by companies which invest in real estate, or interests therein. |
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(4) | Purchase or sell commodities or commodities contracts or oil, gas or mineral programs. This restriction shall not prohibit the Fund, subject to restrictions described in the Prospectus and elsewhere in this Statement of Additional Information, from purchasing, selling or entering into futures contracts, options on futures contracts, forward contracts, or any interest rate, securities-related or other hedging instrument, including swap agreements and other derivative instruments, subject to compliance with any applicable provisions of the federal securities or commodities laws. |
(5) | Borrow money or issue any senior security, except to the extent permitted under the 1940 Act and as interpreted, modified, or otherwise permitted by regulatory authority having jurisdiction, from time to time. |
(6) | Make loans, except to the extent permitted under the 1940 Act, and as interpreted, modified, or otherwise permitted by regulatory authority having jurisdiction, from time to time. |
(7) | Act as an underwriter of securities of other issuers, except to the extent that in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under the federal securities laws. |
Currently, under the 1940 Act, the Fund generally is not permitted to engage in borrowings unless immediately after a borrowing the value of the Funds total assets less liabilities (other than the borrowing) is at least 300% of the principal amount of such borrowing ( i.e. , such principal amount may not exceed 33 1 / 3 % of the Funds total assets). In addition, the Fund is not permitted to declare any cash dividend or other distribution on Common Shares unless, at the time of such declaration, the value of the Funds total assets, less liabilities other than the borrowing, is at least 300% of such principal amount.
Currently, under the 1940 Act, the Fund may generally not lend money or property to any person, directly or indirectly, if such person controls or is under common control with the Fund, except for a loan from the Fund to a company which owns all of the outstanding securities of the Fund, except directors and qualifying shares.
For purposes of the foregoing, majority of the outstanding, when used with respect to particular shares of the Fund (whether voting together as a single class or voting as separate classes), means (i) 67% or more of such shares present at a meeting, if the holders of more than 50% of such shares are present or represented by proxy, or (ii) more than 50% of such shares, whichever is less.
Unless otherwise indicated, all limitations applicable to the Funds investments (as stated above and elsewhere in this Statement of Additional Information) apply only at the time a transaction is entered into. Any subsequent change in a rating assigned by any rating service to a security (or, if unrated, deemed by PIMCO to be of comparable quality), or change in the percentage of the Funds total assets invested in certain securities or other instruments, or change in the average maturity or duration of the Funds investment portfolio, resulting from market fluctuations or other changes in the Funds total assets, will not require the Fund to dispose of an investment. In the event that rating agencies assign different ratings to the same security, PIMCO will determine which rating it believes best reflects the securitys quality and risk at that time, which may be the higher of the several assigned ratings.
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Under the 1940 Act, a senior security does not include any promissory note or evidence of indebtedness where such loan is for temporary purposes only and in an amount not exceeding 5% of the value of the total assets of the issuer at the time the loan is made. A loan is presumed to be for temporary purposes if it is repaid within sixty days and is not extended or renewed.
The Fund would be deemed to concentrate its investments in a particular industry if it invested more than 25% of its total assets in that industry. The Funds industry concentration policy does not preclude it from focusing investments in issuers in a group of related industrial sectors (such as different types of utilities). The Fund interprets its industry concentration policy to apply to direct investments in the securities of issuers in a particular industry, as defined by the Fund. For purposes of this restriction, a foreign government is considered to be an industry. Currency positions are not considered to be an investment in a foreign government for industry concentration purposes. Mortgage-backed securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities are not subject to the Funds industry concentration restrictions, by virtue of the exclusion from that test available to all U.S. Government securities. Similarly, municipal bonds issued by states, municipalities and other political subdivisions, agencies, authorities and instrumentalities of states and multi-state agencies and authorities are not subject to the Funds industry concentration restrictions.
The Fund limits the amount of its total assets that it will invest in any one issuer or in issuers within the same industry. For purposes of these limits, the Fund generally will treat the corporate or other borrower as the issuer of indebtedness held by the Fund. In the case of loan participations where a bank or other lending institution serves as a financial intermediary between the Fund and the borrower, if the participation does not shift to the Fund the direct debtor-creditor relationship with the borrower, SEC interpretations may take the position that the Fund should treat both the lending bank or other lending institution and the borrower as issuers for the purposes of determining whether the Fund has invested more than 5% of its total assets in a single issuer. Treating a financial intermediary as an issuer of indebtedness may restrict the Funds ability to invest in indebtedness related to a single financial intermediary, or a group of intermediaries engaged in the same industry, even if the underlying borrowers represent many different companies and industries.
To the extent the Fund covers its commitment under a reverse repurchase agreement, credit default swap or other derivative instrument by the segregation of liquid assets equal in value to the amount of the Funds commitment, such instrument will not be considered a senior security for purposes of the asset coverage requirements otherwise applicable to borrowings by the Fund or the Funds issuance of Preferred Shares.
The Fund interprets its policies with respect to borrowing and lending to permit such activities as may be lawful for the Fund, to the full extent permitted by the 1940 Act or by exemption from the provisions therefrom pursuant to exemptive order of the SEC.
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The Fund is subject to additional guidelines in order to obtain and maintain ratings on the Preferred Shares of Aaa from Moodys and AAA from Fitch and may become subject to additional guidelines in the future.
Trustees and Officers
The business of the Fund is managed under the direction of the Funds Board of Trustees. Subject to the provisions of the Funds Amended and Restated Agreement and Declaration of Trust (the Declaration), its Third Amended and Restated Bylaws (the Bylaws) and Massachusetts law, the Trustees have all powers necessary and convenient to carry out this responsibility, including the election and removal of the Funds officers.
Board Leadership Structure . The Funds Board of Trustees consists of seven Trustees, six of whom are not interested persons (within the meaning of Section 2(a)(19) of the 1940 Act) of the Fund or of the Investment Manager (the Independent Trustees). An Independent Trustee serves as Chairman of the Trustees and is selected by vote of the majority of the Independent Trustees. The Chairman of the Trustees presides at meetings of the Board and acts as a liaison with service providers, officers, attorneys and other Trustees generally between meetings, and performs such other functions as may be requested by the Board from time to time.
The Board of Trustees meets regularly four times each year to discuss and consider matters concerning the Fund, and also holds special meetings to address matters arising between regular meetings. The Independent Trustees regularly meet outside the presence of Fund management and are advised by independent legal counsel. Regular meetings generally take place in-person; other meetings may take place in-person or by telephone.
The Board of Trustees has established four standing Committees to facilitate the Trustees oversight of the management of the Fund: the Audit Oversight Committee, the Nominating Committee, the Valuation Committee and the Compensation Committee. The functions and role of each Committee are described below under Committees of the Board of Trustees. The membership of each Committee consists of all of the Independent Trustees, which the Board believes allows them to participate in the full range of the Boards oversight duties.
The Board reviews its leadership structure periodically and has determined that this leadership structure, including an Independent Chairman, a supermajority of Independent Trustees and Committee membership limited to Independent Trustees, is appropriate in light of the characteristics and circumstances of the Fund. In reaching this conclusion, the Board considered, among other things, the predominant role of the Investment Manager and Sub-Adviser in the day-to-day management of Fund affairs, the extent to which the work of the Board is conducted through the Committees, the number of portfolios that comprise the Fund Complex (defined below), the variety of asset classes those series include, the net assets of the Fund and the Fund Complex and the management, distribution and other service arrangements of the Fund and the Fund Complex. The Board also believes that its structure, including the presence of one Trustee who is an executive with various Investment Manager-affiliated entities, facilitates an efficient flow of information concerning the management of the Fund to the Independent Trustees.
Risk Oversight . The Fund has retained the Investment Manager and the Sub-Adviser to provide investment advisory services, and, in the case of the Investment Manager, administrative services, and these service providers are immediately responsible for the management of risks that may arise from Fund investments and operations. Some employees of the Investment Manager serve as the Funds officers, including the Funds principal executive officer and principal financial and accounting officer. The Board oversees the performance of these functions by the Investment Manager and Sub-Adviser, both directly and through the Committee structure it has established. The Board receives from the Investment Manager and Sub-Adviser a wide range of reports, both on a regular and as-needed basis, relating to the Funds activities and to the actual and potential risks of the Fund. These include reports on investment risks, compliance with applicable laws, and the Funds financial accounting and reporting. The Board also regularly receives, from the Funds principal underwriter, reports regarding the distribution, sale and marketing of the Funds shares, as well as related risks. In addition, the Board meets periodically with the portfolio manager of the Fund to receive reports regarding the portfolio management of the Fund and its performance, including its investment risks.
In addition, the Board has appointed a Chief Compliance Officer (CCO). The CCO oversees the development of compliance policies and procedures that are reasonably designed to minimize the risk of violations of the federal securities laws (Compliance Policies). The CCO reports directly to the Independent Trustees, and provides presentations to the Board at its quarterly meetings and an annual report on the application of the Compliance Policies. The Board periodically discusses relevant risks affecting the Fund with the CCO at these meetings. The Board has approved the Compliance Policies and reviews the CCOs reports. Further, the Board annually reviews the sufficiency of the Compliance Policies, as well as the appointment and compensation of the CCO.
The Trustees and officers of the Fund, their
ages, the position they hold with the Fund, their term of office and length of time served, a description of their principal occupations during the past five years, the number of portfolios in the fund complex (as defined in SEC regulations) that
the Trustee oversees and any other directorships held by the Trustee are listed in the two tables immediately following. Except as shown, each Trustees and officers principal occupation and business experience for the last five years
have been with the employer(s) indicated, although in some cases the Trustee may have held different positions with such employer(s). Unless otherwise indicated, the business address of the persons listed below is c/o Allianz Global Investors Fund
Independent Trustees ( 1)
Name, Address and Date of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During the Past 5 Years |
Number of Portfolios in Fund Complex (2) Overseen by Trustee |
Other Directorships Held by Trustee |
|||||
Paul Belica 9/27/1921 |
Trustee |
Since inception (October 2004) |
Retired. Formerly Director, Student Loan Finance Corp., Education Loans, Inc., Goal Funding, Inc., Goal Funding II, Inc. and Surety Loan Fund, Inc.; and formerly, Manager of Stratigos Fund LLC, Whistler Fund LLC, Xanthus Fund LLC & Wynstone Fund LLC. | 49 | None. | |||||
Robert E. Connor 9/17/1934 |
Trustee | Since December 2005 | Corporate Affairs Consultant. Formerly, Senior Vice President, Corporate Office, Smith Barney Inc. | 49 | None. |
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Name, Address and Date of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During the Past 5 Years |
Number of Portfolios in Fund Complex (2) Overseen by Trustee |
Other Directorships Held by Trustee |
|||||
James A. Jacobson 2/3/1945 |
Trustee | Since December 2009 | Retired. Formerly, Vice Chairman, Managing Director, Spear, Leeds & Kellogg Specialists, LLC, specialist firm on NYSE (2003-2008). | 44 | Trustee, Alpine Mutual Fund complex. | |||||
Hans W. Kertess 7/12/1939 |
Trustee and Chairman of the Board |
Since inception (October 2004) |
President, H. Kertess & Co., a financial advisory company; formerly, Managing Director, Royal Bank of Canada Capital Markets. | 49 | None. | |||||
William B. Ogden, IV 1/11/1945 |
Trustee | Since September 2006 | Asset Management Industry Consultant. Formerly, Managing Director, Investment Banking Division of Citigroup Global Markets Inc. | 49 | None. | |||||
R. Peter Sullivan III 9/4/1941 |
Trustee | Since December 2005 | Retired. Formerly, Managing Partner, Bear Wagner Specialists LLC, specialist firm on the New York Stock Exchange. | 49 | None. | |||||
Interested Trustee ( 3) |
||||||||||
Name, Address and Date of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During the Past 5 Years |
Number of Portfolios in Fund Complex (2) Overseen by Trustee |
Other Directorships Held by Trustee |
|||||
John C. Maney 8/3/1959 |
Trustee | Since December 2006 | Management Board of Allianz Global Investors Fund Management LLC; Management Board and Managing Director of Allianz Global Investors of America L.P. since January 2005 and also Chief Operating Officer of Allianz Global Investors of America L.P. since November 2006. | 78 | None. |
(1) | Independent Trustees are those Trustees who are not interested persons (as defined in Section 2(a)(19) of the 1940 Act). |
(2) | The term Fund Complex as used herein includes the Fund and the following registered investment companies: each series of Allianz Funds, each series of Allianz Funds Multi-Strategy Trust, each series of PIMCO Funds, each series of Nicholas-Applegate Institutional Funds, PIMCO Global Advisors (Ireland) Limited, PIMCO Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund, PIMCO California Municipal Income Fund II, PIMCO California Municipal Income Fund III, PIMCO New York Municipal Income Fund, PIMCO New |
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York Municipal Income Fund II, PIMCO New York Municipal Income Fund III, PIMCO Corporate Income Fund, PIMCO Corporate Opportunity Fund, PIMCO High Income Fund, Nicholas-Applegate Convertible & Income Fund, Nicholas-Applegate Convertible & Income Fund II, PIMCO Income Strategy Fund, NFJ Dividend, Interest and Premium Strategy Fund, Nicholas-Applegate International and Premium Strategy Fund, PIMCO Global StocksPLUS & Income Fund, Nicholas-Applegate Equity & Convertible Income Fund, Nicholas-Applegate Global Equity & Convertible Income Fund, PIMCO Income Opportunity Fund, PCM Fund Inc., PIMCO Strategic Global Government Fund Inc., each series of Premier VIT, PIMCO Private Account Portfolio Series, each series of Allianz Global Investors Managed Accounts Trust, each series of OCC Cash Reserves, Inc., each series of OCC Accumulation Trust, each series of USAllianz Variable Insurance Products Trust and registered investment companies advised by RCM Capital Management LLC and Nicholas-Applegate Capital Management LLC.
(3) | An Interested Trustee is a Trustee who is an interested person (as defined above) of the Fund. Mr. Maney is an interested person of the Fund due to his affiliation with Allianz Global Investors of America L.P. In addition to Mr. Maneys positions set forth in the table above, he holds the following positions with affiliated persons: Management Board, Managing Director and Chief Operating Officer of Allianz Global Investors of America L.P., Allianz Global Investors of America LLC and Allianz-Pac Life Partners LLC; MemberBoard of Directors and Chief Operating Officer of Allianz Global Investors of America Holdings Inc. and Oppenheimer Group, Inc.; Managing Director and Chief Operating Officer of Allianz Global Investors NY Holdings LLC; Management Board and Managing Director of Allianz Global Investors U.S. Holding LLC; Managing Director and Chief Operating Officer of Allianz Hedge Fund Partners Holding L.P. and Allianz Global Investors U.S. Retail LLC; MemberBoard of Directors and Managing Director of Allianz Global Investors Advertising Agency Inc.; Compensation Committee of NFJ Investment Group LLC; Management Board of Allianz Global Investors Fund Management LLC, Allianz Global Investors Managed Partners LLC, Nicholas-Applegate Holdings LLC and OpCap Advisors LLC; MemberBoard of Directors and Chief Operating Officer of PIMCO Global Advisors (Resources) Limited; Executive Vice President of PIMCO Japan Ltd.; Chief Operating Officer of Allianz Global Investors U.S. Holding II LLC; and Member and ChairmanBoard of Directors, President and Chief Operating Officer of PFP Holdings, Inc. |
In accordance with the Funds staggered board (see Anti-Takeover and Other Provisions in the Declaration of Trust), the Common Shareholders of the Fund elect Trustees to fill the vacancies of Trustees whose terms expire at each annual meeting of Common Shareholders. So long as any Preferred Shares or any other preferred shares of beneficial interest are outstanding Preferred Shareholders and holders of any other preferred shares outstanding, voting as a separate class, will elect two Trustees and the remaining Trustees will be elected by Common Shareholders and Preferred Shareholders and holders of any other preferred shares outstanding, voting together as a single class. Preferred Shareholders and holders of any other preferred shares outstanding are entitled to elect a majority of the Funds Trustees under certain circumstances.
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Officers
Name, Address and Date of Birth |
Position(s) Held with the Fund |
Term of Office and Length of Time Served |
Principal Occupation(s) During the Past 5 Years |
|||
Brian S. Shlissel 11/14/1964 |
President & Chief Executive Officer |
Since inception (October 2004) |
Managing Director, Head of Mutual Fund Services Allianz Global Investors Fund Management LLC; President and Chief Executive Officer of 33 funds in the Fund Complex; Treasurer, Principal Financial and Accounting Officer of 45 funds in the Fund Complex and The Korea Fund, Inc. Formerly, Director of 4 funds in the Fund Complex (2002-2008). | |||
Lawrence G. Altadonna 3/10/1966 |
Treasurer, Principal Financial and Accounting Officer |
Since inception (October 2004) |
Senior Vice President, Allianz Global Investors Fund Management LLC; Treasurer, Principal Financial and Accounting Officer of 33 funds in the Fund Complex; Assistant Treasurer of 45 funds in the Fund Complex and The Korea Fund, Inc. | |||
Thomas J. Fuccillo 3/22/1968 |
Vice President, Secretary and Chief Legal Officer | Since December 2004 | Executive Vice President, Chief Legal Officer and Secretary of Allianz Global Investors Fund Management LLC and Allianz Global Investors Solutions LLC; Executive Vice President of Allianz Global Investors of America L.P.; Vice President, Secretary and Chief Legal Officer of 78 funds in the Fund Complex; Secretary and Chief Legal Officer of The Korea Fund, Inc. | |||
Youse Guia 680 Newport Center Drive Suite 250 Newport Beach, CA 92660 9/3/1972 |
Chief Compliance Officer | Since inception (October 2004) | Senior Vice President and Chief Compliance Officer of Allianz Global Investors of America L.P.; Chief Compliance Officer of 78 funds in the Fund Complex and The Korea Fund, Inc. | |||
Scott Whisten 3/13/1971 |
Assistant Treasurer | Since January 2007 | Vice President, Allianz Global Investors Fund Management LLC; Assistant Treasurer of 78 funds in the Fund Complex. Formerly, Accounting Manager, Prudential Investments, 2000-2005. | |||
Richard J. Cochran 1/23/1961 |
Assistant Treasurer | Since May 2008 | Vice President, Allianz Global Investors Fund Management LLC; Assistant Treasurer of 78 funds in the Fund Complex; formerly, Tax manager, Teachers Insurance Annuity Association/College Retirement Equity Fund (TIAA-CREF) (2002-2008). | |||
Kathleen A. Chapman 11/11/1954 |
Assistant Secretary | Since December 2006 | Assistant Secretary of 78 funds in the Fund Complex. Formerly, ManagerIndividual Investor Group Advisory Law, Morgan Stanley (2004-2005). | |||
Lagan Srivastava | Assistant Secretary | Since December 2006 | Assistant Secretary of 78 funds in the Fund Complex and The Korea Fund, Inc. Formerly, Research Assistant, Dechert LLP, 2004-2005. |
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Each of the Funds executive officers is an interested person of the Fund (as defined in Section 2(a)(19) of the 1940 Act) as a result of his or her position(s) set forth in the table above.
Trustee Qualifications. The Board has determined that each Trustee should continue to serve as such based on several factors (none of which alone is decisive). With the exception of Mr. Jacobson (who became a Board member in December 2009), each Trustee has served in such role for several years and is intimately familiar with the Funds business and service provider arrangements, and has also served for several years as trustee/director to a number of other investment companies advised by the Investment Manager and its affiliates. Among the factors the Board considered when concluding that an individual should serve on the Board were the following: (i) the individuals business and professional experience and accomplishments; (ii) the individuals ability to work effectively with other members of the Board; (iii) the individuals prior experience, if any, serving on the boards of public companies (including, where relevant, other investment companies) and other complex enterprises and organizations; and (iv) how the individuals skills, experiences and attributes would contribute to an appropriate mix of relevant skills and experience on the Board.
In respect of each current Trustee, the individuals substantial professional accomplishments and prior experience, including, in some cases, in fields related to the operations of the Fund, were a significant factor in the determination that the individual should serve as a Trustee of the Fund. Following is a summary of various qualifications, experiences and skills of each Trustee (in addition to business experience during the past five years set forth in the table above) that contributed to the Boards conclusion that an individual should serve on the Board:
Paul Belica Mr. Belica has substantial executive and board experience in the financial services and investment management
industries. He formerly served as director to several other investment companies. Having served as Director, Senior Vice President and Managing Director of Smith Barney, Harris Upham & Co, he provides the Fund with significant financial expertise and serves as the Audit Oversight Committees Chair and has been determined by the Board to be an audit committee financial expert. He also brings significant public sector experience, having formerly served as Chairman of the State of New York Mortgage Agency and as executive director of several related public authorities.
Robert E. Connor Mr. Connor has substantial executive experience in the financial services industry. Through past positions with Smith Barney, Harris Upham & Co., Primerica, Inc. and the Travelers Companies he has gained particular expertise in corporate governance matters, intra- and inter-corporate relations and public relations.
James A. Jacobson Mr. Jacobson has substantial executive and board experience in the financial services industry. He served for more than 15 years as a senior executive at an NYSE specialist firm. He has also served on the NYSE Board of Directors, including terms as Vice Chair. As such, he provides significant expertise on matters relating to portfolio brokerage and trade execution. He has expertise in investment company matters through his service as a trustee of another fund family.
Hans W. Kertess Mr. Kertess has substantial executive experience in the investment management industry. He is the president of a financial advisory company, H. Kertess & Co., and formerly served as the Managing Director of Royal Bank of Canada Capital Markets. He has significant expertise in the investment banking industry.
John C. Maney Mr. Maney has substantial executive and board experience in the investment management industry. He has served in a variety of senior-level positions with investment advisory firms affiliated with the Investment Manager. Because of his familiarity with the Investment Manager and affiliated entities, he serves as an important information resource for the Independent Trustees and as a facilitator of communication with the Investment Manager.
William B. Ogden, IV Mr. Ogden has substantial senior executive experience in the investment banking industry. He served as Managing Director at Citigroup, where he established and led the firms efforts to raise capital for and provide mergers and acquisition advisory services to asset managers and investment advisers. He also has significant expertise with fund products through his senior-level responsibility for originating and underwriting a broad variety of such products.
R. Peter Sullivan, III Mr. Sullivan has substantial executive experience in the financial services industry. He formerly served as Managing Partner at an NYSE specialist firm, and provides the Fund with significant expertise relating to, among other areas, portfolio brokerage and trade execution.
Committees of the Board of Trustees
Audit Oversight Committee. The Audit Oversight Committee provides oversight with respect to the internal and external accounting and auditing procedures of the Fund and, among other things, considers the selection of independent public accountants for the Fund and the scope of the audit, approves all audit and permitted non-audit services proposed to be performed by those auditors on behalf of the Fund and certain affiliates, including the Investment Manager and PIMCO, and the possible effect of those services on the independence of those auditors. Messrs. Belica, Connor, Jacobson, Kertess, Ogden and Sullivan, each of whom is an Independent Trustee, serve on this committee. During the fiscal year ended July 31, 2009 the Audit Oversight Committee met one time.
Nominating Committee. The Nominating Committee is responsible for reviewing and recommending qualified candidates to the Board in the event that a position is vacated or created. The Nominating Committee will review and consider nominees recommended by shareholders to serve as Trustee, provided any such recommendation is submitted in writing to the Fund, c/o Thomas J. Fuccillo, Secretary, at the address of the principal executive offices of the Fund. The Nominating Committee has full discretion to reject nominees recommended by shareholders, and there is no assurance that any such person so recommended and considered by a committee will be nominated for election to the Board. Messrs. Belica, Connor, Jacobson, Kertess, Ogden and Sullivan, each of whom is an Independent Trustee, serve on this committee. During the fiscal year ended July 31, 2009 the Nominating Committee met one time.
Valuation Committee. The Valuation Committee reviews procedures for the valuation of securities and periodically reviews information from the Investment Manager and PIMCO regarding fair value and liquidity determination made pursuant to the Board-approved procedures, and makes related recommendations to the full Board and assists the full Board in resolving particular valuation matters. Messrs. Belica, Connor, Jacobson, Kertess, Ogden and Sullivan, each of whom is an Independent Trustee, serve on this committee. During the fiscal year ended July 31, 2009 the Valuation Committee met one time.
Compensation Committee. The Compensation Committee periodically reviews and sets compensation payable to the Trustees of the Fund who are not directors, officers, partners or employees of the Investment Manager, PIMCO or any entity controlling, controlled by or under common control with the Investment Manager or PIMCO. Messrs. Belica, Connor, Jacobson, Kertess, Ogden and Sullivan, each of whom is an Independent Trustee, serve on this committee. During the fiscal year ended July 31, 2009 the Compensation Committee did not meet in separate session.
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Securities Ownership
For each Trustee, the following table discloses the dollar range of equity securities beneficially owned by the Trustee in the Fund and, on an aggregate basis, in any registered investment companies overseen by the Trustee within the Funds family of investment companies as of December 31, 2009:
Name of Trustee |
Dollar Range of Equity Securities in the Fund |
Aggregate Dollar Range of Equity Securities in All Registered Investment Companies Overseen by Trustee in Family of Investment Companies |
||
Independent Trustees |
||||
Paul Belica |
None | None | ||
Robert E. Connor |
None | None | ||
James A. Jacobson |
None | None | ||
Hans W. Kertess |
None | None | ||
William B. Ogden, IV |
None | None | ||
R. Peter Sullivan III |
None | $10,001 - $50,000 | ||
Interested Trustee | ||||
John C. Maney |
None | $10,001 - $50,000 |
* | The term Family of Investment Companies as used herein includes the Fund and the following registered investment companies: each series of Allianz Funds, each series of PIMCO Funds, each series of Allianz Funds Multi-Strategy Trust, PIMCO Global Advisors (Ireland) Limited, PIMCO Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund, PIMCO California Municipal Income Fund II, PIMCO California Municipal Income Fund III, PIMCO New York Municipal Income Fund, PIMCO New York Municipal Income Fund II, PIMCO New York Municipal Income Fund III, PIMCO Corporate Income Fund, PIMCO Corporate Opportunity Fund, PIMCO High Income Fund, Nicholas-Applegate Convertible & Income Fund, Nicholas-Applegate Convertible & Income Fund II, PIMCO Income Strategy Fund, NFJ Dividend, Interest and Premium Strategy Fund, Nicholas-Applegate International and Premium Strategy Fund, PIMCO Global StocksPLUS & Income Fund, Nicholas-Applegate Equity & Convertible Income Fund, Nicholas-Applegate Global Equity & Convertible Income Fund, PCM Fund Inc., PIMCO Income Opportunity Fund, each series of Premier VIT, PIMCO Strategic Global Government Fund, Inc., each series of PIMCO Funds: Global Investors Series plc, each series of PIMCO Private Account Portfolio Series and each series of Allianz Global Investors Managed Accounts Trust. |
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For Independent Trustees and their immediate family members, the following table provides information regarding each class of securities owned beneficially in an investment adviser or principal underwriter of the Fund, or a person (other than a registered investment company) directly or indirectly controlling, controlled by, or under common control with an investment adviser or principal underwriter of the Fund as of December 31, 2009:
Name of Trustee |
Name of Owners
and Relations to Trustee |
Company | Title of Class |
Value of
Securities |
Percent of
Class |
|||||
Paul Belica | None. | |||||||||
Robert E. Connor | None. | |||||||||
James A. Jacobson | None. | |||||||||
Hans W. Kertess | None. | |||||||||
William B. Ogden, IV | None. | |||||||||
R. Peter Sullivan III | None. |
As of December 31, 2009, the Funds officers and Trustees as a group owned less than 1% of the outstanding Common Shares.
As of February 28, 2010, the following persons owned of record the number of shares of the noted class as set forth below, representing the indicated percentage of such class as of such date. Many of these shares are believed to be held only as nominee. To the knowledge of the Fund, no other person owned of record or beneficially 5% or more of any class of the Funds outstanding equity securities on such date.
Shareholder |
Class | Number of Shares | Percentage of Class | ||||
UBS AG |
Preferred | 1,411 | 21.91 | % | |||
Bank of America Corporation |
Preferred | 1,898 | 29.5 | % 1 | |||
Blue Ridge Investments, L.L.C. |
Preferred | 1,888 | 29.3 | % 1 | |||
Bank of America N.A. |
Preferred | 10 | 0.2 | % 1 | |||
First Trust Portfolios L.P. |
Common | 5,317,348 | 12.4 | % 2 | |||
First Trust Advisors L.P. |
Common | 5,317,348 | 12.4 | % 2 | |||
The Charger Corporation |
Common | 5,317,348 | 12.4 | % 2 |
(1) | Bank of America Corporation, Blue Ridge Investments, L.L.C. and Bank of America N.A., which are affiliates of one another, collectively owned 29.5% of the outstanding Preferred Shares. |
(2) | First Trust Portfolios L.P., First Trust Advisors L.P. and The Charger Corporation, which are affiliates of one another, collectively owned 12.4% of the outstanding Common Shares. |
Compensation
Each of the Independent Trustees also serves as a trustee of NFJ Dividend, Interest & Premium Strategy Fund, Nicholas-Applegate Convertible & Income Fund, Nicholas-Applegate Convertible & Income Fund II, Nicholas-Applegate Equity & Convertible Income Fund, Nicholas-Applegate Global Equity & Convertible Income Fund, Nicholas-Applegate International & Premium Strategy Fund, PCM Fund, Inc., PIMCO California Municipal Income, PIMCO California Municipal Income Fund II, PIMCO California Municipal Income Fund III, PIMCO Corporate Income Fund, PIMCO Corporate Opportunity Fund, PIMCO Income Strategy Fund, PIMCO Global StocksPLUS & Income Fund, PIMCO High Income Fund, PIMCO Income Opportunity Fund, PIMCO Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO Municipal Income Fund III, PIMCO New York Municipal Income Fund, PIMCO New York Municipal Income Fund II, PIMCO New York Municipal Income Fund III, and PIMCO Strategic Global Government Fund, each a closed-end fund for which the Investment Manager serves as investment manager and affiliates of the Investment Manager serve as sub-advisers (together, the Allianz Closed-End Funds) and certain other open-end investment companies for which the Investment Manager serves as investment manager and administrator and affiliates of the Investment Manager serve as investment sub-advisers (together with the Allianz Closed-End Funds, the Allianz Managed Funds). As indicated below, certain of the officers of the Fund are affiliated with the Investment Manager.
Each of the Allianz Managed Funds are expected to hold joint meetings of their boards of trustees whenever possible. Each Trustee, other than any Trustee who is a director, officer, partner or employee of the Investment Manager, PIMCO, or any entity controlling, controlled by
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or under common control with the Investment Manager or PIMCO, receives annual compensation of $250,000, which is payable quarterly. The independent chairman of the boards receives an additional $75,000 per year, payable quarterly. An audit oversight committee chairman receives an additional $50,000 per year, payable quarterly. Trustees will also be reimbursed for meeting-related expenses.
Each Trustees compensation and other costs of joint meetings is allocated pro rata among the Allianz Managed Funds for which such Trustee serves as trustee based on the complexity of issues relating to each such Fund and relative time spent by the Trustees in addressing them, and secondarily, on each such Funds relative net assets (including assets attributable to any outstanding preferred shares issued by an Allianz Closed-End Fund).
Trustees do not currently receive any pension or retirement benefits from the Fund or the Fund Complex.
The following table provides information concerning the compensation paid to the Independent Trustees for the fiscal year ended July 31, 2009. For the calendar year ended December 31, 2009, the Independent Trustees received the compensation set forth in the table below for serving as trustees of the Fund and other funds in the same Fund Complex as the Fund. Each officer and each Trustee who is a director, officer, partner, member or employee of the Investment Manager or the Sub-Adviser, or of any entity controlling, controlled by or under common control with the Investment Manager or the Sub-Adviser, including any Interested Trustee, serves without any compensation from the Fund.
Name of Trustee |
Aggregate
Compensation from the Fund for Fiscal Year Ended July 31, 2009 |
Total Compensation from the Fund and
Fund Complex Paid to Trustees for Calendar Year-Ended December 31, 2009 (1) |
||||
Paul Belica |
$ | 14,121 | $ | 300,000 | ||
Robert E. Connor |
$ | 12,767 | $ | 250,000 | ||
John J. Dalessandro (2) |
$ | 0 | $ | 0 | ||
James A. Jacobson (3) |
$ | 0 | $ | 11,005 | ||
Hans W. Kertess |
$ | 14,970 | $ | 325,000 | ||
William B. Ogden, IV |
$ | 12,767 | $ | 250,000 | ||
R. Peter Sullivan III |
$ | 12,767 | $ | 250,000 | ||
Diana L. Taylor (4) |
$ | 12,767 | $ | 168,750 |
(1) | In addition to the Allianz Closed-End Funds, during the Funds most recently completed fiscal year, the Trustees (except as noted) served as Trustees of three open-end investment companies (each consisting of separate investment portfolios) advised by the Investment Manager. These investment companies are considered to be in the same Fund Complex as the Fund. |
(2) | Mr. Dalessandro served as Trustee of the Fund until his death on September 14, 2008. |
(3) | Mr. Jacobsons appointment as a Trustee of the Fund was effective December 14, 2008. Mr. Jacobson serves as a Trustee to only two of the three open-end investment companies (each consisting of separate investment portfolios) advised by the Investment Manager mentioned above. |
(4) | Ms. Taylor resigned as Trustee on September 10, 2009. Until September 10, 2009, Ms. Taylor served as a Trustee to only two of the three open-end investment companies (each consisting of separate investment portfolios) advised by the Investment Manager, mentioned above. |
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Codes of Ethics
The Fund, the Investment Manager and PIMCO have each adopted a separate code of ethics governing personal trading activities of, as applicable, all Trustees and officers of the Fund, and directors, officers and employees of the Investment Manager and PIMCO, who, in connection with their regular functions, play a role in the recommendation of any purchase or sale of a security by the Fund or obtain information pertaining to such purchase or sale or who have the power to influence the management or policies of the Fund, the Investment Manager or PIMCO, as applicable. Such persons are prohibited from effecting certain transactions, allowed to effect certain exempt transactions (including with respect to securities that may be purchased or held by the Fund), and are required to preclear certain security transactions with the applicable compliance officer or his designee and to report certain transactions on a regular basis. The Fund, the Investment Manager and PIMCO have each developed procedures for administration of their respective codes. Text-only versions of the codes of ethics can be viewed online or downloaded from the EDGAR Database on the SECs internet Web site at www.sec.gov. You may also review and copy those documents by visiting the SECs Public Reference Room in Washington, DC, information on the operation of which may be obtained by calling 1-800-551-8090. Copies may be obtained, after paying a duplicating fee, by electronic request to publicinfo@sec.gov, or by writing the SECs Public Reference Section, Washington, DC 20549-0102.
INVESTMENT MANAGER AND SUB-ADVISER
Investment Manager
Allianz Global Investors Fund Management LLC (the Investment Manager) serves as investment manager to the Fund pursuant to an investment management agreement (the Investment Management Agreement) between it and the Fund. The Investment Manager is a wholly-owned indirect subsidiary of Allianz Global Investors of America L.P. (Allianz). Allianz was organized as a limited partnership under Delaware law in 1987. Allianzs sole general partner is Allianz-Paclife Partners LLC. Allianz-Paclife Partners LLC is a Delaware limited liability company whose sole member is Allianz Global Investors U.S. Holding LLC, a Delaware limited liability company. The sole member of Allianz Global Investors U.S. Holding LLC is Allianz Global Investors of America LLC. Allianz Global Investors of America LLC has two members, Allianz of America, Inc. (Allianz of America), a Delaware corporation that owns a 99.9% non-managing interest, and Allianz Global Investors of America Holdings Inc., a Delaware corporation that owns a 0.01% managing interest. Allianz of America is a wholly-owned subsidiary of Allianz SE. Allianz Global Investors of America Holdings Inc. is a wholly-owned subsidiary of Allianz Global Investors Aktiengesellschaft, which is a wholly-owned indirect subsidiary of Allianz SE. Allianz SE indirectly holds a controlling interest in Allianz. Allianz SE is a European-based, multinational insurance and financial services holding company. The address for Allianz, Allianz-Paclife Partners LLC, Allianz Global Investors U.S. Holding LLC, Allianz Global Investors of America LLC and Allianz Global Investors of America Holdings Inc. is 680 Newport Center Drive, Suite 250, Newport Beach, California 92660. The address for Allianz Global Investors Aktiengesellschaft is Nymphenburger Strasse 112-116, 80636 Munich, Germany. Allianz SEs address is Koeniginstrasse 28, D-80802, Munich, Germany.
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The general partner of Allianz has substantially delegated its management and control of Allianz to an Executive Committee.
The Investment Manager is located at 1345 Avenue of the Americas, New York, NY 10105. The Investment Manager and its investment management affiliates had more than $1.7 trillion in assets under management as of December 31, 2009.
As of February 28, 2010, no shareholder holding 5% or more of the share capital was reported to Allianz SE. Certain broker-dealers that might be controlled by or affiliated with entities owned by the Investment Manager and its affiliates, either directly or indirectly, may be considered to be affiliated persons of the Investment Manager and its affiliates. (Broker-dealer affiliates of such significant institutional shareholders are sometimes referred to herein as Affiliated Brokers). Absent an SEC exemption or other regulatory relief, the Fund is generally precluded from effecting principal transactions with the Affiliated Brokers, and its ability to purchase securities being underwritten by an Affiliated Broker or a syndicate including an Affiliated Broker is subject to restrictions. Similarly, the Funds ability to utilize the Affiliated Brokers for agency transactions is subject to the restrictions of Rule 17e-1 under the 1940 Act.
The Investment Manager, subject to the supervision of the Board of Trustees, is responsible for managing, either directly or through others selected by the Investment Manager, the investments of the Fund. The Investment Manager also furnishes to the Board of Trustees periodic reports on the investment performance of the Fund. As more fully discussed below, the Investment Manager has retained its affiliate, PIMCO, to serve as the Funds sub-adviser.
Investment Management Agreement
Under the terms of the Investment Management Agreement, subject to such policies as the Trustees of the Fund may determine, the Investment Manager, at its expense, will furnish continuously an investment program for the Fund and will make investment decisions on behalf of the Fund and place all orders for the purchase and sale of portfolio securities subject always to the Funds investment objective, policies and restrictions; provided that, so long as PIMCO serves as the sub-adviser for the Fund, the Investment Managers obligation under the Investment Management Agreement with respect to the Fund is, subject always to the control of the Trustees, to determine and review with PIMCO the investment policies of the Fund.
Subject to the control of the Trustees, the Investment Manager also manages, supervises and conducts the other affairs and business of the Fund, furnishes office space and equipment, provides bookkeeping and certain clerical services (excluding determination of the net asset value of the Fund, shareholder accounting services and the accounting services for the Fund) and pays all salaries, fees and expenses of officers and Trustees of the Fund who are affiliated with the Investment Manager. As indicated under Portfolio TransactionsBrokerage and Research Services, the Funds portfolio transactions may be placed with broker-dealers which furnish the Investment Manager and PIMCO, without cost, certain research, statistical and quotation services of value to them or their respective affiliates in advising the Fund or their other clients. In so doing, the Fund may incur greater brokerage commissions and other transactions costs than it might otherwise pay.
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Pursuant to the Investment Management Agreement, the Fund has agreed to pay the Investment Manager an annual management fee, payable on a monthly basis, at the annual rate of 0.75% of the Funds average weekly total managed assets for the services and facilities it provides. Total managed assets means the total assets of the Fund (including any assets attributable to preferred shares and borrowings that may be outstanding) minus accrued liabilities (other than liabilities representing borrowings). All fees and expenses are accrued daily and deducted before payment of dividends to investors.
Except as otherwise described in the Prospectus, the Fund pays, in addition to the investment management fee described above, all expenses not assumed by the Investment Manager, including, without limitation, fees and expenses of Trustees who are not interested persons of the Investment Manager or the Fund, interest charges, taxes, brokerage commissions, expenses of issue of shares, fees and expenses of registering and qualifying the Fund and its classes of shares for distribution under federal and state laws and regulations, charges of custodians, auditing and legal expenses, expenses of determining net asset value of the Fund, reports to shareholders, expenses of meetings of shareholders, expenses of printing and mailing prospectuses, proxy statements and proxies to existing shareholders, and its proportionate share of insurance premiums and professional association dues or assessments. The Fund is also responsible for such nonrecurring expenses as may arise, including litigation in which the Fund may be a party, and other expenses as determined by the Trustees. The Fund may have an obligation to indemnify its officers and Trustees with respect to such litigation.
Pursuant to the Investment Management Agreement, the Fund paid the Investment Manager a total of $5,018,086 for the fiscal year ended July 31, 2009, $8,600,334 for the fiscal year ended July 31, 2008, and $9,475,973 for the fiscal year ended July 31, 2007.
Sub-Adviser
PIMCO, an affiliate of the Investment Manager, serves as sub-adviser for the Fund pursuant to a portfolio management agreement (the Sub-Advisory Agreement) between PIMCO and the Investment Manager. Originally organized in 1971, reorganized as a Delaware general partnership in 1994 and reorganized as a Delaware limited liability company in 2000, PIMCO provides investment management and advisory services to private accounts of institutional and individual clients and to mutual funds. PIMCO is a majority owned subsidiary of Allianz Global Investors of America L.P. (Allianz Global Investors) with a minority interest held by PIMCO Partners, LLC, a California limited liability company. PIMCO Partners, LLC is owned by the current managing directors and executive management of PIMCO. Through various holding company structures, Allianz Global Investors is majority owned by Allianz SE.
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Portfolio Management Agreement
Under the Portfolio Management Agreement, subject always to the control of the Trustees and the supervision of the Investment Manager, PIMCOs obligation is to furnish continuously an investment program for the Fund, to make investment decisions on behalf of the Fund and to place all orders for the purchase and sale of portfolio securities and all other investments for the Fund.
The Investment Manager (and not the Fund) pays a portion of the fees it receives under the Investment Management Agreement to PIMCO in return for PIMCOs services. The fee is currently paid monthly at the annual rate of 0.55% of the Funds average weekly total managed assets, provided, however, that the amounts payable for each month are reduced by the amount, if any, of all fees payable by the Investment Manager to the underwriters of the Funds initial public offering of Common Shares for such month (such that the Investment Manager retains from its investment management fee, on an annual basis, 0.05% of the Funds average weekly total managed assets, after having paid PIMCO and such underwriters).
Pursuant to the Sub-Advisory Agreement, the Investment Manager paid PIMCO a total of $2,609,405 for the fiscal year ended July 31, 2009, $4,471,867 for the fiscal year ended July 31, 2008, and $4,927,506 for the fiscal year ended July 31, 2007.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660. PIMCO had approximately $1 trillion of assets under management as of December 31, 2009.
Certain Terms of the Investment Management and Sub-Advisory Agreements
The Investment Management Agreement and the Sub-Advisory Agreement were each approved by the Trustees of the Fund (including all of the Trustees who are not interested persons of the Investment Manager or PIMCO). By their terms the Investment Management Agreement and Sub-Advisory Agreement each continued in force with respect to the Fund for an initial two year period, and continue in force from year to year thereafter, but only so long as their continuance is approved at least annually by (i) vote, cast in person at a meeting called for that purpose, of a majority of those Trustees who are not interested persons of the Investment Manager, PIMCO or the Fund, and (ii) the majority vote of either the full Board of Trustees or the vote of a majority of the outstanding shares of all classes of the Fund. Each of the Investment Management Agreement and Sub-Advisory Agreement automatically terminates on assignment. The Investment Management Agreement may be terminated on not less than 60 days notice by the Investment Manager to the Fund or by the Fund to the Investment Manager. The Sub-Advisory Agreement may be terminated on not less than 60 days notice by the Investment Manager to PIMCO or by PIMCO to the Investment Manager, or by the Fund at any time by notice to the Investment Manager and PIMCO.
The Investment Management Agreement and the Sub-Advisory Agreement each provide that the Investment Manager or PIMCO, as applicable, shall not be subject to any liability in connection with the performance of its services thereunder in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations and duties.
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Portfolio Manager
William H. Gross, as portfolio manager, is responsible for the day-to-day management of the Fund. The table below provides information about Mr. Gross.
Other Accounts Managed. Mr. Gross also manages the other registered investment companies, other pooled investment vehicles and/or other accounts indicated below. The following table identifies, as of July 31, 2009: (i) the number of registered investment companies, pooled investment vehicles and other accounts managed by the portfolio manager; and (ii) the total assets of such companies, vehicles and accounts, and the number and total assets of such companies, vehicles and accounts with respect to which the advisory fee is based on performance.
Total
Number of Accounts |
Total Assets
of All Accounts (in $Millions) |
Number of
Accounts Paying a Performance Fee |
Total Assets of
Accounts Paying a Performance Fee (in $Millions) |
|||||||
William H. Gross |
||||||||||
Registered Investment Companies |
48 | $ | 244,786.25 | 0 | $ | 0 | ||||
Other Pooled Investment Vehicles |
40 | $ | 20,148.96 | 4 | $ | 671.84 | ||||
Other Accounts |
85 | $ | 37,929.85 | 22 | $ | 11,735.48 |
Conflicts of Interest
From time to time, potential conflicts of interest may arise between the portfolio managers management of the investments of the Fund, on the one hand, and the management of other accounts, on the other. The other accounts might have similar investment objectives or strategies as the Fund, track the same index the Fund tracks or otherwise hold, purchase, or sell securities that are eligible to be held, purchased or sold by the Fund. The other accounts might also have different investment objectives or strategies than the Fund.
Knowledge and Timing of Portfolio Trades. A potential conflict of interest may arise as a result of the portfolio managers day-to-day management of the Fund. Because of his position with the Fund, the portfolio manager knows the size, timing and possible market effect of the Funds trades. It is theoretically possible that the portfolio manager could use this information to the advantage of other accounts he manages and to the possible detriment of the Fund.
Investment Opportunities. A potential conflict of interest may arise as a result of the portfolio managers management of a number of accounts with varying investment guidelines. Often, an investment opportunity may be suitable for both the Fund and other accounts managed by the portfolio manager, but may not be available in sufficient quantities for both the Fund and the other accounts to participate fully. Similarly, there may be limited opportunity to sell an investment held by the Fund and another account. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities on a fair and equitable basis over time.
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Under PIMCOs allocation procedures, investment opportunities are allocated among various investment strategies based on individual account investment guidelines and PIMCOs investment outlook. PIMCO has also adopted additional procedures to complement the general trade allocation policy that are designed to address potential conflicts of interest due to the side-by-side management of the Fund and certain pooled investment vehicles, including investment opportunity allocation issues.
Performance Fees. The portfolio manager may advise certain accounts with respect to which the advisory fee is based entirely or partially on performance. Performance fee arrangements may create a conflict of interest for the portfolio manager in that the portfolio manager may have an incentive to allocate the investment opportunities that he believes might be the most profitable to such other accounts instead of allocating them to the Fund. PIMCO has adopted policies and procedures reasonably designed to allocate investment opportunities between the Fund and such other accounts on a fair and equitable basis over time.
Portfolio Manager Compensation
Profit Sharing Plan. Instead of a bonus, the portfolio manager receives compensation from a non-qualified profit sharing plan consisting of a portion of PIMCOs net profits. Under his employment agreement, the portfolio manager receives a fixed percentage of the profit sharing plan.
Allianz Transaction Related Compensation. In May 2000, a majority interest in the predecessor holding company of PIMCO was acquired by a subsidiary of Allianz AG (currently known as Allianz SE) (Allianz). In connection with the transaction, the portfolio manager received a grant of restricted stock of Allianz, the last of which vested on May 5, 2005.
Securities Ownership
The following table discloses the dollar range of equity securities beneficially owned by the portfolio manager of the Fund. The information is as of July 31, 2009.
Portfolio Manager |
Dollar Range of Equity Securities | |
William H. Gross |
$100,001 $500,000 |
Proxy Voting Policies
The Fund and its Board of Trustees have delegated to the Investment Manager, and the Investment Manager has in turn delegated to PIMCO, responsibility for voting any proxies relating to portfolio securities held by the Fund in accordance with PIMCOs proxy voting policies and procedures. A description of the proxy voting policies and procedures to be followed by PIMCO on behalf of the Fund, including procedures to be used when a vote represents a conflict of interest, is attached hereto as Appendix A (Description of Proxy Voting Policies and Procedures).
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Information about how the Funds voted proxies relating to portfolio securities held during the most recent twelve month period ended June 30th is available without charge, upon request, by calling the Funds shareholder servicing agent at (800) 254-5197, on the Funds website at http://www.allianzinvestors.com/closedendfunds and on the SECs website at http://www.sec.gov.
Investment Decisions and Portfolio Transactions
Investment decisions for the Fund and for the other investment advisory clients of the Investment Manager and PIMCO are made with a view to achieving their respective investment objectives. Investment decisions are the product of many factors in addition to basic suitability for the particular client involved (including the Fund). Some securities considered for investments by the Fund may also be appropriate for other clients served by the Investment Manager and PIMCO. Thus, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time including accounts in which the Investment Manager, PIMCO, their affiliates and their employees may have a financial interest. If a purchase or sale of securities consistent with the investment policies of the Fund and one or more of these clients served by the Investment Manager or PIMCO is considered at or about the same time, transactions in such securities will be allocated among the Fund and clients in a manner deemed fair and reasonable by the Investment Manager or PIMCO, as applicable. The Investment Manager or PIMCO may acquire on behalf of its clients (including the Fund) securities or other financial instruments providing exposure to different aspects of the capital and debt structure of an issuer, including without limitation those that relate to senior and junior/subordinate obligations of such issuer. In certain circumstances, the interests of those clients exposed to one portion of the issuers capital and debt structure may diverge from those clients exposed to a different portion of the issuers capital and debt structure. The Investment Manager or PIMCO may advise some clients or take actions for them in their best interests with respect to their exposures to an issuers capital and debt structure that may diverge from the interests of other clients with different exposures to the same issuers capital and debt structure.
The Investment Manager or PIMCO may aggregate orders for the Fund with simultaneous transactions entered into on behalf of its other clients when, in its reasonable judgment, aggregation may result in an overall economic benefit to the Fund and the other clients in terms of pricing, brokerage commissions or other expenses. When feasible, PIMCO allocates trades prior to execution. When pre-execution allocation is not feasible, PIMCO promptly allocates trades following established and objective procedures. Allocations generally are made at or about the time of execution and before the end of the trading day. As a result, one account may receive a price for a particular transaction that is different from the price received by another account for a similar transaction on the same day. In general, trades are allocated among portfolio managers on a pro rata basis (to the extent a portfolio manager decides to participate fully in the trade), for further allocation by each portfolio manager among that managers eligible accounts. In allocating trades among accounts, portfolio managers generally consider a number of factors, including, but not limited to, each accounts deviation (in terms of risk exposure and/or performance characteristics) from a relevant model portfolio, each accounts investment objectives, restrictions and guidelines, its risk exposure, its available cash, and its existing holdings of similar securities. Once trades are allocated, they may be reallocated only in unusual
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circumstances due to recognition of specific account restrictions. In some cases, the Investment Manager or PIMCO may sell a security on behalf of a client, including the Fund, to a broker-dealer that thereafter may be purchased for the accounts of one or more other clients, including the Fund, from that or another broker-dealer. The Investment Manager and PIMCO have adopted procedures they believe are reasonably designed to obtain the best execution for the transactions by each account.
Brokerage and Research Services
There is generally no stated commission in the case of debt securities, which are traded in the over-the-counter markets, but the price paid by the Fund usually includes an undisclosed dealer commission or mark-up. In underwritten offerings, the price paid by the Fund includes a disclosed, fixed commission or discount retained by the underwriter or dealer. Transactions on U.S. stock exchanges and other agency transactions involve the payment by the Fund of negotiated brokerage commissions. Such commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction. Transactions in foreign securities generally involve the payment of fixed brokerage commissions, which are generally higher than those in the United States.
Subject to the supervision of the Investment Manager, PIMCO places all orders for the purchase and sale of portfolio securities, options, futures contracts and other instruments for the Fund and buys and sells such securities, options, futures contracts and other instruments for the Fund through a substantial number of brokers and dealers. In so doing, PIMCO uses its best efforts to obtain for the Fund the most favorable price and execution available, except to the extent it may be permitted to pay higher brokerage commissions as described below. In seeking the most favorable price and execution, PIMCO, having in mind the Funds best interests, considers all factors it deems relevant, including, by way of illustration, price, the size of the transaction, the nature of the market for the security, the amount of the commission, the timing of the transaction taking into account market prices and trends, the reputation, experience and financial stability of the broker-dealer involved and the quality of service rendered by the broker-dealer in other transactions. Changes in the aggregate amount of brokerage commissions paid by the Fund from year-to-year may be attributable to the volume of portfolio transactions effected by the Fund, the types of instruments in which the Fund invests, or the rates negotiated by PIMCO on behalf of the Fund.
The Fund paid brokerage commissions of $15,508 for the fiscal year ended July 31, 2009, $47,259 for the fiscal year ended July 31, 2008 and $226,343 for the fiscal year ended July 31, 2007.
Subject to the supervision of the Investment Manager, PIMCO places orders for the purchase and sale of portfolio investments for the Funds account with brokers or dealers selected by it in its discretion. In effecting purchases and sales of portfolio securities for the account of the Fund, PIMCO will seek the best price and execution of the Funds orders. In doing so, the Fund may pay higher commission rates than the lowest available when PIMCO believes it is reasonable to do so in light of the value of the brokerage and research services provided by the broker effecting the transaction, as discussed below.
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It has for many years been a common practice in the investment advisory business for advisers of investment companies and other institutional investors to receive research services from broker-dealers which execute portfolio transactions for the clients of such advisers. Consistent with this practice, PIMCO may receive research services from many broker-dealers with which PIMCO places the Funds portfolio transactions. PIMCO may also receive research or research credits from brokers which are generated from underwriting commissions when purchasing new issues of debt securities or other assets for the Fund. These services, which in some cases may also be purchased for cash, include such matters as general economic and security market reviews, industry and company reviews, evaluations of securities and recommendations as to the purchase and sale of securities. Some of these services are of value to PIMCO in advising various of its clients (including the Fund), although not all of these services are necessarily useful and of value in managing the Fund. Neither the management fee paid by the Fund to the Investment Manager nor the Sub-Advisory fee paid by the Investment Manager to PIMCO is reduced because PIMCO and its affiliates receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, PIMCO may cause the Fund to pay a broker-dealer which provides brokerage and research services (as defined in such Act) to PIMCO an amount of disclosed commission for effecting a securities transaction for the Fund in excess of the commission which another broker-dealer would have charged for effecting that transaction.
As noted above, PIMCO may purchase new issues of securities for the Fund in underwritten fixed price offerings. In these situations, the underwriter or selling group member may provide PIMCO with research in addition to selling the securities (at the fixed public offering price) to the Fund or other advisory clients. Because the offerings are conducted at a fixed price, the ability to obtain research from a broker-dealer in this situation provides knowledge that may benefit the Fund, other PIMCO clients, and PIMCO without incurring additional costs. These arrangements may not fall within the safe harbor of Section 28(e) because the broker-dealer is considered to be acting in a principal capacity in underwritten transactions. However, FINRA has adopted rules expressly permitting broker-dealers to provide bona fide research to advisers in connection with fixed price offerings under certain circumstances. As a general matter in these situations, the underwriter or selling group member will provide research credits at a rate that is higher than that which is available for secondary market transactions.
PIMCO may place orders for the purchase and sale of exchange-listed portfolio securities with a broker-dealer that is an affiliate of the Investment Manager or PIMCO where, in the judgment of the Investment Manager or PIMCO, such firm will be able to obtain a price and execution at least as favorable as other qualified broker-dealers. Pursuant to rules of the SEC, a broker-dealer that is an affiliate of the Investment Manager or PIMCO may receive and retain compensation for effecting portfolio transactions for the Fund on a securities exchange if the commissions paid to such an affiliated broker-dealer by the Fund on exchange transactions do not exceed usual and customary brokerage commissions. The rules define usual and customary commissions to include amounts which are reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities being purchased or sold on a securities exchange during
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a comparable period of time. As required by applicable SEC rules, the Board of Trustees has adopted procedures which are reasonably designed to provide that any commissions, fees or other remuneration paid to an affiliated broker are consistent with the foregoing standards.
Since the securities in which the Fund invests consist primarily of fixed income securities, which are generally not subject to stated brokerage commissions, as described above, its investments in securities subject to stated commissions generally constitute a small percentage of the aggregate dollar amount of its transactions.
The Fund did not pay any commissions to affiliated brokers during the fiscal years ended July 31, 2009, July 31, 2008, and July 31, 2007.
References to PIMCO in this section would apply equally to the Investment Manager if the Investment Manager were to assume portfolio management responsibilities for the Fund and place orders for the purchase and sale of the Funds portfolio investments.
Holdings of Securities of the Funds Regular Brokers and Dealers
The following table lists the regular brokers or dealers of the Fund whose securities the Fund acquired during the fiscal year ended July 31, 2009, as well as the Funds holdings in such brokers or dealers as of July 31, 2009.
Broker or Dealer |
Value of Securities Held by the
Fund as of July 31, 2009 |
||
JPMorgan Chase & Co |
$ | 27,962,434 | |
Barclays Capital, Inc. |
$ | 22,006,071 | |
Citigroup, Inc. |
$ | 20,514,399 | |
Morgan Stanley |
$ | 11,594,241 | |
The Goldman Sachs Group, Inc. |
$ | 4,525,500 | |
Credit Suisse Group |
$ | 1,496,233 | |
UBS AG |
$ | 699,994 | |
State Street Corp. |
$ | 489,000 | |
Lehman Brothers Holdings, Inc. |
$ | 250 |
See Distributions in the Prospectus for information relating to distributions made to Fund shareholders.
For U.S. federal income tax purposes, the Fund is currently required to allocate each type of its income (such as ordinary income and net capital gain), if any, between and among Common Shares, the Series T Preferred Shares, the Series W Preferred Shares and the Series TH Preferred Shares in proportion to total distributions paid to each class for the tax year.
While any Preferred Shares are outstanding, the Fund may not declare any cash dividend or other distribution on its Common Shares unless at the time of such declaration (1) all accumulated dividends on the Preferred Shares have been paid and (2) the net asset value of the Funds
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portfolio (determined after deducting the amount of such dividend or other distribution) is at least 200% of the liquidation value of any outstanding Preferred Shares. In addition to delaying or preventing the payment of dividends to holders of Common Shares, these limitations could cause the Fund to incur income and excise tax and, under certain circumstances, impair the ability of the Fund to maintain its qualification for taxation as a regulated investment company. See Tax Matters.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
Shareholder Liability
Under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration contains an express disclaimer of shareholder liability for acts or obligations of the Fund and requires that notice of such disclaimer be given in each agreement, obligation or instrument entered into or executed by the Fund or the Trustees. The Declaration also provides for indemnification out of the Funds property for all loss and expense of any shareholder held personally liable on account of being or having been a shareholder. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which such disclaimer is inoperative or the Fund is unable to meet its obligations, and thus should be considered remote.
Anti-Takeover Provisions
As described below, the Declaration includes provisions that could have the effect of limiting the ability of other entities or persons to acquire control of the Fund or to change the composition of its Board of Trustees, and could have the effect of depriving shareholders of opportunities to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Fund.
The Funds Trustees are divided into three classes (Class I, Class II and Class III), having initial terms of one, two and three years, respectively. At each annual meeting of shareholders, the term of one class will expire and each Trustee elected to that class will hold office for a term of three years. The classification of the Board of Trustees in this manner could delay for an additional year the replacement of a majority of the Board of Trustees. In addition, the Declaration provides that a Trustee may be removed only for cause and only (i) by action of at least seventy-five percent (75%) of the outstanding shares of the classes or series of shares entitled to vote for the election of such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining Trustees. Except as provided in the next paragraph, the affirmative vote or consent of at least seventy-five percent (75%) of the Board of Trustees and at least seventy-five percent (75%) of the shares of the Fund outstanding and entitled to vote thereon are required to authorize any of the following transactions (each a Material Transaction): (1) a merger, consolidation or share exchange of the Fund or any series or class of shares of the Fund with or into any other person or company, or of any such person or company with or into the Fund or any such series or class of shares; (2) the issuance or transfer by the Fund or any series or class of shares (in one or a series of transactions in any twelve-month period) of any securities of the Fund or such series or class to any other person or entity for cash, securities or other property (or combination thereof) having an
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aggregate fair market value of $1,000,000 or more, excluding sales of securities of the Fund or such series or class in connection with a public offering, issuances of securities of the Fund or such series or class pursuant to a dividend reinvestment plan adopted by the Fund and issuances of securities of the Fund or such series or class upon the exercise of any stock subscription rights distributed by the Fund; or (3) a sale, lease, exchange, mortgage, pledge, transfer or other disposition by the Fund or any series or class of shares (in one or a series of transactions in any twelve-month period) to or with any person of any assets of the Fund or such series or class having an aggregate fair market value of $1,000,000 or more, except for transactions in securities effected by the Fund or such series or class in the ordinary course of its business. The same affirmative votes are required with respect to any shareholder proposal as to specific investment decisions made or to be made with respect to the Funds assets or the assets of any series or class of shares of the Fund. Notwithstanding the approval requirements specified in the preceding paragraph, the Declaration requires no vote or consent of the Funds shareholders to authorize a Material Transaction if the transaction is approved by a vote of both a majority of the Board of Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined below), so long as all other conditions and requirements, if any, provided for in the Funds Bylaws and applicable law (including any shareholder voting rights under the 1940 Act) have been satisfied. In addition, the Declaration provides that the Fund may be terminated at any time by vote or consent of at least seventy-five percent (75%) of the Funds shares or, alternatively, by vote or consent of both a majority of the Board of Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined below). In certain circumstances, the Declaration also imposes shareholder voting requirements that are more demanding than those required under the 1940 Act in order to authorize a conversion of the Fund from a closed-end to an open-end investment company. See Repurchase of Common Shares; Conversion to Open-End Fund below. As noted, the voting provisions described above could have the effect of depriving Common Shareholders of an opportunity to sell their Common 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 view of the Funds Board of Trustees, however, these provisions offer several possible advantages, including: (1) requiring persons seeking control of the Fund to negotiate with its management regarding the price to be paid for the amount of Common Shares required to obtain control; (2) promoting continuity and stability; and (3) enhancing the Funds ability to pursue long-term strategies that are consistent with its investment objective and management policies. The Board of Trustees has determined that the voting requirements described above, which are generally greater than the minimum requirements under the 1940 Act, are in the best interests of the Funds Common Shareholders generally. A Continuing Trustee, as used in the discussion above, is any member of the Funds Board of Trustees who either (i) has been a member of the Board for a period of at least thirty-six months (or since the commencement of the Funds operations, if less than thirty-six months) or (ii) was nominated to serve as a member of the Board of Trustees by a majority of the Continuing Trustees then members of the Board. The foregoing is intended only as a summary and is qualified in its entirety by reference to the full text of the Declaration and the Funds Bylaws, both of which have been filed as exhibits to the Funds registration statement on file with the SEC.
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Liability of Trustees
The Declaration provides that the obligations of the Fund are not binding upon the Trustees of the Fund individually, but only upon the assets and property of the Fund, and that the Trustees shall not be liable for errors of judgment or mistakes of fact or law. Nothing in the Declaration, however, protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders will not have the right to cause the Fund to redeem their shares. Instead, the Funds Common Shares will trade in the open market at a price that will be a function of several factors, including dividend levels (which are in turn affected by changes in the rates of interest on the Funds investments and expenses), net asset value, call protection, price, relative demand for and supply of such shares in the market, general market and economic conditions and other factors. Shares of a closed-end investment company may frequently trade at prices lower than net asset value. The Funds Board of Trustees regularly monitors the relationship between the market price and net asset value of the Common Shares. If the Common Shares were to trade at a substantial discount to net asset value for an extended period of time, the Board may consider the repurchase of its Common Shares on the open market or in private transactions, or the making of a tender offer for such shares. There can be no assurance, however, that the Board of Trustees will decide to take or propose any of those actions, or that share repurchases or tender offers, if undertaken, will reduce market discount. The Fund has no present intention to repurchase its Common Shares and would do so only in the circumstances described in this section.
Notwithstanding the foregoing, at any time when the Funds Preferred Shares are outstanding, the Fund may not purchase, redeem or otherwise acquire any of its Common Shares unless (1) all accrued dividends on Preferred Shares have been paid and (2) at the time of such purchase, redemption or acquisition, the net asset value of the Funds portfolio (determined after deducting the acquisition price of the Common Shares) is at least 200% of the liquidation value of the outstanding Preferred Shares (expected to equal the original purchase price per share plus any accrued and unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow to finance the repurchase of shares or to make a tender offer. Interest on any borrowings to finance share repurchase transactions or the accumulation of cash by the Fund in anticipation of share repurchases or tenders will reduce the Funds net income. Any share repurchase, tender offer or borrowing that might be approved by the Board of Trustees would have to comply with the Securities Exchange Act of 1934, as amended, and the 1940 Act and the rules and regulations thereunder.
The Funds Board of Trustees may also from time to time consider submitting to the holders of the shares of beneficial interest of the Fund a proposal to convert the Fund to an open-end investment company. In determining whether to exercise its sole discretion to submit this issue
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to shareholders, the Board of Trustees would consider all factors then relevant, including the relationship of the market price of the Common Shares to net asset value, the extent to which the Funds capital structure is leveraged and the possibility of re-leveraging, the spread, if any, between the yields on securities in the Funds portfolio and interest and dividend charges on Preferred Shares issued by the Fund and general market and economic conditions.
The Declaration requires the affirmative vote or consent of holders of at least seventy-five percent (75%) of each class of the Funds shares entitled to vote on the matter to authorize a conversion of the Fund from a closed-end investment company to an open-end investment company, unless the conversion is authorized by both a majority of the Board of Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined above under Anti-Takeover and Other Provisions in the Declaration of TrustAnti-Takeover Provisions). This seventy-five percent (75%) shareholder approval requirement is higher than is required under the 1940 Act. In the event that a conversion is approved by the Trustees and the Continuing Trustees as described above, the minimum shareholder vote required under the 1940 Act would be necessary to authorize the conversion. Currently, the 1940 Act would require approval of the holders of a majority of the outstanding Common Shares and, if issued, Preferred Shares voting together as a single class, and the holders of a majority of the outstanding Preferred Shares voting as a separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to redeem all Preferred Shares then outstanding (requiring in turn that it liquidate a portion of its investment portfolio), and the Funds Common Shares likely would no longer be listed on the New York Stock Exchange. In addition, if the Fund were to convert to an open-end company, it would not be able to invest more than 15% of its net assets in illiquid securities, which may necessitate a substantial repositioning of the Funds investment portfolio, which may in turn generate substantial transaction costs, which would be borne by Common Shareholders, and may adversely affect Fund performance and Fund dividends. Shareholders of an open-end investment company may require the company to redeem their shares on any business day (except in certain circumstances as authorized by or 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 companies typically engage in a continuous offering of their shares. Open-end companies are thus subject to periodic asset in-flows and out-flows that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset value will result in an increase in the net asset value of those shares that remain outstanding. However, there can be no assurance that share repurchases or tenders at or below net asset value will result in the Funds shares trading at a price equal to their net asset value. Nevertheless, the fact that the Funds shares may be the subject of repurchase or tender offers at net asset value from time to time, or that the Fund may be converted to an open-end company, may reduce any spread between market price and net asset value that might otherwise exist.
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In addition, a purchase by the Fund of its Common Shares will decrease the Funds total assets. This would likely have the effect of increasing the Funds expense ratio. Any purchase by the Fund of its Common Shares at a time when Preferred Shares or other forms of leverage are outstanding will increase the leverage applicable to the outstanding Common Shares then remaining. See the Prospectus under Principal risks of the FundLeverage Risk.
Before deciding whether to take any action if the Funds Common Shares trade below net asset value, the Board of Trustees would consider all relevant factors, including the extent and duration of the discount, the liquidity of the Funds portfolio, the effect of any action that might be taken on the Fund or its shareholders and market considerations. Based on these considerations, even if the Funds shares should trade at a discount, the Board of Trustees may determine that, in the interest of the Fund and its shareholders, no action should be taken.
The following discussion of U.S. federal income tax consequences of an investment in Common Shares of the Fund is based on the Code, U.S. Treasury regulations promulgated thereunder, and other applicable authority, as of the date of this Statement of Additional Information. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative, or judicial interpretation. The following discussion is only a summary of some of the important U.S. federal tax considerations generally applicable to investments in Common Shares of the Fund and does not constitute tax advice. This summary does not purport to be a complete description of the U.S. federal income tax considerations applicable to an investment in Common Shares of the Fund. There may be other U.S. federal income tax consequences applicable to particular shareholders. For example, except as otherwise specifically noted herein, we have not described certain tax considerations that may be relevant to certain types of holders subject to special treatment under the U.S. federal income tax laws, including shareholders subject to the U.S. federal alternative minimum tax, insurance companies, tax-exempt organizations, pension plans and trusts, regulated investment companies, dealers in securities, shareholders holding Common Shares through tax-advantaged accounts (such as 401(k) plans or individual retirement accounts), financial institutions, shareholders holding Common Shares as part of a hedge, straddle, or conversion transaction, entities that are not organized under the laws of the United States or a political subdivision thereof, and persons who are neither citizens nor residents of the United States. This summary assumes that investors hold Common Shares as capital assets (within the meaning of the Code). Shareholders should consult their own tax advisors regarding their particular situation and the possible application of U.S. federal, state, local, foreign or other tax laws.
