As filed with the Securities and Exchange Commission on May 25, 2004
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1933 Act File No. 333-113978
1940 Act File No. 811-21539
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-2
(Check appropriate box or boxes)
[ ] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] Pre-Effective Amendment No. 3
[ ] Post-Effective Amendment No. _
and
[ ] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 3
FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND II
Exact Name of Registrant as Specified in Declaration of Trust
1001 Warrenville Road, Suite 300, Lisle, Illinois 60532
Address of Principal Executive Offices (Number, Street, City, State, Zip Code)
(630) 241-4141
Registrant's Telephone Number, including Area Code
W. Scott Jardine
First Trust Portfolios L.P.
1001 Warrenville Road, Suite 300
Lisle, Illinois 60532
Name and Address (Number, Street, City, State, Zip Code) of Agent for Service
Copies of Communications to:
Eric F. Fess Leonard B. Mackey, Jr.
Chapman and Cutler LLP Clifford Chance US LLP
111 West Monroe Street 200 Park Avenue
Chicago, IL 60603 New York, NY 10166
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 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)
[ ] when declared effective pursuant to section 8(c)
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
---------------- ------------ ------------------ ------------------ ------------
Title of Amount Being Proposed Maximum Proposed Maximum Amount of
Securities Registered Offering Price Aggregate Offering Registration
Being Registered Per Unit Price(1) Fee(2)
---------------- ------------ ------------------ ------------------ ------------
Common Shares, 25,875,000 $20.00 $517,500,000 $65,567.25
$0.01 par value
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) $2.53 previously paid with the initial registration statement.
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.
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SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED MAY 25, 2004
PROSPECTUS
----------
SHARES
FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND II
COMMON SHARES
$20.00 PER SHARE
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The Fund. First Trust/Four Corners Senior Floating Rate Income Fund II (the
"Fund") is a newly organized diversified, closed-end management investment
company.
Investment Objectives. The Fund's primary investment objective is to seek a
high level of current income. As a secondary objective, the Fund will attempt to
preserve capital. The Fund will pursue these objectives through investment in a
portfolio of senior secured floating rate corporate loans ("Senior Loans"). It
is anticipated that at least 80% of the
(continued on the following page)
INVESTING IN THE FUND'S COMMON SHARES INVOLVES CERTAIN RISKS THAT ARE
DESCRIBED IN THE "RISKS" SECTION BEGINNING ON PAGE 22 OF THIS PROSPECTUS.
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PER SHARE TOTAL
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Public offering price $20.00 $
Sales load (1) $.90 $
Estimated offering costs (2) $.04 $
Proceeds, after expenses, to the Fund $19.06 $
(1) The Fund has agreed to pay the underwriters $.00667 per common share as
a partial reimbursement of expenses incurred in connection with the
offering. First Trust Advisors L.P. and Four Corners Capital Management,
LLC (not the Fund) will pay certain additional compensation to certain
underwriters. See "Underwriting."
(2) Total expenses of the offering of the common shares of the Fund (the
"Common Shares") paid by the Fund (other than sales load, but including
the $.00667 per Common Share reimbursement of underwriter expenses) are
estimated to be $ , which represents $.04 per Common Share issued. The
Fund's investment adviser and sub-adviser have agreed to pay (i) all
organizational expenses and (ii) all offering costs of the Fund (other
than sales load, but including the $.00667 per Common Share
reimbursement of underwriter expenses) that exceed $.04 per Common
Share. To the extent that aggregate offering expenses are less than $.04
per common share, up to .10% of the public offering price of the
securities sold in this offering, up to such expense limit, will be paid
to First Trust Portfolios, L.P. as reimbursement for the distribution
services they provide to the Fund. First Trust Portfolios, L.P. is an
affiliate of the Adviser. See "Underwriting."
The underwriters may also purchase up to an additional Common Shares at
the public offering price, less the sales load, within 45 days of the date of
this prospectus solely to cover overallotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The Common Shares will be ready for delivery on or about , 2004.
--------------------
MERRILL LYNCH & CO. RAYMOND JAMES WACHOVIA SECURITIES
ROBERT W. BAIRD & CO. FIXED INCOME SECURITIES L.P. J.J.B. HILLIARD, W.L. LYONS, INC.
OPPENHEIMER & CO. QUICK & REILLY, INC. RBC CAPITAL MARKETS
RYAN BECK & CO. STIFEL, NICOLAUS & COMPANY SUNTRUST ROBINSON HUMPHREY
INCORPORATED
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The date of this prospectus is May , 2004.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
(continued from previous page)
Fund's managed assets will be invested in lower grade debt instruments. Lower
grade debt instruments are commonly referred to as "high yield" or "junk bonds"
and are considered speculative with respect to the issuer's capacity to pay
interest and repay principal. There can be no assurance that the Fund will
achieve its investment objectives. Investment in Senior Loans involves credit
risk and, during periods of generally declining credit quality, it may be
particularly difficult for the Fund to achieve its secondary investment
objective. The Fund may not be appropriate for all investors. See "The Fund's
Investments."
INVESTMENTS IN THE FUND ARE NOT DEPOSITS WITH OR OTHER LIABILITIES OF
MACQUARIE BANK LIMITED ACN 008 583 542, OR OF ANY ENTITY IN THE MACQUARIE BANK
GROUP, AND ARE SUBJECT TO INVESTMENT RISK, INCLUDING POSSIBLE DELAYS IN
REPAYMENT AND LOSS OF INCOME AND CAPITAL INVESTED. NONE OF MACQUARIE BANK
LIMITED, FOUR CORNERS CAPITAL MANAGEMENT, LLC, AND ANY MEMBER COMPANY OF THE
MACQUARIE BANK GROUP GUARANTEES ANY PARTICULAR RATE OF RETURN OR THE PERFORMANCE
OF THE FUND, NOR DO THEY GUARANTEE THE REPAYMENT OF CAPITAL FROM THE FUND.
In addition, the Fund's Common Shares do not represent a deposit or
obligation of, and are not guaranteed or endorsed by, any bank or other insured
depository institution, and are not federally insured by the Federal Deposit
Insurance Corporation (the "FDIC"), the Federal Reserve Board or any other
government agency.
Investment Adviser. First Trust Advisors L.P. ("First Trust Advisors" or the
"Adviser") will be the Fund's investment adviser, responsible for selecting and
supervising the Sub-Adviser, the ongoing monitoring of the Fund's investment
portfolio, managing the Fund's business affairs and providing certain clerical
and bookkeeping and other administrative services.
First Trust Advisors serves as investment adviser or portfolio supervisor to
investment portfolios with approximately $11.8 billion in assets which it
managed or supervised as of April 30, 2004. See the Statement of Additional
Information ("SAI") under "Adviser."
Sub-Adviser. Four Corners Capital Management, LLC ("Four Corners" or the
"Sub-Adviser") will manage the Fund's portfolio subject to the Adviser's
supervision.
Leverage. Within three months after the completion of the offering of Common
Shares described in this prospectus, the Fund intends, subject to then favorable
market conditions, to utilize leverage through the issuance of preferred shares,
commercial paper or notes and/or borrowing in an aggregate amount up to 38% of
the Fund's managed assets after such issuance and/or borrowing. The issuance of
these instruments, which would be senior to the Common Shares, will result in
the financial leveraging of the Common Shares. Whether to offer preferred shares
or engage in another form of leveraging, and, if offered, the terms of such
shares or leveraging and the timing and other terms of their offering or
arrangement will be determined by the Fund's board of trustees ("Board of
Trustees"). Through leveraging, the Fund will seek to obtain a higher return for
the holders of Common Shares than if the Fund did not use leverage. Leverage is
a speculative technique and investors should note that there are special risks
and costs associated with the leveraging of the Common Shares. There can be no
assurance that a leveraging strategy will be successful during any period in
which it is employed. See "Borrowings and Preferred Shares--Effects of
Leverage," "Risks--Leverage Risk" and "Description of Shares."
No Prior History. Because the Fund is newly organized, its shares have no
history of public trading. Shares of closed-end investment companies frequently
trade at a discount from their net asset value. This risk may be greater for
investors expecting to sell their shares in a relatively short period after
completion of the public offering. The Fund's Common Shares have been approved
for listing on the New York Stock Exchange ("NYSE"), subject to notice of
issuance, under the symbol "FCT."
You should read this prospectus, which contains important information about
the Fund, before deciding whether to invest in the Common Shares, and retain it
for future reference. The prospectus sets forth concisely the information about
the Fund that a prospective investor ought to know before investing. The SAI
dated May 25, 2004, containing additional information about the Fund, has been
filed with the Securities and Exchange Commission and is incorporated by
reference in its entirety into this prospectus. You may request a free copy of
the SAI, the table of contents of which is on page 42 of this prospectus, by
calling (800) 988-5891 or by writing to the Fund, or obtain a copy (and other
information regarding the Fund) from the Securities and Exchange Commission's
web site (http://www.sec.gov).
Page 2
TABLE OF CONTENTS
PAGE
Prospectus Summary ...................................................... 4
Summary of Fund Expenses ................................................ 14
The Fund ................................................................ 15
Use of Proceeds ......................................................... 15
The Fund's Investments .................................................. 15
Borrowings and Preferred Shares ......................................... 19
Risks ................................................................... 22
Management of the Fund .................................................. 28
Net Asset Value ......................................................... 30
Distributions ........................................................... 31
Dividend Reinvestment Plan .............................................. 31
Description of Shares ................................................... 32
Certain Provisions in the Declaration of Trust .......................... 34
Closed-End Fund Structure ............................................... 35
Tax Matters ............................................................. 36
Underwriting ............................................................ 38
Administrator, Custodian and Transfer Agent ............................. 40
Legal Opinions .......................................................... 41
Table of Contents for the Statement of Additional Information ........... 42
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS.
NEITHER THE FUND NOR THE UNDERWRITERS HAVE AUTHORIZED ANY OTHER PERSON TO
PROVIDE YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES YOU WITH DIFFERENT OR
INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. NEITHER THE FUND NOR THE
UNDERWRITERS ARE MAKING AN OFFER TO SELL THESE SECURITIES IN ANY JURISDICTION
WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT THE INFORMATION
APPEARING IN THIS PROSPECTUS IS ACCURATE AS OF THE DATE ON THE FRONT COVER ONLY.
Page 3
PROSPECTUS SUMMARY
This is only a Summary. The Summary may not contain all of the information
that you should consider before investing in the Common Shares. You should
review the more detailed information contained in the prospectus, especially the
information set forth under the heading "Risks," and in the SAI.
THE FUND................... First Trust/Four Corners Senior Floating Rate
Income Fund II (the "Fund") is a newly organized,
diversified, closed-end management investment
company. See "The Fund."
THE OFFERING............... The Fund is offering Common Shares of beneficial
interest at $20.00 per share through a group of
underwriters (the "Underwriters") led by Merrill
Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch"). The Common Shares of beneficial
interest are called "Common Shares" in the rest
of this prospectus. You must purchase at least
100 Common Shares ($2,000) in order to
participate in this offering. The Fund has given
the Underwriters an option to purchase up to
additional Common Shares to cover
orders in excess of Common Shares. The Adviser
and the Sub-Adviser have agreed to pay (i) all
organizational expenses and (ii) all offering costs
(other than sales load, but including the $.00667
per Common Share reimbursement of Underwriter
expenses) that exceed $.04 per Common Share.
INVESTMENT OBJECTIVES
AND POLICIES............... The Fund's primary investment objective is to
seek a high level of current income. As a
secondary objective, the Fund will attempt to
preserve capital. The Fund will pursue these
objectives through investment in a portfolio of
senior secured floating rate corporate loans
("Senior Loans"). There can be no assurance that
the Fund will achieve its investment objectives.
Investment in Senior Loans involves credit risk
and, during periods of generally declining credit
quality, it may be particularly difficult for the
Fund to achieve its secondary investment
objective. The Fund may not be appropriate for
all investors. See "The Fund's Investments."
Under normal conditions, the Fund will invest at
least 80% of its Managed Assets (as defined below)
in a diversified portfolio of Senior Loans. The
Fund cannot change this investment policy unless
the Fund's shareholders receive at least 60 days
prior notice of any such change. The portion of the
Fund's assets invested in Senior Loans will vary
from time to time consistent with the Fund's
investment objectives, changes in market prices for
Senior Loans, changes in interest rates and other
economic and market factors. It is anticipated that
at least 80% of the Fund's Managed Assets will be
invested in lower grade debt instruments, although
from time to time all of the Fund's Managed Assets
may be invested in such lower grade debt
instruments. The Fund does not intend to purchase
publicly-traded high yield bonds or equity
securities but may receive such securities as a
result of a restructuring of the debt of the issuer
or the reorganization of a Senior Loan or as part
of a package of securities acquired together with
the Senior Loans of an issuer.
Page 4
Lower grade debt instruments are rated Ba1 or lower
by Moody's Investors Service, Inc. ("Moody's"), BB+
or lower by Standard & Poor's Ratings Group, a
division of the McGraw Hill Companies ("S&P"), or
comparably rated by another nationally recognized
statistical rating organization ("NRSRO") or, if
unrated, are of comparable credit quality. Lower
grade debt instruments are commonly referred to as
"high yield" or "junk bonds" and are considered
speculative with respect to the issuer's capacity
to pay interest and repay principal. They involve
greater risk of loss, are subject to greater price
volatility and are less liquid, especially during
periods of economic uncertainty or change, than
higher rated debt instruments. Lower grade debt
instruments may also be more susceptible to real or
perceived adverse economic and competitive industry
conditions than higher-rated debt instruments.
Unlike higher rated debt instruments, which tend to
react mainly to fluctuations in the general level
of interest rates, the market values of lower grade
debt instruments tend to reflect to a greater
extent individual developments of the issuer,
although movements in the general direction of
interest rates can be expected to impact the market
value of lower grade debt instruments. In addition,
lower grade debt instruments tend to be more
sensitive to economic conditions.
"Managed Assets" means the average daily gross
asset value of the Fund (including assets
attributable to the Fund's Preferred Shares, if
any, and the principal amount of borrowings) minus
the sum of the Fund's accrued and unpaid dividends
on any outstanding Preferred Shares and accrued
liabilities (other than the principal amount of any
borrowings incurred or of commercial paper or notes
issued by the Fund). For purposes of determining
Managed Assets, the liquidation preference of the
Preferred Shares is not treated as a liability.
Percentage limitations described in this prospectus
are as of the time of investment by the Fund and
may be exceeded on a going-forward basis as a
result of market value fluctuations of the Fund's
portfolio and other events.
Senior Loans. Under normal circumstances, the Fund
will invest at least 80% of its Managed Assets in
Senior Loans. Senior Loans generally hold one of
the most senior positions 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
debtholders and stockholders of the Borrower. The
proceeds of Senior Loans primarily are used to
finance leveraged buyouts, recapitalizations,
mergers, acquisitions, stock repurchases, and, to a
lesser extent, 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. This base lending rate is primarily the
London Inter-Bank 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 rate or other base
lending rate used by commercial lenders. The Senior
Loans held by the Fund typically will have a
dollar-weighted average period until the next
Page 5
interest rate adjustment of approximately 90 days
or less. In the experience of the Fund's portfolio
managers, over the last 15 years, because of
prepayments and refinancings, the average life of a
typical Senior Loan has been approximately 18 to 30
months. The Senior Loans in which the Fund will
invest are primarily lower grade.
Under normal circumstances, the Fund may also
invest up to 10% of its Managed Assets through
purchasing revolving credit facilities, investment
grade debtor-in-possession financing, unsecured
loans, other floating rate debt securities, such as
notes, bonds, and asset-backed securities (such as
special purpose trusts investing in bank loans),
investment grade loans and fixed income debt
obligations and money market instruments, such as
commercial paper. See "The Fund's Investments."
The Fund may also invest up to 10% of its
Managed Assets in Senior Loans and, on limited
occasions, equity and debt securities acquired in
connection therewith, of (i) firms that, at the
time of acquisition, have defaulted on their debt
obligations and/or filed for protection under
Chapter 11 of the U.S. Bankruptcy Code or have
entered into a voluntary reorganization in
conjunction with their creditors and stakeholders
in order to avoid a bankruptcy filing, or (ii)
firms prior to an event of default whose acute
operating and/or financial problems have resulted
in the markets valuing their respective securities
and debt at sufficiently discounted prices so as to
be yielding, should they not default, a significant
premium over comparable duration U.S. Treasury
bonds. Investing in the securities and debt of
distressed issuers ("Special Situation
Investments") involves a far greater level of risk
than investing in issuers whose debt obligations
are being met and whose debt trades at or close to
its "par" value. While offering a greater potential
opportunity for capital appreciation, Special
Situation Investments are highly speculative with
respect to the issuer's ability to continue to make
interest payments and/or to pay its principal
obligations in full. Special Situation Investments
can be very difficult to properly value, making
them susceptible to a high degree of price
volatility and rendering them less liquid than
performing debt obligations. Those Special
Situation Investments involved in a bankruptcy
proceeding can be subject to a high degree of
uncertainty with regard to both the timing and the
amount of the ultimate settlement. Special
Situation Investments may also include
non-investment grade debtor-in-possession
financing, sub-performing real estate loans and
mortgages, privately placed senior, mezzanine,
subordinated and junior debt, letters of credit,
trade claims, convertible bonds, and preferred and
common stocks.
Foreign Investments. The Fund may invest up to 15%
of its Managed Assets in U.S. dollar-denominated
foreign investments, predominantly in developed
countries and territories of those countries, but
in no case will the Fund invest in debt securities
of issuers located in emerging markets. The value
Page 6
of foreign investments is affected by changes in
foreign tax laws (including withholding tax),
government policies (in this country or abroad) and
relations between nations, and trading, settlement,
custodial, and other operational risks. In
addition, the costs of investing abroad are
generally higher than in the United States, and
foreign securities markets may be less liquid, more
volatile, and less subject to governmental
supervision than markets in the United States.
Foreign investments could also be affected by other
factors not present in the United States, including
expropriation, armed conflict, confiscatory
taxation, lack of uniform accounting and auditing
standards, less publicly available financial and
other information, and potential difficulties in
enforcing contractual obligations.
Other Securities. Under normal market conditions,
the Fund will invest at least 80% of its Managed
Assets in Senior Loans to meet its investment
objectives. The Fund does not intend to purchase
publicly- traded high yield bonds or equity
securities but may receive such securities as a
result of a restructuring of the debt of the issuer
or the reorganization of a Senior Loan or as part
of a package of securities acquired together with
the Senior Loans of an issuer. The Fund may invest
the remainder of its assets in other investments
and securities of various types. For temporary
defensive purposes, the Fund may depart from its
principal investment strategies and invest part or
all of its assets in securities with remaining
maturities of less than one year, cash equivalents,
or may hold cash. During such periods, the Fund may
not be able to achieve its investment objectives.
INVESTMENT ADVISER
AND SUB-ADVISER............ First Trust Advisors L.P. will be the Fund's
investment adviser, responsible for supervising
the Fund's Sub-Adviser, monitoring the Fund's
investment portfolio, managing the Fund's
business affairs and providing certain clerical
and bookkeeping and other administrative
services. The Adviser, in consultation with the
Sub-Adviser, is also responsible for determining
the Fund's overall investment strategy and
overseeing its implementation. Four Corners will
be the Fund's Sub-Adviser.
First Trust Advisors, a registered investment
adviser, is an Illinois limited partnership formed
in 1991. It serves as investment adviser or
portfolio supervisor to investment portfolios with
approximately $11.8 billion in assets which it
managed or supervised as of April 30, 2004. See the
SAI under "Adviser."
Four Corners specializes in managing portfolios of
Senior Loans and structured finance assets. Four
Corners is a Delaware limited liability company
founded in September 2001 by Macquarie Holdings
(USA), Inc., an affiliate of Macquarie Bank
Limited, and an experienced group of Senior Loan
investment professionals. Four Corners managed and
advised investment portfolios in excess of $1
billion of investment capacity as of March 31,
2004. See the SAI under "Sub-Adviser."
Page 7
BORROWINGS AND
PREFERRED SHARES........... The Fund intends to use leverage through the
issuance of preferred shares of beneficial
interest ("Preferred Shares"), commercial paper
or notes and/or borrowing (each a "Leverage
Instrument" and collectively, the "Leverage
Instruments") in an aggregate amount up to 38% of
the Fund's Managed Assets after such issuance
and/or borrowing. The Fund may borrow from banks
and other financial institutions. Leverage
creates a greater risk of loss, as well as
potential for more gain, for the Common Shares
than if leverage is not used. The Fund's
leveraging strategy may not be successful. See
"Risks--Leverage Risk." Subject to market
conditions, approximately one to three months
after completion of this offering, the Fund
currently intends to establish a leverage
program. Leverage Instruments will have seniority
over the Common Shares. The use of Leverage
Instruments will leverage your investment in the
Common Shares. If the Fund uses Leverage
Instruments, associated costs will be borne
immediately by Common Shareholders and result in
a reduction of the net asset value of the Common
Shares.
There is no guarantee that the Fund's leverage
strategy will be successful. See "Risks--Leverage
Risk." Preferred Shares will pay dividends based on
short-term rates, which will be reset frequently.
Borrowings may be at a fixed or floating rate and
generally will be based upon short-term rates. So
long as the rate of return, net of applicable Fund
expenses, on the Fund's portfolio investments
purchased with leverage exceeds the then current
interest rate or dividend rate on the Leverage
Instruments, the Fund will generate more return or
income than will be needed to pay such dividends or
interest payments. In this event, the excess will
be available to pay higher dividends to holders of
Common Shares. When leverage is employed, the net
asset value and market prices of the Common Shares
and the yield to holders of Common Shares will be
more volatile.
DISTRIBUTIONS.............. The Fund intends to distribute monthly all or a
portion of its net investment income to holders of
the Common Shares. It is anticipated that the
initial monthly dividend on the Fund's Common
Shares will be declared within approximately 45
days after completion of this offering and paid
approximately 60 to 90 days after completion of
this offering. Unless an election is made to
receive dividends in cash, shareholders will
automatically have all dividends and distributions
reinvested in Common Shares through the Fund's
Dividend Reinvestment Plan. See "Dividend
Reinvestment Plan."
The Fund will distribute to holders of its Common
Shares monthly dividends of all or a portion of its
net income after the payment of interest and
dividends in connection with leverage. If the Fund
realizes a long-term capital gain, it will be
required to allocate such gain between the Common
Shares and the Preferred Shares, if any, issued by
the Fund in proportion to the total dividends paid
to each class for the year in which the income is
realized. See "Distributions" and "Borrowings and
Preferred Shares."
Page 8
MARKET PRICE OF SHARES..... Common Shares of closed-end funds frequently trade
at a discount to their net asset value. Because of
this possibility and the recognition that any such
discount may not be in the interest of
shareholders, the Fund's Board of Trustees might
consider from time to time engaging in open- market
repurchases, tender offers for shares or other
programs intended to reduce the discount. We cannot
guarantee or assure, however, that the Fund's Board
of Trustees will decide to engage in any of these
actions. The Fund's net asset value will be reduced
immediately following this offering by the sales
load and the amount of the organization and
offering expenses paid by the Fund. See "Use of
Proceeds." In addition to net asset value, the
market price of the Fund's Common Shares may be
affected by such factors as dividend levels, which
are in turn affected by expenses, dividend
stability, portfolio credit quality, liquidity and
market supply and demand. See "Borrowings and
Preferred Shares," "Risks," and "Description of
Shares." The Common Shares are designed primarily
for long-term investors and you should not purchase
Common Shares of the Fund if you intend to sell
them shortly after purchase.
TAX ASPECTS................ Dividends with respect to the Common Shares
generally will not constitute "qualified dividends"
for federal income tax purposes and thus will not
be eligible for the new lower tax rates.
SPECIAL RISK
CONSIDERATIONS............. Risk is inherent in all investing. The following
discussion summarizes some of the risks that you
should consider before deciding whether to invest
in the Fund. For additional information about the
risks associated with investing in the Fund, see
"Risks."
No Operating History. The Fund is a newly
organized, diversified, closed-end management
investment company with no operating history.
Credit Risk. The Fund's net asset value and ability
to pay dividends is dependent upon the performance
of the Fund's Managed Assets. That performance, in
turn, is subject to a number of risks, primarily
the credit risk of the Fund's underlying assets.
Credit risk is the risk of nonpayment of scheduled
interest and/or principal payments. Credit risk
also 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 security experiences a decline in its
financial status. The value of Senior Loans is
affected by the creditworthiness of the
Borrowers/issuers and by general economic and
specific industry conditions.
Senior Loans. In the event a Borrower fails to pay
scheduled interest or principal payments on a
Senior Loan held by the Fund, the Fund will
experience a reduction in its income and a decline
in the market value of the Senior Loan, which will
likely reduce dividends and lead to a decline in
the net asset value of the Fund's Common Shares. If
the Fund acquires a Senior Loan from another
Lender, for example, by acquiring a participation,
the Fund may also be subject to credit risks with
Page 9
respect to that Lender. See "The Fund's
Investments--Additional Information Concerning
Senior Loans."
Senior Loans generally involve less risk than
unsecured or subordinated debt and equity
instruments of the same issuer because the payment
of principal and interest on Senior Loans is a
contractual obligation of the issuer that, in most
instances, takes precedence over the payment of
dividends, or the return of capital, to the
issuer's shareholders and payments to bond holders.
The Fund generally invests in Senior Loans that are
secured with specific collateral. However, the
value of the collateral may not equal the Fund's
investment when the Senior Loan is acquired or may
decline below the principal amount of the Senior
Loan subsequent to the Fund's investment. Also, to
the extent that collateral consists of stock of the
Borrower or its subsidiaries or affiliates, the
Fund bears the risk that the stock may decline in
value, be relatively illiquid, and/or may lose all
or substantially all of its value, causing the
Senior Loan to be undercollateralized. Therefore,
the liquidation of the collateral underlying a
Senior Loan may not satisfy the issuer's obligation
to the Fund in the event of non-payment of
scheduled interest or principal, and the collateral
may not be readily liquidated.
In the event of the bankruptcy of a Borrower,
the Fund could experience delays and limitations on
its ability to realize the benefits of the
collateral securing the Senior Loan. Among the
credit risks involved in a bankruptcy are
assertions that the pledge of collateral to secure
a Senior Loan constitutes a fraudulent conveyance
or preferential transfer that would have the effect
of nullifying or subordinating the Fund's rights to
the collateral.
Lower Grade Investments. The Senior Loans in which
the Fund invests are generally lower grade. These
lower grade debt instruments may become the subject
of bankruptcy proceedings or otherwise subsequently
default as to the repayment of principal and/or
payment of interest or be downgraded to ratings in
the lower rating categories (Ca or lower by
Moody's, CC or lower by S&P or comparably rated by
another NRSRO). The value of these securities is
affected by the creditworthiness of the issuers of
the securities and by general economic and specific
industry conditions. Issuers of lower grade debt
instruments are not perceived to be as strong
financially as those with higher credit ratings, so
the securities are usually considered speculative
investments. These issuers are generally more
vulnerable to financial setbacks and recession than
more creditworthy issuers which may impair their
ability to make interest and principal payments.
Lower grade debt instruments tend to be less liquid
than higher grade debt instruments. See "Risks--
Credit Risk."
Investment decisions will be based largely on
the credit analysis performed by the Sub-Adviser,
and not on rating agency evaluation. This analysis
may be difficult to perform. Information about a
Senior Loan and its issuer generally is not in the
Page 10
public domain. Moreover, Senior Loans may not be
rated by any NRSRO. Many issuers have not issued
securities to the public and are not subject to
reporting requirements under federal securities
laws. Generally, however, issuers are required to
provide financial information to lenders and
information may be available from other Senior Loan
participants, agents or others that invest in,
trade in, originate or administer Senior Loans.
Illiquidity. Although the resale, or secondary
market for Senior Loans is growing, it is currently
limited. There is no organized exchange or board of
trade on which Senior Loans are traded. Instead,
the secondary market for Senior Loans is an
unregulated inter-dealer or inter-bank resale
market.
Senior Loans usually trade in large
denominations (typically $1 million and higher) and
trades can be infrequent. The market has limited
transparency so that information about actual
trades may be difficult to obtain. Accordingly,
some or many of the Senior Loans in which the Fund
invests will be relatively illiquid.
In addition, Senior Loans in which the Fund
invests may require the consent of the Borrower
and/or agent prior to sale or assignment. These
consent requirements can delay or impede the Fund's
ability to sell Senior Loans and can adversely
affect the price that can be obtained. The Fund may
have difficulty disposing of Senior Loans if it
needs cash to repay debt, to pay dividends, to pay
expenses or to take advantage of new investment
opportunities. In addition, if the Fund purchases a
relatively large assignment of a Senior Loan to
generate extra income sometimes paid to large
lenders, the limitations of the secondary market
may inhibit the Fund from selling a portion of the
Senior Loan and reducing its exposure to the
Borrower when the Sub-Adviser deems it advisable to
do so.
Valuation Difficulties. The Fund will value its
Senior Loans daily. However, because the secondary
market for Senior Loans is limited, it may be
difficult to value some loans. Market quotations
may not be readily available for some Senior Loans
and valuation may require more research than for
liquid securities. In addition, elements of
judgment may play a greater role in valuation of
Senior Loans than for securities with a secondary
market, because there is less reliable objective
data available.
Interest Rate Risk. During normal market
conditions, changes in market interest rates will
affect the Fund in certain ways. The principal
effect will be that the yield on the Fund's Common
Shares will tend to rise or fall as market interest
rates rise and fall. This is because Senior Loans,
the majority of the assets in which the Fund
invests, pay interest at rates which float in
response to changes in market rates. However,
because the rates of interest paid on the Senior
Loans in which the Fund invests will have a
weighted average reset period that is typically
less than 90 days, changes in prevailing interest
rates can be expected to cause some fluctuation in
Page 11
the Fund's Net Asset Value ("NAV"). Similarly, a
sudden and significant increase in market interest
rates may cause a decline in the Fund's NAV. See
"Risks--Interest Rate Risk."
Changes to Net Asset Value. The NAV of the Fund is
expected to change in response to a variety of
factors, primarily in response to changes in the
creditworthiness of the Borrowers on the Senior
Loans in which the Fund invests. Changes in market
interest rates may also have a moderate impact on
the Fund's NAV. Another factor which can affect the
Fund's NAV is changes in the pricing obtained for
the Fund's assets. See "Net Asset Value."
Discount From or Premium to Net Asset Value. Shares
of closed-end investment companies frequently trade
at a discount from their NAV. This risk may be
greater for investors expecting to sell their
shares of the Fund soon after completion of the
public offering. The shares of the Fund were
designed primarily for long-term investors, and
investors in the Common Shares should not view the
Fund as a vehicle for trading purposes. The
possibility that the Common Shares of the Fund
trade at a discount from NAV is a risk separate and
distinct from the risk that the Fund's NAV may
decrease.
Leverage Risk. The Fund may borrow an amount up to
33-1/3% (or such other percentage as permitted by
law) of its Managed Assets (including the amount
borrowed) less all liabilities other than
borrowings. The Fund may also issue Preferred
Shares in an amount up to 50% of the Fund's Managed
Assets (including the proceeds from Leverage
Instruments). However, the Fund intends, under
normal circumstances, to utilize leverage in an
amount up to 38% of the Fund's Managed Assets.
Borrowings and the issuance of preferred shares are
referred to in this prospectus collectively as
"leverage." The Fund may use leverage for
investment purposes, to finance the repurchase of
its Common Shares, and to meet cash requirements.
Although the use of leverage by the Fund may create
an opportunity for increased return for the Common
Shares, it also results in additional risks and can
magnify the effect of any losses. If the income and
gains earned on the securities and investments
purchased with leverage proceeds are greater than
the cost of the leverage, the Common Shares' return
will be greater than if leverage had not been used.
Conversely, if the income or gains from the
securities and investments purchased with such
proceeds does not cover the cost of leverage, the
return to the Common Shares will be less than if
leverage had not been used. There is no assurance
that a leveraging strategy will be successful.
Leverage involves risks and special considerations
for Common Shareholders including:
o the likelihood of greater volatility of NAV and
market price of the Common Shares than a
comparable portfolio without leverage;
o the risk that fluctuations in interest rates on
borrowings and short- term debt or in the
dividend rates on any Preferred Shares that the
Fund may pay will reduce the return to the
Common Shareholders or will result in
Page 12
fluctuations in the dividends paid on the
Common Shares;
o the effect of leverage in a declining market,
which is likely to cause a greater decline in
the NAV of the Common Shares than if the Fund
were not leveraged, which may result in a
greater decline in the market price of the
Common Shares; and
o when the Fund uses financial leverage, the
investment advisory fee payable to the Adviser
and Sub-Adviser will be higher than if the Fund
did not use leverage.
The Sub-Adviser, in its judgment, nevertheless
may determine to continue to use leverage if it
expects that the benefits to the Fund's
shareholders of maintaining the leveraged position
will outweigh the current reduced return.
