J.P. MORGAN INSTITUTIONAL FUNDS
J.P. MORGAN INSTITUTIONAL NEW YORK TAX EXEMPT BOND FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 1, 2000
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS, BUT CONTAINS
ADDITIONAL INFORMATION WHICH SHOULD BE READ IN CONJUNCTION WITH THE FUND'S
PROSPECTUS DATED DECEMBER 1, 2000, AS SUPPLEMENTED FROM TIME TO TIME.
ADDITIONALLY, THIS STATEMENT OF ADDITIONAL INFORMATION INCORPORATES BY REFERENCE
THE FINANCIAL STATEMENTS INCLUDED IN THE SHAREHOLDER REPORTS RELATING TO THE
FUND DATED JULY 31, 2000. THE PROSPECTUS AND THESE FINANCIAL STATEMENTS,
INCLUDING THE INDEPENDENT ACCOUNTANTS' REPORT THEREON, ARE AVAILABLE, WITHOUT
CHARGE UPON REQUEST FROM FUNDS DISTRIBUTOR, INC., ATTENTION: J.P. MORGAN
INSTITUTIONAL FUNDS (800)221-7930.
TABLE OF CONTENTS
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GENERAL........................................................................1
INVESTMENT OBJECTIVE AND POLICIES..............................................1
INVESTMENT RESTRICTIONS.......................................................18
TRUSTEES AND MEMBERS OF THE ADVISORY BOARD....................................20
OFFICERS......................................................................22
CODES OF ETHICS...............................................................24
INVESTMENT ADVISOR............................................................24
DISTRIBUTOR...................................................................25
CO-ADMINISTRATOR..............................................................26
SERVICES AGENT................................................................26
CUSTODIAN AND TRANSFER AGENT..................................................27
SHAREHOLDER SERVICING.........................................................27
FINANCIAL PROFESSIONALS.......................................................28
INDEPENDENT ACCOUNTANTS.......................................................28
EXPENSES......................................................................29
PURCHASE OF SHARES............................................................29
REDEMPTION OF SHARES..........................................................30
EXCHANGE OF SHARES............................................................30
DIVIDENDS AND DISTRIBUTIONS...................................................31
NET ASSET VALUE...............................................................31
PERFORMANCE DATA..............................................................32
PORTFOLIO TRANSACTIONS........................................................33
MASSACHUSETTS TRUST...........................................................34
DESCRIPTION OF SHARES.........................................................35
SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE...........................36
TAXES.........................................................................37
ADDITIONAL INFORMATION........................................................39
FINANCIAL STATEMENTS..........................................................40
APPENDIX A...................................................................A-1
APPENDIX B...................................................................B-1
GENERAL
This Statement of Additional Information relates only to the J.P.
Morgan Institutional New York Tax Exempt Bond Fund (the "Fund"). The Fund is a
series of shares of beneficial interest of the J.P. Morgan Institutional Funds,
an open-end management investment company formed as a Massachusetts business
trust (the "Trust"). The Fund is a non-diversified, open-end management
investment company. In addition to the Fund, the Trust consists of other series
representing separate investment funds (each a "J.P. Morgan Institutional
Fund"). The other J.P. Morgan Institutional Funds are covered by separate
Statements of Additional Information.
This Statement of Additional Information describes the financial
history, investment objective and policies, management and operation of the Fund
and provides additional information with respect to the Fund and should be read
in conjunction with the Fund's current Prospectus (the "Prospectus").
Capitalized terms not otherwise defined herein have the meanings accorded to
them in the Prospectus. The Fund's executive offices are located at 60 State
Street, Suite 1300, Boston, Massachusetts 02109.
Unlike other mutual funds which directly acquire and manage their own
portfolio of securities, the Fund seeks to achieve its investment objective by
investing all of its investable assets in The New York Tax Exempt Bond Portfolio
(the "Portfolio"), a corresponding non-diversified open-end management
investment company having the same investment objective as the Fund. The Fund
invests in the Portfolio through a two-tier master-feeder investment fund
structure. See "Special Information Concerning Investment Structure."
The Portfolio is advised by J.P. Morgan Investment Management Inc.
("JPMIM" or the "Advisor").
Investments in the Fund are not deposits or obligations of, or
guaranteed or endorsed by, Morgan Guaranty Trust Company of New York ("Morgan"),
an affiliate of the Advisor, or any other bank. Shares of the Fund are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board, or any other governmental agency. An investment in the Fund is
subject to risk that may cause the value of the investment to fluctuate, and
when the investment is redeemed, the value may be higher or lower than the
amount originally invested by the investor.
INVESTMENT OBJECTIVE AND POLICIES
The following discussion supplements the information regarding the
investment objective of the Fund and the policies to be employed to achieve this
objective. Since the investment characteristics and expenses of the Fund
correspond directly with those of the Portfolio, the discussion in the Statement
of Additional Information focuses on the investments and investment policies of
the Portfolio. Accordingly, references below to the Fund also include the
Portfolio; similarly, references to the Portfolio also include the Fund unless
the context requires otherwise.
The investment objective of the Fund is to provide a high level of tax
exempt income for New York residents consistent with moderate risk of capital.
The investment objective of the Fund and the investment objective of the
Portfolio are identical. The Fund invests primarily in New York Municipal
Securities (defined below), the income from which is exempt from federal and New
York personal income taxes. It may also invest in other municipal securities
that generate income exempt from federal income tax but not from New York income
tax. In certain circumstances, the Fund may invest in taxable debt obligations
to the extent consistent with its objective.
The Fund is designed for investors subject to federal and New York
State and New York City personal income taxes who seek a high level of income
exempt from Federal, New York State and local income taxes and who are willing
to receive some taxable income and capital gains to achieve that return.
Additionally, the Fund is designed to be an economical and convenient means of
investing in a portfolio consisting primarily of debt obligations that are
exempt from federal and New York State and New York City personal income taxes.
The Fund is not suitable for tax-deferred retirement or pension plans, including
Individual Retirement Accounts (IRAs),
401(k) plans and 403(b) plans. The Fund is not a complete investment program and
there is no assurance that the Fund will achieve its investment objective.
The Advisor actively manages the Fund's duration, the allocation of
securities across market sectors and the selection of securities to maximize
after tax income. The Advisor adjusts the Fund's duration based upon fundamental
economic and capital markets research and the Advisor's interest rate outlook.
For example, if interest rates are expected to rise, the duration may be
shortened to lessen the Fund's exposure to the expected decrease in bond prices.
If interest rates are expected to remain stable, the Advisor may lengthen the
duration in order to enhance the Fund's yield.
Under normal market conditions, the Fund will have a duration of three
to seven years, although the maturities of individual portfolio securities may
vary widely. Duration measures the price sensitivity of the Fund's portfolio,
including expected cash flow under a wide range of interest rate scenarios. A
longer duration generally results in greater price volatility. As a result, when
interest rates increase, the prices of longer duration securities increase more
than the prices of comparable quality securities with a shorter duration.
The Advisor also attempts to enhance after tax income by allocating the
Fund's assets among market sectors. Specific securities which the Advisor
believes are undervalued are selected for purchase within sectors using advanced
quantitative tools, analysis of credit risk, the expertise of a dedicated
trading desk and the judgment of fixed income portfolio managers and analysts.
Although the Portfolio generally purchases securities in order to
generate tax exempt income, it also engages in short-term trading to the extent
consistent with its objective. The annual portfolio turnover rate of the
Portfolio is generally not expected to exceed 75%. Portfolio transactions may
generate taxable capital gains and result in increased transaction costs.
Under normal circumstances, the Fund invests at least 65% of its total
assets in New York municipal bonds. For purposes of this policy, "New York
municipal bonds" has the same meaning as "New York Municipal Securities," which
are obligations of any duration (or maturity) issued by New York, its political
subdivisions and their agencies, authorities and instrumentalities and any other
obligations, the interest from which is exempt from New York State and New York
City personal income taxes. The interest from many but not all New York
Municipal Securities is also exempt from federal income tax. The Fund may also
invest in debt obligations of state and municipal issuers outside of New York.
In general, the interest on such securities is exempt from federal income tax
but subject to New York income tax. A portion of the Fund's distributions from
interest on New York Municipal Securities and other municipal securities in
which the Fund invests may under certain circumstances be subject to federal
alternative minimum tax. See "Taxes".
TAX EXEMPT OBLIGATIONS
Since the Fund invests primarily in New York Municipal Securities, its
performance and the ability of New York issuers to meet their obligations may be
affected by economic, political, demographic or other conditions in the State of
New York. As a result, the value of the Fund's shares may fluctuate more widely
than the value of shares of a fund investing in securities of issuers in
multiple states. The ability of state, county or local governments to meet their
obligations will depend primarily on the availability of tax and other revenues
to those governments and on their general fiscal conditions. Constitutional or
statutory restrictions may limit a municipal issuer's power to raise revenues or
increase taxes. The availability of federal, state and local aid to issuers of
New York Municipal Securities may also affect their ability to meet their
obligations. Payments of principal and interest on revenue bonds will depend on
the economic or fiscal condition of the issuer or specific revenue source from
whose revenues the payments will be made. Any reduction in the actual or
perceived ability of an issuer of New York Municipal
2
Securities to meet its obligations (including a reduction in the rating of its
outstanding securities) would probably reduce the market value and marketability
of the Fund's portfolio securities.
The Fund may invest in municipal securities of any maturity and type.
These include both general obligation bonds secured by the issuer's pledge of
its full faith, credit and taxing authority and revenue bonds payable from
specific revenue sources, but generally not backed by the issuer's taxing
authority. In addition, the Fund may invest in all types of municipal notes,
including tax, revenue and grant anticipation notes, municipal commercial paper,
and municipal demand obligations such as variable rate demand notes and master
demand obligations. There is no specific percentage limitation on these
investments.
MUNICIPAL BONDS. Municipal bonds are debt obligations issued by the
states, territories and possessions of the United States and the District of
Columbia, by their political subdivisions and by duly constituted authorities
and corporations. For example, states, territories, possessions and
municipalities may issue municipal bonds to raise funds for various public
purposes such as airports, housing, hospitals, mass transportation, schools,
water and sewer works. They may also issue municipal bonds to refund outstanding
obligations and to meet general operating expenses. Public authorities issue
municipal bonds to obtain funding for privately operated facilities, such as
housing and pollution control facilities, for industrial facilities or for water
supply, gas, electricity or waste disposal facilities.
Municipal bonds may be general obligation or revenue bonds. General
obligation bonds are secured by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from revenues derived from particular facilities, from the proceeds of a
special excise tax or from other specific revenue sources. They are not
generally payable from the general taxing power of a municipality.
MUNICIPAL NOTES. The Fund may also invest in municipal notes of various
types, including notes issued in anticipation of receipt of taxes, the proceeds
of the sale of bonds, other revenues or grant proceeds, as well as municipal
commercial paper and municipal demand obligations such as variable rate demand
notes and master demand obligations. The interest rate on variable rate demand
notes is adjustable at periodic intervals as specified in the notes. Master
demand obligations permit the investment of fluctuating amounts at periodically
adjusted interest rates. They are governed by agreements between the municipal
issuer and Morgan acting as agent, for no additional fee. Although master demand
obligations are not marketable to third parties, the Fund considers them to be
liquid because they are payable on demand. There is no specific percentage
limitation on these investments. Municipal notes are subdivided into three
categories of short-term obligations: municipal notes, municipal commercial
paper and municipal demand obligations.
Municipal notes are short-term obligations with a maturity at the time
of issuance ranging from six months to five years. The principal types of
municipal notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, grant anticipation notes and project notes. Notes sold in
anticipation of collection of taxes, a bond sale, or receipt of other revenues
are usually general obligations of the issuing municipality or agency.
Municipal commercial paper typically consists of very short-term
unsecured negotiable promissory notes that are sold to meet seasonal working
capital or interim construction financing needs of a municipality or agency.
While these obligations are intended to be paid from general revenues or
refinanced with long-term debt, they frequently are backed by letters of credit,
lending agreements, note repurchase agreements or other credit facility
agreements offered by banks or institutions.
Municipal demand obligations are subdivided into two types: variable
rate demand notes and master demand obligations.
3
Variable rate demand notes are tax exempt municipal obligations or
participation interests that provide for a periodic adjustment in the interest
rate paid on the notes. They permit the holder to demand payment of the notes,
or to demand purchase of the notes at a purchase price equal to the unpaid
principal balance, plus accrued interest either directly by the issuer or by
drawing on a bank letter of credit or guaranty issued with respect to such note.
The issuer of the municipal obligation may have a corresponding right to prepay
at its discretion the outstanding principal of the note plus accrued interest
upon notice comparable to that required for the holder to demand payment. The
variable rate demand notes in which the Fund may invest are payable, or are
subject to purchase, on demand usually on notice of seven calendar days or less.
The terms of the notes provide that interest rates are adjustable at intervals
ranging from daily to six months, and the adjustments are based upon the prime
rate of a bank or other appropriate interest rate index specified in the
respective notes. Variable rate demand notes are valued at amortized cost; no
value is assigned to the right of the Fund to receive the par value of the
obligation upon demand or notice.
Master demand obligations are tax exempt municipal obligations that
provide for a periodic adjustment in the interest rate paid and permit daily
changes in the amount borrowed. The interest on such obligations is, in the
opinion of counsel for the borrower, excluded from gross income for federal
income tax purposes. Although there is no secondary market for master demand
obligations, such obligations are considered by the Fund to be liquid because
they are payable upon demand. The Fund has no specific percentage limitations on
investments in master demand obligations.
PREMIUM SECURITIES. During a period of declining interest rates, many
municipal securities in which the Fund invests likely will bear coupon rates
higher than current market rates, regardless of whether the securities were
initially purchased at a premium. In general, such securities have market values
greater than the principal amounts payable on maturity, which would be reflected
in the net asset value of the Fund's shares. The values of such "premium"
securities tend to approach the principal amount as they near maturity.
PUTS. The Fund may purchase without limit, municipal bonds or notes
together with the right to resell the bonds or notes to the seller at an agreed
price or yield within a specified period prior to the maturity date of the bonds
or notes. Such a right to resell is commonly known as a "put." The aggregate
price for bonds or notes with puts may be higher than the price for bonds or
notes without puts. Consistent with the Fund's investment objective and subject
to the supervision of the Trustees, the purpose of this practice is to permit
the Fund to be fully invested in tax exempt securities while preserving the
necessary liquidity to purchase securities on a when-issued basis, to meet
unusually large redemptions, and to purchase at a later date securities other
than those subject to the put. The principal risk of puts is that the writer of
the put may default on its obligation to repurchase. The Advisor will monitor
each writer's ability to meet its obligations under puts.
Puts may be exercised prior to the expiration date in order to fund
obligations to purchase other securities or to meet redemption requests. These
obligations may arise during periods in which proceeds from sales of Fund shares
and from recent sales of portfolio securities are insufficient to meet
obligations or when the funds available are otherwise allocated for investment.
In addition, puts may be exercised prior to the expiration date in order to take
advantage of alternative investment opportunities or in the event the Advisor
revises its evaluation of the creditworthiness of the issuer of the underlying
security. In determining whether to exercise puts prior to their expiration date
and in selecting which puts to exercise, the Advisor considers the amount of
cash available to the Fund, the expiration dates of the available puts, any
future commitments for securities purchases, alternative investment
opportunities, the desirability of retaining the underlying securities in the
Fund's portfolio and the yield, quality and maturity dates of the underlying
securities.
The Fund values any municipal bonds and notes subject to puts with
remaining maturities of less than 60 days by the amortized cost method. If the
Fund were to invest in municipal bonds and notes with maturities of 60 days or
more that are subject to puts separate from the underlying securities, the puts
and the underlying securities
4
would be valued at fair value as determined in accordance with procedures
established by the Board of Trustees. The Board of Trustees would, in connection
with the determination of the value of a put, consider, among other factors, the
creditworthiness of the writer of the put, the duration of the put, the dates on
which or the periods during which the put may be exercised and the applicable
rules and regulations of the SEC. Prior to investing in such securities, the
Fund, if deemed necessary based upon the advice of counsel, will apply to the
SEC for an exemptive order, which may not be granted, relating to the amortized
valuation of such securities.
Since the value of the put is partly dependent on the ability of the
put writer to meet its obligation to repurchase, the Fund's policy is to enter
into put transactions only with municipal securities dealers who are approved by
the Advisor. Each dealer will be approved on its own merits, and it is the
Fund's general policy to enter into put transactions only with those dealers
which are determined to present minimal credit risks. In connection with such
determination, the Advisor reviews regularly the list of approved dealers,
taking into consideration, among other things, the ratings, if available, of
their equity and debt securities, their reputation in the municipal securities
markets, their net worth, their efficiency in consummating transactions and any
collateral arrangements, such as letters of credit, securing the puts written by
them. Commercial bank dealers normally will be members of the Federal Reserve
System, and other dealers will be members of the National Association of
Securities Dealers, Inc. or members of a national securities exchange. Other put
writers will have outstanding debt rated Aa or better by Moody's Investors
Service, Inc. ("Moody's") or AA or better by Standard & Poor's Ratings Group
("Standard & Poor's"), or will be of comparable quality in the Advisor's
opinion or such put writers' obligations will be collateralized and of
comparable quality in the Advisor's opinion. The Trustees have directed the
Advisor not to enter into put transactions with any dealer which in the judgment
of the Advisor become more than a minimal credit risk. In the event that a
dealer should default on its obligation to repurchase an underlying security,
the Fund is unable to predict whether all or any portion of any loss sustained
could subsequently be recovered from such dealer.
Entering into a put with respect to a tax exempt security may be
treated, depending upon the terms of the put, as a taxable sale of the tax
exempt security by the Fund with the result that, while the put is outstanding,
the Fund will no longer be treated as the owner of the security and the interest
income derived with respect to the security will be treated as taxable income to
the Fund.
NON-MUNICIPAL SECURITIES
The Fund may invest in bonds and other debt securities of domestic
issuers to the extent consistent with its investment objective and policies. The
Fund may invest in U.S. Government, bank and corporate debt obligations, as well
as asset-backed securities and repurchase agreements. The Fund will purchase
such securities only when the Advisor believes that they would enhance the after
tax income of a shareholder of the Fund in the highest federal and New York
income tax brackets. Under normal circumstances, the Fund's holdings of
non-municipal securities and securities of municipal issuers outside New York
will not exceed 35% of its total assets. A description of these investments
appears below. See "Quality and Diversification Requirements." For information
on short-term investments in these securities, see "Money Market Instruments."
ZERO COUPON, PAY-IN-KIND AND DEFERRED PAYMENT SECURITIES. Zero coupon
securities are securities that are sold at a discount to par value and on which
interest payments are not made during the life of the security. Upon maturity,
the holder is entitled to receive the par value of the security. Pay-in-kind
securities are securities that have interest payable by delivery of additional
securities. Upon maturity, the holder is entitled to receive the aggregate par
value of the securities. The Fund accrues income with respect to zero coupon and
pay-in-kind securities prior to the receipt of cash payments. Deferred payment
securities are securities that remain zero coupon securities until a
predetermined date, at which time the stated coupon rate becomes effective and
interest becomes payable at regular intervals. While interest payments are not
made on such securities, holders of such securities are deemed to have received
"phantom income." Because a Fund will distribute "phantom income" to
shareholders, to the extent that
5
shareholders elect to receive dividends in cash rather than reinvesting such
dividends in additional shares, the applicable Fund will have fewer assets with
which to purchase income producing securities. Zero coupon, pay-in-kind and
deferred payment securities may be subject to greater fluctuation in value and
lesser liquidity in the event of adverse market conditions than comparably rated
securities paying cash interest at regular interest payment periods.
ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables or other asset-backed securities collateralized by such
assets. Payments of principal and interest may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution unaffiliated with the entities issuing the securities. The
asset-backed securities in which the Fund may invest are subject to the Fund's
overall credit requirements. However, asset-backed securities, in general, are
subject to certain risks. Most of these risks are related to limited interests
in applicable collateral. For example, credit card debt receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts on credit card debt thereby reducing the
balance due. Additionally, if the letter of credit is exhausted, holders of
asset-backed securities may also experience delays in payments or losses if the
full amounts due on underlying sales contracts are not realized. Because
asset-backed securities are relatively new, the market experience in these
securities is limited and the market's ability to sustain liquidity through all
phases of the market cycle has not been tested.
MONEY MARKET INSTRUMENTS
The Fund may invest in money market instruments, to the extent
consistent with its investment objective and policies, that meet the quality
requirements described below, except that short-term municipal obligations of
New York State issuers may be rated MIG-2 by Moody's or SP-2 by Standard &
Poor's. Under normal circumstances, the Fund will purchase these securities to
invest temporary cash balances or to maintain liquidity to meet withdrawals.
However, the Fund may also invest in money market instruments as a temporary
defensive measure taken during, or in anticipation of, adverse market
conditions. A description of the various types of money market instruments that
may be purchased by the Fund appears below. Also see "Quality and
Diversification Requirements."
U.S. TREASURY SECURITIES. The Fund may invest in direct obligations of
the U.S. Treasury, including Treasury bills, notes and bonds, all of which are
backed as to principal and interest payments by the full faith and credit of the
United States.
ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. The Fund may invest in
obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full faith
and credit" of the United States. Securities which are backed by the full faith
and credit of the United States include obligations of the Government National
Mortgage Association, the Farmers Home Administration, and the Export-Import
Bank. In the case of securities not backed by the full faith and credit of the
United States, the Fund must look principally to the federal agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States itself in the event the agency or
instrumentality does not meet its commitments. Securities in which the Fund may
invest that are not backed by the full faith and credit of the United States
include, but are not limited to: (i) obligations of the Tennessee Valley
Authority, the Federal Home Loan Mortgage Corporation, the Federal Home Loan
Banks and the U.S. Postal Service, each of which has the right to borrow from
the U.S. Treasury to meet its obligations; (ii) securities issued by the Federal
National Mortgage Association, which are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; and (iii)
obligations of the Federal Farm Credit System and the Student Loan Marketing
Association, each of whose obligations may be satisfied only by the individual
credits of the issuing agency.
6
BANK OBLIGATIONS. The Fund may invest in negotiable certificates of
deposit, time deposits and bankers' acceptances of (i) banks, savings and loan
associations and savings banks which have more than $2 billion in total and are
organized under the laws of the United States or any state, (ii) foreign
branches of these banks of equivalent size (Euros) and (iii) U.S. branches of
foreign banks of equivalent size (Yankees). The Fund may not invest in
obligations of foreign branches of foreign banks. The Fund will not invest in
obligations for which the Advisor, or any of its affiliated persons, is the
ultimate obligor or accepting bank.
COMMERCIAL PAPER. The Fund may invest in commercial paper, including
master demand obligations. Master demand obligations are obligations that
provide for a periodic adjustment in the interest rate paid and permit daily
changes in the amount borrowed. Master demand obligations are governed by
agreements between the issuer and Morgan acting as agent, for no additional fee.
The monies loaned to the borrower come from accounts managed by Morgan or its
affiliates, pursuant to arrangements with such accounts. Interest and principal
payments are credited to such accounts. Morgan has the right to increase or
decrease the amount provided to the borrower under an obligation. The borrower
has the right to pay without penalty all or any part of the principal amount
then outstanding on an obligation together with interest to the date of payment.
Since these obligations typically provide that the interest rate is tied to the
Federal Reserve commercial paper composite rate, the rate on master demand
obligations is subject to change. Repayment of a master demand obligation to
participating accounts depends on the ability of the borrower to pay the accrued
interest and principal of the obligation on demand which is continuously
monitored by Morgan. Since master demand obligations typically are not rated by
credit rating agencies, the Fund may invest in such unrated obligations only if
at the time of an investment the obligation is determined by the Advisor to have
a credit quality which satisfies the Fund's quality restrictions. See "Quality
and Diversification Requirements." Although there is no secondary market for
master demand obligations, such obligations are considered by the Fund to be
liquid because they are payable upon demand. The Fund does not have any specific
percentage limitation on investments in master demand obligations. It is
possible that the issuer of a master demand obligation could be a client of
Morgan to whom Morgan, in its capacity as a commercial bank, has made a loan.
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements
with brokers, dealers or banks that meet the Advisor's credit guidelines. In a
repurchase agreement, the Fund buys a security from a seller that has agreed to
repurchase the same security at a mutually agreed upon date and price. The
resale price normally is in excess of the purchase price, reflecting an agreed
upon interest rate. This interest rate is effective for the period of time the
Fund is invested in the agreement and is not related to the coupon rate on the
underlying security. A repurchase agreement may also be viewed as a fully
collateralized loan of money by the Fund to the seller. The period of these
repurchase agreements will usually be short, from overnight to one week, and at
no time will the Fund invest in repurchase agreements for more than thirteen
months. The securities which are subject to repurchase agreements, however, may
have maturity dates in excess of thirteen months from the effective date of the
repurchase agreement. The Fund will always receive securities as collateral
whose market value is, and during the entire term of the agreement remains, at
least equal to 100% of the dollar amount invested by the Fund in the agreement
plus accrued interest, and the Fund will make payment for such securities only
upon physical delivery or upon evidence of book entry transfer to the account of
the custodian. If the seller defaults, the Fund might incur a loss if the value
of the collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon disposal of the collateral by the Fund may be delayed or
limited.
The Fund may make investments in other debt securities, including
without limitation corporate bonds and other obligations described in this
Statement of Additional Information.
ADDITIONAL INVESTMENTS
7
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase
securities on a when-issued or delayed delivery basis. For example, delivery of
and payment for these securities can take place a month or more after the date
of the purchase commitment. The purchase price and the interest rate payable, if
any, on the securities are fixed on the purchase commitment date or at the time
the settlement date is fixed. The value of such securities is subject to market
fluctuation and for money market instruments and other fixed income securities
no interest accrues to the Fund until settlement takes place. At the time the
Fund makes the commitment to purchase securities on a when-issued or delayed
delivery basis, it will record the transaction, reflect the value each day of
such securities in determining its net asset value and, if applicable, calculate
the maturity for the purposes of average maturity from that date. At the time of
settlement a when-issued security may be valued at less than the purchase price.
