As filed with the Securities and Exchange Commission on June 6, 2003
1933 Act File No. 333-
1940 Act File No. 811-21323
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933 |X|
PRE-EFFECTIVE AMENDMENT NO. |_|
POST-EFFECTIVE AMENDMENT NO. |_|
AND/OR
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 4 |X|
(CHECK APPROPRIATE BOX OR BOXES)
EATON VANCE LIMITED DURATION INCOME FUND
----------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
THE EATON VANCE BUILDING, 255 STATE STREET, BOSTON, MASSACHUSETTS 02109
-----------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (617) 482-8260
-----------------------------------------------------------------
ALAN R. DYNNER
THE EATON VANCE BUILDING, 255 STATE STREET, BOSTON, MASSACHUSETTS 02109
-----------------------------------------------------------------------
NAME AND ADDRESS (OF AGENT FOR SERVICE)
COPIES OF COMMUNICATIONS TO:
MARK P. GOSHKO, ESQ. THOMAS A. HALE, ESQ.
KIRKPATRICK & LOCKHART LLP SKADDEN, ARPS, SLATE
75 STATE STREET MEAGHER & FLOM (ILLINOIS)
BOSTON, MASSACHUSETTS 02109 CHICAGO, ILLINOIS 60606
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the effective date of this Registration Statement.
If any of the securities being registered on this form are to 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
===============================================================================
PROPOSED PROPOSED
AMOUNT MAXIMUM MAXIMUM AMOUNT OF
BEING OFFERING AGGREGATE REGISTRATION
TITLE OF SECURITIES BEING REGISTERED PRICE PER OFFERING FEES (1)(2)
REGISTERED (1) UNIT PRICE (1)
(1)
-------------------------------------------------------------------------------
Common Shares of 40 $25,000 $1,000,000 $80.90
Beneficial Interest,
$0.01 par value
===============================================================================
(1)Estimated solely for purposes of calculating the registration fee, pursuant
to Rule 457(o) under the Securities Act of 1933.
(2)Includes Shares that may be offered to the Underwriters pursuant to an
option to cover over-allotments.
------------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATES AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
The information in this Prospectus is incomplete and may be changed. We may not
sell these securities until the registration statement filed with the Securities
and Exchange Commission is effective. This prospectus is not an offer to sell
these securities, and we are not soliciting offers to buy these securities, in
any state where the offer or sale is not permitted.
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION , 2003
--------------------------------------------------------------------------------
$
[EATON VANCE
LOGO]
EATON VANCE LIMITED
DURATION INCOME FUND
________ Shares, Series A
________ Shares, Series B
________ Shares, Series C
________ Shares, Series D
________ Shares, Series E
AUCTION PREFERRED SHARES
LIQUIDATION PREFERENCE $25,000 PER SHARE
--------------------------------------------------------------------------------
INVESTMENT OBJECTIVES AND POLICIES. Eaton Vance Limited Duration Income Fund
(the "Fund") is a newly organized, diversified, closed-end management investment
company. The Fund's investment objective is to provide a high level of current
income. The Fund may, as a secondary objective, also seek capital appreciation
to the extent consistent with its primary goal of high current income.
Under normal market conditions, Eaton Vance Management, the Fund's investment
adviser, expects the Fund to maintain a duration of between two and four years
(including the effect of anticipated leverage). Initially, the Fund is expected
to have a duration of approximately three years (including the effect of
anticipated leverage). Under normal market conditions, the Fund expects to
maintain a weighted average portfolio credit quality of investment grade (which
is at least BBB- as determined by Standard & Poor's Ratings Group ("S&P") or
Fitch Ratings ("Fitch"), Baa3 as determined by Moody's Investors Service, Inc.
("Moody's") or, if unrated, determined to be of comparable quality by Eaton
Vance Management).
INVESTMENT ADVISER. The Fund's investment adviser is Eaton Vance Management
("Eaton Vance" or the "Adviser"). As of May 31, 2003, Eaton Vance and its
subsidiaries managed approximately $62 billion on behalf of funds, institutional
clients and individuals.
PORTFOLIO CONTENTS. The Fund pursues its objectives by investing its assets
primarily in three distinct investment categories: 1) mortgage-backed securities
that are issued, backed or otherwise guaranteed by the U.S. Government or its
agencies or instrumentalities or that are issued by private issuers ("MBS"); 2)
senior, secured floating rate loans made to corporate and other business
entities ("Senior Loans"); and 3) corporate bonds that are of below "investment
grade" quality ("Non-Investment Grade Bonds"). Non-Investment Grade Bonds,
commonly referred to as "junk bonds," are bonds that are rated below investment
grade by each of the national rating agencies who cover the security, or, if
unrated, are determined to be of comparable quality by the Adviser. S&P and
Fitch consider securities rated below BBB-- to be below investment grade and
Moody's considers securities rated below Baa3 to be below investment grade.
Senior Loans in which the Fund invests are also typically of below investment
grade quality. There is no limitation on the percentage of the Fund's assets
that may be allocated to each of these investment categories; provided that,
under normal market conditions, the Fund will invest at least 25% of its total
assets in each category. (continued on inside cover page)
INVESTING IN APS INVOLVES CERTAIN RISKS, INCLUDING THAT THE FUND MAY INVEST
SUBSTANTIAL PORTIONS OF ITS ASSETS IN BELOW INVESTMENT GRADE QUALITY SECURITIES
WITH SPECULATIVE CHARACTERISTICS. SEE "INVESTMENT OBJECTIVES, POLICIES AND
RISKS--RISK CONSIDERATIONS."
NEITHER THE SECURITIES AND EXCHANGE COMMISSION ("SEC") NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
ESTIMATED
PUBLIC OFFERING OFFERING PROCEEDS TO
PRICE SALES LOAD(1) EXPENSES FUND
--------------- ------------- ----------- -----------
$ $ $ $
------------- ---------- ----------- ----------
(1) The Fund and Adviser have agreed to indemnify the Underwriters against
certain liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
The Underwriters are offering the Auction Preferred Shares subject to
various conditions. The Underwriters expect to deliver the APS in
book-entry form, through the facilities of The Depository Trust Company to
purchasers on or about [ ], 2003.
UBS WARBURG
--------------------------------------------------------------------------------
(CONTINUED FROM THE PREVIOUS PAGE)
Capitalized terms not otherwise defined are defined in the Glossary that appears
at the end of this Prospectus. The APS are offered at a price per share of
$25,000 subject to a sales load of $ per share.
Dividends on the APS of the Fund offered hereby will be cumulative from the Date
of Original Issue and payable commencing on the dates specified below (an
"Initial Dividend Payment Date") and, generally, on a weekly basis thereafter on
the days specified below, subject to certain exceptions. The cash dividend rate
(the "Applicable Rate") on the APS for the Initial Dividend Period on such dates
will be the per annum rate specified below:
INITIAL DIVIDEND NORMAL WEEKLY INITIAL
PAYMENT DATE PAYMENT DAY APPLICABLE RATE
------------ ----------- ---------------
Series A %
Series B[(1)] %
Series C %
Series D %
Series E %
[(1) The Initial Dividend Period for Series B of the Fund will be a Dividend
Period of 360 days ending [ ], 2004. The Fund will pay the Series B
accumulated dividends on the first Business Day of each month and the final
dividend payment will be made on [ ], 2004.]
The APS will not be registered on any stock exchange or on any automated
quotation system. APS may only be bought or sold through an order at an auction
with or through a broker-dealer that has entered into an agreement with the
auction agent of the Fund, or in a secondary market that may be maintained by
certain broker-dealers. These broker-dealers are not required to maintain this
market and it may not provide you with liquidity. An increase in the level of
interest rates, particularly during any Special Dividend Period that is a Long
Term Dividend Period as discussed in "Description of APS--Dividends and dividend
periods--General," likely will have an adverse effect on thE secondary market
price of the APS, and a selling shareholder may sell APS between Auctions at a
price per share of less than $25,000.
Each prospective purchaser should review carefully the detailed information
regarding the Auction Procedures which appears in this Prospectus and the Fund's
Statement of Additional Information and should note that (i) an Order
constitutes an irrevocable commitment to hold, purchase or sell APS based upon
the results of the related Auction, (ii) the Auctions will be conducted through
telephone communications, (iii) settlement for purchases and sales will be on
the Business Day following the Auction and (iv) ownership of APS will be
maintained in book-entry form by or through the Securities Depository. In
certain circumstances, holders of APS may be unable to sell their APS in an
Auction and thus may lack liquidity of investment. The APS may only be
transferred pursuant to a Bid or a Sell Order placed in an Auction through a
Broker-Dealer to the Auction Agent or in the secondary market, if any.
This Prospectus sets forth concisely information you should know before
investing in the APS. Please read and retain this Prospectus for future
reference. A Statement of Additional Information for the Fund dated [ ], 2003
has been filed with the SEC and can be obtained without charge by calling
1-800-225-6265 or by writing to the Fund. The table of contents to the Statement
of Additional Information is located at pages through of this Prospectus. This
Prospectus incorporates by reference the entire Statement of Additional
Information of the Fund. The Statement of Additional Information is available
along with other Fund-related materials at the SEC's internet web site
(http://www.sec.gov). The Fund's address is The Eaton Vance Building, 255 State
Street, Boston, Massachusetts 02109 and its telephone number is 1-800-225-6265.
The APS 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.
You should rely only on the information contained or incorporated by reference
in this Prospectus. The Funds has not authorized any other person to provide you
with different information. The Fund is not making an offer of these securities
in any state where the offer is not permitted. You should not assume that the
information appearing in this Prospectus is accurate as of any date other than
the date on the front of this Prospectus.
2
TABLE OF CONTENTS
--------------------------------------------------------------------------------
Prospectus summary......................... Shareholder Servicing Agent, custodian and
Financial highlights....................... transfer agent..............................
The Fund................................... Legal opinions.................................
Use of proceeds............................ Independent auditors...........................
Capitalization............................. Additional information.........................
Portfolio composition...................... Table of contents for the Statement of Additional Information
Investment objectives, policies and risks..
Management of the Fund..................... The Fund's privacy policy......................
Description of APS......................... Glossary.......................................
The Auctions...............................
Taxes......................................
Description of capital structure...........
Certain provisions of the Declaration of
Trust Underwriting.......................
3
Prospectus summary
THIS IS ONLY A SUMMARY. YOU SHOULD REVIEW THE MORE DETAILED INFORMATION
CONTAINED IN THIS PROSPECTUS AND IN THE FUND'S STATEMENT OF ADDITIONAL
INFORMATION.
THE FUND
Eaton Vance Limited Duration Income Fund (the "Fund") is a recently organized,
diversified, closed-end management investment company. The Fund was organized as
a Massachusetts business trust on March 12, 2003. The Fund has registered under
the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's
principal office is located at The Eaton Vance Building, 255 State Street,
Boston, Massachusetts 02109, and its telephone number is 1-800-225-6265. The
Fund commenced operations on May 30, 2003 upon the closing of an initial public
offering of its common shares of beneficial interest, par value $0.01 per share
("Common Shares"). The Common Shares of the Fund are traded on the American
Stock Exchange ("AMEX") under the symbol "EVV." In connection with the initial
public offering of the Fund's Common Shares, the underwriters were granted an
option to purchase additional shares to cover over-allotments.
Certain of the capitalized terms used in this Prospectus are defined in the
Glossary that appears at the end of this Prospectus.
THE OFFERING
The Fund is offering, pursuant to this Prospectus, preferred shares of
beneficial interest, par value $0.01 per share, which have been designated
Auction Preferred Shares, Series A, Series B, Series C, Series D and Series E
(collectively, the "APS"). See "The Fund." Issuance of the APS represents the
leveraging financing contemplated in connection with the offering of the Common
Shares of the Fund.
The Fund is offering an aggregate of the following number of APS of each Series
at a purchase price of $25,000 per share plus accumulated dividends, if any,
from the Date of Original Issue:
Series A--....
Series B--....
Series C--....
Series D--....
Series E--....
The APS are being offered through [UBS Warburg LLC, , ,
, ] (collectively, the "Underwriters"). See "Underwriting".
INVESTMENT OBJECTIVES AND POLICIES
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its investment objective of high current income. The Fund
pursues its objectives by investing its assets primarily in three distinct
investment categories: 1) mortgage-backed securities that are issued, backed or
otherwise guaranteed by the U.S. Government or its agencies or instrumentalities
or that are issued by private issuers ("MBS"); 2) senior, secured floating rate
loans made to corporate and other business entities ("Senior Loans"); and 3)
corporate bonds of below "investment grade" quality ("Non-Investment Grade
Bonds"). Non-Investment Grade Bonds, commonly referred to as "junk bonds," are
bonds that are rated below investment grade by each of the national rating
agencies who cover the security, or, if unrated, are determined to be of
comparable quality by the Adviser. Standard & Poor's Ratings Group ("S&P") and
Fitch Ratings ("Fitch") consider securities rated below BBB-- to be below
investment grade and Moody's Investors Service, Inc. ("Moody's") considers
securities rated below Baa3 to be below investment grade. Senior Loans in which
the Fund invests are also typically of below investment grade quality. The
Adviser has broad discretion to allocate the Fund's assets among the three
principal asset classes; provided that, under normal market conditions, the Fund
will invest at least 25% of its assets in each principal investment category.
4
Under normal market conditions, the Adviser expects to maintain a duration of
between two and four years (including the effect of anticipated leverage).
Initially, the Fund is expected to have a duration of approximately three years
(including the effect of anticipated leverage). This duration policy may only be
changed following provision of 60 days' prior notice to shareholders. In
comparison to maturity (which is the date on which a debt instrument ceases and
the issuer is obligated to repay the principal amount), duration is a measure of
the price volatility of a debt instrument as a result of changes in market rates
of interest, based on the weighted average timing of the instrument's expected
principal and interest payments. Duration differs from maturity in that it
considers a security's yield, coupon payments, principal payments and call
features in addition to the amount of time until the security finally matures.
As the value of a security changes over time, so will its duration. Prices of
securities with longer durations tend to be more sensitive to interest rate
changes than securities with shorter durations. In general, a portfolio of
securities with a longer duration can be expected to be more sensitive to
interest rate changes than a portfolio with a shorter duration.
A team of Eaton Vance investment professionals is responsible for the overall
management of the Fund's investments as well as allocations among the Fund's
three principal investment categories. Individual members of this team with
specialized experience are responsible for the day-to-day portfolio management
within each of the Fund's three main asset classes. The Fund's investments are
actively managed, and securities may be bought or sold on a daily basis. The
Adviser attempts to manage yield through timely trading.
The Adviser's staff monitors the credit quality and price of securities held by
the Fund, as well as other securities that are available to the Fund. Under
normal market conditions, the Fund expects to maintain a weighted average
portfolio credit quality of investment grade (which is at least BBB-- as
determined by S&P or Fitch, Baa3 as determined by Moody's or, if unrated,
determined to be of comparable quality by the Adviser). For this purpose, when a
security is rated by more than one of these rating agencies, the Adviser
generally will use the highest rating. Within this general guideline, the Fund
may invest in individual securities of any credit quality. Although the Adviser
considers ratings when making investment decisions, it performs its own credit
and investment analysis and does not rely primarily on the ratings assigned by
the rating services. In evaluating the quality of a particular security, whether
rated or unrated, the Adviser will normally take into consideration, among other
things, the issuer's financial resources and operating history, its sensitivity
to economic conditions and trends, the ability of its management, its debt
maturity schedules and borrowing requirements, and relative values based on
anticipated cash flow, interest and asset coverage, and earnings prospects. The
Adviser will attempt to reduce the risks of investing in lower rated or unrated
debt instruments through active portfolio management, credit analysis and
attention to current developments and trends in the economy and the financial
markets. When purchasing and selling MBS, the Adviser focuses on the expected
principal payments on an MBS as well as current and anticipated market
conditions.
The Fund will only invest in U.S. dollar denominated securities. The Fund may
invest up to 5% of its assets in U.S. dollar denominated securities of
non-United States issuers. The Fund's investments may have significant exposure
to certain sectors of the economy and thus may react differently to political or
economic developments than the market as a whole.
The Fund may purchase or sell derivative instruments (which derive their value
from another instrument, security or index) only for risk management purposes,
such as hedging against fluctuations in securities prices or interest rates;
diversification purposes; or changing the duration of the Fund. Transactions in
derivative instruments may include the purchase or sale of futures contracts on
securities, indices and other financial instruments, credit-linked notes,
tranches of collateralized loan obligations, options on futures contracts, and
exchange-traded and over-the-counter options on securities or indices, and
interest rate, total return and credit default swaps. Guidelines of any rating
organization that rates any Preferred Shares issued by the Fund may limit the
Fund's ability to engage in such transactions.
INVESTMENT ADVISER AND ADMINISTRATOR
Eaton Vance, an indirect wholly-owned subsidiary of Eaton Vance Corp., is the
Fund's investment adviser and administrator. See "Management of the Funds." As
of May 31, 2003, Eaton and its subsidiaries managed approximately $62 billion on
behalf of funds, institutional clients and individuals.
RISK FACTORS SUMMARY
Risk is inherent in all investing. Therefore, before investing in the Fund you
should consider certain risks carefully. The primary risks of investing in APS
are:
+ If an auction fails you may not be able to sell some or all of your APS;
+ Because of the nature of the market for APS, you may receive less than the
price you paid for your shares if you sell them outside of the auction,
especially when market interest rates are rising;
5
+ A rating agency could downgrade APS, which could affect liquidity;
+ The Fund may be forced to redeem your APS to meet regulatory or rating agency
requirements or may elect to redeem your APS in certain circumstances;
+ In extraordinary circumstances, the Fund may not earn sufficient income from
its investments to pay dividends;
+ If long-term interest rates rise, the value of the Fund's investment
portfolio will decline, reducing the asset coverage for its APS;
+ If an issuer of an obligation in which the Fund invests is downgraded or
defaults, there may be a negative impact on the income and/or asset value of
the Fund's portfolio; and
+ The Fund's investments in Non-Investment Grade Bonds are predominantly
speculative because of the credit risk of their issuers. While offering a
greater potential opportunity for capital appreciation and higher yields,
Non-Investment Grade Bonds typically entail greater potential price volatility
and may be less liquid than higher-rated securities. Issuers of Non-Investment
Grade Bonds are more likely to default on their payments of interest and
principal owed to the Fund, and such defaults will reduce the Fund's net asset
value and income distributions. The prices of these lower rated obligations
are more sensitive to negative developments than higher rated securities.
Adverse business conditions, such as a decline in the issuer's revenues or an
economic downturn, generally lead to a higher non-payment rate. In addition, a
security may lose significant value before a default occurs as the market
adjusts to expected higher non-payment rates.
For additional general risks of investing in APS of the Funds, see "Investment
objectives, policies and risks--Risk considerations."
TRADING MARKET
APS are not listed on an exchange. Instead, you may buy or sell APS at an
auction that normally is held weekly by submitting orders to a broker-dealer
that has entered into an agreement with the auction agent and the Fund (a
"Broker-Dealer"), or to a broker-dealer that has entered into a separate
agreement with a Broker-Dealer. In addition to the auctions, Broker-Dealers and
other broker-dealers may maintain a secondary trading market in APS outside of
auctions, but may discontinue this activity at any time. There is no assurance
that a secondary market will develop, or it does develop, that it will provide
shareholders with liquidity. You may transfer APS outside of auctions only to or
through a Broker-Dealer, or a broker-dealer that has entered into a separate
agreement with a Broker-Dealer.
The table below shows the first auction date for each series of APS of the Fund
and the day on which each subsequent auction will normally be held for each such
series. The first auction date for each series of APS of the Fund will be the
Business Day before the dividend payment date for the initial dividend period
for each such series. The start date for subsequent dividend periods normally
will be the Business Day following the auction date unless the then-current
dividend period is a Special Dividend Period, or the day that normally would be
the auction date or the first day of the subsequent dividend period is not a
Business Day.
6
FIRST AUCTION DATE SUBSEQUENT AUCTION(1)
--------------------------------------------------------------------------------
Series A...................
Series B...................
Series C ..................
Series D...................
Series E...................
----------
[(1) All dates are 2003 except for Series B of the Fund which will have an
Initial Dividend Period of 360 days ending [ ], 2004. The Fund will pay the
Series B accumulated dividends on the first Business Day of each month, and
the final dividend payment will be made on [ ], 2004.]
DIVIDENDS AND DIVIDEND PERIODS
The table on the next page shows the dividend rate for the initial dividend
period of the APS offered in this Prospectus. For subsequent dividend periods,
APS shares will pay dividends based on a rate set at auctions, normally held
weekly. In most instances dividends are also paid weekly, on the day following
the end of the dividend period. The rate set at auction will not exceed the
Maximum Rate. See "The Auction--Auction procedures."
Finally the table below shows the numbers of days of the initial dividend period
for the APS. Subsequent dividend periods generally will be 7 days. The dividend
payment date for Special Dividend Periods of more than 28 days will be set out
in the notice designating a Special Dividend Period. See "Description of
APS--Dividends and dividend periods."
DIVIDEND
PAYMENT NUMBER OF
DATE OF DATE FOR DAYS OF
INITIAL ACCUMULATION INITIAL SUBSEQUENT INITIAL
DIVIDEND OF INITIAL DIVIDEND DIVIDEND DIVIDEND
RATE RATE(1) PERIOD(1) PAYMENT DATE PERIOD
-------- ------------ --------- ------------ --------
Series A.................... %
Series B.................... %
Series C.................... %
Series D.................... %
Series E.................... %
----------
[(1) All dates are 2003 except for Series B of the Fund which will have an
Initial Dividend Period of 360 days ending [ ], 2004. The Fund will pay the
Series B accumulated dividends on the first Business Day of each month, and
the final dividend payment will be made on [ ], 2004.]
TAXATION
Dividends paid with respect to APS should constitute dividends for federal
income tax purposes to the extent attributable to the Fund's current or
accumulated earnings and profits. These dividends generally will be taxable as
[ordinary income to holders.] Corporate holders of the APS generally will not be
entitled to the dividends received deduction for these dividends. Distributions
of net capital gain, to the extent so designated, will be treated as long-term
capital gains.
REDEMPTION
Although the Fund will not ordinarily redeem APS, it may be required to redeem
APS if, for example, the Fund does not meet an asset coverage ratio required by
law or in order to correct a failure to meet a rating agency guideline in a
timely manner. See "Description of APS--Redemption--Mandatory redemption." The
Fund voluntarily may redeem APS in certain circumstances. See "Description of
APS--Redemption--Optional redemption."
7
LIQUIDATION PREFERENCE
The liquidation preference of the APS of each series is $25,000 per share, plus
an amount equal to accumulated but unpaid dividends (whether or not earned or
declared). See "Description of APS--Liquidation rights."
RATING
Shares of APS of the Fund will be issued with a credit quality rating of AAA
from both [ ] and [ ]. The Fund may at some future time look to have its APS
rated by additional or substitute rating agencies. Because the Fund is required
to maintain at least [two] rating, it must own portfolio securities of
sufficient value with adequate credit quality to meet the rating agency's
guidelines. See "Description of APS--Rating agency guidelines and asset
coverage."
VOTING RIGHTS
The 1940 Act requires that the holders of APS and any other Preferred Shares of
the Fund, voting as a separate class, have the right to elect at least two
Trustees of the Fund at all times and to elect a majority of the Trustees at any
time when two years' dividends on the APS or any other Preferred Shares are
unpaid. The holders of APS and any other Preferred Shares of the Fund will vote
as a separate class on certain other matters as required under the Fund's
Agreement and Declaration of Trust ("Declaration of Trust") and the 1940 Act.
See "Description of APS--Voting rights" and "Certain provisions of the
Declarations of Trust."
8
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
Information contained in the tables below under the headings "Income (loss) from
operations" and "Ratios/Supplemental data" shows the unaudited operating
performance of the Fund from the commencement of the Fund's investment
operations on May 30, 2003 until [June 30], 2003. Since the Fund commenced
operations on May 30, 2003, the tables cover approximately five weeks of
operations, during which a substantial portion of the Fund's assets were
invested in high-quality, short-term debt securities. Accordingly, the
information presented may not provide a meaningful picture of the Fund's
operating performance.
FINANCIAL STATEMENTS (UNAUDITED)
FINANCIAL HIGHLIGHTS
AS OF [JUNE 30], 2003
PERIOD ENDED
[JUNE 30], 2003(1)(2)
---------------------
Net asset value-- Beginning of period(3)................ $
INCOME (LOSS) FROM OPERATIONS
Net investment income................................... $
Net realized and unrealized gain........................ ___
Total income from operations............................ $
Common share offering costs............................. $( )
Net asset value-- End of period......................... $
Market value-- End of period............................ $
Total Investment Return on Net Asset Value(4)........... %
Total Investment Return on Market Value(4).............. %
RATIOS/SUPPLEMENTAL DATA+
Net assets, end of period (000's omitted)............... $
Ratios (As a percentage of average daily net assets):
Net expenses.......................................... %(5)
Net investment income................................. %(5)
Portfolio Turnover...................................... %
--------------------------------------------------------------------------------
+ The operating expenses of the Fund reflect a reduction of the investment
adviser fee and a reimbursement of expenses by the Adviser. Had such action
not been taken, the ratios and net investment income per share would have
been as follows:
Ratios (As a percentage of average daily net assets):
Expenses................... %(5)
Net investment income...... (5)
Net investment income per share $
--------------------------------------------------------------------------------
9
(1) For the period from the start of business, May 30, 2003, to [June 30],
2003.
(2) Computed using average common shares outstanding.
(3) Net asset value at beginning of period reflects the deduction of the sales
load of $0.90 per share paid by the shareholder from the $20.000 offering
price.
(4) Total investment return on net asset value is calculated assuming a
purchase at the offering price of $20.000 less the sales load of $0.90 per
share paid by the shareholder on the first day and a sale at the net asset
value on the last day of the period reported. Total investment return on
market value is calculated assuming a purchase at the offering price of
$20.000 less the sales load of $0.90 per share paid by the shareholder on
the first day and a sale at the current market price on the last day of the
period reported. Total investment return on net asset value and total
investment return on market value are not computed on an annualized basis.
(5) Annualized.
10
--------------------------------------------------------------------------------
THE FUND
Eaton Vance Limited Duration Income Fund (the " Fund") is a diversified,
closed-end management investment company. The Fund was organized as a
Massachusetts business trust on March 12, 2003. The Fund has registered under
the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's
principal office is The Eaton Vance Building, 255 State Street, Boston,
Massachusetts 02109, and its telephone number is 1-800-225-6265.
The Fund commenced operations on May 30, 2003 upon the closing of an initial
public offering of shares of its common shares of beneficial interest, $0.01 par
value (the "Common Shares"). The proceeds of such offering was $1,927,900,000
after the payment of offering expenses. In connection with the initial public
offering of the Fund's Common Shares, the underwriters were granted an option to
purchase, at a price of $20.00 per Common Share, the 13,000,000 additional
Common Shares to cover over-allotments. On [ ], 2003, the underwriters
[partially] exercised the over-allotment with respect to the Fund and purchased
the following [ ] Common Shares. [Additionally, on [ ], 2003, the underwriters
again partially exercised the over-allotment with respect to the Fund and
purchased [ ] Common Shares.
Certain of the capitalized terms used in this Prospectus are defined in the
Glossary that appears at the end of this Prospectus.
11
--------------------------------------------------------------------------------
USE OF PROCEEDS
The net proceeds of this offering will be approximately $[ ] after the
payment of the sales load and expected offering costs. See "Underwriting." The
Fund will invest the net proceeds of the offering in accordance with its
investment objective and policies stated below. It is presently anticipated that
the Fund will be able to invest substantially all of the net proceeds in
obligations that meet those investment objectives and policies during a period
estimated not to exceed three months from the completion of the offering of the
APS depending on market conditions and the availability of appropriate
securities. Pending such investment, the proceeds may be invested in high
quality, short-term debt securities.
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund as of
June [30], 2003 as if the Common Shares of the Fund purchased by the
Underwriters pursuant to their overallotment option ("Overallotment Common
Shares") had been issued on that date and as adjusted to give effect to the
issuance of the APS offered hereby.
ACTUAL AS ADJUSTED
-------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
Preferred shares, par value, $0.01 per share (no shares
issued; [ ], as adjusted, at $25,000 per share
liquidation preference)................................. $ -- $
=========== ===========
SHAREHOLDERS' EQUITY:
Common Shares, par value, $0.01 per share ([ ] shares $ $
issued and outstanding).................................
Capital in excess of par value attributable to Common
Shares..................................................
Net undistributed investment income.......................
Net accumulated realized gain (loss)......................
Net unrealized appreciation on investments................
----------- -----------
Net Assets................................................ $ $
=========== ===========
PORTFOLIO COMPOSITION
As of [ ], 2003, the following table indicates the approximate percentage
of the Fund's portfolio invested in long-term and short-term obligations. Also
included in these tables is other information with respect to the composition of
the Fund's investment portfolio as of the same date.
([ ]% long-term; [ ]% short-term)
NUMBER OF
S&P(1) MOODY'S(1) (FITCH(1) ISSUES VALUE PERCENT
------ ---------- --------- ------ ----- -------
AAA Aaa AAA $ %
AA Aa AA %
A A A %
BBB Baa BBB %
BB Ba BB %
B B B %
Cash........................ %
-- -------- -%
Total....................... $ 100.0%
======== ======
----------
(1) Ratings: Using the higher of S&P's, Moody's or Fitch's ratings on the
Fund's investments. S&P and Fitch rating categories may be modified further
by a plus (+) or minus (--) in AA, A, BBB, BB and B ratings. Moody's rating
categories may be modified further by a 1, 2 or 3 in Aa, A, Baa, Ba and B
ratings.
12
--------------------------------------------------------------------------------
INVESTMENT OBJECTIVES, POLICIES AND RISKS
INVESTMENT OBJECTIVES
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its investment objective of high current income. The Fund
pursues its objectives by investing its assets primarily in three distinct
investment categories: 1) mortgage backed securities that are issued, backed or
otherwise guaranteed by the U.S. Government or its agencies or instrumentalities
or that are issued by private issuers ("MBS"); 2) senior, secured floating rate
loans made to corporate and other business entities ("Senior Loans"); and 3)
corporate bonds of below "investment grade" quality ("Non-Investment Grade
Bonds"). Non-Investment Grade Bonds, commonly referred to as "junk bonds," are
bonds that are rated below investment grade by each of the national rating
agencies who cover the security, or, if unrated, are determined to be of
comparable quality by the Adviser. Standard & Poor's Ratings Group ("S&P") and
Fitch Ratings ("Fitch") consider securities rated below BBB-- to be below
investment grade and Moody's Investors Service, Inc. ("Moody's") considers
securities rated below Baa3 to be below investment grade. Senior Loans in which
the Fund invests are also typically of below investment grade quality. The
Adviser has broad discretion to allocate the Fund's assets among the three
principal asset classes; provided that, under normal market conditions, the Fund
will invest at least 25% of its assets in each principal investment category.
PRIMARY INVESTMENT POLICIES
GENERAL COMPOSITION OF THE FUND
A team of Eaton Vance investment professionals is responsible for the overall
management of the Fund's investments as well as allocations among the Fund's
three principal investment categories. Individual members of this team with
specialized expertise are responsible for the day-to-day portfolio management
within each of the Fund's three main asset classes. The Fund's investments are
actively managed, and securities may be bought or sold on a daily basis. The
Adviser attempts to manage yield through timely trading.