Anti-Takeover Provisions. The Fund's Declaration of
Trust includes provisions that could limit the
ability of other entities or persons to acquire
control of the Fund or convert the Fund to open-end
status. These provisions could have the effect of
depriving the Common Shareholders of opportunities
to sell their Common Shares at a premium over the
then current market price of the Common Shares. See
"Certain Provisions in the Declaration of Trust"
and "Risks--Anti-Takeover Provisions."
Certain Other Risks. An investment in the Fund is
subject to certain other risks described in the
"Risks" section of this prospectus.
ADMINISTRATOR,
CUSTODIAN, AND
TRANSFER AGENT............. The Fund has retained PFPC Trust Company as
custodian, and PFPC Inc. as administrator, fund
accountant and transfer agent for the Fund. The
Adviser and the Board of Trustees will be
responsible for monitoring the activities of the
custodian, administrator, fund accountant and
transfer agent. See "Administrator, Custodian,
and Transfer Agent."
Page 13
SUMMARY OF FUND EXPENSES
The following table assumes the issuance of Preferred Shares in an amount
equal to 38% of the Fund's Managed Assets (after their issuance), and shows Fund
expenses as a percentage of net assets attributable to Common Shares.
SHAREHOLDER TRANSACTION EXPENSES:
Sales load paid by you (as a percentage of offering price) ................... 4.50%
Offering expenses borne by the Fund (as a percentage of offering price)....... .20%(1)
Dividend reinvestment plan fees............................................... None(2)
PERCENTAGE OF NET ASSETS ATTRIBUTABLE
TO COMMON SHARES (ASSUMES
PREFERRED SHARES ARE ISSUED)(3)
ANNUAL EXPENSES:
Management fees(4) ........................................................... 1.21%
Other expenses................................................................ .45%(5)
Interest payments on borrowed funds........................................... None
Total annual expenses...................................................... 1.66%
=====
(1) The Adviser and Sub-Adviser have contractually agreed to pay (i) all
organizational expenses of the Fund and (ii) all offering costs (other
than sales load, but including the $.00667 per Common Share
reimbursement of Underwriter expenses) that exceed $.04 per Common
Share.
(2) You will pay brokerage charges if you direct PFPC Inc., as agent for the
Common Shareholders (the "Plan Agent"), to sell your Common Shares held
in a dividend reinvestment account.
(3) The table presented below in this footnote estimates what the Fund's
annual expenses would be stated as percentages of the Fund's net assets
attributable to Common Shares. This table assumes the Fund is the same
size as in the table above, but unlike the table above, assumes that no
Preferred Shares are issued and no other leverage is used. This will be
the case, for instance, prior to the Fund's expected issuance of
Preferred Shares or the use of other Leverage Instruments. In accordance
with these assumptions, the Fund's expenses would be estimated to be as
follows:
PERCENTAGE OF NET ASSETS ATTRIBUTABLE
TO COMMON SHARES (ASSUMES NO PREFERRED
SHARES ARE ISSUED OR OTHER
LEVERAGE INSTRUMENTS ARE USED)
ANNUAL EXPENSES:
Management fees................................................... .75%
Other expenses.................................................... .18%
Total annual expenses........................................... .93%
====
(4) Represents the aggregate fee payable to the Adviser and Sub-Adviser.
(5) If the Fund uses Leverage Instruments in the form of Preferred Shares,
costs of the leverage, estimated to be approximately 1.08% of the total
dollar amount of the Preferred Share offering will be borne immediately
by the Common Shareholders and result in a reduction of the net asset
value of the Common Shares. Assuming the issuance of approximately
25,000,000 Common Shares, and the issuance of Preferred Shares in the
approximate amount of $292,000,000, the offering costs of the Preferred
Share issuance are estimated to be $3,153,000 or approximately $.126 per
Common Share. These offering costs are not included among the expenses
in this table.
The purpose of the table above and the example below is to help you
understand all fees and expenses that you, as a holder of Common Shares, would
bear directly or indirectly. The expenses shown in the table under "Other
Expenses" and "Total Annual Expenses" assume that 25,000,000 Common Shares of
the Fund are issued and outstanding and are based on estimated expense amounts
for the Fund's first full year of operations. If the Fund issues fewer Common
Shares than the number estimated above, the Fund's expense ratio is likely to be
higher. See "Management of the Fund" and "Dividend Reinvestment Plan."
Page 14
The following example illustrates the expenses (including the sales load of
$45, estimated offering expenses of this offering of $2 and the estimated
offering costs of issuing Preferred Shares assuming the Fund issues Preferred
Shares representing 38% of the Fund's capital (after their issuance) of $6.31)
that you would pay on a $1,000 investment in Common Shares, assuming (1) total
net annual expenses of 1.66% of net assets attributable to Common Shares and (2)
a 5% annual return*:
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
$ 69 $103 $139 $240
* THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The
example assumes that the estimated "Other Expenses" set forth in the
Annual Expenses table are accurate and that all dividends and
distributions are reinvested at net asset value. Moreover, the Fund's
actual rate of return may be greater or less than the hypothetical 5%
return shown in the example. In the event that the Fund does not
utilize any leverage, an investor would pay the following expenses
based on the assumptions in the example: one year, $56; three years,
$75; five years, $96; and ten years, $156.
THE FUND
The Fund is a newly organized, diversified, closed-end management investment
company registered under the Investment Company Act of 1940, as amended ("1940
Act"). The Fund was organized on March 25, 2004 as a Massachusetts business
trust pursuant to a Declaration of Trust (the "Declaration"). As a newly
organized entity, the Fund has no operating history. The Fund's principal office
is located at 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532, and its
telephone number is (630) 241-4141. Investment in the Fund involves certain
risks and special considerations, including risks associated with the Fund's use
of leverage. See "Risks."
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$ ($ if the Underwriters exercise the overallotment option in full)
after payment of the estimated offering costs. The Adviser and Sub-Adviser have
agreed to pay (i) all organizational expenses and (ii) all offering costs (other
than sales load) that exceed $.04 per Common Share. The Fund will invest the net
proceeds of the offering in accordance with the Fund's investment objectives and
policies as stated below. We currently anticipate that the Fund will be able to
invest primarily in Senior Loans that meet the Fund's investment objectives and
policies within approximately three to six months after completion of the
offering. The investment process may take more than three months because the
Senior Loan market may not have enough attractively priced and desirable assets
available in that time frame to allow the Fund to invest all available assets.
Pending investment in Senior Loans that meet the Fund's investment objectives
and policies, the net proceeds of the offering will be invested in high quality,
short-term fixed income securities and money market securities.
THE FUND'S INVESTMENTS
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to seek a high level of current
income. As a secondary objective, the Fund will attempt to preserve capital. The
Fund will pursue these objectives through investment in a portfolio of Senior
Loans. Under normal conditions, the Fund will invest at least 80% of its Managed
Assets in a diversified portfolio of Senior Loans. There can be no assurance
that the Fund will achieve its investment objectives.
Corporate debt obligations, such as the Senior Loans, 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 Fund's NAV. There can be no assurance
that the liquidation of collateral securing a Senior Loan or bond, if any, would
satisfy the Borrower's obligation in the event of non-payment of scheduled
Page 15
interest or principal payments, or that such collateral could be readily
liquidated. In the event of a bankruptcy of a Borrower, the Fund could
experience delays or limitations with respect to its ability to realize the
benefits of the collateral, if any, securing a corporate debt obligation. To the
extent that a corporate debt obligation is collateralized by stock in the
Borrower or its subsidiaries, such stock may lose all or substantially all of
its value in the event of a bankruptcy of such Borrower. Some corporate debt
obligations, including Senior Loans, are subject to the risk that a court,
pursuant to fraudulent conveyance or other similar laws, could subordinate such
corporate debt obligations to presently existing or future indebtedness of the
Borrower or take other action detrimental to the holders, including, in certain
circumstances, invalidating such corporate debt obligations 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.
The Fund may invest in corporate debt obligations which are not rated by an
NRSRO, are not registered with the Securities and Exchange Commission or any
state securities commission and are not listed on any national securities
exchange. In evaluating the creditworthiness of corporate debt obligors, the
Sub-Adviser will consider, and may rely in part on, analyses performed by
others. Substantially all of the corporate debt obligations in which the Fund
will invest will be lower grade debt instruments. Lower grade debt instruments
are rated Ba1 or lower by Moody's, BB+ or lower by S&P or comparably rated by
another NRSRO. In the event corporate debt obligations are not rated, they are
likely to be the equivalent of lower grade quality. Debt instruments which are
unsecured and lower grade are viewed by the NRSROs as having speculative
characteristics and are commonly referred to as "junk bonds." A description of
the ratings of corporate bonds by Moody's and S&P is included as Appendix A to
the SAI. The Sub-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 corporate debt obligations in
which the Fund will invest and some of those debt obligations 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 Fund's ability to realize full value and thus cause a material
decline in the Fund's NAV.
When interest rates decline, the value of a portfolio invested in fixed-rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a portfolio invested in fixed-rate obligations can be expected to
decline. Although the Fund's NAV will vary, the Fund's management expects that
investing a significant portion of the Fund's Managed Assets in Senior Loans
will reduce fluctuations in NAV as a result of changes in market interest rates.
However, because the rates of interest paid on the Senior Loans in which the
Fund invests will have a weighted average reset period that is typically less
than 90 days, changes in prevailing interest rates can be expected to cause some
fluctuation in the Fund's NAV. Similarly, a sudden and significant increase in
market interest rates may cause a decline in the Fund's NAV. Other economic
factors (such as a large downward movement in stock prices, a disparity in
supply and demand of certain securities or market conditions that can reduce
liquidity) can also adversely impact the markets for debt obligations. Ratings
downgrades of holdings or their issuers will generally reduce the value of such
holdings.
The Fund may use interest rate swaps for risk management purposes 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 interest, 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
Sub-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.
The Fund may also acquire equity securities as an incident to the purchase
or ownership of a Senior Loan or in connection with a reorganization of a
Borrower. Investments in equity securities incidental to investment in Senior
Loans entail certain risks in addition to those associated with investments in
Senior Loans.
Page 16
SENIOR LOAN CHARACTERISTICS
Senior Loans are loans that typically are made to business Borrowers to
finance leveraged buy-outs, recapitalizations, mergers, stock repurchases and to
finance internal growth. Senior Loans generally hold one of the most senior
positions in the capital structure of a Borrower and are usually secured by
liens on the assets of the Borrowers, including tangible assets such as cash,
accounts receivable, inventory, real estate, property, plant and equipment,
common and/or preferred stock of subsidiaries and other companies, and
intangible assets including trademarks, copyrights, patent rights, and franchise
value. The Fund may also receive guarantees as a form of collateral.
By virtue of their senior position and collateral, Senior Loans typically
provide lenders with the first right to cash flows or proceeds from the sale of
a Borrower's collateral if the Borrower becomes insolvent (subject to the
limitations of bankruptcy law, which may provide higher priority to certain
claims such as, for example, employee salaries, employee pensions, and taxes).
This means Senior Loans are generally repaid before unsecured bank loans,
corporate bonds, subordinated debt, trade creditors, and preferred or common
stockholders.
Senior Loans typically pay interest at least quarterly at rates which equal
a fixed percentage spread over a base rate such as LIBOR. For example, if LIBOR
were 4.00% and the Borrower were paying a fixed spread of 3.00%, the total
interest rate paid by the Borrower would be 7.00%. Base rates and, therefore,
the total rates paid on Senior Loans float, i.e., they change as market rates of
interest change. The fixed spread over the base rate on a Senior Loan typically
does not change.
Although a base rate such as LIBOR can change every day, loan agreements for
Senior Loans typically allow the Borrower the ability to choose how often the
base rate for the loan will change. Such periods can range from one day to one
year, with most Borrowers choosing monthly or quarterly reset periods. During
periods of rising interest rates, Borrowers will tend to choose longer reset
periods, and during periods of declining interest rates, Borrowers will tend to
choose shorter reset periods.
Senior Loans generally are arranged through private negotiations between a
Borrower and several financial institutions represented by an agent who is
usually one of the originating lenders. In larger transactions, it is common to
have several agents. Generally, however, only one such agent has primary
responsibility for on-going administration of a Senior Loan. Agents are
typically paid fees by the Borrower for their services. The agent is primarily
responsible for negotiating the loan agreement which establishes the terms and
conditions of the Senior Loan and the rights of the Borrower and the lenders.
The agent is also responsible for monitoring collateral and for exercising
remedies available to the lenders such as foreclosure upon collateral.
Loan agreements may provide for the termination of the agent's agency status
in the event that it fails to act as required under the relevant loan agreement,
becomes insolvent, enters FDIC receivership, or if not FDIC insured, enters into
bankruptcy. Should such an agent, lender or assignor with respect to an
assignment interpositioned between the Fund and the Borrower become insolvent or
enter FDIC receivership or bankruptcy, any interest in the Senior Loan of such
person and any loan payment held by such person for the benefit of the Fund
should not be included in such person's or entity's bankruptcy estate. If,
however, any such amount were included in such person's or entity's bankruptcy
estate, the Fund would incur certain costs and delays in realizing payment or
could suffer a loss of principal or interest. In this event, the Fund could
experience a decrease in NAV.
The Fund acquires Senior Loans from lenders such as banks, insurance
companies, finance companies, other investment companies and private investment
funds. The Fund may also acquire Senior Loans from U.S. branches of foreign
banks that are regulated by the Federal Reserve System or appropriate state
regulatory authorities.
Senior Loans that the Fund may acquire include participation interests in
lease financings ("Lease Participations") where the collateral quality, credit
quality of the Borrower and the likelihood of payback are believed by the
Sub-Adviser to be the same as those applied to conventional Senior Loans. A
Lease Participation is also required to have a floating interest rate that is
indexed to a benchmark indicator of prevailing interest rates, such as LIBOR or
the Prime Rate.
See "Net Asset Value" for information about the valuation of Senior Loans.
Page 17
ADDITIONAL INFORMATION CONCERNING SENIOR LOANS
The Fund's investments in Senior Loans may take one of several forms
including: acting as one of the group of lenders originating a Senior Loan,
purchasing an assignment of a portion of a Senior Loan from a third party, or
acquiring a participation in a Senior Loan. When the Fund is a member of the
originating syndicate for a Senior Loan, it may share in a fee paid to the
syndicate. When the Fund acquires a participation in, or an assignment of, a
Senior Loan, it may pay a fee to, or forego a portion of interest payments from,
the lender selling the participation or assignment. The Fund will act as lender,
or purchase an assignment or participation, with respect to a Senior Loan only
if the agent is determined by the Sub-Adviser to be creditworthy.
Except for rating agency guidelines imposed on the Fund's portfolio while it
has outstanding Preferred Shares, there is no minimum rating or other
independent evaluation of a Borrower limiting the Fund's investments and most
Senior Loans that the Fund may acquire, if rated, will be rated lower grade,
meaning below investment grade quality. See "Risks--Credit Risk."
Original Lender. When the Fund is one of the original lenders, it will have
a direct contractual relationship with the Borrower and can enforce compliance
by the Borrower with terms of the loan agreement. It also may have negotiated
rights with respect to any funds acquired by other lenders through set-off.
Original lenders also negotiate voting and consent rights under the loan
agreement. Actions subject to lender vote or consent generally require the vote
or consent of the holders of some specified percentage of the outstanding
principal amount of the Senior Loan. Certain decisions, such as reducing the
amount of, or increasing the time for payment of interest on, or repayment of
principal of, a Senior Loan, or releasing collateral therefor, frequently
require the unanimous vote or consent of all lenders affected.
Assignments. When the Fund is a purchaser of an assignment, it typically
succeeds to all the rights and obligations under the loan agreement of the
assigning lender and becomes a lender under the loan agreement with the same
rights and obligations as the assigning lender. Assignments are, however,
arranged through private negotiations between potential assignees and potential
assignors, and the rights and obligations acquired by the purchaser of an
assignment may be more limited than those held by the assigning lender.
Participations. The Fund may also invest in participations in Senior Loans.
The rights of the Fund when it acquires a participation are likely to be more
limited than the rights of an original lender or an investor who acquired an
assignment. Participation by the Fund in a lender's portion of a Senior Loan
typically means that the Fund has a contractual relationship only with the
lender, not with the Borrower. This means that the Fund has the right to receive
payments of principal, interest and any fees to which it is entitled only from
the lender selling the participation and only upon receipt by the lender of
payments from the Borrower.
With a participation, the Fund will have no rights to enforce compliance by
the Borrower with the terms of the loan agreement or any rights with respect to
any funds acquired by other lenders through set-off against the Borrower. In
addition, the Fund may not directly benefit from the collateral supporting the
Senior Loan because it may be treated as a general creditor of the lender
instead of the Borrower. As a result, the Fund may be subject to delays,
expenses and risks that are greater than those that exist when the Fund is the
original lender or holds an assignment. This means the Fund must assume the
credit risk of both the Borrower and the lender selling the participation. The
Fund will consider a purchase of participations only in those situations where
the Fund considers the participating lender to be creditworthy.
In the event of a bankruptcy or insolvency of a Borrower, the obligation of
the Borrower to repay the Senior Loan may be subject to certain defenses that
can be asserted by such Borrower against the Fund as a result of improper
conduct of the lender selling the participation. A participation in a Senior
Loan will be deemed to be a Senior Loan for the purposes of the Fund's
investment objectives and policies.
Senior Loan Market. The market for Senior Loans in which the Fund will
invest surpassed the $1 trillion mark in 2002. New issue volume has exceeded
$200 billion for each of the last six years. According to Standard & Poor's
Leveraged Commentary and Data, over the last nine years, the investor base in
Senior Loans has changed dramatically, with foreign and domestic banks moving
from an approximate combined 75% market share in 1994 to an approximate combined
25% market share at year end 2003, while institutional investors, including
mutual funds, hedge funds, collateralized debt obligations, insurance companies,
Page 18
and pension, endowment, and foundation investors collectively moved from an
approximate 25% market share to an approximate 75% market share over the same
period. According to Loan Pricing Corporation and Securities Data Corp., the
entrance of new investors has helped create an active trading market in Senior
Loans with approximately $145 billion in Senior Loan trades having been executed
in 2003. The growth in the market could continue to result in improved liquidity
for Senior Loans over time.
Market Indices. The Fund may invest in Senior Loan market indices that
synthetically reflect a composite of performance of the Senior Loan market based
on the aggregate performance of a diversified pool of underlying actively traded
"par" Senior Loans. The Fund may take long positions in these indices primarily
as a means of investing its portfolio following the closing of the offering of
the Fund's Common Shares and the receipt of the proceeds from the leveraging of
the Fund through the issuance of Preferred Shares or other debt. From time to
time, the Fund may invest in or short these indices as a means of managing
portfolio exposure or increasing portfolio yield. In the event the Fund invests
in these indices, the Fund expects to reduce its exposure to these indices by
acquiring individual Senior Loans in the primary and secondary markets following
the receipt of the aforementioned proceeds from the offerings of the Common and
Preferred Shares (and/or other debt offering.) Senior Loan market indices are
available in unfunded and funded format, the former making use of credit default
swaps and the latter making use of credit-linked notes. Descriptions of credit
default swaps and credit-linked notes may be found in the SAI. Any investment by
the Fund in a Senior Loan market index will not be included in the limits set
forth in the SAI for credit default swaps and credit-linked notes. In the event
that the Fund were to invest in an unfunded Senior Loan market index, the Fund
will segregate assets in the form of cash and cash equivalents in an amount
equal to the aggregate market value of the unfunded index investment.
Other Investment Companies. The Fund may invest its Managed Assets in
securities of other open- or closed-end investment companies that invest
primarily in securities of the types in which the Fund may invest directly. In
addition, the Fund may invest a portion of its Managed Assets in pooled
investment vehicles (other than investment companies) that invest primarily in
securities of the types in which the Fund may invest directly. The Fund
generally expects that it may invest in other investment companies and/or pooled
investment vehicles including market indices either during periods when it has
large amounts of uninvested cash, such as the period shortly after the Fund
receives the proceeds of the offering of its Common Shares or Preferred Shares
and/or borrowings, or during periods when there is a shortage of attractive
securities of the types in which the Fund may invest in directly available in
the market. As an investor in an investment company, the Fund will bear its
ratable share of that investment company's expenses, and would remain subject to
payment of the Fund's advisory and administrative fees with respect to assets so
invested. Common Shareholders would therefore be subject to duplicative expenses
to the extent the Fund invests in other investment companies. The Sub-Adviser
will take expenses into account when evaluating the investment merits of an
investment in the investment company relative to available securities of the
types in which the Fund may invest directly. In addition, the securities of
other investment companies also may be leveraged and therefore will be subject
to the same leverage risks described herein. As described in the section
entitled "Risks--Leverage Risk," the net asset value and market value of
leveraged shares will be more volatile and the yield to shareholders will tend
to fluctuate more than the yield generated by unleveraged shares. The Fund will
treat its investments in such investment companies as investments in Senior
Loans for all purposes, such as for purposes of determining compliance with the
requirement set forth above that at least 80% of the Fund's Managed Assets be
invested under normal market circumstances in Senior Loans.
BORROWINGS AND PREFERRED SHARES
The Fund anticipates that under current market conditions it will issue
Leverage Instruments representing no more than 38% of its Managed Assets
immediately after the issuance of the Leverage Instruments. If as a result of
market conditions, or any other reason, the Fund does not issue Preferred
Shares, the Fund will limit its borrowing to 33-1/3% (or such other percentage
permitted by law) of its Managed Assets. The Leverage Instruments would have
complete priority upon distribution of assets over Common Shares. The issuance
of Leverage Instruments would leverage the Common Shares. Although the timing
and other terms of the offering of Leverage Instruments and the terms of the
Leverage Instruments would be determined by the Fund's Board of Trustees, the
Fund expects to invest the proceeds derived from any Leverage Instrument
offering in Senior Loans consistent with the Fund's investment objectives and
policies. If Preferred Shares are issued they would pay adjustable rate
dividends based on shorter-term interest rates, which would be redetermined
Page 19
periodically by an auction process. The adjustment period for Preferred Shares
dividends could be as short as one day or as long as a year or more. So long as
the Fund's portfolio is invested in securities that provide a higher rate of
return than the dividend rate or interest rate of the Leverage Instruments,
after taking expenses into consideration, the leverage will cause Common
Shareholders to receive a higher rate of income than if the Fund were not
leveraged.
Leverage creates risk for holders of the Common Shares, including the
likelihood of greater volatility of NAV and market price of the Common Shares,
and the risk that fluctuations in interest rates on borrowings and debt or in
the dividend rates on any Preferred Shares may affect the return to the holders
of the Common Shares or will result in fluctuations in the dividends paid on the
Common Shares. To the extent total return exceeds the cost of leverage, the
Fund's return will be greater than if leverage had not been used. Conversely, if
the total return derived from securities purchased with funds received from the
use of leverage is less than the cost of leverage, the Fund's return will be
less than if leverage had not been used, and therefore the amount available for
distribution to Common Shareholders as dividends and other distributions will be
reduced. In the latter case, the Sub-Adviser in its best judgment nevertheless
may determine to maintain the Fund's leveraged position if it expects that the
benefits to the Fund's Common Shareholders of maintaining the leveraged position
will outweigh the current reduced return. Under normal market conditions, the
Fund anticipates that it will be able to invest the proceeds from leverage at a
higher rate than the costs of leverage, which would enhance returns to Common
Shareholders. Because the income earned on Senior Loans will float with changes
in interest rates, the Sub-Adviser expects that even in an increasing interest
rate environment, the Fund will be able to earn more on its Senior Loan
investments than the cost of its leverage. The fees paid to the Adviser and
Sub-Adviser will be calculated on the basis of the Managed Assets including
proceeds from borrowings for leverage and the issuance of Preferred Shares.
During periods in which the Fund is utilizing financial leverage, the investment
advisory fee payable to the Adviser and Sub-Adviser will be higher than if the
Fund did not utilize a leveraged capital structure. The use of leverage creates
risks and involves special considerations. See "Risks--Leverage Risk."
The Fund's Declaration authorizes the Fund, without prior approval of the
Common Shareholders, to borrow money. In this connection, the Fund may issue
notes or other evidence of indebtedness (including bank borrowings or commercial
paper) and may secure any such borrowings by mortgaging, pledging or otherwise
subjecting as security the Fund's assets. In connection with such borrowing, the
Fund may be required to maintain minimum average balances with the lender or to
pay a commitment or other fee to maintain a line of credit. Any such
requirements will increase the cost of borrowing over the stated interest rate.
Under the requirements of the 1940 Act, the Fund, immediately after any such
borrowings, must have an "asset coverage" of at least 300% (33-1/3% of Managed
Assets after borrowings). With respect to such borrowing, asset coverage means
the ratio which the value of the total assets of the Fund, less all liabilities
and indebtedness not represented by senior securities (as defined in the 1940
Act), bears to the aggregate amount of such borrowing represented by senior
securities issued by the Fund.
The rights of lenders to the Fund to receive interest on and repayment of
principal of any such borrowings will be senior to those of the Common
Shareholders, and the terms of any such borrowings may contain provisions which
limit certain activities of the Fund, including the payment of dividends to
Common Shareholders in certain circumstances. Further, the 1940 Act does (in
certain circumstances) grant to the lenders to the Fund certain voting rights in
the event of default in the payment of interest on or repayment of principal. In
the event that such provisions would impair the Fund's status as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"), the Fund, subject to its ability to liquidate its relatively illiquid
portfolio, intends to repay the borrowings. Any borrowing will likely be ranked
senior or equal to all other existing and future borrowings of the Fund.
Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for the short-term corporate debt securities or Preferred Shares
issued by the Fund. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed by the 1940
Act. It is not anticipated that these covenants or guidelines will impede the
Sub-Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objectives and policies.
Page 20
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares
unless immediately after such issuance the value of the Fund's Managed Assets is
at least 200% of the liquidation value of the outstanding Preferred Shares
(i.e., the liquidation value may not exceed 50% of the Fund's Managed Assets).
In addition, the Fund is not permitted to declare any cash dividend or other
distribution on its Common Shares unless, at the time of such declaration, the
value of the Fund's Managed Assets is at least 200% of such liquidation value.
If Preferred Shares are issued, the Fund intends, to the extent possible, to
purchase or redeem Preferred Shares from time to time to the extent necessary in
order to maintain coverage of any Preferred Shares of at least 200%. In
addition, as a condition to obtaining ratings on the Preferred Shares, the terms
of any Preferred Shares issued are expected to include asset coverage
maintenance provisions which will require the redemption of the Preferred Shares
in the event of non-compliance by the Fund and may also prohibit dividends and
other distributions on the Common Shares in such circumstances. In order to meet
redemption requirements, the Fund may have to liquidate portfolio securities.
Such liquidations and redemptions would cause the Fund to incur related
transaction costs and could result in capital losses to the Fund. Prohibitions
on dividends and other distributions on the Common Shares could impair the
Fund's ability to qualify as a regulated investment company under the Code. If
the Fund has Preferred Shares outstanding, two of the Fund's trustees will be
elected by the holders of Preferred Shares as a class. The remaining trustees of
the Fund will be elected by holders of Common Shares and Preferred Shares voting
together as a single class. In the event the Fund failed to pay dividends on
Preferred Shares for two years, holders of Preferred Shares would be entitled to
elect a majority of the trustees of the Fund.
The Fund may also 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.
EFFECTS OF LEVERAGE
Assuming that the Leverage Instruments will represent approximately 38% of
the Fund's capital and pay dividends or interest at an annual combined average
rate of 1.17%, the income generated by the Fund's portfolio (net of estimated
expenses) must exceed .58% in order to cover the dividend or interest payments
specifically related to the Leverage Instruments. Of course, these numbers are
merely estimates used for illustration. Actual dividend or interest rates on the
Leverage Instruments will vary frequently and may be significantly higher or
lower than the rate estimated above.
The following table is furnished in response to requirements of the
Securities and Exchange Commission.
It is designed to illustrate the effect of leverage on Common Share total
return, assuming investment portfolio total returns (comprised of income and
changes in the value of securities held in the Fund's portfolio) of (10%), (5%),
0%, 5% and 10%. These assumed investment portfolio returns are hypothetical
figures and are not necessarily indicative of the investment portfolio returns
experienced or expected to be experienced by the Fund. See "Risks."
The table further reflects the issuance of Leverage Instruments representing
38% of the Fund's capital, net of expenses, and the Fund's currently projected
annual Preferred Share dividend of 1.17%.
Assumed Portfolio Total Return (Net of Expenses)... (10)% (5)% 0% 5% 10%
Common Share Total Return ......................... (16.89)% (8.81)% (.72)% 7.36% 15.44%
Common Share total return is composed of two elements: the Common Share
dividends paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying dividends or interest on its Leverage
Instruments) and gains or losses on the value of the securities the Fund owns.
As required by Securities and Exchange Commission rules, the table above assumes
that the Fund is more likely to suffer capital losses than to enjoy capital
appreciation. For example, to assume a total return of 0% the Fund must assume
that the interest it receives on its debt security investments is entirely
offset by losses in the value of those bonds.
Page 21
RISKS
Risk is inherent in all investing. The following discussion summarizes some
of the risks that you should consider before deciding whether to invest in the
Fund. For additional information about the risks associated with investing in
the Fund, see "Additional Information About the Fund's Investments" in the SAI.
No Operating History. The Fund is a newly organized, diversified, closed-end
management investment company with no operating history.
Credit Risk. The Fund's ability to pay dividends is dependent upon the
performance of the Fund's Managed Assets. That performance, in turn, is subject
to a number of risks, primarily the credit risk of the Fund's underlying assets.
Credit risk is the risk of nonpayment of scheduled interest and/or principal
payments. Credit risk also 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 security experiences a decline in its
financial status. The value of Senior Loans is affected by the creditworthiness
of Borrowers/issuers and by general economic and specific industry conditions.
Senior Loans. In the event a Borrower fails to pay scheduled interest or
principal payments on a Senior Loan held by the Fund, the Fund will experience a
reduction in its income and a decline in the market value of the Senior Loan,
which will likely reduce dividends and lead to a decline in the NAV of the
Fund's Common Shares. If the Fund acquires a Senior Loan from another Lender,
for example, by acquiring a participation, the Fund may also be subject to
credit risks with respect to that Lender. See "The Fund's
Investments--Additional Information Concerning Senior Loans."
Senior Loans generally involve less risk than unsecured or subordinated debt
and equity instruments of the same issuer because the payment of principal of
and interest on Senior Loans is a contractual obligation of the issuer that, in
most instances, takes precedence over the payment of dividends, or the return of
capital, to the issuer's shareholders and payments to bond holders. The Fund
generally invests in Senior Loans that are secured with specific collateral.
However, the value of the collateral may not equal the Fund's investment when
the Senior Loan is acquired or may decline below the principal amount of the
Senior Loan subsequent to the Fund's investment. Also, to the extent that
collateral consists of stock of the Borrower or its subsidiaries or affiliates,
the Fund bears the risk that the stock may decline in value, be relatively
illiquid, and/or may lose all or substantially all of its value, causing the
Senior Loan to be undercollateralized. Therefore, the liquidation of the
collateral underlying a Senior Loan may not satisfy the issuer's obligation to
the Fund in the event of non-payment of scheduled interest or principal, and the
collateral may not be readily liquidated.
In the event of the bankruptcy of a Borrower, the Fund could experience
delays and limitations on its ability to realize the benefits of the collateral
securing the Senior Loan. Among the credit risks involved in a bankruptcy are
assertions that the pledge of collateral to secure a Senior Loan constitutes a
fraudulent conveyance or preferential transfer that would have the effect of
nullifying or subordinating the Fund's rights to the collateral.
The Senior Loans in which the Fund invests are generally lower grade (i.e.,
rated "Ba1" or lower by Moody's, "BB+" or lower by S&P or comparably rated by
another NRSRO) or unrated but determined to be of comparable credit quality as
lower grade debt instruments. Investment decisions will be based largely on the
credit analysis performed by the Sub-Adviser, and not on rating agency
evaluations. This analysis may be difficult to perform. Information about a
Senior Loan and its issuer generally is not in the public domain. Moreover,
Senior Loans may not be rated by any NRSRO. Many issuers have not issued
securities to the public and are not subject to reporting requirements under
federal securities laws. Generally, however, issuers are required to provide
financial information to lenders and information may be available from other
Senior Loan participants or agents that originate or administer Senior Loans.
Lower Grade Debt Instruments. Investing in lower grade debt instruments
involves additional risks than investment- grade debt instruments. Lower grade
debt instruments are securities rated Ba1 or lower by Moody's or BB+ or lower by
S&P, comparably rated by another NRSRO or, if unrated, of comparable credit
quality. These lower grade debt instruments may become the subject of bankruptcy
proceedings or otherwise subsequently default as to the repayment of principal
and/or payment of interest or be downgraded to ratings in the lower rating
categories (Ca or lower by Moody's, CC or lower by S&P or comparably rated by
another NRSRO). Issuers of lower grade debt instruments are not perceived to be
as strong financially as those with higher credit ratings, so the securities are
usually considered speculative investments. These issuers are generally more
Page 22
vulnerable to financial setbacks and recession than more creditworthy issuers
which may impair their ability to make interest and principal payments. Lower
grade debt instruments tend to be less liquid than higher grade debt
instruments.
