-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EFc0XnpV6YCqvES0hcLGL6cDJS3zsae2A2FJ121mL6mZJrVbXKw2RyIrp6GgwGgc /cy9nercJwhBI+YYU8auSQ== 0000922423-96-000485.txt : 19960912 0000922423-96-000485.hdr.sgml : 19960912 ACCESSION NUMBER: 0000922423-96-000485 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960911 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FUNDAMENTAL FUNDS INC CENTRAL INDEX KEY: 0000315811 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 133076279 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 002-82710 FILM NUMBER: 96628625 BUSINESS ADDRESS: STREET 1: 90 WASHINGTON ST - 19TH FL CITY: NEW YORK STATE: NY ZIP: 10006 BUSINESS PHONE: 2126353005 MAIL ADDRESS: STREET 1: 90 WASHINGTON ST CITY: NEW YORK STATE: NY ZIP: 10006 FORMER COMPANY: FORMER CONFORMED NAME: NEW YORK MUNI FUND INC DATE OF NAME CHANGE: 19920703 497 1 STATEMENT OF ADDITIONAL INFORMATION Rule 497(e) Registration No.:2-82710 STATEMENT OF ADDITIONAL INFORMATION NEW YORK MUNI FUND P.O. Box 1013 Bowling Green Station New York, New York 10274-1013 (800) 322-6864 NEW YORK MUNI FUND (the "Fund") is a series of Fundamental Funds, Inc. (the "Company"), a Maryland corporation. The Fund seeks to provide a high level of income that is excluded from gross income for Federal income tax purposes and exempt from New York State and New York City personal income taxes and is consistent with the preservation of capital. Of course, there can be no assurance that this investment objective will be achieved. The Fund intends to achieve its objective through investing primarily in municipal obligations of New York State, its political subdivisions, and its other duly constituted authorities and corporations, that are rated within the four highest quality grades for bonds as determined by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation ("S&P"), Fitch Investors Service, Inc. ("Fitch") or Duff & Phelps, Inc. ("Duff") or within the three highest quality grades for municipal notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by Fund management to be of comparable quality. While municipal obligations in these categories are generally deemed to have adequate to very strong protection of principal and interest, municipal obligations rated within the lowest of these categories may have speculative characteristics as well. This Statement of Additional Information provides certain detailed information concerning the Fund. It is not a Prospectus and should be read in conjunction with the Fund's current Prospectus, a copy of which may be obtained by writing to Fundamental Service Corporation at the address listed above, or by calling (800) 322-6864. Shareholder inquiries may also be placed through this number. THIS STATEMENT IS DATED APRIL 25, 1996 AS SUPPLEMENTED ON SEPTEMBER 11, 1996 AND SUPPLEMENTS THE FUND'S PROSPECTUS DATED APRIL 25, 1996. TABLE OF CONTENTS PAGE ---- INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS 3 ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS 6 ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES 9 ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS 11 MANAGEMENT OF THE FUND 26 DISTRIBUTION PLAN 31 CALCULATION OF YIELD 32 CUSTODIAN AND INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 36 TAX MATTERS 36 PORTFOLIO TRANSACTIONS 43 OTHER INFORMATION 45 FINANCIAL STATEMENTS 45 APPENDIX A-1 2 INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS As stated in the Fund's Prospectus, the objective of the Fund is to provide investors with a high level of income that is excluded from gross income for Federal income tax purposes and exempt from New York State and New York City personal income taxes and is consistent with the preservation of capital. Of course, there can be no assurance that this objective will be achieved. The Fund intends to attempt to achieve its objective by investing substantially all, and at least 80%, of its total assets in debt obligations which are rated within the four highest quality grades for bonds as determined by Moody's, S&P, Fitch or Duff or within the three highest quality grades for municipal notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by Fund management to be of comparable quality, and which are issued by the State of New York, its political subdivisions, and its other duly constituted authorities and corporations, the interest from which is, in the opinion of counsel to the issuer, totally excluded from gross income for Federal income tax purposes and exempt from New York State and New York City personal income taxes. The investment restrictions described below have been adopted by the Fund as fundamental policies which cannot be changed without approval of a majority of the outstanding shares of the Fund. 1. The Fund will not issue any senior security (as defined in the 1940 Act), except that (a) the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including reverse repurchase agreements, delayed delivery and when-issued securities, which may be considered the issuance of senior securities; (b) the Fund may engage in transactions that may result in the issuance of a senior security to the extent permitted under applicable regulations, interpretations of the 1940 Act or an exemptive order; (c) the Fund may engage in short sales of securities to the extent permitted in its investment program and other restrictions; (d) the purchase or sale of futures contracts and related options shall not be considered to involve the issuance of senior securities; and (e) subject to fundamental restrictions, the Fund may borrow money as authorized by the 1940 Act. 2. The Fund will not underwrite any issue of securities, except to the extent that the purchase of municipal obligations directly from the issuer, in accordance with the Fund's investment objective, policies and restrictions, may be deemed to be an underwriting. 3. The Fund will not purchase or sell real estate. This restriction shall not prevent the Fund from investing in municipal obligations secured by real estate or interests therein. 4. The Fund will not invest in commodity contracts, except that the Fund may, to the extent appropriate under its 3 investment program, purchase securities of companies engaged in whole or in part in such activities, may enter into transactions in financial and index futures contracts and related options and may engage in transactions on a when-issued or forward commitment basis. 5. The Fund will not invest in oil, gas or thermal mineral exploration, or development programs. 6. The Fund will not make loans, except that, to the extent appropriate under its investment program, the Fund may (a) purchase debt instruments, including bonds, debentures, notes and municipal commercial paper; (b) enter into repurchase transactions; and (c) lend portfolio securities provided that the value of such loaned securities does not exceed one-third of the Fund's total assets. 7. The Fund may borrow money from banks (including its custodian bank) or from other lenders to the extent permitted under applicable law, for temporary or emergency purposes, to meet redemptions or for purposes of leveraging, but only if, immediately after such borrowing, the value of the Fund's assets, including the amount borrowed, less its liabilities, is equal to at least 300% of the amount borrowed, plus all outstanding borrowings. If at any time the value of the Fund's assets fails to meet the 300% asset coverage requirement, the Fund will, within three days (not including Sundays and holidays), reduce its borrowings to the extent necessary to meet the 300% test. The Fund may enter into certain futures contracts and options related thereto and the Fund may enter into commitments to purchase securities in accordance with the Fund's investment program, including delayed delivery and when-issued securities and reverse repurchase agreements. 8. The Fund will not invest 25% or more of its total assets in securities of issuers in any one industry; provided, however, that such limitation shall not be applicable to municipal obligations other than those municipal obligations backed only by the assets and revenues of non-governmental users, nor shall it apply to municipal obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities. In addition to the foregoing, the Fund is subject to the following non-fundamental restrictions: 1. The Fund will not purchase a qualified private activity bond if as a result of such purchase more than 20% of the Fund's total assets, determined at market value at the time of the proposed investment, would be invested in qualified private activity bonds. 2. The Fund may purchase and sell futures contracts and related options under the following conditions: (a) the then- current aggregate futures market prices of financial instruments required to be delivered and purchased under open futures contracts 4 shall not exceed 20% of the fund's total assets, at market value; and (b) no more than 5% of the assets, at market value at the time of entering into a contract, shall be committed to margin deposits in relation to futures contracts. 3. The Fund will not invest more than 15% of its net assets in illiquid investments, including repurchase agreements maturing in more than seven days, securities that are not readily marketable and restricted securities not eligible for resale pursuant to Rule 144A under the Securities Act of 1933. 4. The Fund will not make short sales of securities, other than short sales "against the box", or purchase securities on margin except for short-term credits necessary for clearance of portfolio transactions, provided that this restriction will not be applied to limit the use of options, futures contracts and related options, in the manner otherwise permitted by the investment restrictions, policies and investment program of the Fund. Since the Fund may invest in qualified private activity bonds, its shares may not be an appropriate investment for "substantial users" of facilities financed by industrial development bonds (as defined in Treasury regulation section 1.103- 11), or "related persons" to such users (within the meaning of Internal Revenue Code section 147(a)). The Fund, together with any of its "affiliated persons" (as described in the 1940 Act), may only purchase up to 3% of the total outstanding securities of any underlying investment company. Accordingly, when the Fund or such "affiliated persons" hold shares of any of the underlying investment companies, the Fund's ability to invest fully in shares of those investment companies is restricted, and Fundamental Portfolio Advisors, Inc. must then, in some instances, select alternative investments that would not have been its first preference. The 1940 Act also provides that an underlying investment company whose shares are purchased by the Fund will be obligated to redeem shares held by the Fund and its affiliates only in an amount up to 1% of the underlying investment company's outstanding securities during any period of less than 30 days. Shares held by the Fund and its affiliates in excess of 1% of an underlying investment company's outstanding securities therefore will be considered not readily marketable securities, which together with other such illiquid securities may not exceed 15% of the Fund's net assets. In certain circumstances, an underlying investment company may determine to make payment of a redemption by the Fund wholly or partly by a distribution in kind of securities from its portfolio, in lieu of cash, in conformity with rules of the Securities and Exchange Commission. In such cases, the Fund may hold securities distributed by an underlying investment company until Fundamental 5 Portfolio Advisors, Inc. determines that it is appropriate to dispose of such securities. There can be no assurance that funds for investing in municipal obligations will be available for investment. The Fund does not intend to invest in such funds unless, in the judgment of Fundamental Portfolio Advisors, Inc., the potential benefits of such investment justify the payment of any applicable premium or sales charge. Where relevant in this Statement of Additional Information, the term "issuer" is defined as the entity which has either actually issued the security or which is ultimately responsible for payment of the obligation. For purposes of diversification of the Fund's investments, separate issues by the same issuer will be considered as distinct or diverse investments provided that such issues differ either with respect to collateral (i.e., the pledge of specific revenue or taxes standing as security for the payment of the obligation) or guarantor of ultimate payment. ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS MUNICIPAL BONDS Municipal bonds are long-term debt obligations, generally with a maturity at the time of issuance of greater than three years, of states and their political subdivisions issued to obtain funds for various public purposes, including construction of a wide range of public facilities, such as airports, bridges, highways, housing, hospital, mass transportation, schools, streets and water and sewer works. Other purposes for which municipal bonds may be issued include refunding outstanding obligations; obtaining funds for general operating expenses; or obtaining funds to lend to public or private institutions for construction of such facilities as educational, hospital and housing facilities. In addition, certain types of bonds may be issued by public authorities to finance privately operated housing facilities, sports facilities, convention or trade show facilities, and certain local facilities for water supply, gas, electricity, or sewage or solid waste disposal. Other types of qualified private activity bonds, the proceeds of which are used for the construction, equipment, repair or improvement of privately operated industrial or commercial facilities, may constitute municipal bonds, although current Federal tax laws place substantial limitations on the size of such issues. The two principal classifications of municipal bonds are general obligation and revenue bonds. General obligation bonds are secured by the issuer's pledge of faith, credit and taxing power for the payment of principal and interest. Revenue bonds are payable from only revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a 6 special excise tax or other specific revenue sources such as from the user of the facility being financed. Qualified private activity bonds are, in most cases, revenue bonds and do not generally constitute the pledge of the credit or taxing power of the issuer of such bonds. The payment of the principal and interest on such bonds depends solely on the ability of the user of the facilities financed by the bonds to meet its financial obligations and the pledge, if any, of real and personal property so financed as security for such payment. MUNICIPAL NOTES Municipal notes are short-term obligations, generally with a maturity at the time of issuance of six months to three years. The principal types of municipal notes include tax anticipation notes, bond anticipation notes, revenue anticipation notes, and project notes. Tax anticipation notes are sold to provide working capital to states and municipalities in anticipation of collection of taxes. Bond anticipation notes are issued to provide funds temporarily in anticipation of a bond sale. Revenue anticipation notes are sold in expectation of receipt of other revenues, such as funds under the Federal Revenue Sharing Program. Project notes are issued by local agencies in connection with such programs as construction of low-income housing in order to provide construction financing prior to permanent financing. Project notes are guaranteed by the U.S. Department of Housing and Urban Development and consequently are secured by the full faith and credit of the United States. VARIABLE RATE INSTRUMENTS Municipal bonds and notes are sometimes issued with a variable interest rate ("variable rate instruments"). The interest rate on variable rate instruments is usually tied to an objective standard, such as the 90-day Treasury Bill rate or the prime rate of a bank involved in the financing. Prime rates can change daily; the auction for 90-day Treasury Bill rates is held weekly. In addition to having a variable interest rate, any such instruments are subject to repayment of principal on demand by the Fund, usually in not more than five business days. Both the variable rate feature and the principal repayment on demand feature tend to reduce fluctuations in the price of variable rate instruments; these instruments are generally of interest and sold to institutional investors. Also available are participation interests in loans to municipal issuers, which are similar except that these loan participations are made available through a commercial bank that arranges the tax-exempt loan. Participation interests are frequently backed by an irrevocable bank letter of credit or a guarantee by a financial institution and give the Fund the right to demand, on short notice (usually not more than seven days), payment of all or any part of the principal amount and accrued interest. The Board of Directors will determine that the participation interest in the municipal securities meets the Fund's prescribed quality standards. The Fund's management has been 7 instructed by the Board of Directors to monitor the pricing, quality and liquidity of any variable rate demand instruments held, including participation interests supported by letters of credit or guarantee, on the basis of published financial information and reports of the rating agencies and other analytical sources. The Fund's management will also monitor the creditworthiness of the guarantor. Banks retain fees for their role in an amount equal to the excess of the interest paid on the municipal securities over the negotiated yield at which the participation interests were purchased. In the event that the participation interest that the Fund acquires includes the right to demand payment of principal and accrued interest from the issuer of the participation interest pursuant to a letter of credit or other commitment, the maturity will be deemed to be equal to the time remaining until the principal amount can be recovered from the issuer through demand, although the stated maturity may be in excess of one year. To the extent that variable rate instruments and loan participations may lack liquidity (unless payable on demand or within seven days), they are subject to the restriction on illiquid securities, described herein under the caption "Investment Objective, Policies and Restrictions". OTHER INFORMATION A portion of the Fund's assets may be invested in qualified hospital bonds. Such bonds are rated on the basis of feasibility studies that project occupancy levels, revenues and expenses. The gross receipts and income of hospitals are affected by many future events and conditions (including among other things, demand for hospital services, the ability of the hospital to provide such services, competition, actions by insurers and governmental agencies, the cost and possible unavailability of malpractice insurance, and the funding of medicare and medicaid programs), whose effects are often difficult to predict. Changes or future developments in all of the foregoing areas may have an adverse effect on the price or marketability of such bonds. A part of the Fund's assets may be invested in obligations of state and local housing authorities. Such obligations are not part of the general obligations of the state or the municipality in question. To a large extent, such obligations are generally supported by Federal housing subsidy programs. Any weakness in such programs or their administration, or the failure by a state or local housing authority to meet the qualifications required for coverage under such programs, may result in a decrease or the elimination of such Federal subsidies and could adversely affect payment of principal and interest on housing authority bonds. These factors as well as general economic factors affecting housing in general could cause a decrease in the value or marketability of such bonds. A portion of the Fund's assets may be invested in municipal obligations that are moral obligation bonds issued by agencies and authorities of the State of New York (i.e., issued 8 pursuant to the municipality's good faith and credit to pay principal and interest). Under the statutes applicable to such bonds, the State may be called on to restore any deficits in capital reserve funds of such agencies or authorities created with respect to the bonds. Any such restoration requires appropriation by the state legislature for such purposes, and accordingly, the statutes do not constitute legally enforceable obligations or debt of the State. The agencies or authorities in question have no taxing power, and on a default by such agencies or authorities, there are no guarantees that payments of principal and interest will be met. ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES The lower quality securities in which the Fund may invest (i.e., those rated lower than Baa by Moody's or BBB by S&P, Fitch or Duff or determined by Fund management to be a comparable quality if unrated) generally produce a higher current yield than do securities of higher ratings. However, these obligations are considered speculative because they involve greater price volatility and risk than do higher rated securities and the yields on these securities will tend to fluctuate over time. Although the market value of all fixed-income securities varies as a result of changes in prevailing interest rates (e.g., when interest rates rise, the market value of fixed-income securities can be expected to decline), values of lower rated securities tend to react differently than the values of higher rated securities. The prices of lower rated securities are less sensitive to changes in interest rates than higher rated securities. Conversely, lower rated securities also involve a greater risk of default by the issuer in the payment of principal and income and are more sensitive to economic downturns and recessions than higher rated securities. The financial stress resulting from an economic downturn could have a greater negative effect on the ability of issuers of lower rated securities to service their principal and interest payments, to meet projected business goals and to obtain additional financing than on more creditworthy issuers. In the event of an issuer's default in payment of principal or interest on such securities, or any other securities in the Fund's portfolio, the net asset value of the Fund will be negatively affected. Moreover, as the market for lower rated securities is a relatively new one which has not yet been tested through a recession, a severe economic downturn might increase the number of defaults, thereby adversely affecting the value of all outstanding lower rated municipal bonds and disrupting the market for such securities. Securities purchased by the Fund as part of an initial underwriting present an additional risk due to their lack of market history. These risks are exacerbated with respect to securities rated CCC or lower by S&P, Fitch or Duff or Caa or lower by Moody's. Unrated securities generally carry the same risks as do lower rated securities. The Fund may invest in lower rated securities that are structured as zero coupon or pay-in-kind bonds. Such securities 9 may be more speculative and subject to greater fluctuation in value due to changes in interest rates than lower rated, income-bearing securities. In addition, zero coupon and pay-in-kind securities are also subject to the risk that in the event of a default, a fund may realize no return on its investment, because these securities do not pay cash interest. Zero coupon, or deferred interest, securities are debt obligations that do not entitle the holder to any periodic payment of interest prior to maturity or a specified date when the securities begin paying current interest (the "cash payment date") and therefore are issued and traded at a discount from their face amounts or par value. Pay-in-kind securities are securities that pay interest through the issuance of additional securities. Holders of zero coupon securities are considered to receive each year the portion of the original issue discount on such securities that accrues that year and must include such amount in gross income, even though the holders receive no cash payments during the year. Consequently, as a fund is accruing original issue discount on these securities prior to the receipt of cash payment, it is still subject to the requirement that it distribute substantially all of its income to its shareholders in order to qualify as a "regulated investment company" under applicable tax law. Therefore, such fund may have to dispose of its portfolio securities under disadvantageous circumstances or leverage itself by borrowing to generate the cash necessary to satisfy its distribution requirements. Lower rated securities are typically traded among a smaller number of broker-dealers rather than in a broad secondary market. Purchasers of lower rated securities tend to be institutions, rather than individuals, a factor that further limits the secondary market. To the extent that no established retail secondary market exists, many lower rated securities may not be as liquid as Treasury and investment grade securities. The ability of the Fund to sell lower rated securities will be adversely affected to the extent that such securities are thinly traded or illiquid. Moreover, the ability of the Fund to value lower rated securities becomes more difficult, and judgment plays a greater role in valuation, as there is less reliable, objective data available with respect to such securities that are thinly traded or illiquid. Because investors may perceive that there are greater risks associated with the medium to lower rated securities of the type in which the Fund may invest, the yields and prices of such securities may tend to fluctuate more than those for securities with a higher rating. Changes in perception of issuers' creditworthiness tend to occur more frequently and in a more pronounced manner in the lower quality segments of the fixed-income securities market than do changes in higher quality segments of such market, resulting in greater yield and price volatility. The general legislative environment has included discussions and legislative proposals relating to the tax treatment of high-yield securities. Any or a combination of such proposals, if enacted into law, could negatively affect the value of the 10 high-yield securities in the Fund's portfolio. The likelihood of any such legislation is uncertain. Fund management believes that the risks of investing in such high-yielding securities may be minimized through careful analysis of prospective issuers. Although the opinion or ratings services such as Moody's, S&P, Fitch and Duff is considered in selecting portfolio securities, they relate to credit risk and evaluate the safety of the principal and the interest payments of the security, not their market value risk. Additionally, credit rating agencies may experience slight delays in updating ratings to reflect current events. The Fund relies, primarily, on its own credit analysis, which includes a study of the existing debt, capital structure, ability to service debts and to pay dividends, and the current trend of earnings for any issuer under consideration for the Fund's investment portfolio. This may suggest, however, that the achievement of the Fund's investment objective is more dependent on its proprietary credit analysis, than is otherwise the case for a fund that invests in higher quality securities. ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS The financial condition of New York State (the "State") and certain of its public bodies (the "Agencies") and municipalities, particularly New York City (the "City"), could affect the market values and marketability of New York Municipal Obligations which may be held by the Fund. The following information constitutes only a brief summary, does not purport to be a complete description, and is based on information drawn from official statements relating to securities offerings of the State, the City and the Municipal Assistance Corporation for the City of New York ("MAC") available as of the date of this Statement of Additional Information. While the Fund has not independently verified such information, it has no reason to believe that such information is not correct in all material respects. A national recession commenced in mid-1990. The downturn continued through the remainder of the 1990-91 fiscal year, and was followed by a period of weak economic growth during the remainder of the 1991 calendar year. For the calendar year 1992, the national economy continued to recover, although at a rate below all post-war recoveries. The recession was more severe in the State than in other parts of the nation, owing to a significant retrenchment in the financial services industry, cutbacks in defense spending, and an overbuilt real estate market. The State economy remained in recession until 1993, when employment growth resumed. Since early 1993, the State has gained approximately 100,000 jobs. The State's economy expanded modestly during 1995. Although industries that export goods and services abroad are expected to benefit from the lower dollar, growth will be slowed by 11 government cutbacks at all levels. On an average annual basis, employment growth in 1995 was estimated to be about the same as 1994. Both personal income and wages were estimated to have recorded moderate gains in 1995. Employment growth is expected to slow significantly in 1996 as the pace of national economic growth slackens, entire industries experience consolidations, and governmental employment continues to shrink. Personal income is estimated to increase by 4.0% in 1996. The State's budget for the 1995-96 fiscal year was enacted by the Legislature on June 7, 1995, more than two months after the start of the fiscal year. Prior to adoption of the budget, the Legislature enacted appropriations for disbursements considered to be necessary for State operations and other purposes, including all necessary appropriations for debt service. The State Financial Plan for 1995-96 fiscal year was formulated on June 20, 1995 and is based on the State's budget as enacted by the Legislature and signed into law by the Governor. The 1995-96 budget was the first to be enacted in the administration of the Governor, who assumed office on January 1. It was the first budget in over half a century which proposed and, as enacted, projected an absolute year-over-decline in General Fund disbursements. Spending for State operations was projected to drop even more sharply, by 4.6%. Nominal spending from all State funding sources (i.e., excluding Federal aid) was proposed to increase by only 2.5% from the prior fiscal year, in contrast to the prior decade when such spending growth averaged more than 6.0% annually. In his Executive Budget, the Governor indicated that in the 1995-96 fiscal year, the State Financial Plan, based on then-current law governing spending and revenues, would be out of balance by almost $4.7 billion, as a result of the projected structural deficit resulting from the ongoing disparity between sluggish growth in receipts, the effect of prior-year tax changes, and the rapid acceleration of spending growth; the impact of unfunded 1994-95 initiatives, primarily for local aid programs; and the use of one-time solutions, primarily surplus funds from the prior year, to fund recurring spending in the 1994-95 budget. The Governor proposed additional tax cuts, to spur economic growth and provide relief for low and middle income tax payers, which were larger than those ultimately adopted, and which added $240 million to the then projected imbalance or budget gap, bringing their total to approximately $5 billion. This gap was projected to be closed in the 1995-96 State Financial Plan based on the enacted budget, through a series of actions, mainly spending reductions and cost containment measures and certain reestimates that were expected to be recurring, but also through the use of one-time solutions. The General Fund was projected to be balanced on a cash basis for the 1995-96 fiscal year. Total receipts and transfers 12 from other funds were projected to be $33.110 billion, a decrease of $48 million from total receipts in the prior fiscal year. Total General Fund disbursements and transfers to other funds were projected to be $33.055 billion, a decrease of $344 million from the total amount disbursed in the prior fiscal year. The State Financial Plan was based upon forecasts of national and State economic activity. Economic forecasts have frequently failed to predict accurately the timing and magnitude of changes in the national and the State economies. Many uncertainties exist in forecasts of both the national and State economies, including consumer attitudes toward spending, Federal financial and monetary policies, the availability of credit and the condition of the world economy, which could have an adverse effect on the State. There can be no assurance that the State economy will not experience worse-than-predicted results , with corresponding material and adverse effects on the State's projections of receipts and disbursements. The State issued its second quarterly update to the cash-basis 1995-96 State Financial Plan (the "Mid-Year Update") on October 26, 1995. Revisions have been made to estimates of both receipts and disbursements based on: (1) updated economic forecasts for both the nation and the State, (2) an analysis of actual receipts and disbursements through the first six months of the fiscal year, and (3) an assessment of changing program requirements and cost savings initiatives. The Mid-Year Update projects continued balance in the State's 1995-96 Financial Plan,with estimated receipts reduced by a net $71 million and estimated disbursements reduced by a net $30 million. The resulting General Fund balance decreases to $172 million in the Mid-Year Update, reflecting the expected use of $41 million from the Contingency Reserve Fund for payment of litigation and disallowance expenses. On October 2, 1995, the State Comptroller released a report entitled "Comptroller's Report on the Financial Condition of New York State 1995" in which he identified several risks to the State Financial Plan and reaffirmed his estimate that the State faces a potential imbalance in receipts and disbursements of at least $2.7 billion for the State's 1996-97 fiscal year and at least $3.9 billion for the State's 1997-98 fiscal year. There can be no assurance that the State will not face substantial potential budget gaps in future years resulting from a significant disparity between tax revenues projected from a lower recurring receipts base and the spending required to maintain State programs at current levels. To address any potential budgetary imbalance, the State may need to take significant actions to align recurring receipts and disbursements in future fiscal years. On June 6, 1990, Moody's changed its ratings on all the State's outstanding general obligation bonds from A1 to A. On March 26, 1990 and January 13, 1992, S&P changed its ratings on all 13 of the State's outstanding general obligation bonds from AA- to A and from A to A-, respectively. In February 1991, Moody's lowered its rating on the City's general obligation bonds from A to Baa1 and in July 1995, S&P lowered its rating on such bonds from A- to BBB+. Ratings reflect only the respective views of such organizations, and their concerns about the financial condition of New York State and City, the debt load of the State and City and any economic uncertainties about the region. There is no assurance that a particular rating will continue for any given period of time or that any such rating will not be revised downward or withdrawn entirely if, in the judgment of the agency originally establishing the rating, circumstances so warrant. (1) The State, Agencies and Other Municipalities. During the mid 1970's, some of the Agencies and municipalities (in particular, the City) faced extraordinary financial difficulties, which affected the State's own financial condition. These events, including a default on short-term notes issued by the New York State Urban Development Corporation ("UDC") in February 1975, which default was cured shortly thereafter, and a continuation of the financial difficulties of the City, created substantial investor resistance to securities issued by the State and by some of its municipalities and Agencies. For a time, in late 1975 and early 1976, these difficulties resulted in a virtual closing of public credit markets for State and many State related securities. In response to the financial problems confronting it, the State developed and implemented programs for its 1977 fiscal year that included the adoption of a balanced budget on a cash basis (a deficit of $92 million that actually resulted was financed by issuing notes that were paid during the first quarter of the State's 1978 fiscal year). In addition, legislation was enacted limiting the occurrence of additional so-called "moral obligation" and certain other Agency debt, which legislation does not, however, apply to MAC debt. State Financial Plan--GAAP-Basis Results--1995-96 Update. The State issued its first update to the GAAP-basis Financial Plan for the State's 1995-96 fiscal year on September 1, 1995. The September GAAP-basis update projected a General Fund operating surplus of $401 million. The prior projection of the 1995-96 GAAPbasis State Financial Plan, issued in March 1995 as part of the 1995-96 Executive Budget, projected an operating surplus in the General Fund of $800 million. The change to the projection primarily reflects the impact of legislative changes to the 1995-96 Executive Budget, as well as increases in projected accruals for certain local assistance programs (primarily Medicaid). Total revenues in the General Fund are projected at $31.871 billion, consisting of $29.625 billion in tax revenues and $2.246 billion in miscellaneous revenue. Total expenditures in the General Fund are projected at $32.444 billion, including $22.678 billion for grants to local governments, $8.037 billion for State 14 operations, $1.711 billion for general State charges, and $18 million for debt service. Compared to the projections made in March, expenditures for grants to local governments are substantially increased, primarily because of legislative changes to the 1995-96 Executive Budget and increased projected accruals for Medicaid. For all governmental funds, the summary GAAP-basis Financial Plan shows an excess of revenues and other financing sources over expenditures and other financing uses of $359 million. GAAP-Basis Results--1994-95 Fiscal Year. The State's Combined Balance Sheet as of March 31, 1995 showed an accumulated deficit in its combined governmental funds of $1.666 billion reflecting liabilities of $14.778 billion and assets of $13.112 billion. This accumulated governmental funds deficit includes a $3.308 billion accumulated deficit in the General Fund, as well as accumulated surpluses in the special Revenue and Debt Service fund types of $877 million and $1.753 billion, respectively, and a $988 million accumulated deficit in the Capital Projects fund type. The State completed its 1994-95 fiscal year with a combined Governmental Funds operating deficit of $1.791 billion, which included operating deficits int he General Fund of $1.426 billion, in the Capital Projects Funds of $366 million, and in the Debt Service Funds of $38 million. There is an operating surplus in the Special Revenue Funds of $39 million. GAAP-Basis Results--1993-94 Fiscal Year. The State reported a General Fund operating surplus of $914 million for the 1993-94 fiscal year, as compared to an operating surplus of $2.065 billion for the prior fiscal year. The 1993-94 fiscal year surplus reflects several major factors, including the cash basis surplus recorded in 1993-94, the use of $671 million of the 1992-93 surplus to fund operating expenses in 1993-94, net