Under normal market conditions, the Adviser expects to maintain a duration of
between two and four years (including the effect of anticipated leverage).
Initially, the Fund is expected to have a duration of approximately three years
(including the effect of anticipated leverage). This duration policy may only be
changed following provision of 60 days' prior notice to shareholders. In
comparison to maturity (which is the date on which a debt instrument ceases and
the issuer is obligated to repay the principal amount), duration is a measure of
the price volatility of a debt instrument as a result in changes in market rates
of interest, based on the weighted average timing of the instrument's expected
principal and interest payments. Duration differs from maturity in that it
considers a security's yield, coupon payments, principal payments and call
features in addition to the amount of time until the security finally matures.
As the value of a security changes over time, so will its duration. Prices of
securities with longer durations tend to be more sensitive to interest rate
changes than securities with shorter durations. In general, a portfolio of
securities with a longer duration can be expected to be more sensitive to
interest rate changes than a portfolio with a shorter duration.
The Adviser's staff monitors the credit quality and the price of securities held
by the Fund, as well as other securities that are available to the Fund. Under
normal market conditions, the Fund will invest at least 25% of its portfolio in
MBS that are expected to be of the highest quality (generally AAA as determined
by S&P or Fitch, Aaa as determined by Moody's, or, if unrated determined to be
of comparable quality by the Adviser) and at least 25% of its portfolio in each
of Non-Investment Grade Bonds and Senior Loans (many of which are of below
investment grade quality). Under normal market conditions, the Fund will
structure and seek to maintain its portfolio of high quality MBS and lower
quality Non-Investment Grade Bond and Senior Loans in such a manner so that the
Fund has an average dollar weighted portfolio quality of investment grade (which
is BBB- as determined by S&P or Fitch, Baa as determined by Moody's, or, if
unrated determined to be of comparable quality by the Adviser). Within this
general guideline, the Fund may invest in securities of any credit quality. In
order to maintain compliance with this policy, the Fund's holdings of
Non-Investment Grade Bonds and Senior Loans of below investment grade quality
generally will be offset by investments in MBS of the highest quality. The
extremely high credit quality of the MBS will substantially raise the average
portfolio credit quality on a dollar-weighted basis. In addition, to the extent
necessary to maintain compliance with this weighted average portfolio credit
policy, the Fund will focus its investments in Non-Investment Grade Bonds and
Senior Loans on such issues that are rated in the higher tiers of the
non-investment grade range (including in the category just below investment
grade, which is in the BB range as determined by S&P or Fitch, Ba as determined
by Moody's, or if unrated determined to be of comparable quality by the
Adviser). Finally, although the Fund may invest in securities of any quality, to
the extent necessary to comply with its weighted average portfolio credit
13
policy, the Fund will avoid investing significant portions of its assets in the
lower tiers of the non-investment grade category. For purposes of the Fund's
policy on credit quality, when a security is rated by more than one of these
rating agencies, the Adviser generally will use the highest rating. The Fund
will monitor and adjust its portfolio on an ongoing basis in order to remain in
compliance with this credit quality policy.
A "barbell" portfolio such as the Fund that achieves a weighted average
investment grade credit quality by investing substantially in below investment
grade securities and very high quality securities involves certain risk
characteristics that differ from fixed income securities with credit ratings
equivalent to the portfolio average or from a portfolio of similar average
quality consisting mostly of securities of a quality near this average. Most
notably, the Fund's portfolio will contain a higher percentage of assets of
lower quality that each individually involve a higher degree of credit risk and
may be considered to be speculative in nature. For a description of these risk
characteristics, see "Investment objectives, policies and risks - "Primary
Investment Policies - Non-Investment Grade Bonds."
Although the Adviser considers ratings when making investment decisions, it
performs its own credit and investment analysis and does not rely primarily on
the ratings assigned by the rating services. In evaluating the quality of a
particular security, whether rated or unrated, the Adviser will normally take
into consideration, among other things, the issuer's financial resources and
operating history, its sensitivity to economic conditions and trends, the
ability of its management, its debt maturity schedules and borrowing
requirements, and relative values based on anticipated cash flow, interest and
asset coverage, and earnings prospects. The Adviser will attempt to reduce the
risks of investing in lower rated or unrated debt instruments through active
portfolio management, credit analysis and attention to current developments and
trends in the economy and the financial markets. When purchasing and selling
MBS, the Adviser focuses on the expected principal payments on an MBS as well as
current and anticipated market conditions.
Subject to its obligation on a portfolio wide basis to remain in ongoing
compliance with the weighted average portfolio credit policy discussed above,
the Fund is not required to dispose of a security in the event that a Rating
Agency downgrades its assessment of the credit characteristics of a particular
issue or withdraws its assessment. In determining whether to retain or sell such
a security, Eaton Vance may consider such factors as Eaton Vance's assessment of
the credit quality of the issuers 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.
The Fund will only invest in U.S. dollar denominated securities. The Fund may
invest up to 5% of its assets in U.S. dollar denominated securities of
non-United States issuers. The Fund's investments may have significant exposure
to certain sectors of the economy and thus may react differently to political or
economic developments than the market as a whole.
MORTGAGE-BACKED SECURITIES
The Fund invests only in MBS that are backed by a guarantee of the U.S.
Government (or one of its agencies or instrumentalities), although certain of
these instruments may be privately issued. MBS represent participation interests
in pools of fixed-rate and adjustable-rate mortgage loans. Unlike conventional
debt obligations, MBS provide monthly payments derived from the monthly interest
and principal payments (including any prepayments) made by the individual
borrowers on the pooled mortgage loans. The Adviser currently expects to invest
primarily in MBS that include mortgage loans that have had a history of
refinancing opportunities (so called "seasoned MBS"). The Adviser, typically,
considers MBS with mortgages which have been outstanding for ten years or more
to be seasoned MBS. Seasoned MBS tend to have a higher collateral to debt ratio
than other MBS because a greater percentage of the underlying debt has been
repaid and the collateral property may have appreciated in value. The Adviser
may discontinue the practice of focusing on seasoned MBS at any time. The
Adviser expects that under current market conditions many of the MBS held by the
Fund will be premium bonds acquired at prices that exceed their par or principal
value.
The mortgage loans underlying MBS are generally subject to a greater rate of
principal prepayments in a declining interest rate environment and to a lesser
rate of principal prepayments in an increasing interest rate environment,
although the Fund's investment in seasoned MBS mitigates this risk. Under
certain interest and prepayment rate scenarios, the Fund may fail to recover the
full amount of its investment in MBS, notwithstanding any direct or indirect
governmental or agency guarantee. Because faster than expected prepayments must
usually be invested in lower yielding securities, MBS are less effective than
conventional bonds in "locking in" a specified interest rate. Additionally, the
value of Fund Shares may be adversely affected by fluctuations in interest rates
underlying the MBS held by the Fund. In a rising interest rate environment, a
declining prepayment rate will extend the average life of many MBS, which in
turn would lengthen the duration of the Fund's portfolio. This possibility is
often referred to as extension risk. Extending the average life of a
mortgage-backed security increases the risk of depreciation due to future
increases in market interest rates, although investing in seasoned MBS helps
mitigate this extension risk. MBS that are purchased at a premium generate
current income that exceeds market rates for comparable investments but tend to
decrease in value as they mature, which may cause a resulting decrease in the
Fund's net asset value.
14
The Fund may also invest in classes of collateralized mortgage obligations
("CMOs") and various other MBS. In choosing among CMO classes, the Adviser will
evaluate the total income potential of each class and other factors. See
"Additional investment practices--Securitized interests."
Certain government agencies or instrumentalities, such as GNMA, FNMA and FHLMC
provide a guarantee as to timely payment of principal and interest for MBS each
entity issues but may or may not be backed by the full faith and credit of the
U.S. Government.
SENIOR LOANS
Senior Loans hold the most senior position in the capital structure of a
business entity (the "Borrower"), are typically secured with specific collateral
and have a claim on the assets and/or stock of the Borrower that is senior to
that held by subordinated debt holders and stockholders of the Borrower. The
proceeds of Senior Loans primarily are used to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases, refinancings and to
finance internal growth and for other corporate purposes. Senior Loans typically
have rates of interest which are redetermined either daily, monthly, quarterly
or semi-annually by reference to a base lending rate, plus a premium or credit
spread. These base lending rates are primarily the London-Interbank Offered Rate
("LIBOR"), and secondarily the prime rate offered by one or more major United
States banks (the "Prime Rate") and the certificate of deposit ("CD") rate or
other base lending rates used by commercial lenders. The Senior Loans held by
the Fund will have a dollar-weighted average period until the next interest rate
adjustment of approximately 90 days or less. In the experience of the Adviser
over the last decade, because of prepayments the average life of Senior Loans
has been two to four years.
The Fund may also purchase unsecured loans, other floating rate debt securities
such as notes, bonds and asset-backed securities (such as special purpose trusts
investing in bank loans), credit-linked notes, tranches of collateralized loan
obligations, investment grade fixed income debt obligations and money market
instruments, such as commercial paper.
Senior Loans and other floating-rate debt instruments are subject to the risk of
non-payment of scheduled interest or principal. Such non-payment would result in
a reduction of income to the Fund, a reduction in the value of the investment
and a potential decrease in the net asset value of the Fund. There can be no
assurance that the liquidation of any collateral securing a loan would satisfy
the Borrower's obligation in the event of non-payment of scheduled interest or
principal payments, or that such collateral could be readily liquidated. In the
event of bankruptcy of a Borrower, the Fund could experience delays or
limitations with respect to its ability to realize the benefits of the
collateral securing a Senior Loan. The collateral securing a Senior Loan may
lose all or substantially all of its value in the event of bankruptcy of a
Borrower. Some Senior Loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate such Senior Loans
to presently existing or future indebtedness of the Borrower or take other
action detrimental to the holders of Senior Loans including, in certain
circumstances, invalidating such Senior Loans or causing interest previously
paid to be refunded to the Borrower. If interest were required to be refunded,
it could negatively affect the Fund's performance.
Many Senior Loans in which the Fund will invest may not be rated by a Rating
Agency, will not be registered with the Securities and Exchange Commission or
any state securities commission and will not be listed on any national
securities exchange. The amount of public information available with respect to
Senior Loans will generally be less extensive than that available for registered
or exchange listed securities. In evaluating the creditworthiness of Borrowers,
the Adviser will consider, and may rely in part, on analyses performed by
others. Borrowers may have outstanding debt obligations that are rated below
investment grade by a Rating Agency. Many of the Senior Loans in the Fund have
been assigned ratings below investment grade by independent rating agencies. In
the event Senior Loans are not rated, they are likely to be the equivalent of
below investment grade quality. Because of the protective features of Senior
Loans, the Adviser believes that Senior Loans tend to have more favorable loss
recovery rates as compared to more junior types of below investment grade debt
obligations. The Adviser does not view ratings as the determinative factor in
its investment decisions and relies more upon its credit analysis abilities than
upon ratings.
No active trading market may exist for some loans and some loans may be subject
to restrictions on resale. A secondary market may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement periods,
which may impair the ability to realize full value and thus cause a material
decline in the Fund's net asset value. During periods of limited supply and
liquidity of Senior Loans, the Fund's yield may be lower.
When interest rates decline, the value of the Fund invested in fixed-rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of the Fund invested in fixed-rate obligations can be expected to decline.
Although changes in prevailing interest rates can be expected to cause some
fluctuations in the value of Senior Loans (due to the fact that floating rates
15
on Senior Loans only reset periodically), the value of Senior Loans is
substantially less sensitive to changes in market interest rates than fixed-rate
instruments. As a result, the Adviser expects the Fund's policy of investing a
portion of its assets in floating-rate Senior Loans will make the Fund less
volatile and less sensitive to changes in market interest rates than if the Fund
invested exclusively in fixed-rate obligations. Similarly, a sudden and
significant increase in market interest rates may cause a decline in the value
of these investments and in the Fund's net asset value. Other factors
(including, but not limited to, rating downgrades, credit deterioration, a large
downward movement in stock prices, a disparity in supply and demand of certain
securities or market conditions that reduce liquidity) can reduce the value of
Senior Loans and other debt obligations, impairing the Fund's net asset value.
The Fund may purchase and retain in its portfolio a Senior Loan where the
Borrower has experienced, or may be perceived to be likely to experience, credit
problems, including involvement in or recent emergence from bankruptcy
reorganization proceedings or other forms of debt restructuring. Such
investments may provide opportunities for enhanced income as well as capital
appreciation. At times, in connection with the restructuring of a Senior Loan
either outside of bankruptcy court or in the context of bankruptcy court
proceedings, the Fund may determine or be required to accept equity securities
or junior debt securities in exchange for all or a portion of a Senior Loan.
SENIOR LOAN ASSIGNMENTS AND PARTICIPATIONS. The Fund expects to primarily
purchase Senior Loans by assignment from a participant in the original syndicate
of lenders or from subsequent assignees of such interests. The Fund may also
purchase participations in the original syndicate making Senior 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 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. Given the current structure of the
markets for loan participations and assignments, the Fund expects to treat these
securities as illiquid.
SENIOR LOAN VALUATION. The Adviser uses an independent pricing service to value
most loans and other debt securities at their market value. The Adviser may use
the fair value method to value loans or other securities if market quotations
for them are not readily available or are deemed unreliable, or if events
occurring after the close of a securities market and before the Fund values its
assets would materially affect net asset value. Because foreign securities trade
on days when the Shares are not priced, net asset value can change at time when
Shares cannot be redeemed.
NON-INVESTMENT GRADE BONDS
As indicated above, Non-Investment Grade Bonds are those rated lower than
investment grade (i.e., bonds rated lower than Baa3 by Moody's and lower than
BBB-- by S&P and Fitch) or are unrated and of comparable quality as determined
by the Adviser. Non-Investment Grade Bonds rated BB and Ba have speculative
characteristics, while lower rated Non-Investment Grade Bonds are predominantly
speculative.
The Fund may hold securities that are unrated or in the lowest rating categories
(rated C by Moody's or D by S&P or Fitch). Bonds rated C by Moody's are regarded
as having extremely poor prospects of ever attaining any real investment
standing. Bonds rated D by S&P or Fitch are in payment default or a bankruptcy
petition has been filed and debt service payments are jeopardized. In order to
enforce its rights with defaulted securities, the Fund may be required to retain
legal counsel and/or a financial adviser. This may increase the Fund's operating
expenses and adversely affect net asset value.
The credit quality of most securities held by the Fund reflects a greater than
average possibility that adverse changes in the financial condition of an
issuer, or in general economic conditions, or both, may impair the ability of
the issuer to make payments of interest and principal. The inability (or
perceived inability) of issuers to make timely payment of interest and principal
would likely make the values of securities held by the Fund more volatile and
could limit the Fund's ability to sell its securities at favorable prices. In
the absence of a liquid trading market for securities held by it, the Fund may
have difficulties determining the fair market value of such securities.
Although the Adviser considers security ratings when making investment
decisions, it performs its own credit and investment analysis and does not rely
primarily on the ratings assigned by the rating services. In evaluating the
quality of a particular security, whether rated or unrated, the Adviser will
normally take into consideration, among other things, the issuer's financial
resources and operating history, its sensitivity to economic conditions and
trends, the ability of its management, its debt maturity schedules and borrowing
requirements, and relative values based on anticipated cash flow, interest and
asset coverage, and earnings prospects. Because of the greater number of
16
investment considerations involved in investing in high yield, high risk bonds,
the achievement of the Fund's objectives depends more on the Adviser's judgment
and analytical abilities than would be the case if the Fund invested primarily
in securities in the higher rating categories. While the Adviser will attempt to
reduce the risks of investing in lower rated or unrated securities through
active Fund management, diversification, credit analysis and attention to
current developments and trends in the economy and the financial markets, there
can be no assurance that a broadly diversified Fund of such securities would
substantially lessen the risks of defaults brought about by an economic downturn
or recession. In recent years, issuances of Non-Investment Grade Bonds by
companies in various sectors has increased. Accordingly, the Fund's investments
may have significant exposure to certain sectors of the economy and thus may
react differently to political or economic developments than the market as a
whole.
The Fund's high yield securities may have fixed or variable principal payments
and all types of interest rate and dividend payment and reset terms, including
fixed rate, adjustable rate, zero coupon, contingent, deferred, and payment in
kind features.
ADDITIONAL INVESTMENT PRACTICES
OTHER GOVERNMENT SECURITIES
U.S. Government securities include (1) U.S. Treasury obligations, which differ
in their interest rates, maturities and times of issuance: U.S. Treasury bills
(maturities of one year or less), U.S. Treasury notes (maturities of one year to
ten years) and U.S. Treasury bonds (generally maturities of greater than ten
years) and (2) obligations issued or guaranteed by U.S. Government agencies and
instrumentalities which are supported by any of the following: (a) the full
faith and credit of the U.S. Treasury, (b) the right of the issuer to borrow an
amount limited to a specific line of credit from the U.S. Treasury, (c)
discretionary authority of the U.S. Government to purchase certain obligations
of the U.S. Government agency or instrumentality or (d) the credit of the agency
or instrumentality. The Fund may also invest in any other security or agreement
collateralized or otherwise secured by U.S. Government securities. Agencies and
instrumentalities of the U.S. Government include but are not limited to: Federal
Land Banks, Federal Financing Banks, Banks for Cooperatives, Federal
Intermediate Credit Banks, Farm Credit Banks, Federal Home Loan Banks, FHLMC,
FNMA, GNMA, Student Loan Marketing Association, United States Postal Service,
Small Business Administration, Tennessee Valley Authority and any other
enterprise established or sponsored by the U.S. Government. Because the U.S.
Government generally is not obligated to provide support to its
instrumentalities, the Fund will invest in obligations issued by these
instrumentalities only if the Adviser determines that the credit risk with
respect to such obligations is minimal.
The principal of and/or interest on certain U.S. Government securities which may
be purchased by the Fund could be (a) payable in foreign currencies rather than
U.S. dollars or (b) increased or diminished as a result of changes in the value
of the U.S. dollar relative to the value of foreign currencies. The value of
such portfolio securities denominated in foreign currencies may be affected
favorably by changes in the exchange rate between foreign currencies and the
U.S. dollar.
SECURITIZED INTERESTS
The Fund may invest in certain asset-backed securities as discussed below.
Asset-backed securities are payment claims that are securitized in the form of
negotiable paper that is issued by a financing company (generically called a
Special Purpose Vehicle or "SPV"). These securitized payment claims are, as a
rule, corporate financial assets brought into a pool according to specific
diversification rules. The SPV is a company founded solely for the purpose of
securitizing these claims and its only asset is the risk arising out of this
diversified asset pool. On this basis, marketable securities are issued which,
due to the diversification of the underlying risk, generally represent a lower
level of risk than the original assets. The redemption of the securities issued
by the SPV takes place at maturity out of the cash flow generated by the
collected claims. Asset-backed securities may be issued by the U.S. government,
its agencies or instrumentalities, or by non-governmental issuers.
CMOS. The CMO classes in which the Fund may invest include sequential and
parallel pay CMOs, including planned amortization class and target amortization
class securities. CMOs are debt securities issued by either the U.S. government
(or one of its agencies or instrumentalities) or private issuers. The key
feature of the CMO structure is the prioritization of the cash flows from a pool
of mortgages among the several classes of CMO holders, thereby creating a series
of obligations with varying rates and maturities appealing to a wide range of
investors. CMOs generally are secured by an assignment to a trustee under the
indenture pursuant to which the bonds are issued of collateral consisting of a
pool of mortgages. Payments with respect to the underlying mortgages generally
are made to the trustee under the indenture. CMOs are issued in two or more
classes or series with varying maturities and stated rates of interest
determined by the issuer. Senior CMO classes will typically have priority over
residual CMO classes as to the receipt of principal and/or interest payments on
the underlying mortgages. Because the interest and principal payments on the
underlying mortgages are not passed through to holders of CMOs, CMOs of varying
17
maturities may be secured by the same pool of mortgages, the payments on which
are used to pay interest to each class and to retire successive maturities in
sequence. CMOs are designed to be retired as the underlying mortgages are
repaid. In the event of sufficient early prepayments on such mortgages, the
class or series of CMO first to mature generally will be retired prior to
maturity. Therefore, although in most cases the issuer of CMOs will not supply
additional collateral in the event of such prepayments, there will be sufficient
collateral to secure CMOs that remain outstanding. Currently, the Adviser will
consider privately issued CMOs or other mortgage-backed securities as possible
investments for the Fund only when the mortgage collateral is insured,
guaranteed or otherwise backed by the U.S. Government or one or more of its
agencies or instrumentalities (e.g., insured by the Federal Housing
Administration or Farmers Home Administration or guaranteed by the Administrator
of Veterans Affairs or consisting in whole or in part of U.S. Government
securities).
COLLATERALIZED DEBT OBLIGATIONS ("CDOS"). The Fund may invest in CDOs. A CDO is
a structured credit security issued by a special purpose entity that was created
to reapportion the risk and return characteristics of a pool of assets. The
assets, typically non-investment grade bonds, leveraged loans, and other
asset-backed obligations, are used as collateral supporting the various debt and
equity tranches issued by the special purpose entity. CDOs operate similarly to
CMOs and CLOs and are subject to the same inherent risks.
COLLATERALIZED LOAN OBLIGATIONS ("CLOS"). A CLO is a type of CDO that invests
primarily in leveraged loans as collateral underlying the obligations of the
special purpose entity. CLOs operate similarly to CMOs and are subject to the
same inherent risks.
MORTGAGE ROLLS
The Fund may enter into mortgage "dollar rolls" in which the Fund sells
mortgage-backed securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type, coupon and maturity)
securities on a specified future date. During the roll period, the Fund forgoes
principal and interest paid on the mortgage-backed securities. The Fund is
compensated by the difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") as well
as by the interest earned on the cash proceeds of the initial sales. A "covered
roll" is a specific type of dollar roll for which there is an offsetting cash
position or a cash equivalent security position which matures on or before the
forward settlement date of the dollar roll transaction. The Fund will only enter
into covered rolls. Covered rolls are not treated as a borrowing or other senior
security and will be excluded from the calculation of the Fund's borrowings and
other senior securities.
CREDIT-LINKED NOTES
The Fund may invest in credit-linked notes ("CLN"). A CLN is a derivative
instrument. It is a synthetic obligation between two or more parties where the
payment of principal and/or interest is based on the performance of some
obligation (a reference obligation). In addition to credit risk of the reference
obligation and interest rate risk, the buyer/seller of the CLN is subject to
counterparty risk.
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.
WHEN-ISSUED SECURITIES AND FORWARD COMMITMENTS
Securities may be purchased on a "forward commitment" or "when-issued" basis
(meaning securities are purchased or sold with payment and delivery taking place
in the future) in order to secure what is considered to be an advantageous price
and yield at the time of entering into the transaction. However, the yield on a
comparable security when the transaction is consummated may vary from the yield
on the security at the time that the forward commitment or when-issued
transaction was made. From the time of entering into the transaction until
delivery and payment is made at a later date, the securities that are the
subject of the transaction are subject to market fluctuations. In forward
commitment or when-issued transactions, if the seller or buyer, as the case may
be, fails to consummate the transaction the counterparty may miss the
opportunity of obtaining a price or yield considered to be advantageous. Forward
commitment or when-issued transactions may be expected to occur a month or more
before delivery is due. However, no payment or delivery is made until payment is
received or delivery is made from the other party to the transaction. Forward
commitment or when-issued transactions are not entered into for the purpose of
investment leverage.
18
ILLIQUID SECURITIES
The Fund may invest in securities for which there is no readily available
trading market or are otherwise illiquid. Illiquid securities include securities
legally restricted as to resale, such as commercial paper issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended, and securities eligible
for resale pursuant to Rule 144A thereunder. Section 4(2) and Rule 144A
securities may, however, be treated as liquid by the Adviser pursuant to
procedures adopted by the Board, which require consideration of factors such as
trading activity, availability of market quotations and number of dealers
willing to purchase the security. If the Fund invests in Rule 144A securities,
the level of portfolio illiquidity may be increased to the extent that eligible
buyers become uninterested in purchasing such securities.
It may be difficult to sell such securities at a price representing the fair
value until such time as such securities may be sold publicly. Where
registration is required, a considerable period may elapse between a decision to
sell the securities and the time when it would be permitted to sell. Thus, the
Fund may not be able to obtain as favorable a price as that prevailing at the
time of the decision to sell. The Fund may also acquire securities through
private placements under which it may agree to contractual restrictions on the
resale of such securities. Such restrictions might prevent their sale at a time
when such sale would otherwise be desirable.
SWAPS
Swap contracts may be purchased or sold to hedge against fluctuations in
securities prices, interest rates or market conditions, to change the duration
of the overall portfolio, or to mitigate default risk. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) to be exchanged or "swapped" between the parties, which returns
are 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.
INTEREST RATE SWAPS. The Fund will enter into interest rate and total return
swaps only on a net basis, I.E., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the two
payments. Interest rate swaps involve the exchange by the Fund with another
party of their respective commitments to pay or receive interest (E.G., an
exchange of fixed rate payments for floating rate payments). The Fund will only
enter into interest rate swaps on a net basis. If the other party to an interest
rate swap defaults, the Fund's risk of loss consists of the net amount of
payments that the Fund is contractually entitled to receive. The net amount of
the excess, if any, of the Fund's obligations over its entitlements will be
maintained in a segregated account by the Fund's custodian. The Fund will not
enter into any interest rate swap unless the claims-paying ability of the other
party thereto is considered to be investment grade by the Adviser. If there is a
default by the other party to such a transaction, the Fund will have contractual
remedies pursuant to the agreements related to the transaction. These
instruments are traded in the over-the-counter market.
The Fund may use interest rate swaps for risk management purposes only and not
as a speculative investment and would typically use interest rate swaps to
shorten the average interest rate reset time of the Fund's holdings. Interest
rate swaps involve the exchange by the Fund with another party of their
respective commitments to pay or receive interests (E.G., an exchange of fixed
rate payments for floating rate payments). The use of interest rate swaps is a
highly specialized activity which involves investment techniques and risks
different from those associated with ordinary portfolio securities transactions.
If the Adviser is incorrect in its forecasts of market values, interest rates
and other applicable factors, the investment performance of the Fund would be
unfavorably affected.
TOTAL RETURN SWAPS. As stated above, the Fund will enter into total return swaps
only on a net basis. Total return swaps are contracts in which one party agrees
to make payments of the total return from the underlying asset(s) which may
include securities, baskets of securities, or securities indices during the
specified period, in return for payments equal to a fixed or floating rate of
interest or the total return from other underlying asset(s).
CREDIT DEFAULT SWAPS. The Fund may enter into credit default swap contracts for
risk management purposes, including diversification. When the Fund is the buyer
of a credit default swap contract, the Fund is entitled to receive the par (or
other agreed-upon) value of a referenced debt obligation from the counterparty
to the contract in the event of a default by a third party, such as a U.S. or
foreign corporate issuer, on the debt obligation. In return, the Fund would pay
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 have spent the stream of payments and received no benefit from the
contract. When the Fund is the seller of a credit default swap contract, it
receives the stream of payments but is obligated to pay upon default of the
referenced debt obligation. 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
Fund will segregate assets in the form of cash and cash equivalents in an amount
equal to the aggregate market value of the credit default swaps of which it is
the seller, marked to market on a daily basis. These transactions involve
certain risks, including the risk that the seller may be unable to fulfill the
transaction.
19
FUTURES AND OPTIONS ON FUTURES
The fund may purchase and sell various kinds of financial futures contracts and
options thereon to seek to hedge against changes in interest rates or for other
risk management purposes. Futures contracts may be based on various debt
securities and securities indices. Such transactions involve a risk of loss or
depreciation due to unanticipated adverse changes in securities prices, which
may exceed the fund's initial investment in these contracts. The Fund will only
purchase or sell futures contracts or related options in compliance with the
rules of the Commodity Futures Trading Commission. These transactions involve
transaction costs. There can be no assurance that Eaton Vance's use of futures
will be advantageous to the Fund. Rating Agency guidelines on any Preferred
Shares issued by the Fund may limit use of these transactions.
SECURITIES LENDING
The Fund may seek to earn income by lending portfolio securities to
broker-dealers or other institutional borrowers. As with other extensions of
credit, there are risks of delay in recovery or even loss of rights in the
securities loaned if the borrower of the securities fails financially. In the
judgment of the Adviser, the loans will be made only to organizations whose
credit quality or claims paying ability is considered to be at least investment
grade and when the expected returns, net of administrative expenses and any
finders' fees, justifies the attendant risk. Securities loans currently are
required to be secured continuously by collateral in cash, cash equivalents
(such as money market instruments) or other liquid securities held by the
custodian and maintained in an amount at least equal to the market value of the
securities loaned. The financial condition of the borrower will be monitored by
the Adviser on an ongoing basis.
BORROWINGS
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.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements. Under a reverse
repurchase agreement, the Fund temporarily transfers possession of a portfolio
instrument to another party, such as a bank or broker-dealer, in return for
cash. At the same time, the Fund agrees to repurchase the instrument at an
agreed upon time (normally within seven days) and price, which reflects an
interest payment. The Fund may enter into such agreements when it is able to
invest the cash acquired at a rate higher than the cost of the agreement, which
would increase earned income.
When the Fund enters into a reverse repurchase agreement, any fluctuations in
the market value of either the securities transferred to another party or the
securities in which the proceeds may be invested would affect the market value
of the Fund's assets. As a result, such transactions may increase fluctuations
in the market value of the Fund's assets. While there is a risk that large
fluctuations in the market value of the Fund's assets could affect net asset
value, this risk is not significantly increased by entering into reverse
repurchase agreements, in the opinion of the Adviser. Because reverse repurchase
agreements may be considered to be the practical equivalent of borrowing funds,
they constitute a form of leverage. Such agreements will be treated as subject
to investment restrictions regarding "borrowings." If the Fund reinvests the
proceeds of a reverse repurchase agreement at a rate lower than the cost of the
agreement, entering into the agreement will lower the Fund's yield.
PORTFOLIO TURNOVER
The Fund cannot accurately predict its portfolio turnover rate, but the annual
turnover rate may exceed 100% (excluding turnover of securities having a
maturity of one year or less). A high turnover rate (100% or more) necessarily
involves greater expenses to the Fund and may result in a realization of net
short-term capital gains. The Fund may engage in active short-term trading to
benefit from yield disparities among different issues of securities or among the
markets for fixed income securities of different countries, to seek short-term
profits during periods of fluctuating interest rates, or for other reasons. Such
trading will increase the Fund's rate of turnover and may increase the incidence
of net short-term capital gains which, upon distribution by the Fund, are
taxable to Fund Shareholders as ordinary income.
20
RISK CONSIDERATIONS
Risk is inherent in all investing. Investing in any investment company security
involves risk, including the risk that you may receive little or no return on
your investment or even that you may lose part or all of your investment.
Therefore, before investing you should consider carefully the following risks
that you assume when you invest in APS.