The Fund has elected to be treated as a regulated investment company under Subchapter M of the Code and intends each year to qualify and to be eligible to be treated as such. In order to qualify for the special tax treatment accorded regulated investment companies and their shareholders, the Fund must, among other things:
(a) | derive at least 90% of its gross income for each taxable year from (i) 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 gains from options, futures, or forward contracts) derived with respect to its business of investing in such stock, securities, or currencies, or (ii) income from qualified publicly traded partnerships (as defined below); |
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(b) | diversify its holdings so that, at the end of each quarter of the Funds taxable year, (i) at least 50% of the value of the Funds total assets is represented by cash and cash items, U.S. Government securities, securities of other regulated investment companies, and other securities limited in respect of any one issuer to a value not greater than 5% of the value of the Funds total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Funds total assets is invested (x) in the securities (other than those of the U.S. Government or other regulated investment companies) of any one issuer or of two or more issuers which the Fund controls and which are engaged in the same, similar, or related trades or businesses, or (y) in the securities of one or more qualified publicly traded partnerships (as defined below); and |
(c) | distribute with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code without regard to the deduction for dividends paid- generally taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses) and net tax-exempt interest income, for such year. |
In general, for purposes of the 90% gross income requirement described in (a)(i) above, income derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying income if realized by the regulated investment company. However, 100% of the net income derived from an interest in a qualified publicly traded partnership (generally defined as a partnership (i) interests in which are traded on an established securities market or readily tradable on a secondary market or the substantial equivalent thereof, (ii) that derives at least 90% of its income from passive sources defined in Code section 7704(d), and (iii) that derives less than 90% of its income from the qualifying income sources described in paragraph (a)(i) above) will be treated as qualifying income. In addition, although in general the passive loss rules of the Code do not apply to regulated investment companies, such rules do apply to a regulated investment company with respect to items attributable to an interest in a qualified publicly traded partnership. For purposes of the diversification test described in paragraph (b) above, the term outstanding voting securities of such issuer will include the equity securities of a qualified publicly traded partnership. Also, for purposes of diversification test described in paragraph (b) above, the identification of the issuer (or, in some cases, issuers) of a particular Fund investment can depend on the terms and conditions of that investment. In some cases, identification of the issuer (or issuers) is uncertain under current law, and an adverse determination or future guidance by the Internal Revenue Service (IRS) with respect to issuer identification for a particular type of investment may adversely affect the Funds ability to meet the diversification test described in paragraph (b) above.
If the Fund were to fail to qualify as a regulated investment company accorded special tax treatment in any taxable year, the Fund would be subject to federal income tax on its taxable income at corporate rates, and all distributions from current and accumulated earnings and
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profits, including any distributions of net tax-exempt income and net long-term capital gains, would be taxable to shareholders as dividend income. Some portions of such distributions may be eligible for the dividends received deduction in the case of corporate shareholders and to be treated as qualified dividend income in the case of individuals, provided, in both cases, that the shareholder meets certain holding period and other requirements in respect of the Funds shares (as described below). In addition, the Fund could be required to recognize unrealized gains, pay substantial taxes and interest and make substantial distributions before requalifying as a regulated investment company that is accorded special tax treatment.
Capital losses in excess of capital gains (net capital losses) are not permitted to be deducted against the Funds net investment income. The Fund may carry net capital losses forward for eight years and use them to offset capital gains realized during this period; any net capital losses remaining at the conclusion of the eighth taxable year succeeding the taxable year in which such net capital losses arose will expire unused. All net capital losses carried forward are treated as short-term capital losses, and will offset any short-term capital gains before offsetting any long-term capital gains. The Funds ability to use net capital losses to offset gains may be limited as a result of certain (i) acquisitive reorganizations and (ii) shifts in the ownership of the Fund by a shareholder owning or treated as owning 5% or more of the stock of the Fund. See the Funds most recent annual shareholder report for the Funds available capital loss carryovers as of the end of its most recently ended fiscal year.
Distributions
As a regulated investment company, the Fund generally will not be subject to federal income tax on its investment company taxable income (as that term is defined in the Code generally, taxable ordinary income and the excess, if any, of net short-term capital gains over net long-term capital losses) and net capital gain (that is, the excess of net long-term capital gains over net short-term capital losses), if any, that it distributes to shareholders on a timely basis. The Fund intends to distribute to its shareholders, at least annually, all or substantially all of its investment company taxable income (computed without regard to the dividends paid deduction) and net capital gains. Any taxable income including any net capital gain retained by the Fund does retain any investment company taxable income, it will be subject to tax at regular corporate rates. In the case of net capital gain, the Fund is permitted to designate the retained amount as undistributed capital gains in a notice to its shareholders who would then, in turn, be (i) required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amount, and (ii) entitled to credit their proportionate shares of the tax paid by the Fund on such undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds on a properly-filed U.S. tax return to the extent the credit exceeds such liabilities. If the Fund makes this designation, for federal U.S. income tax purposes, the tax basis of the shares owned by a shareholder of the Fund would be increased by an amount equal under current law to the difference between the amount of undistributed capital gains included in the shareholders gross income under clause (i) of the preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence. The Fund is not required to, and there can be no assurance the Fund will, make this designation if it retains all or a portion of its net capital gain in a taxable year. To the extent that the Fund retains any net capital gain, it may be required to liquidate portfolio securities that it might otherwise have continued to hold (including when it might not be advantageous to do so) in order to generate the cash to pay the tax on the amount retained.
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Amounts not distributed by the Fund on a timely basis in accordance with calendar year distribution requirements are subject to a nondeductible 4% excise tax. To avoid the excise tax, the Fund must distribute during each calendar year an amount at least equal to the sum of (1) 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year, (2) 98% of its capital gains in excess of its capital losses (and adjusted for certain ordinary losses) for the twelve-month period ending on October 31 of the calendar year or later if the Fund is permitted to elect and so elects, and (3) all ordinary income and capital gains for previous years that were not distributed during such years. For these purposes, the Fund will be treated as having distributed any amount for which it is subject to U.S. federal income tax. The Fund intends generally to make distributions sufficient to avoid the imposition of the excise tax, although there can be no assurance it will be able to do so. It may determine to pay the excise tax in a year to the extent it is deemed to be in the best interest of the Fund ( e.g. , if the excise tax is de minimis ).
A distribution will be treated as paid on December 31 of the calendar year if it is declared by the Fund in October, November or December of that year to shareholders of record on a date in such a month and paid by the Fund during January of the following year. Such distributions will be taxable to shareholders in the calendar year in which the distributions are declared, rather than the calendar year in which the distributions are received.
Distributions are taxable whether shareholders receive them in cash or reinvest them in additional Common Shares through the Dividend Reinvestment Plan. A shareholder whose distributions are reinvested in Common Shares under the Dividend Reinvestment Plan generally will be treated as having received a dividend equal to either (i) if shares are trading at or above net asset value, the fair market value of the new Common Shares issued to the shareholder or (ii) if shares are trading below net asset value, the amount of cash allocated to the shareholder for the purchase of additional Common Shares on its behalf in the open market.
Distributions received by tax-exempt shareholders generally will not be subject to federal income tax to the extent permitted under applicable tax law.
For U.S. federal income tax purposes, distributions of net investment income generally are taxable to shareholders as ordinary income. Taxes to shareholders on distributions of capital gains generally are determined by how long the Fund owned (and is treated for federal income tax purposes as having owned) the investments that generated them, rather than how long a shareholder has owned his or her shares. Distributions of net capital gains (i.e., the excess of net long-term capital gains from the sale of investments that the Fund owned (or is deemed to have owned) for more than one year over any net short-term capital losses) and that are properly designated by the Fund as capital gain dividends (Capital Gain Dividends) are generally taxable to shareholders as long-term capital gains. Long-term capital gain rates applicable to most individual shareholders have been temporarily reducedin general, to 15% with a 0% rate applying to taxpayers in the 10% and 15% tax rate bracketsfor taxable years beginning before January 1, 2011. It is currently unclear whether Congress will extend, change or eliminate this
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reduced rate to or for tax years beginning on or after January 1, 2011. Distributions of net gains from the sale of investments that the Fund owned (or is deemed to have owned) for one year or less as reduced by any net long-term capital losses for the taxable year, are generally taxable to shareholders as ordinary income. Distributions from capital gains are generally made after applying any available capital loss carryovers.
The ultimate tax characterization of the Funds distributions made in a taxable year cannot be determined finally until after the end of that taxable year. As a result, there is a possibility that the Fund may make total distributions during a taxable year in an amount that exceeds the current and accumulated earnings and profits of the Fund, in which case the excess generally will be treated as a return of capital, which will be tax free to the holders of the shares, up to the amount of the shareholders adjusted tax basis in the applicable shares, with any amounts exceeding such basis treated as gain from the sale of such shares. See the additional discussion below regarding the effect of distributions constituting returns of capital on Common Shareholders.
To the extent the Fund makes distributions of capital gains in excess of the Funds net capital gains for the taxable year (as reduced by any available capital loss carryforwards from prior taxable years), and such distributed excess amounts are supported by the Funds current earnings and profits (realized income and gain of the current year), the distributions will be taxable as ordinary dividend distributions, even though distributed excess amounts would not have been subject to tax if retained by the Fund. Moreover, in such cases the capital loss carryforwards that will remain available for future years are reduced by the excess of current-year capital gains over current-year capital losses.
For taxable years beginning before January 1, 2011, qualified dividend income received by an individual will be taxed at the rates applicable to long-term capital gain. It is currently unclear whether Congress will extend, change or eliminate this provision to or for tax years beginning on or after January 1, 2011. In order for some portion of the dividends received by the Fund shareholder to be qualified dividend income, the Fund must meet holding period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder must meet holding period and other requirements with respect to the Funds shares. A dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (1) if the dividend is received with respect to any share of stock 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 (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90 days before such date), (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, (3) if the recipient elects to have the dividend income treated as investment income for purposes of the rules relating to the limitation on the deductibility of investment-related interest, or (4) if the dividend is received from a non-U.S. corporation that is (a) not eligible for the benefits of a comprehensive income tax treaty with the United States (with the exception of dividends paid on stock of such a non-U.S. corporation readily tradable on an established securities market in the United States) or (b) treated as a passive foreign investment company. If the Fund receives dividends from an underlying investment company that qualifies as a regulated investment
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company (underlying fund), and the underlying fund designates such dividends as qualified dividend income, then the Fund may, in turn, designate a portion of its distributions as qualified dividend income as well, provided the Fund meets the holding period and other requirements with respect to shares of the underlying fund. The Fund does not expect a significant portion of Fund distributions to be derived from qualified dividend income.
In general, distributions of investment income designated by the Fund as derived from qualified dividend income will be treated as qualified dividend income in the hands of a shareholder taxed as an individual, provided the shareholder meets the holding period and other requirements described above with respect to the Funds shares.
In general, dividends of net investment income received by corporate shareholders of the Fund will qualify for the 70% dividends received deduction generally available to corporations only to the extent of the amount of eligible dividends received by the Fund from domestic corporations for the taxable year. A dividend received by the Fund will not be treated as a dividend eligible for the dividends-received deduction (1) if it has been received with respect to any share of stock that the Fund has held for less than 46 days (91 days in the case of certain preferred stock) during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days before such date in the case of certain preferred stock) or (2) to the extent that the Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends received deduction may be disallowed or reduced (1) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the Fund or (2) by application of various provisions of the Code (for instance, the dividends-received deduction is reduced in the case of a dividend received on debt-financed portfolio stock (generally, stock acquired with borrowed funds)). The Fund generally does not expect a significant portion of its distributions to be eligible for the dividends received deduction. If the Fund receives dividends from an underlying fund and the fund designates such dividends as eligible for the dividends received deduction, then the Fund is permitted in turn to designate its distributions derived from those dividends as eligible for the dividends-received deduction as well, provided the Fund meets holding period and other requirements with respect to shares of the underlying fund.
Any distribution of income that is attributable to (i) income received by the Fund in lieu of dividends with respect to securities on loan pursuant to a securities lending transaction or (ii) dividend income received by the Fund on securities it temporarily purchased from a counterparty pursuant to a repurchase agreement that is treated for U.S. federal income tax purposes as a loan by the Fund, will not constitute qualified dividend income to individual shareholders and will not be eligible for the dividends-received deduction for corporate shareholders.
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 and capital gains) 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 between and among its Common Shares, Series T Preferred Shares, Series W Preferred Shares and Series TH Preferred Shares in proportion to the total dividends paid to each class with respect to such tax year. Dividends qualifying and not qualifying for (a) treatment as qualified dividend income and (b) the dividends received deduction, if any, will similarly be allocated between and among any such classes.
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Existing authorities do not specifically address whether dividends that are paid following the close of a taxable year, but that are treated for tax purposes as derived from the income of such prior taxable year, are treated as dividends paid during such prior taxable year for purposes of determining each class proportionate share of a particular type of income. Existing authorities also do not specifically address the allocation of taxable income among the dividends paid to holders of a class of shares during or with respect to a taxable year. It is possible that the IRS could disagree with the Funds position concerning the treatment of dividends paid after the close of a taxable year or with the Funds method of allocation, in which case the IRS could attempt to recharacterize a portion of the dividends paid to the holders of Common or Preferred Shares. If the IRS were to prevail with respect to any such attempted recharacterization, holders of Common or Preferred Shares could be subject to additional tax on amounts so recharacterized and the Fund could be subject to federal income and excise tax.
If the Fund makes a distribution to a shareholder in excess of the Funds current and accumulated earnings and profits (including earnings and profits arising from tax-exempt income) in any taxable year, the excess distribution will be treated as a return of capital to the extent of such shareholders tax basis in its shares, and thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders tax basis in its shares, thus reducing any loss or increasing any gain on a subsequent taxable disposition by the shareholder of its shares. Where one or more such distributions occur in any taxable year of the Fund, the available earnings and profits will be allocated, first, to the distributions made to the holders of Preferred Shares, and only thereafter to distributions made to holders of Common Shares. As a result, in such a case, the holders of Preferred Shares will receive a disproportionate share of the distributions treated as dividends, and the holders of the Common Shares will receive a disproportionate share of the distributions treated as a return of capital.
Dividends and distributions on the Funds shares are generally subject to federal income tax as described herein to the extent they do not exceed the Funds realized income and gains, even though such dividends and distributions may economically represent a return of a particular shareholders investment. Such distributions are likely to occur in respect of shares purchased at a time when the Funds net asset value reflects unrealized gains or income or gains that are realized but not yet distributed. Such realized income and gains may be required to be distributed even when the Funds net asset value also reflects unrealized losses.
Sales, Exchanges or Redemptions of Shares.
The sale, exchange or redemption of shares of the Fund by a shareholder may give rise to a gain or loss. In general, any gain or loss realized upon a taxable disposition of shares will be treated as long-term capital gain or loss if the shares have been held for more than 12 months. Otherwise, the gain or loss on the taxable disposition of shares will be treated as short-term capital gain or loss. However, any loss realized upon a taxable disposition of shares held for six months or less will be treated as long-term, rather than short-term, to the extent of any Capital Gain Dividends
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received (or deemed received) by the shareholder with respect to those shares. All or a portion of any loss realized upon a taxable disposition of shares will be disallowed under the Codes wash sale rule if other substantially identical shares of the Fund are purchased (whether through the automatic reinvestment of dividends or otherwise) within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed loss.
From time to time the Fund may make a tender offer for its Common Shares. Shareholders who tender all Common Shares held, or considered to be held, by them and do not hold (directly or by attribution under certain attribution rules of the Code) any other Fund shares (namely, Preferred Shares) will be treated as having sold their shares and generally will realize a capital gain or loss. If a shareholder tenders fewer than all of its Common Shares, or continues to hold (directly or by attribution) other Fund shares (Preferred Shares), such shareholder may be treated as having received a taxable dividend upon the tender of its Common Shares. In such a case, there is a remote risk that non-tendering shareholders will be treated as having received taxable distributions from the Fund. To the extent that the Fund recognizes net gains on the liquidation of portfolio securities to meet such tenders of Common Shares, the Fund will be required to make additional distributions to its Common Shareholders.
Original Issue Discount, Market Discount, Payment-in-Kind Securities, Preferred Securities and Commodity-Linked Notes
Some debt obligations with a fixed maturity date of more than one year from the date of issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year from the date of issue) that are acquired by the Fund will be treated as debt obligations that are issued originally at a discount. Generally, the amount of the original issue discount (OID) is treated as interest income and is included in the Funds income (and thus is required to be distributed) over the term of the debt security, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt obligation. Increases in the principal amount of an inflation-indexed bond will generally be treated as OID.
Some debt obligations with a fixed maturity date of more than one year from the date of issuance that are acquired by the Fund in the secondary market may be treated as having market discount. Very generally, market discount is the excess of the stated redemption price of a debt obligation over the purchase price of such obligation. Generally, any gain recognized on the disposition of, and any partial payment of principal on, a debt obligation having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the accrued market discount on such debt obligation. Alternatively, the Fund may elect to accrue market discount currently. As of the date of this Statement of Additional Information, the Fund has made this election, and as such, the Fund is required to include currently any accrued market discount on such debt obligations in the Funds taxable income (as ordinary income) and thus distribute it over the term of the debt obligations, even though payment of those amounts is not received until a later time, upon partial or full repayment or disposition of the debt obligations. The Fund reserves the right to revoke this election at any time pursuant to applicable IRS procedures. The rate at which the market discount accrues, and thus is included in the Funds income, will depend upon which of the permitted accrual methods the Fund elects.
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From time to time, a substantial portion of the Funds investments in loans and other debt obligations could be treated as having OID and/or market discount, which, in some cases could be significant.
Some debt obligations with a fixed maturity date of one year or less from the date of issuance that are acquired by the Fund may be treated as having OID or, in certain cases, acquisition discount (very generally, the excess of the stated redemption price over the purchase price). The Fund will be required to include the OID or acquisition discount in income (as ordinary income) and thus distribute it over the term of the debt obligation, even though payment of that amount is not received until a later time, upon partial or full repayment or disposition of the debt obligation. The rate at which OID or acquisition discount accrues, and thus is included in the Funds income, will depend upon which of the permitted accrual method the Fund elects.
Some preferred securities may include provisions that permit the issuer, at its discretion, to defer the payment of distributions for a stated period without any adverse consequences to the issuer. If the Fund owns a preferred security that is deferring the payment of its distributions, the Fund may be required to report income for U.S. federal income tax purposes to the extent of any such deferred distributions even though the Fund has not yet actually received the cash distribution.
In addition, payment-in-kind securities will, and commodity-linked notes may, give rise to income which is required to be distributed and is taxable even though the Fund receives no interest payment in cash on the security during the year.
By reason of holding the foregoing kinds of securities, the Fund may be required to pay out as an income distribution each year an amount which is greater than the total amount of cash interest the Fund actually received. Such distributions may be made from the cash assets of the Fund or by liquidation of portfolio securities, if necessary (including when it is not advantageous to do so). The Fund may realize gains or losses from such liquidations. In the event the Fund realizes net capital gains from such transactions, its shareholders may receive a larger capital gain distribution, if any, than they would in the absence of such transactions.
Higher-Risk Securities
Investments in debt obligations that are at risk of or in default present special tax issues for the Fund. Tax rules are not entirely clear about issues such as whether or to what extent the Fund should recognize market discount on a debt obligation, when the Fund may cease to accrue interest, OID or market discount, when and to what extent the Fund may take deductions for bad debts or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income. These and other related issues will be addressed by the Fund when, as and if it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company and does not become subject to federal income or excise tax.
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Issuer Deductibility of Interest
A portion of the OID accrued on certain high yield discount obligations owned by the Fund may not be deductible to the issuer and thus will instead be treated as a dividend paid by the issuer for purposes of the corporate dividends received deduction. In such cases, if the issuer of the high yield discount obligations is a domestic corporation, dividend payments by the Fund may be eligible for the dividends received deduction to the extent attributable to the deemed dividend portion of such OID.
Municipal Bonds
The interest on municipal bonds is generally exempt from U.S. federal income tax. However, the interest on municipal obligations may be subject to the federal alternative minimum tax both for individuals and corporations (e.g., in the case of interest earned on certain private activity bonds) and may be subject to state and local taxes. The Fund does not expect to invest 50% or more of its assets in municipal bonds on which the interest is exempt from U.S. federal income tax. As a result, it does not expect to be eligible to pay exempt-interest dividends to its shareholders under the applicable tax rules. As a result, interest on municipal bonds is taxable to shareholders of the Fund when received as a distribution from the Fund. In addition, gains realized by the Fund on the sale or exchange of municipal bonds are taxable to shareholders of the Fund.
As discussed in Investment Objective and Policies, unlike most municipal bonds, interest paid by an issuer on a Build America Bond is taxable to the bondholder. Thus, the interest the Fund receives on such bonds will be included in the Funds taxable income and taxable to shareholders as ordinary income when distributed by the Fund.
If the Fund holds, directly or indirectly, one or more tax credit Build America Bonds on one or more applicable dates during a taxable year, it is possible that the Fund will elect to permit its shareholders to claim a tax credit on their income tax returns equal to each shareholders proportionate share of tax credits from the applicable bonds that otherwise would be allowed to the Fund. In such a case, a shareholder will be deemed to receive a distribution of money with respect to its Fund shares equal to the shareholders proportionate share of the amount of such credits and be allowed a credit against the shareholders U.S. federal income tax liability equal to the amount of such deemed distribution, subject to certain limitations imposed by the Code on the credits involved. Even if the Fund is eligible to pass through tax credits to shareholders, the Fund may choose not to do so. If the Fund receives tax credit bond credits from an underlying fund, and the underlying fund made an election to pass through such tax credits to its shareholders, then the Fund is permitted in turn to elect to pass through its proportionate share of those tax credits to its shareholders, provided that the Fund meets the shareholder notice and other requirements.
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Certain Investments in REITs
Any investment by the Fund in equity securities of REITs may result in the Funds receipt of cash in excess of the REITs earnings; if the Fund distributes these amounts, these distributions could constitute a return of capital to Fund shareholders for U.S. federal income tax purposes. Investments in REIT equity securities also may require the Fund to accrue and to distribute income not yet received. To generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its portfolio (including when it is not advantageous to do so) that it otherwise would have continued to hold. Dividends received by the Fund from a REIT generally will not constitute qualified dividend income.
The Fund may invest directly or indirectly in real estate mortgage investment conduits (REMICs) (including by investing in residual interests in CMOs with respect to which an election to be treated as a REMIC is in effect) or equity interests in taxable mortgage pools (TMPs). Under a notice issued by the IRS in October 2006 and Treasury Regulations that have yet to be issued but may apply retroactively, a portion of a regulated investment companys income (including income allocated to the Fund from a REIT or other pass-through entity) that is attributable to a residual interest in a REMIC or an equity interest in a TMPreferred to in the Code as an excess inclusionwill be subject to U.S. federal income tax in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion income of a regulated investment company, such as the Fund, will be allocated to shareholders of the regulated investment company in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related interest directly. As a result, a Fund investing in such interests may not be a suitable investment for charitable remainder trusts, as noted below.
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions), (ii) in the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding tax (discussed below), and (iii) will constitute unrelated business taxable income (UBTI) 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 U.S. federal income tax return, to file such a tax return and pay tax on such income.
Income of a regulated investment company that would be UBTI if earned directly by a tax-exempt entity will not generally be attributed as UBTI to a tax-exempt shareholder of the regulated investment company. Notwithstanding this blocking effect, a tax-exempt shareholder could realize UBTI by virtue of its investment in the Fund if shares in the Fund constitute debt-financed property in the hands of the tax-exempt shareholder within the meaning of Code Section 514(b). A tax-exempt shareholder may also recognize UBTI if the Fund recognizes excess inclusion income derived from direct or indirect investments in residual interests in REMICs or equity interests in TMPs as described above, if the amount of such income recognized by the Fund exceeds the Funds investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that invest in regulated investment companies that invest directly or indirectly in residual interests in REMICs or equity interests in TMPs. Under legislation enacted in December 2006, if a charitable
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remainder trust (CRT), as defined in Section 664 of the Code, realizes any UBTI for a taxable year, a 100% excise tax is imposed on such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI solely as a result of investing in a regulated investment company that recognizes excess inclusion income. Rather, if at any time during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United States, a state or political subdivision, or an agency or instrumentality thereof, and certain energy cooperatives) is a record holder of a share in a regulated investment company that recognizes excess inclusion income, then the regulated investment company will be subject to a tax on that portion of its excess inclusion income for the taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the 1940 Act, the Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholders distributions for the year by the amount of the tax that relates to such shareholders interest in the Fund. CRTs and other tax-exempt shareholders are urged to consult their tax advisors concerning the consequences of investing in the Fund.
Options, Futures, and Forward Contracts, Swap Agreements, and other Derivatives
The U.S. federal income tax treatment of the Funds options activity will vary based on the nature and the subject of the options. In general, option premiums from the Funds option writing activity are not immediately included in the income of the Fund when received. Instead, in the case of certain options (including options on single stocks, options on certain narrow-based indexes and options not listed on certain exchanges) the premiums are recognized when the option contract expires, the option is exercised by the holder, or the Fund transfers or otherwise terminates the option. If a call option written by the Fund with respect to individual stocks is exercised and the Fund sells or delivers the underlying stock, the Fund generally will recognize capital gain or loss equal to (a) the sum of the strike price and the option premium received by the Fund minus (b) the Funds adjusted tax basis in the stock. Such gain or loss generally will be short-term or long-term depending upon the holding period of the underlying stock. If securities are purchased by the Fund pursuant to the exercise of a put option written by it, the Fund will generally subtract the premium received for purposes of computing its cost basis in the stock purchased. Gain or loss arising in respect of a termination of the Funds obligation under an option other than through the exercise of the option and related sale or delivery of the underlying stock will be short-term capital gain or loss depending on whether the premium income received by the Fund is greater or less than the amount paid by the Fund (if any) in termination the transaction. Thus, for example, if an option written by the Fund expires unexercised, the Fund generally will recognize short-term capital gain equal to the premium received.
Certain options that are listed on a qualified board of exchange (listed options) written or purchased by the Fund (including options on futures contracts, broad-based equity indices and debt securities) as well as certain futures contracts will be governed by Section 1256 of the Code (Section 1256 contracts). Gains or losses on Section 1256 contracts generally are considered 60% long-term and 40% short-term capital gains or losses (60/40), although certain foreign currency gains and losses from such contracts may be treated as ordinary in character. Also, Section 1256 contracts held by the Fund at the end of each taxable year (and, for purposes of the nondeductible 4% excise tax, on certain other dates as prescribed under the Code) are marked to
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market with the result that unrealized gains or losses are treated as though they were realized and the resulting gain or loss is treated as ordinary or 60/40 gain or loss, as applicable. Certain options and futures listed on non-U.S. exchanges will meet the requirements for Section 1256 treatment.
Certain covered call-writing activities of the Fund, if any, may trigger the U.S. federal income tax straddle rules of Section 1092 of the Code, requiring that losses be deferred and holding periods be tolled on offsetting positions in options and stocks deemed to constitute substantially similar or related property. Options on single stocks that are not deep in the money may give rise to qualified covered calls, which generally are not subject to the straddle rules; the holding period on stock underlying qualified covered calls that are in the money although not deep in the money will be suspended while such calls are outstanding. Thus, the straddle rules and the rules governing qualified covered calls could cause gains that would otherwise constitute long-term capital gains to be treated as short-term capital gains, and distributions that would otherwise constitute qualified dividend income to fail to satisfy the holding period requirements and therefore to be taxed as ordinary income or to fail to qualify for the 70% dividends received deduction for corporations.
In addition to the foregoing special rules in respect of futures and options transactions, the Funds transactions in other derivatives contracts (e.g., swap agreements and forward contracts), as well as any of its other hedging, short sale or similar transactions may be subject to one or more special tax rules (e.g., notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short sale rules), the effect of which may be, among other things, to accelerate the recognition of income to the Fund, to defer losses to the Fund, to cause adjustments in the holding periods of the Funds securities, to convert lower taxed long-term capital gains or qualified dividend income into higher taxed short-term capital gains or ordinary income and to convert short-term capital losses into long-term capital losses. These rules, therefore, could affect the amount, timing and/or character of distributions to shareholders. In particular, the straddle rules require that certain losses be deferred, and the holding period for positions governed by theses rules generally will not begin until after the offsetting position is no longer outstanding.
Because these and other tax rules applicable to these types of transactions are in some cases uncertain under current law, an adverse determination or future guidance by the IRS with respect to these rules (which determination or guidance could be retroactive) may affect whether the Fund has made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as a regulated investment company and avoid a Fund-level tax.
Book-Tax Differences
Certain of the Funds investments in derivative instruments and foreign currency-denominated instruments, and any of the Funds transactions in foreign currencies and hedging activities, are likely to produce a difference between its book income and the sum of its taxable income and net tax-exempt income (if any). If there are differences between the Funds book income and the sum of its taxable income and net tax-exempt income (if any), the Fund may be required to distribute amounts in excess of its book income or a portion of Fund distributions may be treated as a return of capital to shareholders. If the Funds book income exceeds the sum of its taxable income (including realized capital gains) and net tax-exempt income (if any), the distribution (if
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any) of such excess will be treated as (i) a dividend to the extent of the Funds remaining current and accumulated earnings and profits, (ii) thereafter as a return of capital to the extent of the recipients adjusted tax basis in the shares and (iii) thereafter as gain from the sale or exchange of a capital asset. If the Funds book income is less than the sum of its taxable income (including realized capital gains) and net tax-exempt income (if any), the Fund could be required to make distributions exceeding book income to qualify as a regulated investment company that is accorded special tax treatment.
Foreign Currency Transactions
The Funds transactions in foreign currencies, foreign currency-denominated debt obligations and certain foreign currency options, futures contracts and forward contracts (and similar instruments) may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in the value of the foreign currency concerned. Such ordinary income treatment may accelerate the Funds distributions to shareholders and increase the distributions taxed to shareholders as ordinary income. Losses from such positions may lead to a return of capital to Fund shareholders.
Non-U.S. Taxation
Income received by the Fund from sources within foreign countries may be subject to withholding and other taxes imposed by such countries. Tax treaties between certain countries and the United States may reduce or eliminate such taxes.
If more than 50% of the Funds assets at its year end consists of the securities of non-U.S. (foreign) corporations, the Fund may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata portion of qualified taxes paid by the Fund to non-U.S. countries in respect of non-U.S. securities the Fund has held for at least the minimum period specified in the Code. In such a case, shareholders will include in gross income from non-U.S. sources their pro rata shares of such taxes. A shareholders ability to claim a non-U.S. tax credit or deduction in respect of non-U.S. taxes paid by the Fund may be subject to certain limitations imposed by the Code, as a result of which the shareholder might not get a full credit or deduction for the amount of such taxes. Shareholders who do not itemize on their federal income tax returns may claim a credit (but no deduction) for such non-U.S. taxes.
Under current law, the Fund cannot pass through to shareholders foreign tax credits borne in respect of foreign securities income earned by underlying funds. In general, the Fund may only elect to pass through to its shareholders foreign income taxes it pays provided that it directly holds more than 50% of its assets in foreign stock and securities at the close of its taxable year. Foreign securities held indirectly through an underlying fund do not contribute to this 50% threshold.
If the Fund were to qualify and make an election to pass-through foreign taxes to its shareholders, foreign shareholders of the Fund generally would be subject to increased U.S. federal income taxation without a corresponding benefit for the pass-through of foreign taxes.
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Non-U.S. Shareholders
In general, dividends other than Capital Gain Dividends paid by the Fund to a shareholder that is not a United States person within the meaning of the Code (such shareholder, a non-U.S. person or a non-U.S. shareholder) are subject to withholding of federal income tax at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio interest, short-term capital gains, or non-U.S.-source dividend and interest income) that, if paid to a non-U.S. person directly, would not be subject to withholding. However, effective for taxable years of the Fund beginning before January 1, 2010 (and for taxable years beginning before January 1, 2011 if pending legislation discussed below is enacted), the Fund is not required to withhold any amounts with respect to (i) properly designated distributions (other than distributions to a non-U.S. person (w) that has not provided a satisfactory statement that the beneficial owner is not a United States person, (x) to the extent that the dividend is attributable to certain interest on an obligation if the non-U.S. person is the issuer or is a 10% shareholder of the issuer, (y) that is within certain non-U.S. countries that have inadequate information exchange with the United States, or (z) to the extent the dividend is attributable to interest paid by a person that is a related person of the non-U.S. person and the non-U.S. person is a controlled foreign corporation) from U.S.-source interest income of types similar to those that would not be subject to U.S. federal income tax if earned directly by an individual non-U.S. person (interest-related dividends), and (ii) properly designated distributions (other than distributions to an individual non-U.S. person who is present in the United States for a period or periods aggregating 183 days or more during the year of the distribution or distributions subject to special rules regarding the disposition of U.S. real property interests, as described below) of net short-term capital gains in excess of net long-term capital losses (net short-term capital gain dividends). Pending legislation would extend the exemption from withholding for interest-related distributions and short-term capital gain dividends for one yearthat is, for dividends with respect to taxable years beginning on or after January 1, 2010 but before January 1, 2011. It is unclear at this time whether the legislation will be enacted and, if enacted, what the terms of the extension will be. Depending on the circumstances, the Fund may make designations of interest-related or short-term capital gain dividends with respect to all, some or none of its potentially eligible dividends and/or treat such dividends, in whole or in part, as ineligible for these exemptions from withholding. The Fund does not currently intend to make designations of interest-related dividends or short-term capital gain dividends.
In the case of shares held through an intermediary, the intermediary may withhold even if the Fund makes a designation with respect to a payment. Non-U.S. shareholders should contact their intermediaries regarding the application of these rules to their accounts.
Subject to certain exceptions (e.g., for a fund that is a United States real property holding company as described below), the Fund is generally not required to withhold on the amount of a non-dividend distribution (i.e., a distribution that is not paid out of the Funds current or accumulated earnings and profits for the applicable taxable year) when paid to its non-U.S. shareholders.
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Special rules would apply if the Fund were either a U.S. real property holding corporation (USRPHC) or would be a USRPHC but for the operation of certain exceptions to the definition thereof. Very generally, a USRPHC is a domestic corporation that holds USRPIs the fair market value of which equals or exceeds 50% of the sum of the fair market values of the corporations USPRIs, interests in real property located outside the United States, and other assets. USRPIs are generally defined as any interest in U.S. real property and any interest (other than solely as a creditor) in a USRPHC or former USRPHC.
If the Fund were a USRPHC or would be a USRPHC but for the exceptions referred to above, any distributions by the Fund to a non-U.S. shareholder attributable to gains realized by the Fund on the disposition of USRPIs or to distributions received by the Fund from a lower-tier RIC or REIT that the Fund is required to treat as USRPI gain in its hands generally would be subject to U.S. tax withholding. In addition, such distributions could result in the non-U.S. shareholder being required to file a U.S. tax return and pay tax on the distributions at regular U.S. federal income tax rates. The consequences to a non-U.S. shareholder, including the rate of such withholding and character of such distributions ( e.g. , as ordinary income or USRPI gain), would vary depending upon the extent of the non-U.S. shareholders current and past ownership of the Fund. On and after January 1, 2010, this look-through USRPI treatment for distributions by the Fund, if it were either a USRPHC or would be a USRPHC but for the operation of the exceptions referred to above, to non-U.S. shareholders would apply only to those distributions that, in turn, are attributable to distributions received by the Fund from a lower-tier REIT that the Fund is required to treat as USRPI gain in its hands. Pending legislation proposes to extend the look-through provisions applicable before January 1, 2010 described above for one additional year, i.e. , to distributions made on or after January 1, 2010 but before January 1, 2011. However, as of the date of this Statement of Additional Information, it is unclear whether such legislation will be enacted and, if enacted, what the terms of the extension will be.
In addition, if the Fund were a USRPHC or former USRPHC, a greater-than-5% non-U.S. shareholder generally would be required to file a U.S. tax return in connection with the sale of its Fund shares, and pay related taxes due on any gain realized on the sale. Moreover, if the Fund were a USRPHC or former USRPHC, it could be required to withhold on amounts distributed to a greater-than-5% non-U.S. shareholder to the extent such amounts are in excess of the Funds current and accumulated earnings and profits for the applicable taxable year.
The Fund generally does not expect that it will be a USRPHC or would be a USRPHC but for the operation of certain of the special exceptions referred to above.
In order to qualify for any exemptions from withholding described above or for lower withholding tax rates under income tax treaties, or to establish an exemption from backup withholding, a non-U.S. shareholder must comply with special certification and filing requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN or substitute form). Non-U.S. shareholders should consult their tax advisors in this regard.
Under U.S. federal tax law, a beneficial holder of shares who is a non-U.S. shareholder generally is not subject to U.S. federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund or on Capital Gain Dividends unless (i) such gain or dividend is effectively connected with the conduct of a trade or business carried on by such
103
holder within the United States, (ii) in the case of an individual holder, the holder is present in the United States for a period or periods aggregating 183 days or more during the year of the sale or receipt of the Capital Gain Dividend and certain other conditions are met, or (iii) the special rules relating to gain attributable to the sale or exchange of USRPIs apply to the non-U.S. shareholders sale of Common Shares or to the Capital Gain Dividend the non-U.S. shareholder received (as described above).
If a beneficial holder who is a non-U.S. person has a trade or business in the United States, and the dividends are effectively connected with the conduct by the beneficial holder of a trade or business in the United States, the dividend will be subject to federal net income taxation at regular income tax rates. If a non-U.S. person is eligible for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to federal income tax on a net basis only if it is attributable to a permanent establishment maintained by such person in the United States.
A beneficial holder of shares who is a non-U.S. person may be subject to state and local tax and to the U.S. federal estate tax in addition to the U.S. federal tax on income referred to above.
Backup Withholding
The Fund may be required to withhold and to remit to the U.S. Treasury a percentage of the taxable dividends and other distributions paid to and proceeds of share sales, exchanges, or redemptions made by any individual shareholder who fails to properly furnish the Fund with a correct taxpayer identification number (TIN), who has under-reported dividends or interest income, or who fails to certify to the Fund that he or she is not subject to such withholding. The backup withholding tax rate is 28% for amounts paid through December 31, 2010. The backup withholding tax rate will be 31% for amounts paid after December 31, 2010, unless Congress enacts tax legislation providing otherwise. Corporate shareholders and certain other shareholders specified in the Code generally are exempt from such backup withholding. Backup withholding is not an additional tax. Any amounts withheld may be credited against the shareholders federal income tax liability, provided the appropriate information is furnished to the Internal Revenue Service.
In order for a non-U.S. person to qualify for exemption from the backup withholding tax rates, the non-U.S. person may be required to comply with special certification and filing requirements. Non-U.S. shareholders of the Fund should consult their tax advisors in this regard. Backup withholding is not an additional tax. Any amounts withheld may be credited against the non-U.S. shareholders U.S. federal income tax liability, provided the appropriate information is furnished to the IRS.
Tax Shelter Reporting Regulations
Under U.S. Treasury regulations, if a shareholder recognizes a loss with respect to the Funds shares of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the Internal Revenue Service a disclosure statement on Form 8886. Direct shareholders of portfolio securities are in many cases excepted from this
104
reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. Future guidance may extend the current exception from this reporting requirement to shareholders 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 taxpayers treatment of the loss is proper. Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Shares Purchased Through Tax-Qualified Plans
Special tax rules apply to investments through defined contribution plans and other tax-qualified plans. Shareholders should consult their tax advisors to determine the suitability of shares of the Fund as an investment through such plans and the precise effect of an investment on their particular tax situation.
Other Taxation
Distributions also may be subject to additional state, local and non-U.S. taxes, depending on each shareholders particular situation. Additionally, most states permit mutual funds, such as the Fund, to pass through to their shareholders the state tax exemption on income earned from investments in certain direct U.S. Treasury obligations, as well as some limited types of U.S. government agency securities (such as Federal Farm Credit Bank and Federal Home Loan Bank securities), so long as a fund meets all applicable state requirements. Therefore, shareholders in the Fund may be allowed to exclude from their state taxable income distributions made to them by the Fund to the extent attributable to interest the Fund earned on such investments. The availability of these exemptions varies by state. Investments in securities of certain U.S. government agencies, including securities issued by GNMA and FNMA, and repurchase agreements collateralized by U.S. government securities generally do not qualify for these exemptions. Moreover, these exemptions may not be available to corporate shareholders. All shareholders should consult their tax advisors regarding the applicability of these exemptions to their situation. The Fund will provide information annually to shareholders indicating the amount and percentage of its dividend distribution which is attributable to interest on federal obligations, and will indicate to the extent possible from what types of federal obligations such dividends are derived.
The Fund is organized as a Massachusetts business trust. Under current law, so long as the Fund qualifies for the federal income tax treatment described above, it is believed that the Fund will not be liable for any income or franchise tax imposed by Massachusetts. Shareholders, in any event, are advised to consult their own tax advisors with respect to the particular tax consequences to them of an investment in the Fund.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may compare certain aspects of its portfolio and structure to other substantially similar closed-end funds as categorized by Lipper, Inc. (Lipper), Morningstar Inc. or other independent services. Comparison of the Fund to an alternative investment should be made with consideration of differences in features and expected performance. The Fund may obtain data from sources or reporting services, such as Bloomberg Financial and Lipper, that the Fund believes to be generally accurate.
105
The Fund, in its advertisements, may refer to pending legislation from time to time and the possible effect of such legislation on investors, investment strategy and related matters. At any time in the future, yields and total return may be higher or lower than past yields and there can be no assurance that any historical results will continue.
Past performance is not indicative of future results. At the time Common Shareholders sell their shares, they may be worth more or less than their original investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT
State Street Bank and Trust Co., 801 Pennsylvania Avenue, Kansas City, Missouri 64105, serves as custodian for assets of the Fund. The custodian performs custodial and fund accounting services.
PNC Global Investment Servicing Inc., P.O. Box 43027, Providence, RI 02940, serves as the transfer agent, registrar and dividend disbursement agent for the Common Shares, as well as agent for the Dividend Reinvestment Plan relating to the Common Shares.
Deutsche Bank Trust Company Americas, 280 Park Avenue, 9th Floor, New York, New York 10017, serves as auction agent, transfer agent, registrar, dividend paying agent and redemption agent for the Preferred Shares.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP, 300 Madison Avenue, New York, New York 10017, serves as independent registered public accounting firm for the Fund. PricewaterhouseCoopers LLP provides audit services, tax and other audit related services to the Fund.
Ropes & Gray LLP, One International Place, Boston, Massachusetts 02110, passes upon certain legal matters in connection with shares offered by the Fund, and also acts as counsel to the Fund.
A Registration Statement on Form N-2, including any amendments thereto (the Registration Statement), relating to the Common Shares of the Fund offered hereby, has been filed by the Fund with the SEC, Washington, D.C. The Prospectus and this Statement of Additional Information are parts of, but do not contain all of the information set forth in, the Registration Statement, including any exhibits and schedules thereto. For further information with respect to the Fund and the Common Shares offered or to be offered hereby, reference is made to the Funds Registration Statement. Statements contained in the Prospectus and this Statement of
106
Additional Information as to the contents of any contract or other document referred to are not necessarily complete and in each instance reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. Copies of the Registration Statement may be inspected without charge at the SECs principal office in Washington, D.C., and copies of all or any part thereof may be obtained from the SEC upon the payment of certain fees prescribed by the SEC.
The Funds financial statements appearing in the Funds annual shareholder report for the year ended July 31, 2009 are incorporated by reference in this Statement of Additional Information and have been so incorporated in reliance upon the report of PricewaterhouseCoopers LLP, independent registered public accounting firm for the Fund, which report is included in such annual shareholder report. The annual shareholder report is available upon request and without charge by writing to the Fund at 1345 Avenue of the Americas, New York, New York 10105.
107
Description of Proxy Voting Policy and Procedures
Pacific Investment Management Company LLC (PIMCO)
PIMCO has adopted written proxy voting policies and procedures (Proxy Policy) as required by Rule 206(4)-6 under the Advisers Act. The Proxy Policy has been adopted by the Fund as the policies and procedures that PIMCO will use when voting proxies on behalf of the Fund. Recognizing that proxy voting is a rare event in the realm of fixed income investing and is typically limited to solicitation of consent to changes in features of debt securities, the Proxy Policy also applies to any voting rights and/or consent rights of PIMCO, on behalf of the Fund, with respect to debt securities, including but not limited to, plans of reorganization, and waivers and consents under applicable indentures.
The Proxy Policy is designed and implemented in a manner reasonably expected to ensure that voting and consent rights are exercised in the best interests of the Fund and its shareholders. Each proxy is voted on a case-by-case basis taking into consideration any relevant contractual obligations as well as other relevant facts and circumstances at the time of the vote. In general, PIMCO reviews and considers corporate governance issues related to proxy matters and generally supports proposals that foster good corporate governance practices. PIMCO may vote proxies as recommended by management on routine matters related to the operation of the issuer and on matters not expected to have a significant economic impact on the issuer and/or its shareholders.
PIMCO will supervise and periodically review its proxy voting activities and implementation of the Proxy Policy. PIMCO will review each proxy to determine whether there may be a material conflict between PIMCO and the Fund. If no conflict exists, the proxy will be forwarded to the appropriate portfolio manager for consideration. If a conflict does exist, PIMCO will seek to resolve any such conflict in accordance with the Proxy Policy. PIMCO seeks to resolve any material conflicts of interest by voting in good faith in the best interest of the Funds. If a material conflict of interest should arise, PIMCO will seek to resolve such conflict in the Funds best interest by pursuing any one of the following courses of action: (i) convening a committee to assess and resolve the conflict; (ii) voting in accordance with the instructions of the Board of Trustees; (iii) voting in accordance with the recommendation of an independent third-party service provider; (iv) suggesting to the Board of Trustees that the Fund engage another party to determine how the proxy should be voted; (v) delegating the vote to a third-party service provider; or (vi) voting in accordance with the factors discussed in the Proxy Policy.
Information about how the Funds voted proxies relating to portfolio securities held during the most recent twelve month period ended June 30th is available without charge, upon request, by calling the Funds shareholder servicing agent at (800) 254-5197, on the Funds website at http://www.allianzinvestors.com/closedendfunds and on the SECs website at http://www.sec.gov.
Copies of the written Proxy Policy and the factors that PIMCO may consider in determining how to vote proxies for the Fund are available by calling the Funds shareholder servicing agent at (800) 254-5197 or on the Funds website at http://www.allianzinvestors.com/closedendfunds.
Appendix A1
PART COTHER INFORMATION
Item 25: | Financial Statements and Exhibits |
1. | Financial Statements: |
Included in Part A:
Financial Highlights for each fiscal period since inception and for the six-month period ended January 31, 2010.
Incorporated into Part B by reference to Registrants two most recent Certified Shareholder Reports on Form N-CSR, dated July 31, 2009 and July 31, 2008 (File No. 811-21601):
Schedule of Investments as of July 31, 2009
Statement of Assets and Liabilities as of July 31, 2009
Statement of Operations for the year ended July 31, 2009
Statements of Changes in Net Assets for the two years ended July 31, 2009 and July 31, 2008
Statement of Cash Flows for the year ended July 31, 2009
Notes to Financial Statements
Report of Independent Registered Public Accounting Firm dated September 25, 2009
2. | Exhibits: |
(a)(1) | Agreement and Declaration of Trust dated June 30, 2004. (1) | |
(a)(2) | Amended and Restated Agreement and Declaration of Trust dated October 5, 2004. (2) | |
(a)(3)
|
Amendment No. 1 to the Amended and Restated Agreement and Declaration of Trust dated February 22, 2010, filed herewith. | |
(b)(1) | Bylaws of Registrant dated June 30, 2004. (1) | |
(b)(2) | Amended and Restated Bylaws of the Registrant, dated October 5, 2004. (2) | |
(b)(3) | Second Amended and Restated Bylaws of the Registrant, dated December 14, 2004. (4) | |
(b)(4) | Third Amended and Restated Bylaws of the Registrant, dated December 11, 2008. (5) | |
(b)(5) | Fourth Amended and Restated Bylaws of the Registrant dated March 1, 2010, filed herewith. | |
(c) | None. | |
(d)(1) | Article III (Shares) and Article V (Shareholders Voting Powers and Meetings) of the Amended and Restated Agreement and Declaration of Trust. (2) | |
(d)(2) | Article 10 (Shareholders Voting Powers and Meetings) of the Fourth Amended and Restated Bylaws, filed herewith. | |
(d)(3) | Form of Share Certificate of the Common Shares. (2) | |
(d)(4) | Specimen certificate representing the Registrants Auction Preferred Shares of beneficial interest. (3) | |
(d)(5) | Form of subscription certificate for rights offering, filed herewith. | |
(d)(6) | Form of notice of guaranteed delivery for rights offering, filed herewith. |
(e) | Terms and Conditions of the Dividend Reinvestment Plan. (2) | |
(f) | None. | |
(g)(1) | Investment Management Agreement between Registrant and Allianz Global Investors Fund Management LLC dated as of October 19, 2004. (2) | |
(g)(2) | Form of Portfolio Management Agreement between Allianz Global Investors Fund Management LLC and Pacific Investment Management Company LLC dated as of October 19, 2004. (2) | |
(h)(1) | Form of Dealer Manager Agreement, filed herewith. | |
(i) | None. | |
(j) | Form of Custodian and Investment Accounting Agreement between Registrant and State Street Bank and Trust Company. (2) | |
(k)(1) | Form of Transfer Agency Services Agreement between Registrant and PNC Global Investment Servicing Inc. (2) | |
(k)(2) | Form of Organizational and Offering Expenses Reimbursement Agreement between Registrant and Allianz Global Investors Fund Management LLC. (2) | |
(k)(3) | Form of Auction Agency Agreement between the Registrant and the Auction Agent as to the Registrants Preferred Shares. (3) | |
(k)(4) | Form of Broker-Dealer Agreement as to the Registrants Preferred Shares. (3) | |
(k)(5) | Form of Depository Trust Company Representations letter as to the Registrants Preferred Shares. (3) | |
(k)(6) | Form of Subscription Agent Agreement, filed herewith. | |
(k)(7) | Form of Information Agent Agreement, filed herewith. | |
(l) | Opinion and consent of Ropes & Gray LLP, filed herewith. | |
(m) | None. | |
(n) | Consent of PricewaterhouseCoopers LLP, filed herewith. | |
(o) | None. | |
(p) | Subscription Agreement of Allianz Global Investors of America L.P. dated October 19, 2004. (2) | |
(q) | None. | |
(r)(1) | Code of Ethics of Registrant dated September 14, 2004. (2) | |
(r)(2) | Code of Ethics of Allianz Global Investors Fund Management LLC dated February 9, 2009. (6) | |
(r)(3) | Code of Ethics of Pacific Investment Management Company LLC dated May 1 2009. (6) | |
(s) | Powers of Attorney for Paul Belica, Robert E. Connor, James A. Jacobson, Hans W. Kertess, John C. Maney and William B. Ogden, IV. (7) |
(1) | Incorporated by reference to the Registrants Initial Registration Statement on Form N-2 relating to its common shares of beneficial interest, File No. 333-117187, filed on July 7, 2004. |
(2) | Incorporated by reference to Pre-Effective Amendment No. 2 to the Registrants Initial Registration Statement on Form N-2 relating to its common shares of beneficial interest, File No. 333-117187, filed on October 22, 2004. |
(3) | Incorporated by reference to Pre-Effective Amendment No.1 to the Registrants Registration Statement on Form N-2 relating to its preferred shares of beneficial interest, File No. 333-120227, filed on December 15, 2004. |
(4) | Incorporated by reference to Pre-Effective Amendment No. 2 to the Registrants Initial Registration Statement on Form N-2 relating to its preferred shares of beneficial interest, File No. 333-120227, filed on December 16, 2004. |
(5) | Incorporated by reference to the Registrants Semi-Annual Report filed on Form NSAR-A, File No. 811-21601, filed on March 27, 2009. |
(6) | Incorporated by reference to Post-Effective Amendment No. 157 of PIMCO Funds, File No. 33-12113, filed on June 8, 2009. |
(8) | Incorporated by reference to the Registrants Initial Registration Statement on Form N-2 relating to an offer of transferable rights to subscribe for common shares, File No. 811-21601, filed on January 15, 2010. |
Item 26: | Marketing Arrangements |
Not applicable.
Item 27: | Other Expenses of Issuance and Distribution |
The following table sets forth the estimated expenses to be incurred in connection with the offer described in this Registration Statement.
Securities and Exchange Commission Fees |
$ | 10,141 | |
Financial Industry Regulatory Authority, Inc. Fees |
13,000 | ||
Subscription agent fees |
22,500 | ||
Information agent fees |
10,000 | ||
Legal fees |
200,000 | ||
New York Stock Exchange listing fees |
50,134 | ||
Printing and mailing expenses |
30,000 | ||
Miscellaneous expenses |
10,000 | ||
Total |
$ | 345,775 |
Item 28: | Persons Controlled by or under Common Control with Registrant |
Not applicable.
Item 29: | Number of Holders of Securities |
At March 10, 2010 (for common shares) and February 8, 2010 (for preferred shares)
Title of Class |
Number of Record Holders |
|
Preferred Shares, par value $0.00001 |
328 | |
Common Shares, par value $0.00001 |
30 |
Item 30: | Indemnification |
Reference is made to Article VIII, Sections 1 through 4, of the Registrants Amended and Restated Agreement and Declaration of Trust, which is incorporated by reference herein.
Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the Act), may be permitted to trustees, officers and controlling persons of the Registrant by the Registrant pursuant to the Trusts Amended and Restated Agreement and Declaration of Trust, its Fourth Amended and Restated Bylaws or otherwise, the Registrant is aware that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Act and, therefore, is unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by trustees, officers or controlling persons of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such trustees, officers or controlling persons in connection with the securities being registered, 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 whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
Item 31: | Business and Other Connections of Investment Adviser |
Descriptions of the business of Allianz Global Investors Fund Management LLC, the Registrants investment manager, and Pacific Investment Management Company LLC, the Registrants sub-adviser, are set forth under the captions Investment Manager and Sub-Adviser under Management of the Fund in both the Prospectus and Statement of Additional Information forming part of this Registration Statement. The following sets forth business and other connections of each director and executive officer (and persons performing similar functions) of Allianz Global Investors Fund Management LLC and Pacific Investment Management Company LLC.
