-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LM1xpKN6tw00BT4zDNz5XWqY8IrMHli+6GCVaNr2dfjun6ECv59il/TJfpzgvePd ijl3DUAPZNmQWLmprpOA7Q== 0000950123-96-005208.txt : 19960927 0000950123-96-005208.hdr.sgml : 19960927 ACCESSION NUMBER: 0000950123-96-005208 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960926 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MORGAN STANLEY RUSSIA & NEW EUROPE FUND INC CENTRAL INDEX KEY: 0000918686 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 133756741 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 033-75012 FILM NUMBER: 96634819 BUSINESS ADDRESS: STREET 1: 1221 AVE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10020 BUSINESS PHONE: 2122967100 MAIL ADDRESS: STREET 1: 1221 AVENUE OF THE AMERICAS STREET 2: 1221 AVENUE OF THE AMERICAS CITY: NEW YORK STATE: NY ZIP: 10020 FORMER COMPANY: FORMER CONFORMED NAME: MORGAN STANLEY EUROPEAN EMERGING MARKETS FUND INC DATE OF NAME CHANGE: 19940207 497 1 MORGAN STANLEY RUSSIA & NEW EUROPE FUND, INC. 1 PROSPECTUS 5,000,000 Shares Morgan Stanley Russia & New Europe Fund, Inc. COMMON STOCK ------------------------ The Fund is a non-diversified, closed-end management investment company. The Fund's investment objective is long-term capital appreciation. The Fund intends to invest primarily in equity securities of issuers that, in the opinion of Morgan Stanley Asset Management Inc., are likely to benefit from market and political developments in Russia, the other former Soviet Republics and in other countries in Central and Eastern Europe ("RNE countries"). The Fund also may invest, from time to time, in debt securities issued or guaranteed by the governments of or governmental entities in those countries ("Sovereign Debt"). It is the policy of the Fund, under normal market conditions, to invest substantially all, but not less than 65%, of its total assets in equity securities of Russian and other RNE country issuers and in Sovereign Debt. The Fund expects that, from time to time, a significant portion of its assets will be invested in the securities of Russian issuers. See "Investment Objective and Policies." There can be no assurance that the Fund's investment objective will be achieved. Morgan Stanley Asset Management Inc. will act as the Fund's Investment Manager (the "Investment Manager"). The address of the Fund is 1221 Avenue of the Americas, New York, New York 10020 (telephone number (212) 296-7100). ------------------------ INVESTMENT IN THE FUND INVOLVES SPECIAL CONSIDERATIONS AND RISKS THAT ARE NOT TYPICALLY ASSOCIATED WITH INVESTING IN THE STOCK MARKETS OF THE UNITED STATES, SUCH AS CURRENCY FLUCTUATIONS AND RESTRICTIONS, GREATER GOVERNMENT INVOLVEMENT IN THE ECONOMY AND POLITICAL AND LEGAL UNCERTAINTIES. ADDITIONALLY, MANY OF THE SECURITIES MARKETS IN WHICH THE FUND INTENDS TO INVEST ARE JUST BEGINNING TO DEVELOP AND, AS A CONSEQUENCE, THERE IS SUBSTANTIALLY MORE PRICE VOLATILITY AND LESS LIQUIDITY IN SUCH MARKETS AND THE SETTLEMENT, CLEARING AND REGISTRATION OF SECURITIES TRANSACTIONS ARE SUBJECT TO SIGNIFICANT RISKS. SHARES OF CLOSED-END INVESTMENT COMPANIES HAVE IN THE PAST FREQUENTLY TRADED AT DISCOUNTS FROM THEIR NET ASSET VALUES AND INITIAL OFFERING PRICES. THE RISKS ASSOCIATED WITH THIS CHARACTERISTIC OF CLOSED-END INVESTMENT COMPANIES MAY BE GREATER FOR INVESTORS EXPECTING TO SELL SHARES OF A CLOSED-END INVESTMENT COMPANY SOON AFTER THE COMPLETION OF AN INITIAL PUBLIC OFFERING OF THE COMPANY'S SHARES. SEE "RISK FACTORS AND SPECIAL CONSIDERATIONS." ------------------------ The Underwriters have advised the Fund that they propose to offer the Shares initially at the public offering price of $20.00 per Share. There is no sales charge or underwriting discount charged to investors on purchases of Shares in this offering. The Investment Manager or an affiliate (not the Fund) has agreed to pay the Underwriters from its own assets a commission in connection with sales of Shares in this offering. The Investment Manager also has agreed to pay the Fund's expenses in connection with this offering in order to maintain a net asset value of $20.00 per Share immediately following the completion of this offering. The number of Shares to be sold by the Fund in its initial public offering will not exceed 5,000,000 (plus the number of Shares that may be sold to the Underwriters pursuant to the exercise, if any, of their over-allotment options). See "Underwriters." ------------------------ Prior to this offering, there has been no public market for the Fund's Shares. The Fund's Shares have been approved for listing on the New York Stock Exchange upon notice of issuance under the symbol "RNE." ------------------------ This Prospectus sets forth concisely the information about the Fund that a prospective investor ought to know before investing and should be read and retained for future reference. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ PRICE $20.00 A SHARE ------------------------
PRICE TO PROCEEDS TO PUBLIC SALES LOAD(1) THE FUND(2) --------------------------------------------------------------- Per Share.............................. $20.00 $0.00 $20.00 Total(3)............................... $100,000,000 $0.00 $100,000,000
(Footnotes on following page) ------------------------ The Shares are offered, subject to prior sale, when, as and if accepted by the Underwriters named herein and subject to approval of certain legal matters by Davis Polk & Wardwell, counsel for the Underwriters. It is expected that delivery of the Shares will be made on or about September 30, 1996 at the office of Morgan Stanley & Co. Incorporated, New York, New York, against payment therefor in immediately available funds. ------------------------ MORGAN STANLEY & CO. Incorporated DONALDSON, LUFKIN & JENRETTE Securities Corporation A.G. EDWARDS & SONS, INC. COWEN & COMPANY EVEREN SECURITIES, INC. FAHNESTOCK & CO. INC. September 24, 1996 2 (Continued from previous page) - ------------ (1) The Fund and the Investment Manager have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. The Investment Manager or an affiliate (not the Fund) will pay the Underwriters a commission in the gross amount of 4.0% of the initial public offering price per share of Common Stock, in connection with sale of Shares in this offering (other than shares acquired for accounts managed by the Investment Manager). (2) Before deducting organizational expenses payable by the Fund, estimated at $80,000. Organizational expenses will be amortized over a period not to exceed 60 months from the date the Fund commences operations. Offering expenses, estimated at $420,000, will be paid by Morgan Stanley Asset Management Inc. or an affiliate (not the Fund). (3) The Fund has granted the Underwriters options, exercisable up to 45 days from the date hereof, to purchase up to an aggregate of 750,000 additional Shares at the price to the public for the purpose of covering over-allotments, if any. If the Underwriters exercise such options in full, the total price to the public, sales load and proceeds to the Fund will be $115,000,000, $0.00 and $115,000,000, respectively. See "Underwriters." ------------------------ NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND, THE INVESTMENT MANAGER OR BY ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING TO SELL OR A SOLICITATION OF AN OFFER TO BUY BY ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFERING OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCE IMPLY THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ------------------------ UNTIL OCTOBER 21, 1996 (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE SHARES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ------------------------ TABLE OF CONTENTS Page PROSPECTUS SUMMARY............................................................................ 3 FEE TABLE..................................................................................... 8 THE FUND...................................................................................... 9 USE OF PROCEEDS............................................................................... 10 RISK FACTORS AND SPECIAL CONSIDERATIONS....................................................... 10 INVESTMENT OBJECTIVE AND POLICIES............................................................. 16 INVESTMENT RESTRICTIONS....................................................................... 21 MANAGEMENT OF THE FUND........................................................................ 23 ESTIMATED EXPENSES............................................................................ 30 PORTFOLIO TRANSACTIONS AND BROKERAGE.......................................................... 31 NET ASSET VALUE............................................................................... 32 DIVIDENDS AND DISTRIBUTIONS; DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN................................................ 32 TAXATION...................................................................................... 33 COMMON STOCK.................................................................................. 39 UNDERWRITERS.................................................................................. 42 DIVIDEND PAYING AGENT, TRANSFER AGENT AND REGISTRAR........................................... 44 CUSTODIAN..................................................................................... 44 EXPERTS....................................................................................... 45 LEGAL MATTERS................................................................................. 45 ADDITIONAL INFORMATION........................................................................ 45 REPORT OF INDEPENDENT ACCOUNTANTS............................................................. 46 STATEMENT OF ASSETS AND LIABILITIES........................................................... 47 APPENDIX A.................................................................................... A-1 APPENDIX B.................................................................................... B-1 APPENDIX C.................................................................................... C-1
------------------------ IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE, IN THE OVER-THE-COUNTER MARKETS OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 2 3 PROSPECTUS SUMMARY The following is qualified in its entirety by the more detailed information included elsewhere in this Prospectus. THE FUND................... The Fund is a non-diversified, closed-end management investment company designed for investors desiring to invest a portion of their assets in equity securities of issuers that, in the opinion of Morgan Stanley Asset Management Inc., the Fund's Investment Manager, are likely to benefit from market and political developments in Russia, the other former Soviet Republics and in other countries in Central and Eastern Europe. The Fund may also invest, from time to time, in debt securities issued or guaranteed by governments of or governmental entities in those countries ("Sovereign Debt"). A complete list of countries in which the Fund intends to invest ("RNE countries") is set forth in Appendix A. INVESTMENT OBJECTIVE AND POLICIES................. The Fund's investment objective is long-term capital appreciation. The Fund's policy, under normal market conditions, is to invest substantially all, but not less than 65%, of its total assets in (i) equity securities (A) of companies organized in, or for which the principal trading market is in, an RNE country, (B) denominated in the currency of an RNE country and issued by companies to finance operations in an RNE country and (C) of companies that alone or on a consolidated basis derive 50% or more of their revenues primarily from either goods produced, sales made or services performed in an RNE country (collectively, "RNE country issuers") and (ii) Sovereign Debt. No assurance can be given that the Fund's investment objective will be realized. The Fund intends to invest in equity securities of RNE country issuers and Sovereign Debt as appropriate opportunities arise. The amount invested in any one RNE country will vary depending on market conditions. The Fund is not limited in the percentage of its assets that may be invested in any one country and it is anticipated that, from time to time, the Fund will have a significant portion of its assets invested in securities of Russian issuers. The Fund anticipates that, initially, its investments will be made primarily in Russia, the Czech Republic, Hungary and Poland, which currently have the most developed capital markets of the RNE countries. Bulgaria, Croatia, Estonia, Latvia, Lithuania, Slovakia, Slovenia and the Ukraine also offer current investment opportunities on a more limited basis. As opportunities develop, investments may be made in the remaining RNE countries. THE OFFERING............... The Fund is offering 5,000,000 shares of Common Stock, $0.01 par value (the "Shares"), through a group of underwriters (the "Underwriters") for which Morgan Stanley & Co. Incorporated is acting as lead representative. The Underwriters also have been granted options to 3 4 purchase up to 750,000 additional Shares solely to cover over-allotments, if any. The number of Shares to be sold by the Fund in its initial public offering will not exceed 5,000,000 (plus the number of Shares sold to the Underwriters pursuant to the exercise, if any, of their over-allotment options). The initial public offering price is $20.00 per Share. See "Underwriters." NO SALES LOAD.............. The Shares will be sold during the initial public offering without any sales charges. Morgan Stanley Asset Management Inc. or an affiliate (not the Fund) will pay the Underwriters a commission in the gross amount of 4.0% of the initial public offering price per Share of Common Stock, in connection with the sale of the Shares in this offering. See "Underwriting." Morgan Stanley Asset Management Inc. also has agreed to pay the Fund's expenses in connection with this offering in order to maintain a net asset value of $20.00 per Share immediately following the completion of this offering. LISTING.................... The Fund's Shares have been approved for listing on the New York Stock Exchange upon notice of issuance. SYMBOL..................... "RNE" INVESTMENT MANAGER......... Morgan Stanley Asset Management Inc. (the "Investment Manager"), a wholly owned subsidiary of Morgan Stanley Group Inc., will manage the investments of the Fund pursuant to an Investment Advisory and Management Agreement with the Fund (the "Management Agreement"). As an investment adviser, the Investment Manager emphasizes a global investment strategy. At June 30, 1996, the Investment Manager had, together with its affiliated investment management companies, assets under management (including assets under fiduciary advisory control) totaling approximately $104 billion, of which approximately $9 billion was invested in emerging country markets. The Investment Manager currently acts as investment adviser for 13 closed-end funds which principally invest in emerging markets. Additionally, Morgan Stanley Group Inc. has entered into a definitive agreement to purchase the parent company of Van Kampen American Capital, Inc., the fourth largest non-proprietary mutual fund provider in the United States with approximately $57 billion in assets under management and/or supervision at June 30, 1996. The acquisition is expected to close by November 30, 1996. The Investment Manager is a registered investment adviser under the U.S. Investment Advisers Act of 1940 (the "Advisers Act"). See "Management of the Fund." MANAGEMENT FEES AND ESTIMATED EXPENSES......... The Fund will pay the Investment Manager a fee, computed weekly and payable monthly, at the annual rate of 1.60% of the Fund's average weekly net assets. This fee is higher than those paid by most other U.S. investment companies, primarily because of the additional time and expense required of the Investment Manager in pursuing the Fund's objective of investing in securities of RNE country issuers and Sovereign Debt. This investment objective entails additional time and expense because public information concerning securities of RNE country issuers is limited in comparison to that available for U.S. 4 5 companies and may not be subject to the same accounting standards. See "Management of the Fund." The Fund will be responsible for all of its operating expenses. The Fund's annual normal operating expenses, including advisory, administration and custodial fees, are estimated to be approximately $3,050,000 exclusive of organization expenses estimated to be $80,000 (which are to be amortized over five years). The expenses of this offering estimated to be $420,000 will be paid by the Investment Manager or an affiliate and will not be charged to the capital of the Fund. See "Estimated Expenses." ADMINISTRATION............. Chase Global Funds Services Company (the "Administrator"), a subsidiary of The Chase Manhattan Bank, will provide administrative services to the Fund pursuant to an Administration Agreement (the "Administration Agreement"). The Fund will pay the Administrator an annual administration fee of $65,000 plus 0.09% of the average weekly net assets of the Fund. See "Management of the Fund -- Administration." DIVIDEND DISTRIBUTIONS AND REINVESTMENT............. The Fund intends to distribute to stockholders at least annually substantially all of its net investment income and any net realized capital gains. The Fund may elect annually, however, to retain for investment any net realized long-term capital gains. Unless the Fund is otherwise instructed in writing in the manner described under "Dividends and Distributions; Dividend Reinvestment and Cash Purchase Plan," stockholders will be presumed to have elected to have all distributions automatically reinvested in shares of the Fund. Stockholders who have distributions automatically reinvested may also make additional payments into the dividend reinvestment and cash purchase plan to purchase shares of the Fund on the open market. See "Dividends and Distributions; Dividend Reinvestment and Cash Purchase Plan." Reinvested dividends and undistributed long-term capital gains will generally give rise to tax without a corresponding amount of cash. See "Taxation -- U.S. Federal Income Taxes." CUSTODIAN.................. The Chase Manhattan Bank will act as custodian for the Fund's assets and may employ sub-custodians approved by the Directors of the Fund in accordance with regulations of the U.S. Securities and Exchange Commission. See "Custodian." RISK FACTORS AND SPECIAL CONSIDERATIONS........... The Fund's investments in RNE countries involve certain special considerations not typically associated with investing in securities of U.S. companies, including risks relating to (1) political and economic considerations, such as less social, political and economic stability and the possibility that recent favorable economic developments may be slowed or reversed by unanticipated political or social events; (2) the absence of developed legal structures governing private or foreign investments and private property; (3) the possibility of the loss of all or a substantial portion of the Fund's assets invested in RNE countries as a result of expropriation; (4) restrictions on repatriation of capital; (5) certain national policies which may restrict the Fund's investment 5 6 opportunities, including, without limitation, restrictions on investing in issuers or industries deemed sensitive to relevant national interests; (6) currency exchange matters, including fluctuations in the rate of exchange between the U.S. dollar and the various currencies in which the Fund's portfolio securities are denominated, exchange control regulations, currency exchange restrictions, and costs associated with conversion of investment principal and income from one currency into another; (7) the absence, until recently, in certain RNE countries of a capital market structure or market-oriented economy; (8) less developed and reliable custody and settlement mechanisms; and (9) differences between U.S. securities markets and the securities markets of RNE countries, including potentially greater price volatility in, significantly smaller capitalization of, and relative illiquidity of, some of these non-U.S. securities markets, the absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation. The Fund will be unable to invest in many RNE countries until custody arrangements complying with the U.S. Securities and Exchange Commission are established. In addition, settlement mechanisms in RNE countries are generally less developed and reliable than those in countries with mature economies and this could result in settlement delays and other difficulties. The Fund may be subject to withholding taxes, including withholding taxes on realized capital gains that may exist or may be imposed by the governments of the countries in which the Fund invests. See "Risk Factors and Special Considerations." While the Fund expects that its investments in equity securities of RNE country issuers will be primarily in listed equity securities, it may invest up to 35% of its total assets in unlisted equity securities of RNE country issuers to the extent permitted by any local investment restrictions. Such investments may involve a high degree of business and financial risk. Because of the absence of any liquid trading market for these investments, the Fund may take longer to liquidate these positions than it would in the case of listed securities. In addition to financial and business risks, issuers whose securities are not listed may not be subject to the same disclosure requirements applicable to issuers whose securities are listed. See "Risk Factors and Special Considerations -- Investments in Unlisted Securities." The Fund may also invest a portion of its assets in (i) debt securities of corporate RNE country issuers, (ii) equity or debt securities of corporate or governmental issuers located in countries other than RNE countries and (iii) short-term and medium-term debt securities of the type described below under "Investment Objective and Policies -- Temporary Investments." The Fund may invest up to 50% of its total assets in debt securities, including Sovereign Debt, that are rated below investment grade by Standard & Poor's Ratings Group ("S&P") or Moody's Investors Service, Inc. ("Moody's") or, if unrated, are determined by the Investment Manager to be comparable to securities rated below investment grade by S&P or Moody's. Such lower-quality, non-investment grade securities are commonly referred to as "junk bonds" 6 7 and are regarded as being predominantly speculative and involve significant risks. In addition, the Fund may enter into options and futures contracts on a variety of instruments and indexes and forward currency exchange contracts in order to protect against fluctuation in interest rates, foreign currency exchange risks and declines in the value of portfolio securities or increases in the costs of securities to be acquired. Additionally, the Fund may enter into options transactions on securities for purposes of increasing its investment returns. Each of these types of transactions involves special risks. See "Investment Objective and Policies" and Appendix C to this Prospectus. The Fund is classified as a "non-diversified" investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), which means that the Fund is not limited by the 1940 Act in the proportion of its assets that may be invested in the securities of a single issuer. As a non-diversified investment company, 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 of loss with respect to its portfolio securities. However, the Fund intends to comply with the diversification requirements imposed by the U.S. Internal Revenue Code of 1986, as amended, for qualification as a regulated investment company. See "Investment Restrictions" and "Taxation -- U.S. Federal Income Taxes." The Fund's Articles of Incorporation contain certain anti-takeover provisions that may have the effect of inhibiting the Fund's possible conversion to open-end status and limiting the ability of other persons to acquire control of the Fund. In certain circumstances, these provisions might also inhibit the ability of stockholders to sell their shares at a premium over prevailing market prices. See "Risk Factors and Special Considerations" and "Common Stock." Investors should carefully consider their ability to assume the foregoing risks before making an investment in the Fund. An investment in shares of the Fund may not be appropriate for all investors and should not be considered as a complete investment program. See "Risk Factors and Special Considerations." DISCOUNT TO NET ASSET VALUE...................... Shares of closed-end investment companies frequently trade at a discount from net asset value. This characteristic of shares of a closed-end fund is a risk separate and distinct from the risk that the Fund's net asset value will decrease. The Fund cannot predict whether its shares will trade at, above or below net asset value. The risk of purchasing shares of a closed-end investment company which might trade at a discount from net asset value is more pronounced for investors who purchase in the initial public offering and who wish to sell their shares in a relatively short period of time. See "Net Asset Value." 7 8 FEE TABLE
STOCKHOLDER TRANSACTION EXPENSES: Sales Load (as a percentage of offering price).................................. None Dividend Reinvestment and Cash Purchase Plan Fees............................... None ANNUAL EXPENSES (AS A PERCENTAGE OF NET ASSETS ATTRIBUTABLE TO COMMON SHARES): Management Fees................................................................. 1.60% Other Expenses.................................................................. 1.45% Total Annual Expenses...................................................... 3.05% =====
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF: ------------------------------------------- 1 YEAR 3 YEARS 5 YEARS 10 YEARS ------ ------- ------- -------- EXAMPLE: An investor would pay the following expenses on a $1,000 investment, assuming a 5% annual return............... $ 31 $94 $ 160 $336
