nv148cza
As
Filed Electronically with the Securities and Exchange Commission on
March 3, 2009
Registration
No. 333-156464
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933 o
Pre-Effective
Amendment No. 2 þ
Post-Effective Amendment No. __ o
HIGHLAND CREDIT STRATEGIES FUND
(Exact Name of Registrant as Specified in Charter)
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Address of Principal Executive Offices) (Zip Code)
877-665-1287
(Registrants Area Code and Telephone Number)
James D. Dondero
Highland Credit Strategies Fund
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Name and Address of Agent for Service)
With copies to:
Gregory D. Sheehan, Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
Approximate date of proposed public offering: As soon as practicable after the effective date of
this Registration Statement.
Calculation of Registration Fee Under the Securities Act of 1933:
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Proposed Maximum |
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Proposed Maximum |
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Title of Securities |
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Amount Being |
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Offering Price Per |
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Aggregate Offering |
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Amount of |
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Being Registered |
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Registered (1) |
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Unit (1) |
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Price (1) |
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Registration Fee |
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Common Stock (par value $0.001) |
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9,750,000 |
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$6.83 |
(2) |
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$66,592,500 |
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$2,617.09 |
(3) |
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(1) |
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Estimated solely for the purpose of calculating the registration fee. |
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(2) |
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Net asset value per share for common stock on December 19, 2008. |
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(3) |
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Previously paid. |
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The Registrant hereby amends this Registration Statement on such date or dates as may be necessary
to delay its effective date until the Registrant shall file a further amendment which specifically
states that this Registration Statement shall thereafter become effective in accordance with
section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission acting pursuant to said section 8(a), may determine.
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 Austin I
Conference Room, 2nd Floor, 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 on the Internet.
It is important that your vote be received no later than the time of the Meeting.
Sincerely,
R. Joseph Dougherty
Chairman of the Board
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
Q: WHAT IS BEING PROPOSED AT THE STOCKHOLDER MEETING?
A: 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 the Acquired Fund may not
consider to be in the best interests of Acquired Funds
shareholders.
Acquired Fund is a
closed-end company that has elected to be regulated as a business development
company under 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.
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.
Q: WHY IS THE REORGANIZATION BEING RECOMMENDED?
A: 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 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.
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 3.94%, respectively. Assuming the Reorganization is approved, the estimated
total annual operating expenses of the combined Fund would be 3.87% 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 3.80% of average net assets.
The Proxy Statement/Prospectus contains further explanation of the reasons that the Boards of
Directors/Trustees of the Funds unanimously recommend the Reorganization.
Q: HOW DOES THE ACQUIRING FUNDS INVESTMENT OBJECTIVE AND INVESTMENT STRATEGY DIFFER FROM MY
FUNDS?
A: The Acquiring Fund is registered as a non-diversified, closed-end management investment
company under the Investment Company Act of 1940, as amended (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
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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.
The Acquired Fund is a closed-end company under the 1940 Act
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).
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.
Q: HOW WILL THE REORGANIZATION AFFECT ME?
A: 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 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.
Q: WILL I HAVE TO PAY ANY SALES LOAD, COMMISSION OR OTHER SIMILAR FEE IN CONNECTION WITH THE
REORGANIZATION?
A: 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.
Q: WILL MY DIVIDENDS BE AFFECTED BY THE PROPOSED REORGANIZATION?
A: 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 maybe 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.
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
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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.
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.
Q: WILL I HAVE TO PAY ANY FEDERAL INCOME TAXES AS A RESULT OF THE REORGANIZATION?
A: 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 64.
Q: DO I HAVE THE RIGHT TO SEEK APPRAISAL OF THE FAIR CASH VALUE OF MY SHARES OF COMMON STOCK IF
THE MERGER IS COMPLETED?
A: 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 if 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 66 and Appendix D hereto.
Q: HOW DOES THE BOARD OF DIRECTORS OF THE ACQUIRED FUND SUGGEST THAT I VOTE?
A: After careful consideration, the Board of Directors of the Acquired Fund unanimously recommends
that you vote FOR the proposed Reorganization.
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GENERAL
Q: HOW DO I VOTE MY PROXY?
A: 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.
Q: WHO DO I CALL IF I HAVE QUESTIONS?
A:
We will be pleased to answer your questions about this proxy solicitation. Please call (866) 387-9392 with any questions.
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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 Austin I
Conference Room, 2nd Floor, on April 9, 2009, at 8:00
a.m. Central Time, to consider the following:
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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). |
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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. 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 OR BY TELEPHONE. A SELF-ADDRESSED, POSTAGE-PAID ENVELOPE HAS BEEN ENCLOSED FOR YOUR
CONVENIENCE. YOU MAY ALSO VOTE BY CALLING THE NUMBER ON THE PROXY CARD. PLEASE HELP AVOID THE
EXPENSE OF A FOLLOW-UP MAILING BY VOTING TODAY.
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By order of the Boards of Directors,
M. Jason Blackburn
Secretary
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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 Acquired Fund is a closed-end company
under the 1940 Act 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 its 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 |
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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 Time 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. Although 78.21% of the Acquired Funds assets represented issuers of securities owned by the
Acquiring Fund at December 31, 2008, 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 (which
it has recently done), 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.
- 2 -
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.
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
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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. The statement
of additional information is
incorporated by reference into (and
therefore legally part of) this
Proxy Statement/Prospectus or by
writing to either Fund at NexBank
Tower, 13455 Noel Road, Suite 800,
Dallas, TX 75240. |
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To ask questions about this Proxy Statement/Prospectus
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Call the proxy solicitor at (866) 387-9392. |
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.
- 3 -
TABLE OF CONTENTS
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- 5 -
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 Austin I
Conference Room, 2nd Floor, 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 a 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 under the 1940 Act 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 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.
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)
- 6 -
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 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
- 7 -
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 64.
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.
- 8 -
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 in connection with highly
leveraged transactions, often to finance internal growth, acquisitions, mergers or stock purchases,
or for other
- 9 -
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 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
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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 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.
- 11 -
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.
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
- 12 -
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 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
- 13 -
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.
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
- 14 -
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 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.
- 15 -
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 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
- 16 -
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.
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.
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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 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.
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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.
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 33 1/3% 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
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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 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,
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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 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.
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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 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
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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
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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.
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.
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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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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. |
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
- 23 -
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:
|
|
|
the terms and conditions of the Agreement and the Reorganization; |
|
|
|
|
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; |
|
|
|
|
the historic operating expenses for each Fund; and |
|
|
|
|
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. |
|
More specifically, with respect to the proposed Reorganization, the Board of the Acquired Fund made the following determinations, among others:
|
|
|
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 Time 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 |
- 24 -
|
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|
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.