Allianz Global Investors Fund Management LLC
1345 Avenue of the Americas
New York, NY 10105
Name |
Position with AGIFM |
Other Connections |
||
E. Blake Moore, Jr. |
Chairman of Management Board, Managing Director and Chief Executive Officer |
Chief Executive Officer of Allianz Global Investors Solutions LLC. | ||
Udo Frank | Management Board | Managing Director, Chief Executive Officer, Chairman of the Board, Executive Committee and Board Manager of RCM Capital Management LLC; Managing Director, Chairman of the Board, Chief Executive Officer, Executive Committee and Member Board of Managers of RCM U.S. Holdings LLC; Member, Board of Managers of Caywood-Scholl Capital Management LLC. | ||
Barbara Claussen | Management Board | Member-Management Board, Managing Director, Chief Operating Officer and Executive Committee of NFJ Investment Group L.P.; Management Board of Allianz Global Investors Management Partners LLC; Executive Committee of Oppenheimer Capital LLC. | ||
Marna C. Whittington | Management Board | Managing Director, Chief Executive Officer, Executive Committee of Nicholas-Applegate Capital Management LLC; Managing Director and Chief Executive Officer of Nicholas-Applegate Securities LLC; Member-Management Board, Managing Director and CEO of Allianz Global Investors Management Partners LLC; Executive Committee of Oppenheimer Capital LLC. | ||
John C. Maney | Management Board | Management Board, Managing Director and Chief Operating Officer of Allianz Global Investors of America LLC and Allianz Global Investors of America L.P.; Member, Board of Directors and Managing Director of Allianz Global Investors Advertising Agency Inc.; Managing Director and Chief Operating Officer of Allianz Global |
Name |
Position with AGIFM |
Other Connections |
||
Investors NY Holdings LLC; Management Board and Managing Director of Allianz Global Investors U.S. Holding LLC; Managing Director and Chief Operating Officer of Allianz Global Investors U.S. Retail LLC and Allianz Hedge Fund Partners Holding L.P.; Director and Chief Operating Officer of PIMCO Global Advisors (Resources) Limited; Management Board of Nicholas-Applegate Holdings LLC and Allianz Global Investors Management Partners LLC; Board of Directors and Chief Operating Officer of Oppenheimer Group, Inc. and Allianz Global Investors of America Holdings Inc.; Compensation Committee of NFJ Investment Group LLC; Executive Vice President of PIMCO Japan Ltd.; Chief Operating Officer of Allianz Global Investors U.S. Holdings II LLC; Director, President and Chief Operating Officer of PFP Holdings, Inc. | ||||
Michael J. Puntoriero | Chief Financial Officer | Chief Financial Officer of Allianz Global Investors of America Holdings Inc., Allianz Global Investors Managed Accounts LLC, Allianz Global Investors Solutions LLC, Allianz Global Investors U.S. Holding LLC, Allianz Global Investors U.S. Holding II LLC; Allianz Hedge Fund Partners Holding L.P., NFJ Investment Group LLC, Nicholas-Applegate Capital Management LLC, Nicholas-Applegate Holdings LLC, Oppenheimer Capital LLC, Oppenheimer Group, Inc., Pacific Investment Management Company LLC, PFP Holdings Inc., PIMCO Australia Pty Ltd., PIMCO Canada Holding LLC, PIMCO Canada Management Inc., PIMCO Canada Corp., PIMCO Europe Limited, PIMCO Global Advisors LLC, PIMCO Japan Ltd. and StocksPLUS Management Inc.; Managing Director and Chief Financial Officer of Allianz Global Investors Advertising Agency Inc., Allianz Global Investors of America LLC, Allianz Global Investors of America L.P., Allianz Global Investors Management Partners LLC, Allianz Global Investors U.S. Retail LLC and Allianz Global Investors NY Holdings LLC; Director and Chief Financial Officer of PIMCO Global Advisors (Resources) Limited. Managing Director of Allianz Global Investors Distributors LLC. | ||
Brian S. Shlissel | Executive Vice President | None. | ||
Larry G. Altadonna | Senior Vice President |
None. |
||
Thomas J. Fuccillo | Executive Vice President, Chief Legal Officer and Secretary | Executive Vice President of Allianz Global Investors of America L.P. | ||
Vinh T. Nguyen | Senior Vice President and Treasurer | Senior Vice President and Treasurer of Allianz Global Investors Advertising Agency Inc., Allianz Global Investors of America LLC, Allianz Global Investors of America L.P., Allianz Global Investors of America Holdings Inc., Allianz Global Investors Distributors LLC, Allianz Global Investors Managed Accounts LLC, Allianz Global Investors Management Partners LLC, Allianz Global Investors NY Holdings LLC, Allianz Global Investors Solutions LLC, Allianz Global Investors U.S. Retail LLC, Allianz Global |
Name |
Position with AGIFM |
Other Connections |
||
Investors U.S. Holding LLC, Allianz Hedge Fund Partners Holding L.P., NFJ Investment Group LLC, Nicholas-Applegate Capital Management LLC, Nicholas-Applegate Holdings LLC, Oppenheimer Capital LLC, Oppenheimer Group, Inc., Pacific Investment Management Company LLC, PFP Holdings Inc., PIMCO Canada Holding LLC, PIMCO Canada Management Inc., PIMCO Global Advisors LLC, and PIMCO Global Advisors (Resources) Limited; Vice President and Controller of PIMCO Australia Pty Ltd, PIMCO Europe Limited, and PIMCO Japan Ltd.; and Treasurer of Allianz Global Investors U.S. Holding II LLC. | ||||
Colleen Martin | Senior Vice President and Controller | Senior Vice President and Controller of Allianz Global Investors Advertising Agency Inc., Allianz Global Investors of America LLC, Allianz Global Investors of America L.P., Allianz Global Investors of America Holdings Inc., Allianz Global Investors Managed Accounts LLC, Allianz Global Investors Management Partners LLC, Allianz Global Investors NY Holdings LLC, Allianz Global Investors Solutions LLC, Allianz Global Investors U.S. Holding LLC, Allianz Global Investors NY Holding II, LLC, Allianz Global Investors U.S. Retail LLC, Allianz Hedge Fund Partners Holding L.P., NFJ Investment Group LLC, Nicholas-Applegate Capital Management LLC, Nicholas-Applegate Holdings LLC, Oppenheimer Capital LLC, Oppenheimer Group Inc., PFP Holdings Inc., PIMCO Canada Holding LLC, PIMCO Canada Management Inc., PIMCO Global Advisers LLC, PIMCO Global Advisors (Resources) Limited; Controller of Stocks Plus Management Inc.; Chief Financial Officer, Financial Operations Principal, Senior Vice President and Controller of Allianz Global Investors Distributors LLC; and Chief Financial Officer and Financial Operations Controller of Nicholas-Applegate Securities LLC; and Controller of Allianz Global Investors U.S. Holding II LLC. | ||
Albert A. Pisano | Senior Vice President and Chief Compliance Officer | Senior Vice President of Allianz Global Investors of America L.P. | ||
Kellie E. Davidson | Assistant Secretary | Assistant Secretary of Allianz Global Investors Advertising Agency Inc., Allianz Global Investors of America LLC, Allianz Global Investors of America L.P., Allianz Global Investors of America Holdings Inc., Allianz Global Investors Distributors LLC, Allianz Global Investors Managed Accounts LLC, Allianz Global Investors Management Partners, LLC, Allianz Global Investors NY Holdings LLC, Allianz Global Investors Solutions LLC, Allianz Global Investors U.S. Holding II LLC, Allianz Global Investors U.S. Retail LLC, Allianz Hedge Fund Partners Holding L.P., NFJ Investment Group LLC, Nicholas-Applegate Capital Management LLC, Nicholas-Applegate Holdings LLC, Oppenheimer Capital LLC, Oppenheimer Group, Inc., PFP Holdings Inc., PIMCO Canada Holding LLC, PIMCO Canada Management Inc., PIMCO Global Advisors LLC, and PIMCO Global Advisors (Resources) Limited. |
Name |
Position with AGIFM |
Other Connections |
||
Richard Corcoran | Senior Vice President | None. | ||
Scott Whisten | Senior Vice President | None. | ||
Pamela Wooster | Senior Vice President | None. | ||
Richard J. Lavery | Vice President |
None. |
||
Orhan Dzemaili | Vice President | None. | ||
Lydia Lawrence | Assistant Vice President | None. | ||
Manuel Madero | Assistant Vice President |
None. |
||
Daisy S. Ramraj-Singh | Assistant Vice President | None. |
Pacific Investment Management Company LLC (PIMCO)
840 Newport Center Drive, Suite 300
Newport Beach, CA 92660
Name |
Position with PIMCO |
Other Connections |
||
Adamee, Filip | Vice President, PIMCO | |||
Adatia, Tina | Vice President, PIMCO | |||
Afrasiabi, Mark S. | Senior Vice President, PIMCO | |||
Agredano, Carlos | Vice President, PIMCO | |||
Akerberg, Oskar | Vice President, PIMCO | |||
Agrawal, Shantance | Vice President, PIMCO. | Formerly, Consulting Financial Analyst, White & Case LLP. | ||
Aguirre, Steve | Vice President, PIMCO | |||
Allamanis, Georgios | Vice President, PIMCO | |||
Althof, Michael | Vice President, PIMCO | |||
Amey, Mike | Executive Vice President, PIMCO. | |||
Ananthanarayanan, Mangala V. | Vice President, PIMCO | |||
Anctil, Stacie D. | Senior Vice President, PIMCO; Assistant Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust | |||
Anderson, Joshua M. | Executive Vice President, PIMCO | |||
Andrews, David S. | Executive Vice President, PIMCO | |||
Anochie, Kwame A. | Vice President, PIMCO | |||
Arif, Hozef | Vice President, PIMCO | |||
Arnold, Tammie J. | Managing Director, PIMCO | |||
Arora, Amit | Senior Vice President, PIMCO | formerly Executive Director, J.P. Morgan | ||
Baker, Brian P. | Managing Director, PIMCO; Director, PIMCO Asia Pte Ltd. And PIMCO Asia Limited (Hong Kong) | |||
Balls, Andrew Thomas | Executive Vice President, PIMCO | |||
Bansal, Sharad | Senior Vice President, PIMCO | |||
Barnes, Donna E. | Vice President, PIMCO | |||
Bothurst, Anna | Vice President, PIMCO | |||
Beard, Christopher | Vice President, PIMCO | |||
Beaumont, Stephen B. | Executive Vice President, PIMCO | |||
Beck, Lee Davison | Senior Vice President, PIMCO | formerly Senior Vice President, Allianz Global Investors Distributors |
Benson, Sandra M. | Vice President, PIMCO | |||
Benz II, William R. | Managing Director, PIMCO | |||
Ben-Zvi, Kfir | Vice President, PIMCO |
Executive Vice President, PIMCO |
||
Berman, Scott | Senior Vice President, PIMCO | formerly Vice President, JPMorgan Chase Proprietary Positioning Business | ||
Berndt, Andreas | Senior Vice President, PIMCO | |||
Bertolo, Matteo | Vice President, PIMCO | |||
Bhansali, Vineer | Managing Director, PIMCO | |||
Bierman, Dave H. | Vice President, PIMCO | |||
Bishop, Gregory A. | Executive Vice President, PIMCO | |||
Blair, David James | Senior Vice President, PIMCO | |||
Blau, Volker | Executive Vice President, PIMCO | |||
Blomenkamp, Felix | Senior Vice President, PIMCO | |||
Blute, Ryan Patrick | Senior Vice President, PIMCO | |||
Bodereau, Philippe | Executive Vice President, PIMCO | |||
Boehm, Timo | Vice President, PIMCO | |||
Bolton, Laurence Edwin | Vice President, PIMCO | formerly Senior Associate, Dechert LLP | ||
Bosner, Zeljka | Vice President, PIMCO | |||
Bosomworth, Andrew | Executive Vice President, PIMCO | |||
Boyd,C Robert | Vice President, PIMCO | |||
Bradshaw, Myles E. | Senior Vice President, PIMCO | |||
Brandl, Michael | Vice President, PIMCO | |||
Braun, David L. | Senior Vice President, PIMCO | formerly Executive Vice President and Chief Risk Officer, The Hartford - Hartford Investment Management Co. | ||
Brenner, Matthew H. | Vice President, PIMCO | |||
Bridwell, Jennifer S |
Managing Director, PIMCO |
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Bright, John | Vice President, PIMCO | |||
Brittain, WH Bruce | Executive Vice President, PIMCO | |||
Broadwater, Kevin M. | Senior Vice President, PIMCO | |||
Brons, Jelle | Vice President, PIMCO | |||
Brown, Erik C. | Senior Vice President, PIMCO. Assistant Treasurer, PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust. Vice President, StocksPLUS Management Inc. | |||
Brownell, Mike | Vice President, PIMCO | |||
Brune, Christopher P. | Vice President, PIMCO | |||
Bui, Giang H. | Senior Vice President, PIMCO | |||
Burdian, Michael R. | Vice President, PIMCO | |||
Burns, Michael A. | Senior Vice President, PIMCO. | |||
Burns, Robert | Vice President, PIMCO | |||
Byer, Jeffrey A. | Vice President, PIMCO | |||
Callin, Sabrina C. | Managing Director, PIMCO |
Caltagirone, Christopher | Vice President, PIMCO | |||
Cantrill, Elizabeth D. | Vice President, PIMCO | |||
Carnachan, Robert Scott | Senior Vice President, PIMCO and PIMCO Asia PTE Limited | |||
Cavalieri, John R. | Senior Vice President, PIMCO | |||
Chen, Wing-Harn | Vice President, PIMCO | |||
Cheng, Audrey | Vice President, PIMCO | formerly Associate, Morrison & Foerster, LLP | ||
Chin, Tracy | Vice President, PIMCO and PIMCO Asia PTE Limited | |||
Chipp, William | Senior Vice President, PIMCO | |||
Chopra, Amit | Vice Presdient, PIMCO | |||
Clarida, Richard H | Executive Vice President, PIMCO | |||
Clark, Raymond Matthew | Senior Vice President, PIMCO | |||
Clarke, James Robert | Vice President, PIMCO | |||
Colasuonno, Richard T. | Vice President, PIMCO | |||
Colter Jr., Eugene M. | Senior Vice President, PIMCO | formerly Editorial Director, Peppercorn | ||
Conseil, Cyrille R. | Executive Vice President, PIMCO | |||
Cooke, Anthony H. | Vice President, PIMCO | |||
Cornelius, Darryl P. | Vice President, PIMCO | |||
Cortes Gonzalez, Ana | Vice President, PIMCO | formerly Portfolio Manager, Commerzbank AG | ||
Crescenzi, Anthony | Senior Vice President, PIMCO | formerly Chief Bond Market Strategist, Partner and Chairman, Miller Tabak Asset Management | ||
Cressy, Jonathan B. | Senior Vice President, PIMCO | |||
Cumby III, William S. | Vice President, PIMCO | Formerly Trader, CMBS Capital Markets Desk | ||
Cummings, John B. | Executive Vice President, PIMCO | |||
Cupps, Wendy W. | Managing Director, PIMCO | |||
Dada, Suhail H. |
Managing Director, PIMCO |
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Dahlhoff, Juergen | Vice President, PIMCO | |||
Damodaran, Kumaran | Senior Vice President, PIMCO | Formerly Senior Vice President, Lehman Brothers | ||
Danielsen, Birgitte | Vice President, PIMCO | |||
Darling, James | Senior Vice President, PIMCO | formerly, Vice President, Desjardins Securities Inc. | ||
Das, Aniruddha | Vice President, PIMCO | |||
David, Evan A. | Vice President, PIMCO | |||
Davies, William | Senior Vice President, PIMCO | Formerly ABS Portfolio Manager, Axial Investments | ||
Dawson, Craig A. | Managing Director, PIMCO; Director, PIMCO Europe Ltd. | |||
De Bellis, Mary | Vice President, PIMCO | |||
Della Marie, Katie | Vice President, PIMCO | |||
De Leon, William | Executive Vice President, PIMCO | |||
De Lorenzo, Nicola A. | Vice President, PIMCO | |||
De Silva, Harin A. | Executive Vice President, PIMCO | Formerly Managing Director, Merrill Lynch & Co. |
Devlin, Edward | Executive Vice President, PIMCO | |||
Dewitt, Andrew | Vice President, PIMCO | |||
Dialynas, Chris P. | Managing Director, PIMCO | |||
Dilek, Burcin | Vice President, PIMCO | |||
Dittrich, Hanno | Vice President, PIMCO | formerly Vice President, DWS Holdings & Service GmbH | ||
Dombrovsky, Anton | Vice President, PIMCO | |||
Dorff, David J. | Senior Vice President, PIMCO | |||
Dorrian, Peter G. | Senior Vice President, PIMCO | |||
Dorsten, Matthew P. | Vice President, PIMCO | |||
Dubitsky, Rod S. | Executive Vice President, PIMCO | formerly Managing Director, Credit Suisse | ||
Dugan, Travis J. | Vice President, PIMCO | |||
Durham, Jennifer E. | Executive Vice President and Chief Compliance Officer, PIMCO. Chief Compliance Officer, PIMCO Funds, PIMCO Variable Insurance Trust and PIMCO ETF Trust | |||
Dutta, Manish | Senior Vice President, PIMCO | |||
Edler, Vernon | Senior Vice President, PIMCO | |||
Edwards, Ben M. | Vice President, PIMCO | |||
Eedes, Linda | Senior Vice President, PIMCO | |||
El-Erian, Mohamed A. | Managing Director, PIMCO. Senior Vice President, PIMCO Funds, PIMCO Variable Insurance Trust and PIMCO ETF Trust. | Senior Vice President, the Trust, PIMCO Variable Insurance Trust and PIMCO ETF Trust. Formerly President and CEO of Harvard Management Co. | ||
Ellis, Edward L. | Vice President, PIMCO | |||
Eltz, Antoinette | Vice President, PIMCO | |||
Emons, Ben | Senior Vice President, PIMCO | formerly, Vice President/Portfolio Manager, Nuveen Investments LLC | ||
England, Jason S. | Senior Vice President, PIMCO | |||
Estep, Bret W. | Vice President, PIMCO | |||
Evans, Stefanie D. | Vice President, PIMCO | |||
Fan, Derek Chung L. | Vice President, PIMCO | |||
Feeny, Martin E. | Senior Vice President, PIMCO | |||
Fejdasz, Melissa A. | Vice President, PIMCO | |||
Ferber, Steven E. | Senior Vice President, PIMCO | formerly Executive Vice President, AST Capital Trust Company of Delaware | ||
Fields, Robert A. | Senior Vice President, PIMCO | |||
Finkenzeller, Thomas | Vice President, PIMCO | |||
Fisher III, David N. | Executive Vice President, PIMCO | Formerly Managing Director, Halbis Capital Management | ||
Fisher, Marcellus M. | Senior Vice President, PIMCO | |||
Flaherty, Michael | Vice President, PIMCO | |||
Flattum, David C. | Managing Director, General Counsel, PIMCO. Chief Legal Officer, PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust |
Forsyth, Andrew C. | Vice President, PIMCO | |||
Fournier, Joseph A. | Executive Vice President, PIMCO | |||
Fowler, Ellen | Vice President, PIMCO | |||
Foxall, Julian | Senior Vice President, PIMCO | |||
Frisch, Ursula T. | Senior Vice President, PIMCO | |||
Froehlich, Frank | Vice President, PIMCO | |||
Fuhrmann, Dorothee J. | Executive Vice President, PIMCO | formerly, Managing Director, Lehman Brothers International | ||
Fulford III, Richard F. | Executive Vice President, PIMCO | |||
Furusho, Hiroaki | Vice President, PIMCO | |||
Galli, Leandro J. | Vice President, PIMCO | |||
Gandolfi, Alessandro | Senior Vice President, PIMCO | formerly Director, Sanpaolo IMI Group | ||
Garbuzov, Yuri P. | Senior Vice President, PIMCO | |||
Garnett, Andrew | Vice President, PIMCO | formerly Director, UBS Global Asset Management (UK) Limited) | ||
Getter, Christopher T. | Senior Vice President, PIMCO | formerly Emerging Market Debt Research Analyst, Fidelity Management & Research Co. | ||
Gingrich, Robert M. | Vice President, PIMCO | |||
Giurlani, Gian Luca | Senior Vice President, PIMCO | formerly Managing Director, Crosby Forsyth | ||
Gleason, G. Steven | Executive Vice President, PIMCO | |||
Gomez, Michael A. | Executive Vice President, PIMCO | |||
Gould, Linda J | Senior Vice President, PIMCO | |||
Gourley, Eric | Vice President, PIMCO | |||
Grabar, Gregory S. | Senior Vice President, PIMCO | |||
Grady, Myrrha H. | Vice President, PIMCO | |||
Graham, Stuart T. | Senior Vice President, PIMCO | Formerly, Vice President & Managing Director, MFC Global Investment Management | ||
Graves, Zoya S. | Vice President, PIMCO | |||
Greenwald, Joe | Vice President, PIMCO | |||
Greer, Robert J. | Executive Vice President, PIMCO | |||
Griffiths, John | Senior Vice President, PIMCO | formerly Head of Pension Fund Development, Santander Global Banking & Markets | ||
Grigorian, Arshavir | Vice President, PIMCO | |||
Gross, Jared B. | Senior Vice President, PIMCO | formerly, Senior Vice President, Lehman Brothers | ||
Gross, William H. | Managing Director, Chief Investment Officer and Executive Committee Member, PIMCO. Director and Vice President, StocksPLUS Management, Inc. Senior Vice President of PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust. | |||
Gruben, Kristin L. | Vice President, PIMCO | |||
Grzesik, Marco | Vice President, PIMCO | |||
Gu, Haidi | Vice President, PIMCO | |||
Gubner, Adam | Senior Vice President, PIMCO | Formerly Lead Portfolio Manager, Franklin Mutual Advisors, LLC | ||
Gudefin, Anne E. | Executive Vice President, PIMCO | Formerly Co-Founder and Co-Portfolio Manager, AJL Capital Management LLC | ||
Gupta, Sachin | Senior Vice President, PIMCO |
Gupta, Shailesh | Senior Vice President, PIMCO | |||
Haaf, Tim | Vice President, PIMCO | |||
Hagmeier, William Robert | Vice President, PIMCO | |||
Hally, Gordon C. | Executive Vice President, PIMCO | |||
Hardaway, John P. | Executive Vice President, PIMCO. Vice President, StocksPLUS Management, Inc. Treasurer, the Trust, PIMCO Variable Insurance Trust and ETF Trust | |||
Harris, Brent Richard | Managing Director and Executive Committee Member, PIMCO. Director and President, StocksPLUS Management, Inc. Trustee, Chairman and President of PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust. Director, PIMCO Luxembourg S.A. and PIMCO Luxembourg II | |||
Harumi, Kazunori | Executive Vice President, PIMCO | |||
Hastings, Arthur J. | Senior Vice President, PIMCO. Vice President, StocksPLUS Management Inc. | |||
Hauschild, Matthew R. | Vice President, PIMCO | |||
Heimann, Ilan | Senior Vice President, PIMCO | |||
Hayes, Ray C. | Senior Vice President, PIMCO | |||
Heimann, Ilan | Senior Vice President, PIMCO | |||
Helsing, Jeffrey | Senior Vice President, PIMCO | |||
Heravi, Kaveh C. | Vice President, PIMCO | |||
Herlan, Hans Joerg | Vice President, PIMCO | |||
Hockswender, Thomas R. | Vice President, PIMCO | formerly Executive Director, JPMorgan | ||
Hodge, Douglas M. | Managing Director and Chief Operating Officer, PIMCO; Director and Vice President, StocksPLUS Management Inc.; Director, PIMCO Europe Ltd., PIMCO Asia Pte Ltd., PIMCO Australia Pty Ltd, PIMCO Japan Ltd. and PIMCO Asia Limited (Hong Kong) | |||
Hofmann, Richard P.E. | Senior Vice President, PIMCO | formerly Analyst, Creditsights, Inc. | ||
Holden, Brent L. | Managing Director, PIMCO | |||
Holloway Jr., Dwight F. | Executive Vice President, PIMCO | |||
Horne, Jonathan L. | Senior Vice President, PIMCO | |||
Hsiang, Hwa-Ming | Vice President, PIMCO | |||
Hu, Gang | Senior Vice President, PIMCO | formerly Director, Deutsche Bank | ||
Huerta, Maryam | Vice President, PIMCO | |||
Hyman, Daniel Herbert | Senior Vice President, PIMCO | Formerly, Vice President, Credit Suisse | ||
Ing, Terrence | Vice President, PIMCO |
Ivascyn, Daniel J. | Managing Director, PIMCO. | |||
Jacobs IV, Lew W. | Managing Director, PIMCO | |||
Jacobs, Brian H. | Vice President, PIMCO | |||
Jessop, Andrew R. | Executive Vice President, PIMCO | formerly Managing Director, Goldman Sacs Asset Management | ||
Johnson, Eric D | Senior Vice President, PIMCO | |||
Johnson, Kelly | Vice President, PIMCO | |||
Johnson, Nicholas, J. | Senior Vice President, PIMCO | |||
Jones, Jeff | Vice President, PIMCO | formerly, Head of Leadership Assessment & Development Group, HSBC Holding PLC | ||
Jones, Steven L. | Vice President, PIMCO. Vice President, StocksPLUS Management Inc. | |||
Jordan, Daniel V. | Vice President, PIMCO | |||
Kakuchi, Tadashi | Senior Vice President, PIMCO | |||
Karpov, Natalie | Vice President, PIMCO | |||
Kashkari, Neel T. | Managing Director, PIMCO | formerly Assistant Secretary, U.S. Treasury Department | ||
Katz, Ulrich | Senior Vice President, PIMCO | |||
Kavafyan, Constance | Senior Vice President, PIMCO | |||
Keck, Andreas | Senior Vice President, PIMCO | |||
Kellerhals, Philipp | Senior Vice President, PIMCO | |||
Kelly, Benjamin Marcus | Senior Vice President, PIMCO | |||
Kennedy, Gregory J. | Vice President, PIMCO | Formerly Research Analyst, RedRock Capital Management, LLC | ||
Kersman, Alec | Senior Vice President, PIMCO | |||
Kezelman, Jason M | Vice President, PIMCO | |||
Kiesel, Mark R. | Executive Vice President, PIMCO | |||
Kim, Aaron | Vice President, PIMCO | formerly Executive Director and Counsel, JPMorgan Chase Bank, N.A. | ||
Kim, Lisa | Vice President, PIMCO | |||
King Jr., John Stephen | Senior Vice President, PIMCO. Vice President, Senior Counsel, and Secretary, PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust | |||
King, Stephanie Lorraine | Executive Vice President, PIMCO | |||
Kingston, Rafer A. | Vice President, PIMCO | |||
Kirkbaumer, Steven P. | Senior Vice President, PIMCO | |||
Kirkowski, John J. | Vice President, PIMCO | |||
Kishimoto, Yayoi | Vice President, PIMCO | |||
Klug, Harald | Vice President, PIMCO | |||
Komatsu, Hugo | Vice President, PIMCO | |||
Komatsu, Mitsuaki | Senior Vice President, PIMCO | |||
Korinke, Kimberley Grace | Senior Vice President, PIMCO | |||
Korinke, Ryan P. | Senior Vice President, PIMCO | |||
Kressin, Thomas | Senior Vice President, PIMCO | |||
Kuhner, Kevin D. | Senior Vice President, PIMCO |
Kumar, Mukund | Vice President, PIMCO | |||
Kuraja, Antonija | Vice President, PIMCO | |||
Lachhammer, Stefan | Vice President, PIMCO | |||
Lackey, Warren M. | Senior Vice President, PIMCO | |||
Lahr, Charles M. | Executive Vice President, PIMCO | formerly Analyst, Franklin Mutual Advisers LLC | ||
Lang, Eddie | Vice President, PIMCO | |||
Lange, Thomas | Vice President, PIMCO | |||
Larsen, Henrik P. | Senior Vice President, PIMCO. Vice President, PIMCO Funds, PIMCO Variable Insurance Trust and ETF Trust | |||
LeBrun Jr., Richard R. | Senior Vice President, PIMCO; Assistant Secretary, StocksPLUS Management, Inc. | |||
Lee, Alvin Lip Sin | Vice President, PIMCO | |||
Lee, Robert Ru-Bor | Senior Vice President, PIMCO | |||
Lehavi, Yanay | Executive Vice President, PIMCO | |||
Leong, Chon-Ian | Vice President, PIMCO | |||
Leong, Foong C. | Vice President, PIMCO | |||
Lettich, Bruno J. | Executive Vice President, PIMCO | formerly Managing Director, Merrill Lynch & Co. | ||
Li, Ji | Senior Vice President, PIMCO | formerly Vice President, Goldman Sachs | ||
Lian, Chia Liang | Senior Vice President, PIMCO | |||
Lilly III, Frederick V. | Vice President, PIMCO | formerly Vice President, Portfolio Manager, The Bank of New York | ||
Linder, Astrid | Vice President, PIMCO | |||
Linke, Gordon F. | Senior Vice President, PIMCO | formerly Strategic Account Manager, Barclays Global Investors | ||
Liwski, Michael V. | Vice President, PIMCO | |||
Lofdahl, Christopher F. | Vice President, PIMCO | |||
Loh, Cynthia E. Yue-Ling | Vice President, PIMCO | |||
Loh, John J. | Senior Vice President, PIMCO | |||
Long, Hui | Vice President, PIMCO | formerly Vice President, Countrywide Financial Corp. | ||
Lopez, Joy L. | Vice President, PIMCO | |||
Lopez, Rafael A. | Senior Vice President, PIMCO | |||
Loriferne, Matthieu H. F. | Vice President, PIMCO | |||
Louanges, Matthieu | Executive Vice President, PIMCO | |||
Love, David B. | Vice President, PIMCO | formerly, Director, Treesdale Partners, LLC | ||
Lowe, Erika Hayflick | Senior Vice President, PIMCO | |||
Lown, David C. | Managing Director, PIMCO | |||
Ludwig, Steven | Senior Vice President, PIMCO | |||
Mak, Richard | Senior Vice President, PIMCO | |||
Mandy, Alain | Vice President, PIMCO | formerly Audit Senior Manager/Director, PricewaterhouseCoopers | ||
Manseau Guerdat, Chantal Marie-Helene |
Vice President, PIMCO | |||
Maoui, Idriss | Vice President, PIMCO | formerly Assistant Vice President, Barclays Capital |
Marr, Brad | Vice President, PIMCO | |||
Martel, Rene | Senior Vice President, PIMCO | |||
Martin, Scott W. | Senior Vice President, PIMCO | |||
Martini, Nadege | Vice President, PIMCO | |||
Martinschledde, Juergen | Vice President, PIMCO | |||
Masanao, Tomoya |
Managing Director, PIMCO |
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Mather, Scott A. | Managing Director, PIMCO | |||
Mayershofer, Veronika | Vice President, PIMCO | |||
Mazzocchi, Bettina E. | Vice President, PIMCO | formerly, Vice President, Morgan Stanley | ||
McCann, Patrick Murphy | Vice President, PIMCO | |||
McCarthy, Sean M. | Vice President, PIMCO | formerly Senior Vice President, Lehman Brothers Inc. | ||
McCray, Mark V. | Managing Director, PIMCO | |||
McCulley, Paul A. | Managing Director, PIMCO | |||
McDevitt, Joseph V. | Managing Director, PIMCO. Director and Chief Executive Officer, PIMCO Europe Limited. | |||
McLenaghan, Matthew | Vice Presient, PIMCO | |||
Mead, Robert | Executive Vice President, PIMCO | |||
Meggers, Julie Ann | Senior Vice President, PIMCO | |||
Merz, Frederic | Vice President, PIMCO | |||
Metsch, Mark E. | Vice President, PIMCO | |||
Mewbourne, Curtis A. | Managing Director, PIMCO | |||
Meyn, Cynthia L. | Senior Vice President, PIMCO | formerly Managing Director, Morgan Stanley | ||
Micali, Carlo | Vice President, PIMCO | formerly, Financial Analyst, Perlinski & Co. | ||
Mierau, Kristion T. | Senior Vice President, PIMCO | |||
Mieth, Roland | Vice President, PIMCO | formerly Emerging Markets Marketer/Structurer, JPMorgan | ||
Miller Jr., Kendall P. | Senior Vice President, PIMCO | |||
Miller, John M. |
Managing Director, PIMCO |
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Millimet, Scott A. | Executive Vice President, PIMCO | |||
Milo, Davida J. | Senior Vice President, PIMCO | |||
Minaki, Haruki | Executive Vice President, PIMCO | |||
Minamisawa, Hedetoshi | Vice President, PIMCO | |||
Miny, Julie-Anna | Vice President, PIMCO | |||
Mitchell, Gail | Senior Vice President, PIMCO | |||
Mittal, Mohit | Senior Vice President, PIMCO | |||
Moeljanto, Lanny H. | Vice President, PIMCO | |||
Mogelof, Eric J. | Executive Vice President, PIMCO | |||
Molloy, Carol | Vice President, PIMCO | |||
Monson, Kristen S. | Executive Vice President, PIMCO | |||
Moore, James F. | Executive Vice President, PIMCO | |||
Morena, Robert | Executive Vice President, PIMCO | formerly Managing Director, JPMorgan Asset Management | ||
Morrison, John E. | Vice President, PIMCO | |||
Moyer, Stephen G. | Senior Vice President, PIMCO | formerly Director, Tennenbaum Capital Partners, LLC | ||
Muehlethaler, Jeffrey Charles | Vice President, PIMCO | formerly Vice President, Deutsche Bank |
Mukherji, Raja | Senior Vice President, PIMCO | formerly Senior Research Analyst, Chatham Asset Management | ||
Mulcahy, Matthew J. | Senior Vice President, PIMCO | |||
Murano, Yuko | Vice President, PIMCO | |||
Murata, Alfred T. | Executive Vice President, PIMCO | |||
Murray, John W. | Senior Vice President, PIMCO | formerly Vice President, JER Partners | ||
Nabors, Robin | Senior Vice President, PIMCO | |||
Nambimadom, Ramakrishnan S. | Senior Vice President, PIMCO | |||
Nest, Matthew J. | Senior Vice President, PIMCO | |||
Neumeyer, Christopher D. | Vice President, PIMCO | Formerly Investment Analyst, The Blackstone Group, L.P. | ||
Ng, Albert K. | Vice President, PIMCO | |||
Nguyen, Tommy D. | Vice President, PIMCO | |||
Nicholls, Steven B. | Senior Vice President, PIMCO | |||
Nieves, Roger O. | Senior Vice President, PIMCO | |||
Nojima, Sachiko | Vice President, PIMCO | |||
Nunziata, Cristina | Vice President, PIMCO | |||
OConnell, Gillian | Senior Vice President, PIMCO | |||
Okamura, Shigeki | Senior Vice President, PIMCO | |||
Okuma, Sachiko | Vice President, PIMCO | |||
Okun, Eric A. | Executive Vice President, PIMCO | |||
Olazabal, Joshua A. | Vice President, PIMCO | |||
Oliva, Jennifer L. | Vice President, PIMCO | |||
Ollenburger, Loren P. | Vice President, PIMCO | |||
Ong, Arthur Y.D. | Executive Vice President, PIMCO; Secretary, StocksPLUS Management, Inc.; Secretary, PIMCO Canada Corp. | |||
Ongaro, Douglas J. |
Managing Director, PIMCO |
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Osses, Guillermo Ariel | Executive Vice President, PIMCO | |||
Otterbein, Marie S. | Vice President, PIMCO | |||
Otterbein, Thomas J. | Managing Director, PIMCO | |||
Ozeki, Koyo | Executive Vice President, PIMCO | |||
Padmanabhan, Lalantika | Vice President, PIMCO | |||
Pagani, Lorenzo P. | Senior Vice President, PIMCO | |||
Parikh, Bijal Y. |
Managing Director, PIMCO |
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Parikh, Saumil H. | Executive Vice President, PIMCO | |||
Park, Jung | Executive Vice President, PIMCO | formerly Senior Managing Director, Bear Stearns Asia Limited | ||
Pascutti, Michael J. | Executive Vice President, PIMCO | Formerly Founding Partner, Sandelman Partners | ||
Paulson, Bradley W. | Executive Vice President, PIMCO; Director, Vice President and Secretary, PIMCO Europe Ltd.; Director, PIMCO Asia Pte Ltd.; |
Director, Vice President and Assistant Secretary, PIMCO Australia Pty Ltd.; Vice President and Secretary, PIMCO Japan Ltd.; Director, PIMCO Asia Limited (Hong Kong); and Assistant Secretary, PIMCO Canada Corp. | ||||
Pejavar, Sheila M. | Vice President, PIMCO | |||
Perez, Iohan | Vice President, PIMCO | |||
Perez, Keith | Senior Vice President, PIMCO | |||
Philipp, Elizabeth M. | Executive Vice President, PIMCO | |||
Phillipson, Daniel | Senior Vice President, PIMCO | |||
Pickering, Natalie J. | Senior Vice President, PIMCO | Formerly Principal Senior Director of Business Development and Strategy, Barclays Global Investors. | ||
Pimentel, Rudolph | Senior Vice President, PIMCO | |||
Pont, Nicholas J. | Vice President, PIMCO | |||
Porterfield, Mark J. | Executive Vice President, PIMCO | |||
Posch, Brigitte | Executive Vice President, PIMCO | formerly Managing Director, Deutsche Bank | ||
Pothalingam, Ketishwaran S. | Senior Vice President, PIMCO | formerly Credit Fund Manager, Threadneedle Asset Management | ||
Potthof, Axel | Senior Vice President, PIMCO | |||
Powers, William C. | Managing Director, PIMCO | |||
Price, Rosamond J. | Vice President, PIMCO | |||
Pricer, Jesse L. | Vice President, PIMCO | |||
Putnicki, Matthew S. | Vice President, PIMCO | |||
Putyatin, Vladyslav | Senior Vice President, PIMCO | formerly Director, Deutsche Bank AG | ||
Qiao, Yi | Vice President, PIMCO | |||
Qiu, Ying | Vice President, PIMCO | formerly Portfolio Manager, ING Investment Management | ||
Qu, Wendong | Senior Vice President, PIMCO | |||
Rahari, Pierre-Yves | Vice President, PIMCO | |||
Rahman, Lupin | Vice President, PIMCO | Formerly, Policy Development and Review Economist, Sri Lanka | ||
Ratner, Joshua D. | Senior Vice President, PIMCO. | |||
Ravano, Emanuele | Managing Director, PIMCO | |||
Reimer, Danelle J. | Vice President, PIMCO | |||
Reimer, Ronald M. | Senior Vice President, PIMCO | |||
Reisz, Paul W. | Senior Vice President, PIMCO | |||
Repoulis, Yiannis | Senior Vice President, PIMCO | |||
Reynolds, Joel D. | Vice President, PIMCO | Formerly Vice President, Income Research & Management | ||
Rice, Thomas Edmund | Senior Vice President, PIMCO | |||
Riendeau, Kevin | Vice President, PIMCO | formerly, Vice President, Morgan Stanley | ||
Rodosky, Stephen A. |
Managing Director, PIMCO |
|||
Rogers, William A. | Vice President, PIMCO | |||
Rollins, Melody | Senior Vice President, PIMCO | |||
Romano, Mark A. | Senior Vice President, PIMCO |
Rowe, Cathy T. | Vice President, PIMCO | |||
Rudolph, Lynn | Vice President, PIMCO | |||
Ruebesam, Roland | Vice President, PIMCO | |||
Ruthen, Seth R. | Executive Vice President, PIMCO | |||
Sakane, Yoshiyuki | Vice President, PIMCO | |||
Salastekar, Deepa A. | Vice President, PIMCO | formerly Managing Director, Bear, Stearns & Co., Inc. | ||
Sargent, Jeffrey M. | Executive Vice President, PIMCO. | |||
Schaus, Stacy Leigh | Senior Vice President, PIMCO | |||
Schneider, Gero | Vice President, PIMCO | |||
Schneider, Jerome M. | Executive Vice President, PIMCO | Formerly Senior Managing Director, Bear, Stearns & Co., Inc. | ||
Schneider, Patrick | Vice President, PIMCO | |||
Schuetz, Christian | Vice President, PIMCO | |||
Schuetz, Patricia Ann | Vice President, PIMCO | |||
Schulist, Stephen O. | Senior Vice President, PIMCO | |||
Schultes, Adrian O. | Vice President, PIMCO | |||
Schwab, Gerlinde | Vice President, PIMCO | |||
Schwab, Stephen D. | Vice President, PIMCO | Formerly, Vice President, Fidelity Investments | ||
Schwetz, Myckola | Senior Vice President, PIMCO | |||
Scibisz, Iwona E. | Vice President, PIMCO | |||
Scorah, Ian | Vice President, PIMCO | |||
Seidner, Marc P. | Executive Vice President, PIMCO | formerly Managing Director, Domestic Fixed Income Portfolio Manager, Harvard Management Company | ||
Sejima, Toru | Senior Vice President, PIMCO | |||
Seksaria, Rahul M. | Senior Vice President, PIMCO | |||
Senne, Verena | Senior Vice President, PIMCO | |||
Serafino Jr., George P. | Vice President, PIMCO | |||
Sesay, Therenah | Vice President, PIMCO | |||
Shah, Sapna K. | Vice President, PIMCO | |||
Shaw, Matthew D. | Senior Vice President, PIMCO | |||
Sheehy, Erica H. | Senior Vice President, PIMCO | |||
Shepherd, Julie M. | Vice President, PIMCO | |||
Shiroyama, Taro | Vice President, PIMCO | |||
Short, Jonathan D. | Executive Vice President, PIMCO | |||
Simon, W Scott | Managing Director, PIMCO | |||
Simonian, Joe | Vice President, PIMCO | |||
Singal, Alka | Vice President, PIMCO | |||
Singh, Anil | Vice President, PIMCO | |||
Skobtsov, Ivan | Senior Vice President, PIMCO | |||
Skov, Kimble | Vice President, PIMCO | |||
Smith, Kenton Todd | Senior Vice President, PIMCO | formerly Vice President, First Horizon | ||
Somersan-Coqui, Aylin | Senior Vice President, PIMCO | |||
Sonner, Michael | Senior Vice President, PIMCO | |||
Soto, Alyssa Michele | Vice President, PIMCO | |||
Spajic, Luke | Executive Vice President, PIMCO | |||
Spalding, Scott M. | Senior Vice President, PIMCO | |||
Spandri, Tobias | Vice President, PIMCO | |||
Spicijaric, Jennifer N. | Vice President, PIMCO | |||
Springer, Jeffrey | Senior Vice President, PIMCO |
Stack, Candice E. | Senior Vice President, PIMCO | |||
Stancil, Thomas A. | Vice President, PIMCO | Formerly Partner, Ashland Partners & Co., LLP | ||
Staub, Christian M. | Senior Vice President, PIMCO; Director, President, and Chief Compliance Officer, PIMCO (Switzerland) LLC | |||
Stauffer, Christina | Vice President, PIMCO | |||
Steele, Scott Patrick | Senior Vice President, PIMCO | formerly Chief Investment Officer, BMO Mutual Funds | ||
Steiner, Jason R. | Vice President, PIMCO | Formerly Consultant, Centerline Capital Group. | ||
Stracke, Christian | Managing Director, PIMCO | Formerly Senior Credit Strategist, CreditSights | ||
Strauch, Joel Edward | Senior Vice President, PIMCO | |||
Stravato, Richard | Vice President, PIMCO | |||
Streiff, Thomas F. | Executive Vice President, PIMCO | formerly Managing Director, UBS Investment Bank | ||
Strelow, Peter G | Executive Vice President, PIMCO | |||
Struc, Alexandru | Vice President, PIMCO | |||
Sun, Hao | Vice President, PIMCO | |||
Suo, Yuanyuan | Vice President, PIMCO | |||
Suskind, Donald W. | Senior Vice President, PIMCO. | |||
Taborsky, Mark A. | Executive Vice President, PIMCO | formerly Managing Director of External Management, Harvard Management Company | ||
Takano, Makoto | Managing Director, PIMCO; Director and President, PIMCO Japan Ltd. | |||
Takeuchi, Ichiro | Senior Vice President, PIMCO | |||
Takizuka, Hikaru | Vice President, PIMCO | |||
Tam Joe | Vice President, PIMCO | |||
Tamura, Maiko | Vice President, PIMCO | formerly Manager, AIG Japan Capital Investment Co., Ltd. | ||
Tarman, Daniel | Executive Vice President, PIMCO | |||
Telish, Christine M. | Vice President, PIMCO | |||
Terry, Michael A. | Vice President, PIMCO | Formerly Vice President, Morgan Stanley | ||
Tersin, Dominique | Vice President, PIMCO | |||
Theodore, Kyle J. | Senior Vice President, PIMCO | |||
Thompson, Michael Frazier | Senior Vice President, PIMCO | |||
Thurston, Powell C. | Senior Vice President, PIMCO | |||
Tiwari, Ashish | Vice President, PIMCO | |||
To, Steven P. | Vice President, PIMCO | |||
Toloui-Tehrani, Ramin | Executive Vice President, PIMCO | |||
Tomlinson, Brian | Vice President, PIMCO | |||
Tournier, Eve | Executive Vice President, PIMCO | formerly Managing Director, Deutsche Bank AG |
Weinberger, Michele Deborah | Vice President, PIMCO | formerly Vice President, Goldman Sachs Asset Mgmt | ||
Wendler IV, Paul F. | Vice President, PIMCO | |||
Werber, Keith A. | Vice President, PIMCO | formerly, Vice President, Countrywide Securities Corporation | ||
White, Timothy C. | Senior Vice President, PIMCO | |||
Whitewolf, Lance E. | Vice President, PIMCO | |||
Whitton, Bransby M. | Senior Vice President, PIMCO; Director, PIMCO Asia Pte Ltd. | |||
Wild, Christian | Senior Vice President, PIMCO | |||
Wildermuth, Paul T. | Vice President, PIMCO | |||
Williams III, Charles A | Vice President, PIMCO | |||
Williams, Jason A. | Vice President, PIMCO | |||
Wilner, Mitchell W. | Senior Vice President, PIMCO | |||
Wilson, John F. | Executive Vice President, PIMCO; Director, PIMCO Australia Pty Ltd. | |||
Wilson, Susan L. |
Managing Director, PIMCO |
|||
Winters, Kevin M. | Senior Vice President, PIMCO | |||
Witt, Frank | Executive Vice President, PIMCO | |||
Wittkop, Andrew T. | Senior Vice President, PIMCO | |||
Wolf, Greggory S. | Senior Vice President, PIMCO | |||
Wong, Tammy Nguyen | Vice President, PIMCO | |||
Wood, George H. | Executive Vice President, PIMCO | |||
Worah, Mihir P. | Executive Vice President, PIMCO | |||
Xu, Jianghua | Vice President, PIMCO | |||
Yamamoto, Shinichi | Senior Vice President, PIMCO | |||
Yang, Jing | Vice President, PIMCO | |||
Yasnov, Vadim I. | Vice President, PIMCO | |||
Yildiz, Sadettin | Vice President, PIMCO | |||
Yip, Jonathan | Vice President, PIMCO | |||
Yip, Paul S. | Vice President, PIMCO | formerly Principal Database Admin/Architect, Yahoo, Inc. | ||
Yoon, Jinhy | Vice President, PIMCO | Formerly Vice President, J.P.Morgan Securities Inc. | ||
Yoon, Kenneth G. | Vice President, PIMCO | |||
Young, Robert O. | Executive Vice President, PIMCO | formerly Managing Director, Global Capital Markets | ||
Yu, Anna W. | Vice President, PIMCO | |||
Yu, Cheng-Yuan | Executive Vice President, PIMCO | |||
Yu, Walter | Vice President, PIMCO | |||
Zerner, Mary | Vice President, PIMCO | formerly Senior Vice President, Lazard Asset Management Limited - London | ||
Zhu, Changhong | Managing Director, PIMCO |
Item 32: | Location of Accounts and Records |
The account books and other documents required to be maintained by the Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and the rules thereunder will be maintained at the offices of Allianz Global Investors Fund Management LLC, 1345 Avenue of the Americas, New York, New York 10105, Pacific Investment Management Company LLC, 840 Newport Center Drive, Suite 300, Newport Beach, California 92660, State Street Bank and Trust Company, 801 Pennsylvania Avenue, Kansas City, Missouri 64105, and/or PNC Global Servicing Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809.
Item 33: | Management Services |
Not applicable.
Item 34: | Undertakings |
1. | Registrant undertakes to suspend the offering of its Common Shares until it amends the prospectus filed herewith if (1) subsequent to the effective date of its registration statement, the net asset value declines more than 10 percent from its net asset value as of the effective date of the registration statement, or (2) the net asset value increases to an amount greater than its net proceeds as stated in the prospectus. |
2. | Not applicable. |
3. | Not applicable. |
4. | Not applicable. |
5. | The Registrant undertakes that: |
a. | For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in the form of prospectus filed by the Registrant under Rule 497(h) under the Securities Act of 1933 shall be deemed to be part of this registration statement as of the time it was declared effective; and |
b. | For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of the securities at that time shall be deemed to be the initial bona fide offering thereof. |
6. | The 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. |
NOTICE
A copy of the Agreement and Declaration of Trust of the Registrant, together with all amendments thereto, is on file with the Secretary of The Commonwealth of Massachusetts, and notice is hereby given that this instrument is executed on behalf of the Registrant by any trustee or officer of the Registrant as a trustee or officer, as applicable, and not individually, and that the obligations of or arising out of this instrument are not binding upon any of the trustees of the Registrant or shareholders of the Registrant individually, but are binding only upon the assets and property of the Registrant.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, 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 March, 2010.
PIMCO FLOATING RATE INCOME FUND | ||
By: |
/ S / B RIAN S. S HLISSEL |
|
Name: | Brian S. Shlissel | |
Title: | President and Chief Executive Officer |
Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the date indicated.
Name |
Capacity |
Date |
||
/ S / B RIAN S. S HLISSEL |
President and Chief Executive Officer | March 12, 2010 | ||
Brian S. Shlissel | ||||
/ S / L AWRENCE G. A LTADONNA |
Treasurer and Principal Financial and Accounting Officer | March 12, 2010 | ||
Lawrence G. Altadonna | ||||
P AUL B ELICA * |
Trustee | March 12, 2010 | ||
Paul Belica | ||||
R OBERT E. C ONNOR * |
Trustee | March 12, 2010 | ||
Robert E. Connor | ||||
J AMES A. J ACOBSON * |
Trustee | March 12, 2010 | ||
James A. Jacobson | ||||
H ANS W. K ERTESS * |
Trustee | March 12, 2010 | ||
Hans W. Kertess | ||||
J OHN C. M ANEY * |
Trustee | March 12, 2010 | ||
John C. Maney | ||||
W ILLIAM B. O GDEN , IV* |
Trustee | March 12, 2010 | ||
William B. Ogden, IV | ||||
|
Trustee | |||
R. Peter Sullivan, III |
* By: |
/ S / B RIAN S. S HLISSEL |
|
Brian S. Shlissel | ||
Attorney-In-Fact | ||
Date: March 12, 2010 |
INDEX TO EXHIBITS
Exhibit |
Exhibit Name |
|
(a)(3) |
Amendment No. 1 to Amended and Restated and Declaration of Trust |
|
(b)(6) |
Fourth Amended and Restated Bylaws | |
(d)(5) |
Form of Subscription Certificate for Rights Offering | |
(d)(6) |
Form of Notice of Guaranteed Delivery for Rights Offering | |
(h)(1) |
Form of Dealer Manager Agreement | |
(k)(6) |
Form of Subscription Agent Agreement | |
(k)(7) |
Form of Information Agent Agreement | |
(l) |
Opinion and Consent of Ropes & Gray LLP | |
(n) |
Consent of Pricewaterhouse Coopers LLP |
Exhibit (a)(3)
PIMCO FLOATING RATE STRATEGY FUND
AMENDMENT NO. 1 TO
THE AMENDED AND RESTATED AGREEMENT AND DECLARATION OF TRUST
The undersigned, being at least a majority of the Trustees of PIMCO Floating Rate Strategy Fund (the Trust), hereby amend the Trusts Amended and Restated Agreement and Declaration of Trust dated October 5, 2004 (the Declaration of Trust), a copy of which is on file in the office of the Secretary of State of the Commonwealth of Massachusetts, as follows:
1. The first sentence of Section 1 of Article I of the Declaration of Trust is hereby amended to read in its entirety as follows:
Name. This Trust shall be known as PIMCO Income Strategy Fund II and the Trustees shall conduct the business of the Trust under that name or any other name as they may from time to time determine.
The foregoing amendment shall be effective as of March 1, 2010 and will be filed with the Secretary of State of The Commonwealth of Massachusetts.
IN WITNESS WHEREOF, we have hereunto set our hand for ourselves and for our successors and assigns as of the 22nd day of February, 2010.
/s/ Paul Belica |
/s/ Robert E. Connor |
|||
Paul Belica | Robert E. Connor | |||
/s/ Hans W. Kertess |
|
|||
Hans W. Kertess | John C. Maney | |||
/s/ William B. Ogden, IV |
|
|||
William B. Ogden, IV | R. Peter Sullivan III | |||
/s/ James A. Jacobson |
||||
James A. Jacobson |
Exhibit (b)(6)
FOURTH AMENDED AND RESTATED
BYLAWS
of
PIMCO INCOME STRATEGY FUND II
(Amended and Restated as of March 1, 2010)
ARTICLE 1
Agreement and Declaration of Trust and Principal Office
1.1 Principal Office of the Trust . A principal office of the Trust shall be located in New York, New York. The Trust may have other principal offices within or without Massachusetts as the Trustees may determine or as they may authorize.
1.2 Agreement and Declaration of Trust . These Fourth Amended and Restated Bylaws (the Bylaws) shall be subject to the Agreement and Declaration of Trust, as amended or restated from time to time (the Declaration of Trust), of PIMCO Income Strategy Fund II (formerly, PIMCO Floating Rate Strategy Fund), the Massachusetts business trust established by the Declaration of Trust (the Trust). Capitalized terms used in these Bylaws and not otherwise defined herein shall have the meanings given to such terms in the Declaration of Trust.
ARTICLE 2
Meetings of Trustees
2.1 Regular Meetings . Regular meetings of the Trustees may be held without call or notice at such places and at such times as the Trustees may from time to time determine, provided that notice of the first regular meeting following any such determination shall be given to absent Trustees. A regular meeting of the Trustees may be held without call or notice immediately after and at the same place as the annual meeting of the Shareholders (as defined in the Declaration of Trust).
2.2 Special Meetings . Special meetings of the Trustees may be held at any time and at any place designated in the call of the meeting when called by the Chairman of the Trustees, the President or the Treasurer or by two or more Trustees, sufficient notice thereof being given to each Trustee by the Secretary or an Assistant Secretary or by the officer or the Trustees calling the meeting.
2.3 Notice . It shall be sufficient notice to a Trustee of a special meeting to send notice by mail at least forty-eight hours, or by telegram, telex or telecopy or other electronic facsimile transmission method at least twenty-four hours, before the meeting addressed to the
Trustee at his or her usual or last known business or residence address or to give notice to him or her in person or by telephone at least twenty-four hours before the meeting. Notice of a meeting need not be given to any Trustee if a written waiver of notice, executed by him or her, before or after the meeting, is filed with the records of the meeting, or to any Trustee who attends the meeting without protesting prior thereto or at its commencement the lack of notice to him or her. Neither notice of a meeting nor a waiver of a notice need specify the purposes of the meeting.
2.4 Quorum . At any meeting of the Trustees a majority of the Trustees then in office shall constitute a quorum. Any meeting may be adjourned from time to time by a majority of the votes cast upon the question, whether or not a quorum is present, and the meeting may be held as adjourned without further notice.
ARTICLE 3
Officers and Chairman of the Trustees
3.1 Enumeration; Qualification . The officers of the Trust shall be a President, a Treasurer, a Secretary, a Chief Compliance Officer and such other officers, if any, as the Trustees from time to time may in their discretion elect. The Trust may also have such agents as the Trustees from time to time may in their discretion appoint. Any officer may but need not be a Trustee or a Shareholder. Any two or more offices may be held by the same person.
3.2 Election . The President, the Treasurer, and the Secretary shall be elected annually by the Trustees. Other officers, if any, may be elected or appointed by the Trustees at the same meeting at which the President, Treasurer and Secretary are elected, or at any other time. If required by the 1940 Act, the Chief Compliance Officer shall be elected or appointed by a majority of the trustees, as well as a majority of the Trustees who are not Interested Persons of the Trust (Independent Trustees), and otherwise in accordance with Rule 38a-1 (or any successor rule) under the 1940 Act, as such rule may be amended from time to time (Rule 38a-1). Vacancies in any office may be filled at any time.
3.3 Tenure . The Chairman of the Trustees, if one is elected, the President, the Treasurer, the Secretary and the Chief Compliance Officer shall hold office until their respective successors are chosen and qualified, or in each case until he or she sooner dies, resigns, is removed with or without cause or becomes disqualified, provided that, if required by the 1940 Act, any renewal of the Chief Compliance Officer shall be in accordance with Rule 38a-1. Each other officer shall hold office and each agent of the Trust shall retain authority at the pleasure of the Trustees.
3.4 Powers . Subject to the other provisions of these Bylaws, each officer shall have, in addition to the duties and powers herein and in the Declaration of Trust set forth, such duties and powers as are commonly incident to the office occupied by him or her as if the Trust were organized as a Massachusetts business corporation and such other duties and powers as the Trustees may from time to time designate.
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3.5 Chairman of the Trustees . There shall be an office of the Chairman of the Trustees, which shall serve of behalf of the Trustees, but shall not be an officer of the Trust. The office of the Chairman of the Trustees may be held by more than one person. Any Chairman of the Trustees shall be elected by a majority of the Trustees, as well as a majority of the Independent Trustees if required by the 1940 Act. If required by the 1940 Act, any Chairman of the Trustees shall be an Independent Trustee and may, but need not, be a shareholder. The powers and the duties of the Chairman of the Trustees shall include any and all such powers and duties relating to the operations of the Trustees as, from time to time, may be conferred upon or assigned to such office by the Trustees or as may be required by law, provided that the Chairman of the Trustees shall have no individual authority to act for the Trust as an officer of the Trust. In carrying out the responsibilities and duties of the office, the Chairman of the Trustees may seek assistance and input from other Trustees or Committees of the Trustees, officers of the Trust and the Trusts investment adviser(s) and other service providers, as deemed necessary or appropriate. The Trustees, including a majority of the Independent Trustees if required by the 1940 Act, may appoint one or more persons to perform the duties of the Chairman of the Trustees, in the event of his absence at any meeting or in the event of his disability.
3.6 President; Vice President . The President shall be the chief executive officer. Any Vice President shall have such duties and powers as may be designated from time to time by the Trustees or the President.
3.7 Treasurer; Assistant Treasurer . The Treasurer shall be the chief financial and accounting officer of the Trust, and shall, subject to the provisions of the Declaration of Trust and to any arrangement made by the Trustees with a custodian, investment adviser, sub-adviser or manager, or transfer, shareholder servicing or similar agent, be in charge of the valuable papers, books of account and accounting records of the Trust, and shall have such other duties and powers as may be designated from time to time by the Trustees or by the President. Any Assistant Treasurer shall have such duties and powers as may be designated from time to time by the Trustees or the President.
3.8 Secretary; Assistant Secretary . The Secretary shall record all proceedings of the Shareholders and the Trustees in books to be kept therefor, which books or a copy thereof shall be kept at the principal office of the Trust. In the absence of the Secretary from any meeting of the Shareholders or Trustees, an Assistant Secretary, or if there be none or if he or she is absent, a temporary secretary chosen at such meeting shall record the proceedings thereof in the aforesaid books. Any Assistant Secretary shall have such duties and powers as may be designated from time to time by the Trustees or the President.
3.9 Chief Compliance Officer . The Chief Compliance Officer shall perform the duties and have the responsibilities of the chief compliance officer of the Trust, including if required by the 1940 Act any such duties and responsibilities imposed by Rule 38a-1, and shall have such other duties and powers as may be designated from time to time by the Trustees.
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3.10 Resignations . Any officer may resign at any time by written instrument signed by him or her and delivered to the Chairman of the Trustees, if any, the President or the Secretary, or to a meeting of the Trustees. Such resignation shall be effective upon receipt unless specified to be effective at some other time. Except to the extent expressly provided in a written agreement with the Trust, no officer resigning and no officer removed shall have any right to any compensation for any period following his or her resignation or removal, or any right to damages on account of such removal.
ARTICLE 4
Committees
4.1 Quorum; Voting . Except as provided below or as otherwise specifically provided in the resolutions constituting a Committee of the Trustees and providing for the conduct of its meetings, a majority of the members of any Committee of the Trustees shall constitute a quorum for the transaction of business, and any action of such a Committee may be taken at a meeting by a vote of a majority of the members present (a quorum being present) or evidenced by one or more writings signed by such a majority. Members of a Committee may participate in a meeting of such Committee by means of a conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other at the same time and participation by such means shall constitute presence in person at a meeting.
With respect to a Valuation Committee of the Trustees, one or more of the Committee members shall constitute a quorum for the transaction of business.
Except as specifically provided in the resolutions constituting a Committee of the Trustees and providing for the conduct of its meetings, Article 2, Sections 2.2 and 2.3 of these Bylaws relating to special meetings shall govern the notice requirements for Committee meetings, except that it shall be sufficient notice to a Valuation Committee of the Trustees to send notice by telegram, telex or telecopy or other electronic means (including by telephone voice-message or e-mail) at least fifteen minutes before the meeting.
ARTICLE 5
Reports
5.1 General . The Trustees and officers shall render reports at the time and in the manner required by the Declaration of Trust or any applicable law. Officers and Committees shall render such additional reports as they may deem desirable or as may from time to time be required by the Trustees.
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ARTICLE 6
Fiscal Year
6.1 General . Except as from time to time otherwise provided by the Trustees, the initial fiscal year of the Trust shall end on such date as is determined in advance or in arrears by the Treasurer, and the subsequent fiscal years shall end on such date in subsequent years.
ARTICLE 7
Seal
7.1 General . The seal of the Trust shall, subject to alteration by the Trustees, consist of a flat-faced die with the word Massachusetts, together with the name of the Trust and the year of its organization cut or engraved thereon; provided, however, that unless otherwise required by the Trustees, the seal shall not be necessary to be placed on, and its absence shall not impair the validity of, any document, instrument or other paper executed and delivered by or on behalf of the Trust.
ARTICLE 8
Execution of Papers
8.1 General . Except as the Trustees may generally or in particular cases authorize the execution thereof in some other manner, all deeds, leases, transfers, contracts, bonds, notes, checks, drafts and other obligations made, accepted or endorsed by the Trust shall be executed by the President, any Vice President, the Treasurer or by whomever else shall be designated for that purpose by vote of the Trustees, and need not bear the seal of the Trust.
ARTICLE 9
Issuance of Share Certificates
9.1 Share Certificates . Except as provided in Article 11 hereof, each Shareholder shall be entitled to a certificate stating the number of Shares (as defined in the Declaration of Trust) owned by him or her, in such form as shall be prescribed from time to time by the Trustees. Such certificates shall be signed by the President or any Vice President and by the Treasurer or any Assistant Treasurer. Such signatures may be by facsimile if the certificate is signed by a transfer agent, or by a registrar, other than a Trustee, officer or employee of the Trust. In case any officer who has signed or whose facsimile signature has been placed on such certificate shall cease to be such officer before such certificate is issued, it may be issued by the Trust with the same effect as if he or she were such officer at the time of its issuance.
Notwithstanding the foregoing, in lieu of issuing certificates for Shares, the Trustees or the transfer agent may either issue receipts therefor or may keep accounts upon the books of the Trust for the record holders of such Shares, who shall in either case be deemed, for all purposes hereunder, to be the holders of certificates for such Shares as if they had accepted such certificates and shall be held to have expressly assented and agreed to the terms hereof.
-5-
9.2 Loss of Certificates . In case of the alleged loss or destruction or the mutilation of a share certificate, a duplicate certificate may be issued in place thereof, upon such terms as the Trustees shall prescribe.
9.3 Issuance of New Certificates to Pledgee . A pledgee of Shares transferred as collateral security shall be entitled to a new certificate if the instrument of transfer substantially describes the debt or duty that is intended to be secured thereby. Such new certificate shall express on its face that it is held as collateral security, and the name of pledgor shall be stated thereon, who alone shall be liable as a Shareholder and entitled to vote thereon.
9.4 Discontinuance of Issuance of Certificates . Notwithstanding anything to the contrary in this Article 9, the Trustees may at any time discontinue the issuance of share certificates and may, by written notice to each Shareholder, require the surrender of share certificates to the Trust for cancellation. Such surrender and cancellation shall not affect the ownership of Shares in the Trust.
ARTICLE 10
Shareholders Voting Powers and Meetings
10.1 Voting Powers . The Shareholders shall have power to vote only (i) for the election or removal of Trustees as provided in Article IV, Sections 1 and 3 of the Declaration of Trust and Article 11 hereto, (ii) with respect to any Manager or sub-adviser as provided in Article IV, Section 8 of the Declaration of Trust to the extent required by the 1940 Act, (iii) with respect to certain transactions and other matters to the extent and as provided in Article V, Sections 2 and 3 of the Declaration of Trust and Article 11 hereto, (iv) with respect to any termination of this Trust to the extent and as provided in Article IX, Section 4 of the Declaration of Trust (for the avoidance of any doubt, Shareholders shall have no separate right to vote with respect to the termination of the Trust or a series or class of Shares if the Trustees (including the Continuing Trustees) exercise their right to terminate the Trust or such series or class pursuant to clauses (ii) or (y) of Article IX, Section 4 of the Declaration of Trust), (v) with respect to any amendment of the Declaration of Trust to the extent and as provided in Article IX, Section 7 of the Declaration of Trust and Articles 11 and 12 hereto, (vi) to the same extent as the stockholders of a Massachusetts business corporation as to whether or not a court action, proceeding or claim should or should not be brought or maintained derivatively or as a class action on behalf of the Trust or the Shareholders, and (vii) with respect to such additional matters relating to the Trust as may be required by law, the Declaration of Trust, these Bylaws or any registration of the Trust with the Securities and Exchange Commission (or any successor agency) or any state, or as the Trustees may consider necessary or desirable. Each whole Share shall be entitled to one vote as to any matter on which it is entitled to vote and each fractional Share shall be entitled to a proportionate fractional vote, except as otherwise provided in the Declaration of Trust, these Bylaws, or required by applicable law. Except as otherwise provided in the Declaration of Trust or in respect of the terms of a class of preferred shares of beneficial interest of the Trust as reflected in these Bylaws or required by applicable law, all Shares of the Trust then entitled to vote shall be voted in the aggregate as a single class without regard to classes or series of Shares.
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There shall be no cumulative voting in the election of Trustees. Shares may be voted in person or by proxy. A proxy with respect to Shares held in the name of two or more persons shall be valid if executed by any one of them unless at or prior to exercise of the proxy the Trust receives a specific written notice to the contrary from any one of them. The placing of a Shareholders name on a proxy pursuant to telephonic or electronically transmitted instructions obtained pursuant to procedures reasonably designed to verify that such instructions have been authorized by such Shareholder shall constitute execution of such proxy by or on behalf of such Shareholder. A proxy purporting to be executed by or on behalf of a Shareholder shall be deemed valid unless challenged at or prior to its exercise and the burden of proving invalidity shall rest on the challenger. Until Shares of a particular class or series are issued, the Trustees may exercise all rights of Shareholders and may take any action required by law, the Declaration of Trust or these Bylaws to be taken by Shareholders as to such class or series.
10.2 Voting Power and Meetings . Except as provided in the next sentence, regular meetings of the Shareholders for the election of Trustees and the transaction of such other business as may properly come before the meeting shall be held, so long as Common Shares are listed for trading on the New York Stock Exchange, on at least an annual basis, on such day and at such place as shall be designated by the Trustees. In the event that such a meeting is not held in any annual period if so required, whether the omission be by oversight or otherwise, a subsequent special meeting may be called by the Trustees and held in lieu of such meeting with the same effect as if held within such annual period. Special meetings of the Shareholders or any or all classes or series of Shares may also be called by the Trustees from time to time for such other purposes as may be prescribed by law, by the Declaration of Trust or by these Bylaws, or for the purpose of taking action upon any other matter deemed by a majority of the Trustees and a majority of the Continuing Trustees to be necessary or desirable. A special meeting of Shareholders may be held at any such time, day and place as is designated by the Trustees. Written notice of any meeting of Shareholders, stating the date, time, place and purpose of the meeting, shall be given or caused to be given by a majority of the Trustees and a majority of the Continuing Trustees at least seven days before such meeting to each Shareholder entitled to vote thereat by leaving such notice with the Shareholder at his or her residence or usual place of business or by mailing such notice, postage prepaid, to the Shareholders address as it appears on the records of the Trust. Such notice may be given by the Secretary or an Assistant Secretary or by any other officer or agent designated for such purpose by the Trustees. Whenever notice of a meeting is required to be given to a Shareholder under the Declaration of Trust or these Bylaws, a written waiver thereof, executed before or after the meeting by such Shareholder or his or her attorney thereunto authorized and filed with the records of the meeting, shall be deemed equivalent to such notice. Notice of a meeting need not be given to any Shareholder who attends the meeting without protesting prior thereto or at its commencement the lack of notice to such Shareholder. No ballot shall be required for any election unless required by a Shareholder present or represented at the meeting and entitled to vote in such election. Notwithstanding anything to the contrary in this Section 10.2, no matter shall be properly before any annual or special meeting of Shareholders and no business shall be transacted thereat unless in accordance with Section 10.6 of these Bylaws.
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10.3 Quorum and Required Vote . Except when a larger quorum is required by any provision of law or the Declaration of Trust or these Bylaws, thirty percent (30%) of the Shares entitled to vote on a particular matter shall constitute a quorum for the transaction of business at a Shareholders meeting, except that where any provision of law or the Declaration of Trust or these Bylaws permits or requires that holders of any class or series of Shares shall vote as an individual class or series, then thirty percent (30%) (unless a larger quorum is required as specified above) of Shares of that class or series entitled to vote shall be necessary to constitute a quorum for the transaction of business by that class or series. Any lesser number shall be sufficient for adjournments. Any adjourned session or sessions may be held, within a reasonable time after the date set for the original meeting, without the necessity of further notice. Except when a different vote is required by any provision of law or the Declaration of Trust or these Bylaws, a plurality of the quorum of Shares necessary for the transaction of business at a Shareholders meeting shall decide any questions and a plurality of Shares voted shall elect a Trustee, provided that where any provision of law or of the Declaration of Trust or these Bylaws permits or requires that the holders of any class or series of Shares shall vote as an individual class or series, then a plurality of the quorum of Shares of that class or series necessary for the transaction of business by that class or series at a Shareholders meeting shall decide that matter insofar as that class or series is concerned.
10.4 Action by Written Consent . Any action taken by Shareholders may be taken without a meeting if a majority of Shareholders entitled to vote on the matter (or such larger proportion thereof as shall be required by any express provision of law or the Declaration of Trust or these Bylaws) consent to the action in writing and such written consents are filed with the records of the meetings of Shareholders. Such consent shall be treated for all purposes as a vote taken at a meeting of Shareholders.
10.5 Record Dates . For the purpose of determining the Shareholders who are entitled to vote or act at any meeting or any adjournment thereof, or who are entitled to receive payment of any dividend or of any other distribution, the Trustees may from time to time fix a time, which shall be not more than 90 days before the date of any meeting of Shareholders or the date for the payment of any dividend or of any other distribution, as the record date for determining the Shareholders having the right to notice of and to vote at such meeting and any adjournment thereof or the right to receive such dividend or distribution, and in such case only Shareholders of record on such record date shall have the right notwithstanding any transfer of Shares on the books of the Trust after the record date; or without fixing such record date the Trustees may for any of such purposes close the register or transfer books for all or any part of such period.
10.6 Advance Notice of Shareholder Nominees for Trustees and Other Shareholder Proposals .
(a) As used in this Section 10.6, the term annual meeting refers to any annual meeting of Shareholders as well as any special meeting held in lieu of an annual meeting as described in the first two sentences of Section 10.2 of these Bylaws, and the term special meeting refers to all meetings of Shareholders other than an annual meeting or a special meeting in lieu of an annual meeting.
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(b) The matters to be considered and brought before any annual or special meeting of Shareholders shall be limited to only such matters, including the nomination and election of Trustees, as shall be brought properly before such meeting in compliance with the procedures set forth in this Section 10.6. Only persons who are nominated in accordance with the procedures set forth in this Section 10.6 shall be eligible for election as Trustees, and no proposal to fix the number of Trustees shall be brought before an annual or special meeting of Shareholders or otherwise transacted unless in accordance with the procedures set forth in this Section 10.6, except as may be otherwise provided in these Bylaws with respect to the right of holders of preferred shares of beneficial interest, if any, of the Trust to nominate and elect a specified number of Trustees in certain circumstances.
(c) For any matter to be properly before any annual meeting, the matter must be (i) specified in the notice of meeting given by or at the direction of a majority of the Trustees and a majority of the Continuing Trustees pursuant to Section 10.2 of these Bylaws, (ii) otherwise brought before the meeting by or at the direction of a majority of the Continuing Trustees (or any duly authorized committee thereof), or (iii) brought before the meeting in the manner specified in this Section 10.6(c) by a Shareholder of record entitled to vote at the meeting or by a Shareholder (a Beneficial Owner) that holds Shares entitled to vote at the meeting through a nominee or street name holder of record and that can demonstrate to the Trust such indirect ownership and such Beneficial Owners entitlement to vote such Shares, provided that the Shareholder was the Shareholder of record or the Beneficial Owner held such Shares at the time the notice provided for in this Section 10.6(c) is delivered to the Secretary.
In addition to any other requirements under applicable law and the Declaration of Trust and these Bylaws, persons nominated by Shareholders for election as Trustees and any other proposals by Shareholders may be properly brought before an annual meeting only pursuant to timely notice (the Shareholder Notice) in writing to the Secretary. To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty-five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior years annual meeting; provided , however , with respect to the first annual meeting to be held after the offering of the Trusts Common Shares, the Shareholder Notice must be so delivered or mailed and so received on or before August 1, 2005; provided further , however , if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an Other Annual Meeting Date), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10 th ) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed.
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Any Shareholder desiring to nominate any person or persons (as the case may be) for election as a Trustee or Trustees of the Trust shall deliver, as part of such Shareholder Notice: (i) a statement in writing setting forth (A) the name, age, date of birth, business address, residence address and nationality of the person or persons to be nominated; (B) the class or series and number of all Shares of the Trust owned of record or beneficially by each such person or persons, as reported to such Shareholder by such nominee(s); (C) any other information regarding each such person required by paragraphs (a), (d), (e) and (f) of Item 401 of Regulation S-K or paragraph (b) of Item 22 of Rule 14a-101 (Schedule 14A) under the Securities Exchange Act of 1934, as amended (the Exchange Act), adopted by the Securities and Exchange Commission (or the corresponding provisions of any regulation or rule subsequently adopted by the Securities and Exchange Commission or any successor agency applicable to the Trust); (D) any other information regarding the person or persons to be nominated that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitation of proxies for election of Trustees or directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder; and (E) whether such Shareholder believes any nominee is or will be an interested person of the Trust (as defined in the Investment Company Act of 1940, as amended) and, if not an interested person, information regarding each nominee that will be sufficient for the Trust to make such determination; and (ii) the written and signed consent of the person or persons to be nominated to be named as nominees and to serve as Trustees if elected. In addition, the Trustees may require any proposed nominee to furnish such other information as they may reasonably require or deem necessary to determine the eligibility of such proposed nominee to serve as a Trustee. Any Shareholder Notice required by this Section 10.6(c) in respect of a proposal to fix the number of Trustees shall also set forth a description of and the text of the proposal, which description and text shall state a fixed number of Trustees that otherwise complies with applicable law, these Bylaws and the Declaration of Trust.
Without limiting the foregoing, any Shareholder who gives a Shareholder Notice of any matter proposed to be brought before a Shareholder meeting (whether or not involving nominees for Trustees) shall deliver, as part of such Shareholder Notice: (i) the description of and text of the proposal to be presented; (ii) a brief written statement of the reasons why such Shareholder favors the proposal; (iii) such Shareholders name and address as they appear on the Trusts books; (iv) any other information relating to the Shareholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with the solicitation of proxies with respect to the matter(s) proposed pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder; (v) the class or series and number of all Shares of the Trust owned beneficially and of record by such Shareholder; (vi) any material interest of such Shareholder in the matter proposed (other than as a Shareholder); (vii) a
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representation that the Shareholder intends to appear in person or by proxy at the Shareholder meeting to act on the matter(s) proposed; (viii) if the proposal involves nominee(s) for Trustees, a description of all arrangements or understandings between the Shareholder and each proposed nominee and any other person or persons (including their names) pursuant to which the nomination(s) are to be made by the Shareholder; and (ix) in the case of a Beneficial Owner, evidence establishing such Beneficial Owners indirect ownership of, and entitlement to vote, Shares at the meeting of Shareholders. As used in this Section 10.6, Shares beneficially owned shall mean all Shares which such person is deemed to beneficially own pursuant to Rules 13d-3 and 13d-5 under the Exchange Act.
(d) For any matter to be properly before any special meeting, the matter must be specified in the notice of meeting given by or at the direction of a majority of the Trustees and a majority of the Continuing Trustees pursuant to Section 10.2 of these Bylaws. In the event the Trust calls a special meeting for the purpose of electing one or more Trustees, any Shareholder may nominate a person or persons (as the case may be) for election to such position(s) as specified in the Trusts notice of meeting if and only if the Shareholder provides a notice containing the information required in the Shareholder Notice to the Secretary required with respect to annual meetings by Section 10.6(c) hereof, and such notice is delivered to or mailed and received at the principal executive office of the Trust not later than the close of business on the tenth (10 th ) day following the day on which the date of the special meeting and of the nominees proposed by the Trustees to be elected at such meeting are publicly announced or disclosed.
(e) For purposes of this Section 10.6, a matter shall be deemed to have been publicly announced or disclosed if such matter is disclosed in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service, in a document publicly filed by the Trust with the Securities and Exchange Commission, or in a Web site accessible to the public maintained by the Trust or by its investment adviser or an affiliate of such investment adviser with respect to the Trust.
(f) In no event shall an adjournment or postponement (or a public announcement thereof) of a meeting of Shareholders commence a new time period (or extend any time period) for the giving of notice as provided in this Section 10.6.
(g) The person presiding at any meeting of Shareholders, in addition to making any other determinations that may be appropriate to the conduct of the meeting, shall have the power and duty to (i) determine whether a nomination or proposal of other matters to be brought before a meeting and notice thereof have been duly made and given in the manner provided in this Section 10.6 and elsewhere in these Bylaws and the Declaration of Trust and (ii) if not so made or given, to direct and declare at the meeting that such nomination and/or such other matters shall be disregarded and shall not be considered. Any determination by the person presiding shall be binding on all parties absent manifest error.
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(h) Notwithstanding anything to the contrary in this Section 10.6 or otherwise in these Bylaws, unless required by federal law, no matter shall be considered at or brought before any annual or special meeting unless such matter has been approved for these purposes by a majority of the Continuing Trustees and, in particular, no Beneficial Owner shall have any rights as a Shareholder except as may be required by federal law. Furthermore, nothing in this Section 10.6 shall be construed as creating any implication or presumption as to the requirements of federal law.
ARTICLE 11
Statement Creating Five Series of Auction Market Preferred Shares
A series of Auction Market Preferred Shares, Series M: 3,840 preferred shares of beneficial interest, par value $.00001 per share, liquidation preference $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) thereon, is hereby designated Auction Market Preferred Shares, Series M. Each share of Auction Market Preferred Shares, Series M (sometimes referred to herein as Series M AMPS) may be issued on a date to be determined by the Board of Trustees of the Trust or pursuant to their delegated authority; has an Initial Dividend Rate and an Initial Dividend Payment Date as shall be determined in advance of the issuance thereof by the Board of Trustees of the Trust or pursuant to their delegated authority; and has such other preferences, voting powers, limitations as to dividends, qualifications and terms and conditions of redemption as are set forth in these Bylaws. The Series M AMPS shall constitute a separate series of preferred shares of beneficial interest of the Trust, and each share of Series M AMPS shall be identical.
A series of Auction Market Preferred Shares, Series T: 3,840 preferred shares of beneficial interest, par value $.00001 per share, liquidation preference $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) thereon, is hereby designated Auction Market Preferred Shares, Series T. Each share of Auction Market Preferred Shares, Series T (sometimes referred to herein as Series T AMPS) may be issued on a date to be determined by the Board of Trustees of the Trust or pursuant to their delegated authority; has an Initial Dividend Rate and an Initial Dividend Payment Date as shall be determined in advance of the issuance thereof by the Board of Trustees of the Trust or pursuant to their delegated authority; and has such other preferences, voting powers, limitations as to dividends, qualifications and terms and conditions of redemption as are set forth in these Bylaws. The Series T AMPS shall constitute a separate series of preferred shares of beneficial interest of the Trust, and each share of Series T AMPS shall be identical.
A series of Auction Market Preferred Shares, Series W: 3,840 preferred shares of beneficial interest, par value $.00001 per share, liquidation preference $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) thereon, is hereby designated Auction Market Preferred Shares, Series W. Each share of Auction Market Preferred Shares, Series W (sometimes referred to herein as Series W AMPS) may be issued on a date to be determined by the Board of Trustees of the Trust or pursuant to their delegated authority; has an Initial Dividend Rate and an Initial Dividend Payment Date as shall be determined in advance of the issuance thereof by the Board of Trustees of the Trust or
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pursuant to their delegated authority; and has such other preferences, voting powers, limitations as to dividends, qualifications and terms and conditions of redemption as are set forth in these Bylaws. The Series W AMPS shall constitute a separate series of preferred shares of beneficial interest of the Trust, and each share of Series W AMPS shall be identical.
A series of Auction Market Preferred Shares, Series TH: 3,840 preferred shares of beneficial interest, par value $.00001 per share, liquidation preference $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) thereon, is hereby designated Auction Market Preferred Shares, Series TH. Each share of Auction Market Preferred Shares, Series TH (sometimes referred to herein as Series TH AMPS) may be issued on a date to be determined by the Board of Trustees of the Trust or pursuant to their delegated authority; has an Initial Dividend Rate and an Initial Dividend Payment Date as shall be determined in advance of the issuance thereof by the Board of Trustees of the Trust or pursuant to their delegated authority; and has such other preferences, voting powers, limitations as to dividends, qualifications and terms and conditions of redemption as are set forth in these Bylaws. The Series TH AMPS shall constitute a separate series of preferred shares of beneficial interest of the Trust, and each share of Series TH AMPS shall be identical.
A series of Auction Market Preferred Shares, Series F: 3,840 preferred shares of beneficial interest, par value $.00001 per share, liquidation preference $25,000 per share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) thereon, is hereby designated Auction Market Preferred Shares, Series F. Each share of Auction Market Preferred Shares, Series F (sometimes referred to herein as Series F AMPS) may be issued on a date to be determined by the Board of Trustees of the Trust or pursuant to their delegated authority; has an Initial Dividend Rate and an Initial Dividend Payment Date as shall be determined in advance of the issuance thereof by the Board of Trustees of the Trust or pursuant to their delegated authority; and has such other preferences, voting powers, limitations as to dividends, qualifications and terms and conditions of redemption as are set forth in these Bylaws. The Series F AMPS shall constitute a separate series of preferred shares of beneficial interest of the Trust, and each share of Series F AMPS shall be identical.
11.1 Definitions . (a) Unless the context or use clearly indicates another or different meaning or intent, in Article 11 of these Bylaws the following terms have the following meanings, whether used in the singular or plural:
Accountants Confirmation has the meaning set forth in Section 11.7(c) of these Bylaws.
Additional Trustees has the meaning set forth in Section 11.5(b) of these Bylaws.
Affiliate means any Person known to the Auction Agent to be controlled by, in control of, or under common control with, the Trust.
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Agent Member means a member of or a participant in the Securities Depository that will act on behalf of a Beneficial Owner of one or more AMPS or on behalf of a Potential Beneficial Owner.
AMPS means the Series M AMPS, Series T AMPS, the Series W AMPS, the Series TH AMPS and the Series, F AMPS.
AMPS Basic Maintenance Amount, as of any Valuation Date, means the dollar amount equal to the sum of (i)(A) the product of the number of AMPS Outstanding on such date multiplied by $25,000, plus any redemption premium applicable to AMPS then subject to redemption; (B) the aggregate amount of dividends that will have accumulated at the respective Applicable Rates (whether or not earned or declared) to (but not including) the first respective Dividend Payment Dates for each series of AMPS Outstanding that follow such Valuation Date (plus the aggregate amount of dividends, whether or not earned or declared, that will have accumulated in respect of other outstanding preferred shares to, but not including, the first respective dividend payment dates for such other shares that follow such Valuation Date); (C) the aggregate amount of dividends that would accumulate on shares of each series of AMPS Outstanding from such first respective Dividend Payment Date therefor through the 49th day after such Valuation Date, at the Maximum Applicable Rate (calculated as if such Valuation Date were the Auction Date for the Dividend Period commencing on such Dividend Payment Date) for a 7-Day Dividend Period of shares of such series to commence on such Dividend Payment Date, multiplied by the Volatility Factor (except that (1) if such Valuation Date occurs during a Non-Payment Period, the dividend for purposes of calculation would accumulate at the then current Non-Payment Period Rate and (2) for those days during the period described in this clause (C) in respect of which the Applicable Rate in effect immediately prior to such Dividend Payment Date will remain in effect, the dividend for purposes of calculation would accumulate at such Applicable Rate in respect of those days); (D) the amount of anticipated expenses of the Trust for the 90 days subsequent to such Valuation Date; and (E) any current liabilities as of such Valuation Date to the extent not reflected in any of (i)(A) through (i)(D) (including, without limitation, any payables for portfolio securities of the Trust purchased as of such Valuation Date and any liabilities incurred for the purpose of clearing securities transactions) less (ii) the value ( i.e. , the face value of cash, short-term securities rated MIG-1, VMIG-1 or P-1, and short-term securities that are the direct obligation of the U.S. government, provided in each case that such securities mature on or prior to the date upon which any of (i)(A) through (i)(E) become payable, otherwise the Discounted Value) of any of the Trusts assets irrevocably deposited by the Trust for the payment of any of (i)(A) through (i)(E).
Applicable Percentage has the meaning set forth in Section 11.10(a)(vii) of these Bylaws.
Applicable Rate means the rate per annum at which cash dividends are payable on the AMPS for any Dividend Period.
Applicable Spread has the meaning set forth in Section 11.10(a)(vii) of these Bylaws.
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Approved Price means the fair value as determined by the Trust in accordance with the valuation procedures adopted from time to time by the Board of Trustees of the Trust and for which the Trust receives a mark-to-market price (which, for the purpose of clarity, shall not mean Market Value) from an independent source at least semi-annually.
Auction means a periodic operation of the Auction Procedures.
Auction Agent means Deutsche Bank Trust Company Americas unless and until another commercial bank, trust company or other financial institution appointed by a resolution of the Board of Trustees of the Trust or a duly authorized committee thereof enters into an agreement with the Trust to follow the Auction Procedures for the purpose of determining the Applicable Rate and to act as transfer agent, registrar, dividend paying agent and redemption agent for the AMPS.
Auction Date has the meaning set forth in Section 11.10(a)(ii) of these Bylaws.