Lower grade debt instruments carry particular market risks and may
experience greater volatility in market value than investment grade debt
instruments. Changes in interest rates, the market's perception of the issuers
and the creditworthiness of the issuers may significantly affect the value of
these securities. Some of these securities may have a structure that makes their
reaction to interest rate and other factors difficult to predict, causing their
value to be highly volatile. The secondary market for lower grade debt
instruments may be less liquid than the markets for higher quality debt
instruments, and this may have an adverse effect on the market value of certain
securities.
Lower grade debt instruments face market, issuer and other risks, and their
values may go up and down, sometimes rapidly and unpredictably. Market risk is
the risk that securities may decline in value due to factors affecting
securities markets generally or particular industries. Issuer risk is the risk
that the value of a security may decline for reasons relating to the issuer,
such as changes in the financial condition of the issuer.
The Fund could lose money if the issuer of a debt instrument is unable to
meet its financial obligations or goes bankrupt. The Fund may be subject to more
credit risk than other income funds because it invests in lower grade debt
instruments, which are considered predominantly speculative with respect to the
issuer's continuing ability to meet interest and principal payments. This is
especially true during periods of economic uncertainty or economic downturns.
The value of a lower grade debt instrument may fall when interest rates
rise. Debt instruments with longer durations tend to be more sensitive to
changes in interest rates, usually making them more volatile than debt
instruments with shorter durations.
Lower grade debt instruments may be less liquid than higher quality
instruments. The Fund could lose money if it cannot sell a security at the time
and price that would be most beneficial to the Fund. A security in the lowest
rating categories, that is unrated, or whose credit rating has been lowered may
be particularly difficult to sell. Valuing less liquid securities involves
greater exercise of judgment and may be more subjective than valuing securities
using market quotes.
Interest Rate Risk. During normal market conditions, changes in market
interest rates will affect the Fund. The principal effect will be that the yield
on the Fund's Common Shares will tend to rise or fall as market interest rates
rise and fall. This is because Senior Loans, the majority of the assets in which
the Fund invests, pay interest at rates which float in response to changes in
market rates. However, because the interest rates on the Senior Loans reset over
time, there will be an imperfect correlation between changes in market rates and
changes to rates on the Senior Loans. This means that changes to the interest
paid on the Senior Loans as a whole will tend to lag behind changes in market
rates.
The value of a Senior Loan is partially a function of whether it is paying
what the market perceives to be a market rate of interest for the particular
Senior Loan, given its individual credit and other characteristics. If market
interest rates change, a Senior Loan's value could be affected to the extent the
interest rate paid on that loan does not reset at the same time. The rates of
interest paid on the Senior Loans in which the Fund invests will have a weighted
average reset period that is typically less than 90 days. Therefore, the impact
of the lag between a change in market interest rates and the change in the
overall rate on the portfolio is expected to be limited.
To the extent that changes in total rates of interest are reflected not in a
change to a base rate such as LIBOR but in a change in the spread over the base
rate which is payable on Senior Loans of the type and quality in which the Fund
invests, the Fund's NAV could also be adversely affected. Again, this is because
the value of a Senior Loan in the Fund is partially a function of whether it is
paying what the market perceives to be an appropriate total rate of interest for
the particular Senior Loan, given its individual credit and other
characteristics. However, unlike changes in market rates of interest for which
there is only a temporary lag before the portfolio reflects those changes,
changes in a Senior Loan's value based on changes in the market spread on Senior
Loans held by the Fund may be of longer duration.
Page 23
Changes to Net Asset Value. The NAV of the Fund is expected to change in
response to a variety of factors, primarily in response to changes in the
creditworthiness of the Borrowers on the Senior Loans the Fund acquires. See
"Credit Risk" above. Changes in market interest rates may also have a moderate
impact on the Fund's NAV. See "Interest Rate Risk" above. Another factor which
can affect the Fund's NAV is changes in the pricing obtained for the Fund's
assets. See "Net Asset Value."
Discount From or Premium to Net Asset Value. An investment in the Fund's
Common Shares is subject to investment risk, including the possible loss of the
entire amount that you invest. Your investment in Common Shares represents an
indirect investment in the securities and investments owned by the Fund. The
value of these securities and investments, like other market investments, may
move up or down, sometimes rapidly and unpredictably, sometimes due to market
factors that may be unrelated to the Fund's securities and investments. Your
Common Shares at any point in time may be worth less than what you invested,
even after taking into account the reinvestment of Fund dividends and
distributions. In addition, shares of closed-end management investment companies
frequently trade at a discount from their NAV. This risk may be greater for
investors expecting to sell their shares of the Fund soon after completion of
the public offering. The shares of the Fund were designed primarily for
long-term investors, and investors in the Common Shares should not view the Fund
as a vehicle for trading purposes. The possibility that the Common Shares of the
Fund may trade at a discount from NAV is a risk separate and distinct from the
risk that the Fund's NAV may decrease.
Leverage Risk. The Fund may borrow an amount up to 33-1/3% (or such other
percentage as permitted by law) of its Managed Assets (including the amount
borrowed) less all liabilities other than borrowings. The Fund may also issue
Preferred Shares in an amount up to 50% of the Fund's Managed Assets (including
the proceeds of the Preferred Shares and any borrowings). However, the Fund
intends, under normal circumstances, to utilize leverage in an amount up to 38%
of the Fund's Managed Assets. Borrowings and the issuance of Preferred Shares
are referred to in this prospectus collectively as "leverage." Although the use
of leverage by the Fund may create an opportunity for increased return for the
Common Shares, it also results in additional risks and can magnify the effect of
any losses. If the income and gains earned on the securities and investments
purchased with leverage proceeds are greater than the cost of the leverage, the
Common Shares' return will be greater than if leverage had not been used.
Conversely, if the income or gains from the securities and investments purchased
with such proceeds does not cover the cost of leverage, the return to the Common
Shares will be less than if leverage had not been used. There is no assurance
that a leveraging strategy will be successful. Leverage involves risks and
special considerations for Common Shareholders including:
o the likelihood of greater volatility of NAV and market price of the
Common Shares than a comparable portfolio without leverage;
o the risk that fluctuations in interest rates on borrowings and
short-term debt or in the dividend rates on any Preferred Shares that
the Fund may pay will reduce the return to the Common Shareholders or
will result in fluctuations in the dividends paid on the Common Shares;
o the effect of leverage in a declining market, which is likely to cause
a greater decline in the NAV of the Common Shares than if the Fund were
not leveraged, which may result in a greater decline in the market
price of the Common Shares; and
o when the Fund uses financial leverage, the investment advisory fee
payable to the Adviser and the Sub-Advisor's fee will be higher than if
the Fund did not use leverage.
The Sub-Adviser, in its judgment, nevertheless may determine to continue to
use leverage if it expects that the benefits to the Fund's shareholders of
maintaining the leveraged position will outweigh the current reduced return.
The funds borrowed pursuant to a leverage borrowing program (such as a
credit line or commercial paper program), or obtained through the issuance of
Preferred Shares, constitute a substantial lien and burden by reason of their
prior claim against the income of the Fund and against the net assets of the
Fund in liquidation. The rights of lenders to receive payments of interest on
and repayments of principal on any borrowings made by the Fund under a leverage
borrowing program are senior to the rights of holders of Common Shares and the
holders of Preferred Shares, with respect to the payment of dividends or upon
liquidation. The Fund may not be permitted to declare dividends or other
distributions, including dividends and distributions with respect to Common
Shares or Preferred Shares or purchase Common Shares or Preferred Shares unless
Page 24
at the time thereof, the Fund meets certain asset coverage requirements and no
event of default exists under any leverage borrowing program. In addition, the
Fund may not be permitted to pay dividends on Common Shares unless all dividends
on the Preferred Shares and/or accrued interest on borrowings have been paid, or
set aside for payment. In an event of default under a leverage borrowing
program, the lenders have the right to cause a liquidation of collateral (i.e.,
sell Senior Loans and other assets of the Fund) and, if any such default is not
cured, the lenders may be able to control the liquidation as well. Certain types
of leverage may result in the Fund being subject to covenants relating to asset
coverage and Fund composition requirements. The Fund may be subject to certain
restrictions on investments imposed by guidelines of one or more rating
agencies, which may issue ratings for the Preferred Shares or other leverage
securities issued by the Fund. These guidelines may impose asset coverage or
Fund composition requirements that are more stringent than those imposed by the
1940 Act. The Sub-Adviser does not believe that these covenants or guidelines
will impede it from managing the Fund's portfolio in accordance with the Fund's
investment objectives and policies.
While the Fund may from time to time consider reducing leverage in response
to actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset value associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will benefit the Common
Shareholders. Changes in the future direction of interest rates are very
difficult to predict accurately. If the Fund were to reduce leverage based on a
prediction about future changes to interest rates, and that prediction turned
out to be incorrect, the reduction in leverage would likely operate to reduce
the income and/or total returns to Common Shareholders relative to the
circumstance if the Fund had not reduced leverage. The Fund may decide that this
risk outweighs the likelihood of achieving the desired reduction to volatility
in income and Common Share price if the prediction were to turn out to be
correct, and determine not to reduce leverage as described above.
Restrictive Covenants and 1940 Act Restrictions. With respect to a leverage
borrowing program instituted by the Fund, the credit agreements governing such a
program (the "Credit Agreements") will likely include usual and customary
covenants for this type of transaction, including, but not limited to, limits on
the Fund's ability to: (i) issue Preferred Shares; (ii) incur liens or pledge
portfolio securities or investments; (iii) change its investment objectives or
fundamental investment restrictions without the approval of lenders; (iv) make
changes in any of its business objectives, purposes or operations that could
result in a material adverse effect; (v) make any changes in its capital
structure; (vi) amend the Fund documents in a manner which could adversely
affect the rights, interests or obligations of any of the lenders; (vii) engage
in any business other than the business currently engaged in; (viii) create,
incur, assume or permit to exist certain debt except for certain specific types
of debt; and (ix) permit any of its Employment Retirement Income Security Act
("ERISA") affiliates to cause or permit to occur an event that could result in
the imposition of a lien under the Code or ERISA. In addition, the Credit
Agreements would not permit the Fund's asset coverage ratio (as defined in the
Credit Agreements) to fall below 300% at any time.
Under the requirements of the 1940 Act, the Fund must have asset coverage of
at least 300% immediately after any borrowing, including borrowing under any
leverage borrowing program the Fund implements. For this purpose, asset coverage
means the ratio which the value of the total assets of the Fund, less
liabilities and indebtedness not represented by senior securities, bears to the
aggregate amount of borrowings represented by senior securities issued by the
Fund. The Credit Agreements would limit the Fund's ability to pay dividends or
make other distributions on the Fund's Common Shares unless the Fund complies
with the Credit Agreements' 300% asset coverage test. In addition, the Credit
Agreements will not permit the Fund to declare dividends or other distributions
or purchase or redeem Common Shares or Preferred Shares: (i) at any time that
any event of default under the Credit Agreements has occurred and is continuing;
or (ii) if, after giving effect to such declaration, the Fund would not meet the
Credit Agreements' 300% asset coverage test set forth in the Credit Agreements.
Secondary Market for the Fund's Shares. The issuance of Common Shares
through the Fund's Dividend Reinvestment Plan may have an adverse effect on the
secondary market for the Fund's Common Shares. The increase in the number of
Fund's outstanding Common Shares resulting from issuances pursuant to the Fund's
Dividend Reinvestment Plan and the discount to the market price at which such
Common Shares may be issued, may put downward pressure on the market price for
Common Shares of the Fund. Common Shares will not be issued pursuant to the
Dividend Reinvestment Plan at any time when Common Shares are trading at a lower
price than the Fund's NAV per common share. When the Fund's Common Shares are
trading at a premium, the Fund may also issue Common Shares of the Fund that may
Page 25
be sold through private transactions effected on the NYSE or through
broker-dealers. The increase in the number of outstanding Common Shares
resulting from these offerings may put downward pressure on the market price for
Common Shares.
Limited Secondary Market for Senior Loans; Valuation. Although the resale,
or secondary market for Senior Loans is growing, it is currently limited. There
is no organized exchange or board of trade on which Senior Loans are traded.
Instead, the secondary market for Senior Loans is an unregulated inter-dealer or
inter-bank resale market.
Senior Loans usually trade in large denominations (typically $1 million and
higher) and trades can be infrequent. The market has limited transparency so
that information about actual trades may be difficult to obtain. Accordingly,
some or many of the Senior Loans in which the Fund invests will be relatively
illiquid.
In addition, Senior Loans in which the Fund invests may require the consent
of the Borrower and/or agent prior to sale or assignment. These consent
requirements can delay or impede the Fund's ability to sell Senior Loans and can
adversely affect the price that can be obtained. The Fund may have difficulty
disposing of Senior Loans if it needs cash to repay debt, to pay dividends, to
pay expenses or to take advantage of new investment opportunities. In addition,
if the Fund purchases a relatively large assignment of a Senior Loan to generate
extra income sometimes paid to large lenders, the limitations of the secondary
market may inhibit the Fund from selling a portion of the Senior Loan and
reducing its exposure to the Borrower when the Sub-Adviser deems it advisable to
do so.
The Fund will value its Senior Loans daily. However, because the secondary
market for Senior Loans is limited, it may be difficult to value loans. Market
quotations may not be readily available for some Senior Loans and valuation may
require more research than for liquid securities. In addition, elements of
judgment may play a greater role in valuation of Senior Loans than for
securities with a secondary market, because there is less reliable objective
data available.
Lending Portfolio Securities. To generate additional income, the Fund may
lend portfolio securities in an amount up to 33-1/3% of Managed Assets to
broker-dealers, major banks, or other recognized domestic institutional
Borrowers of securities. As with other extensions of credit, there are risks of
delay in the recovery or even loss of rights in the collateral should the
Borrower default or fail financially. The Fund intends to engage in lending
portfolio securities only when such lending is fully secured by investment grade
collateral held by an independent agent.
Demand for Senior Loans. Although the volume of Senior Loans has increased
in recent years, demand for Senior Loans has also grown. An increase in demand
may benefit the Fund by providing increased liquidity for Senior Loans, but may
also adversely affect the rate of interest payable on Senior Loans acquired by
the Fund, the price of Senior Loans acquired in the secondary markets and the
rights provided to the Fund under the terms of a Senior Loan.
Unsecured Loans and Subordinated Loans. The Fund may invest up to 10% of its
Managed Assets, measured at the time of investment, in unsecured Senior Loans,
subordinated loans or a subordinated portion of a Senior Loan. Unsecured Senior
Loans and subordinated loans share the same credit risks as those discussed
above under "Credit Risk" except that unsecured Senior Loans are not secured by
any collateral of the Borrower and subordinated loans are not the most senior
debt in a Borrower's capital structure. Unsecured Senior Loans do not enjoy the
security associated with collateralization and may pose a greater risk of
non-payment of interest or loss of principal than do secured Senior Loans. The
primary additional risk in a subordinated loan is the potential loss in the
event of default by the issuer of the loan. Subordinated loans and subordinated
portions of Senior Loans in an insolvency bear an increased share, relative to
senior secured lenders, of the ultimate risk that the Borrower's assets are
insufficient to meet its obligations to its creditors.
Short-Term Debt Securities. The Fund may invest in short-term debt
securities. Short-term debt securities are subject to the risk of the issuer's
inability to meet principal and interest payments on the obligation and also may
be subject to price volatility due to such factors as interest rate sensitivity,
market perception of the creditworthiness of the issuer and general market
liquidity.
Because short-term debt securities pay interest at a fixed rate, when
interest rates decline, the value of the Fund's short-term debt securities can
be expected to rise, and when interest rates rise, the value of those securities
can be expected to decline.
Page 26
Investments in Equity Securities Incidental to Investment in Senior Loans.
The Fund may also acquire equity securities as an incident to the purchase or
ownership of a Senior Loan or in connection with a reorganization of a Borrower.
Investments in equity securities incidental to investment in Senior Loans entail
certain risks in addition to those associated with investments in Senior Loans.
The value of the equity securities may be affected more rapidly, and to a
greater extent, by company-specific developments and general market conditions.
These risks may increase fluctuations in the Fund's NAV. The Fund may frequently
possess material non-public information about a Borrower as a result of its
ownership of a Senior Loan to such Borrower. Because of prohibitions on trading
in securities of issuers while in possession of such information, the Fund might
be unable to enter into a transaction in a security of such a Borrower when it
would otherwise be advantageous to do so.
Illiquid Securities. The Fund may invest without limit in illiquid
securities. Illiquid securities may be difficult to dispose of at a fair price
at the times when the Fund believes it is desirable to do so. The market price
of illiquid securities generally is more volatile than that of more liquid
securities, which may adversely affect the price that the Fund pays for or
recovers upon the sale of illiquid securities. Illiquid securities are also more
difficult to value and the Adviser's judgment may play a greater role in the
valuation process. Investment of the Fund's assets in illiquid securities may
restrict the Fund's ability to take advantage of market opportunities. The risks
associated with illiquid securities may be particularly acute in situations in
which the Fund's operations require cash and could result in the Fund borrowing
to meet its short-term needs or incurring losses on the sale of illiquid
securities.
Foreign Securities. The Fund may invest up to 15% of its Managed Assets in
U.S. dollar-denominated foreign securities, but in no case will the Fund invest
in debt securities of issuers located in emerging markets. Investments in non-
U.S. issuers may involve unique risks which differ from investments in
securities of U.S. issuers. These risks are more pronounced to the extent that
the Fund invests a significant portion of its non-U.S. investments in one
region. These risks may include:
o less information about non-U.S. issuers or markets may be available due
to less rigorous disclosure or accounting standards or regulatory
practices;
o many non-U.S. markets are smaller, less liquid and more volatile. In a
changing market, the Sub-Adviser may not be able to sell the Fund's
portfolio securities at times, in amounts and at prices it considers
desirable;
o an adverse effect of currency exchange rates or controls on the value
of the Fund's investments;
o the economies of non-U.S. countries may grow at slower rates than
expected or may experience a downturn or recession;
o economic, political, and social developments may adversely affect the
securities markets; and
o withholding and other non-U.S. taxes may decrease the Fund's return.
Management Risk. The Sub-Adviser's judgment about the attractiveness,
relative value or potential appreciation of a particular sector, security or
investment strategy may prove to be incorrect.
Strategic Transactions. The Fund may use various other investment management
techniques that also involve certain risks and special considerations, including
engaging in hedging and risk management transactions, including credit default
swaps, credit-linked notes, interest rate options, futures, swaps, caps, floors,
and collars and other derivative transactions. These strategic transactions will
be entered into to seek to manage the risks of the Fund's portfolio securities,
but may have the effect of limiting the gains from favorable market movements.
Certain of these strategic transactions may provide investment leverage to the
Fund's portfolio and result in many of the same risks of leverage to Common
Shareholders as discussed above under "--Leverage Risk." See "Additional
Information About the Fund's Investments" in the SAI for more information about
these techniques.
Reinvestment Risk. Reinvestment risk is the risk that income from the Fund
will decline if and when the Fund invests the proceeds from matured, traded, or
called securities at market rates that are below the portfolio's current
earnings rate. A decline in income could affect the market price or the overall
returns on the Fund's Common Shares.
Page 27
Inflation Risk. Inflation risk is the risk that the value of assets or
income from the Fund's investment will be worth less in the future as inflation
decreases the value of money. As inflation increases, the real, or inflation
adjusted, value of the Fund's Common Shares and distributions can decline and
the interest payments on Fund borrowings, if any, may increase or the value of
dividend payments on the Fund's Preferred Shares, if any, may decline.
Regulatory Changes. To the extent that legislation or state or federal bank
or other regulators impose additional requirements or restrictions on the
ability of certain financial institutions to make loans, particularly in
connection with highly leveraged transactions, the availability of Senior Loans
and other related investments sought after by the Fund may be reduced. Further,
such legislation or regulation could depress the market value of Senior Loans
and other debt securities held by the Fund.
Market Event Risk. The terrorist attacks in the United States on September
11, 2001 had a disruptive effect on the securities markets. United States
military and related action in Iraq is ongoing and events in the Middle East
could have significant adverse effects on the U.S. economy and the stock market.
The Fund cannot predict the effects of similar events in the future on the U.S.
economy.
Anti-Takeover Provisions. The Fund's Declaration includes provisions that
could limit the ability of other entities or persons to acquire control of the
Fund or convert the Fund to open-end status. These provisions could have the
effect of depriving the Common Shareholders of opportunities to sell their
Common Shares at a premium over the then current market price of the Common
Shares. See "Certain Provisions in the Declaration of Trust."
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund,
including supervision of the duties performed by the Adviser and the
Sub-Adviser. There are five trustees of the Fund, one of whom is an "interested
person" (as defined in the 1940 Act) and four of whom are not "interested
persons." The names and business addresses of the trustees and officers of the
Fund and their principal occupations and other affiliations during the past five
years are set forth under "Management of the Fund" in the SAI.
INVESTMENT ADVISER
First Trust Advisors, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532, is the investment adviser to the Fund and is responsible for selecting
and supervising the Sub-Adviser. First Trust Advisors serves as investment
adviser or portfolio supervisor to investment portfolios with approximately
$11.8 billion in assets which it managed or supervised as of April 30, 2004.
First Trust Advisors is also responsible for the ongoing monitoring of the
Fund's investment portfolio, managing the Fund's business affairs and providing
certain clerical, bookkeeping and other administrative services.
First Trust Advisors, a registered investment adviser, is an Illinois
limited partnership formed in 1991 and an investment adviser registered with the
Securities and Exchange Commission under the Investment Advisers Act of 1940.
First Trust Advisors is a limited partnership with one limited partner, Grace
Partners of DuPage L.P. ("Grace Partners"), and one general partner, The Charger
Corporation. Grace Partners is a limited partnership with one general partner,
The Charger Corporation, and a number of limited partners. Grace Partners' and
The Charger Corporation's primary business is investment advisory and
broker-dealer services through their interests. The Charger Corporation is an
Illinois corporation controlled by the Robert Donald Van Kampen family. First
Trust Advisors is controlled by Grace Partners and The Charger Corporation.
For additional information concerning First Trust Advisors, including a
description of the services provided, see the SAI.
Page 28
SUB-ADVISER
Four Corners Capital Management, LLC, 515 South Flower Street, Suite 4310,
Los Angeles, California 90071, serves as the investment sub-adviser to the Fund.
In this capacity, the Sub-Adviser is responsible for the selection and ongoing
monitoring of the assets in the Fund's investment portfolio. The Sub-Adviser
specializes in managing portfolios of Senior Loans and structured finance
assets. Four Corners managed and advised investment portfolios in excess of $1
billion of investment capacity as of March 31, 2004. The Sub-Adviser's expertise
is particularly suited to the Fund's focus on Senior Loans. The Sub-Adviser is a
Delaware limited liability company founded in September 2001 by Macquarie
Holdings (USA), Inc., an affiliate of the Macquarie Group, and an experienced
group of senior loan investment professionals.
The Sub-Adviser is owned 66.67% by Macquarie Bank Limited through a
subsidiary and 33.33% by the senior management of Four Corners. Day-to-day
operations and execution of specific investment strategies relating to the Fund
are the responsibility of the Sub-Adviser. Michael P. McAdams is the President
and Chief Investment Officer of the Sub-Adviser and will be co-Portfolio Manager
of the Fund. Robert I. Bernstein is the Managing Director and Chief Credit
Officer of the Sub-Adviser and will be co-Portfolio Manager of the Fund.
Mr. McAdams has been involved with the management of portfolios of senior
loans since 1982. In 1988 he established, and from 1988 until 1995, he was the
portfolio manager for, Pilgrim Prime Rate Trust, the first U.S. investment
company that invested primarily in senior loans. Immediately prior to
establishing Four Corners, Mr. McAdams was Chief Executive Officer of ING
Capital Advisors, LLC, an institutional asset manager then having approximately
$7 billion in senior loan and high yield bond portfolios under management. In
1995, Mr. McAdams was a founding board member of the Loan Syndications and
Trading Association ("LSTA"), the senior loan industry's trade group. Mr.
McAdams has served as Chairman (2001) and Vice Chairman (2002) of the LSTA and
was the first person from the investment side of the industry to serve in any of
those capacities. Today, he remains a Director and is a member of the LSTA's
Mark-to-Market Policy Committee.
Mr. Bernstein's involvement with senior loans began in 1986, and he has been
actively involved in the senior loan market for over 12 years. Prior to joining
Four Corners in November 2001, Mr. Bernstein was most recently a General Partner
of The Yucaipa Companies, a Los Angeles-based private equity investment firm.
While at Yucaipa, Mr. Bernstein completed more than $4 billion of senior loan
and high yield bond financings and private equity investments, and he served on
the boards of three companies. He was previously with Bankers Trust's Leverage
Finance Group, where he arranged senior loan and high yield bond financing for
financial sponsors and corporate issuers. Mr. Bernstein also served as an
infantry officer in the U.S. Marine Corps.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Adviser and the
Fund, the Fund has agreed to pay a fee for the services and facilities provided
by the Adviser at the annual rate of .75% of Managed Assets.
For purposes of calculation of the management fee, the Fund's "Managed
Assets" means the average daily gross asset value of the Fund (which includes
assets attributable to the Fund's Preferred Shares, if any, and the principal
amount of borrowings), minus the sum of the Fund's accrued and unpaid dividends
on any outstanding Preferred Shares and accrued liabilities (other than the
principal amount of any borrowings incurred, commercial paper or notes issued by
the Fund and the liquidation preference of any outstanding Preferred Shares).
In addition to the management fee, the Fund pays all other costs and
expenses of its operations including the compensation of its trustees (other
than those affiliated with the Adviser), custodian, transfer and dividend
disbursing agent expenses, legal fees, leverage expenses, rating agency fees,
listing fees and expenses, expenses of independent auditors, expenses of
preparing, printing, and distributing shareholder reports, notices, proxy
statements and reports to governmental agencies, and taxes, if any.
The Sub-Adviser receives a portfolio management fee at the annual rate of
..38% of Managed Assets, which is paid out of the Adviser's management fee.
Page 29
Both the Adviser and the Sub-Adviser have agreed to pay (i) all
organizational expenses and (ii) all offering costs of the Fund (other than
sales load) that exceed $.04 per Common Share.
Because the fee paid to the Adviser and Sub-Adviser will be calculated on
the basis of the Fund's Managed Assets, which include the proceeds of leverage,
the dollar amount of the Adviser's and Sub-Adviser's fees from the Fund will be
higher (and the Adviser and Sub-Adviser will be benefited to that extent) when
leverage is utilized. In this regard, if the Fund uses leverage in the amount
equal to 38% of the Fund's Managed Assets (after their issuance), the Fund's
management fee would be 1.21% of net assets attributable to Common Shares. See
"Summary of Fund Expenses."
NET ASSET VALUE
The NAV of the Common Shares of the Fund will be computed based upon the
value of the Fund's portfolio securities and other assets. The NAV will be
determined as of the close of regular trading on the New York Stock Exchange
("NYSE") (normally 4:00 p.m. New York City time) on each day the NYSE is open
for trading. Domestic debt securities and foreign securities will normally be
priced using data reflecting the earlier closing of the principal markets for
those securities. The Fund calculates NAV per Common Share by subtracting the
Fund's liabilities (including accrued expenses, dividends payable and any
borrowings of the Fund) and the liquidation value of any outstanding Preferred
Shares from the Fund's Managed Assets (the value of the securities and other
investments the Fund holds plus cash or other assets, including interest accrued
but not yet received) and dividing the result by the total number of Common
Shares outstanding.
The assets in the Fund's portfolio will be valued daily in accordance with
Valuation Procedures adopted by the Board of Trustees. The Sub-Adviser
anticipates that a majority of the Fund's assets will be valued using market
information supplied by third parties. In the event that market quotations are
not readily available, the pricing service does not provide a valuation for a
particular asset, or the valuations are deemed unreliable, or if events
occurring after the close of the principal markets for particular securities
(e.g., domestic debt and foreign securities), but before the Fund values its
assets, would call into doubt whether the earlier market quotations represent
fair value, the Fund may use a fair value method in good faith to value the
Fund's securities and investments. The use of fair value pricing by the Fund
will be governed by Valuation Procedures established by the Fund's Board of
Trustees, and in accordance with the provisions of the 1940 Act.
Senior Loans. The Senior Loans in which the Fund invests are not listed on
any securities exchange or board of trade. Senior Loans are typically bought and
sold by institutional investors in individually negotiated private transactions
that function in many respects like an over-the-counter secondary market,
although typically no formal market-makers exist. This market, while having
substantially grown in the past several years, generally has fewer trades and
less liquidity than the secondary market for other types of securities. Some
Senior Loans have few or no trades, or trade infrequently, and information
regarding a specific Senior Loan may not be widely available or may be
incomplete. Accordingly, determinations of the market value of Senior Loans may
be based on infrequent and dated information. Because there is less reliable,
objective data available, elements of judgment may play a greater role in
valuation of Senior Loans than for other types of securities. For further
information, see "Risks--Limited Secondary Market for Senior Loans; Valuation."
Typically Senior Loans are valued using information provided by an
independent third party pricing service. If the pricing service cannot or does
not provide a valuation for a particular Senior Loan or such valuation is deemed
unreliable, the Fund may value such Senior Loan at a fair value as determined in
good faith under procedures established by the Fund's Board of Trustees, and in
accordance with the provisions of the 1940 Act.
Fair Value. When applicable, fair value is determined by the Board or a
committee of the Board or a designee of the Board. In fair valuing the Fund's
investments, consideration is given to several factors, which may include, among
others, the following:
o the fundamental business data relating to the issuer or borrower;
o an evaluation of the forces which influence the market in which these
securities are purchased and sold;
o the type, size and cost of holding;
Page 30
o the financial statements of the borrower;
o the credit quality and cash flow of the issuer, based on the Adviser's
or external analysis;
o the information as to any transactions in or offers for the holding;
o the price and extent of public trading in similar securities (or equity
securities) of the issuer/borrower, or comparable companies;
o the coupon payments;
o the quality, value and saleability of collateral securing the loan;
o the business prospects of the issuer/borrower, including any ability to
obtain money or resources from a parent or affiliate and an assessment
of the borrower's management;
o the prospects for the borrower's industry, and multiples (of earnings
and/or cash flow) being paid for similar businesses in that industry;
and
o other relevant factors.
Other Securities. Securities for which the primary market is a national
securities exchange or the NASDAQ National Market System are valued at the last
reported sale price (NASDAQ Official Closing Price for NASDAQ National Market
Securities) on the day of valuation. Listed securities for which no sale was
reported on that date are valued at the mean between the most recent bid and
asked prices. Securities traded in the over-the-counter market are valued at
their closing bid prices. Valuation of short-term cash equivalent investments
will be at amortized cost.
DISTRIBUTIONS
The Fund intends to distribute to holders of its Common Shares monthly
dividends of all or a portion of its net income after payment of dividends and
interest in connection with leverage used by the Fund. It is expected that the
initial monthly dividend on the Fund's Common Shares will be declared
approximately 45 days, and paid approximately 60 to 90 days after the completion
of this offering, depending on market conditions. The Fund expects that all or a
portion of any capital gain will be distributed at least annually.
Various factors will affect the level of the Fund's income, including the
asset mix, the average maturity of the Fund's portfolio, the amount of leverage
utilized by the Fund and the Fund's use of hedging. To permit the Fund to
maintain a more stable monthly distribution, the Fund may from time to time
distribute less than the entire amount of income earned in a particular period.
The undistributed income would be available to supplement future distributions.
As a result, the distributions paid by the Fund for any particular monthly
period may be more or less than the amount of income actually earned by the Fund
during that period. Undistributed income will add to the Fund's NAV, and,
correspondingly, distributions from undistributed income will deduct from the
Fund's NAV. Shareholders will automatically have all dividends and distributions
reinvested in Common Shares of the Fund issued by the Fund or purchased in the
open market in accordance with the Fund's dividend reinvestment plan unless an
election is made to receive cash. See "Dividend Reinvestment Plan."
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold
your Common Shares with a brokerage firm that participates in the Fund's
Dividend Reinvestment Plan, unless you elect to receive cash distributions, all
dividends, including any capital gain dividends, on your Common Shares will be
automatically reinvested by PFPC Inc. (the "Plan Agent"), in additional Common
Shares under the Dividend Reinvestment Plan (the "Plan"). If you elect to
receive cash distributions, you will receive all distributions in cash paid by
check mailed directly to you by PFPC Inc., as dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you
will receive will be determined as follows:
Page 31
(1) If the Common Shares are trading at or above net asset value at the time
of valuation, the Fund will issue new shares at a price equal to the greater of
(i) net asset value per Common Share on that date or (ii) 95% of the market
price on that date.
(2) If Common Shares are trading below net asset value at the time of
valuation, the Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or elsewhere, for
the participants' accounts. It is possible that the market price for the Common
Shares may increase before the Plan Agent has completed its purchases.