Although 78.21% of the Acquired Funds assets represented issuers of securities
owned by the Acquiring Fund at December 31, 2008, 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 (which it has recently done), 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. |
|
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 |
|
|
Acquiring |
|
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|
Fund |
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|
Fund |
|
|
Acquiring Fund |
|
Common Shareholder Transaction
Expenses |
|
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|
|
|
|
Sales Load (as a percentage of
offering price) |
|
None(1) |
|
None(1) |
|
None(1) |
Dividend Reinvestment Plan Fees |
|
None(2) |
|
None(3) |
|
None(3) |
- 25 -
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ACTUAL |
|
|
|
|
Percentage of Net Assets |
|
|
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|
Attributable to Common |
|
|
|
|
Shares (Twelve Months ended |
|
PRO FORMA |
|
|
December
31, 2008) |
|
COMBINED(1) |
|
|
Acquired |
|
Acquiring |
|
|
|
|
Fund |
|
Fund |
|
Acquiring Fund |
Management Fee |
|
|
3.21 |
% |
|
|
1.40 |
% |
|
|
1.40 |
% |
Incentive Fee |
|
|
1.29 |
% |
|
|
0.00 |
% |
|
|
0.00 |
% |
Interest Payments on Borrowed Funds |
|
|
2.43 |
% |
|
|
1.63 |
% |
|
|
1.63 |
% |
Other Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Dividend Expense For Short Positions |
|
|
0.00 |
% |
|
|
0.17 |
% |
|
|
0.17 |
% |
Other Expenses(4) |
|
|
2.26 |
% |
|
|
0.75 |
% |
|
|
0.70 |
% |
Total Other Expenses |
|
|
2.26 |
% |
|
|
0.92 |
% |
|
|
0.87 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Annual Expenses |
|
|
9.18 |
% |
|
|
3.94 |
% |
|
|
3.90 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Minus: Management Fee Waivers(5) |
|
|
0.00 |
% |
|
|
0.09 |
% |
|
|
0.07 |
% |
Net Expenses |
|
|
9.18 |
%(6) |
|
|
3.86 |
% |
|
|
3.83 |
% |
|
|
|
|
|
(1) |
|
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. |
|
(2) |
|
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. |
|
(3) |
|
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) |
|
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 estimated to be an amount
equal to 0.06% of the Acquiring Funds pro forma combined average daily net assets. |
|
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|
(5) |
|
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) |
|
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.
- 26 -
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.
(Unaudited)
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|
1 Year |
|
3 Years |
|
5 Years |
|
10 Years |
Acquired Fund |
|
$ |
90 |
|
|
$ |
259 |
|
|
$ |
413 |
|
|
$ |
747 |
|
Acquiring Fund |
|
$ |
39 |
|
|
$ |
119 |
|
|
$ |
201 |
|
|
$ |
418 |
|
Pro Forma Combined Acquiring Fund (1) |
|
$ |
39 |
|
|
$ |
118 |
|
|
$ |
199 |
|
|
$ |
412 |
|
|
|
|
(1) |
|
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.
- 27 -
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 |
|
Acquiring Fund |
Business
|
|
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.
|
|
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 |
|
|
|
|
|
Listing (Common
Shares)
|
|
NYSE under the ticker symbol HCD
|
|
NYSE under the ticker symbol HCF |
|
|
|
|
|
Fiscal Year End
|
|
12/31
|
|
12/31 |
|
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|
|
Investment Adviser
|
|
Highland Capital Management, L.P.
|
|
Highland Capital Management, L.P. |
|
|
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|
|
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.
|
|
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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|
|
Primary Investment
Strategies
|
|
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
|
|
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) |
- 28 -
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|
Acquired Fund |
|
Acquiring Fund |
|
|
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.
|
|
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. |
|
|
|
|
|
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. |
- 29 -
|
|
|
|
|
|
|
Acquired Fund |
|
Acquiring Fund |
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. |
|
|
|
|
|
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. |
- 30 -
|
|
|
|
|
|
|
Acquired Fund |
|
Acquiring Fund |
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. |
|
|
|
|
|
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 33 1/3% 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 33 1/3% of its total assets.
|
|
The Fund may lend its portfolio securities in an
amount up to a maximum of 33 1/3% of its total assets. |
- 31 -
|
|
|
|
|
|
|
Acquired Fund |
|
Acquiring Fund |
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 companys 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.
- 32 -
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. |
- 33 -
ACQUIRED FUND
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium/(Discount) as a % |
|
|
Market price |
|
|
|
|
|
of net asset value |
|
|
High |
|
Low |
|
|
|
|
|
High |
|
Low |
Quarter |
|
Net asset value per share(1) |
|
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
|
|
|
|
|
|
|
|
|
Date |
|
|
Total Amount Outstanding |
|
|
|
Asset Coverage 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 |
|
Acquired Fund
|
|
|
|
|
|
|
|
|
Date |
|
|
Total Amount Outstanding |
|
|
|
Asset Coverage 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.
- 34 -
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 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
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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 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.
- 36 -
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 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
- 37 -
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.
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.
- 38 -
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 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
- 39 -
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 present intention of offering any additional shares on that registration statement. Any
additional offerings of shares will require approval
- 40 -
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. 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.
- 41 -
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 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
- 42 -
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.
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.
- 43 -
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 66 2/3% 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 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
- 44 -
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 reducedin general, to 15% with
lower rates applying to taxpayers in the 10% and 15% rate bracketsfor 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 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.
- 45 -
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 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.
- 46 -
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 described in this prospectus 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 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
- 47 -
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.
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 |
|
|
-61.24 |
% |
|
|
-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 |
|
|
-46.23 |
% |
|
|
-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. |
- 48 -
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.