Auction Market Preferred Shares means shares of AMPS.
Auction Procedures means the procedures for conducting Auctions, as set forth in Section 11.10 of these Bylaws.
Bank Loans means direct purchases of, assignments of, participations in and other interests in (a) any bank loan or (b) any loan made by an investment bank, investment fund or other financial institution, provided that such loan under this clause (b) is similar to those typically made, syndicated, purchased or participated by a commercial bank or institutional loan investor in the ordinary course of business.
Beneficial Owner means a customer of a Broker-Dealer who is listed on the records of that Broker-Dealer (or, if applicable, the Auction Agent) as a holder of AMPS or a Broker-Dealer that holds AMPS for its own account.
Broker-Dealer means any broker-dealer, or other entity permitted by law to perform the functions required of a Broker-Dealer pursuant to Section 11.10 of these Bylaws, that has been selected by the Trust and has entered into a Broker-Dealer Agreement with the Auction Agent that remains effective.
Broker-Dealer Agreement means an agreement between the Auction Agent and a Broker-Dealer pursuant to which such Broker-Dealer agrees to follow the procedures specified in Section 11.10 of these Bylaws.
Business Day means a day on which the New York Stock Exchange is open for trading and which is not a Saturday, Sunday or other day on which banks in New York City are authorized or obligated by law to close.
Catastrophe Bonds means securities that entitle the holders thereof to receive a fixed principal or similar amount and a specified return on such amount, generally having the
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following characteristics: (1) the issuer of such asset-backed security has entered into a swap, insurance contract or similar arrangement with a counterparty pursuant to which such issuer agrees to pay amounts to the counterparty upon the occurrence of certain specified events, including: hurricanes, earthquakes and other events, and (2) payments on such security depend primarily upon the occurrence and/or severity of such events.
Closing Transactions has the meaning set forth in Section 11.8(a)(i) of these Bylaws.
Common Shares means the shares of beneficial interest designated as common shares, par value $0.00001 per share, of the Trust.
Cure Date has the meaning set forth in Section 11.4(a)(ii) of these Bylaws.
Date of Original Issue means, with respect to any Auction Market Preferred Share, the date on which the Trust first issues such share.
Declaration of Trust means the Amended and Restated Agreement and Declaration of Trust of the Trust dated October 5, 2004, as from time to time amended and supplemented.
Deposit Securities means cash and portfolio securities rated at least A2 (having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by Moodys or A (having a remaining maturity of 12 months or less), A-1+ or SP-1+ by S&P.
Discount Factor means a Moodys Discount Factor (if Moodys is then rating the AMPS) or a discount factor included in the calculations used by another Rating Agency then rating the AMPS for purposes of determining such Rating Agencys rating on the AMPS, as applicable, provided that this term shall not apply with respect to Fitch Ratings or its rating on the AMPS.
Discounted Value of any asset of the Trust means the quotient of the Market Value of an Eligible Asset divided by the applicable Discount Factor, provided that with respect to an Eligible Asset that is currently callable, the Discounted Value will be equal to the quotient as calculated above or the call price, whichever is lower, and that with respect to an Eligible Asset that is prepayable, the Discounted Value will be equal to the quotient as calculated above or the par value, whichever is lower.
Dividend Payment Date, with respect to AMPS, has the meaning set forth in Section 11.2(b)(i) of these Bylaws.
Dividend Period means the Initial Dividend Period, any Seven-Day Dividend Period and any Special Dividend Period.
Eligible Asset means a Moodys Eligible Asset (if Moodys is then rating the AMPS) and/or any asset included in the calculations used by another Rating Agency then rating the AMPS for purposes of determining such Rating Agencys rating on the AMPS, as applicable, provided that this term shall not apply with respect to Fitch Ratings or its rating on the AMPS.
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Existing Holder means a Broker-Dealer, or any such other Person that may be permitted by the Trust, that is listed as the holder of record of AMPS in the Share Books.
Extension Period has the meaning set forth in Section 11.2(c)(iii) of these Bylaws.
FHLB, FNMA and FFCB Debentures has the meaning set forth in paragraph (ix) of the definition of Moodys Eligible Assets.
Fitch AMPS Asset Coverage means, as of a particular date or time, sufficient asset coverage with respect to the AMPS such that the Trust is satisfying both the (i) Fitch Total OC Test and the (ii) Fitch Net OC Test as of such date or time.
Fitch AMPS Asset Coverage Report means, with respect to Fitch AMPS Asset Coverage, a report including the information to be provided to Fitch Ratings as called for in the second bullet under Investment Manager Review Surveillance in the Fitch Criteria.
Fitch Covered Forward Commitment has the meaning set forth in Section 11.8(f) of these Bylaws.
Fitch Criteria means the Closed-End Fund Criteria Report issued by Fitch Ratings entitled Closed-End Fund Debt and Preferred Stock Rating Criteria dated August 17, 2009 and attached to these Bylaws as Exhibit 1, which is hereby incorporated by reference into and made a part of these Bylaws. The Trust may, but is not required to, amend or restate the Fitch Criteria from time to time, through an amendment or restatement of Exhibit 1 or otherwise, to reflect revised criteria issued by Fitch Ratings by resolution of the Board of Trustees of the Trust and without shareholder approval.
Fitch Net OC has the meaning given to such term in the Fitch Criteria to be consistent with a AAA rating of the AMPS by Fitch Ratings, and shall be calculated with respect to the Trust in accordance with the applicable formula and related guidance provided in the Fitch Criteria and by Fitch Ratings (including with respect to discount factors, if any, or other treatment to be applied with respect to securities or other assets held by the Trust which are not specifically referenced in the Fitch Criteria), and the good faith determinations of the Trust or its agents of the Fitch Net OC and related interpretations of the Fitch Criteria shall be conclusive and binding on all parties.
Fitch Net OC Test means an asset coverage test with respect to the AMPS that shall be satisfied as of a particular date or time if the Trust has Fitch Net OC in excess of one-hundred percent (100%) as of such date or time.
Fitch Ratings means Fitch, Inc., doing business as Fitch Ratings, or its successors.
Fitch Total OC has the meaning given to such term in the Fitch Criteria to be consistent with a AAA rating of the AMPS by Fitch Ratings, and shall be calculated with respect to the Trust in accordance with the applicable formula and related guidance provided in the Fitch Criteria and by Fitch Ratings (including with respect to discount factors, if any, or other
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treatment to be applied with respect to securities or other assets held by the Trust which are not specifically referenced in the Fitch Criteria), and the good faith determinations of the Trust or its agents of Fitch Total OC and related interpretations of the Fitch Criteria at any time and from time to time shall be conclusive and binding on all parties.
Fitch Total OC Test means an asset coverage test with respect to the AMPS that shall be satisfied as of a particular date or time if the Trust has Fitch Total OC in excess of one-hundred percent (100%) as of such date or time.
Holder means a Person identified as a holder of record of AMPS in the Share Register.
Independent Accountant means a nationally recognized accountant, or firm of accountants, that is, with respect to the Trust, an independent registered public accountant or firm of independent registered public accountants under the Securities Act and serving as such for the Trust.
Initial Dividend Payment Date means, with respect to a series of AMPS, the initial dividend payment date with respect to the Initial Dividend Period as determined by the Board of Trustees of the Trust or pursuant to their delegated authority with respect to such series.
Initial Dividend Period has the meaning set forth in Section 11.2(c)(i) of these Bylaws.
Initial Dividend Rate means, with respect to a series of AMPS, the rate per annum applicable to the Initial Dividend Period for such series of AMPS.
LIBOR Dealers means Merrill Lynch, Pierce, Fenner and Smith Incorporated and such other dealer or dealers as the Trust may from time to time appoint, or, in lieu of any thereof, their respective affiliates or successors.
LIBOR Rate, on any Auction Date, means (i) the rate for deposits in U.S. dollars for the designated Dividend Period, which appears on display page 3750 of Moneylines Telerate Service (Telerate Page 3750) (or such other page as may replace that page on that service, or such other service as may be selected by the LIBOR Dealer or its successors that are LIBOR Dealers) as of 11:00 a.m., London time, on the day that is the London Business Day preceding the Auction Date (the LIBOR Determination Date), or (ii) if such rate does not appear on Telerate Page 3750 or such other page as may replace such Telerate Page 3750, (A) the LIBOR Dealer will determine the arithmetic mean of the offered quotations of the Reference Banks to leading banks in the London interbank market for deposits in U.S. dollars for the designated Dividend Period in an amount determined by such LIBOR Dealer by reference to requests for quotations as of approximately 11:00 a.m. (London time) on such date made by such LIBOR Dealer to the Reference Banks, (B) if at least two of the Reference Banks provide such quotations, LIBOR Rate will equal such arithmetic mean of such quotations, (C) if only one or none of the Reference Banks provide such quotations, LIBOR Rate will be deemed to be the arithmetic mean of the offered quotations that leading banks in The City of New York selected by the LIBOR Dealer (after obtaining the Trusts approval) are quoting on the relevant LIBOR Determination Date for deposits in U.S. dollars for the designated Dividend Period in an amount
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determined by the LIBOR Dealer (after obtaining the Trusts approval) that is representative of a single transaction in such market at such time by reference to the principal London offices of leading banks in the London interbank market; provided, however, that if one of the LIBOR Dealers does not quote a rate required to determine the LIBOR Rate, the LIBOR Rate will be determined on the basis of the quotation or quotations furnished by any Substitute LIBOR Dealer or Substitute LIBOR Dealers selected by the Trust to provide such rate or rates not being supplied by the LIBOR Dealer; provided further, that if the LIBOR Dealer and Substitute LIBOR Dealers are required but unable to determine a rate in accordance with at least one of the procedures provided above, LIBOR Rate will be LIBOR Rate as determined on the previous Auction Date. If the number of Dividend Period days will be (i) 7 or more but fewer than 21 days, such rate will be the seven-day LIBOR rate; (ii) 21 or more but fewer than 49 days, such rate will be the one-month LIBOR rate; (iii) 49 or more but fewer than 77 days, such rate will be the two-month LIBOR rate; (iv) 77 or more but fewer than 112 days, such rate will be the three-month LIBOR rate; (v) 112 or more but fewer than 140 days, such rate will be the four-month LIBOR rate; (vi) 140 or more but fewer than 168 days, such rate will be the five-month LIBOR rate; (vii) 168 or more but fewer than 189 days, such rate will be the six-month LIBOR rate; (viii) 189 or more but fewer than 217 days, such rate will be the seven-month LIBOR rate; (ix) 217or more but fewer than 252 days, such rate will be the eight-month LIBOR rate; (x) 252 or more but fewer than 287 days, such rate will be the nine-month LIBOR rate; (xi)287 or more but fewer than 315 days, such rate will be the ten-month LIBOR rate; (xii) 315 or more but fewer than 343 days, such rate will be the eleven-month LIBOR rate; and (xiii) 343 or more but fewer than 365 days, such rate will be the twelve-month LIBOR rate.
Lien means any material lien, mortgage, pledge, security interest or security agreement of any kind.
London Business Day means any day on which commercial banks are generally open for business in London.
Long Term Dividend Period means a Special Dividend Period consisting of a specified period of one whole year or more but not greater than five years (sometimes referred to as a Long Term Special Rate Period).
Mandatory Redemption Price means $25,000 per Auction Market Preferred Share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) to (but not including) the date fixed for redemption.
Market Value of any asset of the Trust shall be the market value thereof determined by a Pricing Service. The Market Value of any asset shall include any interest accrued thereon. A Pricing Service shall value portfolio securities at the quoted bid prices or the mean between the quoted bid and asked prices or the yield equivalent when quotations are not readily available. Securities for which quotations are not readily available shall be valued at fair value as determined by a Pricing Service using methods which include consideration of: yields or prices of securities of comparable quality, type of issue, coupon, maturity and rating; indications as to value from dealers; and general market conditions. A Pricing Service may employ electronic
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data processing techniques and/or a matrix system to determine valuations. In the event a Pricing Service is unable to value a security, the security shall be valued at the lower of two bid quotations obtained by the Trust from dealers who are members of the Financial Industry Regulatory Authority, Inc. and who make a market in the security, at least one of which shall be in writing. If two bid quotations are not readily available for any securities, such securities shall be valued in good faith at fair value pursuant to procedures approved by the Board of Trustees of the Trust. Futures contracts and options are valued at the closing prices for such instruments established by the exchange or board of trade on which they are traded, or if market quotations are not readily available, are valued at fair value in good faith pursuant to procedures approved by the Board of Trustees of the Trust. All other assets will be valued at fair value on a consistent basis using methods determined in good faith by the Board of Trustees of the Trust.
Maximum Applicable Rate, with respect to AMPS, has the meaning set forth in Section 11.10(a)(vii) of these Bylaws.
Moodys means Moodys Investors Service, Inc. or its successors.
Moodys AMPS Asset Coverage means, as of a particular date or time, sufficient asset coverage with respect to the AMPS such that the Trust has Moodys Eligible Assets having an aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance Amount as of such date or time.
Moodys AMPS Asset Coverage Report means, with respect to Moodys AMPS Asset Coverage, a report signed by any of the President, Treasurer, any Senior Vice President or any Vice President of the Trust which sets forth, as of the related Valuation Date, the assets of the Trust, the Market Value and the Discounted Value thereof (seriatim and in aggregate), and the AMPS Basic Maintenance Amount.
Moodys Discount Factor means, for purposes of determining the Discounted Value of any Moodys Eligible Asset, the percentage determined as follows. The Moodys Discount Factor for any Moodys Eligible Asset other than the securities set forth below will be the percentage provided in writing by Moodys.
(i) Convertible securities (including convertible preferred stock): (1) For convertible securities having a Delta between 0.4 and 0.0, the Moodys Discount Factor shall be 100% of the Moodys Discount Factor applied to non-convertible corporate debt securities (i.e. using the Moodys Discount Factors found in the subsection (ii) of this definition), (2) for convertible securities having a Delta between 0.8 and 0.4, the Moodys Discount Factor shall be 192% for securities rated Baa or above and 226% for securities rated Ba and below, and (3) for convertible securities having a Delta between 1.0 and 0.8, the Moodys Discount Factor shall be 195% for securities rated Baa or above and 229% for securities rated Ba and below; provided, however, that for any unrated convertible security, the Moodys Discount Factor shall be 250%. 1,2
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1 |
Unless conclusions regarding liquidity risk as well as estimates of both the probability and severity of default for applicable Trust assets can be derived from other sources as well as combined with a number of sources as presented by the Trust to Moodys, unrated fixed-income and convertible securities, which are securities that are not rated by any of Moodys, S&P or Fitch Ratings, are limited to 10% of Moodys Eligible Assets for purposes of calculations related to the AMPS Basic Maintenance Amount. If a convertible security is not rated by any of Moodys, S&P or Fitch Ratings, the Trust will consider the security unrated for the purposes of the discounts discussed above. Ratings assigned by S&P and/or Fitch Ratings are generally accepted at face value. However, adjustments to face value may be made to particular categories of credits for which the ratings by S&P and/or Fitch Ratings do not seem to approximate a Moodys rating equivalent. Split-rated securities assigned by S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating categories to the security) will be accepted at the lower of the two ratings. |
2 |
Discount factors are for 7-week exposure period. |
For the purposes of determining such discount factors, Delta, which is intended to express the change in the price of the convertible security per unit of change in the price of the common stock into which the convertible security is convertible, shall be the number provided by Merrill Lynch, Pierce, Fenner and Smith, Incorporated or such other provider as the Trust shall determine from time to time. The Trust shall use commercially reasonable efforts to update such Delta figures monthly.
Upon conversion to common stock, the Discount Factors applicable to common stock will apply:
Common Stocks(1) |
Large-Cap |
Mid-Cap |
Small Cap |
|||||
7 week exposure period | 200% | 205% | 220% |
(1) | 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. |
(ii) Corporate debt securities (non-convertible): 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.
Moodys Rating Category | |||||||||||||||||||||
Term to Maturity of Corporate Debt Security |
Aaa | Aa | A | Baa | Ba | B |
Below B and
Unrated 1 |
||||||||||||||
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 |
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1 |
Unless conclusions regarding liquidity risk as well as estimates of both the probability and severity of default for applicable Trust assets can be derived from other sources as well as combined with a number of sources as presented by the Trust to Moodys, securities rated below B by Moodys and, unrated fixed-income and convertible securities (which are securities that are not rated by any of Moodys, S&P or Fitch Ratings) are limited to 10% of Moodys Eligible Assets for purposes of calculations related to the AMPS Basic Maintenance Amount. If a corporate debt security is not rated by any of Moodys, S&P or Fitch Ratings, the Trust will use the applicable percentage set forth under the column entitled Below B and Unrated in the table above. Ratings assigned by S&P and/or Fitch Ratings are generally accepted by Moodys at face value. However, adjustments to face value may be made to particular categories of credits for which the ratings by S&P and/or Fitch Ratings do not seem to approximate a Moodys rating equivalent. Split-rated securities assigned by S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating categories to the security) will be accepted at the lower of the two ratings. |
The Moodys Discount Factors presented in the immediately preceding table will also apply to Moodys Eligible Assets that are FHLB, FNMA and FFCB Debentures and to rated TRACERs and TRAINs, whereby the ratings in the table will be applied to the underlying securities and the Market Value of each underlying security will be its proportionate amount of the Market Value of the TRACER or TRAIN, provided that (i) the Moodys Discount Factor for any TRAIN or TRACER rated by Moodys will be the percentage determined, based on the Moodys rating of the TRAIN or TRACER, in accordance with the table set forth above and (ii) the Moodys Discount Factors determined from the table shall be multiplied by a factor of 120% for purposes of calculating the Discounted Value of TRAINs. The Moodys Discount Factors presented in the immediately preceding table will also apply to corporate debt securities that do not pay interest in U.S. dollars or euros. The Trust will consult with Moodys to determine incremental discount factors for non-U.S. dollar and non-euro denominated bonds.
(iii) Preferred stock (other than convertible preferred stock, which is subject to paragraph (i) above): The Moodys Discount Factor for preferred stock shall be (A) for preferred stocks issued by a utility, 155%; (B) for preferred stocks of industrial and financial issuers, 209%; and (C) for auction rate preferred stocks, 350%.
(iv) Short-term instruments: The Moodys Discount Factor applied to short-term portfolio securities, including without limitation short-term corporate debt securities, Short Term Money Market Instruments and short-term municipal debt obligations, will be (A) 100%, so long as such portfolio securities mature or have a demand feature at par exercisable within the Moodys Exposure Period; (B) 115%, so long as such portfolio securities do not mature within the Moodys Exposure Period, or have a demand feature at par not exercisable within the Moodys Exposure Period; and (C) 125%, if such securities are not rated by Moodys, so long as such portfolio securities are rated at least A-1+/AA or SP-1+/AA by S&P or Fitch Ratings and mature or have a demand feature at par exercisable within the Moodys Exposure Period. A Moodys Discount Factor of 100% will be applied to cash.
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(v) U.S. Government Securities and U.S. Treasury Strips: The percentage determined by reference to the remaining term to maturity of such asset, in accordance with the table set forth below.
Remaining Term to Maturity |
U.S.
Government Securities Discount Factor |
U.S.
Treasury Strips Discount Factor |
||||
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 |
(vi) Rule 144A Securities: The Moodys Discount Factor applied to Rule 144A Securities whose terms include rights to registration under the Securities Act exercisable within 1 year of the applicable date shall be 100% of the Moodys Discount Factor that would apply were the securities registered under the Securities Act. The Moodys Discount Factor applied to Rule 144A Securities whose terms include rights to registration under the Securities Act that are not exercisable within 1 year of the applicable date shall be 120% of the Moodys Discount Factor that would apply were the securities registered under the Securities Act. The Moodys Discount Factor applied to Rule 144A Securities whose terms do not include rights to registration under the Securities Act shall be 130% of the Moodys Discount Factor that would apply were the securities registered under the Securities Act.
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(vii) Bank Loans: The Moodys Discount Factor applied to senior Bank Loans (Senior Loans) shall be the percentage specified in accordance with the table set forth below (or such lower percentages as Moodys may approve in writing from time to time):
Moodys Rating Category | ||||||||||||
Type of Loan |
Aaa-A | Baa and Ba 1 | B 1 |
Caa and below (including
distressed and unrated) 1 |
||||||||
Senior Loans > $250 MM |
118 | % | 136 | % | 149 | % | 250 | % | ||||
Non-Senior Loans > $250 MM |
128 | % | 146 | % | 159 | % | 260 | % | ||||
Loans < $250 MM |
138 | % | 156 | % | 169 | % | 270 | % | ||||
Second Lien Bank Loans |
168 | % | 185 | % | 200 | % | 270 | % |
1 |
If a Bank Loan is not rated by any of Moodys, S&P or Fitch Ratings, the Trust will use the applicable percentage set forth under the column entitled Caa and below (including distressed and unrated) in the table above. Ratings assigned by S&P and/or Fitch Ratings are generally accepted by Moodys at face value. However, adjustments to face value may be made to particular categories of securities for which the ratings by S&P and/or Fitch Ratings do not seem to approximate a Moodys rating equivalent. Split-rated securities assigned by S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating categories to the security) will be accepted at the lower of the two ratings; provided however, that, in a situation where a security is rated B (or equivalent) by a given Rating Agency and rated Caa (or equivalent) by another Rating Agency, the Trust will use the applicable percentage set forth under the column entitled B in the table above. |
(viii) Asset-backed and mortgage-backed securities: The Moodys Discount Factor applied to asset-backed securities shall be 131%. The Moodys Discount Factor applied to collateralized mortgage obligations, planned amortization class bonds and targeted amortization class bonds shall be determined by reference to the weighted average life of the security and whether cash flow is retained ( i.e. , controlled by a trustee) or excluded ( i.e. , not controlled by a trustee), in accordance with the table set forth below.
Remaining Term to Maturity |
Cash Flow Retained | Cash Flow Excluded | ||||
3 years or less |
133 | % | 141 | % | ||
7 years or less (but longer than 3 years) |
142 | 151 | ||||
10 years or less (but longer than 7 years) |
158 | 168 | ||||
20 years or less (but longer than 10 years) |
174 | 185 |
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The Moodys Discount Factor applied to residential mortgage pass-throughs (including private-placement mortgage pass-throughs) shall be determined by reference to the coupon paid by such security and whether cash flow is retained ( i.e. , controlled by a trustee) or excluded ( i.e ., not controlled by a trustee), in accordance with the table set forth below.
Coupon |
Cash Flow Retained | Cash Flow Excluded | ||||
5% |
166 | % | 173 | % | ||
6 |
162 | 169 | ||||
7 |
158 | 165 | ||||
8 |
154 | 161 | ||||
9 |
151 | 157 | ||||
10 |
148 | 154 | ||||
11 |
144 | 154 | ||||
12 |
142 | 151 | ||||
13 |
139 | 148 | ||||
adjustable |
165 | 172 |
The Moodys Discount Factor applied to fixed-rate pass-throughs that are not rated by Moodys and are serviced by a servicer approved by Moodys shall be determined by reference to the table in the following paragraph (relating to whole loans).
The Moodys Discount Factor applied to whole loans shall be determined by reference to the coupon paid by such security and whether cash flow is retained ( i.e. , controlled by a trustee) or excluded ( i.e. , not controlled by a trustee), in accordance with the table set forth below.
Coupon |
Cash Flow Retained | Cash Flow Excluded | ||||
5% |
172 | % | 179 | % | ||
6 |
167 | 174 | ||||
7 |
163 | 170 | ||||
8 |
159 | 165 | ||||
9 |
155 | 161 | ||||
10 |
151 | 158 | ||||
11 |
148 | 157 | ||||
12 |
145 | 154 | ||||
13 |
142 | 151 | ||||
adjustable |
170 | 177 |
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(ix) Municipal debt obligations: The Moodys Discount Factor applied to municipal debt obligations shall be the percentage determined by reference to the rating on such asset and the shortest Exposure Period set forth opposite such rating that is the same length as or is longer than the Moodys Exposure Period, in accordance with the table set forth below (provided that, except as provided in the following table, any municipal obligation:
Exposure Period |
Aaa | Aa | A | Baa | Other | (V)MIG-1 1 | SP-1+ 2 | Unrated 3 | ||||||||||||||||
7 weeks |
151 | % | 159 | % | 166 | % | 173 | % | 187 | % | 136 | % | 148 | % | 225 | % | ||||||||
8 weeks or less but greater than seven weeks |
154 | 161 | 168 | 176 | 190 | 137 | 149 | 231 | ||||||||||||||||
9 weeks or less but greater than eight weeks |
158 | 163 | 170 | 177 | 192 | 138 | 150 | 240 |
1 |
Municipal debt obligations not rated by Moodys but rated equivalent to MIG-1, (V)MIG-1, or P-1, by S&P and Fitch Ratings that have a maturity less than or equal to 49 days. |
2 |
Municipal debt obligations not rated by Moodys but rated equivalent to MIG-1, (V)MIG-1, or P-1 by S&P and Fitch Ratings that have a maturity greater than 49 days. |
3 |
Unless conclusions regarding liquidity risk as well as estimates of both the probability and severity of default for the corporations or municipal issuers assets can be derived from other sources as well as combined with a number of sources as presented by the Trust to Moodys securities rated below B by Moodys and unrated securities, which are securities rated by neither Moodys, S&P nor Fitch Ratings, are limited to 10% of Moodys Eligible Assets. If a municipal debt security is unrated by Moodys, S&P or Fitch Ratings, the Trust will use the percentage set forth under Other in the Municipal Debt Table. Ratings assigned by S&P or Fitch Ratings are generally accepted by Moodys at face value (e.g., treating a rating of AAA by S&P or Fitch Ratings as Aaa for purposes of the table above and a rating of AA by S&P or Fitch Ratings as Aa for purposes of the table above. However, adjustments to face value may be made to particular categories of credits for which the ratings by S&P and/or Fitch Rating do not seem to approximate a Moodys rating equivalent. Split-rated securities assigned by S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating categories to the security) will be accepted at the lower of the two ratings. |
(x) Structured Notes: The Moodys Discount Factor applied to Structured Notes will be (A) in the case of a corporate issuer, the Moodys Discount Factor determined in accordance with paragraph (ii) under this definition, whereby the rating on the issuer of the Structured Note will be the rating on the Structured Note for purposes of determining the Moodys Discount Factor in the table in paragraph (ii); and (B) in the case of an issuer that is the U.S. government or an agency or instrumentality thereof, the Moodys Discount Factor determined in accordance with paragraph (v) under this definition.
The Moodys Discount Factor for any Moodys Eligible Asset other than the securities set forth above will be the percentage provided in writing by Moodys. Additionally, in order to merit consideration as a Moodys Eligible Asset, securities should be issued by entities which: (a) have not filed for bankruptcy within the past three years, (b) are current on all principal and interest in their fixed income obligations, (c) are current on all preferred stock dividends, and (d) possess a current, unqualified auditors report without qualified, explanatory language.
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Moodys Eligible Assets means
(i) cash (including interest and dividends due on assets rated (A) Baa3 or higher by Moodys 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 the Moodys Exposure Period) and receivables for Moodys 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 (A) settled through clearing house firms or (B) (1) with counterparties having a Moodys long-term debt rating of at least Baa3 or (2) with counterparties having a Moodys Short Term Money Market Instrument rating of at least P-1;
(ii) 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 or Fitch Ratings and not rated by Moodys) need not meet any otherwise applicable rating criteria of S&P or Fitch Ratings;
(iii) | U.S. Government Securities and U.S. Treasury Strips; |
(iv) | Rule 144A Securities; |
(v) | Senior Loans and other Bank Loans*; |
* | Bank Loans that are not Senior Loans will be designated in any Preferred Shares Basic Maintenance Report delivered to Moodys. |
(vi) Corporate debt securities if (A) such securities are rated Caa or higher by Moodys; (B) 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 Moodys Eligible Assets if they are rated by Moodys, S&P or Fitch Ratings; (C) for securities which provide for conversion or exchange into equity capital at some time over their lives, the issuer must be rated at least B3 by Moodys and the discount factor will be 250%; (D) for debt securities rated Ba1 and below, no more than 10% of the original amount of such issue may constitute Moodys Eligible Assets; (E) such securities have been registered under the Securities Act or are restricted as to resale under federal securities laws but are eligible for resale pursuant to Rule 144A under the Securities Act as determined by the Trusts investment manager or portfolio manager acting pursuant to procedures approved by the Board of Trustees, except that such securities that are not subject to U.S. federal securities laws shall be considered Moodys Eligible Assets if they are publicly traded; and (F) such securities are not subject to extended settlement.
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Notwithstanding the foregoing limitations, (x) corporate debt securities not rated at least Caa by Moodys or not rated by Moodys shall be considered to be Moodys Eligible Assets only to the extent the Market Value of such corporate debt securities does not exceed 10% of the aggregate Market Value of all Moodys Eligible Assets; provided, however, that if the Market Value of such corporate debt securities exceeds 10% of the aggregate Market Value of all Moodys Eligible Assets, a portion of such corporate debt securities (selected by the Trust) shall not be considered Moodys Eligible Assets, so that the Market Value of such corporate debt securities (excluding such portion) does not exceed 10% of the aggregate Market Value of all Moodys Eligible Assets; and (y) corporate debt securities rated by none of Moodys, S&P, or Fitch Ratings shall be considered to be Moodys Eligible Assets only to the extent such securities are issued by entities which (i) have not filed for bankruptcy within the past three years, (ii) are current on all principal and interest in their fixed income obligations, (iii) are current on all preferred stock dividends and (iv) possess a current, unqualified auditors report without qualified, explanatory language.
(vii) Convertible securities (including convertible preferred stock), provided that (A) the issuer of common stock must have a Moodys 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 company shall not hold shares exceeding the average weekly trading volume during the preceding month and (F) synthetic convertibles are excluded from asset eligibility.
Convertible Bonds Diversification Guidelines
Type |
Maximum Single
Issuer (%) 1 |
Maximum Single
Industry (%) |
Maximum Single
State (%) 1 |
||||
Utility |
4 | 50 | 7 | 2 | |||
Other |
6 | 20 | n/a |
1 |
Percentage represent a portion of the aggregate market value and number of outstanding shares of the convertible stock portfolio. |
2 |
Utility companies operating in more than one state should be diversified according to the state in which they generate the largest part of their revenues. Publicly available information on utility company revenues by state is available from the Uniform Statistical Report (USR) or the Federal Energy Regulation Commission (FERC). |
(viii) Preferred stocks if (A) dividends on such preferred stock are cumulative, (B) 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
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of such securities, (C) the issuer of such a preferred stock has common stock listed on either the New York Stock Exchange, the American Stock Exchange or the NASDAQ, (D) the issuer of such a preferred stock has a senior debt rating from Moodys of Baa1 or higher or a preferred stock rating from Moodys of Baa3 or higher and (E) 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); provided, however, that convertible preferred stock shall be treated as convertible securities in accordance with paragraph (vii) above. 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 Trust of each issue of preferred stock is $500,000 and the maximum holding of preferred stock of each issue is $5 million. In addition, preferred stocks issued by transportation companies will not be considered Moodys Eligible Assets;
(ix) Asset-backed and mortgage-backed securities:
(A) Asset-backed securities if (1) such securities are rated at least Aa3 by Moodys or at least AA by S&P or Fitch Ratings, (2) the securities are part of an issue that is $250 million or greater, or the issuer of such securities has a total of $500 million or greater of asset-backed securities outstanding at the time of purchase of the securities by the Trust and (3) the expected average life of the securities is not greater than 4 years;
(B) Collateralized mortgage obligations (CMOs), including CMOs with interest rates that float at a multiple of the change in the underlying index according to a pre-set formula, provided that any CMO held by the Trust (1) has been rated Aaa by Moodys or AAA by S&P or Fitch Ratings, (2) does not have a coupon which floats inversely, (3) is not portioned as an interest-only or principal-only strip and (4) is part of an issuance that had an original issue size of at least $100 million;
(C) Planned amortization class bonds (PACs) and targeted amortization class bonds (TACs) provided that such PACs or TACs are (1) backed by certificates of either the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) or the Federal Home Loan Mortgage Corporation (FHLMC) representing ownership in single-family first lien mortgage loans with original terms of 30 years, (2) part of an issuance that had an original issue size of at least $10 million, (3) part of PAC or TAC classes that have payment priority over other PAC or TAC classes, (4) if TACs, TACs that do not support PAC classes, and (5) if TACs, not considered reverse TACs ( i.e. , do not protect against extension risk);
(D) Consolidated senior debt obligations of Federal Home Loan Banks (FHLBs), senior long-term debt of the FNMA, and consolidated systemwide bonds
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and FCS Financial Assistance Corporation Bonds of Federal Farm Credit Banks (FFCBs) (collectively, FHLB, FNMA and FFCB Debentures), provided that such FHLB, FNMA and FFCB Debentures are (1) direct issuance corporate debt rated Aaa by Moodys, (2) senior debt obligations backed by the FHLBs, FFCBs or FNMA, (3) part of an issue entirely denominated in U.S. dollars and (4) not callable or exchangeable debt issues;
(E) Mortgage pass-throughs rated at least Aa by Moodys and pass-throughs issued prior to 1987 (if rated AA by S&P or Fitch Ratings and based on fixed-rate mortgage loans) by Travelers Mortgage Services, Citicorp Homeowners, Citibank, N.A., Sears Mortgage Security or RFC Salomon Brothers Mortgage Securities, Inc., provided that (1) certificates must evidence a proportional, undivided interest in specified pools of fixed or adjustable rate mortgage loans, secured by a valid first lien, on one- to four-family residential properties and (2) the securities are publicly registered (not issued by FNMA, GNMA or FHLMC);
(F) Private-placement mortgage pass-throughs provided that (1) certificates represent a proportional undivided interest in specified pools of fixed-rate mortgage loans, secured by a valid first lien, on one- to four-family residential properties, (2) documentation is held by a trustee or independent custodian, (3) pools of mortgage loans are serviced by servicers that have been approved by FNMA or FHLMC and funds shall be advanced to meet deficiencies to the extent provided in the pooling and servicing agreements creating such certificates, and (4) pools have been rated Aa or better by Moodys; and
(G) Whole loans ( e.g. , direct investments in mortgages) provided that (1) at least 65% of such loans (a) have seasoning of no less than 6 months, (b) are secured by single-family detached residences, (c) are owner-occupied primary residences, (d) are secured by a first-lien, fully-documented mortgage, (e) are neither currently delinquent (30 days or more) nor delinquent during the preceding year, (f) have loan-to-value ratios of 80% or below, (g) carry normal hazard insurance and title insurance, as well as special hazard insurance, if applicable, (h) have original terms to maturity not greater than 30 years, with at least one year remaining to maturity, (i) have a minimum of $10,000 remaining principal balance, (j) for loans underwritten after January 1, 1978, FNMA and/or FHLMC forms are used for fixed-rate loans, and (k) are whole loans and not participations; (2) for loans that do not satisfy the requirements set forth in the foregoing clause (1), (a) non-owner occupied properties represent no greater than 15% of the aggregate of either the adjustable-rate pool or the fixed-rate pool, (b) multi-family properties (those with five or more units) represent no greater than 15% of the aggregate of either the adjustable-rate pool or the fixed-rate pool, (c) condominiums represent no greater than 10% of the aggregate of either the adjustable-rate pool or the fixed-rate pool, and any condominium project must be 80% occupied at the time the loan is originated, (d) properties with loan-to-value ratios exceeding 80% represent no greater than 25% of the aggregate of either the adjustable-rate pool or the fixed-rate pool and that the portion of the mortgage on any
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such property that exceeds a loan-to-value ratio of 80% is insured with Primary Mortgage Insurance from an insurer rated at least Baa3 by Moodys and (e) loan balances in excess of the current FHLMC limit plus $75,000 represent no greater than 25% of the aggregate of either the adjustable-rate pool or the fixed-rate pool, loan balances in excess of $350,000 represent no greater than 10% of the aggregate of either the adjustable-rate pool or the fixed-rate pool, and loan balances in excess of $1,000,000 represent no greater than 5% of the aggregate of either the adjustable-rate pool or the fixed-rate pool; (3) no greater than 5% of the pool of loans is concentrated in any one zip code; (4) the pool of loans contains at least 100 loans or $2 million in loans per servicer; (5) for adjustable-rate mortgages (ARMs), (a) any ARM is indexed to the National Cost of Funds index, the 11th District Cost of Funds index, the 1-year Treasury or the 6-month Treasury, (b) the margin over the given index is between .15% and .25% for either cost-of-funds index and between .175% and .325% for Treasuries, (c) the maximum yearly interest rate increase is 2%, (d) the maximum life-time interest rate increase is 6.25% and (e) ARMs may include Federal Housing Administration and Department of Veterans Affairs loans; and (6) for teaser loans, (a) the initial discount from the current ARM market rate is no greater than 2%, (b) the loan is underwritten at the market rate for ARMs, not the teaser rate, and (c) the loan is seasoned six months beyond the teaser period.
(x) Any municipal debt obligation that (A) pays interest in cash, (B) does not have a Moodys rating, as applicable, suspended by Moodys, and (C) is part of an issue of municipal debt obligations of at least $5,000,000, except for municipal debt obligations rated below A by Moodys, in which case the minimum issue size is $10,000,000;
(xi) Structured Notes, rated TRACERs and TRAINs;
(xii) Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in this definition but only upon receipt by the Trust of a letter from Moodys specifying any conditions on including such financial contract in Moodys Eligible Assets and assuring the Trust that including such financial contract in the manner so specified would not affect the credit rating assigned by Moodys to the AMPS; and
(xiii) Common stock, preferred stock or any debt security of REITs or real estate companies.
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In addition, portfolio holdings as described below must be within the following diversification and issue size requirements in order to be included in Moodys Eligible Assets:
Ratings 1 |
Maximum Single
Issuer 2,3 |
Maximum Single
Industry 3,4 |
Minimum Issue Size
($ in million) 5 |
|||||||
Aaa |
100 | % | 100 | % | $ | 100 | ||||
Aa |
20 | 60 | 100 | |||||||
A |
10 | 40 | 100 | |||||||
Baa |
6 | 20 | 100 | |||||||
Ba |
4 | 12 | 50 | 6 | ||||||
B1-B2 |
3 | 8 | 50 | 6 | ||||||
B3 or below |
2 | 5 | 50 | 6 |
1 |
Refers to the preferred stock and senior debt rating of the portfolio holding. |
2 |
Companies subject to common ownership of 25% or more are considered as one issuer. |
3 |
Percentages represent a portion of the aggregate Market Value of the portfolio holdings. |
4 |
Industries are determined according to Moodys Industry Classifications, as defined herein. |
5 |
Except for preferred stock, which has a minimum issue size of $50 million. |
6 |
Portfolio holdings from issues ranging from $50 million to $100 million are limited to 20% of the Trusts total assets. |
Where the Trust sells an asset and agrees to repurchase such asset in the future, the Discounted Value of such asset will constitute a Moodys Eligible Asset and the amount the Trust is required to pay upon repurchase of such asset will count as a liability for the purposes of the AMPS Basic Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to a third party in the future, cash receivable by the Trust thereby will constitute a Moodys Eligible Asset if the long-term debt of such other party is rated at least A2 by Moodys and such agreement has a term of 30 days or less; otherwise the Discounted Value of such purchased asset will constitute a Moodys Eligible Asset. For the purposes of calculation of Moodys Eligible Assets, portfolio securities which have been called for redemption by the issuer thereof shall be valued at the lower of Market Value or the call price of such portfolio securities.
Notwithstanding the foregoing, an asset will not be considered a Moodys Eligible Asset to the extent that it (i) has been irrevocably deposited for the payment of (i)(A) through (i)(E) under the definition of AMPS Basic Maintenance Amount or to the extent it is subject to any Liens, except for (A) Liens which are being contested in good faith by appropriate proceedings and which Moodys has indicated to the Trust will not affect the status of such asset as a Moodys Eligible Asset, (B) Liens for taxes that are not then due and payable or that can be paid thereafter without penalty, (C) Liens to secure payment for services rendered or cash advanced to the Trust by its investment manager or portfolio manager, the Trusts custodian, transfer agent or registrar or the Auction Agent and (D) Liens arising by virtue of any repurchase agreement, or (ii) has been segregated against obligations of the Trust in connection with an outstanding derivative transaction.
Moodys Exposure Period means the period commencing on a given Valuation Date and ending 49 days thereafter.
Moodys Forward Commitment has the meaning set forth in Section 11.8(d) of these Bylaws.
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Moodys Hedging Transactions has the meaning set forth in Section 11.8(a) of these Bylaws.
Moodys Industry Classification means, for the purposes of determining Moodys Eligible Assets, each of the following industry classifications (or such other classifications as Moodys may from time to time approve for application to the AMPS):
1. | Aerospace and Defense: Major Contractor, Subsystems, Research, Aircraft Manufacturing, Arms, Ammunition |
2. | Automobile: Automobile Equipment, Auto-Manufacturing, Auto Parts Manufacturing, Personal Use Trailers, Motor Homes, Dealers |
3. | Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan, Agency, Factoring, Receivables |
4. | Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and Liquors, Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar, Canned Foods, Corn Refiners, Dairy Products, Meat Products, Poultry Products, Snacks, Packaged Foods, Candy, Gum, Seafood, Frozen Food, Cigarettes, Cigars, Leaf/Snuff, Vegetable Oil |
5. | Buildings and Real Estate: Brick, Cement, Climate Controls, Contracting, Engineering, Construction, Hardware, Forest Products (building-related only), Plumbing, Roofing, Wallboard, Real Estate, Real Estate Development, REITs, Land Development |
6. | Chemicals, Plastics and Rubber: Chemicals (non-agricultural), Industrial Gases, Sulfur, Plastics, Plastic Products, Abrasives, Coatings, Paints, Varnish, Fabricating |
7. | Containers, Packaging and Glass: Glass, Fiberglass, Containers made of: Glass, Metal, Paper, Plastic, Wood or Fiberglass |
8. | Personal and Non-Durable Consumer Products (manufacturing only): Soaps, Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School Supplies |
9. | Diversified/Conglomerate Manufacturing |
10. | Diversified/Conglomerate Service |
11. | Diversified Natural Resources, Precious Metals and Minerals: Fabricating, Distribution |
12. | Ecological: Pollution Control, Waste Removal, Waste Treatment and Waste Disposal |
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13. | Electronics: Computer Hardware, Electric Equipment, Components, Controllers, Motors, Household Appliances, Information Service Communicating Systems, Radios, TVs, Tape Machines, Speakers, Printers, Drivers, Technology |
14. | Finance: Investment Brokerage, Leasing, Syndication, Securities |
15. | Farming and Agriculture: Livestock, Grains, Produce, Agriculture Chemicals, Agricultural Equipment, Fertilizers |
16. | Grocery: Grocery Stores, Convenience Food Stores |
17. | Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs, Research, Health Care Centers, Nursing Homes, HMOs, Hospitals, Hospital Supplies, Medical Equipment |
18. | Home and Office Furnishings, Housewares, and Durable Consumer Products: Carpets, Floor Coverings, Furniture, Cooking, Ranges |
19. | Hotels, Motels, Inns and Gaming |
20. | Insurance: Life, Property and Casualty, Broker, Agent, Surety |
21. | Leisure, Amusement, Motion Pictures, Entertainment: Boating, Bowling, Billiards, Musical Instruments, Fishing, Photo Equipment, Records, Tapes, Sports, Outdoor Equipment (camping), Tourism, Resorts, Games, Toy Manufacturing, Motion Picture Production Theaters, Motion Picture Distribution |
22. | Machinery (non-agricultural, non-construction, non-electronic): Industrial, Machine Tools, Steam Generators |
23. | Mining, Steel, Iron and Non-Precious Metals: Coal, Copper, Lead, Uranium, Zinc, Aluminum, Stainless Steel, Integrated Steel, Ore Production, Refractories, Steel Mill Machinery, Mini-Mills, Fabricating, Distribution and Sales of the foregoing |
24. | Oil and Gas: Crude Producer, Retailer, Well Supply, Service and Drilling |
25. | Printing, Publishing, and Broadcasting: Graphic Arts, Paper, Paper Products, Business Forms, Magazines, Books, Periodicals, Newspapers, Textbooks, Radio, TV, Cable Broadcasting Equipment |
26. | Cargo Transport: Rail, Shipping, Railroads, Railcar Builders, Ship Builders, Containers, Container Builders, Parts, Overnight Mail, Trucking, Truck Manufacturing, Trailer Manufacturing, Air Cargo, Transport |
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27. | Retail Stores: Apparel, Toy, Variety, Drug, Department, Mail Order Catalog, Showroom |
28. | Telecommunications: Local, Long Distance, Independent, Telephone, Telegraph, Satellite, Equipment, Research, Cellular |
29. | Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer, Leather Shoes |
30. | Personal Transportation: Air, Bus, Rail, Car Rental |
31. | Utilities: Electric, Water, Hydro Power, Gas |
32. | Diversified Sovereigns: Semi-sovereigns, Canadian Provinces, Supra-national Agencies |
The Trust will use its discretion in determining which industry classification is applicable to a particular investment in consultation with the Independent Accountant and Moodys, to the extent the Trust considers necessary.
Monthly Valuation Date means the last Business Day of each month of the Trust in each fiscal year of the Trust.
1940 Act means the Investment Company Act of 1940, as amended from time to time.
1940 Act Cure Date, with respect to the failure by the Trust to maintain the 1940 Act Preferred Shares Asset Coverage (as required by these Bylaws) as of the last Business Day of each month, means the last Business Day of the following month.
1940 Act Preferred Shares Asset Coverage means asset coverage, as defined in Section 18(h) of the 1940 Act, of at least 200% with respect to all outstanding senior securities of the Trust which are shares of beneficial interest, including 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 which are shares of beneficial interest of a closed-end investment company as a condition of paying dividends on its common shares).
Non-Call Period has the meaning set forth under the definition of Specific Redemption Provisions.
Non-Payment Period means a period commencing on and including a Dividend Payment Date or redemption date for which the Trust shall fail to (i) declare, prior to the close of business on the second Business Day preceding such Dividend Payment Date, for payment (to the extent permitted by Section 11.2(c)(i) of these Bylaws) within three Business Days after such Dividend Payment Date to the Holders as of 12:00 noon, New York City time, on the Business Day preceding such Dividend Payment Date, the full amount of any dividend on AMPS payable
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on such Dividend Payment Date, provided, however, that if the Trust is not able to make such declaration in compliance with the foregoing because an unforeseen event or unforeseen events causes or cause a day that otherwise would have been a Business Day not to be a Business Day, then the Trust may make such declaration on the Business Day immediately preceding the Dividend Payment Date, if possible, or, if not possible, on the Dividend Payment Date, and in such case the Trust shall not be deemed to have failed to declare a dividend otherwise required to be declared, or (ii) deposit, irrevocably in trust, in same-day funds, with the Auction Agent by 12:00 noon, New York City time, (A) on such Dividend Payment Date the full amount of any cash dividend on such shares payable (if declared) on such Dividend Payment Date or (B) on any such redemption date for any AMPS called for redemption, the Mandatory Redemption Price per share of such AMPS or, in the case of an optional redemption, the Optional Redemption Price per share, and ending on and including the Business Day on which, by 12:00 noon, New York City time, all unpaid cash dividends and unpaid redemption prices shall have been so deposited or shall have otherwise been made available to Holders in same-day funds; provided that a Non-Payment Period shall not end unless the Trust shall have given at least five days but no more than 30 days written notice of such deposit or availability to the Auction Agent, all Existing Holders (at their addresses appearing in the Share Books) and the Securities Depository. Notwithstanding the foregoing, the failure by the Trust to deposit funds as provided for by clauses (ii)(A) or (ii)(B) above within three Business Days after any Dividend Payment Date or redemption date, as the case may be, in each case to the extent contemplated by Section 11.2(c)(i) of these Bylaws, shall not constitute a Non-Payment Period.
Non-Payment Period Rate means, initially, 300% of the applicable Reference Rate, provided that the Board of Trustees of the Trust shall have the authority to adjust, modify, alter or change from time to time the initial Non-Payment Period Rate if the Board of Trustees of the Trust determines and each of Fitch Ratings and Moodys (and any Substitute Rating Agency in lieu of Fitch Ratings or Moodys in the event Fitch Ratings or Moodys shall not rate the AMPS) advises the Trust in writing that such adjustment, modification, alteration or change will not adversely affect its then current ratings on the AMPS.
Normal Dividend Payment Date has the meaning set forth in Section 11.2(b)(i) of these Bylaws.
Notice of Redemption means any notice with respect to the redemption of AMPS pursuant to Section 11.4 of these Bylaws.
Notice of Revocation has the meaning set forth in Section 11.2(c)(iii) of these Bylaws.
Notice of Special Dividend Period has the meaning set forth in Section 11.2(c)(iii) of these Bylaws.
Optional Redemption Price means $25,000 per Auction Market Preferred Share plus an amount equal to accumulated but unpaid dividends (whether or not earned or declared) to (but not including) the date fixed for redemption plus any applicable redemption premium attributable to the designation of a Premium Call Period.
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Outstanding means, as of any date, (i) with respect to AMPS, AMPS theretofore issued by the Trust except, without duplication, (A) any AMPS theretofore canceled or delivered to the Auction Agent for cancellation, or redeemed by the Trust, or as to which a Notice of Redemption shall have been given and Deposit Securities shall have been deposited in trust or segregated by the Trust pursuant to Section 11.4(c) hereto and (B) any AMPS as to which the Trust or any Affiliate (other than an Affiliate that is a Broker-Dealer) thereof shall be a Beneficial Owner, provided that AMPS held by an Affiliate shall be deemed outstanding for purposes of calculating Moodys AMPS Asset Coverage and (ii) with respect to other preferred shares of beneficial interest of the Trust, the meaning equivalent to that for AMPS as set forth in clause (i).
Parity Shares means the AMPS and each other outstanding series of preferred shares of beneficial interest of the Trust the holders of which, together with the holders of the AMPS, shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up, as the case may be, in proportion to the full respective preferential amounts to which they are entitled, without preference or priority one over the other.
Performing means with respect to the issuer of any asset that is a Bank Loan, Corporate Debt Security or other debt, the issuer of such investment is not in default of any payment obligations in respect thereof.
Person means and includes an individual, a corporation, a partnership, a trust, an unincorporated association, a joint venture or other entity or a government or any agency or political subdivision thereof.
Potential Beneficial Owner means a customer of a Broker-Dealer or a Broker-Dealer that is not a Beneficial Owner of AMPS but that wishes to purchase such shares, or that is a Beneficial Owner that wishes to purchase additional AMPS.
Potential Holder means any Broker-Dealer or any such other Person as may be permitted by the Trust, including any Existing Holder, who may be interested in acquiring AMPS (or, in the case of an Existing Holder, additional AMPS).
Premium Call Period has the meaning set forth under the definition of Specific Redemption Provisions.
Pricing Service means any pricing service designated by the Board of Trustees of the Trust and approved by Moodys for purposes of determining whether the Trust has Moodys AMPS Asset Coverage.
Quarterly Valuation Date means the last Business Day of the last month of each fiscal quarter of the Trust in each fiscal year of the Trust, commencing February 28, 2005.
Rating Agency means a nationally recognized statistical rating organization.
Rating Agency AMPS Asset Coverage means, (i) with respect to the asset coverage specifications of Fitch Ratings, Fitch AMPS Asset Coverage, (ii) with respect to the asset
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coverage specifications of Moodys, Moodys AMPS Asset Coverage, and (iii) with respect to a Substitute Rating Agency then rating the AMPS, the asset coverage specifications of such Substitute Rating Agency.
Rating Agency AMPS Asset Coverage Cure Date, with respect to the failure by the Trust to satisfy Fitch AMPS Asset Coverage, Moodys AMPS Asset Coverage or asset coverage specified by a Substitute Rating Agency then rating the AMPS (as required by Section 11.7(a) of these Bylaws) as of a given Valuation Date, means the tenth Business Day following such Valuation Date.
Rating Agency AMPS Asset Coverage Report means a Moodys AMPS Asset Coverage Report, a Fitch AMPS Asset Coverage Report or a similar report to be provided to another Rating Agency, as applicable.
Reference Banks means four major banks in the London interbank market selected by Merrill Lynch, Pierce, Fenner and Smith Incorporated or its affiliates or successors or such other party as the Trust may from time to time appoint.
Reference Rate means the LIBOR Rate (for a Dividend Period of fewer than 365 days) or the applicable Treasury Index Rate (for a Dividend Period of 365 days or more).
REITs means real estate investment trusts.
Request for Special Dividend Period has the meaning set forth in Section 11.2(c)(iii) of these Bylaws.
Response has the meaning set forth in Section 11.2(c)(iii) of these Bylaws.
Rule 144A Securities means securities which are restricted as to resale under federal securities laws but are eligible for resale pursuant to Rule 144A under the Securities Act as determined by the Trusts investment manager or portfolio manager acting pursuant to procedures approved by the Board of Trustees of the Trust.
S&P means Standard & Poors, a division of The McGraw-Hill Companies, Inc., or its successors.
Securities Act means the Securities Act of 1933, as amended from time to time.
Securities Depository means The Depository Trust Company and its successors and assigns or any successor securities depository selected by the Trust as securities depository for the AMPS that agrees to follow the procedures required to be followed by such securities depository in connection with the AMPS.
Senior Loans has the meaning set forth in paragraph (vii) of the definition of Moodys Discount Factor.
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Series M AMPS means the Auction Market Preferred Shares, Series M.
Series T AMPS means the Auction Market Preferred Shares, Series T.
Series W AMPS means the Auction Market Preferred Shares, Series W.
Series TH AMPS means the Auction Market Preferred Shares, Series TH.
Series F AMPS means the Auction Market Preferred Shares, Series F.
Seven-Day Dividend Period means a Subsequent Dividend Period that (a) consists of seven days or (b) would consist of seven days but for the fact that the Dividend Payment Date which immediately follows, or the Dividend Payment Date which falls within, such Subsequent Dividend Period is not a Business Day.
Share Books means the books maintained by the Auction Agent setting forth at all times a current list, as determined by the Auction Agent, of Existing Holders of the AMPS.
Share Register means the register of Holders maintained on behalf of the Trust by the Auction Agent in its capacity as transfer agent and registrar for the AMPS.
Short Term Dividend Period means a Special Dividend Period consisting of a specified number of days, evenly divisible by seven and not fewer than fourteen nor more than 364.
Short Term Money Market Instruments means the following types of instruments if, on the date of purchase or other acquisition thereof by the Trust, the remaining term to maturity thereof is not in excess of 180 days (or 270 days for instruments rated at least Aaa for purposes of determining Moodys Eligible Assets):
(i) commercial paper rated either F-1 by Fitch Ratings or A-1 by S&P if such commercial paper matures in 30 days or P-1 by Moodys and either F-1+ by Fitch Ratings or A-1+ by S&P if such commercial paper matures in over 30 days;
(ii) demand or time deposits in, and bankers acceptances and certificates of deposit of, (A) a depository institution or trust company incorporated under the laws of the United States of America or any state thereof or the District of Columbia or (B) a United States branch office or agency of a foreign depository institution (provided that such branch office or agency is subject to banking regulation under the laws of the United States, any state thereof or the District of Columbia);
(iii) overnight funds;
(iv) U.S. Government Securities; and
(v) Eurodollar demand or time deposits in, or certificates of deposit of, the head office or the London branch office of a depository institution or trust company if the
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certificates of deposit, if any, and the long-term unsecured debt obligations (other than such obligations the ratings of which are based on the credit of a person or entity other than such depository institution or trust company) of such depository institution or trust company that have (1) credit ratings on each Valuation Date of at least P-1 from Moodys and either F-1+ from Fitch Ratings or A-1+ from S&P, in the case of commercial paper or certificates of deposit, and (2) credit ratings on each Valuation Date of at least Aa3 from Moodys and either AA from Fitch Ratings or AA- from S&P, in the case of long-term unsecured debt obligations; provided, however, that in the case of any such investment that matures in no more than one Business Day from the date of purchase or other acquisition by the Trust, all of the foregoing requirements shall be applicable except that the required long-term unsecured debt credit rating of such depository institution or trust company from Moodys, Fitch Ratings and S&P shall be at least A2, A-2 and A, respectively; and provided further, however, that the foregoing credit rating requirements shall be deemed to be met with respect to a depository institution or trust company if (1) such depository institution or trust company is the principal depository institution in a holding company system, (2) the certificates of deposit, if any, of such depository institution or trust company are not rated on any Valuation Date below P-1 by Moodys, F-1+ by Fitch Ratings or A-1+ by S&P and there is no long-term rating, and (3) the holding company shall meet all of the foregoing credit rating requirements (including the preceding proviso in the case of investments that mature in no more than one Business Day from the date of purchase or other acquisition by the Trust); and provided further, that the interest receivable by the Trust shall not be subject to any withholding or similar taxes.
Special Dividend Period (sometimes referred to as a Special Rate Period) means a Short Term Dividend Period or a Long Term Dividend Period.
Specific Redemption Provisions means, with respect to a Special Dividend Period either, or both, of (i) a period (a Non-Call Period) determined by the Board of Trustees of the Trust, after consultation with the Auction Agent and the Broker-Dealers, during which the AMPS subject to such Special Dividend Period shall not be subject to redemption at the option of the Trust and (ii) a period (a Premium Call Period), consisting of a number of whole years and determined by the Board of Trustees of the Trust, after consultation with the Auction Agent and the Broker-Dealers, during each year of which the AMPS subject to such Special Dividend Period shall be redeemable at the Trusts option at a price per share equal to $25,000, plus accumulated but unpaid dividends (whether or not earned or declared) to (but not including) the date fixed for redemption, plus a premium expressed as a percentage or percentages of $25,000, as determined by the Board of Trustees of the Trust after consultation with the Auction Agent and the Broker-Dealers.
Structured Notes means privately negotiated debt obligations where the principal and/or interest is determined by reference to the performance of a benchmark asset or market (an embedded index), such as selected securities or an index of securities, or the differential performance of two assets or markets, such as indices reflecting bonds.
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Subsequent Dividend Period has the meaning set forth in Section 11.2(c)(i) of these Bylaws.
Substitute LIBOR Dealer means any LIBOR Dealer selected by the Trust, as to which Moodys, Fitch Ratings or any other Rating Agency then rating the AMPS shall not have objected; provided, however that none of such entities shall be a LIBOR Dealer.
Substitute Rating Agency means a Rating Agency selected by Merrill Lynch, Pierce, Fenner and Smith Incorporated or its affiliates and successors, after consultation with the Trust, to act as the substitute Rating Agency to determine the credit ratings of the AMPS.
Sufficient Clearing Bids has the meaning set forth in Section 11.10(d)(i) of these Bylaws.
TRACERs means traded custody receipts representing direct ownership in a portfolio of underlying securities.
TRAINs means Targeted Return Index Securities, which are trust certificates comprised of bonds that are chosen to track a particular index.
Treasury Bill means a direct obligation of the U.S. government having a maturity at the time of issuance of 364 days or less.
Treasury Bonds means United States Treasury Bonds or Notes.
Treasury Index Rate means the average yield to maturity for actively traded marketable U.S. Treasury fixed interest rate securities having the same number of 30-day periods to maturity as the length of the applicable Dividend Period, determined, to the extent necessary, by linear interpolation based upon the yield for such securities having the next shorter and next longer number of 30-day periods to maturity treating all Dividend Periods with a length greater than the longest maturity for such securities as having a length equal to such longest maturity, in all cases based upon data set forth in the most recent weekly statistical release published by the Board of Governors of the Federal Reserve System (currently in H.15 (519)); provided, however, if the most recent such statistical release shall not have been published during the 15 days preceding the date of computation, the foregoing computations shall be based upon the average of comparable data as quoted to the Trust by at least three recognized dealers in U.S. government securities selected by the Trust.
Trust means the PIMCO Income Strategy Fund II.
U.S. Government Securities means direct obligations of the United States or of its agencies or instrumentalities that are entitled to the full faith and credit of the United States and that, other than Treasury Bills, provide for the periodic payment of interest and the full payment of principal at maturity or call for redemption.
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U.S. Treasury Securities means direct obligations of the United States Treasury that are entitled to the full faith and credit of the United States.
U.S. Treasury Strips means securities based on U.S. Treasury Securities created through the Separate Trading of Registered Interest and Principal of Securities program.
Valuation Date means, for purposes of determining whether the Trust is maintaining Rating Agency AMPS Asset Coverage, the last Business Day of each week commencing with the Date of Original Issue.
Volatility Factor means 1.89.
Voting Period has the meaning set forth in Section 11.5(b) of these Bylaws.
(b) The foregoing definitions of Accountants Confirmation, AMPS Basic Maintenance Amount, Bank Loans, Closing Transactions, Cure Date, Deposit Securities, Discount Factor, Discounted Value, Fitch AMPS Asset Coverage, Fitch AMPS Asset Coverage Report, Fitch Covered Forward Commitment, Fitch Criteria, Fitch Net OC, Fitch Net OC Test, Fitch Total OC, Fitch Total OC Test, Independent Accountant, LIBOR Dealer, Market Value, Maximum Applicable Rate, Monthly Valuation Date, Moodys Advance Rate, Moodys AMPS Asset Coverage, Moodys AMPS Asset Coverage Report, Moodys Discount Factor, Moodys Eligible Assets, Moodys Exposure Period, Moodys Forward Commitment, Moodys Hedging Transactions, Moodys Industry Classification, Moodys Loan Category, 1940 Act Cure Date, 1940 Act Preferred Shares Asset Coverage, Performing, Quarterly Valuation Date, Rating Agency AMPS Asset Coverage, Rating Agency AMPS Asset Coverage Report, Rating Agency AMPS Asset Coverage Cure Date, Senior Loans, Short Term Money Market Instruments, Structured Notes, Substitute LIBOR Dealer, TRAINs, TRACERs, Treasury Bill, Treasury Bonds, U.S. Government Securities, U.S. Treasury Securities, U.S. Treasury Strips, Valuation Date and Volatility Factor (and any terms defined within such definitions) have been determined by the Board of Trustees of the Trust in order to obtain a rating of AAA from Fitch Ratings and a rating of Aaa from Moodys on the AMPS; and the Board of Trustees of the Trust shall have the authority, without shareholder approval, to amend, alter or repeal from time to time the foregoing definitions (and any terms defined within such definitions) and the restrictions and guidelines set forth thereunder if Fitch Ratings, Moodys or any Substitute Rating Agency advises the Trust in writing that such amendment, alteration or repeal will not adversely affect its then current rating on the AMPS.
11.2 | Dividends . |
(a) The Holders of a particular series of AMPS shall be entitled to receive, when, as and if declared by the Board of Trustees of the Trust, out of funds legally available therefor, cumulative dividends each consisting of cash at the Applicable Rate and no more, payable on the respective dates set forth below. Dividends on the shares of each series of AMPS so declared and payable shall be paid in preference to and in priority over any dividends declared and payable on the Common Shares.
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(b)(i) Cash dividends on shares of each series of AMPS shall accumulate at the relevant Applicable Rate(s) from the Date of Original Issue and shall be payable, when, as and if declared by the Board of Trustees of the Trust, out of funds legally available therefor, commencing on the Initial Dividend Payment Date. Following the Initial Dividend Payment Date for a series of AMPS, dividends on that series of AMPS will be payable, at the option of the Trust, either (i) with respect to any Seven-Day Dividend Period and any Short Term Dividend Period of 35 or fewer days, on the day next succeeding the last day thereof, or (ii) with respect to any Short Term Dividend Period of more than 35 days and with respect to any Long Term Dividend Period, monthly on the first Business Day of each calendar month during such Short Term Dividend Period or Long Term Dividend Period and on the day next succeeding the last day thereof (each such date referred to in clause (i) or (ii) being herein referred to as a Normal Dividend Payment Date), except that if such Normal Dividend Payment Date is not a Business Day, then the Dividend Payment Date shall be the first Business Day next succeeding such Normal Dividend Payment Date; provided, however, that if a Normal Dividend Payment Date is not a Business Day because the New York Stock Exchange 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 communication services, or the dividend payable on such date cannot be paid for any such reason, then the Dividend Payment Date shall be the next succeeding Business Day on which the Trust and its dividend paying agent, if any, are able to cause the dividend to be paid using their reasonable best efforts. Although any particular Dividend Payment Date may not occur on the originally scheduled date because of the exceptions discussed above, the next succeeding Dividend Payment Date, subject to such exceptions, will occur on the next following originally scheduled date. If for any reason a Dividend Period for a series of AMPS is scheduled to begin on the same day and end on the same day as a Dividend Period for another series of AMPS, then the last day of such Dividend Period for such other series of AMPS shall be the second Business Day next succeeding such scheduled day unless the Trust obtains the opinion of tax counsel referred to in this paragraph. Subject to the limitation in the next sentence, if for any reason a Dividend Payment Date cannot be fixed as described above, then the Board of Trustees of the Trust shall fix the Dividend Payment Date. However, no Dividend Period of any series of AMPS shall be co-extensive with any Dividend Period of any other series of AMPS unless the Trust has received an opinion of tax counsel that having such co-extensive periods will not affect the deductibility, for federal income tax purposes, of dividends paid on the different series of AMPS. The Board of Trustees of the Trust before authorizing a dividend may change a Dividend Payment Date if such change does not adversely affect the contract rights of the Holders of AMPS set forth in the Declaration of Trust or the Bylaws. The Initial Dividend Period, Seven-Day Dividend Periods and Special Dividend Periods with respect to a series of AMPS are hereinafter sometimes referred to as Dividend Periods. Each dividend payment date determined as provided above is hereinafter referred to as a Dividend Payment Date.
(ii) Each dividend shall be paid to the Holders as they appear in the Share Register as of 12:00 noon, New York City time, on the Business Day preceding the Dividend Payment Date. Dividends in arrears for any past Dividend Period may be declared and paid at any time, without reference to any regular Dividend Payment Date, to the Holders as they appear on the Share Register on a date, not exceeding 15 days prior to the payment date therefor, as may be fixed by the Board of Trustees of the Trust.
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(c)(i) During the period from and including the Date of Original Issue to but excluding the Initial Dividend Payment Date for a series of AMPS (the Initial Dividend Period), the Applicable Rate for such series of AMPS shall be the Initial Dividend Rate. Commencing on the Initial Dividend Payment Date for a series of AMPS, the Applicable Rate on that series for each subsequent dividend period (hereinafter referred to as a Subsequent Dividend Period), which Subsequent Dividend Period shall commence on and include a Dividend Payment Date and shall end on and include the calendar day prior to the next Dividend Payment Date (or last Dividend Payment Date in a Dividend Period if there is more than one Dividend Payment Date), shall be equal to the rate per annum that results from implementation of the Auction Procedures.
For a series of AMPS, the Applicable Rate for such series for each Dividend Period commencing during a Non-Payment Period shall be equal to the Non-Payment Period Rate; and each Dividend Period, commencing after the first day of and during, but not after the end of, a Non-Payment Period shall be a Seven-Day Dividend Period. Except in the case of the willful failure of the Trust to pay a dividend on a Dividend Payment Date or to redeem any AMPS on the date set for such redemption, any amount of any dividend due on any Dividend Payment Date (if, prior to the close of business on the second Business Day preceding such Dividend Payment Date, the Trust has declared such dividend payable on such Dividend Payment Date to the Holders of such AMPS as of 12:00 noon, New York City time, on the Business Day preceding such Dividend Payment Date) or redemption price with respect to any AMPS not paid to such Holders when due may be paid to such Holders in the same form of funds by 12:00 noon, New York City time, on any of the first three Business Days after such Dividend Payment Date or due date, as the case may be, provided that such amount is accompanied by a late charge calculated for such period of non-payment at the Non-Payment Period Rate applied to the amount of such non-payment based on the actual number of days comprising such period (excluding any days that would have been Business Days but for the occurrence of any unforeseen event or unforeseen events that caused such days not to be Business Days) divided by 365, and in such case such period shall not constitute a Non-Payment Period; provided, however, that the Trust shall not be required to pay any late charge if it declares a dividend on the Dividend Payment Date or the Business Day immediately preceding such Dividend Payment Date in accordance with clause (i) of the definition of Non-Payment Period and deposits payment for such dividend as contemplated by clause (ii)(A) of the definition of Non-Payment Period on or before the second Business Day succeeding the day on which the dividend was declared. In the case of a willful failure of the Trust to pay a dividend on a Dividend Payment Date or to redeem any AMPS on the date set for such redemption, the preceding sentence shall not apply and the Applicable Rate for the Dividend Period commencing during the Non-Payment Period resulting from such failure shall be the Non-Payment Period Rate. For the purposes of the foregoing, payment to a person in same-day funds on any Business Day at any time shall be considered equivalent to payment to such person in New York Clearing House (next-day) funds at the same time on the preceding Business Day, and any payment made after 12:00 noon, New York City time,
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on any Business Day shall be considered to have been made instead in the same form of funds and to the same person before 12:00 noon, New York City time, on the next Business Day.
(ii) The amount of dividends per share of any series of AMPS payable (if declared) on the Initial Dividend Payment Date, each Dividend Payment Date of each Seven-Day Dividend Period, each Dividend Payment Date of each Short Term Dividend Period and each Dividend Payment Date of each Long Term Dividend Period shall be computed by multiplying the Applicable Rate for such Dividend Period by a fraction, the numerator of which will be the number of days in such Dividend Period or part thereof that such share was outstanding and the denominator of which will be 365, multiplying the amount so obtained by $25,000, and rounding the amount so obtained to the nearest cent.