INTEREST RATE RISK
The Fund issues APS, which pay dividends based on short-term interest rates, and
uses the proceeds to buy obligations, which pay interest based on longer-term
yields. Longer-term bond obligation yields are typically, although not always,
higher than short-term interest rates. Both long-term and short-term interest
rates may fluctuate. If short-term interest rates rise, APS rates may rise such
that the amount of dividends paid to APS holders exceeds the income from the
portfolio securities purchased with the proceeds from the sale of APS. Because
income from the Fund's entire investment portfolio (not just the portion
purchased with the proceeds of the APS offering) is available to pay APS
dividends, however, APS dividend rates would need to greatly exceed the Fund's
net portfolio income before the Fund's ability to pay APS dividends would be
jeopardized. If long-term rates rise, the value of the Fund's investment
portfolio will decline, reducing the amount of assets serving as asset coverage
for the APS.
AUCTION RISK
Holders of APS may not be able to sell APS at an Auction if the auction fails;
that is, if there are more APS offered for sale than there are buyers for those
APS. Also, if a hold order is placed at an auction (an order to retain APS) only
at a specified rate, and that bid rate exceeds the rate set at the Auction, the
APS will not be retained. Finally, if you elect to buy or retain APS without
specifying a rate below which you would not wish to continue to hold those APS,
and the auction sets a below market rate, you may receive a lower rate of return
on your APS then the market rate. See "Description of APS" and "The
Auction--Auction procedures."
SECONDARY MARKET RISK
It may not be possible to sell APS between auctions or it may only be possible
to sell them for a price of less than $25,000 per share plus any accumulated
dividends. If the Fund has designated a Special Dividend Period (a dividend
period of more than 7 days), changes in interest rates could affect the price of
APS sold in the secondary market. [The Fund has elected a Special Dividend
Period for its Series B Preferred Shares as its Initial Dividend Period.]
Broker-dealers may maintain a secondary trading market in the APS outside of
Auctions; however, they have no obligation to do so and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the broker-dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. An increase in the level of interest rates,
particularly during any Long Term Dividend Period, likely will have an adverse
effect on the secondary market price of the APS, and a selling Shareholder may
sell APS between Auctions at a price per share of less than $25,000. Accrued APS
dividends, however, should at least partially compensate for the increased
market interest rate.
RATINGS AND ASSET COVERAGE RISK
While [ ] and [ ] assign a rating of "AAA" to the APS, the ratings do not
eliminate or necessarily mitigate the risks of investing in APS. A rating agency
could downgrade APS, which may make APS less liquid at an Auction or in the
secondary market, although the downgrade would probably result in higher
dividend rates. If a rating agency downgrades APS of the Fund, the Fund will
alter its portfolio or redeem APS. The Fund may voluntarily redeem APS under
certain circumstances. A preferred stock rating is an assessment of the capacity
and willingness of an issuer to pay preferred stock obligations. The ratings on
the Preferred Shares are not recommendations to purchase, hold, or sell those
shares, inasmuch as the ratings do not comment as to market price or suitability
for a particular investor. The rating agency guidelines described above also do
not address the likelihood that an owner of the Preferred Shares will be able to
sell such shares in an auction or otherwise. See "Description of APS-- Rating
agency guidelines and asset coverage" for a description of the asset maintenance
tests the Fund must meet.
INCOME RISK
The income investors receive from the Fund is based primarily on the interest it
earns from its investments, which can vary widely over the short- and long-term.
If long-term interest rates drop, the Fund's income available over time to make
dividend payments with respect to APS could drop as well if the Fund purchases
securities with lower interest coupons.
21
CALL AND OTHER REINVESTMENT RISKS
If interest rates fall, it is possible that issuers of callable bonds with high
interest coupons will "call" (or prepay) their bonds before their maturity date.
If a call were exercised by the issuer during a period of declining interest
rates, the Fund is likely to replace such called security with a lower yielding
security. If that were to happen, it could decrease the Fund's dividends and
possibly could affect the market price of Common Shares. Similar risks exist
when the Fund invests the proceeds from matured or traded obligations at market
interest rates that are below the Fund's current earnings rate.
CREDIT RISK
Credit risk is the risk that one or more investments in the Fund's portfolio
will decline in price, or fail to pay interest or principal when due, because
the issuer of the obligation experiences a decline in its financial status. In
general, lower rated bonds carry a greater degree of risk that the issuer will
lose its ability to make interest and principal payments, which could have a
negative impact on the Fund's net asset value or dividends. Securities rated in
the fourth highest category are considered investment grade but they also may
have some speculative characteristics.
Changes in the credit quality of the issuers of obligations held by the Fund
will affect the principal value of (and possibly the income earned on) such
obligations. In addition, the value of such securities are affected by changes
in general economic conditions and business conditions affecting the relevant
economic sectors. Changes by Rating Agencies in their ratings of a security and
in the ability of the issuer to make payments of principal and interest may also
affect the value of the Fund's investments. The amount of information about the
financial condition of an issuer of obligations may not be as extensive as that
made available by corporations whose securities are publicly traded.
If rating agencies lower their ratings of investments in the Fund's portfolio,
the value of those investments could decline, which could jeopardize the rating
agencies' ratings of the APS. Because the primary source of income for the Fund
is the interest and principal payments on the obligations in which it invests,
any default by an issuer of an obligation could have a negative impact on the
Fund's ability to pay dividends on the APS and could result in the redemption of
some or all of the APS.
LIQUIDITY RISK
At times, a portion of the Fund's assets may be invested in securities as to
which the Fund, by itself or together with other accounts managed by Eaton Vance
and its affiliates, holds a major portion of all of such securities. The
secondary market for some such obligations is less liquid than that for more
widely traded obligations. No established resale market exists for certain of
the obligations in which the Fund may invest. The Fund has no limitation on the
amount of its assets that may be invested in securities which are not readily
marketable or are subject to restrictions on resale. In certain situations, the
Fund could find it more difficult to sell such securities at desirable times
and/or prices.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from investment
will be worth less in the future as inflation decreases the value of money. As
inflation increases, the real value of the APS and distributions thereon can
decline. In an inflationary period, however, it is expected that, through the
Auction process, APS dividend rates would increase, tending to offset the risk.
MARKET DISRUPTION
The terrorist attacks in the United States on September 11, 2001 had a
disruptive effect on the securities markets. The Fund cannot predict the effects
of similar events in the future on the U.S. economy. These terrorist attacks and
related events, including the war in Iraq, have led to increased short-term
market volatility and may have long-term effects on U.S. and world economies and
markets. A similar disruption of the financial markets could impact interest
rates, auctions, secondary trading, ratings, credit risk, inflation and other
factors relating to the Preferred Shares. In particular, Non-Investment Grade
Bonds and Senior Loans tend to be more volatile than higher rated fixed income
securities so that these events and any actions resulting from them may have a
greater impact on the prices and volatility on Non-Investment Grade Bonds and
Senior Loans than on higher rated fixed income securities.
22
MANAGEMENT OF THE FUND
BOARD OF TRUSTEES
The management of the Fund, including general supervision of the duties
performed by the Adviser under the Advisory Agreement (as defined below), is the
responsibility of the Fund's Board under the laws of The Commonwealth of
Massachusetts and the 1940 Act.
THE ADVISER
Eaton Vance acts as the Fund's investment adviser under an Investment Advisory
Agreement (the "Advisory Agreement"). The Adviser's principal office is located
at The Eaton Vance Building, 255 State Street, Boston, MA 02109. Eaton Vance,
its affiliates and predecessor companies have been managing assets of
individuals and institutions since 1924 and of investment companies since 1931.
Eaton Vance (or its affiliates) currently serves as the investment adviser to
investment companies and various individual and institutional clients with
combined assets under management of approximately $62 billion as of May 31,
2003. Eaton Vance is an indirect, wholly-owned subsidiary of Eaton Vance Corp.,
a publicly-held holding company, which through its subsidiaries and affiliates
engages primarily in investment management, administration and marketing
activities.
Under the general supervision of the Fund's Board, the Adviser will carry out
the investment and reinvestment of the assets of the Fund, will furnish
continuously an investment program with respect to the Fund, will determine
which securities should be purchased, sold or exchanged, and will implement such
determinations. The Adviser will furnish to the Fund investment advice and
office facilities, equipment and personnel for servicing the investments of the
Fund. The Adviser will compensate all Trustees and officers of the Fund who are
members of the Adviser's organization and who render investment services to the
Fund, and will also compensate all other Adviser personnel who provide research
and investment services to the Fund. In return for these services, facilities
and payments, the Fund has agreed to pay the Adviser as compensation under the
Advisory Agreement a fee in the amount of 0.75% of the average weekly gross
assets of the Fund. Gross assets of the Fund shall be calculated by deducting
accrued liabilities of the Fund not including the amount of any Preferred Shares
outstanding or the principal amount of any indebtedness for money borrowed.
During periods in which the Fund is using leverage, the fees paid to Eaton Vance
for investment advisory services will be higher than if the Fund did not use
leverage because the fees paid will be calculated on the basis of the Fund's
gross assets, including proceeds from any borrowings and from the issuance of
Preferred Shares.
Thomas E. Faust, Jr. (Executive Vice President and Chief Investment Officer of
Eaton Vance), Susan Schiff, Scott H. Page, Payson F. Swaffield, Michael
Weilheimer and other Eaton Vance investment professionals comprise the
investment team responsible for the overall management of the Fund's investments
as well as allocations among the Fund's three principal investment categories.
The following individual members of this team are responsible for the day-to-day
management with each of the Fund's three main asset classes:
MBS. Ms. Schiff is responsible for the day-to-day management of the Fund's MBS
strategy. Ms. Schiff, has been an Eaton Vance portfolio manager since 1991, and
is a Vice President of Eaton Vance. Among other portfolios, she currently
manages Eaton Vance Government Obligations Fund, a registered open-end fund,
which employs an investment strategy primarily focused on MBS. As of May 31,
2003, this fund had assets of [$ ] billion.
SENIOR LOANS. Mr. Page and Mr. Swaffield are responsible for the day-to-day
management of the Fund's Senior Loan strategy. Among other portfolios, Mr. Page
and Mr. Swaffield have each been Eaton Vance portfolio managers since 1996, and
are Vice Presidents of Eaton Vance. They currently co-manage Eaton Vance Prime
Rate Reserves, a registered closed-end interval fund, Eaton Vance Classic Senior
Floating-Rate Fund, a registered closed-end interval fund, Eaton Vance
Floating-Rate Fund, a registered open-end fund, Eaton Vance Floating-Rate High
Income Fund, a registered open-end fund, and Eaton Vance Senior Income Trust, a
registered closed-end fund listed on the New York Stock Exchange, all of which
employ investment strategies primarily focused on Senior Loans. As of May 31,
2003, these funds had combined assets of [$ ] billion. See "Additional
investment information and restrictions -- Litigation involving Eaton Vance" in
the SAI for further information.
NON-INVESTMENT GRADE BONDS. Mr. Weilheimer is responsible for the day-to-day
management of the Fund's Non-Investment Grade Bond strategy. Mr. Weilheimer has
been an Eaton Vance portfolio manager since 1996, and is a Vice President of
Eaton Vance. Among other portfolios, he currently co-manages Eaton Vance High
Income Fund, a registered open-end fund, and Eaton Vance Income Fund of Boston,
a registered open-end fund, both of which employ investment strategies primarily
focused on Non-Investment Grade Bonds. As of May 31, 2003, these funds had
combined assets of [$ ] billion.
The Fund and the Adviser have adopted a Code of Ethics relating to personal
securities transactions. The Code permits Adviser personnel to invest in
securities (including securities that may be purchased or held by the Fund) for
23
their own accounts, subject to certain pre-clearance, reporting and other
restrictions and procedures contained in such Code.
Eaton Vance serves as administrator of the Fund but currently receives no
compensation for providing administrative services to the Fund. Under an
Administration Agreement with the Fund ("Administration Agreement"), Eaton Vance
is responsible for managing the business affairs of the Fund, subject to the
supervision of the Fund's Board. Eaton Vance will furnish to the Fund all office
facilities, equipment and personnel for administering the affairs of the Fund.
Eaton Vance's administrative services include recordkeeping, preparation and
filing of documents required to comply with federal and state securities laws,
supervising the activities of the Fund's custodian and transfer agent, providing
assistance in connection with the Trustees' and shareholders' meetings,
providing service in connection with any repurchase offers and other
administrative services necessary to conduct the Fund's business.
DESCRIPTION OF APS
The following is a brief description of the terms of the APS. This description
does not purport to be complete and is subject to and qualified in its entirety
by reference to the Fund's Declaration of Trust and Amended By-Laws, including
the provisions thereof establishing the APS. The Fund's Declaration of Trust and
the form of Amended By-Laws establishing the terms of the APS have been filed as
exhibits to or incorporated by reference in the Registration Statement of which
this Prospectus is a part. The Amended By-Laws for the Fund may be found in
Appendix B to the Fund's Statement of Additional Information.
GENERAL
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest with preference rights, including Preferred
Shares, having a par value of $0.01 per share, in one or more series, with
rights as determined by the Board of Trustees, by action of the Board of
Trustees without the approval of the Shareholders. The Fund's Amended By-Laws
currently authorize the number of shares of APS of each series set forth below
in "Description of Capital Structure." The APS will have a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared). See "Description of
APS--Liquidation Rights."
The APS of each series will rank on parity with shares of any other series of
APS and with shares of other series of Preferred Shares of the Fund, as to the
payment of dividends and the distribution of assets upon liquidation. All shares
of APS carry one vote per share on all matters on which such shares are entitled
to be voted. APS, when issued, will be fully paid and, subject to matters
discussed in "Certain provisions of the Declaration of Trust," non-assessable
and have no preemptive, conversion or cumulative voting rights. The APS will not
be convertible into Common Shares or other capital stock of the Fund, and the
holders thereof will have no preemptive, or cumulative voting rights.
DIVIDENDS AND DIVIDEND PERIODS
GENERAL
After the Initial Dividend Period, each Subsequent Dividend period for the APS
will generally consist of seven days (a "7-Day Dividend Period"); provided,
however, that prior to any Auction, the Fund may elect, subject to certain
limitations described herein, upon giving notice to holders thereof, a Special
Dividend Period as discussed below. Initially, the Fund has elected an Initial
Dividend Period for Series B of [360] days. [The Fund will pay the Series B
accumulated dividends on the first Business Day of each month, with final
payment being made on [ ], 2004.] The holders of the APS of the Fund will be
entitled to receive, when, as and if declared by that Fund's Board of Trustees,
out of funds legally available therefor, cumulative cash dividends on their APS,
at the Applicable Rate determined as set forth below under "Determination of
Dividend Rate," payable on the dates set forth below. Dividends on the APS of
the Fund so declared and payable shall be paid (i) in preference to and in
priority over any dividends declared and payable on that Fund's Common Shares
and (ii) to the extent permitted under the Code and available, out of the net
tax-exempt income earned on that Fund's investments.
Dividends on the APS will accumulate from the date on which the Fund originally
issues the APS (the "Date of Original Issue") and will be payable on the APS on
the dates described below. Dividends on the APS with respect to the Initial
Dividend Period shall be payable on the Initial Dividend Payment Date. Following
the Initial Dividend Payment Date, dividends on the APS will be payable, at the
option of the Fund, either (i) with respect to any 7-Day Dividend Period and any
Short Term Dividend Period of 28 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 28 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
24
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 referred to herein as a
"Normal Dividend Payment Date"), except that if such Normal Dividend Payment
Date is not a Business Day, the Dividend Payment Date shall be the first
Business Day next succeeding such Normal Dividend Payment Date. 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 Payment Date cannot be fixed as
described above, then the Board of Trustees shall fix the Dividend Payment Date.
The Board of Trustees by resolution prior to authorization of a dividend by the
Board of Trustees may change a Dividend Payment Date if such change does not
adversely affect the contract rights of the holders of APS set forth in the
Amended By-Laws. The Initial Dividend Period, 7-Day Dividend Periods and Special
Dividend Periods 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."
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The Fund
does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the APS, which holder is
expected to be the nominee of the Securities Depository. See "The
Auctions--General--Securities Depository." The Securities Depository will credit
the accounts of the Agent Members of the Existing Holders in accordance with the
Securities Depository's normal procedures which provide for payment in same-day
funds. The Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
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 nominee
of the Securities Depository. Any dividend payment made on the APS first shall
be credited against the earliest declared but unpaid dividends accumulated with
respect to such shares.
Holders of the APS will not be entitled to any dividends, whether payable in
cash, property or stock, in excess of full cumulative dividends except as
described under "Non-Payment Period; Late Charge" below. No interest will be
payable in respect of any dividend payment or payments on the APS which may be
in arrears.
The amount of cash dividends per share of APS payable (if declared) on the
Initial Dividend Payment Date, each 7-Day Dividend Period and each Dividend
Payment Date of each Short 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 for which dividends are payable on such Dividend
Payment Date 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.
During any Long Term Dividend Period, the amount of cash dividends per share of
APS payable (if declared) on any Dividend Payment Date shall be computed by
multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be such number of days in such part of such Dividend
Period that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 360, multiplying
the amount so obtained by $25,000, and rounding the amount so obtained to the
nearest cent.
NOTIFICATION OF DIVIDEND PERIOD
With respect to each Dividend Period that is a Special Dividend Period, the
Fund, 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, may request that the next succeeding Dividend Period
for the APS will be a number of days (other than seven), evenly divisible by
seven, and not fewer than seven 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
Fund may not give a Request for Special 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 prior to such date 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 the APS 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 the APS. Upon receiving such
Request for Special Dividend Period, the Broker-Dealers jointly shall determine
whether, given the factors set forth below, it is advisable that the Fund issue
a Notice of Special Dividend Period as contemplated by such Request for Special
Dividend Period and the Optional Redemption Price of the APS during such Special
Dividend Period and the Specific Redemption Provisions and shall give the Fund
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
25
determination, the Broker-Dealers will consider (i) existing short-term and
long-term market rates and indices of such short-term and long-term rates, (ii)
existing market supply and demand for short-term and long-term securities, (iii)
existing yield curves for short-term and long-term securities comparable to the
APS, (iv) industry and financial conditions which may affect the APS, (v) the
investment objective of the Fund and (vi) the Dividend Periods and dividend
rates at which current and potential beneficial holders of the APS would remain
or become beneficial holders.
If the Broker-Dealers shall not give the Fund and the Auction Agent a Response
by such second Business Day or if the Response states that given the factors set
forth above it is not advisable that the Fund give a Notice of Special Dividend
Period for the APS, the Fund may not give a Notice of Special Dividend Period in
respect of such Request for Special Dividend Period. In the event the Response
indicates that it is advisable that the Fund give a Notice of Special Dividend
Period for the APS, the Fund, by no later than the second Business Day prior to
such Auction Date, may give a notice (a "Notice of Special Dividend Period") to
the Auction Agent, the Securities Depository and each Broker-Dealer, which
notice will specify (i) the duration of the Special Dividend Period, (ii) the
Optional Redemption Price as specified in the related Response and (iii) the
Specific Redemption Provisions, if any, as specified in the related Response.
The Fund also shall provide a copy of such Notice of Special Dividend Period to
[ ] and [ ]. The Fund shall not give a Notice of Special Dividend Period, and,
if such Notice of Special Dividend Period shall have been given already, shall
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 APS Asset Coverage is not satisfied or the Fund shall fail to maintain
[ ] Eligible Assets or [ ] Eligible Assets with an aggregate Discounted Value at
least equal to the APS Basic Maintenance Amount, 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 Fund is an approximately equal rate for securities similar to the APS with
an equal dividend period), (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 related Auction Date or (z) the Broker-Dealers
jointly advise the Fund that, after consideration of the factors listed above,
they have concluded that it is advisable to give a Notice of Revocation. The
Fund also shall provide a copy of such Notice of Revocation to [ ] and [ ]. If
the Fund is prohibited from giving a Notice of Special Dividend Period as a
result of the factors enumerated in clause (x), (y) or (z) above or if the Fund
gives a Notice of Revocation with respect to a Notice of Special Dividend
Period, the next succeeding Dividend Period for that series will be a 7-Day
Dividend Period. In addition, in the event Sufficient Clearing Bids are not made
in any Auction or an Auction is not held for any reason, the next succeeding
Dividend Period will be a 7-Day Dividend Period, and the Fund may not again give
a Notice of Special Dividend Period (and any such attempted notice shall be null
and void) until Sufficient Clearing Bids have been made in an Auction with
respect to a 7-Day Dividend Period.
DETERMINATION OF DIVIDEND RATE
The dividend rate on the APS during the period from and including the Date of
Original Issue for the APS to but excluding the Initial Dividend Payment Date
for the APS (the "Initial Dividend Period") will be the rate per annum set forth
on the inside cover page hereof. Commencing on the Initial Dividend Payment Date
for the APS, the Applicable Rate on the APS for each Subsequent Dividend Period,
which Subsequent Dividend Period shall be a period commencing on and including a
Dividend Payment Date and ending on and including 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 the Auction with respect to such Subsequent Dividend
Period. The Initial Dividend Period and Subsequent Dividend Period for the APS
is referred to herein as a "Dividend Period." Cash dividends shall be calculated
as set forth above under "Dividends--General."
NON-PAYMENT PERIOD; LATE CHARGE
A Non-Payment Period will commence if the Fund fails to (i) declare, prior to
the close of business on the second Business Day preceding any Dividend Payment
Date, for payment on or (to the extent permitted as described below) within
three Business Days after such Dividend Payment Date to the persons who held
such shares 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 the APS payable
on such Dividend Payment Date 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 (if
declared) payable on such Dividend Payment Date or (B) on any redemption date
for the APS called for redemption, the Mandatory Redemption Price per share of
such APS or, in the case of an optional redemption, the Optional Redemption
Price per share. Such Non-Payment Period will consist of the period commencing
on and including the aforementioned Dividend Payment Date or redemption date, as
the case may be, 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 otherwise shall have been made available to the
26
applicable holders in same-day funds, provided that a Non-Payment Period for the
APS will not end unless the Fund shall have given at least five days' but no
more than 30 days' written notice of such deposit or availability to the Auction
Agent, the Securities Depository and all holders of the APS of such series.
Notwithstanding the foregoing, the failure by the Fund 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 below, shall not constitute a "Non-Payment
Period." The Applicable Rate for each Dividend Period for the APS of any series,
commencing during a Non-Payment Period, will be equal to the Non-Payment Period
Rate; and each Dividend Period commencing after the first day of, and during, a
Non-Payment Period shall be a 3-Day Dividend Period. Any dividend on the APS due
on any Dividend Payment Date for such shares (if, prior to the close of business
on the second Business Day preceding such Dividend Payment Date, the Fund has
declared such dividend payable on such Dividend Payment Date to the persons who
held such shares as of 12:00 noon, New York City time, on the Business Day
preceding such Dividend Payment Date) or redemption price with respect to such
shares not paid to such persons when due may be paid to such persons 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
divided by 365. In the case of a willful failure of the Fund to pay a dividend
on a Dividend Payment Date or to redeem any APS 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 will be
considered equivalent to payment to that 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, 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.
The Non-Payment Period Rate initially will be 200% of the applicable Reference
Rate (or 275% of such rate if the Fund has provided notification to the Auction
Agent prior to the Auction establishing the Applicable Rate for any dividend
that net capital gains or other taxable income will be included in such dividend
on the APS), provided that the Board of Trustees of the Fund 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 Fund determines and [ ]
and [ ] (or any Substitute Rating Agency in lieu of [ ] and [ ] in the event
such party shall not rate the APS) advises the Fund in writing that such
adjustment, modification, alteration or change will not adversely affect its
then-current rating on the APS.
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS
Under the 1940 Act, the Fund may not declare dividends or make other
distributions on Common Shares or purchase any such shares if, at the time of
the declaration, distribution or purchase, as applicable (and after giving
effect thereto), asset coverage (as defined in the 1940 Act) with respect to the
outstanding APS would be less than 200% (or such other percentage as in the
future may be required by law). Under the Code, the Fund must, among other
things, distribute each year at least 90% of the sum of its net tax-exempt
income and investment company taxable income in order to maintain its
qualification for tax treatment as a regulated investment company. The foregoing
limitations on dividends, other distributions and purchases in certain
circumstances may impair the Fund's ability to maintain such qualification. See
"Taxes."
Upon any failure to pay dividends on the APS for two years or more, the holders
of the APS will acquire certain additional voting rights. See "Voting rights"
below.
For so long as any APS are outstanding, the Fund will 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 stock, if any, ranking junior to the APS as
to dividends or upon liquidation) in respect of Common Shares or any other stock
of the Fund ranking junior to or on a parity with the APS as to dividends or
upon liquidation, or call for redemption, redeem, purchase or otherwise acquire
for consideration any Common Shares or shares of any other such junior stock
(except by conversion into or exchange for stock of the Fund ranking junior to
APS as to dividends and upon liquidation) or any such parity stock (except by
conversion into or exchange for stock of the Fund ranking junior to or on a
parity with APS as to dividends and upon liquidation), unless (A) immediately
after such transaction, the Fund would have [ ] Eligible Assets with an
aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount, and the 1940 Act APS Asset Coverage (see "Rating Agency guidelines and
asset coverage" and "Redemption" below) would be satisfied, (B) full cumulative
dividends on the APS 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 Fund has redeemed
the full number of APS required to be redeemed by any provision for mandatory
redemption contained in the Amended By-Laws.
27
REDEMPTION
MANDATORY REDEMPTION
The Fund will be required to redeem, out of funds legally available therefor, at
the Mandatory Redemption Price per share, the APS to the extent permitted under
the 1940 Act and Massachusetts law, on a date fixed by the Board of Trustees, if
the Fund fails to maintain [ ] Eligible Assets with an aggregate Discounted
Value equal to or greater than the APS Basic Maintenance Amount or to satisfy
the 1940 Act APS Asset Coverage and such failure is not cured on or before the
APS Basic Maintenance Cure Date or the 1940 Act Cure Date (herein collectively
referred to as a "Cure Date"), as the case may be. "Mandatory Redemption Price"
of APS means $25,000 per share plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption.
Any such redemption will be limited to the lesser number of APS necessary to
restore the Discounted Value or the 1940 Act APS Asset Coverage, as the case may
be, or the maximum number that can be redeemed with funds legally available
under the Declaration of Trust and applicable law.
OPTIONAL REDEMPTION
To the extent permitted under the 1940 Act and under Massachusetts law, upon
giving a Notice of Redemption, as provided below, the Fund, at its option, may
redeem the APS, 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 APS may be redeemed at the option of the Fund during (a) the Initial
Dividend Period with respect to the APS or (b) a Non-Call Period to which such
share is subject. "Optional Redemption Price" means $25,000 per share of APS
plus an amount equal to accumulated but unpaid dividends (whether or not earned
or declared) to the date fixed for redemption plus any applicable redemption
premium, if any, attributable to the designation of a Premium Call Period. The
Fund has the authority to redeem the APS for any reason and may redeem all or
part of the outstanding APS if it anticipates that the Fund's leveraged capital
structure will result in a lower rate of return to holders of Common Shares for
any significant period of time than that obtainable if the Common Shares were
unleveraged.
Notwithstanding the provisions for redemption described above, no APS shall be
subject to optional redemption (i) unless all dividends in arrears on all
remaining outstanding APS, and all capital shares of the Fund ranking on a
parity with the APS with respect to the payment of dividends or upon
liquidation, have been or are being contemporaneously paid or declared and set
aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain [ ] Eligible Assets and [ ] Eligible Assets with an
aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount; PROVIDED, HOWEVER, that the foregoing shall not prevent the purchase or
acquisition of all outstanding APS of such series pursuant to a successful
completion of an otherwise lawful purchase or exchange offer made on the same
terms to, and accepted by, holders of all outstanding APS of such series.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether voluntary
or involuntary, the holders of APS will be entitled to receive, out of the
assets of the Fund available for distribution to shareholders, before any
distribution or payment is made upon any Common Shares or any other shares of
beneficial interest of the Fund ranking junior in right of payment upon
liquidation of APS, $25,000 per share together with the amount of any dividends
accumulated but unpaid (whether or not earned or declared) thereon to the date
of distribution, and after such payment the holders of APS will be entitled to
no other payment. If such assets of the Fund shall be insufficient to make the
full liquidation payment on outstanding APS and liquidation payments on any
other outstanding class or series of Preferred Shares of the Fund ranking on a
parity with the APS as to payment upon liquidation, then such assets will be
distributed among the holders of APS 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 payment of the full amount of liquidation
distribution to which they are entitled, the holders of APS will not be entitled
to any further participation in any distribution of assets by the Fund. A
consolidation, merger or share exchange of the Fund with or into any other
entity or entities 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 Fund
shall not be deemed or construed to be a liquidation, dissolution or winding up
of the Fund.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
The Fund will be required to satisfy two separate asset maintenance requirements
under the terms of the Amended By-Laws. These requirements are summarized below.
28
1940 ACT APS ASSET COVERAGE
The Fund will be required under the Amended By-Laws to maintain, with respect to
the APS, as of the last Business Day of each month in which any APS are
outstanding, asset coverage of at least 200% with respect to senior securities
which are beneficial interests in the Fund, including the APS (or such other
asset coverage as in the future may be specified in or under the 1940 Act as the
minimum asset coverage for senior securities which are beneficial interests of a
closed-end investment company as a condition of paying dividends on its common
stock) ("1940 Act APS Asset Coverage"). If the Fund fails to maintain 1940 Act
APS 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 APS. See "Redemption" below.
The 1940 Act APS Asset Coverage immediately following the issuance of APS
offered hereby (after giving effect to the deduction of the sales load and
offering expenses for the APS) computed using the Fund's net assets as of [ ],
2003 and assuming the Over-allotment Common Shares and the APS had been issued
as of such date will be as follows:
Value of Fund assets less
liabilities not
Constituting Senior =
Securities $ %
-------------------- ---------
Senior securities $
representing indebtedness
plus
liquidation value of APS
APS BASIC MAINTENANCE AMOUNT
The Fund intends that, so long as APS are outstanding, the composition of its
portfolio will reflect guidelines established by [ ] and [ ] in connection with
the Fund's receipt of a rating for such shares on or prior to their Date of
Original Issue of at least AAA from [ ] and [ ] . [ ] and [ ] , which are rating
agencies, issue ratings for various securities reflecting the perceived
creditworthiness of such securities. The guidelines described below have been
developed by [ ] and [ ] in connection with issuances of asset-backed and
similar securities, including debt obligations and variable rate preferred
shares, generally on a case-by-case basis through discussions with the issuers
of these securities. The guidelines are designed to ensure that assets
underlying outstanding debt or preferred shares will be varied sufficiently and
will be of sufficient quality and amount to justify investment grade ratings.
The guidelines do not have the force of law but have been adopted by the Fund in
order to satisfy current requirements necessary for [ ] and [ ] to issue the
above-described ratings for APS, which ratings generally are relied upon by
institutional investors in purchasing such securities. The guidelines provide a
set of tests for portfolio composition and asset coverage that supplement (and
in some cases are more restrictive than) the applicable requirements under the
1940 Act.
The Fund intends to maintain a Discounted Value for its portfolio at least equal
to the APS Basic Maintenance Amount. Both [ ] and [ ] have established
guidelines for determining Discounted Value. These guidelines define eligible
portfolio assets ("[ ] Eligible Assets" and "[ ] Eligible Assets"). To the
extent any particular portfolio holding does not satisfy these guidelines, all
or a portion of such holding's value will not be included in the calculation of
Discounted Value of that Fund's portfolio assets. The [ ] and [ ] guidelines do
not impose any limitations on the percentage of Fund assets that may be invested
in holdings not eligible for inclusion in the calculation of the Discounted
Value of the Fund's portfolio. The amount of such assets included in the
portfolio of the Fund at any time may vary depending upon the rating,
diversification and other characteristics of eligible assets included in the
portfolio, although it is not anticipated in the normal course of business the
value of such assets will exceed 20% of the Fund's total assets. The APS basic
maintenance amount includes the sum of (a) the aggregate liquidation preference
of APS then outstanding and (b) certain accrued and projected payment
obligations of the Fund.