Therefore, the average purchase price per share paid by the Plan Agent may
exceed the market price at that time of valuation, resulting in the purchase of
fewer shares than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and distributions
received in cash to purchase Common Shares in the open market within 30 days of
the valuation date except where temporary curtailment or suspension of purchases
is necessary to comply with federal securities laws. Interest will not be paid
on any uninvested cash payments.
You may withdraw from the Plan at any time by giving written notice to the
Plan Agent, or by telephone at (800) 331-1710, in accordance with such
reasonable requirements as the Plan Agent and Fund may agree upon. If you
withdraw or the Plan is terminated, you will receive a certificate for each
whole share in your account under the Plan and you will receive a cash payment
for any fraction of a share in your account. If you wish, the Plan Agent will
sell your shares and send you the proceeds, minus brokerage commissions.
The Plan Agent maintains all shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or
distributions in Common Shares. However, all participants will pay a pro rata
share of brokerage commissions incurred by the Plan Agent when it makes open
market purchases.
Automatically reinvesting dividends and distributions does not mean that you
do not have to pay income taxes due upon receiving dividends and distributions.
See "Tax Matters."
If you hold your Common Shares with a brokerage firm that does not
participate in the Plan, you will not be able to participate in the Plan and any
dividend reinvestment may be effected on different terms than those described
above. Consult your financial advisor for more information.
The Fund reserves the right to amend or terminate the Plan if in the
judgment of the Board of Trustees the change is warranted. There is no direct
service charge to participants in the Plan; however, the Fund reserves the right
to amend the Plan to include a service charge payable by the participants.
Additional information about the Plan may be obtained from PFPC Inc., 301
Bellevue Parkway, Wilmington, Delaware 19809.
DESCRIPTION OF SHARES
COMMON SHARES
The Declaration authorizes the issuance of an unlimited number of Common
Shares. The Common Shares being offered have a par value of $.01 per share and
subject to the rights of the holders of Preferred Shares, if issued, have equal
rights to the payment of dividends and the distribution of assets upon
liquidation. The Common Shares being offered will, when issued, be fully paid
and, subject to matters discussed in "Certain Provisions in the Declaration of
Trust," non-assessable, and currently have no preemptive or conversion rights
(except as may otherwise be determined by the Trustees in their sole discretion)
or rights to cumulative voting.
Page 32
The Common Shares have been approved for listing on the NYSE, subject to
notice of issuance, under the symbol "FCT." The Fund intends to hold annual
meetings of shareholders so long as the Common Shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing.
Net asset value will be reduced immediately following the offering by the
amount of the sales load and offering expenses paid by the Fund. The Adviser and
Sub-Adviser have agreed to pay (i) all organizational expenses and (ii) all
offering costs (other than sales load) that exceed $.04 per Common Share. See
"Use of Proceeds."
Unlike open-end funds, closed-end funds like the Fund do not continuously
offer shares and do not provide daily redemptions. Rather, if a shareholder
determines to buy additional Common Shares or sell shares already held, the
shareholder may conveniently do so by trading on the exchange through a broker
or otherwise. Shares of closed-end investment companies may frequently trade on
an exchange at prices lower than net asset value. Shares of closed-end
investment companies like the Fund have during some periods traded at prices
higher than net asset value and during other periods have traded at prices lower
than net asset value. Because the market value of the Common Shares may be
influenced by such factors as dividend levels (which are in turn affected by
expenses), dividend stability, portfolio credit quality, net asset value,
relative demand for and supply of such shares in the market, general market and
economic conditions, and other factors beyond the control of the Fund, the Fund
cannot assure you that Common Shares will trade at a price equal to or higher
than net asset value in the future. The Common Shares are designed primarily for
long-term investors, and investors in the Common Shares should not view the Fund
as a vehicle for trading purposes.
PREFERRED SHARES
The Declaration provides that the Fund's Board of Trustees may authorize and
issue Preferred Shares with rights as determined by the Board of Trustees, by
action of the Board of Trustees without the approval of the holders of the
Common Shares. Holders of Common Shares have no preemptive right to purchase any
Preferred Shares that might be issued.
The Fund may elect to issue Preferred Shares as part of its leverage
strategy. The Fund currently intends to issue Leverage Instruments, which may
include Preferred Shares, representing up to 38% of the Fund's Managed Assets
immediately after the Leverage Instruments are issued. The Board of Trustees
also reserves the right to issue Preferred Shares to the extent permitted by the
1940 Act, which currently limits the aggregate liquidation preference of all
outstanding Preferred Shares to 50% of the value of the Fund's Managed Assets
less liabilities and indebtedness of the Fund. We cannot assure you, however,
that any Preferred Shares will be issued. Although the terms of any Preferred
Shares, including dividend rate, liquidation preference and redemption
provisions, will be determined by the Board of Trustees, subject to applicable
law and the Declaration, it is likely that the Preferred Shares will be
structured to carry a relatively short-term dividend rate reflecting interest
rates on short-term bonds, by providing for the periodic redetermination of the
dividend rate at relatively short intervals through an auction, remarketing or
other procedure. The Fund also believes that it is likely that the liquidation
preference, voting rights and redemption provisions of the Preferred Shares will
be similar to those stated below.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Fund, the holders of Preferred
Shares will be entitled to receive a preferential liquidating distribution,
which is expected to equal the original purchase price per Preferred Share plus
accrued and unpaid dividends, whether or not declared, before any distribution
of assets is made to holders of Common Shares. After payment of the full amount
of the liquidating distribution to which they are entitled, the holders of
Preferred Shares will not be entitled to any further participation in any
distribution of assets by the Fund.
Voting Rights. The 1940 Act requires that the holders of any Preferred
Shares, voting separately as a single class, have the right to elect at least
two trustees at all times. The remaining trustees will be elected by holders of
Common Shares and Preferred Shares, voting together as a single class. In
addition, subject to the prior rights, if any, of the holders of any other class
of senior securities outstanding, the holders of any Preferred Shares have the
right to elect a majority of the trustees of the Fund at any time two years'
dividends on any Preferred Shares are unpaid. The 1940 Act also requires that,
in addition to any approval by shareholders that might otherwise be required,
the approval of the holders of a majority of any outstanding Preferred Shares,
Page 33
voting separately as a class, would be required to (1) adopt any plan of
reorganization that would adversely affect the Preferred Shares, and (2) take
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 subclassification as a
closed-end investment company or changes in its fundamental investment
restrictions. See "Certain Provisions in the Declaration of Trust." As a result
of these voting rights, the Fund's ability to take any such actions may be
impeded to the extent that there are any Preferred Shares outstanding. The Board
of Trustees presently intends that, except as otherwise indicated in this
prospectus and except as otherwise required by applicable law or the
Declaration, holders of Preferred Shares will have equal voting rights with
holders of Common Shares (one vote per share, unless otherwise required by the
1940 Act) and will vote together with holders of Common Shares as a single
class.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a separate class, will be required to amend, alter
or repeal any of the preferences, rights or powers of holders of Preferred
Shares so as to affect materially and adversely such preferences, rights or
powers, or to increase or decrease the authorized number of Preferred Shares.
The class vote of holders of Preferred Shares described above will in each case
be in addition to any other vote required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Fund. The terms of
any Preferred Shares issued are expected to provide that (1) they are redeemable
by the Fund in whole or in part at the original purchase price per share plus
accrued dividends per share, (2) the Fund may tender for or purchase Preferred
Shares and (3) the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred Shares by the Fund will
reduce the leverage applicable to the Common Shares, while any resale of shares
by the Fund will increase that leverage.
The discussion above describes the possible offering of Preferred Shares by
the Fund. If the Board of Trustees determines to proceed with such an offering,
the terms of the Preferred Shares may be the same as, or different from, the
terms described above, subject to applicable law and the Fund's Declaration. The
Board of Trustees, without the approval of the holders of Common Shares, may
authorize an offering of Preferred Shares or may determine not to authorize such
an offering, and may fix the terms of the Preferred Shares to be offered.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
Under Massachusetts law, shareholders could, in certain circumstances, be
held personally liable for the obligations of the Fund. However, the Declaration
contains an express disclaimer of shareholder liability for debts or obligations
of the Fund and requires that notice of such limited liability be given in each
agreement, obligation or instrument entered into or executed by the Fund or the
Board of Trustees. The Declaration further provides for indemnification out of
the assets and property of the Fund for all loss and expense of any shareholder
held personally liable for the obligations of the Fund solely by reason of being
or having been a shareholder of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund would be unable to meet its obligations. The
Fund believes that the likelihood of such circumstances is remote.
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. Generally, the Declaration requires a vote by holders of at
least two-thirds of the Common Shares and Preferred Shares, if any, voting
together as a single class, except as described below and in the Declaration, to
authorize: (1) a conversion of the Fund from a closed-end to an open-end
investment company; (2) a merger or consolidation of the Fund with any
corporation, association, trust or other organization, including a series or
class of such other organization (subject to a limited exception if the
acquiring fund is not an operating entity immediately prior to the transaction);
(3) a sale, lease or exchange of all or substantially all of the Fund's assets
(other than in the regular course of the Fund's investment activities, in
connection with the termination of the Fund, and other limited circumstances set
forth in the Declaration); (4) in certain circumstances, a termination of the
Fund; (5) a removal of trustees by shareholders; or (6) certain transactions in
which a Principal Shareholder (as defined in the Declaration) is a party to the
transaction. However, with respect to (1) above, if there are Preferred Shares
outstanding, the affirmative vote of the holders of two- thirds of the Preferred
Shares voting as a separate class shall also be required. With respect to (2)
above, except as otherwise may be required, if the transaction constitutes a
Page 34
plan of reorganization which adversely affects Preferred Shares, if any, then an
affirmative vote of two-thirds of the Preferred Shares voting together as a
separate class is required as well. With respect to (1) through (3), if such
transaction has already been authorized by the affirmative vote of two-thirds of
the trustees, then the affirmative vote of the majority of the outstanding
voting securities, as defined in the 1940 Act (a "Majority Shareholder Vote"),
is required, provided that when only a particular class is affected (or, in the
case of removing a trustee, when the trustee has been elected by only one
class), only the required vote of the particular class will be required. Such
affirmative vote or consent shall be in addition to the vote or consent of the
holders of the Fund's shares otherwise required by law or any agreement between
the Fund and any national securities exchange. Approval of shareholders is not
required, however, for any transaction, whether deemed a merger, consolidation,
reorganization, exchange of shares or otherwise whereby the Fund issues shares
in connection with the acquisition of assets (including those subject to
liabilities) from any other investment company or similar entity. None of the
foregoing provisions may be amended except by the vote of at least two-thirds of
the Common Shares and Preferred Shares, if any, outstanding and entitled to
vote.
The provisions of the Declaration described above could have the effect of
depriving the Common Shareholders of opportunities to sell their Common Shares
at a premium over the then current market price of the Common Shares by
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. The overall effect of these provisions is
to render more difficult the accomplishment of a merger or the assumption of
control by a third party. They provide, however, the advantage of potentially
requiring persons seeking control of the Fund to negotiate with its management
regarding the price to be paid and facilitating the continuity of the Fund's
investment objectives and policies. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are in
the best interests of the Fund and its Common Shareholders.
Reference should be made to the Declaration on file with the Securities and
Exchange Commission for the full text of these provisions.
CLOSED-END FUND STRUCTURE
The Fund is a newly organized, diversified, closed-end management investment
company (commonly referred to as a closed-end fund). Closed-end funds differ
from open-end funds (which are generally referred to as mutual funds) in that
closed-end funds generally list their shares for trading on a stock exchange and
do not redeem their shares at the request of the shareholder. This means that if
you wish to sell your shares of a closed-end fund you must trade them on the
market like any other stock at the prevailing market price at that time. In a
mutual fund, if the shareholder wishes to sell shares of the fund, the mutual
fund will redeem or buy back the shares at "net asset value." Also, mutual funds
generally offer new shares on a continuous basis to new investors, and
closed-end funds generally do not. The continuous inflows and outflows of assets
in a mutual fund can make it difficult to manage the fund's investments. By
comparison, closed-end funds are generally able to stay more fully invested in
securities that are consistent with their investment objectives, and also have
greater flexibility to make certain types of investments, and to use certain
investment strategies, such as financial leverage and investments in illiquid
securities.
Shares of closed-end funds frequently trade at a discount to their NAV.
Because of this possibility and the recognition that any such discount may not
be in the interest of shareholders, the Fund's Board of Trustees might consider
from time to time engaging in open-market repurchases, tender offers for shares
or other programs intended to reduce the discount. We cannot guarantee or
assure, however, that the Fund's Board of Trustees will decide to engage in any
of these actions. Nor is there any guarantee or assurance that such actions, if
undertaken, would result in the shares trading at a price equal or close to net
asset value per share. Although share repurchases and tenders could have a
favorable effect on the market price of the Fund's Common Shares, you should be
aware that the acquisition of Common Shares by the Fund will decrease the
capital of the Fund and, therefore, may have the effect of increasing the Fund's
expense ratio and decreasing the asset coverage with respect to any Preferred
Shares outstanding. Any share repurchases or tender offers will be made in
accordance with requirements of the Securities Exchange Act of 1934, as amended,
the 1940 Act and the principal stock exchange on which the Common Shares are
traded.
Page 35
Conversion to Open-Ended Fund. The Fund may be converted to an open-end
investment company at any time if approved by the holders of two-thirds of the
Fund's shares outstanding and entitled to vote and by the holders of two- thirds
of the Fund's Preferred Shares, if any, voting together as a single class;
provided, however, that such vote shall be by Majority Shareholder Vote if the
action in question was previously approved by the affirmative vote of two-thirds
of the Board of Trustees. Such affirmative vote or consent shall be in addition
to the vote or consent of the holders of the Shares otherwise required by law or
any agreement between the Fund and any national securities exchange. In the
event of conversion, the Common Shares would cease to be listed on the NYSE or
other national securities exchange or market system and the Preferred Shares
would be redeemed and the leverage would cease to exist. The Board of Trustees
believes, however, that the closed-end structure is desirable, given the Fund's
investment objectives and policies. Investors should assume, therefore, that it
is unlikely that the Board of Trustees would vote to convert the Fund to an
open-end investment company. Shareholders of an open-end investment company may
require the company to redeem their shares at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset value,
less such redemption charge, if any, as might be in effect at the time of a
redemption. The Fund expects to pay all such redemption requests in cash, but
intends to reserve the right to pay redemption requests in a combination of cash
or securities. If such partial payment in securities were made, investors may
incur brokerage costs in converting such securities to cash. If the Fund were
converted to an open-end fund, it is likely that new Common Shares would be sold
at net asset value plus a sales load.
TAX MATTERS
The following discussion of federal income tax matters is based on the
advice of Chapman and Cutler LLP, counsel to the Fund.
This section and the discussion in the Statement of Additional Information
summarize some of the main U.S. federal income tax consequences of owning shares
of the Fund. This section is current as of the date of this prospectus. Tax laws
and interpretations change frequently, and this summary does not describe all of
the tax consequences to all taxpayers. For example, this summary generally does
not describe your situation if you are a bank or a financial institution, an
insurance company, a dealer in securities, a non-U.S. shareholder, a tax-exempt
or tax-deferred plan, account or entity, a shareholder that is subject to the
alternative minimum tax or a shareholder that holds its shares as or in a hedge
against currency risk, constructive sale or a conversion transaction or other
investor with special circumstances. In addition, this section does not describe
your state, local or foreign taxes. Investors should consult their own tax
advisors regarding the tax consequences of investing in the Fund.
This discussion also does not address the tax consequences to shareholders
that are subject to special rules, including, without limitation, banks and
financial institutions, insurance companies, dealers in securities, non-U.S.
shareholders, tax- exempt or tax-deferred plans, accounts or entities,
shareholders that are subject to the alternative minimum tax or shareholders
that hold their shares as or in a hedge against currency risk, constructive sale
or a conversion transaction.
Fund Status. The Fund intends to qualify as a "regulated investment company"
under the federal tax laws. If the Fund qualifies as a regulated investment
company and distributes all of its income, the Fund generally will not pay
federal income or excise taxes.
Distributions. Fund distributions are generally taxable. After the end of
each year, you will receive a tax statement that separates your Fund's
distributions into two categories, ordinary income distributions and capital
gains dividends. Ordinary income distributions are generally taxed at your
ordinary tax rate, but, as further discussed below, if the Fund holds equity
securities, under the recently enacted "Jobs and Growth Tax Relief
Reconciliation Act of 2003" (the "Tax Act"), certain ordinary income
distributions received from the Fund may be taxed at new tax rates equal to
those applicable to net capital gains. Generally, you will treat all capital
gains dividends as long-term capital gains regardless of how long you have owned
your shares. To determine your actual tax liability for your capital gains
dividends, you must calculate your total net capital gain or loss for the tax
year after considering all of your other taxable transactions, as described
below. In addition, the Fund may make distributions that represent a return of
Page 36
capital for tax purposes and thus will generally not be taxable to you. The tax
status of your distributions from the Fund is not affected by whether you
reinvest your distributions in additional shares or receive them in cash. The
tax laws may require you to treat distributions made to you in January as if you
had received them on December 31 of the previous year.
Dividends Received Deduction. A corporation that owns shares generally will
not be entitled to the dividends received deduction with respect to dividends
received from the Fund because the dividends received deduction is generally not
available for distributions from regulated investment companies. However, if the
Fund holds equity securities, certain ordinary income dividends on shares that
are attributable to dividends received by the Fund from certain domestic
corporations may be designated by the Fund as being eligible for the dividends
received deduction but this amount is not expected to be significant.
If You Sell Shares. If you sell your shares, you will generally recognize a
taxable gain or loss. To determine the amount of this gain or loss, you must
subtract your tax basis in your shares from the amount you receive in the
transaction. Your tax basis in your shares is generally equal to the cost of
your shares, generally including sales charges. In some cases, however, you may
have to adjust your tax basis after you purchase your shares.
Taxation of Capital Gains and Losses and Certain Ordinary Income Dividends.
Under the Tax Act, if you are an individual, the maximum marginal federal tax
rate for net capital gain is generally 15% (generally 5% for certain taxpayers
in the 10% and 15% tax brackets). These new capital gains rates are generally
effective for taxable years ending on or after May 6, 2003 and beginning before
January 1, 2009. However, special effective date provisions are set forth in the
Tax Act. For periods not covered by the Tax Act, if you are an individual, the
maximum marginal federal tax rate for capital gains is generally 20% (10% for
certain taxpayers in the 10% and 15% tax brackets). The 20% rate is reduced to
18% and the 10% rate is reduced to 8% for net capital gains from most property
acquired after December 31, 2000, with a holding period of more than five years.
Net capital gain equals net long-term capital gain minus net short-term
capital loss for the taxable year. Capital gain or loss is long-term if the
holding period for the asset is more than one year and is short-term if the
holding period for the asset is one year or less. You must exclude the date you
purchase your shares to determine your holding period. However, if you receive a
capital gain dividend from the Fund and sell your share at a loss after holding
it for six months or less, the loss will be recharacterized as long-term capital
loss to the extent of the capital gain dividend received. The tax rates for
capital gains realized from assets held for one year or less are generally the
same as for ordinary income. In addition, the Code treats certain capital gains
as ordinary income in special situations.
Pursuant to the Tax Act, if the Fund holds equity securities, a portion of
the ordinary income dividends received by an individual shareholder from a
regulated investment company such as the Fund generally will be taxed at the
same new rates that apply to net capital gain (as discussed above), but only if
certain holding period requirements are satisfied and the dividends are
attributable to qualified dividends received by the Fund itself. These special
rules relating to the taxation of ordinary income dividends from regulated
investment companies generally apply to taxable years beginning after December
31, 2002 and beginning before January 1, 2009. The Fund generally does not
expect to generate qualifying dividends eligible for the new capital gains tax
rates.
Foreign Tax Credit. If the Fund invests in any foreign securities, the tax
statement that you receive may include an item showing foreign taxes the Fund
paid to other countries. In this case, dividends taxed to you will include your
share of the taxes the Fund paid to other countries. You may be able to deduct
or receive a tax credit for your share of these taxes.
Page 37
UNDERWRITING
Subject to the terms and conditions stated in a purchase agreement
dated , 2004, each Underwriter named below, for which Merrill Lynch,
Pierce, Fenner & Smith Incorporated is acting as representative, has severally
agreed to purchase, and the Fund has agreed to sell to such Underwriter, the
number of Common Shares set forth opposite the name of such Underwriter.
NUMBER OF
UNDERWRITER COMMON SHARES
----------- -------------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated ....................................
Raymond James & Associates, Inc. ............................
Wachovia Capital Markets, LLC ...............................
Robert W. Baird & Co. Incorporated. ........................
Fixed Income Securities L.P. ................................
J.J.B. Hilliard, W.L. Lyons, Inc. ...........................
Oppenheimer & Co. Inc. ......................................
Quick & Reilly, Inc. ........................................
RBC Capital Markets Corporation .............................
Ryan Beck & Co., Inc. .......................................
Stifel, Nicolaus & Company, Incorporated ....................
SunTrust Capital Markets, Inc. ..............................
------------
Total .............................................
============
The purchase agreement provides that the obligations of the Underwriters to
purchase the Common Shares included in this offering are subject to the approval
of certain legal matters by counsel and certain other conditions. The
Underwriters are obligated to purchase all the Common Shares sold under the
purchase agreement if any of the Common Shares are purchased. In the purchase
agreement, the Fund, the Adviser and the Sub-Adviser have agreed to indemnify
the Underwriters against certain liabilities, including liabilities arising
under the Securities Act of 1933, as amended, or to contribute payments the
Underwriters may be required to make for any of those liabilities.
COMMISSIONS AND DISCOUNTS
The Underwriters propose to initially offer some of the Common Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Common Shares to certain dealers at the
public offering price less a concession not in excess of $ per share. The
sales load the Fund will pay of $.90 per share is equal to 4.5% of the initial
offering price. The Underwriters may allow, and the dealers may reallow, a
discount not in excess of $ per share on sales to other dealers. Notwithstanding
the foregoing, certain Underwriters may pay up to an additional $ per share from
the sales load to certain dealers pursuant to existing arrangements with such
dealers. After the initial public offering, the public offering price,
concession and discount may be changed. Investors must pay for any common shares
purchased on or before , 2004.
The following table shows the public offering price, estimated offering
expenses, sales load and proceeds to the Fund. The information assumes either no
exercise or full exercise by the underwriters of their overallotment option.
PER SHARE WITHOUT OPTION WITH OPTION
Public offering price........................ $20.00 $ $
Sales load................................... $.90 $ $
Estimated offering expenses.................. $.04 $ $
Proceeds, after expenses, to the Fund........ $19.06 $ $
Page 38
The Fund will pay its Common Share offering costs up to and including $.04
per Common Share. The Fund has agreed to pay the Underwriters $.00667 per Common
Share as a partial reimbursement of expenses incurred in connection with the
offering. The amount paid by the Fund as this partial reimbursement to the
Underwriters will not exceed .03335% of the total price to the public of the
Common Shares sold in this offering. The Adviser and the Sub-Adviser have agreed
to pay (i) all of the Fund's organizational costs and (ii) all of the Common
Share offering costs (other than sales load but including the $.00667 per Common
Share reimbursement of underwriter expenses) that exceed $.04 per Common Share.
To the extent that aggregate offering expenses are less than $.04 per Common
Share, up to .10% of the public offering price of the securities sold in this
offering, up to such expense limit, will be paid to First Trust Portfolios, L.P.
as reimbursement for the distribution services it provides to the Fund (the
"Contingent Reimbursement Amount"). First Trust Portfolios, L.P. is an affiliate
of the Adviser.
OVERALLOTMENT OPTION
The Fund has granted the Underwriters an option to purchase up to
additional Common Shares at the public offering price, less the sales load,
within 45 days from the date of this prospectus solely to cover any
overallotments. If the Underwriters exercise this option, each will be
obligated, subject to conditions contained in the purchase agreement, to
purchase a number of additional Common Shares proportionate to that
Underwriter's initial amount reflected in the above table.
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of the Common Shares is complete, Securities and
Exchange Commission rules may limit Underwriters and selling group members from
bidding for and purchasing the Fund's Common Shares. However, the
representatives may engage in transactions that stabilize the price of the
Common Shares, such as bids or purchases to peg, fix or maintain that price.
If the Underwriters create a short position in the Common Shares in
connection with the offering, i.e., if they sell more Common Shares than are
listed on the cover of this prospectus, the representative may reduce that short
position by purchasing Common Shares in the open market. The representative may
also elect to reduce any short position by exercising all or part of the
overallotment option described above. The Underwriters also may impose a penalty
bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of the Common Shares sold in this offering for their
account may be reclaimed by the syndicate if such Common Shares are repurchased
by the syndicate in stabilizing or covering transactions. The same penalty bid
may be imposed by an Underwriter who distributes shares to another
broker-dealer, who is not an Underwriter, if said broker-dealer sells shares
which are repurchased by the Underwriters in stabilizing or short covering
transactions. Purchases of the Common Shares to stabilize the price or to reduce
a short position may cause the price of the Common Shares to be higher than it
might be in the absence of such purchases.
Neither the Fund nor any of the Underwriters makes any representations or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Shares. In addition, neither
the Fund nor any of the Underwriters makes any representation that the
representative will engage in these transactions or that these transactions,
once commenced, will not be discontinued without notice.
The Fund has agreed not to offer or sell any additional Common Shares for a
period of 180 days after the date of the purchase agreement without the prior
written consent of the Underwriters, except for the sale of the Common Shares to
the Underwriters pursuant to the purchase agreement and certain transactions
relating to the Fund's Dividend Reinvestment Plan.
The Fund anticipates that the Underwriters may from time to time act as
brokers or, after they have ceased to be Underwriters, dealers in executing the
Fund's portfolio transactions. The Underwriters are active underwriters of, and
dealers in, securities and act as market-makers in a number of such securities,
and therefore can be expected to engage in portfolio transactions with the Fund.
Page 39
The Common Shares will be sold to ensure that NYSE distribution standards
(i.e., round lots, public shares and aggregate market value) will be met.
OTHER RELATIONSHIPS
The Adviser has also agreed to pay from its own assets additional
compensation to Merrill Lynch. This additional compensation will be payable
quarterly at the annual rate of .15% of the Fund's Managed Assets during the
continuance of the Investment Management Agreement or other investment
management agreement between the Adviser and the Fund. Merrill Lynch has agreed
to provide, as requested by the Adviser, specified after-market support services
designed to maintain the visibility of the Fund on an ongoing basis; relevant
information, studies or reports regarding the Fund and the closed end investment
company industry; and consultation regarding market discounts of the Fund. The
total amount of these additional payments to Merrill Lynch will not exceed
4.05571% of the total price to the public of the Common Shares sold in this
offering.
First Trust Portfolios, L.P., an affiliate of the Adviser, will provide
distribution assistance in connection with the sale of the Common Shares of the
Fund, and may pay compensation to their respective employees who assist in
marketing securities. In connection with this distribution assistance, to the
extent the offering expenses payable by the Fund are less than $.04 per Common
Share, the Fund will pay up to .10% of the amount of the total price to the
public of the Common Shares sold in this offering, up to such expense limit, to
First Trust Portfolios, L.P. as reimbursement for its distribution assistance.
Accordingly, the amount payable by the Fund to First Trust Portfolios, L.P. for
its distribution assistance will not exceed .10% of the total price to the
public of the Common Shares sold in this offering. First Trust Portfolios, L.P.
is a registered broker-dealer and a member of the National Association of
Securities Dealers.
The Sub-Adviser (and not the Fund) has agreed to pay from its own assets to
Raymond James & Associates, Inc. ("Raymond James") a quarterly incentive fee at
an annual rate of up to .10% of the Fund's average weekly total managed assets
attributable to Common Shares (including a proportionate share of assets
attributable to any Preferred Shares and other forms of leverage that may be
outstanding) sold by Raymond James in this offering, such fees to be payable
during the continuance of the Investment Management Agreement and subject to the
limitation below. It is not anticipated that Raymond James would be obligated to
provide shareholder or other services to the Fund. The amount of the quarterly
incentive fee will not exceed .31094% of the total price to the public of the
Common Shares sold in this offering.
The total amount of the additional compensation payments to Merrill Lynch
described above, plus the amounts paid by the Fund as the $.00667 per Common
Share partial reimbursement to the Underwriters, the quarterly incentive fee
payable to Raymond James and the Contingent Reimbursement Amount, will not
exceed 4.5% of the total price to the public of the Common Shares sold in this
offering. The sum total of all compensation to Underwriters in connection with
this public offering of Common Shares, including sales load and all forms of
additional compensation to and reimbursement of Underwriters, will be limited to
9.0% of the total price to the public of the Common Shares sold in this
offering.
One or more of the Underwriters of the Common Shares may also act as
underwriters of the Fund's Preferred Shares, if any.
The address of Merrill Lynch is 4 World Financial Center, New York, New York
10080.
ADMINISTRATOR, CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Fund is PFPC Trust Company ("Custodian"),
301 Bellevue Parkway, Wilmington, Delaware 19809. The Fund's transfer,
shareholder services and dividend paying agent is PFPC Inc., 301 Bellevue
Parkway, Wilmington, Delaware 19809. Pursuant to an Administration and
Accounting Services Agreement, PFPC Inc. also provides certain administrative
and accounting services to the Fund, including maintaining the Fund's books of
account, records of the Fund's securities transactions, and certain other books
and records; acting as liaison with the Fund's independent public accountant
providing such accountant with various audit-related information with respect to
Page 40
the Fund; and providing other continuous accounting and administrative services.
As compensation for these services, the Fund has agreed to pay PFPC Inc. an
annual fee, calculated daily and payable on a monthly basis, of .06% of the
Fund's first $250 million of average Managed Assets, subject to decrease with
respect to additional Fund Managed Assets.
LEGAL OPINIONS
Certain legal matters in connection with the Common Shares will be passed
upon for the Fund by Chapman and Cutler LLP, Chicago, Illinois, and for the
Underwriters by Clifford Chance US LLP, New York, New York. Chapman and Cutler
LLP and Clifford Chance US LLP may rely as to certain matters of Massachusetts
law on the opinion of Bingham McCutchen LLP.
Page 42
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
PAGE
The Fund................................................................. S-1
Use of Proceeds.......................................................... S-1
Investment Objectives.................................................... S-1
Investment Restrictions.................................................. S-2
Additional Information About the Fund's Investments...................... S-4
Management of the Fund................................................... S-21
Adviser.................................................................. S-25
Proxy Voting Procedure................................................... S-28
Sub-Adviser.............................................................. S-29
Portfolio Transactions................................................... S-30
Net Asset Value.......................................................... S-31
Federal Income Tax Matters............................................... S-33
Performance Related and Comparative Information.......................... S-37
Experts.................................................................. S-38
Additional Information................................................... S-39
Report of Independent Registered Public Accounting Firm.................. F-1
Financial Statements..................................................... F-2
Appendix A - Description of Ratings...................................... A-1
Page 42
THIS PAGE IS INTENTIONALLY LEFT BLANK.
Page 43
===============================================================================
Until , 2004 (25 days after the date of this prospectus), all dealers that buy,
sell or trade the Common Shares, whether or not participating in this offering,
may be required to deliver a prospectus. This is in addition to the dealers'
obligation to deliver a prospectus when acting as underwriters and with respect
to their unsold allotments or subscriptions.
SHARES
FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE
INCOME FUND II
COMMON SHARES
$20.00 PER SHARE
----------
PROSPECTUS
----------
MERRILL LYNCH & CO.
RAYMOND JAMES
WACHOVIA SECURITIES
ROBERT W. BAIRD & CO.
FIXED INCOME SECURITIES L.P.
J.J.B. HILLIARD, W.L. LYONS, INC.
OPPENHEIMER & CO.
QUICK & REILLY, INC.
RBC CAPITAL MARKETS
RYAN BECK & CO.
STIFEL, NICOLAUS & COMPANY
INCORPORATED
SUNTRUST ROBINSON HUMPHREY
MAY , 2004
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Back Cover
SUBJECT TO COMPLETION, DATED MAY 25, 2004
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT
COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE
REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS
EFFECTIVE. THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT AN OFFER TO SELL
THESE SECURITIES AND OFFER OR SALE IS NOT PERMITTED.
FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND II
STATEMENT OF ADDITIONAL INFORMATION
First Trust/Four Corners Senior Floating Rate Income Fund II (the
"Fund") is a newly organized, closed-end, diversified management investment
company. The Fund's primary investment objective is to seek a high level of
current income. As a secondary objective, the Fund will attempt to preserve
capital. The Fund will pursue these objectives through investment in a portfolio
of senior secured floating rate corporate loans ("Senior Loans"). There can be
no assurance the Fund will achieve its investment objectives. Investment in
Senior Loans involves credit risk and, during periods of generally declining
credit quality, it may be particularly difficult for the Fund to achieve its
secondary investment objective. The Fund may not be appropriate for all
investors. Senior Loans pay income that floats with the prevailing level of
interest rates. Floating rate products are typically less sensitive to interest
rate changes than traditional fixed-income securities. Income-oriented investors
typically have limited alternatives in a rising interest rate environment. This
Statement of Additional Information relating to the Fund's common shares of
beneficial interest, (referred to as "Common Shares") does not constitute a
prospectus, but should be read in conjunction with the Fund's Prospectus dated
May 25, 2004 (the "Prospectus"). This Statement of Additional Information does
not include all information that a prospective investor should consider before
purchasing Common Shares, and investors should obtain and read the Prospectus
prior to purchasing the shares. A copy of the Prospectus may be obtained without
charge by calling (800) 988-5891. You also may obtain a copy of the Prospectus
on the web site of the Securities and Exchange Commission (the "Commission")
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the Prospectus.