- 49 -
Highland Distressed Opportunities, Inc.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended |
|
|
Year Ended |
|
|
|
|
|
|
|
12/31/08 |
|
|
12/31/07 (a) |
|
|
|
|
|
Net Asset Value, Beginning of Period |
|
|
$ 10.27 |
|
|
|
$ 14.33 |
(b |
) |
|
|
|
Income from Investment Operations |
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
|
0.61 |
|
|
|
0.97 |
|
|
|
|
|
Net realized and unrealized gain on investments |
|
|
-6.71 |
|
|
|
-4.43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total from investment operations applicable to
common shareholders |
|
|
-6.10 |
|
|
|
-3.46 |
|
|
|
|
|
Common Stock Offering Cost |
|
|
0.00 |
|
|
|
-0.07 |
|
|
|
|
|
Capital Contribution |
|
|
0.00 |
|
|
|
0.26 |
(c |
) |
|
|
|
Less Distributions Declared to Common Shareholders |
|
|
|
|
|
|
|
|
|
|
|
|
From net investment income |
|
|
-0.75 |
|
|
|
-0.79 |
|
|
|
|
|
From net realized gains |
|
|
0.00 |
|
|
|
0.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distributions Declared |
|
|
-0.75 |
|
|
|
-0.79 |
|
|
|
|
|
Net Asset Value, End of Period |
|
|
$ 3.42 |
|
|
|
$ 10.27 |
|
|
|
|
|
Market Value, End of Period |
|
|
$ 2.15 |
|
|
|
$ 8.57 |
|
|
|
|
|
Market Value Total Return (d)(e) |
|
|
-70.80 |
% |
|
|
-38.85 |
% |
|
|
|
|
Ratios to Average Net Assets/Supplemental Data
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Share Information at End of Period (g): |
|
|
|
|
|
|
|
|
|
|
|
|
Ratios based on average net assets |
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (in 000s) (f) |
|
|
$60,556 |
|
|
|
$182,015 |
|
|
|
|
|
Net operating expenses (excluding interest expense) |
|
|
6.75 |
% |
|
|
5.74 |
% |
|
|
|
|
Interest expenses |
|
|
2.43 |
% |
|
|
3.80 |
% |
|
|
|
|
Dividend expense from short positions |
|
|
0.00 |
% |
|
|
0.00 |
% |
|
|
|
|
Waiver/reimbursement |
|
|
0.62 |
% |
|
|
2.24 |
% |
|
|
|
|
Net expenses (h) |
|
|
8.56 |
% |
|
|
7.30 |
% |
|
|
|
|
Net investment income |
|
|
8.25 |
% |
|
|
8.77 |
% |
|
|
|
|
Portfolio turnover rate (e) |
|
|
49 |
% |
|
|
224 |
% |
|
|
|
|
|
|
|
(a) |
|
Highland Distressed Opportunities, Inc. 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 Company 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 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. |
- 50 -
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 on investments |
|
|
-9.79 |
|
|
|
|
|
|
|
-1.85 |
|
|
|
0.91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total from investment operations applicable
to common shareholders |
|
|
-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 |
|
|
|
0.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distributions Declared |
|
|
-1.72 |
|
|
|
|
|
|
|
-1.95 |
|
|
|
-0.60 |
|
|
|
|
|
Dilutive impact of rights offering |
|
|
-1.32 |
|
|
|
|
|
|
|
0.00 |
|
|
|
0.00 |
|
|
|
|
|
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 |
% |
|
|
(c |
) |
|
|
-17.05 |
% |
|
|
9.06 |
% |
|
|
(c |
) |
Ratios to Average Net Assets/Supplemental Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Share Information at End of Period (g): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios based on average net assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (in 000s) (d) |
|
|
$361,210 |
|
|
|
|
|
|
|
$621,078 |
|
|
|
$692,964 |
|
|
|
|
|
Net operating expenses (excluding interest expense) |
|
|
2.15 |
% |
|
|
|
|
|
|
1.87 |
% |
|
|
1.53 |
% |
|
|
|
|
Interest expenses |
|
|
1.63 |
% |
|
|
|
|
|
|
2.16 |
% |
|
|
1.03 |
% |
|
|
|
|
Dividend expense from short positions |
|
|
0.17 |
% |
|
|
|
|
|
|
0.03 |
% |
|
|
0.00 |
% |
|
|
|
|
Waiver/reimbursement |
|
|
0.09 |
% |
|
|
|
|
|
|
0.00 |
% |
|
|
0.00 |
% |
|
|
|
|
Net expenses |
|
|
3.86 |
% |
|
|
|
|
|
|
4.06 |
% |
|
|
2.56 |
% |
|
|
|
|
Net investment income |
|
|
11.36 |
% |
|
|
|
|
|
|
8.64 |
% |
|
|
7.37 |
% |
|
|
|
|
Portfolio turnover rate |
|
|
78 |
% |
|
|
(c |
) (e) |
|
|
66 |
% |
|
|
46 |
% |
|
|
(c |
) |
|
|
|
(a) |
|
Highland Credit Strategies Fund commenced operations on June 29, 2006. |
|
(b) |
|
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. |
|
(c) |
|
Not annualized. |
|
(d) |
|
Dollars in thousands. |
|
(e) |
|
Portfolio turnover rate excludes securities received from processing in the subscriptions from reorganizations. |
- 51 -
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
December 31, |
|
|
Year Ended
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 |
|
$ |
(84,535,832 |
) |
|
$ |
(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. |
- 52 -
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 |
) |
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.
- 53 -
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 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.
- 54 -
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 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. |
|
|
|
|
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. |
|
- 55 -
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.
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.
- 56 -
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 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.
- 57 -
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, 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.
- 58 -
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.
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.
- 59 -
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.
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.
- 60 -
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 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.
- 61 -
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage |
|
of Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of Class of |
|
Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nature of Issuer's |
|
Securities |
|
Investment |
|
Type of Securities Held in |
|
Spread / |
|
|
|
|
|
Cost of |
|
Value of |
Name of Issuer |
|
Principal 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 |
|
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 |
|
- 62 -
|
|
|
|
(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. |
|
- 63 -
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, 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.
- 64 -
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 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.
- 65 -
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 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. Those 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
- 66 -
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 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. |
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.
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.
- 67 -
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.
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
- 68 -
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 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.
- 69 -
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 |
(Unaudited) |
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Acquired Fund |
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Acquiring Fund |
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Acquiring Fund |
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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$ |
60,556,428 |
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$ |
361,210,505 |
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$ |
(500,000) |
* |
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$ |
421,266,933 |
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Net asset value per
common share |
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$ |
3.42 |
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$ |
6.51 |
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$ |
6.50 |
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* |
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Reflects the estimated reorganization expenses |
- 70 -
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
- 71 -
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 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,
- 72 -
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 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,
- 73 -
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.
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 that the Acquired Fund is required to maintain,
monitoring portfolio and regulatory compliance matters and preparing reports to the Acquired
- 74 -
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 Fund's 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 OfficerRetail 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 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.
- 75 -
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
- 76 -
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 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
- 77 -
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 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.
- 78 -
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.
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
- 79 -
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.
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.
- 80 -
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;
NOW, THEREFORE, in consideration of the premises and of the covenants and agreements hereinafter
set forth, the parties hereto covenant and agree as follows:
A-1
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. |
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(e) |
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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. |
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A-2
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(f) |
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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) |
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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. |
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(h) |
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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. |
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(i) |
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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. |
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Closing Date; Valuation Date. |
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(a) |
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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. |
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(b) |
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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. |
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(c) |
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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. |
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(d) |
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The investment restrictions of Acquired Fund will be temporarily amended to
the extent necessary to effect the transactions contemplated by this Agreement. |
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A-3
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(e) |
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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 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. |
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(f) |
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The Valuation Date will be 4:00 p.m. New York time on the Closing Date (the
Valuation Date). |
3. |
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Closing and Closing Date. |
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(a) |
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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). |
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(b) |
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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. |
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(a) |
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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. |
A-4
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(b) |
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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. |
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(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. |
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(e) |
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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. |
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Representations and warranties of Acquiring Fund and Merger Sub. |
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Acquiring Fund and Merger Sub represent and warrant to and agree with Acquired Fund as
follows; 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) |
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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. |
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(b) |
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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. |
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(c) |
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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. |
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(d) |
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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. |
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A-5
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(e) |
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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. |
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(f) |
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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. |
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(g) |
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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) |
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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). |
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(i) |
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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. |
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(j) |
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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. |
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(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. |
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(l) |
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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. |
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A-6
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(m) |
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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. |
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(n) |
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The issuance of the Merger Shares pursuant to this Agreement will be in
compliance with all applicable federal securities laws. |
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(o) |
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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. |
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(p) |
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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
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. |
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Representations and warranties of Acquired Fund. |
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Acquired Fund represents and warrants to and agrees with Acquiring Fund and Merger Sub that: |
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(a) |
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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. |
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(b) |
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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. |
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(c) |
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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. |
|
A-7
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(d) |
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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. |
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(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. |
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(f) |
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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. |
|
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(g) |
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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) |
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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.