Upon any failure to maintain the required aggregate Discounted Value, the Fund
will seek to alter the composition of its portfolio to retain a Discounted Value
at least equal to the APS Basic Maintenance Amount on or prior to the APS Basic
Maintenance Cure Date, thereby incurring additional transaction costs and
possible losses and/or gains on dispositions of portfolio securities. To the
extent any such failure is not cured in a timely manner, the APS will be subject
to mandatory redemption. See "Description of APS--Redemption." The APS Basic
Maintenance Amount includes the sum of (i) the aggregate liquidation value of
APS then outstanding and (ii) certain accrued and projected payment obligations
of the Fund.
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by [ ] and [ ] . Failure to adopt
any such modifications, however, may result in a change in the ratings described
above or a withdrawal of ratings altogether. In addition, any rating agency
providing a rating for the APS, at any time, may change or withdraw any such
rating. As set forth in the Amended By-Laws, the Fund's Board of Trustees,
without shareholder approval, may modify certain definitions or restrictions
29
that have been adopted by the Fund pursuant to the rating agency guidelines,
provided the Board of Trustees has obtained written confirmation from [ ] that
any such change would not impair the ratings then assigned by [ ] or [ ] to the
APS.
[As recently described by [ ] and [ ] , a preferred shares rating is an
assessment of the capacity and willingness of an issuer to pay preferred shares
obligations.] The ratings on the APS are not recommendations to purchase, hold
or sell APS, inasmuch as the ratings do not comment as to market price or
suitability for a particular investor, nor do the rating agency guidelines
described above address the likelihood that a holder of APS will be able to sell
such shares in an Auction. The ratings are based on current information
furnished to [ ] and [ ] by the Fund and the Adviser and information obtained
from other sources. The ratings may be changed, suspended or withdrawn as a
result of changes in, or the unavailability of, such information. The Common
Shares have not been rated by a rating agency.
A rating agency's guidelines will apply to the Fund's APS only so long as such
agency is rating such shares. The Fund will pay certain fees to each rating
agency that rates the Fund's APS.
VOTING RIGHTS
Except as otherwise indicated in this Prospectus and except as otherwise
required by applicable law, holders of APS of the Fund will be entitled to one
vote per share on each matter submitted to a vote of shareholders and will vote
together with holders of Common Shares and other Preferred Shares of that Fund
as a single class.
In connection with the election of the Fund's Trustees, holders of the APS and
any other Preferred Shares, voting as a separate class, shall be entitled at all
times to elect two of the Fund's Trustees, and the remaining Trustees will be
elected by holders of Common Shares and APS and any other Preferred Shares,
voting together as a single class. In addition, if at any time dividends on
outstanding APS shall be unpaid in an amount equal to at least two full years'
dividends thereon or if at any time holders of any shares of Preferred Shares
are entitled, together with the holders of APS, to elect a majority of the
Trustees of the Fund under the 1940 Act, then the number of Trustees
constituting the Board of Trustees automatically shall be increased by the
smallest number that, when added to the two Trustees elected exclusively by the
holders of APS and any other Preferred Shares as described above, would
constitute a majority of the Board of Trustees as so increased by such smallest
number, and at a special meeting of shareholders which will be called and held
as soon as practicable, and at all subsequent meetings at which Trustees are to
be elected, the holders of the APS and any other Preferred Shares, voting as a
separate class, will be entitled to elect the smallest number of additional
Trustees that, together with the two Trustees which such holders in any event
will be entitled to elect, constitutes a majority of the total number of
Trustees of the Fund as so increased. The terms of office of the persons who are
Trustees at the time of that election will continue. If the Fund thereafter
shall pay, or declare and set apart for payment in full, all dividends payable
on all outstanding APS and any other Preferred Shares for all past Dividend
Periods, the additional voting rights of the holders of APS and any other
Preferred Shares as described above shall cease, and the terms of office of all
of the additional Trustees elected by the holders of APS and any other Preferred
Shares (but not of the Trustees with respect to whose election the holders of
Common Shares were entitled to vote or the two Trustees the holders of APS and
any other Preferred Shares have the right to elect in any event) will terminate
automatically.
The affirmative vote of a majority of the votes entitled to be cast by holders
of outstanding APS and any other Preferred Shares, voting as a separate class,
will be required to (i) authorize, create or issue any class or series of shares
ranking prior to the APS or any other series of Preferred Shares with respect to
the payment of dividends or the distribution of assets on liquidation; provided,
however, that no vote is required to authorize the issuance of another class of
Preferred Shares which are substantially identical in all respects to the APS or
(ii) amend, alter or repeal the provisions of the Declaration of Trust or the
Amended By-Laws, 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 the Amended By-Laws of holders of APS or any other
Preferred Shares. To the extent permitted under the 1940 Act, in the event
shares of more than one series of APS are outstanding, the Fund 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 of a
holder of shares of a series of APS differently than those of a holder of shares
of any other series of APS without the affirmative vote of at least a majority
of votes entitled to be cast by holders of APS of each series adversely affected
and outstanding at such time (each such adversely affected series voting
separately as a class). The Board of Trustees, however, without shareholder
approval, may amend, alter or repeal any or all of the various rating agency
guidelines described herein in the event the Fund receives confirmation from the
rating agencies that any such amendment, alteration or repeal would not impair
the ratings then assigned to the APS. Unless a higher percentage is provided for
under "Certain provisions in the Declaration of Trust," the affirmative vote of
a majority of the votes entitled to be cast by holders of outstanding APS and
any other Preferred Shares, voting as a separate 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 including, among other things, changes in the
Fund's investment objective or changes in the investment restrictions described
30
as fundamental policies under "Investment objectives and policies." The class
vote of holders of APS and any other Preferred Shares described above in each
case will be in addition to a separate vote of the requisite percentage of
Common Shares and APS and any other Preferred Shares, voting together as a
single class, necessary to authorize the action in question.
The foregoing voting provisions will not apply to the APS if, at or prior to the
time when the act with respect to which such vote otherwise would be required
shall be effected, such shares shall have been (i) redeemed or (ii) called for
redemption and sufficient funds shall have been deposited in trust to effect
such redemption.
THE AUCTIONS
GENERAL
Holders of the APS will be entitled to receive cumulative cash dividends on
their shares when, as and if declared by the Board of Trustees of the Fund, out
of the funds legally available therefor, on the Initial Dividend Payment Date
with respect to the Initial Dividend Period and, thereafter, on each Dividend
Payment Date with respect to a Subsequent Dividend Period (generally a period of
seven days subject to certain exceptions set forth under "Description of
APS--Dividends and Dividend Periods--General") at the rate per annum equal to
the Applicable Rate for each such Dividend Period.
The provisions of the Amended By-Laws establishing the terms of the APS offered
hereby will provide that the Applicable Rate for each Dividend Period after the
Initial Dividend Period therefor will be equal to the rate per annum that the
Auction Agent advises has resulted on the Business Day preceding the first day
of such Dividend Period due to implementation of the auction procedures set
forth in the Amended By-Laws (the "Auction Procedures") in which persons
determine to hold or offer to purchase or sell the APS. The Amended Bylaws,
which contain the Auction Procedures, are attached as Appendix B to the Fund's
Statement of Additional Information. Each periodic operation of such procedures
with respect to the APS is referred to hereinafter as an "Auction." If, however,
the Fund should fail to pay or duly provide for the full amount of any dividend
on or the redemption price of the APS called for redemption, the Applicable Rate
for the APS will be determined as set forth under "Description of APS--Dividends
and Dividend Periods--Determination of Dividend Rate."
AUCTION AGENT AGREEMENT
The Fund will enter into an agreement (the "Auction Agent Agreement") with [ ]
("Auction Agent" and together with any successor bank or trust company or other
entity entering into a similar agreement with the Fund, the "Auction Agent"),
which provides, among other things, that the Auction Agent will follow the
Auction Procedures for the purpose of determining the Applicable Rate for the
APS. The Fund will pay the Auction Agent compensation for its services under the
Auction Agent Agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice to the
Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will use its best efforts to
enter into an agreement with a successor Auction Agent containing substantially
the same terms and conditions as the Auction Agent Agreement. The Fund may
terminate the Auction Agent Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
In addition to serving as the Auction Agent, Auction Agent will be the transfer
agent, registrar, dividend disbursing agent and redemption agent for the APS.
The Auction Agent, however, will serve merely as the agent of the Fund, acting
in accordance with the Fund's instructions, and will not be responsible for any
evaluation or verification of any matters certified to it.
BROKER-DEALER AGREEMENTS
The Auctions require the participation of one or more broker-dealers. The
Auction Agent will enter into agreements with [UBS Warburg LLC, , , and .] with
respect to the Fund and may enter into similar agreements (collectively, the
"Broker-Dealer Agreements") with one or more other broker-dealers (collectively,
the "Broker-Dealers") selected by the Fund, which provide for the participation
of such Broker-Dealers in Auctions. A Broker-Dealer Agreement may be terminated
by the Auction Agent or a Broker-Dealer on five days' notice to the other party,
provided that the Broker-Dealer Agreement with [UBS Warburg LLC, , , and .] may
not be terminated without the prior written consent of the Fund, which consent
may not be unreasonably withheld.
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price of
31
APS placed by such Broker-Dealer at such Auction. The service charge (i) for any
7-Day Dividend Period shall be payable at the annual rate of 0.25% of the
purchase price of the APS placed by such Broker-Dealer in any such Auction and
(ii) for any Special Dividend Period shall be determined by mutual consent of
the Fund and any such Broker-Dealer or Broker-Dealers and shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar final maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction. For the purposes of the preceding sentence, the APS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by such
Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
shares as a result of the Auction, (B) a Submitted Bid of a Potential Beneficial
Owner that resulted in such Potential Beneficial Owner purchasing such shares as
a result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders in
Auctions for its own account, unless the Fund notifies all Broker-Dealers that
they no longer may do so; provided that Broker-Dealers may continue to submit
Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its own
account in any Auction of APS, it may have knowledge of Orders placed through it
in that Auction and therefore have an advantage over other Bidders, but such
Broker-Dealer would not have knowledge of Orders submitted by other
Broker-Dealers in that Auction.
SECURITIES DEPOSITORY
The Depository Trust Company initially will act as the Securities Depository for
the Agent Members with respect to the APS. One or more registered certificates
for all of the shares of each series of APS initially will be registered in the
name of Cede & Co., as nominee of the Securities Depository. The certificate
will bear a legend to the effect that such certificate is issued subject to the
provisions restricting transfers of the APS contained in the Amended By-Laws.
Cede & Co. initially will be the holder of record of all APS, and Beneficial
Owners will not be entitled to receive certificates representing their ownership
interest in such shares. The Securities Depository will maintain lists of its
participants and will maintain the positions (ownership interests) of the APS
held by each Agent Member, whether as the Beneficial Owner thereof for its own
account or as nominee for the Beneficial Owner thereof. Payments made by the
Fund to holders of APS will be duly made by making payments to the nominee of
the Securities Depository.
AUCTION PROCEDURES
The following is a brief summary of the procedures to be used in conducting
Auctions. This summary is qualified by reference to the Amended By-Laws set
forth in Appendix B to the Fund's Statement of Additional Information.
AUCTION DATE
An Auction to determine the Applicable Rate for the APS offered hereby for each
Dividend Period for such shares (other than the Initial Dividend Period
therefor) will be held on the last Business Day preceding the first day of such
Dividend Period, which first day is also the Dividend Payment Date for the
preceding Dividend Period (the date of each Auction being referred to herein as
an "Auction Date").
The Auction Date and the first day of the related Dividend Period (both of which
must be Business Days) need not be consecutive calendar days. See "Description
of APS--Dividends and Dividend Periods" for information concerning the
circumstances under which a Dividend Payment Date may fall on a date other than
the days specified above, which may affect the Auction Date.
ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS, EXISTING HOLDERS AND
POTENTIAL HOLDERS
On or prior to each Auction Date for a series of APS:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone orders
("Orders") with respect to a series of APS as follows:
(i) Hold Order--indicating the number of outstanding APS, if any, that such
Beneficial Owner desires to continue to hold without regard to the Applicable
Rate for the next Dividend Period for such shares;
(ii) Bid--indicating the number of outstanding APS, if any, that such
Beneficial Owner desires to continue to hold, provided that the Applicable
32
Rate for the next Dividend Period for such shares is not less than the rate
per annum then specified by such Beneficial Owner; and/or
(iii) Sell Order--indicating the number of outstanding APS, if any, that such
Beneficial Owner offers to sell without regard to the Applicable Rate for the
next Dividend Period for such shares; and
(b) Broker-Dealers will contact customers who are Potential Beneficial Owners
of APS to determine whether such Potential Beneficial Owners desire to submit
Bids indicating the number of APS which they offer to purchase provided that
the Applicable Rate for the next Dividend Period for such shares is not less
than the rates per annum specified in such Bids.
A Beneficial Owner or a 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" and collectively as "Bidders." Any Order submitted by
a Beneficial Owner or a Potential Beneficial Owner to its Broker- Dealer, or by
a Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to APS then held by such Beneficial Owner, as well as Bids for
additional APS. For information concerning the priority given to different types
of Orders placed by Beneficial Owners, see "Submission of Orders by Broker-
Dealers to Auction Agent" below.
The Maximum Applicable Rate for the APS will be the Applicable Percentage of the
Reference Rate. The Auction Agent will round each applicable Maximum Applicable
Rate to the nearest one-thousandth (0.001) 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 (0.001) of one percent. The Auction Agent will not
round the applicable Reference Rate as part of its calculation of the Maximum
Applicable Rate.
The Maximum Applicable Rate for the APS will depend on the credit rating or
ratings assigned to such shares. The Applicable Percentage will be determined
based on (i) the credit ratings assigned on such date to such shares by [ ] and
[ ] (or if either shall not make such rating available, the equivalent of such
rating by a Substitute Rating Agency), and (ii) whether the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS as follows:
APPLICABLE PERCENTAGE
PERCENTAGE OF OF
[ ] CREDIT REFERENCE RATE-- REFERENCE RATE--
RATINGS NO NOTIFICATION NOTIFICATION
---------- --------------- ----------------------
AA--or higher................ % %
A--to A+.....................
BBB--to BBB+.................
Below BBB--...................
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable [ ] and [ ] to
provide a rating for the APS. If [ ] or [ ] shall not make such a rating
available, the Underwriters or their affiliates and successors, after
consultation with the Fund, will select another rating agency (a "Substitute
Rating Agency") to act as a Substitute Rating Agency.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "Acceptance and
rejection of Submitted Bids and Submitted Sell Orders and allocation of Shares."
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to comply with the foregoing. A Broker-Dealer also may hold APS in its
own account as a Beneficial Owner. A Broker-Dealer thus may 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. Any Order placed with the Auction Agent
by a Broker-Dealer as or on behalf of a Beneficial Owner or a Potential
Beneficial Owner will be treated in the same manner as an Order placed with a
Broker-Dealer by a Beneficial Owner or a Potential Beneficial Owner. Similarly,
33
any failure by a Broker-Dealer to submit to the Auction Agent an Order in
respect of any APS held by it or its customers who are Beneficial Owners will be
treated in the same manner as a Beneficial Owner's failure to submit to its
Broker-Dealer an Order in respect of APS held by it, as described in the next
paragraph. 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 thereby. For information concerning the priority
given to different types of Orders placed by Existing Holders, see "Submission
of Orders by Broker-Dealers to Auction Agent." Each purchase or sale in an
Auction will be settled on the Business Day next succeeding the Auction Date at
a price per share equal to $25,000. See "Notification of results; Settlement."
If one or more Orders covering in the aggregate all of the outstanding APS held
by a Beneficial Owner are not submitted to the Auction Agent prior to the
Submission Deadline, either because a Broker-Dealer failed to contact such
Beneficial Owner or otherwise, the Auction Agent shall deem a Hold Order (in the
case of an Auction relating to a Dividend Period of 91 days or less) and 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 Beneficial Owner covering
the number of outstanding the APS held by such Beneficial Owner and not subject
to Orders submitted to the Auction Agent.
If all of the outstanding APS are subject to Submitted Hold Orders, the Dividend
Period next succeeding the Auction automatically shall be the same length as the
immediately preceding Dividend Period, and the Applicable Rate for the next
Dividend Period for all the APS will be 40% of the Reference Rate on the date of
the applicable Auction (or 60% of such rate if the Fund has provided
notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS).
For the purposes of an Auction, the APS for which the Fund shall have given
notice of redemption and deposited moneys therefor with the Auction Agent in
trust or segregated in an account at the Fund's custodian bank for the benefit
of the Auction Agent, as set forth under "Description of APS--Redemption," will
not be considered as outstanding and will not be included in such Auction.
Pursuant to the Amended By-Laws of the Fund, the Fund will be prohibited from
reissuing and its affiliates (other than the Underwriter) will be prohibited
from transferring (other than to the Fund) any APS they may acquire. Neither the
Fund nor any affiliate of the Fund (other than the Underwriter) may submit an
Order in any Auction, except that an affiliate of the Fund that is a
Broker-Dealer may submit an Order.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT
Prior to 1:30 p.m., New York City time, on each Auction Date, or such other time
on the Auction Date as may be specified by the Auction Agent (the "Submission
Deadline"), each Broker-Dealer will submit to the Auction Agent in writing all
Orders obtained by it for the Auction to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the APS subject to such Orders. Any
Order submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline on any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures to
the right of the decimal point, the Auction Agent will round such rate per annum
up to the next highest one-thousandth (0.001) of 1%. If one or more Orders of an
Existing Holder are submitted to the Auction Agent and such Orders cover in the
aggregate more than the number of outstanding APS held by such Existing Holder,
such Orders will be considered valid in the following order of priority:
(i) any Hold Order will be considered valid up to and including the number of
outstanding APS held by such Existing Holder, provided that if more than one
Hold Order is submitted by such Existing Holder and the number of APS subject
to such Hold Orders exceeds the number of outstanding APS held by such
Existing Holder, the number of APS subject to each of such Hold Orders will
be reduced pro rata so that such Hold Orders, in the aggregate, will cover
exactly the number of outstanding APS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such Existing
Holder, up to and including the excess of the number of outstanding APS held
by such Existing Holder over the number of outstanding APS subject to any
Hold Order referred to in clause (i) above (and if more than one Bid
submitted by 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 clause (i) above and of the
foregoing portion of this clause (ii) to any Bid or Bids specifying a lower
rate or rates per annum, the number of shares subject to each of such Bids
will be reduced pro rata so that such Bids, in the aggregate, cover exactly
such remaining number of outstanding shares); and the number of outstanding
34
shares, if any, subject to Bids not valid under this clause (ii) shall be
treated as the subject of a Bid by a Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the excess
of the number of outstanding APS held by such Existing Holder over the sum of
the number of APS subject to Hold Orders referred to in clause (i) above and
the number of APS subject to valid Bids by such Existing Holder referred to
in clause (ii) above; provided that, if more than one Sell Order is submitted
by any Existing Holder and the number of APS subject to such Sell Orders is
greater than such excess, the number of APS subject to each of such Sell
Orders will be reduced pro rata so that such Sell Orders, in the aggregate,
will cover exactly the number of APS equal to such excess.
If more than one Bid of any Potential Holder is submitted in any Auction, each
Bid submitted in such Auction will be considered a separate Bid with the rate
per annum and number of APS therein specified.
DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE RATE
Not earlier than the Submission Deadline for each Auction, the Auction Agent
will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such "Hold Order," "Bid" or "Sell Order" as submitted or
deemed submitted by a Broker-Dealer hereinafter being referred to as a
"Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as the
case may be, or as a "Submitted Order") and will determine the excess of the
number of outstanding APS over the number of outstanding APS subject to
Submitted Hold Orders (such excess being referred to as the "Available APS") and
whether Sufficient Clearing Bids have been made in such Auction. Sufficient
Clearing Bids will have been made if the number of outstanding APS that are the
subject of Submitted Bids of Potential Holders with rates per annum not higher
than the Maximum Applicable Rate equals or exceeds the number of outstanding
shares that are the subject of Submitted Sell Orders (including the number of
shares subject to Bids of Existing Holders specifying rates per annum higher
than the Maximum Applicable Rate). If Sufficient Clearing Bids have been made,
the Auction Agent will determine the lowest rate per annum specified in the
Submitted Bids (the "Winning Bid Rate") which would result in the number of
shares subject to Submitted Bids specifying such rate per annum or a lower rate
per annum being at least equal to the Available APS. If Sufficient Clearing Bids
have been made, the Winning Bid Rate will be the Applicable Rate for the next
Dividend Period for the APS then outstanding. If Sufficient Clearing Bids have
not been made (other than because all outstanding APS are the subject of
Submitted Hold Orders), the Dividend Period next following the Auction
automatically will be a 7-Day Dividend Period, and the Applicable Rate for such
Dividend Period will be equal to the Maximum Applicable Rate.
If Sufficient Clearing Bids have not been made, Beneficial Owners that have
Submitted Sell Orders will not be able to sell in the Auction all, and may not
be able to sell any, of the APS subject to such Submitted Sell Orders. See
"Acceptance and rejection of Submitted Bids and Submitted Sell Orders and
allocation of Shares." Thus, under some circumstances, Beneficial Owners may not
have liquidity of investment.
ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARE
Based on the determinations described under "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and subject to the
discretion of the Auction Agent to round, the Auction Procedures include a pro
rata allocation of shares for purchase and sale, which may result in an Existing
Holder continuing to hold or selling or a Potential Holder purchasing, a number
of shares of a series of APS that is fewer than the number of shares of such
series specified in its Order. To the extent the allocation procedures have that
result, Broker-Dealers that have designated themselves as Existing Holders or
Potential Holders in respect of customer Orders will be required to make
appropriate pro rata allocations among their respective customers. See the
Fund's Amended By-Laws set forth in Appendix E to the Fund's Statement of
Additional Information.
NOTIFICATION OF RESULTS; SETTLEMENT
The Auction Agent will advise each Broker-Dealer who submitted a Bid or Sell
Order in an Auction whether such Bid or Sell Order was accepted or rejected in
whole or in part and of the Applicable Rate for the next Dividend Period for the
related APS by telephone at approximately 3:00 p.m., New York City time, on the
Auction Date for such Auction. Each such Broker-Dealer that submitted an Order
for the account of a customer then will advise such customer whether such Bid or
Sell Order was accepted or rejected, will confirm purchases and sales with each
customer purchasing or selling APS as a result of the Auction and will advise
each customer purchasing or selling APS to give instructions to its Agent Member
of the Securities Depository to pay the purchase price against delivery of such
shares or to deliver such shares against payment therefor as appropriate.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
35
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of APS as determined in such Auction.
Purchasers will make payment through their Agent Members in same-day funds to
the Securities Depository against delivery through their Agent Members; the
Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to APS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for the APS are not held by the Securities
Depository or its nominee, payment will be made in same-day funds to the Auction
Agent against delivery of such certificates.
The following is a simplified example of how a typical Auction works. Assume
that the Fund has 1,000 outstanding APS and three current holders. The three
current holders and three potential holders submit orders through Broker-Dealers
at the Auction:
Current Holder A............ Owns 500 shares, wants Bid order of 2.1%
to sell all 500 shares rate for all 500 shares
if Applicable Rate is
less than 2.1%
Current Holder B............ Owns 300 shares, wants Hold Order--will take
to hold the Applicable Rate
Current Holder C............ Owns 200 shares, wants Bid order of 1.9%
to sell all 200 shares rate for all 200 shares
if Applicable Rate is
less than 1.9%
Potential Holder D.......... Wants to buy 200 shares Places order to buy
at or above 2.0%
Potential Holder E.......... Wants to buy 300 shares Places order to buy
at or above 1.9%
Potential Holder F.......... Wants to buy 200 shares Places order to buy
at or above 2.1%
The lowest dividend rate that will result in all 1,000 APS continuing to be held
is 2.0% (the offer by D). Therefore, the Applicable Rate will be 2.0%. Current
Holders B and C will continue to own their shares. Current Holder A will sell
its shares because A's dividend rate bid was higher than the Applicable Rate.
Potential Holder D will buy 200 shares and Potential Holder E will buy 300
shares because their bid rates were at or below the Applicable Rate. Potential
Holder F will not buy shares because its bid rate was above the Applicable Rate.
SECONDARY MARKET TRADING AND TRANSFER OF APS
The Broker-Dealers may maintain a secondary trading market in the APS outside of
Auctions; however, they have no obligation to do so and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (I.E.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. An increase in the level of interest rates,
particularly during any Long-Term Dividend Period, likely will have an adverse
effect on the secondary market price of the APS, and a selling shareholder may
sell APS between Auctions at a price per share of less than $25,000.
TAXES
GENERAL
The Fund intends to elect and to qualify for the special tax treatment afforded
regulated investment companies ("RICs") under the Code. As long as the Fund so
qualifies, in any taxable year in which it distributes at least 90% of the sum
of its investment company taxable income (consisting generally of taxable net
investment income, net short-term capital gain and net realized gains from
certain hedging transactions) and certain other income the Fund (but not its
shareholders) will not be subject to federal income tax to the extent that it
distributes its investment company taxable income and net capital gain (the
excess of net long-term capital gain over net short-term capital loss). The Fund
intends to distribute substantially all of such income and gain each year.
The APS will constitute stock of the Fund, and distributions by the Fund with
respect to its APS (other than distributions in redemption of APS that are
treated as exchanges of stock under Section 302(b) of the Code) thus will
constitute dividends to the extent of that Fund's current and accumulated
36
earnings and profits as calculated for federal income tax purposes. It is
possible, however, that the Internal Revenue Service (the "IRS") might take a
contrary position, asserting, for example, that the APS constitute debt of the
Fund. If this position were upheld, the discussion of the treatment of
distributions below would not apply. Instead, distributions by the Fund to
holders of APS would constitute interest, whether or not they exceeded the
earnings and profits of the Fund, would be included in full in the income of the
recipient and would be taxed as ordinary income. Kirkpatrick & Lockhart LLP,
counsel to the Fund, believes that such a position, if asserted by the IRS,
would be unlikely to prevail if the issue were properly litigated.
Distributions of any taxable net investment income and net short-term capital
gain will be taxable as ordinary income. Distributions of the Fund's net capital
gain, if any, will be taxable to shareholders as long-term capital gains,
regardless of the length of time they held their shares. Distributions, if any,
in excess of the Fund's earnings and profits will first reduce the adjusted tax
basis of a holder's shares and, after that basis has been reduced to zero, will
constitute capital gains to the shareholder (assuming the shares are held as a
capital asset).
Dividends and other distributions declared by the Fund in October, November or
December of any year and payable to shareholders of record on a date in any of
those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
The Fund will inform shareholders of the source and tax status of all
distributions promptly after the close of each calendar year. The IRS has taken
the position that if a RIC has more than one class of shares, it may designate
distributions made to each class in any year as consisting of no more than that
class's proportionate share of particular types of income for that year,
including ordinary income and net capital gain. A class's proportionate share of
a particular type of income for a year is determined according to the percentage
of total dividends paid by the RIC during that year to the class. Accordingly,
the Fund intends to designate a portion of its distributions as capital gain
dividends in compliance with the IRS position.
Although the matter is not free from doubt, due to the absence of direct
regulatory or judicial authority, in the opinion of Kirkpatrick & Lockhart LLP,
counsel to the Fund, under current law the manner in which the Fund intends to
allocate items of ordinary income and net capital gain among the Fund's Common
Shares and APS will be respected for federal income tax purposes. It is possible
that the IRS could disagree with counsel's opinion and attempt to reallocate the
Fund's net capital gain or other taxable income.
If at any time when APS are outstanding the Fund does not meet the asset
coverage requirements of the 1940 Act, the Fund will be required to suspend
distributions to holders of Common Shares until the asset coverage is restored.
See "Description of APS--Dividends and Dividend Periods--Restrictions on
Dividends and other payments." Such a suspension may prevent the Fund from
distributing at least 90% of the sum of its investment company taxable income
and certain other income and may, therefore, jeopardize the Fund's qualification
for taxation as a RIC. Upon any failure to meet the asset coverage requirements
of the 1940 Act, the Fund, in its sole discretion, may redeem APS in order to
maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its shareholders of failing to qualify for
treatment as a RIC. See "Description of APS--Redemption." There can be no
assurance, however, that any such action would achieve that objective.
Certain of the Fund's investment practices are subject to special Code
provisions that, among other things, may defer the use of certain losses of the
Fund and affect the holding period of securities held by the Fund and the
character of the gains or losses realized by the Fund. These provisions may also
require the Fund to recognize income or gain without receiving cash with which
to make distributions in the amounts necessary to satisfy the requirements for
maintaining RIC status and for avoiding income and excise taxes. The Fund will
monitor its transactions and may make certain tax elections in order to mitigate
the effect of these rules and prevent disqualification of the Fund as a RIC.
SALES OF APS
The sale of APS (including transfers in connection with a redemption or
repurchase of APS) will be a taxable transaction for federal income tax
purposes. A selling shareholder generally will recognize gain or loss equal to
the difference between the amount received and the holder's adjusted tax basis
in the APS. If the APS are held as a capital asset, the gain or loss will be a
capital gain or loss and will be long-term if the APS have been held for more
than one year. Any loss realized on a disposition of APS held for six months or
less will be treated as a long-term, rather than a short-term, capital loss to
the extent of any capital gain distributions received with respect to those APS.
A shareholder's holding period for APS is suspended for any periods during which
the shareholder's risk of loss is diminished as a result of holding one or more
other positions in substantially similar or related property, or through certain
options, sales contracts or short sales. Any loss realized on a sale or exchange
of APS will be disallowed to the extent those APS are replaced by other APS
37
within a period of 61 days beginning 30 days before and ending 30 days after the
date of disposition of the original APS. In that event, the basis of the
replacement APS will be adjusted to reflect the disallowed loss.
BACKUP WITHHOLDING
The Fund is required to withhold a percentage of all taxable dividends, capital
gain distributions and repurchase proceeds payable to any individuals and
certain other non-corporate shareholders who do not provide the Fund with a
correct taxpayer identification number. Such withholding from taxable dividends
and capital gain distributions is also required for such shareholders who fail
to provide certain certifications or otherwise are subject to backup
withholding. Backup withholding is not an additional tax. Any amounts withheld
from payments made to a shareholder may be refunded or credited against the
shareholder's U.S. federal income tax liability, provided that the required
information is furnished to the IRS.
DESCRIPTION OF CAPITAL STRUCTURE
The Fund is an unincorporated business trust established under the laws of the
Commonwealth of Massachusetts by an Agreement and Declaration of Trust dated
March 12, 2003 ("Declaration of Trust"). The Declaration of Trust provides that
the Trustees of the Fund may authorize separate classes of shares of beneficial
interest. The Trustees of the Fund have authorized an unlimited number of shares
of beneficial interest stock, par value $0.01 per share, all of which shares
were initially classified as Common Shares. The Declaration of Trust also
authorizes the issuance of an unlimited number of shares of beneficial interest
with preference rights, including Preferred Shares, having a par value of $0.01
per share, in one or more series, with rights as determined by the Board of
Trustees, by action of the Board of Trustees without the approval of the
Shareholders. For a description of the APS, see "Description of APS." The
following table shows the amount of (i) shares authorized, (ii) shares held by
the Fund for its own account and (iii) shares outstanding, for each class of
authorized securities of the Fund as of [ ], 2003.
