-----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, RFc71eij/Z+wzyKNVSGC+38HEs7PbuBRFzs+kl5Y5Q2izxiQFRKpQObZQMc0YhIB gWuKrqI5GLoeeuIW8FVwzA== 0000757010-01-500014.txt : 20010702 0000757010-01-500014.hdr.sgml : 20010702 ACCESSION NUMBER: 0000757010-01-500014 CONFORMED SUBMISSION TYPE: 485BPOS PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 20010629 EFFECTIVENESS DATE: 20010629 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN TAX FREE TRUST CENTRAL INDEX KEY: 0000757010 STANDARD INDUSTRIAL CLASSIFICATION: [] STATE OF INCORPORATION: MA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: SEC FILE NUMBER: 002-94222 FILM NUMBER: 1671522 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: SEC FILE NUMBER: 811-04149 FILM NUMBER: 1671523 BUSINESS ADDRESS: STREET 1: 777 MARINERS ISLAND BLVD CITY: SAN MATEO STATE: CA ZIP: 94404 BUSINESS PHONE: 4153122000 MAIL ADDRESS: STREET 1: 777 MARINERS ISLAND BLVD CITY: SAN MATEO STATE: CA ZIP: 94404 485BPOS 1 tft485b.txt WRAP AND PART C As filed with the Securities and Exchange Commission on June 28, 2001 File Nos. 02-94222 811-4149 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-1A REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 Pre-Effective Amendment No. Post-Effective Amendment No. 30 (X) ---- and/or REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 Amendment No. 31 (X) ---- FRANKLIN TAX-FREE TRUST ----------------------- (Exact Name of Registrant as Specified in Charter) ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (650)312-2000 MURRAY L. SIMPSON, ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 ----------------------------------------------------------------- (Name and Address of Agent for Service of Process) Approximate Date of Proposed Public Offering: It is proposed that this filing will become effective (check appropriate box) [ ] immediately upon filing pursuant to paragraph (b) [X] on July 1, 2001 pursuant to paragraph (b) [ ] 60 days after filing pursuant to paragraph (a)(1) [ ] on (date) pursuant to paragraph (a)(1) of Rule 485 [ ] 75 days after filing pursuant to paragraph (a)(2) [ ] on (date) pursuant to paragraph (a)(2) of rule 485 If appropriate, check the following box: [ ] This post-effective amendment designates a new effective date for a previously filed post-effective amendment. Prospectus FRANKLIN TAX-FREE TRUST INVESTMENT STRATEGY TAX-FREE INCOME Franklin Florida Insured Tax-Free Income Fund Franklin Insured Tax-Free Income Fund Franklin Massachusetts Insured Tax-Free Income Fund Franklin Michigan Insured Tax-Free Income Fund Franklin Minnesota Insured Tax-Free Income Fund Franklin Ohio Insured Tax-Free Income Fund JULY 1, 2001 [Insert Franklin Templeton Ben Head] The SEC has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense. CONTENTS THE FUNDS [Begin callout] INFORMATION ABOUT EACH FUND YOU SHOULD KNOW BEFORE INVESTING [End callout] 2 Goals and Strategies 4 Main Risks 7 Performance 13 Fees and Expenses 16 Management 18 Distributions and Taxes 20 Financial Highlights YOUR ACCOUNT [Begin callout] INFORMATION ABOUT SALES CHARGES, ACCOUNT TRANSACTIONS AND SERVICES [End callout] 28 Choosing a Share Class 32 Buying Shares 35 Investor Services 39 Selling Shares 41 Account Policies 45 Questions FOR MORE INFORMATION [Begin callout] WHERE TO LEARN MORE ABOUT EACH FUND [End callout] Back Cover THE FUNDS [Insert graphic of bullseye and arrows] GOALS AND STRATEGIES -------------------- GOALS Each Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investment management and the preservation of shareholders' capital. Each state Fund also tries to provide a maximum level of income exempt from personal income taxes, if any, for resident shareholders of that Fund's state. MAIN INVESTMENT STRATEGIES Under normal market conditions, each Fund invests predominately in insured municipal securities whose interest is free from federal income taxes, including the federal alternative minimum tax. In addition, each state Fund invests predominately in insured municipal securities that pay interest free from the personal income taxes, if any, of that Fund's state. Although each Fund tries to invest all of its assets in tax-free securities, it is possible that up to 20% of its assets may be in tax-free securities that pay interest that may be subject to the federal alternative minimum tax and, although not anticipated, in securities that pay taxable interest. [Begin callout] MUNICIPAL SECURITIES are issued by state and local governments, their agencies and authorities, as well as by the District of Columbia and U.S. territories and possessions, to borrow money for various public and private projects. Municipal securities pay a fixed, floating or variable rate of interest, and require that the amount borrowed (principal) be repaid at maturity. [End callout] Each Fund invests at least 65% of its total assets, and normally more than that percentage, in insured municipal securities. Insured municipal securities are covered by insurance policies that guarantee the timely payment of principal and interest. Generally, the Fund buys insured municipal securities only if they are covered by policies issued by AAA-rated municipal bond insurers. Currently, there are four municipal bond insurers with a AAA rating. The Fund pays insurance premiums either directly or indirectly, which increases the credit safety of its insured investments, but decreases its yield. Each Fund may invest the balance of its assets in the following types of securities: (i) uninsured municipal securities secured by an escrow or trust account containing direct U.S. government obligations; (ii) municipal securities rated in one of the top three ratings by U.S. nationally recognized rating services (or comparable unrated securities), which may include uninsured securities and insured securities covered by policies issued by insurers with a rating below AAA but not below A; or (iii) uninsured, short-term, tax-exempt securities rated in the top rating, pending investment in longer-term municipal securities. Each Fund may only invest up to 20% of its total assets in the type of securities described in (ii) above. Each Fund also may invest in municipal lease obligations, which generally are issued to finance the purchase of public property. The property is leased to a state or local government and the lease payments are used to pay the interest on the obligations. These differ from other municipal securities because the money to make the lease payments must be set aside each year or the lease can be cancelled without penalty. If this happens, investors who own the obligations may not be paid. The manager selects securities that it believes will provide the best balance between risk and return within a Fund's range of allowable investments and typically uses a buy and hold strategy. This means it holds securities in the Fund's portfolio for income purposes, rather than trading securities for capital gains, although the manager may sell a security at any time if it believes it could help the Fund meet its goal. The manager also may consider the cost of insurance when selecting securities for a Fund. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of the Fund's assets in a temporary defensive manner by holding all or a substantial portion of its assets in cash, cash equivalents or other high quality short-term investments. Temporary defensive investments generally may include securities that pay taxable interest. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. In these circumstances, a Fund may be unable to achieve its investment goals. IT IS IMPORTANT TO NOTE THAT INSURANCE DOES NOT GUARANTEE THE MARKET VALUE OF AN INSURED SECURITY, OR THE FUND'S SHARE PRICE OR DISTRIBUTIONS, AND SHARES OF THE FUND ARE NOT INSURED. [Insert graphic of chart with line going up and down] MAIN RISKS ---------- INTEREST RATE When interest rates rise, municipal security prices fall. The opposite is also true: municipal security prices rise when interest rates fall. In general, securities with longer maturities are more sensitive to these price changes. CREDIT An issuer of municipal securities may be unable to make interest payments and repay principal. Changes in an issuer's financial strength or in a security's credit rating may affect a security's value and, thus, impact Fund performance. Many of each Fund's portfolio securities are supported by credit enhancements, which may be provided by either U.S. or foreign entities. These securities have the credit risk of the entity providing the credit support. Credit support provided by a foreign entity may be less certain because of the possibility of adverse foreign economic, political or legal developments that may affect the ability of that entity to meet its obligations. A change in the credit rating of any one or more of the municipal bond insurers that insure securities in the Fund's portfolio may affect the value of the securities they insure, the Fund's share price and Fund performance. A Fund might also be adversely impacted by the inability of an insurer to meet its insurance obligations. [Begin callout] Because interest rates and municipal security prices fluctuate, the amount of a Fund's distributions, its yield, and the value of your investment in that Fund will go up and down. This means you could lose money over short or even extended periods. [End callout] INCOME Since each Fund can only distribute what it earns, the Fund's distributions to shareholders may decline when interest rates fall. CALL A municipal security may be prepaid (called) before maturity. An issuer is more likely to call its securities when interest rates are falling, because the issuer can issue new securities with lower interest payments. If a security is called, a Fund may have to replace it with a lower-yielding security. At any time, each Fund may have a large amount of its assets invested in municipal securities subject to call risk. A call of some or all of these securities may lower a Fund's income and yield and its distributions to shareholders. MARKET A security's value may be reduced by market activity or the results of supply and demand. This is a basic risk associated with all securities. When there are more sellers than buyers, prices tend to fall. Likewise, when there are more buyers than sellers, prices tend to rise. Each Fund may invest more than 25% of its assets in municipal securities that finance similar types of projects, such as hospitals, housing, industrial development, transportation or pollution control. A change that affects one project, such as proposed legislation on the financing of the project, a shortage of the materials needed for the project, or a declining need for the project, would likely affect all similar projects, thereby increasing market risk. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS Municipal securities may be issued on a when-issued or delayed delivery basis, where payment and delivery take place at a future date. Since the market price of the security may fluctuate during the time before payment and delivery, the Fund assumes the risk that the value of the security at delivery may be more or less than the purchase price. DIVERSIFICATION The Florida Fund is a non-diversified fund. It may invest a greater portion of its assets in the municipal securities of one issuer than a diversified fund. The Fund may be more sensitive to economic, business, political or other changes affecting similar issuers or securities, which may result in greater fluctuation in the value of its shares. The Fund, however, intends to meet certain tax diversification requirements. The other Funds are all diversified funds. The Franklin Insured Tax-Free Income Fund is diversified nationally and will not invest more than 25% of its total assets in the municipal securities of any one state or territory. STATE Since each state Fund invests predominately in municipal securities of its state, events in that state are likely to affect the Fund's investments and its performance. These events may include economic or political policy changes, tax base erosion, state constitutional limits on tax increases, budget deficits and other financial difficulties, and changes in the credit ratings assigned to the state's municipal issuers. A negative change in any one of these or other areas could affect the ability of a state's municipal issuers to meet their obligations. It is important to remember that economic, budget and other conditions within a state are unpredictable and can change at any time. For these reasons, each state Fund involves more risk than an investment in a fund that does not focus on securities of a single state. To the extent the Franklin Insured Tax-Free Income Fund is invested in a state, events in that state may affect the Fund's investments and its performance. U.S. TERRITORIES Each Fund may invest up to 35% of its assets in municipal securities issued by U.S. territories. As with state municipal securities, events in any of these territories where a Fund is invested may affect the Fund's investments and its performance. More detailed information about the Funds, their policies and risks and about municipal securities ratings can be found in the Funds' Statement of Additional Information (SAI). [Begin callout] Mutual fund shares are not deposits or obligations of, or guaranteed or endorsed by, any bank, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency of the U.S. government. Mutual fund shares involve investment risks, including the possible loss of principal. [End callout] [Insert graphic of a bull and a bear] PERFORMANCE ----------- The bar charts and tables below show the volatility of each Fund's returns, which is one indicator of the risks of investing in a Fund. The bar charts show changes in each Fund's returns from year to year over the calendar years shown. The tables show how each Fund's average annual total returns compare to those of a broad-based securities market index. Of course, past performance cannot predict or guarantee future results. FLORIDA FUND ANNUAL TOTAL RETURNS/1 [Insert bar graph] - -9.85% 21.24% 8.00% 5.02% 6.67% -4.59% 13.14% 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 9.30% WORST QUARTER: Q1 '94 - -8.79% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 SINCE INCEPTION 1 YEAR 5 YEARS (4/30/93) - ------------------------------------------------------------------- Florida Fund - Class A/2 8.30% 4.58% 5.05% Lehman Brothers Municipal Bond 11.68% 5.84% 6.19% Index/3 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.66% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. INSURED FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 11.35% 9.38% 11.83% -3.59% 13.60% 4.18% 8.11% 6.04% -3.40% 12.01% 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.63% WORST QUARTER: Q1 '94 - -4.22% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------- Insured Fund - Class A/2 7.25% 4.35% 6.32% Lehman Brothers Municipal Bond 11.68% 5.84% 7.32% Index/3 SINCE INCEPTION 1 YEAR (5/1/95) - ------------------------------------------------------------------- Insured Fund - Class C/2 9.35% 4.50% 5.26% Lehman Brothers Municipal Bond 11.68% 5.84% 6.85% Index/3 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.69% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. MASSACHUSETTS FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 11.46% 8.98% 11.79% -3.63% 14.06% 8.53% 4.21% 5.39% -3.72% 13.21% 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.87% WORST QUARTER: Q1 '97 - -4.53% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS ------ ------- -------- Massachusetts Fund - Class A/2 8.37% 4.47% 6.39% Lehman Brothers Municipal Bond 11.68% 5.84% 7.32% Index/3 SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------- Massachusetts Fund - Class C/2 10.49% 4.60% 5.35% Lehman Brothers Municipal Bond 11.68% 5.84% 6.85% Index/3 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.50% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. MICHIGAN FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 10.96% 9.45% 12.09% -3.93% 13.83% 8.87% 3.58% 6.47% -2.27% 11.02% 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.70% WORST QUARTER: Q1 '94 - -4.60% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------- Michigan Fund - Class A/2 6.27% 4.52% 6.39% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------- Michigan Fund - Class C/2 8.31% 4.65% 5.41% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.08% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. MINNESOTA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 10.86% 8.62% 10.98% -3.55% 13.31% 3.49% 7.69% 5.68% -3.74% 11.90% 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.70% WORST QUARTER: Q1 '94 - -3.83% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ---------------------------------------------------------------- Minnesota Fund - Class A/2 7.18% 3.97% 5.90% Lehman Brothers Municipal Bond 11.68% 5.84% 7.32% Index/3 SINCE INCEPTION 1 YEAR (5/1/95) - ---------------------------------------------------------------- Minnesota Fund - Class C/2 9.25% 4.11% 4.82% Lehman Brothers Municipal Bond 11.68% 5.84% 6.85% Index/3 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.17% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. OHIO FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 10.95% 8.98% 12.47% -4.48% 14.34% 4.47% 8.16% 5.94% -3.00% 11.34% 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 6.09% WORST QUARTER: Q1 '94 - -4.75% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------- Ohio - Class A/2 6.62% 4.36% 6.28% Lehman Brothers Municipal Bond 11.68% 5.84% 7.32% Index/3 SINCE INCEPTION 1 YEAR (5/1/95) - ------------------------------------------------------------------- Ohio Fund - Class C/2 8.54% 4.52% 5.30% Lehman Brothers Municipal Bond 11.68% 5.84% 6.85% Index/3 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.74% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. [Insert graphic of percentage sign] FEES AND EXPENSES ----------------- This table describes the fees and expenses that you may pay if you buy and hold shares of a Fund. SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT) MASSA- FLORIDA INSURED CHUSETTS MICHIGAN MINNESOTA OHIO CLASS A FUND FUND FUND FUND FUND FUND - -------------------------------------------------------------------- Maximum sales charge (load) as a percentage of offering 4.25% 4.25% 4.25% 4.25% 4.25% 4.25% price Load imposed on purchases 4.25% 4.25% 4.25% 4.25% 4.25% 4.25% Maximum deferred sales charge NONE NONE NONE NONE NONE NONE (load)/1 CLASS B - -------------------------------------------------------------- Maximum sales charge (load) as a percentage of offering - 4.00% - 4.00% - 4.00% price Load imposed on purchases - NONE - NONE - NONE Maximum deferred sales charge - 4.00% - 4.00% - 4.00% (load)/2 CLASS C - -------------------------------------------------------------- Maximum sales charge (load) as a percentage of offering - 1.99% 1.99% 1.99% 1.99% 1.99% price Load imposed on purchases - 1.00% 1.00% 1.00% 1.00% 1.00% Maximum deferred sales charge - 0.99% 0.99% 0.99% 0.99% 0.99% (load)/3 Please see "Choosing a Share Class" on page 28 for an explanation of how and when these sales charges apply. ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS) MASSA- FLORIDA INSURED CHUSETTS MICHIGAN MINNESOTA OHIO CLASS A FUND FUND FUND FUND FUND FUND - ------------------------------------------------------------------ Management fees 0.62% 0.47% 0.53% 0.47% 0.50% 0.48% Distribution and service (12b-1) 0.10% 0.09% 0.10% 0.09% 0.09% 0.09% fees Other expenses 0.06% 0.06% 0.07% 0.08% 0.08% 0.09% ----------------------------------------------- Total annual Fund operating 0.78% 0.62% 0.70% 0.64% 0.67% 0.66% expenses =============================================== CLASS B - ----------------------------------------------------------------- Management fees - 0.47% - 0.47% - 0.48% Distribution and service (12b-1) fees - 0.65% - 0.65% - 0.65% Other expenses - 0.06% - 0.08% - 0.09% ----------------------------------------------- Total annual Fund operating - 1.18% - 1.20% - 1.22% expenses ================================================================= CLASS C - ----------------------------------------------------------------- Management fees - 0.47% 0.53% 0.47% 0.50% 0.48% Distribution and service (12b-1 fees) - 0.65% 0.65% 0.65% 0.65% 0.65% Other expenses - 0.06% 0.07% 0.08% 0.08% 0.09% ----------------------------------------------- Total annual Fund operating - 1.18% 1.25% 1.20% 1.23% 1.22% expenses =============================================== 1. There is a 1% contingent deferred sales charge that applies to investments of $1 million or more (see page 28). 2. Declines to zero after six years. 3. This is equivalent to a charge of 1% based on net asset value. EXAMPLE This example can help you compare the cost of investing in a Fund with the cost of investing in other mutual funds. It assumes: o You invest $10,000 for the periods shown; o Your investment has a 5% return each year; and o The Fund's operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be: MASSA- FLORIDA INSURED CHUSETTS MICHIGAN MINNESOTA OHIO FUND FUND FUND FUND FUND FUND - ------------------------------------------------------------- If you sell your shares at the end of the period: CLASS A 1 Year/1 $501 $486 $493 $488 $491 $490 3 Years $664 $615 $639 $621 $630 $627 5 Years $840 $756 $798 $767 $782 $777 10 Years $1,350 $1,166 $1,259 $1,189 $1,224 $1,213 CLASS B 1 Year - $520 - $522 - $524 3 Years - $675 - $681 - $687 5 Years - $849 - $860 - $870 10 Years/2 - $1,276 - $1,299 - $1,322 CLASS C 1 Year - $318 $325 $320 $323 $322 3 Years - $471 $493 $476 $486 $483 5 Years - $743 $779 $750 $769 $764 10 Years - $1,517 $1,596 $1,534 $1,574 $1,563 MASSA- FLORIDA INSURED CHUSETTS MICHIGAN MINNESOTA OHIO FUND FUND FUND FUND FUND FUND - ------------------------------------------------------------- If you do not sell your shares: CLASS B 1 Year - $120 - $122 - $124 3 Years - $375 - $381 - $387 5 Years - $649 - $660 - $670 10 Years/2 - $1,276 - $1,299 - $1,322 CLASS C 1 Year - $219 $226 $221 $224 $223 3 Years - $471 $493 $476 $486 $483 5 Years - $743 $779 $750 $769 $764 10 Years - $1,517 $1,596 $1,534 $1,574 $1,563 1. Assumes a contingent deferred sales charge (CDSC) will not apply. 2. Assumes conversion of Class B shares to Class A shares after eight years, lowering your annual expenses from that time on. [Insert graphic of briefcase] MANAGEMENT ---------- Franklin Advisers, Inc. (Advisers), One Franklin Parkway, San Mateo, CA 94403-1906, is each Fund's investment manager. Together, Advisers and its affiliates manage over $271 billion in assets. The team responsible for the Funds' management is: SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS Ms. Amoroso has been an analyst or portfolio manager of the Florida Fund since its inception and the Insured, Massachusetts, Michigan, Minnesota and Ohio Funds since 1987. She is the co-Director of Franklin's Municipal Bond Department. She joined Franklin Templeton Investments in 1986. JAMES CONN, VICE PRESIDENT OF ADVISERS Mr. Conn has been an analyst or portfolio manager of the Insured, Massachusetts, Michigan, Minnesota and Ohio Funds since 1999. He joined Franklin Templeton Investments in 1996. Previously, he was a portfolio manager with California Investment Trust. JOHN POMEROY, VICE PRESIDENT OF ADVISERS Mr. Pomeroy has been an analyst or portfolio manager of the Florida, Insured, Massachusetts, Michigan, Minnesota and Ohio Funds since 1989. He joined Franklin Templeton Investments in 1986. FRANCISCO RIVERA, PORTFOLIO MANAGER OF ADVISERS Mr. Rivera has been an analyst or portfolio manager of the Massachusetts Fund since 1996. He joined Franklin Templeton Investments in 1994. CHRISTOPHER SPERRY, PORTFOLIO MANAGER OF ADVISERS Mr. Sperry has been an analyst or portfolio manager of the Florida Fund since 2000. He joined Franklin Templeton Investments in 1996. STELLA S. WONG, VICE PRESIDENT OF ADVISERS Ms. Wong has been an analyst or portfolio manager of the Florida Fund since its inception and the Ohio Fund since 1986. She joined Franklin Templeton Investments in 1986. Each Fund pays Advisers a fee for managing the Fund's assets. For the fiscal year ended February 28, 2001, each Fund paid to the manager for its services the following management fees as a percentage of its average monthly net assets: MANAGEMENT FEES (as a percentage of average monthly assets) - ------------------------------------------------------------- Florida Fund 0.62% Insured Fund 0.47% Massachusetts Fund 0.53% Michigan Fund 0.47% Minnesota Fund 0.50% Ohio Fund 0.48% [Insert graphic of dollar signs and stacks of coins] DISTRIBUTIONS AND TAXES - ----------------------- ON MAY 26, 2001, THE U.S. CONGRESS PASSED AND SENT TO THE PRESIDENT THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001. IT IS EXPECTED THAT THE PRESIDENT WILL SIGN THIS LEGISLATION AND IT WILL BECOME LAW. THE 2001 TAX ACT CONTAINS PROVISIONS THAT WILL REDUCE EFFECTIVE FEDERAL INDIVIDUAL INCOME TAX RATES, PHASED-IN OVER TIME, AND WILL CREATE INVESTMENT, EDUCATIONAL AND RETIREMENT SAVINGS INCENTIVES THROUGH INCREASED PHASE-OUT LIMITS, AND OTHER TAX BENEFITS. INVESTORS SHOULD TALK TO THEIR PERSONAL TAX ADVISORS ABOUT THE IMPLICATIONS OF THESE TAX LAW CHANGES ON THEIR INVESTMENT IN A FUND. INCOME AND CAPITAL GAIN DISTRIBUTIONS Each Fund typically declares income dividends each day that its net asset value is calculated and pays them monthly. A Fund does not pay "interest." Your account begins to receive dividends on the day after the Fund receives your investment and continues to receive dividends through the day it receives a request to redeem your shares. Capital gains, if any, may be distributed at least annually. The amount of any distributions will vary, and there is no guarantee a Fund will pay either income dividends or capital gain distributions. AVOID "BUYING A DIVIDEND" If you invest in a Fund shortly before it makes a capital gain distribution, you will receive some of your investment back in the form of a taxable distribution. TAX CONSIDERATIONS You may receive three different types of distributions from the Fund: o EXEMPT-INTEREST DIVIDENDS. Most Fund distributions consist of exempt-interest dividends (dividends paid from interest earned on municipal securities). Because of this tax exemption, a tax-free fund may not be a suitable investment for retirement plans and other tax-exempt investors. In general, exempt-interest dividends are exempt from regular federal income tax. Exempt-interest dividends from interest earned on municipal securities of a state, or its political subdivisions, generally are also exempt from that state's personal income tax. Income from municipal securities of other states generally does not qualify as tax-free. Exempt-interest dividends are taken into account when determining the taxable portion of your social security or railroad retirement benefits. Each Fund may invest a portion of its assets in private activity bonds. The income from these bonds is a tax preference item when determining your alternative minimum tax. o TAXABLE INCOME DIVIDENDS. Each Fund may invest a portion of its assets in securities that pay income that is not tax-exempt. A Fund may also distribute to you any market discount and net short-term capital gains from the sale of its portfolio securities. If you are a taxable investor, Fund distributions from this income are taxable to you as ordinary income. o CAPITAL GAIN DISTRIBUTIONS. Each Fund may also realize net long-term capital gains and distribute these gains to you as capital gain distributions. These distributions will be taxable to you as long-term capital gains no matter how long you have owned your shares. Distributions of ordinary income and capital gains are taxable whether you reinvest your distributions in additional Fund shares or receive them in cash. Every January, you will receive a statement that shows the tax status of distributions you received for the previous year. BACKUP WITHHOLDING By law, a Fund must withhold 31% of your taxable distributions and redemption proceeds unless you: o provide your correct social security or taxpayer identification number, o certify that this number is correct, o certify that you are not subject to backup withholding, and o certify that you are a U.S. person (including a U.S. resident alien). A Fund also must withhold if the IRS instructs it to do so. When you sell your shares in a Fund, you may realize a capital gain or loss. For tax purposes, an exchange of your Fund shares for shares of a different Franklin Templeton fund is the same as a sale. Distributions of ordinary income and capital gains, and gains from the redemption of your Fund shares are generally subject to state and local taxes. Non-U.S. investors may be subject to U.S. withholding or estate tax, and are subject to special U.S. tax certification requirements. You should consult your tax advisor about the federal, state, local or foreign tax consequences of your investment in a Fund. [Insert graphic of a dollar bill] FINANCIAL HIGHLIGHTS -------------------- The tables below present each Fund's financial performance for the past five years. Certain information reflects financial results for a simple Fund share. The total returns in the table represent the rate that an investor would have earned or lost on an investment in the Fund assuming reinvestment of dividends and capital gains. This information has been audited by PricewaterhouseCoopers LLP, whose report, along with the Fund's financial statements, are included in the annual report, which is available upon request. FLORIDA FUND YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 9.61 10.53 10.43 9.99 10.02 year ----------------------------------- Net investment income/1 .49 .48 .51 .53 .53 ----------------------------------- Net realized and unrealized gains (losses) .74 (.92) .10 .44 (.03) ----------------------------------- Total from investment 1.23 (.44) .61 .97 .50 operations ----------------------------------- Distributions from net (.48) (.48) (.51) (.53) (.53) investment income ----------------------------------- Net asset value, end of year 10.36 9.61 10.53 10.43 9.99 =================================== Total return (%)/2 13.10 (4.22) 6.01 9.94 5.17 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 116,581 108,831 124,488 101,506 77,177 1,000) Ratios to average net assets: (%) Expenses .78 .76 .42 .35 .35 Expenses excluding waiver and payments by affiliate .78 .77 .79 .80 .80 Net investment income 4.87 4.79 4.88 5.16 5.36 Portfolio turnover rate (%) 29.18 23.92 1.81 8.08 32.23 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges. INSURED FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------- 2001 2000/3 1999 1998 1997 - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.24 12.26 12.31 12.15 12.27 year ----------------------------------- Net investment income/1 .60 .61 .64 .67 .69 Net realized and unrealized gains (losses) .74 (1.00) .06 .29 (.11) ----------------------------------- Total from investment 1.34 (.39) .69 .95 .58 operations ----------------------------------- Less distributions from: Net investment income (.60) (.61) (.64) (.67) (.70) Net realized gains - (.02) (.10) (.12) - ----------------------------------- Total distributions (.60) (.63) (.74) (.79) (.70) ----------------------------------- Net asset value, end of year 11.98 11.24 12.26 12.31 12.15 =================================== Total return (%)/2 12.24 (3.21) 5.72 8.09 4.88 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1 1,472 1,446 1,727 1,685 1,662 million) Ratios to average net assets: (%) Expenses .62 .62 .62 .61 .60 Net investment income 5.23 5.23 5.11 5.44 5.68 Portfolio turnover rate (%) 10.40 13.29 13.16 27.77 18.66 CLASS B - ------------------------------------------------------------------ PER SHARE DATA ($) Net asset value, beginning of 11.24 11.14 period --------------- .55 .05 Net investment income/1 Net realized and unrealized gains (losses) .75 .10 --------------- Total from investment 1.30 .15 operations --------------- Distributions from net (.54) (.05) investment income --------------- Net asset value, end of period 12.00 11.24 =============== Total return (%)/2 11.80 1.31 RATIOS/SUPPLEMENTAL DATA Net assets, end of period ($ x 6,291 63 1,000) Ratios to average net assets: (%) Expenses 1.18 1.18/4 Net investment income 4.68 5.23/4 Portfolio turnover rate (%) 10.40 13.29 CLASS C - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.31 12.33 12.38 12.21 12.31 year ----------------------------------- Net investment income/1 .55 .55 .57 .60 .62 Net realized and unrealized gains (losses) .73 (1.00) .05 .29 (.09) ----------------------------------- Total from investment 1.28 (.45) .62 .89 .53 operations ----------------------------------- Distributions from net (.54) (.55) (.57)7(.60) (.63) investment income ----------------------------------- Distributions from net - (.02) (.10) (.12) - realized gains ----------------------------------- Total distributions (.54) (.57) (.67) (.72) (.63) ----------------------------------- Net asset value, end of year 12.05 11.31 12.33 12.38 12.21 =================================== Total return (%)/2 11.55 (3.74) 5.12 7.52 4.42 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 62,212 56,627 65,166 38,057 21,521 1,000) Ratios to average net assets: (%) Expenses 1.18 1.18 1.18 1.18 1.17 Net investment income 4.67 4.66 4.54 4.86 5.10 Portfolio turnover rate (%) 10.40 13.29 13.16 27.77 18.66 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. Annualized. MASSACHUSETTS FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.75 11.71 11.75 11.54 11.65 year ----------------------------------- Net investment income/1 .57 .58 .59 .61 .63 Net realized and unrealized gains (losses) .79 (.96) .03 .35 (.10) ----------------------------------- Total from investment 1.36 (.38) .62 .96 .53 operations ----------------------------------- Distributions from: Net investment income (.57) (.58) (.59) (.62) (.64) Net realized gains - - (.07) (.13) - ----------------------------------- Total distributions (.57) (.58) (.66) (.75) (.64) ----------------------------------- Net asset value, end of year 11.54 10.75 11.71 11.75 11.54 =================================== Total return (%)/2 12.94 (3.34) 5.36 8.50 4.75 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 327,650306,531340,109328,147325,065 1,000) Ratios to average net assets: (%) Expenses .70 .68 .68 .68 .68 Net investment income 5.12 5.16 4.99 5.21 5.51 Portfolio turnover rate (%) 15.69 25.75 6.80 30.46 29.22 CLASS C - -------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.81 11.76 11.80 11.59 11.69 year ------------------------------------ Net investment income/1 .51 .52 .52 .55 .57 Net realized and unrealized gains (losses) .80 (.96) .03 .34 (.09) ------------------------------------ Total from investment 1.31 (.44) .55 .89 .48 operations ------------------------------------ Distributions from net (.51) (.51) (.52) (.55) (.58) investment income ------------------------------------ Distributions from net - - (.07) (.13) - realized gains ------------------------------------ Total distributions (.51) (.51) (.59) (.68) (.58) ------------------------------------ Net asset value, end of year 11.61 10.81 11.76 11.80 11.59 ==================================== Total return (%)/2 12.35 (3.78) 4.74 7.86 4.22 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 28,397 27,253 26,271 13,937 6,378 1,000) Ratios to average net assets: (%) Expenses 1.25 1.24 1.24 1.25 1.25 Net investment income 4.57 4.60 4.44 4.59 4.96 Portfolio turnover rate (%) 15.69 25.75 6.80 30.46 29.22 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. MICHIGAN FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------- 2001 2000/3 1999 1998 1997 - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.37 12.28 12.20 12.00 12.09 year ------------------------------------ Net investment income/1 .60 .60 .61 .63 .66 Net realized and unrealized gains (losses) .70 (.91) .13 .34 (.09) ------------------------------------ Total from investment 1.30 (.31) .74 .97 .57 operations ------------------------------------ Less distributions from: Net investment income (.59) (.60) (.61) (.63) (.66) ------------------------------------ Net realized gains - -4 (.05) (.13) - Total distributions (.59) (.60) (.66) (.77) (.66) Net asset value, end of year 12.08 11.37 12.28 12.20 12.00 ==================================== Total return (%)/2 11.74 (2.57) 6.23 8.37 4.90 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,085 1,058 1,161 1,143 1,112 1 million) Ratios to average net assets: (%) Expenses .64 .63 .63 .63 .62 Net investment income 5.10 5.10 4.98 5.24 5.52 Portfolio turnover rate (%) 10.34 13.73 7.37 20.08 30.03 CLASS B - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.38 11.31 period ------------------------------------ Net investment income1 .54 .05 Net realized and unrealized .73 .07 gains ------------------------------------ Total from investment 1.27 .12 operations ------------------------------------ Distributions from net (.53) (.05) investment income ------------------------------------ Net asset value, end of period 12.12 11.38 ==================================== Total return (%)/2 11.28 1.11 RATIOS/SUPPLEMENTAL DATA Net assets, end of period ($ 7,818 228 x 1,000) Ratios to average net assets: (%) Expenses 1.20 1.19/5 Net investment income 4.52 4.88/5 Portfolio turnover rate (%) 10.34 13.73 CLASS C - ------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.45 12.36 12.27 12.07 12.14 year -------------------------------------- Net investment income/1 .54 .54 .55 .57 .59 Net realized and unrealized gains (losses) .71 (.92) .13 .33 (.07) -------------------------------------- Total from investment 1.25 (.38) .68 .90 .52 operations -------------------------------------- Distributions from net (.53) (.53) (.54) (.57) (.59) investment income -------------------------------------- Distributions from net - - (.05) (.13) - realized gains Total distributions (.53) (.53) (.59) (.70) (.59) ------------------------------------- Net asset value, end of year 12.17 11.45 12.36 12.27 12.07 ===================================== Total return (%)/2 11.14 (3.11) 5.71 7.70 4.44 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 53,620 49,038 49,970 32,873 20,162 1,000) Ratios to average net assets: (%) Expenses 1.20 1.19 1.19 1.20 1.19 Net investment income 4.54 4.54 4.42 4.67 4.94 Portfolio turnover rate (%) 10.34 13.73 7.37 20.08 30.03 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. The Fund made a capital gain distribution of $.0003. 5. Annualized. MINNESOTA FUND CLASS A YEAR ENDED FEBRUARY 28, - ----------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ----------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.13 12.14 12.16 12.01 12.14 year ------------------------------------ Net investment income/1 .58 .59 .61 .64 .65 Net realized and unrealized gains (losses) .76 (.99) .01 .25 (.12) ------------------------------------ Total from investment 1.34 (.40) .62 .89 .53 operations ------------------------------------ Distributions from net (.58) (.59) (.62) (.64) (.66) investment income Distributions from net - (.02) (.02) (.10) - realized gains ------------------------------------ Total distributions (.58) (.61) (.64) (.74) (.66) ------------------------------------ Net asset value, end of year 11.89 11.13 12.14 12.16 12.01 ==================================== Total return (%)/2 12.31 (3.30) 5.18 7.60 4.54 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 465,758 451,142 515,174 495,315 482,128 1,000) Ratios to average net assets: (%) Expenses .67 .66 .67 .65 .66 Net investment income 5.04 5.05 5.01 5.29 5.47 Portfolio turnover rate (%) 24.68 15.79 16.25 14.87 14.40 CLASS C - -------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.18 12.19 12.21 12.05 12.17 year ------------------------------------ Net investment income1 .52 .52 .54 .57 .59 Net realized and unrealized gains (losses) .76 (.98) .01 .26 (.12) ------------------------------------ Total from investment 1.28 (.46) .55 .83 .47 operations ------------------------------------ Distributions from net (.51) (.53) (.55) (.57) (.59) investment income ------------------------------------ Distributions from net - (.02) (.02) (.10) - realized gains ------------------------------------ Total distributions (.51) (.55) (.57) (.67) (.59) ------------------------------------ Net asset value, end of year 11.95 11.18 12.19 12.21 12.05 ==================================== Total return (%)/2 11.74 (3.84) 4.58 7.04 3.98 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 24,738 21,828 20,896 10,131 4,844 1,000) Ratios to average net assets: (%) Expenses 1.23 1.22 1.23 1.22 1.23 Net investment income 4.49 4.50 4.44 4.72 4.87 Portfolio turnover rate (%) 24.68 15.79 16.25 14.87 14.40 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges. OHIO FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------- 2001 2000/3 1999 1998 1997 - -------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.52 12.49 12.45 12.19 12.22 year ------------------------------------ Net investment income/1 .61 .61 .62 .64 .66 Net realized and unrealized gains (losses) .68 (.95) .07 .33 (.03) ------------------------------------ Total from investment 1.29 (.34) .69 .97 .63 operations ------------------------------------ Distributions from net (.60) (.61) (.62) (.64) (.66) investment income Distributions from net - (.02) (.03) (.07) - realized gains ------------------------------------ Total distributions (.60) (.63) (.65) (.71) (.66) ------------------------------------ Net asset value, end of year 12.21 11.52 12.49 12.45 12.19 ==================================== Total return (%)/2 11.48 (2.80) 5.63 8.22 5.35 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 698,853 689,084 776,592 741,079 698,360 1,000) Ratios to average net assets: (%) Expenses .66 .64 .65 .64 .64 Net investment income 5.10 5.07 4.98 5.24 5.43 Portfolio turnover rate (%) 16.45 9.61 6.56 12.84 14.95 CLASS B - -------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.52 11.43 period ------------------------------------ Net investment income/1 .55 .05 Net realized and unrealized gains (losses) .70 .09 ------------------------------------ Total from investment 1.25 .14 operations ------------------------------------ Distributions from net (.54) (.05) investment income ------------------------------------ Net asset value, end of period 12.23 11.52 ==================================== Total return (%)/2 11.04 1.19 RATIOS/SUPPLEMENTAL DATA Net assets, end of period ($ x 3,649 76 1,000) Ratios to average net assets: (%) Expenses 1.22 1.20/4 Net investment income 4.53 5.02/4 Portfolio turnover rate (%) 16.45 9.61 CLASS C - -------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.58 12.56 12.51 12.24 12.26 year ------------------------------------ Net investment income/1 .54 .54 .55 .58 .59 Net realized and unrealized gains (losses) .69 (.96) .08 .34 (.02) ------------------------------------ Total from investment 1.23 (.42) .63 .92 .57 operations ------------------------------------ Distributions from net (.53) (.54) (.55) (.58) (.59) investment income Distributions from net - (.02) (.03) (.07) - realized gains ------------------------------------ Total distributions (.53) (.56) (.58) (.65) (.59) ------------------------------------ Net asset value, end of year 12.28 11.58 12.56 12.51 12.24 ==================================== Total return (%)/2 10.90 (3.41) 5.10 7.66 4.79 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 42,072 40,181 42,258 28,178 15,786 1,000) Ratios to average net assets: (%) Expenses 1.22 1.20 1.21 1.20 1.20 Net investment income 4.55 4.52 4.42 4.67 4.80 Portfolio turnover rate (%) 16.45 9.61 6.56 12.84 14.95 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. Annualized. YOUR ACCOUNT [Insert graphic of pencil marking an X] CHOOSING A SHARE CLASS ---------------------- Each class has its own sales charge and expense structure, allowing you to choose the class that best meets your situation. Your investment representative can help you decide. CLASS B (INSURED, MICHIGAN CLASS C CLASS A AND OHIO FUNDS ONLY) (ALL FUNDS EXCEPT FLORIDA) - ------------------------------------------------------------------------- o Initial sales o No initial o Initial sales charge of 4.25% or sales charge charge of 1% less o Deferred sales o Deferred sales o Deferred sales charge of 1% on charge of 4% on charge of 1% on purchases of $1 shares you sell shares you sell million or more sold within the first within 18 months within 12 months year, declining to 1% within six years and eliminated after that o Lower annual o Higher annual o Higher annual expenses than Class expenses than expenses than B or C due to lower Class A (same as Class A (same as distribution fees Class C) due to Class B) due to higher higher distribution distribution fees. fees. Automatic No conversion to conversion to Class A shares, so Class A shares annual expenses do after eight not decrease. years, reducing future annual expenses. SALES CHARGES - CLASS A THE SALES CHARGE MAKES UP THIS % WHICH EQUALS THIS % OF THE OFFERING OF YOUR NET WHEN YOU INVEST THIS AMOUNT PRICE INVESTMENT - -------------------------------------------------------------------- Under $100,000 4.25 4.44 $100,000 but under $250,000 3.50 3.63 $250,000 but under $500,000 2.50 2.56 $500,000 but under $1 2.00 2.04 million INVESTMENTS OF $1 MILLION OR MORE If you invest $1 million or more, either as a lump sum or through our cumulative quantity discount or letter of intent programs (see page 31), you can buy Class A shares without an initial sales charge. However, there is a 1% contingent deferred sales charge (CDSC) on any shares you sell within 12 months of purchase. The way we calculate the CDSC is the same for each class (please see page 30). DISTRIBUTION AND SERVICE (12B-1) FEES Class A has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution fees of up to 0.15% per year for the Florida Fund and 0.10% per year for the remaining Funds, to those who sell and distribute Class A shares and provide other services to shareholders. Because these fees are paid out of Class A's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS B IF YOU SELL YOUR SHARES WITHIN THIS % IS DEDUCTED FROM THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC - ----------------------------------------------------------------- 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 With Class B shares, there is no initial sales charge. However, there is a CDSC if you sell your shares within six years, as described in the table above. The way we calculate the CDSC is the same for each class (please see page 30). After 8 years, your Class B shares automatically convert to Class A shares, lowering your annual expenses from that time on. MAXIMUM PURCHASE AMOUNT The maximum amount you may invest in Class B shares at one time is $249,999. We place any investment of $250,000 or more in Class A shares, since a reduced initial sales charge is available and Class A's annual expenses are lower. DISTRIBUTION AND SERVICE (12B-1) FEES Class B has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class B shares and for services provided to shareholders. Because these fees are paid out of Class B's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS C THE SALES CHARGE MAKES UP THIS % WHICH EQUALS THIS % WHEN YOU INVEST THIS OF THE OFFERING OF YOUR NET AMOUNT PRICE INVESTMENT - -------------------------------------------------------------------- Under $1 million 1.00 1.01 WE PLACE ANY INVESTMENT OF $1 MILLION OR MORE IN CLASS A SHARES, SINCE THERE IS NO INITIAL SALES CHARGE AND CLASS A'S ANNUAL EXPENSES ARE LOWER. CDSC There is a 1% contingent deferred sales charge (CDSC) on any Class C shares you sell within 18 months of purchase. The way we calculate the CDSC is the same for each class (please see below). DISTRIBUTION AND SERVICE (12B-1) FEES Class C has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class C shares and for services provided to shareholders. Because these fees are paid out of Class C's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. CONTINGENT DEFERRED SALES CHARGE (CDSC) - CLASS A, B & C The CDSC for each class is based on the current value of the shares being sold or their net asset value when purchased, whichever is less. There is no CDSC on shares you acquire by reinvesting your dividends or capital gains distributions. [Begin callout] The HOLDING PERIOD FOR THE CDSC begins on the day you buy your shares. Your shares will age one month on that same date the next month and each following month. For example, if you buy shares on the 18th of the month, they will age one month on the 18th day of the next month and each following month. [End callout] To keep your CDSC as low as possible, each time you place a request to sell shares we will first sell any shares in your account that are not subject to a CDSC. If there are not enough of these to meet your request, we will sell the shares in the order they were purchased. We will use this same method if you exchange your shares into another Franklin Templeton fund (please see page 37 for exchange information). SALES CHARGE REDUCTIONS AND WAIVERS If you qualify for any of the sales charge reductions or waivers below, please let us know at the time you make your investment to help ensure you receive the lower sales charge. QUANTITY DISCOUNTS We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases of Class A shares. [Begin callout] FRANKLIN TEMPLETON FUNDS include all of the U.S. registered mutual funds of Franklin Templeton Investments, except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. [End callout] o CUMULATIVE QUANTITY DISCOUNT - lets you combine all of your shares in Franklin Templeton funds for purposes of calculating the sales charge. You also may combine the shares of your spouse, and your children or grandchildren, if they are under the age of 21. Certain company and retirement plan accounts also may be included. o LETTER OF INTENT (LOI) - expresses your intent to buy a stated dollar amount of shares over a 13-month period and lets you receive the same sales charge as if all shares had been purchased at one time. We will reserve a portion of your shares to cover any additional sales charge that may apply if you do not buy the amount stated in your LOI. TO SIGN UP FOR THESE PROGRAMS, COMPLETE THE APPROPRIATE SECTION OF YOUR ACCOUNT APPLICATION. REINSTATEMENT PRIVILEGE If you sell shares of a Franklin Templeton fund, you may reinvest some or all of the proceeds within 365 days without an initial sales charge. The proceeds must be reinvested within the same share class, except proceeds from the sale of Class B shares will be reinvested in Class A shares. If you paid a CDSC when you sold your Class A or C shares, we will credit your account with the amount of the CDSC paid but a new CDSC will apply. For Class B shares reinvested in Class A, a new CDSC will not apply, although your account will not be credited with the amount of any CDSC paid when you sold your Class B shares. Proceeds immediately placed in a Franklin Bank Certificate of Deposit (CD) also may be reinvested without an initial sales charge if you reinvest them within 365 days from the date the CD matures, including any rollover. This privilege does not apply to shares you buy and sell under our exchange program. Shares purchased with the proceeds from a money fund may be subject to a sales charge. SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales charge or CDSC by various individuals and institutions or by investors who reinvest certain distributions and proceeds within 365 days. Certain investors also may buy Class C shares without an initial sales charge. The CDSC for each class may be waived for certain redemptions and distributions. If you would like information about available sales charge waivers, call your investment representative or call Shareholder Services at 1-800/632-2301. A list of available sales charge waivers also may be found in the Statement of Additional Information (SAI). GROUP INVESTMENT PROGRAM Allows established groups of 11 or more investors to invest as a group. For sales charge purposes, the group's investments are added together. There are certain other requirements and the group must have a purpose other than buying Fund shares at a discount. [Insert graphic of a paper with lines and someone writing] BUYING SHARES - ------------- MINIMUM INVESTMENTS - ------------------------------------------------------------------ INITIAL ADDITIONAL - ------------------------------------------------------------------ Regular accounts $1,000 $50 - ------------------------------------------------------------------ Automatic investment plans $50 $50 - ------------------------------------------------------------------ UGMA/UTMA accounts $100 $50 - ------------------------------------------------------------------ Broker-dealer sponsored wrap account $250 $50 programs - ------------------------------------------------------------------ Full-time employees, officers, trustees and $100 $50 directors of Franklin Templeton entities, and their immediate family members - ------------------------------------------------------------------ PLEASE NOTE THAT YOU MAY ONLY BUY SHARES OF A FUND ELIGIBLE FOR SALE IN YOUR STATE OR JURISDICTION. ACCOUNT APPLICATION If you are opening a new account, please complete and sign the enclosed account application. Make sure you indicate the share class you have chosen. If you do not indicate a class, we will place your purchase in Class A shares. To save time, you can sign up now for services you may want on your account by completing the appropriate sections of the application (see "Investor Services" on page 35). For example, if you would like to link one of your bank accounts to your Fund account so that you may use electronic funds transfer to and from your bank account to buy and sell shares, please complete the bank information section of the application. We will keep your bank information on file for future purchases and redemptions. BUYING SHARES - ---------------------------------------------------------------------- OPENING AN ACCOUNT ADDING TO AN ACCOUNT - ---------------------------------------------------------------------- [Insert graphic of hands shaking] Contact your Contact your investment THROUGH YOUR investment representative INVESTMENT representative REPRESENTATIVE - ---------------------------------------------------------------------- [Insert graphic of If you have another Before requesting a phone and computer] Franklin Templeton telephone or online fund account with your purchase into an BY PHONE/ONLINE bank account existing account, information on file, please make sure we (Up to $100,000 per you may open a new have your bank account shareholder per day) account by phone. At information on file. If this time, a new we do not have this 1-800/632-2301 account may not be information, you will opened online. need to send written franklintempleton.com instructions with your To make a same day bank's name and NOTE: CERTAIN investment, your phone address, a voided check ACCOUNT TYPES ARE order must be received or savings account NOT AVAILABLE FOR and accepted by us by deposit slip, and a ONLINE ACCOUNT 1:00 p.m. Pacific time signature guarantee if ACCESS or the close of the the bank and Fund New York Stock accounts do not have at Exchange, whichever is least one common owner. earlier. To make a same day investment, your phone or online order must be received and accepted by us by 1:00 p.m. Pacific time or the close of the New York Stock Exchange, whichever is earlier. - ---------------------------------------------------------------------- Make your check Make your check payable [Insert graphic of payable to the Fund. to the Fund. Include envelope] your account number on Mail the check and the check. BY MAIL your signed application to Fill out the deposit Investor Services. slip from your account statement. If you do not have a slip, include a note with your name, the Fund name, and your account number. Mail the check and deposit slip or note to Investor Services. - ---------------------------------------------------------------------- [Insert graphic of Call to receive a wire Call to receive a wire three lightning control number and control number and wire bolts] wire instructions. instructions. Wire the funds and To make a same day wire mail your signed investment, please call BY WIRE application to us by 1:00 p.m. Pacific Investor Services. time and make sure your 1-800/632-2301 Please include the wire arrives by 3:00 (or 1-650/312-2000 wire control number or p.m. collect) your new account number on the application. To make a same day wire investment, please call us by 1:00 p.m. Pacific time and make sure your wire arrives by 3:00 p.m. - ---------------------------------------------------------------------- [Insert graphic of Call Shareholder Call Shareholder Services at the two arrows pointing Services at the number number below or our automated in opposite below, or send TeleFACTS system, or send signed directions] signed written written instructions. You also instructions. may place an online exchange BY EXCHANGE You also may place an order. online exchange order. TeleFACTS(R) The TeleFACTS system (Please see page 37 for information 1-800/247-1753 cannot be used to open on exchanges.) (around-the-clock a new account. access) (Please see page 37 Our Website for information on franklintempleton. exchanges.) com - ------------------------------------------------------------------------------ FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of person with a headset] INVESTOR SERVICES ----------------- AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to invest in a Fund by automatically transferring money from your checking or savings account each month to buy shares. To sign up, complete the appropriate section of your account application and mail it to Investor Services. If you are opening a new account, please include the minimum initial investment of $50 with your application. AUTOMATIC PAYROLL DEDUCTION You may invest in a Fund automatically by transferring money from your paycheck to the Fund by electronic funds transfer. If you are interested, indicate on your application that you would like to receive an Automatic Payroll Deduction Program kit. DISTRIBUTION OPTIONS You may reinvest distributions you receive from a Fund in an existing account in the same share class* of the Fund or another Franklin Templeton fund. Initial sales charges and CDSCs will not apply if you reinvest your distributions within 365 days. You also can have your distributions deposited in a bank account, or mailed by check. Deposits to a bank account may be made by electronic funds transfer. Please indicate on your application the distribution option you have chosen, otherwise we will reinvest your distributions in the same share class of the Fund. *Class B and C shareholders may reinvest their distributions in Class A shares of any Franklin Templeton money fund. TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to information about your account or any Franklin Templeton fund. This service is available from touch-tone phones at 1-800/247-1753. For a free TeleFACTS brochure, call 1-800/DIAL BEN. FRANKLIN TEMPLETON ONLINE You can visit us online at FRANKLINTEMPLETON.COM for around-the-clock viewing of information about most Franklin Templeton funds or to register to view your accounts online. You also may register for online transactions that will allow you to buy, sell, or exchange your shares and make certain changes to your account. Some account types may not be able to process any or all transactions online. You also may register online for Franklin Templeton's convenient electronic delivery of your important shareholder documents. This service should be available on our website beginning in July 2001. TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account, allowing you to obtain or view your account information, and conduct a number of transactions by phone or online, including: buy, sell, or exchange shares of most funds; use electronic funds transfer to buy or sell shares of most funds; change your address; request a year-end statement; add or change account services (including distribution options, systematic withdrawals, automatic investment plans). In addition, you may elect to receive your important shareholder documents online and discontinue receiving paper copies. To view your account information or request online transactions, you will first need to register for these services at the shareholder section of our website at FRANKLINTEMPLETON.COM. You will be asked to accept the terms of an online agreement(s) and establish a password for online services. If you are registered for online services, you may enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most Funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Using our shareholder website means you are consenting to sending and receiving personal financial information over the Internet so you should be sure you are comfortable with the risks. As long as we follow reasonable security procedures and act on instructions we reasonably believe are genuine, we will not be responsible for any losses that may occur from unauthorized requests. We will request passwords or other information, and also may record calls. To help safeguard your account, keep your password confidential, and verify the accuracy of your confirmation statements immediately after you receive them. Contact us immediately if you believe someone has obtained unauthorized access to your account or password. For transactions done over the Internet, we recommend the use of an Internet browser with 128-bit encryption. Certain methods of contacting us (such as by phone or by Internet) may be unavailable or delayed during periods of unusual market activity. OF COURSE, YOU CAN DECLINE TELEPHONE BUY, SELL, OR EXCHANGE PRIVILEGES ON YOUR ACCOUNT APPLICATION, OR CHOOSE NOT TO REGISTER FOR ONLINE PRIVILEGES. IF YOU HAVE TELEPHONE/ONLINE PRIVILEGES ON YOUR ACCOUNT AND WANT TO DISCONTINUE THEM, PLEASE CONTACT US FOR INSTRUCTIONS. You may reinstate these privileges at any time in writing, including online registration with respect to online privileges. NOTE: We discourage you from including confidential or sensitive information in any Internet communication to us. If you do choose to send email (encrypted or not) to us over the Internet, you are accepting the associated risks of lack of confidentiality. EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton funds within the same class*, generally without paying any additional sales charges. If you exchange shares held for less than six months, however, you may be charged the difference between the initial sales charge of the two funds if the difference is more than 0.25%. If you exchange shares from a money fund, a sales charge may apply no matter how long you have held the shares. [Begin callout] An EXCHANGE is really two transactions: a sale of one fund and the purchase of another. In general, the same policies that apply to purchases and sales apply to exchanges, including minimum investment amounts. Exchanges also have the same tax consequences as ordinary sales and purchases. [End callout] Generally exchanges may only be made between identically registered accounts, unless you send written instructions with a signature guarantee. Any CDSC will continue to be calculated from the date of your initial investment and will not be charged at the time of the exchange. The purchase price for determining a CDSC on exchanged shares will be the price you paid for the original shares. If you exchange shares subject to a CDSC into a Class A money fund, the time your shares are held in the money fund will not count towards the CDSC holding period. If you exchange your Class B shares for the same class of shares of another Franklin Templeton fund, the time your shares are held in that fund will count towards the eight year period for automatic conversion to Class A shares. Because excessive trading can hurt fund performance, operations and shareholders, each Fund reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges, reject any exchange, or restrict or refuse purchases if (i) the Fund or its manager believes the Fund would be harmed or unable to invest effectively, or (ii) the Fund receives or anticipates simultaneous orders that may significantly affect the Fund (please see "Market Timers" on page 43). *Class Z shareholders of Franklin Mutual Series Fund Inc. may exchange into Class A without any sales charge. Advisor Class shareholders of another Franklin Templeton fund also may exchange into Class A without any sales charge. Advisor Class shareholders who exchange their shares for Class A shares and later decide they would like to exchange into another fund that offers Advisor Class may do so. SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your shares and receive regular payments from your account. A CDSC may apply to withdrawals that exceed certain amounts. Certain terms and minimums apply. To sign up, complete the appropriate section of your application. [Insert graphic of a certificate] SELLING SHARES -------------- You can sell your shares at any time. Please keep in mind that a contingent deferred sales charge (CDSC) may apply. SELLING SHARES IN WRITING Generally, requests to sell $100,000 or less can be made over the phone, online, or with a simple letter. Sometimes, however, to protect you and the Fund we will need written instructions signed by all registered owners, with a signature guarantee for each owner, if: [Begin callout] A SIGNATURE GUARANTEE helps protect your account against fraud. You can obtain a signature guarantee at most banks and securities dealers. A notary public CANNOT provide a signature guarantee. [End callout] o you are selling more than $100,000 worth of shares o you want your proceeds paid to someone who is not a registered owner o you want to send your proceeds somewhere other than the address of record, or preauthorized bank or brokerage firm account We also may require a signature guarantee on instructions we receive from an agent, not the registered owners, or when we believe it would protect the Fund against potential claims based on the instructions received. SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased, we may delay sending you the proceeds until your check, draft or wire/electronic funds transfer has cleared, which may take seven business days or more. A certified or cashier's check may clear in less time. REDEMPTION PROCEEDS Your redemption check will be sent within seven days after we receive your request in proper form. We are not able to receive or pay out cash in the form of currency. Redemption proceeds may be delayed if we have not yet received your signed account application. SELLING SHARES - ------------------------------------------------------------------------------ TO SELL SOME OR ALL OF YOUR SHARES - ------------------------------------------------------------------------------ [Insert graphic of hands shaking] Contact your investment representative THROUGH YOUR INVESTMENT REPRESENTATIVE - ------------------------------------------------------------------------------ [Insert graphic of Send written instructions and endorsed envelope] share certificates (if you hold share certificates) to Investor Services. BY MAIL Corporate, partnership or trust accounts may need to send additional documents. Specify the Fund, the account number and the dollar value or number of shares you wish to sell. If you own both Class A and B shares, also specify the class of shares, otherwise we will sell your Class A shares first. Be sure to include all necessary signatures and any additional documents, as well as signature guarantees if required. A check will be mailed to the name(s) and address on the account, or otherwise according to your written instructions. - --------------------------------------------------------------- [Insert graphic of As long as your transaction is for phone and computer] $100,000 or less, you do not hold share certificates and you have not changed BY PHONE/ONLINE your address by phone or online within the last 15 days, you can sell your 1-800/632-2301 shares by phone or online. franklintempleton.com A check will be mailed to the name(s) and address on the account. Written instructions, with a signature guarantee, are required to send the check to another address or to make it payable to another person. (Please see page 36 for more information.) - --------------------------------------------------------------- [Insert graphic of You can call, write, or visit us online three to have redemption proceeds sent to a lightning bolts] bank account. See the policies above for selling shares by mail, phone, or BY ELECTRONIC FUNDS online. TRANSFER (ACH) Before requesting to have redemption proceeds sent to a bank account, please make sure we have your bank account information on file. If we do not have this information, you will need to send written instructions with your bank's name and address, a voided check or savings account deposit slip, and a signature guarantee if the bank and Fund accounts do not have at least one common owner. If we receive your request in proper form by 1:00 p.m. Pacific time, proceeds sent by ACH generally will be available within two to three business days. - -------------------------------------------------------------------------- [Insert graphic of Obtain a current prospectus for the fund you are two arrows pointing considering. Prospectuses are available online at in opposite franklintempleton.com. directions] BY EXCHANGE Call Shareholder Services at the number below or our automated TeleFACTS TeleFACTS(R) system, or send signed written 1-800/247-1753 instructions. You also may place an (around-the-clock exchange order online. See the access) policies above for selling shares by mail, phone, or online. If you hold share certificates, you will need to return them to the Fund before your exchange can be processed. - --------------------------------------------------------------- FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of paper and pen] ACCOUNT POLICIES ---------------- CALCULATING SHARE PRICE Each Fund calculates its net asset value per share (NAV) each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). Each class's NAV is calculated by dividing its net assets by the number of its shares outstanding. [Begin callout] When you buy shares, you pay the offering price. The offering price is the NAV plus any applicable sales charge. When you sell shares, you receive the NAV minus any applicable contingent deferred sales charge (CDSC). [End callout] Each Fund's assets are generally valued at their market value. If market prices are unavailable, or if an event occurs after the close of the trading market that materially affects the values, assets may be valued at their fair value. Requests to buy and sell shares are processed at the NAV next calculated after we receive your request in proper form. ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250 ($50 for employee and UGMA/UTMA accounts) because you sell some of your shares, we may mail you a notice asking you to bring the account back up to its applicable minimum investment amount. If you choose not to do so within 30 days, we may close your account and mail the proceeds to the address of record. You will not be charged a CDSC if your account is closed for this reason. STATEMENTS AND REPORTS You will receive quarterly account statements that show all your account transactions during the quarter. You also will receive written notification after each transaction affecting your account (except for distributions and transactions made through automatic investment or withdrawal programs, which will be reported on your quarterly statement). You also will receive the Funds' financial reports every six months. To reduce Fund expenses, we try to identify related shareholders in a household and send only one copy of the financial reports. If you need additional copies, please call 1-800/DIAL BEN. You also can review these documents on our website if you have registered to view your account information online. If you are registered for online services, you may also enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Visit us online at franklintempleton.com for more information. INVESTMENT REPRESENTATIVE ACCOUNT ACCESS If there is a dealer or other investment representative of record on your account, he or she will be able to obtain your account information, conduct transactions for your account, and also will receive copies of all notifications and statements and other information about your account directly from the Fund. STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or nominee name account of one dealer to another, as long as both dealers have an agreement with Franklin Templeton Distributors, Inc. We will process the transfer after we receive authorization in proper form from your delivering securities dealer. JOINT ACCOUNTS Unless you specify a different registration, accounts with two or more owners are registered as "joint tenants with rights of survivorship" (shown as "Jt Ten" on your account statement). To make any ownership changes to a joint account, all owners must agree in writing, regardless of the law in your state. JOINT ACCOUNT RISK WITH TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account. If your account has more than one registered owner, telephone/online privileges allow the Fund to accept online registration for online services (including electronic delivery of important shareholder documents) and transaction instructions online or by telephone from only one registered owner. This means that ANY ONE REGISTERED OWNER ON YOUR ACCOUNT, ACTING ALONE AND WITHOUT THE CONSENT OF ANY OTHER REGISTERED OWNER, may give the Fund instructions by telephone, online or in writing (subject to any limitations in telephone or online privileges) to: o Exchange shares from a jointly registered Fund account requiring all registered owner signatures into an identically registered money fund account that only requires one registered owner's signature to redeem shares; o Redeem Fund shares and direct the redemption proceeds to a bank account that may or may not be owned by you and, if owned by you jointly with someone else, only requires one person to withdraw funds by check or otherwise; o Change the bank account to which Fund share redemption proceeds may be sent, which bank account may not be owned by you; o Purchase Fund shares by debiting a bank account that may be owned by you; and o Change the bank account that may be debited for Fund share purchases, which new account may be owned by you. If you do NOT want another registered owner on your account to be able to issue these kinds of instructions to the Fund without your consent, you must instruct the Fund to deny/terminate online privileges and the ability to issue such instructions by telephone so that these types of instructions will only be accepted in writing signed by all account owners. This decision will apply to any other fund into which you may exchange your jointly owned Fund shares. Any later decision to permit these types of instructions by telephone and/or online will need to be given to the Fund in a written instruction signed by all registered owners. MARKET TIMERS The Insured Fund may restrict or refuse purchases or exchanges by Market Timers. The remaining Funds do not allow investments by Market Timers. You may be considered a Market Timer if you have (i) requested an exchange out of any of the Franklin Templeton funds within two weeks of an earlier exchange request out of any fund, or (ii) exchanged shares out of any of the Franklin Templeton funds more than twice within a rolling 90 day period, or (iii) otherwise seem to follow a market timing pattern that may adversely affect the Fund. Accounts under common ownership or control with an account that is covered by (i), (ii), or (iii) also are subject to these limits. Anyone, including the shareholder or the shareholder's agent, who is considered to be a Market Timer by the Fund, its manager or shareholder services agent, will be issued a written notice of their status and the Fund's policies. Identified Market Timers will be required to register with the market timing desk of Franklin Templeton Investor Services, LLC, and to place all purchase and exchange trade requests through the desk. ADDITIONAL POLICIES Please note that the Funds maintain additional policies and reserves certain rights, including: o The Funds may restrict or refuse any order to buy shares, including any purchase under the exchange privilege. o The Funds may modify, suspend, or terminate telephone/online privileges at any time. o At any time, the Funds may change their investment minimums or waive or lower their minimums for certain purchases. o The Funds may modify or discontinue the exchange privilege on 60 days' notice. o In unusual circumstances, we may temporarily suspend redemptions, or postpone the payment of proceeds, as allowed by federal securities laws. o For redemptions over a certain amount, each Fund reserves the right, in the case of an emergency, to make payments in securities or other assets of the Fund, if the payment of cash proceeds by check, wire or electronic funds transfer would be harmful to existing shareholders. o To permit investors to obtain the current price, dealers are responsible for transmitting all orders to the Funds promptly. DEALER COMPENSATION Qualifying dealers who sell Fund shares may receive sales commissions and other payments. These are paid by Franklin Templeton Distributors, Inc. (Distributors) from sales charges, distribution and service (12b-1) fees and its other resources. CLASS A CLASS B CLASS C - -------------------------------------------------------------------- COMMISSION (%) --- 3.00 2.00 Investment under $100,000 4.00 --- --- $100,000 but under $250,000 3.25 --- --- $250,000 but under $500,000 2.25 --- --- $500,000 but under $1 1.85 --- --- million $1 million or more up to 0.75/1 --- --- 12B-1 FEE TO DEALER 0.15 0.15/2 0.65/3 (Florida Fund) 0.10 (all other Funds) A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer commission of up to 0.25% may be paid on Class A NAV purchases by certain trust companies and bank trust departments, eligible governmental authorities, and broker-dealers or others on behalf of clients participating in comprehensive fee programs. MARKET TIMERS. Please note that for Class A NAV purchases by Market Timers, including purchases of $1 million or more, dealers are not eligible to receive the dealer commission. Dealers, however, may be eligible to receive the 12b-1 fee from the date of purchase. 1. During the first year after purchase, dealers may not be eligible to receive the 12b-1 fee. 2. Dealers may be eligible to receive up to 0.15% from the date of purchase. After 8 years, Class B shares convert to Class A shares and dealers may then receive the 12b-1 fee applicable to Class A. 3. Dealers may be eligible to receive up to 0.15% during the first year after purchase and may be eligible to receive the full 12b-1 fee starting in the 13th month. [Insert graphic of question mark] QUESTIONS If you have any questions about the Funds or your account, you can write to us at P.O. Box 997151, Sacramento, CA 95899-9983. You also can call us at one of the following numbers. For your protection and to help ensure we provide you with quality service, all calls may be monitored or recorded. HOURS (PACIFIC TIME, DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY) - ----------------------------------------------------------------- Shareholder Services 1-800/632-2301 5:30 a.m. to 5:00 p.m. 6:30 a.m. to 2:30 p.m. (Saturday) Fund Information 1-800/DIAL BEN 5:30 a.m. to 5:00 p.m. (1-800/342-5236) 6:30 a.m. to 2:30 p.m. (Saturday) Retirement Services 1-800/527-2020 5:30 a.m. to 5:00 p.m. Advisor Services 1-800/524-4040 5:30 a.m. to 5:00 p.m. Institutional 1-800/321-8563 6:00 a.m. to 5:00 p.m. Services TDD (hearing 1-800/851-0637 5:30 a.m. to 5:00 p.m. impaired) TeleFACTS(R) 1-800/247-1753 (around-the-clock (automated) access) FOR MORE INFORMATION You can learn more about each Fund in the following documents: ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS Includes a discussion of recent market conditions and Fund strategies that significantly affected each Fund's performacne during its last fiscal year, financial statements, detailed performance information, portfolio holdings and the auditor's report. STATEMENT OF ADDITIONAL INFORMATION (SAI) Contains more information about each Fund, its investments and policies. It is incorporated by reference (is legally a part of this prospectus). For a free copy of the current annual/semiannual report or the SAI, please contact your investment representative or call us at the number below. You also can view the current annual/semiannual report online at franklintempleton.com. FRANKLIN(R)TEMPLETON(R) 1-800/DIAL BEN(R) (1-800/342-5236) TDD (Hearing Impaired) 1-800/851-0637 franklintempleton.com You also can obtain information about each Fund by visiting the SEC's Public Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this information, after paying a duplicating fee, by writing to the SEC's Public Reference Section, Washington, D.C. 20549-0102 or by electronic request at the following e-mail address: publicinfo@sec.gov. Investment Company Act file #811-4149 TF1 P 07/01 FRANKLIN TAX-FREE TRUST FRANKLIN FLORIDA INSURED TAX-FREE INCOME FUND FRANKLIN INSURED TAX-FREE INCOME FUND FRANKLIN MASSACHUSETTS INSURED TAX-FREE INCOME FUND FRANKLIN MICHIGAN INSURED TAX-FREE INCOME FUND FRANKLIN MINNESOTA INSURED TAX-FREE INCOME FUND FRANKLIN OHIO INSURED TAX-FREE INCOME FUND STATEMENT OF ADDITIONAL INFORMATION JULY 1, 2001 [Insert Franklin Templeton Ben Head] P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R) This Statement of Additional Information (SAI) is not a prospectus. It contains information in addition to the information in the Funds' prospectus. The Funds' prospectus, dated July 1, 2001, which we may amend from time to time, contains the basic information you should know before investing in the Funds. You should read this SAI together with the Funds' prospectus. The audited financial statements and auditor's report in the Funds' Annual Report to Shareholders, for the fiscal year ended February 28, 2001, are incorporated by reference (are legally a part of this SAI). For a free copy of the current prospectus or annual report, contact your investment representative or call 1-800/DIAL BEN (1-800/342-5236). CONTENTS Goals, Strategies, and Risks...................................... 2 State and U.S. Territory Risks.................................... 7 Officers and Trustees............................................. 11 Management and Other Services..................................... 13 Portfolio Transactions............................................ 14 Distributions and Taxes........................................... 15 Organization, Voting Rights and Principal Holders................................................ 17 Buying and Selling Shares......................................... 18 Pricing Shares.................................................... 23 The Underwriter................................................... 23 Performance....................................................... 25 Miscellaneous Information......................................... 28 Description of Ratings............................................ 29 State Tax Treatment............................................... 32 - ------------------------------------------------------------------------------ MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS: o ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT; o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK; o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. - ------------------------------------------------------------------------------ GOALS, STRATEGIES AND RISKS - ------------------------------------------------------------------------------ Generally, the policies and restrictions discussed in this SAI and in the prospectus apply when a Fund makes an investment. In most cases, the Fund is not required to sell a security because circumstances change and the security no longer meets one or more of the Fund's policies or restrictions. If a percentage restriction or limitation is met at the time of investment, a later increase or decrease in the percentage due to a change in the value or liquidity of portfolio securities will not be considered a violation of the restriction or limitation. If a bankruptcy or other extraordinary event occurs concerning a particular security a Fund owns, the Fund may receive stock, real estate, or other investments that the Fund would not, or could not, buy. If this happens, the Fund intends to sell such investments as soon as practicable while trying to maximize the return to shareholders. Each Fund has adopted the following restrictions as fundamental policies. This means they may only be changed if the change is approved by (i) more than 50% of the Fund's outstanding shares or (ii) 67% or more of the Fund's shares present at a shareholder meeting if more than 50% of the Fund's outstanding shares are represented at the meeting in person or by proxy, whichever is less. FUNDAMENTAL INVESTMENT POLICIES Each Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investment management and the preservation of shareholders' capital. Each state Fund also tries to provide a maximum level of income exempt from personal income taxes, if any, for resident shareholders of the Fund's state. Each Fund may not: 1. Borrow money or mortgage or pledge any of its assets, except that borrowings (and a pledge of assets therefore) for temporary or emergency purposes may be made from banks in any amount up to 5% of the total asset value. 2. Buy any securities on "margin" or sell any securities "short," except that it may use such short-term credits as are necessary for the clearance of transactions. 3. Make loans, except through the purchase of readily marketable debt securities which are either publicly distributed or customarily purchased by institutional investors. Although such loans are not presently intended, this prohibition will not preclude the fund from loaning portfolio securities to broker-dealers or other institutional investors if at least 102% cash collateral is pledged and maintained by the borrower; provided such portfolio security loans may not be made if, as a result, the aggregate of such loans exceeds 10% of the value of the Fund's total assets at the time of the most recent loan. 4. Act as underwriter of securities issued by other persons, except insofar as the Fund may be technically deemed an underwriter under the federal securities laws in connection with the disposition of portfolio securities. 5. Purchase the securities of any issuer which would result in owning more than 10% of the voting securities of such issuer, except with respect to the Florida Fund, which will not purchase a security, if as a result: i) more than 25% of its total assets would be invested in the securities of a single issuer or ii) with respect to 50% of its total assets, more than 5% of its assets would be invested in the securities of a single issuer. 6. Purchase securities from or sell to the Trust's officers and trustees, or any firm of which any officer or trustee is a member, as principal, or retain securities of any issuer if, to the knowledge of the Trust, one or more of the Trust's officers, trustees, or investment manager own beneficially more than one-half of 1% of the securities of such issuer and all such officers and trustees together own beneficially more than 5% of such securities. 7. Acquire, lease or hold real estate, except such as may be necessary or advisable for the maintenance of its offices and provided that this limitation shall not prohibit the purchase of municipal and other debt securities secured by real estate or interests therein. 8. Invest in commodities and commodity contracts, puts, calls, straddles, spreads or any combination thereof, or interests in oil, gas, or other mineral exploration or development programs, except that it may purchase, hold and dispose of "obligations with puts attached" in accordance with its investment policies. 9. Invest in companies for the purpose of exercising control or management. 10. Purchase securities of other investment companies, except in connection with a merger, consolidation, acquisition or reorganization, except to the extent permitted by exemptions which may be granted under the Investment Company Act of 1940, which allows the Fund to invest in shares of one or more investment companies, of the type generally referred to as money market funds, managed by Franklin Advisers, Inc. or its affiliates. 11. In the case of the Florida Fund, purchase securities, in private placements or in other transactions, for which there are legal or contractual restrictions on resale. 12. Invest more than 25% of its assets in securities of any industry; although for purposes of this limitation, tax-exempt securities and U.S. government obligations are not considered to be part of any industry. INVESTMENTS, TECHNIQUES, STRATEGIES AND THEIR RISKS As a fundamental policy, each Fund normally invests at least 80% of its total assets in securities that pay interest free from federal income taxes, including the federal alternative minimum tax. In addition, each state Fund normally invests at least 80% of its total assets in securities that pay interest free from the personal income taxes, if any, of its state. As a nonfundamental policy, each state Fund also normally invests at least 65% of its total assets in municipal securities of its state. Unlike the state Funds, the Franklin Insured Tax-Free Income Fund is diversified nationally and will not invest more than 25% of its total assets in the municipal securities of any one state or territory. Municipal securities issued by a Fund's state or that state's counties, municipalities, authorities, agencies, or other subdivisions, as well as qualifying municipal securities issued by U.S. territories such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands, generally pay interest free from federal income tax and from state personal income taxes, if any, for residents of the Fund's state. Each Fund tries to invest all of its assets in tax-free municipal securities. The issuer's bond counsel generally gives the issuer an opinion on the tax-exempt status of a municipal security when the security is issued. Some states may require a Fund to invest a certain amount of its assets in securities of that state, or in securities that are otherwise tax-free under the laws of that state, in order for any portion of the Fund's distributions to be free from the state's personal income taxes. If a Fund's state requires this, the Fund will try to invest its assets as required so that its distributions will be free from personal income taxes for resident shareholders of the Fund's state. BELOW IS A DESCRIPTION OF VARIOUS TYPES OF MUNICIPAL AND OTHER SECURITIES THAT EACH FUND MAY BUY. OTHER TYPES OF MUNICIPAL SECURITIES MAY BECOME AVAILABLE THAT ARE SIMILAR TO THOSE DESCRIBED BELOW AND IN WHICH EACH FUND ALSO MAY INVEST, IF CONSISTENT WITH ITS INVESTMENT GOAL AND POLICIES. MUNICIPAL BONDS have two principal classifications: general obligation bonds and revenue bonds. GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states, counties, cities, towns and regional districts. The proceeds of these obligations are used to fund a wide range of public projects, including construction or improvement of schools, highways and roads. The basic security behind general obligation bonds is the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. The taxes that can be levied for the payment of debt service may be limited or unlimited as to the rate or amount of special assessments. REVENUE BONDS. The full faith, credit and taxing power of the issuer do not secure revenue bonds. Instead, the principal security for a revenue bond generally is the net revenue derived from a particular facility, group of facilities, or, in some cases, the proceeds of a special excise tax or other specific revenue source. Revenue bonds are issued to finance a wide variety of capital projects, including: electric, gas, water and sewer systems; highways, bridges and tunnels; port and airport facilities; colleges and universities; and hospitals. The principal security behind these bonds may vary. For example, housing finance authorities have a wide range of security, including partially or fully insured mortgages, rent subsidized and/or collateralized mortgages, and/or the net revenues from housing or other public projects. Many bonds provide additional security in the form of a debt service reserve fund that may be used to make principal and interest payments. Some authorities have further security in the form of state assurances (although without obligation) to make up deficiencies in the debt service reserve fund. ANTICIPATION NOTES are issued to provide interim financing of various municipal needs in anticipation of the receipt of other sources of money for repayment of the notes. BOND ANTICIPATION notes are normally issued to provide interim financing until a long-term bond financing can be arranged which provides the money for the repayment of the notes. REVENUE ANTICIPATION notes are issued in expectation of the receipt of revenue sources, other than tax receipts, such as federal revenues available under the Federal Revenue Sharing Program. TAX ANTICIPATION notes are issued to finance the short-term working capital needs of municipalities in anticipation of the receipt of various seasonal tax revenues that are used to repay the notes. They are usually general obligations of the issuer and are secured by the taxing power for the payment of principal and interest. CALLABLE BONDS Each Fund may invest in callable bonds, which allow the issuer to repay some or all of the bonds ahead of schedule. If a bond is called, the Fund will receive the principal amount, the accrued interest, and may receive a small additional payment as a call premium. The manager may sell a callable bond before its call date if it believes the bond is at its maximum premium potential. When pricing callable bonds, the call feature is factored into the price of the bonds and may impact a Fund's net asset value. An issuer is more likely to call its bonds when interest rates are below the rate at which the original bond was issued, because the issuer can issue new bonds with lower interest payments. If a bond is called, the Fund may have to replace it with a lower-yielding security. A call of some or all of these securities may lower a Fund's income, its yield and its distributions to shareholders. If the Fund originally paid a premium for the bond because it had appreciated in value from its original issue price, the Fund also may not be able to recover the full amount it paid for the bond. One way for a Fund to protect itself from call risk is to buy bonds with call protection. Call protection is an assurance that the bond will not be called for a specific time period, typically five to 10 years from when the bond is issued. COMMERCIAL PAPER is a promissory note issued by a corporation to finance its short-term credit needs. Each Fund may invest in taxable commercial paper only for temporary defensive purposes. CONVERTIBLE AND STEP COUPON BONDS Each Fund may each invest a portion of its assets in convertible and step coupon bonds. Convertible bonds are zero-coupon securities until a predetermined date, at which time they convert to a specified coupon security. The coupon on step coupon bonds changes periodically during the life of the security based on predetermined dates chosen when the security is issued. Zero coupon bonds tend to react more sharply to changes in interest rates than traditional bonds. ESCROW-SECURED OR PRE-REFUNDED BONDS are created when an issuer uses the proceeds from a new bond issue to buy high grade, interest bearing debt securities, generally direct obligations of the U.S. government in order to redeem (or pre-refunded), before maturity, an outstanding bond issue that is not immediately callable. These securities are then deposited in an irrevocable escrow account held by a trustee bank to secure all future payments of principal and interest on the pre-refunded bond. Pre-refunded bonds often receive a triple A or equivalent rating. Because pre-refunded bonds still bear the same interest rate, and have a very high credit quality, their price may increase. However, as the original bond approaches its call date, the bond's price will fall to its call price. Each Fund's manager attempts to manage the pre-refunded bonds in its portfolio so that it sells them before this decline in price occurs. MUNICIPAL LEASE OBLIGATIONS are created to finance the purchase of property for public use. The property is then leased to a state or a local government and these leases secure the municipal lease obligations. The lease payments are used to pay the interest on the obligations. However, municipal lease obligations differ from other municipal securities because each year the lessee's governing body must appropriate (set aside) the money to make the lease payments. If the money is not appropriated, the issuer or the lessee can end the lease without penalty. If the lease is cancelled, investors who own the municipal lease obligations may not be paid. Each Fund may invest in municipal lease obligations, including certificates of participation. The board of trustees reviews each Fund's municipal lease obligations to try to assure that they are liquid investments based on various factors reviewed by each Fund's manager. Since annual appropriations are required to make lease payments, municipal lease obligations generally are not subject to constitutional limitations on the issuance of debt, and may allow an issuer to increase government liabilities beyond constitutional debt limits. When faced with increasingly tight budgets, local governments have more discretion to curtail lease payments under a municipal lease obligation than they do to curtail payments on other municipal securities. If not enough money is appropriated to make the lease payments, the leased property may be repossessed as security for holders of the municipal lease obligations. If this happens, there is no assurance that the property's private sector or re-leasing value will be enough to make all outstanding payments on the municipal lease obligations or that the payments will continue to be tax-free. While cancellation risk is inherent to municipal lease obligations, each Fund believes that this risk may be reduced, although not eliminated, by its policies on the quality of municipal lease securities in which it may invest. STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped" form. Stripped municipal securities represent separate ownership of principal and interest payments on municipal securities. TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270 days or less) issued by a municipality to meet working capital needs. TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of public authorities to finance various privately operated facilities which are expected to benefit the municipality and its residents, such as business, manufacturing, housing, sports and pollution control, as well as public facilities such as airports, mass transit systems, ports and parking. The payment of principal and interest is solely dependent on the ability of the facility's user to meet its financial obligations and the pledge, if any, of the facility or other property as security for payment. U.S. GOVERNMENT SECURITIES are issued by the U.S. Treasury or by agencies and instrumentalities of the U.S. government and are backed by the full faith and credit of the U.S. government. They include Treasury bills, notes and bonds. VARIABLE OR FLOATING RATE SECURITIES Each Fund may invest in variable or floating rate securities, including variable rate demand notes, which have interest rates that change either at specific intervals (variable rate), from daily up to monthly, or whenever a benchmark rate changes (floating rate). The interest rate adjustments are designed to help stabilize the security's price. While this feature helps protect against a decline in the security's market price when interest rates rise, it lowers a Fund's income when interest rates fall. Of course, a Fund's income from its variable rate investments also may increase if interest rates rise. Variable or floating rate securities may include a demand feature, which may be unconditional. The demand feature allows the holder to demand prepayment of the principal amount before maturity, generally on one to 30 days' notice. The holder receives the principal amount plus any accrued interest either from the issuer or by drawing on a bank letter of credit, a guarantee or insurance issued with respect to the security. Each Fund generally uses variable or floating rate securities as short-term investments while waiting for long-term investment opportunities. ZERO-COUPON AND DELAYED INTEREST SECURITIES Each Fund may invest in zero-coupon and delayed interest securities. Zero-coupon securities make no periodic interest payments, but are sold at a deep discount from their face value. The buyer recognizes a rate of return determined by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date. The discount varies depending on the time remaining until maturity, as well as market interest rates, liquidity of the security, and the issuer's perceived credit quality. The discount, in the absence of financial difficulties of the issuer, typically decreases as the final maturity date approaches. If the issuer defaults, the Fund may not receive any return on its investment. Because zero-coupon securities bear no interest and compound semiannually at the rate fixed at the time of issuance, their value generally is more volatile than the value of other fixed-income securities. Since zero-coupon bondholders do not receive interest payments, when interest rates rise, zero-coupon securities fall more dramatically in value than bonds paying interest on a current basis. When interest rates fall, zero-coupon securities rise more rapidly in value because the bonds reflect a fixed rate of return. An investment in zero-coupon and delayed interest securities may cause the Fund to recognize income and make distributions to shareholders before it receives any cash payments on its investment. To generate cash to satisfy distribution requirements, the Fund may have to sell portfolio securities that it otherwise would have continued to hold or to use cash flows from other sources such as the sale of Fund shares. IN ADDITION TO STANDARD PURCHASES AND SALES OF VARIOUS MUNICIPAL SECURITIES, EACH FUND'S PORTFOLIO MAY ALSO BE SUBJECT TO CERTAIN OTHER CHARACTERISTICS AND RISKS, AND MAY ALSO ENGAGE IN OTHER STRATEGIES, WHICH, ALONG WITH THESE RISKS, ARE DESCRIBED BELOW. SHOULD OTHER STRATEGIES, NOT SPECIFICALLY DESCRIBED BELOW, BECOME AVAILABLE OR ATTRACTIVE, THE MANAGER MAY ENGAGE IN THEM SO LONG AS THEY ARE CONSISTENT WITH EACH FUND'S GOALS AND OBJECTIVES. CREDIT QUALITY All things being equal, the lower a security's credit quality, the higher the risk and the higher the yield the security generally must pay as compensation to investors for the higher risk. A security's credit quality depends on the issuer's ability to pay interest on the security and, ultimately, to repay the principal. Independent rating agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors Service, Inc. (Moody's), and Standard & Poor's Ratings Group (S&P(R)), often rate municipal securities based on their analysis of the issuer's credit quality. Most rating agencies use a descending alphabet scale to rate long-term securities, and a descending numerical scale to rate short-term securities. Securities in the top four ratings are "investment grade," although securities in the fourth highest rating may have some speculative features. These ratings are described at the end of this SAI under "Description of Ratings." An insurance company, bank or other foreign or domestic entity may provide credit support for a municipal security and enhance its credit quality. For example, some municipal securities are insured, which means they are covered by an insurance policy that guarantees the timely payment of principal and interest. Other municipal securities may be backed by letters of credit, guarantees, or escrow or trust accounts that contain securities backed by the full faith and credit of the U.S. government to secure the payment of principal and interest. As discussed in the prospectus, each Fund has limitations on the credit quality of the securities it may buy. These limitations generally are applied when the Fund makes an investment so that the Fund is not required to sell a security because of a later change in circumstances. In addition to considering ratings in its selection of each Fund's portfolio securities, the manager may consider, among other things, information about the financial history and condition of the issuer, revenue and expense prospects and, in the case of revenue bonds, the financial history and condition of the source of revenue to service the bonds. Securities that depend on the credit of the U.S. government are regarded as having a triple A or equivalent rating. DIVERSIFICATION All of the Funds, except the Florida Fund, are diversified funds. The Florida Fund is non-diversified. As a fundamental policy, none of the diversified Funds will buy a security if, with respect to 75% of its net assets, more than 5% would be in the securities of any single issuer (with the exception of obligations of the U.S. government). For this purpose, each political subdivision, agency, or instrumentality, each multi-state agency of which a state is a member, and each public authority that issues private activity bonds on behalf of a private entity, is considered a separate issuer. Escrow-secured or defeased bonds are not generally considered an obligation of the original municipality when determining diversification. Each Fund, including the Florida Fund, intends to meet certain diversification requirements for tax purposes. Generally, to meet federal tax requirements at the close of each quarter, a Fund may not invest more than 25% of its total assets in any one issuer and, with respect to 50% of total assets, may not invest more than 5% of its total assets in any one issuer. These limitations do not apply to U.S. government securities and may be revised if applicable federal income tax requirements are revised. ILLIQUID INVESTMENTS Each Fund may invest up to 10% of its net assets in illiquid securities. Illiquid securities generally are securities that cannot be sold within seven days in the normal course of business at approximately the amount at which the Fund has valued them. INSURANCE Each Fund invests primarily in insured municipal securities. Normally, the underlying rating of an insured security is one of the top three ratings of Fitch, Moody's or S&P. An insurer may insure municipal securities that are rated below the top three ratings or that are unrated if the securities otherwise meet the insurer's quality standards. Each Fund will only enter into a contract to buy an insured municipal security if either permanent insurance or an irrevocable commitment to insure the municipal security by a qualified municipal bond insurer is in place. The insurance feature guarantees the scheduled payment of principal and interest, but does not guarantee (i) the market value of the insured municipal security, (ii) the value of a Fund's shares, or (iii) a Fund's distributions. TYPES OF INSURANCE. There are three types of insurance: new issue, secondary and portfolio. A new issue insurance policy is purchased by the issuer when the security is issued. A secondary insurance policy may be purchased by the Fund after a security is issued. With both new issue and secondary policies, the insurance continues in force for the life of the security and, thus, may increase the credit rating of the security, as well as its resale value. Each Fund may buy a secondary insurance policy at any time, if the manager believes the insurance would be in the best interest of the Fund. The Fund is likely to buy a secondary insurance policy if, in the manager's opinion, the Fund could sell a security at a price that exceeds the current value of the security, without insurance, plus the cost of the insurance. The purchase of a secondary policy, if available, may enable the Fund to sell a defaulted security at a price similar to that of comparable securities that are not in default. The Fund would value a defaulted security covered by a secondary insurance policy at its market value. Each Fund also may buy a portfolio insurance policy. Unlike new issue and secondary insurance, which continue in force for the life of the security, portfolio insurance only covers securities while they are held by the Fund. If the Fund sells a security covered by portfolio insurance, the insurance protection on that security ends and, thus, cannot affect the resale value of the security. As a result, the Fund may continue to hold any security insured under a portfolio insurance policy that is in default or in significant risk of default and, absent any unusual or unforeseen circumstances as a result of the portfolio insurance policy, would likely value the defaulted security, or security for which there is a significant risk of default, at the same price as comparable securities that are not in default. While a defaulted security is held in the Fund's portfolio, the Fund continues to pay the insurance premium on the security but also collects interest payments from the insurer and retains the right to collect the full amount of principal from the insurer when the security comes due. The insurance premium the Fund pays for a portfolio insurance policy is a Fund expense. The premium is payable monthly and is adjusted for purchases and sales of covered securities during the month. If the Fund fails to pay its premium, the insurer may take action against the Fund to recover any premium payments that are due. The insurer may not change premium rates for securities covered by a portfolio insurance policy, regardless of the issuer's ability or willingness to meet its obligations. QUALIFIED MUNICIPAL BOND INSURERS. Each Fund generally buys insured municipal securities only if they are secured by an insurance policy issued by an insurer whose claims paying ability is rated triple A or its equivalent by Fitch, Moody's or S&P. Currently, there are four primary, triple A rated municipal bond insurers. The Fund, however, may invest a portion of its assets in insured municipal securities covered by policies issued by insurers with a rating below triple A or its equivalent. The bond insurance industry is a regulated industry. All bond insurers must be licensed in each state in order to write financial guarantees in that jurisdiction. Regulations vary from state to state. Most regulators, however, require minimum standards of solvency and limitations on leverage and investment of assets. Regulators also place restrictions on the amount an insurer can guarantee in relation to the insurer's capital base. Neither the Funds nor the manager makes any representations as to the ability of any insurance company to meet its obligation to a Fund if called upon to do so. If an insurer is called upon to pay the principal or interest on an insured security that is due for payment but that has not been paid by the issuer, the terms of payment would be governed by the provisions of the insurance policy. After payment, the insurer becomes the owner of the security, appurtenant coupon, or right to payment of principal or interest on the security and is fully subrogated to all of the Funds' rights with respect to the security, including the right to payment. The insurer's rights to the security or to payment of principal or interest are limited, however, to the amount the insurer has paid. MATURITY Municipal securities are issued with a specific maturity date - the date when the issuer must repay the amount borrowed. Maturities typically range from less than one year (short term) to 30 years (long term). In general, securities with longer maturities are more sensitive to price changes, although they may provide higher yields. The Funds have no restrictions on the maturity of the securities they may buy or on its average portfolio maturity. PORTFOLIO TURNOVER The frequency of portfolio transactions, usually referred to as the portfolio turnover rate, varies for each Fund from year to year, depending on market conditions. While short-term trading increases portfolio turnover and may increase costs, the execution costs for municipal securities are substantially less than for equivalent dollar values of equity securities. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of a Fund's assets in a temporary defensive manner or hold a substantial portion of its portfolio in cash, cash equivalents or other high quality short-term investments. Unfavorable market or economic conditions may include excessive volatility or a prolonged general decline in the securities markets in the securities in which the Funds' invest or in the economies of the states and territories where the Funds' invest. Temporary defensive investments generally may include securities that pay taxable interest, including (i) for the state Funds, municipal securities issued by a state or local government other than the Fund's state; (ii) high quality commercial paper; or (iii) securities issued by or guaranteed by the full faith and credit of the U.S. government. Each Fund also may invest all of its assets in municipal securities issued by a U.S. territory such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a "when-issued" basis. When so offered, the price, which is generally expressed in yield terms, is fixed at the time the commitment to buy is made, but delivery and payment take place at a later date. During the time between purchase and settlement, no payment is made by the Fund to the issuer and no interest accrues to the Fund. If the other party to the transaction fails to deliver or pay for the security, the Fund could miss a favorable price or yield opportunity, or could experience a loss. When a Fund makes the commitment to buy a municipal security on a when-issued basis, it records the transaction and includes the value of the security in the calculation of its net asset value. The Fund does not believe that its net asset value or income will be negatively affected by its purchase of municipal securities on a when-issued basis. The Fund will not engage in when-issued transactions for investment leverage purposes. Although a Fund generally will buy municipal securities on a when-issued basis with the intention of acquiring the securities, it may sell the securities before the settlement date if it is considered advisable. When a Fund is the buyer, it will set aside on its books cash or liquid securities, with an aggregate value equal to the amount of its purchase commitments, until payment is made. If assets of a Fund are held in cash pending the settlement of a purchase of securities, the Fund will not earn income on those assets. STATE AND U.S. TERRITORY RISKS - ------------------------------------------------------------------------------- STATE Since each state Fund mainly invests in the municipal securities of its state, its performance is closely tied to the ability of issuers of municipal securities in its state to continue to make principal and interest payments on their securities. The issuers' ability to do this is in turn dependent on economic, political and other conditions within the state. Below is a discussion of certain conditions that may affect municipal issuers in the Funds' various states. It is not a complete analysis of every material fact that may affect the ability of issuers of municipal securities to meet their debt obligations or the economic or political conditions within any state and is subject to change. The information below is based on data available to the Funds from historically reliable sources, but the Funds have not independently verified it. The ability of issuers of municipal securities to continue to make principal and interest payments is dependent in large part on their ability to raise revenues, primarily through taxes, and to control spending. Many factors can affect a state's revenues including the rate of population growth, unemployment rates, personal income growth, federal aid, and the ability to attract and keep successful businesses. A number of factors can also affect a state's spending including the need for infrastructure improvements, increased costs for education and other services, current debt levels, and the existence of accumulated budget deficits. The following gives more information about the risks of investing in the Funds. Please read this information together with the section "Main Risks" in the Prospectus. FLORIDA. Florida's population has grown rapidly in recent years, with the fastest growth among 5-17 year-olds. In the next ten years, the most rapidly growing population will be in the over 85 age group. The rapid growth in the population of both the young and old has required increased expenditures for services, such as schools and health care, and has placed sustained pressure on the state's budget for the funding of these services. As a result, Florida is more vulnerable to increases in the cost of education, Medicaid and other health care services than many other states. While the population of the young and old has grown rapidly, the working age population has grown at a much slower rate and is expected to decline in the coming years. Because of its substantial retirement age population, investment income and transfer payments, such as social security and pension benefits, make up a significant proportion of Florida's income distribution. This income mix historically has led to relatively stable personal income levels across different economic cycles, although it also has created some vulnerability to changes in the consumer price index at the federal level. Florida's tax base has been relatively narrow, with no personal income tax and 60% of its revenues derived from the state's sales and use tax. This reliance on a cyclical revenue source has created some vulnerability to recession and slower growth in the tax base. Recent trends also have shown an increase in internet and mail order sales, which the state has not been able to tax. If this trend continues, states that rely on sales taxes, like Florida, could be adversely affected. To help provide some protection against the historically volatile nature of the sales tax, Florida enacted a constitutional amendment creating a budget stabilization fund. Florida projects a balance in the fund of $847 million by fiscal year end 2000, meeting the required fund level of 5% of the previous year's General Fund revenues. In addition, the year is expected to close with a $962 million combined general and working capital balance. Over the past five years, Florida's debt burden has grown dramatically with the increased need for schools and health care, as well as environmental protection programs designed to help protect the state's important tourism industry. The state's rapidly growing population should continue to place demands on the state's budget and debt burden needed to finance infrastructure and other improvements. While tourism has remained Florida's most important industry, Florida's economy has continued to diversify from a narrow base of agriculture and seasonal tourism into a service and trade economy. Job growth has been steady and unemployment has been around the national rate. Florida's year over year job growth was among the top three fastest in the nation in 1999. Because of its location, much of the state's export sector has relied on exports to Latin America. Although exports have comprised a relatively small part of the gross state product, the sector's dependence on Latin America poses a risk in the event of economic instability in that region. MASSACHUSETTS. In recent years, Massachusetts' economy has been strong and has led the northeast region. Since 1996, total employment gains in the commonwealth have been similar to national levels. Likewise, the commonwealth's unemployment rates have compared favorably with national rates. In November 1999, the unemployment rate in Massachusetts was 3.2%, compared to the national rate of 4.1%. Strong employment growth since 1993, together with low unemployment rates and slow population growth, have begun to cause some concerns of a tight labor market. A labor shortage may be a potential constraint on the further growth of Massachusetts' economy. Although the economy has been strong, the commonwealth's debt levels have remained among the highest in the nation. Spending disciplines imposed during the state's severe financial difficulties in the early 1990s have helped and have resulted in eight consecutive years of balanced financial operations. At the same time, the commonwealth has greatly reduced its reliance on temporary borrowing. While the commonwealth has regained some control over its budget, continuing expenditure pressures may present fiscal challenges. After a period of restrained debt issuance, pressure to increase borrowing has been building. Funding for routine infrastructure needs and a costly tunnel project have been the focus of this pressure. Tax cuts, a relatively high unfunded pension liability, and the substantial reliance of localities on the commonwealth for financial assistance also may strain the commonwealth's resources and limit its financial flexibility. With the rate of economic growth expected to slow in coming years, Massachusetts' biggest challenge is likely to be the long term management of its capital and debt plans. MICHIGAN. While Michigan's economy has diversified to some degree, it has remained dependent on its durable goods manufacturing sector, especially on its cyclical auto industry. In recent years, manufacturing has accounted for 22% of the state's employment and 33% of personal income. While this sector has been strong since the end of the national recession in the early 1990s and has made improvements that could potentially lessen its historical volatility, the state's reliance on manufacturing has made its economy potentially more volatile than the economies of more diverse states and more susceptible to the adverse effects of another recession. Since 1992, Michigan's economy has grown at a healthy pace. Unemployment levels have been below national levels since 1994 and, through 1999, employment levels were at an all-time high. With the help of its strong economy, Michigan's finances also have improved. Tighter budget controls and the positive effect on revenues of the state's relatively strong economy have allowed the state to replenish reserves, which had been severely depleted during the early 1990s. As of September 30, 1999, the state's budget stabilization fund was at more than $1 billion. Michigan may need the increased stability these reserve levels provide to offset higher school funding requirements. The state also has been able to maintain its traditionally low debt levels, although contingent debt levels issued through school programs and based on the state's credit have grown rapidly, approaching levels almost double the state's outstanding direct debt. The state's contingent debt exposure will need to be carefully managed in the coming years to help maintain the state's financial stability. MINNESOTA. Minnesota's economy has been well-diversified, with only slight concentration in the manufacturing sector. Historically, this diversification has allowed the state to perform well during economic cycles, compared with the rest of the nation. The effects of the last national recession were less severe in Minnesota, and the state was able to recover more quickly than many other states. Since late 1994, Minnesota has experienced steady job growth, especially in the services sector. Much