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(i) |
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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. |
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(j) |
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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. |
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(k) |
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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. |
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(l) |
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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 |
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A-8
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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. |
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Covenants of the Acquired Fund and Acquiring Fund. |
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(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. |
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(b) |
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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. |
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(c) |
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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. |
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(d) |
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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. |
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(e) |
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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. |
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Conditions to Acquiring Funds and Merger Subs obligations. |
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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 |
A-9
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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. |
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(b) |
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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. |
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(c) |
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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. |
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(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. |
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(e) |
|
That there will not be any material litigation pending with respect to the
matters contemplated by this Agreement. |
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(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. |
|
A-10
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(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) 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. |
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(h) |
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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. |
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(i) |
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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. |
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(j) |
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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. |
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(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. |
A-11
|
(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), 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. |
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(m) |
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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. |
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(n) |
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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. |
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(o) |
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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. |
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(p) |
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That the Merger Shares shall have been accepted for listing by the New York
Stock Exchange. |
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(r) |
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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. |
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9. |
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Conditions to Acquired Funds obligations. |
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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. |
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(b) |
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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. |
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(c) |
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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. |
|
A-12
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(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. |
|
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(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. |
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(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. |
|
A-13
|
(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. |
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(i) |
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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. |
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(j) |
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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. |
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(k) |
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That the Merger Shares shall have been accepted for listing by the New York
Stock Exchange. |
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(l) |
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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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(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. |
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(b) |
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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 |
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A-14
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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 liabilities required to be paid by it under
this Section 10(b) without the necessity of the Indemnified Parties first paying
the same. |
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11. |
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No broker, etc. |
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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. |
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12. |
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Rule 145. |
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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: |
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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. |
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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. |
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13. |
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Covenants, etc. deemed material. |
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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. |
A-15
14. |
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Sole agreement. |
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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. |
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15. |
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Agreement and declaration of trust of Acquiring Fund. |
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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. |
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16. |
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Amendment. |
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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. |
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Waiver. |
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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. |
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18. |
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Termination. |
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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. |
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19. |
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Miscellaneous. |
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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. |
A-16
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.
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HIGHLAND CREDIT STRATEGIES FUND |
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By: |
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Name: |
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Title: |
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HIGHLAND DISTRESSED OPPORTUNITIES, INC. |
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By: |
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Name: |
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Title: |
A-17
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.
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HCF ACQUISITION LLC |
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By:
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HIGHLAND CREDIT STRATEGIES FUND, the
sole member of HCF Acquisition LLC |
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By: |
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Name: |
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Title: |
A-18
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 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 |
B-1
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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. |
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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 |
B-2
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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 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. |
B-3
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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 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
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 |
B-4
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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
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, |
B-5
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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
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 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. |
B-6
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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 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 |
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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. |
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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. |
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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 (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 |
B-9
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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, 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 |
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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
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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B-11
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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 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. |
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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
|
|
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
|
|
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 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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B-13
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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
|
|
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
|
|
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 |
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Short Sales
|
|
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. |
B-14
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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. |
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|
|
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. |
|
|
|
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. |
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|
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|
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. |
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|
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. |
B-15
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|
|
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
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. |
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|
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. |
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|
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|
|
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 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. |
|
B-16
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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. |
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|
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. |
|
|
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|
|
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-17
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.
|
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|
Aggregate Dollar |
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|
|
|
Range of Equity |
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|
|
|
|
Securities in All |
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|
|
Registered |
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|
|
|
|
Investment |
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|
|
Companies |
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|
|
Overseen by |
|
|
|
|
|
|
Board Member in |
|
|
Dollar Range of |
|
Dollar Range of |
|
Highland Family |
Name of Board |
|
Shares of the |
|
Shares of the |
|
of Investment |
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
|
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|
(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. Dondero1
|
|
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. |
|
|
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. |
|
C-1
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 Dougherty2 |
|
|
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 Borud3 |
|
|
23,920 |
shares |
|
$ |
136,346 |
|
|
|
0.04 |
% |
Common Stock |
|
M. Jason Blackburn4 |
|
|
4,641 |
shares |
|
$ |
26,452 |
|
|
|
0.01 |
% |
Common Stock |
|
Michael Colvin5 |
|
|
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%. |
|
|
|
2 |
|
Mr. Doughertys beneficial ownership of these shares is based on direct ownership and ownership through a retirement plan. |
|
|
|
3 |
|
Mr. Boruds beneficial ownership of these shares is based on direct ownership and ownership through a retirement plan. |
|
|
|
4 |
|
Mr. Blackburns beneficial ownership of these shares is based on ownership through a retirement plan. |
|
|
|
5 |
|
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 |
|
|
|
|
|
|
Nature of Beneficial |
|
(4) Percent of |
(1) Title of Class |
|
(2) Name of 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
|
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Pentagram Partners, L.P. (b)
630 Fifth Avenue, 20th Floor
New York, NY 10111
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1,012,200 shares
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5.7% |
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Common Stock
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RiverNorth Capital Management, Inc.(c)
325 N. LaSalle, Suite 645
Chicago, IL 60654-7030
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1,257,903 shares
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7.1% |
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(a) |
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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. |
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(b) |
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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. |
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(c) |
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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. |
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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.
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(3) Amount and |
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Nature of Beneficial |
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(4) Percent of |
(1) Title of Class |
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(2) Name of Beneficial Owner |
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Ownership |
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Common Stock
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Morgan Stanley (e) 1585 Broadway
New York, NY 10036
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3,764,429 shares
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8.2% |
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(e) |
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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. |
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C-2
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.
D-1
(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 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.
D-2
(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 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 stock to the Register in Chancery, if such is
D-3
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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i
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:
1. |
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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; |
3. |
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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:
1. |
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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 |
2. |
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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:
1. |
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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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3. |
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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.
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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.
10
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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Number of |
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Portfolios in |
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Position |
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Highland Fund |
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Other |
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with the |
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Term of Office |
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Complex |
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Directorships/ |
Name and |
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Acquiring |
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and Length of |
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Principal Occupation(s) |
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Overseen by |
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Trusteeships |
Age |
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Fund |
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Time Served(1) |
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During Past Five Years |
|
Trustee(2) |
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Held |
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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9 |
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None |
11
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Number of |
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Portfolios in |
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Position |
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Highland Fund |
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Other |
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with the |
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Term of Office |
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Complex |
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Directorships/ |
Name and |
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Acquiring |
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and Length of |
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Principal Occupation(s) |
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Overseen by |
|
Trusteeships |
Age |
|
Fund |
|
Time Served(1) |
|
During Past Five Years |
|
Trustee(2) |
|
Held |
Scott Kavanaugh
(Age 48)
|
|
Trustee
|
|
3 years and Trustee
since May 19, 2006.
|
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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.
