-----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, PGMHs/VKXgFdTXymAGP4uWb/SBJpZ/ZfjJKnxwg2Z2SULptjmiitHrtuEqE37XVb zOeSFcIChotruGaWwlL05Q== 0000950169-99-000072.txt : 19990603 0000950169-99-000072.hdr.sgml : 19990603 ACCESSION NUMBER: 0000950169-99-000072 CONFORMED SUBMISSION TYPE: 485APOS PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 19990602 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LM INSTITUTIONAL FUND ADVISORS II INC CENTRAL INDEX KEY: 0001052864 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] STATE OF INCORPORATION: MD FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 485APOS SEC ACT: SEC FILE NUMBER: 333-44423 FILM NUMBER: 99639285 FILING VALUES: FORM TYPE: 485APOS SEC ACT: SEC FILE NUMBER: 811-08611 FILM NUMBER: 99639286 BUSINESS ADDRESS: STREET 1: 100 LIGHT ST 29TH FLOOR CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4104542744 485APOS 1 LM INSTITUTIONAL FUND ADVISORS II, INC. 485APOS As filed with the Securities and Exchange Commission on June 2, 1999. 1933 Act File No. 333-44423 1940 Act File No. 811-8611 SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM N-lA REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X] Pre-Effective Amendment No. [ ] Post-Effective Amendment No. 2 [X] and REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X] Amendment No. 3 [X] LM Institutional Fund Advisors II, Inc. (Exact Name of Registrant as Specified in Charter) 100 Light Street Baltimore, Maryland 21202 (Address of Principal Executive Offices) Registrant's Telephone Number, including Area Code: (410) 539-0000 Copies to: CHARLES A. BACIGALUPO BRYAN CHEGWIDDEN, ESQ. 100 Light Street Ropes & Gray Baltimore, Maryland 21202 One International Place (Name and Address of Boston, Massachusetts 02110 Agent for Service) It is proposed that this filing will become effective: [ ] immediately upon filing pursuant to Rule 485(b) [ ] on June 1, 1998 pursuant to Rule 485(b) [ ] 60 days after filing pursuant to Rule 485(a)(i) [x] on August 1, 1999 pursuant to Rule 485(a)(i) [ ] 75 days after filing pursuant to Rule 485(a)(ii)\ [ ] on pursuant to Rule 485(a)(ii) If appropriate, check the following box: [ ] This post-effective amendment designates a new effective date for a previously filed post-effective amendment. LM INSTITUTIONAL FUND ADVISORS II, INC. Contents of Registration Statement This registration statement consists of the following papers and documents: Cover Sheet Table of Contents Cross Reference Sheets Part A Prospectus for the following Portfolios: LM Value Institutional Portfolio LM Mid Cap Institutional Portfolio Brandywine U.S. Small Cap Portfolio Batterymarch Emerging Markets Portfolio Batterymarch International Equity Portfolio LM Total Return Institutional Portfolio Part B Statement of Additional Information for the following Portfolios: LM Value Institutional Portfolio LM Mid Cap Institutional Portfolio Brandywine U.S. Small Cap Portfolio Batterymarch Emerging Markets Portfolio Batterymarch International Equity Portfolio LM Total Return Institutional Portfolio Part C - Other Information Signature Page Exhibit Index Exhibits -2- LM INSTITUTIONAL FUND ADVISORS II, INC. LM Value Institutional Portfolio LM Mid Cap Institutional Portfolio Brandywine U.S. Small Cap Portfolio Batterymarch Emerging Markets Portfolio Batterymarch International Equity Portfolio LM Total Return Institutional Portfolio Cross Reference Sheet --------------------- Part A. Item No. Prospectus Caption - ---------------- ------------------- 1 Cover Page and Back Cover Page 2 Description of Each Portfolio and Its Investment Strategy Risk Summary; Performance Data 3 Expense Information 4 Not Applicable 5 Not Applicable 6 Management of the Portfolios 7 Purchase of Shares; Redemption of Shares; Exchange Privilege; Net Asset Value; Dividends and Distributions to Shareholders; Tax Information 8 Distribution Plans 9 Financial Highlights -3- LM INSTITUTIONAL FUND ADVISORS II, INC. LM Value Institutional Portfolio LM Mid Cap Institutional Portfolio Brandywine U.S. Small Cap Portfolio Batterymarch Emerging Markets Portfolio Batterymarch International Equity Portfolio LM Total Return Institutional Portfolio Cross Reference Sheet Statement of Additional Part B. Item No. Information Caption 10 Cover Page and Table of Contents 11 Not Applicable 12 Additional Information About Investment Limitations and Policies 13 Management of the Portfolios 14 Principal Holders of Securities 15 Management of the Portfolios; Other Information 16 Portfolio Transactions and Brokerage 17 Other Information 18 Purchases and Redemptions 19 Additional Tax Information 20 Management of the Portfolios 21 Other Information 22 Financial Statements -4- LM INSTITUTIONAL FUND ADVISORS II PROSPECTUS August 1, 1999 o LM Value Institutional Portfolio o LM Mid Cap Institutional Portfolio o Brandywine Small Cap Value Portfolio o Batterymarch Emerging Markets Portfolio o Batterymarch International Equity Portfolio o LM Total Return Institutional Portfolio These securities have not been approved or disapproved by the securities and exchange commission nor has the securities and exchange commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. [GRAPHIC APPEARS HERE]
TABLE OF CONTENTS PROSPECTUS SUMMARY...............................................................3 DESCRIPTION OF EACH PORTFOLIO AND ITS INVESTMENT STRATEGY..................4 LM Value Institutional Portfolio.........................................4 LM Mid Cap Institutional Portfolio.......................................5 Brandywine Small Cap Value Portfolio.....................................5 Batterymarch Emerging Markets Portfolio..................................6 Batterymarch International Equity Portfolio..............................7 LM Total Return Institutional Portfolio..................................8 RISK SUMMARY......................................................................8 PERFORMANCE DATA................................................................13 EXPENSE INFORMATION.............................................................13 LM Value Institutional Portfolio........................................14 LM Mid Cap Institutional Portfolio......................................14 Brandywine Small Cap Value Portfolio....................................15 Batterymarch Emerging Markets Portfolio.................................15 Batterymarch International Equity Portfolio.............................16 LM Total Return Institutional Portfolio.................................16 MANAGEMENT OF THE PORTFOLIOS..................................................17 Board of Directors......................................................17 Manager, Advisers.......................................................17 The Distributor.........................................................20 Portfolio Transactions..................................................20 Expenses 20 PURCHASE OF SHARES.............................................................20 Initial Investment......................................................21 Additional Investments..................................................22 Other Purchase Information..............................................22 Retirement Plans........................................................23 Account Registration Changes............................................23 DISTRIBUTION PLANS..............................................................23 REDEMPTION OF SHARES...........................................................23 Signature Guarantee.....................................................25 EXCHANGE PRIVILEGE..............................................................25 NET ASSET VALUE................................................................26 DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS..................................27 TAX INFORMATION.................................................................28 FINANCIAL HIGHLIGHTS ............................................................29
-2- PROSPECTUS SUMMARY Comparison of the Portfolios The following chart provides general information about each Portfolio. It is qualified in its entirety by the more complete descriptions of the Portfolios appearing elsewhere in this prospectus.
---------------------------------- ----------------------------------- -------------------------------------------- Equity Portfolios Investment Objectives Primary Investments ---------------------------------- ----------------------------------- -------------------------------------------- LM Value Institutional Portfolio Long-term growth of capital Large cap equity securities that are undervalued ---------------------------------- ----------------------------------- -------------------------------------------- LM Mid Cap Institutional Capital appreciation Mid cap equity securities that are Portfolio undervalued ---------------------------------- ----------------------------------- -------------------------------------------- Brandywine Small Cap Value Long-term capital appreciation Small cap equity securities that are Portfolio undervalued ---------------------------------- ----------------------------------- -------------------------------------------- Batterymarch Emerging Markets Long-term capital appreciation Emerging market equity securities Portfolio ---------------------------------- ----------------------------------- -------------------------------------------- Batterymarch International Long-term total return Foreign equity securities Equity Portfolio ---------------------------------- ----------------------------------- -------------------------------------------- LM Total Return Institutional Capital appreciation and current Dividend-paying common stocks, debt Portfolio income in order to achieve an securities and securities convertible into attractive total investment common stocks which offer potential for return consistent with reasonable attractive total return risk ---------------------------------- ----------------------------------- --------------------------------------------
-3- - -------------------------------------------------------------------------------- Manager and Advisers - -------------------------------------------------------------------------------- LM Institutional Advisors, Inc. (the "Manager") serves as the investment manager to each Portfolio. Legg Mason Fund Adviser, Inc. ("LMFA") is the investment adviser to each of the LM Value Institutional Portfolio, the LM Mid Cap Institutional Portfolio and the LM Total Return Institutional Portfolio. Brandywine Asset Management, Inc. ("Brandywine") is the investment adviser to the Brandywine Small Cap Value Portfolio. Batterymarch Financial Management, Inc. ("Batterymarch") is the investment adviser to the Batterymarch Emerging Markets Portfolio and the Batterymarch International Equity Portfolio. LMFA, Brandywine and Batterymarch are referred to as "Advisers." - -------------------------------------------------------------------------------- DESCRIPTION OF EACH PORTFOLIO AND ITS INVESTMENT STRATEGY - -------------------------------------------------------------------------------- The investment objective and policies for each Portfolio are stated below. - -------------------------------------------------------------------------------- LM Value Institutional Portfolio - -------------------------------------------------------------------------------- Adviser: LMFA - -------------------------------------------------------------------------------- Objective: long-term growth of capital - -------------------------------------------------------------------------------- Principal Investment Strategies: The fund invests primarily in equity securities that, in the advisor's opinion, offer the potential for capital growth. The Adviser follows a value discipline in selecting securities. This means the Adviser seeks to purchase securities at large discounts to the Advisor's assessment of their intrinsic value. For the Adviser, assessment of intrinsic value is an ongoing, dynamic process employing both quantitative and qualitative analysis. The Adviser takes a long-term approach to investing, generally characterized by long holding periods and low portfolio turnover. The Adviser typically sells a security when, in the Adviser's assessment, the security no longer appears to offer long-term above average risk adjusted rates of return, or when a more compelling investment opportunity is found. The fund generally invests in companies with market capitalizations greater than $1_billion, but may invest in companies of any size. The fund may invest in debt securities, including government, corporate and money market securities for temporary defensive purposes. The fund may not achieve its investment objective when so invested. Consistent with the investment objective, the fund may also invest in such securities when the adviser believes the return on certain debt securities may equal or exceed the return on equity securities. -4- - -------------------------------------------------------------------------------- LM Mid Cap Institutional Portfolio - -------------------------------------------------------------------------------- Adviser: LMFA - -------------------------------------------------------------------------------- Objective: capital appreciation - -------------------------------------------------------------------------------- Principal Investment Strategies: The fund invests primarily in equity securities, and securities convertible into equity securities, of companies with market capitalizations of less than $2.5 billion that, in the Adviser's opinion, offer the potential for capital appreciation. The fund typically invests in securities of companies that the Adviser believes have one or more of the following characteristics: companies that appear to be undervalued in relation to their long-term earning power or asset values; companies experiencing unusual and possibly one-time developments which, in the opinion of the adviser, may cause the market values of the securities to increase. Such developments may include: a sale or termination of an unprofitable part of the company's business; a change in the company's management or in management's philosophy; a basic change in the industry in which the company operates; the introduction of new products or technologies; or the prospect or effect of acquisition or merger activities; and/or companies involved in actual or anticipated reorganizations or restructurings under the Bankruptcy Code. The fund also invests in debt securities of companies having one or more of the above characteristics. The fund may invest up to 35% of its net assets in debt securities rated below investment grade. The Adviser follows a value discipline in selecting securities. This means the Adviser seeks to purchase securities at large discounts to the Adviser's assessment of their intrinsic value. For the Adviser, assessment of intrinsic value is an ongoing, dynamic process employing both quantitative and qualitative analysis. The Adviser typically sells a security when, in the Adviser's assessment, the security no longer appears to offer long-term above average risk adjusted rates of return, or when a more compelling investment opportunity is found. For temporary defensive purposes, the fund may invest without limit in short-term debt instruments, including government, corporate and money market securities. Such short-term investments will be in issuers whose long-term debt is rated in one of the four highest rating categories by Standard_& Poor's or Moody's Investors Service, Inc., or, if unrated, deemed by the adviser to be of comparable quality. The fund may not achieve its investment objective when so invested. - -------------------------------------------------------------------------------- Brandywine Small Cap Value Portfolio - -------------------------------------------------------------------------------- Adviser: Brandywine - -------------------------------------------------------------------------------- Objective: long-term capital appreciation - -------------------------------------------------------------------------------- Principal Investment Strategies: Under normal market conditions, the Portfolio will invest at least 65% of its total assets in equity securities of "small cap" companies. "Small cap" companies are generally defined as companies at the time of initial investment with an equity market capitalization not in excess of the 40th percentile of the capitalization of issuers traded on the New York Stock Exchange. A company that was a "small cap" company at the time of the Portfolio's initial investment will continue to be treated as such for -5- purposes of the 65% test, even if the equity capitalization exceeds the 40th percentile at the time of subsequent investment. Equity securities include common stock, preferred stock, securities convertible into common stock, rights and warrants to acquire such securities and substantially similar forms of equity with comparable risk characteristics. Although the Portfolio expects to remain substantially fully invested in equity securities, the Portfolio may invest in cash and money market instruments, including repurchase agreements. For temporary defensive purposes, the Portfolio may also invest in investment grade debt and fixed income investments. The Portfolio may also engage in reverse repurchase agreement transactions and other borrowings, purchase restricted and illiquid securities, loan its portfolio securities, and invest in securities of other investment companies. - -------------------------------------------------------------------------------- Batterymarch Emerging Markets Portfolio - -------------------------------------------------------------------------------- Adviser: Batterymarch - -------------------------------------------------------------------------------- Objective: long-term capital appreciation - -------------------------------------------------------------------------------- Principal Investment Strategies: The Adviser intends to invest substantially all of the Portfolio's assets in equity securities and convertible securities of emerging market issuers. Emerging market countries are those countries having less fully developed economic and political systems. The Portfolio intends to invest in Asia, Latin America, the Indian Subcontinent, Southern and Eastern Europe, the Middle East and Africa, although it may not invest in all these markets at all times and may not invest in any particular market when it deems investment in that country or region to be inadvisable. More than 25% of the Portfolio's total assets may be invested in securities of issuers located in a single country. The Adviser focuses on higher-quality, dominant emerging markets companies which the adviser believes to have strong growth prospects and reasonable valuations, selected from an investable universe of approximately 1,000 stocks. The Adviser's emerging markets investment strategy represents a distinctive combination of quantitative methodology and traditional fundamental analysis. Traditional "on-the-ground" fundamental research is combined by the Adviser with tested quantitative valuation disciplines in those markets where reliable data is available. In determining country allocation, the Adviser also merges quantitative and fundamental approaches. The Portfolio may invest without limit in cash and money market instruments, including repurchase agreements, in circumstances when cash is temporarily available, or for temporary defensive purposes when the Adviser believes such action is warranted by abnormal market or economic situations. Up to 10% of the Portfolio's total assets may be rated below investment grade or, if unrated, determined by the Adviser to be below investment grade. -6- - -------------------------------------------------------------------------------- Batterymarch International Equity Portfolio - -------------------------------------------------------------------------------- Adviser: Batterymarch - -------------------------------------------------------------------------------- Objective: long-term total return - -------------------------------------------------------------------------------- Principal Investment Strategies: The Adviser currently intends to invest substantially all of the Portfolio's assets in non-U.S. equity securities. The primary focus of the Adviser is stock selection, with a secondary focus on country allocation. The Adviser uses a bottom-up, quantitative stock selection process for the developed markets portion of the Portfolio's portfolio. The cornerstone of this process is a proprietary stock selection model that ranks the 2,800 stocks in the Portfolio's investable universe by relative attractiveness on a daily basis. The quantitative factors within this model are intended to measure growth, value, fundamental expectations and technical indicators (i.e., supply and demand). Country allocation for the developed markets portion of the Portfolio is based on rankings generated by the Adviser's proprietary country model. The Adviser examines securities from over 20 international stock markets, with emphasis on several of the largest: Japan, the United Kingdom, France, Canada and Germany. The Portfolio may invest up to 35% of its total assets in emerging market securities. The Adviser's investment strategy for the emerging markets portion of the Portfolio represents a distinctive combination of tested quantitative methodology and traditional fundamental analysis. The emerging markets allocation focuses on higher-quality, dominant companies which the Adviser believes to have strong growth prospects and reasonable valuations. Country allocation for the emerging markets portion of the Portfolio also combines quantitative and fundamental approaches. The Portfolio will normally be diversified across a broad range of industries and across a number of countries, consistent with the objective of maximum total return. However, more than 25% of the Portfolio's total assets may be invested in securities of issuers located in a single country, which is currently expected to be the case with respect to both Japan and the United Kingdom. The Portfolio may invest without limit in cash and money market instruments, including repurchase agreements, in circumstances when cash is temporarily available, or for temporary defensive purposes when the Adviser believes such action is warranted by abnormal market or economic situations. Up to 5% of the Portfolio's total assets may be rated below investment grade or, if unrated, determined by the Adviser to be below investment grade. The Adviser may also seek to enhance portfolio returns through active currency hedging strategies. -7- - -------------------------------------------------------------------------------- LM Total Return Institutional Portfolio - -------------------------------------------------------------------------------- Adviser: LMFA - -------------------------------------------------------------------------------- Objective: capital appreciation and current income in order to achieve an attractive total investment return consistent with reasonable risk - -------------------------------------------------------------------------------- Principal Investment Strategies: The fund invests primarily in securities that, in the Adviser's opinion, offer the potential for long-term capital growth and attractive current income. The Adviser follows a value discipline in selecting securities. This means the Adviser seeks to purchase securities at large discounts to the Adviser's assessment of their intrinsic value. For the Adviser, assessment of intrinsic value is an ongoing, dynamic process employing both quantitative and qualitative analysis. The Adviser typically sells a security when, in the Adviser's assessment, the security no longer appears to offer long-term attractive total returns at reasonable risk, or when a more compelling investment opportunity is found. The fund invests primarily in common stocks, debt securities, and securities convertible into common stocks, but is not limited to these types of securities. The fund may invest in securities that do not pay current income but do, in the Adviser's opinion, offer prospects for capital appreciation and future income. The fund may invest in companies of any size. The fund may invest in debt securities, including government, corporate and money market securities for temporary defensive purposes. The fund may not achieve its investment objective when so invested. Consistent with the investment objective, the fund may also invest in such securities when the adviser believes the return on certain debt securities may equal or exceed the return on equity securities. - -------------------------------------------------------------------------------- RISK SUMMARY - -------------------------------------------------------------------------------- In General - At any time, your investment in a mutual fund may be worth more or less than the price you originally paid for it. You may lose money by investing in any mutual fund because: (i) the value of the investments it owns changes, sometimes rapidly and unpredictably; (ii) the mutual fund is not successful in reaching its goal because of its strategy or because it did not implement its strategy properly; or (iii) unforeseen occurrences in the securities markets negatively affect the mutual fund. Market Risk - The Portfolios may invest substantially all of their assets in equity securities. Prices of equity securities generally fluctuate more than those of other securities. A Portfolio may experience a substantial or complete loss on an individual stock. Market risk may affect a single issuer, industry or section of the economy or may affect the market as a whole. The International Equity Portfolio and Emerging Markets Portfolio invest primarily in foreign equity securities. Foreign securities have additional risks, see "Foreign Securities Risk" below. -8- Securities of "small cap" companies entail special risks. Such companies often have limited operating histories and may have more restricted product lines or more limited financial resources than larger, more established companies. For these and other reasons, they may be more severely affected by economic downturns or other adverse developments than are larger, more established companies. Securities of "small cap" companies may be traded "over-the-counter" and often trade less frequently and in more limited volume, may be subject to greater volatility and may be more difficult to value than securities of larger, more established companies. "Small cap" companies are often involved in actual or anticipated reorganizations or restructurings, which involve special risks, including difficulty in obtaining information as to the financial condition of such companies and the fact that market prices of such companies' securities are subject to sudden and erratic price volatility. Investment Models - The proprietary models used by the Advisers to evaluate securities or securities markets are based on the Advisers' understanding of the interplay of market factors and do not assure successful investment. The markets, or the prices of individual securities, may be affected by factors not foreseen in developing the models. Foreign Securities Risk - Investments in foreign securities (including those denominated in U.S. dollars) involve certain risks not typically associated with investments in domestic issuers. The values of foreign securities are subject to economic and political developments in the countries and regions where the companies operate, such as changes in economic or monetary policies, and to changes in exchange rates. Values may also be affected by restrictions on receiving the investment proceeds from a foreign country. In general, less information is publicly available about foreign companies than about U.S. companies. Foreign companies are generally not subject to the same accounting, auditing and financial reporting standards as are U.S. companies. Some securities issued by foreign governments or their subdivisions, agencies and instrumentalities may not be backed by the full faith and credit of the foreign government. Even where a security is backed by the full faith and credit of a foreign government, it may be difficult for a Portfolio to pursue its rights against a foreign government in that country's courts. Some foreign governments have defaulted on principal and interest payments. In addition, a Portfolio's investments in foreign securities may be subject to the risk of nationalization or expropriation of assets, imposition of currency exchange controls or restrictions on the repatriation of foreign currency, confiscatory taxation, political or financial instability and diplomatic developments which could effect the value of a Portfolio's investments in certain foreign countries. Dividends or interest on, or proceeds from the sale of, foreign securities may be subject to foreign withholding taxes, and special U.S. tax considerations may apply. -9- Emerging Markets Risk - The risks of foreign investment are greater for investments in emerging markets. Emerging market countries typically have economic and political systems that are less fully developed, and can be expected to be less stable than those of more advanced countries. Low trading volumes may result in a lack of liquidity and in price volatility. Emerging market countries may have policies that restrict investment by foreigners, or that prevent foreign investors from withdrawing their money at will. Because some of the Portfolios may invest a significant amount of their total assets in emerging market securities, investors should be able to tolerate sudden, sometimes substantial fluctuations in the value of their investments. An investment in any Portfolio that invests in emerging market securities, which includes the Emerging Markets Portfolio and the International Equity Portfolio, should be considered speculative. Currency Risk - Because certain Portfolios (such as the Emerging Markets Portfolio and the International Equity Portfolio) may invest significantly in securities denominated in foreign currencies, their value can be affected by changes in the rates of exchange between those currencies and the U.S. dollar. Currency exchange rates can be volatile and affected by, among other factors, the general economics of a country, the actions of the U.S. and foreign governments or central banks, the imposition of currency controls, and speculation. A security may be denominated in a currency that is different from the currency where the issuer is domiciled. The Portfolios from time to time hedge a portion of their currency risk, using a variety of techniques, including currency futures, forwards, or options. However, these instruments may not always work as intended, and in specific cases a Portfolio may be worse off than if had not used a hedging instrument. For most emerging market currencies, there are not suitable hedging instruments available. Interest rate risk - Each Portfolio is subject to interest rate risk, which is the possibility that the market prices of the Portfolios' investments may decline due to an increase in market interest rates. Generally, the longer the maturity of a fixed-income security, the greater is the effect on its value when rates increase. Certain securities pay interest at variable or floating rates. Variable rate securities reset at specified intervals, while floating rate securities reset whenever there is a change in a specified index rate. In most cases, these reset provisions reduce the effect of market interest rates on the value of the security. However, some securities do not track the underlying index directly, but reset based on formulas that can produce an effect similar to leveraging; others may provide for interest payments that vary inversely with market rates. The market prices of these securities may fluctuate significantly when interest rates change. -10- Credit risk - Each Portfolio is also subject to credit risk, i.e., the risk that an issuer of securities will be unable to pay principal and interest when due, or that the value of the security will suffer because investors believe the issuer is less able to pay. This is broadly gauged by the credit ratings of the securities in which each Portfolio invests. However, ratings are only the opinions of the agencies issuing them and are not absolute guarantees as to quality. Moody's Investors Service considers debt securities rated Baa to have speculative characteristics. Debt securities rated below Baa/BBB are deemed by the ratings agencies to be speculative and may involve major risk of exposure to adverse conditions. These ratings may indicate that the securities are highly speculative and may be in default or in danger of default as to principal and interest. Not all government securities are backed by the full faith and credit of the United States. Some are backed only by the credit of the issuing agency or instrumentality. Accordingly, there is at least a chance of default on these securities. Call risk - Many fixed income securities, especially those issued at high interest rates, provide that the issuer may repay them early. Issuers often exercise this right when interest rates are low. Accordingly, holders of callable securities may not benefit fully from the increase in value that other fixed-income securities experience when rates decline. Furthermore, the fund reinvests the proceeds of the payoff at current yields, which are lower than those paid by the security that was paid off. Special risks of high yield securities - Securities rated below Baa/BBB, commonly known as junk bonds or high yield securities, reflect a greater possibility that the issuers may be unable to make timely payments of interest and principal and thus default. If this happens, or is perceived as likely to happen, the values of those investments will usually be more volatile. These securities may be less liquid than higher-rated securities, which means a Portfolio may have difficulty selling them at times, and may have to apply a greater degree of judgment in establishing a price. Although the Advisers consider credit ratings in making investment decisions, they perform their own investment analysis and do not rely on ratings assigned by the rating agencies. When a Portfolio buys lower rated debt, the achievement of its goals depends more on the Advisers' ability than would be the case if a Portfolio were buying investment grade debt. Year 2000 - Like other mutual funds (and most organizations around the world), the Portfolios could be adversely affected by computer problems related to the year 2000. These could interfere with operations of the Portfolios, their Manager, distributor or Adviser, or could impact companies in which the Portfolios invest. -11- While no one knows if these problems will have any impact on the Portfolios or on financial markets in general, the manager and its affiliates are taking steps to protect fund investors. These include efforts to determine that the problem will not directly affect the systems used by major service providers. Whether these steps will be effective can only be known for certain in the year 2000. Derivatives - A Portfolio may engage in a variety of transactions using "derivatives," such as futures, options, warrants and swaps. Derivatives are financial instruments whose value depends upon, or is derived from, the value of something else, such as one or more underlying investments, indexes or currencies. Derivatives may be traded on organized exchanges, or in individually negotiated transactions with other parties (these are known as "over the counter"). A Portfolio may use derivatives both for hedging and non-hedging purposes. Although the Advisers have the flexibility to use these strategies, they may choose not to for a variety of reasons, even under very volatile market conditions. Derivatives involve special risks and costs and may result in losses to a Portfolio. The successful use of derivatives requires sophisticated management and a Portfolio will depend on the Advisers' ability to analyze and manage derivatives transactions. The prices of derivatives may move in unexpected ways, especially in abnormal market conditions. Some derivatives are "leveraged" and therefore may magnify or otherwise increase investment losses to a Portfolio. A Portfolio's use of derivatives may also increase the amount of taxes payable by shareholders. Other risks arise from the potential inability to terminate or sell derivatives positions. A liquid secondary market may not always exist for a Portfolio's derivatives positions at any time. In fact, many over-the-counter instruments will not be liquid. Over-the-counter instruments also involve the risk that the other party will not meet its obligations to a Portfolio. Hedging - The decision as to whether and to what extent a Portfolio will engage in hedging transactions to hedge against such risks as credit risk, currency risk and market risk will depend on a number of factors, including prevailing market conditions, the composition of a Portfolio's portfolio and the availability of suitable transactions. Accordingly, there can be no assurance that a Portfolio will engage in hedging transactions at any given time or from time to time. Turnover - The investment strategies employed by the Portfolios often involve high turnover rates. This results in higher trading costs and could cause a Portfolio to realize higher levels of taxable gains. -12- Other Policies - In addition to the main investment strategies described above, a Portfolio may also make other types of investments, and therefore may be subject to other risks. Some of these risks are described in the Portfolios' SAI. At times the Advisers may judge that market conditions make pursuing a Portfolio's investment strategies inconsistent with the best interests of its shareholders. The Advisers then may temporarily use alternative strategies that are mainly designed to limit a Portfolio's losses. Although the Advisers have the flexibility to use these strategies, it may choose not to for a variety of reasons, even in very volatile market conditions. These strategies may cause a Portfolio to miss out on investment opportunities, and may prevent a Portfolio from achieving its goal. - -------------------------------------------------------------------------------- PERFORMANCE DATA - -------------------------------------------------------------------------------- None of the Portfolios have a full calendar year of performance to report. Since each Portfolio's performance can be expected to vary from year to year, however, there are risks of investing in the Portfolios. - -------------------------------------------------------------------------------- EXPENSE INFORMATION - -------------------------------------------------------------------------------- The following tables describe the fees and expenses that you may pay if you buy and hold shares of a Portfolio. The examples beside the tables are intended to help you compare the cost of investing in a Portfolio with the cost of investing in other mutual funds. The examples assume that you invest $10,000 in a Portfolio for the time periods indicated and then redeem all of your shares at the end of those periods. The examples also assume that your investment has a 5% return each year and that the Portfolio's operating expenses remain the same. Your actual costs may be higher or lower. -13-
- -------------------------------------------------------------------------------------------------- LM Value Institutional Portfolio - -------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class --------------------------- ----- ------------------ Shareholder Fees (Fees paid directly 1 year $110 from your investment) None None 3 years $343 5 years $595 10 years $1317 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example ----------------------- Management Fees .60% .60% 1 year $135 12b-1 Fees None .25% 3 years $421 Other Expenses .48% .48% 5 years $729 Total 10 years $1601 Operating Expenses 1.08% 1.33% Expense Reimbursement* (.33%) (.33%) Net Expenses .75% 1.00% - -------------------------------------------------------------------------------------------------------------------- LM Mid Cap Institutional Portfolio - -------------------------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class ---------------------------- ----- ------------------ Shareholder Fees (Fees paid directly 1 year $87 from your investment) None None 3 years $271 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example Management Fees .60% .60% 1 year $112 12b-1 Fees None .25% 3 years $350 Other Expenses .25% .25% Total Operating Expenses .85% 1.10% Expense Reimbursement* (.10%) (.10%) Net Expenses .75% 1.00%
-14-
- ------------------------------------------------------------------------------------------------- Brandywine Small Cap Value Portfolio - ------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class ---------------------------- ----- ------------------ Shareholder Fees (Fees paid directly 1 year $642 from your investment) None None 3 years $1899 5 years $3118 10 years $6014 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example ----------------------- Management Fees .65% .65% 1 year $686 12b-1 Fees None .25% 3 years $1964 Other Expenses 5.82% 5.82% 5 years $3218 10 years $6170 Total Operating Expenses 6.47% 6.72% Expense Reimbursement* (5.62%) (5.62%) Net Expenses .85% 1.10%
- ------------------------------------------------------------------------------------------------- Batterymarch Emerging Markets Portfolio - ------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class ---------------------------- ----- ------------------ Shareholder Fees (Fees paid directly 1 year $153 from your investment) None None 3 years $474 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example ----------------------- Management Fees .65% .65% 1 year $178 12b-1 Fees None .25% 3 years $551 Other Expenses .85% .85% Total Operating Expenses 1.50% 1.75% Expense Reimbursement* (.05%) (.05%) Net Expenses 1.45% 1.70%
-15-
- -------------------------------------------------------------------------------------------------------------------- Batterymarch International Equity Portfolio - -------------------------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class --------------------------- ----- ------------------ Shareholder Fees (Fees paid directly 1 year $107 from your investment) None None 3 years $334 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example ----------------------- Management Fees .65% .65% 1 year $132 12b-1 Fees None .25% 3 years $412 Other Expenses .40% .40% Total Operating Expenses 1.05% 1.30% Expense Reimbursement* (.05%) (.05%) Net Expenses 1.00% 1.25% - ------------------------------------------------------------------------------------------------- LM Total Return Institutional Portfolio - ------------------------------------------------------------------------------------------------- Institutional Financial Institutional Class Example Class Intermediary Class ----- ------------------ Shareholder Fees (Fees paid directly 1 year $87 from your investment) None None 3 years $271 Annual Fund Operating Expenses (Expenses that are Financial Intermediary deducted from fund assets) Class Example ----------------------- Management Fees .60% .60% 1 year $112 12b-1 Fees None .25% 3 years $350 Other Expenses .25% .25% Total Operating Expenses .85% 1.10% Expense Reimbursement* (.10%) (.10%) Net Expenses .75% 1.00%
*Reflects the Manager's contractual obligation to limit Portfolio expenses through [date]. "Other expenses" for the Value Institutional and Small Cap Value Portfolios are based on actual expenses for the period from each Portfolio's inception through March 31, 1999 (the fiscal year end). "Other Expenses" for the other Portfolios are based on estimated amounts for the current -16- fiscal year. The 12b-1 fees shown in the tables reflect the amount to which the Directors have currently limited payments under the Portfolios' Distribution Plans. Pursuant to each Portfolio's Distribution Plan, the Directors may increase the 12b-1 fees to 0.40% of average net assets without shareholder approval. As a result of the 12b-1 fees, long-term shareholders of the Financial Intermediary Class may pay more than the economic equivalent of the maximum sales charge permitted by the National Association of Securities Dealers, Inc. - -------------------------------------------------------------------------------- MANAGEMENT OF THE PORTFOLIOS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- General - -------------------------------------------------------------------------------- LM Institutional Fund Advisors II, Inc. ("LMIFA II") is an open-end management investment company comprised of a variety of separate investment portfolios. LMIFA II was organized as a Maryland corporation on January 13, 1998. - -------------------------------------------------------------------------------- Board of Directors - -------------------------------------------------------------------------------- The business affairs of LMIFA II are managed under the direction of a Board of Directors, and the Directors of LMIFA II are responsible for generally overseeing the conduct of each Portfolio's business. Information about the Directors and executive officers of LMIFA II may be found in the SAI. The Board of Directors has retained the Manager and the Advisers to manage the Portfolios' affairs, furnish a continuing investment program for the Portfolios and make investment decisions on their behalf, subject to such policies as the Directors may determine. - -------------------------------------------------------------------------------- Manager, Advisers and Portfolio Managers - -------------------------------------------------------------------------------- The Portfolios are managed by the Manager. Each Portfolio pays the Manager a monthly fee based on the average net assets of the Portfolio at the following rates: Annual Percentage of Portfolio Average Net Assets ---------- ------------------ LM Value Institutional Portfolio 0.60% LM Mid Cap Institutional Portfolio 0.60% Brandywine Small Cap Value Portfolio 0.65% Batterymarch Emerging Markets Portfolio 0.65% Batterymarch International Equity Portfolio 0.65% LM Total Return Institutional Portfolio 0.60% -17- The Manager is a Maryland corporation formed on February 20, 1998 and is a wholly owned subsidiary of Legg Mason, Inc., a financial services holding company. In order to assist in carrying out its investment advisory responsibilities, the Manager has retained the Advisers to render advisory services to the Portfolios. The Manager pays the fees of the Advisers. The Manager pays a Portfolio's Adviser a monthly fee based on the average net assets of the Portfolio at the following rates:
------------------------------------------------------------- ------------------------- PORTFOLIO ADVISER ADVISER FEE ------------------------------------------------------------- ------------------------- LM Value Institutional LMFA .55% ------------------------------------------------------------- ------------------------- LM Mid Cap Institutional LMFA .55% ------------------------------------------------------------- ------------------------- Brandywine Small Cap Value Brandywine .60% ------------------------------------------------------------- ------------------------- Batterymarch Emerging Markets Batterymarch .60% ------------------------------------------------------------- ------------------------- Batterymarch International Equity Batterymarch .60% ------------------------------------------------------------- ------------------------- LM Total Return Institutional LMFA .55% ------------------------------------------------------------- -------------------------
LMFA. LMFA acts as adviser or manager to eighteen investment company portfolios which had aggregate assets under management of approximately $13.947 billion as of March 31, 1999. LMFA's address is 100 Light Street, Baltimore, Maryland 21202. LMFA is a subsidiary of Legg Mason, Inc. Brandywine. Brandywine, a wholly owned subsidiary of Legg Mason, Inc., acts as investment adviser to institutional accounts, such as corporate pension plans, mutual funds and endowment funds, as well as to individual investors. Total assets under management by Brandywine were approximately $6.951 billion as of March 31, 1999. The address of Brandywine is Three Christina Centre, Suite 1200, 201 N. Walnut Street, Wilmington, Delaware 19801. Batterymarch. Batterymarch, a wholly owned subsidiary of Legg Mason, Inc., acts as investment adviser to institutional accounts, such as corporate pension plans, mutual funds and endowment funds, as well as to individual investors. Total assets under management by Batterymarch were approximately $4.473 billion as of March 31, 1999. The address of Batterymarch is 200 Clarendon Street, Boston, Massachusetts 02116. Expense Limitations. The Manager and the Advisers have until [July 31, 2000] voluntarily agreed to waive their fees and/or reimburse each Portfolio in any month to the extent a Portfolio's expenses (exclusive of taxes, interest, deferred organizational expenses, 12b-1 fees, brokerage and extraordinary expenses) exceed during that month the annual rate of that Portfolio's average net assets set forth below: -18- LM Value Institutional Portfolio, LM Mid Cap Institutional Portfolio and LM Total Return Institutional Portfolio 0.75% Brandywine Small Cap Value Portfolio 0.85% Batterymarch International Equity Portfolio 1.00% Batterymarch Emerging Markets Portfolio 1.45% Any amounts waived or reimbursed in a particular fiscal year will be subject to repayment by a Portfolio to the Manager and the Advisers to the extent that from time to time during the next three fiscal years the repayment will not cause a Portfolio's expenses to exceed the limit, if any, imposed by the Manager and the Advisers at that time. These agreements are voluntary and may be terminated by the Manager and the Advisers at any time. Portfolio Managers. The names and business experience for the past five years for each portfolio manager are set forth in the following chart.