To facilitate such acquisitions, the Fund will maintain with the custodian a
segregated account with liquid assets, consisting of cash, U.S. Government
securities or other appropriate securities, in an amount at least equal to such
commitments. On delivery dates for such transactions, the Fund will meet its
obligations from maturities or sales of the securities held in the segregated
account and/or from cash flow. If the Fund chooses to dispose of the right to
acquire a when-issued security prior to its acquisition, it could, as with the
disposition of any other portfolio obligation, incur a gain or loss due to
market fluctuation. Also, the Fund may be disadvantaged if the other party to
the transaction defaults.
INVESTMENT COMPANY SECURITIES. Securities of other investment companies
may be acquired by the Fund to the extent permitted under the 1940 Act or any
order pursuant thereto. These limits currently require that, as determined
immediately after a purchase is made, (i) not more than 5% of the value of the
Fund's total assets will be invested in the securities of any one investment
company, (ii) not more than 10% of the value of its total assets will be
invested in the aggregate in securities of investment companies as a group, and
(iii) not more than 3% of the outstanding voting stock of any one investment
company will be owned by the Fund, provided however, that the Fund may invest
all of its investable assets in an open-end investment company that has the same
investment objective as the Fund. As a shareholder of another investment
company, the Fund would bear, along with other shareholders, its pro rata
portion of the other investment company's expenses, including advisory fees.
These expenses would be in addition to the advisory and other expenses that the
Fund bears directly in connection with its own operations. The Fund has applied
for exemptive relief from the SEC to permit the Fund's corresponding Portfolio
to invest in affiliated investment companies. If the requested relief is
granted, the Fund's corresponding Portfolio would then be permitted to invest in
affiliated funds, subject to certain conditions specified in the applicable
order.
The Securities and Exchange Commission ("SEC") has granted the
Portfolio an exemptive order permitting it to invest its uninvested cash in any
of the following affiliated money market funds: J.P. Morgan Institutional Prime
Money Market Fund, J.P. Morgan Institutional Tax Exempt Money Market Fund, J.P.
Morgan Institutional Federal Money Market Fund and J.P. Morgan Institutional
Treasury Money Market Fund. The order sets forth the following conditions: (1)
the Portfolio may invest in one or more of the permitted money market funds up
to an aggregate limit of 25% of its assets; and (2) the Advisor will waive
and/or reimburse its advisory fee from the Portfolio in an amount sufficient to
offset any doubling up of investment advisory and shareholder servicing fees.
REVERSE REPURCHASE AGREEMENTS. The Fund may enter into reverse
repurchase agreements. In a reverse repurchase agreement, a Fund sells a
security and agrees to repurchase the same security at a mutually agreed upon
date and price reflecting the interest rate effective for the term of the
agreement. For purposes of the 1940 Act a reverse repurchase agreement is also
considered as the borrowing of money by the Fund and, therefore, a form of
leverage. Leverage may cause any gains or losses for the Fund to be magnified.
The Fund will invest the proceeds of borrowings under reverse repurchase
agreements. In addition, except for liquidity purposes, the Fund will enter into
a reverse repurchase agreement only when the expected return from the investment
of the proceeds is greater than the expense of the transaction. The Fund will
not invest the proceeds of a reverse repurchase agreement for a period which
exceeds the duration of the reverse repurchase agreement. The Fund will
establish and maintain with the custodian a separate account with a segregated
portfolio of securities in an amount at least equal to its purchase
8
obligations under its reverse repurchase agreements. All forms of borrowing
(including reverse repurchase agreements and securities lending) are limited in
the aggregate and may not exceed 33-1/3% of the Fund's total assets.
LOANS OF PORTFOLIO SECURITIES. The Fund may lend its securities if such
loans are secured continuously by cash or equivalent collateral or by a letter
of credit in favor of the Fund at least equal at all times to 100% of the market
value of the securities loaned, plus accrued interest. While such securities are
on loan, the borrower will pay the Fund any income accruing thereon. Loans will
be subject to termination by the Fund in the normal settlement time, generally
three business days after notice, or by the borrower on one day's notice.
Borrowed securities must be returned when the loan is terminated. Any gain or
loss in the market price of the borrowed securities which occurs during the term
of the loan inures to the Fund and its respective investors. The Fund may pay
reasonable finders' and custodial fees in connection with a loan. In addition,
the Fund will consider all facts and circumstances including the
creditworthiness of the borrowing financial institution, and the Fund will not
make any loans in excess of one year. The Fund will not lend its securities to
any officer, Trustee, Member of the Advisory Board, Director, employee or other
affiliate of the Fund, the Advisor or the Distributor, unless otherwise
permitted by applicable law. All forms of borrowing (including reverse
repurchase agreements and securities lending) are limited in the aggregate and
may not exceed 33-1/3% of the Fund's total assets.
ILLIQUID INVESTMENTS; PRIVATELY PLACED AND OTHER UNREGISTERED
SECURITIES. The Fund may not acquire any illiquid securities if, as a result
thereof, more than 15% of the Fund's net assets would be in illiquid
investments. Subject to this non-fundamental policy limitation, the Fund may
acquire investments that are illiquid or have limited liquidity, such as private
placements or investments that are not registered under the Securities Act of
1933, as amended (the "1933 Act"), and cannot be offered for public sale in the
United States without first being registered under the 1933 Act. An illiquid
investment is any investment that cannot be disposed of within seven days in the
normal course of business at approximately the amount at which it is valued by
the Portfolio. The price the Fund pays for illiquid securities or receives upon
resale may be lower than the price paid or received for similar securities with
a more liquid market. Accordingly the valuation of these securities will reflect
any limitations on their liquidity.
The Fund may also purchase Rule 144A securities sold to institutional
investors without registration under the 1933 Act. These securities may be
determined to be liquid in accordance with guidelines established by the Advisor
and approved by the Trustees. The Trustees will monitor the Advisor's
implementation of these guidelines on a periodic basis.
As to illiquid investments, the Fund is subject to a risk that should
the Fund decide to sell them when a ready buyer is not available at a price the
Fund deems representative of their value, the value of the Fund's net assets
could be adversely affected. Where an illiquid security must be registered under
the 1933 Act, before it may be sold, the Fund may be obligated to pay all or
part of the registration expenses, and a considerable period may elapse between
the time of the decision to sell and the time the Fund may be permitted to sell
a security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell.
SYNTHETIC VARIABLE RATE INSTRUMENTS. The Fund may invest in certain
synthetic variable rate instruments. Such instruments generally involve the
deposit of a long-term tax exempt bond in a custody or trust arrangement and the
creation of a mechanism to adjust the long-term interest rate on the bond to a
variable short-term rate and a right (subject to certain conditions) on the part
of the purchaser to tender it periodically to a third party at par. Morgan will
review the structure of synthetic variable rate instruments to identify credit
and liquidity risks (including the conditions under which the right to tender
the instrument would no longer be available) and will monitor those risks. In
the event that the right to tender the instrument is no longer available, the
risk to the Fund will be that of holding the long-term bond. In the case of some
types of instruments credit enhancement is not
9
provided, and if certain events, which may include (a) default in the payment of
principal or interest on the underlying bond, (b) downgrading of the bond below
investment grade or (c) a loss of the bond's tax exempt status, occur, then (i)
the put will terminate and (ii) the risk to the Fund will be that of holding a
long-term bond.
QUALITY AND DIVERSIFICATION REQUIREMENTS
The Fund is registered as a non-diversified investment company which
means that the Fund is not limited by the 1940 Act in the proportion of its
assets that may be invested in the obligations of a single issuer. Thus, the
Fund may invest a greater proportion of its assets in the securities of a
smaller number of issuers and, as a result, may be subject to greater risk with
respect to its portfolio securities. The Fund, however, will comply with the
diversification requirements imposed by the Internal Revenue Code of 1986, as
amended (the "Code"), for qualification as a regulated investment company. See
"Taxes".
It is the current policy of the Fund that under normal circumstances at
least 90% of total assets will consist of securities that at the time of
purchase are rated Baa or better by Moody's or BBB or better by Standard &
Poor's. The remaining 10% of total assets may be invested in securities that are
rated B or better by Moody's or Standard & Poor's. See "Below Investment Grade
Debt" below. In each case, the Fund may invest in securities which are unrated,
if in the Advisor's opinion, such securities are of comparable quality.
Securities rated Baa by Moody's or BBB by Standard & Poor's are considered
investment grade, but have some speculative characteristics. Securities rated Ba
or B by Moody's and BB or B by Standard & Poor's are below investment grade and
considered to be speculative with regard to payment of interest and principal.
These standards must be satisfied at the time an investment is made. If the
quality of the investment later declines, the Fund may continue to hold the
investment.
The Fund invests principally in a portfolio of "investment grade" tax
exempt securities. An investment grade bond is rated, on the date of investment,
within the four highest ratings of Moody's, currently Aaa, Aa, A and Baa or of
Standard & Poor's, currently AAA, AA, A and BBB, while high grade debt is rated,
on the date of the investment, within the two highest of such ratings.
Investment grade municipal notes are rated, on the date of investment, MIG-1 or
MIG-2 by Standard & Poor's or SP-1 and SP-2 by Moody's. Investment grade
municipal commercial paper is rated, on the date of investment, Prime 1 or Prime
2 by Moody's and A-1 or A-2 by Standard & Poor's. The Fund may also invest up to
10% of its total assets in securities which are "below investment grade." Such
securities must be rated, on the date of investment, B or better by Moody's or
Standard & Poor's, or of comparable quality. The Fund may invest in debt
securities which are not rated or other debt securities to which these ratings
are not applicable, if in the opinion of the Advisor, such securities are of
comparable quality to the rated securities discussed above. In addition, at the
time the Fund invests in any commercial paper, bank obligation, repurchase
agreement, or any other money market instruments, the investment must have
received a short term rating of investment grade or better (currently Prime-3 or
better by Moody's or A-3 or better by Standard & Poor's) or the investment must
have been issued by an issuer that received a short term investment grade rating
or better with respect to a class of investments or any investment within that
class that is comparable in priority and security with the investment being
purchased by the Fund. If no such ratings exists, the investment must be of
comparable investment quality in the Advisor's opinion, but will not be eligible
for purchase if the issuer or its parent has long term outstanding debt rated
below BBB.
BELOW INVESTMENT GRADE DEBT. Certain lower rated securities purchased
by the Fund, such as those rated Ba or B by Moody's or BB or B by Standard &
Poor's (commonly known as junk bonds), may be subject to certain risks with
respect to the issuing entity's ability to make scheduled payments of principal
and interest and to greater market fluctuations. While generally providing
higher coupons or interest rates than investments in higher quality securities,
lower quality fixed income securities involve greater risk of loss of principal
and income, including the possibility of default or bankruptcy of the issuers of
such securities, and have greater price volatility, especially during periods of
economic uncertainty or change. These lower quality fixed income securities tend
to be affected by economic changes and short-term corporate and industry
developments to a greater extent than higher quality
10
securities, which react primarily to fluctuations in the general level of
interest rates. To the extent that the Fund invests in such lower quality
securities, the achievement of its investment objective may be more dependent on
the Advisor's own credit analysis.
Lower quality fixed income securities are affected by the market's
perception of their credit quality, especially during times of adverse
publicity, and the outlook for economic growth. Economic downturns or an
increase in interest rates may cause a higher incidence of default by the
issuers of these securities, especially issuers that are highly leveraged. The
market for these lower quality fixed income securities is generally less liquid
than the market for investment grade fixed income securities. It may be more
difficult to sell these lower rated securities to meet redemption requests, to
respond to changes in the market, or to value accurately the Fund's portfolio
securities for purposes of determining the Fund's net asset value. See Appendix
A for more detailed information on these ratings.
In determining suitability of investment in a particular unrated
security, the Advisor takes into consideration asset and debt service coverage,
the purpose of the financing, history of the issuer, existence of other rated
securities of the issuer, and other relevant conditions, such as comparability
to other issuers.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase and sell (a) exchange traded and over-the-counter
(OTC) put and call options on fixed income securities, indexes of fixed income
securities and futures contracts on fixed income securities and indexes of fixed
income securities and (b) futures contracts on fixed income securities and
indexes of fixed income securities. Each of these instruments is a derivative
instrument as its value derives from the underlying asset or index.
The Fund may use futures contracts and options for hedging and risk
management purposes. The Fund may not use futures contracts and options for
speculation.
The Fund may utilize options and futures contracts to manage its
exposure to changing interest rates and/or security prices. Some options and
futures strategies, including selling futures contracts and buying puts, tend to
hedge the Fund's investments against price fluctuations. Other strategies,
including buying futures contracts, writing puts and calls and buying calls,
tend to increase market exposure. Options and futures contracts may be combined
with each other or with forward contracts in order to adjust the risk and return
characteristics of the Fund's overall strategy in a manner deemed appropriate to
the Advisor and consistent with the Fund's objective and policies. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
The use of options and futures is a highly specialized activity which
involves investment strategies and risks different from those associated with
ordinary portfolio securities transactions, and there can be no guarantee that
their use will increase the Fund's return. While the use of these instruments by
the Fund may reduce certain risks associated with owning its portfolio
securities, these techniques themselves entail certain other risks. If the
Advisor applies a strategy at an inappropriate time or judges market conditions
or trends incorrectly, options and futures strategies may lower the Fund's
return. Certain strategies limit the Fund's possibilities to realize gains as
well as its exposure to losses. A Fund could also experience losses if the
prices of its options and futures positions were poorly correlated with its
other investments, or if it could not close out its positions because of an
illiquid secondary market. In addition, the Fund will incur transaction costs,
including trading commissions and option premiums, in connection with its
futures and options transactions and these transactions could significantly
increase the Fund's turnover rate.
11
The Fund may purchase put and call options on securities, indexes of
securities and futures contracts, or purchase and sell futures contracts, only
if such options are written by other persons and if (i) the aggregate premiums
paid on all such options which are held at any time do not exceed 20% of the
Fund's net assets, and (ii) the aggregate margin deposits required on all such
futures or options thereon held at any time do not exceed 5% of the Fund's total
assets. In addition, the Fund will not purchase or sell (write) futures
contracts, options on futures contracts or commodity options for risk management
purposes if, as a result, the aggregate initial margin and options premiums
required to establish these positions exceed 5% of the net asset value of the
Fund.
OPTIONS
PURCHASING PUT AND CALL OPTIONS. By purchasing a put option, the Fund
obtains the right (but not the obligation) to sell the instrument underlying the
option at a fixed strike price. In return for this right, the Fund pays the
current market price for the option (known as the option premium). Options have
various types of underlying instruments, including specific securities, indexes
of securities, indexes of securities prices, and futures contracts. The Fund may
terminate its position in a put option it has purchased by allowing it to expire
or by exercising the option. The Fund may also close out a put option position
by entering into an offsetting transaction, if a liquid market exits. If the
option is allowed to expire, the Fund will lose the entire premium it paid. If
the Fund exercises a put option on a security, it will sell the instrument
underlying the option at the strike price. If the Fund exercises an option on an
index, settlement is in cash and does not involve the actual sale of securities.
If an option is American style, it may be exercised on any day up to its
expiration date. A European style option may be exercised only on its expiration
date.
The buyer of a typical put option can expect to realize a gain if the
underlying instrument falls substantially. However, if the price of the
instrument underlying the option does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss (limited to the
amount of the premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the instrument underlying the option at the option's
strike price. A call buyer typically attempts to participate in potential price
increases of the instrument underlying the option with risk limited to the cost
of the option if security prices fall. At the same time, the buyer can expect to
suffer a loss if security prices do not rise sufficiently to offset the cost of
the option.
SELLING (WRITING) PUT AND CALL OPTIONS. When the Fund writes a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for the receipt of the premium, the Fund assumes the
obligation to pay the strike price for the instrument underlying the option if
the other party to the option chooses to exercise it. The Fund may seek to
terminate its position in a put option it writes before exercise by purchasing
an offsetting option in the market at its current price. If the market is not
liquid for a put option the Fund has written, however, the Fund must continue to
be prepared to pay the strike price while the option is outstanding, regardless
of price changes, and must continue to post margin as discussed below.
If the price of the underlying instrument rises, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received. If security prices remain the same over time, it is
likely that the writer will also profit, because it should be able to close out
the option at a lower price. If security prices fall, the put writer would
expect to suffer a loss. This loss should be less than the loss from purchasing
and holding the underlying instrument directly, however, because the premium
received for writing the option should offset a portion of the decline.
Writing a call option obligates the Fund to sell or deliver the
option's underlying instrument in return for the strike price upon exercise of
the option. The characteristics of writing call options are similar to those of
writing
12
put options, except that writing calls generally is a profitable strategy if
prices remain the same or fall. Through receipt of the option premium a call
writer offsets part of the effect of a price decline. At the same time,
because a call writer must be prepared to deliver the underlying instrument
in return for the strike price, even if its current value is greater, a call
writer gives up some ability to participate in security price increases.
The writer of an exchange traded put or call option on a security, an
index of securities or a futures contract is required to deposit cash or
securities or a letter of credit as margin and to make mark to market payments
of variation margin as the position becomes unprofitable.
OPTIONS ON INDEXES. The Fund may purchase or sell put and call options
on any securities index based on securities in which the Fund may invest.
Options on securities indexes are similar to options on securities, except that
the exercise of securities index options is settled by cash payment and does not
involve the actual purchase or sale of securities. In addition, these options
are designed to reflect price fluctuations in a group of securities or segment
of the securities market rather than price fluctuations in a single security.
The Fund, in purchasing or selling index options, is subject to the risk that
the value of its portfolio securities may not change as much as index because
the Fund's investments generally will not match the composition of an index.
For a number of reasons, a liquid market may not exist and thus the
Fund may not be able to close out an option position that it has previously
entered into. When the Fund purchases an OTC option, it will be relying on its
counterparty to perform its obligations, and the Fund may incur additional
losses if the counterparty is unable to perform.
EXCHANGE TRADED AND OTC OPTIONS. All options purchased or sold by the
Fund will be traded on a securities exchange or will be purchased or sold by
securities dealers (OTC options) that meet creditworthiness standards approved
by the Advisor. While exchange-traded options are obligations of the Options
Clearing Corporation, in the case of OTC options, the Fund relies on the dealer
from which it purchased the option to perform if the option is exercised. Thus,
when the Fund purchases an OTC option, it relies on the dealer from which it
purchased the option to make or take delivery of the underlying securities.
Failure by the dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the transaction.
Provided that the Fund has arrangements with certain qualified dealers
who agree that the Fund may repurchase any option it writes for a maximum price
to be calculated by a predetermined formula, the Fund may treat the underlying
securities used to cover written OTC options as liquid. In these cases, the OTC
option itself would only be considered illiquid to the extent that the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
FUTURES CONTRACTS
The Fund may purchase and sell futures contracts. When the Fund
purchases a futures contract, it agrees to purchase a specified quantity of an
underlying instrument at a specified future date or to make a cash payment based
on the value of a securities index. When the Fund sells a futures contract, it
agrees to sell a specified quantity of the underlying instrument at a specified
future date or to receive a cash payment based on the value of a securities
index. The price at which the purchase and sale will take place is fixed when
the Fund enters into the contract. Futures can be held until their delivery
dates or the position can be (and normally is) closed out before then. There is
no assurance, however, that a liquid market will exist when the Fund wishes to
close out a particular position.
When the Fund purchases a futures contract, the value of the futures
contract tends to increase and decrease in tandem with the value of its
underlying instrument. Therefore, purchasing futures contracts will tend to
increase the Fund's exposure to positive and negative price fluctuations in the
underlying instrument, much as if it had purchased the underlying instrument
directly. When the Fund sells a futures contract, by contrast, the value of its
13
futures position will tend to move in a direction contrary to the value of the
underlying instrument. Selling futures contracts, therefore, will tend to offset
both positive and negative market price changes, much as if the underlying
instrument had been sold.
The purchaser or seller of a futures contract is not required to
deliver or pay for the underlying instrument unless the contract is held until
the delivery date. However, when the Fund buys or sells a futures contract it
will be required to deposit "initial margin" with its custodian in a segregated
account in the name of its futures broker, known as a futures commission
merchant (FCM). Initial margin deposits are typically equal to a small
percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments equal to the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of this amount. The Fund may be
obligated to make payments of variation margin at a time when it is
disadvantageous to do so. Furthermore, it may not always be possible for the
Fund to close out its futures positions. Until it closes out a futures position,
the Fund will be obligated to continue to pay variation margin. Initial and
variation margin payments do not constitute purchasing on margin for purposes of
the Fund's investment restrictions. In the event of the bankruptcy of an FCM
that holds margin on behalf of the Fund, the Fund may be entitled to return of
margin owed to it only in proportion to the amount received by the FCM's other
customers, potentially resulting in losses to the Fund.
The Fund will segregate liquid assets in connection with its use of
options and futures contracts to the extent required by the staff of the
Securities and Exchange Commission. Securities held in a segregated account
cannot be sold while the futures contract or option is outstanding, unless they
are replaced with other suitable assets. As a result, there is a possibility
that segregation of a large percentage of the Fund's assets could impede
portfolio management or the Fund's ability to meet redemption requests or other
current obligations.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and sell (write)
put and call options, including put and call options on futures contracts.
Futures contracts obligate the buyer to take and the seller to make delivery at
a future date of a specified quantity of a financial instrument or an amount of
cash based on the value of a securities index. Currently, futures contracts are
available on various types of fixed income securities, including but not limited
to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and
on indexes of fixed income securities.
Unlike a futures contract, which requires the parties to buy and sell a
security or make a cash settlement payment based on changes in a financial
instrument or securities index on an agreed date, an option on a futures
contract entitles its holder to decide on or before a future date whether to
enter into such a contract. If the holder decides not to exercise its option,
the holder may close out the option position by entering into an offsetting
transaction or may decide to let the option expire and forfeit the premium
thereon. The purchaser of an option on a futures contract pays a premium for the
option but makes no initial margin payments or daily payments of cash in the
nature of "variation" margin payments to reflect the change in the value of the
underlying contract as does a purchaser or seller of a futures contract.
The seller of an option on a futures contract receives the premium paid
by the purchaser and may be required to pay initial margin. Amounts equal to the
initial margin and any additional collateral required on any options on futures
contracts sold by the Fund are paid by the Fund into a segregated account, in
the name of the FCM, as required by the 1940 Act and the SEC's interpretations
thereunder.
COMBINED POSITIONS. The Fund may purchase and write options in
combination with each other, or in combination with futures or forward
contracts, to adjust the risk and return characteristics of the overall
position. For example, the Fund may purchase a put option and write a call
option on the same underlying instrument, in order to construct a combined
position whose risk and return characteristics are similar to selling a futures
contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option
14
at a lower price, in order to reduce the risk of the written call option in the
event of a substantial price increase. Because combined options positions
involve multiple trades, they result in higher transaction costs and may be more
difficult to open and close out.
CORRELATION OF PRICE CHANGES. Because there are a limited number of
types of exchange-traded options and futures contracts, it is likely that the
standardized options and futures contracts available will not match the Fund's
current or anticipated investments exactly. The Fund may invest in options and
futures contracts based on securities with different issuers, maturities, or
other characteristics from the securities in which it typically invests, which
involves a risk that the options or futures position will not track the
performance of the Fund's other investments.
Options and futures contracts prices can also diverge from the prices
of their underlying instruments, even if the underlying instruments match the
Fund's investments well. Options and futures contracts prices are affected by
such factors as current and anticipated short term interest rates, changes in
volatility of the underlying instrument, and the time remaining until expiration
of the contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. The Fund may purchase or sell options and
futures contracts with a greater or lesser value than the securities it wishes
to hedge or intends to purchase in order to attempt to compensate for
differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in the Fund's options or
futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS. There is no assurance that
a liquid market will exist for any particular option or futures contract at any
particular time even if the contract is traded on an exchange. In addition,
exchanges may establish daily price fluctuation limits for options and futures
contracts and may halt trading if a contract's price moves up or down more than
the limit in a given day. On volatile trading days when the price fluctuation
limit is reached or a trading halt is imposed, it may be impossible for the Fund
to enter into new positions or close out existing positions. If the market for a
contract is not liquid because of price fluctuation limits or otherwise, it
could prevent prompt liquidation of unfavorable positions, and could potentially
require the Fund to continue to hold a position until delivery or expiration
regardless of changes in its value. As a result, the Fund's access to other
assets held to cover its options or futures positions could also be impaired.
(See "Exchange Traded and OTC Options" above for a discussion of the liquidity
of options not traded on an exchange.)
POSITION LIMITS. Futures exchanges can limit the number of futures and
options on futures contracts that can be held or controlled by an entity. If an
adequate exemption cannot be obtained, the Fund or the Advisor may be required
to reduce the size of its futures and options positions or may not be able to
trade a certain futures or options contract in order to avoid exceeding such
limits.
ASSET COVERAGE FOR FUTURES CONTRACTS AND OPTIONS POSITIONS. Although
the Fund will not be a commodity pool, certain derivatives subject the Fund to
the rules of the Commodity Futures Trading Commission which limit the extent to
which the Fund can invest in such derivatives. The Fund may invest in futures
contracts and options with respect thereto for hedging purposes without limit.
However, the Fund may not invest in such contracts and options for other
purposes if the sum of the amount of initial margin deposits and premiums paid
for unexpired options with respect to such contracts, other than for bona fide
hedging purposes, exceeds 5% of the liquidation value of the Fund's assets,
after taking into account unrealized profits and unrealized losses on such
contracts and options; provided, however, that in the case of an option that is
in-the-money at the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation.