of this growth has occurred in the Minneapolis-St. Paul metropolitan area and has created labor shortages in some industries. These shortages have in turn resulted in higher-than-average wage levels. Higher wages, together with a tight labor market, could limit future job expansion in the state. Strong financial management, healthy reserve levels and a moderate debt burden have allowed the state to maintain its strong credit rating. With the recent strength of its economy and growth in revenues, Minnesota has increased its general fund balance to $2.0 billion as of June 30, 1999, with a budgetary reserve of $1.3 billion. With its balances and reserves near historic levels, several tax cuts have been proposed. OHIO. Ohio's financial performance has been strong, aided recently by the continuing diversification of the state's economy. Although manufacturing has remained a large part of the economy, the state's overall employment mix has moved more in line with that of the nation, improving the state's economic stability. Nonetheless, the state's reliance on manufacturing creates vulnerability to recession and potential financial volatility. The state's sizable financial reserves, however, may lend some stability and help protect the state against future spending pressures and economic cycles. In recent years, Ohio's employment growth has slowed to below the national average. For the year ended December 1999, job growth was 0.8%, compared to 2.2% for the nation. Much of this growth has been concentrated in the construction and finance, insurance, and real estate sectors. Unemployment was 4.2% in December 1999, which was the same as the national rate. The state's population growth also has been slow and, from 94 - 99, was the slowest in the Great Lakes region. Ohio's direct debt levels have been moderate. As a result, debt service payments on its general obligation debt and lease obligations have been manageable. The state has enjoyed large operating surpluses over the last seven fiscal years, which have allowed the state to restore its reserves to levels above those before the last recession. A recent court decision requiring major changes to the state's school funding programs, however, may create some pressure on the state's ability to maintain a balanced budget, especially in the event of an economic slowdown. U.S. TERRITORIES Since each Fund may invest up to 35% of its assets in municipal securities issued by U.S. territories, the ability of municipal issuers in U.S. territories to continue to make principal and interest payments also may affect a Fund's performance. As with municipal issuers, the ability to make these payments is dependent on economic, political and other conditions. Below is a discussion of certain conditions within some of the territories where the Funds may invest. It is not a complete analysis of every material fact that may affect the ability of issuers of U.S. territory municipal securities to meet their debt obligations or the economic or political conditions within the territories and is subject to change. It is based on data available to the Funds from historically reliable sources, but it has not been independently verified by the Funds. PUERTO RICO. In recent years, Puerto Rico's financial performance has improved. Overall, as of March 2000, Moody's considered Puerto Rico's outlook to be positive. Relatively strong revenue growth and more aggressive tax collection procedures resulted in a general fund surplus for fiscal 1999 (audited) of $497 million, including an unreserved balance of $185.4 million. Between fiscal years 1993 and 1999, Puerto Rico has experienced a 4.3% drop in the unemployment rate, a 54% increase in hotel registrations, a 31% in retail sales, a 76% increase in exports, and a 22% decrease in welfare recipients. While Puerto Rico's debt per capita levels are at the higher end of the spectrum compared to American states that is partly explained by the fact that Puerto Rico generally centralizes its debt issuance at the state level. S&P rates Puerto Rico's general obligation debt at A, with a stable outlook. Moody's rates the island's general obligation debt at Baa1. The Moody's rating has been at Baa1 since 1976 and the S&P A-rating has been in place since 1956. Going forward, these debt levels may increase as Puerto Rico attempts to finance significant capital and infrastructure improvements. Puerto Rico also will need to address its large unfunded pension liability of more than $6 billion. Puerto Rico also faces challenges from the 1996 passage of a bill eliminating Section 936 of the Internal Revenue Code. This section has given certain U.S. corporations operating in Puerto Rico significant tax advantages. These incentives have helped considerably with Puerto Rico's economic growth, especially with the development of its manufacturing sector. U.S. firms that have benefited from these incentives have provided a significant portion of Puerto Rico's revenues, employment and deposits in local financial institutions. The section 936 incentives are being phased out over a 10-year period ending in 2006. It is hoped that this long phase-out period will give Puerto Rico sufficient time to lessen the potentially negative effects of section 936's elimination. In the fifth year of this phase-out period, business continues to show interest in Puerto Rico as manufacturing and services/commerce continue to represent the largest sector of employment. Outstanding issues relating to the potential for a transition to statehood also may have broad implications for Puerto Rico and its financial and credit position. GUAM. Guam's economy has been heavily dependent on tourism. It has been especially dependent on Japanese tourism, which has made Guam vulnerable to fluctuations in the relationship between the U.S. dollar and the Japanese yen. The recent Asian economic crisis and Typhoon Paka, which hit Guam in December 1997, negatively affected both tourism and other economic activities in Guam and contributed to a decline of 1.8% in gross island product between 1997 and 1998. In the early to mid-1990s, Guam's financial position deteriorated due to a series of natural disasters that led to increased spending on top of already significant budget gaps. As a result, the government introduced a comprehensive financial plan in June 1995 to help balance the budget and reduce the general fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21 million deficit and ended the year with a negative unreserved general fund balance of $158.9 million. Another deficit is expected in 1999. While Guam's debt burden has been manageable, Guam's ability to maintain current debt levels may be challenged in the near future. U.S. military downsizing has reduced the federal presence on the island and also may reduce federal support for infrastructure projects. At the same time, Guam has faced increasing pressure to improve its infrastructure to help generate economic development. Overall, as of May 18, 2000, S&P's outlook for Guam was negative due to Guam's continued weak financial position and inability to meet the goals of the financial plan. MARIANA ISLANDS. The Mariana Islands became a U.S. territory in 1975. At that time, the U.S. government agreed to exempt the islands from federal minimum wage and immigration laws in an effort to help stimulate industry and the economy. The islands' minimum wage has been more than $2 per hour below the U.S. level and tens of thousands of workers have emigrated from various Asian countries to provide cheap labor for the islands' industries. Recently, the islands' tourism and apparel industries combined to help increase gross business receipts from $224 million in 1985 to $2.575 billion in 1997. By sector, the breakdown was garment manufacturing 33%, tourism 23%, retail trade 18%, services 17% and other 9%. Gross business revenue tax collections totaled $68.6 million in fiscal year 1998. Also in fiscal year 1998, general fund revenues totaled $234 million while expenditures totaled $238 million. The population of all the islands combined was 67,212 at fiscal year end 1996 and average earnings per capita totaled $9,702. At fiscal year end 1995, the most recent year available, unemployment among eligible labor force participants stood at 2.3%. U.S. VIRGIN ISLANDS. The U.S. Virgin Islands has suffered numerous years of budget imbalances. Since fiscal 1989, the Virgin Islands has incurred budget deficits in all but four fiscal years. As of June 30, 1999, the accumulated deficit was close to $341 million. To help finance this deficit, the government issued a $300 million bond, which allowed it to meet a $13 million payroll payment and to begin to pay off the backlog of payments to vendors. The Virgin Islands' large public sector payroll (approximately 32.8% of employment), relatively small private sector that is dependent on tourism and related services (21% of employment), and heavy reliance on taxes as a revenue source (close to 97% of all revenues), together with the effects of three major hurricanes in the past ten years, have contributed to its financial problems. The U.S. Virgin Islands are not experiencing the record economic boom that the mainland is. In 1999, employment decreased 1.7% following two years of minimal growth. The unemployment rate for 1999 was 4.8%, which is the lowest level since 1993. The Virgin Islands are highly dependent on tourism, which contracted in 1999. While the islands have experienced an increase in hotel occupancy, the majority of visitors come via cruise ships. The number of cruise ship passengers decreased 12% in 1999, which resulted in an overall decline of 8% for the year. A significant reason for the decrease in cruise ships was due to the damage suffered to the docks from recent hurricanes. After Hurricane Jose in October 1999, only 39 ships were able to dock in October compared to 65 in October 1998. In September 1998, the Department of Interior Office of Inspector General issued an audit report on the Virgin Islands. It noted that while the Virgin Islands had made improvements in its financial situation, problems remained in the areas of overall financial management, expenditure control and revenue collections. To help improve its financial position, the Virgin Islands has developed a five-year economic recovery plan. Central to this plan is a reduction in government spending. In June 1999, the governor implemented a strict hiring freeze and mandated a 5% reduction in personnel expenditures each year through fiscal 2004, a 50% reduction in overtime expenses, and various other cost saving initiatives. In October, the government and the Department of Interior entered into a Memorandum of Understanding stipulating that federal grants will be awarded contingent on several financial performance and accountability standards being met that will demonstrate improvement in the economic and financial condition of the islands. Since the plan is new, it is not yet certain whether or to what extent the plan will be successful in helping the Virgin Islands improve its financial condition. OFFICERS AND TRUSTEES - ------------------------------------------------------------------------------ The Trust has a board of trustees. The board is responsible for the overall management of the Trust, including general supervision and review of each Fund's investment activities. The board, in turn, elects the officers of the Trust who are responsible for administering the Trust's day-to-day operations. The board also monitors each Fund to ensure no material conflicts exist among share classes. While none is expected, the board will act appropriately to resolve any material conflict that may arise. The name, age and address of the officers and board members, as well as their affiliations, positions held with the Trust, and principal occupations during the past five years are shown below. Frank H. Abbott, III (80) 1045 Sansome Street, San Francisco, CA 94111 TRUSTEE President and Director, Abbott Corporation (an investment company); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, MotherLode Gold Mines Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food processing) (until 1996). Harris J. Ashton (69) 191 Clapboard Ridge Road, Greenwich, CT 06830 TRUSTEE Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat packing company); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Chairman of the Board, General Host Corporation (nursery and craft centers) (until 1998). S. Joseph Fortunato (68) Park Avenue at Morris County, P.O. Box 1945 Morristown, NJ 07962-1945 TRUSTEE Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee, as the case may be, of 49 of the investment companies in Franklin Templeton Investments. Edith E. Holiday (49) 3239 38th Street, N.W., Washington, D.C. 20016 TRUSTEE Director, Amerada Hess Corporation (exploration and refining of oil and gas) (1993-present), Hercules Incorporated (chemicals, fibers and resins) (1993-present), Beverly Enterprises, Inc. (health care) (1995-present), H.J. Heinz Company (processed foods and allied products) (1994-present) and RTI International Metals, Inc. (manufacture and distribution of titanium) (1999-present); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Assistant to the President of the United States and Secretary of the Cabinet (1990-1993), General Counsel to the United States Treasury Department (1989-1990), and Counselor to the Secretary and Assistant Secretary for Public Affairs and Public Liaison-United States Treasury Department (1988-1989). *Charles B. Johnson (68) One Franklin Parkway, San Mateo, CA 94403-1906 CHAIRMAN OF THE BOARD AND TRUSTEE Chairman of the Board, Chief Executive Officer, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President, Franklin Templeton Distributors, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. *Rupert H. Johnson, Jr. (60) One Franklin Parkway, San Mateo, CA 94403-1906 PRESIDENT AND TRUSTEE Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Director, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin Advisory Services, LLC; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Frank W.T. LaHaye (72) 20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014 TRUSTEE Chairman, Peregrine Venture Management Company (venture capital); Director, The California Center for Land Recycling (redevelopment); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, General Partner, Miller & LaHaye and Peregrine Associates, the general partners of Peregrine Venture funds. Gordon S. Macklin (73) 8212 Burning Tree Road, Bethesda, MD 20817 TRUSTEE Director, Martek Biosciences Corporation, WorldCom, Inc. (communications services), MedImmune, Inc. (biotechnology), Overstock.com (internet services), White Mountains Insurance Group, Ltd. (holding company) and Spacehab, Inc. (aerospace services); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chairman, White River Corporation (financial services) (until 1998) and Hambrecht & Quist Group (investment banking) (until 1992), and President, National Association of Securities Dealers, Inc. (until 1987). Sheila Amoroso (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Harmon E. Burns (56) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Director, Franklin Investment Advisory Services, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Rafael R. Costas, Jr. (36) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Martin L. Flanagan (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND CHIEF FINANCIAL OFFICER President, Member - Office of the President, Chief Financial Officer and Chief Operating Officer, Franklin Resources, Inc.; Executive Vice President, Franklin/Templeton Investor Services, LLC; President and Chief Financial Officer, Franklin Mutual Advisers, LLC; Executive Vice President, Chief Financial Officer and Director, Templeton Worldwide, Inc.; Executive Vice President and Chief Operating Officer, Templeton Investment Counsel, LLC; Executive Vice President, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Chief Financial Officer, Franklin Advisory Services, LLC; officer and/or director of some of the other subsidiaries of Franklin Resources, Inc.; and officer and/or director or trustee, as the case may be, of 51 of the investment companies in Franklin Templeton Investments. David P. Goss (54) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Associate General Counsel, Franklin Templeton Investments; President, Chief Executive Officer and Director, Franklin Select Realty Trust, Property Resources, Inc., Property Resources Equity Trust, Franklin Real Estate Management, Inc. and Franklin Properties, Inc.; officer and director of some of the other subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Franklin Real Estate Income Fund and Franklin Advantage Real Estate Income Fund (until 1996). Barbara J. Green (53) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice President and Deputy General Counsel, Franklin Resources, Inc.; Senior Vice President, Templeton Worldwide, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Deputy Director, Division of Investment Management, Executive Assistant and Senior Advisor to the Chairman, Counselor to the Chairman, Special Counsel and Attorney Fellow, U.S. Securities and Exchange Commission (1986-1995), Attorney, Rogers & Wells (until 1986), and Judicial Clerk, U.S. District Court (District of Massachusetts) (until 1979). Edward V. McVey (63) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Templeton Distributors, Inc.; officer of one of the other subsidiaries of Franklin Resources, Inc. and of 29 of the investment companies in Franklin Templeton Investments. Kimberley Monasterio (37) One Franklin Parkway, San Mateo, CA 94403-1906 TREASURER AND PRINCIPAL ACCOUNTING OFFICER Senior Vice President, Franklin Templeton Services, LLC; and officer of 33 of the investment companies in Franklin Templeton Investments. Murray L. Simpson (64) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND SECRETARY Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director of some of the subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Executive Officer and Managing Director, Templeton Franklin Investment Services (Asia) Limited (until 2000) and Director, Templeton Asset Management Ltd. (until 1999). Thomas Walsh (39) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. *This board member is considered an "interested person" under federal securities laws. Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers. The Trust pays noninterested board members $1,450 per month plus $1,300 per meeting attended. Board members who serve on the audit committee of the Trust and other funds in Franklin Templeton Investments receive a flat fee of $2,000 per committee meeting attended, a portion of which is allocated to the Trust. Members of a committee are not compensated for any committee meeting held on the day of a board meeting. Noninterested board members also may serve as directors or trustees of other funds in Franklin Templeton Investments and may receive fees from these funds for their services. The fees payable to noninterested board members by the Trust are subject to reductions resulting from fee caps limiting the amount of fees payable to board members who serve on other boards within Franklin Templeton Investments. The following table provides the total fees paid to noninterested board members by the Trust and by Franklin Templeton Investments. NUMBER OF TOTAL FEES BOARDS IN TOTAL FEES RECEIVED FROM FRANKLIN RECEIVED FRANKLIN TEMPLETON FROM THE TEMPLETON INVESTMENTS TRUST/1 INVESTMENTS/2 ON WHICH NAME ($) ($) EACH SERVES/3 - ------------------------------------------------------------------------- Frank H. Abbott, III 23,056 156,953 28 Harris J. Ashton 25,267 359,404 48 S. Joseph Fortunato 23,564 359,629 49 Edith E. Holiday 31,700 248,305 28 Frank W.T. LaHaye 24,356 165,529 28 Gordon S. Macklin 25,267 359,504 48 1. For the fiscal year ended February 28, 2001. 2. For the calendar year ended December 31, 2000. 3. We base the number of boards on the number of registered investment companies in Franklin Templeton Investments. This number does not include the total number of series or funds within each investment company for which the board members are responsible. Franklin Templeton Investments currently includes 52 registered investment companies, with approximately 156 U.S. based funds or series. Noninterested board members are reimbursed for expenses incurred in connection with attending board meetings, paid pro rata by each fund in Franklin Templeton Investments for which they serve as director or trustee. No officer or board member received any other compensation, including pension or retirement benefits, directly or indirectly from the Funds or other funds in Franklin Templeton Investments. Certain officers or board members who are shareholders of Franklin Resources, Inc. (Resources) may be deemed to receive indirect remuneration by virtue of their participation, if any, in the fees paid to its subsidiaries. Board members historically have followed a policy of having substantial investments in one or more of the funds in Franklin Templeton Investments, as is consistent with their individual financial goals. In February 1998, this policy was formalized through adoption of a requirement that each board member invest one-third of fees received for serving as a director or trustee of a Templeton fund in shares of one or more Templeton funds and one-third of fees received for serving as a director or trustee of a Franklin fund in shares of one or more Franklin funds until the value of such investments equals or exceeds five times the annual fees paid such board member. Investments in the name of family members or entities controlled by a board member constitute fund holdings of such board member for purposes of this policy, and a three year phase-in period applies to such investment requirements for newly elected board members. In implementing such policy, a board member's fund holdings existing on February 27, 1998, are valued as of such date with subsequent investments valued at cost. MANAGEMENT AND OTHER SERVICES - ------------------------------------------------------------------------------ MANAGER AND SERVICES PROVIDED Each Fund's manager is Franklin Advisers, Inc. The manager is a wholly owned subsidiary of Resources, a publicly owned company engaged in the financial services industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal shareholders of Resources. The manager provides investment research and portfolio management services, and selects the securities for each Fund to buy, hold or sell. The manager's extensive research activities include, as appropriate, traveling to meet with issuers and to review project sites. The manager also selects the brokers who execute the Funds' portfolio transactions. The manager provides periodic reports to the board, which reviews and supervises the manager's investment activities. To protect the Funds, the manager and its officers, directors and employees are covered by fidelity insurance. The manager and its affiliates manage numerous other investment companies and accounts. The manager may give advice and take action with respect to any of the other funds it manages, or for its own account, that may differ from action taken by the manager on behalf of each Fund. Similarly, with respect to each Fund, the manager is not obligated to recommend, buy or sell, or to refrain from recommending, buying or selling any security that the manager and access persons, as defined by applicable federal securities laws, may buy or sell for its or their own account or for the accounts of any other fund. The manager is not obligated to refrain from investing in securities held by the Funds or other funds it manages. The Funds, their manager and principal underwriter have each adopted a code of ethics, as required by federal securities laws. Under the code of ethics, employees who are designated as access persons may engage in personal securities transactions, including transactions involving securities that are being considered for a Fund or that are currently held by the Funds, subject to certain general restrictions and procedures. The personal securities transactions of access persons of the Funds, their manager and principal underwriter will be governed by the code of ethics. The code of ethics is on file with, and available from, the U.S. Securities and Exchange Commission (SEC). MANAGEMENT FEES Each Fund pays the manager a fee equal to a monthly rate of: o 5/96 of 1% of the value of its net assets up to and including $100 million; and o 1/24 of 1% of the value of its net assets over $100 million up to and including $250 million; and o 9/240 of 1% of the value of its net assets in excess of $250 million. The fee is computed at the close of business on the last business day of each month according to the terms of the management agreement. Each class of a Fund's shares pays its proportionate share of the fee. For the last three fiscal years ended February 28, 2001, February 29, 2000 and February 28, 1999, the Funds paid the following management fees: MANAGEMENT FEES PAID ($) -------------------------------- 2001 2000 1999 - ------------------------------------------------------------------ Florida Fund/1 675,892 705,624 279,543 Insured Fund 6,989,183 7,715,627 8,186,468 Massachusetts Fund 1,778,329 1,854,148 1,842,232 Michigan Fund 5,241,308 5,567,281 5,623,372 Minnesota Fund 2,391,163 2,541,127 2,591,321 Ohio Fund 3,520,361 3,798,880 3,822,228 1. For the fiscal years ended February 29, 2000 and February 28, 1999, management fees, before any advance waiver, totaled $718,877 and $697,080, respectively. Under an agreement by the manager to limit its fees, the Fund paid the management fees shown. ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, LLC (FT Services) has an agreement with the manager to provide certain administrative services and facilities for each Fund. FT Services is wholly owned by Resources and is an affiliate of the Funds' manager and principal underwriter. The administrative services FT Services provides include preparing and maintaining books, records, and tax and financial reports, and monitoring compliance with regulatory requirements. ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an annual rate of: o 0.15% of each Fund's average daily net assets up to $200 million; o 0.135% of each Fund's average daily net assets over $200 million up to $700 million; o 0.10% of each Fund's average daily net assets over $700 million up to $1.2 billion; and o 0.075% of each Fund's average daily net assets over $1.2 billion. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the manager paid FT Services the following administration fees: ADMINISTRATION FEES PAID ($) --------------------------------------- 2001 2000 1999 - --------------------------------------------------------------------- Florida Fund 164,657 178,612 169,903 Insured Fund 1,697,967 1,826,809 1,895,252 Massachusetts Fund 487,351 512,885 506,241 Michigan Fund 1,382,784 1,458,837 1,465,757 Minnesota Fund 671,998 720,407 730,139 Ohio Fund 1,001,829 1,066,409 1,066,391 SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor Services, LLC (Investor Services) is each Fund's shareholder servicing agent and acts as the Fund's transfer agent and dividend-paying agent. Investor Services is located at One Franklin Parkway, San Mateo, CA 94403-1906. Please send all correspondence to Investor Services to P.O. Box 997151, Sacramento, CA 95899-9983. For its services, Investor Services receives a fixed fee per account. Each Fund also will reimburse Investor Services for certain out-of-pocket expenses, which may include payments by Investor Services to entities, including affiliated entities, that provide sub-shareholder services, recordkeeping and/or transfer agency services to beneficial owners of the Fund. The amount of reimbursements for these services per benefit plan participant Fund account per year will not exceed the per account fee payable by a Fund to Investor Services in connection with maintaining shareholder accounts. CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New York, NY 10286, acts as custodian of each Fund's securities and other assets. AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105, is the Funds' independent auditor. The auditor gives an opinion on the financial statements included in the Trust's Annual Report to Shareholders and reviews the Trust's registration statement filed with the SEC. PORTFOLIO TRANSACTIONS - ------------------------------------------------------------------------------ Since most purchases by the Funds are principal transactions at net prices, the Funds incur little or no brokerage costs. Each Fund deals directly with the selling or buying principal or market maker without incurring charges for the services of a broker on its behalf, unless it is determined that a better price or execution may be obtained by using the services of a broker. Purchases of portfolio securities from underwriters will include a commission or concession paid by the issuer to the underwriter, and purchases from dealers will include a spread between the bid and ask prices. As a general rule, the Funds do not buy securities in underwritings where they are given no choice, or only limited choice, in the designation of dealers to receive the commission. The Funds seek to obtain prompt execution of orders at the most favorable net price. Transactions may be directed to dealers in return for research and statistical information, as well as for special services provided by the dealers in the execution of orders. It is not possible to place a dollar value on the special executions or on the research services the manager receives from dealers effecting transactions in portfolio securities. The allocation of transactions to obtain additional research services allows the manager to supplement its own research and analysis activities and to receive the views and information of individuals and research staffs of other securities firms. As long as it is lawful and appropriate to do so, the manager and its affiliates may use this research and data in their investment advisory capacities with other clients. If the Funds' officers are satisfied that the best execution is obtained, the sale of Fund shares, as well as shares of other funds in Franklin Templeton Investments, also may be considered a factor in the selection of broker-dealers to execute the Funds' portfolio transactions. If purchases or sales of securities of the Funds and one or more other investment companies or clients supervised by the manager are considered at or about the same time, transactions in these securities will be allocated among the several investment companies and clients in a manner deemed equitable to all by the manager, taking into account the respective sizes of the funds and the amount of securities to be purchased or sold. In some cases this procedure could have a detrimental effect on the price or volume of the security so far as the Funds are concerned. In other cases it is possible that the ability to participate in volume transactions may improve execution and reduce transaction costs to the Funds. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the Funds did not pay any brokerage commissions. As of February 28, 2001, the Funds did not own securities of their regular broker-dealers. DISTRIBUTIONS AND TAXES - ------------------------------------------------------------------------------ Each multiclass Fund calculates income dividends and capital gain distributions the same way for each class. The amount of any income dividends per share will differ, however, generally due to the difference in the distribution and service (Rule 12b-1) fees applicable to each class. DISTRIBUTIONS OF NET INVESTMENT INCOME Each Fund receives income generally in the form of interest on its investments. This income, less expenses incurred in the operation of the Fund, constitutes the Fund's net investment income from which dividends may be paid to you. This net investment income may either be tax-exempt or taxable when distributed to you. EXEMPT-INTEREST DIVIDENDS By meeting certain requirements of the Internal Revenue Code (Code), the Funds qualify to pay exempt-interest dividends to you. These dividends are derived generally from interest income exempt from regular federal income tax when earned by the Fund, and are not subject to regular federal income tax when they are paid to you. In addition, to the extent that exempt-interest dividends of the state Funds are derived from interest on obligations of that state or its political subdivisions, or from interest on qualifying obligations of U.S. territories such as Puerto Rico, the U.S. Virgin Islands and Guam, they also may be exempt from that state's personal income tax, if any. Income from municipal securities of other states generally does not qualify as tax-free. TAXABLE INCOME DIVIDENDS Each Fund may earn taxable income from many sources, including temporary investments, discount on stripped obligations or their coupons, income from securities loans or other taxable transactions, and ordinary income on the sale of market discount bonds. If you are a taxable investor, any income dividends the Fund pays from this income will be taxable to you as ordinary income. CAPITAL GAIN DISTRIBUTIONS Each Fund may realize capital gains and losses on the sale or other disposition of its portfolio securities. Distributions from net short-term capital gains are taxable to you as ordinary income. Distributions from net long-term capital gains are taxable to you as long-term capital gains, regardless of how long you have owned your shares in the Fund. Any net capital gains realized by the Fund generally are distributed once each year, and may be distributed more frequently, if necessary, to reduce or eliminate excise or income taxes on the Fund. FIVE YEAR GAINS Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), capital gain distributions from the Fund's sale of securities held for more than five years are subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). INFORMATION ON THE AMOUNT AND TAX CHARACTER OF DISTRIBUTIONS Each Fund will inform you of the amount of your income dividends and capital gain distributions at the time they are paid, and will advise you of their tax status for federal income tax purposes shortly after the close of each calendar year. This information will include the portion of the distributions that on average is comprised of taxable income or interest income that is a tax preference item when determining your alternative minimum tax. If you have not owned your Fund shares for a full year, the Fund may designate and distribute to you, as taxable, tax-exempt or tax preference income, a percentage of income that may not be equal to the actual amount of each type of income earned during the period of your investment in the Fund. Taxable distributions declared in December but paid in January are taxable to you as if paid in December. 2001 TAX ACT On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. This Tax Act includes provisions that will significantly reduce individual income tax rates, provide for marriage penalty relief, eliminate current phase-outs of the standard deduction and personal exemptions, provide for additional savings incentives for individuals through expansion of retirement and education savings programs, and provide for limited estate, gift and generation-skipping tax relief. While these provisions have important tax impacts on individual investors in a Fund, their impact on the taxation of a Fund are limited. See your personal tax advisor for more information. ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each Fund has elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code (Code). It has qualified as a regulated investment company for its most recent fiscal year, and intends to continue to qualify during the current fiscal year. As a regulated investment company, the Funds generally pay no federal income tax on the income and gains distributed to you. The board reserves the right not to maintain the qualification of a Fund as a regulated investment company if it determines this course of action to be beneficial to shareholders. In that case, the Fund would be subject to federal, and possibly state, corporate taxes on its taxable income and gains, and distributions to you (including dividends from tax-exempt interest) would be taxed as ordinary income dividends to the extent of the Fund's earnings and profits. EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Code requires each Fund to distribute to you by December 31 of each year, at a minimum, the following amounts: o 98% of its taxable ordinary income earned during the calendar year; o 98% of its capital gain net income earned during the twelve month period ending October 31; and o 100% of any undistributed amounts from the prior year. Each Fund intends to declare and pay these distributions in December (or to pay them in January, in which case you must treat them as received in December), but can give no assurances that its distributions will be sufficient to eliminate all taxes. REDEMPTIONS Redemptions (including redemptions in kind) and exchanges of Fund shares are taxable transactions for federal and state income tax purposes. If you redeem your Fund shares, or exchange them for shares of a different Franklin Templeton fund, the IRS requires you to report any gain or loss on your redemption or exchange. If you hold your shares as a capital asset, any gain or loss that you realize is a capital gain or loss and is long-term or short-term, generally depending on how long you have owned your shares. FIVE YEAR GAINS Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), gain from the redemption of Fund shares held for more than five years may be subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). If you are in the 28% or higher tax bracket, you may elect to mark-to-market your Fund shares as of January 2, 2001. If you make this election, any Fund shares that you acquired before this date will be eligible for the 18% maximum rate of tax, beginning in 2006. However, in making the election, you are required to pay a tax on any appreciation in the value of your Fund shares as of January 2, 2001, and to restart your holding period in the shares as of that date. The election does not apply to Fund shares redeemed on or before January 2, 2002. REDEMPTIONS AT A LOSS WITHIN SIX MONTHS OF PURCHASE If you redeem or exchange Fund shares that you have held for six months or less: o any loss incurred is disallowed to the extent of any exempt-interest dividends paid to you on your shares, and o any remaining loss is treated as a long-term capital loss to the extent of any long-term capital gains distributed to you by the Fund. WASH SALES All or a portion of any loss that you realize on the redemption of your Fund shares is disallowed to the extent that you buy other shares in the Fund (through reinvestment of dividends or otherwise) within 30 days before or after your share redemption. Any loss disallowed under these rules is added to your tax basis in the new shares. DEFERRAL OF BASIS If you redeem some or all of your shares in a Fund, and then reinvest the redemption proceeds in the Fund or in another Franklin Templeton fund within 90 days of buying the original shares, the sales charge that would otherwise apply to your reinvestment may be reduced or eliminated. In reporting any gain or loss on your redemption, all or a portion of the sales charge that you paid for your original shares in the Fund is excluded from your tax basis in the shares sold and added to your tax basis in the new shares. DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because each Fund's income is derived primarily from interest rather than dividends, generally none of its distributions are expected to qualify for the corporate dividends-received deduction. TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity bonds, while exempt from regular federal income tax, is a tax preference item for taxpayers when determining their alternative minimum tax under the Code and under the income tax provisions of several states. Private activity bond interest could subject you to or increase your liability under federal and state alternative minimum taxes, depending on your personal or corporate tax position. Persons defined in the Code as substantial users (or persons related to such users) of facilities financed by private activity bonds should consult their tax advisors before buying Fund shares. ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS - ------------------------------------------------------------------------------- Each Fund is a series of Franklin Tax-Free Trust, an open-end management investment company, commonly called a mutual fund. The Trust was organized as a Massachusetts business trust in September 1984, and is registered with the SEC. As a shareholder of a Massachusetts business trust, you could, under certain circumstances, be held personally liable as a partner for its obligations. The Agreement and Declaration of Trust, however, contains an express disclaimer of shareholder liability for acts or obligations of the Fund. The Declaration of Trust also provides for indemnification and reimbursement of expenses out of the Fund's assets if you are held personally liable for obligations of the Fund. The Declaration of Trust provides that each Fund shall, upon request, assume the defense of any claim made against you for any act or obligation of the Fund and satisfy any judgment thereon. All such rights are limited to the assets of the Fund. The Declaration of Trust further provides that each Fund may maintain appropriate insurance (for example, fidelity bonding and errors and omissions insurance) for the protection of the Fund, its shareholders, trustees, officers, employees and agents to cover possible tort and other liabilities. Furthermore, the activities of the Fund as an investment company, as distinguished from an operating company, would not likely give rise to liabilities in excess of the Fund's total assets. Thus, the risk that you would incur financial loss on account of shareholder liability is limited to the unlikely circumstance in which both inadequate insurance exists and the Fund itself is unable to meet its obligations. The Insured, Michigan and Ohio Funds currently offer three classes of shares, Class A, Class B and Class C. The Massachusetts and Minnesota Funds currently offer two classes of shares, Class A and Class C. The full title of each class is: o Franklin Insured Tax-Free Income Fund - Class A o Franklin Insured Tax-Free Income Fund - Class B o Franklin Insured Tax-Free Income Fund - Class C o Franklin Massachusetts Insured Tax-Free Income Fund - Class A o Franklin Massachusetts Insured Tax-Free Income Fund - Class C o Franklin Michigan Insured Tax-Free Income Fund - Class A o Franklin Michigan Insured Tax-Free Income Fund - Class B o Franklin Michigan Insured Tax-Free Income Fund - Class C o Franklin Minnesota Insured Tax-Free Income Fund - Class A o Franklin Minnesota Insured Tax-Free Income Fund - Class C o Franklin Ohio Insured Tax-Free Income Fund - Class A o Franklin Ohio Insured Tax-Free Income Fund - Class B o Franklin Ohio Insured Tax-Free Income Fund - Class C The Florida Fund offers only one share class. Because its sales charge structure and Rule 12b-1 plan are similar to those of Class A shares, shares of the Florida Fund are considered Class A shares for redemption, exchange and other purposes. The Funds may offer additional classes of shares in the future. Shares of each class represent proportionate interests in each Fund's assets. On matters that affect a Fund as a whole, each class has the same voting and other rights and preferences as any other class. On matters that affect only one class, only shareholders of that class may vote. Each class votes separately on matters affecting only that class, or expressly required to be voted on separately by state or federal law. Shares of each class of a series have the same voting and other rights and preferences as the other classes and series of the Trust for matters that affect the Trust as a whole. Additional series may be offered in the future. The Trust has noncumulative voting rights. For board member elections, this gives holders of more than 50% of the shares voting the ability to elect all of the members of the board. If this happens, holders of the remaining shares voting will not be able to elect anyone to the board. The Trust does not intend to hold annual shareholder meetings. The Trust or a series of the Trust may hold special meetings, however, for matters requiring shareholder approval. A meeting may be called by the board to consider the removal of a board member if requested in writing by shareholders holding at least 10% of the outstanding shares. In certain circumstances, we are required to help you communicate with other shareholders about the removal of a board member. A special meeting also may be called by the board in its discretion. From time to time, the number of Fund shares held in the "street name" accounts of various securities dealers for the benefit of their clients or in centralized securities depositories may exceed 5% of the total shares outstanding. To the best knowledge of the Funds, no other person holds beneficially or of record more than 5% of the outstanding shares of any class. As of June 1, 2001, the officers and board members, as a group, owned of record and beneficially less than 1% of the outstanding shares of each Fund and class. The board members may own shares in other funds in Franklin Templeton Investments. BUYING AND SELLING SHARES - ------------------------------------------------------------------------------- Each Fund continuously offers its shares through securities dealers who have an agreement with Franklin Templeton Distributors, Inc. (Distributors). A securities dealer includes any financial institution that, either directly or through affiliates, has an agreement with Distributors to handle customer orders and accounts with a Fund. This reference is for convenience only and does not indicate a legal conclusion of capacity. Banks and financial institutions that sell shares of a Fund may be required by state law to register as securities dealers. For investors outside the U.S., the offering of Fund shares may be limited in many jurisdictions. An investor who wishes to buy shares of the Fund should determine, or have a broker-dealer determine, the applicable laws and regulations of the relevant jurisdiction. Investors are responsible for compliance with tax, currency exchange or other regulations applicable to redemption and purchase transactions in any jurisdiction to which they may be subject. Investors should consult appropriate tax and legal advisors to obtain information on the rules applicable to these transactions. All checks, drafts, wires and other payment mediums used to buy or sell shares of the Fund must be denominated in U.S. dollars. We may, in our sole discretion, either (a) reject any order to buy or sell shares denominated in any other currency or (b) honor the transaction or make adjustments to your account for the transaction as of a date and with a foreign currency exchange factor determined by the drawee bank. We may deduct any applicable banking charges imposed by the bank from your account. When you buy shares, if you submit a check or a draft that is returned unpaid to the Fund we may impose a $10 charge against your account for each returned item. INITIAL SALES CHARGES The maximum initial sales charge is 4.25% for Class A and 1% for Class C. There is no initial sales charge for Class B. The initial sales charge for Class A shares may be reduced for certain large purchases, as described in the prospectus. We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases. Franklin Templeton funds include the U.S. registered mutual funds in Franklin Templeton Investments except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on Class A shares, you may combine the amount of your current purchase with the cost or current value, whichever is higher, of your existing shares in Franklin Templeton funds. You also may combine the shares of your spouse, children under the age of 21 or grandchildren under the age of 21. If you are the sole owner of a company, you also may add any company accounts, including retirement plan accounts. LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by completing the letter of intent section of your account application. A letter of intent is a commitment by you to invest a specified dollar amount during a 13 month period. The amount you agree to invest determines the sales charge you pay. By completing the letter of intent section of the application, you acknowledge and agree to the following: o You authorize Distributors to reserve 5% of your total intended purchase in Class A shares registered in your name until you fulfill your LOI. Your periodic statements will include the reserved shares in the total shares you own, and we will pay or reinvest dividend and capital gain distributions on the reserved shares according to the distribution option you have chosen. o You give Distributors a security interest in the reserved shares and appoint Distributors as attorney-in-fact. o Distributors may sell any or all of the reserved shares to cover any additional sales charge if you do not fulfill the terms of the LOI. o Although you may exchange your shares, you may not sell reserved shares until you complete the LOI or pay the higher sales charge. After you file your LOI with the Fund, you may buy Class A shares at the sales charge applicable to the amount specified in your LOI. Sales charge reductions based on purchases in more than one Franklin Templeton fund will be effective only after notification to Distributors that the investment qualifies for a discount. Any Class A purchases you made within 90 days before you filed your LOI also may qualify for a retroactive reduction in the sales charge. If you file your LOI with the Fund before a change in the Fund's sales charge, you may complete the LOI at the lower of the new sales charge or the sales charge in effect when the LOI was filed. Your holdings in Franklin Templeton funds acquired more than 90 days before you filed your LOI will be counted towards the completion of the LOI, but they will not be entitled to a retroactive reduction in the sales charge. Any redemptions you make during the 13 month period will be subtracted from the amount of the purchases for purposes of determining whether the terms of the LOI have been completed. If the terms of your LOI are met, the reserved shares will be deposited to an account in your name or delivered to you or as you direct. If the amount of your total purchases, less redemptions, is more than the amount specified in your LOI and is an amount that would qualify for a further sales charge reduction, a retroactive price adjustment will be made by Distributors and the securities dealer through whom purchases were made. The price adjustment will be made on purchases made within 90 days before and on those made after you filed your LOI and will be applied towards the purchase of additional shares at the offering price applicable to a single purchase or the dollar amount of the total purchases. If the amount of your total purchases, less redemptions, is less than the amount specified in your LOI, the sales charge will be adjusted upward, depending on the actual amount purchased (less redemptions) during the period. You will need to send Distributors an amount equal to the difference in the actual dollar amount of sales charge paid and the amount of sales charge that would have applied to the total purchases if the total of the purchases had been made at one time. Upon payment of this amount, the reserved shares held for your account will be deposited to an account in your name or delivered to you or as you direct. If within 20 days after written request the difference in sales charge is not paid, we will redeem an appropriate number of reserved shares to realize the difference. If you redeem the total amount in your account before you fulfill your LOI, we will deduct the additional sales charge due from the sale proceeds and forward the balance to you. GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A shares at a reduced sales charge that applies to the group as a whole. The sales charge is based on the combined dollar value of the group members' existing investments, plus the amount of the current purchase. A qualified group is one that: o Was formed at least six months ago, o Has a purpose other than buying Fund shares at a discount, o Has more than 10 members, o Can arrange for meetings between our representatives and group members, o Agrees to include Franklin Templeton fund sales and other materials in publications and mailings to its members at reduced or no cost to Distributors, o Agrees to arrange for payroll deduction or other bulk transmission of investments to the Fund, and o Meets other uniform criteria that allow Distributors to achieve cost savings in distributing shares. WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased without an initial sales charge or contingent deferred sales charge (CDSC) by investors who reinvest within 365 days: o Dividend and capital gain distributions from any Franklin Templeton fund. The distributions generally must be reinvested in the same share class. Certain exceptions apply, however, to Class C shareholders who chose to reinvest their distributions in Class A shares of the Fund before November 17, 1997, and to Advisor Class or Class Z shareholders of a Franklin Templeton fund who may reinvest their distributions in the Fund's Class A shares. o Annuity payments received under either an annuity option or from death benefit proceeds, if the annuity contract offers as an investment option the Franklin Templeton Variable Insurance Products Trust. You should contact your tax advisor for information on any tax consequences that may apply. o Redemption proceeds from a repurchase of shares of Franklin Floating Rate Trust, if the shares were continuously held for at least 12 months. If you immediately placed your redemption proceeds in a Franklin Bank CD or a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date the CD matures, including any rollover, or the date you redeem your money fund shares. o Redemption proceeds from the sale of Class A shares of any of the Templeton Global Strategy Funds if you are a qualified investor. If you paid a CDSC when you redeemed your Class A shares from a Templeton Global Strategy Fund, a new CDSC will apply to your purchase of Fund shares and the CDSC holding period will begin again. We will, however, credit your Fund account with additional shares based on the CDSC you previously paid and the amount of the redemption proceeds that you reinvest. If you immediately placed your redemption proceeds in a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date they are redeemed from the money fund. WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without an initial sales charge or CDSC by various individuals and institutions due to anticipated economies in sales efforts and expenses, including: o Trust companies and bank trust departments investing assets held in a fiduciary, agency, advisory, custodial or similar capacity and over which the trust companies and bank trust departments or other plan fiduciaries or participants, in the case of certain retirement plans, have full or shared investment discretion. We may accept orders for these accounts by telephone or other means of electronic data transfer directly from the bank or trust company, with payment by federal funds received by the close of business on the next business day following the order. o Any state or local government or any instrumentality, department, authority or agency thereof that has determined the Fund is a legally permissible investment and that can only buy Fund shares without paying sales charges. Please consult your legal and investment advisors to determine if an investment in the Fund is permissible and suitable for you and the effect, if any, of payments by the Fund on arbitrage rebate calculations. o Broker-dealers, registered investment advisors or certified financial planners who have entered into an agreement with Distributors for clients participating in comprehensive fee programs o Qualified registered investment advisors who buy through a broker-dealer or service agent who has entered into an agreement with Distributors o Registered securities dealers and their affiliates, for their investment accounts only o Current employees of securities dealers and their affiliates and their family members, as allowed by the internal policies of their employer o Officers, trustees, directors and full-time employees of Franklin Templeton Investments, and their family members, consistent with our then-current policies o Any investor who is currently a Class Z shareholder of Franklin Mutual Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z shareholder who had an account in any Mutual Series fund on October 31, 1996, or who sold his or her shares of Mutual Series Class Z within the past 365 days o Investment companies exchanging shares or selling assets pursuant to a merger, acquisition or exchange offer o Accounts managed by Franklin Templeton Investments o Certain unit investment trusts and their holders reinvesting distributions from the trusts In addition, Class C shares may be purchased without an initial sales charge by any investor who buys Class C shares through an omnibus account with Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are sold within 18 months of purchase. DEALER COMPENSATION Securities dealers may at times receive the entire sales charge. A securities dealer who receives 90% or more of the sales charge may be deemed an underwriter under the Securities Act of 1933, as amended. Financial institutions or their affiliated brokers may receive an agency transaction fee in the percentages indicated in the dealer compensation table in the Funds' prospectus. Distributors may pay the following commissions, out of its own resources, to securities dealers who initiate and are responsible for purchases of Class A shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus 0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3 million to $50 million, plus 0.25% on sales over $50 million to $100 million, plus 0.15% on sales over $100 million. These breakpoints are reset every 12 months for purposes of additional purchases. In addition to the payments above, Distributors and/or its affiliates may provide financial support to securities dealers that sell shares of Franklin Templeton Investments. This support is based primarily on the amount of sales of fund shares and/or total assets with Franklin Templeton Investments. The amount of support may be affected by: total sales; net sales; levels of redemptions; the proportion of a securities dealer's sales and marketing efforts in Franklin Templeton Investments; a securities dealer's support of, and participation in, Distributors' marketing programs; a securities dealer's compensation programs for its registered representatives; and the extent of a securities dealer's marketing programs relating to Franklin Templeton Investments. Financial support to securities dealers may be made by payments from Distributors' resources, from Distributors' retention of underwriting concessions and, in the case of funds that have Rule 12b-1 plans, from payments to Distributors under such plans. In addition, certain securities dealers may receive brokerage commissions generated by fund portfolio transactions in accordance with the rules of the National Association of Securities Dealers, Inc. Distributors routinely sponsors due diligence meetings for registered representatives during which they receive updates on various Franklin Templeton funds and are afforded the opportunity to speak with portfolio managers. Invitation to these meetings is not conditioned on selling a specific number of shares. Those who have shown an interest in Franklin Templeton funds, however, are more likely to be considered. To the extent permitted by their firm's policies and procedures, registered representatives' expenses in attending these meetings may be covered by Distributors. CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in Class A shares, either as a lump sum or through our cumulative quantity discount or letter of intent programs, a CDSC may apply on any shares you sell within 12 months of purchase. For Class C shares, a CDSC may apply if you sell your shares within 18 months of purchase. The CDSC is 1% of the value of the shares sold or the net asset value at the time of purchase, whichever is less. For Class B shares, there is a CDSC if you sell your shares within six years, as described in the table below. The charge is based on the value of the shares sold or the net asset value at the time of purchase, whichever is less. IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC - --------------------------------------------------------------------------- 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 CDSC WAIVERS. The CDSC for any share class generally will be waived for: o Account fees o Redemptions of Class A shares by investors who purchased $1 million or more without an initial sales charge if the securities dealer of record waived its commission in connection with the purchase o Redemptions by a Fund when an account falls below the minimum required account size o Redemptions following the death of the shareholder or beneficial owner o Redemptions through a systematic withdrawal plan set up before February 1, 1995 o Redemptions through a systematic withdrawal plan set up on or after February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of your account's net asset value depending on the frequency of your plan EXCHANGE PRIVILEGE If you request the exchange of the total value of your account, accrued but unpaid income dividends and capital gain distributions will be reinvested in the