(iii) The Trust may, at its sole option and to the extent permitted by law, by telephonic and written notice (a Request for Special Dividend Period) to the Auction Agent and to each Broker-Dealer, request that the next succeeding Dividend Period for a series of AMPS be a number of days (other than seven), evenly divisible by seven and not fewer than fourteen nor more than 364 in the case of a Short Term Dividend Period or one whole year or more but not greater than five years in the case of a Long Term Dividend Period, specified in such notice, provided that the Trust may not give a Request for Special Dividend Period for a Dividend Period of greater than 28 days (and any such request shall be null and void) unless, for any Auction occurring after the initial Auction, Sufficient Clearing Bids were made in the last occurring Auction and unless full cumulative dividends and any amounts due with respect to redemptions have been paid in full. Such Request for Special Dividend Period, in the case of a Short Term Dividend Period, shall be given on or prior to the second Business Day but not more than seven Business Days prior to an Auction Date for a series of AMPS and, in the case of a Long Term Dividend Period, shall be given on or prior to the second Business Day but not more than 28 days prior to an Auction Date for a series of AMPS. Upon receiving such Request for Special Dividend Period, the Broker-Dealer(s) shall jointly determine the Optional Redemption Price of the AMPS of the applicable series of AMPS during such Special Dividend Period and the Specific Redemption Provisions and shall give the Trust and the Auction Agent written notice (a Response) of such determination by no later than the second Business Day prior to such Auction Date. In making such determination the Broker-Dealer(s) will consider (1) existing short-term and long-term market rates and indices of such short-term and long-term rates, (2) existing market supply and demand for short-term and long-term securities, (3) existing yield curves for short-term and long-term securities comparable to the AMPS, (4) industry and financial conditions which may affect the AMPS of the applicable series, (5) the investment objective of the Trust, and (6) the Dividend Periods and dividend rates at which current and potential beneficial holders of the AMPS would remain or become beneficial holders. After providing the Request for Special Dividend Period to the Auction Agent and each Broker-Dealer as set forth above, the Trust may by no later than the second Business Day prior to such Auction Date give a notice (a Notice of Special Dividend Period) to the Auction Agent,
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the Securities Depository and each Broker-Dealer which notice will specify (i) the duration of the Special Dividend Period, (ii) the Optional Redemption Price, if any, as specified in the related Response and (iii) the Specific Redemption Provisions, if any, as specified in the related Response. The Trust also shall provide a copy of such Notice of Special Dividend Period to Fitch Ratings, Moodys and any Substitute Rating Agency. The Trust shall not give a Notice of Special Dividend Period and, if the Trust has given a Notice of Special Dividend Period, the Trust is required to give telephonic and written notice of its revocation (a Notice of Revocation) to the Auction Agent, each Broker-Dealer, and the Securities Depository on or prior to the Business Day prior to the relevant Auction Date if (x) either the 1940 Act Preferred Shares Asset Coverage is not satisfied or the Trust shall fail to maintain both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage, on each of the two Valuation Dates immediately preceding the Business Day prior to the relevant Auction Date on an actual basis and on a pro forma basis giving effect to the proposed Special Dividend Period (using as a pro forma dividend rate with respect to such Special Dividend Period the dividend rate which the Broker-Dealers shall advise the Trust is an approximately equal rate for securities similar to the AMPS with an equal dividend period) or (y) sufficient funds for the payment of dividends payable on the immediately succeeding Dividend Payment Date have not been irrevocably deposited with the Auction Agent by the close of business on the third Business Day preceding the Auction Date immediately preceding such Dividend Payment Date. The Trust also shall provide a copy of such Notice of Revocation to Fitch Ratings, Moodys and any Substitute Rating Agency. If the Trust is prohibited from giving a Notice of Special Dividend Period as a result of any of the factors enumerated in clause (x) or (y) above or if the Trust gives a Notice of Revocation with respect to a Notice of Special Dividend Period for any series of AMPS, the next succeeding Dividend Period for that series will be a Seven-Day Dividend Period. In addition, in the event Sufficient Clearing Bids are not made in an Auction, or if an Auction is not held for any reason, such next succeeding Dividend Period will be a Seven-Day Dividend Period and the Trust may not again give a Notice of Special Dividend Period for the AMPS (and any such attempted notice shall be null and void) until Sufficient Clearing Bids have been made in an Auction with respect to a Seven-Day Dividend Period. If an Auction is not held because an unforeseen event or unforeseen events cause a day that otherwise would have been a Dividend Payment Date or an Auction Date not to be a Business Day, then the length of the Dividend Period relating to such Dividend Payment Date shall be extended by seven days (or a multiple thereof if necessary because of such unforeseen event or events) (an Extension Period), the Applicable Rate for such Extension Period shall be the Applicable Rate for the Dividend Period so extended and the Dividend Payment Date for such Dividend Period shall be the first Business Day next succeeding the end of such Extension Period. The Trust will not declare a Special Dividend Period unless it has received confirmation from Moodys and Fitch Ratings, and any Substitute Rating Agency, that the proposed Special Dividend Period will not adversely affect such Rating Agencys then current rating on the AMPS.
(d)(i) Holders shall not be entitled to any dividends, whether payable in cash, property or AMPS, in excess of full cumulative dividends as herein provided. Except for the
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late charge payable pursuant to Section 11.2(c)(i) hereof, no interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment on the AMPS that may be in arrears.
(ii) For so long as any AMPS are Outstanding, the Trust shall not declare, pay or set apart for payment any dividend or other distribution (other than a dividend or distribution paid in shares of, or options, warrants or rights to subscribe for or purchase, Common Shares or other shares of beneficial interest, if any, ranking junior to the AMPS as to dividends or upon liquidation) in respect of the Common Shares or any other shares of beneficial interest of the Trust ranking junior to or on a parity with the AMPS as to dividends or upon liquidation, or call for redemption, redeem, purchase or otherwise acquire for consideration any Common Shares or any other such junior shares (except by conversion into or exchange for shares of the Trust ranking junior to the AMPS as to dividends and upon liquidation) or any other such Parity Shares (except by conversion into or exchange for stock of the Trust ranking junior to or on a parity with the AMPS as to dividends and upon liquidation), unless (A) immediately after such transaction, the Trust shall maintain both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage, and the Trust shall maintain the 1940 Act Preferred Shares Asset Coverage, (B) full cumulative dividends on 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 (C) the Trust has redeemed the full number of AMPS required to be redeemed by any provision for mandatory redemption contained herein. Further, for so long as any AMPS are Outstanding, the Trust shall not declare, pay or set apart for payment any dividend or other distribution on any Parity Shares other than the AMPS unless contemporaneously herewith it declares, pays or sets apart for payment, as the case may be, the same proportionate share of dividends on the AMPS.
(e) Each dividend shall consist of cash at the Applicable Rate.
(f) No fractional AMPS shall be issued.
(g) Solely for purposes of the proviso in clause (i) under the definition of Non-Payment Period, the second parenthetical in the second sentence of the second paragraph of Section 11.2(c)(i) of these Bylaws and the last sentence of Section 11.2(c)(iii) of these Bylaws, any day on which banks in New York City generally are closed, for any reason, while the New York Stock Exchange remains open for trading and any day which otherwise would be a Business Day as defined in these Bylaws on which the Auction Agent is closed for business, for any reason, shall be considered a day which is not a Business Day.
11.3 Liquidation Rights . Upon any liquidation, dissolution or winding up of the Trust, whether voluntary or involuntary, the Holders of AMPS then outstanding shall be entitled to receive, out of the assets of the Trust available for distribution to shareholders, before any distribution or payment is made upon any Common Shares or any other shares of beneficial interest ranking junior in right of payment upon liquidation to the AMPS, the sum of $25,000 per share plus accumulated but unpaid dividends (whether or not earned or declared) thereon to (but
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not including) the date of distribution, and after such payment the Holders will be entitled to no other payments. If upon any liquidation, dissolution or winding up of the Trust, the amounts payable with respect to the AMPS and any other Outstanding class or series of preferred shares of beneficial interest of the Trust ranking on a parity with the AMPS as to payment upon liquidation are not paid in full, the Holders and the holders of such other class or series will share ratably in any such distribution of assets in proportion to the respective preferential amounts to which they are entitled. After payment of the full amount of the liquidating distribution to which they are entitled, the Holders will have no right or claim to any of the remaining assets of the Trust. A consolidation, merger or statutory share exchange of the Trust with or into any other trust or entity or a sale, whether for cash, shares of stock, securities or properties, of all or substantially all or any part of the assets of the Trust shall not be deemed or construed to be a liquidation, dissolution or winding up of the Trust.
11.4 | Redemption . |
(a) AMPS shall be redeemable by the Trust as provided below:
(i) To the extent permitted under the 1940 Act and Massachusetts law, upon giving a Notice of Redemption, the Trust at its option may redeem shares of any series of AMPS, in whole or in part, out of funds legally available therefor, at the Optional Redemption Price per share, on any Dividend Payment Date; provided that no AMPS may be redeemed at the option of the Trust during (A) the Initial Dividend Period with respect to a series of shares or (B) a Non-Call Period to which such share is subject.
(ii) The Trust shall redeem, out of funds legally available therefor, at the Mandatory Redemption Price per share, AMPS to the extent permitted under the 1940 Act and Massachusetts law, on a date fixed by the Board of Trustees of the Trust, if the Trust fails (x) to maintain both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage as provided in Section 11.7(a) or (y) to satisfy the 1940 Act Preferred Shares Asset Coverage as provided in Section 11.6 and such failure is not cured on or before the Rating Agency AMPS Asset Coverage Cure Date or the 1940 Act Cure Date (herein collectively referred to as a Cure Date), as the case may be. The number of AMPS to be redeemed shall be equal to the lesser of (i) the minimum number of AMPS the redemption of which, if deemed to have occurred immediately prior to the opening of business on the Cure Date, together with all other preferred shares of beneficial interest of the Trust subject to redemption or retirement, would result in (x) the Trust having both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage or (y) satisfaction of the 1940 Act Preferred Shares Asset Coverage, as the case may be, on such Cure Date (provided that, if there is no such minimum number of AMPS and other preferred shares of beneficial interest of the Trust the redemption of which would have such result, all AMPS and other preferred shares of beneficial interest of the Trust then Outstanding shall be redeemed), and (ii) the maximum number of AMPS, together with all other preferred shares of beneficial interest of the Trust subject to redemption or retirement, that can be redeemed out of funds expected to be legally available therefor on such redemption date. In determining the number of
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AMPS required to be redeemed in accordance with the foregoing, the Trust shall allocate the number required to be redeemed which would result in (x) the Trust having Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage or (y) satisfaction of the 1940 Act Preferred Shares Asset Coverage, as the case may be, pro rata among AMPS of all series and other preferred shares of beneficial interest of the Trust subject to redemption pursuant to provisions similar to those contained in this Section 11.4(a)(ii); provided that AMPS which may not be redeemed at the option of the Trust due to the designation of a Non-Call Period applicable to such shares (A) will be subject to mandatory redemption only to the extent that other shares are not available to satisfy the number of shares required to be redeemed and (B) will be selected for redemption in an ascending order of outstanding number of days remaining in the Non-Call Period (with shares with the lowest number of days to be redeemed first) and by lot in the event of shares having an equal number of days remaining in such Non-Call Period. The Trust shall effect such redemption on a Business Day which is not later than 35 days after such Cure Date, except that if the Trust does not have funds legally available for the redemption of all of the required number of AMPS and other preferred shares of beneficial interest of the Trust which are subject to mandatory redemption or the Trust otherwise is unable to effect such redemption on or prior to 35 days after such Cure Date, the Trust shall redeem those AMPS which it is unable to redeem on the earliest practicable date on which it is able to effect such redemption out of funds legally available therefor.
(b) Notwithstanding any other provision of this Section 11.4, no AMPS may be redeemed pursuant to Section 11.4(a)(i) of these Bylaws unless (i) all dividends in arrears on all remaining outstanding Parity Shares shall have been or are being contemporaneously paid or declared and set apart for payment, and (ii) redemption thereof would not result in the Trusts failure to maintain Fitch AMPS Asset Coverage or Moodys AMPS Asset Coverage. In the event that less than all the outstanding shares of a series of AMPS are to be redeemed and there is more than one Holder, the shares of that series of AMPS to be redeemed shall be selected by lot or such other method as the Trust shall deem fair and equitable.
(c) Whenever AMPS are to be redeemed, the Trust, not less than 17 nor more than 30 days prior to the date fixed for redemption, shall mail a notice (Notice of Redemption) by first-class mail, postage prepaid, to each Holder of AMPS to be redeemed and to the Auction Agent. The Notice of Redemption shall set forth (i) the redemption date, (ii) the amount of the redemption price, (iii) the aggregate number of AMPS of such series to be redeemed, (iv) the place or places where AMPS of such series are to be surrendered for payment of the redemption price, (v) a statement that dividends on the shares to be redeemed shall cease to accumulate on such redemption date and (vi) the provision of these Bylaws pursuant to which such shares are being redeemed. No defect in the Notice of Redemption or in the mailing or publication thereof shall affect the validity of the redemption proceedings, except as required by applicable law.
If the Notice of Redemption shall have been given as aforesaid and, concurrently or thereafter, the Trust shall have deposited in trust with the Auction Agent, or segregated in an
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account at the Trusts custodian bank for the benefit of the Auction Agent, Deposit Securities (with a right of substitution) having an aggregate Discounted Value (calculated using Moodys Eligible Assets and Moodys Discount Factors for these purposes) equal to the redemption payment (including any applicable premiums) for the AMPS as to which such Notice of Redemption has been given with irrevocable instructions and authority to pay the redemption price to the Holders of such shares, then upon the date of such deposit or, if no such deposit is made, then upon such date fixed for redemption (unless the Trust shall default in making the redemption payment), all rights (including without limitation voting rights) of the Holders of such shares as shareholders of the Trust by reason of the ownership of such shares will cease and terminate (except their right to receive the redemption price in respect thereof, but without interest), and such shares shall no longer be deemed Outstanding; provided, however, that unless otherwise provided in the Fitch Criteria, such shares shall be deemed to be Outstanding for purposes of calculating Fitch AMPS Asset Coverage (but not for the other purposes specified above, including with respect to the rights of Holders). The Trust shall be entitled to receive, from time to time, from the Auction Agent the interest, if any, on such Deposit Securities deposited with the Auction Agent and the Holders of any shares so redeemed shall have no claim to any of such interest. In case the Holder of any shares so called for redemption shall not claim the redemption payment for his shares within one year after the date of redemption, the Auction Agent shall, upon demand, pay over to the Trust such amount remaining on deposit and the Auction Agent shall thereupon be relieved of all responsibility to the Holder of such shares called for redemption and such Holder thereafter shall look only to the Trust for the redemption payment.
11.5 | Voting Rights . |
(a) General . Except as otherwise provided in the Declaration of Trust or Bylaws or as otherwise required by applicable law, each Holder of AMPS shall be entitled to one vote for each share held on each matter submitted to a vote of shareholders of the Trust, and the holders of Outstanding preferred shares of beneficial interest of the Trust, including AMPS, and of Common Shares shall vote together as a single class; provided that the holders of Outstanding preferred shares of beneficial interest of the Trust, including AMPS, shall be entitled, as a class, to the exclusion of the holders of all other securities and classes of shares of beneficial interest of the Trust, to elect two trustees of the Trust. Subject to Section 11.5(b) hereof, the holders of shares of beneficial interest of the Trust, including the holders of preferred shares of beneficial interest of the Trust, including AMPS, voting as a single class, shall elect the balance of the trustees.
(b) Right to Elect Majority of Board of Trustees . Except as otherwise required by law, during any period in which any one or more of the conditions described below shall exist (such period being referred to herein as a Voting Period), the number of trustees constituting the Board of Trustees of the Trust shall be automatically increased by the smallest number that, when added to the two trustees elected exclusively by the holders of preferred shares of beneficial interest of the Trust, including the AMPS, would constitute a majority of the Board of Trustees of the Trust as so increased by such smallest number; and the holders of preferred shares of beneficial interest of the Trust shall be entitled, voting
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separately as one class (to the exclusion of the holders of all other securities and classes of shares of beneficial interest of the Trust), to elect such smallest number of additional trustees (as so elected, the Additional Trustees), in addition to the two trustees that such holders are in any event entitled to elect.
A Voting Period shall commence:
(i) if at any time accumulated dividends (whether or not earned or declared, and whether or not funds are then legally available in an amount sufficient therefor) on any outstanding preferred shares, including the AMPS, equal to at least two full years dividends shall be due and unpaid and sufficient cash or specified securities shall not have been deposited with the Auction Agent for the payment of such accumulated dividends; or
(ii) if at any time holders of any preferred shares of beneficial interest of the Trust, including the holders of AMPS, are entitled to elect a majority of the trustees of the Trust under the 1940 Act.
Upon the termination of a Voting Period, the voting rights described in this Section 11.5(b) shall cease, subject always, however, to the revesting of such voting rights in the Holders upon the further occurrence of any of the events described in this Section 11.5(b), the terms of the Additional Trustees shall terminate automatically, and the remaining Trustees shall constitute the Trustees of the Trust.
(c) Right to Vote with Respect to Certain Other Matters . So long as any AMPS are Outstanding, the Trust shall not, without the affirmative vote or consent of the holders of a majority of the preferred shares of the Trust, including the AMPS, Outstanding at the time, voting separately as one class: (i) authorize, create or issue any class or series of shares of beneficial interest ranking prior to the AMPS or any other series of preferred shares of beneficial interest of the Trust with respect to payment of dividends or the distribution of assets upon dissolution, liquidation or winding up the affairs of the Trust; provided, however, that no vote is required to authorize the issuance of another series of AMPS or another class of preferred shares of beneficial interest of the Trust that is substantially identical in all respects to the AMPS; or (ii) amend, alter or repeal the provisions of the Declaration of Trust or Bylaws, whether by merger, consolidation or otherwise, so as to adversely affect any of the contract rights expressly set forth in the Declaration of Trust or Bylaws of holders of AMPS or any other preferred shares of beneficial interest of the Trust. To the extent permitted under the 1940 Act, in the event shares of more than one series of preferred shares of the Trust, including the AMPS, are outstanding, the Trust shall not approve any of the actions set forth in clause (i) or (ii) which adversely affects the contract rights expressly set forth in the Declaration of Trust or Bylaws of a Holder of a series of AMPS differently than those of a Holder of any other series of preferred shares of the Trust, including the AMPS, without the affirmative vote of the holders of at least a majority of the AMPS of each series adversely affected and Outstanding at such time (each such adversely affected series voting separately as a class). Unless a higher percentage is provided for under the Declaration of Trust or these
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Bylaws, the affirmative vote of the holders of a majority of the outstanding preferred shares of beneficial interest of the Trust, including AMPS, voting together as a single class, will be required to approve any plan of reorganization (including bankruptcy proceedings) adversely affecting such shares or any action requiring a vote of security holders under Section 13(a) of the 1940 Act. To the extent permitted under the 1940 Act, in the event shares of more than one series of AMPS are outstanding, with respect to any action requiring Shareholder approval pursuant to the operation of Section 2 or Section 3 of Article V of the Declaration of Trust, the affirmative vote of at least seventy-five percent of the AMPS of each series Outstanding at such time (each such series voting separately as a class) shall also be required. The class (and, where applicable, the series) vote of holders of preferred shares of beneficial interest of the Trust, including AMPS, described above will in each case be in addition to a separate vote of the requisite percentage of Common Shares and preferred shares of beneficial interest of the Trust, including AMPS, voting together as a single class, necessary to authorize the action in question.
(d) Voting Procedures .
(i) As soon as practicable after the accrual of any right of the holders of preferred shares of beneficial interest of the Trust to elect additional trustees as described in Section 11.5(b) above, the Trust shall call a special meeting of such holders and instruct the Auction Agent and any other registrar for preferred shares of beneficial interest of the Trust other than AMPS to mail a notice of such special meeting to such holders, such meeting to be held not less than 10 nor more than 20 days after the date of mailing of such notice. If the Trust fails to send such notice to the Auction Agent and any other applicable registrar, or if the Trust does not call such a special meeting, it may be called by any such holder on like notice. The record date for determining the holders entitled to notice of and to vote at such special meeting shall be the close of business on the fifth Business Day preceding the day on which such notice is mailed. At any such special meeting and at each meeting held during a Voting Period at which trustees are to be elected, such holders, voting together as a class (to the exclusion of the holders of all other securities and classes of shares of beneficial interest of the Trust), shall be entitled to elect the number of Trustees prescribed in Section 11.5(b) above. At any such meeting or adjournment thereof in the absence of a quorum, a majority of such holders present in person or by proxy shall have the power to adjourn the meeting without notice, other than by an announcement at the meeting, to a date not more than 120 days after the original record date.
(ii) Except as otherwise required by applicable law, for purposes of determining any rights of the Holders to vote on any matter or the number of shares required to constitute a quorum, whether such right is created by these Bylaws, by the other provisions of the Declaration of Trust, by statute or otherwise, an Auction Market Preferred Share which is not Outstanding shall not be counted.
(iii) The terms of office of all persons who are trustees of the Trust at the time of a special meeting of Holders and holders of other preferred shares of beneficial
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interest of the Trust to elect trustees shall continue, notwithstanding the election at such meeting by the Holders and such other holders of the number of trustees that they are entitled to elect, and the persons so elected by the Holders and such other holders, together with the two incumbent trustees elected by the Holders and such other holders of preferred shares of beneficial interest of the Trust and the remaining incumbent trustees elected by the holders of the Common Shares and preferred shares of beneficial interest of the Trust, shall constitute the duly elected trustees of the Trust.
(iv) Simultaneously with the termination of a Voting Period, the terms of office of the Additional Trustees shall automatically terminate, the remaining trustees shall constitute the trustees of the Trust and the voting rights of the Holders and such other holders to elect additional trustees pursuant to Section 11.5(b) above shall cease, subject to the provisions of the last sentence of Section 11.5(b).
(e) Exclusive Remedy . Unless otherwise required by law, the Holders shall not have any rights or preferences other than those specifically set forth herein. The Holders shall have no preemptive rights or rights to cumulative voting. In the event that the Trust fails to pay any dividends on the AMPS, the exclusive remedy of the Holders shall be the right to vote for trustees pursuant to the provisions of this Section 11.5.
11.6 1940 Act Preferred Shares Asset Coverage . The Trust shall maintain, as of the last Business Day of each month in which any AMPS are Outstanding, the 1940 Act Preferred Shares Asset Coverage.
11.7 Rating Agency AMPS Asset Coverage .
(a) So long as any AMPS are outstanding and any Rating Agency then rating the AMPS so requires, the Trust shall maintain, on each Valuation Date, and shall verify to its satisfaction that it is maintaining on such Valuation Date, both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage. Upon any failure to maintain Fitch AMPS Asset Coverage or Moodys AMPS Asset Coverage, the Trust will use its best efforts to alter the composition of its portfolio to achieve both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage on or prior to the Rating Agency AMPS Asset Coverage Cure Date.
(b) On or before 5:00 p.m., New York City time, on the third Business Day after a Valuation Date on which the Trust fails to satisfy Rating Agency AMPS Asset Coverage specified by a particular Rating Agency, the Trust shall complete and deliver to (i) the Auction Agent and (ii) such Rating Agency, the Rating Agency AMPS Asset Coverage Report called for by such Rating Agency, as of the date of such failure, which will be deemed to have been delivered to such recipient if the recipient receives a copy or telecopy, telex or other electronic transcription thereof and on the same day the Trust mails to the recipient for delivery on the next Business Day the complete Rating Agency AMPS Asset Coverage Report. The Trust will deliver to each applicable Rating Agency a Rating Agency AMPS Asset Coverage Report called for by such Rating Agency on or before 5:00 p.m., New York City time, on the third Business Day after a Valuation Date on which the Trust cures its
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failure to maintain Rating Agency AMPS Asset Coverage specified by such Rating Agency, or, with respect to Moodys, on which the Trust fails to maintain Eligible Assets with an aggregate Discounted Value which exceeds the AMPS Basic Maintenance Amount by 5% or more. The Trust will also deliver (i) a Fitch AMPS Asset Coverage Report to the Auction Agent and Fitch Ratings as of each Monthly Valuation Date on or before the third Business Day after such date and (ii) a Moodys AMPS Asset Coverage Report to the Auction Agent and Moodys as of each Quarterly Valuation Date on or before the third Business Day after such date. Additionally, on or before 5:00 p.m., New York City time, on the third Business Day after the first day of a Special Dividend Period, the Trust will deliver (i) a Fitch AMPS Asset Coverage Report to the Auction Agent and Fitch Ratings and (ii) a Moodys AMPS Asset Coverage Report to the Auction Agent and Moodys. The Trust shall also provide (i) Fitch Ratings with a Fitch AMPS Asset Coverage Report when specifically requested by Fitch Ratings or as otherwise required under the Fitch Criteria or (ii) Moodys with a Moodys AMPS Asset Coverage Report when specifically requested by Moodys.
(c) With respect to Moodys ratings of the AMPS, within twenty Business Days after the date of delivery of a Moodys AMPS Asset Coverage Report to the Auction Agent and Moodys in accordance with the third sentence of Section 11.7(b) above relating to a Quarterly Valuation Date (except as described in the following sentence), the Independent Accountant will confirm in writing to the Auction Agent and Moodys, (i) the mathematical accuracy of the calculations reflected in such Report, (ii) that, in such Report, the Trust correctly determined the assets of the Trust which constitute Moodys Eligible Assets at such Quarterly Valuation Date in accordance with these Bylaws, (iii) that, in such Report, the Trust determined whether the Trust had, at such Quarterly Valuation Date in accordance with these Bylaws, Moodys Eligible Assets with an aggregate Discounted Value at least equal to the AMPS Basic Maintenance Amount, (iv) with respect to the S&P ratings on portfolio securities of the Trust, the issuer name, issue size and coupon rate, if any, listed in such Report, that the Independent Accountant has verified such information in reference to third-party information sources (such as Reuters or Bloomberg) and the Independent Accountant shall provide a listing in its letter of any differences, (v) with respect to the Fitch Ratings ratings on portfolio securities of the Trust, the issuer name, issue size and coupon rate, if any, listed in such Report, that the Independent Accountant has verified such information in reference to third-party information sources (such as Reuters or Bloomberg) and the Independent Accountant shall provide a listing in its letter of any differences, (vi) with respect to the Moodys ratings on portfolio securities of the Trust, the issuer name, issue size and coupon rate, if any, listed in such Report, that the Independent Accountant has verified such information in reference to third-party information sources (such as Reuters or Bloomberg) and the Independent Accountant shall provide a listing in its letter of any differences and (vii) that the Independent Accountant has compared the prices in such Report to the prices in the applicable pricing appraisal report provided by the custodian of the Trusts assets to the Trust for purposes of valuing securities in the Trusts portfolio and verified that such information agrees (in the event such information does not agree, the Independent Accountant will provide a listing in its letter of such differences) (such confirmation is herein called the Accountants Confirmation). Notwithstanding the foregoing sentence, the Independent Accountant will provide the confirmation described in
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the foregoing sentence with respect to Moodys AMPS Asset Coverage Reports delivered pursuant to the third sentence of Section 11.7(b) above only for such Moodys AMPS Asset Coverage Reports relating to the last fiscal quarter of each fiscal year.
(d) With respect to Moodys ratings of the AMPS, within twenty Business Days after the date of delivery to the Auction Agent and Moodys of a Moodys AMPS Asset Coverage Report in accordance with the second sentence of Section 11.7(b) above relating to the Rating Agency AMPS Asset Coverage Cure Date with respect to such failure, the Trust shall cause the Independent Accountant to provide to the Auction Agent and Moodys an Accountants Confirmation as to such Moodys AMPS Asset Coverage Report.
(e) With respect to Moodys ratings of the AMPS, if any Accountants Confirmation delivered to Moodys pursuant to subparagraph (c) or (d) of this Section 11.7 shows that an error was made in the Moodys AMPS Asset Coverage Report for a particular Valuation Date for which such Accountants Confirmation was required to be delivered, or shows that a lower aggregate Discounted Value for the aggregate of all Moodys Eligible Assets of the Trust was determined by the Independent Accountant, the calculation or determination made by such Independent Accountant shall be final and conclusive and shall be binding on the Trust, and the Trust shall accordingly amend and deliver the Moodys AMPS Asset Coverage Report to the Auction Agent and Moodys promptly following receipt by the Trust of such Accountants Confirmation.
(f) Within five Business Days after the Date of Original Issue of the AMPS, the Trust will complete and deliver to Moodys a Moodys AMPS Asset Coverage Report as of the close of business on such Date of Original Issue. Also, on or before 5:00 p.m., New York City time, on the first Business Day after any Common Shares are repurchased by the Trust, the Trust will complete and deliver (i) a Fitch AMPS Asset Coverage Report to Fitch Ratings and (ii) a Moodys AMPS Asset Coverage Report to Moodys, in each case as of the close of business on such date that Common Shares are repurchased.
11.8 Certain Other Restrictions .
(a) For so long as any AMPS are rated by Moodys, the Trust will not buy or sell financial futures contracts, write, purchase or sell call options on financial futures contracts or purchase put options on financial futures contracts or write call options (except covered call options) on portfolio securities unless it receives written confirmation from Moodys that engaging in such transactions would not impair the ratings then assigned to the AMPS by Moodys, except that the Trust may purchase or sell exchange-traded financial futures contracts based on any index approved by Moodys or Treasury Bonds, and purchase, write or sell exchange-traded put options on such financial futures contracts, any index approved by Moodys or Treasury Bonds, and purchase, write or sell exchange-traded call options on such financial futures contracts, any index approved by Moodys or Treasury Bonds (collectively Moodys Hedging Transactions), subject to the following limitations:
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(i) the Trust will not engage in any Moodys Hedging Transaction based on any index approved by Moodys (other than transactions that terminate a futures contract or option held by the Trust by the Trusts taking the opposite position thereto (Closing Transactions)) that would cause the Trust at the time of such transaction to own or have sold:
(A) outstanding financial futures contracts based on such index exceeding in number 10% (or such higher percentage as Moodys may approve) of the average number of daily traded financial futures contracts based on such index in the 30 days preceding the time of effecting such transaction as reported by The Wall Street Journal ; or
(B) outstanding financial futures contracts based on any index approved by Moodys having a Market Value exceeding 50% (or such higher percentage as Moodys may approve) of the Market Value of all portfolio securities of the Trust constituting Moodys Eligible Assets owned by the Trust (other than Moodys Eligible Assets already subject to a Moodys Hedging Transaction);
(ii) the Trust will not engage in any Moodys Hedging Transaction based on Treasury Bonds (other than Closing Transactions) that would cause the Trust at the time of such transaction to own or have sold:
(A) outstanding financial futures contracts based on Treasury Bonds with such contracts having an aggregate Market Value exceeding 20% (or such higher percentage as Moodys may approve) of the aggregate Market Value of Moodys Eligible Assets owned by the Trust and rated Aa or higher by Moodys (or, if not rated by Moodys but rated by S&P or Fitch Ratings, rated AAA by S&P or Fitch Ratings); or
(B) outstanding financial futures contracts based on Treasury Bonds with such contracts having an aggregate Market Value exceeding 80% of the aggregate Market Value of all portfolio securities of the Trust constituting Moodys Eligible Assets owned by the Trust (other than Moodys Eligible Assets already subject to a Moodys Hedging Transaction) and rated Baa or A by Moodys (or, if not rated by Moodys but rated by S&P or Fitch Ratings, rated A or AA by S&P or Fitch Ratings)
(for purposes of the foregoing clauses (i) and (ii), the Trust shall be deemed to own the number of financial futures contracts that underlie any outstanding options written by the Trust);
(iii) the Trust will engage in Closing Transactions to close out any outstanding financial futures contract based on any index approved by Moodys if the amount of open interest in such index as reported by The Wall Street Journal is less than an amount to be mutually determined by Moodys and the Trust;
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(iv) the Trust will engage in a Closing Transaction to close out any outstanding financial futures contract by no later than the fifth Business Day of the month in which such contract expires and will engage in a Closing Transaction to close out any outstanding option on a financial futures contract by no later than the first Business Day of the month in which such option expires;
(v) the Trust will engage in Moodys Hedging Transactions only with respect to financial futures contracts or options thereon having the next settlement date or the settlement date immediately thereafter;
(vi) the Trust (A) will not engage in options and futures transactions for leveraging or speculative purposes, except that an option or futures transaction shall not for these purposes be considered a leveraged position or speculative so long as the combination of the Trusts non-derivative positions, together with the relevant option or futures transaction, produces a synthetic investment position, or the same economic result, that could be achieved by an investment, consistent with the Trusts investment objectives and policies, in a security that is not an option or futures transaction, and (B) will not write any call options or sell any financial futures contracts for the purpose of hedging the anticipated purchase of an asset prior to completion of such purchase; and
(vii) while the Trust may use options and futures transactions for hedging and risk management purposes, it will not enter into an option or futures transaction unless, after giving effect thereto, the Trust would continue to have Moodys AMPS Asset Coverage.
(b) For purposes of determining whether the Trust has Moodys AMPS Asset Coverage, the Discounted Value of Moodys Eligible Assets that the Trust is obligated to deliver or receive pursuant to an outstanding futures contract or option shall be as follows:
(i) assets subject to call options written by the Trust that are either exchange-traded and readily reversible or that expire within 49 days after the date as of which such valuation is made shall be valued at the lesser of (A) Discounted Value and (B) the exercise price of the call option written by the Trust;
(ii) assets subject to call options written by the Trust not meeting the requirements of clause (i) of this sentence shall have no value;
(iii) assets subject to put options written by the Trust shall be valued at the lesser of (A) the exercise price and (B) the Discounted Value of the assets subject to the option;
(iv) futures contracts shall be valued at the lesser of (A) settlement price and (B) the Discounted Value of the assets subject to the futures contract, provided that, if a contract matures within 49 days after the date as of which such valuation is made, where the Trust is the seller the contract may be valued at the settlement price and where the Trust is the buyer the contract may be valued at the Discounted Value of the assets subject to the futures contract; and
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(v) where delivery may be made to the Trust with any security of a class of securities, the Trust shall assume that it will take delivery of the security with the lowest Discounted Value.
(c) For purposes of determining whether the Trust has Moodys AMPS Asset Coverage, the following amounts shall be subtracted from the aggregate Discounted Value of the Moodys Eligible Assets held by the Trust to the extent the relevant asset is a Moodys Eligible Asset:
(i) 10% of the exercise price of a written call option;
(ii) the exercise price of any written put option;
(iii) where the Trust is the seller under a financial futures contract, 10% of the settlement price of the financial futures contract;
(iv) where the Trust is the purchaser under a financial futures contract, any amounts payable by the Trust under such financial futures contract;
(v) the settlement price of the underlying financial futures contract if the Trust writes put options on a financial futures contract; and
(vi) 105% of the Market Value of the underlying financial futures contract if the Trust writes call options on a financial futures contract and does not own the underlying contract.
(d) For so long as any AMPS are rated by Moodys, the Trust will not enter into any Moodys Forward Commitment, herein defined as any contract to purchase securities for a fixed price at a future date beyond customary settlement time (other than such contracts that constitute Moodys Hedging Transactions), except that the Trust may enter into Moodys Forward Commitments subject to the following limitations:
(i) for each Moodys Forward Commitment, the Trust will maintain with its custodian (A) cash, cash equivalents or short-term, fixed-income securities rated P-1, MIG-1 or VMIG-1 by Moodys or A-1 by S&P or Fitch Ratings and maturing in one year or less with a fair market value that equals or exceeds the amount by which the Trusts obligations under any Moodys Forward Commitments to which it is from time to time a party exceed obligations to the Trust arising from securities sales by the Trust that are scheduled to settle at a future date, or (B) long-term, fixed-income securities with a then current market value that equals or exceeds the amount by which the Trusts obligations under any Moodys Forward Commitments to which it is from time to time a party exceed obligations to the Trust arising from securities sales by the Trust that are scheduled to settle on a future date, or (C) a combination of assets described in
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(A) and (B) above that in the aggregate equals or exceeds the amount by which the Trusts obligations under any Moodys Forward Commitments to which it is from time to time a party exceed obligations to the Trust arising from securities sales by the Trust that are scheduled to settle on a future date; and
(ii) the Trust will not enter into a Moodys Forward Commitment unless, after giving effect thereto, the Trust would continue to have Moodys AMPS Asset Coverage.
For purposes of determining whether the Trust has Moodys AMPS Asset Coverage, the Discounted Value of all Moodys Forward Commitments to which the Trust is a party and of all securities deliverable to the Trust pursuant to such Moodys Forward Commitments shall be zero.
(e) For so long as any AMPS are Outstanding and Moodys is rating such shares, the Trust, unless it has received written confirmation from Moodys that such action would not impair the rating then assigned to the AMPS by Moodys will not:
(i) borrow money except for the purpose of clearing transactions in portfolio securities (which borrowings under any circumstances shall be limited to an amount equal to 5% of the Market Value of the Trusts assets at the time of such borrowings and which borrowings shall be repaid within 60 days and not be extended or renewed and shall not cause the Trust to fail to satisfy Moodys AMPS Asset Coverage);
(ii) engage in short sales of securities;
(iii) lend any securities;
(iv) issue any class or series of shares of beneficial interest ranking prior to or on a parity with the AMPS with respect to the payment of dividends or the distribution of assets upon dissolution, liquidation or winding up of the Trust;
(v) merge or consolidate into or with any other corporation or entity; and
(vi) change any Pricing Service of the Trust.
(f) For so long as any AMPS are rated by Fitch Ratings, the Trust will not enter into any Fitch Covered Forward Commitment, herein defined as any contract to purchase securities for a fixed price at a future date beyond customary settlement time which, after giving effect thereto, would result in the Trust failing to satisfy Fitch AMPS Asset Coverage.
11.9 Notice . All notices or communications, unless otherwise specified in these Bylaws, shall be sufficiently given if in writing and delivered in person or mailed by first-class mail, postage prepaid. Notice shall be deemed given on the earlier of the date received or the date seven days after which such notice is mailed.
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11.10 | Auction Procedures . |
(a) Certain Definitions . As used in this Section 11.10, the following terms shall have the following meanings, unless the context otherwise requires:
(i) AMPS means the AMPS being auctioned pursuant to this Section 11.10
(ii) Auction Date means the first Business Day preceding the first day of a Dividend Period.
(iii) Available AMPS has the meaning specified in Section 11.10(d)(i)(A) below.
(iv) Bid has the meaning specified in Section 11.10(b)(i)(B) below.
(v) Bidder has the meaning specified in Section 11.10(b)(i)(B) below.
(vi) Hold Order has the meaning specified in Section 11.10(b)(i)(B) below.
(vii) Maximum Applicable Rate for any Dividend Period will be the greater of the Applicable Percentage of the Reference Rate or the Applicable Spread plus the Reference Rate. The Auction Agent will round each applicable Maximum Applicable Rate to the nearest one-thousandth (.001) of one percent per annum, with any such number ending in five ten-thousandths of one percent being rounded upwards to the nearest one-thousandth (.001) of one percent. The Auction Agent will not round the applicable Reference Rate as part of its calculation of the Maximum Applicable Rate.
The Applicable Percentage shall be the percentage determined based on the lower of the credit ratings assigned on such date by Moodys and Fitch Ratings as follows:
Credit Ratings |
Applicable Percentage |
|||
Moodys |
Fitch |
|||
Aaa |
AAA | 125% | ||
Aa3 to Aa1 |
AA- to AA+ | 150% | ||
A3 to A1 |
A- to A+ | 200% | ||
Baa3 to Baa1 |
BBB- to BBB+ | 250% | ||
Ba1 and lower |
BB+ and lower | 300% |
The Applicable Percentage as so determined shall be further subject to upward but not downward adjustment in the discretion of the Board of Trustees of the Trust after consultation with the Broker-Dealers, provided that the Board of Trustees has received assurance from Moodys, Fitch Ratings and from any other Rating Agency then rating the AMPS that such increase will not impair such Rating Agencys rating thereof, and further provided that immediately following any such increase the Trust would satisfy both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage. The Trust shall take all
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reasonable action necessary to enable Moodys or Fitch Ratings to provide a rating for each series of AMPS. If Moodys or Fitch Ratings shall not make such a rating available, Merrill Lynch, Pierce, Fenner and Smith Incorporated or its affiliates and successors, after consultation with the Trust, shall select another Rating Agency to act as a Substitute Rating Agency.
Applicable Spread means the spread determined based on the credit rating assigned to the series of AMPS on such date by Moodys and Fitch Ratings as follows:
Credit Ratings |
Applicable Spread over Reference Rate |
|||
Moodys |
Fitch |
|||
Aaa |
AAA | 125 bps | ||
Aa3 to Aa1 |
AA-to AA+ | 150 bps | ||
A3 to A1 |
A- to A+ | 200 bps | ||
Baa3 to Baa1 |
BBB-to BBB+ | 250 bps | ||
Ba1 and lower |
BB+ and lower | 300 bps |
The 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 that immediately following any such increase the Trust would satisfy both Fitch AMPS Asset Coverage and Moodys AMPS Asset Coverage. The Trust will take all reasonable action necessary to enable either Moodys or Fitch Ratings to provide a rating for each series of AMPS. If neither Moodys nor Fitch Ratings will make such a rating available, the Trust will select another Rating Agency to act as a substitute Rating Agency.
For purposes of this definition, the prevailing rating of shares of a series of AMPS will be (i) AAA if such shares have a rating of AAA by Moodys or Fitch Ratings or the equivalent of such ratings by such agencies or substitute rating agencies selected as provided below; (ii) if not AAA, then AA- if such shares have a rating of AA- or better by Moodys or Fitch Ratings or the equivalent of such ratings by such agencies or substitute rating agencies selected as provided below, (iii) if not AA- or higher, than A- if such shares have a rating of A- or better by Moodys or Fitch Ratings or the equivalent of such ratings by such agencies or substitute rating agencies selected as provided below, (iv) if not A- or higher then BBB- if such shares have a rating of BBB- or better by Moodys or Fitch Ratings or the equivalent of such ratings by such agencies or substitute rating agencies selected as provided below, (v) if not BBB- or higher, then below BBB-; provided, however, that if such shares are rated by only one rating agency, the prevailing rating will be determined without reference to the rating of any other rating agency.
(viii) Order has the meaning specified in Section 11.10(b)(i)(B) below.
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(ix) Sell Order has the meaning specified in Section 11.10(b)(i)(B) below.
(x) Submission Deadline means 1:00 p.m., New York City time, on any Auction Date or such other time on any Auction Date as may be specified by the Auction Agent from time to time as the time by which each Broker-Dealer must submit to the Auction Agent in writing all Orders obtained by it for the Auction to be conducted on such Auction Date.
(xi) Submission Processing Deadline means the earlier of (i) 40 minutes after the Submission Deadline and (ii) the time when the Auction Agent begins to disseminate the results of the Auction to the Broker-Dealers.
(xii) Submitted Bid has the meaning specified in Section 11.10(d)(i) below.
(xiii) Submitted Hold Order has the meaning specified in Section 11.10(d)(i) below.
(xiv) Submitted Order has the meaning specified in Section 11.10(d)(i) below.
(xv) Submitted Sell Order has the meaning specified in Section 11.10(d)(i) below.
(xvi) Sufficient Clearing Bids has the meaning specified in Section 11.10(d)(i) below.
(xvii) Winning Bid Rate has the meaning specified in Section 11.10(d)(i)(C) below.
(b) Orders by Beneficial Owners, Potential Beneficial Owners, Existing Holders and Potential Holders .
(i) Unless otherwise permitted by the Trust, Beneficial Owners and Potential Beneficial Owners may only participate in Auctions through their Broker-Dealers. Broker-Dealers will submit the Orders of their respective customers who are Beneficial Owners and Potential Beneficial Owners to the Auction Agent, designating themselves as Existing Holders in respect of shares subject to Orders submitted or deemed submitted to them by Beneficial Owners and as Potential Holders in respect of shares subject to Orders submitted to them by Potential Beneficial Owners. A Broker-Dealer may also hold AMPS in its own account as a Beneficial Owner. A Broker-Dealer may thus submit Orders to the Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and therefore participate in an Auction as an Existing Holder or Potential Holder on behalf of both itself and its customers. On or prior to the Submission Deadline on each Auction Date:
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(A) each Beneficial Owner may submit to its Broker-Dealer information as to:
(1) the number of Outstanding AMPS, if any, held by such Beneficial Owner which such Beneficial Owner desires to continue to hold without regard to the Applicable Rate for the next succeeding Dividend Period for such shares;
(2) the number of Outstanding AMPS, if any, held by such Beneficial Owner which such Beneficial Owner desires to continue to hold, provided that the Applicable Rate for the next succeeding Dividend Period for such shares shall not be less than the rate per annum specified by such Beneficial Owner; and/or
(3) the number of Outstanding AMPS, if any, held by such Beneficial Owner which such Beneficial Owner offers to sell without regard to the Applicable Rate for the next succeeding Dividend Period; and
(B) each Broker-Dealer, using a list of Potential Beneficial Owners that shall be maintained in good faith in a commercially reasonable manner for the purpose of conducting a competitive Auction, shall contact Potential Beneficial Owners, including Persons that are not Beneficial Owners, on such list to determine the number of Outstanding AMPS, if any, which each such Potential Beneficial Owner offers to purchase, provided that the Applicable Rate for the next succeeding Dividend Period shall not be less than the rate per annum specified by such Potential Beneficial Owner.
For the purposes hereof, the communication by a Beneficial Owner or Potential Beneficial Owner to a Broker-Dealer, or the communication by a Broker-Dealer acting for its own account to the Auction Agent, of information referred to in clause (A) or (B) of this Section 11.10(b)(i) is hereinafter referred to as an Order and each Beneficial Owner and each Potential Beneficial Owner placing an Order, including a Broker-Dealer acting in such capacity for its own account, is hereinafter referred to as a Bidder; an Order containing the information referred to in clause (A)(1) of this Section 11.10(b)(i) is hereinafter referred to as a Hold Order; an Order containing the information referred to in clause (A)(2) or (B) of this Section 11.10(b)(i) is hereinafter referred to as a Bid; and an Order containing the information referred to in clause (A)(3) of this Section 11.10(b)(i) is hereinafter referred to as a Sell Order. Inasmuch as a Broker-Dealer participates in an Auction as an Existing Holder or a Potential Holder only to represent the interests of a Beneficial Owner or Potential Beneficial Owner, whether it be its customers or itself, all discussion herein relating to the consequences of an Auction for Existing Holders and Potential Holders also applies to the underlying beneficial ownership interests represented.
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(ii)(A) A Bid by a Beneficial Owner or an Existing Holder shall constitute an irrevocable offer to sell:
(1) the number of Outstanding AMPS specified in such Bid if the Applicable Rate determined on such Auction Date shall be less than the rate per annum specified in such Bid; or
(2) such number or a lesser number of Outstanding AMPS to be determined as set forth in Section 11.10(e)(i)(D) if the Applicable Rate determined on such Auction Date shall be equal to the rate per annum specified therein; or
(3) a lesser number of Outstanding AMPS to be determined as set forth in Section 11.10(e)(ii)(C) if such specified rate per annum shall be higher than the Maximum Applicable Rate and Sufficient Clearing Bids do not exist.
(B) A Sell Order by a Beneficial Owner or an Existing Holder shall constitute an irrevocable offer to sell:
(1) the number of Outstanding AMPS specified in such Sell Order; or
(2) such number or a lesser number of Outstanding AMPS to be determined as set forth in Section 11.10(e)(ii)(C) if Sufficient Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable offer to purchase:
(1) the number of Outstanding AMPS specified in such Bid if the Applicable Rate determined on such Auction Date shall be higher than the rate per annum specified in such Bid; or
(2) such number or a lesser number of Outstanding AMPS to be determined as set forth in Section 11.10(e)(i)(E) if the Applicable Rate determined on such Auction Date shall be equal to the rate per annum specified therein.
(c) Submission of Orders by Broker-Dealers to Auction Agent .
(i) Each Broker-Dealer shall submit in writing or through the Auction Agents auction processing system to the Auction Agent prior to the Submission Processing Deadline on each Auction Date all Orders that were (x) received by the Broker-Dealer from Beneficial Owners or Potential Beneficial Owners prior to the Submission Deadline or (y) initiated internally by the Broker-Dealer for its own account prior to the Submission Deadline, in each case designating itself (unless otherwise permitted by the Trust) as an Existing Holder in respect of shares subject to Orders submitted or deemed submitted to it by Beneficial Owners and as a Potential
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Holder in respect of shares subject to Orders submitted to it by Potential Beneficial Owners, and specifying with respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the Broker-Dealer unless otherwise permitted by the Trust);
(B) the aggregate number of Outstanding AMPS that are the subject of such Order;
(C) to the extent that such Bidder is a Beneficial Owner or an Existing Holder:
(1) the number of Outstanding AMPS, if any, subject to any Hold Order placed by such Beneficial Owner or Existing Holder;
(2) the number of Outstanding AMPS, if any, subject to any Bid placed by such Beneficial Owner or Existing Holder and the rate per annum specified in such Bid; and
(3) the number of Outstanding AMPS, if any, subject to any Sell Order placed by such Beneficial Owner or Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per annum specified in such Potential Holders Bid.
(ii) If any rate per annum specified in any Bid contains more than three figures to the right of the decimal point, the Auction Agent shall round such rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the Outstanding AMPS held by an Existing Holder are not submitted to the Auction Agent prior to the Submission Processing Deadline, the Auction Agent shall deem a Hold Order (in the case of any Auction other than an Auction relating to a Special Dividend Period longer than 91 days) or a Sell Order (in the case of an Auction relating to a Special Dividend Period of longer than 91 days) to have been submitted on behalf of such Existing Holder covering the number of Outstanding AMPS held by such Existing Holder and not subject to Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in the aggregate more than the number of Outstanding AMPS held by such Existing Holder are submitted to the Auction Agent, such Order shall be considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder shall be considered valid up to and including the number of Outstanding AMPS held by
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such Existing Holder; provided that if more than one Hold Order is submitted on behalf of such Existing Holder and the number of AMPS subject to such Hold Orders exceeds the number of Outstanding AMPS held by such Existing Holder, the number of AMPS subject to each of such Hold Orders shall be reduced pro rata so that such Hold Orders, in the aggregate, will cover exactly the number of Outstanding AMPS held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be considered valid, in the ascending order of their respective rates per annum if more than one Bid is submitted on behalf of such Existing Holder, up to and including the excess of the number of Outstanding AMPS held by such Existing Holder over the number of AMPS subject to any Hold Order referred to in Section 11.10(c)(iv)(A) above (and if more than one Bid submitted on behalf of such Existing Holder specifies the same rate per annum and together they cover more than the remaining number of shares that can be the subject of valid Bids after application of Section 11.10(c)(iv)(A) above and of the foregoing portion of this Section 11.10(c)(iv)(B) to any Bid or Bids specifying a lower rate or rates per annum, the number of shares subject to each of such Bids shall be reduced pro rata so that such Bids, in the aggregate, cover exactly such remaining number of shares); and the number of shares, if any, subject to Bids not valid under this Section 11.10(c)(iv)(B) shall be treated as the subject of a Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and including the excess of the number of Outstanding AMPS held by such Existing Holder over the number of AMPS subject to Hold Orders referred to in Section 11.10(c)(iv)(A) and Bids referred to in Section 11.10(c)(iv)(B); provided that if more than one Sell Order is submitted on behalf of any Existing Holder and the number of AMPS subject to such Sell Orders is greater than such excess, the number of AMPS subject to each of such Sell Orders shall be reduced pro rata so that such Sell Orders, in the aggregate, cover exactly the number of AMPS equal to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder, each Bid submitted shall be a separate Bid with the rate per annum and number of AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner as a Potential Beneficial Owner to its Broker-Dealer prior to the Submission Deadline, or by a Broker-Dealer to the Auction Agent, prior to the Submission Processing Deadline on any Auction Date shall be irrevocable.
(vii) The Trust shall not be responsible for a Broker-Dealers failure to act in accordance with the instructions of Beneficial Owners or Potential Beneficial Owners or failure to comply with the provisions of this Section 11.10.
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(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable Rate .
(i) Not earlier than the Submission Deadline on each Auction Date, the Auction Agent shall assemble all Orders submitted or deemed submitted to it by the Broker-Dealers (each such Order as submitted or deemed submitted by a Broker-Dealer being hereinafter referred to individually as a Submitted Hold Order, a Submitted Bid or a Submitted Sell Order, as the case may be, or, more generally, as a Submitted Order) and shall determine:
(A) the excess of the total number of Outstanding AMPS over the number of Outstanding AMPS that are the subject of Submitted Hold Orders (such excess being hereinafter referred to as the Available AMPS);
(B) from the Submitted Orders whether the number of Outstanding AMPS that are the subject of Submitted Bids by Potential Holders specifying one or more rates per annum equal to or lower than the Maximum Applicable Rate exceeds or is equal to the sum of:
(1) the number of Outstanding AMPS that are the subject of Submitted Bids by Existing Holders specifying one or more rates per annum higher than the Maximum Applicable Rate, and
(2) the number of Outstanding AMPS that are subject to Submitted Sell Orders (if such excess or such equality exists (other than because the number of Outstanding AMPS in clause (1) above and this clause (2) are each zero because all of the Outstanding AMPS are the subject of Submitted Hold Orders), such Submitted Bids by Potential Holders being hereinafter referred to collectively as Sufficient Clearing Bids); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum specified in the Submitted Bids (the Winning Bid Rate) that if:
(1) each Submitted Bid from Existing Holders specifying the Winning Bid Rate and all other Submitted Bids from Existing Holders specifying lower rates per annum were rejected, thus entitling such Existing Holders to continue to hold the AMPS that are the subject of such Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the Winning Bid Rate and all other Submitted Bids from Potential Holders specifying lower rates per annum were accepted, thus entitling the Potential Holders to purchase the AMPS that are the subject of such Submitted Bids, would result in the number of shares subject to all Submitted Bids specifying the Winning Bid Rate or a lower rate per annum being at least equal to the Available AMPS.
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(ii) Promptly after the Auction Agent has made the determinations pursuant to Section 11.10(d)(i), the Auction Agent shall advise the Trust of the Maximum Applicable Rate and, based on such determinations, the Applicable Rate for the next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate for the next succeeding Dividend Period shall be equal to the Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because all of the Outstanding AMPS are the subject of Submitted Hold Orders), that the Applicable Rate for the next succeeding Dividend Period shall be equal to the Maximum Applicable Rate; or
(C) if all of the Outstanding AMPS are the subject of Submitted Hold Orders, that the Dividend Period next succeeding the Auction shall automatically be the same length as the immediately preceding Dividend Period and the Applicable Rate for the next succeeding Dividend Period shall be equal to 80% of the Reference Rate on the date of the Auction.
(e) Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares . Existing Holders shall continue to hold the AMPS that are subject to Submitted Hold Orders, and, based on the determinations made pursuant to Section 11.10(d)(i), the Submitted Bids and Submitted Sell Orders shall be accepted or rejected and the Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the provisions of Section 11.10(e)(iii) and Section 11.10(e)(iv), Submitted Bids and Submitted Sell Orders shall be accepted or rejected in the following order of priority and all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be accepted and the Submitted Bid of each of the Existing Holders specifying any rate per annum that is higher than the Winning Bid Rate shall be accepted, thus requiring each such Existing Holder to sell the Outstanding AMPS that are the subject of such Submitted Sell Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders specifying any rate per annum that is lower than the Winning Bid Rate shall be rejected, thus entitling each such Existing Holder to continue to hold the Outstanding AMPS that are the subject of such Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders specifying any rate per annum that is lower than the Winning Bid Rate shall be accepted;
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(D) the Submitted Bid of each of the Existing Holders specifying a rate per annum that is equal to the Winning Bid Rate shall be rejected, thus entitling each such Existing Holder to continue to hold the Outstanding AMPS that are the subject of such Submitted Bid, unless the number of Outstanding AMPS subject to all such Submitted Bids shall be greater than the number of Outstanding AMPS (Remaining Shares) equal to the excess of the Available AMPS over the number of Outstanding AMPS subject to Submitted Bids described in Section 11.10(e)(i)(B) and Section 11.10(e)(i)(C), in which event the Submitted Bids of each such Existing Holder shall be accepted, and each such Existing Holder shall be required to sell Outstanding AMPS, but only in an amount equal to the difference between (1) the number of Outstanding AMPS then held by such Existing Holder subject to such Submitted Bid and (2) the number of AMPS obtained by multiplying (x) the number of Remaining Shares by (y) a fraction the numerator of which shall be the number of Outstanding AMPS held by such Existing Holder subject to such Submitted Bid and the denominator of which shall be the sum of the number of Outstanding AMPS subject to such Submitted Bids made by all such Existing Holders that specified a rate per annum equal to the Winning Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders specifying a rate per annum that is equal to the Winning Bid Rate shall be accepted but only in an amount equal to the number of Outstanding AMPS obtained by multiplying (x) the difference between the Available AMPS and the number of Outstanding AMPS subject to Submitted Bids described in Section 11.10(e)(i)(B), Section 11.10(e)(i)(C) and Section 11.10(e)(i)(D) by (y) a fraction the numerator of which shall be the number of Outstanding AMPS subject to such Submitted Bid and the denominator of which shall be the number of Outstanding AMPS subject to such Submitted Bids made by all such Potential Holders that specified rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because all of the Outstanding AMPS are subject to Submitted Hold Orders), subject to the provisions of Section 11.10(e)(iii), Submitted Orders shall be accepted or rejected as follows in the following order of priority and all other Submitted Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate per annum that is equal to or lower than the Maximum Applicable Rate shall be rejected, thus entitling such Existing Holder to continue to hold the Outstanding AMPS that are the subject of such Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate per annum that is equal to or lower than the Maximum Applicable Rate shall be accepted, thus requiring such Potential Holder to purchase the Outstanding AMPS that are the subject of such Submitted Bid; and
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(C) the Submitted Bids of each Existing Holder specifying any rate per annum that is higher than the Maximum Applicable Rate shall be accepted and the Submitted Sell Orders of each Existing Holder shall be accepted, in both cases only in an amount equal to the difference between (1) the number of Outstanding AMPS then held by such Existing Holder subject to such Submitted Bid or Submitted Sell Order and (2) the number of AMPS obtained by multiplying (x) the difference between the Available AMPS and the aggregate number of Outstanding AMPS subject to Submitted Bids described in Section 11.10(e)(ii)(A) and Section 11.10(e)(ii)(B) by (y) a fraction the numerator of which shall be the number of Outstanding AMPS held by such Existing Holder subject to such Submitted Bid or Submitted Sell Order and the denominator of which shall be the number of Outstanding AMPS subject to all such Submitted Bids and Submitted Sell Orders. If all of the Outstanding shares of a series of AMPS are subject to Submitted Hold Orders, all Submitted Bids for shares of such series shall be rejected.
(iii) If, as a result of the procedures described in Section 11.10(e), any Existing Holder would be entitled or required to sell, or any Potential Holder would be entitled or required to purchase, a fraction of an Auction Market Preferred Share on any Auction Date, the Auction Agent shall, in such manner as in its sole discretion it shall determine, round up or down the number of AMPS to be purchased or sold by any Existing Holder or Potential Holder on such Auction Date so that each Outstanding Auction Market Preferred Share purchased or sold by each Existing Holder or Potential Holder on such Auction Date shall be a whole Auction Market Preferred Share.
(iv) If, as a result of the procedures described in Section 11.10(e), any Potential Holder would be entitled or required to purchase less than a whole Auction Market Preferred Share on any Auction Date, the Auction Agent shall, in such manner as in its sole discretion it shall determine, allocate AMPS for purchase among Potential Holders so that only whole AMPS are purchased on such Auction Date by any Potential Holder, even if such allocation results in one or more of such Potential Holders not purchasing any AMPS on such Auction Date.
(v) Based on the results of each Auction, the Auction Agent shall determine, with respect to each Broker-Dealer that submitted Bids or Sell Orders on behalf of Existing Holders or Potential Holders, the aggregate number of Outstanding AMPS to be purchased and the aggregate number of the Outstanding AMPS to be sold by such Potential Holders and Existing Holders and, to the extent that such aggregate number of Outstanding shares to be purchased and such aggregate number of Outstanding shares to be sold differ, the Auction Agent shall determine to which other Broker-Dealer or Broker-Dealers acting for one or more purchasers such Broker-Dealer shall deliver, or from which other Broker-Dealer or Broker-Dealers acting for one or more sellers such Broker-Dealer shall receive, as the case may be, Outstanding AMPS.
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(f) Miscellaneous .
(i) To the extent permitted by applicable law, the Trust may in its sole discretion interpret the provisions of this Section 11.10 to resolve any inconsistency or ambiguity, remedy any formal defect or make any other change or modification that does not substantially adversely affect the rights of Beneficial Owners of AMPS.
(ii) Unless otherwise permitted by the Trust, a Beneficial Owner or an Existing Holder (A) may sell, transfer or otherwise dispose of AMPS only pursuant to a Bid or Sell Order in accordance with the procedures described in this Section 11.10 or to or through a Broker-Dealer or to such other persons as may be permitted by the Trust, provided that in the case of all transfers other than pursuant to Auctions such Beneficial Owner or Existing Holder, its Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of such transfer and (B) except as otherwise required by law, shall have the ownership of the AMPS held by it maintained in book entry form by the Securities Depository in the account of its Agent Member, which in turn will maintain records of such Beneficial Owners beneficial ownership. The Trust may not submit an Order in any Auction.
(iii) All of the Outstanding AMPS of a series shall be registered in the name of the nominee of the Securities Depository unless otherwise required by law or unless there is no Securities Depository. If there is no Securities Depository, at the Trusts option and upon its receipt of such documents as it deems appropriate, any AMPS may be registered in the Share Register in the name of the Beneficial Owner thereof and such Beneficial Owner thereupon will be entitled to receive certificates therefor and required to deliver certificates therefor upon transfer or exchange thereof.
11.11 | Securities Depository; Stock Certificates . |
(a) If there is a Securities Depository, all of the AMPS of each series shall be issued to the Securities Depository and registered in the name of the Securities Depository or its nominee. Certificates may be issued as necessary to represent AMPS. All such certificates shall bear a legend to the effect that such certificates are issued subject to the provisions restricting the transfer of AMPS contained in these Bylaws. Unless the Trust shall have elected, during a Non-Payment Period, to waive this requirement, the Trust will also issue stop-transfer instructions to the Auction Agent for the AMPS. Except as provided in paragraph (b) below, the Securities Depository or its nominee will be the Holder, and no Beneficial Owner shall receive certificates representing its ownership interest in such shares.
(b) If the Applicable Rate applicable to all AMPS of a series shall be the Non-Payment Period Rate or there is no Securities Depository, the Trust may at its option issue one or more new certificates with respect to such shares (without the legend referred to in Section 11.11(a)) registered in the names of the Beneficial Owners or their nominees and rescind the stop-transfer instructions referred to in Section 11.11(a) with respect to such shares.
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ARTICLE 12
Amendment to the Bylaws
12.1 General . Except to the extent that the Declaration of Trust or applicable law requires a vote or consent of Shareholders or a higher vote or consent by the Trustees and/or the Continuing Trustees, these Bylaws may be amended, changed, altered or repealed, in whole or part, only by resolution of a majority of the Trustees and a majority of the Continuing Trustees then in office at any meeting of the Trustees, or by one or more writings signed by such Trustees and Continuing Trustees.
12.2 Article 11 . Without limiting the provisions of Section 12.1, the Board of Trustees of the Trust may, by resolution duly adopted, without shareholder approval (except as otherwise required by Article 11 or required by applicable law), amend Article 11 to (a) reflect any amendments thereto which the Board of Trustees of the Trust is entitled to adopt pursuant to the terms of Article 11 without shareholder approval or (b) add additional series of AMPS or additional shares of a series of AMPS (and terms relating thereto) to the series and AMPS described herein, provided that the Board of Trustees shall not authorize, create or issue an additional series of AMPS unless it has received assurance from Moodys, Fitch Ratings and from any other Rating Agency then rating the AMPS that such authorization, creation or issuance will not impair such Rating Agencys then current rating thereof. Each such additional series and all such additional AMPS shall be governed by the terms of Article 11.
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Exhibit 1
Fitch Criteria dated August 17, 2009
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Fund & Asset Manager Rating Group |
Closed-End Fund Criteria Report
Analysts
Ian Rasmussen
+1 212 908-0232
ian.rasmussen@fitchratings.com
Yuriy Layvand, CPA
+1 212 908-9191
yuriy.layvand@fitchratings.com
Nathan Flanders
+1 212 908-0827
nathan.flanders@fitchratings.com
Roger Merritt
+1 212 908-0636
roger.merritt@fitchratings.com
Viktoria Baklanova, CFA
+1 212 908-9162
viktoria.baklanova@fitchratings.com
Related Research
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U.S. Leveraged Closed-End Funds: Taking Remedial Actions to Offset Market Stresses, Feb 11, 2009 |
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Rating Market Value Structures, April 18, 2008 |
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FAQs on ARS Issued by Closed-End Funds, June 4, 2008 |
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Closed-End Funds Leverage Refinancing & Fitch ARS Ratings, May 7, 2008 |
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Auction-Rate Securities Issued by Closed-End Funds Credit Good, Liquidity Constrained, March 13, 2008 |
Correction
This report was originally published on July 17, 2009. Changes were made to clarify certain discount factors for convertible preferred stock and Fitchs treatment of putable securities. The changes are as follows: language pertaining to the 1940 Act, pages 6, 8, 13, 14, and 16; certain discount factors for treatment of busted convertible preferred stock, page 10; definition of FFELP students loans, page 11; clarification on Fitchs treatment of putable securities, page 11; and inclusion of certain corporate industries, page 17.
Closed-End Fund Debt and Preferred Stock Rating Criteria
Background
This report updates and replaces the criteria report titled Closed-End Fund Debt and Preferred Stock Rating Criteria, published on March 3, 2006, and finalizes the proposed changes outlined in Fitch Ratings exposure draft report on the topic published on May 1, 2009. The updated rating criteria for debt and preferred stock issued by CEFs follow a firmwide initiative to update Fitchs methodology for related market value structures in recognition of heightened market volatility and asset correlation, as noted in Fitch Research on Rating Market Value Structures, dated April 18, 2008 (available on Fitchs web site at www.fitchratings.com) .
This criteria report addresses only U.S. leveraged CEFs regulated under the Investment Company Act of 1940, as amended (1940 Act). CEFs domiciled outside the U.S., such as CEFs operating under Puerto Rican securities regulation, will be addressed in separate rating criteria to be published in the near future.
Criteria Highlights
The key components of Fitchs updated rating criteria for debt and preferred stock issued by CEFs are discussed below.
Continued Emphasis on Portfolio Market Value Analysis
Stress-testing a portfolios market value to determine a funds ability to redeem rated liabilities through asset dispositions remains a core element of Fitchs rating methodology for CEFs. The structural protections afforded by the 1940 Act provide a baseline set of protections. However, Fitch also considers credit, market value, and/or structural risks not addressed in the 1940 Act, as well as additional protections within the offering memorandum and other governing documents that may differ from 1940 Act requirements.
Updated Asset Discount Factors
Discount factors applicable to fund portfolio assets used to calculate the amount of overcollateralization (OC) in place to support rated liabilities were revised by Fitch. The number of asset categories and corresponding discount factors have also been simplified and consolidated. The revised discount factors incorporate heightened asset price volatility, observed across many asset classes in the past 18 months, and Fitchs updated view on asset market value risk, resulting in an overall more conservative view across most asset classes.
CEFs have dynamic portfolios, both in terms of composition and market value. As such, Fitch expects the value of assets and the discount factors applied to portfolio assets to change over time. The potential for variability of these elements, together with Fitchs view that the exposure period for potential market value deterioration prior to redemption is approximately 45 business days, necessitates regular reviews of both portfolio assets and leverage, as well as recalculation of the Fitch OC and 1940 Act coverage tests.
www.fitchratings.com | August 17, 2009 |
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Fund & Asset Manager Rating Group |
Enhanced Diversification Guidelines
Issuer and industry concentration thresholds, reflecting Fitchs view on idiosyncratic, systemic, and portfolio asset correlation risks, were enhanced. Higher than expected issuer and/or sector concentrations may result in higher discount factors and/or lower ratings.
Explicit Recognition of Potential Subordination Risks
An additional overcollateralization test, the Fitch Net OC test, has been added to capture subordination risks faced by the rated debt and preferred stock due to the presence of any other unrated or senior debt in the funds capital structure, which may have a first priority on fund assets.
Inclusion of Leverage and Derivative Securities When Calculating Asset Coverage
Various forms of leverage utilized by CEFs, including derivative securities, have been included into Fitchs analysis to determine total effective leverage and the degree of downside protection available to rated preferred stock and noteholders. This is intended to reflect the systemic changes in fund capital structures following the auction-rate security crisis in February 2008. Revisions also reflect significant developments in the capital markets, including greater use of off balance sheet derivatives, which may increase asset value volatility experienced by funds.
More Flexibility for Fund Governing Documents
Fitchs rating analysis of debt and preferred stock issued by CEFs will focus on the appropriateness of portfolio holdings and asset coverage relative to the agencys published criteria. The absence of a detailed framework outlining Fitchs criteria in fund bylaws or other operating documents will not, on its own, have adverse rating implications. However, Fitch will continue to evaluate the appropriateness of liquidation/redemption procedures as outlined within fund bylaws or other operating documents. The absence of such mechanisms within fund bylaws or other operating documents could have adverse rating implications.
Reliance on 1940 Act-Mandated Asset Coverage for Certain CEFs
In certain instances, Fitch believes it may be possible to assign ratings to obligations of CEFs based on the nature of the assets and the protections afforded by the 1940 Act. Fitch would view such treatment as being potentially applicable for funds that: invest only in lower risk assets (defined as assets with Fitch discount factors less conservative than those implied by the 1940 Act); have appropriate levels of issuer and industry diversification (as consistent with the Fitch diversification criteria); restrict forms of leverage to those envisioned under the 1940 Act; and have mandatory deleveraging provisions and an exposure period similar to standards set forth under the Fitch Total OC and Fitch Net OC tests.
Standardized Surveillance Reporting Process
Fitch has developed a standardized surveillance template for reporting portfolio holdings for reviewing 1940 Act and Fitch OC tests. This template is intended to aid in a funds implementation of the changes to Fitch criteria and provide for more timely, transparent, and accurate surveillance of outstanding ratings.
Additional Considerations
The existing regulatory guidelines of the 1940 Act provide a number of unique structural protections for investors in CEF debt and preferred stock, including
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minimum OC ratios and mechanisms designed to protect these investors from losses. Additional protections documented in fund bylaws, prospectus, and statement of preferences typically require funds to redeem a portion or all of their outstanding debt and preferred stock if minimum asset coverage ratios are breached and remain uncured following applicable grace periods.
Wherever possible, Fitch recognizes the structural protections afforded by the 1940 Act in its rating analysis while acknowledging that developments in the CEF industry may expose investors to additional risks that are not directly addressed by the 1940 Act. These risks include an expanded universe of portfolio assets, higher concentration risks, more complex capital structures, and on- and off-balance sheet liabilities not explicitly addressed or captured in the 1940 Act coverage ratios. As such, Fitchs rating criteria seeks to go beyond the regulatory requirements for CEFs, wherever necessary, to capture these risks in the ratings Fitch assigns to debt and preferred stock issued by CEFs.