15
In addition, the Fund will comply with guidelines established by the
SEC with respect to coverage of options and futures contracts by mutual funds,
and if the guidelines so require, will set aside appropriate liquid assets in a
segregated custodial account in the amount prescribed. Securities held in a
segregated account cannot be sold while the futures contract or option is
outstanding, unless they are replaced with other suitable assets. As a result,
there is a possibility that segregation of a large percentage of the Fund's
assets could impede portfolio management or a Fund's ability to meet redemption
requests or other current obligations.
SWAPS AND RELATED SWAP PRODUCTS. The Fund may engage in swap
transactions, including, but not limited to, interest rate, currency, securities
index, basket, specific security and commodity swaps, interest rate caps, floors
and collars and options on interest rate swaps (collectively defined as "swap
transactions").
The Fund may enter into swap transactions for any legal purpose
consistent with its investment objective and policies, such as for the purpose
of attempting to obtain or preserve a particular return or spread at a lower
cost than obtaining that return or spread through purchases and/or sales of
instruments in cash markets, to protect against currency fluctuations, as a
duration management technique, to protect against any increase in the price of
securities the Fund anticipates purchasing at a later date, or to gain exposure
to certain markets in the most economical way possible. The Fund will not sell
interest rate caps, floors or collars if it does not own securities with coupons
which provide the interest that a Fund may be required to pay.
Swap agreements are two-party contracts entered into primarily by
institutional counterparties for periods ranging from a few weeks to several
years. In a standard swap transaction, two parties agree to exchange the returns
(or differentials in rates of return) that would be earned or realized on
specified notional investments or instruments. The gross returns to be exchanged
or "swapped" between the parties are calculated by reference to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency or
commodity, or in a "basket" of securities representing a particular index. The
purchaser of an interest rate cap or floor, upon payment of a fee, has the right
to receive payments (and the seller of the cap is obligated to make payments) to
the extent a specified interest rate exceeds (in the case of a cap) or is less
than (in the case of a floor) a specified level over a specified period of time
or at specified dates. The purchaser of an interest rate collar, upon payment of
a fee, has the right to receive payments (and the seller of the collar is
obligated to make payments) to the extent that a specified interest rate falls
outside an agreed upon range over a specified period of time or at specified
dates. The purchaser of an option on an interest rate swap, upon payment of a
fee (either at the time of purchase or in the form of higher payments or lower
receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional
amount with pre-specified terms with the seller of the option as the
counterparty.
The "notional amount" of a swap transaction is the agreed upon basis
for calculating the payments that the parties have agreed to exchange. For
example, one swap counterparty may agree to pay a floating rate of interest
(e.g., 3 month LIBOR) calculated based on a $10 million notional amount on a
quarterly basis in exchange for receipt of payments calculated based on the same
notional amount and a fixed rate of interest on a semi-annual basis. In the
event the Fund is obligated to make payments more frequently than it receives
payments from the other party, it will incur incremental credit exposure to that
swap counterparty. This risk may be mitigated somewhat by the use of swap
agreements which call for a net payment to be made by the party with the larger
payment obligation when the obligations of the parties fall due on the same
date. Under most swap agreements entered into by the Fund, payments by the
parties will be exchanged on a "net basis", and the Fund will receive or pay, as
the case may be, only the net amount of the two payments.
The amount of the Fund's potential gain or loss on any swap transaction
is not subject to any fixed limit. Nor is there any fixed limit on the Fund's
potential loss if it sells a cap or collar. If the Fund buys a cap, floor or
collar, however, the Fund's potential loss is limited to the amount of the fee
that it has paid. When measured against
16
the initial amount of cash required to initiate the transaction, which is
typically zero in the case of most conventional swap transactions, swaps, caps,
floors and collars tend to be more volatile than many other types of
instruments.
The use of swap transactions, caps, floors and collars involves
investment techniques and risks which are different from those associated with
portfolio security transactions. If the Advisor is incorrect in its forecasts of
market values, interest rates, and other applicable factors, the investment
performance of the Fund will be less favorable than if these techniques had not
been used. These instruments are typically not traded on exchanges. Accordingly,
there is a risk that the other party to certain of these instruments will not
perform its obligations to the Fund or that the Fund may be unable to enter into
offsetting positions to terminate its exposure or liquidate its position under
certain of these instruments when it wishes to do so. Such occurrences could
result in losses to the Fund.
The Advisor will, however, consider such risks and will enter into swap
and other derivatives transactions only when it believes that the risks are not
unreasonable.
The Fund will maintain cash or liquid assets in a segregated account
with its custodian in an amount sufficient at all times to cover its current
obligations under its swap transactions, caps, floors and collars. If the Fund
enters into a swap agreement on a net basis, it will segregate assets with a
daily value at least equal to the excess, if any, of the Fund's accrued
obligations under the swap agreement over the accrued amount the Fund is
entitled to receive under the agreement. If the Fund enters into a swap
agreement on other than a net basis, or sells a cap, floor or collar, it will
segregate assets with a daily value at least equal to the full amount of a
Fund's accrued obligations under the agreement.
The Fund will not enter into any swap transaction, cap, floor, or
collar, unless the counterparty to the transaction is deemed creditworthy by the
Advisor. If a counterparty defaults, the Fund may have contractual remedies
pursuant to the agreements related to the transaction. The swap markets in which
many types of swap transactions are traded have grown substantially in recent
years, with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the markets for certain types of swaps (e.g., interest rate swaps) have become
relatively liquid. The markets for some types of caps, floors and collars are
less liquid.
The liquidity of swap transactions, caps, floors and collars will be as
set forth in guidelines established by the Advisor and approved by the Trustees
which are based on various factors, including (1) the availability of dealer
quotations and the estimated transaction volume for the instrument, (2) the
number of dealers and end users for the instrument in the marketplace, (3) the
level of market making by dealers in the type of instrument, (4) the nature of
the instrument (including any right of a party to terminate it on demand) and
(5) the nature of the marketplace for trades (including the ability to assign or
offset the Fund's rights and obligations relating to the instrument). Such
determination will govern whether the instrument will be deemed within the 15%
restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value
of the instrument are recognized as unrealized gains or losses by marking to
market to reflect the market value of the instrument. When the instrument is
terminated, the Fund will record a realized gain or loss equal to the
difference, if any, between the proceeds from (or cost of) the closing
transaction and a Fund's basis in the contract.
The federal income tax treatment with respect to swap transactions,
caps, floors, and collars may impose limitations on the extent to which a Fund
may engage in such transactions.
RISK MANAGEMENT
17
The Fund may employ non-hedging risk management techniques. Examples of
such strategies include synthetically altering the duration of its portfolio or
the mix of securities in its portfolio. For example, if the Advisor wishes to
extend maturities in a fixed income portfolio in order to take advantage of an
anticipated decline in interest rates, but does not wish to purchase the
underlying long-term securities, it might cause the Fund to purchase futures
contracts on long-term debt securities. Similarly, if the Advisor wishes to
decrease exposure to fixed income securities or purchase equities, it could
cause the Fund to sell futures contracts on debt securities and purchase futures
contracts on a stock index. Such non-hedging risk management techniques are not
speculative, but because they involve leverage include, as do all leveraged
transactions, the possibility of losses as well as gains that are greater than
if these techniques involved the purchase and sale of the securities themselves
rather than their synthetic derivatives.
SPECIAL FACTORS AFFECTING THE FUND
The Fund intends to invest a high proportion of its assets in municipal
obligations in New York Municipal Securities. Payment of interest and
preservation of principal is dependent upon the continuing ability of New York
issuers and/or obligors of New York Municipal Securities to meet their
obligations thereunder.
The fiscal stability of New York is related, at least in part, to the
fiscal stability of its localities and authorities. Various New York agencies,
authorities and localities have issued large amounts of bonds and notes either
guaranteed or supported by New York through lease-purchase arrangements, other
contractual arrangements or moral obligation provisions. While debt service is
normally paid out of revenues generated by projects of such New York agencies,
authorities and localities, in the past the State has had to provide special
assistance, in some cases of a recurring nature, to enable such agencies,
authorities and localities to meet their financial obligations and, in some
cases, to prevent or cure defaults. The presence of such aid in the future
should not be assumed. To the extent that New York agencies and local
governments require State assistance to meet their financial obligations, the
ability of New York to meet its own obligations as they become due or to obtain
additional financing could be adversely affected.
For further information concerning New York Municipal Obligations, see
Appendix B to this Statement of Additional Information. The summary set forth
above and in Appendix B is based on information from an official statement of
New York general obligation municipal obligations and does not purport to be
complete.
PORTFOLIO TURNOVER
The Portfolio's turnover rates for the fiscal year ended March 31,
1999, for the four months ended July 31, 1999 and for the fiscal year ended July
31, 2000 were 44, (not annualized) and 86%, respectively. A rate of 100%
indicates that the equivalent of all of the Portfolio's assets have been sold
and reinvested in a year. High portfolio turnover may result in the
realization of substantial net capital gains or losses. To the extent net
short term capital gains are realized, any distributions resulting from such
gains are considered ordinary income for federal income tax purposes. See
"Taxes" below.
INVESTMENT RESTRICTIONS
The investment restrictions of the Fund and Portfolio are identical,
unless otherwise specified. Accordingly, references below to the Fund also
include the Portfolio unless the context requires otherwise; similarly,
references to the Portfolio also include the Fund unless the context requires
otherwise.
The investment restrictions below have been adopted by the Fund and
Portfolio. Except where otherwise noted, these investment restrictions are
"fundamental" policies which, under the 1940 Act, may not be changed without the
vote of a majority of the outstanding voting securities of the Fund or
Portfolio, as the case may be. A
18
"majority of the outstanding voting securities" is defined in the 1940 Act as
the lesser of (a) 67% or more of the voting securities present at a meeting if
the holders of more than 50% of the outstanding voting securities are present or
represented by proxy, or (b) more than 50% of the outstanding voting securities.
The percentage limitations contained in the restrictions below apply at the time
of the purchase of securities. Whenever the Fund is requested to vote on a
change in the fundamental investment restrictions of the Portfolio, the Trust
will hold a meeting of Fund shareholders and will cast its votes as instructed
by the Fund's shareholders.
The Fund and its corresponding Portfolio:
1. May not purchase any security which would cause the Fund to concentrate its
investments in the securities of issuers primarily engaged in any
particular industry except as permitted by the SEC;
2. May not issue senior securities, except as permitted under the Investment
Company Act of 1940 or any rule, order or interpretation thereunder;
3. May not borrow money, except to the extent permitted by applicable law;
4. May not underwrite securities of other issuers, except to the extent that
the Fund, in disposing of portfolio securities, may be deemed an
underwriter within the meaning of the 1933 Act;
5. May not purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may (a) invest in securities or other
instruments directly or indirectly secured by real estate, (b) invest in
securities or other instruments issued by issuers that invest in real
estate and (c) make direct investments in mortgages;
6. May not purchase or sell commodities or commodity contracts unless acquired
as a result of ownership of securities or other instruments issued by
persons that purchase or sell commodities or commodities contracts; but
this shall not prevent the Fund from purchasing, selling and entering into
financial futures contracts (including futures contracts on indices of
securities, interest rates and currencies), options on financial futures
contracts (including futures contracts on indices of securities, interest
rates and currencies), warrants, swaps, forward contracts, foreign currency
spot and forward contracts or other derivative instruments that are not
related to physical commodities; and
7. May make loans to other persons, in accordance with the Fund's investment
objective and policies and to the extent permitted by applicable law.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS. The investment restrictions
described below are not fundamental policies of the Fund and its corresponding
Portfolio and may be changed by their Trustees. These non-fundamental investment
policies require that the Fund and its corresponding Portfolio:
(i) May not acquire any illiquid securities, such as repurchase agreements
with more than seven days to maturity or fixed time deposits with a
duration of over seven calendar days, if as a result thereof, more than
15% of the market value of the Fund's net assets would be in investments
which are illiquid;
(ii) May not purchase securities on margin, make short sales of securities, or
maintain a short position, provided that this restriction shall not be
deemed to be applicable to the purchase or sale of when-issued or delayed
delivery securities, or to short sales that are covered in accordance with
SEC rules; and
(iii) May not acquire securities of other investment companies, except as
permitted by the 1940 Act or any order pursuant thereto.
19
There will be no violation of any investment restriction if that
restriction is complied with at the time the relevant action is taken
notwithstanding a later change in market value of an investment, in net or total
assets, in the securities rating of the investment, or any other later change.
For purposes of fundamental investment restrictions regarding industry
concentration, the Advisor may classify issuers by industry in accordance with
classifications set forth in the DIRECTORY OF COMPANIES FILING ANNUAL REPORTS
WITH THE SECURITIES AND EXCHANGE COMMISSION or other sources. In the absence of
such classification or if the Advisor determines in good faith based on its own
information that the economic characteristics affecting a particular issuer make
it more appropriately considered to be engaged in a different industry, the
Advisor may classify an issuer accordingly. For instance, personal credit
finance companies and business credit finance companies are deemed to be
separate industries and wholly owned finance companies are considered to be in
the industry of their parents if their activities are primarily related to
financing the activities of their parents.
TRUSTEES AND MEMBERS OF THE ADVISORY BOARD
TRUSTEES
The Trustees of the Trust, who are also the Trustees of the Portfolio
and the other Master Portfolios as defined below, their principal occupations
during the past five years and dates of birth are set forth below. The mailing
address of the Trustees is c/o Pierpont Group Inc., 461 Fifth Avenue, New York,
New York 10017.
FREDERICK S. ADDY - Trustee, Retired. Former Executive Vice President
and Chief Financial Officer Amoco Corporation. His date of birth is January 1,
1932.
WILLIAM G. BURNS - Trustee, Retired, Former Vice Chairman and Chief
Financial Officer, NYNEX. His date of birth is November 2, 1932.
ARTHUR C. ESCHENLAUER - Trustee, Retired, Former Senior Vice
President, Morgan Guaranty Trust Company of New York. His date of birth is
May 23, 1934.
MATTHEW HEALEY(1) - Trustee, Chairman and Chief Executive Officer;
Chairman, Pierpont Group, Inc., since prior to 1995. His date of birth is
August 23, 1937.
MICHAEL P. MALLARDI - Trustee, Retired, Prior to April 1996, Senior
Vice President, Capital Cities/ABC, Inc. and President, Broadcast Group. His
date of birth is March 17, 1934.
The Trustees of the Trust are the same as the Trustees of the
Portfolio. A majority of the disinterested Trustees have adopted written
procedures reasonably appropriate to deal with potential conflicts of interest
arising from the fact that the same individuals are Trustees of the Trust, the
Portfolio and the J.P. Morgan Institutional Funds, up to and including creating
a separate board of trustees.
Each Trustee is currently paid an annual fee of $75,000 for serving as
Trustee of the Trust, each of the Master Portfolios (as defined below), J.P.
Morgan Funds and J.P. Morgan Series Trust and is reimbursed for expenses
incurred in connection with service as a Trustee. The Trustees may hold various
other directorships unrelated to the Fund.
Trustee compensation expenses paid by the Trust for the calendar year
ended December 31, 1999 are set forth below.
- - -----------------------------
(1) Mr. Healey is an "interested person" (as defined in the 1940 Act) of the
Trust.
20
TOTAL TRUSTEE COMPENSATION
ACCRUED BY THE MASTER
AGGREGATE TRUSTEE PORTFOLIOS(*), J.P. MORGAN FUNDS,
COMPENSATION PAID BY J.P. MORGAN SERIES TRUST AND THE
NAME OF TRUSTEE THE TRUST DURING 1999 TRUST DURING 1999(**)
- - --------------------------------------- ---------------------- ---------------------------------
Frederick S. Addy, Trustee $22,488 $75,000
William G. Burns, Trustee $22,488 $75,000
Arthur C. Eschenlauer, Trustee $22,488 $75,000
Matthew Healey, Trustee(***), $22,488 $75,000
Chairman and Chief Executive
Officer
Michael P. Mallardi, Trustee $22,488 $75,000
(*) Includes the Portfolio and 18 other Portfolios (collectively the "Master
Portfolios") for which JPMIM acts as investment adviser.
(**) No investment company within the fund complex has a pension or
retirement plan. Currently there are 22 investment companies (comprised of 19
investment companies comprising the Master Portfolios, the Trust, the J.P.
Morgan Funds and J.P. Morgan Series Trust) in the fund complex.
(***) During 1999, Pierpont Group, Inc. paid Mr. Healey, in his role as
Chairman of Pierpont Group, Inc., compensation in the amount of $153,800,
contributed $23,100 to a defined contribution plan on his behalf and paid
$17,300 in insurance premiums for his benefit.
The Trustees decide upon matters of general policy and are responsible
for overseeing the Trust's and Portfolio's business affairs. The Portfolio and
the Trust have entered into a Fund Services Agreement with Pierpont Group, Inc.
to assist the Trustees in exercising their overall supervisory responsibilities
over the affairs of the Portfolio and the Trust. Pierpont Group, Inc. was
organized in July 1989 to provide services for the J.P. Morgan Family of Funds
(formerly the "Pierpont Family of Funds"), and the Trustees are the equal and
sole shareholders of Pierpont Group, Inc. The Trust and the Portfolio have
agreed to pay Pierpont Group, Inc. a fee in an amount representing its
reasonable costs in performing these services. These costs are periodically
reviewed by the Trustees. The principal offices of Pierpont Group, Inc. are
located at 461 Fifth Avenue, New York, New York 10017.
The aggregate fees paid to Pierpont Group, Inc. by the Fund and the
Portfolio during the indicated fiscal years are set forth below:
FUND -- For the fiscal year ended March 31, 1999, for the four months ended July
31, 1999 and for the fiscal year ended July 31, 2000: $4,066, $1,428 and $2,546,
respectively.
PORTFOLIO -- For the fiscal year ended March 31, 1999, for the four months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $6,630, $2,300 and
$4,457, respectively.
21
MEMBERS OF THE ADVISORY BOARD
The Trustees determined as of January 26, 2000 to establish an advisory
board and appoint four members ("Members of the Advisory Board") thereto. Each
member serves at the pleasure of the Trustees. The advisory board is distinct
from the Trustees and provides advice to the Trustees as to investment,
management and operations of the Trust; but has no power to vote upon any matter
put to a vote of the Trustees. The advisory board and the members thereof also
serve each of the J.P. Morgan Funds, J.P. Morgan Series Trust and collectively,
together with the Trust (the "Trusts) and the Master Portfolios. It is also the
current intention of the Trustees that the Members of the Advisory Board will be
proposed at the next shareholders' meeting, expected to be held within a year
from the date hereof, for election as Trustees of each of the Trusts and the
Master Portfolios. The creation of the Advisory Board and the appointment of the
members thereof was designed so that the Board of Trustees will continuously
consist of persons able to assume the duties of Trustees and be fully familiar
with the business and affairs of each of the Trusts and the Master Portfolios,
in anticipation of the current Trustees reaching the mandatory retirement age of
seventy. Each member of the Advisory Board is paid an annual fee of $75,000 for
serving in this capacity for the Trust, each of the Master Portfolios, the J.P.
Morgan Funds and the J.P. Morgan Series Trust and is reimbursed for expenses
incurred in connection for such service. The members of the Advisory Board may
hold various other directorships unrelated to these funds. The mailing address
of the Members of the Advisory Board is c/o Pierpont Group, Inc., 461 Fifth
Avenue, New York, New York 10017. Their names, principal occupations during the
past five years and dates of birth are set forth below:
Ann Maynard Gray -- Former President, Diversified Publishing Group and
Vice President, Capital Cities/ABC, Inc. Her date of birth is August 22, 1945.
John R. Laird -- Retired; Former Chief Executive Officer, Shearson
Lehman Brothers and The Boston Company. His date of birth is June 21, 1942.
Gerard P. Lynch -- Retired; Former Managing Director, Morgan Stanley
Group and President and Chief Operating Officer, Morgan Stanley Services, Inc.
His date of birth is October 5, 1936.
James J. Schonbachler -- Retired; Prior to September, 1998, Managing
Director, Bankers Trust Company and Chief Executive Officer and Director,
Bankers Trust A.G., Zurich and BT Brokerage Corp. His date of birth is
January 26, 1943.
OFFICERS
The Trust's and Portfolio's executive officers (listed below), other
than the Chief Executive Officer and the officers who are employees of the
Advisor, are provided and compensated by Funds Distributor, Inc. ("FDI"), a
wholly owned indirect subsidiary of Boston Institutional Group, Inc. The
officers conduct and supervise the business operations of the Trust and the
Portfolio. The Trust and the Portfolio have no employees.
The officers of the Trust and the Portfolio, their principal
occupations during the past five years and dates of birth are set forth below.
Unless otherwise specified, each officer holds the same position with the Trust
and the Portfolio. The business address of each of the officers unless otherwise
noted is Funds Distributor, Inc., 60 State Street, Suite 1300, Boston,
Massachusetts 02109.
MATTHEW HEALEY; Chief Executive Officer; Chairman, Pierpont Group,
since prior to 1995. His address is c/o Pierpont Group Inc., 461 Fifth Avenue,
New York, New York 10017. His date of birth is August 23, 1937.
22
MARGARET W. CHAMBERS; Vice President and Secretary. Senior Vice
President and General Counsel of FDI since April, 1998. From August 1996 to
March 1998, Ms. Chambers was Vice President and Assistant General Counsel for
Loomis, Sayles & Company, L.P. From January 1986 to July 1996, she was an
associate with the law firm of Ropes & Gray. Her date of birth is October 12,
1959.
MARIE E. CONNOLLY; Vice President and Assistant Treasurer. President,
Chief Executive Officer, Chief Compliance Officer and Director of FDI, Premier
Mutual Fund Services, Inc., an affiliate of FDI ("Premier Mutual") and an
officer of certain investment companies advised or administered by FDI since
prior to 1995. Her date of birth is August 1, 1957.
DOUGLAS C. CONROY; Vice President and Assistant Treasurer. Assistant
Vice President and Assistant Department Manager of Treasury Services and
Administration of FDI and an officer of certain investment companies distributed
or administered by FDI. Prior to April 1997, Mr. Conroy was Supervisor of
Treasury Services and Administration of FDI since prior to 1995. His date of
birth is March 31, 1969.
KAREN JACOPPO-WOOD; Vice President and Assistant Secretary. Vice
President and Senior Counsel of FDI and an officer of certain investment
companies distributed or administered by FDI. From June 1994 to January 1996,
Ms. Jacoppo-Wood was a Manager of SEC Registration at Scudder, Stevens & Clark,
Inc. Her date of birth is December 29, 1966.
CHRISTOPHER J. KELLEY; Vice President and Assistant Secretary. Vice
President and Senior Associate General Counsel of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI. From
April 1994 to July 1996, Mr. Kelley was Assistant Counsel at Forum Financial
Group. His date of birth is December 24, 1964.
KATHLEEN K. MORRISEY; Vice President and Assistant Secretary. Vice
President and Assistant Secretary of FDI. Manager of Treasury Services
Administration and an officer of certain investment companies advised or
administered by Montgomery Asset Management, L.P. and Dresdner RCM Global
Investors, Inc., and their respective affiliates. From July 1994 to November
1995, Ms. Morrisey was a Fund Accountant II for Investors Bank & Trust Company.
Her date of birth is July 5, 1972.
MARY A. NELSON; Vice President and Assistant Treasurer. Vice President
and Manager of Treasury Services and Administration of FDI and Premier Mutual
and an officer of certain investment companies distributed or administered by
FDI. Her date of birth is April 22, 1964.
MARY JO PACE; Assistant Treasurer. Vice President, Morgan Guaranty
Trust Company of New York since 1990. Ms. Pace serves in the Funds
Administration group as a Manager for the Budgeting and Expense Processing
Group. Prior to September 1995, Ms. Pace served as a Fund Administrator for
Morgan Guaranty Trust Company of New York. Her address is 60 Wall Street, New
York, New York 10260. Her date of birth is March 13, 1966.
GEORGE A. RIO; President and Treasurer. Executive Vice President and
Client Service Director of FDI since April 1998. From June 1995 to March 1998,
Mr. Rio was Senior Vice President and Senior Key Account Manager for Putnam
Mutual Funds. His date of birth is January 2, 1955.
CHRISTINE ROTUNDO; Assistant Treasurer. Vice President, Morgan
Guaranty Trust Company of New York. Ms. Rotundo serves as Manager of the Funds
Infrastructure group and is responsible for the management of special projects.
Prior to January 2000, she served as Manager of the Tax Group in the Funds
Administration group and was responsible for U.S. mutual fund tax matters. Her
address is 60 Wall Street, New York, New York 10260. Her date of birth is
September 26, 1965.
23
ELBA VASQUEZ; Vice President and Assistant Secretary. Vice President
of FDI since February 1999. Ms. Vasquez served as a Sales Associate for FDI from
May 1996. Prior to that she served in various mutual fund sales and marketing
positions for U.S. Trust Company of New York. Her date of birth is December 14,
1961.
As of October 31, 2000, Trustees, Members of the Advisory Board and
Officers as a group owned less than 1% of the outstanding shares of the Fund.
CODES OF ETHICS
The Trust, FDI and the Advisor have adopted codes of ethics pursuant to
Rule 17j-1 under the 1940 Act. Each of these codes permits personnel subject to
such code to invest in securities, including securities that may be purchased or
held by the Funds. Such purchases, however, are subject to procedures reasonably
necessary to prevent access persons from engaging in any unlawful conduct set
forth in Rule 17j-1.
INVESTMENT ADVISOR
The Fund has not retained the services of an investment adviser because
each Fund seeks to achieve its investment objective by investing all of its
investable assets in a corresponding Portfolio. Subject to the supervision of
the Portfolio's Trustees, the Advisor makes the Portfolio's day-to-day
investment decisions, arranges for the execution of Portfolio transactions and
generally manages the Portfolio's investments. Prior to October 28, 1998, Morgan
was the Investment Advisor. JPMIM, a wholly owned subsidiary of J.P. Morgan &
Co. Incorporated ("J.P. Morgan"), is a registered investment adviser under the
Investment Advisers Act of 1940, as amended, and manages employee benefit funds
of corporations, labor unions and state and local governments and the accounts
of other institutional investors, including investment companies. Certain of the
assets of employee benefit accounts under its management are invested in
commingled pension trust funds for which Morgan serves as trustee.