proceeds of $575 million in bonds issued by the New York Local Government Assistance Corporation ("LGAC") and the accumulation of a $265 million balance in the Contingency Reserve Fund ("CRF") . Revenues increased $543 million (1.7%) over prior fiscal year revenues with the largest increase occurring in personal income taxes. Expenditures increased $1.659 billion (5.6%) over the prior fiscal year, with the largest increase occurring in State aid for social services programs. The Special Revenue fund and Debt Service fund ended 1993- 94 with operating surpluses of $149 million and $23 million, respectively. The Capital Projects fund ended with an operating deficit of $35 million. GAAP-Basis Results--1992-93 Fiscal Year. The State completed its 1992-93 fiscal year with a GAAP-basis operating surplus of $2.065 billion in the General Fund and an accumulated deficit of $2.551 billion. The Combined Statement of Revenues, 15 Expenditures and Changes in Fund Balances reported total revenues of $31.085 billion, total expenditures of $29.337 billion, and net other financing sources and uses of $317 million. The surplus primarily reflects the 1992-93 cash-basis surplus and the net proceeds of $881 million in bonds issued by LGAC. The Special Revenue, Debt Service and Capital Projects fund types ended the 1992-93 fiscal year with GAAP-basis operating surpluses of $131 million, $381 million, and $57 million, respectively. State Financial Plan--Cash-Basis Results--General Fund. The General Fund is the principal operating fund of the State and is used to account for all financial transactions, except those required to be accounted for in another fund. It is the State's largest fund and receives almost all State taxes and other resources not dedicated to particular purposes. General Fund moneys are also transferred to other funds, primarily to support certain capital projects and debt service payments in other fund types. The General Fund is projected to be balanced on a cash basis for the 1995-96 fiscal year. Total receipts and transfers from other funds are projected to be $33.110 billion, a decrease of $48 million from total receipts in the prior fiscal year. Total General Fund disbursements and transfers to other funds are projected to be $33.055 billion, a decrease of $344 million from the total amount disbursed in the prior fiscal year. New York State's financial operations have improved during recent fiscal years. During the period 1989-90 through 1991-92, the State incurred General Fund operating deficits that were closed with receipts from the issuance of tax and revenue anticipation notes ("TRANs"). First, the national recession, and then the lingering economic slowdown in the New York and regional economy, resulted in repeated shortfalls in receipts and three budget deficits. For its 1992-93, 1993-94 and 1994-95 fiscal years, the State recorded balanced budgets on a cash basis, with substantial fund balances in 1992-93 and 1993-94, and smaller fund balance in 1994-95, as described below. New York State ended its 1994-95 fiscal year with the General fund in balance. The closing fund balance of $158 million reflects $157 million in the Tax Stabilization Reserve Fund and $1 million in the Contingency Reserve Fund ("CRF"). The CRF was established in State Fiscal year 199394, funded partly with surplus monies, to assist the State in financing the 1994-95 fiscal year costs of extraordinary litigation known or anticipated at that time; the opening fund balance in State fiscal year 1994-95 was $265 million. The $241 million change in the fund balance reflects the use of $264 million in the CRF as planned, as well as the required deposit of $23 million to the Tax Stabilization Reserve Fund. In addition, $278 million was on deposit in the tax refund reserve account, $250 million of which was deposited at the end of 16 the State's 1994-95 fiscal year to continue the process of restructuring the State's cash flow as part of the New York Local Government Assistance Corporation ("LGAC") program. Compared to the State Financial Plan for 1994-1995 as formulated on June 16, 1994, reported receipts fell short of original projections by $1.163 billion, primarily in the categories of personal income and business taxes. of this amount, the personal income tax accounts for $800 million, reflecting weak estimated tax collections and lower withholding due to reduced wage and salary growth, more severe reductions in brokerage industry bonuses than projected earlier, and deferral of capital gains realizations in anticipation of potential Federal tax changes. Business taxes fell short by $373 million, primarily reflecting lower payments from banks as substantial overpayments of 1993 liability depressed net collections in the 1994-95 fiscal year. These shortfalls were offset by better performance in the remaining taxes, particularly the user taxes and fees, which exceeded projections by $210 million. Of this amount, $277 million was attributable to certain restatements for accounting treatment purposes pertaining to the CRF and LGAC; these restatements had no impact on balance in the General Fund. Disbursements were also reduced from original projections by $848 million. After adjusting for the net impact of restatements relating to the CRF and LGAC which raised disbursements by $38 million, the variance is $886 million. Well over two-thirds of this variance is in the category of grants to local governments, primarily reflecting the conservative nature of the original estimates of projected costs for social services and other programs. Lower education costs are attributable to the availability of $110 million in additional lottery proceeds and the use of LGAC bond proceeds. The spending reductions also reflect $188 million in actions initiated in January 1995 by the Governor to reduce spending to avert a potential gap in the 1994-95 State Financial Plan. These actions included savings from a hiring freeze, halting the development of certain services, and the suspension of nonessential capital projects. These actions, together with $71 million in other measures comprised the Governor's $259 million gapclosing plan, submitted to the Legislature in connection with the 1995-96 Executive Budget. The State ended its 1993-94 fiscal year with a balance of $1.140 billion in the tax refund reserve account, $265 million in the CRF and $134 million in its tax stabilization reserve fund. These fund balances were primarily the result of an improving national economy, State employment growth, tax collections that exceeded earlier projections and disbursements that were below expectations. Before the deposit of $1.140 billion in the tax refund reserve account, General Fund receipts in 1993-94 exceeded those 17 originally projected when the State Financial Plan for the year was formulated on April 16, 1993 by $1.002 billion. Greater-thanexpected receipts in the personal income tax, the bank tax, the corporation franchise tax and the estate tax accounted for most of this variance, and more than offset weaker-than-projected collections from the sales and use tax and miscellaneous receipts. The higher receipts resulted, in part, because the New York economy performed better than forecasted. Employment growth started in the first quarter of the State's 1993-94 year, and although this lagged the national economic recovery, the growth in New York began earlier than forecasted. The New York economy exhibited signs of strength in the service sector, in construction, and in trade. Disbursements and transfer from the General Fund were $303 million below the level projected in April 1993, an amount that would have been $423 million had the State not accelerated the payment of Medicaid billings, which in the April 1993 State Financial Plan were planned to be deferred into the 1994-95 fiscal year. Compared to the estimates included in the State Financial Plan formulated in April 1993, disbursements were lower for Medicaid, capital projects, and debt service (due to refundings). In addition, $114 million of school and payments were funded from the proceeds of LGAC bonds. Disbursements were higherthan-expected for general support for public schools. The State also made the first of six required payments to the State of Delaware related to the settlement of Delaware's litigation against the State regarding the disposition of abandoned property receipts. During the 1993-94 fiscal year, the State also established and funded the CRF as a way to assist the State in financing the cost of litigation affecting the State. The CRF was initially funded with a transfer of $100 million attributable to the positive margin recorded in the 1992-93 fiscal year. In addition, the State augmented this initial deposit with $132 million on debt service savings attributable to the refinancing of State and public authority bonds during 1993-94. A year-end transfer of $36 million was also made to the CRF, which, after a disbursement for authorized fund purposes, brought the CRF balance at the end of 1993-94 to $265 million. This amount was $165 million higher than the amount originally targeted for this reserve fund. The State ended the 1992-93 fiscal year with a balance on a cash basis of $671 million in the General Fund that was deposited in the tax refund reserve account and $67 million in the Tax Stabilization Fund. After reflecting a 1992-93 year-end deposit to the refund reserve account of $671 million, reported 1992-93 General Fund receipts were $45 million higher than originally projected in April 1992. If not for that year-end transaction, which had the effect of reducing 1992-93 receipts by $671 million and making 18 those receipts available in 1993-94, General Fund receipts would have been $716 million higher than originally projected. During its 1989-90, 1990-91 and 1991-92 fiscal years, the State incurred cash-basis operating deficits in the General Fund of $775 million, $1.081 billion and $575 million, respectively, prior to the issuance of short-term TRANs, owing to lower-thanprojected receipts. Cash-Basis Results--Other Governmental Funds. Activity in the three other governmental funds has remained relatively stable over the last three fiscal years, with Federally-funded programs comprising approximately two-thirds of these funds. The most significant change in the structure of these funds has been the redirection, beginning in the 1993-94 fiscal year, of a portion of transportation-related revenues from the General Fund to two new dedicated funds in the Special Revenue and Capital Projects Fund types. These revenues totalling $676 million in the 1994-95 fiscal year were used to support the capital programs of the Department of Transportation and the Metropolitan Transportation Authority ("MTA"). The Special Revenue Funds account for State receipts from specific sources that are legally restricted in use to specified purposes and include all moneys received from the Federal government. Total receipts in Special Revenue Funds are projected at $25.547 billion in the State's 1995-96 fiscal year. Disbursements from Special Revenue Funds are projected to be $26.002 billion for the State's 1995-96 fiscal year. The Capital Projects Funds are used to finance the acquisition and construction of major capital facilities and to aid local government units and Agencies in financing capital constructions. Federal grants for capital projects, largely highway-related, are projected to account for 24% of the $4.170 billion in total projected receipts in Capital Projects Funds in the State's,1995-96 fiscal year. Total disbursements for capital projects are projected to be $4.160 billion during the State's 1995-96 fiscal year. The Debt Service Funds serve to fulfill State debt service on long-term general obligation State debt and other State lease/purchase and contractual obligation financing commitments. Total receipts in Debt Service Funds are projected to reach $2.409 billion in the State's 1995-96 fiscal year. Total disbursements from Debt Service Funds for debt service, lease/purchase and contractual obligation financing commitments are projected to be $2.506 billion for the 1995-96 fiscal year. State Borrowing Plan. The State anticipates that its capital programs will be financed, in part, through borrowings by the State and public authorities in the 1995-96 fiscal year. The 19 State expects to issue $248 million in general obligation bonds (including $70 million for purposes of redeeming outstanding BANs) and $186 million in general obligation commercial paper . The Legislature has also authorized the issuance of up to $33 million in COPs during the State's 1995-96 fiscal year for equipment purchases and $14 million for capital purposes. The projection of the State regarding its borrowings for the 1995-96 fiscal year may change , if circumstances require. In addition, the LGAC is authorized to provide net proceeds of up to $529 million during the 1995-96 fiscal year to redeem notes sold in June 1995. State Agencies. The fiscal stability of the State is related, at least in part, to the fiscal stability of its localities and various of its Agencies. Various Agencies have issued bonds secured, in part, by non-binding statutory provisions for State appropriations to maintain various debt service reserve funds established for such bonds (commonly referred to as "moral obligation" provisions). At September 30, 1994, there were 18 Agencies that had outstanding debt of $100 million or more. The aggregate outstanding debt, including refunding bonds, of these 18 Agencies was $70.3 billion as of September 30, 1994. As of March 31, 1995, aggregate Agency debt outstanding as State supported debt was $27.9 billion and as State-related was $36.1 billion. Debt service on the outstanding Agency obligations normally is paid out of revenues generated by the Agencies' projects or programs, but in recent years the State has provided special financial assistance, in some cases on a recurring basis, to certain Agencies for operating and other expenses and for debt service pursuant to moral obligation indebtedness provisions or otherwise. Additional assistance is expected to continue to be required in future years. Several Agencies have experienced financial difficulties in the past. Certain Agencies continue to experience financial difficulties requiring financial assistance from the State. Failure of the State to appropriate necessary amounts or to take other action to permit certain Agencies to meet their obligations could result in a default by one or more of such Agencies. If a default were to occur, it would likely have a significant effect on the marketability of obligations of the State and the Agencies. These Agencies are discussed below. The New York State Housing Finance Agency ("HFA") provides financing for multifamily housing, State University construction, hospital and nursing home development, and other programs. In general, HFA depends upon mortgagors in the housing programs it finances to generate sufficient funds from rental income, subsidies and other payments to meet their respective mortgage repayment obligations to HFA, which provide the principal source of funds for the payment of debt service on HFA bonds, as well as to meet operating and maintenance costs of the projects financed. From 20 January 1, 1976 through March 31, 1987, the State was called upon to appropriate a total of $162.8 million to make up deficiencies in the debt service reserve funds of HFA pursuant to moral obligation provisions. The State has not been called upon to make such payments since the 1986-87 fiscal year and no payments are anticipated during the 1995-96 fiscal year. UDC has experienced, and expects to continue to experience, financial difficulties with the housing programs it had undertaken prior to 1975, because a substantial number of these housing program mortgagors are unable to make full payments on their mortgage loans. Through a subsidiary, UDC is currently attempting to increase its rate of collection by accelerating its program of foreclosures and by entering into settlement agreements. UDC has been, and will remain, dependent upon the State for appropriations to meet its operating expenses. The State also has appropriated money to assist in the curing of a default by UDC on notes which did not contain the State's moral obligation provision. The MTA oversees New York City's subway and bus lines by its affiliates, the New York City Transit Authority and the Manhattan and Bronx Surface Transit Operating Authority (collectively, the "TA"). Through MTA's subsidiaries, the Long Island Rail Road Company, the Metro-North Commuter Railroad Company and the Metropolitan Suburban Bus Authority, the MTA operates certain commuter rail and bus lines in the New York metropolitan area. In addition, the Staten Island Rapid Transit Authority, an MTA subsidiary, operates a rapid transit line on Staten Island. Through its affiliated agency, the Triborough Bridge and Tunnel Authority (the "TBTA"), the MTA operates certain toll bridges and tunnels. Because fare revenues are not sufficient to finance the mass transit portion of these operations, the MTA has depended and will continue to depend for operating support upon a system of State, local government and TBTA support and, to the extent available, Federal operating assistance, including loans, grants and subsidies. If current revenue projections are not realized and/or operating expenses exceed current projections, the TA or commuter railroads may be required to seek additional State assistance, raise fares or take other actions. Over the past several years the State has enacted several taxes--including a surcharge on the profits of banks, insurance corporations and general business corporations doing business in the 12-county region (the "Metropolitan Transportation Region") served by the MTA and a special .25% regional sales and use tax-that provide additional revenues for mass transit purposes, including assistance to the MTA. In addition, since 1987, State law has required that the proceeds of .25% mortgage recording tax paid on certain mortgages in the metropolitan Transportation Region be deposited in a special MTA fund for operating or capital expenses. Further, in 1993, the State dedicated a portion of certain additional State petroleum business tax receipts to fund operating or capital assistance to the MTA. For the 1995-96 21 State fiscal year, total State assistance to the MTA is estimated at approximately $1.1 billion. In 1981, the State Legislature authorized procedures for the adoption, approval and amendment of a five-year plan for the capital program designed to upgrade the performance of the MTA's transportation systems and to supplement, replace and rehabilitate facilities and equipment, and also granted certain additional bonding authorization therefor. On April 5, 1993, the Legislature approved, and the Governor subsequently signed into law, legislation authorizing a five-year $9.56 billion capital plan for the MTA for 1992-1996. The MTA has received approval of the 1992-1996 Capital Program based on this legislation from the MTA Capital Program Review Board (the "CPRB"), as State law requires. This is the third five-year plan since the Legislature authorized procedures for the adoption, approval and amendment of a five-year plan in 1981 for a capital program designed to upgrade the performance of the MTA's transportation systems and to supplement, replace and rehabilitate facilities and equipment. The MTA, the TBTA and the TA are collectively authorized to issue an aggregate of $3.1 billion of bonds (net of certain statutory exclusions) to finance a portion of the 1992-96 Capital Program. The 1992-96 Capital Program was expected to be financed in significant part through dedication of the State petroleum business tax receipts. There can be no assurance that such governmental actions will be taken, that sources currently identified will not be decreased or eliminated, or that the 1992-1996 Capital Program will not be delayed or reduced. If the MTA capital program is delayed or reduced because of funding shortfalls or other factors, ridership and