e497
Filed pursuant to Rule 497(b)
File No. 333-156464
Highland
Distressed Opportunities, Inc.
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
Special
Meeting of Stockholders to be held April 9, 2009
March 5, 2009
Dear Stockholder:
You are being asked to vote on a proposed merger of Highland
Distressed Opportunities, Inc. (Acquired Fund) into
Highland Credit Strategies Fund (Acquiring Fund and
together with the Acquired Fund, the Funds), as
further described below. As a result of the merger, your common
shares in the Acquired Fund will be converted to common shares
of the Acquiring Fund (and cash in lieu of any fractional
shares). The conversion will be done on the basis of the
relative net asset values of the two Funds.
The Board of Directors of the Acquired Fund has called a special
meeting of stockholders of the Acquired Fund (the
Meeting) to be held at The Westin Galleria Dallas,
13340 Dallas Parkway, Dallas, TX 75240, on April 9, 2009,
at 8:00 a.m. Central Time, so that stockholders can
vote on an Agreement and Plan of Merger and Liquidation
(Agreement). The Agreement provides for the merger
of Acquired Fund with and into HCF Acquisition LLC (Merger
Sub), a Delaware limited liability company to be organized
as a wholly owned subsidiary of the Acquiring Fund (the
Merger), with Merger Sub being the surviving entity
(although it will exist only for a short period of time, as
noted below) and pursuant to which common stockholders of
Acquired Fund will receive shares of beneficial interest of
Acquiring Fund (and cash in lieu of any fractional shares).
Immediately after the Merger, Merger Sub will distribute its
assets to Acquiring Fund, and Acquiring Fund will assume the
liabilities of Merger Sub, in complete liquidation and
dissolution of Merger Sub (collectively with the Merger, the
Reorganization). It is expected that the liquidation
and dissolution of Merger Sub will occur shortly after the
effective time of the Merger. As a result of the Reorganization,
each common stockholder of the Acquired Fund will become a
common shareholder of the Acquiring Fund. The attached combined
Proxy Statement and Prospectus includes detailed information
about the proposed Reorganization and Agreement. After
careful consideration, the Board of the Acquired Fund
unanimously recommends that you support the Reorganization and
vote FOR the proposed Agreement.
The investment objective of the Acquired Fund is similar to that
of the Acquiring Fund in that both emphasize capital
appreciation and current income, although current income may be
relatively more important for the Acquiring Fund and capital
appreciation relatively more important for the Acquired Fund. In
addition the Funds investment policies, strategies and
risks are similar in that both invest a substantial portion of
their assets in senior loans and below investment grade bonds.
Highland Capital Management, L.P. is the investment adviser to
each Fund.
Your vote is very important to us regardless of the number of
shares you own. Whether or not you plan to attend the Meeting in
person, please read the Proxy Statement and Prospectus and cast
your vote promptly. To vote, simply date, sign and return the
proxy card in the enclosed postage-paid envelope or follow the
instructions on the proxy card for voting by touch-tone
telephone or by fax.
It is important that your vote be received no later than the
time of the Meeting.
Sincerely,
R. Joseph Dougherty
Director
Highland Distressed Opportunities, Inc.
IMPORTANT
NOTICE
TO STOCKHOLDERS OF
HIGHLAND DISTRESSED OPPORTUNITIES, INC.
QUESTIONS &
ANSWERS
Although we recommend that you read the complete Proxy Statement
and Prospectus (Proxy Statement/Prospectus), we have
provided for your convenience a brief overview of the proposals
to be voted on at the special meeting of stockholders.
APPROVAL
OF REORGANIZATION OF THE ACQUIRED FUND
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WHAT IS BEING PROPOSED AT THE STOCKHOLDER MEETING? |
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You are being asked to vote on a proposed merger of Highland
Distressed Opportunities, Inc. (Acquired Fund) into
Highland Credit Strategies Fund (Acquiring Fund and
together with the Acquired Fund, the Funds), as
further described below. As a result of the merger, your common
shares in Acquired Fund will be converted to common shares of
the Acquiring Fund (and cash in lieu of any fractional shares).
The conversion will be done on the basis of the relative net
asset values of the two Funds. The proposed Reorganization
involves the merger of Acquired Fund with and into HCF
Acquisition LLC (Merger Sub), a Delaware limited
liability company to be organized as a wholly owned subsidiary
of Acquiring Fund, followed by the subsequent liquidation and
dissolution of Merger Sub. This type of transaction is sometimes
referred to as a triangular merger. The proposed
Reorganization is structured as a triangular merger in order to
address the requirements of provisions in the Acquired
Funds charter documents that are intended to deter
hostile takeovers and other transactions which the
Board of Directors of the Acquired Fund may not consider to be
in the best interests of Acquired Funds stockholders. See
Anti-Takeover Provisions in the Proxy
Statement/Prospectus. Acquired Fund is a closed-end company that
has elected to be regulated as a business development company
under the Investment Company Act of 1940, as amended (the
1940 Act). Acquiring Fund is a closed-end registered
investment company that pursues similar (although not identical)
investment strategies to those of the Acquired Fund and is
managed by Highland Capital Management, L.P.
(Highland), the same investment adviser as that of
the Acquired Fund. The Acquiring Fund does not expect any
material changes in its portfolio holdings after the proposed
Reorganization, other than changes made in the ordinary course. |
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Unlike the Acquired Fund, the Acquiring Fund is not subject to
the requirements applicable to business development companies,
although it is subject to the requirements applicable to
registered investment companies. For example, the Acquiring Fund
has more flexibility in the types of instruments and issuers in
which it can invest. The Acquired Fund is required to invest at
least 70% of its total assets in certain qualifying
assets, including securities of eligible portfolio
companies as defined in the 1940 Act and the rules
thereunder, while the Acquiring Fund is not subject to these
requirements. In addition, unlike the Acquired Fund, the
Acquiring Fund is not required to offer significant
managerial assistance (within the meaning of the 1940 Act)
to its portfolio companies. Restrictions on issuance of senior
securities also differ between the Funds: while under the 1940
Act the Acquired Fund is permitted to issue senior securities
representing indebtedness if such securities have an asset
coverage of at least 200%, the Acquiring Fund may only issue
such senior securities if they have an asset coverage of at
least 300%. This means that under the 1940 Act the Acquiring
Fund is generally not permitted to borrow as much as the
Acquired Fund. |
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WHY IS THE REORGANIZATION BEING RECOMMENDED? |
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The Board of Directors of the Acquired Fund has determined that
the Reorganization should benefit its common stockholders. The
Board of Trustees of the Acquiring Fund has determined that the
Reorganization should benefit its common shareholders. The
investment objective of the Acquired Fund and the Acquiring Fund
are similar in that both emphasize capital appreciation and
current income, although current income may be relatively more
important for the Acquiring Fund and capital appreciation
relatively more important for the Acquired Fund. Also the Funds
seek to achieve their objectives in similar ways by investing a
substantial portion of their assets in senior loans and below
investment grade bonds. Each Fund is managed by the same
investment adviser and has the same members on its Board. The
Acquired |
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Fund does not intend to make any material changes in its
portfolio before the Reorganization, other than selling
portfolio securities, when appropriate, to reduce Acquired
Funds outstanding borrowings and in connection with normal
portfolio management activities. |
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In reaching this determination, the Board of Directors of the
Acquired Fund also considered that if stockholders approve the
Reorganization, the annual operating expenses of the combined
Fund are expected to be lower than the Acquired Funds
current annual operating expenses. This is primarily due to the
Acquiring Funds lower advisory and administration fees and
lack of an incentive fee. As of each Funds twelve months
ended December 31, 2008, the total annual operating
expenses, including costs of leverage, as a percentage of
average net assets, of the Acquired Fund and the Acquiring Fund
were 9.18% and 3.95%, respectively. Assuming the Reorganization
is approved, the estimated total annual operating expenses of
the combined Fund would be 3.90% of average net assets and, with
the contractual fee waivers currently in place, the estimated
net annual operating expenses of the combined Fund would be
3.83% of average net assets. |
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The Proxy Statement/Prospectus contains further explanation of
the reasons that the Boards of Directors/Trustees of the Funds
unanimously recommend the Reorganization. |
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HOW DOES THE ACQUIRING FUNDS INVESTMENT OBJECTIVE AND
INVESTMENT STRATEGY DIFFER FROM MY FUNDS? |
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The Acquiring Fund is registered as a non-diversified,
closed-end management investment company under the 1940 Act. The
Acquiring Funds investment objective is to provide both
current income and capital appreciation. The Acquiring Fund
invests at least 80% of its assets in the following categories
of securities and instruments of corporations and other business
entities: (i) secured and unsecured floating and fixed rate
loans; (ii) bonds and other debt obligations;
(iii) debt obligations of stressed, distressed and bankrupt
issuers; (iv) structured products, including but not
limited to, mortgage-backed and other asset-backed securities
and collateralized debt obligations; and (v) equities. A
significant portion of the Acquiring Funds assets may be
invested in securities rated below investment grade (Ba/BB or
lower), which are commonly referred to as junk
securities. Both Funds have broad investment mandates that
allow them to invest in many types of securities. The Acquiring
Fund may also engage in short sales, while the Acquired Fund
currently does not. See Risk Factors and Special
Considerations for more information. |
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The Acquired Fund is a closed-end company that has elected to be
regulated as a business development company under the 1940 Act.
The Acquired Funds investment objective is to provide
total return generated by both capital appreciation and current
income. The Acquired Fund invests primarily in
financially-troubled or distressed companies that are either
middle-market companies or unlisted companies. The Acquired Fund
seeks to achieve its objective by investing in senior secured
debt, mezzanine debt and unsecured debt, each of which may
include an equity component, and in equity investments.
Generally, distressed companies are those that (i) are
facing financial or other difficulties and (ii) are or have
been operating under the provisions of the U.S. Bankruptcy
Code or other similar laws or, in the near future, may become
subject to such provisions or otherwise be involved in a
restructuring of their capital structure. The term
middle-market refers to companies with annual
revenues between $50 million and $1 billion. The term
unlisted refers to companies not listed on a
national securities exchange (for example, companies whose
securities are quoted on the over-the-counter bulletin board or
through Pink Sheets LLC would not be listed on a
national securities exchange, although they may be considered
public companies). |
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Both Funds invest a substantial portion of their assets in
senior loans and below investment grade bonds. As of
December 31, 2008, the Acquired Fund and the Acquiring Fund
invested 75.25% and 91.44% of their assets, respectively, in
senior loans and below investment grade bonds. In addition, as
of December 31, 2008, 78.21% of the assets in the Acquired
Funds portfolio represented issuers whose securities were
also owned by the Acquiring Fund. |
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HOW WILL THE REORGANIZATION AFFECT ME? |
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If stockholders approve the Reorganization and you are a holder
of common stock of the Acquired Fund, you will receive newly
issued common shares of the Acquiring Fund (and cash for any
fractional common shares), the aggregate net asset value of
which will equal the aggregate net asset value, taking into |
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account the Acquired Funds proportionate share of the
costs of the Reorganization, of the common stock you held
immediately prior to the Reorganization. The Acquiring Fund
common shares received by Acquired Fund common stockholders will
trade on New York Stock Exchange and will likely trade at a
discount from net asset value, which might be greater or less
than the trading discount of the Acquired Funds common
stock at the time of the closing of the Reorganization. |
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WILL I HAVE TO PAY ANY SALES LOAD, COMMISSION OR OTHER
SIMILAR FEE IN CONNECTION WITH THE REORGANIZATION? |
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You will pay no sales loads or commissions in connection with
the Reorganization. However, part of the costs associated with
the Reorganization will be borne by the Acquired Fund and thus
indirectly by its common stockholders. |
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WILL MY DIVIDENDS BE AFFECTED BY THE PROPOSED
REORGANIZATION? |
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If you are a common stockholder of the Acquired Fund, you
receive distributions, which may contain returns of capital, on
a quarterly basis. As shareholders of the Acquiring Fund, you
will receive distributions, which may contain returns of
capital, on a monthly basis. The rate of a Funds
distribution may vary from one distribution to another. The
distribution is not guaranteed and may be reduced or eliminated.
The Acquiring Funds current yield as of December 31,
2008 on a net asset value basis is higher than that of the
Acquired Fund. There is no guarantee that the Acquiring
Funds yield will continue at its current levels, and may
decline. |
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The Acquiring Fund will not permit any holder of certificated
common stock of the Acquired Fund at the time of the
Reorganization to reinvest dividends or other distributions,
transfer shares of the Acquiring Fund or pledge shares of the
Acquiring Fund until the certificates for stock of the Acquired
Fund have been surrendered to PNC Global Investment Servicing
(U.S.) Inc. (PNC), the Acquiring Funds
transfer agent, or, in the case of lost certificates, until an
adequate surety bond has been posted. To obtain information on
how to return your stock certificates for the Acquired Fund if
and when the Reorganization is completed, please call PNC at
877-247-1888. |
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If a shareholder is not, for the reasons above, permitted to
reinvest dividends or other distributions on shares of the
Acquiring Fund, the Acquiring Fund will pay all such dividends
and other distributions in cash, notwithstanding any election
the shareholder may have made previously to reinvest dividends
and other distributions on stock of the Acquired Fund. |
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WILL I HAVE TO PAY ANY FEDERAL INCOME TAXES AS A RESULT OF
THE REORGANIZATION? |
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The Reorganization is intended to qualify as a
reorganization within the meaning of
Section 368(a)(1) of the Internal Revenue Code of 1986, as
amended. If the Reorganization so qualifies, in general,
stockholders of the Acquired Fund will not recognize gain or
loss upon the conversion of their Acquired Fund shares solely
into shares of the Acquiring Fund in connection with the
Reorganization. However, stockholders of the Acquired Fund
generally will recognize gain or loss with respect to any cash
such holders receive pursuant to the Reorganization in lieu of
the conversion of their Acquired Fund shares into fractional
shares of Acquiring Fund to the extent any such cash received is
greater or less (as the case may be) than the tax basis
allocable to the fractional shares. Additionally, if the
Reorganization so qualifies, the Acquired Fund will not
recognize gain or loss directly as a result of the
Reorganization. It is expected that a distribution or
distributions of net income and net short-term and long-term
capital gain will be made by the Acquired Fund shortly prior to
the closing of the Reorganization, which generally will be
taxable to Acquired Fund shareholders and neither the Acquiring
Fund nor its shareholders will recognize any gain or loss
directly in connection with the Reorganization. Should the Board
decide to consummate the Reorganization even if it does not
qualify as a reorganization within the meaning of
Section 368(a)(1), it will notify Acquired Fund
stockholders and re-solicit proxies. See Federal Income
Tax Consequences of the Reorganization beginning on
page 68. |
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DO I HAVE THE RIGHT TO SEEK APPRAISAL OF THE FAIR CASH
VALUE OF MY SHARES OF COMMON STOCK IF THE MERGER IS
COMPLETED? |
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Yes. But, if you wish to exercise your appraisal rights, you
must not vote in favor of adoption of the Agreement and Plan of
Merger and Liquidation and approval of the Reorganization, and
you must strictly follow all of the other requirements under
Section 262 of the Delaware General Corporation Law (the
DGCL), governing appraisal rights. In addition, you
should note that it is a condition to closing of the
Reorganization that there have been no demands for appraisal
made or that the Board of both the Acquired Fund and Acquiring
Fund in its sole discretion has determined to continue the
Reorganization notwithstanding such demands. However, the Board
may choose not to continue the Reorganization. If you comply
with these requirements and the Board chooses to continue the
Reorganization notwithstanding the demands for appraisal rights,
you will have the right to receive the fair cash
value of your shares, as determined under the DGCL,
instead of the consideration provided in the Agreement and Plan
of Merger and Liquidation. The amount you will receive if you
exercise your appraisal rights may be less than, equal to or
more than the amount that you would otherwise receive under the
Agreement and Plan of Merger and Liquidation. See
Appraisal Rights beginning on page 71 and
Appendix D hereto. |
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HOW DOES THE BOARD OF DIRECTORS OF THE ACQUIRED
FUND SUGGEST THAT I VOTE? |
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After careful consideration, the Board of Directors of the
Acquired Fund unanimously recommends that you vote
FOR the proposed Reorganization. |
GENERAL
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HOW DO I VOTE MY PROXY? |
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You may use the enclosed postage-paid envelope to mail your
proxy card or you may attend the meeting in person. You may also
vote by phone by calling the proxy solicitor at
(866) 387-9392
or by fax by following the instructions on the proxy card. |
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WHO DO I CALL IF I HAVE QUESTIONS? |
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We will be pleased to answer your questions about this proxy
solicitation. Please call
(866) 387-9392
with any questions. |
HIGHLAND
DISTRESSED OPPORTUNITIES INC.
(the Acquired
Fund)
NOTICE OF SPECIAL MEETING OF
STOCKHOLDERS
TO BE HELD APRIL 9,
2009
This is the formal agenda for the Acquired Funds
stockholder meeting. It tells you what matters will be voted on
and the time and place of the meeting in case you want to attend
in person.
To the stockholders of the Acquired Fund:
A stockholder meeting for the Acquired Fund will be held at The
Westin Galleria Dallas, 13340 Dallas Parkway, Dallas, TX 75240,
on April 9, 2009, at 8:00 a.m. Central Time, to
consider the following:
1. A proposal to approve an Agreement and Plan of Merger
and Liquidation among Highland Distressed Opportunities, Inc.
(the Acquired Fund), Highland Credit Strategies Fund
(the Acquiring Fund) and HCF Acquisition LLC, a
wholly owned subsidiary of the Acquiring Fund (Merger
Sub), pursuant to which the Acquired Fund will merge with
and into Merger Sub (the Merger) with Merger Sub
being the surviving entity and the common stockholders of
Acquired Fund receiving shares of beneficial interest of
Acquiring Fund (and cash in lieu of any fractional shares);
immediately after the Merger, Merger Sub will distribute its
assets to Acquiring Fund and Acquiring Fund will assume the
liabilities of Merger Sub, in complete liquidation and
dissolution of Merger Sub (collectively with the Merger, the
Reorganization). Immediately after the
Reorganization, the Acquired Fund will withdraw its election to
be regulated as a business development company (by approving the
Reorganization, a stockholder is also approving this withdrawal).
2. Any other business that may properly come before the
meeting or any adjournment thereof.
Stockholders of record as of the close of business on
February 6, 2009, are entitled to vote at the meeting or
any adjournment thereof. Stockholders of to the Acquired Fund
are entitled to appraisal rights under Section 262 of the
Delaware General Corporation Law in connection with the
Reorganization. However, it is a condition to closing that there
have been no demands for appraisal made or that the Board of
both the Acquired Fund and Acquiring Fund in its sole discretion
has determined to continue the Reorganization notwithstanding
such demands.
Your attention is called to the accompanying Proxy Statement and
Prospectus. Regardless of whether you plan to attend the
meeting, PLEASE COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED
PROXY CARD PROMPTLY so that a quorum will be present and your
shares may be voted. You may also vote by calling the proxy
solicitor at
(866) 387-9392
or by fax by following the instructions on the proxy card. If
you are present at the meeting, you may change your vote, if
desired, at that time.
YOUR VOTE IS IMPORTANT, REGARDLESS OF THE NUMBER OF SHARES
YOU OWN. YOU CAN VOTE EASILY AND QUICKLY BY MAIL, BY TELEPHONE
OR BY FAX. A
SELF-ADDRESSED,
POSTAGE-PAID ENVELOPE HAS BEEN ENCLOSED FOR YOUR CONVENIENCE.
YOU MAY ALSO VOTE BY CALLING OR FAXING TO THE NUMBER ON THE
PROXY CARD. PLEASE HELP AVOID THE EXPENSE OF A
FOLLOW-UP
MAILING BY VOTING TODAY.
By order of the Board of Directors,
M. Jason Blackburn
Secretary
Dated: March 5, 2009
PROXY
STATEMENT
of
Highland Distressed Opportunities, Inc.
(the Acquired Fund)
And
PROSPECTUS
for
Common Shares of
Highland Credit Strategies Fund
(the Acquiring Fund)
The address of the Acquired Fund and the Acquiring Fund (each, a
Fund) is NexBank Tower, 13455 Noel Road,
Suite 800, Dallas, Texas 75240. The telephone number of the
Acquired Fund is 1-877-247-1888 and the Acquiring Fund is
1-877-665-1287.
This Proxy Statement and Prospectus (Proxy
Statement/Prospectus) contains the information
stockholders of the Acquired Fund should know before voting on
the proposed Reorganization. Please read it carefully and retain
it for future reference. For ease of reading, shares
and shareholders has been used in certain places in
the Proxy Statement/Prospectus to describe, respectively, the
stock of the Acquired Fund and holders of stock of the Acquired
Fund. The Statement of Additional Information which relates to
this Proxy Statement/Prospectus is available at no charge by
calling
1-877-247-1888
for the Acquired Fund and
1-877-665-1287
for the Acquiring Fund.
The Acquired Fund is a closed-end company and has elected to be
regulated as a business development company under the 1940 Act.
The Acquiring Fund is registered as a non-diversified,
closed-end management investment company under the 1940 Act. The
Acquired Funds investment objective is to provide total
return generated by both capital appreciation and current
income. The Acquiring Funds investment objective is to
provide both current income and capital appreciation.
How the
Reorganization Will Work
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The Reorganization, which was structured based on advice of
counsel will work as follows. Pursuant to the Reorganization,
Acquired Fund will merge with and into HCF Acquisition LLC
(Merger Sub), a wholly owned subsidiary of the
Acquiring Fund (the Merger), with Merger Sub being
the surviving entity and the separate corporate existence of
Acquired Fund shall thereupon cease. Common stockholders of
Acquired Fund will receive shares of beneficial interest, with
$0.001 par value, of Acquiring Fund (the Merger
Shares) (and cash in lieu of any fractional shares) having
an aggregate net asset value equal to the value of assets of
Acquired Fund on the Valuation Date less the value of the
liabilities of Acquired Fund on such Valuation Date.
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Immediately after the Merger and as part of the Reorganization,
Merger Sub will distribute its assets to Acquiring Fund, and
Acquiring Fund will assume the liabilities of Merger Sub, in
complete liquidation and dissolution of Merger Sub.
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Before the Reorganization, Merger Sub will elect to be regulated
as a business development company by filing the requisite forms
with the Securities and Exchange Commission (the
SEC) and, after the Reorganization, it will file the
forms necessary to withdraw its election.
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In connection with the Reorganization, the Acquired Fund will
withdraw its election to be regulated as a business development
company under the 1940 Act, and by approving the Reorganization
shareholders are also approving such withdrawal.
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Prior to the Merger, Acquired Fund will declare and pay to its
stockholders a dividend or dividends
and/or other
distribution in an amount such that it will have distributed all
of its net investment income and net long-term and short-term
capital gains (if any), as described in Section 8(l) of the
Agreement.
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The Reorganization is conditioned upon the approval of Acquired
Funds shareholders. If the Reorganization is not approved
by the Acquired Funds shareholders, the Fund will continue
to exist and its Board of Directors will consider what
additional action, if any, to take.
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It is intended that the Reorganization will be a tax-free
reorganization for U.S. federal income tax purposes. This
means that no gain or loss is expected to be recognized by the
Acquired Fund or its shareholders directly as a result of the
Reorganization, except, however, that shareholders of the
Acquired Fund may recognize gain or loss with respect to cash
such holders receive pursuant to the Reorganization in lieu of
fractional shares of Acquiring Fund. Since the Reorganization
will end the tax year of the Acquired Fund, it will accelerate
distributions of any dividends from the Acquired Fund to its
stockholders. Specifically, the Acquired Fund will recognize any
net investment company taxable income and any net capital gains
in the short taxable year ending on the date of the
Reorganization, and will declare and pay a distribution or
distributions of such income and such gains to its shareholders
on or before that date. Any such distribution or distributions
generally will be taxable to stockholders receiving such
distribution or distributions. As of December 31, 2008, the
amount of undistributed income was approximately $1,067,487, or
$0.06 per share. There is no guarantee that any distributions
will be made to shareholders prior to the date of the
Reorganization or that such distributions will be equal to the
amounts listed above. For more information about the
U.S. federal income tax consequences of the Reorganization,
see Federal Income Tax Consequences of the
Reorganization.
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Rationale
for the Reorganization
The Board of Directors of the Acquired Fund and the Board of
Trustees of the Acquiring Fund (each a Board)
believes that the Reorganization of the Acquired Fund into the
Acquiring Fund, a fund with a similar investment objective and
having a combined portfolio with greater assets, offers you
potential benefits. These potential benefits and Board
considerations include:
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Economies of Scale in Expenses. A
combined Fund offers economies of scale that may lead to a
reduction in operating expenses. Due to the combined Funds
lower management fee, lower administration fee, no incentive
fee, lower interest expense due to lower leverage and
elimination of overlapping expenses, the estimated annual
operating expenses of the combined Fund are expected to be lower
than the current annual operating expenses of the Acquired Fund.
Each Fund incurs New York Stock Exchange (NYSE)
listing fees, costs for legal, auditing, and custodial services,
and miscellaneous fees. Additionally, the Acquired Fund incurs
expenses related to Sarbanes-Oxley implementation that the
Acquiring Fund does not and that the combined Fund would not
incur. Many of these expenses overlap and there may be an
opportunity to reduce them over time if the Funds are combined.
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Exchange of Common Shares at Net Asset Value
(NAV). On its closing date, the
Reorganization will result in the Acquired Fund shareholders
receiving shares of beneficial interest the Acquiring Fund and
cash (in lieu of fractional shares) based on the Acquired
Funds NAV (i.e., the shareholder of Acquired Fund will
receive its common shares of the Acquiring Fund and cash (in
lieu of fractional shares) with an aggregate NAV equal to the
value of the Acquired Fund shares held immediately before the
Valuation Date for the Merger). Because the Acquiring Fund
historically has traded at a greater premium or narrower
discount than the Acquired Fund since inception of the Acquired
Fund, Acquired Fund stockholders would receive shares of the
Acquiring Fund, which based on historical trading, may
potentially trade at a narrower discount than shares of the
Acquired Fund.
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Enhanced Common Share
Liquidity. Following the Reorganization, the
substantially larger trading market in the common shares of the
Acquiring Fund, as compared to that of the Acquired Fund prior
to the Reorganization, may provide Acquired Fund shareholders
with enhanced market liquidity. Trading
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discounts can result from many different factors, however, and
there is no assurance that the Acquiring Fund will continue to
trade at a smaller discount to NAV.
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Increased Asset Size. The Acquiring
Fund will obtain additional assets without incurring
underwriting expenses and other transaction expenses associated
with offering new shares. In addition, the Acquiring Fund is
obtaining the additional portfolio securities of the Acquired
Fund without the commensurate brokerage costs, dealer spreads or
other trading expenses. It is also obtaining these securities in
a manner that is likely to minimize the market impact of such
acquisition on the short-term prices of these securities.
However, the increase in Acquiring Fund shares as a result of
the Reorganization may also cause Acquiring Fund shares to trade
at a larger discount from NAV. Because shareholders of the
Acquired Fund will receive Acquiring Fund shares, Acquired Fund
shareholders may share in these potential benefits.
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Portfolio Management Efficiencies. The
Reorganization would permit Acquired Fund shareholders to pursue
similar investment goals in a larger fund. The greater asset
size of the combined Fund may allow the combined Fund, relative
to the Acquired Fund, to obtain better net prices on securities
trades and achieve greater diversification of portfolio
holdings. For example, at December 31, 2008, 78.21% of the
Acquired Funds assets represented issuers of securities
owned by the Acquiring Fund; however, such issuers made up only
22.91% of the Acquiring Funds assets.
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Shareholders Ability to
Margin. Stocks that trade below $5.00 are not
currently marginable. Since the Acquired Fund currently trades
well below $5.00 per share, and the Acquiring Fund has recently
been trading at around $5.00 per share, if the Reorganization is
approved, Acquired Fund shareholders would receive shares of the
Acquiring Fund that would be more likely to be marginable (based
on current market prices). Additionally, marginable securities
may be more liquid that those that are not marginable because
many institutional/large investors are believed to avoid stocks
that are not marginable. However, if the price per share of the
Acquiring Fund trades below $5.00 (it currently trades at less
than $5.00 per share), the shares of the Acquiring Fund would no
longer be marginable. It is possible that the Reorganization
will exert downward pressure on the price per share of the
Acquiring Fund.
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The Board of the Acquired Fund unanimously recommends that you
vote FOR the Reorganization into the Acquiring Fund. Please see
Reasons for the Proposed Reorganization for a
description of the factors considered by the Board in deciding
to approve the Reorganization and recommend its approval by
shareholders.
Who Bears
the Expenses Associated with the Proxy
Statement/Prospectus
The costs associated with the Reorganization will be borne by
each of the Acquired Fund and the Acquiring Fund in proportion
to their respective net assets determined at the close of
regular trading on the NYSE on the date of the
Reorganizations closing.
Who is
Eligible to Vote
Shareholders of record on February 6, 2009 are entitled to
attend and vote at the meeting or any adjourned meeting. Each
share is entitled to one vote. Shares represented by properly
executed proxy cards, unless revoked before or at the meeting,
will be voted according to shareholders instructions. If
you sign a proxy card but do not fill in a vote, your shares
will be voted for the Reorganization. If any other business
comes before the meeting, your shares will be voted at the
discretion of the persons named as proxies.
The common shares of the Acquiring Fund are listed on the NYSE
under the ticker symbol HCF and will continue to be
so listed subsequent to the Reorganization. The common shares of
the Acquiring Fund are listed on the NYSE under the ticker
symbol HCD.
3
Where to
Get More Information
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A Statement of Additional Information dated March 5, 2009,
which relates to this Proxy Statement/Prospectus and the
Reorganization, has been filed with the SEC and contains
additional information about the Acquired Fund and the Acquiring
Fund and the annual report on Form
10-K of the
Acquired Fund for the fiscal year ended December 31, 2008
has been filed with the SEC and contains additional information
about the Acquired Fund.
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On file with the SEC or available at no charge by calling our
toll free number: 877-247-1888 for the Acquired Fund and
877-665-1287 for the Acquiring Fund or by writing to either Fund
at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240.
The Statement of Additional Information and the Acquired
Funds annual report on Form
10-K are
incorporated by reference into (and therefore legally part of)
this Proxy Statement/Prospectus.
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To ask questions about this Proxy Statement/Prospectus
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Call the proxy solicitor at (866) 387-9392.
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The date of this Proxy Statement/Prospectus is March 5,
2009.
Shares of the Acquiring Fund have not been approved or
disapproved by the SEC. The SEC has not passed upon the accuracy
or adequacy of this Proxy Statement/Prospectus. Any
representation to the contrary is a criminal offense.
Shares of the Acquiring Fund are not deposits or obligations
of, or guaranteed or endorsed by, any bank or other depository
institution. These shares are not federally insured by the
Federal Deposit Insurance Corporation, the Federal Reserve Board
or any other government agency.
4
TABLE OF
CONTENTS
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6
INTRODUCTION
This Proxy Statement/Prospectus is being used by the Acquired
Funds Board to solicit proxies to be voted at the special
meeting of the Acquired Funds shareholders
(Meeting). The Meeting will be held at The Westin
Galleria Dallas, 13340 Dallas Parkway, Dallas, TX 75240, on
April 9, 2009, at 8:00 a.m. Central Time. At the
Meeting, the Acquired Fund will consider a proposal to approve
an Agreement and Plan of Merger and Liquidation providing for
the Reorganization of the Acquired Fund into the Acquiring Fund.
This Proxy Statement/Prospectus is being mailed to you on or
about March 5, 2009.
This Proxy Statement/Prospectus includes information about the
proposal. A comparison summary is provided with respect to the
proposal. You should read carefully the proxy statement, as well
as the Appendices and the enclosed materials, because they
contain details that are not in the summary.
SUMMARY
OF INFORMATION RELATED TO PROPOSAL
The following is a summary of certain information regarding the
proposal contained elsewhere in this Proxy Statement/Prospectus
and is qualified in its entirety by reference to the more
complete information contained in this Proxy
Statement/Prospectus and in the Statement of Additional
Information. Shareholders should read the entire Proxy
Statement/Prospectus carefully.
PROPOSAL:
REORGANIZATION OF THE ACQUIRED FUND
The Proposed Reorganization. The Board of the
Acquired Fund, including the Directors who are not
interested persons (as defined in the Investment
Company Act of 1940, as amended (the 1940 Act)) of
the Acquired Fund, has unanimously approved the Agreement and
Plan of Merger and Liquidation. If quorum is present at the
Meeting and a majority of the outstanding voting securities of
the Acquired Fund (as defined in the 1940 Act) approve the
Agreement and Plan of Merger and Liquidation, then the Acquired
Fund will merge with and into Merger Sub (the
Merger) with Merger Sub being the surviving entity
and common stockholders of the Acquired Fund receiving shares of
beneficial interest of the Acquiring Fund (the Merger
Shares) (and cash in lieu of any fractional shares) having
an aggregate net asset value equal to the value of the assets of
Acquired Fund on the Valuation Date less then value of the
liabilities of Acquired Fund on such Valuation Date. Merger Sub
will elect to be regulated as a business development company by
filing the requisite forms with the SEC. Immediately after the
Merger, Merger Sub will distribute its assets to Acquiring Fund,
and Acquiring Fund will assume the liabilities of Merger Sub, in
complete liquidation of Merger Sub. The Acquired Fund and Merger
Sub will then withdraw their elections to be regulated as
business development companies. By approving the Reorganization,
shareholders of the Acquired Fund are also approving such
withdrawal of its election to be treated as a business
development company. The aggregate value of Acquiring Fund
common shares and any cash you receive in the Reorganization
will equal the aggregate net asset value, taking into account
your Funds proportionate share of the costs of the
Reorganization, of your Acquired Fund common shares held
immediately prior to the Reorganization.
Summary
of Fund Comparisons
Investment Objectives and Policies. The
Acquired Fund is a closed-end company that has elected to be
regulated as a business development company under the 1940 Act.
The Acquiring Fund is registered as a non-diversified,
closed-end management investment company under the 1940 Act. The
Acquired Fund seeks total return generated by both capital
appreciation and current income. The Acquiring Fund seeks to
provide both current income and capital appreciation. The
investment objective of the Acquired Fund and the Acquiring Fund
are similar in that both emphasize capital appreciation and
current income, although current income may be relatively more
important for the Acquiring Fund and capital appreciation
relatively more important for the Acquired Fund. Also the Funds
seek to achieve their objectives in similar ways by investing a
substantial portion of their assets in senior loans and below
investment grade bonds. Highland is the investment adviser to
each Fund.
7
The Acquiring Fund invests at least 80% of its assets in the
following categories of securities and instruments of
corporations and other business entities: (i) secured and
unsecured floating and fixed rate loans; (ii) bonds and
other debt obligations; (iii) debt obligations of stressed,
distressed and bankrupt issuers; (iv) structured products,
including but not limited to, mortgage-backed and other
asset-backed securities and collateralized debt obligations; and
(v) equities. A significant portion of the Acquiring
Funds assets may be invested in securities rated below
investment grade (Ba/BB or lower), which are commonly referred
to as junk securities or high-yield
securities.
The Acquired Fund invests primarily in financially-troubled or
distressed companies that are either middle-market companies or
unlisted companies. The Acquired Fund seeks to achieve its
objective by investing in senior secured debt, mezzanine debt
and unsecured debt, each of which may include an equity
component, and in equity investments. Generally, distressed
companies are those that (i) are facing financial or other
difficulties and (ii) are or have been operating under the
provisions of the U.S. Bankruptcy Code or other similar
laws or, in the near future, may become subject to such
provisions or otherwise be involved in a restructuring of their
capital structure. The term middle-market refers to
companies with annual revenues between $50 million and
$1 billion. The term unlisted refers to
companies not listed on a national securities exchange (for
example, companies whose securities are quoted on the
over-the-counter bulletin board or through Pink Sheets LLC would
not be listed on a national securities exchange,
although they may be considered public companies).
Dividends and other Distributions. The
Acquired Fund intends to make distributions, which may contain
returns of capital, to holders of common shares on a quarterly
basis. The Acquiring Fund intends to make distributions, which
may contain returns of capital, to holders of common shares of
the Acquiring Fund on a monthly basis. The rate of a Funds
distribution may vary from one distribution to another. The
Acquiring Funds current yield as of December 31, 2008
on a net asset value basis is higher than that of the Acquired
Fund. However, since November 2008, the Acquiring Funds
monthly distribution rate was lower than the monthly
distribution rate during the previous twelve months.
Purchase and Sale. Purchase and sale
procedures for the common shares of the Funds are similar.
Investors typically purchase and sell common shares of the Funds
on the NYSE through a broker-dealer.
Redemptions. The common shares of each Fund
have no redemption rights. However, the Board of each Fund may
consider open market share repurchases of, or tendering for,
common shares to seek to reduce or eliminate any discount in the
market place of the common shares from the NAV thereof, although
neither Fund has ever engaged in any such purchases. Each
Funds ability to repurchase, or tender for, its common
shares may be limited by the 1940 Act asset coverage
requirements and the terms of the credit facility to which it is
a party. The Board of each Fund has no present intention of
authorizing the repurchase of its common shares or conducting a
tender offer for such common shares.
Expenses. Due to the Acquiring Funds
lower management fee, lower administration fee, no incentive
fee, lower interest expense due to lower leverage and
elimination of overlapping expenses, the estimated annual
operating expenses of the Acquiring Fund should be lower than
the current annual operating expenses the Acquired Fund.
Leverage. Both Funds employ leverage through
borrowings through a credit facility. As of December 31,
2008, leverage as a percentage of total assets of the Acquired
Fund and the Acquiring Fund was 20.4% and 28.1%, respectively.
Performance and Premium/Discount Profile. The
Acquired Fund and the Acquiring Fund commenced investment
operations and public trading in February 2007 and June 2006,
respectively, and have a limited operating history and history
of public trading.
The Acquiring Funds
1-year
performance as of December 31, 2008 on a net asset value
basis and market value basis is better than that of the Acquired
Fund. Please see Additional Information Related to the
Reorganization of the Acquired Fund Past Performance
of Each Fund and Additional Information Related to
the Reorganization of the Acquired Fund Information
About the Funds Common Share Price Data
8
for further information. There is no guarantee or assurance as
to the future performance of the Acquiring Fund.
Background and Reasons for the Proposed
Reorganization. The Board of the Acquired Fund
considered that the Acquired Fund has been trading at a larger
discount from net asset value than the Acquiring Fund. In
addition, the Board considered that there are limited prospects
for growth of the Acquired Fund, given the discount, current
market conditions and its performance history. For the reasons
set forth below under Reasons for the Proposed
Reorganization and based upon its evaluation of relevant
information the Board of the Acquired Fund anticipates that the
common shareholders of the Acquired Fund should benefit from the
Reorganization.
The Board of the Acquired Fund has also determined that
participation in the Reorganization, which is being effected at
the Funds respective net asset values per share, is in the
best interests of the Acquired Fund and that the interests of
its stockholders will not be diluted as a result of the
Reorganization. Although the Board of each Fund determined that
the Reorganization would not result in dilution of the interests
of the shareholders of such Fund, the Board also considered the
fact that the net asset value (NAV) per share of the
combined Acquiring Fund will decrease by the expenses related to
the Reorganization, estimated to be 1 cent per share. However,
as a result of the Reorganization, stockholders of the Acquired
Fund will have a smaller percentage of ownership in the combined
Fund than they did in any of the separate Funds.
Expenses Associated with the
Reorganization. The costs associated with the
Reorganization generally will be borne by each of the Acquired
Fund and the Acquiring Fund in proportion to their respective
net assets determined at the close of regular trading on the
NYSE on the date of the Reorganizations closing. As a
result, part of the costs associated with the Reorganization
will be indirectly borne by the shareholders of each of the
Acquired Fund and the Acquiring Fund based on the number of
shares owned.
Tax Consequences. The Reorganization is
intended to qualify as a reorganization within the
meaning of Section 368(a)(1) of the Internal Revenue Code
of 1986, as amended (Code). If the Reorganization so
qualifies, in general, shareholders of the Acquired Fund will
not recognize gain or loss upon the conversion of their Acquired
Fund shares into shares of the Acquiring Fund in connection with
the Reorganization. However, shareholders of the Acquired Fund
generally will recognize gain or loss with respect to any cash
they receive pursuant to the Reorganization in lieu of the
conversion of their Acquired Fund shares into fractional shares
of Acquiring Fund to the extent any such cash received is
greater or less (as the case may be) than the tax basis
allocable to the fractional shares. Additionally, if the
Reorganization so qualifies, the Acquired Fund will not
recognize gain or loss directly as a result of the
Reorganization and neither the Acquiring Fund nor its
shareholders will recognize any gain or loss directly in
connection with the Reorganization. Should the Board decide to
consummate the Reorganization even if it does not qualify as a
reorganization within the meaning of
Section 368(a)(1), it will notify Acquired Fund
shareholders and re-solicit proxies. See Federal Income
Tax Consequences of the Reorganization beginning on
page 68.
Required Vote. Shareholder approval of the
Reorganization requires, if a quorum is present at the Meeting,
the affirmative vote of a majority of the outstanding voting
securities of the Acquired Fund, which is defined in the 1940
Act as the lesser of (a) 67% or more of the voting
securities present at the Meeting, if the holders of more than
50% of the outstanding voting securities of the Acquired Fund
are present or represented by proxy, or (b) more than 50%
of the outstanding voting securities of the Acquired Fund. The
presence in person or by proxy of shareholders of the Acquired
Fund entitled to cast at least a majority of the votes entitled
to be cast shall constitute a quorum for the Meeting.
The Board of the Acquired Fund unanimously recommends that
you vote FOR the Acquired Funds proposed
Reorganization.
9
RISK
FACTORS AND SPECIAL CONSIDERATIONS RELATED TO
PROPOSAL
Because each of the Acquiring Fund and the Acquired Fund, under
normal market conditions, invest a substantial amount of its
assets in below investment grade securities, any general risks
inherent in such investments are applicable to both the
Acquiring Fund and the Acquired Fund and will apply to the
Acquiring Fund after the Reorganization. The general risks of
investing in the Acquiring Fund are described below, including
comparisons to certain risks of investing in the Acquired Fund.
The Reorganization itself is not expected to adversely affect
the right of common shareholders of either of the Funds. For
information regarding the percentage limitations, if any, of an
investment described in the risks listed below, see
Comparison of the Funds: Investment Objectives and
Policies.
Limited Operating History. The Acquiring Fund
and the Acquired Fund are both recently organized. They
commenced investment operations and public trading in June 2006
and February 2007, respectively, and have a limited operating
history and history of public trading that investors can use to
evaluate their investment performance and volatility.
Asset Allocation Risk. Because the Funds
invests in a broad array of asset classes, they are subject to
asset allocation risk. When deciding on which investments to
make for a Fund, Highland relies on its expectations regarding
particular securities or interest rates. Highland may be
incorrect in its expectations and allocate assets to an asset
class that underperforms other asset classes.
Investment and Market Discount Risk. An
investment in the Acquiring Funds common shares is subject
to investment risk, including the possible loss of the entire
amount that you invest. As with any stock, the price of the
Acquiring Funds shares will fluctuate with market
conditions and other factors. If common shares are sold, the
price received may be more or less than the original investment.
Common shares are designed for long-term investors and should
not be treated as trading vehicles. Shares of closed-end
management investment companies frequently trade at a discount
to their NAV.
Risks of Non-Diversification and Other Focused
Strategies. While the Adviser invests in a number
of fixed-income and equity instruments issued by different
issuers and employs multiple investment strategies with respect
to the Acquiring Funds portfolio, it is possible that a
significant amount of the Acquiring Funds investments
could be invested in the instruments of only a few companies or
other issuers or that at any particular point in time one
investment strategy could be more heavily weighted than the
others. The focus of the Acquiring Funds portfolio in any
one issuer would subject the Acquiring Fund to a greater degree
of risk with respect to defaults by such issuer or other adverse
events affecting that issuer, and the focus of the portfolio in
any one industry or group of industries would subject the
Acquiring Fund to a greater degree of risk with respect to
economic downturns relating to such industry or industries. The
focus of the Acquiring Funds portfolio in any one
investment strategy would subject the Acquiring Fund to a
greater degree of risk than if the Acquiring Funds
portfolio were varied in its investments with respect to several
investment strategies.
Illiquidity of Investments. The investments
made by the Acquiring Fund may be very illiquid, and
consequently, the Acquiring Fund may not be able to sell such
investments at prices that reflect the Advisers assessment
of their fair value or the amount paid for such investments by
the Acquiring Fund. Illiquidity may result from the absence of
an established market for the investments as well as legal,
contractual or other restrictions on their resale by the
Acquiring Fund and other factors. Furthermore, the nature of the
Acquiring Funds investments, especially those in
financially stressed and distressed companies, may require a
long holding period prior to being able to determine whether the
investment will be profitable or not. There is no limit on the
amount of the Acquiring Funds portfolio that can be
invested in illiquid securities.
Risks of Investing in Senior Loans. Senior
loans, such as bank loans, are typically at the most senior
level of the capital structure, and are sometimes secured by
specific collateral, including, but not limited to, trademarks,
patents, accounts receivable, inventory, equipment, buildings,
real estate, franchises and common and preferred stock of the
obligor or its affiliates. A portion of the Acquiring
Funds investments may consist of loans and participations
therein originated by banks and other financial institutions,
typically referred to as bank loans. The Acquiring
Funds investments may include loans of a type generally
incurred by borrowers
10
in connection with highly leveraged transactions, often to
finance internal growth, acquisitions, mergers or stock
purchases, or for other reasons. As a result of the additional
debt incurred by the borrower in the course of the transaction,
the borrowers creditworthiness is often judged by the
rating agencies to be below investment grade. Such loans are
typically private corporate loans which are negotiated by one or
more commercial banks or financial institutions and syndicated
among a group of commercial banks and financial institutions. In
order to induce the lenders to extend credit and to offer a
favorable interest rate, the borrower often provides the lenders
with extensive information about its business which is not
generally available to the public. To the extent the Acquiring
Fund receives material non-public information, it may be
prohibited from trading in certain securities, even when it
might otherwise be beneficial to do so.
Bank loans often, but not always, contain restrictive covenants
designed to limit the activities of the borrower in an effort to
protect the right of lenders to receive timely payments of
principal and interest. Such covenants may include restrictions
on distribution payments, specific mandatory minimum financial
ratios, limits on total debt and other financial tests. Bank
loans usually have shorter terms than subordinated obligations
and may require mandatory prepayments from excess cash flow,
asset dispositions and offerings of debt
and/or
equity securities. The bank loans and other debt obligations to
be acquired by the Acquiring Fund are likely to be below
investment grade.
The Acquiring Fund may acquire interests in bank loans and other
debt obligations either directly (by way of sale or assignment)
or indirectly (by way of participation). The purchaser of an
assignment typically succeeds to all the rights and obligations
of the assigning institution and becomes a lender under the
credit agreement with respect to the debt obligation; however,
its rights can be more restricted than those of the assigning
institution, and, in any event, the Acquiring Fund may not be
able unilaterally to enforce all rights and remedies under the
loan and any associated collateral. A participation interest in
a portion of a debt obligation typically results in a
contractual relationship only with the institution participating
out the interest, not with the borrower. In purchasing
participations, the Acquiring Fund generally will have no right
to enforce compliance by the borrower with the terms of the loan
agreement or any rights of setoff against the borrower, and the
Acquiring Fund may not directly benefit from the collateral
supporting the debt obligation in which it has purchased the
participation. As a result, the Acquiring Fund will be exposed
to the credit risk of both the borrower and the institution
selling the participation.
Purchasers of bank loans are predominantly commercial banks,
investment funds and investment banks. As secondary market
trading volumes increase, new bank loans frequently adopt
standardized documentation to facilitate loan trading, which the
Adviser believes should improve market liquidity. There can be
no assurance, however, that future levels of supply and demand
in bank loan trading will provide an adequate degree of
liquidity or that the current level of liquidity will continue.
Because of the provision to holders of such loans of
confidential information relating to the borrower, the unique
and customized nature of the loan agreement, the limited
universe of eligible purchasers and the private syndication of
the loan, bank loans are not as easily purchased or sold as a
publicly traded-security.
Second Lien Loans Risk. Second lien loans are
subject to the same risks associated with investment in senior
loans and non-investment grade securities. However, second lien
loans are second in right of payment to senior loans and
therefore are subject to additional risk that the cash flow of
the borrower and any property securing the loan may be
insufficient to meet scheduled payments after giving effect to
the senior secured obligations of the borrower. Second lien
loans are expected to have greater price volatility than senior
loans and may be less liquid. There is also a possibility that
originators will not be able to sell participations in second
lien loans, which would create greater credit risk exposure.
Other Secured Loans Risk. Secured loans other
than senior loans and second lien loans are subject to the same
risks associated with investment in senior loans, second lien
loans and non-investment grade securities. However, such loans
may rank lower in right of payment than any outstanding senior
loans and second lien loans of the borrower and therefore are
subject to additional risk that the cash flow of the borrower
and any property securing the loan may be insufficient to meet
scheduled payments after giving effect to the higher ranking
secured obligations of the borrower. Lower ranking secured loans
are expected to have greater price volatility than senior loans
and second lien loans and may be less liquid. There is also a
possibility that
11
originators will not be able to sell participations in lower
ranking secured loans, which would create greater credit risk
exposure.
Unsecured Loans Risk. Unsecured loans are
subject to the same risks associated with investment in senior
loans, second lien loans, other secured loans and non-investment
grade securities. However, because unsecured loans have lower
priority in right of payment to any higher ranking obligations
of the borrower and are not backed by a security interest in any
specific collateral, they are subject to additional risk that
the cash flow of the borrower and available assets may be
insufficient to meet scheduled payments after giving effect to
any higher ranking obligations of the borrower. Unsecured loans
are expected to have greater price volatility than senior loans,
second lien loans and other secured loans and may be less
liquid. There is also a possibility that originators will not be
able to sell participations in unsecured loans, which would
create greater credit risk exposure.
Loans other than senior loans may not be acceptable collateral
under the Acquired Funds current credit facility or under
any future credit facilities, or may require a higher
collateral-to-loan ratio, and therefore to the extent the
Acquired Fund invests in such loans its ability to borrow may be
reduced.
Risks of Investing in Obligations of Stressed, Distressed and
Bankrupt Issuers. The Acquiring Fund is
authorized to invest in the securities and other obligations of
stressed, distressed and bankrupt issuers, including debt
obligations that are in covenant or payment default. There is no
limit on the amount of the Acquiring Funds portfolio that
can be invested in stressed, distressed or bankrupt issuers, and
the Acquiring Fund may invest for purposes of control. Such
investments generally trade significantly below par and are
considered speculative. The repayment of defaulted obligations
is subject to significant uncertainties. Defaulted obligations
might be repaid only after lengthy workout or bankruptcy
proceedings, during which the issuer might not make any interest
or other payments. Typically such workout or bankruptcy
proceedings result in only partial recoveries, which may be in
the form of cash payments or an exchange of the defaulted
obligation for other debt or equity securities of the issuer or
its affiliates, which may in turn be illiquid or speculative. It
is also possible that there could be limited or no recovery for
creditors in a bankruptcy or workout.
There are a number of significant risks inherent in the
bankruptcy process, including, without limitation, those set
forth in this paragraph. First, many events in a bankruptcy are
the product of contested matters and adversary proceedings and
are beyond the control of the creditors. While creditors are
generally given an opportunity to object to significant actions,
there can be no assurance that a bankruptcy court in the
exercise of its broad powers would not approve actions that
would be contrary to the interests of the Acquiring Fund.
Second, a bankruptcy filing by an issuer may adversely and
permanently affect the issuer. The issuer may lose its market
position and key employees and otherwise become incapable of
restoring itself as a viable entity. If for this or any other
reason the proceeding is converted to a liquidation, the value
of the issuer may not equal the liquidation value that was
believed to exist at the time of the investment. Third, the
duration of a bankruptcy proceeding is difficult to predict. A
creditors return on investment can be adversely affected
by delays while the plan of reorganization is being negotiated,
approved by the creditors and confirmed by the bankruptcy court
and until it ultimately becomes effective. Fourth, the
administrative costs in connection with a bankruptcy proceeding
are frequently high and would be paid out of the debtors
estate prior to any return to creditors. For example, if a
proceeding involves protracted or difficult litigation, or turns
into a liquidation, substantial assets may be devoted to
administrative costs. Fifth, bankruptcy law permits the
classification of substantially similar claims in
determining the classification of claims in a reorganization.
Because the standard for classification is vague, there exists
the risk that the Acquiring Funds influence with respect
to the class of securities or other obligations it owns can be
lost by increases in the number and amount of claims in that
class or by different classification and treatment. Sixth, in
the early stages of the bankruptcy process it is often difficult
to estimate the extent of, or even to identify, any contingent
claims that might be made. Seventh, especially in the case of
investments made prior to the commencement of bankruptcy
proceedings, creditors can lose their ranking and priority if
they exercise domination and control over a debtor
and other creditors can demonstrate that they have been harmed
by such actions. Eighth, certain claims that have priority by
law (for example, claims for taxes) may be substantial.
In any investment involving stressed and distressed debt
obligations, there exists the risk that the transaction
involving such debt obligations will be unsuccessful, take
considerable time or will result in a
12
distribution of cash or a new security or obligation in exchange
for the stressed and distressed debt obligations, the value of
which may be less than the Acquiring Funds purchase price
of such debt obligations. Furthermore, if an anticipated
transaction does not occur, the Acquiring Fund may be required
to sell its investment at a loss. Given the substantial
uncertainties concerning transactions involving stressed and
distressed debt obligations in which the Acquiring Fund invests,
there is a potential risk of loss by the Acquiring Fund of its
entire investment in any particular investment.
Investments in companies operating in workout modes or under
Chapter 11 of the Bankruptcy Code are also, in certain
circumstances, subject to certain additional liabilities which
may exceed the value of the Acquiring Funds original
investment in a company. For example, under certain
circumstances, creditors who have inappropriately exercised
control over the management and policies of a debtor may have
their claims subordinated or disallowed or may be found liable
for damages suffered by parties as a result of such actions. The
Advisers active management style may present a greater
risk in this area than would a more passive approach. In
addition, under certain circumstances, payments to the Acquiring
Fund and distributions by the Acquiring Fund or payments on the
debt may be reclaimed if any such payment is later determined to
have been a fraudulent conveyance or a preferential payment.
The Adviser, on behalf of the Acquiring Fund (and its other
clients), may participate on committees formed by creditors to
negotiate with the management of financially troubled companies
that may or may not be in bankruptcy or may negotiate directly
with debtors with respect to restructuring issues. If the
Acquiring Fund does choose to join a committee, the Acquiring
Fund would likely be only one of many participants, all of whom
would be interested in obtaining an outcome that is in their
individual best interests. There can be no assurance that the
Acquiring Fund would be successful in obtaining results most
favorable to it in such proceedings, although the Acquiring Fund
may incur significant legal and other expenses in attempting to
do so. As a result of participation by the Acquiring Fund on
such committees, the Acquiring Fund may be deemed to have duties
to other creditors represented by the committees, which might
thereby expose the Acquiring Fund to liability to such other
creditors who disagree with the Acquiring Funds actions.
Participation by the Acquiring Fund on such committees may cause
the Acquiring Fund to be subject to certain restrictions on its
ability to trade in a particular investment and may also make
the Acquiring Fund an insider or an
underwriter for purposes of the federal securities
laws. Either circumstance will restrict the Acquiring
Funds ability to trade in or acquire additional positions
in a particular investment when it might otherwise desire to do
so.
Distressed debt obligations that are at risk of or in default
present special tax issues for the Acquiring Fund because the
U.S. federal income tax rules relating to those obligations
are currently unclear. For instance, tax rules are unclear as to
whether the Acquiring Fund should recognize market discount on
certain distressed debt obligations and, if so, the amount of
market discount the Acquiring Fund should recognize and when the
Acquiring Fund may cease to accrue interest, original issue
discount or market discount. These and other related issues will
be addressed by the Acquiring Fund when, as and if it invests in
such securities, in order to seek to ensure that it distributes
sufficient income to preserve its status as a regulated
investment company (RIC) and that it does not become
subject to Fund-level U.S. federal income
and/or
excise taxes.
Risks of Investing in High-Yield Securities. A
portion of the Acquiring Funds investments will consist of
investments that may generally be characterized as
high-yield securities or junk
securities. Such securities are typically rated below
investment grade by one or more nationally recognized
statistical rating organizations or are unrated but of
comparable credit quality to obligations rated below investment
grade, and have greater credit and liquidity risk than more
highly rated obligations. High-yield securities are generally
unsecured and may be subordinate to other obligations of the
obligor. The lower rating of high-yield securities reflects a
greater possibility that adverse changes in the financial
condition of the issuer or in general economic conditions
(including, for example, a substantial period of rising interest
rates or declining earnings) or both may impair the ability of
the issuer to make payment of principal and interest. Many
issuers of high-yield securities are highly leveraged, and their
relatively high debt to equity ratios create increased risks
that their operations might not generate sufficient cash flow to
service their obligations. Overall declines in the below
investment grade bond and other markets may adversely affect
such issuers by inhibiting their ability to refinance their
obligations at maturity.
13
High-yield securities are often issued in connection with
leveraged acquisitions or recapitalizations in which the issuers
incur a substantially higher amount of indebtedness than the
level at which they had previously operated. High-yield
securities that are debt instruments have historically
experienced greater default rates than has been the case for
investment grade securities. The Acquiring Fund may also invest
in equity securities issued by entities whose obligations are
unrated or are rated below investment grade.
The Acquiring Fund is authorized to invest in obligations of
issuers which are generally trading at significantly higher
yields than had been historically typical of the applicable
issuers obligations. Such investments may include debt
obligations that have a heightened probability of being in
covenant or payment default in the future. Such investments
generally are considered speculative. The repayment of defaulted
obligations is subject to significant uncertainties. Defaulted
obligations might be repaid only after lengthy workout or
bankruptcy proceedings, during which the issuer might not make
any interest or other payments. Typically such workout or
bankruptcy proceedings result in only partial recovery of cash
payments or an exchange of the defaulted security for other debt
or equity securities of the issuer or its affiliates, which may
in turn be illiquid or speculative.
High-yield securities purchased by the Acquiring Fund are
subject to certain additional risks to the extent that such
obligations may be unsecured and subordinated to substantial
amounts of senior indebtedness, all or a significant portion of
which may be secured. Moreover, such obligations purchased by
the Acquiring Fund may not be protected by financial covenants
or limitations upon additional indebtedness and are unlikely to
be secured by collateral.
Insolvency Considerations with Respect to Issuers of Debt
Obligations. Various laws enacted for the
protection of creditors may apply to the debt obligations held
by the Acquiring Fund. The information in this paragraph is
applicable with respect to U.S. issuers subject to United
States bankruptcy laws. Insolvency considerations may differ
with respect to other issuers. If a court in a lawsuit brought
by an unpaid creditor or representative of creditors of an
issuer of a debt obligation, such as a trustee in bankruptcy or
a creditors committee, were to find that the issuer did
not receive fair consideration or reasonably equivalent value
for incurring the indebtedness constituting the debt obligation
and, after giving effect to such indebtedness, the issuer
(i) was insolvent, (ii) was engaged in a business for
which the remaining assets of such issuer constituted
unreasonably small capital or (iii) intended to incur, or
believed that it would incur, debts beyond its ability to pay
such debts as they mature, such court could determine to
invalidate, in whole or in part, such indebtedness as a
fraudulent conveyance, to subordinate such indebtedness to
existing or future creditors of such issuer, or to recover
amounts previously paid by such issuer in satisfaction of such
indebtedness.
The measure of insolvency for purposes of the foregoing will
vary. Generally, an issuer would be considered insolvent at a
particular time if the sum of its debts were then greater than
all of its property at a fair valuation, or if the present fair
saleable value of its assets was then less than the amount that
would be required to pay its probable liabilities on its
existing debts as they became absolute and matured. There can be
no assurance as to what standard a court would apply in order to
determine whether the issuer was insolvent after
giving effect to the incurrence of the indebtedness constituting
the debt obligation or that, regardless of the method of
valuation, a court would not determine that the issuer was
insolvent upon giving effect to such incurrence. In
addition, in the event of the insolvency of an issuer of a debt
obligation, payments made on such debt obligation could be
subject to avoidance as a preference if made within
a certain period of time (which may be as long as one year)
before insolvency. Similarly, a court might apply the doctrine
of equitable subordination to subordinate the claim of a lending
institution against an issuer, to claims of other creditors of
the borrower, when the lending institution, another investor, or
any of their transferees, is found to have engaged in unfair,
inequitable, or fraudulent conduct. In general, if payments on a
debt obligation are avoidable, whether as fraudulent conveyances
or preferences, such payments can be recaptured either from the
initial recipient (such as the Fund) or from subsequent
transferees of such payments (such as the investors in the
Acquiring Fund). To the extent that any such payments are
recaptured from the Acquiring Fund the resulting loss will be
borne by the investors. However, a court in a bankruptcy or
insolvency proceeding would be able to direct the recapture of
any such payment from such a recipient or transferee only to the
extent that such court has jurisdiction over such recipient or
transferee or its assets. Moreover, it is likely that avoidable
payments could not be recaptured directly from any such
recipient or transferee that has given value in exchange for its
note, in good faith and without knowledge that the payments were
avoidable. Although the
14
Adviser will seek to avoid conduct that would form the basis for
a successful cause of action based upon fraudulent conveyance,
preference or equitable subordination, these determinations are
made in hindsight and a court could disagree with the Acquiring
Funds position, and, in any event, there can be no
assurance as to whether any lending institution or other
investor from which the Acquiring Fund acquired the debt
obligations engaged in any such conduct (or any other conduct
that would subject the debt obligations and the issuer to
insolvency laws) and, if it did, as to whether such creditor
claims could be asserted in a U.S. court (or in the courts
of any other country) against the Acquiring Fund.
Leverage Risk. The Acquiring Fund has the
ability to use leverage through the issuance of preferred
shares, borrowings from a credit facility or both. The Acquiring
Fund currently leverages through borrowings from a credit
facility and has no present intention of issuing preferred
shares. The use of leverage, which can be described as exposure
to changes in price at a ratio greater than the amount of equity
invested, either through the issuance of preferred shares,
borrowings or other forms of market exposure, magnifies both the
favorable and unfavorable effects of price movements in the
investments made by the Acquiring Fund. Insofar as the Acquiring
Fund continues to employ leverage in its investment operations,
the Acquiring Fund will be subject to substantial risks of loss.
The Acquiring Fund currently leverages through borrowings from a
credit facility. The Acquiring Fund has entered into a revolving
credit agreement with The Bank of Nova Scotia
(Scotia) to borrow up to $380,000,000 (the
Loan Agreement). Such borrowings constitute
financial leverage. The Loan Agreement contains customary
covenant, negative covenant and default provisions, including
covenants that limit the Acquiring Funds ability to,
without the prior consent of Scotia: (i) pay dividends in
certain circumstances, (ii) incur additional debt or
(iii) adopt or carry out any plan of liquidation,
reorganization, incorporation, recapitalization, merger or
consolidation or sell, transfer or otherwise dispose of all or a
substantial part of its assets. In addition, the Acquiring Fund
agreed not to purchase assets not contemplated by the investment
policies and restrictions in effect when the Loan Agreement
became effective. The prohibition on the payment of dividends or
distributions might impair the ability of the Acquiring Fund to
meet the RIC distribution requirements and to avoid Acquiring
Fund-level U.S. federal income
and/or
excise taxes. Furthermore, the Acquiring Fund may not incur
additional debt from any other party, except for in limited
circumstances (e.g., in the ordinary course of business).
In addition, the Loan Agreement contains a covenant requiring
asset coverage ratios that may be more stringent than those
required by the 1940 Act. Such restrictions shall apply only so
long as the Loan Agreement remains in effect. Any senior
security representing indebtedness, as defined in
Section 18(g) of the 1940 Act, must have asset coverage of
at least 300%. Debt incurred under the Loan Agreement will be
considered a senior security for this purpose. The Acquiring
Fund has notified Scotia regarding the proposed Reorganization
and expects to receive Scotias consent prior to the time
of closing.
Indebtedness issued under the Loan Agreement is not convertible
into any other securities of the Acquiring Fund. Outstanding
amounts would be payable at maturity or such earlier times as
required by the Loan Agreement. The Acquiring Fund may be
required to prepay outstanding amounts under the Loan Agreement
or incur a penalty rate of interest in the event of the
occurrence of certain events of default. The Acquiring Fund is
expected to indemnify the lenders under the Loan Agreement
against certain liabilities they may incur in connection with
the credit facility. The Acquiring Fund is required to pay
commitment fees under the terms of the Loan Agreement. With the
use of borrowings, there is a risk that the interest rates paid
by the Acquiring Fund on the amount it borrows will be higher
than the return on the Acquiring Funds investments. The
credit facility with Scotia may in the future be replaced or
refinanced by one or more credit facilities having substantially
different terms or by the issuance of preferred shares, or the
Acquiring Fund may be unable to renew or replace its credit
facility upon the termination of the current facility. Any of
these situations could adversely impact income or total return
to shareholders.
In order to obtain and maintain the required ratings of loans
made under the Loan Agreement or another credit facility, the
Acquiring Fund must comply with investment quality,
diversification and other guidelines established by Moodys
and/or
S&P and the credit facility, respectively. The Acquiring
Fund does not anticipate that such guidelines will have a
material adverse effect on the Acquiring Funds common
shareholders or its ability to achieve its investment
objectives. Moodys and S&P receive fees in connection
with their ratings issuances.
15
The Acquired Fund also has the ability to use leverage through
the issuance of preferred shares, borrowings from a credit
facility or both. The Acquired Fund is allowed to borrow amounts
such that its asset coverage, as defined in the 1940 Act, is at
least 200% after such borrowing. The Acquired Fund currently
leverages through borrowings from a credit facility. The credit
facility imposes stricter limitations than the 1940 Act,
requiring generally that asset coverage be at least 300% after a
borrowing. Please see Additional Information Related to
the Reorganization of the Acquired Fund Description
of Capital Stock Acquired Fund Credit
Facility for a description of the credit facility.
Preferred Share Risk. Preferred share risk is
the risk associated with the issuance of the preferred shares by
the Acquiring Fund to leverage the common shares. If preferred
shares are issued, the NAV and market value of the common shares
will be more volatile, and the yield to the holders of common
shares will tend to fluctuate with changes in the shorter-term
dividend rates on the preferred shares. The Acquiring Fund will
pay (and the holders of common shares will bear) all costs and
expenses relating to the issuance and ongoing maintenance of the
preferred shares, including higher advisory fees. Accordingly,
the Acquiring Fund cannot assure common shareholders that the
issuance of preferred shares will result in a higher yield or
return to the holders of the common shares. If the dividend rate
and other costs of the preferred shares approach the net rate of
return on the Acquiring Funds investment portfolio, the
benefit of leverage to the holders of the common shares would be
reduced. If the dividend rate and other costs of the preferred
shares exceed the net rate of return on the Acquiring
Funds portfolio, the leverage will result in a lower rate
of return to the holders of common shares than if the Acquiring
Fund had not issued preferred shares.
Similarly, any decline in the NAV of the Acquiring Funds
investments will be borne entirely by the holders of common
shares. Therefore, if the market value of the Acquiring
Funds portfolio declines, the leverage will result in a
greater decrease in NAV to the holders of common shares than if
the Acquiring Fund were not leveraged. This greater NAV decrease
will also tend to cause a greater decline in the market price
for the common shares. The Acquiring Fund might be in danger of
failing to maintain the required asset coverage of the preferred
shares or of losing its ratings on the preferred shares or, in
an extreme case, the Acquiring Funds current investment
income might not be sufficient to meet the dividend requirements
on the preferred shares. In order to counteract such an event,
the Acquiring Fund might need to liquidate investments in order
to fund a redemption of some or all of the preferred shares.
Liquidation at times of low prices may result in capital loss
and may reduce returns to the holders of common shares.
If preferred shares are issued, holders of preferred shares may
have differing interests than holders of common shares and
holders of preferred shares may at times have disproportionate
influence over the Acquiring Funds affairs. If preferred
shares are issued, holders of preferred shares, voting
separately as a single class, would have the right to elect two
members of the board of trustees at all times. The remaining
members of the board of trustees would be elected by holders of
common shares and preferred shares, voting as a single class.
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,
voting separately as a class, would be required to
(i) adopt any plan of reorganization that would adversely
affect the preferred shares and (ii) take any action
requiring a vote of security holders under Section 13(a) of
the 1940 Act, including, among other things, changes in the
Acquiring Funds subclassification as a closed-end
investment company or changes in its fundamental investment
restrictions.
The Acquiring Fund anticipates that any preferred shares that it
issues would be initially given the highest ratings by
Moodys (Aaa) or by S&P (AAA),
but no assurance can be given that such ratings will be
obtained. No minimum rating is required for the issuance of
preferred shares by the Acquiring Fund.
Common Stock Risk. The Acquiring Fund will
have exposure to common stocks. Although common stocks have
historically generated higher average total returns than fixed
income securities over the long-term, common stocks also have
historically experienced significantly more volatility in those
returns. Therefore, the Acquiring Funds exposure to common
stocks could result in worse performance than would be the case
had the Acquiring Fund been invested solely in debt securities.
An adverse event, such as an unfavorable earnings report, may
depress the value of a particular common stock held by the
Acquiring Fund. Also, the price of common stock is sensitive to
general movements in the stock market and a drop in the stock
market may depress the price of a common stock to which the
Acquiring Fund has exposure. Common stock prices
16
fluctuate for several reasons, including changes in
investors perceptions of the financial condition of an
issuer or the general condition of the relevant stock market, or
when political or economic events affecting an issuer occur. In
addition, common stock prices may be particularly sensitive to
rising interest rates, as the cost of capital rises and
borrowing costs increase.
Dividend Risk. Dividends on common stock are
not fixed but are declared at the discretion of an issuers
board of directors. There is no guarantee that the issuers of
the common stocks in which the Acquiring Fund invests will
declare dividends in the future or that, if declared, the
dividends will remain at current levels or increase over time.
Small and Mid-Cap Securities Risk. The
Acquiring Fund may invest in companies with small or
medium-sized capitalizations. Securities issued by small and
medium-sized companies can be more volatile than, and perform
differently from, larger company securities. There may be less
trading in a small or medium-sized companys securities,
which means that buy and sell transactions in those securities
could have a larger impact on the securitys price than is
the case with larger company securities. Small or medium-sized
companies may have fewer business lines; changes in any one line
of business, therefore, may have a greater impact on a small or
medium-sized companys security price than is the case for
a larger company. In addition, small or medium-sized company
securities may not be well known to the investing public.
Non-U.S. Securities
Risk. Both the Acquired Fund and the Acquiring
Fund may invest up to 20% of its total assets in
non-U.S. securities,
including emerging market securities. Investing in
non-U.S. securities
involves certain risks not involved in domestic investments,
including, but not limited to: (i) fluctuations in foreign
exchange rates; (ii) future foreign economic, financial,
political and social developments; (iii) different legal
systems; (iv) the possible imposition of exchange controls
or other foreign governmental laws or restrictions;
(v) lower trading volume; (vi) much greater price
volatility and illiquidity of certain
non-U.S. securities
markets; (vii) different trading and settlement practices;
(viii) less governmental supervision; (ix) changes in
currency exchange rates; (x) high and volatile rates of
inflation; (xi) fluctuating interest rates; (xii) less
publicly available information; and (xiii) different
accounting, auditing and financial recordkeeping standards and
requirements.
Certain countries in which the Acquiring Fund may invest,
especially emerging market countries, historically have
experienced, and may continue to experience, high rates of
inflation, high interest rates, exchange rate fluctuations,
large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. Many of these
countries are also characterized by political uncertainty and
instability. These risks are especially evident in the Middle
East and Africa. The cost of servicing external debt will
generally be adversely affected by rising international interest
rates because many external debt obligations bear interest at
rates which are adjusted based upon international interest
rates. In addition, with respect to certain foreign countries,
there is a risk of: (i) the possibility of expropriation or
nationalization of assets; (ii) confiscatory taxation;
(iii) difficulty in obtaining or enforcing a court
judgment; (iv) economic, political or social instability;
and (v) diplomatic developments that could affect
investments in those countries. In addition, individual foreign
economies may differ favorably or unfavorably from the
U.S. economy in such respects as: (i) growth of gross
domestic product; (ii) rates of inflation;
(iii) capital reinvestment; (iv) resources;
(v) self-sufficiency; and (vi) balance of payments
position.
As a result of these potential risks, Highland may determine
that, notwithstanding otherwise favorable investment criteria,
it may not be practicable or appropriate to invest in a
particular country. The Acquiring Fund may invest in countries
in which foreign investors, including Highland, have had no or
limited prior experience.
Emerging Markets Risk. Both the Acquired Fund
and the Acquiring Fund may invest up to 20% of its total assets
in securities of issuers based in emerging markets. Investing in
securities of issuers based in emerging markets entails all of
the risks of investing in securities of
non-U.S. issuers,
but to a heightened degree. Emerging market countries generally
include every nation in the world except the United States,
Canada, Japan, Australia, New Zealand and most countries located
in Western Europe. These heightened risks include:
(i) greater risks of expropriation, confiscatory taxation,
nationalization, and less social, political and economic
stability; (ii) the smaller size of the markets for such
securities and a lower volume of trading, resulting in lack of
liquidity and in price volatility; and (iii) certain
national policies which may restrict the
17
Acquiring Funds investment opportunities including
restrictions on investing in issuers or industries deemed
sensitive to relevant national interests.
Foreign Currency Risk. Because the Acquiring
Fund may invest in securities denominated or quoted in
currencies other than the U.S. dollar, changes in foreign
currency exchange rates may affect the value of securities owned
by the Acquiring Fund, the unrealized appreciation or
depreciation of investments and gains on and income from
investments. Currencies of certain countries may be volatile and
therefore may affect the value of securities denominated in such
currencies, which means that the Acquiring Funds NAV could
decline as a result of changes in the exchange rates between
foreign currencies and the U.S. dollar. These risks often
are heightened for investments in smaller or emerging capital
markets. In addition, the Acquiring Fund may enter into foreign
currency transactions in an attempt to enhance total return
which may further expose the Acquiring Fund to the risks of
foreign currency movements and other risks. The use of foreign
currency transactions can result in the Acquiring Fund incurring
losses as a result of the imposition of exchange controls,
suspension of settlements or the inability of the Acquiring Fund
to deliver or receive a specified currency.
Investments in Unseasoned Companies. The
Acquiring Fund may invest in the securities of less seasoned
companies. These investments may present greater opportunities
for growth, but also involve greater risks than customarily are
associated with investments in securities of more established
companies. Some of the companies in which the Acquiring Fund may
invest will be
start-up
companies which may have insubstantial operational or earnings
history or may have limited products, markets, financial
resources or management depth. Some may also be emerging
companies at the research and development stage with no products
or technologies to market or approved for marketing. Securities
of emerging companies may lack an active secondary market and
may be subject to more abrupt or erratic price movements than
securities of larger, more established companies or stock market
averages in general. Competitors of certain companies may have
substantially greater financial resources than many of the
companies in which the Acquiring Fund may invest.
Initial Public Offerings Risk. The Acquiring
Fund may invest in shares of companies through initial public
offerings (IPOs). IPOs and companies that have
recently gone public have the potential to produce substantial
gains for the Acquiring Fund. However, there is no assurance
that the Acquiring Fund will have access to profitable IPOs. The
investment performance of the Acquiring Fund during periods when
it is unable to invest significantly or at all in IPOs may be
lower than during periods when the Acquiring Fund is able to do
so. Securities issued in IPOs are subject to many of the same
risks as investing in companies with smaller market
capitalizations. Securities issued in IPOs have no trading
history, and information about the companies may be available
for limited periods of time. In addition, the prices of
securities sold in IPOs may be highly volatile or may decline
shortly after the IPO.
Securities Lending Risk. The Acquiring Fund
may lend its portfolio securities (up to a maximum of one-third
of its total assets) to banks or dealers which are determined by
the Adviser to present acceptable credit risk to the Acquiring
Fund. Securities lending is subject to the risk that loaned
securities may not be available to the Acquiring Fund on a
timely basis and the Acquiring Fund may, therefore, lose the
opportunity to sell the securities at a desirable price. Any
loss in the market price of securities loaned by the Acquiring
Fund that occurs during the term of the loan would be borne by
the Acquiring Fund and would adversely affect the Acquiring
Funds performance. Also, there may be delays in recovery,
or no recovery, of securities loaned should the borrower of the
securities fail financially while the loan is outstanding.
Although the Acquiring Fund generally has the ability to recall
loaned securities pursuant to a securities lending arrangement
in the event that a shareholder vote is held, there is a risk
that any delay in recovery of such security will result in the
holder of such security being unable to vote. All of the
aforementioned risks may be greater for
non-U.S. securities.
These lending transactions must be fully collateralized at all
times, but involve some credit risk to the Acquiring Fund if the
borrower or the party (if any) guaranteeing the loan should
default on its obligation and the Acquiring Fund is delayed in
or prevented from recovering the collateral. In addition, any
income or gains and losses from investing and reinvesting any
cash collateral delivered by a borrower pursuant to a loan are
generally at the Acquiring Funds risk, and to the extent
any such losses reduce the amount of cash below the amount
required to be returned to the borrower upon the termination of
any loan, the Acquiring Fund may be required to pay or cause to
be paid to such borrower or another entity an amount equal to
such shortfall in cash.
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Risks Associated with Options on
Securities. There are several risks associated
with transactions in options on securities, such as
exchange-listed, over-the-counter and index options. For
example, there are significant differences between the
securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction
not to achieve its objectives. A decision as to whether, when
and how to use options involves the exercise of skill and
judgment, and even a well conceived transaction may be
unsuccessful to some degree because of market behavior or
unexpected events.
As the writer of a covered call option, the Acquiring Fund
forgoes, during the options life, the opportunity to
profit from increases in the market value of the security
covering the call option above the sum of the premium and the
strike price of the call, but has retained the risk of loss
should the price of the underlying security decline. As the
Acquiring Fund writes covered calls over more of its portfolio,
its ability to benefit from capital appreciation becomes more
limited. The writer of an option has no control over the time
when it may be required to fulfill its obligation as a writer of
the option. Once an option writer has received an exercise
notice, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver
the underlying security at the exercise price.
When the Acquiring Fund writes covered put options, it bears the
risk of loss if the value of the underlying stock declines below
the exercise price minus the put premium. If the option is
exercised, the Acquiring Fund could incur a loss if it is
required to purchase the stock underlying the put option at a
price greater than the market price of the stock at the time of
exercise plus the put premium the Acquiring Fund received when
it wrote the option. While the Acquiring Funds potential
gain in writing a covered put option is limited to distributions
earned on the liquid assets securing the put option plus the
premium received from the purchaser of the put option, the
Acquiring Fund risks a loss equal to the entire exercise price
of the option minus the put premium.
Exchange-Listed Option Risks. There can be no
assurance that a liquid market will exist when the Acquiring
Fund seeks to close out an option position on an options
exchange. Reasons for the absence of a liquid secondary market
on an exchange include the following: (i) there may be
insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading
halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options;
(iv) unusual or unforeseen circumstances may interrupt
normal operations on an exchange; (v) the facilities of an
exchange or the Options Clearing Corporation may not at all
times be adequate to handle current trading volume; or
(vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to
discontinue the trading of options (or a particular class or
series of options). If trading were discontinued, the secondary
market on that exchange (or in that class or series of options)
would cease to exist. However, outstanding options on that
exchange that had been issued by the Options Clearing
Corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms. If
the Acquiring Fund were unable to close out a covered call
option that it had written on a security, it would not be able
to sell the underlying security unless the option expired
without exercise.
The hours of trading for options on an exchange may not conform
to the hours during which the underlying securities are traded.
To the extent that the options markets close before the markets
for the underlying securities, significant price and rate
movements can take place in the underlying markets that cannot
be reflected in the options markets. Call options are marked to
market daily and their value will be affected by changes in the
value and dividend rates of the underlying common stocks, an
increase in interest rates, changes in the actual or perceived
volatility of the stock market and the underlying common stocks
and the remaining time to the options expiration.
Additionally, the exercise price of an option may be adjusted
downward before the options expiration as a result of the
occurrence of certain corporate events affecting the underlying
equity security, such as extraordinary dividends, stock splits,
merger or other extraordinary distributions or events. A
reduction in the exercise price of a call option would written
by the Acquiring Fund reduce the Acquiring Funds capital
appreciation potential on the underlying security.
Over-the-Counter Option Risk. The Acquiring
Fund may write (sell) unlisted (OTC or
over-the-counter) options. Options written by the
Acquiring Fund with respect to
non-U.S. securities,
indices or sectors generally will be OTC options. OTC options
differ from exchange-listed options in that they are two-party
19
contracts, with exercise price, premium and other terms
negotiated between buyer and seller, and generally do not have
as much market liquidity as exchange-listed options. The
counterparties to these transactions typically will be major
international banks, broker-dealers and financial institutions.
The Acquiring Fund may be required to treat as illiquid those
securities being used to cover certain written OTC options. The
OTC options written by the Acquiring Fund will not be issued,
guaranteed or cleared by the Options Clearing Corporation. In
addition, the Acquiring Funds ability to terminate the OTC
options may be more limited than with exchange-traded options.
Banks, broker-dealers or other financial institutions
participating in such transactions may fail to settle a
transaction in accordance with the terms of the option as
written. In the event of default or insolvency of the
counterparty, the Acquiring Fund may be unable to liquidate an
OTC option position.
Index Option Risk. The Acquiring Fund may sell
index put and call options from time to time. The purchaser of
an index put option has the right to any depreciation in the
value of the index below the exercise price of the option on or
before the expiration date. The purchaser of an index call
option has the right to any appreciation in the value of the
index over the exercise price of the option on or before the
expiration date. Because the exercise of an index option is
settled in cash, sellers of index call options, such as the
Acquiring Fund, cannot provide in advance for their potential
settlement obligations by acquiring and holding the underlying
securities. The Acquiring Fund will lose money if it is required
to pay the purchaser of an index option the difference between
the cash value of the index on which the option was written and
the exercise price and such difference is greater than the
premium received by the Acquiring Fund for writing the option.
The value of index options written by the Acquiring Fund, which
will be priced daily, will be affected by changes in the value
and dividend rates of the underlying common stocks in the
respective index, changes in the actual or perceived volatility
of the stock market and the remaining time to the options
expiration. The value of the index options also may be adversely
affected if the market for the index options becomes less liquid
or smaller. Distributions paid by the Acquiring Fund on its
common shares may be derived in part from the net index option
premiums it receives from selling index put and call options,
less the cost of paying settlement amounts to purchasers of the
options that exercise their options. Net index option premiums
can vary widely over the short term and long term.
Interest Rate Risk. Interest rate risk is the
risk that debt securities, and the Acquiring Funds net
assets, may decline in value because of changes in interest
rates. Generally, fixed rate debt securities will decrease in
value when interest rates rise and increase in value when
interest rates decline. This means that the NAV of the common
shares will fluctuate with interest rate changes and the
corresponding changes in the value of the Acquiring Funds
debt security holdings.
Prepayment Risk. If interest rates fall, the
principal on bonds and loans held by the Acquiring Fund may be
paid earlier than expected. If this happens, the proceeds from a
prepaid security may be reinvested by the Acquiring Fund in
securities bearing lower interest rates, resulting in a possible
decline in the Acquiring Funds income and distributions to
shareholders. The Acquiring Fund may invest in pools of
mortgages or other assets issued or guaranteed by private
issuers or U.S. government agencies and instrumentalities.
Asset-Backed Securities Risk. Payment of
interest and repayment of principal on asset-backed securities
may be largely dependent upon the cash flows generated by the
assets backing the securities and, in certain cases, supported
by letters of credit, surety bonds or other credit enhancements.