The foregoing Fee Table is intended to assist investors in understanding the costs and expenses that an investor in the Fund will bear directly or indirectly. The Example set forth above assumes the absence of a sales load, reinvestment of all dividends and distributions at net asset value and an expense ratio of 3.05%. The tables above and the assumption in the Example of a 5% annual return are required by U.S. Securities and Exchange Commission (the "Commission") regulations applicable to all investment companies. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN. Actual expenses and annual rates of return may be more or less than those assumed for purposes of the Example. In addition, while the Example assumes reinvestment of all dividends and distributions at net asset value, participants in the Fund's Dividend Reinvestment and Cash Purchase Plan may receive shares purchased or issued at a price or value different from net asset value. See "Dividends and Distributions; Dividend Reinvestment and Cash Purchase Plan." The figures provided under "Other Expenses" are based upon estimated amounts for the Fund's first fiscal year. See "Management of the Fund" for additional information. 8 9 THE FUND The Fund, incorporated in Maryland on February 3, 1994, is a non-diversified, closed-end management investment company registered under the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's investment objective is long-term capital appreciation. The Fund seeks to achieve its objective by investing primarily in equity securities of issuers that, in the opinion of the Investment Manager, are likely to benefit from market and political developments in Russia, the other former Soviet Republics and in other countries in Central and Eastern Europe. A complete list of countries in which the Fund intends to invest ("RNE countries") is set forth in Appendix A. The Fund is not limited in the percentage of its assets that may be invested in any one country and it is anticipated that, from time to time, the Fund may have a significant portion of its assets invested in securities of Russian issuers. The Fund also may invest, from time to time, in debt securities issued or guaranteed by RNE country governments or governmental entities ("Sovereign Debt"). No assurance can be given that the Fund's investment objective will be realized. The Fund permits investors to gain exposure to the securities markets of RNE countries that many investors would have difficulty investing in directly. Due to the risks inherent in international investments generally, the Fund should be considered as a vehicle for investing a portion of an investor's assets in foreign securities markets and not as a complete investment program. At all times after its Initial Investment Period (as defined below under "Use of Proceeds"), except during periods when a temporary defensive investment strategy is appropriate, as determined by the Fund's investment manager, the Fund intends to invest substantially all, but not less than 65%, of its total assets in equity securities of RNE country issuers (as defined below under "Use of Proceeds") and in Sovereign Debt. The Fund's holdings of equity securities are expected to consist primarily of listed equity securities; however, the Fund may invest up to 35% of its total assets in unlisted equity securities of RNE country issuers to the extent permitted by any local investment restrictions, including investments in new and early stage companies. The Fund may also invest a portion of its assets in (i) debt securities of corporate RNE country issuers, (ii) equity or debt securities of corporate or governmental issuers located in countries other than RNE countries and (iii) short-term and medium-term debt securities of the type described below under "Investment Objective and Policies -- Temporary Investments." The Fund may invest up to 50% of its total assets in debt securities, including Sovereign Debt, that are rated below investment grade by S&P or Moody's or, if unrated, are determined by the Investment Manager to be comparable to securities rated below investment grade by S&P or Moody's. Such lower-quality, non-investment grade securities are commonly referred to as "junk bonds" and are regarded as being predominantly speculative and involve significant risks. See "Investment Objective and Policies" and "Risk Factors and Special Considerations." Most RNE countries have had centrally planned economies which were primarily influenced by socialist or communist political philosophies and were characterized by nationalized industries, fixed prices and limited external trade. Over the past several years, however, most of these countries have undertaken political and economic reforms, founded upon an ideological shift from socialism or communism to capitalism. The reforms have had the effect, with varying degrees of success, of creating market-driven economies and have made foreign investments in these countries possible. The Investment Manager believes that current conditions in most RNE countries, including, among other things, established infrastructures, technical expertise and significant natural resources, will result in a significant level of economic activity, offering the potential for long-term capital appreciation from investment in equity securities of RNE country issuers and Sovereign Debt. 9 10 USE OF PROCEEDS The net proceeds of this offering (estimated to be approximately $100,000,000 if the Underwriters' over-allotment options are not exercised) will be invested in accordance with the policies set forth under "Investment Objective and Policies -- Temporary Investments." The Fund expects to invest gradually by purchasing, on a selective basis in the open market and in private transactions, equity securities (i) of companies organized in, or for which the principal trading market is in, an RNE country, (ii) denominated in the currency of an RNE country and issued by companies to finance operations in an RNE country and (iii) of companies that alone or on a consolidated basis derive 50% or more of their revenues primarily from either goods produced, sales made or services performed in an RNE country (collectively, "RNE country issuers"). The Fund may also invest from time to time in Sovereign Debt. The Fund believes that, due to the nature of the equity securities markets of RNE countries generally, combined with certain investment diversification requirements applicable to the Fund and the Fund's desire to invest selectively in order to avoid adversely influencing the prices paid by the Fund for its portfolio securities, it may take up to one year from the date of completion of the offering made hereby (the "Initial Investment Period"), depending upon market conditions and the availability of appropriate securities, for the Fund to be fully invested in accordance with its investment objective and policies. RISK FACTORS AND SPECIAL CONSIDERATIONS Investors should recognize that investing in securities of RNE country issuers involves certain special considerations and risk factors, including those set forth below, which are not typically associated with investing in securities of U.S. issuers. See "Appendix B -- Russia and New European Countries." ECONOMIC AND POLITICAL RISKS The economies of individual RNE countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of Gross Domestic Product ("GDP") or Gross National Product ("GNP"), as the case may be, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments position. Further, the economies of RNE countries generally are heavily dependent upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. Business entities in RNE countries have only a limited history of operating in a market-oriented economy, and the ultimate impact of such RNE countries' attempts to move toward more market-oriented economies is currently unclear. The social and economic difficulties resulting from local corruption and crime could adversely affect the value of the Fund's investments. Finally, nationalization, expropriation or confiscatory taxation, currency blockage, political changes, government regulation, social instability or diplomatic developments could adversely affect the economy of an RNE country or the Fund's investments in such country. The Fund intends to seek investment opportunities in Russia, the other former Soviet Republics and in other countries in Central and Eastern Europe. Investing in these countries involves significant economic and political risk. For example, most of these countries have had centrally planned, socialist economies since shortly after World War II. The governments of these countries currently are implementing or considering reforms directed at political and economic liberalization, including efforts to decentralize the economic decision-making process and move towards a more market-oriented economy. These reforms have met with resistance, in some instances, and have prompted certain political parties to advocate the return to a centrally planned economy. There can be no assurance that these reforms will continue or, if continued, will achieve their goals. Despite the implementation of privatization programs by RNE countries, the governments of RNE countries have exercised and continue to exercise significant influence over many aspects of the local economies, and the number of public sector enterprises in the RNE countries is substantial. New governments and new economic policies may have an unpredictable impact on the economies of the RNE countries. Future actions by the government of an RNE country could have a significant effect on the local economy, which could affect private sector companies, market conditions and prices and yields of securities in the Fund's portfolio. 10 11 In addition, upon the accession to power of Communist regimes, the governments of a number of RNE countries expropriated a large amount of private property. The claims of many property owners against those governments were never settled and any future settlements could have an adverse effect on the value of certain investments in the Fund's portfolio. There can also be no assurance that the Fund's investments in these countries would not be expropriated, nationalized or otherwise confiscated. In the event of the settlement of any such claims or such expropriation, nationalization or other confiscation, the Fund could lose its entire investment in the country involved. In addition, any change in the leadership or policies of RNE countries could halt the expansion of or reverse the liberalization of foreign investment policies now occurring and adversely affect existing investment opportunities. ABSENCE OF DEVELOPED LEGAL STRUCTURES In the years since the fall of Communism, the RNE countries have been developing a body of securities and tax laws and laws governing corporations and other business entities. Legal structures governing private and foreign investment and private property, where they have been implemented, are new. Laws may not exist to cover all business and commercial relationships or to protect investors, particularly minority shareholders, adequately and furthermore, the administration of laws and regulations by government agencies may be subject to considerable discretion. There is a low level of monitoring and regulation of securities markets in RNE countries generally, and of the activities of investors in such markets, and there has been no or very limited enforcement to date of existing regulations. In addition, even in circumstances where adequate laws exist, it may not be possible to obtain swift and equitable enforcement of the law. FOREIGN INVESTMENT AND REPATRIATION RESTRICTIONS; EXCHANGE CONTROLS Some RNE countries prohibit certain kinds of investment or impose substantial restrictions on investments in their capital markets, particularly their equity markets, by foreign entities such as the Fund. For example, certain countries require governmental approval prior to investment by foreign persons, or limit the amount of investment by foreign persons in a particular company, or limit the investment by foreign persons to only a specific class of securities of a company that may have less advantageous terms than securities of the company available for purchase by nationals. Moreover, certain national policies of certain RNE countries may restrict investment opportunities in issuers or industries deemed sensitive to national interests. Some countries require governmental registration or approval for the repatriation of investment income, capital or the proceeds of sales of securities by foreign investors. In addition, if there is a deterioration in a country's balance of payments or for other reasons, a country may impose temporary restrictions on foreign capital remittances abroad. The Fund could be adversely affected by delays in, or a refusal to grant, any required governmental approval for repatriation of capital, as well as by the application to the Fund of any restrictions on investments or by withholding taxes imposed by RNE countries on interest or dividends paid on securities held by the Fund or gains from the disposition of such securities. If for any reason the Fund was unable, through borrowing or otherwise, to distribute an amount equal to substantially all of its investment company taxable income (as defined for U.S. tax purposes) within applicable time periods, the Fund would cease to qualify for the favorable tax treatment afforded to regulated investment companies under the U.S. Internal Revenue Code of 1986, as amended (the "Code"). See "Taxation." In RNE countries that currently restrict direct foreign investment in the securities of companies listed and traded on the stock exchanges in those countries, indirect foreign investment may still be possible through investment funds which have been specially authorized. The Fund may invest in such investment funds, subject to the provisions of the 1940 Act as discussed below under "Investment Restrictions." However, if the Fund invests in such investment funds, the Fund's stockholders may bear not only their proportionate share of the expenses of the Fund (including operating expenses and the fees of the Investment Manager), but may also bear indirectly similar expenses of the underlying investment funds. See also "Taxation -- U.S. Federal Income Taxes -- Passive Foreign Investment Companies." 11 12 FOREIGN CURRENCY CONSIDERATIONS The Fund's assets will be invested primarily in equity securities of RNE country issuers and Sovereign Debt and substantially all of the income received by the Fund will be in foreign currencies. The Fund anticipates that in general the foreign currencies received by it with respect to most of its RNE country investments will be freely convertible into U.S. dollars on foreign exchange markets and that in most cases the U.S. dollars received will be fully repatriable out of the various RNE countries in which the Fund invests. However, there can be no assurance that RNE countries will not impose restrictions in the future on the movement of U.S. dollars or these foreign currencies across local borders or the convertibility of such foreign currencies into U.S. dollars. If such restrictions are imposed, they may interfere with the conversion of such foreign currencies to U.S. dollars and therefore with the payment of any distributions the Fund may make to its stockholders. Moreover, the currencies of some RNE countries are not currently freely convertible into other currencies and are not internationally traded. The Fund will compute and distribute its income in U.S. dollars, and the computation of income will be made on the date that the income is earned by the Fund at the foreign exchange rate in effect on that date. Therefore, if the value of the foreign currencies in which the Fund receives its income falls relative to the U.S. dollar between the earning of the income and the time at which the Fund converts the foreign currencies to U.S. dollars, the Fund may be required to liquidate securities in order to make distributions if the Fund has insufficient cash in U.S. dollars to meet distribution requirements. See "Dividends and Distributions; Dividend Reinvestment and Cash Purchase Plan." The liquidation of investments, if required, may have an adverse impact on the Fund's performance. In addition, if the liquidated investments include securities that have been held less than three months, such sales may jeopardize the Fund's status as a regulated investment company under the Code. See "Taxation -- U.S. Federal Income Taxes." Since the Fund will invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the value of securities in the Fund's portfolio and the unrealized appreciation or depreciation of investments. Further, the Fund may incur costs in connection with conversions between various currencies. Foreign exchange dealers realize a profit based on the difference between the prices at which they are buying and selling various currencies. Thus, a dealer normally will offer to sell a foreign currency to the Fund at one rate, while offering a lesser rate of exchange should the Fund desire immediately to resell that currency to the dealer. The Fund will conduct its foreign currency exchange transactions either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign currency exchange market, or through entering into forward, futures or options contracts to purchase or sell foreign currencies. The Fund may seek to protect the value of some portion or all of its portfolio holdings against currency risks by engaging in hedging transactions. The Fund may enter into forward currency exchange contracts and currency futures contracts and options on such futures contracts, as well as purchase put or call options on currencies, in U.S. or foreign markets. In order to hedge against adverse market shifts, the Fund may purchase put and call options on securities, write covered call options on securities and enter into securities index futures contracts and related options. The Fund may also hedge against interest rate fluctuations affecting portfolio securities by entering into interest rate futures contracts and options thereon. For a description of such hedging strategies, see "Investment Objective and Policies -- Foreign Currency Hedging Transactions; Options and Futures Contracts" and Appendix C. There can be no guarantee that instruments suitable for hedging currency or market shifts will be available at the time when the Fund wishes to use them. Moreover, investors should be aware that in most RNE countries markets for these hedging instruments are either not highly developed or do not currently exist at all. SECURITIES MARKETS OF RNE COUNTRIES The securities markets of RNE countries have substantially less market capitalization and trading volume than the securities markets of the United States, Japan and Western Europe. Further, securities of RNE country issuers are generally less liquid and more volatile than securities of comparable U.S. issuers. Accordingly, these securities markets may be subject to greater influence by adverse events generally affecting these markets, and by large investors trading significant blocks of securities or by larger dispositions than is the case in the United States. The limited liquidity of some of these markets may affect the Fund's ability to 12 13 acquire or dispose of securities at a price and time that it wishes to do so. In the securities markets of most RNE countries, a few large companies account for a substantial portion of such markets' total capitalization. The securities markets of RNE countries are not as highly regulated and supervised as U.S. securities markets. Consequently, the prices at which the Fund may acquire investments may be affected by trading on material non-public information and securities transactions by brokers in anticipation of transactions by the Fund. Commissions and other transaction costs on certain RNE country securities exchanges are generally higher than in the United States, and securities settlements in such exchanges may in some instances be subject to delays and related administrative costs. In addition, securities traded in certain RNE countries may be subject to risks due to the inexperience of financial intermediaries, the lack of modern technology, the lack of a sufficient capital base to expand business operations and the possibility of permanent or temporary termination of trading and greater spreads between bid and asked prices for securities in such markets. CUSTODY AND SETTLEMENT MECHANISMS At present, custody arrangements complying with the requirements of the U.S. Securities and Exchange Commission are already available in Russia, the Czech Republic, Poland, Hungary, Estonia and Slovakia. The Fund expects that steps will be taken to permit the establishment of appropriate custody arrangements in a number of additional RNE countries, although there can be no assurance as to when or if those arrangements will occur. Since the Fund will not invest in a market unless adequate custodial arrangements are available, the range of RNE countries in which the Fund may currently invest is limited. In addition, the governments of certain RNE countries may require that a governmental or quasi-governmental authority act as custodian of the Fund's assets invested in such countries. These authorities may not be qualified to act as foreign custodians under the 1940 Act and, as a result, the Fund would not be able to invest in these countries in the absence of exemptive relief from the Commission. In addition, the risk of loss through government confiscation may be increased in such countries. Because the securities markets in RNE countries have only recently formed, and the banking and telecommunications systems remain relatively undeveloped, settlement, clearing and registration of securities transactions are subject to significant risks not normally associated with investments in the United States and other more developed markets. In certain markets, ownership of shares (except where shares are held through depositories that meet the requirements of the 1940 Act) is defined according to entries in the issuer's share register and normally evidenced by extracts from the register or in certain limited cases by formal share certificates. However, in the absence of a central registration system, these services are carried out by the issuer's themselves or by a separate registrar. These registrars are not necessarily subject to effective state supervision and it is possible the Fund could lose its share registration through fraud, negligence or even mere oversight. In such jurisdictions, the Fund will endeavor to ensure that its interests continue to be appropriately recorded, either itself or through a custodian or other agent inspecting the share register and by obtaining extracts of share registers through regular audits. However, these extracts have no legal enforceability and it is possible that a subsequent illegal amendment or other fraudulent act may deprive the Fund of its ownership rights. In addition, while applicable regulations may impose liability on registrars for losses resulting from their errors, it may be difficult for the Fund to enforce any rights it may have against the registrar or the issuer of the securities in the event of the loss of a share registration. An issuer's management may be able to exert considerable influence over who can purchase and sell the issuer's shares by illegally instructing the registrar to refuse to record transactions on the share register. This practice may prevent the Fund from investing in the securities of certain RNE country issuers deemed suitable by the Investment Manager. Further, this also could cause a delay in the sale of portfolio securities by the Fund if a potential purchaser is deemed unsuitable, which may expose the Fund to potential loss on the investment. Moreover, if the local postal and banking systems do not meet the same standards as those of the United States, no guarantee can be given that all entitlements attaching to securities acquired by the Fund, including those relating to dividends, can be realized. There is the risk that payments of dividends or other distributions by bank wire or by check sent through the mail could be delayed or lost. In addition, there is the risk of loss in connection with the 13 14 insolvency of an issuer's bank or transfer agent, particularly because these institutions may not be guaranteed by the state. In light of the risks described above, the Board of Directors of the Fund will approve certain procedures concerning the Fund's investments. Among these procedures is a requirement that the Fund will not invest in an RNE country that has no central registration system unless the RNE country issuer's registrar has entered into a contract with a local sub-custodian containing certain protective conditions, including, among other things, the sub-custodian's right to conduct regular share confirmations on behalf of the Fund. This requirement will likely have the effect of precluding investments in certain RNE country issuers that the Fund would otherwise make. In accordance with procedures to be adopted by the Fund, the Fund's Global Custodian will undertake to provide certain information on a periodic basis to the Board of Directors concerning the share registration and custody arrangements that exist in RNE countries. REPORTING STANDARDS RNE country issuers are subject to accounting, auditing and financial standards and requirements that differ, in some cases significantly, from those applicable to U.S. issuers. In particular, the assets and profits appearing on the financial statements of an RNE country issuer may not reflect its financial position or results of operations in the way they would be reflected had such financial statements been prepared in accordance with U.S. generally accepted accounting principles. There is substantially less publicly available information about RNE country issuers than there is about U.S. issuers, and the information that is available may not be conceptually comparable to, or prepared on the same basis as, that available in more developed capital markets, which may make it difficult to assess the financial status of particular companies. INVESTMENTS IN UNLISTED SECURITIES The Fund may invest up to 35% of its total assets in the aggregate in equity securities purchased directly from issuers or in unregulated over-the-counter markets or other unlisted securities markets which may involve a high degree of business and financial risk that can result in substantial losses. Because of the absence of active and regulated trading markets for these investments, and because of the difficulties in determining market values accurately, the Fund may take longer to liquidate these positions than would be the case for publicly listed securities. Although these securities may be resold in privately negotiated transactions, the prices realized on these sales could be less than those originally paid by the Fund. Further, companies whose securities are not publicly listed may not be subject to public disclosure and other investor protection requirements applicable to publicly traded securities. INVESTMENTS IN LOWER-QUALITY SECURITIES The Fund may invest up to 50% of its total assets in debt securities, including Sovereign Debt, that are rated below investment grade by Standard & Poor's Ratings Group ("S&P") or Moody's Investors Service, Inc. ("Moody's") or if unrated, are determined by the Investment Manager to be comparable to securities rated below investment grade by S&P or Moody's. Such lower-quality, non-investment grade securities (that is, rated Ba1 or lower by Moody's or BB+ or lower by S&P) are commonly referred to as "junk bonds" and are regarded as being predominantly speculative with respect to the issuer's capacity to pay interest and repay principal in accordance with the terms of the obligation and involve major risk exposure to adverse conditions. For example, lower-quality securities generally tend to fluctuate in value in response to economic changes (and the outlook for economic growth), short-term corporate and industry developments and the market's perception of their credit quality (which may not be based on fundamental analysis) to a greater extent than investment grade securities which react primarily to fluctuations in the general level of interest rates (although lower-quality securities are also affected by changes in interest rates). In the past, economic downturns or an increase in interest rates have under certain circumstances caused a higher incidence of default by the issuers of these securities. To the extent that the issuer of any lower-quality debt security held by the Fund defaults, the Fund may incur additional expenses in order to enforce its rights under such security or to participate in a restructuring of the obligation. In addition, the prices of lower-quality debt securities generally tend to be more volatile and the market less liquid than is the case with investment grade securities. Adverse economic events 14 15 can further exacerbate these tendencies. Consequently, the Fund may at times experience difficulty in liquidating its investments in such securities at the prices it desires. There also can be significant disparities in the prices quoted for lower-quality debt securities by various dealers which may make valuing such securities by the Fund more subjective. It is anticipated that the Fund's holdings of lower-quality debt securities will consist predominantly of Sovereign Debt, some of which may trade at a discount to face value. The Fund may invest in Sovereign Debt to hold and trade in appropriate circumstances. Investment in Sovereign Debt may involve a high degree of risk and such securities may be considered speculative in nature. The issuers or governmental authorities that control the repayment of Sovereign Debt may not be able or willing to repay the principal or interest when due in accordance with the terms of such debt. A sovereign debtor's willingness or ability to repay principal and interest due in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign reserves, the availability of sufficient foreign exchange on the date a payment is due, the relative size of its debt service burden to the economy as a whole, the sovereign debtor's policy towards the International Monetary Fund and the political constraints to which a sovereign debtor may be subject. Sovereign debtors may default on their debt and may also be dependent on expected disbursements from foreign governments, multilateral agencies and others abroad to reduce principal and interest arrearages on their debt. The commitment on the part of these governments, agencies and others to make such disbursements may be conditioned on a sovereign debtor's implementation of economic reforms, its economic performance and the timely service of its debtor's obligations. Failure to implement economic reforms, achieve appropriate levels of economic performance or repay principal or interest when due may result in the cancellation of commitments by third parties to lend funds to the sovereign debtor, which may further impair the debtor's ability or willingness to timely service its debts. In certain instances, the Fund may invest in Sovereign Debt that is in default as to payment of principal or interest. To the extent the Fund is holding any non-performing Sovereign Debt or other nonperforming debt, it may incur additional expenses in connection with any restructuring of the issuer's obligations or in otherwise enforcing its rights thereunder. As a result of the foregoing, a sovereign debtor may default on its obligations. If such an event occurs, the Fund may have limited legal recourse against the issuer and/or guarantor. Remedies must, in some cases, be pursued in the courts of the defaulting party itself, and the ability of the holder of Sovereign Debt to obtain recourse may be subject to the political climate in the relevant country. In addition, no assurance can be given that the holders of commercial bank debt will not contest payments to the holders of other Sovereign Debt obligations in the event of default under their commercial bank loan agreements. Sovereign debtors in developing economies are among the world's largest debtors to commercial banks, other governments, international financial organizations and other financial institutions. The issuers of the Sovereign Debt in which the Fund expects to invest have in the past experienced substantial difficulties in servicing their external debt obligations, which led to defaults on certain obligations and the restructuring of certain indebtedness. Restructuring arrangements have included, among other things, reducing and rescheduling interest and principal payments by negotiating new or amended credit agreements and obtaining new credit to finance interest payments. Holders of certain Sovereign Debt may be requested to participate in the restructuring of such obligations and to extend further loans to their issuers. There can be no assurance that the Sovereign Debt in which the Fund may invest will not be subject to similar restructuring arrangements or to requests for new credit which may adversely affect the Fund's holdings. Furthermore, certain participants in the secondary market for such debt may be directly involved in negotiating the terms of these arrangements and may therefore have access to information not available to other market participants. The Fund may experience difficulties in disposing of certain Sovereign Debt obligations because there may be a thin trading market for such securities. The lack of a liquid secondary market may have an adverse impact on the market price of such securities and the Fund's ability to dispose of particular securities when necessary to meet the Fund's liquidity needs or in response to a specific economic event such as a deterioration in the creditworthiness of the issuer. The lack of a liquid secondary market for certain Sovereign Debt securities also may make it more difficult for the Fund to obtain accurate market quotations for purposes of valuing the Fund's portfolio and calculating its net asset value. 