Ratings Assigned to Securities Issued by Closed-End Funds
Fitch assigns long-term credit ratings to debt and preferred stock issued by leveraged CEFs. The long-term credit ratings address the likelihood of full and timely payment of interest or dividends on each payment date and principal upon optional or mandatory redemption or at maturity. While Fitchs criteria is applicable to lower rating categories, historically the majority of Fitch-rated CEFs have operated to maintain AAA or AA ratings, which in some measure reflects the baseline protections afforded by the 1940 Act.
Fitch rates debt and preferred stock issued by CEFs on the basis of the protections afforded by the funds operating documents and the extent to which the fund is viewed as operating in a manner consistent with Fitchs current rating criteria. Historically, CEF governing documents incorporated most, if not every, aspect of the rating criteria that prevailed when the fund was originally rated. Going forward, the absence of detailed descriptions of Fitchs CEF rating criteria, including asset-specific discount factors, will not, on its own, have adverse rating implications, provided that the fund maintains sufficient deleveraging mechanisms and adheres to the current Fitch rating criteria, available on Fitchs web site at www.fichratings.com. From the perspective of the investor and the manager, Fitch believes this change offers greater transparency and easier implementation of any future criteria changes.
Long-term credit ratings assigned to securities issued by CEFs are based on the following:
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Structural Mechanisms: OC triggers, mandatory redemption parameters, and other structural protections for rated debt obligations. |
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Capital Structure: The funds capital structure and sufficiency of asset coverage, according to seniority of the liabilities. |
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Investment Portfolio: Evaluation of the funds portfolio assets with a focus on the potential market value loss under stress scenarios. |
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Investment Manager Review: Qualitative assessment of the funds investment manager. |
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Legal Considerations: Integrity of the legal structure. |
In some cases, Fitch may also assign short-term credit ratings that address the likelihood of full and timely payment of principal and interest or dividends to the debt or preferred stock investors on the next payment date. Short-term credit ratings are
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assigned only to issues of notes and preferred stock that offer a demand feature for investors to put the securities back to the fund or the liquidity provider on pre-specified periods or dates. The ratings are based on the following:
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Liquidity Providers Obligation: The liquidity providers obligation to purchase all debt or preferred stock tendered for sale that has not been sold on the tender date (and whether there are any outs to the liquidity providers obligation). |
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Liquidity Providers Credit Strength: The credit strength of the liquidity provider or the guarantor supporting the liquidity providers obligation. |
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Legal Considerations: The integrity of the legal structure. |
Fitchs ratings do not address liquidity in the secondary markets, such as those where auction-rate securities trade. In these cases, only long-term ratings are assigned that address the credit risk based on the instruments stated maturity rather than the ability to access secondary market liquidity.
Structural Mechanisms
Fitchs rating criteria for CEF debt and preferred stock assess the amount of OC available to debt and preferred stock, which depends on the amount and type of asset collateral held by the fund. The analytical focus is on the structural mechanisms in place to protect investors from market value risk, or the risk that the market value of the portfolio may decline and jeopardize the ability to meet interest or dividends on the next payment date (and repayment of principal upon an optional or mandatory redemption or the repayment of principal upon maturity to debt investors). CEF debt and preferred stock investors are exposed to various risks including:
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Credit Risk: The risk of loss due to spread widening or an actual obligor default. |
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Interest Rate Risk: The risk that a fixed-income securitys value will decline due to an increase in general interest rates. |
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Liquidity Risk: The risk that a security cannot be sold quickly enough in the market to prevent a further loss. This risk is only present in the event of mandatory redemption as typically required, per the funds governing documents, in case of a breach of certain asset coverage ratios. |
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Leverage Risk: The risk that leverage carried by the fund will exacerbate market losses allocated to investors and, depending on the exact nature of each form of debt, may also subordinate rated noteholders. |
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Moral Hazard Risk: The risk that an investment manager may manage a funds portfolio and leverage to the benefit of common stockholders and to the detriment of debt and preferred stockholders. |
Overcollateralization
OC is measured by evaluating the market value of collateral available to retire rated liabilities adjusted by discount factors to address the possibility that market values could decline further prior to sale. The presence of market-based OC is a major mitigant to the aforementioned risks and serves as the primary source of credit enhancement and protection for rated obligations. Consequently, Fitch expects CEFs with rated instruments to maintain overcollateralization guidelines within their governing documents demonstrated by asset coverage tests. Fitch will assign ratings by analyzing how funds ensure sufficient OC compared with Fitch OC tests. By ensuring a minimum standard for OC, the asset coverage tests are designed to protect CEF debt and preferred stock investors against default on principal and any accrued interest or dividends.
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Mandatory Redemption
To ensure CEFs maintain sufficient OC for debt and preferred stock for a given rating level, Fitch reviews the funds governing documents for mandatory deleveraging provisions that set forth procedures for curing breaches to either the 1940 Act or Fitch OC tests. Deleveraging provisions usually take the form of a cure period followed by a set period for mandatory redemptions if needed. For instance, upon a breach of either the 1940 Act or Fitch OC tests, the fund is first afforded a cure period within which it may take voluntary action to bring the tests back into compliance. During this period, funds may sell assets and use proceeds to deleverage the portfolio or seek a capital injection through an equity offering. With respect to curing a breach to the Fitch OC tests, fund managers may also elect to rebalance the portfolio toward more liquid and less risky assets.
If the manager fails to cure a breach of either test within the available cure period, the governing documents require redemption of debt and preferred stock within a predefined period in sufficient amounts so as to restore the coverage levels above the failed test(s) to compliance. Fitchs CEF rating criteria are based on an expectation of deleveraging provisions outlining mandatory redemptions over a pre-specified and limited timeframe. Fitch expects that, in addition to mandatory deleveraging provisions, CEFs would have other provisions to help increase asset coverage upon breaching the tests (such as ceasing distributions to common shareholders until the OC is restored). In the absence of such deleveraging mechanisms, Fitch would expect to apply more conservative rating criteria than outlined in this report.
Exposure Period
The exposure period is the time between the valuation date prior to an asset coverage test breach and the final date allowed for mandatory redemption, as specified in the fund governing documents. During this period, investors in fund debt and preferred stock are exposed to market value declines. A given funds exposure period is determined in accordance with the frequency of OC tests and the mandatory redemption guidelines under which the fund operates. Fitch calculates investor exposure as the sum of the following periods:
|
Valuation Period: The frequency with which the fund calculates coverage ratios to ensure it is passing the tests (usually weekly for Fitch OC tests). |
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Cure Period: The number of days the fund has to cure any breach before entering into a mandatory redemption period (usually 10 business days for Fitch OC tests). |
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Mandatory Redemption Period: The covenanted time allotted for redeeming shares or notes, during which time funds cannot issue additional leverage nor declare/pay common stock dividends (usually 30 days). This period is set to account for mandated shareholder notification periods, auction dates, and other structural considerations. |
The average of the aforementioned periods is 45 business days for Fitch-rated CEFs. The actual exposure period is the central factor in Fitchs rating analysis, as it limits the maximum number of days that a CEF debt or preferred stock investor is exposed to portfolio market value declines before deleveraging or being redeemed at par plus accrued interest or dividends. In determining the asset discount factors presented in the table on pages 1011, Fitch assumed a 45-business-day exposure period to determine the maximum potential market value loss an asset may experience in a stressed scenario.
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Bylaws or statements of preferences specifying an exposure period greater than 45 business days may result in more conservative discount factors being applied to the funds portfolio assets to achieve the same rating level on the debt and preferred stock of the CEF. For example, the exposure period to comply with the 1940 Act test typically averages 78 business days (given month-end coverage valuation, a one-month cure period, and a one-month mandatory redemption period). Fitch notes that the 1940 Act alone does not mandate fund deleveraging upon breach but restricts payments/declaration of common dividends and limits the issuance of new leverage until sufficient 1940 Act asset coverage is attained. However, fund operating documents usually include mandatory redemptions as a provision for curing a breach. Conversely, should the bylaws or statements of preferences specify an exposure of less than 45 business days, this may result in less conservative discount factors being applied to the funds portfolio assets. Such instances will be assessed by Fitch on a case-by-case basis.
Capital Structure
1940 Act Coverage Ratio Test Baseline Protection to Rated Debt and Preferred Stockholders
Fitch monitors funds compliance with the 1940 Act test, as it remains the regulatory framework under which U.S. CEFs operate. However, Fitch also acknowledges certain shortcomings in the 1940 Act test, including that it does not capture certain forms of collateralized leverage more recently utilized by CEFs nor does it differentiate between investments in different asset classes. That said, the 1940 Act test, as typically incorporated into fund governing documents, has the benefit of effectively limiting the amount of leverage a fund can assume by requiring a minimum asset OC of 200% for preferred stock leverage and a minimum asset OC of 300% for senior debt leverage. The 200% asset coverage for preferred stock is typically calculated in one of two ways, both of which yield the same result:
[Total Assets at MV Current Liabilities a ] |
||
= | [All 1940 Act Leverage b + Accrued Expenses and Fees on Leverage] | |
or | ||
[Common Equity + All 1940 Act Leverage + Accrued Expenses and Fees on Leverage] |
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= | [All 1940 Act Leverage + Associated Accrued Expenses and Fees] |
a |
Current liabilities do not include any liabilities associated with fund leverage, as recognized by the 1940 Act in Section 18. |
b |
1940 Act Leverage only includes leverage that funds interpret to be recognized as leverage under Section 18 of the 1940 Act (e.g. preferred stock, notes, and bank facility). This typically excludes all types of economic leverage, reverse repurchase agreements, mortgage dollar rolls, and others. |
The 300% asset coverage for senior debt is typically calculated in one of two ways, both of which also yield the same result:
[Total Assets at MV Current Liabilities] |
||
= | [All Senior 1940 Act Leverage c + Accrued Expenses and Fees on Leverage] | |
or | ||
[Common Equity + All 1940 Act Leverage + Accrued Expenses and Fees on Leverage] |
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= | [All Senior 1940 Act Leverage + Accrued Expenses and Fees on Leverage] |
c |
Senior 1940 Act Leverage only includes leverage that funds interpret to be recognized as Senior Securities other than preferred stock under Section 18 of the 1940 Act. (e.g. notes, bank facility). This also typically also excludes all types of economic leverage, reverse repurchase agreements, mortgage dollar rolls, and others. |
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Fitch incorporates compliance with 1940 Act coverage ratios into its rating criteria, as noncompliance with the ratios has important consequences for investors of debt and preferred stock issued by CEFs. For instance, funds breaching the mandated asset coverage ratios are not permitted to pay declared dividends or declare new dividends to common stock holders, thus effectively trapping cash in the portfolio to help improve the asset coverage ratios and acting as a strong incentive for restoring asset coverage. Furthermore, fund governing documents are typically written to ensure compliance with the ratios by requiring mandatory redemptions of debt upon breach of the 1940 Act test.
With respect to certain asset classes, the implied discount factors of the 1940 Act are more conservative than those set forth by Fitch. For example, Fitchs discount factor for U.S. government securities is 1.10, whereas the 1940 Act would impose a discount factor of 2.00 on a CEF backed by such collateral. Given the more conservative nature of the 1940 Act, in such instances, Fitch may elect to rely on the guidelines of the 1940 Act when evaluating such funds. That said, the guidelines of the 1940 Act are not always sufficiently conservative for all funds and underlying assets types to achieve an AAA rating in all instances.
To determine the sufficiency of the 1940 Act for a given CEF, Fitch will seek to determine that the fund: only purchases lower risk assets; has appropriate levels of issuer and industry diversification; restricts forms of leverage to those envisioned under the 1940 Act; and maintains conservative mandatory deleveraging provisions. This further presumes that appropriate triggers are in place to promote deleveraging and redemption of rated obligations within a 45-business-day period and that the governing documents are sufficiently restrictive. The chart on page 12 depicts which assets on a stand-alone basis have Fitch discount factors that are lower than those implied by the 1940 Act test and, therefore, may be more suitable to be analyzed on the basis of the asset coverage afforded under the terms of the 1940 Act test. Fitchs guidelines for determining the appropriateness of fund diversification are outlined in Diversification Guideline, pages 1417.
Fitch CEF Ratings Guidelines Augmenting 1940 Act Protections
Similar to the 1940 Act, Fitchs CEF rating criteria also measure the OC of debt and preferred stock but utilize the Fitch Total OC and Fitch Net OC tests (together, the Fitch OC tests), which address the potential for additional forms of leverage and further market value declines in fund assets during the redemption period. Fitch OC tests seek to measure the sufficiency of fund assets to meet all principal and interest/dividends payments of debt and preferred stock upon optional or mandatory redemption. In the absence of other qualitative considerations, Fitch OC and Fitch Net OC ratios in excess of 100% are generally deemed to be consistent with the rating assigned to the debt and preferred stock.
In developing and formulating the updated discount factors, Fitch sought to reflect each asset classs unique risk profile based on historically observed worst-case performance as well as expectations for potential continued adverse performance in the future. Fitch sought to determine the magnitude and implied stress of historically observed market value price declines and then increased such declines to derive an expected AAA market value stress (for more information on Fitchs determination of asset-specific discount factors, see Appendix 3: Market Value Approach to Discount Factor Development, pages 2325) .
While for certain asset classes the discount factors are lower than those implied by the 1940 Act, in many cases the discount factors may be higher (more conservative) and in some cases substantially so. For example, the discount factor for preferred
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stock is 2.5 (see Fitch Discount Factors table, pages 1011) , compared to an implied discount factor of 2.0 under the 1940 Act for preferred stock leverage. When rating the debt and preferred stock of a CEF that invests in higher risk asset classes, Fitch will evaluate the sufficiency of the funds asset coverage in the context of the Fitch OC and Fitch Net OC tests, in addition to the funds compliance with the parameters of the 1940 Act.
The calculation of fund leverage both on and off balance sheet is another area Fitchs criteria address risks not fully captured by the 1940 Act. Such leverage may take the form of reverse repurchase agreements or certain derivative transactions. For funds utilizing such nontraditional forms of leverage, the full effect of leverage on asset value, asset coverage, and income volatility may potentially be understated for the purposes of the 1940 Act. This is in contrast to the Fitch OC tests, which seek to capture such leverage exposure.
Fitchs rating criteria also seeks to evaluate the priority of claims of various CEF liabilities in a more explicit fashion than the 1940 Act tests. Specifically, the Fitch Net OC test measures the amount of OC remaining for Fitch-rated securities after other portfolio assets have been allocated to more senior securities. In other words, the Fitch Net OC test measures OC on a net basis after taking into account certain fund assets that are held as collateral for other fund liabilities. The Fitch Net OC test also assesses whether the remaining unencumbered fund assets continue to be consistent with Fitchs diversification guidelines.
Fitch Total Overcollateralization Test: Sufficiency of Asset Coverage
Fitch evaluates a funds asset coverage on the basis of the Fitch Total OC test for each rated class of leverage in the funds capital structure. The calculation of the Fitch Total OC test includes, in the numerator, all portfolio assets on a discounted basis regardless of whether such assets are serving as collateralization for a senior liability or are otherwise unencumbered. The calculation includes, in the denominator, all portfolio liabilities that are pari passu or are senior to the rated debt or preferred stock. The rationale behind capturing all assets, even those that are held as collateral for other fund liabilities, is to assess whether the assets are sufficient to meet liability payments associated with debtholders senior to or pari passu with the rated debt and preferred stock (based on Fitchs expectation of potential market value declines in those assets). In the absence of other qualitative considerations and for a given rating level, the test output is expected to remain in excess of 100% and is calculated as follows:
Fitch Total OC = |
Total Net Discounted Assets at MV a |
|
Fitch Rated Liability + Other Liabilities Pari Passu and Senior to Rated Liability |
a |
Total net discounted assets at market value (MV) equal total portfolio assets at MV and accrued income, including assets held as collateral for other fund liabilities, less current liabilities that settle in 10 days that are not part of a rolling leverage strategy (such as to-be-announced [TBA] securities, futures, forwards, among others), then discounted at the Fitch discount factors in the table on pages 1011 and adjusted as per the Fitch diversification criteria discussed on pages 1417. |
Fitch Net Overcollateralization Test: Protection Against Subordination Risk
If a fund has liabilities that are senior to the Fitch-rated debt and preferred stock or if it has liabilities that are secured by specific asset collateral, Fitch will also evaluate a funds asset coverage on the basis of the Fitch Net OC test. The Fitch Net OC test assesses whether the fund has sufficient assets to provide asset coverage for the rated debt or preferred stock after first repaying other more senior liabilities and/or liabilities secured by specific asset collateral. The Fitch Net OC test also includes any assets in the fund that remain unencumbered by senior liabilities. Similar to the Fitch Total OC test, the result of this test should be greater than 100% and is calculated as follows:
Fitch Net OC = |
Available Net Discounted Assets a |
|
Fitch Rated Liability + Other Liabilities That Are Pari Passu |
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a |
Available net discounted assets equals total portfolio assets at MV and accrued income minus all assets that are either held as collateral for other fund liabilities and/or subject to a first claim of a senior liability in the capital structure minus current liabilities that settle in 10 days that are not part of a rolling leverage strategy (such as TBA security rolls, futures, forwards, among others), then discounted at the Fitch discount factors in the table on pages 1011 and adjusted per the Fitch diversification criteria presented on pages 1417. |
Examples of when the Fitch Net OC test may be relevant include CEFs that utilize senior bank lines. Depending on the collateral requirements of other more senior fund liabilities, the Fitch Total OC test may be either more or less conservative than the Fitch Net OC test. For instance, if more senior liabilities are secured by specific assets, which result in the remaining portfolio assets being more highly concentrated by issuer and/or industry, this could result in a more conservative evaluation of asset coverage under the Fitch Net OC test versus the Fitch Total OC test.
Fitch Asset Discount Factors
The table on the following pages outlines the discount factors for AAA, AA, A, and BBB rating stresses for each group of assets, assuming a 45-day redemption period. Fitch will determine discount factors for other collateral types, redemption periods, and rating stresses on a case-by-case basis.
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Fitch Discount Factors
f |
Busted convertible securities are defined as convertible securities having a conversion premium in excess of 70%. Conversion premium is calculated as: (MV of the convertible security MV of total stock into which the security may be converted to)/MV of the convertible security). |
g |
Typical convertible securities are defined as convertible securities that have a conversion premium between 20% and 70%. |
h |
Equity sensitive convertible securities are defined as convertible securities that have a conversion premium less than 20%. |
i |
Distressed convertibles have a bid price below 60% of par, as defined on page 303 of the March 2008 edition of A Guide to the Lehman Brothers Global Family of Indices. |
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Fitch Discount Factors (continued)
s |
Case-by-case basis. Note: For all asset classes, asset maturity is calculated on the basis of the securitys final maturity, except for securities that contain a put provision at the security holders option, with no outs to exercise such right. In such instances and for the purpose of determining the appropriate asset discount factor, the next available put date may be assumed to be the asset maturity date. |
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Discount Factors Relative to the 1940 Act 200% and 300% Asset Coverage Ratios
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Accounting for CEF Liabilities in Fitch OC Tests
The market dislocation in 2007 and 2008 caused CEF managers to meaningfully change the capital structures of closed-end funds in ways not always expected by the 1940 Act. For example, failures in the auction-rate security market led to traditional retail-oriented leverage being partially replaced with nontraditional institutional-oriented leverage.
Fitch defines traditional leverage as fund liabilities captured by the 1940 Act asset coverage tests, such as preferred stock, notes, bank credit facilities, and financing through asset-backed commercial paper (ABCP) conduits. Fitch defines nontraditional leverage as fund leverage that is typically excluded from the 1940 Act asset coverage tests, such as reverse repurchase agreements, floating-rate certificates of tender option bonds, securities lending arrangements, to be announced (TBA) security rolls, forwards, futures, total return swaps, credit default swaps, and purchased and written put and call options, among others. Guidelines of the 1940 Act generally allow funds to exclude such leverage from their asset coverage tests if the leverage is fully collateralized by segregated liquid assets or if completely offsetting leverage positions exist, e.g. long and short credit default swaps referencing the same name.
Given the significant changes in the industry, the asset coverage ratios of the 1940 Act regulation do not fully capture the spectrum of potential forms of leverage that can be assumed by a CEF. For example, the 1940 Act asset coverage ratio for a CEF with reverse repurchase agreement leverage will understate the amount of leverage presented and overstate the amount of asset coverage to rated debt or preferred stockholders. To address these issues, Fitch seeks to capture the leveraged asset exposure associated with these various new forms of liabilities. (For more information on how to calculate the Fitch Total OC test and Fitch Net OC test based on various types of traditional and nontraditional leverage, see Appendix 1: Fund Liabilities, pages 2021.)
Furthermore, if a fund has other liabilities in its capital structure, the rated debt and preferred stock may be exposed to subordination risk and refinancing risk as follows:
|
Subordination Risk: Senior liabilities generally have priority of claim on portfolio assets over the rated debt or preferred stock. At times, such liabilities may also have specific earmarked collateral. The Fitch Net OC test seeks to assess whether such earmarked collateral serves to the detriment of the rated debt or preferred stockholders by selecting the highest quality assets for collateral and leaving lower quality and less diversified assets available for the rated liabilities. Fitch reviews the governing documents of senior liabilities to determine the level of security over fund assets. |
|
Refinancing Risk: Refinancing risk occurs when senior debt is called early, forcing the fund to liquidate portfolio assets to repay the loan. Fitch views longer termination notice periods more favorably, as they may serve to minimize forced asset sales into a distressed environment and offer additional time to find alternative financing sources. |
Fitch may assign AAA ratings to notes and preferred stock that are subordinate to other forms of leverage due to a combination of the following: the 1940 Act framework limits most forms of senior leverage to 33% and total traditional leverage to 50%; the Fitch Net OC test measures the sufficiency of assets unencumbered by senior leverage to meet principal and interest/dividend payments of rated liabilities; and the longer term nature of financing typically employed by CEFs minimizes the risk of forced asset liquidation associated with not being able to maintain leverage during a period of illiquidity. In situations where these factors are not deemed sufficient, a rating may be assigned that is lower than asset coverage ratios alone would otherwise indicate.
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Investment Portfolio
Diversification Guidelines
Fitch developed its discount factors for various asset classes based on extensive analysis of historical price declines and volatility of various indices. As a result, the discount factors implicitly assume that the CEF portfolio being evaluated has diversification levels comparable to the proxy index. From this perspective, the main source of potential disparity is a portfolio not being as diverse as the underlying index in terms of issuer and/or corporate industry or municipal sector/state composition, contributing to potentially higher idiosyncratic and systemic risks. To address these risks, Fitchs ratings guidelines for CEFs include a minimum diversification framework.
Fitch acknowledges the minimum overcollateralization guidelines set forth by the 1940 Act as a baseline diversification framework to support debt and preferred stock. Specifically, funds regulated under the 1940 Act may elect to register as a diversified or nondiversified company with respect to single issuer concentration and register their intent to either concentrate or not concentrate in a particular industry. With respect to issuer concentration, the guidelines of the 1940 Act generally permit diversified funds to invest up to 5% in a single issuer (with no more than 10% of voting rights) as part of 75% of their portfolio and up to 25% in a single issuer as part of their remaining 25% of the portfolio (also known as the Safe Harbor provision), together not exceeding 25% in any single issuer. With respect to corporate industry or municipal sector concentration, the guidelines of the 1940 Act generally permit funds to register their intent to either not concentrate in any particular industry/sector and be subject to a 25% concentration limitation or concentrate in a particular industry/sector and invest more than 25% in that industry/sector. Naturally, the nondiversified/concentrated fund status is utilized primarily by sector funds, such as real estate- and energy-sector CEFs.
Although these provisions serve as baselines of protection, Fitch views them as being insufficient to protect rated debt and preferred stock investors from increased systemic and idiosyncratic risks present in portfolios concentrated in a particular industry or issuer, respectively. As such, Fitchs rating criteria includes the following issuer diversification and industry diversification framework.
Issuer Diversification
Portfolios with a small number of assets, or those where individual asset balances represent a disproportionately high exposure in a given portfolio, carry added risk that portfolio performance may be adversely affected by the underperformance of a few assets. For purposes of calculating the numerator of the Fitch OC tests, eligible exposure to a single issuer is calculated based on the following:
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Up to 10% exposure to one obligor can be counted toward the Fitch OC tests. Any excess exposure to that obligor is not eligible for credit. |
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Up to 5% exposure to five other obligors can be counted towards the Fitch OC tests. Any excess exposure to those five obligors is not eligible for credit. |
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Up to 3% exposure in all other obligors can be counted toward the Fitch OC tests. Any excess exposure to such obligors is not eligible for credit. |
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Fitch Corporate Issuer Diversification Guidelines
Obligor |
Maximum Amount
Eligible for Fitch OC Tests (%) a |
||
Largest Obligor |
10 | b | |
Next Five Largest Obligors |
5 | ||
All Other Obligors |
3 |
a |
On a case-by-case basis, Fitch may raise its issuer concentration thresholds for funds where Fitch rates the their issued debt or preferred stock below investment grade, since such rating already reflects, to an extent, the increased risk associated with the idiosyncratic risk in the funds portfolio. |
b |
On a case-by-case basis, Fitch may raise its issuer concentration thresholds for exposure to broadly diversified investment portfolios or holding companies. |
The 10%, 5%, and 3% concentrations shown in the table above are measured as the sum of all securities issued by such obligors at the market value of such securities plus accrued income relative to total portfolio assets at market value plus accrued income. This methodology does not restrict a fund from having individual issuer exposure in excess of these guidelines but seeks to exclude such exposure from the calculation of the Fitch OC tests. Obligor concentrations for corporate obligors are a sum of debt and equity securities issues by an entity at both the holding and operating company level, if applicable. It is not uncommon for some fund managers to invest in other diversified funds, indices, or investment vehicles. In such cases, Fitchs single obligor guidelines may not apply.
For municipal obligors, concentration is aggregated by obligations, the repayment of which relies on the same sources of revenue.
Fitch Municipal Issuer Diversification Guidelines
Obligor |
Maximum Amount
Eligible for Fitch OC Tests (%) a |
||
State-Level General Obligations and Other Municipal Issues Backed by State-Level Taxing Authority |
20 | ||
Largest Obligor |
10 | b | |
Next Five Largest Obligors |
5 | ||
All Other Obligors |
3 |
a |
On a case-by-case basis, Fitch may raise its issuer concentration thresholds for funds where Fitch rates the their issued debt or preferred stock below investment grade, since such rating already reflects, to an extent, the increased risk associated with the idiosyncratic risk in the funds portfolio. |
b |
On a case-by-case basis, Fitch may raise its issuer concentration thresholds for exposure to broadly diversified investment portfolios or holding companies. |
Corporate Industry and Municipal Sector/State Diversification
Assets within a single corporate industry tend to behave similarly in terms of price movements, default rates, and rating migration. Of course, this is sensible since companies within a particular industry are subject to similar economic factors, as well as trends in supply and demand. It has also been observed that the financing characteristics of a particular industry can influence the likelihood of asset co-behavior. In periods of credit expansion, particular industries have seen dramatic increases in the level of financing provided by the capital markets. The general increase in leverage within an industry makes companies in the industry more vulnerable to default during periods of economic contraction. To a certain extent, the same can be said for municipal securities, as the financial condition of a given state will likely affect the performance of securities backed by the revenue of such state. Municipal securities of the same sector may also exhibit higher levels of co-behavior. For example, healthcare and higher education securities may be affected by nationwide economic/regulatory factors that extend beyond state borders.
Fitch applies a 25% concentration threshold to corporate industry, municipal sector, or municipal state exposure to address the potential systemic risk associated with outsized exposures by industry, sector, or state. That is not to say that a fund cannot have exposure in excess of 25% but that excess exposure will be discounted to a greater
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degree to account for increased risks. Specifically, the discount factor for exposure in excess of the 25% threshold will be increased by an additional 1.1 times (x) the applicable discount factor for municipal asset types and 1.5x the applicable discount factor for nonmunicipal asset types to reflect increased correlation risk to the fund. The multiples applied to the discount factors on the basis of portfolio concentration were derived by comparing the performance of broad market indices to indices concentrated in particular corporate industries and municipal sectors and states. The 25% level of concentration was chosen as it has regulatory significance set forth by the 1940 Act. As discussed, guidelines of the 1940 Act distinguish between industry concentrated and nonconcentrated investment companies using a 25% concentration threshold, where registered industry nonconcentrated investment companies are limited to a 25% single industry concentration and registered industry concentrated investment companies are not.
Summary of Industry Diversification Guidelines for Corporate Closed-End Funds
Exposure in Excess of 25% to a Single Industry
Additional 1.5 times (x) Multiple to
Applicable Asset Discount Factor
To implement the diversification framework, corporate industry and municipal sector and state exposures are calculated as a percentage of the total portfolio market value plus accrued income. For corporate securities, Fitch uses industry designations consistent with its structured credit rating criteria, as illustrated in the top right table on the page 17.
As mentioned, Fitchs discount factors are based on historical price declines of representative indices, which are typically diversified by corporate industry or municipal sector/state. That said, certain indices utilized by Fitch to derive discount factors, such as and the Merrill Lynch Preferred Stock indices for preferred stock securities and the Alerian MLP Index for equity securities issued by master limited partnerships (MLPs), are inherently sector concentrated. As such, Fitch will not apply an additional discount factor multiple with respect to preferred stock securities or securities issued by MLPs, royalty income trusts, or marine transportation securities.
When evaluating sector concentration for municipal securities, Fitch considers all investments, with the exception of state-level general obligation (GO) bonds and other issues backed by state-level taxing authority. This is intended to ensure an appropriate amount of portfolio diversification without creating an incentive for portfolios to diversify away from what is traditionally the most creditworthy and liquid of municipal issuances.
When evaluating state concentration for municipal securities, Fitch considers all securities issued by entities within the state, including state-level GO bonds and other issues backed by state-level taxing authority. This is intended to capture overall risk exposure to a given state, regardless of the security or issuer type.
Fitch considers the effect of the municipal diversification framework to be more pronounced with respect to single-state funds, which typically invest nearly all portfolio assets in municipal obligations of issuers within a single state. Fitch defines single-state funds as those investing more than 25% in a single state. In the event a portfolio has both high sector and state concentrations, both multiples to the asset
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Municipal Sectors for Purposes of Determining Funds Single Sector Exposure a
Sectors Subject to 25% Threshold b
General Obligation
Healthcare
Higher Education
Housing Revenue
Investor-Owned Utilities
Lease and Tax-Backed
Municipal
Transportation
Utility Revenue
a |
Based on Fitch financial guarantors criteria. |
b |
Investments in state-level general obligation bonds issued and other issues backed by state-level taxing authority are exempt from the 25% threshold. |
discount factor are applicable. The municipal sector designations are consistent with Fitchs financial guarantors rating criteria and are illustrated in the table at left.
The aforementioned issuer, industry, sector, and state concentration frameworks exclude U.S. government and agency securities. Also, direct or indirect (e.g. derivatives, exchange traded funds) investments in diversified indices (e.g. S&P 500) are not subject to issuer or sector diversification frameworks given that they represent exposure to diversified indices with limited idiosyncratic or systemic risks; however, they exhibit systematic (market) risk, which is addressed by the asset discount factors. Alternatively, if the investment exposure is to a sector-specific index (e.g. S&P Financials), the sector diversification framework continues to apply to address sector-specific or systemic risks.
Corporate Industries for Purposes of Determining Funds Single Industry Exposure a
Industries Subject to 25% Threshold Per Fund
Aerospace and Defense
Automobiles, Building and Materials, Chemicals
Banking, Finance, and Insurance
Broadcasting, Media, and Cable
Business Services
Computer and Electronics, Telecommunications
Consumer Products
Energy (Oil & Gas)
Environmental Services
Farming and Agricultural Services
Food and Drug Retail
Food, Beverage and Tobacco
Gaming, Leisure and Entertainment
General Retail
Healthcare
Industrial/Manufacturing
Lodging and Restaurants
Metals and Mining
Packaging and Containers
Paper and Forest Products
Pharmaceuticals
Real Estate
Sovereigns
Textiles and Furniture
Transportation and Distribution
Utilities (Power)
a |
Based on Fitch corporate CDO criteria. |
Summary of Sector/State Diversification Guidelines for Municipal Closed-End Funds a
Exposure in Excess of 25% to a Single State |
Exposure in Excess of 25% Exposure to a Single
|
Exposure in Excess of 20% to State-Level
|
||
Additional 1.1x Multiple to Applicable Asset Discount Factor | Additional 1.1x Multiple to Applicable Asset Discount Factor | No Credit |
a |
This table summarizes sector/state diversification guidelines that are applicable to municipal CEFs. Other general guidelines, such as the issuer diversification framework, continue to apply. |
b |
Excludes state-level general obligation bonds and issues backed by state-level taxing authority. |
Within a given fund, exposure to a specific corporate industry or municipal sector/state may take the form of various security types with differing discount factors. For example, a real estate fund may have exposure to both common equity and preferred stock of such issuers. In instances where a fund has industry concentration in excess of 25%, the intention of Fitchs industry diversification framework is to apply the discount factor multiple on a pro rata basis across all instruments within such industry to avoid selectively applying the uplift to securities with higher (or lower) discount factors ( for an example of how the uplift for excess industry concentration is allocated to portfolio assets, see Appendix 2, page 22) .
Investment Manager Review
Surveillance
Fitch monitors fund compliance with Fitch OC and 1940 Act tests as follows:
|
On a weekly basis, funds internally calculate the Fitch OC and 1940 Act tests. If |
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Fund & Asset Manager Rating Group |
the resultant ratios are less than 10% above the minimum passing threshold (e.g. 105% for a Fitch OC tests and 205% for a 1940 Act test for preferred stock), Fitch would expect to have more frequent dialogue with the investment manager. |
|
On at least a monthly basis, funds calculate and provide Fitch with updated portfolio holdings and completed Fitch OC and 1940 Act test results. |
|
Typically, on an annual basis, Fitch performs a review of each rated fund and its investment manager. The review includes reviewing the funds adherence to its stated investment objectives and constraints, net asset value performance, recent coverage ratios, an evaluation of the alignment of interests between the fund manager and the rated noteholders, and a discussion with the fund manager to determine future investment strategies, plans, and other forms of research. |
|
In periods of heightened credit and/or liquidity stress, Fitch reserves the right to initiate more frequent/detailed surveillance procedures. |
The regular reporting of asset coverage tests and updated portfolio holdings to Fitch by the fund manager and/or administrator is central to Fitchs surveillance process and critical to maintaining the outstanding ratings on CEF debt and preferred stock. Failure to receive this information in a timely manner may result in negative rating actions and/or the withdrawal of assigned ratings.
To facilitate standardized reporting of fund information and to assist in the adoption of the new criteria and weekly testing, Fitch has developed a reporting template. The Microsoft Excel-based template includes a coverage page that summarizes the funds assets, liabilities, and relevant asset coverage ratios and a portfolio holdings page, with built-in formulas for determining asset discount factors and diversification guidelines (for the sample surveillance cover sheet, see Appendix 4, pages 2627) . Parties interested in receiving a copy of the reporting template may contact any of the analysts listed on page 1.
In addition to the information and analysis provided by the funds, Fitch performs its own internal analysis to support ratings surveillance. First, to assist in developing a current credit opinion for each fund and to measure up-to-date performance for all rated CEF debt and preferred stock, Fitch will internally calculate a 1940 Act ratio on a regular basis to gauge portfolio volatility between monthly surveillance reports. The internal monitoring serves as a trigger point for further dialogue with managers and helps Fitch verify performance figures noted in the monthly/weekly surveillance reports received from funds. Fitch also periodically monitors ongoing asset price movements to ensure discount factors remain appropriate.
In determining the appropriate rating for debt or preferred stock issued by a CEF, Fitch will evaluate the sufficiency of asset coverage on the basis of the Fitch OC tests relative to the applicable rating stress. Should a fund maintain insufficient asset coverage at a given rating stress, a downgrade may be forthcoming, with the magnitude of the downgrade being dictated by the rating stress under which the fund is able to pass the Fitch OC tests. For example, absent other qualitative considerations, if a fund does not satisfy the Fitch OC tests under an AAA rating stress but satisfies the Fitch OC tests under an AA rating stress, the debt or preferred stock will likely be rated AA.
Fitchs rating analysis will also include dialogue with the fund manager and other qualitative considerations, such as the volatility and cushion of asset coverage ratios relative to price decline expectations.
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Fund & Asset Manager Rating Group |
Finally, Fitchs rating analysis also considers the sufficiency of asset coverage as calculated pursuant to the 1940 Act. While Fitch believes the Fitch OC tests are more robust measures of asset coverage, it recognizes that failure of the 1940 Act coverage ratios can have implications for the fund in terms of forced asset sales and deleveraging.
The Rating Process
Fitch assigns ratings at the request of a funds management and after reviewing all pertinent material and conducting an on-site manager review. Specifically, Fitchs initial and ongoing reviews of CEFs encompass an analysis of the following areas:
|
Investment Policies and Procedures: Sector overview, sector allocation and diversification, portfolio strategy construction and target composition, use of derivatives, and asset liquidity. |
|
Operations: Asset pricing and portfolio valuation, fair value pricing procedures, trading and settlement trade, reconciliation, and technology support; |
|
Legal and Compliance: Regulatory compliance, including compliance with the governing documents on the 1940 Act and Fitch OC asset coverage tests, SEC examinations, board of directors structure, and external and internal audits. |
|
Organization: Organizational and management structure, assets by amount and type under management, key personnel biographies and track records, product marketing, and distribution. |
The on-site review includes meetings with the portfolio management team and related personnel. During the on-site review, the company has an opportunity to present information on its history, ownership structure, business plans, and investment strategies, as well as demonstrate its credit selection and portfolio monitoring capabilities. Fitch also evaluates the appropriateness of the alignment of interests between the fund manager and the rated noteholders. The organization is expected to provide detailed information on its operating processes, related technologies, and controls, as well as comprehensive profiles of its staffing resources
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Appendix 1: Fund Liabilities
Treatment of Fund Liabilities for Fitch OC Test Calculations
Fitch OC Tests for Rated Debt or Preferred Stock |
||||||||
Fitch Total OC Test |
Fitch Net OC Test |
|||||||
Column 1 |
Column 2 |
Column 3 |
Column 4 |
Column 5 |
||||
Treatment of Nonrated
|
Numerator |
Denominator |
Numerator |
Denominator |
||||
Current Liabilities |
Current liabilities that will settle within 10 days (does not include rolled securities, forwards, futures, and other leverage instruments) | No adjustments | + Amount in column 2 | No adjustments | ||||
Notes or Preferred Stock (Subordinate to Rated Liability) |
+ Discounted MV of reinvested assets | No adjustments |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities |
No adjustments | ||||
Notes or Preferred Stock (Pari Passu to Rated Liability) |
+ Discounted MV of reinvested assets | + Outstanding liability +accrued interest and fees |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities |
+ Outstanding liability; + accrued interest and fees |
||||
Notes or Preferred Stock (Senior to Rated Liability) |
+ Discounted MV of reinvested assets | + Outstanding liability +accrued interest and fees |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities; if no earmarked collateral, then - column 3 |
No adjustments | ||||
Bank Credit Facilities |
+ Discounted MV of reinvested assets | + Outstanding liability +accrued interest and fees |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities; if no earmarked collateral, then column 3 |
No adjustments | ||||
ABCP Conduit Financing Facilities |
+ Discounted MV of reinvested assets | + Outstanding liability +accrued interest and fees |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities; if no earmarked collateral, then column 3 |
No adjustments | ||||
Reverse Repurchase Agreements |
+ Discounted MV of reinvested assets | + Outstanding liability +accrued interest and fees |
+ Amount in column 2 Any earmarked asset collateral MV for the liabilities; |
No adjustments | ||||
Floating Rate Certificates of Tender Option Bonds (TOB) |
+ Discounted MV of reinvested assets + Discounted MV of bond in TOB subject to an additional 10% haircut |
+ Note liability; +accrued interest and fees |
+ Amount in column 2 Bond collateral MV held in TOB trust |
No adjustments | ||||
Securities Lending |
+ Discounted MV of securities lent + Discounted MV of collateral held for securities lent |
+ Liability due upon return of securities |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Security Rolls (e.g. Mortgage Dollar Rolls) |
+ Discounted referenced assets MV | + Liability due on settlement date |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Futures and Forwards (Long) |
+ Discounted referenced assets MV + Discounted MV of collateral held |
+ Liability due on settlement date |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Futures and Forwards (Short) |
+ Amount receivable on settlement date | + Referenced asset MV multiplied by 1 + [1 (1/Discount Factor)] |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
+ Discounted MV of collateral held | ||||||||
Interest Rate Swaps (Long, Pay Fixed and Receive Floating) |
+ Discounted referenced assets MV of fixed-rate leg | + MV of floating rate leg |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Interest Rate Swaps (Short, Pay Floating and Receive Fixed) |
+ MV of floating-rate leg | + Referenced asset MV multiplied by 1 + [1 (1 /Discount Factor)] |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Total Return Swaps (Long) |
+ Discounted referenced assets MV | + (Referenced asset MV equity stake or collateral put up) |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Credit Default Swaps (Long Credit, Protection Seller, Not as Hedge or Offset To Another CDS) |
+ Discounted (CDS notional ± MV) + Discounted MV of assets reinvested proceeds or assets segregated as a result of entering into the position (such as received upfront fee and any collateral held) |
+ CDS notional |
+ Amount in column 2 Amount in column 3 |
No adjustments | ||||
Credit Default Swaps (Short Credit, Protection Buyer, Not as Hedge or Offset to Another CDS) |
+ Lower of 0 or (CDS MV present value of future payments) | No adjustments | + Amount in column 2 | No adjustments | ||||
Put Options (Purchased) |
+ Max {0, (Strike price - Reference Asset MV x [1 + (1 (1/Discount Factor))] } | No adjustments | + Amount in column 2 | No adjustments | ||||
Call Options (Purchased) |
+ Max {0, (Reference Asset MV/ Discount Factor) Strike Price} | No adjustments | + Amount in column 2 | No adjustments |
93 | Closed-End Fund Debt and Preferred Stock Rating Criteria August 17, 2009 |
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Fund & Asset Manager Rating Group |
Appendix 1: Fund Liabilities (continued)
Treatment of Fund Liabilities for Fitch OC Test Calculations (continued)
Fitch OC Tests for Rated Debt or Preferred Stock |
||||||||
Fitch Total OC Test |
Fitch Net OC Test |
|||||||
Column 1 |
Column 2 |
Column 3 |
Column 4 |
Column 5 |
||||
Treatment of Nonrated
|
Numerator |
Denominator |
Numerator |
Denominator |
||||
Put Options (Written) |
+ Min {0, (Reference Asset MV/ Discount Factor) Strike Price} |
No adjustments |
+ Amount in column 2 |
No adjustments | ||||
Call Options (Written) |
+ Min {0, (Strike price Reference Asset MV x [1 + (1 (1/Discount Factor))] } |
No adjustments |
+ Amount in column 2 |
No adjustments | ||||
Any On- and Off-Balance Sheet Liabilities Not Addressed Above |
Case-by-case basis | Case-by-case basis | Case-by-case basis | Case-by-case basis |
Note: derivative positions that are used to hedge portfolio assets should first be netted before determining any net long or short derivative exposure. Treatment for any net derivative exposure (an amount not used to hedge or offset other derivatives or portfolio assets) is described in the table above. Appropriate discount factors from the Fitch Discount Factors table on pages 1011 apply where noted. Fitch expects funds to transact with highly rated counterparties. Significant negative market values on derivative positions with low rated or nonrated counterparties may result in negative rating implications.
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Appendix 2: Calculation of Industry and Sector Concentration
The table below is an example of a portfolio with two assets in the real estate industry that, in aggregate, constitute 27.50% of the portfolio (exceeding the 25% Fitch industry concentration threshold). The example illustrates how the multiple of 1.5x the base discount factor for industry overconcentration is allocated to securities in that industry.
Allocation of Excess Industry Concentration
Label: | MV | A | B | C | D | E | F | G | H | I | J | = (MV x G/F) | ||||||||||||||||
Formula: | = AB | = C x Tot MV |
= MV/
Sector MV |
(Sector
MVD)/Sector MV |
= F x 1.5 | = 1G |
=
(F x G) + (H x I) |
+ (MV x G/I) | ||||||||||||||||||||
Security |
Industry |
Portfolio
(%) |
MV (USD) |
Industry's
Weight in Portfolio (%) |
Fitch
Industry Concentration Threshold (%) |
Excess of
Asset's Industry Over Limit (%) |
Total Excess
(USD) |
Allocated
Excess (USD) |
Assets
Standard Discount Factor |
Standard DF
Applied to % of Asset |
Excess
industry Discount Factor |
Excess
DF Applied to % of Asset |
Weighted
Average DF |
Total
Discount Asset (USD) |
||||||||||||||
Asset A |
Real Estate | 17.50 | 7.00 | 27.50 | 25.00 | 2.5 | 1.00 | 0.64 | 2.50 | 90.91 | 3.75 | 9.09 | 2.61 | 2.72 | ||||||||||||||
Asset B |
Real Estate | 10.00 | 4.00 | 27.50 | 25.00 | 2.5 | 1.00 | 0.36 | 2.60 | 90.91 | 3.90 | 9.09 | 2.72 | 1.49 | ||||||||||||||
Asset C |
Telecoms | 22.50 | 9.00 | 22.50 | 25.00 | 0.0 | | | 2.60 | 100.00 | 3.90 | 0.00 | 2.6 | 3.46 | ||||||||||||||
Asset D |
Healthcare | 25.00 | 10.00 | 25.00 | 25.00 | 0.0 | | | 2.60 | 100.00 | 3.90 | 0.00 | 2.6 | 3.85 | ||||||||||||||
Asset E |
Utilities | 25.00 | 10.00 | 25.00 | 25.00 | 0.0 | | | 2.60 | 100.00 | 3.90 | 0.00 | 2.6 | 3.85 | ||||||||||||||
100.00 | 40.00 | 1.00 | 2.60 | 15.36 | ||||||||||||||||||||||||
Total MV |
Step 1: First, total dollar amount of excess concentration is determined by industry. This is depicted as USD1.00 in column D and calculated as 2.5% of the industrys excess concentration, multiplied by the USD40 total portfolio value.
Step 2: The dollar amount is then allocated to individual securities based on the weights of those securities in that industry (USD0.64 and USD0.36 i n column E). This represents each securitys dollar share of their industrys overconcentration.
Step 3: Discount factors are then allocated to each security based on its share of the industrys concentration. Column F is the standard discount factor for the security and column G is the percentage of that assets market value (MV) to which it is applicable. Column H is the standard discount factor for the security multiplied by the additional 1.5 multiple that captures systemic risk from industry overconcentration. Column I is the percentage of the securitys MV to which the more conservative discount factor is applicable.
Step 4: Column J is the weighted average discount factor for each asset and the portfolio.
Step 5: Finally, the total discounted assets used in Fitchs OC tests in the last column is calculated by discounting the securitys MV by the appropriate discount factors (Column J) and their weights obtained in Step 3.
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Appendix 3: Market Value Approach to Discount Factor Development
Fitch has developed discount factors through historical worst-loss stress testing, an approach that is consistent with its criteria as detailed in the research report titled Rating Market Value Structures, published on April 18, 2008. To reflect the dynamic and diverse nature of CEF portfolios, Fitch has developed specific discount factors for common asset types.
Discounted portfolio assets are used as the numerator for the Fitch OC tests and are calculated by dividing current portfolio market value by the appropriate discount factor for each asset type. Discount factors are not intended to provide a static view of asset performance, rather they express current views of potential market value loss through current economic conditions and the credit cycle. Fitch will perform a periodic review of discount factors using the methodology described in this criteria report. Fitchs determination of asset discount factors was primarily based on worst-loss events experienced by each asset class. Therefore, even if future analysis indicates more positive and/or stable asset performance than implied in the currently presented discount factors, Fitch may leave the discount factors unchanged.
Fitch established discount factors through determination of the appropriate asset categorization, quantitative analysis, and modeling of historical asset price movements, and other qualitative considerations.
Categorization of Asset Classes
Fitch reviewed major asset classes within the CEF investable universe and assigned asset groups differentiated by type and exhibited magnitude of market value risk (for a list of Fitch-identified asset classes, see table, page 1011) . This approach segregated assets by sector, subordination in the issuers capital structure, domicile, credit rating, and duration. Market-based characteristics, such as price or spread measures, were not utilized when segregating assets into distinct categories for the purposes of assigning asset discount factors. The grouping of asset types is intended to strike an appropriate balance between differences in market value performance of asset subclasses and the diminishing benefit of overly specific classification (due to the correlation of similar assets and the challenges a more expanded approach would bring to implementation by funds). Assigning portfolio assets to broader groups is intended to allow funds to allocate discount factors and perform the Fitch OC tests in an efficient and transparent manner.
Quantitative Analysis and Modeling
For each asset class, Fitch constructed a base-case stress based on historical index performance and considered the volatility and liquidity of the given index. The base-case stress was then converted into an expected loss at each rating level by multiplying the base-case stress by a representative factor for higher rating stress scenarios.
Volatility
Fitchs analysis of a given asset category was based on observation of the worst-case price decline experienced by the index, given a rolling 45-business-day exposure period. The analysis used historical price data drawn from an assets representative index. At times, Fitch used multiple indices for its analysis, looking at both price volatility and index constituents. Qualified indices typically had at least 10 years of available data.
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Fund & Asset Manager Rating Group |
Representative indices for each asset class were selected on the basis of the best fit between the index constituents. Factors Fitch considered in determining robustness included: frequency of data points; length of pricing history; inclusion of multiple stress periods and business cycles; and appropriateness of data series for the asset category under consideration. Examples of indices used include the S&P 500 Index, as a proxy for historical price volatility of U.S. large cap common stock; the Alerian MLP Index, for MLPs; the LSTA Leveraged Loan Index, for first lien leveraged loans; and the Lehman Intermediate Corporate Index, for U.S. investment-grade corporate debt that matures in less than 10 years.
As an added measure of conservatism, in certain instances, Fitch increased historically observed worst losses if the asset class had experienced its worst 45-business- day loss within the preceding six months. This was intended to address the uncertainty of potential further price declines in the near future. The size of the increase was based on the timing of the observed worst loss and the degree of historical volatility experienced by the index.
Liquidity
Fitch views market liquidity in periods of stress to be particularly relevant to ensure deleveraging mechanisms work as intended. Therefore, Fitch constructed separate liquidity stresses based on observations of stressed liquidations and discussions with various internal sector analysts and external market participants. The amount of liquidity adjustments varied by asset type; for example, publicly traded equities received no additional liquidity haircut given the deep, established market for such securities.
Overall, Fitch made an assessment of an assets liquidity profile based on factors such as:
|
Market size. |
|
Market volumes (current and historical). |
|
Bid/offer spreads, both in regular and stressed markets. |
|
Observed liquidation prices during periods of stress. |
|
Breadth and diversity of investors. |
|
Size of issue. |
|
Transparency of the issuer. |
|
Assessment of normal and large block trading sizes. |
|
Depth of market-making and stability in times of stress. |
Expected Loss
A base-case stress was calculated for each asset class as the sum of the worst loss plus any illiquidity adjustment. Each base-case stress was classified by Fitch as being consistent with a particular rating stress, as determined by reviewing the main worst-loss drivers, the scale of decline during the specific economic period, and the magnitude of worst loss compared to other historical losses. Once a rating level was determined for each base-case stress, the base-case stress was increased using corresponding multipliers to reflect higher expected losses under higher rating stress scenarios. The multiplier was based on historical asset performance by rating category. For example, to increase a BBB stress to an AAA level, a multiple of two was used. Therefore, if an asset classs observed worst case loss for a 45-business-day period was 11% and this loss was deemed consistent with a BBB stress, then an AAA level worst loss was estimated at 22% over the 45-day period.
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Fund & Asset Manager Rating Group |
Qualitative Assessment
Calculating base-case historical stresses per asset category was only one of a number of factors Fitch considered when determining discount factors. Fitch also analyzed the fundamental characteristics of assets, which included an analysis of the assets structure (e.g. convertible securities) and information transparency (e.g. liquidity). The assets place in the issuers capital structure was also analyzed, with assets falling lower in the capital structure typically receiving higher discount factors. For example, equities received more conservative discount factors compared to bonds. However, this was not always the case; for instance, third-lien secured leveraged loans received lower discount factors than unsecured high-yield bonds, primarily due to the relatively poor liquidity associated with such loans.
Furthermore, given the importance of robust historical data in determining worst-loss estimates, asset classes that did not include significant periods of stress were afforded little to no credit for the purpose of Fitchs analysis.
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Fund & Asset Manager Rating Group |
Appendix 4: Surveillance Template
Example of CEF Surveillance Template Cover Sheet
Report Date:
Fund Name:
99 | Closed-End Fund Debt and Preferred Stock Rating Criteria August 17, 2009 |
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Fund & Asset Manager Rating Group |
Appendix 4: Surveillance Template (continued)
CEF Surveillance Template
Report Date:
Fund Name:
Assets |
Type |
Account |
Notes |
Market Value (USD) | ||||
Balance Sheet Summary |
||||||||
Cash |
Cash unrestricted | 5,000,000 | ||||||
Investments |
Investments not held as collateral | 3,646,073,706 | ||||||
Collateral |
Cash and investments held as collateral | 0 | ||||||
Receivables |
Receivables for investments sold | 20,000,000 | ||||||
Receivables interest and dividends | 25,000,000 | |||||||
Derivatives |
Unrealized appreciation of derivatives | List types of derivatives | 0 | |||||
Other |
All other assets | 5,000,000 | ||||||
Total Assets |
3,701,073,706 | |||||||
Liabilities |
Type |
Account |
Notes |
Market Value (USD) | ||||
Current liabilities |
Payable for investments purchased |
10,000,000 | ||||||
All other current liabilities |
500,000 | |||||||
Leverage |
Securities lending |
10,000,000 | ||||||
Dollar, mortgage and treasury rolls |
0 | |||||||
Reverse repurchase agreements |
0 | |||||||
Tender option bonds |
0 | |||||||
Commercial paper borrowing facility |
0 | |||||||
Bank credit facility |
400,000,000 | |||||||
Notes (if Fitch rated, list all series and number of shares) |
||||||||
Notes series A |
20,000,000 | |||||||
Notes series B |
20,000,000 | |||||||
Notes series C |
20,000,000 | |||||||
Notes series D |
20,000,000 | |||||||
Notes series E |
20,000,000 | |||||||
All other senior debt |
0 | |||||||
Payables |
Payable interest on borrowings |
1,000,000 | ||||||
Derivatives |
Unrealized depreciation on derivatives |
List types of derivatives | 0 | |||||
Other |
Payables not associated with leverage or current liabilities |
1,500,000 | ||||||
Total Liabilities |
523,000,000 | |||||||
Equity |
Type |
Account |
Share Outstanding |
Market Value (USD) | ||||
Leverage |
Preferred stock (if Fitch rated, list all series and number of shares) |
|||||||
Preferred series A |
4,000 | 100,000,000 | ||||||
Preferred series B |
4,000 | 100,000,000 | ||||||
Preferred series C |
4,000 | 100,000,000 | ||||||
Preferred series D |
4,000 | 100,000,000 | ||||||
Accrued dividends |
350,000 | |||||||
Common |
Common stock |
300,000,000 | 1,800,000,000 | |||||
Other |
Remaining equity |
977,723,706 | ||||||
Total Equity |
3,178,073,706 | |||||||
Common Stock Price Per Share |
USD6.00 |
Funds NAV | 9.26 |
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Fund & Asset Manager Rating Group |
Copyright © 2009 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.
Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. All of the information contained herein is based on information obtained from issuers, other obligors, underwriters, and other sources which Fitch believes to be reliable. Fitch does not audit or verify the truth or accuracy of any such information. As a result, the information in this report is provided as is without any representation or warranty of any kind. A Fitch rating is an opinion as to the creditworthiness of a security. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed, suspended, or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from USD1,000 to USD750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from USD10,000 to USD1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of Great Britain, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
101 | Closed-End Fund Debt and Preferred Stock Rating Criteria August 17, 2009 |
Control No. | Maximum Primary Subscription Shares Available: | |
Number of Rights Issued: |
SUBSCRIPTION CERTIFICATE
THE OFFER EXPIRES AT 5:00 P.M., EASTERN TIME, ON APRIL 23, 2010 (unless extended)
PIMCO INCOME STRATEGY FUND II
SUBSCRIPTION RIGHTS FOR COMMON SHARES OF BENEFICIAL INTEREST
IN ORDER TO EXERCISE YOUR RIGHTS, YOU MUST COMPLETE THIS CARD AND RETURN IT TO THE SUBSCRIPTION AGENT.
Dear Shareholder:
You are entitled to exercise the Rights issued to you as of March 24, 2010, the Record Date for the Offer, to subscribe for the number of common shares of beneficial interest, par value $.00001 per share (the Shares), of PIMCO Income Strategy Fund II (the Fund) shown on this Subscription Certificate pursuant to the primary subscription upon the terms and conditions specified in the Funds prospectus, dated March [ ], 2010 (the Prospectus). The terms and conditions of the Offer set forth in the Prospectus are incorporated by reference herein. Capitalized terms not defined herein have the meanings attributed to them in the Prospectus. As a Rights holder, you are entitled to purchase one Share for each three Rights you exercise. If you hold less than three Rights, you are entitled to subscribe for one Share. In accordance with the over-subscription privilege, as a Rights holder, you also are entitled to subscribe for additional Shares subject to certain limitations and subject to allotment, if Shares remaining after the exercise of Rights pursuant to the primary subscription are available and you have fully exercised all Rights issued to you (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share). To the extent that sufficient Shares are not available to honor all over-subscription requests, unsubscribed Shares will be allocated pro-rata among those Record Date Shareholders who over-subscribe based on the number of the Funds common shares they owned on the Record Date. The Fund will not offer or sell any Shares that are not subscribed for pursuant to the primary subscription or the over-subscription privilege.
In order to exercise your Rights, you must deliver to the subscription agent, The Colbent Corporation, by 5:00 p.m., Eastern time, on April 23, 2010 (unless extended, the Expiration Date), either (1) a properly completed and executed subscription certificate and a money order or check drawn on a bank located in the United States of America and payable to PIMCO Income Strategy Fund II for an amount equal to the number of Shares subscribed for under the primary subscription and over-subscription (if applicable) multiplied by the estimated Subscription Price of $[ ] per Share, or (2) a Notice of Guaranteed Delivery guaranteeing delivery of (i) a properly completed and executed subscription certificate and (ii) a money order or check drawn on a bank located in the United States of America and payable to PIMCO Income Strategy Fund II for an amount equal to the number of Shares subscribed for under the primary subscription and over-subscription (if applicable) multiplied by the estimated Subscription Price of $[ ] per Share.
If a Notice of Guaranteed Delivery is used, a properly completed subscription certificate, together with payment in full, as described above, must be received by the subscription agent, The Colbent Corporation, no later than April 28, 2010, unless the Offer is extended. See The OfferMethod for Exercising Rights and The OfferPayment for Shares in the Prospectus.
No later than [ ], 2010, The Colbent Corporation will send you a confirmation (or, if you own your common shares through a depository or nominee, to such depository or nominee), showing (i) the number of Shares acquired pursuant to the primary subscription, (ii) the number of Shares, if any, acquired pursuant to the over-subscription privilege, (iii) the per Share and the aggregate purchase price for all of the Shares acquired by you, and (iv) any additional amount payable by you or any excess to be refunded to you. Any excess payment to be refunded will be mailed as promptly as practicable.
Participants in the Funds dividend reinvestment plan (the Plan) will have any Shares acquired pursuant to the primary subscription or over-subscription privilege credited to their shareholder dividend reinvestment accounts in the Plan.
Shareholders whose common shares are held of record by Cede & Co. or by any other depository or nominee on their behalf or their broker-dealers behalf will have any Shares acquired during the subscription period credited to the account of Cede & Co. or other depository or nominee. Share certificates for all Shares acquired pursuant to the primary subscription or over-subscription privilege will be mailed promptly after payment for the Shares subscribed for has cleared. |
SAMPLE CALCULATION:
To subscribe for your primary subscription Shares please complete line A on the card below.
100 Shares = 100 Rights. 100 Rights divided by 3 = 33 primary subscription shares. The maximum number of primary subscription shares would be 33. Fractional shares will be dropped. If you hold less than 3 Rights in total, you can subscribe for one common share.
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A. | 100 | ÷3 = | 33 | × | $[ ] | = | $[ ] | |||||||
(No. of Rights)
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(No. of Shares)
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(Estimated Subscription Price)
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(Payment to be remitted)
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Please note that $[ ] is an estimated Subscription Price only. The Subscription Price will be determined on April 23, 2010, the Expiration Date (unless extended) and could be higher or lower than the estimated Subscription Price depending on changes in the net asset value and the price of a common share.
To subscribe for any Shares pursuant to the over-subscription privilege, please complete line B below. Please Note: Only Record Date Shareholders who have exercised their primary subscription
METHOD OF EXERCISE OF RIGHTS:
By First Class Mail : | By Express Mail or Overnight Courier : | By Hand : | ||
The Colbent Corporation |
The Colbent Corporation | The Colbent Corporation | ||
Rights Offering |
Rights Offering | Rights Offering | ||
Attention: Corporate Actions |
Attention: Corporate Actions | Attention: Corporate Actions | ||
P.O. Box 859208 |
161 Bay State Road | 161 Bay State Road | ||
Braintree, MA 02185-9208 |
Braintree, MA 02184 | Braintree, MA 02184 |
Confirm by Telephone: [1-781-930-4900]. Delivery to an address other than one of the addresses listed above will not constitute valid delivery.
SECTION 1: DETAILS OF SUBSCRIPTION. PLEASE FILL IN ALL APPLICABLE INFORMATION.
A. | Primary subscription: | ÷ 3 = | × | $[ ] | = | $ | ||||||||||
(3 Rights = 1 Share) | (Rights exercised) | (No. of Shares requested rounded down to nearest whole Share) |
(Estimated Subscription Price) |
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B. | Over-subscription privilege*: | × | $[ ] | = | $ | |||||||||||
(No. of Shares requested) |
(Estimated Subscription Price) |
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C. | Total amount of check or money order enclosed (total of A + B): | = | $ | |||||||||||||
D. | The following broker-dealer is being designated as having been instrumental in the exercise of these Rights: | |||||||||||||||
¨ UBS Securities LLC | ||||||||||||||||
¨ | ||||||||||||||||
Representative Name: | ||||||||||||||||
E. | Sell any remaining Rights | ¨ | ||||||||||||||
F. | Sell all of my Rights | ¨ |
* | You can only over-subscribe if you have fully exercised your primary subscription Rights. |
SECTION 1. TO SUBSCRIBE: I hereby irrevocably subscribe for the number of Shares indicated as the total of A and B hereon upon the terms and conditions specified in the Prospectus relating thereto, receipt of which is acknowledged. I hereby agree that if I fail to pay for the Shares for which I have subscribed (or are deemed to have subscribed for as set forth above), the Fund may exercise any of the remedies set forth in the Prospectus.
TO SELL: If I have checked either the box on line E or line F, I authorize the sale of Rights by the Subscription Agent according to the procedures described in the Prospectus.
Signature(s) of Subscriber(s)/Seller(s)
Address for delivery of shares if other than shown on front
If permanent change of address, check here ¨
Please give your telephone number: ( )
Please give your e-mail address: |
SECTION 2. TO TRANSFER RIGHTS (except pursuant to E or F above): For value received, of the Rights represented by this Subscription Certificate are assigned to:
(Print Full Name of Assignee) Social Security Number
(Print Full Address)
(Print Full Address)
Signature(s) of Assignor(s)
IMPORTANT: The signature(s) must correspond in every particular, without alteration, with the name(s) as printed on your Subscription Certificate. Your Signature must he guaranteed by an Eligible Guarantor Institution as that term is defined under Rule 17Ad-15 of the Securities Exchange Act of 1934, which may include:
a) a commercial bank or trust company, or
b) a member firm of a domestic stock exchange, or
c) a savings hank or credit union.
Signature Guaranteed (Name of Bank or Firm)
By (Signature of Officer and Title)
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NOTICE OF GUARANTEED DELIVERY
FOR
SUBSCRIPTION CERTIFICATES
ISSUED BY
PIMCO INCOME STRATEGY FUND II
This form, or one substantially equivalent hereto (the Notice), must be used to exercise Rights pursuant to the rights offering (the Rights Offering) described in the prospectus, dated March [ ], 2010 (the Prospectus), of PIMCO Income Strategy Fund II, a Massachusetts business trust (the Fund), if a holder of Rights cannot deliver the certificate(s) evidencing the Rights (the Subscription Certificate(s)), to the Subscription Agent listed below (the Subscription Agent) at or prior to 5:00 p.m., Eastern time, on April 23, 2010, unless such time is extended by the Fund as described in the Prospectus (as such date may be extended, the Expiration Date). Such form must be delivered by hand or sent by telegram, facsimile transmission, first class mail or overnight courier to the Subscription Agent, and must be received by the Subscription Agent on or prior to the Expiration Date. See The OfferSubscription Agent in the Prospectus.
The final subscription price (the Subscription Price) for common shares of beneficial interest, par value $0.00001 per share (the Shares), of the Fund to be issued pursuant to the Rights Offering has not yet been determined. Three Rights will entitle the holder to acquire one Share at a Subscription Price, estimated for purposes of this notice, of $[ ] per Share. Payment of the estimated Subscription Price of $[ ] per Share subscribed for upon exercise of such Rights must be received by the Subscription Agent in the manner specified in the Prospectus at or prior to the close of business on the third business day after the Expiration Date if the Subscription Certificate(s) evidencing such Rights is (are) being delivered pursuant to the Guaranteed Delivery Procedures thereof. See The OfferPayment for Shares in the Prospectus.
The Subscription Agent is:
The Colbent Corporation
By First Class Mail Only: | By Hand, Express Mail or Overnight Courier: | |
The Colbent Corporation | The Colbent Corporation | |
Rights Offering | Rights Offering | |
Attention: Corporate Actions | Attention: Corporate Actions | |
P.O. Box 859208 | 161 Bay State Road | |
Braintree, Massachusetts 02185-9208 | Braintree, Massachusetts 02184 |
By Facsimile: [1-781-930-4939]
Telephone Number for Confirmation: [1-781-930-4900]
Telephone Number for Information: The Altman Group, 1-866-207-3647
DELIVERY OF THIS INSTRUMENT TO AN ADDRESS OTHER THAN AS SET FORTH ABOVE OR TRANSMISSION OF THIS INSTRUMENT VIA FACSIMILE OTHER THAN AS SET FORTH ABOVE DOES NOT CONSTITUTE A VALID DELIVERY.
Ladies and Gentlemen:
The undersigned hereby represents that the undersigned is the holder of Subscription Certificate(s) representing a total of Right(s) and that such Subscription Certificate(s) cannot be delivered to the Subscription Agent at or prior to 5:00 p.m., Eastern time, on the Expiration Date. Upon the terms and subject to the conditions set forth in the Prospectus, receipt of which is hereby acknowledged, the undersigned hereby elects to exercise such Right(s) to subscribe for Shares with respect to each of the Rights represented by such Subscription Certificate(s).
The undersigned understands that payment in U.S. dollars of the estimated Subscription Price of $[ ] per Share for each Share subscribed for must be received by the Subscription Agent at or prior to 5:00 p.m., Eastern time, on the third business day after the Expiration Date and represents that such payment, in the aggregate amount of $ , either (check appropriate box):
¨ | is being delivered to the Subscription Agent herewith | |
or |
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¨ | has been or will be delivered separately to the Subscription Agent in the manner set forth below (check appropriate box and complete information relating thereto) |
¨ | Wire transfer of funds | |||||
Name of transferor institution: | ||||||
Date of transfer: | ||||||
Confirmation number (if available): | ||||||
¨ | Uncertified check (Payment by uncertified check will not be deemed to have been received by the Subscription Agent until such check has cleared. Holders paying by such means are urged to make payment sufficiently in advance of the Expiration Date to ensure that such payment clears by such date.) | |||||
¨ | Certified check | |||||
¨ | Bank draft (cashiers check) | |||||
¨ | Money order | |||||
Name of maker: | ||||||
Date of check, draft or money order: | ||||||
Check, draft or money order number: | ||||||
Bank on which check is drawn or issuer of money order: |
Signature(s): |
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Address: | ||||||
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Name(s): | Area Code and Tel. No(s).: |
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(Please type or print) |
Subscription Rights Certificate No(s). (if available): |
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GUARANTEE OF DELIVERY
(Not To Be Used For Subscription Certificate Signature Guarantee)
The undersigned, a member firm of a registered national securities exchange or of the Financial Industry Regulatory Authority. Inc., or a commercial bank or trust company having an office or correspondent in the United States, or a bank, stockbroker, savings and loan association or credit union with membership in an approved signature medallion program, pursuant to Rule 17Ad-15 under the Securities Exchange Act of 1934, as amended, guarantees that the undersigned will deliver to the Subscription Agent the Subscription Certificate(s) representing the Rights being exercised hereby, with any required signature guarantee and any other required documents, all within three (3) business days after the date hereof.
Dated: , 2010
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(Address) |
(Name of Firm) |
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(Area Code and Telephone Number) |
(Authorized Signature) |
The institution which completes this form must communicate the guarantee to the Subscription Agent and must deliver the Subscription Certificate(s) to the Subscription Agent within the time period shown in the Prospectus. Failure to do so could result in a financial loss to such institution.