Asset-backed security values may also be affected by the
creditworthiness of the servicing agent for the pool, the
originator of the loans or receivables or the entities providing
the credit enhancement. In addition, the underlying assets are
subject to prepayments that shorten the securities
weighted average maturity and may lower their return.
Mortgage-Backed Securities Risk. A
mortgage-backed security, which represents an interest in a pool
of assets such as mortgage loans, will mature when all the
mortgages in the pool mature or are prepaid. Therefore,
mortgage-backed securities do not have a fixed maturity, and
their expected maturities may vary when interest rates rise or
fall.
When interest rates fall, homeowners are more likely to prepay
their mortgage loans. An increased rate of prepayments on the
Acquiring Funds mortgage-backed securities will result in
an unforeseen loss of interest income to the Acquiring Fund as
the Acquiring Fund may be required to reinvest assets at a lower
interest rate. Because prepayments increase when interest rates
fall, the price of mortgage-backed securities does not increase
as much as that of other fixed income securities when interest
rates fall.
20
When interest rates rise, homeowners are less likely to prepay
their mortgage loans. A decreased rate of prepayments lengthens
the expected maturity of a mortgage-backed security. Therefore,
the prices of mortgage-backed securities may decrease more than
prices of other fixed income securities when interest rates rise.
Timely payment of interest and principal of mortgage backed
securities may be supported by various forms of private
insurance or guarantees, including individual loan, title, pool
and hazard insurance purchased by the issuer. There can be no
assurance that the private insurers can meet their obligations
under the policies. An unexpectedly high rate of defaults on the
mortgages held by a mortgage pool may adversely affect the value
of a mortgage backed security and could result in losses to the
Acquiring Fund. The risk of such defaults is generally higher in
the case of mortgage pools that include sub-prime or
Alt-A mortgages. These types of mortgages are made
to borrowers with weakened credit histories or with a lower
capacity to make timely payments on their mortgages. Market
factors adversely affecting mortgage loan repayments may include
a general economic downturn, high unemployment, a general
slowdown in the real estate market, a drop in the market prices
of real estate, or an increase in interest rates resulting in
higher mortgage payments by holders of adjustable rate mortgages.
The market for mortgage-backed and asset-backed securities has
recently experienced high volatility and a lack of liquidity. As
a result, the value of many of these securities has
significantly declined. There can be no assurance that these
markets will become more liquid or less volatile, and it is
possible that the value of these securities could decline
further.
Repurchase Agreement Risk. The Acquiring Fund
may enter into repurchase agreements up to a maximum of
331/3%
of its total assets. Repurchase agreements may be considered
loans to the seller, collateralized by the underlying
securities. The risk to the Acquiring Fund is limited to the
ability of the seller to pay the
agreed-upon
sum on the repurchase date; in the event of default, the
repurchase agreement provides that the Acquiring Fund is
entitled to sell the underlying collateral. If the value of the
collateral declines after the agreement is entered into, and if
the seller defaults under a repurchase agreement when the value
of the underlying collateral is less than the repurchase price,
the Acquiring Fund could incur a loss of both principal and
interest. If the seller were to be subject to a federal
bankruptcy proceeding, the ability of the Acquiring Fund to
liquidate the collateral could be delayed or impaired because of
certain provisions of the bankruptcy laws.
Credit Default Swaps Risk. Credit default
swaps involve greater risks than if the Acquiring Fund had
invested in the reference obligation directly. In addition to
general market risks, credit default swaps are subject to
illiquidity risk, counterparty risk and credit risks. The
Acquiring Fund will enter into swap agreements only with
counterparties which the Adviser believes to be creditworthy. A
buyer also will lose its investment and recover nothing should
no event of default occur. If an event of default were to occur,
the value of the reference obligation received by the seller,
coupled with the periodic payments previously received, may be
less than the full notional value it pays to the buyer,
resulting in a loss of value to the seller. When the Acquiring
Fund acts as a seller of a credit default swap agreement it is
exposed to many of the same risks of leverage described under
Leverage Risk since if an event of default occurs
the seller generally must pay the buyer the full notional value
of the reference obligation. There is no percentage limitation
on the Acquiring Funds investments in credit default swaps.
Derivatives Risk. Derivative transactions in
which the Acquiring Fund may engage for hedging and speculative
purposes or to enhance total return, including engaging in
transactions such as options, futures, swaps, foreign currency
transactions, forward foreign currency contracts, currency swaps
or options on currency futures and other derivatives
transactions (collectively, Derivative
Transactions), involve certain risks and special
considerations. Derivative Transactions have risks, including
the imperfect correlation between the value of such instruments
and the underlying assets, the possible default of the other
party to the transaction or illiquidity of the derivative
instruments. Furthermore, the ability to successfully use
Derivative Transactions depends on the Advisers ability to
predict pertinent market movements, which cannot be assured.
Because many derivatives are leveraged, and thus
provide significantly more market exposure than the money paid
or deposited when the transaction is entered into, a relatively
small adverse market movement can not only result in the loss of
the entire investment, but may also expose the Acquiring Fund to
the possibility of a loss exceeding the original amount
invested. Thus, the use of Derivative Transactions may result in
losses
21
greater than if they had not been used, may require the
Acquiring Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market
values, may limit the amount of appreciation the Acquiring Fund
can realize on an investment or may cause the Acquiring Fund to
hold a security that it might otherwise sell. The use of foreign
currency transactions can result in the Acquiring Funds
incurring losses as a result of the imposition of exchange
controls, the suspension of settlements or the inability of the
Acquiring Fund to deliver or receive a specified currency.
Additionally, amounts paid by the Acquiring Fund as premiums and
cash or other assets held in margin accounts with respect to
Derivative Transactions are not otherwise available to the
Acquiring Fund for investment purposes. In addition, the
Acquiring Funds Derivative Transactions are generally
subject to numerous special and complex tax rules. Because the
tax rules applicable to such transactions may be uncertain under
current law, an adverse determination or future Internal Revenue
Service (IRS) guidance with respect to these rules
may affect whether the Acquiring Fund has made sufficient
distributions, and otherwise satisfied the relevant
requirements, to maintain its qualification as a RIC and avoid
Fund-level U.S. federal income
and/or
excise taxes. Therefore, the Acquiring Funds investments
in derivative instruments may be limited by these or other
U.S. federal income tax considerations.
If a put or call option purchased by the Acquiring Fund is not
sold when it has remaining value, and if the market price of the
underlying security remains equal to or greater than the
exercise price (in the case of a put), or remains less than or
equal to the exercise price (in the case of a call), the
Acquiring Fund will lose its entire investment in the option.
Also, where a put or call option on a particular security is
purchased to hedge against price movements in a related
security, the price of the put or call option may move more or
less than the price of the related security. If restrictions on
exercise were imposed, the Acquiring Fund might be unable to
exercise an option it had purchased. If the Acquiring Fund were
unable to close out an option that it had purchased on a
security, it would have to exercise the option in order to
realize any profit or the option may expire worthless.
Counterparty Risk. The Acquiring Fund will be
subject to credit risk with respect to the counterparties to the
derivative contracts purchased or sold by the Acquiring Fund. If
a counterparty becomes bankrupt, or otherwise fails to perform
its obligations under a derivative contract due to financial
difficulties, the Acquiring Fund may experience significant
delays in obtaining any recovery under the derivative contract
in a bankruptcy or other reorganization proceeding. The
Acquiring Fund may obtain only a limited recovery or may obtain
no recovery in such circumstances.
Market Risk Generally. The profitability of a
significant portion of the Acquiring Funds investment
program depends to a great extent upon correctly assessing the
future course of the price movements of securities and other
investments and the movements of interest rates. There can be no
assurance that the Adviser will be able to predict accurately
these price and interest rate movements. With respect to certain
investment strategies the Acquiring Fund utilizes, there is a
high degree of market risk.
Reinvestment Risk. The Acquiring Fund
reinvests the cash flows received from a security. The
additional income from such reinvestment, sometimes called
interest-on-interest,
is reliant on the prevailing interest rate levels at the time of
reinvestment. There is a risk that the interest rate at which
interim cash flows can be reinvested will fall. Reinvestment
risk is greater for longer holding periods and for securities
with large, early cash flows such as high-coupon bonds.
Reinvestment risk also applies generally to the reinvestment of
the proceeds the Acquiring Fund receives upon the maturity or
sale of a portfolio security.
Timing Risk. Many agency, corporate and
municipal bonds, and most mortgage-backed securities, contain a
provision that allows the issuer to call all or part
of the issue before the bonds maturity date
often after 5 or 10 years. The issuer usually retains the
right to refinance the bond in the future if market interest
rates decline below the coupon rate. There are three
disadvantages to the call provision. First, the cash flow
pattern of a callable bond is not known with certainty. Second,
because an issuer is more likely to call the bonds when interest
rates have dropped, the Acquiring Fund is exposed to
reinvestment risk, i.e., the Acquiring Fund may have to reinvest
at lower interest rates the proceeds received when the bond is
called. Finally, the capital appreciation potential of a bond
will be reduced because the price of a callable bond may not
rise much above the price at which the issuer may call the bond.
Inflation Risk. Inflation risk results from
the variation in the value of cash flows from a security due to
inflation, as measured in terms of purchasing power. For
example, if the Acquiring Fund purchases a bond in
22
which it can realize a coupon rate of 5%, but the rate of
inflation increases from 2% to 6%, then the purchasing power of
the cash flow has declined. For all but adjustable bonds or
floating rate bonds, the Acquiring Fund is exposed to inflation
risk because the interest rate the issuer promises to make is
fixed for the life of the security. To the extent that interest
rates reflect the expected inflation rate, floating rate bonds
have a lower level of inflation risk. In addition, during any
periods of rising inflation, dividend rates of any variable rate
preferred shares issued by the Fund would likely increase, which
would tend to further reduce returns to common shareholders.
Arbitrage Risks. The Acquiring Fund engages in
capital structure arbitrage and other arbitrage strategies.
Arbitrage strategies entail various risks including the risk
that external events, regulatory approvals and other factors
will impact the consummation of announced corporate events
and/or the
prices of certain positions. In addition, hedging is an
important feature of capital structure arbitrage. There is no
guarantee that the Adviser will be able to hedge the Acquiring
Funds portfolio in the manner necessary to employ
successfully the Acquiring Funds strategy. The general
risks of using arbitrage strategies do not apply to the Acquired
Fund since it generally does not use arbitrage strategies.
Short Sales Risk. Short selling involves
selling securities which may or may not be owned and borrowing
the same securities for delivery to the purchaser, with an
obligation to replace the borrowed securities at a later date.
Short selling allows the Acquiring Fund to profit from declines
in market prices to the extent such decline exceeds the
transaction costs and the costs of borrowing the securities.
However, since the borrowed securities must be replaced by
purchases at market prices in order to close out the short
position, any appreciation in the price of the borrowed
securities would result in a loss. There can be no assurance
that the securities necessary to cover a short position will be
available for purchase. Purchasing securities to close out the
short position can itself cause the price of the securities to
rise further, thereby exacerbating the loss. The Acquiring Fund
may mitigate such losses by replacing the securities sold short
before the market price has increased significantly. Under
adverse market conditions, the Acquiring Fund might have
difficulty purchasing securities to meet its short sale delivery
obligations, and might have to sell portfolio securities to
raise the capital necessary to meet its short sale obligations
at a time when fundamental investment considerations would not
favor such sales. Short sales by the Acquiring Fund that are not
made against the box theoretically involve unlimited
loss potential since the market price of securities sold short
may continuously increase. The general risks of using short
sales do not apply to the Acquired Fund since it generally does
not use short sales.
Risks of Investing in Structured Finance
Securities. A portion of the Acquiring
Funds investments may consist of collateralized mortgage
obligations, collateralized bond obligations, collateralized
loan obligations or similar instruments. Structured finance
securities may present risks similar to those of the other types
of debt obligations in which the Acquiring Fund may invest and,
in fact, such risks may be of greater significance in the case
of structured finance securities. Moreover, investing in
structured finance securities may entail a variety of unique
risks. Among other risks, structured finance securities may be
subject to prepayment risk. In addition, the performance of a
structured finance security will be affected by a variety of
factors, including the securitys priority in the capital
structure of the issuer thereof, the availability of any credit
enhancement, the level and timing of payments and recoveries on
and the characteristics of the underlying receivables, loans or
other assets that are being securitized, remoteness of those
assets from the originator or transferor, the adequacy of and
ability to realize upon any related collateral and the
capability of the servicer of the securitized assets. In
addition, the complex structure of the security may not be fully
understood at the time of investment and may produce unexpected
investment results. Investments in structured finance securities
may also be subject to illiquidity risk. Collateralized mortgage
obligations may have risks similar to those of mortgage-backed
securities. See Mortgage-Backed Securities Risk for
more information.
Risks of Investing in Preferred
Securities. There are special risks associated
with investing in preferred securities, including:
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Deferral. Preferred securities may include
provisions that permit the issuer, at its discretion, to defer
distributions for a stated period without any adverse
consequences to the issuer. If the Acquiring Fund owns a
preferred security that is deferring the payment of its
distributions, the Acquiring Fund may be required to report
income for U.S. federal income tax purposes to the extent
of any such deferred
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distribution even though the Acquiring Fund has not yet received
such income. In order to receive the special treatment accorded
to RICs and their shareholders under the Code and to avoid
U.S. federal income
and/or
excise taxes at the Acquiring Fund level, the Acquiring Fund may
be required to distribute this reported income to shareholders
in the tax year in which the income is reported (without a
corresponding receipt of cash). Therefore, the Acquiring Fund
may be required to pay out as an income distribution in any such
tax year an amount greater than the total amount of income the
Acquiring Fund actually received, and to sell portfolio
securities to obtain cash needed for these income distributions.
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Subordination. Preferred securities are
subordinated to bonds and other debt instruments in a
companys capital structure in terms of priority to
corporate income and liquidation payments, and therefore will be
subject to greater credit risk than more senior debt instruments.
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Liquidity. Preferred securities may be
substantially less liquid than many other securities, such as
common stock or U.S. government securities.
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Limited Voting Rights. Generally, preferred
security holders have no voting rights with respect to the
issuing company unless preferred dividends have been in arrears
for a specified number of periods, at which time the preferred
security holders may elect a number of directors to the
issuers board. Generally, once all the arrearages have
been paid, the preferred security holders no longer have voting
rights.
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Risks of Investing in Synthetic Securities. In
addition to credit risks associated with holding non-investment
grade loans and high-yield debt securities, with respect to
synthetic securities the Acquiring Fund will usually have a
contractual relationship only with the counterparty of such
synthetic securities, and not the Reference Obligor (as defined
below) on the Reference Obligation (as defined below). The
Acquiring Fund generally will have no right to enforce directly
compliance by the Reference Obligor with the terms of the
Reference Obligation nor any rights of setoff against the
Reference Obligor, nor have any voting rights with respect to
the Reference Obligation. The Acquiring Fund will not benefit
directly from any collateral supporting the Reference Obligation
or have the benefit of the remedies on default that would
normally be available to a holder of such Reference Obligation.
In addition, in the event of insolvency of its counterparty, the
Acquiring Fund will be treated as a general creditor of such
counterparty and will not have any claim with respect to the
credit risk of the counterparty as well as that of the Reference
Obligor. As a result, investments in synthetic securities are
subject to an additional degree of risk because they are subject
to the credit risk of the counterparty as well as that of the
Reference Obligor. The Adviser may not perform independent
credit analyses of any particular counterparty, or any entity
guaranteeing the obligations of such counterparty. A
Reference Obligation is the debt security or other
obligation upon which the synthetic security is based. A
Reference Obligor is the obligor on a Reference
Obligation. There is no maximum amount of the Acquiring
Funds assets that may be invested in these securities.
Valuation Risk. Fair value is defined as the
amount for which assets could be sold in an orderly disposition
over a reasonable period of time, taking into account the nature
of the asset. Fair value pricing, however, involves judgments
that are inherently subjective and inexact, since fair valuation
procedures are used only when it is not possible to be sure what
value should be attributed to a particular asset or when an
event will affect the market price of an asset and to what
extent. Currently, the Acquiring Fund does not utilize Sterling
Valuation Group, Inc. for its quarterly valuation. Instead it
relies upon the Adviser for fair value pricing. There can be no
assurance that fair value pricing will reflect actual market
value and it is possible that the fair value determined for a
security will be materially different from the value that
actually could be or is realized upon the sale of that asset.
Although the valuation policies of the Acquired Fund and
Acquiring Fund are substantially similar, the valuation policy
of the Acquired Fund requires its Board and the Funds
Valuation Committee to consider both the fair value assigned by
the Acquired Funds investment adviser and that supplied by
an independent valuation firm (currently, Sterling Valuation
Group, Inc., as indicated above) the Board has engaged for the
valuation of securities for which market quotations are not
readily available. The Acquiring Funds Board is not
required to consider valuation provided by independent valuation
firm. It is possible that the fair value pricing of a security
could differ under the two policies; however, Highland expects
the values of Acquired Fund assets that are fair valued will not
change as a result of the application of the Acquiring
Funds fair valuation policies.
24
Market Disruption and Geopolitical Risk. The
aftermath of the war in Iraq and the continuing occupation of
Iraq, instability in the Middle East and terrorist attacks in
the United States and around the world may result in market
volatility and may have long-term effects on the U.S. and
worldwide financial markets and may cause further economic
uncertainties in the United States and worldwide. The Adviser
does not know how long the securities markets may be affected by
these events and cannot predict the effects of the occupation or
similar events in the future on the U.S. economy and
securities markets.
Risks of Investing in a Fund with Anti-Takeover
Provisions. The Acquiring Funds Agreement
and Declaration of Trust includes provisions that could limit
the ability of other entities or persons to acquire control of
the Acquiring Fund or convert the Acquiring Fund to open-end
status. These provisions could deprive the holders of common
shares of opportunities to sell their common shares at a premium
over the then current market price of the common shares or at
NAV.
Key Adviser Personnel Risk. The Acquiring
Funds ability to identify and invest in attractive
opportunities is dependent upon Highland, its investment
adviser. If one or more key individuals leaves Highland,
Highland may not be able to hire qualified replacements or may
require an extended time to do so. This situation could prevent
the Acquiring Fund from achieving its investment objectives.
Given the risks described above, an investment in the common
shares of the Acquiring Fund may not be appropriate for all
investors. You should carefully consider your ability to assume
these risks before making an investment in the Acquiring Fund.
There are no restrictions on the Acquiring Funds ability
to pay dividends with respect to any class of securities. See
Information About the Funds: Dividends and Other
Distributions for more information.
DESCRIPTION
OF THE REORGANIZATION
You are being asked to approve an Agreement and Plan of Merger
and Liquidation to which your Fund is a party, a form of which
is attached to this Proxy Statement/Prospectus as
Appendix A (the Agreement). Additional
information about the Reorganization and Agreement is set forth
below under Further Information on the
Reorganization. The Agreement provides for Reorganization
on the following terms:
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Pursuant to the Reorganization, Acquired Fund will merge with
and into HCF Acquisition LLC, a wholly owned subsidiary of
Acquiring Fund (the Merger), with Merger Sub being
the surviving entity and the separate corporate existence of
Acquired Fund shall thereupon cease. Common stockholders of
Acquired Fund will receive shares of beneficial interest, with
$0.001 par value, of Acquiring Fund (the Merger
Shares) (and cash in lieu of any fractional shares) having
an aggregate net asset value equal to the value of assets of
Acquired Fund on the Valuation Date less the value of the
liabilities of Acquired Fund on such Valuation Date. Immediately
after the Merger, Merger Sub will distribute its assets to
Acquiring Fund, and Acquiring Fund will assume the liabilities
of Merger Sub, in complete liquidation and dissolution of Merger
Sub.
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The Acquiring Fund will issue and cause to be listed on the NYSE
newly issued Merger Shares (and cash in lieu of any fractional
shares) in an amount equal to the value of the Acquired
Funds net assets attributable to its common shares (taking
into account the Acquired Funds proportionate share of the
costs of the Reorganization). Common shareholders of record of
the Acquired Fund will have their shares of the Acquired Fund
converted into Merger Shares in proportion to their holdings of
the Acquired Funds shares immediately prior to the Merger.
Acquired Fund common shareholders will receive cash for any
Acquiring Fund fractional shares they otherwise would be
entitled to receive other than with respect to shares held in a
Dividend Reinvestment Plan account. As a result, common
shareholders of the Acquired Fund will end up as common
shareholders of the Acquiring Fund.
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Before the Reorganization, Merger Sub will elect to be regulated
as a business development company by filing the requisite forms
with the Securities and Exchange Commission (the
SEC) and, after the Reorganization, it will file the
forms necessary to withdraw its election.
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25
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After the Reorganization, the Acquired Fund will then
(1) withdraw its election to be regulated as a business
development company and de-register with the SEC and
(2) de-list from the NYSE.
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The distribution of Merger Shares pursuant to the Reorganization
will be accomplished by opening new accounts on the books of the
Acquiring Fund in the names of the Acquired Funds common
shareholders of record as of the closing date of the
Reorganization and transferring the Merger Shares to those
accounts. Each such account for a former common shareholder of
the Acquired Fund will be credited with the pro rata
number of Merger Shares (rounded down, in the case of
fractional shares held other than in a Dividend Reinvestment
Plan account, to the next largest number of whole shares) due
such shareholder. If fractional Merger Shares otherwise would
have been credited to an account, the Acquiring Fund will issue
cash for such fractional shares (except for shares held in a
Dividend Reinvestment Plan account). See Further
Information on the Reorganization Additional Terms
of the Agreement and Plan of Merger and Liquidation below
for a description of the procedures to be followed by the
Acquired Funds shareholders to obtain Merger Shares (and
cash in lieu of any fractional shares).
REASONS
FOR THE PROPOSED REORGANIZATION
The Boards of the Funds considered the Reorganization at
meetings held on October 24, November 6 and December
18-19, 2008.
At the December
18-19
meeting, the Board of each Fund, including the
Trustees/Directors who are not interested persons
(as defined in the 1940 Act) of each Fund, unanimously approved
the Agreement.
The Board of the Acquired Fund has determined that participation
in the Reorganization is in the best interests of the Fund and
that the interests of its shareholders will not be diluted as a
result of that Reorganization. Similarly, the Acquiring
Funds Board has determined that participation in the
Reorganization is in the best interests of its common
shareholders and that the interests of such shareholders will
not be diluted as a result of the Reorganization. Although the
Board of each Fund determined that the Reorganization would not
result in dilution of the interests of the shareholders of such
Fund, the Board also considered the fact that the net asset
value (NAV) per share of the combined Acquiring Fund
will decrease by the expenses related to the Reorganization,
estimated to be 1 cent per share. In addition, as a result of
the Reorganization, shareholders of each Fund, particularly the
shareholders of the Acquired Fund, will have a smaller
percentage of ownership in the larger combined Fund than they
did in any of the separate Funds.
The Board of the Acquired Fund believes that reorganizing the
Acquired Fund into the Acquiring Fund, a fund with a similar
investment objective and policies, and having a combined
portfolio with greater assets, offers you potential benefits. In
determining whether or not to approve the Agreement, the Board
of the Acquired Fund reviewed a number of factors and various
information about the Funds and the proposed Reorganization, and
considered, among other things:
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the terms and conditions of the Agreement and the Reorganization;
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the fact that the Reorganization would not result in the
dilution of shareholders interests;
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the compatibility of and differences between the Funds
investment goals, policies, risks and principal investment
strategies;
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the Funds relative asset sizes;
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the fact that the Reorganization is expected to be tax-free for
federal income tax purposes;
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the fact that no gain or loss is expected to be recognized by
Acquired Fund stockholders for federal income tax purposes as a
result of the Reorganization (except to the extent of cash
received in lieu of any fractional share of Acquiring Fund);
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the respective tax positions of each Fund;
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the historic operating expenses for each Fund; and
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26
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the historic performance of each Fund for the past one-year
period ended October 31, 2008, the year-to-date period
ended October 31, 2008 and for the period February 26,
2007 (inception of the Acquired Fund) through October 31,
2008.
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More specifically, with respect to the proposed Reorganization,
the Board of the Acquired Fund made the following
determinations, among others:
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Economies of Scale in Expenses. A
combined Fund offers economies of scale that may lead to a
reduction in operating expenses. Due to the combined Funds
lower management fee, lower administration fee, no incentive
fee, lower interest expense due to lower leverage and
elimination of overlapping expenses, the estimated annual
operating expenses of the combined Fund are expected to be lower
than the current annual operating expenses of the Acquired Fund.
Each Fund incurs New York Stock Exchange (NYSE)
listing fees, costs for legal, auditing, and custodial services,
and miscellaneous fees. Additionally, the Acquired Fund incurs
expenses related to Sarbanes-Oxley implementation that the
Acquiring Fund does not and that the combined Fund would not
incur. Many of these expenses overlap and there may be an
opportunity to reduce them over time if the Funds are combined.
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Exchange of Common Shares at Net Asset Value
(NAV). On its closing date, the
Reorganization will result in the Acquired Fund shareholders
receiving shares of beneficial interest the Acquiring Fund and
cash (in lieu of fractional shares) based on the Acquired
Funds NAV (i.e., the shareholder of Acquired Fund
will receive common shares of the Acquiring Fund and cash (in
lieu of fractional shares) with an aggregate NAV equal to the
value of the Acquired Fund shares held immediately before the
Valuation Date for the Merger). Because the Acquiring Fund
historically has traded at a greater premium or narrower
discount than the Acquired Fund since inception of the Acquired
Fund, Acquired Fund stockholders would receive shares of the
Acquiring Fund, which based on historical trading, may
potentially trade at a narrower discount than shares of the
Acquired Fund.
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Enhanced Common Share
Liquidity. Following the Reorganization, the
substantially larger trading market in the common shares of the
Acquiring Fund, as compared to that of the Acquired Fund prior
to the Reorganization, may provide Acquired Fund shareholders
with enhanced market liquidity. Trading discounts can result
from many different factors, however, and there is no assurance
that the Acquiring Fund will continue to trade at a smaller
discount to NAV.
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Increased Asset Size. The Acquiring
Fund will obtain additional assets without incurring
underwriting expenses and other transaction expenses associated
with offering new shares. In addition, the Acquiring Fund is
obtaining the additional portfolio securities of the Acquired
Fund without the commensurate brokerage costs, dealer spreads or
other trading expenses. It is also obtaining these securities in
a manner that is likely to minimize the market impact of such
acquisition on the short-term prices of these securities.
However, the increase in Acquiring Fund shares as a result of
the Reorganization may also cause Acquiring Fund shares to trade
at a larger discount from NAV. Because shareholders of the
Acquired Fund will receive Acquiring Fund shares, Acquired Fund
shareholders may share in these potential benefits.
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Portfolio Management Efficiencies. The
Reorganization would permit Acquired Fund shareholders to pursue
similar investment goals in a larger fund. The greater asset
size of the combined Fund may allow the combined Fund, relative
to the Acquired Fund, to obtain better net prices on securities
trades and achieve greater diversification of portfolio
holdings. For example, at December 31, 2008, 78.21% of the
Acquired Funds assets represented issuers of securities
owned by the Acquiring Fund; however, such issuers made up only
22.91% of the Acquiring Funds assets.
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Shareholders Ability to
Margin. Stocks that trade below $5.00 are not
currently marginable. Since the Acquired Fund currently trades
well below $5.00 per share, and the Acquiring Fund has recently
been trading at around $5.00 per share, if the Reorganization is
approved, Acquired Fund shareholders would receive shares of the
Acquiring Fund that would be more likely to be marginable (based
on current market prices). Additionally, marginable securities
may be more liquid that those that are not marginable because
many institutional/large investors are believed to avoid stocks
that are not
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27
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marginable. However, if the price per share of the Acquiring
Fund trades below $5.00 (it currently trades at less than $5.00
per share), the shares of the Acquiring Fund would no longer be
marginable. It is possible that the Reorganization will exert
downward pressure on the price per share of the Acquiring Fund.
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Accordingly, for the reasons noted above, together with other
factors and information considered relevant, and recognizing
that there can be no assurance that any economies of scale or
other benefits will be realized, the Board of the Acquired Fund
concluded that the Reorganization would be in the best interests
of the Acquired Fund and its shareholders. The Board of the
Acquired Fund unanimously recommends that you vote FOR the
Reorganization of the Acquired Fund into the Acquiring Fund.
COMPARATIVE
FEES AND EXPENSE RATIOS
As the tables below indicate, the pro forma annual
operating expenses of the Acquiring Fund are lower than the
annual operating expenses of the Acquired Fund.
The
Funds Expenses
The tables below illustrate the change in operating expenses
expected as a result of the Reorganization. The tables set forth
(i) the fees, expenses and interest payments on borrowed
funds paid by the Acquired Fund for the twelve-month period
ended December 31, 2008; (ii) the fees, expenses, and
interest payments on borrowed funds paid by the Acquiring Fund
for the twelve-month period ended December 31, 2008; and
(iii) the pro forma fees, expenses and interest
payments on borrowed funds for the Acquiring Fund for the
twelve-month period ended December 31, 2008, assuming the
Reorganization had been completed at the beginning of such
period. The following tables show each Funds expenses as a
percentage of net assets attributable to common shares and
borrowing in an amount equal to 37.68% of the Acquired
Funds total assets and 28.5% of the Acquiring Funds
total assets and 28.5% of the combined Funds total assets
after the Reorganization is completed.
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Pro Forma
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Actual
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Combined(1)
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Acquired
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Acquiring
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Acquiring
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Fund
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Fund
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Fund
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Common Shareholder Transaction Expenses
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Sales Load (as a percentage of offering price)
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None(1
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)
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None(1
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)
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None(1
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Dividend Reinvestment Plan Fees
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None(2
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)
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None(3
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None(3
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Actual
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Percentage of Net Assets Attributable to Common
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Shares (Twelve Months Ended
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Pro Forma
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December 31, 2008)
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Combined(1)
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Acquired
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Acquiring
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Acquiring
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Fund
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Fund
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Fund
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Management Fee
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3.21
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%
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1.40
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%
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1.40
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%
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Incentive Fee
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1.29
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%
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0.00
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%
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0.00
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%
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Interest Payments on Borrowed Funds
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2.43
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%
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1.63
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%
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1.63
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%
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Other Expenses
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Dividend Expense For Short Positions
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0.00
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%
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0.17
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%
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0.17
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%
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Other Expenses(4)
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2.26
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%
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0.75
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%
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0.70
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%
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Total Other Expenses
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2.26
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%
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0.92
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%
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0.87
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%
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Total Annual Expenses
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9.18
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%
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3.95
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%
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3.90
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%
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Minus: Management Fee Waivers(5)
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0.00
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%
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0.09
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%
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0.07
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%
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Net Expenses
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9.18
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%(6)
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3.86
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%
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3.83
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%
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(1) |
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Shares of the Funds purchased on the secondary market are not
subject to sales charges but may be subject to brokerage
commissions or other charges. The table does not include an
underwriting commission paid by shareholders in the initial
offering of each Fund. |
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(2) |
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Each participant in the Acquired Funds dividend
reinvestment plan pays a proportionate share of the brokerage
commissions incurred with respect to open market purchases in
connection with such plan. |
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(3) |
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Common shareholders will be charged a $2.50 service charge and
pay a brokerage commission of $0.05 per share sold if they
direct the Plan Agent to sell common shares held in a dividend
reinvestment plan account. Each participant in the Acquiring
Funds Dividend Reinvestment Plan will pay a pro rata share
of brokerage commissions incurred when dividend reinvestment
occurs in open-market purchases because the NAV per common share
is greater than the market value per common share. |
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(4) |
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In connection with the Reorganization, there are certain other
transaction expenses not reflected in Other Expenses
which include, but are not limited to: costs related to the
preparation, printing and distributing of the Proxy
Statement/Prospectus to shareholders; costs related to
preparation and distribution of materials distributed to each
Funds Board; expenses incurred in connection with the
preparation of each Agreement and the registration statement on
Form N-14; SEC filing fees; legal and audit fees; portfolio
transfer taxes (if any); and any similar expenses incurred in
connection with the Reorganization. Such expenses are currently
estimated to be an amount equal to 0.06% of the Acquiring
Funds pro forma combined average net assets,
although this percentage may change. |
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(5) |
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The Adviser has contractually agreed to waive a portion of the
Acquiring Funds advisory fee and administration fee until
July 17, 2010. In connection with reorganizations of
Prospect
Street®
High Income Portfolio Inc. and Prospect
Street®
Income Shares Inc. into the Acquiring Fund on July 18,
2008, Highland agreed to waive certain advisory and/or
administration fees for a period of two years until
July 17, 2010. Highland agreed to waive advisory fees and
administration fees received from the Acquiring Fund in an
amount equal to $828,224 and $403,801, respectively, each year
in connection with the reorganizations in equal monthly amounts.
Highland may not recoup any amounts waived pursuant to this
waiver. Differences between the actual and pro forma combined
waiver amounts (expressed as a percentage of net assets) are due
to the increased assets size of the Acquiring Fund after the
Reorganization. The percentage of net assets attributable to the
waiver is based on the dollar amount for the next year, which is
greater than the amount waived during the twelve months ended
December 31, 2008 because the waiver started in July 2008. |
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(6) |
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The Adviser voluntarily agreed to waive the investment income
component of the incentive fee payable to it by the Acquired
Fund for the second quarter ended June 30, 2008. This
waiver applied only to the second quarter ended June 30,
2008. If this waiver had been reflected in the fee table the
Net Total Annual Expenses of the Acquired Fund would
have been 8.56%. Highland may not recoup any amounts waived
pursuant to this waiver. |
The purpose of the tables in this section is to assist you in
understanding the various costs and expenses that a shareholder
will bear directly or indirectly by investing in a Funds
common shares and the Acquiring Funds costs and expenses
that are expected to be incurred in the first year following the
Reorganization.
Example
The following example is intended to help you compare the costs
of investing in the Acquiring Fund pro forma after the
Reorganization with the costs of investing in the Acquired Fund
and the Acquiring Fund without the Reorganization. An investor
would pay the following expenses on a $1,000 investment in
common shares, assuming (i) the operating expense ratio for
each Fund (as a percentage of net assets attributable to common
shares) set forth in the table above for years 1 through 10,
(ii) average borrowings under the Acquired Funds
credit facility of $79 million and the Acquiring
Funds credit facility of $257 million prior to the
Reorganization, (iii) borrowings under the Acquiring
Funds credit facility of $309 million after the
Reorganization, (iv) a 5% annual return throughout the
period, and (v) the contractual fee waivers noted above
after the Reorganization, but only for the period of such
contractual waivers.
29
(Unaudited)
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1 Year
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3 Years
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5 Years
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10 Years
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Acquired Fund
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$
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90
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$
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259
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$
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413
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$
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747
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Acquiring Fund
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$
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39
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$
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119
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$
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201
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$
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418
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Pro Forma Combined Acquiring Fund(1)
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$
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39
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$
|
118
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$
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199
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$
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412
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(1) |
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The pro forma combined row shown assumes the
Reorganization is completed. |
The example set forth above assumes the reinvestment of all
dividends and other distributions at NAV and that the percentage
of the Acquiring Funds assets represented by leverage of
the Acquiring Fund will remain the same pre-and
post-Reorganization. The example set forth above should not be
considered a representation of past or future expenses or annual
rates of return. Actual expenses or annual rates of return may
be more or less than those assumed for purposes of the example.
BOARDS
EVALUATION AND RECOMMENDATION
After careful consideration of all factors deemed relevant,
including the reasons described herein, the Board of the
Acquired Fund, including the Directors who are not
interested persons (as defined in the 1940 Act) of
the Fund, the Acquiring Fund or the Adviser, approved the
Reorganization. In particular, the Directors determined that
participation in the Reorganization involving the Fund is in its
best interests and that the interests of its stockholders would
not be diluted as a result of the Reorganization. Similarly, the
Board of the Acquiring Fund, including the Trustees who are not
interested persons (as defined in the 1940 Act) of
any Fund or the Adviser, approved the Reorganization. They also
determined that participation in the Reorganization is in the
Acquiring Funds best interests and that the interests of
its stockholders would not be diluted as a result of the
Reorganization. Although the Board of each Fund determined that
the Reorganization would not result in dilution of the interests
of the shareholders of such Fund, the Board also considered the
fact that the net asset value (NAV) per share of the
combined Acquiring Fund will decrease by the expenses related to
the Reorganization, estimated to be 1 cent per share.
REQUIRED
VOTE
Approval of the Reorganization requires, if a quorum is present
at the Meeting, the affirmative vote of a majority of the
outstanding voting securities of the Acquired Fund, which is
defined in the 1940 Act as the lesser of (a) 67% or more of
the voting securities present at the Meeting, if the holders of
more than 50% of the outstanding voting securities of the
Acquired Fund are present or represented by proxy, or
(b) more than 50% of the outstanding voting securities of
the Acquired Fund.
The Directors of the Acquired Fund unanimously recommend
that
shareholders vote FOR the proposal to approve the Agreement and
Plan of
Merger and Liquidation.
30
ADDITIONAL
INFORMATION RELATED TO THE REORGANIZATION OF THE ACQUIRED
FUND
COMPARISON
OF THE FUNDS: INVESTMENT OBJECTIVES AND POLICIES
The following tables compare the investment objectives and
policies of the Acquired Fund to the Acquiring Fund and
summarize the types of investments that each may engage in. For
a more complete description of the types of investments, please
refer to Appendix B.
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Acquired Fund
|
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Acquiring Fund
|
|
Business
|
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The Fund is a closed-end company, organized as a Delaware
corporation on August 22, 2006, that has elected to be regulated
as a business development company under the 1940 Act.
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The Fund is a non-diversified, closed-end management investment
company organized as a Delaware statutory trust on March 10,
2006.
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Net Assets
(December 31, 2008)
|
|
$60.6 million
|
|
$361.2 million
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Listing (Common Shares)
|
|
NYSE under the ticker symbol HCD
|
|
NYSE under the ticker symbol HCF
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Fiscal Year End
|
|
12/31
|
|
12/31
|
Investment Adviser
|
|
Highland Capital Management, L.P.
|
|
Highland Capital Management, L.P.
|
Portfolio Managers
|
|
Brad Borud
Greg Stuecheli
|
|
Brad Borud
Brad Means
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Investment Objective(s)
|
|
The Funds investment objective is to provide total return
generated by both capital appreciation and current income. The
investment objective may be changed without shareholder approval.
|
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The Funds investment objective is to provide both current
income and capital appreciation. The investment objective may be
changed without shareholder approval.
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31
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Acquired Fund
|
|
Acquiring Fund
|
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Primary Investment
Strategies
|
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The Fund pursues its objectives by investing in senior secured
debt, mezzanine debt and unsecured debt, each of which may
include an equity component, and in equity investments.
The Fund has filed an election to be regulated as a business
development company (BDC) under the Investment
Company Act of 1940 (the 1940 Act).
While the Funds primary focus will be to generate capital
appreciation and current income through investments in senior
secured debt, mezzanine debt, unsecured debt and equity
investments, the Fund may invest up to 30% of the portfolio in
opportunistic investments that the research platform of the
Investment Adviser identifies during the investment process in
order to seek to enhance returns to stockholders. Such
investments may include, for example, investments in the senior
secured debt, mezzanine debt, unsecured debt, equity
investments, other debt obligations, options, structured
products and other derivatives of middle-market or unlisted
companies operating in the financial sector or foreign and/or
larger, listed companies. The Fund expects that these companies
generally will have debt securities that are non-investment
grade.
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The Fund pursues its objectives by investing primarily in the
following categories of securities and instruments of
corporations and other business entities: (i) secured and
unsecured floating and fixed rate loans; (ii) bonds and other
debt obligations; (iii) debt obligations of stressed, distressed
and bankrupt issuers; (iv) structured products, including but
not limited to, mortgage-backed and other asset-backed
securities and collateralized debt obligations; and (v)
equities.
Additionally, within the categories of obligations and
securities in which the Fund may invest, Highland may employ
various trading strategies, including but not limited to,
capital structure arbitrage, pair trades, and shorting. The Fund
may also invest in these categories of obligations and
securities through the use of derivatives.
Highland will seek to achieve its capital appreciation objective
by investing in category (iii) and (v) obligations and
securities, and to a lesser extent, in category (i), (ii), and
(iv) obligations.
Under normal market conditions, at least 80% of the Funds
assets will be invested in one or more of these principal
investment categories. Subject only to this general guideline,
the Adviser has broad discretion to allocate the Funds
assets among these investment categories and to change
allocations as conditions warrant. The Adviser has full
discretion regarding the capital markets from which it can
access investment opportunities in accordance with the
investment limitations set forth in this prospectus. A
significant portion of the Funds assets may be invested in
securities rated below investment grade, which are commonly
referred to as junk securities.
|
Leverage and
Borrowing
|
|
The Fund employs leverage through borrowings through a credit
facility and, as of December 31, 2008, the Fund had borrowings
of approximately $15.5 million.
|
|
The Fund employs leverage through borrowings through a credit
facility and, as of December 31, 2008, the Fund had borrowings
of approximately $141 million.
|
Diversification
|
|
The Fund is non-diversified.
|
|
The Fund is non-diversified.
|
Concentration
|
|
There is no limit on the amount of the Funds portfolio
that can be concentrated in one industry.
|
|
The Fund may not invest 25% or more of its assets in the
securities of issuers in one industry.
|
32
|
|
|
|
|
|
|
Acquired Fund
|
|
Acquiring Fund
|
|
Illiquid Securities
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in illiquid securities.
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in illiquid securities.
|
Portfolio Turnover
|
|
The Funds portfolio turnover rate may exceed 100% per year.
|
|
The Funds portfolio turnover rate may exceed 100% per year.
|
Senior Loans,
Unsecured Loans,
Second Lien Loans and
Other Secured Loans
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in senior loans, including bank loans,
unsecured loans, second lien loans and other secured loans.
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in senior loans, including bank loans,
unsecured loans, second lien loans and other secured loans.
|
Investment Grade
Securities
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in investment grade securities, however, a
significant portion of the Funds assets may be invested in
securities rated below investment grade, which are commonly
referred to as junk securities.
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in investment grade securities, however, a
significant portion of the Funds assets may be invested in
securities rated below investment grade, which are commonly
referred to as junk securities.
|
Non-Investment
Grade Securities
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in non-investment grade securities and a
significant portion of the Funds assets may be invested in
securities rated below investment grade, which are commonly
referred to as junk securities.
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in non-investment grade securities and a
significant portion of the Funds assets may be invested in
securities rated below investment grade, which are commonly
referred to as junk securities.
|
Asset-Backed
Securities and
Mortgaged-Backed Securities
|
|
The Fund may invest in asset-backed securities and
mortgage-backed securities.
|
|
The Fund may invest in asset-backed securities and
mortgage-backed securities.
|
Collateralized Loan
Obligations and Bond Obligations
|
|
The Fund may invest in collateralized loan obligations and bond
obligations. The Fund invests in the lower tranches of
collateralized bond obligations.
|
|
The Fund may invest in collateralized loan obligations and bond
obligations. The Fund invests in the lower tranches of
collateralized bond obligations.
|
Distressed Debt and
Stressed Debt
|
|
The Fund may invest in the securities and other obligations of
stressed, distressed and bankrupt issuers, including debt
obligations that are in covenant or payment default.
|
|
The Fund may invest in the securities and other obligations of
stressed, distressed and bankrupt issuers, including debt
obligations that are in covenant or payment default.
|
Equity Securities
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in equity securities including common and
preferred stocks.
|
|
There is no limit on the amount of the Funds portfolio
that can be invested in equity securities including common
stock, preferred stocks, convertible securities, warrants and
depository receipts.
|
Money Market
Instruments and U.S.
Government Securities
|
|
The Fund may invest in money market instruments and U.S.
government securities.
|
|
The Fund may invest in money market instruments and U.S.
government securities.
|
|
|
|
|
|
Other Investment
Companies
|
|
The Fund may invest in the securities of other investment
companies (including exchange traded funds (ETFs))
to the extent that such investments are consistent with the
Funds investment objectives and principal investment
strategies and permissible under the 1940 Act.
|
|
The Fund may invest in the securities of other investment
companies (including exchange traded funds (ETFs))
to the extent that such investments are consistent with the
Funds investment objectives and principal investment
strategies and permissible under the 1940 Act.
|
33
|
|
|
|
|
|
|
Acquired Fund
|
|
Acquiring Fund
|
|
Zero-Coupon
Securities and
Deferred Payment
Obligations
|
|
The Fund may invest in zero-coupon bonds and deferred payment
obligations and there is no limit on the amount of the
Funds portfolio that can be invested in these securities.
|
|
The Fund may invest in zero-coupon bonds and deferred payment
obligations and there is no limit on the amount of the
Funds portfolio that can be invested in these securities.
|
Derivatives
|
|
The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on
securities, financial futures, equity, fixed-income and interest
rate indices, and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors
or collars and enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency
swaps or options on currency or currency futures or credit
transactions and credit default swaps. The Fund also may
purchase derivative instruments that combine features of these
instruments. Apart from senior loan based derivatives,
derivatives are not a significant part of the Funds
investments. However, the Fund has no limit on the amount of its
total assets that may be invested in derivative instruments.
|
|
The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on
securities, financial futures, equity, fixed-income and interest
rate indices, and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors
or collars and enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency
swaps or options on currency or currency futures or credit
transactions and credit default swaps. The Fund also may
purchase derivative instruments that combine features of these
instruments. Apart from senior loan based derivatives,
derivatives are not a significant part of the Funds
investments. However, the Fund has no limit on the amount of its
total assets that may be invested in derivative instruments.
|
|
|
|
|
|
Senior Loan Based
Derivatives
|
|
The Fund may obtain exposure to senior loans and baskets of
senior loans through the use of derivative instruments.
|
|
The Fund may obtain exposure to senior loans and baskets of
senior loans through the use of derivative instruments.
|
|
|
|
|
|
Swaps
|
|
The Fund may invest in swaps including credit default swaps,
interest rate swaps, total return swaps and currency swaps. The
Fund may use swaps for risk management purposes and as a
speculative investment.
|
|
The Fund may invest in swaps including credit default swaps,
interest rate swaps, total return swaps and currency swaps. The
Fund may use swaps for risk management purposes and as a
speculative investment.
|
|
|
|
|
|
Credit Linked Notes
|
|
The Fund may invest in CLNs for risk management purposes and to
vary its portfolio. A CLN is a derivative instrument.
|
|
The Fund may invest in CLNs for risk management purposes and to
vary its portfolio. A CLN is a derivative instrument.
|
|
|
|
|
|
Options
|
|
The Fund may purchase and sell put and call options on
securities and indices.
|
|
The Fund may purchase and sell put and call options on
securities and indices.
|
|
|
|
|
|
Futures Contracts and
Options on Futures
Contracts
|
|
The Fund may enter into contracts for the purchase or sale for
future delivery (futures contracts) of securities,
aggregates of securities or indices or prices thereof. The Fund
will engage in such transactions only for bona fide risk
management and other portfolio management purposes.
|
|
The Fund may enter into futures contracts of securities,
aggregates of securities or indices or prices thereof, other
financial indices and U.S. government debt securities or options
on the above. The Fund will engage in such transactions only for
bona fide risk management and other portfolio management
purposes.
|
34
|
|
|
|
|
|
|
Acquired Fund
|
|
Acquiring Fund
|
|
Foreign Currency and
Forward Foreign
Currency Contracts
|
|
The Fund may buy or sell foreign currencies or deal in forward
foreign currency contracts for hedging and speculative purposes
or to enhance total return,
|
|
The Fund may enter into foreign currency transactions in an
attempt to enhance total return. The Fund may enter into forward
currency contracts to purchase or sell foreign currencies for a
fixed amount of U.S. dollars or another foreign currency.
|
|
|
|
|
|
Short Sales
|
|
The Fund does not engage in short sales.
|
|
The Fund may engage in short sales against the box and not
against the box. Subject to the requirements of the 1940 Act and
the Code, the Fund will not make a short sale if, after giving
effect to such sale, the market value of all securities sold
short by the Fund exceeds 25% of the value of its total assets.
The Fund may make short sales against the box without respect to
such limitations.
|
|
|
|
|
|
Repurchase
Agreements
|
|
The Fund may enter into repurchase agreements.
|
|
The Fund may enter into repurchase agreements up to a maximum
331/3%
of its total assets.
|
|
|
|
|
|
Reverse Repurchase
Agreements
|
|
The Fund does not enter into reverse repurchase agreements.
|
|
The Fund may enter into reverse repurchase agreements. Reverse
repurchase agreements will be considered borrowings by the Fund
and would be subject to any restrictions on borrowing.
|
Inverse Floaters
|
|
The Fund may invest in inverse floaters.
|
|
The Fund may invest in inverse floaters.
|
|
|
|
|
|
Pay-in-kind
(PIK) Bonds
|
|
The Fund may invest in PIK bonds.
|
|
The Fund may invest in PIK bonds.
|
|
|
|
|
|
When-Issued,
Delayed-Delivery and
Forward Commitment
Purchases
|
|
The Fund may purchase securities on a when-issued basis and may
purchase or sell securities on a forward commitment
basis.
|
|
The Fund may purchase securities on a when-issued basis and may
purchase or sell securities on a forward commitment
basis.
|
|
|
|
|
|
Securities Lending
|
|
The Fund may lend its portfolio securities in an amount up to a
maximum of
331/3%
of its total assets.
|
|
The Fund may lend its portfolio securities in an amount up to a
maximum of
331/3%
of its total assets.
|
Foreign Securities
|
|
The Fund may invest up to 20% of its total assets in non-U.S.
securities.
|
|
The Fund may invest up to 20% of its total assets in non-U.S.
securities.
|
|
|
|
|
|
Temporary
Defensive Position
|
|
Under certain market conditions, the Fund may adopt a temporary
defensive position to invest its assets in cash or cash
equivalents.
|
|
Under certain market conditions, the Fund may adopt a temporary
defensive position to invest its assets in cash or cash
equivalents.
|
Under the 1940 Act, the Acquired Fund, as a business development
company, generally may not acquire any assets other than assets
of the type listed in Section 55(a) of the 1940 Act, which
are sometimes referred to as qualifying assets,
unless, at the time the acquisition is made, qualifying assets
represent at least 70% of the Acquired Funds total assets.
The Acquiring Fund, which is not a business development company,
is not subject to this restriction.
The Statement of Additional Information sets forth the Acquiring
Funds fundamental investment restrictions, which may not
be changed without the vote of a majority of the outstanding
voting securities.
35
INFORMATION
ABOUT THE FUNDS
OUTSTANDING
SECURITIES
Set forth below is information about each Funds common
shares as of December 31, 2008.
Acquiring
Fund
|
|
|
|
|
|
|
Title of Class
|
|
Amount Authorized
|
|
Amount Held by Fund
|
|
Amount Outstanding
|
|
Common Shares
|
|
Unlimited
|
|
|
|
55,526,190
|
Acquired
Fund
|
|
|
|
|
|
|
Title of Class
|
|
Amount Authorized
|
|
Amount Held by Fund
|
|
Amount Outstanding
|
|
Common Shares
|
|
550,000,000
|
|
|
|
17,716,771
|
COMMON
SHARE PRICE DATA
The following table sets forth the high and low sales prices for
common shares of each Fund on the NYSE for each full quarterly
period within the two most recent fiscal years or since
inception and each full quarter since the beginning of the
current fiscal year, along with the NAV and discount or premium
to NAV for each quotation.
The Acquiring Fund only makes public its net asset value on a
weekly basis, and the Acquired Fund only makes public its net
asset value on a quarterly basis. Accordingly, the net asset
value and the premium and discount from net asset value in the
table below are based on the publicly available net asset values
for the week or quarter, as applicable, in which the high and
low sales price occurred. Since the net asset value and the
premium and discount from net asset value is based on the
publicly available net asset values for the week, which may not
fall on the same date as the high and low sales prices, the
range of net asset values and the premium and discount from net
asset value for the common shares during the periods shown may
be broader or more narrow than what is shown in this table.
ACQUIRING
FUND
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium/
|
|
|
|
|
|
|
|
|
|
(Discount) as a %
|
|
|
|
Market Price
|
|
|
Net Asset Value per Share
|
|
|
of Net Asset Value
|
|
Quarter
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
|
2nd Quarter 2006*
|
|
|
20.60
|
|
|
|
20.18
|
|
|
|
19.07
|
|
|
|
19.06
|
|
|
|
8.0
|
%
|
|
|
5.9
|
%
|
3rd Quarter 2006
|
|
|
21.00
|
|
|
|
19.91
|
|
|
|
19.13
|
|
|
|
19.18
|
|
|
|
9.8
|
%
|
|
|
3.8
|
%
|
4th Quarter 2006
|
|
|
21.20
|
|
|
|
20.31
|
|
|
|
19.97
|
|
|
|
19.44
|
|
|
|
6.2
|
%
|
|
|
4.5
|
%
|
1st Quarter 2007
|
|
|
21.46
|
|
|
|
20.41
|
|
|
|
20.29
|
|
|
|
20.37
|
|
|
|
5.8
|
%
|
|
|
0.2
|
%
|
2nd Quarter 2007
|
|
|
21.12
|
|
|
|
19.80
|
|
|
|
20.51
|
|
|
|
20.45
|
|
|
|
3.0
|
%
|
|
|
(3.2
|
)%
|
3rd Quarter 2007
|
|
|
20.04
|
|
|
|
17.31
|
|
|
|
20.60
|
|
|
|
19.33
|
|
|
|
(2.7
|
)%
|
|
|
(10.4
|
)%
|
4th Quarter 2007
|
|
|
18.35
|
|
|
|
15.73
|
|
|
|
19.63
|
|
|
|
17.99
|
|
|
|
(6.5
|
)%
|
|
|
(12.6
|
)%
|
1st Quarter 2008
|
|
|
15.54
|
|
|
|
12.95
|
|
|
|
17.85
|
|
|
|
14.53
|
|
|
|
(12.9
|
)%
|
|
|
(10.9
|
)%
|
2nd Quarter 2008
|
|
|
14.29
|
|
|
|
13.44
|
|
|
|
15.20
|
|
|
|
14.63
|
|
|
|
(6.0
|
)%
|
|
|
(8.1
|
)%
|
3rd Quarter 2008
|
|
|
13.20
|
|
|
|
9.47
|
|
|
|
14.41
|
|
|
|
12.64
|
|
|
|
(8.4
|
)%
|
|
|
(25.1
|
)%
|
4th Quarter 2008
|
|
|
9.22
|
|
|
|
5.13
|
|
|
|
12.13
|
|
|
|
7.01
|
|
|
|
(24.0
|
)%
|
|
|
(26.8
|
)%
|
|
|
|
* |
|
The Acquiring Fund commenced operations on June 29,
2006. |
36
ACQUIRED
FUND
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium/
|
|
|
|
|
|
|
|
|
|
Net Asset
|
|
|
(Discount) as a %
|
|
|
|
Market Price
|
|
|
Value per
|
|
|
of Net Asset Value
|
|
Quarter
|
|
High
|
|
|
Low
|
|
|
Share(1)
|
|
|
High
|
|
|
Low
|
|
|
1st Quarter 2007*
|
|
|
15.15
|
|
|
|
14.13
|
|
|
$
|
14.05
|
|
|
|
7.8
|
%
|
|
|
0.6
|
%
|
2nd Quarter 2007
|
|
|
15.04
|
|
|
|
14.03
|
|
|
$
|
14.08
|
|
|
|
6.8
|
%
|
|
|
(0.2
|
)%
|
3rd Quarter 2007
|
|
|
14.41
|
|
|
|
10.45
|
|
|
$
|
12.34
|
|
|
|
16.8
|
%
|
|
|
(15.3
|
)%
|
4th Quarter 2007
|
|
|
13.07
|
|
|
|
8.51
|
|
|
$
|
10.27
|
|
|
|
27.3
|
%
|
|
|
(17.1
|
)%
|
1st Quarter 2008
|
|
|
9.21
|
|
|
|
6.15
|
|
|
$
|
8.26
|
|
|
|
11.5
|
%
|
|
|
(25.5
|
)%
|
2nd Quarter 2008
|
|
|
8.58
|
|
|
|
5.74
|
|
|
$
|
7.24
|
|
|
|
18.5
|
%
|
|
|
(20.7
|
)%
|
3rd Quarter 2008
|
|
|
5.98
|
|
|
|
2.97
|
|
|
$
|
6.69
|
|
|
|
(10.6
|
)%
|
|
|
(55.6
|
)%
|
4th Quarter 2008
|
|
|
3.29
|
|
|
|
0.96
|
|
|
$
|
3.42
|
|
|
|
(3.8
|
)%
|
|
|
(71.9
|
)%
|
|
|
|
(1) |
|
Net asset value per share is generally determined as of the last
day in the relevant quarter and therefore may not reflect the
net asset value per share on the date of the high and low sales
prices. The net asset value shown is based on outstanding shares
at the end of the applicable period. |
|
* |
|
The Acquired Fund commenced operations on January 18, 2007,
and began trading on the NYSE on February 27, 2008. |
As of December 31, 2008, (i) the net value per share
for common shares of the Acquiring Fund was $6.51 and the market
price per share was $5.70, representing a discount to NAV of
12.4%, and (ii) the NAV per share for common shares of the
Acquired Fund was $3.42 and the market price per share was
$2.15, representing a discount to NAV of 37.1%.
The NAV per share and market price per share of the common
shares of each Fund may fluctuate prior to the closing date of
the Reorganization. Depending on market conditions immediately
prior to the closing date of the Reorganization, Acquiring Fund
common shares may trade at a larger or smaller discount to NAV
than the Acquired Funds common shares. This could result
in the Acquiring Fund common shares having a market value that
is greater or less than the market value of the Acquired
Funds common shares on the closing date of the
Reorganization.
ASSET
COVERAGE OF SENIOR SECURITIES
The following tables provide information about senior securities
of each of Acquiring Fund and Acquired Fund as of the dates
below (which are the ends of each fiscal year). Both Funds
employ leverage through borrowings through a credit facility.
Asset coverage is calculated by subtracting the Funds
total liabilities, not including any amount representing bank
loans and senior securities, from the Funds total assets
and dividing the result by the principal amount of the
borrowings outstanding.
Acquiring
Fund
|
|
|
|
|
|
|
|
|
|
|
Total Amount
|
|
|
Asset Coverage
|
|
Date
|
|
Outstanding
|
|
|
per $1000
|
|
|
December 31, 2008
|
|
$
|
141,000,000
|
|
|
$
|
3,562
|
|
December 31, 2007
|
|
$
|
248,000,000
|
|
|
$
|
3,504
|
|
December 31, 2006
|
|
$
|
285,000,000
|
|
|
$
|
3,429
|
|
37
Acquired
Fund
|
|
|
|
|
|
|
|
|
|
|
Total Amount
|
|
|
Asset Coverage
|
|
Date
|
|
Outstanding
|
|
|
per $1000
|
|
|
December 31, 2008
|
|
$
|
15,500,000
|
|
|
$
|
4,907
|
|
December 31, 2007
|
|
$
|
142,000,000
|
|
|
$
|
2,282
|
|
In light of the broader unprecedented market dislocation that
began in 2007, continued into 2008 and accelerated in the fourth
quarter, the Acquired Fund and Acquiring Fund have reduced their
leverage over the year ended December 31, 2008 by using
excess funds generated in the course of each Funds
operations to pay down each such Funds credit facility.
SHARE
REPURCHASES
Common shares of each of the Acquiring Fund and the Acquired
Fund have traded at a premium to NAV at certain times and at a
discount to NAV at certain times.
Each Fund may from time to time take action to attempt to reduce
or eliminate a market value discount from NAV by repurchasing
their common shares in the open market or by tendering for their
common shares at NAV.
Subject to its investment restrictions, a Fund may borrow to
finance the repurchase of shares or to make a tender offer.
Interest on any borrowings to finance share repurchase
transactions or the accumulation of cash by a Fund in
anticipation of share repurchases or tenders will reduce the
Funds net income. The Fund will comply with the Securities
Exchange Act of 1934, as amended (the
1934 Act), the 1940 Act and the rules and
regulations thereunder in connection with any share repurchase,
tender offer or borrowing that might be approved by the
Funds Board. Any such borrowings will be subject to the
limitations imposed by the 1940 Act and the Rating Agency
Guidelines.
The repurchase by a Fund of its common shares at prices below
NAV will result in an increase in the NAV of those common shares
that remain outstanding. However, there can be no assurance that
common share repurchases or tender offers at or below NAV will
result in the Funds common shares trading at a price equal
to their NAV. Nevertheless, the fact that a Funds common
shares may be the subject of repurchase or tender offers from
time to time, or that the Fund may be converted to an open-end
investment company, may reduce any spread between market price
and NAV that might otherwise exist.
In addition, a purchase by the Fund of its common shares will
decrease the Funds total assets which would likely have
the effect of increasing the Funds expense ratio. Any
purchase by the Fund of its common shares at a time when
preferred shares are outstanding will increase the leverage
applicable to the outstanding common shares then remaining.
Before deciding whether to take any action if the common shares
trade below NAV, a Funds Board would likely consider all
relevant factors, including the extent and duration of the
discount, the liquidity of the Funds portfolio, the impact
of any action that might be taken on the Fund or its
shareholders and market considerations. Based on these
considerations, even if a Funds shares should trade at a
discount, the Funds Board may determine that, in the
interest of the Fund and its shareholders, no action should be
taken.
DIVIDENDS
AND OTHER DISTRIBUTIONS
Both
Funds.
Distributions, which may contain returns of capital, on each
Funds common shares are declared based on annual
projections of net investment income (defined as dividends and
interest income received on underlying portfolio securities, net
of Fund expenses). The Acquiring Fund pays monthly distributions
to common shareholders. The Acquired Fund pays quarterly
distributions to common shareholders. As a result of market
conditions or investment decisions, the amount of distributions
may exceed net investment income earned at certain times
throughout the period. It is anticipated that, on an annual
basis, the amount of distributions to common shareholders will
not exceed net investment income (as defined above) allocated to
common
38
shareholders for income tax purposes. Each Fund generally
intends to pay any net long-term and short-term capital gain
distributions annually. However, from time to time, the
Acquiring Fund may determine to retain net long-term capital
gains for reinvestment and pay a Fund-level tax on those
retained amounts, in which case shareholders may be required to
include in income for U.S. federal income tax purposes, as
long-term capital gain, their shares of such undistributed
amounts, and entitled to a credit
and/or
refund on their U.S. income tax returns on their
proportionate shares of the tax paid by the Fund on
undistributed amounts. See the Statement of Additional
Information under Tax Matters.
Various factors will affect the level of each Funds
current income and current gains, such as its asset mix, and
each Funds use of options. To permit each Fund to maintain
more stable dividends and annual distributions, each Fund may
from time to time distribute less than the entire amount of
income and gains earned in the relevant month, quarter or year,
as applicable. The undistributed income and gains would be
available to supplement future distributions. As a result, the
distributions paid by each Fund for any particular period may be
more or less than the amount of income and gains actually earned
by each Fund during the applicable period. Undistributed income
and gains will add to each Funds NAV and, correspondingly,
distributions from undistributed income and gains and from
capital, if any, will be deducted from each Funds NAV.
Shareholders will automatically have all dividends and other
distributions reinvested in common shares of each Fund issued by
each Fund or purchased in the open market in accordance with
each Funds Dividend Reinvestment Plan unless an election
is made to receive cash. Each participant in each Funds
Dividend Reinvestment Plan will pay a pro rata portion of
brokerage commissions incurred in connection with open market
purchases, and participants requesting a sale of securities
through the plan agent of the Dividend Reinvestment Plan of the
Acquiring Fund are subject to a sales fee and a brokerage
commission.
DIVIDEND
REINVESTMENT PLAN
Each Fund offers its shareholders a Dividend Reinvestment Plan
(the Plan), which offers the opportunity to earn
compounded yields. The terms of each Plan is set forth below.
Acquired Fund. Unless the registered owner of
your shares elects to receive cash by contacting the Plan Agent,
the agent for stockholders that is administering the Acquired
Funds Plan, all dividends declared for your shares will be
automatically reinvested by the Plan Agent in additional Shares.
If the registered owner of your shares elects not to participate
in the Plan, you will receive all dividends in cash paid by
check mailed directly to you (or, if the shares are held in
street or other nominee name, then to such nominee) by PNC, as
the dividend disbursing agent. You may elect not to participate
in the Plan and to receive all dividends in cash by sending
written instructions or by contacting PNC, as the dividend
disbursing agent.
The Plan Agent will open an account for each common stockholder
under the Plan in the same name in which such common
stockholders shares are registered. Whenever the Acquired
Fund declares a dividend or other distribution (together, a
dividend) payable in cash, non-participants in the
Plan will receive cash and participants in the Plan will receive
the equivalent in shares. The shares will be acquired by the
Plan Agent for the participants accounts, depending upon
the circumstances described below, either (i) through
receipt of additional unissued but authorized shares
(newly-issued shares) or (ii) by purchase of
outstanding shares on the open market (open-market
purchases) on the NYSE or elsewhere.
If, on the payment date for any dividend, the market price per
share plus estimated brokerage commissions is greater than the
net asset value per share (such condition being referred to
herein as market premium), the Plan Agent will
invest the dividend amount in newly-issued shares, including
fractions, on behalf of the Plan participants. The number of
newly-issued shares to be credited to each participants
account will be determined by dividing the dollar amount of the
dividend by the net asset value per share on the payment date;
provided that, if the net asset value per share is less than 95%
of the market price per share on the payment date, the dollar
amount of the dividend will be divided by 95% of the market
price per share on the payment date.
If, on the payment date for any dividend, the net asset value
per share is greater than the market value per share plus
estimated brokerage commissions (such condition being referred
to herein as market
39
discount), the Plan Agent will invest the dividend amount
in shares acquired on behalf of the participants in open-market
purchases.
In the event of a market discount on the payment date for any
dividend, the Plan Agent will have until the last business day
before the next date on which the shares trade on an
ex-dividend basis or 120 days after the payment
date for such dividend, whichever is sooner (the last
purchase date), to invest the dividend amount in shares
acquired in open-market purchases. It is contemplated that the
Acquired Fund will pay quarterly dividends. Therefore, the
period during which open-market purchases can be made will exist
only from the payment date of each dividend through the date
before the ex-dividend date of the third month of
the quarter. If, before the Plan Agent has completed its
open-market purchases, the market price of a share exceeds the
net asset value per share, the average per share purchase price
paid by the Plan Agent may exceed the net asset value of the
shares, resulting in the acquisition of fewer shares than if the
dividend had been paid in newly-issued shares on the dividend
payment date. Because of the foregoing difficulty with respect
to open market purchases, if the Plan Agent is unable to invest
the full dividend amount in open market purchases during the
purchase period or if the market discount shifts to a market
premium during the purchase period, the Plan Agent may cease
making open-market purchases and may invest the uninvested
portion of the dividend amount in newly-issued shares at the net
asset value per share at the close of business on the last
purchase date; provided that, if the net asset value per share
is less than 95% of the market price per share on the payment
date, the dollar amount of the dividend will be divided by 95%
of the market price per share on the payment date.
The Plan Agent maintains all stockholders accounts in the
Plan and furnishes written confirmation of all transactions in
the accounts, including information needed by stockholders for
tax records. shares in the account of each Plan participant will
be held by the Plan Agent on behalf of the Plan participant, and
each stockholder proxy will include those shares purchased or
received pursuant to the Plan. The Plan Agent will forward all
proxy solicitation materials to participants and vote proxies
for shares held under the Plan in accordance with the
instructions of the participants. In the case of stockholders
such as banks, brokers or nominees that hold shares for others
who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from
time to time by the record stockholders name and held for
the account of beneficial owners who participate in the Plan.
There will be no brokerage charges with respect to Shares issued
directly by the Acquired Fund. However, each participant will
pay a pro rata share of brokerage commissions incurred in
connection with open-market purchases.
The automatic reinvestment of dividends will not relieve
participants of any federal, state or local income tax that may
be payable (or required to be withheld) on such dividends.
Participants that request a sale of Shares through the Plan
Agent are subject to a $2.50 sales fee and a brokerage
commission of $0.05 per Share sold.
The Fund reserves the right to amend or terminate the Plan.
There is no direct service charge to participants in the Plan;
however, the Acquired Fund reserves the right to amend the Plan
to include a service charge payable by the participants. All
correspondence concerning the Plan should be directed to the
Plan Agent at PNC, 301 Bellevue Parkway, Wilmington, Delaware
19809; telephone
877-247-1888
for the Acquired Fund and
877-665-1287
for the Acquiring Fund.
Acquiring Fund. Unless the registered owner of
common shares elects to receive cash by contacting the Plan
Agent, all dividends declared for the common shares of the
Acquiring Fund will be automatically paid in the form of, or
reinvested by the Plan Agent (agent for shareholders in
administering the Acquiring Funds Plan) in, additional
common shares of the Acquiring Fund. If you are a registered
owner of common shares and elect not to participate in the Plan,
you will receive all dividends in cash paid by check mailed
directly to you (or, if the shares are held in street or other
nominee name, then to such nominee) by PNC, as dividend
disbursing agent. You may elect not to participate in the Plan
and to receive all dividends in cash by sending written
instructions or by contacting PNC, as dividend disbursing agent,
at the address set forth below. Participation in the Plan is
completely voluntary and may be terminated or resumed at any
time without penalty by contacting the Plan Agent before the
dividend record date; otherwise such termination or
40
resumption will be effective with respect to any subsequently
declared dividend or other distribution. Some brokers may
automatically elect to receive cash on your behalf and may
re-invest that cash in additional shares of the Acquiring Fund
for you.
The Plan Agent will open an account for each shareholder under
the Plan in the same name in which such shareholders
shares are registered. Whenever the Acquiring Fund declares a
dividend or other distribution (together, a
dividend) payable in cash, non-participants in the
Plan will receive cash and participants in the Plan will receive
the equivalent in common shares. The common shares will be
acquired by the Plan Agent for the participants accounts,
depending upon the circumstances described below, either
(i) through receipt of additional unissued but authorized
shares from the Acquiring Fund (newly issued shares)
or (ii) by purchase of outstanding common shares on the
open market (open-market purchases) on the NYSE or
elsewhere.
If, on the payment date for any dividend, the market price per
common share plus estimated brokerage commissions is greater
than the NAV per common share (such condition being referred to
herein as market premium), the Fund will issue
common shares, including fractions, to the participants in the
amount of the dividend. The number of newly issued common shares
to be credited to each participants account will be
determined by dividing the dollar amount of the dividend by the
NAV per common share on the payment date; provided that, if the
NAV per common share is less than 95% of the market price per
common share on the payment date, the dollar amount of the
dividend will be divided by 95% of the market price per common
share on the payment date.
If, on the payment date for any dividend, the NAV per common
share is greater than the market value per common share plus
estimated brokerage commissions (such condition being referred
to herein as market discount), the Plan Agent will
invest the dividend amount in common shares acquired on behalf
of the participants in open-market purchases.
In the event of a market discount on the payment date for any
dividend, the Plan Agent will have until the last business day
before the next date on which the common shares trade on an
ex-dividend basis or 120 days after the payment
date for such dividend, whichever is sooner (the last
purchase date), to invest the dividend amount in common
shares acquired in open-market purchases. It is contemplated
that the Acquiring Fund will pay monthly dividends. Therefore,
the period during which open-market purchases can be made will
exist only from the payment date of each dividend through the
date before the ex-dividend date of the third month
of the quarter. If, before the Plan Agent has completed its
open-market purchases, the market price of a common share
exceeds the NAV per common share, the average per common share
purchase price paid by the Plan Agent may exceed the NAV of the
common shares, resulting in the acquisition of fewer common
shares than if the dividend had been paid in newly issued common
shares on the dividend payment date. Because of the foregoing
difficulty with respect to open market purchases, if the Plan
Agent is unable to invest the full dividend amount in open
market purchases during the purchase period or if the market
discount shifts to a market premium during the purchase period,
the Plan Agent may cease making open-market purchases and may
invest the uninvested portion of the dividend amount in newly
issued common shares at the NAV per common share at the close of
business on the last purchase date; provided that, if the NAV
per common share is less than 95% of the market price per common
share on the payment date, the dollar amount of the dividend
will be divided by 95% of the market price per common share on
the payment date.
The Plan Agent maintains all shareholders accounts in the
Plan and furnishes written confirmation of all transactions in
the accounts, including information needed by shareholders for
tax records. Common shares in the account of each Plan
participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder proxy will include those
shares purchased or received pursuant to the Plan. The Plan
Agent will forward all proxy solicitation materials to
participants and vote proxies for shares held under the Plan in
accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees
which hold shares for others who are the beneficial owners, the
Plan Agent will administer the Plan on the basis of the number
of common shares certified from time to time by the record
shareholders name and held for the account of beneficial
owners who participate in the Plan.
41
There will be no brokerage charges with respect to common shares
issued directly by the Acquiring Fund. However, each participant
will pay a pro rata share of brokerage commissions incurred in
connection with open-market purchases. The automatic
reinvestment of dividends will not relieve participants of any
federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. Accordingly, any
taxable dividend received by a participant that is reinvested in
additional common shares will be subject to federal (and
possibly state and local) income tax even though such
participant will not receive a corresponding amount of cash with
which to pay such taxes. See Tax Matters.
Participants who request a sale of shares through the Plan Agent
are subject to a $2.50 sales fee and pay a brokerage commission
of $0.05 per share sold.
The Acquiring Fund reserves the right to amend or terminate the
Plan. There is no direct service charge to participants in the
Plan; however, the Acquiring Fund reserves the right to amend
the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the
Plan Agent at PNC, 301 Bellevue Parkway, Wilmington, Delaware
19809; telephone
877-247-1888
for the Acquired Fund and
877-665-1287
for the Acquiring Fund.
DESCRIPTION
OF CAPITAL STRUCTURE
ACQUIRED
FUND
Common
Stock
The Acquired Fund is a corporation organized under the laws of
Delaware pursuant to a certificate of incorporation dated as of
August 22, 2006. The Acquired Fund is authorized to issue
550,000,000 Shares, par value $0.001 per Share. Each Share
has one vote and, when issued and paid for, is fully paid and
non-assessable, except that the Board shall have the power to
cause stockholders to pay expenses of the Acquired Fund by
setting off charges due from stockholders from declared but
unpaid dividends or distributions owed the stockholders
and/or by
reducing the number of Shares owned by each respective
stockholder. All Shares are equal as to dividends, assets and
voting privileges and have no conversion, preemptive or other
subscription rights. The Acquired Fund will send annual reports,
including financial statements, to all holders of its Shares.
Any additional offerings of Shares will require approval by the
Board. Any additional offering of Shares will be subject to the
requirements of the 1940 Act, which provides that Shares may not
be issued at a price below the then current net asset value,
exclusive of sales load, except in connection with an offering
to existing holders of Shares or with the consent of a majority
of the Acquired Funds outstanding voting securities.
Preferred
Stock
The Acquired Funds Certificate of Incorporation and
By-laws provide that the Board may authorize and issue preferred
stock (the Preferred Stock) with rights as
determined by the Board, by action of the Board without the
approval of the holders of the Shares. Holders of Shares have no
preemptive right to purchase any Preferred Stock that might be
issued. Whenever Preferred Stock is outstanding, the holders of
Shares will not be entitled to receive any distributions from
the Acquired Fund unless all accrued dividends on Preferred
Stock have been paid, unless asset coverage (as defined in the
1940 Act) with respect to Preferred Stock would be at least 200%
after giving effect to the distributions and unless certain
other requirements imposed by any rating agencies rating the
Preferred Stock have been met.
Liquidation Preference. In the event of any
voluntary or involuntary liquidation, dissolution or winding up
of the Acquired Fund, the holders of Preferred Stock will be
entitled to receive a preferential liquidating distribution,
which is expected to equal the original purchase price per share
of Preferred Stock plus accrued and unpaid dividends, whether or
not declared, before any distribution of assets is made to
holders of Shares. After payment of the full amount of the
liquidating distribution to which they are entitled, the holders
of
42
Preferred Stock will not be entitled to any further
participation in any distribution of assets by the Acquired Fund.
Voting Rights. The 1940 Act requires that the
holders of any Preferred Stock, voting separately as a single
class, have the right to elect at least two directors on the
Board at all times. The remaining directors on the Board will be
elected by holders of Shares and Preferred Stock, 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 Stock have
the right to elect a majority of the directors on the Board at
any time two years dividends on any Preferred Stock are
unpaid. The 1940 Act also requires that, in addition to any
approval by stockholders that might otherwise be required, the
approval of the holders of a majority of any outstanding
Preferred Stock, voting separately as a class, would be required
to (i) adopt any plan of reorganization that would
adversely affect the Preferred Stock, and (ii) take any
action requiring a vote of security holders under
Section 13(a) of the 1940 Act. As a result of these voting
rights, the Acquired Funds ability to take any such
actions may be impeded to the extent that there is any Preferred
Stock outstanding. The Board presently intends that, except as
otherwise indicated in this prospectus and except as otherwise
required by applicable law, holders of Preferred Stock will have
equal voting rights with holders of Shares (one vote per share,
unless otherwise required by the 1940 Act) and will vote
together with holders of Shares as a single class.
The affirmative vote of the holders of a majority of the
outstanding Preferred Stock, voting as a separate class, will be
required to amend, alter or repeal any of the preferences,
rights or powers of holders of Preferred Stock so as to affect
materially and adversely such preferences, rights or powers, or
to increase or decrease the authorized number of shares of
Preferred Stock. The class vote of holders of Preferred Stock
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 Stock by the
Acquired Fund. The terms of any Preferred Stock
would typically provide that (i) they are redeemable by the
Acquired Fund in whole or in part at the original purchase price
per share plus accrued dividends per share, (ii) the
Acquired Fund may tender for or purchase Preferred Stock and
(iii) the Acquired Fund may subsequently resell any shares
so tendered for or purchased. Any redemption or purchase of
Preferred Stock by the Acquired Fund will reduce the leverage
applicable to the shares, while any resale of shares by the
Acquired Fund will increase that leverage.
The discussion above describes the possible offering of
Preferred Stock by the Acquired Fund. If the Board determines to
proceed with such an offering, the terms of the Preferred Stock
may be the same as, or different from, the terms described
above, subject to applicable law and the Acquired Funds
Certificate of Incorporation and By-laws. The Board, without the
approval of the holders of Shares, may authorize an offering of
Preferred Stock or may determine not to authorize such an
offering, and may fix the terms of the Preferred Stock to be
offered.
The Acquired Fund may apply for ratings for any Preferred Stock
from Moodys, S&P or Fitch. In order to obtain and
maintain the required ratings, the Acquired Fund will be
required to comply with investment quality, diversification and
other guidelines established by Moodys, S&P
and/or
Fitch. Such guidelines will likely be more restrictive than the
restrictions set forth above. The Acquired Fund does not
anticipate that such guidelines would have a material adverse
effect on the holders of Shares or the Acquired Funds
ability to achieve its investment objective.
Under the 1940 Act, the Acquired Fund is not permitted to issue
senior securities unless after such issuance the value of the
Acquired Funds total assets, less certain ordinary course
liabilities, is at least 200% of the amount of any debt
outstanding and 200% of the liquidation preference of any
Preferred Stock outstanding. In addition, the Acquired Fund is
not permitted to declare any cash distributions on its Shares
unless, at the time of such declaration, the value of the
Acquired Funds total assets is at least 200% of the
liquidation preference of the Acquired Funds outstanding
Preferred Stock and 200% of the amount of the Acquired
Funds outstanding senior securities representing debt. If
senior securities are issued, the Acquired Fund intends, to the
extent possible, to purchase or redeem senior securities from
time to time to the extent necessary in order to maintain
coverage of any senior
43
securities of at least 200%. In addition, as a condition to
obtaining ratings on the senior securities, the terms of any
senior securities issued are expected to include asset coverage
maintenance provisions which will require the redemption of the
senior securities in the event of non-compliance by the Acquired
Fund and may also prohibit distributions on the Shares in such
circumstances.
The Acquired Fund may also borrow money as a temporary measure
for liquidity and extraordinary or emergency purposes, including
the payment of dividends and the settlement of securities
transactions which otherwise might require untimely dispositions
of Acquired Fund securities.
Credit
Facility
The Acquired Fund currently leverages through borrowings from a
credit facility, which borrowings are expected to be paid down
prior to the closing of the Reorganization.
In accordance with the 1940 Act, with certain limited
exceptions, the Acquired Fund is only allowed to borrow amounts
such that its asset coverage, as defined in the 1940 Act, is at
least 200% after such borrowing. The Acquired Fund entered into
a Revolving Credit and Security Agreement with Liberty Street
Funding LLC, as conduit lender, and The Bank of Nova Scotia,
acting through its New York agency, as secondary lender and
agent (the Agent) on June 27, 2008, as amended
November 25, 2008 (the Credit Agreement). Under
the Credit Agreement, the Acquired Fund may borrow on a
revolving basis up to $60 million, subject to the
satisfaction of certain conditions including compliance with
borrowing base tests and asset coverage limits. The Credit
Agreement imposes stricter limitations than the 1940 Act,
requiring generally that asset coverage be at least 350% after a
borrowing. The Credit Agreement expires in May 2009 and
borrowings thereunder are secured by substantially all of the
assets in the Acquired Funds portfolio, including cash and
cash equivalents. The interest rate charged is based on
prevailing commercial paper rates if the conduit lender makes
the advance, other than through participations, plus commitment
and utilization fees. However, if the conduit lender does not
make the advance, other than through participations, the
interest rate is based on the prevailing Eurodollar rate,
Federal Funds rate or the agents reference rate, in each
case plus an applicable spread and commitment and utilization
fees. The Acquired Fund pays a commitment fee at the annual rate
of 1.25% on the total commitment amount, and a utilization fee
at the annual rate of 0.75% on outstanding borrowings. The
Credit Agreement contains customary events of default (with
grace periods where customary) including, among other things,
failure to pay interest or principal when due and failure to
comply with certain asset coverage and borrowing base tests.
ACQUIRING
FUND
Common
Stock
The Acquiring Fund is a statutory trust organized under the laws
of Delaware pursuant to an Agreement and Declaration of Trust
dated as of March 10, 2006 (Declaration of
Trust). The Acquiring Fund is authorized to issue an
unlimited number of common shares of beneficial interest, par
value $0.001 per share. Each common share has one vote and, when
issued and paid for is fully paid and non-assessable, except
that the trustees shall have the power to cause shareholders to
pay expenses of the Acquiring Fund by setting off charges due
from shareholders from declared but unpaid dividends or
distributions owed the shareholders
and/or by
reducing the number of common shares owned by each respective
shareholder. The Acquiring Fund currently is not aware of any
expenses that will be paid pursuant to this provision, except to
the extent fees payable under its Dividend Reinvestment Plan are
deemed to be paid pursuant to this provision.
The Acquiring 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. All common shares are equal as to
dividends, assets and voting privileges and have no conversion,
preemptive or other subscription rights. The Acquiring Fund will
send annual and semi-annual reports, including financial
statements, to all holders of its shares.
While the Acquiring Fund has filed a registration statement to
permit it to offer additional shares from time to time, such
registration statement has not been declared effective and the
Acquiring Fund has no
44
present intention of offering any additional shares on that
registration statement. Any additional offerings of shares will
require approval by the Acquiring Funds Board. Any
additional offering of common shares will be subject to the
requirements of the 1940 Act, which provides that shares may not
be issued at a price below the then current NAV, exclusive of
sales load, except in connection with an offering to existing
holders of common shares or with the consent of a majority of
the Acquiring Funds common shareholders. The Acquiring
Fund currently issues additional shares under its Dividend
Reinvestment Plan and, if approved, the Acquiring Fund will
issue additional shares pursuant to the Reorganization.