J.P. Morgan, through the Advisor and other subsidiaries, acts as
investment advisor to individuals, governments, corporations, employee benefit
plans, mutual funds and other institutional investors with combined assets under
management of approximately $373 billion.
Morgan, whose principal offices are at 60 Wall Street, New York, New
York 10260, is a New York trust company which conducts a general banking and
trust business. Morgan is subject to regulation by the New York State Banking
Department and is a member bank of the Federal Reserve System. Through offices
in New York City and abroad, Morgan offers a wide range of services, primarily
to governmental, institutional, corporate and high net worth individual
customers in the United States and throughout the world. The firm, through its
predecessor firms, has been in business for over a century and has been managing
investments since 1913. Morgan, is a wholly owned subsidiary of J.P.
Morgan, a bank holding company organized under the laws of the State of
Delaware.
The basis of the Advisor's investment process is fundamental investment
research as the firm believes that fundamentals should determine an asset's
value over the long term. J.P. Morgan currently employs approximately 415 full
time research analysts, capital market researchers, portfolio managers and
traders and has one of the largest research staffs in the money management
industry. The Advisory has investment management divisions located in New York,
London, Tokyo, Frankfurt and Singapore to cover companies, industries and
countries on site.
The investment advisory services the Advisor provides to the Portfolio
are not exclusive under the terms of the Advisory Agreement. The Advisor is free
to and does render similar investment advisory services to others. The Advisor
serves as investment advisor to personal investors and other investment
companies and acts as
24
fiduciary for trusts, estates and employee benefit plans. Certain of the assets
of trusts and estates under management are invested in common trust funds for
which the Advisor serves as trustee. The accounts which are managed or advised
by the Advisor have varying investment objectives and the Advisor invests assets
of such accounts in investments substantially similar to, or the same as, those
which are expected to constitute the principal investments of the Portfolio.
Such accounts are supervised by officers and employees of the Advisor who may
also be acting in similar capacities for the Portfolio. See "Portfolio
Transactions."
Sector weightings are generally similar to a benchmark with the
emphasis on security selection as the method to achieve investment performance
superior to the benchmark. The benchmark for the Portfolio is currently the
Lehman Brothers New York 1 to 17 Years Municipal Bond Index. Previously the
fund has used the Lehman Brothers 1-16 year Municipal Bond Index as a
comparative broad-based securities market index. The fund has chosen the Lehman
Brothers New York 1 to 17 Years Municipal Bond Index, because it measures New
York tax-exempt bond market performance and reflects the universe of securities
in which the fund invests.
The Portfolio is managed by employees of the Advisor who, in acting for
their customers, including the Portfolio, do not discuss their investment
decisions with any personnel of J.P. Morgan with the exception of certain
investment management affiliates of J.P. Morgan or broker affiliates of J.P.
Morgan which execute transactions on behalf of the Fund.
As compensation for the services rendered and related expenses such as
salaries of advisory personnel borne by the Advisor under the Investment
Advisory Agreement, the Portfolio has agreed to pay the Advisor a fee, which is
computed daily and may be paid monthly, equal to the annual rate of 0.30% of the
Portfolio's average daily net assets.
For the fiscal year ended March 31, 1999, the four months ended July
31, 1999 and for the fiscal year ended July 31, 2000, the advisory fees paid by
the Portfolio were $796,521, $298,444 and $809,418, respectively.
See "Expenses" below for applicable expense limitations.
The Investment Advisory Agreement provides that it will continue in
effect for a period of two years after execution only if specifically approved
thereafter annually in the same manner as the Distribution Agreement. See
"Distributor" below. The Investment Advisory Agreement will terminate
automatically if assigned and is terminable at any time without penalty by a
vote of a majority of the Portfolio's Trustees, or by a vote of the holders of a
majority of the Portfolio's outstanding voting securities, on 60 days' written
notice to the Advisor and by the Advisor on 90 days' written notice to the
Portfolio. See "Additional Information."
Under separate agreements, Morgan provides certain financial, fund
accounting and administrative services to the Trust and the Portfolio and
shareholder services for the Trust. See "Services Agent" and "Shareholder
Servicing" below.
DISTRIBUTOR
FDI serves as the Trust's exclusive Distributor and holds itself
available to receive purchase orders for the Fund's shares. In that capacity,
FDI has been granted the right, as agent of the Trust, to solicit and accept
orders for the purchase of the Fund's shares in accordance with the terms of the
Distribution Agreement between the Trust and FDI. Under the terms of the
Distribution Agreement between FDI and the Trust, FDI receives no compensation
in its capacity as the Trust's distributor.
25
The Distribution Agreement shall continue in effect with respect to the
Fund for a period of two years after execution only if it is approved at least
annually thereafter (i) by a vote of the holders of a majority of the Fund's
outstanding shares or by its Trustees and (ii) by a vote of a majority of the
Trustees of the Trust who are not "interested persons" (as defined by the 1940
Act) of the parties to the Distribution Agreement, cast in person at a meeting
called for the purpose of voting on such approval (see "Trustees and Members of
the Advisory Board" and "Officers"). The Distribution Agreement will terminate
automatically if assigned by either party thereto and is terminable at any time
without penalty by a vote of a majority of the Trustees of the Trust, a vote of
a majority of the Trustees who are not "interested persons" of the Trust, or by
a vote of the holders of a majority of the Fund's outstanding shares as defined
under "Additional Information," in any case without payment of any penalty on 60
days' written notice to the other party. The principal offices of FDI are
located at 60 State Street, Suite 1300, Boston, Massachusetts 02109.
CO-ADMINISTRATOR
Under Co-Administration Agreements with the Trust and the Portfolio
dated August 1, 1996, FDI also serves as the Trust's and the Portfolio's
Co-Administrator. The Co-Administration Agreements may be renewed or amended by
the respective Trustees without a shareholder vote. The Co-Administration
Agreements are terminable at any time without penalty by a vote of a majority of
the Trustees of the Trust or the Portfolio, as applicable, on not more than 60
days' written notice nor less than 30 days' written notice to the other party.
The Co-Administrator may subcontract for the performance of its obligations,
provided, however, that unless the Trust or the Portfolio, as applicable,
expressly agrees in writing, the Co-Administrator shall be fully responsible for
the acts and omissions of any subcontractor as it would for its own acts or
omissions. See "Services Agent" below.
FDI (i) provides office space, equipment and clerical personnel for
maintaining the organization and books and records of the Trust and the
Portfolio; (ii) provides officers for the Trust and the Portfolio; (iii)
prepares and files documents required for notification of state securities
administrators; (iv) reviews and files marketing and sales literature; (v) files
Portfolio regulatory documents and mails Portfolio communications to Trustees
and investors; and (vi) maintains related books and records.
For its services under the Co-Administration Agreements, the Fund and
Portfolio have agreed to pay FDI fees equal to its allocable share of an annual
complex-wide charge of $425,000 plus FDI's out-of-pocket expenses. The amount
allocable to the Fund or Portfolio is based on the ratio of its net assets to
the aggregate net assets of the Trust, the Master Portfolios and certain other
investment companies subject to similar agreements with FDI.
The table below sets forth for the Fund and the Portfolio the
administrative fees paid to FDI for the fiscal periods indicated.
FUND -- For the fiscal year ended March 31, 1999, for the four months ended July
31, 1999 and for the fiscal year ended July 31, 2000: $2,990, $882 and $1,916,
respectively.
PORTFOLIO -- For the fiscal year ended March 31, 1999, for the four months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $3,052, $880 and
$1,981, respectively.
SERVICES AGENT
The Trust, on behalf of the Fund, and the Portfolio have entered into
Administrative Services Agreements (the "Services Agreements") with Morgan,
pursuant to which Morgan is responsible for certain administrative and related
services provided to the Fund and Portfolio. The Services Agreements may be
terminated at any time,
26
without penalty, by the Trustees or Morgan, in each case on not more than 60
days' nor less than 30 days' written notice to the other party.
Under the Services Agreements, Morgan provides certain administrative
and related services to the Fund and the Portfolio, including services related
to tax compliance, preparation of financial statements, calculation of
performance data, oversight of service providers and certain regulatory and
Board of Trustee matters.
Under the Services Agreements, the Fund and the Portfolio have agreed
to pay Morgan fees equal to its allocable share of an annual complex-wide
charge. This charge is calculated daily based on the aggregate net assets of the
Master Portfolios and J.P. Morgan Series Trust in accordance with the following
annual schedule: 0.09% of the first $7 billion of their aggregate average daily
net assets and 0.04% of their aggregate average daily net assets in excess of $7
billion, less the complex-wide fees payable to FDI. The portion of this charge
payable by the Fund and Portfolio is determined by the proportionate share that
its net assets bear to the total net assets of the Trust, the Master Portfolios,
the other investors in the Master Portfolios for which Morgan provides similar
services and J.P. Morgan Series Trust.
The table below sets forth for the Fund and the Portfolio the fees
paid to Morgan as Services Agent.
FUND -- For the fiscal year ended March 31, 1999, for the four months ended July
31, 1999 and for the fiscal year ended July 31, 2000: $45,134, $15,661 and
$38,925, respectively.
PORTFOLIO -- For the fiscal year ended March 31, 1999, for the four months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $73,366, $25,575 and
$68,240, respectively.
CUSTODIAN AND TRANSFER AGENT
The Bank of New York ("BONY"), One Wall Street, New York, New York
10286, serves as the Trust's custodian and fund accounting agent. Pursuant to
the Custodian Contract and Fund Accounting Agreement with the Trust, BONY is
responsible for holding portfolio securities and cash and maintaining the books
of account and records of the Fund's portfolio transactions.
State Street Bank and Trust Company ("State Street"), 225 Franklin
Street, Boston, Massachusetts 02110, serves as the Trust's transfer and dividend
disbursing agent. As transfer agent and dividend disbursing agent, State Street
is responsible for maintaining account records detailing the ownership of Fund
shares and for crediting income, capital gains and other changes in share
ownership to shareholder accounts.
SHAREHOLDER SERVICING
The Trust, on behalf of the Fund, has entered into a Shareholder
Servicing Agreement with Morgan pursuant to which Morgan acts as shareholder
servicing agent for its customers and for other Fund investors who are customers
of a Financial Professional. Under this agreement, Morgan is responsible for
performing shareholder account, administrative and servicing functions, which
include but are not limited to, answering inquiries regarding account status and
history, the manner in which purchases and redemptions of Fund shares may be
effected, and certain other matters pertaining to the Fund; assisting customers
in designating and changing dividend options, account designations and
addresses; providing necessary personnel and facilities to coordinate the
establishment and maintenance of shareholder accounts and records with the
Fund's transfer agent; transmitting purchase and redemption orders to the Fund's
transfer agent and arranging for the wiring or other transfer of funds to and
from customer accounts in connection with orders to purchase or redeem Fund
shares; verifying purchase and redemption orders, transfers among and changes in
accounts; informing the Distributor of the gross amount of purchase orders for
Fund shares; monitoring the activities of the Fund's transfer agent; and
providing other related services.
27
Effective August 1, 1998, under the Shareholder Servicing Agreement,
the Fund has agreed to pay Morgan for these services a fee at an annual rate of
0.10% (expressed as a percentage of the average daily net asset value of Fund
shares owned by or for shareholders).
The shareholder servicing fees paid by the Fund to Morgan for the
fiscal year ended March 31, 1999, for the four months ended July 31, 1999 and
for the fiscal year ended July 31, 2000: $152,227, $60,929 and $157,592,
respectively.
If Morgan were prohibited from providing any of the services under the
Shareholder Servicing Agreement and the Services Agreements, the Trustees would
seek an alternative provider of such services. In such event, changes in the
operation of the Fund or the Portfolio might occur and a shareholder might no
longer be able to avail himself or herself of any services then being provided
to shareholders by Morgan.
The Fund may be sold to or through financial intermediaries who are
customers of J.P. Morgan ("financial professionals"), including financial
institutions and broker-dealers, that may be paid fees by J.P. Morgan or its
affiliates for services provided to their clients that invest in the Fund. See
"Financial Professionals" below. Organizations that provide record keeping or
other services to certain employee benefit or retirement plans that include the
Fund as an investment alternative may also be paid a fee.
FINANCIAL PROFESSIONALS
The services provided by financial professionals may include
establishing and maintaining shareholder accounts, processing purchase and
redemption transactions, arranging for bank wires, performing shareholder
subacounting, answering client inquiries regarding the Trust, assisting clients
in changing dividend options, account designations and addresses, providing
periodic statements showing the client's account balance and integrating these
statements with those of other transactions and balances in the client's other
accounts serviced by the financial professional, transmitting proxy statements,
periodic reports, updated prospectuses and other communications to shareholders
and, with respect to meetings of shareholders, collecting, tabulating and
forwarding executed proxies and obtaining such other information and performing
such other services as J.P. Morgan or the financial professional's clients may
reasonably request and agree upon with the financial professional.
Although there is no sales charge levied directly by the Fund,
financial professionals may establish their own terms and conditions for
providing their services and may charge investors a transaction or other fee for
their services. Such charges may vary among financial professionals and will not
be remitted to the Fund or J.P. Morgan.
The Fund has authorized one or more brokers to accept purchase and
redemption orders on its behalf. Such brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
The Fund will be deemed to have received a purchase or redemption order when an
authorized broker or, if applicable, a broker's authorized designee, accepts the
order. These orders will be priced at the Fund's net asset value next calculated
after they are so accepted.
INDEPENDENT ACCOUNTANTS
The independent accountants of the Trust and the Portfolio are
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036. PricewaterhouseCoopers LLP conducts an annual audit of the financial
statements of the Fund and the Portfolio, assists in the preparation and/or
review of the Fund's and the Portfolio's federal and state income tax returns
and consults with the Fund and the Portfolio as to matters of accounting and
federal and state income taxation.
28
EXPENSES
In addition to the fees payable to Pierpont Group, Inc., JPMIM, Morgan
and FDI under various agreements discussed under "Trustees and Members of the
Advisory Board," "Officers," "Investment Advisor", "Co- Administrator",
"Distributor", "Services Agent" and "Shareholder Servicing" above, the Fund and
the Portfolio are responsible for usual and customary expenses associated with
their respective operations. Such expenses include organization expenses, legal
fees, accounting and audit expenses, insurance costs, the compensation and
expenses of the Trustees, costs associated with registration fees under federal
securities laws, and extraordinary expenses applicable to the Fund or the
Portfolio. For the Fund, such expenses also include transfer, registrar and
dividend disbursing costs, the expenses of printing and mailing reports, notices
and proxy statements to Fund shareholders; and filing fees under state
securities laws. For the Portfolio, such expenses also include custodian fees
and brokerage expenses.
J.P. Morgan has agreed that it will reimburse the Fund until
November 28, 2001, as described in the Prospectus, to the extent necessary to
maintain the Fund's total operating expenses (which include expenses of the Fund
and the Portfolio) at the annual rate of 0.50% of the Fund's average daily net
assets. This limit does not cover extraordinary expenses.
The table below sets forth for the Fund the fees and other expenses
Morgan reimbursed under the expense reimbursement arrangement described above or
pursuant to prior expense reimbursement arrangement for the fiscal periods
indicated.
FUND -- For the fiscal year ended March 31, 1999, for the four months ended July
31, 1999 and for the fiscal year ended July 31, 2000: $110,632, $57,604 and
$93,011, respectively.
PORTFOLIO -- For the fiscal year ended March 31, 1999 for the four months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: no expenses of the
portfolio were reimbursed by Morgan.
PURCHASE OF SHARES
ADDITIONAL MINIMUM BALANCE INFORMATION. If your account balance falls
below the minimum for 30 days as a result of selling shares (and not because of
performance), the Fund reserves the right to request that you buy more shares or
close your account. If your account balance is still below the minimum 60 days
after notification, the Fund reserves the right to close out your account and
send the proceeds to the address of record.
METHOD OF PURCHASE. Investors may open Fund accounts and purchase
shares as described in the Prospectus. References in the Prospectus and this
Statement of Additional Information to customers of Morgan or a Financial
Professional include customers of their affiliates and references to
transactions by customers with Morgan or a Financial Professional include
transactions with their affiliates. Only Fund investors who are using the
services of a financial institution acting as shareholder servicing agent
pursuant to an agreement with the Trust on behalf of the Fund may make
transactions in shares of the Fund. All purchase orders must be accepted by the
Distributor.
The Fund may, at its own option, accept securities in payment for
shares. The securities delivered in such a transaction are valued by the method
described in "Net Asset Value" as of the day the Fund receives the securities.
This is a taxable transaction to the shareholder. Securities may be accepted in
payment for shares only if they are, in the judgment of the Advisor appropriate
investments for the Fund's corresponding Portfolio. In addition, securities
accepted in payment for shares must: (i) meet the investment objective and
policies of Portfolio; (ii) be acquired by the Fund for investment and not for
resale (other than for resale to the Portfolio); (iii) be liquid securities
which are not restricted as to transfer either by law or liquidity of market;
and (iv) if stock, have a value which is readily ascertainable as evidenced
by a listing on a stock exchange, OTC market or by readily available market
quotations
29
from a dealer in such securities. The Fund reserves the right to accept or
reject at its own option any and all securities offered in payment for its
shares.
Prospective investors may purchase shares with the assistance of a
Financial Professional, and a Financial Professional may charge the investor a
fee for this service and other services it provides to its customers.
REDEMPTION OF SHARES
Investors may redeem shares as described in the Prospectus.
If the Trust, on behalf of the Fund, and the Portfolio determines that
it would be detrimental to the best interest of the remaining shareholders of a
Fund to make payment wholly or partly in cash, payment of the redemption price
may be made in whole or in part by a distribution in kind of securities from the
Fund, in lieu of cash, in conformity with the applicable rule of the SEC. If
shares are redeemed in kind, the redeeming shareholder might incur transaction
costs in converting the assets into cash. The method of valuing portfolio
securities is described under "Net Asset Value," and such valuation will be made
as of the same time the redemption price is determined. The Trust on behalf of
the Fund and the Portfolio have elected to be governed by Rule 18f-1 under the
1940 Act pursuant to which the Fund and the Portfolio are obligated to redeem
shares solely in cash up to the lesser of $250,000 or one percent of the net
asset value of the Fund during any 90 day period for any one shareholder. The
Trust will redeem Fund shares in kind only if it has received a redemption in
kind from the Portfolio and therefore shareholders of the Fund that receive
redemptions in kind will receive securities of the Portfolio. The Portfolio has
advised the Trust that the Portfolio will not redeem in kind except in
circumstances in which the Fund is permitted to redeem in kind.
FURTHER REDEMPTION INFORMATION. Investors should be aware that
redemptions from the Fund may not be processed if a redemption request is not
submitted in proper form. To be in proper form, the Fund must have received the
shareholder's taxpayer identification number and address. In addition, if a
shareholder sends a check for the purchase of fund shares and shares are
purchased before the check has cleared, the transmittal of redemption proceeds
from the shares will occur upon clearance of the check which may take up to 15
days. The Trust, on behalf of the Fund, and the Portfolio, reserve the right to
suspend the right of redemption and to postpone the date of payment upon
redemption as follows: (i) for up to seven days, (ii) during periods when the
New York Stock Exchange is closed for other than weekends and holidays or when
trading on such Exchange is restricted as determined by the SEC by rule or
regulation, (iii) during periods in which an emergency, as determined by the
SEC, exists that causes disposal by the Portfolio of, or evaluation of the net
asset value of, its portfolio securities to be unreasonable or impracticable, or
(iv) for such other periods as the SEC may permit. For information regarding
redemption orders placed through a financial professional, please see "Financial
Professionals" above.
EXCHANGE OF SHARES
An investor may exchange shares of the Fund for shares of any J.P.
Morgan Institutional Fund, J.P. Morgan Fund or J.P. Morgan Series Trust fund
without charge. An exchange may be made so long as after the exchange the
investor has shares, in each fund in which he or she remains an investor, with a
value of at least that fund's minimum investment amount. Shareholders should
read the prospectus of the fund into which they are exchanging and may only
exchange between fund accounts that are registered in the same name, address and
taxpayer identification number. Shares are exchanged on the basis of relative
net asset value per share. Exchanges are in effect redemptions from one fund and
purchases of another fund and the usual purchase and redemption procedures and
requirements are applicable to exchanges. The Funds generally intend to pay
redemption proceeds in cash, however, since they reserve the right at their sole
discretion to pay redemptions over $250,000 in-kind as a portfolio of
representative stocks rather than in cash, each Fund reserves the right to deny
an exchange request in excess of that amount. See "Redemption of Shares".
Shareholders subject to federal income tax who exchange
30
shares in one fund for shares in another fund may recognize capital gain or loss
for federal income tax purposes. Shares of the fund to be acquired are purchased
for settlement when the proceeds from redemption become available. In the case
of investors in certain states, state securities laws may restrict the
availability of the exchange privilege. The Fund reserves the right to
discontinue, alter or limit its exchange privilege at any time.
DIVIDENDS AND DISTRIBUTIONS
The Fund declares and pays dividends and distributions as described
under "Dividends and Distributions" in the Prospectus.
Dividends and capital gains distributions paid by a Fund are
automatically reinvested in additional shares of the Fund unless the shareholder
has elected to have them paid in cash. Dividends and distributions to be paid in
cash are credited to the shareholder's account at Morgan or at his financial
professional or, in the case of certain Morgan customers, are mailed by check in
accordance with the customer's instructions. Each Fund reserves the right to
discontinue, alter or limit the automatic reinvestment privilege at any time.
If a shareholder has elected to receive dividends and/or capital gain
distributions in cash and the postal or other delivery service is unable to
deliver checks to the shareholder's address of record, such shareholder's
distribution option will automatically be converted to having all dividend and
other distributions reinvested in additional shares. No interest will accrue on
amounts represented by uncashed distribution or redemption checks.
NET ASSET VALUE
The Fund computes its net asset value separately for each class of
shares outstanding once daily as of the close of trading on the New York Stock
Exchange (normally 4:00 p.m. eastern time) on each business day as described in
the prospectus. The net asset value will not be computed on the day the
following legal holidays are observed: New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day. On days when U.S. trading markets close
early in observance of these holidays, the Fund will close for purchases and
redemptions at the same time. The Fund and the Portfolio may also close for
purchases and redemptions at such other times as may be determined by the Board
of Trustees to the extent permitted by applicable law. The days on which net
asset value is determined are the Fund's business days.
The net asset value of the Fund is equal to the value of the Fund's
investment in its corresponding Portfolio (which is equal to the Fund's pro rata
share of the total investment of the Fund and of any other investors in the
Portfolio less the Fund's pro rata share of the Portfolio's liabilities) less
the Fund's liabilities. The following is a discussion of the procedures used by
the Portfolio corresponding to the Fund in valuing its assets.
Listed options on debt securities traded on U.S. option exchanges shall
be valued at their closing price on such exchanges. Futures on debt securities
and related options traded on commodities exchanges shall be valued at their
closing price as of the close of such commodities exchanges, which is currently
4:15p.m., New York time. Options and future traded on foreign exchanges shall be
valued at the last sale or close price available prior to the calculation of the
Funds' net asset value. Non-listed OTC options and swaps shall be valued at the
closing price provided by a counterparty or third-party broker.
Fixed income securities with a maturity of 60 days or more, are
generally valued using bid quotations readily available from and supplied
daily by pricing services or brokers. If such prices are generally not readily
available from the Fund's pricing services or brokers, such securities are
priced in accordance with fair value procedures adopted by the Trustees. Such
fair value procedures include the use of pricing services, which use prices
based upon yields or prices of securities of comparable quality, coupon,
maturity
31
and type; indications as to values from dealers; and general market conditions.
Fixed income securities with a remaining maturity of less than 60 days are
valued by the amortized cost method.
PERFORMANCE DATA
From time to time, the Fund may quote performance in terms of yield,
tax equivalent yield, actual distributions, total returns or capital
appreciation in reports, sales literature and advertisements published by the
Trust. Current performance information for the Fund may be obtained by calling
the number provided on the cover page of this Statement of Additional
Information. See also the Prospectus.
Comparative performance information may be used from time to time in
advertising the Funds' shares, including appropriate market indices including
the benchmarks indicated under "Investment Advisor" above or data from Lipper
Analytical Services, Inc., Micropal, Inc., Ibbotson Associates, Morningstar
Inc., the Dow Jones Industrial Average and other industry publications.
YIELD QUOTATIONS. As required by regulations of the SEC, the annualized
yield for the Fund is computed by dividing the Fund's net investment income per
share earned during a 30-day period by the net asset value on the last day of
the period. The average daily number of shares outstanding during the period
that are eligible to receive dividends is used in determining the net investment
income per share. Income is computed by totaling the interest earned on all debt
obligations during the period and subtracting from that amount the total of all
recurring expenses incurred during the period. The 30-day yield is then
annualized on a bond-equivalent basis assuming semi-annual reinvestment and
compounding of net investment income. Annualized tax-equivalent yield reflects
the approximate annualized yield that a taxable investment must earn for
shareholders at specified federal and New York income tax levels to produce an
after-tax yield equivalent to the annualized tax-exempt yield.
The historical yield information for the Fund at July 31, 2000: 30-day
yield: 4.48%; 30-day tax equivalent yield at 39.6% tax rate: 7.42%.
TOTAL RETURN QUOTATIONS. The Fund may advertise "total return" and
non-standardized total return data. The total return shows what an investment in
a Fund would have earned over a specified period of time (one, five or ten years
or since commencement of operations, if less) assuming that all distributions
and dividends by the Fund were reinvested on the reinvestment dates during the
period and less all recurring fees. This method of calculating total return is
required by regulations of the SEC. Total return data similarly calculated,
unless otherwise indicated, over other specified periods of time may also be
used. All performance figures are based on historical earnings and are not
intended to indicate future performance.