Fund at net asset value on the date of the exchange, and then the entire share balance will be exchanged into the new fund. Backup withholding and information reporting may apply. If a substantial number of shareholders should, within a short period, sell their Fund shares under the exchange privilege, the Fund might have to sell portfolio securities it might otherwise hold and incur the additional costs related to such transactions. On the other hand, increased use of the exchange privilege may result in periodic large inflows of money. If this occurs, it is each Fund's general policy to initially invest this money in short-term, tax-exempt municipal securities, unless it is believed that attractive investment opportunities consistent with the Fund's investment goals exist immediately. This money will then be withdrawn from the short-term, tax-exempt municipal securities and invested in portfolio securities in as orderly a manner as is possible when attractive investment opportunities arise. The proceeds from the sale of shares of an investment company generally are not available until the seventh day following the sale. The funds you are seeking to exchange into may delay issuing shares pursuant to an exchange until that seventh day. The sale of Fund shares to complete an exchange will be effected at net asset value at the close of business on the day the request for exchange is received in proper form. SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell your shares and receive regular payments from your account on a monthly, quarterly, semiannual or annual basis. The value of your account must be at least $5,000 and the minimum payment amount for each withdrawal must be at least $50. There are no service charges for establishing or maintaining a systematic withdrawal plan. Each month in which a payment is scheduled, we will redeem an equivalent amount of shares in your account on the day of the month you have indicated on your account application or, if no day is indicated, on the 20th day of the month. If that day falls on a weekend or holiday, we will process the redemption on the next business day. For plans set up before June 1, 2000, we will continue to process redemptions on the 25th day of the month (or the next business day) unless you instruct us to change the processing date. Available processing dates currently are the 1st, 5th, 10th, 15th, 20th and 25th days of the month. When you sell your shares under a systematic withdrawal plan, it is a taxable transaction. To avoid paying sales charges on money you plan to withdraw within a short period of time, you may not want to set up a systematic withdrawal plan if you plan to buy shares on a regular basis. Shares sold under the plan also may be subject to a CDSC. Redeeming shares through a systematic withdrawal plan may reduce or exhaust the shares in your account if payments exceed distributions received from the Fund. This is especially likely to occur if there is a market decline. If a withdrawal amount exceeds the value of your account, your account will be closed and the remaining balance in your account will be sent to you. Because the amount withdrawn under the plan may be more than your actual yield or income, part of the payment may be a return of your investment. To discontinue a systematic withdrawal plan, change the amount and schedule of withdrawal payments, or suspend one payment, we must receive instructions from you at least three business days before a scheduled payment. A Fund may discontinue a systematic withdrawal plan by notifying you in writing and will discontinue a systematic withdrawal plan automatically if all shares in your account are withdrawn or if the Fund receives notification of the shareholder's death or incapacity. REDEMPTIONS IN KIND Each Fund has committed itself to pay in cash (by check) all requests for redemption by any shareholder of record, limited in amount, however, during any 90-day period to the lesser of $250,000 or 1% of the value of the Fund's net assets at the beginning of the 90-day period. This commitment is irrevocable without the prior approval of the SEC. In the case of redemption requests in excess of these amounts, the board reserves the right to make payments in whole or in part in securities or other assets of the Fund, in case of an emergency, or if the payment of such a redemption in cash would be detrimental to the existing shareholders of the Fund. In these circumstances, the securities distributed would be valued at the price used to compute the Fund's net assets and you may incur brokerage fees in converting the securities to cash. The Funds do not intend to redeem illiquid securities in kind. If this happens, however, you may not be able to recover your investment in a timely manner. SHARE CERTIFICATES We will credit your shares to your Fund account. We do not issue share certificates unless you specifically request them. This eliminates the costly problem of replacing lost, stolen or destroyed certificates. If a certificate is lost, stolen or destroyed, you may have to pay an insurance premium of up to 2% of the value of the certificate to replace it. Any outstanding share certificates must be returned to the Fund if you want to sell or exchange those shares or if you would like to start a systematic withdrawal plan. The certificates should be properly endorsed. You can do this either by signing the back of the certificate or by completing a share assignment form. For your protection, you may prefer to complete a share assignment form and to send the certificate and assignment form in separate envelopes. GENERAL INFORMATION If dividend checks are returned to the Fund marked "unable to forward" by the postal service, we will consider this a request by you to change your dividend option to reinvest all distributions. The proceeds will be reinvested in additional shares at net asset value until we receive new instructions. Distribution or redemption checks sent to you do not earn interest or any other income during the time the checks remain uncashed. Neither the Funds nor their affiliates will be liable for any loss caused by your failure to cash such checks. The Funds are not responsible for tracking down uncashed checks, unless a check is returned as undeliverable. In most cases, if mail is returned as undeliverable we are required to take certain steps to try to find you free of charge. If these attempts are unsuccessful, however, we may deduct the costs of any additional efforts to find you from your account. These costs may include a percentage of the account when a search company charges a percentage fee in exchange for its location services. Sending redemption proceeds by wire or electronic funds transfer (ACH) is a special service that we make available whenever possible. By offering this service to you, the Funds are not bound to meet any redemption request in less than the seven day period prescribed by law. Neither the Funds nor their agents shall be liable to you or any other person if, for any reason, a redemption request by wire or ACH is not processed as described in the prospectus. Franklin Templeton Investor Services, LLC (Investor Services) may pay certain financial institutions that maintain omnibus accounts with the Funds on behalf of numerous beneficial owners for recordkeeping operations performed with respect to such owners. For each beneficial owner in the omnibus account, the Fund may reimburse Investor Services an amount not to exceed the per account fee that the Fund normally pays Investor Services. These financial institutions also may charge a fee for their services directly to their clients. There are special procedures for banks and other institutions that wish to open multiple accounts. An institution may open a single master account by filing one application form with a Fund, signed by personnel authorized to act for the institution. Individual sub-accounts may be opened when the master account is opened by listing them on the application, or by providing instructions to the Fund at a later date. These sub-accounts may be registered either by name or number. Each Fund's investment minimums apply to each sub-account. Each Fund will send confirmation and account statements for the sub-accounts to the institution. If you buy or sell shares through your securities dealer, we use the net asset value next calculated after your securities dealer receives your request, which is promptly transmitted to the Fund. If you sell shares through your securities dealer, it is your dealer's responsibility to transmit the order to the Fund in a timely fashion. Your redemption proceeds will not earn interest between the time we receive the order from your dealer and the time we receive any required documents. Any loss to you resulting from your dealer's failure to transmit your redemption order to the Fund in a timely fashion must be settled between you and your securities dealer. Certain shareholder servicing agents may be authorized to accept your transaction request. For institutional accounts, there may be additional methods of buying or selling Fund shares than those described in this SAI or in the prospectus. In the event of disputes involving multiple claims of ownership or authority to control your account, the Fund has the right (but has no obligation) to: (a) freeze the account and require the written agreement of all persons deemed by the Fund to have a potential property interest in the account, before executing instructions regarding the account; (b) interplead disputed funds or accounts with a court of competent jurisdiction; or (c) surrender ownership of all or a portion of the account to the IRS in response to a notice of levy. PRICING SHARES - ------------------------------------------------------------------------------ When you buy shares, you pay the offering price. The offering price is the net asset value (NAV) per share plus any applicable sales charge, calculated to two decimal places using standard rounding criteria. When you sell shares, you receive the NAV minus any applicable CDSC. The value of a mutual fund is determined by deducting the fund's liabilities from the total assets of the portfolio. The net asset value per share is determined by dividing the net asset value of the fund by the number of shares outstanding. Each Fund calculates the NAV per share of each class each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). The Funds do not calculate the NAV on days the New York Stock Exchange (NYSE) is closed for trading, which include New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. When determining its NAV, each Fund values cash and receivables at their realizable amounts, and records interest as accrued. Each Fund values over-the-counter portfolio securities within the range of the most recent quoted bid and ask prices. If portfolio securities trade both in the over-the-counter market and on a stock exchange, each Fund values them according to the broadest and most representative market as determined by the manager. Municipal securities generally trade in the over-the-counter market rather than on a securities exchange. In the absence of a sale or reported bid and ask prices, information with respect to bond and note transactions, quotations from bond dealers, market transactions in comparable securities, and various relationships between securities are used to determine the value of municipal securities. Generally, trading in U.S. government securities and money market instruments is substantially completed each day at various times before the close of the NYSE. The value of these securities used in computing the NAV is determined as of such times. Occasionally, events affecting the values of these securities may occur between the times at which they are determined and the close of the NYSE that will not be reflected in the computation of the NAV. If events materially affecting the values of these securities occur during this period, the securities will be valued at their fair value as determined in good faith by the board. Other securities for which market quotations are readily available are valued at the current market price, which may be obtained from a pricing service, based on a variety of factors including recent trades, institutional size trading in similar types of securities (considering yield, risk and maturity) and/or developments related to specific issues. Securities and other assets for which market prices are not readily available are valued at fair value as determined following procedures approved by the board. With the approval of the board, each Fund may use a pricing service, bank or securities dealer to perform any of the above described functions. THE UNDERWRITER - ------------------------------------------------------------------------------ Franklin Templeton Distributors, Inc. (Distributors) acts as the principal underwriter in the continuous public offering of the Fund's shares. Distributors is located at One Franklin Parkway, San Mateo, CA 94403-1906. Distributors pays the expenses of the distribution of Fund shares, including advertising expenses and the costs of printing sales material and prospectuses used to offer shares to the public. Each Fund pays the expenses of preparing and printing amendments to its registration statements and prospectuses (other than those necessitated by the activities of Distributors) and of sending prospectuses to existing shareholders. The table below shows the aggregate underwriting commissions Distributors received in connection with the offering of the Funds' shares, the net underwriting discounts and commissions Distributors retained after allowances to dealers, and the amounts Distributors received in connection with redemptions or repurchases of shares for the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999: AMOUNT RECEIVED IN CONNECTION WITH TOTAL AMOUNT REDEMPTIONS COMMISSIONS RETAINED BY AND RECEIVED DISTRIBUTORS REPURCHASES ($) ($) ($) - ------------------------------------------------------------------------------- 2001 Florida Fund 188,036 13,388 0 Insured Fund 1,475,148 96,011 38,840 Massachusetts Fund 562,549 36,714 23,360 Michigan Fund 1,340,897 82,879 48,597 Minnesota Fund 512,580 32,100 16,554 Ohio Fund 1,068,705 68,030 27,051 2000 Florida Fund 347,787 24,507 1,130 Insured Fund 2,135,976 134,057 78,535 Massachusetts Fund 861,945 54,163 29,631 Michigan Fund 2,163,050 128,077 56,030 Minnesota Fund 819,118 46,686 37,510 Ohio Fund 1,699,643 105,552 81,934 1999 Florida Fund 610,778 42,251 85 Insured Fund 3,799,368 242,769 38,597 Massachusetts Fund 1,115,229 66,155 24,083 Michigan Fund 2,630,865 163,572 10,821 Minnesota Fund 1,378,166 80,608 6,400 Ohio Fund 2,308,355 146,830 15,696 Distributors may be entitled to payments from the Funds under the Rule 12b-1 plans, as discussed below. Except as noted, Distributors received no other compensation from the Funds for acting as underwriter. DISTRIBUTION AND SERVICE (12B-1) FEES The board has adopted a separate plan pursuant to Rule 12b-1 for each class. Although the plans differ in some ways for each class, each plan is designed to benefit the Fund and its shareholders. The plans are expected to, among other things, increase advertising of the Fund, encourage sales of the Fund and service to its shareholders, and increase or maintain assets of the Fund so that certain fixed expenses may be spread over a broader asset base, resulting in lower per share expense ratios. In addition, a positive cash flow into the Fund is useful in managing the Fund because the manager has more flexibility in taking advantage of new investment opportunities and handling shareholder redemptions. Under each plan, the Fund pays Distributors or others for the expenses of activities that are primarily intended to sell shares of the class. These expenses also may include service fees paid to securities dealers or others who have executed a servicing agreement with the Fund, Distributors or its affiliates and who provide service or account maintenance to shareholders (service fees); the expenses of printing prospectuses and reports used for sales purposes, and of preparing and distributing sales literature and advertisements; and a prorated portion of Distributors' overhead expenses related to these activities. Together, these expenses, including the service fees, are "eligible expenses." The 12b-1 fees charged to each class are based only on the fees attributable to that particular class. THE CLASS A PLAN. The Florida Fund may pay up to per year and each of the remaining Funds may pay up to 0.10% per year of the remaining Funds of Class A's average daily net assets. The Class A plan is a reimbursement plan. It allows the Fund to reimburse Distributors for eligible expenses that Distributors has shown it has incurred. The Fund will not reimburse more than the maximum amount allowed under the plan. Except for the Florida Fund's expenses, any unreimbursed expenses from one year may not be carried over to or reimbursed in later years. For the fiscal year ended February 28, 2001, the amounts paid by the Funds pursuant to the Class A plan were: FLORIDA INSURED MASSACHUSETTS FUND FUND FUND ($) ($) ($) - ------------------------------------------------------------------------------ Advertising 1,604 78,476 24,271 Printing and mailing prospectuses other than to current shareholders 997 40,180 5,985 Payments to underwriters 658 20,673 5,163 Payments to broker-dealers 102,881 1,016,934 234,094 Other 3,262 148,203 26,585 ------------------------------------------------ Total 109,402 1,304,466 296,098 ================================================ MICHIGAN MINNESOTA OHIO FUND FUND FUND ($) ($) ($) - ------------------------------------------------------------------------------ Advertising 60,731 37,590 37,286 Printing and mailing prospectuses other than to current shareholders 23,141 8,985 14,853 Payments to underwriters 17,540 5,241 10,628 Payments to broker-dealers 766,633 327,779 512,539 Other 109,317 38,478 74,067 --------------------------------------------- Total 977,462 418,073 649,373 ============================================= THE CLASS B AND C PLANS. Each Fund pays Distributors up to 0.65% per year of the class's average daily net assets, out of which 0.15% may be paid for services to the shareholders (service fees). The Class B and C plans also may be used to pay Distributors for advancing commissions to securities dealers with respect to the initial sale of Class B and C shares. Class B plan fees payable to Distributors are used by Distributors to pay third party financing entities that have provided financing to Distributors in connection with advancing commissions to securities dealers. Resources owns a minority interest in one of the third party financing entities. The Class B and C plans are compensation plans. They allow each Fund to pay a fee to Distributors that may be more than the eligible expenses Distributors has incurred at the time of the payment. Distributors must, however, demonstrate to the board that it has spent or has near-term plans to spend the amount received on eligible expenses. Each Fund will not pay more than the maximum amount allowed under the plans. Under the Class B plan, the amounts paid by the Funds pursuant to the plan for the fiscal year ended February 28, 2001, were: INSURED FUND MICHIGAN FUND OHIO FUND ($) ($) ($) - ----------------------------------------------------------------------- Advertising 156 258 129 Printing and mailing prospectuses other than to current shareholders 3 5 3 Payments to underwriters 96 210 112 Payments to broker-dealers 7,435 14,562 7,061 Other 157 337 182 ---------------------------------------------- Total 7,847 15,372 7,487 ============================================== Under the Class C plan, the amounts paid by the Fund pursuant to the plan for the fiscal year ended February 28, 2001, were: INSURED FUND MASSACHUSETTS FUND ($) ($) - ------------------------------------------------------------------------ Advertising 4,395 3,912 Printing and mailing prospectuses other than to current shareholders 1,136 703 Payments to underwriters 2,246 1,786 Payments to broker-dealers 343,969 163,353 Other 6,448 4,574 ---------------------------------- Total 358,194 174,328 ================================== MICHIGAN FUND MINNESOTA FUND OHIO FUND ($) ($) ($) - ------------------------------------------------------------------ Advertising 4,795 2,380 3,648 Printing and mailing prospectuses other than to current shareholders 999 516 885 Payments to underwriters 2,552 1,276 1,865 Payments to broker-dealers 297,677 137,721 248,999 Other 7,092 3,484 5,820 ------------------------------------------- Total 313,115 145,377 261,217 =========================================== THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or others are entitled to under each plan, each plan also provides that to the extent the Fund, the manager or Distributors or other parties on behalf of the Fund, the manager or Distributors make payments that are deemed to be for the financing of any activity primarily intended to result in the sale of Fund shares within the context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then such payments shall be deemed to have been made pursuant to the plan. To the extent fees are for distribution or marketing functions, as distinguished from administrative servicing or agency transactions, certain banks may not participate in the plans because of applicable federal law prohibiting certain banks from engaging in the distribution of mutual fund shares. These banks, however, are allowed to receive fees under the plans for administrative servicing or for agency transactions. Distributors must provide written reports to the board at least quarterly on the amounts and purpose of any payment made under the plans and any related agreements, and furnish the board with such other information as the board may reasonably request to enable it to make an informed determination of whether the plans should be continued. Each plan has been approved according to the provisions of Rule 12b-1. The terms and provisions of each plan also are consistent with Rule 12b-1. PERFORMANCE - ------------------------------------------------------------------------------ Performance quotations are subject to SEC rules. These rules require the use of standardized performance quotations or, alternatively, that every non-standardized performance quotation furnished by a Fund be accompanied by certain standardized performance information computed as required by the SEC. Average annual total return and current yield quotations used by the Funds are based on the standardized methods of computing performance mandated by the SEC. Performance figures reflect Rule 12b-1 fees from the date of the plan's implementation. An explanation of these and other methods used by the Funds to compute or express performance follows. Regardless of the method used, past performance does not guarantee future results, and is an indication of the return to shareholders only for the limited historical period used. AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding the average annual rates of return over the periods indicated below that would equate an initial hypothetical $1,000 investment to its ending redeemable value. The calculation assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, and income dividends and capital gain distributions are reinvested at net asset value. The quotation assumes the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. If a change is made to the sales charge structure, historical performance information will be restated to reflect the maximum initial sales charge currently in effect. When considering the average annual total return quotations for Class A and C shares, you should keep in mind that the maximum initial sales charge reflected in each quotation is a one time fee charged on all direct purchases, which will have its greatest impact during the early stages of your investment. This charge will affect actual performance less the longer you retain your investment in the Funds. The average annual total returns for the indicated periods ended February 28, 2001, were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - ------------------------------------------------------------------------------ CLASS A Florida Fund 4/30/93 8.26 4.93 - 5.05 Insured Fund 4/03/85 7.46 4.52 6.17 7.49 Massachusetts Fund 4/03/85 8.11 4.59 6.23 6.94 Michigan Fund 4/03/85 7.03 4.71 6.27 7.26 Minnesota Fund 4/03/85 7.58 4.23 5.82 7.13 Ohio Fund 4/03/85 6.75 4.56 6.16 7.22 - ------------------------------------------------------------------------------- SINCE INCEPTION (%) - ------------------------------------------------------------------------------- CLASS B Insured Fund 2/01/00 7.80 8.57 Michigan Fund 2/01/00 7.28 7.88 Ohio Fund 2/01/00 7.04 7.74 - ------------------------------------------------------------------------------- SINCE INCEPTION 1 YEAR (%) 5 YEARS (%) (%) - ------------------------------------------------------------------------------- CLASS C Insured Fund 5/01/95 9.49 4.65 5.33 Michigan Fund 5/01/95 9.00 4.86 5.46 Minnesota Fund 4.37 5/01/95 9.66 4.88 Ohio Fund 5/01/95 8.78 4.70 5.29 The following SEC formula was used to calculate these figures: n P(1+T) = ERV where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of each period at the end of each period CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total return assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, income dividends and capital gain distributions are reinvested at net asset value, the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. Cumulative total return, however, is based on the actual return for a specified period rather than on the average return over the periods indicated above. The cumulative total returns for the indicated periods ended February 28, 2001 were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - ------------------------------------------------------------------------------- CLASS A Florida Fund 4/30/93 8.26 27.21 - 47.04 Insured Fund 4/03/85 7.46 24.71 82.05 215.71 Massachusetts Fund 4/03/85 8.11 25.14 83.00 190.65 Michigan Fund 4/03/85 7.03 25.86 83.71 204.80 Minnesota Fund 4/03/85 7.58 23.01 76.06 199.17 Ohio Fund 4/03/85 6.75 24.97 81.86 202.94 - ------------------------------------------------------------------------------- SINCE 1 YEAR INCEPTION (%) (%) - ------------------------------------------------------------------------------- CLASS B Insured Fund 2/01/00 7.80 9.26 Michigan Fund 2/01/00 7.28 8.51 Ohio Fund 2/01/00 7.04 8.36 - ------------------------------------------------------------------------------- SINCE 1 YEAR 5 YEARS INCEPTION (%) (%) (%) - ------------------------------------------------------------------------------- CLASS C Insured Fund 5/01/95 9.49 25.52 34.68 Massachusetts Fund 10.23 5/01/95 25.99 35.35 Michigan Fund 5/01/95 9.00 26.78 36.36 Minnesota Fund 9.66 23.84 32.07 5/01/95 Ohio Fund 5/01/95 8.78 25.79 35.10 CURRENT YIELD Current yield shows the income per share earned by a Fund. It is calculated by dividing the net investment income per share earned during a 30-day base period by the applicable maximum offering price per share on the last day of the period and annualizing the result. Expenses accrued for the period include any fees charged to all shareholders of the class during the base period. The yields for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ------------------------------------------------------------------------------ Florida Fund 4.01 - - Insured Fund 4.13 3.74 3.72 Massachusetts Fund 4.11 - 3.70 Michigan Fund 3.89 3.51 3.48 Minnesota Fund 4.22 - 3.81 Ohio Fund 4.05 3.71 3.68 The following SEC formula was used to calculate these figures: 6 Yield = 2 [(a-b + 1) - 1] --- cd where: a = interest earned during the period b = expenses accrued for the period (net of reimbursements) c = the average daily number of shares outstanding during the period that were entitled to receive dividends d = the maximum offering price per share on the last day of the period TAXABLE-EQUIVALENT YIELD Each Fund also may quote a taxable-equivalent yield that shows the before-tax yield that would have to be earned from a taxable investment to equal the yield. Taxable-equivalent yield is computed by dividing the portion of the yield that is tax-exempt by one minus the highest applicable combined federal and state income tax rate and adding the product to the portion of the yield that is not tax-exempt, if any. The taxable-equivalent yields for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ------------------------------------------------------------------------- Florida Fund 6.64 - - Insured Fund 6.84 6.19 6.16 Massachusetts Fund 7.22 - 6.50 Michigan Fund 6.72 6.07 6.01 Minnesota Fund 7.58 - 6.85 Ohio Fund 7.21 6.60 6.55 As of February 28, 2001, the combined federal and state income tax rates upon which the taxable-equivalent yield quotations were based were as follows: Combined Rate (%) ----------------- Florida Fund 39.60 Insured Fund 39.60 Massachusetts Fund 43.10 Michigan Fund 42.14 Minnesota Fund 44.34 Ohio Fund 43.82 From time to time, as any changes to the rates become effective, taxable-equivalent yield quotations advertised by the Funds will be updated to reflect these changes. The Funds expect updates may be necessary as tax rates are changed by federal and state governments. The advantage of tax-free investments, like the Funds, will be enhanced by any tax rate increases. Therefore, the details of specific tax increases may be used in sales material for the Funds. CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are calculated according to a formula prescribed by the SEC, are not indicative of the amounts that were or will be paid to shareholders. Amounts paid to shareholders are reflected in the quoted current distribution rate or taxable-equivalent distribution rate. The current distribution rate is usually computed by annualizing the dividends paid per share by a class during a certain period and dividing that amount by the current maximum offering price. The current distribution rate differs from the current yield computation because it may include distributions to shareholders from sources other than interest, if any, and is calculated over a different period of time. The current distribution rates for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ----------------------------------------------------------------------------- Florida Fund 4.49 - - Insured Fund 4.80 4.41 4.35 Massachusetts Fund 4.67 - 4.25 Michigan Fund 4.74 4.34 4.30 Minnesota Fund 4.69 - 4.25 Ohio Fund 4.75 4.37 4.33 A taxable-equivalent distribution rate shows the taxable distribution rate equivalent to the current distribution rate. The advertised taxable-equivalent distribution rate will reflect the most current federal and state tax rates available to the Fund. The taxable-equivalent distribution rates for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ---------------------------------------------------------------------------- Florida Fund 7.43 - - Insured Fund 7.95 7.30 7.20 Massachusetts Fund 8.21 - 7.47 Michigan Fund 8.19 7.50 7.43 Minnesota Fund 8.43 - 7.64 Ohio Fund 8.45 7.78 7.71 VOLATILITY Occasionally statistics may be used to show the Fund's volatility or risk. Measures of volatility or risk are generally used to compare the Fund's net asset value or performance to a market index. One measure of volatility is beta. Beta is the volatility of a fund relative to the total market, as represented by an index considered representative of the types of securities in which the fund invests. A beta of more than 1.00 indicates volatility greater than the market and a beta of less than 1.00 indicates volatility less than the market. Another measure of volatility or risk is standard deviation. Standard deviation is used to measure variability of net asset value or total return around an average over a specified period of time. The idea is that greater volatility means greater risk undertaken in achieving performance. OTHER PERFORMANCE QUOTATIONS Each Fund also may quote the performance of shares without a sales charge. Sales literature and advertising may quote a cumulative total return, average annual total return and other measures of performance with the substitution of net asset value for the public offering price. Each Fund may include in its advertising or sales material information relating to investment goals and performance results of funds belonging to Franklin Templeton Investments. Resources is the parent company of the advisors and underwriter of Franklin Templeton funds. COMPARISONS To help you better evaluate how an investment in a Fund may satisfy your investment goal, advertisements and other materials about the Fund may discuss certain measures of Fund performance as reported by various financial publications. Materials also may compare performance (as calculated above) to performance as reported by other investments, indices, and averages. These comparisons may include, but are not limited to, the following examples: o Salomon Smith Barney Broad Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate and mortgage bonds. o Lehman Brothers Aggregate Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate, mortgage and Yankee bonds. o Lehman Brothers Municipal Bond Index or its component indices - measures yield, price and total return for the municipal bond market. o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of 20 general obligation bonds maturing in 20 years. o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds. The index attempts to track the new-issue market as closely as possible, so it changes bonds twice a month, adding all new bonds that meet certain requirements and deleting an equivalent number according to their secondary market trading activity. As a result, the average par call date, average maturity date, and average coupon rate can and have changed over time. The average maturity generally has been about 29-30 years. o Financial publications: The WALL STREET JOURNAL, and BUSINESS WEEK, FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines - provide performance statistics over specified time periods. o Salomon Smith Barney Composite High Yield Index or its component indices - measures yield, price and total return for the Long-Term High-Yield Index, Intermediate-Term High-Yield Index and Long-Term Utility High-Yield Index. o Historical data supplied by the research departments of CS First Boston Corporation, the J.P. Morgan Chase and Co., Salomon Smith Barney Inc., Merrill Lynch and Lehman Brothers(R). o Morningstar - information published by Morningstar, Inc., including Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's assessment of the historical risk-adjusted performance of a fund over specified time periods relative to other funds within its category. o Lipper, Inc. - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund Performance Analysis - measure total return and average current yield for the mutual fund industry and rank individual mutual fund performance over specified time periods, assuming reinvestment of all distributions, exclusive of any applicable sales charges. From time to time, advertisements or information for each Fund may include a discussion of certain attributes or benefits to be derived from an investment in the Fund. The advertisements or information may include symbols, headlines, or other material that highlights or summarizes the information discussed in more detail in the communication. Advertisements or sales material issued by each Fund also may discuss or be based upon information in a recent issue of the Special Report on Tax Freedom Day published by the Tax Foundation, a Washington, D.C. based nonprofit research and public education organization. The report illustrates, among other things, the annual amount of time the average taxpayer works to satisfy his or her tax obligations to the federal, state and local taxing authorities. Advertisements or information also may compare each Fund's performance to the return on certificates of deposit (CDs) or other investments. You should be aware, however, that an investment in the Fund involves the risk of fluctuation of principal value, a risk generally not present in an investment in a CD issued by a bank. CDs are frequently insured by an agency of the U.S. government. An investment in a Fund is not insured by any federal, state or private entity. In assessing comparisons of performance, you should keep in mind that the composition of the investments in the reported indices and averages is not identical to any Fund's portfolio, the indices and averages are generally unmanaged, and the items included in the calculations of the averages may not be identical to the formula used by a Fund to calculate its figures. In addition, there can be no assurance that a Fund will continue its performance as compared to these other averages. MISCELLANEOUS INFORMATION - ------------------------------------------------------------------------------ The Funds may help you achieve various investment goals such as accumulating money for retirement, saving for a down payment on a home, college costs and other long-term goals. The Franklin College Costs Planner may help you in determining how much money must be invested on a monthly basis to have a projected amount available in the future to fund a child's college education. (Projected college cost estimates are based upon current costs published by the College Board.) The Franklin Retirement Planning Guide leads you through the steps to start a retirement savings program. Of course, an investment in the Funds cannot guarantee that these goals will be met. The Funds are members of Franklin Templeton Investments, one of the largest mutual fund organizations in the U.S., and may be considered in a program for diversification of assets. Founded in 1947, Franklin is one of the oldest mutual fund organizations and now services approximately 3 million shareholder accounts. In 1992, Franklin, a leader in managing fixed-income mutual funds and an innovator in creating domestic equity funds, joined forces with Templeton, a pioneer in international investing. The Mutual Series team, known for its value-driven approach to domestic equity investing, became part of the organization four years later. In 2001, the Fiduciary Trust team, known for providing global investment management to institutions and high net worth clients worldwide, joined the organization. Together, Franklin Templeton Investments has over $271 billion in assets under management for more than 5 million U.S. based mutual fund shareholder and other accounts. Franklin Templeton Investments offers 107 U.S. based open-end investment companies to the public. The Fund may identify itself by its Nasdaq symbol or CUSIP number. Franklin is a leader in the tax-free mutual fund industry and manages more than $44 billion in municipal security assets for over three quarters of a million investors. Under current tax laws, municipal securities remain one of the few investments offering the potential for tax-free income. In 2001, taxes could cost $46 on every $100 earned from a fully taxable investment based on the combination of the new 39.1% federal tax rate and the highest state tax rate of 7.2% (after the federal tax deduction). Franklin tax-free funds, however, offer tax relief through a professionally managed portfolio of tax-free securities selected based on their yield, quality and maturity. An investment in a Franklin tax-free fund can provide you with the potential to earn income free of federal taxes and, depending on the fund, state and local taxes as well, while supporting state and local public projects. Franklin tax-free funds also may provide tax-free compounding, when dividends are reinvested. An investment in Franklin's tax-free funds can grow more rapidly than similar taxable investments. Municipal securities are generally considered to be creditworthy, second in quality only to securities issued or guaranteed by the U.S. government and its agencies. The market price of municipal securities, however, may fluctuate. This fluctuation will have a direct impact on the net asset value of the Fund's shares. Currently, there are more mutual funds than there are stocks listed on the New York Stock Exchange. While many of them have similar investment goals, no two are exactly alike. Shares of the Funds are generally sold through securities dealers, whose investment representatives are experienced professionals who can offer advice on the type of investments suitable to your unique goals and needs, as well as the risks associated with such investments. DESCRIPTION OF RATINGS - ------------------------------------------------------------------------------ MUNICIPAL BOND RATINGS MOODY'S INVESTORS SERVICE, INC. (MOODY'S) INVESTMENT GRADE Aaa: Municipal bonds rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt-edged." Interest payments are protected by a large or exceptionally stable margin, and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa: Municipal bonds rated Aa are judged to be high quality by all standards. Together with the Aaa group, they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large, fluctuation of protective elements may be of greater amplitude, or there may be other elements present that make the long-term risks appear somewhat larger. A: Municipal bonds rated A possess many favorable investment attributes and are considered upper medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present that suggest a susceptibility to impairment sometime in the future. Baa: Municipal bonds rated Baa are considered medium-grade obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. These bonds lack outstanding investment characteristics and, in fact, have speculative characteristics as well. BELOW INVESTMENT GRADE Ba: Municipal bonds rated Ba are judged to have predominantly speculative elements and their future cannot be considered well assured. Often the protection of interest and principal payments may be very moderate and, thereby, not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Municipal bonds rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Municipal bonds rated Caa are of poor standing. These issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Municipal bonds rated Ca represent obligations that are speculative to a high degree. These issues are often in default or have other marked shortcomings. C: Municipal bonds rated C are the lowest-rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Con.(-): Municipal bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals that begin when facilities are completed, or (d) payments to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon the completion of construction or the elimination of the basis of the condition. Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating classification from Aa through Caa in its municipal bond ratings. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates that the issue ranks in the lower end of its generic rating category. STANDARD & POOR'S RATINGS GROUP (S&P(R)) INVESTMENT GRADE AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess the ultimate degree of protection as to principal and interest. In the market, they move with interest rates and, hence, provide the maximum safety on all counts. AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the majority of instances differ from AAA issues only in a small degree. Here, too, prices move with the long-term money market. A: Municipal bonds rated A are regarded as upper medium-grade. They have considerable investment strength but are not entirely free from adverse effects of changes in economic and trade conditions. Interest and principal are regarded as safe. They predominantly reflect money rates in their market behavior but also, to some extent, economic conditions. BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. BELOW INVESTMENT GRADE BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and repay principal in accordance with the terms of the obligations. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While these bonds will likely have some quality and protective characteristics, they are outweighed by large uncertainties or major risk exposures to adverse conditions. C: This rating is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in default and payment of interest and/or repayment of principal is in arrears. Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. FITCH INVESTORS SERVICE, INC. (FITCH) INVESTMENT GRADE AAA: Municipal bonds rated AAA are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal that is unlikely to be affected by reasonably foreseeable events. AA: Municipal bonds rated AA are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong although not quite as strong as bonds rated AAA and not significantly vulnerable to foreseeable future developments. A: Municipal bonds rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB: Municipal bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BELOW INVESTMENT GRADE BB: Municipal bonds rated BB are considered speculative. The obligor's ability to pay interest and repay principal may be affected over time by adverse economic changes. Business and financial alternatives can be identified, however, that could assist the obligor in satisfying its debt service requirements. B: Municipal bonds rated B are considered highly speculative. While bonds in this class are currently meeting debt service requirements, the probability of continued timely payment of principal and interest reflects the obligor's limited margin of safety and the need for reasonable business and economic activity throughout the life of the issue. CCC: Municipal bonds rated CCC have certain identifiable characteristics which, if not remedied, may lead to default. The ability to meet obligations requires an advantageous business and economic environment. CC: Municipal bonds rated CC are minimally protected. Default in payment of interest and/or principal seems probable over time. C: Municipal bonds rated C are in imminent default in the payment of interest or principal. DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest and/or principal payments. Such bonds are extremely speculative and should be valued on the basis of their ultimate recovery value in liquidation or reorganization of the obligor. DDD represents the highest potential for recovery while D represents the lowest potential for recovery. Plus (+) or minus (-) signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus or minus signs are not used with the AAA, DDD, DD or D categories. MUNICIPAL NOTE RATINGS MOODY'S Moody's ratings for state, municipal and other short-term obligations will be designated Moody's Investment Grade (MIG). This distinction is in recognition of the differences between short-term credit risk and long-term risk. Factors affecting the liquidity of the borrower are uppermost in importance in short-term borrowing; factors of the first importance in long-term borrowing risk are of lesser importance in the short run. Symbols used will be as follows: MIG 1: Notes are of the best quality enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. MIG 2: Notes are of high quality, with margins of protection ample, although not so large as in the preceding group. MIG 3: Notes are of favorable quality, with all security elements accounted for, but lacking the undeniable strength of the preceding grades. Market access for refinancing, in particular, is likely to be less well established. MIG 4: Notes are of adequate quality, carrying specific risk but having protection and not distinctly or predominantly speculative. S&P Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After June 29, 1984, for new municipal note issues due in three years or less, the ratings below will usually be assigned. Notes maturing beyond three years will most likely receive a bond rating of the type recited above. SP-1: Issues carrying this designation have a very strong or strong capacity to pay principal and interest. Issues determined to possess overwhelming safety characteristics will be given a "plus" (+) designation. SP-2: Issues carrying this designation have a satisfactory capacity to pay principal and interest. SHORT-TERM DEBT & COMMERCIAL PAPER RATINGS MOODY'S Moody's short-term debt ratings are opinions of the ability of issuers to repay punctually senior debt obligations. These obligations have an original maturity not exceeding one year, unless explicitly noted. Moody's commercial paper ratings, which are also applicable to municipal paper investments, are opinions of the ability of issuers to repay punctually their promissory obligations not having an original maturity in excess of nine months. Moody's employs the following designations for both short-term debt and commercial paper, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: P-1 (Prime-1): Superior capacity for repayment. P-2 (Prime-2): Strong capacity for repayment. S&P S&P's ratings are a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues within the "A" category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety, as follows: A-1: This designation indicates the degree of safety regarding timely payment is very strong. A "plus" (+) designation indicates an even stronger likelihood of timely payment. A-2: Capacity for timely payment on issues with this designation is strong. The relative degree of safety, however, is not as overwhelming as for issues designated A-1. A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. FITCH Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of generally up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. The short-term rating places greater emphasis than a long-term rating on the existence of liquidity necessary to meet the issuer's obligations in a timely manner. F-1+: Exceptionally strong credit quality. Regarded as having the strongest degree of assurance for timely payment. F-1: Very strong credit quality. Reflects an assurance of timely payment only slightly less in degree than issues rated F-1+. F-2: Good credit quality. A satisfactory degree of assurance for timely payment, but the margin of safety is not as great as for issues assigned F-1+ and F-1 ratings. F-3: Fair credit quality. Have characteristics suggesting that the degree of assurance for timely payment is adequate; however, near-term adverse changes could cause these securities to be rated below investment grade. F-5: Weak credit quality. Have characteristics suggesting a minimal degree of assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic conditions. D: Default. Actual or imminent payment default. LOC: The symbol LOC indicates that the rating is based on a letter of credit issued by a commercial bank. STATE TAX TREATMENT - ------------------------------------------------------------------------------- The following information on the state income tax treatment of dividends from the funds is based upon correspondence and sources believed to be reliable. Except where otherwise noted, the information pertains to individual state income taxation only. You may be subject to local taxes on dividends or the value of your shares. Corporations, trusts, estates and other entities may be subject to other taxes and should consult with their tax advisors or their state department of revenue. For some investors, a portion of the dividend income may be subject to the federal and/or state alternative minimum tax. FLORIDA Although Florida does not impose a personal income tax, it does impose an intangible personal property tax on intangible property having a taxable situs in Florida. This tax is imposed on the value of certain intangible personal property, including shares of a mutual fund. However, according to Florida Statute Section 199.185, there is an exemption for shares of a mutual fund, such as the Florida Fund, that is organized as a business trust, if, on the January 1 assessment date, at least 90% of the net asset value of the portfolio of assets corresponding to such shares consists of exempt property. Exempt property includes notes, bonds and other obligations issued by the state of Florida or its municipalities, counties and other taxing districts or by the U.S. government and its agencies. If, on the date of assessment, the 90% threshold is not met, only that portion, if any, of the value of the mutual fund shares attributable to notes, bonds and obligations of the U.S. government and its agencies will be exempt. MASSACHUSETTS Chapter 62, Section 2, of the Massachusetts General Laws states that dividends received from a regulated investment company, such as the Massachusetts Fund, are exempt from state personal income tax to the extent that such dividends are attributable to interest on obligations of the U.S. government or its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands). Dividends received from the fund, which are either exempt-interest dividends or capital gain dividends, to the extent that the interest or gains are attributable to obligations of the Commonwealth of Massachusetts, or any political subdivision, agency or instrumentality within the commonwealth, also are exempt from state personal income tax. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or other obligations from other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. Capital gain dividends attributable to obligations other than of the Commonwealth of Massachusetts, or any political subdivision, agency or instrumentality thereof will be taxable as follows: Net short-term capital gain distributions will be taxable as dividend income while net long-term capital gain distributions will be taxable at reduced rates ranging from five percent to two percent based upon the applicable holding period of the asset as determined under Massachusetts law. By the 2001 tax year, these reduced rates will range from five percent to zero percent. In determining the Massachusetts excise tax on corporations subject to state taxation, distributions from the fund generally will be included in a corporate shareholder's net income, and in the case of corporations that are defined as "intangible property corporations," shares of the fund will be included in the computation of net worth. MICHIGAN Section 206.30(1) of the Michigan Compiled Laws generally provides that taxable income, for purposes of the Michigan individual income tax, is determined by reference to federal adjusted gross income, with certain modifications. Interest and dividends derived from obligations or securities of states other than Michigan (less related expenses) must be added back in determining Michigan taxable income. Interest and dividends derived from obligations or securities of Michigan (and its political subdivisions) are exempt and are not, therefore, added back in determining Michigan taxable income. Further, income derived from obligations of the U.S. government that the state is prohibited by law from subjecting to a net income tax is subtracted in determining Michigan taxable income. Pursuant to Michigan Revenue Administrative Bulletin 1989-10, this includes direct obligations of the U.S. government, its agencies, instrumentalities, or possessions (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands). Michigan Revenue Administrative Bulletin 1986-3 states that a regulated investment company, such as the Michigan Fund, which invests in tax-free municipal obligations of the state of Michigan and its political and governmental subdivisions, is permitted to pass-through the exemption of such interest to its shareholders to the extent that such interest qualifies as an exempt-interest dividend of a regulated investment company. The exempt nature of interest from obligations of the U.S. and its territories and possessions also may be passed through to shareholders. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or from obligations of other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund, such as for temporary or defensive purposes, the distributions will be taxable. Any distributions of net short-term and net long-term capital gains earned by the fund generally will be included in each shareholder's Michigan taxable income and taxed at ordinary income tax rates. MINNESOTA Section 290.01 of the Code of Minnesota provides that individual shareholders generally will not be subject to state income taxation on the exempt-interest dividends distributed by a regulated investment company, such as the Minnesota Fund, to the extent that such exempt-interest dividends are derived from interest income on obligations of the state of Minnesota or its political subdivisions, municipalities, governmental agencies or instrumentalities, and provided that at least 95% of the exempt-interest dividends that are distributed to shareholders are derived from such obligations. However, such dividends are taken into account in computing the state's alternative minimum tax to the extent they are derived from Minnesota private activity bonds. Minnesota Reg.ss. 8002.0300 generally states that dividends paid by the fund, to the extent attributable to interest derived from obligations of the U.S. government, its authorities, commissions, instrumentalities or territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands), also will be exempt from Minnesota's personal income tax. As a matter of policy, the fund will continue to seek to earn at least 95% of its income from interest on Minnesota obligations and less than 5% from direct U.S. government, Puerto Rico or other obligations to try to ensure that the fund continues to qualify to pay exempt-interest dividends on income from obligations of Minnesota and its political subdivisions, municipalities, governmental agencies and its instrumentalities. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or other obligations from other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. Any distributions of net short-term and net long-term capital gains earned by the fund are included in each shareholder's Minnesota taxable income and are taxed at ordinary income tax rates. OHIO Section 5747.01(A) of the Ohio Revised Code states generally that interest on obligations of the state of Ohio and its subdivisions and authorities and of the U.S. and its territories and possessions (to the extent included in federal adjusted gross income but exempt from state income taxes under U.S. laws) is exempt from Ohio state personal income tax. Distributions of income attributable to obligations of the U.S., its territories and possessions by regulated investment companies, such as the Ohio Fund, also will be exempt from the Ohio personal income tax and the Ohio corporation franchise tax computed on the net income basis. In addition, distributions made by the Ohio Fund that are attributable to interest payments on obligations issued by or on behalf of the state of Ohio, its political subdivisions or agencies or instrumentalities or its political subdivisions will be exempt from Ohio personal income tax provided that at all times at least 50 percent of the value of the total assets of the Ohio Fund consists of Ohio obligations, or similar obligations of other states or their subdivisions. Shares of the Ohio Fund will, however, be included in a shareholder's tax base for purposes of computing the Ohio corporation franchise tax on the net worth basis. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or other obligations from other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable on a pro rata basis. Shareholders who are subject to the Ohio personal income tax or the Ohio corporation franchise tax computed on the net income basis will not be subject to such taxes on distributions of "capital gain dividends" to the extent that such distributions are attributable to profit made on the sale, exchange or other disposition by the Ohio Fund of exempt obligations of the state of Ohio and its subdivisions and authorities. PROSPECTUS FRANKLIN TAX-FREE TRUST INVESTMENT STRATEGY TAX-FREE INCOME FRANKLIN ALABAMA TAX-FREE INCOME FUND FRANKLIN FLORIDA TAX-FREE INCOME FUND FRANKLIN GEORGIA TAX-FREE INCOME FUND FRANKLIN KENTUCKY TAX-FREE INCOME FUND FRANKLIN LOUISIANA TAX-FREE INCOME FUND FRANKLIN MARYLAND TAX-FREE INCOME FUND FRANKLIN MISSOURI TAX-FREE INCOME FUND FRANKLIN NORTH CAROLINA TAX-FREE INCOME FUND FRANKLIN TEXAS TAX-FREE INCOME FUND FRANKLIN VIRGINIA TAX-FREE INCOME FUND JULY 1, 2001 [Insert Franklin Templeton Ben Head] The SEC has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense. CONTENTS THE FUNDS [Begin callout] INFORMATION ABOUT EACH FUND YOU SHOULD KNOW BEFORE INVESTING [End callout] 2 Goals and Strategies 4 Main Risks 7 Performance 17 Fees and Expenses 21 Management 23 Distributions and Taxes 26 Financial Highlights YOUR ACCOUNT [Begin callout] INFORMATION ABOUT SALES CHARGES, ACCOUNT TRANSACTIONS AND SERVICES [End callout] 37 Choosing a Share Class 41 Buying Shares 44 Investor Services 48 Selling Shares 50 Account Policies 54 Questions FOR MORE INFORMATION [Begin callout] WHERE TO LEARN MORE ABOUT EACH FUND [End callout] Back Cover THE FUNDS [Insert graphic of bullseye and arrows] GOALS AND STRATEGIES -------------------- GOALS Each Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investing, while seeking preservation of shareholders' capital. Each Fund also tries to provide a maximum level of income exempt from personal income taxes, if any, for resident shareholders of that Fund's state. MAIN INVESTMENT STRATEGIES Under normal market conditions, each Fund invests mainly in municipal securities whose interest is free from federal income taxes, including the federal alternative minimum tax. In addition, each state Fund invests mainly in municipal securities that pay interest free from the personal income taxes, if any, of the Fund's state. Although each Fund tries to invest all of its assets in tax-free securities, it is possible that up to 20% of its assets may be in tax-free securities that pay interest that may be subject to the federal alternative minimum tax and, although not anticipated, in securities that pay taxable interest. [Begin callout] MUNICIPAL SECURITIES are issued by state and local governments, their agencies and authorities, as well as by the District of Columbia and U.S. territories and possessions, to borrow money for various public and private projects. Municipal securities pay a fixed, floating or variable rate of interest, and require that the amount borrowed (principal) be repaid at maturity. [End callout] Each Fund only buys municipal securities rated in the top four ratings by U.S. nationally recognized rating services (or comparable unrated securities). The manager selects securities that it believes will provide the best balance between risk and return within a Fund's range of allowable investments and typically uses a buy and hold strategy. This means it holds securities in the Fund's portfolio for income purposes, rather than trading securities for capital gains, although the manager may sell a security at any time if it believes it could help the Fund meet its goal. Each Fund also may invest in municipal lease obligations, which generally are issued to finance the purchase of public property. The property is leased to a state or local government and the lease payments are used to pay the interest on the obligations. These differ from other municipal securities because the money to make the lease payments must be set aside each year or the lease can be cancelled without penalty. If this happens, investors who own the obligations may not be paid. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of the Fund's assets in a temporary defensive manner by holding all or a substantial portion of its assets in cash, cash equivalents or other high quality short-term investments. Temporary defensive investments generally may include securities that pay taxable interest. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. In these circumstances, a Fund may be unable to achieve its investment goals. [Insert graphic of chart with line going up and down] MAIN RISKS ---------- INTEREST RATE When interest rates rise, municipal security prices fall. The opposite is also true: municipal security prices rise when interest rates fall. In general, securities with longer maturities are more sensitive to these price changes. CREDIT An issuer of municipal securities may be unable to make interest payments and repay principal. Changes in an issuer's financial strength or in a security's credit rating may affect a security's value and, thus, impact Fund performance. Many of each Fund's portfolio securities may be supported by credit enhancements, which may be provided by either U.S. or foreign entities. These securities have the credit risk of the entity providing the credit support. Credit support provided by a foreign entity may be less certain because of the possibility of adverse foreign economic, political or legal developments that may affect the ability of that entity to meet its obligations. To the extent that a Fund holds insured securities, a change in the credit rating of any one or more of the municipal bond insurers that insure securities in the Fund's portfolio may affect the value of the securities they insure, the Fund's share price and Fund performance. A Fund might also be adversely impacted by the inability of an insurer to meet its insurance obligations. [Begin callout] Because interest rates and municipal security prices fluctuate, the amount of a Fund's distributions, its yield, and the value of your investment in that Fund will go up and down. This means you could lose money over short or even extended periods. [End callout] INCOME Since each Fund can only distribute what it earns, the Fund's distributions to shareholders may decline when interest rates fall. CALL A municipal security may be prepaid (called) before maturity. An issuer is more likely to call its securities when interest rates are falling, because the issuer can issue new securities with lower interest payments. If a security is called, a Fund may have to replace it with a lower-yielding security. At any time, each Fund may have a large amount of its assets invested in municipal securities subject to call risk. A call of some or all of these securities may lower a Fund's income and yield and its distributions to shareholders. MARKET A security's value may be reduced by market activity or the results of supply and demand. This is a basic risk associated with all securities. When there are more sellers than buyers, prices tend to fall. Likewise, when there are more buyers than sellers, prices tend to rise. Each Fund may invest more than 25% of its assets in municipal securities that finance similar types of projects, such as hospitals, housing, industrial development, transportation or pollution control. A change that affects one project, such as proposed legislation on the financing of the project, a shortage of the materials needed for the project, or a declining need for the project, would likely affect all similar projects, thereby increasing market risk. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS Municipal securities may be issued on a when-issued or delayed delivery basis, where payment and delivery take place at a future date. Since the market price of the security may fluctuate during the time before payment and delivery, the Fund assumes the risk that the value of the security at delivery may be more or less than the purchase price. DIVERSIFICATION The Maryland Fund is a non-diversified fund. It may invest a greater portion of its assets in the municipal securities of one issuer than a diversified fund. This Fund may be more sensitive to economic, business, political or other changes affecting similar issuers or securities, which may result in greater fluctuation in the value of its shares. The Fund, however, intends to meet certain tax diversification requirements. The other Funds are all diversified funds. STATE Since each state Fund invests mainly in municipal securities of its state, events in that state are likely to affect the Fund's investments and its performance. These events may include economic or political policy changes, tax base erosion, state constitutional limits on tax increases, budget deficits and other financial difficulties, and changes in the credit ratings assigned to the state's municipal issuers. A negative change in any one of these or other areas could affect the ability of a state's municipal issuers to meet their obligations. It is important to remember that economic, budget and other conditions within a state are unpredictable and can change at any time. For these reasons, each state Fund may involve more risk than an investment in a fund that does not focus on securities of a single state. U.S. TERRITORIES Each Fund may invest up to 35% of its assets in municipal securities issued by U.S. territories. As with state municipal securities, events in any of these territories where a Fund is invested may affect the Fund's investments and its performance. More detailed information about the Funds, their policies and risks and about municipal securities ratings can be found in the Funds' Statement of Additional Information (SAI). [Begin callout] Mutual fund shares are not deposits or obligations of, or guaranteed or endorsed by, any bank, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency of the U.S. government. Mutual fund shares involve investment risks, including the possible loss of principal. [End callout] [Insert graphic of a bull and a bear] PERFORMANCE ----------- The bar charts and tables below show the volatility of each Fund's returns, which is one indicator of the risks of investing in a Fund. The bar charts show changes in each Fund's returns from year to year over the calendar years shown. The tables show how each Fund's average annual total returns compare to those of a broad-based securities market index. Of course, past performance cannot predict or guarantee future results. ALABAMA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.40% 8.79% 12.24% -4.44% 15.28% 4.95% 9.03% 3.42% -3.60% 9.75 - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 6.25% WORST QUARTER: Q1 '94 - -4.36% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Alabama Fund - Class A/2 5.13% 3.70% 6.13% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Alabama Fund - Class C/2 7.11% 3.83% 4.78% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.21% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. FLORIDA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.56% 8.81% 12.01% -3.34% 14.67% 4.39% 8.11% 6.34% -3.31% 10.90% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.93% WORST QUARTER: Q1 '94 - -3.84% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Florida Fund - Class A/2 6.15% 4.27% 6.48% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Florida Fund - Class C/2 8.14% 4.40% 5.30% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.03% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. GEORGIA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.23% 8.82% 11.89% -3.74% 14.06% 4.66% 7.84% 5.63% -3.82% 11.41% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.84% WORST QUARTER: Q1 '94 - -4.26% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Georgia Fund - Class A/2 6.68% 4.11% 6.26% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Georgia Fund - Class C/2 8.77% 4.26% 5.05% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.94% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. KENTUCKY FUND ANNUAL TOTAL RETURNS/1 [Insert bar graph] 10.48% 13.90% -8.52% 19.86% 4.26% 9.35% 6.09% -4.23% 11.47% - ------------------------------------------------------------------------------- 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 8.79% WORST QUARTER: Q1 '94 - -7.34% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 SINCE INCEPTION 1 YEAR 5 YEARS (10/12/91) - ------------------------------------------------------------------------------- Kentucky Fund/2 6.78% 4.33% 6.22% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.97% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.68% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. LOUISIANA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.23% 8.98% 11.13% -4.80% 14.59% 4.83% 8.79% 5.39% -3.87% 11.67% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 5.84% WORST QUARTER: Q1 '94 - -4.47% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Louisiana Fund - Class A/2 6.93% 4.32% 6.24% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Louisiana Fund - Class C/2 8.97% 4.45% 5.33% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.58% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. MARYLAND FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.06% 8.87% 12.15% -5.09% 17.27% 3.96% 8.54% 5.88% -3.81% 11.66% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 7.25% WORST QUARTER: Q1 '94 - -4.78% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Maryland Fund - Class A/2 6.95% 4.21% 6.47% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Maryland Fund - Class C/2 8.95% 4.39% 5.49% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.89% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. MISSOURI FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 11.97% 9.02% 13.28% -5.09% 15.68% 4.70% 9.14% 5.76% -4.31% 11.65% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 6.44% WORST QUARTER: Q1 '94 - -4.84% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Missouri Fund - Class A/2 6.93% 4.34% 6.50% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Missouri Fund - Class C/2 9.03% 4.46% 5.35% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.80% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. NORTH CAROLINA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 11.50% 9.12% 11.67% -5.73% 16.12% 4.08% 8.91% 5.94% -4.23% 11.53% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 7.28% WORST QUARTER: Q1 '94 - -4.97% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- North Carolina Fund - Class A/2 6.81% 4.19% 6.21% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- North Carolina Fund - Class C/2 8.88% 4.32% 5.25% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.89% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. TEXAS FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.14% 8.56% 11.59% -2.79% 13.32% 5.17% 9.10% 5.10% -4.50% 8.49% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 4.96% WORST QUARTER: Q1 '94 - -3.48% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Texas Fund - Class A/2 3.87% 3.65% 6.00% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Texas Fund - Class C/2 5.77% 3.81% 4.79% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.37% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. VIRGINIA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Insert bar graph] 12.53% 8.95% 12.40% -4.64% 15.45% 4.17% 8.50% 5.83% -4.09% 10.72% - ------------------------------------------------------------------------------- 91 92 93 94 95 96 97 98 99 00 YEAR [Begin callout] BEST QUARTER: Q1 '95 6.53% WORST QUARTER: Q1 '94 - -4.30% [End callout] AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - ------------------------------------------------------------------------------- Virginia Fund - Class A/2 6.03% 3.98% 6.32% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - ------------------------------------------------------------------------------- Virginia Fund - Class C/2 8.07% 4.13% 5.09% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.19% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. [Insert graphic of percentage sign] FEES AND EXPENSES ----------------- This table describes the fees and expenses that you may pay if you buy and hold shares of a Fund.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT) ALABAMA FLORIDA GEORGIA KENTUCKY LOUISIANA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ CLASS A Maximum sales charge (load) as a percentage of offering price 4.25% 4.25% 4.25% 4.25% 4.25% Load imposed on purchases 4.25% 4.25% 4.25% 4.25% 4.25% Maximum deferred sales charge (load)/1 None None None None None CLASS B Maximum sales charge (load) as a percentage of offering price - 4.00% - - - Load imposed on purchases - None - - - Maximum deferred sales charge (load)/2 - 4.00% - - - CLASS C Maximum sales charge (load) as a percentage of offering price 1.99% 1.99% 1.99% - 1.99% Load imposed on purchases 1.00% 1.00% 1.00% - 1.00% Maximum deferred sales 0.99% 0.99% 0.99% - 0.99% charge (load)/3 NORTH MARYLAND MISSOURI CAROLINA TEXAS VIRGINIA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ CLASS A Maximum sales charge (load) as a percentage of offering price 4.25% 4.25% 4.25% 4.25% 4.25% Load imposed on purchases 4.25% 4.25% 4.25% 4.25% 4.25% Maximum deferred sales charge (load)/1 None None None None None CLASS C Maximum sales charge (load) as a percentage of offering price 1.99% 1.99% 1.99% 1.99% 1.99% Load imposed on purchases 1.00% 1.00% 1.00% 1.00% 1.00% Maximum deferred sales 0.99% 0.99% 0.99% 0.99% 0.99% charge (load)/3 Please see "Choosing a Share Class" on page 37 for an explanation of how and when these sales charges apply. ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS) ALABAMA FLORIDA GEORGIA KENTUCKY LOUISIANA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ CLASS A Management fees 0.56% 0.47% 0.58% 0.63%/4 0.58% Distribution and service (12b-1) fees 0.10% 0.10% 0.10% 0.10% 0.09% Other expenses 0.07% 0.05% 0.08% 0.09% 0.07% --------------------------------------------------------------- Total annual Fund operating expenses 0.73% 0.62% 0.76% 0.82%/4 0.74% --------------------------------------------------------------- --------------------------------------------------------------- CLASS B Management fees - 0.47% - - - Distribution and service (12b-1) fees - 0.65% - - - Other expenses - 0.05% - - - --------------------------------------------------------------- Total annual Fund operating expenses - 1.17% - - - --------------------------------------------------------------- --------------------------------------------------------------- CLASS C Management fees 0.56% 0.47% 0.58% - 0.58% Distribution and service (12b-1) fees 0.65% 0.65% 0.65% - 0.64% Other expenses 0.07% 0.05% 0.08% - 0.07% --------------------------------------------------------------- Total annual Fund operating expense 1.28% 1.17% 1.31% - 1.29% --------------------------------------------------------------- --------------------------------------------------------------- NORTH MARYLAND MISSOURI CAROLINA TEXAS VIRGINIA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ CLASS A Management fees 0.55% 0.52% 0.52% 0.62% 0.52% Distribution and service (12b-1) fees 0.10% 0.10% 0.10% 0.10% 0.10% Other expenses 0.08% 0.07% 0.07% 0.09% 0.08% --------------------------------------------------------------- Total annual Fund operating expenses 0.73% 0.69% 0.69% 0.81% 0.70% --------------------------------------------------------------- --------------------------------------------------------------- CLASS C Management fees 0.55% 0.52% 0.52% 0.62% 0.52% Distribution and service (12b-1) fees 0.65% 0.65% 0.65% 0.65% 0.64% Other expenses 0.08% 0.07% 0.07% 0.09% 0.08% --------------------------------------------------------------- Total annual Fund operating expenses 1.28% 1.24% 1.24% 1.36% 1.24% --------------------------------------------------------------- ---------------------------------------------------------------
1. There is a 1% contingent deferred sales charge that applies to investments of $1 million or more (see page 37). 2. Declines to zero after six years. 3. This is equivalent to a charge of 1% based on net asset value. 4. For the fiscal year ended February 28, 2001, the manager had agreed in advance to limit its management fees. With this reduction, management fees were 0.26% and total annual Fund operating expenses were 0.45%. The manager may end this arrangement at any time upon notice to the Fund's Board of Trustees. EXAMPLE This example can help you compare the cost of investing in a Fund with the cost of investing in other mutual funds. It assumes: o You invest $10,000 for the periods shown; o Your investment has a 5% return each year; and o The Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions your costs would be: ALABAMA FLORIDA GEORGIA KENTUCKY LOUISIANA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ If you sell your shares at the end of the period: CLASS A 1 Year/1 $496 $486 $499 $505 $497 3 Years $648 $615 $658 $676 $651 5 Years $814 $756 $829 $861 $819 10 Years $1,293 $1,166 $1,327 $1,395 $1,304 CLASS B 1 Year - $519 - - - 3 Years - $672 - - - 5 Years - $844 - - - 10 Years/2 - $1,267 - - - CLASS C 1 Year $328 $317 $331 - $329 3 Years $502 $468 $511 - $505 5 Years $795 $737 $811 - $800 10 Years $1,630 $1,506 $1,663 - $1,641 If you do not sell your shares: CLASS B 1 Year - $119 - - - 3 Years - $372 - - - 5 Years - $644 - - - 10 Years/2 - $1,267 - - - CLASS C 1 Year $229 $218 $232 - $230 3 Years $502 $468 $511 - $505 5 Years $795 $737 $811 - $800 10 Years $1,630 $1,506 $1,663 - $1,641 NORTH MARYLAND MISSOURI CAROLINA TEXAS VIRGINIA FUND FUND FUND FUND FUND - ------------------------------------------------------------------------------------------------------ If you sell your shares at the end of the period: CLASS A 1 Year/1 $496 $492 $492 $504 $493 3 Years $648 $636 $636 $673 $639 5 Years $814 $793 $793 $856 $798 10 Years $1,293 $1,247 $1,247 $1,384 $1,259 CLASS C 1 Year $328 $324 $324 $336 $324 3 Years $502 $489 $489 $526 $489 5 Years $795 $774 $774 $837 $774 10 Years $1,630 $1,585 $1,585 $1,719 $1,585 If you do not sell your shares: CLASS C 1 Year $229 $225 $225 $237 $225 3 Years $502 $489 $489 $526 $489 5 Years $795 $774 $774 $837 $774 10 Years $1,630 $1,585 $1,585 $1,719 $1,585
1. Assumes a contingent deferred sales charge (CDSC) will not apply. 2. Assumes conversion of Class B shares to Class A shares after eight years, lowering your annual expenses from that time on. [Insert graphic of briefcase] MANAGEMENT ---------- Franklin Advisers, Inc. (Advisers), One Franklin Parkway, San Mateo, CA 94403-1906, is each Fund's investment manager. Together, Advisers and its affiliates manage over $271 billion in assets. The team responsible for the Funds' management is: SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS Ms. Amoroso has been an analyst or portfolio manager of each Fund since its inception. She is the co-Director of Franklin's Municipal Bond Department. She joined Franklin Templeton Investments in 1986. JAMES CONN, VICE PRESIDENT OF ADVISERS Mr. Conn has been an analyst or portfolio manager of the Alabama and Maryland Funds since 1999. He joined Franklin Templeton Investments in 1996. Previously, he was a portfolio manager with California Investment Trust. CARRIE HIGGINS, VICE PRESIDNET OF ADVISERS Ms. Higgins has been an analyst or portfolio manager of the Missouri Fund since 1992. She joined Franklin Templeton Investments in 1990. JOHN POMEROY, VICE PRESIDENT OF ADVISERS Mr. Pomeroy has been an analyst or portfolio manager of the Alabama, Georgia and Maryland Funds since 1989. He joined Franklin Templeton Investments in 1986. FRANCISCO RIVERA, PORTFOLIO MANAGER OF ADVISERS Mr. Rivera has been an analyst or portfolio manager of the Georgia, Kentucky, Louisiana and Texas Funds since 1996. He joined Franklin Templeton Investments in 1994. CHRISTOPHER SPERRY, PORTFOLIO MANAGER OF ADVISERS Mr. Sperry has been an analyst or portfolio manager of the Florida Fund since 2000. He joined Franklin Templeton Investments in 1996. JOHN WILEY, VICE PRESIDENT OF ADVISERS Mr. Wiley has been an analyst or portfolio manager of the Louisiana and Texas Funds since 1991. He joined Franklin Templeton Investments in 1989. STELLA S. WONG, VICE PRESIDENT OF ADVISERS Ms. Wong has been an analyst or portfolio manager of the Florida, Maryland, Missouri, North Carolina and Virginia Funds since their inception. She joined Franklin Templeton Investments in 1986. Each Fund pays Advisers a fee for managing the Fund's assets. For the fiscal year ended February 28, 2001, each Fund paid to the manager for its services the following management fees as a percentage of its average monthly net assets: MANAGEMENT FEES - ------------------------------------------------------------------------------- Alabama Fund 0.56% Florida Fund 0.47% Georgia Fund 0.58% Kentucky Fund 0.26%/1 Louisiana Fund 0.58% Maryland Fund 0.55% Missouri Fund 0.52% North Carolina Fund 0.52% Texas Fund 0.62% Virginia Fund 0.52% 1. Management fees, before any advance waiver, were 0.63%. Under an agreement by the manager to limit its fees, the Fund paid the fees as shown. The manager may end this arrangement at any time upon notice to the Fund's Board of Trustees. [Insert graphic of dollar signs and stacks of coins] DISTRIBUTIONS AND TAXES ----------------------- ON MAY 26, 2001, THE U.S. CONGRESS PASSED AND SENT TO THE PRESIDENT THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001. IT IS EXPECTED THAT THE PRESIDENT WILL SIGN THIS LEGISLATION AND IT WILL BECOME LAW. THE 2001 TAX ACT CONTAINS PROVISIONS THAT WILL REDUCE EFFECTIVE FEDERAL INDIVIDUAL INCOME TAX RATES, PHASED-IN OVER TIME, AND WILL CREATE INVESTMENT, EDUCATIONAL AND RETIREMENT SAVINGS INCENTIVES THROUGH INCREASED CONTRIBUTION LIMITS, INCREASED PHASE-OUT LIMITS, AND OTHER TAX BENEFITS. INVESTORS SHOULD TALK TO THEIR PERSONAL TAX ADVISORS ABOUT THE IMPLICATIONS OF THESE TAX LAW CHANGES ON THEIR INVESTMENT IN THE FUNDS. INCOME AND CAPITAL GAIN DISTRIBUTIONS Each Fund typically declares income dividends each day that its net asset value is calculated and pays them monthly. A Fund does not pay "interest." Your account begins to receive dividends on the day after the Fund receives your investment and continues to receive dividends through the day it receives a request to redeem your shares. Capital gains, if any, may be distributed at least annually. The amount of any distributions will vary, and there is no guarantee a Fund will pay either income dividends or capital gain distributions. AVOID "BUYING A DIVIDEND" If you invest in a Fund shortly before it makes a capital gain distribution, you will receive some of your investment back in the form of a taxable distribution. TAX CONSIDERATIONS You may receive three different types of distributions from the Fund: o EXEMPT-INTEREST DIVIDENDS Most Fund distributions consist of exempt-interest dividends (dividends paid from interest earned on municipal securities). Because of this tax exemption, a tax-free fund may not be a suitable investment for retirement plans and other tax-exempt investors. In general, exempt-interest dividends are exempt from regular federal income tax. Exempt-interest dividends from interest earned on municipal securities of a state, or its political subdivisions, generally are also exempt from that state's personal income tax. Income from municipal securities of other states generally does not qualify as tax-free. Exempt-interest dividends are taken into account when determining the taxable portion of your social security or railroad retirement benefits. Each Fund may invest a portion of its assets in private activity bonds. The income from these bonds is a tax preference item when determining your alternative minimum tax. o TAXABLE INCOME DIVIDENDS Each Fund may invest a portion of its assets in securities that pay income that is not tax-exempt. A Fund may also distribute to you any market discount and net short-term capital gains from the sale of its portfolio securities. If you are a taxable investor, Fund distributions from this income are taxable to you as ordinary income. o CAPITAL GAIN DISTRIBUTIONS Each Fund may also realize net long-term capital gains and distribute these gains to you as capital gain distributions. These distributions will be taxable to you as long-term capital gains no matter how long you have owned your shares. Distributions of ordinary income and capital gains are taxable whether you reinvest your distributions in additional Fund shares or receive them in cash. Every January, you will receive a statement that shows the tax status of distributions you received for the previous year. BACKUP WITHHOLDING By law, a Fund must withhold 31% of your taxable distributions and redemption proceeds unless you: o provide your correct social security or taxpayer identification number, o certify that this number is correct, o certify that you are not subject to backup withholding, and o certify that you are a U.S. person (including a U.S. resident alien). A Fund also must withhold if the IRS instructs it to do so. When you sell your shares in a Fund, you may realize a capital gain or loss. For tax purposes, an exchange of your Fund shares for shares of a different Franklin Templeton fund is the same as a sale. Distributions of ordinary income and capital gains, and gains from the redemption of your Fund shares are generally subject to state and local taxes. Non-U.S. investors may be subject to U.S. withholding or estate tax, and are subject to special U.S. tax certification requirements. You should consult your tax advisor about the federal, state, local or foreign tax consequences of your investment in a Fund. [Insert graphic of a dollar bill] FINANCIAL HIGHLIGHTS -------------------- This table presents each Fund's financial performance for the past five years. Certain information reflects financial results for a simple Fund share. The total returns in the table represent the rate that an investor would have earned or lost on an investment in a Fund assuming reinvestment of dividends and capital gains. This information has been audited by PricewaterhouseCoopers LLP, whose report, along with the Fund's financial statements, are included in the annual report, which is available upon request. ALABAMA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.62 11.68 11.98 11.73 11.73 ---------------------------------------------------- Net investment income/1 .58 .61 .62 .64 .65 Net realized and unrealized gains (losses) .47 (1.06) (.25) .36 .01 ---------------------------------------------------- Total from investment operations 1.05 (.45) .37 1.00 .66 ---------------------------------------------------- Distributions from net investment income (.59) (.60) (.62) (.65) (.66) Distributions from net realized gains - (.01) (.05) (.10) - ---------------------------------------------------- Total distributions (.59) (.61) (.67) (.75) (.66) ---------------------------------------------------- Net asset value, end of year 11.08 10.62 11.68 11.98 11.73 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 10.11 (3.92) 3.21 8.79 5.84 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 210,198 203,256 238,670 216,982 193,466 Ratios to average net assets: (%) Expenses .73 .72 .71 .72 .71 Net investment income 5.32 5.46 5.23 5.39 5.62 Portfolio turnover rate (%) 11.12 20.99 8.67 10.44 15.47 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.68 11.74 12.04 11.78 11.77 ---------------------------------------------------- Net investment income/1 .52 .55 .56 .58 .59 Net realized and unrealized gains (losses) .47 (1.06) (.25) .36 .01 ---------------------------------------------------- Total from investment operations .99 (.51) .31 .94 .60 ---------------------------------------------------- Distributions from net investment income (.53) (.54) (.56) (.58) (.59) Distributions from net realized gains - (.01) (.05) (.10) - ---------------------------------------------------- Total distributions (.53) (.55) (.61) (.68) (.59) ---------------------------------------------------- Net asset value, end of year 11.14 10.68 11.74 12.04 11.78 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 9.46 (4.46) 2.62 8.23 5.28 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 14,475 14,056 14,895 9,469 5,683 Ratios to average net assets: (%) Expenses 1.28 1.27 1.27 1.29 1.28 Net investment income 4.77 4.91 4.67 4.80 5.05 Portfolio turnover rate (%) 11.12 20.99 8.67 10.44 15.47 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges. FLORIDA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 20001 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.89 11.91 11.87 11.59 11.69 ---------------------------------------------------- Net investment income/2 .61 .61 .62 .64 .67 Net realized and unrealized gains (losses) .64 (1.02) .05 .30 (.08) ---------------------------------------------------- Total from investment operations 1.25 (.41) .67 .94 .59 ---------------------------------------------------- Distributions from net investment income (.60) (.61) (.62) (.65) (.69) Distributions from net realized gains - -/3 (.01) (.01) - ---------------------------------------------------- Total distributions (.60) (.61) (.63) (.66) (.69) ---------------------------------------------------- Net asset value, end of year 11.54 10.89 11.91 11.87 11.59 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/4 11.77 (3.54) 5.75 8.37 5.20 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1 million) 1,539 1,510 1,786 1,650 1,458 Ratios to average net assets: (%) Expenses .62 .62 .61 .61 .60 Net investment income 5.41 5.37 5.19 5.45 5.78 Portfolio turnover rate (%) 12.05 26.39 7.66 5.60 12.00 CLASS B - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of period 10.90 10.83 ---------------------------------------------------- Net investment income/2 .55 .05 Net realized and unrealized gains (losses) .67 .07 ---------------------------------------------------- Total from investment operations 1.22 .12 ---------------------------------------------------- Distributions from net investment income (.54) (.05) Distributions from net realized gains - - ---------------------------------------------------- Total distributions - - ---------------------------------------------------- Net asset value, end of period 11.58 10.90 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/4 11.42 1.07 RATIOS/SUPPLEMENTAL DATA Net assets, end of period ($ x 1,000) 7,412 304 Ratios to average net assets: (%) Expenses 1.17 1.17/5 Net investment income 4.81 5.325/ Portfolio turnover rate (%) 12.05 26.39 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.98 12.01 11.96 11.67 11.76 ---------------------------------------------------- Net investment income/2 .55 .55 .55 .60 .60 Net realized and unrealized gains (losses) .66 (1.04) .06 .29 (.07) ---------------------------------------------------- Total from investment operations 1.21 (.49) .61 .89 .53 ---------------------------------------------------- Distributions from net investment income (.54) (.54) (.55) (.59) (.62) Distributions from net realized gains - -/3 (.01) (.01) - ---------------------------------------------------- Total distributions (.54) (.54) (.56) (.60) (.62) ---------------------------------------------------- Net asset value, end of year 11.65 10.98 12.01 11.96 11.67 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/4 11.26 (4.14) 5.21 7.80 4.65 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 74,194 72,135 82,596 56,027 23,556 Ratios to average net assets: (%) Expenses 1.17 1.17 1.17 1.17 1.17 Net investment income 4.86 4.83 4.63 4.88 5.17 Portfolio turnover rate (%) 12.05 26.39 7.66 5.60 12.00 1. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 2. Based on average shares outstanding effective year ended February 29, 2000. 3. The Fund made a capital gain distribution of $.0009. 4. Total return does not include sales charges and is not annualized. 5. Annualized. GEORGIA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.03 12.07 12.12 11.86 11.88 ---------------------------------------------------- Net investment income/1 .59 .59 .61 .63 .65 Net realized and unrealized gains (losses) .70 (1.03) .01 .27 (.02) ---------------------------------------------------- Total from investment operations 1.29 (.44) .62 .90 .63 ---------------------------------------------------- Distributions from net investment income (.59) (.60) (.61) (.64) (.65) Distributions from net realized gains - -/2 (.06) - - ---------------------------------------------------- Total distributions (.59) (.60) (.67) (.64) (.65) ---------------------------------------------------- Net asset value, end of year 11.73 11.03 12.07 12.12 11.86 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/3 11.93 (3.71) 5.22 7.75 5.47 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 163,352 151,670 164,669 149,642 139,903 Ratios to average net assets: (%) Expenses .76 .75 .76 .76 .75 Net investment income 5.15 5.14 5.00 5.28 5.49 Portfolio turnover rate (%) 18.67 46.90 12.84 14.77 17.47 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.10 12.15 12.19 11.92 11.92 ---------------------------------------------------- Net investment income/1 .53 .53 .54 .57 .58 Net realized and unrealized gains (losses) .71 (1.05) .02 .27 (.01) ---------------------------------------------------- Total from investment operations 1.24 (.52) .56 .84 .57 ---------------------------------------------------- Distributions from net investment income (.53) (.53) (.54) (.57) (.57) Distributions from net realized gains - -/2 (.06) - - ---------------------------------------------------- Total distributions (.53) (.53) (.60) (.57) (.57) ---------------------------------------------------- Net asset value, end of year 11.81 11.10 12.15 12.19 11.92 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/3 11.36 (4.32) 4.70 7.19 4.97 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 16,780 14,811 17,277 9,107 4,484 Ratios to average net assets: (%) Expenses 1.31 1.30 1.31 1.32 1.32 Net investment income 4.60 4.58 4.45 4.72 4.87 Portfolio turnover rate (%) 18.67 46.90 12.84 14.77 17.47 1. Based on average shares outstanding effective year ended February 29, 2000. 2. The Fund made a capital gain distribution of $.002. 3. Total return does not include sales charges. KENTUCKY FUND YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.42 11.47 11.45 11.05 11.04 ---------------------------------------------------- Net investment income/1 .57 .58 .59 .61 .61 Net realized and unrealized gains (losses) .61 (1.04) .03 .40 .01 ---------------------------------------------------- Total from investment operations 1.18 (.46) .62 1.01 .62 ---------------------------------------------------- Distributions from net investment income (.57) (.59) (.60) (.61) (.61) ---------------------------------------------------- Net asset value, end of year 11.03 10.42 11.47 11.45 11.05 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.65 (4.13) 5.51 9.38 5.86 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 76,369 63,964 64,516 54,211 44,289 Ratios to average net assets: (%) Expenses .45 .45 .42 .35 .34 Expenses excluding waiver and payments by affiliate .82 .81 .81 .81 .81 Net investment income 5.34 5.31 5.12 5.40 5.63 Portfolio turnover rate (%) 12.80 16.31 10.49 26.61 24.81 1. Based on average shares outstanding year ended February 29, 2000. 2. Total return does not include sales charges. LOUISIANA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.55 11.59 11.61 11.32 11.32 ---------------------------------------------------- Net investment income/1 .58 .58 .60 .63 .65 Net realized and unrealized gains (losses) .67 (1.03) (.01) .30 - ---------------------------------------------------- Total from investment operations 1.25 (.45) .59 .93 .65 ---------------------------------------------------- Distributions from net investment income (.58) (.59) (.61) (.64) (.65) ---------------------------------------------------- Net asset value, end of year 11.22 10.55 11.59 11.61 11.32 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 12.05 (3.93) 5.23 8.46 5.94 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 154,750 144,299 158,099 134,922 112,981 Ratios to average net assets: (%) Expenses .74 .74 .75 .76 .76 Net investment income 5.32 5.29 5.14 5.50 5.76 Portfolio turnover rate (%) 8.63 27.31 14.99 15.26 13.68 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.62 11.66 11.68 11.37 11.37 ---------------------------------------------------- Net investment income/1 .52 .53 .54 .57 .58 Net realized and unrealized gains (losses) .67 (1.04) (.01) .32 - ---------------------------------------------------- Total from investment operations 1.19 (.51) .53 .89 .58 ---------------------------------------------------- Distributions from net investment income (.52) (.53) (.55) (.58) (.58) ---------------------------------------------------- Net asset value, end of year 11.29 10.62 11.66 11.68 11.37 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.46 (4.45) 4.61 8.02 5.27 ---------------------------------------------------- RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 12,424 10,730 9,982 4,469 3,004 Ratios to average net assets: (%) Expenses 1.29 1.29 1.31 1.32 1.33 Net investment income 4.77 4.74 4.58 4.95 5.29 Portfolio turnover rate (%) 8.63 27.31 14.99 15.26 13.68 1. Based on average shares outstanding effective February 29, 2000. 2. Total return does not include sales charges. MARYLAND FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.63 11.66 11.64 11.33 11.38 ---------------------------------------------------- Net investment income/1 .57 .56 .58 .59 .61 Net realized and unrealized gains (losses) .72 (1.00) .06 .32 (.03) ---------------------------------------------------- Total from investment operations 1.29 (.44) .64 .91 .58 ---------------------------------------------------- Distributions from net investment income (.56) (.56) (.58) (.60) (.63) Distributions from net realized gains - (.03) (.04) - - ---------------------------------------------------- Total distributions (.56) (.59) (.62) (.60) (.63) ---------------------------------------------------- Net asset value, end of year 11.36 10.63 11.66 11.64 11.33 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 12.44 (3.86) 5.64 8.27 5.24 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 248,964 221,176 253,014 213,005 185,234 Ratios to average net assets: (%) Expenses .73 .72 .74 .74 .73 Net investment income 5.16 5.07 4.91 5.20 5.42 Portfolio turnover rate (%) 13.01 11.78 6.02 3.19 12.71 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.72 11.75 11.72 11.40 11.44 ---------------------------------------------------- Net investment income/1 .51 .51 .51 .54 .55 Net realized and unrealized gains (losses) .73 (1.01) .07 .31 (.03) ---------------------------------------------------- Total from investment operations 1.24 (.50) .58 .85 .52 ---------------------------------------------------- Distributions from net investment income (.50) (.50) (.51) (.53) (.56) Distributions from net realized gains - (.03) (.04) - - ---------------------------------------------------- Total distributions (.50) (.53) (.55) (.53) (.56) ---------------------------------------------------- Net asset value, end of year 11.46 10.72 11.75 11.72 11.40 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.83 (4.37) 5.11 7.70 4.68 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 22,547 17,298 16,826 10,515 5,084 Ratios to average net assets: (%) Expenses 1.28 1.27 1.29 1.30 1.27 Net investment income 4.61 4.53 4.35 4.63 4.78 Portfolio turnover rate (%) 13.01 11.78 6.02 3.19 12.71 1. Based on average shares outstanding effective February 29, 2000. 2. Total return does not reflect sales charges. MISSOURI FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.02 12.19 12.23 11.83 11.94 ---------------------------------------------------- Net investment income/1 .60 .60 .61 .64 .65 Net realized and unrealized gains (losses) .75 (1.15) - .44 (.07) ---------------------------------------------------- Total from investment operations 1.35 (.55) .61 1.08 .58 ---------------------------------------------------- Distributions from net investment income (.60) (.61) (.62) (.64) (.65) Distributions from net realized gains - (.01) (.03) (.04) (.04) ---------------------------------------------------- Total distributions (.60) (.62) (.65) (.68) (.69) ---------------------------------------------------- Net asset value, end of year 11.77 11.02 12.19 12.23 11.83 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 12.50 (4.62) 5.12 9.43 5.06 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 373,190 346,649 386,948 308,045 269,564 Ratios to average net assets: (%) Expenses .69 .69 .70 .71 .70 Net investment income 5.22 5.16 4.99 5.32 5.56 Portfolio turnover rate (%) 38.38 18.43 15.21 14.30 21.81 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.06 12.24 12.27 11.85 11.97 ---------------------------------------------------- Net investment income/1 .54 .53 .54 .58 .57 Net realized and unrealized gains (losses) .75 (1.16) .01 .45 (.07) ---------------------------------------------------- Total from investment operations 1.29 (.63) .55 1.03 .50 ---------------------------------------------------- Distributions from net investment income (.53) (.54) (.55) (.57) (.58) Distributions from net realized gains - (.01) (.03) (.04) (.04) ---------------------------------------------------- Total distributions (.53) (.55) (.58) (.61) (.62) ---------------------------------------------------- Net asset value, end of year 11.82 11.06 12.24 12.27 11.85 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.94 (5.21) 4.58 8.96 4.32 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 28,695 23,537 20,396 10,045 4,295 Ratios to average net assets: (%) Expenses 1.24 1.24 1.25 1.27 1.27 Net investment income 4.67 4.62 4.44 4.75 4.92 Portfolio turnover rate (%) 38.38 18.43 15.21 14.30 21.81 1. Base on average shares outstanding effective February 29, 2000. 2. Total return does not include sales charges. NORTH CAROLINA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.04 12.16 12.11 11.73 11.75 ---------------------------------------------------- Net investment income/1 .60 .60 .60 .62 .64 Net realized and unrealized gains (losses) .73 (1.12) .06 .38 (.03) ---------------------------------------------------- Total from investment operations 1.33 (.52) .66 1.00 .61 ---------------------------------------------------- Distributions from net investment income (.59) (.60) (.61) (.62) (.63) ---------------------------------------------------- Net asset value, end of year 11.78 11.04 12.16 12.11 11.73 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 12.38 (4.37) 5.54 8.78 5.38 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 342,402 315,101 349,419 297,406 260,979 Ratios to average net assets: (%) Expenses .69 .68 .70 .70 .70 Net investment income 5.25 5.18 4.95 5.24 5.47 Portfolio turnover rate (%) 9.61 21.07 5.44 9.95 9.98 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 11.12 12.24 12.18 11.79 11.80 ---------------------------------------------------- Net investment income/1 .54 .54 .54 .56 .57 Net realized and unrealized gains (losses) .74 (1.13) .06 .39 (.02) ---------------------------------------------------- Total from investment operations 1.28 (.59) .60 .95 .55 ---------------------------------------------------- Distributions from net investment income (.53) (.53) (.54) (.56) (.56) ---------------------------------------------------- Net asset value, end of year 11.87 11.12 12.24 12.18 11.79 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.79 (4.88) 5.02 8.22 4.83 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 43,476 38,577 38,171 20,043 9,607 Ratios to average net assets: (%) Expenses 1.24 1.23 1.25 1.26 1.26 Net investment income 4.70 4.63 4.40 4.69 4.85 Portfolio turnover rate (%) 9.61 21.07 5.44 9.95 9.98 1. Based on average shares outstanding effective February 29, 2000. 2. Total return does not include sales charges. TEXAS FUND YEAR ENDED FEBRUARY 28, CLASS A - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.22 11.42 11.68 11.37 11.58 ---------------------------------------------------- Net investment income/1 .58 .58 .60 .62 .66 Net realized and unrealized gains (losses) .37 (1.16) (.05) .36 - ---------------------------------------------------- Total from investment operations .95 (.58) .55 .98 .66 ---------------------------------------------------- Distributions from net investment income (.57) (.58) (.60) (.64) (.67) Distributions from net realized gains - (.04) (.21) (.03) (.20) ---------------------------------------------------- Total distributions (.57) (.62) (.81) (.67) (.87) ---------------------------------------------------- Net asset value, end of year 10.60 10.22 11.42 11.68 11.37 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 9.53 (5.21) 4.86 8.91 5.91 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 103,010 104,433 127,739 130,578 126,612 Ratios to average net assets: (%) Expenses .81 .78 .77 .76 .75 Net investment income 5.53 5.35 5.17 5.44 5.70 Portfolio turnover rate (%) 14.02 20.93 25.26 34.52 35.57 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.36 11.57 11.81 11.49 11.68 ---------------------------------------------------- Net investment income1 .53 .53 .53 .58 .60 Net realized and unrealized gains (losses) .37 (1.18) (.03) .35 .02 ---------------------------------------------------- Total from investment operations .90 (.65) .50 .93 .62 ---------------------------------------------------- Distributions from net investment income (.51) (.52) (.53) (.58) (.61) Distributions from net realized gains - (.04) (.21) (.03) (.20) ---------------------------------------------------- Total distributions (.51) (.56) (.74) (.61) (.81) ---------------------------------------------------- Net asset value, end of year 10.75 10.36 11.57 11.81 11.49 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 8.90 (5.77) 4.40 8.31 5.48 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 4,486 4,650 5,229 2,076 740 Ratios to average net assets: (%) Expenses 1.36 1.34 1.33 1.33 1.32 Net investment income 4.97 4.79 4.61 4.79 5.03 Portfolio turnover rate (%) 14.02 20.93 25.26 34.52 35.57 1. Based on average shares outstanding effective February 29, 2000. 2. Total return does not reflect sales charges. VIRGINIA FUND CLASS A YEAR ENDED FEBRUARY 28, - ------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.79 11.88 11.88 11.65 11.72 ---------------------------------------------------- Net investment income1 .59 .59 .60 .62 .65 Net realized and unrealized gains (losses) .65 (1.09) .03 .35 (.07) ---------------------------------------------------- Total from investment operations 1.24 (.50) .63 .97 .58 ---------------------------------------------------- Distributions from net investment income (.58) (.59) (.60) (.64) (.64) Distributions from net realized gains - - (.03) (.10) (.01) ---------------------------------------------------- Total distributions (.58) (.59) (.63) (.74) (.65) ---------------------------------------------------- Net asset value, end of year 11.45 10.79 11.88 11.88 11.65 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.80 (4.31) 5.40 8.53 5.15 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 356,599 327,235 379,670 332,199 287,172 Ratios to average net assets: (%) Expenses .70 .68 .68 .69 .69 Net investment income 5.27 5.19 4.98 5.29 5.56 Portfolio turnover rate (%) 8.89 22.53 8.90 12.90 19.25 CLASS C - ------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of year 10.86 11.95 11.95 11.71 11.77 ---------------------------------------------------- Net investment income/1 .53 .53 .53 .57 .58 Net realized and unrealized gains (losses) .66 (1.09) .03 .34 (.05) ---------------------------------------------------- Total from investment operations 1.19 (.56) .56 .91 .53 ---------------------------------------------------- Distributions from net investment income (.52) (.53) (.53) (.57) (.58) Distributions from net realized gains - - (.03) (.10) (.01) ---------------------------------------------------- Total distributions (.52) (.53) (.56) (.67) (.59) ---------------------------------------------------- Net asset value, end of year 11.53 10.86 11.95 11.95 11.71 ---------------------------------------------------- ---------------------------------------------------- Total return (%)/2 11.23 (4.82) 4.78 7.97 4.61 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 24,766 21,454 22,796 13,186 6,674 Ratios to average net assets: (%) Expenses 1.24 1.23 1.24 1.25 1.25 Net investment income 4.72 4.64 4.42 4.72 4.94 Portfolio turnover rate (%) 8.89 22.53 8.90 12.90 19.25 1. Based on average shares outstanding effective February 29, 2000. 2. Total return does not include sales charges. YOUR ACCOUNT [Insert graphic of pencil marking an "X"] CHOOSING A SHARE CLASS ---------------------- Each class has its own sales charge and expense structure, allowing you to choose the class that best meets your situation. Your investment representative can help you decide. CLASS A CLASS B CLASS C (FLORIDA FUND ONLY) (ALL FUNDS EXCEPT KENTUCKY) - ------------------------------------------------------------------------------- o Initial sales o No initial o Initial sales charge of 4.25% sales charge charge of 1% or less o Deferred o Deferred sales o Deferred sales sales charge of charge of 4% charge of 1% on 1% on purchases on shares you shares you sell of $1 million or sell within the within 18 months more sold within first year, 12 months declining to 1% within six years and eliminated after that o Lower annual o Higher annual o Higher annual expenses expenses than expenses than than Class A Class B or C Class A (same as (same as Class B) due due to lower Class C) due to to higher distribution distribution fees higher distribution fees. No conversion to fees. Automatic Class A shares, so annual conversion to Class A expenses do not decrease. shares after eight years, reducing future annual expenses. SALES CHARGES - CLASS A THE SALES CHARGE MAKES UP THIS % WHICH EQUALS THIS % WHEN YOU INVEST THIS AMOUNT OF THE OFFERING OF YOUR NET PRICE INVESTMENT - ------------------------------------------------------------------------------- Under $100,000 4.25 4.44 $100,000 but under $250,000 3.50 3.63 $250,000 but under $500,000 2.50 2.56 $500,000 but under $1 million 2.00 2.04 INVESTMENTS OF $1 MILLION OR MORE If you invest $1 million or more, either as a lump sum or through our cumulative quantity discount or letter of intent programs (see page 40), you can buy Class A shares without an initial sales charge. However, there is a 1% contingent deferred sales charge (CDSC) on any shares you sell within 12 months of purchase. The way we calculate the CDSC is the same for each class (please see page 39). DISTRIBUTION AND SERVICE (12B-1) FEES Class A has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution fees of up to 0.10% per year to those who sell and distribute Class A shares and provide other services to shareholders. Because these fees are paid out of Class A's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS B IF YOU SELL YOUR SHARES WITHIN THIS % IS DEDUCTED FROM YOUR THIS MANY YEARS AFTER BUYING THEM PROCEEDS AS A CDSC - ------------------------------------------------------------------------------- 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 With Class B shares, there is no initial sales charge. However, there is a CDSC if you sell your shares within six years, as described in the table above. The way we calculate the CDSC is the same for each class (please see page 39). After 8 years, your Class B shares automatically convert to Class A shares, lowering your annual expenses from that time on. MAXIMUM PURCHASE AMOUNT The maximum amount you may invest in Class B shares at one time is $249,999. We place any investment of $250,000 or more in Class A shares, since a reduced initial sales charge is available and Class A's annual expenses are lower. DISTRIBUTION AND SERVICE (12B-1) FEES Class B has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class B shares and for services provided to shareholders. Because these fees are paid out of Class B's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS C THE SALES CHARGE MAKES UP THIS % WHICH EQUALS THIS OF THE OFFERING % OF YOUR NET WHEN YOU INVEST THIS AMOUNT PRICE INVESTMENT - ------------------------------------------------------------------------------- Under $1 million 1.00 1.01 WE PLACE ANY INVESTMENT OF $1 MILLION OR MORE IN CLASS A SHARES, SINCE THERE IS NO INITIAL SALES CHARGE AND CLASS A'S ANNUAL EXPENSES ARE LOWER. CDSC There is a 1% contingent deferred sales charge (CDSC) on any Class C shares you sell within 18 months of purchase. The way we calculate the CDSC is the same for each class (please see below). DISTRIBUTION AND SERVICE (12B-1) FEES Class C has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class C shares and for services provided to shareholders. Because these fees are paid out of Class C's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. CONTINGENT DEFERRED SALES CHARGE (CDSC) - CLASS A, B & C The CDSC for each class is based on the current value of the shares being sold or their net asset value when purchased, whichever is less. There is no CDSC on shares you acquire by reinvesting your dividends or capital gains distributions. [Begin callout] The HOLDING PERIOD FOR THE CDSC begins on the day you buy your shares. Your shares will age one month on that same date the next month and each following month. For example, if you buy shares on the 18th of the month, they will age one month on the 18th day of the next month and each following month. [End callout] To keep your CDSC as low as possible, each time you place a request to sell shares we will first sell any shares in your account that are not subject to a CDSC. If there are not enough of these to meet your request, we will sell the shares in the order they were purchased. We will use this same method if you exchange your shares into another Franklin Templeton fund (please see page 46 for exchange information). SALES CHARGE REDUCTIONS AND WAIVERS If you qualify for any of the sales charge reductions or waivers below, please let us know at the time you make your investment to help ensure you receive the lower sales charge. QUANTITY DISCOUNTS We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases of Class A shares. [Begin callout] FRANKLIN TEMPLETON FUNDS include all of the U.S. registered mutual funds of Franklin Templeton Investments, except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. [End callout] o CUMULATIVE QUANTITY DISCOUNT - lets you combine all of your shares in Franklin Templeton funds for purposes of calculating the sales charge. You also may combine the shares of your spouse, and your children or grandchildren, if they are under the age of 21. Certain company and retirement plan accounts also may be included. o LETTER OF INTENT (LOI) - expresses your intent to buy a stated dollar amount of shares over a 13-month period and lets you receive the same sales charge as if all shares had been purchased at one time. We will reserve a portion of your shares to cover any additional sales charge that may apply if you do not buy the amount stated in your LOI. TO SIGN UP FOR THESE PROGRAMS, COMPLETE THE APPROPRIATE SECTION OF YOUR ACCOUNT APPLICATION. REINSTATEMENT PRIVILEGE If you sell shares of a Franklin Templeton fund, you may reinvest some or all of the proceeds within 365 days without an initial sales charge. The proceeds must be reinvested within the same share class, except proceeds from the sale of Class B shares will be reinvested in Class A shares. If you paid a CDSC when you sold your Class A or C shares, we will credit your account with the amount of the CDSC paid but a new CDSC will apply. For Class B shares reinvested in Class A, a new CDSC will not apply, although your account will not be credited with the amount of any CDSC paid when you sold your Class B shares. Proceeds immediately placed in a Franklin Bank Certificate of Deposit (CD) also may be reinvested without an initial sales charge if you reinvest them within 365 days from the date the CD matures, including any rollover. This privilege does not apply to shares you buy and sell under our exchange program. Shares purchased with the proceeds from a money fund may be subject to a sales charge. SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales charge or CDSC by various individuals and institutions or by investors who reinvest certain distributions and proceeds within 365 days. Certain investors also may buy Class C shares without an initial sales charge. The CDSC for each class may be waived for certain redemptions and distributions. If you would like information about available sales charge waivers, call your investment representative or call Shareholder Services at 1-800/632-2301. A list of available sales charge waivers also may be found in the Statement of Additional Information (SAI). GROUP INVESTMENT PROGRAM Allows established groups of 11 or more investors to invest as a group. For sales charge purposes, the group's investments are added together. There are certain other requirements and the group must have a purpose other than buying Fund shares at a discount. [Insert graphic of a paper with lines and someone writing] BUYING SHARES ------------- MINIMUM INVESTMENTS - ------------------------------------------------------------------------------- INITIAL ADDITIONAL - ------------------------------------------------------------------------------- Regular accounts $1,000 $50 - ------------------------------------------------------------------------------- Automatic investment plans $50 $50 - ------------------------------------------------------------------------------- UGMA/UTMA accounts $100 $50 - ------------------------------------------------------------------------------- Broker-dealer sponsored wrap account programs $250 $50 - ------------------------------------------------------------------------------- Full-time employees, officers, trustees and directors of Franklin Templeton entities, and their immediate family members $100 $50 - ------------------------------------------------------------------------------- PLEASE NOTE THAT YOU MAY ONLY BUY SHARES OF A FUND ELIGIBLE FOR SALE IN YOUR STATE OR JURISDICTION. ACCOUNT APPLICATION If you are opening a new account, please complete and sign the enclosed account application. Make sure you indicate the share class you have chosen. If you do not indicate a class, we will place your purchase in Class A shares. To save time, you can sign up now for services you may want on your account by completing the appropriate sections of the application (see "Investor Services" on page 44). For example, if you would like to link one of your bank accounts to your Fund account so that you may use electronic funds transfer to and from your bank account to buy and sell shares, please complete the bank information section of the application. We will keep your bank information on file for future purchases and redemptions. BUYING SHARES - ------------------------------------------------------------------------------- OPENING AN ACCOUNT ADDING TO AN ACCOUNT - ------------------------------------------------------------------------------- [Insert graphic of hands shaking] Contact your investment Contact your investment THROUGH YOUR representative representative INVESTMENT REPRESENTATIVE - ------------------------------------------------------------------------------- [Insert graphic If you have another Before requesting a of phone and Franklin Templeton fund telephone or online computer] account with your bank purchase into an account information on existing account, BY PHONE/ONLINE file, you may open a new please make sure we account by phone. At have your bank account (Up to $100,000 this time, a new account information on file. If per shareholder may not be opened online. we do not have this per day) information, you will To make a same day need to send written 1-800/632-2301 investment, your phone instructions with your order must be received bank's name and franklintempleton.com and accepted by us by address, a voided check 1:00 p.m. Pacific time or savings account NOTE: CERTAIN or the close of the New deposit slip, and a ACCOUNT TYPES ARE York Stock Exchange, signature guarantee if NOT AVAILABLE FOR whichever is earlier. the bank and Fund ONLINE ACCOUNT accounts do not have at ACCESS least one common owner. To make a same day investment, your phone or online order must be received and accepted by us by 1:00 p.m. Pacific time or the close of the New York Stock Exchange, whichever is earlier. - ------------------------------------------------------------------------------- Make your check payable Make your check payable [Insert graphic to the Fund. to the Fund. Include your of envelope] account number on the Mail the check and check. BY MAIL signed application to Investor Services. Fill out the deposit slip from your account statement. If you do not have a slip, include a note with your name, the Fund name, and your account number. Mail the check and deposit slip or note to Investor Services. - ------------------------------------------------------------------------------- [Insert graphic Call to receive a wire Call to receive a wire of three control number and wire control number and wire lightning bolts] instructions. instructions. Wire the funds and mail To make a same day wire your signed application investment, please call BY WIRE to Investor Services. us by 1:00 p.m. Pacific Please include the wire time and make sure your 1-800/632-2301 control number or your wire arrives by 3:00 p.m. (or new account number on 1-650/312-2000 the application. collect) To make a same day wire investment, please call us by 1:00 p.m. Pacific time and make sure your wire arrives by 3:00 p.m. - ------------------------------------------------------------------------------- [Insert graphic Call Shareholder Call Shareholder of two Services at the number Services at the number arrows pointing in below, or send signed below or our automated opposite written instructions. TeleFACTS system, or directions] You also may place an send signed written online exchange order. instructions. You also BY EXCHANGE The TeleFACTS system may place an online cannot be used to open exchange order. TeleFACTS(R) a new account. 