Any additional offerings of common shares would result in
current shareholders owning a smaller proportionate interest in
the Acquiring Fund than they owned prior to such offering to the
extent that shareholders do not purchase sufficient shares in
such offering to maintain their percentage interest. The
Acquiring Funds net asset value would be reduced
immediately following an offering of the shares due to the costs
of such offering, which will be borne entirely by the Acquiring
Fund. The sale of shares by the Acquiring Fund (or the
perception that such sales may occur) may have an adverse effect
on prices of shares in the secondary market. An increase in the
number of shares available may put downward pressure on the
market price for shares. If the Acquiring Fund were unable to
invest the proceeds of an additional offering of shares as
intended, the Acquiring Funds per share distribution may
decrease and the Acquiring Fund may not participate in market
advances to the same extent as if such proceeds were fully
invested as planned.
Unlike open-end funds, closed-end funds like the Acquiring 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 do so by trading through a broker on the NYSE or
otherwise. Shares of closed-end investment companies frequently
trade on an exchange at prices lower than NAV. 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, NAV, relative demand for and
supply of such shares in the market, general market and economic
conditions and other factors beyond the control of the Acquiring
Fund, the Acquiring Fund cannot assure you that common shares
will trade at a price equal to or higher than NAV in the future.
The common shares are designed primarily for long-term investors
and you should not purchase the common shares if you intend to
sell them soon after purchase. See the Statement of Additional
Information under Repurchase of Common Shares.
Preferred
Shares
The Declaration of Trust provides that the Acquiring Funds
Board may authorize and issue preferred shares with rights as
determined by the Board, by action of the Board 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. Whenever preferred shares are outstanding,
the holders of common shares will not be entitled to receive any
distributions from the Acquiring Fund unless all accrued
dividends on preferred shares have been paid, unless asset
coverage (as defined in the 1940 Act) with respect to preferred
shares would be at least 200% after giving effect to the
distributions and unless certain other requirements imposed by
any rating agencies rating the preferred shares have been met.
The Acquiring Fund may issue preferred shares as part of its
leverage strategy. 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, subject to applicable law and the Declaration of Trust,
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 Acquiring 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 Acquiring 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.
45
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 Acquiring 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 Acquiring 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,
voting separately as a class, would be required to
(i) adopt any plan of reorganization that would adversely
affect the preferred shares, and (ii) take any action
requiring a vote of security holders under Section 13(a) of
the 1940 Act, including, among other things, changes in the
Acquiring Funds subclassification as a closed-end
investment company or changes in its fundamental investment
restrictions. As a result of these voting rights, the Acquiring
Funds 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, 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
Acquiring Fund. The terms of the preferred shares
are expected to provide that (i) they are redeemable by the
Acquiring Fund in whole or in part at the original purchase
price per share plus accrued dividends per share, (ii) the
Acquiring Fund may tender for or purchase preferred shares and
(iii) the Acquiring Fund may subsequently resell any shares
so tendered for or purchased. Any redemption or purchase of
preferred shares by the Acquiring Fund will reduce the leverage
applicable to the common shares, while any resale of shares by
the Acquiring Fund will increase that leverage.
The discussion above describes the possible offering of
Preferred Shares by the Acquiring Fund. If the Board 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 Declaration
of Trust. 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.
Other
Shares
The Board (subject to applicable law and the Declaration of
Trust) may authorize an offering, without the approval of the
holders of common shares, of other classes of shares, or other
classes or series of shares, as they determine to be necessary,
desirable or appropriate, having such terms, rights,
preferences, privileges, limitations and restrictions as the
board of trustees see fit. The Acquiring Fund currently does not
expect to issue any other classes of shares, or series of
shares, except for the common shares.
Credit
Facility
The Acquiring Fund currently leverages through borrowings from a
credit facility.
The Acquiring Fund has entered into a revolving credit agreement
with The Bank of Nova Scotia (Scotia) to borrow up
to $380,000,000 (the Loan Agreement). At
December 31, 2008, the Acquiring Fund had outstanding
borrowings totaling $141,000,000. Such borrowings constitute
financial leverage. The Loan
46
Agreement contains covenants that limit the Acquiring
Funds ability to, without the prior consent of Scotia:
(i) pay dividends in certain circumstances, (ii) incur
additional debt, or (iii) adopt or carry out any plan of
liquidation, reorganization, incorporation, recapitalization,
merger or consolidation or sell, transfer or otherwise dispose
of all or a substantial part of its assets. The Acquiring Fund
has notified Scotia regarding the proposed Reorganization and
expects to receive Scotias consent prior to the time of
closing. For instance, the Acquiring Fund agreed not to purchase
assets not contemplated by the investment policies and
restrictions in effect when the Loan Agreement became effective.
Furthermore, the Acquiring Fund may not incur additional debt
from any other party, except for in limited circumstances
(e.g., in the ordinary course of business). In addition,
the Loan Agreement contains a covenant requiring asset coverage
ratios that may be more stringent than those required by the
1940 Act. Such restrictions shall apply only so long as the Loan
Agreement remains in effect. Any senior security representing
indebtedness, as defined in Section 18(g) of the 1940 Act,
must have asset coverage of at least 300%. Debt incurred under
the Loan Agreement will be considered a senior security for this
purpose. The Acquiring Fund will have 300% asset coverage
immediately following the Reorganization. For information about
the Loan Agreement, see Risk Factors and Special
Considerations Related to Proposal Leverage
Risk.
COMPARISON
OF CHARTERS AND BY-LAWS
The Acquired Fund is governed by an Amended and Restated
Certificate of Incorporation (the Certificate). The
Acquiring Fund is governed by an Agreement and Declaration of
Trust (the Declaration of Trust and together with
the Certificate, the Charters).
Powers and Liabilities Relating to
Shares. The Certificate permits Directors of
the Acquired Fund, without shareholder approval, to provide for
the issuance of all or any of the preferred shares in one or
more classes or series, and to fix for each such class or series
such voting powers, full or limited, or no voting powers, and
such distinctive designations, preferences and relative,
participating, optional or other special rights and such
qualifications, limitations or restrictions as shall be stated
in the resolution adopted by the Board of Directors providing
for the issuance of such class or series. The Declaration of
Trust permits the Trustees of the Acquiring Fund, without
shareholder approval, to issue, sell, repurchase, redeem,
retire, cancel, acquire, hold, resell, reissue, dispose of,
transfer and otherwise deal in, Shares including Shares in
fractional denominations.
The Declaration of Trust limits the personal liability of any
shareholder in connection with Acquiring Fund property or the
acts, obligations or affairs of the Acquiring Fund. Shareholders
have the same limitation of personal liability as is extended to
stockholders of a private corporation for profit incorporated
under the Delaware General Corporation Law. The Certificate does
not have a similar provision, though stockholders have limited
personal liability under the Delaware General Corporation Law.
Shareholder Voting Requirements
Generally.
Holders of record of Common Shares of the Acquired Fund shall
have one vote in respect of each share of stock held by such
holder of record on the books of the Acquired Fund for the
election of directors and on all other matters submitted to a
vote of stockholders of the Acquired Fund. The affirmative vote
of the holders of at least seventy-five percent (75%) of the
then outstanding shares of the Acquired Funds capital
stock entitled to vote generally in the election of directors,
voting together as a single class, shall be required to amend in
any respect or repeal the article relating to Amendments. In the
Acquiring Funds Declaration of Trust, no amendment may be
made to the By-laws or the Declaration of Trust except after a
majority of the trustees have approved a resolution therefor, by
the affirmative vote of the holders of not less than 75% of the
shares of each affected class or series outstanding, voting as
separate classes or series, unless such amendment has been
approved by 80% of the Trustees, in which case approval by a
Majority Shareholder Vote (as defined below) is required.
Majority Shareholder Vote means the vote, at the
annual or a special meeting of the security holders of such
company duly called: (A) of 67% of more of the voting
securities present at such meeting, if the holders of more than
50% of the outstanding voting securities of such company are
present or represented by proxy; or (B) of more than 50% of
the outstanding voting securities of such company, whichever is
the less.
47
Shareholders of the Acquiring Fund shall have no power to vote
on any matter except matters on which a vote of Shareholders is
required by applicable law, the Declaration of Trust or
resolution of the Trustees. The Declaration of Trust expressly
provides that no matter for which voting is required by the
Statutory Trust Act in the absence of the contrary
provision in the Declaration of Trust shall require any vote.
Except as otherwise provided herein, any matter required to be
submitted to Shareholders and affecting one or more classes or
series of shares shall require approval by the required vote of
all the affected classes and series of shares voting together as
a single class; provided, however, that as to any matter with
respect to which a separate vote of any class or series of
shares is required by the 1940 Act, such requirement as to a
separate vote by that class or series of shares shall apply in
addition to a vote of all the affected classes and series voting
together as a single class. Shareholders or a particular class
or series of shares shall not be entitled to vote on any matter
that affects only one or more other classes or series of shares.
There shall be no cumulative voting in the election or removal
of trustees.
In the Acquired Funds Certificate, any director may be
removed for cause from office by the action of the holders of at
least 75% of the then outstanding shares of the Acquired
Funds capital stock entitled to vote for the election of
the respective director. In the Acquiring Funds
Declaration of Trust, any of the trustees may be removed for
cause and only by action taken by a majority of the remaining
trustees followed by the holders of at least 75% of the Shares
then entitled to vote in an election of such trustee.
In the Acquired Funds Certificate, the affirmative vote of
the holders of at least 75% of the then outstanding shares of
the Acquired Funds capital stock entitled to vote
generally in the election of directors, voting together as a
single class, is required to amend Article VI relating to
Directors, Article VIII relating to Stockholders and
Article IX relating to the amendment or repeal of By-laws.
However, the Board of Directors is empowered to adopt, amend of
repeal the By-laws of the Acquired Fund, provided however, that
any adoption, amendment or repeal of the By-laws by the Board of
Directors requires the approval of at least
662/3%
of the total number of all authorized directors (whether or not
there exists any vacancies in previously authorized
directorships at the time any resolution providing for adoption,
amendment or repeal is presented to the Board of Directors).
Shareholder Voting Requirements Merger and
Consolidation. The Acquired Funds
Certificate states that the conversion of the Acquired Fund from
a business development company to an investment company, the
liquidation and dissolution of the Acquired Fund, the merger or
consolidation of the Acquired Fund with any entity in a
transaction as a result of which the governing documents of the
surviving entity do not contain substantially the same
anti-takeover provisions as described in the Certificate, and
any amendment to the provision relating to merger and
consolidation requires the approval of (i) the
holders of at least eighty percent (80%) of the then outstanding
shares of the Acquired Funds capital stock, voting
together as a single class, or (ii) at least (A) a
majority of the continuing directors and
(B) the holders of at least seventy-five percent (75%) of
the then outstanding shares of the Acquired Funds capital
stock entitled to vote generally in the election of directors,
voting together as a single class.
The Acquiring Funds Declaration of Trust states that the
Acquiring Fund may merge or consolidate with any other
corporation, association, trust or other organization or may
sell, lease or exchange all or substantially all of the Acquired
Funds property or the property, including its good will,
upon such terms and conditions and for such consideration when
and as authorized by two-thirds of the trustees and approved by
a majority shareholder vote and any such merger, consolidation,
sale, lease or exchange shall be determined for all purposes to
have been accomplished under and pursuant to the statutes of the
State of Delaware.
Governing Law. The Acquired Fund is
governed by the Delaware General Corporations Law. The Acquiring
Fund is governed by the Delaware Statutory Trust Act.
FEDERAL
INCOME TAX MATTERS
The following discussion summarizes certain U.S. federal
income tax considerations affecting the Funds and their
shareholders that are U.S. persons as defined
for U.S. federal income tax purposes. It reflects
provisions of the Code, existing Treasury regulations, rulings
published by the IRS, and other applicable
48
authorities, as of the date of this prospectus. These
authorities may be changed, possibly with retroactive effect, or
subject to new legislative, administrative, or judicial
interpretations. Your investment in the Funds may have other tax
implications. Please consult your tax advisor about federal,
state, local, foreign or other tax laws applicable to you. For
more information, including information about the tax
consequences to foreign persons of investing in the Funds,
please see the Statement of Additional Information under
Tax Matters.
Each Fund intends to qualify each year as a RIC under the Code.
A RIC is not subject to tax at the company level on income and
gains from investments that are distributed to shareholders.
However, a Funds failure to qualify as a RIC would result
in Fund-level taxation and consequently a reduction in income
available for distribution to shareholders.
Amounts not distributed on a timely basis in accordance with a
calendar year distribution requirement are subject to a
nondeductible 4% federal excise tax at the Fund level. To avoid
the tax, a Fund must distribute during each calendar year an
amount at least equal to the sum of (i) 98% of its ordinary
income (not taking into account any capital gains or losses) for
the calendar year, (ii) 98% of its capital gains in excess
of its capital losses (adjusted for certain ordinary losses) for
a one-year period generally ending on October 31 of the calendar
year (unless an election is made to use the Funds taxable
year) and (iii) certain undistributed amounts from previous
years on which the Fund paid no U.S. federal income tax.
Each Fund reserves the right to pay the excise tax when
circumstances warrant.
Certain of the Funds investment practices may be subject
to special and complex U.S. federal income tax provisions
that may, among other things: (i) disallow, suspend or
otherwise limit the allowance of certain losses or deductions,
(ii) convert lower taxed long-term capital gain or
qualified dividend income into higher taxed
short-term capital gain or ordinary income,
(iii) accelerate income, (iv) convert short-term
losses into long-term losses, (v) cause the Trust to
recognize income or gain without a corresponding receipt of
cash, (vi) adversely affect the time a purchase or sale of
stock or securities is deemed to occur, (vii) cause
adjustments in the holding periods of the Funds
securities, and (viii) adversely alter the characterization
of certain complex financial transactions. These
U.S. federal income tax provisions could therefore affect
the amount, timing and character of distributions to
shareholders. Each Fund intends to monitor its transactions and
may make certain tax elections. In addition, a Fund may be
required to borrow money or dispose of securities to mitigate
the effect of certain of these provisions, prevent the
Funds disqualification as a RIC, and avoid incurring
Fund-level U.S. federal income
and/or
excise taxes.
Special tax rules may change the treatment of gains and losses
recognized by a Fund when the Fund invests in certain foreign
securities or currencies. The application of these special rules
may also affect the timing, amount and character of
distributions made by a Fund. In addition, dividend, interest
and other income received by a Fund from investments outside the
United States may be subject to withholding and other taxes
imposed by foreign countries. Tax treaties between the United
States and other countries may reduce or eliminate such taxes.
The Funds do not expect that they will be eligible to elect to
treat any foreign taxes they pay as paid by their shareholders,
and therefore shareholders will not be entitled to claim a
credit or deduction for such taxes on their own tax returns.
Foreign taxes paid by a Fund will reduce the return from the
Funds underlying investments.
Distributions paid to shareholders by a Fund from its net
realized long-term capital gains (that is, the excess of any net
long-term capital gain over net short-term capital loss) that
the Fund designates as capital gain dividends (capital
gain dividends) are taxable to shareholders as long-term
capital gains, regardless of how long shareholders have held
their shares. Long-term capital gain rates applicable to
individuals have been temporarily reduced in
general, to 15% with lower rates applying to taxpayers in the
10% and 15% rate brackets for taxable years
beginning before January 1, 2011. All other dividends paid
to shareholders by a Fund (including dividends from net
investment income and from short-term capital gains (that is,
the excess of any net short-term capital gain over any net
long-term capital loss)) from its earnings and profits are
generally subject to tax as ordinary income. For taxable years
beginning before January 1, 2011, distributions of
investment income designated by a Fund as derived from
qualified dividend income will be taxed in the hands
of individuals at the rates applicable to long-term capital
gains, provided holding periods and other requirements are met
at both the shareholder and Fund levels. It is not generally
expected that a significant
49
portion of either Funds distributions will qualify for
favorable tax treatment as qualified dividend income
for individual shareholders or as income eligible for the
dividend-received deduction for corporate shareholders.
Dividends and other taxable distributions are taxable to
shareholders even if they are reinvested in additional common
shares of the Funds. Dividends and other distributions paid by
the Funds are generally treated as received by shareholders at
the time the dividend or distribution is made. If, however, a
Fund pays you a dividend in January that was declared in the
previous October, November or December and a shareholder was the
owner of record on a specified date in one of such months, then
such dividend will be treated for tax purposes as being paid by
the Fund and received by the shareholder on December 31 of the
year in which the dividend was declared.
The price of common shares purchased at any time may reflect the
amount of a forthcoming distribution. If you purchase common
shares just prior to a distribution, you will receive a
distribution that will be taxable to you even though it
represents in part a return of your invested capital.
The Funds will send you information after the end of each year
setting forth the amount and tax status of any distributions
paid to you by the Funds.
If you sell or otherwise dispose of common shares of a Fund, you
will generally recognize a gain or loss in an amount equal to
the difference between your tax basis in such shares of the Fund
and the amount you receive in exchange for such shares. If you
hold your common shares as capital assets, any such gain or loss
generally will be long-term capital gain or loss if you have
held (or are treated as having held) such shares for more than
one year at the time of sale.
A Fund may be required to withhold, for U.S. federal backup
withholding tax purposes, a portion of the dividends,
distributions and redemption proceeds payable to a non-corporate
shareholder who fails to provide the Trust (or its agent) with
the shareholders correct taxpayer identification number
(in the case of an individual, generally, such individuals
social security number) or to make the required certification,
or who has been notified by the IRS that such shareholder is
subject to backup withholding. Certain shareholders are exempt
from backup withholding. Backup withholding is not an additional
tax and any amount withheld may be refunded or credited against
your U.S. federal income tax liability, if any, provided
that you furnish the required information to the IRS.
The discussions set forth herein and in the Statement of
Additional Information do not constitute tax advice, and you are
urged to consult your own tax advisor to determine the specific
U.S. federal, state, local and foreign tax consequences to
you of investing in the Funds.
ANTI-TAKEOVER
PROVISIONS
ACQUIRED
FUND
The Acquired Funds Certificate and By-laws include
provisions that could have the effect of limiting the ability of
other entities or persons to acquire control of the Acquired
Fund or to change the composition of its Board. This could have
the effect of depriving stockholders of an opportunity to sell
their stock at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control over
the Acquired Fund. Such attempts could have the effect of
increasing the expenses of the Acquired Fund and disrupting the
normal operation of the Acquired Fund. The Board is divided into
three classes, with the term of one class expiring at each
annual meeting of stockholders. At each annual meeting, one
class of Board members is elected to a three-year term. This
provision could delay for up to two years the replacement of a
majority of the Board. A Board member may be removed from office
for cause by the action of a majority of the remaining Board
members followed by a vote of the holders of at least 75% of the
stock then entitled to vote for the election of the respective
Board member.
In addition, the Acquired Funds Certificate and By-laws
require the favorable vote of a majority of the Directors
followed by the favorable vote of the holders of at least 75% of
the outstanding stock of each
50
affected class or series of the Acquired Fund, voting separately
as a class or series, to approve, adopt or authorize certain
transactions with Principal Stockholders (as defined below),
unless 80% of the Directors have by resolution approved a
memorandum of understanding with the Principal Stockholder with
respect to and substantially consistent with such transaction,
in which case approval by a majority of the outstanding
voting securities (as defined in the 1940 Act) of the
Acquired Fund, with each class and series of shares voting
together as a single class, unless otherwise required, will be
required. For purposes of these provisions, a Principal
Stockholder refers to any person (as defined in the Acquired
Funds Certificate) who, whether directly or indirectly and
whether alone or together with its affiliates and associates,
beneficially owns 10% or more of the outstanding stock of the
voting securities of the Acquired Fund.
The Principal Stockholder transactions subject to these special
approval requirements are: the merger or consolidation of the
Acquired Fund or any subsidiary of the Acquired Fund with or
into any Principal Stockholder; the issuance of any securities
of the Acquired Fund to any Principal Stockholder for cash,
except pursuant to any automatic dividend reinvestment plan; the
sale, lease or exchange of all or any substantial part of the
assets of the Acquired Fund to any Principal Stockholder, except
assets having an aggregate fair market value of less than 5% of
the total assets of the Acquired Fund, aggregating for the
purpose of such computation all assets sold, leased or exchanged
in any series of similar transactions within a twelve-month
period; or the sale, lease or exchange to the Acquired Fund or
any subsidiary of the Acquired Fund, in exchange for securities
of the Acquired Fund, of any assets of any Principal
Stockholder, except assets having an aggregate fair market value
of less than 5% of the total assets of the Acquired Fund,
aggregating for purposes of such computation all assets sold,
leased or exchanged in any series of similar transactions within
a twelve-month period.
To convert the Acquired Fund to an investment company, to
liquidate and dissolve the Acquired Fund, to merge or
consolidate the Acquired Fund with any entity in a transaction
as a result of which the governing documents of the surviving
entity do not contain substantially the same anti-takeover
provisions as those included in the Certificate or to amend any
of the provisions discussed herein, the Acquired Funds
Certificate and By-laws require the approval of (i) the
holders of at least 80% of the then outstanding shares of the
Acquired Funds capital stock, voting together as a single
class, or (ii) at least (A) a majority of the
continuing directors (as defined in the Certificate)
and (B) the holders of at least 75% of the then outstanding
shares of the Acquired Funds capital stock entitled to
vote generally in the election of directors, voting together as
a single class. You should assume that it is not likely that the
Board would vote to convert the Acquired Fund to an investment
company.
For purposes of calculating a majority of the outstanding
voting securities under the Acquired Funds
certificate of incorporation and bylaws, each class and series
of stock of the Acquired Fund will vote together as a single
class, except to the extent required by the 1940 Act or the
Acquired Funds certificate of incorporation and bylaws,
with respect to any class or series of shares. If a separate
class vote is required, the applicable proportion of stock of
the class or series, voting as a separate class or series, also
will be required.
The Board has determined that provisions with respect to the
Board and the stockholder voting requirements described above,
which voting requirements are greater than the minimum
requirements under Delaware law or the 1940 Act, are in the best
interest of stockholders generally. Reference should be made to
the Acquired Funds Certificate and By-laws on file with
the SEC for the full text of these provisions.
ACQUIRING
FUND
Similar to the Acquired Fund, the Acquiring Funds
Declaration of Trust includes provisions that could have the
effect of limiting the ability of other entities or persons to
acquire control of the Fund or to change the composition of its
board of trustees. These provisions are similar to, but not
identical to those of the Acquired Fund. This could have the
effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by
discouraging a third party from seeking to obtain control over
the Fund. Such attempts could have the effect of increasing the
expenses of the Fund and disrupting the normal operation of the
Fund. The board of trustees is divided into three classes, with
the terms of one class expiring at each annual meeting of
shareholders. At each annual meeting, one class of trustees is
elected to a three-year
51
term. This provision could delay for up to two years the
replacement of a majority of the board of trustees. A trustee
may be removed from office (for cause, and not without cause) by
the action of a majority of the remaining trustees followed by a
vote of the holders of at least 75% of the shares then entitled
to vote for the election of the respective trustee.
In addition, the Declaration of Trust requires the favorable
vote of a majority of the Funds board of trustees followed
by the favorable vote of the holders of at least 75% of the
outstanding shares of each affected class or series of the Fund,
voting separately as a class or series, to approve, adopt or
authorize certain transactions with Principal Shareholders (as
defined below), unless the transaction has been approved by at
least 80% of the trustees, in which case a majority of the
outstanding voting securities (as defined in the 1940 Act)
of the Fund shall be required. For purposes of these provisions,
a Principal Shareholder refers to any person who,
whether directly or indirectly and whether alone or together
with its affiliates and associates, beneficially owns 5% or more
of the outstanding shares of all outstanding classes or series
of shares of beneficial interest of the Fund.
The Principal Shareholder transactions subject to these special
approval requirements are: the merger or consolidation of the
Fund or any subsidiary of the Fund with or into any Principal
Shareholder; the issuance of any securities of the Fund to any
Principal Shareholder for cash, except pursuant to any automatic
dividend reinvestment plan; the sale, lease or exchange of all
or any substantial part of the assets of the Fund to any
Principal Shareholder, except assets having an aggregate fair
market value of less than 2% of the total assets of the Fund,
aggregating for the purpose of such computation all assets sold,
leased or exchanged in any series of similar transactions within
a twelve-month period; or the sale, lease or exchange to the
Fund or any subsidiary of the Fund, in exchange for securities
of the Fund, of any assets of any Principal Shareholder, except
assets having an aggregate fair market value of less than 2% of
the total assets of the Fund, aggregating for purposes of such
computation all assets sold, leased or exchanged in any series
of similar transactions within a twelve-month period.
To convert the Fund to an open-end investment company, the
Declaration of Trust requires the favorable vote of a majority
of the board of the trustees followed by the favorable vote of
the holders of at least 75% of the outstanding shares of each
affected class or series of shares of the Fund, voting
separately as a class or series, unless such amendment has been
approved by at least 80% of the trustees, in which case a
majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund shall be required. The foregoing
vote would satisfy a separate requirement in the 1940 Act that
any conversion of the Fund to an open-end investment company be
approved by the shareholders. If approved in the foregoing
manner, conversion of the Fund to an open-end investment company
could not occur until 90 days after the shareholders
meeting at which such conversion was approved and would also
require at least 30 days prior notice to all
shareholders. Following any such conversion, it is possible that
certain of the Funds investment policies and strategies
would have to be modified to assure sufficient portfolio
liquidity. In the event of conversion, the common shares would
cease to be listed on the NYSE or other national securities
exchanges or market systems. 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 NAV, 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 reserves 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 shares
would be sold at NAV plus a sales load. The board of trustees
believes, however, that the closed-end structure is desirable in
light of the Funds investment objectives and policies.
Therefore, you should assume that it is not likely that the
board of trustees would vote to convert the Fund to an open-end
fund.
For the purposes of calculating a majority of the
outstanding voting securities under the Declaration of
Trust, each class and series of the Fund shall vote together as
a single class, except to the extent required by the 1940 Act or
the Declaration of Trust, with respect to any class or series of
shares. If a separate class vote is required, the applicable
proportion of shares of the class or series, voting as a
separate class or series, also will be required.
52
The Declaration of Trust also provides that the Fund may be
liquidated upon the approval of 80% of the trustees.
The board of trustees has determined that provisions with
respect to the board of trustees and the shareholder voting
requirements described above, which voting requirements are
greater than the minimum requirements under Delaware law or the
1940 Act, are in the best interest of shareholders generally.
Reference should be made to the Declaration of Trust on file
with the SEC for the full text of these provisions.
PAST
PERFORMANCE OF EACH FUND
As shown in the table below, the performance of the Acquiring
Fund on a net asset value basis and market value basis has
exceeded that of the Acquired Fund for the one-year period ended
December 31, 2008. However, there is no guarantee or
assurance as to the future performance of the Acquiring Fund.
Each Funds performance at market price may differ from its
results at NAV. Although market price performance generally
reflects investment results, it may also be influenced by
several factors, including changes in investor perceptions of
each Fund or its investment adviser, market conditions,
fluctuations in supply and demand for each Funds shares
and changes in each Funds distributions.
TOTAL
RETURNS AS OF DECEMBER 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquired Fund*
|
|
|
Acquiring Fund**
|
|
|
|
|
|
|
Market
|
|
|
|
|
|
Market
|
|
|
|
NAV
|
|
|
Price
|
|
|
NAV
|
|
|
Price
|
|
|
1 year
|
|
|
(61.25
|
)%
|
|
|
(70.80
|
)%
|
|
|
(57.68
|
)%
|
|
|
(57.84
|
)%
|
3 years
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
5 years
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
10 years/Since Inception
|
|
|
(46.31
|
)%
|
|
|
(58.66
|
)%
|
|
|
(26.82
|
)%
|
|
|
(31.92
|
)%
|
|
|
|
* |
|
The Acquired Fund commenced investment operations and public
trading on February 22, 2007. |
|
** |
|
The Acquiring Fund commenced investment operations on
June 29, 2006. |
53
FINANCIAL
HIGHLIGHTS
The following Financial Highlights tables are intended to help
you understand each Funds financial performance since
inception. This information for each period presented, derived
from each Funds Financial Statements, has been audited
(except where noted) by PricewaterhouseCoopers LLP, whose report
is included in the Acquiring Funds Annual Report and the
Acquired Funds Annual Report on
Form 10-K,
which are incorporated by reference into the Statement of
Additional Information and available upon request.
Highland
Distressed Opportunities, Inc.
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
12/31/08
|
|
|
12/31/07(a)
|
|
|
Net Asset Value, Beginning of Year
|
|
$
|
10.27
|
|
|
$
|
14.33
|
(b)
|
Net investment income
|
|
|
0.61
|
|
|
|
0.97
|
|
Net realized and unrealized loss on investments
|
|
|
(6.71
|
)
|
|
|
(4.43
|
)
|
|
|
|
|
|
|
|
|
|
Total from investment operations
|
|
|
(6.10
|
)
|
|
|
(3.46
|
)
|
Common Stock Offering Cost
|
|
|
|
|
|
|
(0.07
|
)
|
Capital Contribution
|
|
|
|
|
|
|
0.26
|
(c)
|
Distributions Paid
|
|
|
(0.75
|
)
|
|
|
(0.79
|
)
|
Net Asset Value, End of Year
|
|
$
|
3.42
|
|
|
$
|
10.27
|
|
Market price per share, Beginning of Year
|
|
$
|
8.57
|
|
|
$
|
15.00
|
|
Market price per share, End of Year
|
|
$
|
2.15
|
|
|
$
|
8.57
|
|
Total investment return(d)
|
|
|
|
|
|
|
|
|
Based on net asset value per share
|
|
|
(61.24
|
)%
|
|
|
(23.30
|
)%(e)
|
Based on market price per share
|
|
|
(70.80
|
)%
|
|
|
(38.85
|
)%(e)
|
Net assets, end of year(f)
|
|
$
|
60,556
|
|
|
$
|
182,015
|
|
Ratios to Average Net Assets/Supplemental Data:
|
|
|
|
|
|
|
|
|
Total operating expense including interest expense
|
|
|
9.18
|
%
|
|
|
9.54
|
%(g)
|
Total operating expenses excluding interest expense
|
|
|
6.75
|
%
|
|
|
5.74
|
%(g)
|
Interest expense
|
|
|
2.43
|
%
|
|
|
3.80
|
%(g)
|
Waiver/reimbursement
|
|
|
0.62
|
%
|
|
|
2.24
|
%(g)
|
Net expense(h)
|
|
|
8.56
|
%
|
|
|
7.30
|
%(g)
|
Net investment income
|
|
|
8.25
|
%
|
|
|
8.77
|
%(g)
|
Portfolio turnover rate
|
|
|
49
|
%
|
|
|
224
|
%(e)
|
Debt:
|
|
|
|
|
|
|
|
|
Total loan outstanding, end of year(f)
|
|
$
|
15,500
|
|
|
$
|
142,000
|
|
Asset Coverage per $1000 indebtedness, end of year(i)
|
|
$
|
4,907
|
|
|
$
|
2,282
|
|
|
|
|
(a)
|
|
Highland Distressed Opportunities,
Inc. (the Acquired Fund) commenced operations on
January 18, 2007.
|
|
(b)
|
|
Net asset value at the beginning of
the period reflects the deduction of the one-time initial sales
load in connection with the offering.
|
|
(c)
|
|
On February 20, 2007, the
Investment Adviser contributed an additional $87,596 in capital
to the Acquired Fund prior to the offering. No additional shares
were issued in the transaction. The contribution per share is
based on the pre-offering share amount of 333,333.33.
|
|
(d)
|
|
Total investment return based on
market value may result in substantially different returns than
investment return based on net asset value, because market value
can be significantly greater or less than the net asset value.
Investment return assumes reinvestment of distributions.
|
|
(e)
|
|
Not annualized.
|
|
(f)
|
|
Dollars in thousands.
|
|
(g)
|
|
Ratios to average net assets for
the year ended December 31, 2007 are calculated using the
net assets of the period starting from the offering on
February 27, 2007 through December 31, 2007.
|
|
(h)
|
|
Net expense ratio has been
calculated after applying any waiver/reimbursement.
|
|
(i)
|
|
Calculated by subtracting the
Acquired Funds total liabilities (not including any bank
loans and senior securities) from the Acquired Funds total
assets, and dividing such amounts by the principal amount of the
debt outstanding.
|
54
Highland
Credit Strategies Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
12/31/08
|
|
|
12/31/07
|
|
|
12/31/06(a)
|
|
|
Net Asset Value, Beginning of Period
|
|
$
|
17.99
|
|
|
$
|
20.08
|
|
|
$
|
19.06
|
|
Income from Investment Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
1.35
|
|
|
|
1.71
|
|
|
|
0.71
|
|
Net realized and unrealized gain/(loss) on investments
|
|
|
(9.79
|
)
|
|
|
(1.85
|
)
|
|
|
0.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total from investment operations
|
|
|
(8.44
|
)
|
|
|
(0.14
|
)
|
|
|
1.62
|
|
Less Distributions Declared to Common Shareholders
|
|
|
|
|
|
|
|
|
|
|
|
|
From net investment income
|
|
|
(1.46
|
)
|
|
|
(1.65
|
)
|
|
|
(0.60
|
)
|
From net realized gains
|
|
|
(0.26
|
)
|
|
|
(0.30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distributions Declared to Common Shareholders
|
|
|
(1.72
|
)
|
|
|
(1.95
|
)
|
|
|
(0.60
|
)
|
Dilutive impact of rights offering
|
|
|
(1.32
|
)
|
|
|
|
|
|
|
|
|
Net Asset Value, End of Period
|
|
$
|
6.51
|
|
|
$
|
17.99
|
|
|
$
|
20.08
|
|
Market Value, End of Period
|
|
$
|
5.70
|
|
|
$
|
15.82
|
|
|
$
|
21.66
|
|
Market Value Total Return(b)
|
|
|
(57.84
|
)%
|
|
|
(17.05
|
)%
|
|
|
9.06
|
%(c)
|
Ratios and Supplemental Data
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (in 000s)
|
|
$
|
361,211
|
|
|
$
|
621,078
|
|
|
$
|
692,964
|
|
Common Share Information at End of Year:
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios based on average net assets of common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross operating expenses (including interest expense)
|
|
|
3.78
|
%
|
|
|
4.03
|
%
|
|
|
2.56
|
%
|
Interest expenses
|
|
|
1.63
|
%
|
|
|
2.16
|
%
|
|
|
1.03
|
%
|
Dividend expense from short positions
|
|
|
0.17
|
%
|
|
|
0.03
|
%
|
|
|
N/A
|
|
Fees and expenses waived
|
|
|
0.09
|
%
|
|
|
|
|
|
|
|
|
Net expenses
|
|
|
3.86
|
%
|
|
|
4.06
|
%
|
|
|
2.56
|
%
|
Net investment income
|
|
|
11.36
|
%
|
|
|
8.64
|
%
|
|
|
7.37
|
%
|
Ratios based on managed net assets of common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross operating expenses
|
|
|
2.69
|
%
|
|
|
2.94
|
%
|
|
|
2.20
|
%
|
Interest expense
|
|
|
1.16
|
%
|
|
|
1.58
|
%
|
|
|
0.89
|
%
|
Dividend expense from short positions
|
|
|
0.12
|
%
|
|
|
0.02
|
%
|
|
|
N/A
|
|
Fees and expenses waived
|
|
|
0.06
|
%
|
|
|
|
|
|
|
|
|
Net expenses
|
|
|
2.75
|
%
|
|
|
2.96
|
%
|
|
|
2.20
|
%
|
Net investment income
|
|
|
8.12
|
%
|
|
|
6.31
|
%
|
|
|
6.33
|
%
|
Portfolio turnover rate
|
|
|
78
|
%
|
|
|
66
|
%
|
|
|
46
|
%(c)
|
|
|
|
(a)
|
|
Highland Credit Strategies Fund
commenced operations on June 29, 2006.
|
|
(b)
|
|
Based on market value per share.
Distributions, if any, are assumed for purposes of this
calculation to be reinvested at prices obtained under the
Funds Dividend reinvestment plan.
|
|
(c)
|
|
Not annualized.
|
55
SELECTED
FINANCIAL DATA
ACQUIRING
FUND
The following table sets forth selected historical financial and
operating data for Acquiring Fund, as of and for the dates and
period indicated. The selected historical financial data are
derived from the Acquiring Funds December 31, 2008
and December 31, 2007 financial statements, which have been
audited by PricewaterhouseCoopers LLP, Acquiring Funds
independent registered public accounting firm. This selected
financial data should be read in conjunction with Acquiring
Funds financial statements.
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Total Investment Income
|
|
$
|
97,893,590
|
|
|
$
|
86,865,105
|
|
Net Expenses
|
|
$
|
24,817,494
|
|
|
$
|
27,760,416
|
|
Net Investment Income
|
|
$
|
73,076,096
|
|
|
$
|
59,104,689
|
|
Net realized and unrealized gain/(loss) on investments
|
|
$
|
(558,938,817
|
)
|
|
$
|
17,716,313
|
|
Net increase/(decrease) in stockholders equity resulting from
operations
|
|
$
|
(485,862,721
|
)
|
|
$
|
(4,761,752
|
)
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
529,859,897
|
|
|
$
|
916,967,476
|
|
Borrowing Outstanding
|
|
$
|
141,000,000
|
|
|
$
|
248,000,000
|
|
Stockholders Equity
|
|
$
|
361,210,505
|
|
|
$
|
621,078,161
|
|
ACQUIRED
FUND
The following table sets forth selected historical financial and
operating data for Acquired Fund, as of and for the dates and
period indicated. The selected historical financial data are
derived from Acquired Funds December 31, 2008 and
December 31, 2007 financial statements, which have been
audited by PricewaterhouseCoopers LLP, Acquired Funds
independent registered public accounting firm. This selected
financial data should be read in conjunction with Acquired
Funds financial statements.
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2008
|
|
|
Period Ended December 31, 2007(a)
|
|
|
Total investment income
|
|
$
|
21,978,674
|
|
|
$
|
31,329,721
|
|
Net expenses
|
|
$
|
11,188,738
|
|
|
$
|
14,240,203
|
|
Net investment income
|
|
$
|
10,789,936
|
|
|
$
|
17,089,518
|
|
Net realized and unrealized gain/(loss) on investments
|
|
$
|
(118,960,982
|
)
|
|
$
|
(74,340,032
|
)
|
Net increase/(decrease) in stockholders equity (net
assets) resulting from operations
|
|
$
|
(108,171,046
|
)
|
|
$
|
(57,250,514
|
)
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
87,162,000
|
|
|
$
|
346,923,924
|
|
Borrowings outstanding
|
|
$
|
15,500,000
|
|
|
$
|
142,000,000
|
|
Stockholders equity (net assets)
|
|
$
|
60,556,428
|
|
|
$
|
182,015,052
|
|
|
|
|
(a) |
|
Highland Distressed Opportunities, Inc. commenced operations on
January 18, 2007. |
56
ACQUIRED
FUND SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
(In
thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
Q1 *
|
|
|
Q2
|
|
|
Q3
|
|
|
Q4
|
|
|
Total
|
|
|
Total investment income
|
|
$
|
1,653
|
|
|
$
|
9,577
|
|
|
$
|
9,521
|
|
|
$
|
10,578
|
|
|
$
|
31,330
|
|
Total investment income per share
|
|
$
|
0.09
|
|
|
$
|
0.54
|
|
|
$
|
0.54
|
|
|
$
|
0.60
|
|
|
$
|
1.77
|
|
Net investment income
|
|
$
|
1,290
|
|
|
$
|
6,173
|
|
|
$
|
4,266
|
|
|
$
|
5,361
|
|
|
$
|
17,090
|
|
Net investment income per share
|
|
$
|
0.07
|
|
|
$
|
0.35
|
|
|
$
|
0.24
|
|
|
$
|
0.30
|
|
|
$
|
0.97
|
|
Net realized and unrealized gain/(loss)
|
|
$
|
(934
|
)
|
|
$
|
(5,729
|
)
|
|
$
|
(30,386
|
)
|
|
$
|
(37,291
|
)
|
|
$
|
(74,340
|
)
|
Net realized and unrealized gain/(loss) per share
|
|
$
|
(0.05
|
)
|
|
$
|
(0.32
|
)
|
|
$
|
(1.72
|
)
|
|
$
|
(2.10
|
)
|
|
$
|
(4.20
|
)
|
Net increase/(decrease) in stockholders equity (net
assets) resulting from operations
|
|
$
|
356
|
|
|
$
|
443
|
|
|
$
|
(26,120
|
)
|
|
$
|
(31,929
|
)
|
|
$
|
(57,251
|
)
|
Net increase/(decrease) in stockholders equity (net
assets) resulting from operations per share
|
|
$
|
0.02
|
|
|
$
|
0.03
|
|
|
$
|
(1.47
|
)
|
|
$
|
(1.80
|
)
|
|
$
|
(3.23
|
)
|
|
|
|
* |
|
Highland Distressed Opportunities, Inc. commenced operations on
January 18, 2007. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
|
Q1
|
|
|
Q2
|
|
|
Q3
|
|
|
Q4
|
|
|
Total
|
|
|
Total investment income
|
|
$
|
7,893
|
|
|
$
|
6,479
|
|
|
$
|
4,086
|
|
|
$
|
3,520
|
|
|
$
|
21,979
|
|
Total investment income per share
|
|
$
|
0.45
|
|
|
$
|
0.37
|
|
|
$
|
0.23
|
|
|
$
|
0.20
|
|
|
$
|
1.24
|
|
Net investment income
|
|
$
|
3,481
|
|
|
$
|
4,050
|
|
|
$
|
1,972
|
|
|
$
|
1,286
|
|
|
$
|
10,790
|
|
Net investment income per share
|
|
$
|
0.20
|
|
|
$
|
0.23
|
|
|
$
|
0.11
|
|
|
$
|
0.07
|
|
|
$
|
0.61
|
|
Net realized and unrealized gain/(loss)
|
|
$
|
(34,511
|
)
|
|
$
|
(17,433
|
)
|
|
$
|
(9,076
|
)
|
|
$
|
(57,971
|
)
|
|
$
|
(118,961
|
)
|
Net realized and unrealized gain/(loss) per share
|
|
$
|
(1.95
|
)
|
|
$
|
(0.98
|
)
|
|
$
|
(0.51
|
)
|
|
$
|
(3.27
|
)
|
|
$
|
(6.71
|
)
|
Net increase/(decrease) in stockholders equity (net
assets) resulting from operations
|
|
$
|
(31,030
|
)
|
|
$
|
(13,383
|
)
|
|
$
|
(7,103
|
)
|
|
$
|
(56,655
|
)
|
|
$
|
(108,171
|
)
|
Net increase/(decrease) in stockholders equity (net
assets) resulting from operations per share
|
|
$
|
(1.75
|
)
|
|
$
|
(0.76
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(3.20
|
)
|
|
$
|
(6.11
|
)
|
57
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF ACQUIRED FUND
Some of the statements in this report constitute forward-looking
statements, which relate to future events or the future
performance or financial condition of Highland Distressed
Opportunities, Inc. (the Acquired Fund,
we, us and our). The
forward-looking statements contained in this report involve
risks and uncertainties, including statements as to:
|
|
|
|
|
our future operating results;
|
|
|
|
the benefits of the proposed reorganization of the Acquired Fund
into the Acquiring Fund, announced on December 19, 2008;
|
|
|
|
our business prospects and the prospects of our portfolio
companies;
|
|
|
|
the impact of investments that we expect to make;
|
|
|
|
our contractual arrangements and relationships with third
parties;
|
|
|
|
the dependence of our future success on the general economy and
its impact on the industries in which we invest;
|
|
|
|
our expected financings and investments;
|
|
|
|
the adequacy of our cash resources and working capital,
including our ability to obtain continued financing on favorable
terms;
|
|
|
|
the timing of cash flows, if any from the operations of our
portfolio companies; and
|
|
|
|
the ability of our investment adviser to locate suitable
investments for us and to monitor and administer our investments.
|
We have generally identified such statements by using words such
as anticipates, believes,
expects, intends, will,
should, may and similar expressions to
identify forward-looking statements. Our actual results could
differ materially from those projected in the forward-looking
statements for any reason. We have based the forward-looking
statements included in this report on information available to
us on the date of this report, and we assume no obligation to
update any such forward-looking statements. Although we
undertake no obligation to revise or update any forward-looking
statements, whether as a result of new information, future
events or otherwise, you are advised to consult any additional
disclosures that we may make directly to you or through reports
and other information that we in the future may file with the
Securities and Exchange Commission (SEC), including
proxy statements, annual reports on
Form 10-K,
quarterly reports on
Form 10-Q
and current reports on
Form 8-K.
The public may read and copy any materials filed by the Acquired
Fund with the SEC at the SECs Public Reference Room at
100 F Street, NE, Washington, DC 20549. The public may
obtain information on the operation of the Public Reference Room
by calling the SEC at
1-800-SEC-0330.
The SEC maintains an Internet site
(http://www.sec.gov)
that contains reports, proxy and information statements, and
other information regarding issuers that file electronically.
Information about the Acquired Fund is also available at
http://www.HighlandHCD.com.
Overview
This discussion is as of December 31, 2008. We were
incorporated in Delaware on August 22, 2006 and initially
funded on January 18, 2007. We commenced material
operations on February 27, 2007. Our investment objective
is total return generated by both capital appreciation and
current income. We will seek to achieve this objective by
investing in financially-troubled or distressed companies that
are either middle-market companies or unlisted companies by
investing in senior secured debt, mezzanine debt and unsecured
debt, each of which may include an equity component, and in
equity investments.
Generally, distressed companies are those that (i) are
facing financial or other difficulties and (ii) are or have
been operating under the provisions of the U.S. Bankruptcy
Code or other similar laws or, in the near future, may become
subject to such provisions or otherwise be involved in a
restructuring of their capital
58
structure. We use the term middle-market to refer to
companies with annual revenues between $50 million and
$1 billion. We use the term unlisted to refer
to companies not listed on a national securities exchange (for
example, companies whose securities are quoted on the
over-the-counter bulletin board or through Pink Sheets LLC would
not be listed on a national securities exchange,
although they may be considered public companies).
We have elected to be treated as a business development company
(a BDC) under the Investment Company Act of 1940
(the 1940 Act). As a BDC, we are required to comply
with certain regulatory requirements. For instance, we are
generally prohibited from acquiring assets other than
qualifying assets unless, after giving effect to the
acquisition, at least 70% of our total assets are qualifying
assets. Qualifying assets generally include securities of
eligible portfolio companies (as defined in the 1940
Act), cash, cash equivalents, U.S. government securities
and high-quality debt instruments maturing in one year or less
from the time of investment. Additionally, we have elected to be
treated as a regulated investment company under Subchapter M of
the Internal Revenue Code of 1986 (the Code).
On February 26, 2007, the Acquired Fund closed its initial
public offering (IPO or the Offering)
and sold 17,000,000 shares of its common stock at a price
of $15.00 per share, less an underwriting discount and
commissions totaling $0.675 per share. We commenced material
operations on February 27, 2007 as we received $243,525,000
in total net proceeds from the IPO. On March 23, 2007 the
Acquired Fund issued 284,300 shares of common stock to
cover the underwriters partial exercise of the
over-allotment option on the Offering and received approximately
$4,072,698 in net proceeds after deducting underwriting
discounts and commissions.
On December 19, 2008, the Board of Directors of the
Acquired Fund approved an agreement and plan of merger and
liquidation (Agreement). The Agreement provides for
the merger of the Acquired Fund with and into HCF Acquisition
LLC (Merger Sub), a Delaware limited liability
company to be organized as a wholly owned subsidiary of Highland
Credit Strategies Fund (the Acquiring Fund), a
non-diversified, closed-end management investment company also
managed by the Highland Capital Management, L.P. (the
Merger), with Merger Sub being the surviving entity
and pursuant to which common stockholders of the Acquired Fund
will receive shares of beneficial interest of the Acquiring Fund
(and cash in lieu of any fractional shares). Immediately after
the Merger, Merger Sub will distribute its assets to the
Acquiring Fund, and the Acquiring Fund will assume the
liabilities of Merger Sub, in complete liquidation and
dissolution of Merger Sub (collectively with the Merger, the
Reorganization). As a result of the Reorganization,
each common stockholder of the Acquired Fund will become a
common shareholder of the Acquiring Fund.
The closing of the Reorganization is subject to several
conditions, including the approval of the Acquired Funds
stockholders. If stockholders of the Acquired Fund do not
approve the reorganization or, if such other conditions are not
satisfied or waived, the Acquired Fund will continue its current
operations. There is no assurance that the requisite stockholder
approval will be obtained for the Reorganization or such other
conditions will be satisfied.
On December 24, 2008, the Acquiring Fund filed with the
Securities and Exchange Commission a proxy statement/prospectus
with respect to the Reorganization. The Acquired Fund expects to
mail the proxy statement/prospectus to its stockholders and to
solicit approval of the reorganization in March 2009. The
Acquired Fund and the Acquiring Fund will bear the costs of the
reorganization. It is currently expected that the Reorganization
will qualify as a tax-free reorganization for federal income tax
purposes. The number of shares of the Acquiring Fund (and cash
for fractional shares) that stockholders of the Acquired Fund
will receive in the Reorganization will be based on the relative
net asset values of the Acquired Fund and the Acquiring Fund as
of the close of business on the valuation date for the
Reorganization. Subject to stockholder approval and the
satisfaction or waiver of certain conditions, the Reorganization
is currently expected to occur in the 2nd quarter of 2009.
Until the date of the stockholder meeting to consider the
Reorganization and, if approved, during the period between the
stockholder meeting and the closing of the Reorganization, the
Acquired Fund may determine to use funds received from interest
payments or the sale of investments to pay down the Acquired
59
Funds credit facility and may maintain a larger cash
position than under normal circumstances pending the
Reorganization.
Critical
Accounting Policies
Our discussion and analysis of our financial condition and
results of operations are based upon our financial statements,
which have been prepared in conformity with accounting
principles generally accepted in the United States of America
(GAAP). The preparation of these financial
statements requires management to make estimates and assumptions
that affect the reported amount of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and
expenses during the reported period. Changes in the economic
environment, financial markets and any other parameters used in
determining such estimates could cause actual results to differ
materially. In addition to the discussion below, our significant
accounting policies are further described in the notes to the
financial statements.
Valuation
of Investments
We use the following valuation methods to determine either
current market value for investments for which market quotations
are available, or if not available, then fair value, as
determined in good faith pursuant to policies and procedures
approved by the Acquired Funds Board:
Market
Quotations Available
The market value of each security listed or traded on any
recognized securities exchange or automated quotation system
will be the last reported sale price at the relevant valuation
date on the composite tape or on the principal exchange on which
such security is traded. If no sale is reported on that date,
the Acquired Fund utilizes, when available, pricing quotations
from principal market makers. Such quotations may be obtained
from third-party pricing services or directly from investment
brokers and dealers in the secondary market. Generally, the
Acquired Funds loan and bond positions are not traded on
exchanges and consequently are valued based on market prices
received from third-party pricing services or broker-dealer
sources. The Acquired Fund obtains multiple broker-dealer quotes
when available, but places greater reliance on quotes from
broker-dealers that serve as underwriters for the issuer. In
order to validate market quotations, the Acquired Fund evaluates
information, as available and as applicable, to determine if the
quotations are representative of fair value, including, but not
limited to, the source and nature of the quotations, qualitative
analysis of the issuer and internally developed expectations and
models. The valuation of certain securities for which there is
little to no market activity may take into account appraisal
reports obtained by management from independent valuation firms.
Short-term debt securities having a remaining maturity of
60 days or less when purchased and debt securities
originally purchased with maturities in excess of 60 days
but which currently have maturities of 60 days or less may
be valued at cost adjusted for amortization of premiums and
accretion of discounts.
Market
Quotations Not Available
Securities for which market quotations are not readily
available, or for which the Acquired Fund has determined the
price received from a pricing service or broker-dealer is
stale or otherwise does not represent fair value,
are valued by the Acquired Fund at fair value, taking into
account factors reasonably determined to be relevant, including:
(i) the fundamental analytical data relating to the
investment; (ii) the nature and duration of restrictions on
disposition of the securities; and (iii) an evaluation of
the forces that influence the market in which these securities
are purchased and sold. The Acquired Fund takes the following
steps each time it determines its net asset value in order to
determine the value of its securities for which market
quotations are not readily available, as determined in good
faith pursuant to policies and procedures approved by the Board:
1. The valuation process begins with each portfolio company
or investment being initially valued by the investment
professionals responsible for the portfolio investment.
60
2. Preliminary valuation conclusions will then be
documented and discussed with Highland Capital Management,
L.P.s (the Investment Adviser) senior
management.
3. The Acquired Funds valuation committee, comprised
of the Investment Advisers investment professionals and
other senior management, will then review these preliminary
valuations. An independent valuation firm engaged by the
Acquired Funds Board reviews all of these preliminary
valuations each quarter.
4. Finally, the Board discusses valuations and reviews the
fair value of each investment in the Acquired Funds
portfolio in good faith, pursuant to policies and procedures
approved by the Board, based on the input of the valuation
committee and an independent valuation firm.
As part of the valuation process, management takes into account
the following types of factors, if relevant, in determining the
fair value of our investments: the enterprise value of a
portfolio company (an estimate of the total fair value of the
portfolio companys debt and equity), the nature and
realizable value of any collateral, the portfolio companys
ability to make payments and its earnings and discounted cash
flow, the markets in which the portfolio company does business,
comparison to publicly traded securities, changes in the
interest rate environment and the credit markets generally that
may affect the price at which similar investments may be made in
the future and other relevant factors. When an external event
such as a purchase transaction, public offering or subsequent
equity sale occurs, we use the pricing indicated by the external
event to corroborate our valuation.
Revenue
Recognition
We record interest income, adjusted for amortization of premium
and accretion of discount, on an accrual basis. Origination,
closing
and/or
commitment fees associated with investments in portfolio
companies are accreted into interest income over the respective
terms of the applicable loans. Upon the prepayment of a loan or
debt security, any prepayment penalties and unamortized loan
origination, closing and commitment fees are recorded as
interest income.
Payment-in-kind
(PIK) interest, computed at the contractual rate
specified in each loan agreement, is added to the principal
balance of the loan and recorded as interest income. To maintain
the Acquired Funds status as a RIC, this non-cash source
of income must be paid out to stockholders in the form of
distributions, even though the Acquired Fund has not yet
collected cash. We do not accrue as a receivable interest on
loans and debt securities if we have reason to doubt our ability
to collect such interest.
Net
Realized Gains or Losses and Net Change in Unrealized
Appreciation or Depreciation
We measure realized gains or losses by the difference between
the net proceeds from the repayment or sale and the amortized
cost basis of the investment, without regard to unrealized
appreciation or depreciation previously recognized, but
considering unamortized upfront fees. Net change in unrealized
appreciation or depreciation reflects the change in portfolio
investment values during the reporting period, including the
reversal of previously recorded unrealized appreciation or
depreciation, when gains or losses are realized.
Within the context of these critical accounting policies, we are
not currently aware of any reasonably likely events or
circumstances that would result in materially different amounts
being reported.
61
Portfolio
and Investment Activity
The following table summarizes the historical composition of our
investment portfolio, exclusive of cash and cash equivalents, as
a percentage of total investments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
|
|
|
|
|
|
|
|
|
Senior Loans
|
|
|
Notes and Bonds
|
|
|
Claims
|
|
|
Equity Interests
|
|
|
December 31, 2008
|
|
|
47.4
|
%
|
|
|
27.8
|
%
|
|
|
0.1
|
%
|
|
|
24.7
|
%
|
September 30, 2008
|
|
|
60.5
|
%
|
|
|
24.9
|
%
|
|
|
0.7
|
%
|
|
|
13.9
|
%
|
June 30, 2008
|
|
|
68.1
|
%
|
|
|
27.0
|
%
|
|
|
0.2
|
%
|
|
|
4.7
|
%
|
March 31, 2008
|
|
|
49.7
|
%
|
|
|
40.4
|
%
|
|
|
0.5
|
%
|
|
|
9.4
|
%
|
December 31, 2007
|
|
|
48.4
|
%
|
|
|
34.8
|
%
|
|
|
0.5
|
%
|
|
|
16.3
|
%
|
September 30, 2007
|
|
|
50.3
|
%
|
|
|
34.4
|
%
|
|
|
1.2
|
%
|
|
|
14.1
|
%
|
June 30, 2007
|
|
|
45.9
|
%
|
|
|
35.4
|
%
|
|
|
0.8
|
%
|
|
|
17.9
|
%
|
March 31, 2007
|
|
|
76.7
|
%
|
|
|
21.1
|
%
|
|
|
0.8
|
%
|
|
|
1.4
|
%
|
Our equity investments increased as a percentage of total
investments during the fourth quarter. This was caused primarily
by a decline in our loan and bond investments while the equity
investments maintained their value in large part. However,
during the fourth quarter we did not increase our equity
holdings through additional investments.
Bank debt typically accrues interest at variable rates
determined by reference to a base lending rate, such as LIBOR or
prime rate, and typically will have maturities of 3 to
5 years. Corporate notes and bonds will typically accrue
interest at fixed rates and have stated maturities at
origination that range from 5 to 10 years. At
December 31, 2008, the weighted average yield of our
portfolio investments, exclusive of cash and cash equivalents,
was approximately 5.7%. At December 31, 2008, the weighted
average yield of our investments in senior loans and corporate
notes and bonds was approximately 6.0%. Yields are computed
assuming a fully settled portfolio; using interest rates as of
the report date and include amortization of senior loan discount
points, original issue discount and market premium or discount;
weighted by their respective costs when averaged.
As of December 31, 2008, approximately 85.3% of our
portfolio consisted of investments in 10 issuers. This is a
material increase from prior quarters as we have sought to
consolidate our holdings into fewer core positions. We
accomplished this consolidation by liquidating smaller, non-core
positions and using the proceeds to pay down the credit
facility. Additional information regarding these specific
investments has been outlined below. This additional information
is limited to publicly available information, and does not
address the creditworthiness or financial viability of the
issuer, or the future plans of the Acquired Fund as it relates
to a specific investment. Furthermore, while the objective of
the Acquired Fund is to invest primarily in financially-troubled
or distressed companies, the Acquired Fund can and does invest
in issuers that are not financially-troubled or distressed at
the time of investment. The Acquired Fund may have sold some, or
all, of the positions outlined below subsequent to
December 31, 2008.
Argatroban
Royalty Sub, LLC
Argatroban Royalty Sub, LLC, a wholly-owned subsidiary of
Encysive Pharmaceuticals, was established to issue senior
secured bonds backed by the royalty cash stream from the sales
of Argatroban, a branded pharmaceutical marketed by
GlaxoSmithKline plc. Argatroban is a synthetic direct thrombin
inhibitor indicated as an anticoagulant for prophylaxis or
treatment of thrombosis in patients with heparin-induced
thrombocytopenia, or HIT, which is a profound allergic reaction
to anticoagulation therapy with heparin. More information can be
found at www.argatroban.com.
Azithromycin
Royalty Sub, LLC
Azithromycin Royalty Sub, LLC, a wholly-owned subsidiary of
InSite Vision Inc., was established to issue senior secured
bonds backed by the royalty cash stream from the sales of
azithromycin ophthalmic
62
solution, a branded pharmaceutical sold under the brand name
AzaSite®
and marketed by Inspire Pharmaceuticals, Inc. The solution is
used to treat conjunctivitis. More information can be found at
www.azasite.com.
Baker &
Taylor, Inc.
Baker & Taylor, Inc. (B&T) is engaged
in the distribution of books, music, video and game products. In
addition, unique information services built around the
B&Ts proprietary databases as well as specialized
consulting and outsourcing services are provided to customers.
Customers include retailers (including Internet retailers),
public, academic and school libraries and various departments of
federal and local governments. B&T distributes its products
throughout the United States and worldwide.
Celtic
Pharma Phinco B.V.
Celtic Pharmaceuticals Phinco B.V. (Celtic Pharma)
is a private investment fund with a mandate to purchase a
diversified portfolio of novel pharmaceutical products in the
later stages of development that have already demonstrated
initial proof of principle efficacy in human clinical trials.
Celtic Pharma has $250 million of equity commitments in
addition to raising $156 million of high-yield bonds.
Celtic Pharma has invested in nine drug programs since its 2004
inception. More information can be found at www.celticpharma.com.
Comcorp
Broadcasting, Inc.
Comcorp Broadcasting, Inc. (ComCorp) is a
privately-held regional broadcasting company based in Lafayette,
LA. ComCorp operates 23 TV stations in 10 markets in Texas,
Louisiana, and Indiana. ComCorp filed for bankruptcy in June
2006 after it was unable to meet its ongoing debt obligations.
ComCorp, and its direct and indirect subsidiaries, exited
bankruptcy with an effective date of October 4, 2007 under
reorganization plans filed (Plans) with the United
States Bankruptcy Court in the Western District of Louisiana
(Case
No. 06-50410).
Copies of the Plans and the Confirmation Orders may be
downloaded, without cost, at www.kccllc.net/cca, or be requested
free of charge by calling Kurtzman Carson Consultants LLC at
1-866-381-9100.
Fontainebleau
Florida Hotel, LLC
Fontainebleau Florida Hotel, LLC is the owner of the
Fontainebleau Miami Beach, an 825 room luxury hotel
redevelopment in Miami Beach, Florida. The parent company of
Fontainebleau Florida Hotel, LLC and developer of the resort is
Fontainebleau Resorts, LLC (Fontainebleau).
Fontainebleau is led by Chairman Jeffrey Soffer, who also serves
as Chief Executive Officer of Turnberry, Ltd., a creator of
luxury condominium and condominium-hotel developments, and
President and Chief Financial Officer Glenn Schaeffer, a former
Chief Executive Officer of Mandalay Resort Group. The
Fontainebleau Miami was renovated and expanded into a
22-acre
destination resort, which opened in the fall of 2008. More
information can be found at www.bleaumiamibeach.com.
Genesys
Ventures IA, LP
Genesys Ventures IA, LP, a limited partnership with Genesys
Capital Partners of Toronto, Ontario, was established to hold
the preferred equity of three late-stage venture healthcare
companies.
Kepler
Holdings Limited
Kepler Holdings Limited is a Bermuda-based special purpose
vehicle with a portfolio comprised of pre-defined segments of
Hannover Res natural catastrophe property reinsurance
business.
LVI
Services, Inc.
LVI Services, Inc. (LVI) is a remediation and
facility services firm serving commercial, industrial, retail,
government, healthcare and education end markets. From a
nationwide branch network, LVI provides asbestos abatement, soft
and structural demolition, mold remediation, emergency response,
fireproofing,
63
decontamination and decommissioning, lead-based paint abatement
and infection control. More information can be found at
www.lviservices.com.
Penhall
Holding Company
Penhall Holding Company is the parent company of Penhall
International Corporation (Penhall), one of the
largest providers of concrete cutting, breaking and highway
grinding services in the United States. Penhalls business
model is centered on utilizing a nationwide network of
approximately 800 skilled operators and an extensive fleet of
specialized construction equipment to perform primarily
non-residential and infrastructure-related construction work.
The Acquired Fund operates 41 locations in the United States and
Canada, and has a customer base that includes construction
contractors, industrial companies, manufacturers, government
agencies and municipalities.
Results
of Operations
Results comparisons are for the year ended December 31,
2008 (Fiscal 2008) and the period from
January 18, 2007 (commencement of operations) through
December 31, 2007 (Fiscal 2007). These
comparisons between current and prior periods may not
necessarily be meaningful as we were incorporated in Delaware on
August 22, 2006, initially funded on January 18, 2007,
and commenced material operations on February 27, 2007.
Investment
Income
We primarily generate revenue in the form of interest income on
the debt securities that we own, dividend income on any common
or preferred stock that we own, and capital gains or losses on
any debt or equity securities that we acquire and subsequently
sell. We also may acquire investments, which may pay cash or
in-kind dividends on a recurring or otherwise negotiated basis.
Investment income for Fiscal 2008 and Fiscal 2007 was
approximately $22.0 million and $31.3 million,
respectively, of which approximately $0.1 million and
$0.8 million, respectively, was attributable to invested
cash and cash equivalents and approximately $21.9 million
and $30.5 million, respectively, was attributable to
portfolio investments. For Fiscal 2008 and Fiscal 2007, of the
approximately $21.9 million and $30.5 million,
respectively, in investment income from investments other than
cash and cash equivalents, approximately $3.5 million and
$2.6 million, respectively, of PIK interest income was
recorded. In Fiscal 2008, investment income decreased as
compared to Fiscal 2007 for three primary reasons: 1) LIBOR
was significantly lower for the majority of 2008 versus 2007,
2) defaults in the portfolio increased in 2008 and
3) we reduced our leverage by over 50% during 2008,
decreasing the total amount of revenue generating assets.
Operating
Expenses
Operating expenses for Fiscal 2008 and Fiscal 2007 were
approximately $11.2 million and $14.2 million,
respectively. These amounts consisted of advisory fees of
approximately $4.2 million and $6.3 million, incentive
fees of approximately $1.7 million and $2.5 million,
and administrative fees, accounting fees, professional fees,
directors fees, taxes and other expenses of approximately
$3.0 million and $2.4 million, respectively, for
Fiscal 2008 and Fiscal 2007.
Additionally, for the quarter ended June 30, 2008, the
Investment Adviser voluntarily waived incentive fees of
approximately $0.8 million. Pursuant to an agreement with
the Investment Adviser, advisory fees of approximately
$2.7 million were waived during Fiscal 2007. Additionally,
for Fiscal 2007 the Investment Adviser voluntarily waived
incentive fees of approximately $1.7 million.
Net
Investment Income
The Acquired Funds net investment income totaled
approximately $10.8 million and $17.1 million,
respectively, for Fiscal 2008 and for Fiscal 2007. Net
investment income was lower in Fiscal 2008 primarily due to
lower LIBOR rates, a smaller asset base, and higher defaults.
64
Net
Unrealized Depreciation on Investments
For Fiscal 2008 and Fiscal 2007, the Acquired Funds
investments had net unrealized depreciation of approximately
$34.4 million and $60.0 million, respectively.
Net
Realized Losses
For Fiscal 2008 and Fiscal 2007, the Acquired Fund had net
realized losses on investments of approximately
$84.5 million and $14.3 million, respectively.
Net
Decrease in Stockholders Equity (Net Assets) from
Operations
For Fiscal 2008 and Fiscal 2007, the Acquired Fund had a net
decrease in stockholders equity (net assets) resulting
from operations of approximately $108.2 million ($6.11 per
share) and $57.3 million ($3.23 per share), respectively.
For Fiscal 2008 and Fiscal 2007, the decrease in
stockholders equity (net assets) resulting from operations
was primarily attributable to net realized and net unrealized
depreciation on investments, respectively, as discussed above.
Financial
Condition, Liquidity and Capital Resources
In light of the broader unprecedented market dislocation that
began in 2007, continued into 2008 and accelerated in the fourth
quarter, we reduced our leverage from approximately 43.8% at
December 31, 2007, to approximately 20.4% at
December 31, 2008. On November 25, 2008, we amended
our existing credit agreement with the credit facility provider,
extending the maturity date from December 1, 2008 to
May 29, 2009. Additionally, on December 19, 2008, the
Board approved an agreement and plan of merger and liquidation
(Agreement). The Agreement provides for the merger
of the Acquired Fund with and into HCF Acquisition LLC
(Merger Sub), a Delaware limited liability company
to be organized as a wholly owned subsidiary of Highland Credit
Strategies Fund (the Acquiring Fund), a
non-diversified, closed-end management investment company also
managed by the Investment Adviser (the Merger), with
Merger Sub being the surviving entity and pursuant to which
common stockholders of the Acquired Fund will receive shares of
beneficial interest of the Acquiring Fund (and cash in lieu of
any fractional shares). Immediately after the Merger, Merger Sub
will distribute its assets to the Acquiring Fund, and the
Acquiring Fund will assume the liabilities of Merger Sub, in
complete liquidation and dissolution of Merger Sub (collectively
with the Merger, the Reorganization). As a result of
the Reorganization, if consummated, each common stockholder of
the Acquired Fund will become a common shareholder of the
Acquiring Fund.
During Fiscal 2008, liquidity and capital resources were
generated primarily from cash flows from operations, including
investment sales and prepayments and income earned from
investments and cash equivalents. The liquidity generated from
these sources was used to reduce the amount outstanding on the
credit facility and to pay shareholder distributions. At year
end, the Acquired Fund had no cash on hand but had approximately
$14.4 million in receivables for investments sold and
interest due from investments. This was partially offset by
approximately $11.1 million in payables, mainly for
investments purchased but not yet settled.
Although the Acquired Fund has $44.5 million available on
its credit facility, certain restrictions within the agreement
significantly limit the amount we can effectively borrow.
Regardless, we do not anticipate drawing down on the facility in
the first quarter of 2009, and we are likely to fund our
operations through additional sales of investments, if
warranted, and interest from investments. At December 31,
2008, the Acquired Fund had $15.5 million in borrowings
outstanding. During the first quarter, we intend to use excess
funds to primarily repay borrowings under our credit facility,
make strategic investments to meet our investment objectives, to
make cash distributions to holders of our common stock and to
fund our operating expenses. If the Reorganization into the
Acquiring Fund described above is not approved by stockholders
or is otherwise not consummated prior to the expiration of our
credit facility on May 29, 2009, there can be no assurance
that we will be able to renew or extend the facility on
favorable terms. If we are unable to do so, we may need to sell
investments and may not be able to use leverage as a part of our
investment strategy.
65
During Fiscal 2008, the Acquired Fund generated approximately
$135.4 million in cash flows from operations, of which
$126.5 million was used to repay borrowings under its
credit facilities and approximately $13.3 million was used
to make cash distributions to holders of our common stock.
Contractual
Obligations
The following table shows our significant contractual
obligations for the repayment of outstanding borrowings under
our revolving credit facility as of December 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Year
|
|
|
|
(Dollars in millions)
|
|
|
|
|
|
|
|
|
|
2010 and
|
|
|
|
Total
|
|
|
2009
|
|
|
thereafter
|
|
|
Revolving Credit Facility(1)
|
|
$
|
15.5
|
|
|
$
|
15.5
|
|
|
$
|
|
|
|
|
|
(1) |
|
At December 31, 2008, approximately $44.5 million
remained unused under our revolving credit facility. Our current
credit facility, as amended, terminates on May 29, 2009. |
In addition, we have certain obligations with respect to the
investment advisory and administration services we receive. See
Our Investment Adviser and
Our Administrator. We incurred
approximately $4.2 million for investment advisory services
and approximately $0.7 million for administrative services
for the year ended December 31, 2008. As of
December 31, 2008, we had unfunded commitments to fund
senior loans to Comcorp Broadcasting, Inc. ($58,999).
Off-Balance
Sheet Arrangements
At December 31, 2008, we did not have any off-balance sheet
liabilities or other contractual obligations that are reasonably
likely to have a current or future material effect on our
financial condition, other than the investment advisory and
management agreement and the administration agreement described
above.
Distributions
We have elected to be taxed as a regulated investment company
under Subchapter M of the Internal Revenue Code of 1986. In
order to maintain our status as a regulated investment company,
we are required to meet specified
source-of-income
and asset diversification requirements and must distribute
annually at least 90% of our investment company taxable income.
Additionally, we must distribute at least 98% of our income
(both ordinary income and net capital gains) to avoid an excise
tax. We intend to make distributions to our stockholders on a
quarterly basis of substantially all of our net operating
income. We also intend to make distributions of net realized
capital gains, if any, at least annually.
We may not be able to achieve operating results that will allow
us to make distributions at a specific level or to increase the
amount of these distributions from time to time. In addition, we
may be limited in our ability to make distributions due to the
asset coverage test for borrowings when applicable to us as a
business development company under the Investment Company Act of
1940 and due to provisions in our credit facilities. If we do
not distribute a certain percentage of our income annually, we
will suffer adverse tax consequences, including possible loss of
our status as a regulated investment company. We cannot assure
stockholders that they will receive any distributions or
distributions at a particular level.
On December 4, 2008, the Acquired Funds Board
declared a fourth quarter distribution of $0.075 per share
($1,328,758), which was paid on December 31, 2008 to common
stockholders of record on December 19, 2008. The Acquired
Fund has established an opt out Dividend
Reinvestment Plan (the Plan) for its common
stockholders. As a result, if the Acquired Fund declares a cash
distribution in future periods, a stockholders cash
distribution will be automatically reinvested in additional
shares of the Acquired Funds common stock unless the
stockholder specifically opts out of the Plan and
elects to receive cash distributions. For the fourth quarter
distribution, holders of 1,829,815 shares participated in
the Plan. As a result, of the $1,328,758 total amount
distributed, $137,236 was used by the Plan agent to purchase
shares in the open market, including fractions, on behalf of the
Plan participants. On September 5, 2008, the Acquired
66
Funds Board declared a third quarter distribution of $0.15
per share ($2,657,516), which was paid on September 30,
2008 to common stockholders of record on September 19,
2008. On June 6, 2008, the Acquired Funds Board
declared a second quarter distribution of $0.2625 per share
($4,650,652), which was paid on June 30, 2008 to common
stockholders of record on June 20, 2008. On March 7,
2008, the Acquired Funds Board declared a first quarter
distribution of $0.2625 per share ($4,650,652), which was paid
on March 31, 2008 to common stockholders of record on
March 20, 2008.
ACQUIRED
FUNDS PORTFOLIO COMPANIES
The following table sets forth certain information regarding the
approximately $72.6 million in value as of
December 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nature of
|
|
Percentage
|
|
|
of Total
|
|
|
Type of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuers
|
|
of Class of
|
|
|
Portfolio
|
|
|
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
|
|
Securities
|
|
|
Investment
|
|
|
Held in
|
|
Spread /
|
|
|
|
|
|
Cost of
|
|
|
Value of
|
|
Name of Issuer
|
|
Business
|
|
Held
|
|
|
Value
|
|
|
Portfolio
|
|
Coupon(a)
|
|
|
Maturity
|
|
|
Investment
|
|
|
Investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Argatroban Royalty Sub, LLC
|
|
Healthcare
|
|
|
5.51
|
%
|
|
|
4.05
|
%
|
|
18.5% Senior Secured Fixed Bond (h)
|
|
|
18.50
|
%
|
|
|
9/21/2014
|
|
|
$
|
3,306,706
|
|
|
$
|
2,942,968
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Azithromycin Royalty Sub, LLC
|
|
Healthcare
|
|
|
7.69
|
%
|
|
|
5.99
|
%
|
|
16.00% Senior Unsecured Fixed Bond (h)
|
|
|
16.00
|
%
|
|
|
5/15/2019
|
|
|
|
4,974,238
|
|
|
|
4,350,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Baker & Taylor, Inc.
|
|
Diversified
Media
|
|
|
5.03
|
%
|
|
|
4.87
|
%
|
|
11.50% Senior Secured Fixed Bond (h)
|
|
|
11.50
|
%
|
|
|
7/1/2013
|
|
|
|
8,749,446
|
|
|
|
3,537,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BST Safety Textiles Acquisition GmbH
|
|
Transportation -
Automotive
|
|
|
0.43
|
%
|
|
|
0.16
|
%
|
|
Second Lien Facility
|
|
|
14.60
|
%
|
|
|
6/30/2009
|
|
|
|
674,415
|
|
|
|
117,943
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Celtic Pharma Phinco B.V.
|
|
Healthcare
|
|
|
5.45
|
%
|
|
|
10.76
|
%
|
|
17.00% Senior Unsecured Fixed Bond, PIK (h)
|
|
|
17.00
|
%
|
|
|
6/15/2012
|
|
|
|
10,132,572
|
|
|
|
7,815,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cinacalcet Royalty Sub, LLC
|
|
Healthcare
|
|
|
1.04
|
%
|
|
|
1.06
|
%
|
|
15.50% Senior Secured Fixed Bond, PIK (h)
|
|
|
15.50
|
%
|
|
|
3/30/2017
|
|
|
|
1,023,972
|
|
|
|
768,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comcorp Broadcasting, Inc.
|
|
Broadcasting
|
|
|
1.11
|
%
|
|
|
1.16
|
%
|
|
Revolving Loan (b) (c)(d)
|
|
|
7.52
|
%
|
|
|
4/3/2013
|
|
|
|
1,825,953
|
|
|
|
843,134
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comcorp Broadcasting, Inc.
|
|
Broadcasting
|
|
|
11.42
|
%
|
|
|
12.17
|
%
|
|
Term Loan (c)(d)
|
|
|
7.75
|
%
|
|
|
4/3/2013
|
|
|
|
18,525,278
|
|
|
|
8,835,713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Communications Corp. of America
|
|
Broadcasting
|
|
|
12.57
|
%
|
|
|
0.00
|
%
|
|
Common (j)
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
7,187,203
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Delta Air Lines, Inc.
|
|
Aerospace
|
|
|
0.00
|
%
|
|
|
0.48
|
%
|
|
Common (j)
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
215,657
|
|
|
|
348,762
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Emerson Reinsurance Ltd.
|
|
Financial
|
|
|
0.30
|
%
|
|
|
1.79
|
%
|
|
Tranche C Term Loan
|
|
|
7.25
|
%
|
|
|
12/15/2011
|
|
|
|
1,495,043
|
|
|
|
1,297,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Flatiron Re Ltd.
|
|
Financial
|
|
|
0.01
|
%
|
|
|
0.03
|
%
|
|
Closing Date Term Loan
|
|
|
5.71
|
%
|
|
|
12/29/2010
|
|
|
|
25,704
|
|
|
|
24,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Flatiron Re Ltd.
|
|
Financial
|
|
|
0.00
|
%
|
|
|
0.02
|
%
|
|
Delayed Draw Term Loan
|
|
|
5.71
|
%
|
|
|
12/29/2010
|
|
|
|
12,451
|
|
|
|
12,011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fontainebleu Florida Hotel, LLC
|
|
Gaming/Leisure
|
|
|
2.73
|
%
|
|
|
7.02
|
%
|
|
Tranche C Term Loan
|
|
|
8.00
|
%
|
|
|
6/6/2012
|
|
|
|
6,000,000
|
|
|
|
5,100,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Genesys Ltd.
|
|
Healthcare
|
|
|
57.14
|
%
|
|
|
23.98
|
%
|
|
Common (j)
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
12,000,000
|
|
|
|
17,412,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ICO Global
Communications
|
|
Wireless
Communications
|
|
|
0.09
|
%
|
|
|
0.21
|
%
|
|
Common (j)
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
500,000
|
|
|
|
153,882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kepler Holdings Ltd.
|
|
Financial
|
|
|
2.50
|
%
|
|
|
6.06
|
%
|
|
Term Loan
|
|
|
7.00
|
%
|
|
|
6/30/2009
|
|
|
|
5,006,959
|
|
|
|
4,400,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lake at Las Vegas Joint Venture/LLV-1, LLC
|
|
Gaming/Leisure
|
|
|
0.67
|
%
|
|
|
0.38
|
%
|
|
Revolving Loan Credit-Linked Deposit (e)
|
|
|
14.35
|
%
|
|
|
6/20/2012
|
|
|
|
3,611,111
|
|
|
|
273,831
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lake at Las Vegas Joint Venture/LLV-1, LLC
|
|
Gaming/Leisure
|
|
|
6.25
|
%
|
|
|
2.95
|
%
|
|
Term Loan, PIK (e)
|
|
|
14.35
|
%
|
|
|
6/20/2012
|
|
|
|
28,269,771
|
|
|
|
2,143,697
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life Technologies Corp.
|
|
Healthcare
|
|
|
0.20
|
%
|
|
|
2.59
|
%
|
|
Term B Facility (f)
|
|
|
3.00
|
%
|
|
|
9/30/2015
|
|
|
|
1,955,100
|
|
|
|
1,881,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LVI Services, Inc.
|
|
Service
|
|
|
5.07
|
%
|
|
|
5.65
|
%
|
|
Tranche B Term Loan
|
|
|
6.49
|
%
|
|
|
11/16/2011
|
|
|
|
9,317,890
|
|
|
|
4,102,590
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MetroFlag BP, LLC/MetroFlag Cable, LLC
|
|
Housing
|
|
|
2.56
|
%
|
|
|
0.52
|
%
|
|
Second Lien Term Loan
|
|
|
12.00
|
%
|
|
|
1/6/2009
|
|
|
|
5,000,000
|
|
|
|
375,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Molecular Insight Pharmaceuticals, Inc.
|
|
Healthcare
|
|
|
0.69
|
%
|
|
|
1.13
|
%
|
|
Floating Senior Unsecured Bond (h)(i)
|
|
|
10.80
|
%
|
|
|
11/1/2012
|
|
|
|
1,026,832
|
|
|
|
822,081
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MPH Mezzanine II, LLC
|
|
Housing
|
|
|
0.67
|
%
|
|
|
0.00
|
%
|
|
Mezzanine 2B (d)(e)
|
|
|
7.48
|
%
|
|
|
2/9/2008
|
|
|
|
10,000,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MPH Mezzanine III, LLC
|
|
Housing
|
|
|
0.27
|
%
|
|
|
0.00
|
%
|
|
Mezzanine 3 (d)(e)
|
|
|
8.48
|
%
|
|
|
2/9/2008
|
|
|
|
4,000,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.24
|
%
|
|
|
0.01
|
%
|
|
ALPA Trade Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
431,377
|
|
|
|
5,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.20
|
%
|
|
|
0.01
|
%
|
|
Bell Atlantic Trade Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
434,058
|
|
|
|
4,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.20
|
%
|
|
|
0.01
|
%
|
|
EDC Trade Claims (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
447,357
|
|
|
|
4,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.43
|
%
|
|
|
0.01
|
%
|
|
Flight Attendant Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
739,501
|
|
|
|
10,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.12
|
%
|
|
|
0.00
|
%
|
|
GE Trade Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
275,185
|
|
|
|
2,820
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nature of
|
|
Percentage
|
|
|
of Total
|
|
|
Type of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuers
|
|
of Class of
|
|
|
Portfolio
|
|
|
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
|
|
Securities
|
|
|
Investment
|
|
|
Held in
|
|
Spread /
|
|
|
|
|
|
Cost of
|
|
|
Value of
|
|
Name of Issuer
|
|
Business
|
|
Held
|
|
|
Value
|
|
|
Portfolio
|
|
Coupon(a)
|
|
|
Maturity
|
|
|
Investment
|
|
|
Investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.39
|
%
|
|
|
0.01
|
%
|
|
IAM Trade Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
728,935
|
|
|
|
8,889
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.69
|
%
|
|
|
0.02
|
%
|
|
Pinnacle Trade Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
1,529,071
|
|
|
|
15,854
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc.
|
|
Aerospace
|
|
|
0.14
|
%
|
|
|
0.01
|
%
|
|
Retiree Claim (j)
|
|
|
N/A
|
|
|
|
8/21/2013
|
|
|
|
487,621
|
|
|
|
6,603
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pacific Clarion, LLC
|
|
Housing
|
|
|
10.76
|
%
|
|
|
1.16
|
%
|
|
Term Loan (d) (e)(g)
|
|
|
15.00
|
%
|
|
|
1/23/2009
|
|
|
|
4,945,680
|
|
|
|
841,053
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Penhall Holding Co.
|
|
Service
|
|
|
9.70
|
%
|
|
|
3.61
|
%
|
|
Term Loan, PIK
|
|
|
12.29
|
%
|
|
|
4/1/2012
|
|
|
|
5,762,042
|
|
|
|
2,619,549
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Penton Media, Inc.
|
|
Diversified Media
|
|
|
0.75
|
%
|
|
|
0.59
|
%
|
|
Second Lien Term Loan
|
|
|
8.42
|
%
|
|
|
2/1/2014
|
|
|
|
2,035,654
|
|
|
|
425,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tegrant Corp.
|
|
Forest Products/Containers
|
|
|
1.33
|
%
|
|
|
0.14
|
%
|
|
Second Lien Term Loan
|
|
|
6.96
|
%
|
|
|
3/8/2015
|
|
|
|
1,000,000
|
|
|
|
103,340
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totes Isotoner Corp.
|
|
Consumer Non-Durables
|
|
|
6.14
|
%
|
|
|
1.40
|
%
|
|
Second Lien Term Loan
|
|
|
9.88
|
%
|
|
|
1/31/2014
|
|
|
|
3,400,514
|
|
|
|
1,013,169
|
|
|
|
|
(a) |
|
Senior loans in which the Acquired Fund invests generally pay
interest at rates which are periodically determined by reference
to a base lending rate plus a premium (unless otherwise
identified by footnote (g), all senior loans carry a variable
rate interest). These base lending rates are generally
(i) the Prime Rate offered by one or more major United
States banks, (ii) the lending rate offered by one or more
European banks such as the London Interbank Offered Rate
(LIBOR) or (iii) the Certificate of Deposit
rate. Rate shown represents the weighted average rate at
December 31, 2008. Senior loans, while exempt from
registration under the Securites Act of 1933 (the
1933 Act), contain certain restrictions on
resale and cannot be sold publicly. Senior secured floating rate
loans often require prepayments from excess cash flow or permit
the borrower to repay at its election. The degree to which
borrowers repay, whether as a contractual requirement or at
their election, cannot be predicted with accuracy. As a result,
the actual remaining maturity may be substantially less than the
stated maturity shown. |
|
(b) |
|
Senior loan asset has additional unfunded loan commitments. |
|
(c) |
|
Affiliated issuer. |
|
(d) |
|
Represents fair value as determined by the Acquired Funds
investment adviser, in good faith, pursuant to the policies and
procedures approved by the Acquired Funds Board of
Directors (the Board). Securities with a total
aggregate market value of $27,931,900 or 46.1% of net assets,
were fair valued as of December 31, 2008. |
|
(e) |
|
The issuer is in default of certain debt covenants. Income is
not being accrued. |
|
(f) |
|
All or a portion of this position has not settled. Contract
rates do not take effect until settlement date. |
|
(g) |
|
Fixed rate senior loan. |
|
(h) |
|
Securities exempt from registration under Rule 144A of the
1933 Act. These securities may only be resold, in
transactions exempt from registration, to qualified
institutional buyers. At December 31, 2008, these
securities amounted to $20,236,841 or 33.4% of net assets. |
|
(i) |
|
Floating rate asset. The interest rate shown reflects the rate
in effect at December 31, 2008. |
|
(j) |
|
Non-income producing security. |
|
(k) |
|
Cost basis for U.S. federal income tax purposes is $178,369,294. |
|
|
|
PIK
Payment-in-Kind.