As required by regulations of the SEC, the average annual total return
of the Fund for a period is computed by assuming a hypothetical initial payment
of $1,000. It is then assumed that all of the dividends and distributions by the
Fund over the period are reinvested. It is then assumed that at the end of the
period, the entire amount is redeemed. The average annual total return is then
calculated by determining the annual rate required for the initial payment to
grow to the amount which would have been received upon redemption.
Aggregate total returns, reflecting the cumulative percentage change
over a measuring period, may also be calculated.
The historical return information for the Fund at July 31, 2000:
Average annual total return, 1 year: 4.32%; average annual total return, 5
years: 5.01%; average annual total return, commencement of investment
operations(2)
- - ----------------------------
(2) The fund's inception date was April 11, 1994, commencement of investment
operations was April 15, 1994.
32
(April 15, 1994) to period end: 5.47%; aggregate total return, 1 year: 4.32%;
aggregate total return, 5 years: 27.69%; aggregate total return, commencement of
investment operations (April 15, 1994) to period end: 39.81%.
GENERAL. The Fund's performance will vary from time to time depending
upon market conditions, the composition of the Portfolio, and operating
expenses. Consequently, any given performance quotation should not be considered
representative of the Fund's performance for any specified period in the future.
In addition, because performance will fluctuate, it may not provide a basis for
comparing an investment in the Fund with certain bank deposits or other
investments that pay a fixed yield or return for a stated period of time.
From time to time, the Fund may, in addition to any other permissible
information, include the following types of information in advertisements,
supplemental sales literature and reports to shareholders: (1) discussions of
general economic or financial principles (such as the effects of compounding and
the benefits of dollar-cost averaging); (2) discussions of general economic
trends; (3) presentations of statistical data to supplement such discussions;
(4) descriptions of past or anticipated portfolio holdings for the Fund; (5)
descriptions of investment strategies for the Fund; (6) descriptions or
comparisons of various savings and investment products (including, but not
limited to, qualified retirement plans and individual stocks and bonds), which
may or may not include the Fund; (7) comparisons of investment products
(including the Fund) with relevant markets or industry indices or other
appropriate benchmarks; (8) discussions of fund rankings or ratings by
recognized rating organizations; and (9) discussions of various statistical
methods quantifying the Fund's volatility relative to its benchmark or to past
performance, including risk adjusted measures. The Fund may also include
calculations, such as hypothetical compounding examples, which describe
hypothetical investment results in such communications. Such performance
examples will be based on an express set of assumptions and are not indicative
of the performance of the Fund.
PORTFOLIO TRANSACTIONS
The Advisor places orders for the Portfolio for all purchases and
sales of portfolio securities, enters into repurchase agreements, and may enter
into reverse repurchase agreements and execute loans of portfolio securities on
behalf of the Portfolio. See "Investment Objective and Policies."
Fixed income and debt securities and municipal bonds and notes are
generally traded at a net price with dealers acting as principal for their own
accounts without a stated commission. The price of the security usually includes
profit to the dealers. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On occasion,
certain securities may be purchased directly from an issuer, in which case no
commissions or discounts are paid.
Portfolio transactions for the Portfolio will be undertaken principally
to accomplish a Portfolio's objective in relation to expected movements in the
general level of interest rates. The Portfolio may engage in short-term trading
consistent with its objective. See "Investment Objective and Policies --
Portfolio Turnover."
In connection with portfolio transactions for the Portfolio, the
Advisor intends to seek the best execution on a competitive basis for both
purchases and sales of securities.
Subject to the overriding objective of obtaining the best execution of
orders, the Advisor may allocate a portion of the Portfolio's brokerage
transactions to affiliates of the Advisor. In order for affiliates of the
Advisor to effect any portfolio transactions for the Portfolio, the commissions,
fees or other remuneration received by such affiliates must be reasonable and
fair compared to the commissions, fees, or other remuneration paid to other
brokers in connection with comparable transactions involving similar securities
being purchased or sold on a securities exchange during a comparable period of
time. Furthermore, the Trustees of the Portfolio, including a
33
majority of the Trustees who are not "interested persons," have adopted
procedures which are reasonably designed to provide that any commissions, fees,
or other remuneration paid to such affiliates are consistent with the foregoing
standard.
Portfolio securities will not be purchased from or through or sold to
or through the Co-Administrator, the Distributor or the Advisor or any other
"affiliated person" (as defined in the 1940 Act) of the Co-Administrator,
Distributor or Advisor when such entities are acting as principals, except to
the extent permitted by law. In addition, the Portfolio will not purchase
securities from any underwriting group of which the Advisor or an affiliate of
the Advisor is a member, except to the extent permitted by law.
Investment decisions made by the Advisor are the product of many
factors in addition to basic suitability for the particular portfolio or other
client in question. Thus, a particular security may be bought or sold for
certain clients even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling the same security. The Fund
may only sell a security to other portfolios or accounts managed by the Advisor
or its affiliates in accordance with procedures adopted by the Trustees.
On those occasions when the Advisor deems the purchase or sale of a
security to be in the best interests of the Portfolio as well as other customers
including other Portfolios, the Advisor to the extent permitted by applicable
laws and regulations, may, but is not obligated to, aggregate the securities to
be sold or purchased for the Portfolio with those to be sold or purchased for
other customers in order to obtain best execution, including lower brokerage
commissions if appropriate. In such event, allocation of the securities so
purchased or sold as well as any expenses incurred in the transaction will be
made by the Advisor in the manner it considers to be most equitable and
consistent with its fiduciary obligations to the Portfolio. In some instances,
this procedure might adversely affect the Portfolio.
If the Portfolio writes options that effect a closing purchase
transaction with respect to an option written by it, normally such transaction
will be executed by the same broker-dealer who executed the sale of the option.
The writing of options by the Portfolio will be subject to limitations
established by each of the exchanges governing the maximum number of options in
each class which may be written by a single investor or group of investors
acting in concert, regardless of whether the options are written on the same or
different exchanges or are held or written in one or more accounts or through
one or more brokers. The number of options which the Portfolio may write may be
affected by options written by the Advisor for other investment advisory
clients. An exchange may order the liquidation of positions found to be in
excess of these limits, and it may impose certain other sanctions.
MASSACHUSETTS TRUST
The Trust is a "Massachusetts business trust" of which the Fund is a
separate and distinct series. A copy of the Declaration of Trust for the Trust
is on file in the office of the Secretary of The Commonwealth of Massachusetts.
Under Massachusetts law, shareholders of such a trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. However, the Trust's Declaration of Trust provides that the shareholders
will not be subject to any personal liability for the acts or obligations of any
Fund and that every written agreement, obligation, instrument or undertaking
made on behalf of any Fund will contain a provision to the effect that the
shareholders are not personally liable thereunder.
Effective January 1, 1998, the name of the Trust was changed from "The
JPM Institutional Funds" to "J.P. Morgan Institutional Funds", and the Fund's
name changed accordingly. Effective October 28, 1998 the name of the Fund was
changed from "J.P. Morgan Institutional New York Total Return Bond Fund" to J.P.
Morgan Institutional New York Tax Exempt Bond Fund", and the Portfolio's name
changed accordingly
34
The Trust's Declaration of Trust further provides that the name of the
Trust refers to the Trustees collectively as Trustees, not as individuals or
personally, that no Trustee, officer, employee or agent of a Fund is liable to a
Fund or to a shareholder, and that no Trustee, officer, employee, or agent is
liable to any third persons in connection with the affairs of a Fund, except as
such liability may arise from his or its own bad faith, willful misfeasance,
gross negligence or reckless disregard of his or its duties to such third
persons. It also provides that all third persons shall look solely to Fund
property for satisfaction of claims arising in connection with the affairs of a
Fund. With the exceptions stated, the Trust's Declaration of Trust provides that
a Trustee, officer, employee, or agent is entitled to be indemnified against all
liability in connection with the affairs of a Fund.
The Trust shall continue without limitation of time subject to the
provisions in the Declaration of Trust concerning termination by action of the
shareholders or by action of the Trustees upon notice to the shareholders.
DESCRIPTION OF SHARES
The Trust is an open-end management investment company organized as a
Massachusetts business trust in which the Fund represents a separate series of
shares of beneficial interest. See "Massachusetts Trust."
The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares ($0.001 par value) of one or more series
and classes within any series and to divide or combine the shares (of any
series) without changing the proportionate beneficial interest of each
shareholder in a Fund (or in the assets of other series, if applicable). Each
share represents an equal proportional interest in a Fund with each other share.
Upon liquidation of the Fund, holders are entitled to share pro rata in the net
assets of the Fund available for distribution to such shareholders. See
"Massachusetts Trust." Shares of a Fund have no preemptive or conversion rights
and are fully paid and nonassessable. The rights of redemption and exchange are
described in the Prospectus and elsewhere in this Statement of Additional
Information.
The shareholders of the Trust are entitled to one vote for each dollar
of net asset value (or a proportionate fractional vote in respect of a
fractional dollar amount), on matters on which shares of the Fund shall be
entitled to vote. Subject to the 1940 Act, the Trustees themselves have the
power to alter the number and the terms of office of the Trustees, to lengthen
their own terms, or to make their terms of unlimited duration subject to certain
removal procedures, and appoint their own successors, PROVIDED, HOWEVER, that
immediately after such appointment the requisite majority of the Trustees have
been elected by the shareholders of the Trust. The voting rights of shareholders
are not cumulative so that holders of more than 50% of the shares voting can, if
they choose, elect all Trustees being selected while the shareholders of the
remaining shares would be unable to elect any Trustees. It is the intention of
the Trust not to hold meetings of shareholders annually. The Trustees may call
meetings of shareholders for action by shareholder vote as may be required by
either the 1940 Act or the Trust's Declaration of Trust.
Shareholders of the Trust have the right, upon the declaration in
writing or vote of more than two-thirds of its outstanding shares, to remove a
Trustee. The Trustees will call a meeting of shareholders to vote on removal of
a Trustee upon the written request of the record holders of 10% of the Trust's
shares. In addition, whenever ten or more shareholders of record who have been
such for at least six months preceding the date of application, and who hold in
the aggregate either shares having a net asset value of at least $25,000 or at
least 1% of the Trust's outstanding shares, whichever is less, shall apply to
the Trustees in writing, stating that they wish to communicate with other
shareholders with a view to obtaining signatures to request a meeting for the
purpose of voting upon the question of removal of any Trustee or Trustees and
accompanied by a form of communication and request which they wish to transmit,
the Trustees shall within five business days after receipt of such application
either: (1) afford to such applicants access to a list of the names and
addresses of all shareholders as recorded on the books of the Trust; or (2)
inform such applicants as to the approximate number of shareholders of record,
and the approximate cost of mailing to them the proposed communication and form
of request. If the Trustees elect to follow the latter
35
course, the Trustees, upon the written request of such applicants, accompanied
by a tender of the material to be mailed and of the reasonable expenses of
mailing, shall, with reasonable promptness, mail such material to all
shareholders of record at their addresses as recorded on the books, unless
within five business days after such tender the Trustees shall mail to such
applicants and file with the SEC, together with a copy of the material to be
mailed, a written statement signed by at least a majority of the Trustees to the
effect that in their opinion either such material contains untrue statements of
fact or omits to state facts necessary to make the statements contained therein
not misleading, or would be in violation of applicable law, and specifying the
basis of such opinion. After opportunity for hearing upon the objections
specified in the written statements filed, the SEC may, and if demanded by the
Trustees or by such applicants shall, enter an order either sustaining one or
more of such objections or refusing to sustain any of them. If the SEC shall
enter an order refusing to sustain any of such objections, or if, after the
entry of an order sustaining one or more of such objections, the SEC shall find,
after notice and opportunity for hearing, that all objections so sustained have
been met, and shall enter an order so declaring, the Trustees shall mail copies
of such material to all shareholders with reasonable promptness after the entry
of such order and the renewal of such tender.
The Trustees have authorized the issuance and sale to the public of
shares of 22 series of the Trust. The Trustees have no current intention to
create any classes within the initial series or any subsequent series. The
Trustees may, however, authorize the issuance of shares of additional series and
the creation of classes of shares within any series with such preferences,
privileges, limitations and voting and dividend rights as the Trustees may
determine. The proceeds from the issuance of any additional series would be
invested in separate, independently managed portfolios with distinct investment
objectives, policies and restrictions, and share purchase, redemption and net
asset valuation procedures. Any additional classes would be used to distinguish
among the rights of different categories of shareholders, as might be required
by future regulations or other unforeseen circumstances. All consideration
received by the Trust for shares of any additional series or class, and all
assets in which such consideration is invested, would belong to that series or
class, subject only to the rights of creditors of the Trust and would be subject
to the liabilities related thereto. Shareholders of any additional series or
class will approve the adoption of any management contract or distribution plan
relating to such series or class and of any changes in the investment policies
related thereto, to the extent required by the 1940 Act.
For information relating to mandatory redemption of Fund shares or
their redemption at the option of the Trust under certain circumstances, see the
Prospectus.
As of October 31, 2000, the following owned of record more than 5% of
the outstanding shares of the Fund:
Morgan as Agent for Trust of LHP Klotz FBO R Klotz (8.29%);Charles
Schwab & Co., Inc. FBO Customers (6.97%); Morgan as Agent for G.
Attfield and A. Hubbard (6.46%); and Morgan as Agent for G. Attfield
and A. Hubbard (6.22%).
SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE
Unlike other mutual funds which directly acquire and manage their own
portfolio of securities, the Fund is an open-end management investment company
which seeks to achieve its investment objective by investing all of its
investable assets in a corresponding Master Portfolio, a separate registered
investment company with the same investment objective and policies as the Fund.
Fund shareholders are entitled to one vote for each dollar of net asset value
(or a proportionate fractional vote in respect of a fractional dollar amount),
on matters on which shares of the Fund shall be entitled to vote.
In addition to selling a beneficial interest to the Fund, the Portfolio
may sell beneficial interests to other mutual funds or institutional investors.
Such investors will invest in the Portfolio on the same terms and conditions
36
and will bear a proportionate share of the Portfolio's expenses. However, the
other investors investing in the Portfolio may sell shares of their own fund
using a different pricing structure than the Fund. Such different pricing
structures may result in differences in returns experienced by investors in
other funds that invest in the Portfolio. Such differences in returns are not
uncommon and are present in other mutual fund structures. Information concerning
other holders of interests in the Portfolio is available from Morgan at
(800) 766-7722.
The Trust may withdraw the investment of the Fund from the Portfolio at
any time if the Board of Trustees of the Trust determines that it is in the best
interests of the Fund to do so. Upon any such withdrawal, the Board of Trustees
would consider what action might be taken, including the investment of all the
assets of the Fund in another pooled investment entity having the same
investment objective and restrictions as the Fund or the retaining of an
investment adviser to manage the Fund's assets in accordance with the investment
policies with respect to the Portfolio described above and in the Fund's
prospectus described below.
Certain changes in the Portfolio's fundamental investment policies or
restrictions, or a failure by the Fund's shareholders to approve such change in
the Portfolio's investment restrictions, may require withdrawal of the Fund's
interest in the Portfolio. Any such withdrawal could result in a distribution in
kind of portfolio securities (as opposed to a cash distribution) from the
Portfolio which may or may not be readily marketable. The distribution in kind
may result in the Fund having a less diversified portfolio of investments or
adversely affect the Fund's liquidity, and the Fund could incur brokerage, tax
or other charges in converting the securities to cash. Notwithstanding the
above, there are other means for meeting shareholder redemption requests, such
as borrowing.
Smaller funds investing in the Portfolio may be materially affected by
the actions of larger funds investing in the Portfolio. For example, if a large
fund withdraws from the Portfolio, the remaining funds may subsequently
experience higher pro rata operating expenses, thereby producing lower returns.
Additionally, because the Portfolio would become smaller, it may become
less diversified, resulting in potentially increased portfolio risk (however,
these possibilities also exist for traditionally structured funds which have
large or institutional investors who may withdraw from a fund). Also funds with
a greater pro rata ownership in the Portfolio could have effective voting
control of the operations of the Portfolio. Whenever the Fund is requested to
vote on matters pertaining to the Portfolio (other than a vote by the Fund to
continue the operation of the Portfolio upon the withdrawal of another investor
in the Portfolio), the Trust will hold a meeting of shareholders of the Fund and
will cast all of its votes proportionately as instructed by the Fund's
shareholders. The Trust will vote the shares held by Fund shareholders who do
not give voting instructions in the same proportion as the shares of Fund
shareholders who do give voting instructions. Shareholders of the Fund who do
not vote will have no affect on the outcome of such matters.
TAXES
The following discussion of tax consequences is based on U.S. federal
tax laws in effect on the date of this Statement of Additional Information.
These laws and regulations are subject to change by legislative or
administrative action, possibly on a retroactive basis.
The Fund intends to qualify and remain qualified as a regulated
investment company under Subchapter M of the Code. As a regulated investment
company, the Fund must, among other things, (a) derive at least 90% of its gross
income from dividends, interest, payments with respect to loans of stock and
securities, gains from the sale or other disposition of stock, securities or
foreign currency and other income (including but not limited to gains from
options, futures, and forward contracts) derived with respect to its business of
investing in such stock, securities or foreign currency and (b) diversify its
holdings so that, at the end of each fiscal quarter, (i) at least 50% of the
value of the Fund's total assets is represented by cash, U.S. Government
securities, investments in other regulated investment companies and other
securities limited, in respect of any one issuer, to an amount not greater than
5% of
37
the Fund's total assets, and 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of its total assets is invested
in the securities of any one issuer (other than U.S. Government securities or
the securities of other regulated investment companies).
As a regulated investment company, the Fund (as opposed to its
shareholders) will not be subject to federal income taxes on the net investment
income and capital gains that it distributes to its shareholders, provided that
at least 90% of its net investment income and realized net short-term capital
gains in excess of net long-term capital losses for the taxable year is
distributed in accordance with the Code's timing requirements.
Under the Code, the Fund will be subject to a 4% excise tax on a
portion of its undistributed taxable income and capital gains if it fails to
meet certain distribution requirements by the end of the calendar year. The Fund
intends to make distributions in a timely manner and accordingly does not expect
to be subject to the excise tax.
For federal income tax purposes, dividends that are declared by the
Fund in October, November or December as of a record date in such month and
actually paid in January of the following year will be treated as if they were
paid on December 31 of the year declared. Therefore, such dividends will
generally be taxable to a shareholder in the year declared rather than the year
paid.
The Fund intends to qualify to pay exempt-interest dividends to its
shareholders by having, at the close of each quarter of its taxable year, at
least 50% of the value of its total assets consist of tax exempt securities. An
exempt-interest dividend is that part of dividend distributions made by the Fund
which consists of interest received by the Fund on tax exempt securities.
Shareholders will not incur any federal income tax on the amount of
exempt-interest dividends received by them from the Fund (other than the
alternative minimum tax under certain circumstances). In view of the Fund's
investment policies, it is expected that a substantial portion of all dividends
will be exempt-interest dividends, although the Fund may from time to time
realize and distribute net short-term capital gains and may invest limited
amounts in taxable securities under certain circumstances. To the extent that
this capital loss is used to offset future gains, it is probable that the gains
so offset will not be distributed to shareholders.
Distributions of net investment income (other than exempt-interest
dividends) and realized net short-term capital gains in excess of net long-term
capital losses are generally taxable to shareholders of the Fund as ordinary
income whether such distributions are taken in cash or reinvested in additional
shares. The Fund generally pays a monthly dividend. If dividend payments exceed
income earned by the Fund, the over-distribution would be considered a return of
capital rather than a dividend payment. The Fund intends to pay dividends in
such a manner so as to minimize the possibility of a return of capital.
Distributions of net long-term capital gains (i.e., net long-term capital gains
in excess of net short-term capital losses) are taxable to shareholders of the
Fund as long-term capital gains, regardless of whether such distributions are
taken in cash or reinvested in additional shares and regardless of how long a
shareholder has held shares in the Fund. In general, long-term capital gain of
an individual shareholder will be subject to a 20% rate of tax.
Gains or losses on sales of portfolio securities will be treated as
long-term capital gains or losses if the securities have been held for more than
one year except in certain cases where, if applicable, a put option is acquired
or a call option is written thereon or the straddle rules described below are
otherwise applicable. Other gains or losses on the sale of securities will be
short-term capital gains or losses. Gains and losses on the sale, lapse or other
termination of options on securities will be treated as gains and losses from
the sale of securities. If an option written by the Fund lapses or is terminated
through a closing transaction, such as a repurchase by the Fund of the option
from its holder, the Fund will realize a short-term capital gain or loss,
depending on whether the premium income is greater or less than the amount paid
by the Fund in the closing transaction. If securities are purchased by
38
the Fund pursuant to the exercise of a put option written by it, the Fund will
subtract the premium received from its cost basis in the securities purchased.
Any distribution of net investment income or capital gains will have
the effect of reducing the net asset value of Fund shares held by a shareholder
by the same amount as the distribution. If the net asset value of the shares is
reduced below a shareholder's cost as a result of such a distribution, the
distribution, although constituting a return of capital to the shareholder, will
be taxable as described above. Investors should thus consider the consequences
of purchasing shares in the Fund shortly before the Fund declares a sizable
dividend distribution.
Any gain or loss realized on the redemption or exchange of Fund shares
by a shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held for more than one year, and
otherwise as short-term capital gain or loss. Long-term capital gain of an
individual holder generally is subject to a maximum tax rate of 20%. However,
if Fund shares are acquired after December 31, 2000 and held for more than
five years, the maximum long-term capital gain tax rate will be reduced to
18%. A shareholder that acquires Fund shares prior to January 1, 2001 may
elect to treat such Fund shares as having been acquired on January 1, 2001.
To make such election, a shareholder would have to treat the Fund shares as
having been sold on January 1, 2001 for their fair market value and would
have to recognize and pay tax on any gain, but would not be entitled to
recognize any loss. Any loss realized by a shareholder upon the redemption or
exchange of shares in the Fund held for six months or less (i) will be
treated as a long-term capital loss to the extent of any long-term capital
gain distributions received by the shareholder with respect to such shares,
and (ii) will be disallowed to the extent of any exempt-interest dividends
received by the shareholder with respect to such shares. In addition, no loss
will be allowed on the redemption or exchange of shares of the Fund, if
within a period beginning 30 days before the date of such redemption or
exchange and ending 30 days after such date, the shareholder acquires (such
as through dividend reinvestment) securities that are substantially identical
to shares of the Fund. Investors are urged to consult their tax advisors
concerning the limitations on the deductibility of capital losses.
Options and futures contracts entered into by the Portfolio may create
"straddles" for U.S. federal income tax purposes and this may affect the
character and timing of gains or losses realized by the Portfolio on options and
futures contacts or on the underlying securities.
Certain options and futures held by the Fund at the end of each fiscal
year will be required to be "marked to market" for federal income tax purposes
- - -- i.e., treated as having been sold at market value. For options and futures
contracts, 60% of any gain or loss recognized on these deemed sales and on
actual dispositions will be treated as long-term capital gain or loss, and the
remainder will be treated as short-term capital gain or loss regardless of how
long the Fund has held such options or futures.
If a correct and certified taxpayer identification number is not on
file, the Fund is required, subject to certain exemptions, to withhold 31% of
certain payments made or distributions declared to non-corporate shareholders.
For federal income tax purposes, the fund had a capital loss
carryforward at July 31, 2000 of $1,268,554, all of which expires in the year
2008. To the extent that this capital loss is used to offset future capital
gains, it is probabley that gains so offset will not be distributed to
shareholders.
STATE AND LOCAL TAXES. The Fund may be subject to state or local taxes
in jurisdictions in which the Fund is deemed to be doing business. In addition,
the treatment of the Fund and its shareholders in those states which have income
tax laws might differ from treatment under the federal income tax laws.
Shareholders should consult their own tax advisors with respect to any state or
local taxes.
OTHER TAXATION. The Trust is organized as a Massachusetts business
trust and, under current law, neither the Trust nor the Fund is liable for any
income or franchise tax in The Commonwealth of Massachusetts, provided that the
Fund continues to qualify as a regulated investment company under Subchapter M
of the Code. The Portfolio is organized as a New York trust. The Portfolio is
not subject to any federal income taxation or income or franchise tax in the
State of New York or The Commonwealth of Massachusetts. The investment by the
Fund in the Portfolio does not cause the Fund to be liable for any income or
franchise tax in the State of New York.
ADDITIONAL INFORMATION
39
Telephone calls to the Fund, J.P. Morgan or a Financial Professional as
shareholder servicing agent may be tape recorded. With respect to the securities
offered hereby, this Statement of Additional Information and the Prospectus do
not contain all the information included in the Trust's registration statement
filed with the SEC under the 1933 Act and the Trust's and the Portfolio's
registration statements filed under the 1940 Act. Pursuant to the rules and
regulations of the SEC, certain portions have been omitted. The registration
statement including the exhibits filed therewith may be examined at the office
of the SEC in Washington, D.C.
Statements contained in this Statement of Additional Information and
the Prospectus concerning the contents of any contract or other document are not
necessarily complete, and in each instance, reference is made to the copy of
such contract or other document filed as an exhibit to the applicable
Registration Statements. Each such statement is qualified in all respects by
such reference.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in the
Prospectus and this Statement of Additional Information, in connection with the
offer contained therein and, if given or made, such other information or
representations must not be relied upon as having been authorized by any of the
Trust, the Fund or the Distributor. The Prospectus and this Statement of
Additional Information do not constitute an offer by the Fund or by the
Distributor to sell or solicit any offer to buy any of the securities offered
hereby in any jurisdiction to any person to whom it is unlawful for the Fund or
the Distributor to make such offer in such jurisdictions.