fare revenues may decline, which could, among other things, impair the MTA's ability to meet its operating expenses without additional State assistance. The cities, towns, villages and school districts of the State are political subdivisions of the State with the powers granted by the State Constitution and statutes. As the sovereign, the State retains broad powers and responsibilities with respect to the government, finances and welfare of these political subdivisions, especially in education and social services. In recent years the State has been called upon to provide added financial assistance to certain localities. Other Localities. Certain localities in addition to the City could have financial problems leading to requests for additional State-assistance during the State's 1995-96 fiscal year and thereafter. The potential impact on the State of such actions by localities is not included in the projections of the State receipts and disbursements in the State's 1995-96 fiscal year. 22 Municipalities and school districts have engaged in substantial short-term and long-term borrowings. In 1993, the total indebtedness of all localities in the State, other than the City, was approximately $17.7 billion. A small portion (approximately $105 million) of this indebtedness represented borrowing to finance budgetary deficits and was issued pursuant to enabling State legislation. State law requires the Comptroller to review and make recommendations concerning the budgets of those local government units other than the City authorized by State law to issue debt to finance deficits during the period that such deficit financing is outstanding. Fifteen localities had outstanding indebtedness for deficit financing at the close of their fiscal year ending in 1993. Certain proposed Federal expenditure reductions would reduce, or in some cases eliminate, Federal funding of some local programs and accordingly might impose substantial increased expenditure requirements on affected localities to increase local revenues to sustain those expenditures. If the State, the City or any of the Agencies were to suffer serious financial difficulties jeopardizing their respective access to the public credit markets, the marketability of notes and bonds issued by localities within the State could be adversely affected. Localities also face anticipated and potential problems resulting from certain pending litigation, judicial decisions and long-range economic trends. The longer-range, potential problems of declining city population, increasing expenditures and other economic trends could adversely affect localities and require increasing State assistance in the future. Because of significant fiscal difficulties experienced from time to time by the City of Yonkers, a Financial Control Board was created by the State in 1984 to oversee Yonkers' fiscal affairs. Future actions taken by the Governor or the State Legislature to assist Yonkers in this crisis could result in the allocation of State resources in amounts that cannot yet be determined. Certain litigation pending against the State or its officers or employees could have a substantial or long-term adverse effect on State finances. Among the more significant of these litigations are those that involve: (i) the validity and fairness of agreements and treaties by which various Indian tribes transferred title to the State of approximately six million acres of land in central New York; (ii) certain aspects of the State's Medicaid rates and regulations, including reimbursements to providers of mandatory and optional Medicaid services; (iii) contamination in the Love Canal area of Niagara Falls; (iv) a challenge to the State's practice of reimbursing certain Office of Mental Health patient-care expenses with clients' Social Security benefits; (v) a challenge to the methods by which the State reimburses localities for the administrative costs of food stamp programs; (vi) a challenge to the State's possession of certain funds taken pursuant to the State's Abandoned Property law; (vii) 23 alleged responsibility of State officials to assist in remedying racial segregation in the City of Yonkers; (viii) an action, in which the state is a third party defendant, for injunctive or other appropriate relief, concerning liability for the maintenance of stone groins constructed along certain areas of Long Island's shoreline; (ix) actions challenging the constitutionality of legislation enacted during the 1990 legislative session which changed the actuarial funding methods for determining contributions to State employee retirement systems; (x) an action against State and City officials alleging that the present level of shelter allowance for public assistance recipients is inadequate under statutory standards to maintain proper housing; (xi) an action challenging legislation enacted in 1990 which had the effect of deferring certain employer contributions to the State Teachers' Retirement System and reducing State aid to school districts by a like amount; (xii) a challenge to the constitutionality of financing programs of the Thruway Authority authorized by Chapters 166 and 410 of the Laws of 1991 (described below in this Part); (xiii) a challenge to the constitutionality of financing programs of the Metropolitan Transportation Authority and the Thruway Authority authorized by Chapter 56 of the Laws of 1993 (described below in this Part); (xiv) challenges to the delay by the State Department of Social Services in making two one-week Medicaid payments to the service providers; (xv) challenges by commercial insurers, employee welfare benefit plans, and health maintenance organizations to provisions of Section 2807-c of the Public Health Law which impose 13%, 11% and 9% surcharges on inpatient hospital bills and a bad debt and charity care allowance on all hospital bills paid by such entities; (xvi) challenges to the promulgation of the State's proposed procedure to determine the eligibility for and nature of home care services for Medicaid recipients; (xvii) a challenge to State implementation of a program which reduces Medicaid benefits to certain home-relief recipients; and (xviii) challenges to the rationality and retroactive application of State regulations recelebrating nursing home Medicaid rates. Adverse developments or decisions in such cases could affect the ability of the State to maintain a balanced 1995-96 State Financial Plan. (2) New York City. In the mid- 1970s, the City had large accumulated past deficits and until recently was not able to generate sufficient tax and other ongoing revenues to cover expenses in each fiscal year. However, the City's operating results for the fiscal year ending June 30, 1995 were balanced in accordance with GAAP, the thirteenth consecutive year in which the City achieved balanced operating results in accordance with GAAP. The City's ability to maintain balanced operating results in future years is subject to numerous contingencies and future developments. The City's economy, whose rate of growth slowed substantially over the past three years, is currently in recession. During the 1990 and 1991 fiscal years, as a result of the slowing 24 economy, the City has experienced significant shortfalls in almost all of its major tax sources and increases in social services costs, and has been required to take actions to close substantial budget gaps in order to maintain balanced budgets in accordance with the Financial Plan. In 1975, the City became unable to market its securities and entered a period of extraordinary financial difficulties. In response to this crisis, the State created MAC to provide financing assistance to the City and also enacted the New York State Financial Emergency Act for the City of New York (the "Emergency Act") which, among other things, created the Financial Control Board (the "Control Board") to oversee the City's financial affairs and facilitate its return to the public credit markets. The State also established the Office of the State Deputy Comptroller ("OSDC") to assist the Control Board in exercising its powers and responsibilities. On June 30, 1986, the Control Board's powers of approval over the City Financial Plan were suspended pursuant to the Emergency Act. However, the Control Board, MAC and OSDC continue to exercise various monitoring functions relating to the City's financial condition. The City prepares and operates under a four-year financial plan which is submitted annually to the Control Board for review and which the City periodically updates. The City's independently audited operating results for each of its fiscal years from 1981 through 1995 show a General Fund surplus reported in accordance with GAAP. The City has eliminated the cumulative deficit in its net General Fund position. According to a recent OSDC economic report, the City's economy was slow to recover from the recession and is expected to experience a weak employment situation, and moderate wage and income growth, during the 1995-96 period. Also, Financial Plan reports of OSDC, the Control Board, and the City Comptroller have variously indicated that many of the City's balanced budgets have been accomplished, in part, through the use of non-recurring resource, tax and fee increases, personnel reductions and additional State assistance; that the City has not yet brought its long-term expenditures in line with recurring revenues; that the City's proposed gap-closing programs, if implemented, would narrow future budget gaps; that these programs tend to rely heavily on actions outside the direct control of the City; and that the City is therefore likely to continue to face futures projected budget gaps requiring the City to reduce expenditures and/or increase revenues. According to the most recent staff reports of OSDC, the Control Board and the City Comptroller during the four-year period covered by the current Financial Plan, the City is relying on obtaining substantial resources from initiatives needing approval and cooperation of its municipal labor unions, Covered Organizations, and City Council, as well as the State and Federal governments, among others, and there can be no assurance that such approval can be obtained. 25 The City requires certain amounts of financing for seasonal and capital spending purposes. The City has issued $1.75 billion of notes for seasonal financing purposes during the 1994 fiscal year. The City's capital financing program projects long-term financing requirements of approximately $17 billion for the City's fiscal years 1995 through 1998 for the construction and rehabilitation of the City's infrastructure and other fixed assets. The major capital requirement include expenditures for the City's water supply system, and waste disposal systems, roads, bridges, mass transit, schools and housing. In addition, the City and the Municipal Water Finance Authority issued about $1.8 billion in refunding bonds in the 1994 fiscal year. State Economic Trends. The State historically has been one of the wealthiest states in the nation. For decades, however, the State has grown more slowly than the nation as a whole, gradually eroding its relative economic position. Statewide, urban centers have experienced significant changes involving migration of the more affluent to the suburbs and an influx of generally less affluent residents. Regionally, the older Northeast cities have suffered because of the relative success that the South and the West have had in attracting people and business. The City has also had to face greater competition as other major cities have developed financial and business capabilities which make them less dependent on the specialized services traditionally available almost exclusively in the City. During the 1982-83 recession, overall economic activity in the State declined less than that of the nation as a whole. However, in the calendar years 1984 through 1991, the State's rate of economic expansion was somewhat slower than that of the nation. In the 1990-91 recession, the economy of the State, and that of the rest of the Northeast, was more heavily damaged than that of the nation as a whole and has been slower to recover. The total employment growth rate in the State has been.below the national average since 1984. The unemployment rate in the State dipped below the national rate in the second half of 1981 and remained lower until 1991; since then, it has been higher. According to data published by the U.S. Bureau of Economic Analysis, during the past ten years, total personal income in the State rose slightly faster than the national average only from 1986 through 1988. MANAGEMENT OF THE FUND DIRECTORS AND OFFICERS Directors and officers of the Fund, together with information as to their principal business occupations during the last five years, are shown below. Each director who is considered to be an "interested person" of the Fund, as defined in the 1940 Act, is indicated by as asterisk (*). 26 James C. Armstrong: Director of the Fund. Mr. Armstrong is a partner in Armstrong/Seltzer Communications Inc., a New York management, consulting and public relations firm. He was formerly Executive Director, Global Public Affairs Institute at New York University and Professor, Bell of Pennsylvania Chair in Telecommunications, Temple University, and is a management consultant. He was with American Telephone and Telegraph Company for 15 years. His last position with AT&T was Director, Corporate Policy Analysis. Mr. Armstrong previously held positions at the Institute for Defense Analysis, the Office of the Postmaster General, and on the faculty of the University of Maryland. He has been a consultant to government, academic and business organizations, and has served on various government-industry task forces and committees. Mr. Armstrong was an Officer in the United States Navy and holds a Ph.D. in nuclear physics. Mr. Armstrong's address is 51 Mt. Pleasant Road, Morristown, New Jersey 07960. James A. Bowers: Director of the Fund. Mr. Bowers is a consultant for Prototypes (formerly, Director of Finance and Administration), the American Telephone and Telegraph Company, The RAND Corporation and CogniTech Services Corporation. He was employed at AT&T for 23 years. His latest position with AT&T was in the Treasury Department as District Manager-Securities and Exchange Commission Reporting. Mr. Bowers holds Bachelor of Science and Master of Arts degrees in Economics from Florida Atlantic University. Mr. Bowers' address is 60 East Eighth Street, New York, N.Y. 10003. Clark L. Bullock: Director of the Fund. Mr. Bullock is Chairman of the Board of Shelter Rock Investors Services Corp., a privately-held, New York-based investment company. Mr. Bullock received a Masters of Science degree in Mathematical Economics from Purdue University in 1972 and a Bachelor of Arts degree in International Relations from the University of Arizona. Mr. Bullock's address is c/o Shelter Rock Investors, 150 Hopper Avenue, Waldwick, NJ 07463. L. Greg Ferrone: Director of the Fund. Mr. Ferrone is a consultant with IntraNet, Inc., a provider of computer systems to the domestic and international banking industry. Previously he was the Director of Sales & Marketing for RAV Communications Inc., Vice President/Regional Manager with National Westminster Bank USA and an officer at Security Pacific Bank. Mr. Ferrone received a Bachelor of Science degree from Rensselaer Polytechnic Institute in 1972 and studied at the Stonier Graduate School of Banking. Mr. Ferrone's address is 83 Ronald Court, Ramsey, New Jersey 07446. *Vincent J. Malanga: Chairman of the Board, Chief Executive Officer, President and Treasurer of the Fund, The California Muni Fund and Fundamental Fixed Income Fund. Mr. Malanga is President, Treasurer and a Director of Fundamental Portfolio Advisors, Inc., Executive Vice President, Secretary and 27 a Director of Fundamental Service Corporation, and President, LaSalle Economics Inc., an economic consulting firm. Mr. Malanga is Vice President, Secretary and a 50% shareholder of LaSalle Portfolio Management, Inc., the general partner of both LPM Financial Futures Fund I, Limited Partnership and LPM Equities Fund Limited Partnership. Prior thereto, he was a Vice President and Senior Economist at A. Gary Shilling & Company, Inc., an economic consulting and brokerage firm. He previously served as an Economist at White, Weld & Co. (an investment banking and brokerage firm) and so served from 1976 to 1978. Prior thereto, Mr. Malanga, who holds a Ph.D. in Economics from Fordham University, was an Economist at the Federal Reserve Bank of New York. Mr. Malanga's address is 90 Washington Street, 19th Floor, New York, New York 10006. David P. Wieder: Vice President of the Fund, Secretary of Fundamental Portfolio Advisors, Inc., and President and a Director of Fundamental Shareholder Services, Inc. Mr. Wieder holds a Bachelor of Science degree in Economics from Cornell University. Mr. Wieder's address is 90 Washington Street, 19th Floor, New York, New York 10006. Carole M. Laible: Secretary of the Fund. Treasurer and Secretary of Fundamental Shareholder Services, Inc. She was formerly a General Service Manager for McGladrey & Pullen. Ms. Laible receibved a Bachelor of Science degree from St. John's University in 1985. Ms. Laible's address is 90 Washington Street, 19th Floor, New York, New York 10006. All of the Directors of the Fund are also Trustees of The California Muni Fund and Fundamental Fixed-Income Fund. All of the officers of the Fund hold similar offices with The California Muni Fund and Fundamental Fixed-Income Fund. For services and attendance at board meetings and meetings of committees which are common to the Fund, Fundamental Fixed-Income Fund and The California Muni Fund (other affiliated mutual funds for which the Fund's investment manager acts as the investment adviser), each Director of the Fund who is not affiliated with the Fund's investment manager is compensated at the rate of $6,500 per quarter prorated among the three funds based on their respective net assets at the end of each quarter. Each such Director is also reimbursed by the three funds, on the same basis, for actual out-of-pocket expenses relating to his attendance at meetings. For the fiscal year ended December 31, 1995, Directors' fees totalling $73,332 were paid by the Fund to the Directors as a group. As of the date of this Statement of Additional Information, Directors and officers of the Fund as a group owned beneficially less than 1% of the Fund's outstanding shares. 28 COMPENSATION TABLE (FOR EACH CURRENT BOARD MEMBER RECEIVING COMPENSATION FROM A FUNDAMENTAL FUND FOR THE MOST RECENTLY COMPLETED FISCAL YEAR) AGGREGATE COMPENSATION FROM FUND AGGREGATE COMPENSATION PAID BY ALL HIGH- U.S. FUNDS MANAGED YIELD TAX- GOV'T BY CALI- MUNI- FREE STRA- FUNDAMENTAL FORNIA CIPAL MONEY TEGIC PORTFOLIO NAME NY MUNI MUNI BOND MARKET INCOME ADVISORS, INC. - ---- ------- ---- ---- ------ ------ -------------- James C. Armstrong $18,333 $1,376 $117 $4,518 $1,656 $26,000 James A. Bowers 18,333 1,376 117 4,518 1,656 26,000 Clark L. Bullock 18,333 1,376 117 4,518 1,656 26,000 L. Greg Ferrone 18,333 1,376 117 4,518 1,656 26,000 PORTFOLIO REVIEW COMMITTEE Pursuant to the terms of an assurance of discontinuance (the "assurance") entered into with the Department of Law of the State of New York, the Fund has established and will maintain for a period of at least five years from April 15, 1994, a Portfolio Review Committee of its Board of Directors, consisting of no fewer than three independent directors. Messrs. James C. Armstrong, James A. Bowers and Clark L. Bullock constitute the Portfolio Review Committee's members. The Portfolio Review Committee oversees the Fund's (i) investment performance and strategies; (ii) the adequacy of internal controls and procedures applicable to portfolio personnel and activity; (iii) the amendment, as they may deem necessary in the exercise of their duties, of the Fund's Prospectus; and (iv) compliance with investment policies stated in the Fund's Prospectus, with such other policies as the Board of Directors may from time to time establish, and with all applicable laws, rules and regulations. The Portfolio Review Committee also reviews all annual and semi-annual reports prior to their dissemination to shareholders. 