All or a portion of the stated interest rate may be PIK interest. |
FURTHER
INFORMATION ON THE REORGANIZATION
FEDERAL
INCOME TAX CONSEQUENCES OF THE REORGANIZATION
The Reorganization is intended to be a tax-free reorganization
for U.S. federal income tax purposes. As a condition to
each Funds obligation to consummate the Reorganization,
Ropes & Gray LLP (Tax Counsel) will
deliver an opinion (Tax Opinion) to the Acquired
Fund and the Acquiring Fund, dated as of that
Reorganizations closing date, that is reasonably
satisfactory to each Fund and substantially to the effect that,
68
on the basis of existing provisions of the Code, current
administrative rules and court decisions generally for
U.S. federal income tax purposes, except as noted below:
|
|
|
|
|
The Reorganization will qualify as a reorganization
(as defined in section 368(a) of the Code), and each of the
Acquired Fund and Acquiring Fund will be a party to a
reorganization (within the meaning of section 368(b)
of the Code);
|
|
|
|
Under Section 1032 of the Code, no gain or loss will be
recognized by the Acquiring Fund upon the Merger or upon
Acquiring Funds subsequent receipt of Merger Subs
assets and its assumption of all liabilities of Merger Sub in
complete liquidation of Merger Sub;
|
|
|
|
Under Section 362(b) of the Code, the tax basis of the
Acquired Funds assets in the hands of the Acquiring Fund
will be the same as the basis of such assets in the hands of the
Acquired Fund immediately prior to the Reorganization;
|
|
|
|
Under Section 1223(2) of the Code, the holding periods of
such assets in the hands of the Acquiring Fund will include the
periods during which such assets were held by the Acquired Fund;
|
|
|
|
Under Sections 361 and 357(a) of the Code, no gain or loss
will be recognized by the Acquired Fund upon the Merger or upon
Acquiring Funds subsequent receipt of Merger Subs
assets and its assumption of all liabilities of Merger Sub in
complete liquidation of Merger Sub;
|
|
|
|
Under Section 354 of the Code, no gain or loss will be
recognized by Acquired Fund stockholders on the conversion of
shares of Acquired Common Stock into Merger Shares, except to
the extent such stockholders are paid cash in lieu of fractional
Merger Shares in the Reorganization;
|
|
|
|
Under Section 358 of the Code, the aggregate tax basis of
Merger Shares received by Acquired Fund stockholders will be the
same as the aggregate tax basis of shares of Acquired Fund
converted into Merger Shares reduced by the portion of the
adjusted basis in Acquired Fund common shares that is allocable
to any fractional Merger Shares for which cash is received;
|
|
|
|
Under Section 1223(1) of the Code, the holding periods of
Merger Shares received by Acquired Fund stockholders will
include the holding periods of shares of Acquired Fund converted
into such Merger Shares, provided that shares of Acquired Fund
are held by such shareholders as capital assets; and
|
|
|
|
The Acquiring Fund will succeed to and take into account the
items of the Acquired Fund described in Section 381(c) of
the Code, subject to the conditions and limitations specified in
Sections 381, 382, 383, and 384 of the Code and the
regulations thereunder.
|
The Tax Opinion will be based on certain factual certifications
made by officers of the Acquiring Fund and the Acquired Fund and
will be based on certain customary assumptions. The Tax Opinion
will not express any view with respect to the effect of the
Reorganization on any transferred asset as to which any
unrealized gain or loss is required to be recognized under
U.S. federal income tax principles (i) at the end of a
taxable year or (ii) on the termination or transfer thereof
without reference to whether such a termination or transfer
would otherwise be a taxable transaction.
The Tax Opinion is not binding on the IRS or the courts and is
not a guarantee that the tax consequences of the Reorganization
will be as described above.
Prior to the closing of the Reorganization, the Acquired Fund
will declare and pay to its stockholders one or more
distributions that will have the effect of distributing all of
its investment company taxable income (without regard to the
dividends paid deduction) and net realized capital gain,
including those realized on the disposition of any portfolio
securities in connection with the Reorganization (after
reduction by any available capital loss carryforwards), if any,
that have not previously been distributed to them. Any such
distribution will generally be taxable to Acquired Fund
stockholders.
The Acquiring Funds ability to use pre-Reorganization
capital losses (including any capital loss carryforwards, net
current year capital losses, and net realized losses that exceed
certain thresholds) of the Acquired Fund to offset capital gains
of the combined Fund is expected to be limited due to the
application of
69
loss limitation rules under U.S. federal tax law. First, if
the Reorganization had occurred on December 31, 2008 (as of
which date all numeric examples below are calculated), Acquired
Funds pre-Reorganization losses would go into loss
limitation, and the combined Funds use of these
losses to offset gains would be subject to an annual cap until
expiration of the losses. For example, on December 31,
2008, the Acquired Fund had approximately $79.3 million in
capital loss carryforwards and net
year-to-date
losses. If the Reorganization had occurred on December 31,
2008, the use of these losses by Acquiring Fund to offset any
post-Reorganization gains would be subject to an annual cap of
approximately $2.1 million until the losses expire. In
addition, as of December 31, 2008, the Acquired Fund had
approximately $94.5 million of net unrealized losses, which
also would be subject to the annual cap to the extent realized
within the five-year period following the Reorganization.
Second, for the first taxable year ending after the closing date
of the Reorganization, only that percentage of the Acquiring
Funds capital gain net income for such taxable year
(excluding capital loss carryforwards) as corresponds to the
percentage of its year that remains following the Reorganization
can be reduced by capital loss carryforwards of the Acquired
Fund. That percentage is also applied to the loss limitation
amount for that first year. Third, for five years beginning
after the closing date of the Reorganization, each Funds
pre-Reorganization losses cannot be used to offset unrealized
gains in the other Fund that are built in at the
time of the Reorganization and that exceed certain thresholds.
This limitation affects the combined Fund only to the extent
that either Fund has built-in gains as of the date of the
Reorganization; the limitation would have no effect if the
Reorganization had taken place on December 31, 2008 since
neither Fund had net built-in gains as of that date. Indeed, the
effect of all of these limitations will depend on several
factors, including the amount of gains and losses in each Fund
at the time of the Reorganization and at the close of each
taxable year.
Furthermore, as a result of the spreading of Acquired
Funds capital loss carryfowards over a combined asset base
that is roughly 703% of the size of Acquired Funds asset
base (as of December 31, 2008), the benefits of those
capital loss carryforwards to the Acquired Funds
shareholders will be further diminished. As of December 31,
2008, Acquired Funds capital loss carryforwards
represented about 147% of the Funds net assets and were
due to expire in 2015 and 2016. As of the same date, the
Acquiring Funds capital loss carryforwards represented
about 35% of the Acquiring Funds net assets and were due
to expire from 2009 to 2016. As a result of the spreading-of
losses-effect and the application of the loss limitation rules,
under certain circumstances, the Acquired Fund shareholders
could receive more distributions and pay more taxes, or pay
taxes sooner, than they would have if the Reorganization had not
occurred.
In addition, if at the time of the Reorganization, either Fund
has any built-in (unrealized) gains or (in the case
of the Acquiring Fund) any taxable gains realized but not
distributed to its shareholders prior to the Reorganization, the
shareholders of the other Fund may receive a greater amount of
taxable distributions than they otherwise would have had the
Reorganization not occurred.
This summary of the U.S. federal income tax consequences of
the Reorganization is made without regard to the particular
facts and circumstances of any particular shareholder.
Shareholders are urged to consult their own tax Advisers as to
the specific consequences to them of the Reorganization,
including the applicability and effect of state, local,
non-U.S. and
other tax laws.
ADDITIONAL
TERMS OF THE AGREEMENT AND PLAN OF MERGER AND
LIQUIDATION
Certain terms of the Agreement are described above. The
following is a summary of certain additional terms of the
Agreement. This summary and any other description of the terms
of the Agreement contained in this Proxy Statement/Prospectus
are qualified in their entirety by Appendix A hereto, which
is the form of the Agreement.
Surrender of Share Certificates. With respect
to any Acquired Fund stockholder holding Acquired Fund share
certificates as of the Closing Date, Acquiring Fund will not
permit such stockholder to receive dividends and other
distributions on the Merger Shares (although such dividends and
other distributions will be credited to the account of such
stockholder), receive certificates representing the Merger
Shares or pledge such Merger Shares until such stockholder has
surrendered his or her outstanding Acquired Fund certificates
or, in the event of lost, stolen or destroyed certificates,
posted adequate bond. In the event that a stockholder is not
permitted
70
to receive dividends and other distributions on the Merger
Shares as provided in the preceding sentence, Acquiring Fund
will pay any such dividends or distributions in additional
shares, notwithstanding any election that the stockholder made
previously with respect to the payment, in cash or otherwise, of
dividends and distributions on shares of Acquired Fund. Acquired
Fund will, at its expense, request the stockholders of Acquired
Fund to surrender their outstanding Acquired Fund certificates,
or post adequate bond, as the case may be.
Conditions to Closing the Reorganization. The
obligation of each Fund to consummate its Reorganization is
subject to the satisfaction of certain conditions, including the
performance by the other participating Fund of all of its
obligations under the Agreement and the receipt of all consents,
orders and permits necessary to consummate the Reorganization.
The obligations of each Fund to consummate the transactions is
subject to there having been no demands for appraisal made or
that the Board of both the Acquired Fund and Acquiring Fund in
its sole discretion has determined to continue the
Reorganization notwithstanding such demands.
In addition, the obligations of the Funds that are parties to
the Agreement are subject to approval of the Agreement by the
necessary vote of the outstanding shares of the Acquired Fund,
in accordance with the provisions of the Acquired Funds
Certificate and By-Laws. The Funds obligations are also
subject to the receipt of a favorable opinion of
Ropes & Gray LLP as to the U.S. federal income
tax consequences of their Reorganization.
Termination of the Agreement. The Boards of
the Funds that are parties to the Agreement may terminate the
Agreement by mutual consent (even if shareholders of the
applicable Acquired Fund have already approved it) if the Boards
believe that proceeding with that Reorganization would for any
reason be inadvisable or not in the best interests of such Fund
or its shareholders, or if demands for appraisal have been made
or may still be made in accordance with Delaware law.
Expenses of the Reorganization. The costs
associated with the Reorganization will be borne by each of the
Acquired Fund and the Acquiring Fund in proportion to their
respective net assets determined at the close of regular trading
on the NYSE on the date of the Reorganizations closing.
Neither the Funds nor the Adviser will pay any expenses of
shareholders arising out of or in connection with the
Reorganization.
PAYMENT
OF UNDISTRIBUTED INCOME IN ADVANCE OF REORGANIZATION
The Acquired Fund generally retains an amount of earned net
income that is not distributed in regular dividend payments in
order to provide a reserve to regularize dividend payments over
time. The Acquired Fund intends to declare and pay a special
dividend
and/or other
distributions on its common shares in advance of the
Reorganization, which together with all previous such
distributions, shall have the effect of distributing all of the
acquired Funds net investment income, including any such
reserved income, and any net long-term and short-term capital
gains, for the short taxable year ending on the date of the
Reorganization. The record date for such special dividend
and/or other
distributions will be a date or dates following the approval of
the Reorganization.
APPRAISAL
RIGHTS
Because the Reorganization is structured in part as a Merger of
Acquired Fund with and into Merger Sub in which the Acquired
Fund shareholders will receive shares of a Delaware statutory
trust, not a Delaware corporation, under Section 262 of the
Delaware General Corporation Law, any holder of the Acquired
Funds common stock who does not wish to accept the
consideration provided in the Merger (shares of beneficial
interest of Acquiring Fund (and cash in lieu of any fractional
shares) having an aggregate net asset value equal to the value
of assets of Acquired Fund on the Valuation Date less the value
of the liabilities of Acquired Fund on such Valuation Date) may
dissent from the Merger and elect to exercise appraisal rights
and have the fair value of their shares of Acquired Fund common
stock judicially determined and paid in cash, together with
interest paid at a statutorily determined rate, if any, in lieu
of the merger consideration (assuming the Merger is consumated).
The valuation will exclude any element of value arising from the
accomplishment or expectation of the Merger. The
court-determined valuation might be less than, equal to, or more
than the per share price provided for in the Agreement and Plan
of Merger and Liquidation. As discussed below, the
71
Acquiring Fund reserves the right to assert, in any appraisal
proceedings, that, the fair value of a share of
Acquired Fund common stock is less than (i) the NAV of the
shares of beneficial interest in the Acquiring Fund to be
received in the Merger by the holders of the Acquired Fund
common stock and (ii) the trading value of the shares of
beneficial interest of the Acquiring Fund.
The following summary of the provisions of Section 262 of
the DGCL is not a complete statement of the law pertaining to
appraisal rights under the DGCL, and is qualified in its
entirety by reference to the full text of Section 262 of
the DGCL, a copy of which is attached to this proxy statement as
Appendix D. If you wish to exercise appraisal rights or
wish to preserve your right to do so, you should carefully
review Section 262 of the DGCL and are urged to consult
your own legal counsel. However, you should note that it is a
condition to closing that there have been no demands for
appraisal made or that the Board of both the Acquired Fund and
Acquiring Fund in its sole discretion has determined to continue
the Reorganization notwithstanding such demands.
All references in Section 262 of the DGCL and in this
summary to a stockholder are to the record holder of
shares of Acquired Fund common stock as to which appraisal
rights are asserted. A person having a beneficial interest in
shares of Acquired Fund common stock held of record in the name
of another person, such as a broker or nominee, must act
promptly to cause the record holder to follow properly the steps
summarized below and in a timely manner to perfect appraisal
rights.
Under Section 262 of the DGCL, when a merger is submitted
for approval at a meeting of stockholders, as in the case of the
Agreement and Plan of Merger and Liquidation, not less than
twenty days before the meeting a constituent corporation must
notify each of its stockholders for whom appraisal rights are
available that such appraisal rights are available and include
in the notice a copy of Section 262 of the DGCL. This Proxy
Statement/Prospectus constitutes the notice, and we attach the
applicable statutory provisions to this Proxy
Statement/Prospectus as Appendix D.
In order to exercise your appraisal rights effectively, you must
satisfy each of the following primary requirements:
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you must hold your shares of Acquired Fund common stock as of
the date you make your demand for appraisal rights and continue
to hold your shares of Acquired Fund common stock through the
effective time of the Merger;
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you must deliver to the Acquired Fund a written notice of your
demand for appraisal of your shares of Acquired Fund common
stock before the taking of the vote at the Meeting;
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you must not have voted in favor of adoption of the Agreement
and Plan of Merger and Liquidation; if you vote by proxy and
wish to exercise appraisal rights, you must vote against the
adoption of the Agreement and Plan of Merger and Liquidation or
mark your proxy card to indicate that you abstain from voting on
the adoption of the Agreement and Plan of Merger and
Liquidation; and
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you must file a petition in the Delaware Court of Chancery
demanding a determination of the fair value of the shares within
120 days after the effective time of the Merger.
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A demand for appraisal must be executed by or on behalf of the
stockholder of record and must reasonably inform the Acquired
Fund of the identity of the stockholder of record and that such
stockholder intends thereby to demand appraisal of the shares of
Acquired Fund common stock. If you fail strictly to comply with
any of the above requirements or otherwise fail strictly to
comply with the requirements of Section 262 of the DGCL,
you will have no appraisal rights with respect to your shares.
You will receive no further notices from us regarding your
appraisal rights.
Neither voting (in person or by proxy) against, abstaining from
voting on or failing to vote on the proposal to adopt the
Agreement and Plan of Merger and Liquidation will constitute a
written demand for appraisal within the meaning of
Section 262 of the DGCL. The written demand for appraisal
must be in addition to and separate from any proxy or vote.
72
The address for purposes of making an appraisal demand is:
Secretary, Highland Distressed Opportunities, Inc., NexBank
Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240.
Only a holder of record of shares of Acquired Fund common stock,
or a person duly authorized and explicitly purporting to act on
his or her behalf, is entitled to assert an appraisal right for
the shares of Acquired Fund common stock registered in his or
her name. Beneficial owners who are not record holders and who
wish to exercise appraisal rights are advised to consult with
the appropriate record holders promptly as to the timely
exercise of appraisal rights. A record holder, such as a broker,
who holds shares of Acquired Fund common stock as a nominee for
others, may exercise appraisal rights with respect to the shares
of Acquired Fund common stock held for one or more beneficial
owners, while not exercising such rights for other beneficial
owners. In such a case, the written demand should set forth the
number of shares as to which the demand is made. Where no shares
of Acquired Fund common stock are expressly mentioned, the
demand will be presumed to cover all shares of Acquired Fund
common stock held in the name of such record holder.
A demand for the appraisal of shares of Acquired Fund common
stock owned of record by two or more joint holders must identify
and be signed by all of the holders. A demand for appraisal
signed by trustees, executors, administrators, guardians,
attorneys in fact, officers of corporations or others acting in
a fiduciary or representative capacity must so identify the
persons signing the demand.
An appraisal demand may be withdrawn by a former stockholder who
has not commenced an appraisal proceeding or joined that
proceeding as a named party within sixty days after the
effective time of the Merger by delivery of a written withdrawal
to the surviving corporation, or thereafter only with written
approval of the surviving or resulting corporation. Upon
withdrawal of an appraisal demand, the former stockholder must
accept the terms of the Merger and will be entitled to receive
the consideration provided in the Merger (shares of beneficial
interest of Acquiring Fund (and cash in lieu of any fractional
shares) having an aggregate net asset value equal to the value
of assets of Acquired Fund on the Valuation Date less the value
of the liabilities of Acquired Fund on such Valuation Date)
referred to above, without interest and less any applicable
withholding taxes. As used in this paragraph and throughout the
remainder of this section, references to the surviving or
resulting corporation mean, from and after the liquidation and
dissolution of Merger Sub, the Acquiring Fund.
Within ten days after the effective time of the Merger, the
surviving or resulting corporation must give written notice of
the effective time of the Merger to each of the Acquired
Funds former stockholders who did not vote in favor of the
Agreement and Plan of Merger and Liquidation and who made a
written demand for appraisal in accordance with Section 262
of the DGCL. Within 120 days after the effective time of
the Merger, but not later, either the surviving or resulting
corporation or any dissenting stockholder who has complied with
the requirements of Section 262 of the DGCL may file a
petition in the Delaware Court of Chancery demanding a
determination of the fair value of the shares of Acquired Fund
common stock held by all stockholders demanding appraisal of
their shares. The surviving or resulting corporation is under no
obligation to, and has no present intent to, file a petition for
appraisal, and stockholders seeking to exercise appraisal rights
should not assume that the surviving or resulting corporation
will file a petition or that it will initiate any negotiations
with respect to the fair value of the shares. Stockholders who
desire to have their shares appraised should initiate any
petitions necessary for the perfection of their appraisal rights
within the time periods and in the manner prescribed in
Section 262 of the DGCL. A stockholder who timely files a
petition for appraisal with the Delaware Court of Chancery must
serve a copy upon the surviving or resulting corporation, which
in turn shall file a duly verified list containing the names and
addresses of all stockholders who have demanded payment for
their shares and with whom agreements as to value have not been
reached, with the Delaware Register in Chancery within
20 days of such service. If the Delaware Court of Chancery
so orders, the Delaware Register in Chancery will then give
notice of the time and place for the hearing of the petition by
registered or certified mail to both the surviving or resulting
corporation and stockholders on the list. Such notice will also
be given by one or more publications at least one week before
the hearing, in a generally-circulated newspaper in Wilmington,
Delaware, or whichever publication the Delaware Court of
Chancery chooses.
73
Within 120 days after the effective time of the Merger, any
stockholder who has complied with the provisions of
Section 262 of the DGCL up to that point may receive from
the surviving or resulting corporation, upon written request, a
statement setting forth the aggregate number of shares not voted
in favor of the Agreement and Plan of Merger and Liquidation and
with respect to which they have received demands for appraisal,
and the aggregate number of holders of those shares. A person
who is the beneficial owner of shares of Acquired Fund common
stock held in a voting trust or by a nominee on behalf of such
person may, in such persons own name, file a petition or
request from the corporation the statement described in the
previous sentence. The surviving or resulting corporation must
mail this statement to the stockholder within 10 days of
receipt of the request.
If a hearing on the petition is held, the Delaware Court of
Chancery is empowered to determine which dissenting stockholders
are entitled to an appraisal of their shares. The Delaware Court
may require dissenting stockholders who hold stock represented
by certificates to submit their certificates representing shares
for notation thereon of the pendency of the appraisal
proceedings, and the Delaware Court of Chancery is empowered to
dismiss the proceedings as to any dissenting stockholder who
does not comply with this request. Accordingly, dissenting
stockholders are cautioned to retain their share certificates,
pending resolution of the appraisal proceedings.
After determination of the dissenting stockholders entitled to
an appraisal, the Delaware Court of Chancery will appraise the
shares held by such dissenting stockholders at their fair value
as of the effective time of the Merger, exclusive of any value
arising from accomplishment or expectation of the Merger, along
with interest, if any, to be paid upon the amount determined to
be the fair value.
In determining fair value, the Delaware Court of
Chancery is required to take into account all relevant factors.
Moreover, the Acquired Fund does not anticipate offering more
than the merger consideration to any stockholder exercising
appraisal rights and reserves the right to assert, in any
appraisal proceeding, that, for purposes of Section 262,
the fair value of a share of Acquired Fund common
stock is less than (i) the NAV of the shares of beneficial
interest in the Acquiring Fund to be received in the Merger by
the holders of the Acquired Fund common stock and (ii) the
trading value of the shares of beneficial interest of the
Acquiring Fund. In Weinberger v. UOP, Inc. the Delaware
Supreme Court discussed the factors that could be considered in
determining fair value in an appraisal proceeding, stating that
proof of value by any techniques or methods which are
generally considered acceptable in the financial community and
otherwise admissible in court should be considered and
that fair price obviously requires consideration of all
relevant factors involving the value of a company. The
Delaware Supreme Court has stated that in making this
determination of fair value the court must consider market
value, asset value, dividends, earnings prospects, the nature of
the enterprise and any other factors which could be ascertained
as of the date of the Merger which throw any light on future
prospects of the merged corporation. Section 262 provides
that fair value is to be exclusive of any element of value
arising from the accomplishment or expectation of the
merger. In Cede & Co. v. Technicolor, Inc.,
the Delaware Supreme Court stated that such exclusion is a
narrow exclusion that does not encompass known elements of
value, but which rather applies only to the speculative
elements of value arising from such accomplishment or
expectation. In Weinberger, the Delaware Supreme Court construed
Section 262 to mean that elements of future value,
including the nature of the enterprise, which are known or
susceptible of proof as of the date of the merger and not the
product of speculation, may be considered.
Stockholders should be aware that the fair value of their shares
as determined under Section 262 of the DGCL could be
greater than, the same as, or less than (i) the NAV of the
shares of beneficial interest in the Acquiring Fund to be
received in the Merger by the holders of the Acquired Fund
common stock and (ii) the trading value of the shares of
beneficial interest of the Acquiring Fund.
The Delaware Court of Chancery may also assess costs among the
parties as the Delaware Court of Chancery deems equitable.
However, costs do not include attorneys and expert witness
fees. Each dissenting stockholder is responsible for his or her
attorneys and expert witness expenses, although, upon
application of a dissenting stockholder, the Delaware Court of
Chancery may order all or a portion of the expenses incurred by
any dissenting stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable
attorneys fees and fees and expenses of experts, to be
charged pro rata against the value of all
74
shares entitled to appraisal. Determinations by the Delaware
Court of Chancery are subject to appellate review by the
Delaware Supreme Court.
The Delaware Court of Chancery will direct payment of the fair
value and interest, if any, by the surviving or resulting
corporation to the stockholders entitled thereto. Payments will
be made to stockholders in the case of holders of uncertificated
stock, and in the case of holders of shares represented by
certificates upon the surrender of such certificates to us.
No appraisal proceedings in the Delaware Court of Chancery shall
be dismissed as to any dissenting stockholder without the
approval of the Delaware Court of Chancery, and this approval
may be conditioned upon terms which the Delaware Court of
Chancery deems just.
If no petition for appraisal is filed with the Delaware Court of
Chancery within 120 days after the effective time of the
Merger, stockholders rights to appraisal shall cease, and
all holders of shares of Acquired Fund common stock will be
entitled to receive the consideration offered pursuant to the
Agreement and Plan of Merger and Liquidation.
From and after the effective time of the Merger, former holders
of Acquired Fund common stock, whether or not they have demanded
appraisal rights, will not be entitled to vote their shares of
Acquired Fund common stock for any purpose and are not entitled
to receive payment of dividends or other distributions on the
shares (except dividends or other distributions payable to
stockholders of record at a date which is before the effective
time of the Merger).
Failure to follow the steps required by Section 262 of the
DGCL for perfecting appraisal rights may result in the loss of
appraisal rights, in which event you will be entitled to receive
the consideration with respect to your dissenting shares in
accordance with the Agreement and Plan of Merger and Liquidation.
CAPITALIZATION
The following tables set forth the capitalization of each Fund
as of December 31, 2008, and the pro forma combined
capitalization of the Acquiring Fund as if the proposed
Reorganization had occurred on that date. The tables also
reflect the proceeds received from the Acquiring Funds
rights offering completed on January 28, 2008 and the
Acquiring Funds acquisition of Prospect Street High Income
Portfolio Inc. (PHY) and Prospect Street Income
Shares Inc. (CNN) on July 18, 2008. The
tables, which are unaudited, should not be relied upon to
determine the amount of Acquiring Fund shares that will actually
be received and distributed. The information presented in the
tables could have changed materially since December 31,
2008.
If the Reorganization of your Fund(s) had taken place on
December 31, 2008:
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Pro Forma
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Actual
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Adjustment
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Combined
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Acquired Fund
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Acquiring Fund
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Acquiring Fund
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(Unaudited)
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Shares Outstanding
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Common Shares
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17,716,771
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55,526,190
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64,835,077
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Net Assets
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Common Shares
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$
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60,556,428
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$
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361,210,505
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$
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(500,000
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$
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421,266,933
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Net asset value per common share
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$
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3.42
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$
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6.51
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$
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6.50
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Reflects the estimated reorganization expenses |
75
MANAGEMENT
OF THE FUNDS
TRUSTEES/DIRECTORS
AND OFFICERS
The Directors of the Acquired Fund are the same individuals as
the Trustees of the Acquiring Fund. Each Funds Board
provides broad supervision over the affairs of each Fund. The
officers of each Fund are responsible for the Funds
operations. The Trustees/Directors and officers of the Funds,
together with their principal occupations during the past five
years, are listed in the Statement of Additional Information.
Each of the Trustees/Directors serves as a Trustee/Director for
other open-end and closed-end investment companies for which the
Adviser serves as investment adviser.
Beneficial
Ownership of Shares
Please see Appendix C to the Proxy Statement/Prospectus for
information regarding the holdings of each Director in the
Acquired Fund and Acquiring Fund and for information regarding
the persons who owned of record or beneficially 5% or more of
the outstanding common shares of the Acquired Fund and the
Acquiring Fund.
INVESTMENT
ADVISER
Highland acts as investment adviser to both the Acquired Fund
and the Acquiring Fund. Highland is located at NexBank Tower,
13455 Noel Road, Suite 800, Dallas, Texas 75240. As of
December 31, 2008, the Adviser managed approximately
$28.4 billion in assets on behalf of investors around the
world. Highland is controlled by James Dondero and Mark Okada,
by virtue of their respective share ownership, and its general
partner, Strand Advisors, Inc., of which Mr. Dondero is the
sole stockholder. Messrs. Dondero and Okada have managed
portfolios together since 1990. Mr. Dondero serves as the
Chief Executive Officer and President of the Acquired Fund and
Mr. Okada as the Executive Vice President of the Acquired
Fund.
The Acquiring Fund may in the future be managed by another SEC
registered investment adviser that is an affiliate of Highland
(the Affiliated Adviser). To the extent consistent
with positions of the SEC staff, the novation of the Acquiring
Funds investment advisory agreement to the Affiliated
Adviser may be completed without shareholder approval. The
Affiliated Adviser has substantially the same ownership as
Highland and the portfolio managers of the Acquiring Fund would
not change in connection with any change in investment adviser.
Any such change would be subject to the approval of the Board of
the Acquiring Fund.
Since each Fund employs leverage, the Adviser benefits because
each Funds assets subject to an advisory fee increase with
leverage. Furthermore, the Adviser also benefits to the extent
that each Funds assets subject to an advisory fee are
derived from the reinvested collateral received on portfolio
securities loaned.
The Adviser has built a professional working environment, a
firm-wide compliance culture and compliance procedures and
systems designed to protect against potential incentives that
may favor one account over another. The Adviser has adopted
policies and procedures that address the allocation of
investment opportunities, execution of portfolio transactions,
personal trading by employees and other potential conflicts of
interest that are designed to ensure that all client accounts
are treated equitably over time. Nevertheless, the Adviser
furnishes advisory services to numerous clients in addition to
each Fund, and the Adviser may, consistent with applicable law,
make investment recommendations to other clients or accounts
(including accounts which are hedge funds or have performance or
higher fees paid to the Adviser, or in which portfolio managers
have a personal interest in the receipt of such fees), which may
be the same as or different from those made to each Fund. In
addition, the Adviser, its affiliates and any officer, director,
stockholder or employee may or may not have an interest in the
securities whose purchase and sale the Adviser recommends to
each Fund. Actions with respect to securities of the same kind
may be the same as or different from the action which the
Adviser, or any of its affiliates, or any officer, director,
stockholder, employee or any member of their families may take
with respect to the same securities. Moreover, the Adviser may
refrain from rendering any advice or services concerning
securities of companies of which any of the Advisers (or
its affiliates) officers, directors or employees are
directors or officers, or companies as to which the Adviser or
any of its affiliates or the officers, directors and employees
of any of them has any substantial economic
76
interest or possesses material non-public information. In
addition to its various policies and procedures designed to
address these issues, the Adviser includes disclosure regarding
these matters to its clients in both its Form ADV and
investment advisory agreements.
The Adviser may also have clients that invest in different
levels of the capital structure of a company, such as equity
versus senior loans, or that take contrary provisions in
multiple levels of the capital structure. This may create
situations where a client could be disadvantaged because of the
investment activities conducted by the Adviser for other client
accounts.
The Adviser, its affiliates or their officers and employees
serve or may serve as officers, directors or principals of
entities that operate in the same or related lines of business
or of investment funds managed by affiliates of the Adviser.
Accordingly, these individuals may have obligations to investors
in those entities or funds or to other clients, the fulfillment
of which might not be in the best interests of each Fund. As a
result, the Adviser will face conflicts in the allocation of
investment opportunities to each Fund and other funds and
clients. In order to enable such affiliates to fulfill their
fiduciary duties to each of the clients for which they have
responsibility, the Adviser will endeavor to allocate investment
opportunities in a fair and equitable manner which may, subject
to applicable regulatory constraints, involve pro rata
co-investment by each Fund and such other clients or may involve
a rotation of opportunities among each Fund and such other
clients.
While the Adviser does not believe there will be frequent
conflicts of interest, if any, the Adviser and its affiliates
have both subjective and objective procedures and policies in
place designed to manage the potential conflicts of interest
between the Advisers fiduciary obligations to each Fund
and their similar fiduciary obligations to other clients so
that, for example, investment opportunities are allocated in a
fair and equitable manner among each Fund and such other
clients. An investment opportunity that is suitable for multiple
clients of the Adviser and its affiliates may not be capable of
being shared among some or all of such clients due to the
limited scale of the opportunity or other factors, including
regulatory restrictions imposed by the 1940 Act. There can be no
assurance that the Advisers or its affiliates
efforts to allocate any particular investment opportunity fairly
among all clients for whom such opportunity is appropriate will
result in an allocation of all or part of such opportunity to
each Fund. Not all conflicts of interest can be expected to be
resolved in favor of each Fund.
Under current SEC regulations, each Fund may be prohibited from
co-investing with any unregistered fund managed now or in the
future by the Adviser in certain private placements in which the
Adviser negotiates non-pricing terms.
Acquired
Fund
The Adviser, subject to the overall supervision of the Acquired
Funds Board, manages the
day-to-day
operations of, and provides investment advisory services to, the
Acquired Fund. For providing these services, the Adviser
receives a base management fee and an incentive fee from the
Acquired Fund. The base management fee is equal to 2.00% per
annum of the Acquired Funds Managed Assets. Managed Assets
are the value of total assets of the Acquired Fund less all
accrued liabilities of the Acquired Fund (other than the
aggregate amount of any outstanding borrowings, preferred stock
issuances, or other instruments or obligations constituting
financial leverage). The base management fee is payable
quarterly in arrears; however, the Adviser contractually agreed
to waive or reimburse the Acquired Fund for all base management
fees during the first three months of the Acquired Funds
operations and half of all the base management fees during the
next three months of the Acquired Funds operations. This
contractual waiver expired on August 31, 2007.
The incentive fee consists of two components: (1) the
Pre-Incentive Fee Net Investment Income and (2) the Capital
Gains Fee. Pre-Incentive Fee Net Investment Income is calculated
and payable quarterly in arrears. For this purpose,
Pre-Incentive Fee Net Investment Income means interest income,
dividend income and any other income (including any other fees
(other than fees for providing managerial assistance), such as
commitment, origination, structuring, diligence and consulting
fees or other fees that we receive from portfolio companies)
accrued during the calendar quarter, minus the Acquired
Funds operating expenses for the quarter (including the
base management fee, any expenses payable under the
administration agreement, and any interest expense and dividends
paid on any issued and outstanding preferred stock, but
excluding the incentive
77
fee). Pre-Incentive Fee Net Investment Income includes, in the
case of investments with a deferred interest feature (such as
market discount, debt instruments with PIK interest, preferred
stock with PIK dividends and zero coupon securities), accrued
income that we have not yet received in cash. The Adviser is not
under any obligation to reimburse the Acquired Fund for any part
of the incentive fee it received that was based on accrued
income that we never received as a result of a default by an
entity on an obligation that resulted in the accrual of such
income. Pre-Incentive Fee Net Investment Income does not include
any realized capital gains, realized and unrealized capital
losses or unrealized capital appreciation or depreciation.
Pre-Incentive Fee Net Investment Income, expressed as a rate of
return on the value of the Acquired Funds net assets at
the end of the immediately preceding calendar quarter, is
compared to the hurdle rate of 1.75% per quarter
(7.00% annualized) (the Hurdle Rate). The Acquired
Fund will pay the Adviser an incentive fee with respect to the
Acquired Funds Pre-Incentive Fee Net Investment Income in
each calendar quarter as follows: (1) no incentive fee in
any calendar quarter in which Pre-Incentive Fee Net Investment
Income does not exceed the Hurdle Rate; (2) 100% of
Pre-Incentive Fee Net Investment Income with respect to that
portion of such Pre-Incentive Fee Net Investment Income, if any,
that exceeds the Hurdle Rate but is less than 2.1875% in any
calendar quarter (8.75% annualized) (the
Catch-up
Provision); and (3) 20% of the amount of
Pre-Incentive Fee Net Investment Income, if any, that exceeds
2.1875% in any calendar quarter (8.75% annualized). With respect
to the Acquired Funds Pre-Incentive Fee Net Investment
Income from the Acquired Funds commencement of operations
until December 31, 2007, the Adviser voluntarily agreed to
waive or reimburse the
Catch-Up
Provision, provided, however, that for such period the Acquired
Fund will pay the Adviser 20% of Pre-Incentive Fee Net
Investment Income with respect to that portion of such
Pre-Incentive Fee Net Investment Income, if any, that exceeds
the Hurdle Rate, but is less than 2.1875% in any calendar
quarter (8.75% annualized). These calculations are appropriately
prorated for any period of less than three months and adjusted
for any share issuances or repurchases during the relevant
quarter.
The second part of the incentive fee (the Capital Gains
Fee) is determined and payable in arrears as of the end of
each calendar year (or upon termination of the Investment
Advisory and Management Agreement), beginning on
December 31, 2007, and is calculated at the end of each
applicable year by subtracting (A) the sum of the Acquired
Funds cumulative aggregate realized capital losses and
aggregate unrealized capital depreciation from (B) the
Acquired Funds cumulative aggregate realized capital
gains, in each case calculated from the date of the IPO of the
Acquired Funds shares. If such amount is positive at the
end of such year, then the Capital Gains Fee for such year is
equal to 20% of such amount, less the aggregate amount of
Capital Gains Fees paid in all prior years. If such amount is
negative, then there is no Capital Gains Fee for such year.
As a business development company, the Acquired Fund offers, and
must provide upon request, managerial assistance to its
portfolio companies. (The Acquiring Fund is not subject to such
a requirement.) This assistance could involve, among other
things, participating in board and management meetings,
consulting with and advising officers of portfolio companies and
providing other organizational and financial guidance or
exercising strategic or managerial influence over such
companies. The Investment Adviser will provide managerial
assistance on the Acquired Funds behalf to those portfolio
companies that request this assistance. The Investment Adviser
will not receive any compensation from the portfolio companies
for providing such managerial assistance. In addition,
affiliates of the Investment Adviser, such as Barrier Advisors,
Inc., may receive fees for providing services to portfolio
companies.
The
Acquiring Fund
The Adviser provides the following services to the Acquiring
Fund: (i) furnishes an investment program for the Acquiring
Fund; (ii) determines, subject to the overall supervision
and review of the board of trustees, the investments to be
purchased, held, sold or exchanged by the Acquiring Fund and the
portion, if any, of the assets of the Acquiring Fund to be held
uninvested; (iii) makes changes in the investments of the
Acquiring Fund; and (iv) votes, exercises consents and
exercises all other rights pertaining to such investments.
Subject to the foregoing, the Adviser, at its own expense, will
have the authority to engage one or more
sub-advisers
in connection with the portfolio management of the Acquiring
Fund, which
sub-advisers
may be affiliates of the Adviser; provided, however, that the
Adviser shall remain responsible to the Acquiring Fund with
respect to its duties and obligations set forth in the
investment advisory agreement.
78
In return for its advisory services, the Adviser will receive an
annual fee, payable monthly, in an amount equal to 1.00% of the
average weekly value of the Acquiring Funds Managed Assets
(the Advisory Fee). Managed Assets means
the total assets of the Acquiring Fund, including any form of
investment leverage, minus all accrued expenses incurred in the
normal course of operations, but not excluding any liabilities
or obligations attributable to investment leverage obtained
through (i) indebtedness of any type (including, without
limitation, borrowing through a credit facility or the issuance
of debt securities), (ii) the issuance of preferred shares
or other similar preference securities, (iii) the
reinvestment of collateral received for securities loaned in
accordance with the Acquiring Funds investment objectives
and policies,
and/or
(iv) any other means. The accrued fees will be payable
monthly as promptly as possible after the end of each month
during which the investment advisory agreement is in effect. The
Adviser may waive a portion of its fees. A discussion regarding
the basis for the approval of the investment advisory agreement
by the Acquiring Funds board is available in the Acquiring
Funds report to shareholders for the period ending
June 30, 2008.
In addition to the advisory fee of Highland, the Acquiring Fund
pays all other costs and expenses of its operations, including,
but not limited to, compensation of its trustees (other than
those affiliated with Highland), custodian, transfer and
dividend disbursing agent expenses, legal 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 reimbursement of actual expenses of the Adviser or others
for registration and maintenance of the Acquiring Funds
registrations with the SEC and other jurisdictions and taxes, if
any.
COMPARISON
OF INVESTMENT ADVISORY AGREEMENTS
The following highlights the material differences in the
Funds Investment Advisory Agreements. A copy of each
Funds Investment Advisory Agreement is attached as an
exhibit to its registration statement filed with the SEC.
Generally, the two agreements are substantially similar.
1. The Acquired Funds Agreement provides for a base
management fee and an incentive fee. The base management fee is
equal to 2.00% per annum of the Acquired Funds Managed
Assets (as described above). The incentive fee consists of two
components: (1) the Pre-Incentive Fee Net Investment Income
and (2) the Capital Gains Fee. Pre-Incentive Fee Net
Investment Income is calculated as described above and paid
based on the Hurdle Rate also described above. The second part
of the incentive fee (the Capital Gains Fee) is
determined as of the end of each calendar year and is calculated
as described above. During the fiscal period ended
December 31, 2007 and December 31, 2008 the fees paid
to the Adviser were $4,442,475 and $5,064,974. The fee paid
under the Acquiring Funds Agreement is 1.00% of the
average weekly value of the Acquiring Funds Managed Assets
(as described above). During the fiscal period ended
December 31, 2006, December 31, 2007 and
December 31, 2008 the fees paid to the Adviser were
$3,879,925, $9,368,976 and $9,000,340.
2. The services provided by the Adviser to the Acquiring
Fund are substantially similar to those provided to the Acquired
Fund. However, the Adviser provides additional services to the
Acquired Fund because of its election to be regulated as a
business development company under the 1940 Act. The Adviser may
provide significant managerial assistance to those portfolio
companies to which the Acquired Fund is required to provide such
assistance under the 1940 Act and who require such assistance,
including among other things, monitoring the operations of the
Acquired Funds portfolio companies, participating in board
and management meetings, consulting with and advising officers
of portfolio companies and providing other organizational and
financial consultation.
ADMINISTRATOR/SUB-ADMINISTRATOR/ACCOUNTING
SERVICES AGENT
Acquired
Fund
Pursuant to a separate administration agreement, the Adviser
furnishes the Acquired Fund with office facilities, equipment
and clerical, bookkeeping and recordkeeping services at such
facilities. Under the administration agreement, the Adviser also
performs, or oversees the performance of, the Acquired
Funds required administrative services, which include,
among other things, being responsible for the financial records
79
that the Acquired Fund is required to maintain, monitoring
portfolio and regulatory compliance matters and preparing
reports to the Acquired Funds stockholders and reports
filed with the SEC. In addition, the Investment Adviser assists
the Acquired Fund in determining, and arranging for the
publishing of, the Acquired Funds net asset value,
overseeing the preparation and filing of tax returns and the
printing and disseminating of reports to stockholders, and
generally overseeing the payment of expenses and the performance
of administrative and professional services rendered to the
Acquired Fund by others. For providing these services, the
Adviser receives an annual administration fee, payable quarterly
in arrears at an annual rate of 0.35% of the Acquired
Funds Managed Assets. Under a separate
sub-administration
agreement, the Adviser has delegated certain administrative
functions to PNC Global Investment Servicing Inc.
(PNC) (formerly PFPC Inc.), at an annual rate,
payable by Highland, of 0.01% of the average weekly value of
Acquired Funds Managed Assets. The administration
agreement may be terminated by either party without penalty upon
60 days written notice to the other party. Highland
earned for administration services $1,103,702 in fees for the
fiscal period ended December 31, 2007 and $734,056 for the
fiscal year ended December 31, 2008.
Acquiring
Fund
Under an administration agreement dated June 29, 2006 and
amended June 6, 2008 (the Administration
Agreement), Highland provides administration services to
the Acquiring Fund, provides executive and other personnel
necessary to administer the Acquiring Fund and furnishes office
space. Some of the administrative services provided by Highland
under the Administration Agreement, include, but are not limited
to, preparing and coordinating the Acquiring Funds state
filings; determining and overseeing publication of the Acquiring
Funds NAV and distribution amounts; overseeing and
liaising with services providers, such as the custodian and
transfer agent; monitoring leverage compliance; coordinating the
negotiation of credit agreements and other agreements with
counterparties; investigating customer complaints; determining
and monitoring expense accruals; authorizing expenditures and
bill payments on behalf of the Acquiring Fund; and performing
such additional administrative duties as requested by the
Acquiring Fund. Highland will receive an annual fee, payable
monthly, in an amount equal to 0.20% of the average weekly value
of the Acquiring Funds Managed Assets. Highland earned for
administration services $775,985, $1,873,796 and $1,800,068 in
fees for the fiscal periods ended December 31, 2006,
December 31, 2007 and 2008, respectively. The accrued fees
are payable monthly as promptly as possible after the end of
each month during which this Agreement is in effect. Highland
may waive a portion of its fees. Under a separate
sub-administration
agreement, dated June 29, 2006, Highland has delegated
certain administrative functions to PNC, at an annual rate,
payable by Highland, of 0.01% of the average weekly value of the
Acquiring Funds Managed Assets. Some of the administrative
services delegated to PNC, include, but are not limited to,
preparing monthly security transaction listings; coordinating
communications with other service providers; coordinating
printing of shareholder reports; monitoring compliance with
various regulatory schemes applicable to the Acquiring Fund;
assisting in preparation of proxy materials, fidelity bond and
insurance policies and with SEC examination and responses
thereto; and coordinating preparation of board materials.
PORTFOLIO
MANAGEMENT
The Acquired Funds portfolio is managed by Brad Borud and
Greg Stuecheli. Brad Borud and Brad Means manage the Acquiring
Fund.
Brad Borud. Mr. Borud is a Partner,
Senior Trader and Chief Investment Officer Retail
Products at Highland. Prior to his current duties,
Mr. Borud served as a Senior Trader and
Co-Director
of Portfolio Management for Highland from 2003 to 2008, as a
Portfolio Manager and Team Leader from 2001 to 2003, as a
Portfolio Manager from 1998 to 2001, and as a Portfolio Analyst
from 1996 to 1998. As a Portfolio Manager, Mr. Borud
covered a wide range of industries, including wireline
telecommunications, wireless telecommunications,
telecommunication equipment manufacturers, multi-channel video
and media. Prior to joining Highland in November 1996,
Mr. Borud worked as a Global Finance Analyst in the
Corporate Finance Group at NationsBank from 1995 to 1996 where
he was involved in the originating, structuring, modeling and
credit analysis of leveraged transactions for large corporate
accounts in the Southwest region of the United
80
States. In 1994, Mr. Borud served at Conseco Capital
Management as an Analyst Intern in the Fixed Income Research
Department, following the transportation and energy sectors.
Mr. Borud has a BS in Business Finance from Indiana
University.
Brad Means. Mr. Means is a Partner and
Senior Portfolio Manager at Highland. Prior to joining Highland
in May 2004, Mr. Means was a Managing Director in FTI
Consultings Corporate Finance group where he worked on
corporate turnaround, restructuring and bankruptcy advisory
engagements. From 1998 to 2001, he was a Director in
PricewaterhouseCoopers LLPs Chairmans Office and
focused on enterprise strategy, venture capital, business
development and divestiture initiatives. Prior to his role in
the Chairmans Office, Mr. Means worked in the
Strategic Change Consulting and the Assurance &
Business Advisory groups of Price Waterhouse serving clients
across a broad range of industries including Automotive, Energy,
Financials and Industrials. He holds an MBA from the Stanford
Graduate School of Business and a BSBA in Finance and Accounting
from Creighton University. He has earned the right to use the
Chartered Financial Analyst designation.
Greg Stuecheli. Mr. Stuecheli is a
Partner and Senior Portfolio Manager at Highland. Prior to his
current duties, Mr. Stuecheli was a Portfolio Manager for
Highland covering distressed and special situation credit and
equity investments. Prior to joining Highland in June 2002,
Mr. Stuecheli served as an analyst for Gryphon Management
Partners, LP from 2000 to 2002, where his primary
responsibilities included researching long and short investment
ideas. In 1999, Mr. Stuecheli was a Summer Associate at
Hicks, Muse, Tate & Furst, and from 1995 to 1998,
Mr. Stuecheli worked as a chemical engineer at Jacobs
Engineering Group and Cytec Industries. Mr. Stuecheli
received an MBA from Southern Methodist University and a BS in
Chemical Engineering from Rensselaer Polytechnic Institute. He
has earned the right to use the Chartered Financial Analyst
designation.
The Statement of Additional Information provides additional
information about the portfolio managers compensation,
other accounts managed by the portfolio managers and the
portfolio managers ownership of securities issued by the
Acquiring Fund.
PORTFOLIO
TRANSACTIONS WITH AFFILIATES
In placing portfolio transactions for the Funds, the Adviser
will give primary consideration to securing the most favorable
price and efficient execution. Consistent with this policy, the
Adviser may consider the financial responsibility, research and
investment information and other services provided by brokers or
dealers who may effect or be a party to any such transaction or
other transactions to which other clients of the Adviser may be
a party. Neither the Funds nor the Adviser has adopted a formula
for allocation of the Funds investment transaction
business. The Adviser has access to supplemental investment and
market research and security and economic analysis provided by
brokers who may execute brokerage transactions at a higher cost
to the Funds than would otherwise result when allocating
brokerage transactions to other brokers on the basis of seeking
the most favorable price and efficient execution. The Adviser,
therefore, is authorized to place orders for the purchase and
sale of securities for the Funds with such brokers, subject to
review by the Funds Boards from time to time with respect
to the extent and continuation of this practice. The services
provided by such brokers may be useful or beneficial to the
Adviser in connection with its services to other clients.
On occasions when the Adviser deems the purchase or sale of a
security to be in the best interest of the Funds as well as
other clients, the Adviser, to the extent permitted by
applicable laws and regulations, may, but shall be under no
obligation to, aggregate the securities to be so sold or
purchased in order to obtain the most favorable price or
lower brokerage commissions and efficient execution. In such
event, allocation of the securities so purchased or sold, as
well as the expenses incurred in the transaction, will be made
by the Adviser in the manner it considers to be the most
equitable and consistent with its fiduciary obligations to the
Funds and to such other clients.
OTHER
SERVICE PROVIDERS
The custodian of the assets of the Funds is PFPC
Trust Company (8800 Tinicum Blvd., 4th Floor,
Philadelphia, PA 19153; telephone
(877) 665-1287.
The custodian will perform custodial, fund accounting and
81
portfolio accounting services. PNC (301 Bellevue Parkway,
Wilmington, Delaware 19809; telephone
(877) 247-1888
serves as the transfer agent for the Funds with respect to their
common shares.
EXPENSES
Acquired
Fund
The Acquired Fund bears all costs and expenses of its operations
and transactions, including those relating to offerings made
under this prospectus; the cost and expenses of any independent
valuation firm retained for purposes of valuing securities in
connection with the determination of the Acquired Funds
net asset value; expenses incurred by Adviser payable to third
parties in monitoring the Acquired Fund s investments and
performing due diligence on prospective portfolio companies;
interest payable on debt or dividends payable on preferred
stock, if any, incurred to finance its investments; future
offerings of shares of common stock and other securities, if
any; management fees payable under the Investment Advisory and
Management Agreement; administration fees payable under the
administration agreement; trading and transfer fees, commissions
and similar costs payable to third parties relating to, or
associated with, making or disposing of investments; transfer
agent and custodial fees; registration fees; listing fees;
taxes; independent director fees and expenses; costs of
preparing and filing reports or other documents with the SEC;
the costs of any reports, proxy statements or other notices to
stockholders, including printing costs (other than costs
associated with this Proxy Statement/Prospectus, which will be
borne as discussed herein); the Acquired Funds allocable
portion of any joint fidelity bond, directors and
officers/errors and omissions liability insurance, and any
other insurance premiums; indemnification payments; audit and
legal fees and expenses; and all other expenses incurred by the
Acquired Fund.
Acquiring
Fund
The Acquiring Fund pays all costs and expenses of its
operations, including, but not limited to, compensation of its
trustees (other than those affiliated with the Adviser),
custodian, transfer and dividend disbursing agent expenses,
legal fees, listing fees and expenses, expenses of independent
auditors, expenses of preparing, printing and distributing
shareholder reports, notices, proxy statements (other than costs
associated with this Proxy Statement/Prospectus, which will be
borne as discussed herein) and reports to governmental agencies,
and reimbursement of actual expenses of the Adviser or others
for registration and maintenance of the Acquiring Funds
registration with the SEC and other jurisdictions and taxes, if
any.
VOTING
INFORMATION AND REQUIRED VOTE
Acquired Fund common shares are entitled to one vote per share.
Approval of the Reorganization requires, if a quorum is present
at the Meeting, the affirmative vote of a majority of the
outstanding voting securities of the Acquired Fund, which is
defined in the 1940 Act as the lesser of (a) 67% or more of
the voting securities present at the Meeting, if the holders of
more than 50% of the outstanding voting securities of the
Acquired Fund are present or represented by proxy, or
(b) more than 50% of the outstanding voting securities of
the Acquired Fund.
If the accompanying form of proxy card is properly executed and
returned in time to be voted at the Meeting, the shares covered
thereby will be voted in accordance with the instructions marked
thereon. Executed and returned proxy cards that are unmarked
will be voted FOR the applicable proposal and in the discretion
of the persons named as proxies in connection with any other
matter which may properly come before the Meeting or any
adjournment thereof. The Board of the Acquired Fund does not
know of any matter to be considered at the Meeting other than
the proposal referred to in this Proxy Statement/Prospectus.
Voting on the proposal does not limit the transferability of
common shares and common shareholders can sell their shares at
any time before the Meeting or before the Reorganization.
However, common shareholders that wish to exercise their
appraisal rights must hold their common shares as discussed
under Appraisal Rights above.
A majority of the shares entitled to vote, present in person or
represented by proxy shall constitute a quorum
(Quorum) for the Meeting. Shares represented by
properly executed proxies that constitute
82
abstentions or broker non-votes will be treated as shares that
are present and entitled to vote for purposes of determining a
Quorum. These shares will have the same effect as votes
against the Proposal. Broker non-votes
are proxies for shares held by brokers or nominees as to which
(1) the broker or nominee does not have discretionary
voting power and (ii) the broker or nominee has not
received instructions from the beneficial owner or other person
who is entitled to instruct how the shares will be voted.
If a Quorum is present but sufficient votes to approve the
proposal are not received, the Acquired Fund may propose one or
more adjournments of the Meeting to permit further solicitation
of proxies. Any adjournment will require the affirmative vote of
a majority of those shares that are present in person or
represented by proxy at the meeting and entitled to vote on the
adjournment. The persons named as proxies will vote in favor of
any such adjournment all proxies that they are entitled to vote
in favor of the Proposal. They will vote against any such
adjournment any proxy that directs them to vote against the
Proposal. Shares represented by properly executed proxies that
constitute abstentions will also be treated as abstentions on a
proposal to adjourn the Meeting. Therefore, these shares will
have the same effect as votes against any such adjournment.
Broker non-votes will have no effect on a proposal to adjourn.
The following table summarizes how the quorum and voting
requirements for the Proposal are determined:
|
|
|
|
|
|
|
Quorum
|
|
Voting for the Proposal
|
|
In General
|
|
All shares present in person or by proxy are counted
towards a quorum.
|
|
Shares present in person will be voted in person at
the Meeting. Shares present by proxy will be voted in accordance
with instructions.
|
Signed Proxy with no Voting Instruction (other than Broker
Non-Vote)
|
|
Considered present at Meeting.
|
|
Voted for the Proposal.
|
Signed Proxy with Broker Non-Vote
|
|
Considered present at Meeting.
|
|
Not voted. Same effect as a vote against the
Proposal.
|
Signed Proxy with Vote to Abstain
|
|
Considered present at Meeting.
|
|
Not voted. Same effect as a vote against the
Proposal.
|
If the required approval of shareholders is not obtained with
respect to the proposal, the Acquired Fund will continue to
engage in business and the Board will consider what further
action may be appropriate.
However, shareholders should be aware that the Reorganization as
proposed is not expected to result in recognition of gain or
loss to shareholders for U.S. federal income tax purposes
(except to the extent such shareholders are paid cash in lieu of
fractional Merger Shares in the Reorganization) and that shares
of each Fund may be sold at any time prior to the consummation
of the proposed Reorganization.
INFORMATION
CONCERNING THE MEETING
EXPENSES
AND METHODS OF SOLICITATION
In addition to the mailing of these proxy materials, proxies may
be solicited by telephone, by fax or in person by the Directors,
officers and employees of the Acquired Fund; by personnel of the
Adviser and its transfer agent, PNC; or by broker-dealer firms.
Persons holding shares as nominees will be reimbursed by the
Fund, upon request, for their reasonable expenses in sending
soliciting material to the principals of the accounts. The costs
associated with the Reorganization, including the proxy
solicitation expenses, will be borne by each of the Acquired
Fund and the Acquiring Fund in proportion to their respective
net assets determined at the close of regular trading on the
NYSE on the date of the Reorganizations closing; provided,
however, that such costs will in any event be paid by the party
directly incurring such costs if and to the extent that the
payment by the other party of such costs would result in the
disqualification of the applicable Fund, as the case may be, as
a RIC under Subchapter M of the Code or would prevent the
transaction from qualifying as a tax-free reorganization under
the Code.
83
The Altman Group has been retained to assist in the solicitation
of proxies at an estimated cost of approximately $33,000 plus
reasonable expenses.
REVOKING
PROXIES
A shareholder may revoke his or her proxy by appearing at the
Meeting and voting in person, or by giving written notice of
such revocation to the Acquired Fund Secretary or by
returning a later-dated proxy before the Meeting.
OUTSTANDING
SHARES
As of February 6, 2009 (the record date), the
number of shares of beneficial interest the Acquired Fund
outstanding was 17,716,771.
OTHER
BUSINESS
Directors do not intend to present any other business at the
Meeting nor are they aware that any shareholder intends to do
so. If, however, any other matters are properly brought before
the Meeting, the persons named in the accompanying proxy will
vote thereon in accordance with their judgment.
SHAREHOLDERS
PROPOSALS AND COMMUNICATIONS
Any proposals of shareholders that are intended for inclusion in
the Acquired Funds proxy statement and form of proxy for
the Acquired Funds 2009 annual meeting of shareholders
(assuming one is held, which would not be the case if the
Reorganization were to occur before the date set for the
meeting) pursuant to SEC
Rule 14a-8
must have been received at the Acquired Funds principal
executive office no later than December 24, 2008 and must
comply with the requirements of
Rule 14a-8
and all other legal requirements. Such proposals must also
comply with the requirements as to form and substance
established by the SEC if such proposals are to be included in
the proxy statement and form of proxy. The deadline for receipt
of timely notice of shareholder proposals for submission to the
2009 annual meeting of shareholders is March 9, 2009.
Shareholders of the Acquired Fund who wish to communicate with
Directors should send communications to the attention of the
Secretary of the Acquired Fund, NexBank Tower, Suite 800,
13455 Noel Road, Dallas, Texas 75240, and communications will be
directed to the Director or Directors indicated in the
communication or, if no Director or Directors are indicated, to
the Chairman of the Board.
PROXY
STATEMENT/PROSPECTUS DELIVERY
Householding is the term used to describe the
practice of delivering one copy of a document to a household of
shareholders instead of delivering one copy of a document to
each shareholder in the household. Shareholders of the Acquired
Fund who share a common address and who have not opted out of
the householding process should receive a single copy of this
Proxy Statement/Prospectus together with one proxy card for each
account. If you received more than one copy of this Proxy
Statement/Prospectus, you may elect to household in the future;
if you received a single copy of this Proxy
Statement/Prospectus, you may opt out of householding in the
future; and you may, in any event, obtain an additional copy of
this Proxy Statement/Prospectus by writing to the Acquired Fund
at the following address: 13455 Noel Road, Suite 800,
Dallas, Texas 75240, or by calling the Acquired Fund at the
following number:
(877) 247-1888.
OWNERSHIP
OF SHARES OF THE FUNDS
Please see Appendix C to the Proxy Statement/Prospectus for
information regarding the holdings of each Trustee/Director in
each Fund and for information regarding the persons who owned of
record or beneficially 5% or more of the outstanding common
shares of each Fund.
84
EXPERTS
The independent registered public accounting firm for the
Acquired Fund and the Acquiring Fund is PricewaterhouseCoopers
LLP, 2001 Ross Avenue, Suite 1800, Dallas, TX 75201. The
financial highlights and financial statements, including the
reports of PricewaterhouseCoopers LLP, of (i) the Acquired
Fund, for the period ended December 31, 2008, and
(ii) the Acquiring Fund, for the period ended
December 31, 2008, are incorporated by reference into the
Statement of Additional Information. The financial statements
for each Funds fiscal year ended 2008 and financial
highlights have been audited by PricewaterhouseCoopers LLP, as
stated in their reports incorporated by reference in the
Statement of Additional Information. These financial statements
and financial highlights have been included in reliance on their
reports given on their authority as experts in accounting and
auditing.
AVAILABLE
INFORMATION
Each Fund is subject to the informational requirements of the
1934 Act and the 1940 Act and files reports, proxy
statements and other information with the SEC. These reports,
proxy statements and other information filed by the Funds can be
inspected and copied (for a duplication fee) at the Public
Reference Room of the SEC at 100 F Street, N.E.,
Washington, D.C., and at the Central Regional Office (1801
California Street, Suite 4800, Denver, CO 80202). Copies of
these materials can also be obtained by mail from the Public
Reference Room of the SEC at 100 F Street, N.E.,
Washington, D.C. 20549, at prescribed rates. The public may
obtain information on the operation of the Public Reference Room
by calling the SEC at
1-800-SEC-0330.
In addition, copies of these documents may be viewed on-screen
or downloaded from the SECs Internet site at
http://www.sec.gov.
In addition, reports, proxy statements and other information
concerning the Funds may be inspected at the offices of the
NYSE, 20 Broad Street, New York, New York 10005.
85
APPENDIX A
The Form of Agreement and Plan of Merger and Liquidation has
been included to provide investors with information regarding
its terms. It is not intended to provide any factual information
about the Funds. Accordingly, shareholders should not rely on
the representations and warranties in the Form of Agreement and
Plan of Merger and Liquidation as characterizations of the
actual state of facts at the time they were made or otherwise.
In addition, the Form of Agreement and Plan of Merger and
Liquidation may be revised from that shown here prior to its
execution, and may be amended after its execution. Should
material changes be made to the Form of Agreement and Plan of
Merger and Liquidation, the Funds will take such steps as may be
required by applicable law.
FORM OF
AGREEMENT AND PLAN OF MERGER AND LIQUIDATION
This Agreement and Plan of Merger and Liquidation (the
Agreement) is made as
of ,
2009 in Dallas, Texas, by and among Highland Credit Strategies
Fund, a Delaware statutory trust (Acquiring Fund),
and Highland Distressed Opportunities, Inc., a Delaware
corporation (Acquired Fund). HCF Acquisition LLC
(Merger Sub), a Delaware limited liability company
to be organized as a wholly owned subsidiary of Acquiring Fund,
will become a party hereto as provided herein. Each of the
Acquired Fund and Acquiring Fund is sometimes hereinafter
referred to as a Fund or, together, the
Funds).
This Agreement is intended to be and is adopted as a plan of
reorganization within the meaning of Sections 362, 368, and
381 of the United States Internal Revenue Code of 1986, as
amended (the Code), and the Treasury regulations
promulgated thereunder, and the parties intend, for
U.S. federal income tax purposes, that the Merger and
Liquidation (each, as defined below) together be treated as a
reorganization under Section 368(a) of the Code.
The reorganization will consist of the merger (the
Merger) of Acquired Fund with and into Merger Sub in
which Merger Sub will be the surviving entity and pursuant to
which common stockholders of Acquired Fund will receive full
shares of beneficial interest of Acquiring Fund (the
Merger Shares) (and cash in lieu of fractional
shares) having an aggregate net asset value equal to the value
of the assets of the Acquired Fund on the Valuation Date (as
defined below) less the value of the liabilities of the Acquired
Fund on the Valuation Date. Before the Closing Date, Acquired
Fund will declare and pay to its stockholders a dividend or
dividends in an amount such that it will have distributed
(i) the sum of (a) its net investment income and
(b) the excess of its net short-term capital gains over net
long-term capital losses, and (ii) net capital gains, all
as described in Section 8(l) hereof. No certificates
representing the Merger Shares will be issued. Immediately after
the Merger, Merger Sub will distribute its assets to Acquiring
Fund, and Acquiring Fund will assume the liabilities of Merger
Sub, in complete liquidation and dissolution of Merger Sub as
provided herein, all upon the terms and conditions hereinafter
set forth in this Agreement (the Liquidation).
WHEREAS,
Section 18-209
of the Delaware Limited Liability Company Act, 6 Del.C.
§ 18-101, et seq. (the LLC
Act), and Section 264 of the General Corporation Law
of the State of Delaware, 8 Del. C. § 101,
et seq. (the DGCL) authorize the
merger of a Delaware corporation with and into a Delaware
limited liability company; and
WHEREAS, the Board of Trustees of Acquiring Fund has
determined that the Merger and the Liquidation of Merger Sub as
contemplated hereby are in the best interests of Acquiring Fund
and its shareholders and that the interests of the existing
shareholders of Acquiring Fund will not be diluted as a result
of this transaction; and
WHEREAS, the Board of Directors of Acquired Fund has
determined that the Merger is in the best interests of Acquired
Fund and its stockholders and that the interests of the existing
stockholders of Acquired Fund will not be diluted as a result of
this transaction;
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NOW, THEREFORE, in consideration of the premises and of
the covenants and agreements hereinafter set forth, the parties
hereto covenant and agree as follows:
AGREEMENT
1. Merger and Liquidation.
(a) Subject to the requisite approval of the stockholders
of Acquired Fund and to the other terms and conditions contained
herein (including Acquired Funds obligation to distribute
to its stockholders (i) the sum of (a) its net
investment income and (b) the excess of its net short-term
capital gains over net long-term capital losses, and
(ii) net capital gains, all as described in
Section 8(l) hereof), at the Effective Time (as
defined below in Section 3) Acquired Fund shall be
merged with and into Merger Sub and the separate corporate
existence of Acquired Fund shall thereupon cease. Merger Sub
shall be the surviving company in the Merger (sometimes
hereinafter referred to as the Surviving Company) in
accordance with
Section 18-209
of the LLC Act and Section 264 of the DGCL, and the
separate limited liability company existence of Merger Sub with
all its rights, privileges, immunities, powers and franchises
shall continue unaffected by the Merger. The Merger shall have
the effects specified in the LLC Act and the DGCL.
(b) At the Effective Time, as a result of the Merger and
without any action on the part of the holder of any stock of
Acquired Fund:
(i) Each share of common stock of Acquired Fund (the
Acquired Common Stock) issued and outstanding
immediately prior to the Effective Time shall, by virtue of the
Merger and without any action on the part of the holder thereof,
be converted into, and become exchangeable for, the right to
receive the number of Merger Shares (and cash in lieu of
fractional Merger Shares) provided for in Section 2.
(ii) Certificates representing interests in shares of
Acquired Common Stock will represent the right to receive a
number of Merger Shares (and cash in lieu of fractional Merger
Shares) after the Effective Time, as determined in accordance
with Section 2. Acquiring Fund shall not issue certificates
representing Merger Shares in connection with such exchange.
(iii) The membership interests in Merger Sub issued and
outstanding immediately prior to the Effective Time shall remain
unchanged as a result of the Merger and shall remain as the
issued and outstanding membership interests of the Surviving
Company.
(c) The certificate of formation of Merger Sub as in effect
immediately prior to the Effective Time shall be the certificate
of formation of the Surviving Company (the Certificate of
Formation), unless and until amended in accordance with
its terms and applicable law. The limited liability company
agreement of the Merger Sub in effect immediately prior to the
Effective Time shall be the limited liability company agreement
of the Surviving Company (the LLC Agreement), unless
and until amended in accordance with its terms and applicable
law.
(d) At the Effective Time, Merger Sub shall continue in
existence as the Surviving Company, and without further
transfer, succeed to and possess all of the rights, privileges
and powers of Acquired Fund, and all of the assets and property
of whatever kind and character of Acquired Fund shall vest in
Merger Sub without further act or deed; thereafter, Merger Sub,
as the Surviving Company, shall be liable for all of the
liabilities and obligations of Acquired Fund, and any claim or
judgment against Acquired Fund may be enforced against Merger
Sub, as the Surviving Company, in accordance with
Section 18-209
of the LLC Act and Section 259 of the DGCL.
(e) All Merger Shares to be issued pursuant to the Merger
shall be deemed issued and outstanding as of the Effective Time
and, whenever a dividend or other distribution is declared by
Acquiring Fund in respect of the Merger Shares, the record date
for which is at or after the Effective Time, that declaration
shall include dividends or other distributions in respect of all
Merger Shares issuable pursuant to this Agreement.
(f) From and after the Effective Time, there shall be no
transfers on the stock transfer books of the Acquired Fund of
the shares of Acquired Common Stock that were outstanding
immediately prior to the Effective Time.
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(g) In accordance with Section 262 of the DGCL,
appraisal rights shall be available to holders of shares of
Acquired Common Stock in connection with the Merger.
(h) As soon as is reasonably practicable after the
Effective Time, Merger Sub shall be dissolved and Acquiring Fund
will assume all of Merger Subs liabilities and
obligations, known and unknown, contingent or otherwise, whether
or not determinable, and Merger Sub will distribute to Acquiring
Fund, which will be the sole member of Merger Sub at such time,
all of the assets of Merger Sub in complete liquidation of its
interest in Merger Sub. As soon as reasonably practicable after
such assumption by Acquiring Fund of Merger Subs
liabilities and obligations and such distribution of Merger
Subs assets to Acquiring Fund, and after the taking of all
other actions required under the laws of the State of Delaware
and the Certificate of Formation and LLC Agreement of Merger Sub
in connection with the dissolution and termination of Merger
Sub, Merger Sub shall prepare, execute and file a Certificate of
Cancellation with the Secretary of State of the State of
Delaware, and elsewhere as may be necessary or appropriate, and
such other documents as may be required to dissolve and
terminate Merger Sub.
(i) As soon as practicable following the requisite approval
of the stockholders of Acquired Fund, Acquired Fund will, at its
expense, liquidate such of its portfolio securities as Acquiring
Fund indicates it does not wish to acquire. Such liquidation
will be substantially completed before the Closing Date, unless
otherwise agreed by Acquired Fund and Acquiring Fund.
Notwithstanding the foregoing, nothing in this paragraph
(i) will require Acquired Fund to dispose of or purchase
any assets if, in the reasonable judgment of the Acquired Fund,
such disposition or purchase would adversely affect the tax-free
nature of the Merger and Liquidation (collectively, a
reorganization under the Code) or would violate Acquired
Funds fiduciary duty to its shareholders.
2. Closing Date; Valuation Date.
(a) The net asset value of the Merger Shares (and cash paid
in lieu of fractional Merger Shares), the value of the assets of
Acquired Fund and the value of the liabilities of Acquired Fund
will in each case be determined as of the Valuation Date.
(b) The net asset value of the Merger Shares (and cash paid
in lieu of fractional Merger Shares) and the value of the assets
and liabilities of Acquired Fund will be determined by Acquiring
Fund, in cooperation with Acquired Fund, pursuant to valuation
procedures customarily used by Acquiring Fund in determining the
net asset value of Acquiring Funds shares of beneficial
interest.
(c) The Acquired Common Stock will be converted into, and
become exchangeable for, the right to receive the number of
Merger Shares (as described in Section 1(b) above)
determined by dividing the net assets per share of Acquired
Fund, computed in the manner and as of the time and date set
forth in this Section 2, by the net asset value of one
Merger Share, computed in the manner and as of the time and date
set forth in this Section 2. If based on this calculation,
a stockholder of Acquired Common Stock would be entitled to
receive fractional Merger Shares, that stockholder will instead
receive cash in lieu of those fractional Merger Shares equal to
the product of the number of fractional Merger Shares (rounded
to the nearest ten thousandths) to which the stockholder is
entitled and the net asset value of one Merger Share as
described in the immediately preceding sentence.
(d) The investment restrictions of Acquired Fund will be
temporarily amended to the extent necessary to effect the
transactions contemplated by this Agreement.
(e) With respect to any Acquired Fund stockholder holding
Acquired Fund share certificates as of the Closing Date,
Acquiring Fund will not permit such stockholder to receive
dividends and other distributions on the Merger Shares (although
such dividends and other distributions will be credited to the
account of such stockholder), receive certificates representing
the Merger Shares or pledge such Merger Shares until such
stockholder has surrendered his or her outstanding Acquired Fund
certificates or, in the event of lost, stolen or destroyed
certificates, posted adequate bond. In the event that a
stockholder is not permitted to receive dividends and other
distributions on the Merger Shares as provided in the preceding
sentence, Acquiring Fund will pay any such dividends or
distributions in additional shares, notwithstanding any election
that the stockholder made previously with respect to the
payment, in cash or otherwise, of dividends and distributions
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on shares of Acquired Fund. Acquired Fund will, at its expense,
request the stockholders of Acquired Fund to surrender their
outstanding Acquired Fund certificates, or post adequate bond,
as the case may be.
(f) The Valuation Date will be 4:00 p.m. New York time
on the Closing Date (the Valuation Date).
3. Closing and Closing Date.
(a) The Closing Date shall be such date as the parties may
agree to in writing. All acts taking place at the Closing shall
be deemed to take place simultaneously as of the time
immediately after the close of business on the Closing Date
unless otherwise agreed to by the parties. The close of business
on the Closing Date shall be as of 4:00 p.m. New York Time.
The Closing shall be held at the offices
of
or at such other time
and/or place
as the parties may agree. As soon as practicable following the
Closing, Acquired Fund and Acquiring Fund will cause the
Certificate of Merger (the Certificate of Merger) to
be executed, acknowledged and filed with the Secretary of State
of the State of Delaware as required by the DGCL and the LLC
Act. The Merger shall become effective upon the filing of the
Certificate of Merger with the Secretary of State of the State
of Delaware or such later time as may be provided for in the
Certificate of Merger (the Effective Time).
(b) In the event that on the Valuation Date (i) the
primary trading market for portfolio securities of the Acquiring
Fund or Acquired Fund shall be closed to trading or trading
thereupon shall be restricted or (ii) trading or the
reporting of trading shall be disrupted so that, in the judgment
of the Board of Directors of the Acquired Fund or the Board of
Trustees of the Acquiring Fund, accurate appraisal of the value
of the net assets of the Acquiring Fund or Acquired Fund is
impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been
fully resumed and reporting shall have been restored.
4. Expenses, fees, etc.
(a) All fees and expenses, including legal and accounting
expenses, proxy materials and proxy solicitation with respect to
Acquired Fund, the costs of liquidating before the Closing Date
portfolio securities of Acquired Fund to the extent required
under Section 1(i), portfolio transfer taxes (if any) or
other similar expenses incurred in connection with the
consummation by Acquired Fund, Merger Sub and Acquiring Fund of
the transactions contemplated by this Agreement (together with
the SEC registration fee specified below, Expenses)
will be borne by Acquired Fund and Acquiring Fund (for itself
and Merger Sub) in proportion to their respective net assets
determined at the Valuation Date; provided, however, that such
Expenses will in any event be paid by the party directly
incurring such Expenses if and to the extent that the payment by
the other party of such Expenses would result in the
disqualification of Acquiring Fund or Acquired Fund, as the case
may be, as a regulated investment company within the
meaning of Section 851 of the Code or would prevent the
transactions from qualifying as a tax-free reorganization under
the Code.
(b) In the event the transactions contemplated by this
Agreement are not consummated by reason of (i) Acquiring
Funds being either unwilling or unable to go forward
(other than by reason of the nonfulfillment or failure of any
condition to Acquiring Funds or Merger Subs
obligations referred to in Section 8 (except subsection
8(a)(ii))) or (ii) the non-fulfillment or failure of any
condition to Acquired Funds obligations referred to in
Section 9 (except subsection 9(a)(ii)), Acquiring Fund will
pay directly all reasonable fees and expenses incurred by
Acquired Fund in connection with such transactions, including,
without limitation, legal, accounting and filing fees.
(c) In the event the transactions contemplated by this
Agreement are not consummated by reason of (i) Acquired
Funds being either unwilling or unable to go forward
(other than by reason of the nonfulfillment or failure of any
condition to Acquired Funds obligations referred to in
Section 9 (except subsection 9(a)(ii))) or (ii) the
non-fulfillment or failure of any condition to Acquiring
Funds or Merger Subs obligations referred to in
Section 8 (except subsection 8(a)(ii)), Acquired Fund will
pay directly all reasonable fees and expenses incurred by
Acquiring Fund
and/or
Merger Sub in connection with such transactions, including
without limitation legal, accounting and filing fees.
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(d) In the event the transactions contemplated by this
Agreement are not consummated for any reason other than
(i) Acquiring Funds or Acquired Funds being
either unwilling or unable to go forward or (ii) the
non-fulfillment or failure of any condition to Acquiring
Funds, Merger Subs or Acquired Funds
obligations referred to in Section 8 (except subsection
8(a)(ii)) or Section 9 (except subsection 9(a)(ii)) of this
Agreement, then each of Acquiring Fund (for itself and Merger
Sub) and Acquired Fund will bear all of its own expenses
incurred in connection with such transactions.
(e) Notwithstanding any other provisions of this Agreement,
if for any reason the transactions contemplated by this
Agreement are not consummated, no party will be liable to the
other party for any damages resulting therefrom, including
without limitation consequential damages, except as specifically
set forth above.
5. Representations and warranties of Acquiring
Fund and Merger Sub.
Acquiring Fund and Merger Sub represent and warrant to and agree
with Acquired Fund that (except as disclosed to Acquired Fund);
provided that with respect to the representations and warranties
made by and concerning Merger Sub, such representations and
warranties will be deemed to have been made as of the date
Merger Sub becomes a party to this Agreement:
(a) Acquiring Fund is a statutory trust duly established,
validly existing and in good standing under the laws of the
State of Delaware and has power to own all of its properties and
assets and to carry out its obligations under this Agreement.
Acquiring Fund is not required to qualify as a foreign
association in any jurisdiction. Acquiring Fund has all
necessary federal, state and local authorizations to carry on
its business as now being conducted and to carry out this
Agreement.
(b) Merger Sub is a limited liability company duly formed,
validly existing and in good standing under the laws of the
State of Delaware, and has all the requisite power and authority
to own, lease and operate its properties and assets and to carry
on its business as it is now being conducted.
(c) Acquiring Fund is registered under the Investment
Company Act of 1940, as amended (the 1940 Act), as a
closed-end management investment company, and such registration
has not been revoked or rescinded and is in full force and
effect.
(d) Merger Sub has filed an election under the 1940 Act to
be regulated as a business development company, and such
election has not been revoked or rescinded and is in full force
and effect.
(e) A statement of assets and liabilities, statement of
operations, statement of changes in net assets and schedule of
investments (indicating their market values) of Acquiring Fund
as of and for the fiscal year ended December 31, 2008,
audited
by ,
the Acquiring Funds independent registered public
accounting firm, will be furnished to Acquired Fund prior to the
Closing Date. The statements of assets and liabilities and the
schedules of investments will fairly present the financial
position of Acquiring Fund as of their date, and the statements
of operations and changes in net assets will fairly reflect the
results of its operations and changes in net assets for the
periods covered thereby in conformity with U.S. generally
accepted accounting principles.
(f) There are no material legal, administrative or other
proceedings pending or, to the knowledge of Acquiring Fund or
Merger Sub, threatened against Acquiring Fund or Merger Sub
which assert liability or which may, if successfully prosecuted
to their conclusion, result in liability on the part of
Acquiring Fund or Merger Sub, other than as have been disclosed
in the Prospectuses (as defined below) or otherwise disclosed in
writing to Acquired Fund.
(g) Acquiring Fund has no known liabilities of a material
nature, contingent or otherwise, other than those shown as
belonging to it on its statement of assets and liabilities as of
December 31, 2008 and those incurred in the ordinary course
of Acquiring Funds business as an investment company since
such date. Before the Closing Date, Acquiring Fund will advise
Acquired Fund of all material liabilities, contingent or
otherwise, incurred by it subsequent to December 31, 2008,
whether or not incurred in the ordinary course of business.
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(h) No consent, approval, authorization or order of any
court or governmental authority is required for the consummation
by Acquiring Fund or Merger Sub of the transactions contemplated
by this Agreement, except such as may be required under the
Securities Act of 1933, as amended (the
1933 Act), the Securities Exchange Act of 1934,
as amended (the 1934 Act), the 1940 Act, state
securities or blue sky laws (which term as used herein will
include the laws of the District of Columbia and of Puerto Rico)
or the
Hart-Scott-Rodino
Antitrust Improvements Act of 1976 (the H-S-R Act).
(i) The registration statement and any amendment thereto
(including any post-effective amendment) (the Registration
Statement) filed with the Securities and Exchange
Commission (the Commission) by Acquiring Fund on
Form N-14
relating to the Merger Shares issuable hereunder and the proxy
statement of Acquired Fund included therein (the Proxy
Statement), on the effective date of the Registration
Statement, (i) comply in all material respects with the
provisions of the 1933 Act, the 1934 Act and the 1940
Act and the rules and regulations thereunder and (ii) do
not contain any untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary
to make the statements therein not misleading; and at the time
of the stockholders meeting referred to in
Section 7(a) and at the Closing Date, the prospectus
contained in the Registration Statement (the
Prospectus), as amended or supplemented by any
amendments or supplements thereto, will not contain any untrue
statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the
statements therein not misleading; provided, however, that none
of the representations and warranties in this subsection will
apply to statements in or omissions from the Registration
Statement, the Prospectus or the Proxy Statement made in
reliance upon and in conformity with information furnished by
Acquired Fund for use in the Registration Statement, the
Prospectus or the Proxy Statement.
(j) There are no material contracts outstanding to which
Acquiring Fund or Merger Sub is a party, other than as will be
disclosed in the Registration Statement or otherwise disclosed
in writing to Acquired Fund.
(k) All of the issued and outstanding shares of beneficial
interest of Acquiring Fund have been offered for sale and sold
in conformity with all applicable federal securities laws.
(l) For each taxable year of its operation, Acquiring Fund
has met the requirements of Subchapter M of the Code for
qualification and treatment as a regulated investment
company, has elected to be treated as such, and has
computed its U.S. federal income tax under Section 852
of the Code.