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9 |
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None |
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James F. Leary (Age
78)
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Trustee
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3 years and Trustee
since May 19, 2006.
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Managing Director,
Benefit Capital
Southwest, Inc. (a
financial consulting
firm) since January
1999.
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9 |
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Board Member of
Capstone Group of
Funds (7
portfolios). |
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Bryan A. Ward (Age
53)
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Trustee
|
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3 years and Trustee
since May 19, 2006.
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Senior Manager,
Accenture, LLP (a
consulting firm) since
January 2002.
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9 |
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None. |
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INTERESTED TRUSTEE
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R. Joseph
Dougherty(4)
(Age 38)
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Trustee
and Chairman of the
Board
|
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3 years and Trustee
since March 10,
2006.
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Team Leader of Investment
Adviser since 2000,
Director/Trustee of
the funds in the
Highland Fund Complex
since 2004 and
President and Chief
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9 |
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None. |
12
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Number of |
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Portfolios in |
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Position |
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Highland Fund |
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Other |
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with the |
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Term of Office |
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Complex |
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Directorships/ |
Name and |
|
Acquiring |
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and Length of |
|
Principal Occupation(s) |
|
Overseen by |
|
Trusteeships |
Age |
|
Fund |
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Time Served(1) |
|
During Past Five Years |
|
Trustee(2) |
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Held |
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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. |
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ACQUIRING
FUND OFFICERS
The business address of each Officer is NexBank Tower, 13455 Noel Road, Suite 800, Dallas,
Texas 75240.
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Position with |
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Term of Office and |
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Name and |
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the Acquiring |
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Length of Time |
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Age |
|
Fund |
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Served |
|
Principal Occupation(s) During Past Five Years |
R. Joseph Dougherty (Age 38) |
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President and Chief Executive Officer |
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Indefinite Term; Chairman of the Board since 2004; President and Chief Executive Officer since December 2008 |
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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. |
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Brad
Borud (Age 37)
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Executive Vice
President
|
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Indefinite Term and
Officer since
December 2008.
|
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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. |
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M. Jason Blackburn
(Age 32)
|
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Chief Financial
Officer (Principal
Accounting
Officer), Treasurer
and Secretary
|
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Indefinite Term and
Officer since May
19, 2006.
|
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Assistant Controller of the Investment
Adviser since November 2001; Treasurer and
Secretary of the funds in the Highland Fund
Complex. |
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Michael Colvin (Age
39)
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Chief Compliance
Officer
|
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Indefinite Term and
Officer since July
2007.
|
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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
|
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|
|
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Name and Age |
|
Position with Acquired Fund |
|
Time
Served |
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Principal Occupation(s) During Past Five Years |
James D. Dondero
(Age 46) |
|
President and Chief Executive Officer |
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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. |
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Mark Okada
(Age 46)
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Executive Vice
President |
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Indefinite Term; Officer since September 2006 |
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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. |
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R. Joseph Dougherty
(Age 38)
|
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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. |
|
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|
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M. Jason Blackburn
(Age 32)
|
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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. |
|
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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. |
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(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
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(2) |
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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.
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|
Aggregate Compensation from |
|
|
Aggregate Compensation from the |
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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 |
|
|
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|
|
|
|
|
|
|
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 |
|
Highland Distressed |
|
Highland Credit |
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|
|
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 ($) |
|
Principal Amount ($) |
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Security |
|
Value ($) |
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Value ($) |
|
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 |
|
|
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. |
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2,735,694 |
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2,735,694 |
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First Lien Term Loan, PIK, 8.25%, 12/30/12
|
|
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1,641,417 |
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|
1,641,417 |
|
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2,062,273 |
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|
2,062,273 |
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Second Lien Term Loan, PIK, 10.50%, 06/28/13
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592,903 |
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|
592,903 |
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Northwest Airlines, Inc. |
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2,312,255 |
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|
2,312,255 |
|
|
Term Loan, 3.44%, 12/31/10
|
|
|
1,724,087 |
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|
|
|
|
|
1,724,087 |
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United Air Lines, Inc. |
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2,482,449 |
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2,482,449 |
|
|
Tranche B Loan, 2.65%, 02/01/14
|
|
|
1,169,234 |
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|
|
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|
1,169,234 |
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11,183,457 |
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11,183,457 |
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|
BROADCASTING - 4.4% |
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ComCorp Broadcasting, Inc. |
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|
1,095,572 |
|
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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 |
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|
|
8,835,713 |
|
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|
14,137,141 |
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Univision Communications, Inc. |
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|
4,623,000 |
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|
4,623,000 |
|
|
Second Lien Term Loan, 2.96%, 03/29/09
|
|
|
3,259,215 |
|
|
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|
|
|
3,259,215 |
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9,066,523 |
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9,678,847 |
|
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18,745,370 |
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CABLE/WIRELESS VIDEO - 2.1% |
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Broadstripe, LLC |
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|
14,152,867 |
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|
|
|
|
|
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 |
|
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|
|
|
|
|
824,073 |
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|
|
|
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|
|
|
8,990,277 |
|
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|
|
|
|
|
8,990,277 |
|
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|
CHEMICALS - 0.7% |
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Arclin US Holdings, Inc. |
|
|
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|
|
|
|
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|
|
|
400,000 |
|
|
|
|
|
|
|
400,000 |
|
|
First Lien Term Loan, 5.04%, 07/10/14
|
|
|
178,000 |
|
|
|
|
|
|
|
178,000 |
|
|
|
|
|
|
|
|
|
|
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|
|
Solutia, Inc. |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,965,075 |
|
|
|
|
|
|
|
1,965,075 |
|
|
Term Loan, 8.50%, 02/28/14
|
|
|
1,346,077 |
|
|
|
|
|
|
|
1,346,077 |
|
|
|
|
|
|
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|
|
|
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|
|
Tronox Worldwide, LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,910,160 |
|
|
|
|
|
|
|
1,910,160 |
|
|
Revolving Credit Loan, 5.97%, 11/28/10 (b)
|
|
|
1,509,026 |
|
|
|
|
|
|
|
1,509,026 |
|
|
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|
3,033,103 |
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|
3,033,103 |
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|
|
CONSUMER DURABLES - 0.4% |
|
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|
Rexair LLC |
|
|
|
|
|
|
|
|
|
|
|
|
|
2,090,614 |
|
|
|
|
|
|
|
2,090,614 |
|
|
First Lien Term Loan, 5.71%, 06/30/10
|
|
|
1,672,491 |
|
|
|
|
|
|
|
1,672,491 |
|
|
|
|
|
|
|
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|
|
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|
|
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|
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|
|
|
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|
|
|
|
|
|
|
|
1,672,491 |
|
|
|
|
|
|
|
1,672,491 |
|
|
|
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|
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|
|
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|
|
|
|
|
|
|
|
|
CONSUMER NON-DURABLES - 0.2% |
|
|
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|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
Totes Isotoner Corp. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,377,228 |
|
|
|
3,377,228 |
|
|
Second Lien Term Loan, 9.88%, 01/31/14
|
|
|
|
|
|
|
1,013,169 |
|
|
|
1,013,169 |
|
|
|
|
|
|
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|
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|
|
|
|
|
|
|
|
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|
|
|
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|
|
|
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|
|
1,013,169 |
|
|
|
1,013,169 |
|
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|
|
|
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|
|
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|
|
DIVERSIFIED MEDIA - 5.5% |
|
|
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|
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|
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|
|
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|
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|
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|
|
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 $1,074,431,218. |
|
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 |
|
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.