29 The Portfolio Review Committee is required to keep a record of its meetings and has the authority to retain such expert (legal, financial or accounting) assistance as the Committee in its sole discretion deems necessary in the exercise of their duties. Fundamental Service Corporation has designated a Compliance Officer who has day-to-day responsibility for the Fund's compliance with applicable Federal and state laws, rules and regulations, the assurance entered into with the Department of Law of the State of New York, and the rules, policies and by-laws of the National Association of Securities Dealers, Inc., particularly as they pertain to sales materials. The Compliance Officer also assists the work of the Portfolio Review Committee. INVESTMENT MANAGEMENT As discussed in the Fund's Prospectus, a Management Agreement (the "Agreement") between the Company, on behalf of the Fund, and Fundamental Portfolio Advisors, Inc. (the "Manager"), was adopted by the Board of Directors of the Fund on October 3, 1990, and was approved by shareholders on November 29, 1990. Vincent J. Malanga, Chairman of the Board, Chief Executive Officer, President and Treasurer of the Fund, and Dr. Lance M. Brofman, Chief Portfolio Strategist of the Fund, each own approximately 48.5% of the outstanding shares of the voting capital stock of the Manager. The Manager has agreed that it will notify the Fund's Board of Directors before engaging any new clients of material significance; that, if requested, each Director will receive a weekly portfolio transaction statement from the Manager in order to review all trades made by the Manager; and that if at any time three or more Directors who are "non-interested persons" of the Fund desire to purchase or sell any security for or of the Fund, the Manager, at the direction of the "non-interested" Directors, will immediately purchase or sell such security, as the case may be, at the expense and risk of the Fund. TRANSFER AGENT Fundamental Shareholder Services, Inc., P.O. Box 1013, Bowling Green Station, New York, New York 10274-1013, an affiliate of Fundamental Portfolio Advisors, Inc. and Fundamental Service Corporation, performs all services in connection with the transfer of shares of the Fund, acts as its dividend disbursing agent, and as administrator of the exchange, check redemption, telephone redemption and expedited redemption privileges of the Fund pursuant to a Transfer Agency and Service Agreement dated as of February 1, 1990. During the fiscal year ended December 31, 1995, fees paid to the Transfer Agent by the Fund amounted to $375,225. 30 DISTRIBUTION PLAN The Board of Directors and shareholders of the Fund have approved a plan of distribution under Rule 12b-1 of the 1940 Act (the "Plan"). Pursuant to the Plan, the Fund may pay certain promotional and advertising expenses and may compensate certain registered securities dealers and financial institutions for services provided in connection with the processing of orders for purchase or redemption of the shares of the Fund and furnishing other shareholder services. Payments by the Fund shall not in the aggregate in any fiscal year of the Fund exceed 1/2 of 1% of daily net assets of the Fund. The Fund may enter into shareholder processing and service agreements (the "Shareholder Service Agreements") with any securities dealer who is registered under the Securities Exchange Act of 1934 and a member in good standing of the National Association of Securities Dealers, Inc., and with banks and other financial institutions, who may wish to establish accounts or sub-accounts on behalf of their customers ("Shareholder Service Agents"). For processing investor purchase and redemption orders, responding to inquiries from Fund shareholders concerning the status of their accounts and operations of the Fund and communicating with the Fund, the Fund may pay each such Shareholder Service Agent to cover expenditures for advertising, sales literature and other promotional materials on behalf of the Fund. The fees payable to Shareholder Service Agents under Shareholder Service Agreements will be negotiated by the Fund's management. The Fund's management will report quarterly to the Board of Directors on the rate to be paid under each such agreement and the amounts paid or payable under such agreements. It will be based upon the management's analysis of (1) the contribution that the Shareholder Service Agent makes to the Fund by increasing Fund assets and reducing expense ratios; (2) the nature, quality and scope of services being provided by the Shareholder Service Agent; (3) the cost to the Fund if shareholder services were provided directly by the Fund or other authorized persons; (4) the costs incurred by the Shareholder Servicing Agent in connection with providing services to shareholders; and (5) the need to respond to competitive offers of others which could result in assets being withdrawn from the Fund and an increase in the expense ratio for the Fund. The Board of Directors of the Fund, including a majority of the "disinterested" Directors who have no direct or indirect financial interest in the operation of the Plan or any agreements relating thereto, authorized the Fund to enter into an agreement with Fundamental Service Corporation, a Delaware corporation, under the Plan. The agreement provides that the Fund may pay the usual and customary agency's commission to Fundamental Service Corporation for producing and placing Fund advertising in newspapers, magazines or other periodicals, on radio or television, or in direct marketing campaigns. In addition to the foregoing, the Fund may pay Fundamental Service Corporation for marketing research and promotional services specifically relating to the 31 distribution of Fund shares, including office space, facilities and equipment, salaries, training and administrative expenses, computer systems and software, communications, supplies, photocopying and similar types of expenses. The following persons own of record 5% or more of the outstanding shares of voting stock of Fundamental Service Corporation: Mr. Vincent J. Malanga (43.71%); Mr. Thomas W. Buckingham (43.71%); and Dr. Lance M. Brofman (9.90%). The Plan will continue in effect until December 31, 1996. The Plan will continue in effect from year to year if specifically approved at least annually by the Board of Directors and the affirmative vote of a majority of the Directors who are not parties to any Shareholder Service Agreement or "interested persons" of any such party by votes cast in person at a meeting called for such purpose. In approving the Plan, the Directors determined, in the exercise of their business judgment and in light of their fiduciary duties as Directors of the Fund, that there was a reasonable likelihood that the Plan would benefit the Fund and its shareholders. The Plan may only be renewed if the Directors make a similar determination for each subsequent year. The Plan may not be amended to increase the maximum amount of payments by the Fund to its Shareholder Service Agents without shareholder approval, and all material amendments to the provisions of the Plan must be approved by a vote of the Board of Directors and of the Directors who have no direct or indirect interest in the Plan, cast in person at a meeting called for the purpose of such vote. The Plan provides that the Fund's management shall provide, and that the independent Directors shall review, quarterly reports setting forth the amounts expended pursuant to the Plan and the purpose for which the amounts were expended. It further provides that while the Plan is in effect, the selection and nomination of those Directors of the Fund who are not "interested persons" of the Fund is committed to the discretion of the independent Directors. During the year ended December 31, 1995, the Fund paid $885,389 for expenses incurred pursuant to the Plan, which amount was spent in the distribution of the Fund's shares, including expenses for: advertising -- $336,448; printing and mailing of Prospectuses to other than current shareholders -- $17,708; and sales, and shareholder servicing support services and other distribution services, -- $531,233. Of the amount paid by the Fund during last year, $420,197 was paid to Fundamental Service Corporation for expenses incurred and services rendered by it pursuant to the Plan. CALCULATION OF YIELD The Fund's yield quotations and average annual total return quotations as they may appear in the Prospectus, this Statement of Additional Information or in advertising and sales 32 material, are calculated by standard methods prescribed by the Securities and Exchange Commission. The Fund's yield is computed by dividing the Fund's net investment income per share during a base period of 30 days, or one month, by the net asset value per share of the Fund on the last day of such base period in accordance with the following formula: a-b 6 Yield = 2[( ----------+1) -1] cd Where: a = dividends and interest earned during the period b = expenses accrued for the eriod (net of reimbursements) c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. For purposes of calculating interest earned on debt obligations as provided in item "a" above: 1. The yield to maturity of each obligation held by the Fund is computed based on the market value of the obligation (including actual accrued interest, if any) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest, if any). 2. The yield to maturity of each obligation is then divided by 360 and the resulting quotient is multiplied by the market value of the obligation (including actual accrued interest, if any) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the portfolio. For these purposes, it is assumed that each month has 30 days. 3. Interest earned on all debt obligations during the 30-day or one-month period is then totaled. 4. The maturity of an obligation with a call provision(s) is the next call date on which the obligation reasonably may be expected to be called or, if none, the maturity date. 5. In the case of a tax-exempt obligation issued without original issue discount and having a current market discount, the 33 coupon rate of interest of the obligation is used in lieu of yield to maturity to determine interest income earned on the obligation. In the case of a tax-exempt obligation with original issue discount where the discount based on the current market value of the obligation exceeds the then remaining portion of original issue discount (i.e. market discount), the yield to maturity used to determine interest income earned on the obligation is the imputed rate based on the original issue discount calculation. In the case of a tax-exempt obligation with original issue discount where the discount based on the current market value of the obligation is less than the then remaining portion of the original issue discount (market premium), the yield to maturity used to determine interest income earned on the obligation is based on the market value of the obligation. With respect to the treatment of discount and premium on mortgage or other receivables-backed obligations which are expected to be subject to monthly payments of principal and interest ("pay downs"), the Fund accounts for gain or loss attributable to actual monthly pay downs as an increase or decrease to interest income during the period. In addition, the Fund may elect (1) to amortize the discount or premium on a remaining security, based on the cost of the security, to the weighted average maturity date, if such information is available, or to the remaining term of the security, if the weighted average maturity date is not available, or (2) not to amortize the discount or premium on a remaining security. For the purposes of computing yield, dividend income is recognized by accruing 1/360 of the stated dividend rate of each obligation in the Fund's portfolio each day that the obligation is in the portfolio. The Fund does not use equalization accounting in the calculation of yield. Expenses accrued during any base period, if any, pursuant to the Plan are included among the expenses accrued during the base period. Any reimbursement accrued pursuant to the Plan during a base period, if any, will reduce expenses accrued pursuant to such plan, but only to the extent the reimbursement does not exceed the accrued expenses for the base period. The Fund's yield for the one-month period ended December 31, 1995 determined in accordance with the above formula was 3.71%. Average annual total return quotations are computed by finding the average annual compounded rates of return that would cause a hypothetical investment made on the first day of a designated period (assuming all dividends and distributions are reinvested) to equal the ending redeemable value of such hypothetical investment on the last day of the designated period in accordance with the following formula: n P(1+T) = ERV 34 Where: P = a hypothetical initial payment of $1000 T = average annual total return n = number of years ERV = ending redeemable value of a hypothetical $1000 payment made at the end of a designated period (or fractional portion thereof) For purposes of the above computation, it is assumed that all dividends and distributions made by the Fund are reinvested at net asset value during the designated period. The average annual total return quotation is determined to the nearest 1/100 of 1%. The average annual total return for the year ended December 31, 1995 was - 15.67%. For the five-year period ended December 31, 1995, the average annual total return was 6.04% and for the ten year period ended December 31, 1995, the average annual total return was 5.82%. In determining the average annual total return (calculated as provided above), recurring fees, if any, that are charged to all shareholder accounts are taken into consideration. For any account fees that vary with the size of the account, the account fee used for purposes of the above computation is assumed to be the fee that would be charged to the Fund's mean account size. The Fund may also from time to time advertise its taxable equivalent yield. The Fund's taxable equivalent yield is determined by dividing that portion of the Fund's yield (calculated as described above) that is tax-exempt by one minus the stated marginal Federal income tax rate and adding the product to that portion, if any, of the yield of the Fund that is not tax-exempt. The taxable equivalent yield of the Fund for the one-month period ended December 31, 1995 was 6.98% for a taxpayer whose income was subject to the then highest combined Federal, New York State and New York City income tax rate of 46.88%. The Fund's yield and average annual total return will vary from time to time depending on market conditions, the composition of the Fund's portfolio and operating expenses of the Fund. These factors and possible differences in the methods used in calculating yields and returns should be considered when comparing performance information regarding the Fund to information published for other investment companies and other investment vehicles. Yields and return quotations should also be considered relative to changes in the value of the Fund's shares and the risks associated with the Fund's investment objectives and policies. At any time in the future, yields and return quotations may be higher or lower than past yields or return quotations and there can be no assurance that any historical yield or return quotation will continue in the future. 35 CUSTODIAN AND INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Chase Manhattan Bank, N.A. (the "Bank"), 114 West 47th Street, New York, New York, acts as Custodian of the Fund's cash and securities. The Bank also acts as bookkeeping agent for the Fund, and in that capacity, monitors the Fund's accounting records and calculates its net asset value. McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New York, acts as independent certified public accountants for the Fund, performing an annual audit of the Fund's financial statements and preparing its tax returns. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the Fund and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The Fund has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the Fund is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) and at least 90% of its tax-exempt income (net of expenses allocable thereto) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the Fund made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains 36 from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "ShortShort Gain Test"). For purposes of these calculations, gross income includes tax-exempt income. However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the Fund may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the Fund from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the Fund at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the Fund on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation (including municipal obligations) purchased by the Fund at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued during the period of time the Fund held the debt obligation. In general, for purposes of determining whether capital gain or loss recognized by the Fund on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (1) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (2) the asset is otherwise held by the Fund as part of a "straddle" (which term generally excludes a situation where the asset is stock and the Fund grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (3) the asset is stock and the Fund grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (1) above. In addition, the Fund may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. 