PIMCO Income Strategy Fund
PIMCO Income Strategy Fund II
[ ] Common Shares
Issuable Upon Exercise of Rights
to Subscribe for such Shares
DEALER MANAGER AGREEMENT
New York, New York
March [ ], 2010
UBS Securities LLC
299 Park Avenue
New York, New York 10171-0026
Ladies and Gentlemen:
Each of [ PIMCO Income Strategy Fund (formerly, PIMCO Floating Rate Income Fund) / PIMCO Income Strategy Fund II (formerly, PIMCO Floating Rate Strategy Fund) ], a voluntary association with transferable shares organized and existing under and by virtue of the laws of The Commonwealth of Massachusetts (commonly referred to as a Massachusetts business trust) (the Fund), and Allianz Global Investors Fund Management LLC (the Investment Manager), hereby confirms the agreement with and appointment of UBS Securities LLC to act as dealer manager (the Dealer Manager) in connection with the issuance by the Fund to the holders of record (the Record Date Shareholders) at the close of business on the record date set forth in the Prospectus (as defined herein) (the Record Date) of transferable rights entitling such Record Date Shareholders to subscribe for up to [ ] shares (each a Share and, collectively, the Shares) of common shares of beneficial interest, par value $0.00001 per share (the Common Shares), of the Fund (the Offer). Pursuant to the terms of the Offer, the Fund is issuing each Record Date Shareholder one transferable right (each a Right and, collectively, the Rights) for each Common Share held by such Record Date Shareholder on the Record Date. Such Rights entitle their holders to acquire during the subscription period set forth in the Prospectus (the Subscription Period), at the price set forth in
such Prospectus (the Subscription Price), one Share for each [ ] Rights exercised (the Primary Subscription) (except that any Record Date Shareholder who is issued fewer than [ ] Rights will be able to subscribe for one full Share pursuant to the Primary Subscription), on the terms and conditions set forth in such Prospectus. No fractional Shares will be issued. Any Record Date Shareholder who fully exercises all Rights initially issued to such Record Date Shareholder (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) will be entitled to subscribe for, subject to allocation, additional Shares (the Over-Subscription Privilege) on the terms and conditions set forth in the Prospectus. The Rights are transferable and are expected to be listed on the New York Stock Exchange, Inc. (the NYSE) under the symbol [ PFL.RT / PFN.RT ].
The Investment Manager acts as the Funds investment manager pursuant to an Investment Management Agreement by and between the Fund and the Investment Manager, dated as of [ August 19, 2003 / October 19, 2004 ] (the Investment Management Agreement). Pacific Investment Management Company LLC (PIMCO or the Sub-Adviser) acts as the Funds sub-adviser pursuant to a Portfolio Management Agreement by and between the Investment Manager and PIMCO, as accepted and agreed to by the Fund, dated as of [ August 19, 2003 / October 19, 2004 ] (the Portfolio Management Agreement).
The Fund has filed with the Securities and Exchange Commission (the Commission) a registration statement on Form N-2 (Nos. 333-[ 164386 / 164388 ]) and 811-[ 21374 / 21601 ]) and a related preliminary prospectus and preliminary statement of additional information under the Investment Company Act of 1940, as amended (the Investment Company Act), the Securities Act of 1933, as amended (the Securities Act), and the rules and regulations of the Commission under the Investment Company Act and the Securities Act (the Rules and Regulations), and has filed such amendments to such registration statement on Form N-2, if any, and such amended preliminary prospectuses and preliminary statements of additional information as may have been required to the date hereof. If the registration statement has not become effective, a further amendment to such registration statement, including forms of a final prospectus and final statement of additional information necessary to permit such registration statement to become effective, will promptly be filed by the Fund with the Commission. If the registration statement has become effective and any prospectus or statement of additional information contained therein omits certain information at the time of effectiveness pursuant to Rule 430A of the Rules and Regulations, a final prospectus and final statement of additional information containing such omitted information will promptly be filed by the Fund with the Commission in accordance with Rule 497(h) of the Rules and Regulations. The term Registration Statement means the registration statement, as amended, at the time it becomes or became effective, including financial statements
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and all exhibits and all documents, if any, incorporated therein by reference, and any information deemed to be included by Rule 430A. The term Prospectus means the final prospectus and final statement of additional information in the forms filed with the Commission pursuant to Rule 497(c), (e), (h) or (j) of the Rules and Regulations, as the case may be, as from time to time amended or supplemented pursuant to the Securities Act.
The Prospectus and letters to owners of Common Shares of the Fund, subscription certificates and other forms used to exercise rights, brochures, wrappers, any letters from the Fund to securities dealers, commercial banks and other nominees and any newspaper announcements, press releases and other offering materials and information that the Fund may use, approve, prepare or authorize for use in connection with the Offer, are collectively referred to hereinafter as the Offering Materials.
1. | Representations and Warranties . |
a. | Each of the Fund and the Investment Manager jointly and severally represents and warrants to, and agrees with, the Dealer Manager as of the date hereof, as of the date of the commencement of the Offer (such later date being hereinafter referred to as the Representation Date), as of the Expiration Date (as defined below) and as of each closing date (a Closing Date) of the purchase of Shares upon exercise of Rights that: |
i. |
The Fund meets the requirements for use of Form N-2 under the Securities Act and the Investment Company Act and the Rules and Regulations. At the time the Registration Statement became or becomes effective, the Registration Statement contained or will contain all statements required to be stated therein in accordance with and did or will comply in all material respects with the requirements of the Securities Act, the Investment Company Act and the Rules and Regulations and did not or will not contain an untrue statement of a material fact or omit to state any material fact required to be stated |
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therein or necessary to make the statements therein not misleading. From the time the Registration Statement became or becomes effective through the expiration date of the Offer set forth in the Prospectus, as it may be extended as provided in the Prospectus (the Expiration Date), and the last Closing Date, the Prospectus and the other Offering Materials have not contained and will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided , however , that the representations and warranties in this subsection shall not apply to statements in or omissions from the Registration Statement, Prospectus or Offering Materials made in reliance upon and in conformity with information relating to the Dealer Manager furnished to the Fund in writing by the Dealer Manager expressly for use in the Registration Statement, Prospectus or other Offering Materials as described in Section 7(g) hereof. |
ii. | The Fund (i) has been duly formed, is validly existing as an unincorporated voluntary association under the laws of The Commonwealth of Massachusetts (commonly known as a Massachusetts business trust), (ii) has full power and authority to conduct all the activities conducted by it, to own or lease all assets owned or leased by it and to conduct its business as described in the Registration Statement and the Prospectus, (iii) has made all necessary filings required under any federal, state, local or foreign law, regulation or rule, (iv) is duly licensed and qualified to do business and in good standing in each jurisdiction in which its ownership or leasing of property or its conducting of business requires such qualification, except where the failure to be so qualified or be in good standing would not have a material adverse effect on the condition (financial or other), business prospects, properties, net assets or results of operations of the Fund; (i) owns, possesses or has obtained and currently maintains all governmental licenses, permits, consents, orders, approvals and other authorizations, whether foreign or domestic, necessary to carry on its business as contemplated in the Prospectus (collectively, the Licenses and Permits); and (vi) has no subsidiaries. |
iii. |
The Fund is duly registered with the Commission under the Investment Company Act as a diversified, closed-end management investment company, no order of suspension or revocation of such registration has been issued or proceedings therefor initiated or, to the best of the Funds and the Investment Managers knowledge, threatened by the Commission, and all required action has been taken by the Fund under the Securities Act and the Investment Company |
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Act, as the case may be, necessary to make the public offering and consummate the issuance of the Rights and the issuance and sale of the Shares by the Fund upon exercise of the Rights, and the provisions of the Funds Amended and Restated Agreement and Declaration of Trust (the Declaration of Trust) and Amended and Restated Bylaws (the Bylaws) comply as to form in all material respects with the requirements of the Investment Company Act and the Rules and Regulations. |
iv. | PricewaterhouseCoopers LLP, the independent registered public accounting firm whose report on the financial statements of the Fund set forth or incorporated by reference in the Registration Statement and the Prospectus, is an independent registered public accounting firm with respect to the Fund as required by the Securities Act and the Investment Company Act, the Securities Act, the Rules and Regulations and by the rules of the Public Company Accounting Oversight Board. |
v. | The financial statements of the Fund, together with the related notes and schedules thereto, set forth or incorporated by reference in the Registration Statement and the Prospectus present fairly in all material respects the financial condition of the Fund as of the dates or for the periods indicated in conformity with generally accepted accounting principles in the United States applied on a consistent basis; and the information set forth in the Prospectus under the headings Summary of Fund Expenses and Financial Highlights presents fairly in all material respects the information stated therein. |
vi. |
The documents incorporated by reference in the Registration Statement and the Prospectus, at the time they became effective or were filed with the Commission, as the case may be, complied in all material respects with the requirements of the Securities Act or the Exchange Act, as applicable, and the rules and regulations of the Commission thereunder, and none of such documents contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, and any further documents so filed and incorporated by reference in the Registration Statement and |
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the Prospectus, as amended or supplemented, when such documents become effective or are filed with the Commission, as the case may be, will conform in all material respects to the requirements of the Securities Act or the Securities Exchange Act of 1934, as amended (the Exchange Act), as applicable, and the rules and regulations of the Commission thereunder and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they are made, not misleading. |
vii. | The Fund has an authorized and outstanding capitalization as set forth in the Prospectus; the issued and outstanding Common Shares have been duly authorized and are validly issued, fully paid and non-assessable (except as described or referenced to in the Registration Statement and the Prospectus) and conform in all material respects to the description thereof in the Prospectus under the heading Description of capital structure; the Rights have been duly authorized by all requisite action on the part of the Fund for issuance pursuant to the Offer; the certificates for the Shares are in due and proper form; the Shares have been duly authorized by all requisite action on the part of the Fund for issuance and sale pursuant to the terms of the Offer and, when issued and delivered by the Fund upon exercise of the Rights pursuant to the terms of the Offer against payment of the consideration set forth in the Prospectus, will be validly issued, fully paid and non-assessable (except as described or referenced to in the Registration Statement and the Prospectus); the Shares and the Rights conform in all material respects to all statements relating thereto contained in the Registration Statement, the Prospectus and the other Offering Materials; and the issuance of each of the Rights and the Shares has been done in compliance with all applicable federal and state securities laws and is not subject to any preemptive rights. |
viii. |
Except as set forth in the Prospectus, subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, (A) the Fund has not incurred any liabilities or obligations, direct or contingent, or entered into any transactions, other than in the ordinary course of |
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business, that are material to the Fund, (B) there has not been any material change in the Common Shares or long-term debt of the Fund, or any material adverse change, or any development involving a prospective material adverse change, in the condition (financial or other), business, prospects, net worth or results of operations of the Fund, (C) there has been no dividend or distribution paid or declared in respect of the Funds Common Shares [NTD: confirm the planned dividend dates. ] and (D) the Fund has not incurred any long-term debt. |
ix. |
This dealer manager agreement (the Dealer Manager Agreement) has been duly authorized, executed and delivered by the Fund. Each of the Subscription Agency Agreement (the Subscription Agency Agreement), dated as of [ ], 2010, between the Fund and The Altman Group (the Subscription Agent), the Information Agent Agreement (the Information Agent Agreement), dated as of [ ], 2010, between the Fund and the Colbent Corporation (the Information Agent), the Investment Management Agreement, the Custodian and Investment Accounting Agreement (the Custodian Agreement), dated as of [ ], between the Fund and State Street Bank and Trust Company, Transfer Agency Services Agreement (the Transfer Agency Agreement), dated as of [ ], between the Fund and PNC Global Investment Servicing Inc. (formerly, PFPC, Inc.), the Organizational and Offering Expenses Reimbursement Agreement (the Expense Reimbursement Agreement), dated as of [ ], between the Fund and PIMCO Advisers Fund Management LLC, the Auction Agency Agreement (the Auction Agency Agreement), dated as of [ ], between the Fund and Deutsche Bank Trust Company Americas, as auction agent with respect to the Funds auction preferred shares, and [ insert other Fund agreements ] (collectively, all the foregoing agreements set forth in this sentence are the Fund Agreements), has been duly authorized, executed and delivered by the Fund; the Dealer Manager Agreement and each of the Fund Agreements complies in all material respects with all applicable provisions of the Investment Company Act, the Investment Advisers Act of 1940, as amended (the Advisers Act), and the rules and regulations under such Acts; and, assuming due authorization, execution and delivery by the other parties thereto, the Dealer Manager Agreement and each of the Fund Agreements constitutes |
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a legal, valid, binding and enforceable obligation of the Fund, subject (A) to the qualification that the enforceability of the Funds obligations thereunder may be limited by bankruptcy, insolvency, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors rights, to general principles of equity (regardless of whether enforceability is considered in a proceeding in equity or at law), (B) in the case of the Investment Management Agreement, to termination under the Investment Company Act or the reasonableness or fairness of compensation payable thereunder and (C) except as rights to indemnity under this Dealer Manager Agreement may be limited by federal or state securities laws. |
x. | Neither the issuance of the Rights, nor the issuance and sale of the Shares pursuant to exercise of the Rights, nor the execution, delivery, performance and consummation by the Fund of any other of the transactions contemplated in this Dealer Manager Agreement and the Fund Agreements, nor the consummation of the transactions contemplated in this Dealer Manager Agreement or in the Registration Statement nor the fulfillment of the terms hereof or thereof will (A) conflict with or violate the Declaration of Trust or Bylaws, or (B) conflict with, result in a breach or violation of, or constitute a default or an event of default under, or result in the creation or imposition of any lien, charge or encumbrance upon any properties or assets of the Fund under the Declaration of Trust or Bylaws, or under the terms and provisions of any agreement, indenture, mortgage, loan agreement, note, insurance or surety agreement, lease or other instrument to which the Fund is a party or by which it may be bound or to which any of the property or assets of the Fund is subject, except where such conflict, breach violation, default or lien referenced in (B) does not or would not have, either individually or in the aggregate, a material adverse effect on the condition (financial or other), business prospects, properties, net assets or results of operations of the Fund, of (C) result in any violation of any law, rule or regulation, or order of any court, governmental instrumentality, securities exchange or association or arbitrator, whether foreign or domestic, applicable to the Fund, other than state securities or blue sky laws applicable in connection with the Offer of the Shares. |
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xi. | The Fund is not currently in breach of, or in default under, any written agreement or instrument to which it is a party or by which it or its property is bound or affected, except where such violation, either individually or in the aggregate, does not or would not have a material adverse effect on the condition (financial or other), business prospects, properties, net assets or results of operations of the Fund. |
xii. | No person has any right to the registration of any securities of the Fund because of the filing of the Registration Statement with the Commission. |
xiii. | Except as set forth in the Registration Statement, there is no pending or, to the knowledge of the Fund or the Investment Manager, threatened action, suit, claim, investigation or proceeding affecting the Fund or to which the Fund is a party before or by any court or governmental agency, authority or body or any arbitrator which, if determined adversely, would result in any material adverse change in the condition (financial or other), business prospects, net worth or operations of the Fund, or which might materially and adversely affect the properties or assets thereof of a character required to be disclosed in the Registration Statement or the Prospectus or the consummation of the transactions contemplated hereby. |
xiv. | There are no franchises, contracts or other documents of the Fund that are material or otherwise required to be described in the Registration Statement or the Prospectus or to be filed or incorporated by reference as exhibits to the Registration Statement which are not described or filed or incorporated by reference therein as permitted by the Securities Act, the Investment Company Act or the Rules and Regulations. |
xv. |
No consent, approval, authorization, notification or order of, or filing with, or the issuance of any license or permit by, any court or governmental agency or body is required for the consummation by the Fund of the transactions contemplated by this Dealer Manager Agreement, the Subscription Agency Agreement, the Rights and the Offer or the Registration Statement, except such as have been obtained, or if the registration statement filed with respect to the Shares is not effective under the Securities Act as of the time of execution hereof, such as may be required (and shall be obtained as provided in this |
9
Dealer Manager Agreement) under the Investment Company Act, the Securities Act and the Exchange Act, or by the Financial Industry Regulatory Authority, Inc. (FINRA) or the NYSE. |
xvi. | The Common Shares have been duly listed on the NYSE and prior to their issuance the Shares and the Rights will have been duly approved for listing, subject to official notice of issuance, on the NYSE. |
xvii. | No transaction has occurred between or among the Fund and any of its officers or trustees, shareholders or affiliates or any affiliate or affiliates of any such officer or trustee or shareholder or affiliate that is required to be described in and is not described in the Registration Statement and the Prospectus. |
xviii. | The Fund (A) has not taken, directly or indirectly, any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Fund to facilitate the issuance of the Rights or the sale or resale of the Rights and the Shares, (B) has not since the filing of the Registration Statement sold, bid for or purchased, or paid anyone any compensation for soliciting purchases of, Common Shares of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer Manager Agreement) and (C) will not, until the later of the expiration of the Rights or the completion of the distribution (within the meaning of the anti-manipulation rules under the Exchange Act) of the Shares, sell, bid for or purchase, pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer Manager Agreement and except as relates to the Funds auction preferred shares); provided that any action in connection with the Funds dividend reinvestment plan will not be deemed to be within the terms of this Section 1(a)(xviii). |
xix. |
The Fund has complied in all previous tax years and intends to direct the investment of the proceeds of the offering described in the Registration Statement and the Prospectus in such a manner as to continue to comply, with the requirements of |
10
Subchapter M of the Internal Revenue Code of 1986, as amended (Subchapter M of the Code), and has qualified and intends to continue to qualify as a regulated investment company under Subchapter M of the Code. |
xx. | The Fund has complied in the last five years, and intends to direct the investment of the proceeds of the offering described in the Registration Statement and the Prospectus in such a manner as to continue to comply, with the provisions of Section 18 of the Investment Company Act. |
xxi. | The Fund has filed all Federal, state, local and foreign tax returns which are required to be filed through the date hereof, which returns are true and correct in all material respects or has received timely extensions thereof, and has paid all taxes shown on such returns and all assessments received by it to the extent that the same are material and have become due. There are no tax audits or investigations pending, which if adversely determined would have a material adverse effect on the Fund; nor are there any material proposed additional tax assessments against the Fund. |
xxii. | The Fund has (a) appointed a Chief Compliance Officer and (b) adopted and implemented written policies and procedures which the Board of Trustees of the Fund has determined are reasonably designed to prevent violations of the federal securities laws in a manner required by and consistent with Rule 38a-1 of the Rules and Regulations under the Investment Company Act and is in compliance in all material respects with such Rule. |
xxiii. | The Offering Materials complied and comply with the requirements of the Securities Act and the Rules and Regulations, including Rule 482 under the Securities Act. Other than the Offering Materials, the Fund has not, without the written permission of the Dealer Manager, used, approved, prepared or authorized any letters to beneficial owners of the Common Shares, forms used to exercise rights, any letters from the Fund to securities dealers, commercial banks and other nominees or any newspaper announcements or other offering materials and information in connection with the Offer; provided, however, that any use of transmittal documentation and subscription documentation independently prepared by the Dealer Manager, broker-dealers, trustees, nominees or other financial intermediaries shall not cause a violation of this section 1(a)(xxiiii). |
11
xxiv. | Any Offering Materials authorized in writing by or prepared by the Fund, the Investment Manager or the Sub-Adviser used in connection with the issuance of the Rights does not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. Moreover, all Offering Materials complied and will comply in all material respects with the applicable requirements of the Securities Act, the Investment Company Act, the Rules and Regulations and the rules and interpretations of FINRA. |
xxv. | The Fund is insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which it is engaged and which the Fund deems adequate; all policies of insurance insuring the Fund or its business, assets, employees, officers and trustees, including the Funds trustees and officers errors and omissions insurance policy and its fidelity bond required by Rule 17g-1 of the Rules and Regulations under the Investment Company Act, are in full force and effect; the Fund is in compliance with the terms of such policy and fidelity bond in all material respects; and there are no claims by the Fund under any such policy or fidelity bond as to which any insurance company is denying liability or defending under a reservation of rights clause; the Fund has not been refused any insurance coverage sought or applied for; and the Fund has no reason to believe that it will not be able to renew its existing insurance coverage and fidelity bond as and when such coverage and fidelity bond expires or to obtain similar coverage and fidelity bond from similar insurers as may be necessary to continue its business |
xxvi. |
The Fund maintains a system of internal accounting controls sufficient to provide reasonable assurance that (A) transactions are executed in accordance with managements general or specific authorization; (B) transactions are recorded as necessary to permit preparation of financial statements in conformity with U.S. generally accepted accounting principles and to maintain accountability for assets; (C) access to assets |
12
is permitted only in accordance with managements general or specific authorization; and (D) the recorded accountability for assets is compared with existing assets through an asset reconciliation procedure or otherwise at reasonable intervals and appropriate action is taken with respect to any differences. |
xxvii. | The Fund has established and maintains disclosure controls and procedures; such disclosure controls and procedures (as such term is defined in Rule 30a-3 under the Investment Company Act) are designed to ensure that material information relating to the Fund is made known to the Funds Chief Executive Officer and its Chief Financial Officer by others within the Fund, and such disclosure controls and procedures are effective to perform the functions for which they were established; the Funds independent registered public accounting firm and the Audit Oversight Committee of the Board of Trustees of the Fund have been advised of: (A) any significant deficiencies in the design or operation of internal controls over financial reporting which could adversely affect the Funds ability to record, process, summarize, and report financial data; and (B) any fraud, whether or not material, that involves management or other employees who have a role in the Funds internal controls over financial reporting; any material weaknesses in the Funds internal controls over financial reporting have been identified for the Funds independent registered public accounting firm; and since the date of the most recent evaluation of such disclosure controls and procedures, there have been no significant changes in internal controls over financial reporting or in other factors that could materially affect internal controls over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses. |
xxviii. | No person is serving or acting as an officer, trustee or investment adviser of the Fund except in accordance with the provisions of the Investment Company Act. Except as disclosed in the Registration Statement, and the Prospectus, no trustee of the Fund is (A) an interested person (as defined in the Investment Company Act) of the Fund or (B) an affiliated person (as defined in the Investment Company Act) of the Dealer Manager. For purposes of this Section 1(a)(xxvii), the Fund and the Investment Manager shall be entitled to rely on representations from such officers, trustees and investment advisers. |
13
xxix. | The Fund and its officers and directors, in their capacities as such, are in compliance in all material respects with the applicable provisions of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder. |
xxx. | The Funds Board of Trustees has validly appointed an audit committee whose composition satisfies the requirements of Rules 303A.06 and 303A.07(a) of the NYSE Listed Company Manual and the Board of Trustees and/or the audit committee has adopted a charter that satisfies the requirements of Rule 303A.07(c) of the NYSE Listed Company Manual. The audit committee has reviewed the adequacy of its charter within the past twelve months. |
xxxi. | Any statistical, demographic or market-related data included in the Registration Statement, the Prospectus or the other Offering Materials are based on or derived from sources that the Fund and the Investment Manager believe to be reasonably reliable and accurate in all material respects and all such data included in the Registration Statement, the Prospectus and the other Offering Materials accurately reflects in all material respects the materials upon which it is based or from which it was derived. |
xxxii. | The Fund or, to the Funds knowledge, any other person associated with or acting on behalf of the Fund including, without limitation, any trustee, officer, agent or employee of the Fund, has not, directly or indirectly, while acting on behalf of the Fund (i) used any corporate funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity; (ii) made any unlawful payment to foreign or domestic government officials or employees or to foreign or domestic political parties or campaigns from corporate funds; (iii) violated any provision of the Foreign Corrupt Practices Act of 1977, as amended (FCPA); or (iv) made any other unlawful payment. |
xxxiii. |
The operations of the Fund are and have been conducted at all times in compliance with applicable financial recordkeeping |
14
and reporting requirements of the Currency and Foreign Transactions Reporting Act of 1970, as amended, the money laundering statutes of all jurisdictions, the rules and regulations thereunder and any related or similar rules, regulations or guidelines, issued, administered or enforced by any governmental agency (collectively, the Money Laundering Laws) and no action, suit or proceeding by or before any court or governmental agency, authority or body or any arbitrator involving the Fund with respect to the Money Laundering Laws is pending, or to the best knowledge of the Fund, threatened. |
xxxiv. | Neither the Fund nor, to the knowledge of the Fund, any trustee, officer, agent, employee or affiliate of the Fund is currently subject to any U.S. sanctions administered by the Office of Foreign Assets Control of the U.S. Treasury Department (OFAC); and the Fund will not directly or indirectly use the proceeds of the offering, or lend, contribute or otherwise make available such proceeds to any subsidiary, joint venture partner or other person or entity, for the purpose of financing the activities of any person currently subject to any U.S. sanctions administered by OFAC. |
b. | The Investment Manager represents and warrants to, and agrees with, the Dealer Manager as of the date hereof, as of the Representation Date, as of the Expiration Date and as of each Closing Date that: |
i. | The Investment Manager has, or at the relevant time had, been duly formed, is validly existing as a limited liability company under the laws of the State of Delaware with full power and authority to conduct all of the activities conducted by it, to own or lease all of the assets owned or leased by it and to conduct its business as described in the Registration Statement and the Prospectus, and the Investment Manager is duly licensed and qualified to do business and in good standing in each jurisdiction in which it is required to be so qualified, except to the extent that failure to be so qualified or be in good standing would not have a material adverse effect on the Investment Managers ability to provide services to the Fund; and the Investment Manager owns, possesses or has obtained and currently maintains all governmental licenses, permits, consents, orders, approvals and other authorizations, whether foreign or domestic, necessary to carry on its business as contemplated in the Registration Statement and the Prospectus. |
15
ii. | The Investment Manager is (A) duly registered as an investment adviser under the Advisers Act and (B) not prohibited by the Advisers Act or the Investment Company Act from acting as the investment adviser for the Fund as contemplated by the Investment Management Agreement, the Registration Statement and the Prospectus. |
iii. | The Investment Manager has, or at the relevant time had, full power and authority to enter into each of this Dealer Manager Agreement, the Investment Management Agreement and the Portfolio Management Agreement (collectively, this Dealer Manager Agreement, the Investment Management Agreement and the Portfolio Management Agreement being referred to as the Investment Manager Agreements) and to carry out all the terms and provisions hereof and thereof to be carried out by it; and each Investment Manager Agreement has been duly and validly authorized, executed and delivered by the Investment Manager; none of the Investment Manager Agreements violate in any material respect any of the applicable provisions of the Investment Company Act or the Advisers Act; and assuming due authorization, execution and delivery by the other parties thereto, each Investment Manager Agreement constitutes a legal, valid and binding obligation of the Investment Manager, enforceable in accordance with its terms, (i) subject, as to enforcement, to applicable bankruptcy, insolvency and similar laws affecting creditors rights generally and to general equitable principles (regardless of whether enforcement is sought in a proceeding in equity or at law), (ii) in the case of the Investment Management Agreement and the Portfolio Management Agreement, subject to termination under the Investment Company Act or the reasonableness or fairness of compensation payable thereunder, and (iii) except as rights to indemnity thereunder may be limited by federal or state securities laws. |
iv. |
Neither (A) the execution and delivery by the Investment Manager of any Investment Manager Agreement nor (B) the consummation by the Investment Manager of the transactions contemplated by, or the performance of its obligations under, any Investment Manager Agreement conflicts or will conflict |
16
with, or results or will result in a breach of, (1) the limited liability company agreement, the bylaws or other organizational documents of the Investment Manager, (2) any agreement or instrument to which the Investment Manager is a party or by which the Investment Manager is bound, or (3) any law, rule or regulation, or order of any court, governmental instrumentality, securities exchange or association or arbitrator, whether foreign or domestic, applicable to the Investment Manager. |
v. | No consent, approval, authorization or order of any court, governmental agency or body or securities exchange or association, whether foreign or domestic, is required for the consummation of the transactions contemplated in, or the performance by the Investment Manager of its obligations under, any Investment Manager Agreement, except such as (A) have been obtained under the Securities Act, the Exchange Act, the Investment Company Act or the Advisers Act, and (B) may be required by the NYSE, FINRA or under state securities or blue sky laws, in connection with the Offer as contemplated by this Dealer Manager Agreement. |
vi. | The description of the Investment Manager and its business, and the statements attributable to the Investment Manager, in the Registration Statement and the Prospectus comply in all material respects with the requirements of the Securities Act and the Investment Company Act and do not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein (in the case of the Prospectus in light of the circumstances in which they were made) not misleading. |
vii. | Except as set forth in the Registration Statement, there is no action, suit or proceeding before or by any court, commission, regulatory body, administrative agency or other governmental agency or body, foreign or domestic, now pending or, to the knowledge of the Investment Manager, threatened against or affecting the Investment Manager of a nature required to be disclosed in the Registration Statement or the Prospectus or that might reasonably be expected to result in any material adverse change in the condition, financial or otherwise, or business affairs of the Investment Manager or the ability of the Investment Manager to fulfill its respective obligations under any Investment Manager Agreement. |
17
viii. | The Investment Manager (A) has not taken, directly or indirectly, any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Fund to facilitate the issuance of the Rights or the sale or resale of the Rights and the Shares, (B) has not since the filing of the Registration Statement sold, bid for or purchased, or paid anyone any compensation for soliciting purchases of, Common Shares of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer Manager Agreement) and (C) will not, until the later of the expiration of the Rights or the completion of the distribution (within the meaning of the anti-manipulation rules under the Exchange Act) of the Shares, sell, bid for or purchase, pay or agree to pay any person any compensation for soliciting another to purchase any other securities of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer Manager Agreement); provided that any action in connection with (i) the Funds dividend reinvestment plan or (ii) the Funds auction preferred shares will not be deemed to be within the terms of this Section 1(b)(viii). |
ix. | The Investment Manager has adopted and implemented written policies and procedures under Rule 206(4) 7 of the Advisers Act reasonably designed to prevent violation of the Advisers Act by the Investment Manager and its supervised persons. |
x. | The Investment Manager or, to the Investment Managers knowledge, any other person associated with or acting on behalf of the Investment Manager including, without limitation, any trustee, officer, agent or employee of the Investment Manager, has not, directly or indirectly, while acting on behalf of the Investment Manager (A) used any corporate funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity; (B) made any unlawful payment to foreign or domestic government officials or employees or to foreign or domestic political parties or campaigns from corporate funds; (C) violated any provision of the FCPA; or (D) made any other unlawful payment. |
18
xi. | The operations of the Investment Manager are and have been conducted at all times in compliance with applicable Money Laundering Laws and no action, suit or proceeding by or before any court or governmental agency, authority or body or any arbitrator involving the Investment Manager with respect to the Money Laundering Laws is pending, or to the best knowledge of the Investment Manager, threatened. |
xii. | Neither the Investment Manager nor, to the knowledge of the Investment Manager, any member, director, trustee, officer, agent, employee or affiliate of the Investment Manager is currently subject to any U.S. sanctions administered by OFAC; and the Investment Manager will not directly or indirectly direct the proceeds of the offering, or lend, contribute or otherwise make available such proceeds to any subsidiary, joint venture partner or other person or entity, for the purpose of financing the activities of any person currently subject to any U.S. sanctions administered by OFAC. |
xiii. | The Sub-Adviser has been duly formed, is validly existing as a limited liability company under the laws of Delaware with full power and authority to conduct all of the activities conducted by it, to own or lease all of the assets owned or leased by it and to conduct its business as described in the Registration Statement and Prospectus, and the Sub-Adviser is duly licensed and qualified to do business and in good standing in each jurisdiction in which it is required to be so qualified, except to the extent that failure to be so qualified or be in good standing would not have a material adverse affect on the Sub-Advisers ability to provide services to the Fund; and the Sub-Adviser owns, possesses or has obtained and currently maintains all governmental licenses, permits, consents, orders, approvals and other authorizations, whether foreign or domestic, necessary to carry on its business as contemplated in the Registration Statement and the Prospectus. |
xiv. | The Sub-Adviser is (A) duly registered as an investment adviser under the Advisers Act and (B) not prohibited by the Advisers Act or the Investment Company Act from acting as the investment sub-adviser for the Fund as contemplated by the Portfolio Management Agreement, the Registration Statement and the Prospectus. |
19
xv. | The Sub-Adviser has, or at the relevant time had, full power and authority to enter into the Portfolio Management Agreement and to carry out all the terms and provisions hereof and thereof to be carried out by it; and the Portfolio Management Agreement has been duly and validly authorized, executed and delivered by the Sub-Adviser; the Portfolio Management Agreement does not violate in any material respect any of the applicable provisions of the Investment Company Act or the Advisers Act; and assuming due authorization, execution and delivery by the other parties thereto, the Portfolio Management Agreement constitutes a legal, valid and binding obligation of the Sub-Adviser, enforceable in accordance with its terms, (A) subject, as to enforcement, to applicable bankruptcy, insolvency and similar laws affecting creditors rights generally and to general equitable principles (regardless of whether enforcement is sought in a proceeding in equity or at law), (B) subject to termination under the Investment Company Act or the reasonableness or fairness of compensation payable thereunder and (C) except as rights to indemnity thereunder may be limited by federal or state securities laws. |
xvi. | Neither (A) the execution and delivery by the Sub-Adviser of the Portfolio Management Agreement nor (B) the consummation by the Sub-Adviser of the transactions contemplated by, or the performance of its obligations under, the Portfolio Management Agreement conflicts or will conflict with, or results or will result in a breach of, the limited liability company agreement or other organizational documents of the Sub-Adviser or any agreement or instrument to which the Sub-Adviser is a party or by which the Sub-Adviser is bound, or any law, rule or regulation, or order of any court, governmental instrumentality, securities exchange or association or arbitrator, whether foreign or domestic, applicable to the Sub-Adviser. |
xvii. |
No consent, approval, authorization or order of any court, governmental agency or body or securities exchange or association, whether foreign or domestic, is required for the consummation of the transactions contemplated in, or the performance by the Sub-Adviser of its obligations under, the Portfolio Management Agreement, except such as (A) have |
20
been obtained under the Act, the Investment Company Act or the Advisers Act, and (B) may be required under state securities or blue sky laws, in connection with the Offer as contemplated by this Dealer Manager Agreement. |
xviii. | The description of the Sub-Adviser and its business, and the statements attributable to the Sub-Adviser, in the Registration Statement and the Prospectus comply in all material respects with the requirements of the Act and the Investment Company Act and do not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein (in the case of the Prospectus in light of the circumstances in which they were made) not misleading. |
xix. | Except as set forth in the Registration Statement, there is no action, suit or proceeding before or by any court, commission, regulatory body, administrative agency or other governmental agency or body, foreign or domestic, now pending or, to the knowledge of the Sub-Adviser, threatened against or affecting the Sub-Adviser of a nature required to be disclosed in the Registration Statement or Prospectus or that might reasonably be expected to result in any material adverse change in the ability of the Sub-Adviser to fulfill its respective obligations under the Portfolio Management Agreement. |
xx. |
The Sub-Adviser (A) has not taken, directly or indirectly, any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Fund to facilitate the issuance of the Rights or the sale or resale of the Rights and the Shares, (B) has not since the filing of the Registration Statement sold, bid for or purchased, or paid anyone any compensation for soliciting purchases of, Common Shares of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer Manager Agreement) and (C) will not, until the later of the expiration of the Rights or the completion of the distribution (within the meaning of the anti-manipulation rules under the Exchange Act) of the Shares, sell, bid for or purchase, pay or agree to pay any person any compensation for soliciting another to purchase any other securities of the Fund (except for the solicitation of exercises of the Rights pursuant to this Dealer |
21
Manager Agreement); provided that any action in connection with (i) the Funds dividend reinvestment plan or (ii) the Funds auction preferred shares will not be deemed to be within the terms of this Section 1(b)(xx). |
xxi. | The Sub-Adviser has adopted and implemented written policies and procedures under Rule 206(4) 7 of the Advisers Act reasonably designed to prevent violation of the Advisers Act by the Sub-Adviser and its supervised persons. |
xxii. | The Sub-Adviser or, to the Sub-Advisers knowledge, any other person associated with or acting on behalf of the Sub-Adviser including, without limitation, any trustee, officer, agent or employee of the Sub-Adviser, has not, directly or indirectly, while acting on behalf of the Sub-Adviser (A) used any corporate funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity; (B) made any unlawful payment to foreign or domestic government officials or employees or to foreign or domestic political parties or campaigns from corporate funds; (C) violated any provision of the FCPA; or (D) made any other unlawful payment. |
xxiii. | The operations of the Sub-Adviser are and have been conducted at all times in compliance with applicable Money Laundering Laws and no action, suit or proceeding by or before any court or governmental agency, authority or body or any arbitrator involving the Sub-Adviser with respect to the Money Laundering Laws is pending, or to the best knowledge of the Sub-Adviser , threatened. |
xxiv. | Neither the Sub-Adviser nor, to the knowledge of the Sub-Adviser, any member, director, trustee, officer, agent, employee or affiliate of the Sub-Adviser is currently subject to any U.S. sanctions administered by OFAC; and the Sub-Adviser will not directly or indirectly direct the proceeds of the offering, or lend, contribute or otherwise make available such proceeds to any subsidiary, joint venture partner or other person or entity, for the purpose of financing the activities of any person currently subject to any U.S. sanctions administered by OFAC. |
22
c. | Any certificate required by this Dealer Manager Agreement that is signed by any officer of the Fund on behalf of the Fund or the Investment Manager on behalf of the Investment Manager and delivered to the Dealer Manager or counsel for the Dealer Manager shall be deemed a representation and warranty by the Fund or the Investment Manager, as the case may be, to the Dealer Manager, as to the matters covered thereby. |
2. | Agreement to Act as Dealer Manager . |
a. | On the basis of the representations and warranties contained herein, and subject to the terms and conditions of the Offer: |
i. | The Fund hereby appoints the Dealer Manager to solicit the exercise of Rights and authorizes the Dealer Manager to sell Shares purchased by the Dealer Manager from the Fund through the exercise of Rights as described herein; the Fund hereby authorizes the Dealer Manager to form and manage a group of selling broker-dealers (each a Selling Group Member and collectively the Selling Group) that enter into a Selling Group Agreement with the Dealer Manager substantially in the form attached hereto as Exhibit A to solicit the exercise of Rights and to sell Shares purchased by the Selling Group Member from the Dealer Manager as described herein; and the Fund hereby authorizes other soliciting broker-dealers (each a Soliciting Dealer and collectively the Soliciting Dealers) that enter into a Soliciting Dealer Agreement with the Dealer Manager substantially in the form attached hereto as Exhibit B to solicit the exercise of Rights. The Dealer Manager hereby agrees to solicit the exercise of Rights in accordance with its customary practice subject to the terms and conditions of this Dealer Manager Agreement, the procedures described in the Registration Statement, the Prospectus and, where applicable, the terms and conditions of such Selling Group Agreement or Soliciting Dealer Agreement; and the Dealer Manager hereby agrees to form and manage the Selling Group to solicit the exercise of Rights and to sell Shares to the Selling Group purchased by the Dealer Manager from the Fund through the exercise of Rights as described herein in accordance with its customary practice subject to the terms and conditions of this Dealer Manager Agreement, the procedures described in the Registration Statement, the Prospectus and, where applicable, the terms and conditions of the Selling Group Agreement. |
23
ii. | The Fund hereby authorizes the Dealer Manager to buy and exercise Rights, including unexercised Rights delivered to the Subscription Agent for resale and Rights of Record Date Shareholders as of the Record Date whose record addresses are outside the United States held by the Subscription Agent for which no instructions are received, on the terms and conditions set forth in such Prospectus, and to sell Shares to the public or to Selling Group Members at the offering price set by the Dealer Manager from time to time. Sales of Shares by the Dealer Manager or Selling Group Members shall not be at a price higher than the offering price set by the Dealer Manager from time to time. |
b. | To the extent permitted by applicable law, the Fund agrees to furnish, or cause to be furnished, to the Dealer Manager, lists, or copies of those lists, showing the names and addresses of, and number of Common Shares held by, Record Date Shareholders as of the Record Date, and the Dealer Manager agrees to use such information only in connection with the Offer, and not to furnish the information to any other person except for securities brokers and dealers that have been requested by the Dealer Manager to solicit exercises of Rights. |
c. | The Dealer Manager agrees to provide to the Fund, in addition to the services described in Section 2(a), financial structuring services in connection with the Offer. Each of the Fund and the Investment Manager and the Dealer Manager agree that they are each responsible for making their own independent judgments with respect to the Offer and that any opinions or views expressed by the Dealer Manager to the Fund or the Investment Manager regarding such transactions, including, but not limited to, any opinions or views with respect to the price or market for the Funds securities, do not constitute advice or recommendations to the Fund or the Investment Manager. No fee, other than the fees provided for in Section 3 of this Dealer Manager Agreement and the reimbursement of the Dealer Managers out-of-pocket expenses as described in Section 5 of this Dealer Manager Agreement, will be payable by the Fund, or any other party hereto, to the Dealer Manager in connection with the financial structuring services provided by the Dealer Manager pursuant to this Section 2(c). |
d. |
The Fund and the Dealer Manager agree that the Dealer Manager is an independent contractor with respect to the solicitation of the exercise of Rights and the performance of financial structuring services for the Fund contemplated by this Dealer Manager |
24
Agreement. The Fund and the Investment Manager further acknowledge that the Dealer Manager is acting pursuant to a contractual relationship created solely by this Dealer Manager Agreement, entered into on an arms length basis, and in no event do the parties intend that the Dealer Manger act or be responsible as a fiduciary to the Fund or the Investment Manager or their respective managements, stockholders or creditors or any other person in connection with any activity that the Dealer Manager may undertake or has undertaken in furtherance of the Offer, including any purchase and sale of the Shares, either before or after the date hereof. The Dealer Manager, Selling Group Members and Soliciting Dealers hereby expressly disclaim any fiduciary or similar obligations to the Fund or the Investment Manager, either in connection with the transactions contemplated by this Dealer Manager Agreement or any matters leading up to such transactions, and the Fund and the Investment Manager each hereby confirms its understanding and agreement to that effect. The Fund, Dealer Manager, Selling Group Members and Soliciting Dealers agree that they are each responsible for making their own independent judgments with respect to any such transactions, and that any opinions or views expressed by the Dealer Manager, Selling Group Members or Soliciting Dealers to the Fund regarding such transactions, including but not limited to any opinions or views with respect to the subscription price or market for the Funds Shares, do not constitute advice or recommendations to the Fund. The Fund hereby waives and releases, to the fullest extent permitted by law, any claims that the Fund may have against the Dealer Manager, Selling Group Members and Soliciting Dealers with respect to any breach or alleged breach of any fiduciary or similar duty to the Fund in connection with the transactions contemplated by this Dealer Manager Agreement or any matters leading up to such transactions. |
e. | In rendering the services contemplated by this Dealer Manager Agreement, the Dealer Manager acknowledges that it is not authorized to use any solicitation material other than the Prospectus (as supplemented or amended, if applicable) and the other Offering Materials. |
f. |
In rendering the services contemplated by this Dealer Manager Agreement, the Dealer Manager will not be subject to any liability to the Fund or the Investment Manager or any of its affiliates, for any act or omission on the part of any soliciting broker or dealer (except with |
25
respect to the Dealer Manager acting in such capacity) or any other person, and the Dealer Manager will not be liable for acts or omissions in performing its obligations under this Dealer Manager Agreement, except for any losses, claims, damages, liabilities and expenses that are finally judicially determined to have resulted primarily from the bad faith, willful misconduct or gross negligence of the Dealer Manager or by reason of the reckless disregard of the obligations and duties of the Dealer Manager under this Dealer Manager Agreement. |
3. |
Dealer Manager Fees . In full payment for the financial structuring and soliciting services rendered and to be rendered hereunder by the Dealer Manager, the Fund agrees to pay the Dealer Manager a fee (the Dealer Manager Fee) equal to [ ]% of the aggregate Subscription Price for the Shares issued pursuant to the exercise of Rights and the Over-Subscription Privilege. In full payment for the soliciting efforts to be rendered, the Dealer Manager agrees to reallow selling fees (the Selling Fees) to Selling Group Members equal to [ ]% of the Subscription Price per Share for each Share issued pursuant to either (a) the exercise of Rights and the Over-Subscription Privilege where such Selling Group Member is so designated on the subscription form or (b) the purchase of Shares for resale from the Dealer Manager in accordance with the Selling Group Agreement. In full payment for the soliciting efforts to be rendered, the Dealer Manager agrees to reallow soliciting fees (the Solicitation Fees) to Soliciting Dealers equal to [ ]% of the Subscription Price per Share for each Share issued pursuant to the exercise of Rights and the Over-Subscription Privilege where such Soliciting Dealer is so designated on the subscription form, subject to a maximum fee based on the number of Common Shares held by such Soliciting Dealer through The Depository Trust Company (DTC) on the Record Date. The Dealer Manager agrees to pay the Selling Fees or Solicitation Fees, as the case may be, to the broker-dealer designated on the applicable portion of the form used by the holder to exercise Rights and the Over-Subscription Privilege, and if no broker-dealer is so designated or a broker-dealer is otherwise not entitled to receive compensation pursuant to the terms of the Selling Group Agreement or Soliciting Dealer Agreement, then the Dealer Manager shall retain such Selling Fee or Solicitation Fee for Shares issued pursuant to the exercise of Rights and the Over-Subscription Privilege. Payment to the Dealer Manager by the Fund will be in the form of a wire transfer of same day funds to an account or accounts identified by the Dealer Manager. Such payment will be made on each date on which the Fund issues Shares after the Expiration Date. Payment to a Selling Group Member or Soliciting Dealer will be made by the Dealer Manager directly to such Selling Group Member |
26
or Soliciting Dealer by check to an address identified by such broker-dealer. Such payments shall be made on or before the tenth business day following the day the Fund issues Shares after the Expiration Date. |
4. | Other Agreements . |
a. | The Fund covenants with the Dealer Manager as follows: |
i. | The Fund will use its best efforts to cause the Registration Statement to become effective and maintain its effectiveness under the Securities Act, and will advise the Dealer Manager promptly as to the time at which the Registration Statement and any amendments thereto (including any post effective amendment) becomes so effective. |
ii. | The Fund will notify, and confirm the notice in writing to, the Dealer Manager immediately (A) of the effectiveness of the Registration Statement and any amendment thereto (including any post-effective amendment), (B) of the receipt of any comments from the Commission, (C) of any request by the Commission for any amendment to the Registration Statement or any amendment or supplement to the Prospectus or for additional information, (D) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for that purpose and (E) of the receipt of any written notice regarding the suspension of the qualification of the Shares or the Rights for offering or sale in any jurisdiction. The Fund will make every reasonable effort to prevent the issuance of any stop order described in subsection (D) hereunder and, if any such stop order is issued, to obtain the lifting thereof at the earliest possible moment. |
iii. |
The Fund will give the Dealer Manager notice of its intention to file any amendment to the Registration Statement (including any post-effective amendment) or any amendment or supplement to the Prospectus (including any revised prospectus which the Fund proposes for use by the Dealer Manager in connection with the Offer, which differs from the prospectus on file at the Commission at the time the Registration Statement becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 497(c), (e) or (h) of the Rules and Regulations), whether pursuant to the |
27
Investment Company Act, the Securities Act, or otherwise, and will furnish the Dealer Manager with copies of any such amendment or supplement a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such amendment or supplement to which the Dealer Manager or counsel for the Dealer Manager shall reasonably object. |
iv. | The Fund will, without charge, deliver to the Dealer Manager, as soon as practicable, a copy of the Registration Statement as originally filed and of each amendment thereto as it may reasonably request, in each case with the exhibits filed therewith. |
v. | The Fund will, without charge, furnish to the Dealer Manager, from time to time during the period when the Prospectus is required to be delivered under the Securities Act, such number of copies of the Prospectus (as amended or supplemented) as the Dealer Manager may reasonably request for the purposes contemplated by the Securities Act or the Rules and Regulations. |
vi. |
If any event shall occur as a result of which it is necessary or appropriate, in the reasonable opinion of counsel for the Dealer Manager, to amend or supplement the Registration Statement or the Prospectus (or other Offering Materials) in order to make the Prospectus (or other Offering Materials) not contain an untrue statement of material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading in the light of the circumstances existing at the time it is delivered to a Record Date Shareholder, the Fund will forthwith amend or supplement the Prospectus by preparing for filing with the Commission (and furnishing to the Dealer Manager a reasonable number of copies of) an amendment or amendments of the Registration Statement or an amendment or amendments of or a supplement or supplements to the Prospectus (in form and substance reasonably satisfactory to counsel for the Dealer Manager), at the Funds expense, which will amend or supplement the Registration Statement or the Prospectus (or otherwise will amend or supplement such other Offering Materials) so that the Prospectus (or such other Offering Materials) will not contain any untrue statement of a |
28
material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances existing at the time the Prospectus (or such other Offering Materials) is delivered to a Record Date Shareholder, not misleading. |
vii. | The Fund will endeavor, in cooperation with the Dealer Manager and its counsel, to confirm that the Rights and the Shares are not required to be qualified for offering and sale under the applicable securities laws of such states and other jurisdictions of the United States as the Dealer Manager may designate. |
viii. | The Fund will make generally available to its security holders as soon as practicable an earnings statement (which need not be audited) covering a twelve month period beginning not later than the first day of the Funds fiscal semi-annual period next following the date of this Dealer Manager Agreement satisfying the provisions of Section 11(a) of the Securities Act and the rules and regulations of the Commission thereunder, including Rule 158 under the Securities Act. |
ix. | For a period of 180 days from the date of this Dealer Manager Agreement, the Fund will not, without the prior consent of the Dealer Manager, offer or sell, or enter into any agreement to sell, any equity or equity related securities of the Fund or securities convertible into such securities, other than the Rights and the Shares and the Common Shares issued in reinvestment of dividends or distributions; provided that any action in connection with the Funds auction preferred shares will not be deemed to be within the terms of this Section 4(a)(ix). |
x. | The Fund will use the net proceeds from the Offer as set forth under Use of proceeds in the Prospectus. |
xi. | The Fund will use its best efforts to cause the Rights and the Shares to be duly authorized for listing by the NYSE, subject to official notice of issuance, prior to the time the Rights are issued. |
xii. | The Fund will use its best efforts to maintain its qualification as a regulated investment company under Subchapter M of the Code. |
29
xiii. | The Fund will apply the net proceeds from the Offer in such a manner as to continue to comply with the requirements of the Prospectus and the Investment Company Act. |
xiv. | The Fund will advise or cause the Subscription Agent (A) to advise the Dealer Manager and, only where specifically noted, each Selling Group Member who specifically requests, from day to day during the period of, and promptly after the termination of, the Offer, as to the names and addresses (to the extent permitted by applicable law) of all Record Date Shareholders exercising Rights, the total number of Rights exercised by each Record Date Shareholder (to the extent permitted by applicable law) during the immediately preceding day, indicating the total number of Rights verified to be in proper form for exercise, rejected for exercise and being processed and, for the Dealer Manager and each Selling Group Member, the number of Rights exercised on subscription certificates indicating the Dealer Manager or such Selling Group Member, as the case may be, as the broker-dealer with respect to such exercise, and as to such other information as the Dealer Manager may reasonably request; and will notify the Dealer Manager and each Selling Group Member, not later than 5:00 P.M., New York City time, on the first business day following the Expiration Date, of the total number of Rights exercised and Shares related thereto, the total number of Rights verified to be in proper form for exercise, rejected for exercise and being processed and, for the Dealer Manager and each Selling Group Member, the number of Rights exercised on subscription certificates indicating the Dealer Manager or such Selling Group Member, as the case may be, as the broker-dealer with respect to such exercise, and as to such other information as the Dealer Manager may reasonably request; (B) to sell any Rights received for resale from Record Date Shareholders exclusively to or through the Dealer Manager, which may, at its election, purchase such Rights as principal or act as agent for the resale thereof; and (C) to issue Shares upon the Dealer Managers exercise of Rights no later than the close of business on the business day following the day that full payment for such Shares has been received by the Subscription Agent. |
30
b. | Neither the Fund, the Investment Manager nor the Sub-Adviser will take, directly or indirectly, any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Fund to facilitate the issuance of the Rights or the sale or resale of the Rights or the Shares; provided that any action in connection with the Funds dividend reinvestment plan will not be deemed to be within the meaning of this Section 4(b). |
c. | The use of any reference to the Dealer Manager in any Offering Materials or any other document or communication prepared, approved or authorized by the Fund or the Investment Manager in connection with the Offer is subject to the prior approval of the Dealer Manager, provided that if such reference to the Dealer Manager is required by applicable law, the Fund and the Investment Manager agree to notify the Dealer Manager within a reasonable time prior to such use, and the Dealer Manager shall not unreasonably withhold its consent. |
d. | The use of any reference to the Fund, the Investment Manager or the Sub-Adviser in any document or written communication prepared, approved or authorized by the Dealer Manager in connection with the Offer is subject to the prior approval of the Fund, the Investment Manager or the Sub-Adviser, respectively, provided that if such reference to the Fund, the Investment Manager or the Sub-Adviser is required by applicable law, the Dealer Manager agrees to notify the Fund, the Investment Manager or the Sub-Adviser, as applicable, within a reasonable time prior to such use, and the Fund, the Investment Manager or the Sub-Adviser, as applicable, shall not unreasonably withhold its consent. |
5. | Payment of Expenses . |
a. |
The Fund will pay all expenses incident to the performance of its obligations under this Dealer Manager Agreement and in connection with the Offer, including, but not limited to, expenses relating to (i) the printing and filing of the Registration Statement as originally filed and of each amendment thereto, (ii) the preparation, issuance and delivery of the certificates for the Shares and subscription certificates relating to the Rights, (iii) the fees and disbursements of the Funds counsel (including the fees and disbursements of local counsel) and independent registered public accounting firm, (iv) the printing or other production and delivery to the Dealer Manager of copies of the |
31
Registration Statement as originally filed and of each amendment thereto and of the Prospectus and any amendments or supplements thereto, (v) the fees and expenses incurred with respect to filing with and review by FINRA, including the fees and disbursements of the Dealer Managers counsel with respect thereto, (vi) the fees and expenses incurred in connection with the listing of the Shares on the NYSE, (vii) the printing or other production, mailing and delivery expenses incurred in connection with Offering Materials, including all reasonable out-of-pocket fees and expenses, if any, incurred by the Dealer Manager, Selling Group Members, Soliciting Dealers and other brokers, dealers and financial institutions in connection with their customary mailing and handling of materials related to the Offer to their customers, (viii) the fees and expenses incurred with respect to the Subscription Agent and the Information Agent and (ix) all other fees and expenses (excluding the announcement, if any, of the Offer in The Wall Street Journal) incurred in connection with or relating to the Offer. The Fund agrees to pay the foregoing expenses whether or not the transactions contemplated under this Dealer Manager Agreement are consummated. |
b. | In addition to any fees that may be payable to the Dealer Manager under this Dealer Manager Agreement, the Fund agrees to reimburse the Dealer Manager upon request made from time to time for its reasonable expenses incurred in connection with its activities under this Dealer Manager Agreement, including the reasonable fees and disbursements of its legal counsel (excluding blue sky filing fees and fees, expenses and disbursements in connection with filings with FINRA which are paid directly by the Fund), in an amount up to $[100,000]. |
c. | If this Dealer Manager Agreement is terminated by the Dealer Manager in accordance with the provisions of Section 6 or Section 9(a)(i), 9(a)(ii) or 9(a)(iii), the Fund agrees to reimburse the Dealer Manager for all of its reasonable out-of-pocket expenses incurred in connection with its performance hereunder, including the reasonable fees and disbursements of counsel for the Dealer Manager. In the event the transactions contemplated hereunder are not consummated for reasons other than as described in the previous sentence, the Fund agrees to pay all of the costs and expenses incurred which the Fund would have paid if such transactions had been consummated as set forth in Sections 5(a) and 5(b). |
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6. | Conditions of the Dealer Managers Obligations . The obligations of the Dealer Manager hereunder (including any obligation to pay for Shares issuable upon exercise of Right by the Dealer Manager) are subject to the accuracy of the respective representations and warranties of the Fund and the Investment Manager contained herein, to the performance by the Fund and the Investment Manager of their respective obligations hereunder, and to the following further conditions: |
a. | The Registration Statement shall have become effective not later than 5:30 P.M., New York City time, on the Record Date, or at such later time and date as may be approved by the Dealer Manager; the Prospectus and any amendment or supplement thereto shall have been filed with the Commission in the manner and within the time period required by Rule 497(c), (e), (h) or (j), as the case may be, under the Securities Act; no stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or, to the knowledge of the Fund, the Investment Manager or the Dealer Manager, shall be contemplated by the Commission; and the Fund shall have complied with any request of the Commission for additional information (to be included in the Registration Statement, the Prospectus or otherwise). |
b. | On the Representation Date and the Expiration Date, the Dealer Manager shall have received: |
i. | The opinions, dated the Representation Date and the Expiration Date, of Ropes & Gray LLP, counsel for the Fund, in form and substance satisfactory to counsel for the Dealer Manager to the effect that: |
(1) | The Registration Statement and all post-effective amendments filed with the Commission on or before the Representation Date or the Expiration Date, as the case may be, if any, have been declared effective or otherwise become effective under the Securities Act; the filing of the Prospectus, and any supplements thereto, pursuant to Rule 497 under the Securities Act has been made in the manner and within the time period required by Rule 497; and based upon oral inquiries to the Commission staff on the Representation Date or the Expiration Date, as the case may be,, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceeding for any such purpose is pending or threatened by the Commission. |
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(2) | The Fund has been duly organized and is validly existing and in good standing as an unincorporated voluntary association (commonly known as a Massachusetts business trust) under and by virtue of the laws of The Commonwealth of Massachusetts and has full power and authority to own or lease its properties and to conduct its business as described in the Registration Statement and the Prospectus. The Certificate of Designation relating to the Funds conduct of business in the State of New York is on file with the Department of State of the State of New York, and the Fund is entitled to transact intrastate business in the State of California. |
(3) |
The Funds capitalization is as set forth in the Registration Statement and the Prospectus. The Fund has an indefinite number of authorized common shares of beneficial interest, par value $0.00001 per share. The outstanding Common Shares have been duly authorized and are validly issued, fully paid and, except as provided below, nonassessable. The Common Shares and the Shares conform in all material respects as to legal matters to the description of them under each section entitled Description of capital structure in the Prospectus. The Rights conform in all material respects to the descriptions thereof contained in the Prospectus under the headings The OfferImportant Terms of the Offer, The OfferSubscription Price, The OfferOver-Subscription Privilege and The OfferSale and Transferability of Rights insofar as such descriptions relate to the form of Subscription Certificate in the Registration Statement. The Rights have been duly authorized by all requisite action on the part of the Fund. The Shares have been duly authorized and, when issued and delivered by the Fund pursuant to the terms of the Offer against payment of the consideration as set forth in the Prospectus, will be validly issued, fully paid and, except as provided below, non-assessable. Except as |
34
contemplated by this Dealer Manager Agreement, under Massachusetts law and the Declaration of Trust and Bylaws, no person is entitled to any preemptive or other similar rights with respect to the Rights or the Shares. |
(4) | To the best of such counsels knowledge after due inquiry, the Fund was deemed to be registered under Section 8(a) of the Investment Company Act upon receipt by the Commission of the notification of registration. To such counsels knowledge after the inquiry described above, the Commission has not issued to the Fund notice of any hearing or other proceeding to consider suspension or revocation of any such registration. To the best of such counsels knowledge after due inquiry, all required action has been taken by the Fund under the Securities Act, the Investment Company Act and the Rules and Regulations to make the public offering and consummate the issuance of the Rights and the issuance and sale of the Shares by the Fund upon exercise of the Rights pursuant to the terms of the Offer, and the provisions of the Funds agreement and declaration of trust and by-laws do not conflict with the requirements of the Investment Company Act and the Rules and Regulations. |
(5) |
The Fund has, or at the relevant time had, full power and authority to enter into the Dealer Manager Agreement and each of the Fund Agreements and to perform all of the terms and provisions thereof to be carried out by it. The Dealer Manager Agreement and each Fund Agreement has been duly and validly authorized, executed and delivered by the Fund. The Dealer Manager Agreement and each Fund Agreement complies in all material respects with all applicable provisions of the Investment Company Act and the Advisers Act, as the case may be. Assuming due authorization, execution and delivery by the other parties thereto, each Fund Agreement constitutes the legal, valid and binding obligation of the Fund enforceable in accordance with its terms, subject as to |
35
enforcement to bankruptcy, insolvency, moratorium, reorganization and other laws of general applicability relating to or affecting creditors rights and to general equity principles (regardless of whether enforceability is considered in a proceeding in equity or at law). |
(6) | None of (a) the execution and delivery by the Fund of the Dealer Manager Agreement or any of the Fund Agreements, (b) the issuance of the Rights and the issuance and sale of the Shares upon exercise of the Rights pursuant to the terms of the Offer or (c) the performance by the Fund of its obligations under the Dealer Manager Agreement or any of the Fund Agreements, or consummation by the Fund of the other transactions contemplated by the Dealer Manager Agreement or any of the Fund Agreements conflicts, or at the relevant time conflicted with, or will conflict with, or results, or at the relevant time resulted, or will result in a breach of, the Declaration of Trust or Bylaws of the Fund or, to such counsels knowledge, any agreement or instrument to which the Fund is a party or by which the Fund is bound, or violates or will violate any federal statute, law or regulation that, in such counsels experience, is normally applicable to transactions of this type, or any judgment, injunction, order or decree of any federal governmental agency or body that is applicable to the Fund and that is known to such counsel, which conflict, breach or violation, either individually or in the aggregate, and with respect to such agreements or instruments and such statutes, laws or regulations, judgments, injunctions orders or decrees, would have a material adverse effect on the condition or business of the Fund. |
(7) | To the best of such counsels knowledge, the Fund is not currently in breach of, or in default under, any material written agreement or instrument to which it is a party or by which it or its property is bound or affected. |
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(8) | No consent, approval, authorization or order of any court or governmental agency or body or securities exchange or securities association is required by the Fund for the consummation by the Fund of the transactions contemplated in the Dealer Manager Agreement and the Fund Agreements, except such as (a) have been obtained under the Securities Act, the Investment Company Act or the Exchange Act and (b) may be required by the New York Stock Exchange or the Financial Industry Regulatory Authority, Inc., or under state securities or Blue Sky laws in connection with the Offer as contemplated by the Dealer Manager Agreement. |
(9) | To such counsels knowledge after due inquiry, based upon identified correspondence with the NYSE, authorizing the Rights for trading on the NYSE and the Shares for listing on the NYSE, the Rights have been authorized for trading on the NYSE and the Shares have been authorized for listing on the NYSE, subject to official notice of issuance. |
(10) | To such counsels knowledge, there are no legal or governmental proceedings pending or threatened against the Fund, or to which the Fund or any of its properties is subject, that are required to be described in the Registration Statement or the Prospectus but are not described therein as required. |
(11) | To such counsels knowledge, there are no agreements, contracts, indentures, leases or other instruments that are required to be described in the Prospectus or to be filed as an exhibit to the Registration Statement which have not been so described or filed as an exhibit or incorporated therein by reference. |
(12) | The section in the Prospectus entitled Tax matters and the section in the SAI entitled [ ] to the extent that it states matters of United States law or legal conclusions with respect thereto, presents a fair summary of the principal federal income tax rules currently in effect applicable to the Fund and to the purchase of the Shares upon exercise of the Rights, and to the ownership and disposition of the Rights and the Shares. |
37
(13) | The Registration Statement, as it may be amended, and the Prospectus, as it may be amended or supplemented, complied as to form in all material respects with the applicable requirements of the Securities Act and the Investment Company Act, except in each case for the financial statements and schedules, the notes thereto and any schedules and other financial data contained or incorporated by reference therein or omitted therefrom, as to which such counsel need express no opinion, and with respect to the placement of information in the Prospectus called for by Item 2, Section 3 of Form N-2, as to which such counsel need express no opinion. |
Such counsel shall also state that, while they have not independently verified the accuracy, completeness or fairness of the statements made or the information contained in the Registration Statement or the Prospectus and, except in the respects and to the extent set forth in paragraphs 3, 12 and 13 above, such counsel are not passing upon and do not assume any responsibility therefore, in the course of the preparation by the Fund of the Registration Statement and the Prospectus, such counsel have participated in discussions with representatives of the Dealer Manager and employees and officers of the Fund, the Investment Manager and the Sub-Adviser and in discussions with the Funds independent registered public accounting firm, in which the business and the affairs of the Fund, the Investment Manager and the Sub-Adviser and the contents of the Registration Statement and the Prospectus were discussed. Such counsel may also state that (i) there is no assurance that all material facts as to the Fund, the Investment Manager or Sub-Adviser and their affairs were disclosed to such counsel or that such counsels familiarity with the Fund and the Investment Manager or the Sub-Adviser is such that such counsel would have necessarily recognized the materiality of such facts as were disclosed to such counsel, and that such counsel have to a large extent relied upon statements of representatives of the Fund, the Investment Manager and Sub-Adviser as to the materiality of the facts disclosed to such counsel and (ii) many of the determinations required to be made in preparation of the Registration Statement and the Prospectus involve matters of a non-legal nature. Such counsel shall state that, subject to the foregoing, |
38
on the basis of information that such counsel have gained in the course of performing the services referred to above, no facts have come to such counsels attention that would lead such counsel to believe that, (i) the Registration Statement, as of its effective date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary in order to make the statements therein not misleading, (ii) as of its date and on the Representation Date or Expiration Date, as the case may be, the Prospectus contained or contains any untrue statement of a material fact or omitted or omits to state a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading (in each case in (i) and (ii) above, other than the financial statements and schedules, the notes thereto and any schedules and other financial data contained or incorporated by reference therein or omitted therefrom, as to which such counsel need express no opinion). |
The opinions of such counsel as to the non-assessability of the outstanding Common Shares and the Shares may state that, under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Fund; that, however, the Funds Declaration of Trust disclaims shareholder liability for acts or obligations of the Fund and requires that notice of such disclaimer be given in each agreement, obligation, and instrument entered into or executed by the Fund or the Trustees; that the Declaration of Trust provides for indemnification out of the property of the Fund for all loss and expense of any shareholder held personally liable solely by reason of being or having been a shareholder of the Fund; and that thus, the risk of a shareholders incurring financial loss on account of being a shareholder is limited to circumstances in which the Fund itself would be unable to meet its obligations. |
ii. | The opinions, dated the Representation Date and the Expiration Date, of [Thomas J. Fuccillo], counsel for the Investment Manager, in form and substance satisfactory to counsel for the Dealer Manager to the effect that: |
(1) |
The Investment Manager is a limited liability company, is validly existing and in good standing |
39
under the Delaware Limited Liability Company Act (6 Del. C §. 18 101, et seq.) and has, or at the relevant time had, all necessary limited liability company power and authority to enter into and deliver the Investment Manager Agreements and perform its obligations thereunder and to carry on its business as it is now being conducted and as described in the Registration Statement and the Prospectus. Based solely on (a) a status search report of the corporate records of the Secretary of State of the State of California, prepared by Corporation Service Company, dated as of the Expiration Date or the Representation Date, as the case may be, showing the status of the Investment Manager as Active and in Good Standing, and (b) certificates from public officials in the State of New York, such counsel shall confirm that the Investment Manager is qualified to do business in the following States: California and New York, such States being those in which its ownership or leasing of property or its conducting of business may require such qualification and where failure to so qualify would have a material adverse effect on the ability of the Investment Manager to perform its obligations under the Investment Manager Agreements. |
(2) | The execution, delivery and performance of the Investment Manager Agreements by the Investment Manager have been, or were at the relevant time, duly authorized by all necessary limited liability company action of the Investment Manager and no other actions on the part of the Investment Manager or its members or any subsidiary of the Investment Manager or its members is necessary to authorize and consummate the transactions contemplated thereby, and the Investment Manager Agreements have been duly and validly executed and delivered by the Investment Manager. |
(3) |
Each of the Investment Manager Agreements constitutes a legally valid and binding agreement of the Investment Manager, enforceable against the Investment Manager in accordance with its terms, subject to (a) the effect of bankruptcy, insolvency, |
40
reorganization, moratorium or other similar laws now or hereafter in effect relating to or affecting the rights or remedies of creditors generally; (b) the effect of general principles of equity, whether enforcement is considered in a proceeding in equity or at law, and the discretion of the court before which any proceeding therefor may be brought; (c) the unenforceability under certain circumstances under law or court decisions of provisions providing for the indemnification of or contribution to a party with respect to a liability where such indemnification or contribution is contrary to public policy; and (d) the unenforceability of any provision requiring the payment of attorneys fees, except to the extent that a court determines such fees to be reasonable. In addition, the opinions set forth above do not represent an opinion as to the reasonableness of the compensation payable under the Investment Manager Agreements. |
(4) | Neither the execution and delivery of the Investment Manager Agreements by the Investment Manager, nor the consummation by the Investment Manager of transactions contemplated by the Investment Manager Agreements, nor compliance by the Investment Manager with any of the terms and provisions of the Investment Manager Agreements will: |
(a) violate any provision of the Limited Liability Company Agreement of the Investment Manager, effective May 23, 2000, as amended on July 1, 2001, December 12, 2001, October 31, 2002, May 3, 2004, April 1, 2005 and [ ], which is still in full force and effect and which has not been further amended or supplemented through the date hereof, |
(b) violate any federal, Delaware or New York statute, rule or regulation applicable to the Investment Manager (other than federal and state securities or blue sky laws, the Investment Company Act and the Advisers Act and the rules and regulations thereunder as to which such counsel need express no opinion), |
41
(c) violate any agreement to which the Investment Manager is a party or by which it is bound and which is material to the Investment Managers businesses taken as a whole (the Material Agreements), |
(d) violate any order, writ, injunction or decree, known to such counsel and applicable to the Investment Manager, or |
(e) require any consents, approvals, authorizations, registrations, declarations or filings by the Investment Manager under any federal or Delaware statute, rule or regulation applicable to the Investment Manager, except as have been obtained under the Securities Act, the Investment Company Act or the Advisers Act and the rules and regulations thereunder. |
No opinion need be expressed by such counsel in this paragraph 4 as to the application of Section 548 of the federal Bankruptcy Code and comparable provisions of state or foreign law or of any antifraud laws, antitrust or trade regulation laws. |
(5) | The Investment Manager is duly registered as an investment adviser under the Advisers Act and is not prohibited by the Advisers Act, Investment Company Act or the rules and regulations thereunder from acting as investment manager for the Fund as contemplated by the Investment Management Agreement and the Prospectus. |
(6) | The description of the Investment Manager and its business, and the statements attributable to the Investment Manager, set forth in the Registration Statement and the Prospectus under the headings [ ] do not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. |
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(7) | Other than as disclosed in the Prospectus, there is no action, suit or proceeding before or by any court, commission, regulatory body, administrative agency or other governmental agency or body, foreign or domestic, now pending or, to such counsels knowledge, threatened against the Investment Manager of a nature required to be disclosed in the Prospectus or that might reasonably result in any material adverse change in the ability of the Investment Manager to fulfill its obligations under the Investment Management Agreement or the Portfolio Management Agreement. |
In rendering such opinion, such counsel may rely as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Fund, the Investment Manager, their affiliates and public officials. |
iii. | The opinions, dated the Representation Date and the Expiration Date, of [ ], counsel for the Sub-Adviser, in form and substance satisfactory to counsel for the Dealer Manager to the effect that: |
(1) |