(m) As of the Closing Date and the Effective Time,
Acquiring Fund will have filed all federal, state, and other tax
returns and reports which will have been required to be filed by
Acquiring Fund and will have paid or will pay all federal, state
and other taxes shown to be due on said returns or on any
assessments received by Acquiring Fund, will have adequately
provided for all tax liabilities on its books, and to the
knowledge of Acquiring Fund, will not have had any tax
deficiency or liability asserted against it or question with
respect thereto raised by the Internal Revenue Service or by any
state or local tax authority for taxes in excess of those
already paid. As of the Closing Date and the Effective Time,
Acquiring Fund will not be under audit by the Internal Revenue
Service or by any state or local tax authority for taxes in
excess of those already paid.
(n) The issuance of the Merger Shares pursuant to this
Agreement will be in compliance with all applicable federal
securities laws.
(o) The Merger Shares have been duly authorized and, when
issued and delivered pursuant to this Agreement, will be legally
and validly issued and will be fully paid and nonassessable by
Acquiring Fund (except as set forth in the Registration
Statement), and no shareholder of Acquiring Fund will have any
preemptive right of subscription or purchase in respect thereof.
(p) All of the issued and outstanding membership interests
in Merger Sub are, and at the Effective Time will be, owned by
the Acquiring Fund, as sole member (the Member), and
there are (i) no other membership interests or voting
securities of Merger Sub, (ii) no securities of Merger Sub
convertible into or exchangeable for membership interests or
voting securities of Merger Sub and (iii) no options or
other rights to acquire from Merger Sub, and no obligations of
Merger Sub to issue, any membership interests, voting securities
or securities convertible into or exchangeable for capital
membership interests or voting securities of Merger Sub. Merger
Sub has not conducted any business prior to the date hereof and
has no, and prior to the Effective
A-6
Time will have no, assets, liabilities or obligations of any
nature other than those incident to its formation and pursuant
to this Agreement and the Merger and the other transactions
contemplated by this Agreement.
6. Representations and warranties of Acquired Fund.
Acquired Fund represents and warrants to and agrees with
Acquiring Fund and Merger Sub that (except as disclosed to
Acquiring Fund and Merger Sub):
(a) Acquired Fund is a corporation duly organized, validly
existing and in good standing under the laws of the State of
Delaware and has power to own all of its properties and assets
and to carry out its obligations under this Agreement. Acquired
Fund is duly qualified or licensed to do business as a foreign
corporation and is in good standing under the laws of any other
jurisdiction in which the character of the properties owned,
leased or operated by it therein or in which the transaction of
its business makes such qualification or licensing necessary.
Acquired Fund has all necessary federal, state and local
authorizations to carry on its business as now being conducted
and to carry out this Agreement.
(b) Acquired Fund is a closed-end company that has filed an
election under the 1940 Act to be regulated as a business
development company, and such election has not been revoked or
rescinded and is in full force and effect.
(c) A statement of assets and liabilities, statement of
operations, statement of changes in net assets and schedule of
investments (indicating their market values) of Acquired Fund as
of and for the fiscal year ended December 31, 2008, audited
by ,
the Acquired Funds independent registered public
accounting firm, will be furnished to Acquiring Fund prior to
the Closing Date. The statements of assets and liabilities and
schedules of investments will fairly present the financial
position of Acquired Fund as of their date, and the statements
of operations and changes in net assets will fairly reflect the
results of its operations and changes in net assets for the
periods covered thereby in conformity with U.S. generally
accepted accounting principles.
(d) There are no material legal, administrative or other
proceedings pending or, to the knowledge of Acquired Fund,
threatened against Acquired Fund which assert liability or which
may, if successfully prosecuted to their conclusion, result in
liability on the part of Acquired Fund, other than as have been
disclosed in the Registration Statement or otherwise disclosed
in writing to the Acquiring Fund.
(e) Acquired Fund has no known liabilities of a material
nature, contingent or otherwise, other than those shown as
belonging to it on its statement of assets and liabilities as of
December 31, 2008 and those incurred in the ordinary course
of Acquired Funds business as an investment company since
such date. Before the Closing Date, Acquired Fund will advise
Acquiring Fund of all material liabilities, contingent or
otherwise, incurred by it subsequent to December 31, 2008,
whether or not incurred in the ordinary course of business.
(f) No consent, approval, authorization or order of any
court or governmental authority is required for the consummation
by Acquired Fund of the transactions contemplated by this
Agreement, except such as may be required under the
1933 Act, the 1934 Act, the 1940 Act, state securities
or blue sky laws or the H-S-R Act.
(g) The Registration Statement, the Prospectus and the
Proxy Statement, on the Effective Date of the Registration
Statement and insofar as they do not relate to Acquiring Fund
(i) comply in all material respects with the provisions of
the 1933 Act, the 1934 Act and the 1940 Act and the
rules and regulations thereunder and (ii) do not contain
any untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make
the statements therein not misleading; and at the time of the
stockholders meeting referred to in Section 7(a)
below and on the Closing Date, the Prospectus, as amended or
supplemented by any amendments or supplements thereto, will not
contain any untrue statement of a material fact or omit to state
a material fact required to be stated therein or necessary to
make the statements therein not misleading; provided, however,
that the representations and warranties in this subsection will
apply only to statements of fact or omissions of statements of
fact relating to Acquired Fund contained in the Registration
Statement, the Prospectus or the Proxy Statement, as such
Registration Statement, Prospectus and Proxy Statement will be
furnished to Acquired Fund in definitive form as soon as
practicable following effectiveness of the Registration
Statement and before any public distribution of the Prospectus
or Proxy Statement.
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(h) There are no material contracts outstanding to which
Acquired Fund is a party, other than as will be disclosed in the
Registration Statement or otherwise disclosed in writing to
Acquiring Fund.
(i) All of the issued and outstanding shares of beneficial
interest of Acquired Fund have been offered for sale and sold in
conformity with all applicable federal securities laws.
(j) For each taxable year of its operation (including the
taxable year ending on the Effective Date), Acquired Fund has
met the requirements of Subchapter M of the Code for
qualification and treatment as a regulated investment
company, has elected to be treated as such, and has
computed its U.S. federal income tax under Section 852
of the Code.
(k) As of the Closing Date and the Effective Time, Acquired
Fund has filed or will file all federal, state and other tax
returns and reports which will have been required to be filed by
Acquired Fund and will have paid or will pay all federal, state
or other taxes shown to be due on said returns or on any
assessments received by Acquired Fund, will have adequately
provided for all tax liabilities on its books, and to the
knowledge of Acquired Fund, will not have had any tax deficiency
or liability asserted against it or any question with respect
thereto raised by the Internal Revenue Service or by any state
or local tax authority for taxes in excess of those already
paid. As of the Closing Date and the Effective Time, Acquired
Fund will not be under audit by the Internal Revenue Service or
by any state or local tax authority for taxes in excess of those
already paid.
(l) On the Closing Date, the Acquired Fund will have good
and marketable title to all of its Investments (as defined
below) and other assets to be held immediately prior to the
Effective Time and Merger Sub will acquire good and marketable
title thereto, subject to no encumbrances, liens or security
interests whatsoever and without any restrictions on the full
transfer thereof, including such restrictions as might arise
under the 1933 Act, other than as previously disclosed to
Acquiring Fund. As used in this Agreement, the term
Investments means Acquired Funds investments
shown on the schedule of its investments as of December 31,
2008, as supplemented with such changes as Acquired Fund makes
in connection with its business as a business development
company and changes resulting from stock dividends, stock
splits, mergers and similar corporate actions.
7. Covenants of the Acquired Fund and Acquiring
Fund.
(a) Acquired Fund agrees to call a meeting of its
stockholders as soon as is practicable after the effective date
of the Registration Statement for, among other things, the
purpose of considering the matters contemplated by this
Agreement.
(b) Acquiring Fund has filed the Registration Statement
with the Commission. Each of Acquired Fund and Acquiring Fund
will cooperate with the other, and each will furnish to the
other the information relating to itself required by the
1933 Act, the 1934 Act and the 1940 Act and the rules
and regulations thereunder to be set forth in the Registration
Statement, including the Prospectus and the Proxy Statement.
(c) Prior to the Effective Time, the Acquiring Fund shall
cause Merger Sub to be organized and shall cause Merger Sub to
duly adopt and execute and become a party to this Agreement and
cause Merger Sub to take all necessary action to be taken by
Merger Sub to implement the provisions of this Agreement.
(d) As soon as reasonably practicable after the Effective
Time, the Acquiring Fund will assume all of Merger Subs
liabilities and obligations, known and unknown, contingent or
otherwise, whether or not determinable, and Merger Sub will make
a liquidating distribution of all of its assets to the Acquiring
Fund, which will be Merger Subs sole member at such time.
(e) Acquired Fund covenants that it will, from time to
time, as and when reasonably requested by the Acquiring Fund,
execute and deliver or cause to be executed and delivered all
such assignments and other instruments, and will take or cause
to be taken such further action as the Acquiring Fund or Merger
Sub may reasonably deem necessary or desirable in order to
ultimately vest and confirm Merger Subs and, following the
liquidating distribution referred to in paragraph
(d) above, the Acquiring Funds title to and
possession of all of the assets of the Acquired Fund and to
otherwise carry out the intent and purpose of this Agreement.
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(f) With respect to covenants and representations made by
and concerning Merger Sub, such representations and covenants
will be deemed to have been made as of the date Merger Sub
becomes a party to this Agreement.
8. Conditions to Acquiring Funds and Merger
Subs obligations.
The obligations of Acquiring Fund and Merger Sub hereunder are
subject to the following conditions:
(a) That this Agreement will have been adopted and the
transactions contemplated hereby will have been approved by the
affirmative vote of (i) at least a majority of the
Directors of Acquired Fund (including a majority of those
Directors who are not interested persons of Acquired
Fund, as defined in Section 2(a)(19) of the 1940 Act),
(ii) holders of a majority of the outstanding common shares
of Acquired Fund, (iii) a majority of the Trustees of
Acquiring Fund (including a majority of those Trustees who are
not interested persons of Acquiring Fund, as defined
in Section 2(a)(19) of the 1940 Act), and (iv) Acquiring
Fund, as the sole Member of Merger Sub.
(b) No demands for appraisal shall have been or none may
still be made in accordance with DGCL Section 262, or if such
demands for appraisal have been made or may still be made in
accordance with Delaware law, the Boards of the Acquired Fund
and Acquiring Fund have determined to continue the
Reorganization notwithstanding such appraisals.
(c) That Acquired Fund will have furnished to Acquiring
Fund a statement of Acquired Funds assets and liabilities,
with values determined as provided in Section 2 of this
Agreement, together with a list of Investments with their
respective tax costs, all as of the Valuation Date, certified on
Acquired Funds behalf by Acquired Funds President
(or any Vice President) and Treasurer (or Assistant Treasurer)
and a certificate of both such officers, dated the Closing Date,
to the effect that as of the Valuation Date and as of the
Closing Date there has been no material adverse change in the
financial position of Acquired Fund since December 31, 2008
other than changes in the Investments and other assets and
properties since that date or changes in the market value of the
Investments and other assets of Acquired Fund or changes due to
dividends paid or losses from operations.
(d) That Acquired Fund will have furnished to Acquiring
Fund a statement, dated the Closing Date, signed on behalf of
Acquired Fund by Acquired Funds President (or any Vice
President) and Treasurer (or Assistant Treasurer) certifying
that as of the Valuation Date and as of the Closing Date all
representations and warranties of Acquired Fund made in this
Agreement are true and correct in all material respects as if
made at and as of such dates, and that Acquired Fund has
complied with all of the agreements and satisfied all of the
conditions on its part to be performed or satisfied at or before
each of such dates.
(e) That there will not be any material litigation pending
with respect to the matters contemplated by this Agreement.
(f) That Acquiring Fund will have received an opinion of
Ropes & Gray LLP
and/or
Morris, Nichols, Arsht & Tunnell LLP, dated the
Closing Date, in form satisfactory to Acquiring Fund, to the
effect that (i) Acquired Fund is a corporation duly
incorporated, validly existing and in good standing under the
laws of the State of Delaware, and, to the knowledge of such
counsel, is not required to qualify to do business as a foreign
corporation in any jurisdiction except as may be required by
state securities or blue sky laws, (ii) this Agreement has
been duly authorized, executed, and delivered by Acquired Fund
and, assuming that the Registration Statement, the Prospectus
and the Proxy Statement comply with the 1933 Act, the
1934 Act and the 1940 Act and assuming due authorization,
execution and delivery of this Agreement by Acquiring Fund and
Merger Sub, is a valid and binding obligation of Acquired Fund,
(iii) Acquired Fund has power to sell, assign, convey,
transfer and deliver the assets contemplated hereby, and
(iv) no consent, approval, authorization or order of any
court or governmental authority is required for the consummation
by Acquired Fund of the transactions contemplated hereby, except
such as have been obtained under the 1933 Act, the
1934 Act, the 1940 Act and such as may be required under
state securities or blue sky laws and the H-S-R Act.
(g) That Acquiring Fund will have received an opinion of
Ropes & Gray LLP dated as of the Closing Date (which
opinion will be based upon certain factual representations and
subject to certain qualifications)
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reasonably satisfactory to the Acquiring Fund and substantially
to the effect that, on the basis of the existing provisions of
the Code, current administrative rules and court decisions,
generally for federal income tax purposes: (i) the
transactions contemplated by this Agreement will constitute a
reorganization within the meaning of Section 368(a) of the
Code and Acquired Fund and Acquiring Fund will each be a
party to a reorganization within the meaning of the
Code; (ii) no gain or loss will be recognized by the
Acquiring Fund upon the Merger or Liquidation; (iii) the
basis of the Assets (defined as all Investments and other assets
of the Acquired Fund) in the hands of Acquiring Fund will be the
same as the basis of such Assets in the hands of the Acquired
Fund immediately prior to the Merger; (iv) the holding
periods of the Assets in the hands of Acquiring Fund will
include the periods during which such Assets were held by the
Acquired Fund; (v) no gain or loss will be recognized by
the Acquired Fund upon the Merger or Liquidation; (vi) no
gain or loss will be recognized by Acquired Fund stockholders on
the conversion of shares of Acquired Common Stock into Merger
Shares (except to the extent an Acquired Fund stockholder
receives cash in lieu of fractional Merger Shares);
(vii) the aggregate basis of Merger Shares received by
Acquired Fund stockholders will be the same as the aggregate
basis of shares of Acquired Common Stock converted into such
Merger Shares (except to the extent reduced by the portion of
the adjusted basis in shares of Acquired Common Stock that is
allocable to any fractional Merger Shares for which cash in lieu
of such fractional Merger Shares is received); (viii) the
holding periods of Merger Shares received by Acquired Fund
stockholders will include the holding periods of shares of
Acquired Common Stock converted into such Merger Shares,
provided that at the time of the Merger, shares of Acquired
Common Stock are held by such stockholders as capital assets;
and (ix) the Acquiring Fund will succeed to and take into
account the items of the Acquired Fund described in
Section 381(c) of the Code, subject to the conditions and
limitations specified in Sections 381, 382, 383, and 384 of
the Code and the regulations thereunder (the Tax
Opinion). The Tax Opinion will not express any view with
respect to the effect of the transactions contemplated by this
Agreement on any transferred asset as to which any unrealized
gain or loss is required to be recognized under
U.S. federal income tax principles (1) at the end of a
taxable year or (ii) on the termination or transfer thereof
without reference to whether such a termination or transfer
would otherwise be a taxable transaction. The Tax Opinion may
state that it is not a guarantee that the tax consequences of
the transactions contemplated by this Agreement will be as
described in such opinion.
(h) That the assets of Acquired Fund to be acquired by
Acquiring Fund will include no assets which Acquiring Fund, by
reason of charter limitations or of investment restrictions
disclosed in the Registration Statement in effect on the Closing
Date, may not properly acquire.
(i) That the Registration Statement will have become
effective under the 1933 Act, and no stop order suspending
such effectiveness will have been instituted or, to the
knowledge of Acquiring Fund, threatened by the Commission.
(j) That Acquiring Fund and Merger Sub will have received
from the Commission, any relevant state securities
administrator, the Federal Trade Commission (the
FTC) and the Department of Justice (the
Department) such order or orders as
Ropes & Gray LLP deems reasonably necessary or
desirable under the 1933 Act, the 1934 Act, the 1940
Act, any applicable state securities or blue sky laws and the
H-S-R Act in connection with the transactions contemplated
hereby and that all such orders will be in full force and effect.
(k) That all actions taken by or on behalf of Acquired Fund
and Merger Sub in connection with the transactions contemplated
by this Agreement and all documents incidental thereto will be
satisfactory in form and substance to Acquiring Fund, Merger Sub
and Ropes & Gray LLP.
(l) That, before the Closing Date, Acquired Fund will have
declared a dividend or dividends which, together with all
previous such dividends, will have the effect of distributing to
the shareholders of Acquired Fund (i) all of the excess of
(X) Acquired Funds investment interest excludable
from gross income under Section 103(a) of the Code over
(Y) Acquired Funds deductions disallowed under
Sections 265 and 171(a)(2) of the Code, (ii) all of
Acquired Funds investment company taxable income (as
defined in Section 852 of the Code) (computed in each case
without regard to any deduction for dividends paid), and
(iii) all of its net capital gain (as defined in
Section 1222 of the Code) realized (after reduction by any
capital loss carryover),
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in each case for both the current taxable year of the Acquired
Fund (which will end at the Effective Time) and immediately
preceding taxable year of the Acquired Fund.
(m) That Acquired Funds custodian will have delivered
to Acquiring Fund a certificate identifying all of the assets of
Acquired Fund held by such custodian as of the Valuation Date.
(n) That Acquired Funds transfer agent will have
provided to Acquiring Fund or its transfer agent (i) the
originals or true copies of all of the records of Acquired Fund
in the possession of such transfer agent as of the Closing Date,
(ii) a certificate setting forth the number of shares of
Acquired Fund outstanding as of the Valuation Date, and
(iii) the name and address of each holder of record of any
such shares and the number of shares held of record by each such
stockholder.
(o) If at any time the Acquiring Fund and Merger Sub shall
consider or be advised that any further assignment, conveyance
or assurance is necessary or advisable to vest, perfect or
confirm of record in the Surviving Company or Acquiring Fund the
title to any property or right of the Acquired Fund, or
otherwise to carry out the provisions hereof, the proper
representatives of the Acquired Fund as of the Effective Time
shall execute and deliver any and all proper deeds, assignments
and assurances and do all things necessary or proper to vest,
perfect or convey title to such property or right in the
Surviving Company or Acquiring Fund, as the case may be, and
otherwise to carry out the provisions hereof.
(p) That the Merger Shares shall have been accepted for
listing by the New York Stock Exchange.
(q) The Acquiring Fund and the Acquired Fund will have
received an opinion of Morris, Nichols, Arsht &
Tunnell LLP in such form and addressing such matters as the
Funds may mutually agree.
9. Conditions to Acquired Funds
obligations.
The obligations of Acquired Fund hereunder will be subject to
the following conditions:
(a) That this Agreement will have been adopted and the
transactions contemplated hereby will have been approved by the
affirmative vote of (i) at least a majority of the
Directors of Acquired Fund (including a majority of those
Directors who are not interested persons of Acquired
Fund, as defined in Section 2(a)(19) of the 1940 Act),
(ii) holders of a majority of the outstanding shares of
Acquired Fund, (iii) a majority of the Trustees of
Acquiring Fund (including a majority of those Trustees who are
not interested persons of Acquiring Fund, as defined
in Section 2(a)(19) of the 1940 Act), and
(iv) Acquiring Fund, as the sole Member of Merger Sub.
(b) No demands for appraisal shall have been or none may
still be made in accordance with DGCL Section 262, or if such
demands for appraisal have been made or may still be made in
accordance with Delaware law, the Boards of the Acquired Fund
and Acquiring Fund have determined to continue the
Reorganization notwithstanding such demands.
(c) That Acquiring Fund will have furnished to Acquired
Fund a statement of Acquiring Funds assets and
liabilities, together with a list of portfolio holdings with
values determined as provided in Section 2 of this
Agreement, all as of the Valuation Date, certified on behalf of
Acquiring Fund by Acquiring Funds President (or any Vice
President) and Treasurer (or Assistant Treasurer) and a
certificate of both such officers, dated the Closing Date, to
the effect that as of the Valuation Date and as of the Closing
Date there has been no material adverse change in the financial
position of Acquiring Fund since December 31, 2008, other
than changes in its portfolio securities since that date,
changes in the market value of its portfolio securities or
changes due to dividends paid or losses from operations.
(d) That Acquiring Fund will have furnished to Acquired
Fund a statement, dated the Closing Date, signed on behalf of
Acquiring Fund by Acquiring Funds President (or any Vice
President) and Treasurer (or Assistant Treasurer) certifying
that as of the Valuation Date and as of the Closing Date all
representations and warranties of Acquiring Fund made in this
Agreement are true and correct in all material respects as if
made at and as of such dates, and that Acquiring Fund has
complied with all of the agreements and satisfied all of the
conditions on its part to be performed or satisfied at or prior
to each of such dates.
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(e) That there will not be any material litigation pending
or threatened with respect to the matters contemplated by this
Agreement.
(f) That Acquired Fund will have received an opinion of
Ropes & Gray LLP
and/or
Morris, Nichols, Arsht & Tunnell LLP, dated the
Closing Date, in form satisfactory to Acquired Fund, to the
effect that (i) Acquiring Fund is a statutory trust duly
formed, validly existing and in good standing in conformity with
the laws of the State of Delaware and, to the knowledge of such
counsel, is not required to qualify to do business as a foreign
association in any jurisdiction except as may be required by
state securities or blue sky laws, (ii) Merger Sub is a
limited liability company duly formed, validly existing and in
good standing in conformity with the laws of the State of
Delaware, and, to the knowledge of such counsel, is not required
to qualify to do business as a foreign association in any
jurisdiction except as may be required by state securities or
blue sky laws, (iii) this Agreement has been duly
authorized, executed and delivered by Acquiring Fund and by the
Member on behalf of Merger Sub, and, assuming that the
Prospectus, the Registration Statement and the Proxy Statements
comply with the 1933 Act, the 1934 Act and the 1940
Act and assuming due authorization, execution and delivery of
this Agreement by Acquired Fund, is a valid and binding
obligation of Acquiring Fund and Merger Sub, (iv) the
Merger Shares to be delivered to Acquired Fund as provided for
by this Agreement are duly authorized and upon such delivery
will be validly issued and will be fully paid and nonassessable
(except as set forth in the Registration Statement) by Acquiring
Fund and no shareholder of Acquiring Fund has any preemptive
right to subscription or purchase in respect thereof,
(v) no consent, approval, authorization or order of any
court or governmental authority is required for the consummation
by Acquiring Fund or Merger Sub of the transactions contemplated
herein, except such as have been obtained under the
1933 Act, the 1934 Act and the 1940 Act and such as
may be required under state securities or blue sky laws and the
H-S-R Act, and (vi) the Registration Statement has become
effective under the 1933 Act, and, to the best of the
knowledge of such counsel, no stop order suspending the
effectiveness of the Registration Statement has been issued and
no proceedings for that purpose have been instituted or are
pending or contemplated under the 1933 Act.
(g) That Acquired Fund will have received a Tax Opinion of
Ropes & Gray LLP dated as of the Closing Date (the
substance of which is described above in Section 8(g)) and
reasonably satisfactory to the Acquired Fund. The Tax Opinion
will not express any view with respect to the effect of the
transactions contemplated by this Agreement on any transferred
asset as to which any unrealized gain or loss is required to be
recognized under U.S. federal income tax principles
(i) at the end of a taxable year or (ii) on the
termination or transfer thereof without reference to whether
such a termination or transfer would otherwise be a taxable
transaction. The Tax Opinion may state that it is based on
certain factual representations and subject to certain
qualifications. The Tax Opinion may also state that it is not a
guarantee that the tax consequences of the transactions
contemplated by this Agreement will be as described in such
opinion.
(h) That all proceedings taken by or on behalf of Acquiring
Fund and Merger Sub in connection with the transactions
contemplated by this Agreement and all documents incidental
thereto will be satisfactory in form and substance to Acquired
Fund and Ropes & Gray LLP.
(i) That the Registration Statement will have become
effective under the 1933 Act and no stop order suspending
such effectiveness will have been instituted or, to the
knowledge of Acquiring Fund, threatened by the Commission.
(j) That Acquired Fund will have received from the
Commission, any relevant state securities administrator, the FTC
and the Department such order or orders as Ropes &
Gray LLP deems reasonably necessary or desirable under the
1933 Act, the 1934 Act, the 1940 Act, any applicable
state securities or blue sky laws and the H-S-R Act in
connection with the transactions contemplated hereby and that
all such orders will be in full force and effect.
(k) That the Merger Shares shall have been accepted for
listing by the New York Stock Exchange.
(l) The Acquired Fund will have received an opinion of
Morris, Nichols, Arsht & Tunnell LLP in such form and
addressing such matters as the Funds may mutually agree.
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10. Indemnification.
(a) Acquired Fund will indemnify and hold harmless, out of
the assets of Acquired Fund but no other assets, Acquiring Fund,
its trustees and its officers (for purposes of this
subparagraph, the Indemnified Parties) against any
and all expenses, losses, claims, damages and liabilities at any
time imposed upon or reasonably incurred by any one or more of
the Indemnified Parties in connection with, arising out of, or
resulting from any claim, action, suit or proceeding in which
any one or more of the Indemnified Parties may be involved or
with which any one or more of the Indemnified Parties may be
threatened by reason of any breach of any representation or
warranty of the Acquired Fund contained in this Agreement or
untrue statement or alleged untrue statement of a material fact,
to the extent based on or derived from documents provided by the
Acquired Fund, contained in the Registration Statement, the
Prospectus, the Proxy Statement or any amendment or supplement
to any of the foregoing, or arising out of or based upon the
omission or alleged omission to state in any of the foregoing a
material fact relating to Acquired Fund required to be stated
therein or necessary to make the statements relating to Acquired
Fund therein not misleading, including, without limitation, any
amounts paid by any one or more of the Indemnified Parties in a
reasonable compromise or settlement of any such claim, action,
suit or proceeding, or threatened claim, action, suit or
proceeding made with the consent of Acquired Fund. The
Indemnified Parties will notify Acquired Fund in writing within
ten days after the receipt by any one or more of the Indemnified
Parties of any notice of legal process or any suit brought
against or claim made against such Indemnified Party as to any
matters covered by this Section 10(a). Acquired Fund will
be entitled to participate at its own expense in the defense of
any claim, action, suit or proceeding covered by this
Section 10(a) or, if it so elects, to assume at its expense
by counsel satisfactory to the Indemnified Parties the defense
of any such claim, action, suit or proceeding and, if Acquired
Fund elects to assume such defense, the Indemnified Parties will
be entitled to participate in the defense of any such claim,
action, suit or proceeding at their expense. Acquired
Funds obligation under this Section 10(a) to
indemnify and hold harmless the Indemnified Parties will
constitute a guarantee of payment so that Acquired Fund will pay
in the first instance any expenses, losses, claims, damages and
liabilities required to be paid by it under this
Section 10(a) without the necessity of the Indemnified
Parties first paying the same.
(b) Acquiring Fund will indemnify and hold harmless, out of
the assets of Acquiring Fund but no other assets, Acquired Fund,
its directors and its officers (for purposes of this
subparagraph, the Indemnified Parties) against any
and all expenses, losses, claims, damages and liabilities at any
time imposed upon or reasonably incurred by any one or more of
the Indemnified Parties in connection with, arising out of, or
resulting from any claim, action, suit or proceeding in which
any one or more of the Indemnified Parties may be involved or
with which any one or more of the Indemnified Parties may be
threatened by reason of any breach of any representation or
warranty of the Acquiring Fund contained in this Agreement or
untrue statement or alleged untrue statement of a material fact,
to the extent based on or derived from documents provided by the
Acquiring Fund, contained in the Registration Statement, the
Prospectuses, the Proxy Statement, or any amendment or
supplement to any thereof, or arising out of, or based upon, the
omission or alleged omission to state in any of the foregoing a
material fact relating to Acquiring Fund required to be stated
therein or necessary to make the statements relating to
Acquiring Fund therein not misleading, including without
limitation any amounts paid by any one or more of the
Indemnified Parties in a reasonable compromise or settlement of
any such claim, action, suit or proceeding, or threatened claim,
action, suit or proceeding made with the consent of Acquiring
Fund. The Indemnified Parties will notify Acquiring Fund in
writing within ten days after the receipt by any one or more of
the Indemnified Parties of any notice of legal process or any
suit brought against or claim made against such Indemnified
Party as to any matters covered by this Section 10(b).
Acquiring Fund will be entitled to participate at its own
expense in the defense of any claim, action, suit or proceeding
covered by this Section 10(b) or, if it so elects, to
assume at its expense by counsel satisfactory to the Indemnified
Parties the defense of any such claim, action, suit or
proceeding and, if Acquiring Fund elects to assume such defense,
the Indemnified Parties will be entitled to participate in the
defense of any such claim, action, suit or proceeding at their
own expense. Acquiring Funds obligation under this
Section 10(b) to indemnify and hold harmless the
Indemnified Parties will constitute a guarantee of payment so
that Acquiring Fund will pay in the first instance any expenses,
losses, claims, damages and
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liabilities required to be paid by it under this
Section 10(b) without the necessity of the Indemnified
Parties first paying the same.
11. No broker, etc.
Each of Acquired Fund and Acquiring Fund represents that there
is no person who has dealt with it who by reason of such
dealings is entitled to any brokers or finders or
other similar fee or commission arising out of the transactions
contemplated by this Agreement.
12. Rule 145.
Pursuant to Rule 145 under the 1933 Act, Acquiring
Fund will, in connection with the issuance of any Merger Shares
to any person who at the time of the transaction contemplated
hereby is deemed to be an affiliate of a party to the
transaction pursuant to Rule 145(c), cause to be affixed
upon any certificates issued to such person a legend as follows:
THESE SHARES HAVE NOT BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD OR
OTHERWISE TRANSFERRED EXCEPT TO HIGHLAND CREDIT STRATEGIES
FUND UNLESS (I) A REGISTRATION STATEMENT WITH RESPECT
THERETO IS EFFECTIVE UNDER THE SECURITIES ACT OF 1933, AS
AMENDED, OR (II) IN THE OPINION OF COUNSEL REASONABLY
SATISFACTORY TO HIGHLAND CREDIT STRATEGIES FUND SUCH
REGISTRATION IS NOT REQUIRED.
and, further, Acquiring Fund will issue stop transfer
instructions to Acquiring Funds transfer agent with
respect to such shares. Acquired Fund will provide Acquiring
Fund on the Closing Date with the name of any Acquired Fund
shareholder who is to the knowledge of Acquired Fund an
affiliate of Acquired Fund on such date.
13. Covenants, etc. deemed material.
All covenants, agreements, representations and warranties made
under this Agreement and any certificates delivered pursuant to
this Agreement will be deemed to have been material and relied
upon by each of the parties, notwithstanding any investigation
made by them or on their behalf.
14. Sole agreement.
This Agreement supersedes all previous correspondence and oral
communications between the parties regarding the subject matter
hereof, constitutes the only understanding with respect to such
subject matter, and will be construed in accordance with and
governed by the laws of the State of Delaware.
15. Agreement and declaration of trust of
Acquiring Fund.
Notice is hereby given that this instrument is adopted on behalf
of Acquiring Funds trustees solely in their capacities as
trustees, and not individually, and that Acquiring Funds
obligations under this instrument are not binding on or
enforceable against any of its trustees, officers, or
shareholders but are only binding on and enforceable against its
property. Acquired Fund, in asserting any rights or claims under
this Agreement, shall look only to Acquiring Funds
property in settlement of such rights or claims and not to such
trustees, officers, or shareholders.
16. Amendment.
The parties hereto by mutual consent of their respective Boards
of Directors/Trustees may amend, modify or supplement this
Agreement in such manner as may be agreed upon by them in
writing, at any time prior to the Effective Time, including
after it is approved by stockholders of the Acquired Fund, to
the extent permitted by applicable law.
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17. Waiver.
At any time on or prior to the Exchange Date, the
trustees/directors of the Acquired Fund or the Acquiring Fund,
after consultation with counsel, may waive any condition to a
Funds respective obligations hereunder if they have
determined such waiver will not have a material adverse
consequence to the stockholders/shareholders of either Fund.
18. Termination.
This Agreement may be terminated and the transactions herein
provided for abandoned at any time, whether before or after
approval of this Agreement by the stockholders of the Acquired
Fund, by action of the Board of Directors/Trustees of either
Fund, if the applicable Board for such Fund determines for any
reason that the consummation of the transactions provided for
herein would for any reason be inadvisable or not in the best
interests of such Fund or its shareholders or if demands for
appraisal have been made or may still be made in accordance with
Delaware law.
19. Miscellaneous.
This Agreement may be executed in counterparts, each of which
when so executed shall be deemed to be an original, and such
counterparts shall together constitute but one and the same
instrument.
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IN WITNESS WHEREOF, Acquiring Fund and Acquired Fund, pursuant
to approval and authorization duly given by resolutions adopted
by their respective Boards of Trustees and Directors, as
applicable, have each caused this Agreement to be executed as of
the date first written above by a duly authorized officer.
HIGHLAND CREDIT STRATEGIES FUND
Name:
HIGHLAND DISTRESSED OPPORTUNITIES, INC.
Name:
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IN WITNESS WHEREOF, Merger Sub, pursuant to approval and
authorization duly given by its Member has caused this Agreement
to be executed as of the date indicated below by its sole member.
HCF ACQUISITION LLC
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By:
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HIGHLAND CREDIT STRATEGIES FUND,
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the sole member of HCF Acquisition LLC
Name:
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APPENDIX B
Description
of Investment Types
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Illiquid Securities |
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Certain of a Funds investments may be illiquid. Illiquid
securities are subject to legal or contractual restrictions on
disposition or lack an established secondary trading market. The
sale of restricted and illiquid securities often requires more
time and results in higher brokerage charges or dealer discounts
and other selling expenses than does the sale of securities
eligible for trading on national securities exchanges or in the
over-the-counter markets. Restricted securities may sell at a
price lower than similar securities that are not subject to
restrictions on resale. |
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Senior Loans |
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Senior loans hold the most senior position in the capital
structure of a business entity, are typically secured with
specific collateral and have a claim on the general assets 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. These base lending rates generally are LIBOR, the prime
rate offered by one or more major United States banks (Prime
Rate) or the certificate of deposit (CD) rate or other base
lending rates used by commercial lenders. |
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Loans and other corporate debt obligations are subject to the
risk of non-payment of scheduled interest or principal. Such
non-payment would result in a reduction of income to a Fund, a
reduction in the value of the investment and a potential
decrease in the NAV of a Fund. There can be no assurance that
the liquidation of any collateral securing a senior loan would
satisfy a borrowers obligation in the event of non-payment
of scheduled interest or principal payments, or that such
collateral could be readily liquidated. In the event of
bankruptcy of a borrower, a Fund could experience delays or
limitations with respect to its ability to realize the benefits
of the collateral securing a senior loan. To the extent that a
senior loan 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 the bankruptcy of a borrower. Some
senior loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate
senior loans to presently existing or future indebtedness of the
borrower or take other action detrimental to the holders of
senior loans including, in certain circumstances, invalidating
such senior loans or causing interest previously paid to be
refunded to the borrower. If interest were required to be
refunded, it could negatively affect a Funds performance.
To the extent a senior loan is subordinated in the capital
structure, it will have characteristics similar to other
subordinated debtholders, including a greater risk of nonpayment
of interest or principal. |
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Many loans in which the Fund may invest, and the issuers of such
loans, may not be rated by a rating agency, will not be
registered with the SEC or any state securities commission and
will not be listed on any national securities exchange. The
amount of public information available with respect to issuers
of senior loans will generally be less extensive than that
available |
B-1
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for issuers of registered or exchange listed securities. In
evaluating the creditworthiness of borrowers, the Adviser will
consider, and may rely in part, on analyses performed by others.
The Adviser does not view ratings as the determinative factor in
its investment decisions and relies more upon its credit
analysis abilities than upon ratings. Borrowers may have
outstanding debt obligations that are rated below investment
grade by a rating agency. A high percentage of senior loans held
by a Fund may be rated, if at all, below investment grade by
independent rating agencies. In the event senior loans are not
rated, they are likely to be the equivalent of below investment
grade quality. Debt securities which are unsecured and rated
below investment grade (i.e., Ba and below by Moodys or BB
and below by S&P) and comparable unrated bonds, are viewed
by the rating agencies as having speculative characteristics and
are commonly known as junk bonds. A description of
the ratings of corporate bonds by Moodys and S&P
included as Appendix A to the Statement of Additional
Information. Because senior loans are senior in a
borrowers capital structure and are often secured by
specific collateral, the Adviser believes that senior loans have
more favorable loss recovery rates as compared to most other
types of below investment grade debt obligations. However, there
can be no assurance that a Funds actual loss recovery
experience will be consistent with the Advisers prior
experience or that a Funds senior loans will achieve any
specific loss recovery rates. |
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No active trading market may exist for many senior loans, and
some senior loans may be subject to restrictions on resale. A
secondary market may be subject to irregular trading activity,
wide bid/ask spreads and extended trade settlement periods,
which may impair the ability to realize full value on the
disposition of an illiquid senior loan, and cause a material
decline in a Funds NAV. |
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Use of Agents. Senior loans generally are
arranged through private negotiations between a borrower and a
group of financial institutions initially 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
ongoing administration of a senior loan. Agents are typically
paid fees by the borrower for their services. The agent is
primarily responsible for negotiating the credit 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. |
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Credit agreements may provide for the termination of the
agents status in the event that it fails to act as
required under the relevant credit 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 inter-positioned between a 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 a Fund
should not be included in such persons or entitys
bankruptcy estate. If, however, any such amount were included in
such persons or entitys bankruptcy estate, a Fund
would incur certain costs and delays in realizing payment or
could suffer a loss of principal or interest. In this event, a
Fund could experience a decrease in NAV. |
B-2
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Form of Investment. A Funds 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
a Fund is a member of the originating syndicate for a senior
loan, it may share in a fee paid to the syndicate. When a 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. A 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 Adviser to be creditworthy. |
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Original Lender. When a 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 credit 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 credit agreement. Actions subject to
lender vote or consent generally require the vote or consent of
the majority of the holders of some specified percentage of the
outstanding principal amount of the senior loan. Certain
decisions, such as reducing the interest rate, or extending the
maturity of a senior loan, or releasing collateral securing a
senior loan, among others, frequently require the unanimous vote
or consent of all lenders affected. |
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Assignments. When a Fund is a purchaser of an
assignment, it typically succeeds to all the rights and
obligations under the credit agreement of the assigning lender
and becomes a lender under the credit 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. |
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Participations. A Fund may also invest in
participations in senior loans. The rights of a 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 a Fund in a lenders portion
of a senior loan typically means that the Fund has only a
contractual relationship 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. |
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With a participation, a Fund will have no rights to enforce
compliance by the borrower with the terms of the credit
agreement or any rights with respect to any funds acquired by
other lenders through setoff against the borrower. In addition,
a 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 a senior secured creditor 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. A Fund will consider a
purchase of |
B-3
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participations only in those situations where the Adviser
considers the participating lender to be creditworthy. |
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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 a 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 a
Funds investment objectives and policies. |
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Investing in senior loans involves investment risk. Some
borrowers default on their senior loan payments. A Fund attempts
to manage this credit risk through multiple different
investments within the portfolio and ongoing analysis and
monitoring of borrowers. A Fund also is subject to market,
liquidity, interest rate and other risks. |
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Second Lien Loans |
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Second lien loans are loans made by public and private
corporations and other non-governmental entities and issuers for
a variety of purposes. Second lien loans are second in right of
payment to one or more senior loans of the related borrower.
Second lien loans typically are secured by a second priority
security interest or lien to or on specified collateral securing
the borrowers obligation under the loan and typically have
similar protections and rights as senior loans. Second lien
loans are not (and by their terms cannot) become subordinate in
right of payment to any obligation of the related borrower other
than senior loans of such borrower. Second lien loans, like
senior loans, typically have adjustable floating rate interest
payments. Because second lien loans are second to senior loans,
they present a greater degree of investment risk but often pay
interest at higher rates reflecting this additional risk. Such
investments generally are of below investment grade quality.
Other than their subordinated status, second lien loans have
many characteristics and risks similar to senior loans discussed
above. In addition, second lien loans of below investment grade
quality share many of the risk characteristics of non-investment
grade securities. As in the case of senior loans, a Fund may
purchase interests in second lien loans through assignments or
participations. |
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Second lien loans are subject to the same risks associated with
investment in senior loans and non-investment grade securities.
Because second lien loans are second in right of payment to one
or more senior loans of the related borrower, they therefore are
subject to additional risk that the cash flow of the borrower
and any property securing the loan may be insufficient to meet
scheduled payments after giving effect to the senior secured
obligations of the borrower. Second lien loans are also expected
to have greater price volatility than senior loans and may be
less liquid. There is also a possibility that originators will
not be able to sell participations in second lien loans, which
would create greater credit risk exposure. |
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The risks associated with second lien loans are higher than the
risks of loans with first priority over the collateral. In the
event of default on a second lien loan, the first priority lien
holder has first claim to the underlying collateral of the loan.
It is possible that no collateral value would remain for the
second priority lien holder, resulting in a loss to a Fund. |
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Other Secured Loans |
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Secured loans other than senior loans and second lien loans are
made by public and private corporations and other
non-governmental entities and issuers for a variety of purposes.
Such secured loans may rank lower in right |
B-4
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of payment to one or more senior loans and second lien loans of
the borrower. Such secured loans typically are secured by a
lower priority security interest or lien to or on specified
collateral securing the borrowers obligation under the
loan, and typically have more subordinated protections and
rights than senior loans and second lien loans. Secured loans
may become subordinated in right of payment to more senior
obligations of the borrower issued in the future. Such secured
loans may have fixed or adjustable floating rate interest
payments. Because such secured loans may rank lower as to right
of payment than senior loans and second lien loans of the
borrower, they may present a greater degree of investment risk
than senior loans and second lien loans but often pay interest
at higher rates reflecting this additional risk. Such
investments generally are of below investment grade quality.
Other than their more subordinated status, such investments have
many characteristics and risks similar to senior loans and
second lien loans discussed above. In addition, secured loans of
below investment grade quality share many of the risk
characteristics of non-investment grade securities. As in the
case of senior loans and second lien loans, a Fund may purchase
interests in other secured loans through assignments or
participations. Other secured loans are subject to the same
risks associated with investment in senior loans, second lien
loans and non-investment grade securities. Because such loans,
however, may rank lower in right of payment to senior loans and
second lien loans of the borrower, they may be subject to
additional risk that the cash flow of the borrower and any
property securing the loan may be insufficient to repay the
scheduled payments after giving effect to more senior secured
obligations of the borrower. Such secured loans are also
expected to have greater price volatility than senior loans and
second lien loans and may be less liquid. There is also a
possibility that originators will not be able to sell
participations in other secured loans, which would create
greater credit risk exposure. |
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Unsecured Loans |
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Unsecured loans are loans made by public and private
corporations and other non-governmental entities and issuers for
a variety of purposes. Unsecured loans generally have lower
priority in right of payment compared to holders of secured debt
of the borrower. Unsecured loans are not secured by a security
interest or lien to or on specified collateral securing the
borrowers obligation under the loan. Unsecured loans by
their terms may be or may become subordinate in right of payment
to other obligations of the borrower, including senior loans,
second lien loans and other secured loans. Unsecured loans may
have fixed or adjustable floating rate interest payments.
Because unsecured loans are subordinate to the secured debt of
the borrower, they present a greater degree of investment risk
but often pay interest at higher rates reflecting this
additional risk. Such investments generally are of
non-investment grade quality. Other than their subordinated and
unsecured status, such investments have many characteristics and
risks similar to senior loans, second lien loans and other
secured loans discussed above. In addition, unsecured loans of
non-investment grade quality share many of the risk
characteristics of non-investment grade securities. As in the
case of secured loans, a Fund may purchase interests in
unsecured loans through assignments or participations. |
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Unsecured loans are subject to the same risks associated with
investment in senior loans, second lien loans, other secured
loans and non-investment grade securities. However, because
unsecured loans rank lower in right of payment to any secured
obligations of the borrower, they may be subject to |
B-5
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additional risk that the cash flow of the borrower and available
assets may be insufficient to meet scheduled payments after
giving effect to the secured obligations of the borrower.
Unsecured loans are also expected to have greater price
volatility than secured loans and may be less liquid. There is
also a possibility that loan originators will not be able to
sell participations in unsecured loans, which would create
greater credit risk exposure. |
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Investment Grade Securities |
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A Fund may invest in a wide variety of bonds that are rated or
determined by the Adviser to be of investment grade quality of
varying maturities issued by U.S. corporations and other
business entities. Bonds are fixed or variable rate debt
obligations, including bills, notes, debentures, money market
instruments and similar instruments and securities. Bonds
generally are used by corporations and other issuers to borrow
money from investors for a variety of business purposes. The
issuer pays the investor a fixed or variable rate of interest
and normally must repay the amount borrowed on or before
maturity. Certain bonds are perpetual in that they
have no maturity date. Some investment grade securities, such as
zero coupon bonds, do not pay current interest, but are sold at
a discount from their face values. Although more creditworthy
and generally less risky than non-investment grade securities,
investment grade securities are still subject to market and
credit risk. Market risk relates to changes in a securitys
value as a result of interest rate changes generally. Investment
grade securities have varying levels of sensitivity to changes
in interest rates and varying degrees of credit quality. In
general, bond prices rise when interest rates fall, and fall
when interest rates rise. Longer-term bonds and zero coupon
bonds are generally more sensitive to interest rate changes.
Credit risk relates to the ability of the issuer to make
payments of principal and interest. The values of investment
grade securities like those of other debt securities may be
affected by changes in the credit rating or financial condition
of an issuer. Investment grade securities are generally
considered medium-and high-quality securities. Some, however,
may possess speculative characteristics, and may be more
sensitive to economic changes and to changes in the financial
condition of issuers. The market prices of investment grade
securities in the lowest investment grade categories may
fluctuate more than higher-quality securities and may decline
significantly in periods of general or regional economic
difficulty. Like non-investment grade securities, such
investment grade securities in the lowest investment grade
categories may be thinly traded, making them difficult to sell
promptly at an acceptable price. |
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Non-Investment Grade Securities |
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A Fund may invest in securities rated below investment grade,
such as those rated Ba or lower by Moodys and BB or lower
by S&P or securities comparably rated by other rating
agencies or in unrated securities determined by Highland to be
of comparable quality. Securities rated Ba by Moodys are
judged to have speculative elements, their future cannot be
considered as well assured and often the protection of interest
and principal payments may be very moderate. Securities rated BB
by S&P are regarded as having predominantly speculative
characteristics and, while such obligations have less near-term
vulnerability to default than other speculative grade debt, they
face major ongoing uncertainties or exposure to adverse
business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal
payments. Securities rated C are regarded as having extremely
poor prospects of ever attaining any real investment standing.
Securities rated D are in default and the payment of interest
and/or repayment of principal is in arrears. The Acquiring Fund
may purchase |
B-6
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securities rated as low as D. When Highland believes it to be in
the best interests of a Funds shareholders, a Fund will
reduce its investment in lower grade securities. |
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Lower grade securities, though high yielding, are characterized
by high risk. They may be subject to certain risks with respect
to the issuing entity and to greater market fluctuations than
certain lower yielding, higher rated securities. The secondary
market for lower grade securities may be less liquid than that
of higher rated securities. Adverse conditions could make it
difficult at times for a Fund to sell certain securities or
could result in lower prices than those used in calculating the
Funds NAV. |
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The prices of debt securities generally are inversely related to
interest rate changes; however, the price volatility caused by
fluctuating interest rates of securities also is inversely
related to the coupon of such securities. Accordingly, lower
grade securities may be relatively less sensitive to interest
rate changes than higher quality securities of comparable
maturity, because of their higher coupon. This higher coupon is
what the investor receives in return for bearing greater credit
risk. The higher credit risk associated with lower grade
securities potentially can have a greater effect on the value of
such securities than may be the case with higher quality issues
of comparable maturity, and will be a substantial factor in a
Funds relative share price volatility. |
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Lower grade securities may be particularly susceptible to
economic downturns. It is likely that an economic recession
could disrupt severely the market for such securities and may
have an adverse impact on the value of such securities. In
addition, it is likely that any such economic downturn could
adversely affect the ability of the issuers of such securities
to repay principal and pay interest thereon and increase the
incidence of default for such securities. |
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The ratings of Moodys and S&P and the other rating
agencies represent their opinions as to the quality of the
obligations which they undertake to rate. Ratings are relative
and subjective and, although ratings may be useful in evaluating
the safety of interest and principal payments, they do not
evaluate the market value risk of such obligations. Although
these ratings may be an initial criterion for selection of
portfolio investments, Highland also will independently evaluate
these securities and the ability of the issuers of such
securities to pay interest and principal. To the extent that a
Fund invests in lower grade securities that have not been rated
by a rating agency, the Funds ability to achieve its
investment objectives will be more dependent on Highlands
credit analysis than would be the case when the Fund invests in
rated securities. |
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Asset-Backed Securities |
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Asset-backed securities are generally issued as pass-through
certificates, which represent undivided fractional ownership
interests in an underlying pool of assets, or as debt
instruments, which are also known as collateralized obligations,
and are generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and
issuing such debt. Asset-backed securities are often backed by a
pool of assets representing the obligations of a number of
different parties. Credit card receivables are generally
unsecured, and the debtors are entitled to the protection of a
number of state and federal consumer credit laws which give
debtors the right to set off certain amounts owed on the credit
cards, thereby |
B-7
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reducing the balance due. Most issuers of automobile receivables
permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to
another party, there is a risk that the purchaser would acquire
an interest superior to that of the holders of the related
automobile receivables. In addition, because of the large number
of vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of
the automobile receivables may not have an effective security
interest in all of the obligations backing such receivables.
Therefore, there is a possibility that recoveries on repossessed
collateral may not, in some cases, be able to support payments
on these securities. |
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Royalty Securities |
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Companies holding rights to intellectual property may create
bankruptcy remote special purpose entities whose underlying
assets are royalty license agreements and intellectual property
rights related to a product. The Funds expect to make royalty
investments related to pharmaceutical royalties that are secured
by rights related to one or more drugs. The Funds may also
invest in royalty securities related to other industries. |
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In a typical structure in the pharmaceutical industry, a small
pharmaceutical company has developed a molecule and licensed the
commercial opportunity to a large-cap pharmaceutical company in
exchange for payments upon completion of certain milestones (for
example, FDA approval) and a percentage royalty upon
commercialization of the product. After completion of the
milestone, the small pharmaceutical company sells a senior
secured financing against the royalty stream, which is
non-recourse to either of the pharmaceutical companies. |
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In addition, a company, the sponsor, may create a wholly owned
subsidiary, the issuer, that issues the royalty securities. The
sponsor sells, assigns and contributes to the issuer rights
under one or more license agreements, including the right to
receive royalties and certain other payments from sales of the
pharmaceutical or other products. The sponsor also pledges the
equity ownership interests in the issuer to the trustee under
the indenture related to the notes. In return, the sponsor
receives the proceeds of the securities from the issuer. The
issuer of the securities grants a security interest in its
assets to the trustee and is responsible for the debt service on
the notes. An interest reserve account may be established to
provide a source for payments should there be a cash flow
shortfall for one or more periods. Many structures include a
100% cash flow sweep, which means that the principal is paid
down by all cash flows received. Although the notes may have a
legal maturity date of up to five to sixteen years from
issuance, the expected weighted average maturity of the notes
may be significantly shorter because of expected required
principal repayments if funds are available. |
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Collateralized Loan Obligations and Bond Obligations |
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A Fund may invest in certain asset-backed securities that are
securitizing certain financial assets by issuing securities in
the form of negotiable paper that are issued by a financing
company (generally called a Special Purpose Vehicle or
SPV). These securitized assets are, as a rule,
corporate financial assets brought into a pool according to
specific diversification rules. The SPV is a company founded
solely for the purpose of securitizing these claims and its only
asset is the diversified asset pool. On this basis, marketable
securities are issued which, due to the diversification of the
underlying risk, generally represent a lower level of risk than
the original assets. The |
B-8
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redemption of the securities issued by the SPV takes place at
maturity out of the cash flow generated by the collected claims. |
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A collateralized loan obligation (CLO) is a
structured debt security issued by an SPV that was created to
reapportion the risk and return characteristics of a pool of
assets. The assets, typically senior loans, are used as
collateral supporting the various debt tranches issued by the
SPV. The key feature of the CLO structure is the prioritization
of the cash flows from a pool of debt securities among the
several classes of securities issued by a CLO. |
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A Fund may also invest in collateralized bond obligations
(CBOs), which are structured debt securities backed
by a diversified pool of high yield, public or private fixed
income securities. These may be fixed pools or may be
market value (or managed) pools of collateral. The
CBO issues debt securities that are typically separated into
tranches representing different degrees of credit quality. |
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The top tranche of securities has the greatest collateralization
and pays the lowest interest rate. Lower CBO tranches have a
lesser degree of collateralization quality and pay higher
interest rates intended to compensate for the attendant risks.
The bottom tranche specifically receives the residual interest
payments (i.e., money that is left over after the higher
tranches have been paid) rather than a fixed interest rate. The
return on the lower tranches of CBOs/CLOs is especially
sensitive to the rate of defaults in the collateral pool and
lower tranches of CBOs/CLOs typically present the highest risk
of loss of entire investment and are required to bear losses
before the higher tranches. Under normal market conditions, a
Fund expects to invest in the lower tranches of CBOs/CLOs. |
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Distressed Debt |
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A Fund may invest in the securities and other obligations of
distressed and bankrupt issuers, including debt obligations that
are in covenant or payment default. Such investments generally
trade significantly below par and are considered speculative.
The repayment of defaulted obligations is subject to significant
uncertainties. Defaulted obligations might be repaid only after
lengthy workout or bankruptcy proceedings, during which the
issuer might not make any interest or other payments. Typically
such workout or bankruptcy proceedings result in only partial
recovery of cash payments or an exchange of the defaulted
obligation for other debt or equity securities of the issuer or
its affiliates, which may in turn be illiquid or speculative. A
Fund may invest in securities of a company for purposes of
gaining control. |
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Stressed Debt |
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A Fund may invest in securities and other obligations of
stressed issuers. Stressed issuers are issuers that are not yet
deemed distressed or bankrupt and whose debt securities are
trading at a discount to par, but not yet at distressed levels.
An example would be an issuer that is in technical default of
its credit agreement, or undergoing strategic or operational
changes, which results in market pricing uncertainty. |
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Mezzanine Debt |
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Structurally, mezzanine loans usually rank subordinate in
priority of payment to senior debt, such as senior bank debt,
and are often unsecured. However, mezzanine loans rank senior to
common and preferred equity in a borrowers capital
structure. Mezzanine debt is often used in leveraged buyout and
real estate finance transactions. Typically, mezzanine loans
have elements of both debt and equity instruments, offering the
fixed returns in the form of interest payments associated with
senior debt, while providing lenders an opportunity to
participate in the capital appreciation of a borrower, if |
B-9
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any, through an equity interest. This equity interest typically
takes the form of warrants. Due to their higher risk profile and
often less restrictive covenants as compared to senior loans,
mezzanine loans generally earn a higher return than senior
secured loans. The warrants associated with mezzanine loans are
typically detachable, which allows lenders to receive repayment
of their principal on an agreed amortization schedule while
retaining their equity interest in the borrower. |
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Mezzanine loans also may include a put feature,
which permits the holder to sell its equity interest back to the
borrower at a price determined through an
agreed-upon
formula. The Company believes that mezzanine loans offer an
alternative investment opportunity based upon their historical
returns and resilience during economic downturns. |
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High-Yield Bonds |
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High-yield bonds are income securities that are typically lower
grade securities of distressed issuers. Such bonds may have
fixed or variable principal payments and all types of interest
rate and dividend payment and reset terms, including fixed rate,
adjustable rate, zero coupon, contingent, deferred, payment in
kind and auction rate features as well as a broad range of
maturities. |
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Lower grade securities, though high-yielding, are characterized
by high risk. They may be subject to certain risks with respect
to the issuing entity and to greater market fluctuations than
certain lower yielding, higher rated securities. The retail
secondary market for lower grade securities may be less liquid
than that of higher rated securities. Adverse conditions could
make it difficult at times for a Fund to sell certain securities
or could result in lower prices than those used in calculating a
Funds net asset value. |
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The prices of debt securities generally are inversely related to
interest rate changes; however, the price volatility caused by
fluctuating interest rates of securities also is inversely
related to the coupon of such securities. Accordingly, below
investment grade securities may be relatively less sensitive to
interest rate changes than higher quality securities of
comparable maturity, because of their higher coupon. This higher
coupon is what the investor receives in return for bearing
greater credit risk. The higher credit risk associated with
below investment grade securities potentially can have a greater
effect on the value of such securities than may be the case with
higher quality issues of comparable maturity, and will be a
substantial factor in a Funds relative Share price
volatility. Distressed debt securities often are priced based on
estimated recovery value and are less sensitive to interest rate
movement. |
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Lower grade securities may be particularly susceptible to
economic downturns. It is likely that an economic recession
could severely disrupt the market for such securities and may
have an adverse impact on the value of such securities. In
addition, it is likely that any such economic downturn could
adversely affect the ability of the issuers of such securities
to repay principal and pay interest thereon and increase the
incidence of default for such securities. |
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The ratings of Moodys, S&P and any other rating
agencies represent their opinions as to the quality of the
obligations which they undertake to rate. Ratings are relative
and subjective and, although ratings may be useful in evaluating
the safety of interest and principal payments, they do not
evaluate the market value risk of such obligations. |
B-10
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Common Stocks |
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Common stocks are shares of a corporation or other entity that
entitle the holder to a pro rata share of the profits, if any,
of the corporation without preference over any other shareholder
or class of shareholders, including holders of such
entitys preferred stock and other senior equity
securities. Common stock usually carries with it the right to
vote and frequently an exclusive right to do so. In selecting
common stocks for investment, a Fund generally expects to focus
primarily on the securitys dividend paying capacity rather
than on its potential for capital appreciation. A Fund may
acquire an interest in common stocks in various ways, including
upon the default of a senior loan secured by such common stock
or by acquiring common stock for investment. A Fund may also
acquire warrants or other rights to purchase a borrowers
common stock in connection with the making of a senior loan. |
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Preferred Securities |
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Preferred securities are equity securities, but they have many
characteristics of fixed income securities, such as a fixed
dividend payment rate and/or a liquidity preference over the
issuers common shares. However, because preferred
securities are equity securities, they may be more susceptible
to risks traditionally associated with equity investments than a
Funds fixed income securities. |
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The market value of preferred securities may be affected by
favorable and unfavorable changes impacting companies in the
utilities and financial services sectors, which are prominent
issuers of preferred securities, and by actual and anticipated
changes in tax laws, such as changes in U.S. federal corporate
income tax rates or the dividends-received deduction. Because
the claim on an issuers earnings represented by
traditional preferred securities may become onerous when
interest rates fall below the rate payable on such securities,
the issuer may redeem the securities. Thus, in declining
interest rate environments in particular, a Funds holdings
of higher rate-paying fixed rate preferred securities may be
reduced and a Fund would be unable to acquire securities of
comparable credit quality paying comparable rates with the
redemption proceeds. |
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Fixed rate preferred stocks have fixed dividend rates. They can
be perpetual, with no mandatory redemption date, or issued with
a fixed mandatory redemption date. Certain issues of preferred
stock are convertible into other equity securities. Perpetual
preferred stocks provide a fixed dividend throughout the life of
the issue, with no mandatory retirement provisions, but may be
callable. Sinking fund preferred stocks provide for the
redemption of a portion of the issue on a regularly scheduled
basis with, in most cases, the entire issue being retired at a
future date. The value of fixed rate preferred stocks can be
expected to vary inversely with interest rates. |
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Adjustable rate preferred stocks have a variable dividend rate
which is determined periodically, typically quarterly, according
to a formula based on a specified premium or discount to the
yield on particular U.S. Treasury securities, typically the
highest base-rate yield of one of three U.S. Treasury
securities: the
90-day
Treasury bill; the
10-year
Treasury note; and either the
20-year or
30-year
Treasury bond or other index. The premium or discount to be
added to or subtracted from this base-rate yield is fixed at the
time of issuance and cannot be changed without the approval of
the holders of the adjustable rate preferred stock. Some
adjustable rate preferred stocks have a maximum and a minimum
rate and in some cases are convertible into common stock. |
B-11
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Auction rate preferred stocks pay dividends that adjust based on
periodic auctions. Such preferred stocks are similar to
short-term corporate money market instruments in that an auction
rate preferred stockholder has the opportunity to sell the
preferred stock at par in an auction, normally conducted at
least every 49 days, through which buyers set the dividend
rate in a bidding process for the next period. The dividend rate
set in the auction depends on market conditions and the credit
quality of the particular issuer. Typically, the auction rate
preferred stocks dividend rate is limited to a specified
maximum percentage of an external commercial paper index as of
the auction date. Further, the terms of the auction rate
preferred stocks generally provide that they are redeemable by
the issuer at certain times or under certain conditions. |
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Convertible Securities |
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A convertible security is a bond, debenture, note, preferred
stock or other security that may be converted into or exchanged
for a prescribed amount of common stock or other equity security
of the same or a different issuer within a particular period of
time at a specified price or formula. A convertible security
entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible
security matures or is redeemed, converted or exchanged. Before
conversion, convertible securities have characteristics similar
to nonconvertible income securities in that they ordinarily
provide a stable stream of income with generally higher yields
than those of common stocks of the same or similar issuers, but
lower yields than comparable nonconvertible securities. |
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The value of a convertible security is influenced by changes in
interest rates, with investment value declining as interest
rates increase and increasing as interest rates decline. The
credit standing of the issuer and other factors also may have an
effect on the convertible securitys investment value.
Convertible securities rank senior to common stock in a
corporations capital structure but are usually
subordinated to comparable nonconvertible securities.
Convertible securities may be subject to redemption at the
option of the issuer at a price established in the convertible
securitys governing instrument. |
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Money Market Instruments |
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Money market instruments include short-term U.S. government
securities, U.S. dollar-denominated, high quality commercial
paper (unsecured promissory notes issued by corporations to
finance their short-term credit needs), certificates of deposit,
bankers acceptances and repurchase agreements relating to
any of the foregoing. U.S. government securities include
Treasury notes, bonds and bills, which are direct obligations of
the U.S. government backed by the full faith and credit of the
United States and securities issued by agencies and
instrumentalities of the U.S. government, which may be
guaranteed by the U.S. Treasury, may be supported by the
issuers right to borrow from the U.S. Treasury or may be
backed only by the credit of the federal agency or
instrumentality itself. |
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U.S. Government Securities |
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U.S. government securities may include debt obligations of
varying maturities issued by the U.S. Treasury or issued or
guaranteed by an agency or instrumentality of the U.S.
government, including the Federal Housing Administration,
Federal Financing Bank, Farmers Home Administration,
Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association (GNMA),
General Services Administration, Central Bank for Cooperatives,
Federal Farm Credit Banks, Federal Home Loan Banks, Federal Home
Loan Mortgage Corporation |
B-12
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(FHLMC), Federal National Mortgage Association (FNMA), Maritime
Administration, Tennessee Valley Authority, District of Columbia
Armory Board, Student Loan Marketing Association, Resolution
Trust Corporation and various institutions that previously
were or currently are part of the Farm Credit System (which has
been undergoing reorganization since 1987). Some U.S. government
securities, such as U.S. Treasury bills, Treasury notes and
Treasury bonds, which differ only in their interest rates,
maturities and times of issuance, are supported by the full
faith and credit of the United States government. Others are
supported by (i) the right of the issuer to borrow from the
U.S. Treasury, such as securities of the Federal Home Loan
Banks; (ii) the discretionary authority of the U.S.
government to purchase the agencys obligations, such as
securities of the FNMA; or (iii) only the credit of the
issuer. No assurance can be given that the U.S. government will
provide financial support in the future to U.S. government
agencies, authorities or instrumentalities that are not
supported by the full faith and credit of the United States.
Securities guaranteed as to principal and interest by the U.S.
government, its agencies, authorities or instrumentalities
include (i) securities for which the payment of principal
and interest is backed by an irrevocable letter of credit issued
by the U.S. government or any of its agencies, authorities or
instrumentalities; and (ii) participations in loans made to
non-U.S.
governments or other entities that are so guaranteed. The
secondary market for certain of these participations is limited
and therefore may be regarded as illiquid. |
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FNMA and FHLMC hold or guarantee approximately $5 trillion worth
of mortgages. The value of the companies securities fell
sharply in 2008 due to concerns that the firms did not have
sufficient capital to offset losses resulting from the mortgage
crisis. In mid-2008, the U.S. Treasury Department was authorized
to increase the size of home loans in certain residential areas
FNMA and FHLMC could buy, and until 2009, to lend FNMA and FHLMC
emergency funds and to purchase the entities stock. More
recently, in September 2008, the U.S. Treasury Department
announced that the government would be taking over FNMA and
FHLMC and placing the companies into a conservatorship. The
effect that this conservatorship will have on the
companies debt and equity securities is unclear. |
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Other Investment Companies |
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A Fund may invest in the securities of other investment
companies to the extent that such investments are consistent
with the Funds investment objectives and principal
investment strategies and permissible under the 1940 Act. Under
one provision of the 1940 Act, a Fund may not acquire the
securities of other investment companies if, as a result,
(i) more than 10% of the Funds total assets would be
invested in securities of other investment companies,
(ii) such purchase would result in more than 3% of the
total outstanding voting securities of any one investment
company being held by the Fund or (iii) more than 5% of the
Funds total assets would be invested in any one investment
company. Other provisions of the 1940 Act are less restrictive
provided that a Fund is able to meet certain conditions. These
limitations do not apply to the acquisition of shares of any
investment company in connection with a merger, consolidation,
reorganization or acquisition of substantially all of the assets
of another investment company. |
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A Fund, as a holder of the securities of other investment
companies, will bear its pro rata portion of the other
investment companies expenses, |
B-13
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including advisory fees. These expenses will be in addition to
the direct expenses incurred by a Fund. |
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Exchange Traded Funds |
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Subject to the limitations on investment in other investment
companies, a Fund may invest in exchange traded funds
(ETFs). ETFs, such as SPDRs, NASDAQ 100 Index
Trading Stock (QQQs), iShares and various country index funds,
are funds whose shares are traded on a national exchange or the
National Association of Securities Dealers Automatic
Quotation System (NASDAQ). ETFs may be based on underlying
equity or fixed income securities. SPDRs, for example, seek to
provide investment results that generally correspond to the
performance of the component common stocks of the S&P 500.
ETFs do not sell individual shares directly to investors and
only issue their shares in large blocks known as creation
units. The investor purchasing a creation unit may sell
the individual shares on a secondary market. Therefore, the
liquidity of ETFs depends on the adequacy of the secondary
market. There can be no assurance that an ETFs investment
objective will be achieved. ETFs based on an index may not
replicate and maintain exactly the composition and relative
weightings of securities in the index. ETFs are subject to the
risks of investing in the underlying securities. A Fund, as a
holder of the securities of the ETF, will bear its pro rata
portion of the ETFs expenses, including advisory fees.
These expenses are in addition to the direct expenses of the
Funds own operations. |
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Structured Investments |
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The Acquiring Fund may invest a portion of its assets in
interests in entities organized and operated solely for the
purpose of restructuring the investment characteristics of
securities. This type of restructuring involves the deposit with
or purchase by an entity, such as a corporation or a trust, of
specified instruments and the issuance by that entity of one or
more classes of securities (Structured Investments)
backed by, or representing interests in the underlying
instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Investments to
create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate
provisions, and the extent of the payments made with respect to
Structured Investments is dependent on the extent of the cash
flow on the underlying instruments. Because Structured
Investments of the type in which the Acquiring Fund anticipates
it will invest typically involve no credit enhancement, their
credit risk generally will be equivalent to that of the
underlying instruments. |
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The Acquiring Fund is permitted to invest in a class of
Structured Investments that is either subordinated or not
subordinated to the right of payment of another class.
Subordinated Structured Investments typically have higher yields
and present greater risks than unsubordinated Structured
Investments. |
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Certain issuers of Structured Investments may be deemed to be
investment companies as defined in the Investment
Company Act. As a result, the Acquiring Funds investment
in these Structured Investments may be limited by the
restrictions contained in the Investment Company Act. Structured
Investments are typically sold in private placement
transactions, and there currently is no active trading market
for Structured Investments. |
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Zero Coupon Securities |
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Zero coupon securities are debt obligations that are issued or
purchased at a significant discount from face value. The
discount approximates the total amount of interest the security
will accrue and compound over the period until maturity or the
particular interest payment date at a rate of interest |
B-14
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reflecting the market rate of the security at the time of
issuance. Zero coupon securities do not require the periodic
payment of interest. These investments benefit the issuer by
mitigating its need for cash to meet debt service, but generally
require a higher rate of return to attract investors who are
willing to defer receipt of cash. These investments may
experience greater volatility in market value than securities
that make regular payments of interest. A Fund accrues income on
these investments for tax and accounting purposes, which is
distributable to shareholders and which, because no cash is
received at the time of accrual, may require the liquidation of
other portfolio securities to satisfy the Funds
distribution obligations, in which case the Fund will forego the
purchase of additional income producing assets with these funds. |
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Deferred Payment Obligations |
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Deferred payment securities are securities that remain zero
coupon securities until a predetermined date, at which time the
stated coupon rate becomes effective and interest becomes
payable at regular intervals. Deferred payment securities are
subject to greater fluctuations in value and may have lesser
liquidity in the event of adverse market conditions than
comparably rated securities paying cash interest at regular
interest payment periods. |
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Derivative Transactions |
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A Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on
securities, financial futures, equity, fixed-income and interest
rate indices, and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors
or collars and enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency
swaps or options on currency or currency futures or credit
transactions and credit default swaps. A Fund also may purchase
derivative instruments that combine features of these
instruments. A Fund may use Derivative Transactions as a
portfolio management or hedging technique to seek to protect
against possible adverse changes in the market value of senior
loans or other securities held in or to be purchased for the
Funds portfolio, protect the value of the Funds
portfolio, facilitate the sale of certain securities for
investment purposes, manage the effective interest rate exposure
of the Fund, protect against changes in currency exchange rates,
manage the effective maturity or duration of the Funds
portfolio, or establish positions in the derivatives markets as
a temporary substitute for purchasing or selling particular
securities. |
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Derivative Transactions have risks, including the imperfect
correlation between the value of such instruments and the
underlying assets, the possible default of the other party to
the transaction or illiquidity of the derivative instruments.
Furthermore, the ability to use successfully Derivative
Transactions depends on the Advisers ability to predict
pertinent market movements, which cannot be assured. Thus, the
use of Derivative Transactions may result in losses greater than
if they had not been used, may require a Fund to sell or
purchase portfolio securities at inopportune times or for prices
other than current market values, may limit the amount of
appreciation a Fund can realize on an investment, or may cause a
Fund to hold a security that it might otherwise sell. The use of
currency transactions can result in a Fund incurring losses as a
result of the imposition of exchange controls, suspension of
settlements or the inability of a Fund to |
B-15
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deliver or receive a specified currency. Additionally, amounts
paid by a Fund as premiums and cash or other assets held in
margin accounts with respect to Derivative Transactions are not
otherwise available to the Fund for investment purposes. |
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Senior Loan Based Derivatives |
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A Fund may obtain exposure to senior loans and baskets of senior
loans through the use of derivative instruments. For example, a
Fund may invest in a derivative instrument known as the
Loan-Only Credit Default Swap Index (LCDX), a
tradeable index with 100 equally-weighted underlying single-name
long-only credit default swaps (LCDS). Each
underlying LCDS references an issuer whose loans trade in the
secondary leveraged loan market. A Fund can either buy the Index
(take on credit exposure) or sell the Index (pass credit
exposure to a counterparty). In either case, the Fund is in
essence taking a macro view of the market as a whole rather than
on a particular issuer. To compensate investors for the change
in the value of the Index over time, an upfront payment is made
at the time of a trade to account for the change in the present
value of the Index since inception. The payment is the
difference between par (or 100) and the amount of the
purchase price, plus or minus (depending on whether the Fund is
a buyer or seller of the Index) accrued interest. Each version
of the Index launches with a fixed coupon which the seller of
the Index pays quarterly (and the buyer of the Index receives
quarterly). The amount of payments received or paid is the
coupon times the notional amount. Investments in the Index may
involve greater risks than if the Fund had invested in the
reference obligation directly. A Fund will not engage in these
transactions for speculative purposes and will use them only as
a means to hedge or manage the risks associated with assets held
in, or anticipated to be purchased for, the investment portfolio
or obligations incurred by the Fund. |
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Investment in the LCDX Index involves many of the risks
associated with investments in derivative instruments discussed
generally above, including counterparty risk, the risk of loss
due to unanticipated adverse changes in securities prices and
interest rates, the inability to close out a position, imperfect
correlation between a position and the desired hedge,
uncertainty regarding the tax rules applicable to these
transactions, and portfolio management constraints on securities
subject to such transactions. The potential loss on these
instruments may be substantially greater than the initial
investment therein. |
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Credit Default Swaps |
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To the extent consistent with Subchapter M of the Internal
Revenue Code of 1986, as amended (the Code), a Fund
may enter into credit default swap agreements. 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 par
value (full notional value) of the reference obligation in
exchange for the reference obligation. A Fund may be either the
buyer or seller in the transaction. If a Fund is a buyer and no
event of default occurs, the Fund loses its investment and
recovers nothing. However, if an event of default occurs, the
buyer receives full notional value for a reference obligation
that may have little or no value. As a seller, a Fund receives
income throughout the term of the contract, which typically is
between six months and three years, provided that there is no
default event. |
B-16
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Swaps |
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Swap contracts may be purchased or sold to obtain investment
exposure and/or to hedge against fluctuations in securities
prices, currencies, interest rates or market conditions, to
change the duration of the overall portfolio or to mitigate
default risk. In a standard swap transaction, two
parties agree to exchange the returns (or differentials in rates
of return) on different currencies, securities, baskets of
currencies or securities, indices or other instruments, which
returns are calculated with respect to a notional
value, i.e., the designated reference amount of exposure
to the underlying instruments. A Fund intends to enter into
swaps primarily on a net basis, i.e., the two payment streams
are netted out, with the Fund receiving or paying, as the case
may be, only the net amount of the two payments. If the other
party to a swap contract defaults, the Funds risk of loss
will consist of the net amount of payments that the Fund is
contractually entitled to receive. The net amount of the excess,
if any, of the Funds obligations over its entitlements
will be maintained in a segregated account by the Funds
custodian. A Fund will not enter into a swap agreement unless
the claims-paying ability of the other party thereto is
considered to be investment grade by the Adviser. If there is a
default by the other party to such a transaction, the Fund will
have contractual remedies pursuant to the agreements related to
the transaction. Swap instruments are not exchange-listed
securities and may be traded only in the over-the-counter market. |
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Interest Rate Swaps |
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Interest rate swaps involve the exchange by a 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 Acquiring Fund may use interest rate swaps for
risk management purposes and as a speculative investment. |
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Total Return Swaps |
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Total return swaps are contracts in which one party agrees to
make payments of the total return from the designated underlying
asset(s), which may include securities, baskets of securities,
or securities indices, during the specified period, in return
for receiving payments equal to a fixed or floating rate of
interest or the total return from the other designated
underlying asset(s). The Acquiring Fund may use total return
swaps for risk management purposes and as a speculative
investment. |
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Currency Swaps |
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Currency swaps involve the exchange of the two parties
respective commitments to pay or receive fluctuations with
respect to a notional amount of two different currencies (e.g.,
an exchange of payments with respect to fluctuations in the
value of the U.S. dollar relative to the Japanese yen). The
Acquiring Fund may enter into currency swap contracts and
baskets thereof for risk management purposes and as a
speculative investment. |
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Credit-Linked Notes |
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A credit-linked note (CLNs) is a derivative
instrument. It is a synthetic obligation between two or more
parties where the payment of principal and/or interest is based
on the performance of some obligation (a reference obligation).
In addition to credit risk of the reference obligations and
interest rate risk, the buyer/seller of the CLN is subject to
counterparty risk. |
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Options |
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An option on a security is a contract that gives the holder of
the option, in return for a premium, the right to buy from (in
the case of a call) or sell to (in the case of a put) the writer
of the option the security underlying the option at a specified
exercise or strike price. The writer of an option on
a security has the obligation upon exercise of the option to
deliver the underlying security upon payment of the exercise
price or to pay the exercise |
B-17
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price upon delivery of the underlying security. Certain options,
known as American style options may be exercised at
any time during the term of the option. Other options, known as
European style options, may be exercised only on the
expiration date of the option. |
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If an option written by a Fund expires unexercised, the Fund
realizes on the expiration date a capital gain equal to the
premium received by the Fund at the time the option was written.
If an option purchased by a Fund expires unexercised, the Fund
realizes a capital loss equal to the premium paid. Prior to the
earlier of exercise or expiration, an exchange-traded option may
be closed out by an offsetting purchase or sale of an option of
the same series (type, underlying security, exercise price and
expiration). There can be no assurance, however, that a closing
purchase or sale transaction can be effected when a Fund
desires. A Fund may sell put or call options it has previously
purchased, which could result in a net gain or loss depending on
whether the amount realized on the sale is more or less than the
premium and other transaction costs paid on the put or call
option when purchased. A Fund will realize a capital gain from a
closing purchase transaction if the cost of the closing option
is less than the premium received from writing the option, or,
if it is more, the Fund will realize a capital loss. If the
premium received from a closing sale transaction is more than
the premium paid to purchase the option, a Fund will realize a
capital gain or, if it is less, the Fund will realize a capital
loss. |
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Futures Contracts and Options on Futures Contracts |
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The sale of a futures contract creates an obligation by a Fund,
as seller, to deliver the specific type of financial instrument
called for in the contract at a specified future time for a
specified price. Options on futures contracts are similar to
options on securities except that an option on a futures
contract gives the purchaser the right in return for the premium
paid to assume a position in a futures contract (a long position
if the option is a call and a short position if the option is a
put). |
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At the time a futures contract is purchased or sold, a Fund must
allocate cash or securities as a deposit payment (initial
margin). It is expected that the initial margin that a
Fund will pay may range from approximately 1% to approximately
5% of the value of the securities or commodities underlying the
contract. In certain circumstances, however, such as periods of
high volatility, a Fund may be required by an exchange to
increase the level of its initial margin payment. Additionally,
initial margin requirements may be increased generally in the
future by regulatory action. An outstanding futures contract is
valued daily and the payment in case of variation
margin may be required, a process known as marking
to the market. Transactions in listed options and futures
are usually settled by entering into an offsetting transaction,
and are subject to the risk that the position may not be able to
be closed if no offsetting transaction can be arranged. |
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Forward Foreign Currency Contracts |
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A Fund may enter into forward currency contracts to purchase or
sell foreign currencies for a fixed amount of U.S. dollars or
another foreign currency. A forward currency contract involves
an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date
of the forward currency contract agreed upon by the parties, at
a price set at the time the forward currency contract is entered
into. Forward currency contracts are traded directly between
currency traders (usually large commercial banks) and their
customers. |
B-18
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Short Sales |
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The Acquiring Fund may attempt to limit exposure to a possible
market decline in the value of its portfolio securities through
short sales of securities that Highland believes possess
volatility characteristics similar to those being hedged. In
addition, the Acquiring Fund intends to use short sales for
non-hedging purposes to pursue its investment objectives. |
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A short sale is a transaction in which a Fund sells a security
it does not own in anticipation that the market price of that
security will decline. When a Fund makes a short sale, it must
borrow the security sold short from a broker-dealer and deliver
it to the buyer upon conclusion of the sale. A Fund may have to
pay a fee to borrow particular securities and is often obligated
to pay over any payments received on such borrowed securities. |
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A Funds obligation to replace the borrowed security will
be secured by collateral deposited with the broker-dealer,
usually cash, U.S. government securities or other liquid
securities. A Fund will also be required to designate on its
books and records similar collateral with its custodian to the
extent, if any, necessary so that the aggregate collateral value
is at all times at least equal to the current market value of
the security sold short. Depending on arrangements made with the
broker-dealer from which it borrowed the security regarding
payment over of any payments received by a Fund on such
security, the Fund may not receive any payments (including
interest) on its collateral deposited with such broker-dealer. |
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If the price of the security sold short increases between the
time of the short sale and the time a Fund replaces the borrowed
security, the Fund will incur a loss; conversely, if the price
declines, the Fund will realize a gain. Any gain will be
decreased, and any loss increased, by the transaction costs
described above. Although a Funds gain is limited to the
price at which it sold the security short, its potential loss is
unlimited. |
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A Fund may also sell a security short if it owns at least an
equal amount of the security sold short or another security
convertible or exchangeable for an equal amount of the security
sold short without payment of further compensation (a short sale
against-the-box). In a short sale against-the-box, the short
seller is exposed to the risk of being forced to deliver stock
that it holds to close the position if the borrowed stock is
called in by the lender, which would cause gain or loss to be
recognized on the delivered stock. |
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|
Purchasing securities to close out the short position can itself
cause the price of the securities to rise further, thereby
exacerbating the loss. Short-selling exposes a Fund to unlimited
risk with respect to that security due to the lack of an upper
limit on the price to which an instrument can rise. |
|
Capital Structure Arbitrage |
|
Capital structure arbitrage typically involves establishing long
and short positions in securities (or their derivatives) at
different tiers within an issuers capital structure in
ratios designed to maintain a generally neutral overall exposure
to the issuer while exploiting a pricing inefficiency. Some
issuers may also have more than one class of shares or an
equivalent vehicle that trades in a different market (e.g.,
European equities and their American Depositary Receipt
counterparts). This strategy seeks to profit from the disparity
in prices between the various related securities in anticipation
that over time all tiers and classes will become more
efficiently priced relative to one another. |
B-19
|
|
|
Pair Trades |
|
Pair trades involve the establishment of a long position in one
security and a short position in another security at the same
time. A pair trade attempts to minimize the effect of larger
market trends and emphasizes the performance of one security
relative to another. |
|
Repurchase Agreements |
|
Repurchase agreements are loans or arrangements under which a
Fund purchases securities and the seller agrees to repurchase
the securities within a specific time and at a specific price.
The Acquiring Fund may enter into repurchase agreements up to a
maximum
331/3%
of its total assets. The repurchase price is generally higher
than the Funds purchase price, with the difference being
income to the Fund. Under the direction of the Board, the
Adviser reviews and monitors the creditworthiness of any
institution which enters into a repurchase agreement with a
Fund. The counterpartys obligations under the repurchase
agreement are collateralized with U.S. Treasury and/or agency
obligations with a market value of not less than 100% of the
obligations, valued daily. Collateral is held by a Funds
custodian in a segregated, safekeeping account for the benefit
of the Fund. Repurchase agreements afford a Fund an opportunity
to earn income on temporarily available cash at low risk. In the
event of commencement of bankruptcy or insolvency proceedings
with respect to the seller of the security before repurchase of
the security under a repurchase agreement, a Fund may encounter
delay and incur costs before being able to sell the security.