This Statement of Additional Information is dated May 25, 2004.
TABLE OF CONTENTS
The Fund.....................................................................1
Use of Proceeds..............................................................1
Investment Objectives........................................................1
Investment Restrictions......................................................2
Additional Information About the Fund's Investments..........................4
Management of the Fund......................................................21
Adviser.....................................................................25
Proxy Voting Procedures.....................................................28
Sub-Adviser.................................................................29
Portfolio Transactions......................................................29
Net Asset Value.............................................................31
Federal Income Tax Matters..................................................31
Performance Related and Comparative Information.............................35
Experts.....................................................................36
Additional Information......................................................37
Report of Independent Registered Public Accounting Firm....................F-1
First Trust/Four Corners Senior Floating Rate Income Fund
Statement of Assets and Liabilities........................................F-2
Appendix A Description of Ratings......................................A-1
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THE FUND
The Fund was organized as a Massachusetts business trust pursuant to a
Declaration of Trust (the "Declaration") on March 25, 2004. Under Massachusetts
law, shareholders of a trust may, under certain circumstances, be held
personally liable as partners for its obligations. However, the Declaration
contains an express disclaimer of shareholder liability for acts or obligations
of the Fund and requires that notice of this disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Fund or the
board of trustees of the Fund (the "Board of Trustees" or "Trustees"). The
Declaration further provides for indemnification out of the assets and property
of the Fund for all loss and expense of any shareholder personally liable for
the obligations of the Fund. Thus, the risk of a shareholder incurring financial
loss on account of shareholder liability is limited to circumstances in which
both inadequate insurance exists and the Fund itself is unable to meet its
obligations. The Fund believes the likelihood of these circumstances is remote.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately: $__________ ($__________ if the Underwriters exercise the
overallotment option in full) after payment of organization and offering costs.
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to seek a high level of
current income. As a secondary objective, the Fund will attempt to preserve
capital. The Fund will pursue these objectives through investment in a portfolio
of Senior Loans. Under normal conditions, the Fund will invest at least 80% of
its Managed Assets in a diversified portfolio of Senior Loans. The Fund cannot
change this investment policy unless the Fund's shareholders receive at least 60
days prior notice of any such change.
The Senior Loans in which the Fund will invest will be lower grade debt
instruments. The Sub-Adviser anticipates that generally at least 80% of the
Fund's Managed Assets will be invested in lower grade debt investments, and from
time to time, 100% all of the Fund's Managed Assets may be invested in lower
grade debt instruments. Lower grade debt instruments are rated Ba1 or lower by
Moody's Investors Service, Inc. ("Moody's"), BB+ or lower by Standard & Poor's
Ratings Group, a division of the McGraw Hill Companies ("S&P"), comparably rated
by another nationally recognized statistical rating organization ("NRSRO"), or
are unrated securities of comparable credit quality. Lower grade debt
instruments are commonly referred to as "junk bonds" and are considered
speculative with respect to the issuer's capacity to pay interest and repay
principal. They involve greater risk of loss, are subject to greater price
volatility and are less liquid, especially during periods of economic
uncertainty or change, than higher rated debt instruments. See Appendix A to
this Statement of Additional Information for further information about debt
ratings.
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"Managed Assets" generally means the average daily gross asset value of
the Fund (including assets attributable to the preferred shares of the Fund, if
any, and the principal amount of borrowings) minus the sum of the Fund's accrued
and unpaid dividends or any outstanding preferred shares and accrued liabilities
(other than the principal amount of any borrowings incurred, commercial paper or
notes issued by the Fund and the liquidation preference of any outstanding
preferred shares). For purposes of determining Managed Assets, the liquidation
preference of the preferred shares is not treated as a liability. Percentage
limitations described in this Statement of Additional Information are as of the
time of investment by the Fund and could from time to time be exceeded on a
going-forward basis as a result of market value fluctuations of the Fund's
portfolio and other events.
The Common Shares may trade at a discount or premium to net asset value.
An investment in the Fund may not be appropriate for all investors and is not
intended to be a complete investment program. No assurance can be given that the
Fund will achieve its investment objectives. For further discussion of the
Fund's portfolio composition and associated special risk considerations, see
"The Fund's Investments" in the Prospectus.
INVESTMENT RESTRICTIONS
The Fund's investment objectives and certain fundamental investment
policies of the Fund are described in the Prospectus. The Fund, as a fundamental
policy, may not:
1. With respect to 75% of its total assets, purchase any
securities, if as a result more than 5% of the Fund's total assets would
then be invested in securities of any single issuer or if, as a result,
the Fund would hold more than 10% of the outstanding voting securities
of any single issuer; provided, that Government securities (as defined
in the Investment Company Act of 1940 (the "1940 Act")), securities
issued by other investment companies and cash items (including
receivables) shall not be counted for purposes of this limitation.
2. Purchase any security if, as a result of the purchase, 25% or
more of the Fund's total assets (taken at current value) would be
invested in the securities of Borrowers and other issuers having their
principal business activities in the same industry; provided, that this
limitation shall not apply with respect to obligations issued or
guaranteed by the U.S. Government or by its agencies or
instrumentalities.
3. Borrow money, except as permitted by the 1940 Act, the rules
thereunder and interpretations thereof or pursuant to a Commission
exemptive order.
4. 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%; (iii) the
borrowings permitted by investment restriction 3 above, or (iv) pursuant
to a Commission exemptive order.
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5. Make loans of money or property to any person, except for
obtaining interests in Senior Loans in accordance with its investment
objectives, through loans of portfolio securities or the acquisition of
securities subject to repurchase agreements, or pursuant to a Commission
rule or exemptive order.
6. Act as an underwriter of securities, except to the extent the
Fund may be deemed to be an underwriter in certain cases when disposing
of its portfolio investments or acting as an agent or one of a group of
co-agents in originating Senior Loans.
7. Purchase or sell real estate, commodities or commodities
contracts except pursuant to the exercise by the Fund of its rights
under loan agreements, bankruptcy or reorganization, or pursuant to a
Commission rule or exemptive order, and except to the extent the
interests in Senior Loans the Fund may invest in are considered to be
interests in real estate, commodities or commodities contracts and
except to the extent that hedging instruments the Fund may invest in are
considered to be commodities or commodities contracts.
For purposes of fundamental investment restriction numbers 1 and 2
above, the Fund will treat the Lender selling a participation and any persons
interpositioned between the Lender and the Fund as an issuer.
Except as noted above, the foregoing fundamental investment policies,
together with the investment objectives of the Fund, cannot be changed without
approval by holders of a majority of the outstanding voting securities of the
Fund, as defined in the 1940 Act, which includes Common Shares and preferred
shares, if any, voting together as a single class, and of the holders of the
outstanding preferred shares voting as a single class. Under the 1940 Act a
"majority of the outstanding voting securities" means the vote of: (A) 67% or
more of the Fund's shares present at a meeting, if the holders of more than 50%
of the Fund's shares are present or represented by proxy; or (B) more than 50%
of the Fund's shares, whichever is less.
In addition to the foregoing fundamental investment policies, the Fund
is also subject to the following non-fundamental restrictions and policies,
which may be changed by the Board of Trustees. The Fund may not:
1. Sell any security "short," write, purchase or sell puts,
calls or combinations thereof, or purchase or sell financial futures or
options, except to the extent that the hedging transactions in which the
Fund may engage would be deemed to be any of the foregoing transactions.
2. Invest in securities of other investment companies, except
that the Fund may purchase securities of other investment companies to
the extent permitted by: (i) the 1940 Act, as amended from time to time;
(ii) the rules and regulations promulgated by the Commission under the
1940 Act, as amended from time to time; or (iii) an exemption or other
relief from the provisions of the 1940 Act. The Fund will rely on
representations of Borrowers in Loan Agreements in determining whether
the Borrowers are investment companies.
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3. Make investments for the purpose of exercising control or
participation in management, except to the extent that exercise by the
Fund of its rights under Loan Agreements would be deemed to constitute
control or participation.
The Fund does not have a minimum holding period for its investments and
may engage in the trading of securities for the purpose of realizing short-term
profits. Moreover, it will adjust its portfolio as it deems advisable in view of
prevailing or anticipated market conditions to accomplish the Fund's investment
objectives. Frequency of portfolio turnover will not be a limiting factor if the
Fund considers it advantageous to purchase or sell securities. The Fund
anticipates that the annual portfolio turnover rate of the Fund will be less
than 100%.
The foregoing restrictions and limitations will apply only at the time
of purchase of securities, and the percentage limitations will not be considered
violated unless an excess or deficiency occurs or exists immediately after and
as a result of an acquisition of securities, unless otherwise indicated.
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS
SENIOR LOANS
Senior Loans are typically arranged through private negotiations
between a borrower ("Borrower") and several lenders ("Lenders") represented in
each case by one or more Lenders acting as agent of the several Lenders (the
"Agent"). On behalf of the several Lenders, the Agent, which is frequently the
entity that originates the Senior Loan and invites the other parties to join the
lending syndicate, will be primarily responsible for negotiating the Senior Loan
agreements that establish the relative terms, conditions and rights of the
Borrower and the several Lenders (the "Loan Agreements"). The co-agents, on the
other hand, are not responsible for administration of a Senior Loan, but are
part of the initial group of Lenders that commit to providing funding for a
Senior Loan once the Borrower and an Agent negotiate and agree on material
terms. In large transactions, it is common to have several Agents; however, one
Agent typically has primary responsibility for documentation and administration
of the Senior Loan. The Fund will not act as sole Agent in a transaction. The
Agent is required to administer and manage the Senior Loan and to service or
monitor the collateral. The Agent also is responsible for the collection of
principal and interest and fee payments from the Borrower and the apportionment
of these payments to the credit of all Lenders which are parties to the Loan
Agreement. The Agent is generally responsible for monitoring compliance by the
Borrower with the restrictive covenants in the Loan Agreement and of notifying
the Lenders of any adverse change in the Borrower's financial condition. In
addition, the Agent generally is responsible for determining that the Lenders
have obtained a perfected security interest in the collateral securing the
Senior Loan.
Lenders generally rely on the Agent to collect their portion of the
payments on the Senior Loan and to use appropriate creditor remedies against the
Borrower. Typically under Loan Agreements, the Agent is given broad discretion
in enforcing the Loan Agreement. The Borrower compensates the Agent for these
services. Compensation may include special fees paid on structuring and funding
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the Senior Loan and other fees paid on a continuing basis. The precise duties
and rights of an Agent are defined in the Loan Agreement.
When the Fund is an Agent, it has, as a party to the Loan Agreement, a
direct contractual relationship with the Borrower and, prior to allocating
portions of the Senior Loan to Lenders, if any, assumes all risks associated
with the Senior Loan. The Agent may enforce compliance by the Borrower with the
terms of the Loan Agreement. Agents also have voting and consent rights under
the applicable Loan Agreement. Action subject to Agent vote or consent generally
requires the vote or consent of the holders of some specified percentage of the
outstanding principal amount of the Senior Loan, which percentage varies
depending on the relevant Loan Agreement. Certain decisions, such as reducing
the amount or increasing the time for payment of interest on or repayment of
principal of a Senior Loan, or releasing all or substantially all of the
collateral therefor, frequently require the consent of all Lenders affected.
Each Lender in a Senior Loan is generally responsible for performing its
own credit analysis and its own investigation of the financial condition of the
Borrower. Generally, Loan Agreements will hold the Fund, as Agent, liable for
any action taken or omitted constituting gross negligence or willful misconduct.
In the event of a Borrower's default on a loan, the Loan Agreements generally
provide that the Lenders do not have recourse against the Agent. Instead,
Lenders will be required to look to the Borrower for recourse.
Acting in the capacity of an Agent in a Senior Loan may subject the Fund
to certain risks in addition to those associated with the Fund's role as a
Lender. An Agent is charged with the above described duties and responsibilities
to Lenders and Borrowers subject to the terms of the Loan Agreement. Failure to
adequately discharge responsibilities in accordance with the standard of care
set forth in the Loan Agreement may expose the Fund to liability for breach of
contract. If a relationship of trust is found between the Agent and the Lenders,
the Agent will be held to a higher standard of conduct in administering the
loan. In consideration of these risks, the Fund will invest no more than 20% of
its Managed Assets in Senior Loans in which it acts as an Agent or co-agent and
the size of any individual loan will not exceed 5% of the Fund's Managed Assets.
Lending Fees. In the process of buying, selling and holding Senior Loans
the Fund may receive certain fees. These fees are in addition to interest
payments received and may include facility fees, commitment fees, commissions
and prepayment penalty fees. When the Fund buys a 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. These 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
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requiring the Borrower to prepay the Senior Loan with any free cash flow. Free
cash flow is generally defined as net cash flow after scheduled debt service
payments and permitted capital expenditures, and includes the proceeds from
asset dispositions or sales of securities. A breach of a covenant which is not
waived by the Agent, or by the Lenders directly, as the case may be, is normally
an event of acceleration; i.e., the Agent, or the Lenders directly, as the case
may be, has the right to call the outstanding Senior Loan. The typical practice
of an Agent or a Lender in relying exclusively or primarily on reports from the
Borrower 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 of a Senior Loan to vote on certain changes
which may be made to the Loan Agreement, such as waiving a breach of a covenant.
However, the holder of the participation will, in almost all cases, have the
right to vote on certain fundamental issues such as changes in principal amount,
payment dates and interest rate.
Administration of Loans. The Agent typically administers the terms of
the Loan Agreement. In these 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 members of the lending
syndicate to use appropriate credit remedies against the Borrower. The Agent is
typically responsible for monitoring compliance with covenants contained in the
Loan Agreement based upon reports prepared by the Borrower. The seller of the
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 holders of the
Senior Loan. The Agent is compensated by the Borrower for providing these
services under a Loan Agreement. Compensation may include special fees paid upon
structuring and funding the Senior Loan and other fees paid on a continuing
basis.
A financial institution's appointment as Agent may 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 other
intermediate participants similar risks may arise.
Prepayments. Senior Loans may require, in addition to scheduled payments
of interest and principal, the prepayment of the Senior Loan from free cash flow
or asset sales. The degree to which Borrowers prepay Senior Loans, whether as a
contractual requirement or at their election, may be affected by, among other
factors, general business conditions, the financial condition of the Borrower
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and competitive conditions among Lenders. 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 should be able to
reinvest prepayments in other Senior Loans that have similar or identical yields
and because receipt of such fees may mitigate any adverse impact on the Fund's
yield.
Other Information Regarding Senior Loans. 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 also
may invest in Senior Loans of Borrowers who 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.
To the extent that collateral consists of the stock of the Borrower's
subsidiaries or other affiliates, the Fund will be subject to the risk that this
stock will decline in value. Such a decline, whether as a result of bankruptcy
proceedings or otherwise, could cause the 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 fully secured by assets of, shareholders or owners, even if
the Senior Loans are not otherwise collateralized by assets of the Borrower;
provided, however, that the 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 the 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 the securities, other than in connection with such pledge
or replacement, will be strictly limited for the protection of the holders of
Senior Loans. During any period in which the Senior Loan is temporarily
unsecured, the Senior Loan will not be treated as a secured Senior Loan for
purposes of the Fund's policy of investing in normal circumstances at least 80%
of its Managed Assets in secured Senior Loans.
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. Such action by a court could be based, for example, on a
"fraudulent conveyance" claim to the effect that the Borrower did not receive
fair consideration for granting the security interest in the loan collateral to
the Fund. For 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
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the Senior Loan is subordinated to other debt of a Borrower in bankruptcy or
other proceedings, it is unlikely that the Fund would be able to recover the
full amount of the principal and interest due on the Loan.
Senior Loans generally hold the most senior position in the capital
structure of a business entity. Their secured position in a Borrower's capital
structure typically provides the holder of a Senior Loan with the first right to
cash flows and/or proceeds from the sale of collateral in the event of
liquidation after default. In order of priority, Senior Loans are typically
repaid before unsecured senior loans, unsecured senior bonds, subordinated debt,
trade creditors, and preferred and common stockholders. However, these factors
do not assure full payment of principal or interest, and delays or limitations
may result in the event of bankruptcy.
Senior Loans are floating rate instruments which are issued at a fixed
spread over some pre-defined base rate. The spread is set at the time the loan
is originated, and is typically referenced to the London Inter-Bank Offered Rate
("LIBOR") but also can be referenced to the rate on certificates of deposit or
the Prime Rate. The spread at the time of origination of a loan is a function of
several factors, including credit quality of the issuer, the structure of the
individual deal, and the general market conditions at the time of the
origination. As conditions change, the required spreads that market participants
demand from a specific borrower, or industry, may change and could result in
required spreads narrowing or widening for all corporate credits. It should be
noted that since most corporate loans may be pre-paid at par without penalty,
should general market spreads narrow, there is a high probability that the
Borrower would choose to refinance at a lower spread. Should an existing loan be
refinanced at a lower rate, or should there be a decrease in credit spreads in
the corporate loan market in general or for a particular industry, it is
expected there will be a decrease in portfolio income and a decrease in overall
portfolio return. The use of leverage in the portfolio will increase the impact
of the decreased income due to spread compression. Senior Loans also may
incorporate pre-determined "step-ups" where the spread increases by some
specified amount if the credit quality of the issuer deteriorates and
"step-downs" where the spread increases if the credit quality of the borrower
improves. Should credit quality decline, and the step-up be triggered, the
coupon income associated with loans to this borrower will increase. Similarly,
should a borrower's credit quality improve and the step-down become operative,
investor income will decrease due to the decrease in income associated with that
particular borrower.
Senior Loans are direct obligations of corporations or other business
entities and are arranged by banks or other commercial lending institutions and
made generally to finance internal growth, mergers, acquisitions, stock
repurchases, and leveraged buyouts. Senior Loans usually include restrictive
covenants which must be maintained by the Borrower. A breach of a covenant,
which is not waived by the Agent, is normally an event of acceleration, i.e.,
the Agent has the right to call the outstanding Senior Loan. These covenants, in
addition to the timely payment of interest and principal, may include
restrictions on dividend payments, and usually state that a Borrower must
maintain specific minimum financial ratios, as well as establishing limits on
total debt. In addition, Senior Loan covenants may include mandatory prepayment
provisions stemming from free cash flow. Free cash flow is cash that is in
excess of capital expenditures plus debt service requirements of principal and
interest. The free cash flow shall be applied to prepay the Senior Loan in an
order of maturity described in the loan documents. Under certain interests in
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Senior Loans, the Fund may have an obligation to make additional loans upon
demand by the Borrower. The Fund intends to reserve against contingent
obligations by segregating sufficient assets in high quality short-term liquid
investments or borrowing to cover the obligations.
Senior Loans, unlike certain bonds, usually do not have call protection.
This means that investments comprising the Fund's portfolio, while having a
stated one to ten-year term, may be prepaid, often without penalty.
The Fund may be required to pay and receive various fees and commissions
in the process of purchasing, selling and holding Senior Loans. The fee
component may include any, or a combination of, the following elements:
arrangement fees, assignment fees, non-use fees, facility fees, letter of credit
fees and ticking fees. Arrangement fees are paid at the commencement of a Senior
Loan as compensation for the initiation of the transaction. An assignment fee
may be paid when a Senior Loan is assigned to another party. A non-use fee is
paid based upon the amount committed but not used typically under a revolving
credit facility, which may be issued coincident to the Senior Loan. Facility
fees are on-going annual fees paid in connection with a Senior Loan. Letter of
credit fees are paid if a Senior Loan involves a letter of credit. Ticking fees
are paid from the initial commitment indication until Senior Loan closing if for
an extended period. The fees are negotiated at the time of transaction.
LOWER GRADE DEBT INSTRUMENTS
The Senior Loans in which the Fund invests are generally lower grade.
These lower grade debt instruments may become the subject of bankruptcy
proceedings or otherwise subsequently default as to the repayment of principal
and/or payment of interest or be downgraded to ratings in the lower rating
categories (Ca or lower by Moody's, CC or lower by S&P or comparably rated by
another NRSRO). The value of these securities is affected by the
creditworthiness of the issuers of the securities and by general economic and
specific industry conditions. Issuers of lower grade debt instruments are not
perceived to be as strong financially as those with higher credit ratings, so
the securities are usually considered speculative investments. These issuers
generally are more vulnerable to financial setbacks and recession than more
creditworthy issuers which may impair their ability to make interest and
principal payments. Lower grade debt instruments tend to be less liquid than
higher grade debt instruments.
Investing in lower grade debt instruments involves additional risks than
investment-grade debt instruments. Lower grade debt instruments are securities
rated Ba1 or lower by Moody's or BB+ or lower by S&P, or comparably rated by any
other NRSRO or considered to be of comparable credit quality. When prevailing
economic conditions cause a narrowing of the spreads between the yields derived
from lower grade or comparable debt instruments and those derived from higher
rated issues, the Fund may invest in higher rated debt instruments which provide
similar yields but have less risk. In addition, the Fund may be forced to buy
higher rated, lower yielding debt instruments, which would decrease the Fund's
return, if issuers redeem their lower grade debt instruments at a higher than
expected rate. Changes in economic or other circumstances are more likely to
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lead to a weakened capacity to make principal and interest payments on
securities rated Ba1 by Moody's or lower or BB+ by S&P or lower than is the case
with higher grade securities.
The Fund will normally invest in securities rated below B by both
Moody's and S&P (or comparably rated by another NRSRO) only if it is determined
that the financial condition of the issuer or the protection afforded to the
particular securities is stronger than would otherwise be indicated by the lower
ratings. Lower grade debt instruments tend to offer higher yields than higher
rated debt instruments with the same maturities because the historical financial
condition of the issuers of the securities may not have been as strong as that
of other issuers. Since lower grade debt instruments generally involve greater
risk of loss of income and principal than higher rated debt instruments,
investors should consider carefully the relative risks associated with
investments in lower grade debt instruments. Investment in these securities is a
long-term investment strategy and, accordingly, investors in the Fund should
have the financial ability and willingness to remain invested for the long-term.
See "Risks Relating to Lower Grade Debt Instruments" below.
Fluctuations in the prices of fixed-income debt instruments may be
caused by, among other things, the supply and demand for similarly rated debt
instruments. In addition, the prices of debt instruments fluctuate in response
to the general level of interest rates. Fluctuations in the prices of debt
instruments subsequent to their acquisition will not affect cash income from
such debt instruments but will be reflected in the Fund's net asset value.
The Fund will perform its own investment analysis and rating assignment,
and will not rely principally on the ratings assigned by the rating services,
although these ratings will be considered. A description of corporate bond
ratings is contained in Appendix A to this Statement of Additional Information.
Ratings of securities represent the rating agencies' opinions regarding their
credit quality and are not a guarantee of quality. Rating agencies attempt to
evaluate the safety of principal and interest payments and do not evaluate the
risks of fluctuations in market value. Also, rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that an
issuer's current financial condition may be better or worse than a rating
indicates. Therefore, the financial history, the financial condition, the
prospects and the management of an issuer, among other things, also will be
considered in selecting securities for the Fund's portfolio. Since some issuers
do not seek ratings for their securities, non-rated securities also will be
considered for investment by the Fund only when it is determined that the
financial condition of the issuers of the securities and/or the protection
afforded by the terms of the securities themselves limit the risk to the Fund to
a degree comparable to that of rated securities that are consistent with the
Fund's objectives and policies.
Risks Relating To Investing In Lower Grade Debt Instruments. Senior
Loans are subject to the risk of an issuer's inability to meet principal and
interest payments on the obligations (credit risk) and also may be subject to
price volatility due to such factors as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity
(market risk). Lower grade or similar unrated debt instruments are more likely
to react to developments affecting market and credit risk than are more highly
rated debt instruments, which react primarily to movements in the general level
of interest rates. Both credit risk and market risk will be considered in making
investment decisions for the Fund. The achievement of its investment objectives
S-10
may be more dependent on the Fund's own credit analysis and rating assignment
than is the case for higher quality securities.
Under adverse economic conditions, there is a risk that highly leveraged
issuers may be unable to service their debt obligations or to repay their
obligations upon maturity. During an economic downturn or recession, securities
of highly leveraged issuers are more likely to default than securities of higher
rated issuers. In addition, the secondary market for lower grade debt
instruments, which is concentrated in relatively few market makers, may not be
as liquid as the secondary market for more highly rated debt instruments. Under
adverse market or economic conditions, the secondary market for lower grade debt
instruments could contract further, independent of any specific adverse changes
in the condition of a particular issuer. As a result, the Fund could find it
more difficult to sell these securities or may be able to sell the securities
only at prices lower than if the securities were widely traded. Prices realized
upon the sale of lower grade debt instruments, under these circumstances, may be
less than the prices used in calculating the Fund's net asset value. Under
circumstances where the Fund owns the majority of an issue, market and credit
risks may be greater. Moreover, from time to time, it may be more difficult to
value lower grade debt instruments than more highly rated debt instruments.
In addition to the risk of default, there are the related costs of
recovery on defaulted issues. The Fund will attempt to reduce these risks
through diversification of the portfolio and by analysis of each issuer and its
ability to make timely payments of income and principal, as well as broad
economic trends in corporate developments.
Since investors generally perceive that there are greater risks
associated with the lower grade debt instruments of the type in which the Fund
may invest, the yields and prices of these debt instruments may tend to
fluctuate more than those for higher rated debt instruments. In the lower
quality segments of the Senior Loan market, changes in perceptions of issuers'
creditworthiness tend to occur more frequently and in a more pronounced manner
than do changes in higher quality fixed income securities.
Lower grade or unrated debt instruments also present risks based on
payment expectations. If an issuer calls the obligation for redemption, the Fund
may have to replace the security with a lower yielding security, resulting in a
decreased return for investors.
SPECIAL SITUATION INVESTMENTS
The Fund may invest up to 10% of its Managed Assets in secured senior
loans and, on limited occasions, equity and other debt securities acquired in
connection therewith, of firms that, at the time of acquisition, have defaulted
on their debt obligations and/or filed for protection under Chapter 11 of the
U.S. Bankruptcy Code or have entered into a voluntary reorganization in
conjunction with their creditors and stakeholders in order to avoid a bankruptcy
filing, or those same issuers prior to an event of default whose acute operating
and/or financial problems have resulted in the markets' valuing their respective
securities and debt at sufficiently discounted prices so as to be yielding,
should they not default, a significant premium over comparable duration U.S.
Treasury bonds ("Special Situation Investments").
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Special Situation Investments are speculative and involve significant
risk. Special Situation Investments frequently do not produce income while they
are outstanding and may require the Fund to bear certain extraordinary expenses
in order to protect and recover its investment. Therefore, the Fund's ability to
achieve current income for its stockholders may be diminished. The Fund also
will be subject to significant uncertainty as to when and in what manner and for
what value the obligations evidenced by the Special Situation Investments
eventually will be satisfied (e.g., through a liquidation of the obligor's
assets, an exchange offer or plan of reorganization involving the Special
Situation Investments or a payment of some amount in satisfaction of the
obligation). In addition, even if an exchange offer is made or a plan of
reorganization is adopted with respect to Special Situation Investments held by
the Fund, there can be no assurance that the securities or other assets received
by the Fund in connection with the exchange offer or plan of reorganization will
not have a lower value or income potential than may have been anticipated when
the investment was made. Moreover, any securities received by the Fund upon
completion of an exchange offer or plan of reorganization may be restricted as
to resale. As a result of the Fund's participation in negotiations with respect
to any exchange offer or plan of reorganization with respect to an issuer of
Special Situation Investments, the Fund may be restricted from disposing of the
securities.
ILLIQUID SECURITIES
The Fund may invest without limit in illiquid securities. Most of the
Senior Loans in which the Fund will invest will be, at times, illiquid. Illiquid
securities also include repurchase agreements that have a maturity of longer
than seven days, certain securities with legal or contractual restrictions on
resale (restricted securities) and securities that are not readily marketable
either within or outside the United States. The Sub-Adviser will monitor the
liquidity of restricted securities under the supervision of the Trustees.
Repurchase agreements subject to demand are deemed to have a maturity equal to
the applicable notice period.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities that have not been
registered under the Securities Act are referred to as restricted securities and
are purchased directly from the issuer or in the secondary market ("Direct
Placement Securities"). Limitations on resale may have an adverse effect on the
marketability of portfolio securities and the Fund might be unable to dispose of
restricted or other illiquid securities promptly or at reasonable prices. The
Fund might also have to register the restricted securities to dispose of them
resulting in additional expense and delay. Adverse market conditions could
impede the public offering of securities.
Over time, a large institutional market has developed for certain
securities that are not registered under the Securities Act including repurchase
agreements, commercial paper, foreign securities, municipal securities,
convertible securities and corporate bonds and notes. Institutional investors
depend on an efficient institutional market in which the unregistered security
can be readily resold or on an issuer's ability to honor a demand for repayment.
S-12
The fact that there are contractual or legal restrictions on resale to the
general public or to certain institutions may not be indicative of the liquidity
of such investments.
FOREIGN SECURITIES
The Fund may invest up to 15% of its Managed Assets in U.S. currency
denominated fixed-income issues of foreign governments and other foreign issuers
(based on issuer's domicile), and preferred stock. But in no case will the Fund
invest in debt securities of issuers located in emerging markets. "Foreign
government securities" include debt securities issued or guaranteed, as to
payment of principal and interest, by governments, semi-governmental entities,
governmental agencies, supranational entities and other governmental entities
(each a "Governmental Entity" and collectively, "Governmental Entities") of
foreign countries denominated in the currencies of such countries or in U.S.
dollars (including debt securities of a Governmental Entity in any such country
denominated in the currency of another such country).
A "supranational entity" is an entity constituted by the national
governments of several countries to promote economic development. Examples of
such supranational entities include, among others, the World Bank (International
Bank for Reconstruction and Development), the European Investment Bank and the
Asian Development Bank. Debt securities of "semi-governmental entities" are
issued by entities owned by a national, state, or equivalent government or are
obligations of a political unit that are not backed by the national government's
"full faith and credit" and general taxing powers. Examples of semi-government
issuers include, among others, the Province of Ontario and the City of
Stockholm.
Investment in Sovereign Debt Can Involve a High Degree of Risk. The
Governmental Entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when due in accordance
with the terms of the debt. A Governmental Entity's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the
Governmental Entity's policy toward the International Monetary Fund and the
political constraints to which a Governmental Entity may be subject.
Governmental Entities also may depend on expected disbursements from foreign
governments, multilateral agencies and others to reduce principal and interest
arrearages on their debt. The commitment on the part of these governments,
agencies and others to make disbursements may be conditioned on a Governmental
Entity's implementation of economic reforms and/or economic performance and the
timely service of the debtor's obligations. Failure to implement such reforms,
achieve the levels of economic performance or repay principal or interest when
due may result in the cancellation of such third parties' commitments to lend
funds to the Governmental Entity, which may further impair the debtor's ability
or willingness to service its debts in a timely manner. Consequently,
Governmental Entities may default on their sovereign debt. Holders of sovereign
debt (including the Funds) may be requested to participate in the rescheduling
of the debt and to extend further loans to Governmental Entities. There is no
bankruptcy proceeding by which sovereign debt on which Governmental Entities
have defaulted may be collected in whole or in part.
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Foreign Securities Involve Certain Risks. These risks include political
or economic instability in the country of issue, the difficulty of predicting
international trade patterns, the possibility of imposition of exchange
controls, and the seizure or nationalization of foreign deposits. Such
securities also may be subject to greater fluctuations in price than securities
issued by United States corporations or issued or guaranteed by the U.S.
Government, its instrumentalities or agencies. In addition, there may be less
publicly available information about a foreign issuer or government than about a
domestic issuer or the U.S. Government. Foreign issuers generally are not
subject to uniform accounting, auditing and financial reporting standards
comparable to those applicable to domestic issuers. There is generally less
government regulation of securities exchanges, brokers and listed companies
abroad than in the United States and, with respect to certain foreign countries,
there is a possibility of confiscatory taxation and diplomatic developments
which could affect investment. In many instances, foreign fixed-income
securities may provide higher yields than securities of domestic issuers which
have similar maturities and quality. These securities may be less liquid than
securities of U.S. issuers, its instrumentalities or agencies. Finally, in the
event of a default of any foreign debt obligations, it may be more difficult for
the Fund to obtain or to enforce a judgment against the issuers of these
securities.
Investing in the fixed-income markets of developing countries involves
exposure to economies that are generally less diverse and mature and to
political systems which can be expected to have less stability than those of
developed countries. Historical experience indicates that the markets of
developing countries have been more volatile than the markets of developed
countries. The risks associated with investments in foreign securities may be
greater with respect to investments in developing countries and are certainly
greater with respect to investments in the securities of financially and
operationally troubled issuers.