AMOUNT
OUTSTANDING
(EXCLUSIVE OF
AMOUNT HELD BY AMOUNT HELD BY
FUND FOR ITS FUND FOR ITS OWN
TITLE OF CLASS AMOUNT AUTHORIZED OWN ACCOUNT ACCOUNT)
---------------------- ----------------- ----------------- -----------------
Common Shares................. Unlimited -0-
Auction Preferred Shares......
Series A.................... [ ] -0- -0-
Series B.................... [ ] -0- -0-
Series C.................... [ ] -0- -0-
Series D.................... [ ] -0- -0-
Series E.................... [ ] -0- -0-
Holders of Common Shares are entitled to share equally in dividends declared by
a Board of Trustees payable to holders of Common Shares and in the net assets of
the Fund available for distribution to holders of Common Shares after payment of
the preferential amounts payable to holders of any outstanding Preferred Shares.
Neither holders of Common Shares nor holders of Preferred Shares have
pre-emptive or conversion rights and Common Shares are not redeemable. 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, 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 holders of the Common
Shares. The Declaration of Trust provides that Shareholders are not liable for
any liabilities of the Fund, requires inclusion of a clause to that effect in
every agreement entered into by the Fund and indemnifies shareholders against
any such liability. Although shareholders of an unincorporated business trust
established under Massachusetts law, in certain limited circumstances, may be
held personally liable for the obligations of the Fund as though they were
general partners, the provisions of the Declaration of Trust described in the
foregoing sentence make the likelihood of such personal liability remote.
Holders of Common Shares are entitled to one vote for each share held and will
vote with the holders of any outstanding APS or other Preferred Shares on each
matter submitted to a vote of holders of Common Shares, except as described
under "Description of APS--Voting rights."
38
Shareholders are entitled to one vote for each share held. The Common Shares,
APS and any other Preferred Shares do not have cumulative voting rights, which
means that the holders of more than 50% of the Common Shares, APS and any other
Preferred Shares voting for the election of Trustees can elect all of the
Trustees standing for election by such holders, and, in such event, the holders
of the remaining Common Shares, APS and any other Preferred Shares will not be
able to elect any of such Trustees.
So long as any APS or any other Preferred Shares are outstanding, holders of
Common Shares will not be entitled to receive any dividends of or other
distributions from the Fund, unless at the time of such declaration, (1) all
accrued dividends on Preferred Shares or accrued interest on borrowings has been
paid and (2) the value of the Fund's total assets (determined after deducting
the amount of such dividend or other distribution), less all liabilities and
indebtedness of the Fund not represented by senior securities, is at least 300%
of the aggregate amount of such securities representing indebtedness and at
least 200% of the aggregate amount of securities representing indebtedness plus
the aggregate liquidation value of the outstanding Preferred Shares (expected to
equal the aggregate original purchase price of the outstanding Preferred Shares
plus redemption premium, if any, together with any accrued and unpaid dividends
thereon, whether or not earned or declared and on a cumulative basis). In
addition to the requirements of the 1940 Act, the Fund is required to comply
with other asset coverage requirements as a condition of the Fund obtaining a
rating of the Preferred Shares from a rating agency. These requirements include
an asset coverage test more stringent than under the 1940 Act. See "Description
of APS--Dividends and Dividend Periods--Restrictions on Dividends and other
payments."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The Common Shares of the Fund commenced trading on the AMEX on May 28, 2003. At
[ ], 2003, the net asset value per share of Common Shares and the closing price
per share of Common Shares on the AMEX were $[ ], and $[ ], respectively.
PREFERRED SHARES
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of Preferred Shares 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 holders of Common Shares nor holders of Preferred Shares have
pre-emptive rights to purchase any APS or any other Preferred Shares that might
be issued. It is anticipated that the net asset value per share of the APS will
equal its original purchase price per share plus accumulated dividends per
share.
CERTAIN PROVISIONS OF THE DECLARATIONS OF TRUST
ANTI-TAKEOVER PROVISIONS IN THE DECLARATION OF TRUST
The Declaration of Trust 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, and could have the effect of
depriving holders of Common Shares of an opportunity to sell their shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund. These provisions may have the effect of
discouraging attempts to acquire control of the Fund, which attempts could have
the effect of increasing the expenses of the Fund and interfering with the
normal operation of the Fund. The Board is divided into three classes, with the
term of one class expiring at each annual meeting of holders of Common Shares
and Preferred Shares. At each annual meeting, one class of Trustees is elected
to a three-year term. This provision could delay for up to two years the
replacement of a majority of the Board of Trustees. A Trustee may be removed
from office only for cause by a written instrument signed by the remaining
Trustees or by a vote of the holders of at least two-thirds of the class of
shares of the Fund that elected such Trustee and is entitled to vote on the
matter.
In addition, the Declaration of Trust requires the favorable vote of the holders
of at least 75% of the outstanding shares of each class of the Fund, voting as a
class, then entitled to vote to approve, adopt or authorize certain transactions
with 5%-or-greater holders of a class of shares and their associates, unless the
Board shall by resolution have approved a memorandum of understanding with such
holders, in which case normal voting requirements would be in effect. For
purposes of these provisions, a 5%-or-greater holder of a class of shares (a
"Principal Shareholder") refers to any person who, whether directly or
indirectly and whether alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding shares of any class of
beneficial interest of the Fund. The transactions subject to these special
approval requirements are: (i) the merger or consolidation of the Fund or any
subsidiary of the Fund with or into any Principal Shareholder; (ii) the issuance
of any securities of the Fund to any Principal Shareholder for cash; (iii) the
sale, lease or exchange of all or any substantial part of the assets of the Fund
to any Principal Shareholder (except assets having an aggregate fair market
value of less than $1,000,000, aggregating for the purpose of such computation
all assets sold, leased or exchanged in any series of similar transactions
39
within a twelve-month period); or (iv) the sale, lease or exchange to the Fund
or any subsidiary thereof, in exchange for securities of the Fund, of any assets
of any Principal Shareholder (except assets having an aggregate fair market
value of less than $1,000,000, aggregating for the purposes of such computation
all assets sold, leased or exchanged in any series of similar transactions
within a twelve-month period).
The Board has determined that provisions with respect to the Board and the 75%
voting requirements described above, which voting requirements are greater than
the minimum requirements under Massachusetts law or the 1940 Act, are in the
best interest of holders of Common Shares and Preferred Shares generally.
Reference should be made to the Declaration of Trust on file with the SEC for
the full text of these provisions.
CONVERSION TO OPEN-END FUND
The Fund may be converted to an open-end investment company at any time if
approved by the lesser of (i) two-thirds or more of the Fund's then outstanding
Common Shares and Preferred Shares (if any), each voting separately as a class,
or (ii) more than 50% of the then outstanding Common Shares and Preferred Shares
(if any), voting separately as a class if such conversion is recommended by at
least 75% of the Trustees then in office. If approved in the foregoing manner,
conversion of the Fund could not occur until 90 days after the Shareholders'
meeting at which such conversion was approved and would also require at least 30
days' prior notice to all Shareholders. The composition of the Fund's portfolio
likely would prohibit it from complying with regulations of the SEC applicable
to open-end investment companies. Accordingly, conversion likely would require
significant changes in the Fund's investment policies and liquidation of a
substantial portion of its relatively illiquid portfolio. Conversion of the Fund
to an open-end investment company also would require the redemption of any
outstanding Preferred Shares and could require the repayment of borrowings. The
Board believes, however, that the closed-end structure is desirable, given the
Fund's investment objective and policies. Investors should assume, therefore,
that it is unlikely that a Board would vote to convert the Fund to an open-end
investment company.
40
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Underwriting
The underwriters named below (the "Underwriters"), acting through UBS Warburg
LLC, 299 Park Avenue, New York, New York, [ ], and [ ] as lead managers and [ ]
and [ ] as their representatives (together with the lead managers, the
"Representatives"), have severally agreed, subject to the terms and conditions
of the Underwriting Agreement with the Fund and the Adviser, to purchase from
the Fund the number of APS set forth below their respective names. The
Underwriters are committed to purchase and pay for all of the Fund's APS if any
are purchased.
UNDERWRITER
-----------------------------------------------------
FUND UBS WARBURG LLC [ ] [ ] [ ]
------------- --------------- ----------- ------------ ------------
Series A.............
Series B.............
Series C.............
Series D.............
Series E.............
The Underwriters have advised the Fund that they propose initially to offer the
APS of the Fund to the public at the public offering price set forth on the
cover page of this Prospectus, and to certain dealers at such price less a
concession not in excess of $[ ] per share. The Underwriters may allow, and such
dealers may reallow, a discount not in excess of $[ ] per share to other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed. Investors must pay for any APS purchased
on or before [ ], 2003.
The Underwriters will act in Auctions as Broker-Dealers as set forth under "The
Auctions--General-- Broker-Dealer Agreements" and will be entitled to fees for
services as Broker-Dealers as set forth therein. The Underwriters also may
provide information to be used in ascertaining the Reference Rate.
The Fund anticipates that the Representatives and certain other Underwriters may
from time to time act as brokers and dealers in connection with the execution of
the Fund's portfolio transactions after they have ceased to be principal
underwriters of the Fund under the 1940 Act and, subject to certain conditions,
may act as such brokers while they are principal underwriters.
In connection with this offering, certain of the Underwriters or selected
dealers may distribute prospectuses electronically.
The Fund and the Adviser have agreed to indemnify the Underwriters against
certain liabilities including liabilities under the Securities Act of 1933, as
amended.
41
--------------------------------------------------------------------------------
SHAREHOLDER SERVICING AGENT, CUSTODIAN AND TRANSFER AGENT
Pursuant to a shareholder servicing agreement ("Shareholder Servicing
Agreement") between UBS Warburg LLC (the "Shareholder Servicing Agent") and
Eaton Vance, the Shareholder Servicing Agent will (i) undertake to make public
information pertaining to the Fund on an ongoing basis and to communicate to
investors and prospective investors the Fund's features and benefits (including
periodic seminars or conference calls, responses to questions from current or
prospective shareholders and specific shareholder contact where appropriate);
(ii) make available to investors and prospective investors market price, net
asset value, yield and other information regarding the Fund, if reasonably
obtainable, for the purpose of maintaining the visibility of the Fund in the
investor community; (iii) at the request of Eaton Vance, provide certain
economic research and statistical information and reports, if reasonably
obtainable, on behalf of the Fund, and consult with representatives and Trustees
of the Fund in connection therewith, which information and reports shall
include: (a) statistical and financial market information with respect to the
Fund's market performance and (b) comparative information regarding the Fund and
other closed-end management investment companies with respect to (1) the net
asset value of their respective shares, (2) the respective market performance of
the Fund and such other companies and (3) other relevant performance indicators;
and (iv) at the request of Eaton Vance, provide information to and consult with
the Board with respect to applicable modifications to dividend policies or
capital structure, repositioning or restructuring of the Fund, conversion of the
Fund to an open-end management investment company, liquidation or merger;
provided, however, that under the terms of the Shareholder Servicing Agreement,
the Shareholder Servicing Agent is not obligated to render any opinions,
valuations or recommendations of any kind or to perform any such similar
services. For these services, Eaton Vance will pay the Shareholder Servicing
Agent a fee computed weekly and payable quarterly equal on an annual basis up to
0.10% of the Fund's average weekly gross assets. Under the terms of the
Shareholder Servicing Agreement, the Shareholder Servicing Agent is relieved
from liability to Eaton Vance for any act or omission in the course of its
performances under the Shareholder Servicing Agreement in the absence of gross
negligence or willful misconduct by the Shareholder Servicing Agent. The
Shareholder Servicing Agreement will continue so long as the Advisory Agreement
remains in effect between the Fund and the Adviser or any successor in interest
or affiliate of the Adviser, as and to the extent that such Advisory Agreement
is renewed periodically in accordance with the 1940 Act.
Investors Bank & Trust Company ("IBT"), 200 Clarendon Street, Boston, MA 02116
is the custodian of the Fund and will maintain custody of the securities and
cash of the Fund. IBT maintains the Fund's general ledger and computes net asset
value per share at least weekly. IBT also attends to details in connection with
the sale, exchange, substitution, transfer and other dealings with the Fund's
investments, and receives and disburses all funds. IBT also assists in
preparation of shareholder reports and the electronic filing of such reports
with the SEC.
PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027 is the transfer agent and
dividend disbursing agent of the Fund.
LEGAL OPINIONS
Certain legal matters in connection with the APS will be passed upon for the
Fund by Kirkpatrick & Lockhart LLP, Boston, Massachusetts, and for the
Underwriters by Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago,
Illinois and its affiliated entities. Skadden, Arps, Slate, Meagher & Flom
(Illinois) and its affiliated entities may rely as to certain matters of
Massachusetts law on the opinion of Kirkpatrick & Lockhart LLP.
42
--------------------------------------------------------------------------------
INDEPENDENT AUDITORS
Deloitte & Touche LLP, Boston, Massachusetts, are the independent auditors for
the Fund and will audit the Fund's financial statements.
ADDITIONAL INFORMATION
The Prospectus and the Statement of Additional Information do not contain all of
the information set forth in the Registration Statement that the Fund has filed
with the SEC. The complete Registration Statement may be obtained from the SEC
upon payment of the fee prescribed by its rules and regulations. The Statement
of Additional Information can be obtained without charge by calling
1-800-225-6265.
Statements contained in this Prospectus 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 of which this Prospectus forms a part,
each such statement being qualified in all respects by such reference.
43
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TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
Additional investment information and restrictions..............................
Trustees and officers...........................................................
Investment advisory and other services..........................................
Determination of net asset value................................................
Portfolio trading...............................................................
Taxes...........................................................................
Other information...............................................................
Independent auditors............................................................
Independent auditors' report....................................................
Financial statements............................................................
Appendix A: Ratings of bonds....................................................
Appendix B: Amended By-Laws.....................................................
THE FUND'S PRIVACY POLICY
The Fund is committed to ensuring your financial privacy. This notice is being
sent to comply with privacy regulations of the Securities and Exchange
Commission. The Fund has in effect the following policy with respect to
nonpublic personal information about its customers:
o Only such information received from you, through application forms or
otherwise, and information about your Fund transactions will be collected.
o None of such information about you (or former customers) will be disclosed
to anyone, except as permitted by law (which includes disclosure to
employees necessary to service your account).
o Policies and procedures (including physical, electronic and procedural
safeguards) are in place that are designed to protect the confidentiality of
such information.
For more information about the Fund's privacy policies call 1-800-262-1122.
44
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GLOSSARY
"7-DAY DIVIDEND PERIOD" means a Dividend Period consisting of seven days.
"1940 ACT" means the Investment Company Act of 1940, as amended from time to
time.
"1940 ACT APS ASSET COVERAGE" has the meaning set forth on page [ ] of this
Prospectus.
"1940 ACT CURE DATE" has the meaning set forth on page [ ] of this Prospectus.
"ADVISER" means Eaton Vance Management.
"AGENT MEMBER" means the member of the Securities Depository that will act on
behalf of a Beneficial Owner of one or more APS or on behalf of a Potential
Beneficial Owner.
"ALTERNATE TREASURY BILL RATE" on any date means the Interest Equivalent of the
yield as calculated by reference to the arithmetic average of the bid price
quotations of the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as determined by bid
price quotations as of any time on the Business Day immediately preceding such
date, obtained from at least three recognized primary U.S. Government securities
dealers selected by the Auction Agent.
"AMENDED BY-LAWS" means the By-laws of the Fund, as amended [ ], 2003,
specifying the powers, preferences and rights of the APS. The Fund's Amended
By-Laws are contained in Appendix B to the Fund's Statement of Additional
Information.
"APPLICABLE PERCENTAGE" has the meaning set forth on page [ ] of this
Prospectus.
"APPLICABLE RATE" means the rate per annum at which cash dividends are payable
on APS for any Dividend Period.
"APS" means the Auction Preferred Shares with a par value of $0.01 per share and
a liquidation preference of $25,000 per share, plus an amount equal to
accumulated but unpaid dividends thereon (whether or not earned or declared), of
the Fund.
"APS BASIC MAINTENANCE AMOUNT" has the meaning set forth on page [ ] of this
Prospectus.
"APS BASIC MAINTENANCE CURE DATE" has the meaning set forth on page [ ] of this
Prospectus.
"AUCTION" means a periodic operation of the Auction Procedures.
"AUCTION AGENT" means [ ], unless and until another commercial bank, trust
company or other financial institution appointed by a resolution of the Board of
Trustees of the Fund or a duly authorized committee thereof enters into an
agreement with each to follow the Auction Procedures for the purpose of
determining the Applicable Rate and to act as transfer agent, registrar,
dividend disbursing agent and redemption agent for the APS.
"AUCTION AGENT AGREEMENT" means the agreement entered into between the Fund and
the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
"AUCTION DATE" has the meaning set forth on page [ ] of this Prospectus.
"AUCTION PROCEDURES" means the procedures for conducting Auctions set forth in
Section 10 of the Fund's Amended By-Laws contained in Appendix B to the Fund's
Statement of Additional Information.
"AVAILABLE APS" has the meaning specified in Paragraph 10(d)(i) of the Auction
Procedures.
"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 APS or a Broker-Dealer that holds APS for its own account.
45
"BID" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"BIDDER" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"BOARD OF TRUSTEES" or "BOARD" means the Board of Trustees of the Fund.
"BROKER-DEALER" means any broker-dealer, or other entity permitted by law to
perform the functions required of a Broker-Dealer in the Auction Procedures,
that has been selected by the Fund and has entered into a Broker-Dealer
Agreement with the Auction Agent that remains effective.
"BROKER-DEALER AGREEMENT" means an agreement entered into between the Auction
Agent and a Broker-Dealer, including UBS Warburg LLC, ,
, , and pursuant to which such Broker-Dealer agrees to follow
the Auction Procedures.
"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.
"CEDE & CO." means the nominee of DTC, and in whose name the shares of APS
initially will be registered.
"CODE" means the Internal Revenue Code of 1986, as amended.
"COMMON SHARES" means the Common Shares, par value $0.01 per share, of the Fund.
"DATE OF ORIGINAL ISSUE" means, with respect to each APS, the date on which such
share first is issued by the Fund.
"DECLARATION OF TRUST" means the Agreement and Declaration of Trust of the Fund.
"DISCOUNTED VALUE" of any asset of each means with respect to an [ ] Eligible
Asset, the quotient of the market value thereof divided by the applicable [ ]
Discount Factor.
"DIVIDEND PAYMENT DATE" has the meaning set forth on page [ ] of this
Prospectus.
"DIVIDEND PERIODS" has the meaning set forth on page [ ] of this Prospectus.
"DTC" means The Depository Trust Company.
"ELIGIBLE ASSETS" means [ ] Eligible Assets.
"EXISTING HOLDER" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of APS in the
records of the Auction Agent.
"FITCH" means Fitch Ratings or its successors.
"[ ] ELIGIBLE ASSETS" has the meaning set forth on page [ ]of this Prospectus.
"FUND" means each Eaton Vance Limited Duration Income Fund, a Massachusetts
business trust that is the issuer of APS.
"HOLD ORDER" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"IBT" means Investors Bank & Trust Company, the custodian of the Fund's assets.
"INITIAL DIVIDEND PAYMENT DATE" has the meaning set forth on the inside cover
page of this Prospectus.
"INITIAL DIVIDEND PERIOD" means, with respect to the APS, the period from and
including the Date of Original Issue to but excluding the Initial Dividend
Payment Date of the APS.
46
"IRS" means the Internal Revenue Service.
"LONG TERM DIVIDEND PERIOD" has the meaning set forth on page [ ] of this
Prospectus.
"MANDATORY REDEMPTION PRICE" has the meaning set forth on page [ ] of this
Prospectus.
"MARGINAL TAX RATE" means the maximum marginal federal income tax rate
applicable to an individual's or a corporation's ordinary income, whichever is
greater.
"MAXIMUM APPLICABLE RATE" has the meaning specified under "The Auction--Orders
by Beneficial Owners, Potential Beneficial Owners, Existing Holders and
Potential Holders" in this Prospectus.
"MOODY'S" means Moody's Investors Service, Inc. or its successors.
"[ ] ELIGIBLE ASSETS" has the meaning set forth on page [ ] of this Prospectus.
"NON-CALL PERIOD" has the meaning set forth under "Specific Redemption
Provisions" below.
"NON-PAYMENT PERIOD" has the meaning set forth on page [ ] of this Prospectus.
"NON-PAYMENT PERIOD RATE" has the meaning set forth on page [ ] of this
Prospectus.
"NOTICE OF REVOCATION" has the meaning set forth on page [ ] of this Prospectus.
"NOTICE OF SPECIAL DIVIDEND PERIOD" has the meaning set forth on page [ ] of
this Prospectus.
"OPTIONAL REDEMPTION PRICE" has the meaning set forth on page [ ] of this
Prospectus.
"ORDER" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"POTENTIAL BENEFICIAL OWNER" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of APS but that wishes to purchase
such shares, or that is a Beneficial Owner that wishes to purchase additional
APS.
"POTENTIAL HOLDER" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring APS (or, in the case of an Existing Holder, additional APS).
"PREFERRED SHARES" means preferred shares of beneficial interest, par value
$0.01 per share, of the Fund.
"PREMIUM CALL PERIOD" has the meaning set forth under "Specific Redemption
Provisions" below.
"REFERENCE RATE" means: (i) with respect to a Dividend Period or a Short Term
Dividend Period having 28 or fewer days, the higher of the applicable ["AA"
Composite Commercial Paper Rate] and the [ ], (ii) with respect to any Short
Term Dividend Period, having more than 28 but fewer than 183 days, the
applicable ["AA" Composite Commercial Paper Rate], (iii) with respect to any
Short Term Dividend Period having 183 or more but fewer than 364 days, the
applicable [U.S. Treasury Bill Rate] and (iv) with respect to any Long Term
Dividend Period, the applicable [U.S. Treasury Note Rate].
"REQUEST FOR SPECIAL DIVIDEND PERIOD" has the meaning set forth on page [ ] of
this Prospectus.
"RESPONSE" has the meaning set forth on page [ ] of this Prospectus.
"S&P" means Standard & Poor's, or its successors.
"[ ] ELIGIBLE ASSETS" has the meaning set forth on page [ ]of this Prospectus.
"SECURITIES DEPOSITORY" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
47
agrees to follow the procedures required to be followed by such securities
depository in connection with the APS.
"SELL ORDER" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"SHORT TERM DIVIDEND PERIOD" has the meaning set forth on page [ ] of this
Prospectus.
"SPECIAL DIVIDEND PERIOD" has the meaning set forth on page [ ] of this
Prospectus.
"SPECIFIC REDEMPTION PROVISIONS" means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a "Non-Call Period")
determined by the Board of Trustees of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during which the APS subject to such
Dividend Period shall not be subject to redemption at the option of the Fund and
(ii) a period (a "Premium Call Period"), consisting of a number of whole years
and determined by the Board of Trustees of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during each year of which the APS subject
to such Dividend Period shall be redeemable at the Fund's option at a price per
share equal to $25,000 plus accumulated but unpaid dividends plus a premium
expressed as a percentage of $25,000, as determined by the Board of Trustees of
the Fund after consultation with the Auction Agent and the Broker-Dealers.
"SUBMISSION DEADLINE" has the meaning specified in Subsection 10(a)(x) of the
Auction Procedures.
"SUBMITTED BID" has the meaning specified in Subsection 10(d)(i) of the Auction
Procedures.
"SUBMITTED HOLD ORDER" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"SUBMITTED ORDER" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"SUBMITTED SELL ORDER" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"SUBSEQUENT DIVIDEND PERIOD" means each Dividend Period after the Initial
Dividend Period.
"SUBSTITUTE RATING AGENCY" and "SUBSTITUTE RATING AGENCIES" shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations, respectively, selected by UBS
Warburg LLC, or its respective affiliates and successors, after consultation
with the Fund, to act as a substitute rating agency or substitute rating
agencies, as the case may be, to determine the credit ratings of the APS.
"SUFFICIENT CLEARING BIDS" has the meaning specified in Subsection 10(d)(i) of
the Auction Procedures.
"U.S. TREASURY BILL RATE" on any date means (i) the Interest Equivalent of the
rate on the actively traded Treasury Bill with a maturity most nearly comparable
to the length of the related Dividend Period, as such rate is made available on
a discount basis or otherwise by the Federal Reserve Bank of New York in its
Composite 3:30 p.m. Quotations for U.S. Government Securities report for such
Business Day, or (ii) if such yield as so calculated is not available, the
Alternate Treasury Bill Rate on such date.
"U.S. TREASURY NOTE RATE" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 p.m. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. "Alternate Treasury Note Rate" on
any date means the yield as calculated by reference to the arithmetic average of
the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
"VALUATION DATE" means, for purposes of determining whether the Fund is
maintaining the APS Basic Maintenance Amount, each Business Day commencing with
[ ], 2003.
"WINNING BID RATE" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
48
[EATON VANCE LOGO]
49
STATEMENT OF ADDITIONAL INFORMATION SUBJECT TO COMPLETION , 2003
--------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
, 2003
EATON VANCE LIMITED DURATION INCOME FUND
THE EATON VANCE BUILDING
255 STATE STREET
BOSTON, MASSACHUSETTS 02109
(800) 225-6265
TABLE OF CONTENTS
Page
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Additional investment information and restrictions.........................3
Trustees and officers.....................................................15
Investment advisory and other services....................................19
Determination of net asset value..........................................21
Portfolio trading.........................................................22
Taxes.....................................................................24
Other information.........................................................26
Independent auditors......................................................27
Independent Auditors' Report..............................................28
Statement Of Assets And Liabilities.......................................29
Notes to financial statements.............................................30
APPENDIX A: Ratings......................................................31
APPENDIX B: Amended By-Laws...............................................37
THIS STATEMENT OF ADDITIONAL INFORMATION ("SAI") IS NOT A PROSPECTUS AND IS
AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR
ACCOMPANIED BY THE PROSPECTUS OF EATON VANCE LIMITED DURATION INCOME FUND (THE
"FUND") DATED , 2003, AS SUPPLEMENTED FROM TIME TO TIME, WHICH IS INCORPORATED
HEREIN BY REFERENCE. THIS SAI SHOULD BE READ IN CONJUNCTION WITH SUCH
PROSPECTUS, A COPY OF WHICH MAY BE OBTAINED WITHOUT CHARGE BY CONTACTING YOUR
FINANCIAL INTERMEDIARY OR CALLING THE FUND AT 1-800-225-6265.
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT COMPLETE AND
MAY BE CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
STATEMENT OF ADDITIONAL INFORMATION, WHICH IS NOT A 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.
Capitalized terms used in this SAI and not otherwise defined have the meanings
given them in the Fund's Prospectus.
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
Primary investment strategies are described in the Prospectus. The following is
a description of the various investment policies that may be engaged in, whether
as a primary or secondary strategy, and a summary of certain attendant risks.
Eaton Vance may not buy any of the following instruments or use any of the
following techniques unless it believes that doing so will help to achieve the
Fund's investment objectives.
MORTGAGE-BACKED SECURITIES
GENERAL
The Fund's investments in mortgage-backed securities may include conventional
mortgage pass-through securities, floating rate mortgage-backed securities and
certain classes of multiple class CMOs (as described below). Mortgage-backed
securities differ from bonds in that the principal is paid back by the borrower
over the length of the loan rather than returned in a lump sum at maturity.
Government National Mortgage Association ("GNMA") Certificates and Federal
National Mortgage Association ("FNMA") Mortgage-Backed Certificates are
mortgage-backed securities representing part ownership of a pool of mortgage
loans. GNMA loans -- issued by lenders such as mortgage bankers, commercial
banks and savings and loan associations -- are either insured by the Federal
Housing Administration or guaranteed by the Veterans Administration. A "pool" or
group of such mortgages is assembled and, after being approved by GNMA, is
offered to investors through securities dealers. Once such pool is approved by
GNMA, the timely payment of interest and principal on the Certificates issued
representing such pool is guaranteed by the full faith and credit of the U.S.
Government. FNMA, a federally chartered corporation owned entirely by private
stockholders, purchases both conventional and federally insured or guaranteed
residential mortgages from various entities, including savings and loan
associations, savings banks, commercial banks, credit unions and mortgage
bankers, and packages pools of such mortgages in the form of pass-through
securities generally called FNMA Mortgage-Backed Certificates, which 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. GNMA Certificates
and FNMA Mortgage-Backed Certificates are called "pass-through" securities
because a pro rata share of both regular interest and principal payments, as
well as unscheduled early prepayments, on the underlying mortgage pool is passed
through monthly to the holder of the Certificate (i.e., the Fund). The Fund may
purchase GNMA Certificates, FNMA Mortgage-Backed Certificates and various other
mortgage-backed securities on a when-issued basis subject to certain limitations
and requirements.
The Federal Home Loan Mortgage Corporation ("FHLMC"), a corporate
instrumentality of the U.S. Government created by Congress for the purposes of
increasing the availability of mortgage credit for residential housing, issues
participation certificates ("PCs") representing undivided interest in FHLMC'S
mortgage portfolio. While FHLMC guarantees the timely payment of interest and
ultimate collection of the principal of its PCs, its PCs are not backed by the
full faith and credit of the U.S. Government. FHLMC PCs differ from GNMA
Certificates in that the mortgages underlying the PCs are monthly "conventional"
mortgages rather than mortgages insured or guaranteed by a federal agency or
instrumentality. However, in several other respects, such as the monthly
pass-through of interest and principal (including unscheduled prepayments) and
the unpredictability of future unscheduled prepayments on the underlying
mortgage pools, FHLMC PCs are similar to GNMA Certificates.
While it is not possible to accurately predict the life of a particular issue of
a mortgage-backed "pass-through" security held by the Fund, the actual life of
any such security is likely to be substantially less than the average final
maturities of the mortgage loans underlying the security. This is because
unscheduled early prepayments of principal on the security owned by the Fund
will result from the prepayment, refinancings or foreclosure of the underlying
mortgage loans in the mortgage pool. The Fund, when the monthly payments (which
may include unscheduled prepayments) on such a security are passed through to
it, may be able to reinvest them only at a lower rate of interest. Because of
the regular scheduled payments of principal and the early unscheduled
prepayments of principal, the mortgage-backed "pass-through" security is less
effective than other types of obligations as a means of "locking-in" attractive
2
long-term interest rates. As a result, this type of security may have less
potential for capital appreciation during periods of declining interest rates
than other U.S. Government securities of comparable maturities, although many
issues of mortgage-backed "pass-through" securities may have a comparable risk
of decline in market value during periods of rising interest rates. If such a
security has been purchased by the Fund at a premium above its par value, both a
scheduled payment of principal and an unscheduled prepayment of principal, which
would be made at par, will accelerate the realization of a loss equal to that
portion of the premium applicable to the payment or prepayment. If such a
security has been purchased by the Fund at a discount from its par value, both a
scheduled payment of principal and an unscheduled prepayment of principal will
increase current returns and will accelerate the recognition of income, which,
when distributed to Fund shareholders, will be taxable as ordinary income.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS")
The CMO classes in which the Fund may invest include sequential and parallel pay
CMOs, including planned amortization class and target amortization class
securities. CMOs are debt securities issued by the FHLMC and by financial
institutions and other mortgage lenders which are generally fully collateralized
by a pool of mortgages held under an indenture. The key feature of the CMO
structure is the prioritization of the cash flows from a pool of mortgages among
the several classes of CMO holders, thereby creating a series of obligations
with varying rates and maturities appealing to a wide range of investors. CMOs
generally are secured by an assignment to a trustee under the indenture pursuant
to which the bonds are issued of collateral consisting of a pool of mortgages.