FINANCIAL STATEMENTS
The financial statements and the report thereon of
PricewaterhouseCoopers LLP are incorporated herein by reference to the Fund's
July 31, 2000 annual report filing made with the SEC on September 29, 2000
pursuant to Section 30(b) of the 1940 Act and Rule 30b2-1 thereunder (Accession
Number 0000894088-00-000014). The financial statements are available without
charge upon request by calling J.P. Morgan Funds Services at (800)766-7722. The
Fund's financial statements include the financial statements of the Portfolio.
40
APPENDIX A
DESCRIPTION OF SECURITY RATINGS
STANDARD & POOR'S
CORPORATE AND MUNICIPAL BONDS
AAA - Debt rated AAA have the highest ratings assigned by Standard & Poor's
to a debt obligation. Capacity to pay interest and repay principal is
extremely strong.
AA - Debt rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issues only in a small
degree.
A - Debt rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher rated categories.
BBB - Debt rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt
in higher rated categories.
BB - Debt rated BB are regarded as having less near-term vulnerability to
default than other speculative issues. However, they face major
ongoing uncertainties or exposure to adverse business, financial or
economic conditions which could lead to inadequate capacity to meet
timely interest and principal payments.
B - An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to
meet its financial commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor's
capacity or willingness to meet its financial commitment on the
obligation.
CCC - An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation. In
the event of adverse business, financial, or economic conditions, the
obligor is not likely to have the capacity to meet its financial
commitment on the obligation.
CC - An obligation rated CC is currently highly vulnerable to nonpayment.
C - The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments
on this obligation are being continued.
A-1
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
A - Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are
further refined with the designations 1, 2, and 3 to indicate the
relative degree of safety.
A-1 - This designation indicates that the degree of safety regarding timely
payment is very strong.
A-2 - This designation indicates that the degree of safety regarding timely
payment is satisfactory.
A-3 - This designation indicates that the degree of safety regarding timely
payment is adequate.
SHORT-TERM TAX-EXEMPT NOTES
SP-1 - The short-term tax-exempt note rating of SP-1 is the highest rating
assigned by Standard & Poor's and has a very strong or strong capacity
to pay principal and interest. Those issues determined to possess
overwhelming safety characteristics are given a "plus" (+)
designation.
SP-2 - The short-term tax-exempt note rating of SP-2 has a satisfactory
capacity to pay principal and interest.
MOODY'S
CORPORATE AND MUNICIPAL BONDS
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt 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 Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long
term risks appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well- assured. Often the
protection of interest and principal payments may be very moderate,
and thereby not well safeguarded during both good and bad times over
the future. Uncertainty of position characterizes bonds in this class.
A-2
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
Prime-1 - Issuers rated Prime-1 (or related supporting institutions) have
a superior capacity for repayment of short-term promissory
obligations. Prime-1 repayment capacity will normally be
evidenced by the following characteristics:
- Leading market positions in well established industries.
- High rates of return on funds employed.
- Conservative capitalization structures with moderate reliance
on debt and ample asset protection.
- Broad margins in earnings coverage of fixed financial charges
and high internal cash generation.
- Well established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while
sound, may be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Prime-3 Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in
changes in the level of debt protection measurements and may require
relatively high financial leverage. Adequate alternate liquidity is
maintained.
SHORT-TERM TAX EXEMPT NOTES
MIG-1 - The short-term tax-exempt note rating MIG-1 is the highest rating
assigned by Moody's for notes judged to be the best quality.
Notes with this rating enjoy 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.
MIG-2 - MIG-2 rated notes are of high quality but with margins of protection not
as large as MIG-1.
A-3
APPENDIX B
ADDITIONAL INFORMATION CONCERNING NEW YORK MUNICIPAL SECURITIES
The following information constitutes only a brief summary, does not
purport to be a complete description, and is based primarily on information
drawn from the Annual Information Statement of the State of New York (the
"State") available as of the date of this Statement of Additional Information.
While the Fund has not independently verified this information, it has no reason
to believe that such information is not correct in all material respects.
The State's fiscal year begins on April 1st and ends on March 31st. On
March 30, 2000, the State adopted the debt service portion of the State budget
for the 2000-01 fiscal year; on May 5, 2000, it enacted the remainder of the
budget. The Governor approved the budget as passed by the Legislature. Prior to
passing the budget in its entirety for the 2000-01 fiscal year, the State
enacted appropriations that permitted the State to continue its operations.
Following enactment of the 2000-01 budget, the State prepared a
Financial Plan for the 2000-01 fiscal year (the "2000-01 Financial Plan") that
sets forth projected receipts and disbursements based on the actions taken by
the Legislature. For fiscal year 2000-01, General Fund disbursements, including
transfers to support capital projects, debt service and other funds, were
estimated at $38.92 billion, an increase of $1.75 billion or 4.72% over
1999-2000. Projected spending under the 2000-01 enacted budget was $992 million
above the Governor's Executive Budget recommendations.
The 2000-01 Financial Plan projected closing balances in the General
Fund and other reserves of $3.2 billion, including $1.71 billion in the General
Fund. This closing balance is comprised of $675 million in reserves for
potential labor costs resulting from new collective bargaining agreements and
other spending commitments, $547 million in the Tax Stabilization Reserve Fund
(TSRF) (for use in case of unanticipated deficits), $150 million in the
Contingency Reserve Fund (CRF) (which helps offset litigation risks), and $338
million in the Community Projects Fund (CPF) (which finances legislative
initiatives). In addition to the $1.71 billion balance in the General Fund, $1.2
billion was projected for reserve in the STAR Special Revenue Fund and $250
million in the Debt Reduction Reserve Fund (DRRF).
Several developments arising from negotiations on the budget will
affect State finances in subsequent years. First, a portion of Legislative
additions to the 2000-01 Executive Budget will recur at higher spending levels
in 2001-02 and beyond, including increased funding for school aid, tuition
assistance, and prescription drug coverage for the elderly. Second, the
Legislature enacted the Debt Reform Act of 2000 (Debt Reform Act). The Debt
Reform Act, which applies to new State-supported debt issued on or after April
1, 2000, imposes caps on new debt outstanding and new debt service costs,
restricts the use of debt to capital purposes only, and restricts the maximum
term of State debt issuances to no more than 30 years. Finally, the State
adopted an additional tax relief package that will reduce tax receipts by $1.2
billion when fully effective; this package includes the elimination or reduction
of gross receipts taxes on energy ($330 million), the expansion of the "Power
for Jobs" energy tax credit program ($125 million), a college tuition deduction
or credit taken against personal income taxes ($200 million), and reduction of
the marriage penalty for taxpayers who file jointly ($200 million).
Many complex political, social and economic forces influence the
State's economy and finances, which in turn may affect the State Financial Plan.
These forces may affect the State unpredictably from fiscal year to fiscal year
and are influenced by governments, institutions, and organizations that are not
subject to the State's control. The State Financial Plan also is based upon
forecasts of national and State economic activity. Economic forecasts frequently
have failed to predict accurately the timing and magnitude of changes in the
national and State economies. The Division of Budget (DOB) believes that its
projections of receipts and disbursements relating to the current State
Financial Plan, and the assumptions on which they are based, are reasonable.
Actual results, however, could differ materially and adversely from the
projections set forth in the State's Annual Information Statement and summarized
below, and
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those projections may be changed materially and adversely from time
to time. See the section entitled "Special Considerations" below for a
discussion of risks and uncertainties faced by the State.
2000-01 STATE FINANCIAL PLAN
Four governmental fund types comprise the State Financial Plan: the
General Fund, the Special Revenue Funds, the Capital Projects Funds, and the
Debt Service Funds. The State's fund structure adheres to the accounting
standards of the Governmental Accounting Standards Board.
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.
In the State's 2000-01 fiscal year, the General Fund (exclusive of transfers) is
expected to account for approximately 46.6 % of All Governmental Funds
disbursements and 67.8 % of total State Funds disbursements. General Fund moneys
also are transferred to other funds, primarily to support certain capital
projects and debt service payments in other fund types.
Total receipts and transfers from other funds are projected to be
$39.72 billion in 2000-01, an increase of $2.32 billion over 1999-2000. Total
General Fund disbursements and transfers to other funds are projected to be
$39.29 billion, an increase of $2.12 billion over 1999-2000.
On July 31, 2000, the State released the first of three quarterly
updates to the 2000-01 Financial Plan (the "July Update"). In the July Update,
the State continues to project the 2000-01 Financial Plan will remain in
balance. At the end of the first quarter of the 2000-01 fiscal year, the General
Fund had a cash balance of $6.75 billion, $446 million above the estimate in the
Financial Plan. Total General Fund receipts and transfers from other funds
totaled $14.93 billion in the first quarter, $464 million higher than the
Financial Plan cashflow projections. Total General Fund disbursements and
transfers to other funds totaled $9.35 billion in the first quarter, $18 million
above the cashflow projections, which is attributable to the timing of payments
and not anticipated to affect year-end totals.
PROJECTED GENERAL FUND RECEIPTS
Total General Fund receipts and transfers in 2000-01 are projected to
be $39.72 billion, an increase of $2.32 billion from the $37.40 billion recorded
in 1999-2000. This total includes $36.35 billion in tax receipts, $1.34 billion
in miscellaneous receipts, and $2.03 billion in transfers from other funds. The
transfer of $3.4 billion net resources through the tax refund reserve account
from 1999-2000 to the 2000-01 fiscal period has the effect of exaggerating the
growth in State receipts from year to year by depressing reported 1999-2000
figures and inflating 2000-01 projections.
The PERSONAL INCOME TAX is imposed on the income of individuals,
estates and trusts and is based, with certain modifications, on federal
definitions of income and deductions. Net General Fund personal income tax
collections are projected to reach $24.33 billion in 2000-01, well over half of
all General Fund receipts and nearly $4 billion above the reported 1999-2000
collection total. Much of this increase is associated with the $3.4 billion net
impact of the transfer of the surplus from 1999-2000 to the current year as
partially offset by the diversion of an additional $1.99 billion in income tax
receipts to the School Tax Relief (STAR) fund. The STAR program was created in
1997 as a State-funded local property tax relief program funded through the use
of personal income tax receipts. Adjusted for these transactions, the growth in
net income tax receipts is roughly $1.3 billion, an increase of almost 5 %.
This growth is largely a function of two factors: (i) the 9 % growth in
income tax liability projected for tax year 2000; and (ii) the impact of the
1999 tax year settlement recorded early in the 2000-01 fiscal year.
B-2
The most significant statutory changes made this fiscal year provide
for an increase, phased-in over two years, in the earned income tax credit from
25% to 30% of the federal credit.
USER TAXES AND FEES are comprised of three-quarters of the State's 4%
sales and use tax, cigarette, alcoholic beverage, container, and auto rental
taxes, and a portion of the motor fuel excise levies. This category also
includes receipts from the motor vehicle registration fees and alcoholic
beverage license fees. Dedicated transportation funds outside of the General
Fund receive a portion of motor fuel tax and motor vehicle registration fees and
all of the highway use taxes. Receipts from user taxes and fees are projected to
total $7.02 billion, a decrease of $583 million below reported collections in
the prior year.
The sales tax and cigarette tax components of this category account for
virtually all of the 2000-01 decline. Growth in base sales tax yield, after
adjusting for tax law and other changes, is projected at 4.5%. Modest decreases
in motor fuel and alcoholic beverage taxes over 1999-2000 levels also are
expected. However, receipts from auto rental taxes are estimated to increase
modestly.
BUSINESS TAXES include franchise taxes based generally on net income of
general business, bank and insurance corporations, as well as
gross-receipts-based taxes on utilities and gallonage-based petroleum business
taxes.
Total business tax collections in 2000-01 are now projected to be $4.23
billion, $332 million below results for the prior fiscal year. The
year-over-year decline in projected receipts in this category is largely
attributable to statutory changes. These include the first year impact of a
scheduled corporation franchise tax rate reduction, a reduction in the cap on
tax liability for non-life insurers, and the expansion of the economic
development zone (renamed Empire Zones, effective May 19, 2000) and zone
equivalent areas tax credits. Ongoing tax reductions include the second year of
the corporation franchise rate reduction, the gross receipts tax rate cut from
3.25% to 2.5%, the continuation of the "Power for Jobs" program, and the use of
tax credits for investments in certified capital companies.
OTHER TAXES include the estate and gift tax, the real property gains
tax and pari-mutual taxes. Taxes in this category are now projected to total
$766 million, $341 million below last year's amount. The primary factors
accounting for most of the expected decline are legislation enacted previously
that repealed both the real property gains tax and the gift tax and
significantly reduced estate tax rates, and the incremental effects of tax
reductions in the pari-mutual tax.
MISCELLANEOUS RECEIPTS include investment income, abandoned property
receipts, medical provider assessments, minor federal grants, receipts from
public authorities, and certain other license and fee revenues. Miscellaneous
receipts are expected to total $1.34 billion, down $309 million from the prior
year amount. This reflects the loss of non-recurring receipts received in
1999-2000 and the phase-out of the medical provider assessments completed in
January 2000.
TRANSFERS FROM OTHER FUNDS to the General Fund consist primarily of tax
revenues in excess of debt service requirements, including the 1% sales tax used
to support payments to Local Government Assistance Corporation (LGAC).
Transfers from other funds are expected to total $2.03 billion, or $108
million less than total receipts from this category during 1999-2000. Total
transfers of sales taxes in excess of LGAC debt service requirements are
expected to decrease by approximately $74 million, while transfers from all
other funds are expected to decrease by $34 million.
PROJECTED GENERAL FUND DISBURSEMENTS
General Fund disbursements, including transfers to support capital
projects, debt service and other funds, are estimated in the July Update to be
at $39.29 billion in 2000-01, an increase of $370 million over
B-3
the Financial Plan enacted in May 2000. The entire net increase in disbursements
reflects the cost of labor agreements ratified by State employee unions and
approved by the State Legislature.
Following the pattern of the last three fiscal years, education
programs receive the largest share of new funding contained in the 2000-01
Financial Plan. School aid is expected to grow by $850 million or 8.0% over
1999-2000 levels (on a State fiscal year basis). Outside of education, the
largest growth in spending is for State Operations ($801 million increase); and
general State charges ($104 million).
The Financial Plan also reflects the use of resources from the Health
Care Reform Act of 2000 (HCRA 2000) that will help finance several health and
mental hygiene programs in Special Revenue Funds, including prescription drug
assistance for the elderly, supplemental Medicare insurance, and other public
health services.
GRANTS TO LOCAL GOVERNMENTS is the largest category of General Fund
disbursements and includes financial assistance to local governments and
not-for-profit corporations, as well as entitlement benefits to individuals. The
largest areas of spending in this category are for aid to elementary and
secondary schools (43%) and for the State's share of Medicaid payments to
providers (21%). Grants to Local Governments are projected in the July Update to
be at $26.87 billion in 2000-01, an increase of $1.23 billion over 1999-2000.
Under the 2000-01 enacted budget, General Fund spending on school aid
is projected at $11.47 billion on a State fiscal year basis, an increase of $850
million from the prior year. The budget provides additional funding for
operating aid, building aid, and several other targeted aid programs. For all
other educational programs, disbursements are projected to grow by $376 million
to $3.23 billion.
Spending for Medicaid in 2000-01 is projected to total $5.59 billion,
an increase of 4% from 1999-2000. Welfare spending is projected at $1.20
billion, a decrease of $77 million from the prior year. Disbursements for all
other health and social welfare programs are projected to total $1.93 billion,
an increase of $262 million.
The remaining disbursements primarily support community-based mental
hygiene programs, local transportation programs, and revenue sharing payments to
local governments. Revenue sharing and other general purpose aid to local
governments is projected at $923 million.
STATE OPERATIONS pays for the costs of operating the Executive,
Legislative, and Judicial branches of government, including the prison system,
mental hygiene institutions, and the State University system (SUNY). Spending in
State operations is projected in the July Update to be $7.40 billion, an
increase of $801 million over the prior year. The growth reflects $324 million
for new labor contacts, offset by $30 million in savings from efficiencies in
agency operations, a $38 million reduction in one-time receipts from the State
University, and a $56 million decrease in Federal grants from the Department of
Correctional Services. The State's overall workforce is expected to remain
stable at around 195,000 employees.
GENERAL STATE CHARGES account for the costs of providing fringe
benefits to State employees and retirees of the Executive, Legislature, and
Judiciary. These payments, many of which are mandated by statute and collective
bargaining agreements, include employer contributions for pensions, social
security, health insurance, workers' compensation, and unemployment insurance.
General State charges also cover State payments-in-lieu-of-taxes to local
governments for certain State-owned lands, and the costs of defending lawsuits
against the State and its public officers.
Disbursements in this category are estimated at $2.19 billion, an
increase of $104 million from the prior year. The change primarily reflects
higher health insurance rates in calendar year 2000, primarily to cover the
increasing cost of providing prescription drug benefits for State employees. The
2000-01 spending estimate continues to assume the $250 million in offset funds
related to the dissolution of the
B-4
Medical Malpractice Insurance Association (MMIA), which is the last year these
funds are expected to be available.
This category accounts for debt service on short-term obligations of
the State, i.e., the interest costs of the State's commercial paper program. The
commercial paper program is expected to have a maximum of $45 million
outstanding during 2000-01, as this program is being replaced with additional
variable rate general obligation bonds. The majority of the State's debt service
is for long-term bonds, and is shown in the Financial Plan as a transfer to the
General Debt Service Fund.
TRANSFERS TO OTHER FUNDS from the General Fund are made primarily to
finance certain portions of State capital projects spending and debt service on
long-term bonds where these costs are not funded from other sources.
Long-term debt service transfers are projected at $2.26 billion in
2000-01, an increase of $18 million from 1999- 2000. The increase reflects debt
service costs from prior-year bond sales (net of refunding savings), and certain
sales planned to occur during the 2000-01 fiscal year to support new capital
spending, primarily for economic development, the environment and education.
Transfers for capital projects provide General Fund support for
projects that are not financed with bond proceeds, dedicated taxes, other
revenues, or federal grants. Transfers in this category are projected to total
$234 million in 2000-01, an increase of $23 million from the prior year.
All other transfers, which reflect the remaining transfers from the
General Fund to other funds, are estimated to total $294 million in 2000-01, a
decline of $94 million from 1999-2000.
The Debt Reduction Reserve Fund (DRRF) is assumed by DOB to be
reclassified from the General Fund to the Capital Projects fund type in 2000-01.
The 2000-01 Financial Plan reflects the deposit of an additional $250 million in
General Fund receipts to DRRF in 2000-01, as well as $250 million in one-time
resources from the State's share of tobacco settlement proceeds.
NON-RECURRING RESOURCES
The DOB estimates that the 2000-01 State Financial Plan contains new
actions that provide non-recurring resources or savings totaling approximately
$36 million, excluding use of the 1999-2000 surplus.
GENERAL FUND CLOSING BALANCE
The July Update projects a closing balance of $1.34 billion in the
General Fund for 2000-01, a decrease of $370 million from the Financial Plan
enacted in May 2000. The planned use of labor reserves to finance approved labor
agreements accounts for the decline. The closing balance is comprised of $305
million in remaining reserves for collective bargaining and other purposes, $547
million in the Tax Stabilization Reserve Fund (for unanticipated budget
shortfalls), $150 million in the Contingency Reserve Fund (for litigation
risks), and $338 million in the Community Projects Fund (for legislative
initiatives). The closing fund balance does not include additional reserves of
$1.2 billion in the School Tax Relief (STAR) Special Reserve Fund (for future
STAR payments) and $250 million in the Debt Reduction Reserve Fund (for 2001-02
debt reduction).
OUTYEAR PROJECTIONS OF RECEIPTS AND DISBURSEMENTS
State law requires the Governor to propose a balanced budget each year.
Preliminary analysis by DOB indicates that the State will have a 2001-02 budget
gap of approximately $2 billion, which is comparable with gaps projected
following enactment of recent state budgets. This estimate includes projected
costs of new collective bargaining agreements, no assumed operating
efficiencies, and the
B-5
planned application of approximately $1.2 billion in STAR tax reduction
reserves. In recent years, the State has closed projected budget gaps which DOB
estimates have ranged from $5.0 billion to less than $1 billion. DOB will
formally update its projections of receipts and disbursements for future years
as part of the Governor's 2001-02 Executive Budget submission. The revised
expectations for these years will reflect the cumulative impact of tax
reductions and spending commitments enacted over the last several years as well
as new 2001-02 Executive Budget recommendations.
Sustained growth in the State's economy could contribute to closing
projected budget gaps over the next several years, both in terms of
higher-than-projected tax receipts and in lower-than-expected entitlement
spending. The State assumes that savings from initiatives by State agencies to
deliver services more efficiently, workforce management efforts, maximization of
federal and non-General Fund spending offsets, and other actions necessary to
help bring projected disbursements and receipts into balance.
From 1999-2000 through 2002-03, the State expects to receive $1.54
billion under the nationwide settlement with cigarette manufacturers. Counties,
including New York City, are projected to receive settlement payments of $1.47
billion over the same period. The State plans to use $1.29 billion in tobacco
settlement money over the next three years to finance health programs under HCRA
2000 ($1.01 billion) and projected increased costs in Medicaid ($274 million).
The remaining $250 million in one-time tobacco payments from 1999-2000 will be
deposited to DRRF.
OTHER GOVERNMENTAL FUNDS
In addition to the General Fund, the State Financial Plan includes
Special Revenue Funds, Capital Projects Funds and Debt Service Funds which are
discussed below. Amounts below do not include other sources and uses of funds
transferred to or from other fund types.
All Governmental Funds spending is estimated at $77.53 billion in
2000-01, an increase of $4.17 billion or 5.7% above the prior year. When
spending for the STAR tax relief program is excluded, spending growth is 4.6%.
The spending growth is comprised of changes in the General Fund ($1.81 billion
excluding transfers), Special Revenue Funds ($2.03 billion), Capital Projects
Funds ($124 million) and Debt Service Funds ($206 million).
SPECIAL REVENUE FUNDS
Total disbursements for programs supported by Special Revenue Funds are
projected at $33.25 billion, an increase of $2.03 billion or 6.5% over
1999-2000. Special Revenue Funds include federal grants and State special
revenue funds.
Federal grants are projected to comprise 69% of all Special Revenue
Funds spending in 2000-01, comparable to prior years. Disbursements from federal
funds are estimated at $22.87 billion, an increase of $798 million or 3.6%.
Medicaid is the largest program within federal funds, accounting for over half
of total spending in this category. In 2000- 01, Medicaid spending is projected
at $14.93 billion, an increase of $396 million over 1999-2000. The remaining
growth in federal funds is primarily for the Child Health Plus program, which is
estimated at to increase by $86 million in 2000-01, as well as increased
spending in various social service programs.
State special revenue spending is projected to be $10.38 billion, an
increase of $1.23 billion or 13.5% from the last fiscal year. The spending
reflects the next phase of the STAR program valued at $2.0 billion (up $785
million from 1999-2000), and $617 million in additional spending resulting from
HCRA 2000. This growth is offset by decreased spending of $176 million due to
the elimination of medical provider assessments on January 1, 2000.
CAPITAL PROJECTS FUNDS
B-6
Spending from Capital Projects Funds in 2000-01 is projected at $4.35
billion, an increase of $124 million or 2.9% from last fiscal year. The increase
is attributed to $184 million for new capital projects, primarily for
transportation, economic development, the environment and education and planned
increases for school construction and economic development programs.
DEBT SERVICE FUNDS
Spending from Debt Service Funds is estimated at $3.79 billion in
2000-01, up $206 million or 5.7% from 1999- 2000. Transportation purposes,
including debt service on bonds issued for State and local highway and bridge
programs financed through the New York State Thruway Authority and supported by
the Dedicated Highway and Bridge Trust Fund, account for $127 million of the
year-to-year growth. Debt service for educational purposes, including State and
City University programs financed through the Dormitory Authority, will increase
by $59 million. The remaining growth is for a variety of programs in mental
health and corrections, and for general obligation financings.
GAAP-BASIS FINANCIAL PLAN (2000-01)
State law requires the State to update its projected GAAP-basis
financial results for the current fiscal year on or before September first of
each year. The State bases its GAAP projections on the cash estimates in the
July Update and the actual results for 1999-2000 as reported by the State
Comptroller on July 28, 2000.
The State ended 1999-2000 with an accumulated General Fund surplus of
$3.93 billion, as measured by GAAP, marking the third consecutive fiscal year
that has ended with an accumulated surplus. During 2000-01, the State expects to
close the fiscal year with a positive GAAP balance of $1.84 billion in the
General Fund.
The GAAP-basis General Fund Financial Plan for 2000-01 projects tax
revenues of $34.22 billion and miscellaneous revenues of $3.04 billion, which
will finance projected expenditures of $39.31 billion and net financing uses of
$43 million.
SPECIAL CONSIDERATIONS
Despite recent budgetary surpluses recorded by the State, actions
affecting the level of receipts and disbursements, the relative strength of the
State and regional economy, and actions by the federal government could impact
projected budget gaps for the State. These gaps would result from a disparity
between recurring revenues and the costs of increasing the level of support for
State programs. To address a potential imbalance in any given fiscal year, the
State would be required to take actions to increase receipts and/or reduce
disbursements as it enacts the budget for that year, and, under the State
Constitution, the Governor is required to propose a balanced budget each year.
There can be no assurance, however, that the Legislature will enact the
Governor's proposals or that the State's actions will be sufficient to preserve
budgetary balance in a given fiscal year or to align recurring receipts and
disbursements in future fiscal years.
Many complex political, social and economic forces influence the
State's economy and finances, which may in turn affect the 2000-01 Financial
Plan. These forces may affect the State unpredictably from fiscal year to fiscal
year and are influenced by governments, institutions, and events that are not
subject to the State's control. The 2000-01 Financial Plan is based upon
forecasts of national and State economic activity developed through both
internal analysis and review of national and State economic forecasts prepared
by commercial forecasting services and other public and private forecasters.