- ----------------------------------------------------------- ------------------------------------------------------------- Portfolio Manager and Business Experience Portfolio (past five years) - ----------------------------------------------------------- ------------------------------------------------------------- LM Value Institutional Portfolio LMFA since 1982. William H. Miller, III is a portfolio manager - ----------------------------------------------------------- ------------------------------------------------------------- LM Mid Cap Institutional Portfolio William H. Miller, III (see above) - ----------------------------------------------------------- ------------------------------------------------------------- Brandywine Small Cap Value Portfolio Henry F. Otto is a senior portfolio manager at Brandywine. Mr. Otto has been employed by Brandywine since 1987. Steven M. Tonkovich is a portfolio manager and analyst at Brandywine. Mr. Tonkovich has been employed by Brandywine since 1989. - ----------------------------------------------------------- ------------------------------------------------------------- Batterymarch Emerging Markets Portfolio Batterymarch emerging markets team - ----------------------------------------------------------- ------------------------------------------------------------- Batterymarch International Equity Portfolio Batterymarch developed markets (EAFE) team - ----------------------------------------------------------- ------------------------------------------------------------- LM Total Return Institutional Portfolio Nancy T. Dennin is a portfolio manager and Senior Vice President of LMFA. Ms. Dennin has been employed by LMFA since 1985. - ----------------------------------------------------------- -------------------------------------------------------------
-19- - -------------------------------------------------------------------------------- The Distributor - -------------------------------------------------------------------------------- Legg Mason Wood Walker, Incorporated ("LMWW") is the distributor of each Portfolio's shares. LMWW pays certain expenses in connection with the offering of shares of each Portfolio, including any compensation to its financial advisors, the printing and distribution of prospectuses, SAIs and periodic reports used in connection with the offering to prospective investors, and expenses relating to any supplementary sales literature or advertising. The Portfolios bear the expenses of preparing, setting in type and mailing the prospectuses, SAIs and periodic reports to existing shareholders. - -------------------------------------------------------------------------------- Portfolio Transactions - -------------------------------------------------------------------------------- Each Portfolio's Adviser places all orders for the purchase and sale of portfolio investments with brokers or dealers selected by it in its discretion. It will seek the best price and execution of each Portfolio's orders. However, the Adviser may pay higher commission rates than the lowest available when it believes it is reasonable to do so in light of the value of brokerage and research services provided by the broker effecting the transaction. The Adviser may also consider sales of shares of the Portfolio (or other portfolios or other funds managed by it or its affiliates, to the extent permitted by applicable law) in selecting broker-dealers to execute Portfolio transactions. The Portfolios may use LMWW, among others, as broker for agency transactions in listed and over-the-counter securities at commission rates and under circumstances consistent with the policy of best execution. Some securities considered by an Adviser for purchase by a Portfolio may also be appropriate for other clients served by the Adviser. Transactions in such securities will be allocated among the Portfolios and such other clients in a manner considered fair and reasonable by the Adviser. - -------------------------------------------------------------------------------- Expenses - -------------------------------------------------------------------------------- Each Portfolio pays its share of all expenses of LMIFA II that are not assumed by the Manager, the Adviser or other parties, including Directors', auditing, legal, custodial, transfer agency and distribution fees (which are in turn allocated to the Financial Intermediary Class of shares). - -------------------------------------------------------------------------------- PURCHASE OF SHARES - -------------------------------------------------------------------------------- The Portfolios offer two classes of shares: Institutional Class and Financial Intermediary Class. Shares in the Financial Intermediary Class bear a 12b-1 fee. See "Distribution Plans" below for more information. -20- - -------------------------------------------------------------------------------- Initial Investment - -------------------------------------------------------------------------------- Prior to or concurrent with the initial purchase of shares in any Portfolio, each investor must open an account for that Portfolio by completing and signing an Application and mailing it to Boston Financial Data Services (the "Transfer Agent" or "BFDS") at the following address: P.O. Box 953, Boston, Massachusetts 02103. The Portfolios have established minimum investment criteria that vary depending upon which class of shares you wish to purchase. For Institutional Class shares, investors must have at least $50 million in assets and invest in the aggregate at least $1 million in the Portfolios and the portfolios of LM Institutional Fund Advisors I, Inc. For Financial Intermediary Class shares, investors must have at least $30 million in assets and invest in the aggregate at least $1 million in the Portfolios and the portfolios of LM Institutional Fund Advisors I, Inc. The Portfolios reserve the right to revise the minimum investment requirement and may waive it in their sole discretion. A purchase order, together with payment in proper form, received by the Transfer Agent prior to the close of regular trading on the Exchange (ordinarily 4:00 p.m., Eastern time) ("close of the Exchange") will be effected at that day's net asset value. An order received after the close of the Exchange will generally be effected at the net asset value determined on the next business day. However, orders received by certain retirement plans and other financial intermediaries by the close of the Exchange and communicated to the Transfer Agent by 9:00 a.m., Eastern time, on the following business day will be effected at the net asset value determined on the prior business day. Purchases of shares can be made by wiring federal funds to State Street Bank and Trust Company. Before wiring federal funds, the investor must first telephone the Portfolio at 1-888-42-LMIFA to receive instructions for wire transfer. On the telephone, the following information will be required: shareholder name; name of the person authorizing the transaction; shareholder account number; name of the Portfolio and class of shares to be purchased; amount being wired; and name of the wiring bank. Funds should be wired through the Federal Reserve System to: State Street Bank and Trust Company ABA # 011-000-028 LM Institutional Fund Advisors [insert name of Portfolio] [Insert your account name and number] The wire should state that the funds are for the purchase of shares of a specific Portfolio and include the account name and number. Shares may also be purchased and paid for by the contribution of eligible portfolio securities, subject in each case to approval by the Manager. Approval will depend on, among other things, the nature and quality of the securities offered and the current needs of the Portfolio in question. Securities offered in payment for shares will be valued in the same way and at the same time the Portfolio values it portfolio securities for purposes of determining net asset value. See "How Each Portfolio Values Its Shares," below. Investors who -21- wish to purchase Portfolio shares through the contribution of securities should contact the Portfolio at 1-888-42-LMIFA for instructions. Investors should also realize that at the time of contribution they may be required to recognize a gain or loss for tax purposes on securities contributed. The Portfolio has full discretion to reject any securities offered as payment for shares. As described below, each Portfolio may offer Financial Intermediary Class shares that are offered primarily through financial intermediaries. Each Portfolio may pay financial intermediaries for their services out of that class's assets pursuant to the class' distribution plan or otherwise. Legg Mason and its affiliates (including the Manager and the Advisers) may also from time to time, at their own expense, make payments to financial intermediaries that sell shares of the Portfolios or to other parties in connection with the sale of shares. If investors effect transactions through a broker or agent, investors may be charged a fee by that broker or agent. Any shares purchased or received as a distribution will be credited directly to the investor's account. - -------------------------------------------------------------------------------- Additional Investments - -------------------------------------------------------------------------------- Additional investments may be made at any time at the relevant net asset value for that class by following the procedures outlined above. Investors should always furnish a shareholder account number when making additional purchases. - -------------------------------------------------------------------------------- Other Purchase Information - -------------------------------------------------------------------------------- Purchases will be made in full and fractional shares. In the interest of economy and convenience, certificates for shares will not be issued. Each Portfolio and LMWW reserves the right, in its sole discretion, to suspend the offering of shares or to reject any purchase order, in whole or in part, when, in the judgment of management, such suspension or rejection is in the best interests of the Portfolio; to waive the minimum initial investment for certain investors; and to redeem shares if information provided in the Application should prove to be incorrect in any manner judged by a Portfolio to be material (e.g., in a manner such as to render the shareholder ineligible to purchase shares of a Portfolio). A Portfolio may suspend the offering of shares at any time and resume it at any time thereafter. Shares of the Portfolios may not be qualified or registered for sale in all States. Prospective investors should inquire as to whether shares of a particular Portfolio are available for offer and sale in their State of residence. Shares of the Portfolio may not be offered or sold in any State unless registered or qualified in that jurisdiction or unless an exemption from registration or qualification is available. Purchases and sales of Portfolio shares should be made for long-term investment purposes only. Each Portfolio reserves the right to restrict purchases of shares (including exchanges) when a pattern of frequent purchases and sales made in response to short-term fluctuations in share price appears evident. -22- - -------------------------------------------------------------------------------- Retirement Plans - -------------------------------------------------------------------------------- Shares of the Portfolios are available for purchase by retirement plans, including 401(k) plans, 403(b) plans and Individual Retirement Accounts ("IRAs"). The administrator of a plan or employee benefits office can provide participants or employees with detailed information on how to participate in the plan and how to elect a Portfolio as an investment option. Participants in a retirement or savings plan may be permitted to elect different investment options, alter the amounts contributed to the plan, or change how contributions are allocated among investment options in accordance with the plan's specific provisions. The plan administrator or employee benefits office should be consulted for details. For questions about participant accounts, participants should contact their employee benefits office, the plan administrator, or the organization that provides recordkeeping services for the plan. Investors who purchase shares through retirement plans should be aware that the plan administrator may aggregate purchase and redemption orders of participants in the plan. Therefore, there may be a delay between the time the investor places an order with the plan administrator and the time the order is forwarded to the Transfer Agent for execution. - -------------------------------------------------------------------------------- Account Registration Changes - -------------------------------------------------------------------------------- Changes in registration or account privileges may be made in writing to the Transfer Agent. Signature guarantees may be required. See "Signature Guarantee" below. All correspondence must include the account number and must be sent to: Boston Financial Data Services P.O. Box 953 Boston, Massachusetts, 02103 - -------------------------------------------------------------------------------- DISTRIBUTION PLANS - -------------------------------------------------------------------------------- The Board of Directors has adopted Distribution Plans pursuant to Rule 12b-1 under the 1940 Act with respect to shares of the Financial Intermediary Class of each Portfolio. Under the terms of each Plan, a Portfolio is permitted to pay, out of the assets of the Financial Intermediary Class of the Portfolio, in an amount up to 0.40% on an annual basis of the average daily net assets of that class, LMWW, financial intermediaries and other parties that provide services in connection with or are otherwise involved in the distribution of shares or administration of plans or programs that use Portfolio shares as their funding medium, and to reimburse certain other expenses and payments. Payments under the Plans are currently limited to 0.25% of average daily net assets. For more information regarding the Plans and their terms, see the SAI. - -------------------------------------------------------------------------------- REDEMPTION OF SHARES - -------------------------------------------------------------------------------- Portfolio shares may be redeemed through three methods: (1) by sending a written request for redemption to the Transfer Agent at P.O. Box 953, Boston, Massachusetts 02103; (2) by calling the Portfolio at 1-888-42-LMIFA; or (3) by wire communication with the Transfer Agent. In each case, the investor should first notify the Portfolio -23- at 1-888-42-LMIFA of the intention to redeem. No charge is made for redemptions. Shareholders who wish to be able to redeem by telephone or wire communication must complete an authorization form in advance. Redemptions over $10,000,000 may be initiated by telephone, but must be confirmed in writing prior to processing. With respect to telephone redemptions or transfers, the Transfer Agent will process orders based on instructions from a shareholder, or any person claiming to act as his or her representative, who can provide it with his or her account registration and address as it appears on its records. The Transfer Agent will employ these and other reasonable procedures to confirm that instructions communicated by telephone are genuine; if it fails to employ reasonable procedures, the Transfer Agent may be liable for any losses due to unauthorized or fraudulent instructions. Upon receipt of a request for redemption as described below (a request "in good order") before the close of the Exchange on any day when the Exchange is open, the Transfer Agent will redeem Portfolio shares at that day's net asset value per share. Requests for redemption received by the Transfer Agent after the close of the Exchange will be executed at the net asset value next determined. However, orders received by certain retirement plans and other financial intermediaries by the close of the Exchange and communicated to the Transfer Agent by 9:00 a.m., Eastern time, on the following business day will be effected at the net asset value determined on the prior business day. The Portfolios may refuse to effect redemption requests during periods permitted by federal securities laws. Requests for redemption should indicate: 1) The number of shares or dollar amount to be redeemed and the investor's shareholder account number; 2) The investor's name and the names of any co-owner of the account, using exactly the same name or names used in establishing the account; 3) Proof of authorization to request redemption on behalf of any co-owner of the account (please contact the Portfolio for further details); and 4) The name, address, and account number to which the redemption payment should be sent. Payment of the redemption price normally will be made by wire one business day after receipt of a redemption request in good order. However, each Portfolio reserves the right to postpone the payment date when the Exchange is closed, when trading is restricted, or during other periods as permitted by federal securities laws, or to take up to seven days to make payment upon redemption if the Portfolio involved could be adversely affected by immediate payment. Redemption proceeds may also be paid in kind at the discretion of the Portfolio. Shareholders who receive a redemption in kind may incur costs to dispose of such securities. Shareholders of some investment companies have experienced difficulty contacting their funds by telephone during periods of intense market activity. Shareholders who are unable to contact a Portfolio by telephone and wish to make a redemption should follow the instructions for redeeming by mail or by wire. -24- Other supporting legal documents, such as copies of the trust instrument or power of attorney, may be required from corporations or other organizations, fiduciaries or persons other than the shareholder of record making the request for redemption or repurchase. If you have a question concerning the sale or redemption of shares, please contact the Portfolio or the Transfer Agent. Any Portfolio may elect to close any shareholder account when the current value of the account is less than $1 million due to redemptions or exchanges by the shareholder by redeeming all of the shares in the account and mailing the proceeds to the investor. If a Portfolio elects to redeem the shares in an account, the shareholder will be notified that the account is below $1 million and will be allowed 30 days in which to make an additional investment in order to avoid having the account closed. Shares will be redeemed at the net asset value calculated on the day of redemption. Any Portfolio may change the $1 million minimum account balance from time to time without notice to shareholders. - -------------------------------------------------------------------------------- Signature Guarantee - -------------------------------------------------------------------------------- When a signature guarantee is called for, the shareholder should have "Signature Guaranteed" stamped under his signature and guaranteed by any of the following entities: U.S. banks, foreign banks having a U.S. correspondent bank, credit unions, savings associations, U.S. registered dealers and brokers, municipal securities dealers and brokers, government securities dealers and brokers, national securities exchanges, registered securities associations and clearing agencies (each an "Eligible Guarantor Institution"). Each Portfolio and its agents reserve the right to reject any signature guarantee pursuant to written signature guarantee standards or procedures, which may be revised in the future to permit them to reject signature guarantees from Eligible Guarantor Institutions that do not, based on credit guidelines, satisfy such written standards or procedures. Any Portfolio may change the signature guarantee requirements from time to time without prior notice to shareholders. - -------------------------------------------------------------------------------- EXCHANGE PRIVILEGE - -------------------------------------------------------------------------------- Shareholders in any Portfolio may exchange their shares for shares of the same class of any of the other Portfolios or of any of the portfolios offered by LM Institutional Fund Advisors I, Inc., provided that the shares of that class are being offered at the time of the proposed exchange. Investments by exchange among any of the Portfolios are made at the per share net asset values next determined after the order for exchange is received in good order. The exchange privilege is not intended as a vehicle for short-term trading. Excessive exchange activity may interfere with portfolio management and have an adverse effect on all shareholders. In order to limit excessive exchange activity and in other circumstances where a Portfolio believes doing so would be in its best interest, the Portfolio reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges or reject any exchange. For further information concerning the exchange privilege, or to make an exchange, please contact the Portfolio at 1-888-42-LMIFA. -25- - -------------------------------------------------------------------------------- NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value per share of each class of shares is determined daily for each Portfolio as of the close of regular trading on the Exchange (normally 4:00 p.m., Eastern time), on every day that the Exchange is open, by subtracting the Portfolio's liabilities attributable to a given class of shares from its total assets attributable to the class and dividing the result by the number of shares of that class outstanding. Net asset value will not be determined on days on which the Exchange is closed. Portfolio securities and other assets for which market quotations are readily available are valued at current market value. Current market value means the last sale price of the day for a comparable position, or, in the absence of any such sales, the mean between representative bid and asked prices obtained from a quotation reporting system. Securities with remaining maturities of 60 days or less are generally valued at amortized cost. Fixed income securities, including those to be purchased under firm commitment agreements, are normally valued on the basis of quotations obtained from brokers and dealers or pricing services which take into account appropriate factors such as institutional-size trading in similar groups of securities, yield, quality, coupon rate, maturity, type of issue, trading characteristics and other market data. Certain fixed income securities for which daily market quotations are not readily available may be valued with reference to fixed income securities whose prices are more readily available and whose durations are comparable to those of the securities being valued. Other assets and securities for which no quotations are readily available are valued at fair value as determined in good faith by the Directors or persons acting at their direction. The values of foreign securities quoted in foreign currencies are translated into U.S. dollars at current exchange rates or at such other rates as the Directors or persons acting at their direction may determine in computing net asset value. Because of time zone differences, foreign exchanges and securities markets will usually be closed prior to the time of the closing of the Exchange and values of foreign investments will be determined as of the earlier closing of such exchanges and securities markets. However, events affecting the values of such foreign securities may occasionally occur between the earlier closings of such exchanges and securities markets and the closing of the Exchange which will not be reflected in the computation of the net asset value. If an event materially affecting the value of such foreign securities occurs during such period, then such securities will be valued at fair value as determined in good faith by the Directors or persons acting at their direction. -26- - -------------------------------------------------------------------------------- DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS - -------------------------------------------------------------------------------- The LM Value Institutional Portfolio and the LM Total Return Institutional Portfolio declare and pay dividends quarterly out of their net investment income for that quarter. All other Portfolios declare and pay dividends annually out of their net investment income for that year. Distributions of net realized capital gains are made annually. Shareholders may elect to receive dividends and distributions in one of four ways: 1) Receive both dividends and other distributions in shares of the same class of the distributing Portfolio; 2) Receive dividends in cash and other distributions in shares of the same class of the distributing Portfolio; 3) Receive dividends in shares of the same class of the distributing Portfolio and other distributions in cash; or 4) Receive both dividends and other distributions in cash. If no election is made, both dividends and other distributions are credited to a shareholder's Portfolio account in shares (of the same class as the shares already held) at the net asset value of the shares determined as of the close of the Exchange on the reinvestment date. Reinvestment of dividends and other distributions occurs on the ex-dividend date. An election to receive dividends or other distributions in cash rather than additional shares may be made by notifying the Transfer Agent in writing. If a shareholder has elected to receive dividends and/or other distributions in cash and the postal or other delivery service is unable to deliver checks to the shareholder's address of record, such shareholder's distribution option will automatically be converted to having all dividends and other distributions reinvested in additional shares. No interest will accrue on amounts represented by uncashed distribution or redemption checks. The Directors reserve the right to revise the dividend policy or postpone the payment of dividends if warranted in their judgment due to unusual circumstances, such as an unexpected large expense, loss or fluctuation in net asset value. -27- - -------------------------------------------------------------------------------- TAX INFORMATION - -------------------------------------------------------------------------------- Each Portfolio intends to qualify as a "regulated investment company" for federal income tax purposes and to meet all other requirements necessary for it to be relieved of federal taxes on income and gains it distributes to shareholders. Each Portfolio will distribute substantially all its net investment income and net realized capital gains to its shareholders on a current basis. Distributions from a Portfolio (whether paid in cash or reinvested in shares of the Portfolio) will be taxable to shareholders (other than IRAs, other qualified retirement plans and other tax-exempt investors) as ordinary income to the extent derived from the Portfolio's investment income and net short-term gains. Portfolio distributions of net capital gains (that is, the excess of net gains from capital assets held for more than one year over net losses from capital assets held for not more than one year) will be taxable as long-term capital gain. Special tax rules apply to investments through defined contributions plans and other tax-qualified plans. Shareholders should consult their tax adviser to determine the suitability of shares of a Portfolio as an investment through such plans and the precise effect of an investment on their particular tax situation. A Portfolio's investments in foreign securities may be subject to withholding taxes at the source on dividend or interest payments. In that case, a Portfolio's yield on those securities would be decreased. If at the end of a Portfolio's fiscal year more than 50% of the value of its total assets represents securities of foreign corporations, the Portfolio may make an election to treat any foreign taxes paid by it as paid by its shareholders. In this case, shareholders who are U.S. citizens, U.S. corporations and, in some cases, U.S. residents generally will be required to include in U.S. taxable income their pro rata share of such taxes, but may then generally be entitled to claim a foreign tax credit or deduction (but not both) for their share of such taxes. A shareholder's ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by a Portfolio may be subject to certain limitations (including a holding period requirement, applicable to both a Portfolio and its shareholders, imposed by the Taxpayer Relief Act of 1997). A Portfolio's transactions in foreign currencies and hedging activities may give rise to ordinary income or loss to the extent such income or loss results from fluctuations in value of the foreign currency concerned. In addition, such activities will likely produce a difference between book income and taxable income. This difference may cause a portion of a Portfolio's income distributions to constitute a return of capital for tax purposes or require a Portfolio to make distributions exceeding book income to qualify as a regulated investment company for tax purposes. Investment in an entity that qualifies as a "passive foreign investment company" under the Internal Revenue Code of 1986 could subject a Portfolio to a U.S. federal income tax or other charge on certain "excess distributions" with respect to the investment, and on the proceeds from disposition of the investment. A Portfolio may make an election to mark the gains (and to a limited extent losses) in such investments "to the -28- market" as though it had sold and repurchased its holdings in those passive foreign investment companies on the last day of the Portfolio's taxable year. Early each year each Portfolio will notify its shareholders of the amount and tax status of distributions paid during that year. The foregoing is a summary of certain federal income tax consequences of investing in a Portfolio. Shareholders are urged to consult their tax advisers with respect to the effects of this investment on their particular tax situation (including possible liability for state and local taxes). - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS - -------------------------------------------------------------------------------- The financial highlights tables are intended to help you understand each Portfolios' recent financial performance for the past five years of, if shorter, since the inception of the Portfolio's operations. Certain information reflects financial results for a single fund share. The total returns represent the rate that an investor would have earned or lost on an investment in the Portfolios, assuming reinvestment of all dividends and distributions. This information has been derived from the fund's financial statements, which have been audited by_______. Its report and the Portfolios' financial statements are included in the Portfolios' annual report to shareholders, which is available upon request. LEGG MASON VALUE INSTITUTIONAL PORTFOLIO, INC. FINANCIAL HIGHLIGHTS Contained below is per share operating data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Institutional Class Intermediary Class ----------------------------------------------------------- 1999 * 1999 ** ------------------ --------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $10.00 $10.81 Net investment income (loss) 0.04 A 0.03 B Net realized and unrealized gain (loss) on investments 5.83 5.04 ------------------ --------------- Total from investment operations 5.87 5.07 ------------------ --------------- Distributions to shareholders from net investment income (0.02) (0.02) ------------------ --------------- Total distributions (0.02) (0.02) ------------------ --------------- Net asset value, end of period $15.85 $15.86 ================== =============== Total return 58.81% C 46.95% C RATIOS / SUPPLEMENTAL DATA: Ratios to average net assets Expenses 0.75% A, D 1.00% B,D Net investment income 0.85% A, D 0.44% B,D Portfolio turnover rate 28.6% D 28.6% D Net assets, end of period (in thousands) $115,798 $18,751
- ------------------------------- * For the period September 22, 1998 (commencement of operations) to March 31, 1999. ** For the period October 22, 1998 (commencement of operations) to March 31, 1999. A Net of fees waived and reimbursements made by the Advisor in excess of a voluntary expense limitation of .75% until July 31, 1999. If no fees had not been waived by LMIA the annualized ratio of expenses to average daily net assets for the period would have been 1.08%. B Net of fees waived and reimbursements made by the Advisor in excess of a voluntary expense limitation of 1.00% until July 31, 1999. If no fees had not been waived by LMIA the annualized ratio of expenses to average daily net assets for the period would have been 1.33%. C Not annualized D Annualized BRANDYWINE SMALL CAP VALUE PORTFOLIO FINANCIAL HIGHLIGHTS Contained below is per share operating data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements. August 17, 1998 A to March 31, 1999 ------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $10.00 ------------------------- Net investment income B 0.04 Net realized and unrealized gain on investments (1.47) ------------------------- Total from investment operations (1.43) ------------------------- Distributions to shareholders from net investment income (0.02) ------------------------- Total distributions (0.02) ------------------------- Net asset value, end of period $8.55 ========================= Total Return -14.38% C RATIOS / SUPPLEMENTAL DATA: Ratios to average net assets Expenses B 0.85% D Net investment income B 0.71% D Portfolio turnover rate 45.05% D Net assets, end of period $1,945,597 - ---------------------------------------- A Commencement of operations B Net of fees waived by LMIA pursuant to a voluntary expense limitation of 0.85% until July 31, 1999. If no fees had been waived and reimbursed by LMIA, the annualized ratio of expenses to average daily net asset for the period would have been 6.47%. C Not annualized D Annualized -29- - - -------------------------------------------------------------------------------- APPENDIX A -- PRIOR PERFORMANCE OF ADVISERS' OTHER ACCOUNTS - -------------------------------------------------------------------------------- The LM Value Institutional Portfolio and the Brandywine Small Cap Value Portfolio have performance results only for the period from September 22, 1998, and August 17, 1998, respectively, to March 31, 1999. The other four Portfolios have not yet commenced operations and have no performance record of their own. However, the Advisers have managed other client accounts that have investment objectives and policies that are similar, but not necessarily identical to, those of the Portfolios. Representative investment performance for these accounts is stated below. The investment performance is shown on an annual total return basis, with returns for periods of less than one year not annualized, and on an average annual total return basis. The performance information is provided through March 31, 1999. The prior performance information shown is in two forms: (1) composites of certain of the Adviser's separately managed accounts and (2) SEC-registered, open-end investment companies. In each case, the account or accounts have investment objectives and policies substantially similar (although not necessarily identical) to those of the relevant Portfolio; were managed throughout the periods shown using investment styles and strategies substantially similar (although not necessarily identical) to those of the relevant Portfolio; and, to the extent a composite of accounts is shown, the composite includes all of the fully-discretionary, fee-paying accounts managed by such Adviser during the periods shown using investment objectives, policies and strategies substantially similar (although not necessarily identical) to those of the relevant Portfolio. The performance information for composites has been adjusted to give effect to the Portfolios' estimated fees and expenses, before waivers and reimbursements, for the Financial Intermediary Class shares as shown in the table on page _. The performance information for composites assumes reinvestment of all dividends and proceeds from capital transactions and has been prepared in accordance with the Performance Presentation Standards established by the Association for Investment Management and Research ("AIMR standards"), except for the deduction of estimated fees and expenses as noted above. The performance results would be more favorable if they had been adjusted for estimated fees and expenses of the Institutional Class shares of the Portfolios. Accounts included in composites are generally not subject to the diversification requirements, specific tax restrictions and investment limitations imposed on each of the Portfolios by the 1940 Act or the Code. The performance results for these accounts might have been adversely affected had the accounts been subject to these requirements, restrictions and limitations. Performance for SEC-registered, open-end investment companies is calculated using the SEC's standardized total return formula, which is based upon the change in value of an assumed initial investment of $1,000 from the beginning through the end of a period and assumes reinvestment of all dividends and other distributions. For periods of more than one year, the result is then annualized and expressed as a percentage of the initial investment, and includes the effect of operating expenses, including advisory fees. Information about the investment objectives, policies, expenses and net assets of each of the investment companies follows the performance information. The method for calculating performance for the composites produces a different result than if the performance were calculated using the SEC's method for calculating the total return of an open-end investment company. -1- A Portfolio's expenses, timing of purchases and sales of portfolio securities, timing and availability of cash flows, cash positions (which are typically greater for open-end investment companies than for separate accounts), and brokerage commissions are some of the reasons that might cause performance results of the Portfolio to vary from that of the accounts and/or investment companies shown below. In particular, the large infusions of cash that are typically associated with the commencement of operations of new mutual funds such as the Portfolios, as well as differences in the amount of assets, which can affect the ability and the manner in which security positions are accumulated or liquidated, may also cause a Portfolio's performance to vary from that of the accounts and/or investment companies shown below. As noted above, the investment objective, policies, styles and strategies of each Portfolio are not necessarily identical to those of the relevant accounts and/or investment companies shown below. Again, for these and other reasons, the performance of the Portfolios will vary from that of the accounts and/or investment companies. Prior Performance of Accounts Similar to the LM Value Institutional Portfolio. The investment performance for the period from July 1, 1989 to June 30, 1999 for the Primary class of shares of the Legg Mason Value Trust ("Value Trust") is shown below. The benchmark index to which Value Trust is compared is the S&P 500 Index. The S&P 500 Index is an unmanaged index representing the performance of 500 companies selected by S&P. Although used as a benchmark, the Index's performance may not be comparable to Value Trust's performance because, unlike the performance of Value Trust, the Index's performance has not been adjusted for any fees or expenses.
- -------------------------------------------------------------------------------------------------------------------- Yearly Total Return Year Ended June 30 Account Performance (%) S&P 500 Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1999 - ---------------------------------------- ------------------------------------- ------------------------------------- 1998 38.48 30.16 - ---------------------------------------- ------------------------------------- ------------------------------------- 1997 52.16 34.71 - ---------------------------------------- ------------------------------------- ------------------------------------- 1996 28.64 26.00 - ---------------------------------------- ------------------------------------- ------------------------------------- 1995 27.59 26.07 - ---------------------------------------- ------------------------------------- ------------------------------------- 1994 4.86 1.41 - ---------------------------------------- ------------------------------------- ------------------------------------- 1993 13.95 13.63 - ---------------------------------------- ------------------------------------- ------------------------------------- 1992 18.48 13.41 - ---------------------------------------- ------------------------------------- ------------------------------------- 1991 -5.20 7.39 - ---------------------------------------- ------------------------------------- ------------------------------------- 1990 4.80 16.49 - ---------------------------------------- ------------------------------------- -------------------------------------
-2-
- ------------------------------------ ------------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS Period ended Account S&P 500 June 30 Performance (%) Performance (%) - ------------------------------------ -------------------------------------------- ---------------------------------- 1 Year - ------------------------------------ -------------------------------------------- ---------------------------------- 3 Year - ------------------------------------ -------------------------------------------- ---------------------------------- 5 Year - ------------------------------------ -------------------------------------------- ---------------------------------- 10 Year - ------------------------------------ -------------------------------------------- ----------------------------------
Value Trust, which commenced operations on April 16, 1982, is a diversified open-end investment company. Value Trust's investment objective is long-term growth of capital. Value Trust invests primarily in securities that appear to be undervalued in relation to the long-term earning power or asset value of their issuers. Value Trust invests primarily in companies with a record of earnings and dividends, reasonable return on equity, and sound finances. Value Trust may from time to time invest in securities that pay no dividends or interest. Current dividend income is not a prerequisite in the selection of equity securities. Value Trust normally invests primarily in equity securities. It may invest in debt securities for temporary defensive purposes and, consistent with its investment objective, during periods when or under circumstances where LMFA believes the return on certain debt securities may equal or exceed the return on equity securities. Value Trust may invest in debt securities of both foreign and domestic issuers of any maturity without regard to rating, and may invest its assets in such securities without regard to a percentage limit. LMFA currently anticipates that, under normal market conditions, Value Trust will invest no more than 25% of its total assets in long-term debt securities. Up to 10% of Value Trust's total assets may be invested in debt securities not rated investment grade, i.e., not rated at least BBB by S&P or Baa by Moody's or, if unrated by those entities, deemed by LMFA to be of comparable quality. Value Trust may purchase preferred stock, indexed securities, closed-end investment companies, foreign securities (25% or less of total assets), illiquid securities (10% or less of net assets) and when-issued securities; may invest in futures and options transactions, including puts and calls; and may enter into forward foreign currency contracts. As of June 30, 1999, Value Trust had approximately $___________ in assets. For its fiscal year ended March 31, 1999, the Primary shares of Value Trust had a total expense ratio of ____%. Legg Mason Capital Management, Inc. ("LMCM"), an affiliate of LMFA (the Adviser to the Portfolio) that shares investment personnel with LMFA, manages separate accounts in a manner substantially similar (although not necessarily identical to) that of the Portfolio. The total return for the composite of these accounts for the year ended June 30, 1999 and the period from January 1, 1999 through June 30, 1999 was _____% and _____%, respectively, and the average annual total return for the composite for one year (July 1, 1998 to June 30, 1999) was _____% and since inception (January 1, 1997 to June 30, 1999) was _____%. The number of accounts included in the composite has ranged from 1 to __ over the relevant period and the aggregate assets of the accounts has ranged from $___ million to $_____ million over the period. All of the fully discretionary tax-exempt accounts of LMCM with assets greater than $3 million are included in the composite after a period of three months and after the account becomes fully invested. Taxable and non-fully discretionary accounts and accounts that hold large amounts of cash are not managed by LMCM in a manner that is substantially similar to the Portfolio. The inclusion of taxable accounts, non-fully discretionary accounts, or accounts that hold large amounts of cash -3- might have adversely affected the performance of the composite. Accounts included in the composite are generally not subject to the diversification requirements, specific tax restrictions and investment limitations imposed on the Portfolio by the 1940 Act or the Code. The performance results for these accounts might have been adversely affected had the accounts been subject to these requirements, restrictions and limitations. These potential differences do not adversely affect the determination that the accounts included in this composite are managed in a substantially similar manner to the Portfolio. The performance information does not represent the performance of the Portfolio, which has been in operation only since September 22, 1998. The performance information should not be considered a prediction of future performance of the Portfolio. The Portfolio's performance may be higher or lower than that shown. Prior Performance of an Account Similar to the LM Mid Cap Institutional Portfolio. The investment performance for the period from July 1, 1989 to June 30, 1999 for the Primary class of shares of the Legg Mason Special Investment Trust ("Special Investment Trust") is shown below. The benchmark index to which Special Investment Trust is compared is the Russell 2000 Index. The Russell 2000 Index is an unmanaged index representing the performance of the 2000 smallest of the 3000 largest U.S.-domiciled corporations, ranked by market capitalization. Although used as a benchmark, the Index's performance may not be comparable to Special Investment Trust's performance since, unlike the performance of Special Investment Trust, the Index's performance has not been adjusted for any fees or expenses.
- -------------------------------------------------------------------------------------------------------------------- Yearly Total Return - -------------------------------------------------------------------------------------------------------------------- Year Ended June 30 Account Performance (%) Russell 2000 Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1999 - ---------------------------------------- ------------------------------------- ------------------------------------- 1998 22.29 16.51 - ---------------------------------------- ------------------------------------- ------------------------------------- 1997 22.52 16.33 - ---------------------------------------- ------------------------------------- ------------------------------------- 1996 25.89 23.89 - ---------------------------------------- ------------------------------------- ------------------------------------- 1995 8.85 20.11 - ---------------------------------------- ------------------------------------- ------------------------------------- 1994 4.97 4.34 - ---------------------------------------- ------------------------------------- ------------------------------------- 1993 25.72 26.01 - ---------------------------------------- ------------------------------------- ------------------------------------- 1992 12.34 14.54 - ---------------------------------------- ------------------------------------- ------------------------------------- 1991 14.37 1.33 - ---------------------------------------- ------------------------------------- ------------------------------------- 1990 10.96 2.96 - ---------------------------------------- ------------------------------------- -------------------------------------
-4-
- ---------------------------------------- --------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS - ---------------------------------------- --------------------------------------------------------------------------- Period ended Account Russell 2000 June 30 Performance (%) Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 3 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 5 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 10 Year - ---------------------------------------- ------------------------------------- -------------------------------------
Special Investment Trust, which commenced operations on December 30, 1985, is a diversified open-end investment company. Special Investment Trust's investment objective is capital appreciation. Current income is not a consideration. Special Investment Trust invests principally in equity securities, and securities convertible into equity securities, of companies with market capitalizations of less than $2.5 billion which LMFA believes have one or more of the following characteristics: they are not closely followed by, or are out of favor with, investors, and appear to be undervalued in relation to their long-term earning power or asset values; unusual developments have occurred which suggest the possibility that the market value of the securities will increase; or they are involved in actual or anticipated reorganizations or restructurings under the Bankruptcy Code (no more than 20% of Special Investment Trust's total assets may be invested in such securities). Special Investment Trust also invests in debt securities of companies having one or more of these characteristics. Special Investment Trust may invest in larger, more highly-capitalized companies when circumstances warrant such investments. Special Investment Trust may invest up to 20% of its total assets in securities of companies involved in actual or anticipated reorganizations or restructurings, and may purchase debt securities. Up to 35% of its net assets may be invested in debt securities not rated at least BBB by S&P, or Baa by Moody's, and securities unrated by those entities, deemed by LMFA to be of comparable quality. Special Investment Trust may purchase preferred stock, indexed securities, closed-end investment companies, foreign securities (25% or less of total assets), illiquid securities (10% or less of net assets) and when-issued securities; may invest in futures and options transactions, including puts and calls; and may enter into forward foreign currency contracts. When conditions warrant, for temporary defensive purposes, Special Investment Trust also may invest without limit in short-term debt instruments. As of June 30, 1999, Special Investment Trust had approximately $____________ in assets. For its fiscal year ended March 31, 1999, the Primary shares of Special Investment Trust had a total expense ratio of ____%. The performance information does not represent the performance of the Portfolio, which has not yet commenced operations and has no performance record of its own. The performance of the Portfolio. The Portfolio's performance may be higher or lower than that shown. Prior Performance of Accounts Similar to the Brandywine Small Cap Value Portfolio. The investment performance for the period from July 1, 1989 to June 30, 1999 of all accounts managed by Brandywine that are substantially similar to the Portfolio is shown below. The benchmark index to which the accounts are compared is the Russell 2000 Index. The Russell 2000 Index is an unmanaged index representing the performance of the 2000 smallest of the 3000 largest U.S.-domiciled corporations, -5- ranked by market capitalization. Although used as a benchmark, the Index's performance may not be comparable to the accounts' performance since, unlike the performance of the accounts, the Index's performance has not been adjusted for any fees or expenses.
- ----------------------------------------------------------------------------------------------------------------------- Yearly Total Return - ----------------------------------------------------------------------------------------------------------------------- Composite Year Ended June 30 Performance (%) Russell 2000 Performance (%) - ------------------------------------------- -------------------------------- ------------------------------------------ 1999 - ------------------------------------------- -------------------------------- ------------------------------------------ 1998 23.16 16.51 - ------------------------------------------- -------------------------------- ------------------------------------------ 1997 32.65 16.33 - ------------------------------------------- -------------------------------- ------------------------------------------ 1996 19.21 23.89 - ------------------------------------------- -------------------------------- ------------------------------------------ 1995 16.87 20.11 - ------------------------------------------- -------------------------------- ------------------------------------------ 1994 6.26 4.34 - ------------------------------------------- -------------------------------- ------------------------------------------ 1993 22.53 26.01 - ------------------------------------------- -------------------------------- ------------------------------------------ 1992 18.01 14.54 - ------------------------------------------- -------------------------------- ------------------------------------------ 1991 13.21 1.33 - ------------------------------------------- -------------------------------- ------------------------------------------ 1990 -2.82 2.96 - ------------------------------------------- -------------------------------- ------------------------------------------
- ---------------------------------------- ------------------------------------------------------------------------------ AVERAGE ANNUAL RETURNS - ---------------------------------------- ------------------------------------------------------------------------------ Period ended Composite Russell 2000 June 30 Performance (%) Performance (%) - ---------------------------------------- ------------------------------------- ---------------------------------------- 1 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- 3 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- 5 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- 10 Year - ---------------------------------------- ------------------------------------- ----------------------------------------
The number of accounts included in the composite has ranged from __ to __ over the relevant period and the aggregate assets of the accounts has ranged from $__ million to $__ billion over the period. One of the accounts included in the composite is a registered open-end investment company. Accounts included in the composite are generally not subject to the diversification requirements, specific tax restrictions and investment limitations imposed on the Portfolio by the 1940 Act or the Code. The performance results for these accounts might have been adversely affected had the accounts been subject to these requirements, restrictions and limitations. In addition, the accounts included in the composite have invested in so-called "micro" cap stocks to a greater extent than the Portfolio is likely to. These -6- potential differences do not adversely affect the determination that the accounts included in this composite are managed in a substantially similar manner to the Portfolio. The performance information does not represent the performance of the Portfolio, which has been in operation only since August 17, 1998. The performance information should not be considered a prediction of future performance of the Portfolio. The Portfolio's performance may be higher or lower than that shown. Prior Performance of Accounts Similar to the Batterymarch Emerging Markets Portfolio. The investment performance for the period from January 1, 1994 to June 30, 1999 of all accounts managed by Batterymarch that are substantially similar to the Portfolio is shown below. The benchmark index to which the accounts are compared is the MSCI Emerging Markets Free Index with Gross Dividends ("MSCI EMF"). The MSCI EMF is an unmanaged index representing the performance of a market weighted aggregate of 26 individual emerging country indices and takes into account local and market restrictions on share ownership by foreigners. Although used as a benchmark, the Index's performance may not be comparable to the accounts' performance since, unlike the performance of the accounts, the Index's performance has not been adjusted for any fees or expenses.
- -------------------------------------------------------------------------------------------------------------------- Yearly Total Return - -------------------------------------------------------------------------------------------------------------------- Year Ended June 30 Composite Performance (%) MSCI EMF Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1999 - ---------------------------------------- ------------------------------------- ------------------------------------- 1998 -34.01 -39.08 - ---------------------------------------- ------------------------------------- ------------------------------------- 1997 19.99 12.82 - ---------------------------------------- ------------------------------------- ------------------------------------- 1996 10.61 8.47 - ---------------------------------------- ------------------------------------- ------------------------------------- 1995 -7.51 0.01 - ---------------------------------------- ------------------------------------- ------------------------------------- 1994 (beginning January 1, 1994) -10.82 -9.04 - ---------------------------------------- ------------------------------------- -------------------------------------
-7-
- ---------------------------------------- ------------------------------------------------------------------------------ AVERAGE ANNUAL RETURNS - ---------------------------------------- ------------------------------------- ---------------------------------------- Period ended Composite MSCI EMF June 30 Performance (%) Performance (%) - ---------------------------------------- ------------------------------------- ---------------------------------------- 1 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- 3 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- 5 Year - ---------------------------------------- ------------------------------------- ---------------------------------------- Since Inception (January 1, 1994) - ---------------------------------------- ------------------------------------- ----------------------------------------
The number of accounts included in the composite has ranged from __ to __ over the relevant period and the aggregate assets of the accounts has ranged from $__ million to $__ billion over the period. One of the accounts included in the composite is the mutual fund described below. Accounts included in the composite are generally not subject to the diversification requirements, specific tax restrictions and investment limitations imposed on the Portfolio by the 1940 Act or the Code. The performance results for these accounts might have been adversely affected had the accounts been subject to these requirements, restrictions and limitations. These potential differences do not adversely affect the determination that the accounts included in this composite are managed in a substantially similar manner to the Portfolio. The performance of the composite is calculated based on AIMR standards, including the performance of the "mutual fund account" included in the composite, while the separate performance of the mutual fund shown below is calculated according to the SEC's method for calculating performance. The investment performance for the period from May 28, 1996 to June 30, 1999 for the Primary shares of the Legg Mason Emerging Markets Trust ("Emerging Markets Trust"), which has been advised by Batterymarch since its inception, is shown below.