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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
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Fund Logo Here
(print in this blue box will show through
window on outbound envelope)
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Highland Distressed Opportunities, Inc.
Proxy for the Special Meeting of Stockholders
To be held on April 9, 2009 |
THIS
PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
The undersigned, revoking any previously executed proxies, hereby appoints R. Joseph Dougherty and
M. Jason Blackburn, or each of them acting individually, as proxies of the undersigned, each with
full power of substitution, to represent and vote all of the common shares of the Fund that the
undersigned would be entitled to vote at the Special Meeting of Stockholders of Highland Distressed
Opportunities, Inc. to be held at The Westin Galleria Dallas, 13340
Dallas Parkway, Dallas, TX 75240 Austin I Conference Room, 2nd
Floor, on April 9, 2009, at 8:00
a.m. Central Time, and at any and all adjournments thereof.
Receipt of the Notice of Special Meeting of Stockholders dated March 5, 2009 and the accompanying
Proxy Statement/Prospectus, which describes the matters to be considered and voted on, is hereby
acknowledged.
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YOUR VOTE IS IMPORTANT. SPECIFY YOUR DESIRED
ACTION BY CHECK MARKS IN THE APPROPRIATE SPACE.
THIS PROXY WILL BE VOTED AS SPECIFIED. IF NO
SPECIFICATION IS MADE, THE PROXY WILL BE VOTED IN
FAVOR OF EACH ITEM. THE PERSONS NAMED AS PROXIES
HAVE DISCRETIONARY AUTHORITY, WHICH THEY INTEND
TO EXERCISE IN FAVOR OF THE PROPOSALS REFERRED TO
AND ACCORDING TO THEIR BEST JUDGEMENT AS TO
ANY OTHER MATTERS THAT PROPERLY COME BEFORE THE
SPECIAL MEETING OR ANY ADJOURNMENTS THEREOF. |
PLEASE FOLD HERE AND RETURN ENTIRE BALLOT DO NOT DETACH
Highland Distressed Opportunities, Inc.
Special Meeting of Stockholders April 9, 2009
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Vote
by Phone, by Mail or by Fax! |
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To vote your proxy by phone, call 1-866-387-9392 and provide the control number found on the reverse side of this proxy
card. Representatives are available to assist you Monday Friday 9 a.m. to 10 p.m.
Eastern Time. |
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MAIL: |
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To vote your proxy by mail check the appropriate voting box on the reverse side of this proxy card, sign and date the
card and return it in the enclosed postage-paid
envelope. |
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FAX: |
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To
vote by fax, please fax your ballot to 1-888-810-3042 (no cover page
is needed). |
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NOTE: PLEASE SIGN EXACTLY AS YOUR NAME(S) APPEAR ON THIS PROXY. If joint owners, EITHER may sign
this Proxy. When signing as attorney, executor, administrator, trustee, guardian, or custodian for
a minor, please give your full title. When signing on behalf of a corporation or as a partner for a
partnership, please give the full corporate or partnership name and your title, if any. |
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PLEASE COMPLETE, SIGN, DATE AND RETURN THIS PROXY IN THE ENCLOSED ENVELOPE AS SOON AS POSSIBLE. |
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Signature and Titles, if applicable
Date |
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Signature (Joint Owners)
Date |
IT IS IMPORTANT THAT PROXIES BE VOTED PROMPTLY.
EVERY STOCKHOLDERS VOTE IS IMPORTANT.
Highland Distressed Opportunities, Inc.
CONTROL NUMBER
PLEASE VOTE YOUR PROXY TODAY!
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF HIGHLAND DISTRESSED OPPORTUNITIES,
INC. THE SHARES REPRESENTED BY THIS PROXY WILL BE VOTED AS INDICATED BELOW, OR FOR THE PROPOSAL IF
YOU SIGN, DATE AND RETURN THIS PROXY BUT NO CHOICE IS INDICATED. THE BOARD OF DIRECTORS OF HIGHLAND
DISTRESSED OPPORTUNITIES, INC. RECOMMENDS A VOTE FOR THE PROPOSAL.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE PROPOSAL.
PLEASE FOLD HERE AND RETURN ENTIRE BALLOT DO NOT DETACH
TO VOTE, MARK BLOCKS BELOW IN BLUE OR BLACK INK. Example: ■
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FOR |
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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).
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THIS PROXY CARD IS VALID ONLY WHEN SIGNED AND DATED.
PLEASE DO NOT FORGET TO SIGN THE REVERSE SIDE OF THIS CARD.
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(BARCODE HERE)
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(TAGID HERE)
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(CUSIP HERE) |
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION
Article V of the Registrants Agreement and Declaration of Trust, dated as of March 10, 2006,
provides as follows:
5.1 No Personal Liability of Shareholders, Trustees, etc. No Shareholder of the Trust shall be
subject in such capacity to any personal liability whatsoever to any Person in connection with
Trust Property or the acts, obligations or affairs of the Trust. Shareholders shall 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. No Trustee or officer of the Trust shall
be subject in such capacity to any personal liability whatsoever to any Person, save only liability
to the Trust or its Shareholders arising from bad faith, willful misfeasance, gross negligence or
reckless disregard for his duty to such Person; and, subject to the foregoing exception, all such
Persons shall look solely to the Trust Property for satisfaction of claims of any nature arising in
connection with the affairs of the Trust. If any Shareholder, Trustee or officer, as such, of the
Trust, is made a party to any suit or proceeding to enforce any such liability, subject to the
foregoing exception, he shall not, on account thereof, be held to any personal liability. Any
repeal or modification of this Section 5.1 shall not adversely affect any right or protection of a
Trustee or officer of the Trust existing at the time of such repeal or modification with respect to
acts or omissions occurring prior to such repeal or modification.