The Sub-Adviser is a limited liability company, is validly existing and in good standing under the Delaware Limited Liability Company Act (6 Del. C §. 18 101, et seq.), and has, or at the relevant time had, necessary limited liability company power and authority to enter into and deliver the Portfolio Management Agreement and perform its obligations thereunder and to carry on its business as it is now being conducted and as described in the Registration Statement and the Prospectus. Based solely on (a) a status search report of the corporate records of the Secretary of State of the State of California, prepared by Corporation Service Company, dated as of the Expiration Date or the Representation Date, as the case may be, showing the status of the Sub-Adviser as Active and in Good Standing, and (b) certificates from public officials in the State of New York, such counsel shall confirm that the Sub-Adviser is qualified to do business in the following States: California and New York, such States being those in which its |
43
ownership or leasing of property or its conducting of business may require such qualification and where failure to so qualify would have a material adverse effect on the ability of the Sub-Adviser to perform its obligations under the Portfolio Management Agreement. |
(2) | The execution, delivery and performance of the Portfolio Management Agreement by the Sub-Adviser have been, or were at the relevant time, duly authorized by all necessary limited liability company action of the Sub-Adviser and no other actions on the part of the Sub-Adviser or its members or any subsidiary of the Sub-Adviser or its members is necessary to authorize and consummate the transactions contemplated thereby, and the Portfolio Management Agreement has been duly and validly executed and delivered by the Sub-Adviser. |
(3) | The Portfolio Management Agreement constitutes a legally valid and binding agreement of the Sub-Adviser, enforceable against the Sub-Adviser in accordance with its terms, subject to (a) the effect of bankruptcy, insolvency, reorganization, moratorium or other similar laws now or hereafter in effect relating to or affecting the rights or remedies of creditors generally; (b) the effect of general principles of equity, whether enforcement is considered in a proceeding in equity or at law, and the discretion of the court before which any proceeding therefor may be brought; (c) the unenforceability under certain circumstances under law or court decisions of provisions providing for the indemnification of or contribution to a party with respect to a liability where such indemnification or contribution is contrary to public policy; and (d) the unenforceability of any provision requiring the payment of attorneys fees, except to the extent that a court determines such fees to be reasonable. In addition, the opinions set forth above do not represent an opinion as to the reasonableness of the compensation payable under the Portfolio Management Agreement. |
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(4) | Neither the execution and delivery of the Portfolio Management Agreement by the Sub-Adviser, nor the consummation by the Sub-Adviser of transactions contemplated by the Portfolio Management Agreement, nor compliance by the Sub-Adviser with any of the terms and provisions of the Portfolio Management Agreement will: |
(a) violate any provision of the Limited Liability Company Agreement of the Sub-Adviser, effective May 5, 2000, as amended on [ ], which is still in full force and effect and which has not been further amended or supplemented through the date hereof, |
(b) violate any federal, Delaware or New York statute, rule or regulation applicable to the Sub-Adviser (other than federal and state securities or blue sky laws, the Investment Company Act and the Advisers Act and the rules and regulations thereunder as to which such counsel need express no opinion), |
(c) violate any agreement to which the Sub-Adviser is a party or by which it is bound and which is material to the Sub-Advisers businesses taken as a whole (the Material Agreements), |
(d) violate any order, writ, injunction or decree, known to such counsel and applicable to the Sub-Adviser, or |
(e) require any consents, approvals, authorizations, registrations, declarations or filings by the Sub-Adviser under any federal or Delaware statute, rule or regulation applicable to the Sub-Adviser, except as have been obtained under the Securities Act, the Investment Company Act, the Advisers Act and the rules and regulations thereunder. |
45
No opinion need be expressed by such counsel in this paragraph 4 as to the application of Section 548 of the federal Bankruptcy Code and comparable provisions of state or foreign law or of any antifraud laws, antitrust or trade regulation laws. |
(5) | The Sub-Adviser is duly registered as an investment adviser under the Advisers Act and is not prohibited by the Advisers Act, Investment Company Act, or the rules and regulations thereunder from acting as investment adviser for the Fund as contemplated by the Portfolio Management Agreement and the Prospectus. |
(6) | The description of the Sub-Adviser and its business, and the statements attributable to the Sub-Adviser, set forth in the Registration Statement and the Prospectus under the headings [ ] do not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. |
(7) | Other than as disclosed in the Prospectus, there is no action, suit or proceeding before or by any court, commission, regulatory body, administrative agency or other governmental agency or body, foreign or domestic, now pending or, to such counsels knowledge, threatened against the Sub-Adviser of a nature required to be disclosed in the Prospectus or that might reasonably result in any material adverse change in the ability of the Sub-Adviser to fulfill its obligations under the Portfolio Management Agreement. |
In rendering such opinion, such counsel may rely as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Fund, the Sub-Adviser, their affiliates and public officials. |
c. | The Dealer Manager shall have received from Skadden, Arps, Slate, Meagher & Flom LLP, counsel for the Dealer Manager, such opinion or opinions, dated the Representation Date and the Expiration Date, with respect to the Offer, the Registration Statement, the Prospectus and other related matters as the Dealer Manager may reasonably require, and the Fund shall have furnished to such counsel such documents as they reasonably request for the purpose of enabling them to pass upon such matters. |
46
d. | The Fund shall have furnished to the Dealer Manager a certificate of the Fund, signed by the President of the Fund, dated the Representation Date and the Expiration Date, to the effect that the signer of such certificate carefully examined the Registration Statement, the Prospectus, any supplement to the Prospectus and this Dealer Manager Agreement and that, to the best of the signers knowledge: |
i. | the representations and warranties of the Fund in this Dealer Manager Agreement are true and correct in all material respects on and as of the Representation Date or the Expiration Date, as the case may be (except that references to the Registration Statement or Prospectus shall be to such documents as they may have been amended or supplemented at the date of such certificate), with the same effect as if made on the Representation Date or the Expiration Date, as the case may be, and the Fund has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to the Representation Date or the Expiration Date, as the case may be; |
ii. | no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or, to the Funds knowledge, threatened; and |
iii. | since the date of the most recent balance sheet included or incorporated by reference in the Prospectus, there has been no material adverse change, or any development involving a prospective material adverse change, in the condition (financial or other), business, prospects, net worth or results of operations of the Fund (excluding fluctuations in the Funds net asset value due to investment activities in the ordinary course of operations, and changes in the market price per share of the Common Shares and discount or premium of such market price per share to net asset value per share), except as set forth in or contemplated in the Prospectus (as it may be amended or supplemented at the date of such certificate). |
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e. | The Investment Manager shall have furnished to the Dealer Manager certificates of the Investment Manager, signed by the President, Treasurer, Secretary or Vice President or any other senior officer of comparable authority, dated the Representation Date and the Expiration Date, to the effect that the signer of such certificate has carefully examined the Registration Statement, the Prospectus, any supplement to the Prospectus and this Dealer Manager Agreement and, to the best knowledge of such signer, the representations and warranties of the Investment Manager in this Dealer Manager Agreement are true and correct in all material respects on and as of the Representation Date or the Expiration Date, as the case may be, with the same effect as if made on the Representation Date or the Expiration Date, as the case may be (except that references to the Registration Statement or Prospectus shall be to such documents as they may have been amended or supplemented at the date of such certificate). |
f. | PricewaterhouseCoopers LLP shall have furnished to the Dealer Manager letters, dated the Representation Date and the Expiration Date, in form and substance satisfactory to the Dealer Manager stating in effect that: |
i. | it is an independent registered public accounting firm with respect to the Fund within the meaning of the Securities Act and the applicable Rules and Regulations and the rules and regulations adopted by the Commission and the Public Accounting Oversight Board; |
ii. | in its opinion, the audited financial statements examined by it and included or incorporated by reference in the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Securities Act and the Investment Company Act and the respective Rules and Regulations with respect to registration statements on Form N-2; |
iii. | it has performed procedures specified by the Public Accounting Oversight Board for a review of the interim financial information for the period ended [ ]; |
iv. |
it has performed specified procedures, not constituting an audit in accordance with generally accepted auditing standards, including a reading of the latest available unaudited financial information of the Fund, a reading of the minute |
48
books of the Fund, and inquiries of officials of the Fund responsible for financial and accounting matters and on the basis of such inquiries and procedures nothing came to its attention that caused it to believe that at a specified date not more than five business days prior to the Representation Date or the Expiration Date, as the case may be, there was any change in the Common Shares, any decrease in net assets or any increase in long-term debt of the Fund as compared with amounts shown in the most recent statement of assets and liabilities included or incorporated by reference in the Registration Statement, except as the Registration Statement discloses has occurred or may occur, or they shall state any specific changes, increases or decreases; and |
v. | in addition to the procedures referred to in clause (iii) above, it has compared certain dollar amounts (or percentages as derived from such dollar amounts) and other financial information regarding the operations of the Fund appearing in the Registration Statement, which have previously been specified by the Dealer Manager and which shall be specified in such letter, and have found such items to be in agreement with, the accounting and financial records of the Fund. |
g. | Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus (excluding an amendment or supplement subsequent to the Representation Date), there shall not have been (i) any change, increase or decrease specified in the letter or letters referred to in Section 6(f), or (ii) any change, or any development involving a prospective change, in or affecting the condition (financial or other), business prospects, net worth or results of operations of the Fund, the effect of which, in any case referred to in clause (i) or (ii) above, is, in the judgment of the Dealer Manager, so material and adverse as to make it impractical or inadvisable to proceed with the Offer as contemplated by the Registration Statement and the Prospectus. |
h. | Prior to the Representation Date, the Fund and the Investment Manager shall have furnished to the Dealer Manager such further information, certificates and documents as the Dealer Manager or its counsel may reasonably request. |
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i. | If any of the conditions specified in this Section 6 shall not have been fulfilled in all material respects when and as provided in this Dealer Manager Agreement or waived by the Dealer Manager, or if any of the opinions and certificates mentioned above or elsewhere in this Dealer Manager Agreement shall not be in all material respects satisfactory in form and substance to the Dealer Manager and its counsel, this Dealer Manager Agreement and all obligations of the Dealer Manager hereunder may be canceled at, or at any time prior to, the Expiration Date by the Dealer Manager. Notice of such cancellation shall be given to the Fund in writing or by telephone confirmed in writing. |
7. | Indemnity and Contribution. |
a. |
Each of the Fund and the Investment Manager, jointly and severally, agrees to indemnify, defend and hold harmless the Dealer Manager, its partners, directors and officers, and any person who controls the Dealer Manager within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, and the successors and assigns of all of the foregoing persons from and against any loss, damage, expense, liability or claim (including the reasonable cost of investigation) which the Dealer Manager or any such person may incur under the Securities Act, the Exchange Act, the Investment Company Act, the Advisers Act, the common law or otherwise, insofar as such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or in the Registration Statement as amended by any post-effective amendment thereof by the Fund) or in a Prospectus (the term Prospectus for the purpose of this Section 7 being deemed to include any preliminary prospectus, the Offering Materials, the Prospectus and the Prospectus as amended or supplemented by the Fund), or arises out of or is based upon any omission or alleged omission to state a material fact required to be stated in either such Registration Statement or Prospectus or necessary to make the statements made therein not misleading (with respect to the Prospectus, in light of the circumstances under which they were made), except insofar as any such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in and in conformity with information furnished in writing by or on behalf of the Dealer Manager to the Fund, the Investment Manager or the Sub-Adviser expressly for use with reference to the Dealer Manager in such Registration Statement or such Prospectus or arises out of or is based upon any omission or alleged omission to state a material fact |
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in connection with such information required to be stated in such Registration Statement or such Prospectus or necessary to make such information not misleading (with respect to the Prospectus, in light of the circumstances under which they were made). |
If any action, suit or proceeding (together, a Proceeding) is brought against the Dealer Manager or any such person in respect of which indemnity may be sought against the Fund or the Investment Manager pursuant to the foregoing paragraph, the Dealer Manager or such person shall promptly notify the Fund and the Investment Manager in writing of the institution of such Proceeding and the Fund or the Investment Manager shall assume the defense of such Proceeding, including the employment of counsel reasonably satisfactory to such indemnified party and payment of all fees and expenses; provided, however, that the omission to so notify the Fund or the Investment Manager shall not relieve the Fund or the Investment Manager from any liability which the Fund or the Investment Manager may have to the Dealer Manager or any such person or otherwise. The Dealer Manager or such person shall have the right to employ its or their own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of the Dealer Manager or of such person unless the employment of such counsel shall have been authorized in writing by the Fund or the Investment Manager, as the case may be, in connection with the defense of such Proceeding or the Fund or the Investment Manager shall not have, within a reasonable period of time in light of the circumstances, employed counsel to have charge of the defense of such Proceeding or such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from, additional to or in conflict with those available to the Fund or the Investment Manager (in which case the Fund or the Investment Manager shall not have the right to direct the defense of such Proceeding on behalf of the indemnified party or parties), in any of which events such fees and expenses shall be borne by the Fund or the Investment Manager and paid as incurred (it being understood, however, that the Fund or the Investment Manager shall not be liable for the expenses of more than one separate counsel (in addition to any local counsel) in any one Proceeding or series of related Proceedings in the same jurisdiction representing the indemnified parties who are parties to such Proceeding). Neither the Fund nor the Investment Manager shall be liable for any settlement of any Proceeding effected without its written consent but if settled with the written consent of the Fund or the Investment Manager, the Fund |
51
or the Investment Manager, as the case may be, agrees to indemnify and hold harmless the Dealer Manager and any such person from and against any loss or liability by reason of such settlement. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by the second sentence of this paragraph, then the indemnifying party agrees that it shall be liable for any settlement of any Proceeding effected without its written consent if (i) such settlement is entered into more than 60 business days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement and (iii) such indemnified party shall have given the indemnifying party at least 30 days prior notice of its intention to settle. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened Proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such Proceeding and does not include an admission of fault, culpability or a failure to act, by or on behalf of such indemnified party. |
b. |
The Dealer Manager agrees to indemnify, defend and hold harmless the Fund and the Investment Manager, and each of their respective shareholders, partners, managers, members, trustees, directors and officers, and any person who controls the Fund or the Investment Manager within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, and the successors and assigns of all of the foregoing persons from and against any loss, damage, expense, liability or claim (including the reasonable cost of investigation) which, jointly or severally, the Fund or the Investment Manager or any such person may incur under the Securities Act, the Exchange Act, the Investment Company Act, the Advisers Act, the common law or otherwise, insofar as such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in and in conformity with information furnished in writing by or on behalf of the Dealer Manager to the Fund, the Investment Manager or the Sub-Adviser expressly for use with reference to the Dealer Manager in the |
52
Registration Statement (or in the Registration Statement as amended by any post-effective amendment thereof by the Fund) or in a Prospectus, or arises out of or is based upon any omission or alleged omission to state a material fact in connection with such information required to be stated in such Registration Statement or such Prospectus or necessary to make such information not misleading (with respect to the Prospectus, in light of the circumstances under which they were made). |
If any Proceeding is brought against the Fund, the Investment Manager or any such person in respect of which indemnity may be sought against the Dealer Manager pursuant to the foregoing paragraph, the Fund, the Investment Manager or such person shall promptly notify the Dealer Manager in writing of the institution of such Proceeding and the Dealer Manager shall assume the defense of such Proceeding, including the employment of counsel reasonably satisfactory to such indemnified party and payment of all fees and expenses; provided, however, that the omission to so notify the Dealer Manager shall not relieve the Dealer Manager from any liability which the Dealer Manager may have to the Fund, the Investment Manager or any such person or otherwise. The Fund, the Investment Manager or such person shall have the right to employ its own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of the Fund, the Investment Manager or such person, as the case may be, unless the employment of such counsel shall have been authorized in writing by the Dealer Manager in connection with the defense of such Proceeding or the Dealer Manager shall not have, within a reasonable period of time in light of the circumstances, employed counsel to have charge of the defense of such Proceeding or such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to or in conflict with those available to the Dealer Manager (in which case the Dealer Manager shall not have the right to direct the defense of such Proceeding on behalf of the indemnified party or parties, but the Dealer Manager may employ counsel and participate in the defense thereof but the fees and expenses of such counsel shall be at the expense of the Dealer Manager), in any of which events such fees and expenses shall be borne by the Dealer Manager and paid as incurred (it being understood, however, that the Dealer Manager shall not be liable for the expenses of more than one separate counsel (in addition to any local counsel) in any one Proceeding or series of related Proceedings |
53
in the same jurisdiction representing the indemnified parties who are parties to such Proceeding). The Dealer Manager shall not be liable for any settlement of any such Proceeding effected without the written consent of the Dealer Manager but if settled with the written consent of the Dealer Manager, the Dealer Manager agrees to indemnify and hold harmless the Fund, the Investment Manager and any such person from and against any loss or liability by reason of such settlement. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by the second sentence of this paragraph, then the indemnifying party agrees that it shall be liable for any settlement of any Proceeding effected without its written consent if (i) such settlement is entered into more than 60 business days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement and (iii) such indemnified party shall have given the indemnifying party at least 30 days prior notice of its intention to settle. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened Proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such Proceeding. |
c. |
If the indemnification provided for in this Section 7 is unavailable to an indemnified party under subsections (a) and (b) of this Section 7 in respect of any losses, damages, expenses, liabilities or claims referred to therein, then each applicable indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, damages, expenses, liabilities or claims (i) in such proportion as is appropriate to reflect the relative benefits received by the Fund and the Investment Manager on the one hand and the Dealer Manager on the other hand from the Offer or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Fund and the Investment Manager on the one hand and of the Dealer Manager on the other in connection with the statements or omissions which |
54
resulted in such losses, damages, expenses, liabilities or claims, as well as any other relevant equitable considerations. The relative benefits received by the Fund or the Investment Manager on the one hand and the Dealer Manager on the other shall be deemed to be in the same respective proportions as the total proceeds from the Offer (net of the Dealer Manager Fee but before deducting expenses) received by the Fund and the total Dealer Manager Fee received by the Dealer Manager, bear to the aggregate public offering price of the Shares. The relative fault of the Fund and the Investment Manager on the one hand and of the Dealer Manager on the other shall be determined by reference to, among other things, whether the untrue statement or alleged untrue statement of a material fact or omission or alleged omission relates to information supplied by the Fund or the Investment Manager or by the Dealer Manager and the parties relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, damages, expenses, liabilities and claims referred to in this subsection shall be deemed to include any legal or other fees or expenses reasonably incurred by such party in connection with investigating, preparing to defend or defending any Proceeding. |
d. | The Fund and the Investment Manager and the Dealer Manager agree that it would not be just and equitable if contribution pursuant to this Section 7 were determined by pro rata allocation or by any other method of allocation that does not take account of the equitable considerations referred to in subsection (c) above. Notwithstanding the provisions of this Section 7, the Dealer Manager shall not be required to contribute any amount in excess of the Dealer Manager Fee received by it. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. |
e. |
Notwithstanding any other provisions in this Section 7, no party shall be entitled to indemnification or contribution under this Dealer Manager Agreement against any loss, claim, liability, expense or damage arising by reason of such persons willful misfeasance, bad faith or gross negligence in the performance of its duties or such persons reckless disregard of its obligations and duties under this Dealer Manager Agreement. The parties hereto acknowledge that this Section 7(e) shall not be construed to imply that the Dealer Manager |
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has any obligations or duties under this Dealer Manager Agreement (except the obligation to solicit the exercise of Rights on the terms and subject to the conditions herein). For avoidance of doubt, it is understood that the Dealer Manager has no duty hereunder to the Fund or the Investment Manager to perform any due diligence investigation. |
f. | The indemnity and contribution agreements contained in this Section 7 and the covenants, warranties and representations of the Fund contained in this Dealer Manager Agreement shall remain in full force and effect regardless of any investigation made by or on behalf of the Dealer Manager, its partners, directors or officers or any person (including each partner, officer or director of such person) who controls the Dealer Manager within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, or by or on behalf of the Fund or the Investment Manager, its shareholders, partners, managers, members, trustees, directors or officers or any person who controls the Fund or the Investment Manager within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, and shall survive any termination of this Dealer Manager Agreement or the issuance and delivery of the Rights. The Fund and the Investment Manager and the Dealer Manager agree promptly to notify each other of the commencement of any Proceeding against it and, in the case of the Fund or the Investment Manager, against any of the Funds or the Investment Managers shareholders, partners, managers, members, trustees, officers or directors in connection with the issuance of the Rights or the issuance and sale of the Shares, or in connection with the Registration Statement or Prospectus. |
g. | The Fund and the Investment Manager acknowledge that the statement of the principal business address of the Dealer Manager under the caption [ ] in the Prospectus constitutes the only information furnished in writing to the Fund by the Dealer Manager expressly for use in such document. |
8. | Representations, Warranties and Agreements to Survive Delivery . The respective agreements, representations, warranties, indemnities and other statements of the Fund or its officers, of the Investment Manager and of the Dealer Manager set forth in or made pursuant to this Dealer Manager Agreement shall survive the Expiration Date and will remain in full force and effect, regardless of any investigation made by or on behalf of Dealer Manager or the Fund or the Investment Manager or any of the officers, directors or controlling persons referred to in Section 7 hereof, and will survive delivery of and payment for the Shares pursuant to the Offer. The provisions of Sections 5 and 7 hereof shall survive the termination or cancellation of this Dealer Manager Agreement. |
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9. | Termination of Agreement . |
a. | This Dealer Manager Agreement shall be subject to termination in the absolute discretion of the Dealer Manager, by notice given to the Fund prior to the expiration of the Offer, if prior to such time (i) financial, political, economic, currency, banking or social conditions in the United States or Switzerland shall have undergone any material change the effect of which on the financial markets makes it, in the Dealer Managers judgment, impracticable or inadvisable to proceed with the Offer, (ii) there has occurred any outbreak or material escalation of hostilities, terrorist activities or other calamity or crisis the effect of which on the financial markets of the United States or Switzerland is such as to make it, in the Dealer Managers judgment, impracticable or inadvisable to proceed with the Offer, (iii) trading in the Common Shares or in the Rights shall have been suspended by the Commission or the NYSE, (iv) trading in securities generally on the NYSE shall have been suspended or limited or (v) a banking moratorium shall have been declared either by Federal or New York State authorities. |
b. | If this Dealer Manager Agreement is terminated pursuant to this Section, such termination shall be without liability of any party to any other party except as provided in Section 5 and the Dealer Manager shall not have any obligation to purchase any Shares upon exercise of Rights. |
10. | Notices . All communications hereunder will be in writing and effective only on receipt, and, if sent to the Dealer Manager, will be mailed, delivered or telegraphed and confirmed to UBS Securities LLC, 299 Park Avenue, New York, New York 10171-0026, Attn: Todd Reit, and, if to the Fund or the Investment Manager, shall be sufficient in all respects if delivered or sent to the Fund or the Investment Manager, as the case may be, at the offices of the Fund or the Investment Manager at 1345 Avenue of the Americas, New York, New York 10105, Attn: Brian Shlissel. |
11. | Successors . This Dealer Manager Agreement will inure to the benefit of and be binding upon the parties hereto and their respective successors and will inure to the benefit of the officers and directors and controlling persons referred to in Section 7 hereof, and no other person will have any right or obligation hereunder. |
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12. | Applicable Law . This Dealer Manager Agreement will be governed by and construed in accordance with the laws of the State of New York. |
13. | Submission to Jurisdiction . Except as set forth below, no claim (a Claim) which relates to the terms of this Dealer Manager Agreement or the transactions contemplated hereby may be commenced, prosecuted or continued in any court other than the courts of the State of New York located in the City and County of New York or in the United States District Court for the Southern District of New York, which courts shall have jurisdiction over the adjudication of such matters, and each of the Fund, the Investment Manager and the Dealer Manager consents to the jurisdiction of such courts and personal service with respect thereto. Each of the Fund, the Investment Manager and the Dealer Manager hereby consents to personal jurisdiction, service and venue in any court in which any Claim arising out of or in any way relating to this Dealer Manager Agreement is brought by any third party against the Dealer Manager or any indemnified party. Each of the Dealer Manager, the Fund (on its behalf and, to the extent permitted by applicable law, on behalf of its unitholders and affiliates) and the Investment Manager (on its behalf and, to the extent permitted by applicable law, on behalf of its stockholders and affiliates) waives all right to trial by jury in any action, proceeding or counterclaim (whether based upon contract, tort or otherwise) in any way arising out of or relating to this Dealer Manager Agreement. Each of the Dealer Manager, the Fund and the Investment Manager agrees that a final judgment in any such action, proceeding or counterclaim brought in any such court shall be conclusive and binding upon the Dealer Manager, the Fund or the Investment Manager, as the case may be, and may be enforced in any other courts in the jurisdiction of which the Dealer Manager, the Fund or the Investment Manager is or may be subject, by suit upon such judgment. |
14. | Counterparts . This Dealer Manager Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. |
15. | Disclaimer of Liability of Trustees and Beneficiaries . A copy of the Declaration of Trust of the Fund is on file with the Secretary of State of The Commonwealth of Massachusetts, and notice hereby is given that this Dealer Manager Agreement is executed on behalf of the Fund by an officer or Trustee of the Fund in his or her capacity as an officer or Trustee of the Fund and not individually and that the obligations under or arising out of this Dealer Manager Agreement are not binding upon any of the Trustees, officers or shareholders individually but are binding only upon the assets and properties of the Fund. |
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If the foregoing is in accordance with your understanding of our agreement, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among the Fund, the Investment Manager and the Dealer Manager.
Very truly yours, | ||
PIMCO INCOME STRATEGY FUND / | ||
PIMCO INCOME STRATEGY FUND II | ||
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ALLIANZ GLOBAL INVESTORS FUND MANAGEMENT LLC |
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The foregoing Dealer Manager Agreement is hereby confirmed and accepted as of the date first above written. |
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UBS SECURITIES LLC |
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Exhibit A
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
[ ] Common Shares
Issuable Upon Exercise of Transferable Rights
to Subscribe for Such Shares
SELLING GROUP AGREEMENT
UBS Securities LLC
299 Park Avenue
New York, New York 10171-0026
Ladies and Gentlemen:
We understand that [ PIMCO Income Strategy Fund / PIMCO Income Strategy Fund II ], (the Fund) is issuing to its shareholders of record (Record Date Shareholders) as of the close of business on [ ], 2010 (the Record Date) transferable rights (Rights) to subscribe for an aggregate of up to [ ] shares (the Shares) of the Funds common shares of beneficial interest, par value $0.00001 per share (the Common Shares), upon the terms and subject to the conditions set forth in the Funds Prospectus (the Prospectus) dated [ ], 2010 (the Offer). Pursuant to the terms of the Offer, the Fund is issuing each Record Date Shareholder one transferable right (each a Right and, collectively, the Rights) for each Common Share held by such Record Date Shareholder on the Record Date. Such Rights entitle their holders to acquire during the subscription period set forth in the Prospectus (the Subscription Period), at the price set forth in such Prospectus (the Subscription Price), one Share for each [ ] Rights (except that any Record Date Shareholder who is issued fewer than [ ] Rights will be able to subscribe for one full Share pursuant to the primary subscription), on the terms and conditions set forth in such Prospectus. No fractional Shares will be issued. Any Record Date Shareholder who fully exercises all Rights initially issued to such Record Date Shareholder (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) will be entitled to subscribe for, subject to allocation, additional Shares (the Over-Subscription Privilege) on the terms and conditions set forth in such Prospectus. The Rights are transferable and are expected to be listed on the New York Stock Exchange, Inc.
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 2
Rights Offer Expiring [ ], 2010, unless extended
We further understand that the Fund has appointed UBS Securities LLC to act as the dealer manager (the Dealer Manager) in connection with the Offer and has authorized the Dealer Manager to form and manage a group of broker-dealers (each a Selling Group Member and collectively the Selling Group) to solicit the exercise of Rights and to sell Shares purchased by the Dealer Manager from the Fund through the exercise of Rights.
We hereby express our interest in participating in the Offer as a Selling Group Member.
We hereby agree with you as follows:
1. | We have received and reviewed the Funds prospectus dated [ ], 2010 (the Prospectus) relating to the Offer and we understand that additional copies of the Prospectus (or of the Prospectus as it may be subsequently supplemented or amended, if applicable) and any other solicitation materials authorized by the Fund relating to the Offer (Offering Materials) will be supplied to us in reasonable quantities upon our request therefor to you. We agree that we will not use any solicitation material other than the Prospectus (as supplemented or amended, if applicable) and such Offering Materials and we agree not to make any written representations concerning the Fund to any holders or prospective holders of Shares or Rights other than those contained in the Offering Materials or otherwise previously authorized in writing by the Fund or otherwise permitted by applicable law. |
2. |
From time to time during the period (the Subscription Period) commencing on [ ], 2010 and ending at 5:00 p.m., New York City time, on the Expiration Date (the term Expiration Date means [ ], 2010, unless and until the Fund shall, in its sole discretion, have extended the period for which the Offer is open, in which event the term Expiration Date with respect to the Offer will mean the latest time and date on which the Offer, as so extended by the Fund, will expire), we may solicit the exercise of Rights in connection with the Offer. We will be entitled to receive fees in the amounts and at the times described in Section 4 of this selling group agreement (the Selling Group Agreement) with |
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 3
Rights Offer Expiring [ ], 2010, unless extended
respect to Shares purchased pursuant to the exercise of Rights and with respect to which [ ] (the Subscription Agent) has received, no later than 5:00 p.m., New York City time, on the Expiration Date, either (i) a properly completed and executed Subscription Certificate identifying us as the broker-dealer having been instrumental in the exercise of such Rights, and full payment for such Shares or (ii) a Notice of Guaranteed Delivery guaranteeing to the Subscription Agent by the close of business of the third business day after the Expiration Date of a properly completed and duly executed Subscription Certificate, similarly identifying us, and full payment for such Shares. We understand that we will not be paid these fees with respect to Shares purchased pursuant to an exercise of Rights for our own account or for the account of any of our affiliates. We also understand and agree that we are not entitled to receive any fees in connection with the solicitation of the exercise of Rights other than pursuant to the terms of this Selling Group Agreement and, in particular, that we will not be entitled to receive any fees under the Funds Soliciting Dealer Agreement. We agree to solicit the exercise of Rights in accordance with the Securities Act of 1933, as amended (the Securities Act), the Securities Exchange Act of 1934, as amended (the Exchange Act), and the Investment Company Act of 1940, as amended, and the rules and regulations under each such Act, any applicable securities laws of any state or jurisdiction where such solicitations may be lawfully made, the applicable rules and regulations of any self-regulatory organization or registered national securities exchange and customary practice and subject to the terms of the Subscription Agent Agreement between the Fund and the Subscription Agent and the procedures described in the Funds registration statement on Form N-2 (File Nos. 333-[ ] and 811-[ ]), as amended (the Registration Statement). |
3. |
From time to time during the Subscription Period, we may indicate interest in purchasing Shares from the Dealer Manager. We understand that from time to time the Dealer Manager intends to offer Shares obtained or to be obtained by the Dealer Manager through the exercise of Rights to Selling Group Members who have so indicated interest at prices which shall be determined by the Dealer Manager (the Offering Price). We agree that with respect to any such Shares purchased by us |
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 4
Rights Offer Expiring [ ], 2010, unless extended
from the Dealer Manager the sale of such Shares to us shall be irrevocable and we will offer them to the public at the Offering Price at which we purchase them from the Dealer Manager. Shares not sold by us at such Offering Price may be offered by us after the next succeeding Offering Price is set at the latest Offering Price set by the Dealer Manager. The Dealer Manager agrees that, if requested by any Selling Group Member, and subject to applicable law, the Dealer Manager will set a new Offering Price prior to 4:00 p.m., New York City time, on any business day. We agree to advise the Dealer Manager from time to time upon request, prior to the termination of this Selling Group Agreement, of the number of Shares remaining unsold which were purchased by us from the Dealer Manager and, on the Dealer Managers request, we will resell to the Dealer Manager any of such Shares remaining unsold at the purchase price thereof if in the Dealer Managers opinion such Shares are needed to make delivery against sales made to other Selling Group Members. Any shares purchased hereunder from the Dealer Manager shall be subject to regular way settlement through the facilities of the Depository Trust Company. |
4. | We understand that you will remit to us on or before the tenth business day following the day the Fund issues Shares after the Expiration Date, following receipt by you from the Fund of the Dealer Manager Fee, a selling fee equal to [ ]% of the Subscription Price per Share for (A) each Share issued pursuant to the exercise of Rights or the Over-Subscription Privilege pursuant to each Subscription Certificate upon which we are designated, as certified to you by the Subscription Agent, as a result of our solicitation efforts in accordance with Section 2 and (B) each Share sold by the Dealer Manager to us in accordance with Section 3 less any Shares resold to the Dealer Manager in accordance with Section 3. Your only obligation with respect to payment of the foregoing selling fee to us is to remit to us amounts owing to us and actually received by you from the Fund. Except as aforesaid, you shall be under no liability to make any payments to us pursuant to this Selling Group Agreement. |
5. | We agree that you, as Dealer Manager, have full authority to take such action as may seem advisable to you in respect of all matters pertaining to the Offer. You are authorized to approve on our behalf any amendments or supplements to the Registration Statement or the Prospectus. |
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 5
Rights Offer Expiring [ ], 2010, unless extended
6. | We represent that we are a member in good standing of the Financial Industry Regulatory Authority, Inc. (FINRA) and, in making sales of Shares, agree to comply with all applicable rules of FINRA including, without limitation, NASD Conduct Rules 2420, 2730, 2740 and 2750 and FINRA Rule 5130. We understand that no action has been taken by you or the Fund to permit the solicitation of the exercise of Rights or the sale of Shares in any jurisdiction (other than the United States) where action would be required for such purpose. We agree that we will not, without your approval in advance, buy, sell, deal or trade in, on a when-issued basis or otherwise, the Rights or the Shares or any other option to acquire or sell Shares for our own account or for the accounts of customers, except as provided in Sections 2 and 3 hereof and except that we may buy or sell Rights or Shares in brokerage transactions on unsolicited orders which have not resulted from activities on our part in connection with the solicitation of the exercise of Rights and which are executed by us in the ordinary course of our brokerage business. We will keep an accurate record of the names and addresses of all persons to whom we give copies of the Registration Statement, the Prospectus, any preliminary prospectus (or any amendment or supplement thereto) or any Offering Materials and, when furnished with any subsequent amendment to the Registration Statement and any subsequent prospectus, we will, upon your request, promptly forward copies thereof to such persons. |
7. | Nothing contained in this Selling Group Agreement will constitute the Selling Group Members partners with the Dealer Manager or with one another or create any association between those parties, or will render the Dealer Manager or the Fund liable for the obligations of any Selling Group Member. The Dealer Manager will be under no liability to make any payment to any Selling Group Member other than as provided in Section 4 of this Selling Group Agreement, and will be subject to no other liabilities to any Selling Group Member, and no obligations of any sort will be implied. We agree to indemnify and hold harmless you and each other Selling Group Member and each person, if any, who controls you and any such Selling Group Member within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act, against loss or liability caused by any breach by us of the terms of this Selling Group Agreement. |
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 6
Rights Offer Expiring [ ], 2010, unless extended
8. | We agree to pay any transfer taxes which may be assessed and paid on account of any sales or transfers for our account. |
9. | All communications to you relating to the Offer will be addressed to: UBS Securities LLC, 299 Park Avenue, New York, New York 10171-0026, Attn: William Dowson, Syndicate Department. |
10. | This Selling Group Agreement will be governed by the internal laws of the State of New York. |
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 7
Rights Offer Expiring [ ], 2010, unless extended
A signed copy of this Selling Group Agreement will be promptly returned to the Selling Group Member at the address set forth below.
Very truly yours, | ||
UBS Securities LLC | ||
By: |
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Name: |
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Title: |
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PLEASE COMPLETE THE INFORMATION BELOW:
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Printed Firm Name | Address | |||
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Contact at Selling Group Member | ||||
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Authorized Signature | Area Code and Telephone | |||
Number | ||||
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Name and Title | Facsimile Number |
Dated:
Payment of the Selling Fee shall be mailed by check to the following address:
Exhibit B
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Rights Offering for Common Shares
SOLICITING DEALER AGREEMENT
THE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME,
[ ], 2010, UNLESS EXTENDED
To Securities Dealers and Brokers:
The [ PIMCO Income Strategy Fund / PIMCO Income Strategy Fund II ], (the Fund) is issuing to its shareholders of record (Record Date Shareholders) as of the close of business on [ ], 2010 (the Record Date) transferable rights (Rights) to subscribe for an aggregate of up to [ ] shares (the Shares) of the Funds common shares of beneficial interest, par value $0.00001 per share (the Common Shares), upon the terms and subject to the conditions set forth in the Funds Prospectus (the Prospectus) dated [ ], 2010 (the Offer). Each such Record Date Shareholder is being issued one Right for each full Common Share owned on the Record Date. Such Rights entitle their holders to acquire during the Subscription Period (as hereinafter defined) at the Subscription Price (as hereinafter defined), one Share for each [ ] Rights (except that any Record Date Shareholder who is issued fewer than [ ] Rights will be able to subscribe for one full Share pursuant to the primary subscription), on the terms and conditions set forth in such Prospectus. No fractional shares will be issued. Any Record Date Shareholder who fully exercises all Rights initially issued to such holder (other than those Rights that cannot be exercised because they represent the right to acquire less than one Share) will be entitled to subscribe for, subject to allocation, additional Shares (the Over-Subscription Privilege) on the terms and conditions set forth in such Prospectus. Shares acquired pursuant to the Over-Subscription Privilege are subject to allotment,
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 2
Rights Offer Expiring [ ], 2010, unless extended
as more fully described in the Prospectus. The Rights are transferable and are expected to be listed on the New York Stock Exchange, Inc. The Subscription Price will be as set forth in the Prospectus. The Subscription Period will commence on [ ], 2010 and end at 5:00 p.m., New York City time on the Expiration Date (the term Expiration Date means [ ], 2010, unless and until the Fund shall, in its sole discretion, have extended the period for which the Offer is open, in which event the term Expiration Date with respect to the Offer will mean the latest time and date on which the Offer, as so extended by the Fund, will expire).
For the duration of the Offer, the Fund has authorized and the Dealer Manager has agreed to reallow a Solicitation Fee to any qualified broker or dealer executing a Soliciting Dealer Agreement who solicits the exercise of Rights and the Over-Subscription Privilege in connection with the Offer and who complies with the procedures described below (a Soliciting Dealer). Upon timely delivery to [ ], the Funds Subscription Agent for the Offer, of payment for Shares purchased pursuant to the exercise of Rights and the Over-Subscription Privilege and of properly completed and executed documentation as set forth in this Soliciting Dealer Agreement, a Soliciting Dealer will be entitled to receive the Solicitation Fee equal to [ ]% of the Subscription Price per Share so purchased subject to a maximum fee based on the number of Common Shares held by such Soliciting Dealer through The Depository Trust Company (DTC) on the Record Date; provided, however, that no payment shall be due with respect to the issuance of any Shares until payment therefor is actually received. A qualified broker or dealer is a broker or dealer which is a member of a registered national securities exchange in the United States or the Financial Industry Regulatory Authority, Inc. (FINRA) or any foreign broker or dealer not eligible for membership who agrees to conform to the Rules of FINRA, including, without limitation, NASD Conduct Rules 2420, 2730, 2740 and 2750 and FINRA Rule 5130, in making solicitations in the United States to the same extent as if it were a member thereof.
The Fund has authorized and the Dealer Manager has agreed to pay the Solicitation Fees payable to the undersigned Soliciting Dealer and to indemnify such Soliciting Dealer on the terms set forth in the Dealer Manager Agreement, dated [], 2010, among UBS Securities LLC as the dealer manager (the Dealer Manager), the Fund and others (the Dealer Manager Agreement). Solicitation
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 3
Rights Offer Expiring [ ], 2010, unless extended
and other activities by Soliciting Dealers may be undertaken only in accordance with the applicable rules and regulations of the Securities and Exchange Commission and only in those states and other jurisdictions where such solicitations and other activities may lawfully be undertaken and in accordance with the laws thereof. Compensation will not be paid for solicitations in any state or other jurisdiction in which, in the opinion of counsel to the Fund or counsel to the Dealer Manager, such compensation may not lawfully be paid. No Soliciting Dealer shall be paid Solicitation Fees with respect to Shares purchased pursuant to an exercise of Rights and the Over-Subscription Privilege for its own account or for the account of any affiliate of the Soliciting Dealer. No Soliciting Dealer or any other person is authorized by the Fund or the Dealer Manager to give any information or make any representations in connection with the Offer other than those contained in the Prospectus and other authorized solicitation material furnished by the Fund through the Dealer Manager. No Soliciting Dealer is authorized to act as agent of the Fund or the Dealer Manager in any connection or transaction. In addition, nothing herein contained shall constitute the Soliciting Dealers partners with the Dealer Manager or with one another, or agents of the Dealer Manager or of the Fund, or create any association between such parties, or shall render the Dealer Manager or the Fund liable for the obligations of any Soliciting Dealer. The Dealer Manager shall be under no liability to make any payment to any Soliciting Dealer, and shall be subject to no other liabilities to any Soliciting Dealer, and no obligations of any sort shall be implied.
In order for a Soliciting Dealer to receive Solicitation Fees, the Subscription Agent must have received from such Soliciting Dealer no later than 5:00 p.m., New York City time, on the Expiration Date, either (i) a properly completed and duly executed Subscription Certificate with respect to Shares purchased pursuant to the exercise of Rights and the Over-Subscription Privilege and full payment for such Shares; or (ii) a Notice of Guaranteed Delivery guaranteeing delivery to the Subscription Agent by close of business on the third business day after the Expiration Date, of (a) full payment for such Shares and (b) a properly completed and duly executed Subscription Certificate with respect to Shares purchased pursuant to the exercise of Rights. Solicitation Fees will only be paid after receipt by the Subscription Agent of a properly completed and duly executed Soliciting Dealer Agreement and a Subscription Certificate designating the Soliciting Dealer in the applicable portion hereof. In the case of a Notice of Guaranteed Delivery,
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 4
Rights Offer Expiring [ ], 2010, unless extended
Solicitation Fees will only be paid after delivery in accordance with such Notice of Guaranteed Delivery has been effected. Solicitation Fees will be paid by the Fund (through the Subscription Agent) to the Soliciting Dealer by check to an address designated by the Soliciting Dealer below by the tenth business day following the day the Fund issues Shares after the Expiration Date.
All questions as to the form, validity and eligibility (including time of receipt) of this Soliciting Dealer Agreement will be determined by the Fund, in its sole discretion, which determination shall be final and binding. Unless waived, any irregularities in connection with a Soliciting Dealer Agreement or delivery thereof must be cured within such time as the Fund shall determine. None of the Fund, the Dealer Manager, the Subscription Agent, the Information Agent for the Offer or any other person will be under any duty to give notification of any defects or irregularities in any Soliciting Dealer Agreement or incur any liability for failure to give such notification.
The acceptance of Solicitation Fees from the Fund by the undersigned Soliciting Dealer shall constitute a representation by such Soliciting Dealer to the Fund that: (i) it has received and reviewed the Prospectus; (ii) in soliciting purchases of Shares pursuant to the exercise of the Rights and the Over-Subscription Privilege, it has complied with the applicable requirements of the Securities Exchange Act of 1934, as amended (the Exchange Act), the applicable rules and regulations thereunder, any applicable securities laws of any state or jurisdiction where such solicitations were made, and the applicable rules and regulations of any self-regulatory organization or registered national securities exchange; (iii) in soliciting purchases of Shares pursuant to the exercise of the Rights and the Over-Subscription Privilege, it has not published, circulated or used any soliciting materials other than the Prospectus and any other authorized solicitation material furnished by the Fund through the Dealer Manager and has not made any written representations concerning the Fund to any holders or prospective holders of Shares or Rights other than those contained in such materials or otherwise previously authorized in writing by the Fund or otherwise permitted by applicable law; (iv) it has not purported to act as agent of the Fund or the Dealer Manager in any connection or transaction relating to the Offer; (v) the information contained in this Soliciting Dealer Agreement is, to its best knowledge, true and complete; (vi) it is not affiliated with the Fund; (vii) it
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 5
Rights Offer Expiring [ ], 2010, unless extended
will not accept Solicitation Fees paid by the Fund pursuant to the terms hereof with respect to Shares purchased by the Soliciting Dealer pursuant to an exercise of Rights and the Over-Subscription Privilege for its own account; (viii) it will not remit, directly or indirectly, any part of Solicitation Fees paid by the Fund pursuant to the terms hereof to any beneficial owner of Shares purchased pursuant to the Offer; and (ix) it has agreed to the amount of the Solicitation Fees and the terms and conditions set forth herein with respect to receiving such Solicitation Fees. By returning a Soliciting Dealer Agreement and accepting Solicitation Fees, a Soliciting Dealer will be deemed to have agreed to indemnify the Fund and the Dealer Manager against losses, claims, damages and liabilities to which the Fund may become subject as a result of the breach of such Soliciting Dealers representations made herein and described above. In making the foregoing representations, Soliciting Dealers are reminded of the possible applicability of the anti-manipulation rules under the Exchange Act if they have bought, sold, dealt in or traded in any Shares for their own account since the commencement of the Offer.
Upon expiration of the Offer, no Solicitation Fees will be payable to Soliciting Dealers with respect to Shares purchased thereafter.
Capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Dealer Manager Agreement or, if not defined therein, in the Prospectus.
This Soliciting Dealer Agreement will be governed by the laws of the State of New York.
Please execute this Soliciting Dealer Agreement below accepting the terms and conditions hereof and confirming that you are a member firm of the FINRA or a foreign broker or dealer not eligible for membership who has conformed to the Rules of FINRA, including without limitation, NASD Conduct Rules 2420, 2730, 2740 and 2750 and FINRA Rule 5130, in making solicitations of the type being undertaken pursuant to the Offer in the United States to the same extent as if you were a member thereof, and certifying that you have solicited the purchase of the Shares pursuant to exercise of the Rights, all as described above, in accordance with the terms and conditions set forth in this Soliciting Dealer
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 6
Rights Offer Expiring [ ], 2010, unless extended
Agreement. Please forward two executed copies of this Soliciting Dealer Agreement to UBS Securities LLC, 299 Park Avenue, New York, New York 10171-0026, Attn: William Dowson, Syndicate Department.
PIMCO Income Strategy Fund /
PIMCO Income Strategy Fund II
Soliciting Dealer Agreement - Page 7
Rights Offer Expiring [ ], 2010, unless extended
A signed copy of this Soliciting Dealer Agreement will be promptly returned to the Soliciting Dealer at the address set forth below.
Very truly yours, | ||
UBS Securities LLC | ||
By: |
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Name: |
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Title: |
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PLEASE COMPLETE THE INFORMATION BELOW:
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Printed Firm Name | Address | |||||
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Contact at Soliciting Dealer | ||||||
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Authorized Signature | Area Code and Telephone Number | |||||
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Name and Title | Facsimile Number |
Dated:
Payment of the Solicitation Fee shall be mailed
by check to the following address:
SUBSCRIPTION AGENCY AGREEMENT
Agreement made as of the _th day of March, 2010 between PIMCO Income Strategy Fund II (PFN) with principal offices at 1345 Avenue of the Americas, New York, New York 10105 (the Fund) and The Colbent Corporation with principal offices at 161 Bay State Drive Braintree, Massachusetts 02184 (Colbent).
W I T N E S S E T H
WHEREAS, the Fund desires to engage Colbent to act as Subscription Agent in a rights offering by the Fund (the Rights Offering); and
WHEREAS, Colbent owns proprietary software for, and is in the business of performing the functions of a subscription agent for certain rights offerings, and desires to be engaged for such purposes in connection with the Rights Offering; and
NOW, THEREFORE, the Fund hereby engages Colbent as subscription agent to perform the processing services set forth on Exhibit 1 hereto required to complete the Rights Offering and Colbent agrees to provide such services under the following terms and conditions:
1. | Engagement. |
The Fund hereby engages Colbent to act as Subscription Agent to complete the Rights Offering. Colbent and the Fund will consult with each other concerning the specific services to be provided by Colbent and an agreeable timetable to perform the services. As Subscription Agent, Colbent shall be responsible to supply all needed personnel and software required to complete the Rights Offering, with the exception of staffing and telephone support for the Rights Offering, which will be supplied or arranged for by the Fund.
2. | Specific Services, Fees. |
Exhibit 1, attached hereto and made a part hereof, as the same shall be amended from time to time by the agreement of the parties, shall set forth the agreed upon services, procedures, time lines, fees, out of pocket expenses and other performance standards required of each party for the Rights Offering.
3. | Term. |
The term of this Agreement shall commence on the date first set forth above and shall continue for the duration of the Rights Offering.
1
4. | Representations and Warranties of Colbent. |
Colbent represents and warrants to the Fund that:
4.1 It is a corporation duly organized and existing and in good standing under the laws of The Commonwealth of Massachusetts;
4.2 It is duly qualified to carry on its business in The Commonwealth of Massachusetts;
4.3 It is empowered under applicable laws and by its Articles of Incorporation and By-Laws to enter into and perform this Agreement;
4.4 All requisite corporate proceedings have been taken to authorize it to enter into and perform this Agreement;
4.5 It is the sole owner of the Corporate Reorg System (CRS ¨ ) and other related proprietary software (the CRS ¨ Software System), and has the right to use the other software in providing the processing services as provided hereunder; and
4.6 Colbents CRS Software System and Colbents use of such other software do not infringe upon any copyright, patent or other proprietary interest of any person, firm or organization.
5. | Representations and Warranties of the Fund. |
The Fund represents and warrants to Colbent that:
5.1 It is a business trust organized and existing and in good standing under the laws of the Commonwealth of Massachusetts;
5.2 It is empowered under applicable laws and by its Agreement and Declaration of Trust and by Laws to enter into and perform this Agreement
5.3 All requisite corporate proceedings have been taken to authorize it to enter into and perform this Agreement; and
5.4 The execution, delivery and performance of this agreement by the Fund will not require the consent of any other party, or violate, conflict with, or result in the breach of any term condition, or provision of any existing contract, agreement, law, ordinance, rule or regulation to which it is subject.
2
6. | Confidentiality. |
Both parties agree that they, their personnel, agents or representatives will not, at any time during the term of this Agreement or after its termination, reveal, divulge, or make known to any person, firm, corporation or other business organization, any customers lists, trade secrets, cost figures and projections, profit figures and projections or any other secret, confidential or proprietary information whatsoever, whether of the Fund or Colbent or any of the Issuers, used or gained by the Fund or Colbent during performance under this Agreement. Colbent and the Fund further covenant and agree to retain all such knowledge and information acquired during and after the term of this Agreement respecting such lists, trade secrets, or any secret, confidential or proprietary information whatsoever in trust for the sole benefit of the Fund or Colbent and their successors and assigns. The above prohibition of disclosure shall not apply to the extent that the Fund or Colbent must disclose such data or this agreement to a governmental authority or a court of competent jurisdiction.
The Fund acknowledges that its personnel may be exposed to proprietary information of Colbent, including, but not limited to Colbents proprietary CRS Software System, and the Fund agrees that it will take all appropriate steps to ensure that its personnel will keep all aspects of Colbents CRS Software System confidential.
Both parties acknowledge and agree that a breach of this Section by a party or its personnel, agents or representatives is highly likely to cause significant, irreparable harm to the other party and that such other party shall be entitled to temporary, preliminary and/or injunctive relief, or any other equitable remedy deemed appropriate by a reviewing court, to prevent a breach or threatened breach of this Section in order to protect its interests in its Confidential Information.
7. | Standard of Care. |
Each party will at all times act in good faith and agrees to use its best efforts to insure the accuracy of all services performed under this Agreement, but assumes no responsibility, and will not be liable, for loss or damage due to errors unless said errors are caused by its gross negligence or willful misconduct or that of its employees or agents.
8. | Colbent Indemnification. |
Colbent hereby agrees to indemnify, defend and hold harmless the Fund and its respective officers, shareholders, employees and representatives from and against any and all losses, claims, damages, liabilities and expenses, including reasonable attorneys fees and costs, arising out of (i) Colbents performance of the services under this Agreement, subject to the standard of care in Section 7 hereof; and (ii) any infringement or misappropriation of third party intellectual property rights related to Colbents CRS Software System and any other software utilized by Colbent in performing services under this Agreement.
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The Fund shall provide Colbent with prompt written notice of any assertion of any claim, demand or the institution of any action that may expose Colbent to liability hereunder. In defending any such claim, demand or action, Colbent shall be represented by counsel of its own choosing that is acceptable to the Fund.
9. | Force Majeure. |
In the event either party is unable to perform its obligations under the terms of this Agreement because of acts of God, strikes, equipment or transmission failure or damage reasonably beyond its control, such party shall not be liable for damages to the other for any damages resulting from such failure to perform or otherwise from such causes.
10. | Consequential Damages. |
Neither party to this Agreement shall be liable to the other party for consequential damages under any provision of this Agreement or for any consequential damages arising out of any act or failure to act hereunder even if that party has been advised of or has foreseen the possibility of such damages.
11. | Disaster Plan. |
Colbent will maintain a disaster back-up plan whereby the services contemplated by this Agreement can be performed by Colbent on an alternative computer hardware and software system within forty-eight (48) hours if there is a catastrophic event that renders Colbents computer hardware and software system upon which the services are then being performed inoperable.
12. | Insurance. |
Colbent maintains and will maintain throughout the term of this Agreement errors and omissions insurance coverage in the amount of Ten Million Dollars ($10,000,000.00) per error.
13. | Right to Audit. |
The Fund and/or its internal auditors and examiners may conduct, at the Funds option and expense, appropriate audits and examinations of Colbents operations relating to the performance of the services hereunder, and to verify that the services are being performed in accordance with this Agreement. Such audits shall require reasonable prior notice to Colbent; provided, however, that any audit shall not interfere with Colbents ability to perform its obligations hereunder. The Fund, its examiners or auditors shall not have access to Colbents proprietary data or the proprietary data that does not in any way relate to the Fund or of any other Colbent customer.
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14. | Amendment, Successors and Assigns. |
This Agreement may be amended or modified by a written agreement executed by both parties. This Agreement shall be binding on and shall inure to the benefit of the respective successors and assigns of the parties hereto.
15. | Massachusetts Law to Apply. |
This Agreement shall be construed and the provisions thereof interpreted under and in accordance with the internal laws of The Commonwealth of Massachusetts without regard to the conflict of laws provisions thereof.
The Funds Agreement and Declaration of Trust is on file with the Secretary of State of the Commonwealth of Massachusetts. This Agreement is executed on behalf of the Fund by an officer of the Fund as an officer and not individually, and the obligation imposed upon the Fund by this Agreement are not binding upon the Funds Trustees, officers or the Funds shareholders individually but are binding only upon the assets and property of the Fund.
16. | Survival. |
All provisions regarding indemnification, warranty, liability and limits thereon, and confidentiality and/or protection of proprietary rights and trade secrets shall survive the termination of this Agreement.
17. | Severability. |
If any provision or provisions of this Agreement shall be held invalid, unlawful, or unenforceable, the validity, legality, and enforceability of the remaining provisions shall not in any way be affected or impaired.
18. | Merger of Agreement. |
This Agreement constitutes the entire agreement between the parities hereto and supersedes any prior agreement with respect to the subject matter hereof whether oral or written.
19. | Counterparts. |
This Agreement may be executed by the parties hereto on any number of counterparts, and all of said counterparts taken together shall be deemed to constitute one and the same instrument.
Specific Services and Fees
See Separate attachment, labeled as Exhibit 1
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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed in their names and on their behalf by and through their duly authorized officers as of the day set forth in this Agreement.
PIMCO Income Strategy Fund II (PFN) |
Name: Brian Shlissel |
Title: President |
The Colbent Corporation |
Name: Donald Beardsley |
Title: Vice President of Operations |
6
The Colbent Corporation
Rights Offering Proposal for
Allianz Investors
A. | Fees for Services* |
Fee |
Service Provided |
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$22,500.00 | Project Management Fee; all-in flat fee for project. Out of pocket expenses for postage and other materials to be billed as incurred | |
Included | Per subscription form generated | |
Included | Per replacement forms/fulfillment | |
Included | Mailing of Subscription forms (depending on the number of enclosures) | |
Included | Per subscription form processed (registered and beneficial) | |
Included | Per defective subscription form received | |
Included | Per notice of guaranteed delivery received | |
Included | Per sale of right (if applicable) | |
Included | Per invoice mailed (if applicable) | |
Included | Per refund check issued and mailed (if applicable) | |
Included | Per solicitation check processed and mailed (if applicable) | |
Included | Per withdrawal of subscription certificate (if applicable) | |
Included | Per Pro-ration (if applicable) | |
$1500.00 | Per offer extension | |
$5000.00 | Minimum charge should the project be cancelled for any reason prior to the mailing of the subscription form | |
Included for 3 months if extended; after that $500 per month | DTCC connectivity fee; typically one month |
| Excludes out-of-pocket expenses as described in Section C, Items Not Covered |
The Colbent Corporation
Confidential
B. | Services Covered |
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Designate an operational team to carry out Subscription Agent duties, including document review and execution of legal agreement, review of subscription forms and communication materials, project management and on-going project updates and reporting. |
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Calculating Rights to be distributed to each shareholder and printing shareholder information on the subscription form. |
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Issuing subscription forms, and causing forms to be mailed to registered shareholders. |
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Tracking and reporting the number of exercises made, as required. |
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Processing Rights received and exercised. |
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Deposit participant checks daily and forward all participant funds to Fund at the end of the offering period. |
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Providing receipt summation of checks received. |
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Run a pro-ration against the file if the rights offering is oversubscribed. |
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Interface with the Depository Trust Company (DTC). |
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Issuing/ Printing (if applicable,) and mailing stock certificates and/or checks. |
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Interfacing with the Information Agent. |
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Calculating, issuing and mailing of proration and/or over-subscription checks if applicable. |
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Calculating, issuing and mailing of solicitation checks if applicable. |
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Interface with Transfer Agent produce a create tape for all shares being issued. |
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Produce and Report to IRS 1099Bs (for the sale of rights) to registered shareholders at year end. |
C. | Items Not Covered |
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Items not specified in the Services Covered section set forth in this Agreement, including any services associated with new duties, legislation or regulatory fiat which become effective after the date of this Agreement (these will be provided on an appraisal basis) |
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All out-of-pocket expenses such as telephone line charges, certificates, checks, postage, stationary, wire transfers and excess material disposal (these will be billed as incurred) |
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Reasonable legal review fees if referred to outside counsel. |
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Overtime charges assessed in the event of late delivery of material for mailings unless the target mail date is rescheduled. |
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Additional programming to accommodate project specific requirements. |
D. | Assumptions |
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This Exhibit is based upon document review and information known at this time about the transaction. |
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Proposal based upon document review and information known at this time about the transaction. |
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Significant changes made in the term or requirements of this transaction could require modifications to this Exhibit. |
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This Exhibit must be executed prior to the initial mailing. |
The Colbent Corporation
Confidential
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The Fund is responsible for printing of materials (Rights Card, Prospectus and ancillary documents). |
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Material to be mailed to shareholders must be received no less than five (5) business days prior to the start of the mailing project. |
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Accrued interest in Deposit account will be used to offset bank fees. All remaining account interest will go back to the company. |
E. | Payment for Services |
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The Project Management Fee will be rendered and payable upon the effective date of the transaction. An invoice for any out-of-pocket and per items fees realized will be rendered and payable on a monthly basis, except for postage expenses in excess of $5,000.00. Funds for such mailing expenses must be received one (1) business day prior to the scheduled mail date. |
The Colbent Corporation | Allianz Investors | |||||||
By: |
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By: |
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Donald Beardsley | ||||||||
Title: |
Vice President, The Colbent Corporation |
Title: |
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Date: |
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Date: |
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The Colbent Corporation
Confidential
This will serve as the agreement between The Altman Group, Inc. (The Altman Group), with offices at 60 E. 42nd Street, Suite 916, New York, NY 10165 and PIMCO Income Strategy Fund II (the Fund), with offices at 1345 Avenue of the Americas, New York, NY 10105, pursuant to which The Altman Group will serve the Fund as Information Agent for the upcoming Rights Offering (the Offer).
1. | Services: |
As Information Agent, The Altman Group will handle the following services and they will be performed promptly and diligently in compliance with all applicable laws and regulations. These services include, but not limited to:
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Provide strategic counsel to the Fund and its advisors on the execution of the steps to best ensure the overall success of the Offer. |
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Develop a timeline, detailing the logistics and suggested communications methods. |
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Coordinate the ordering and receipt of the Depository Trust Company participant list(s) and non-objecting beneficial owner (NOBO) list(s). |
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Typeset and place any summary advertisement in publication selected by the Fund. |
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Contact the reorganization departments at all banks and brokerage firms to determine the number of holders and quantity of materials needed. |
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Coordinate the printing of sufficient documents for the eligible universe of holders (if requested). |
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Complete the mailing of needed Offer material to any registered holders. |
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Distribute the Offer material to banks and brokers, and follow up to ensure the correct processing of such by each firm. |
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Distribute the documents directly to the decision maker at each major institutional holder, if any, to avoid the delay associated with the material being filtered through the holders custodian bank or brokerage firm. |
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Establish a dedicated toll-free number to answer questions, provide assistance and fulfill requests for Offer materials. |
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If requested, conduct an outbound phone campaign to targeted universe of registered and NOBO holders to confirm receipt and understanding of the Offer materials. |
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Maintain contact with the bank and broker reorganization departments for ongoing monitoring of the response to the Offer. |
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Provide feedback to the Fund and its advisors as to the response to the Offer. |
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Establish ongoing coordination with the depositary to verify expected tenders. |
2. | Fees: |
a) | The Altman Group agrees to complete the work described above for a fee of $7,500, plus $2,500 for each extension of at least five business days beyond the original expiration date of the offer. |
b) |
Reasonable out-of-pocket expenses shall be reimbursed by the Fund, and will include such charges as search notification, postage, messengers, warehouse charges and overnight couriers, other expenses incurred by The Altman Group in obtaining or converting depository participant listings, |
transmissions from Broadridge Financial Solutions (Broadridge), shareholder and/or Non-Objecting Beneficial Owners (NOBOs) list processing; and reasonable and customary charges for data processing, supplies, in-house photocopying, telephone and facsimile usage, and other similar activities. |
c) | Inbound calls, and if applicable outbound calls, will be charged at a fee of $4.00 per contact. In addition, directory assistance will be charged at a rate of $0.35 per each look-up. |
d) | A data processing fee of $600 will be incurred for receiving, converting and processing electronic lists of registered holders and or NOBO lists, if such lists are to be used for telephone calling effort. |
3. | Billing and Payment: |
a) | A final invoice for the base fee and any out-of-pocket expenses will be invoiced to the Fund after the completion of the project. |
b) | Banks, brokers and proxy intermediaries will be directed to send their invoices directly to the Fund for payment. The Altman Group will, if requested, assist in reviewing and approving any or all of these invoices. |
4. | Records: |
Copies of supplier invoices and other back-up material in support of The Altman Groups out-of-pocket expenses will be available for review at the offices of The Altman Group upon reasonable notice and during normal business hours.
5. | Confidentiality: |
The Altman Group acknowledges its responsibility, both during and after the term of this agreement, to preserve the confidentiality of any proprietary or confidential information or data developed by The Altman Group on behalf of the Fund or disclosed by the Fund to The Altman Group.
6. | Indemnification: |
It is acknowledged that Altman cannot undertake to verify facts supplied to it by the Fund or factual matters included in material prepared by the Fund and approved by the Fund. Accordingly, the Fund agrees to indemnify and hold Altman and all its employees harmless against any loss, damage, expense (including, without limitation, legal and other related fees and expenses), liability or claim arising out of Altmans fulfillment of the Agreement (except for any loss, damage, expense, liability or claim resulting out of Altmans gross negligence, or willful misconduct). At its election, the Fund may assume the defense of any such action, with counsel that is acceptable to Altman, and the Fund shall thereafter not be liable to Altman for any legal expenses incurred by Altman in connection with the defense of such action, except if counsel retained by the Fund for Altman should subsequently be deemed by Altman to be unacceptable and such determination is conveyed to the Fund. The Fund shall not be liable under this Agreement with respect to any settlement made by Altman without the prior written consent of the Fund to such settlement. Altman hereby agrees to advise the Fund of any such liability or claim promptly after receipt of the notice thereof; provided however, that Altmans right to indemnification hereunder shall not be limited by its failure to promptly advise the Fund of any such liability or claim, except to the extent that the Fund is prejudiced by such failure.
7. | Termination: |
The Altman Groups appointment under this Agreement shall be effective as of the date of this letter and will continue thereafter until the termination or completion of the assignment, or until such date as The Altman Group may complete the duties requested by the Fund or its counsel. The Fund will be responsible for paying all reasonable, out-of-pocket expenses incurred on behalf of the Fund by The Altman Group during the course of the assignment including reasonable out-of-pocket expenses processed after the completion of the assignment. To the extent the Offer does not occur, The Altman Group will return to the Fund the Base Fee less any reasonable out-of-pocket expenses incurred by The Altman Group hereunder through the date of the termination hereof.
8. | Governing Law: |
This Agreement will be governed and construed in accordance with the laws of the State of New York for contracts made and to be performed entirely in New York, and shall inure to the benefit of, and the obligations created hereby shall be binding upon, the successors and assigns of the parties hereto, except that The Altman Group may neither assign its rights nor delegate its duties without the Funds prior written consent.
The Funds Agreement and Declaration of Trust is on file with the Secretary of State of the Commonwealth of Massachusetts. This Agreement is executed on behalf of the Fund by an officer of the Fund as an officer and not individually, and the obligations imposed upon the Fund by this Agreement are not binding upon any of the Funds Trustees, officers or the Funds shareholders individually but are binding only upon the assets and property of the Fund.
If you are in agreement with the above, kindly sign a copy of this agreement in the space provided for that purpose below and return copy to us. Additionally, an invoice for the retainer is attached and The Altman Group requires that the retainer be received by us upon execution of this agreement.
THE ALTMAN GROUP, INC. |
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Paul J. Torre, Senior Managing Director |
Agreed to and accepted as of the date set forth on this agreement:
PIMCO Floating Rate Fund, Inc. | ||
By; |
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Print Authorized Name & Title | ||
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Authorized Signature | ||
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Date |
[Ropes & Gray Letterhead]
March 12, 2010
PIMCO Income Strategy Fund II
1345 Avenue of the Americas
New York, New York 10105
Ladies and Gentlemen:
We have acted as counsel to PIMCO Income Strategy Fund II (the Fund ) in connection with the registration statement of the Fund on Form N-2 under the Securities Act of 1933 (file no. 333-164388) and the Investment Company Act of 1940 (file no. 811-21601) (the Registration Statement ) with respect to the issuance of transferable rights to subscribe for additional common shares of beneficial interest of the Fund, par value of $0.00001 per share (the Common Shares ). The Common Shares are anticipated to be issued in accordance with a Dealer Manager Agreement substantially in the form filed as an exhibit to the Registration Statement among the Fund, Allianz Global Investors Fund Management LLC and UBS Securities LLC (the Dealer Manager Agreement ).
We have examined the Funds Amended and Restated Agreement and Declaration of Trust, as amended, on file in the office of the Secretary of The Commonwealth of Massachusetts (the Declaration of Trust ), the Funds Fourth Amended and Restated Bylaws and the Dealer Manager Agreement, and are familiar with the actions contemplated by the Fund in connection with the pending issuance and sale of the Common Shares. We also have examined originals or copies, certified or otherwise identified to our satisfaction, of such records of the Fund and such agreements, certificates of public officials, certificates of officers or other representatives of the Fund and others, and such other documents, certificates and records as we have deemed necessary or appropriate as a basis for the opinions set forth herein.
In our examination, we have assumed the legal capacity of all natural persons, the genuineness of all signatures, the authenticity of all documents submitted to us as originals, the conformity to original documents of all documents submitted to us as facsimile, electronic, certified, conformed or photostatic copies and the authenticity of the originals of such copies. In making our examination of documents, we have assumed that the parties thereto, other than the Fund, had or will have the power, corporate or other, to enter into and to perform all obligations thereunder and have also assumed the due authorization by all requisite action, corporate or other, and the due execution and delivery by such parties of such documents and the validity and binding effect thereof on such parties. We also have assumed that the Dealer Manager Agreement will be executed and delivered in substantially the form reviewed by us. As to any facts material to the opinions expressed herein that we did not independently establish or verify, we have relied upon statements and representations of officers and other representatives of the Fund and others.
PIMCO Income Strategy Fund II |
- 2 - | March 12, 2010 |
Based upon the foregoing, we are of the opinion that:
1. | The Fund is a duly organized and validly existing unincorporated voluntary association with transferable shares under and by virtue of the laws of The Commonwealth of Massachusetts. |
2. | The Common Shares have been duly authorized and, when issued and paid for in accordance with the Dealer Manager Agreement, will be validly issued, fully paid and, except as described in the following paragraph, nonassessable by the Fund. |
The Fund is an entity of the type commonly known as a Massachusetts business trust. Under Massachusetts law, shareholders could, under certain circumstances, be held personally liable for the obligations of the Fund. However, the Declaration of Trust disclaims shareholder liability for acts or obligations of the Fund and requires that a notice of such disclaimer be given in each note, bond, contract, instrument, certificate or undertaking entered into or executed by the Fund or its trustees. The Declaration of Trust provides for indemnification out of the property of the Fund for all loss and expense of any shareholder of the Fund held personally liable solely by reason of his being or having been a shareholder. Thus, the risk of a shareholders incurring financial loss on account of being a shareholder is limited to circumstances in which the Fund itself would be unable to meet its obligations.
We understand that this opinion is to be used in connection with the registration of the Common Shares for offering and sale pursuant to the Securities Act of 1933, as amended. We consent to the filing of this opinion with and as part of the Registration Statement and to the references to our firm under the captions Tax matters and Legal matters in the prospectus, and Counsel in the Statement of Additional Information, contained in the Registration Statement.
Very truly yours,
/s/ Ropes & Gray LLP
Ropes & Gray LLP
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in this Registration Statement on Form N-2 (Registration Statement) of our report dated September 25, 2009, relating to the financial statements and financial highlights which appear in the July 31, 2009 Annual Report to Shareholders of PIMCO Floating Rate Income Fund and PIMCO Floating Rate Strategy Fund (now PIMCO Income Strategy Fund and PIMCO Income Strategy Fund II), which is also incorporated by reference into the Registration Statement.
We also consent to the references to us under the headings Dealer Manager Agreement, Financial Highlights, Independent Registered Public Accounting Firm and Financial Statements in such Registration Statement.
PricewaterhouseCoopers LLP
New York, NY
March 12, 2010