- ----------------------------------------------------------------------------------------------------------------------- Yearly Total Return - ----------------------------------------------------------------------------------------------------------------------- MSCI EMF Year Ended June 30 Account Performance (%) Performance (%) - ------------------------------------------------- --------------------------------------- ----------------------------- 1999 - ------------------------------------------------- --------------------------------------- ----------------------------- 1998 -34.42 -39.08 - ------------------------------------------------- --------------------------------------- ----------------------------- 1997 27.41 12.82 - ------------------------------------------------- --------------------------------------- ----------------------------- 1996 (Inception of May 28, 1996) 0.20 -0.45 - ------------------------------------------------- --------------------------------------- -----------------------------
-8-
- ----------------------------------------------------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS - ------------------------------------------------- --------------------------------------- ----------------------------- Period ended MSCI EMF June 30 Account Performance (%) Performance (%) - ------------------------------------------------- --------------------------------------- ----------------------------- 1 Year - ------------------------------------------------- --------------------------------------- ----------------------------- Since Inception (May 28, 1996) - ------------------------------------------------- --------------------------------------- -----------------------------
Emerging Markets Trust, which commenced operations on May 28, 1996, is a diversified open-end investment company. Emerging Markets Trust's investment objective is long-term capital appreciation. Emerging Markets Trust normally invests at least 65% of its total assets in emerging market equity securities. Assets not invested in emerging market equity securities may be invested in any combination of debt securities of the U.S. Government, equity securities of issuers in developed countries, cash and money market instruments, including repurchase agreements. Batterymarch intends Emerging Markets Trust to be substantially fully invested in equity securities and convertible securities of emerging market issuers. Emerging Markets Trust may use options and stock index futures and may also enter into forward foreign currency exchange contracts in order to protect against fluctuations in exchange rates. More than 25% of Emerging Markets Trust's total assets may be denominated in a single currency. When abnormal market or economic situations warrant in the opinion of Batterymarch, Emerging Markets Trust may invest without limit for temporary defensive purposes in short-term debt instruments, including government, corporate and money market securities of domestic issuers, as well as repurchase agreements. Emerging Markets Trust also may purchase preferred stock, convertible securities, open- and closed-end investment companies, illiquid securities (15% or less of net assets) and when-issued securities; may invest in futures and options transactions, including puts and calls; and may borrow money, lend securities and enter into repurchase and reverse repurchase agreements. As of June 30, 1999, Emerging Markets Trust had approximately $___________ in assets. For its fiscal year ended December 31, 1998, the Primary shares of Emerging Markets Trust had a total expense ratio of ____% (after fee waivers; ____% in the absence of such waivers). THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER THAN THAT SHOWN. Prior Performance of Accounts Similar to the Batterymarch International Equity Portfolio. The investment performance for the period from July 1, 1989 to June 30, 1999 of all accounts managed by Batterymarch that are substantially similar to the Portfolio is shown below. The benchmark index to which the accounts are compared is the MSCI Europe Australia & Far East Index ("MSCI EAFE"). The MSCI EAFE is an unmanaged index representing the performance of share prices of approximately 1100 companies listed on stock exchanges around the world. Twenty countries are included in the Index. Although used as a benchmark, the Index's performance may not be comparable to the accounts' performance since, unlike the performance of the accounts, the Index's performance has not been adjusted for any fees or expenses. -9-
- -------------------------------------------------------------------------------------------------------------------- Yearly Total Return - ---------------------------------------- ------------------------------------- ------------------------------------- Year Ended June 30 Composite Performance (%) MSCI EAFE Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1999 - ---------------------------------------- ------------------------------------- ------------------------------------- 1998 11.72 6.38 - ---------------------------------------- ------------------------------------- ------------------------------------- 1997 18.51 13.16 - ---------------------------------------- ------------------------------------- ------------------------------------- 1996 14.24 13.62 - ---------------------------------------- ------------------------------------- ------------------------------------- 1995 1.20 1.95 - ---------------------------------------- ------------------------------------- ------------------------------------- 1994 17.32 17.30 - ---------------------------------------- ------------------------------------- ------------------------------------- 1993 6.60 20.70 - ---------------------------------------- ------------------------------------- ------------------------------------- 1992 8.26 -0.31 - ---------------------------------------- ------------------------------------- ------------------------------------- 1991 -15.96 -11.23 - ---------------------------------------- ------------------------------------- ------------------------------------- 1990 25.04 3.53 - ---------------------------------------- ------------------------------------- ------------------------------------- - ---------------------------------------- --------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS - ---------------------------------------- ------------------------------------- ------------------------------------- Period ended Composite MSCI EAFE June 30 Performance (%) Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 3 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 5 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 10 Year - ---------------------------------------- ------------------------------------- -------------------------------------
The number of accounts included in the composite has ranged from __ to __ over the relevant period and the aggregate assets of the accounts has ranged from $___ million to $___ billion over the period. One of the accounts included in the composite is the mutual fund described below. Accounts included in the composite are generally not subject to the diversification requirements, specific tax restrictions and investment limitations imposed on the Portfolio by the 1940 Act or the Code. The performance results for these accounts might have been adversely affected had the accounts been subject to these requirements, restrictions and limitations. These potential differences do not adversely affect the determination that the accounts included in this composite are managed in a substantially similar manner to the Portfolio. The performance of the composite is calculated based on AIMR standards, including the performance of the "mutual fund account" included in the composite, while the separate performance of the mutual fund shown below is calculated according to the SEC's method for calculating performance. -10- The investment performance for the period from February 17, 1995 to March 31, 1999 for the Primary shares of the Legg Mason International Equity Trust ("International Equity Trust"), which has been advised by Batterymarch since its inception, is shown below.
- ----------------------------------------------------------------------------------------------------------------------- Yearly Total Return - ----------------------------------------------------------------------------------------------------------------------- MSCI EAFE Year Ended June 30 Account Performance (%) Performance (%) - ------------------------------------------------- --------------------------------------- ----------------------------- 1999 - ------------------------------------------------- --------------------------------------- ----------------------------- 1998 5.73 6.38 - ------------------------------------------------- --------------------------------------- ----------------------------- 1997 18.74 13.16 - ------------------------------------------------- --------------------------------------- ----------------------------- 1996 15.90 13.62 - ------------------------------------------------- --------------------------------------- ----------------------------- 1995 (Inception February 17, 1995) 4.00 6.08 - ------------------------------------------------- --------------------------------------- ----------------------------- - ----------------------------------------------------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS - ----------------------------------------------------------------------------------------------------------------------- Period ended June 30 Account Performance (%) MSCI EAFE Performance (%) - ------------------------------------------------- --------------------------------------- ----------------------------- 1 Year - ------------------------------------------------- --------------------------------------- ----------------------------- 3 Years - ------------------------------------------------- --------------------------------------- ----------------------------- Since Inception (February 17, 1995) - ------------------------------------------------- --------------------------------------- -----------------------------
International Equity Trust, which commenced operations on February 17, 1995, is a diversified open-end investment company. International Equity Trust's investment objective is maximum long-term total return. International Equity Trust normally invests at least 65% of its assets in equity securities of companies located outside the United States, and Batterymarch currently intends to invest substantially all of International Equity Trust's assets in non-U.S. equity securities. International Equity Trust may invest up to 35% of its total assets in emerging market securities. When cash is temporarily available, or for temporary defensive purposes, when Batterymarch believes such action is warranted by abnormal market or economic situations, International Equity Trust may invest without limit in cash and U.S. dollar-denominated money market instruments, including repurchase agreements of domestic issuers. When Batterymarch believes such action is warranted by abnormal market or economic situations, for temporary defensive purposes, International Equity Trust also may invest without limit in short-term debt instruments, including government, corporate and money market securities of domestic issuers. International Equity Trust is authorized to invest in stock index futures and options. International Equity Trust may also enter into forward foreign currency exchange contracts in order to protect against fluctuations in exchange rates. International Equity Trust also may purchase securities other than common stock, such as debentures or preferred stock that may or may not be convertible into common -11- stock. Some of these instruments may be rated below investment grade. International Equity Trust will not purchase securities rated below investment grade (or comparable unrated securities) if, as a result, more than 5% of its assets would be so invested. International Equity Trust may also invest in open- and closed-end investment companies, illiquid securities (15% or less of net assets) and when-issued securities; may invest in futures and options transactions, including puts and calls; and may borrow money, lend securities and enter into repurchase and reverse repurchase agreements. As of June 30, 1999, International Equity Trust had approximately $___________ in assets. For its fiscal year ended December 31, 1998, the Primary shares of International Equity Trust had a total expense ratio of ____%. THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER THAN THAT SHOWN. Prior Performance of an Account Similar to the LM Total Return Institutional Portfolio. The investment performance for the period from July 1, 1989 to June 30, 1999 for the Primary class of shares of the Legg Mason Total Return Trust, Inc. ("Total Return Trust") is shown below. The benchmark index to which Total Return Trust is compared is the S&P 500 Index. The S&P 500 Index is an unmanaged index representing the performance of 500 companies selected by S&P. Although used as a benchmark, the Index's performance may not be comparable to Total Return Trust's performance since, unlike the performance of Total Return Trust, the Index's performance has not been adjusted for any fees or expenses.
- -------------------------------------------------------------------------------------------------------------------- Yearly Total Return - -------------------------------------------------------------------------------------------------------------------- Year Ended June 30 Account Performance (%) S&P 500 Index Performance (%) - ------------------------------------- ------------------------------------- ---------------------------------------- 1999 - ------------------------------------- ------------------------------------- ---------------------------------------- 1998 23.31 30.16 - ------------------------------------- ------------------------------------- ---------------------------------------- 1997 38.14 34.71 - ------------------------------------- ------------------------------------- ---------------------------------------- 1996 23.28 26.00 - ------------------------------------- ------------------------------------- ---------------------------------------- 1995 11.83 26.07 - ------------------------------------- ------------------------------------- ---------------------------------------- 1994 4.69 1.41 - ------------------------------------- ------------------------------------- ---------------------------------------- 1993 14.66 13.63 - ------------------------------------- ------------------------------------- ---------------------------------------- 1992 25.09 13.41 - ------------------------------------- ------------------------------------- ---------------------------------------- 1991 2.45 7.39 - ------------------------------------- ------------------------------------- ---------------------------------------- 1990 -0.84 16.49 - ------------------------------------- ------------------------------------- ----------------------------------------
-12-
- ---------------------------------------- --------------------------------------------------------------------------- AVERAGE ANNUAL RETURNS - ---------------------------------------- ------------------------------------- ------------------------------------- Period ended Account S&P 500 Index June 30 Performance (%) Performance (%) - ---------------------------------------- ------------------------------------- ------------------------------------- 1 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 3 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 5 Year - ---------------------------------------- ------------------------------------- ------------------------------------- 10 Year - ---------------------------------------- ------------------------------------- -------------------------------------
Total Return Trust, which commenced operations on November 21, 1985, is a diversified open-end investment company. Total Return Trust's investment objective is to obtain capital appreciation and current income in order to achieve an attractive total investment return consistent with reasonable risk. Total Return Trust invests in dividend-paying common stocks, debt securities and securities convertible into common stocks which, in the opinion of LMFA, offer potential for attractive total return. Total Return Trust also invests in common stocks and securities convertible into common stocks which do not pay current dividends but which, in LMFA's opinion, offer prospects for capital appreciation and future income. Total Return Trust may invest in debt securities, including government, corporate and money market securities, consistent with its investment objective, during periods when or under circumstances where LMFA believes the return on certain debt securities may equal or exceed the return on equity securities. Total Return Trust may invest in debt securities of any maturity of both foreign and domestic issuers without regard to rating and may invest its assets in such securities without regard to a percentage limit. LMFA currently anticipates that, under normal market conditions, Total Return Trust will invest no more than 50% of its total assets in intermediate-term and long-term debt securities, and no more than 5% of its total assets in debt securities not rated investment grade, i.e., not rated at least BBB by S&P or Baa by Moody's or, if unrated by those entities, deemed by LMFA to be of comparable quality. Total Return Trust also may purchase preferred stock, indexed securities, closed-end investment companies, foreign securities (25% or less of total assets), illiquid securities (10% or less of net assets) and when-issued securities; may invest in futures and options transactions, including puts and calls; and may enter into forward foreign currency contracts. As of June 30, 1999, Total Return Trust had approximately $__________ in assets. For its fiscal year ended June 30, 1999, the Primary shares of Total Return Trust had a total expense ratio of ____%. THE PERFORMANCE INFORMATION DOES NOT REPRESENT THE PERFORMANCE OF THE PORTFOLIO, WHICH HAS NOT YET COMMENCED OPERATIONS AND HAS NO PERFORMANCE RECORD OF ITS OWN. THE PERFORMANCE INFORMATION SHOULD NOT BE CONSIDERED A PREDICTION OF FUTURE PERFORMANCE OF THE PORTFOLIO. THE PORTFOLIO'S PERFORMANCE MAY BE HIGHER OR LOWER THAN THAT SHOWN. -13- LM INSTITUTIONAL FUND ADVISORS II, INC. - -------------------------------------------------------------------------------- CUSTODIAN: TRANSFER AND SHAREHOLDER STATE STREET BANK SERVICING AGENT: AND TRUST CO. BOSTON FINANCIAL DATA P.O. Box 1713 SERVICES Boston, Massachusetts 02105 P.O. Box 953 Boston, Massachusetts, 02103 - -------------------------------------------------------------------------------- (LOGO) COUNSEL: INDEPENDENT ACCOUNTANT: ROPES & GRAY ERNST & YOUNG LLP One International Place 2001 Market Street Boston, MA 02110 Philadelphia, PA 19103 (617) 951-7000 - -------------------------------------------------------------------------------- DISTRIBUTOR: Legg Mason Wood Walker, Incorporated 100 Light Street P.O. Box 1476 Baltimore, MD 21203-1476 410-539-0000 800-822-5544 For investors who want more information about LMIFA II, the following documents are available upon request. Annual Reports The annual and semi-annual reports of LMIFA II provides additional information about their investments. In the annual report, you will also find a discussion of the market conditions and investment strategies that significantly affected the performance of LMIFA II during the last fiscal year. STATEMENT OF ADDITIONAL INFORMATION The SAI contains additional detailed information about LMIFA II and is incorporated by reference into (legally part of) this prospectus. Investors can receive free copies of these materials, request other information about the Funds and make shareholder inquiries by calling Legg Mason Wood Walker, Incorporated ("LMWW") at 1-800-822-5544. You can review, for a fee, the reports of the Portfolios and SAI by writing to the SEC's Public Reference Section, Washington, D.C. 20459-6009, or by calling the SEC at 1-800-SEC-0330. You can get copies of this information for free on the SEC's Internet site at http://www.sec.gov. LMIFA II's Investment Company Act of 1940 file number is 811-8611. -14- - -------------------------------------------------------------------------------- LM INSTITUTIONAL FUND ADVISORS II, INC. August 1, 1999 - -------------------------------------------------------------------------------- STATEMENT OF ADDITIONAL INFORMATION LM Institutional Fund Advisors II, Inc. (the "Fund") is a no-load, open-end diversified management investment company. LM Institutional Fund Advisors II, Inc. currently consists of six separate professionally managed investment portfolios which are described in this Statement of Additional Information ("SAI"). Each of these portfolios is referred to herein as a "Portfolio". This SAI is not a prospectus and should be read in conjunction with the Prospectus for the Portfolios, dated August 1, 1999, which has been filed with the Securities and Exchange Commission ("SEC"). Copies of the Portfolios' Prospectus are available without charge from Legg Mason Wood Walker, Incorporated at 1-888-42-LMIFA. TABLE OF CONTENTS ------------------
DEFINITIONS.......................................................................................................1 ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES..................................................2 ADDITIONAL INFORMATION ABOUT SECURITIES, INVESTMENT TECHNIQUES AND RELATED RISKS..................................4 FOREIGN SECURITIES.......................................................................................4 OPTIONS ON SECURITIES....................................................................................7 FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS................................................................8 RISKS ASSOCIATED WITH FUTURES AND OPTIONS...............................................................11 ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS TRADED ON FOREIGN EXCHANGES...............................................................................................14 COVER FOR HEDGING STRATEGIES............................................................................14 FOREIGN CURRENCY EXCHANGE TRANSACTIONS..................................................................15 PREFERRED STOCKS AND CONVERTIBLE SECURITIES.............................................................16 DEBT AND FIXED INCOME SECURITIES........................................................................16 COMMERCIAL PAPER AND OTHER SHORT-TERM INVESTMENTS.......................................................26 LOAN PARTICIPATIONS AND ASSIGNMENTS.....................................................................26 INDEXED SECURITIES AND STRUCTURED NOTES.................................................................27 FORWARD COMMITMENTS.....................................................................................28 RESTRICTED AND ILLIQUID SECURITIES......................................................................28 SECURITIES OF OTHER INVESTMENT COMPANIES................................................................29 REPURCHASE AGREEMENTS...................................................................................29 REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING.......................................................30 LOANS OF PORTFOLIO SECURITIES...........................................................................31 DURATION................................................................................................31 PORTFOLIO TURNOVER......................................................................................32 ALTERNATIVE INVESTMENT STRATEGIES.......................................................................32 NEW INVESTMENT PRODUCTS.................................................................................33 INVESTMENT POLICIES.....................................................................................33 RATINGS OF DEBT OBLIGATIONS.............................................................................33 REITs...................................................................................................33 VALUATION OF PORTFOLIO SHARES....................................................................................34 MANAGEMENT OF THE PORTFOLIOS.....................................................................................35
-i-
Directors and Officers..................................................................................35 Manager and Advisers....................................................................................37 PURCHASES AND REDEMPTIONS........................................................................................42 EXCHANGE PRIVILEGE...............................................................................................42 PORTFOLIO TRANSACTIONS AND BROKERAGE.............................................................................43 ADDITIONAL TAX INFORMATION.......................................................................................44 OTHER INFORMATION................................................................................................45 PERFORMANCE INFORMATION..........................................................................................48
-ii- DEFINITIONS "Adviser" means the investment advisory firm that manages a Portfolio's assets. LMFA, Brandywine and Batterymarch are each Advisers. "Batterymarch" means Batterymarch Financial Management, Inc., 200 Clarendon Street, Boston, Massachusetts 02116. Batterymarch is the Adviser to the Batterymarch Emerging Markets Portfolio and the Batterymarch International Equity Portfolio. "Brandywine" means Brandywine Asset Management, Inc., Three Christina Centre, Suite 1200, 201 N. Walnut Street, Wilmington, Delaware 19801. Brandywine is the Adviser to the Brandywine Small Cap Value Portfolio. "Code" means the Internal Revenue Code of 1986, as amended. "Distributor" means the party that is responsible for the distribution or sale of the Fund's shares. Legg Mason is the Fund's Distributor. "Exchange" means the New York Stock Exchange. "Fundamental Investment Limitation" means an investment limitation of a Portfolio that may be changed only with the affirmative vote of the lesser of (a) more than 50% of the outstanding shares of the relevant Portfolio or (b) 67% or more of the shares of the relevant Portfolio present at a shareholders' meeting if more than 50% of the outstanding shares of that Portfolio are represented at the meeting in person or by proxy. Only those policies or limitations expressly designated as such are fundamental investment limitations. All other policies and restrictions may be changed without shareholder approval. "Independent Director" means a Director of the Fund who is not an "interested person" (as defined in the 1940 Act) of the Fund. "Legg Mason" means Legg Mason Wood Walker, Incorporated. "LMFA" means Legg Mason Fund Adviser, Inc., 100 Light Street, Baltimore, MD 21202. LMFA is the Adviser to the LM Value Institutional Portfolio, the LM Mid Cap Institutional Portfolio and the LM Total Return Institutional Portfolio. "Manager" means LM Institutional Advisors, Inc., 100 Light Street, Baltimore, MD 21202. "1940 Act" means the Investment Company Act of 1940, as amended. "NRSROs" means nationally recognized (or foreign) statistical rating organizations, including Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's ("S&P"). "Plan" means the Fund's Distribution and Shareholder Services Plans. "SEC" means the Securities and Exchange Commission. "12b-1 Director" means a Director of the Fund who is an Independent Director and who has no direct or indirect financial interest in the operation of the Fund's Plans or the Fund's Underwriting Agreement. ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES Each Portfolio has adopted certain fundamental investment limitations that are set forth below. Each Portfolio may: (1) make loans, borrow money or issue senior securities to the fullest extent permitted by the 1940 Act, the rules or regulations thereunder or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to time. (2) not concentrate investments in a particular industry or group of industries as concentration is defined under the 1940 Act, the rules or regulations thereunder or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to time. Securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities and repurchase agreements thereon will not be considered to represent an industry. (3) underwrite securities to the fullest extent permitted by the 1940 Act, the rules or regulations thereunder or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to time. (4) purchase or sell commodities, commodities contracts, futures contracts, options, forward contracts or real estate to the fullest extent permitted by the 1940 Act, the rules or regulations thereunder or applicable orders of the SEC, as such statute, rules, regulations or orders may be amended from time to time. Additional Information - ----------------------- The fundamental investment limitations set forth above limit a Portfolio's ability to engage in certain investment practices and purchase securities to the extent permitted by, or consistent with, the 1940 Act. Relevant limitations of the 1940 Act are described below, which -2- are based either on the 1940 Act itself, the rules or regulations thereunder, or interpretations promulgated by the SEC. As such, these limitations of the 1940 Act are not "fundamental," that is, the limitations will change as the statute, rules, regulations or interpretations change, and no shareholder vote will be required or sought. Fundamental investment restriction (1). The 1940 Act presently limits a Portfolio's ability to borrow up to one-third of the value of its total assets. Borrowing by a Portfolio allows it to leverage its portfolio, which exposes it to certain risks. Leveraging increases the effect of any increase or decrease in the value of portfolio securities on a Portfolio's net asset value, and money borrowed will be subject to interest costs (which may include commitment fees and/or the cost of maintaining minimum average balances) which may or may not exceed the return from the securities purchased with borrowed funds. The 1940 Act also restricts the ability of any mutual fund to lend. Under the 1940 Act, a Portfolio may only make loans if expressly permitted to do so by the Portfolio's investment policies, and a Portfolio may not make loans to persons who control or are under common control with the Portfolio. Thus, the 1940 Act effectively prohibits a Portfolio from making loans to certain persons when conflicts of interest or undue influence are most likely present. The Portfolios may, however, make other loans which if made would expose shareholders to additional risks, such as the failure of the other party to repay the loan. The ability of a mutual fund to issue senior securities is severely circumscribed by complex regulatory constraints under the 1940 Act that restrict, for instance, the amount, timing, and form of senior securities that may be issued. Certain portfolio management techniques such as the purchase of securities on margin, short sales, or the writing of puts on portfolio securities, may be considered senior securities unless appropriate steps are taken to segregate a Portfolio's assets or otherwise cover its obligations. Fundamental investment restriction (2). "Concentration" is interpreted under the 1940 Act to mean investment of 25% or more of a Portfolio's total assets in a single industry. If a Portfolio were to "concentrate" its investments in a particular industry, investors would be exposed to greater risks because the Portfolio's performance would be largely dependent on that industry's performance. Fundamental investment restriction (3). The 1940 Act prohibits a diversified mutual fund from underwriting securities in excess of 25% of its total assets. Fundamental investment restriction (4). This restriction would permit investment in commodities, commodities contracts (e.g., futures contracts or options), forward contracts or real estate to the extent permitted under the 1940 Act. However, it is unlikely that the Portfolios would make such investments, other than the use of futures contracts, options, forward contracts and certain real estate-related securities as explained in the Prospectus and this Statement of Additional Information. Each Portfolio, however, would like the ability to consider using these -3- investment techniques in the future. Commodities, as opposed to commodity futures, represent the actual underlying bulk goods, such as grains, metals and food stuffs. Real estate-related securities include real estate investment trusts, commercial and residential mortgage-backed securities, and real estate financings, and such instruments are generally sensitive to factors such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, overbuilding, and the management skill and creditworthiness of the issuer. ADDITIONAL INFORMATION ABOUT SECURITIES, INVESTMENT TECHNIQUES AND RELATED RISKS FOREIGN SECURITIES Investing in the securities of issuers in any foreign country, or in securities denominated in a foreign currency, involves special risks and considerations not typically associated with investing in U.S. issuers or U.S. dollar-denominated securities. These include risks resulting from differences in accounting, auditing and financial reporting standards; lower liquidity than U.S. securities; the possibility of nationalization, expropriation or confiscatory taxation; adverse changes in investment or exchange control regulations (which may include suspension of the ability to transfer currency out of a country); and political instability. In many cases, there is less publicly available information concerning foreign issuers than is available concerning U.S. issuers. Additionally, purchases and sales of foreign securities and dividends and interest payable on those securities may be subject to foreign taxes and tax withholding. Foreign securities generally exhibit greater price volatility and a greater risk of illiquidity. To the extent a Portfolio purchases securities denominated in a foreign currency, a change in the value of any such currency against the U.S. dollar will result in a change in the U.S. dollar value of the Portfolio's assets and the Portfolio's income available for distribution. In addition, a Portfolio is required to compute and distribute its income in U.S. dollars. Therefore, if the exchange rate for a foreign currency declines after a Portfolio's income has been earned and translated into U.S. dollars (but before payment), the Portfolio could be required to liquidate portfolio securities to make such distributions. Similarly, if an exchange rate declines between the time a Portfolio incurs expenses in U.S. dollars and the time such expenses are paid, the amount of such currency required to be converted into U.S. dollars in order to pay such expenses in U.S. dollars will be greater than the equivalent amount in any such currency of such expenses at the time they were incurred. The relative performance of various countries' securities markets historically has reflected wide variations relating to the unique characteristics of each country's economy. Individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments position. Bank deposit insurance, if any, may be subject to widely varying regulations and limits in foreign countries. -4- Foreign securities purchased by a Portfolio may be listed on foreign exchanges, traded over-the-counter or purchased in private transactions. Transactions on foreign exchanges are usually subject to mark-ups or commissions higher than negotiated commissions on U.S. transactions. There is less government supervision and regulation of exchanges and brokers in many foreign countries than in the United States. Additional costs associated with an investment in foreign securities may include higher custodial fees than apply to domestic custodial arrangements and transaction costs of foreign currency conversions. Certain of the foregoing risks may also apply to some extent to securities of U.S. issuers that are denominated in foreign currencies or that are traded in foreign markets, or to securities of U.S. issuers having significant foreign operations. EMERGING MARKET ISSUERS. The risks of foreign investment, described above, are greater for investments in emerging market issuers, and such investments should therefore be considered speculative. Debt securities of governmental and other issuers in emerging market countries will typically be rated below investment grade or be of comparable quality. For more information about lower-rated securities, see "Debt and Fixed Income Securities -- Lower-Rated Securities" below. Investors are strongly advised to consider carefully the special risks involved in emerging markets, which are in addition to the usual risks of investing in developed markets around the world. Emerging market countries may experience substantial rates of inflation or deflation. Inflation, deflation and rapid fluctuations in such rates have had, and may continue to have, very negative effects on the economies and securities markets of certain emerging market countries. While some emerging market countries have sought to develop a number of corrective mechanisms to reduce inflation or deflation or mitigate their effects, inflation and deflation may continue to have significant effects both on emerging market countries and their securities markets. In addition, many of the currencies of emerging market countries have experienced steady devaluations relative to the U.S. dollar, and major devaluations have occurred in certain countries. Economies in emerging market countries generally are dependent heavily upon international trade and, accordingly, have been and may continue to be affected adversely by economic conditions, trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. Because of the high levels of foreign-denominated debt owed by many emerging market countries, fluctuating exchange rates can significantly affect the debt service obligations of those countries. This could, in turn, affect local interest rates, profit margins and exports, which are a major source of foreign exchange earnings. Hedging instruments are not typically available with respect to investments in emerging market countries and, to the extent they are available, the -5- ongoing and indeterminate nature of the foregoing risks (and the costs associated with hedging transactions) would make it virtually impossible to hedge effectively against such risks. To the extent an emerging market country faces a liquidity crisis with respect to its foreign exchange reserves, it may increase restrictions on the outflow of any foreign exchange. Repatriation is ultimately dependent on the ability of a Portfolio to liquidate its investments and convert the local currency proceeds obtained from such liquidation into U.S. dollars. Where this conversion must be done through official channels (usually the central bank or certain authorized commercial banks), the ability to obtain U.S. dollars is dependent on the supply of such U.S. dollars through those channels and, if available, upon the willingness of those channels to allocate those U.S. dollars to the Portfolio. In such a case, a Portfolio's ability to obtain U.S. dollars may be adversely affected by any increased restrictions imposed on the outflow of foreign exchange. If the Portfolio is unable to repatriate any amounts due to exchange controls, it may be required to accept an obligation payable at some future date by the central bank or other governmental entity of the jurisdiction involved. If such conversion can legally be done outside official channels, either directly or indirectly, a Portfolio's ability to obtain U.S. dollars may not be affected as much by any increased restrictions except to the extent of the price which may be required to be paid for the U.S. dollars. Many emerging market countries have little experience with the corporate form of business organization, and may not have well developed corporation and business laws or concepts of fiduciary duty in the business context. The securities markets of emerging market countries are substantially smaller, less developed, less liquid and more volatile than the securities markets of the U.S. and other more developed countries. Disclosure and regulatory standards in many respects are less stringent than in the U.S. and other major markets. There also may be a lower level of monitoring and regulation of an emerging market country's securities markets and the activities of investors in such markets; enforcement of existing regulations has been extremely limited. Some emerging markets have different settlement and clearance procedures, which, for example, may not call for delivery of a security to a Portfolio until well after the Portfolio has paid for such security. In certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct such transactions. The inability of a Portfolio to make intended securities purchases due to settlement problems could cause that Portfolio to miss attractive investment opportunities. Inability to dispose of a portfolio security caused by settlement problems could result either in losses to the Portfolio due to subsequent declines in value of the portfolio security or, if the Portfolio has entered into a contract to sell the security, in possible liability to the purchaser. The risk also exists that an emergency situation may arise in one or more emerging market countries as a result of which trading of securities may cease or may be substantially curtailed and prices for a Portfolio's portfolio securities in such markets may not be readily available. -6- SOVEREIGN DEBT SECURITIES. Sovereign debt is subject to risks in addition to those relating to foreign investments generally. As a sovereign entity, the issuing government may be immune from lawsuits in the event of its failure or refusal to pay the obligations when due. The debtor's willingness or ability to repay 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 the debt service burden to the economy as a whole, the sovereign debtor's policy toward principal international lenders and the political constraints to which the sovereign debtor may be subject. Sovereign debtors also may be dependent on expected disbursements from foreign governments or multinational agencies, the country's access to trade and other international credits, and the country's balance of trade. Some emerging market sovereign debtors have in the past rescheduled their debt payments or declared moratoria on payments, and similar occurrences may happen in the future. DEPOSITARY RECEIPTS. American Depositary Receipts, or "ADRs," are securities issued by a U.S. depositary (usually a bank) and represent a specified quantity of underlying non-U.S. securities on deposit with a custodian bank as collateral. A foreign issuer of the security underlying an ADR is generally not subject to the same reporting requirements in the United States as a domestic issuer. Accordingly, the information available to a U.S. investor will be limited to the information the foreign issuer is required to disclose in its own country and the market value of an ADR may not reflect undisclosed material information concerning the issuer or the underlying security. ADRs may also be subject to exchange rate risks if the underlying securities are denominated in foreign currency. The Portfolios may also invest in similar non-U.S. instruments issued by foreign banks or trust companies such as "GDRs" and "EDRs." For purposes of its investment policies, each Portfolio will treat ADRs and similar instruments as equivalent to investment in the underlying securities. OPTIONS ON SECURITIES Under an option contract, one party generally has the right to require the other to buy or sell a specified amount of securities, units of an index, currencies or futures contracts, and may exercise that right if the market price of the underlying instrument moves in a direction advantageous to the holder of the option. Options with respect to securities indices typically call for cash settlement instead of delivery of the securities that comprise the index. A Portfolio may purchase call options on securities for any purpose. For example, a call option may be purchased by a Portfolio on a security that its Adviser intends to include in the Portfolio's investment portfolio in order to fix the cost of a future purchase. Call options also may be used as a means of participating in an anticipated price increase of a security on a more limited risk basis than would be possible if the security itself were purchased. In the event of a decline in the price of the underlying security, use of this strategy would serve to limit the Portfolio's potential loss to the option premium paid; conversely, if the market price of the -7- underlying security increases above the exercise price and the Portfolio either sells or exercises the option, any profit realized would be reduced by the premium. A Portfolio may purchase put options on securities for any purpose. For example, a put option may be purchased by a Portfolio in order to hedge against a decline in the market value of securities held in its portfolio. The put option enables a Portfolio to sell the underlying security at the predetermined exercise price; thus the potential for loss to the Portfolio below the exercise price is limited to the option premium paid. If the market price of the underlying security is higher than the exercise price of the put option, any profit the Portfolio realizes on the sale of the security would be reduced by the premium paid for the put option less any amount for which the put option may be sold. A Portfolio may also write call and put options. FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS A futures contract on a security or foreign currency is a bilateral agreement pursuant to which one party agrees to make, and the other party agrees to accept, delivery of the specified type of security or foreign currency called for in the contract at a specified future time and at a specified price. A Portfolio may, for example, purchase a futures contract on a security or foreign currency when it intends to purchase securities or foreign currency but has not yet done so. This strategy may minimize the effect of all or part of an increase in the market price of the security or the relative value of the foreign currency that a Portfolio intends to purchase in the future. A rise in the price of the security or foreign currency prior to its purchase may either be offset by an increase in the value of the futures contract purchased by a Portfolio or avoided by taking delivery of the security or foreign currency under the futures contract. Conversely, a fall in the market price of the underlying security or foreign currency may result in a corresponding decrease in the value of the futures position. A Portfolio may sell a futures contract on a security or foreign currency, for example, in order to continue to receive the income from a security or foreign currency, while endeavoring to avoid part or all of the decline in the market value of that security that would accompany an increase in interest rates. Each Portfolio will limit its use of futures contracts and futures options to hedging transactions or other circumstances permitted to registered investment companies by regulatory authorities. For example, a Portfolio might use futures contracts to attempt to hedge against anticipated changes in interest rates that might adversely affect either the value of the Portfolio's securities or the price of the securities which the Portfolio intends to purchase. A Portfolio's hedging may include sales of futures contracts as an offset against the effect of expected increases in interest rates, and purchases of futures contracts as an offset against the effect of expected declines in interest rates. Although other techniques could be used to reduce exposure to interest rate fluctuations, a Portfolio may be able to hedge its exposure more effectively and perhaps at a lower cost by using futures contracts and options on futures contracts. -8- Futures contracts may also be used for non-hedging purposes, such as to simulate full investment in underlying securities while retaining a cash balance for Portfolio management purposes, as a substitute for direct investment in a security, to facilitate trading, to reduce transaction costs, or to seek higher investment returns when a futures contract or option is priced more attractively than the underlying security or index. A financial futures contract sale creates an obligation by the seller to deliver the type of financial instrument called for in the contract in a specified delivery month for a stated price. A financial futures contract purchase creates an obligation by the purchaser to take delivery of the type of financial instrument called for in the contract in a specified delivery month at a stated price. The specific instruments delivered or taken, respectively, at settlement date are not determined until on or near that date. The determination is made in accordance with the rules of the exchange on which the futures contract sale or purchase was made. Futures contracts are traded in the United States only on commodity exchanges or boards of trade -- known as "contract markets" -- approved for such trading by the Commodity Futures Trading Commission (the "CFTC"), and must be executed through a futures commission merchant or brokerage firm which is a member of the relevant contract market. When a purchase or sale of a futures contract is made by a Portfolio, the Portfolio is required to deposit with its custodian (or a broker, if legally permitted) a specified amount of cash or U.S. Government securities ("initial margin"). The margin required for a futures contract is set by the exchange on which the contract is traded and may be modified during the term of the contract. The initial margin is in the nature of a performance bond or good faith deposit on the futures contract which is returned to the Portfolio upon termination of the contract, assuming all contractual obligations have been satisfied. Under certain circumstances, such as during periods of high volatility, a Portfolio may be required by an exchange to increase the level of its initial margin payment. Additionally, initial margin requirements may be increased generally in the future by regulatory action. Each Portfolio expects to earn interest income on its initial margin deposits. A futures contract held by a Portfolio is valued daily at the official settlement price of the exchange on which it is traded. Each day the Portfolio pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by a Portfolio but is instead settlement between the Portfolio and the broker of the amount one would owe the other if the futures contract expired. In computing daily net asset value, each Portfolio will mark to market its open futures positions. A Portfolio is also required to deposit and maintain margin with respect to put and call options on futures contracts written by it. Such margin deposits will vary depending on the nature of the underlying futures contract (and the related initial margin requirements) and the current market value of the option and other futures positions held by the Portfolio. Although some futures contracts call for making or taking delivery of the underlying securities or currencies, generally those contracts are closed out prior to delivery by offsetting -9- purchases or sales of matching futures contracts (involving the same currency or underlying security and delivery month). If an offsetting purchase price is less than the original sale price, the Portfolio realizes a gain, or if it is more, the Portfolio realizes a loss. If an offsetting sale price is more than the original purchase price, the Portfolio realizes a gain, or if it is less, the Portfolio realizes a loss. If the Portfolio is unable to enter into a closing transaction, the amount of the Portfolio's potential loss is unlimited. In general, 40% of the gain or loss arising from the closing out of a futures contract traded on an exchange approved by the CFTC is treated as short-term gain or loss, and 60% is treated as long-term gain or loss. The Portfolio will also bear transaction costs for each contract which will be included in these calculations. A Portfolio will not enter into futures contracts or option positions if, immediately thereafter, the initial margin deposits plus premiums paid by it, less the amount by which any such options positions are "in-the-money" at the time of purchase, would exceed 5% of the fair market value of the Portfolio's total assets. A call option is "in-the-money" if the value of the futures contract that is the subject of the option exceeds the exercise price. A put option is "in-the-money" if the exercise price exceeds the value of the futures contract that is the subject of the option. A Portfolio may purchase and write call and put options on futures contracts it may buy or sell and enter into closing transactions with respect to such options to terminate existing positions. In return for the premium paid, options on futures contracts give the purchaser the right to assume a position in a futures contract at the specified option exercise price at any time during the period of the option. The Portfolio may use options on futures contracts in lieu of writing or buying options directly on the underlying securities or purchasing and selling the underlying futures contracts. For example, to hedge against a possible decrease in the value of its portfolio securities, a Portfolio may purchase put options or write call options on futures contracts rather than selling futures contracts. Similarly, a Portfolio may purchase call options or write put options on futures contracts as a substitute for the purchase of futures contracts to hedge against a possible increase in the price of securities which the Portfolio expects to purchase. Such options generally operate in the same manner as options purchased or written directly on the underlying investments. As with options on securities, the holder or writer of an option may terminate his position by selling or purchasing an offsetting option. There is no guarantee that such closing transactions can be effected. An index futures contract is a contract to buy or sell units of an index at a specified future date at a price agreed upon when the contract is made. Entering into a contract to buy units of an index is commonly referred to as buying or purchasing a contract or holding a long position in the index. Entering into a contract to sell units of an index is commonly referred to as selling a contract or holding a short position. A unit is the current value of the index. A Portfolio may enter into stock index futures contracts, debt index futures -10- contracts, or other index futures contracts appropriate to its objective. A Portfolio may also purchase and sell options on index futures contracts. For example, the Standard & Poor's 500 Composite Stock Price Index ("S&P 500") is composed of 500 selected common stocks, most of which are listed on the New York Stock Exchange. The S&P 500 assigns relative weightings to the common stocks included in the Index, and the value fluctuates with changes in the market values of those common stocks. In the case of the S&P 500, contracts are to buy or sell 500 units. Thus, if the value of the S&P 500 were $150, one contract would be worth $75,000 (500 units x $150). The stock index futures contract specifies that no delivery of the actual stocks making up the index will take place. Instead, settlement in cash must occur upon the termination of the contract, with the settlement being the difference between the contract price and the actual level of the stock index at the expiration of the contract. For example, if a Portfolio enters into a futures contract to buy 500 units of the S&P 500 at a specified future date at a contract price of $150 and the S&P 500 is at $154 on that future date, the Portfolio will gain $2,000 (500 units x gain of $4). If the Portfolio enters into a futures contract to sell 500 units of the stock index at a specified future date at a contract price of $150 and the S&P 500 is at $152 on that future date, the Portfolio will lose $1,000 (500 units x loss of $2). The requirements for qualification as a regulated investment company also may limit the extent to which a Portfolio may enter into futures or options on futures. See "Additional Tax Information." RISKS ASSOCIATED WITH FUTURES AND OPTIONS In considering the Portfolios' use of futures contracts and options, particular note should be taken of the following: (1) Positions in futures contracts and options may be closed out only on an exchange or board of trade which provides a secondary market for such futures contracts or options. Futures exchanges may limit the amount of fluctuation permitted in certain futures contract and option prices during a single trading day. The daily limit establishes the maximum amount that the price of a futures contract or option may vary either up or down from the previous day's settlement price at the end of the current trading session. Once the daily limit has been reached in a futures contract or option subject to the limit, no more trades may be made on that day at a price beyond that limit. The daily limit governs only price movements during a particular trading day and therefore does not limit potential losses because the limit may work to prevent the liquidation of unfavorable positions. For example, futures prices have occasionally moved to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of positions and subjecting some holders of futures contracts to substantial losses. -11- (2) The ability to establish and close out positions in either futures contracts or exchange-listed options is also subject to the maintenance of a liquid secondary market. Consequently, it may not be possible for a Portfolio to close a position and, in the event of adverse price movements, the Portfolio would have to make daily cash payments of variation margin (except in the case of purchased options). However, in the event futures contracts or options have been used to hedge portfolio securities, such securities generally will not be sold until the contracts can be terminated. In such circumstances, an increase in the price of the securities, if any, may partially or completely offset losses on the futures contract. However, there is no guarantee that the price of the securities will, in fact, correlate with the price movements in the contracts and thus provide an offset to losses on the contracts. The inability to close out a futures or option position may also restrict the Portfolio's ability to sell the underlying security or currency at a time when the Adviser might otherwise do so. (3) Successful use by a Portfolio of futures contracts and options will depend upon its Adviser's ability to predict market movements, which may require different skills and techniques than predicting changes in the prices of individual securities. Moreover, futures contracts relate not to the current level of the underlying instrument but to anticipated levels at some point in the future. There is, in addition, the risk that movements in the price of the futures contract or option will not correlate with movements in the prices of the securities or currencies being hedged. If the price of the securities or currencies being hedged has moved in a favorable direction, this advantage may be partially offset by losses in the futures or option position. In addition, if the Portfolio has insufficient cash, it may have to sell assets from its investment portfolio to meet daily variation margin requirements. Any such sale of assets may or may not be made at prices that reflect the rising market; consequently, a Portfolio may need to sell assets at a time when such sales are disadvantageous to the Portfolio. If the price of the futures or option contract moves more than the price of the underlying securities or currencies, the Portfolio will experience either a loss or a gain on the futures contract or option that may or may not be completely offset by movements in the price of the securities or currencies that are the subject of the hedge. (4) The value of an option position will reflect, among other things, the current market price of the underlying security, currency or futures contract, the time remaining until expiration, the relationship of the exercise price to the market price, the historical price volatility of the underlying security, currency or futures contract and general market conditions. For this reason, the successful use of options as a hedging strategy depends upon the Adviser's ability to forecast the direction of price fluctuations in the underlying market. (5) In addition to the possibility that there may be an imperfect correlation, or no correlation at all, between price movements in the futures and options position and the securities or currencies being hedged, movements in the prices of futures and options contracts may not correlate perfectly with movements in the prices of the hedged securities or currencies due to price distortions in the futures and options markets. There may be several reasons unrelated to the value of the underlying securities or currencies which cause this situation to occur. First, as -12- noted above, all participants in the futures market are subject to initial and variation margin requirements. If, to avoid meeting additional margin deposit requirements or for other reasons, investors choose to close a significant number of futures contracts through offsetting transactions, distortions in the normal price relationship between the securities or currencies and the futures markets may occur. Second, because the margin deposit requirements in the futures market are less onerous than margin requirements in the securities market, there may be increased participation by speculators in the futures market; such speculative activity in the futures market also may cause temporary price distortions. Third, participants could make or take delivery of the underlying securities or currencies instead of closing out their contracts. As a result, a correct forecast of general market trends may not result in successful hedging through the use of futures or options contracts over the short term. In addition, activities of large traders involving arbitrage and other investment strategies may result in temporary price distortions. (6) Options normally have expiration dates of up to nine months. The exercise price of the options may be below, equal to or above the current market value of the underlying security, currency or futures contract. Options that expire unexercised have no value, and the Portfolio will realize a loss in the amount paid and any transaction costs. (7) Like options on securities, options on futures contracts have a limited life. The ability to establish and close out options on futures will be subject to the development and maintenance of liquid secondary markets on the relevant exchanges or boards of trade. There can be no certainty that liquid secondary markets for all options on futures contracts will develop. (8) Purchasers of options on futures contracts pay a premium in cash at the time of purchase. This amount and the transaction costs are all that is at risk. Sellers of options on futures contracts, however, must post an initial margin and are subject to additional margin calls which could be substantial in the event of adverse price movements. In addition, although the maximum amount at risk when the Portfolio purchases an option is the premium paid for the option and the transaction costs, there may be circumstances when the purchase of an option on a futures contract would result in a loss to the Portfolio when the use of a futures contract would not, such as when there is no movement in the value of the securities or currencies being hedged. (9) A Portfolio's activities in the futures and options markets may result in a higher portfolio turnover rate and additional transaction costs in the form of added brokerage commissions; however, a Portfolio also may save on commissions by using such contracts as a hedge rather than buying or selling individual securities in anticipation or as a result of market movements. (10) A Portfolio may purchase and write both exchange-traded options and options traded on the OTC market. Exchange markets for options on debt securities exist but are relatively new, and the ability to establish and close out positions on the exchanges is subject to the maintenance of a liquid secondary market. Although the Portfolios intend to purchase or write only those exchange-traded options for which there appears to be an active secondary market, there is no assurance that a liquid secondary market will exist for any particular option at any specific time. -13- Closing transactions may be effected with respect to options traded in the OTC markets only by negotiating directly with the other party to the option contract, or in a secondary market for the option if such market exists. Although the Portfolios will enter into OTC options only with dealers which agree to enter into, and which are expected to be capable of entering into, closing transactions with the Portfolios, there can be no assurance that a Portfolio will be able to liquidate an OTC option at a favorable price at any time prior to expiration. In the event of insolvency of the contra-party, a Portfolio may be unable to liquidate an OTC option. Accordingly, it may not be possible to effect closing transactions with respect to certain options, with the result that the Portfolio would have to exercise those options which it has purchased in order to realize any profit. With respect to options written by a Portfolio, the inability to enter into a closing transaction may result in material losses to the Portfolio. For example, because a Portfolio must maintain a covered position with respect to any call option it writes on a security or futures contract the Portfolio may not sell the underlying security or futures contract or invest any cash, U.S. Government securities or short-term debt securities used as cover during the period it is obligated under such option. This requirement may impair a Portfolio's ability to sell a portfolio security or make an investment at a time when such a sale or investment might be advantageous. ADDITIONAL RISKS OF OPTIONS ON SECURITIES, FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS TRADED ON FOREIGN EXCHANGES Options on securities, options on currencies, futures contracts and options on futures contracts may be traded on foreign exchanges. Such transactions may not be regulated as effectively as similar transactions in the United States, may not involve a clearing mechanism and related guarantees and are subject to the risk of governmental actions affecting trading in, or the price of, foreign