Payments with respect to the underlying mortgages generally are made to the
trustee under the indenture. Payments of principal and interest on the
underlying mortgages are not passed through to the holders of the CMOs as such
(that is, the character of payments of principal and interest is not passed
through and therefore payments to holders of CMOs attributable to interest paid
and principal repaid on the underlying mortgages do not necessarily constitute
income and return of capital, respectively, to such holders), but such payments
are dedicated to payment of interest on and repayment of principal of the CMOs.
CMOs are issued in two or more classes or series with varying maturities and
stated rates of interest determined by the issuer. Senior CMO classes will
typically have priority over residual CMO classes as to the receipt of principal
and/or interest payments on the underlying mortgages. Because the interest and
principal payments on the underlying mortgages are not passed through to holders
of CMOs, CMOs of varying maturities may be secured by the same pool of
mortgages, the payments on which are used to pay interest to each class and to
retire successive maturities in sequence. CMOs are designed to be retired as the
underlying mortgages are repaid. In the event of sufficient early prepayments on
such mortgages, the class or series of CMO first to mature generally will be
retired prior to maturity. Therefore, although in most cases the issuer of CMOs
will not supply additional collateral in the event of such prepayments, there
will be sufficient collateral to secure CMOs that remain outstanding. Currently,
the Adviser will consider privately issued CMOs or other mortgage-backed
securities as possible investments for the Fund only when the mortgage
collateral is insured, guaranteed or otherwise backed by the U.S. Government or
one or more of its agencies or instrumentalities (e.g., insured by the Federal
Housing Administration or Farmers Home Administration or guaranteed by the
Administrator of Veterans Affairs or consisting in whole or in part of U.S.
Government securities).
RISKS OF CERTAIN MORTGAGE-BACKED AND INDEXED SECURITIES
Although not mortgage-backed securities, index amortizing notes and other
callable securities are subject to extension risk resulting from the issuer's
failure to exercise its option to call or redeem the notes before their stated
maturity date. The residual classes of CMOs are subject to both prepayment and
extension risk.
Other types of floating rate derivative debt securities present more complex
types of interest rate risks. For example, range floaters are subject to the
risk that the coupon will be reduced to below market rates if a designated
interest rate floats outside of a specified interest rate band or collar. Dual
index or yield curve floaters are subject to depreciation in the event of an
unfavorable change in the spread between two designated interest rates. The
market values of currency-linked securities may be very volatile and may decline
during periods of unstable currency exchange rates.
3
SENIOR LOANS
STRUCTURE OF SENIOR LOANS
A Senior 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 group of loan investors ("Loan Investors"). The
Agent typically administers and enforces the Senior Loan on behalf of the other
Loan Investors in the syndicate. In addition, an institution, typically but not
always the Agent, holds any collateral on behalf of the Loan Investors.
Senior Loans primarily include senior floating rate loans to corporations and
secondarily institutionally traded senior floating rate debt obligations issued
by an asset-backed pool, and interests therein. Loan interests primarily take
the form of assignments purchased in the primary or secondary market. Loan
interests may also take the form of participation interests in a Senior Loan.
Such loan interests may be acquired from U.S. or foreign commercial banks,
insurance companies, finance companies or other financial institutions who have
made loans or are Loan Investors or from other investors in loan interests.
The Fund typically purchases "Assignments" from the Agent or other Loan
Investors. The purchaser of an Assignment typically succeeds to all the rights
and obligations under the Loan Agreement of the assigning Loan Investor and
becomes a Loan Investor under the Loan Agreement with the same rights and
obligations as the assigning Loan Investor. 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 Loan Investor.
The Fund also may invest in "Participations." Participations by the Fund in a
Loan Investor's portion of a Senior Loan typically will result in the Fund
having a contractual relationship only with such Loan Investor, 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 Loan
Investor selling the Participation and only upon receipt by such Loan Investor
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 Loan Investors through set-off against the
Borrower and the Fund may not directly benefit from the collateral supporting
the Senior Loan in which it has purchased the Participation. As a result, the
Fund may assume the credit risk of both the Borrower and the Loan Investor
selling the Participation. In the event of the insolvency of the Loan Investor
selling a Participation, the Fund may be treated as a general creditor of such
Loan Investor. The selling Loan Investors and other persons interpositioned
between such Loan Investors and the Fund with respect to such Participations
will likely conduct their principal business activities in the banking, finance
and financial services industries. Persons engaged in such industries may be
more susceptible to, among other things, fluctuations in interest rates, changes
in the Federal Open Market Committee's monetary policy, governmental regulations
concerning such industries and concerning capital raising activities generally
and fluctuations in the financial markets generally.
The Fund will only acquire Participations if the Loan Investor selling the
Participation, and any other persons interpositioned between the Fund and the
Loan Investor, at the time of investment has outstanding debt or deposit
obligations rated investment grade (BBB or A-3 or higher by Standard & Poor's
Ratings Group ("S&P") or Baa or P-3 or higher by Moody's Investors Service, Inc.
("Moody's") or comparably rated by another nationally recognized rating agency)
or determined by the Adviser to be of comparable quality. Securities rated Baa
by Moody's have speculative characteristics. Long-term debt rated BBB by S&P is
regarded by S&P as having adequate capacity to pay interest and repay principal
and debt rated Baa by Moody's is regarded by Moody's as a medium grade
obligation, i.e., it is neither highly protected nor poorly secured. Commercial
paper rated A-3 by S&P indicates that S&P believes such obligations exhibit
adequate protection parameters but that adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the obligor to
meet its financial commitment on the obligation and issues of commercial paper
rated P-3 by Moody's are considered by Moody's to have an acceptable ability for
repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. 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.
4
LOAN COLLATERAL
In order to borrow money pursuant to a Senior Loan, a Borrower will frequently,
for the term of the Senior Loan, pledge collateral, including but not limited
to, (i) working capital assets, such as accounts receivable and inventory; (ii)
tangible fixed assets, such as real property, buildings and equipment; (iii)
intangible assets, such as trademarks and patent rights (but excluding
goodwill); and (iv) security interests in shares of stock of subsidiaries or
affiliates. In the case of Senior Loans made to non-public companies, the
company's shareholders or owners may provide collateral in the form of secured
guarantees and/or security interests in assets that they own. In many instances,
a Senior Loan may be secured only by stock in the Borrower or its subsidiaries.
Collateral may consist of assets that may not be readily liquidated, and there
is no assurance that the liquidation of such assets would satisfy fully a
Borrower's obligations under a Senior Loan.
CERTAIN FEES PAID TO THE FUND
In the process of buying, selling and holding Senior 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, amendment fees,
commissions and prepayment penalty fees. When the Fund buys a Senior Loan it may
receive a facility fee and when it sells a Senior 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 a Senior Loan. In
certain circumstances, the Fund may receive a prepayment penalty fee upon the
prepayment of a Senior Loan by a Borrower. Other fees received by the Fund may
include covenant waiver fees and covenant modification fees.
BORROWER COVENANTS
A Borrower must comply with various restrictive covenants contained in a loan
agreement or note purchase agreement between the Borrower and the holders of the
Senior Loan (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 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 Loan Investors directly, as the case may be, is normally an event of
acceleration; i.e., the Agent, or the Loan Investors directly, as the case may
be, has the right to call the outstanding Senior Loan. The typical practice of
an Agent or a Loan Investor in relying exclusively or primarily on reports from
the Borrower to monitor the Borrower's compliance with covenants may involve a
risk of fraud by the Borrower. In the case of a Senior Loan in the form of a
Participation, the agreement between the buyer and seller may limit the rights
of the holder 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 Senior 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 Senior 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 Loan Investors 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 Senior Loan usually does,
but is often not obligated to, notify holders of Senior Loans of any failures of
compliance. The Agent may monitor the value of the collateral and, if the value
of the collateral declines, may accelerate the Senior Loan, may give the
Borrower an opportunity to provide additional collateral or may seek other
protection for the benefit of the participants in the Senior 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 Senior Loan and other fees paid on a continuing basis. With respect to
Senior Loans for which the Agent does not perform such administrative and
5
enforcement functions, the Fund will perform such tasks on its own behalf,
although a collateral bank will typically hold any collateral on behalf of the
Fund and the other Loan Investors pursuant to the applicable Loan Agreement.
A financial institution's 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 Senior
Loans. However, if assets held by the Agent for the benefit of the Fund were
determined to be subject to the claims of the Agent's general creditors, the
Fund might incur certain costs and delays in realizing payment on a Senior Loan,
or suffer a loss of principal and/or interest. In situations involving
intermediate participants similar risks may arise.
PREPAYMENTS
Senior Loans will usually require, in addition to scheduled payments of interest
and principal, the prepayment of the Senior Loan from free cash flow, as defined
above. The degree to which Borrowers prepay Senior 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 Loan Investors, 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 Senior Loan
with the proceeds from the prepayment of the former. Prepayments generally will
not materially affect the Fund's performance because the Fund typically is able
to reinvest prepayments in other Senior Loans that have similar yields and
because receipt of such fees may mitigate any adverse impact on the Fund's
yield.
OTHER INFORMATION REGARDING SENIOR LOANS
From time to time the Adviser and its affiliates may borrow money from various
banks in connection with their business activities. Such banks may also sell
interests in Senior Loans to or acquire them from the Fund or may be
intermediate participants with respect to Senior Loans in which the Fund owns
interests. Such banks may also act as Agents for Senior Loans held by the Fund.
The Fund may acquire interests in Senior 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 Senior Loans of Borrowers that have
obtained bridge loans from other parties. A Borrower's 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 Borrower's perceived
creditworthiness.
The Fund will be subject to the risk that collateral securing a loan will
decline in value or have no value. Such a decline, whether as a result of
bankruptcy proceedings or otherwise, could cause the Senior 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
Senior Loans guaranteed by, or secured by assets of, shareholders or owners,
even if the Senior Loans are not otherwise collateralized by assets of the
Borrower; provided, however, that such guarantees are fully secured. 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 Senior Loan. On
occasions when such stock cannot be pledged, the Senior 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 the Senior Loan. However,
the Borrower's 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 Senior Loans and, indirectly, Senior Loans themselves.
If a Borrower becomes involved in bankruptcy proceedings, a court may invalidate
the Fund's security interest in the loan collateral or subordinate the Fund's
rights under the Senior Loan to the interests of the Borrower's unsecured
creditors or cause interest previously paid to be refunded to the Borrower. If a
court required interest to be refunded, it could negatively affect the Fund's
performance. 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
6
the Fund. For Senior Loans made in connection with a highly leveraged
transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of the 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 Fund's security interest in loan
collateral. If the Fund's security interest in loan collateral is invalidated or
the Senior Loan is subordinated to other debt of a Borrower in bankruptcy or
other proceedings, the Fund would have substantially lower recovery, and perhaps
no recovery on the full amount of the principal and interest due on the Loan.
The Fund may acquire warrants and other equity securities as part of a unit
combining a Senior Loan and equity securities of a Borrower or its affiliates.
The acquisition of such equity securities will only be incidental to the Fund's
purchase of a Senior Loan. The Fund may also acquire equity securities or debt
securities (including non-dollar denominated debt securities) issued in exchange
for a Senior Loan or issued in connection with the debt restructuring or
reorganization of a Borrower, or if such acquisition, in the judgment of the
Adviser, may enhance the value of a Senior Loan or would otherwise be consistent
with the Fund's investment policies.
DEBTOR-IN-POSSESSION FINANCING
The Fund may invest in debtor-in-possession financing (commonly called "DIP
financings"). DIP financings are arranged when an entity seeks the protections
of then bankruptcy court under chapter 11 of the U.S. Bankruptcy Code. These
financings allow the entity to continue its business operations while
reorganizing under chapter 11. Such financings are senior liens on unemcumbered
security (I.E., security not subject to other creditors claims. There is a risk
that the entity will not emerge from chapter 11 and be forced to liquidate its
assets under chapter 7 of the Bankruptcy Code. In such event, the Fund's only
recourse will be against the property securing the DIP financing.
LITIGATION INVOLVING EATON VANCE
On October 15, 2001, an amended consolidated complaint was filed in the United
States District Court for the District of Massachusetts against four Eaton Vance
closed-end interval funds (the "Interval Funds"); their Trustees and certain
officers of the Interval Funds; Eaton Vance, the Interval Funds' administrator;
Boston Management and Research, the Interval Funds' investment adviser; and
Eaton Vance Corp., the parent of Eaton Vance and Boston Management and Research.
The Complaint, framed as a class action, alleges that for the period between May
25, 1998 and March 5, 2001, the Interval Funds' assets were incorrectly valued
and certain matters were not properly disclosed, in violation of the federal
securities laws. The Complaint seeks unspecified damages. The named defendants
believe that the Complaint is without merit and are vigorously contesting the
lawsuit. Eaton Vance believes that the lawsuit is not likely to have a material
adverse affect on its ability to render services to the Fund.
REGULATORY CHANGES
To the extent that legislation or state or federal regulators that regulate
certain financial institutions impose additional requirements or restrictions
with respect to the ability of such institutions to make loans, particularly in
connection with highly leveraged transactions, the availability of Senior Loans
for investment may be adversely affected. Further, such legislation or
regulation could depress the market value of Senior Loans.
CREDIT QUALITY
Many Senior Loans in which the Fund may invest are of below investment grade
credit quality. Accordingly, these Senior Loans are subject to similar or
identical risks and other characteristics described below in relation to
Non-Investment Grade Bonds.
NON-INVESTMENT GRADE BONDS
Investments in Non-Investment Grade Bonds 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
7
principal and income risk, including the possibility of issuer default and
bankruptcy. Non-Investment Grade Bonds are regarded as predominantly speculative
with respect to the issuer's 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
Non-Investment Grade Bonds may be more complex than for issuers of higher
quality securities.
Non-Investment Grade Bonds 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 Non-Investment Grade Bond prices because the
advent of recession could lessen the ability of an issuer to make principal and
interest payments on its debt obligations. If an issuer of Non-Investment Grade
Bonds defaults, in addition to risking payment of all or a portion of interest
and principal, the Fund may incur additional expenses to seek recovery. In the
case of Non-Investment Grade Bonds structured as zero-coupon, step-up or
payment-in-kind securities, their market prices will normally be affected to a
greater extent by interest rate changes, and therefore tend to be more volatile
than securities which pay interest currently and in cash. Eaton Vance seeks to
reduce these risks through diversification, credit analysis and attention to
current developments in both the economy and financial markets.
The secondary market on which Non-Investment Grade Bonds are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market 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 Non-Investment
Grade Bonds, especially in a thinly traded market. When secondary markets for
Non-Investment Grade Bonds are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is no 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 these securities. The Fund will be more dependent on Eaton
Vance's research and analysis when investing in Non-Investment Grade Bonds.
Eaton Vance seeks to minimize the risks of investing in all securities through
in-depth credit analysis and attention to current developments in interest rate
and market conditions.
A general description of the ratings of securities by S&P, Fitch and Moody's is
set forth in Appendix A to this SAI. Such ratings represent these rating
organizations' 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 may have the same yield. For these reasons, the use of credit ratings as
the sole method of evaluating Non-Investment Grade Bonds can involve certain
risks. For example, credit ratings evaluate the safety or principal and interest
payments, not the market value risk of Non-Investment Grade Bonds. Also, credit
rating agencies may fail to change credit ratings in a timely fashion to reflect
events since the security was last rated. Eaton Vance does not rely solely on
credit ratings when selecting securities for the Fund, and develops its own
independent analysis of issuer credit quality.
In the event that a rating agency or Eaton Vance downgrades its assessment of
the credit characteristics of a particular issue, the Fund is not required to
dispose of such security. In determining whether to retain or sell a downgraded
security, Eaton Vance may consider such factors as Eaton Vance's 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 the creditworthiness of issuers of
Non-Investment Grade Bonds may be more complex than for issuers of high quality
debt securities.
OTHER INVESTMENTS
FIXED INCOME SECURITIES
Fixed income securities include preferred, preference and convertible
securities, equipment lease certificates, equipment trust certificates and
conditional sales contracts. Preference stocks are stocks that have many
characteristics of preferred stocks, but are typically junior to an existing
class of preferred stocks. Equipment lease certificates are debt obligations
secured by leases on equipment (such as railroad cars, airplanes or office
8
equipment), with the issuer of the certificate being the owner and lessor of the
equipment. Equipment trust certificates are debt obligations secured by an
interest in property (such as railroad cars or airplanes), the title of which is
held by a trustee while the property is being used by the borrower. Conditional
sales contracts are agreements under which the seller of property continues to
hold title to the property until the purchase price is fully paid or other
conditions are met by the buyer.
Fixed-rate bonds may have a demand feature allowing the holder to redeem the
bonds at specified times. These bonds are more defensive than conventional
long-term bonds (protecting to some degree against a rise in interest rates)
while providing greater opportunity than comparable intermediate term bonds,
since they may be retained if interest rates decline. Acquiring these kinds of
bonds provides the contractual right to require the issuer of the bonds to
purchase the security at an agreed upon price, which right is contained in the
obligation itself rather than in a separate agreement or instrument. Since this
right is assignable only with the bond, it will not be assigned any separate
value.
Certain securities may permit the issuer at its option to "call," or redeem, the
securities. If an issuer were to redeem securities during a time of declining
interest rates, the Fund may not be able to reinvest the proceeds in securities
providing the same investment return as the securities redeemed.
The rating assigned to a security by a rating agency does not reflect assessment
of the volatility of the security's market value or of the liquidity of an
investment in the securities. Credit ratings are based largely on the issuer's
historical financial condition and the rating agency's investment analysis at
the time of rating, and the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition. Credit
quality in the high yield, high risk bond market can change from time to time,
and recently issued credit ratings may not fully reflect the actual risks posed
by a particular high yield security. In addition to lower rated securities, the
Fund also may invest in higher rated securities. For a description of corporate
bond ratings, see Appendix A.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements (the purchase of a security
coupled with an agreement to resell at a higher price) with respect to its
permitted investments. In the event of the bankruptcy of the other party to a
repurchase agreement, the Fund might experience delays in recovering its cash.
To the extent that, in the meantime, the value of the securities the Fund
purchased may have decreased, the Fund could experience a loss. Repurchase
agreements which mature in more than seven days will be treated as illiquid. The
Fund's repurchase agreements will provide that the value of the collateral
underlying the repurchase agreement will always be at least equal to the
repurchase price, including any accrued interest earned on the agreement, and
will be marked to market daily.
ZERO COUPONS BONDS
Zero coupon bonds are debt obligations which do not require the periodic payment
of interest and are issued at a significant discount from face value. The
discount approximates the total amount of interest the bonds will accrue and
compound over the period until maturity at a rate of interest reflecting the
market rate of the security at the time of issuance. The Fund is required to
accrue income from zero coupon bonds on a current basis, even though it does not
receive that income currently in cash and the Fund is required to distribute its
income for each taxable year. Thus, the Fund may have to sell other investments
to obtain cash needed to make income distributions.
INDEXED SECURITIES
The Fund may invest in securities that fluctuate in value with an index. Such
securities generally will either be issued by the U.S. Government or one of its
agencies or instrumentalities or, if privately issued, collateralized by
mortgages that are insured, guaranteed or otherwise backed by the U.S.
Government, its agencies or instrumentalities. The interest rate or, in some
cases, the principal payable at the maturity of an indexed security may change
positively or inversely in relation to one or more interest rates, financial
indices, securities prices or other financial indicators ("reference prices").
An indexed security may be leveraged to the extent that the magnitude of any
change in the interest rate or principal payable on an indexed security is a
multiple of the change in the reference price. Thus, indexed securities may
decline in value due to adverse market changes in reference prices. Because
indexed securities derive their value from another instrument, security or
index, they are considered derivative debt securities, and are subject to
9
different combinations of prepayment, extension, interest rate and/or other
market risks.
SHORT SALES
The Fund may utilize short sales for hedging purposes. A short sale is affected
by selling a security which the Fund does not own, or, if the Fund does own the
security, is not to be delivered upon consummation of the sale. The Fund may
engage in short sales "against the box" (I.E., short sales of securities the
Fund already owns) for hedging purposes. If the price of the security in the
short sale decreases, the Fund will realize a profit to the extent that the
short sale price for the security exceeds the market price. If the price of the
security increases, the Fund will realize a loss to the extent that the market
price exceeds the short sale price. Selling securities short runs the risk of
losing an amount greater than the initial investment therein.
Purchasing securities to close out the short position can itself cause the price
of the securities to rise further, thereby exacerbating the loss. Short-selling
exposes the Fund to unlimited risk with respect to that security due to the lack
of an upper limit on the price to which an instrument can rise. Although the
Fund reserves the right to utilize short sales, the Adviser is under no
obligation to utilize shorts at all.
FOREIGN INVESTMENTS
The Fund may invest up to 5% of its total assets in U.S. dollar denominated
securities of non-U.S. issuers. Because foreign companies are not subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to U.S. companies, there may be less
publicly available information about a foreign company than about a domestic
company. Volume and liquidity in most foreign debt markets is less than in the
United States and securities of some foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. There is generally less
government supervision and regulation of securities exchanges, broker-dealers
and listed companies than in the United States. Mail service between the United
States and foreign countries may be slower or less reliable than within the
United States, thus increasing the risk of delayed settlements of portfolio
transactions or loss of certificates for portfolio securities. Payment for
securities before delivery may be required. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments which
could affect investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in such
respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Foreign securities markets, while growing in volume and sophistication, are
generally not as developed as those in the United States, and securities of some
foreign issuers (particularly those located in developing countries) may be less
liquid and more volatile than securities of comparable U.S. companies.
American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) and
Global Depositary Receipts (GDRs) may be purchased. ADRs, EDRs and GDRs are
certificates evidencing ownership of shares of a foreign issuer and are
alternatives to directly purchasing the underlying foreign securities in their
national markets and currencies. However, they continue to be subject to many of
the risks associated with investing directly in foreign securities. These risks
include foreign exchange risk as well as the political and economic risks of the
underlying issuer's country. ADRs, EDRs and GDRs may be sponsored or
unsponsored. Unsponsored receipts are established without the participation of
the issuer. Unsponsored receipts may involve higher expenses, they may not
pass-through voting or other shareholder rights, and they may be less liquid.
OPTIONS
Call options may be purchased to provide exposure to increases in the market
(E.G., with respect to temporary cash positions) or to hedge against an increase
in the price of securities or other investments that the Fund intends to
purchase or has sold short. Similarly, put options may be purchased for
speculative purposes or to hedge against a decrease in the market generally or
in the price of securities or other investments held by the Fund. Buying options
may reduce the Fund's returns, but by no more than the amount of the premiums
paid for the options.
The Fund may write covered call options (I.E., where the Fund owns the security
or other investment that is subject to the call) to enhance returns when the
Adviser perceives that the option premium offered is in excess of the premium
10
that the Adviser would expect to be offered under existing market conditions, or
if the exercise price of the option is in excess of the price that the Adviser
expects the security or other underlying investment to reach during the life of
the option. Writing covered call options may limit the Fund's gain on portfolio
investments if the option is exercised because the Fund will have to sell the
underlying investments below the current market price. Purchasing and writing
put and call options are highly specialized activities and entail greater than
ordinary market risks.
SECURITIES LENDING
As described in the Prospectus, the Fund may lend a portion of its portfolio
securities to broker-dealers or other institutional borrowers. Loans will be
made only to organizations whose credit quality or claims paying ability is
considered by the Adviser to be at least investment grade. All securities loans
will be collateralized on a continuous basis by cash or U.S. government
securities having a value, marked to market daily, of at least 100% of the
market value of the loaned securities. The Fund may receive loan fees in
connection with loans that are collateralized by securities or on loans of
securities for which there is special demand. The Fund may also seek to earn
income on securities loans by reinvesting cash collateral in MBS or other
securities consistent with its investment objective and policies, seeking to
invest at rates that are higher than the "rebate" rate that it normally will pay
to the borrower with respect to such cash collateral. Any such reinvestment will
be subject to the investment policies, restrictions and risk considerations
described in the Prospectus and in this SAI.
Securities loans may result in delays in recovering, or a failure of the
borrower to return, the loaned securities. The defaulting borrower ordinarily
would be liable to the Fund for any losses resulting from such delays or
failures, and the collateral provided in connection with the loan normally would
also be available for that purpose. Securities loans normally may be terminated
by either the Fund or the borrower at any time. Upon termination and the return
of the loaned securities, the Fund would be required to return the related cash
or securities collateral to the borrower and it may be required to liquidate
longer term portfolio securities in order to do so. To the extent that such
securities have decreased in value, this may result in the Fund realizing a loss
at a time when it would not otherwise do so. The Fund also may incur losses if
it is unable to reinvest cash collateral at rates higher than applicable rebate
rates paid to borrowers and related administrative costs. These risks are
substantially the same as those incurred through investment leverage, and will
be subject to the investment policies, restrictions and risk considerations
described in the Prospectus and in this SAI.
The Fund will receive amounts equivalent to any interest or other distributions
paid on securities while they are on loan, and the Fund will not be entitled to
exercise voting or other beneficial rights on loaned securities. The Fund will
exercise its right to terminate loans and thereby regain these rights whenever
the Adviser considers it to be in the Fund's interest to do so, taking into
account the related loss of reinvestment income and other factors.
SHORT-TERM TRADING
Securities may be sold in anticipation of market decline (a rise in interest
rates) or purchased in anticipation of a market rise (a decline in interest
rates) and later sold. In addition, a security may be sold and another purchased
at approximately the same time to take advantage of what the Adviser believes to
be a temporary disparity in the normal yield relationship between the two
securities. Yield disparities may occur for reasons not directly related to the
investment quality of particular issues or the general movement of interest
rates, such as changes in the overall demand for or supply of various types of
fixed income securities or changes in the investment objectives of investors.
TEMPORARY INVESTMENTS
The Fund may invest temporarily in cash or cash equivalents. Cash equivalents
are highly liquid, short-term securities such as commercial paper, certificates
of deposit, short-term notes and short-term U.S. Government obligations.
INVESTMENT RESTRICTIONS
The following investment restrictions of the Fund are designated as fundamental
policies and as such cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities, which as used in this SAI
11
means the lesser of (a) 67% of the shares of the Fund present or represented by
proxy at a meeting if the holders of more than 50% of the outstanding shares are
present or represented at the meeting or (b) more than 50% of outstanding shares
of the Fund. As a matter of fundamental policy the Fund may not:
(1) Borrow money, except as permitted by the Investment Company Act of 1940 (the
"1940 Act"). The 1940 Act currently requires that any indebtedness incurred
by a closed-end investment company have an asset coverage of at least 300%;
(2) Issue senior securities, as defined in the 1940 Act, other than (i)
preferred shares which immediately after issuance will have asset coverage
of at least 200%, (ii) indebtedness which immediately after issuance will
have asset coverage of at least 300%, or (iii) the borrowings permitted by
investment restriction (1) above. The 1940 Act currently defines "senior
security" as any bond, debenture, note or similar obligation or instrument
constituting a security and evidencing indebtedness, and any stock of a
class having priority over any other class as to distribution of assets or
payment of dividends. Debt and equity securities issued by a closed-end
investment company meeting the foregoing asset coverage provisions are
excluded from the general 1940 Act prohibition on the issuance of senior
securities;
(3) Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of purchases and sales of
securities). The purchase of investment assets with the proceeds of a
permitted borrowing or securities offering will not be deemed to be the
purchase of securities on margin;
(4) Underwrite securities issued by other persons, except insofar as it may
technically be deemed to be an underwriter under the Securities Act of 1933
in selling or disposing of a portfolio investment;
(5) Make loans to other persons, except by (a) the acquisition of loan
interests, debt securities and other obligations in which the Fund is
authorized to invest in accordance with its investment objectives and
policies, (b) entering into repurchase agreements, and (c) lending its
portfolio securities;
(6) Purchase or sell real estate, although it may purchase and sell securities
which are secured by interests in real estate and securities of issuers
which invest or deal in real estate. The Fund reserves the freedom of action
to hold and to sell real estate acquired as a result of the ownership of
securities;
(7) Purchase or sell physical commodities or contracts for the purchase or sale
of physical commodities. Physical commodities do not include futures
contracts with respect to securities, securities indices or other financial
instruments; and
(8) With respect to 75% of its total assets, invest more than 5% of its total
assets in the securities of a single issuer or purchase more than 10% of the
outstanding voting securities of a single issuer, except obligations issued
or guaranteed by the U.S. government, its agencies or instrumentalities and
except securities of other investment companies; or invest more 25% or more
of its total assets in any single industry (other than securities issued or
guaranteed by the U.S. government or its agencies or instrumentalities).
The Fund may borrow money as a temporary measure for extraordinary or emergency
purposes, including the payment of dividends and the settlement of securities
transactions which otherwise might require untimely dispositions of Fund
securities. The 1940 Act currently requires that the Fund have 300% asset
coverage with respect to all borrowings other than temporary borrowings.
For purposes of construing restriction (8), securities of the U.S. Government,
its agencies, or instrumentalities are not considered to represent industries.
Municipal obligations backed by the credit of a governmental entity are also not
considered to represent industries.
The Fund has adopted the following nonfundamental investment policy which may be
changed by the Board without approval of the Fund's shareholders. As a matter of
nonfundamental policy, the Fund may not make short sales of securities or
maintain a short position, unless at all times when a short position is open it
either owns an equal amount of such securities or owns securities convertible
into or exchangeable, without payment of any further consideration, for
securities of the same issue as, and equal in amount to, the securities sold
short.
12
Upon the Board's approval, the Fund may invest more than 10% of its total assets
in one or more other management investment companies (or may invest in
affiliated investment companies) to the extent permitted by the 1940 Act and
rules thereunder.
Whenever an investment policy or investment restriction set forth in the
Prospectus or this SAI states a maximum percentage of assets that may be
invested in any security or other asset or describes a policy regarding quality
standards, such percentage limitation or standard shall be determined
immediately after and as a result of the Fund's acquisition of such security or
asset. Accordingly, any later increase or decrease resulting from a change in
values, assets or other circumstances or any subsequent rating change made by a
rating service (or as determined by the Adviser if the security is not rated by
a rating agency) will not compel the Fund to dispose of such security or other
asset. Notwithstanding the foregoing, the Fund must always be in compliance with
the borrowing policies set forth above.
As described in the Prospectus, under normal market circumstances, the Fund
expects to maintain a weighted average portfolio credit quality of investment
grade. In determining the average credit quality of the Fund, Eaton Vance
intends to use a methodology, based structurally on the S&P or Moody's rating
system (or both) described in Appendix A to this SAI, which assumes a linear
relationship in the credit quality ratings for ratings between C and AAA (Aaa).