15 16 NET ASSET VALUE DISCOUNT; NONDIVERSIFICATION The Fund is a newly organized company with no prior operating history. Prior to this offering, there has been no public market for the Fund's shares. Shares of closed-end investment companies frequently trade at a discount from net asset value. This characteristic of shares of a closed-end fund is a risk separate and distinct from the risk that a fund's net asset value will decrease. The Fund cannot predict whether its own shares will trade at, below or above net asset value. The risk of purchasing shares of a closed-end investment company which might trade at a discount from net asset value is more pronounced for investors who purchase in the initial public offering and who wish to sell their shares in a relatively short period of time. The Fund is classified as a non-diversified investment company under the 1940 Act, 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, will be subject to greater risk of loss with respect to its portfolio securities. The Fund, however, intends to comply with the diversification requirements imposed by the Code for qualification as a regulated investment company. See "Taxation -- U.S. Federal Income Taxes" and "Investment Restrictions." ADDITIONAL CONSIDERATIONS Certain considerations concerning the Fund's hedging transactions are discussed below under "Investment Objective and Policies -- Foreign Currency Hedging Transactions; Options and Futures Contracts" and in Appendix C. The Fund's Articles of Incorporation contain certain anti-takeover provisions that may have the effect of inhibiting the Fund's possible conversion to open-end status and limiting the ability of other persons to acquire control of the Fund. In certain circumstances, these provisions might also inhibit the ability of stockholders to sell their shares at a premium over prevailing market prices. See "Common Stock." Certain considerations concerning the Fund's ability to enter into repurchase agreements, purchase securities on a when-issued or delayed delivery basis and lend portfolio securities are discussed below under "Investment Objective and Policies -- Temporary Investments" and " -- Lending of Portfolio Securities." The Fund may be subject to withholding taxes, including withholding taxes on realized capital gains that may exist or may be imposed by the governments of the countries in which the Fund invests. RNE countries generally have less defined tax laws and procedures than in more developed economies and such laws may permit retroactive taxation. As a result, the Fund could become subject to local tax liabilities in the future that it did not anticipate in conducting its investment activities or valuing its assets. Investment in shares of Common Stock of the Fund should not be considered a complete investment program and may not be appropriate for all investors. Investors should carefully consider their ability to assume these risks before making an investment in the Fund. INVESTMENT OBJECTIVE AND POLICIES The investment objective of the Fund is long-term capital appreciation. The Fund seeks to achieve this objective by investing primarily in equity securities (i) of companies organized in, or for which the principal trading market is in, an RNE country, (ii) denominated in the currency of an RNE country and issued by companies to finance operations in an RNE country and (iii) of companies that alone or on a consolidated basis derive 50% or more of their revenues primarily from either goods produced, sales made or services performed in an RNE country. The Fund may also invest, from time to time, in Sovereign Debt. Income is not a consideration in selecting investments or an investment objective. The Fund's investment objective is a fundamental policy which may not be changed without the approval of a majority of the Fund's outstanding voting securities. As used herein, a "majority of the Fund's outstanding voting securities" means the lesser of (i) 67% of the shares represented at a meeting at which more than 50% of the outstanding shares are 16 17 represented and (ii) more than 50% of the outstanding shares. There is no assurance the Fund will be able to achieve its investment objective. It is the Fund's policy, under normal market conditions, to invest substantially all, but not less than 65%, of its total assets in equity securities of RNE country issuers and in Sovereign Debt. For this purpose, "equity securities" means common and preferred stock (including convertible preferred stock), bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, swap agreements, equity interests in trusts and partnerships and American, European, Global or other types of Depositary Receipts. The Fund's definition of "RNE country issuers" includes companies that may have characteristics and business relationships common to companies in other geographical regions. As a result, the value of the securities of such companies may reflect economic and market forces applicable to such other regions, as well as in the RNE countries. The Fund believes, however, that investment in such companies will be appropriate because the Fund will invest only in those companies which, in its view, have sufficiently strong exposure to economic and market forces in RNE countries such that their value will tend to reflect developments in RNE countries to a greater extent than developments in other regions. The Fund intends to invest in equity securities of RNE country issuers and Sovereign Debt as appropriate opportunities arise. The amount invested in any one RNE country will vary depending on market conditions. The Fund is not limited in the percentage of its assets that may be invested in any one country and it is anticipated that, from time to time, the Fund may have a significant portion of its assets invested in securities of Russian issuers. The Fund anticipates that, initially, its investments will be made primarily in Russia, the Czech Republic, Hungary and Poland, which currently have the most developed capital markets of the RNE countries. Bulgaria, Croatia, Estonia, Latvia, Lithuania, Slovakia, Slovenia and the Ukraine also offer current investment opportunities on a more limited basis. As opportunities develop, investments may be made in the remaining RNE countries. The Fund intends to purchase and hold securities for long-term capital appreciation and does not expect to trade for short-term gain. Accordingly, it is anticipated that the annual portfolio turnover rate normally will not exceed 75%, although in any particular year, market conditions could result in portfolio activity at a greater or lesser rate than anticipated. The portfolio turnover rate for a year is calculated by dividing the lesser of sales or purchases of portfolio securities during that year by the average monthly value of the Fund's portfolio securities, excluding money market instruments. The rate of portfolio turnover will not be a limiting factor when the Fund deems it appropriate to purchase or sell securities for the Fund. However, the U.S. federal tax requirement that the Fund derive less than 30% of its gross income from the sale or disposition of securities held less than three months may limit the Fund's ability to dispose of its securities. See "Taxation -- U.S. Federal Income Taxes." TYPES OF INVESTMENTS The Fund will invest primarily in equity securities of RNE country issuers and Sovereign Debt traded both in the securities markets of RNE countries and in securities markets outside of RNE countries. Subject to obtaining any necessary local regulatory approvals and certain other restrictions, the Fund may invest through investment funds, pooled accounts or other investment vehicles designed to permit investment in a portfolio of stocks listed in a particular developing country or region. This could occur, for example, if a country requires foreign portfolio investment to be made through an investment vehicle. To the extent that the Fund's assets are not invested in equity securities of RNE country issuers or in Sovereign Debt, the remainder of the assets may be invested in (i) debt securities of corporate RNE country issuers, (ii) equity or debt securities of corporate or governmental issuers located in countries other than RNE countries and (iii) short-term and medium-term debt securities of the type described below under "Temporary Investments." The Fund's assets may be invested in debt securities when the Fund believes that, based upon factors such as relative interest rate levels and foreign exchange rates, such debt securities offer opportunities for long-term capital appreciation. It is likely that many of the debt securities in which the Fund will invest will be unrated. The Fund may invest up to 50% of its total assets in debt securities, including 17 18 Sovereign Debt, that are rated below investment grade by S&P or Moody's or if unrated, are determined by the Investment Manager to be comparable to securities rated below investment grade by S&P or Moody's. Such lower-quality, non-investment grade securities are commonly referred to as "junk bonds" and are regarded as being predominantly speculative and involve significant risks. It is anticipated that the Fund's holdings of lower-quality debt securities will consist predominantly of Sovereign Debt, some of which may trade at substantial discounts from face value and which may include Sovereign Debt comparable to securities rated as low as D by S&P or C by Moody's. The Fund may invest in Sovereign Debt to hold and trade in appropriate circumstances. The Fund will only invest in Sovereign Debt when the Fund believes such investments offer opportunities for long-term capital appreciation. Investment in Sovereign Debt involves a high degree of risk and such securities are generally considered to be speculative in nature. For a discussion of the specific risks associated with investments in lower-quality securities, generally, and Sovereign Debt, specifically, see "Risk Factors and Special Considerations -- Investments in Lower-Quality Securities." The Fund may invest indirectly in securities of RNE country issuers through sponsored or unsponsored American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") and other types of Depositary Receipts (collectively, hereinafter referred to as "Depositary Receipts"). Depositary Receipts may not necessarily be denominated in the same currency as the underlying securities into which they may be converted. In addition, the issuers of the stock of unsponsored Depositary Receipts are not obligated to disclose material information in the United States and, therefore, there may not be a correlation between such information and the market value of the Depositary Receipts. ADRs are Depositary Receipts typically issued by a United States bank or trust company which evidence ownership of underlying securities issued by a foreign corporation. EDRs, GDRs and other types of Depositary Receipts are typically issued by foreign banks or trust companies, although they also may be issued by United States banks or trust companies, and evidence ownership of underlying securities issued by either a foreign or a United States corporation. Generally, Depositary Receipts in registered form are designed for use in the United States securities markets and Depositary Receipts in bearer form are designed for use in securities markets outside the United States. For purposes of the Fund's investment policies, the Fund's investments in ADRs, EDRs, GDRs and other types of Depositary Receipts will be deemed to be investments in the underlying securities. The Fund may also invest through debt-equity conversion funds established to exchange foreign debt of countries whose principal repayments are in arrears into a portfolio of listed and unlisted equities, subject to certain repatriation restrictions. For temporary defensive purposes, the Fund may invest less than 65% of its total assets in equity securities of RNE country issuers and Sovereign Debt, in which case the Fund may invest in other equity or debt securities or may invest in debt securities of the kind described under "Temporary Investments" below. UNLISTED SECURITIES Securities in which the Fund may invest include equity securities purchased directly from issuers or in the unregulated over-the-counter markets or other unlisted securities markets which may involve a high degree of business and financial risk. As a result of the absence of a public trading market for these securities, they may be less liquid than publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized from these sales could be less than those originally paid by the Fund or less than what may be considered the fair value of such securities. Further, issuers whose securities are not listed may not be subject to the disclosure and other investor protection requirements which may be applicable if their securities were listed. If such securities are required to be registered under the securities laws of one or more jurisdictions before being resold, the Fund may be required to bear the expenses of registration. The Fund does not intend to invest more than 35% of its total assets in unlisted securities. 18 19 TEMPORARY INVESTMENTS During periods in which the Investment Manager believes changes in economic, financial or political conditions make it advisable, the Fund may for temporary defensive purposes reduce its holdings in equity and other securities and invest in certain short-term (less than 12 months to maturity) and medium-term (not greater than five years to maturity) debt securities or hold cash. The short-term and medium-term debt securities in which the Fund may invest consist of (a) obligations of the governments of the United States or RNE countries, their respective agencies or instrumentalities; (b) bank deposits and bank obligations (including certificates of deposit, time deposits and bankers' acceptances) of U.S. or RNE country banks denominated in any currency; (c) floating rate securities and other instruments denominated in any currency issued by international development agencies; (d) finance company and corporate commercial paper and other short-term corporate debt obligations of U.S. or RNE country corporations; and (e) repurchase agreements with banks and broker-dealers with respect to such securities. The Fund intends to invest for temporary defensive purposes only in short-term and medium-term debt securities that are rated A or better by S&P or Moody's or, if unrated, that the Investment Manager believes to be of comparable quality, i.e., subject to relatively low risk of loss of interest or principal. Repurchase agreements with respect to the securities described in the preceding paragraph are contracts under which a buyer of a security simultaneously commits to resell the security to the seller at an agreed upon price and date. Under a repurchase agreement, the seller is required to maintain the value of the securities subject to the repurchase agreement at not less than their repurchase price. The Investment Manager will monitor the value of such securities daily to determine that the value equals or exceeds the repurchase price including accrued interest. Repurchase agreements may involve risks in the event of default or insolvency of the seller, including possible delays or restrictions upon the Fund's ability to dispose of the underlying securities. The Fund expects to be fully invested in accordance with its investment objective and policies within one year from the date of completion of the offering made hereby. Pending such investment, the Fund's assets may be invested entirely in the investments described above. FOREIGN CURRENCY HEDGING TRANSACTIONS; OPTIONS AND FUTURES CONTRACTS In order to hedge against foreign currency exchange rate risks, the Fund may enter into forward foreign currency exchange contracts and foreign currency futures contracts and may purchase and write (sell) put and call options on foreign currency and on foreign currency futures contracts. The Fund may also seek to hedge against interest rate fluctuations affecting portfolio securities by entering into interest rate futures contracts and options thereon. The Fund may seek to increase its return or hedge all or a portion of its portfolio investments through transactions in options on securities. In addition, the Fund may seek to hedge all or a portion of the investments held by it, or which it intends to acquire, against adverse market fluctuations by entering into stock index futures contracts and options thereon. Under the regulations of the U.S. Commodity Futures Trading Commission ("CFTC"), the Fund will not be considered a "commodity pool," as defined under such regulations, as a result of entering into the transactions in futures contracts and related options described above, provided, among other things, that: (1) such transactions are entered into solely for bona fide hedging purposes, as defined under CFTC regulations; or (2) with respect to any Fund transactions in futures contracts or related options which are not entered into for bona fide hedging purposes, the aggregate initial margin and premiums do not exceed 5% of its total assets (after taking into account any unrealized profits and losses). The Fund will only engage in transactions in options and futures which are traded on a recognized securities or futures exchange, including non-U.S. exchanges to the extent permitted by the CFTC. Moreover, when the Fund purchases a futures contract or a call option thereon or writes a put option thereon, an amount 19 20 of cash or liquid securities will be deposited in a segregated account with the Fund's custodian in accordance with the regulations of the U.S. Securities and Exchange Commission. For a description of each of the instruments referred to above and an explanation of certain of the associated risks, limitations on use and possible strategies the Fund may utilize in connection therewith, see Appendix C. SWAPS The Fund may enter into swaps and options on swaps related to the equity and fixed income markets in which the Fund may invest. Swaps are agreements to exchange cash flows based on a notional principal amount. The Fund's use of swaps is subject to segregation and cover requirements which are similar to those to which it is subject upon writing uncovered options. The Fund may enter into swaps on a net basis, i.e., the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments on the payment date. The Fund will not enter into any swap transaction unless the unsecured senior debt or the claims-paying ability of the other party thereto is rated in the highest rating category of at least one nationally recognized rating organization at the time of entering into such transaction. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. LENDING OF PORTFOLIO SECURITIES The Fund may from time to time lend securities (but not in excess of 33 1/3% of its total assets) from its portfolio to brokers, dealers and financial institutions and receive collateral in cash or securities believed by the Investment Manager to be equivalent to securities rated investment grade by S&P or Moody's which, while the loan is outstanding, will be maintained at all times in an amount equal to at least 100% of the current market value of the loaned securities, including any accrued interest or dividend receivable. Any cash collateral received by the Fund will be invested in short-term securities, the income from which will increase the return to the Fund. The Fund will retain all rights of beneficial ownership as to the loaned portfolio securities, including voting rights and rights to interest or other distributions, and will have the right to regain record ownership of loaned securities to exercise such beneficial rights. Such loans will be terminable at any time. The Fund may pay finders', administrative and custodial fees to persons unaffiliated with the Fund in connection with the arranging of such loans. 20 21 INVESTMENT RESTRICTIONS The following restrictions are fundamental policies of the Fund that may not be changed without the approval of the holders of a majority of the Fund's outstanding voting securities (as defined in "Investment Objective and Policies"). If a percentage restriction on investment or use of assets set forth below is adhered to at the time a transaction is effected, later changes will not be considered a violation of the restriction. Also, if the Fund receives from an issuer of securities held by the Fund subscription rights to purchase securities of that issuer, and if the Fund exercises such subscription rights at a time when the Fund's portfolio holdings of securities of that issuer would otherwise exceed the limits set forth below, it will not constitute a violation if, prior to receipt of securities upon exercise of such rights, and after announcement of such rights, the Fund has sold at least as many securities of the same class and value as it would receive on exercise of such rights. As a matter of fundamental policy: 1. The Fund will not invest more than 25% of its total assets in a particular industry (including for this purpose any securities issued by a government other than the U.S. government). 2. The Fund may not make any investment for the purpose of exercising control or management. 3. The Fund may not buy or sell commodities or commodity contracts or real estate or interests in real estate, except that it may purchase and sell futures contracts on stock indices, interest rates and foreign currencies, swaps, securities which are secured by real estate or commodities, and securities of companies which invest or deal in real estate or commodities. 4. The Fund may not make loans, except that the Fund may (i) buy and hold debt instruments in accordance with its investment objective and policies, (ii) enter into repurchase agreements to the extent permitted under applicable law, and (iii) make loans of portfolio securities. 5. The Fund may not act as an underwriter except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under applicable securities laws. 6. The Fund may issue senior securities or borrow money in an amount not in excess of 33 1/3% of the Fund's total assets (including the amount borrowed and excluding the liability for the borrowing). 7. The Fund may purchase securities on margin and engage in short sales of securities. As a matter of operating policy, which may be changed by the Fund's Board of Directors without a stockholder vote: 1. The Fund will not purchase securities on margin, except such short-term credits as may be necessary for clearance of transactions and the maintenance of margin with respect to futures contracts. 2. The Fund will not make short sales of securities or maintain a short position (except that the Fund may maintain short positions in foreign currency contracts, options and futures contracts and may make short sales of securities "against the box"). 3. The Fund will not issue senior securities, borrow money or pledge its assets, except that the Fund may borrow from a lender (i) for temporary or emergency purposes, (ii) for such short-term credits necessary for the clearance or settlement of the transactions, (iii) to finance repurchases of its shares (see "Common Stock"), or (iv) to pay any dividends required to be distributed in order for the Fund to maintain its qualification as a regulated investment company under the Code or otherwise to avoid taxation under the Code, in amounts not exceeding 33 1/3% of its total assets (including the amount borrowed and excluding the liability for the borrowing), provided that the Fund will not purchase additional portfolio securities when its borrowings exceed 5% of its assets. The Fund may pledge its assets to secure such borrowings. Unlike fundamental policies, operating policies of the Fund may be changed by the Directors of the Fund, without a vote of the Fund's stockholders, if the Directors determine such action is warranted. The Fund will notify its stockholders of any change in any of the operating policies set forth above. Such notice will also include a discussion of the increased risks of investment in the Fund, if any, associated with such a change. Under the 1940 Act, the Fund may invest only up to 10% of its total assets in the aggregate in shares of other investment companies and only up to 5% of its total assets in any one investment company, provided the 21 22 investment does not represent more than 3% of the voting stock of the acquired investment company at the time such shares are purchased. As a stockholder in any investment company, the Fund will bear its ratable share of that investment company's expenses, and would remain subject to payment of the Fund's management, advisory and administrative fees with respect to assets so invested. Stockholders of the Fund would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. See also "Taxation -- U.S. Federal Income Taxes -- Passive Foreign Investment Companies." The Fund may be prohibited under the 1940 Act, absent exemptive relief, from purchasing the securities of any company that, in its most recent fiscal year, derived more than 15% of its gross revenues from securities-related activities. As a result of legal restrictions or market practices or both, the Fund, as a U.S. entity, may be precluded from purchasing shares in public offerings by certain RNE country issuers. Additionally, under the 1940 Act, the Fund may not purchase any security of which the Investment Manager or any of its affiliates is a principal underwriter during the public offering of such security. In addition to the foregoing restrictions, the Fund may be subject to investment limitations, portfolio diversification requirements and other restrictions imposed by certain RNE countries in which it expects to invest. 22 23 MANAGEMENT OF THE FUND DIRECTORS AND OFFICERS OF THE FUND The Directors and officers of the Fund are listed below together with their respective positions and a brief statement of their principal occupations during the past five years and, in the case of Directors, their positions with certain international organizations and publicly held companies.
PRINCIPAL OCCUPATION DURING PAST FIVE NAME AND ADDRESS POSITION WITH FUND YEARS - --------------------------------- ------------------ ---------------------------------------- Barton M Biggs (63)*............. Director and Chairman and Director of Morgan Stanley 1221 Avenue of the Americas Chairman of the Asset Management Inc. and Morgan Stanley New York, New York 10020 Board Asset Management Limited; Managing Director of Morgan Stanley & Co. Incorporated; Director of Morgan Stanley Group Inc.; Member of the Investment Advisory Council of The Thailand Fund; Director of the Rand McNally Company; Member of the Yale Development Board; Director and officer of various investment companies managed by Morgan Stanley Asset Management Inc. Warren J. Olsen (39)*............ Director and Principal of Morgan Stanley & Co. 1221 Avenue of the Americas President Incorporated and Morgan Stanley Asset New York, New York 10020 Management Inc.; Director and officer of various investment companies managed by Morgan Stanley Asset Management Inc. Peter J. Chase (63).............. Director Chairman and Chief Financial Officer, 1441 Paseo De Peralta High Mesa Technologies, LLC; Chairman of Santa Fe, New Mexico 87501 CGL, Inc.; Director of thirteen investment companies managed by Morgan Stanley Asset Management, Inc.; Member of the Investment Advisory Council of The Thailand Fund. John W. Croghan (66)............. Director Chairman of Lincoln Capital Management 200 South Wacker Drive Company; Director of St. Paul Bancorp, Chicago, Illinois 60606 Inc. and Lindsay Manufacturing Co.; Director of thirteen investment companies managed by Morgan Stanley Asset Management Inc., Previously Director of Blockbuster Entertainment Corporation. David B. Gill (70)............... Director Director of thirteen investment 26210 Ingleton Circle companies managed by Morgan Stanley Easton, Maryland 21601 Asset Management Inc.; Director of the Mauritius Fund Limited; Director of Moneda Chile Fund Limited; Director of First NIS Regional Fund SIAC; Director of Commonwealth Africa Investment Fund Ltd.; Member of the Investment Advisory Council of The Thailand Fund; Chairman of the Advisory Board of Advent Latin American Private Equity Fund; Chairman and Director of Norinvest Bank; Director of Surinvest International Limited;
23 24
PRINCIPAL OCCUPATION DURING PAST FIVE NAME AND ADDRESS POSITION WITH FUND YEARS - --------------------------------- ------------------ ---------------------------------------- Director of National Registry Company; Previously Director of Capital Markets Department of the International Finance Corporation; Trustee, Batterymarch Finance Management; Chairman and Director of Equity Fund of Latin America S.A. and Director of Commonwealth Equity Fund Limited; and Director of Global Securities, Inc. Graham E. Jones (63)............. Director Senior Vice President of BGK Properties; 330 Garfield Street Trustee of nine investment companies Suite 200 managed by Weiss, Peck & Greer; Trustee Santa Fe, New Mexico 87501 of eleven investment companies managed by Morgan Grenfell Capital Management Incorporated; Director of thirteen investment companies managed by Morgan Stanley Asset Management Inc.; Member of the Investment Advisory Council of The Thailand Fund, Previously Chief financial Officer of Practice Management Systems, Inc. John A. Levin (58)............... Director President of John A. Levin & Co., Inc.; One Rockefeller Plaza Director of fourteen investment New York, New York 10020 companies managed by Morgan Stanley Asset Management Inc. William G. Morton, Jr. (59)...... Director Chairman and Chief Executive Officer of 1 Boston Place Boston Stock Exchange; Director of Tandy Boston, Massachusetts 02108 Corporation; Director of thirteen investment companies managed by Morgan Stanley Asset Management Inc. Peter A. Nadosy (51)*............ Director Vice Chairman and Director of Morgan 1221 Avenue of the Americas Stanley Asset Management Inc. and New York, New York 10020 Managing Director of Morgan Stanley & Co. Incorporated; Previously President of Morgan Stanley Asset Management Inc. Frederick B. Whittemore (65)*.... Director Advisory Director of Morgan Stanley & 1251 Avenue of the Americas Co. Incorporated; Chairman for the New York, New York 10020 United States National Committee for Pacific Economic Cooperation; Director and officer of thirteen investment companies managed by Morgan Stanley Asset Management Inc.; Previously Managing Director of Morgan Stanley & Co. Incorporated. Harold J. Schaaff, Jr. (36)*..... Vice President Principal of Morgan Stanley & Co. 1221 Avenue of the Americas Incorporated; General Counsel and New York, New York 10020 Secretary of Morgan Stanley Asset Management Inc.; Officer of various investment companies managed by Morgan Stanley Asset Management Inc.
24 25
PRINCIPAL OCCUPATION DURING PAST FIVE NAME AND ADDRESS POSITION WITH FUND YEARS - --------------------------------- ------------------ ---------------------------------------- Wells.Joseph P. Stadler (41)*.... Vice President Vice President of Morgan Stanley Asset 1221 Avenue of the Americas Management Inc.; Officer of various New York, New York 10020 investment companies managed by Morgan Stanley Asset Management Inc.; Previously with Price Waterhouse LLP. Valerie Y. Lewis (40)*........... Secretary Vice President of Morgan Stanley Asset 1221 Avenue of the Americas Management Inc.; Officer of various New York, New York 10020 investment companies managed by Morgan Stanley Asset Management Inc.; Previously with Citicorp. James R. Rooney (37)*............ Treasurer Vice President and Manager of Fund 73 Tremont Street Administration, Chase Global Funds Boston, Massachusetts 02108 Services Company; Officer of various investment companies managed by Morgan Stanley Asset Management Inc.; Previously Assistant Vice President and Manager of Fund Compliance and Control, Scudder Stevens & Clark Inc. and Audit Manager, Ernst & Young LLP. Belinda Brady (28)*.............. Assistant Manager, Fund Administration, Chase 73 Tremont Street Treasurer Global Funds Services Company; Officer Boston, Massachusetts 02108 of various investment companies managed by Morgan Stanley Asset Management Inc.; Previously with Price Waterhouse LLP.