Such a delay may involve loss of interest or a decline in price
of the security. If the court characterizes the transaction as a
loan and a Fund has not perfected a security interest in the
security, the Fund may be required to return the security to the
sellers estate and be treated as an unsecured creditor of
the seller. As an unsecured creditor, a Fund would be at risk of
losing some or all of the principal and interest involved in the
transaction. |
|
Reverse Repurchase Agreements |
|
A reverse repurchase agreement is an instrument under which a
Fund sells an underlying debt security and simultaneously
obtains the commitment of the purchaser (generally, a commercial
bank or a broker or dealer) to sell the security back to the
Fund at an agreed upon price on an agreed upon date. Reverse
repurchase agreements could involve certain risks in the event
of default or insolvency of the other party, including possible
delays or restrictions upon a Funds ability to dispose of
the underlying securities. An additional risk is that the market
value of securities sold by a Fund under a reverse repurchase
agreement could decline below the price at which the Fund is
obligated to repurchase them. Reverse repurchase agreements will
be considered borrowings by a Fund and as such would be subject
to any restrictions on borrowing. |
|
|
|
Reverse repurchase agreements are also generally subject to
earmarking and coverage requirements, with the result that, the
Fund will designate on its books and records on an ongoing
basis, cash, U.S. government securities, or other liquid high
grade debt obligations in an amount at least equal to the
Funds obligations under the reverse repurchase agreement. |
|
Pay-in-kind
Bonds |
|
Pay-in-kind,
or PIK bonds, are bonds which pay interest through
the issuance of additional debt or equity securities. Similar to
zero coupon obligations, PIK bonds also carry additional risk as
holders of these types of securities realize no cash until the
cash payment date unless a portion of such securities is sold
and, if the issuer defaults, a Fund may obtain no return at all
on its investment. The market price of PIK bonds is affected by
interest rate changes to a greater extent, and therefore tends
to be more |
B-20
|
|
|
|
|
volatile, than that of securities which pay interest in cash.
Additionally, current federal tax law requires the holder of
certain PIK bonds to accrue income with respect to these
securities prior to the receipt of cash payments. To maintain
its qualification as a regulated investment company and avoid
liability for federal income and excise taxes, a Fund may be
required to distribute income accrued with respect to these
securities and may have to dispose of portfolio securities under
disadvantageous circumstances in order to generate cash to
satisfy these distribution requirements. |
|
When-Issued, Delayed-Delivery and Forward Commitment
Purchases |
|
A Fund may purchase securities on a when-issued
basis and may purchase or sell securities on a forward
commitment basis in order to acquire the security or to
offset against anticipated changes in interest rates and prices.
When such transactions are negotiated, the price, which is
generally expressed in yield terms, is fixed at the time the
commitment is made, but delivery and payment for the securities
take place at a later date. When-issued securities and forward
commitments may be sold prior to the settlement date, but a Fund
will enter into when-issued and forward commitments only with
the intention of actually receiving or delivering the
securities, as the case may be. If a Fund disposes of the right
to acquire a when-issued security prior to its acquisition or
disposes of its right to deliver or receive against a forward
commitment, it might incur a gain or loss. At the time a Fund
enters into a transaction on a when-issued or forward commitment
basis, it will designate on its books and records cash or liquid
debt securities equal to at least the value of the when-issued
or forward commitment securities. The value of these assets will
be monitored daily to ensure that their marked to market value
will at all times equal or exceed the corresponding obligations
of a Fund. There is always a risk that the securities may not be
delivered and that a Fund may incur a loss. Settlements in the
ordinary course, which may take substantially more than five
business days, are not treated by a Fund as when-issued or
forward commitment transactions and accordingly are not subject
to the foregoing restrictions. |
|
Securities Lending |
|
A Fund may lend its portfolio securities in an amount up to a
maximum of
331/3%
of its total assets to registered broker-dealers or other
institutional investors deemed by the Adviser to be of good
standing under agreements which require that the loans be
secured continuously by collateral in cash, cash equivalents or
U.S. Treasury bills maintained on a current basis at an amount
at least equal to the market value of the securities loaned. A
Fund continues to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned as well as
the benefit of an increase and the detriment of any decrease in
the market value of the securities loaned and would also receive
compensation based on investment of the collateral. A Fund would
not, however, have the right to vote any securities having
voting rights during the existence of the loan, but would call
the loan in anticipation of an important vote to be taken among
holders of the securities or of the giving or withholding of
consent on a material matter affecting the investment. |
|
|
|
As with other extensions of credit, there are risks of delay in
recovery or even loss of rights in the collateral should the
borrower of the securities fail financially. In addition, any
income or gains and losses from investing and reinvesting any
cash collateral delivered by a borrower pursuant to a loan are
generally at a Funds risk, and to the extent any such
losses reduce the amount of cash below the amount required to be
returned to the borrower |
B-21
|
|
|
|
|
upon the termination of any loan, a Fund may be required to pay
or cause to be paid to such borrower or another entity an amount
equal to such shortfall in cash. A Fund will lend portfolio
securities only to firms that are judged by the Investment
Adviser to present acceptable credit risk. |
|
Non-U.S.
Securities |
|
A Fund may invest up to 20% of its total assets in
non-U.S.
securities, including emerging market securities.
Non-U.S.
securities may include securities denominated in U.S. dollars or
in non-U.S.
currencies or multinational currency units. For purposes of the
Acquiring Fund, a company is deemed to be a
non-U.S.
company if it meets the following tests: (i) such company
was not organized in the United States; (ii) such
companys primary business office is not in the United
States; (iii) the principal trading market for such
companys securities is not located in the United States;
(iv) less than 50% of such companys assets are
located in the United States; or (v) 50% or more of such
issuers revenues are derived from outside the United
States.
Non-U.S.
securities markets generally are not as developed or efficient
as those in the United States. Securities of some
non-U.S.
issuers are less liquid and more volatile than securities of
comparable U.S. issuers. Similarly, volume and liquidity in most
non-U.S.
securities markets are less than in the United States and, at
times, volatility of price can be greater than in the United
States. |
|
|
|
Because evidences of ownership of such securities usually are
held outside the United States, A Fund would be subject to
additional risks if it invested in
non-U.S.
securities, which include possible adverse political and
economic developments, seizure or nationalization of foreign
deposits and adoption of governmental restrictions which might
adversely affect or restrict the payment of principal and
interest on the
non-U.S.
securities to investors located outside the country of the
issuer, whether from currency blockage or otherwise. |
|
|
|
Since
non-U.S.
securities may be purchased with and payable in foreign
currencies, the value of these assets as measured in U.S.
dollars may be affected favorably or unfavorably by changes in
currency rates and exchange control regulations. |
|
Temporary Defensive Position |
|
During periods in which Highland determines that it is
temporarily unable to follow a Funds investment strategy
or that it is impractical to do so or pending re-investment of
proceeds received in connection with the sale of a security, the
Fund may deviate from its investment strategy and invest all or
any portion of its assets in cash or cash equivalents.
Highlands determination that it is temporarily unable to
follow a Funds investment strategy or that it is
impractical to do so will generally occur only in situations in
which a market disruption event has occurred and where trading
in the securities selected through application of the
Funds investment strategy is extremely limited or absent.
In such a case, shares of a Fund may be adversely affected and
the Fund may not pursue or achieve its investment objectives. |
B-22
APPENDIX C
OWNERSHIP
OF SHARES OF THE FUNDS
Set forth in the table below is the dollar range of shares
beneficially owned by each Director/Trustee in each Fund.
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregate Dollar
|
|
|
|
|
|
|
Range of Equity
|
|
|
|
|
|
|
Securities in All
|
|
|
|
|
|
|
Registered
|
|
|
|
|
|
|
Investment
|
|
|
|
|
|
|
Companies
|
|
|
|
|
|
|
Overseen by
|
|
|
|
|
|
|
Board Member in
|
|
|
Dollar Range of
|
|
Dollar Range of
|
|
Highland Family
|
|
|
Shares of the
|
|
Shares of the
|
|
of Investment
|
Name of Board Member
|
|
Acquired Fund*
|
|
Acquiring Fund*
|
|
Companies*
|
|
INTERESTED DIRECTOR/TRUSTEE
|
|
|
|
|
|
|
R. Joseph Dougherty
|
|
None
|
|
Over $100,000
|
|
Over $100,000
|
NON-INTERESTED DIRECTORS/TRUSTEES
|
|
|
|
|
|
|
Timothy K. Hui
|
|
None
|
|
$1-10,000
|
|
$1-10,000
|
Scott F. Kavanaugh
|
|
None
|
|
$10,001-50,000
|
|
$10,001-50,000
|
James F. Leary
|
|
None
|
|
$10,001-50,000
|
|
$10,001-50,000
|
Bryan A. Ward
|
|
None
|
|
$1-10,000
|
|
$1-10,000
|
|
|
|
* |
|
Valued as of December 31, 2008. Family of Investment
Companies consists of twelve registered investment
companies as of December 31, 2008 that share the Adviser as
their investment adviser and that hold themselves out to the
investors as related companies for purposes of investment and
investor services. |
As of December 31, 2008, the Directors/Trustees and
officers of each of the Acquired Fund and the Acquiring Fund, as
a group, owned 3.93% of the Acquired Funds outstanding
common shares, and less than 1.00% of the Acquiring Funds
outstanding common shares.
Set forth in the tables below is the security ownership in each
Fund of each Director/Trustee and executive officer.
Acquired
Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) Amount and
|
|
|
|
|
|
|
|
|
|
(2) Name of
|
|
Nature of Beneficial
|
|
|
(4) Value of
|
|
|
|
|
(1) Title of Class
|
|
Beneficial Owner
|
|
Ownership*
|
|
|
Securities
|
|
|
(5) Percent of Class
|
|
|
Common Stock
|
|
R. Joseph Dougherty
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Timothy K. Hui
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Scott F. Kavanaugh
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
James F. Leary
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Bryan A. Ward
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
James D. Dondero(1)
|
|
|
695,549.44
|
shares
|
|
$
|
1,495,431
|
|
|
|
3.93
|
%
|
Common Stock
|
|
Mark Okada
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
M. Jason Blackburn
|
|
|
None
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Michael Colvin
|
|
|
None
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Valued as of December 31, 2008. Except as otherwise
indicated, each person has sole voting and investment power. |
C-1
|
|
|
(1) |
|
Mr. Donderos ownership of these shares is based on
his indirect ownership of the Adviser. Mr. Dondero
disclaims beneficial ownership of shares held by the Adviser,
except to the extent of his pecuniary interest therein. |
Acquiring
Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) Amount and
|
|
|
|
|
|
|
|
|
|
(2) Name of
|
|
Nature of Beneficial
|
|
|
(4) Value of
|
|
|
|
|
(1) Title of Class
|
|
Beneficial Owner
|
|
Ownership*
|
|
|
Securities
|
|
|
(5) Percent of Class
|
|
|
Common Stock
|
|
R. Joseph Dougherty(1)
|
|
|
22,475
|
shares
|
|
$
|
128,109
|
|
|
|
0.04
|
%
|
Common Stock
|
|
Timothy K. Hui
|
|
|
410
|
shares
|
|
$
|
2,325
|
|
|
|
|
**
|
Common Stock
|
|
Scott F. Kavanaugh
|
|
|
4,525
|
shares
|
|
$
|
25,793
|
|
|
|
0.01
|
%
|
Common Stock
|
|
James F. Leary
|
|
|
2,615
|
shares
|
|
$
|
14,906
|
|
|
|
|
**
|
Common Stock
|
|
Bryan A. Ward
|
|
|
110
|
shares
|
|
$
|
627
|
|
|
|
|
**
|
Common Stock
|
|
Brad Borud(2)
|
|
|
23,920
|
shares
|
|
$
|
136,346
|
|
|
|
0.04
|
%
|
Common Stock
|
|
M. Jason Blackburn(3)
|
|
|
4,641
|
shares
|
|
$
|
26,452
|
|
|
|
0.01
|
%
|
Common Stock
|
|
Michael Colvin(4)
|
|
|
489
|
shares
|
|
$
|
2,789
|
|
|
|
|
**
|
|
|
|
* |
|
Valued as of December 31, 2008. Except as otherwise
indicated, each person has sole voting and investment power. |
|
** |
|
Less than 0.01%. |
|
(1) |
|
Mr. Doughertys beneficial ownership of these shares
is based on direct ownership and ownership through a retirement
plan. |
|
(2) |
|
Mr. Boruds beneficial ownership of these shares is
based on direct ownership and ownership through a retirement
plan. |
|
(3) |
|
Mr. Blackburns beneficial ownership of these shares
is based on ownership through a retirement plan. |
|
(4) |
|
Mr. Colvins beneficial ownership of these shares is
based on ownership through a retirement plan. |
Share
Ownership and Certain Beneficial Owners
To the knowledge of management of the Funds and the Board, the
following stockholder(s)/shareholder(s) or groups,
as the term is defined in Section 13(d) of the Securities
Exchange Act of 1934, as amended (the
1934 Act), beneficially owned, or were owners
of record of, more than 5% of the Acquired Funds
outstanding shares as of February 6, 2009:
Acquired
Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) Amount and
|
|
|
|
|
|
|
(2) Name of
|
|
Nature of Beneficial
|
|
|
(4) Percent of
|
|
(1) Title of Class
|
|
Beneficial Owner
|
|
Ownership
|
|
|
Class
|
|
|
Common Stock
|
|
Highland Capital Management, L.P. (a) NexBank Tower
13455 Noel Road, Suite 800
Dallas, TX 75240
|
|
|
996,489.17
|
shares
|
|
|
5.6
|
%
|
Common Stock
|
|
Pentagram Partners, L.P. (b)
630 Fifth Avenue, 20th Floor
New York, NY 10111
|
|
|
1,012,200
|
shares
|
|
|
5.7
|
%
|
Common Stock
|
|
RiverNorth Capital Management, Inc.(c) 325 N. LaSalle,
Suite 645
Chicago, IL 60654-7030
|
|
|
1,257,903
|
shares
|
|
|
7.1
|
%
|
|
|
|
(a) |
|
Based on information contained in a Schedule 13D filed jointly
by Highland Capital Management, L.P., Strand Advisors, Inc. and
James D. Dondero on April 14, 2008. Reflects sole voting power
and sole dispositive power with respect to all shares. |
C-2
|
|
|
(b) |
|
Based on information contained in a Schedule 13G filed jointly
by Pentagram Partners, L.P., RJ II, Inc. and Richard
Jacinto, II on January 9, 2009. Reflects sole voting power
and sole dispositive power with respect to all shares. |
|
(c) |
|
Based on information contained in a Schedule 13G filed by
RiverNorth Capital Management, Inc. on January 23, 2009.
Reflects sole voting power and sole dispositive power with
respect to all shares. |
To the knowledge of management of the Funds and the Board, the
following stockholder(s)/shareholders(s) or groups,
as the term is defined in Section 13(d) of the
1934 Act, beneficially owned, or were owners of record of,
more than 5% of the Acquiring Funds outstanding shares as
of February 6, 2009.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3) Amount and
|
|
|
|
|
|
|
(2) Name of
|
|
Nature of Beneficial
|
|
|
(4) Percent of
|
|
(1) Title of Class
|
|
Beneficial Owner
|
|
Ownership
|
|
|
Class
|
|
|
Common Stock
|
|
Morgan Stanley (a)
1585 Broadway
New York, NY 10036
|
|
|
3,764,429
|
shares
|
|
|
8.2
|
%
|
|
|
|
(a) |
|
Based on information contained in a Schedule 13G filed
jointly by Morgan Stanley and Morgan Stanley & Co.
Incorporated on February 17, 2009. Reflects sole voting
power with respect to 2,071,068 shares, shared voting power
with respect to 1,693,361 shares and sole dispositive power
with respect to all shares. |
C-3
APPENDIX D
SECTION 262
OF THE DELAWARE GENERAL CORPORATION LAW
§ 262. Appraisal rights.
(a) Any stockholder of a corporation of this State who
holds shares of stock on the date of the making of a demand
pursuant to subsection (d) of this section with respect to
such shares, who continuously holds such shares through the
effective date of the merger or consolidation, who has otherwise
complied with subsection (d) of this section and who has
neither voted in favor of the merger or consolidation nor
consented thereto in writing pursuant to § 228 of this
title shall be entitled to an appraisal by the Court of Chancery
of the fair value of the stockholders shares of stock
under the circumstances described in subsections (b) and
(c) of this section. As used in this section, the word
stockholder means a holder of record of stock in a
stock corporation and also a member of record of a nonstock
corporation; the words stock and share
mean and include what is ordinarily meant by those words and
also membership or membership interest of a member of a nonstock
corporation; and the words depository receipt mean a
receipt or other instrument issued by a depository representing
an interest in one or more shares, or fractions thereof, solely
of stock of a corporation, which stock is deposited with the
depository.
(b) Appraisal rights shall be available for the shares of
any class or series of stock of a constituent corporation in a
merger or consolidation to be effected pursuant to § 251
(other than a merger effected pursuant to § 251(g) of this
title), § 252, § 254, § 257, § 258, §
263 or § 264 of this title:
(1) Provided, however, that no appraisal rights under this
section shall be available for the shares of any class or series
of stock, which stock, or depository receipts in respect
thereof, at the record date fixed to determine the stockholders
entitled to receive notice of and to vote at the meeting of
stockholders to act upon the agreement of merger or
consolidation, were either (i) listed on a national
securities exchange or (ii) held of record by more than
2,000 holders; and further provided that no appraisal rights
shall be available for any shares of stock of the constituent
corporation surviving a merger if the merger did not require for
its approval the vote of the stockholders of the surviving
corporation as provided in subsection (f) of § 251 of
this title.
(2) Notwithstanding paragraph (1) of this subsection,
appraisal rights under this section shall be available for the
shares of any class or series of stock of a constituent
corporation if the holders thereof are required by the terms of
an agreement of merger or consolidation pursuant to §§
251, 252, 254, 257, 258, 263 and 264 of this title to accept for
such stock anything except:
a. Shares of stock of the corporation surviving or
resulting from such merger or consolidation, or depository
receipts in respect thereof;
b. Shares of stock of any other corporation, or
depository receipts in respect thereof, which shares of stock
(or depository receipts in respect thereof) or depository
receipts at the effective date of the merger or consolidation
will be either listed on a national securities exchange or held
of record by more than 2,000 holders;
c. Cash in lieu of fractional shares or fractional
depository receipts described in the foregoing subparagraphs a.
and b. of this paragraph; or
d. Any combination of the shares of stock,
depository receipts and cash in lieu of fractional shares or
fractional depository receipts described in the foregoing
subparagraphs a., b. and c. of this paragraph.
(3) In the event all of the stock of a subsidiary Delaware
corporation party to a merger effected under § 253 of
this title is not owned by the parent corporation immediately
prior to the merger, appraisal rights shall be available for the
shares of the subsidiary Delaware corporation.
(c) Any corporation may provide in its certificate of
incorporation that appraisal rights under this section shall be
available for the shares of any class or series of its stock as
a result of an amendment to its certificate
D-1
of incorporation, any merger or consolidation in which the
corporation is a constituent corporation or the sale of all or
substantially all of the assets of the corporation. If the
certificate of incorporation contains such a provision, the
procedures of this section, including those set forth in
subsections (d) and (e) of this section, shall apply
as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which
appraisal rights are provided under this section is to be
submitted for approval at a meeting of stockholders, the
corporation, not less than 20 days prior to the meeting,
shall notify each of its stockholders who was such on the record
date for such meeting with respect to shares for which appraisal
rights are available pursuant to subsection (b) or
(c) hereof that appraisal rights are available for any or
all of the shares of the constituent corporations, and shall
include in such notice a copy of this section. Each stockholder
electing to demand the appraisal of such stockholders
shares shall deliver to the corporation, before the taking of
the vote on the merger or consolidation, a written demand for
appraisal of such stockholders shares. Such demand will be
sufficient if it reasonably informs the corporation of the
identity of the stockholder and that the stockholder intends
thereby to demand the appraisal of such stockholders
shares. A proxy or vote against the merger or consolidation
shall not constitute such a demand. A stockholder electing to
take such action must do so by a separate written demand as
herein provided. Within 10 days after the effective date of
such merger or consolidation, the surviving or resulting
corporation shall notify each stockholder of each constituent
corporation who has complied with this subsection and has not
voted in favor of or consented to the merger or consolidation of
the date that the merger or consolidation has become
effective; or
(2) If the merger or consolidation was approved pursuant to
§ 228 or § 253 of this title, then either a
constituent corporation before the effective date of the merger
or consolidation or the surviving or resulting corporation
within 10 days hereafter shall notify each of the holders
of any class or series of stock of such constituent corporation
who are entitled to appraisal rights of the approval of the
merger or consolidation and that appraisal rights are available
for any or all shares of such class or series of stock of such
constituent corporation, and shall include in such notice a copy
of this section. Such notice may, and, if given on or after the
effective date of the merger or consolidation, shall, also
notify such stockholders of the effective date of the merger or
consolidation. Any stockholder entitled to appraisal rights may,
within 20 days after the date of mailing of such notice,
demand in writing from the surviving or resulting corporation
the appraisal of such holders shares. Such demand will be
sufficient if it reasonably informs the corporation of the
identity of the stockholder and that the stockholder intends
thereby to demand the appraisal of such holders shares. If
such notice did not notify stockholders of the effective date of
the merger or consolidation, either (i) each such
constituent corporation shall send a second notice before the
effective date of the merger or consolidation notifying each of
the holders of any class or series of stock of such constituent
corporation that are entitled to appraisal rights of the
effective date of the merger or consolidation or (ii) the
surviving or resulting corporation shall send such a second
notice to all such holders on or within 10 days after such
effective date; provided, however, that if such second notice is
sent more than 20 days following the sending of the first
notice, such second notice need only be sent to each stockholder
who is entitled to appraisal rights and who has demanded
appraisal of such holders shares in accordance with this
subsection. An affidavit of the secretary or assistant secretary
or of the transfer agent of the corporation that is required to
give either notice that such notice has been given shall, in the
absence of fraud, be prima facie evidence of the facts stated
therein. For purposes of determining the stockholders entitled
to receive either notice, each constituent corporation may fix,
in advance, a record date that shall be not more than
10 days prior to the date the notice is given, provided,
that if the notice is given on or after the effective date of
the merger or consolidation, the record date shall be such
effective date. If no record date is fixed and the notice is
given prior to the effective date, the record date shall be the
close of business on the day next preceding the day on which the
notice is given.
(e) Within 120 days after the effective date of the
merger or consolidation, the surviving or resulting corporation
or any stockholder who has complied with subsections (a)
and (d) of this section hereof and who is otherwise
entitled to appraisal rights, may commence an appraisal
proceeding by filing a petition in the
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Court of Chancery demanding a determination of the value of the
stock of all such stockholders. Notwithstanding the foregoing,
at any time within 60 days after the effective date of the
merger or consolidation, any stockholder who has not commenced
an appraisal proceeding or joined that proceeding as a named
party shall have the right to withdraw such stockholders
demand for appraisal and to accept the terms offered upon the
merger or consolidation. Within 120 days after the
effective date of the merger or consolidation, any stockholder
who has complied with the requirements of subsections (a)
and (d) of this section hereof, upon written request, shall
be entitled to receive from the corporation surviving the merger
or resulting from the consolidation a statement setting forth
the aggregate number of shares not voted in favor of the merger
or consolidation and with respect to which demands for appraisal
have been received and the aggregate number of holders of such
shares. Such written statement shall be mailed to the
stockholder within 10 days after such stockholders
written request for such a statement is received by the
surviving or resulting corporation or within 10 days after
expiration of the period for delivery of demands for appraisal
under subsection (d) of this section hereof, whichever is
later. Notwithstanding subsection (a) of this section, a
person who is the beneficial owner of shares of such stock held
either in a voting trust or by a nominee on behalf of such
person may, in such persons own name, file a petition or
request from the corporation the statement described in this
subsection.
(f) Upon the filing of any such petition by a stockholder,
service of a copy thereof shall be made upon the surviving or
resulting corporation, which shall within 20 days after
such service file in the office of the Register in Chancery in
which the petition was filed a duly verified list containing the
names and addresses of all stockholders who have demanded
payment for their shares and with whom agreements as to the
value of their shares have not been reached by the surviving or
resulting corporation. If the petition shall be filed by the
surviving or resulting corporation, the petition shall be
accompanied by such a duly verified list. The Register in
Chancery, if so ordered by the Court, shall give notice of the
time and place fixed for the hearing of such petition by
registered or certified mail to the surviving or resulting
corporation and to the stockholders shown on the list at the
addresses therein stated. Such notice shall also be given by 1
or more publications at least 1 week before the day of the
hearing, in a newspaper of general circulation published in the
City of Wilmington, Delaware or such publication as the Court
deems advisable. The forms of the notices by mail and by
publication shall be approved by the Court, and the costs
thereof shall be borne by the surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall
determine the stockholders who have complied with this section
and who have become entitled to appraisal rights. The Court may
require the stockholders who have demanded an appraisal for
their shares and who hold stock represented by certificates to
submit their certificates of stock to the Register in Chancery
for notation thereon of the pendency of the appraisal
proceedings; and if any stockholder fails to comply with such
direction, the Court may dismiss the proceedings as to such
stockholder.
(h) After the Court determines the stockholders entitled to
an appraisal, the appraisal proceeding shall be conducted in
accordance with the rules of the Court of Chancery, including
any rules specifically governing appraisal proceedings. Through
such proceeding the Court shall determine the fair value of the
shares exclusive of any element of value arising from the
accomplishment or expectation of the merger or consolidation,
together with interest, if any, to be paid upon the amount
determined to be the fair value. In determining such fair value,
the Court shall take into account all relevant factors. Unless
the Court in its discretion determines otherwise for good cause
shown, interest from the effective date of the merger through
the date of payment of the judgment shall be compounded
quarterly and shall accrue at 5% over the Federal Reserve
discount rate (including any surcharge) as established from time
to time during the period between the effective date of the
merger and the date of payment of the judgment. Upon application
by the surviving or resulting corporation or by any stockholder
entitled to participate in the appraisal proceeding, the Court
may, in its discretion, proceed to trial upon the appraisal
prior to the final determination of the stockholders entitled to
an appraisal. Any stockholder whose name appears on the list
filed by the surviving or resulting corporation pursuant to
subsection (f) of this section and who has submitted such
stockholders certificates of
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stock to the Register in Chancery, if such is required, may
participate fully in all proceedings until it is finally
determined that such stockholder is not entitled to appraisal
rights under this section.
(i) The Court shall direct the payment of the fair value of
the shares, together with interest, if any, by the surviving or
resulting corporation to the stockholders entitled thereto.
Payment shall be so made to each such stockholder, in the case
of holders of uncertificated stock forthwith, and the case of
holders of shares represented by certificates upon the surrender
to the corporation of the certificates representing such stock.
The Courts decree may be enforced as other decrees in the
Court of Chancery may be enforced, whether such surviving or
resulting corporation be a corporation of this State or of any
state.
(j) The costs of the proceeding may be determined by the
Court and taxed upon the parties as the Court deems equitable in
the circumstances. Upon application of a stockholder, the Court
may order all or a portion of the expenses incurred by any
stockholder in connection with the appraisal proceeding,
including, without limitation, reasonable attorneys fees
and the fees and expenses of experts, to be charged pro rata
against the value of all the shares entitled to an appraisal.
(k) From and after the effective date of the merger or
consolidation, no stockholder who has demanded appraisal rights
as provided in subsection (d) of this section shall be
entitled to vote such stock for any purpose or to receive
payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of
record at a date which is prior to the effective date of the
merger or consolidation); provided, however, that if no petition
for an appraisal shall be filed within the time provided in
subsection (e) of this section, or if such stockholder
shall deliver to the surviving or resulting corporation a
written withdrawal of such stockholders demand for an
appraisal and an acceptance of the merger or consolidation,
either within 60 days after the effective date of the
merger or consolidation as provided in subsection (e) of
this section or thereafter with the written approval of the
corporation, then the right of such stockholder to an appraisal
shall cease. Notwithstanding the foregoing, no appraisal
proceeding in the Court of Chancery shall be dismissed as to any
stockholder without the approval of the Court, and such approval
may be conditioned upon such terms as the Court deems just;
provided, however that this provision shall not affect the right
of any stockholder who has not commenced an appraisal proceeding
or joined that proceeding as a named party to withdraw such
stockholders demand for appraisal and to accept the terms
offered upon the merger or consolidation within 60 days
after the effective date of the merger or consolidation, as set
forth in subsection (e) of this section.
(l) The shares of the surviving or resulting corporation to
which the shares of such objecting stockholders would have been
converted had they assented to the merger or consolidation shall
have the status of authorized and unissued shares of the
surviving or resulting corporation.
D-4
STATEMENT OF ADDITIONAL INFORMATION
RELATING TO REORGANIZATION OF
HIGHLAND DISTRESSED OPPORTUNITIES, INC.
(the Acquired Fund)
INTO
HIGHLAND CREDIT STRATEGIES FUND
(the Acquiring Fund, and together with the Acquired Fund, the Funds)
DATED
March 5, 2009
This Statement of Additional Information (SAI) is available to the shareholders of the
Acquired Fund in connection with the proposed reorganization (the Reorganization) whereby
the Acquired Fund will merge with and into HCF Acquisition LLC (Merger Sub), a wholly owned
subsidiary of the Acquiring Fund (the Merger), with Merger Sub being the surviving entity and
common stockholders of the Acquired Fund will receive shares of beneficial interest of the
Acquiring Fund (and cash in lieu of any fractional shares) having an aggregate net asset value
equal to the value of the assets of Acquired Fund on the Valuation Date less the value of the
liabilities of Acquired Fund on such Valuation Date. Immediately after the Merger, Merger Sub will
distribute its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger
Sub, in complete liquidation of Merger Sub. As a result of the Reorganization, a common stockholder
of the Acquired Fund will become a shareholder of the Acquiring Fund. The Acquired Fund will then
terminate its registration under the 1940 Act and withdraw its election to be regulated as a
business development company. Unless otherwise defined herein, capitalized terms have the meanings
given to them in the Proxy Statement and Prospectus dated
March 5, 2009, relating to the
Reorganization (the Proxy Statement/Prospectus).
THIS SAI IS NOT A PROSPECTUS AND SHOULD BE READ IN CONJUNCTION WITH THE PROXY STATEMENT/PROSPECTUS.
A copy of the Proxy Statement/Prospectus may be obtained, without charge, by writing to Highland
Funds, c/o PFPC Inc., P.O. Box 9840, Providence, RI 02940 or by
calling 1-877-247-1888. You may
also obtain a copy of the Proxy Statement/Prospectus on the SECs web site at (http://www.sec.gov).
TABLE OF CONTENTS
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INVESTMENT RESTRICTIONS
Except as described below, the Acquiring Fund, as a fundamental policy, may not, without the
approval of the holders of a majority of the outstanding common shares and preferred shares, if
any, voting together as a single class, and of the holders of a majority of the outstanding
preferred shares, if any, voting as a separate class:
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invest 25% or more of the value of its total assets in any single industry or group of
industries; |
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issue senior securities or borrow money other than as permitted by the Investment Company Act
of 1940, as amended (the 1940 Act), or pledge its assets other than to secure such
issuances or in connection with hedging transactions, short sales, securities lending,
when-issued and forward commitment transactions and similar investment strategies; |
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make loans of money or property to any person, except through loans of portfolio securities
up to a maximum of 33 1/3% of the Acquiring Funds total assets, the purchase of debt
securities, including bank loans (senior loans) and participations therein, or the entry into
repurchase agreements up to a maximum of 33 1/3% of the Acquiring Funds total assets; |
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underwrite the securities of other issuers, except to the extent that, in connection with the
disposition of portfolio securities or the sale of its own securities, the Acquiring Fund may
be deemed to be an underwriter; |
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purchase or sell real estate, except that the Acquiring Fund may invest in securities of
companies that deal in real estate or are engaged in the real estate business, including real
estate investment trusts and real estate operating companies, and instruments secured by real
estate or interests therein and the Acquiring Fund may acquire, hold and sell real estate
acquired through default, liquidation, or other distributions of an interest in real estate as
a result of the Acquiring Funds ownership of such other assets; or |
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purchase or sell commodities or commodity contracts for any purposes except as, and to the
extent, permitted by applicable law without the Acquiring Fund becoming subject to
registration with the Commodity Futures Trading Commission (the CFTC) as a commodity
pool. |
As currently relevant to the Acquiring Fund, the 1940 Act requires an asset coverage of 200%
for a closed-end fund issuing preferred stock and 300% for borrowings exceeding 5% of the Acquiring
Funds assets (excluding temporary borrowings).
The Acquiring Fund will not engage in any activities described under investment restriction
number 2 pursuant to which the lenders would be able to foreclose on more than 33 1/3% of the
Acquiring Funds total assets.
The Acquiring Fund is also subject to the following non-fundamental restrictions and policies,
which may be changed by the Acquiring Funds Board of Trustees (Acquiring Fund Board) and
without shareholder approval. The Acquiring Fund may not:
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make any short sale of securities except in conformity with applicable laws, rules and
regulations and unless after giving effect to such sale, the market value of all securities
sold short does not exceed 25% of the value of the Acquiring Funds total assets and the
Acquiring Funds aggregate short sales of a particular class of securities of an issuer does
not exceed 25% of the then outstanding securities of that class. The Acquiring Fund may also
make short sales against the box without respect to such limitations. In this type of short
sale, at the time of the sale, the Acquiring Fund owns or has the immediate and unconditional
right to acquire at no additional cost the identical security; and |
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purchase securities of open-end or closed-end investment companies except in compliance with
the 1940 Act or any exemptive relief obtained thereunder. Under the 1940 Act, the Acquiring
Fund may invest up to 10% of its total assets in the aggregate in shares of other investment
companies and up to 5% of its total assets in shares of any one investment company, provided
the investment does not represent more than 3% |
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of the voting stock of the acquired investment company at the time such shares are
purchased. As a shareholder in any investment company, the Acquiring Fund will bear its
ratable share of that investment companys expenses and will remain subject to payment of
advisory fees and other expenses with respect to assets invested therein. Holders of common
shares will therefore be subject to duplicative expenses to the extent the Acquiring Fund
invests in other investment companies. In addition, the securities of other investment
companies may be leveraged and will therefore be subject to the risks of leverage. 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. |
In addition, to comply with the federal tax requirements for qualification as a regulated
investment company, the Acquiring Funds investments must meet certain diversification
requirements. See Tax Matters.
For purposes of this SAI, a majority of the outstanding shares means (a) 67% or more of a
Funds outstanding voting securities present at a meeting, if the holders of more than 50% of its
outstanding voting securities are present or represented by proxy, or (b) more than 50% of its
outstanding voting securities, whichever is less (a 1940 Act Majority Vote).
The percentage limitations applicable to the Acquiring Funds portfolio described in the Proxy
Statement/Prospectus and this SAI apply only at the time of investment, except that the percentage
limitation with respect to borrowing applies at all times, and the Acquiring Fund will not be
required to sell securities due to subsequent changes in the value of securities it owns.
ADDITIONAL INVESTMENT INFORMATION
The following is a description of the various investments the Acquiring Fund may acquire,
whether as a primary or secondary strategy. The information supplements the discussion of the
Acquiring Funds investment objectives, policies and techniques that are described in the Proxy
Statement/Prospectus.
SHORT-TERM DEBT SECURITIES
For temporary defensive purposes or to keep cash on hand, the Acquiring Fund may invest up to
100% of its total assets in cash equivalents and short-term debt securities. Short-term debt
investments are defined to include, without limitation, the following:
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U.S. government securities, including bills, notes and bonds differing as to maturity and
rates of interest that are either issued or guaranteed by the U.S. Treasury or by U.S.
government agencies or instrumentalities. U.S. government securities include securities
issued by (a) the Federal Housing Administration, Farmers Home Administration, Export-Import
Bank of the United States, Small Business Administration, and Government National Mortgage
Association, whose securities are supported by the full faith and credit of the United States;
(b) the Federal Home Loan Banks, Federal Intermediate Credit Banks, and Tennessee Valley
Authority, whose securities are supported by the right of the agency to borrow from the U.S.
Treasury; (c) the Federal National Mortgage Association, whose securities are supported by the
discretionary authority of the U.S. government to purchase certain obligations of the agency
or instrumentality; and (d) the Student Loan Marketing Association, whose securities are
supported only by its credit. While the U.S. government provides financial support to such
U.S. government-sponsored agencies or instrumentalities, no assurance can be given that it
always will do so since it is not so obligated by law. The U.S. government, its agencies and
instrumentalities do not guarantee the market value of their securities. Consequently, the
value of such securities may fluctuate. |
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Certificates of deposit issued against funds deposited in a bank or a savings and loan
association. Such certificates are for a definite period of time, earn a specified rate of
return and are normally negotiable. The issuer of a certificate of deposit agrees to pay the
amount deposited plus interest to the bearer of the certificate on the date specified thereon.
Certificates of deposit purchased by the Acquiring Fund may not be fully insured by the
Federal Deposit Insurance Corporation. |
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Repurchase agreements, which involve purchases of debt securities. At the time the Acquiring
Fund purchases securities pursuant to a repurchase agreement, it simultaneously agrees to
resell and redeliver such securities to the seller, who also simultaneously agrees to buy back
the securities at a fixed price and time. This assures a predetermined yield for the
Acquiring Fund during its holding period, since the resale price is always greater than the
purchase price and reflects an agreed-upon market rate. Such actions afford an opportunity
for the Acquiring Fund to invest temporarily available cash. The Acquiring Fund may enter
into repurchase agreements only with respect to obligations of the U.S. government, its
agencies or instrumentalities; certificates of deposit; or bankers acceptances in which the
Acquiring Fund may invest. Repurchase agreements may be considered loans to the seller,
collateralized by the underlying securities. The risk to the Acquiring Fund is limited to the
ability of the seller to pay the agreed-upon sum on the repurchase date; in the event of
default, the repurchase agreement provides that the Acquiring Fund is entitled to sell the
underlying collateral. If the value of the collateral declines after the agreement is entered
into, and if the seller defaults under a repurchase agreement when the value of the underlying
collateral is less than the repurchase price, the Acquiring Fund could incur a loss of both
principal and interest. If the seller were to be subject to a federal bankruptcy proceeding,
the ability of the Acquiring Fund to liquidate the collateral could be delayed or impaired
because of certain provisions of the bankruptcy laws. |
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Commercial paper, which consists of short-term unsecured promissory notes, including variable
rate master demand notes issued by corporations to finance their current operations. Master
demand notes are direct lending arrangements between the Acquiring Fund and a corporation.
There is no secondary market for such notes. However, they are redeemable by the Acquiring
Fund at any time. Highland Capital Management, L.P. (Highland or the
Investment Adviser) will consider the financial condition of the corporation (e.g.,
earning power, cash flow and other liquidity ratios) and will continually monitor the
corporations ability to meet all of its financial obligations, because the Acquiring Funds
liquidity might be impaired if the corporation were unable to pay principal and interest on
demand. Investments in commercial paper will be limited to commercial paper rated in the
highest categories by a major rating agency and which mature within one year of the date of
purchase or carry a variable or floating rate of interest. |
EQUITY SECURITIES
The Acquiring Fund may invest in equity securities including preferred stock, convertible
securities, warrants and depository receipts.
Preferred Stock. Preferred stock has a preference over common stock in liquidation (and
generally dividends as well) but is subordinated to the liabilities of the issuer in all respects.
As a general rule, the market value of preferred stock with a fixed dividend rate and no conversion
element varies inversely with interest rates and perceived credit risk, while the market price of
convertible preferred stock generally also reflects some element of conversion value. Because
preferred stock is junior to debt securities and other obligations of the issuer, deterioration in
the credit quality of the issuer will cause greater changes in the value of a preferred stock than
in a more senior debt security with similar stated yield characteristics. Unlike interest payments
on debt securities, preferred stock dividends are payable only if declared by the issuers board of
directors. Preferred stock also may be subject to optional or mandatory redemption provisions.
Convertible Securities. A convertible security is a bond, debenture, note, preferred stock or
other security that may be converted into or exchanged for a prescribed amount of common stock or
other equity security of the same or a different issuer within a particular period of time at a
specified price or formula. A convertible security entitles the holder to receive interest paid or
accrued on debt or the dividend paid on preferred stock until the convertible security matures or
is redeemed, converted or exchanged. Before conversion, convertible securities have
characteristics similar to nonconvertible income securities in that they ordinarily provide a
stable stream of income with generally higher yields than those of common stocks of the same or
similar issuers, but lower yields than comparable nonconvertible securities. The value of a
convertible security is influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline. The credit standing of the
issuer and other factors also may have an effect on the convertible securitys investment value.
Convertible securities rank senior to common stock in a corporations capital structure, but are
usually subordinated
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to comparable nonconvertible securities. Convertible securities may be subject to redemption at
the option of the issuer at a price established in the convertible securitys governing instrument.
Warrants. Warrants, which are privileges issued by corporations enabling the owners to
subscribe to and purchase a specified number of shares of the corporation at a specified price
during a specified period of time. Subscription rights normally have a short life span to
expiration. The purchase of warrants involves the risk that the Acquiring Fund could lose the
purchase value of a right or warrant if the right to subscribe to additional shares is not
exercised prior to the warrants expiration. Also, the purchase of warrants involves the risk that
the effective price paid for the warrant added to the subscription price of the related security
may exceed the value of the subscribed securitys market price such as when there is no movement in
the level of the underlying security.
Depository Receipts.. The Acquiring Fund may invest in both sponsored and unsponsored
American Depository Receipts (ADRs), European Depository Receipts (EDRs),
Global Depository Receipts (GDRs) and other similar global instruments. ADRs typically
are issued by an American bank or trust company and evidence ownership of underlying securities
issued by a non-U.S. corporation. EDRs, which are sometimes referred to as Continental Depository
Receipts, are receipts issued in Europe, typically by non-U.S. banks and trust companies, that
evidence ownership of either non-U.S. or U.S. underlying securities. GDRs are depository receipts
structured like global debt issues to facilitate trading on an international basis. Unsponsored
ADR, EDR and GDR programs are organized independently and without the cooperation of the issuer of
the underlying securities. As a result, available information concerning the issuer may not be as
current as for sponsored ADRs, EDRs and GDRs, and the prices of unsponsored ADRs, EDRs and GDRs may
be more volatile than if such instruments were sponsored by the issuer. Investments in ADRs, EDRs
and GDRs may present additional investment considerations of non-U.S. securities.
VARIABLE AND FLOATING RATE INSTRUMENTS
The Acquiring Fund may purchase rated and unrated variable and floating rate instruments.
These instruments may include variable amount master demand notes that permit the indebtedness
thereunder to vary in addition to providing for periodic adjustments in the interest rate. The
Acquiring Fund may invest in leveraged inverse floating rate debt instruments (Inverse Floaters).
The interest rate of an Inverse Floater resets in the opposite direction from the market rate of
interest to which it is indexed. An Inverse Floater may be considered to be leveraged to the
extent that its interest rate varies by a magnitude that exceeds the magnitude of the change in the
index rate of interest. The higher degree of leverage inherent in Inverse Floaters is associated
with greater volatility in their market values. Issuers of unrated variable and floating rate
instruments must satisfy the same criteria as set forth above for the Acquiring Fund. The absence
of an active secondary market with respect to particular variable and floating rate instruments,
however, could make it difficult for the Acquiring Fund to dispose of a variable or floating rate
instrument if the issuer defaulted on its payment obligation or during periods when the Acquiring
Fund is not entitled to exercise its demand rights.
Such instruments may include variable amount master demand notes that permit the indebtedness
thereunder to vary in addition to providing for periodic adjustments in the interest rate. The
absence of an active secondary market with respect to particular variable and floating rate
instruments could make it difficult for the Acquiring Fund to dispose of a variable or floating
rate note if the issuer defaulted on its payment obligation or during periods that the Acquiring
Fund is not entitled to exercise its demand rights, and the Acquiring Fund could, for these or
other reasons, suffer a loss, with respect to such instruments.
DERIVATIVE TRANSACTIONS AND RISK MANAGEMENT
Consistent with its investment objectives and policies set forth in the Proxy
Statement/Prospectus, the Acquiring Fund may also enter into certain risk management transactions.
In particular, the Acquiring Fund may purchase and sell futures contracts, exchange listed and
over-the-counter put and call options on securities, equity and other indices and futures
contracts, forward foreign currency contracts, and may enter into various interest rate
transactions. Derivative Transactions may be used to attempt to protect against possible changes
in the market value of the Acquiring Funds portfolio resulting from fluctuations in the securities
markets and changes in interest rates,
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to protect the Acquiring Funds unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes and to establish a position in the
securities markets as a temporary substitute for purchasing particular securities. Any or all of
these Derivative Transactions may be used at any time. There is no particular strategy that
requires use of one technique rather than another. Use of any Derivative Transaction is a function
of market conditions. The ability of the Acquiring Fund to manage them successfully will depend on
Highlands ability to predict pertinent market movements as well as sufficient correlation among
the instruments, which cannot be assured. The Derivative Transactions that the Acquiring Fund may
use are described below.
Futures Contracts and Options on Futures Contracts. In connection with its Derivative
Transactions and other risk management strategies, the Acquiring Fund may also enter into contracts
for the purchase or sale for future delivery (futures contracts) of securities, aggregates of
securities or indices or prices thereof, other financial indices and U.S. government debt
securities or options on the above. The Acquiring Fund will engage in such transactions only for
bona fide risk management and other portfolio management purposes.
Forward Foreign Currency Contracts. The Acquiring Fund may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S. dollars or another
foreign currency. A forward currency contract involves an obligation to purchase or sell a
specific currency at a future date, which may be any fixed number of days from the date of the
forward currency contract agreed upon by the parties, at a price set at the time the forward
currency contract is entered into. Forward currency contracts are traded directly between currency
traders (usually large commercial banks) and their customers.
The Acquiring Fund may engage in various forward currency contract strategies, including
without limitation the following:
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The Acquiring Fund may purchase a forward currency contract to lock in the U.S. dollar
price of a security denominated in a foreign currency that the Acquiring Fund intends to
acquire. The Acquiring Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security or a dividend or
interest payment denominated in a foreign currency. |
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The Acquiring Fund may also use forward currency contracts to shift the Acquiring Funds
exposure to foreign currency exchange rate changes from one currency to another. For
example, if the Acquiring Fund owns securities denominated in a foreign currency and
Highland believes that currency will decline relative to another currency, the Acquiring
Fund might enter into a forward currency contract to sell the appropriate amount of the
first foreign currency with payment to be made in the second currency. |
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The Acquiring Fund may also purchase forward currency contracts to enhance income when
Highland anticipates that the foreign currency will appreciate in value but securities
denominated in that currency do not present attractive investment opportunities. |
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The Acquiring Fund may also use forward currency contracts to offset against a decline
in the value of existing investments denominated in a foreign currency. Such a transaction
would tend to offset both positive and negative currency fluctuations, but would not offset
changes in security values caused by other factors. |
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The Acquiring Fund could also enter into a forward currency contract to sell another
currency expected to perform similarly to the currency in which the Acquiring Funds
existing investments are denominated. This type of transaction could offer advantages in
terms of cost, yield or efficiency, but may not offset currency exposure as effectively as
a simple forward currency transaction to sell U.S. dollars. This type of transaction may
result in losses if the currency sold does not perform similarly to the currency in which
the Acquiring Funds existing investments are denominated. |
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The Acquiring Fund may also use forward currency contracts in one currency or a basket
of currencies to attempt to offset against fluctuations in the value of securities
denominated in a different currency if Highland anticipates that there will be a
correlation between the two currencies. |
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The cost to the Acquiring Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the market
conditions then prevailing. Because |
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forward currency contracts are usually entered into on a principal basis, no fees or
commissions are involved. |
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When the Acquiring Fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity of the
contract. Failure by the counterparty to do so would result in the loss of some or all of
any expected benefit of the transaction. Secondary markets generally do not exist for
forward currency contracts, with the result that closing transactions generally can be made
for forward currency contracts only by negotiating directly with the counterparty. Thus,
there can be no assurance that the Acquiring Fund will in fact be able to close out a
forward currency contract at a favorable price prior to maturity. In addition, in the
event of insolvency of the counterparty, the Acquiring Fund might be unable to close out a
forward currency contract. In either event, the Acquiring Fund would continue to be
subject to market risk with respect to the position, and would continue to be required to
maintain a position in securities denominated in the foreign currency or to maintain cash
or liquid assets in a segregated account. The precise matching of forward currency
contract amounts and the value of the securities involved generally will not be possible
because the value of such securities, measured in the foreign currency, will change after
the forward currency contract has been established. Thus, the Acquiring Fund might need to
purchase or sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts. The projection of short-term
currency market movements is extremely difficult, and the successful execution of a
short-term strategy is highly uncertain. |
Calls on Securities, Indices and Futures Contracts. In order to enhance income or reduce
fluctuations on net asset value, the Acquiring Fund may sell or purchase call options (calls) on
securities and indices based upon the prices of futures contracts and debt or equity securities
that are traded on U.S. and non-U.S. securities exchanges and in the over-the-counter markets. A
call option gives the purchaser of the option the right to buy, and obligates the seller to sell,
the underlying security, futures contract or index at the exercise price at any time or at a
specified time during the option period. All such calls sold by the Acquiring Fund must be
covered as long as the call is outstanding (i.e., the Acquiring Fund must own the instrument
subject to the call or other securities or assets acceptable for applicable segregation and
coverage requirements). A call sold by the Acquiring Fund exposes the Acquiring Fund during the
term of the option to possible loss of opportunity to realize appreciation in the market price of
the underlying security, index or futures contract and may require the Acquiring Fund to hold an
instrument which it might otherwise have sold. The purchase of a call gives the Acquiring Fund the
right to buy a security, futures contract or index at a fixed price. Calls on futures on
securities must also be covered by assets or instruments acceptable under applicable segregation
and coverage requirements.
Puts on Securities, Indices and Futures Contracts. The Acquiring Fund may purchase put
options (puts) that relate to securities (whether or not it holds such securities in its
portfolio), indices or futures contracts. For the same purposes, the Acquiring Fund may also sell
puts on securities, indices or futures contracts on such securities if the Acquiring Funds
contingent obligations on such puts are covered by assets consisting of cash or securities having a
value not less than the exercise price. In selling puts, there is a risk that the Acquiring Fund
may be required to buy the underlying security at a price higher than the current market price.
Interest Rate Transactions. Among the Derivative Transactions in which the Acquiring Fund may
enter into are interest rate swaps and the purchase or sale of interest rate caps and floors. The
Acquiring Fund expects to enter into these transactions primarily to preserve a return or spread on
a particular investment or portion of its portfolio as a duration management technique or to
protect against any increase in the price of securities the Acquiring Fund anticipates purchasing
at a later date. Interest rate swaps involve the exchange by the Acquiring Fund with another party
of their respective commitments to pay or receive interest, e.g., an exchange of floating rate
payments for fixed rate payments with respect to a notional amount of principal. 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 on a notional principal amount from
the party selling such 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 on a notional principal amount from the party selling such interest
rate floor.
The Acquiring Fund may enter into interest rate swaps, caps and floors on either an asset-
based or liability-based basis, depending on whether it is offsetting volatility with respect to
its assets or liabilities, and will usually enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with the Acquiring Fund
6
receiving or paying, as the case may be, only the net amount of the two payments on the payment
dates. Inasmuch as these Derivative Transactions are entered into for good faith risk management
purposes. Highland and the Acquiring Fund will not treat them as being subject to its borrowing
restrictions. The Acquiring Fund will accrue the net amount of the excess, if any, of the
Acquiring Funds obligations over its entitlements with respect to each interest rate swap on a
daily basis and will designate on its books and records with a custodian an amount of cash or
liquid securities having an aggregate net asset value at all times at least equal to the accrued
excess. The Acquiring Fund will enter into interest rate swap, cap or floor transactions only with
counterparties that are judged by Highland to present acceptable credit risk. If there is a
default by the other party to such a transaction, the Acquiring Fund will have contractual remedies
pursuant to the agreements related to the transaction. The swap market has grown substantially in
recent years with a large number of banks and investment banking firms acting both as principals
and as agents utilizing standardized swap documentation. Caps and floors are more recent
innovations for which standardized documentation has not yet been developed and, accordingly, they
are less liquid than swaps.
ADDITIONAL CHARACTERISTICS AND RISKS OF DERIVATIVE TRANSACTIONS
In order to manage the risk of its securities portfolio, or to enhance income or gain as
described in the Proxy Statement/Prospectus, the Acquiring Fund will engage in Derivative
Transactions. The Acquiring Fund will engage in such activities in the Investment Advisers
discretion, and may not necessarily be engaging in such activities when movements in interest rates
that could affect the value of the assets of the Acquiring Fund occur. The Acquiring Funds
ability to pursue certain of these strategies may be limited by applicable regulations of the CFTC.
The Acquiring Funds Derivative Transactions may accelerate and/or increase the amount of taxes
payable by shareholders.
PUT AND CALL OPTIONS ON SECURITIES AND INDICES
The Acquiring Fund may purchase and sell put and call options on securities and indices. A
put option gives the purchaser of the option the right to sell and the writer the obligation to buy
the underlying security at the exercise price during the option period. The Acquiring Fund may
also purchase and sell options on securities indices (index options). Index options are similar
to options on securities except that, rather than taking or making delivery of securities
underlying the option at a specified price upon exercise, an index option gives the holder the
right to receive cash upon exercise of the option if the level of the securities index upon which
the option is based is greater, in the case of a call, or less, in the case of a put, than the
exercise price of the option. The purchase of a put option on a security could protect the
Acquiring Funds holdings in a security or a number of securities against a substantial decline in
the market value. A call option gives the purchaser of the option the right to buy and the seller
the obligation to sell the underlying security or index at the exercise price during the option
period or for a specified period prior to a fixed date. The purchase of a call option on a
security could protect the Acquiring Fund against an increase in the price of a security that it
intended to purchase in the future. In the case of either put or call options that it has
purchased, if the option expires without being sold or exercised, the Acquiring Fund will
experience a loss in the amount of the option premium plus any related commissions. When the
Acquiring Fund sells put and call options, it receives a premium as the seller of the option. The
premium that the Acquiring Fund receives for selling the option will serve as a partial offset, in
the amount of the option premium, against changes in the value of the securities in its portfolio.
During the term of the option, however, a covered call seller has, in return for the premium on the
option, given up the opportunity for capital appreciation above the exercise price of the option if
the value of the underlying security increases, but has retained the risk of loss should the price
of the underlying security decline. Conversely, a secured put seller retains the risk of loss
should the market value of the underlying security decline below the exercise price of the option,
less the premium received on the sale of the option. The Acquiring Fund is authorized to purchase
and sell exchange listed options and over-the-counter options (OTC Options) which are
privately negotiated with the counterparty. Listed options are issued by the Options Clearing
Corporation (OCC), which guarantees the performance of the obligations of the parties to
such options.
The Acquiring Funds ability to close out its position as a purchaser or seller of an exchange
listed put or call option is dependent upon the existence of a liquid secondary market on option
exchanges. Among the possible reasons for the absence of a liquid secondary market on an exchange
are: (i) insufficient trading interest in certain options; (ii) restrictions on transactions
imposed by an exchange; (iii) trading halts, suspensions or other restrictions imposed with respect
to particular classes or series of options or underlying securities; (iv) interruption of the
normal operations on an exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume;
7
or (vi) a decision by one or more exchanges to discontinue the trading of options (or a particular
class or series of options), in which event the secondary market on that exchange (or in that class
or series of options) would cease to exist, although outstanding options on that exchange that had
been listed by the OCC as a result of trades on that exchange would generally continue to be
exercisable in accordance with their terms. OTC Options are purchased from or sold to dealers,
financial institutions or other counterparties which have entered into direct agreements with the
Acquiring Fund. With OTC Options, such variables as expiration date, exercise price and premium
will be agreed upon between the Acquiring Fund and the counterparty, without the intermediation of
a third party such as the OCC. If the counterparty fails to make or take delivery of the securities
underlying an option it has written, or otherwise settle the transaction in accordance with the
terms of that option as written, the Acquiring Fund would lose the premium paid for the option as
well as any anticipated benefit of the transaction.
The hours of trading for options on securities may not conform to the hours during which the
underlying securities are traded. To the extent that the option markets close before the markets
for the underlying securities, significant price movements can take place in the underlying markets
that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS
Characteristics.. The Acquiring Fund may sell financial futures contracts or purchase put and
call options on such futures as an offset against anticipated market movements. The sale of a
futures contract creates an obligation by the Acquiring Fund, as seller, to deliver the specific
type of financial instrument called for in the contract at a specified future time for a specified
price. Options on futures contracts are similar to options on securities except that an option on
a futures contract gives the purchaser the right in return for the premium paid to assume a
position in a futures contract (a long position if the option is a call and a short position if the
option is a put).
Margin Requirements. At the time a futures contract is purchased or sold, the Acquiring Fund
must allocate cash or securities as a deposit payment (initial margin). It is expected that the
initial margin that the Acquiring Fund will pay may range from approximately 1% to approximately 5%
of the value of the securities or commodities underlying the contract. In certain circumstances,
however, such as periods of high volatility, the Acquiring Fund may be required by an exchange to
increase the level of its initial margin payment. Additionally, initial margin requirements may be
increased generally in the future by regulatory action. An outstanding futures contract is valued
daily and the payment in case of variation margin may be required, a process known as marking to
the market. Transactions in listed options and futures are usually settled by entering into an
offsetting transaction, and are subject to the risk that the position may not be able to be closed
if no offsetting transaction can be arranged.
Limitations on Use of Futures and Options on Futures. The Acquiring Fund currently may enter
into such transactions without limit for bona fide strategic purposes, including risk management
and duration management and other portfolio strategies. The Acquiring Fund may also engage in
transactions in futures contracts or related options for non-strategic purposes to enhance income
or gain provided that the Acquiring Fund will not enter into a futures contract or related option
(except for closing transactions) for purposes other than bona fide strategic purposes, or risk
management including duration management if, immediately thereafter, the sum of the amount of its
initial deposits and premiums on open contracts and options would exceed 5% of the Acquiring Funds
liquidation value, i.e., net assets (taken at current value); provided, however, that in the case
of an option that is in-the-money at the time of the purchase, the in-the-money amount may be
excluded in calculating the 5% limitation. The above policies are non-fundamental and may be
changed by the Acquiring Funds Board at any time. Also, when required, an account of cash
equivalents designated on the books and records will be maintained and marked to market on a daily
basis in an amount equal to the market value of the contract.
Segregation and Cover Requirements. Futures contracts, interest rate swaps, caps, floors and
collars, short sales, reverse repurchase agreements and dollar rolls, and listed or OTC options on
securities, indices and futures contracts sold by the Acquiring Fund are generally subject to
earmarking and coverage requirements of either the CFTC or the SEC, with the result that, if the
Acquiring Fund does not hold the security or futures contract underlying the instrument, the
Acquiring Fund will be required to designate on its books and records an ongoing basis, cash, U.S.
government securities, or other liquid securities in an amount at least equal to the Acquiring
Funds obligations with respect to such instruments.
8
Such Amounts Fluctuate as the Obligations Increase or Decrease. The earmarking requirement
can result in the Acquiring Fund maintaining securities positions it would otherwise liquidate,
segregating assets at a time when it might be disadvantageous to do so or otherwise restrict
portfolio management.
Derivative Transactions Present Certain Risks. With respect to Derivative Transactions and
risk management, the variable degree of correlation between price movements of strategic
instruments and price movements in the position being offset create the possibility that losses
using the strategy may be greater than gains in the value of the Acquiring Funds position. The
same is true for such instruments entered into for income or gain. In addition, certain instruments
and markets may not be liquid in all circumstances. As a result, in volatile markets, the
Acquiring Fund may not be able to close out a transaction without incurring losses substantially
greater than the initial deposit. Although the contemplated use of these instruments predominantly
for Derivative Transactions should tend to minimize the risk of loss due to a decline in the value
of the position, at the same time they tend to limit any potential gain which might result from an
increase in the value of such position. The ability of the Acquiring Fund to successfully utilize
Derivative Transactions will depend on the Investment Advisers ability to predict pertinent market
movements and sufficient correlations, which cannot be assured. Finally, the daily deposit
requirements in futures contracts that the Acquiring Fund has sold create an on going greater
potential financial risk than do options transactions, where the exposure is limited to the cost of
the initial premium. Losses due to the use of Derivative Transactions will reduce net asset value.
Regulatory Considerations. The Acquiring Fund has claimed an exclusion from the term
commodity pool operator under the Commodity Exchange Act and, therefore, is not subject to
registration or regulation as a commodity pool operator under the Commodity Exchange Act.
OTHER INVESTMENT POLICIES AND TECHNIQUES
When-Issued and Forward Commitment Securities. The Acquiring Fund may purchase securities on a
when-issued basis and may purchase or sell securities on a forward commitment basis in order to
acquire the security or to offset against anticipated changes in interest rates and prices. When
such transactions are negotiated, the price, which is generally expressed in yield terms, is fixed
at the time the commitment is made, but delivery and payment for the securities take place at a
later date. When-issued securities and forward commitments may be sold prior to the settlement
date, but the Acquiring Fund will enter into when-issued and forward commitments only with the
intention of actually receiving or delivering the securities, as the case may be. If the Acquiring
Fund disposes of the right to acquire a when-issued security prior to its acquisition or disposes
of its right to deliver or receive against a forward commitment, it might incur a gain or loss. At
the time the Acquiring Fund enters into a transaction on a when-issued or forward commitment basis,
it will designate on its books and records cash or liquid securities equal to at least the value of
the when-issued or forward commitment securities. The value of these assets will be monitored
daily to ensure that their marked to market value will at all times equal or exceed the
corresponding obligations of the Acquiring Fund. There is always a risk that the securities may
not be delivered and that the Acquiring Fund may incur a loss. Settlements in the ordinary course,
which may take substantially more than five business days, are not treated by the Acquiring Fund as
when-issued or forward commitment transactions and accordingly are not subject to the foregoing
restrictions.
Pay-In-Kind Securities. The Acquiring Fund may invest in Pay-in-kind, or PIK securities.
PIK securities are securities which pay interest through the issuance of additional debt or equity
securities. Similar to zero coupon obligations, PIK securities also carry additional risk as
holders of these types of securities typically do not receive cash until the final payment date on
the security unless such security is sold. In addition, if the issuer defaults, the Acquiring Fund
may obtain no return at all on its investment. The market price of PIK securities is affected by
interest rate changes to a greater extent, and therefore tends to be more volatile, than that of
securities which pay interest in cash. Additionally, current U.S. federal income tax law requires
the holder of certain PIK securities to accrue interest income with respect to these securities
prior to the actual receipt of cash payments. In order to receive the special treatment accorded
to regulated investment companies (RICs) and their shareholders under Subchapter M of the U.S.
Internal Revenue Code of 1986, as amended (the Code) and to avoid liability for U.S. federal
income and/or excise taxes at the Acquiring Fund level, the Acquiring Fund may be required to
distribute income accrued with respect to these securities prior to the Acquiring Funds receipt of
cash and thus may have to
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dispose of portfolio securities under disadvantageous circumstances in order to generate cash to
satisfy these distribution requirements.
Brady Bonds. The Acquiring Funds emerging market debt securities may include emerging market
governmental debt obligations commonly referred to as Brady Bonds. Brady Bonds are debt securities,
generally denominated in U.S. dollars, issued under the framework of the Brady Plan, an initiative
announced by U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor nations
(primarily emerging market countries) to restructure their outstanding external indebtedness
(generally, commercial bank debt). Brady Bonds are created through the exchange of existing
commercial bank loans to foreign entities for new obligations in connection with debt
restructuring. A significant amount of the Brady Bonds that the Acquiring Fund may purchase have
no or limited collateralization, and the Acquiring Fund will be relying for payment of interest and
(except in the case of principal collateralized Brady Bonds) principal primarily on the willingness
and ability of the foreign government to make payment in accordance with the terms of the Brady
Bonds. A substantial portion of the Brady Bonds and other sovereign debt securities in which the
Acquiring Fund may invest are likely to be acquired at a discount.
Mezzanine Investments. The Acquiring Fund may invest in certain high yield securities known as
mezzanine investments, which are subordinated debt securities which are generally issued in private
placements in connection with an equity security (e.g., with attached warrants). Such mezzanine
investments may be issued with or without registration rights. Similar to other high yield
securities, maturities of mezzanine investments are typically seven to ten years, but the expected
average life is significantly shorter at three to five years. Mezzanine investments are usually
unsecured and subordinate to other obligations of the issuer.
Loan Participations and Assignments. The Acquiring Fund may invest in fixed and floating rate
loans (Loans) arranged through private negotiations between a corporation or foreign
government and one or more financial institutions (Lenders). The Acquiring Funds
investments in Loans are expected in most instances to be in the form of participations in Loans
(Participations) and assignments of all or a portion of Loans (Assignments)
from third parties. Participations typically will result in the Acquiring Fund having a
contractual relationship only with the Lender not the borrower. The Acquiring Fund will have the
right to receive payments of principal, interest and any fees to which it is entitled only from the
Lender selling the Participation and the Acquiring Fund and only upon receipt by the Lender of the
payments by the borrower. In connection with purchasing Participations, the Acquiring Fund
generally has no direct right to enforce compliance by the borrower with the terms of the loan
agreement relating to the Loan, nor any rights of set-off against the borrower, and the Acquiring
Fund may not directly benefit from any collateral supporting the Loan in which is has purchased the
Participation. As a result the Acquiring Fund will assume the credit risk of both the borrower and
the Lender that is selling the Participation. In the event of the insolvency of the Lender selling
a Participation, the Acquiring Fund may be treated as a general creditor of the Lender and may not
benefit from any set-off between the Lender and the borrower. The Acquiring Fund will acquire
Participations only if the Lender interpositioned between the Acquiring Fund and the borrower is
determined by Highland to be creditworthy. When the Acquiring Fund purchases Assignments from
Lenders, the Acquiring Fund will acquire direct rights against the borrower on the Loan. However,
since Assignments are arranged through private negotiations between potential assignees and
assignors, the rights and obligations acquired by the Acquiring Fund as the purchaser of an
Assignment may differ from, and be more limited than, those held by the assigning Lender.
The Acquiring Fund may have difficulty disposing of Assignments and Participations. Because
there is no public market for such securities, the Acquiring Fund anticipates that such securities
could be sold only to a limited number of institutional investors. The lack of a liquid secondary
market will have an adverse impact on the value of such securities and on the Acquiring Funds
ability to dispose of particular Assignments or Participations when necessary to meet the Acquiring
Funds liquidity needs or in response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower. The lack of a liquid secondary market for Assignments and
Participations also may make it more difficult for the Acquiring Fund to assign a value to those
securities for purposes of valuing the Acquiring Funds portfolio and calculating its net asset
value.
Project Loans. The Acquiring Fund may invest in project loans, which are fixed income
securities of issuers whose revenues are primarily derived from mortgage loans to multi-family,
nursing home and other real estate development projects. The principal payments on these mortgage
loans will be insured by agencies and authorities of the U.S. Government.
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Zero Coupons and Deferred Payment Obligations. The Acquiring Fund may invest in zero-coupon
bonds, which are normally issued at a significant discount from face value and do not provide for
periodic interest payments. Zero-coupon bonds may experience greater volatility in market value
than similar maturity debt obligations which provide for regular interest payments. Additionally,
current U.S. federal income tax law requires the holder of certain zero-coupon bonds to accrue
interest income with respect to these securities prior to the actual receipt of cash payments by
the holder. In order to receive the special treatment accorded to RICs and their shareholders
under the Code and to avoid liability for U.S. federal income and/or excise taxes at the Acquiring
Fund level, the Acquiring Fund may be required to distribute income accrued with respect to these
securities prior to the Acquiring Funds receipt of cash and thus may have to dispose of Acquiring
Fund securities under disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements.
The Acquiring Fund may invest in Deferred Payment Securities. Deferred payment securities are
securities that remain Zero-Coupon Securities until a predetermined date, at which time the stated
coupon rate becomes effective and interest becomes payable at regular intervals. Deferred payment
securities are subject to greater fluctuations in value and may have lesser liquidity in the event
of adverse market conditions than comparably rated securities paying cash interest at regular
interest payment periods.
MANAGEMENT
OF THE FUNDS
BOARD OF TRUSTEES
The Board of Trustees of the Acquiring Fund provides broad oversight over the operations and
affairs of the Acquiring Fund and they protect the interests of shareholders. The Board has
overall responsibility to manage and control the business affairs of the Acquiring Fund, including
the complete and exclusive authority to establish policies regarding the management, conduct and
operation of the Acquiring Funds business. The names and ages of the Trustees and officers of the
Acquiring Fund, the year each was first elected or appointed to office, their principal business
occupations during the last five years, the number of funds overseen by each Trustee and other
directorships or trusteeships they hold are shown below. The business address of each Trustee is
NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240.
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INDEPENDENT TRUSTEES(3)
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Timothy Hui (Age 60)
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Trustee
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3 years and Trustee
since May 19, 2006.
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Vice President since
February 2008, Dean of
Educational Resources
from July 2006 to
January 2008,
Assistant Provost for
Graduate Education
from July 2004 to June
2006, and Assistant
Provost for
Educational Resources,
July 2001 to June 2004
at Philadelphia
Biblical University.
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Held |
Scott Kavanaugh
(Age 48)
|
|
Trustee
|
|
3 years and Trustee
since May 19, 2006.
|
|
Vice-Chairman,
President and Chief
Operating Officer at
Keller Financial
Group since September
2007; Chairman and
Chief Executive
Officer at First
Foundation Bank since
September 2007;
Private investor since
February 2004; Sales
Representative at
Round Hill Securities
from March 2003 to
January 2004;
Executive at Provident
Funding Mortgage
Corporation from
February 2003 to July
2003; Executive Vice
President, Director
and Treasurer at
Commercial Capital
Bank from January 2000
to February 2003;
Managing Principal and
Chief Operating
Officer at Financial
Institutional Partners
Mortgage Company and
Managing Principal and
President of Financial
Institutional
Partners, LLC (an
investment banking
firm) from April 1998
to February 2003.
|
|
|
9 |
|
|
None |
|
|
|
|
|
|
|
|
|
|
|
|
|
James F. Leary (Age
78)
|
|
Trustee
|
|
3 years and Trustee
since May 19, 2006.
|
|
Managing Director,
Benefit Capital
Southwest, Inc. (a
financial consulting
firm) since January
1999.
|
|
|
9 |
|
|
Board Member of
Capstone Group of
Funds (7
portfolios). |
|
|
|
|
|
|
|
|
|
|
|
|
|
Bryan A. Ward (Age
53)
|
|
Trustee
|
|
3 years and Trustee
since May 19, 2006.
|
|
Senior Manager,
Accenture, LLP (a
consulting firm) since
January 2002.
|
|
|
9 |
|
|
None. |
|
|
|
|
|
|
|
|
|
|
|
|
|
INTERESTED TRUSTEE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R. Joseph
Dougherty(4)
(Age 38)
|
|
Trustee
and Chairman of the
Board
|
|
3 years and Trustee
since March 10,
2006.
|
|
Team Leader of Investment
Adviser since 2000,
Director/Trustee of
the funds in the
Highland Fund Complex
since 2004 and
President and Chief
|
|
|
9 |
|
|
None. |
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
|
|
|
|
Portfolios in |
|
|
|
|
Position |
|
|
|
|
|
Highland Fund |
|
Other |
|
|
with the |
|
Term of Office |
|
|
|
Complex |
|
Directorships/ |
Name and |
|
Acquiring |
|
and Length of |
|
Principal Occupation(s) |
|
Overseen by |
|
Trusteeships |
Age |
|
Fund |
|
Time Served(1) |
|
During Past Five Years |
|
Trustee(2) |
|
Held |
|
|
|
|
|
|
Executive Officer of
the funds in the
Highland Fund Complex
since December 2008; Senior Vice President of Highland
Distressed Opportunities, Inc. since September 2006;
Senior Vice President
of the funds in the
Highland Fund Complex
from 2004 to December
2008. |
|
|
|
|
|
|
ACQUIRING
FUND OFFICERS
The business address of each Officer is NexBank Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240.
|
|
|
|
|
|
|
|
|
Position with |
|
Term of Office and |
|
|
Name and |
|
the Acquiring |
|
Length of Time |
|
|
Age |
|
Fund |
|
Served |
|
Principal Occupation(s) During Past Five Years |
R. Joseph Dougherty (Age 38) |
|
President and Chief Executive Officer |
|
Indefinite Term; Chairman of the Board since 2004; President and Chief Executive Officer since December 2008 |
|
Team Leader of the Investment Adviser since 2000, Director/Trustee of the funds in the Highland Fund Complex since 2004 and President and Chief Executive Officer of the funds in the Highland Fund Complex since December 2008; Senior Vice President of Highland Distressed Opportunities, Inc. since September 2006; Senior Vice President of the funds in the Highland Fund Complex from 2004 to December 2008. |
|
|
|
|
|
|
|
Brad
Borud (Age 37)
|
|
Executive Vice
President
|
|
Indefinite Term and
Officer since
December 2008.
|
|
Senior Trader and Chief Investment Officer
Retail Products of the Investment Adviser since April
2008 and Executive Vice President of the
funds in the Highland Complex since December
2008; Senior Trader and Co-Director of
Portfolio Management of the Adviser from 2003
to March 2008. |
|
|
|
|
|
|
|
M. Jason Blackburn
(Age 32)
|
|
Chief Financial
Officer (Principal
Accounting
Officer), Treasurer
and Secretary
|
|
Indefinite Term and
Officer since May
19, 2006.
|
|
Assistant Controller of the Investment
Adviser since November 2001; Treasurer and
Secretary of the funds in the Highland Fund
Complex. |
|
|
|
|
|
|
|
Michael Colvin (Age
39)
|
|
Chief Compliance
Officer
|
|
Indefinite Term and
Officer since July
2007.
|
|
General Counsel and Chief Compliance Officer
of the Investment Adviser since June 2007 and Chief
Compliance Officer of the funds in the
Highland Fund Complex since July 2007;
Shareholder in the Corporate and Securities
Group at Greenberg Traurig, LLP from January
2007 to June 2007; Partner in the Private
Equity Practice Group at Weil, Gotshal &
Manges, LLP from January 2003 to January
2007. |
ACQUIRED
FUND OFFICERS
|
|
|
|
|
|
|
Name and Age |
|
Position with Acquired Fund |
|
Time
Served |
|
Principal Occupation(s) During Past Five Years |
James D. Dondero
(Age 46) |
|
President and Chief Executive Officer |
|
Indefinite Term; Officer since September 2006 |
|
President and Director of Strand
Advisors, Inc. (Strand), the General Partner of the Investment Adviser.
Chairman of the Board of Directors of Highland Financial Partners, L.P. and President of the
funds in the Highland Fund Complex from 2004 to December 2008. |
|
|
|
|
|
|
|
Mark Okada
(Age 46)
|
|
Executive Vice
President |
|
Indefinite Term; Officer since September 2006 |
|
Executive Vice President of Strand; Chief Investment Officer of
the Investment Adviser and Executive Vice President of the funds in the Highland Fund Complex from 2004 to December 2008. |
|
|
|
|
|
|
|
R. Joseph Dougherty
(Age 38)
|
|
Senior Vice President |
|
Indefinite Term; Officer since September 2006 |
|
Team Leader of the Investment Adviser since 2000, Director/Trustee of the funds in the Highland Fund Complex since 2004 and President and Chief Executive Officer of the funds in the Highland Fund Complex since December 2008; Senior Vice President of Highland Distressed Opportunities, Inc. since September 2006; Senior Vice President of the funds in the Highland Fund Complex from 2004 to December 2008. |
|
|
|
|
|
|
|
M. Jason Blackburn
(Age 32)
|
|
Treasurer and Secretary |
|
Indefinite Term; Officer since September 2006 |
|
Assistant Controller of the Investment Adviser since November 2001 and Treasurer and Secretary of the funds in the Highland Fund Complex. |
|
|
|
|
|
|
|
Michael Colvin
(Age 39)
|
|
Chief Compliance
Officer |
|
Indefinite Term; Officer since July 2007 |
|
General Counsel and Chief
Compliance Officer of the Investment Adviser since June 2007 and Chief
Compliance Officer of the funds in the Highland Fund Complex since
July 2007; Shareholder in the Corporate and Securities Group at
Greenberg Traurig, LLP, January 2007 to June 2007; Partner in the
Private Equity Practice Group at Weil, Gotshal & Manges, LLP from January 2003 to January 2007. |
|
|
|
(1) |
|
After a Trustees initial term, each Trustee is expected to serve a three-year term
concurrent with the class of Trustees with which he serves. Messrs. Leary and Ward, as Class
I Trustees, were re-elected in 2007; Messrs. Hui and Kavanaugh, as Class II Trustees, were
re-elected in 2008; and Mr. Dougherty, the sole Class III Trustee, is expected to stand for
re-election in 2009. |
13
|
|
|
(2) |
|
The Highland Fund Complex consists of all of the registered investment companies advised by
Highland as of the date of this Statement of Additional Information. In addition, each
Trustee oversees Highland Distressed Opportunities Fund, Inc., a closed-end company that has
filed an election to be regulated as a business development company under the Investment
Company Act. |
|
(3) |
|
Independent Trustees are those who are not interested persons as that term is defined under
Section 2(a)(19) of the Investment Company Act. |
|
(4) |
|
Mr. Dougherty is deemed to be an interested person of the Acquiring Fund under the Investment
Company Act because of his position with the Investment Adviser. |
COMPENSATION OF TRUSTEES
The executive officers of the Acquiring Fund and the Trustees who are interested persons (as
defined in the 1940 Act) receive no direct remuneration from the
Acquiring Fund. Each Independent Trustee receives an annual retainer of $150,000 payable in quarterly
installments and allocated among each portfolio in the Highland Funds Complex based upon relative
net assets. Independent Trustees
are reimbursed for actual out-of-pocket expenses relating to attendance at meetings. The Trustees
do not have any pension or retirement plan.
The following table summarizes the compensation paid by the Acquiring Fund to the Trustees and
the aggregate compensation paid by the Highland Fund Complex to the Trustees.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregate Compensation from |
|
|
Aggregate Compensation from the |
|
Highland Fund Complex for the |
|
|
Acquiring Fund for the fiscal year |
|
calendar year ended December 31, |
Name of Trustee |
|
ended December 31, 2008 |
|
2008 |
INTERESTED TRUSTEE |
|
|
|
|
|
|
|
|
R. Joseph Dougherty |
|
$ |
0 |
|
|
$ |
0 |
|
|
|
|
|
|
|
|
|
|
INDEPENDENT TRUSTEES |
|
|
|
|
|
|
|
|
Bryan A. Ward |
|
$ |
23,863 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
|
|
Scott F. Kavanaugh |
|
$ |
23,863 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
|
|
James F. Leary |
|
$ |
23,863 |
|
|
$ |
150,000 |
|
|
|
|
|
|
|
|
|
|
Timothy K. Hui |
|
$ |
23,863 |
|
|
$ |
150,000 |
|
BOARD COMMITTEES
In connection with the Boards responsibility for the overall management and supervision of
the Acquiring Funds affairs, the Trustees meet periodically throughout the year to oversee the
Acquiring Funds activities, review contractual arrangements with service providers for the
Acquiring Fund and review the Acquiring Funds performance. To fulfill these duties, the Acquiring
Fund has an Audit Committee, a Nominating Committee, a Litigation Committee and a Qualified Legal
Compliance Committee.
The Audit Committee consists of Timothy Hui, Scott Kavanaugh, James Leary and Bryan Ward. The
Audit Committee acts according to the Audit Committee charter. Scott Kavanaugh has been appointed
as Chairman of the Audit Committee. The Audit Committee is responsible for (i) oversight of the
Acquiring Funds accounting and financial reporting processes and the audits of the Acquiring
Funds financial statements and (ii) providing assistance to the Board in connection with its
oversight of the integrity of the Acquiring Funds financial statements,
14
the Acquiring Funds compliance with legal and regulatory requirements and the independent
registered public accounting firms qualifications, independence and performance. The Board has
determined that the Acquiring Fund has one audit committee financial expert serving on its Audit
Committee, Jim Leary, who is independent for the purpose of the definition of audit committee
financial expert as applicable to the Acquiring Fund. The Audit
Committee met four times during
the last fiscal year.
The Nominating Committees function is to canvass, recruit, interview, solicit and nominate
trustees. The Nominating Committee considers recommendations for nominees from shareholders sent
to the Secretary of the Acquiring Fund, NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas
75240. A nomination submission must include all information relating to the recommended nominee
that is required to be disclosed in solicitations or proxy statements for the election of trustees,
as well as information sufficient to evaluate the factors listed above. Nomination submissions
must be accompanied by a written consent of the individual to stand for election if nominated by
the Board and to serve if elected by the shareholders, and such additional information must be
provided regarding the recommended nominee as reasonably requested by the Nominating Committee.
The Nominating Committee is comprised of Messrs. Hui, Kavanaugh, Leary and Ward. The Nominating
Committee met one time during the last fiscal year.
The Litigation Committees function is to seek to address any potential conflicts of interest
between or among the Acquiring Fund and the Investment Adviser in connection with any potential or
existing litigation or other legal proceeding relating to securities held by the Acquiring Fund and
the Investment Adviser or another client of the Investment Adviser. The Litigation Committee is
comprised of Messrs. Hui, Kavanaugh, Leary and Ward. The
Litigation Committee met four times during
the last fiscal year.
The Qualified Legal Compliance Committee (the QLCC) is charged with compliance with Rules
205.2(k) and 205.3(c) of the Code of Federal Regulations regarding alternative reporting procedures
for attorneys representing the Acquiring Fund who appear and practice before the Securities and
Exchange Commission (the Commission) on behalf of the Acquiring Fund. The QLCC is comprised of
Messrs. Hui, Kavanaugh, Leary and Ward. The QLCC did not meet during the last fiscal year.
PROXY VOTING POLICIES AND PROCEDURES
The Board of the Acquiring Fund has delegated the voting of proxies for the Acquiring Funds
securities to Highland pursuant to Highlands proxy voting policies and procedures. Under these
policies and procedures, Highland will vote proxies related to the Acquiring Funds securities in
the best interests of the Fund and its shareholders. A copy of Highlands proxy voting policies and
procedures is attached as Appendix B to this SAI and may be changed from time to time by Highland
with the approval of the Acquiring Funds Board of Trustees. The Acquiring Funds proxy voting
record for the most recent 12-month period ending June 30 is available without charge, upon
request, by (i) calling 1-877-665-1287 or (ii) visiting the SECs web site (http://www.sec.gov).
CODES OF ETHICS
The Acquiring Fund and the Investment Adviser have adopted codes of ethics under Rule 17j-1 of
the 1940 Act. These codes permit personnel subject to the codes to invest in securities, including
securities that may be purchased or held by the Acquiring Fund. These codes can be reviewed and
copied at the SECs Public Reference Room in Washington, D.C. Information on the operation of the
Public Reference Room may be obtained by calling the SEC at 1-202-551-8090. The codes of ethics are
available on the EDGAR Database on the SECs 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 SECs Public Reference Section, Washington,
D.C. 20549-0102.