Additional costs could be incurred in connection with the Fund's
international investment activities. Foreign countries may impose taxes on
income on foreign investments. Foreign brokerage commissions are generally
higher than U.S. brokerage commissions. Increased custodian costs as well as
administrative difficulties (such as the applicability of foreign laws to
foreign custodians in various circumstances) may be associated with the
maintenance of assets in foreign jurisdictions.
PAY-IN-KIND AND DEFERRED PAYMENT SECURITIES
The Fund may invest in pay-in-kind and deferred payment securities only
if the Fund receives the instruments in connection with owning Senior Loans of
an issuer. Pay-in-kind securities are securities that have interest payable by
delivery of additional securities. Upon maturity, the holder is entitled to
receive the aggregate par value of the securities. Deferred payment securities
are securities that pay no or a reduced rate of interest until a predetermined
date, at which time the stated coupon rate becomes effective and interest
becomes payable at regular intervals. Holders of certain of these types of
securities are deemed to have received income ("phantom income") annually,
notwithstanding that cash may not be received currently. The Fund accrues income
with respect to these securities for federal income tax and accounting purposes
prior to the receipt of cash payments. The effect of owning instruments which do
not make current interest payments is that a fixed yield is earned not only on
the original investment but also, in effect, on all discount accretion during
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the life of the obligations. This implicit reinvestment of earnings at the same
rate eliminates the risk of being unable to invest distributions at a rate as
high as the implicit yield on the deferred payment portion of bond, but at the
same time eliminates the holder's ability to reinvest at higher rates in the
future. For this reason, some of these securities may be subject to
substantially greater price fluctuations during periods of changing market
interest rates than are comparable securities which pay interest currently,
which fluctuation increases the longer the period to maturity. These investments
benefit the issuer by mitigating its need for cash to meet debt service, but
also require a higher rate of return to attract investors who are willing to
defer receipt of cash. Pay-in-kind and deferred payment securities may be
subject to greater fluctuation in value and lesser liquidity in the event of
adverse market conditions than comparable rated securities paying cash interest
at regular intervals. The Fund also may buy loans that provide for the payment
of additional income if certain operational benchmarks are achieved by the
Borrower that is to be paid on a deferred basis at an uncertain future date.
In addition to the above described risks, there are certain other risks
related to investing in pay-in-kind and deferred payment securities. During a
period of severe market conditions, the market for the securities may become
even less liquid. In addition, as these securities may not pay cash interest,
the Fund's investment exposure to these securities and their risks, including
credit risk, will increase during the time these securities are held in the
Fund's portfolio. Further, to maintain its qualification for pass-through
treatment under the federal tax laws, the Fund is required to distribute income
to its shareholders and, consequently, may have to dispose of its portfolio
securities under disadvantageous circumstances to generate the cash, or may have
to leverage itself by borrowing the cash to satisfy these distributions, as they
relate to the distribution of phantom income and the value of the paid-in-kind
interest. The required distributions will result in an increase in the Fund's
exposure to these securities.
CREDIT DEFAULT SWAP TRANSACTIONS
The Fund may invest up to 5% of its Managed Assets in credit default
swap transactions (as measured by the notional amounts of the swaps), including
credit-linked notes (described below) for hedging and investment purposes.
However, given the current state of developments in the market, the Sub-Adviser
has no present intention to utilize such instruments. The "buyer" in a credit
default contract is obligated to pay the "seller" a periodic stream of payments
over the term of the contract provided that no event of default on an underlying
reference obligation has occurred. If an event of default occurs, the seller
must pay the buyer the full notional value, or "par value," of the reference
obligation. Credit default swap transactions are either "physical delivery"
settled or "cash" settled. Physical delivery entails the actual delivery of the
reference asset to the seller in exchange for the payment of the full par value
of the reference asset. Cash settled entails a net cash payment from the seller
to the buyer based on the difference of the par value of the reference asset and
the current value of the reference asset that may have, through default, lost
some, most or all of its value. The Fund may be either the buyer or seller in a
credit default swap transaction. If the Fund is a buyer and no event of default
occurs, the Fund will have made a series of periodic payments and recover
nothing of monetary value. However, if an event of default occurs, the Fund (if
S-15
the buyer) will receive the full notional value of the reference obligation
either through a cash payment in exchange for the asset or a cash payment in
addition to owning the reference assets. As a seller, the Fund receives a fixed
rate of income throughout the term of the contract, which typically is between
six months and five years, provided that there is no event of default. 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. If an event of default occurs,
the seller must pay the buyer the full notional value of the reference
obligation through either physical settlement or cash settlement. Credit default
swap transactions involve greater risks than if the Fund had invested in the
reference obligation directly.
The Fund also may purchase credit default swap contracts in order to
hedge against the risk of default of debt securities it holds, in which case the
Fund would function as the counterparty referenced in the preceding paragraph.
This would involve the risk that the swap may expire worthless and would only
generate income in the event of an actual default by the issuer of the
underlying obligation (as opposed to a credit downgrade or other indication of
financial instability). It would also involve credit risk that the seller may
fail to satisfy its payment obligations to the Fund in the event of a default.
CREDIT-LINKED NOTES
The Fund may invest in credit-linked notes. Credit-linked notes are
securities that are collateralized by one or more credit default swaps on
corporate credits. The difference between a credit default swap and a
credit-linked note is that the buyer of a credit-linked note receives the
principal payment from the seller at the time the contract is originated.
Through the purchase of a credit-linked note, the buyer assumes the risk of the
reference asset and funds this exposure through the purchase of the note. The
buyer takes on the exposure to the seller to the full amount of the funding it
has provided. The seller has hedged its risk on the reference asset without
acquiring any additional credit exposure. The Fund has the right to receive
periodic interest payments from the issuer of the credit-linked note at an
agreed-upon interest rate, and a return of principal at the maturity date.
Credit-linked notes are subject to credit risk of the corporate credits
underlying the credit default swaps. If one of the underlying corporate credits
defaults, the Fund may receive the security that has defaulted, and the Fund's
principal investment would be reduced by the difference between the original
face value security and the current value of the defaulted security.
Credit-linked notes typically are privately negotiated transactions
between two or more parties. The Fund bears the risk that the issuer of the
credit-linked note will default or become bankrupt. The Fund bears the risk of
loss of its principal investment, and the periodic interest payments expected to
be received for the duration of its investment in the credit-linked note.
The market for credit-linked notes is, or suddenly can become, illiquid.
The other parties to the transaction may be the only investors with sufficient
understanding of the derivative to be interested in bidding for it. Changes in
liquidity may result in significant, rapid and unpredictable changes in the
prices for credit-linked notes. In certain cases, a market price for a
credit-linked note may not be available. The collateral for a credit-linked note
S-16
is one or more credit default swaps, which, as described above, are subject to
additional risk.
New financial products continue to be developed and the Fund may invest
in any products that may be developed to the extent consistent with its
investment objectives and the regulatory and federal tax requirements applicable
to investment companies.
STRUCTURED NOTES AND RELATED INSTRUMENTS
The Fund may invest up to 5% of its Managed Assets in "structured" notes
and other related instruments, which are privately negotiated debt obligations
where the principal and/or interest is determined by reference to the
performance of a benchmark asset, market or interest rate (an "embedded" index),
such as selected securities or debt investments, an index of such, or specified
interest rates, or the differential performance of two assets or markets, such
as indexes reflecting bonds. However, given the current state of developments in
the market, the Sub-Adviser has no present intention to utilize such
instruments. The terms of structured instruments normally provide that their
principal and/or interest payments are to be adjusted upwards or downwards (but
ordinarily not below zero) to reflect changes in the embedded index while the
structured instruments are outstanding. As a result, the interest and/or
principal payments that may be made on a structured product may vary widely,
depending on a variety of factors, including the volatility of the embedded
index and the effect of changes in the embedded index on principal and/or
interest payments. The rate of return on structured notes may be determined by
applying a multiplier to the performance or differential performance of the
referenced index(es) or other assets. Application of a multiplier involves
leverage that will serve to magnify the potential for gain and the risk of loss.
As a result, a relatively small decline in the value of a referenced Senior Loan
or basket of Senior Loans could result in a relatively large loss in the value
of a structured note.
INTEREST RATE AND OTHER HEDGING TRANSACTIONS
The Fund may enter into various interest rate hedging and risk
management transactions. Certain of these interest rate hedging and risk
management transactions involve derivative instruments. A derivative is a
financial instrument whose performance is derived at least in part from the
performance of an underlying index, security or asset. The values of certain
derivatives can be affected dramatically by even small market movements,
sometimes in ways that are difficult to predict. There are many different types
of derivatives, with many different uses. The Fund expects to enter into these
transactions primarily to seek to preserve a return on a particular investment
or portion of its portfolio, and also may enter into such transactions to seek
to protect against decreases in the anticipated rate of return on floating or
variable rate financial instruments the Fund owns or anticipates purchasing at a
later date, or for other risk management strategies such as managing the
effective dollar-weighted average duration of the Fund's portfolio. The Fund
also may engage in hedging transactions to seek to protect the value of its
portfolio against declines in net asset value resulting from changes in interest
rates or other market changes. Market conditions will determine whether and in
what circumstances the Fund would employ any of the hedging and risk management
techniques described below. The successful utilization of hedging and risk
management transactions requires skills different from those needed in the
S-17
selection of the Fund's portfolio securities. The Fund believes that the
Sub-Adviser possesses the skills necessary for the successful utilization of
hedging and risk management transactions. The Fund will incur brokerage and
other costs in connection with its hedging transactions.
The Fund may enter into interest rate swaps or total rate of return
swaps or purchase or sell interest rate caps or floors. Interest rate swaps
involve the exchange by the Fund with another party of their respective
obligations to pay or receive interest, e.g., an exchange of an obligation to
make floating rate payments for an obligation to make fixed rate payments. For
example, the Fund may seek to shorten the effective interest rate
redetermination period of a Senior Loan in its portfolio with an interest rate
redetermination period of one-year. The Fund could exchange the Borrower's
obligation to make fixed rate payments for one-year for an obligation to make
payments that readjust monthly.
The purchase of an interest rate cap entitles the purchaser, to the
extent that a specified index exceeds a predetermined interest rate, to receive
payments of interest at the difference of the index and the predetermined rate
on a notional principal amount (the reference amount with respect to which
interest obligations are determined although no actual exchange of principal
occurs) from the party selling the interest rate cap. The purchase of an
interest rate floor entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of interest at
the difference of the index and the predetermined rate on a notional principal
amount from the party selling the interest rate floor.
In circumstances in which the Sub-Adviser anticipates that interest
rates will decline, the Fund might, for example, enter into an interest rate
swap as the floating rate payor or, alternatively, purchase an interest rate
floor. In the case of purchasing an interest rate floor, if interest rates
declined below the floor rate, the Fund would receive payments from its
counterparty which would wholly or partially offset the decrease in the payments
it would receive in respect of the portfolio assets being hedged. In the case
where the Fund purchases an interest rate swap, if the floating rate payments
fell below the level of the fixed rate payment set in the swap agreement, the
Fund's counterparty would pay the Fund amounts equal to interest computed at the
difference between the fixed and floating rates over the notional principal
amount. Such payments would offset or partially offset the decrease in the
payments the Fund would receive in respect of floating rate portfolio assets
being hedged.
The successful use of swaps, caps and floors to preserve the rate of
return on a portfolio of financial instruments depends on the Sub-Adviser's
ability to predict correctly the direction and extent of movements in interest
rates.
Although the Fund believes that use of the hedging and risk management
techniques described above will benefit the Fund, if the Sub-Adviser's judgment
about the direction or extent of the movement in interest rates is incorrect,
the Fund's overall performance would be worse than if it had not entered into
any such transactions.
Because these hedging transactions are entered into for good-faith risk
management purposes, the Sub-Adviser and the Fund believe these obligations do
not constitute senior securities. The Fund usually will enter into interest rate
S-18
swaps on a net basis, i.e., where the two parties make net payments with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Fund's obligations over
its entitlements with respect to each interest rate swap will be accrued and an
amount of cash or liquid securities having an aggregate net asset value at least
equal to the accrued excess will be maintained in a segregated account by the
Fund's custodian. If the Fund enters into a swap on other than a net basis, the
Fund will maintain in the segregated account the full amount of the Fund's
obligations under each swap. Accordingly, the Fund does not treat swaps as
senior securities. The Fund may enter into swaps, caps and floors with member
banks of the Federal Reserve System, members of the New York Stock Exchange or
other entities determined by the Adviser, pursuant to procedures adopted and
reviewed on an ongoing basis by the Board of Trustees, to be creditworthy. If a
default occurs by the other party to the transaction, the Fund will have
contractual remedies pursuant to the agreements related to the transaction but
remedies may be subject to bankruptcy and insolvency laws which could affect the
Fund's rights as a creditor. The swap market has grown substantially in recent
years with a large number of banks and financial services firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the swap market has become relatively liquid. Caps and floors are more recent
innovations and they are less liquid than swaps. There can be no assurance,
however, that the Fund will be able to enter into interest rate swaps or to
purchase interest rate caps or floors at prices or on terms the Sub-Adviser
believes are advantageous to the Fund. In addition, although the terms of
interest rate swaps, caps and floors may provide for termination, there can be
no assurance that the Fund will be able to terminate an interest rate swap or to
sell or offset interest rate caps or floors that it has purchased.
The Fund also may engage in credit derivative transactions. Default risk
derivatives are linked to the price of reference securities or loans after a
default by the issuer or borrower, respectively. Market spread derivatives are
based on the risk that changes in market factors, such as credit spreads, can
cause a decline in the value of a security, loan or index. There are three basic
transactional forms for credit derivatives: swaps, options and structured
instruments. The use of credit derivatives is a highly specialized activity
which involves strategies and risks different from those associated with
ordinary portfolio security transactions. If the Sub-Adviser is incorrect in its
forecasts of default risks, market spreads or other applicable factors, the
investment performance of the Fund would diminish compared with what it would
have been if these techniques were not used. Moreover, even if the Sub-Adviser
is correct in its forecasts, there is a risk that a credit derivative position
may correlate imperfectly with the price of the asset or liability being hedged.
Credit derivative transaction exposure will be limited to 20% of the Managed
Assets of the Fund. Such exposure will be attained through the use of
derivatives described above and through credit default swap transactions and
credit linked securities, both of which are discussed below.
LENDING OF SECURITIES
Consistent with applicable regulatory requirements, the Fund may lend
its portfolio securities in any amount to brokers, dealers and financial
institutions, provided that loans are callable at any time by the Fund and are
at all times secured by cash or equivalent collateral that is equal to at least
the market value, determined daily, of the loaned securities. During the time
S-19
portfolio securities are on loan, the borrower will pay the Fund an amount
equivalent to any dividend or interest paid on the securities and the Fund may
invest the cash collateral and earn additional income, or it may receive an
agreed-upon amount of interest income from the borrower. The advantage of the
loans is that the Fund continues to receive payments in lieu of the interest and
dividends of the loaned securities, while at the same time earning interest
either directly from the borrower or on the collateral which will be invested in
short-term obligations.
A loan may be terminated by the borrower on one business day's notice or
by the Fund at any time. If the borrower fails to maintain the requisite amount
of collateral, the loan automatically terminates, and the Fund could use the
collateral to replace the securities while holding the borrower liable for any
excess of replacement cost over collateral. As with any extensions of credit,
there are risks of delay in recovery and in some cases even loss of rights in
the collateral should the borrower of the securities fail financially. However,
these loans of portfolio securities will only be made to firms deemed to be
creditworthy. On termination of the loan, the borrower is required to return the
securities to the Fund, and any gain or loss in the market price during the loan
would inure to the Fund.
Since voting or consent rights which accompany loaned securities pass to
the borrower, the Fund will follow the policy of calling the loan, in whole or
in part as may be appropriate, to permit the exercise of its rights if the
matters involved would have a material effect on the Fund's investment in the
securities which are the subject of the loan. The Fund will pay reasonable
finders, administrative and custodial fees in connection with a loan of its
securities or may share the interest earned on collateral with the borrower.
OTHER INVESTMENT COMPANIES
The Fund may invest its Managed Assets in securities of other open- or
closed-end investment companies that invest primarily in securities of the types
in which the Fund may invest directly. In addition, the Fund may invest a
portion of its Managed Assets in pooled investment vehicles (other than
investment companies) that invest primarily in securities of the types in which
the Fund may invest directly. For instance, the Fund may purchase the Select
Aggregate Market Index, or SAMI. SAMI is a synthetic composite of performance of
the leveraged loan market through credit derivatives based on 50 of the most
widely traded leveraged, or high yield, loans. The Fund generally expects that
it may invest in other investment companies and/or pooled investment vehicles
such as SAMI or similar indices either during periods when it has large amounts
of uninvested cash, such as the period shortly after the Fund receives the
proceeds of the offering of its Common Shares or Preferred Shares and/or
borrowings, or during periods when there is a shortage of attractive securities
of the types in which the Fund may invest in directly available in the market.
As an investor in an investment company, the Fund will bear its ratable share of
that investment company's expenses, and would remain subject to payment of the
Fund's advisory and administrative fees with respect to assets so invested.
Common Shareholders would therefore be subject to duplicative expenses to the
extent the Fund invests in other investment companies. The Sub-Adviser will take
expenses into account when evaluating the investment merits of an investment in
the investment company relative to available securities of the types in which
the Fund may invest directly. In addition, the securities of other investment
companies also may be leveraged and therefore will be subject to the same
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leverage risks described herein. As described in the section entitled
"Risks--Leverage Risk," the net asset value and market value of leveraged shares
will be more volatile and the yield to shareholders will tend to fluctuate more
than the yield generated by unleveraged shares. The Fund will treat its
investments in such investment companies as investments in Senior Loans for all
purposes, such as for purposes of determining compliance with the requirement
set forth above that at least 80% of the Fund's Managed Assets be invested under
normal market circumstances in Senior Loans.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The management of the Fund, including general supervision of the duties
performed for the Fund under the Investment Management Agreement, is the
responsibility of the Board of Trustees. The Trustees set broad policies for the
Fund and choose the Fund's officers. The following is a list of the Trustees and
officers of the Fund and a statement of their present positions and principal
occupations during the past five years, with the Trustee who is an "interested
person" (as such term is defined in the 1940 Act) of the Fund indicated by an
asterisk. The mailing address of the officers and Trustees, unless otherwise
noted, is 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532.
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF OFFICE COMPLEX OTHER
AND YEAR FIRST OVERSEEN BY TRUSTEESHIPS
POSITION AND ELECTED OR PRINCIPAL OCCUPATIONS TRUSTEE OR HELD BY
NAME, ADDRESS AND AGE OFFICES WITH FUND APPOINTED DURING PAST 5 YEARS OFFICER TRUSTEE
Trustee who is an
Interested Person of the
Fund
------------------------
James A. Bowen(1)* President, o One Year(2) President, First Trust 17 Portfolios None
D.O.B.: 09/55 Chairman of the Portfolios, L.P. and First
Board, Chief o 2004 Trust Advisors; Chairman
Executive Officer of the Board of
and Trustee Directors, Bond Wave, LLC
Trustees who are not
Interested Persons of the
Fund
------------------------
Richard E. Erickson Trustee o One Year(2) Physician, 17 Portfolios None
327 Gundersen Drive Sportsmed/Wheaton
Carol Stream, IL 60188 o 2004 Orthopedics
D.O.B.: 04/51
Thomas R. Kadlec Trustee o One Year(2) Vice President, Chief 17 Portfolios None
26W110 Sandpiper Court Financial Officer (1990
Wheaton, IL 60188-4541 o 2004 to Present), ADM Investor
D.O.B.: 11/57 Services, Inc. (Futures
Commission Merchant);
Registered Representative
(2000 to Present),
Segerdahl & Company,
Inc., an NASD member
(Broker-Dealer)
S-21
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF OFFICE COMPLEX OTHER
AND YEAR FIRST OVERSEEN BY TRUSTEESHIPS
POSITION AND ELECTED OR PRINCIPAL OCCUPATIONS TRUSTEE OR HELD BY
NAME, ADDRESS AND AGE OFFICES WITH FUND APPOINTED DURING PAST 5 YEARS OFFICER TRUSTEE
Niel B. Nielson Trustee o One Year(2) President (2002 to 17 Portfolios Director of
1117 Mountain Terrace Present), Covenant Good News
Lookout Mountain, GA 30750 o 2004 College; Pastor (1997 to Publishers
D.O.B.: 03/54 2002), College Church in - Crossway
Wheaton Books; Covenant
Transport Inc.
David M. Oster Trustee o One Year(2) Trader (Self-Employed) 6 Portfolios None
3N550 Wildflower Lane (1987 to Present)
West Chicago, IL 60185 o 2004 (Options Trading and
D.O.B.: 03/64 Market Making)
Officers of the Fund
---------------------
Mark R. Bradley Treasurer, o Indefinite Chief Financial Officer, 17 Portfolios N/A
D.O.B.: 11/57 Controller, Chief term Managing Director, First
Financial Officer Trust Portfolios, L.P. and
and Chief o 2004 First Trust Advisors
Accounting Officer
Susan M. Brix Assistant Vice o Indefinite Representative, First 17 Portfolios N/A
D.O.B.: 01/60 President term Trust Portfolios, L.P.;
Assistant Portfolio
o 2004 Manager, First Trust
Advisors
Robert F. Carey Vice President o Indefinite Senior Vice President, 17 Portfolios N/A
D.O.B.: 07/63 term First Trust Portfolios,
L.P. and First Trust
o 2004 Advisors
W. Scott Jardine Secretary o Indefinite General Counsel, First 17 Portfolios N/A
D.O.B.: 05/60 term Trust Portfolios, L.P. and
First Trust Advisors
o 2004
Roger Testin Vice President o Indefinite Vice President (August 17 Portfolios N/A
D.O.B.: 06/66 term 2001-Present), First
Trust Advisors; Analyst
o 2004 (1998-2001), Dolan
Capital Management
--------------------
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
of President of First Trust Advisors, investment adviser of the Fund.
(2) Trustees are elected each year by shareholders and serve a one year term
until their successors are elected. Mr. Bowen's officer positions with the
Fund have an indefinite term.
The Board of Trustees of the Fund has four standing committees, the
Executive Committee (and Pricing and Dividend Committee), the Nominating and
Governance Committee, the Valuation Committee, and the Audit Committee. The
Executive Committee, which meets between Board meetings, is authorized to
exercise all powers of and to act in the place of the Board of Trustees to the
extent permitted by the Fund's Declaration of Trust and By-laws. The members of
the Executive Committee shall also serve as a special committee of the Board
known as the Pricing and Dividend Committee which is authorized to exercise all
of the powers and authority of the Board in respect of the issuance and sale,
through an underwritten public offering, of the Common Shares of the Fund and
all other such matters relating to such financing, including determining the
price at which such shares are to be sold and approval of the final terms of the
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underwriting agreement, including approval of the members of the underwriting
syndicate. Such committee is also responsible for the declaration and setting of
dividends. Messrs. Kadlec and Bowen are members of the Executive Committee. The
Nominating and Governance Committee is responsible for appointing and nominating
non-interested persons to the Fund's Board of Trustees. Messrs. Erickson,
Nielson, Kadlec and Oster are members of the Nominating and Governance
Committee. If there is no vacancy on the Board of Trustees, the Board will not
actively seek recommendations from other parties, including shareholders. When a
vacancy on the Board occurs and nominations are sought to fill such vacancy, the
Nominating and Governance Committee may seek nominations from those sources it
deems appropriate in its discretion, including Shareholders of the Fund. To
submit a recommendation for nomination as a candidate for a position on the
Board, Shareholders of the Fund shall mail such recommendation to W. Scott
Jardine at the Fund's address, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532. Such recommendation shall include the following information: (a) evidence
of Fund ownership of the person or entity recommending the candidate (if a Fund
Shareholder), (b) a full description of the proposed candidate's background,
including their education, experience, current employment, and date of birth,
(c) names and addresses of at least three professional references for the
candidate, (d) information as to whether the candidate is an "interested person"
in relation to such Fund, as such term is defined in the 1940 Act, as amended,
and such other information that may be considered to impair the candidate's
independence and (e) any other information that may be helpful to the Committee
in evaluating the candidate. If a recommendation is received with satisfactorily
completed information regarding a candidate during a time when a vacancy exists
on the Board or during such other time as the Nominating and Governance
Committee is accepting recommendations, the recommendation will be forwarded to
the Chair of the Nominating and Governance Committee and the outside counsel to
the independent trustees. Recommendations received at any other time will be
kept on file until such time as the Nominating and Governance Committee is
accepting recommendations, at which point they may be considered for nomination.
The Valuation Committee is responsible for the oversight of the pricing
procedures of the Fund. Messrs. Erickson, Kadlec and Oster are members of the
Valuation Committee. The Audit Committee is responsible for overseeing the
Fund's accounting and financial reporting process, the system of internal
controls, audit process and evaluating and appointing independent auditors
(subject also to Board approval). Messrs. Erickson, Nielson, Kadlec and Oster
serve on the Audit Committee. Because the Fund is newly organized, none of the
committees have met during the Fund's last fiscal year.
Messrs. Erickson, Nielson and Bowen are also trustees of First Defined
Portfolio Fund, LLC, an open-end fund advised by First Trust Advisors with 11
portfolios. Messrs. Bowen, Erickson, Nielson, Kadlec and Oster are also trustees
of the First Trust Value Line(R) 100 Fund, First Trust Value Line(R) Dividend
Fund, First Trust/Four Corners Senior Floating Rate Income Fund, Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund and First
Trust/Value Line(R) & Ibbotson Equity Allocation Fund, closed-end funds advised
by First Trust Advisors. None of the Trustees who are not "interested persons"
of the Fund, nor any of their immediate family members, has ever been a
director, officer or employee of, or consultant to, First Trust Advisors, First
Trust Portfolios, L.P. ("First Trust Portfolios") or their affiliates. In
addition, Mr. Bowen and the other officers of the Fund, hold the same positions
with the First Defined Portfolio Fund, LLC, First Trust Value Line(R) 100 Fund,
First Trust Value Line(R) Dividend Fund, First Trust/Four Corners Senior
Floating Rate Income Fund, Macquarie/First Trust Global Infrastructure/Utilities
S-23
Dividend & Income Fund and First Trust/Value Line(R) & Ibbotson Equity
Allocation Fund as they hold with the Fund.
The officers and Trustee who is an "interested person" as designated
above serve without any compensation from the Fund. Trustees who are not
interested persons of the Fund ("Independent Trustees") receive a $10,000 annual
retainer for serving as trustee of the Fund, $1,000 per meeting fee for their
attendance (in-person or through electronic means), $500 for attendance
in-person or through electronic means at a committee meeting and are reimbursed
for expenses incurred as a result of attendance at meetings of the Trustees. The
following table sets forth estimated compensation to be paid by the Fund
projected during the Fund's first full fiscal year to each of the Independent
Trustees and estimated total compensation to be paid to each of the Independent
Trustees by the First Trust Fund Complex for a full calendar year. The Fund has
no retirement or pension plans.
ESTIMATED TOTAL
COMPENSATION
ESTIMATED AGGREGATE FROM FUND AND
NAME OF TRUSTEE COMPENSATION FROM FUND (1) FUND COMPLEX(2)
Richard E. Erickson $13,000 $99,500
Thomas R. Kadlec $13,000 $99,500
Niel B. Nielson $13,000 $99,500
David M. Oster $13,000 $78,000
--------------------
(1) The compensation estimated to be paid by the Fund to the Independent
Trustees for the first full fiscal year for services to the Fund.
(2) The total estimated compensation to be paid to Messrs. Erickson, Kadlec
and Nielson, Independent Trustees, from the Fund and Fund Complex for a
full calendar year is based on estimated compensation to be paid to these
Trustees for a full calendar year for services as Trustees to the First
Defined Portfolio Fund, LLC, an open-end fund (with 11 portfolios)
advised by First Trust Advisors plus estimated compensation to be paid to
these Trustees by the First Value Line(R) 100 Fund, the First Trust Value
Line(R) Dividend Fund, the First Trust/Four Corners Senior Floating Rate
Income Fund, the Macquarie/First Trust Global Infrastructure/Utilities
Dividend & Income Fund, First Trust/Value Line(R) & Ibbotson Equity
Allocation Fund and the Fund for a full calendar year. Mr. Oster is
currently not a Trustee of the First Defined Portfolio Fund, LLC.
Accordingly, his estimated total compensation is based on the estimated
compensation to be paid by the First Trust Value Line(R) 100 Fund, the
First Trust Value Line(R) Dividend Fund, the First Trust/Four Corners
Senior Floating Rate Income Fund, the Macquarie/First Trust Global
Infrastructure/Utilities Dividend & Income Fund, First Trust/Value
Line(R) & Ibbotson Equity Allocation Fund and the Fund for a full
calendar year.
The Fund has no employees. Its officers are compensated by First Trust
Advisors. Shareholders of the Fund will elect trustees at the next annual
meeting of shareholders.
The following table sets forth the dollar range of equity securities
beneficially owned by the Trustees in the Fund and in other funds overseen by
the Trustees in the First Trust Fund Complex as March 31, 2004:
S-24
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN
ALL REGISTERED
DOLLAR RANGE OF INVESTMENT COMPANIES
EQUITY SECURITIES OVERSEEN BY TRUSTEE IN
TRUSTEE IN THE FUND FIRST TRUST FUND COMPLEX
Mr. Bowen None $50,001 - $100,000
Mr. Erickson None $ 1 - $ 10,000
Mr. Kadlec None $50,001 - $100,000
Mr. Nielson None $10,001 - $ 50,000
Mr. Oster None $10,001 - $ 50,000
As of December 31, 2003, the Trustees of the Fund who are not
"interested persons" of the Fund and immediate family members do not own
beneficially or of record any class of securities of an investment adviser or
principal underwriter of the Fund or any person directly or indirectly
controlling, controlled by, or under common control with an investment adviser
or principal underwriter of the Fund.
As of May 21, 2004, First Trust Portfolios L.P. owned both beneficially
and of record all of the Common Shares of the Fund.
ADVISER
First Trust Advisors L.P., 1001 Warrenville Road, Suite 300, Lisle,
Illinois 60532, is the investment adviser to the Fund. As investment adviser,
First Trust Advisors provides the Fund with professional investment supervision
and selects the Fund's Sub-Adviser and permits any of its officers or employees
to serve without compensation as Trustees or officers of the Fund if elected to
such positions. First Trust Advisors supervises the activities of the Fund's
Sub-Adviser and provides the Fund with certain other services necessary with the
management of the portfolio.
First Trust Advisors is an Illinois limited partnership formed in 1991
and an investment adviser registered with the Commission under the Investment
Advisers Act of 1940. First Trust Advisors is a limited partnership with one
limited partner, Grace Partners of DuPage L.P. ("Grace Partners"), and one
general partner, The Charger Corporation. Grace Partners is a limited
partnership with one general partner, The Charger Corporation, and a number of
limited partners. Grace Partners' and The Charger Corporation's primary business
is investment advisory and broker/dealer services through their interests. The
Charger Corporation is an Illinois corporation controlled by the Robert Donald
Van Kampen family. First Trust Advisors is controlled by Grace Partners and The
Charger Corporation.
First Trust Advisors is also adviser or subadviser to approximately 25
mutual funds and six closed-end funds (including the Fund) and is the portfolio
supervisor of certain unit investment trusts sponsored by First Trust
Portfolios. First Trust Portfolios specializes in the underwriting, trading and
distribution of unit investment trusts and other securities. First Trust
Portfolios, an Illinois limited partnership formed in 1991, acts as sponsor for
successive series of The First Trust Combined Series, FT Series (formerly known
S-25
as The First Trust Special Situations Trust), the First Trust Insured Corporate
Trust, The First Trust of Insured Municipal Bonds and The First Trust GNMA.
First Trust Portfolios introduced the first insured unit investment trust in
1974 and to date, more than $48 billion in First Trust Portfolios unit
investment trusts have been deposited.
First Trust Advisors acts as investment adviser to the Fund pursuant to
an Investment Management Agreement. The Investment Management Agreement
continues in effect for the Fund from year to year after its initial two-year
term so long as its continuation is approved at least annually by the Trustees
including a majority of the Trustees who are not parties to the agreement or
interested persons of any such party except in their capacity as Trustees of the
Fund, or the vote of a majority of the outstanding voting securities of the
Fund. It may be terminated at any time without the payment of any penalty upon
60 days' written notice by either party, or by a majority vote of the
outstanding voting securities of the Fund (accompanied by appropriate notice),
and will terminate automatically upon assignment. The Investment Management
Agreement also may be terminated, at any time, without payment of any penalty,
by the Board or by vote of a majority of the outstanding voting securities of
the Fund, in the event that it shall have been established by a court of
competent jurisdiction that the Adviser, or any officer or director of the
Adviser, has taken any action which results in a breach of the covenants of the
Adviser set forth in the Investment Management Agreement. The Investment
Management Agreement provides that First Trust Advisors, shall not be liable for
any loss sustained by reason of the purchase, sale or retention of any security,
whether or not the purchase, sale or retention shall have been based upon the
investigation and research made by any other individual, firm or corporation, if
the recommendation shall have been selected with due care and in good faith,
except loss resulting from willful misfeasance, bad faith or gross negligence on
the part of the Adviser in performance of its obligations and duties, or by
reason of its reckless disregard of its obligations and duties under the
Investment Management Agreement. As compensation for its services, the Fund pays
First Trust Advisors a fee as described in the Prospectus. Provisions regarding
expense limitations are described in the Prospectus. See "Summary of Fund
Expenses" and "Management of the Fund--Investment Management Agreement" in the
Fund's Prospectus.