Securities with a rating below C will not be assigned any value in the
calculation of average credit quality. For the purpose of determining the Fund's
average credit quality, when a security is rated by more than one nationally
recognized statistical rating agency, the Adviser generally will use the highest
rating available. Within this general guideline, the Fund may invest in
individual securities of any credit quality. The Fund's holdings of
Non-Investment Grade Bonds and Senior Loans with lower credit ratings generally
will be offset by MBS with very high credit ratings. A "barbell" portfolio of
lower rated and higher rated securities may have risk characteristics that
differ from fixed income securities with credit ratings equivalent to the
portfolio average.
13
------------------------------------------------------------------------------------------------------------------------
TRUSTEES AND OFFICERS
The Trustees of the Fund are responsible for the overall management and
supervision of the affairs of the Fund. The Trustees and officers of the Fund
are listed below. Except as indicated, each individual has held the office shown
or other offices in the same company for the last five years. The business
address of each Trustee and officer is The Eaton Vance Building, 255 State
Street, Boston, Massachusetts 02109. As used in this SAI, "EVC" refers to Eaton
Vance Corp., "EV" refers to Eaton Vance, Inc., "BMR" refers to Boston Management
and Research, and "EVD" refers to Eaton Vance Distributors Inc. EVC and EV are
the corporate parent and trustee, respectively, of Eaton Vance and BMR.
NUMBER OF
PORTFOLIOS IN
TERM OF OFFICE FUND COMPLEX OTHER
NAME AND POSITION(S) AND LENGTH PRINCIPAL OCCUPATION(S) OVERSEEN BY DIRECTORSHIPS
DATE OF BIRTH WITH THE FUND OF SERVICE DURING PAST FIVE YEARS TRUSTEE(1) HELD
-------------------- --------------- -------------- ------------------------ ---------------- -------------
INTERESTED
TRUSTEES
Jessica M. Bibliowicz Trustee(2) Since 4/8/03 President and Chief 186 None
11/28/59 Three Years Executive Officer of
National Financial
Partners (financial
services company)
(since April 1999).
President and Chief
Operating Officer of
John A. Levin & Co.
(registered investment
adviser) (July 1997 to
April 1999) and a
Director of Baker,
Fentress & Company
which owns John A.
Levin & Co. (July 1997
to April 1999). Ms.
Bibliowicz is an
interested person
because of her
affiliation with a
brokerage firm.
James B. Hawkes Trustee(2) and Since 3/12/03 Chairman, President and 191 Director of EVC
11/9/41 Vice President Three Years Chief Executive Officer
of BMR, Eaton Vance,
EVC and EV; Director of
EV and EVC; Vice
President and Director
of EVD. Trustee and/or
officer of 191
registered investment
companies in the Eaton
Vance Fund Complex. Mr.
Hawkes is an interested
person because of his
positions with BMR,
Eaton Vance, EVC and
EV, which are
affiliates of the Fund.
NON-INTERESTED
TRUSTEES
Samuel L. Hayes, III Trustee(3) Since 4/8/03 Jacob H. Schiff 191 Director of
2/23/35 Three Years Professor of Investment Tiffany & Co.
Banking Emeritus, (specialty
Harvard University retailer) and
Graduate School of Telect, Inc.
Business (telecommunication
Administration. services company)
14
Norton H. Reamer Trustee(3) Since 4/8/03 President, Unicorn 191 None
9/21/35 Three Years Corporation (an
investment and
financial advisory
services company)
(since September 2000).
Chairman, Hellman,
Jordan Management Co.,
Inc. (an investment
management company)
(since November 2000).
Advisory Director of
Berkshire Capital
Corporation (investment
banking firm) (since
June 2002). Formerly,
Chairman of the Board,
United Asset Management
Corporation (a holding
company owning
institutional
investment management
firms) and Chairman,
President and Director,
UAM Funds (mutual
funds).
Lynn A. Stout Trustee(4) Since 4/8/03 Professor of Law, 186 None
9/14/57 Three Years University of
California at Los
Angeles School of Law
(since July 2001).
Formerly, Professor of
Law, Georgetown
University Law Center.
----------
(1) Includes both master and feeder funds in master-feeder structure.
(2) Class I Trustees whose term expires in 2004.
(3) Class II Trustees whose terms expires in 2005.
(4) Class III Trustees whose term expires in 2006.
PRINCIPAL OFFICERS WHO ARE NOT TRUSTEES
TERM OF OFFICE
POSITION(S) AND LENGTH
NAME AND DATE OF BIRTH WITH THE FUND OF SERVICE PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
--------------------------- ---------------- --------------- ------------------------------------------------
Thomas E. Faust Jr. President Since 3/12/03 Executive Vice President of Eaton Vance, BMR, EVC
5/31/58 and EV; Chief Investment Officer of Eaton Vance and
BMR and Director of EVC. Chief Executive Officer of
Belair Capital Fund LLC, Belcrest Capital Fund LLC,
Belmar Capital Fund LLC; Belport Capital Fund LLC
and Belrose Capital Fund LLC (private investment
companies sponsored by Eaton Vance). Officer of 51
registered investment companies managed by Eaton
Vance or BMR
James L. O'Connor Treasurer Since 3/12/03 Vice President of BMR, Eaton Vance and EVD.
4/1/45 Officer of 113 registered investment
companies managed by Eaton Vance or BMR.
15
Scott H. Page Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
11/30/59 Officer of 11 registered investment
companies managed by Eaton Vance or BMR.
Susan Schiff Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
3/13/61 Officer of 25 registered investment
companies managed by Eaton Vance or BMR.
Payson F. Swaffield Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
8/13/56 Officer of 11 registered investment
companies managed by Eaton Vance or BMR.
Michael W. Weilheimer Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
2/11/61 Officer of 8 registered investment companies
managed by Eaton Vance or BMR.
The Governance Committee of the Board of Trustees of the Fund is comprised of
those Trustees who are not "interested persons" of the Fund, as that term is
defined under the 1940 Act ("noninterested Trustees"). Ms. Stout currently
serves as the Governance Committee's chair. The purpose of the Committee is to
undertake a periodic review of, and make recommendations with respect to: (i)
the Board's performance; (ii) Trustee compensation; (iii) appointment of new
Trustees; (iv) identity, duties and composition of the various Board committees;
(v) development and maintenance of the Board's membership, structure and
operations; (vi) policies and procedures adopted or approved by the Board to
comply with regulatory requirements that relate to fund governance; and (vii)
any other matters related to fund governance.
The Trustees will, when a vacancy exists or is anticipated, consider any nominee
for Trustee recommended by a shareholder if such recommendation is submitted to
the Trustees in writing and contains sufficient background information
concerning the individual to enable a proper judgement to be made as to such
individual's qualifications.
Messrs. Hayes (Chairman), Reamer and Ms. Stout are members of the Audit
Committee of the Board of Trustees of the Fund. The Audit Committee's functions
include making recommendations to the Trustees regarding the selection and
performance of the independent accountants, and reviewing matters relative to
accounting and auditing practices and procedures, accounting records, and the
internal accounting controls, of the Fund, and certain service providers.
Messrs. Hayes (Chairman), Reamer and Ms. Stout are members of the Special
Committee of the Board of Trustees of the Fund. The purpose of the Special
Committee is to consider, evaluate and make recommendations to the full Board of
Trustees concerning (i) all contractual arrangements with service providers to
the Fund, including investment advisory, administrative, transfer agency,
custodial and fund accounting and distribution services, and (ii) all other
matters in which Eaton Vance or its affiliates has any actual or potential
conflict of interest with the Fund.
As of the date of this SAI, no Committee other than the Special Committee had
not held any meetings.
When considering approval of the investment advisory agreement between the Fund
and the Adviser, the noninterested Trustees considered, among other things, the
following:
+ An independent report comparing the fees and expenses of the Fund;
+ Information on the relevant peer group(s) of funds;
+ The economic outlook and the general investment outlook in the relevant
investment markets;
+ Eaton Vance's results and financial condition and the overall organization of
the Adviser;
+ Arrangements regarding the distribution of Fund shares;
+ The procedures used to determine the fair value of the Fund's assets;
+ The allocation of brokerage, including allocations to soft dollar brokerage
and allocations to firms that sell Eaton Vance fund shares;
16
+ Eaton Vance's management of the relationship with the custodian,
subcustodians and fund accountants;
+ The resources devoted to Eaton Vance's compliance efforts undertaken on
behalf of the funds it manages and the record of compliance with the
investment policies and restrictions and with policies on personal securities
transactions;
+ The quality nature, cost and character of the administrative and other
non-investment management services provided by Eaton Vance and its
affiliates;
+ Investment management staffing;
+ Operating expenses (including transfer agency expenses) to be paid to third
parties; and
+ Information to be provided to investors, including the Fund's shareholders.
In addition to the factors mentioned above, the noninterested Trustees also
reviewed the level of the Adviser's profits in respect of the management of the
Eaton Vance funds, including the Fund. The noninterested Trustees considered the
profits realized by Eaton Vance and its affiliates in connection with the
operation of the Fund. The noninterested Trustees also considered Eaton Vance's
profit margins in comparison with available industry data.
The non-interested Trustees did not consider any single factor as controlling in
determining whether or not to approve the investment advisory agreement. Nor are
the items described herein all encompassing of the matters considered by the
noninterested Trustees. In assessing the information provided by Eaton Vance and
its affiliates, the noninterested Trustees also took into consideration the
benefits to shareholders of investing in a fund that is part of large family of
funds which provides a large variety of shareholder services.
Based on their consideration of all factors that it deemed material and assisted
by the advice of its independent counsel, the non-interested Trustees concluded
that the approval of the investment advisory agreement, including the fee
structure (described herein) is in the interests of shareholders.
SHARE OWNERSHIP
THE FOLLOWING TABLE SHOWS THE DOLLAR RANGE OF EQUITY SECURITIES BENEFICIALLY
OWNED BY EACH TRUSTEE IN THE FUND AND ALL EATON VANCE FUNDS OVERSEEN BY THE
TRUSTEE AS OF DECEMBER 31, 2002.
AGGREGATE DOLLAR RANGE OF EQUITY
DOLLAR RANGE OF SECURITIES OWNED IN ALL REGISTERED
EQUITY SECURITIES FUNDS OVERSEEN BY TRUSTEE IN THE
NAME OF TRUSTEE OWNED IN THE FUND EATON VANCE FUND COMPLEX
--------------------------- ----------------- ----------------------------------
INTERESTED TRUSTEES
Jessica M. Bibliowicz.... None $10,001--$50,000
James B. Hawkes.......... None over $100,000
NONINTERESTED TRUSTEES
Samuel L. Hayes, III..... None over $100,000
Norton H. Reamer......... None over $100,000
Lynn A. Stout............ None $10,001--$50,000
As of December 31, 2002, no noninterested Trustee or any of their immediate
family members owned beneficially or of record any class of securities of EVC,
EVD or any person controlling, controlled by or under common control with EVC or
EVD.
During the calendar years ended December 31, 2001 and December 31, 2002, no
noninterested Trustee (or their immediate family members) had:
1. Any direct or indirect interest in Eaton Vance, EVC, EVD or any person
controlling, controlled by or under common control with EVC or EVD;
17
2. Any direct or indirect material interest in any transaction or series of
similar transactions with (i) the Trust or any Fund; (ii) another fund
managed by EVC, distributed by EVD or a person controlling, controlled by or
under common control with EVC or EVD; (iii) EVC or EVD; (iv) a person
controlling, controlled by or under common control with EVC or EVD; or (v) an
officer of any of the above; or
3. Any direct or indirect relationship with (i) the Trust or any Fund; (ii)
another fund managed by EVC, distributed by EVD or a person controlling,
controlled by or under common control with EVC or EVD; (iii) EVC or EVD; (iv)
a person controlling, controlled by or under common control with EVC or EVD;
or (v) an officer of any of the above.
During the calendar years ended December 31, 2001 and December 31, 2002, no
officer of EVC, EVD or any person controlling, controlled by or under common
control with EVC or EVD served on the Board of Directors of a company where a
noninterested Trustee of the Fund or any of their immediate family members
served as an officer.
Trustees of the Fund who are not affiliated with the Adviser may elect to defer
receipt of all or a percentage of their annual fees in accordance with the terms
of a Trustees Deferred Compensation Plan (the "Trustees' Plan"). Under the
Trustees' Plan, an eligible Trustee may elect to have his deferred fees invested
by the Fund in the shares of one or more funds in the Eaton Vance Family of
Funds, and the amount paid to the Trustees under the Trustees' Plan will be
determined based upon the performance of such investments. Deferral of Trustees'
fees in accordance with the Trustees' Plan will have a negligible effect on the
Fund's assets, liabilities, and net income per share, and will not obligate the
Fund to retain the services of any Trustee or obligate the Fund to pay any
particular level of compensation to the Trustee. The Fund does not have a
retirement plan for its Trustees.
The fees and expenses of the noninterested Trustees of the Fund are paid by the
Fund. (The Trustees of the Fund who are members of the Eaton Vance organization
receive no compensation from the Fund.) During the Fund's fiscal year ending
October 31, 2003, it is anticipated that the noninterested Trustees of the Fund
will earn the following compensation in their capacities as Trustees. For the
year ended December 31, 2002, the noninterested Trustees earned the compensation
set forth below in their capacities as Trustees from the funds in the Eaton
Vance fund complex(1).
JESSICA M. SAMUEL L. NORTON H. LYNN A.
SOURCE OF COMPENSATION BIBLIOWICZ HAYES, III REAMER STOUT
--------------------------- -------------------------------------------- ---------
Fund*........................................$.....1,000 $ 1,000 $ 1,000 $ 1,000
Fund Complex.................................$...160,000 $ 180,000 $ 160,000 $ 160,000 (2)
----------
* ESTIMATED
(1) AS OF MAY 28, 2003, THE EATON VANCE FUND COMPLEX CONSISTED OF 191 REGISTERED INVESTMENT COMPANIES OR SERIES THEREOF.
(2) INCLUDES $16,000 OF DEFERRED COMPENSATION.
INVESTMENT ADVISORY AND OTHER SERVICES
Eaton Vance, its affiliates and its predecessor companies have been managing
assets of individuals and institutions since 1924 and of investment companies
since 1931. They maintain a large staff of experienced fixed-income, senior loan
and equity investment professionals to service the needs of their clients. The
fixed-income group focuses on all kinds of taxable investment-grade and
high-yield securities, tax-exempt investment-grade and high-yield securities,
and U.S. Government securities. The senior loan group focuses on senior floating
rate loans, unsecured loans and other floating rate debt securities such as
notes, bonds and asset backed securities. The equity group covers stocks ranging
from blue chip to emerging growth companies. Eaton Vance and its affiliates act
as adviser to a family of mutual funds, and individual and various institutional
accounts, including corporations, hospitals, retirement plans, universities,
foundations and trusts.
The Fund will be responsible for all of its costs and expenses not expressly
stated to be payable by Eaton Vance under the Advisory Agreement or
Administration Agreement. Such costs and expenses to be borne by the Fund
18
include, without limitation: custody and transfer agency fees and expenses,
including those incurred for determining net asset value and keeping accounting
books and records; expenses of pricing and valuation services; the cost of share
certificates; membership dues in investment company organizations; expenses of
acquiring, holding and disposing of securities and other investments; fees and
expenses of registering under the securities laws, stock exchange listing fees
and governmental fees; rating agency fees and preferred share remarketing
expenses; expenses of reports to shareholders, proxy statements and other
expenses of shareholders' meetings; insurance premiums; printing and mailing
expenses; interest, taxes and corporate fees; legal and accounting expenses;
compensation and expenses of Trustees not affiliated with Eaton Vance; expenses
of conducting repurchase offers for the purpose of repurchasing Fund shares; and
investment advisory and administration fees. The Fund will also bear expenses
incurred in connection with any litigation in which the Fund is a party and any
legal obligation to indemnify its officers and Trustees with respect thereto, to
the extent not covered by insurance.
The Advisory Agreement with the Adviser continues in effect to April 14, 2005
and from year to year so long as such continuance is approved at least annually
(i) by the vote of a majority of the noninterested Trustees of the Fund or of
the Adviser cast in person at a meeting specifically called for the purpose of
voting on such approval and (ii) by the Board of Trustees of the Fund or by vote
of a majority of the outstanding interests of the Fund. The Fund's
Administration Agreement continues in effect from year to year so long as such
continuance is approved at least annually by the vote of a majority of the
Fund's Trustees. Each agreement may be terminated at any time without penalty on
sixty (60) days' written notice by the Trustees of the Fund or Eaton Vance, as
applicable, or by vote of the majority of the outstanding shares of the Fund.
Each agreement will terminate automatically in the event of its assignment. Each
agreement provides that, in the absence of willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations or duties to the Fund under
such agreements on the part of Eaton Vance, Eaton Vance shall not be liable to
the Fund for any loss incurred, to the extent not covered by insurance.
Eaton Vance is a business trust organized under Massachusetts law. EV serves as
trustee of Eaton Vance. Eaton Vance and EV are subsidiaries of EVC, a Maryland
corporation and publicly-held holding company. EVC through its subsidiaries and
affiliates engages primarily in investment management, administration and
marketing activities. The Directors of EVC are James B. Hawkes, John G. L.
Cabot, Thomas E. Faust Jr., Leo I. Higdon, Jr., John M. Nelson, Vincent M.
O'Reilly and Ralph Z. Sorenson. All shares of the outstanding Voting Common
Stock of EVC are deposited in a voting trust, the voting trustees of which are
Messrs. James B. Hawkes, Jeffrey P. Beale, Alan R. Dynner, Thomas E. Faust, Jr.,
Thomas J. Fetter, Scott H. Page, Duncan W. Richardson, William M. Steul, Payson
F. Swaffield, Michael W. Weilheimer and Wharton P. Whitaker (all of whom are
officers of Eaton Vance). The voting trustees have unrestricted voting rights
for the election of Directors of EVC. All of the outstanding voting trust
receipts issued under said voting trust are owned by certain of the officers of
BMR and Eaton Vance who are also officers, or officers and Directors of EVC and
EV. As indicated under "Trustees and Officers", all of the officers of the Fund
(as well as Mr. Hawkes who is also a Trustee) hold positions in the Eaton Vance
organization.
EVC and its affiliates and their officers and employees from time to time have
transactions with various banks, including the custodian of the Fund, IBT. It is
Eaton Vance's opinion that the terms and conditions of such transactions were
not and will not be influenced by existing or potential custodial or other
relationships between the Fund and such banks.
CODE OF ETHICS
The Adviser and the Fund have adopted a Code of Ethics governing personal
securities transactions. Under the Code, Eaton Vance employees may purchase and
sell securities (including securities held or eligible for purchase by the Fund)
subject to certain pre-clearance and reporting requirements and other
procedures.
The Code can be reviewed and copied at the Securities and Exchange Commission's
public reference room in Washington, DC (call 1-202-942-8090 for information on
the operation of the public reference room); on the EDGAR Database on the SEC's
Internet site (http:/www.sec.gov); or, upon payment of copying fees, by writing
the SEC's public reference section, Washington, DC 20549-0102, or by electronic
mail at publicinfo@sec.gov.
19
INVESTMENT ADVISORY SERVICES
Under the general supervision of the Fund's Board of Trustees, Eaton Vance will
carry out the investment and reinvestment of the assets of the Fund, will
furnish continuously an investment program with respect to the Fund, will
determine which securities should be purchased, sold or exchanged, and will
implement such determinations. Eaton Vance will furnish to the Fund investment
advice and provide related office facilities and personnel for servicing the
investments of the Fund. Eaton Vance will compensate all Trustees and officers
of the Fund who are members of the Eaton Vance organization and who render
investment services to the Fund, and will also compensate all other Eaton Vance
personnel who provide research and investment services to the Fund.
ADMINISTRATIVE SERVICES
Under the Administration Agreement, Eaton Vance is responsible for managing the
business affairs of the Fund, subject to the supervision of the Fund's Board of
Trustees. Eaton Vance will furnish to the Fund all office facilities, equipment
and personnel for administering the affairs of the Fund. Eaton Vance will
compensate all Trustees and officers of the Fund who are members of the Eaton
Vance organization and who render executive and administrative services to the
Fund, and will also compensate all other Eaton Vance personnel who perform
management and administrative services for the Fund. Eaton Vance's
administrative services include recordkeeping, preparation and filing of
documents required to comply with federal and state securities laws, supervising
the activities of the Fund's custodian and transfer agent, providing assistance
in connection with the Trustees and shareholders' meetings, providing services
in connection with quarterly repurchase offers and other administrative services
necessary to conduct the Fund's business.
DETERMINATION OF NET ASSET VALUE
The net asset value per Share of the Fund is determined no less frequently than
weekly, generally on the last day of the week that the New York Stock Exchange
(the "Exchange") is open for trading, as of the close of regular trading on the
Exchange (normally 4:00 p.m. New York time). The Fund's net asset value per
Share is determined by IBT, in the manner authorized by the Trustees of the
Fund. Net asset value is computed by dividing the value of the Fund's total
assets, less its liabilities by the number of shares outstanding.
The Adviser uses an independent pricing service to value most loans,
mortgage-backed securities (other than seasoned mortgage-backed securities) and
other debt securities at their market value. Seasoned mortgage-backed securities
are valued through the use of an independent matrix pricing system which takes
into account bond prices, yield differentials, anticipated prepayment and
interest rates provided by dealers. The Adviser may use the fair value method to
value loans or other securities if market quotations for them are not readily
available or are deemed unreliable, or if events occurring after the close of a
securities market and before the Fund values its assets would materially affect
net asset value. A security that is fair valued may be valued at a price higher
or lower than actual market quotations or the value determined by other funds
using their own fair valuation procedures.
The Trustees have approved and monitor the procedures under which Senior Loans
are valued. The Adviser and the Valuation Committee may implement new pricing
methodologies or expand mark-to-market valuation of Senior Loans in the future,
which may result in a change in the Fund's net asset value per share. The Fund's
net asset value per share will also be affected by fair value pricing decisions
and by changes in the market for Senior Loans. In determining the fair value of
a Senior Loan, the Adviser will consider relevant factors, data, and
information, including: (i) the characteristics of and fundamental analytical
data relating to the Senior Loan, including the cost, size, current interest
rate, period until next interest rate reset, maturity and base lending rate of
the Senior Loan, the terms and conditions of the Senior Loan and any related
agreements, and the position of the Senior Loan in the Borrower's debt
structure; (ii) the nature, adequacy and value of the collateral, including the
Fund's rights, remedies and interests with respect to the collateral; (iii) the
creditworthiness of the Borrower, based on an evaluation of its financial
condition, financial statements and information about the Borrower's business,
cash flows, capital structure and future prospects; (iv) information relating to
the market for the Senior Loan, including price quotations for and trading in
the Senior Loan and interests in similar Senior Loans and the market environment
and investor attitudes towards the Senior Loan and interests in similar Senior
Loans; (v) the experience, reputation, stability and financial condition of the
Agent and any intermediate participants in the Senior Loan; and (vi) general
economic and market conditions affecting the fair value of the Senior Loan. The
fair value of each Senior Loan is reviewed and approved by the Adviser's
Valuation Committee and the Fund's Trustees.
20
Non-loan holdings (other than debt securities, including short term obligations)
may be valued on the basis of prices furnished by one or more pricing services
which determine prices for normal, institutional-size trading units of such
securities using market information, transactions for comparable securities and
various relationships between securities which are generally recognized by
institutional traders. In certain circumstances, portfolio securities will be
valued at the last sale price on the exchange that is the primary market for
such securities, or the average of the last quoted bid price and asked price for
those securities for which the over-the-counter market is the primary market or
for listed securities in which there were no sales during the day. Marketable
securities listed on the NASDAQ National Market System are valued at the NASDAQ
official closing price. The value of interest rate swaps will be based upon a
dealer quotation.
Debt securities for which the over-the-counter market is the primary market are
normally valued on the basis of prices furnished by one or more pricing services
at the mean between the latest available bid and asked prices. OTC options are
valued at the mean between the bid and asked prices provided by dealers.
Financial futures contracts listed on commodity exchanges and exchange-traded
options are valued at closing settlement prices. Short-term obligations having
remaining maturities of less than 60 days are valued at amortized cost, which
approximates value, unless the Trustees determine that under particular
circumstances such method does not result in fair value. As authorized by the
Trustees, debt securities (other than short-term obligations) may be valued on
the basis of valuations furnished by a pricing service which determines
valuations based upon market transactions for normal, institutional-size trading
units of such securities. Mortgage-backed "pass-through" securities are valued
through use of an independent matrix pricing system applied by the Adviser which
takes into account closing bond valuations, yield differentials, anticipated
prepayments and interest rates provided by dealers. Securities for which there
is no such quotation or valuation and all other assets are valued at fair value
as determined in good faith by or at the direction of the Fund's Trustees.
Generally, trading in the foreign securities owned by the Fund is substantially
completed each day at various times prior to the close of the Exchange. The
values of these securities used in determining the net asset value of the Fund
generally are computed as of such times. Occasionally, events affecting the
value of foreign securities may occur between such times and the close of the
New York Stock Exchange which will not be reflected in the computation of the
Fund's net asset value (unless the Fund deems that such events would materially
affect its net asset value, in which case an adjustment would be made and
reflected in such computation).
PORTFOLIO TRADING
Decisions concerning the execution of portfolio security transactions, including
the selection of the market and the executing firm, are made by the Adviser. The
Adviser is also responsible for the execution of transactions for all other
accounts managed by it. The Adviser places the portfolio security transactions
of the Fund and of all other accounts managed by it for execution with many
firms. The Adviser uses its best efforts to obtain execution of portfolio
security transactions at prices which are advantageous to the Fund and at
reasonably competitive spreads or (when a disclosed commission is being charged)
at reasonably competitive commission rates. In seeking such execution, the
Adviser will use its best judgment in evaluating the terms of a transaction, and
will give consideration to various relevant factors, including without
limitation the full range and quality of the executing firm's services, the
value of the brokerage and research services provided, the responsiveness of the
firm to the Adviser, the size and type of the transaction, the nature and
character of the market for the security, the confidentiality, speed and
certainty of effective execution required for the transaction, the general
execution and operational capabilities of the executing firm, the reputation,
reliability, experience and financial condition of the firm, the value and
quality of the services rendered by the firm in this and other transactions, and
the reasonableness of the spread or commission, if any.
The Fund will acquire Senior Loans from major international banks, selected
domestic regional banks, insurance companies, finance companies and other
financial institutions. In selecting financial institutions from which Senior
Loans may be acquired, the Adviser will consider, among other factors, the
financial strength, professional ability, level of service and research
capability of the institution. While these financial institutions are generally
not required to repurchase Senior Loans which they have sold, they may act as
principal or on an agency basis in connection with their sale by the Fund.
21
Other fixed income obligations which may be purchased and sold by the Fund are
generally traded in the over-the-counter market on a net basis (I.E., without
commission) through broker-dealers or banks acting for their own account rather
than as brokers, or otherwise involve transactions directly with the issuers of
such obligations. The Fund may also purchase fixed income and other securities
from underwriters, the cost of which may include undisclosed fees and
concessions to the underwriters.
Transactions on stock exchanges and other agency transactions involve the
payment of negotiated brokerage commissions. Such commissions vary among
different broker-dealer firms, and a particular broker-dealer may charge
different commissions according to such factors as the difficulty and size of
the transaction and the volume of business done with such broker-dealer.
Transactions in foreign securities often involve the payment of brokerage
commissions, which may be higher than those in the United States. There is
generally no stated commission in the case of securities traded in the over-the-
counter markets, but the price paid or received usually includes an undisclosed
dealer markup or markdown.
Although spreads or commissions paid on portfolio security transactions will, in
the judgment of the Adviser, be reasonable in relation to the value of the
services provided, commissions exceeding those which another firm might charge
may be paid to broker-dealers who were selected to execute transactions on
behalf of the Adviser's clients in part for providing brokerage and research
services to the Adviser.
As authorized in Section 28(e) of the Securities Exchange Act of 1934, a broker
or dealer who executes a portfolio transaction on behalf of the Fund may receive
a commission which is in excess of the amount of commission another broker or
dealer would have charged for effecting that transaction if the Adviser
determines in good faith that such compensation was reasonable in relation to
the value of the brokerage and research services provided. This determination
may be made on the basis of that particular transaction or on the basis of
overall responsibilities which the Adviser and its affiliates have for accounts
over which they exercise investment discretion. In making any such
determination, the Adviser will not attempt to place a specific dollar value on
the brokerage and research services provided or to determine what portion of the
commission should be related to such services. Brokerage and research services
may include advice as to the value of securities, the advisability of investing
in, purchasing, or selling securities, and the availability of securities or
purchasers or sellers of securities; furnishing analyses and reports concerning
issuers, industries, securities, economic factors and trends, portfolio strategy
and the performance of accounts; effecting securities transactions and
performing functions incidental thereto (such as clearance and settlement); and
the "Research Services" referred to in the next paragraph.
It is a common practice of the investment advisory industry and of the advisers
of investment companies, institutions and other investors to receive research,
analytical, statistical and quotation services, data, information and other
services, products and materials which assist such advisers in the performance
of their investment responsibilities ("Research Services") from broker-dealer
firms which execute portfolio transactions for the clients of such advisers and
from third parties with which such broker-dealers have arrangements. Consistent
with this practice, the Adviser receives Research Services from many
broker-dealer firms with which the Adviser places the Fund's transactions and
from third parties with which these broker-dealers have arrangements. These
Research Services include such matters as general economic, political, business
and market information, industry and company reviews, evaluations of securities
and portfolio strategies and transactions, proxy voting data and analysis
services, technical analysis of various aspects of the securities market,
recommendations as to the purchase and sale of securities and other portfolio
transactions, financial, industry and trade publications, news and information
services, pricing and quotation equipment and services, and research oriented
computer hardware, software, data bases and services. Any particular Research
Service obtained through a broker-dealer may be used by the Adviser in
connection with client accounts other than those accounts which pay commissions
to such broker-dealer. Any such Research Service may be broadly useful and of
value to the Adviser in rendering investment advisory services to all or a
significant portion of its clients, or may be relevant and useful for the
management of only one client's account or of a few clients' accounts, or may be
useful for the management of merely a segment of certain clients' accounts,
regardless of whether any such account or accounts paid commissions to the
broker-dealer through which such Research Service was obtained. The advisory fee
paid by the Fund is not reduced because the Adviser receives such Research
Services. The Adviser evaluates the nature and quality of the various Research
Services obtained through broker-dealer firms and attempts to allocate
sufficient portfolio security transactions to such firms to ensure the continued
receipt of Research Services which the Adviser believes are useful or of value
to it in rendering investment advisory services to its clients.
22
The Fund and the Adviser may also receive Research Services from underwriters
and dealers in fixed-price offerings, which Research Services are reviewed and
evaluated by the Adviser in connection with its investment responsibilities. The
investment companies sponsored by the Adviser or its affiliates may allocate
trades in such offerings to acquire information relating to the performance,
fees and expenses of such companies and other mutual funds, which information is
used by the Trustees of such companies to fulfill their responsibility to
oversee the quality of the services provided by various entities, including the
Adviser, to such companies. Such companies may also pay cash for such
information.
Subject to the requirement that the Adviser shall use its best efforts to seek
and execute portfolio security transactions at advantageous prices and at
reasonably competitive spreads or commission rates, the Adviser is authorized to
consider as a factor in the selection of any broker-dealer firm with whom
portfolio orders may be placed the fact that such firm has sold or is selling
shares of the Fund or of other investment companies sponsored by the Adviser.