- --------------- * Interested person of the Fund (as defined in the 1940 Act) Messrs. Biggs and Nadosy are directors and officers and Messrs. Olsen, Klein, Schaaff and Stadler and Ms. Lewis are officers of the Investment Manager. Mr. Whittemore is an Advisory Director of Morgan Stanley & Co. Incorporated, an affiliate of the Investment Manager and a registered broker-dealer, and he is the owner of a beneficial interest in the Investment Manager. Mr. Rooney and Ms. Brady are employees of Chase Global Funds Services Company, an affiliate of The Chase Manhattan Bank, the Fund's Administrator. The officers of the Fund, together with the Investment Manager, conduct and supervise the Fund's daily business operations. The Directors review and supervise the actions of the officers and the Fund's Investment Manager and decide general policy. The Fund pays to each of its Directors who is not an officer or employee of the Investment Manager or any of their affiliates, in addition to certain out-of-pocket expenses, an annual fee of $3,000. 25 26 Each of the Directors who is not an "affiliated person" of the Investment Manager within the meaning of the 1940 Act may enter into a deferred fee arrangement (the "Fee Arrangement") with the Fund, pursuant to which such Director defers to a later date the receipt of his Director's fees. The deferred fees owed by the Fund are credited to a bookkeeping account maintained by the Fund on behalf of such Director and accrue income from and after the date of credit in an amount equal to the amount that would have been earned had such fees (and all income earned thereon) been invested and reinvested either (i) in shares of the Fund or (ii) at a rate equal to the prevailing rate applicable to 90-day U.S. Treasury Bills at the beginning of each calendar quarter for which this rate is in effect, whichever method is elected by a Director. Under a Fee Arrangement, deferred Directors' fees (including the return accrued thereon) will become payable in cash upon such Director's resignation from the Board of Directors in generally equal annual installments over a period of five years (unless the Fund has agreed to a longer or shorter payment period) beginning on the first day of the year following the year in which such Director's resignation occurred. In the event of a Director's death, remaining amounts payable to him under the Fee Arrangement will thereafter be payable to his designated beneficiary; in all other events, a Director's right to receive payments is nontransferable. Under the Fee Arrangement, the Board of Directors of the Fund, in its sole discretion, has reserved the right, at the request of a Director or otherwise, to accelerate or extend the payment of amounts in the deferred fee account at any time after the termination of a Director's service as a director. In addition, in the event of the liquidation, dissolution or winding up of the Fund or the distribution of all or substantially all of the Fund's assets and property to its shareholders (other than in connection with a reorganization or merger into another investment company advised by the Investment Manager), all unpaid amounts in the deferred fee account maintained by the Fund will be paid in a lump sum to Directors participating in the Fee Arrangement on the effective date thereof. Set forth below is a table showing the aggregate compensation paid by the Fund to each of its Directors, as well as the total compensation paid to each Director by other U.S. registered investment companies advised by the Investment Manager or its affiliates (collectively the "Fund Complex") for their services as directors of such investment companies for the fiscal year ended December 31, 1995.
TOTAL NUMBER OF PENSION OR DEFERRED FUNDS RETIREMENT TOTAL COMPENSATION CURRENTLY BENEFITS ACCRUED COMPENSATION FROM FUND IN FUND AGGREGATE DEFERRED AS PART FROM FUND COMPLEX COMPLEX COMPENSATION COMPENSATION OF THE COMPLEX FOR FOR WHICH FROM FROM FUND'S PAID TO INDIVIDUAL DIRECTOR NAME OF DIRECTORS FUND FUND EXPENSES DIRECTORS DIRECTORS SERVES - --------------------------- ------------ ------------ ---------------- ------------ ------------ --------- Barton M. Biggs(1)......... $0 0 None $ 0 $ 0 17 Warren J. Olsen(1)......... 0 0 None 0 0 17 Peter J. Chase............. 0 0 None 47,300 0 13 John W. Croghan............ 0 0 None 48,645 35,657 13 David B. Gill.............. 0 0 None 46,719 26,719 13 Graham E. Jones............ 0 0 None 47,673 21,723 13 John A. Levin.............. 0 0 None 49,546 21,796 14 Peter A. Nadosy(1)......... 0 0 None 0 0 1 William G. Morton, Jr. .... 0 0 None 48,400 0 13 Frederick B. Whittemore(1)............ 0 0 None 28,254 0 16
- --------------- (1) Messrs. Biggs and Nadosy are directors and officers of the Investment Manager, Mr. Olsen is an officer of the Investment Manager and Mr. Whittemore is a director of Morgan Stanley & Co. Incorporated, an affiliate of the Investment Manager, and therefore are "interested persons" of the Fund within the meaning of the 1940 Act. As such, Messrs. Biggs, Olsen, Nadosy and Whittemore currently do not receive any compensation from the Fund or any other investment company in the Fund Complex for their services as a director of such investment companies. The Fund's Board of Directors has an audit committee that is responsible for reviewing financial and accounting matters. The members of the audit committee are Messrs. Croghan, Levin and Morton. The Board of Directors also has a valuation committee, the members for which are Messrs. Olsen and Levin. The members of the audit committee receive an additional $500 per year for serving on the committee. 26 27 As of the date of this Prospectus, none of the officers or Directors of the Fund own any shares of the Fund's Common Stock. The Board of Directors is divided into three classes, each class having a term of three years. Each year the term of one class expires. The Fund's By-Laws provide that each Director holds office until (i) the expiration of his term and until his successor has been elected and qualified, (ii) his death, (iii) his resignation, (iv) December 31 of the year in which he reaches seventy-three years of age or (v) his removal as provided by statute or the Articles of Incorporation. See "Common Stock." The Articles of Incorporation of the Fund contain a provision permitted under the Maryland General Corporation Law (the "MGCL") which by its terms eliminates the personal liability of the Fund's Directors and officers to the Fund or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, subject to certain qualifications described below. The Articles of Incorporation and the By-Laws of the Fund provide that the Fund will indemnify directors, officers, employees or agents of the Fund to the full extent permitted by the MGCL. Under Maryland law, a corporation may indemnify any director or officer made a party to any proceeding by reason of service in that capacity unless it is established that (1) the act or omission of the director or officer was material to the matter giving rise to the proceeding and (A) was committed in bad faith or (B) was the result of active and deliberate dishonesty; (2) the director or officer actually received an improper personal benefit in money, property or services; or (3) in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. The Articles of Incorporation further provide that to the fullest extent permitted by the MGCL, and subject to the requirements of the 1940 Act, no Director or officer will be liable to the Fund or its stockholders for money damages. Under Maryland law, a corporation may restrict or limit the liability of directors or officers to the corporation or its stockholders for money damages, except to the extent that (1) it is proved that the person actually received an improper benefit or profit in money, property, or services or (2) a judgment or other final adjudication adverse to the person is entered in a proceeding based on a finding in the proceeding that the person's action, or failure to act, was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding. Nothing in the Articles of Incorporation or the By-Laws of the Fund protects or indemnifies a Director, officer, employee or agent against any liability to which he would otherwise be subject by reason of acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, or protects or indemnifies a Director or officer of the Fund against any liability to the Fund or its stockholders to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office. INVESTMENT MANAGER The Fund will employ Morgan Stanley Asset Management Inc. (the "Investment Manager"), a wholly owned subsidiary of Morgan Stanley Group Inc., pursuant to an Investment Advisory and Management Agreement, dated as of the date hereof (the "Management Agreement"), to manage the investment and reinvestment of the assets of the Fund, subject to the supervision of the Fund's Directors. The Investment Manager's principal business address is 1221 Avenue of the Americas, New York, New York 10020. The Investment Manager provides portfolio management and named fiduciary services to various closed-end and open-end investment companies, taxable and nontaxable institutions, international organizations and individuals investing in United States and international equity and fixed income securities. At June 30, 1996, the Investment Manager had, together with its affiliated investment management companies, assets under management (including assets under fiduciary advisory control) totaling approximately $104 billion, of which approximately $9 billion was invested in emerging country markets. The Investment Manager currently acts as investment adviser for 13 closed-end funds which principally invest in emerging markets. Morgan Stanley Group Inc. has entered into a definitive agreement to purchase the parent company of Van Kampen American Capital, Inc., the fourth largest non-proprietary mutual fund provider in the United States with approximately $57 billion in assets under management and/or supervision at June 30, 1996. The acquisition is expected to close by October 31, 1996. The Investment Manager is a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act"). The Investment Manager was one of the first institutional investors 27 28 to enter the capital markets of RNE countries, doing so in 1993, and manages several investment companies investing in the RNE countries. The Investment Manager is under no restriction and remains free, at any time, to sponsor and advise new investment vehicles with investment restrictions similar or identical to those of the Fund. As an investment adviser, the Investment Manager emphasizes a global investment strategy and benefits from research coverage of a broad spectrum of equity investment opportunities worldwide. The Investment Manager draws upon the capabilities of its asset management specialists located in its various offices throughout the world. It also draws upon the research capabilities of Morgan Stanley Group Inc. and its other affiliates, as well as the research and investment ideas of other companies whose brokerage services the Investment Manager utilizes. Certain investments may be appropriate for the Fund and also for other clients advised by the Investment Manager. Investment decisions for the Fund and other clients will be made with a view to achieving their respective investment objectives and after consideration of such factors as their current holdings, tax aspects, availability of cash for investments and the size of their investments generally. Frequently a particular security may be bought or sold for only one client (i.e., an investment otherwise appropriate for the Fund may not be acquired by the Fund) or in different amounts and at different times for more than one but less than all clients. Likewise, a particular security may be bought for one or more clients when one or more other clients are selling the security. In addition, purchases or sales of the same security may be made for two or more clients on the same day, in which event, such transactions will be allocated among the clients in a manner believed by the Investment Manager to be equitable to each. In some cases, this procedure could have an adverse effect on the price or amount of the securities purchased or sold by the Fund. Purchase and sale orders for the Fund may be combined with those of other clients of the Investment Manager in the interest of the most favorable net results to the Fund. In providing advisory services to the Fund, members of the Investment Manager's senior management, including Mr. Barton M. Biggs, Mr. Madhav Dhar and Ms. Marianne L. Hay, will establish guidelines regarding the allocation of the Fund's investments among various RNE countries and the strategy for those investments. The Investment Manager's senior management will meet regularly to review the equity markets and determine the Fund's asset mix. Barton Biggs joined Morgan Stanley in 1973 as a General Partner and Managing Director. He formed Morgan Stanley's research department, and was Director of U.S. research from 1973 to 1979. He was also Director of Global Research from 1979 to 1986 and from 1991 to 1991. Currently, he is Director of Global Strategy. In 1975, he founded Morgan Stanley Asset Management Inc. which currently has ten offices and assets of about $61.3 billion. He is the Chairman of the Investment Manager and all of its investment companies. He is a member of the Operating Committee and Management Committee of the Morgan Stanley Group, and was elected to the Board of Directors in 1991. In addition, he is a director of the Rand McNally Company. Prior to joining Morgan Stanley, he spent eight years as a managing partner of a hedge fund, Fairfield Partners. He graduated from Yale University and the New York University Graduate School of Business with Distinction, and served three years as an officer in the U.S. Marine Corps. The Institutional Investor magazine named him as a strategist to its All-American Research Team ten times and in 1996 he was voted top global strategist by the Institutional Investor International Research Poll. Madhav Dhar is a Managing Director of Morgan Stanley & Co. Incorporated. He joined the Investment Manager in 1984 to focus on asset allocation and investment strategy. Mr. Dhar is a co-head of the Investment Manager's Emerging Markets Group with approximately $9 billion under management and serves as a co- portfolio manager of the Global Emerging Markets Portfolios. Mr. Dhar also coordinates the Investment Manager's developing country fund effort and has been involved in the launching of each of Morgan Stanley's country funds. He holds a B.S. (honors) in physics from St. Stephens College, Delhi University (India), and an MBA from Carnegie-Mellon University. Marianne L. Hay is a Managing Director of Morgan Stanley & Co. Incorporated and is a co-head of the Investment Manager's Emerging Markets Group with approximately $9 billion under management and served as co-portfolio manager of the Global Emerging Markets Portfolios. She joined the Investment Manager in 28 29 June 1993 as a Principal to work with the Investment Manager's senior management covering all emerging markets, asset allocation, product development and client service. Ms. Hay has 17 years' investment experience. Prior to joining the Investment Manager, she was a director of Martin Currie Investment Management Ltd., where her responsibilities included geographic asset allocation and portfolio management for global and emerging markets funds, as well as being director in charge of the company's North American clients. Prior to her tenure at Martin Currie, she worked for the Bank of Scotland and the investment management firm of Ivory and Sime plc. She graduated with an honors degree in genetics from Edinburgh University and holds a Diploma in Education and the qualification of the Association of the Institute of Bankers in Scotland. Once allocation and strategic guidelines have been established for the Fund's investments by the Investment Manager's senior management, the Fund's portfolio will be managed on a day-to-day basis by Michael Hewett. Mr. Hewett joined the Investment Manager's London office in August 1994 where he specializes in the securities markets of the former Soviet Union and North Africa. Mr. Hewett has been actively involved in the Investment Manager's investments throughout the RNE countries. Prior to joining the Investment Manager, Mr. Hewett spent three years in the Investment Banking Division of Morgan Stanley, where he spent time in both the Tokyo and London offices and worked on a variety of deals including IPO's, privatizations, project financings and acquisitions. He holds an M.A. (honors) degree from Oxford University in Politics, Philosophy and Economics. Mr. Hewett will be assisted by Paul Psaila. Mr. Psaila joined the Investment Manager in 1994 and is currently an analyst covering Central and Eastern Europe and working on general investment strategy issues. Before joining the Investment Manager, Mr. Psaila was a Research Associate for the Overseas Development Council for a year and worked as an Associate at the International Monetary Fund for two years. He speaks both Spanish and French. He is a political science graduate from Brandeis University and graduated from the Johns Hopkins School of Advanced International Studies with a Masters degree in International Economics and Latin American Studies. MANAGEMENT AGREEMENT Under the terms of the Management Agreement, the Investment Manager will make all investment decisions, prepare and make available research and statistical data, and supervise the purchase and sale of securities on behalf of the Fund, including the selection of brokers and dealers to carry out the transactions, all in accordance with the Fund's investment objective and policies, under the direction and control of the Fund's Board of Directors. The Investment Manager also will be responsible for maintaining records and furnishing or causing to be furnished all required records or other information of the Fund to the extent such records, reports and other information are not maintained or furnished by the Fund's administrators, custodians or other agents. The Investment Manager will pay the salaries and expenses of the Fund's officers and employees, as well as the fees and expenses of the Fund's Directors, who are directors, officers or employees of the Investment Manager or any of its affiliates. However, the Fund will bear travel expenses or an appropriate fraction thereof of officers and Directors of the Fund who are directors, officers or employees of the Investment Manager or its affiliates to the extent that such expenses relate to attendance at meetings of the Fund's Board of Directors or any committee thereof. The Investment Manager has agreed to pay the Fund's expenses in connection with this offering in order to maintain a net asset value of $20.00 per Share immediately following the completion of this offering. The Fund will pay all of its other expenses, including, among others, organization expenses (but not the overhead or employee costs of the Investment Manager); legal fees and expenses of counsel to the Fund; auditing and accounting expenses; taxes and governmental fees; dues and expenses incurred in connection with membership in investment company organizations; fees and expenses of the Fund's custodians, sub-custodians, transfer agents and registrars; fees and expenses with respect to administration, except as may be provided otherwise pursuant to administration agreements; expenses for portfolio pricing services by a pricing agent, if any; expenses relating to investor and public relations; freight, insurance and other charges in connection with the shipment of the Fund's portfolio securities; brokerage commissions and other costs of acquiring or disposing of any portfolio holding of the Fund; expenses of preparation and distribution of reports, notices and dividends to 29 30 stockholders; expenses of the dividend reinvestment and cash purchase plan (except for brokerage expenses paid by participants in such plan); costs of stationery; any litigation expenses; and costs of stockholders' and other meetings. For services under the Management Agreement, the Investment Manager will receive a fee, computed weekly and payable monthly, at an annual rate of 1.60% of the Fund's average weekly net assets. The Fund's management and advisory fees are higher than advisory fees paid by most other U.S. investment companies, primarily because of the additional time and expense required of the Investment Manager in pursuing the Fund's objective of investing in securities of RNE country issuers and Sovereign Debt. This investment objective entails additional time and expense because available public information concerning securities of RNE country issuers is limited in comparison to that available for U.S. companies and accounting standards are more flexible. In addition, available research concerning RNE country issuers is not comparable to available research concerning U.S. companies. Under the Management Agreement, the Investment Manager is permitted to provide investment advisory services to other clients, including clients who may invest in RNE country issuers and Sovereign Debt. Conversely, information furnished by others to the Investment Manager in the course of providing services to clients other than the Fund may be useful to the Investment Manager in providing services to the Fund. The Management Agreement will initially be effective for a period of two years and will continue in effect from year to year thereafter provided such continuance is specifically approved at least annually by (i) a vote of a majority of those members of the Board of Directors who are not "interested persons" of the Investment Manager or the Fund, cast in person at a meeting called for the purpose of voting on such approval and (ii) by a majority vote of either the Fund's Board of Directors or the Fund's outstanding voting securities. The Management Agreement may be terminated at any time, without payment of penalty, by the Fund's Board of Directors, by a vote of a majority the Fund's outstanding voting securities, or by the Investment Manager upon 60 days' written notice. The Management Agreement will automatically terminate in the event of its assignment, as defined under the 1940 Act. The Management Agreement provides that the Investment Manager will not be liable for any act or omission, error of judgment or mistake of law, or for any loss suffered by the Fund in connection with matters to which the Management Agreement relates, except for a loss resulting from willful misfeasance, bad faith or gross negligence on the part of the Investment Manager in the performance of its duties, or from reckless disregard by it of its obligations and duties under the Management Agreement. ADMINISTRATOR Under an Administration Agreement (the "Administration Agreement") between the Fund and Chase Global Funds Services Company (the "Administrator"), a subsidiary of The Chase Manhattan Bank, the Administrator will provide administrative services to the Fund. Such administrative services include maintenance of the Fund's books and records, calculation of net asset value, preparation and filing of reports with respect to certain of the Fund's U.S. reporting requirements, monitoring of custody arrangements with the Fund's custodians and other accounting and general administrative services. The Directors of the Fund will supervise and monitor the administrative services provided by the Administrator. The Administrator, a Delaware corporation, provides administrative services to investment companies and at June 30, 1996 had approximately $64 billion of investment company assets under administration. The Administrator's principal business address is 73 Tremont Street, Boston, Massachusetts 02108. Under the Administration Agreement, the Fund will pay to the Administrator an annual administration fee of $65,000 plus 0.09% of the average weekly net assets of the Fund, computed weekly and payable monthly. ESTIMATED EXPENSES On the basis of the anticipated size of the Fund immediately following the receipt of the net proceeds from this offering, the Investment Manager estimates that the Fund's normal annual operating expenses, 30 31 including management, administrative and custodial fees, exclusive of amortization of organization expenses, will be approximately $3,050,000. While this estimate has been made in good faith on the basis of information made available to the Investment Manager, there can be no assurance, given the nature of the Fund as one of a few investment companies investing primarily in equity securities of RNE country issuers, that actual operating expenses will not be substantially more or less than such estimate. The Fund's annual operating expenses will be higher than normal annual operating expenses of most closed-end investment companies of comparable size investing in the United States and reflect the specialized nature of the Fund, the extent of the advisory effort involved and the costs of communication and other costs associated with investing in RNE countries rather than in the United States. Costs incurred by the Fund in connection with its initial registration and public offering of shares, estimated at $420,000, will be paid by the Investment Manager or an affiliate and will not be charged to the capital of the Fund; costs incurred in connection with the Fund's organization, estimated at $80,000, will be deferred and amortized on a straight-line basis over five years starting with the commencement of the Fund's operations. PORTFOLIO TRANSACTIONS AND BROKERAGE The Investment Manager will place orders for securities to be purchased by the Fund. The primary objective of the Investment Manager in choosing brokers for the purchase and sale of securities for the Fund's portfolio will be to obtain the most favorable net results taking into account such factors as price, commission, size of order, difficulty of execution and the degree of skill required of the broker-dealer. The capability and financial condition of the broker may also be criteria for the choice of that broker. The placing and execution of orders for the Fund also will be subject to restrictions under U.S. securities laws, including certain prohibitions against trading among the Fund and its affiliates (including the Investment Manager or its affiliates). The Fund may utilize affiliates of the Investment Manager in connection with the purchase or sale of securities in accordance with rules or exemptive orders adopted by the Commission when the Investment Manager believes that the charge for the transaction does not exceed usual and customary levels. In addition, the Fund may purchase securities in a placement for which affiliates of the Investment Manager have acted as agent to or for issuers, consistent with applicable rules adopted by the Commission or regulatory authorization, if necessary. The Fund will not purchase securities from or sell securities to any affiliate of the Investment Manager acting as principal. The Investment Manager on behalf of the Fund may place brokerage transactions through brokers who provide it with investment research services, including market and statistical information and quotations for the Fund's portfolio valuation purposes. The terms "investment research" and "market and statistical information and quotations" include advice as to the value of securities, the advisability of investing in, purchasing or selling securities, and the availability of securities and potential buyers or sellers of securities, as well as the furnishing of analyses and reports concerning issuers, industries, securities, economic factors and trends, and portfolio strategy, each and all as consistent with those services mentioned in Section 28(e) of the Securities Exchange Act of 1934, as amended (the "1934 Act"). Research provided to the Investment Manager in advising the Fund will be in addition to and not in lieu of the services required to be performed by the Investment Manager itself, and the Investment Manager's fees will not be reduced as a result of the receipt of such supplemental information. It is the opinion of the management of the Fund that such information is only supplementary to the Investment Manager's own research efforts, because the information must still be analyzed, weighed and reviewed by the Investment Manager's staff. Such information may be useful to the Investment Manager in providing services to clients other than the Fund, and not all such information is necessarily used by the Investment Manager in connection with the Fund. Conversely, information provided to the Investment Manager by brokers and dealers through whom other clients of the Investment Manager effect securities transactions may prove useful to the Investment Manager in providing services to the Fund. 31 32 The Fund's Board of Directors will review at least annually the commissions allocated by the Investment Manager on behalf of the Fund to determine if such allocations were reasonable in relation to the benefits inuring to the Fund. NET ASSET VALUE The Fund intends to determine its net asset value no less frequently than the close of business on the last business day of each week by dividing the value of the net assets of the Fund (the value of its assets less its liabilities) by the total number of shares of Common Stock outstanding. In valuing the Fund's assets, all listed equity securities for which market quotations are readily available will, regardless of purchase price, be valued at the last sales price on the date of determination. Listed securities with no such sales price and unlisted equity securities are valued at the mean between the current bid and asked prices, if any, obtained from reputable brokers. Short-term investments having a maturity of 60 days or less are valued at cost with accrued interest or discount earned included in interest receivable. Other securities as to which market quotations are readily available will be valued at their market values. All other securities and assets will be taken at fair value as determined in good faith by the Board of Directors although the actual calculation may be done by others. In instances where price cannot be determined in accordance with the above procedures, or in instances in which the Board of Directors determines it is impractical or inappropriate to determine price in accordance with the above procedures, the price will be at fair value as determined in good faith in a manner as the Board of Directors may prescribe. All assets and liabilities of the Fund not denominated in U.S. dollars will be initially valued in the currency in which they are denominated and then will be translated into U.S. dollars at the prevailing foreign exchange rate on the date of valuation. The Fund's obligation to pay any local taxes, such as tax on remittances from an RNE country, will become a liability on the date the Fund recognizes income or marks-to-market its assets and will have the effect of reducing the Fund's net asset value. DIVIDENDS AND DISTRIBUTIONS; DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN The Fund intends to distribute to stockholders, at least annually, substantially all of its investment company taxable income from dividends and interest earnings and any net realized capital gains. See "Taxation -- U.S. Federal Income Taxes." The Fund may elect annually, however, to retain for reinvestment any net realized long-term capital gains. Pursuant to the Dividend Reinvestment and Cash Purchase Plan (the "Plan"), each stockholder will be deemed to have elected, unless the Plan Agent (as defined below) is otherwise instructed by the stockholder