5.2 Mandatory Indemnification. (a) The Trust hereby agrees to indemnify each person who at any
time serves as a Trustee or officer of the Trust (each such person being an indemnitee) against
any liabilities and expenses, including amounts paid in satisfaction of judgments, in compromise or
as fines and penalties, and reasonable counsel fees reasonably incurred by such indemnitee in
connection with the defense or disposition of any action, suit or other proceeding, whether civil
or criminal, before any court or administrative or investigative body in which he may be or may
have been involved as a party or otherwise or with which he may be or may have been threatened,
while acting in any capacity set forth in this Article V by reason of his having acted in any such
capacity, except with respect to any matter as to which he shall not have acted in good faith in
the reasonable belief that his action was in the best interest of the Trust or, in the case of any
criminal proceeding, as to which he shall have had reasonable cause to believe that the conduct was
unlawful, provided, however, that no indemnitee shall be indemnified hereunder against any
liability to any person or any expense of such indemnitee arising by reason of (i) willful
misfeasance, (ii) bad faith, (iii) gross negligence, or (iv) reckless disregard of the duties
involved in the conduct of his position (the conduct referred to in such clauses (i) through (iv)
being sometimes referred to herein as disabling conduct). Notwithstanding the foregoing, with
respect to any action, suit or other proceeding voluntarily prosecuted by any indemnitee as
plaintiff, indemnification shall be mandatory only if the prosecution of such action, suit or other
proceeding by such indemnitee (1) was authorized by a majority of the Trustees or (2) was
instituted by the indemnitee to enforce his or her rights to indemnification hereunder in a case in
which the indemnitee is found to be entitled to such indemnification. The rights to
indemnification set forth in this Declaration shall continue as to a person who has ceased to be a
Trustee or officer of the Trust and shall inure to the benefit of his or her heirs, executors and
personal and legal representatives. No amendment or restatement of this Declaration or repeal of
any of its provisions shall limit or eliminate any of the benefits provided to any person who at
any time is or was a Trustee or officer of the Trust or otherwise entitled to indemnification
hereunder in respect of any act or omission that occurred prior to such amendment, restatement or
repeal.
(b) Notwithstanding the foregoing, no indemnification shall be made hereunder unless there has been
a determination (i) by a final decision on the merits by a court or other body of competent
jurisdiction before whom the issue of entitlement to indemnification hereunder was brought that
such indemnitee is entitled to indemnification hereunder or, (ii) in the absence of such a
decision, by (1) a majority vote of a quorum of those Trustees who are neither interested
persons of the Trust (as defined in Section 2(a)(19) of the 1940 Act) nor parties to the
proceeding (Disinterested Non-Party Trustees), that the indemnitee is entitled to
indemnification hereunder, or (2) if such quorum is not obtainable or even if obtainable, if such
majority so directs, independent legal counsel in a written opinion concludes that the indemnitee
should be entitled to indemnification hereunder. All determinations to make advance payments in
connection with the expense of defending any proceeding shall be authorized and made in accordance
with the immediately succeeding paragraph (c) below.
(c) The Trust shall make advance payments in connection with the expenses of defending any action
with respect to which indemnification might be sought hereunder if the Trust receives a written
affirmation by the indemnitee of the indemnitees good faith belief that the standards of conduct
necessary for indemnification have been met and a written undertaking to reimburse the Trust unless
it is subsequently determined that the indemnitee is entitled to such indemnification and if a
majority of the Trustees determine that the applicable standards of conduct necessary for
indemnification appear to have been met. In addition, at least one of the following conditions
must be met: (i) the indemnitee shall provide adequate security for his undertaking, (ii) the
Trust shall be insured against losses arising by reason of any lawful advances, or (iii) a majority
of a quorum of the Disinterested Non-Party Trustees, or if a majority vote of such quorum so
direct, independent legal counsel in a written opinion, shall conclude, based on a review of
readily available facts (as opposed to a full trial-type inquiry), that there is substantial reason
to believe that the indemnitee ultimately will be found entitled to indemnification.
(d) The rights accruing to any indemnitee under these provisions shall not exclude any other right
which any person may have or hereafter acquire under this Declaration, the By-Laws of the Trust,
any statute, agreement, vote of stockholders or Trustees who are disinterested persons (as
defined in Section 2(a)(19) the 1940 Act) or any other right to which he or she may be lawfully
entitled.
(e) Subject to any limitations provided by the 1940 Act and this Declaration, the Trust shall have
the power and authority to indemnify and provide for the advance payment of expenses to employees,
agents and other Persons providing services to the Trust or serving in any capacity at the request
of the Trust to the full extent corporations organized under the Delaware General Corporation Law
may indemnify or provide for the advance payment of expenses for such Persons, provided that such
indemnification has been approved by a majority of the Trustees.
5.3 No Bond Required of Trustees. No Trustee shall, as such, be obligated to give any bond or
other security for the performance of any of his duties hereunder.
5.4 No Duty of Investigation; Notice in Trust Instruments, etc. No purchaser, lender, transfer
agent or other person dealing with the Trustees or with any officer, employee or agent of the
Trust shall be bound to make any inquiry concerning the validity of any transaction purporting to
be made by the Trustees or by said officer, employee or agent or be liable for the application of
money or property paid, loaned, or delivered to or on the order of the Trustees or of said
officer, employee or agent. Every obligation, contract, undertaking, instrument, certificate,
Share, other security of the Trust, and every other act or thing whatsoever executed in connection
with the Trust shall be conclusively taken to have been executed or done by the executors thereof
only in their capacity as Trustees under this Declaration or in their capacity as officers,
employees or agents of the Trust. The Trustees may maintain insurance for the protection of the
Trust Property, its Shareholders, Trustees, officers, employees and agents in such amount as the
Trustees shall deem adequate to cover possible tort liability, and such other insurance as the
Trustees in their sole judgment shall deem advisable or is required by the 1940 Act.
5.5 Reliance on Experts, etc. Each Trustee and officer or employee of the Trust shall, in the
performance of its duties, be fully and completely justified and protected with regard to any act
or any failure to act resulting from reliance in good faith upon the books of account or other
records of the Trust, upon an opinion of counsel, or upon reports made to the Trust by any of the
Trusts officers or employees or by any advisor, administrator, manager, distributor, selected
dealer, accountant, appraiser or other expert or consultant selected with reasonable care by the
Trustees, officers or employees of the Trust, regardless of whether such counsel or expert may also
be a Trustee.
Insofar as indemnification for liabilities arising under the Securities Act of 1933, may be
permitted to trustees, officers and controlling persons of the Acquiring Fund, pursuant to the
foregoing provisions or otherwise, the Acquiring Fund has been advised that in the opinion of the
Commission such indemnification is against public policy as expressed in the Securities Act of 1933
and is, therefore, unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Acquiring Fund of expenses incurred or paid by a
trustee, officer or controlling person of the Acquiring Fund in the successful defense of any
action, suit or proceeding) is asserted by such trustee, officer or controlling person in
connection with the securities being registered, the Acquiring Fund will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public policy as expressed
in the Securities Act of 1933 and will be governed by the final adjudication of such issue.
2
Reference is made to Section 8 of the underwriting agreement attached as Exhibit 7(a) and Section 7
of the dealer manager agreement attached as Exhibit 7(b), which are incorporated herein by
reference and discuss the rights, responsibilities and limitations with respect to indemnity and
contribution.
ITEM 16. EXHIBITS
(1) |
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Agreement and Declaration of Trust (Incorporated by reference to Pre-Effective Amendment No.