ADMINISTRATION SERVICES
Pursuant to the administration services agreement between the Acquiring Fund and Highland,
Highland performs the following services: (i) prepare monthly security transaction listings; (ii)
supply various normal and customary portfolio and Acquiring Fund statistical data as requested on
an ongoing basis; (iii) prepare for execution and file the Acquiring Funds federal and state tax
returns; prepare a fiscal tax provision in coordination with the
15
annual audit; prepare an excise tax provision; and prepare all relevant Form 1099 calculations;
(iv) coordinate contractual relationships and communications between the Acquiring Fund and its
contractual service providers; (v) coordinate printing of the Acquiring Funds annual and
semi-annual shareholder reports; (vi) prepare income and capital gain distributions; (vii) prepare
the semiannual and annual financial statements; (viii) monitor the Acquiring Funds compliance with
Code, SEC and prospectus requirements; (ix) prepare, coordinate with the Acquiring Funds counsel
and coordinate the filing with the SEC: semi-annual reports on Form N-SAR and Form N-CSR; Form
N-Q; and Form N-PX based upon information provided by the Acquiring Fund, assist in the preparation
of Forms 3, 4 and 5 pursuant to Section 16 of the Securities Exchange Act of 1934, as amended, and
Section 30(f) of the 1940 Act for the officers and trustees of the Acquiring Fund, such filings to
be based on information provided by those persons; (x) assist in the preparation of notices of
meetings of shareholders and coordinate preparation of proxy statements; (xi) assist in obtaining
the fidelity bond and trustees and officers/errors and omissions insurance policies for the
Acquiring Fund in accordance with the requirements of Rule 17g-1 and 17d-1(d)(7) under the 1940
Act; (xii) monitor the Acquiring Funds assets to assure adequate fidelity bond coverage is
maintained; (xiii) draft agendas and resolutions for quarterly and special board meetings; (xiv)
coordinate the preparation, assembly and mailing of board materials; (xv) attend board meetings and
draft minutes thereof; (xvi) maintain the Acquiring Funds calendar to assure compliance with
various filing and board approval deadlines; (xvii) assist the Acquiring Fund in the handling of
SEC examinations and responses thereto; (xviii) assist the Acquiring Funds chief executive officer
and chief financial officer in making certifications required under the SECs disclosure forms;
(xix) prepare and coordinate the Acquiring Funds state notice filings; (xx) furnish the Acquiring
Funds office space in the offices of Highland, or in such other place or places as may be agreed
from time to time, and all necessary office facilities, simple business equipment, supplies,
utilities and telephone service for managing the affairs of the Acquiring Fund; (xxi) perform
clerical, bookkeeping, recordkeeping, and all other administrative services not provided by the
Acquiring Funds other service providers; (xxii) determine or oversee the determination and
publication of the Acquiring Funds net asset value in accordance with the Acquiring Funds policy
as adopted from time to time by the Board of Trustees; (xxiii) oversee the maintenance by the
Acquiring Funds custodian and transfer agent and dividend disbursing agent of certain books and
records of the Acquiring Fund as required under Rule 31a-1(b)(2)(iv) of the 1940 Act and maintain
(or oversee maintenance by such other persons as approved by the board of trustees) such other
books and records required by law or for the proper operation of the Acquiring Fund; (xxiv)
determine the amounts available for distribution as dividends and distributions to be paid by the
Acquiring Fund to its shareholders; calculate, analyze and prepare a detailed income analysis and
forecast future earnings for presentation to the Board; prepare and arrange for the printing of
dividend notices to shareholders, as applicable; and provide to the Acquiring Funds dividend
disbursing agent and custodian with such information as is required for such parties to effect the
payment of dividends and distributions and to implement the Acquiring Funds dividend reinvestment
plan; (xxv) serve as liaison between the Acquiring Fund and each of its service providers; (xxvi)
assist in monitoring and tracking the daily cash flows of the individual assets of the Acquiring
Fund, as well as security position data of portfolio investments; assist in resolving any
identified discrepancies with the appropriate third party, including the Acquiring Funds
custodian, administrative agents and other service providers, through various means including
researching available data via agent notices, financial news and data services, and other sources;
(xxvii) monitor compliance with leverage tests under the Acquiring Funds credit facility, and
communicate with leverage providers and rating agencies; (xxviii) coordinate negotiation and
renewal of credit agreements for presentation to the Board; (xxix) coordinate negotiations of
agreements with counterparties and the Acquiring Funds custodian for derivatives, short sale and
similar transactions, as applicable; (xxx) provide assistance with the settlement of trades of
portfolio securities; (xxxi) coordinate and oversee the provision of legal services to the
Acquiring Fund; (xxxii) cooperate with the Acquiring Funds independent registered public
accounting firm in connection with audits and reviews of the Acquiring Funds financial statements,
including interviews and other meetings, and provide necessary information and coordinate
confirmations of bank loans and other assets for which custody is not through DTC, as necessary;
(xxxiii) provide Secretary and any Assistant Secretaries, Treasurer and any Assistant Treasurers
and other officers for the Acquiring Fund as requested; (xxxiv) develop or assist in developing
compliance guidelines and procedures; (xxxv) investigate and research customer and other complaints
to determine liability, facilitate resolution and promote equitable treatment of all parties;
(xxxvi) determine and monitor expense accruals for the Acquiring Fund; (xxxvii) authorize
expenditures and approve bills for payment on behalf of the Acquiring Fund; (xxxviii) monitor the
number of shares of the Acquiring Fund registered and assist in the registration of additional
shares, as necessary; (xxxix) prepare such reports as the Board may request from time to time; (xl)
administer and oversee any securities lending program of the Acquiring Fund; and perform such
additional administrative duties relating to the administration of the Acquiring Fund as may
subsequently be agreed upon in writing between the Acquiring Fund and Highland. Highland shall have
the authority to engage a sub-administrator in connection with
16
the administrative services of the Acquiring Fund, which sub-administrator may be an affiliate of
Highland; provided, however, that Highland shall remain responsible to the Acquiring Fund with
respect to its duties and obligations set forth in the administration services agreement.
ADMINISTRATION AND ACCOUNTING SERVICES
Highland provides administration services to the Acquiring Fund, For such services, Highland
receives an annual fee, payable monthly, in an amount equal to 0.20% of the average weekly value of
the Acquiring Funds Managed Assets. The Acquiring Funds Managed Assets will be an
amount equal to the total assets of the Acquiring Fund, including any form of investment leverage,
minus all accrued expenses incurred in the normal course of operations, but not excluding any
liabilities or obligations attributable to investment leverage obtained through (i) indebtedness of
any type (including, without limitation, borrowing through a credit facility or the issuance of
debt securities), (ii) the issuance of preferred stock or other similar preference securities,
(iii) the reinvestment of collateral received for securities loaned in accordance with the
Acquiring Funds investment objectives and policies, and/or (iv) any other means. Under a separate
sub-administration agreement, Highland has delegated certain administrative functions to PNC
Global Investment Servicing (U.S.) Inc. (PNC).
The Acquiring Fund is a party to an administration and accounting services agreement with PNC
Inc. pursuant to which PNC provides administrative and accounting services to the Acquiring Fund.
Pursuant to the Acquiring Funds Administration and Accounting Services Agreement dated April 10,
2006, PNC receives an annual fee, payable monthly, in an amount equal to 0.01%, subject to a
minimum fee, of the average weekly value of the Acquiring Funds Managed Assets plus certain other
fees.
PORTFOLIO MANAGERS
The
Acquiring Fund is managed by Brad Borud (since April 2008) and Brad
Means (since January 2009). As of January 1, 2009 they managed the
following client accounts.
Brad Borud
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
|
|
|
Total Number |
|
|
|
Accounts Managed |
|
Total Assets Managed |
|
|
of Accounts |
|
Total Assets |
|
with Performance- |
|
with Performance- |
Type of Accounts |
|
Managed |
|
Managed |
|
Based Advisory Fee |
|
Based Advisory Fee |
Registered
Investment
Companies: |
|
|
9 |
|
|
$ |
3,039,600,000 |
|
|
|
2 |
|
|
$ |
106,700,000 |
|
Other Pooled
Investment
Vehicles: |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
Other Accounts: |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
Brad Means
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
Total Number of |
|
|
|
|
Number of |
|
|
|
Accounts Managed |
|
Total Assets Managed |
|
|
Accounts |
|
Total Assets |
|
with Performance- |
|
with Performance- |
Type of Accounts |
|
Managed |
|
Managed |
|
Based Advisory Fee |
|
Based Advisory Fee |
Registered Investment Companies: |
|
|
4 |
|
|
$ |
2,249,100,000 |
|
|
|
0 |
|
|
$ |
0 |
|
Other Pooled Investment Vehicles: |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
Other Accounts: |
|
|
0 |
|
|
$ |
0 |
|
|
|
0 |
|
|
$ |
0 |
|
17
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Conflicts of Interest
The Investment Adviser has built a professional working environment, a firm-wide compliance
culture and compliance procedures and systems designed to protect against potential incentives that
may favor one account over another. The Investment Adviser has adopted policies and procedures
that address the allocation of investment opportunities, execution of portfolio transactions,
personal trading by employees and other potential conflicts of interest that are designed to ensure
that all client accounts are treated equitably over time. Nevertheless, the Investment Adviser
furnishes advisory services to numerous clients in addition to the Acquiring Fund, and the
Investment Adviser may, consistent with applicable law, make investment recommendations to other
clients or accounts (including accounts which are hedge funds or have performance or higher fees
paid to the Investment Adviser, or in which portfolio managers have a personal interest in the
receipt of such fees), which may be the same as or different from those made to the Acquiring Fund.
In addition, the Investment Adviser, its affiliates and any officer, director, stockholder or
employee may or may not have an interest in the securities whose purchase and sale the Investment
Adviser recommends to the Acquiring Fund. Actions with respect to securities of the same kind may
be the same as or different from the action which the Investment Adviser, or any of its affiliates,
or any officer, director, stockholder, employee or any member of their families may take with
respect to the same securities. Moreover, the Investment Adviser may refrain from rendering any
advice or services concerning securities of companies of which any of the Investment Advisers (or
its affiliates) officers, directors or employees are directors or officers, or companies as to
which the Investment Adviser or any of its affiliates or the officers, directors and employees of
any of them has any substantial economic interest or possesses material non-public information. In
addition to its various policies and procedures designed to address these issues, the Investment
Adviser includes disclosure regarding these matters to its clients in both its Form ADV and
investment advisory agreements.
The Investment Adviser, its affiliates or their officers and employees serve or may serve as
officers, directors or principals of entities that operate in the same or related lines of business
or of investment funds managed
18
by affiliates of the Investment Adviser. Accordingly, these individuals may have obligations to
investors in those entities or funds or to other clients, the fulfillment of which might not be in
the best interests of the Acquiring Fund. As a result, the Investment Adviser will face conflicts
in the allocation of investment opportunities to the Acquiring Fund and other funds and clients. In
order to enable such affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Investment Adviser will endeavor to allocate investment opportunities
in a fair and equitable manner which may, subject to applicable regulatory constraints, involve pro
rata co-investment by the Acquiring Fund and such other clients or may involve a rotation of
opportunities among the Acquiring Fund and such other clients.
The Investment Adviser and its affiliates have both subjective and objective procedures and
policies in place designed to manage the potential conflicts of interest between the Investment
Advisers fiduciary obligations to the Acquiring Fund and their similar fiduciary obligations to
other clients so that, for example, investment opportunities are allocated in a fair and equitable
manner among the Acquiring Fund and such other clients. An investment opportunity that is suitable
for multiple clients of the Investment Adviser and its affiliates may not be capable of being
shared among some or all of such clients due to the limited scale of the opportunity or other
factors, including regulatory restrictions imposed by the 1940 Act. There can be no assurance that
the Investment Advisers or its affiliates efforts to allocate any particular investment
opportunity fairly among all clients for whom such opportunity is appropriate will result in an
allocation of all or part of such opportunity to the Acquiring Fund. Not all conflicts of interest
can be expected to be resolved in favor of the Acquiring Fund.
Under current SEC regulations, the Acquiring Fund may be prohibited from co-investing with any
unregistered fund managed now or in the future by Highland in certain private placements in which
Highland negotiates non-pricing terms.
COMPENSATION
Highlands financial arrangements with its portfolio managers, its competitive compensation
and its career path emphasis at all levels reflect the value senior management places on key
resources. Compensation may include a variety of components and may vary from year to year based
on a number of factors, including the relative pre-tax performance of a portfolio managers
underlying account, the pre-tax combined performance of the portfolio managers underlying
accounts, and the pre-tax relative performance of the portfolio managers underlying accounts
measured against other employees. The principal components of compensation include a base salary,
a discretionary bonus, various retirement benefits and one or more of the incentive compensation
programs established by Highland, such as its Short-Term Incentive Plan and its Long-Term
Incentive Plan, described below.
BASE COMPENSATION
Generally, portfolio managers receive base compensation based on their seniority and/or their
position with Highland, which may include the amount of assets supervised and other management
roles within Highland. Base compensation is determined by taking into account current industry
norms and market data to ensure that Highland pays a competitive base compensation.
DISCRETIONARY COMPENSATION
In addition to base compensation, portfolio managers may receive discretionary compensation,
which can be a substantial portion of total compensation. Discretionary compensation can include a
discretionary cash bonus paid to recognize specific business contributions and to ensure that the
total level of compensation is competitive with the market, as well as participation in incentive
plans, including one or more of the following:
Short-Term Incentive PlanThe purpose of this plan is to attract and retain the
highest quality employees for positions of substantial responsibility, and to provide additional
incentives to a select group of management or highly -compensated employees of Highland in order
to promote the success of Highland.
Long-Term Incentive PlanThe purpose of this plan is to create positive morale and
teamwork, to attract and retain key talent and to encourage the achievement of common goals.
This plan seeks to reward participating employees based on the increased value of Highland.
19
Because each persons compensation is based on his or her individual performance, Highland
does not have a typical percentage split among base salary, bonus and other compensation. Senior
portfolio managers who perform additional management functions may receive additional compensation
in these other capacities. Compensation is structured such that key professionals benefit from
remaining with Highland. Highland believes it is in the best interest of shareholders to maintain
stability of portfolio management personnel.
SECURITIES OWNERSHIP OF PORTFOLIO MANAGERS
The following table sets forth the dollar range of equity securities of the Acquiring Fund
beneficially owned by each portfolio manager as of the end of the Acquiring Funds most recently
completed fiscal year.
|
|
|
|
|
|
|
Dollar Range of Equity Securities Beneficially Owned |
|
|
by Portfolio Manager in the Acquiring Fund for the |
Name of Portfolio Manager |
|
fiscal year ended December 31, 2008 |
Brad Borud |
|
$ |
100,001 - $500,000 |
|
Brad Means |
|
$ |
10,001 - 50,000 |
|
PORTFOLIO TRANSACTIONS AND BROKERAGE
Selection of Broker-Dealers; Order Placement
Subject to the overall review of the Board, the Investment Adviser is responsible for
decisions to buy and sell securities and other portfolio holdings of the Acquiring Fund, for
selecting the broker or dealer to be used, and for negotiating any commission rates paid. In
underwritten offerings, securities usually are purchased at a fixed price that includes an amount
of compensation to the underwriter, generally referred to as the underwriters concession or
discount. On occasion, certain money market instruments may be purchased directly from an issuer,
in which case no commissions or discounts are paid.
The Investment Adviser and its affiliates manage other accounts, including private funds and
individual accounts that invest in senior loans and other Acquiring Fund investments. Although
investment decisions for the Acquiring Fund are made independently from those of such other
accounts, investments of the type the Acquiring Fund may make also may be made on behalf of such
other accounts. When the Acquiring Fund and one or more other accounts is prepared to invest in, or
desires to dispose of, the same investment, available investments or opportunities for each are
allocated in a manner believed by the Investment Adviser to be equitable over time. The Investment
Adviser may (but is not obligated to) aggregate orders, which may include orders for accounts in
which the Investment Adviser or its affiliates have an interest, to purchase and sell securities to
obtain favorable execution or lower brokerage commissions, to the extent permitted by applicable
laws and regulations. Although the Investment Adviser believes that, over time, the potential
benefits of participating in volume transactions and negotiating lower transaction costs should
benefit all participating accounts, in some cases these activities may adversely affect the price
paid or received or the size of the position obtained by or disposed of for the Acquiring Fund.
Where trades are aggregated, the investments or proceeds, as well as the expenses incurred, will be
allocated by the Investment Adviser in a manner designed to be equitable and consistent with the
Investment Advisers fiduciary duty to the Acquiring Fund and its other clients (including its duty
to seek to obtain best execution of client trades).
Commission Rates; Brokerage and Research Services
In placing orders for the Acquiring Funds portfolio, the Investment Adviser is required to
give primary consideration to obtaining the most favorable price and efficient execution. This
means that the Investment Adviser will seek to execute each transaction at a price and commission,
if any, which provides the most favorable total cost
20
or proceeds reasonably attainable in the circumstances. In seeking the most favorable price
and execution, the Investment Adviser, having in mind the Acquiring Funds best interests, will
consider all factors it deems relevant, including, by way of illustration: price; the size, type
and difficulty of the transaction; the nature of the market for the security; the amount of the
commission; the timing of the transaction taking into account market prices and trends; operational
capabilities; the reputation, experience and financial stability of the broker-dealer involved; and
the quality of service rendered by the broker-dealer in other transactions. Though the Investment
Adviser generally seeks reasonably competitive commissions or spreads, the Acquiring Fund will not
necessarily be paying the lowest commission or spread available. The Investment Adviser may place
portfolio transactions, to the extent permitted by law, with brokerage firms participating in a
distribution of the Acquiring Funds shares if it reasonably believes that the quality of execution
and the commission are comparable to that available from other qualified firms.
The Investment Adviser seeks to obtain best execution considering the execution price and
overall commission costs paid and other factors. The Investment Adviser routes its orders to
various broker-dealers for execution at its discretion. Factors involved in selecting brokerage
firms include the size, type and difficulty of the transaction, the nature of the market for the
security, the reputation, experience and financial stability of the broker-dealer involved, the
quality of service, the quality of research and investment information provided and the firms risk
in positioning a block of securities. Within the framework of the policy of obtaining the most
favorable price and efficient execution, the Investment Adviser does consider brokerage and
research services (as defined in the Securities Exchange Act of 1934, as amended) provided by
brokers who effect portfolio transactions with the Investment Adviser or the Acquiring Fund.
Brokerage and research services are services that brokerage houses customarily provide to
institutional investors and include statistical and economic data and research reports on
particular issuers and industries.
Affiliated Brokers; Regular Broker-Dealers
Highland is currently affiliated with NexBank Securities, Inc. (NexBank), a FINRA
member broker-dealer that is indirectly controlled by the principals of Highland. Absent an
exemption from the SEC or other regulatory relief, the Acquiring Fund is generally precluded from
effecting certain principal transactions with affiliated brokers. The Acquiring Fund may utilize
affiliated brokers for agency transactions subject to compliance with policies and procedures
adopted pursuant to Rule 17e-1 under the Investment Company Act. These policies and procedures are
designed to provide that commissions, fees or other remuneration received by any affiliated broker
or its affiliates for agency transactions are reasonable and fair compared to the remuneration
received by other brokers in comparable transactions.
During the fiscal period ended December 31, 2006, the Acquiring Fund paid brokerage
commissions of $166,787, of which $1,815 was paid to NexBank.
During the fiscal year ended December 31, 2007, the Acquiring Fund paid brokerage commissions
of $99,535, of which $26,414 was paid to NexBank.
During the fiscal year ended December 31, 2008, the Acquiring Fund paid brokerage
commissions of $382,281, of which $20,122 was paid to NexBank.
During
the fiscal year ended December 31, 2008,
transactions in which the Acquiring Fund used NexBank as broker
comprised 6.36% of the aggregate
dollar amount of transactions involving the payment of commissions,
and 5.26% of the aggregate
brokerage commissions paid by the Acquiring Fund. 100% of the $362,159 paid to other brokers by the
Acquiring Fund during the fiscal year ended December 31, 2008 (representing commissions on
transactions involving approximately $273,242,588) was directed to those brokers at least partially
on the basis of research services they provided. At that date, the Acquiring
Fund did not hold any securities of its regular brokers or dealers. For these purposes, regular
brokers or dealers are (a) the brokers or dealers that received the greatest dollar amount of
brokerage commissions by virtue of direct or indirect participation in the Acquiring Funds
portfolio transactions during the Acquiring Funds most recent fiscal year, (b) the brokers or
dealers that engaged as principal in the largest dollar amount of portfolio transaction of the
Acquiring Fund during the Acquiring Funds most recent fiscal year, or (c) the brokers or dealers
that sold the largest dollar amount of securities of the Acquiring Fund during the Acquiring Funds
most recent fiscal year.
21
REPURCHASE OF COMMON SHARES
The Acquiring Fund is a closed-end management investment company and as such its shareholders
will not have the right to cause the Acquiring Fund to redeem their shares. Instead, the Acquiring
Funds common shares will trade in the open market at a price that will be a function of several
factors, including dividend levels (which are in turn affected by expenses), net asset value, call
protection, dividend stability, relative demand for and supply of such shares in the market,
general market and economic conditions and other factors. Because shares of a closed-end
investment company may frequently trade at prices lower than net asset value, the Board may
consider action that might be taken to reduce or eliminate any material discount from net asset
value in respect of common shares, which may include the repurchase of such shares in the open
market or in private transactions, the making of a tender offer for such shares, or the conversion
of the Acquiring Fund to an open-end investment company. The Board may decide not to take any of
these actions. In addition, there can be no assurance that share repurchases or tender offers, if
undertaken, will reduce market discount.
Notwithstanding the foregoing, at any time when there are outstanding borrowings, the
Acquiring Fund may not purchase, redeem or otherwise acquire any of its common shares unless (i)
all accrued preferred shares dividends have been paid and (ii) at the time of such purchase,
redemption or acquisition, the net asset value of the Acquiring Funds portfolio (determined after
deducting the acquisition price of the common shares) is at least 200% of the liquidation value of
the outstanding borrowings. Any service fees incurred in connection with any tender offer made by
the Acquiring Fund will be borne by the Acquiring Fund and will not reduce the stated consideration
to be paid to tendering shareholders.
Subject to its investment restrictions, the Acquiring Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to finance share
repurchase transactions or the accumulation of cash by the Acquiring Fund in anticipation of share
repurchases or tenders will reduce the Acquiring Funds net income. Any share repurchase, tender
offer or borrowing that might be approved by the Board would have to comply with the Securities
Exchange Act of 1934, as amended, the Investment Company Act and the rules and regulations
thereunder.
The repurchase by the Acquiring Fund of its shares at prices below net asset value will result
in an increase in the net asset value of those shares that remain outstanding. However, there can
be no assurance that share repurchases or tender offers at or below net asset value will result in
the Acquiring Funds shares trading at a price equal to their net asset value. Nevertheless, the
fact that the Acquiring Funds shares may be the subject of repurchase or tender offers from time
to time, or that the Acquiring Fund may be converted to an open-end investment company, may reduce
any spread between market price and net asset value that might otherwise exist.
Before deciding whether to take any action if the common shares trade below net asset value,
the Board would likely consider all relevant factors, including the extent and duration of the
discount, the liquidity of the Acquiring Funds portfolio, the impact of any action that might be
taken on the Acquiring Fund or its shareholders and market considerations. Based on these
considerations, even if the Acquiring Funds shares should trade at a discount, the Board may
determine that, in the interest of the Acquiring Fund and its shareholders, no action should be
taken.
If the Board determines to repurchase common shares in a private transaction or to make a
tender offer for the common shares, it is expected that the terms of any such offer will require a
selling or tendering (as applicable) shareholder to sell or tender (and thus effectively sell) all
of his or her common shares held, or considered to be held under certain attribution rules of the
Code, by such shareholder. In either such case, shareholders who sell (in a private repurchase
transaction) or successfully tender and effectively sell (pursuant to a tender offer) to the
Acquiring Fund all common shares held or considered to be held by them generally will be treated as
having sold their shares and generally will realize a capital gain or loss. On the other hand, if
a shareholder sells or tenders and effectively sells, as applicable, fewer than all of his or her
common shares, such shareholder may be treated as having received a taxable dividend upon the sale
or tender of his or her common shares. In such a case, there is a risk that shareholders whose
percentage share interests in the Acquiring Fund increase as a result of such sale or tender will
be treated as having received a taxable distribution from the Acquiring Fund. The extent of such
risk will vary depending upon the particular circumstances of the private repurchase or tender
offer, in particular whether such offer is a single and isolated event or is part of a plan for
periodically redeeming the common shares of the
22
Acquiring Fund; if isolated, any such risk is likely remote. If, instead, the Board
determines to repurchase common shares on the open market, such that a selling shareholder would
have no specific knowledge that he or she is selling his or her shares to the Acquiring Fund, it is
less likely that shareholders whose percentage share interests in the Acquiring Fund increase as a
result of any such open-market sale will be treated as having received a taxable distribution from
the Acquiring Fund.
To the extent the Acquiring Fund recognizes net gains on the liquidation of portfolio securities to
meet any such repurchase or tender, the Acquiring Fund will be required to make additional
distributions to its common shareholders.
TAX MATTERS
The following discussion of U.S. federal income tax consequences of investment in the
Acquiring Fund is based on the Code, U.S. Treasury regulations promulgated thereunder, and other
applicable authority, as of the date of this SAI. These authorities are subject to change by
legislative or administrative action, possibly with retroactive effect. The following discussion
is only a summary of some of the important U.S. federal tax considerations generally applicable to
investments in the Acquiring Fund and does not constitute tax advice. There may be other tax
considerations applicable to particular shareholders. Shareholders should consult their own tax
advisors regarding their particular situation and the possible application of foreign, state and
local tax laws.
Taxation of the Acquiring Fund
The Acquiring Fund intends to elect to be treated and to qualify each year as a regulated
investment company under Subchapter M of the Code (RIC). In order to qualify for the special tax
treatment accorded RICs and their shareholders, the Acquiring Fund must, among other things:
(i) derive at least 90% of its gross income for each taxable year from: (a) dividends,
interest (including tax-exempt interest), payments with respect to certain securities loans, gains
from the sale or other disposition of stock, securities or foreign currencies, or other income
(including but not limited to gains from options, futures and forward contracts) derived with
respect to its business of investing in such stock, securities or foreign currencies; and (b) net
income derived from interests in qualified publicly traded partnerships (as defined below);
(ii) diversify its holdings so that, at the end of each quarter of the Acquiring Funds
taxable year, (a) at least 50% of the market value of the Acquiring Funds total assets consists of
cash and cash items, U.S. government securities, the securities of other RICs and other securities
limited, in respect of any one issuer, to an amount not greater than 5% of the value of the
Acquiring Funds total assets and not more than 10% of the outstanding voting securities of such
issuer, and (b) not more than 25% of the value of the Acquiring Funds total assets is invested (x)
in the securities (other than U.S. government securities and the securities of other RICs) of any
one issuer or of two or more issuers that the Acquiring Fund controls (by owning 20% or more of
their voting power) and that are determined to be engaged in the same business or similar or
related trades or businesses, or (y) in the securities of one or more qualified publicly traded
partnerships (as defined below); and
(iii) distribute to its shareholders with respect to each taxable year at least 90% of the sum
of its investment company taxable income (as that term is defined in the Code without regard to the
deduction for dividends paidgenerally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and any net tax-exempt interest income
(the excess of its gross tax-exempt interest over certain disallowed deductions), for such year.
In general, for purposes of the 90% gross income requirement described in (i) above, income
derived from a partnership will be treated as qualifying income only to the extent such income is
attributable to items of income of the partnership which would be qualifying income if realized
directly by the RIC. However, 100% of the net income derived from an interest in a qualified
publicly traded partnership (defined as a partnership (x) interests in which are traded on an
established securities market or readily tradable on a secondary market or the substantial
equivalent thereof (y) that derives at least 90% of its income from the passive income sources
defined in Code section 7704(d), and (z) that derives less than 90% of its income from the
qualifying income described in (i)(a)
23
above) will be treated as qualifying income. In addition, although in general the passive
loss rules of the Code do not apply to RICs, such rules do apply to a RIC with respect to items
attributable to an interest in a qualified publicly traded partnership.
For purposes of meeting the diversification requirement described in (ii) above, in the case
of the Acquiring Funds investment in Participations, the Acquiring Fund shall treat both the
Lender of and the borrower under the underlying Loan as an issuer. Also, for purposes of (ii)(a)
above, the term outstanding voting securities of such issuer will include the equity securities
of a qualified publicly traded partnership.
If the Acquiring Fund qualifies as a RIC that is accorded special tax treatment, the Acquiring
Fund will not be subject to U.S. federal income tax on income distributed in a timely manner to its
shareholders in the form of dividends (including Capital Gain Dividends, as defined below in
Acquiring Fund Distributions).
If, for any taxable year, the Acquiring Fund were to fail to qualify as a RIC accorded special
tax treatment, the Acquiring Fund would be subject to tax on its taxable income at corporate rates,
and all distributions from earnings and profits, including any distributions of net tax-exempt
income and net long-term capital gains, would be taxable to shareholders as ordinary income. Some
portions of such distributions may be eligible for the dividends-received deduction in the case of
corporate shareholders and to be treated as qualified dividend income and thus taxable at the
lower long-term capital gain rate in the case of shareholders taxed as individuals. In addition,
the Acquiring Fund could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying as a RIC that is accorded special
tax treatment.
The Acquiring Fund intends to distribute at least annually to its shareholders substantially
all of its investment company taxable income (computed without regard to the dividends-paid
deduction) and may distribute its net capital gain. Any investment company taxable income retained
by the Acquiring Fund will be subject to Acquiring Fund-level tax at regular corporate rates. The
Acquiring Fund may also retain for investment its net capital gain. If the Acquiring Fund retains
any net capital gain, it will be subject to Acquiring Fund-level tax at regular corporate rates on
the amount retained, but may designate the retained amount as undistributed capital gains in a
notice to its shareholders who (i) will be required to include in income for U.S. federal income
tax purposes, as long-term capital gain, their shares of such undistributed amount, and (ii) will
be entitled to credit their proportionate shares of the tax paid by the Acquiring Fund on such
undistributed amount against their U.S. federal income tax liabilities, if any, and to claim
refunds on a properly-filed U.S. tax return to the extent the credit exceeds such liabilities. For
U.S. federal income tax purposes, the tax basis of shares owned by a shareholder of the Acquiring
Fund will be increased by an amount equal under current law to the difference between the amount of
undistributed capital gains included in the shareholders gross income under clause (i) of the
preceding sentence and the tax deemed paid by the shareholder under clause (ii) of the preceding
sentence.
In determining its net capital gain for Capital Gain Dividend purposes, a RIC generally must
treat any net capital loss or any net long-term capital loss incurred after October 31 as if it had
been incurred in the succeeding year. Treasury regulations permit a RIC, in determining its
taxable income, to elect to treat all or part of any net capital loss, any net long-term capital
loss or any foreign currency loss incurred after October 31 as if it had been incurred in the
succeeding year.
If the Acquiring Fund fails to distribute in a calendar year at least an amount equal to the
sum of 98% of its ordinary income for such year and 98% of its capital gain net income (adjusted
for certain ordinary losses) for the one-year period ending on October 31 of such year (unless an
election is made to use the Acquiring Funds fiscal year), plus any retained amount from the prior
year, the Acquiring Fund will be subject to a nondeductible 4% excise tax on the undistributed
amounts. For these purposes, the Acquiring Fund will be treated as having distributed any amount
on which it has been subject to corporate income tax in the taxable year ending with the calendar
year. The Acquiring Fund reserves the right to pay the excise tax when circumstances warrant.
Acquiring Fund Distributions
Distributions are taxable to shareholders even if they are paid from income or gains earned by
the Acquiring Fund before a shareholders investment (and thus were included in the price the
shareholder paid). Distributions are taxable whether shareholders receive them in cash or reinvest
them in additional shares through the
24
Acquiring Funds Dividend Reinvestment Plan. A shareholder whose distributions are reinvested
in shares will be treated as having received a dividend equal to either (i) the fair market value
of the new shares issued to the shareholder, or (ii) if the shares are trading below net asset
value, the amount of cash allocated to the shareholder for the purchase of shares on its behalf in
the open market. See Dividend Reinvestment Plan in the Acquiring Funds Proxy
Statement/Prospectus for more information.
Dividends and other distributions paid by the Acquiring Fund are generally treated under the
Code as received by you at the time the dividend or distribution is made. However, a dividend paid
to shareholders in January of a year generally is deemed to have been paid by the Acquiring Fund on
December 31 of the preceding year, if the dividend was declared and payable to shareholders of
record on a date in October, November or December of that preceding year.
The Acquiring Fund will send you information after the end of each year setting forth the
amount and tax status of any distributions paid to you by the Acquiring Fund. Ordinary income
dividends and Capital Gain Dividends may also be subject to state and local taxes.
For U.S. federal income tax purposes, distributions of investment income are generally taxable
as ordinary income. Taxes on distributions of capital gains are determined by how long the
Acquiring Fund has owned or is treated as having owned the investments that generated them, rather
than how long a shareholder has owned his or her shares. Distributions attributable to the excess
of net long-term capital gain earned from the sale of investments that the Acquiring Fund owned (or
is treating as having owned) for more than one year over net short-term capital loss from the sale
of investments that the Acquiring Fund owned (or is treating as having owned) for one year or less
and that are properly designated by the Acquiring Fund as capital gain dividends (Capital Gain
Dividends) will generally be taxable to the shareholder receiving such distributions as long-term
capital gains. Distributions from capital gains are generally made after applying any available
capital loss carryovers. Long-term capital gain rates applicable to individuals have been
temporarily reducedin general, to 15% with lower rates applying to taxpayers in the 10% and 15%
rate bracketsfor taxable years beginning before January 1, 2011. Distributions attributable to
the excess of net short-term capital gain from the sale of investments that the Acquiring Fund
owned (or is treating as having owned) for one year or less over net long-term capital loss from
the sale of investments that the Acquiring Fund owned (or is treating as having owned) for more
than one year will generally be taxable to the shareholder receiving such distributions as ordinary
income. For taxable years beginning before January 1, 2011, distributions of investment income
designated by the Acquiring Fund as derived from qualified dividend income will be taxed in the
hands of individuals at the rates applicable to long-term capital gain, provided holding period and
other requirements are met at both the shareholder and Acquiring Fund level. The Acquiring Fund
does not expect a significant portion of Acquiring Fund distributions to be derived from qualified
dividend income.
In order for some portion of the dividends received by a Acquiring Fund shareholder to be
qualified dividend income, the Acquiring Fund must meet holding period and other requirements
with respect to some portion of the dividend-paying stocks in its portfolio and the shareholder
must meet holding period and other requirements with respect to the Acquiring Funds shares. A
dividend will not be treated as qualified dividend income (at either the Acquiring Fund or
shareholder level) (1) if the dividend is received with respect to any share of stock held for
fewer than 61 days during the 121-day period beginning on the date which is 60 days before the date
on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain
preferred stock, 91 days during the 181-day period beginning 90 days before such date), (2) to the
extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to
make related payments with respect to positions in substantially similar or related property, (3)
if the recipient elects to have the dividend income treated as investment income for purposes of
the limitation on deductibility of investment interest, or (4) if the dividend is received from a
foreign corporation that is (a) not eligible for the benefits of a comprehensive income tax treaty
with the United States (with the exception of dividends paid on stock of such a foreign corporation
readily tradable on an established securities market in the United States) or (b) treated as a
passive foreign investment company.
In general, distributions of investment income designated by the Acquiring Fund as derived
from qualified dividend income will be treated as qualified dividend income by a shareholder taxed
as an individual, provided the shareholder meets the holding period and other requirements
described in the paragraph immediately above with respect to the Acquiring Funds shares.
25
Dividends of net investment income received by corporate shareholders of the Acquiring Fund
will qualify for the 70% dividends-received deduction generally available to corporations to the
extent of the amount of qualifying dividends received by the Acquiring Fund from domestic
corporations for the taxable year. A dividend received by the Acquiring Fund will not be treated
as a qualifying dividend (1) if it has been received with respect to any share of stock that the
Acquiring Fund has held for less than 46 days (91 days in the case of certain preferred stock)
during the 91-day period beginning on the date which is 45 days before the date on which such share
becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days
before such date in the case of certain preferred stock) or (2) to the extent that the Acquiring
Fund is under an obligation (pursuant to a short sale or otherwise) to make related payments with
respect to positions in substantially similar or related property. Moreover, the
dividends-received deduction may be disallowed or reduced (1) if the stock on which the dividend is
paid is considered to be debt-financed (generally, acquired with borrowed funds), (2) if the
corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the
Acquiring Fund or (3) by application of the Code. The Acquiring Fund does not expect a significant
portion of Acquiring Fund distributions to be eligible for this corporate dividends-received
deduction.
To the extent that the Acquiring Fund makes a distribution of income received by the Acquiring
Fund in lieu of dividends (a substitute payment) with respect to securities on loan pursuant to a
securities lending transaction, such income will not constitute qualified dividend income to
individual shareholders and will not be eligible for the dividends-received deduction for corporate
shareholders. Similar consequences may apply to repurchase agreements and certain Derivative
Transactions.
Return of Capital Distributions
If the Acquiring Fund makes a distribution to a shareholder in excess of the Acquiring Funds
current and accumulated earnings and profits in any taxable year, the excess distribution will be
treated as a return of capital to the extent of such shareholders tax basis in its shares, and
thereafter as capital gain. A return of capital is not taxable, but it reduces a shareholders tax
basis in its shares, thus reducing any loss or increasing any gain on a subsequent taxable
disposition by the shareholder of its shares.
Dividends and distributions on the Acquiring Funds shares are generally subject to U.S.
federal income tax as described herein to the extent they do not exceed the Acquiring Funds
realized income and gains, even though such dividends and distributions may economically represent
a return of a particular shareholders investment. Such distributions are likely to occur in
respect of shares purchased at a time when the Acquiring Funds net asset value reflects either
unrealized gains, or realized but undistributed income or gains. Such realized income and gains
may be required to be distributed even when the Acquiring Funds net asset value also reflects
unrealized losses.
Tax Implications of Certain Acquiring Fund Investments
Some debt obligations with a fixed maturity date of more than one year from the date of
issuance that are acquired by the Acquiring Fund in the secondary market may be treated as having
market discount. Generally, any gain recognized on the disposition of, and any partial payment of
principal on, a debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the accrued market discount on such debt
security. Market discount generally accrues in equal daily installments. The Acquiring Fund may
make one or more of the elections applicable to debt obligations having market discount, which
could affect the character and timing of recognition of income.
Some debt obligations with a fixed maturity date of more than one year from the date of
issuance (and zero-coupon debt obligations with a fixed maturity date of more than one year from
the date of issuance) that are acquired by the Acquiring Fund will be treated as debt obligations
that are issued originally at a discount. Generally, the amount of the original issue discount
(OID) is treated as interest income and is included in taxable income (and required to be
distributed) over the term of the debt security, even though payment of that amount is not received
until a later time, usually when the debt security matures. In addition, PIK bonds will give rise
to income which is required to be distributed and is taxable even though the Acquiring Fund holding
the security receives no interest payment in cash on the security during the year.
26
Some debt obligations with a fixed maturity date of one year or less from the date of issuance
that are acquired by the Acquiring Fund may be treated as having acquisition discount or OID.
Generally, the Acquiring Fund will be required to include the acquisition discount or OID in income
over the term of the debt security, even though payment of that amount is not received until a
later time, usually when the debt security matures. The Acquiring Fund may make one or more of the
elections applicable to debt obligations having acquisition discount or OID, which could affect the
character and timing of recognition of income.
Some preferred securities may include provisions that permit the issuer, at its discretion, to
defer the payment of distributions for a stated period without any adverse consequences to the
issuer. If the Acquiring Fund owns a preferred security that is deferring the payment of its
distributions, the Acquiring Fund may be required to report income for U.S. federal income tax
purposes to the extent of any such deferred distribution even though the Acquiring Fund has not yet
actually received the cash distribution.
If the Acquiring Fund holds the foregoing kinds of securities, it may be required to pay out
as an income distribution each year an amount which is greater than the total amount of cash
interest (or dividends in the case of preferred securities) the Acquiring Fund actually received.
Such distributions may be made from the cash assets of the Acquiring Fund or by liquidation of
portfolio securities, if necessary. The Acquiring Fund may realize gains or losses from such
liquidations. In the event the Acquiring Fund realizes net capital gains from such transactions,
its shareholders may receive a larger capital gain distribution than they would in the absence of
such transactions.
Investments in distressed debt obligations that are at risk of or in default present special
tax issues for the Acquiring Fund. Tax rules are not entirely clear about issues such as whether
and to what extent the Acquiring Fund should recognize market discount on a debt obligations, when
the Acquiring Fund may cease to accrue interest, OID or market discount, when and to what extent
the Acquiring Fund may take deductions for bad debts or worthless securities and how the Acquiring
Fund should allocate payments received on obligations in default between principal and income.
These and other related issues will be addressed by the Acquiring Fund when, as and if it invests
in such securities, in order to seek to ensure that it distributes sufficient income to preserve
its status as a RIC and does not become subject to U.S. federal income or excise tax.
A portion of the interest paid or accrued on certain high-yield discount obligations owned by
the Acquiring Fund may not (and interest paid on debt obligations, if any, that are considered for
tax purposes to be payable in the equity of the issuer or a related party will not) be deductible
to the issuer. This may affect the cash flow of the issuer. If a portion of the interest paid or
accrued on certain high yield discount obligations is not deductible, that portion will be treated
as a dividend paid by the issuer to the Acquiring Fund. In such cases, if the issuer of the
obligation is a domestic corporation, dividend payments by the Acquiring Fund may be eligible for
the dividends-received deduction to the extent of the deemed dividend portion of such accrued
interest received by the Acquiring Fund.
Any transactions by the Acquiring Fund in foreign currencies, foreign currency-denominated
debt obligations and certain foreign currency options, futures contracts and forward contracts (and
similar instruments) may give rise to ordinary income or loss to the extent such income or loss
results from fluctuations in the value of the foreign currency concerned.
Any equity investments by the Acquiring Fund in certain passive foreign investment companies
(PFICs) could potentially subject the Acquiring Fund to a U.S. federal income tax (including
interest charges) on distributions received from the company or on proceeds received from the
disposition of shares in the company. This tax cannot be eliminated by making distributions to
Acquiring Fund shareholders. However, the Acquiring Fund may elect to avoid the imposition of that
tax. For example, the Acquiring Fund may elect to treat a PFIC as a qualified electing fund
(i.e., make a QEF election), in which case the Acquiring Fund will be required to include its
share of the companys income and net capital gains annually, regardless of whether it receives any
distribution from the company. The Acquiring Fund also may make an election to mark the gains (and
to a limited extent losses) in such holdings to the market as though it had sold and repurchased
its holdings in those PFICs on the last day of the Acquiring Funds taxable year. Such gains and
losses are treated as ordinary income and loss. The QEF and mark-to-market elections may
accelerate the recognition of income (without the receipt of cash) and increase the amount required
to be distributed by the Acquiring Fund to avoid taxation. Making either of these elections
therefore may require the Acquiring Fund to liquidate other investments (including when it is not
advantageous to
27
do so) to meet its distribution requirement, which also may accelerate the recognition of gain and
affect the Acquiring Funds total return. Dividends paid by PFICs will not be eligible to be
treated as qualified dividend income.
Income received by the Acquiring Fund from sources within foreign countries may be subject to
withholding and other taxes imposed by such countries. Tax treaties between certain countries and
the U.S. may reduce or eliminate such taxes. Shareholders generally will not be entitled to claim
a credit or deduction with respect to foreign taxes incurred by the Acquiring Fund.
The Acquiring Funds Derivative Transactions, as well as any of its other hedging, straddle
and short sale transactions, generally are subject to special tax rules (including, for instance,
notional principal contract, mark-to-market, constructive sale, straddle, wash sale and short-sale
rules). These rules may affect whether gains and losses recognized by the Acquiring Fund are
treated as ordinary or capital and/or as short-term or long-term, accelerate the recognition of
income or gains to the Acquiring Fund, defer losses, and cause adjustments in the holding periods
of the Acquiring Funds securities. The rules could therefore affect the amount, timing and/or
character of distributions to shareholders. In addition, because the tax rules applicable to
derivative financial instruments are in some cases uncertain under current law, in particular in
respect of certain credit derivative transactions (e.g., credit default swaps) and certain other
swaps with contingent payment obligations, an adverse determination or future guidance by the
Internal Revenue Service (IRS) with respect to these rules (which determination or guidance could
be retroactive) may affect whether the Acquiring Fund has made sufficient distributions, and
otherwise satisfied the relevant requirements, to maintain its qualification as a RIC and avoid a
Acquiring Fund-level tax.
In addition, certain of these transactions (as well as any transactions in foreign currencies
or foreign currency-denominated instruments) are likely to produce a difference between its book
income and its taxable income. If the Acquiring Funds book income (if any) exceeds the sum of its
taxable income and net tax-exempt income (if any), the distribution (if any) of such excess
generally will be treated as (i) a dividend to the extent of the Acquiring Funds remaining
earnings and profits (including earnings and profits arising from any tax-exempt income), (ii)
thereafter, as a return of capital to the extent of the recipients basis in its shares, and (iii)
thereafter, as gain from the sale or exchange of a capital asset. If the Acquiring Funds book
income is less than the sum of its taxable income and net tax-exempt income (if any), the Acquiring
Fund could be required to make distributions exceeding book income to qualify as a RIC that is
accorded special tax treatment and to avoid an Acquiring Fund-level tax.
An investment by the Acquiring Fund in equity securities of real estate investment trusts (as
defined in section 856 of the Code) (REITs) may result in the Acquiring Funds receipt of cash in
excess of a REITs earnings; if the Acquiring Fund distributes these amounts, these distributions
could constitute a return of capital to Acquiring Fund shareholders for U.S. federal income tax
purposes. Any investments by the Acquiring Fund in REIT equity securities also may require the
Acquiring Fund to accrue and distribute income not yet received. To generate sufficient cash to
make the requisite distributions, the Acquiring Fund may be required to sell securities in its
portfolio (including when it is not advantageous to do so) that it otherwise would have continued
to hold. Dividends received by the Acquiring Fund from a REIT generally will not constitute
qualified dividend income.
Under a notice issued by the IRS in October 2006 and Treasury regulations that have yet to be
issued but may apply retroactively, a portion of the Acquiring Funds income (including income
allocated to the Acquiring Fund from a REIT or other pass-through entity) (if any) that is
attributable to a residual interest in a real estate mortgage investment conduit (REMIC) or an
equity interest in a taxable mortgage pool (TMP) (referred to in the Code as an excess
inclusion) will be subject to U.S. federal income tax in all events. This notice also provides,
and the regulations are expected to provide, that excess inclusion income of a RIC will be
allocated to shareholders of the RIC in proportion to the dividends received by such shareholders,
with the same consequences as if the shareholders held the related interest directly. As a result,
to the extent the Acquiring Fund invests in any such interests, it may not be a suitable investment
for certain tax-exempt shareholders, as noted below in Tax-Exempt Shareholders).
In general, excess inclusion income allocated to shareholders (i) cannot be offset by net
operating losses (subject to a limited exception for certain thrift institutions), (ii) will
constitute unrelated business taxable income (UBTI) to entities (including a qualified pension
plan, an individual retirement account, a 401(k) plan, a Keogh
28
plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an
entity that is allocated excess inclusion income, and otherwise might not be required to file a
U.S. federal income tax return, to file such a tax return and pay tax on such income, and (iii) in
the case of a non-U.S. shareholder, will not qualify for any reduction in U.S. federal withholding
tax.
Backup Withholding
The Acquiring Fund generally is required to withhold and remit to the U.S. Treasury a
percentage of the taxable distributions and redemption proceeds paid to any individual shareholder
who fails to properly furnish the Acquiring Fund with a correct taxpayer identification number, who
has under-reported dividend or interest income, or who fails to certify to the Acquiring Fund that
he or she is not subject to such withholding. Backup withholding is not an additional tax. Any
amounts withheld may be credited against the shareholders U.S. federal income tax liability,
provided the appropriate information is furnished to the IRS.
Sale, Exchange or Redemption of Acquiring Fund Shares
The sale, exchange or redemption of Acquiring Fund shares may give rise to a gain or loss. In
general, any gain or loss realized upon a taxable disposition of shares will be treated as
long-term capital gain or loss if the shares have been held for more than 12 months. Otherwise,
the gain or loss on the taxable disposition of Acquiring Fund shares will be treated as short-term
capital gain or loss. However, any loss realized upon a taxable disposition of shares held for six
months or less will be treated as long-term, rather than short-term, to the extent of any long-term
capital gain distributions received (or deemed received) by the shareholder with respect to the
shares. All or a portion of any loss realized upon a taxable disposition of Acquiring Fund shares
will be disallowed if other substantially identical shares of the Acquiring Fund are purchased
within 30 days before or after the disposition. In such a case, the basis of the newly purchased
shares will be adjusted to reflect the disallowed loss.
Shareholders may be entitled to offset their capital gain dividends with capital loss. The
Code contains a number of statutory provisions affecting the circumstances under which capital loss
may be offset against capital gain and limiting the use of loss from certain investments and
activities. Accordingly, shareholders that have capital losses are urged to consult their tax
advisors.
Tax Shelter Reporting Regulations
Under Treasury regulations, if a shareholder recognizes a loss with respect to common shares
of $2 million or more for an individual shareholder or $10 million or more for a corporate
shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. Direct
shareholders of portfolio securities are in many cases excepted from this reporting requirement,
but under current guidance, shareholders of a RIC are not excepted. Future guidance may extend the
current exception from this reporting requirement to shareholders of most or all RICs. The fact
that a loss is reportable under these regulations does not affect the legal determination of
whether the taxpayers treatment of the loss is proper. Shareholders should consult their tax
advisors to determine the applicability of these regulations in light of their individual
circumstances.
Non-U.S. Shareholders
Distributions properly designated as Capital Gain Dividends generally will not be subject to
withholding of U.S. federal income tax. In general, dividends other than Capital Gain Dividends
paid by the Acquiring Fund to a shareholder that is not a U.S. person within the meaning of the
Code (a foreign person) are subject to withholding of U.S. federal income tax at a rate of 30%
(or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio
interest, short-term capital gains, or foreign-source dividend and interest income) that, if paid
to a foreign person directly, would not be subject to withholding.
However, effective for taxable years of a RIC beginning before January 1, 2010, the Acquiring
Fund will not be required to withhold any amounts (i) with respect to distributions (other than
distributions to a foreign person (w) that has not provided a satisfactory statement that the
beneficial owner was not a U.S. person, (x) to the extent that the dividend is attributable to
certain interest on an obligation if the foreign person is the issuer of such
29
obligation or a 10% shareholder of the issuer, (y) that was within certain foreign countries
that have inadequate information exchange with the United States, or (z) to the extent the dividend
paid is attributable to interest paid by a person that is a related person of the foreign person
and the foreign person is a controlled foreign corporation) from U.S.-source interest income of
types similar to those not subject to U.S. federal income tax if earned directly by an individual
foreign person, to the extent such distributions are properly designated by the Acquiring Fund
(interest-related dividends), and (ii) with respect to distributions (other than (a)
distributions to an individual foreign person who is present in the United States for a period or
periods aggregating 183 days or more during the year of the distribution and (b) distributions
subject to special rules regarding the disposition of U.S. real property interests (USRPIs, as
described below)) of net short-term capital gains in excess of net long-term capital losses to the
extent such distributions are properly designated by the Acquiring Fund (short-term capital gain
dividends). Depending on the circumstances, the Acquiring Fund may make designations of
interest-related and/or short-term capital gain dividends with respect to all, some or none of its
potentially eligible dividends and/or treat such dividends, in whole or in part, as ineligible for
these exemptions from withholding. Absent legislation extending these exemptions for taxable years
beginning on or after January 1, 2010, these special withholding exemptions for interest-related
and short-term capital gain dividends will expire and these dividends generally will be subject to
withholding as described above. It is currently unclear whether Congress will extend the
exemptions for tax years beginning on or after January 1, 2010.
In the case of shares held through an intermediary, the intermediary may withhold even if the
Acquiring Fund makes a designation with respect to a payment. Foreign persons should contact their
intermediaries regarding the application of these rules to their accounts.
A foreign person is not, in general, subject to U.S. federal income tax on gains (and is not
allowed a deduction for losses) realized on the sale of shares of the Acquiring Fund or on Capital
Gain Dividends unless (i) such gain or dividend is effectively connected with the conduct of a
trade or business carried on by such holder within the United States, (ii) in the case of an
individual holder, the holder is present in the United States for a period or periods aggregating
183 days or more during the year of the sale or the receipt of the Capital Gain Dividend and
certain other conditions are met, or (iii) the shares constitute USRPIs or the Capital Gain
Dividends are attributable to gains from the sale or exchange of USRPIs in accordance with certain
special rules. If a foreign person is eligible for the benefits of a tax treaty, any effectively
connected income or gain will generally be subject to U.S. federal income tax on a net basis only
if it is also attributable to a permanent establishment maintained by the shareholder in the United
States.
Special rules apply to distributions to certain foreign persons from a RIC that is either a
U.S. real property holding corporation (USRPHC) or would be a USRPHC absent exclusions from
USRPI treatment for interests in domestically controlled REITs or RICs and not-greater-than-5%
interests in publicly traded classes of stock in REITs or RICs. Additionally, special rules apply
to the sale of shares in a RIC that is a USRPHC. Very generally, a USRPHC is a domestic
corporation that holds USRPIs USRPIs are defined generally as any interest in U.S. real property
or any equity interest in a USRPHC the fair market value of which equals or exceeds 50% of the
sum of the fair market values of the corporations USRPIs, interests in real property located
outside the United States and other assets. The Acquiring Fund generally does not expect that it
will be a USRPHC or would be a USRPHC but for the operation of these exceptions, and thus does not
expect these special tax rules to apply.
In order to qualify for any exemption from withholding described above (to the extent
applicable) or for lower withholding tax rates under income tax treaties, or to establish an
exemption from backup withholding, a foreign person must comply with applicable certification
requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form
W-8BEN or substitute form). Foreign persons should contact their tax advisors in this regard.
A foreign person may be subject to state and local tax and to the U.S. federal estate tax in
addition to the federal tax on income referred to above.
Tax-Exempt Shareholders
Under current law, the Acquiring Fund serves to block (that is, prevent the attribution to
shareholders of) UBTI from being realized by tax-exempt shareholders. Notwithstanding this
blocking effect, a tax-exempt
30
shareholder could realize UBTI by virtue of its investment in the Acquiring Fund if shares in the
Acquiring Fund constitute debt-financed property in the hands of the tax-exempt shareholder within
the meaning of Code section 514(b).
A tax-exempt shareholder may also recognize UBTI if the Acquiring Fund recognizes excess
inclusion income derived from direct or indirect investments in residual interests in REMICs or
equity interests in TMPs if the amount of such income recognized by the Acquiring Fund exceeds the
Acquiring Funds investment company taxable income (after taking into account deductions for
dividends paid by the Acquiring Fund). Furthermore, any investment in residual interests of a
collateralized mortgage obligation that has elected to be treated as a REMIC can create complex tax
consequences, especially if the Acquiring Fund has state or local governments or other tax-exempt
organizations as shareholders.
In addition, special tax consequences apply to charitable remainder trusts (CRTs) that
invest in RICs that invest directly or indirectly in residual interests in REMICs or equity
interests in TMPs. Under legislation enacted in December 2006, a CRT (as defined in section 664 of
the Code) that realizes any UBTI for a taxable year must pay an excise tax annually of an amount
equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI as a
result of investing in a RIC that recognizes excess inclusion income. Rather, if at any time
during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the United
States, a state or political subdivision, or an agency or instrumentality thereof, and certain
energy cooperatives) is a record holder of a share in a RIC that recognizes excess inclusion
income, then the RIC will be subject to a tax on that portion of its excess inclusion income for
the taxable year that is allocable to such shareholders at the highest federal corporate income tax
rate. The extent to which this IRS guidance remains applicable in light of the December 2006
legislation is unclear. To the extent permitted under the 1940 Act, the Acquiring Fund may elect
to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce
such shareholders distributions for the year by the amount of the tax that relates to such
shareholders interest in the Acquiring Fund. The Acquiring Fund has not yet determined whether
such an election will be made.
CRTs and other tax-exempt investors are urged to consult their tax advisors concerning the
consequences of investing in the Acquiring Fund.
Shares Purchased Through Tax Qualified Plans
Special tax rules apply to investments through defined contribution plans and other
tax-qualified plans. Shareholders should consult their tax advisors to determine the suitability
of shares of the Acquiring Fund as an investment through such plans and the precise effect of an
investment on their particular tax situation.
General Considerations
The U.S. federal income tax discussion set forth above is for general information only.
Prospective investors should consult their tax advisors regarding the specific federal tax
consequences of purchasing, holding, and disposing of shares of the Acquiring Fund, as well as the
effects of state, local and foreign tax law and any proposed tax law changes.
EXPERTS
PricewaterhouseCoopers LLP, located at 2001 Ross Avenue, Suite 1800, Dallas, Texas 75201,
provides accounting and auditing services to the Acquiring Fund.
ADDITIONAL INFORMATION
A registration statement on Form N-14, relating to the shares offered by the Prospectus/Proxy
Statement (the Registration Statement), has been filed by the Acquiring Fund with the
SEC. For further information with respect to the Acquiring Fund, the Acquired Fund and their
shares, reference is made to the Registration Statement. Statements contained in the Proxy
Statement/Prospectus and this SAI as to the contents of any contract or other document referred to
are not necessarily complete and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement, each such statement being
qualified in
31
all respects by such reference. A copy of the Registration Statement may be inspected without
charge at the SECs principal office in Washington, D.C., and copies of all or any part thereof may
be obtained from the SEC upon the payment of certain duplicating fees prescribed by the SEC, by
either calling the SEC at 202-551-8090, or by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the SECs Public Reference Section, Washington, D.C. 20549-0102.
FINANCIAL STATEMENTS
Acquired Fund and Acquiring Fund Financial Statements
The Acquired Funds financial statements appearing in the Acquired Funds Form 10-K for the period
ended December 31, 2008 are incorporated by reference in this Statement of Additional Information
and have been so incorporated in reliance upon the report of PricewaterhouseCoopers LLP,
independent registered public accounting firm for the Acquired Fund. The Acquired
Funds Forms 10-K are available upon request and without charge by writing to the
Acquired Trust at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 or by calling
(877) 247-1888.
The Acquiring Funds financial statements appearing in the Acquiring Funds annual shareholder
report for the period ended December 31, 2008 are incorporated by reference in this Statement of
Additional Information and have been so incorporated in reliance upon the report of
PricewaterhouseCoopers LLP, independent registered public accounting firm for the Acquiring Fund.
The annual shareholder report is available upon request and without charge by writing to the
Acquiring Fund at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240 or by calling
(877) 665-1287.
32
Pro Forma Financial Statements
Shown below are the financial statements for the Acquiring Fund and the Acquired Fund, pro
forma of the Acquiring Fund financial statements including the proceeds of its rights offering and
the reorganizations of Prospect Street High Income Portfolio Inc. and Prospect Street Income Shares
Inc. into the Acquiring Fund and pro forma financial statements for the combined Fund. The pro
forma Combined Schedule of Investments and the pro forma Combined Statement of Assets and
Liabilities have been prepared as though the Reorganization had been effective
on December 31,
2008. The pro forma Combined Statement of Operations reflects the results of the Acquiring Fund
and the Acquired Fund for the twelve months ended December 31, 2008 as if the Reorganization
occurred on January 1, 2008.
The first table presents the Schedule of Investments for the Acquiring Fund and the Acquired
Fund and pro forma figures for the combined Fund. The second table presents the Statements of
Assets and Liabilities for the Acquiring Fund and the Acquired Fund, pro forma figures for the
Acquiring Fund including the proceeds of its rights offering and reorganizations of Prospect Street
High Income Portfolio Inc. and Prospect Street Income Shares Inc. into the Acquiring Fund, and
estimated pro forma figures for the combined Fund. The third table presents the Statements of
Operations for the Acquiring Fund and the Acquired Fund, pro forma figures for the Acquiring Fund
including the proceeds of its rights offering, and estimated pro forma figures for the combined
Fund. These tables are followed by the Notes to the pro forma Financial Statements.
33
PRO FORMA SCHEDULE OF INVESTMENTS
As of December 31, 2008
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Pro Forma Combined |
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Pro Forma Combined |
Highland Credit |
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Highland Distressed |
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Highland Credit |
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Highland Credit |
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Highland Distressed |
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Highland Credit |
Strategies Fund (HCF) |
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Opportunities Inc. (HCD) |
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Strategies Fund (HCF) |
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Strategies Fund (HCF) |
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Opportunities Inc. (HCD) |
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Strategies Fund (HCF) |
Principal Amount ($) |
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Principal Amount ($) |
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Principal Amount ($) |
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Security |
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Value ($) |
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Value ($) |
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Value ($) |
Senior Loans (a) - 74% |
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AEROSPACE - 2.7% |
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AWAS Capital, Inc. |
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1,653,129 |
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1,653,129 |
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Second Lien Priority Term Facility, 7.50%, 03/15/13
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743,908 |
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743,908 |
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Continental Airlines, Inc. |
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571,429 |
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571,429 |
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Tranche A-1 Term Loan, 5.56%, 06/01/11
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380,000 |
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380,000 |
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1,428,571 |
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1,428,571 |
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Tranche A-2 Term Loan, 5.56%, 06/01/11
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950,000 |
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950,000 |
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Delta Airlines, Inc. |
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6,985,803 |
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6,985,803 |
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Term Loan Equipment Notes, 4.97%, 09/29/12
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3,981,908 |
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3,981,908 |
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|
|
IAP Worldwide Services, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,735,694 |
|
|
|
|
|
|
|
2,735,694 |
|
|
First Lien Term Loan, PIK, 8.25%, 12/30/12
|
|
|
1,641,417 |
|
|
|
|
|
|
|
1,641,417 |
|
|
2,062,273 |
|
|
|
|
|
|
|
2,062,273 |
|
|
Second Lien Term Loan, PIK, 10.50%, 06/28/13
|
|
|
592,903 |
|
|
|
|
|
|
|
592,903 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,312,255 |
|
|
|
|
|
|
|
2,312,255 |
|
|
Term Loan, 3.44%, 12/31/10
|
|
|
1,724,087 |
|
|
|
|
|
|
|
1,724,087 |
|
|
|
|
|
|
|
|
|
|
|
|
|
United Air Lines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,482,449 |
|
|
|
|
|
|
|
2,482,449 |
|
|
Tranche B Loan, 2.65%, 02/01/14
|
|
|
1,169,234 |
|
|
|
|
|
|
|
1,169,234 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,183,457 |
|
|
|
|
|
|
|
11,183,457 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BROADCASTING - 4.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ComCorp Broadcasting, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,095,572 |
|
|
|
1,825,953 |
|
|
|
2,921,525 |
|
|
Revolving Loan, 7.77%, 04/03/13 (b) (c) (d)
|
|
|
505,880 |
|
|
|
843,134 |
|
|
|
1,349,014 |
|
|
11,309,712 |
|
|
|
18,849,521 |
|
|
|
30,159,233 |
|
|
Term Loan, 7.75%, 04/03/13 (c) (d)
|
|
|
5,301,428 |
|
|
|
8,835,713 |
|
|
|
14,137,141 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Univision Communications, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,623,000 |
|
|
|
|
|
|
|
4,623,000 |
|
|
Second Lien Term Loan, 2.96%, 03/29/09
|
|
|
3,259,215 |
|
|
|
|
|
|
|
3,259,215 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,066,523 |
|
|
|
9,678,847 |
|
|
|
18,745,370 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CABLE/WIRELESS VIDEO - 2.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadstripe, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
14,152,867 |
|
|
|
|
|
|
|
14,152,867 |
|
|
First Lien Term Loan, PIK, 9.22%, 06/30/11 (d) (e)
|
|
|
8,166,204 |
|
|
|
|
|
|
|
8,166,204 |
|
|
1,428,203 |
|
|
|
|
|
|
|
1,428,203 |
|
|
Revolver, 9.96%, 06/30/11 (d) (e)
|
|
|
824,073 |
|
|
|
|
|
|
|
824,073 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,990,277 |
|
|
|
|
|
|
|
8,990,277 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CHEMICALS - 0.7% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Arclin US Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
400,000 |
|
|
|
|
|
|
|
400,000 |
|
|
First Lien Term Loan, 5.04%, 07/10/14
|
|
|
178,000 |
|
|
|
|
|
|
|
178,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Solutia, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,965,075 |
|
|
|
|
|
|
|
1,965,075 |
|
|
Term Loan, 8.50%, 02/28/14
|
|
|
1,346,077 |
|
|
|
|
|
|
|
1,346,077 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Tronox Worldwide, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,910,160 |
|
|
|
|
|
|
|
1,910,160 |
|
|
Revolving Credit Loan, 5.97%, 11/28/10 (b)
|
|
|
1,509,026 |
|
|
|
|
|
|
|
1,509,026 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,033,103 |
|
|
|
|
|
|
|
3,033,103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSUMER DURABLES - 0.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rexair LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,090,614 |
|
|
|
|
|
|
|
2,090,614 |
|
|
First Lien Term Loan, 5.71%, 06/30/10
|
|
|
1,672,491 |
|
|
|
|
|
|
|
1,672,491 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,672,491 |
|
|
|
|
|
|
|
1,672,491 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSUMER NON-DURABLES - 0.2% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totes Isotoner Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,377,228 |
|
|
|
3,377,228 |
|
|
Second Lien Term Loan, 9.88%, 01/31/14
|
|
|
|
|
|
|
1,013,169 |
|
|
|
1,013,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,013,169 |
|
|
|
1,013,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DIVERSIFIED MEDIA - 5.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Clarke American Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,970,000 |
|
|
|
|
|
|
|
1,970,000 |
|
|
Tranche B Term Loan, 4.21%, 06/30/14
|
|
|
1,004,700 |
|
|
|
|
|
|
|
1,004,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cydcor, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
8,750,000 |
|
|
|
|
|
|
|
8,750,000 |
|
|
First Lien Tranche B Term Loan, 9.00%, 02/05/13
|
|
|
7,656,250 |
|
|
|
|
|
|
|
7,656,250 |
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
Second Lien Tranche B Term Loan, 12.00%, 02/05/14
|
|
|
2,400,000 |
|
|
|
|
|
|
|
2,400,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
DTN, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,747,837 |
|
|
|
|
|
|
|
1,747,837 |
|
|
Tranche C Term Loan, 7.02%, 03/10/13
|
|
|
1,380,791 |
|
|
|
|
|
|
|
1,380,791 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Endurance Business Media, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
Second Lien Term Loan, 9.25%, 01/26/14
|
|
|
1,950,000 |
|
|
|
|
|
|
|
1,950,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Metro-Goldwyn-Mayer, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,229,309 |
|
|
|
|
|
|
|
6,229,309 |
|
|
Tranche B Term Loan, 4.24%, 04/09/12
|
|
|
2,668,200 |
|
|
|
|
|
|
|
2,668,200 |
|
|
2,947,500 |
|
|
|
|
|
|
|
2,947,500 |
|
|
Tranche B-1 Term Loan, 4.71%, 04/09/12
|
|
|
1,262,503 |
|
|
|
|
|
|
|
1,262,503 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Nielsen Finance LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,378,243 |
|
|
|
|
|
|
|
2,378,243 |
|
|
Dollar Term Loan, 4.24%, 08/09/13
|
|
|
1,617,205 |
|
|
|
|
|
|
|
1,617,205 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Penton Media, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
10,000,000 |
|
|
|
2,000,000 |
|
|
|
12,000,000 |
|
|
Second Lien Term Loan, 8.42%, 02/01/14
|
|
|
2,125,000 |
|
|
|
425,000 |
|
|
|
2,550,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Tribune Co. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,730,667 |
|
|
|
|
|
|
|
2,730,667 |
|
|
Tranche X Advance, 7.08%, 06/04/09 (e)
|
|
|
784,084 |
|
|
|
|
|
|
|
784,084 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22,848,733 |
|
|
|
425,000 |
|
|
|
23,273,733 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ENERGY - 7.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alon USA Energy, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
216,202 |
|
|
|
|
|
|
|
216,202 |
|
|
Edington Facility, 4.45%, 08/05/13
|
|
|
140,532 |
|
|
|
|
|
|
|
140,532 |
|
|
1,729,620 |
|
|
|
|
|
|
|
1,729,620 |
|
|
Paramount Facility, 3.11%, 08/05/13
|
|
|
1,124,253 |
|
|
|
|
|
|
|
1,124,253 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Crusader Energy Group, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
14,985,000 |
|
|
|
|
|
|
|
14,985,000 |
|
|
Second Lien Term Loan, 11.25%, 07/17/13
|
|
|
10,864,125 |
|
|
|
|
|
|
|
10,864,125 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Maxum Petroleum, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,840,201 |
|
|
|
|
|
|
|
5,840,201 |
|
|
Term Loan, 8.25%, 09/18/13
|
|
|
5,431,387 |
|
|
|
|
|
|
|
5,431,387 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Resolute Aneth, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,000,000 |
|
|
|
|
|
|
|
6,000,000 |
|
|
Second Lien Term Loan, 8.01%, 06/26/13
|
|
|
4,170,000 |
|
|
|
|
|
|
|
4,170,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Venoco, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
14,500,000 |
|
|
|
|
|
|
|
14,500,000 |
|
|
Second Lien Loan, 6.25%, 05/07/14
|
|
|
9,570,000 |
|
|
|
|
|
|
|
9,570,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31,300,297 |
|
|
|
|
|
|
|
31,300,297 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FINANCIAL - 1.8% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Emerson Reinsurance Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,300,000 |
|
|
|
|
|
|
|
1,300,000 |
|
|
Series A Loan, 3.75%, 12/15/11
|
|
|
1,189,500 |
|
|
|
|
|
|
|
1,189,500 |
|
|
500,000 |
|
|
|
|
|
|
|
500,000 |
|
|
Series B Loan, 5.00%, 12/15/11
|
|
|
457,500 |
|
|
|
|
|
|
|
457,500 |
|
|
200,000 |
|
|
|
1,500,000 |
|
|
|
1,700,000 |
|
|
Series C Loan, 7.25%, 12/15/11
|
|
|
173,000 |
|
|
|
1,297,500 |
|
|
|
1,470,500 |
|
34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
|
|
|
|
|
|
|
|
|
|
|
|
Flatiron Re Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25,529 |
|
|
|
25,529 |
|
|
Closing Date Term Loan, 5.71%, 12/29/10
|
|
|
|
|
|
|
24,796 |
|
|
|
24,796 |
|
|
|
|
|
|
12,366 |
|
|
|
12,366 |
|
|
Delayed Draw Term Loan, 5.71%, 12/29/10
|
|
|
|
|
|
|
12,011 |
|
|
|
12,011 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Kepler Holdings Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
5,000,000 |
|
|
Term Loan, 7.00%, 06/30/09
|
|
|
|
|
|
|
4,400,000 |
|
|
|
4,400,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,820,000 |
|
|
|
5,734,307 |
|
|
|
7,554,307 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOOD/TOBACCO - 0.7% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DS Waters of America, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,848,889 |
|
|
|
|
|
|
|
1,848,889 |
|
|
Term Loan, 3.45%, 10/29/12
|
|
|
1,340,444 |
|
|
|
|
|
|
|
1,340,444 |
|
|
|
|
|
|
|
|
|
|
|
|
|
PBM Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,825,481 |
|
|
|
|
|
|
|
1,825,481 |
|
|
Term Loan, 2.72%, 09/28/12
|
|
|
1,469,512 |
|
|
|
|
|
|
|
1,469,512 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,809,956 |
|
|
|
|
|
|
|
2,809,956 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOREST PRODUCTS/CONTAINERS - 0.9% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Boise Paper Holdings LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500,000 |
|
|
|
|
|
|
|
2,500,000 |
|
|
Second Lien Term Loan, 9.25%, 02/23/15
|
|
|
625,000 |
|
|
|
|
|
|
|
625,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Newark Group, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,512,271 |
|
|
|
|
|
|
|
1,512,271 |
|
|
Credit-Link Letter of Credit, 6.98%, 03/09/13
|
|
|
952,730 |
|
|
|
|
|
|
|
952,730 |
|
|
340,349 |
|
|
|
|
|
|
|
340,349 |
|
|
Term Loan, 8.39%, 03/09/13
|
|
|
214,420 |
|
|
|
|
|
|
|
214,420 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Tegrant Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
1,000,000 |
|
|
Second Lien Term Loan, 6.96%, 03/08/15
|
|
|
|
|
|
|
103,340 |
|
|
|
103,340 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Verso Paper Finance Holdings LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,928,000 |
|
|
|
|
|
|
|
4,928,000 |
|
|
Term Loan, 10.01%, 02/01/13
|
|
|
1,848,000 |
|
|
|
|
|
|
|
1,848,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,640,150 |
|
|
|
103,340 |
|
|
|
3,743,490 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAMING/LEISURE - 17.3% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drake Hotel Acquisition |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,041,285 |
|
|
|
|
|
|
|
6,041,285 |
|
|
B Note 1, 8.27%, 04/01/09 (d) (e)
|
|
|
3,719,619 |
|
|
|
|
|
|
|
3,719,619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Fontainebleau Florida Hotel LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
12,500,000 |
|
|
|
6,000,000 |
|
|
|
18,500,000 |
|
|
Tranche C Term Loan, 8.00%, 06/06/12
|
|
|
10,625,000 |
|
|
|
5,100,000 |
|
|
|
15,725,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Fontainebleau Las Vegas LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,333,333 |
|
|
|
|
|
|
|
1,333,333 |
|
|
Initial Term Loan, 5.44%, 06/06/14
|
|
|
383,333 |
|
|
|
|
|
|
|
383,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ginn LA Conduit Lender, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,937,249 |
|
|
|
|
|
|
|
3,937,249 |
|
|
First Lien Tranche A Credit-Linked Deposit, 7.75%, 06/08/11 (e)
|
|
|
485,581 |
|
|
|
|
|
|
|
485,581 |
|
|
8,438,203 |
|
|
|
|
|
|
|
8,438,203 |
|
|
First Lien Tranche B Term Loan, 7.75%, 06/08/11 (e)
|
|
|
1,040,684 |
|
|
|
|
|
|
|
1,040,684 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Green Valley Ranch Gaming LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,557,223 |
|
|
|
|
|
|
|
1,557,223 |
|
|
First Lien Term Loan, 4.25%, 02/16/14
|
|
|
649,362 |
|
|
|
|
|
|
|
649,362 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Second Lien Term Loan, 5.08%, 08/16/14
|
|
|
177,500 |
|
|
|
|
|
|
|
177,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Kuilima Resort Co. |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,621,285 |
|
|
|
|
|
|
|
4,621,285 |
|
|
First Lien Term Loan, 6.75%, 09/30/10 (e)
|
|
|
1,790,748 |
|
|
|
|
|
|
|
1,790,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Lake at Las Vegas Joint Venture |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,551,702 |
|
|
|
3,611,111 |
|
|
|
8,162,813 |
|
|
Revolving Loan Credit-Linked Deposit Account, 14.35%, 06/20/12 (e)
|
|
|
345,156 |
|
|
|
273,831 |
|
|
|
618,987 |
|
|
34,125,359 |
|
|
|
|
|
|
|
34,125,359 |
|
|
Term Loan DIP, 9.96%, 07/16/09
|
|
|
34,125,359 |
|
|
|
|
|
|
|
34,125,359 |
|
|
42,548,822 |
|
|
|
33,756,283 |
|
|
|
76,305,105 |
|
|
Term Loan, PIK, 14.35%, 06/20/12 (e)
|
|
|
2,738,589 |
|
|
|
2,143,697 |
|
|
|
4,882,286 |
|
|
|
|
|
|
|
|
|
|
|
|
|
WAICCS Las Vegas 3 LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,000,000 |
|
|
|
|
|
|
|
6,000,000 |
|
|
First Lien Term Loan, 4.94%, 02/01/09
|
|
|
4,950,000 |
|
|
|
|
|
|
|
4,950,000 |
|
|
7,000,000 |
|
|
|
|
|
|
|
7,000,000 |
|
|
Second Lien Term Loan, 10.44%, 02/01/09
|
|
|
4,375,000 |
|
|
|
|
|
|
|
4,375,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65,405,931 |
|
|
|
7,517,528 |
|
|
|
72,923,459 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HEALTHCARE - 6.7% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aveta, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,824,862 |
|
|
|
|
|
|
|
3,824,862 |
|
|
MMM Original Term Loan, 5.97%, 08/22/11
|
|
|
2,715,652 |
|
|
|
|
|
|
|
2,715,652 |
|
|
568,201 |
|
|
|
|
|
|
|
568,201 |
|
|
NAMM New Term Loan, 5.97%, 08/22/11
|
|
|
403,423 |
|
|
|
|
|
|
|
403,423 |
|
|
1,023,872 |
|
|
|
|
|
|
|
1,023,872 |
|
|
NAMM Original Term Loan, 5.97%, 08/22/11
|
|
|
726,949 |
|
|
|
|
|
|
|
726,949 |
|
|
3,134,561 |
|
|
|
|
|
|
|
3,134,561 |
|
|
PHMC Acquisition Term Loan, 5.97%, 08/22/11
|
|
|
2,225,539 |
|
|
|
|
|
|
|
2,225,539 |
|
|
|
|
|
|
|
|
|
|
|
|
|
CCS Medical, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
11,525,184 |
|
|
|
|
|
|
|
11,525,184 |
|
|
First Lien Term Loan, 4.71%, 09/30/12
|
|
|
6,310,038 |
|
|
|
|
|
|
|
6,310,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Danish Holdco A/S |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500,000 |
|
|
|
|
|
|
|
2,500,000 |
|
|
Facility D, 7.63%, 11/01/16
|
|
|
1,187,500 |
|
|
|
|
|
|
|
1,187,500 |
|
|
3,318,750 |
|
|
|
|
|
|
|
3,318,750 |
|
|
Mezzanine Facility, PIK, 11.38%, 05/01/17
|
|
|
829,688 |
|
|
|
|
|
|
|
829,688 |
|
|
|
|
|
|
|
|
|
|
|
|
|
LifeCare Holdings |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,408,539 |
|
|
|
|
|
|
|
5,408,539 |
|
|
Term Loan, 7.67%, 08/11/12
|
|
|
3,049,064 |
|
|
|
|
|
|
|
3,049,064 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Life Technologies Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,995,000 |
|
|
|
1,995,000 |
|
|
Term B Facility, 09/30/15
|
|
|
|
|
|
|
1,881,963 |
|
|
|
1,881,963 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical Staffing Network, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
915,000 |
|
|
|
|
|
|
|
915,000 |
|
|
First Lien Term Loan, 5.66%, 07/02/13
|
|
|
663,375 |
|
|
|
|
|
|
|
663,375 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Nyco Holdings 3 ApS |
|
|
|
|
|
|
|
|
|
|
|
|
|
73,709 |
|
|
|
|
|
|
|
73,709 |
|
|
Facility A3, 2.98%, 12/29/13
|
|
|
51,443 |
|
|
|
|
|
|
|
51,443 |
|
|
46,954 |
|
|
|
|
|
|
|
46,954 |
|
|
Facility A4, 2.98%, 12/29/13
|
|
|
32,770 |
|
|
|
|
|
|
|
32,770 |
|
|
332,000 |
|
|
|
|
|
|
|
332,000 |
|
|
Facility A5, 2.98%, 12/29/13
|
|
|
231,709 |
|
|
|
|
|
|
|
231,709 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Talecris Biotherapeutics Holdings Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
8,931,646 |
|
|
|
|
|
|
|
8,931,646 |
|
|
First Lien Term Loan, 5.64%, 12/06/13
|
|
|
7,636,557 |
|
|
|
|
|
|
|
7,636,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Triumph Healthcare Second Holdings LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
500,000 |
|
|
|
|
|
|
|
500,000 |
|
|
Second Lien Term Loan, 11.15%, 07/28/14
|
|
|
237,500 |
|
|
|
|
|
|
|
237,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26,301,207 |
|
|
|
1,881,963 |
|
|
|
28,183,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HOUSING - 5.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Custom Building Products, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,573,419 |
|
|
|
|
|
|
|
3,573,419 |
|
|
First Lien Term Loan, 8.00%, 10/20/11
|
|
|
2,501,393 |
|
|
|
|
|
|
|
2,501,393 |
|
|
1,625,000 |
|
|
|
|
|
|
|
1,625,000 |
|
|
Second Lien Term Loan, 10.75%, 04/20/12
|
|
|
901,875 |
|
|
|
|
|
|
|
901,875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
LBREP/L-Suncal Master I LLC
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,190,581 |
|
|
|
|
|
|
|
3,190,581 |
|
|
First Lien Term Loan, 5.50%, 01/18/10 (e) |
|
|
239,294 |
|
|
|
|
|
|
|
239,294 |
|
|
|
|
|
|
|
|
|
|
|
|
|
MetroFlag BP, LLC / MetroFlag Cable, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
5,000,000 |
|
|
Second Lien Term Loan, 12.00%, 01/06/09
|
|
|
|
|
|
|
375,000 |
|
|
|
375,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
MPH Mezzanine II, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,000,000 |
|
|
|
10,000,000 |
|
|
|
16,000,000 |
|
|
Mezzanine 2B, 8.28%, 02/09/09 (d) (e)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MPH Mezzanine III, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,000,000 |
|
|
|
4,000,000 |
|
|
|
8,000,000 |
|
|
Mezzanine 3, 9.28%, 02/09/09 (d) (e)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 2005 Land Investors LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,501,944 |
|
|
|
|
|
|
|
2,501,944 |
|
|
Second Lien Term Loan, 10.71%, 05/09/12
|
|
|
375,292 |
|
|
|
|
|
|
|
375,292 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pacific Clarion LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
19,802,292 |
|
|
|
4,950,573 |
|
|
|
24,752,865 |
|
|
Term Loan, 15.00%, 01/23/09 (d) (e) (f)
|
|
|
3,364,410 |
|
|
|
841,053 |
|
|
|
4,205,463 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Roofing Supply Group LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,790,148 |
|
|
|
|
|
|
|
3,790,148 |
|
|
Term Loan, PIK, 9.25%, 08/24/13
|
|
|
1,914,025 |
|
|
|
|
|
|
|
1,914,025 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Universal Buildings Products, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
923,249 |
|
|
|
|
|
|
|
923,249 |
|
|
Term Loan, 7.01%, 04/28/12
|
|
|
590,879 |
|
|
|
|
|
|
|
590,879 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Westgate Investments LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
8,202,958 |
|
|
|
|
|
|
|
8,202,958 |
|
|
Senior Secured Loan, PIK, 13.00%, 09/25/10 (f)
|
|
|
6,972,514 |
|
|
|
|
|
|
|
6,972,514 |
|
|
1,980,405 |
|
|
|
|
|
|
|
1,980,405 |
|
|
Senior Unsecured Loan, PIK, 18.00%, 09/25/12
|
|
|
1,287,263 |
|
|
|
|
|
|
|
1,287,263 |
|
35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
|
3,165,493 |
|
|
|
|
|
|
|
3,165,493 |
|
|
Third Lien Term Loan, 18.00%, 06/30/15 (b) (f)
|
|
|
1,741,021 |
|
|
|
|
|
|
|
1,741,021 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weststate Land Partners LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Second Lien Term Loan, 10.75%, 10/31/09 (e)
|
|
|
200,000 |
|
|
|
|
|
|
|
200,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,087,966 |
|
|
|
1,216,053 |
|
|
|
21,304,019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INFORMATION TECHNOLOGY - 1.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Infor Enterprise Solutions Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
Dollar Tranche B-1, Second Lien Term Commitment, 6.96%, 07/28/12
|
|
|
537,480 |
|
|
|
|
|
|
|
537,480 |
|
|
3,800,000 |
|
|
|
|
|
|
|
3,800,000 |
|
|
Initial Dollar, Second Lien Term Loan, 7.71%, 03/02/14
|
|
|
565,250 |
|
|
|
|
|
|
|
565,250 |
|
|
2,200,000 |
|
|
|
|
|
|
|
2,200,000 |
|
|
Second Lien Delayed Draw Term Loan, 7.71%, 03/02/14
|
|
|
327,250 |
|
|
|
|
|
|
|
327,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Serena Software, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,706,667 |
|
|
|
|
|
|
|
1,706,667 |
|
|
Term Loan, 4.25%, 03/10/13
|
|
|
1,237,333 |
|
|
|
|
|
|
|
1,237,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Verint Systems, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,000,000 |
|
|
|
|
|
|
|
6,000,000 |
|
|
Term Loan, 4.45%, 05/27/14
|
|
|
3,090,000 |
|
|
|
|
|
|
|
3,090,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,757,313 |
|
|
|
|
|
|
|
5,757,313 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MANUFACTURING - 1.9% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acument Global Technologies, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
7,822,450 |
|
|
|
|
|
|
|
7,822,450 |
|
|
Term Loan, 4.96%, 08/11/13
|
|
|
3,520,102 |
|
|
|
|
|
|
|
3,520,102 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Hunter Defense Technologies, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
948,185 |
|
|
|
|
|
|
|
948,185 |
|
|
Term Loan, 4.71%, 08/22/14
|
|
|
549,947 |
|
|
|
|
|
|
|
549,947 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Manitowoc Co., Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Term B Loan, 6.50%, 08/25/14
|
|
|
715,000 |
|
|
|
|
|
|
|
715,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Matinvest 2 SAS / Butterfly Wendal US, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
1,254,328 |
|
|
|
|
|
|
|
1,254,328 |
|
|
B-2 Facility, 4.14%, 06/22/14
|
|
|
896,844 |
|
|
|
|
|
|
|
896,844 |
|
|
1,116,317 |
|
|
|
|
|
|
|
1,116,317 |
|
|
C-2 Facility, 4.64%, 06/22/15
|
|
|
798,167 |
|
|
|
|
|
|
|
798,167 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Matinvest 2 SAS / Deutsche Connector |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,091,124 |
|
|
|
|
|
|
|
1,091,124 |
|
|
Mezzanine A USD Facility, PIK, 10.08%, 06/22/16
|
|
|
463,728 |
|
|
|
|
|
|
|
463,728 |
|
|
|
|
|
|
|
|
|
|
|
|
|
United Central Industrial Supply Co., LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,560,194 |
|
|
|
|
|
|
|
1,560,194 |
|
|
Term Loan, 3.32%, 03/31/12
|
|
|
1,228,653 |
|
|
|
|
|
|
|
1,228,653 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,172,441 |
|
|
|
|
|
|
|
8,172,441 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
METALS/MINERALS - 0.8% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Euramax International Holdings B.V. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,326,316 |
|
|
|
|
|
|
|
1,326,316 |
|
|
Second Lien European Loan, 11.00%, 06/29/13
|
|
|
364,737 |
|
|
|
|
|
|
|
364,737 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Euramax International, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,752,918 |
|
|
|
|
|
|
|
2,752,918 |
|
|
Domestic Term Loan, 6.75%, 06/29/12
|
|
|
1,169,990 |
|
|
|
|
|
|
|
1,169,990 |
|
|
6,673,684 |
|
|
|
|
|
|
|
6,673,684 |
|
|
Second Lien Domestic Term Loan, 11.00%, 06/29/13
|
|
|
1,751,842 |
|
|
|
|
|
|
|
1,751,842 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,286,569 |
|
|
|
|
|
|
|
3,286,569 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RETAIL - 2.2% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollar General Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Tranche B-2 Term Loan, 3.21%, 07/07/14
|
|
|
1,482,900 |
|
|
|
|
|
|
|
1,482,900 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Home Interiors & Gifts, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
7,223,706 |
|
|
|
|
|
|
|
7,223,706 |
|
|
Initial Term Loan, 10.36%, 03/31/11 (e)
|
|
1,264,149 |
|
|
|
|
|
|
|
1,264,149 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spirit Finance Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,500,000 |
|
|
|
|
|
|
|
6,500,000 |
|
|
Term Loan, 6.19%, 08/01/13
|
|
|
2,356,250 |
|
|
|
|
|
|
|
2,356,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Sports Authority, Inc., The |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,950,000 |
|
|
|
|
|
|
|
1,950,000 |
|
|
Term Loan, 3.71%, 05/03/13
|
|
|
1,092,000 |
|
|
|
|
|
|
|
1,092,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Toys R Us |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,970,149 |
|
|
|
|
|
|
|
5,970,149 |
|
|
Tranche B Term Loan, 4.83%, 07/19/12
|
|
|
2,895,522 |
|
|
|
|
|
|
|
2,895,522 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,090,821 |
|
|
|
|
|
|
|
9,090,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SERVICE - 5.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LVI Services, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,377,348 |
|
|
|
9,377,348 |
|
|
Tranche B Term Loan, 6.49%, 11/16/11
|
|
|
|
|
|
|
4,102,590 |
|
|
|
4,102,590 |
|
|
|
|
|
|
|
|
|
|
|
|
|
NES Rentals Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
7,765,705 |
|
|
|
|
|
|
|
7,765,705 |
|
|
Second Lien Permanent Term Loan, 9.13%, 07/20/13
|
|
|
3,416,910 |
|
|
|
|
|
|
|
3,416,910 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Penhall Holding Co. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,070,928 |
|
|
|
581,220 |
|
|
|
3,652,148 |
|
|
Term Loan PIK, 10.31%, 04/01/12
|
|
|
1,381,917 |
|
|
|
2,619,549 |
|
|
|
4,001,466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Safety-Kleen Systems, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,627,119 |
|
|
|
|
|
|
|
1,627,119 |
|
|
Synthetic Letter of Credit, 3.94%, 08/02/13
|
|
|
1,448,136 |
|
|
|
|
|
|
|
1,448,136 |
|
|
6,112,542 |
|
|
|
|
|
|
|
6,112,542 |
|
|
Term Loan B, 3.94%, 08/02/13
|
|
|
5,440,163 |
|
|
|
|
|
|
|
5,440,163 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Valleycrest Cos., LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,664,957 |
|
|
|
|
|
|
|
4,664,957 |
|
|
New Term Loan, 4.20%, 10/04/13
|
|
|
3,172,170 |
|
|
|
|
|
|
|
3,172,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,859,296 |
|
|
|
6,722,139 |
|
|
|
21,581,435 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TRANSPORTATION AUTOMOTIVE - 2.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BST Safety Textiles Acquisition GMBH |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,695,830 |
|
|
|
673,957 |
|
|
|
3,369,787 |
|
|
Second Lien Facility, 14.60%, 06/30/09
|
|
|
471,770 |
|
|
|
117,943 |
|
|
|
589,713 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Motor Coach Industries International, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,632,981 |
|
|
|
|
|
|
|
3,632,981 |
|
|
Second Lien Loan, PIK, 13.50%, 12/01/09 (e)
|
|
|
2,395,194 |
|
|
|
|
|
|
|
2,395,194 |
|
|
4,156,765 |
|
|
|
|
|
|
|
4,156,765 |
|
|
Tranche A DIP, 12.75%, 09/16/09
|
|
|
3,408,547 |
|
|
|
|
|
|
|
3,408,547 |
|
|
2,974,633 |
|
|
|
|
|
|
|
2,974,633 |
|
|
Tranche B DIP, 15.25%, 09/16/09 (d)
|
|
|
2,656,942 |
|
|
|
|
|
|
|
2,656,942 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,932,453 |
|
|
|
117,943 |
|
|
|
9,050,396 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TRANSPORTATION LAND TRANSPORTATION - 0.7% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New Century Transportation, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,302,339 |
|
|
|
|
|
|
|
2,302,339 |
|
|
Term Loan, 6.03%, 08/14/12
|
|
|
1,496,520 |
|
|
|
|
|
|
|
1,496,520 |
|
|
|
|
|
|
|
|
|
|
|
|
|
SIRVA Worldwide, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
907,630 |
|
|
|
|
|
|
|
907,630 |
|
|
Revolving Credit Loan (Exit Finance), 9.50%, 05/12/12 (b)
|
|
|
440,200 |
|
|
|
|
|
|
|
440,200 |
|
|
3,012,623 |
|
|
|
|
|
|
|
3,012,623 |
|
|
Second Lien Term Loan, PIK, 12.00%, 05/12/15
|
|
|
376,578 |
|
|
|
|
|
|
|
376,578 |
|
|
1,531,399 |
|
|
|
|
|
|
|
1,531,399 |
|
|
Term Loan (Exit Finance), 9.50%, 05/12/12
|
|
|
819,298 |
|
|
|
|
|
|
|
819,298 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,132,596 |
|
|
|
|
|
|
|
3,132,596 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UTILITY - 3.8% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Coleto Creek Power, LP |
|
|
|
|
|
|
|
|
|
|
|
|
|
184,651 |
|
|
|
|
|
|
|
184,651 |
|
|
First Lien Synthetic Letter of Credit, 4.21%, 06/28/13
|
|
|
124,270 |
|
|
|
|
|
|
|
124,270 |
|
|
2,606,593 |
|
|
|
|
|
|
|
2,606,593 |
|
|
First Lien Term Loan, 4.21%, 06/28/13
|
|
|
1,754,237 |
|
|
|
|
|
|
|
1,754,237 |
|
|
4,875,000 |
|
|
|
|
|
|
|
4,875,000 |
|
|
Second Lien Term Loan, 5.46%, 06/28/13
|
|
|
2,793,375 |
|
|
|
|
|
|
|
2,793,375 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Entegra TC LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
9,498,306 |
|
|
|
|
|
|
|
9,498,306 |
|
|
Third Lien Term Loan, PIK, 7.46%, 10/19/15
|
|
|
3,273,496 |
|
|
|
|
|
|
|
3,273,496 |
|
|
|
|
|
|
|
|
|
|
|
|
|
GBGH LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,049,746 |
|
|
|
|
|
|
|
5,049,746 |
|
|
First Lien Advance, PIK, 11.50%, 08/07/13 (d) (e)
|
|
|
2,805,639 |
|
|
|
|
|
|
|
2,805,639 |
|
|
5,945,865 |
|
|
|
|
|
|
|
5,945,865 |
|
|
Second Lien Advance, PIK, 11.50%, 08/07/14 (d) (e)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mach Gen LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
8,951,182 |
|
|
|
|
|
|
|
8,951,182 |
|
|
Term C Loan, PIK, 9.70%, 02/22/15
|
|
|
5,082,302 |
|
|
|
|
|
|
|
5,082,302 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15,833,319 |
|
|
|
|
|
|
|
15,833,319 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
|
|
|
|
|
|
|
|
|
|
|
|
Total Senior Loans
|
|
|
277,224,899 |
|
|
|
34,410,289 |
|
|
|
311,635,188 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $499,117,174) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Denominated Senior Loans (a) - 2.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AUSTRALIA - 2.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AUD
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SMG H5 Property Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
22,885,307 |
|
|
|
|
|
|
|
22,885,307 |
|
|
Facility A Term Loan, 8.86%, 12/24/12 (g)
|
|
|
9,972,258 |
|
|
|
|
|
|
|
9,972,258 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Foreign Denominated Senior Loans
|
|
|
9,972,258 |
|
|
|
|
|
|
|
9,972,258 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $18,423,992) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-Backed Securities (h) - 2.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AB CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-1A, Class C, 6.60%, 04/15/21 (i)
|
|
|
200,000 |
|
|
|
|
|
|
|
200,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
ACA CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,000,000 |
|
|
|
|
|
|
|
4,000,000 |
|
|
Series 2006-2A, Class B, 5.22%, 01/20/21 (i)
|
|
|
400,000 |
|
|
|
|
|
|
|
400,000 |
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-1A, Class D, 7.10%, 06/15/22 (i)
|
|
|
220,000 |
|
|
|
|
|
|
|
220,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Babson CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-2A, Class D, 6.45%, 04/15/21 (i)
|
|
|
150,000 |
|
|
|
|
|
|
|
150,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Bluemountain CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-3A, Class D, 3.27%, 03/17/21 (i)
|
|
|
342,600 |
|
|
|
|
|
|
|
342,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cent CDO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-15A, Class C, 4.41%, 03/11/21 (i)
|
|
|
257,700 |
|
|
|
|
|
|
|
257,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Columbus Nova CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007- 1A, Class D, 3.50%, 05/16/19 (i)
|
|
|
180,000 |
|
|
|
|
|
|
|
180,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Industrial Finance Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1BA, Class B2L, 5.53%, 12/22/20
|
|
|
100,000 |
|
|
|
|
|
|
|
100,000 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-2A, Class B2L, 6.20%, 03/01/21 (i)
|
|
|
98,400 |
|
|
|
|
|
|
|
98,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cornerstone CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500,000 |
|
|
|
|
|
|
|
2,500,000 |
|
|
Series 2007-1A, Class C, 7.15%, 07/15/21 (i)
|
|
|
344,750 |
|
|
|
|
|
|
|
344,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Goldman Sachs Asset Management CLO PLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,000,000 |
|
|
|
|
|
|
|
4,000,000 |
|
|
Series 2007-1A, Class D, 5.94%, 08/01/22 (i)
|
|
|
520,000 |
|
|
|
|
|
|
|
520,000 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-1A, Class E, 8.19%, 08/02/22 (i)
|
|
|
130,000 |
|
|
|
|
|
|
|
130,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Greywolf CLO, Ltd |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-1A, Class D, 3.74%, 02/18/21 (i)
|
|
|
117,300 |
|
|
|
|
|
|
|
117,300 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-1A, Class E, 6.19%, 02/18/21 (i)
|
|
|
160,000 |
|
|
|
|
|
|
|
160,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
GSC Partners CDO Fund, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
Series 2007-8A, Class C, 6.03%, 04/17/21 (i)
|
|
|
274,020 |
|
|
|
|
|
|
|
274,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gulf Stream Sextant CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-1A, Class D, 4.27%, 06/17/21 (i)
|
|
|
75,000 |
|
|
|
|
|
|
|
75,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Hillmark Funding |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2006-1A, Class C, 3.87%, 05/21/21 (i)
|
|
|
229,780 |
|
|
|
|
|
|
|
229,780 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class D, 5.77%, 05/21/21 (i)
|
|
|
103,420 |
|
|
|
|
|
|
|
103,420 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Inwood Park CDO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class C, 5.20%, 01/20/21 (i)
|
|
|
170,000 |
|
|
|
|
|
|
|
170,000 |
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class D, 5.90%, 01/20/21 (i)
|
|
|
118,000 |
|
|
|
|
|
|
|
118,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Limerock CLO |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-1A, Class D, 6.89%, 04/24/23 (i) |
|
|
240,000 |
|
|
|
|
|
|
|
240,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Madison Park Funding Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-5A, Class C, 3.62%, 02/26/21 (i)
|
|
|
216,000 |
|
|
|
|
|
|
|
216,000 |
|
|
1,500,000 |
|
|
|
|
|
|
|
1,500,000 |
|
|
Series 2007-5A, Class D, 5.67%, 02/26/21 (i)
|
|
|
160,230 |
|
|
|
|
|
|
|
160,230 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Marquette US/European CLO, PLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class D1, 6.50%, 07/15/20 (i)
|
|
|
152,400 |
|
|
|
|
|
|
|
152,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Navigator CDO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
961,909 |
|
|
|
|
|
|
|
961,909 |
|
|
Series 2006-2A, Class D, 5.03%, 09/20/20 (i)
|
|
|
115,583 |
|
|
|
|
|
|
|
115,583 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ocean Trails CLO |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class D, 8.57%, 10/12/20 (i)
|
|
|
20,000 |
|
|
|
|
|
|
|
20,000 |
|
|
2,500,000 |
|
|
|
|
|
|
|
2,500,000 |
|
|
Series 2007-2A, Class C, 7.10%, 06/27/22 (i)
|
|
|
350,000 |
|
|
|
|
|
|
|
350,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
PPM Grayhawk CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2007-1A, Class C, 5.90%, 04/18/21 (i)
|
|
|
102,300 |
|
|
|
|
|
|
|
102,300 |
|
|
1,150,000 |
|
|
|
|
|
|
|
1,150,000 |
|
|
Series 2007-1A, Class D, 8.10%, 04/18/21 (i)
|
|
|
126,006 |
|
|
|
|
|
|
|
126,006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primus CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
|
|
|
|
5,000,000 |
|
|
Series 2007-2A, Class D, 7.15%, 07/15/21 (i)
|
|
|
560,500 |
|
|
|
|
|
|
|
560,500 |
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-2A, Class E, 9.50%, 07/15/21 (i)
|
|
|
245,600 |
|
|
|
|
|
|
|
245,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Rampart CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,000,000 |
|
|
|
|
|
|
|
4,000,000 |
|
|
Series 2006-1A, Class C, 6.00%, 04/18/21 (i)
|
|
|
472,000 |
|
|
|
|
|
|
|
472,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
St. James River CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
Series 2007-1A, Class E, 6.46%, 06/11/21 (i)
|
|
|
450,000 |
|
|
|
|
|
|
|
450,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Stanfield Daytona CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,200,000 |
|
|
|
|
|
|
|
1,200,000 |
|
|
Series 2007-1A, Class B1L, 4.89%, 04/27/21 (i)
|
|
|
146,040 |
|
|
|
|
|
|
|
146,040 |
|
|
4,000,000 |
|
|
|
|
|
|
|
4,000,000 |
|
|
Stanfield McLaren CLO, Ltd.