Many uncertainties exist in forecasts of both the national and State economies,
including consumer attitudes toward spending, the extent of corporate and
governmental restructuring, the condition of the financial sector,
federal, fiscal and monetary policies, the level of interest rates, 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
B-7
results in the current fiscal year that are worse than predicted, with
corresponding material and adverse effects on the State's projections of
receipts and disbursements.
Projections of total State receipts in the 2000-01 Financial Plan are
based on the State tax structure in effect during the fiscal year and on
assumptions relating to basic economic factors and their historical
relationships to State tax receipts. In preparing projections of State receipts,
economic forecasts relating to personal income, wages, consumption, profits and
employment have been particularly important. The projection of receipts from
most tax or revenue sources is generally made by estimating the change in yield
of such tax or revenue source caused by economic and other factors, rather than
by estimating the total yield of such tax or revenue source from its estimated
tax base. The forecasting methodology, however, ensures that State fiscal year
collection estimates for taxes that are based on a computation of annual
liability, such as the business and personal income taxes, are consistent with
estimates of total liability under such taxes.
Projections of total State disbursements are based on assumptions
relating to economic and demographic factors, potential collective bargaining
agreements, levels of disbursements for various services provided by local
governments (where the cost is partially reimbursed by the State), and the
results of various administrative and statutory mechanisms in controlling
disbursements for State operations. Factors that may affect the level of
disbursements in the fiscal year include uncertainties relating to the economy
of the nation and the State, the policies of the federal government, collective
bargaining negotiations and changes in the demand for and use of State services.
An ongoing risk to the 2000-01 Financial Plan arises from the potential
impact of certain litigation and of federal disallowances now pending against
the State, which could adversely affect the State's projections of receipts and
disbursements. The 2000-01 Financial Plan contains projected reserves of $150
million in 2000-01 for such events, but assumes no significant federal
disallowance or other federal actions that could affect State finances.
Additional risks to the 2000-01 Financial Plan arise out of actions at
the federal level. The Personal Responsibility and Work Opportunity
Reconciliation Act of 1996 created a new Temporary Assistance to Needy Families
program (TANF) partially funded with a fixed federal block grant to states.
Congress has recently debated proposals under which the federal government would
take a portion of state reserves from the TANF block grant for use in funding
other federal programs. It has also considered proposals that would lower the
State's share of mass transit operating assistance. Finally, several proposals
to alter federal tax law that have surfaced in recent years could adversely
affect State revenues, since many State taxes depend on federal definitions of
income. While Congress has not enacted these proposals, it may do so in the
future, or it may take other actions that could have an adverse effect on State
finances.
The 2000-01 Financial Plan assumes the availability of certain
resources to finance portions of General Fund spending for fringe benefits,
health and welfare programs. These resources could become unavailable or
decrease, placing additional pressures on budget balance.
The Division of the Budget believes that its projections of receipts
and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely from projections. In the past, the State
has taken management actions to address potential Financial Plan shortfalls, and
may take similar actions should adverse variances occur in its projections for
the current fiscal year.
GAAP-BASIS RESULTS FOR PRIOR FISCAL YEARS
1999-2000 FISCAL YEAR
The State completed its 1999-2000 fiscal year with a combined
governmental funds operating surplus of $3.03 billion, which included operating
surpluses in the General Fund ($2.23 billion), in Special
B-8
Revenue Funds ($665 million), in Debt Service Funds ($38 million) and in Capital
Projects Funds ($99 million).
GENERAL FUND
The State reported a General Fund operating surplus of $2.23 billion
for the 1999-2000 fiscal year, as compared to an operating surplus of $1.08
billion for the 1998-99 fiscal year. The operating surplus for 1999-2000
resulted in part from higher personal income tax receipts, and increases in
taxes receivable and other assets of $754 million and $137 million,
respectively, and decreases in deferred revenues, due to other funds and other
liabilities of $134 million. These gains were partially offset by decreases in
accounts receivable and money due from other funds of $77 million, increases in
payables to local governments and accrued liabilities of $80 million and $175
million, respectively, and an increase in tax refunds payable of $537 million.
The State reported an accumulated fund balance of $3.92 billion in the
General Fund for 1999-2000. The accumulated fund balance is $50 million higher
after a restatement by the State Comptroller to reflect the reclassification of
the Debt Reduction Reserve Fund to the General Fund.
General Fund revenues increased $2.30 billion (6.4%) over the prior
fiscal year with increases in personal income and consumption and use taxes, and
miscellaneous revenues. Business tax and other tax revenues fell from the prior
fiscal year. Personal income taxes grew $1.98 billion, an increase of nearly
9.7%. The increase in personal income taxes was caused by strong employment and
wage growth and the continued strong performance of the financial markets during
1999. Consumption and use taxes increased $327 million, or 4.5%, to reflect a
continuing high level of consumer confidence. Miscellaneous revenues increased
$303 million (14.1%), primarily due to growth in investment earnings, fees,
licenses, royalties and rents and reimbursements from regulated industries used
to fund State administrative costs (e.g., banking and insurance). These
increases were partially offset by decreases in business and other taxes.
Business taxes decreased nearly $301 million, or 6.2%, because of prior year
refunds and the application of credit carryforwards which were applied against
current year (1999) liabilities. Other taxes decreased $12 million, or 1.1%.
General Fund expenditures increased $1.39 billion (3.9%) from the prior
fiscal year, with the largest increases occurring in education, health and
environment. Education expenditures grew $739 million (6.1%) due mainly to an
increase in spending for support for public schools, handicapped pupil education
and municipal and community colleges. Health and environment expenditures
increased over $215 million (33.5%) primarily reflecting increased spending for
local health programs. Personal service costs increased $202 million (3.3%)
principally as a result of increases in wages as required by recently approved
collective bargaining agreements. Non-personal service costs increased $264
million (11.7%) due primarily to increased spending for goods and services.
Net other financing sources in the General Fund increased $192 million
(45.9%) primarily because transfers of surplus revenues from the Debt Service
Funds increased by nearly $100 million and transfers from the Abandoned Property
Fund and the Hospital Bad Debt and Charity Accounts increased by nearly $120
million.
SPECIAL REVENUE, DEBT SERVICE AND CAPITAL PROJECTS FUND TYPES
An operating surplus of $665 million was reported for the Special
Revenue Funds for the 1999-2000 fiscal year which increased the accumulated fund
balance to $2.14 billion after restatement of prior year fund balances. As a
result of legislation enacted during the fiscal year ended March 31, 2000, the
Hospital Bad Debt and Charity Accounts were reclassified to Special Revenue
Funds thereby increasing the beginning fund balance by $1.01 billion. Revenues
increased $2.15 billion over the prior fiscal year (6.9%) as a result of
increases in tax, federal grants, and miscellaneous revenues. Expenditures
increased
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$1.49 billion (5.4%) as a result of increased costs for local assistance grants
and non-personal service. Net other financing uses increased $174 million
(4.5%).
Debt Service Funds ended the 1999-2000 fiscal year with an operating
surplus of $38 million and, as a result, the accumulated fund balance increased
to $2.06 billion. Revenues increased $200 million (7.4%) primarily because of
increases in dedicated taxes. Debt service expenditures increased $429 million
(15.0%). Net other financing sources increased $113 million (36.1%) due
primarily to increases in transfers from the General Fund.
An operating surplus of $99 million was reported in the Capital
Projects Funds for the State's 1999-2000 fiscal year and, as a result, the
accumulated fund balance deficit decreased to $129 million. Revenues increased
$93 million (3.7%) primarily because federal grant revenues increased $90
million for transportation projects. Expenditures increased $84 million (2.3%)
primarily because of increases capital construction spending for transportation
projects. Net other financing sources decreased by $63 million (4.6%).
1998-99 FISCAL YEAR
The State completed its 1998-99 fiscal year with a combined
governmental funds operating surplus of $1.32 billion, which included operating
surpluses in the General Fund ($1.078 billion), in Debt Service Funds ($209
million) and in Capital Projects Funds ($154 million) offset, in part, by an
operating deficit in Special Revenue Funds ($117 million).
1997-98 FISCAL YEAR
The State completed its 1997-98 fiscal year with a combined
governmental funds operating surplus of $1.80 billion, which included an
operating surplus in the General Fund of $1.56 billion, in Capital Projects
Funds of $232 million and in Special Revenue Funds of $49 million, offset, in
part, by an operating deficit of $43 million in Debt Service Funds.
CASH-BASIS RESULTS FOR PRIOR FISCAL YEARS
GENERAL FUND 1997-98 THROUGH 1999-2000
New York State's financial operations have improved during recent
fiscal years. During its last eight fiscal years, the State has recorded
balanced budgets on a cash basis, with positive year-end fund balances.
1999-2000 FISCAL YEAR
The State ended its 1999-2000 fiscal year in balance on a cash basis,
with a General Fund cash surplus as reported by the DOB of $1.51 billion. As in
recent years, strong growth in receipts above forecasted accounts produced most
of the year-end surplus. Spending was also modestly below projections, further
adding to the surplus.
The State reported a General Fund closing balance of $1.17 billion, an
increase of $275 million from the prior fiscal year. The balance was held in
four accounts within the General Fund: the Tax Stabilization Reserve Fund
(TSRF), the Contingency Reserve Fund (CRF) the Debt Reduction Reserve Fund
(DRRF) and the Community Projects Fund (CPF). The balance is comprised of $547
million in the TSRF after a deposit of $74 million in 1999-2000; $107 million in
the CRF; $250 million in the DRRF; and $263 million in the CPF.
The closing fund balance excludes $3.97 billion that the State
deposited into the tax refund reserve account at the close of 1999-2000 to pay
for tax refunds in 2000-01 of which $521 million was
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made available as a result of the Local Government Assistance Corporation (LGAC)
financing program and was required to be on deposit as of March 31, 2000. The
tax refund reserve account transaction has the effect of decreasing reported
personal income tax receipts in 1999- 2000, while increasing reported receipts
in 2000-01.
General Fund receipts and transfers from other funds (net of tax refund
reserve account activity) for the 1999- 2000 fiscal year totaled $37.40 billion,
an increase of 1.6% from 1998-99 levels. General Fund disbursements and
transfers to other funds totaled $37.17 billion for the 1999-2000 fiscal year,
an increase of 1.6% from the prior fiscal year.
1998-99 FISCAL YEAR
The State ended its 1998-99 fiscal year on March 31, 1999, in balance
on a cash basis, with a General Fund cash surplus as reported by DOB of
approximately $1.82 billion. The cash surplus was derived primarily from
higher-than- projected tax collections as a result of continued economic growth,
particularly in the financial markets and securities industries.
The General Fund had a closing balance of $892 million, an increase of
$254 million from the prior fiscal year. The TSRF closing balance was $473
million, following an additional deposit of $73 million in 1998-99. The CRF
closing balance was $107 million, in following a $39 million deposit in 1998-99.
The CPF closed the fiscal year with a balance of $312 million. The General Fund
closing balance did not include $2.31 billion in the tax refund reserve account,
of which $521 million was made available as a result of the LGAC financing
program and was required to be on deposit on March 31, 1999.
General Fund receipts and transfers from other funds (net of tax refund
reserve account activity) for the 1998-99 fiscal year totaled $36.82 billion, an
annual increase of 6.2% over 1997-98. General Fund disbursements and transfers
to other funds were $36.57 billion, an annual increase of 6.1%.
1997-98 FISCAL YEAR
The State ended its 1997-98 fiscal year in balance on a cash basis,
with a General Fund cash surplus as reported by DOB of approximately $2.04
billion. The cash surplus was derived primarily from higher-than-anticipated
receipts and lower spending on welfare, Medicaid, and other entitlement
programs.
The General Fund closing balance was $638 million, an increase of $205
million from the prior fiscal year. The balance included $400 million in the
TSRF, after a required deposit of $15 million (repaying a transfer made in
1991-92) and an additional deposit of $68 million made from the 1997-98 surplus.
(The CRF closing balance was $68 million, following a $27 million deposit from
the surplus. The CPF closed the fiscal year with a balance of $170 million. The
General Fund closing balance did not include $2.39 billion in the tax refund
reserve account, of which $521 million was made available as a result of the
LGAC financing program and was required to be on deposit on March 31, 1998.)
General Fund receipts and transfers from other funds (net of tax refund
reserve account activity) for the 1997-98 fiscal year totaled $34.67 billion, an
increase of 4.9% from the previous fiscal year. General Fund disbursements and
transfers to other funds totaled $34.47 billion, an increase of 4.8%.
OTHER GOVERNMENTAL FUNDS (1997-98 THROUGH 1999-2000)
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 of a portion of
transportation-related revenues from the General Fund to two dedicated funds in
the Special Revenue and Capital Projects fund types. These revenues are used to
support the capital programs of the Department of Transportation, the
Metropolitan Transportation Authority (MTA) and other transit entities.
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In the SPECIAL REVENUE FUNDS, disbursements increased from $27.65
billion to $31.22 billion over the last three years, primarily as a result of
increased costs for the federal share of Medicaid and the initial costs of the
STAR program. Other activity reflected dedication of taxes for mass
transportation purposes, new lottery games, and new fees for criminal justice
programs.
Disbursements in the CAPITAL PROJECTS FUNDS increased over the
three-year period from $3.57 billion to $4.22 billion, primarily for education,
environment, public protection and transportation programs. The composition of
this fund type's receipts also has changed as dedicated taxes, federal grants
and reimbursements from public authority bonds increased, while general
obligation bond proceeds declined.
Activity in the DEBT SERVICE FUNDS reflected increased use of bonds
during the three-year period for improvements to the State's capital facilities
and the ongoing costs of the LGAC fiscal reform program. The increases were
moderated by the refunding savings achieved by the State over the last several
years using strict present value savings criteria. Disbursements in this fund
type increased from $3.09 billion to $3.59 billion over the three-year period.
THE NEW YORK ECONOMY
New York is the third most populous state in the nation and has a
relatively high level of personal wealth. The State's economy is diverse, with a
comparatively large share of the nation's finance, insurance, transportation,
communications and services employment, and a very small share of the nation's
farming and mining activity. The State's location and its air transport
facilities and natural harbors have made it an important link in international
commerce. Travel and tourism constitute an important part of the economy. Like
the rest of the nation, New York has a declining proportion of its workforce
engaged in manufacturing, and an increasing proportion engaged in service
industries.
New York's employment remained strong for the first six months of 2000.
Most industry sectors experienced employment gains, with the service sector
accounting for the largest increases. The July forecast makes no change in the
employment outlook from the forecast contained in the Financial Plan enacted in
May 2000. Strong job growth is expected to continue throughout the rest of 2000.
Total employment growth of 2.1% is expected to exceed national employment
growth, although less than the 2.6% growth in 1999. As in the recent past,
employment increases are expected to be concentrated in the services sector.
Wage growth for 2000 is expected to be 8.2%, while personal income growth is
estimated at 6.5%.
Given the importance of the securities industry in the New York State
economy, a significant change in stock market performance during the forecast
horizon could result in financial sector profits and bonuses that are
significantly different from those embodied in the forecast. Any actions by the
Federal Reserve Board to moderate inflation by increasing interest rates more
than anticipated may have an adverse impact in New York given the sensitivity of
financial markets to interest rate shifts and the prominence of these markets in
the New York economy. In addition, there is a possibility that
greater-than-anticipated mergers, downsizing, and relocation of firms caused by
deregulation and global competition may have a significant adverse effect on
employment growth.
SERVICES: The services sector, which includes entertainment, personal
services, such as health care and auto repairs, and business-related services,
such as information processing, law and accounting, is the State's leading
economic sector. The services sector accounts for more than three of every ten
nonagricultural jobs in New York and has a noticeably higher proportion of total
jobs than does the rest of the nation.
MANUFACTURING: Manufacturing employment continues to decline in
importance in New York, as in most other states, and New York's economy is less
reliant on this sector than in the past. However, it
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remains an important sector of the State economy, particularly for the upstate
economy, as high concentrations of manufacturing industries for transportation
equipment, optics and imaging, materials processing, and refrigeration, heating,
and electrical equipment products are located in the upstate region.
TRADE: Wholesale and retail trade is the second largest sector in terms
of nonagricultural jobs in New York but is considerably smaller when measured by
income share. Trade consists of wholesale businesses and retail businesses, such
as department stores and eating and drinking establishments.
FINANCE, INSURANCE AND REAL ESTATE: New York City is the nation's
leading center of banking and finance and, as a result, this is a far more
important sector in the State than in the nation as a whole. Although this
sector accounts for under one-tenth of all nonagricultural jobs in the State, it
contributes about one-fifth of total wages.
AGRICULTURE: Farming is an important part of the economy of large
regions of the State, although it constitutes a very minor part of total State
output. Principal agricultural products of the State include milk and dairy
products, greenhouse and nursery products, apples and other fruits, and fresh
vegetables. New York ranks among the nation's leaders in the production of these
commodities.
GOVERNMENT: Federal, State and local government together are the third
largest sector in terms of nonagricultural jobs, with the bulk of the employment
accounted for by local governments. Public education is the source of nearly
one-half of total State and local government employment.
ECONOMIC AND DEMOGRAPHIC TRENDS
In the calendar years 1987 through 1998, the State's rate of economic
growth was somewhat slower than that of the nation. In particular, during the
1990-91 recession and post-recession period, 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. However, the situation has been
improving during recent years. In 1999, for the first time in 13 years, the
employment growth rate of the State surpassed the national growth rate. Although
the State unemployment rate has been higher than the national rate since 1991,
the gap between them has narrowed in recent years.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied substantially.
Because New York City is a regional employment center for a multi-state region,
State personal income measured on a residence basis understates the relative
importance of the State to the national economy and the size of the base to
which State taxation applies.
DEBT AND OTHER FINANCING ACTIVITIES
Financing activities of the State include general obligation debt and
State-guaranteed debt, to which the full faith and credit of the State has been
pledged, as well as lease-purchase and contractual-obligation financings, moral
obligation and other financings through public authorities and municipalities,
where the State's legal obligation to make payments to those public authorities
and municipalities for their debt service is subject to annual appropriation by
the Legislature.
The State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
The State's 2000-01 borrowing plan projects issuances of $367 million
in general obligation bonds, including $45 million for purposes of redeeming the
remaining outstanding BANs. The State does not anticipate issuing new BANs
during the 2000-01 fiscal year. The State is expected to issue up to $276
million in COPs to finance equipment purchases (including costs of issuance,
reserve funds, and other costs) during the 2000-01 fiscal year. Of this amount,
it is anticipated that approximately $76 million will
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be used to finance agency equipment acquisitions. Approximately $200 million is
expected to finance the purchase of new welfare computer systems designed to
improve case management, fraud detection and child support collection
capabilities.
Borrowings by public authorities pursuant to lease-purchase and
contractual-obligation financings for capital programs of the State are
projected to total approximately $2.91 billion, including costs of issuance,
reserve funds, and other costs, net of anticipated refundings and other
adjustments in 2000-01.
PUBLIC AUTHORITIES
The fiscal stability of the State is related in part to the fiscal
stability of its public authorities. For the purposes of this AIS, public
authorities refer to public benefit corporations, created pursuant to State law,
other than local authorities. Public authorities are not subject to the
constitutional restrictions on the incurrence of debt that apply to the State
itself and may issue bonds and notes within the amounts and restrictions set
forth in legislative authorization. The State's access to the public credit
markets could be impaired and the market price of its outstanding debt may be
materially and adversely affected if any of its public authorities were to
default on their respective obligations. As of December 31, 1999, there were 17
public authorities that had outstanding debt of $100 million or more, and the
aggregate outstanding debt, including refunding bonds, of these State public
authorities was $95 billion, only a portion of which constitutes State-supported
or State-related debt.
The State has numerous public authorities with various
responsibilities, including those which finance, construct and/or operate
revenue-producing public facilities. Public authorities generally pay their
operating expenses and debt service costs from revenues generated by the
projects they finance or operate, such as tolls charged for the use of highways,
bridges or tunnels, charges for public power, electric and gas utility services,
rentals charged for housing units, and charges for occupancy at medical care
facilities. In addition, State legislation authorizes several financing
techniques for public authorities. Also, there are statutory arrangements
providing for State local assistance payments otherwise payable to localities to
be made under certain circumstances to public authorities. Although the State
has no obligation to provide additional assistance to localities whose local
assistance payments have been paid to public authorities under these
arrangements, the affected localities may seek additional State assistance if
local assistance payments are diverted. Some authorities also receive moneys
from State appropriations to pay for the operating costs of certain of their
programs. As described below, the MTA receives the bulk of this money in order
to provide transit and commuter services.
Beginning in 1998, the Long Island Power Authority (LIPA) assumed
responsibility for the provision of electric utility services previously
provided by Long Island Lighting Company for Nassau, Suffolk and a portion of
Queen Counties, as part of an estimated $7 billion financing plan. As of the
date of this AIS, LIPA has issued over $7 billion in bonds secured solely by
ratepayer charges. LIPA's debt is not considered either State-supported or
State-related debt.
METROPOLITAN TRANSPORTATION AUTHORITY
The MTA oversees the operation of subway and bus lines in New York City
by its affiliates, the New York City Transit Authority and the Manhattan and
Bronx Surface Transit Operating Authority (collectively, the TA). The MTA
operates certain commuter rail and bus services in the New York metropolitan
area through the MTA's subsidiaries, the Long Island Rail Road Company, the
Metro-North Commuter Railroad Company, and the Metropolitan Suburban Bus
Authority. In addition, the Staten Island Rapid Transit Operating Authority, an
MTA subsidiary, operates a rapid transit line on Staten Island. Through its
affiliated agency, the Triborough Bridge and Tunnel Authority (TBTA), the MTA
operates certain intrastate toll bridges and tunnels. Because fare revenues are
not sufficient to finance the mass transit portion of these operations, the MTA
has depended on, and will continue to depend on, operating support from the
State, local governments and TBTA, including loans, grants and subsidies. If
current
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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.
Since 1980, 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 Metropolitan Transportation Region
served by the MTA and a special one-quarter of 1% regional sales and use
tax--that provide revenues for mass transit purposes, including assistance to
the MTA. Since 1987, State law also has required that the proceeds of a
one-quarter of 1% mortgage recording tax paid on certain mortgages in the
Metropolitan Transportation Region be deposited in a special MTA fund for
operating or capital expenses. In 1993, the State dedicated a portion of certain
additional State petroleum business tax receipts to fund operating or capital
assistance to the MTA. The 2000-01 enacted budget provides State assistance to
the MTA totaling approximately $1.35 billion and initiates a five-year State
transportation plan that includes nearly $2.2 billion in dedicated revenue
support for the MTA's 2000-04 Capital Program. This capital commitment includes
an additional $800 million of newly dedicated State petroleum business tax
revenues, motor vehicle fees, and motor fuel taxes not previously dedicated to
the MTA.
State legislation accompanying the 2000-01 enacted State budget
increased the aggregate bond cap for the MTA, TBTA and TA to $16.5 billion in
order to finance a portion of the $17.1 billion MTA capital plan for the 2000-04
Capital Program. On May 4, 2000, the Capital Program Review Board approved the
MTA's $17.1 billion capital program for transit purposes for 2000 through 2004.
The 2000-04 Capital Program is the fifth capital plan since the Legislature
authorized procedures for the adoption, approval and amendment of MTA capital
programs and is designed to upgrade the performance of the MTA's transportation
system by investing in new rolling stock, maintaining replacement schedules for
existing assets, bringing the MTA system into a state of good repair, and making
major investments in system expansion projects such as the Second Avenue Subway
project and the East Side Access project.
The currently approved 2000-04 Capital Program assumes the issuance of
an estimated $8.9 billion in new money bonds. The remainder of the plan is
projected to be financed with assistance from the Federal Government, the State,
the City of New York, and from various other revenues generated from actions
taken by the MTA. In addition, $1.6 billion in State support is projected to be
financed using proceeds from State general obligation bonds under the proposed
$3.8 billion Transportation Infrastructure Bond Act of 2000, if approved by the
voters in the November 2000 general election. Further, the enacted State budget
authorized the MTA to undertake a major debt restructuring initiative which will
enable the MTA to refund approximately $13.7 billion in bonds, consolidate its
credit sources, and obviate the need for debt service reserves. The
authorization for debt restructuring includes outstanding bonds secured by
service contracts with the State.
There can be no assurance that all the necessary governmental actions
for future capital programs will be taken, that funding sources currently
identified will not be decreased or eliminated, or that the 2000-04 Capital
Program or parts thereof will not be delayed or reduced. Should funding levels
fall below current projections, the MTA would have to revise its 2000-04 Capital
Program accordingly. If the 2000-04 Capital Program is delayed or reduced,
ridership and fare revenues may decline, which could, among other things, impair
the MTA's ability to meet its operating expenses without additional assistance.
THE CITY OF NEW YORK
The fiscal health of the State also may be affected by the fiscal
health of New York City, which continues to receive significant financial
assistance from the State. State aid contributes to the City's ability to
balance its budget and meet its cash requirements. The State also may be
affected by the ability of the City and certain entities issuing debt for the
benefit of the City to market their securities successfully in the public credit
markets.
In recent years, the State constitutional debt limit would have
prevented the City from entering into new capital contracts. To prevent
disruptions in the capital program, two actions were taken to
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increase the City's capital financing capacity: (i) the State Legislature
created the New York City Transitional Finance Authority (TFA) in 1997, and
(ii) in 1999, the City created TSASC, Inc., a not-for-profit corporation
empowered to issue tax-exempt debt backed by tobacco settlement revenues.
During the 2000 legislative session, the State enacted legislation that
increased the borrowing authority of the TFA by $4 billion, to $11.5 billion,
which the City expects will provide sufficient financing capacity to continue
its capital program over the next four fiscal years.