1-800/247-1753 (Please see page 46 for (around-the-clock (Please see page 46 for information on access) information on exchanges.) exchanges.) Our Website franklintempleton.com - ------------------------------------------------------------------------------- FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of person with a headset] INVESTOR SERVICES ----------------- AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to invest in a Fund by automatically transferring money from your checking or savings account each month to buy shares. To sign up, complete the appropriate section of your account application and mail it to Investor Services. If you are opening a new account, please include the minimum initial investment of $50 with your application. AUTOMATIC PAYROLL DEDUCTION You may invest in a Fund automatically by transferring money from your paycheck to the Fund by electronic funds transfer. If you are interested, indicate on your application that you would like to receive an Automatic Payroll Deduction Program kit. DISTRIBUTION OPTIONS You may reinvest distributions you receive from a Fund in an existing account in the same share class* of the Fund or another Franklin Templeton fund. Initial sales charges and CDSCs will not apply if you reinvest your distributions within 365 days. You also can have your distributions deposited in a bank account, or mailed by check. Deposits to a bank account may be made by electronic funds transfer. Please indicate on your application the distribution option you have chosen, otherwise we will reinvest your distributions in the same share class of the Fund. *Class B and C shareholders may reinvest their distributions in Class A shares of any Franklin Templeton money fund. TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to information about your account or any Franklin Templeton fund. This service is available from touch-tone phones at 1-800/247-1753. For a free TeleFACTS brochure, call 1-800/DIAL BEN. FRANKLIN TEMPLETON ONLINE You can visit us online at franklintempleton.com for around-the-clock viewing of information about most Franklin Templeton funds or to register to view your accounts online. You also may register for online transactions that will allow you to buy, sell, or exchange your shares and make certain changes to your account. Some account types may not be able to process any or all transactions online. You also may register online for Franklin Templeton's convenient electronic delivery of your important shareholder documents. This service should be available on our website in July 2001. TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account, allowing you to obtain or view your account information, and conduct a number of transactions by phone or online, including: buy, sell, or exchange shares of most funds; use electronic funds transfer to buy or sell shares of most funds; change your address; request a year-end statement; add or change account services (including distribution options, systematic withdrawals, automatic investment plans). In addition, you may elect to receive your important shareholder documents online and discontinue receiving paper copies. To view your account information or request online transactions, you will first need to register for these services at the shareholder section of our website at franklintempleton.com. You will be asked to accept the terms of an online agreement(s) and establish a password for online services. If you are registered for online services, you may enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most Funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Using our shareholder website means you are consenting to sending and receiving personal financial information over the Internet so you should be sure you are comfortable with the risks. As long as we follow reasonable security procedures and act on instructions we reasonably believe are genuine, we will not be responsible for any losses that may occur from unauthorized requests. We will request passwords or other information, and also may record calls. To help safeguard your account, keep your password confidential, and verify the accuracy of your confirmation statements immediately after you receive them. Contact us immediately if you believe someone has obtained unauthorized access to your account or password. For transactions done over the Internet, we recommend the use of an Internet browser with 128-bit encryption. Certain methods of contacting us (such as by phone or by Internet) may be unavailable or delayed during periods of unusual market activity. OF COURSE, YOU CAN DECLINE TELEPHONE BUY, SELL, OR EXCHANGE PRIVILEGES ON YOUR ACCOUNT APPLICATION, OR CHOOSE NOT TO REGISTER FOR ONLINE PRIVILEGES. IF YOU HAVE TELEPHONE/ONLINE PRIVILEGES ON YOUR ACCOUNT AND WANT TO DISCONTINUE THEM, PLEASE CONTACT US FOR INSTRUCTIONS. You may reinstate these privileges at any time in writing, including online registration with respect to online privileges. NOTE: We discourage you from including confidential or sensitive information in any Internet communication to us. If you do choose to send email (encrypted or not) to us over the Internet, you are accepting the associated risks of lack of confidentiality. EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton funds within the same class*, generally without paying any additional sales charges. If you exchange shares held for less than six months, however, you may be charged the difference between the initial sales charge of the two funds if the difference is more than 0.25%. If you exchange shares from a money fund, a sales charge may apply no matter how long you have held the shares. [Begin callout] An EXCHANGE is really two transactions: a sale of one fund and the purchase of another. In general, the same policies that apply to purchases and sales apply to exchanges, including minimum investment amounts. Exchanges also have the same tax consequences as ordinary sales and purchases. [End callout] Generally exchanges may only be made between identically registered accounts, unless you send written instructions with a signature guarantee. Any CDSC will continue to be calculated from the date of your initial investment and will not be charged at the time of the exchange. The purchase price for determining a CDSC on exchanged shares will be the price you paid for the original shares. If you exchange shares subject to a CDSC into a Class A money fund, the time your shares are held in the money fund will not count towards the CDSC holding period. If you exchange your Class B shares for the same class of shares of another Franklin Templeton fund, the time your shares are held in that fund will count towards the eight year period for automatic conversion to Class A shares. Because excessive trading can hurt fund performance, operations and shareholders, each Fund reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges, reject any exchange, or restrict or refuse purchases if (i) the Fund or its manager believes the Fund would be harmed or unable to invest effectively, or (ii) the Fund receives or anticipates simultaneous orders that may significantly affect the Fund (please see "Market Timers" on page 52. *Class Z shareholders of Franklin Mutual Series Fund Inc. may exchange into Class A without any sales charge. Advisor Class shareholders of another Franklin Templeton fund also may exchange into Class A without any sales charge. Advisor Class shareholders who exchange their shares for Class A shares and later decide they would like to exchange into another fund that offers Advisor Class may do so. SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your shares and receive regular payments from your account. A CDSC may apply to withdrawals that exceed certain amounts. Certain terms and minimums apply. To sign up, complete the appropriate section of your application. [Insert graphic of a certificate] SELLING SHARES -------------- You can sell your shares at any time. Please keep in mind that a contingent deferred sales charge (CDSC) may apply. SELLING SHARES IN WRITING Generally, requests to sell $100,000 or less can be made over the phone, online, or with a simple letter. Sometimes, however, to protect you and the Fund we will need written instructions signed by all registered owners, with a signature guarantee for each owner, if: [Begin callout] A SIGNATURE GUARANTEE helps protect your account against fraud. You can obtain a signature guarantee at most banks and securities dealers. A notary public CANNOT provide a signature guarantee. [End callout] o you are selling more than $100,000 worth of shares o you want your proceeds paid to someone who is not a registered owner o you want to send your proceeds somewhere other than the address of record, or preauthorized bank or brokerage firm account We also may require a signature guarantee on instructions we receive from an agent, not the registered owners, or when we believe it would protect the Fund against potential claims based on the instructions received. SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased, we may delay sending you the proceeds until your check, draft or wire/electronic funds transfer has cleared, which may take seven business days or more. A certified or cashier's check may clear in less time. REDEMPTION PROCEEDS Your redemption check will be sent within seven days after we receive your request in proper form. We are not able to receive or pay out cash in the form of currency. Redemption proceeds may be delayed if we have not yet received your signed account application. SELLING SHARES - ------------------------------------------------------------------------------- TO SELL SOME OR ALL OF YOUR SHARES - ------------------------------------------------------------------------------- [Insert graphic of hands shaking] Contact your investment representative THROUGH YOUR INVESTMENT REPRESENTATIVE - ------------------------------------------------------------------------------- [Insert graphic of Send written instructions and endorsed envelope] share certificates (if you hold share certicates) to Investor Services. Corporate, partnership or trust BY MAIL accounts may need to send additional documents. Specify the Fund, the account number and the dollar value or number of shares you wish to sell. If you own both Class A and B shares, also specify the class of shares, otherwise we will sell your Class A shares first. Be sure to include all necessary signatures and any addtional documents, as well as signature guarantees if required. A check will be mailed to the name(s) and address on the account, or otherwise according to your written instructions. - ------------------------------------------------------------------------------- [Insert graphic of As long as your transaction is for $100,000 or less, you phone and computer] do not hold share certificates and you have not changed your address by phone or online within the last 15 days, BY PHONE/ONLINE you can sell your shares by phone or online. 1-800/632-2301 A check will be mailed to the name(s) and address on the franklintempleton.com account. Written instructions, with a signature guarantee, are required to send the check to another address or to make it payable to another person. (Please see page 44 for more information.) - ------------------------------------------------------------------------------- [Insert graphic of You can call, write, or visit us online to have three redemption proceeds sent to a bank account. See the lightning bolts] policies above for selling shares by mail, phone, or online. BY ELECTRONIC FUNDS TRANSFER (ACH) Before requesting to have redemption proceeds sent to a bank account, please make sure we have your bank account information on file. If we do not have this information, you will need to send written instructions with your bank's name and address, a voided check or savings account deposit slip, and a signature guarantee if the bank and Fund accounts do not have at least one common owner. If we receive your request in proper form by 1:00 p.m. Pacific time, proceeds sent by ACH generally will be available within two to three business days. - ------------------------------------------------------------------------------- [Insert graphic of Obtain a current prospectus for the fund you are two arrows pointing considering. Prospectuses are available online at in opposite franklintempleton.com. directions] BY EXCHANGE Call Shareholder Services at the number below or our our automated TeleFACTS system, or send signed written TeleFACTS(R) instructions. You also may place an exchange order 1-800/247-1753 online. Se the policies above for selling shares by (around-the-clock mail, phone, or online access) If you hold share certificates, you will need to return them to the Fund before your exchange can be processed. - ------------------------------------------------------------------------------- FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of paper and pen] ACCOUNT POLICIES ---------------- CALCULATING SHARE PRICE Each Fund calculates its net asset value per share (NAV) each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). Each class's NAV is calculated by dividing its net assets by the number of its shares outstanding. [Begin callout] When you buy shares, you pay the offering price. The offering price is the NAV plus any applicable sales charge. When you sell shares, you receive the NAV minus any applicable contingent deferred sales charge (CDSC). [End callout] Each Fund's assets are generally valued at their market value. If market prices are unavailable, or if an event occurs after the close of the trading market that materially affects the values, assets may be valued at their fair value. Requests to buy and sell shares are processed at the NAV next calculated after we receive your request in proper form. ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250 ($50 for employee and UGMA/UTMA accounts) because you sell some of your shares, we may mail you a notice asking you to bring the account back up to its applicable minimum investment amount. If you choose not to do so within 30 days, we may close your account and mail the proceeds to the address of record. You will not be charged a CDSC if your account is closed for this reason. STATEMENTS AND REPORTS You will receive quarterly account statements that show all your account transactions during the quarter. You also will receive written notification after each transaction affecting your account (except for distributions and transactions made through automatic investment or withdrawal programs, which will be reported on your quarterly statement). You also will receive the Funds' financial reports every six months. To reduce Fund expenses, we try to identify related shareholders in a household and send only one copy of the financial reports. If you need additional copies, please call 1-800/DIAL BEN. You also can review these documents on our website if you have registered to view your account information online. If you are registered for online services, you may also enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Visit us online at franklintempleton.com for more information. INVESTMENT REPRESENTATIVE ACCOUNT ACCESS If there is a dealer or other investment representative of record on your account, he or she will be able to obtain your account information, conduct transactions for your account, and also will receive copies of all notifications and statements and other information about your account directly from the Fund. STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or nominee name account of one dealer to another, as long as both dealers have an agreement with Franklin Templeton Distributors, Inc. We will process the transfer after we receive authorization in proper form from your delivering securities dealer. JOINT ACCOUNTS Unless you specify a different registration, accounts with two or more owners are registered as "joint tenants with rights of survivorship" (shown as "Jt Ten" on your account statement). To make any ownership changes to a joint account, all owners must agree in writing, regardless of the law in your state. JOINT ACCOUNT RISK WITH TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account. If your account has more than one registered owner, telephone/online privileges allow the Fund to accept online registration for online services (including electronic delivery of important shareholder documents) and transaction instructions online or by telephone from only one registered owner. This means that ANY ONE REGISTERED OWNER ON YOUR ACCOUNT, ACTING ALONE AND WITHOUT THE CONSENT OF ANY OTHER REGISTERED OWNER, may give the Fund instructions by telephone, online or in writing (subject to any limitations in telephone or online privileges) to: o Exchange shares from a jointly registered Fund account requiring all registered owner signatures into an identically registered money fund account that only requires one registered owner's signature to redeem shares; o Redeem Fund shares and direct the redemption proceeds to a bank account that may or may not be owned by you and, if owned by you jointly with someone else, only requires one person to withdraw funds by check or otherwise; o Change the bank account to which Fund share redemption proceeds may be sent, which bank account may not be owned by you; o Purchase Fund shares by debiting a bank account that may be owned by you; and o Change the bank account that may be debited for Fund share purchases, which new account may be owned by you. If you do NOT want another registered owner on your account to be able to issue these kinds of instructions to the Fund without your consent, you must instruct the Fund to deny/terminate online privileges and the ability to issue such instructions by telephone so that these types of instructions will only be accepted in writing signed by all account owners. This decision will apply to any other fund into which you may exchange your jointly owned Fund shares. Any later decision to permit these types of instructions by telephone and/or online will need to be given to the Fund in a written instruction signed by all registered owners. MARKET TIMERS The Funds do not allow investments by Market Timers. You may be considered a Market Timer if you have (i) requested an exchange out of any of the Franklin Templeton funds within two weeks of an earlier exchange request out of any fund, or (ii) exchanged shares out of any of the Franklin Templeton funds more than twice within a rolling 90 day period, or (iii) otherwise seem to follow a market timing pattern that may adversely affect the Fund. Accounts under common ownership or control with an account that is covered by (i), (ii), or (iii) also are subject to these limits. ADDITIONAL POLICIES Please note that the Funds maintain additional policies and reserve certain rights, including: o The Funds may restrict or refuse any order to buy shares, including any purchase under the exchange privilege. o The Funds may modify, suspend, or terminate telephone/online privileges at any time. o At any time, the Funds may change their investment minimums or waive or lower their minimums for certain purchases. o The Funds may modify or discontinue the exchange privilege on 60 days' notice. o In unusual circumstances, we may temporarily suspend redemptions, or postpone the payment of proceeds, as allowed by federal securities laws. o For redemptions over a certain amount, each Fund reserves the right, in the case of an emergency, to make payments in securities or other assets of the Fund, if the payment of cash proceeds by check, wire or electronic funds transfer would be harmful to existing shareholders. o To permit investors to obtain the current price, dealers are responsible for transmitting all orders to the Funds promptly. DEALER COMPENSATION Qualifying dealers who sell Fund shares may receive sales commissions and other payments. These are paid by Franklin Templeton Distributors, Inc. (Distributors) from sales charges, distribution and service (12b-1) fees and its other resources. CLASS A CLASS B CLASS C - ------------------------------------------------------------------------------- COMMISSION (%) --- 3.00 2.00 Investment under $100,000 4.00 --- --- $100,000 but under $250,000 3.25 --- --- $250,000 but under $500,000 2.25 --- --- $500,000 but under $1 million 1.85 --- --- $1 million or more up to 0.75/1 --- --- 12B-1 FEE TO DEALER 0.10 0.15/2 0.65/3 A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer commission of up to 0.25% may be paid on Class A NAV purchases by certain trust companies and bank trust departments, eligible governmental authorities, and broker-dealers or others on behalf of clients participating in comprehensive fee programs. 1. During the first year after purchase, dealers may not be eligible to receive the 12b-1 fee. 2. Dealers may be eligible to receive up to 0.15% from the date of purchase. After 8 years, Class B shares convert to Class A shares and dealers may then receive the 12b-1 fee applicable to Class A. 3. Dealers may be eligible to receive up to 0.15% during the first year after purchase and may be eligible to receive the full 12b-1 fee starting in the 13th month. [Insert graphic of question mark]QUESTIONS If you have any questions about the Funds or your account, you can write to us at P.O. Box 997151, Sacramento, CA 95899-9983. You also can call us at one of the following numbers. For your protection and to help ensure we provide you with quality service, all calls may be monitored or recorded. HOURS (PACIFIC TIME, DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY) - ------------------------------------------------------------------------------- Shareholder Services 1-800/632-2301 5:30 a.m. to 5:00 p.m. 6:30 a.m. to 2:30 p.m. (Saturday) Fund Information 1-800/DIAL BEN 5:30 a.m. to 5:00 p.m. (1-800/342-5236) 6:30 a.m. to 2:30 p.m. (Saturday) Retirement Services 1-800/527-2020 5:30 a.m. to 5:00 p.m. Advisor Services 1-800/524-4040 5:30 a.m. to 5:00 p.m. Institutional Services 1-800/321-8563 6:00 a.m. to 5:00 p.m. TDD (hearing impaired) 1-800/851-0637 5:30 a.m. to 5:00 p.m. TeleFACTS(R)(automated) 1-800/247-1753 (around-the-clock access) FOR MORE INFORMATION You can learn more about each Fund in the following documents: ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS Includes a discussion of recent market conditions and each Fund's strategies that significantly affected Fund performance during its last fiscal year, financial statements, detailed performance information, portfolio holdings and the auditor's report. STATEMENT OF ADDITIONAL INFORMATION (SAI) Contains more information about each Fund, its investments and policies. It is incorporated by reference (is legally a part of this prospectus). For a free copy of the current annual/semiannual report or the SAI, please contact your investment representative or call us at the number below. You also can view the current annual/semiannual report online at franklintempleton.com. FRANKLIN(R)TEMPLETON(R) 1-800/DIAL BEN(R) (1-800/342-5236) TDD (Hearing Impaired) 1-800/851-0637 franklintempleton.com You also can obtain information about each Fund by visiting the SEC's Public Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this information, after paying a duplicating fee, by writing to the SEC's Public Reference Section, Washington, D.C. 20549-0102 or by electronic request at the following e-mail address: publicinfo@sec.gov. Investment Company Act file #811-4149 TF2 P 07/01 FRANKLIN TAX-FREE TRUST FRANKLIN ALABAMA TAX-FREE INCOME FUND FRANKLIN FLORIDA TAX-FREE INCOME FUND FRANKLIN GEORGIA TAX-FREE INCOME FUND FRANKLIN KENTUCKY TAX-FREE INCOME FUND FRANKLIN LOUISIANA TAX-FREE INCOME FUND FRANKLIN MARYLAND TAX-FREE INCOME FUND FRANKLIN MISSOURI TAX-FREE INCOME FUND FRANKLIN NORTH CAROLINA TAX-FREE INCOME FUND FRANKLIN TEXAS TAX-FREE INCOME FUND FRANKLIN VIRGINIA TAX-FREE INCOME FUND STATEMENT OF ADDITIONAL INFORMATION JULY 1, 2001 [Insert Franklin Templeton Ben Head] P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R) This Statement of Additional Information (SAI) is not a prospectus. It contains information in addition to the information in the Funds' prospectus. The Funds' prospectus, dated July 1, 2001, which we may amend from time to time, contains the basic information you should know before investing in the Funds. You should read this SAI together with the Funds' prospectus. The audited financial statements and auditor's report in the Funds' Annual Report to Shareholders, for the fiscal year ended February 28, 2001, are incorporated by reference (are legally a part of this SAI). For a free copy of the current prospectus or annual report, contact your investment representative or call 1-800/DIAL BEN (1-800/342-5236). CONTENTS Goals, Strategies and Risks.................................. 2 Officers and Trustees........................................ 12 Management and Other Services................................ 14 Portfolio Transactions....................................... 16 Distributions and Taxes...................................... 16 Organization, Voting Rights and Principal Holders............ 18 Buying and Selling Shares.................................... 19 Pricing Shares............................................... 24 The Underwriter.............................................. 25 Performance.................................................. 27 Miscellaneous Information.................................... 30 Description of Ratings....................................... 31 State Tax Treatment.......................................... 34 MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS: o ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT; o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK; o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. GOALS, STRATEGIES AND RISKS - ------------------------------------------------------------------------------- Generally, the policies and restrictions discussed in this SAI and in the prospectus apply when a Fund makes an investment. In most cases, the Fund is not required to sell a security because circumstances change and the security no longer meets one or more of the Fund's policies or restrictions. If a percentage restriction or limitation is met at the time of investment, a later increase or decrease in the percentage due to a change in the value or liquidity of portfolio securities will not be considered a violation of the restriction or limitation. If a bankruptcy or other extraordinary event occurs concerning a particular security the Fund owns, the Fund may receive stock, real estate, or other investments that the Fund would not, or could not, buy. If this happens, the Fund intends to sell such investments as soon as practicable while trying to maximize the return to shareholders. Each Fund has adopted certain investment restrictions as fundamental and non-fundamental policies. A fundamental policy may only be changed if the change is approved by (i) more than 50% of a Fund's outstanding shares or (ii) 67% or more of a Fund's shares present at a shareholder meeting if more than 50% of a Fund's outstanding shares are represented at the meeting in person or by proxy, whichever is less. A non-fundamental policy may be changed by the board of trustees without the approval of shareholders. FUNDAMENTAL INVESTMENT POLICIES Each Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investment management and the preservation of shareholders' capital. Each state Fund also tries to provide a maximum level of income exempt from personal income taxes, if any, for resident shareholders of the Fund's state. Each Fund may not: 1. Borrow money or mortgage or pledge any of its assets, except that borrowings (and a pledge of assets therefore) for temporary or emergency purposes may be made from banks in any amount up to 5% of the total asset value. 2. Buy any securities on "margin" or sell any securities "short," except that it may use such short-term credits as are necessary for the clearance of transactions. 3. Make loans, except through the purchase of readily marketable debt securities which are either publicly distributed or customarily purchased by institutional investors. Although such loans are not presently intended, this prohibition will not preclude the Fund from loaning portfolio securities to broker-dealers or other institutional investors if at least 102% cash collateral is pledged and maintained by the borrower; provided such portfolio security loans may not be made if, as a result, the aggregate of such loans exceeds 10% of the value of the Fund's total assets at the time of the most recent loan. 4. Act as underwriter of securities issued by other persons, except insofar as the Fund may be technically deemed an underwriter under the federal securities laws in connection with the disposition of portfolio securities. 5. Purchase the securities of any issuer which would result in owning more than 10% of the voting securities of such issuer, except with respect to the Maryland Fund, which will not purchase a security, if as a result: i) more than 25% of its total assets would be invested in the securities of a single issuer or ii) with respect to 50% of its total assets, more than 5% of its assets would be invested in the securities of a single issuer. 6. Purchase securities from or sell to the Trust's officers and trustees, or any firm of which any officer or trustee is a member, as principal, or retain securities of any issuer if, to the knowledge of the Trust, one or more of the Trust's officers, trustees, or investment manager own beneficially more than one-half of 1% of the securities of such issuer and all such officers and trustees together own beneficially more than 5% of such securities. 7. Acquire, lease or hold real estate, except such as may be necessary or advisable for the maintenance of its offices and provided that this limitation shall not prohibit the purchase of municipal and other debt securities secured by real estate or interests therein. 8. Invest in commodities and commodity contracts, puts, calls, straddles, spreads or any combination thereof, or interests in oil, gas, or other mineral exploration or development programs, except that it may purchase, hold and dispose of "obligations with puts attached" in accordance with its investment policies. 9. Invest in companies for the purpose of exercising control or management. 10. Purchase securities of other investment companies, except in connection with a merger, consolidation or reorganization, except to the extent the Fund invests its uninvested daily cash balances in shares of the Franklin Tax-Exempt Money Fund and other tax-exempt money funds in Franklin Templeton Investments provided i) its purchases and redemptions of such money market fund shares may not be subject to any purchase or redemption fees, ii) its investments may not be subject to duplication of management fees, nor to any charge related to the expense of distributing the Fund's shares (as determined under Rule 12b-1, as amended under the federal securities laws) and iii) aggregate investments by the Fund in any such money market fund do not exceed (A) the greater of (i) 5% of the Fund's total net assets or (ii) $2.5 million, or (B) more than 3% of the outstanding shares of any such money market fund. 11. Invest more than 25% of its assets in securities of any industry; although for purposes of this limitation, tax-exempt securities and U.S. government obligations are not considered to be part of any industry. INVESTMENTS, TECHNIQUES, STRATEGIES AND THEIR RISKS As a fundamental policy, each Fund normally invests at least 80% of its total assets in securities that pay interest free from federal income taxes, including the federal alternative minimum tax. In addition, each state Fund normally invests at least 80% of its total assets in securities that pay interest free from the personal income taxes, if any, of its state. As a nonfundamental policy, each state Fund also normally invests at least 65% of its total assets in municipal securities of its state. Municipal securities issued by a Fund's state or that state's counties, municipalities, authorities, agencies, or other subdivisions, as well as qualifying municipal securities issued by U.S. territories such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands, generally pay interest free from federal income tax and from state personal income taxes, if any, for residents of the Fund's state. Each Fund tries to invest all of its assets in tax-free municipal securities. The issuer's bond counsel generally gives the issuer an opinion on the tax-exempt status of a municipal security when the security is issued. Some states may require a Fund to invest a certain amount of its assets in securities of that state, or in securities that are otherwise tax-free under the laws of that state, in order for any portion of the Fund's distributions to be free from the state's personal income taxes. If a Fund's state requires this, the Fund will try to invest its assets as required so that its distributions will be free from personal income taxes for resident shareholders of the Fund's state. BELOW IS A DESCRIPTION OF VARIOUS TYPES OF MUNICIPAL AND OTHER SECURITIES THAT EACH FUND MAY BUY. OTHER TYPES OF MUNICIPAL SECURITIES MAY BECOME AVAILABLE THAT ARE SIMILAR TO THOSE DESCRIBED BELOW AND IN WHICH EACH FUND ALSO MAY INVEST, IF CONSISTENT WITH ITS INVESTMENT GOAL AND POLICIES. MUNICIPAL BONDS have two principal classifications: general obligation bonds and revenue bonds. GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states, counties, cities, towns and regional districts. The proceeds of these obligations are used to fund a wide range of public projects, including construction or improvement of schools, highways and roads. The basic security behind general obligation bonds is the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. The taxes that can be levied for the payment of debt service may be limited or unlimited as to the rate or amount of special assessments. REVENUE BONDS. The full faith, credit and taxing power of the issuer do not secure revenue bonds. Instead, the principal security for a revenue bond generally is the net revenue derived from a particular facility, group of facilities, or, in some cases, the proceeds of a special excise tax or other specific revenue source. Revenue bonds are issued to finance a wide variety of capital projects, including: electric, gas, water and sewer systems; highways, bridges and tunnels; port and airport facilities; colleges and universities; and hospitals. The principal security behind these bonds may vary. For example, housing finance authorities have a wide range of security, including partially or fully insured mortgages, rent subsidized and/or collateralized mortgages, and/or the net revenues from housing or other public projects. Many bonds provide additional security in the form of a debt service reserve fund that may be used to make principal and interest payments. Some authorities have further security in the form of state assurances (although without obligation) to make up deficiencies in the debt service reserve fund. ANTICIPATION NOTES are issued to provide interim financing of various municipal needs in anticipation of the receipt of other sources of money for repayment of the notes. BOND ANTICIPATION notes are normally issued to provide interim financing until a long-term bond financing can be arranged which provides the money for the repayment of the notes. REVENUE ANTICIPATION notes are issued in expectation of the receipt of revenue sources, other than tax receipts, such as federal revenues available under the Federal Revenue Sharing Program. TAX ANTICIPATION notes are issued to finance the short-term working capital needs of municipalities in anticipation of the receipt of various seasonal tax revenues that are used to repay the notes. They are usually general obligations of the issuer and are secured by the taxing power for the payment of principal and interest. CALLABLE BONDS Each Fund may invest in callable bonds, which allow the issuer to repay some or all of the bonds ahead of schedule. If a bond is called, the Fund will receive the principal amount, the accrued interest, and may receive a small additional payment as a call premium. The manager may sell a callable bond before its call date if it believes the bond is at its maximum premium potential. When pricing callable bonds, the call feature is factored into the price of the bonds and may impact a Fund's net asset value. An issuer is more likely to call its bonds when interest rates are below the rate at which the original bond was issued, because the issuer can issue new bonds with lower interest payments. If a bond is called, the Fund may have to replace it with a lower-yielding security. A call of some or all of these securities may lower a Fund's income, its yield and its distributions to shareholders. If the Fund originally paid a premium for the bond because it had appreciated in value from its original issue price, the Fund also may not be able to recover the full amount it paid for the bond. One way for a Fund to protect itself from call risk is to buy bonds with call protection. Call protection is an assurance that the bond will not be called for a specific time period, typically five to 10 years from when the bond is issued. COMMERCIAL PAPER is a promissory note issued by a corporation to finance its short-term credit needs. Each Fund may invest in taxable commercial paper only for temporary defensive purposes. CONVERTIBLE AND STEP COUPON BONDS Each Fund may each invest a portion of its assets in convertible and step coupon bonds. Convertible bonds are zero-coupon securities until a predetermined date, at which time they convert to a specified coupon security. The coupon on step coupon bonds changes periodically during the life of the security based on predetermined dates chosen when the security is issued. Zero coupon bonds tend to react more sharply to changes in interest rates than traditional bonds. ESCROW-SECURED OR PRE-REFUNDED BONDS are created when an issuer uses the proceeds from a new bond issue to buy high grade, interest bearing debt securities, generally direct obligations of the U.S. government in order to redeem (or pre-refunded), before maturity, an outstanding bond issue that is not immediately callable. These securities are then deposited in an irrevocable escrow account held by a trustee bank to secure all future payments of principal and interest on the pre-refunded bond. Pre-refunded bonds often receive a triple A or equivalent rating. Because pre-refunded bonds still bear the same interest rate, and have a very high credit quality, their price may increase. However, as the original bond approaches its call date, the bond's price will fall to its call price. Each Fund's manager attempts to manage the pre-refunded bonds in its portfolio so that it sells them before this decline in price occurs. MUNICIPAL LEASE OBLIGATIONS are created to finance the purchase of property for public use. The property is then leased to the state or a local government and these leases secure the municipal lease obligations. The lease payments are used to pay the interest on the obligations. However, municipal lease obligations differ from other municipal securities because each year the lessee's governing body must appropriate (set aside) the money to make the lease payments. If the money is not appropriated, the issuer or the lessee can end the lease without penalty. If the lease is cancelled, investors who own the municipal lease obligations may not be paid. Each Fund may invest in municipal lease obligations, including certificates of participation. The board of trustees reviews each Fund's municipal lease obligations to try to assure that they are liquid investments based on various factors reviewed by each Fund's manager. Since annual appropriations are required to make lease payments, municipal lease obligations generally are not subject to constitutional limitations on the issuance of debt, and may allow an issuer to increase government liabilities beyond constitutional debt limits. When faced with increasingly tight budgets, local governments have more discretion to curtail lease payments under a municipal lease obligation than they do to curtail payments on other municipal securities. If not enough money is appropriated to make the lease payments, the leased property may be repossessed as security for holders of the municipal lease obligations. If this happens, there is no assurance that the property's private sector or re-leasing value will be enough to make all outstanding payments on the municipal lease obligations or that the payments will continue to be tax-free. While cancellation risk is inherent to municipal lease obligations, each Fund believes that this risk may be reduced, although not eliminated, by its policies on the quality of municipal lease securities in which it may invest. STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped" form. Stripped municipal securities represent separate ownership of principal and interest payments on municipal securities. TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270 days or less) issued by a municipality to meet working capital needs. TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of public authorities to finance various privately operated facilities which are expected to benefit the municipality and its residents, such as business, manufacturing, housing, sports and pollution control, as well as public facilities such as airports, mass transit systems, ports and parking. The payment of principal and interest is solely dependent on the ability of the facility's user to meet its financial obligations and the pledge, if any, of the facility or other property as security for payment. U.S. GOVERNMENT SECURITIES are issued by the U.S. Treasury or by agencies and instrumentalities of the U.S. government and are backed by the full faith and credit of the U.S. government. They include Treasury bills, notes and bonds. VARIABLE OR FLOATING RATE SECURITIES Each Fund may invest in variable or floating rate securities, including variable rate demand notes, which have interest rates that change either at specific intervals (variable rate), from daily up to monthly, or whenever a benchmark rate changes (floating rate). The interest rate adjustments are designed to help stabilize the security's price. While this feature helps protect against a decline in the security's market price when interest rates rise, it lowers a Fund's income when interest rates fall. Of course, a Fund's income from its variable rate investments also may increase if interest rates rise. Variable or floating rate securities may include a demand feature, which may be unconditional. The demand feature allows the holder to demand prepayment of the principal amount before maturity, generally on one to 30 days' notice. The holder receives the principal amount plus any accrued interest either from the issuer or by drawing on a bank letter of credit, a guarantee or insurance issued with respect to the security. Each Fund generally uses variable or floating rate securities as short-term investments while waiting for long-term investment opportunities. ZERO-COUPON AND DELAYED INTEREST SECURITIES Each Fund may invest in zero-coupon and delayed interest securities. Zero-coupon securities make no periodic interest payments, but are sold at a deep discount from their face value. The buyer recognizes a rate of return determined by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date. The discount varies depending on the time remaining until maturity, as well as market interest rates, liquidity of the security, and the issuer's perceived credit quality. The discount, in the absence of financial difficulties of the issuer, typically decreases as the final maturity date approaches. If the issuer defaults, the Fund may not receive any return on its investment. Because zero-coupon securities bear no interest and compound semiannually at the rate fixed at the time of issuance, their value generally is more volatile than the value of other fixed-income securities. Since zero-coupon bondholders do not receive interest payments, when interest rates rise, zero-coupon securities fall more dramatically in value than bonds paying interest on a current basis. When interest rates fall, zero-coupon securities rise more rapidly in value because the bonds reflect a fixed rate of return. An investment in zero-coupon and delayed interest securities may cause the Fund to recognize income and make distributions to shareholders before it receives any cash payments on its investment. To generate cash to satisfy distribution requirements, the Fund may have to sell portfolio securities that it otherwise would have continued to hold or to use cash flows from other sources such as the sale of Fund shares. IN ADDITION TO STANDARD PURCHASES AND SALES OF VARIOUS MUNICIPAL SECURITIES, EACH FUND'S PORTFOLIO MAY ALSO BE SUBJECT TO CERTAIN OTHER CHARACTERISTICS AND RISKS, AND MAY ALSO ENGAGE IN OTHER STRATEGIES, WHICH, ALONG WITH THESE RISKS, ARE DESCRIBED BELOW. SHOULD OTHER STRATEGIES, NOT SPECIFICALLY DESCRIBED BELOW, BECOME AVAILABLE OR ATTRACTIVE, THE MANAGER MAY ENGAGE IN THEM SO LONG AS THEY ARE CONSISTENT WITH EACH FUND'S GOALS AND OBJECTIVES. CREDIT QUALITY All things being equal, the lower a security's credit quality, the higher the risk and the higher the yield the security generally must pay as compensation to investors for the higher risk. A security's credit quality depends on the issuer's ability to pay interest on the security and, ultimately, to repay the principal. Independent rating agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors Service, Inc. (Moody's), and Standard & Poor's Ratings Group (S&P(R)), often rate municipal securities based on their analysis of the issuer's credit quality. Most rating agencies use a descending alphabet scale to rate long-term securities, and a descending numerical scale to rate short-term securities. Securities in the top four ratings are "investment grade," although securities in the fourth highest rating may have some speculative features. These ratings are described at the end of this SAI under "Description of Ratings." An insurance company, bank or other foreign or domestic entity may provide credit support for a municipal security and enhance its credit quality. For example, some municipal securities are insured, which means they are covered by an insurance policy that guarantees the timely payment of principal and interest. Other municipal securities may be backed by letters of credit, guarantees, or escrow or trust accounts that contain securities backed by the full faith and credit of the U.S. government to secure the payment of principal and interest. As discussed in the prospectus, each Fund has limitations on the credit quality of the securities it may buy. These limitations generally are applied when the Fund makes an investment so that the Fund is not required to sell a security because of a later change in circumstances. In addition to considering ratings in its selection of each Fund's portfolio securities, the manager may consider, among other things, information about the financial history and condition of the issuer, revenue and expense prospects and, in the case of revenue bonds, the financial history and condition of the source of revenue to service the bonds. Securities that depend on the credit of the U.S. government are regarded as having a triple A or equivalent rating. DIVERSIFICATION All of the Funds, except the Maryland Fund, are diversified funds. The Maryland Fund is non-diversified. As a fundamental policy, none of the diversified Funds will buy a security if, with respect to 75% of its net assets, more than 5% would be in the securities of any single issuer (with the exception of obligations of the U.S. government). For this purpose, each political subdivision, agency, or instrumentality, each multi-state agency of which a state is a member, and each public authority that issues private activity bonds on behalf of a private entity, is considered a separate issuer. Escrow-secured or defeased bonds are not generally considered an obligation of the original municipality when determining diversification. Each Fund, including the Maryland Fund, intends to meet certain diversification requirements for tax purposes. Generally, to meet federal tax requirements at the close of each quarter, a Fund may not invest more than 25% of its total assets in any one issuer and, with respect to 50% of total assets, may not invest more than 5% of its total assets in any one issuer. These limitations do not apply to U.S. government securities and may be revised if applicable federal income tax requirements are revised. ILLIQUID INVESTMENTS Each Fund may invest up to 10% of its net assets in illiquid securities. Illiquid securities generally are securities that cannot be sold within seven days in the normal course of business at approximately the amount at which the Fund has valued them. MATURITY Municipal securities are issued with a specific maturity date - the date when the issuer must repay the amount borrowed. Maturities typically range from less than one year (short term) to 30 years (long term). In general, securities with longer maturities are more sensitive to price changes, although they may provide higher yields. The Funds have no restrictions on the maturity of the securities they may buy or on its average portfolio maturity. PORTFOLIO TURNOVER The frequency of portfolio transactions, usually referred to as the portfolio turnover rate, varies for each Fund from year to year, depending on market conditions. While short-term trading increases portfolio turnover and may increase costs, the execution costs for municipal securities are substantially less than for equivalent dollar values of equity securities. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of a Fund's assets in a temporary defensive manner or hold a substantial portion of its portfolio in cash, cash equivalents or other high quality short-term investments. Unfavorable market or economic conditions may include excessive volatility or a prolonged general decline in the securities markets in the securities in which the Funds' invest or in the economies of the states and territories where the Funds' invest. Temporary defensive investments generally may include securities that pay taxable interest, including (i) municipal securities issued by a state or local government other than the Fund's state; (ii) high quality commercial paper; or (iii) securities issued by or guaranteed by the full faith and credit of the U.S. government. Each Fund also may invest all of its assets in municipal securities issued by a U.S. territory such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a "when-issued" basis. When so offered, the price, which is generally expressed in yield terms, is fixed at the time the commitment to buy is made, but delivery and payment take place at a later date. During the time between purchase and settlement, no payment is made by the Fund to the issuer and no interest accrues to the Fund. If the other party to the transaction fails to deliver or pay for the security, the Fund could miss a favorable price or yield opportunity, or could experience a loss. When a Fund makes the commitment to buy a municipal security on a when-issued basis, it records the transaction and includes the value of the security in the calculation of its net asset value. The Fund does not believe that its net asset value or income will be negatively affected by its purchase of municipal securities on a when-issued basis. The Fund will not engage in when-issued transactions for investment leverage purposes. Although a Fund generally will buy municipal securities on a when-issued basis with the intention of acquiring the securities, it may sell the securities before the settlement date if it is considered advisable. When a Fund is the buyer, it will set aside on its books cash or liquid securities, with an aggregate value equal to the amount of its purchase commitments, until payment is made. If assets of a Fund are held in cash pending the settlement of a purchase of securities, the Fund will not earn income on those assets. STATE AND U.S. TERRITORY RISKS STATE Since each state Fund mainly invests in the municipal securities of its state, its performance is closely tied to the ability of issuers of municipal securities in its state to continue to make principal and interest payments on their securities. The issuers' ability to do this is in turn dependent on economic, political and other conditions within the state. Below is a discussion of certain conditions that may affect municipal issuers in the Funds' various states. It is not a complete analysis of every material fact that may affect the ability of issuers of municipal securities to meet their debt obligations or the economic or political conditions within any state and is subject to change. The information below is based on data available to the Funds from historically reliable sources, but the Funds have not independently verified it. The ability of issuers of municipal securities to continue to make principal and interest payments is dependent in large part on their ability to raise revenues, primarily through taxes, and to control spending. Many factors can affect a state's revenues including the rate of population growth, unemployment rates, personal income growth, federal aid, and the ability to attract and keep successful businesses. A number of factors can also affect a state's spending including the need for infrastructure improvements, increased costs for education and other services, current debt levels, and the existence of accumulated budget deficits. The following gives more information about the risks of investing in the Funds. Please read this information together with the section "Main Risks" in the Prospectus. ALABAMA. Alabama's employment base continues to shift from its long reliance on textile and manufacturing to other areas. Although manufacturing has remained an important part of the economy, the trade, construction, transportation and service sectors have supplied most of the state's recent job growth. In particular, recent acceleration in the construction and retail payroll levels have helped offset slowdowns in other areas. Aggressive economic development and business recruitment policies over the last few years have helped to increase growth throughout the state. These policies have brought in significant capital investments, helping offset losses in its textile, apparel and food processing sectors. The transportation/automobile sector in particular has seen a dramatic increase in investment and job growth. However, overall employment growth has currently slowed to a crawl. Though the unemployment rate in December 2000 was lower at 4.6% than the previous year, it is expected to rise as initial unemployment claims throughout the South have soared. Alabama's economic growth and personal income levels have continued to lag national and regional averages. Historically, Alabama has been able to maintain a relatively low overall debt burden as well as balanced financial operations. Under the state's constitution, expenditure reductions are required to prevent deficit spending should the state experience revenue shortfalls. Because of weak tax collections, many state agencies are in the middle of budget cuts. In addition, many suits have been filed challenging proposed cuts to education because of earlier court orders requiring Alabama to remedy funding inequities and other inadequacies in its school systems. Although the state's revenue and tax collections have slowed, the rating agencies Moody's and S&P have both recently considered the state's financial outlook to be stable because of the automatic spending cuts imposed by the state constitution. FLORIDA. Florida's population has grown rapidly in recent years, with the fastest growth among 5-17 year-olds. In the next ten years, the most rapidly growing population will be in the over 85 age group. The rapid growth in the population of both the young and old has required increased expenditures for services, such as schools and health care, and has placed sustained pressure on the state's budget for the funding of these services. As a result, Florida is more vulnerable to increases in the cost of education, Medicaid and other health care services than many other states. While the population of the young and old has grown rapidly, the working age population has grown at a much slower rate and is expected to decline in the coming years. Because of its substantial retirement age population, investment income and transfer payments, such as social security and pension benefits, make up a significant proportion of Florida's income distribution. This income mix historically has led to relatively stable personal income levels across different economic cycles, although it also has created some vulnerability to changes in the consumer price index at the federal level. Florida's tax base has been relatively narrow, with no personal income tax and 60 percent of its revenues derived from the state's sales and use tax. This reliance on a cyclical revenue source has created some vulnerability to recession and slower growth in the tax base. Recent trends also have shown an increase in internet and mail order sales, which the state has not been able to tax. If this trend continues, states that rely on sales taxes, like Florida, could be adversely affected. To help provide some protection against the historically volatile nature of the sales tax, Florida enacted a constitutional amendment creating a budget stabilization fund. Florida projects a balance in this fund of $894 million by FYE 2001, meeting the required level of 5 percent of the previous year's General Fund revenues. In addition, fiscal year 2000 closed with a $860 million combined general and working capital balance. This is a record level of reserves, well above many other states. Over the past five years, Florida's debt burden has grown dramatically with the increased need for schools and health care, as well as environmental protection programs designed to help protect the state's important tourism industry. The state's rapidly growing population should continue to place demands on the state's budget and debt burden needed to finance infrastructure and other improvements. While tourism has remained Florida's most important industry, Florida's economy has continued to diversify from a narrow base of agriculture and seasonal tourism into a service and trade economy. Job growth has been steady and unemployment has been around the national rate. For 2000, Florida's year over year job growth was 3.7 percent, well above the national growth rate of 2.0 percent. Because of its location, much of the state's export sector has relied on exports to Latin America. Although exports have comprised a relatively small part of the gross state product, the sector's dependence on Latin America poses a risk in the event of economic instability in that region. GEORGIA. In the 1990s, Georgia had been among the fastest growing states in terms of population, which had helped fuel employment growth and provided low-cost labor for economic growth. However, in FY 2001, employment growth has slowed due to the economic slowdown. The slowdown is particularly pronounced in the service and manufacturing industries. Although Georgia's expansion continues to moderate, the pace of growth will remain above the national average. Georgia is expected to continue to attract migration into the state given the state's low cost of doing business, extensive transportation infrastructure, below average unemployment rates, access to export markets, availability of land and water, and its central location. Atlanta, which has been at the heart of the state's economic growth, has been a trade, service and transportation center for much of the southeast region. Financially, the state's strong economic and revenue growth has so far allowed the state to meet the needs of its growing population, while maintaining a sound financial position. The state has generated operating surpluses in each of the last six fiscal years from 1995 to 2000, and also has fully funded its reserves. However, given the economic slowdown in FY 2001, Georgia is not expected to enjoy the same kind of budgetary surplus it has in past years. KENTUCKY. Kentucky's economy has performed at or above national levels in both employment and personal income growth over the past several years. Its economy has been moving towards a more modern manufacturing and service-oriented base, with less emphasis on its traditionally low-wage coal, tobacco, and apparel industries. However, two of Kentucky's key industries have been affected by the recent slowing of the national economy. The automotive manufacturing sector has been hit and a number of layoffs have been announced within the high-tech sector. The state's per capita personal income levels have remained consistently below the national average. The labor markets remain tight, although at FYE 2000, Kentucky's unemployment rate had fallen to 4.2% compared to 4.1% for the U.S. Since fiscal 1993, Kentucky's financial management has steadily improved. Results for FYE 2000 were positive, with a General Fund balance of $638.4 million, up from $487.5 million at FYE 1999. That was the seventh consecutive year of positive financial results for the state, due in part to the state's economic growth and a strong record of spending controls. The state's debt ratios, while declining, have remained high relative to other states. The Kentucky state budget continues to emphasize spending for education (especially post-secondary), economic development, criminal justice and information technology. LOUISIANA. Louisiana's economy has been historically cyclical due to its reliance on oil and gas production and petro-chemical products. The state has made some improvements towards a more diversified economy, however, with strong growth in its service sector, especially in healthcare and tourism services. Nonetheless, much of the state's recent economic growth has come from the up turn in the oil and gas sector. Gaming and construction have also contributed. While higher oil prices have taken off some of the pressure on oil-producing companies, the high costs of operating offshore rigs has deterred the exploration and construction of new rigs. Future growth could be limited by the state's dependence on the cyclical oil and gas industry, as well as below average wealth and income levels. Historically, Louisiana's main revenue sources, namely its sales tax, individual and corporate income tax, and severance and royalty taxes, have fluctuated with economic cycles and the oil and gas industry. This fluctuation has created instability and budget problems in the past. During the last several years, however, the state's financial position has somewhat improved. The state has dedicated annual surpluses to debt prepayment or to one-time expenditures. Therefore, at FYE 2000, the unreserved portion of its General Fund reserves remained relatively low at $294 million. Unreserved General Fund balances were actually a negative $81 million, since most of the reserves had been designated for construction projects. The state remains vulnerable, however, to the volatility of its oil and gas industry. Its relatively high debt burdens, unfunded pension liabilities, generally low reserves, and unfunded risk management claims for judgments against the state could affect the state's performance in future years. MARYLAND. Maryland's economic base continues to be well diversified. The state's leading employment and income sectors have been services (34.2%), trade (23.1%) and government (18.3%). The state's dependence on government is larger than most other states due to its close proximity to Washington D.C., making Maryland vulnerable to federal budget cuts and downsizing. At the same time, the state's reliance on the manufacturing sector (7.6%) has been smaller than most other states. Recently, economic growth has come mainly from the business services sector, specifically in the areas of personnel supply, computer and data processing. In addition, employment gains in aerospace, medical research and distribution industries have more than offset the losses seen in the utility, communications and healthcare industries. As a result, unemployment for the state measured 3.5% in 1999, the lowest it had been in more than 20 years, and 3.9% in 2000. Maryland's financial performance has been strong historically. Contributing factors have included high per capita income levels, a well-educated workforce, an advanced infrastructure and diversified employment opportunities. In each of the last four fiscal years, the state has generated operating surpluses while building its financial reserves. Maryland is required to maintain a Revenue Stabilization Reserve Fund equal to 5% of General Fund revenues and at FYE 2000, the balance was $581.9 million or 6.3% of revenues. Debt levels, while high relative to other states, have remained manageable. This relatively high debt level (ranked 10th nationally) is somewhat offset by the rapid amortization of the debt, which is due to a constitutional provision requiring that it be retired within 15 years. In addition, the Capital Debt Affordability Committee seeks to limit total debt to 3.2% of the state's personal income and debt service below 8% of revenues, which measured 2.6% and 5% respectively at FYE 2000. Maryland is in the third year of a five year 10% income tax reduction plan and continues to show no ill effects. On the funding side, health and education continue to be the main focus as they accounted for more than half of the state's expenditures in fiscal year 2000. Education received most of the budgeted increases for fiscal year 2001 and Maryland plans to spend $250 million of the estimated $1 billion in tobacco settlement proceeds on various healthcare initiatives. MISSOURI. Missouri historically has enjoyed a diversified economy that has tended to mirror the national economy. Net migration and personal income growth, however, have been at or above the national average. In March 2001, the state unemployment rate was 3.9%. The service sector comprises the largest source of the state's employment at 28%. Continued declines in the state's manufacturing sector have spread throughout the state's economy impacting construction, transportation and trade. Previously, auto plants had been a positive for the state's economy, but due to the business's cyclical nature and generally weak economic conditions, the state's economic condition is not expected to improve quickly. The state is heavily dependent on old-economy industries and employers with little development of new-economy industries. From a financial standpoint, Missouri's reluctance to rely heavily on borrowing to meet capital needs has resulted in a low debt burden. Missouri has seen positive year-end GAAP fund balances every year since 1993. Spending on school reform will continue to be a challenge for the state. NORTH CAROLINA. North Carolina's economy continued to experience growth through 2000. From 1994 to 1999, job growth was 2.9%, slightly ahead of the national rate of 2.4%. Although the rate of job growth slowed in 2000 after 7 years of increases, the state still managed to record an increase of 1.7%. Below average business costs, a strong durable manufacturing sector, diverse agriculture, three prestigious universities, and access to ports for trade and commerce have all contributed to the state's recent economic strength. However, manufacturing has remained a significant part of the state's economy and has created some vulnerability to recession. 