This policy is not inconsistent with a rule of the National Association of
Securities Dealers, Inc. ("NASD"), which rule provides that no firm which is a
member of the NASD shall favor or disfavor the distribution of shares of any
particular investment company or group of investment companies on the basis of
brokerage commissions received or expected by such firm from any source.
Securities considered as investments for the Fund may also be appropriate for
other investment accounts managed by the Adviser or its affiliates. Whenever
decisions are made to buy or sell securities by the Fund and one or more of such
other accounts simultaneously, the Adviser will allocate the security
transactions (including "hot" issues) in a manner which it believes to be
equitable under the circumstances. As a result of such allocations, there may be
instances where the Fund will not participate in a transaction that is allocated
among other accounts. If an aggregated order cannot be filled completely,
allocations will generally be made on a pro rata basis. An order may not be
allocated on a pro rata basis where, for example: (i) consideration is given to
portfolio managers who have been instrumental in developing or negotiating a
particular investment; (ii) consideration is given to an account with
specialized investment policies that coincide with the particulars of a specific
investment; (iii) pro rata allocation would result in odd-lot or de minimis
amounts being allocated to a portfolio or other client; or (iv) where the
Adviser reasonably determines that departure from a pro rata allocation is
advisable. While these aggregation and allocation policies could have a
detrimental effect on the price or amount of the securities available to the
Fund from time to time, it is the opinion of the Trustees of the Fund that the
benefits from the Adviser's organization outweigh any disadvantage that may
arise from exposure to simultaneous transactions.
TAXES
The following discussion of federal income tax matters is based on the advice of
Kirkpatrick & Lockhart LLP, counsel to the Fund. The Fund intends to elect to be
treated and to qualify each year as a RIC under the Code. Accordingly, the Fund
intends to satisfy certain requirements relating to sources of its income and
diversification of its assets and to distribute substantially all of its net
income and net short-term and long-term capital gains (after reduction by any
available capital loss carryforwards) in accordance with the timing requirements
imposed by the Code, so as to maintain its RIC status and to avoid paying any
federal income or excise tax. To the extent it qualifies for treatment as a RIC
and satisfies the above-mentioned distribution requirements, the Fund will not
be subject to federal income tax on income paid to its shareholders in the form
of dividends or capital gain distributions.
In order to avoid incurring a federal excise tax obligation, the Code requires
that the Fund distribute (or be deemed to have distributed) by December 31 of
each calendar year an amount at least equal to the sum of (i) 98% of its
ordinary income for such year and (ii) 98% of its capital gain net income (which
is the excess of its realized net long-term capital gain over its realized net
short-term capital loss), generally computed on the basis of the one-year period
ending on October 31 of such year, after reduction by any available capital loss
carryforwards, plus 100% of any ordinary income and capital gain net income from
the prior year (as previously computed) that were not paid out during such year
and on which the Fund paid no federal income tax. Under current law, provided
that the Fund qualifies as a RIC for federal income tax purposes, the Fund
should not be liable for any income, corporate excise or franchise tax in The
Commonwealth of Massachusetts.
23
If the Fund does not qualify as a RIC for any taxable year, the Fund's taxable
income will be subject to corporate income taxes, and all distributions from
earnings and profits, including distributions of net capital gain (if any), will
be taxable to the shareholder as ordinary income. In addition, in order to
requalify for taxation as a RIC, the Fund may be required to recognize
unrealized gains, pay substantial taxes and interest, and make certain
distributions.
The Fund's investment in zero coupon and certain other securities will cause it
to realize income prior to the receipt of cash payments with respect to these
securities. Such income will be accrued daily by the Fund and, in order to avoid
a tax payable by the Fund, the Fund may be required to liquidate securities that
it might otherwise have continued to hold in order to generate cash so that the
Fund may make required distributions to its shareholders.
Investments in lower rated or unrated securities may present special tax issues
for the Fund to the extent that the issuers of these securities default on their
obligations pertaining thereto. The Code is not entirely clear regarding the
federal income tax consequences of the Fund's taking certain positions in
connection with ownership of such distressed securities.
Any recognized gain or income attributable to market discount on long-term debt
obligations (I.E., obligations with a term of more than one year except to the
extent of a portion of the discount attributable to original issue discount)
purchased by the Fund is taxable as ordinary income. A long-term debt obligation
is generally treated as acquired at a market discount if purchased after its
original issue at a price less than (i) the stated principal amount payable at
maturity, in the case of an obligation that does not have original issue
discount or (ii) in the case of an obligation that does have original issue
discount, the sum of the issue price and any original issue discount that
accrued before the obligation was purchased, subject to a DE MINIMIS exclusion.
The Fund's investments in options, futures contracts, hedging transactions,
forward contracts (to the extent permitted) and certain other transactions will
be subject to special tax rules (including mark-to-market, constructive sale,
straddle, wash sale, short sale and other rules), the effect of which may be to
accelerate income to the Fund, defer Fund losses, cause adjustments in the
holding periods of securities held by the Fund, convert capital gain into
ordinary income and convert short-term capital losses into long-term capital
losses. These rules could therefore affect the amount, timing and character of
distributions to shareholders. The Fund may be required to limit its activities
in options and futures contracts in order to enable it to maintain its RIC
status.
Any loss realized upon the sale or exchange of Fund shares with a holding period
of 6 months or less will be treated as a long-term capital loss to the extent of
any capital gain distributions received with respect to such shares. In
addition, all or a portion of a loss realized on a redemption or other
disposition of Fund shares may be disallowed under "wash sale" rules to the
extent the shareholder acquires other shares of the same Fund (whether through
the reinvestment of distributions or otherwise) within the period beginning 30
days before the redemption of the loss shares and ending 30 days after such
date. Any disallowed loss will result in an adjustment to the shareholder's tax
basis in some or all of the other shares acquired.
Sales charges paid upon a purchase of shares cannot be taken into account for
purposes of determining gain or loss on a sale of the shares before the 91st day
after their purchase to the extent a sales charge is reduced or eliminated in a
subsequent acquisition of shares of the Fund (or of another fund) pursuant to
the reinvestment or exchange privilege. Any disregarded amounts will result in
an adjustment to the shareholder's tax basis in some or all of any other shares
acquired.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Certain distributions declared in October, November or December and paid
in the following January will be taxed to shareholders as if received on
December 31 of the year in which they were declared. In addition, certain other
distributions made after the close of a taxable year of the Fund may be "spilled
back" and treated as paid by the Fund (except for purposes of the 4% excise tax)
during such taxable year. In such case, Shareholders will be treated as having
received such dividends in the taxable year in which the distributions were
actually made.
24
Amounts paid by the Fund to individuals and certain other shareholders who have
not provided the Fund with their correct taxpayer identification number ("TIN")
and certain certifications required by the Internal Revenue Service (the "IRS")
as well as shareholders with respect to whom the Fund has received certain
information from the IRS or a broker may be subject to "backup" withholding of
federal income tax arising from the Fund's taxable dividends and other
distributions as well as the gross proceeds of sales of shares, at a rate of up
to 30% for amounts paid during 2003. An individual's TIN is generally his or her
social security number. Backup withholding is not an additional tax. Any amounts
withheld under the backup withholding rules from payments made to a Shareholder
may be refunded or credited against such Shareholder's U.S. federal income tax
liability, if any, provided that the required information is furnished to the
IRS.
The foregoing discussion does not address the special tax rules applicable to
certain classes of investors, such as tax-exempt entities, foreign investors,
insurance companies and financial institutions. Shareholders should consult
their own tax advisers with respect to special tax rules that may apply in their
particular situations, as well as the state, local, and, where applicable,
foreign tax consequences of investing in the Fund.
The Fund will inform Shareholders of the source and tax status of all
distributions promptly after the close of each calendar year. The IRS has taken
the position that if a RIC has more than one class of shares, it may designate
distributions made to each class in any year as consisting of no more than that
class's proportionate share of particular types of income for that year,
including ordinary income and net capital gain. A class's proportionate share of
a particular type of income for a year is determined according to the percentage
of total dividends paid by the RIC during that year to the class. Accordingly,
the Fund intends to designate a portion of its distributions in capital gain
dividends in accordance with the IRS position.
Although the matter is not free from doubt, due to the absence of direct
regulatory or judicial authority, in the opinion of Kirkpatrick & Lockhart LLP,
counsel to the Fund, under current law the manner in which the Fund intends to
allocate items of ordinary income and net capital gain among the Fund's Common
Shares and Auction Preferred Shares will be respected for federal income tax
purposes. It is possible that the IRS could disagree with counsel's opinion and
attempt to reallocate the Fund's net capital gain or other taxable income.
STATE AND LOCAL TAXES
Shareholders should consult their own tax advisers as the state or local tax
consequences of investing in the Fund.
OTHER INFORMATION
The Fund is an organization of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust may, in
certain circumstances, be held personally liable as partners for the obligations
of the trust. The Declaration of Trust contains an express disclaimer of
shareholder liability in connection with the Fund property or the acts,
obligations or affairs of the Fund. The Declaration of Trust also provides for
indemnification out of the Fund property of any shareholder held personally
liable for the claims and liabilities to which a shareholder may become subject
by reason 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 the Fund itself is unable to meet its obligations. The
Fund has been advised by its counsel that the risk of any shareholder incurring
any liability for the obligations of the Fund is remote.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law; but nothing in the Declaration of
Trust protects a Trustee against any liability to the Fund or its shareholders
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. Voting rights are not cumulative, which means that the
holders of more than 50% of the shares voting for the election of Trustees can
elect 100% of the Trustees and, in such event, the holders of the remaining less
than 50% of the shares voting on the matter will not be able to elect any
Trustees.
The Declaration of Trust provides that no person shall serve as a Trustee if
shareholders holding two-thirds of the outstanding shares have removed him from
that office either by a written declaration filed with the Fund's custodian or
25
by votes cast at a meeting called for that purpose. The Declaration of Trust
further provides that the Trustees of the Fund shall promptly call a meeting of
the shareholders for the purpose of voting upon a question of removal of any
such Trustee or Trustees when requested in writing so to do by the record
holders of not less than 10 per centum of the outstanding shares.
The Fund's Prospectus and this SAI do not contain all of the information set
forth in the Registration Statement that the Fund has filed with the SEC. The
complete Registration Statement may be obtained from the SEC upon payment of the
fee prescribed by its Rules and Regulations.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, Boston, Massachusetts are the independent auditors for
the Fund, providing audit services, tax return preparation, and assistance and
consultation with respect to the preparation of filings with the SEC.
26
--------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Trustees and Shareholder of
Eaton Vance Limited Duration Income Fund:
We have audited the accompanying statement of assets and liabilities of Eaton
Vance Limited Duration Income Fund (the "Fund") as of May 6, 2003 and the
related statement of operations for the period from March 12, 2003 (date of
organization) through May 6, 2003. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Eaton Vance Limited Duration
Income Fund as of May 6, 2003, and the result of its operations for the period
from March 12, 2003 (date of organization) through May 6, 2003 in conformity
with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
Boston, Massachusetts
May 7, 2003
27
---------------------------------------------------------------------------------------------
Eaton Vance Limited Duration Income Fund
STATEMENT OF ASSETS AND LIABILITIES
MAY 6, 2003
ASSETS
Cash.......................................................................... $ 100,000
Offering costs................................................................ 800,000
Receivable from Adviser....................................................... 7,500
-----------
Total assets.................................................................. $ 907,500
===========
LIABILITIES
Accrued offering costs........................................................ $ 800,000
Accrued organizational costs.................................................. 7,500
-----------
Total liabilities............................................................. $ 807,500
===========
Net assets applicable to 5,000 common shares of beneficial
interest issued and outstanding................................................. $ 100,000
===========
NET ASSET VALUE AND OFFERING PRICE PER SHARE.................................... $ 20.00
===========
STATEMENT OF OPERATIONS
PERIOD FROM MARCH 12, 2003 (DATE OF ORGANIZATION) THROUGH MAY 6, 2003
INVESTMENT INCOME............................................................... $ --
----------
EXPENSES
Organization costs............................................................ $ 7,500
Expense reimbursement......................................................... (7,500)
----------
Net expenses............................................................... $ --
----------
NET INVESTMENT INCOME........................................................... $ --
==========
See notes to financial statements.
28
NOTES TO FINANCIAL STATEMENTS
NOTE 1: ORGANIZATION
The Fund was organized as a Massachusetts business trust on March 12, 2003, and
has been inactive since that date except for matters relating to its
organization and registration as a diversified, closed-end management investment
company under the Investment Company Act of 1940, as amended, and the Securities
Act of 1933, as amended, and the sale of 5,000 common shares to Eaton Vance
Management, the Fund's Investment Adviser.
Eaton Vance Management, or an affiliate, has agreed to reimburse all
organizational costs, estimated at approximately $7,500.
Eaton Vance Management, or an affiliate, has agreed to pay all offering costs
(other than sales loads) that exceed $0.04 per common share.
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its primary goal of high current income.
NOTE 2: ACCOUNTING POLICIES
The Fund's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require the
use of management estimates. Actual results may differ from those estimates.
The Fund's share of offering costs will be recorded within paid in capital as a
reduction of the proceeds from the sale of common shares upon the commencement
of Fund operations. The offering costs reflected above assume the sale of
20,000,000 common shares.
NOTE 3: INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment advisory agreement between the Adviser and the Fund,
the Fund has agreed to pay an investment advisory fee, payable on a monthly
basis, at an annual rate of 0.75% of the average weekly gross assets of the
Fund. Gross assets of the Fund shall be calculated by deducting accrued
liabilities of the Fund not including the amount of any preferred shares
outstanding or the principal amount of any indebtedness for money borrowed.
In addition, Eaton Vance has contractually agreed to reimburse the Fund for fees
and other expenses in the amount of 0.20% of the average weekly gross assets for
the first 5 full years of the Fund's operations, 0.15% of average weekly gross
assets in year 6, 0.10% in year 7 and 0.05% in year 8.
NOTE 4: FEDERAL INCOME TAXES
The Fund intends to comply with the requirements of the Internal Revenue Code
applicable to regulated investment companies and to distribute all of its
taxable income, including any net realized gain on investments.
29
APPENDIX A: RATINGS
--------------------------------------------------------------------------------
Description of securities ratings+
Moody's Investors Service, Inc.
LONG-TERM DEBT SECURITIES RATINGS
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long term risk appear somewhat larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment 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 other good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
ABSENCE OF RATING: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
-------------------------
+ The ratings indicated herein are believed to be the most recent ratings
available at the date of this SAI for the securities listed. Ratings are
generally given to securities at the time of issuance. While the rating agencies
may from time to time revise such ratings, they undertake no obligation to do
30
so, and the ratings indicated do not necessarily represent ratings which would
be given to these securities on the date of the Fund's fiscal year end.
2. The issue or issuer belongs to a group of securities or companies that are
not rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not published in
Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date data to permit a judgment to be formed; if a bond is
called for redemption; or for other reasons.
NOTE: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its 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.
SHORT-TERM DEBT SECURITIES RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's 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.
STANDARD & POOR'S RATINGS GROUP
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.
31
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 exhibit 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.
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 which
is assigned an actual or implied CCC debt rating.
C: The rating C is typically applied to debt subordinated to senior debt which
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.
C1: The Rating C1 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 also will 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.
P: 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.
L: The letter "L" indicates that the rating pertains to the principal amount of
those bonds to the extent that the underlying deposit collateral is insured by
32
the Federal Deposit Insurance Corp. and interest is adequately collateralized.
In the case of certificates of deposit, the letter "L" indicates that the
deposit, combined with other deposits being held in the same right and capacity,
will be honored for principal and accrued pre-default interest up to the federal
insurance limits within 30 days after closing of the insured institution or, in
the event that the deposit is assumed by a successor insured institution, upon
maturity.
NR: NR indicates no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
COMMERCIAL PAPER
COMMERCIAL PAPER RATING DEFINITIONS
A S&P's 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: A short-term obligation rated A-1 is rated in the highest category by S&P.
The obligor's capacity to meet its financial commitment on the obligation is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
B: A short-term obligation rated B is regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if payments on
an obligation are jeopardized.
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.
FITCH RATINGS
INVESTMENT GRADE BOND RATINGS
AAA: Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
33
AA: Bonds considered to be investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very strong, although
not quite as strong as bonds rated 'AAA'. Because bonds rated in the 'AAA' and
'AA' categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated 'F-1+'.
I: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit quality.
The obligor's ability to pay interest and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances, however, are
more likely to have adverse impact on these bonds, and therefore, impair timely
payment. The likelihood that the ratings of these bonds will fall below
investment grade is higher than for bonds with higher ratings.
HIGH YIELD BOND RATINGS
BB: Bonds are considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified that could assist the
obligor in satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC: Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC: Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C: Bonds are in imminent default in payment of interest or principal.
DDD, DD AND D: Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. 'DDD'
represents the highest potential for recovery on these bonds, and 'D' represents
the lowest potential for recovery.
PLUS (+) OR MINUS (-): The ratings from AA to C may be modified by the addition
of a plus or minus sign to indicate the relative position of a credit within the
rating category.
NR: Indicates that Fitch does not rate the specific issue.
CONDITIONAL: A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
F-1+: Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1: Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
'F-1+'.
34
F-2: Good Credit Quality. Issues carrying this rating have a satisfactory degree
of assurance for timely payment, but the margin of safety is not as great as the
'F-1+' and 'F-1' categories.
F-3: Fair Credit Quality. Issues carrying this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse change could cause these securities to be rated below
investment grade.
* * * * * * * *
NOTES: Bonds which are unrated expose the investor to risks with respect to
capacity to pay interest or repay principal which are similar to the risks of
lower-rated speculative bonds. The Fund is dependent on the Adviser's judgment,
analysis and experience in the evaluation of such bonds.
Investors should note that the assignment of a rating to a bond by a rating
service may not reflect the effect of recent developments on the issuer's
ability to make interest and principal payments.
35
APPENDIX B: AMENDED BY-LAWS
--------------------------------------------------------------------------------
EATON VANCE LIMITED DURATION INCOME FUND
Amendment No. 2 to By-laws
Statement
creating five series of
Auction Preferred Shares
[To be filed by pre-effective amendment. Terms currently under
negotiation with rating agencies.]
36
PART C
OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS
(1) FINANCIAL STATEMENTS:
Included in Part A:
Financial Highlights*
Included in Part B:
Independent Auditor's Report
Statement of Assets and Liabilities as of May 6, 2003
Notes to Financial Statement
Unaudited Financial Statement*
-----------------
*To be added by amendment.
(2) EXHIBITS:
(a) Agreement and Declaration of Trust dated March 12, 2003 is
incorporated herein by reference to the Registrant's initial
Registration Statement on Form N-2 (File Nos. 333-103901 and
811-21323) as to the Registrant's common shares of beneficial
interest ("Common Shares") filed with the Securities and Exchange
Commission (the "Commission") on March 18, 2003 (Accession No.
0000898432-03-0003087) ("Initial Common Shares Registration
Statement").
(b)(1) By-Laws are incorporated herein by reference to the Registrant's
Initial Common Shares Registration Statement.
(2) Form of Amended By-Laws to be filed by amendment.
(c) Not applicable.
(d)(1) Form of Specimen Certificate for Common Shares of Beneficial
Interest are incorporated herein by reference to the Registrant's
Pre-Effective Amendment No. 1 to the Initial Common Shares
Registration Statement filed with the Commission on April 25, 2003
(Accession No. 0000950135-03-00258) ("Pre-Effective Amendment No. 1
to the Initial Common Shares Registration Statement").
(2) Form of Specimen Certificate of Series A Auction Preferred Shares
filed herewith.
(3) Form of Specimen Certificate of Series B Auction Preferred Shares
filed herewith.
(4) Form of Specimen Certificate of Series C Auction Preferred Shares
filed herewith.
(5) Form of Specimen Certificate of Series D Auction Preferred Shares
filed herewith.
(6) Form of Specimen Certificate of Series E Auction Preferred Shares
filed herewith.
(e) Dividend Reinvestment Plan is incorporated herein by reference to
the Registrant's Pre-Effective Amendment No. 1 to the Initial
Common Shares Registration Statement.
(f) Not applicable.
(g)(1) Investment Advisory Agreement dated April 14, 2003 is incorporated
herein by reference to the Registrant's Pre-Effective Amendment No.
1 to the Initial Common Shares Registration Statement.
(2) Expense Reimbursement Arrangement is incorporated herein by
reference to the Registrant's Pre-Effective Amendment No. 1 to the
Initial Common Shares Registration Statement.
(h)(1) Form of Underwriting Agreement is incorporated herein by reference
to the Registrant's Pre-Effective Amendment No. 2 to the Initial
Common Shares Registration Statement filed with the Commission on
May 23, 2003 (Accession No. 0000950135-03-003249) ("Pre-Effective
Amendment No. 2 to the Initial Common Shares Registration
Statement").
(2) Form of Master Agreement Among Underwriters is incorporated herein
by reference to the Registrant's Pre-Effective Amendment No. 2 to
the Initial Common Shares Registration Statement.
(3) Form of Master Selected Dealers Agreement is incorporated herein by
reference to the Registrant's Pre-Effective Amendment No. 2 to the
Initial Common Shares Registration Statement.
(4) Form of Underwriting Agreement as to Registrant's Auction Preferred
Shares filed herewith.
(5) Form of Master Agreement Among Underwriters as to Registrant's
Auction Preferred Shares is incorporated herein by referent to the
Registrant's Pre-Effective Amendment No. 2 to the Initial Common
Shares Registration Statement.
(6) Form of Master Selected Dealers Agreement as to Registrant's
Auction Preferred Shares is incorporated herein by referent to the
Registrant's Pre-Effective Amendment No. 2 to the Initial Common
Shares Registration Statement.
(i) The Securities and Exchange Commission has granted the Registrant
an exemptive order that permits the Registrant to enter into
deferred compensation arrangements with its independent Trustees.
See In the Matter of Capital Exchange Fund, Inc., Release No.
IC-20671 (November 1, 1994).
(j)(1) Master Custodian Agreement with Investors Bank & Trust Company
dated April 14, 2003 is incorporated herein by reference to the
Registrant's Pre-Effective Amendment No. 1 to the Initial Common
Shares Registration Statement.
(2) Extension Agreement dated August 31, 2000 to Master Custodian
Agreement with Investors Bank & Trust Company filed as Exhibit
(g)(4) to Post-Effective Amendment No. 85 to the Registration
Statement of Eaton Vance Municipals Trust (File Nos. 33-572,
811-4409) filed with the Commission on January 23, 2001 (Accession
No. 0000940394-01-500027) and incorporated herein by reference.
(3) Delegation Agreement dated December 11, 2000, with Investors Bank &
Trust Company filed as Exhibit (j)(e) to Amendment No. 5 to the
Registration Statement of the Eaton Vance Prime Rate Reserves (File
Nos. 333-32267, 811-05808) filed April 3, 2002 (Accession No.
0000940394-01-500126) and incorporated herein by reference.
(k)(1) Amendment to the Transfer Agency and Services Agreement dated April
14, 2003 is incorporated herein by reference to the Registrant's
Pre-Effective Amendment No. 1 to the Initial Common Shares
Registration Statement.
(2) Transfer Agency and Services Agreement dated December 21, 1998, as
amended, filed as Exhibit (k)(1) to Pre-Effective Amendment No. 1
to the Registration Statement of Eaton Vance Municipal Income Trust
(File Nos. 333-68719 and 811-09141) filed with the Commission on
December 12, 1999 (Accession No. 0000950135-99-000298) and
incorporated herein by reference.
(3) Administration Agreement dated April 14, 2003 is incorporated
herein by reference to the Registrant's Pre-Effective Amendment No.
1 to the Initial Common Shares Registration Statement.
(4) Form of Shareholder Servicing Agreement dated May 30, 2003 is
incorporated herein by reference to the Registrant's Pre-Effective
Amendment No. 2 to the Initial Common Shares Registration
Statement.
(5) Form of Additional Compensation Agreement dated May 30, 2003 is
incorporated herein by reference to the Registrant's Pre-Effective
Amendment No. 2 to the Initial Common Shares Registration
Statement.
(6) Form of Auction Agreement between Registrant and the Auction Agent
as to Registrant's Auction Preferred Shares to be filed by
amendment.
(7) Form of Broker-Dealer Agreement as to Registrant's Auction
Preferred Shares to be filed by amendment.
(l) Opinion and Consent of Kirkpatrick & Lockhart LLP as to
Registrant's Auction Preferred Shares to be filed by amendment.
(m) Not applicable.
(n) Consent of Independent Auditors dated June 6, 2003 filed herewith.
(o) Not applicable.
(p) Letter Agreement with Eaton Vance Management dated May 2, 2003 is
incorporated herein by referent to the Registrant's Pre-Effective
Amendment No. 2 to the Initial Common Shares Registration
Statement.
(q) Not applicable.
(r) Code of Ethics adopted by Eaton Vance Corp., Eaton Vance
Management, Boston Management and Research, Eaton Vance
Distributors, Inc. and the Eaton Vance Funds effective September 1,
2000, as revised June 4, 2002, filed as Exhibit (p) to
Post-Effective Amendment No. 45 to the Registration Statement of
Eaton Vance Investment Trust (File Nos. 33-1121, 811-4443) filed
with the Commission on July 24, 2002 (Accession No.
0000940394-02-000462) and incorporated herein by reference.
(s) Power of Attorney dated April 14, 2003 is incorporated herein by
reference to the Registrant's Pre-Effective Amendment No. 1 to the
Initial Common Shares Registration Statement.
ITEM 25. MARKETING ARRANGEMENTS
See Form of Underwriting Agreement filed herewith.
ITEM 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The approximate expenses in connection with the offering are as
follows:
Registration and Filing Fees $
National Association of Securities Dealers,
Inc. Fees
American Stock Exchange Fees
Costs of Printing and Engraving
Accounting Fees and Expenses
Legal Fees and Expenses
--------
Total $
-------
ITEM 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL
None.
ITEM 28. NUMBER OF HOLDERS OF SECURITIES
Set forth below is the number of record holders as of May 21, 2003, of each
class of securities of the Registrant:
TITLE OF CLASS NUMBER OF RECORD HOLDERS
-------------- ------------------------
Common Shares of Beneficial 1
interest, par value $0.01 per share
Series A Auction Preferred Shares, 0
par value $0.01 per share
Series B Auction Preferred Shares, 0
par value $0.01 per share
Series C Auction Preferred Shares, 0
par value $0.01 per share
Series D Auction Preferred Shares, 0
par value $0.01 per share
Series E Auction Preferred Shares, 0
par value $0.01 per share
ITEM 29. INDEMNIFICATION
The Registrant's By-Laws filed in the Registrant's Initial Common Shares
Registration Statement, the Form of Underwriting Agreement filed in the
Registrant's Pre-Effective Amendment No. 2 to the Initial Common Shares
Registration Statement and the Form of Underwriting Agreement filed herewith
contain provisions limiting the liability, and providing for indemnification, of
the Trustees and officers under certain circumstances.
Registrant's Trustees and officers are insured under a standard investment
company errors and omissions insurance policy covering loss incurred by reason
of negligent errors and omissions committed in their official capacities as
such.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act"), may be permitted to directors,
officers and controlling persons of the Registrant pursuant to the provisions
described in this Item 29, or otherwise, the Registrant has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is therefore
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 a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person 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 Securities Act and will be governed by the final
adjudication of such issue.
ITEM 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Reference is made to: (i) the information set forth under the caption
"Investment Advisory and Other Services" in the Statement of Additional
information; (ii) the Eaton Vance Corp. 10-K filed under the Securities Exchange
Act of 1934 (File No. 1-8100); and (iii) the Form ADV of Eaton Vance Management
(File No. 801-15930) filed with the Commission, all of which are incorporated
herein by reference.
ITEM 31. LOCATION OF ACCOUNTS AND RECORDS
All applicable accounts, books and documents required to be maintained by
the Registrant by Section 31(a) of the Investment Company Act of 1940 and the
Rules promulgated thereunder are in the possession and custody of the
Registrant's custodian, Investors Bank & Trust Company, 200 Clarendon Street,
16th Floor, Boston, MA 02116, and its transfer agent, PFPC Inc., 4400 Computer
Drive, Westborough, MA 01581-5120, with the exception of certain corporate
documents and portfolio trading documents which are in the possession and
custody of Eaton Vance Management, The Eaton Vance Building, 255 State Street,
Boston, MA 02109. Registrant is informed that all applicable accounts, books and
documents required to be maintained by registered investment advisers are in the
custody and possession of Eaton Vance Management.
ITEM 32. MANAGEMENT SERVICES
Not applicable.
ITEM 33. UNDERTAKINGS
1. The Registrant undertakes to suspend offering of Preferred Shares until
the prospectus is amended if (1) subsequent to the effective date of this
Registration Statement, the net asset value declines more than 10 percent
from its net asset value as of the effective date of this 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 the purpose of determining any liability under the Securities Act,
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 pursuant to 497(h)
under the 1933Act shall be deemed to be part of the Registration
Statement as of the time it was declared effective; and
b. for the purpose of determining any liability under the Securities Act,
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 such 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 an oral or written request, its Statement of Additional
Information.
NOTICE
A copy of the Agreement and Declaration of Trust of Eaton Vance Limited
Duration Income Fund is on file with the Secretary of State of the Commonwealth
of Massachusetts and notice is hereby given that this instrument is executed on
behalf of the Registrant by an officer of the Registrant as an officer and not
individually and that the obligations of or arising out of this instrument are
not binding upon any of the Trustees, officers or shareholders individually, but
are binding only upon the assets and property of the Registrant.
SIGNATURES
Pursuant to 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 Boston and the Commonwealth of Massachusetts, on the 6th day of June
2003.
EATON VANCE LIMITED DURATION INCOME FUND
By: /s/ THOMAS E. FAUST JR.
-----------------------
Thomas E. Faust Jr.
President
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 dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ THOMAS E. FAUST JR. President and Principal June 6, 2003
------------------------------ Executive Officer
Thomas E. Faust Jr.
/s/ JAMES L. O'CONNOR Treasurer and Principal June 6, 2003
------------------------------ Financial and
James L. O'Connor Accounting Officer
/s/ JESSICA M. BIBLIOWICZ* Trustee June 6, 2003
------------------------------
Jessica M. Bibliowicz
/s/ JAMES B. HAWKES Trustee June 6, 2003
------------------------------
James B. Hawkes
/s/ SAMUEL L. HAYES, III* Trustee June 6, 2003
------------------------------
Samuel L. Hayes, III
/s/ NORTON H. REAMER* Trustee June 6, 2003
------------------------------
Norton H. Reamer
/s/ LYNN A. STOUT* Trustee June 6, 2003
------------------------------
Lynn A. Stout
* BY: /s/ ALAN R. DYNNER
--------------------------------------
Alan R. Dynner (As attorney in-fact)
INDEX TO EXHIBITS
(d)(2) Form of Specimen Certificate of Series A Auction Preferred Shares
(d)(3) Form of Specimen Certificate of Series B Auction Preferred Shares
(d)(4) Form of Specimen Certificate of Series C Auction Preferred Shares
(d)(5) Form of Specimen Certificate of Series D Auction Preferred Shares
(d)(6) Form of Specimen Certificate of Series E Auction Preferred Shares
(h)(4) Form of Underwriting Agreement as to Registrant's Auction Preferred
Shares
(n) Consent of Independent Auditors dated June 6, 2003