in writing, to have all distributions automatically reinvested by American Stock Transfer & Trust Company (the "Plan Agent") in Fund shares pursuant to the Plan. Stockholders who do not participate in the Plan will receive all distributions in cash paid by check in U.S. dollars mailed directly to the stockholder by American Stock Transfer & Trust Company, as paying agent. Stockholders who do not wish to have distributions automatically reinvested should notify the Fund, c/o the Plan Agent for Morgan Stanley Russia & New Europe Fund, Inc. at American Stock Transfer & Trust Company, 40 Wall Street, New York, New York 10005. The Plan Agent will serve as agent for the stockholders in administering the Plan. If the Directors of the Fund declare an income dividend or realized capital gains distribution payable either in the Fund's Common Stock or in cash, as stockholders may have elected, non-participants in the Plan will receive cash and participants in the Plan will receive Common Stock to be issued by the Fund or to be purchased in the open market by the Plan Agent. If the market price per share on the valuation date equals or exceeds the net asset value per share on that date, the Fund will issue new shares to participants at net asset value, unless the net asset value is less than 95% of the market price on the valuation date, in which case, at 95% of the market price. The valuation date will be the dividend or distribution payment date or, if that date is not a trading day on the exchange on which the Fund's shares are then listed, the next preceding trading day. If the net asset value exceeds the market price of Fund shares on such valuation date, or if the Fund should declare a dividend or distribution payable only in cash, the Plan Agent will, as agent for the participants, buy Fund shares in the open market with the cash in respect of such dividend or distribution, for the participants' account on, or shortly after, the payment date. 32 33 Participants in the Plan have the option of making additional payments to the Plan Agent, annually, in any amount from $100 to $3,000, for investment in the Fund's Common Stock. The Plan Agent will use all funds received from participants (as well as any dividends and distributions received in cash) to purchase Fund shares in the open market on or about January 15 of each year. No participant will have any authority to direct the time or price at which the Plan Agent may purchase the Common Stock on its behalf. Any voluntary cash payments received more than thirty days prior to such date will be returned by the Plan Agent, and interest will not be paid on any uninvested cash payments. To avoid unnecessary cash accumulations, and also to allow ample time for receipt and processing by the Plan Agent, it is suggested that participants send in voluntary cash payments to be received by the Plan Agent approximately ten days before January 15. A participant may withdraw a voluntary cash payment by written notice, if the notice is received by the Plan Agent not less than forty-eight hours before such payment is to be invested. All voluntary cash payments should be made by check drawn on a U.S. bank (or a non-U.S. bank, if U.S. currency is imprinted on the check) payable in U.S. dollars and should be mailed to the Plan Agent for Morgan Stanley Russia & New Europe Fund, Inc. at American Stock Transfer & Trust Company, 40 Wall Street, New York, New York 10005. The Plan Agent will maintain all stockholder accounts in the Plan and will furnish written confirmations of all transactions in the account, including information needed by stockholders for personal and tax records. Shares in the account of each Plan participant will be held by the Plan Agent in non-certificated form in the name of the participant, and each stockholder's proxy will include those shares purchased pursuant to the Plan. In the case of stockholders, such as banks, brokers or nominees, which hold shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of shares certified from time to time by the stockholder as representing the total amount registered in the stockholder's name and held for the account of beneficial owners who are participating in the Plan. There is no charge to participants for reinvesting dividends or distributions. The Plan Agent's fees for the handling of the reinvestment of dividends and distributions will be paid by the Fund. However, each participant's account will be charged a pro rata share of brokerage commissions incurred with respect to the Plan Agent's open market purchases in connection with the reinvestment of dividends or distributions. A participant will also pay brokerage commissions incurred in purchases from voluntary cash payments made by the participant. Brokerage charges for purchasing small amounts of stock for individual accounts through the Plan are expected to be less than the usual brokerage charges for such transactions, because the Plan Agent will be purchasing stock for all participants in blocks and prorating the lower commission thus attainable. The automatic reinvestment of dividends and distributions will not relieve participants of any income tax which may be payable on such dividends and distributions. See "Taxation -- U.S. Federal Income Taxes." Experience under the Plan may indicate that changes are desirable. Accordingly, the Fund reserves the right to amend or terminate the Plan as applied to any voluntary cash payment made and any dividend or distribution paid subsequent to notice of the change sent to all stockholders at least 90 days before the record date for such dividend or distribution. The Plan also may be amended or terminated by the Plan Agent by at least 90 days' written notice to all stockholders. All correspondence concerning the Plan should be directed to the Plan Agent for Morgan Stanley Russia & New Europe Fund, Inc. at American Stock Transfer & Trust Company, 40 Wall Street, New York, New York 10005. TAXATION U.S. FEDERAL INCOME TAXES The Fund intends to qualify and be treated as a regulated investment company under the Code. To so qualify, the Fund must, among other things: (a) derive at least 90% of its gross income from dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of stock or securities and gains from the sale or other disposition of foreign currencies, or other income (including gains from options, futures contracts and forward contracts) derived with respect to the Fund's business of investing in 33 34 stocks, securities or currencies; (b) derive less than 30% of its gross income from the sale or other disposition of the following assets held for less than three months -- (i) stock and securities, (ii) options, futures and forward contracts (other than options, futures and forward contracts on foreign currencies), and (iii) foreign currencies (and options, futures and forward contracts on foreign currencies) which are not directly related to the Fund's principal business of investing in stocks and securities (or options and futures with respect to stock or securities); and (c) diversify its holdings so that, at the end of each quarter, (i) at least 50% of the value of the Fund's total assets is represented by cash and cash items (including receivables), U.S. Government securities, securities of other regulated investment companies, and other securities, with such other securities limited in respect of any one issuer to an amount not greater in value than 5% of the Fund's total assets and to not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of the Fund's total assets is invested in the securities (other than U.S. Government securities or securities of other regulated investment companies) of any one issuer or of any two or more issuers that the Fund controls and that are determined to be engaged in the same business or similar or related businesses. The Fund expects that all of its foreign currency gains will be directly related to its principal business of investing in stock and securities. Legislation is currently pending before the U.S. Congress that would repeal the requirement that a regulated investment company must derive less than 30% of its gross income from the sale or other disposition of assets described in (b) above, that are held for less than three months. However, it cannot be predicted whether this legislation will become law and, if so enacted, what form it will eventually take. As a regulated investment company, provided that the Fund distributes to its stockholders at least 90% of its investment company taxable income for the taxable year, the Fund will not be subject to U.S. federal income tax on the portion of its investment company taxable income that it distributes to its stockholders; however, the Fund will be subject to tax on the portion of its income and gains that it does not distribute to its stockholders. Investment company taxable income includes, among other things, dividends, interest and net short-term capital gains in excess of net long-term capital losses, but does not include net long-term capital gains in excess of net short-term capital losses. The Fund intends to distribute annually to its stockholders substantially all of its investment company taxable income. If necessary, the Fund may borrow money temporarily or liquidate assets to make such distributions. As discussed below, however, it is possible that the Fund may not distribute net long-term capital gains in excess of short-term capital losses. Dividend distributions of investment company taxable income are taxable to a U.S. stockholder as ordinary income to the extent of the Fund's current and accumulated earnings and profits, whether paid in cash or in shares of Common Stock. Thus, reinvested dividends will give rise to tax without a corresponding receipt of cash. Distributions in excess of the Fund's current and accumulated earnings and profits will first reduce the adjusted tax basis of a holder's stock and, to the extent such distributions exceed the positive adjusted tax basis of such stock, will constitute capital gains to such holder (assuming the stock is held as a capital asset). Since the Fund will not invest in the stock of domestic corporations, distributions to corporate stockholders of the Fund will not be entitled to the deduction for dividends received by corporations. If the Fund fails to satisfy the 90% distribution requirement or fails to qualify as a regulated investment company in any taxable year, it will be subject to tax in such year on all of its taxable income, whether or not the Fund makes any distributions to its stockholders. As a regulated investment company, the Fund also will not be subject to U.S. federal income tax on the portion of its net long-term capital gains in excess of net short-term capital losses and capital loss carryovers from the prior eight years, if any, that it distributes to its stockholders. If the Fund retains for reinvestment or otherwise an amount of such net long-term capital gains, it will be subject to a tax of up to 35% of the amount retained. The Board of Directors of the Fund will determine at least once a year whether to distribute any net long-term capital gains in excess of net short-term capital losses and capital loss carryovers from prior years. The Fund expects to designate amounts retained as undistributed capital gains in a notice to its stockholders who are stockholders of record as of the close of a taxable year of the Fund who, if subject to U.S. federal income taxation, (a) will be required to include in income for U.S. federal income tax purposes, as long-term capital gains, their proportionate shares of the undistributed amount, and (b) will be entitled to credit against their U.S. federal income tax liabilities their proportionate shares of the tax paid by the Fund on the undistributed amount and to claim refunds to the extent that their credits exceed their liabilities. For U.S. federal income tax purposes, the basis of shares owned by a stockholder of the Fund will be increased by an 34 35 amount equal to 65% of the amount of undistributed capital gains included in the stockholder's income. Distributions of net long-term capital gains, if any, by the Fund are taxable to its stockholders as long-term capital gains whether paid in cash or in shares and regardless of how long the stockholder has held the Fund's shares. Such distributions of net long-term capital gains are not eligible for the dividends received deduction. Under the Code, net long-term capital gains will be taxed at a rate no greater than 28% for individuals and 35% for corporations. Stockholders will be notified annually as to the U.S. federal income tax status of their dividends and distributions. Stockholders receiving dividends or distributions in the form of additional shares pursuant to the Plan should be treated for U.S. federal income tax purposes as receiving a distribution in an amount equal to the amount of money that the stockholders receiving cash dividends or distributions will receive, and should have a cost basis in the shares equal to such amount. If the net asset value of shares is reduced below a stockholder's cost as a result of a distribution by the Fund, the distribution will be taxable even if it, in effect, represents a return of invested capital. Investors considering buying shares just prior to a dividend or capital gain distribution payment date should be aware that, although the price of shares purchased at that time may reflect the amount of the forthcoming distribution, those who purchase just prior to the record date for a distribution will receive a distribution which will be taxable to them. The amount of capital gains realized and distributed (which from an investment standpoint may represent a partial return of capital rather than income) in any given year will be the result of investment performance, among other things, and can be expected to vary from year to year. If the Fund is the holder of record of any stock on the record date for any dividends payable with respect to such stock, such dividends are included in the Fund's gross income not as of the date received but as of the later of (a) the date such stock became ex-dividend with respect to such dividends (i.e., the date on which a buyer of the stock would not be entitled to receive the declared, but unpaid, dividends) or (b) the date the Fund acquired such stock, either of which dates may be earlier than the date the dividend is received. Accordingly, in order to satisfy its income distribution requirements, the Fund may be required to pay dividends based on anticipated income, and stockholders may receive dividends in an earlier year than would otherwise be the case. Under the Code, the Fund may be subject to a 4% excise tax on a portion of its undistributed income. To avoid the tax, the Fund must distribute annually at least 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year and at least 98% of its capital gain net income for the 12-month period ending, as a general rule, on October 31 of the calendar year. For this purpose, any income or gain retained by the Fund that is subject to corporate income tax will be treated as having been distributed at year-end. For purposes of the excise tax, a registered investment company shall: (1) reduce its capital gain net income, but not below its net capital gain, by the amount of any net ordinary loss for the calendar year; and (2) exclude foreign currency gains and losses incurred after October 31 of any year, or after the end of its taxable year if it has made a taxable year election, in determining the amount of ordinary taxable income for the current calendar year and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year. In addition, the minimum amounts that must be distributed in any year to avoid the excise tax will be increased or decreased to reflect any under-distribution or over-distribution, as the case may be, in the previous year. For a distribution to qualify under the foregoing test, the distribution generally must be declared and paid during the year. Any dividend declared by the Fund in October, November or December of any year and payable to stockholders of record on a specified date in such a month shall be deemed to have been received by each stockholder on December 31 of such year and to have been paid by the Fund not later than December 31 of such year, provided that such dividend is actually paid by the Fund during January of the following year. Accordingly, such distributions will be taxable to shareholders in the year the distributions are declared and become payable, rather than the year in which the distributions are received by the shareholders. The Fund will maintain accounts and calculate income by reference to the U.S. dollar for U.S. federal income tax purposes. Certain investments will be maintained and income therefrom calculated by reference to non-U.S. currencies, and such calculations will not necessarily correspond to the Fund's distributable income 35 36 and capital gains for U.S. federal income tax purposes as a result of fluctuations in currency exchange rates. Furthermore, exchange control regulations may restrict the ability of the Fund to repatriate investment income or the proceeds of sales of securities. These restrictions and limitations may limit the Fund's ability to make sufficient distributions to satisfy the 90% and 98% distribution requirements for avoiding income and excise taxes. The Fund's transactions in foreign currencies, forward contracts, options and futures contracts (including options and futures contracts on foreign currencies) will be subject to special provisions of the Code that, among other things, may affect the character of gains and losses realized by the Fund (i.e., may affect whether gains or losses are ordinary or capital), accelerate recognition of income to the Fund, defer Fund losses, and affect the determination of whether capital gains and losses are characterized as long-term or short-term capital gains or losses. These rules could therefore affect the character, amount and timing of distributions to stockholders. These provisions also may require the Fund to mark-to-market certain types of the positions in its portfolio (i.e., treat them as if they were sold for fair value at the close of the taxable year) which may cause the Fund to recognize income without receiving cash with which to make distributions in amounts necessary to satisfy the 90% and 98% distribution requirements for avoiding income and excise taxes. The Fund will monitor its transactions, will make the appropriate tax elections, and will make the appropriate entries in its books and records when it acquires any foreign currency, option, futures contract, forward contract, or hedged investment to mitigate the effect of these rules and prevent disqualification of the Fund as a regulated investment company and minimize the imposition of income and excise taxes. The Fund may make investments that accrue income that is not matched by a current receipt of cash by the Fund, such as investments in certain obligations having original issue discount (i.e., an amount equal to the excess of the stated redemption price of the security at maturity over its issue price), or market discount (i.e., an amount equal to the excess of the stated redemption price of the security at maturity over its basis immediately after it was acquired) if the Fund elects to accrue market discount on a current basis on debt instruments, including Sovereign Debt. In addition, income may continue to accrue for federal income tax purposes with respect to a non-performing investment. Any of the foregoing income would be treated as income earned by the Fund and therefore would be subject to the distribution requirements of the Code. Because such income may not be matched by a concurrent receipt of cash to the Fund, the Fund may be required to borrow money temporarily or liquidate other securities to be able to make distributions to its investors. The extent to which the Fund may liquidate securities at a gain may be limited by the 30% limitation discussed above. For backup withholding purposes, the Fund may be required to withhold 31% of reportable payments (which may include dividends and capital gain distributions) to certain noncorporate shareholders. A stockholder, however, may avoid becoming subject to this requirement by filing an appropriate form certifying under penalty of perjury that such stockholder's taxpayer identification number is correct and that such stockholder is not subject to backup withholding, or is exempt from backup withholding. Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules from payments made to a shareholder may be credited against such shareholder's federal income tax liability. Upon the sale or exchange of its shares, a stockholder will realize a taxable gain or loss depending upon the amount realized and the stockholder's basis in the shares. Such gain or loss will be treated as capital gain or loss if the shares are capital assets in the stockholder's hands, and will be long-term if the stockholder's holding period for the shares is more than 12 months and otherwise will be short-term. Any loss realized on a sale or exchange will be disallowed to the extent that the shares disposed of are replaced (including replacement through the reinvestment of dividends and capital gains distributions in the Fund) within a period of 61 days beginning 30 days before and ending 30 days after the disposition of the shares. In such a case, the basis of the shares acquired will be adjusted to reflect the disallowed loss. Any loss realized by a stockholder on the sale of Fund shares held by the stockholder for six months or less will be treated for federal income tax purposes as a long-term capital loss to the extent of any distributions of long-term capital gains received by the stockholder with respect to such shares. 36 37 A repurchase by the Fund of shares generally will be treated as a sale of the shares by a stockholder provided that after the repurchase the stockholder does not own, either directly or by attribution under Section 318 of the Code, any shares. If, after a repurchase a stockholder continues to own, directly or by attribution, any shares, and has not experienced a meaningful reduction in its proportionate interest in the Fund, it is possible that any amounts received in the repurchase by such stockholder will be taxable as a dividend to such stockholder. If, in addition, the Fund has made such repurchases as part of a series of redemptions, there is a risk that stockholders who do not have any of their shares repurchased would be treated as having received a dividend distribution as a result of their proportionate increase in the ownership of the Fund. Passive Foreign Investment Companies If the Fund purchases stock in certain foreign passive investment entities described in the Code as passive foreign investment companies ("PFIC"), the Fund will be subject to U.S. federal income tax on a portion of any "excess distribution" with respect to the stock of a PFIC held by the Fund (distributions received by the Fund on such stock in any year that exceeds 125% of the average annual distribution received by the Fund in the three preceding years or the Fund's holding period, if shorter, and any gain from the disposition of such PFIC stock) even if such income is distributed as a taxable dividend by the Fund to its stockholders. Additional charges in the nature of interest may be imposed on the Fund in respect of deferred taxes arising from such "excess distributions." If the Fund were to invest in a PFIC and elect to treat the PFIC as a "qualified electing fund" under the Code (and if the PFIC were to comply with certain reporting requirements), in lieu of the foregoing requirements the Fund would be required to include in income each year its pro rata share of the PFIC's ordinary earnings and net realized capital gains, whether or not such amounts were actually distributed to the Fund. Legislation has been proposed in the U.S. Congress which would, in the case of a PFIC having "marketable stock," permit U.S. stockholders, such as the Fund, to elect to mark-to-market the PFIC stock annually. Otherwise, U.S. stockholders would be treated substantially the same as under current law. Special rules applicable to mutual funds would classify as "marketable stock" all stock in PFICs held by the Fund. It is unclear if or when the proposed legislation will become law and if it is enacted the form it will take. On March 31, 1992, the U.S. Internal Revenue Service released proposed regulations providing a mark-to-market election for regulated investment companies that would have effects similar to the proposed legislation. These regulations would be effective for taxable years ending after promulgation of the regulations as final regulations. Whether and to what extent final regulations may be applied retroactively by the Fund is unclear. Foreign Tax Credits Income and gains received by the Fund from sources outside the United States may be subject to withholding and other taxes imposed by foreign countries. If (i) the Fund qualifies as a regulated investment company, (ii) certain distribution requirements are satisfied, and (iii) more than 50% of the value of the Fund's total assets at the close of any taxable year consists of stocks or securities of foreign corporations, which for this purpose should include obligations issued by foreign government issuers, the Fund may elect, for U.S. federal income tax purposes, to treat any foreign country's income or withholding taxes paid by the Fund that can be treated as income taxes under U.S. federal income tax principles, as paid by its stockholders. The Fund expects all of the foregoing conditions to be satisfied, and expects to make the foregoing election in each year that it qualifies to do so. As a consequence, each stockholder will be required to include in its income an amount equal to its allocable share of such income taxes paid by the Fund to a foreign country's government and the stockholders will be entitled, subject to certain limitations, to credit their portions of these amounts against their U.S. federal income tax due, if any, or to deduct their portions from their U.S. taxable income, if any. In general, a stockholder may elect each year whether to claim a deduction or a credit for such foreign taxes paid. However, no deductions for foreign taxes may be claimed by certain foreign stockholders, and by non-corporate stockholders who do not itemize deductions. Stockholders that are exempt from tax under Section 501(a) of the Code, such as pension plans, generally will derive no benefit from the Fund's election. However, such stockholders increase should not be disadvantaged because the amount of additional income 37 38 they are deemed to receive equal to their allocable share of such foreign countries' income taxes paid by the Fund generally will not be subject to U.S. federal income tax. The amount of foreign taxes that may be credited against a stockholder's U.S. federal income tax liability will generally be limited to an amount equal to the stockholder's United States federal income tax rate multiplied by its foreign source taxable income. For this purpose, the Fund expects that the capital gains and foreign currency gains it distributes, whether as dividends or capital gains distributions, generally will not be treated as foreign source taxable income. In addition, this limitation must be applied separately to certain categories of foreign source income, one of which is foreign source passive income. For this purpose, foreign source passive income includes dividends, interest, capital gains and certain foreign currency gains. As a consequence, certain stockholders may not be able to claim a foreign tax credit for the full amount of their proportionate share of foreign taxes paid by the Fund although taxes that cannot be claimed in the year they are paid as a result of this limitation may be carried back or carried forward to certain prior or succeeding years. Each stockholder will be notified within 60 days of the close of the Fund's taxable year whether, pursuant to the election described above, the foreign taxes paid by the Fund will be treated as paid by its stockholders for that year and, if so, such notification will designate (i) such stockholder's portion of the foreign taxes paid and (ii) the portion of the Fund's dividends and distributions that represents income derived from foreign sources. Foreign Stockholders Taxation of a stockholder who, as to the United States, is a foreign investor depends, in part, on whether the stockholder's income from the Fund is "effectively connected" with a United States trade or business carried on by the stockholder. If the foreign investor is not a resident alien and the income from the Fund is not effectively connected with a United States trade or business carried on by the foreign investor, distributions of net investment income and net realized short-term capital gains will be subject to a 30% (or lower treaty rate) United States withholding tax. Furthermore, foreign investors may be subject to an increased United States tax on their income resulting from the Fund's election (described above) to "pass-through" amounts of foreign taxes paid by the Fund, but may not be able to claim a credit or deduction with respect to the foreign taxes treated as having been paid by them. Distributions of net realized long-term capital gains, amounts retained by the Fund which are designated as undistributed capital gains, and gains realized upon the sale of shares of the Fund will not be subject to United States tax unless a foreign investor who is a nonresident alien individual is physically present in the United States for more than 182 days during the taxable year and, in the case of gain realized upon the sale of Fund shares, unless (i) such gain is attributable to an office or fixed place of business in the United States or (ii) such nonresident alien individual has a tax home in the United States and such gain is not attributable to an office or fixed place of business located outside the United States. If the Fund retains capital gains and designates such amounts as described above, foreign stockholders who are not subject to U.S. federal income tax on net capital gains can obtain a refund of their proportionate shares of the taxes paid by the Fund by filing a U.S. federal income tax return. In the case of a foreign investor who is a nonresident alien individual, the Fund may be required to withhold U.S. federal income tax at a rate of 31%, unless the foreign investor files an appropriate form certifying under penalty of perjury as to his nonresident alien status. If a foreign investor is a resident alien or if dividends or distributions from the Fund are effectively connected with a United States trade or business carried on by the foreign investor, dividends of net investment income, distributions of net short-term and long-term capital gains, amounts retained by the Fund that are designated as undistributed capital gains and any gains realized upon the sale of shares of the Fund will be subject to United States income tax at the rates applicable to United States citizens or domestic corporations. If the income from the Fund is effectively connected with a United States trade or business carried on by a foreign investor that is a corporation, then such foreign investor also may be subject to the 30% branch profits tax at a 30% rate (or lower treaty rate) on its effectively connected earnings and profits withdrawn from its U.S. trade or business. 