37 Any gain recognized by the Fund on the lapse of, or any gain or loss recognized by the Fund from a closing transaction with respect to, an option written by the Fund will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the Fund will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the Fund may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Transactions that may be engaged in by the Fund (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The Fund, however, may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the Fund that are not Section 1256 contracts. The IRS has held in several private rulings (and Treasury Regulations now provide) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. In addition to satisfying the requirements described above, the Fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the Fund's taxable year, at least 50% of the value of the Fund's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated 38 investment companies, and securities of other issuers (as to which the Fund has not invested more than 5% of the value of the Fund's total assets in securities of such issuer and as to which the Fund does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the Fund controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security, not the issuer of the option. If for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the Fund's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). (Tax-exempt interest on municipal obligations is not subject to the excise tax.) The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall: (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year; and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The Fund intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that 39 the Fund may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. Fund Distributions The Fund anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but will not qualify for the 70% dividends-received deduction for corporate shareholders. The Fund may either retain or distribute to shareholders its net capital gain for each taxable year. The Fund currently intends to distribute any such amounts. Net capital gain that is distributed and designated as a capital gain dividend, will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the Fund prior to the date on which the shareholder acquired his shares. The Fund intends to qualify to pay exempt-interest dividends by satisfying the requirement that at the close of each quarter of the Fund's taxable year at least 50% of the Fund's total assets consists of tax-exempt municipal obligations. Distributions from the Fund will constitute exempt-interest dividends to the extent of the Fund's tax-exempt interest income (net of expenses and amortized bond premium). Exempt-interest dividends distributed to shareholders of the Fund are excluded by them from gross income for federal income tax purposes. However, shareholders required to file a federal income tax return will be required to report the receipt of exempt-interest dividends on their returns. Moreover, while exempt-interest dividends are excluded from gross income for federal income tax purposes, they may be subject to alternative minimum tax ("AMT") in certain circumstances and may have other collateral tax consequences discussed below. Distributions by the Fund of any investment company taxable income or of any net capital gain will be taxable to shareholders as discussed above. AMT is imposed in addition to, but only to the extent it exceeds, the regular tax and is -- computed at a maximum marginal rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers -- on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. Exemptinterest dividends derived from certain "private activity" municipal obligations issued after August 7, 1986 will generally constitute an item of tax preference includable in AMTI for both corporate and noncorporate taxpayers. In addition, exempt-interest 40 dividends derived from all municipal obligations, regardless of the date of issue, must be included in adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Exempt-interest dividends must be taken into account in computing the portion, if any, of social security or railroad retirement benefits that must be included in an individual shareholder's gross income and subject to federal income tax. Further, a shareholder of the Fund is denied a deduction for interest on indebtedness incurred or continued to purchase or carry shares of the Fund. Moreover, a shareholder who is (or is related to) a "substantial user" of a facility financed by industrial development bonds held by the Fund will likely be subject to tax on dividends paid by the Fund which are derived from interest on such bonds. Receipt of exempt-interest dividends may result in other collateral federal income tax consequences to certain taxpayers, including financial institutions, property and casualty insurance companies and foreign corporations engaged in a trade or business in the United States. Prospective investors should consult their own tax advisers as to such consequences. Distributions by the Fund that do not constitute ordinary income dividends, exempt-interest dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from a sale of the shares, as discussed below. Distributions by the Fund will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the Fund (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the Fund reflects undistributed income or gain, or unrealized appreciation in the value of assets held by the Fund, a subsequent distribution of such amounts will be taxable to the shareholder in the manner described above, although it economically constitutes a return of capital. Ordinarily, shareholders are required to take distributions by the Fund into account in the year in which they are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the Fund) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the 41 U.S. federal income tax consequences of distributions made (or deemed made) to them during the year. The Fund will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder who (1) has provided either an incorrect tax identification number or no number at all, (2) is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly, or (3) has failed to certify to the Fund that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the Fund in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the Fund within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be disallowed to the extent of the amount of exempt-interest dividends received on such shares and (to the extent not disallowed) will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of noncorporate taxpayers, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the Fund is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the Fund is not effectively connected with a U.S. trade or business of a foreign shareholder, ordinary income paid to the shareholder will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) on the gross amount of the dividend. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized 42 on the sale of shares of the Fund, capital gain dividends and exempt-interest dividends. If the income from the Fund is effectively connected with a U.S. trade or business of a foreign shareholder, then ordinary income and capital gain dividends received in respect of, and any gains realized on, the sale of shares of the Fund will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of a foreign noncorporate shareholder, the Fund may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding (or taxable at a reduced treaty rate), unless the shareholder furnishes the Fund with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the Fund, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and Treasury Regulations issued thereunder as in effect on the date of this Statement. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, perhaps with retroactive effect. Rules of state and local taxation of ordinary income dividends, exempt-interest dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences to them of federal, state and local tax rules with respect to an investment in the Fund. PORTFOLIO TRANSACTIONS The Fund's management provides the Fund with investment advice and recommendations for the purchase and sale of portfolio securities. Newly issued securities are usually purchased from the issuer or an underwriter, at prices including underwriting fees; other purchases and sales are usually placed with those dealers from whom it appears that the best price or execution will be obtained. All orders for the purchase and sale of portfolio securities are placed by the Fund's management, subject to the general control of the Fund's Directors. The Fund's management may sell portfolio securities prior to their maturity if market conditions and other considerations indicate, in the opinion of the 43 Fund's management, that such sale would be advisable. In addition, the Fund's management may engage in short-term trading when it believes it is consistent with the Fund's investment objective. Also, a security may be sold and another of comparable quality may be simultaneously purchased to take advantage of what the Fund's management believes to be a temporary disparity in the normal yield relationships of two securities. The frequency of portfolio transactions -- the Fund's turnover rates -- will vary from year to year depending upon market conditions. For the years ended December 31, 1994 and 1995, the Fund's annual rate of portfolio turnover was approximately 290% and 348%, respectively. Because a high turnover rate increases transaction costs and the possibility of taxable short-term gains (see "Dividends and Tax Status" in the Fund's Prospectus), the Fund's management weighs the added costs of short-term investment against anticipated gains. The Fund's management is generally responsible for the implementation, or supervision of the implementation, of investment decisions, including the allocation of principal business and portfolio brokerage, and the negotiation of commissions. It is the Fund's policy to seek execution of its purchases and sales at the most favorable prices through responsible broker-dealers and in agency transactions, at competitive commission rates. When considering broker-dealers, the Fund will take into account such factors as the price of the security, the size and difficulty of the order, the rate of commission, if any, the reliability, financial condition, integrity and general execution and operational capabilities of competing broker-dealers, and the brokerage and research services which they provide to the Fund's management. The Board of Directors of the Fund is authorized to adopt a brokerage allocation policy pursuant to the Securities Exchange Act of 1934 which would permit the Fund to pay a broker-dealer which furnishes research services a higher commission than that which might be charged by another broker-dealer which does not furnish research services, or which furnishes research services deemed to be of a lesser value, provided that such commission is deemed reasonable in relation to the value of the brokerage and research services provided by the broker-dealer. Section 28(e)(3) of the Securities Exchange Act of 1934 defines "Brokerage and Research Services" as including, among other things, advice as to the value of securities, the advisability of investing in, purchasing or selling securities, the availability of securities or purchasers or sellers of securities, furnishing analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy and performance of accounts, and offering securities transactions and performing functions incidental thereto (such as clearance and settlement). It is not the Fund's practice to allocate principal business or brokerage on the basis of sales of Fund shares which 44 may be made through brokers or dealers, although broker-dealers effecting purchases of Fund shares for their customers may participate in principal transactions of brokerage allocation as described above. The Fund pays LAS Investments, Inc. ("LAS") commissions or fees for effecting, or participating in the effectuation of (but not executing), transactions in futures contracts and options thereon on behalf of the Fund ("Fund Futures and Options Transactions"). LAS is located at 190 South LaSalle Street, Chicago, Illinois. Mr. Donald E. Newell is the chief executive officer of LAS and the owner of all of its outstanding shares. Messrs. Malanga and Newell are each executive officers and 50% shareholders of LaSalle Portfolio Management, Inc. As a result of Mr. Newell's business relationship with Mr. Malanga, certain procedures incorporating the standards of Rule 17e-1 of the 1940 Act govern the computation and review of all commissions paid and payable to LAS. The procedures limit the commissions or fees received, or to be received, by LAS for Fund Futures and Options Transactions to an amount which is reasonable and fair compared to the commissions, fees or other remuneration received by other introducing brokers in connection with comparable transactions involving similar futures contracts or options on futures contracts, as the case may be, being purchased or sold on a commodities exchange during a comparable period of time. The Fund's independent Board Members determine no less frequently than quarterly that all transactions with LAS during the quarter were effected in compliance with such procedures. Beginning in July 1990, all of the Fund's transactions in futures contracts and related options were effected through Sierra Securities, Inc., a broker-dealer located at 190 South LaSalle Street, Chicago, Illinois ("Sierra"). The total amount of commissions paid to Sierra as introducing broker on such transactions for the Fund's account during the years 1990 through 1995 and during January of 1996 was $11,298. The Manager has represented that during such period, it believes that Mr. Donald Newell was a minority shareholder of Sierra. As a result of Mr. Newell's business relationship with Mr. Malanga (see discussion above), all of the futures and options transactions Sierra performed on behalf of the Fund may have been subject to certain standards comparable to those set forth in Rule 17e-1 of the 1940 Act (the "Rule"). On February 1, 1996, the Manager commenced using LAS as its introducing broker for Fund transactions in futures contracts and related options in place of Sierra. At a meeting held on May 2, 1996, the Fund's Board of Directors, including a majority of the independent Directors, adopted new standards and procedures for the Fund comparable to those set forth in the Rule for transactions in futures contracts and related options through LAS, an affiliated broker-dealer. See above discussion pertaining to LAS. From January 1, 1990 to January 31, 1996, the Manager directed syndicate designations in the aggregate dollar amount of $858,094 to Capital Institutional Services, Inc. ("CIS") in connection with the Fundamental Funds' bond purchases through underwriting syndicates. The Manager has represented that CIS, a third-party research provider, at the Manager's direction, paid portions of such syndicate designations to approximately 30 different firms that provided research services used by the Manager in managing the Fundamental Funds, including Capital Market Services, Inc. ("CMS"). Further, that CMS was paid by CIS $115,000 for research provided to the Manager and used by it in managing the Fund and the other funds in the Fundamental complex. The $115,000 dollar amount paid by CIS to CMS for the three most recent fiscal years of the Fund was: $35,000 in 1995; $55,000 in 1994; and $25,000 in 1993. The Manager has also represented that it was recently learned that at all times during the three most recent fiscal years of the Fund, CMS was 100% owned by Mr. Newell's wife. See above for a discussion of Mr. Newell's business relationship with Mr. Malanga. On May 23, 1996, in order to remove any appearance of impropriety concerning all of the payments made by CIS to CMS in return for research the Manager obtained from CMS, the Fund's independent Directors asked the Manager to obtain $115,000 "to or for the benefit of the [Fundamental] Funds, either from CMS or one of its affiliates directly, or out of [the Manager's] own resources." That request is currently under consideration by the Manager. OTHER INFORMATION As of April 22, 1996, the Directors and officers of the Fund as a group beneficially owned less than 1% of the outstanding shares of the Fund As of such date, no persons were known by Fund management to have owned beneficially, directly or indirectly, 5% or more of the outstanding shares of the Fund. FINANCIAL STATEMENTS Audited financial statements of the Fund for the year ended December 31, 1995 are attached hereto. 45 APPENDIX RATINGS OF MUNICIPAL BONDS MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's Investors Services, Inc. rating symbols and their meanings is as follows: Aaa-Bonds which are Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa-Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in the Aaa securities or fluctuation of protective elements may be of a greater amplitude or there may be other elements present which make the long-term risk appear somewhat larger than Aaa securities. A-Bonds which are rated A possess many favorable investment attributes and are to be considered as upper-medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa-Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba-Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B-Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. A-1 Caa-Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca-Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C-Bonds which are rated C are the lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Moody's applies numerical modifiers 1, 2 and 3 to show relative standing within the major rating categories, except in the Aaa category. The modifier 1 indicates a ranking for the security in the higher end of a rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of a rating category. I. Con. (---)--Bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by 1. earnings of projects under construction, 2. earnings of projects unseasoned in operation experience, 3. rentals which begin when facilities are completed, or 4. payments to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon completion of construction or elimination of condition. STANDARD & POOR'S CORPORATION A brief description of the applicable S&P Corporation rating symbols and their meanings is as follows: AAA-This is the highest rating assigned by S&P to a debt obligation and indicates an extremely strong capacity to pay principal and interest. AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to repay principal and interest is very strong, and in the majority of instances they differ from AAA issues in only small degrees. A-Bonds rated A have a strong capacity to pay principal and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. BBB-Bonds rated BBB are regarded as having an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. A-2 BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While such bonds will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. C-The rating C is reserved for income bonds on which no interest is being paid. D-Bonds rated D are in default, and payment of interest and/or repayment of principal is in arrears. Plus (+) or minus (-): The ratings from AA to BBB may be modified by the addition of a plus or minus sign to show relative standing within the major ratings categories. Provisional Ratings: the letter "p" indicates that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the issuance of the bonds being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. Accordingly, the investor should exercise his own judgment with respect to such likelihood and risk. FITCH Ratings A brief description of the applicable Fitch Investors Service, Inc. rating symbols and their meanings is as follows: AAA Bonds rated AAA are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. AA Bonds rated AA are considered to be investment grade and of the very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated AAA. Because bonds rated in the AAA and AA categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issuers is generally rated F-1+. A-3 A Bonds rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB Bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds and, therefore, impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BB Bonds rated BB are considered speculative. The obligor's ability to pay interest and repay principal may be affected over time by adverse economic changes. However, business and financial alternatives can be identified which could assist the obligor in satisfying its debt service requirements. B Bonds rated B are considered highly speculative. While bonds in this class are currently meeting debt service requirements, the probability of continued timely payment of principal and interest reflects the obligor's limited margin of safety and the need for reasonable business and economic activity throughout the life of the issue. CCC Bonds rated CCC have certain identifiable characteristics, which, if not remedied, may lead to default. The ability to meet obligations requires an advantageous business and economic environment. CC Bonds rated CC are minimally protected. Default in payment of interest and/or principal seems probable over time. C Bonds rated C are in imminent default in payment of interest or principal. A-4 DDD, DD AND D Bonds rated DDD, DD and D are in actual or imminent default of interest and/or principal payments. Such bonds are extremely speculative and should be valued on the basis of their ultimate recovery value in liquidation or reorganization of the obligor. DDD represents the highest potential for recovery on these bonds and D represents the lowest potential for recovery. Plus (+) and minus (-) signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus and minus signs, however, are not used in the AAA Category covering 12-36 months or the DDD, DD or D categories. DUFF & PHELPS, INC. RATING SCALE DEFINITION AAA Highest credit quality. The risk factors are negligible, being only slightly more than for