securities. The value of such positions also could be adversely affected by (1) other complex foreign political, legal and economic factors, (2) lesser availability than in the United States of data on which to make trading decisions, (3) delays in the Portfolios' ability to act upon economic events occurring in foreign markets during non-business hours in the United States, (4) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States and (5) lesser trading volume. COVER FOR HEDGING STRATEGIES Each Portfolio will comply with guidelines established by the SEC with respect to coverage of hedging strategies by mutual funds, and, if the guidelines so require, will set aside cash or liquid securities in a segregated account with its custodian in the amount prescribed, as marked to market daily. Securities, options or futures positions used for cover and securities held in a segregated account cannot be sold or closed out while the hedging strategy is outstanding, unless they are replaced with similar assets. As a result, there is a possibility that the use of cover or segregation involving a large percentage of a Portfolio's assets could impede portfolio management or a Portfolio's ability to meet redemption requests or other current obligations. -14- FOREIGN CURRENCY EXCHANGE TRANSACTIONS Each Portfolio that may invest in securities that are denominated in foreign currencies may engage in a variety of foreign currency exchange transactions to protect against uncertainty in the level of future exchange rates. These transactions may be engaged in connection with the purchase and sale of portfolio securities ("transaction hedging") and to protect the value of specific portfolio positions ("position hedging"). A Portfolio may engage in transaction hedging to protect against a change in the foreign currency exchange rates between the date on which the Portfolio contracts to purchase or sell the security and the settlement date, or to "lock in" the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. A Portfolio may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate. If conditions warrant, for transaction hedging purposes, a Portfolio may also enter into contracts to purchase or sell foreign currencies at a future date ("forward contracts") and may purchase and sell foreign currency futures contracts. A foreign currency forward contract is a negotiated agreement to exchange currency at a future time at a rate or rates that may be higher or lower than the spot rate. Foreign currency futures contracts are standardized exchange-traded contracts and have margin requirements. Each Portfolio may also purchase, sell and write exchange-listed and over-the-counter call and put options on foreign currency futures contracts and on foreign currencies. A Portfolio may engage in "position hedging" to protect against a decline in the value relative to the U.S. dollar of the currencies in which its portfolio securities are denominated or quoted (or an increase in the value of the currency in which securities the Portfolio intends to buy are denominated). For position hedging purposes, each Portfolio may purchase, sell or write foreign currency futures contracts, foreign currency forward contracts, and options on exchanges or over-the-counter markets. In connection with position hedging, a Portfolio may also purchase or sell foreign currency on a spot basis. A Portfolio's currency hedging transactions may call for the delivery of one foreign currency in exchange for another foreign currency and may at times involve currencies other than those in which its portfolio securities are then denominated. "Cross hedging" activities will be used when a Portfolio's Adviser believes that such transactions provide significant hedging opportunities for the Portfolio. Cross hedging transactions by a Portfolio involve the further risk of imperfect correlation between changes in the values of the currencies to which such transactions relate and changes in the values of such currencies and of the currency or other asset or liability which is the subject of the hedge. The decision as to whether and to what extent a Portfolio will engage in foreign currency exchange transactions will depend on a number of factors, including prevailing market conditions, the composition of a Portfolio's investments and the availability of suitable -15- transactions. Accordingly, there can be no assurance that a Portfolio will engage in foreign currency exchange transactions at any given time or from time to time. For a further discussion of the risks associated with purchasing and selling futures contracts and options, see "Risks Associated with Futures and Options" above. A Portfolio may also use other foreign currency exchange instruments and techniques when available and deemed appropriate by its Adviser. PREFERRED STOCKS AND CONVERTIBLE SECURITIES A preferred stock pays dividends at a specified rate and has preference over common stock in the payment of dividends and the liquidation of an issuer's assets but is junior to the debt securities of the issuer in those same respects. The market prices of preferred stocks are subject to changes in interest rates and are more sensitive to changes in an issuer's creditworthiness than are the prices of debt securities. Shareholders of preferred stock may suffer a loss of value if dividends are not paid. Under ordinary circumstances, preferred stock does not carry voting rights. A convertible security is a bond, debenture, note, preferred stock or other security that may be converted into or exchanged for a prescribed amount of common stock (or another equity security) of the same or a different issuer within a particular period of time at a specified price or formula. A convertible security entitles the holder to receive interest paid or accrued on debt or the dividend paid on preferred stock until the convertible security matures or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to nonconvertible debt securities in that they ordinarily provide a stream of income with generally higher yields than those of common stocks of the same or similar issuers. Convertible securities are usually subordinated to comparable-tier nonconvertible securities but rank senior to common stock in a corporation's capital structure. The value of a convertible security is a function of (1) its yield in comparison with the yields of other securities of comparable maturity and quality that do not have a conversion privilege and (2) its worth, at market value, if converted into the underlying common stock. A convertible security may be subject to redemption at the option of the issuer at a price established in the convertible security's governing instrument. If a convertible security held by a Portfolio is called for redemption, the Portfolio will be required to (1) permit the issuer to redeem the security, (2) convert it into the underlying common stock or (3) sell it to a third party. Any of these actions could have an adverse effect on a Portfolio's ability to achieve its investment objective. DEBT AND FIXED INCOME SECURITIES The Portfolios may invest in a variety of debt and fixed income securities. These securities share one principal risk: their values fluctuate with changes in interest rates. Thus, a -16- decrease in interest rates will generally result in an increase in the value of a Portfolio's fixed income investments. Conversely, during periods of rising interest rates, the value of a Portfolio's fixed income investments will generally decline. The magnitude of these fluctuations will generally be greater when a Portfolio's duration or average maturity is longer. Changes in the value of portfolio securities will not affect interest income from those securities, but will be reflected in a Portfolio's net asset value. The most common types of these instruments, and the associated risks, are described below. Subject to its investment policies and applicable law, each of the Portfolios may invest in these and other instruments. U.S. GOVERNMENT OBLIGATIONS. U.S. Government securities include (1) U.S. Treasury bills (maturity of one year or less), U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds (maturities generally greater than ten years) and (2) obligations issued or guaranteed by U.S. Government agencies or instrumentalities which are supported by any of the following: (a) the full faith and credit of the U.S. Government (such as GNMA certificates); (b) the right of the issuer to borrow an amount limited to a specific line of credit from the U.S. Government (such as obligations of the Federal Home Loan Banks); (c) the discretionary authority of the U.S. Government to purchase certain obligations of agencies or instrumentalities (such as securities issued by Fannie Mae); or (d) only the credit of the instrumentality (such as securities issued by Freddie Mac). In the case of obligations not backed by the full faith and credit of the United States, a Portfolio must look principally to the agency or instrumentality issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitments. Neither the U.S. Government nor any of its agencies or instrumentalities guarantees the market value of the securities they issue. Therefore, the market value of such securities will fluctuate in response to changes in interest rates. INFLATION-INDEXED SECURITIES. The Portfolios may also invest in inflation-indexed U.S. Treasury securities (also known as "Treasury Inflation-Protection Securities"). The principal value of Treasury Inflation-Protection Securities is adjusted daily in accordance with changes in the Consumer Price Index, while interest is calculated on the basis of the adjusted principal value on the payment date. The principal value of these securities declines in periods of deflation, but holders at maturity receive no less than par. If inflation is lower than expected during the period a Portfolio holds the security, the Portfolio may earn less on the security than on a conventional bond. Any increase in principal value is taxable in the year the increase occurs, even though holders do not receive cash representing the increase at that time. Changes in market interest rates from causes other than inflation will likely affect the price of these securities in the same manner as more traditional obligations. MORTGAGE-RELATED SECURITIES. Mortgage-related securities represent an interest in a pool of mortgages made by lenders such as commercial banks, savings and loan institutions, mortgage bankers and others. Mortgage-related securities may be issued by governmental, government-related or non-governmental entities, and provide regular payments which consist of interest and, in most cases, principal. In contrast, other forms of debt securities -17- normally provide for periodic payment of interest in fixed amounts with principal payments at maturity or specified call dates. In effect, payments on mortgage-related securities are a "pass-through" of the payments made by the individual borrowers on their mortgage loans, net of any fees paid to the issuer or guarantor of such securities. Additional payments to holders of mortgage-related securities are caused by repayments resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs which may be incurred. As prepayment rates of individual pools of mortgage loans vary widely, it is not possible to predict accurately the average life of a particular security. Although mortgage-related securities are issued with stated maturities of up to forty years, unscheduled or early payments of principal and interest on the underlying mortgages may shorten considerably the securities' effective maturities. The volume of prepayments of principal on a pool of mortgages underlying a particular mortgage-related security will influence the yield of that security, and the principal returned to a Portfolio may be reinvested in instruments whose yield may be higher or lower than that which might have been obtained had such prepayments not occurred. When interest rates are declining, such prepayments usually increase, and reinvestments of such principal prepayments will be at a lower rate than that on the original mortgage-related security. An increase in mortgage prepayments could cause the Portfolio to incur a loss on a mortgage-related security that was purchased at a premium. On the other hand, a decrease in the rate of prepayments, resulting from an increase in market interest rates or other causes, may extend the effective maturities of mortgage-related securities, increasing their sensitivity to changes in market interest rates and potentially increasing the volatility of a Portfolio's shares. The rate of prepayment may also be affected by general economic conditions, the location and age of the mortgages, and other social and demographic conditions. In determining the average maturity or duration of a mortgage-related security, a Portfolio's Adviser must apply certain assumptions and projections about the maturity and prepayment of such security; actual prepayment rates may differ. Because of prepayments, mortgage-related securities may have less potential for capital appreciation during periods of declining interest rates than other securities of comparable maturities, although they may have a similar risk of decline in market value during periods of rising interest rates. Most issuers or poolers provide guarantees of payments, regardless of whether the mortgagor actually makes the payment. The guarantees made by issuers or poolers are often backed by various forms of credit, insurance and collateral, although these may be in amounts less than the full obligation of the pool to its shareholders. Pools often consist of whole mortgage loans or participations in loans. The majority of these loans are made to purchasers of one- to four-family homes. The terms and characteristics of the mortgage instruments are generally uniform within a pool but may vary among pools. For example, in addition to fixed-rate, fixed-term mortgages, the Portfolios may purchase pools of variable-rate mortgages, growing-equity mortgages, graduated-payment mortgages and other types. -18- All poolers apply standards for qualification to lending institutions which originate mortgages for the pools. Poolers also establish credit standards and underwriting criteria for individual mortgages included in the pools. In addition, many mortgages included in pools are insured through private mortgage insurance companies. The average life of mortgage-related securities varies with the maturities and the nature of the underlying mortgage instruments. For example, securities issued by the Government National Mortgage Association ("GNMA") tend to have a longer average life than participation certificates ("PCs") issued by the Federal Home Loan Mortgage Corporation ("FHLMC") because there is a tendency for the conventional and privately-insured mortgages underlying FHLMC PCs to repay at faster rates than the Federal Housing Administration and Veterans Administration loans underlying GNMAs. In addition, the term of a security may be shortened by unscheduled or early payments of principal and interest on the underlying mortgages. The occurrence of mortgage prepayments is affected by factors including the level of interest rates, general economic conditions, the location and age of the mortgage and other social and demographic conditions. In determining the dollar-weighted average maturity of a Portfolio, the Portfolio's Adviser will follow industry practice in assigning an average life to the mortgage-related securities held by each Portfolio unless the interest rate on the mortgages underlying the securities is such that a different prepayment rate is likely. For example, if a GNMA has a high interest rate relative to the market, that GNMA is likely to have a shorter overall maturity than a GNMA with a market rate coupon. Moreover, Western Asset may deem it appropriate to change the projected average life for a Portfolio's mortgage-related securities as a result of fluctuations in market interest rates and other factors. Yields on mortgage-related securities are typically quoted based on the maturity of the underlying instruments and the associated average life assumption. Actual prepayment experience may cause the yield to differ from the yield expected on the basis of average life. Reinvestment of the prepayments may occur at higher or lower interest rates than the original investment, thus affecting the yield of the Portfolio. The compounding effect from reinvestments of monthly payments received by each Portfolio will increase the yield to shareholders compared to bonds that pay interest semi-annually. GOVERNMENT MORTGAGE-RELATED SECURITIES. GNMA is the principal federal government guarantor of mortgage-related securities. GNMA is a wholly owned U.S. Government corporation within the Department of Housing and Urban Development. GNMA pass-through securities are considered to have a relatively low risk of default in that (1) the underlying mortgage loan portfolio is comprised entirely of government-backed loans and (2) the timely payment of both principal and interest on the securities is guaranteed by the full faith and credit of the U.S. Government, regardless of whether they have been collected. GNMA pass-through securities are, however, subject to the same market risk as comparable debt securities. -19- Therefore, the effective maturity and market value of a Portfolio's GNMA securities can be expected to fluctuate in response to changes in interest rate levels. Residential mortgage loans are also pooled by Freddie Mac, a corporate instrumentality of the U.S. Government. The mortgage loans in Freddie Mac's portfolio are not government backed; Freddie Mac, not the U.S. Government, guarantees the timely payment of interest and ultimate collection of principal on Freddie Mac securities. Freddie Mac also issues guaranteed mortgage certificates, on which it guarantees semiannual interest payments and a specified minimum annual payment of principal. Fannie Mae is a government-sponsored corporation owned entirely by private stockholders. It is subject to general regulation by the Secretary of Housing and Urban Development. Fannie Mae purchases residential mortgages from a list of approved seller/servicers, which include savings and loan associations, savings banks, commercial banks, credit unions and mortgage bankers. Pass-through securities issued by Fannie Mae are guaranteed as to timely payment of principal and interest only by Fannie Mae, not the U.S. Government. PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. Mortgage-related securities offered by private issuers include pass-through securities comprised of pools of residential mortgage loans; mortgage-backed bonds which are considered to be debt obligations of the institution issuing the bonds and are collateralized by mortgage loans; and bonds and collateralized mortgage obligations ("CMOs") which are collateralized by mortgage-related securities issued by Freddie Mac, Fannie Mae or GNMA or by pools of mortgages. CMOs are typically structured with classes or series which have different maturities and are generally retired in sequence. Each class of obligations receives periodic interest payments according to the coupon rate on the obligations. However, all monthly principal payments and any prepayments from the collateral pool are generally paid first to the "Class 1" holders. Thereafter, all payments of principal are generally allocated to the next most senior class of obligations until that class of obligations has been fully repaid. Although full payoff of each class of obligations is contractually required by a certain date, any or all classes of obligations may be paid off sooner than expected because of an increase in the payoff speed of the pool. Other allocation methods may be used. Payment of interest or principal on some classes or series of a CMO may be subject to contingencies or some classes or series may bear some or all of the risk of default on the underlying mortgages. Mortgage-related securities created by non-governmental issuers generally offer a higher rate of interest than government and government-related securities because there are no direct or indirect government guarantees of payment in the former securities, resulting in higher risks. Where privately issued securities are collateralized by securities issued by Freddie Mac, Fannie Mae or GNMA, the timely payment of interest and principal is supported by the government- -20- related securities collateralizing such obligations. The market for conventional pools is smaller and less liquid than the market for the government and government- related mortgage pools. Certain private mortgage pools are organized in such a way that the SEC staff considers them to be closed-end investment companies. Each Portfolio's investment in such pools is constrained by federal statute, which restricts investments in the shares of other investment companies. The private mortgage-related securities in which the Portfolios may invest include foreign mortgage pass-through securities ("Foreign Pass-Throughs"), which are structurally similar to the pass-through instruments described above. Such securities are issued by originators of and investors in mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment bankers, specialized financial institutions and special purpose subsidiaries of the foregoing. Foreign Pass-Throughs usually are backed by a pool of fixed rate or adjustable-rate mortgage loans. Certain Foreign Pass-Throughs in which the Portfolios invest typically are not guaranteed by an entity having the credit status of GNMA, but generally utilize various types of credit enhancement. ASSET-BACKED SECURITIES. Asset-backed securities refer to securities that directly or indirectly represent a participation in, or are secured by and payable from, assets such as motor vehicle installment sales, installment loan contracts, leases of various types of real and personal property and receivables from revolving credit (credit card) agreements. Such assets are securitized through the use of trusts or special purpose corporations. Asset-backed securities are backed by a pool of assets representing the obligations often of a number of different parties. Certain of such securities may be illiquid. The principal on asset-backed securities, like that on mortgage-backed securities, may be prepaid at any time. As a result, if such securities are purchased at a premium, a prepayment rate that is faster than expected will reduce yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect. Conversely, if the securities are purchased at a discount, prepayments faster than expected will increase yield to maturity and prepayments slower than expected will decrease it. Accelerated prepayments also reduce the certainty of the yield because the Portfolio must reinvest the assets at the then-current rates. Accelerated prepayments on securities purchased at a premium also impose a risk of loss of principal. On the other hand, a decrease in the rate of prepayments may extend the effective maturities of the securities, increasing their sensitivity to changes in market interest rates and potentially increasing the volatility of a Portfolio's shares. The rate of prepayment may also be affected by general economic conditions and other social and demographic conditions. Each type of asset-backed security also entails unique risks depending on the type of assets involved and the legal structure used. For example, credit card receivables are generally unsecured obligations of the credit card holder and the debtors are entitled to the protection of a -21- number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. There have also been proposals to cap the interest rate that a credit card issuer may charge. In some transactions, the value of the asset-backed security is dependent on the performance of a third party acting as credit enhancer or servicer. Furthermore, in some transactions (such as those involving the securitization of vehicle loans or leases) it may be administratively burdensome to perfect the interest in the underlying collateral, and the underlying collateral may become damaged or stolen. Most issuers of automobile receivables permit the servicers to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of the automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. Because asset-backed securities are relatively new, the market experience in these securities is limited and the market's ability to sustain liquidity through all phases of the market cycle is not certain. MUNICIPAL OBLIGATIONS. Municipal obligations include obligations issued to obtain funds for various public purposes, including constructing a wide range of public facilities, such as bridges, highways, housing, hospitals, mass transportation, schools and streets. Other public purposes for which municipal obligations may be issued include the refunding of outstanding obligations, the obtaining of funds for general operating expenses and the making of loans to other public institutions and facilities. In addition, certain types of industrial development bonds ("IDBs") and private activity bonds ("PABs") are issued by or on behalf of public authorities to finance various privately operated facilities, including certain pollution control facilities, convention or trade show facilities, and airport, mass transit, port or parking facilities. Municipal obligations also include short-term tax anticipation notes, bond anticipation notes, revenue anticipation notes and other forms of short-term debt obligations. Such notes may be issued with a short-term maturity in anticipation of the receipt of tax payments, the proceeds of bond placements or other revenues. Municipal obligations also include municipal lease obligations and certificates of participation. Municipal lease obligations, which are issued by state and local governments to acquire land, equipment and facilities, typically are not fully backed by the municipality's credit, and, if funds are not appropriated for the following year's lease payments, a lease may terminate, with the possibility of default on the lease obligation and significant loss to the Portfolio. Certificates of participation are participations in municipal lease obligations or installment sales contracts. Each certificate represents a proportionate interest in or right to the payments made. The two principal classifications of municipal obligations are "general obligation" and "revenue" bonds. "General obligation" bonds are secured by the issuer's pledge of its faith, credit -22- and taxing power. "Revenue" bonds are payable only from the revenues derived from a particular facility or class of facilities or from the proceeds of a special excise tax or other specific revenue source such as the corporate user of the facility being financed. IDBs and PABs are usually revenue bonds and are not payable from the unrestricted revenues of the issuer. The credit quality of IDBs and PABs is usually directly related to the credit standing of the corporate user of the facilities. The ability of state, county or local governments to meet their obligations will depend primarily on the availability of tax and other revenues to those governments and on their fiscal conditions generally. The amounts of tax and other revenues available to governmental issuers may be affected from time to time by economic, political and demographic conditions within or outside of the particular state. In addition, constitutional or statutory restrictions may limit a government's power to raise revenues or increase taxes. The availability of federal, state and local aid to issuers of municipal securities may also affect their ability to meet their obligations. Payments of principal and interest on revenue bonds will depend on the economic condition of the facility or specific revenue source from whose revenues the payments will be made. The facility's economic status, in turn, could be affected by economic, political and demographic conditions affecting the particular state. CORPORATE DEBT SECURITIES. A Portfolio may invest in debt securities (i.e., bonds, debentures, notes and other similar debt instruments) of domestic or foreign non-governmental issuers which meet the minimum credit quality criteria, if any, set forth for the Portfolio. Corporate debt securities may pay fixed or variable rates of interest, or interest at a rate contingent upon some other factor, such as the price of some commodity. These securities may include warrants, may be convertible into preferred or common equity, or may be bought as part of a unit containing common stock. LOWER-RATED SECURITIES. Non-investment grade securities, i.e., securities rated below Baa by Moody's or BBB by S&P or comparable ratings of other NRSROs or unrated securities of comparable quality, are described as "speculative" by Moody's and S&P and may be subject to greater market fluctuations and greater risk of loss of income or principal, including a greater possibility of default or bankruptcy of the issuer of such securities, than are more highly rated debt securities. Such securities are commonly referred to as "junk bonds." A Portfolio's Adviser seeks to minimize the risks of investing in all securities through diversification, in-depth credit analysis and attention to current developments in interest rates and market conditions and will monitor the ratings of securities held by the Portfolios and the creditworthiness of their issuers. If the rating of a security in which a Portfolio has invested falls below the minimum rating in which the Portfolio is permitted to invest, the Portfolio will either dispose of that security within a reasonable time or hold the security for so long as the Portfolio's Adviser determines appropriate for that Portfolio, having due regard for market conditions, tax implications and other applicable factors. See the Appendix to the Prospectus for a description of the ratings assigned to fixed income securities by the rating agencies. -23- A debt security may be callable, i.e., subject to redemption at the option of the issuer at a price established in the security's governing instrument. If a debt security held by a Portfolio is called for redemption, the Portfolio will be required to permit the issuer to redeem the security or sell it to a third party. Either of these actions could have an adverse effect on a Portfolio's ability to achieve its investment objective because, for example, the Portfolio may be able to reinvest the proceeds only in securities with lower yields or may receive a price upon sale that is lower than it would have received in the absence of the redemption. The market for lower-rated securities has expanded rapidly in recent years. This growth has paralleled a long economic expansion. At certain times in the past, the prices of many lower-rated securities declined, indicating concerns that issuers of such securities might experience financial difficulties. At those times, the yields on lower-rated securities rose dramatically, reflecting the risk that holders of such securities could lose a substantial portion of their value as a result of the issuers' financial restructuring or default. There can be no assurance that such declines will not recur. The ratings of Moody's and S&P represent the opinions of those agencies as to the quality of the debt securities which they rate. Such ratings are relative and subjective, and are not absolute standards of quality. Unrated debt securities are not necessarily of lower quality than rated securities, but they may not be attractive to as many buyers. If securities are rated investment grade by one rating organization and below investment grade by the other, a Portfolio's investment adviser may rely on the rating that it believes is more accurate. Each Portfolio's Adviser will consider a security's quality and credit rating when determining whether such security is an appropriate investment. Subject to its investment objective, policies and applicable law, a Portfolio may purchase a security with the lowest rating. Where one of the NRSROs has assigned an investment grade rating to an instrument and others have given it a lower rating, the Portfolios may consider the instrument to be investment grade. The market for lower-rated securities may be thinner and less active than that for higher-rated securities, which can adversely affect the prices at which these securities can be sold, and may make it difficult for a Portfolio to obtain market quotations daily. If market quotations are not available, these securities will be valued by a method that the Portfolios' Boards of Directors believe accurately reflects fair market value. Judgment may play a greater role in valuing lower-rated debt securities than is the case with respect to securities for which a broader range of dealer quotations and last-sale information is available. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the values and liquidity of lower-rated securities, especially in a thinly traded market. Although the prices of lower-rated bonds are generally less sensitive to interest rate changes than are higher-rated bonds, the prices of lower-rated bonds may be more sensitive to adverse economic changes and developments regarding the individual issuer. Although the market for lower-rated debt securities is not new, and the market has previously weathered economic downturns, there has been in recent years a substantial increase in the use of such -24- securities to fund corporate acquisitions and restructurings. Accordingly, the past performance of the market for such securities may not be an accurate indication of its performance during future economic downturns or periods of rising interest rates. When economic conditions appear to be deteriorating, medium- to lower-rated securities may decline in value due to heightened concern over credit quality, regardless of the prevailing interest rates. Investors should carefully consider the relative risks of investing in high yield securities and understand that such securities are not generally meant for short-term investing. Adverse economic developments can disrupt the market for lower-rated securities, and severely affect the ability of issuers, especially highly leveraged issuers, to service their debt obligations or to repay their obligations upon maturity which may lead to a higher incidence of default on such securities. Lower-rated securities are especially affected by adverse changes in the industries in which the issuers are engaged and by changes in the financial condition of the issuers. Highly leveraged issuers may also experience financial stress during periods of rising interest rates. In addition, the secondary market for lower-rated securities, which is concentrated in relatively few market makers, may not be as liquid as the secondary market for more highly rated securities. As a result, a Portfolio could find it more difficult to sell these securities or may be able to sell the securities only at prices lower than if such securities were widely traded. Therefore, prices realized upon the sale of such lower rated or unrated securities, under these circumstances, may be less than the prices used in calculating a Portfolio's net asset value. Lower-rated or unrated debt obligations also present risks based on payment expectations. If an issuer calls an obligation for redemption, the Portfolio may have to replace the security with a lower yielding security, resulting in a decreased return for investors. If a Portfolio experiences unexpected net redemptions, it may be forced to sell its higher-rated securities, resulting in a decline in the overall credit quality of the Portfolio's investment portfolio and increasing the exposure of the Portfolio to the risks of lower-rated securities. STRIPPED SECURITIES. Stripped securities are created by separating bonds into their principal and interest components and selling each piece separately (commonly referred to as IOs and POs). The yield to maturity on an IO or PO class of stripped mortgage-backed securities is extremely sensitive not only to changes in prevailing interest rates but also to the rate of principal payments (including prepayments) on the underlying assets. A rapid rate of principal prepayments may have a measurably adverse effect on a Portfolio's yield to maturity to the extent it invests in IOs. If the assets underlying the IOs experience greater than anticipated prepayments of principal, the Portfolio may fail to recoup fully its initial investment in these securities. Conversely, POs tend to increase in value if prepayments are greater than anticipated and decline if prepayments are slower than anticipated. The secondary market for stripped mortgage-backed securities may be more volatile and less liquid than that for other mortgage-backed securities, potentially limiting a Portfolio's ability to buy or sell those securities at any particular time. -25- ZERO COUPON AND PAY-IN-KIND SECURITIES. A zero coupon bond is a security that makes no fixed interest payments but instead is sold at a discount from its face value. The bond is redeemed at its face value on the specified maturity date. Zero coupon bonds may be issued as such, or they may be created by a broker who strips the coupons from a bond and separately sells the rights to receive principal and interest. The prices of zero coupon bonds tend to fluctuate more in response to changes in market interest rates than do the prices of interest-paying debt securities with similar maturities. A Portfolio investing in zero coupon bonds generally accrues income on such securities prior to the receipt of cash payments. Since each Portfolio must distribute substantially all of its income to shareholders to qualify as a regulated investment company under federal income tax law, a Portfolio investing in zero coupon bonds may have to dispose of other securities to generate the cash necessary for the distribution of income attributable to its zero coupon bonds. Pay-in-kind securities have characteristics similar to those of zero coupon securities, but interest on such securities may be paid in the form of obligations of the same type rather than cash. COMMERCIAL PAPER AND OTHER SHORT-TERM INVESTMENTS Each of the Portfolios may invest or hold cash or other short-term investments, including commercial paper. Commercial paper represents short-term unsecured promissory notes issued in bearer form by banks or bank holding companies, corporations and finance companies. The Portfolios may purchase commercial paper issued pursuant to the private placement exemption in Section 4(2) of the Securities Act of 1933. Section 4(2) paper is restricted as to disposition under federal securities laws in that any resale must similarly be made in an exempt transaction. The Portfolios may or may not regard such securities as illiquid, depending on the circumstances of each case. Any Portfolio may also invest in obligations (including certificates of deposit, demand and time deposits and bankers' acceptances) of U.S. banks and savings and loan institutions. While domestic bank deposits are insured by an agency of the U.S. Government, the Portfolios will generally assume positions considerably in excess of the insurance limits. LOAN PARTICIPATIONS AND ASSIGNMENTS The purchase of loan participations and assignments entails special risks. A Portfolio's ability to receive payments of principal and interest and other amounts in connection with loan participations and assignments will depend primarily on the financial condition of the borrower. The failure by the Portfolio to receive scheduled interest or principal payments on a loan participation or assignment would adversely affect the income of the Portfolio and would likely reduce the value of its assets. Because loan participations are not generally rated by independent credit rating agencies, a decision by a Portfolio to invest in a particular loan participation will depend almost exclusively on its Adviser's credit analysis of the borrower. In addition to the other risks associated with investments in debt securities, participations and assignments involve the additional risk that the insolvency of any financial institution interposed between the -26- Portfolio and the borrower could delay or prevent the flow of payments from the borrower on the underlying loan. A Portfolio may have limited rights to enforce the terms of the underlying loan, and the liquidity of loan participations and assignments may be limited. The borrower of a loan in which a Portfolio holds a participation interest may, either at its own election or pursuant to terms of the loan documentation, prepay amounts of the loan from time to time. There is no assurance that the Portfolio will be able to reinvest the proceeds of any loan prepayment at the same interest rate or on the same terms as those of the original loan participation. Corporate loans in which a Portfolio may purchase a loan participation or assignment are made generally to finance internal growth, mergers, acquisitions, stock repurchases, leveraged buy-outs, and other corporate activities. The highly leveraged capital structure of the borrowers in certain of these transactions may make such loans especially vulnerable to adverse changes in economic or market conditions. Certain of the loan participations or assignments acquired by a Portfolio may involve unfunded commitments of the lenders or revolving credit facilities under which a borrower may from time to time borrow and repay amounts up to the maximum amount of the facility. In such cases, the Portfolio would have an obligation to advance its portion of such additional borrowings upon the terms specified in the loan documentation. INDEXED SECURITIES AND STRUCTURED NOTES The values of indexed securities and structured notes are linked to currencies, other securities, interest rates, commodities, indices or other financial indicators ("reference instruments"). These instruments differ from other types of debt securities in several respects. The interest rate or principal amount payable at maturity may vary based on changes in one or more specified reference instruments, such as a floating interest rate compared with a fixed interest rate or the currency exchange rates between two currencies (neither of which need be the currency in which the instrument is denominated). An indexed security or structured note may be positively or negatively indexed; that is, its value or interest rate may increase or decrease if the value of the reference instrument increases. Further, the change in the principal amount payable with respect to, or the interest rate of, an indexed security or structured note may be a multiple of the percentage change (positive or negative) in the value of the underlying reference instrument(s). Investment in indexed securities and structured notes involves certain risks, including the credit risk of the issuer and the normal risks of price changes in response to changes in interest rates. Further, in the case of certain indexed securities or structured notes, a decline in the reference instrument may cause the interest rate to be reduced to zero, and any further declines in the reference instrument may then reduce the principal amount payable on maturity. Finally, -27- these securities may be less liquid than other types of securities, and may be more volatile than their underlying reference instruments. FORWARD COMMITMENTS Each Portfolio may enter into commitments to purchase securities on a "forward commitment" basis, including purchases on a "when-issued" basis or a "to be announced" basis. When such transactions are negotiated, certain terms may be fixed at the time the commitment is made, but delivery and payment for the securities takes place at a later date. Such securities are often the most efficiently priced and have the best liquidity in the bond market. During the period between a commitment and settlement, no payment is made by the purchaser for the securities purchased and, thus, no interest accrues to the purchaser from the transaction. In a "to be announced" transaction, a Portfolio commits to purchase securities for which all specific information is not yet known at the time of the trade, particularly the exact face amount in forward commitment mortgage-backed securities transactions. A Portfolio may sell the securities subject to a forward commitment purchase, which may result in a gain or loss. When a Portfolio purchases securities on a forward commitment basis, it assumes the risks of ownership, including the risk of price fluctuation, at the time of purchase, not at the time of receipt. Purchases of forward commitment securities also involve a risk of loss if the seller fails to deliver after the value of the securities has risen. Depending on market conditions, a Portfolio's forward commitment purchases could cause its net asset value to be more volatile. Each Portfolio may also enter into a forward commitment to sell securities it owns and will generally do so only with the intention of actually delivering the securities. The use of forward commitments enables a Portfolio to hedge against anticipated changes in interest rates and prices. In a forward sale, a Portfolio does not participate in gains or losses on the security occurring after the commitment date. Forward commitments to sell securities also involve a risk of loss if the seller fails to take delivery after the value of the securities has declined. Forward commitment transactions involve additional risks similar to those associated with investments in options and futures contracts. See "Options and Futures Contracts." It is not expected that any Portfolio's purchases of forward commitments will at any time exceed, in the aggregate, 20% of that Portfolio's total assets. RESTRICTED AND ILLIQUID SECURITIES Restricted securities are securities subject to legal or contractual restrictions on their resale, such as private placements. Such restrictions might prevent the sale of restricted securities at a time when the sale would otherwise be desirable. No securities for which there is not a readily available market ("illiquid securities") will be acquired by any Portfolio if such -28- acquisition would cause the aggregate value of illiquid securities to exceed 15% of the Portfolio's net assets. Under SEC regulations, certain securities acquired through private placements can be traded freely among qualified purchasers. The SEC has stated that an investment company's board of directors, or its investment adviser acting under authority delegated by the board, may determine that a security eligible for trading under this rule is "liquid." The Portfolios intend to rely on this rule, to the extent appropriate, to deem specific securities acquired through private placement as "liquid." The Boards have delegated to a Portfolio's Adviser the responsibility for determining whether a particular security eligible for trading under this rule is "liquid." Investing in these restricted securities could have the effect of increasing a Portfolio's illiquidity if qualified purchasers become, for a time, uninterested in buying these securities. Restricted securities may be sold only (1) pursuant to SEC Rule 144A or other exemption, (2) in privately negotiated transactions or (3) in public offerings with respect to which a registration statement is in effect under the Securities Act of 1933, as amended. Rule 144A securities, although not registered in the U.S., may be sold to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933, as amended. Each Portfolio's Adviser, acting pursuant to guidelines established by its Board of Directors, may determine that some Rule 144A securities are liquid for purposes of limitations on the amount of illiquid investments a Portfolio may own. Where registration is required, a Portfolio may be obligated to pay all or part of the registration expenses and a considerable period may elapse between the time of the decision to sell and the time the Portfolio may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, the Portfolio might obtain a less favorable price than prevailed when it decided to sell. Illiquid securities may be difficult to value, and a Portfolio may have difficulty disposing of such securities promptly. The Portfolios do not consider foreign securities to be restricted if they can be freely sold in the principal markets in which they are traded, even if they are not registered for sale in the U.S. SECURITIES OF OTHER INVESTMENT COMPANIES Investments in other investment companies may involve the payment of substantial premiums above the net asset value of such issuers' portfolio securities, and the total return on such investments will be reduced by the operating expenses and fees of such investment companies, including advisory fees. The Portfolios may invest in both closed-end and open-end investment companies. REPURCHASE AGREEMENTS A repurchase agreement is an agreement under which securities are acquired from a securities dealer or bank subject to resale at an agreed upon price and date. The securities are -29- held by a Portfolio as collateral until retransferred and will be supplemented by additional collateral if necessary to maintain a total market value equal to or in excess of the value of the repurchase agreement. The Portfolio bears a risk of loss in the event that the other party to a repurchase agreement defaults on its obligations and the Portfolio is delayed or prevented from exercising its rights to dispose of the collateral securities. A Portfolio also bears the risk that the proceeds from any sale of collateral will be less than the repurchase price. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWING A reverse repurchase agreement is a portfolio management technique in which a Portfolio temporarily transfers possession of a portfolio instrument to another person, such as a financial institution or broker-dealer, in return for cash. At the same time, the Portfolio agrees to repurchase the instrument at an agreed upon time (normally within seven days) and price, including interest payment. While engaging in reverse repurchase agreements, each Portfolio will maintain cash or securities in a segregated account at its custodian bank with a value at least equal to the Portfolio's obligation under the agreements, adjusted daily. Reverse repurchase agreements may expose a Portfolio to greater fluctuations in the value of its assets and renders the segregated assets unavailable for sale or other disposition. The Portfolios may also enter into dollar roll transactions in which a Portfolio sells a fixed income security for delivery in the current month and simultaneously contracts to purchase substantially similar (same type, coupon and maturity) securities at an agreed upon future time. By engaging in the dollar roll transaction the Portfolio foregoes principal and interest paid on the security that is sold, but receives the difference between the current sales price and the forward price for the future purchase. The Portfolio would also be able to earn interest on the income that is received from the initial sale. The obligation to purchase securities on a specified future date involves the risk that the market value of the securities that a Portfolio is obligated to purchase may decline below the purchase price. In addition, in the event the other party to the transaction files for bankruptcy, becomes insolvent or defaults on its obligation, a Portfolio may be adversely affected. Each Portfolio will limit its investments in reverse repurchase agreements and other borrowing (including dollar roll transactions) to no more than one-third of its total assets. To avoid potential leveraging effects of such borrowing, a Portfolio will not make investments while its borrowing (including reverse repurchase agreements but excluding dollar rolls) is in excess of 5% of its total assets. To avoid potential leveraging effects of dollar rolls, each Portfolio will segregate assets as required by the Investment Company Act of 1940. The 1940 Act requires a Portfolio to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of at least 300% of the amount borrowed. If the asset coverage should decline below 300% as a result of market fluctuations or for other reasons, a Portfolio may be required to sell some of its holdings within -30- three days to reduce the debt and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing may increase the effect on net asset value of any increase or decrease in the market value of the Portfolio. Money borrowed will be subject to interest costs which may or may not be recovered by appreciation of the securities purchased. A Portfolio also may be required to maintain minimum average balances in connection with such borrowing or to pay a commitment or other fee to maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate. The Portfolios may enter into reverse repurchase agreements and dollar roll transactions as a method of borrowing. LOANS OF PORTFOLIO SECURITIES A Portfolio may lend its portfolio securities, provided that cash or equivalent collateral, equal to at least 100% of the market value of the securities loaned, is continuously maintained by the borrower with the Portfolio. During the time securities are on loan, the borrower will pay the Portfolio an amount equivalent to any dividends or interest paid on such securities, and the Portfolio may invest the cash collateral and earn additional income, or it may receive an agreed upon amount of interest income from the borrower who has delivered equivalent collateral. These loans are subject to termination at the option of the Portfolio or the borrower. A Portfolio may pay administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. No Portfolio presently expects to have on loan at any given time securities totaling more than one-third of its net assets. A Portfolio runs the risk that the counterparty to a loan transaction will default on its obligation and that the value of the collateral received may decline before the Portfolio can dispose of it. DURATION Duration is a measure of the expected life of a fixed income security on a cash flow basis. Duration takes the time intervals over which the interest and principal payments are scheduled and weights each by the present values of the cash to be received at the corresponding future point in time. For any fixed income security with interest payments occurring prior to the payment of principal, duration is always less than maturity. For example, a current coupon bond with a maturity of 3.5 years will have a duration of approximately three years. In general, the lower the stated or coupon rate of interest of a fixed income security, the longer its duration; conversely, the higher the stated or coupon rate of interest of a fixed income security, the shorter its duration. There may be circumstances under which even duration calculations do not properly reflect the interest rate exposure of a security. For example, floating variable rate securities may have final maturities of ten or more years; however, their interest exposure corresponds to the -31- frequency of the coupon reset. Similarly, many mortgage pass-through securities may have stated final maturities of 30 years, but current prepayment rates are more critical in determining the security's interest rate exposure. In these situations, the Adviser may consider other analytical techniques that incorporate the economic life of a security into its determination of interest rate exposure. PORTFOLIO TURNOVER While it is impossible to predict portfolio turnover rates, the turnover rates of the LM Value Institutional Portfolio and the Brandywine Small Cap Value Portfolio, for the period ended March 31, 1999 on an annualized basis were 28.6% and 45.1% respectively. The LM Mid Cap Institutional Portfolio, the Batterymarch Emerging Markets Portfolio, the Batterymarch International Equity Portfolio and the LM Total Return Institutional Portfolio currently expect that their average turnover rate will not exceed 100%, 50%, 75% and 100% respectively. The length of time a Portfolio has held a particular security is not generally a consideration in investment decisions. A change in the securities held by a Portfolio is known as "portfolio turnover." As a result of a Portfolio's investment policies, under certain market conditions a Portfolio's portfolio turnover rate may be higher than that of other mutual funds. Portfolio turnover generally involves some expense to a Portfolio, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestment in other securities. These transactions may result in realization of taxable capital gains. Higher portfolio turnover rates, such as those above 100%, are likely to result in higher brokerage commissions or other transactions costs and could give rise to a greater amount of taxable capital gains. ALTERNATIVE INVESTMENT STRATEGIES At times a Portfolio's Adviser may judge that conditions in the securities markets make pursuing the Portfolio's typical investment strategy inconsistent with the best interests of its shareholders. At such times, the Adviser may temporarily use alternative strategies, primarily designed to reduce fluctuations in the value of the Portfolio's assets. In implementing these defensive strategies, a Portfolio may invest without limit in securities that the Adviser believes present less risk to a Portfolio, including equity securities, debt and fixed income securities, preferred stocks, U.S. Government and agency obligations, cash or money market instruments, or in other securities the Adviser considers consistent with such defensive strategies. As a result of these strategies, the Batterymarch Emerging Markets Portfolio and the Batterymarch International Equity Portfolio may invest up to 100% of their assets in securities of U.S. issuers. It is impossible to predict when, or for how long, a Portfolio will use these alternative strategies. -32- NEW INVESTMENT PRODUCTS New types of mortgage-backed and asset-backed securities, derivative instruments and hedging instruments are developed and marketed from time to time. Consistent with its investment limitations, each Portfolio expects to invest in those new types of securities and instruments that its Adviser believes may assist the Portfolio in achieving its investment objective. INVESTMENT POLICIES The investment objective of each of the Western Asset Core, the Western Asset Limited Duration, the Western Asset Intermediate and the Western Asset Money Market Portfolio are "fundamental." Except for investment policies designated as fundamental in this Prospectus or the SAI, the investment policies described in this Prospectus and in the SAI are not fundamental policies. Changes to fundamental investment policies require shareholder approval; the Directors may change any non-fundamental investment policy without shareholder approval. RATINGS OF DEBT OBLIGATIONS Moody's, S&P and NRSROs are private organizations that provide ratings of the credit quality of debt obligations. A description of the ratings assigned to corporate debt obligations by Moody's and S&P is included as Appendix A to the Prospectus. A Portfolio may consider these ratings in determining whether to purchase, sell or hold a security. Ratings are not absolute assurances of quality. Consequently, securities with the same maturity, interest rate and rating may have different market prices. Credit rating agencies attempt to evaluate the safety of principal and interest payments and do not evaluate the risks of fluctuations in market value. Also, rating agencies may fail to make timely changes in credit ratings in response to subsequent events, so that an issuer's current financial condition may be better or worse than the rating indicates. REITs REITs pool investors' funds for investment primarily in income producing real estate or real estate related loans or interests. Under the Internal Revenue Code of 1986 (the "Code"), a REIT is not taxed on income it distributes to its shareholders if it complies with several requirements relating to its organization, ownership, assets, and income and a requirement that it generally distribute to its shareholders at least 95% of its taxable income (other than net capital gains) for each taxable year. REITs can generally be classified as Equity REITs, Mortgage REITs, and Hybrid REITs. Equity REITs, which invest the majority of their assets directly in -33- real property, derive their income primarily from rents. Equity REITs can also realize capital gains by selling properties that have appreciated in value. Mortgage REITs, which invest the majority of their assets in real estate mortgages, derive their income primarily from interest payments. Hybrid REITS combine the characteristics of both Equity REITs and Mortgage REITs. While a Portfolio will not generally invest in real estate directly, it may be subject to risks similar to those associated with the direct ownership of real estate. These risks include declines in the value of real estate, risks related to general and local economic conditions, dependency on management skill, heavy cash flow dependency, possible lack of availability of mortgage funds, overbuilding, extended vacancies of properties, increased competition, increases in property taxes and operating expenses, changes in zoning laws, losses due to costs resulting from the clean-up of environmental problems, liability to third parties for damages resulting from environmental problems, casualty or condemnation losses, limitations on rents, changes in neighborhood values and in the appeal of properties to tenants and changes in interest rates. In addition to these risks, REITs may be affected by changes in the value of the underlying property owned by the trusts, or by the quality of any credit they extend. Further, REITs are dependent upon management skills and generally may not be diversified. REITs are also subject to heavy cash flow dependency, defaults by borrowers and self-liquidation. In addition, REITs could possibly fail to qualify for tax-free pass-through of income under the Code or to maintain their exemptions from registration under the 1940 Act. The above factors may also adversely affect a borrower's or a lessee's ability to meet its obligations to the REIT. In the event of a default by a borrower or lessee, the REIT may experience delays in enforcing its rights as a mortgagee or lessor and may incur substantial costs associated with protecting its investments. In addition to the foregoing risks, certain "special purpose" REITs in which a Portfolio invests may invest their assets in specific real estate sectors, such as hotel REITs, nursing home REITs or warehouse REITs, and are therefore subject to the risks associated with adverse developments in any such sectors. VALUATION OF PORTFOLIO SHARES As described in the Prospectus, securities owned by any of the Portfolios for which market quotations are readily available are valued at current market value. Securities are valued at the last sale price for a comparable position on the day the securities are being valued or, lacking any sales on such day, at the last available bid price. In cases where securities are traded on more than one market, the securities are generally valued on the market considered by the Adviser as the primary market. -34- Occasionally, events affecting the value of foreign investments occur between the time at which they are determined and the close of trading on the Exchange, which events will not be reflected in a computation of a Portfolio's net asset value on that day. If events materially affecting the value of such investments occur during such time period, the investments will be valued at their fair value as determined in good faith by, or under the direction of, the Board of Directors. MANAGEMENT OF THE PORTFOLIOS Directors and Officers The Fund's officers are responsible for the operation of the Fund under the direction of its Board of Directors. The officers and Directors of the Fund and their principal occupations during the past five years are set forth below. An asterisk (*) indicates Interested Directors. The business address of Mr. Livingston is 117 Colorado Boulevard, Pasadena, California 91105. The business address of each officer and Director is 100 Light Street, Baltimore, Maryland 21202, unless otherwise indicated. Catherine H. Bray, 41, Director; Portfolio Manager, T. Rowe Price, June 1989-May 1996. *Edmund J. Cashman, 61, Director; Senior Executive Vice President and Director of Legg Mason, Inc.; Officer and/or Director of various other affiliates of Legg Mason, Inc.; President or Vice Chairman of the Board and Director/Trustee of four Legg Mason funds. *W. Curtis Livingston, III, 53, Director and Vice Chairman; Director of Western Asset Management Company (investment management firm) ("Western Asset"), March 1999-present; President, Director and Chief Executive Officer of Western Asset, December 1980-March 1999; President, Pacific American Income Shares, Inc.; Director, Legg Mason, Inc.; Director and President, LM Institutional Fund Advisors I, Inc.; Director and Vice Chairman of LM Institutional Advisors, Inc. Emmett J. Rice, 78, Director; Governor, Federal Reserve Central Bank, June 1979-February 1987; Director, Jardine-Fleming China Region Fund, July 1992-present; Director, Albermarle Corporation and Tredegar Industries, Inc. *Edward A. Taber, 54, Chairman, Director and President; Senior Executive Vice President of Legg Mason, Inc.; Director of the Legg Mason Value Trust, Inc., the Legg Mason Total Return Trust, Inc. and the Legg Mason Special Investment Trust, Inc.; Trustee of the Legg Mason Tax-Free Income Fund and the Legg Mason Cash Reserve Trust; President of the Legg Mason Income Trust, Inc., the Legg Mason Global Trust, Inc., LM Institutional Fund Advisors II, Inc. and the Legg Mason Investors Trust, Inc.; Director of Western Asset, Western Asset Global Management, Limited, Bartlett & Co., Batterymarch Financial Management, Inc., Gray, -35- Seifert & Co., Inc. (investment adviser), GSH & Co. Inc. (investment adviser holding company), Fairfield Group, Inc. (investment adviser), LM Institutional Advisors, Inc., and Legg Mason Fund Adviser, Inc.; formerly director of Taxable Fixed Income Division of T. Rowe Price Associates, Inc. Robert M. Tarola, 48, Director; Senior Vice President and Chief Financial Officer, Helix Health, Inc., July 1996-present; Partner, Price Waterhouse LLP, May 1974-June 1996. Linda R. Taylor, 52, Director. Marie K. Karpinski, 49, Vice President and Treasurer; Vice President and Treasurer of twenty-one Legg Mason/Bartlett funds (open-end investment companies), 1986-present; Vice President and Treasurer of LM Institutional Fund Advisors I, Inc.; Assistant Treasurer of Pacific American Income Shares, Inc. (closed-end investment company), 1988-present; Treasurer of Legg Mason Fund Adviser, Inc., March 1986-present; Vice-President of Legg Mason Wood Walker, Incorporated., 1992-present; Assistant Vice-President of Legg Mason Wood Walker, Incorporated, 1989-1992. Officers and Directors of the Fund who are affiliated persons of the Manager, the Advisers, LMFA or Legg Mason receive no salary or fees from the Fund. Each Independent Director receives an annual retainer of $500 per Portfolio and a per meeting fee of $500 per Portfolio. The following table provides certain information relating to the compensation of the Fund's Directors and senior executive officers.