38 39 The tax consequences to a foreign stockholder entitled to claim the benefits of an applicable tax treaty may be different from those described in this section. Stockholders may be required to provide appropriate documentation to establish their entitlement to the benefits of such a treaty. Foreign investors are advised to consult their own tax advisers with respect to (a) whether their income from the Fund is effectively connected with a United States trade or business carried on by them, (b) whether they may claim the benefits of an applicable tax treaty and (c) any other tax consequences to them resulting from an investment in the Fund. Notices Stockholders will be notified annually by the Fund as to the United States federal income tax status of the dividends, distributions and deemed distributions made by the Fund to its stockholders. Furthermore, stockholders will be sent, if appropriate, various written notices after the close of the Fund's taxable year as to the U.S. federal income tax status of certain dividends, distributions and deemed distributions that were paid (or that were treated as having been paid) by the Fund to its stockholders during the preceding taxable year. OTHER TAXATION Dividends, distributions and deemed distributions also may be subject to additional state, local and foreign taxes depending on each stockholder's particular position. Investors should consult with their tax advisers concerning the state, local and foreign tax consequences, if any, resulting from an investment in the Fund. THE U.S. FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS A SUMMARY INCLUDED FOR GENERAL INFORMATION PURPOSES ONLY. IN VIEW OF THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, EACH SHAREHOLDER IS ADVISED TO CONSULT HIS OWN TAX ADVISER WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES TO HIM OF PARTICIPATION IN THE FUND, INCLUDING THE EFFECT AND APPLICABILITY OF STATE, LOCAL, FOREIGN, AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS. COMMON STOCK The authorized capital stock of the Fund is 100,000,000 shares of Common Stock, $0.01 par value. Shares of the Fund, when issued, will be fully paid and nonassessable and will have no conversion, preemptive or other subscription rights. Holders of Common Stock are entitled to one vote per share on all matters to be voted upon by stockholders and are not able to cumulate their votes in the election of Directors. Thus, holders of more than 50% of the shares voting for the election of Directors have the power to elect 100% of the Directors. All shares are equal as to assets, earnings and the receipt of dividends and distributions, if any, as may be declared by the Board of Directors out of funds available therefor. In the event of liquidation, dissolution or winding up of the Fund, each share of Common Stock is entitled to receive its proportion of the Fund's assets remaining after payment of all debts and expenses. The Fund's Board of Directors has the authority to classify and reclassify any authorized but unissued shares of capital stock and to establish the rights and preferences of such unclassified shares. The Fund does not presently intend to offer additional shares of Common Stock, except that additional shares may be issued under the Plan. Other offerings of the Fund's shares will require approval of the Fund's Board of Directors and may require stockholder approval. Any such additional offerings would also be subject to the requirements of the 1940 Act, including the requirement that shares may not be sold at a price below the then current net asset value (exclusive of underwriting discounts and commissions) except in connection with an offering to existing stockholders or with the consent of a majority of the Fund's shares. The Fund is a closed-end investment company, and as such its stockholders do not have the right to cause the Fund to redeem their shares of Common Stock. The Fund, however, may repurchase shares of Common Stock from time to time in the open market or in private transactions when it can do so at prices at or below the current net asset value per share on terms that represent a favorable investment opportunity. Subject to its investment limitations, the Fund may borrow to finance the repurchase of shares. However, the payment of 39 40 interest on such borrowings will increase the Fund's expenses and consequently reduce net income. In addition, the Fund is required under the 1940 Act to maintain "asset coverage" of not less than 300% of its "senior securities representing indebtedness" as such terms are defined in the 1940 Act. The Fund's shares of Common Stock will trade in the open market at a price which is a function of several factors, including their net asset value and yield. The shares of closed-end investment companies frequently sell at a discount from, but sometimes at or at a premium over, their net asset values. See "Risk Factors and Special Considerations." There can be no assurance that it will be possible for investors to resell shares of the Fund at or above the price at which shares are offered by this Prospectus or that the market price of the Fund's shares will equal or exceed net asset value. The Fund may from time to time repurchase its shares at prices below their net asset value or make a tender offer for its shares. While this may have the effect of increasing the net asset value of those shares that remain outstanding, the effect of such repurchases on the market price of the remaining shares cannot be predicted. Any offer by the Fund to repurchase shares will be made at a price based upon the net asset value of the shares at the close of business on or within 14 days after the last date of the offer. Each offer will be made and stockholders notified in accordance with the requirements of the 1934 Act and the 1940 Act, either by publication or mailing or both. Each offering document will contain such information as is prescribed by such laws and the rules and regulations promulgated thereunder. When a repurchase offer is authorized by the Fund's Board of Directors, a stockholder wishing to accept the offer may be required to offer to sell all (but not less than all) of the shares owned by such stockholder (or attributed to him for federal income tax purposes under Section 318 of the Code). The Fund will purchase all shares tendered in accordance with the terms of the offer unless it determines to accept none of them (based upon one of the conditions set forth below). Persons tendering shares may be required to pay a service charge to help defray certain costs of the transfer agent. Any such service charges will not be deducted from the consideration paid for the tendered shares. During the period of a repurchase offer, the Fund's stockholders will be able to determine the Fund's current net asset value (which will be calculated weekly) by use of a tollfree telephone number. In the event that the Fund would have to liquidate certain investments to finance such repurchases of shares, and the portfolio securities to be liquidated have been held less than three months, such sales may jeopardize the Fund's status as a regulated investment company under the Code because of the limitation imposed thereunder that not more than 30% of the Fund's gross income may be derived from the sale of securities held for less than three months. The Fund's Articles of Incorporation and By-Laws include provisions that could limit the ability of others to acquire control of the Fund, to modify the structure of the Fund or to cause it to engage in certain transactions. These provisions, described below, also could have the effect of depriving stockholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of the Fund in a tender offer or similar transaction. In the opinion of the Fund, however, these provisions offer several possible advantages. They potentially require persons seeking control of the Fund to negotiate with its management regarding the price to be paid for the shares required to obtain such control, they promote continuity and stability and they enhance the Fund's ability to pursue long-term strategies that are consistent with its investment objective. The Fund's Articles of Incorporation provide that the Fund's Board of Directors have the sole power to adopt, alter or repeal the Fund's By-Laws. The Directors are divided into three classes, each having a term of three years, with the term of one class expiring each year. In addition, a Director may be removed from office only with cause and only by a majority of the Fund's stockholders, and the affirmative vote of 75% or more of the Fund's outstanding shares is required to amend, alter or repeal the provisions in the Fund's Articles of Incorporation relating to amendments to the Fund's By-Laws and to removal of Directors. See "Management of the Fund -- Directors and Officers of the Fund." These provisions could delay the replacement of a majority of the Directors and have the effect of making changes in the Board of Directors more difficult than if such provisions were not in place. The affirmative vote of the holders of 75% or more of the outstanding shares is required to (1) convert the Fund from a closed-end to an open-end investment company, (2) merge or consolidate with any other entity or enter into a share exchange transaction in which the Fund is not the successor corporation, (3) dissolve or liquidate the Fund, (4) sell all or substantially all of its assets, (5) cease to be an investment company 40 41 registered under the 1940 Act or (6) issue to any person securities in exchange for property worth $1,000,000 or more, exclusive of sales of securities in connection with a public offering, issuance of securities pursuant to a dividend reinvestment plan or other stock dividend or issuance of securities upon the exercise of any stock subscription rights. However, if such action has been approved or authorized by the affirmative vote of at least 70% of the entire Board of Directors, the affirmative vote of only a majority of the outstanding shares would be required for approval, except in the case of the issuance of securities, in which no stockholder vote would be required unless otherwise required by applicable law. The affirmative vote of the holders of 75% or more of the outstanding shares entitled to vote thereon is required to amend, alter or repeal the foregoing provisions of the Fund's Articles of Incorporation. The principal purpose of the above provisions is to increase the Fund's ability to resist takeover attempts and attempts to change the fundamental nature of the business of the Fund that are not supported by either the Board of Directors or a large majority of the stockholders. These provisions make it more difficult to liquidate, takeover or open-end the Fund and thereby are intended to discourage investors from purchasing its shares with the hope of making a quick profit by forcing the Fund to change its structure. These provisions, however, would apply to all actions proposed by anyone, including management, and would make changes in the Fund's structure accomplished through a transaction covered by the provisions more difficult to achieve. The foregoing provisions also could impede or prevent transactions in which holders of shares of Common Stock might obtain prices for their shares in excess of the current market prices at which the Fund's shares were then trading. Although these provisions could have the effect of depriving stockholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Fund, the Fund believes the conversion of the Fund from a closed-end to an open-end investment company to eliminate the discount may not be desired by stockholders, who purchased their Common Stock in preference to stock of the many mutual funds available. The Fund intends to hold annual meetings of its stockholders as required by the rules of the New York Stock Exchange. Under Maryland law and the Fund's By-Laws, the Fund will call a special meeting of its stockholders upon the written request of stockholders entitled to cast at least 25% of all the votes at such meeting. Such request for such a special meeting must state the purpose of the meeting and the matters proposed to be acted on at it. The secretary of the Fund is required to (i) inform the stockholders who make the request of the reasonably estimated cost of preparing and mailing a notice of the meeting and (ii) on payment of these costs to the Fund, notify each stockholder entitled to notice of the meeting. Notwithstanding the above, under Maryland law and the Fund's By-Laws, unless requested by stockholders entitled to cast a majority of all the votes entitled to be cast at the meeting, a special meeting need not be called to consider any matter which is substantially the same as a matter voted on at any special meeting of the stockholders held during the preceding 12 months. 41 42 UNDERWRITERS Under the terms and subject to the conditions contained in the Underwriting Agreement, dated the date hereof, the Underwriters named below, for whom Morgan Stanley & Co. Incorporated is acting as Representative, have severally agreed to purchase, and the Fund has agreed to sell to them, severally, the number of shares of Common Stock set forth opposite their respective names below:
NUMBER UNDERWRITERS OF SHARES -------------------------------------------------------------------------- --------- Morgan Stanley & Co. Incorporated......................................... 490,000 Donaldson, Lufkin & Jenrette Securities Corporation....................... 489,500 A.G. Edwards & Sons, Inc.................................................. 489,500 Cowen & Company........................................................... 489,500 EVEREN Securities, Inc.................................................... 489,500 Fahnestock & Co. Inc...................................................... 489,500 Alex. Brown & Sons Incorporated........................................... 75,000 Merrill Lynch, Pierce, Fenner & Smith Incorporated........................ 75,000 Oppenheimer & Co., Inc. .................................................. 75,000 PaineWebber Incorporated.................................................. 75,000 Prudential Securities Incorporated........................................ 75,000 Advest, Inc. ............................................................. 37,500 Arnhold and S. Bleichroeder, Inc. ........................................ 37,500 Robert W. Baird & Co. Incorporated........................................ 37,500 William Blair & Company................................................... 37,500 J.C. Bradford & Co. ...................................................... 37,500 Burnham Securities, Inc. ................................................. 37,500 The Chicago Corporation................................................... 37,500 Crowell, Weedon & Co. .................................................... 37,500 Dain Bosworth Incorporated................................................ 37,500 Dominick & Dominick Incorporated.......................................... 37,500 First Albany Corporation.................................................. 37,500 First of Michigan Corporation............................................. 37,500 Folger Nolan Fleming Douglas Incorporated................................. 37,500 Gilford Securities Incorporated........................................... 37,500 Gruntal & Co., Incorporated............................................... 37,500 Guzman & Company.......................................................... 37,500 J.J.B. Hilliard, W.L. Lyons, Inc. ........................................ 37,500 Interstate/Johnson Lane Corporation....................................... 37,500 Janney Montgomery Scott Inc. ............................................. 37,500 Josephthal Lyon & Ross Incorporated....................................... 37,500 Ladenburg, Thalmann & Co. Inc. ........................................... 37,500 Laidlaw Equities Inc. .................................................... 37,500 Legg Mason Wood Walker, Incorporated...................................... 37,500 McDonald & Company Securities, Inc. ...................................... 37,500 Morgan Keegan & Company, Inc. ............................................ 37,500 NatCity Investments, Inc. ................................................ 37,500 Needham & Company, Inc. .................................................. 37,500 The Ohio Company.......................................................... 37,500 Ormes Capital Markets, Inc. .............................................. 37,500
42 43
NUMBER UNDERWRITERS OF SHARES -------------------------------------------------------------------------- --------- Parker/Hunter Incorporated................................................ 37,500 Piper Jaffray Inc. ....................................................... 37,500 Principal Financial Securities, Inc. ..................................... 37,500 Ragen MacKenzie Incorporated.............................................. 37,500 Rauscher Pierce Refsnes, Inc. ............................................ 37,500 The Robinson-Humphrey Company, Inc. ...................................... 37,500 Rodman & Renshaw, Inc. ................................................... 37,500 Roney & Co. .............................................................. 37,500 Scott & Stringfellow, Inc. ............................................... 37,500 Muriel Siebert & Co., Inc. ............................................... 37,500 Stifel, Nicolaus & Company, Incorporated.................................. 37,500 Sutro & Co. Incorporated.................................................. 37,500 Tucker Anthony Incorporated............................................... 37,500 Van Kasper & Co. ......................................................... 37,500 Wedbush Morgan Securities................................................. 37,500 Wheat, First Securities, Inc. ............................................ 37,500 --------- Total..................................................................... 5,000,000 ========
The Underwriting Agreement provides that the obligations of the several Underwriters to pay for and accept delivery of the Shares are subject to the approval of certain legal matters by their counsel and to certain other conditions. The Underwriters are committed to take and pay for all of the Shares (other than those covered by the over-allotment options described below) if any are taken. The Underwriters have advised the Fund that they propose to offer the Shares initially at the public offering price set forth on the cover page of this Prospectus. There is no sales charge or underwriting discount charged to investors on purchases of Shares in the offering. The Investment Manager or an affiliate (not the Fund) has agreed to pay the Underwriters from its own assets a commission in connection with sales of the Shares in the offering (other than Shares acquired for accounts managed by the Investment Manager), in the gross amount of $0.80 per Share. Such payment is equal to 4.0% of the initial public offering price per Share. From this amount, the Underwriters may allow to selected dealers a payment in an amount not in excess of $0.60 per Share sold by such dealers. Pursuant to the Underwriting Agreement, the Fund and the Investment Manager have agreed to indemnify the several Underwriters in connection with this offering against certain liabilities, including liabilities under the Securities Act of 1933, as amended. The Fund has granted to the Underwriters options, exercisable from time to time for up to 45 days from the date of this Prospectus, to purchase up to 750,000 additional shares of Common Stock at the initial public offering price set forth on the cover page of this Prospectus. The Underwriters may exercise such options solely for the purpose of covering over-allotments, if any, incurred in the sale of the Shares offered hereby. The Fund has agreed in the Underwriting Agreement not to offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, any Shares or any securities convertible into or exercisable or exchangeable for Common Stock or enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of Shares, whether any such transaction described above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise, for a period of 180 days after the date of this Prospectus, provided that the Fund may issue shares under its dividend reinvestment and cash purchase plan during such 180-day period. Prior to the offering, there has been no public market for the Common Stock or any other securities of the Fund. Consequently, the initial public offering price has been determined by negotiations among the Fund, the 43 44 Investment Manager and the Underwriters. There can be no assurance, however, that the price at which the Shares will sell in the public market after the offering will not be lower than the price at which they are sold by the Underwriters. In order to satisfy one of the requirements for listing of the Fund's Common Stock on the New York Stock Exchange, the Underwriters will undertake to sell lots of 100 or more Shares to a minimum of 2,000 beneficial holders in the United States. The Investment Manager is an affiliate of Morgan Stanley & Co. Incorporated. Certain Directors and officers of the Fund are also affiliated with Morgan Stanley & Co. Incorporated. The Fund anticipates that Morgan Stanley & Co. Incorporated and certain of the other Underwriters may from time to time act as brokers or dealers in connection with the execution of the Fund's portfolio transactions after they have ceased to be selling agents or underwriters of the Fund's Common Stock and, subject to certain restrictions, may act as brokers while they are selling agents or underwriters. Employees of the Investment Manager and its affiliates, and directors and officers of the Fund and any other investment company managed by the Investment Manager, may purchase Shares in this offering at the price appearing on the cover page of this Prospectus, provided that the Shares must be held by the investor for up to 90 days and, provided further, that if the Shares trade in the secondary market at a premium over the public offering price when secondary trading commences, sales to these associated persons will be canceled. DIVIDEND PAYING AGENT, TRANSFER AGENT AND REGISTRAR American Stock Transfer & Trust Company (the "Transfer Agent") acts as the Fund's dividend paying agent, transfer agent and the registrar for the Fund's Common Stock. The principal address of the Transfer Agent is 40 Wall Street, New York, New York 10005. For its services, the Transfer Agent will receive a monthly maintenance fee of $1,000 plus out of pocket expenses. CUSTODIAN The Chase Manhattan Bank acts as global custodian for all of the Fund's assets (the "Global Custodian"). The principal business address of the Global Custodian is 270 Park Avenue, New York, New York 10017-2070. Under a global custody agreement (the "Global Custody Agreement") between the Global Custodian and the Fund, the Global Custodian has agreed to hold all property of the Fund delivered to it in safekeeping in a segregated account, receive and collect all income and transaction proceeds with respect to such property, accept and deliver securities on the purchase, sale, redemption, exchange or conversion thereof, pay from the Fund's account the purchase price of any securities acquired by the Fund, as well as any taxes and other expenses payable in connection with securities transactions, maintain all necessary books and records with respect to the property of the Fund held by it, provide the Fund with periodic reports regarding the Fund's account and, in general, attend to all nondiscretionary details in connection with the sale, purchase, transfer and other dealings with the securities and other property of the Fund held by it. For its services the Global Custodian will receive a fee calculated as a percentage of the Fund's assets in its custody, plus an amount for each transaction effected in the Fund's account. In addition, the Global Custodian will be reimbursed by the Fund for any out-of-pocket expenses incurred by it in connection with the performance of its duties under the Global Custody Agreement. The Global Custody Agreement provides that the Fund shall indemnify the Global Custodian against any liability, loss or expense (including attorneys fees and disbursements) incurred in connection with the Global Custody Agreement, except to the extent such liability, loss or expense results from the negligence or willful misconduct of or breach by the Global Custodian or any sub-custodian. The Global Custodian may employ one or more sub-custodians outside the United States that are approved by the Board of Directors in accordance with regulations under the 1940 Act. The fees and expenses of any such sub-custodians are paid by the Global Custodian. 44 45 EXPERTS The statement of assets and liabilities of the Fund has been included in this Prospectus in reliance upon the report of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. The address of Price Waterhouse LLP is 1177 Avenue of the Americas, New York, New York 10036. LEGAL MATTERS The validity of the Common Stock offered hereby will be passed on for the Fund by Rogers & Wells, New York and by its special Maryland counsel, Piper & Marbury L.L.P., Baltimore, Maryland. Certain legal matters will be passed upon for the Underwriters by Davis Polk & Wardwell, New York, New York. It is likely that foreign persons, such as any sub-custodians of the Fund, will not have assets in the United States that could be attached in connection with any U.S. action, suit or proceeding. The Fund has been advised that there is substantial doubt as to the enforceability in the countries in which such persons reside of the civil remedies and criminal penalties afforded by the U.S. federal securities laws. It is also unclear if extradition treaties now in effect between the United States and any such countries would subject such persons to effective enforcement of criminal penalties. The books and records of the Fund required under U.S. law will be maintained at the Fund's principal office in the United States and will be subject to inspection by the Commission. ADDITIONAL INFORMATION The Fund has filed with the U.S. Securities and Exchange Commission, Washington, D.C. 20549, a Registration Statement under the U.S. Securities Act of 1933, as amended, with respect to the Common Stock offered hereby. Further information concerning the Shares and the Fund may be found in the Registration Statement, of which this Prospectus constitutes a part. The Registration Statement may be inspected without charge at the Commission's office in Washington, D.C., and copies of all or any part thereof may be obtained from such office after payment of the fees prescribed by the Commission. The Commission maintains a Web site at http://www.sec.gov containing reports, proxy and information statements and other information regarding registrants, including the Fund, that file electronically with the Commission. 45 46 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholder and Board of Directors of Morgan Stanley Russia & New Europe Fund, Inc. In our opinion, the accompanying statement of assets and liabilities presents fairly, in all material respects, the financial position of Morgan Stanley Russia & New Europe Fund, Inc. (the "Fund") at September 12, 1996 in conformity with generally accepted accounting principles. This financial statement is the responsibility of the Fund's management; our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit of this financial statement in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York September 24, 1996 46 47 MORGAN STANLEY RUSSIA & NEW EUROPE FUND, INC. STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 12, 1996
Assets: Cash.......................................................................... $100,000 Deferred organization costs (Note 1).......................................... 80,000 -------- Total Assets............................................................... 180,000 -------- Liabilities: Organization costs payable.................................................... 80,000 Commitments (Note 2) Net Assets: Common Stock, $0.01 par value, authorized 100,000,000 shares; 5,000 shares issued and outstanding........................................ 50 Paid-in Surplus............................................................... 99,950 -------- Total Net Assets.............................................................. $100,000 ======== Net Asset Value per share....................................................... $ 20.00 ========