Series 2007-1A, Class B1L, 4.58%, 02/27/21 (i)
|
|
|
582,000 |
|
|
|
|
|
|
|
582,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Stone Tower CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-6A, Class C, 5.90%, 04/17/21 (i)
|
|
|
320,000 |
|
|
|
|
|
|
|
320,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Venture CDO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-9A, Class D, 8.67%, 10/12/21 (i)
|
|
|
185,000 |
|
|
|
|
|
|
|
185,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Westbrook CLO, Ltd. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Series 2006-1A, Class D, 3.23%, 12/20/20 (i)
|
|
|
107,500 |
|
|
|
|
|
|
|
107,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,742,129 |
|
|
|
|
|
|
|
8,742,129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Asset-Backed Securities
|
|
|
8,742,129 |
|
|
|
|
|
|
|
8,742,129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $50,350,697) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Asset-Backed Securities (h) - 0.2% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IRELAND - 0.2% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EUR |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Static Loan Funding |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-1X, Class D, 12.15%, 07/31/17 (i)
|
|
|
361,412 |
|
|
|
|
|
|
|
361,412 |
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
Series 2007-1X, Class E, 9.65%, 07/31/17 (i)
|
|
|
333,611 |
|
|
|
|
|
|
|
333,611 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
695,023 |
|
|
|
|
|
|
|
695,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Foreign Asset-Backed Securities
|
|
|
695,023 |
|
|
|
|
|
|
|
695,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $5,380,959) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate Notes and Bonds - 39.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AEROSPACE - 0.3% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Delta Air Lines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
|
|
|
|
5,000,000 |
|
|
8.00%, 06/30/23 (e)
|
|
|
100,000 |
|
|
|
|
|
|
|
100,000 |
|
|
7,000,000 |
|
|
|
|
|
|
|
7,000,000 |
|
|
8.30%, 12/15/29 (e)
|
|
|
157,500 |
|
|
|
|
|
|
|
157,500 |
|
37
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500,000 |
|
|
|
|
|
|
|
2,500,000 |
|
|
8.88%, 12/30/27 (e)
|
|
|
9,375 |
|
|
|
|
|
|
|
9,375 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,623,507 |
|
|
|
|
|
|
|
1,623,507 |
|
|
9.06%, 05/20/12
|
|
|
974,104 |
|
|
|
|
|
|
|
974,104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,240,979 |
|
|
|
|
|
|
|
1,240,979 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BROADCASTING - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Young Broadcasting, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,065,000 |
|
|
|
|
|
|
|
3,065,000 |
|
|
10.00%, 03/01/11 (j)
|
|
|
45,975 |
|
|
|
|
|
|
|
45,975 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
45,975 |
|
|
|
|
|
|
|
45,975 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CHEMICALS - 0.3% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Georgia Gulf Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
9.50%, 10/15/14
|
|
|
610,000 |
|
|
|
|
|
|
|
610,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Tronox Worldwide, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
6,750,000 |
|
|
|
|
|
|
|
6,750,000 |
|
|
9.50%, 12/01/12 (e) (j)
|
|
|
708,750 |
|
|
|
|
|
|
|
708,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,318,750 |
|
|
|
|
|
|
|
1,318,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSUMER NON-DURABLES - 0.2% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spectrum Brands, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,530,000 |
|
|
|
|
|
|
|
2,530,000 |
|
|
12.50%, 10/02/13 (j) (k)
|
|
|
702,075 |
|
|
|
|
|
|
|
702,075 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
702,075 |
|
|
|
|
|
|
|
702,075 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DIVERSIFIED MEDIA - 0.8% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Baker & Taylor, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,300,000 |
|
|
|
8,300,000 |
|
|
11.50%, 07/01/13
|
|
|
|
|
|
|
3,537,875 |
|
|
|
3,537,875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,537,875 |
|
|
|
3,537,875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ENERGY - 0.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Energy XXI Gulf Coast, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,150,000 |
|
|
|
|
|
|
|
4,150,000 |
|
|
10.00%, 06/15/13
|
|
|
1,846,750 |
|
|
|
|
|
|
|
1,846,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,846,750 |
|
|
|
|
|
|
|
1,846,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FINANCIAL - 4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allied Capital Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,500,000 |
|
|
|
|
|
|
|
3,500,000 |
|
|
6.00%, 04/01/12
|
|
|
2,424,296 |
|
|
|
|
|
|
|
2,424,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
HUB International Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
22,200,000 |
|
|
|
|
|
|
|
22,200,000 |
|
|
10.25%, 06/15/15 (i)
|
|
|
9,906,750 |
|
|
|
|
|
|
|
9,906,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
National City Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
|
|
|
|
3,000,000 |
|
|
5.75%, 02/01/09
|
|
|
2,985,084 |
|
|
|
|
|
|
|
2,985,084 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Penhall International, Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,500,000 |
|
|
|
|
|
|
|
3,500,000 |
|
|
12.00%, 08/01/14 (i)
|
|
|
1,347,500 |
|
|
|
|
|
|
|
1,347,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,663,630 |
|
|
|
|
|
|
|
16,663,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FOREST PRODUCTS/CONTAINERS - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NewPage Holding Corp., PIK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
311,080 |
|
|
|
|
|
|
|
311,080 |
|
|
10.27%, 11/01/13 (h)
|
|
|
116,655 |
|
|
|
|
|
|
|
116,655 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
116,655 |
|
|
|
|
|
|
|
116,655 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAMING/LEISURE - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tropicana Entertainment LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
28,974,000 |
|
|
|
|
|
|
|
28,974,000 |
|
|
9.63%, 12/15/14 (e)
|
|
|
434,610 |
|
|
|
|
|
|
|
434,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
434,610 |
|
|
|
|
|
|
|
434,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HEALTHCARE - 25.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Argatroban Royalty Sub LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
11,683,914 |
|
|
|
3,306,706 |
|
|
|
14,990,620 |
|
|
18.50%, 09/21/14 (i)
|
|
|
10,398,683 |
|
|
|
2,942,968 |
|
|
|
13,341,651 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Azithromycin Royalty Sub LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
10,000,000 |
|
|
|
5,000,000 |
|
|
|
15,000,000 |
|
|
16.00%, 05/15/19 (i)
|
|
|
8,700,000 |
|
|
|
4,350,000 |
|
|
|
13,050,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Celtic Pharma Phinco B.V. |
|
|
|
|
|
|
|
|
|
|
|
|
|
34,135,102 |
|
|
|
10,561,138 |
|
|
|
44,696,240 |
|
|
PIK, 17.00%, 06/15/12 (i)
|
|
|
25,259,976 |
|
|
|
7,815,242 |
|
|
|
33,075,218 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cinacalcet Royalty Sub LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
371,434 |
|
|
|
|
|
|
|
371,434 |
|
|
8.00%, 03/30/17 (i)
|
|
|
397,435 |
|
|
|
|
|
|
|
397,435 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Fosamprenavir Pharma |
|
|
|
|
|
|
|
|
|
|
|
|
|
4,630,077 |
|
|
|
|
|
|
|
4,630,077 |
|
|
15.50%, 06/15/18 (i)
|
|
|
4,028,167 |
|
|
|
|
|
|
|
4,028,167 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Molecular Insight Pharmaceuticals, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,569,004 |
|
|
|
1,027,602 |
|
|
|
3,596,606 |
|
|
10.80%, 11/01/12 (h) (i)
|
|
|
2,055,203 |
|
|
|
822,081 |
|
|
|
2,877,284 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pharma 17 (Sanctura XR) |
|
|
|
|
|
|
|
|
|
|
|
|
|
22,000,000 |
|
|
|
|
|
|
|
22,000,000 |
|
|
16.00%, 11/05/24 (i)
|
|
|
19,140,000 |
|
|
|
|
|
|
|
19,140,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pharma II (Risperidone) |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
7.00%, 01/18/18 (i)
|
|
|
1,620,000 |
|
|
|
|
|
|
|
1,620,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pharma IV (Eszopiclone)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,792,059 |
|
|
|
|
|
|
|
2,792,059 |
|
|
12.00%, 06/30/14 (i)
|
|
|
2,540,774 |
|
|
|
|
|
|
|
2,540,774 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pharma V (Duloxetine) |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,760,000 |
|
|
|
|
|
|
|
1,760,000 |
|
|
13.00%, 10/15/13 (i)
|
|
|
1,601,600 |
|
|
|
|
|
|
|
1,601,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pharma X (Sensipar-Cinacalcet) |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,077,500 |
|
|
|
1,038,750 |
|
|
|
3,116,250 |
|
|
15.50%, 03/30/17 PIK (i)
|
|
|
1,537,350 |
|
|
|
768,675 |
|
|
|
2,306,025 |
|
|
|
|
|
|
|
|
|
|
|
|
|
TCD Pharma |
|
|
|
|
|
|
|
|
|
|
|
|
|
15,500,000 |
|
|
|
|
|
|
|
15,500,000 |
|
|
16.00%, 04/15/24 (i)
|
|
|
13,485,000 |
|
|
|
|
|
|
|
13,485,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90,764,188 |
|
|
|
16,698,966 |
|
|
|
107,463,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HOUSING - 0.9% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realogy Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
7,000,000 |
|
|
|
|
|
|
|
7,000,000 |
|
|
10.50%, 04/15/14
|
|
|
1,242,500 |
|
|
|
|
|
|
|
1,242,500 |
|
|
9,322,000 |
|
|
|
|
|
|
|
9,322,000 |
|
|
12.38%, 04/15/15 (j)
|
|
|
1,305,080 |
|
|
|
|
|
|
|
1,305,080 |
|
|
|
|
|
|
|
|
|
|
|
|
|
SUSA Partnership LP |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
7.45%, 07/01/18
|
|
|
1,037,114 |
|
|
|
|
|
|
|
1,037,114 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,584,694 |
|
|
|
|
|
|
|
3,584,694 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INFORMATION TECHNOLOGY - 0.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charys Holding Co., Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
|
|
|
|
5,000,000 |
|
|
8.75%, 02/16/12 (d) (e) (i)
|
|
|
1,136,000 |
|
|
|
|
|
|
|
1,136,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
MagnaChip Semiconductor |
|
|
|
|
|
|
|
|
|
|
|
|
|
13,000,000 |
|
|
|
|
|
|
|
13,000,000 |
|
|
5.25%, 12/15/11 (h) (j)
|
|
|
520,000 |
|
|
|
|
|
|
|
520,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Spansion LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000,000 |
|
|
|
|
|
|
|
5,000,000 |
|
|
11.25%, 01/15/16 (i) (j)
|
|
|
375,000 |
|
|
|
|
|
|
|
375,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,031,000 |
|
|
|
|
|
|
|
2,031,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
TELECOMMUNICATIONS - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nordic Telephone Co. Holdings APS |
|
|
|
|
|
|
|
|
|
|
|
|
|
500,000 |
|
|
|
|
|
|
|
500,000 |
|
|
8.88%, 05/01/16 (i)
|
|
|
352,500 |
|
|
|
|
|
|
|
352,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
352,500 |
|
|
|
|
|
|
|
352,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TRANSPORTATION AUTOMOTIVE - 2.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
American Tire Distributors Holdings, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
11,500,000 |
|
|
|
|
|
|
|
11,500,000 |
|
|
10.13%, 04/01/12 (h)
|
|
|
8,567,500 |
|
|
|
|
|
|
|
8,567,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Delphi Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,750,000 |
|
|
|
|
|
|
|
3,750,000 |
|
|
6.50%, 05/01/09 (e)
|
|
|
75,000 |
|
|
|
|
|
|
|
75,000 |
|
|
3,933,000 |
|
|
|
|
|
|
|
3,933,000 |
|
|
6.55%, 06/15/09 (e) (j)
|
|
|
78,660 |
|
|
|
|
|
|
|
78,660 |
|
|
8,334,000 |
|
|
|
|
|
|
|
8,334,000 |
|
|
7.13%, 05/01/29 (e) (j)
|
|
|
166,680 |
|
|
|
|
|
|
|
166,680 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,887,840 |
|
|
|
|
|
|
|
8,887,840 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UTILITY - 0.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Kiowa Power |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
5.74%, 03/30/21 (i)
|
|
|
1,533,834 |
|
|
|
|
|
|
|
1,533,834 |
|
|
|
|
|
|
|
|
|
|
|
|
|
USGEN New England PCG |
|
|
|
|
|
|
|
|
|
|
|
|
|
56,303 |
|
|
|
|
|
|
|
56,303 |
|
|
7.46%, 01/02/15 (e)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,533,834 |
|
|
|
|
|
|
|
1,533,834 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
WIRELESS COMMUNICATIONS - 3.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alltel Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,000,000 |
|
|
|
|
|
|
|
2,000,000 |
|
|
7.88%, 07/01/32
|
|
|
1,960,000 |
|
|
|
|
|
|
|
1,960,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Digicel Group, Ltd. PIK |
|
|
|
|
|
|
|
|
|
|
|
|
|
19,492,000 |
|
|
|
|
|
|
|
19,492,000 |
|
|
9.13%, 01/15/15 (i) (j)
|
|
|
12,377,420 |
|
|
|
|
|
|
|
12,377,420 |
|
|
|
|
|
|
|
|
|
|
|
|
|
ICO North America, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,173,000 |
|
|
|
|
|
|
|
2,173,000 |
|
|
8.50%, 08/15/09
|
|
|
543,250 |
|
|
|
|
|
|
|
543,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,880,670 |
|
|
|
|
|
|
|
14,880,670 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Corporate Notes and Bonds
|
|
|
144,404,150 |
|
|
|
20,236,841 |
|
|
|
164,640,991 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $249,617,494) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Claims (l) - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AEROSPACE - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Delta Airlines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
581,794 |
|
|
|
|
|
|
|
581,794 |
|
|
Delta ALPA Claim, 12/31/10
|
|
|
14,545 |
|
|
|
|
|
|
|
14,545 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Northwest Airlines, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000,000 |
|
|
|
3,000,000 |
|
|
|
6,000,000 |
|
|
ALPA Trade Claim, 8/21/2013
|
|
|
5,640 |
|
|
|
5,640 |
|
|
|
11,280 |
|
|
|
|
|
|
2,500,000 |
|
|
|
2,500,000 |
|
|
Bell Atlantic Trade Claim, 08/21/13
|
|
|
|
|
|
|
4,700 |
|
|
|
4,700 |
|
|
|
|
|
|
2,500,000 |
|
|
|
2,500,000 |
|
|
EDC Trade Claims, 08/21/13
|
|
|
|
|
|
|
4,700 |
|
|
|
4,700 |
|
|
5,326,500 |
|
|
|
5,326,500 |
|
|
|
10,653,000 |
|
|
Flight Attendant Claim, 8/21/2013
|
|
|
10,014 |
|
|
|
10,014 |
|
|
|
20,028 |
|
|
|
|
|
|
1,500,000 |
|
|
|
1,500,000 |
|
|
GE Trade Claim, 08/21/13
|
|
|
|
|
|
|
2,820 |
|
|
|
2,820 |
|
|
3,161,250 |
|
|
|
4,728,134 |
|
|
|
7,889,384 |
|
|
IAM Trade Claim, 8/21/2013
|
|
|
5,943 |
|
|
|
8,889 |
|
|
|
14,832 |
|
|
|
|
|
|
8,433,116 |
|
|
|
8,433,116 |
|
|
Pinnacle Trade Claim, 08/21/13
|
|
|
|
|
|
|
15,854 |
|
|
|
15,854 |
|
|
3,512,250 |
|
|
|
3,512,250 |
|
|
|
7,024,500 |
|
|
Retiree Claim, 8/21/2013
|
|
|
6,603 |
|
|
|
6,603 |
|
|
|
13,206 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42,745 |
|
|
|
59,220 |
|
|
|
101,965 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Claims
|
|
|
42,745 |
|
|
|
59,220 |
|
|
|
101,965 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $2,474,100) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stocks - 8.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AEROSPACE - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,694 |
|
|
|
30,433 |
|
|
|
50,127 |
|
|
Delta Air Lines, Inc. (l)
|
|
|
225,698 |
|
|
|
348,762 |
|
|
|
574,460 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
225,698 |
|
|
|
348,762 |
|
|
|
574,460 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BROADCASTING - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
753,981 |
|
|
|
1,256,635 |
|
|
|
2,010,616 |
|
|
Communications Corp. of America (c) (d) (l)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
108,472 |
|
|
|
|
|
|
|
108,472 |
|
|
Gray Television, Inc., Class A
|
|
|
62,914 |
|
|
|
|
|
|
|
62,914 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62,914 |
|
|
|
|
|
|
|
62,914 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DIVERSIFIED MEDIA - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46,601 |
|
|
|
|
|
|
|
46,601 |
|
|
American Banknote Corp.
(d) (l)
|
|
489,310 |
|
|
|
|
|
|
|
489,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
489,310 |
|
|
|
|
|
|
|
489,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FINANCIAL - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
555,258 |
|
|
|
|
|
|
|
555,258 |
|
|
Altiva Financial Corp. (l)
|
|
|
3,609 |
|
|
|
|
|
|
|
3,609 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,609 |
|
|
|
|
|
|
|
3,609 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HEALTHCARE - 7.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,000,000 |
|
|
|
12,000,000 |
|
|
|
19,000,000 |
|
|
Genesys Ltd. (c) (d) (l)
|
|
|
10,157,000 |
|
|
|
17,412,000 |
|
|
|
27,569,000 |
|
|
1,072,961 |
|
|
|
|
|
|
|
1,072,961 |
|
|
Microvision, Inc. (j) (l)
|
|
|
1,802,574 |
|
|
|
|
|
|
|
1,802,574 |
|
|
36,795 |
|
|
|
|
|
|
|
36,795 |
|
|
UnitedHealth Group, Inc.
|
|
|
978,747 |
|
|
|
|
|
|
|
978,747 |
|
|
22,397 |
|
|
|
|
|
|
|
22,397 |
|
|
WellPoint, Inc. (l)
|
|
|
943,586 |
|
|
|
|
|
|
|
943,586 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,881,907 |
|
|
|
17,412,000 |
|
|
|
31,293,907 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HOUSING - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
8 |
|
|
Westgate Investments LLC, Class B-1 (l)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SERVICE - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
200,964 |
|
|
|
|
|
|
|
200,964 |
|
|
Safety-Kleen Systems, Inc. (l)
|
|
|
502,411 |
|
|
|
|
|
|
|
502,411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
502,411 |
|
|
|
|
|
|
|
502,411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TELECOMMUNICATIONS - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
232 |
|
|
|
|
|
|
|
232 |
|
|
Knology, Inc. (l)
|
|
|
1,197 |
|
|
|
|
|
|
|
1,197 |
|
|
70,342 |
|
|
|
|
|
|
|
70,342 |
|
|
Micadent PLC (d) (l)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
1 |
|
|
Viatel Holding (Bermuda)
Ltd. (l)
|
|
1 |
|
|
|
|
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,198 |
|
|
|
|
|
|
|
1,198 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TRANSPORTATION AUTOMOTIVE - 0% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,544,148 |
|
|
|
|
|
|
|
1,544,148 |
|
|
Delphi Corp. (l)
|
|
|
41,692 |
|
|
|
|
|
|
|
41,692 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41,692 |
|
|
|
|
|
|
|
41,692 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TRANSPORTATION LAND TRANSPORTATION - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,030 |
|
|
|
|
|
|
|
18,030 |
|
|
SIRVA Worldwide, Inc. (d) (l)
|
|
|
585,074 |
|
|
|
|
|
|
|
585,074 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
585,074 |
|
|
|
|
|
|
|
585,074 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
|
|
|
Highland Credit |
|
Highland Distressed |
|
Highland Credit |
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
|
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Strategies Fund (HCF) |
Principal Amount ($) |
|
Principal Amount ($) |
|
Principal Amount ($) |
|
Security |
|
Value ($) |
|
Value ($) |
|
Value ($) |
UTILITY - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
81,194 |
|
|
|
|
|
|
|
81,194 |
|
|
Entegra TC LLC (l)
|
|
|
324,776 |
|
|
|
|
|
|
|
324,776 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
324,776 |
|
|
|
|
|
|
|
324,776 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
WIRELESS COMMUNICATIONS - 0.5% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,078,905 |
|
|
|
138,632 |
|
|
|
1,217,537 |
|
|
ICO Global Communications Holding Ltd. (l)
|
|
|
1,219,163 |
|
|
|
153,882 |
|
|
|
1,373,045 |
|
|
554,527 |
|
|
|
|
|
|
|
554,527 |
|
|
ICO Global Communications Holding Ltd.
(Restricted) (l)
|
|
615,525 |
|
|
|
|
|
|
|
615,525 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,834,688 |
|
|
|
153,882 |
|
|
|
1,988,570 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Common Stocks
(HCF Cost $40,816,981)
|
|
|
17,953,277 |
|
|
|
17,914,644 |
|
|
|
35,867,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred Stocks - 2.4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,000 |
|
|
|
|
|
|
|
10,000 |
|
|
Adelphia Communications Corp., Series B (l)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,000,000 |
|
|
|
|
|
|
|
1,000,000 |
|
|
Adelphia Recovery Trust (l)
|
|
|
9,900 |
|
|
|
|
|
|
|
9,900 |
|
|
2,150,537 |
|
|
|
|
|
|
|
2,150,537 |
|
|
Dfine, Inc., Series D (d) (l)
|
|
|
9,999,997 |
|
|
|
|
|
|
|
9,999,997 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,009,897 |
|
|
|
|
|
|
|
10,009,897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Preferred Stocks
(HCF Cost $10,934,997)
|
|
|
10,009,897 |
|
|
|
|
|
|
|
10,009,897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants (l) - 0.1% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,000 |
|
|
|
|
|
|
|
20,000 |
|
|
Clearwire Corp., expires 08/15/10
|
|
|
50 |
|
|
|
|
|
|
|
50 |
|
|
1,000 |
|
|
|
|
|
|
|
1,000 |
|
|
Grande Communications, expires 04/01/11
|
|
|
10 |
|
|
|
|
|
|
|
10 |
|
|
49,317 |
|
|
|
|
|
|
|
49,317 |
|
|
IAP Worldwide Services, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,444 |
|
|
|
|
|
|
|
14,444 |
|
|
IAP Worldwide Services, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,312 |
|
|
|
|
|
|
|
7,312 |
|
|
IAP Worldwide Services, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
643,777 |
|
|
|
|
|
|
|
643,777 |
|
|
Microvision, Inc., expires 07/23/13 (d)
|
|
|
309,013 |
|
|
|
|
|
|
|
309,013 |
|
|
6,000 |
|
|
|
|
|
|
|
6,000 |
|
|
Sirius XM Radio, Inc., expires 03/15/10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
309,073 |
|
|
|
|
|
|
|
309,073 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Warrants
|
|
|
309,073 |
|
|
|
|
|
|
|
309,073 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost $1,010,349) |
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments - 128.7% |
|
|
|
|
|
|
|
|
469,353,451 |
|
|
|
72,620,994 |
|
|
|
541,974,445 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(HCF Cost of $878,126,743) (m) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40
|
|
|
(a) |
|
Senior loans (also called bank loans, leveraged loans, or floating rate loans) in which the
Fund invests, generally pay interest at rates which are periodically determined by reference to a
base lending rate plus a premium. (Unless otherwise identified by footnote (f), all senior loans
carry a variable rate interest.) These base lending rates are generally (i) the Prime Rate offered
by one or more major United States banks, (ii) the lending rate offered by one or more European
banks such as the London Interbank Offered Rate (LIBOR) or (iii) the Certificate of Deposit rate.
Rate shown represents the weighted average rate at December 31, 2008. Senior loans, while exempt
from registration under the Securities Act of 1933 (the 1933 Act), contain certain restrictions
on resale and cannot be sold publicly. Senior secured floating rate loans often require prepayments
from excess cash flow or permit the borrower to repay at its election. The degree to which
borrowers repay, whether as a contractual requirement or at their election, cannot be predicted
with accuracy. As a result, the actual remaining maturity may be substantially less than the stated
maturity shown. |
|
(b) |
|
Senior Loan assets have additional unfunded loan commitments. |
|
(c) |
|
Affiliated issuer. |
|
(d) |
|
Represents fair value as determined by the respective Funds Board of Directors/Trustees (the Board) or its
designee in good faith, pursuant to the policies and procedures approved by the Board. Securities
with a total aggregate market value of $77,952,489, or 18.50% of net assets, were fair valued as of
December 31, 2008. |
|
(e) |
|
The issuer is in default of its payment obligation. Income is not being accrued. |
|
(f) |
|
Fixed rate senior loan. |
|
(g) |
|
Loans held on participation. |
|
(h) |
|
Floating rate asset. The interest rate shown reflects the rate in effect at December 31, 2008. |
|
(i) |
|
Securities exempt from registration under Rule 144A of the 1933 Act. These securities may only
be resold, in transactions exempt from registration, to qualified institutional buyers. At December
31, 2008, these securities amounted to $147,367,185 or 34.98% of net assets. |
41
|
|
|
(j) |
|
Securities (or a portion of securites) on loan. |
|
(k) |
|
Step Coupon. A bond that pays an initial coupon rate for the first period and then a higher
coupon rate for the following periods until maturity. Spectrum Brands, Inc., (Corporate Note &
Bond) has a rate of 12.50% until 04/02/09. |
|
(l) |
|
Non-income producing security. |
|
(m) |
|
Cost for U.S. federal income tax purposes is $1,068,948,673. |
|
PIK |
|
Payment-in-Kind |
|
ADR |
|
American Depositary Receipt |
|
AUD |
|
Australian Dollar |
|
CDO |
|
Collateralized Debt Obligation |
|
CLO |
|
Collateralized Loan Obligation |
|
DIP |
|
Debtor-in-Possession |
|
EUR |
|
Euro Currency |
|
GBP |
|
Great Britain Pound |
|
PIK |
|
Payment-in-Kind |
Credit Default Swap Agreement outstanding as of December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Counterparty |
|
Referenced Obligation |
|
Buy/Sell Protection |
|
(Pay)/Receive Rate |
| |
Expiration Date |
|
Notional Amount |
|
Unrealized Appreciation |
Goldman Sachs Credit Partners L.P. |
|
CDX.NA.HY.9 |
|
Buy (1) |
|
|
|
|
-3.75 |
% |
|
|
12/20/2012 |
|
|
|
5,919,200 |
|
$ |
282,453 |
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
282,453 |
|
|
|
|
(1) |
|
If a credit event occurs as defined under the terms of the Credit Default Swap Index (CDX), the reference obligation that defaults drops out of the CDX and the CDX
is quoted without the obligation until the next series of the CDX is issued. Unlike traditional credit default swap arrangments, the Fund, as a buyer of protection, will not receive the underlying reference obligation upon default. |
|
Forward foreign currency contracts outstanding as of December 31, 2008 were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal |
|
|
|
Net |
Contracts |
|
|
|
Amount |
|
|
|
Unrealized |
to Buy or |
|
|
|
Covered by |
|
|
|
Appreciation/ |
to Sell |
|
Currency |
|
Contracts |
|
Expiration |
|
(Depreciation) |
Buy |
|
EUR |
|
5,400,000 |
|
02/04/09 |
|
|
542,385 |
|
Sell |
|
EUR |
|
7,500,000 |
|
02/04/09 |
|
|
1,169,603 |
|
Buy |
|
GBP |
|
4,500,000 |
|
02/04/09 |
|
|
(178,162 |
) |
Sell |
|
GBP |
|
7,000,000 |
|
02/04/09 |
|
|
3,587,825 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,121,651 |
|
42
Statement of Assets and Liabilities
Pro Forma Combined Statement of Assets and Liabilities for Highland Credit Strategies Fund and Highland Distressed Opportunities Inc. as of December 31, 2008 (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
Highland Credit |
|
Highland Distressed |
|
Pro Forma |
|
Highland Credit |
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Adjustments |
|
Strategies Fund (HCF) |
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaffiliated Investments, at value |
|
|
453,389,143 |
|
|
|
45,530,147 |
|
|
|
|
|
|
|
498,919,290 |
|
Affiliated Investments, at value |
|
|
15,964,308 |
|
|
|
27,090,847 |
|
|
|
|
|
|
|
43,055,155 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investments, at value |
|
|
469,353,451 |
|
|
|
72,620,994 |
|
|
|
|
|
|
|
541,974,445 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash |
|
|
413,581 |
|
|
|
|
|
|
|
|
|
|
|
413,581 |
|
Foreign Currency |
|
|
|
|
|
|
10 |
|
|
|
|
|
|
|
10 |
|
Net unrealized appreciation on credit default swaps |
|
|
282,543 |
|
|
|
|
|
|
|
|
|
|
|
282,543 |
|
Net unrealized appreciation on forward currency contracts |
|
|
5,121,651 |
|
|
|
|
|
|
|
|
|
|
|
5,121,651 |
|
Cash held as collateral for securities loaned |
|
|
5,278,238 |
|
|
|
|
|
|
|
|
|
|
|
5,278,238 |
|
Receivable for: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments Sold |
|
|
31,976,119 |
|
|
|
12,106,871 |
|
|
|
|
|
|
|
44,082,990 |
|
Swap agreements |
|
|
728,802 |
|
|
|
|
|
|
|
|
|
|
|
728,802 |
|
Dividends and interest receivables |
|
|
16,646,536 |
|
|
|
2,337,202 |
|
|
|
|
|
|
|
18,983,738 |
|
Other assets |
|
|
58,976 |
|
|
|
96,923 |
|
|
|
|
|
|
|
155,899 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
|
529,859,897 |
|
|
|
87,162,000 |
|
|
|
|
|
|
|
617,021,897 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due to Custodian |
|
|
|
|
|
|
122,505 |
|
|
|
|
|
|
|
122,505 |
|
Note payable |
|
|
141,000,000 |
|
|
|
15,500,000 |
|
|
|
|
|
|
|
156,500,000 |
|
Foreign currency |
|
|
124,927 |
|
|
|
|
|
|
|
|
|
|
|
124,927 |
|
Dividends payable on securities sold short |
|
|
1,849 |
|
|
|
|
|
|
|
|
|
|
|
1,849 |
|
Net discount and unrealized depreciation on unfunded transactions |
|
|
9,363,299 |
|
|
|
31,756 |
|
|
|
|
|
|
|
9,395,055 |
|
Payable upon receipt of securities loaned |
|
|
5,278,238 |
|
|
|
|
|
|
|
|
|
|
|
5,278,238 |
|
Payables for: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest payable |
|
|
397 |
|
|
|
|
|
|
|
|
|
|
|
397 |
|
Investments purchased |
|
|
11,060,518 |
|
|
|
9,809,787 |
|
|
|
|
|
|
|
20,870,305 |
|
Excise tax |
|
|
353,670 |
|
|
|
|
|
|
|
|
|
|
|
353,670 |
|
Investment advisory fee payable |
|
|
401,886 |
|
|
|
627,965 |
|
|
|
|
|
|
|
1,029,851 |
|
Administration fee |
|
|
60,151 |
|
|
|
109,894 |
|
|
|
|
|
|
|
170,045 |
|
Interest expense |
|
|
637,420 |
|
|
|
112,469 |
|
|
|
|
|
|
|
749,889 |
|
Directors fees |
|
|
25,000 |
|
|
|
5,100 |
|
|
|
|
|
|
|
30,100 |
|
Accrued expenses and other liabilities |
|
|
342,037 |
|
|
|
286,096 |
|
|
|
500,000 |
(1) |
|
|
1,128,133 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
168,649,392 |
|
|
|
26,605,572 |
|
|
|
500,000 |
|
|
|
195,754,964 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Assets Applicable to Common Shares: |
|
|
361,210,505 |
|
|
|
60,556,428 |
|
|
|
(500,000 |
) |
|
|
421,266,933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Composition of Net Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Par value of common shares |
|
|
55,526 |
|
|
|
17,717 |
|
|
|
(8,408 |
) |
|
|
64,835 |
|
Paid-in capital in excess of par value of common shares |
|
|
1,011,627,967 |
|
|
|
253,018,580 |
|
|
|
8,408 |
|
|
|
1,264,654,955 |
|
Undistributed net investment income |
|
|
4,907,190 |
|
|
|
1,067,487 |
|
|
|
(500,000) |
(1) |
|
|
5,474,677 |
|
Accumulated net realized gain/(loss) from investments, swaps and foreign currency
transactions |
|
|
(246,392,014 |
) |
|
|
(99,083,521 |
) |
|
|
|
|
|
|
(345,475,535 |
) |
Net unrealized appreciation/(depreciation) on investments, unfunded transactions,
short positions, forward currency contracts, swaps and translation of assets and
liabilities denominated in foreign currency |
|
|
(408,988,164 |
) |
|
|
(94,463,835 |
) |
|
|
|
|
|
|
(503,451,999 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Assets Applicable to Common Shares |
|
|
361,210,505 |
|
|
|
60,556,428 |
|
|
|
(500,000) |
(1) |
|
|
421,266,933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Assets |
|
|
361,210,505 |
|
|
|
60,556,428 |
|
|
|
|
|
|
|
421,266,933 |
|
Shares outstanding |
|
|
55,526,190 |
|
|
|
17,716,771 |
|
|
|
(8,407,884) |
(2) |
|
|
64,835,077 |
|
Net asset value per share (net assets/shares outstanding) |
|
|
6.51 |
|
|
|
3.42 |
|
|
|
|
|
|
|
6.50 |
(3) |
|
|
|
(1) |
|
Reflects adjustments for estimated reorganization expenses of $500,000. |
|
(2) |
|
Reflects adjustments to the number of shares outstanding due to the reorganization. |
|
(3) |
|
Reflects the expenses borne by the funds relating to the reorganization. |
See Notes to Pro Forma Combined Financial Statements
43
Statement of Operations
Pro Forma Combined Statement of Operations for Highland Credit Strategies Fund and Highland Distressed Opportunities Inc. for the Year Ended December 31, 2008 (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma Combined |
|
|
Highland Credit |
|
Highland Distressed |
|
Pro Forma |
|
Highland Credit |
|
|
Strategies Fund (HCF) |
|
Opportunities Inc. (HCD) |
|
Adjustments |
|
Strategies Fund (HCF) |
Investment Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaffliated interest income |
|
|
96,273,069 |
|
|
|
20,092,839 |
|
|
|
|
|
|
|
116,365,908 |
|
Affiliated interest income |
|
|
1,090,199 |
|
|
|
1,845,150 |
|
|
|
|
|
|
|
2,935,349 |
|
Dividends |
|
|
301,565 |
|
|
|
40,685 |
|
|
|
|
|
|
|
342,250 |
|
Securities lending income |
|
|
228,757 |
|
|
|
|
|
|
|
|
|
|
|
228,757 |
|
Other income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income |
|
|
97,893,590 |
|
|
|
21,978,674 |
|
|
|
|
|
|
|
119,872,264 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory fees |
|
|
9,000,340 |
|
|
|
4,194,605 |
|
|
|
(2,366,135 |
) a |
|
|
10,828,810 |
|
Incentive fees |
|
|
|
|
|
|
1,680,346 |
|
|
|
(1,680,346 |
) b |
|
|
|
|
Administration fees |
|
|
1,800,068 |
|
|
|
734,056 |
|
|
|
(368,362 |
) a |
|
|
2,165,762 |
|
Accounting service fees |
|
|
469,448 |
|
|
|
154,590 |
|
|
|
(95,787 |
) c |
|
|
528,251 |
|
Transfer agent fees |
|
|
48,073 |
|
|
|
29,890 |
|
|
|
(29,890 |
) c |
|
|
48,073 |
|
Professional fees |
|
|
614,153 |
|
|
|
1,281,198 |
|
|
|
(1,184,511 |
) c |
|
|
710,840 |
|
Trustees fees |
|
|
91,350 |
|
|
|
19,881 |
|
|
|
|
|
|
|
111,231 |
|
Custodian fees |
|
|
108,996 |
|
|
|
28,827 |
|
|
|
(6,684 |
) c |
|
|
131,139 |
|
Registration fees |
|
|
55,444 |
|
|
|
24,097 |
|
|
|
(24,097 |
) c |
|
|
55,444 |
|
Franchise tax expense |
|
|
|
|
|
|
80,393 |
|
|
|
(80,393 |
) c |
|
|
|
|
Excise tax expense |
|
|
566,930 |
|
|
|
115,421 |
|
|
|
|
|
|
|
682,351 |
|
Rating agency fees |
|
|
53,333 |
|
|
|
66,184 |
|
|
|
(66,184 |
) c |
|
|
53,333 |
|
Reports to shareholders |
|
|
127,409 |
|
|
|
131,041 |
|
|
|
(105,157 |
) c |
|
|
153,293 |
|
Interest Expense |
|
|
10,461,088 |
|
|
|
3,173,667 |
|
|
|
|
|
|
|
13,634,755 |
|
Reorganization expense related to PHY and CNN |
|
|
671,545 |
|
|
|
|
|
|
|
|
|
|
|
671,545 |
|
Other Expenses |
|
|
200,272 |
|
|
|
284,519 |
|
|
|
(264,847 |
) c |
|
|
219,944 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net operating expenses |
|
|
24,268,449 |
|
|
|
11,998,715 |
|
|
|
(6,272,393 |
) |
|
|
29,994,771 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends on securities sold short |
|
|
1,102,612 |
|
|
|
|
|
|
|
|
|
|
|
1,102,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Expenses |
|
|
25,371,061 |
|
|
|
11,998,715 |
|
|
|
(6,272,393 |
) |
|
|
31,097,383 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Fee waiver |
|
|
(553,567 |
) |
|
|
(809,977 |
) |
|
|
809,977 |
d |
|
|
(553,567 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Net expense |
|
|
24,817,494 |
|
|
|
11,188,738 |
|
|
|
(5,462,416 |
) |
|
|
30,543,816 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
|
73,076,096 |
|
|
|
10,789,936 |
|
|
|
5,462,416 |
|
|
|
89,328,448 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Realized and Unrealized Gain/(Loss) on Investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gain/(loss) on investments |
|
|
(139,205,568 |
) |
|
|
(84,535,832 |
) |
|
|
|
|
|
|
(223,741,400 |
) |
Net realized gain/(loss) on short positions |
|
|
2,324,028 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gain/(loss) on swaps |
|
|
(64,551,724 |
) |
|
|
|
|
|
|
|
|
|
|
(64,551,724 |
) |
Net realized gain/(loss) on foreign currency transactions |
|
|
(3,587,588 |
) |
|
|
(82 |
) |
|
|
|
|
|
|
(3,587,670 |
) |
Net change in unrealized appreciation/(depreciation) on investments |
|
|
(362,573,562 |
) |
|
|
(34,392,439 |
) |
|
|
|
|
|
|
(396,966,001 |
) |
Net change in unrealized appreciation/(depreciation) on unfunded transactions |
|
|
(7,352,563 |
) |
|
|
(31,756 |
) |
|
|
|
|
|
|
(7,384,319 |
) |
Net change in unrealized appreciation/(depreciation) on short positions |
|
|
(398,025 |
) |
|
|
|
|
|
|
|
|
|
|
(398,025 |
) |
Net change in unrealized appreciation/(depreciation) on forward currency contracts |
|
|
6,396,909 |
|
|
|
|
|
|
|
|
|
|
|
6,396,909 |
|
Net change in unrealized appreciation/(depreciation) on swaps |
|
|
6,652,870 |
|
|
|
|
|
|
|
|
|
|
|
6,652,870 |
|
Net change in unrealized appreciation/(depreciation) on translation of assets and
liabilities denominated in foreign currency |
|
|
3,356,406 |
|
|
|
(873 |
) |
|
|
|
|
|
|
3,355,533 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized and unrealized gain/(loss) on investments |
|
|
(558,938,817 |
) |
|
|
(118,960,982 |
) |
|
|
|
|
|
|
(680,223,827 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease)/increase in net assets, applicable to common shareholders, from
operations |
|
|
(485,862,721 |
) |
|
|
(108,171,046 |
) |
|
|
5,462,416 |
|
|
|
(590,895,379 |
) |
See Notes to Pro Forma Combined Financial Statements
|
|
|
(a) |
|
Reflects the decrease in the advisory and administration fee due to the lower advisory and
administration fee of HCF relative to HCD. |
|
(b) |
|
Reflects the elimination of the incentive fee as HCF does not charge an incentive fee. |
|
(c) |
|
Reflects the elimination of duplicative expenses and expenses
relating to HCDs operations as a business development company, and economies of scale due to the proposed
merger. |
|
(d) |
|
Reflects the elimination of the HCD fee waiver. |
44
Highland Distressed Opportunities, Inc. Merger With and Into Highland Credit Strategies Fund
Notes to Pro Forma Combined Financial Statements (Unaudited)
1. Basis of Combination:
The accompanying unaudited Pro Forma Combined Statement of Assets and Liabilities, including the Pro
Forma Combined Schedule of Investments at December 31, 2008 and the related Pro Forma Combined Statement of
Operations (Pro Forma Statements) for the twelve months
ended December 31, 2008, reflect the
accounts of Highland Distressed Opportunities, Inc. (Acquired Fund) and Highland Credit Strategies Fund
(Acquiring Fund), each a Fund. Following the reorganization, Highland Credit Strategies Fund will be the
accounting survivor.
Pursuant to an Agreement and Plan of Merger and Liquidation (Agreement)
the Acquired Fund will merge with and into HCF Acquisition LLC (Merger Sub), a Delaware
limited liability company to be organized as a wholly owned subsidiary of the Acquiring Fund
(the Merger), with Merger Sub being the surviving entity and pursuant to which common
stockholders of Acquired Fund will receive shares of beneficial interest of Acquiring Fund
(and cash in lieu of any fractional shares). Immediately after the Merger, Merger Sub will distribute
its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger Sub, in complete
liquidation and dissolution of Merger Sub (collectively with the Merger, the Reorganization).
As a result of the Reorganization, each common stockholder of the Acquired Fund will become a common
shareholder of the Acquiring Fund.
Under the terms of the Agreement, the Reorganization is intended to qualify as a reorganization within
the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. If the Reorganization so
qualifies, in general, stockholders of the Acquired Fund will recognize no gain or loss upon the receipt solely of
shares of the Acquiring Fund in connection with the Reorganization. Additionally, the Acquired Fund will
recognize no gain or loss as a result of the Reorganization. Neither the Acquiring Fund nor its shareholders will
recognize any gain or loss in connection with the Reorganization. However, stockholders of the Acquired Fund may
recognize gain or loss with respect to cash such holders receive pursuant to the Agreement in lieu of fractional shares. The reorganization would be accomplished by an acquisition of the net assets of the Acquired Fund in
exchange for shares of the Acquiring Fund at net asset value. The unaudited Pro Forma Combined Schedule of
Investments and the unaudited Pro Forma Combined Statement of Assets and Liabilities have been prepared as
though the combination had been effective on December 31, 2008. The unaudited Pro Forma Combined Statement
of Operations reflects the results of the Funds for the twelve months
ended December 31, 2008 as if the merger
occurred on January 1, 2008. These pro forma statements have been derived from the books and records of the
Funds utilized in calculating daily net asset values at the dates indicated above in conformity with U.S. generally
accepted accounting principles. The historical cost of investment securities will be carried forward to the surviving
entity. The fiscal year end for the Funds is December 31. The Pro Forma Combined Financial Statements should be
read in conjunction with the historical financial statements of each Fund, which are incorporated by reference in the
Statement of Additional Information.
2. Use of Estimates:
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles (GAAP) requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
3. Investment Valuation:
In
computing the combined Funds net assets attributable to Common Shares, securities with readily
available market quotations use those quotations for valuation. When portfolio securities are
traded on the relevant day of valuation, the valuation will be the last reported sale price on that
day. If there are no such sales on that day, the security will be valued at the mean between the
most recently quoted bid and asked prices provided by the principal market makers. If there is more
than one such principal market maker, the value shall be the average of such means. Securities
without a sale price or quotations from principal market makers on the valuation day will be valued
by an independent pricing service. If securities do not have readily available market quotations or
pricing service prices, including circumstances under which such are determined not to be accurate
or current (including when events materially affect the value of securities occurring between the
time when market price is determined and calculation of the combined Funds net asset value), such
securities are valued at their fair value, as determined by Highland Capital Management, L.P. in
good faith in accordance with procedures approved by the combined Funds Board of Trustees. In these cases,
the combined Funds net asset value will reflect the affected portfolio securities value as determined in
the judgment of the Board of Trustees or its designee instead of being determined by the market.
Using a fair value pricing methodology to value securities may result in a value that is different
from a securitys most recent
45
sale price and from the prices used by other
investment companies to calculate their net asset
values. There can be no assurance that the combined Funds valuation of a security will not differ from the
amount that it realizes upon the sale of such security. Short-term investments, that is, those with
a remaining maturity of 60 days or less, are valued at amortized cost. Repurchase agreements are
valued at cost plus accrued interest. Foreign price quotations are converted to U.S. dollar
equivalents using the 4 PM London Time Spot Rate.
The valuation policies of the Acquired Fund and Acquiring Fund are substantially similar, except that the valuation
policy of the Acquired Fund requires its Board and the Funds Valuation Committee to consider both the fair value assigned by
the Acquired Funds investment adviser and that supplied by an
independent valuation firm (currently, Sterling Valuation Group, Inc., as indicated above) the Board has engaged for the
valuation of securities
for which market quotations are not readily available. However, securities held by both
Funds have been determined to
have the same value under both valuation policies.
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 157 (FAS 157), Fair Value Measurement, which is effective for
financial statements issued for fiscal years beginning after November 15, 2007. FAS 157 defines how
fair value should be determined for financial reporting purposes, establishes a framework for
measuring fair value under GAAP, and requires additional disclosures about the use of fair value
measurements, but it is not expected to result in any changes to the
fair value measurements of a
Funds investments. FAS 157 requires companies to provide expanded information about the assets and
liabilities measured at fair value and the potential effect of these fair valuations on net assets.
The Funds
have adopted FAS 157 as of January 1, 2008. The Funds have performed an analysis of all
existing investments and derivative instruments to determine the significance and character of all
inputs to their fair value determination. Based on this assessment, the adoption of FAS 157 did not
have any material effect on the Funds net asset value. However, the adoption of FAS 157 does
require the Funds to provide additional disclosures about the inputs used to develop the
measurements and the effect of certain measurements on changes in net assets for the reportable
periods as contained in the Funds periodic filings. The three levels of the fair value hierarchy
established under FAS 157 are described below:
Level 1 Quoted unadjusted prices
for identical instruments in active markets to which a Fund
has access at the date of measurement;
Level 2 Quoted prices for similar instruments in active markets that are not active; and
model-derived valuations in which all significant inputs and significant value drivers are
observable in active markets. Level 2 inputs are those in markets for which there are few
transactions, the prices are not current, little public information exists or instances where
prices vary substantially over time or among brokered market
makers; and
Level 3 Model derived valuations in which one or more significant inputs or significant value
drivers are unobservable. Unobservable inputs are those inputs that
reflect a Funds own
assumptions that market participants would use to price the asset or liability based on the best
available information.
The inputs or methodology used for valuing
securities are not necessarily an indication of the risk
associated with investing in those securities. A summary of the inputs used to value the combined Funds
assets as of December 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments in Securities |
|
|
|
|
|
|
|
|
|
|
|
|
(Market Value) |
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
|
Portfolio Investments |
|
$ |
6,407,249 |
|
|
$ |
103,193,334 |
|
|
$ |
432,373,862 |
|
|
$ |
541,974,445 |
|
Cash, cash equivalents and foreign currency |
|
|
10 |
|
|
|
|
|
|
|
|
|
|
|
10 |
|
|
Total |
|
$ |
6,407,259 |
|
|
$ |
103,193,334 |
|
|
$ |
432,373,862 |
|
|
$ |
541,974,455 |
|
|
Other Financial Instruments (Unrealized Appreciation/(Depreciation)) * |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forward Foreign Currency Contracts |
|
|
|
|
|
$ |
5,121,651 |
|
|
|
|
|
|
$ |
5,121,651 |
|
Credit Default Swap Trades |
|
|
|
|
|
|
282,543 |
|
|
|
|
|
|
|
282,543 |
|
|
Total |
|
|
|
|
|
$ |
5,404,194 |
|
|
|
|
|
|
$ |
5,404,194 |
|
|
|
|
|
* |
|
Other financial instruments are derivative instruments not reflected in the Investment
Portfolio, such as, forwards and swaps, which are valued at the unrealized
appreciation/(depreciation) on investment. |
The combined Fund did not have any liabilities that were measured at fair value on a recurring basis at
December 31, 2008.
The following table presents our assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) at December 31, 2007
and at December 31, 2008.
Assets at Fair Value using unobservable inputs (Level 3)
|
|
|
|
|
|
|
Portfolio Investments |
Balance as of December 31, 2007 |
|
|
66,427,959 |
|
Market Value of Level 3 from 7/18/08 merger |
|
|
32,447,700 |
|
Transfers in/(out) of Level 3 |
|
|
380,208,848 |
|
Net Amortization/(accretion) of premium/(discount) |
|
|
1,438,927 |
|
Net realized gains/(losses) |
|
|
(15,801,463 |
) |
Net unrealized gains/(losses) |
|
|
(195,726,264 |
) |
Net purchases and sales |
|
|
163,378,155 |
|
|
|
|
|
|
|
|
|
|
|
Balance as
of December 31, 2008 |
|
|
432,373,862 |
|
Investments designated as Level 3 may include assets valued using quotes or indications furnished
by brokers which are based on models or estimates and may not be executable prices. In light of the
developing market conditions, the Investment Adviser continues to search for observable data points
and evaluate broker quotes and indications received for portfolio investments.
4. Capital Shares:
The unaudited pro forma net asset values per share assumes additional shares of capital stock
of the Acquiring Fund were issued in connection with the proposed acquisition of the Acquired Fund
as of December 31, 2007. The number of additional shares issued was calculated by dividing the net
asset value of each class of the Acquired Fund by the respective class net asset value per share of
the Acquiring Fund.
5. Pro Forma Operations:
In the Pro Forma Combined Statement of Operations certain expenses have been adjusted to
reflect the expected expenses of the combined entity. The pro forma investment management fees of
the combined entity are based on the fee schedules in effect for the Acquiring Funds combined
level of average net assets for the twelve months ended December
31, 2008.
6. Federal Income Taxes:
It is the policy of the Funds to comply with the federal income and excise tax requirements of
the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies.
Accordingly, the Funds intend to distribute substantially all of their net investment income and
net realized gains on investments, if any, to their shareholders. Therefore, no federal income tax
provision is required.
46
APPENDIX A
RATINGS OF INVESTMENTS
Standard & PoorsA brief description of the applicable rating symbols of Standard & Poors
and their meanings (as published by Standard & Poors) follows:
Issue Credit Rating Definitions
A Standard & Poors 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 (including ratings on medium-term note programs and commercial
paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the currency in which
the obligation is denominated. The opinion evaluates the obligors capacity and willingness to
meet its financial commitments as they come due, and may assess terms, such as collateral security
and subordination, which could affect ultimate payment in the event of default. 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 & Poors from other sources it considers reliable. Standard & Poors 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:
|
|
|
Likelihood of paymentcapacity and willingness of the obligor to meet its financial
commitment on an obligation in accordance with the terms of the obligation; |
|
|
|
|
Nature of and provisions of the obligation; |
|
|
|
|
Protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other
laws affecting creditors rights. |
Issue ratings are an assessment of default risk, but may incorporate an assessment of relative
seniority or ultimate recovery in the event of default. Junior obligations are typically rated
lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such
differentiation may apply when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
Appendix A-1
AAA
An obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors
capacity to meet its financial commitment on the obligation is extremely strong.
AA
An obligation rated AA differs from the highest-rated obligations only to a small degree.
The obligors 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
obligors 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 obligors inadequate capacity to meet its financial
commitment on the obligation.
B
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the
obligor currently has the capacity to meet its financial commitment on the obligation. Adverse
business, financial, or economic conditions will likely impair the obligors 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.
Appendix A-2
C
A C rating is assigned to obligations that are currently highly vulnerable to nonpayment,
obligations that have payment arrearages allowed by the terms of the documents, or obligations of
an issuer that is the subject of a bankruptcy petition or similar action which have not experienced
a payment default. Among others, the C rating may be assigned to subordinated debt, preferred
stock or other obligations on which cash payments have been suspended in accordance with the
instruments terms.
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 & Poors 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.
NR
This indicates that no rating has been requested, that there is insufficient information on
which to base a rating or that Standard & Poors does not rate a particular obligation as a matter
of policy.
Short-Term Issue Credit Ratings
A-1
A short-term obligation rated A-1 is rated in the highest category by Standard & Poors.
The obligors 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
obligors 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 obligors capacity to meet its financial commitment on the obligation is satisfactory.
A-3
A short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse
economic conditions or changing circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
B
A short-term obligation rated B is regarded as having significant speculative
characteristics. Ratings of B-1, B-2, and B-3 may be assigned to indicate finer distinctions
within the B category. 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 obligors
inadequate capacity to meet its financial commitment on the obligation.
Appendix A-3
B-1
A short-term obligation rated B-1 is regarded as having significant speculative
characteristics, but the obligor has a relatively stronger capacity to meet its financial
commitments over the short-term compared to other speculative-grade obligors.
B-2
A short-term obligation rated B-2 is regarded as having significant speculative
characteristics, and the obligor has an average speculative-grade capacity to meet its financial
commitments over the short-term compared to other speculative-grade obligors.
B-3
A short-term obligation rated B-3 is regarded as having significant speculative
characteristics, and the obligor has a relatively weaker capacity to meet its financial commitments
over the short-term compared to other speculative-grade obligors.
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 & Poors 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.
Dual Ratings
Standard & Poors assigns dual ratings to all debt issues that have a put option or demand
feature as part of their structure. The first rating addresses the likelihood of repayment of
principal and interest as due, and the second rating addresses only the demand feature. The
long-term rating symbols are used for bonds to denote the long-term maturity and the short-term
rating symbols for the put option (for example, AAA/A-1+). With U.S. municipal short-term demand
debt, note rating symbols are used with the short-term issue credit rating symbols (for example,
SP-1+/A-1+).
Active Qualifiers (Currently applied and/or outstanding)
i
This subscript is used for issues in which the credit factors, terms, or both, that determine
the likelihood of receipt of payment of interest are different from the credit factors, terms or
both that determine the likelihood of receipt of principal on the obligation. The i subscript
indicates that the rating addresses the interest portion of the obligation only. The i subscript
will always be used in conjunction with the p subscript, which addresses likelihood of receipt of
principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that
the principal portion is rated AAA and the interest portion of the obligation is not rated.
L
Ratings qualified with L apply only to amounts invested up to federal deposit insurance
limits.
Appendix A-4
p
This subscript is used for issues in which the credit factors, the terms, or both, that
determine the likelihood of receipt of payment of principal are different from the credit factors,
terms or both that determine the likelihood of receipt of interest on the obligation. The p
subscript indicates that the rating addresses the principal portion of the obligation only. The
p subscript will always be used in conjunction with the i subscript, which addresses likelihood
of receipt of interest. For example, a rated obligation could be assigned ratings of AAAp NRi
indicating that the principal portion is rated AAA and the interest portion of the obligation is
not rated.
pi
Ratings with a pi subscript are based on an analysis of an issuers published financial
information, as well as additional information in the public domain. They do not, however, reflect
in-depth meetings with an issuers management and are therefore based on less comprehensive
information than ratings without a pi subscript. Ratings with a pi subscript are reviewed
annually based on a new years financial statements, but may be reviewed on an interim basis if a
major event occurs that may affect the issuers credit quality.
pr
The letters pr indicate that the rating is provisional. A provisional rating assumes the
successful completion of the project financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful, timely completion
of the project. This rating, however, while addressing credit quality subsequent to completion of
the project, makes no comment on the likelihood of or the risk of default upon failure of such
completion. The investor should exercise his own judgment with respect to such likelihood and
risk.
Preliminary
Preliminary ratings are assigned to issues, including financial programs, in the following
circumstances.
|
|
|
Preliminary ratings may be assigned to obligations, most commonly structured and
project finance issues, pending receipt of final documentation and legal opinions.
Assignment of a final rating is conditional on the receipt and approval by Standard &
Poors of appropriate documentation. Changes in the information provided to Standard &
Poors could result in the assignment of a different rating. In addition, Standard &
Poor s reserves the right not to issue a final rating. |
|
|
|
|
Preliminary ratings are assigned to Rule 415 Shelf Registrations. As specific
issues, with defined terms, are offered from the master registration, a final rating
may be assigned to them in accordance with Standard & Poors policies. The final
rating may differ from the preliminary rating. |
t
This symbol indicates termination structures that are designed to honor their contracts to
full maturity or, should certain events occur, to terminate and cash settle all their contracts
before their final maturity date.
unsolicited
Unsolicited ratings are those credit ratings assigned at the initiative of Standard & Poors
and not at the request of the issuer or its agents.
Appendix A-5
Inactive Qualifiers (No longer applied or outstanding)
*
This symbol indicated 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. Discontinued use in August 1998.
c
This qualifier was used to provide additional information to investors that the bank may
terminate its obligation to purchase tendered bonds if the long-term credit rating of the issuer is
below an investment-grade level and/or the issuers bonds are deemed taxable. Discontinued use in
January 2001.
q
A q subscript indicates that the rating is based solely on quantitative analysis of publicly
available information. Discontinued use in April 2001.
r
The r modifier was assigned to securities containing extraordinary risks, particularly
market risks, that are not covered in the credit rating. The absence of an r modifier should not
be taken as an indication that an obligation will not exhibit extraordinary non-credit related
risks. Standard & Poors discontinued the use of the r modifier for most obligations in June
2000 and for the balance of obligations (mainly structured finance transactions) in November 2002.
Moodys Investors Service, Inc.A brief description of the applicable Moodys Investors
Service, Inc. (Moodys) rating symbols and their meanings (as published by Moodys) follows:
Long-Term Obligation Ratings
Moodys long-term obligation ratings are opinions of the relative credit risk of a 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.
Moodys Long-Term Rating Definitions:
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.
Baa
Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade
and as such may possess certain speculative characteristics.
Appendix A-6
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: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating classification
from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates
a ranking in the lower end of that generic rating category.
Medium-Term Note Ratings
Moodys assigns long-term ratings to individual debt securities issued from medium-term note
(MTN) programs, in addition to indicating ratings to MTN programs themselves. Notes issued under
MTN programs with such indicated ratings are rated at issuance at the rating applicable to all pari
passu notes issued under the same program, at the programs relevant indicated rating, provided
such notes do not exhibit any of the characteristics listed below:
|
|
|
Notes containing features that link interest or principal to the credit performance
of any third party or parties (i.e., credit-linked notes); |
|
|
|
|
Notes allowing for negative coupons, or negative principal |
|
|
|
|
Notes containing any provision that could obligate the investor to make any
additional payments |
|
|
|
|
Notes containing provisions that subordinate the claim. |
For notes with any of these characteristics, the rating of the individual note may differ from
the indicated rating of the program.
For credit-linked securities, Moodys policy is to look through to the credit risk of the
underlying obligor. Moodys policy with respect to non-credit linked obligations is to rate the
issuers ability to meet the contract as stated, regardless of potential losses to investors as a
result of non-credit developments. In other words, as long as the obligation has debt standing in
the event of bankruptcy, we will assign the appropriate debt class level rating to the instrument.
Appendix A-7
Market participants must determine whether any particular note is rated, and if so, at what
rating level. Moodys encourages market participants to contact Moodys Ratings Desks or visit
www.moodys.com directly if they have questions regarding ratings for specific notes issued under a
medium-term note program. Unrated notes issued under an MTN program may be assigned an NR (not
rated) symbol.
Short-Term Ratings:
Moodys 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.
Moodys employs the following designations to indicate the relative repayment ability of rated
issuers:
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.
Appendix A-8
APPENDIX B
HIGHLAND CAPITAL MANAGEMENT, L.P.
PROXY VOTING POLICY
1. Application; General Principles
1.1. This proxy voting policy (the Policy) applies to securities held in Client accounts as
to which the above-captioned investment adviser (the Company) has voting authority, directly or
indirectly. Indirect voting authority exists where the Companys voting authority is implied by a
general delegation of investment authority without reservation of proxy voting authority.
1.2. The Company shall vote proxies in respect of securities owned by or on behalf of a Client
in the Clients best economic interests and without regard to the interests of the Company or any
other Client of the Company.
2. Voting; Procedures
2.1. Monitoring. A settlement designee of the Company shall have responsibility for
monitoring portfolios managed by the Company for securities subject to a proxy vote. Upon the
receipt of a proxy notice related to a security held in a portfolio managed by the Company, the
settlement designee shall forward all relevant information to the portfolio manager(s) with
responsibility for the security.
2.2. Voting.
2.2.1. Upon receipt of notice from the settlement designee, the portfolio manager(s)
with responsibility for purchasing the security subject to a proxy vote shall evaluate the
subject matter of the proxy and cause the proxy to be voted on behalf of the Client. In
determining how to vote a particular proxy, the portfolio manager(s) shall consider, among
other things, the interests of each Client account as it relates to the subject matter of
the proxy, any potential conflict of interest the Company may have in voting the proxy on
behalf of the Client and the procedures set forth in this Policy.
2.2.2. If a proxy relates to a security held in a registered investment company or
business development company (Retail Fund) portfolio, the portfolio manager(s) shall
notify the Compliance Department and a designee from the Retail Funds group. Proxies for
securities held in the Retail Funds will be voted by the designee from the Retail Funds
group in a manner consistent with the best interests of the applicable Retail Fund and a
record of each vote will be reported to the Retail Funds Board of Directors in accordance
with the procedures set forth in Section 4 of this Policy.
2.3. Conflicts of Interest. If the portfolio manager(s) determine that the Company
may have a potential material conflict of interest (as defined in Section 3 of this Policy) in
voting a particular proxy, the portfolio manager(s) shall contact the Companys Compliance
Department prior to causing the proxy to be voted.
2.3.1. For a security held by a Retail Fund, the Company shall disclose the conflict
and the determination of the manner in which it proposes to vote to the Retail Funds Board
of Directors. The Companys determination shall take into account only the interests of the
Retail Fund, and the Compliance Department shall document the basis for the decision and
furnish the documentation to the Board of Directors.
2.3.2. For a security held by an unregistered investment company, such as a hedge fund
and structured products (Non-Retail Funds), where a material conflict of interest has been
identified the
Appendix B-1
Company may resolve the conflict by following the recommendation of a disinterested
third party or by abstaining from voting.
2.4. Non-Votes. The Company may determine not to vote proxies in respect of
securities of any issuer if it determines it would be in its Clients overall best interests not to
vote. Such determination may apply in respect of all Client holdings of the securities or only
certain specified Clients, as the Company deems appropriate under the circumstances. As examples,
the portfolio manager(s) may determine: (a) not to recall securities on loan if, in its judgment,
the negative consequences to Clients of disrupting the securities lending program would outweigh
the benefits of voting in the particular instance or (b) not to vote certain foreign securities
positions if, in its judgment, the expense and administrative inconvenience outweighs the benefits
to Clients of voting the securities.
2.5. Recordkeeping. Following the submission of a proxy vote, the applicable
portfolio manager(s) shall submit a report of the vote to a settlement designee of the Company.
Records of proxy votes by the Company shall be maintained in accordance with Section 4 of this
Policy.
2.6. Certification. On a quarterly basis, each portfolio manager shall certify to the
Compliance Department that they have complied with this Policy in connection with proxy votes
during the period.
3. Conflicts of Interest
3.1. Voting the securities of an issuer where the following relationships or circumstances
exist are deemed to give rise to a material conflict of interest for purposes of this Policy:
3.1.1. The issuer is a Client of the Company accounting for more than 5% of the
Companys annual revenues.
3.1.2. The issuer is an entity that reasonably could be expected to pay the Company
more than $1 million through the end of the Companys next two full fiscal years.
3.1.3. The issuer is an entity in which a Covered Person (as defined in the Retail
Funds and the Companys Policies and Procedures Designed to Detect and Prevent Insider
Trading and to Comply with Rule 17j-1 of the Investment Company Act of 1940, as amended
(each, a Code of Ethics)) has a beneficial interest contrary to the position held by the
Company on behalf of Clients.
3.1.4. The issuer is an entity in which an officer or partner of the Company or a
relative1 of any such person is or was an officer, director or employee, or such
person or relative otherwise has received more than $150,000 in fees, compensation and other
payment from the issuer during the Companys last three fiscal years; provided,
however, that the Compliance Department may deem such a relationship not to be a
material conflict of interest if the Company representative serves as an officer or director
of the issuer at the direction of the Company for purposes of seeking control over the
issuer.
3.1.5. The matter under consideration could reasonably be expected to result in a
material financial benefit to the Company through the end of the Companys next two full
fiscal years (for example, a vote to increase an investment advisory fee for a Retail Fund
advised by the Company or an affiliate).
3.1.6. Another Client or prospective Client of the Company, directly or indirectly,
conditions future engagement of the Company on voting proxies in respect of any Clients
securities on a particular matter in a particular way.
|
|
|
1 |
|
For the purposes of this Policy, relative includes
the following family members: spouse, minor children or stepchildren or
children or stepchildren sharing the persons home. |
Appendix B-2
3.1.7. The Company holds various classes and types of equity and debt securities of the
same issuer contemporaneously in different Client portfolios.
3.1.8. Any other circumstance where the Companys duty to serve its Clients interests,
typically referred to as its duty of loyalty, could be compromised.
3.2. Notwithstanding the foregoing, a conflict of interest described in Section 3.1 shall not
be considered material for the purposes of this Policy in respect of a specific vote or
circumstance if:
3.2.1. The securities in respect of which the Company has the power to vote account for
less than 1% of the issuers outstanding voting securities, but only if: (i) such securities
do not represent one of the 10 largest holdings of such issuers outstanding voting
securities and (ii) such securities do not represent more than 2% of the Clients holdings
with the Company.
3.2.2. The matter to be voted on relates to a restructuring of the terms of existing
securities or the issuance of new securities or a similar matter arising out of the holding
of securities, other than common equity, in the context of a bankruptcy or threatened
bankruptcy of the issuer.
4. Recordkeeping and Retention
4.1. The Company shall retain records relating to the voting of proxies, including:
4.1.1. Copies of this Policy and any amendments thereto.
4.1.2. A copy of each proxy statement that the Company receives regarding Client securities.
4.1.3. Records of each vote cast by the Company on behalf of Clients.
4.1.4. A copy of any documents created by the Company that were material to making a
decision how to vote or that memorializes the basis for that decision.
4.1.5. A copy of each written request for information on how the Company voted proxies
on behalf of the Client, and a copy of any written response by the Company to any (oral or
written) request for information on how the Company voted.
4.2. These records shall be maintained and preserved in an easily accessible place for a
period of not less than five years from the end of the Companys fiscal year during which the last
entry was made in the records, the first two years in an appropriate office of the Company.
4.3. The Company may rely on proxy statements filed on the SECs EDGAR system or on proxy
statements and records of votes cast by the Company maintained by a third party, such as a proxy
voting service (provided the Company had obtained an undertaking from the third party to provide a
copy of the proxy statement or record promptly on request).
4.4. Records relating to the voting of proxies for securities held by the Retail Funds will be
reported periodically to the Retail Funds Boards of Directors and, with respect to Retail Funds
other than business development companies, to the SEC on an annual basis pursuant to Form N-PX.
Appendix B-3