- ------------------------------------------ ---------------------------------- -------------------------------------- Aggregate Compensation From the Fund Name of Person and Position Total Compensation From the Fund* and Complex Paid to Directors** - ------------------------------------------ ---------------------------------- -------------------------------------- Catherine H. Bray Director $13,125 $13,125 - ------------------------------------------ ---------------------------------- -------------------------------------- Edmund J. Cashman Director 0 0 - ------------------------------------------ ---------------------------------- -------------------------------------- W. Curtis Livingston, III Director 0 0 - ------------------------------------------ ---------------------------------- -------------------------------------- Emmett J. Rice Director $13,125 $13,125 - ------------------------------------------ ---------------------------------- -------------------------------------- Edward A. Taber III Director and President 0 0 - ------------------------------------------ ---------------------------------- --------------------------------------
-36-
- ------------------------------------------ ---------------------------------- -------------------------------------- Robert M. Tarola Director $ 6,125 $ 6,125 - ------------------------------------------ ---------------------------------- -------------------------------------- Linda R. Taylor Director $13,125 $13,125 - ------------------------------------------ ---------------------------------- --------------------------------------
*Represents fees paid to each person during the fiscal period ended March 31, 1999. **Represents aggregate compensation paid to each person during the fiscal period ended March 31, 1999. - -------------------------------------------------------------------------------- Manager and Advisers The Manager. The Manager, a wholly owned subsidiary of Legg Mason, Inc., a financial services holding company, serves as investment manager to the Portfolios of the Fund under separate Investment Management Agreements dated June 3, 1998 between the Manager and the Fund (the "Management Agreements"). The Management Agreements were most recently approved by the Board of Directors, including a majority of Independent Directors, on March 27, 1998, other than the LM Total Return Institutional Portfolio, which was most recently approved by the Board of Directors, including a majority of Independent Directors, on May 29, 1998. Under the Management Agreement, the Manager is responsible, subject to the general supervision of the Fund's Board of Directors, for the actual management of the Fund's assets, including the responsibility for making decisions and placing orders to buy, sell or hold a particular security, consistent with the investment objectives and policies described in the Prospectus and this Statement of Additional Information. The Manager also is responsible for the compensation of Directors and officers of the Fund who are employees of the Manager or its affiliates. The Manager receives for its services a fee as described in the Prospectus. As noted below, the Manager has delegated responsibility for the selection of the Fund's investments to the Advisers. Each Portfolio pays all of its other expenses which are not assumed by the Manager. These expenses include, among others, expenses of preparing and printing prospectuses, statements of additional information, proxy statements and reports and of distributing them to existing shareholders, custodian charges, transfer agency fees, organizational expenses, compensation of the Directors who are not "interested persons" of the Manager, or its affiliates, as that term is defined in the 1940 Act, legal and audit expenses, insurance expenses, expenses of registering and qualifying shares of the Portfolios for sale under federal and state law, Rule 12b-1 fees, governmental fees, expenses incurred in connection with membership in investment company organizations, interest expense, taxes and brokerage fees and commissions. The Portfolios also are liable for such nonrecurring expenses as may arise, including litigation to which a Portfolio or the Fund may be a party. The Fund may also have an obligation to indemnify its Directors and officers with respect to litigation. -37- Under the Management Agreement, the Manager will not be liable for any error of judgment or mistake of law or for any loss suffered by the Portfolios in connection with the performance of the Management Agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless disregard by it of its obligations or duties thereunder. The Management Agreement terminates automatically upon assignment and is terminable with respect to any Portfolio at any time without penalty by vote of the Fund's Board of Directors, by vote of a majority of that Portfolio's outstanding voting securities, or by the Manager, on not less than 60 days' notice to the Fund, and may be terminated immediately upon the mutual written consent of the Manager and the Fund. For the period ended March 31, 1999, the Manager has received $62,027 (and had fees waived of $78,094) and $0 (and had fees waived of $7,607 and additional reimbursements of $58,187)for the LM Value Institutional Portfolio and the Brandywine Small Cap Value Portfolio, respectively. Advisers LMFA. LMFA, a wholly owned subsidiary of Legg Mason, Inc., serves as Adviser to the LM Value Institutional Portfolio, the LM Mid Cap Institutional Portfolio and the LM Total Return Institutional Portfolio under separate Investment Advisory Agreements dated June 3, 1998 between LMFA and the Manager (the "LMFA Advisory Agreements"). The LMFA Advisory Agreements were most recently approved by the Board of Directors, including a majority of the Independent Directors, on March 27, 1998, other than for the LM Total Return Institutional Portfolio, which was most recently approved by the Board of Directors, including a majority of Independent Directors, on May 29, 1998. Under the LMFA Advisory Agreement, LMFA is responsible, subject to the general supervision of the Fund's Board of Directors and the Manager, for the actual management of the Portfolios' assets, including the responsibility for making decisions and placing orders to buy, sell or hold a particular security, consistent with the investment objectives and policies described in the Prospectus and this Statement of Additional Information. LMFA receives from the Manager for its services an advisory fee as described in the Prospectus. Under the LMFA Advisory Agreement, LMFA will not be liable for any error of judgment or mistake of law or for any loss suffered by the Portfolios in connection with the performance of the LMFA Advisory Agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless disregard by it of its obligations or duties thereunder. -38- The LMFA Advisory Agreement terminates automatically upon assignment and is terminable with respect to any Portfolio at any time without penalty by vote of the Fund's Board of Directors, by vote of a majority of that Portfolio's outstanding voting securities, or by LMFA, on not less than 60 days' notice, and may be terminated immediately upon the mutual written consent of the parties. Brandywine. Brandywine, a wholly owned subsidiary of Legg Mason, Inc., serves as the Adviser to the Brandywine Small Cap Value Portfolio under an Investment Advisory Agreement dated June 3, 1998 between Brandywine and the Manager (the "Brandywine Advisory Agreement"). The Brandywine Advisory Agreement was most recently approved by the Board of Directors, including a majority of the Independent Directors, on March 27, 1998. Under the Brandywine Advisory Agreement, Brandywine is responsible, subject to the general supervision of the Fund's Board of Directors and the Manager, for the actual management of the Portfolios' assets, including the responsibility for making decisions and placing orders to buy, sell or hold a particular security, consistent with the investment objectives and policies described in the Prospectus and this Statement of Additional Information. Brandywine also is responsible for the compensation of Directors and officers of the Fund who are employees of Brandywine or its affiliates. Brandywine receives from the Manager for its services to the Portfolios' an advisory fee as described in the Prospectus. Under the Brandywine Advisory Agreement, Brandywine will not be liable for any error of judgment or mistake of law or for any loss suffered by the Portfolios in connection with the performance of the Brandywine Advisory Agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless disregard by it of its obligations or duties thereunder. The Brandywine Advisory Agreement terminates automatically upon assignment and is terminable with respect to the Portfolio at any time without penalty by vote of the Fund's Board of Directors, by vote of a majority of the Portfolio's outstanding voting securities, or by Brandywine, on not less than 60 days' notice, and may be terminated immediately upon the mutual written consent of the parties. Batterymarch. Batterymarch, a wholly owned subsidiary of Legg Mason, Inc., serves as the Adviser to the Batterymarch Emerging Markets Portfolio and the Batterymarch International Equity Portfolio under separate Investment Advisory Agreements dated June 3, 1998 between Batterymarch and the Manager (the "Batterymarch Advisory Agreements"). The Batterymarch Advisory Agreements were most recently approved by the Board of Directors, including a majority of the Independent Directors, on March 27, 1998. Under the Batterymarch Advisory Agreement, Batterymarch is responsible, subject to the general supervision of the Fund's Board of Directors and the Manager, for the actual -39- management of the Portfolios' assets, including the responsibility for making decisions and placing orders to buy, sell or hold a particular security, consistent with the investment objectives and policies described in the Prospectus and this Statement of Additional Information. Batterymarch also is responsible for the compensation of Directors and officers of the Fund who are employees of Batterymarch or its affiliates. Batterymarch receives from the Manager for its services to the Portfolios' an advisory fee as described in the Prospectus. Under the Batterymarch Advisory Agreement, Batterymarch will not be liable for any error of judgment or mistake of law or for any loss suffered by the Portfolios in connection with the performance of the Batterymarch Advisory Agreement, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services or a loss resulting from willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless disregard by it of its obligations or duties thereunder. The Batterymarch Advisory Agreement terminates automatically upon assignment and is terminable with respect to any Portfolio at any time without penalty by vote of the Fund's Board of Directors, by vote of a majority of that Portfolio's outstanding voting securities, or by Batterymarch, on not less than 60 days' notice, and may be terminated immediately upon the mutual written consent of the parties. Distributor Legg Mason, 100 Light Street, P.O. Box 1476, Baltimore, MD 21203-1476, acts as distributor of the Fund's shares pursuant to an Underwriting Agreement with the Fund dated June 3, 1998 (the "Underwriting Agreement"). Legg Mason is not obligated to sell any specific amount of Fund shares and receives no compensation pursuant to the Underwriting Agreement. The Underwriting Agreement is terminable with respect to any Portfolio without penalty, at any time, by vote of a majority of the Fund's Independent Directors, or by vote of the holders of a majority of the shares of that Portfolio, or by Legg Mason upon 60 days' notice to the Fund. The Fund has adopted a Plan for each Portfolio which, among other things, permits the Fund to pay Legg Mason fees for its services related to sales and distribution of Financial Intermediary Class shares and the provision of ongoing services to Financial Intermediary Class shareholders. Payments are made only from assets attributable to Financial Intermediary Class shares. Under the Plan, the aggregate fees may not exceed an annual rate of 0.40% of each Portfolio's average daily net assets attributable to Financial Intermediary Class shares. Payments under the Plan are currently limited to 0.25% of average daily net assets. The Board of Directors may increase the limit up to 0.40% of average daily net assets as provided by the Plan without obtaining shareholder approval. Distribution activities for which such payments may be made include, but are not limited to, compensation to persons who engage in or support distribution and redemption of Shares, printing of prospectuses and reports for persons other than existing -40- shareholders, advertising, preparation and distribution of sales literature, overhead, travel and telephone expenses, all with respect to Financial Intermediary Class shares only. The Plan was approved by the sole shareholder of the Financial Intermediary Class of each Portfolio on June 3, 1998. Legg Mason may pay all or a portion of the fee to its investment executives. The Plan will continue in effect only so long as it is approved at least annually by the vote of a majority of the Board of Directors, including a majority of the 12b-1 Directors, cast in person at a meeting called for the purpose of voting on the Plan. The Plan may be terminated by a vote of a majority of the 12b-1 Directors or by a vote of a majority of the outstanding voting securities of the Financial Intermediary Class shares. Any change in the Plan that would materially increase the distribution cost to a Portfolio requires shareholder approval; otherwise the Plan may be amended by the Directors, including a majority of the 12b-1 Directors, as previously described. The Plan was most recently approved on June 3, 1998. In accordance with Rule 12b-1, the Plan provides that Legg Mason will submit to the Fund's Board of Directors, and the Directors will review, at least quarterly, a written report of any amounts expended pursuant to the Plan and the purposes for which expenditures were made. In addition, as long as the Plan is in effect, the selection and nomination of the Independent Directors will be committed to the discretion of such Independent Directors. For the fiscal period ended March 31, 1999, the LM Value Institutional Portfolio and the Brandywine Small Cap Value Portfolio paid Legg Mason $15,579 and $0, respectively in distribution and service fees under the Plan from assets attributable to Financial Intermediate Class shares. During the period ended March 31, 1999 Legg Mason incurred the following expenses with respect to Financial Intermediate Class shares:
- ------------------------------------ --------------------------------------- --------------------------------------- LM Value Institutional Brandywine Small Cap Value - ------------------------------------ --------------------------------------- --------------------------------------- Advertising, printing and mailing prospectuses to prospective shareholders $0 $0 - ------------------------------------ --------------------------------------- --------------------------------------- Compensation to underwriters $0 $0 - ------------------------------------ --------------------------------------- --------------------------------------- Compensation to broker-dealers $15,679 $0 - ------------------------------------ --------------------------------------- --------------------------------------- Compensation to sales personnel $0 $0 - ------------------------------------ --------------------------------------- ---------------------------------------
-41-
- ------------------------------------------ ---------------------------------- -------------------------------------- Interest, carrying or other financial charges $0 $0 - ------------------------------------ --------------------------------------- --------------------------------------- Other $0 $0 - ------------------------------------ --------------------------------------- --------------------------------------- Total Expenses $15,679 $0 - ------------------------------------ --------------------------------------- ---------------------------------------
PURCHASES AND REDEMPTIONS The Fund reserves the right to modify the mail, telephone or wire redemption services or to terminate the telephone or wire redemption services described in the Prospectus at any time without prior notice to shareholders. The Fund also reserves the right to suspend or postpone redemptions (1) for any period during which the Exchange is closed (other than for customary weekend and holiday closings), (2) when trading in markets the Fund normally utilizes is restricted or an emergency, as defined by rules and regulations of the SEC, exists, making disposal of the Fund's investments or determination of its net asset value not reasonably practicable, or (3) for such other periods as the SEC by regulation or order may permit for the protection of the Fund's shareholders. The Fund agrees to redeem shares of each Portfolio solely in cash up to the lesser of $250,000 or 1% of the relevant Portfolio's net assets during any 90-day period for any one shareholder. In consideration of the best interests of the remaining shareholders, the Fund reserves the right to pay any redemption price exceeding this amount in whole or in part by a distribution in kind of readily marketable securities held by a Portfolio in lieu of cash. It is highly unlikely that shares would ever be redeemed in kind. If shares are redeemed in kind, however, the redeeming shareholder should expect to incur transaction costs upon the disposition of the securities received in the distribution. EXCHANGE PRIVILEGE Shareholders in any of the Portfolios are entitled to exchange their shares for shares of the other Portfolios or of the portfolios of LM Institutional Fund Advisors I, Inc., provided that such shares are eligible for sale in the shareholder's state of residence, and are being offered at the time. When a shareholder decides to exchange shares of a Portfolio, the Fund's transfer agent will redeem shares of the Portfolio and invest the proceeds in shares of the Portfolio selected. Redemptions of shares of the Portfolio will be made at their net asset value determined on the same day that the request is received in proper order, if received before the close of regular trading on the Exchange. If the request is received by the transfer agent after such close of regular trading, shares will be redeemed at their net asset value determined as of the close of the Exchange on the next day the Exchange is open. -42- There is no charge for the exchange privilege and no sales charge imposed on an exchange, but the Portfolios reserve the right to modify or terminate the exchange privilege at any time. For more information concerning the exchange privilege, or to make an exchange, please contact the Portfolios. PORTFOLIO TRANSACTIONS AND BROKERAGE Under the various Management Agreements and Advisory Agreements, the Manager and the Advisers are responsible for the execution of the Portfolios' transactions. In selecting brokers or dealers, the Advisers must seek the most favorable price (including the applicable dealer spread) and execution for such transactions, subject to the possible payment as described below of higher brokerage commissions or spreads to brokers or dealers who provide research and analysis. The Portfolios may not always pay the lowest commission or spread available. Rather, in placing orders on behalf of the Portfolios, the Advisers will also take into account such factors as size of the order, difficulty of execution, efficiency of the executing broker's or dealer's facilities (including the services described below) and any risk assumed by the executing broker or dealer. Consistent with the policy of obtaining most favorable price and execution, an Adviser may give consideration to research, statistical and other services furnished by brokers or dealers to the Adviser for its use, may place orders with brokers or dealers who provide supplemental investment and market research and securities and economic analysis, and may pay to those brokers or dealers a higher brokerage commission or spread than may be charged by other brokers or dealers. Such research, analysis and other services may be useful to an Adviser in connection with services to clients other than the Portfolios. An Adviser's fee is not reduced by reason of its receiving such brokerage and research services. The Portfolios may not buy securities from, or sell securities to, an Adviser or its affiliated persons as principal, except as permitted by the rules and regulations of the SEC. Subject to certain conditions, the Portfolios may purchase securities that are offered in underwritings in which an affiliate of an Adviser is a participant, although the Portfolios may not make such purchases directly from such affiliate. The Advisers will select brokers to execute portfolio transactions. In the over-the-counter market, the Portfolios generally will deal with responsible primary market-makers unless a more favorable execution can otherwise be obtained. Investment decisions for the Portfolios are made independently from those of other funds and accounts advised by the Advisers. However, the same security may be held in the portfolios of more than one fund or account. When two or more accounts simultaneously engage in the purchase or sale of the same security, the prices and amounts will be equitably allocated to each account. In some cases, this procedure may adversely affect the price or quantity of the security available to a particular account. In other cases, however, an account's ability to participate in -43- larger volume transactions may produce better executions and prices. During the fiscal period ended March 31, 1999 the LM Value Institutional Portfolio and the Brandywine Small Cap Value Portfolio paid $122,652 and $9,266, respectively, in brokerage commissions on transactions. No brokerage commissions were paid by any Portfolio to affiliated persons. ADDITIONAL TAX INFORMATION General Requirements for "Pass-Through" Treatment In order to continue to qualify for treatment as a regulated investment company ("RIC") under the Code, each Portfolio must distribute annually to its shareholders at least 90% of its investment company taxable income (consisting generally of net investment income and net short-term capital gain, if any) and must meet several additional requirements. With respect to each Portfolio, these requirements include the following: (1) the Portfolio must derive at least 90% of its gross income each taxable year from dividends, interest, payments with respect to securities loans and gains from the sale or other disposition of securities or other income (including but not limited to gains from options or futures ) derived with respect to its business of investing in securities ("Income Requirement"); (2) at the close of each quarter of the Portfolio's taxable year, at least 50% of the value of its total assets must be represented by cash and cash items, U.S. Government securities, securities of other regulated investment companies and other securities, with those other securities limited, in respect of any one issuer, to an amount that does not exceed 5% of the value of the Portfolio's total assets and not 10% of the outstanding voting securities of such issuer; and (3) at the close of each quarter of the Portfolio's taxable year, not more than 25% of its total assets may be invested in securities (other than U.S. Government securities and securities of other regulated investment companies) of any one issuer and two or more issuers which the Portfolio controls and which are engaged in the same, similar, or related trades or businesses. If a Portfolio fails to distribute in a calendar year substantially all of its ordinary income for such year and substantially all of its capital gain net income for the one-year period ending October 31 (or later if the Portfolio is permitted and so elects), plus any retained amount from the prior year, the Portfolio will be subject to a 4% excise tax on the undistributed amounts. A distribution declared by a Portfolio in October, November or December of any year and payable to shareholders of record on a date in such months will be deemed to have been paid by the Portfolio and received by the shareholders on December 31 if the distribution is paid by the Portfolio during the following January. Such a distribution, therefore, will be taxable to shareholders for the year in which that December 31 falls. Each Portfolio intends generally to make distributions sufficient to avoid imposition of the 4% excise tax. Original Issue Discount -44- A Portfolio may purchase debt securities issued with original issue discount. Original issue discount that accrues in a taxable year will be treated as income earned by the Portfolio and therefore an equivalent amount must be distributed to satisfy the distribution requirement and avoid imposition of the 4% excise tax. Because the original issue discount earned by a Portfolio in a taxable year may not be represented by cash income, the Portfolio may have to dispose of other securities and use the proceeds thereof to make distributions in amounts necessary to satisfy those distribution requirements. A Portfolio may realize capital gains or losses from such dispositions, which would increase or decrease the Portfolio's investment company taxable income and/or net capital gain. Miscellaneous If a Portfolio invests in shares of preferred stock or otherwise holds dividend-paying securities as a result of exercising a conversion privilege, a portion of the dividends from the Portfolio's investment company taxable income (whether paid in cash or reinvested in additional shares) may be eligible for the dividends-received deduction allowed to corporations that meet certain holding period requirements. The eligible portion may not exceed the aggregate dividends received by the Portfolio from U.S. corporations. However, dividends received by a corporate shareholder and deducted by it pursuant to the dividends-received deduction are subject indirectly to the alternative minimum tax. Dividends and interest received by a Portfolio, and gains realized by a Portfolio on foreign securities, may be subject to income, withholding or other taxes imposed by foreign countries and U.S. possessions that would reduce the yield on the Portfolio's securities. Tax conventions between certain countries and the United States may reduce or eliminate these foreign taxes, however, and foreign countries generally do not impose taxes on capital gains in respect of investments by foreign investors. OTHER INFORMATION LMIFA II was incorporated in Maryland on January 13, 1998. Each Portfolio is an open-end, diversified management company. The Directors of LMIFA II may, without shareholder approval, create, in addition to the Portfolios, other series of shares representing separate investment portfolios. Any such series may be divided without shareholder approval into two or more classes of shares having such terms as the Directors may determine. Establishment and offering of additional portfolios or classes of shares of a portfolio will not alter the rights of the Fund's shareholders. LMIFA II has a total of [7] billion shares of common stock at par value $0.001. Each share has one vote, with fractional shares voting proportionally. Voting on matters pertinent only to a particular Portfolio, such as the adoption of an investment advisory contract for that Portfolio, is limited to that Portfolio's shareholders. Shares of all classes of a Portfolio will vote together as a single class except when otherwise required by law or as determined by the -45- Directors. Shares are freely transferable, are entitled to dividends as declared by the Directors, and, if a Portfolio were liquidated, would receive the net assets of that Portfolio. Voting rights are not cumulative, and all shares of the Portfolios are fully paid and nonassessable and have no preemptive or conversion rights. Although no Portfolio intends to hold annual shareholder meetings, it will hold a special meeting of shareholders when the Investment Company Act of 1940 (the "1940 Act") requires a shareholder vote on certain matters (including the election of Directors in certain cases or approval of an advisory contract). When issued, shares are fully paid, non-assessable, redeemable and freely transferable. Shares do not have preemptive rights or subscription rights. In liquidation of a Portfolio, each shareholder is entitled to receive his or her pro rata share of the net assets of that Portfolio. PRINCIPAL HOLDERS OF SECURITIES [Information to be provided by Legg Mason] Set forth below is a table which contains the name, address and percentage of ownership of each person who is known by the Fund to own beneficially five percent or more of the outstanding shares of any class of Portfolio as of May 27, 1999: % of Ownership Name and Address May 27, 1999 - ---------------- ------------- LM Value Institutional Portfolio Financial Intermediary Class Bank One 30.22% LSU Foundation 451 Florida Street Baton Rouge, LA 70801-1775 National Automatic Sprinkler 10.98% Metal Trades Pension Fund 8000 Corporate Drive Landover, MD 20785-2239 IBEW Local 728 Pension Fund 9.45% c/o Administrative Services Inc. 7990 SW 117th Avenue Miami, FL 33183-3845 Trans National Group Services L 8.07% 2 Charlesgate West Boston, MA 02113-3340 James W. Moore Trust 7.93% 1617 Hendry Street, Suite 306 Fort Myers, FL 33901-2970 City of Pottsville 5.92% Police Pension Plan 401 North Centre Street Post Office Box 30 Pottsville, PA 17901-0050 Penn Prime Trust 5.43% 530 Walnut Street, PA 4944 Philadelphia, PA 19106-3620 Institutional Class Charles Schwab & Co. Inc. 45.84% Special Custody Account Benefit of Customers 101 Montgomery Street San Francisco, CA 94104-4122 Firstar Trust Company Trust 11.43% United Communications Corp. Ret. 515 East Wisconsin Avenue Milwaukee, WI 53202-4604 Schneider National Inc. 6.87% 401 K Savings and Retirement Pla 510 Marquette, Suite 500 Minneapolis, MN 55401-1118 Houston Muni Employees Pension 5.21% 1111 Bagby Street, Suite 1450 Houston, TX 77002-2546 LM Mid-Cap Institutional Portfolio Financial Intermediary Class LM Institutional Advisers, Inc. 100% 100 Light St. Baltimore, MD 21202 -46- Institutional Class LM Institutional Advisers, Inc. 100% Brandywine Small Cap Value Portfolio Financial Intermediary Class LM Institutional Advisors, Inc. 100% Institutional Class The Hilda E. Bretzlaff Foundation 88.08% Village Center Mall 400 North Main Street, Suite 303 Milford, MI 48381-1928 Metro Suburbia Inc. 6.26% 4 New York Plaza, 2nd Floor New York, NY 10004-2413 Paul Scherer & Co. 5.00% 4 New York Plaza, 2nd Floor New York, NY 10004-2413 Batterymarch Emerging Markets Portfolio Financial Intermediary Class LM Institutional Advisers, Inc. 100% Institutional Class LM Institutional Advisers, Inc. 100% Batterymarch International Equity Portfolio Financial Intermediary Class LM Institutional Advisers, Inc. 100% Institutional Class LM Institutional Advisers, Inc. 100% LM Total Return Portfolio Financial Intermediary Class LM Institutional Advisers, Inc. 100% -47- Institutional Class LM Institutional Advisers, Inc. 100% Because they hold more than 25% of the outstanding voting securities of a Fund, LM Institutional Advisers, Inc. may be deemed to control the LM Mid Cap Institutional, Batterymarch Emerging Markets, Batterymarch International Equity and LM Total Return Portfolios and LSU Foundation and the Hilda E. Bretzloff Foundation may be deemed to control the LM Value Institutional and Brandwine Small Cap Portfolios. The Officers and Directors of the Funds own in the aggregate less than 1% of the outstanding shares of each Portfolio. PERFORMANCE INFORMATION Each Portfolio may, from time to time, include its total return in marketing materials or reports to shareholders or prospective investors. Quotations of average annual total return for a class of shares of a Portfolio will be expressed in terms of the average annual compounded rate of return of a hypothetical investment in that class of shares over periods of one, five and ten years (up to the life of the class), calculated pursuant to the following formula: P (1 + T)n = ERV (where P = a hypothetical initial payment of $1,000, T = the average annual total return, n = number of years, and ERV = the ending redeemable value of a hypothetical $1,000 payment made at the beginning of the period). All total return figures reflect the deduction of a proportional share of Portfolio expenses on an annual basis and assume that all dividends and other distributions are reinvested when paid. The performance of each class of a Portfolio will differ because each class is subject to different expenses. The LM Value Institutional Portfolio's total returns as of March 31, 1999 were as follows: Average Cumulative Annual Total Return Total Return Life of Portfolio(A) 58.81%(Institutional Class) ____% 46.95%(Financial Intermediory Class) (A) Portfolio's inception - September 22, 1998. The Brandywine Small Cap Value Portfolio's total returns as of March 31, 1999 were as follows: Average -48- Cumulative Annual Total Return Total Return Life of Portfolio(A) -14.38% ____% (A) Portfolio's inception - August 17, 1998. Each Portfolio's performance may fluctuate daily depending upon such factors as the average maturity of its securities, changes in investments, changes in interest rates and variations in operating expenses. Therefore, current performance does not provide a basis for determining future performance. The fact that a Portfolio's performance will fluctuate and that shareholders' principal is not guaranteed or insured should be considered in comparing the Portfolio's performance with the performance of other investments. From time to time each Portfolio may compare the performance of a class of shares in advertising and sales literature to the performance of other investment companies, groups of investment companies or various market indices. One such market index is the S&P 500, a widely recognized, unmanaged index composed of the capitalization-weighted average of the prices of 500 of the largest publicly traded stocks in the U.S. The S&P 500 includes reinvestment of all dividends. It takes no account of the costs of investing or the tax consequences of distributions. The Portfolios invest in many securities that are not included in the S&P 500. Each Portfolio may also cite rankings and ratings, and compare the return of a class of shares with data published by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc., Wiesenberger Investment Company Services, Value Line, Morningstar, and other services or publications that monitor, compare and/or rank the performance of investment companies. Each Portfolio may also refer in such materials to mutual fund performance rankings, ratings, comparisons with funds having similar investment objectives, and other mutual funds reported in independent periodicals, including, but not limited to, Financial World, Money Magazine, Forbes, Business Week, Barron's, Fortune, the Kiplinger Letters, the Wall Street Journal, and the New York Times. Each Portfolio may compare the investment return of a class of shares to the return on certificates of deposit and other forms of bank deposits, and may quote from organizations that track the rates offered on such deposits. Bank deposits are insured by an agency of the federal government up to specified limits. In contrast, Portfolio shares are not insured, the value of Portfolio shares may fluctuate, and an investor's shares, when redeemed, may be worth more or less than the investor originally paid for them. Unlike the interest paid on many certificates of deposit, which remains at a specified rate for a specified period of time, the return of each class of shares will vary. Portfolio advertisements may reference the history of Legg Mason and its affiliates, the education and experience of the portfolio manager, and the fact that the portfolio manager engages in a particular style of investing (e.g., growth or value). -49- In advertising, each Portfolio may illustrate hypothetical investment plans designed to help investors meet long-term financial goals, such as saving for a child's college education or for retirement. Sources such as the Internal Revenue Service, the Social Security Administration, the Consumer Price Index and Chase Global Data and Research may supply data concerning interest rates, college tuitions, the rate of inflation, Social Security benefits, mortality statistics and other relevant information. Each Portfolio may use other recognized sources as they become available. Each Portfolio may use data prepared by Ibbotson Associates of Chicago, Illinois ("Ibbotson") to compare the returns of various capital markets and to show the value of a hypothetical investment in a capital market. Ibbotson relies on different indices to calculate the performance of common stocks, corporate and government bonds and Treasury bills. Each Portfolio may illustrate and compare the historical volatility of different portfolio compositions where the performance of stocks is represented by the performance of an appropriate market index, such as the S&P 500, and the performance of bonds is represented by a nationally recognized bond index, such as the Lehman Brothers Long-Term Government Bond Index. Each Portfolio may also include in advertising biographical information on key investment and managerial personnel. Each Portfolio may advertise examples of the potential benefits of periodic investment plans, such as dollar cost averaging, a long-term investment technique designed to lower average cost per share. Under such a plan, an investor invests in a mutual fund at regular intervals a fixed dollar amount thereby purchasing more shares when prices are low and fewer shares when prices are high. Although such a plan does not guarantee profit or guard against loss in declining markets, the average cost per share could be lower than if a fixed number of shares were purchased at the same intervals. Investors should consider their ability to purchase shares through low price levels. Each Portfolio may discuss Legg Mason's tradition of service. Since 1899, Legg Mason and its affiliated companies have helped investors meet their specific investment goals and have provided a full spectrum of financial services. Legg Mason affiliates serve as investment advisers for private accounts and mutual funds with assets of more than $88 billion as of March 31, 1999. In advertising, each Portfolio may discuss the advantages of saving through tax-deferred retirement plans or accounts, including the advantages and disadvantages of "rolling over" a distribution from a retirement plan into an IRA, factors to consider in determining whether you qualify for such a rollover, and the other options available. These discussions may include graphs or other illustrations that compare the growth of a hypothetical tax-deferred investment to the after-tax growth of a taxable investment. Custodian, Transfer Agent and Dividend-Disbursing Agent -50- State Street Bank and Trust Company, P.O. Box 1790, Boston, Massachusetts 02105, serves as custodian of the Fund's assets. Boston Financial Data Services, Inc., P.O. Box 953, Boston, Massachusetts 02103, serves as transfer and dividend-disbursing agent and administrator of various shareholder services. Shareholders who request an historical transcript of their account will be charged a fee based upon the number of years researched. The Fund reserves the right, upon 60 days' written notice, to make other charges to investors to cover administrative costs. Independent Accountants _________ have been selected to serve as the Fund's independent accountants. The statements of assets and liabilities of the Portfolios and related notes thereto included in this Statement of Additional Information have been so included in reliance upon the report of ________ given on their authority as experts in auditing and accounting. Legal Counsel Ropes & Gray, Boston, MA, serves as legal counsel to the Fund. LM INSTITUTIONAL FUND ADVISORS II, INC. STATEMENT OF ASSETS AND LIABILITIES _________ __, 1999 [To be provided] -51- Report of Independent Auditors [To be provided] -52- PART C. OTHER INFORMATION Item 23. Exhibits (a) Articles of Amendment and Restatement -- previously filed (1) (i) Articles Supplementary -- previously filed (1) (b) Bylaws -- previously filed (1) (c) Instruments Defining Rights of Security Holders -- none (d) (1) Investment advisory agreements -- (i) LM Value Institutional -- previously filed (1) (ii) LM Mid Cap Institutional -- previously filed (1) (iii) LM Total Return Institutional -- previously filed (1) (iv) Brandywine Small Cap Value -- previously filed (1) (v) Batterymarch Emerging Markets -- previously filed (1) (vi) Batterymarch International Equity -- previously filed (1) (2) Investment management agreements (i) LM Value Institutional -- previously filed (1) (ii) LM Mid Cap Institutional -- previously filed (1) (iii) LM Total Return Institutional-- previously filed (1) (iv) Brandywine Small Cap Value -- previously filed (1) (v) Batterymarch Emerging Markets -- previously filed (1) (vi) Batterymarch International Equity -- previously filed (1) (e) Underwriting Agreement -- previously filed (1) (f) Bonus or profit sharing contracts -- none (g) Custodian agreement -- filed herewith (h) (i) Transfer Agent agreement -- filed herewith (ii)Administration agreements -- none (i) Opinion of counsel -- previously filed (1) (j) Other opinions, appraisals, rulings and consents Accountants' consent -- filed herewith (k) Financial statements omitted from Item 22 -- not applicable (l) Agreement for providing initial capital -- none (m) Plan pursuant to Rule 12b-1 (i) LM Value Institutional -- previously filed (1) (ii) LM Mid Cap Institutional -- previously filed (1) (iii) LM Total Return Institutional -- previously filed (1) (iv) Brandywine Small Cap Value -- previously filed (1) (v) Batterymarch Emerging Markets -- previously filed (1) (vi) Batterymarch International Equity -- previously filed (1) (n) Financial Data Schedules -- not applicable (o) Multiple Class (Rule 18F-3) Plan -- previously filed (1) -5- (1) Incorporated herein by reference to corresponding Exhibit of Pre-Effective Amendment No. 1 to the Registration Statement, SEC File No. 333-44423, filed June 4, 1998. Item 24. Persons Controlled by or under Common Control with Registrant ------------------------------------------------------------- LM Institutional Advisors, Inc. may be deemed to control the LM Mid-Cap Institutional Portfolio, Batterymarch Emerging Markets Portfolio, Batterymarch International Equity Portfolio and LM Total Return Institutional Portfolio as a result of its ownership of 100% of the outstanding shares of each such Fund. Item 25. Indemnification --------------- Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended, may be provided to directors, officers and controlling persons of the Registrant, pursuant to the foregoing provisions or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in connection with the successful defense of any action, suit or proceeding or payment pursuant to any insurance policy) is asserted against the Registrant by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is prohibited as against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Item 26. Business and Other Connections of Investment Adviser ---------------------------------------------------- I. Legg Mason Fund Adviser, Inc. ("Fund Adviser"), adviser for the LM Value Institutional Portfolio, LM Mid Cap Institutional Portfolio, and LM Total Return Institutional Portfolio is a registered investment adviser incorporated on January 20, 1982. Fund Adviser is engaged primarily in the investment advisory business. Fund Adviser also serves as investment adviser or manager to seventeen open-end registered investment companies. Information as to the officers and directors of Fund Adviser is included in its Form ADV filed with the Securities and Exchange Commission as in effect on the date hereof (Registration Number 801-16958) and is incorporated herein by reference. II. Batterymarch Financial Management, Inc. ("Batterymarch"), adviser to the Batterymarch Emerging Markets Portfolio and Batterymarch International Equity Portfolio, is -6- a registered investment adviser incorporated on September 19, 1994. Batterymarch is engaged primarily in the investment advisory business. Information as to the officers and directors of Batterymarch is included in its Form ADV filed with the Securities and Exchange Commission as in effect on the date hereof (registration number 801-48035) and is incorporated herein by reference. III. Brandywine Asset Management, Inc. ("Brandywine"), adviser to the Brandywine Small Cap Value Portfolio, is a registered investment adviser incorporated on [ ]. Brandywine is engaged primarily in the investment advisory business. Information as to the officers and directors of Brandywine is included in its Form ADV filed with the Securities and Exchange Commission as in effect on the date hereof (registration number 801- ) and is incorporated herein by reference. Item 27. Principal Underwriters ---------------------- (a) Legg Mason Cash Reserve Trust Legg Mason Special Investment Trust, Inc. Legg Mason Value Trust, Inc. Legg Mason Tax-Exempt Trust, Inc. Legg Mason Income Trust, Inc. Legg Mason Total Return Trust, Inc. Legg Mason Tax-Free Income Fund Legg Mason Global Trust, Inc. Legg Mason Investors Trust, Inc. LM Institutional Fund Advisors I, Inc. LM Institutional Fund Advisors II, Inc. Legg Mason Focus Trust, Inc. (b) The following table sets forth information concerning each director and officer of the Registrant's principal underwriter, Legg Mason Wood Walker, Incorporated ("LMWW").