NOTE 1. ORGANIZATION: Morgan Stanley Russia & New Europe Fund, Inc. (formerly Morgan Stanley European Emerging Markets Fund, Inc.) (the "Fund") was organized in Maryland on February 3, 1994 and is registered with the Securities and Exchange Commission as a non-diversified closed-end management investment company under the Investment Company Act of 1940. The Fund has had no operations other than the issue of shares of its common stock on September 11, 1996 to Morgan Stanley Asset Management Inc. ("MSAM" or the "Investment Manager"). Organization costs estimated at $80,000 will be deferred and amortized on a straight-line basis over a 60-month period from the date the Fund commences operations. NOTE 2. AGREEMENTS: The Fund intends to enter into an Investment Advisory and Management Agreement with the Investment Manager pursuant to which the Investment Manager will be responsible for providing investment management services to the Fund. For its services under the Investment Advisory and Management Agreement, MSAM will receive a fee, computed weekly and payable monthly, at the annual rate of 1.60% of the Fund's average weekly net assets. The Investment Manager has agreed to pay the Fund's offering expenses in connection with the initial public offering of the Fund's Common Stock in order to maintain a net asset value of $20.00 per share immediately following the completion of the offering. The Fund intends to enter into an administration agreement pursuant to which Chase Global Funds Services Company (the "Administrator"), a subsidiary of The Chase Manhattan Bank, will provide the Fund with certain administrative services. For its administrative services, the Administrator will receive an annual fee of $65,000 plus 0.09% of the average weekly net assets of the Fund. The Fund also intends to enter into a global custody agreement with The Chase Manhattan Bank (the "Global Custodian") pursuant to which the Global Custodian will provide the Fund with custody services for all of the Fund's assets. The custody agreement with the Global Custodian provides for an annual fee based on the amount of assets under custody, plus transactional fees. 47 48 APPENDIX A LIST OF RNE COUNTRIES Albania Armenia Azerbaijan Belarus People's Republic of Bulgaria Croatia Czech Republic Estonia Georgia Republic of Hungary Kazakhstan Kyrgyzstan Latvia Lithuania Macedonia Moldova Montenegro Republic of Poland Romania Russian Federation Serbia Slovakia Slovenia Tajikistan Turkmenistan Ukraine Uzbekistan A-1 49 APPENDIX B RUSSIA AND NEW EUROPEAN COUNTRIES The information set forth in this Appendix has been extracted from various sources believed by the Fund to be reliable. However, the Fund makes no representation as to the accuracy of the information, nor has the Fund or its Board of Directors attempted to verify it. Furthermore, no representation is made that any correlation will exist between RNE countries, economies or stock markets in general and the performance of the Fund. INTRODUCTION A complete list of countries in which the Fund intends to invest (the "RNE countries") is set forth in Appendix A and includes Russia, the other former Soviet Republics and countries in Central and Eastern Europe. The Fund anticipates that initially its investments will consist primarily of listed equity securities, unlisted equity securities and debt instruments of issuers in Russia, the Czech Republic, Poland and Hungary, which are currently the RNE countries that the Fund believes offer the greatest opportunity for immediate investment. Investment opportunities also exist, on a more limited basis, in Bulgaria, Croatia, Slovenia, Slovakia, the Ukraine and the Baltic States (Lithuania, Latvia and Estonia). As opportunities develop, investments may be made in Albania, Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Macedonia, Moldova, Montenegro, Romania, Serbia, Tajikistan, Turkmenistan and Uzbekistan. The economies and securities markets of the Czech Republic, Poland and Hungary, as well as Russia, are separately discussed below. Data on the United States, the European Community and Germany appear for comparative purposes only. Political and Economic Developments. Most RNE countries have had centrally planned economies which were primarily influenced by socialist or communist political philosophies and were characterized by nationalized industries, fixed prices and limited external trade. Over the past several years, most of these countries have undertaken political and economic reforms, founded upon an ideological shift from socialism or communism to capitalism. These reforms have had the effect, with varying degrees of success, of creating market-driven economies and have made foreign investment in these countries possible. The transition to a market-driven economy has been difficult in most of the formerly socialist or communist RNE countries and had the immediate effect of high inflation rates, increased unemployment and a significant decline in living standards as real wages fell. In addition, most of these countries' external trade was formerly limited to the former Soviet Union and other Warsaw Pact countries. As a consequence of all of these factors, many of these countries have experienced a significant drop in GDP. In the last two years, these reforms have led to an improvement in the economies of the more developed RNE countries. The economies of the Czech Republic, Poland and Hungary have been growing in real terms over the last two years, and the Organization for Economic Cooperation and Development (the "OECD") forecasts real GDP growth in Russia in 1996. In addition, significant progress has been made in all of these countries in reducing inflation and government budget deficits. In 1995, the combined total GDP of Russia, the Czech Republic, Poland and Hungary was approximately $570.1 billion and the combined total GDP of all RNE countries was approximately $750 billion. By way of comparison, in the same period, the GDP for the United States was $7.3 trillion. In 1995, the average GDP per capita of the Czech Republic, Poland and Hungary was $3,865. By way of comparison, in the same year, the GDP per capita for Germany was $29,643. The Investment Manager believes that current conditions in most RNE countries will result in a significant level of economic activity, offering the potential for long-term capital appreciation from investment in equity securities of RNE country issuers and Sovereign Debt. The strategic location of these countries between Western Europe and Asia should benefit the economies of many RNE countries by permitting them to take advantage of the modernization, technology and capital available in Western Europe and the large consumer base of Asia. Many RNE countries have privatized and are privatizing formerly state-run enterprises and there is a substantial restructuring of established industries as their economies shift from B-1 50 quota-driven command economies to free market, supply and demand-driven economies and companies begin to identify and exploit domestic and export markets. The private sector, however, is not as developed in RNE countries as it is in Western Europe. The total population of RNE countries is approximately 410 million (more than 6% of the world's population). The population of most RNE countries is well-educated, with literacy rates that compare favorably to those in Western Europe. For example, in the Czech Republic, Poland and Hungary, the literacy rates averaged 99% in 1993 as compared with 100% in Germany in the same period. Annual wage rates, however, in the Czech Republic, Poland and Hungary are significantly lower than in the United States and Germany, averaging $5,024 in 1995 for workers in the manufacturing industries. It should be noted, however, that RNE countries have adopted the principles of capitalism with varying degrees of success. The ideological shift from communism to capitalism and the accompanying changes from a centrally-planned economy to one driven by demand has, in the view of the Investment Manager, better positioned the RNE countries to begin the process of "catching up" (i.e., achieve parity in living standards) with Western Europe. However, the process has been difficult and there can be no guarantee that these countries will not abandon their reforms under political pressure, especially as the process of moving to a market economy may in the short-term be painful and cause a certain amount of social injustice. Some of these countries, including Armenia, Azerbaijan, Georgia, Montenegro, Romania and Serbia, are currently characterized by varying degrees of political instability. Consequently, the reforms undertaken in these countries may or may not be completed. Although there has been a great increase in foreign investment in RNE countries, there can be no guarantee that the infusion of capital will be sufficient to allow the countries to "catch up," or achieve parity with developed countries in terms of economic development. In addition, there is the risk that if reforms are abandoned foreign assets could be nationalized or expropriated. B-2 51 SELECTED ECONOMIC DATA OF CERTAIN RNE COUNTRIES
CONSUMER PRICE GDP 1995 GDP PER CAPITA, POPULATION INFLATION COUNTRY (US$ BILLIONS) 1995(US$) 1993(MILLIONS) LITERACY RATE 1995 - ------------------------ ----------------- ----------------- -------------- --------------- --------------- Albania................. $ 2.45(e) $ 726(e) 3.4 100% 8.0% Armenia................. 0.13(e) 36(e) 3.7 n/av 176.0 Azerbaijan.............. 1.58(e) 213(e) 7.4 n/av 412.0 Belarus................. 2.74(e) 266(e) 10.3 n/av 250.0 Bulgaria................ 13.01(e) 1,550(e) 8.5 96 62.0 Croatia................. 16.00(e) 3,347(e) 4.8 97 2.0 Czech Republic.......... 44.94(e) 4,320(e) 10.3 100 9.1 Estonia................. 3.51(e) 2,340(e) 1.5 100 28.8 Georgia................. 0.05(e) 10(e) 5.6 98 250.0 Hungary................. 43.75 4,248 10.3 99 28.2 Latvia.................. 5.84(e) 2,246(e) 2.6 n/av 23.2 Lithuania............... 6.09(e) 1,646(e) 3.7 n/av 35.5 Moldova................. 1.70(e) 386(e) 4.4 96 30.0 Poland.................. 117.46 3,027 38.4 99 26.8 Romania................. 3.55 1,567 22.8 97 32.3 Russia.................. 363.98 2,456 148.5 98 198.0 Serbia and Montenegro... 14.80 1,404 10.7 n/av 79.0 Slovakia................ 17.38 3,219 5.3 100 99 Slovenia................ 18.55 9,369 2.0 99 12.6 Ukraine................. 31.90(e) 624(e) 51.1 98 380.0
- --------------- Sources: The World Almanac, 1996; The World Bank Atlas, 1995; The Economist Intelligence Unit Country Reports, 1996. n/av = not available e = estimated Securities Markets. Among RNE countries, there are active stock markets in Russia, the Czech Republic, Hungary and Poland. There are also less active stock markets in Bulgaria, Croatia, Estonia, Latvia, Lithuania, Slovenia, Slovakia and the Ukraine and the Fund expects that stock markets will develop in other RNE countries in the near future. The securities markets of RNE countries continue to develop rapidly following the implementation of political and economic reforms. These markets are largely affected by the inflow of international funds which in turn is affected by world economic events and monetary policy. The returns from these markets may show a low correlation with global equity markets thereby providing opportunities for investment diversification. The securities markets of Russia, the Czech Republic, Poland and Hungary have developed fastest and had a total market capitalization of approximately $40 billion as of December 31, 1995. By comparison, the aggregate market capitalization on the New York Stock Exchange was $6.0 trillion as of December 31, 1995. During 1995, the average weekly trading volume on the exchanges of the Czech Republic, Poland and Hungary was approximately $69.8 million, $53.3 million and $6.8 million, respectively. As Russian securities are primarily traded over the counter, no official weekly volume figures are available. The average weekly trading volume on the New York Stock Exchange during 1995 was approximately $59.3 billion. B-3 52 STOCK MARKET DATA FOR CERTAIN RNE COUNTRIES
MARKET PRICE/ CAPITALIZATION NUMBER OF EARNINGS AT DECEMBER 31, 1995 LISTED SECURITIES RATIO (US$ BILLIONS) AT DECEMBER 31, 1995 AT DECEMBER 31, 1995 -------------------- -------------------- -------------------- Czech Republic....................... $15.66 65(3) 11.2 Hungary.............................. 2.40 42 12.0 Poland............................... 4.56 65 7.0 Russia............................... 15.86 50(4) n/av Taiwan(1)............................ 187.21 347 21.4 United States (1)(2)................. 6,013 2,675 18.5
- --------------- Source: International Finance Corporation, Emerging Stock Market Factbook 1996. (1) Included for comparative purposes only. (2) New York Stock Exchange only. (3) In addition, approximately 1,635 companies are traded over-the-counter. (4) Number of stocks listed on the Moscow Times 50. n/av = not available
STOCK INDICES DATE OF ---------------------------------- STOCK MARKET DECEMBER DECEMBER DECEMBER ESTABLISHMENT 1993 1994 1995 ------------- -------- -------- -------- Czech Republic (1)........................... June 1993 n/av 557 426 Hungary (2).................................. June 1990 1264.1 1470.1 1528.9 Poland (3)................................... April 1991 12,439.0 7473.1 7859.5 Russia(4).................................... March 1994 n/av 92.9 62.7
- --------------- Source: International Finance Corporation, Emerging Stock Market Factbook 1996. (1) PX 50 (April 1994 = 1,000). (2) BSE BUX (January 1992 = 1,000). (3) WIG All Share Perf. (April 1991 = 1,000). (4) MT 50 (August 1994 = 100). n/av = not available RUSSIA Introduction. The Russian Federation has a land area of approximately 6.6 million square miles. By the middle of 1995, it had a population of approximately 148.5 million, which accounts for approximately 40% of the population of all of the RNE countries. Political and Economic Developments. At the beginning of the 20th century, the Russian Empire extended throughout vast territories in Eastern Europe and included most of northern and central Asia. It was ruled as an autocracy by the Romanov dynasty. Discontent, especially in the urban areas, grew in the first decade of the 20th century. Token reforms were made by the government, but were insufficient to placate the increasingly restive workers and peasants. In February 1917, the Tsar abdicated. A provisional government was formed, but it was soon replaced by the Bolsheviks in November 1917. A Federation was formed, but it, in turn, was replaced by the Union of Soviet Socialist Republics (the "Soviet Union") in 1922. The Soviet Union experienced considerable hardship as a result of the collectivization campaign in the early 1930s and the widespread repression under Stalin, who established a dictatorship after the death of Lenin in 1924. Shortly after the death of Stalin in 1953, Nikita Khrushchev assumed predominance in the Soviet leadership. He instituted certain political and economic reforms, but was overthrown in 1964 and replaced by Leonid Brezhnev. Throughout the 1970s, Soviet economic performance gradually worsened. Brezhnev's successor, Yuri Andropov made some cautious attempts at economic reforms during his short tenure. These reforms were continued and greatly expanded under Mikhail Gorbachev. In the early 1990s, the Soviet Republics became, by stages, first states in a loose federation, then fully independent states, some of which were constituted into the Commonwealth of Independent States. The Soviet Union was dissolved in December 1992. B-4 53 In June 1991, Boris Yeltsin was elected president of Russia. He proceeded to propose and implement a variety of political and economic reforms to transform Russia from a centrally-planned economy to a market oriented system, although many of these reforms were considered controversial and were delayed by political maneuvering and opposition. In July 1996, Yeltsin succeeded in winning re-election but questions concerning his health continue to be raised and it was recently announced that Yeltsin was considering undergoing heart by-pass surgery. The recent civil war in Chechnya has highlighted the political tensions that exist between the central government in Moscow and some of the regions within the Russian Federation. The risk exists that armed conflict in Chechnya will continue, which could deter foreign investment and international aid and weaken the reformist government's control. Although statistical indicators show that Russia's economy is improving, Russia has suffered severe economic hardship over the past five years. The economic reforms initiated by Yeltsin's government since January 1992 have sought to liberalize most prices, reduce central government expenditures and achieve lasting structural changes by means of the transfer to private ownership of state enterprises. Considerable progress has been made towards these goals. A far reaching privatization scheme has been implemented which has resulted in almost 80% of the industrial workforce shifting from the state to the private sector. The vast majority of retail prices have been liberalized, which resulted in high inflation through 1995. In addition, dramatic re-structuring has occurred in many of Russia's key industries such as the energy sector. The ruble has become freely convertible for trade purposes, and, although it has suffered tremendous depreciation over the last five years, it now trades within a managed "crawling band" against the U.S. dollar. The International Monetary Fund ("IMF") has recognized Russia's progress and in 1996 granted a further three year $10.1 billion loan program, complementing its earlier standby facility of $6.8 billion in 1995. The $10.1 billion loan is to be dispensed over the three years subject to the fulfillment of various economic criteria. As a result of spending related to Yeltsin's campaign for re-election, the IMF recently withheld the July installment of the loan and is expected to reconsider the release of the funds in August. Russia has also managed to make significant progress in re-structuring its debts with both the Paris and London Clubs of creditors. Russia's economy has not displayed positive growth since 1990, but most recently the rate of contraction has fallen substantially. The rate of GDP growth, in real terms, was -8.7% in 1993, -12.6% in 1994 and -4.0% in 1995. Russia's economy has been characterized by high rates of inflation. The relaxation of price controls caused inflation to reach a high of 2,000% per annum in 1991. Since then the annual rate of inflation has fallen to 876% in 1993, 307% in 1994 and 198% in 1995. Inflation has continued to decline dramatically during 1996 with monthly April inflation being recorded at 2.2% for the month. These recent statistics indicate that Russia's drastic economic reforms have produced encouraging results, and the economic situation appears to be stabilizing. However, opposition parties to the reform process are still a strong political force, particularly in the Russian parliament. President Yeltsin's reelection, by a substantial margin, in July of 1996 appears to have removed a great deal of the political uncertainty in Russia, and has re-affirmed the country's commitment to economic reform. Furthermore, the Investment Manager believes that if Yeltsin were to step down from the presidency due to health problems, that the political situation in Russia is sufficiently stable to absorb a change in leadership. Securities Markets. After the 1990 law relating to the establishment of securities exchanges, a significant number of exchanges were created throughout Russia. This number has now fallen from over 200 exchanges to approximately 60 exchanges, the largest of which are located in Moscow, St. Petersburg and Vladivostok. The vast majority of share transactions are carried out in the over-the-counter market between Moscow brokers. A screen based system known as the Russian Trading System ("RTS"), modeled on NASDAQ, has been in existence since early 1995. Although the majority of large scale trades are executed outside of RTS, the system is steadily increasing its share of market volume. As a result of Russia's mass privatization process, there are a significant number of companies whose equity securities could trade in Russia. However, during the first quarter of 1996, approximately 104 issues were listed on the RTS, 50 of which are included in the Moscow Times 50 index. Approximately 21 of those issues are considered to be fully liquid, trading at least every three days. In June 1996 the market capitalization of the top 50 stocks in Russia B-5 54 was approximately $19 billion and although no price/earnings ratio is currently available, the Investment Manager believes that the Russian market is generally undervalued. Russia's securities markets are regulated by the Federal Securities Market Commission. Legislation has been recently passed to help the Commission protect shareholders' rights and also to ensure against securities fraud. Although shareholder protection is increasing in Russia, nearly all of the legislation is new and has not been implemented or tested. The Moscow over-the-counter market is also self-regulated by its brokers, through a body known as PAUFOR. Membership in PAUFOR has certain requirements including minimum capitalization and annual audits of financial statements. PAUFOR is responsible for the maintenance of an orderly market, and has established numerous dealing practices and rules. Clearing and settlement procedures in Russia, while improving, are still being developed. Transfer of share ownership generally may only be effected through the traded company's share registry and there may be significant delays and difficulties in getting shares properly issued and registered. Certain organizations, such as the National Registry Company, sponsored by the IFC and the European Bank of Reconstruction and Development ("EBRD") , have been set up to help with these problems and are beginning to become integrated into the market. Russian companies, with few exceptions, generally have no meaningful historical financial data, and shareholder reporting obligations are unclear. This is changing however, as many of the larger capitalized companies have engaged Western accounting firms to help them prepare their financial statements. Russian accounting differs significantly from Western accounting, and as a result the current Russian accounts published by firms are unreliable. Also, there are limitations on private security ownership and foreign ownership of certain strategic industries, particularly those associated with national defense. SELECTED ECONOMIC DATA FOR RUSSIA
1991 1992 1993(E) 1994 1995 ------ ------- ------ ------- ------ GDP Growth.................................... (5.0)% (14.5)% (8.7)% (12.6)% (4.0)% Inflation Rate................................ 93% 1,354% 876% 307% 198% Total External Debt (US$ billions)............ $67.5 $79.0 $83.1 $94.2 $105.7(e) Exchange Rate (Ruble per US$)................. 22 220 932 2,191 4,558
- --------------- Source: The Economist Intelligence Unit Country Reports, 1996. e = estimated THE CZECH REPUBLIC Introduction. The Czech Republic has a land area of approximately 30,000 square miles. By the middle of 1995, it had a population of approximately 10.3 million, which accounts for nearly 3.0% of the population of all of the RNE countries. Political and Economic Developments. The Republic of Czechoslovakia was established in 1918, following the collapse of the Austro-Hungarian Empire by the joining of the Czech lands of Bohemia and Moravia, and Slovakia. From 1918 to 1939, a stable democratic system of government existed in Czechoslovakia and the country's economy was considered to be the most industrialized and prosperous in Eastern and Central Europe. Czechoslovakia was occupied by German forces from 1939 to 1945. After the expulsion of the German forces, a communist People's Republic was established in 1948 under the Soviet Union's influence. Subsequently, the country aligned itself with the Soviet-led Eastern European bloc, joining the Council for Mutual Assistance (CMEA) and the Warsaw Pact. Czechoslovakia followed a rigid Stalinist pattern of government. In the 1960s, reforms were undertaken that contemplated more genuine elections, greater freedom of expression and greater separation of the Communist Party and the State. However, Czechoslovakia's reformist policies were regarded by other members of the Eastern European bloc and, in particular, the Soviet Union as endangering the unity of the Warsaw Pact countries. In 1968, Warsaw Pact forces invaded Czechoslovakia and replaced the government with a less reform-minded government. B-6 55 In the late 1980s, as a result of the general weakening of communist control in many Eastern and Central European countries, a series of demonstrations occurred, which led indirectly to the establishment of several opposition parties. Late in 1989, a new government was formed with a majority of non-Communist members. In 1990, the first free legislative elections since 1946 were held and this led to the establishment of a new federal government committed to political and economic reform; Czechoslovakia became a federation known as the "Czech and Slovak Republics." Subsequently, negotiations were held to dissolve Czechoslovakia into separate states. In November 1992, the Czechoslovakian Federal Assembly adopted legislation providing for the constitutional disbanding of the Federation. On January 1, 1993, Czechoslovakia officially became two separate nations, namely, the Czech Republic and Slovakia. Price controls in the former Czechoslovakia were removed in January 1991 and this led to a steep rise in inflation. In 1991, the consumer price index rose at an annual rate of 56.6%. Since then, however, the implementation of a tight monetary and fiscal policy by the government has resulted in a lessening of inflation. In 1995, the consumer price index is estimated to have risen at an annual rate of 9.1%. The Czech Central Bank remains vigilant in its fight against inflation, and continues to implement a tight monetary policy using both open market operations and higher reserve requirements. Reform policies initially caused a fall in domestic demand which, combined with the loss of the Soviet export market, resulted in a pronounced drop in output in 1991, with real GDP falling by 14.2%. Since then, a recovery in domestic demand and a pronounced improvement in exports has caused the economy to grow in real terms by 2.6% in 1994 and 4.8% in 1995. The Czech Republic has been extremely successful at restricting state expenditures, and as a result has run a budget surplus over the last three years. The budget surplus as a percentage of GDP has been 0.1%, 1.0% and 0.6% in 1993, 1994 and 1995 respectively. The Czech Republic has fulfilled several of the economic and fiscal requirements set forth in the Maastricht Treaty, namely, its budget deficit is less than 3% of GDP, government debt is less than 60% of GDP and its currency has not been subject to devaluation in the past two years. The June 1996 parliamentary elections prevented the formation of a majority government. A coalition, minority government has been formed by the former Premier Vaclav Klaus. Despite these changes, it is expected that the Czech Republic will continue on its reformist path. Before the dissolution of Czechoslovakia, a large scale mass-privatization program was implemented that distributed shares in almost 1,500 state-owned companies with an estimated market capitalization of $10 billion to the citizens of Czechoslovakia. The program has resulted in the rapid transfer of the majority of state enterprises into the private sector, which is speeding economic restructuring and recovery. Foreign companies have been able to participate, to some extent, in the privatization process. Nominally or wholly private firms now produce over 60% of the country's output. However, through the National Property Fund, the government continues to hold significant minority positions in most large Czech enterprises. Exports continue to play an important role in the recovery of the economy. Despite the collapse of the Soviet Union in 1991 (formerly Czechoslovakia's largest trading partner), exporters entered into other markets and hard-currency exports rose from approximately $13.0 million in 1993 to $14.0 million in 1994 and an estimated $17.0 million in 1995. As a result of the growth in the economy, demand for imports has also increased dramatically up 39.6% in 1995, and events caused the Czech republic to have an increased but manageable current account deficit of 4.2% of GDP. Germany and Austria are now the Czech Republic's principal trading partners, due in part to their historic and geographic links with the Czech Republic. The Czech government has entered into agreements with the European Community as well as the European Free Trade Association and this has helped to further increase in exports. The rate of unemployment stood at 2.9% in December 1995. The Securities Market. The Prague Stock Exchange ("PSE") was originally opened in 1871, but was closed at the end of World War II. The PSE was reopened in June 1993 following the mass-privatization of state-owned industries. There are only 65 companies that have satisfied the disclosure requirements of the PSE and are officially "listed." Currently, there are 1,635 companies eligible for over-the-counter trading, with approximately 330-350 companies trading actively each session. At the end of 1995, the market capitalization of the PSE was approximately $15.7 billion with an estimated weekly turnover of approximately $69.8 million. Approximately 80% of this volume was from over-the-counter trades. At the end of 1995, average price to earnings ratio of the PX 50 index was 11.2. The Czech securities markets are regulated by a Securities Commission established by the Ministry of Finance. The Securities Commission administers and regulates the B-7 56 financial reporting system, supervises participants in the securities markets and establishes guidelines for the listing of securities. Clearing and settlement of trades occurs within three business days and is effected through the Czech National Bank's Clearing Centre. The Czech Commercial Code and the Accountancy Act, both promulgated in 1992, establish requirements relating to the capitalization, books and records and auditing of Czech companies. All Czech enterprises are required to publish financial reports, including an income statement and balance sheet. Currently, companies with foreign participation, joint stock companies and certain limited liability companies are required to have annually audited financial statements which are approved by two auditors, one of which is required to be a Czech national and the other of which may be a foreign auditing firm recognized by the Ministry of Finance. Foreign Investment and Repatriation. Currently, there are no restrictions on foreign portfolio investment except that certain restrictions exist with respect to securities offered in privatizations or by financial or defense institutions. There are no restrictions on the repatriation of the proceeds of securities transactions. Since January 1, 1991, the Czech Koruna has been internally convertible. The Czech National Bank is responsible for fixing foreign exchange rates for the Koruna and controlling the Czech Republic's monetary policy. SELECTED ECONOMIC DATA FOR THE CZECH REPUBLIC
1991(1) 1992(1) 1993 1994 1995 ------- ------- ------ ------- -------- GDP Growth................................. (14.2)% (6.4)% (0.9)% 2.6% 4.8% Inflation Rate............................. 56.6% 11.1% 20.8% 10.0% 9.1% Current Account (US$ millions)............. $328 $(140) $682 $(81) $(1,900) Total External Debt (US$ billions)......... $7.2 $6.8 $8.5 $10.7 $14.9 Exchange Rate (Koruna per US$)............. 29.5 28.3 29.2 28.8 26.5