risk-free U.S. Treasury debt. AA+ High credit quality. Protection factors are strong. AA- Risk is AA modest but may vary slightly from time to time AA- because of economic conditions. A+ Protection factors are average but adequate. However, A risk factors are more variable and greater in periods of A- economic stress. BBB+ Below average protection factors but still considered BBB sufficient for prudent investment. Considerable BBB- variability in risk during economic cycles. BB+ Below investment grade but deemed likely to meet BB obligations when due. Present or prospective financial BB- protection factors fluctuate according to industry conditions or company fortunes. Overall quality may move up or down frequently within this category. B+ Below investment grade and possessing risk that B obligations will not be met when due. Financial B- protection factors will fluctuate widely according to economic cycles, industry conditions and/or company fortunes. Potential exists for frequent changes in the rating within this category or into a higher or lower rating grade. CCC Well below investment grade securities. Considerable uncertainty exists as to timely payment of principal, interest or preferred dividends. Protection factors are narrow and risk can be substantial with unfavorable A-5 economic/industry conditions, and/or with unfavorable company developments. DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or interest payments. DP Preferred stock with dividend arrearages. RATING SCALE DEFINITION HIGH GRADE Duff 1+ Highest certainty of timely payment. Short-term liquidity, including internal operating factors and/or access to alternative sources of funds, is outstanding, and safety is just below risk-free U.S. Treasury short-term obligations. Duff 1 Very high certainty of timely payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are minor. Duff 1- High certainty of timely payment. Liquidity factors are strong and supported by good fundamental protection factors. Risk factors are very small. GOOD GRADE Duff 2 Good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although ongoing funding needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small. SATISFACTORY GRADE Duff 3 Satisfactory liquidity and other protection factors qualify issues as to investment grade. Risk factors are larger and subject to more variation. Nevertheless, timely payment is expected. NON-INVESTMENT GRADE Duff 4 Speculative investment characteristics. Liquidity is not sufficient to insure against disruption in debt service. Operating factors and market access may be subject to a high degree of variation. DEFAULT Issuer failed to meet scheduled principal and/or interest payments. A-6 RATINGS OF MUNICIPAL NOTES MOODY'S INVESTORS SERVICE, INC. A brief description of the applicable Moody's Investors Service, Inc. rating symbols for municipal notes and their meanings is as follows: MIG-1 - This is the highest rating assigned by Moody's to municipal notes and designates noted judged to be of the best quality. MIG-2 - This rating designates notes of a high quality by all standards. However, the margins of protection, although ample, are not as large as in the preceding group. MIG-3 - This rating designates notes which are of a favorable quality, with all security elements accounted for. However, such notes are lacking the undeniable strength of notes in the preceding two groups. Market access for refinancing, in particular, is likely to be less well established. SHORT-TERM RATINGS FITCH Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. Although the credit analysis is similar to Fitch's bond rating analysis, the short-term rating places greater emphasis than bond ratings on the existence of liquidity necessary to meet the issuer's obligations in a timely manner. F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated F-1+. F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated F-1+. A-7 F-2 Good Credit Quality. Issues carrying this rating have a satisfactory degree of assurance for timely payments, but the margin of safety is not as great as the F-1+ and F-1 categories. SHORT-TERM MUNICIPAL LOANS Moody's highest rating for short-term municipal loans is MIG-1/VMIG-1. Moody's states that short-term municipal securities rated MIG-1/VMIG-1 are of the best quality, enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. Loans bearing the MIG-2/VMIG-2 designation are of high quality, with margins of protection ample although not so large as in the MIG-1/VMIG-1 group. S&P's highest rating for short-term municipal loans is SP-1. S&P states that short-term municipal securities bearing the SP-1 designation have very strong or strong capacity to pay principal and interest. Those issues rated SP-1 which are determined to possess overwhelming safety characteristics will be given a plus (+) designation. Issues rated SP-2 have satisfactory capacity to pay principal and interest. OTHER MUNICIPAL SECURITIES AND COMMERCIAL PAPER "Prime-1" is the highest rating assigned by Moody's for other short-term municipal securities and commercial paper, and "A- 1+" and "A-1" are the two highest ratings for commercial paper assigned by S&P (S&P does not rate short-term tax-free obligations). Moody's uses the numbers 1, 2 and 3 to denote relative strength within its highest classification of "Prime", while S&P uses the number 1+, 1, 2 and 3 to denote relative strength within its highest classification of "A". Issuers rated "Prime" by Moody's have the following characteristics: their short-term debt obligations carry the smallest degree of investment risk, margins of support for current indebtedness are large or stable with cash flow and asset protection well assured, current liquidity provides ample coverage of near-term liabilities and unused alternative financing arrangements are generally available. While protective elements may change over the intermediate or longer term, such changes are most unlikely to impair the fundamentally strong position of short-term obligations. Commercial paper issuers rated "A" by S&P have the following characteristics: liquidity ratios are better than industry average, long-term debt rating is A or better, the issuer has access to at least two additional channels of borrowing, and basic earnings and cash flow are in an upward trend. Typically, the issuer is a strong company in a well-established industry and has superior management. A-8 (Left column) NEW YORK MUNI FUND, INC. STATEMENT OF ASSETS AND LIABILITIES December 31, 1995 - -------------------------------------------------------------------------------- ASSETS Cash............................................ $ 409,040 Investment in securities at value (Note 4) (cost $277,479,404).................. 271,490,055 Receivables: Interest...................................... 4,009,011 Investment securities sold.................... 2,013,478 Capital stock sold............................ 80,216,384 ------------ Total assets.............................. 358,137,968 ------------ LIABILITIES Notes payable (Note 6).......................... 64,575,000 Payables: Investment securities purchased............... 65,761,095 Capital stock redeemed........................ 199,009 Dividend declared............................. 89,475 Accrued expenses.............................. 821,758 ------------ Total liabilities......................... 131,446,337 ------------ NET ASSETS consisting of: Accumulated net realized loss................... $(19,488,520) Unrealized depreciation of securities........... (5,989,349) Paid-in-capital applicable to 231,288,831 shares of $.01 par value capital stock........ 252,169,500 ------------ ------------ $226,691,631 ============ NET ASSET VALUE PER SHARE......................... $.98 ==== (Right column) STATEMENT OF OPERATIONS For the Year ended December 31, 1995 - -------------------------------------------------------------------------------- INVESTMENT INCOME Interest income................................. $ 13,442,670 EXPENSES (Notes 2 and 3) Management fee.................................. $ 885,389 Custodian and accounting fees................... 218,290 Transfer agent fees............................. 375,225 Professional fees............................... 238,536 Directors' fees................................. 72,596 Printing and postage............................ 30,079 Interest........................................ 3,771,000 Distribution expenses........................... 838,008 Operating expenses on defaulted bonds........... 96,013 Other........................................... 43,850 ---------- Total expenses............................ 6,568,986 ------------ Net investment income..................... 6,873,684 ------------ REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized (loss) gain on: Investments................................... 2,599,302 Futures contracts............................. (147,344) Options written............................... (73,794) ---------- 2,378,164 Net unrealized appreciation of investments...... 25,287,298 ------------ Net gain on investments......................... 27,665,462 ------------ NET INCREASE IN NET ASSETS FROM OPERATIONS........ $ 34,539,146 ============ STATEMENTS OF CHANGES IN NET ASSETS - --------------------------------------------------------------------------------
Year Ended Year Ended December 31, December 31, ------------ ------------ 1995 1994 INCREASE (DECREASE) IN NET ASSETS FROM: OPERATIONS Net investment income............................................. $ 6,873,684 $ 11,648,285 Net realized gain (loss) on investments and futures contracts..... 2,451,958 (21,046,462) Net realized (loss) on option contracts written................... (73,794) (96,873) Unrealized appreciation (depreciation) on investments............. 25,287,298 (27,168,378) ------------ ------------ Net increase (decrease) in net assets from operations....... 34,539,146 (36,663,428) DIVIDENDS PAID TO SHAREHOLDERS FROM: Investment income................................................. (6,873,684) (11,649,104) Net realized gain from investments................................ (112,509) (1,888,345) CAPITAL SHARE TRANSACTIONS (Note 5)................................. (13,526,231) (12,686,075) ------------ ------------ Total increase (decrease)................................... 14,026,722 (62,886,952) NET ASSETS: Beginning of year................................................. 212,664,909 275,551,861 ------------ ------------ End of year....................................................... $226,691,631 $212,664,909 ============ ============
See Notes to Financial Statements. 5 NEW YORK MUNI FUND, INC. STATEMENT OF CASH FLOWS For the Year Ended December 31, 1995 - -------------------------------------------------------------------------------- Increase (Decrease) in Cash Cash Flows From Operating Activities Net increase to net assets from operations................... $ 34,539,146 Adjustments to reconcile net increase in net assets from operations to net cash provided by operating activities: Purchase of investment securities.......................... (880,868,531) Proceeds on sale of securities............................. 920,163,169 Premiums paid to close options written..................... (197,468) (Decrease) in interest receivable.......................... 424,294 Increase in accrued expenses............................... 42,616 Net accretion of discount on securities.................... (51,045) Net realized gain (loss): Investments.............................................. (2,869,205) Options written.......................................... 73,794 Unrealized depreciation on securities and options written for the period........................................... (25,287,298) ------------- Net cash provided by operating activities.............. 45,969,472 ------------- Cash Flows From Financing Activities:* Net proceeds from notes payable............................ 44,575,000 Proceeds on shares sold.................................... 2,994,410,794 Payment on shares repurchased.............................. (3,094,316,286) Cash dividends paid........................................ (1,036,308) ------------- Net cash used in financing activities.................. (56,366,800) ------------- Net decrease in cash................................... (10,397,328) Cash at beginning of year...................................... 10,806,368 ------------- Cash at end of year............................................ $ 409,040 ============= - --------------- *Non-cash financing activities not included herein consist of reinvestment of dividends of $6,361,886. Cash payments for interest expense totaled $3,667,093. See Notes to Financial Statements. 6 NEW YORK MUNI FUND STATEMENT OF INVESTMENTS December 31, 1995
Principal Amount Issue000 Type0 Rating00 Value ------ -------- ----- -------- ----- $10,075,000 Battery Park City, HDA, RB, Series A, 5.25%, 11/01/17........................... FCLT AA $ 9,818,793 4,780,000++ Cayuga County, HIC, Auburn Memorial Hospital, Asset Guaranty Insured, 6.00%, 1/01/21....................................................... FCLT AAA 4,958,294 2,000,000 City University, NY, COP, John Jay College, AMBAC Insured, 5.00%, 8/15/09....... FCLT AAA 1,940,280 3,045,000++ Franklin County, SWMA, Solid Waste System Project, RB, 6.25%, 6/01/15........... FCLT BBB 3,129,864 3,615,000++ Glen Cove, IDA, CFR, The Regency at Glen Cove Project, AMBAC Insured, ETM, CAB, 10/15/19................................................... FCLT AAA 871,034 2,165,000++ Glen Cove, IDA, CFR, The Regency at Glen Cove Project, ETM, CAB, 10/15/19....... FCLT AAA 521,657 2,000,000++ Lyons, MCF, Initiatives Corporation Project, RB, 6.80%, 9/01/24................. FCLT BAA1 2,142,460 5,290,000++ New York City, ECF, MBIA lnsured, 5.50%, 10/01/08............................... FCSI AAA 5,448,435 5,925,000++ New York City, ECF, MBIA lnsured, 5.50%, 4/01/08................................ FCSI AAA 6,102,454 4,225,000++ New York City, GO, IFRN*, 17.36%, 10/01/03...................................... SRIB A- 6,899,805 18,330,000 New York City, GO, IFRN*, 3.725%, 8/01/12....................................... INLT A- 18,354,012 13,640,000++ New York City, GO, IFRN*, 3.725%, 8/01/14....................................... INLT A- 13,581,621 14,600,000 New York City, GO, IFRN*, 3.939%, 8/15/17....................................... INLT A- 13,939,058 6,680,000++ New York City, Health & Hospital Corp, RB, Series A, 6.00%, 2/15/05............. FCSI BBB- 6,707,388 25,315,000++ New York City, Health & Hospital Corp, RB, Series A, 6.30%, 2/15/20............. FCLT BBB 25,787,125 5,375,000 New York City, Health & Hospital Corp, RB, Series A, AMBAC Insured, 5.75%, 2/15/22................................................................ FCLT AAA 5,466,160 2,113,000++ New York City, IDA, Imclone Systems Inc Project, AMT, 10.75%, 6/15/96........... FCSI NR 2,103,217 2,200,000 New York City, IDA, Imclone Systems Inc Project, AMT, 11.25%, 5/01/04........... FCSI NR 2,407,416 8,500,000 New York City, IDA, SFR, Terminal One Group Association Project, AMT, 6.00%, 1/01/15................................................................ FCLT A 8,621,210 11,870,000++ New York City, IFRN*, 8/15/10................................................... INLT A- 11,964,960 2,000,000 New York State DAR, HNHRB, LOC Republic National Bank, 5.50%, 7/01/09........... FCSI AA 1,942,520 700,000 New York State DAR, HNHRB, LOC Republic National Bank, 5. 75%, 7/01/14.......... FCLT AA 685,951 4,500,000++ New York State DAR, NHRB, LOC Chemical Bank, 5.75%, 7/01/17..................... FCLT AA3 4,518,765 1,350,000 New York State DAR, NHRB, Our Lady of Consolation, Geriatric Care, FHA Insured, 6.05%, 8/01/35................................................... FCLT AA 1,386,139 1,000,000 New York State DAR, NHRB, Wesley Gardens Corporation, FHA Insured, 6.125%, 8/01/35............................................................... FCLT AA 1,014,850 4,000,000 New York State DAR, RB, Court Facilities Lease 5.25%, 5/15/21................... FCLT BBB+ 3,749,600 4,760,000 New York State DAR, RB, Court Facilities Lease 5.50%, 5/15/23................... FCLT BBB+ 4,615,677 2,400,000 New York State DAR, RB, University of Rochester Strong Memorial Hospital, MBIA Insured, 5.50%, 7/01/21.................................................. FCLT AAA 2,405,688 500,000 New York State Energy, RDA, Western New York Nuclear Service Center Project, 5.50%, 4/01/05................................................................ FCSI BAA1 496,735 3,500,000 New York State HFA, RB, Service Contract Obligation, 5.375%, 3/15/23............ FCLT BAA1 3,290,385 5,000,000 New York State MCFFA, Mental Health Services Facilities, FGIC Insured, 5.50%, 8/15/21................................................................ FCLT AAA 5,012,500
7 NEW YORK MUNI FUND STATEMENT OF INVESTMENTS (continued) December 31, 1995
Principal Amount Issue000 Type0 Rating00 Value ------ -------- ----- -------- ----- 3,700,000 New York State Mortgage Agency, RB, AMT,6.10%, 4/01/26.......................... FCLT AA $ 3,728,157 25,000,000++ New York State Thruway Authority, Convertible, FGIC lnsured, IFRN*, 3.57%, 1/01/04................................................................ LRIB AAA 25,081,000 450,000 New York State Thruway Authority, General Revenue, MBIA Insured, 5.75%, 1/01/19. FCLT AAA 453,726 5,000,000 New York State Thruway Authority, Highway & Bridge Trust Fund, 5.80%, 4/01/09... FCSI A+ 5,163,400 1,500,000 New York State UDC, Correctional Capital Facilities, 5.75%, 1/01/13............. FCLT A 1,498,380 5,000,000 New York State UDC, Correctional Capital Facilities, FSA Insured, 5.25%, 1/01/21 FCLT AAA 4,993,050 5,500,000 New York State UDC, RB, Correctional Capital Facilities, FSA Insured, 5.375%, 1/01/25............................................................... FCLT AAA 5,444,120 6,445,000++ New York State, Housing of New York Corp, RB, Refunding, 5.50%, 11/01/20........ FCLT AA 6,324,672 1,120,000++ New York State, MCFFA, Central Suffolk Hospital Project, 6.125%, 11/01/16....... FCLT BBB 1,101,766 2,000,000++ New York State, MCFFA, Insured Mortgage Project, FHA Insured, 6.20%, 2/15/35.... FCLT AA+ 2,110,140 12,080,000++ New York State, MCFFA, Insured Mortgage Project, MBIA Insured, 5.90%, 8/15/33... FCLT AAA 12,500,505 1,000,000 New York State, MCFFA, Mercy Medical Center, LOC Natwest Bank, 5.875%, 11/01/15. FCLT AA- 1,030,820 1,750,000++ New York State, MCFFA, RB, 6.50%, 11/01/14...................................... FCLT BBB 1,843,065 4,020,000~++ Niagara County, IDA, Falls Street Faire Project, AMT, 10.00%, 9/01/06........... FCSI NR 1,599,638 9,805,000~++ Niagara County, IDA, Falls Street Faire Project, AMT, 10.00%, 9/01/06........... FCSI NR 3,901,606 5,870,000~++ Niagara Falls, URA, Old Falls Street Improvement Project, 11.00%, 5/01/99....... FCSI NR 2,896,023 4,350,000++ Onondaga County, IDA, Community General Hospital Project, 6.625%, 1/01/18....... FCLT BAA1 4,507,992 2,470,000++ Onondaga County, IDA, Resource Recovery Project, AMT, 7.00%, 5/01/15............ FCLT A- 2,590,388 3,400,000++ Onondaga County, IDA, Series A, Crouse Irving Project, LOC Fleet Bank, 7.90%, 1/01/17................................................................ FCLT A- 3,937,880 855,000 Puerto Rico Industrial, Tourist, Educational, Medical & Environmental Control Facs, 6.25% Dr Pila Hospital Proj, FHA Insured, 8/01/32............... FCLT AAA 899,674 ------------ Total Investments (cost $277,479,404**)................................ $271,490,055 ============ * Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear an inverse relationship to the interest rate on another security or the value of an index. Rates shown are at year end. ** Cost for Federal income tax purposes is $277,130,118. ~ The value of these non-income producing securities has been estimated in good faith using procedures approved by the Fund's Board of Directors. See Note 4 to the financial statements. ++ Approximately $163,131,754 market value of securities are segregated in whole or in part as collateral securing a line of credit.