Position and Positions and Name and Principal Offices with Offices with Business Address* Underwriter - LMWW Registrant - ------------------ --------------------------- ------------------- Raymond A. Mason Chairman of the Board None John F. Curley, Jr. the Retired Vice Chairman of the Board None
-7-
James W. Brinkley President and Director None Edmund J. Cashman, Jr. Director None Senior Executive Vice President Richard J. Himelfarb Director None Senior Executive Vice President Edward A. Taber III Director None Senior Executive Vice President Robert A. Frank Director None Executive Vice President Robert G. Sabelhaus Director None Executive Vice President Charles A. Bacigalupo Senior Vice President, Secretary None and Director F. Barry Bilson Senior Vice President and Director None Thomas M. Daly, Jr. Senior Vice President and Director None Jerome M. Dattel Senior Vice President and Director None Robert G. Donovan Senior Vice President and Director None Thomas E. Hill Senior Vice President and Director None One Mill Place Easton, MD 21601
-8-
Arnold S. Hoffman Senior Vice President and Director None 1735 Market Street Philadelphia, PA 19103 Carl Hohnbaum Senior Vice President and None 24th Floor Director Two Oliver Plaza Pittsburgh, PA 15222 William B. Jones, Jr. Senior Vice President and Director None 1747 Pennsylvania Avenue, N.W. Washington, D.C. 20006 Laura L. Lange Senior Vice President and Director None Marvin H. McIntyre Senior Vice President and Director None 1747 Pennsylvania Avenue, N.W. Washington, D.C. 20006 Mark I. Preston Senior Vice President and Director None Joseph Sullivan Senior Vice President and Director None M. Walter D'Alessio, Jr. Director None 1735 Market Street Philadelphia, PA 19103 W. William Brab Senior Vice President None Deepak Chowdhury Senior Vice President None 255 Alhambra Circle Coral Gables, FL 33134 Harry M. Ford, Jr. Senior Vice President None Dennis A. Green Senior Vice President None William F. Haneman, Jr. Senior Vice President None One Battery Park Plaza New York, New York 10005 Theodore S. Kaplan Senior Vice President and None
-9-
General Counsel Seth J. Lehr Senior Vice President None 1735 Market St Philadelphia, PA 19103 Horace M. Lowman, Jr. Senior Vice President and None Asst. Secretary Robert L. Meltzer Senior Vice President None One Battery Park Plaza New York, NY 10004 Jonathan M. Pearl Senior Vice President None 1777 Reisterstown Rd. Pikesville, MD 21208 John A. Pliakas Senior Vice President None 125 High Street Boston, MA 02110 Gail Reichard Senior Vice President None Timothy C. Scheve Senior Vice President and Treasurer None Elisabeth N. Spector Senior Vice President None Robert J. Walker, Jr. Senior Vice President None 200 Gibraltar Road Horsham, PA 19044 William H. Bass, Jr. Vice President None Nathan S. Betnun Vice President None John C. Boblitz Vice President None Andrew J. Bowden Vice President None D. Stuart Bowers Vice President None Edwin J. Bradley, Jr. Vice President
-10-
Scott R. Cousino Vice President None Joseph H. Davis, Jr. Vice President None 1735 Market Street Philadelphia, PA 19380 Terrence R. Duvernay Vice President None 1100 Poydras St. New Orleans, LA 70163 John R. Gilner Vice President None Richard A. Jacobs Vice President None C. Gregory Kallmyer Vice President None Edward W. Lister, Jr. Vice President None Marie K. Karpinski Vice President and Treasurer None Mark C. Micklem Vice President None 1747 Pennsylvania Ave. Washington, DC 20006 Hance V. Myers, III Vice President None 1100 Poydras St. New Orleans, LA 70163 Gerard F. Petrik, Jr. Vice President None Douglas F. Pollard Vice President None K. Mitchell Posner Vice President None 1735 Market Street Philadelphia, PA 19103 Carl W. Riedy, Jr. Vice President None Jeffrey M. Rogatz Vice President None Thomas E. Robinson Vice President None Douglas M. Schmidt Vice President None
-11-
Robert W. Schnakenberg Vice President None 1111 Bagby St. Houston, TX 77002 Henry V. Sciortino Vice President None 1735 Market St. Philadelphia, PA 19103 Chris Scitti Vice President None Eugene B. Shephard Vice President None 1111 Bagby St. Houston, TX 77002-2510 Lawrence D. Shubnell Vice President None Alexsander M. Stewart Vice President None One World Trade Center New York, NY 10048 Robert S. Trio Vice President None 1747 Pennsylvania Ave. Washington, DC 20006 William A. Verch Vice President None Lewis T. Yeager Vice President None Joseph F. Zunic Vice President None
- ---------- * All addresses are 100 Light Street, Baltimore, Maryland 21202, unless otherwise indicated. (c) The Registrant has no principal underwriter which is not an affiliated person of the Registrant or an affiliated person of such an affiliated person. Item 28. Location of Accounts and Records -------------------------------- State Street Bank and Trust Company P.O. Box 1713 Boston, Massachusetts 02105 -12- Item 29. Management Services -- none ---------------------- Item 30. Undertakings -- none SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant, LM Institutional Fund Advisors II, Inc. has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Baltimore and State of Maryland, on the 1st day of June, 1999. LM INSTITUTIONAL FUND ADVISORS II, INC. By: /s/ Edward A. Taber, III ----------------------------- Edward A. Taber, III President and Director Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ W. Curtis Livingston, III Director June 1, 1999 - ----------------------------- W. Curtis Livingston, III* /s/ Edward A. Taber, III President and Director June 1, 1999 - ------------------------ Edward A. Taber, III* /s/ Catherine H. Bray Director June 1, 1999 - --------------------- Catherine H. Bray* /s/ Edmund J. Cashman, Jr. Director June 1, 1999 - -------------------------- Edmund J. Cashman, Jr.* /s/ Emmett J. Rice Director June 1, 1999 - ------------------ Emmett J. Rice* /s/ Robert M. Tarola Director June 1, 1999 - -------------------- Robert M. Tarola* /s/ Linda R. Taylor Director June 1, 1999 - ------------------- Linda R. Taylor* -13- /s/ Marie K. Karpinski Vice President June 1, 1999 - ---------------------- and Treasurer Marie K. Karpinski * By: /s/ Marie K. Karpinski ------------------------- Marie K. Karpinski Attorney-in Fact Pursuant to Powers of Attorney Filed previously and for Herself 14 Exhibit Index ------------- Exhibit (g) Custodian Agreement Exhibit (h)(i) Transfer Agent Agreement EX-99 2 EXHIBIT 99(G) CUSTODIAN CONTRACT Between LM INSTITUTIONAL FUND ADVISORS II, INC. and STATE STREET BANK AND TRUST COMPANY CUSTODIAN CONTRACT This Contract between LM Institutional Fund Advisors II, Inc. a corporation organized and existing under the laws of the State of Maryland, having its principal place of business at 100 Light Street, Baltimore, Maryland 21202 hereinafter called the "FUND", and State Street Bank and Trust Company, a Massachusetts trust company, having its principal place of business at 225 Franklin Street, Boston, Massachusetts, 02110, hereinafter called the "Custodian," WITNESSETH: WHEREAS, the Fund is authorized to issue shares in separate series, with each such series representing interests in a separate portfolio of securities and other assets; and WHEREAS, the Fund intends to initially offer shares in six (6) series, LM Value Institutional Portfolio, LM Mid Cap Institutional Portfolio, Brandywine Small Cap Value Portfolio, Batterymarch Emerging Markets Portfolio, Batterymarch International Equity Portfolio, and LM Total Return Institutional Portfolio (such series together with all other series subsequently established by the Fund and made subject to this Contract in accordance with paragraph 17, being herein referred to as the "Portfolio(s)"); NOW THEREFORE, in consideration of the mutual covenants and agreements hereinafter contained, the parties hereto agree as follows: 1. Employment of Custodian and Property to be Held by It The Fund hereby employs the Custodian as the custodian of the assets of the Portfolios of the Fund, including securities which the Fund, on behalf of the applicable Portfolio desires to be held in places within the United States ("domestic securities") and securities it desires to be held outside the United States ("foreign securities") pursuant to the provisions of the Articles of Incorporation. The Fund on behalf of the Portfolio(s) agrees to deliver to the Custodian all securities and cash of the Portfolios, and all payments of income, payments of principal or capital distributions received by it with respect to all securities owned by the Portfolio(s) from time to time, and the cash consideration received by it for such new or treasury shares of capital stock of the Fund representing interests in the Portfolios, ("Shares") as may be issued or sold from time to time. The Custodian shall not be responsible for any property of a Portfolio held or received by the Portfolio and not delivered to the Custodian. Upon receipt of "Proper Instructions" (within the meaning of Section 5), the Custodian shall on behalf of the applicable Portfolio(s) from time to time employ one or more sub-custodians, located in the United States but only in accordance with an applicable vote by the Board of Directors of the Fund on behalf of the applicable Portfolio(s), and provided that the Custodian shall have no more or less responsibility or liability to the Fund on account of any actions or omissions of any sub-custodian so employed than any such sub-custodian has to the Custodian; provided, however, that (a) the Custodian will be liable to the Fund for the Custodian's own negligence in transmitting any instructions received by it from the Fund and for the Custodian's own negligence in connection with the delivery of any securities, cash or other assets held by it to any sub-custodian and (b) in the event of any loss, damage or expense suffered or incurred by the Fund caused by or resulting from actions or omissions for which the Custodian would be liable pursuant to this section, the Custodian shall promptly reimburse the Fund in the amount of any such loss, damage or expense. The Custodian may employ as sub-custodian for the Fund's foreign securities on behalf of the applicable Portfolio(s) the foreign banking institutions and foreign securities depositories designated in Schedule A hereto but only in accordance with the provisions of Section 3. The Fund may instruct the Custodian, through Proper Instructions, to cease the employment of any one or more sub-custodians for maintaining custody of the Fund's assets, and to cause the prompt delivery of such assets to another sub-custodian acceptable to the Fund and the Custodian. 2. Duties of the Custodian with Respect to Property of the Fund Held By the Custodian in the United States 2.1 Holding Securities. The Custodian shall hold and physically segregate for the account of each Portfolio all non-cash property, to be held by it in the United States including all domestic securities owned by such Portfolio, other than (a) securities which are maintained pursuant to Section 2.10 in a clearing agency which acts as a securities depository or in a book-entry system authorized by the U.S. Department of the Treasury and certain federal agencies (each, a "U.S. Securities System") and (b) commercial paper of an issuer for which State Street Bank and Trust Company acts as issuing and paying agent ("Direct Paper") which is deposited and/or maintained in the Direct Paper System of the Custodian (the "Direct Paper System") pursuant to Section 2.11. 2.2 Delivery of Securities. The Custodian shall release and deliver domestic securities owned by a Portfolio held by the Custodian or in a U.S. Securities System account of the Custodian or in the Custodian's Direct Paper book entry system account ("Direct Paper System Account") only upon receipt of Proper Instructions from the Fund on behalf of the applicable Portfolio, which may be continuing instructions when deemed appropriate by the parties, and only in the following cases: 1) Upon sale of such securities for the account of the Portfolio and receipt of payment therefor; 2) Upon the receipt of payment in connection with any repurchase agreement related to such securities entered into by the Portfolio; 3) In the case of a sale effected through a U.S. Securities System, in accordance with the provisions of Section 2.10 hereof; 4) To the depository agent in connection with tender or other similar offers for securities of the Portfolio; 5) To the issuer thereof or its agent when such securities are called, redeemed, retired or otherwise become payable; provided that, in any such case, the cash or other consideration is to be delivered to the Custodian; 6) To the issuer thereof, or its agent, for transfer into the name of the Portfolio or into the name of any nominee or nominees of the Custodian or into the name or nominee name of any agent appointed pursuant to Section 2.9 or into the name or nominee name of any sub-custodian appointed pursuant to Section 1; or for exchange for a different number of bonds, certificates or other evidence representing the same aggregate face amount or number of units; provided that, in any such case, the new securities are to be delivered to the Custodian; 7) Upon the sale of such securities for the account of the Portfolio, to the broker or its clearing agent, against a receipt, for examination in accordance with "street delivery" custom; provided that in any such case, the Custodian shall have no responsibility or liability for any loss arising from the delivery of such securities prior to receiving payment for such securities except as may arise from the Custodian's own negligence or willful misconduct; 8) For exchange or conversion pursuant to any plan of merger, consolidation, recapitalization, reorganization or readjustment of the securities of the issuer of such securities, or pursuant to provisions for conversion contained in such securities, or pursuant to any deposit agreement; provided that, in any such case, the new securities and cash, if any, are to be delivered to the Custodian; 9) In the case of warrants, rights or similar securities, the surrender thereof in the exercise of such warrants, rights or similar securities or the surrender of interim receipts or temporary securities for definitive securities; provided that, in any such case, the new securities and cash, if any, are to be delivered to the Custodian; 10) For delivery in connection with any loans of securities made by the Portfolio, but only against receipt of adequate collateral as agreed upon from time to time by the Custodian and the Fund on behalf of the Portfolio, which may be in the form of cash or obligations issued by the United States government, its agencies or instrumentalities, except that in connection with any loans for which collateral is to be credited to the Custodian's account in the book-entry system authorized by the U.S. Department of the Treasury, the Custodian will not be held liable or responsible for the delivery of securities owned by the Portfolio prior to the receipt of such collateral; 11) For delivery as security in connection with any borrowings by the Fund on behalf of the Portfolio requiring a pledge of assets by the Fund on behalf of the Portfolio, but only against receipt of amounts borrowed; 12) For delivery in accordance with the provisions of any agreement among the Fund on behalf of the Portfolio, the Custodian and a broker-dealer registered under the Securities Exchange Act of 1934 (the "Exchange Act") and a member of The National Association of Securities Dealers, Inc. ("NASD"), relating to compliance with the rules of The Options Clearing Corporation and of any registered national securities exchange, or of any similar organization or organizations, regarding escrow or other arrangements in connection with transactions by the Portfolio of the Fund; 13) For delivery in accordance with the provisions of any agreement among the Fund on behalf of the Portfolio, the Custodian, and a Futures Commission Merchant registered under the Commodity Exchange Act, relating to compliance with the rules of the Commodity Futures Trading Commission and/or any Contract Market, or any similar organization or organizations, regarding account deposits in connection with transactions by the Portfolio of the Fund; 14) Upon receipt of instructions from the transfer agent ("Transfer Agent") for the Fund, for delivery to such Transfer Agent or to the holders of shares in connection with distributions in kind, as may be described from time to time in the currently effective prospectus and statement of additional information of the Fund, related to the Portfolio ("Prospectus"), in satisfaction of requests by holders of Shares for repurchase or redemption; and 15) For any other proper corporate purpose, but only upon receipt of, in addition to Proper Instructions from the Fund on behalf of the applicable Portfolio, a certified copy of a resolution of the Board of Directors or of the Executive Committee signed by an officer of the Fund and certified by the Secretary or an Assistant Secretary, specifying the securities of the Portfolio to be delivered, setting forth the purpose for which such delivery is to be made, declaring such purpose to be a proper corporate purpose, and naming the person or persons to whom delivery of such securities shall be made. 2.3 Registration of Securities. Domestic securities held by the Custodian (other than bearer securities) shall be registered in the name of the Portfolio or in the name of any nominee of the Fund on behalf of the Portfolio or of any nominee of the Custodian which nominee shall be assigned exclusively to the Portfolio, unless the Fund has authorized in writing the appointment of a nominee to be used in common with other registered investment companies having the same investment adviser as the Portfolio, or in the name or nominee name of any agent appointed pursuant to Section 2.9 or in the name or nominee name of any sub-custodian appointed pursuant to Section 1. All securities accepted by the Custodian on behalf of the Portfolio under the terms of this Contract shall be in "street name" or other good delivery form. If, however, the Fund directs the Custodian to maintain securities in "street name", the Custodian shall utilize its best efforts only to timely collect income due the Fund on such securities and to notify the Fund on a best efforts basis only of relevant corporate actions including, without limitation, pendency of calls, maturities, tender or exchange offers. 2.4 Bank Accounts. The Custodian shall open and maintain a separate bank account or accounts in the United States in the name of each Portfolio of the Fund, subject only to draft or order by the Custodian acting pursuant to the terms of this Contract, and shall hold in such account or accounts, subject to the provisions hereof, all cash received by it from or for the account of the Portfolio, other than cash maintained by the Portfolio in a bank account established and used in accordance with Rule 17f-3 under the Investment Company Act of 1940. Funds held by the Custodian for a Portfolio may be deposited by it to its credit as Custodian in the Banking Department of the Custodian or in such other banks or trust companies as it may in its discretion deem necessary or desirable; provided, however, that every such bank or trust company shall be qualified to act as a custodian under the Investment Company Act of 1940 and that each such bank or trust company and the funds to be deposited with each such bank or trust company shall on behalf of each applicable Portfolio be approved by vote of a majority of the Board of Directors of the Fund. Such funds shall be deposited by the Custodian in its capacity as Custodian and shall be withdrawable by the Custodian only in that capacity. 2.5 Availability of Federal Funds. Upon mutual agreement between the Fund on behalf of each applicable Portfolio and the Custodian, the Custodian shall, upon the receipt of Proper Instructions from the Fund on behalf of a Portfolio, make federal funds available to such Portfolio as of specified times agreed upon from time to time by the Fund and the Custodian in the amount of checks received in payment for Shares of such Portfolio which are deposited into the Portfolio's account. 2.6 Collection of Income. Subject to the provisions of Section 2.3, the Custodian shall collect, and shall require any sub-custodian to collect, on a timely basis all income and other payments with respect to registered domestic securities held hereunder to which each Portfolio shall be entitled either by law or pursuant to custom in the securities business, and shall collect on a timely basis all income and other payments with respect to bearer domestic securities if, on the date of payment by the issuer, such securities are held by the Custodian or its agent thereof and shall promptly credit such income, as collected, to such Portfolio's custodian account. Without limiting the generality of the foregoing, the Custodian shall detach and present for payment all coupons and other income items requiring presentation as and when they become due and shall collect interest when due on securities held hereunder. Income due each Portfolio on securities loaned pursuant to the provisions of Section 2.2 (10) shall be the responsibility of the Fund. The Custodian will have no duty or responsibility in connection therewith, other than to provide the Fund with such information or data as may be necessary to assist the Fund in arranging for the timely delivery to the Custodian of the income to which the Portfolio is properly entitled. The Custodian shall promptly notify the Fund by facsimile transmission or in such other manner as the Fund and the Custodian may agree in writing if any amount payable with respect to Shares of the Fund or other assets of the Fund is not received by the Custodian when due. 2.7 Payment of Fund Monies. Upon receipt of Proper Instructions from the Fund on behalf of the applicable Portfolio, which may be continuing instructions when deemed appropriate by the parties, the Custodian shall pay out monies of a Portfolio in the following cases only: 1) Upon the purchase of domestic securities, options, futures contracts or options on futures contracts for the account of the Portfolio but only (a) against the delivery of such securities or evidence of title to such options, futures contracts or options on futures contracts to the Custodian (or any bank, banking firm or trust company doing business in the United States or abroad which is qualified under the Investment Company Act of 1940, as amended, to act as a custodian and has been designated by the Custodian as its agent for this purpose) registered in the name of the Portfolio or in the name of a nominee of the Custodian referred to in Section 2.3 hereof or in proper form for transfer; (b) in the case of a purchase effected through a U.S. Securities System, in accordance with the conditions set forth in Section 2.10 hereof; (c) in the case of a purchase involving the Direct Paper System, in accordance with the conditions set forth in Section 2. 11; (d) in the case of repurchase agreements entered into between the Fund on behalf of the Portfolio and the Custodian, or another bank, or a broker-dealer which is a member of NASD, (i) against delivery of the securities either in certificate form or through an entry crediting the Custodian's account at the Federal Reserve Bank with such securities or (ii) against delivery of the receipt evidencing purchase by the Portfolio of securities owned by the Custodian along with written evidence of the agreement by the Custodian to repurchase such securities from the Portfolio or (e) for transfer to a time deposit account of the Fund in any bank, whether domestic or foreign; such transfer may be effected prior to receipt of a confirmation from a broker and/or the applicable bank pursuant to Proper Instructions from the Fund as defined in Section 5; 2) In connection with conversion, exchange or surrender of securities owned by the Portfolio as set forth in Section 2.2 hereof; 3) For the redemption or repurchase of Shares issued by the Portfolio as set forth in Section 4 hereof; 4) For the payment of any expense or liability incurred by the Portfolio, including but not limited to the following payments for the account of the Portfolio: interest, taxes, management, accounting, transfer agent and legal fees, and operating expenses of the Fund whether or not such expenses are to be in whole or part capitalized or treated as deferred expenses; 5) For the payment of any dividends on Shares of the Portfolio declared pursuant to the governing documents of the Fund; 6) For payment of the amount of dividends received in respect of securities sold short; 7) For any other proper purpose, but only upon receipt of, in addition to Proper Instructions from the Fund on behalf of the Portfolio, a certified copy of a resolution of the Board of Directors or of the Executive Committee of the Fund signed by an officer of the Fund and certified by its Secretary or an Assistant Secretary, specifying the amount of such payment, setting forth the purpose for which such payment is to be made, declaring such purpose to be a proper purpose, and naming the person or persons to whom such payment is to be made. 2.8 Liability for Payment in Advance of Receipt of Securities Purchased. Except as specifically stated otherwise in this Contract, in any and every case where payment for purchase of domestic securities for the account of a Portfolio is made by the Custodian in advance of receipt of the securities purchased in the absence of specific written instructions from the Fund on behalf of such Portfolio to so pay in advance, the Custodian shall be absolutely liable to the Fund for such securities to the same extent as if the securities had been received by the Custodian. 2.9 Appointment of Agents. The Custodian may at any time or times in its discretion appoint (and may at any time remove) any other bank or trust company which is itself qualified under the Investment Company Act of 1940, as amended, to act as a custodian, as its agent to carry out such of the provisions of this Section 2 as the Custodian may from time to time direct; provided, however, that the appointment of any agent shall not relieve the Custodian of its responsibilities or liabilities hereunder. In the event of any loss, damage or expense suffered or incurred by the Fund, caused by or resulting from the actions or omissions of any agent for which the Custodian would be liable if said act or omission had been committed by the Custodian, the Custodian shall promptly reimburse the Fund in the amount of any such loss, damage or expense. 2.10 Deposit of Fund Assets in U.S. Securities Systems. The Custodian may deposit and/or maintain securities owned by a Portfolio in a clearing agency registered with the Securities and Exchange Commission under Section 17A of the Securities Exchange Act of 1934, which acts as a securities depository, or in the book-entry system authorized by the U.S. Department of the Treasury and certain federal agencies, collectively referred to herein as "U.S. Securities System" in accordance with applicable Federal Reserve Board and Securities and Exchange Commission rules and regulations, if any, and subject to the following provisions: 1) The Custodian may keep securities of the Portfolio in a U.S. Securities System provided that such securities are represented in an account ("Account") of the Custodian in the U.S. Securities System which shall not include any assets of the Custodian other than assets held as a fiduciary, custodian or otherwise for customers; 2) The records of the Custodian with respect to securities of the Portfolio which are maintained in a U.S. Securities System shall identify by book-entry those securities belonging to the Portfolio; 3) The Custodian shall pay for securities purchased for the account of the Portfolio upon (i) receipt of advice from the U.S. Securities System that such securities have been transferred to the Account, and (ii) the making of an entry on the records of the Custodian to reflect such payment and transfer for the account of the Portfolio. The Custodian shall transfer securities sold for the account of the Portfolio upon (i) receipt of advice from the U.S. Securities System that payment for such securities has been transferred to the Account, and (ii) the making of an entry on the records of the Custodian to reflect such transfer and payment for the account of the Portfolio. Copies of all advices from the U.S. Securities System of transfers of securities for the account of the Portfolio shall identify the Portfolio, be maintained for the Portfolio by the Custodian and be provided to the Fund at its request. Upon request, the Custodian shall furnish the Fund on behalf of the Portfolio confirmation of each transfer to or from the account of the Portfolio in the form of a written advice or notice and shall furnish to the Fund on behalf of the Portfolio copies of daily transaction sheets reflecting each day's transactions in the U.S. Securities System for the account of the Portfolio. 4) The Custodian shall provide the Fund for the Portfolio with any report obtained by the Custodian on the U.S. Securities System's accounting system, internal accounting control or procedures for safeguarding securities deposited in the U.S. Securities System; 5) The Custodian shall have received from the Fund on behalf of the Portfolio the initial certificate required by Section 14 hereof; 6) At the written request of the Fund, the Custodian will terminate the use of any such Securities System as promptly as practicable; 7) Anything to the contrary in this Contract notwithstanding, the Custodian shall be liable to the Fund for the benefit of the Portfolio for any loss or damage to the Portfolio resulting from use of the U.S. Securities System by reason of any negligence, misfeasance or misconduct of the Custodian or any of its agents or of any of its or their employees or from failure of the Custodian or any such agent to enforce effectively such rights as it may have against the U.S. Securities System; at the election of the Fund, it shall be entitled to be subrogated to the rights of the Custodian with respect to any claim against the U.S. Securities System or any other person which the Custodian may have as a consequence of any such loss or damage if and to the extent that the Portfolio has not been made whole for any such loss or damage. In the event of any such subrogation, the Custodian shall cooperate with the Fund in asserting such rights and shall take all actions reasonably necessary to enable the Fund to assert such rights. 2.11 Fund Assets Held in the Custodian's Direct Paper System. The Custodian may deposit and/or maintain securities owned by a Portfolio in the Direct Paper System of the Custodian subject to the following provisions: 1) No transaction relating to securities in the Direct Paper System will be effected in the absence of Proper Instructions from the Fund on behalf of the Portfolio; 2) The Custodian may keep securities of the Portfolio in the Direct Paper System only if such securities are represented in an account ("Account") of the Custodian in the Direct Paper System which shall not include any assets of the Custodian other than assets held as a fiduciary, custodian or otherwise for customers; 3) The records of the Custodian with respect to securities of the Portfolio which are maintained in the Direct Paper System shall identify by book-entry those securities belonging to the Portfolio; 4) The Custodian shall pay for securities purchased for the account of the Portfolio upon the making of an entry on the records of the Custodian to reflect such payment and transfer of securities to the account of the Portfolio. The Custodian shall transfer securities sold for the account of the Portfolio upon the making of an entry on the records of the Custodian to reflect such transfer and receipt of payment for the account of the Portfolio; 5) The Custodian shall furnish the Fund on behalf of the Portfolio confirmation of each transfer to or from the account of the Portfolio, in the form of a written advice or notice, of Direct Paper on the next business day following such transfer and shall furnish to the Fund on behalf of the Portfolio copies of daily transaction sheets reflecting each day's transaction in the U.S. Securities System for the account of the Portfolio; 6) The Custodian shall provide the Fund on behalf of the Portfolio with any report on its system of internal accounting control as the Fund may reasonably request from time to time. 2.12 Segregated Account. The Custodian shall upon receipt of Proper Instructions from the Fund on behalf of each applicable Portfolio establish and maintain a segregated account or accounts for and on behalf of each such Portfolio, into which account or accounts may be transferred cash and/or securities, including securities maintained in an account by the Custodian pursuant to Section 2.10 hereof, (i) in accordance with the provisions of any agreement among the Fund on behalf of the Portfolio, the Custodian and a broker-dealer registered under the Exchange Act and a member of the NASD (or any futures commission merchant registered under the Commodity Exchange Act), relating to compliance with the rules of The Options Clearing Corporation and of any registered national securities exchange (or the Commodity Futures Trading Commission or any registered contract market), or of any similar organization or organizations, regarding escrow or other arrangements in connection with transactions by the Portfolio, (ii) for purposes of segregating cash or government securities in connection with options purchased, sold or written by the Portfolio or commodity futures contracts or options thereon purchased or sold by the Portfolio, (iii) for the purposes of compliance by the Portfolio with the procedures required by Investment Company Act Release No. 10666, or any subsequent release or releases of the Securities and Exchange Commission relating to the maintenance of segregated accounts by registered investment companies and (iv) for other proper corporate purposes, but only, in the case of clause (iv), upon receipt of, in addition to Proper Instructions from the Fund on behalf of the applicable Portfolio, a certified copy of a resolution of the Board of Directors or of the Executive Committee signed by an officer of the Fund and certified by the Secretary or an Assistant Secretary, setting forth the purpose or purposes of such segregated account and declaring such purposes to be proper corporate purposes. 2.13 Ownership Certificates for Tax Purposes. The Custodian shall, and shall require any sub-custodian to, promptly execute ownership and other certificates and affidavits for all federal and state tax purposes in connection with receipt of income or other payments with respect to domestic securities of each Portfolio held by it and in connection with transfers of securities. 2.14 Proxies. The Custodian shall, with respect to the domestic securities held hereunder, cause to be promptly executed by the registered holder of such securities, if the securities are registered otherwise than in the name of the Portfolio or a nominee of the Portfolio, all proxies, without indication of the manner in which such proxies are to be voted, and shall promptly deliver to the Portfolio such proxies, all proxy soliciting materials and all notices relating to such securities. 2.15 Communications Relating to Portfolio Securities. Subject to the provisions of Section 2.3, the Custodian shall transmit promptly to the Fund for each Portfolio all written information (including, without limitation, pendency of calls and maturities of domestic securities and expirations of rights in connection therewith and notices of exercise of call and put options written by the Fund on behalf of the Portfolio and the maturity of futures contracts purchased or sold by the Portfolio) received by the Custodian from issuers of the securities being held for the Portfolio. With respect to tender or exchange offers, the Custodian shall transmit promptly to the Portfolio all written information received by the Custodian from issuers of the securities whose tender or exchange is sought and from the party (or his agents) making the tender or exchange offer. If the Portfolio desires to take action with respect to any tender offer, exchange offer or any other similar transaction, the Portfolio shall if reasonably practicable notify the Custodian at least three business days prior to the date on which the Custodian is to take such action. If the Portfolio provides the Custodian with such notification less than three business days prior to the date on which the Custodian is to take such action, the Custodian shall use best efforts only to take such action. 3. Duties of the Custodian with Respect to Property of the Fund Held Outside of the United States 3.1 Appointment of Foreign Sub-Custodians. The Fund hereby authorizes and instructs the Custodian to employ as sub-custodians for the Portfolio's securities and other assets maintained outside the United States the foreign banking institutions and foreign securities depositories designated on Schedule A hereto ("foreign sub-custodians"). Upon receipt of "Proper Instructions", as defined in Section 5 of this Contract, together with a certified resolution of the Fund's Board of Directors, the Custodian and the Fund may agree to amend Schedule A hereto from time to time to designate additional foreign banking institutions and foreign securities depositories to act as sub-custodian. Upon receipt of Proper Instructions, the Fund may instruct the Custodian to cease the employment of any one or more such sub-custodians for maintaining custody of the Portfolio's assets and to cause the delivery of such assets to the Custodian (if reasonably practicable) or to another sub-custodian acceptable to the Custodian and the Fund. 3.2 Assets to be Held. The Custodian shall limit the securities and other assets maintained in the custody of the foreign sub-custodians to: (a) "foreign securities", as defined in paragraph (c)(l) of Rule 17f-5 under the Investment Company Act of 1940, and (b) cash and cash equivalents in such amounts as the Custodian or the Fund may determine to be reasonably necessary to effect the Portfolio's foreign securities transactions. The Custodian shall identify on its books as belonging to the Fund, the foreign securities of the Fund held by each foreign sub-custodian. 3.3 Foreign Securities Systems. Except as may otherwise be agreed upon in writing by the Custodian and the Fund, assets of the Portfolios shall be maintained in a clearing agency which acts as a securities depository or in a book-entry system for the central handling of securities located outside of the United States (each a "Foreign Securities System") only through arrangements implemented by the foreign banking institutions serving as sub-custodians pursuant to the terms hereof (Foreign Securities Systems and U.S. Securities Systems are collectively referred to herein as the "Securities Systems"). Where possible, such arrangements shall include entry into agreements containing the provisions set forth in Section 3.5 hereof. 3.4 Holding Securities. The Custodian may hold securities and other non-cash property for all of its customers, including the Fund, with a foreign sub-custodian in a single account that is identified as belonging to the Custodian for the benefit of its customers, provided however, that (i) the records of the Custodian with respect to securities and other non-cash property of the Fund which are maintained in such account shall identify by book-entry those securities and other non-cash property belonging to the Fund and (ii) the Custodian shall require that securities and other non-cash property so held by the foreign sub-custodian be held separately from any assets of the Custodian, of the foreign sub-custodian or of others. 3.5 Agreements with Foreign Banking Institutions. Each agreement with a foreign banking institution shall provide that: (a) the assets of each Portfolio will not be subject to any right, charge, security interest, lien or claim of any kind in favor of the foreign banking institution or its creditors or agent, except a claim of payment for their safe custody or administration; (b) beneficial ownership for the assets of each Portfolio will be freely transferable without the payment of money or value other than for custody or administration; (c) adequate records will be maintained identifying the assets as belonging to each applicable Portfolio; (d) officers of or auditors employed by, or other representatives of the Custodian, including to the extent permitted under applicable law the independent public accountants for the Fund, will be given access to the books and records of the foreign banking institution relating to its actions under its agreement with the Custodian; and (e) assets of the Portfolios held by the foreign sub-custodian will be subject only to the instructions of the Custodian or its agents. 3.6 Access of Independent Accountants of the Fund. Upon request of the Fund, the Custodian will use its best efforts to arrange for the Fund, its independent accountants and/or its attorneys to be afforded access to the books and records of any foreign banking institution employed as a foreign sub-custodian insofar as such books and records relate to the performance of such foreign banking institution under its agreement with the Custodian. 3.7 Reports by Custodian. The Custodian will supply to the Fund from time to time, as mutually agreed upon, statements in respect of the securities and other assets of the Portfolio(s) held by foreign sub-custodians, including but not limited to an identification of entities having possession of the Portfolio(s) securities and other assets and advices or notifications of any transfers of securities to or from each custodial account maintained by a foreign banking institution for the Custodian on behalf of each applicable Portfolio indicating, as to securities acquired for a Portfolio, the identity of the entity having physical possession of such securities. The Custodian shall also provide to the Fund such other information as may be reasonably requested by the Fund to evidence compliance with Rule 17f-5 under the Investment Company Act. 3.8 Transactions in Foreign Custody Account. (a) Except as otherwise provided in paragraph (b) of this Section 3.8, the provision of Sections 2.2 and 2.7 of this Contract shall apply, mutatis mutandis to the foreign securities of the Fund held outside the United States by foreign sub-custodians. (b) Notwithstanding any provision of this Contract to the contrary, settlement and payment for securities received for the account of each applicable Portfolio and delivery of securities maintained for the account of each applicable Portfolio may be effected in accordance with the customary established securities trading or securities processing practices and procedures in the jurisdiction or market in which the transaction occurs, including, without limitation, delivering securities to the purchaser thereof or to a dealer therefor (or an agent for such purchaser or dealer) against a receipt with the expectation of receiving later payment for such securities from such purchaser or dealer. (c) Securities maintained in the custody of a foreign subcustodian may be maintained in the name of such entity's nominee to the same extent as set forth in Section 2.3 of this Contract, and the Fund agrees to hold any such nominee harmless from any liability as a holder of record of such securities (except liability for failing to act in accordance with instructions). 3.9 Liability of Foreign Sub-Custodians. Each agreement pursuant to which the Custodian employs a foreign banking institution as a foreign sub-custodian shall require the institution to exercise reasonable care and diligence in the performance of its duties and to indemnify, and hold harmless, the Custodian and each Fund from and against any loss, damage, cost, expense, liability or claim arising out of or in connection with the institution's performance of such obligations. At the election of the Fund, it shall be entitled to be subrogated to the rights of the Custodian with respect to any claims against a foreign banking institution as a consequence of any such loss, damage, cost, expense, liability or claim if and to the extent that the Fund has not been made whole for any such loss, damage, cost, expense, liability or claim. In the event of such subrogation, the Custodian shall cooperate with the Fund in asserting such rights and shall take all actions reasonably necessary to enable the Fund to assert such rights. 3.10 Liability of Custodian. The Custodian shall be liable for the acts or omissions of a foreign banking institution to the same extent as set forth with respect to sub-custodians generally in this Contract and, regardless of whether assets are maintained in the custody of a foreign banking institution, a foreign securities depository or a branch of a U.S. bank as contemplated by paragraph 3.13 hereof, the Custodian shall not be liable for any loss, damage, cost, expense, liability or claim resulting from nationalization, expropriation, currency restrictions, or acts of war or terrorism or any loss where the sub-custodian has otherwise exercised reasonable care and diligence. In the event that any sub-custodian appointed pursuant to the provisions of this Section 3 fails to perform any of its obligations under the terms and conditions of the applicable sub-custodian agreement, the Custodian shall use its best efforts to cause such sub-custodian to fully perform its obligations. In the event that the Custodian is unable to cause such sub-custodian to perform its obligations thereunder, the Custodian shall forthwith notify the Fund of the same and, upon the Fund's request, terminate such sub-custodian as a sub-custodian for the Fund in accordance with the termination provisions of the applicable sub-custodian agreement and, if requested by the Fund, appoint another sub-custodian acceptable to the Custodian and the Fund. 3.11 Reimbursement for Advances. If the Fund requires the Custodian to advance cash or securities for any purpose for the benefit of a Portfolio including the purchase or sale of foreign exchange or of contracts for foreign exchange, or in the event that the Custodian or its nominee shall incur or be assessed any taxes, charges, expenses, assessments, claims or liabilities in connection with the performance of this Contract, except such as may arise from its or its nominee's own negligent action, negligent failure to act or willful misconduct, any property at any time held for the account of the applicable Portfolio, having a fair market value not in excess of 125% of the advance, shall be security therefor if specifically identified as such by the Custodian and should the Fund fail to repay the Custodian promptly, the Custodian shall be entitled to utilize available cash and to dispose of such Portfolios assets to the extent necessary to obtain reimbursement. For any property identified as security under this paragraph, the Fund may substitute other property of equivalent value upon permission of the Custodian, which permission shall not be unreasonably withheld. 3.12 Monitoring Responsibilities. The Custodian shall furnish annually to the Fund, during the month of June, and as reasonably requested by the Fund from time to time, information concerning the foreign sub-custodians employed by the Custodian. Such information shall be similar in kind and scope to that furnished to the Fund in connection with the initial approval of this Contract. In addition, the Custodian shall monitor the performance and financial condition of the foreign sub-custodians and foreign securities depositories to the extent practicable and will promptly inform the Fund in the event that the Custodian learns of a material adverse change in the performance or financial condition of a foreign sub-custodian or any material loss of the assets of the Fund. 3.13 Branches of U.S. Banks. (a) Except as otherwise set forth in this Contract, the provisions hereof shall not apply where the custody of the Portfolios assets are maintained in a foreign branch of a banking institution which is a "bank" as defined by Section 2(a)(5) of the Investment Company Act of 1940 meeting the qualification set forth in Section 26(a) of said Act. The appointment of any such branch as a sub-custodian shall be governed by paragraph 1 of this Contract. (b) Cash held for each Portfolio of the Fund in the United Kingdom shall be maintained in an interest bearing account established for the Fund with the Custodian's London branch, which account shall be subject to the direction of the Custodian, State Street London Ltd. or both. 3.14 Tax Law. Except as provided in Section 2.13, the Custodian shall have no responsibility or liability for any obligations now or hereafter imposed on the Fund or the Custodian as custodian of the Fund by the tax law of the United States of America or any state or political subdivision thereof. It shall be the responsibility of the Fund to notify the Custodian of the obligations imposed on the Fund or the Custodian as custodian of the Fund by the tax law of jurisdictions other than those mentioned in the above sentence, including responsibility for withholding and other taxes, assessments or other governmental charges, certifications and governmental reporting. The sole responsibility of the Custodian with regard to such tax law shall be to use reasonable efforts to assist the Fund with respect to any claim for exemption or refund under the tax law of jurisdictions for which the Fund has provided such information. 4. Payments for Sales or Repurchases or Redemptions of Shares of the Fund The Custodian shall receive from the distributor for the Shares or from the Transfer Agent of the Fund and promptly deposit into the account of the appropriate Portfolio such payments as are received for Shares of that Portfolio issued or sold from time to time by the Fund. The Custodian will provide timely notification to the Fund on behalf of each such Portfolio and the Transfer Agent of any receipt by it of payments for Shares of such Portfolio. From such funds as may be available for the purpose but subject to the limitations of the Articles of Incorporation and any applicable votes of the Board of Directors of the Fund pursuant thereto, the Custodian shall, upon receipt of instructions from the Transfer Agent, make funds available for payment to holders of Shares who have delivered to the Transfer Agent a request for redemption or repurchase of their Shares. In connection with the redemption or repurchase of Shares of a Portfolio, the Custodian is authorized upon receipt of instructions from the Transfer Agent to wire funds to or through a commercial bank designated by the redeeming shareholders. In connection with the redemption or repurchase of Shares of the Fund, the Custodian shall honor checks drawn on the Custodian by a holder of Shares, which checks have been furnished by the Fund to the holder of Shares, when presented to the Custodian in accordance with such procedures and controls as are mutually agreed upon from time to time between the Fund and the Custodian. 