- --------------- Source: The Economist Intelligence Unit Country Reports, 1996. (1) Data for the years 1991 to 1992 is for Czechoslovakia. POLAND Introduction. Poland has a land area of approximately 121,000 square miles. By the middle of 1995, it had a population of approximately 38.4 million, which accounts for nearly 11.1% of the population of all of the RNE countries. Political and Economic Development. Poland was declared an independent republic in November 1918. The country was ruled by a military regime from 1926 until 1939. It was invaded and occupied by Germany in 1939 and subsequently by Soviet forces in 1945. A pro-communist provisional government was set up under Soviet auspices in 1946. The elections in January 1947 were won by a communist-led bloc, which subsequently established a People's Republic. Minor economic and political reforms were undertaken in the 1960s; however, Poland continued to be characterized by a centrally-planned economy, nationalized industries, fixed prices and little external trade. Social discontent increased in the 1970s. In the 1980s, labor unrest grew. At first the government attempted to suppress the trade unions and, in particular, Solidarity, but later made concessions, which, by the end of the 1980s, resulted in the government proposing the adoption of radical economic and political reforms. The late 1980s and early 1990s were characterized by extensive reshuffling of the government. In May 1990, the first fully free elections in more than 50 years were held. The government that resulted has demonstrated a commitment to continue the process of moving from a communist economy to a market-driven capitalist one. The first post-communist government in Poland implemented a stabilization and liberalization program in January 1990 that expanded the reforms started during the 1980s. That program led to a drastic reduction in the money supply, higher interest rates, elimination of the budget deficit and price liberalization. The extreme austerity measures had profound economic and social repercussions. In the first quarter of 1990, industrial B-8 57 production and officially recorded real wages dropped by about 30% and 50% respectively. Unemployment, which was 6.3% at the end of 1990, grew to 11.8% by the end of 1991 as the number of pensioners grew by 12%. The government was under pressure to meet demands for higher social spending. The inadequacy of the tax administration system, growing unemployment, and the delay in the receipt of revenues from the mass privatization program led to a deficit between budget funding and payment schedules. As a consequence, the government incurred high budget deficits, which reached more than 6% of GDP in 1992. After two years of contraction, GDP began to increase in 1992 and 1993, rising 2.6% and 3.8% respectively, and culminating with almost 7% growth in 1995. Industrial output rose by 9.4% in real terms from 1994 to 1995 and Poland was the first country in Central and Eastern Europe to achieve recovery of GDP to pre-transition levels. The combination of tight monetary and fiscal policies -- coupled with a "crawling-peg" exchange rate and regulated wages -- led to a significant decline in inflation. During the first months of 1990, inflation was more than 5% a month, but by 1995 it fell to 26.8% per annum. The slowdown in inflation led Poland's Central Bank to cut the discount rate by 2% during winter 1995-96. Economic reform has led to the dislocation of many of the country's workforce. The unemployment rate rose during the early 1990s, reaching approximately 16.7% in the third quarter of 1994 and then declined to 15% by the end of 1995. Growth in exports has been an important component of Poland's economic performance. The depreciation of Poland's currency against the US dollar coupled with the liberalization of trade led to a rapid increase in exports, especially to Western Europe. Officially recorded merchandise exports were $17.1 billion in 1994 and $22.9 in 1995. Along with improved economic growth, imports have increased. Officially recorded merchandise imports were $18.9 billion in 1994 and are estimated to have increased $25.5 billion in 1995. Since the fall of communism, the composition of Poland's exports has changed dramatically. After more than 40 years, Russia (the former Soviet Union) lost its position as Poland's largest trading partner and was replaced by Germany. In 1995, 38.3% of the country's exports went to Germany. In March 1991, certain western creditor governments agreed to cancel 50% of Poland's debt in two stages on the condition that the Polish economy stay within IMF fiscal and economic guidelines. Since that time, Poland's external debt situation has improved significantly. Total external hard currency debt was $53.6 billion in 1991 and has fallen to an estimated $43.5 billion by 1995. Total external debt as a percentage of GDP was 37% in 1995. As a percentage of exports, external debt was 190% by 1995. As a consequence of the debt reduction, Poland's government was able to issue a five-year $250m Eurobond in June 1995. One of the government's most important economic achievements has been privatization. In August 1992, the government designed a mass privatization program that offered shares in 514 state-owned companies through a selection of 15 National Investment Funds (NIF). Every Polish citizen is entitled to a voucher at a nominal fee that entitles the holder to one share of each NIF, which are managed by both domestic and international investment managers. Vouchers in the investment funds started trading on July 15, 1996 and the NIFs are expected to list in 1997. It is estimated that the private sector in Poland contributes 65% of GDP, compared to 31% in 1990. The Securities Market. The Warsaw Stock Exchange ("WSE") was re-opened by an act of the Polish government in July 1991, 52 years after its close in 1939. The trading system is similar to the French par casier method of quotation, the main features being that it is order driven, centralized onto a single exchange floor and paperless. On December 31, 1995, the market capitalization on the WSE was approximately $4.6 billion with an estimated weekly turnover of $53.3 million. The average price to earnings ratio of the WIG All Share index at the end of 1995 was 7.0. The government of Poland has established a Securities Commission (the "Commission") as its main administrative body responsible for monitoring the Polish securities market, supervising all public trading, including trading on the WSE, and regulating brokers. In addition, a Brokers Association is responsible for regulating the activities and conduct of brokers. Currently, there are two categories of publicly traded securities: securities listed on the WSE and securities traded over-the-counter. The disclosure requirements are less stringent for issuers whose securities are traded over-the-counter. Clearing and settlement occurs within three business days through the National Depository for Securities, which is operated by the WSE. B-9 58 The Polish Commercial Code sets forth requirements regarding capitalization, shareholders meetings, records and auditing for Polish companies. Recent amendments to the Commercial Code are aimed at modernizing its legal norms and adapting them to models prevailing in the European Community. All joint stock companies, limited liability companies and certain other entities are required to have annually audited financial statements. Foreign Investment and Repatriation. Currently, there are no restrictions on foreign investment in Polish securities, except with respect to securities of issuers whose business relates to management of sea or air ports, real estate, the defense industry, wholesaling of imported consumer goods or legal services. Investments may be made in such industries if authorization is obtained from the Ministry of Privatization. Also, permission must be sought from the relevant licensing authority to purchase shares of issuers in industries where licenses from the Polish government are required, such as the banking or brokerage industry or a business involving the production of alcohol, cigarettes or medicine. In early 1990, internal convertibility of the Polish zloty was introduced. Both the initial investment in and any profits resulting from business activities may be freely repatriated, provided the currency exchange is made at an authorized foreign exchange bank. In the case of dividends, repatriation is only allowed after an audit certificate has been issued and the necessary taxes have been paid. The National Bank of Poland is responsible for overseeing the banking system in Poland and for controlling monetary policy and exchange rates. SELECTED ECONOMIC DATA FOR POLAND
1991 1992 1993 1994 1995 ------ ------- ------ ------- ------ GDP Growth.................................... (7.0)% 2.6% 3.8% 5.3% 7.0% Inflation Rate................................ 76.7% 45.3% 36.9% 33.3% 26.8% Current Account (US$ billions)................ $(2.2) $(3.1) $(5.8) $(2.5) $(2.2)(e) Total External Hard-currency Debt (US$ billions)................................... $53.6 $48.7 $45.3 $42.2 $43.5(e) Exchange Rate (New Zloty per US$)............. 1.06 1.36 1.81 2.27 2.43
- --------------- Source: The Economist Intelligence Unit Country Reports, 1996. e = estimated HUNGARY Introduction. Hungary has a land area of approximately 36,000 square miles. By the middle of 1995, it had a population of approximately 10.3 million, which accounts for nearly 3.0% of the population of all of the RNE countries. Political and Economic Developments. Hungary allied itself with Germany before World War II. Having sought to break the alliance in 1944, Hungary was forcibly occupied by German forces. In January 1945, Hungary was liberated by Soviet troops and it became a republic in February 1946. In the 1947 elections, the communists became the largest single party and by the end of the year emerged as the leading political force. A People's Republic was established in 1949. Opposition was subsequently removed by means of purges and political trials. After the death of Stalin in 1953, a period of liberalization followed. Nevertheless, until the mid-1980s, Hungary was characterized by having a centrally-planned economy, nationalized industries, fixed prices and little external trade. In March 1985, the electoral law was revised, giving voters a wide choice of candidates, albeit still all members of the state party, the Hungarian Socialist Workers' Party (HSWP). In May 1988, a special ideological conference of the HSWP was held and this led in the following months to a relaxation of censorship laws, the establishment of trade unions and independent political groups and the adoption of an austere economic program designed to revitalize the economy. In February 1989, the HSWP agreed to support a multi-party political system and the first free multi-party elections were held in March and April 1990. The resulting government declared its intention to withdraw from the Warsaw Pact, seek membership in the European Community and effect a full transition to a Western-style market economy. B-10 59 Through the use of tight monetary and fiscal policies, the government was able to slow inflation after price controls were relaxed in January 1991. Inflation declined from 35.0% in 1991 to 18.8% in 1994, but rose again to 28.2% in 1995. Over 90% of price controls were removed in 1991 and now almost all state subsidies have been cut. Attempts to control inflation caused significant contraction in the economy through 1993, as GDP declined by 11.9% in 1991, 3.0% in 1992, and 0.8% in 1993. However, the economy began to expand and GDP grew by 2.9% in 1994 and by 1.5% in 1995. The structural adjustments that the public sector has been undergoing has put upward pressure on unemployment. The number of unemployed accounted for 11.6% of the work force in February 1996. The rapid rise in unemployment and other factors associated with moving to a market economy have placed considerable demands on the social security system and this, combined with an inefficient and inadequate system of taxation, has contributed to the government's budget deficit, which in 1995 was estimated to amount approximately to 3.3% of Hungary's GDP. In March 1995, the Hungarian government implemented an austerity plan designed to ameliorate what is known as a "twin deficits" problem--large current account and budget deficits. The plan called for a 9% currency devaluation, the introduction of a crawling peg exchange rate system, a comprehensive 8% tariffs increase, and a 3% reduction in public sector wages. Many of the plan's goals were achieved in a short period of time. The current account deficit was reduced from $4.1 billion in 1994 to slightly less than $2.5 billion by the end of 1995 and the total public sector deficit was cut 9.8% of GDP to 6.5%. Austerity measures, however, reduced economic growth in 1995 to 1.5% versus 2.9% in 1994 and growth in industrial production dropped almost in half from 9.5% in 1994. As a result of Hungary's progress toward macroeconomic stabilization, the International Monetary Fund granted a standby credit and the country has been officially admitted to the OECD. The government has indicated that it intends to continue to privatize most state-owned companies. To date, a substantial number of state-run enterprises have been privatized and a substantial portion of sales have been to foreign investors. Although there was relatively little privatization in late 1994 and early 1995, the government hoped that the passage of the privatization law in May 1995 would expedite the process by making it more transparent and allowing for "simplified" privatization of smaller companies. Privatization receipts rose to $3.6 billion in 1995, more than the entire amount raised during the period from 1990 to 1994. The government has encouraged privatization by extending tax incentives, enacting legislation allowing repatriation of profits and otherwise liberalizing foreign investment rules. Hungary has attracted more foreign investment than any other Eastern European country. By late 1995, the privatization process was unexpectedly accelerated. The proceeds from the sale of companies such as the state oil and gas company raised $3.5 billion, more than three times the sum originally budgeted by the government, and foreign direct investment reached roughly $4.5 billion, an all-time high. As a result, monetary reserves increased from less than $7 billion in 1994 to about $12 billion in 1995. Exports continue to play a pivotal role in the economy, despite the greatly reduced demand of other ex-Warsaw Pact nations. The value of exports in dollar terms increased from $10.7 billion in 1994 to $12.9 billion in 1995. GDP per capita at the end of 1995 was $4,248. In the first quarter of 1996, real wages declined 9.5% compared to the corresponding period of 1995. The unemployment rate in Hungary was 10.4% at the end of 1995. The Securities Market. The Budapest Stock Exchange ("BSE") was established in June 1990. The BSE served to create an organized marketplace for the public offering and trading of new securities, many of which were expected to arise from the planned privatizations of state-owned enterprises. On December 31, 1995, capitalization on the BSE was approximately $2.4 billion, with an estimated weekly turnover of $6.8 million. Although currently only 42 companies are listed on the BSE, additional listings are anticipated. The average price to earnings ratio of the BSE BUX index was approximately 12.0 as of December 31, 1995. The State Securities Supervision (SSS) is responsible for monitoring the securities market and establishing guidelines for the regulation of new issues, market participants and the BSE. Clearing and settlement occurs within five business days and is effected through the Clearing Depository Center, which is operated by the BSE. The Hungarian Companies Act sets forth requirements regarding capitalization, shareholders meetings, records and auditing for various legal entities organized in Hungary. Currently, an annual audit is required for B-11 60 public limited and certain limited liability companies and it is anticipated that an annual audit will be required of all businesses by 1998. Foreign Investment and Repatriation. Currently, there are no restrictions on foreign investment in Hungarian securities, but investment in certain sectors, such as banking, defense, utilities and insurance, may require prior approval from the government. All foreigners must register their holdings of shares and the Ministry of Finance and Ministry of Trade must be advised if ownership exceeds 50% of the securities of a company. Repatriation of dividends and capital in dollars is automatic if the initial investment was in dollars, and the shareholders' resolutions granting such outlays are valid. The State Banking Supervision and the National Bank of Hungary, an independent entity, are responsible for the supervision and control of the banking system, monetary policy and foreign exchange. SELECTED ECONOMIC DATA FOR HUNGARY
1991 1992 1993 1994 1995 -------- ------- ------ ------- ------ GDP Growth.................................. (11.9)% (3.0)% (0.8)% 2.9 1.5 Inflation Rate.............................. 35.0% 23.0% 22.5% 18.8 28.2 Current Account (US$ billions).............. $0.4 $0.4 $(4.3) $(4.1) $(2.5) Total External Debt (US$ billions).......... $22.6 $22.0 $24.2 $28.0 $30.8 Exchange Rate (Forint per US$).............. 75.7 79.0 91.9 105.2 125.7
- --------------- Source: The Economist Intelligence Unit Country Reports, 1996. B-12 61 APPENDIX C DESCRIPTION OF VARIOUS FOREIGN CURRENCY AND INTEREST RATE HEDGES AND OPTIONS ON SECURITIES AND SECURITIES INDEX FUTURES CONTRACTS AND RELATED OPTIONS FOREIGN CURRENCY HEDGING TRANSACTIONS Foreign Currency Sales Contract. A forward foreign currency exchange contract involves an obligation to purchase or sell a specified amount of a foreign currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks and brokers). The Fund has established procedures consistent with the general statement of policy of the U.S. Securities and Exchange Commission concerning forward purchases or sales of foreign currencies. Since that policy currently recommends that an amount of the Fund's assets equal to the amount of the commitment be held aside or segregated to be used to pay for the commitment, the Fund will always have liquid, unencumbered assets available sufficient to cover any commitments under contracts to purchase or sell foreign currencies or to limit any potential risk. The segregated account will be marked to market on a daily basis. While these contracts are not presently regulated by the U.S. Commodity Futures Trading Commission (the "CFTC"), the CFTC may in the future assert authority to regulate forward foreign currency exchange contracts. In such event, the Fund's ability to utilize forward foreign currency exchange contracts in the manner set forth above may be restricted. Foreign Currency Futures Contracts and Related Options. A foreign currency futures contract is a standardized contract for the delivery of a specified amount of a foreign currency at a future date at a price set at the time of the contract. Foreign currency futures contracts traded in the United States are traded on regulated exchanges. Parties to a futures contract must make initial "margin" deposits to secure performance of the contract, which generally range from 2% to 15% of the contract price. There also are requirements to make "variation" margin deposits as the value of the futures contract fluctuates. The Fund may enter into futures contracts for hedging purposes only. In addition, the Fund may not enter into futures contracts on foreign currency (or with respect to interest rates or securities indexes (described below)) or related options if the aggregate amount of initial margin deposits and premiums on the Fund's futures and related options positions would exceed 5% of the fair market value of the Fund's total assets after taking into account unrealized profits and unrealized losses on any such contracts it has entered into. In addition, with respect to long positions in futures contracts on currency (or with respect to interest rates or stock indexes) or options on futures, the underlying commodity value of such contracts will not exceed the sum of cash and cash equivalents segregated for this purpose plus accrued profits on the contracts held at the futures commission merchant. The Fund may purchase and write call and put options on foreign currency futures contracts. An option on a foreign currency futures contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in a foreign currency futures contract at a specified exercise price at any time on or before the expiration date of the option. The potential loss related to the purchase of an option on a futures contract is limited to the premium paid for the option (plus transaction costs). Because the value of the option is fixed at the point of sale, there are no daily cash payments by the purchaser to reflect changes in the value of the underlying contract; however, the value of the option does change daily. To the extent the Fund purchases an option on a foreign currency futures contract any change in the value of such option would be reflected in the net asset value of the Fund. Options on Currencies. A put option purchased by the Fund on a currency gives the Fund the right to sell the currency at the exercise price until the expiration of the option. A call option purchased by the Fund gives the Fund the right to purchase a currency at the exercise price until the expiration of the option. Currency Hedging Strategies. The Fund may enter into forward foreign currency exchange contracts and foreign currency futures contracts and related options in several circumstances. For example, when the Fund enters into a contract for the purchase or sale of a security denominated in a foreign currency, or when C-1 62 the Fund anticipates the receipt in a foreign currency of dividends or interest payments on a security which it holds, the Fund may desire to "lock in" the dollar price of the security or the dollar equivalent of such dividend or interest payment, as the case may be. In addition, when the Investment Manager believes that the currency of a particular foreign country may suffer a substantial decline against the dollar, it may enter into a forward or futures contract to sell, for a fixed amount of dollars, the amount of foreign currency approximating the value of some or all of the Fund's portfolio securities denominated in such foreign currency. At the maturity of a forward or futures contract, the Fund may either accept or make delivery of the currency specified in the contract or, prior to maturity, enter into an offsetting contract. Such offsetting transactions with respect to forward contracts must be effected with the currency trader who is a party to the original forward contract. Offsetting transactions with respect to futures contracts are effected on the same exchange on which the initial transaction occurred. The Fund will enter into such futures contracts and related options if it is expected that there will be a liquid market in which to close out such contract. There can, however, be no assurance that such a liquid market will exist in which to close a futures contract or related option or that the opposite party to the forward contract will agree to the offset, in which case the Fund may suffer a loss. As a matter of operating policy, which may be changed by the Fund's Board of Directors without a shareholders vote, the Fund will not enter into such forward or futures contracts to protect the value of its portfolio securities on a regular basis, and will not do so if, as a result, the Fund will have more than 20% of the value of its total assets committed to the consummation of such contracts. The Fund also will not enter into such forward or futures contracts or maintain a net exposure to such contracts where the consummation of the contracts would obligate the Fund to deliver an amount of foreign currency in excess of the value of the Fund's portfolio securities or other assets denominated in that currency. Further, the Fund generally will not enter into a forward or futures contract with a term of greater than one year. The Fund may attempt to accomplish objectives similar to those described above with respect to forward and futures contracts for currency by means of purchasing put or call options on foreign currencies on exchanges. While the Fund may enter into forward, futures and options contracts to reduce currency exchange rate risks, changes in currency prices may result in a poorer overall performance for the Fund than if it had not engaged in any such transaction. Moreover, there may be an imperfect correlation between the Fund's portfolio holdings of securities denominated in a particular currency and forward, futures or options contracts entered into by the Fund. Such imperfect correlation may prevent the Fund from achieving the intended hedge or expose the Fund to risk of foreign exchange loss. Certain provisions of the Code may limit the extent to which the Fund may enter into forward or futures contracts or engage in options transactions. These transactions may also affect the character and timing of income and the amount of gain or loss recognized by the Fund and its stockholders for U.S. federal income tax purposes. See "Taxation -- U.S. Federal Income Taxes." INTEREST RATE FUTURES AND OPTIONS THEREON Interest Rate Futures Contracts. The Fund may enter into futures contracts on government debt securities for the purpose of hedging its portfolio against the adverse effects of anticipated movements in interest rates. For example, the Fund may enter into futures contracts to sell U.S. Government Treasury Bills (take a "short position") in anticipation of an increase in interest rates. Generally, as interest rates rise, the market value of any fixed-income securities held by the Fund will fall, thus reducing the net asset value of the Fund. However, the value of the Fund's short position in the futures contracts will also tend to increase, thus offsetting all or a portion of the depreciation in the market value of the Fund's fixed-income investments which are being hedged. The Fund may also enter into futures contracts to purchase government debt securities (take a "long position") in anticipation of a decline in interest rates. The Fund might employ this strategy in order to offset entirely or in part an increase in the cost of any fixed-income securities it intends to subsequently purchase. Options on Futures Contracts. The Fund may purchase and write call and put options on interest rate futures contracts which are traded on contract markets and enter into closing transactions with respect to such C-2 63 options to terminate an existing position. The Fund may use such options in connection with its hedging strategies. Generally, these strategies would be employed under the same market and market sector conditions in which the Fund enters into futures contracts. An option on an interest rate futures contract operates in the same manner as an option on a foreign currency futures contract (described above), except that it gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate futures contract instead of a currency futures contract. The Fund may purchase put options on futures contracts rather than taking a short position in the underlying futures contract in anticipation of an increase in interest rates. Similarly, the Fund may purchase call options on futures contracts as a substitute for taking a long position in futures contracts to hedge against the increased cost resulting from a decline in interest rates of fixed-income securities which the Fund intends to purchase. The Fund also may write a call option on a futures contract rather than taking a short position in the underlying futures contract, or write a put option on a futures contract rather than taking a long position in the underlying futures contracts. The writing of an option, however, will only constitute a partial hedge, since the Fund could be required to enter into futures contract at an unfavorable price and will in any event be able to benefit only to the extent of the premium received. Risk Factors in Transactions in Interest Rate Futures Contracts and Options Thereon. The Fund's ability to effectively hedge all or a portion of its fixed income securities through the use of interest rate futures contracts and options thereon depends in part on the degree to which price movements in the securities underlying the option or futures contract correlate with price movements of the fixed-income securities held by the Fund. In addition, disparities in the average maturity or the quality of the Fund's investments as compared to the financial instrument underlying an option or futures contract may also reduce the correlation in price movements. Transactions in options on futures contracts involve similar risks, as well as the additional risk that movements in the price of the option will not correlate with movements in the price of the underlying futures contract. OPTIONS ON SECURITIES AND SECURITIES INDEX FUTURES CONTRACTS AND RELATED OPTIONS Options on Securities. In order to hedge against market shifts, the Fund may purchase put and call options on securities. In addition, the Fund may seek to increase its income or may hedge a portion of its portfolio investments through writing (i.e., selling) covered call options. A put option gives the holder the right to sell to the writer of the option an underlying security at a specified price at any time during or at the end of the option period. In contrast, a call option gives the purchaser the right to buy the underlying security covered by the option from the writer of the option at the stated exercise price. A "covered" call option means that so long as the Fund is obligated as the writer of the option, it will own (i) the underlying securities subject to the option, or (ii) securities convertible or exchangeable without the payment of any consideration into the securities subject to the option. As a matter of operating policy, the value of the underlying securities on which options will be written at any one time will not exceed 5% of the total assets of the Fund. The Fund will receive a premium from writing call options, which increases the Fund's return on the underlying security in the event the option expires unexercised or is closed out at a profit. By writing a call, the Fund will limit its opportunity to profit from an increase in the market value of the underlying security above the exercise price of the option for as long as the Fund's obligation as writer of the option continues. Thus, in some periods the Fund will receive less total return and in other periods greater total return from writing covered call options than it would have received from its underlying securities had it not written call options. The Fund may purchase options on securities (including Sovereign Debt) that are listed on securities exchanges or traded over the counter. In purchasing a put option, the Fund will seek to benefit from a decline in the market price of the underlying security, while in purchasing a call option, the Fund will seek to benefit from an increase in the market price of the underlying security. If an option purchased is not sold or exercised when it has remaining value, or if the market price of the underlying security remains equal to or greater than the exercise price, in the case of a put, or remains equal to or below the exercise price, in the case of a call, during the life of the option, the Fund will lose its investment in the option. For the purchase of an option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price, in the case of a put, and must increase sufficiently above the exercise price, in the case of a call, to cover the premium and transaction costs. Because premiums paid by the Fund on options are small in relation to the C-3 64 market value of the investments underlying the options, buying options can result in large amounts of leverage. The leverage offered by trading in options could cause the Fund's net asset value to be subject to more frequent and wider fluctuation than would be the case if the Fund did not invest in options. Stock Index Futures Contracts and Related Options. The Fund may, for hedging purposes, enter into securities index futures contracts and purchase and write put and call options on stock index futures contracts, in each case that are traded on regulated exchanges, including non-U.S. exchanges to the extent permitted by the CFTC. A stock index futures contract is an agreement to take or make delivery of an amount of cash equal to the difference between the value of the index at the beginning and at the end of the contract period. Successful use of stock index futures will be subject to the Investment Manager's ability to predict correctly movements in the direction of the relevant stock market. No assurance can be given that the Investment Manager's judgment in this respect will be correct. The Fund may enter into stock index futures contracts to sell a stock index in anticipation of or during a market decline to attempt to offset the decrease in market value of equities in its portfolio that might otherwise result. When the Fund is not fully invested in common stocks and anticipates a significant market advance, it may enter into futures contracts to purchase the index in order to gain rapid market exposure that may in part or entirely offset increases in the cost of common stocks that it intends to purchase. In a substantial majority of these transactions, the Fund will purchase such securities upon termination of the futures position but, under unusual market conditions, a futures position may be terminated without the corresponding purchase of common stocks. The Fund may purchase and write put and call options on stock index futures contracts in order to hedge all or a portion of its investments and may enter into closing purchase transactions with respect to written options in order to terminate existing positions. There is no guarantee that such closing transactions can be effected. An option on a stock index futures contract operates in the same manner as an option on a foreign currency futures contract (described above), except that it gives the purchaser the right, in return for the premium paid, to assume a position in a stock index futures contract instead of a currency futures contract. C-4 65 MORGAN STANLEY RUSSIA & NEW EUROPE FUND, INC. -----END PRIVACY-ENHANCED MESSAGE-----