2000 unemployment, while still below the national average, ended higher at 3.6% than 1999's unemployment rate of 3.2%. Although North Carolina's outstanding debt has increased dramatically since 1993, debt levels on a per capita basis remain very low at $387. Although North Carolina has had large, one-time expenses over the last 3 years, the state was been able to meet these adequately through conservative budgeting and continue its recent trend of strong financial performance. However, because of declining tax revenues through 2001, the Governor has issued a fiscal state of emergency to close a widening budget gap. These proposed measures, when implemented, should save the state well in excess of the projected budget gap. S&P continues to have a stable outlook for North Carolina's credit rating. TEXAS. The Texas economy has continued to diversify and move away from its dependence on the volatile oil and gas sector. The state's high-tech sector has become increasingly prominent and is second only to California in total jobs. The construction, government and services industries also have experienced strong growth in recent years due in part to a relatively high rate of net migration to the state. Texas exports are estimated to have been $103 billion in 2000 and have grown by 40% since 1996. Texas ranked fourth among states in the rate of personal income growth from 1996 though 1999 with 7.9% per year. The state ranked second to California in the dollar increase in personal income. High technology industries represent slightly more than oil and gas industries as a percentage of the economy, at 8.9% of total gross state product versus 8.5% for oil and gas. Although the economy remains strong, it appears that economic growth is slowing down. The Comptroller estimates that Texas' real gross state product will rise by 4.3% in 2001 and about an average of 4.2% annually in 2002 and 2003, compared to actual growth rates of 7.1% in 2000, 5% in 1999, and 6.1% in 1998. Key to the Texas economy are its exports, which represent 13 cents of every dollar of U.S. exports. Almost 45% of Texas' exports go to Mexico, which highlights the fact that the Texas economy is more reliant on international trade than ever before. Electronics, industrial machinery (including computers), chemicals and transportation equipment make up almost two-thirds of Texas exports. Financially, the state's performance has improved since the budget deficits of the mid-1980s when the oil and gas sector declined. From 1997 through 1999, Texas posted a General Fund operating surpluses of $760 million, $353 million and $697 million, respectively. However in 2000, the state ended the year with a General Fund operating deficit of $439 million as a result of increased spending, specifically to accommodate the large population growth. The 2000-2001 biennial budget was balanced, but included the use of $1 billion, or almost all, of the state's accumulated General Fund surplus. Since the state does not have a personal income tax, its reliance on cyclical sales taxes could result in some budget instability. The state's debt burden has been relatively modest. In recent years, however, the state's debt position has grown. The state also has moved away from issuing debt designed to be self-supporting and towards issuing debt supported by the general revenue fund. Nonetheless, on a per capita basis the state's debt has remained below the national average. VIRGINIA. Despite the slowing national economy, Virginia's economy remains relatively healthy. Virginia's economy has experienced strong growth in recent years, especially in the areas of business services, high-technology industries and retail trade. Despite cut backs over the past several years, the federal government maintains a large and diverse presence that should help stabilize the Commonwealth's economy as federal surpluses grow. The Commonwealth's unemployment rate has remained one of the nation's lowest due to strong job creation, while personal income levels have continued to exceed the national average. The jobless rate is the fourth lowest in the nation with unemployment at 2.7% at FYE 2000. Historically, Virginia's debt levels have been low, although they have begun to increase due to some large highway and university construction projects. Revenues and expenses have likewise grown. Overall, financial results have been positive with surpluses in each of the past five fiscal years. The fund balance at FYE 2000 was $1,374 million up from $1,173 million at FYE 1999. In coming years, the state will have to fund increased expenditures for education, as well as the elimination of its car tax. When fully phased in during fiscal 2003, the elimination of the car tax is expected to cost the state more than $2.6 billion. U.S. TERRITORIES Since each Fund may invest up to 35% of its assets in municipal securities issued by U.S. territories, the ability of municipal issuers in U.S. territories to continue to make principal and interest payments also may affect a Fund's performance. As with municipal issuers, the ability to make these payments is dependent on economic, political and other conditions. Below is a discussion of certain conditions within some of the territories where the Funds may invest. It is not a complete analysis of every material fact that may affect the ability of issuers of U.S. territory municipal securities to meet their debt obligations or the economic or political conditions within the territories and is subject to change. It is based on data available to the Funds from historically reliable sources, but it has not been independently verified by the Funds. PUERTO RICO. In recent years, Puerto Rico's financial performance has improved. In April 2001, Moody's changed Puerto Rico's outlook to stable from positive. Relatively strong revenue growth and more aggressive tax collection procedures resulted in a General Fund surplus for fiscal 1999 (audited) of $497 million, including an unreserved balance of $185.4 million. Between fiscal years 1993 and 1999, Puerto Rico has experienced a 4.3% drop in the unemployment rate, a 54% increase in hotel registrations, a 31% in retail sales, a 76% increase in exports, and a 22% decrease in welfare recipients. While Puerto Rico's debt per capita levels are at the higher end of the spectrum compared to American states, that is partly explained by the fact that Puerto Rico generally centralizes its debt issuance at the state level. S&P rates Puerto Rico's general obligation debt at A, with a stable outlook. Moody's rates the island's general obligation debt at Baa1. The Moody's rating has been at Baa1 since 1976 and the S&P A rating has been in place since 1956. Going forward, these debt levels may increase as Puerto Rico attempts to finance significant capital and infrastructure improvements. Puerto Rico also will need to address its large unfunded pension liability of more than $6 billion. Puerto Rico also faces challenges from the 1996 passage of a bill eliminating Section 936 of the Internal Revenue Code. This section has given certain U.S. corporations operating in Puerto Rico significant tax advantages. These incentives have helped considerably with Puerto Rico's economic growth, especially with the development of its manufacturing sector. U.S. firms that have benefited from these incentives have provided a significant portion of Puerto Rico's revenues, employment and deposits in local financial institutions. The section 936 incentives are being phased out over a 10-year period ending in 2006. It is hoped that this long phase-out period will give Puerto Rico sufficient time to lessen the potentially negative effects of section 936's elimination. In the fifth year of this phase-out period, business continues to show interest in Puerto Rico as manufacturing and services/commerce continue to represent the largest sector of employment. Outstanding issues relating to the potential for a transition to statehood also may have broad implications for Puerto Rico and its financial and credit position. GUAM. Guam's economy continues to contract, however there have been some signs of improvement. Guam is heavily dependent on tourism. It has been especially dependent on Japanese tourism, which has made Guam vulnerable to fluctuations in the relationship between the U.S. dollar and the Japanese yen. However, the past two years (1999 and 2000) have seen a improvement in tourism. This increased tourism (particularly Japan and Korea) has helped create job growth in the services and retail trade industries as well. Seventy-five percent of tourism is derived from Japan and in 2000, Guam saw arrivals increase 5.2%. Tourism from Korea, the second largest market, increased 79% in 2000. Despite the pickup in the largest industry, tourism, unemployment still remains high at 15.1%. This is down from 15.6% in 1999. Despite an 11% increase in service employment in 2000, Guam experienced significant declines in construction and government employment levels as the U.S. continues to decrease its military presence. Guam has also seen an improvement in personal income, which grew 4% in 2000 compared to 1.5% in 1999 and negative growth in 1998. This is a positive trend since the highest paid jobs tend to be military jobs, which have been decreasing. In the early to mid-1990s, Guam's financial position deteriorated due to a series of natural disasters that led to increased spending on top of already significant budget gaps. As a result, the government introduced a comprehensive financial plan in June 1995 to help balance the budget and reduce the General Fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21 million deficit and ended the year with a negative unreserved General Fund balance of $158.9 million. The 1998 Asian economic crisis and Typhoon Paka, which hit Guam in December 1997, negatively affected both tourism and other economic activities in Guam and contributed to a decline of 1.8% in gross island product between 1997 and 1998. Additional deficits are expected in 1999 and 2000 when the audited financial reports for those periods become available. While Guam's debt burden has been manageable, Guam's ability to maintain current debt levels may be challenged in the near future. U.S. military downsizing has reduced the federal presence on the island and also may reduce federal support for infrastructure projects. At the same time, Guam has faced increasing pressure to improve its infrastructure to help generate economic development. Overall, as of May 15, 2001, S&P's outlook for Guam was negative due to Guam's continued weak financial position and its inability to meet the goals of the financial plan. MARIANA ISLANDS. The Commonwealth of the Mariana Islands became a U.S. territory in 1975. At that time, the U.S. government agreed to exempt the islands from federal minimum wage and immigration laws in an effort to help stimulate industry and the economy. The islands' minimum wage is more than $2 per hour below the U.S. level and tens of thousands of workers have emigrated from various Asian countries to provide cheap labor for the islands' industries. The islands' tourism and apparel industries combined to help increase gross business receipts from $224 million in 1985 to $2.575 billion in 1997. However, a decline in tourism caused by the 1998 Asian economic crisis caused gross business receipt revenue to decline to $2.24 billion in 1998 and $ 2.21 billion in 1999. The breakdown by sector for 1999 was garment manufacturing 36%, retail trade/gas stations 20%, services 16%, tourism 7%(hotels, restaurants only) and other 21%. Gross business revenue tax collections totaled $54.2 million in fiscal year 1999. Also in fiscal year 1999, General Fund revenues totaled $221 million while expenditures totaled $162 million. In 1999, the General Fund balance had a deficit of $39 million, an improvement from 1998's deficit of $49 million. The population of all the islands combined was 67,212 at FYE 1996 and the estimate for 1999 is 78,425. The average earnings per capita totaled $10,192 in 1998. At FYE 1995, the most recent year available, almost 85% of all persons 16 years and older participated in the labor force, compared to 64% in 1980. U.S. VIRGIN ISLANDS. The U.S. Virgin Islands Government has suffered numerous years of budget imbalances over the past decade. The Government's cash flow problems have created recurring annual General Fund deficits. Although the financial operations of the Government have rarely been audited since fiscal year 1995, the accumulated deficit at June 30, 1999 was estimated to be about $341 million. To help finance this deficit, the government has issued several bond deals. A $300 million bond issued in 1999 allowed the Government to finance working capital needs, pay outstanding obligations to vendors, and make past due income tax refunds. The Virgin Islands' large public sector payroll (approximately 32.8% of employment), relatively small private sector that is dependent on tourism and related services (21% of employment), and heavy reliance on taxes as a revenue source (close to 97% of all revenues), together with the effects of three major hurricanes in the past ten years, have contributed to its financial problems. The U.S. Virgin Islands did not participate in the record economic boom experienced by the mainland U.S. in the late 1990s. The U.S. Virgin Islands continue to experience high unemployment rates and low wealth levels. The Virgin Islands are highly dependent on tourism, which contracted in 1999, but improved in 2000. While the islands have experienced an increase in hotel occupancy, the majority of visitors come via cruise ships (over 1.4 million cruise passengers in 1999). The Government reported a 25% increase in cruise and air visitor arrivals in 2000. In September 1998, the Department of Interior Office of Inspector General issued an audit report on the Virgin Islands. It noted that while the Virgin Islands had made improvements in its financial situation, problems remained in the areas of overall financial management, expenditure control and revenue collections. To help improve its financial position, the Virgin Islands has developed a five-year economic recovery plan. Central to this plan is a reduction in government spending. In June 1999, the governor implemented a strict hiring freeze and mandated a 5% reduction in personnel expenditures each year through fiscal 2004, a 50% reduction in overtime expenses, and various other cost saving initiatives. In October 1999, the government and the Department of Interior entered into a Memorandum of Understanding stipulating that federal grants will be awarded contingent on several financial performance and accountability standards being met that will demonstrate improvement in the economic and financial condition of the islands. Since the plan is new, it is not yet certain whether or to what extent the plan will be successful in helping the Virgin Islands improve its financial condition. OFFICERS AND TRUSTEES - ------------------------------------------------------------------------------- The Trust has a board of trustees. The board is responsible for the overall management of the Trust, including general supervision and review of each Fund's investment activities. The board, in turn, elects the officers of the Trust who are responsible for administering the Trust's day-to-day operations. The board also monitors each Fund to ensure no material conflicts exist among share classes. While none is expected, the board will act appropriately to resolve any material conflict that may arise. The name, age and address of the officers and board members, as well as their affiliations, positions held with the Trust, and principal occupations during the past five years are shown below. Frank H. Abbott, III (80) 1045 Sansome Street, San Francisco, CA 94111 TRUSTEE President and Director, Abbott Corporation (an investment company); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, MotherLode Gold Mines Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food processing) (until 1996). Harris J. Ashton (69) 191 Clapboard Ridge Road, Greenwich, CT 06830 TRUSTEE Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat packing company); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Chairman of the Board, General Host Corporation (nursery and craft centers) (until 1998). S. Joseph Fortunato (68) Park Avenue at Morris County, P.O. Box 1945 Morristown, NJ 07962-1945 TRUSTEE Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee, as the case may be, of 49 of the investment companies in Franklin Templeton Investments. Edith E. Holiday (49) 3239 38th Street, N.W., Washington, DC 20016 TRUSTEE Director, Amerada Hess Corporation (exploration and refining of oil and gas) (1993-present), Hercules Incorporated (chemicals, fibers and resins) (1993-present), Beverly Enterprises, Inc. (health care) (1995-present), H.J. Heinz Company (processed foods and allied products) (1994-present) and RTI International Metals, Inc. (manufacture and distribution of titanium) (1999-present); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Assistant to the President of the United States and Secretary of the Cabinet (1990-1993), General Counsel to the United States Treasury Department (1989-1990), and Counselor to the Secretary and Assistant Secretary for Public Affairs and Public Liaison-United States Treasury Department (1988-1989). *Charles B. Johnson (68) One Franklin Parkway, San Mateo, CA 94403-1906 CHAIRMAN OF THE BOARD AND TRUSTEE Chairman of the Board, Chief Executive Officer, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President, Franklin Templeton Distributors, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. *Rupert H. Johnson, Jr. (60) One Franklin Parkway, San Mateo, CA 94403-1906 PRESIDENT AND TRUSTEE Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Director, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin Advisory Services, LLC; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Frank W.T. LaHaye (72) 20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014 TRUSTEE Chairman, Peregrine Venture Management Company (venture capital); Director, The California Center for Land Recycling (redevelopment); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, General Partner, Miller & LaHaye and Peregrine Associates, the general partners of Peregrine Venture funds. Gordon S. Macklin (73) 8212 Burning Tree Road, Bethesda, MD 20817 TRUSTEE Director, Martek Biosciences Corporation, WorldCom, Inc. (communications services), MedImmune, Inc. (biotechnology), Overstock.com (internet services), White Mountains Insurance Group, Ltd. (holding company) and Spacehab, Inc. (aerospace services); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chairman, White River Corporation (financial services) (until 1998) and Hambrecht & Quist Group (investment banking) (until 1992), and President, National Association of Securities Dealers, Inc. (until 1987). Sheila Amoroso (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Harmon E. Burns (56) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Director, Franklin Investment Advisory Services, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Rafael R. Costas, Jr. (36) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Martin L. Flanagan (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND CHIEF FINANCIAL OFFICER President, Member - Office of the President, Chief Financial Officer and Chief Operating Officer, Franklin Resources, Inc.; Executive Vice President, Franklin/Templeton Investor Services, LLC; President and Chief Financial Officer, Franklin Mutual Advisers, LLC; Executive Vice President, Chief Financial Officer and Director, Templeton Worldwide, Inc.; Executive Vice President and Chief Operating Officer, Templeton Investment Counsel, LLC; Executive Vice President, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Chief Financial Officer, Franklin Advisory Services, LLC; officer and/or director of some of the other subsidiaries of Franklin Resources, Inc.; and officer and/or director or trustee, as the case may be, of 51 of the investment companies in Franklin Templeton Investments. David P. Goss (54) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Associate General Counsel, Franklin Templeton Investments; President, Chief Executive Officer and Director, Franklin Select Realty Trust, Property Resources, Inc., Property Resources Equity Trust, Franklin Real Estate Management, Inc. and Franklin Properties, Inc.; officer and director of some of the other subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Franklin Real Estate Income Fund and Franklin Advantage Real Estate Income Fund (until 1996). Barbara J. Green (53) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice President and Deputy General Counsel, Franklin Resources, Inc.; Senior Vice President, Templeton Worldwide, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Deputy Director, Division of Investment Management, Executive Assistant and Senior Advisor to the Chairman, Counselor to the Chairman, Special Counsel and Attorney Fellow, U.S. Securities and Exchange Commission (1986-1995), Attorney, Rogers & Wells (until 1986), and Judicial Clerk, U.S. District Court (District of Massachusetts) (until 1979). Edward V. McVey (63) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Templeton Distributors, Inc.; officer of one of the other subsidiaries of Franklin Resources, Inc. and of 29 of the investment companies in Franklin Templeton Investments. Kimberley Monasterio (37) One Franklin Parkway, San Mateo, CA 94403-1906 TREASURER AND PRINCIPAL ACCOUNTING OFFICER Senior Vice President, Franklin Templeton Services, LLC; and officer of 33 of the investment companies in Franklin Templeton Investments. Murray L. Simpson (64) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND SECRETARY Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director of some of the subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Executive Officer and Managing Director, Templeton Franklin Investment Services (Asia) Limited (until 2000) and Director, Templeton Asset Management Ltd. (until 1999). Thomas Walsh (39) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. *This board member is considered an "interested person" under federal securities laws. Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers. The Trust pays noninterested board members $1,450 per month plus $1,300 per meeting attended. Board members who serve on the audit committee of the Trust and other funds in Franklin Templeton Investments receive a flat fee of $2,000 per committee meeting attended, a portion of which is allocated to the Trust. Members of a committee are not compensated for any committee meeting held on the day of a board meeting. Noninterested board members also may serve as directors or trustees of other funds in Franklin Templeton Investments and may receive fees from these funds for their services. The fees payable to noninterested board members by the Trust are subject to reductions resulting from fee caps limiting the amount of fees payable to board members who serve on other boards within Franklin Templeton Investments. The following table provides the total fees paid to noninterested board members by the Trust and by Franklin Templeton Investments. NUMBER OF BOARDS IN TOTAL FEES FRANKLIN TOTAL RECEIVED TEMPLETON FEES FROM INVESTMENTS RECEIVED FRANKLIN ON WHICH NAME FROM THE TEMPLETON EACH NAME TRUST($)/1 INVESTMENTS($)/2 SERVES/3 - ------------------------------------------------------------------------------- Frank H. Abbott, III 23,056 156,953 28 Harris J. Ashton 25,267 359,404 48 S. Joseph Fortunato 23,564 359,629 49 Edith E. Holiday 31,700 248,305 28 Frank W.T. LaHaye 24,356 165,529 28 Gordon S. Macklin 25,267 359,504 48 1. For the fiscal year ended February 28, 2001. 2. For the calendar year ended December 31, 2000. 3. We base the number of boards on the number of registered investment companies in Franklin Templeton Investments. This number does not include the total number of series or funds within each investment company for which the board members are responsible. Franklin Templeton Investments currently includes 52 registered investment companies, with approximately 156 U.S. based funds or series. Noninterested board members are reimbursed for expenses incurred in connection with attending board meetings, paid pro rata by each fund in Franklin Templeton Investments for which they serve as director or trustee. No officer or board member received any other compensation, including pension or retirement benefits, directly or indirectly from the Funds or other funds in Franklin Templeton Investments. Certain officers or board members who are shareholders of Franklin Resources, Inc. (Resources) may be deemed to receive indirect remuneration by virtue of their participation, if any, in the fees paid to its subsidiaries. Board members historically have followed a policy of having substantial investments in one or more of the funds in Franklin Templeton Investments, as is consistent with their individual financial goals. In February 1998, this policy was formalized through adoption of a requirement that each board member invest one-third of fees received for serving as a director or trustee of a Templeton fund in shares of one or more Templeton funds and one-third of fees received for serving as a director or trustee of a Franklin fund in shares of one or more Franklin funds until the value of such investments equals or exceeds five times the annual fees paid such board member. Investments in the name of family members or entities controlled by a board member constitute fund holdings of such board member for purposes of this policy, and a three year phase-in period applies to such investment requirements for newly elected board members. In implementing such policy, a board member's fund holdings existing on February 27, 1998, are valued as of such date with subsequent investments valued at cost. MANAGEMENT AND OTHER SERVICES - ------------------------------------------------------------------------------- MANAGER AND SERVICES PROVIDED Each Fund's manager is Franklin Advisers, Inc. The manager is a wholly owned subsidiary of Resources, a publicly owned company engaged in the financial services industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal shareholders of Resources. The manager provides investment research and portfolio management services, and selects the securities for each Fund to buy, hold or sell. The manager's extensive research activities include, as appropriate, traveling to meet with issuers and to review project sites. The manager also selects the brokers who execute the Funds' portfolio transactions. The manager provides periodic reports to the board, which reviews and supervises the manager's investment activities. To protect the Funds, the manager and its officers, directors and employees are covered by fidelity insurance. The manager and its affiliates manage numerous other investment companies and accounts. The manager may give advice and take action with respect to any of the other funds it manages, or for its own account, that may differ from action taken by the manager on behalf of each Fund. Similarly, with respect to each Fund, the manager is not obligated to recommend, buy or sell, or to refrain from recommending, buying or selling any security that the manager and access persons, as defined by applicable federal securities laws, may buy or sell for its or their own account or for the accounts of any other fund. The manager is not obligated to refrain from investing in securities held by the Funds or other funds it manages. The Funds, their manager and principal underwriter have each adopted a code of ethics, as required by federal securities laws. Under the code of ethics, employees who are designated as access persons may engage in personal securities transactions, including transactions involving securities that are being considered for a Fund or that are currently held by the Funds, subject to certain general restrictions and procedures. The personal securities transactions of access persons of the Funds, their manager and principal underwriter will be governed by the code of ethics. The code of ethics is on file with, and available from, the U.S. Securities and Exchange Commission (SEC). MANAGEMENT FEES Each Fund pays the manager a fee equal to a monthly rate of: o 5/96 of 1% of the value of its net assets up to and including $100 million; and o 1/24 of 1% of the value of its net assets over $100 million up to and including $250 million; and o 9/240 of 1% of the value of its net assets in excess of $250 million. The fee is computed at the close of business on the last business day of each month according to the terms of the management agreement. Each class of a Fund's shares pays its proportionate share of the fee. For the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the Funds paid the following management fees: MANAGEMENT FEES PAID ($) ----------------------------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------------------- Alabama Fund 1,228,177 1,322,835 1,332,672 Florida Fund 7,333,105 8,076,283 8,253,117 Georgia Fund 968,748 1,008,098 990,149 Kentucky Fund/1 177,830 177,706 143,286 Louisiana Fund 938,871 946,909 908,906 Maryland Fund 1,377,883 1,424,210 1,369,242 Missouri Fund 1,971,021 2,044,766 1,860,465 North Carolina Fund 1,900,389 1,968,656 1,834,435 Texas Fund 661,295 733,060 786,294 Virginia Fund 1,881,538 1,969,003 1,958,381 1. For the fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, management fees, before any advance waiver, totaled $433,107, $412,900, and $377,311, respectively. Under an agreement by the manager to limit its fees, the Fund paid the management fees shown. ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, LLC (FT Services) has an agreement with the manager to provide certain administrative services and facilities for each Fund. FT Services is wholly owned by Resources and is an affiliate of the Funds' manager and principal underwriter. The administrative services FT Services provides include preparing and maintaining books, records, and tax and financial reports, and monitoring compliance with regulatory requirements. ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an annual rate of: o 0.15% of each Fund's average daily net assets up to $200 million; o 0.135% of each Fund's average daily net assets over $200 million up to $700 million; o 0.10% of each Fund's average daily net assets over $700 million up to $1.2 billion; and o 0.075% of each Fund's average daily net assets over $1.2 billion. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the manager paid FT Services the following administration fees: ADMINISTRATION FEES PAID ($) ------------------------------------------------------------ 2001 2000 1999 - -------------------------------------------------------------------------------- Alabama Fund 327,343 355,294 353,966 Florida Fund 1,754,359 1,886,005 1,902,604 Georgia Fund 252,224 265,346 257,705 Kentucky Fund 103,453 99,013 89,842 Louisiana Fund 243,355 245,118 233,010 Maryland Fund 367,338 384,188 362,711 Missouri Fund 544,571 568,299 508,048 North Carolina Fund 523,152 546,466 501,620 Texas Fund 160,989 183,786 198,223 Virginia Fund 517,579 548,267 539,321 SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin Templeton Investor Services, LLC (Investor Services) is each Fund's shareholder servicing agent and acts as the Fund's transfer agent and dividend-paying agent. Investor Services is located at One Franklin Parkway, San Mateo, CA 94403-1906. Please send all correspondence to Investor Services to P.O. Box 997151, Sacramento, CA 95899-9983. For its services, Investor Services receives a fixed fee per account. Each Fund also will reimburse Investor Services for certain out-of-pocket expenses, which may include payments by Investor Services to entities, including affiliated entities, that provide sub-shareholder services, recordkeeping and/or transfer agency services to beneficial owners of the Fund. The amount of reimbursements for these services per benefit plan participant Fund account per year will not exceed the per account fee payable by a Fund to Investor Services in connection with maintaining shareholder accounts. CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New York, NY 10286, acts as custodian of each Fund's securities and other assets. AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105, is the Funds' independent auditor. The auditor gives an opinion on the financial statements included in the Trust's Annual Report to Shareholders and reviews the Trust's registration statement filed with the SEC. PORTFOLIO TRANSACTIONS - ------------------------------------------------------------------------------- Since most purchases by the Funds are principal transactions at net prices, the Funds incur little or no brokerage costs. Each Fund deals directly with the selling or buying principal or market maker without incurring charges for the services of a broker on its behalf, unless it is determined that a better price or execution may be obtained by using the services of a broker. Purchases of portfolio securities from underwriters will include a commission or concession paid by the issuer to the underwriter, and purchases from dealers will include a spread between the bid and ask prices. As a general rule, the Funds do not buy securities in underwritings where they are given no choice, or only limited choice, in the designation of dealers to receive the commission. The Funds seek to obtain prompt execution of orders at the most favorable net price. Transactions may be directed to dealers in return for research and statistical information, as well as for special services provided by the dealers in the execution of orders. It is not possible to place a dollar value on the special executions or on the research services the manager receives from dealers effecting transactions in portfolio securities. The allocation of transactions to obtain additional research services allows the manager to supplement its own research and analysis activities and to receive the views and information of individuals and research staffs of other securities firms. As long as it is lawful and appropriate to do so, the manager and its affiliates may use this research and data in their investment advisory capacities with other clients. If the Funds' officers are satisfied that the best execution is obtained, the sale of Fund shares, as well as shares of other funds in Franklin Templeton Investments, also may be considered a factor in the selection of broker-dealers to execute the Funds' portfolio transactions. If purchases or sales of securities of the Funds and one or more other investment companies or clients supervised by the manager are considered at or about the same time, transactions in these securities will be allocated among the several investment companies and clients in a manner deemed equitable to all by the manager, taking into account the respective sizes of the funds and the amount of securities to be purchased or sold. In some cases this procedure could have a detrimental effect on the price or volume of the security so far as the Funds are concerned. In other cases it is possible that the ability to participate in volume transactions may improve execution and reduce transaction costs to the Funds. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the Funds did not pay any brokerage commissions. As of February 28, 2001, the Funds did not own securities of their regular broker-dealers. DISTRIBUTIONS AND TAXES - ------------------------------------------------------------------------------- INCOME AND CAPITAL GAIN DISTRIBUTIONS Each multiclass Fund calculates income dividends and capital gain distributions the same way for each class. The amount of any income dividends per share will differ, however, generally due to the difference in the distribution and service (Rule 12b-1) fees applicable to each class. DISTRIBUTIONS OF NET INVESTMENT INCOME Each Fund receives income generally in the form of interest on its investments. This income, less expenses incurred in the operation of the Fund, constitutes the Fund's net investment income from which dividends may be paid to you. This net investment income may either be tax-exempt or taxable when distributed to you. EXEMPT-INTEREST DIVIDENDS. By meeting certain requirements of the Internal Revenue Code(Code), each Fund qualifies to pay exempt-interest dividends to you. These dividends are derived from interest income exempt from regular federal income tax, and are not subject to regular federal income tax when they are paid to you. In addition, to the extent that exempt-interest dividends are derived from interest on obligations of any state or its political subdivisions, or from interest on qualifying U.S. territorial obligations (including qualifying obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also may be exempt from that state's personal income tax. Income from municipal securities of other states generally does not qualify as tax-free. TAXABLE INCOME DIVIDENDS. Each Fund may earn taxable income from many sources, including temporary investments, the discount on stripped obligations or their coupons, income from securities loans or other taxable transactions, and ordinary income on the sale of market discount bonds. If you are a taxable investor, any income dividends a Fund pays from this income will be taxable to you as ordinary income. DISTRIBUTIONS OF CAPITAL GAINS CAPITAL GAIN DISTRIBUTIONS. Each Fund may realize capital gains and losses on the sale or other disposition of its portfolio securities. Distributions from net short-term capital gains are taxable to you as ordinary income. Distributions from net long-term capital gains are taxable to you as long-term capital gains, regardless of how long you have owned your shares in the Fund. Any net capital gains realized by a Fund generally are distributed once each year, and may be distributed more frequently, if necessary, to reduce or eliminate excise or income taxes on the Fund. FIVE YEAR GAINS. Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), capital gain distributions from a Fund's sale of securities held for more than five years are subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). INFORMATION ON THE AMOUNT AND TAX CHARACTER OF DISTRIBUTIONS Each Fund will inform you of the amount of your income dividends and capital gain distributions at the time they are paid, and will advise you of their tax status for federal income tax purposes shortly after the close of each calendar year. This information will include the portion of the distributions that on average are comprised of taxable income or interest income that is a tax preference item when determining your alternative minimum tax. If you have not owned your Fund shares for a full year, the Fund may designate and distribute to you, as taxable, tax-exempt or tax preference income, a percentage of income that may not be equal to the actual amount of each type of income earned during the period of your investment in the Fund. Taxable distributions declared in December but paid in January are taxable to you as if paid in December. 2001 TAX ACT On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. This Tax Act includes provisions that will significantly reduce individual income tax rates, provide for marriage penalty relief, eliminate current phase-outs of the standard deduction and personal exemptions, provide for additional savings incentives for individuals through expansion of retirement and education savings programs, and provide for limited estate, gift and generation-skipping tax relief. While these provisions have important tax impacts on individual investors in a Fund, their impact on the taxation of a Fund are limited. See your personal tax advisor for more information. ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each Fund has elected to be treated as a regulated investment company under Subchapter M of the Code. It has qualified as a regulated investment company for its most recent fiscal year, and intends to continue to qualify during the current fiscal year. As a regulated investment company, the Fund generally pays no federal income tax on the income and gains it distributes to you. The board reserves the right not to maintain the qualification of a Fund as a regulated investment company if it determines this course of action to be beneficial to shareholders. In that case, the Fund would be subject to federal, and possibly state, corporate taxes on its taxable income and gains, and distributions to you (including dividends from tax-exempt interest) would be taxed as ordinary income dividends to the extent of the Fund's earnings and profits. EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Code requires a Fund to distribute to you by December 31 of each year, at a minimum, the following amounts: o 98% of its taxable ordinary income earned during the calendar year; o 98% of its capital gain net income earned during the twelve month period ending October 31; and o 100% of any undistributed amounts from the prior year. Each Fund intends to declare and pay these distributions in December (or to pay them in January, in which case you must treat them as received in December), but can give no assurances that its distributions will be sufficient to eliminate all taxes. REDEMPTION OF FUND SHARES REDEMPTIONS. Redemptions (including redemptions in kind) and exchanges of Fund shares are taxable transactions for federal and state income tax purposes. If you redeem your Fund shares, or exchange them for shares of a different Franklin Templeton fund, the IRS requires you to report any gain or loss on your redemption or exchange. If you hold your shares as a capital asset, any gain or loss that you realize is a capital gain or loss and is long-term or short-term, generally depending on how long you have owned your shares. FIVE YEAR GAINS. Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), gain from the redemption of Fund shares held for more than five years may be subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). If you are in the 28% or higher tax bracket, you may elect to mark your Fund shares to market as of January 2, 2001. If you make this election, any Fund shares that you acquired before this date will be eligible for the 18% maximum rate of tax, beginning in 2006. However, in making the election, you are required to pay a tax on any appreciation in the value of your Fund shares as of January 2, 2001, and to restart your holding period in the shares as of that date. The election does not apply to Fund shares redeemed on or before January 2, 2002. REDEMPTIONS AT A LOSS WITHIN SIX MONTHS OF PURCHASE. If you redeem or exchange Fund shares held for six months or less: o any loss incurred is disallowed to the extent of any exempt-interest dividends paid to you on your shares, and o any remaining loss is treated as a long-term capital loss to the extent of any long-term capital gains distributed to you by a Fund. WASH SALES. All or a portion of any loss that you realize on the redemption of your Fund shares is disallowed to the extent that you buy other shares in the Fund (through reinvestment of dividends or otherwise) within 30 days before or after your share redemption. Any loss disallowed under these rules is added to your tax basis in the new shares. DEFERRAL OF BASIS. If you redeem some or all of your shares in a Fund, and then reinvest the redemption proceeds in the Fund or in another Franklin Templeton fund within 90 days of buying the original shares, the sales charge that would otherwise apply to your reinvestment may be reduced or eliminated. In reporting any gain or loss on your redemption, all or a portion of the sales charge that you paid for your original shares in the Fund is excluded from your tax basis in the shares sold and added to your tax basis in the new shares. DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because the Fund's income is derived primarily from interest rather than dividends, generally none of its distributions are expected to qualify for the corporate dividends-received deduction. INVESTMENT IN COMPLEX SECURITIES Each Fund may invest in securities issued or purchased at a discount, such as zero coupon, step-up or payment-in-kind(PIK) bonds, that may require it to accrue and distribute income not yet received. In order to generate sufficient cash to make these distributions, a Fund may be required to sell securities in its portfolio that it otherwise might have continued to hold. These rules could affect the amount, timing and tax character of income distributed to you by the Fund. TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity bonds, while exempt from regular federal income tax, is a tax preference item for taxpayers when determining their alternative minimum tax under the Code and under the income tax provisions of several states. Private activity bond interest could subject you to or increase your liability under federal and state alternative minimum taxes, depending on your personal or corporate tax position. Persons defined in the Code as substantial users (or persons related to such users) of facilities financed by private activity bonds should consult their tax advisors before buying Fund shares. ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS - ------------------------------------------------------------------------------- Each Fund is a series of Franklin Tax-Free Trust, an open-end management investment company, commonly called a mutual fund. The Trust was organized as a Massachusetts business trust in September 1984, and is registered with the SEC. As a shareholder of a Massachusetts business trust, you could, under certain circumstances, be held personally liable as a partner for its obligations. The Agreement and Declaration of Trust, however, contains an express disclaimer of shareholder liability for acts or obligations of the Fund. The Declaration of Trust also provides for indemnification and reimbursement of expenses out of the Fund's assets if you are held personally liable for obligations of the Fund. The Declaration of Trust provides that each Fund shall, upon request, assume the defense of any claim made against you for any act or obligation of the Fund and satisfy any judgment thereon. All such rights are limited to the assets of the Fund. The Declaration of Trust further provides that each Fund may maintain appropriate insurance (for example, fidelity bonding and errors and omissions insurance) for the protection of the Fund, its shareholders, trustees, officers, employees and agents to cover possible tort and other liabilities. Furthermore, the activities of the Fund as an investment company, as distinguished from an operating company, would not likely give rise to liabilities in excess of the Fund's total assets. Thus, the risk that you would incur financial loss on account of shareholder liability is limited to the unlikely circumstance in which both inadequate insurance exists and the Fund itself is unable to meet its obligations. Each Fund, except the Florida and Kentucky Funds, currently offers two classes of shares, Class A and Class C. The Florida Fund currently offers three classes of shares, Class A, Class B and Class C. The Funds may offer additional classes of shares in the future. The full title of each class is: o Franklin Alabama Tax-Free Income Fund - Class A o Franklin Alabama Tax-Free Income Fund - Class C o Franklin Florida Tax-Free Income Fund - Class A o Franklin Florida Tax-Free Income Fund - Class B o Franklin Florida Tax-Free Income Fund - Class C o Franklin Georgia Tax-Free Income Fund - Class A o Franklin Georgia Tax-Free Income Fund - Class C o Franklin Louisiana Tax-Free Income Fund - Class A o Franklin Louisiana Tax-Free Income Fund - Class C o Franklin Maryland Tax-Free Income Fund - Class A o Franklin Maryland Tax-Free Income Fund - Class C o Franklin Missouri Tax-Free Income Fund - Class A o Franklin Missouri Tax-Free Income Fund - Class C o Franklin North Carolina Tax-Free Income Fund - Class A o Franklin North Carolina Tax-Free Income Fund - Class C o Franklin Texas Tax-Free Income Fund - Class A o Franklin Texas Tax-Free Income Fund - Class C o Franklin Virginia Tax-Free Income Fund - Class A o Franklin Virginia Tax-Free Income Fund - Class C The Kentucky Fund offers only one share class. Because its sales charge structure and Rule 12b-1 plan are similar to those of Class A shares, shares of the Kentucky Fund are considered Class A shares for redemption, exchange and other purposes. The Funds may offer additional classes of shares in the future. Shares of each class represent proportionate interests in each Fund's assets. On matters that affect a Fund as a whole, each class has the same voting and other rights and preferences as any other class. On matters that affect only one class, only shareholders of that class may vote. Each class votes separately on matters affecting only that class, or expressly required to be voted on separately by state or federal law. Shares of each class of a series have the same voting and other rights and preferences as the other classes and series of the Trust for matters that affect the Trust as a whole. Additional series may be offered in the future. The Trust has noncumulative voting rights. For board member elections, this gives holders of more than 50% of the shares voting the ability to elect all of the members of the board. If this happens, holders of the remaining shares voting will not be able to elect anyone to the board. The Trust does not intend to hold annual shareholder meetings. The Trust or a series of the Trust may hold special meetings, however, for matters requiring shareholder approval. A meeting may be called by the board to consider the removal of a board member if requested in writing by shareholders holding at least 10% of the outstanding shares. In certain circumstances, we are required to help you communicate with other shareholders about the removal of a board member. A special meeting also may be called by the board in its discretion. As of June 1, 2001, the principal shareholders of the Funds, beneficial or of record, were: PERCENTAGE NAME AND ADDRESS SHARE CLASS (%) LOUISIANA TAX FREE INCOME FUND Southwest Securities Inc FBO Class C 5.25 Billie Jean Horton PO Box 509002 Dallas, TX 75250 TEXAS TAX FREE INCOME FUND First Clearing Corporation Class C 5.36 Ethan W Grace C Dodgen Revocable Living Trust 4831 W Lawther Drive Dallas, TX 75214-1849 Wexford Clearing Services Corp FBO Class C 7.53 Family Limited Partnership Alo Family Limited 4512 Teas St Bellaire, TX 77401-4223 From time to time, the number of Fund shares held in the "street name" accounts of various securities dealers for the benefit of their clients or in centralized securities depositories may exceed 5% of the total shares outstanding. To the best knowledge of the Fund, no other person holds beneficially or of record more than 5% of the outstanding shares of any class. As of June 1, 2001, the officers and board members, as a group, owned of record and beneficially less than 1% of the outstanding shares of each Fund and class. The board members may own shares in other funds in Franklin Templeton Investments. BUYING AND SELLING SHARES - ------------------------------------------------------------------------------- Each Fund continuously offers its shares through securities dealers who have an agreement with Franklin Templeton Distributors, Inc. (Distributors). A securities dealer includes any financial institution that, either directly or through affiliates, has an agreement with Distributors to handle customer orders and accounts with a Fund. This reference is for convenience only and does not indicate a legal conclusion of capacity. Banks and financial institutions that sell shares of a Fund may be required by state law to register as securities dealers. For investors outside the U.S., the offering of Fund shares may be limited in many jurisdictions. An investor who wishes to buy shares of the Fund should determine, or have a broker-dealer determine, the applicable laws and regulations of the relevant jurisdiction. Investors are responsible for compliance with tax, currency exchange or other regulations applicable to redemption and purchase transactions in any jurisdiction to which they may be subject. Investors should consult appropriate tax and legal advisors to obtain information on the rules applicable to these transactions. All checks, drafts, wires and other payment mediums used to buy or sell shares of the Fund must be denominated in U.S. dollars. We may, in our sole discretion, either (a) reject any order to buy or sell shares denominated in any other currency or (b) honor the transaction or make adjustments to your account for the transaction as of a date and with a foreign currency exchange factor determined by the drawee bank. We may deduct any applicable banking charges imposed by the bank from your account. When you buy shares, if you submit a check or a draft that is returned unpaid to the Fund we may impose a $10 charge against your account for each returned item. INITIAL SALES CHARGES The maximum initial sales charge is 4.25% for Class A and 1% for Class C. There is no initial sales charge for Class B. The initial sales charge for Class A shares may be reduced for certain large purchases, as described in the prospectus. We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases. Franklin Templeton funds include the U.S. registered mutual funds in Franklin Templeton Investments except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on Class A shares, you may combine the amount of your current purchase with the cost or current value, whichever is higher, of your existing shares in Franklin Templeton funds. You also may combine the shares of your spouse, children under the age of 21 or grandchildren under the age of 21. If you are the sole owner of a company, you also may add any company accounts, including retirement plan accounts. LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by completing the letter of intent section of your account application. A letter of intent is a commitment by you to invest a specified dollar amount during a 13 month period. The amount you agree to invest determines the sales charge you pay. By completing the letter of intent section of the application, you acknowledge and agree to the following: o You authorize Distributors to reserve 5% of your total intended purchase in Class A shares registered in your name until you fulfill your LOI. Your periodic statements will include the reserved shares in the total shares you own, and we will pay or reinvest dividend and capital gain distributions on the reserved shares according to the distribution option you have chosen. o You give Distributors a security interest in the reserved shares and appoint Distributors as attorney-in-fact. o Distributors may sell any or all of the reserved shares to cover any additional sales charge if you do not fulfill the terms of the LOI. o