8 NEW YORK MUNI FUND STATEMENT OF INVESTMENTS (continued) December 31, 1995 Legend 0Type FCLT -Fixed Coupon Long Term FCSI -Fixed Coupon Short or Intermediate Term LRIB -Residual Interest Bond Long Term SRIB -Residual Interest Bond Short or Intermediate Term INLT -Indexed Inverse Floating Rate Bond Long Term INSI -Indexed Inverse Floating Rate Bond Short or Intermediate Term 00Ratings If a security has a split rating the highest applicable rating is used, including published ratings on identical credits for individual securities not individually rated. Ratings are unaudited. NR-Not Rated 000Issue AMBAC American Municipal Bond Assurance Corporation AMT Alternative Minimum Tax CAB Capital Appreciation Bond CFR Civic Facility Revenue COP Certificate of Participation DAR Dormitory Authority Revenue ECF Educational Construction Fund ETM Escrowed to Maturity FGIC Financial Guaranty Insurance Corporation FHA Federal Housing Administration FSA Financial Security Association GO General Obligation HDA Housing Development Authority HIC Hospital Improvement Corporation HFA Housing Finance Agency HNHRB Hospital and Nursing Home Revenue Bonds IDA Industrial Development Authority MBIA Municipal Bond Insurance Assurance Corporation MCF Medical Care Facilities MCFFA Medical Care Facilities Finance Agency NHRB Nursing Home Revenue Bonds RB Revenue Bond RDA Research and Development Authority SFR Special Facilities Revenue SWMA Solid Waste Management Authority UDC Urban Development Corporation URA Urban Renewal Authority See Notes to Financial Statements. 9 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS December 31, 1995 - -------------------------------------------------------------------------------- 1. Significant Accounting Policies New York Muni Fund, Inc. (the Fund) is an open-end management investment company registered under the Investment Company Act of 1940. The Fund seeks to provide a high level of income that is excluded from gross income for Federal income tax purposes and exempt from New York State and New York City personal income taxes and is consistent with the preservation of capital. The following is a summary of significant accounting policies followed in the preparation of its financial statements: Valuation of Securities-Investments are stated at value based on prices provided by a pricing service when such prices are believed to reflect the fair market value of such securities. Securities not priced in this manner are at the mean of the last reported bid and asked prices provided by principal market makers and recognized dealers in such securities. Other assets and securities for which no quotations are readily available are valued in good faith under methods approved by the Board of Directors. Futures Contracts and Options Written on Future Contracts-Initial margin deposits with respect to these contracts are maintained by the Fund's custodian in segregated asset accounts. Subsequent changes in the daily valuation of open contracts are recognized as unrealized gains or losses. Variation margin payments are made or received as daily appreciation or depreciation in the value of these contracts occurs. Realized gains or losses are recorded when a contract is closed. Options Written on Municipal Bonds-The Fund writes options on municipal bonds. Premiums received for options written are recorded as a liability and subsequently marked to market daily to reflect the current value of the options written. If the written option expires unexercised, the premium received is treated as realized gain. If the option is exercised, the premium received is used to reduce the cost of the security purchased or sold. Federal Income Taxes-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to "regulated investment companies" and to distribute all of its taxable and tax exempt income to its shareholders. Therefore, no provision for federal income tax is required. Distributions-The Fund declares dividends daily from its net investment income and pays such dividends on the last business day of each month. Distributions of net capital gains, if any, realized on sales of investments are made annually, as declared by the Fund's Board of Directors. Distributions are determined in accordance with income tax regulations. Dividends are reinvested at the net asset value unless shareholders request payment in cash. General-Securities transactions are accounted for on a trade date basis. Interest income is accrued as earned. Premiums and original issue discount on securities purchased are amortized over the life of the respective securities. Realized gains and losses from the sale of securities are recorded on an identified cost basis. Net operating expenses incurred on properties collateralizing defaulted bonds are charged to operating expenses as incurred. Costs incurred to restructure defaulted bonds are charged to realized losses as incurred. Accounting Estimates-The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and decreases in net assets from operations during the reporting period. Actual results could differ from those estimates. 10 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS (continued) December 31, 1995 - -------------------------------------------------------------------------------- 2. Investment Advisory Fees and Other Transactions with Affiliates Under a Management Agreement, the Fund pays an investment management fee to Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's average daily net asset value up to $100 million and decreasing by .02% of each $100 million increase in net assets down to 0.4% of net assets in excess of $500 million. The Manager is required to reimburse the Fund an amount not exceeding the amount of fees payable to the Manager under the agreement for any fiscal year, if, and to the extent that the aggregate operating expenses of the Fund for any fiscal year including the fees payable to the Manager, but excluding interest expenses, taxes, brokerage fees and commissions, expenses paid pursuant to the Distribution Plan, and extraordinary expenses exceeds, on an annual basis, 1.5% of the average daily net assets of the Fund. No such reimbursement was required for the year ended December 31, 1995. Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1 promulgated under the Investment Company Act of 1940, the Fund may pay certain promotional and advertising expenses and may compensate certain registered securities dealers and financial institutions for services provided in connection with the processing of orders for purchase or redemption of the Fund's shares and furnishing other shareholder services. Payments by the Fund shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily net assets of the Fund. Under a distribution agreement with Fundamental Service Corporation (FSC), an affiliate of the Manager, amounts are paid under the Plan to compensate FSC for the services it provides and the expenses it bears in distributing the Fund's shares to investors. Any cumulative distribution expenses related to the Fund incurred by FSC in excess of the annual maximum amount payable by the Fund under the Plan may be carried forward for three years in anticipation of reimbursement by the Fund on a "first in-first out" basis. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to FSC will cease and the Fund will not be required to make payments past the termination date. Amounts paid to FSC pursuant to the agreement totaled $420,197 for the year ended December 31, 1995. The Fund compensates Fundamental Shareholder Services, Inc., an affiliate of the manager, for the services it provides under a Transfer Agent and Service Agreement. Transfer agent fees for the year ended December 31, 1995 are set forth in the statement of operations. 3. Directors' Fees All of the Directors of the Fund are also directors or trustees of two other affiliated mutual funds for which the Manager acts as investment adviser. For services and attendance at board meetings and meetings of committees which are common to each Fund, each Director who is not affiliated with the Manager is compensated at the rate of $6,500 per quarter pro rated among the funds based on their respective average net assets. 4. Complex Securities, Concentrations of Credit Risk, and Investment Transactions Inverse Floating Rate Notes (IFRN): The Fund invests in variable rate securities commonly called "inverse floaters". The interest rates on these securities have an inverse relationship to the interest rate of other securities or the value of an index. Changes in interest rate on the other security or index inversely affect the rate paid on the inverse floater, and the inverse floater's price will be more volatile than that of a fixed-rate bond. Certain interest rate movements and other market factors can substantially affect the liquidity of IFRN's. 11 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS (continued) December 31, 1995 - -------------------------------------------------------------------------------- Futures Contracts and Options on Futures Contracts: The Fund invests in futures contracts, consisting primarily of US Treasury Bond Futures. A futures contract is an agreement between two parties to buy and sell a security for a set price on a future date. Futures contracts are traded on designated "contract markets" which through their clearing corporations, guarantee performance of the contracts. In addition the Fund invests in options on US Treasury Bond Futures which give the holder a right to buy or sell futures contracts in the future. Unlike a futures contract which requires the parties to the contract to buy and sell a security on a set date, an option on a futures contract entitles its holder to decide before a future date whether to enter into such a futures contract. Both types of contracts are marked to market daily and changes in valuation will effect the net asset value of the Fund. The Fund's principal investment objective in holding or issuing derivative financial instruments is as a hedge against interest-rate fluctuations in its municipal bond portfolio, and to enhance its total return. The Fund's principal objective is to maximize the level of tax-exempt interest income while maintaining acceptable levels of interest rate and liquidity risk. To achieve this objective, the Fund uses a combination of derivative financial instruments principally consisting of US Treasury Bond Futures and Options on US Treasury Bond Futures. Typically the Fund sells treasury bond futures contracts or writes treasury bond option contracts. These activities create off balance sheet risk since the Fund may be unable to enter into an offsetting position and under the terms of the contract must deliver the underlying security at a specified time at a specified price. The cost to the Fund of acquiring the security to deliver may be in excess of recorded amounts and result in a loss to the Fund. During the year ended December 31, 1995, the Fund had daily average notional amounts outstanding of approximately $6,300 and $904,100 of short positions on US Treasury Bond Futures and options written on US Treasury Bond Futures, respectively. Realized gains and losses from these transactions are stated separately in the Statement of Operations. The following table summarizes option contracts written by the Fund for the year ended December 31, 1995. Number of Premiums Realized Contracts Received Cost Loss --------- -------- ---- ---- Contracts outstanding December 31, 1994 100 $123,674 Options written........................ - - - Contracts closed or expired............ 100 (123,674) $197,468 ($73,794) --- -------- Contracts outstanding December 31, 1995 - $ 0 === ======== Concentration of Credit Risk: The Fund owns 100% of two Niagara Falls Industrial Development Agency bonds ("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara Falls New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May 1, 2009 which are in default. The IDA Bonds are secured by commercial retail and office buildings known as the Falls Street Faire and Falls Street Station Projects ("Projects"). The URA Bond is secured by certain rental payments from the Projects. There is uncertainty as to the timing of events and the subsequent ability of the Projects to generate cash flows sufficient to service the IDA and URA Bonds. These bonds are valued under methods determined by the Board of Directors. In the aggregate these bonds are valued at $8,397,267 at December 31, 1995 (42.64% of their face value of $19,695,000). No interest income was accrued on these bonds during the year ended December 31, 1995. 12 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS (continued) December 31, 1995 - -------------------------------------------------------------------------------- On October 6, 1992 the Fund entered into an agreement to restructure the terms of the IDA bonds whereby the lessors of the Projects agreed to surrender control of the Projects and waive any and all rights and interests of any kind in the Projects. Legal, investment banking, and other restructuring costs charged to realized loss totaled approximately $269,900 for year ended December 31, 1995 ($1,193,500 cumulatively from October 6, 1992 to December 31, 1995). The Fund has retained an investment banker to assist them in finding the highest and best use for the Projects. The Fund, through its investment banker, engaged a manager to operate the Projects on its behalf, and the Fund is paying the net operating expenses of the Projects. Net operating expenses related to the Projects for the year ended December 31, 1995 are disclosed in the statement of operations, and cumulatively from October 6, 1992 to December 31, 1995 totaled approximately $372,000. Other Investment Transactions: During the year ended December 31, 1995, purchases and sales of investment securities, other than short-term obligations, were $865,543,943 and $878,083,183 respectively. As of December 31, 1995 net unrealized depreciation of portfolio securities on a federal income tax basis amounted to $5,640,063 composed of unrealized appreciation of $8,244,445 and unrealized depreciation of $13,884,508. 5. Capital Stock As of December 31, 1995 there were 500,000,000 shares of $.01 par value capital stock authorized. Transactions in capital stock were as follows:
Year Ended Year Ended December 31, 1995 December 31, 1994 ------------------------------- ------------------------------- Shares Amount Shares Amount ------ ------ ------ ------ Shares sold.................................. 3,269,945,429 $3,074,627,178 2,943,748,646 $3,005,186,891 Shares issued on reinvestment of dividends... 6,772,089 6,361,886 10,690,975 11,094,904 Shares redeemed.............................. (3,287,552,791) (3,094,515,295) 2,946,253,498) (3,028,967,870) ------------- -------------- ------------- -------------- Net increase (decrease)...................... (10,835,273) $ (13,526,231) 8,186,123 $ (12,686,075) ============= ============== ============= ==============
6.Line of Credit The Fund has line of credit agreements with banks collateralized by cash and portfolio securities. Borrowings under these agreements bear interest linked to the banks' prime rate. 13 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS (continued) December 31, 1995 - -------------------------------------------------------------------------------- 7.Selected Financial Information
Years Ended December 31, ---------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net Asset Value, Beginning of Year......................... $0.88 $1.18 $1.21 $1.14 $1.04 ----- ----- ----- ----- ----- Income from investment operations: Net investment income...................................... .035 .056 .065 .061 .059 Net realized and unrealized gains (losses) on investments........................................... .101 (.290) .082 .070 .100 ----- ----- ----- ----- ----- Total from investment operations................... .136 (.234) .147 .131 .159 ----- ----- ----- ----- ----- Less Distributions: Dividends from net investment income....................... (.035) (.056) (.065) (.060) (.059) Dividends from net realized gains.......................... (.001) (.010) (.112) (.001) - ----- ----- ----- ----- ----- Total distributions................................ (.036) (.066) (.177) (.061) (.059) ----- ----- ----- ----- ----- Net Asset Value, End of Year............................... $0.98 $0.88 $1.18 $1.21 $1.14 ===== ===== ===== ===== ===== Total Return............................................... 15.67% (20.47%) 12.58% 11.83% 15.73% RATIOS/SUPPLEMENTAL DATA Net Assets, End of Year (000).............................. $226,692 $212,665 $275,552 $196,516 $183,307 Ratios to Average Net Assets: Interest expense......................................... 2.09% 1.59% .61% .19% .09% Operating expenses....................................... 1.55% 1.62% 1.44% 1.50% 1.69% ----- ----- ----- ----- ----- Total expenses..................................... 3.64% 3.21% 2.05% 1.69% 1.78% ===== ===== ===== ===== ===== Net investment income.............................. 3.81% 5.34% 5.20% 5.16% 5.47% Portfolio turnover rate.................................... 347.50% 289.69% 404.05% 460.58% 365.12% BANK LOANS Amount outstanding at end of year (000 omitted)............ $ 64,575 $ 20,000 $ 20,873 $ 725 $ - Average amount of bank loans outstanding during the year (000 omitted)............................................ $ 49,603 $ 54,479 $ 24,100 $ 5,194 $ 1,483* Average number of shares outstanding during the year (000 omitted)............................................ 191,692 206,323 184,664 161,404 167,206* Average amount of debt per share during the year........... $ .259 $ .264 $ .131 $ .032 $ .009 *Based on monthly average
14 NEW YORK MUNI FUND NOTES TO FINANCIAL STATEMENTS (continued) December 31, 1995 - -------------------------------------------------------------------------------- 8. Contingencies The Fund has been named as a defendant in a class action lawsuit alleging that the Fund invested in certain derivative financial instruments that were inconsistent with the Fund's stated investment objectives. The suit claims that the defendants, which include the Fund's investment adviser, distributor, and certain control persons, are liable for damages because there existed material misstatements or omissions in the prospectuses that rendered them misleading. Management has entered into negotiations with the plaintiffs who have consented to a series of adjournments of all operative dates in the litigation. These negotiations have resulted in a settlement in principle with the plaintiffs that, if consummated, would require a payment of approximately $500,000 or more under certain future circumstances by the Fund's investment adviser and no liability or cost to the Fund or its shareholders. The contemplated stipulation of settlement expressly states that the setttlement does not constitute an admission of wrongdoing by the Fund or any of the other defendants. The settlement remains subject to final documentation and agreement by the parties and approval by the Court. If the settlement is not successfully concluded, the Fund intends to contest the litigation vigorously. If this litigation ever goes forward, it would involve significant complexities that preclude a present determination of whether any liability to the Fund ultimately would result and, if so, whether any such liability would be material to the financial position of the Fund. Accordingly, and because the contemplated settlement does not require any payment by the Fund, no amount has been accrued in the financial statements with respect to this matter. 15 INDEPENDENT AUDITOR'S REPORT The Board of Directors and Shareholders New York Muni Fund, Inc. We have audited the accompanying statement of assets and liabilities, including the statement of investments, of New York Muni Fund, Inc. as of December 31, 1995, and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for each of the two years in the period then ended, and selected financial information for each of the five years in the period then ended. These financial statements and selected financial information are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and selected financial information based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and selected financial information are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 1995 by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and selected financial information referred to above present fairly, in all material respects, the financial position of New York Muni Fund, Inc. as of December 31, 1995 and the results of its operations, cash flows, changes in net assets, and selected financial information for the periods indicated, in conformity with generally accepted accounting principles. As explained in Note 4, the financial statements include securities valued at $8,397,267 (3.7% of net assets) whose values have been estimated by the Board Directors in the absence of readily estimatable market values. We have reviewed the procedures used by the Board of Directors in arriving at its estimate of value of such securities and have inspected underlying documentation, and, in the circumstances, we believe the procedures are reasonable and the documentation appropriate. However, those estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. New York, New York February 13, 1996 16 (Left column) NEW YORK MUNI FUND, INC.(r) 90 Washington Street New York, NY 10006 1-800-322-6864 Independent Auditors McGladrey & Pullen, LLP New York, NY 10017 Attorney Kramer, Levin, Naftalis, Nessen, Kamin & Frankel 919 Third Avenue New York, NY 10022 This report and the financial statements contained herein are submitted for the general information of the shareholders of theFund. The report is not authorized for distribution to prospective investors in the Fund unless preceded or accompanied by an effective prospectus. (Right Column) NEW YORK MUNI FUND, INC.(r) Annual Report December 31, 1995 NEW YORK MUNI FUND Triple Tax-Free Investing FUNDAMENTAL Fundamental Family of Funds -----END PRIVACY-ENHANCED MESSAGE-----