In addition to the fee of First Trust Advisors, the Fund pays all other
costs and expenses of its operations, including compensation of its Trustees
(other than those affiliated with First Trust Advisors), custodian, transfer
agency, administrative, accounting and dividend disbursing expenses, legal fees,
sub-licensing fee, expenses of independent auditors, expenses of preparing,
printing and distributing shareholder reports, notices, proxy statements and
reports to governmental agencies, and taxes, if any. All fees and expenses are
accrued daily and deducted before payment of dividends to investors.
On April 18, 2004, the Trustees of the Fund met with members of First
Trust Advisors and the Sub-Adviser (the "Fund Advisers") to consider, among
other things, the possible approval of the Investment Management Agreement
between the Fund and First Trust Advisors and the Sub-Advisory Agreement between
the Adviser, the Sub-Adviser and the Fund. Prior to the meeting, the Independent
Trustees received a memorandum describing their legal obligations and duties
relating to the approval of an investment advisory contract, including the
S-26
duties of the Trustees under the 1940 Act and the general principles of state
law; the requirements of the 1940 Act in such matters; the fiduciary duty of the
Adviser; the standards used in determining whether boards of trustees have
fulfilled their duties; and various factors to be considered by the Trustees in
voting on whether to approve advisory agreements. In evaluating the Investment
Management Agreement and the Sub-Advisory Agreement, the Independent Trustees
met with their legal counsel privately (outside the presence of the interested
Trustee and officers of the Fund Advisers) to discuss their responsibilities and
obligations with respect to the Investment Management Agreement and Sub-Advisory
Agreement and the terms of the proposed agreements.
In evaluating the Investment Management Agreement and the Sub-Advisory
Agreement, the Trustees considered narrative information concerning, among other
things, the nature of the services to be provided by the respective adviser or
sub-adviser (as described below), the fees to be paid to the respective adviser
and the sub-adviser and the experience, resources and staffing of the respective
adviser and sub-adviser.
More specifically, First Trust Advisors already serves as investment
adviser on the various funds in the First Trust complex. Accordingly, the
Trustees noted that they were already well informed as to its personnel,
staffing, experience, investment philosophy and fees paid by other clients. In
evaluating the Investment Management Agreement, the Trustees reviewed the
supervisory services to be provided by First Trust Advisors, as the investment
adviser, the personnel resources available to fulfill such function (including
the job descriptions and background of newly-hired employees) and the advisory
fees to be paid to First Trust Advisors. More specifically, First Trust Advisors
updated the Trustees regarding its activities that are designed to strengthen
its regulatory oversight systems and its ability to monitor the various
sub-advisers serving the funds. In this regard, First Trust Advisors has hired
an Assistant General Counsel as well as a manager responsible for sub-adviser
oversight. The Trustees reviewed the division of services provided to the Fund
by the Adviser and the Sub-Adviser and the corresponding allocation of fees,
which were the product of arm's length negotiations between the parties. In this
review, the Trustees also took into account the role of First Trust Advisors in
connection with the use of leverage by the Fund and the additional monitoring
and supervision required for this activity.
In evaluating the Sub-Advisory Agreement with Four Corners, the Trustees
similarly considered the nature of the services to be provided and the fees to
be paid. More specifically, Four Corners already serves as a sub-adviser to
funds in the First Trust complex, including funds investing in the senior loan
asset class. Accordingly, the Trustees were already well informed of Four
Corner's experience and skill with the senior loan asset class (including the
performance of the existing funds), its personnel, resources, investment
personnel (their qualifications, duties and their historical experience with
this asset class), investment philosophy and process and fees received for
similar services and took these factors into account when considering Four
Corners as sub-adviser for this Fund. In particular, the co-Portfolio Managers
of the Fund, Mr. McAdams and Mr. Bernstein, have been significantly involved in
the management of portfolios of senior loans since the 1980s. In addition, the
Trustees reviewed the financial resources and ownership of Four Corners,
including its affiliation with Macquarie Group, an international financial
services firm. The Trustees also reviewed Four Corners' regulatory filings (e.g.
its most recent Form ADV filing). In approving the Sub-Advisory Agreement and
the fees payable thereunder, the Trustees also took into account, in particular,
the level of complexity required in managing this asset class, Four Corners'
investment philosophy and the experience of the co-Portfolio Managers in
managing this asset class. The Trustees were also made
S-27
aware of Four Corners' performance history in the senior loan asset class,
including default rates for senior loan assets held in portfolios managed by
Four Corners.
In evaluating the overall advisory arrangement, the Trustees also
received and reviewed written information regarding advisory fees paid by other
analogous closed-end funds and their respective expense ratios. It was noted
that another closed-end fund sub-advised by Four Corners has performed very well
as compared to its peer group.
The Board of Trustees, including all of the Independent Trustees of the
Fund, and the sole shareholder of the Fund, each approved the Investment
Management Agreement and the Sub-Advisory Agreement. The Independent Trustees
determined that the terms of the Fund's Investment Management Agreement and the
Sub-Advisory Agreement, including the fees, are fair and reasonable, and that
they will enable the Fund to obtain high quality investment management services.
The Trustees did not identify in their discussions any single factor as all
important or controlling but rather reviewed all pertinent in formation as part
of their deliberations.
The Fund, Adviser and Sub-Adviser have adopted codes of ethics under
Rule 17j-1 under the 1940 Act. These codes permit personnel subject to the code
to invest in securities, including securities that may be purchased or held by
the Fund. These codes can be reviewed and copied at the Commission's Public
Reference Room in Washington, D.C. Information on the operation of the Public
Reference Room may be obtained by calling the Commission at (202) 942-8090. The
codes of ethics are available on the EDGAR Database on the Commission's web site
(http://www.sec.gov), and copies of these codes may be obtained, after paying a
duplicating fee, by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the Commission Public Reference Section,
Washington, DC 20549-0102.
PROXY VOTING PROCEDURES
The Fund has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently and solely in the
best economic interests of the Fund.
A senior member of the Adviser is responsible for oversight of the
Fund's proxy voting process. The Adviser has engaged the services of
Institutional Shareholder Services, Inc. ("ISS"), to make recommendations to the
Adviser on the voting of proxies relating to securities held by the Fund. ISS
provides voting recommendations based upon established guidelines and practices.
The Adviser reviews ISS recommendations and frequently follows the ISS
recommendations. However, on selected issues, the Adviser may not vote in
accordance with the ISS recommendations when the Adviser believes that specific
ISS recommendations are not in the best economic interest of the Fund. If the
Adviser manages the assets of a company or its pension plan and any of the
Adviser's clients hold any securities in that company, the Adviser will vote
proxies relating to that company's securities in accordance with the ISS
recommendations to avoid any conflict of interest. If a client requests the
Adviser to follow specific voting guidelines or additional guidelines, the
Adviser will review the request and inform the client only if the Adviser is not
able to follow the client's request.
S-28
The Adviser has adopted the ISS Proxy Voting Guidelines. While these
guidelines are not intended to be all-inclusive, they do provide guidance on the
Adviser's general voting policies.
When required by applicable regulations, information regarding how the
Fund voted proxies relating to portfolio securities will be available without
charge by calling (800) 988-5891 or by accessing the Commission's website at
http://www.sec.gov.
SUB-ADVISER
Four Corners Capital Management, LLC acts as investment sub-adviser to
the Fund with responsibility for the overall management of the Fund. Its address
is 515 South Flower Street, Suite 4310, Los Angeles, California 90071. Four
Corners is 66.67% owned by Macquarie Bank Limited ("MBL") through a subsidiary
and 33.33% by its senior management.
The Sub-Adviser, subject to the Board of Trustees' and Adviser's
supervision, provides the Fund with discretionary investment services.
Specifically, the Sub-Adviser is responsible for managing the investments of the
Fund in accordance with the Fund's investment objectives, policies, and
restrictions as provided in the Prospectus and this Statement of Additional
Information, as may be subsequently changed by the Board of Trustees and
publicly described. The Sub-Adviser further agrees to conform to all applicable
laws and regulations of the Commission in all material respects and to conduct
its activities under the Sub-Advisory Agreement in accordance with applicable
regulations of any governmental authority pertaining to its investment advisory
services. In the performance of its duties, the Sub-Adviser will satisfy its
fiduciary duties to the Fund, will monitor the Fund's investments in Senior
Loans (and other assets in which the Sub-Adviser is authorized to invest), and
will comply with the provisions of the Fund's Declaration of Trust and By-laws,
as amended from time to time, and the stated investment objectives, policies and
restrictions of the Fund. The Sub-Adviser is responsible for effecting all
security transactions on behalf of the Fund. Pursuant to a Sub-Advisory
Agreement between the Adviser, the Sub-Adviser and the Fund, the Adviser has
agreed to pay for the services and facilities provided by the Sub-Adviser
through a sub-advisory fee, as set forth in the Prospectus. For purposes of
calculation of the sub-advisory fee, the Fund's "managed assets" shall mean the
average daily gross asset value of the Fund (which includes assets attributable
to the Fund's preferred shares, if any, and the principal amount of any
borrowings), minus the sum of the Fund's accrued and unpaid dividends on any
outstanding preferred shares and accrued liabilities (other than the principal
amount of any borrowings incurred, commercial paper or notes issued by the Fund
and the liquidation preference of any outstanding preferred shares). Through a
separate agreement, the Adviser has committed to pay the Sub-Adviser a sum equal
to 1.5 times the annualized pro-forma Sub-Advisory Fee in effect if the
Sub-Advisory Agreement is terminated for any reason other than for cause or the
appointment of the Sub-Adviser as the Fund's investment adviser.
All fees and expenses are accrued daily and deducted before payment of
dividends to investors. The Sub-Advisory Agreement has been approved by a
majority of the disinterested trustees of the Fund and the sole shareholder of
the Fund.
S-29
PORTFOLIO TRANSACTIONS
The Sub-Adviser is responsible for decisions to buy and sell securities
for the Fund and for the placement of the Fund's securities business, the
negotiation of the prices to be paid for principal trades and the allocation of
its transactions among various dealer firms. Portfolio securities will normally
be purchased directly from an underwriter or in the over-the-counter market from
the principal dealers in the securities, unless it appears that a better price
or execution may be obtained through other means. Portfolio securities will not
be purchased from the Fund's affiliates except in compliance with the 1940 Act.
With respect to interests in Senior Loans, the Fund generally will
engage in privately negotiated transactions for purchase or sale in which the
Sub-Adviser will negotiate on behalf of the Fund, although a more developed
market may exist for certain Senior Loans. The Fund may be required to pay fees,
or forego a portion of interest and any fees payable to the Fund, to the Lender
selling participations or assignments to the Fund. The Sub-Adviser will identify
and choose the Lenders from whom the Fund will purchase assignments and
participations by considering their professional ability, level of service,
relationship with the Borrower, financial condition, credit standards and
quality of management. Although the Fund may hold interests in Senior Loans
until maturity or prepayment of the Senior Loan, the illiquidity of many Senior
Loans may restrict the ability of the Sub-Adviser to locate in a timely manner
persons willing to purchase the Fund's interests in Senior Loans at a fair price
should the Fund desire to sell its interests. See "Risks" in the Prospectus.
The Fund expects that substantially all other portfolio transactions
will be effected on a principal (as opposed to an agency) basis and,
accordingly, does not expect to pay any brokerage commissions. Purchases from
underwriters will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers will include the spread between the bid
and asked price. It is the policy of the Sub-Adviser to seek the best execution
under the circumstances of each trade. The Sub-Adviser evaluates price as the
primary consideration, with the financial condition, reputation and
responsiveness of the dealer considered secondary in determining best execution.
Given the best execution obtainable, it will be the Sub-Adviser's practice to
select dealers which, in addition, furnish research information (primarily
credit analyses of issuers and general economic reports) and statistical and
other services to the Sub-Adviser. It is not possible to place a dollar value on
information and statistical and other services received from dealers. Since it
is only supplementary to the Sub-Adviser's own research efforts, the receipt of
research information is not expected to reduce significantly the Sub-Adviser's
expenses. While the Sub-Adviser will be primarily responsible for the placement
of the business of the Fund, the policies and practices of the Sub-Adviser in
this regard must be consistent with the foregoing and will, at all times, be
subject to review by the Board of Trustees of the Fund.
Securities considered as investments for the Fund also may be
appropriate for other investment accounts managed by the Sub-Adviser or its
affiliates. Whenever decisions are made to buy or sell securities by the Fund
and one or more of the other accounts simultaneously, the Sub-Adviser may
aggregate the purchases and sales of the securities and will allocate the
securities transactions in a manner which it believes to be equitable under the
circumstances. As a result of the allocations, there may be instances where the
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Fund will not participate in a transaction that is allocated among other
accounts. 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 Sub-Adviser organization outweigh any disadvantage that may
arise from exposure to simultaneous transactions.
NET ASSET VALUE
The NAV of the Common Shares of the Fund will be computed based upon the
value of the Fund's portfolio securities and other assets. The NAV will be
determined as of the close of regular trading on the New York Stock Exchange
(normally 4:00 p.m. eastern time) on each day the New York Stock Exchange is
open for trading. Domestic debt securities and foreign securities will normally
be priced using data reflecting the earlier closing of the principal markets for
those securities. The Fund calculates NAV per Common Share by subtracting the
Fund's liabilities (including accrued expenses, dividends payable and any
borrowings of the Fund) and the liquidation value of any outstanding preferred
shares from the Fund's Managed Assets (the value of the securities and other
investments the Fund holds plus cash or other assets, including interest accrued
but not yet received) and dividing the result by the total number of Common
Shares outstanding.
The assets in the Fund's portfolio will be valued daily in accordance
with Valuation Procedures adopted by the Board of Trustees. The Sub-Adviser
anticipates that a majority of the Fund's assets will be valued using market
information supplied by third parties. In the event that market quotations are
not readily available, the pricing service does not provide a valuation for a
particular asset, or the valuations are deemed unreliable, or if events
occurring after the close of the principal markets for particular securities
(e.g., domestic debt and foreign securities), but before the Fund values its
assets, would call into doubt whether the earlier market quotation represents
fair value, the Fund may use a fair value method in good faith to value the
Fund's securities and investments. The use of fair value pricing by the Fund
will be governed by Valuation Procedures established by the Board of Trustees,
and in accordance with the provisions of the 1940 Act.
For purposes of determining the NAV of the Fund, readily marketable
portfolio securities listed on any exchange other than the NASDAQ National
Market are valued, except as indicated below, at the last sale price on the
business day as of which such value is being determined. If there has been no
sale on such day, the securities are valued at the mean of the most recent bid
and asked prices on such day. Securities admitted to trade on the NASDAQ
National Market are valued at the NASDAQ Official Closing Price as determined by
NASDAQ. Portfolio securities traded on more than one securities exchange are
valued at the last sale price on the business day as of which such value is
being determined at the close of the exchange representing the principal market
for such securities.
U.S. Equity securities traded in the over-the-counter market, but
excluding securities admitted to trading on the NASDAQ National Market, are
valued at the closing bid prices. Fixed income securities with a remaining
maturity of 60 days or more will be valued by the Fund using a pricing service.
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When price quotes are not available, fair market value is based on prices of
comparable securities. Fixed income securities maturing within 60 days are
valued by the Fund on an amortized cost basis. Non-U.S. securities, currencies
and other assets denominated in non-U.S. currencies are translated into U.S.
dollars at the exchange rate of such currencies against the U.S. dollar as
provided by a pricing service. All assets denominated in non-U.S. currencies
will be converted into U.S. dollars at the exchange rates in effect at the time
of valuation.
Any derivative transaction that the Fund enters into may, depending on
the applicable market environment, have a positive or negative value for
purposes of calculating NAV. Forward foreign currency exchange contracts which
are traded in the United States on regulated exchanges are valued by calculating
the mean between the last bid and asked quotation supplied to a pricing service
by certain independent dealers in such contracts. Any option transaction that
the Fund enters into may, depending on the applicable market environment, have
no value or a positive value. Exchange traded options and futures contracts are
valued at the closing price in the market where such contracts are principally
traded.
Illiquid Securities. The Senior Loans in which the Fund may invest are
not listed on any securities exchange or board of trade. Senior Loans are
typically bought and sold by institutional investors in individually negotiated
private transactions that function in many respects like an over-the-counter
secondary market, although typically no formal market-makers exist. Some senior
loans have few or no trades, or trade infrequently, and information regarding a
specific senior loan may not be widely available or may be incomplete.
Accordingly, determinations of the market value of senior loans and
other illiquid securities may be based on infrequent and dated information.
Because there is less reliable, objective data available, elements of judgment
may play a greater role in valuation of Infrastructure Senior Loans and other
illiquid securities held by the Fund than for other types of assets held by the
Fund. For further information, see "Risks--Illiquid Securities" and
"Risks--Senior Loans" in the Fund's Prospectus.
Typically senior loans and other illiquid securities are valued using
information provided by an independent third party pricing service. If the
pricing service cannot or does not provide a valuation for a particular senior
loan (which is the case for most, if not all, unlisted investments) or such
valuation is deemed unreliable, the Fund may value such senior loan at a fair
value as determined in good faith under procedures established by the Trustees,
and in accordance with the provisions of the 1940 Act.
Foreign Listed Securities. Foreign exchange-listed securities will
generally be valued using information provided by an independent third party
pricing service. If the pricing service cannot or does not provide a valuation
for a particular foreign listed security or such valuation is deemed unreliable,
the Board or its designee may value such security at a fair value as determined
in good faith under procedures established by the Board of Trustees, and in
accordance with the provisions of the 1940 Act.
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Fair Value. When applicable, especially with unlisted securities, fair
value is determined by the Trustees or a committee of the Board or a designee of
the Board. In fair valuing the Fund's investments, consideration is given to
several factors, which may include, among others, the following:
o the fundamental business data relating to the issuer or borrower;
o an evaluation of the forces which influence the market in which
these securities are purchased and sold;
o the type, size and cost of holding;
o the financial statements of the issuer or borrower;
o the credit quality and cash flow of issuer, based on the Adviser's
or external analysis;
o the information as to any transactions in or offers for the holding;
o the price and extent of public trading in similar securities (or
equity securities) of the issuer/borrower, or comparable companies;
o the coupon payments;
o the quality, value and saleability of collateral securing the
security or loan;
o the business prospects of the issuer/borrower, including any ability
to obtain money or resources from a parent or affiliate and an
assessment of the issuer's or borrower's management;
o the prospects for the issuer's or borrower's industry, and multiples
(of earnings and/or cash flow) being paid for similar businesses in
that industry; and
o other relevant factors.
FEDERAL INCOME TAX MATTERS
The following discussion of federal income tax matters is based upon the
advice of Chapman and Cutler LLP, counsel to the Fund.
GENERAL
Set forth below is a discussion of certain U.S. federal income tax
issues concerning the Fund and the purchase, ownership and disposition of Fund
shares. This discussion does not purport to be complete or to deal with all
aspects of federal income taxation that may be relevant to shareholders in light
of their particular circumstances. This discussion also does not address the tax
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consequences to shareholders that are subject to special rules, including
without limitation, banks or financial institutions, insurance companies,
dealers in securities, non-U.S. shareholders, tax-exempt or tax-deferred plans,
accounts or entities, shareholders that are subject to the alternative minimum
tax or shareholders that holds their shares as or in a hedge against currency
risk, constructive sale or a conversion transaction. Unless otherwise noted,
this discussion assumes you are a U.S. shareholder and that you hold your shares
as a capital asset. This discussion is based upon present provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the regulations
promulgated thereunder, and judicial and administrative ruling authorities, all
of which are subject to change, which change may be retroactive. In addition,
this discussion does not address state, local or foreign tax consequences.
Prospective investors should consult their own tax advisors with regard to the
federal tax consequences of the purchase, ownership, or disposition of Fund
shares, as well as the tax consequences arising under the laws of any state,
locality, non-U.S. country, or other taxing jurisdiction.
The Fund intends to qualify annually and to elect to be treated as a
regulated investment company under the Code and to comply with applicable
distribution requirements so that it will not pay federal income tax on income
and capital gains distributed to its shareholders.
To qualify for the favorable U.S. federal income tax treatment generally
accorded to regulated investment companies, the Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies or other income
derived with respect to its business of investing in such stock, securities or
currencies; (b) diversify its holdings so that, at the end of each quarter of
the taxable year, (i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. Government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer generally limited for
the purposes of this calculation to an amount not greater than 5% of the value
of the Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. Government securities or
the securities of other regulated investment companies) of any one issuer, or
two or more issuers which the Fund controls and are engaged in the same, similar
or related trades or businesses; and (c) distribute at least 90% of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of net long-term capital
losses) and at least 90% of its net tax-exempt interest income each taxable
year.
As a regulated investment company, the Fund generally will not be
subject to U.S. federal income tax on its investment company taxable income (as
that term is defined in the Code, but without regard to the deduction for
dividends paid) and net capital gain (the excess of net long-term capital gain
over net short-term capital loss), if any, that it distributes to shareholders.
The Fund intends to distribute to its shareholders, at least annually,
substantially all of its investment company taxable income and net capital gain.
If the Fund retains any net capital gain or investment company taxable income,
it will generally be subject to federal income tax at regular corporate rates on
the amount retained. In addition, amounts not distributed on a timely basis in
accordance with a calendar year distribution requirement are subject to a
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nondeductible 4% excise tax unless, generally, the Fund distributes during each
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
income (not taking into account any capital gains or losses) for the calendar
year, (2) at least 98% of its capital gains in excess of its capital losses
(adjusted for certain ordinary losses) for the one-year period ending October 31
of the calendar year, and (3) any ordinary income and capital gains for previous
years that were not distributed during those years. To prevent application of
the excise tax, the Fund intends to make its distributions in accordance with
the calendar year distribution requirement. A distribution will be treated as
paid on December 31 of the current calendar year if it is declared by the Fund
in October, November or December with a record date in such a month and paid by
the Fund during January of the following calendar year. These distributions will
be taxable to shareholders in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
If the Fund failed to qualify as a regulated investment company or
failed to satisfy the 90% distribution requirement in any taxable year, the Fund
would be taxed as an ordinary corporation on its taxable income (even if such
income were distributed to its shareholders) and all distributions out of
earnings and profits would be taxed to shareholders as ordinary income.
DISTRIBUTIONS
Dividends paid out of the Fund's investment company taxable income
generally are taxable to a shareholder as ordinary income to the extent of the
Fund's earnings and profits, whether paid in cash or reinvested in additional
shares. However, pursuant to the recently enacted "Jobs and Growth Tax Relief
Reconciliation Act of 2003" (the "Tax Act"), if the Fund holds equity
securities, certain ordinary income distributions received from the Fund may be
taxed at new lower tax rates. In particular, under the Tax Act, a portion of the
ordinary income dividends received by an individual shareholder from a regulated
investment company such as the Fund are generally taxed at the same new rates
that apply to net capital gain, provided certain holding period requirements are
satisfied and provided the dividends are attributable to "qualified dividends"
received by the Fund itself (i.e., generally 15% or 5% for taxpayers in the 10%
and 15% tax brackets). Dividends received by the Fund from REITs and foreign
corporations are qualified dividends eligible for this lower tax rate only in
certain circumstances. These special rules relating to the taxation of ordinary
income dividends from regulated investment companies generally apply to taxable
years beginning after December 31, 2002 and beginning before January 1, 2009.
The Fund generally does not expect to generate qualified dividends eligible for
the new lower tax rates.
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly designated as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. Shareholders
receiving distributions in the form of additional shares, rather than cash,
generally will have a cost basis in each such share equal to the value of a
share of the Fund on the reinvestment date. A distribution of an amount in
excess of the Fund's current and accumulated earnings and profits will be
treated by a shareholder as a return of capital which is applied against and
reduces the shareholder's basis in his or her shares. To the extent that the
S-35
amount of any distribution exceeds the shareholder's basis in his or her shares,
the excess will be treated by the shareholder as gain from a sale or exchange of
the shares.
Shareholders will be notified annually as to the U.S. federal tax status
of distributions, and shareholders receiving distributions in the form of
additional shares will receive a report as to the value of those shares.
DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares generally will not be entitled to the
dividends received deduction with respect to dividends received from the Fund
because the dividends received deduction is generally not available for
distributions from regulated investment companies. However, if the Fund holds
equity securities, certain ordinary income dividends on shares that are
attributable to dividends received by the Fund from certain domestic
corporations may be designated by the Fund as being eligible for the dividends
received deduction but this amount is not expected to be significant.
SALE OR EXCHANGE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, a shareholder may realize a capital gain
or loss which will be long-term or short-term, depending upon the shareholder's
holding period for the shares. Generally, a shareholder's gain or loss will be a
long-term gain or loss if the shares have been held for more than one year.
Any loss realized on a sale or exchange will be disallowed to the extent
that shares disposed of are replaced (including through reinvestment of
dividends) within a period of 61 days beginning 30 days before and ending 30
days after disposition of shares or to the extent that the shareholder, during
such period, acquires or enters into an option or contract to acquire,
substantially identical stock or securities. In this case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized by a shareholder on a disposition of Fund shares held by the
shareholder for six months or less will be treated as a long-term capital loss
to the extent of any distributions of net capital gain received by the
shareholder with respect to the shares.
NATURE OF THE FUND'S INVESTMENTS
Certain of the Fund's investment practices may be subject to special and
complex federal income tax provisions that may, among other things, (1)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (2) convert lower taxed long-term capital gain into higher taxed
short-term capital or ordinary income, (3) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (4)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (5) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (6) adversely alter the characterization of
certain complex financial transactions. The Fund will monitor its transactions,
S-36
will make the appropriate tax elections and take appropriate actions in order to
mitigate the effect of these rules and prevent disqualification of the Fund from
being taxed as a regulated investment company (including disposing of certain
investments to generate cash or borrowing cash to satisfy its distribution
requirements).
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Fund with their correct taxpayer identification number or to make
required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. The withholding percentage
is 28% until 2011, when the percentage will revert to 31% unless amended by
Congress. Corporate shareholders and certain other shareholders specified in the
Code generally are exempt from backup withholding. This withholding is not an
additional tax. Any amounts withheld may be credited against the shareholder's
U.S. federal income tax liability.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote yield figures from time to time. The "Yield" of the
Fund is computed by dividing the net investment income per share earned during a
30-day period (using the average number of shares entitled to receive dividends)
by the net asset value per share on the last day of the period. The Yield
formula provides for semiannual compounding which assumes that net investment
income is earned and reinvested at a constant rate and annualized at the end of
a six-month period.
The Yield formula is as follows: YIELD = 2[((a-b/cd) +1)/6/ -1].
Where: a = dividends and interest earned during the period. (For this
purpose, the Fund will recalculate the yield to maturity based on market
value of each portfolio security on each business day on which net asset
value is calculated.)
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends.
d = the ending net asset value per share of the Fund for the period.
The Fund may quote total return figures from time to time. A "Total
Return" on a per share basis is the amount of dividends received per share plus
or minus the change in the net asset value per share for a period. A "Total
Return Percentage" may be calculated by dividing the value of a share at the end
of a period (including reinvestment of distributions) by the value of the share
at the beginning of the period and subtracting one. For a given period, an
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"Average Annual Total Return" may be computed by finding the average annual
compounded rate that would equate a hypothetical initial amount invested of
$1,000 to the ending redeemable value.
Average Annual Total Return is computed as follows: ERV = P(1+T)/n/
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at
the beginning of the period at the end of the period (or fractional
portion thereof).
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other substantially
similar closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar,
Inc. or other independent services. Comparison of the Fund to an alternative
investment should be made with consideration of differences in features and
historical asset class performance. The Fund may obtain data from sources or
reporting services, such as Bloomberg Financial ("Bloomberg") and Lipper, that
the Fund believes to be generally accurate.
Past performance is not indicative of future results.
At the time Common Shareholders sell their shares, they may be worth
more or less than their original investment.
The Sub-Adviser believes that the Fund has the potential to provide
Common Shareholders diversification within their portfolios by using an
investment which has relatively low historical correlations with equity and
longer-term fixed-income investments. Senior Loans are relatively illiquid
investments compared to equity securities. Please refer to "Net Asset Value."
EXPERTS
The Statement of Net Assets of the Fund as of May 18, 2004, appearing in
this Statement of Additional Information has been audited by Deloitte & Touche
LLP, independent auditors, as set forth in their report thereon appearing
elsewhere herein, and is included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing. Deloitte & Touche
LLP provides accounting and auditing services to the Fund. The principal
business address of Deloitte & Touche LLP is 180 North Stetson Avenue, Chicago,
Illinois 60601.
S-38
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the Commission. The Fund's Prospectus and this Statement of Additional
Information do not contain all of the information set forth in the Registration
Statement, including any exhibits and schedules thereto. For further information
with respect to the Fund and the shares offered hereby, reference is made to the
Fund's Registration Statement. Statements contained in the Fund's Prospectus and
this Statement of Additional Information as to the contents of any contract or
other document referred to are not necessarily complete and in each instance
reference is made to the copy of the contract or other document filed as an
exhibit to the Registration Statement, each statement being qualified in all
respects by such reference. Copies of the Registration Statement may be
inspected without charge at the Commission's principal office in Washington, DC,
and copies of all or any part thereof may be obtained from the Commission upon
the payment of certain fees prescribed by the Commission.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholder of
First Trust/Four Corners Senior Floating Rate Income Fund II
We have audited the accompanying statement of net assets of First
Trust/Four Corners Senior Floating Rate Income Fund II (the "Fund"), as of May
18, 2004. This statement of assets and liabilities is the responsibility of the
Fund's management. Our responsibility is to express an opinion on this statement
of assets and liabilities based on our audit.
We conducted our audit in accordance with standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
statement of assets and liabilities is free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statement. Our procedures included confirmation of
cash owned as of May 18, 2004, by correspondence with the Fund's custodian. 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 statement of assets and liabilities referred to
above presents fairly, in all material respects, the financial position of First
Trust/Four Corners Senior Floating Rate Income Fund II as of May 18, 2004, in
conformity with accounting principles generally accepted in the United States of
America.
DELOITTE & TOUCHE LLP
Chicago, Illinois
May 24, 2004
F-1
FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND II
STATEMENT OF ASSETS AND LIABILITIES
MAY 18, 2004
ASSETS:
Cash $ 100,008
Offering costs $1,000,000
----------
$1,100,008
LIABILITIES:
Offering costs payable $1,000,000
----------
Net Assets $ 100,008
==========
NET ASSETS - Applicable to 5,236 shares $ 100,008
==========
NET ASSET VALUE PER SHARE (net assets divided by
5,236 shares.) $19.100
=======
MAXIMUM OFFERING PRICE PER SHARE (net asset
value plus sales charge of 4.5% of offering price.) $20.000
=======
NOTES TO STATEMENT OF ASSETS AND LIABILITIES:
Note 1. Organization
First Trust/Four Corners Senior Floating Rate Income Fund II (the "Fund") is a
newly organized, diversified, closed-end management investment company
registered under the Investment Company Act of 1940, as amended (the "1940
Act"). The Fund was organized as a Massachusetts business trust on March 25,
2004, pursuant to a Declaration of Trust governed by the laws of the
Commonwealth of Massachusetts. As a newly organized entity, the Fund has no
operating history. The Fund has had no operations through May 18, 2004 other
than those relating to organizational matters and the sale and issuance of 5,236
common shares of beneficial interest to First Trust Portfolios, L.P. (the
"Adviser").
Note 2. Significant Accounting Policies
The Adviser has assumed organization costs estimated to be $45,000. The Adviser
has also agreed to assume any offering costs in excess of $.04 a share, if any.
The Fund's statement of assets and liabilities is prepared in conformity with
accounting principles generally accepted in the United States of America, which
may require management to make estimates and assumptions that affect the
F-2
reported amounts and disclosures in the statement of assets and liabilities.
Actual results could differ from those estimates.
The Fund intends to comply in its initial fiscal year and thereafter with
provisions of the Internal Revenue Code applicable to regulated investment
companies and as such, will not be subject to federal income taxes on otherwise
taxable income (including net realized capital gains) distributed to
shareholders.
Offering costs will be charged to paid-in-capital in proportion to the number of
shares sold during the offering period.
Note 3. Fees and Other Transactions with Affiliated Parties
On April 18, 2004, the Fund's Board of Trustees approved an Investment
Management Agreement (the "Agreement") with the Adviser. The Fund has agreed to
pay a fee for the services and facilities provided by the Adviser at the annual
rate of .75% of Managed Assets as defined in the Agreement.