4 to the Registrants Registration Statement, File Nos. 333-132436 and 811-21869, filed on
June 9, 2006) |
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(2) |
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By-laws (Incorporated by reference to Pre-Effective Amendment No. 4 to the Registrants
Registration Statement, File Nos. 333-132436 and 811-21869, filed on June 9, 2006) |
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(3) |
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Voting Trust Agreement. (Not Applicable) |
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(4) |
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Form of Agreement and Plan of Merger and Liquidation. (Filed herewith as Appendix A to the Proxy
Statement/Prospectus) |
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(5) |
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Provisions of instruments defining the rights of holders of securities are contained in the
Registrants Agreement and Declaration of Trust and By-laws. |
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(6) |
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Investment Advisory Agreement. (Incorporated by reference to Pre-Effective Amendment No. 5 to
the Registrants Registration Statement, File Nos. 333-132436 and 811-21869, filed on June 21,
2006) |
(7) |
(a) |
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Underwriting Agreement. (Incorporated by reference to Pre- Effective Amendment No. 5 to
the Registrants Registration Statement, File Nos. 333-132436 and 811-21869, filed on June 21,
2006) |
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(b) |
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Dealer Manager Agreement with respect to rights offering. (Incorporated by
reference to Pre-Effective Amendment No. 2 to the Registrants Registration Statement,
File Nos. 333-147121 and 811-21869, filed on December 14, 2007) |
(8) |
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Bonus, profit sharing or pension contracts. (Not applicable) |
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(9) |
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Custodian Services Agreement. (Incorporated by reference to Pre-Effective Amendment No. 4 to
the Registrants Registration Statement, File Nos. 333-132436 and 811-21869, filed on June 9,
2006) |
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(10) |
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12b-1 or 18f-3 Plans. (Not applicable) |
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(11) |
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Opinion and Consent of Counsel as to the legality of shares
being registered. (Incorporated by reference to Pre-Effective Amendment No. 1 to the Registrants Registration
Statement on Form N-14, File No. 333-156464, filed on March 2, 2009) |
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(12) |
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Form of Opinion and Consent of Counsel regarding certain tax matters and consequences to shareholders
discussed in the Proxy Statement/Prospectus. (Incorporated by reference to Pre-Effective Amendment No. 1 to the Registrants Registration
Statement on Form N-14, File No. 333-156464, filed on March 2, 2009) |
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(13) |
(a) |
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Administration Services Agreement. (Incorporated by reference to Pre-Effective Amendment
No. 5 to the Registrants Registration Statement, File Nos. 333-132436 and 811-21869, filed on
June 21, 2006) |
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(b) |
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Sub-administration Services Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 4 to the Registrants Registration Statement, File Nos.
333-132436 and 811-21869, filed on June 9, 2006) |
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(c) |
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Transfer Agency Services Agreement. (Incorporated by reference to Pre-Effective
Amendment No. 4 to the Registrants Registration Statement, File Nos. 333-132436 and
811-21869, filed on June 9, 2006) |
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(d) |
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Accounting Services Agreement. (Incorporated by reference to Pre-Effective
Amendment No. 4 to the Registrants Registration Statement, File Nos. 333-132436 and
811-21869, filed on June 9, 2006) |
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(e) |
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Marketing and Structuring Fee Agreement. (Incorporated by reference to
Pre-Effective Amendment No. 5 to the Registrants Registration Statement, File Nos.
333-132436 and 811-21869, filed on June 21, 2006) |
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(f) |
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Form of Amendment No. 1 to Administration Services
Agreement. (Incorporated by reference to the Registrants
Registration Statement on Form N-14, File No. 333-156464, filed on December 24, 2008) |
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(g) |
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Amended and Restated Revolving Credit and Security Agreement,
dated August 22, 2008, among the Registrant, Liberty Street Funding LLC and
The Bank of Nova Scotia, acting through its New York Agency.
(Incorporated by reference to Pre-Effective Amendment No. 1 to
the Registrants Registration Statement on Form N-14, File
No. 333-156464, filed on March 2, 2009) |
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(14) |
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Consent of Independent Registered Public Accounting Firm. (Incorporated by reference to Pre-Effective Amendment No. 1 to
the Registrants Registration Statement on Form N-14, File
No. 333-156464, filed on March 2, 2009) |
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(15) |
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Omitted Financial Statements. (Not applicable) |
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(16) |
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Powers of Attorney. (Incorporated by reference to the
Registrants Registration Statement on Form N-14, File No.
333-156464, filed on December 24, 2008) |
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(17) |
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Contractual Fee Waiver. (Incorporated by reference to Pre-Effective Amendment No. 1 to the Registrants Registration Statement on Form N-14, File No. 333-149424, filed April 17, 2008) |
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ITEM 17. UNDERTAKINGS
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The undersigned registrant agrees that prior to any public reoffering of the
securities registered through the use of a prospectus which is a part of this
registration statement by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c) of the Securities Act of 1933 (1933 Act), the
reoffering prospectus will contain the information called for by the applicable
registration form for the reofferings by persons who may be deemed underwriters, in
addition to the information called for by the other items of the applicable form. |
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The undersigned registrant agrees that every prospectus that is filed under
paragraph (1) above will be filed as a part of an amendment to the registration
statement and will not be used until the amendment is effective, and that, in
determining any liability under the 1933 Act, each post-effective amendment shall be
deemed a new registration statement for the securities offered therein, and the
offering of the securities at that time shall be deemed the initial bona fide offering
of them. |
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(3) |
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The undersigned registrant agrees to file by post-effective amendment, an
opinion of counsel supporting the tax consequences of the proposed reorganization
within a reasonable time after receipt of such opinion. |
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(4) |
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The undersigned registrant undertakes to register Merger Sub either as an investment
company under the Investment Company Act of 1940 (1940 Act) or elect that Merger
Sub will be regulated as a business development company under the 1940 Act prior to the
consummation of the Merger described in the Prospectus/Proxy Statement.
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4
SIGNATURES
As required by the Securities Act of 1933, as amended (the 1933 Act), this registration
statement has been signed on behalf of the registrant in the City of Dallas and State of Texas, on
the 3rd day of March, 2009.
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HIGHLAND CREDIT STRATEGIES FUND
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/s/ R. Joseph Dougherty |
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R. Joseph Dougherty |
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Chief Executive Officer and President |
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As required by the 1933 Act, this registration statement has been signed by the following persons
in the capacities and on the dates indicated.
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NAME |
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TITLE |
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/s/ R. Joseph Dougherty
R. Joseph Dougherty
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Trustee, Chief Executive Officer and President |
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/s/ Timothy Hui
Timothy Hui*
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|
Trustee |
|
|
|
/s/ Scott Kavanaugh
Scott Kavanaugh*
|
|
Trustee |
|
|
|
/s/ James Leary
James Leary*
|
|
Trustee |
|
|
|
/s/ Bryan Ward
Bryan Ward*
|
|
Trustee |
|
|
|
/s/ M. Jason Blackburn
M. Jason Blackburn
|
|
Chief Financial Officer (Principal Accounting
Officer),
Treasurer and Secretary |
|
*By: /s/ M. Jason Blackburn
M. Jason Blackburn
|
|
|
Attorney-in-Fact |
|
|
March
3, 2009 |
|
|
5