5. Proper Instructions Proper Instructions as used throughout this Contract means a writing signed or initialed by one or more person or persons as the Board of Directors shall have from time to time authorized. Each such writing shall set forth the specific transaction or type of transaction involved, including a specific statement of the purpose for which such action is requested. Oral instructions will be considered Proper Instructions if the Custodian reasonably believes them to have been given by a person authorized to give such instructions with respect to the transaction involved. The Fund shall cause all oral instructions to be confirmed in writing. Proper Instructions may include communications effected directly between electro-mechanical or electronic devices provided that the instructions are consistent with any security procedures agreed to by the Fund and the Custodian, including but not limited to, the security procedures selected by the Fund on the Funds Transfer Addendum to this Contract. For purposes of this Section, Proper Instructions shall include instructions received by the Custodian pursuant to any three-party agreement which requires a segregated asset account in accordance with Section 2.12. 6. Actions Permitted without Express Authority The Custodian may in its discretion, without express authority from the Fund on behalf of each applicable Portfolio: 1) make payments to itself or others for minor expenses of handling securities or other similar items relating to its duties under this Contract, provided that all such payments shall be accounted for to the Fund on behalf of the Portfolio; 2) surrender securities in temporary form for securities in definitive form; 3) endorse for collection, in the name of the Portfolio, checks, drafts and other negotiable instruments; and 4) in general, attend to all non-discretionary details in connection with the sale, exchange, substitution, purchase, transfer and other dealings with the securities and property of the Portfolio except as otherwise directed by the Board of Directors of the Fund. 7. Evidence of Authority The Custodian shall be protected in acting upon any instructions, notice, request, consent, certificate or other instrument or paper reasonably believed by it to be genuine and to have been properly executed by or on behalf of the Fund. The Custodian may receive and accept a certified copy of a vote of the Board of Directors of the Fund as conclusive evidence (a) of the authority of any person to act in accordance with such vote or (b) of any determination or of any action by the Board of Directors pursuant to the Articles of Incorporation as described in such vote, and such vote may be considered as in full force and effect until receipt by the Custodian of written notice to the contrary. 8. Duties of Custodian with Respect to the Books of Account and Calculation of Net Asset Value and Net Income The Custodian shall cooperate with and supply necessary information to the entity or entities appointed by the Board of Directors of the Fund to keep the books of account of each Portfolio and/or compute the net asset value per share of the outstanding shares of each Portfolio or, if directed in writing to do so by the Fund on behalf of the Portfolio, shall itself keep such books of account and/or compute such net asset value per share. If so directed, the Custodian shall also calculate daily the net income of the Portfolio as described in the Fund's currently effective prospectus related to such Portfolio and shall advise the Fund and the Transfer Agent daily of the total amounts of such net income and, if instructed in writing by an officer of the Fund to do so, shall advise the Transfer Agent periodically of the division of such net income among its various components. The calculations of the net asset value per share and the daily income of each Portfolio shall be made at the time or times described from time to time in the Fund's currently effective prospectus related to such Portfolio. On each day that the Custodian computes the net asset value per share of the Fund, the Custodian will provide information sufficient to permit the Fund to verify that portfolio transactions are reconciled with the Fund's trading records. 9. Records The Custodian shall with respect to each Portfolio create and maintain all records relating to its activities and obligations under this Contract in such manner as will meet the obligations of the Fund under the Investment Company Act of 1940, with particular attention to Section 31 thereof and Rules 31a-1 and 31a-2 thereunder and under applicable state and federal tax laws. All such records shall be the property of the Fund and shall at all times during the regular business hours of the Custodian be open for inspection and audit by duly authorized officers, employees, agents and auditors of and attorneys for the Fund and employees and agents of the Securities and Exchange Commission. The Custodian shall, at the Fund's request, supply the Fund with a tabulation of securities owned by each Portfolio and held by the Custodian and shall, when requested to do so by the Fund and for such compensation as shall be agreed upon between the Fund and the Custodian, include certificate numbers in such tabulations. 10. Opinion of Fund's Independent Accountant The Custodian shall take all reasonable action, as the Fund on behalf of each applicable Portfolio may from time to time request, to obtain from year to year favorable opinions from the Fund's independent accountants with respect to its activities hereunder in connection with the preparation of the Fund's Form N-1A, and Form N-SAR or other annual reports to the Securities and Exchange Commission and with respect to any other requirements of such Commission. 11. Reports to Fund by Independent Public Accountants The Custodian shall provide the Fund, on behalf of each of the Portfolios at such times as the Fund may reasonably require, with reports by independent public accountants on the accounting system, internal accounting control and procedures for safeguarding cash, securities, futures contracts and options on futures contracts, including cash, securities, and other assets deposited and/or maintained in a Securities System or with a sub-custodian, relating to the services provided by the Custodian, directly or through any agent, under this Contract; such reports, shall be of sufficient scope and in sufficient detail, as may reasonably be required by the Fund to provide reasonable assurance that any material inadequacies would be disclosed by such examination, and, if there are no such inadequacies, the reports shall so state. 12. Compensation of Custodian The Custodian shall be entitled to reasonable compensation for its services and expenses as Custodian, as agreed upon in writing from time to time between the Fund on behalf of each applicable Portfolio and the Custodian. The Custodian shall provide the Fund a written invoice for each such payment. 13. Responsibility of Custodian So long as and to the extent that it is in the exercise of reasonable care, the Custodian shall not be responsible for the title, validity or genuineness of any property or evidence of title thereto received by it or delivered by it pursuant to this Contract and shall be held harmless in acting upon any notice, request, consent, certificate or other instrument reasonably believed by it to be genuine and to be signed by the proper party or parties, including any futures commission merchant acting pursuant to the terms of a three-party futures or options agreement. The Custodian shall be held to the exercise of reasonable care in carrying out the provisions of this Contract, but shall be kept indemnified by and shall be without liability to the Fund for any action taken or omitted by it in good faith without negligence. It shall be entitled to rely on and may act upon advice of counsel (who may be counsel for the Fund) on all matters, and shall be without liability for any action reasonably taken or omitted pursuant to such advice that such actions or omissions comply with the terms of the Contract and with all applicable laws, provided the Custodian acts in good faith and without negligence. The Custodian shall be liable for the acts or omissions of a foreign banking institution employed as a sub-custodian to the same extent as set forth with respect to sub-custodians generally in this Contract. If the Fund on behalf of a Portfolio requires the Custodian to take any action with respect to securities, which action involves the payment of money or which action may, in the opinion of the Custodian, result in the Custodian or its nominee assigned to the Fund or the Portfolio being liable for the payment of money or incurring liability of some other form, the Fund on behalf of the Portfolio, as a prerequisite to requiring the Custodian to take such action, shall provide indemnity to the Custodian in an amount and form satisfactory to it. If the Fund requires the Custodian, its affiliates, subsidiaries or agents, to advance cash or securities for any purpose (including but not limited to securities settlements, foreign exchange contracts and assumed settlement) or in the event that the Custodian or its nominee shall incur or be assessed any taxes, charges, expenses, assessments, claims or liabilities in connection with the performance of this Contract, except such as may arise from its or its nominee's or agent's own negligent action, negligent failure to act or willful misconduct, (collectively referred to herein as a "Liability"), then in such event cash held for the account of the Fund and securities issued by United States issuers or other securities selected by the Custodian equal in value to not more than 125% of such Advance and accrued interest on the Advance or the anticipated amount of such Liability, held at any time for the account of the Fund by the Custodian or sub-custodian, shall be held as security for such Liability or for such Advance and the accrued interest on the Advance. The Custodian shall designate the security or securities constituting security for an Advance or Liability (the "Designated Securities") by notice in writing to the Fund (which may be sent by telefax). In the event the value of the Designated Securities shall decline to less than 110% of the amount of such Advance and accrued interest on the Advance or the anticipated amount of such Liability, then the Custodian may designate in the same manner additional securities to be held as security for such obligation ("Additional Securities") but the aggregate value of the Designated Securities and the Additional Securities shall not be in excess of 125% of the amount of such Advance and the accrued interest on the Advance or the anticipated amount of such Liability. At the request of the Fund, the Custodian shall agree to substitution of a security or securities which have a value equal to the value of the Designated or Additional Securities which the Fund desires to be released from their status as security, and such release from status as security shall be effective upon the Custodian and the Fund agreeing in writing as to the identity of the substituted security or securities, which shall thereupon become Designated Securities. Notwithstanding the above, the Custodian shall, at the request of the Fund, immediately release from their status as security any or all of the Designated Securities or Additional Securities upon the Custodian's receipt from such Fund of cash or cash equivalents in an amount equal to 100% of the value of the Designated Securities or Additional Securities that the Fund desires to be released from their status as security pursuant to this Section. The Fund shall reimburse the Custodian in respect of a Liability and shall pay any Advances upon demand; provided, however, that the Custodian first notified the Fund of such demand for repayment or reimbursement. If, upon notification, the Fund shall fail to pay such advance or interest when due or shall fail to reimburse the Custodian promptly in respect of a Liability, the Fund acknowledges and agrees that the Custodian shall be entitled to apply cash held for the Fund and/or dispose of the Designated Securities and Additional Securities to the extent necessary to obtain repayment or reimbursement. Interest, dividends and other distributions paid or received on the Designated Securities or Additional Securities, other than payments of principal or payments upon retirement, redemption or repurchase, shall remain the property of the Fund, and shall not be subject to this Section. To the extent that the dispositions of the Fund's property, designated as security for such Advance or Liability, results in an amount less than necessary to obtain repayment or reimbursement, the Fund shall continue to be liable to the Custodian for the difference between the proceeds of the dispositions of the Fund's property, designated as security for such Advance or Liability, and the amount of the repayment or reimbursement due to the Custodian and the Custodian shall be entitled to designate Additional Securities to secure the amount of the shortfall and shall have the same rights with respect to such Additional Securities as are provided herein with respect to Designated Securities generally. In no event shall the Custodian be liable for indirect, special or consequential damages. 14. Effective Period. Termination and Amendment This Contract shall become effective as of its execution, shall continue in full force and effect until terminated as hereinafter provided, may be amended at any time by mutual agreement of the parties hereto and may be terminated by either party by an instrument in writing delivered or mailed, postage prepaid to the other party, such termination to take effect not sooner than thirty (30) days after the date of such delivery or mailing; provided, however that the Custodian shall not with respect to a Portfolio act under Section 2.10 hereof in the absence of receipt of an initial certificate of the Secretary or an Assistant Secretary that the Board of Directors of the Fund has approved the initial use of a particular Securities System by such Portfolio, as required by Rule 17f-4 under the Investment Company Act of 1940, as amended and that the Custodian shall not with respect to a Portfolio act under Section 2.11 hereof in the absence of receipt of an initial certificate of the Secretary or an Assistant Secretary that the Board of Directors has approved the initial use of the Direct Paper System by such Portfolio; provided further, however, that the Fund shall not amend or terminate this Contract in contravention of any applicable federal or state regulations, or any provision of the Articles of Incorporation, and further provided, that the Fund on behalf of one or more of the Portfolios may at any time by action of its Board of Directors (i) substitute another bank or trust company for the Custodian by giving notice as described above to the Custodian, or (ii) immediately terminate this Contract in the event of the appointment of a conservator or receiver for the Custodian by the Comptroller of the Currency or upon the happening of a like event at the direction of an appropriate regulatory agency or court of competent jurisdiction. Upon termination of the Contract, the Fund on behalf of each applicable Portfolio shall pay to the Custodian such compensation as may be due as of the date of such termination and shall likewise reimburse the Custodian for its costs, expenses and disbursements. 15. Successor Custodian If a successor custodian for the Fund, of one or more of the Portfolios shall be appointed by the Board of Directors of the Fund, the Custodian shall, upon termination, promptly deliver to such successor custodian at the office of the Custodian, duly endorsed and in the form for transfer, all securities and funds, as well as all books and records, of each applicable Portfolio then held by it hereunder and shall transfer to an account of the successor custodian all of the securities of each such Portfolio held in a Securities System. If no such successor custodian shall be appointed, the Custodian shall, in like manner, upon receipt of a certified copy of a vote of the Board of Directors of the Fund, deliver at the office of the Custodian and promptly transfer such securities, funds, books and records, and other properties in accordance with such vote. In the event that no written order designating a successor custodian or certified copy of a vote of the Board of Directors shall have been delivered to the Custodian on or before the date when such termination shall become effective, then the Custodian shall have the right to deliver to a bank or trust company, which is a "bank" as defined in the Investment Company Act of 1940, doing business in Boston, Massachusetts, of its own selection, having an aggregate capital, surplus, and undivided profits, as shown by its last published report, of not less than $25,000,000, all securities, funds and other properties held by the Custodian on behalf of each applicable Portfolio and all instruments held by the Custodian relative thereto and all other property held by it under this Contract on behalf of each applicable Portfolio and to transfer to an account of such successor custodian all of the securities of each such Portfolio held in any Securities System. Thereafter, such bank or trust company shall be the successor of the Custodian under this Contract. The Custodian agrees to cooperate with the successor custodian and the Fund in the execution of documents and performance of other actions necessary or desirable in order to substitute the successor custodian for the Custodian. In the event that securities, funds and other properties remain in the possession of the Custodian after the date of termination hereof owing, to failure of the Fund to procure the certified copy of the vote referred to or of the Board of Directors to appoint a successor custodian, the Custodian shall be entitled to fair compensation for its services during such period as the Custodian retains possession of such securities, funds and other properties and the provisions of this Contract relating to the duties and obligations of the Custodian shall remain in full force and effect. 16. Interpretive and Additional Provisions In connection with the operation of this Contract, the Custodian and the Fund on behalf of each of the Portfolios, may from time to time agree on such provisions interpretive of or in addition to the provisions of this Contract as may in their joint opinion be consistent with the general tenor of this Contract. Any such interpretive or additional provisions shall be in a writing signed by both parties and shall be annexed hereto, provided that no such interpretive or additional provisions shall contravene any applicable federal or state regulations or any provision of the Articles of Incorporation of the Fund. No interpretive or additional provisions made as provided in the preceding sentence shall be deemed to be an amendment of this Contract. 17. Additional Funds In the event that the Fund establishes one or more series of Shares in addition to LM Value Institutional Portfolio, LM Mid Cap Institutional Portfolio, Brandywine Small Cap Value Portfolio, Batterymarch Emerging Markets Portfolio, Batterymarch International Equity Portfolio, and LM Total Return Institutional Portfolio with respect to which it desires to have the Custodian render services as custodian under the terms hereof, it shall so notify the Custodian in writing, and if the Custodian agrees in writing to provide such services, such series of Shares shall become a Portfolio hereunder. 18. Massachusetts Law to Apply This Contract shall be construed and the provisions thereof interpreted under and in accordance with laws of The Commonwealth of Massachusetts. 19. Prior Contracts This Contract supersedes and terminates, as of the date hereof, all prior contracts between the Fund on behalf of each of the Portfolios and the Custodian relating to the custody of the Fund's assets. 20. Reproduction of Documents This Contract and all schedules, exhibits, attachments and amendments hereto may be reproduced by any photographic, photostatic, microfilm, micro-card, miniature photographic or other similar process. The parties hereto all/each agree that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding, whether or not the original is in existence and whether or not such reproduction was made by a party in the regular course of business, and that any enlargement, facsimile or further reproduction of such reproduction shall likewise be admissible in evidence. 21. Notices. Any notice, instruction or other instrument required to be given hereunder may be delivered in person to the offices of the parties as set forth herein during normal business hours or delivered prepaid registered mail or by telex, cable or telecopy to the parties at the following addresses or such other addresses as may be notified by any party from time to time. To the Fund: LM Institutional Fund Advisors II, Inc. 100 Light Street, 29th Floor Baltimore, Maryland 21202 Attention: Kathi Bair Telephone: 410-454-2744 Telecopy: 410-454-3445 To the Custodian: State Street Bank and Trust Company 1776 Heritage Drive, JAB/4SW North Quincy, Massachusetts 02171 Attention: Edward M. Buccigross Telephone: 617-985-6834 Telecopy: 617-985-5450 Such notice, instruction or other instrument shall be deemed to have been served in the case of a registered letter at the expiration of five business days after posting, in the case of cable twenty-four hours after dispatch and, in the case of telex, immediately on dispatch and if delivered outside normal business hours it shall be deemed to have been received at the next time after delivery when normal business hours commence and in the case of cable, telex or telecopy on the business day after the receipt thereof. Evidence that the notice was properly addressed, stamped and put into the post shall be conclusive evidence of posting. 22. Data Access Service Addendum The Fund and the Custodian agree to be bound by the terms of the Data Access Services Addendum attached hereto. 23. Shareholder Communications Securities and Exchange Commission Rule 14b-2 requires banks which hold securities for the account of customers to respond to requests by issuers of securities for the names, addresses and holdings of beneficial owners of securities of that issuer held by the bank unless the beneficial owner has expressly objected to disclosure of this information. In order to comply with the rule, the Custodian needs the Fund to indicate whether the Fund authorizes the Custodian to provide the Fund's name, address, and share position to requesting companies whose stock the Fund owns. If the Fund tells the Custodian "no", the Custodian will not provide this information to requesting companies. If the Fund tells the Custodian "yes" or do not check either "yes" or "no" below, the Custodian is required by the rule to treat the Fund as consenting to disclosure of this information for all securities owned by the Fund or any funds or accounts established by the Fund. For the Fund's protection, the Rule prohibits the requesting company from using the Fund's name and address for any purpose other than corporate communications. Please indicate below whether the Fund consents or objects by checking one of the alternatives below. YES [ ] The Custodian is authorized to release the Fund's name, address, and share positions. NO [ ] The Custodian is not authorized to release the Fund's name, address, and share positions. 24. Miscellaneous 24.1 Expenses of the Fund In addition to any liability to the Fund for which the Custodian is determined to be liable under this Contract, the Custodian shall be liable to the Fund for all reasonable costs and expenses incurred by the Fund in connection with a claim by the Fund against the Custodian, an Agent or sub-custodian for which the Custodian is liable under this Contract, including, reasonable attorneys' fees and expenses and other reasonable fees incurred in any investigation, lawsuit or other proceeding related to such claim. Nothing in this paragraph shall preclude the parties from agreeing to payment of such expenses by the Custodian in connection with a claim settled by arbitration, mediation or negotiation. 24.2 Assignment This Contract may not be assigned by either party without the written consent of the other. 24.3 Insurance The Custodian agrees to maintain insurance adequate to the protection of all assets of the Fund that may come into the Custodian's care under this Contract. 24.4 Confidentiality The Custodian agrees that all books, records, information and data pertaining to the business of the Fund which are exchanged or received pursuant to the negotiation or carrying out of this Contract shall remain confidential, shall not be voluntarily disclosed to any other person, except as may be required by law, and shall not be used by the Custodian for any purpose not directly related to the business of the Fund, except with the Fund's written consent. 24.5 Separate Portfolios Notwithstanding any other provision of this Contract, the parties agree that the assets and liabilities of each series of the Fund are separate and distinct from the assets and liabilities of each other series and that no series shall be liable or shall be charged for any debt, obligation or liability of any other series, whether arising under this Contract or otherwise. IN WITNESS WHEREOF, each of the parties has caused this instrument to be executed in its name and behalf by its duly authorized representative and its seal to be hereunder affixed as of the eighteenth day of August,1998. LM INSTITUTIONAL FUND ADVISORS II, INC. FUND SIGNATURE ATTESTED TO BY: By: /s/ MARIE K. KARPINSKI By: /s/ KATHI D. BAIR ------------------------------------ ----------------------------- Name: Marie K. Karpinski Name: Kathi D. Bair ------------------------------- ------------------------ Title: Vice President and Treasurer Title: Secretary ------------------------------ -------------------------- STATE STREET BANK AND TRUST COMPANY SIGNATURE ATTESTED TO BY: By: /s/ RONALD E. LOGUE By: /s/ MARC L. PARSONS ---------------------------- ----------------------------- Narne: Ronald E. Logue Name: Marc L. Parsons --------------------------------- --------------------------- Title: Executive Vice President Title: Associate Counsel --------------------------------- -------------------------- DATA ACCESS SERVICES ADDENDUM TO CUSTODIAN AGREEMENT AGREEMENT between LM Institutional Fund Advisors II, Inc. (the "Customer") and State Street Bank and Trust Company ("State Street"). PREAMBLE WHEREAS, State Street has been appointed as custodian of certain assets of the Customer pursuant to a certain Custodian Agreement (the "Custodian Agreement") dated as of August 18, 1998; WHEREAS, State Street has developed and utilizes proprietary accounting and other systems, including State Street's proprietary Multicurrency HORIZON(SM) Accounting System, in its role as custodian of the Customer, and maintains certain Customer-related data ("Customer Data") in databases under the control and ownership of State Street (the "Data Access Services"); and WHEREAS, State Street makes available to the Customer certain Data Access Services solely for the benefit of the Customer, and intends to provide additional services, consistent with the terms and conditions of this Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements herein contained, and for other good and valuable consideration, the parties agree as follows: 1. SYSTEM AND DATA ACCESS SERVICES (a) System. Subject to the terms and conditions of this Agreement, State Street hereby agrees to provide the Customer with access to State Street's Multicurrency HORIZON(SM) Accounting System and the other information systems (collectively, the "System") as described in Attachment A, on a remote basis for the purpose of obtaining reports and information, solely on computer hardware, system software and telecommunication links as listed in Attachment B (the "Designated Configuration") of the Customer, or certain third parties approved by State Street that serve as investment advisors or investment managers or in other service capacities to the Customer such as the Customer's independent auditors (each, an "Investment Advisor"), solely with respect to the Customer, or on any designated substitute or back-up equipment configuration with State Street's written consent, such consent not to be unreasonably withheld. (b) Data Access Services. State Street agrees to make available to the Customer the Data Access Services subject to the terms and conditions of this Agreement and data access operating standards and procedures as may be issued by State Street from time to time. The ability of the Customer to originate electronic instructions to State Street on behalf of the Customer in order to (i) effect the transfer or movement of cash or securities held under custody by State Street or (ii) transmit accounting or other information (such transactions are referred to herein as "Client Originated Electronic Financial Instructions"), and (iii) access data for the purpose of reporting and analysis, shall be deemed to be Data Access Services for purposes of this Agreement. (c) Additional Services. State Street may from time to time agree to make available to the Customer additional Systems that are not described in the attachments to this Agreement. In the absence of any other written agreement concerning such additional systems, the term "System" shall include, and this Agreement shall govern, the Customer's access to and use of any additional System made available by State Street and/or accessed by the Customer. 2. NO USE OF THIRD PARTY SYSTEMS-LEVEL SOFTWARE State Street and the Customer acknowledge that in connection with the Data Access Services provided under this Agreement, the Customer will have access, through the Data Access Services, to Customer Data and to functions of State Street's proprietary systems; provided, however that in no event will the Customer have direct access to any third party systems-level software that retrieves data for, stores data from, or otherwise supports the System. 3. LIMITATION ON SCOPE OF USE a. Designated Equipment: Designated Location. The System and the Data Access Services shall be used and accessed solely on and through the Designated Configuration at the offices of the Customer or the Investment Advisor located in Baltimore, Maryland ("Designated Location"). b. Designated Configuration: Trained Personnel. State Street shall be responsible for supplying, installing and maintaining the Designated Configuration at the Designated Location. State Street and the Customer agree that each will engage or retain the services of trained personnel to enable both parties to perform their respective obligations under this Agreement. State Street agrees to use commercially reasonable efforts to maintain the System so that it remains serviceable, provided, however, that State Street does not guarantee or assure uninterrupted remote access use of the System. c. Scope of Use. The Customer will use the System and the Data Access Services only for the processing of securities transactions, the keeping of books of account for the Customer and accessing data for purposes of reporting and analysis. The Customer shall not, and shall cause its employees and agents not to (i) permit any third party to use the System or the Data Access Services, (ii) sell, rent, license or otherwise use the System or the Data Access Services in the operation of a service bureau or for any purpose other than as expressly authorized under this Agreement, (iii) use the System or the Data Access Services for any fund, trust or other investment vehicle without the prior written consent of State Street, (iv) allow access to the System or the Data Access Services through terminals or any other computer or telecommunications facilities located outside the Designated Locations, (v) allow or cause any information (other than portfolio holdings, valuations of portfolio holdings, and other information reasonably necessary for the management or distribution of the assets of the Customer) transmitted from State Street's databases, including data from third party sources, available through use of the System or the Data Access Services to be redistributed or retransmitted to another computer, terminal or other device for other than use for or on behalf of the Customer or (vi) modify the System in any way, including without limitation, developing any software for or attaching any devices or computer programs to any equipment, system, software or database which forms a part of or is resident on the Designated Configuration. d. Other Locations. Except in the event of an emergency or of a planned System shutdown, the Customer's access to services performed by the System or to Data Access Services at the Designated Location may be transferred to a different location only upon the prior written consent of State Street. In the event of an emergency or System shutdown, the Customer may use any back-up site included in the Designated Configuration or any other back-up site agreed to by State Street, which agreement will not be unreasonably withheld. The Customer may secure from State Street the right to access the System or the Data Access Services through computer and telecommunications facilities or devices complying with the Designated Configuration at additional locations only upon the prior written consent of State Street and on terms to be mutually agreed upon by the parties. e. Title. Title and all ownership and proprietary rights to the System, including any enhancements or modifications thereto, whether or not made by State Street, are and shall remain with State Street. f. No Modification. Without the prior written consent of State Street, the Customer shall not modify, enhance or otherwise create derivative works based upon the System, nor shall the Customer reverse engineer, decompile or otherwise attempt to secure the source code for all or any part of the System. g. Security Procedures. The Customer shall comply with data access operating standards and procedures and with user identification or other password control requirements and other security procedures as may be issued from time to time by State Street for use of the System on a remote basis and to access the Data Access Services. The Customer shall have access only to the Customer Data and authorized transactions agreed upon from time to time by State Street and, upon notice from State Street, the Customer shall discontinue remote use of the System and access to Data Access Services for any security reasons cited by State Street; provided, that, in such event, State Street shall, for a period not less than 180 days (or such other shorter period specified by the Customer) after such discontinuance, assume responsibility to provide accounting services under the terms of the Custodian Agreement. h. Inspections. State Street shall have the right to inspect the use of the System and the Data Access Services by the Customer and the Investment Advisor to ensure compliance with this Agreement. The on-site inspections shall be upon prior written notice to the Customer and the Investment Advisor and at reasonably convenient times and frequencies so as not to result in an unreasonable disruption of the Customer's or the Investment Advisor's business. 4. PROPRIETARY INFORMATION a. Proprietary Information. The Customer acknowledges and State Street represents that the System and the databases, computer programs, screen formats, report formats, interactive design techniques, documentation and other information made available to the Customer by State Street as part of the Data Access Services and through the use of the System constitute copyrighted, trade secret, or other proprietary information of substantial value to State Street. Any and all such information provided by State Street to the Customer shall be deemed proprietary and confidential information of State Street (hereinafter "Proprietary Information"). The Customer agrees that it will hold such Proprietary Information in the strictest confidence and secure and protect it in a manner consistent with its own procedures for the protection of its own confidential information and to take appropriate action by instruction or agreement with its employees who are permitted access to the Proprietary Information to satisfy its obligations hereunder. The Customer further acknowledges that State Street shall not be required to provide the Investment Advisor with access to the System unless it has first received from the Investment Advisor an undertaking with respect to State Street's Proprietary Information in the form of Attachment C to this Agreement. The Customer shall use all commercially reasonable efforts to assist State Street in identifying and preventing any unauthorized use, copying or disclosure of the Proprietary Information or any portions thereof or any of the logic, formats or designs contained therein. b. Cooperation. Without limitation of the foregoing, the Customer shall advise State Street immediately in the event the Customer learns or has reason to believe that any person to whom the Customer has given access to the Proprietary Information, or any portion thereof, has violated or intends to violate the terms of this Agreement, and the Customer will, at its expense, co-operate with State Street in seeking injunctive or other equitable relief in the name of the Customer or State Street against any such person. c. Injunctive Relief. The Customer acknowledges that the disclosure of any Proprietary Information, or of any information which at law or equity ought to remain confidential, will immediately give rise to continuing irreparable injury to State Street inadequately compensable in damages at law. In addition, State Street shall be entitled to obtain immediate injunctive relief against the breach or threatened breach of any of the foregoing undertakings, in addition to any other legal remedies which may be available. d. Survival. The provisions of this Section 4 shall survive the termination of this Agreement. 5. LIMITATION ON LIABILITY a. Limitation on Amount and Time for Bringing Action. The Customer agrees that any liability of State Street to the Customer or any third party arising out of State Street's provision of Data Access Services or the System under this Agreement shall be limited to the amount of fees paid to State Street for such services. In no event shall State Street be liable to the Customer or any other party for any special, indirect, punitive or consequential damages even if advised of the possibility of such damages. No action, regardless of form, arising out of this Agreement may be brought by the Customer more than two years after the Customer has knowledge that the cause of action has arisen. b. Limited Warranties. NO OTHER WARRANTIES, WHETHER EXPRESS OR IMPLIED, INCLUDING, WITHOUT LIMITATION, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE, ARE MADE BY STATE STREET. c. Third-Party Data. Organizations from which State Street may obtain certain data included in the System or the Data Access Services are solely responsible for the contents of such data, and State Street shall have no liability for claims arising out of the contents of such third-party data, including, but not limited to, the accuracy thereof. d. Regulatory Requirements. As between State Street and the Customer, the Customer shall be solely responsible for the accuracy of any accounting statements or reports produced using the Data Access Services and the System and the conformity thereof with any requirements of law. e. Force Majeure. Neither party shall be liable for any costs or damages due to delay or nonperformance under this Agreement arising out of any cause or event beyond such party's control, including without limitation, cessation of services hereunder or any damages resulting therefrom to the other party, or the Customer as a result of work stoppage, power or other mechanical failure, computer virus, natural disaster, governmental action, or communication disruption. 6. INDEMNIFICATION The Customer agrees to indemnify and hold State Street harmless from any loss, damage or expense including reasonable attorney's fees, (a "loss") suffered by State Street arising from (i) the negligence or willful misconduct in the use by the Customer of the Data Access Services or the System, including any loss incurred by State Street resulting from a security breach at the Designated Location or committed by the Customer's employees or agents or the Investment Advisor and (ii) any loss resulting from incorrect Client Originated Electronic Financial Instructions. State Street shall be entitled to rely on the validity and authenticity of Client Originated Electronic Financial Instructions without undertaking any further inquiry as long as such instruction is undertaken in conformity with security procedures established by State Street from time to time. 7. FEES Fees and charges for the use of the System and the Data Access Services and related payment terms shall be as set forth in the Custody Fee Schedule in effect from time to time between the parties (the "Fee Schedule"). Any tariffs, duties or taxes imposed or levied by any government or governmental agency by reason of the transactions contemplated by this Agreement, including, without limitation, federal, state and local taxes, use, value added and personal property taxes (other than income, franchise or similar taxes which may be imposed or assessed against State Street) shall be borne by the Customer. Any claimed exemption from such tariffs, duties or taxes shall be supported by proper documentary evidence delivered to State Street. 8. TRAINING, IMPLEMENTATION AND CONVERSION a. Training. State Street agrees to provide training, at a designated State Street training facility or at the Designated Location, to the Customer's personnel in connection with the use of the System on the Designated Configuration. The Customer agrees that it will set aside, during regular business hours or at other times agreed upon by both parties, sufficient time to enable all operators of the System and the Data Access Services, designated by the Customer, to receive the training offered by State Street pursuant to this Agreement. b. Installation and Conversion. State Street shall be responsible for the technical installation and conversion ("Installation and Conversion") of the Designated Configuration. The Customer shall have the following responsibilities in connection with Installation and Conversion of the System: (i) The Customer shall be solely responsible for the timely acquisition and maintenance of the hardware and software that attach to the Designated Configuration in order to use the Data Access Services at the Designated Location. (ii) State Street and the Customer each agree that they will assign qualified personnel to actively participate during the Installation and Conversion phase of the System implementation to enable both parties to perform their respective obligations under this Agreement. 9. SUPPORT During the term of this Agreement, State Street agrees to provide the support services set out in Attachment D to this Agreement. 10. TERM OF AGREEMENT a. Term of Agreement. This Agreement shall become effective on the date of its execution by State Street and shall remain in full force and effect until terminated as herein provided. b. Termination of Agreement. Either party may terminate this Agreement (i) for any reason by giving the other party at least one-hundred and eighty days' prior written notice in the case of notice of termination by State Street to the Customer or thirty days' notice in the case of notice from the Customer to State Street of termination; or (ii) immediately for failure of the other party to comply with any material term and condition of the Agreement by giving the other party written notice of termination. In the event the Customer shall cease doing business, shall become subject to proceedings under the bankruptcy laws (other than a petition for reorganization or similar proceeding) or shall be adjudicated bankrupt, this Agreement and the rights granted hereunder shall, at the option of State Street, immediately terminate with notice to the Customer. This Agreement shall in any event terminate as to any Customer within 90 days after the termination of the Custodian Agreement applicable to such Customer. c. Termination of the Right to Use. Upon termination of this Agreement for any reason, any right to use the System and access to the Data Access Services shall terminate and the Customer shall immediately cease use of the System and the Data Access Services. Immediately upon termination of this Agreement for any reason, the Customer shall return to State Street all copies of documentation and other Proprietary Information in its possession; provided, however, that in the event that either party terminates this Agreement or the Custodian Agreement for any reason other than the Customer's breach, State Street shall provide the Data Access Services for a period of time and at a price to be agreed upon by the parties. 