FISCAL OVERSIGHT
In response to the City's fiscal crisis in 1975, the State took action
to assist the City in returning to fiscal stability. Among those actions, the
State established the Municipal Assistance Corporation for the City of New York
(NYC MAC) to provide financing assistance to the City; the New York State
Financial Control Board (the Control Board) to oversee the City's financial
affairs; and the Office of the State Deputy Comptroller for the City of New York
(OSDC) to assist the Control Board in exercising its powers and
responsibilities. A "control period" existed from 1975 to 1986, during which the
City was subject to certain statutorily-prescribed fiscal controls. The Control
Board terminated the control period 1986 when certain statutory conditions were
met. State law requires the Control Board to reimpose a control period upon the
occurrence, or "substantial likelihood and imminence" of the occurrence, of
certain events, including (but not limited to) a City operating budget deficit
of more than $100 million or impaired access to the public credit markets.
Currently, the City and its Covered Organizations (i.e., those
organizations which receive or may receive moneys from the City directly,
indirectly or contingently) operate under the City's Financial Plan. The City's
Financial Plan summarizes its capital, revenue and expense projections and
outlines proposed gap-closing programs for years with projected budget gaps. The
City's projections set forth in its Financial Plan are based on various
assumptions and contingencies, some of which are uncertain and may not
materialize. Unforeseen developments and changes in major assumptions could
significantly affect the City's ability to balance its budget as required by
State law and to meet its annual cash flow and financing requirements.
MONITORING AGENCIES
The staffs of the Control Board, OSDC and the City Comptroller issue
periodic reports on the City's Financial Plans. The reports analyze the City's
forecasts of revenues and expenditures, cash flow, and debt service
requirements, as well as evaluate compliance by the City and its Covered
Organizations with its Financial Plan. According to staff reports, economic
growth in New York City has been very strong in recent years, led by a surge in
Wall Street profitability which resulted in increased tax revenues and produced
a substantial surplus for the City in City fiscal years 1996-97, 1997-98 and
1998-99. Recent staff reports also indicate that the City projects a surplus for
City fiscal year 1999- 2000. Although several sectors of the City's economy have
expanded over the last several years, especially tourism, media, business and
professional services, City tax revenues remain heavily dependent on the
continued profitability of the securities industries and the performance of the
national economy. In addition, the size of recent tax reductions has increased
to over $2.3 billion in City fiscal year 1999-2000 through the expiration of a
personal income tax surcharge, the repeal of the non-resident earnings tax and
the elimination of the sales tax on clothing items costing less than $110. The
Mayor has proposed additional tax reductions that would raise the total worth of
recent tax cuts to $3.7 billion by City fiscal year 2003-04. Staff reports have
indicated that recent City budgets have been balanced in part through the use of
nonrecurring resources and that the City's Financial Plan relies in part on
actions outside its direct control. These reports also have indicated that the
City has not yet brought its long-term expenditure growth in line with recurring
revenue growth and that the City is likely to continue to face substantial gaps
between forecast revenues and expenditures in future years that must be closed
with reduced expenditures and/or increased revenues. In addition to these
monitoring agencies, the Independent Budget Office (IBO) has been established
pursuant to the City Charter to provide analysis to elected officials and the
public on relevant fiscal and budgetary issues affecting the City.
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OTHER LOCALITIES
Certain localities outside New York City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The potential impact on the State of any future
requests by localities for additional oversight or financial assistance is not
included in the projections of the State's receipts and disbursements for the
State's 2000-01 fiscal year.
The State has provided extraordinary financial assistance to select
municipalities, primarily cities, since the 1996-97 fiscal year. Funding has
essentially been continued or increased in each subsequent fiscal year. Such
funding in 2000-01 totals $200.4 million. The 2000-01 enacted budget increased
General Purpose State Aid for local governments by $11 million to $562 million.
While the distribution of General Purpose State Aid for local
governments was originally based on a statutory formula, in recent years both
the total amount appropriated and the shares appropriated to specific localities
have been determined by the Legislature. A State commission established to study
the distribution and amounts of general purpose local government aid failed to
agree on any recommendations for a new formula.
Counties, cities, towns, villages and school districts have engaged in
substantial short-term and long-term borrowings. In 1998, the total indebtedness
of all localities in the State, other than New York City, was approximately
$20.3 billion. A small portion (approximately $80 million) of that 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 New York City) authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding.
Twenty-three localities had outstanding indebtedness for deficit financing at
the close of their fiscal year ending in 1998.
Like the State, local governments must respond to changing political,
economic and financial influences over which they have little or no control.
Such changes may adversely affect the financial condition of certain local
governments. For example, the federal government may reduce (or in some cases
eliminate) federal funding of some local programs which, in turn, may require
local governments to fund these expenditures from their own resources. It is
also possible that the State, New York City, or any of their respective public
authorities may suffer serious financial difficulties that could jeopardize
local access to the public credit markets, which may adversely affect the
marketability of notes and bonds issued by localities within the State.
Localities also may face unanticipated problems resulting from certain pending
litigation, judicial decisions and long-range economic trends. Other large-scale
potential problems, such as declining urban populations, increasing
expenditures, and the loss of skilled manufacturing jobs, also may adversely
affect localities and necessitate State assistance.
LITIGATION
GENERAL
The legal proceedings listed below involve State finances and programs
and miscellaneous civil rights, real property, contract and other tort claims in
which the State is a defendant and the potential monetary claims against the
State are substantial, generally in excess of $100 million. These proceedings
could adversely affect the financial condition of the State in the 2000-01
fiscal year or thereafter.
The State is party to other claims and litigation which its legal
counsel has advised are not probable of adverse court decisions or are not
deemed adverse and material. Although the amounts of potential losses resulting
from this litigation, if any, are not presently determinable, it is the State's
opinion that its ultimate liability in these cases is not expected to have a
material and adverse effect on the State's financial position in the 2000-01
fiscal year or thereafter.
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The General Purpose Financial Statements for the 1999-2000 fiscal year
report estimated probable awarded and anticipated unfavorable judgments of $895
million, of which $132 million is expected to be paid during the 1999-2000
fiscal year.
Adverse developments in the proceedings described below, other
proceedings for which there are unanticipated, unfavorable and material
judgments, or the initiation of new proceedings could affect the ability of the
State to maintain a balanced 2000-01 Financial Plan. The State believes that the
proposed 2000-01 Financial Plan includes sufficient reserves to offset the costs
associated with the payment of judgments that may be required during the 2000-01
fiscal year. These reserves include (but are not limited to) amounts
appropriated for Court of Claims payments and projected fund balances in the
General Fund. In addition, any amounts ultimately required to be paid by the
State may be subject to settlement or may be paid over a multi-year period.
There can be no assurance, however, that adverse decisions in legal proceedings
against the State would not exceed the amount of all potential 2000-01 Financial
Plan resources available for the payment of judgments, and could therefore
affect the ability of the State to maintain a balanced 2000-01 Financial Plan.
TAX LAW
In NEW YORK ASSOCIATION OF CONVENIENCE STORES, ET AL. V. URBACH, ET
AL., petitioners, New York Association of Convenience Stores, National
Association of Convenience Stores, M.W.S. Enterprises, Inc. and Sugarcreek
Stores, Inc. are seeking to compel respondents, the Commissioner of Taxation and
Finance and the Department of Taxation and Finance, to enforce sales and excise
taxes imposed, pursuant to Tax Law Articles 12-A, 20 and 28, on tobacco products
and motor fuel sold to non-Indian consumers on Indian reservations. In orders
dated August 13, 1996 and August 24, 1996, the Supreme Court, Albany County,
ordered, INTER ALIA, that there be equal implementation and enforcement of said
taxes for sales to non-Indian consumers on and off Indian reservations, and
further ordered that, if respondents failed to comply within 120 days, no
tobacco products or motor fuel could be introduced onto Indian reservations
other than for Indian consumption or, alternately, the collection and
enforcement of such taxes would be suspended statewide. Respondents appealed to
the Appellate Division, Third Department, and invoked CPLR 5519(a)(1), which
provides that the taking of the appeal stayed all proceedings to enforce the
orders pending the appeal. Petitioners' motion to vacate the stay was denied. In
a decision entered May 8, 1997, the Third Department modified the orders by
deleting the portion thereof that provided for the statewide suspension of the
enforcement and collection of the sales and excise taxes on motor fuel and
tobacco products. The Third Department held, INTER ALIA, that petitioners had
not sought such relief in their petition and that it was an error for the
Supreme Court to have awarded such undemanded relief without adequate notice of
its intent to do so. On May 22, 1997, respondents appealed to the Court of
Appeals on other grounds, and again invoked the statutory stay. On October 23,
1997, the Court of Appeals granted petitioners' motion for leave to cross appeal
from the portion of the Third Department's decision that deleted the statewide
suspension of the enforcement and collection of the sales and excise taxes on
motor fuel and tobacco. On July 9, 1998, the New York Court of Appeals reversed
the order of the Appellate Division, Third Department, and remanded the matter
to the Supreme Court, Albany County, for further proceedings. The Court held
that the petitioners had standing to assert an equal protection claim, but that
their claim did not implicate racial discrimination. The Court remanded the case
to Supreme Court, Albany County, for resolution of the question of whether there
was a rational basis for the Tax Department's policy of non-enforcement of the
sales and excise taxes on reservation sales of cigarettes and motor fuel to
non-Indians. In a footnote, the Court stated that, in view of its disposition of
the case, petitioners' cross-appeal regarding the statewide suspension of the
taxes is "academic." By decision and judgment dated July 9, 1999, the Supreme
Court, Albany County, granted judgment dismissing the petition. On September 2,
1999, petitioners appealed to the Appellate Division, Third Department, from the
July 9, 1999 decision and order. On August 3, 2000, the Third Department
affirmed the judgment dismissing the petition.
LINE ITEM VETO
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In an action commenced in June 1998 by the Speaker of the Assembly of
the State of New York against the Governor of the State of New York (SILVER V.
PATAKI, Supreme Court, New York County), the Speaker challenges the Governor's
application of his constitutional line item veto authority to certain portions
of budget bills adopted by the State Legislature contained in Chapters 56, 57
and 58 of the Laws of 1998. On July 10, 1998, the State filed a motion to
dismiss this action. By order entered January 7, 1999, the Court denied the
State's motion to dismiss. On January 27, 1999, the State appealed that order.
By decision dated July 20, 2000, the Appellate Division reversed the January 7,
1999 order and dismissed the petition.
REAL PROPERTY CLAIMS
On March 4, 1985 in ONEIDA INDIAN NATION OF NEW YORK, ET AL. V. COUNTY
OF ONEIDA, the United States Supreme Court affirmed a judgment of the United
States Court of Appeals for the Second Circuit holding that the Oneida Indians
have a common-law right of action against Madison and Oneida Counties for
wrongful possession of 872 acres of land illegally sold to the State in 1795. At
the same time, however, the Court reversed the Second Circuit by holding that a
third-party claim by the counties against the State for indemnification was not
properly before the federal courts. The case was remanded to the District Court
for an assessment of damages, which action is still pending. The counties may
still seek indemnification in the State courts.
In 1998, the United States filed a complaint in intervention in ONEIDA
INDIAN NATION OF NEW YORK. In December 1998, both the United States and the
tribal plaintiffs moved for leave to amend their complaints to assert claims for
250,000 acres, to add the State as a defendant, and to certify a class made up
of all individuals who currently purport to hold title within said 250,000 acre
area. These motions were argued March 29, 1999 and are still awaiting
determination. The District Court has not yet rendered a decision. By order
dated February 24, 1999, the District Court appointed a federal settlement
master. A conference scheduled by the District Court for May 26, 1999 to address
the administration of this case has been adjourned indefinitely.
Several other actions involving Indian claims to land in upstate New
York are also pending. Included are CAYUGA INDIAN NATION OF NEW YORK V. CUOMO,
ET AL., and CANADIAN ST. REGIS BAND OF MOHAWK INDIANS, ET AL. V. STATE OF NEW
YORK, ET AL., both in the United States District Court for the Northern District
of New York. The Supreme Court's holding in ONEIDA INDIAN NATION OF NEW YORK may
impair or eliminate certain of the State's defenses to these actions, but may
enhance others. In the CAYUGA INDIAN NATION OF NEW YORK case, by order dated
March 29, 1999, the United States District Court for the Northern District of
New York appointed a federal settlement master. In October 1999, the District
Court granted the Federal Government's motion to have the State held jointly and
severally liable for any damages owed to the plaintiffs. At the conclusion of
the damages phase of the trial of this case, a jury verdict of $35 million in
damages plus $1.9 million representing the fair rental value of the properties
at issue was rendered against the defendants. On July 17, 2000, a bench hearing
was commenced to determine whether prejudgment interest is appropriate and, if
so, the amount thereof. In the CANADIAN ST. REGIS BAND OF MOHAWK INDIANS case,
the United States District Court for the Northern District of New York has
directed the parties to rebrief outstanding motions to dismiss brought by the
defendants. The State filed its brief on July 1, 1999. The motions were argued
in September 1999. No decision has been rendered on these motions. In SENECA
NATION OF INDIANS, by order dated November 22, 1999, the District Court
confirmed the July 12, 1999 magistrate's report, which recommended granting the
State's motion to dismiss that portion of the action relating to the right of
way where the New York State Thruway crosses the Cattaraugus Reservation in Erie
and Chatauqua Counties and denying the State's motion to dismiss the Federal
Government's damage claims. The District Court has set a trial date of October
17, 2000 for that portion of the case related to the plaintiff's claim of
ownership of the islands in the Niagara River.
CIVIL RIGHTS CLAIMS
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In an action commenced in 1980 (UNITED STATES, ET AL. V. YONKERS
BOARD OF EDUCATION, ET AL.), the United States District Court for the
Southern District of New York found, in 1985, that Yonkers and its public
schools were intentionally segregated. In 1986, the District Court ordered
Yonkers to develop and comply with a remedial educational improvement plan
(EIP I). On January 19, 1989, the District Court granted motions by Yonkers
and the NAACP to add the State Education Department, the Yonkers Board of
Education, and the State Urban Development Corporation as defendants, based
on allegations that they had participated in the perpetuation of the
segregated school system. On August 30, 1993, the District Court found that
vestiges of a dual school system continued to exist in Yonkers. On March 27,
1995, the District Court made factual findings regarding the role of the
State and the other State defendants (the State) in connection with the
creation and maintenance of the dual school system, but found no legal basis
for imposing liability. On September 3, 1996, the United States Court of
Appeals for the Second Circuit, based on the District Court's factual
findings, held the State defendants liable under 42 USC Section 1983 and the
Equal Educational Opportunity Act, 20 USC Sections 1701, ET SEQ., for the
unlawful dual school system, because the State, INTER ALIA, had taken no
action to force the school district to desegregate despite its actual or
constructive knowledge of DE JURE segregation. By order dated October 8,
1997, the District Court held that vestiges of the prior segregated school
system continued to exist and that, based on the State's conduct in creating
and maintaining that system, the State is liable for eliminating segregation
and its vestiges in Yonkers and must fund a remedy to accomplish that goal.
Yonkers presented a proposed educational improvement plan (EIP II) to
eradicate these vestiges of segregation. The October 8, 1997 order of the
District Court ordered that EIP II be implemented and directed that, within
10 days of the entry of the order, the State make available to Yonkers
$450,000 to support planning activities to prepare the EIP II budget for
1998-99 and the accompanying capital facilities plan. A final judgment to
implement EIP II was entered on October 14, 1997. On November 7, 1997, the
State appealed that judgment to the Second Circuit. Additionally, the Court
adopted a requirement that the State pay to Yonkers approximately $9.85
million as its pro rata share of the funding of EIP I for the 1996-97 school
year. The requirement for State funding of EIP I was reduced to an order on
December 2, 1997 and reduced to a judgment on February 10, 1998. The State
appealed that order to the Second Circuit on December 31, 1997 and amended
the notice of appeal after entry of the judgment.
On June 15, 1998, the District Court issued an opinion setting forth
the formula for the allocation of the costs of EIP I and EIP II between the
State and the City for the school years 1997-98 through 2005-06. That opinion
was reduced to an order on July 27, 1998. The order directed the State to pay
$37.5 million by August 1, 1998 for estimated EIP costs for the 1997-98 school
year. The State made this payment, as directed. On August 24, 1998, the State
appealed that order to the Second Circuit. The city of Yonkers and the Yonkers
Board of Education cross appealed to the Second Circuit from that order. By
stipulation of the parties approved by the Second Circuit on November 19, 1998,
the appeals from the July 27, 1998 order were withdrawn without prejudice to
reinstatement upon determination of the State's appeal of the October 14, 1997
judgment discussed above.
On April 15, 1999, the District Court issued two additional orders. The
first order directed the State to pay to Yonkers an additional $11.3 million by
May 1, 1999, as the State's remaining share of EIP costs for the 1997-98 school
year. The second order directed the State to pay to Yonkers $69.1 million as its
share of the estimated EIP costs for the 1998-99 school year. The State made
both payments on April 30, 1999.
In a decision dated June 22, 1999, the Second Circuit found no basis
for the District Court's findings that vestiges of a dual system continued to
exist in Yonkers and reversed the order directing the implementation of EIP
II. The Second Circuit also affirmed the District Court's order requiring the
State to pay one-half of the cost of EIP I for the 1996-97 school year and
remanded the case to the District Court for further proceedings consistent
with its decision. On July 2, 1999 the NAACP filed a petition for rehearing
of the June 22, 1999 decision before the Second Circuit, EN BANC. The State
has joined in the City of Yonkers motion to stay further implementation of
EIP II pending the decision on the petition for rehearing. By order dated
August 5, 1999, the Second Circuit granted the motion staying further
implementation of EIP II pending appeal.
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On July 27, 1999, the City of Yonkers moved in the District Court to
modify the July 27, 1998 order to require the State to make payments for EIP
expenses each month from July 1999 through April 2000 of $9.22 million per
month instead of paying $92.2 million by May 1, 2000. By memorandum and order
dated July 29, 1999, the District Court denied this motion.
In a decision dated November 16, 1999, the Second Circuit vacated its
June 22, 1999 decision. In this decision, the Second Circuit again affirmed the
District Court's order requiring the State to pay one-half of the cost of EIP I
for the 1996-97 school year. The Second Circuit also found no basis for the
District Court's findings that vestiges of a dual system continued to exist in
Yonkers, and therefore vacated the District Court's EIP II order. The Second
Circuit, however, remanded to the District Court for the limited purpose of
making further findings on the existing record as to whether any other vestiges
of the dual system remain in the Yonkers public schools. On May 22, 2000, the
United States Supreme Court denied the State's petition for certiorari, seeking
leave to appeal the November 16, 1999 decision and the underlying September 3,
1996 decision.
On April 17, 2000, the District Court issued an additional order,
directing the State to pay to Yonkers $44.3 million as its share of the
estimated EIP costs for the 1999-2000 school year. On May 17, 2000, the State
appealed that order to the Second Circuit. The appeals of all of these funding
orders have been consolidated with the May 17, 2000 appeal of the April 17, 2000
order.
SCHOOL AID
In CAMPAIGN FOR FISCAL EQUITY, INC., ET AL. V. STATE, ET AL. (Supreme
Court, New York County), plaintiffs challenge the funding for New York City
public schools. Plaintiffs seek a declaratory judgment that the State's public
school financing system violates article 11, section 1 of the State Constitution
and Title VI of the federal Civil Rights Act of 1964 and injunctive relief that
would require the State to satisfy State Constitutional standards. This action
was commenced in 1993. The trial of this action concluded July 27, 2000.
STATE PROGRAMS
MEDICAID
Several cases challenge provisions of Chapter 81 of the Laws of 1995
which alter the nursing home Medicaid reimbursement methodology on and after
April 1, 1995. Included are NEW YORK STATE HEALTH FACILITIES ASSOCIATION, ET AL.
V. DEBUONO, ET AL., ST. LUKE'S NURSING CENTER, ET AL. V. DEBUONO, ET AL., NEW
YORK ASSOCIATION OF HOMES AND SERVICES FOR THE AGING V. DEBUONO ET AL. (three
cases), HEALTHCARE ASSOCIATION OF NEW YORK STATE V. DEBUONO and BAYBERRY NURSING
HOME ET AL. V. PATAKI, ET AL. Plaintiffs allege that the changes in methodology
have been adopted in violation of procedural and substantive requirements of
State and federal law.
In a consolidated action commenced in 1992, Medicaid recipients and
home health care providers and organizations challenge promulgation by the State
Department of Social Services (DSS) in June 1992 of a home assessment resource
review instrument (HARRI), which is to be used by DSS to determine eligibility
for and the nature of home care services for Medicaid recipients, and challenge
the policy of DSS of limiting reimbursable hours of service until a patient is
assessed using the HARRI (DOWD, ET AL. V. BANE, Supreme Court, New York County).
In a related case, RODRIGUEZ V. DEBUONO, on April 19, 1999, the United States
District Court for the Southern District of New York enjoined the State's use of
task based assessment, which is similar to the HARRI, unless the State assesses
safety monitoring as a separate task based assessment, on the grounds that its
use without such additional assessment violated federal Medicaid law and the
Americans with Disabilities Act. The State appealed from the April 19, 1999
order and on July 12, 1999 argued the appeal before the Second Circuit. By order
dated October 6, 1999, the Second Circuit
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reversed the April 19, 1999 order and vacated the injunction. On October 20,
1999, petitioners filed a request for rehearing EN BANC.
In several cases, plaintiffs seek retroactive claims for reimbursement
for services provided to Medicaid recipients who were also eligible for Medicare
during the period January 1, 1987 to June 2, 1992. Included are MATTER OF NEW
YORK STATE RADIOLOGICAL SOCIETY V. WING, APPEL V. WING, E.F.S. MEDICAL SUPPLIES
V. DOWLING, KELLOGG V. WING, LIFSHITZ V. WING, NEW YORK STATE PODIATRIC MEDICAL
ASSOCIATION V. WING and NEW YORK STATE PSYCHIATRIC ASSOCIATION V. WING. These
cases were commenced after the State's reimbursement methodology was held
invalid in NEW YORK CITY HEALTH AND HOSPITAL CORP. V. PERALES. The State
contends that these claims are time-barred. In a judgment dated September 5,
1996, the Supreme Court, Albany County, dismissed MATTER OF NEW YORK STATE
RADIOLOGICAL SOCIETY V. WING as time-barred. By order dated November 26, 1997,
the Appellate Division, Third Department, affirmed that judgment. By decision
dated June 9, 1998, the Court of Appeals denied leave to appeal. In a decision
entered December 15, 1998, the Appellate Division, First Department, dismissed
the remaining cases in accordance with the result in MATTER OF NEW YORK STATE
RADIOLOGICAL SOCIETY V. WING. By decision dated July 8, 1999, the Court of
Appeals denied leave to appeal.
Several cases, including PORT JEFFERSON HEALTH CARE FACILITY, ET AL.
V. WING (Supreme Court, Suffolk County), challenge the constitutionality of
Public Health Law Section 2807-d, which imposes a tax on the gross receipts
hospitals and residential health care facilities receive from all patient
care services. Plaintiffs allege that the tax assessments were not uniformly
applied, in violation of federal regulations. In a decision dated June 30,
1997, the Court held that the 1.2% and 3.8% assessments on gross receipts
imposed pursuant to Public Health Law Sections 2807-d(2)(b)(ii) and
2807-d(2)(b)(iii), respectively, are unconstitutional. An order entered
August 27, 1997 enforced the terms of the decision. The State appealed that
order. By decision and order dated August 31, 1998, the Appellate Division,
Second Department, affirmed that order. On September 30, 1998, the State
moved for re-argument or, in the alternative, for a certified question for
the Court of Appeals to review. By order dated January 7, 1999, the motion
was denied. A final order was entered in Supreme Court on January 26, 1999.
On February 23, 1999, the State appealed that order to the Court of Appeals.
In a decision entered December 16, 1999, the Court of Appeal reversed the
decision below and upheld constitutionality of the assessments. On May 15,
2000, plaintiffs filed a petition for certiorari with the United States
Supreme Court seeking to appeal the December 6, 1999 decision. The State's
response is due June 15, 2000.
In DENTAL SOCIETY, ET AL. V. PATAKI, ET AL. (United States District
Court, Northern District of New York, commenced February 2, 1999), plaintiffs
challenge the State's reimbursement rates for dental care provided under the
State's dental Medicaid program. Plaintiffs claim that the State's Medicaid
fee schedule violates Title XIX of the Social Security Act (42 U.S.C. Section
1396a et seq.) and the federal and State Constitutions. On June 25, 1999, the
State filed its answer. The parties have entered into a settlement agreement
dated May 8, 2000 that will increase Medicare dental reimbursement rates
prospectively over a four-year period, beginning June 1, 2000.
SHELTER ALLOWANCE
In an action commenced in March 1987 against State and New York City
officials (JIGGETTS, ET AL. V. BANE, ET AL., Supreme Court, New York County),
plaintiffs allege that the shelter allowance granted to recipients of public
assistance is not adequate for proper housing. In a decision dated April 16,
1997, the Court held that the shelter allowance promulgated by the
Legislature and enforced through the State Department of Social Services
regulations is not reasonably related to the cost of rental housing in New
York City and results in homelessness to families in New York City. A
judgment was entered on July 25, 1997, directing, INTER ALIA, that the State
(i) submit a proposed schedule of shelter allowances (for the Aid to
Dependent Children program and any successor program) that bears a reasonable
relation to the cost of housing in New York City; and (ii) compel the New
York City Department of Social Services to pay plaintiffs a monthly shelter
allowance in the full amount of their contract rents, provided they continue
to meet the eligibility requirements for public assistance, until such time
as a lawful shelter allowance is
B-22
implemented, and provide interim relief to other eligible recipients of Aid to
Dependent Children under the interim relief system established in this case.
The State appealed to the Appellate Division, First Department from each and
every provision of this judgment except that portion directing the continued
provision of interim relief. By decision and order dated May 6, 1999, the
Appellate Division, First Department, affirmed the July 25, 1997 judgment. By
order dated July 8, 1999, the Appellate Division denied the State's motion for
leave to appeal to the Court of Appeals from the May 6, 1999 decision and order.
By order dated October 14, 1999, the Court of Appeals dismissed the State's
motion for leave to appeal.
B-23