F-3
APPENDIX A
RATINGS OF INVESTMENTS
Standard & Poor's Corporation -- A brief description of the applicable
Standard & Poor's Corporation, a division of The McGraw-Hill Companies
("Standard & Poor's" or "S&P") rating symbols and their meanings (as published
by S&P) follows:
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program. It
takes into consideration the creditworthiness of guarantors, insurers, or other
forms of credit enhancement on the obligation. The issue credit rating is not a
recommendation to purchase, sell, or hold a financial obligation, inasmuch as it
does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days-including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based in varying degrees, on the following
considerations:
o Likelihood of payment--capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance
with the terms of the obligation;
o Nature of and provisions of the obligation; and
o Protection afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization, or other arrangement
under the laws of bankruptcy and other laws affecting creditors'
rights.
A-1
The issue ratings definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above.
AAA
An obligation rated `AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA
An obligation rated `AA' differs from the highest-rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A
An obligation rated `A' is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB
An obligation rated `BBB' exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
BB, B, CCC, CC, and C
Obligations rated `BB', `B', `CCC', `CC', and `C' are regarded as having
significant speculative characteristics. `BB' indicates the least degree of
speculation and `C' the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB
An obligation rated `BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions, which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B
An obligation rated `B' is more vulnerable to nonpayment than
obligations rated `BB', but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
A-2
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC
An obligation rated `CCC' is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC
An obligation rated `CC' is currently highly vulnerable to nonpayment.
C
The `C' rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued.
D
An obligation rated `D' is in payment default. The `D' rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's 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.
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.
C
The `c' subscript is used to provide additional information to investors
that the bank may terminate its obligation to purchase tendered bonds if the
long-term credit rating of the issuer is below an investment-grade level and/or
the issuer's bonds are deemed taxable.
P
The letter `p' indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project financed by the debt
being rated and indicates that payment of debt service requirements is largely
or entirely dependent upon the successful, timely completion of the project.
This rating, however, while addressing credit quality subsequent to completion
A-3
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.
*
Continuance of the ratings is contingent upon Standard & Poor's receipt
of an executed copy of the escrow agreement or closing documentation confirming
investments and cash flows.
R
The `r' highlights derivative, hybrid, and certain other obligations
that Standard & Poor's believes may experience high volatility or high
variability in expected returns as a result of noncredit risks. Examples of such
obligations are securities with principal or interest return indexed to
equities, commodities, or currencies; certain swaps and options; and
interest-only and principal-only mortgage securities. The absence of an `r'
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
N.R.
Not rated.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
BOND INVESTMENT QUALITY STANDARDS
Under present commercial bank regulations issued by the Comptroller of
the Currency, bonds rated in the top four categories (`AAA', `AA', `A', `BBB',
commonly known as investment-grade ratings) generally are regarded as eligible
for bank investment. Also, the laws of various states governing legal
investments impose certain rating or other standards for obligations eligible
for investment by savings banks, trust companies, insurance companies, and
fiduciaries in general.
SHORT-TERM ISSUE CREDIT RATINGS
Notes. A Standard & Poor's note ratings reflects the liquidity factors
and market access risks unique to notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment:
o Amortization schedule -- the larger the final maturity relative
to other maturities, the more likely it will be treated as a
note; and
A-4
o Source of payment -- the more dependent the issue is on the
market for its refinancing, the more likely it will be treated
as a note.
Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2
Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3
Speculative capacity to pay principal and interest.
Commercial Paper
An S&P commercial paper rating is a current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from `A-1' 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
Standard & Poor's. 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.
A-5
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 Standard & Poor's
believes that such payments will be made during such grace period. The `D'
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
Moody's Investors Service, Inc. -- A brief description of the applicable
Moody's Investors Service, Inc. ("Moody's") rating symbols and their meanings
(as published by Moody's) follows:
LONG-TERM OBLIGATION RATINGS
Moody's long-term obligation ratings are opinions of the relative credit
risk of fixed-income obligations with an original maturity of one year or more.
They address the possibility that a financial obligation will not be honored as
promised. Such ratings reflect both the likelihood of default and any financial
loss suffered in the event of default.
Aaa
Obligations rated Aaa are judged to be of the highest quality, with
minimal credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to
very low credit risk.
A
Obligations rated A are considered upper-medium grade and are subject to
low credit risk.
A-6
Baa
Obligations rated Baa are subject to moderate credit risk. They are
considered medium-grade and as such may possess certain speculative
characteristics.
Ba
Obligations rated Ba are judged to have speculative elements and are
subject to substantial credit risk.
B
Obligations rated B are considered speculative and are subject to high
credit risk.
Caa
Obligations rated Caa are judged to be of poor standing and are subject
to very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C
Obligations rated C are the lowest rated class of bonds and are
typically in default, with little prospect for recovery of principal or
interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic rating
category from Aa through Caa. The modifier 1 indicates that the issuer or
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
SHORT-TERM RATINGS
Moody's short-term ratings are opinions of the ability of issuers to
honor short-term financial obligations. Ratings may be assigned to issuers,
short-term programs or to individual short-term debt instruments. Such
obligations generally have an original maturity not exceeding thirteen months,
unless explicitly noted.
Moody's employs the following designations to indicate the relative
repayment ability of rated issuers:
A-7
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior
ability to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability
to repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP
Issuers (or supporting institutions) rated Not Prime do not fall within
any of the Prime rating categories.
Note: Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced
by the senior-most long-term rating of the issuer, its guarantor or
support-provider.
DEMAND OBLIGATION RATINGS
In the case of variable rate demand obligations (VRDOs), a two-component
rating is assigned; a long or short-term debt rating and a demand obligation
rating. The first element represents Moody's evaluation of the degree of risk
associated with scheduled principal and interest payments. The second element
represents Moody's evaluation of the degree of risk associated with the ability
to receive purchase price upon demand ("demand feature"), using a variation of
the MIG rating scale, the Variable Municipal Investment Grade or VMIG rating.
When either the long- or short-term aspect of a VRDO is not rated, that piece is
designated NR, e.g., Aaa/NR or NR/VMIG 1. VMIG rating expirations are a function
of each issue's specific structural or credit features.
VMIG 1
This designation denotes superior credit quality. Excellent protection
is afforded by the superior short-term credit strength of the liquidity provider
and structural and legal protections that ensure the timely payment of purchase
price upon demand.
VMIG 2
This designation denotes strong credit quality. Good protection is
afforded by the strong short-term credit strength of the liquidity provider and
structural and legal protections that ensure the timely payment of purchase
price upon demand.
A-8
VMIG 3
This designation denotes acceptable credit quality. Adequate protection
is afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
SG
This designation denotes speculative-grade credit quality. Demand
features rated in this category may supported by a liquidity provider that does
not have an investment grade short-term rating or may lack the structural and/or
legal protections necessary to ensure the timely payment of purchase price upon
demand.
Fitch Ratings -- A brief description of the applicable Fitch Ratings
("Fitch") ratings symbols and meanings (as published by Fitch) follows:
LONG-TERM CREDIT RATINGS
International Long-term Credit Ratings are more commonly referred to as
simply "Long-term Ratings". The following scale applies to foreign currency and
local currency ratings.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
AAA
Highest credit quality. 'AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. 'AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. 'A' ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
A-9
BBB
Good credit quality. 'BBB' ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
BB
Speculative. 'BB' ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change over
time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B
Highly speculative. 'B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon sustained, favorable business or
economic developments. A 'CC' rating indicates that default of some kind appears
probable. 'C' ratings signal imminent default.
DDD, DD, D
Default. The ratings of obligations in this category are based on their
prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. 'DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. 'DD' indicates
potential recoveries in the range of 50%-90% and 'D' the lowest recovery
potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated 'DDD' have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated 'DD' and 'D' are generally undergoing a formal
reorganization or liquidation process; those rated 'DD' are likely to satisfy a
higher portion of their outstanding obligations, while entities rated 'D' have a
poor prospect of repaying all obligations.
A-10
SHORT-TERM CREDIT RATINGS
International Short-term Credit Ratings are more commonly referred to as
simply "Short-term Ratings". The following scale applies to foreign currency and
local currency ratings.
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
F1
Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2
Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
F3
Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B
Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business and
economic environment.
D
Default. Denotes actual or imminent payment default.
A-11
Notes to Long-term and Short-term ratings:
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the `AAA' Long-term
rating category, to categories below `CCC', or to Short-term ratings other than
`F1'.
`NR' indicates that Fitch Ratings does not rate the issuer or issue in
question.
`Withdrawn': A rating is withdrawn when Fitch Ratings deems the amount
of information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive," indicating a
potential upgrade, "Negative," for a potential downgrade, or "Evolving," if
ratings may be raised, lowered or maintained. Rating Watch is typically resolved
over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to move over
a one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, ratings for which outlooks are `stable' could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch Ratings may be unable to identify
the fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
A-12
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Registrant has not conducted any business as of the date of this filing, other
than in connection with its organization. Financial Statements indicating that
the Registrant has met the net worth requirements of Section 14(a) of the 1940
Act are included in this Pre-effective Amendment to the Registration Statement.
2. Exhibits:
a. Declaration of Trust of Registrant dated March 25, 2004. Filed on
April 29, 2004 as Exhibit a. to Registrant's Registration Statement on
Form N-2 (File No. 333-113978) and incorporated herein by reference.
b. By-Laws of Registrant. Filed on April 29, 2004 as Exhibit b. to
Registrant's Registration Statement on Form N-2 (File No. 333-113978)
and incorporated herein by reference.
c. None.
d. Form of Share Certificate.*
e. Terms and Conditions of the Dividend Reinvestment Plan.*
f. None.
g.1 Form of Investment Management Agreement between Registrant and First
Trust Advisors L.P.*
g.2 Form of Sub-Advisory Agreement between Registrant, First Trust Advisors
L.P. and Four Corners Capital Management, LLC.*
h.1 Form of Purchase Agreement.*
i. None.
j. Form of Custodian Services Agreement between Registrant and PFPC Trust
Company.*
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.*
k.2 Form of Administration and Accounting Services Agreement between
Registrant and PFPC Inc.*
k.3 Form of Additional Compensation Agreement between First Trust Advisors
L.P. and Merrill Lynch.*
k.4 Form of Incentive Fee Agreement between Four Corners Capital Management,
LLC and Raymond James.*
l.1 Opinion and consent of Chapman and Cutler LLP.*
l.2 Opinion and consent of Bingham McCutchen LLP.*
m. None.
n. Independent Auditors' Consent.*
o. None.
p. Subscription Agreement between Registrant and First Trust Portfolios L.P.*
q. None.
r.1 Code of Ethics of Registrant.*
r.2 Code of Ethics of First Trust Portfolios L.P.*
r.3 Code of Ethics of First Trust Advisors L.P.*
r.4 Code of Ethics of Four Corners Capital Management, LLC.*
s. Powers of attorney for Messrs. Bowen, Erickson, Kadlec, Nielson and
Oster. Filed on April 29, 2004 as Exhibit s. to Registrant's
Registration Statement on Form N-2 (File No. 333-113978) and incorporated
herein by reference.
-------------------------
* Filed herewith.
Item 25: Marketing Arrangements
Reference is made to the Form of Purchase Agreement among the Registrant, First
Trust Advisors L.P., Four Corners Capital Management, LLC and the Underwriters
for the Registrant's common shares of beneficial interest as filed herewith as
exhibit h.1.
Item 26: Other Expenses of Issuance and Distribution
----------------------------------------------------- ---------------------
Securities and Exchange Commission Fees $63,350
----------------------------------------------------- ---------------------
National Association of Securities Dealers, Inc. Fees $55,500
----------------------------------------------------- ---------------------
Printing and Engraving Expenses $203,528
----------------------------------------------------- ---------------------
Legal Fees $350,000
----------------------------------------------------- ---------------------
Listing Fees $40,000
----------------------------------------------------- ---------------------
Accounting Expenses $10,500
----------------------------------------------------- ---------------------
Blue Sky Filing Fees and Expenses $0
----------------------------------------------------- ---------------------
Miscellaneous Expenses $202,250*
----------------------------------------------------- ---------------------
Total $925,128
----------------------------------------------------- ---------------------
-------------------------
* The Adviser and a Sub-Adviser have agreed to pay (i) all organizational
expenses and (ii) offering costs (other than sales load) that exceed $.04 per
Common Share.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At May 19, 2004:
----------------------------------- ---------------------------------
Title of Class Number of Record Holders
----------------------------------- ---------------------------------
Common Shares, $0.01 par value 1
----------------------------------- ---------------------------------
Item 29: Indemnification
Section 5.3 of the Registrant's Declaration of Trust provides as
follows:
Page 2
(a) Subject to the exceptions and limitations contained in paragraph (b)
below:
(i) every person who is or has been a Trustee or officer of the
Trust (hereinafter referred to as a "Covered Person") shall be
indemnified by the Trust against all liability and against all expenses
reasonably incurred or paid by him or her in connection with any claim,
action, suit or proceeding in which that individual becomes involved as
a party or otherwise by virtue of being or having been a Trustee or
officer and against amounts paid or incurred by that individual in the
settlement thereof; and
(ii) the words "claim," "action," "suit" or "proceeding" shall
apply to all claims, actions, suits or proceedings (civil, criminal,
administrative or other, including appeals), actual or threatened; and
the words "liability" and "expenses" shall include, without limitation,
attorneys' fees, costs, judgments, amounts paid in settlement or
compromise, fines, penalties and other liabilities.
(b) No indemnification shall be provided hereunder to a Covered Person:
(i) against any liability to the Trust or the Shareholders by
reason of a final adjudication by the court or other body before which
the proceeding was brought that the Covered Person engaged in willful
misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of that individual's office;
(ii) with respect to any matter as to which the Covered Person
shall have been finally adjudicated not to have acted in good faith in
the reasonable belief that that individual's action was in the best
interest of the Trust; or
(iii) in the event of a settlement involving a payment by a
Trustee, Trustee Emeritus or officer or other disposition not involving
a final adjudication as provided in paragraph (b)(i) or (b)(ii) above
resulting in a payment by a Covered Person, unless there has been either
a determination that such Covered Person did not engage in willful
misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of that individual's office by the court
or other body approving the settlement or other disposition or by a
reasonable determination, based upon a review of readily available facts
(as opposed to a full trial-type inquiry) that that individual did not
engage in such conduct:
(A) by vote of a majority of the Disinterested Trustees
(as defined below) acting on the matter (provided that a majority of the
Disinterested Trustees then in office act on the matter); or
(B) by written opinion of (i) the then-current legal
counsel to the Trustees who are not Interested Persons of the Trust or
(ii) other legal counsel chosen by a majority of the Disinterested
Trustees (or if there are no Disinterested Trustees with respect to the
matter in question, by a majority of the Trustees who are not Interested
Persons of the Trust) and determined by them in their reasonable
judgment to be independent.
Page 3
(c) The rights of indemnification herein provided may be insured against
by policies maintained by the Trust, shall be severable, shall not
affect any other rights to which any Covered Person may now or hereafter
be entitled, shall continue as to a person who has ceased to be a
Covered Person and shall inure to the benefit of the heirs, executors
and administrators of such person. Nothing contained herein shall limit
the Trust from entering into other insurance arrangements or affect any
rights to indemnification to which Trust personnel, including Covered
Persons, may be entitled by contract or otherwise under law.
(d) Expenses of preparation and presentation of a defense to any claim,
action, suit, or proceeding of the character described in paragraph (a)
of this Section 5.3 shall be advanced by the Trust prior to final
disposition thereof upon receipt of an undertaking by or on behalf of
the Covered Person to repay such amount if it is ultimately determined
that the Covered Person is not entitled to indemnification under this
Section 5.3, provided that either:
(i) such undertaking is secured by a surety bond or some other
appropriate security or the Trust shall be insured against losses
arising out of any such advances; or
(ii) a majority of the Disinterested Trustees acting on the matter
(provided that a majority of the Disinterested Trustees then in office
act on the matter) or legal counsel meeting the requirement in Section
5.3(b)(iii)(B) above in a written opinion, shall determine, based upon a
review of readily available facts (as opposed to a full trial-type
inquiry), that there is reason to believe that the Covered Person
ultimately will be found entitled to indemnification.
As used in this Section 5.3, a "Disinterested Trustee" is one (i) who is
not an "Interested Person" of the Trust (including anyone who has been
exempted from being an "Interested Person" by any rule, regulation or
order of the Commission), and (ii) against whom none of such actions,
suits or other proceedings or another action, suit or other proceeding
on the same or similar grounds is then or had been pending.
(e) With respect to any such determination or opinion referred to in
clause (b)(iii) above or clause (d)(ii) above, a rebuttable presumption
shall be afforded that the Covered Person has not engaged in willful
misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of such Covered Person's office in
accordance with pronouncements of the Commission.
Page 4
Sections 6 and 7 of the Purchase Agreement provide as follows:
SECTION 6. Indemnification.
(a) Indemnification of Underwriters. The Fund and the Investment
Advisers, jointly and severally, agree to indemnify and hold harmless each
Underwriter and each person, if any, who controls any Underwriter within the
meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act, as follows:
(i) against any and all loss, liability, claim, damage and
expense whatsoever, as incurred, arising out of any untrue statement or
alleged untrue statement of a material fact contained in the
Registration Statement (or any amendment thereto), including the Rule
430A Information and the Rule 434 Information, if applicable, or the
omission or alleged omission therefrom of a material fact required to be
stated therein or necessary to make the statements therein not
misleading or arising out of any untrue statement or alleged untrue
statement of a material fact included in any preliminary prospectus or
the Prospectus (or any amendment or supplement thereto), or the omission
or alleged omission therefrom of a material fact necessary in order to
make the statements therein, in the light of the circumstances under
which they were made, not misleading;
(ii) against any and all loss, liability, claim, damage and
expense whatsoever, as incurred, to the extent of the aggregate amount
paid in settlement of any litigation, or any investigation or proceeding
by any governmental agency or body, commenced or threatened, or of any
claim whatsoever based upon any such untrue statement or omission, or
any such alleged untrue statement or omission; provided that (subject to
Section 6(e) below) any such settlement is effected with the written
consent of the Fund; and
(iii) against any and all expense whatsoever, as incurred
(including the fees and disbursements of counsel chosen by Merrill
Lynch), reasonably incurred in investigating, preparing or defending
against any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim
whatsoever based upon any such untrue statement or omission, or any such
alleged untrue statement or omission, to the extent that any such
expense is not paid under (i) or (ii) above;
provided, however, that this indemnity agreement shall not apply to any loss,
liability, claim, damage or expense to the extent arising out of any untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity with written information furnished to the Fund or an
Investment Adviser by any Underwriter through Merrill Lynch expressly for use in
the Registration Statement (or any amendment thereto), including the Rule 430A
Information and the Rule 434 Information, if applicable, or any preliminary
prospectus or the Prospectus (or any amendment or supplement thereto); provided,
further, that the indemnity agreement contained in this Section 6(a) shall not
inure to the benefit of any Underwriter (or to the benefit of any person
controlling such Underwriter) from whom the person asserting any such loss,
liability, claim, damage and expense purchased the Securities which are the
subject thereof if the Prospectus corrected any such alleged untrue statement or
omission and if such Prospectus was delivered to such Underwriter in a timely
manner and if such Underwriter failed to send or give a copy of the Prospectus
to such person at or prior to the written confirmation of the sale of such
Securities to such person.
Page 5
(b) Indemnification of the Fund, Investment Advisers, Trustees, Directors
and Officers. Each Underwriter severally agrees to indemnify and hold harmless
the Fund and the Investment Advisers, their respective trustees and directors,
each of the Fund's officers who signed the Registration Statement, and each
person, if any, who controls the Fund or an Investment Adviser within the
meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act, against any
and all loss, liability, claim, damage and expense described in the indemnity
contained in subsection (a) of this Section, as incurred, but only with respect
to untrue statements or omissions, or alleged untrue statements or omissions,
made in the Registration Statement (or any amendment thereto), including the
Rule 430A Information and the Rule 434 Information, if applicable, or any
preliminary prospectus or the Prospectus (or any amendment or supplement
thereto) in reliance upon and in conformity with written information furnished
to the Fund or the Investment Advisers by such Underwriter through Merrill Lynch
expressly for use in the Registration Statement (or any amendment thereto) or
such preliminary prospectus or the Prospectus (or any amendment or supplement
thereto).
(c) Indemnification for Marketing Materials. In addition to the foregoing
indemnification, the Fund and the Investment Advisers also, jointly and
severally, agree to indemnify and hold harmless each Underwriter and each
person, if any, who controls any Underwriter within the meaning of Section 15 of
the 1933 Act or Section 20 of the 1934 Act, against any and all loss, liability,
claim, damage and expense described in the indemnity contained in Section 6(a),
as limited by the proviso set forth therein, with respect to any sales material.
(d) Actions against Parties; Notification. Each indemnified party shall
give notice as promptly as reasonably practicable to each indemnifying party of
any action commenced against it in respect of which indemnity may be sought
hereunder, but failure to so notify an indemnifying party shall not relieve such
indemnifying party from any liability hereunder to the extent it is not
materially prejudiced as a result thereof and in any event shall not relieve it
from any liability which it may have otherwise than on account of this indemnity
agreement. In the case of parties indemnified pursuant to Section 6(a) above,
counsel to the indemnified parties shall be selected by Merrill Lynch, and, in
the case of parties indemnified pursuant to Section 6(b) above, counsel to the
indemnified parties shall be selected by the Fund or an Investment Adviser, as
applicable. In each case such counsel shall be reasonably satisfactory to the
indemnified party, and the indemnifying party shall have the right to assume the
defense of such action. An indemnified party may participate at its own expense
in the defense of any such action; provided, however, that counsel to the
indemnifying party shall not (except with the consent of the indemnified party)
also be counsel to the indemnified party. In no event shall the indemnifying
party be liable for fees and expenses of more than one counsel (in addition to
any local counsel) separate from its own counsel for all indemnified parties in
connection with any one action or separate but similar or related actions in the
same jurisdiction arising out of the same general allegations or circumstances.
No indemnifying party shall, without the prior written consent of the
indemnified parties, settle or compromise or consent to the entry of any
Page 6
judgment with respect to any litigation, or any investigation or proceeding by
any governmental agency or body, commenced or threatened, or any claim
whatsoever in respect of which indemnification or contribution could be sought
under this Section 6 or Section 7 hereof (whether or not the indemnified parties
are actual or potential parties thereto), unless such settlement, compromise or
consent (i) includes an unconditional release of each indemnified party from all
liability arising out of such litigation, investigation, proceeding or claim and
(ii) does not include a statement as to or an admission of fault, culpability or
a failure to act by or on behalf of any indemnified party.
(e) Settlement without Consent if Failure to Reimburse. If at any time an
indemnified party shall have requested an indemnifying party to reimburse the
indemnified party for reasonable fees and expenses of counsel, such indemnifying
party agrees that it shall be liable for any settlement of the nature
contemplated by Section 6(a)(ii) effected without its written consent if (i)
such settlement is entered into more than 60 days after receipt by such
indemnifying party of the aforesaid request, (ii) such indemnifying party shall
have received notice of the terms of such settlement at least 30 days prior to
such settlement being entered into and (iii) such indemnifying party shall not
have reimbursed such indemnified party in accordance with such request prior to
the date of such settlement.
SECTION 7. Contribution.
If the indemnification provided for in Section 6 hereof is for any reason
unavailable to or insufficient to hold harmless an indemnified party in respect
of any losses, liabilities, claims, damages or expenses referred to therein,
then each indemnifying party shall contribute to the aggregate amount of such
losses, liabilities, claims, damages and expenses incurred by such indemnified
party, as incurred, (i) in such proportion as is appropriate to reflect the
relative benefits received by the Fund or the Investment Advisers on the one
hand and the Underwriters on the other hand from the offering of the Securities
pursuant to this Agreement or (ii) if the allocation provided by clause (i) is
not permitted by applicable law, in such proportion as is appropriate to reflect
not only the relative benefits referred to in clause (i) above but also the
relative fault of the Fund and the Investment Advisers on the one hand and of
the Underwriters on the other hand in connection with the statements or
omissions which resulted in such losses, liabilities, claims, damages or
expenses, as well as any other relevant equitable considerations.
The relative benefits received by the Fund and the Investment Advisers on the
one hand and the Underwriters on the other hand in connection with the offering
of the Securities pursuant to this Agreement shall be deemed to be in the same
respective proportions as the total net proceeds from the offering of the
Securities pursuant to this Agreement (before deducting expenses) received by
the Fund and the total underwriting discount received by the Underwriters
(whether from the Fund or otherwise), in each case as set forth on the cover of
the Prospectus, or, if Rule 434 is used, the corresponding location on the Term
Sheet, bear to the aggregate initial public offering price of the Securities as
set forth on such cover.
The relative fault of the Fund and the Investment Advisers on the one hand and
the Underwriters on the other hand shall be determined by reference to, among
other things, whether any such untrue or alleged untrue statement of a material
fact or omission or alleged omission to state a material fact relates to
Page 7
information supplied by the Fund or the Investment Advisers or by the
Underwriters and the parties' relative intent, knowledge, access to information
and opportunity to correct or prevent such statement or omission.
The Fund, the Investment Advisers and the Underwriters agree that it would not
be just and equitable if contribution pursuant to this Section 7 were determined
by pro rata allocation (even if the Underwriters were treated as one entity for
such purpose) or by any other method of allocation which does not take account
of the equitable considerations referred to above in this Section 7. The
aggregate amount of losses, liabilities, claims, damages and expenses incurred
by an indemnified party and referred to above in this Section 7 shall be deemed
to include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or defending against any litigation, or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, or any claim whatsoever based upon any such untrue or alleged untrue
statement or omission or alleged omission.
Notwithstanding the provisions of this Section 7, no Underwriter shall be
required to contribute any amount in excess of the amount by which the total
price at which the Securities underwritten by it and distributed to the public
were offered to the public exceeds the amount of any damages which such
Underwriter has otherwise been required to pay by reason of any such untrue or
alleged untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the 1933 Act) shall be entitled to contribution from any person who was
not guilty of such fraudulent misrepresentation.
For purposes of this Section 7, each person, if any, who controls an Underwriter
within the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act
shall have the same rights to contribution as such Underwriter, and each trustee
of the Fund and each director of an Investment Adviser, respectively, each
officer of the Fund who signed the Registration Statement, and each person, if
any, who controls the Fund or any Investment Adviser, within the meaning of
Section 15 of the 1933 Act or Section 20 of the 1934 Act, shall have the same
rights to contribution as the Fund and such Investment Adviser, respectively.
The Underwriters' respective obligations to contribute pursuant to this Section
7 are several in proportion to the number of Initial Securities set forth
opposite their respective names in Schedule A hereto and not joint.
Reference is made to the forms of Additional Compensation Agreements and
attached Indemnification Agreements filed herewith as exhibits k.3 and k.4.
Insofar as indemnification for liability arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, 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
of 1933 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
Page 8
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 of 1933 and will be governed by the final adjudication of such issue.
Item 30: Business and Other Connections of Investment Advisers
First Trust Advisors L.P. ("First Trust Advisors") serves as investment adviser
to the funds and also serves as adviser or sub-adviser to 38 mutual funds and is
the portfolio supervisor of certain unit investment trusts. Its principal
address is 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532.
The principal business of certain of First Trust Advisors' principal executive
officers involves various activities in connection with the family of unit
investment trusts sponsored by First Trust Portfolios L.P. ("First Trust
Portfolios"). The principal address of First Trust Portfolios is 1001
Warrenville Road, Suite 300, Lisle, Illinois 60532.
OTHER BUSINESS, PROFESSION, VOCATION OR EMPLOYMENT DURING PAST TWO YEARS
NAME AND POSITION WITH
FIRST TRUST ADVISORS L.P. EMPLOYMENT DURING PAST TWO YEARS
James A. Bowen, Managing Director/President Managing Director/President, First Trust
Portfolios
Ronald Dean McAlister, Managing Director Managing Director, First Trust Portfolios
Mark R. Bradley, Chief Financial Officer and Chief Financial Officer and Managing
Managing Director Director, First Trust Portfolios and
Chief Financial Officer, Bondwave LLC
Robert W. Bredemeier, Chief Operating Officer and Chief Operations Officer and Managing
Managing Director Director, First Trust Portfolios
Robert Franklin Carey, Chief Investment Officer and Senior Vice President, First Trust
Senior Vice President Portfolios
William Scott Jardine, General Counsel General Counsel, First Trust Portfolios
and Secretary of Bondwave LLC
Scott Hall, Managing Director Managing Director, First Trust Portfolios
Andy Roggensack, Managing Director Managing Director, First Trust Portfolios
Page 9
Jason Henry, Senior Vice President Senior Vice President, First Trust
Portfolios
David McGarel, Senior Vice President Senior Vice President, First Trust
Portfolios
Bob Porcellino, Senior Vice President Senior Vice President, First Trust
Portfolios
Mark Sullivan, Senior Vice President Senior Vice President, First Trust
Portfolios
Al Davis, Vice President Vice President, First Trust Portfolios
Jon Carl Erickson, Vice President Vice President, First Trust Portfolios
Bob James, Vice President Vice President, First Trust Portfolios
Mitch Mohr, Vice President Vice President, First Trust Portfolios
David Pinsen, Vice President Vice President, First Trust Portfolios
Jonathan Steiner, Vice President Vice President, First Trust Portfolios
Rick Swiatek, Vice President Vice President, First Trust Portfolios
Roger Testin, Vice President Vice President, First Trust Portfolios
Kitty Collins, Assistant Vice President Assistant Vice President, First Trust
Portfolios
Charles Bradley, Assistant Vice President Assistant Vice President, First Trust
Portfolios
b) Sub-Adviser. Four Corners Capital Management, LLC ("Four Corners")
serves as investment sub-adviser of the Fund. Reference is made to: (i) the
information set forth under "Management of the Fund" in the Prospectus and
"Sub-Adviser" in the Statement of Additional Information; and (ii) the Form ADV
of Four Corners (File No. 801-60738) filed with the Commission, all of which are
incorporated herein by reference.
Item 31: Location of Accounts and Records
First Trust Advisors L.P. maintains the Declaration of Trust, By-Laws, minutes
of trustees and shareholders meetings and contracts of the Registrant, all
advisory material of the investment adviser, all general and subsidiary ledgers,
journals, trial balances, records of all portfolio purchases and sales, and all
other required records.
Page 10
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its shares until it amends
its prospectus if (1) subsequent to the effective date of its Registration
Statement, the net asset value declines more than 10 percent from its net asset
value as of the effective date of the Registration Statement, or (2) the net
asset value increases to an amount greater than its net proceeds as stated in
the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities Act of 1933,
the information omitted from the form of prospectus filed as part of a
registration statement in reliance upon Rule 430A and contained in the form of
prospectus filed by the Registrant under Rule 497(h) under the Securities Act of
1933 shall be deemed to be part of the Registration Statement as of the time it
was declared effective.
b. For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of the securities at that time shall be deemed to be
the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means designed
to ensure equally prompt delivery, within two business days of receipt of a
written or oral request, any Statement of Additional Information.
Page 11
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in
this City of Lisle, and State of Illinois, on the 25th day of May, 2004.
FIRST TRUST/FOUR CORNERS SENIOR
FLOATING RATE INCOME FUND II
By: /s/ James A. Bowen
-------------------------------
James A. Bowen, President
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed below by the following persons in the capacities and
on the date indicated.
--------------------- ------------------------------------- -----------------
Signature Title Date
--------------------- ------------------------------------- -----------------
/s/ James A. Bowen President, Chairman of the May 25, 2004
------------------- Board and Trustee
James A. Bowen (Principal Executive Officer)
--------------------- ------------------------------------- -----------------
/s/ Mark R. Bradley Chief Financial Officer and May 25, 2004
-------------------- Treasurer (Principal Financial
Mark R. Bradley and Accounting Officer)
--------------------- ------------------------------------- -----------------
Page 12
INDEX TO EXHIBITS
d. Form of Share Certificate.
e. Terms and Conditions of the Dividend Reinvestment Plan.
g.1 Form of Investment Management Agreement between Registrant and First
Trust Advisors L.P.
g.2 Form of Sub-Advisory Agreement between Registrant, First Trust
Advisors L.P. and Four Corners Capital Management, LLC.
h.1 Form of Purchase Agreement.
j. Form of Custodian Services Agreement between Registrant and PFPC Trust
Company.
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.
k.2 Form of Administration and Accounting Services Agreement between
Registrant and PFPC Inc.
k.3 Form of Additional Compensation Agreement between First Trust Advisors
L.P. and Merrill Lynch.
k.4 Form of Incentive Fee Agreement between Four Corners Capital Management,
LLC and Raymond James.
l.1 Opinion and consent of Chapman and Cutler LLP.
l.2 Opinion and consent of Bingham McCutchen LLP.
n. Independent Auditors' Consent.
p. Subscription Agreement between Registrant and First Trust
Portfolios L.P.
r.1 Code of Ethics of Registrant.
r.2 Code of Ethics of First Trust Portfolios L.P.
r.3 Code of Ethics of First Trust Advisors L.P.
r.4 Code of Ethics of Four Corners Capital Management, LLC.