11. MISCELLANEOUS a. Assignment; Successors. This Agreement and the rights and obligations of the Customer and State Street hereunder shall not be assigned by either party without the prior written consent of the other party, except that State Street may assign this Agreement to a successor of all or a substantial portion of its business, or to a party controlling, controlled by, or under common control with State Street. b. Survival. All provisions regarding indemnification, warranty, liability and limits thereon, and confidentiality and/or protection of proprietary rights and trade secrets shall survive the termination of this Agreement. c. Entire Agreement. This Agreement and the attachments hereto constitute the entire understanding of the parties hereto with respect to the Data Access Services and the use of the System and supersedes any and all prior or contemporaneous representations or agreements, whether oral or written, between the parties as such may relate to the Data Access Services or the System, and cannot be modified or altered except in a writing duly executed by the parties. This Agreement is not intended to supersede or modify the duties and liabilities of the parties hereto under the Custodian Agreement or any other agreement between the parties hereto except to the extent that any such agreement specifically refers to the Data Access Services or the System. No single waiver of any right hereunder shall be deemed to be a continuing waiver. d. Severability. If any provision or provisions of this Agreement shall be held to be invalid, unlawful, or unenforceable, the validity, legality, and enforceability of the remaining provisions shall not in any way be affected or impaired. e. Governing Law. This Agreement shall be interpreted and construed in accordance with the internal laws of The Commonwealth of Massachusetts without regard to the conflict of laws provisions thereof. ATTACHMENT A Multicurrency HORIZON(SM) Accounting System System Product Description -------------------------- I. The Multicurrency HORIZON(SM) Accounting System is designed to provide lot level portfolio and general ledger accounting for SEC and ERISA type requirements and includes the following services: 1) recording of general ledger entries; 2) calculation of daily income and expense; 3) reconciliation of daily activity with the trial balance, and 4) appropriate automated feeding mechanisms to (i) domestic and international settlement systems, (ii) daily, weekly and monthly evaluation services, (iii) portfolio performance and analytic services, (iv) customer's internal computing systems and (v) various State Street provided information services products. II. HORIZON(R) Gateway. HORIZON(R) Gateway provides customers with the ability to (i) generate reports using information maintained on the Multicurrency HORIZON(R) Accounting System which may be viewed or printed at the customer's location; (ii) extract and download data from the Multicurrency HORIZON(R) Accounting System; and (iii) access previous day and historical data. The following information which may be accessed for these purposes: 1) holdings; 2) holdings pricing; 3) transactions, 4) open trades; 5) income; 6) general ledger and 7) cash. III. SaFiRe(SM). SaFiRe(SM) is designed to provide the customer with the ability to prepare its own financial reports by permitting the customer to access customer information maintained on the Multicurrency HORIZON(R) Accounting System, to organize such information in a flexible reporting format and to have such reports printed on the customer's desktop or by its printing provider. ATTACHMENT B ------------ LEGG MASON FRAME-RELAY NETWORK [DIAGRAM OF L.M. FRAME-RELAY NETWORK HERE] Legg Mason 100 South Light Street 25th Floor Baltimore, Maryland 21202 Contact: Jim Manring 410-454-3032 Dan Cochran 410-454-2230 Fax 410-454-3330 ATTACHMENT C Undertaking The Undersigned understands that in the course of its employment as Investment Advisor to LM Institutional Fund Advisors II, Inc. (the "Customer") it will have access to State Street Bank and Trust Company's ("State Street") Multicurrency HORIZON(SM) Accounting System and other information systems (collectively, the "System"). The Undersigned acknowledges that the System and the databases, computer programs, screen formats, report formats, interactive design techniques, documentation and other information made available to the Undersigned by State Street as part of the Data Access Services provided to the Customer and through the use of the System constitute copyrighted, trade secret, or other proprietary information of substantial value to State Street. Any and all such information provided by State Street to the Undersigned shall be deemed proprietary and confidential information of State Street (hereinafter "Proprietary Information"). The Undersigned agrees that it will hold such Proprietary Information in confidence and secure and protect it in a manner consistent with its own procedures for the protection of its own confidential information and to take appropriate action by instruction or agreement with its employees who are permitted access to the Proprietary Information to satisfy its obligations hereunder. The Undersigned will not attempt to intercept data, gain access to data in transmission, or attempt entry into any system or files for which it is not authorized. It will not intentionally adversely affect the integrity of the System through the introduction of unauthorized code or data, or through unauthorized deletion. Upon notice by State Street for any reason, any right to use the System and access to the Data Access Services shall terminate and the Undersigned shall immediately cease use of the System and the Data Access Services. Immediately upon notice by State Street for any reason, the Undersigned shall return to State Street all copies of documentation and other Proprietary Information in its possession. LEGG MASON FUND ADVISER, INC. By: __________________________________ Title: _______________________________ Date: ________________________________ Undertaking The Undersigned understands that in the course of its employment as independent accountants for LM Institutional Fund Advisors II, Inc. (the "Customer") it will have access to State Street Bank and Trust Company's ("State Street") Multicurrency HORIZON(SM) Accounting System and other information systems (collectively, the "System"). The Undersigned acknowledges that the System and the databases, computer programs, screen formats, report formats, interactive design techniques, documentation and other information made available to the Undersigned by State Street as part of the Data Access Services provided to the Customer and through the use of the System constitute copyrighted, trade secret, or other proprietary information of substantial value to State Street. Any and all such information provided by State Street to the Undersigned shall be deemed proprietary and confidential information of State Street (hereinafter "Proprietary Information"). The Undersigned agrees that it will hold such Proprietary Information in confidence and secure and protect it in a manner consistent with its own procedures for the protection of its own confidential information and to take appropriate action by instruction or agreement with its employees who are permitted access to the Proprietary Information to satisfy its obligations hereunder. The Undersigned will not attempt to intercept data, gain access to data in transmission, or attempt entry into any system or files for which it is not authorized. It will not intentionally adversely affect the integrity of the System through the introduction of unauthorized code or data, or through unauthorized deletion. Upon notice by State Street for any reason, any right to use the System and access to the Data Access Services shall terminate and the Undersigned shall immediately cease use of the System and the Data Access Services. Immediately upon notice by State Street for any reason, the Undersigned shall return to State Street all copies of documentation and other Proprietary Information in its possession. Coopers & Lybrand L.L.P. By: ____________________________________ Title: _________________________________ Date: __________________________________ ATTACHMENT D Support During the term of this Agreement, State Street agrees to provide the following on-going support services: a. Telephone Support. The Customer Designated Persons may contact State Street's Multicurrency HORIZON(SM) Help Desk and Customer Assistance Center between the hours of 8 a.m. and 6 p.m. (Eastern time) on all business days for the purpose of obtaining answers to questions about the use of the System, or to report apparent problems with the System. From time to time, the Customer shall provide to State Street a list of persons, not to exceed five in number, who shall be permitted to contact State Street for assistance (such persons being referred to as "the Customer Designated Persons"). b. Technical Support. State Street will provide technical support to assist the Customer in using the System and the Data Access Services. The total amount of technical support provided by State Street shall not exceed 10 resource days per year. State Street shall provide such additional technical support as is expressly set forth in the fee schedule in effect from time to time between the parties (the "Fee Schedule"). Technical support, including during installation and testing, is subject to the fees and other terms set forth in the Fee Schedule. c. Maintenance Support. State Street shall use commercially reasonable efforts to correct system functions that do not work according to the System Product Description as set forth on Attachment A in priority order in the next scheduled delivery release or otherwise as soon as is practicable. d. System Enhancements. State Street will provide to the Customer any enhancements to the System developed by State Street and made a part of the System; provided that, sixty (60) days prior to installing any such enhancement, State Street shall notify the Customer and shall offer the Customer reasonable training on the enhancement. Charges for system enhancements shall be as provided in the Fee Schedule. State Street retains the right to charge for related systems or products that may be developed and separately made available for use other than through the System. e. Custom Modifications. In the event the Customer desires custom modifications in connection with its use of the System, the Customer shall make a written request to State Street providing specifications for the desired modification. Any custom modifications may be undertaken by State Street in its sole discretion in accordance with the Fee Schedule. f. Limitation on Support. State Street shall have no obligation to support the Customer's use of the System: (i) for use on any computer equipment or telecommunication facilities which does not conform to the Designated Configuration or (ii) in the event the Customer has modified the System in breach of this Agreement. FUNDS TRANSFER ADDENDUM (LOGO) OPERATING GUIDELINES 1. OBLIGATION OF THE SENDER: State Street is authorized to promptly debit Client's (as named below) account(s) upon the receipt of a payment order in compliance with the selected Security Procedure chosen for funds transfer and in the amount of money that State Street has been instructed to transfer. State Street shall execute payment orders in compliance with the Security Procedure and with the Client's instructions on the execution date provided that such payment order is received by the customary deadline for processing such a request, unless the payment order specifies a later time. All payment orders and communications received after this time will be deemed to have been received on the next business day. 2. SECURITY PROCEDURE: The Client acknowledges that the Security Procedure it has designated on the Selection Form was selected by the Client from Security Procedures offered by State Street. The Client shall restrict access to confidential information relating to the Security Procedure to authorized persons as communicated in writing to State Street. The Client must notify State Street immediately if it has reason to believe unauthorized persons may have obtained access to such information or of any change in the Client's authorized personnel. State Street shall verify the authenticity of all instructions according to the Security Procedure. 3. ACCOUNT NUMBERS: State Street shall process all payment orders on the basis of the account number contained in the payment order. In the event of a discrepancy between any name indicated on the payment order and the account number, the account number shall take precedence and govern. 4. REJECTION: State Street reserves the right to decline to process or delay the processing of a payment order which (a) is in excess of the collected balance in the account to be charged at the time of State Street's receipt of such payment order; (b) if initiating such payment order would cause State Street, in State Street's sole judgment, to exceed any volume, aggregate dollar, network, time, credit or similar limits upon wire transfers which are applicable to State Street; or (c) if State Street, in good faith, is unable to satisfy itself that the transaction has been properly authorized. 5. CANCELLATION OR AMENDMENT: State Street shall use reasonable efforts to act on all authorized requests to cancel or amend payment orders received in compliance with the Security Procedure provided that such requests are received in a timely manner affording State Street reasonable opportunity to act. However, State Street assumes no liability if the request for amendment or cancellation cannot be satisfied. 6. ERRORS: State Street shall assume no responsibility for failure to detect any erroneous payment order provided that State Street complies with the payment order instructions as received and State Street complies with the Security Procedure. The Security Procedure is established for the purpose of authenticating payment orders only and not for the detection of errors in payment orders. 7. INTEREST AND LIABILITY LIMITS: State Street shall assume no responsibility for lost interest with respect to the refundable amount of any unauthorized payment order, unless State Street is notified of the unauthorized payment order within thirty (30) days of notification by State Street of the acceptance of such payment order. In no event shall State Street be liable for special, indirect or consequential damages, even if advised of the possibility of such damages and even for failure to execute a payment order. 8. AUTOMATED CLEARING HOUSE ("ACH") CREDIT ENTRIES/PROVISIONAL PAYMENTS: When a Client initiates or receives ACH credit and debit entries pursuant to these Guidelines and the rules of the National Automated Clearing House Association and the New England Clearing House Association, State Street will act as an Originating Depository Financial Institution and/or Receiving Depository Institution, as the case may be, with respect to such entries. Credits given by State Street with respect to an ACH credit entry are provisional until State Street receives final settlement for such entry from the Federal Reserve Bank. If State Street does not receive such final settlement, the Client agrees that State Street shall receive a refund of the amount credited to the Client in connection with such entry, and the party making payment to the Client via such entry shall not be deemed to have paid the amount of the entry. 9. CONFIRMATION STATEMENTS: Confirmation of State Street's execution of payment orders shall ordinarily be provided within 24 hours notice which may be delivered through State Street's proprietary information systems, such as, but not limited to Horizon and GlobalQuest(R), or by facsimile or callback. The Client must report any objections to the execution of a payment order within 30 days. FUNDS TRANSFER ADDENDUM (LOGO) SECURITY PROCEDURE(S) SELECTION FORM Please select one or more of the funds transfer security procedures indicated below. [ ] SWIFT SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a cooperative society owned and operated by member financial institutions that provides telecommunication services for its membership. Participation is limited to securities brokers and dealers, clearing and depository institutions, recognized exchanges for securities, and investment management institutions. SWIFT provides a number of security features through encryption and authentication to protect against unauthorized access, loss or wrong delivery of messages, transmission errors, loss of confidentiality and fraudulent changes to messages. SWIFT is considered to be one of the most secure and efficient networks for the delivery of funds transfer instructions. Selection of this security procedure would be most appropriate for existing SWIFT members. [ ] Standing Instructions Standing Instructions may be used where funds are transferred to a broker on the Client's established list of brokers with which it engages in foreign exchange transactions. Only the date, the currency and the currency amount are variable. In order to establish this procedure, State Street will send to the Client a list of the brokers that State Street has determined are used by the Client. The Client will confirm the list in writing, and State Street will verify the written confirmation by telephone. Standing Instructions will be subject to a mutually agreed upon limit. If the payment order exceeds the established limit, the Standing Instruction will be confirmed by telephone prior to execution. [ ] Remote Batch Transmission Wire transfer instructions are delivered via Computer-to-Computer (CPU-CPU) data communications between the Client and State Street. Security procedures include encryption and or the use of a test key by those individuals authorized as Automated Batch Verifiers. Clients selecting this option should have an existing facility for completing CPU-CPU transmissions. This delivery mechanism is typically used for high-volume business. [ ] Global Horizon Interchange(sm) Funds Transfer Service Global Horizon Interchange Funds Transfer Service (FTS) is a State Street proprietary microcomputer-based wire initiation system. FTS enables Clients to electronically transmit authenticated Fedwire, CHIPS or internal book transfer instructions to State Street. This delivery mechanism is most appropriate for Clients with a low-to-medium number of transactions (50-75 per day), allowing Clients to enter, batch, and review wire transfer instructions on their PC prior to release to State Street. [ ] Telephone Confirmation (Callback) Telephone confirmation will be used to verify all non-repetitive funds transfer instructions received via untested facsimile or phone. This procedure requires Clients to designate individuals as authorized initiators and authorized verifiers. State Street will verify that the instruction contains the signature of an authorized person and prior to execution, will contact someone other than the originator at the Client's location to authenticate the instruction. Selection of this alternative is appropriate for Clients who do not have the capability to use other security procedures. [ ] Repetitive Wires For situations where funds are transferred periodically (minimum of one instruction per calendar quarter) from an existing authorized account to the same payee (destination bank and account number) and only the date and currency amount are variable, a repetitive wire may be implemented. Repetitive wires will be subject to a mutually agreed upon limit. If the payment order exceeds the established limit, the instruction will be confirmed by telephone prior to execution. Telephone confirmation is used to establish this process. Repetitive wire instructions must be reconfirmed annually. This alternative is recommended whenever funds are frequently transferred between the same two accounts. [ ] Transfers Initiated by Facsimile The Client faxes wire transfer instructions directly to State Street Mutual Fund Services. Standard security procedure requires the use of a random number test key for all transfers. Every six months the Client receives test key logs from State Street. The test key contains alpha-numeric characters, which the Client puts on each document faxed to State Street. This procedure ensures all wire instructions received via fax are authorized by the Client. We provide this option for Clients who wish to batch wire instructions and transmit these as a group to State Street Mutual Fund Services once or several times a day. FUNDS TRANSFER ADDENDUM (LOGO) [ ] Automated Clearing House (ACH) State Street receives an automated transmission or a magnetic tape from a Client for the initiation of payment (credit) or collection (debit) transactions through the ACH network. The transactions contained on each transmission or tape must be authenticated by the Client. Clients using ACH must select one or more of the following delivery options: [ ] Global Horizon Interchange Automated Clearing House Service Transactions are created on a microcomputer, assembled into batches and delivered to State Street via fully authenticated electronic transmissions in standard NACHA formats. [ ] Transmission from Client PC to State Street Mainframe with Telephone Callback [ ] Transmission from Client Mainframe to State Street Mainframe with Telephone Callback [ ] Transmission from DST Systems to State Street Mainframe with Encryption [ ] Magnetic Tape Delivered to State Street with Telephone Callback State Street is hereby instructed to accept funds transfer instructions only via the delivery methods and security procedures indicated. The selected delivery methods and security procedure(s) will be effective ________________ for payment orders initiated by our organization. Key Contact Information Whom shall we contact to implement your selection(s)? CLIENT OPERATIONS CONTACT ALTERNATE CONTACT - ------------------------------ --------------------------------- Name Name - ------------------------------ --------------------------------- Address Address - ------------------------------ --------------------------------- City/State/Zip Code City/State/Zip Code - ------------------------------ --------------------------------- Telephone Number Telephone Number - ------------------------------ --------------------------------- Facsimile Number Facsimile Number - ------------------------------ SWIFT Number - ------------------------------ Telex Number FUNDS TRANSFER ADDENDUM (LOGO) INSTRUCTION(S) TELEPHONE CONFIRMATION Fund LM Institutional Fund Advisors II, Inc. ----------------------------------------- Investment Adviser Legg Mason Fund Adviser, Inc. ------------------------------ Authorized Initiators Please Type or Print Please provide a listing of Fund officers or other individuals are currently authorized to INITIATE wire transfer instructions to State Street:
NAME TITLE (Specify whether position SPECIMEN SIGNATURE is with Fund or Investment Adviser) Marie K. Karpinski Vice President & Treasurer /s/ Marie K. Karpinski - ---------------------- --------------------------------- ----------------------- Susan L. Silva Fund Manager /s/ Susan L. Silva - ---------------------- --------------------------------- ----------------------- W. Shane Hughes Fund Manager /s/ W. Shane Hughes - ---------------------- --------------------------------- ----------------------- - ---------------------- --------------------------------- ----------------------- - ---------------------- --------------------------------- ----------------------- Authorized Verifiers Please Type or Print Please provide a listing of Fund officers of other individuals who will be CALLED BACK to verify the initiation of repetitive wires of $10 million or more and all non repetitive wire instructions: NAME CALLBACK PHONE NUMBER DOLLAR LIMITATION (IF ANY) Marie K. Karpinski 410-454-2790 N/A - ---------------------- --------------------------------- ----------------------- Susan L. Silva 410-454-2759 N/A - ---------------------- --------------------------------- ----------------------- W. Shane Hughes 410-454-2780 N/A - ---------------------- --------------------------------- ----------------------- - ---------------------- --------------------------------- ----------------------- - ---------------------- --------------------------------- -----------------------
TRANSFER AGENCY AND SERVICE AGREEMENT between LM INSTITUTIONAL FUND ADVISORS II, INC. and STATE STREET BANK AND TRUST COMPANY 1G - Domestic Corp/Series TABLE OF CONTENTS Page 1. Terms of Appointment; Duties of the Bank ...................1 2. Fees and Expenses ..........................................3 3. Representations and Warranties of the Bank .................4 4. Representations and Warranties of the Fund .................4 5. Wire Transfer Operating Guidelines .........................5 6. Data Access and Proprietary Information ....................6 7. Indemnification ............................................8 8. Standard of Care ...........................................9 9. Confidentiality ............................................9 10. Covenants of the Fund and the Bank ........................10 11. Termination of Agreement ..................................10 12. Additional Funds ..........................................11 13. Assignment ................................................11 14. Amendment .................................................11 15. Massachusetts Law to Apply ................................11 16. Force Majeure .............................................11 17. Consequential Damages .....................................12 18. Merger of Agreement .......................................12 19. Counterparts...............................................12 20. Reproduction of Documents .................................12 TRANSFER AGENCY AND SERVICE AGREEMENT AGREEMENT made as of the 13th day of August, 1998, by and between LM INSTITUTIONAL FUND ADVISORS II, INC., a Maryland corporation, having its principal office and place of business at 100 Light Street, Baltimore, Maryland 21202 (the "Fund"), and STATE STREET BANK AND TRUST COMPANY, a Massachusetts trust company having its principal office and place of business at 225 Franklin Street, Boston, Massachusetts 02110 (the "Bank"). WHEREAS, the Fund is authorized to issue shares in separate series, with each such series representing interests in a separate portfolio of securities and other assets; and WHEREAS, the Fund intends to initially offer shares in six (6) series, such series shall be named in the attached Schedule A which may be amended by the parties from time to time (each such series, together with all other series subsequently established by the Fund and made subject to this Agreement in accordance with Article 13, being herein referred to as a "Portfolio", and collectively as the "Portfolios"); WHEREAS, the Fund on behalf of the Portfolios desires to appoint the Bank as its transfer agent, dividend disbursing agent, custodian of certain retirement plans and agent in connection with certain other activities, and the Bank desires to accept such appointment; NOW, THEREFORE, in consideration of the mutual covenants herein contained, the parties hereto agree as follows: l. Terms of Appointment; Duties of the Bank 1.l Subject to the terms and conditions set forth in this Agreement, the Fund, on behalf of the Portfolios, hereby employs and appoints the Bank to act as, and the Bank agrees to act as its transfer agent for the Fund's authorized and issued shares of its common stock, $.001 par value, ("Shares"), dividend disbursing agent, custodian of certain retirement plans and agent in connection with any accumulation, open-account or similar plans provided to the shareholders of each of the respective Portfolios of the Fund ("Shareholders") and set out in the currently effective prospectus and statement of additional information ("prospectus") of the Fund on behalf of the applicable Portfolio, including without limitation any periodic investment plan or periodic withdrawal program. 1.2 The Bank agrees that it will perform the following services: (a) In accordance with procedures established from time to time by agreement between the Fund on behalf of each of the Portfolios, as applicable and the Bank, the Bank shall: (i) Receive for acceptance, orders for the purchase of Shares, and promptly deliver payment and appropriate documentation thereof to the Custodian of the Fund authorized pursuant to the Articles of Incorporation of the Fund (the "Custodian"); (ii) Pursuant to purchase orders, issue the appropriate number of Shares and hold such Shares in the appropriate Shareholder account; (iii) Receive for acceptance redemption requests and redemption directions and deliver the appropriate documentation thereof to the Custodian; (iv) In respect to the transactions in items (i), (ii) and (iii) above, the Bank shall execute transactions directly with broker-dealers authorized by the Fund; (v) At the appropriate time as and when it receives monies paid to it by the Custodian with respect to any redemption, pay over or cause to be paid over in the appropriate manner such monies as instructed by the redeeming Shareholders; (vi) Effect transfers of Shares by the registered owners thereof upon receipt of appropriate instructions; (vii) Prepare and transmit payments for dividends and distributions declared by the Fund on behalf of the applicable Portfolio; (viii) Issue replacement certificates for those certificates alleged to have been lost, stolen or destroyed upon receipt by the Bank of indemnification satisfactory to the Bank and protecting the Bank and the Fund, and the Bank at its option, may issue replacement certificates in place of mutilated stock certificates upon presentation thereof and without such indemnity; (ix) Maintain records of account for and advise the Fund and its Shareholders as to the foregoing and (x) Record the issuance of shares of the Fund and maintain pursuant to SEC Rule 17Ad-10(e) a record of the total number of shares of the Fund which are authorized, based upon data provided to it by the Fund, and issued and outstanding. The Bank shall also provide the Fund on a regular basis with the total number of shares which are authorized and issued and outstanding and shall have no obligation, when recording the issuance of shares, to monitor the issuance of such shares or to take cognizance of any laws relating to the issue or sale of such shares, which functions shall be the sole responsibility of the Fund. 2 (b) In addition to and neither in lieu nor in contravention of the services set forth in the above paragraph (a), the Bank shall: (i) perform the customary services of a transfer agent, dividend disbursing agent, custodian of certain retirement plans and, as relevant, agent in connection with accumulation, open-account or similar plans (including without limitation any periodic investment plan or periodic withdrawal program), including but not limited to: maintaining all Shareholder accounts, preparing Shareholder meeting lists, mailing Shareholder proxies, Shareholder reports and prospectuses to current Shareholders, withholding taxes on U.S. resident and non-resident alien accounts, preparing and filing U.S. Treasury Department Forms 1099 and other appropriate forms required with respect to dividends and distributions by federal authorities for all Shareholders, preparing and mailing confirmation forms and statements of account to Shareholders for all purchases and redemptions of Shares and other confirmable transactions in Shareholder accounts, preparing and mailing activity statements for Shareholders, and providing Shareholder account information and (ii) provide a system which will enable the Fund to monitor the total number of Shares sold in each State. (c) In addition, the Fund shall (i) identify to the Bank in writing those transactions and assets to be treated as exempt from blue sky reporting for each State and (ii) verify the establishment of transactions for each State on the system prior to activation and thereafter monitor the daily activity for each State. The responsibility of the Bank for the Fund's blue sky State registration status is solely limited to the initial establishment of transactions subject to blue sky compliance by the Fund and the reporting of such transactions to the Fund as provided above. (d) Procedures as to who shall provide certain of these services in Section 1 may be established from time to time by agreement between the Fund on behalf of each Portfolio and the Bank per the attached service responsibility schedule. The Bank may at times perform only a portion of these services and the Fund or its agent may perform these services on the Fund's behalf. (e) The Bank shall provide additional services on behalf of the Fund (e.g., escheatment services) which may be agreed upon in writing between the Fund and the Bank. 2. Fees and Expenses 2.1 For the performance by the Bank pursuant to this Agreement, the Fund agrees on behalf of each of the Portfolios to pay the Bank an annual maintenance fee for each Shareholder account as set out in the initial fee schedule attached hereto. Such fees and out-of-pocket expenses and advances identified under Section 2.2 below may be changed from time to time subject to mutual written agreement between the Fund and the Bank. 3 2.2 In addition to the fee paid under Section 2.1 above, the Fund agrees on behalf of each of the Portfolios to reimburse the Bank for out-of-pocket expenses, including but not limited to confirmation production, postage, forms, telephone, microfilm, microfiche, mailing and tabulating proxies, records storage, or advances incurred by the Bank for the items set out in the fee schedule attached hereto. In addition, any other expenses incurred by the Bank at the request or with the consent of the Fund, will be reimbursed by the Fund on behalf of the applicable Portfolio. 2.3 The Fund agrees on behalf of each of the Portfolios to pay all fees and reimbursable expenses within five days following the receipt of the respective billing notice. Postage for mailing of dividends, proxies, Fund reports and other mailings to all shareholder accounts shall be advanced to the Bank by the Fund at least seven (7) days prior to the mailing date of such materials. 3. Representations and Warranties of the Bank The Bank represents and warrants to the Fund that: 3.1 It is a trust company duly organized and existing and in good standing under the laws of The Commonwealth of Massachusetts. 3.2 It is duly qualified to carry on its business in The Commonwealth of Massachusetts. 3.3 It is empowered under applicable laws and by its Charter and By-Laws to enter into and perform this Agreement. 3.4 All requisite corporate proceedings have been taken to authorize it to enter into and perform this Agreement. 3.5 It has and will continue to have access to the necessary facilities, equipment and personnel to perform its duties and obligations under this Agreement. 4. Representations and Warranties of the Fund The Fund represents and warrants to the Bank that: 4.1 It is a corporation duly organized and existing and in good standing under the laws of the State of Maryland. 4.2 It is empowered under applicable laws and by its Articles of Incorporation and By-Laws to enter into and perform this Agreement. 4.3 All corporate proceedings required by said Articles of Incorporation and By-Laws have been taken to authorize it to enter into and perform this Agreement. 4 4.4 It is an open-end and diversified management investment company registered under the Investment Company Act of 1940, as amended. 4.5 A registration statement under the Securities Act of 1933, as amended on behalf of each of the Portfolios is currently effective and will remain effective, and appropriate state securities law filings have been made and will continue to be made, with respect to all Shares of the Fund being offered for sale. 5. Wire Transfer Operating Guidelines/Articles 4A of the Uniform Commercial Code 5.1 The Bank is authorized to promptly debit the appropriate Fund account(s) upon the receipt of a payment order in compliance with the selected security procedure (the "Security Procedure") chosen for funds transfer and in the amount of money that the Bank has been instructed to transfer. The Bank shall execute payment orders in compliance with the Security Procedure and with the Fund instructions on the execution date provided that such payment order is received by the customary deadline for processing such a request, unless the payment order specifies a later time. All payment orders and communications received after this the customary deadline will be deemed to have been received the next business day. 5.2 The Fund acknowledges that the Security Procedure it has designated on the Fund Selection Form was selected by the Fund from security procedures offered by the Bank. The Fund shall restrict access to confidential information relating to the Security Procedure to authorized persons as communicated to the Bank in writing. The Fund must notify the Bank immediately if it has reason to believe unauthorized persons may have obtained access to such information or of any change in the Fund's authorized personnel. The Bank shall verify the authenticity of all Fund instructions according to the Security Procedure. 5.3 The Bank shall process all payment orders on the basis of the account number contained in the payment order. In the event of a discrepancy between any name indicated on the payment order and the account number, the account number shall take precedence and govern. 5.4 The Bank reserves the right to decline to process or delay the processing of a payment order which (a) is in excess of the collected balance in the account to be charged at the time of the Bank's receipt of such payment order; (b) if initiating such payment order would cause the Bank, in the Bank's sole judgement, to exceed any volume, aggregate dollar, network, time, credit or similar limits which are applicable to the Bank; or (c) if the Bank, in good faith, is unable to satisfy itself that the transaction has been properly authorized. 5 5.5 The Bank shall use reasonable efforts to act on all authorized requests to cancel or amend payment orders received in compliance with the Security Procedure provided that such requests are received in a timely manner affording the Bank reasonable opportunity to act. However, the Bank assumes no liability if the request for amendment or cancellation cannot be satisfied. 5.6 The Bank shall assume no responsibility for failure to detect any erroneous payment order provided that the Bank complies with the payment order instructions as received and the Bank complies with the Security Procedure. The Security Procedure is established for the purpose of authenticating payment orders only and not for the detection of errors in payment orders. 5.7 The Bank shall assume no responsibility for lost interest with respect to the refundable amount of any unauthorized payment order, unless the Bank is notified of the unauthorized payment order within thirty (30) days of notification by the Bank of the acceptance of such payment order. In no event (including failure to execute a payment order) shall the Bank be liable for special, indirect or consequential damages, even if advised of the possibility of such damages. 5.8 When the Fund initiates or receives Automated Clearing House credit and debit entries pursuant to these guidelines and the rules of the National Automated Clearing House Association and the New England Clearing House Association, the Bank will act as an Originating Depository Financial Institution and/or receiving depository Financial Institution, as the case may be, with respect to such entries. Credits given by the Bank with respect to an ACH credit entry are provisional until the Bank receives final settlement for such entry from the Federal Reserve Bank. If the Bank does not receive such final settlement, the Fund agrees that the Bank shall receive a refund of the amount credited to the Fund in connection with such entry, and the party making payment to the Fund via such entry shall not be deemed to have paid the amount of the entry. 5.9 Confirmation of Bank's execution of payment orders shall ordinarily be provided within twenty four (24) hours notice of which may be delivered through the Bank' s proprietary information systems, or by facsimile or call-back. Fund must report any objections to the execution of an order within thirty (30) days. 6. Data Access and Proprietary Information 6.1 The Fund acknowledges that the data bases, computer programs, screen formats, report formats, interactive design techniques, and documentation manuals furnished to the Fund by the Bank as part of the Fund's ability to access certain Fund-related data ("Customer Data") maintained by the Bank on data bases under the control and ownership of the Bank ("Data Access Services") constitute copyrighted, trade secret, or other proprietary information (collectively, "Proprietary Information") of substantial value to the Bank or other third party. In no event shall Proprietary Information be deemed Customer Data. The 6 Fund agrees to treat all Proprietary Information as proprietary to the Bank and further agrees that it shall not divulge any Proprietary Information to any person or organization except as may be provided hereunder. Without limiting the foregoing, the Fund agrees for itself and its employees and agents: (a) to access Customer Data solely from locations as may be designated in writing by the Bank and solely in accordance with the Bank's applicable user documentation; (b) to refrain from copying or duplicating in any way the Proprietary Information; (c) to refrain from obtaining unauthorized access to any portion of the Proprietary Information, and if such access is inadvertently obtained, to inform in a timely manner of such fact and dispose of such information in accordance with the Bank's instructions; (d) to refrain from causing or allowing the data acquired hereunder from being retransmitted to any other computer facility or other location, except with the prior written consent of the Bank; (e) that the Fund shall have access only to those authorized transactions agreed upon by the parties; (f) to honor all reasonable written requests made by the Bank to protect at the Bank's expense the rights of the Bank in Proprietary Information at common law, under federal copyright law and under other federal or state law. Each party shall take reasonable efforts to advise its employees of their obligations pursuant to this Section 6. The obligations of this Section shall survive any earlier termination of this Agreement. 6.2 If the Fund notifies the Bank that any of the Data Access Services do not operate in material compliance with the most recently issued user documentation for such services, the Bank shall endeavor in a timely manner to correct such failure. Organizations from which the Bank may obtain certain data included in the Data Access Services are solely responsible for the contents of such data and the Fund agrees to make no claim against the Bank arising out of the contents of such third-party data, including, but not limited to, the accuracy thereof. DATA ACCESS SERVICES AND ALL COMPUTER PROGRAMS AND SOFTWARE SPECIFICATIONS USED IN CONNECTION THEREWITH ARE PROVIDED ON AN AS IS, AS AVAILABLE BASIS. THE BANK EXPRESSLY DISCLAIMS ALL WARRANTIES EXCEPT THOSE EXPRESSLY STATED HEREIN INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. 7 6.3 If the transactions available to the Fund include the ability to originate electronic instructions to the Bank in order to (i) effect the transfer or movement of cash or Shares or (ii) transmit Shareholder information or other information, then in such event the Bank shall be entitled to rely on the validity and authenticity of such instruction without undertaking any further inquiry as long as such instruction is undertaken in conformity with security procedures established by the Bank from time to time. 7. Indemnification 7.1 The Bank shall not be responsible for, and the Fund shall on behalf of the applicable Portfolio indemnify and hold the Bank harmless from and against, any and all losses, damages, costs, charges, counsel fees, payments, expenses and liability arising out of or attributable to: (a) all actions of the Bank or its agents or subcontractors required to be taken pursuant to this Agreement, provided that such actions are taken in good faith and without negligence or willful misconduct; (b) the Fund's lack of good faith, negligence or willful misconduct which arise out of the breach of any representation or warranty of the Fund hereunder; (c) the reliance on or use by the Bank or its agents or subcontractors of information, records, documents or services which (i) are received by the Bank or its agents or subcontractors, and (ii) have been prepared, maintained or performed by the Fund or any other person or firm on behalf of the Fund including but not limited to any previous transfer agent or registrar; (d) the reliance on, or the carrying out by the Bank or its agents or subcontractors of any instructions or requests of the Fund on behalf of the applicable Portfolio; (e) the offer or sale of Shares in violation of federal or state securities laws or regulations requiring that such Shares be registered or in violation of any stop order or other determination or ruling by any federal or any state agency with respect to the offer or sale of such Shares; (f) the negotiations and processing of checks made payable to prospective or existing Shareholders tendered to the Bank for the purchase of Shares, such checks are commonly known as "third party checks"; and (g) upon the Fund's request entering into any agreements required by the National Securities Clearing Corporation (the "NSCC") required by the NSCC for the transmission of Fund or Shareholder data through the NSCC clearing systems. 8 7.2 At any time the Bank may apply to any officer of the Fund for instructions, and may consult with legal counsel with respect to any matter arising in connection with the services to be performed by the Bank under this Agreement, and the Bank and its agents or subcontractors shall not be liable and shall be indemnified by the Fund on behalf of the applicable Portfolio for any action taken or omitted by it in reliance upon such instructions or upon the opinion of such counsel. The Bank, its agents and subcontractors shall be protected and indemnified in acting upon any paper or document, reasonably believed to be genuine and to have been signed by the proper person or persons, or upon any instruction, information, data, records or documents provided the Bank or its agents or subcontractors by machine readable input, telex, CRT data entry or other similar means authorized by the Fund, and shall not be held to have notice of any change of authority of any person, until receipt of written notice thereof from the Fund. The Bank, its agents and subcontractors shall also be protected and indemnified in recognizing stock certificates which are reasonably believed to bear the proper manual or facsimile signatures of the officers of the Fund, and the proper countersignature of any former transfer agent or former registrar, or of a co-transfer agent or co-registrar. 7.3 In order that the indemnification provisions contained in this Section 7 shall apply, upon the assertion of a claim for which the Fund may be required to indemnify the Bank, the Bank shall promptly notify the Fund of such assertion, and shall keep the Fund advised with respect to all developments concerning such claim. The Fund shall have the option to participate with the Bank in the defense of such claim or to defend against said claim in its own name or in the name of the Bank. The Bank shall in no case confess any claim or make any compromise in any case in which the Fund may be required to indemnify the Bank except with the Fund's prior written consent. 8. Standard of Care The Bank shall at all times act in good faith and agrees to use its best efforts within reasonable limits to insure the accuracy of all services performed under this Agreement, but assumes no responsibility and shall not be liable for loss or damage due to errors unless said errors are caused by its negligence, bad faith, or willful misconduct or that of its employees. 9. Confidentiality 9.1 The Bank and the Fund agree that all books, records, information and data pertaining to the business of the other party which are exchanged or received pursuant to the negotiation or the carrying out of this Agreement shall remain confidential, and shall not be voluntarily disclosed to any other person, except as may be required by law. 9 9.2 In case of any requests or demands for the inspection of the Shareholder records of the Fund, the Bank will endeavor to notify the Fund and to secure instructions from an authorized officer of the Fund as to such inspection. The Bank reserves the right, however, to exhibit the Shareholder records to any person whenever it is advised by its counsel that it may be held liable for the failure to exhibit the Shareholder records to such person. 10. Covenants of the Fund and the Bank 10.1 The Fund shall on behalf of each of the Portfolios promptly furnish to the Bank the following: (a) A certified copy of the resolution of the Board of Directors of the Fund authorizing the appointment of the Bank and the execution and delivery of this Agreement. (b) A copy of the Articles of Incorporation and By-Laws of the Fund and all amendments thereto. 10.2 The Bank hereby agrees to establish and maintain facilities and procedures reasonably acceptable to the Fund for safekeeping of stock certificates, check forms and facsimile signature imprinting devices, if any; and for the preparation or use, and for keeping account of, such certificates, forms and devices. 10.3 The Bank shall keep records relating to the services to be performed hereunder, in the form and manner as it may deem advisable. To the extent required by Section 31 of the Investment Fund Act of 1940, as amended, and the Rules thereunder, the Bank agrees that all such records prepared or maintained by the Bank relating to the services to be performed by the Bank hereunder are the property of the Fund and will be preserved, maintained and made available in accordance with such Section and Rules, and will be surrendered promptly to the Fund on and in accordance with its request. 11. Termination of Agreement 11.1 This Agreement may be terminated by either party upon one hundred twenty (120) days written notice to the other. 11.2 Should the Fund exercise its right to terminate, all out-of-pocket expenses associated with the movement of records and material will be borne by the Fund on behalf of the applicable Portfolio(s). Additionally, the Bank reserves the right to charge for any other reasonable expenses associated with such termination and a charge equivalent to the average of three (3) months' fees. 10 12. Additional Funds In the event that the Fund establishes one or more series of Shares in addition to the attached Schedule A with respect to which it desires to have the Bank render services as transfer agent under the terms hereof, it shall so notify the Bank in writing, and if the Bank agrees in writing to provide such services, such series of Shares shall become a Portfolio hereunder. 13. Assignment 13.1 Except as provided in Section 14.3 below, neither this Agreement nor any rights or obligations hereunder may be assigned by either party without the written consent of the other party. 13.2 This Agreement shall inure to the benefit of and be binding upon the parties and their respective permitted successors and assigns. 13.3 The Bank may, without further consent on the part of the Fund, subcontract for the performance hereof with (i) Boston Financial Data Services, Inc., a Massachusetts corporation ("BFDS") which is duly registered as a transfer agent pursuant to Section 17A(c)(2) of the Securities Exchange Act of 1934, as amended ("Section 17A(c)(2)"), (ii) a BFDS subsidiary duly registered as a transfer agent pursuant to Section 17A(c)(2) or (iii) a BFDS affiliate; provided, however, that the Bank shall be as fully responsible to the Fund for the acts and omissions of any subcontractor as it is for its own acts and omissions. 14. Amendment This Agreement may be amended or modified by a written agreement executed by both parties and authorized or approved by a resolution of the Board of Directors of the Fund. 15. Massachusetts Law to Apply This Agreement shall be construed and the provisions thereof interpreted under and in accordance with the laws of The Commonwealth of Massachusetts. 16. Force Majeure In the event either party is unable to perform its obligations under the terms of this Agreement because of acts of God, strikes, equipment or transmission failure or damage reasonably beyond its control, or other causes reasonably beyond its control, such party shall not be liable for damages to the other for any damages resulting from such failure to perform or otherwise from such causes. 11 17. Consequential Damages Neither party to this Agreement shall be liable to the other party for consequential damages under any provision of this Agreement or for any consequential damages arising out of any act or failure to act hereunder. 18. Merger of Agreement This Agreement constitutes the entire agreement between the parties hereto and supersedes any prior agreement with respect to the subject matter hereof whether oral or written. 19. Counterparts This Agreement may be executed by the parties hereto on any number of counterparts, and all of said counterparts taken together shall be deemed to constitute one and the same instrument. 20. Reproduction of Documents This Agreement and all schedules, exhibits, attachments and amendments hereto may be reproduced by any photographic, photostatic, microfilm, micro-card, miniature photographic or other similar process. The parties hereto each agree that any such reproduction shall be admissible in evidence as the original itself in any judicial or administrative proceeding, whether or not the original is in existence and whether or not such reproduction was made by a party in the regular course of business, and that any enlargement, facsimile or further reproduction shall likewise be admissible in evidence. 12 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed in their names and on their behalf by and through their duly authorized officers, as of the day and year first above written. LM INSTITUTIONAL FUND ADVISORS II, INC. BY: /s/ MARIE K. KARPINSKI ----------------------------------- ATTEST: /s/ LAURA V. ATWATER - ------------------------------------- STATE STREET BANK AND TRUST COMPANY BY: /s/ RONALD E. LOGUE ----------------------------------- Executive Vice President ATTEST: /s/ (SIGNATURE ILLEGIBLE) - -------------------------------------- STATE STREET BANK & TRUST COMPANY FUND SERVICE RESPONSIBILITIES* Service Performed Responsibility Bank Fund 1. Receives orders for the purchase X of Shares. 2. Issue Shares and hold Shares in X Shareholders accounts. 3. Receive redemption requests. X 4. Effect transactions 1-3 above X directly with broker-dealers. 5. Pay over monies to redeeming X Shareholders. 6. Effect transfers of Shares. X 7. Prepare and transmit dividends X and distributions. 8. Reporting of abandoned property. X X 9. Maintain records of account. X 10. Maintain and keep a current and X accurate control book for each issue of securities. 11. Mail proxies. X X 12. Mail Shareholder reports. X X 13. Mail prospectuses to current X X Shareholders. 14. Withhold taxes on U.S. resident X and non-resident alien accounts. Service Performed Responsibility Bank Fund 15. Prepare and file U.S. Treasury X Department forms. 16. Prepare and mail account and X confirmation statements for Shareholders. 17. Provide Shareholder account X information. 18. Blue sky reporting. X * Such services are more fully described in Section 1.2(a), (b) and (c) of the Agreement. LM INSTITUTIONAL FUND ADVISORS II, INC. BY: /s/ Marie K. Karpinski ------------------------------------ ATTEST: /s/ Laura V. Atwater ------------------------------ STATE STREET BANK AND TRUST COMPANY BY: /s/ Ronald E. Logue ------------------------------------ Executive Vice President ATTEST: /s/ (SIGNATURE ILLEGIBLE) ------------------------------ SCHEDULE A LM Value Institutional Portfolio LM Mid Cap Institutional Portfolio Brandywine Small Cap Value Portfolio Batterymarch International Equity Portfolio Batterymarch Emerging Markets Portfolio LM Total Return Institutional Portfolio -----END PRIVACY-ENHANCED MESSAGE-----