Although you may exchange your shares, you may not sell reserved shares until you complete the LOI or pay the higher sales charge. After you file your LOI with the Fund, you may buy Class A shares at the sales charge applicable to the amount specified in your LOI. Sales charge reductions based on purchases in more than one Franklin Templeton fund will be effective only after notification to Distributors that the investment qualifies for a discount. Any Class A purchases you made within 90 days before you filed your LOI also may qualify for a retroactive reduction in the sales charge. If you file your LOI with the Fund before a change in the Fund's sales charge, you may complete the LOI at the lower of the new sales charge or the sales charge in effect when the LOI was filed. Your holdings in Franklin Templeton funds acquired more than 90 days before you filed your LOI will be counted towards the completion of the LOI, but they will not be entitled to a retroactive reduction in the sales charge. Any redemptions you make during the 13 month period will be subtracted from the amount of the purchases for purposes of determining whether the terms of the LOI have been completed. If the terms of your LOI are met, the reserved shares will be deposited to an account in your name or delivered to you or as you direct. If the amount of your total purchases, less redemptions, is more than the amount specified in your LOI and is an amount that would qualify for a further sales charge reduction, a retroactive price adjustment will be made by Distributors and the securities dealer through whom purchases were made. The price adjustment will be made on purchases made within 90 days before and on those made after you filed your LOI and will be applied towards the purchase of additional shares at the offering price applicable to a single purchase or the dollar amount of the total purchases. If the amount of your total purchases, less redemptions, is less than the amount specified in your LOI, the sales charge will be adjusted upward, depending on the actual amount purchased (less redemptions) during the period. You will need to send Distributors an amount equal to the difference in the actual dollar amount of sales charge paid and the amount of sales charge that would have applied to the total purchases if the total of the purchases had been made at one time. Upon payment of this amount, the reserved shares held for your account will be deposited to an account in your name or delivered to you or as you direct. If within 20 days after written request the difference in sales charge is not paid, we will redeem an appropriate number of reserved shares to realize the difference. If you redeem the total amount in your account before you fulfill your LOI, we will deduct the additional sales charge due from the sale proceeds and forward the balance to you. GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A shares at a reduced sales charge that applies to the group as a whole. The sales charge is based on the combined dollar value of the group members' existing investments, plus the amount of the current purchase. A qualified group is one that: o Was formed at least six months ago, o Has a purpose other than buying Fund shares at a discount, o Has more than 10 members, o Can arrange for meetings between our representatives and group members, o Agrees to include Franklin Templeton fund sales and other materials in publications and mailings to its members at reduced or no cost to Distributors, o Agrees to arrange for payroll deduction or other bulk transmission of investments to the Fund, and o Meets other uniform criteria that allow Distributors to achieve cost savings in distributing shares. WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased without an initial sales charge or contingent deferred sales charge (CDSC) by investors who reinvest within 365 days: o Dividend and capital gain distributions from any Franklin Templeton fund. The distributions generally must be reinvested in the same share class. Certain exceptions apply, however, to Class C shareholders who chose to reinvest their distributions in Class A shares of the Fund before November 17, 1997, and to Advisor Class or Class Z shareholders of a Franklin Templeton fund who may reinvest their distributions in the Fund's Class A shares. o Annuity payments received under either an annuity option or from death benefit proceeds, if the annuity contract offers as an investment option the Franklin Templeton Variable Insurance Products Trust. You should contact your tax advisor for information on any tax consequences that may apply. o Redemption proceeds from a repurchase of shares of Franklin Floating Rate Trust, if the shares were continuously held for at least 12 months. If you immediately placed your redemption proceeds in a Franklin Bank CD or a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date the CD matures, including any rollover, or the date you redeem your money fund shares. o Redemption proceeds from the sale of Class A shares of any of the Templeton Global Strategy Funds if you are a qualified investor. If you paid a CDSC when you redeemed your Class A shares from a Templeton Global Strategy Fund, a new CDSC will apply to your purchase of Fund shares and the CDSC holding period will begin again. We will, however, credit your Fund account with additional shares based on the CDSC you previously paid and the amount of the redemption proceeds that you reinvest. If you immediately placed your redemption proceeds in a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date they are redeemed from the money fund. WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without an initial sales charge or CDSC by various individuals and institutions due to anticipated economies in sales efforts and expenses, including: o Trust companies and bank trust departments investing assets held in a fiduciary, agency, advisory, custodial or similar capacity and over which the trust companies and bank trust departments or other plan fiduciaries or participants, in the case of certain retirement plans, have full or shared investment discretion. We may accept orders for these accounts by telephone or other means of electronic data transfer directly from the bank or trust company, with payment by federal funds received by the close of business on the next business day following the order. o Any state or local government or any instrumentality, department, authority or agency thereof that has determined the Fund is a legally permissible investment and that can only buy Fund shares without paying sales charges. Please consult your legal and investment advisors to determine if an investment in the Fund is permissible and suitable for you and the effect, if any, of payments by the Fund on arbitrage rebate calculations. o Broker-dealers, registered investment advisors or certified financial planners who have entered into an agreement with Distributors for clients participating in comprehensive fee programs o Qualified registered investment advisors who buy through a broker-dealer or service agent who has entered into an agreement with Distributors o Registered securities dealers and their affiliates, for their investment accounts only o Current employees of securities dealers and their affiliates and their family members, as allowed by the internal policies of their employer o Officers, trustees, directors and full-time employees of Franklin Templeton Investments, and their family members, consistent with our then-current policies o Any investor who is currently a Class Z shareholder of Franklin Mutual Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z shareholder who had an account in any Mutual Series fund on October 31, 1996, or who sold his or her shares of Mutual Series Class Z within the past 365 days o Investment companies exchanging shares or selling assets pursuant to a merger, acquisition or exchange offer o Accounts managed by Franklin Templeton Investments o Certain unit investment trusts and their holders reinvesting distributions from the trusts In addition, Class C shares may be purchased without an initial sales charge by any investor who buys Class C shares through an omnibus account with Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are sold within 18 months of purchase. DEALER COMPENSATION Securities dealers may at times receive the entire sales charge. A securities dealer who receives 90% or more of the sales charge may be deemed an underwriter under the Securities Act of 1933, as amended. Financial institutions or their affiliated brokers may receive an agency transaction fee in the percentages indicated in the dealer compensation table in the Funds' prospectus. Distributors may pay the following commissions, out of its own resources, to securities dealers who initiate and are responsible for purchases of Class A shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus 0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3 million to $50 million, plus 0.25% on sales over $50 million to $100 million, plus 0.15% on sales over $100 million. These breakpoints are reset every 12 months for purposes of additional purchases. In addition to the payments above, Distributors and/or its affiliates may provide financial support to securities dealers that sell shares of Franklin Templeton Investments. This support is based primarily on the amount of sales of fund shares and/or total assets with Franklin Templeton Investments. The amount of support may be affected by: total sales; net sales; levels of redemptions; the proportion of a securities dealer's sales and marketing efforts in Franklin Templeton Investments; a securities dealer's support of, and participation in, Distributors' marketing programs; a securities dealer's compensation programs for its registered representatives; and the extent of a securities dealer's marketing programs relating to Franklin Templeton Investments. Financial support to securities dealers may be made by payments from Distributors' resources, from Distributors' retention of underwriting concessions and, in the case of funds that have Rule 12b-1 plans, from payments to Distributors under such plans. In addition, certain securities dealers may receive brokerage commissions generated by fund portfolio transactions in accordance with the rules of the National Association of Securities Dealers, Inc. Distributors routinely sponsors due diligence meetings for registered representatives during which they receive updates on various Franklin Templeton funds and are afforded the opportunity to speak with portfolio managers. Invitation to these meetings is not conditioned on selling a specific number of shares. Those who have shown an interest in Franklin Templeton funds, however, are more likely to be considered. To the extent permitted by their firm's policies and procedures, registered representatives' expenses in attending these meetings may be covered by Distributors. CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in Class A shares, either as a lump sum or through our cumulative quantity discount or letter of intent programs, a CDSC may apply on any shares you sell within 12 months of purchase. For Class C shares, a CDSC may apply if you sell your shares within 18 months of purchase. The CDSC is 1% of the value of the shares sold or the net asset value at the time of purchase, whichever is less. For Class B shares, there is a CDSC if you sell your shares within six years, as described in the table below. The charge is based on the value of the shares sold or the net asset value at the time of purchase, whichever is less. IF YOU SELL YOUR CLASS B SHARES WITHIN THIS MANY YEARS AFTER THIS % IS DEDUCTED FROM YOUR AFTER BUYING THEM PROCEEDS AS A CDSC - ------------------------------------------------------------------------------- 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 CDSC WAIVERS. The CDSC for any share class generally will be waived for: o Account fees o Redemptions of Class A shares by investors who purchased $1 million or more without an initial sales charge if the securities dealer of record waived its commission in connection with the purchase o Redemptions by a Fund when an account falls below the minimum required account size o Redemptions following the death of the shareholder or beneficial owner o Redemptions through a systematic withdrawal plan set up before February 1, 1995 o Redemptions through a systematic withdrawal plan set up on or after February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of your account's net asset value depending on the frequency of your plan EXCHANGE PRIVILEGE If you request the exchange of the total value of your account, accrued but unpaid income dividends and capital gain distributions will be reinvested in the Fund at net asset value on the date of the exchange, and then the entire share balance will be exchanged into the new fund. Backup withholding and information reporting may apply. If a substantial number of shareholders should, within a short period, sell their Fund shares under the exchange privilege, the Fund might have to sell portfolio securities it might otherwise hold and incur the additional costs related to such transactions. On the other hand, increased use of the exchange privilege may result in periodic large inflows of money. If this occurs, it is each Fund's general policy to initially invest this money in short-term, tax-exempt municipal securities, unless it is believed that attractive investment opportunities consistent with the Fund's investment goals exist immediately. This money will then be withdrawn from the short-term, tax-exempt municipal securities and invested in portfolio securities in as orderly a manner as is possible when attractive investment opportunities arise. The proceeds from the sale of shares of an investment company generally are not available until the seventh day following the sale. The funds you are seeking to exchange into may delay issuing shares pursuant to an exchange until that seventh day. The sale of Fund shares to complete an exchange will be effected at net asset value at the close of business on the day the request for exchange is received in proper form. SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell your shares and receive regular payments from your account on a monthly, quarterly, semiannual or annual basis. The value of your account must be at least $5,000 and the minimum payment amount for each withdrawal must be at least $50. There are no service charges for establishing or maintaining a systematic withdrawal plan. Each month in which a payment is scheduled, we will redeem an equivalent amount of shares in your account on the day of the month you have indicated on your account application or, if no day is indicated, on the 20th day of the month. If that day falls on a weekend or holiday, we will process the redemption on the next business day. For plans set up before June 1, 2000, we will continue to process redemptions on the 25th day of the month (or the next business day) unless you instruct us to change the processing date. Available processing dates currently are the 1st, 5th, 10th, 15th, 20th and 25th days of the month. When you sell your shares under a systematic withdrawal plan, it is a taxable transaction. To avoid paying sales charges on money you plan to withdraw within a short period of time, you may not want to set up a systematic withdrawal plan if you plan to buy shares on a regular basis. Shares sold under the plan also may be subject to a CDSC. Redeeming shares through a systematic withdrawal plan may reduce or exhaust the shares in your account if payments exceed distributions received from the Fund. This is especially likely to occur if there is a market decline. If a withdrawal amount exceeds the value of your account, your account will be closed and the remaining balance in your account will be sent to you. Because the amount withdrawn under the plan may be more than your actual yield or income, part of the payment may be a return of your investment. To discontinue a systematic withdrawal plan, change the amount and schedule of withdrawal payments, or suspend one payment, we must receive instructions from you at least three business days before a scheduled payment. A Fund may discontinue a systematic withdrawal plan by notifying you in writing and will discontinue a systematic withdrawal plan automatically if all shares in your account are withdrawn or if the Fund receives notification of the shareholder's death or incapacity. REDEMPTIONS IN KIND Each Fund has committed itself to pay in cash (by check) all requests for redemption by any shareholder of record, limited in amount, however, during any 90-day period to the lesser of $250,000 or 1% of the value of the Fund's net assets at the beginning of the 90-day period. This commitment is irrevocable without the prior approval of the SEC. In the case of redemption requests in excess of these amounts, the board reserves the right to make payments in whole or in part in securities or other assets of the Fund, in case of an emergency, or if the payment of such a redemption in cash would be detrimental to the existing shareholders of the Fund. In these circumstances, the securities distributed would be valued at the price used to compute the Fund's net assets and you may incur brokerage fees in converting the securities to cash. The Funds do not intend to redeem illiquid securities in kind. If this happens, however, you may not be able to recover your investment in a timely manner. SHARE CERTIFICATES We will credit your shares to your Fund account. We do not issue share certificates unless you specifically request them. This eliminates the costly problem of replacing lost, stolen or destroyed certificates. If a certificate is lost, stolen or destroyed, you may have to pay an insurance premium of up to 2% of the value of the certificate to replace it. Any outstanding share certificates must be returned to the Fund if you want to sell or exchange those shares or if you would like to start a systematic withdrawal plan. The certificates should be properly endorsed. You can do this either by signing the back of the certificate or by completing a share assignment form. For your protection, you may prefer to complete a share assignment form and to send the certificate and assignment form in separate envelopes. GENERAL INFORMATION If dividend checks are returned to the Fund marked "unable to forward" by the postal service, we will consider this a request by you to change your dividend option to reinvest all distributions. The proceeds will be reinvested in additional shares at net asset value until we receive new instructions. Distribution or redemption checks sent to you do not earn interest or any other income during the time the checks remain uncashed. Neither the Funds nor their affiliates will be liable for any loss caused by your failure to cash such checks. The Funds are not responsible for tracking down uncashed checks, unless a check is returned as undeliverable. In most cases, if mail is returned as undeliverable we are required to take certain steps to try to find you free of charge. If these attempts are unsuccessful, however, we may deduct the costs of any additional efforts to find you from your account. These costs may include a percentage of the account when a search company charges a percentage fee in exchange for its location services. Sending redemption proceeds by wire or electronic funds transfer (ACH) is a special service that we make available whenever possible. By offering this service to you, the Funds are not bound to meet any redemption request in less than the seven day period prescribed by law. Neither the Funds nor their agents shall be liable to you or any other person if, for any reason, a redemption request by wire or ACH is not processed as described in the prospectus. Franklin Templeton Investor Services, LLC (Investor Services) may pay certain financial institutions that maintain omnibus accounts with the Funds on behalf of numerous beneficial owners for recordkeeping operations performed with respect to such owners. For each beneficial owner in the omnibus account, the Fund may reimburse Investor Services an amount not to exceed the per account fee that the Fund normally pays Investor Services. These financial institutions also may charge a fee for their services directly to their clients. There are special procedures for banks and other institutions that wish to open multiple accounts. An institution may open a single master account by filing one application form with a Fund, signed by personnel authorized to act for the institution. Individual sub-accounts may be opened when the master account is opened by listing them on the application, or by providing instructions to the Fund at a later date. These sub-accounts may be registered either by name or number. Each Fund's investment minimums apply to each sub-account. Each Fund will send confirmation and account statements for the sub-accounts to the institution. If you buy or sell shares through your securities dealer, we use the net asset value next calculated after your securities dealer receives your request, which is promptly transmitted to the Fund. If you sell shares through your securities dealer, it is your dealer's responsibility to transmit the order to the Fund in a timely fashion. Your redemption proceeds will not earn interest between the time we receive the order from your dealer and the time we receive any required documents. Any loss to you resulting from your dealer's failure to transmit your redemption order to the Fund in a timely fashion must be settled between you and your securities dealer. Certain shareholder servicing agents may be authorized to accept your transaction request. For institutional accounts, there may be additional methods of buying or selling Fund shares than those described in this SAI or in the prospectus. In the event of disputes involving multiple claims of ownership or authority to control your account, the Fund has the right (but has no obligation) to: (a) freeze the account and require the written agreement of all persons deemed by the Fund to have a potential property interest in the account, before executing instructions regarding the account; (b) interplead disputed funds or accounts with a court of competent jurisdiction; or (c) surrender ownership of all or a portion of the account to the IRS in response to a notice of levy. PRICING SHARES - ------------------------------------------------------------------------------- When you buy shares, you pay the offering price. The offering price is the net asset value (NAV) per share plus any applicable sales charge, calculated to two decimal places using standard rounding criteria. When you sell shares, you receive the NAV minus any applicable CDSC. The value of a mutual fund is determined by deducting the fund's liabilities from the total assets of the portfolio. The net asset value per share is determined by dividing the net asset value of the fund by the number of shares outstanding. Each Fund calculates the NAV per share of each class each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). The Funds do not calculate the NAV on days the New York Stock Exchange (NYSE) is closed for trading, which include New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. When determining its NAV, each Fund values cash and receivables at their realizable amounts, and records interest as accrued. Each Fund values over-the-counter portfolio securities within the range of the most recent quoted bid and ask prices. If portfolio securities trade both in the over-the-counter market and on a stock exchange, each Fund values them according to the broadest and most representative market as determined by the manager. Municipal securities generally trade in the over-the-counter market rather than on a securities exchange. In the absence of a sale or reported bid and ask prices, information with respect to bond and note transactions, quotations from bond dealers, market transactions in comparable securities, and various relationships between securities are used to determine the value of municipal securities. Generally, trading in U.S. government securities and money market instruments is substantially completed each day at various times before the close of the NYSE. The value of these securities used in computing the NAV is determined as of such times. Occasionally, events affecting the values of these securities may occur between the times at which they are determined and the close of the NYSE that will not be reflected in the computation of the NAV. If events materially affecting the values of these securities occur during this period, the securities will be valued at their fair value as determined in good faith by the board. Other securities for which market quotations are readily available are valued at the current market price, which may be obtained from a pricing service, based on a variety of factors including recent trades, institutional size trading in similar types of securities (considering yield, risk and maturity) and/or developments related to specific issues. Securities and other assets for which market prices are not readily available are valued at fair value as determined following procedures approved by the board. With the approval of the board, each Fund may use a pricing service, bank or securities dealer to perform any of the above described functions. THE UNDERWRITER - ------------------------------------------------------------------------------- Franklin Templeton Distributors, Inc. (Distributors) acts as the principal underwriter in the continuous public offering of each Fund's shares. Distributors is located at One Franklin Parkway, San Mateo, CA 94403-1906. Distributors pays the expenses of the distribution of Fund shares, including advertising expenses and the costs of printing sales material and prospectuses used to offer shares to the public. Each Fund pays the expenses of preparing and printing amendments to its registration statements and prospectuses (other than those necessitated by the activities of Distributors) and of sending prospectuses to existing shareholders. The table below shows the aggregate underwriting commissions Distributors received in connection with the offering of the Funds' shares, the net underwriting discounts and commissions Distributors retained after allowances to dealers, and the amounts Distributors received in connection with redemptions or repurchases of shares for the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999: AMOUNT RECEIVED IN CONNECTION WITH TOTAL AMOUNT REDEMPTIONS COMMISSIONS RETAINED BY AND RECEIVED DISTRIBUTORS REPURCHASES ($) ($) ($) ------------------------------------------------------------------------------ 2001 Alabama Fund 350,588 21,669 4,867 Florida Fund 2,097,369 147,119 31,927 Georgia Fund 306,936 19,432 4,762 Kentucky Fund 322,976 22,573 - Louisiana Fund 321,129 21,693 14,490 Maryland Fund 658,972 39,434 10,730 Missouri Fund 890,302 56,993 8,587 North Carolina Fund 835,710 51,163 15,672 Texas Fund 101,597 6,830 1,392 Virginia Fund 860,071 56,442 17,470 2000 Alabama Fund 624,909 39,449 9,329 Florida Fund 3,006,465 185,581 111,775 Georgia Fund 511,135 31,316 17,239 Kentucky Fund 371,403 24,773 - Louisiana Fund 548,792 34,132 41,092 Maryland Fund 864,012 52,768 19,255 Missouri Fund 1,430,784 90,808 30,196 North Carolina Fund 1,125,627 66,963 40,672 Texas Fund 133,956 7,798 6,270 Virginia Fund 1,130,274 73,691 42,643 1999 Alabama Fund 1,184,364 76,087 3,487 Florida Fund 5,317,330 337,465 35,807 Georgia Fund 760,914 42,248 11,492 Kentucky Fund 343,647 22,834 - Louisiana Fund 716,996 46,235 3,048 Maryland Fund 1,309,307 82,392 10,749 Missouri Fund 1,996,212 120,370 5,859 North Carolina Fund 1,781,352 100,011 14,317 Texas Fund 282,886 17,460 1,125 Virginia Fund 1,754,574 110,385 10,724 Distributors may be entitled to payments from the Funds under the Rule 12b-1 plans, as discussed below. Except as noted, Distributors received no other compensation from the Funds for acting as underwriter. DISTRIBUTION AND SERVICE (12B-1) FEES The board has adopted a separate plan pursuant to Rule 12b-1 for each class. Although the plans differ in some ways for each class, each plan is designed to benefit the Fund and its shareholders. The plans are expected to, among other things, increase advertising of the Fund, encourage sales of the Fund and service to its shareholders, and increase or maintain assets of the Fund so that certain fixed expenses may be spread over a broader asset base, resulting in lower per share expense ratios. In addition, a positive cash flow into the Fund is useful in managing the Fund because the manager has more flexibility in taking advantage of new investment opportunities and handling shareholder redemptions. Under each plan, the Fund pays Distributors or others for the expenses of activities that are primarily intended to sell shares of the class. These expenses also may include service fees paid to securities dealers or others who have executed a servicing agreement with the Fund, Distributors or its affiliates and who provide service or account maintenance to shareholders (service fees); the expenses of printing prospectuses and reports used for sales purposes, and of preparing and distributing sales literature and advertisements; and a prorated portion of Distributors' overhead expenses related to these activities. Together, these expenses, including the service fees, are "eligible expenses." The 12b-1 fees charged to each class are based only on the fees attributable to that particular class. THE CLASS A PLAN. Each Fund may pay up to 0.10% per year of Class A's average daily net assets. The Class A plan is a reimbursement plan. It allows the Fund to reimburse Distributors for eligible expenses that Distributors has shown it has incurred. The Fund will not reimburse more than the maximum amount allowed under the plan. Any unreimbursed expenses from one year may not be carried over to or reimbursed in later years. For the fiscal year ended February 28, 2001, the amounts paid by the Funds pursuant to the Class A plan were: ALABAMA FLORIDA GEORGIA KENTUCKY LOUISIANA FUND FUND FUND FUND FUND ($) ($) ($) ($) ($) - ------------------------------------------------------------------------------- Advertising 10,220 98,760 18,139 3,010 8,308 Printing and mailing prospectuses other than to current shareholders 4,480 32,345 2,000 1,255 2,981 Payments to underwriters 5,243 24,657 1,925 1,847 4,616 Payments to broker-dealers 163,244 1,183,125 122,365 56,482 114,658 Other 21,197 143,709 8,000 4,862 14,060 ------------------------------------------------------ Total 204,384 1,482,596 152,429 67,456 144,623 ====================================================== NORTH MARYLAND MISSOURI CAROLINA TEXAS VIRGINIA FUND FUND FUND FUND FUND ($) ($) ($) ($) ($) - ------------------------------------------------------------------------------- Advertising 16,507 17,796 14,859 14,248 21,742 Printing and mailing prospectuses other than to current shareholders 3,379 6,039 6,235 1,537 6,387 Payments to underwriters 4,180 9,058 8,538 564 7,073 Payments to broker-dealers 188,020 287,420 259,110 70,395 267,723 Other 16,720 33,325 33,809 4,254 32,069 ------------------------------------------------------ Total 228,806 353,638 322,551 90,998 334,994 ====================================================== THE CLASS B AND C PLANS. Each Fund pays Distributors up to 0.65% per year of the class's average daily net assets, out of which 0.15% may be paid for services to the shareholders(service fees). The Class B and C plans also may be used to pay Distributors for advancing commissions to securities dealers with respect to the initial sale of Class B and C shares. Class B plan fees payable to Distributors are used by Distributors to pay third party financing entities that have provided financing to Distributors in connection with advancing commissions to securities dealers. Resources owns a minority interest in one of the third party financing entities. The Class B and C plans are compensation plans. They allow each Fund to pay a fee to Distributors that may be more than the eligible expenses Distributors has incurred at the time of the payment. Distributors must, however, demonstrate to the board that it has spent or has near-term plans to spend the amount received on eligible expenses. Each Fund will not pay more than the maximum amount allowed under the plans. For the fiscal year ended February 28, 2001, the amounts paid by the Funds pursuant to the Class B plan were: FLORIDA FUND ($) - ------------------------------------------------------------------------------- Advertising 319 Printing and mailing prospectuses other than to current shareholders 7 Payments to underwriters 238 Payments to broker-dealers 14,397 Other 363 --------- Total 15,324 ========== For the fiscal year ended February 28, 2001, the amounts paid by the Funds pursuant to the Class C plan were: ALABAMA FLORIDA GEORGIA KENTUCKY LOUISIANA FUND FUND FUND FUND FUND ($) ($) ($) ($) ($) - ------------------------------------------------------------------------------- Advertising 1,370 6,997 3,227 - 980 Printing and mailing prospectuses other than to current shareholders 347 1,687 303 - 273 Payments to underwriters 585 2,025 577 - 620 Payments to broker-dealers 85,945 438,000 89,475 - 70,010 Other 1,902 8,466 1,559 - 1,579 ------------------------------------------------------ Total 90,149 457,175 95,141 - 73,462 ====================================================== NORTH MARYLAND MISSOURI CAROLINA TEXAS VIRGINIA FUND FUND FUND FUND FUND ($) ($) ($) ($) ($) - ------------------------------------------------------------------------------- Advertising 2,569 2,296 3,847 939 2,050 Printing and mailing prospectuses other than to current shareholders 320 507 741 81 422 Payments to underwriters 1,166 1,633 1,859 119 1,339 Payments to broker-dealers 111,155 153,689 248,964 27,829 138,166 Other 2,611 4,100 5,150 349 3,279 ------------------------------------------------------ Total 117,821 162,225 260,561 29,317 145,256 ====================================================== THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or others are entitled to under each plan, each plan also provides that to the extent the Fund, the manager or Distributors or other parties on behalf of the Fund, the manager or Distributors make payments that are deemed to be for the financing of any activity primarily intended to result in the sale of Fund shares within the context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then such payments shall be deemed to have been made pursuant to the plan. To the extent fees are for distribution or marketing functions, as distinguished from administrative servicing or agency transactions, certain banks may not participate in the plans because of applicable federal law prohibiting certain banks from engaging in the distribution of mutual fund shares. These banks, however, are allowed to receive fees under the plans for administrative servicing or for agency transactions. Distributors must provide written reports to the board at least quarterly on the amounts and purpose of any payment made under the plans and any related agreements, and furnish the board with such other information as the board may reasonably request to enable it to make an informed determination of whether the plans should be continued. Each plan has been approved according to the provisions of Rule 12b-1. The terms and provisions of each plan also are consistent with Rule 12b-1. PERFORMANCE - ------------------------------------------------------------------------------- Performance quotations are subject to SEC rules. These rules require the use of standardized performance quotations or, alternatively, that every non-standardized performance quotation furnished by a Fund be accompanied by certain standardized performance information computed as required by the SEC. Average annual total return and current yield quotations used by the Funds are based on the standardized methods of computing performance mandated by the SEC. Performance figures reflect Rule 12b-1 fees from the date of the plan's implementation. An explanation of these and other methods used by the Funds to compute or express performance follows. Regardless of the method used, past performance does not guarantee future results, and is an indication of the return to shareholders only for the limited historical period used. AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding the average annual rates of return over the periods indicated below that would equate an initial hypothetical $1,000 investment to its ending redeemable value. The calculation assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, and income dividends and capital gain distributions are reinvested at net asset value. The quotation assumes the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. If a change is made to the sales charge structure, historical performance information will be restated to reflect the maximum initial sales charge currently in effect. When considering the average annual total return quotations for Class A and C shares, you should keep in mind that the maximum initial sales charge reflected in each quotation is a one time fee charged on all direct purchases, which will have its greatest impact during the early stages of your investment. This charge will affect actual performance less the longer you retain your investment in the Funds. The average annual total returns for the indicated periods ended February 28, 2001, were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - ------------------------------------------------------------------------------- CLASS A Alabama Fund 09/01/87 5.44 3.78 5.91 6.61 Florida Fund 09/01/87 7.05 4.47 6.35 7.09 Georgia Fund 09/01/87 7.17 4.29 6.08 6.84 Kentucky Fund 10/12/91 6.93 4.60 6.18 6.18 Louisiana Fund 09/01/87 7.27 4.50 6.05 6.80 Maryland Fund 10/03/88 7.68 4.49 6.30 6.56 Missouri Fund 09/01/87 7.71 4.42 6.38 6.93 North Carolina Fund 09/01/87 7.61 4.48 6.11 6.87 Texas Fund 09/01/87 4.92 3.74 5.84 6.70 Virginia Fund 09/01/87 7.04 4.26 6.18 6.87 SINCE 1 YEAR INCEPTION (%) (%) - ------------------------------------------------------------------------------- CLASS B Alabama Fund - - Florida Fund 02/01/00 7.42 7.98 Georgia Fund - - Kentucky Fund - - Louisiana Fund - - Maryland Fund - - Missouri Fund - - North Carolina Fund - - Texas Fund - - Virginia Fund - - SINCE 1 YEAR 5 YEARS INCEPTION (%) (%) (%) - -------------------------------------------------------------------------------- CLASS C Alabama Fund 05/01/95 7.35 3.89 4.71 Florida Fund 05/01/95 9.17 4.62 5.34 Georgia Fund 05/01/95 9.28 4.44 5.07 Kentucky Fund - - - Louisiana Fund 05/01/95 9.33 4.64 5.30 Maryland Fund 05/01/95 9.71 4.63 5.52 Missouri Fund 05/01/95 9.85 4.55 5.37 North Carolina Fund 05/01/95 9.70 4.63 5.29 Texas Fund 05/01/95 6.87 3.91 4.76 Virginia Fund 05/01/95 9.12 4.40 5.16 The following SEC formula was used to calculate these figures: n P(1+T) = ERV where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of each period at the end of each period CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total return assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, income dividends and capital gain distributions are reinvested at net asset value, the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. Cumulative total return, however, is based on the actual return for a specified period rather than on the average return over the periods indicated above. The cumulative total returns for the indicated periods ended February 28, 2001, were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - ------------------------------------------------------------------------------- CLASS A Alabama Fund 09/01/87 5.44 20.36 77.57 137.24 Florida Fund 09/01/87 7.05 24.43 85.05 152.15 Georgia Fund 09/01/87 7.17 23.38 80.39 144.11 Kentucky Fund 10/12/91 6.93 25.22 - 75.58 Louisiana Fund 09/01/87 7.27 24.63 79.97 143.10 Maryland Fund 10/03/88 7.68 24.54 84.28 120.07 Missouri Fund 09/01/87 7.71 24.15 85.60 147.11 North Carolina Fund 09/01/87 7.61 24.52 80.94 145.29 Texas Fund 09/01/87 4.92 20.17 76.35 139.98 Virginia Fund 09/01/87 7.04 23.20 82.21 145.28 SINCE 1 YEAR INCEPTION (%) (%) - ------------------------------------------------------------------------------- CLASS B Alabama Fund - - Florida Fund 02/01/00 7.42 8.62 Georgia Fund - - Kentucky Fund - - Louisiana Fund - - Maryland Fund - - Missouri Fund - - North Carolina Fund - - Texas Fund - - Virginia Fund - - SINCE 1 YEAR 5 YEAR INCEPTION (%) (%) (%) - ------------------------------------------------------------------------------- CLASS C Alabama Fund 05/01/95 7.35 21.04 30.81 Florida Fund 05/01/95 9.17 25.32 35.49 Georgia Fund 05/01/95 9.28 24.27 33.42 Kentucky Fund - - - Louisiana Fund 05/01/95 9.33 25.46 35.16 Maryland Fund 05/01/95 9.71 25.41 36.83 Missouri Fund 05/01/95 9.85 24.89 35.65 North Carolina Fund 05/01/95 9.70 25.41 35.11 Texas Fund 05/01/95 6.87 21.14 31.17 Virginia Fund 05/01/95 9.12 24.01 34.08 CURRENT YIELD Current yield shows the income per share earned by a Fund. It is calculated by dividing the net investment income per share earned during a 30-day base period by the applicable maximum offering price per share on the last day of the period and annualizing the result. Expenses accrued for the period include any fees charged to all shareholders of the class during the base period. The yields for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ------------------------------------------------------------------------------- Alabama Fund 4.49 - 4.10 Florida Fund 4.29 3.93 3.91 Georgia Fund 4.15 - 3.75 Kentucky Fund 4.62 - - Louisiana Fund 4.52 - 4.12 Maryland Fund 4.22 - 3.83 Missouri Fund 4.26 - 3.86 North Carolina Fund 4.29 - 3.89 Texas Fund 4.55 - 4.15 Virginia Fund 4.25 - 3.86 The following SEC formula was used to calculate these figures: 6 Yield = 2 [(A-B + 1) - 1] --- cd where: a = interest earned during the period b = expenses accrued for the period (net of reimbursements) c = the average daily number of shares outstanding during the period that were entitled to receive dividends d = the maximum offering price per share on the last day of the period TAXABLE-EQUIVALENT YIELD Each Fund also may quote a taxable-equivalent yield that shows the before-tax yield that would have to be earned from a taxable investment to equal the yield. Taxable-equivalent yield is computed by dividing the portion of the yield that is tax-exempt by one minus the highest applicable combined federal and state income tax rate and adding the product to the portion of the yield that is not tax-exempt, if any. The taxable-equivalent yields for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) ------------------------------------------------------------------------------ Alabama Fund 7.83 - 7.15 Florida Fund 7.10 6.51 6.47 Georgia Fund 7.31 - 6.60 Kentucky Fund 8.14 - - Louisiana Fund 7.96 - 7.26 Maryland Fund 7.58 - 6.88 Missouri Fund 7.50 - 6.80 North Carolina Fund 7.70 - 6.98 Texas Fund 7.53 - 6.87 Virginia Fund 7.47 - 6.78 As of February 28, 2001, the combined federal and state income tax rates upon which the taxable-equivalent yield quotations were based were as follows: Combined Rate (%) - ------------------------------------------------------------------------------- Alabama Fund 42.62 Florida Fund 39.60 Georgia Fund 43.22 Kentucky Fund 43.22 Louisiana Fund 43.22 Maryland Fund 44.36 Missouri Fund 43.22 North Carolina Fund 44.28 Texas Fund 39.60 Virginia Fund 43.07 From time to time, as any changes to the rates become effective, taxable-equivalent yield quotations advertised by the Funds will be updated to reflect these changes. The Funds expect updates may be necessary as tax rates are changed by federal and state governments. The advantage of tax-free investments, like the Funds, will be enhanced by any tax rate increases. Therefore, the details of specific tax increases may be used in sales material for the Funds. CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are calculated according to a formula prescribed by the SEC, are not indicative of the amounts that were or will be paid to shareholders. Amounts paid to shareholders are reflected in the quoted current distribution rate or taxable-equivalent distribution rate. The current distribution rate is usually computed by annualizing the dividends paid per share by a class during a certain period and dividing that amount by the current maximum offering price. The current distribution rate differs from the current yield computation because it may include distributions to shareholders from sources other than interest, if any, and is calculated over a different period of time. The current distribution rates for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ------------------------------------------------------------------------------- Alabama Fund 4.93 - 4.50 Florida Fund 5.03 4.62 4.59 Georgia Fund 4.73 - 4.27 Kentucky Fund 4.96 - - Louisiana Fund 4.92 - 4.47 Maryland Fund 4.76 - 4.27 Missouri Fund 4.83 - 4.40 North Carolina Fund 4.90 - 4.43 Texas Fund 5.15 - 4.66 Virginia Fund 4.89 - 4.46 A taxable-equivalent distribution rate shows the taxable distribution rate equivalent to the current distribution rate. The advertised taxable-equivalent distribution rate will reflect the most current federal and state tax rates available to the Fund. The taxable-equivalent distribution rates for the 30-day period ended February 28, 2001, were: CLASS A (%) CLASS B (%) CLASS C (%) - ------------------------------------------------------------------------------- Alabama Fund 8.59 - 7.84 Florida Fund 8.33 7.65 7.60 Georgia Fund 8.33 - 7.52 Kentucky Fund 8.74 - - Louisiana Fund 8.67 - 7.87 Maryland Fund 8.55 - 7.67 Missouri Fund 8.51 - 7.75 North Carolina Fund 8.79 - 7.95 Texas Fund 8.53 - 7.72 Virginia Fund 8.59 - 7.83 VOLATILITY Occasionally statistics may be used to show a Fund's volatility or risk. Measures of volatility or risk are generally used to compare a Fund's net asset value or performance to a market index. One measure of volatility is beta. Beta is the volatility of a fund relative to the total market, as represented by an index considered representative of the types of securities in which the fund invests. A beta of more than 1.00 indicates volatility greater than the market and a beta of less than 1.00 indicates volatility less than the market. Another measure of volatility or risk is standard deviation. Standard deviation is used to measure variability of net asset value or total return around an average over a specified period of time. The idea is that greater volatility means greater risk undertaken in achieving performance. OTHER PERFORMANCE QUOTATIONS Each Fund also may quote the performance of shares without a sales charge. Sales literature and advertising may quote a cumulative total return, average annual total return and other measures of performance with the substitution of net asset value for the public offering price. Each Fund may include in its advertising or sales material information relating to investment goals and performance results of funds belonging to Franklin Templeton Investments. Resources is the parent company of the advisors and underwriter of Franklin Templeton funds. COMPARISONS To help you better evaluate how an investment in a Fund may satisfy your investment goal, advertisements and other materials about the Fund may discuss certain measures of Fund performance as reported by various financial publications. Materials also may compare performance (as calculated above) to performance as reported by other investments, indices, and averages. These comparisons may include, but are not limited to, the following examples: o Salomon Smith Barney Broad Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate and mortgage bonds. o Lehman Brothers Aggregate Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate, mortgage and Yankee bonds. o Lehman Brothers Municipal Bond Index or its component indices - measures yield, price and total return for the municipal bond market. o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of 20 general obligation bonds maturing in 20 years. o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds. The index attempts to track the new-issue market as closely as possible, so it changes bonds twice a month, adding all new bonds that meet certain requirements and deleting an equivalent number according to their secondary market trading activity. As a result, the average par call date, average maturity date, and average coupon rate can and have changed over time. The average maturity generally has been about 29-30 years. o Financial publications: The WALL STREET JOURNAL, and BUSINESS WEEK, FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines - provide performance statistics over specified time periods. o Salomon Smith Barney Composite High Yield Index or its component indices - measures yield, price and total return for the Long-Term High-Yield Index, Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index. o Historical data supplied by the research departments of CS First Boston Corporation, the J.P. Morgan Chase & Co., Salomon Smith Barney Inc., Merrill Lynch and Lehman Brothers(R). o Morningstar - information published by Morningstar, Inc., including Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's assessment of the historical risk-adjusted performance of a fund over specified time periods relative to other funds within its category. o Lipper Inc.- Mutual Fund Performance Analysis and Lipper - Fixed Income Fund Performance Analysis - measure total return and average current yield for the mutual fund industry and rank individual mutual fund performance over specified time periods, assuming reinvestment of all distributions, exclusive of any applicable sales charges. From time to time, advertisements or information for each Fund may include a discussion of certain attributes or benefits to be derived from an investment in the Fund. The advertisements or information may include symbols, headlines, or other material that highlights or summarizes the information discussed in more detail in the communication. Advertisements or sales material issued by each Fund also may discuss or be based upon information in a recent issue of the Special Report on Tax Freedom Day published by the Tax Foundation, a Washington, D.C. based nonprofit research and public education organization. The report illustrates, among other things, the annual amount of time the average taxpayer works to satisfy his or her tax obligations to the federal, state and local taxing authorities. Advertisements or information also may compare each Fund's performance to the return on certificates of deposit (CDs) or other investments. You should be aware, however, that an investment in the Fund involves the risk of fluctuation of principal value, a risk generally not present in an investment in a CD issued by a bank. CDs are frequently insured by an agency of the U.S. government. An investment in a Fund is not insured by any federal, state or private entity. In assessing comparisons of performance, you should keep in mind that the composition of the investments in the reported indices and averages is not identical to any Fund's portfolio, the indices and averages are generally unmanaged, and the items included in the calculations of the averages may not be identical to the formula used by a Fund to calculate its figures. In addition, there can be no assurance that a Fund will continue its performance as compared to these other averages. MISCELLANEOUS INFORMATION - ------------------------------------------------------------------------------- The Funds may help you achieve various investment goals such as accumulating money for retirement, saving for a down payment on a home, college costs and other long-term goals. The Franklin College Costs Planner may help you in determining how much money must be invested on a monthly basis to have a projected amount available in the future to fund a child's college education. (Projected college cost estimates are based upon current costs published by the College Board.) The Franklin Retirement Planning Guide leads you through the steps to start a retirement savings program. Of course, an investment in the Funds cannot guarantee that these goals will be met. The Funds are members of Franklin Templeton Investments, one of the largest mutual fund organizations in the U.S., and may be considered in a program for diversification of assets. Founded in 1947, Franklin is one of the oldest mutual fund organizations and now services approximately 3 million shareholder accounts. In 1992, Franklin, a leader in managing fixed-income mutual funds and an innovator in creating domestic equity funds, joined forces with Templeton, a pioneer in international investing. The Mutual Series team, known for its value-driven approach to domestic equity investing, became part of the organization four years later. In 2001, the Fiduciary Trust team, known for providing global investment management to institutions and high net worth clients worldwide, joined the organization. Together, Franklin Templeton Investments has over $271 billion in assets under management for more than 5 million U.S. based mutual fund shareholder and other accounts. Franklin Templeton Investments offers 107 U.S. based open-end investment companies to the public. Each Fund may identify itself by its Nasdaq symbol or CUSIP number. Franklin is a leader in the tax-free mutual fund industry and manages more than $45 billion in municipal security assets for over three quarters of a million investors. Under current tax laws, municipal securities remain one of the few investments offering the potential for tax-free income. In 2001, taxes could cost $46 on every $100 earned from a fully taxable investment based on the combination of the new 39.1 % federal tax rate and the highest state tax rate of 7.2% (after the federal tax deduction) for 2001. Franklin tax-free funds, however, offer tax relief through a professionally managed portfolio of tax-free securities selected based on their yield, quality and maturity. An investment in a Franklin tax-free fund can provide you with the potential to earn income free of federal taxes and, depending on the fund, state and local taxes as well, while supporting state and local public projects. Franklin tax-free funds also may provide tax-free compounding, when dividends are reinvested. An investment in Franklin's tax-free funds can grow more rapidly than similar taxable investments. Municipal securities are generally considered to be creditworthy, second in quality only to securities issued or guaranteed by the U.S. government and its agencies. The market price of municipal securities, however, may fluctuate. This fluctuation will have a direct impact on the net asset value of the Fund's shares. Currently, there are more mutual funds than there are stocks listed on the New York Stock Exchange. While many of them have similar investment goals, no two are exactly alike. Shares of the Funds are generally sold through securities dealers, whose investment representatives are experienced professionals who can offer advice on the type of investments suitable to your unique goals and needs, as well as the risks associated with such investments. DESCRIPTION OF RATINGS - ------------------------------------------------------------------------------- MUNICIPAL BOND RATINGS MOODY'S INVESTORS SERVICE, INC. (MOODY'S) INVESTMENT GRADE Aaa: Municipal bonds rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt-edged." Interest payments are protected by a large or exceptionally stable margin, and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa: Municipal bonds rated Aa are judged to be high quality by all standards. Together with the Aaa group, they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large, fluctuation of protective elements may be of greater amplitude, or there may be other elements present that make the long-term risks appear somewhat larger. A: Municipal bonds rated A possess many favorable investment attributes and are considered upper medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present that suggest a susceptibility to impairment sometime in the future. Baa: Municipal bonds rated Baa are considered medium-grade obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. These bonds lack outstanding investment characteristics and, in fact, have speculative characteristics as well. BELOW INVESTMENT GRADE Ba: Municipal bonds rated Ba are judged to have predominantly speculative elements and their future cannot be considered well assured. Often the protection of interest and principal payments may be very moderate and, thereby, not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Municipal bonds rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Municipal bonds rated Caa are of poor standing. These issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Municipal bonds rated Ca represent obligations that are speculative to a high degree. These issues are often in default or have other marked shortcomings. C: Municipal bonds rated C are the lowest-rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Con.(-): Municipal bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals that begin when facilities are completed, or (d) payments to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon the completion of construction or the elimination of the basis of the condition. Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating classification from Aa through Caa in its municipal bond ratings. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates that the issue ranks in the lower end of its generic rating category. STANDARD & POOR'S RATINGS GROUP (S&P(R)) INVESTMENT GRADE AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess the ultimate degree of protection as to principal and interest. In the market, they move with interest rates and, hence, provide the maximum safety on all counts. AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the majority of instances differ from AAA issues only in a small degree. Here, too, prices move with the long-term money market. A: Municipal bonds rated A are regarded as upper medium-grade. They have considerable investment strength but are not entirely free from adverse effects of changes in economic and trade conditions. Interest and principal are regarded as safe. They predominantly reflect money rates in their market behavior but also, to some extent, economic conditions. BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. BELOW INVESTMENT GRADE BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and repay principal in accordance with the terms of the obligations. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While these bonds will likely have some quality and protective characteristics, they are outweighed by large uncertainties or major risk exposures to adverse conditions. C: This rating is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in default and payment of interest and/or repayment of principal is in arrears. Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. FITCH INVESTORS SERVICE, INC. (FITCH) INVESTMENT GRADE AAA: Municipal bonds rated AAA are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal that is unlikely to be affected by reasonably foreseeable events. AA: Municipal bonds rated AA are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong although not quite as strong as bonds rated AAA and not significantly vulnerable to foreseeable future developments. A: Municipal bonds rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB: Municipal bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BELOW INVESTMENT GRADE BB: Municipal bonds rated BB are considered speculative. The obligor's ability to pay interest and repay principal may be affected over time by adverse economic changes. Business and financial alternatives can be identified, however, that could assist the obligor in satisfying its debt service requirements. B: Municipal bonds rated B are considered highly speculative. While bonds in this class are currently meeting debt service requirements, the probability of continued timely payment of principal and interest reflects the obligor's limited margin of safety and the need for reasonable business and economic activity throughout the life of the issue. CCC: Municipal bonds rated CCC have certain identifiable characteristics which, if not remedied, may lead to default. The ability to meet obligations requires an advantageous business and economic environment. CC: Municipal bonds rated CC are minimally protected. Default in payment of interest and/or principal seems probable over time. C: Municipal bonds rated C are in imminent default in the payment of interest or principal. DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest and/or principal payments. Such bonds are extremely speculative and should be valued on the basis of their ultimate recovery value in liquidation or reorganization of the obligor. DDD represents the highest potential for recovery while D represents the lowest potential for recovery. Plus (+) or minus (-) signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus or minus signs are not used with the AAA, DDD, DD or D categories. MUNICIPAL NOTE RATINGS MOODY'S Moody's ratings for state, municipal and other short-term obligations will be designated Moody's Investment Grade (MIG). This distinction is in recognition of the differences between short-term credit risk and long-term risk. Factors affecting the liquidity of the borrower are uppermost in importance in short-term borrowing; factors of the first importance in long-term borrowing risk are of lesser importance in the short run. Symbols used will be as follows: MIG 1: Notes are of the best quality enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. MIG 2: Notes are of high quality, with margins of protection ample, although not so large as in the preceding group. MIG 3: Notes are of favorable quality, with all security elements accounted for, but lacking the undeniable strength of the preceding grades. Market access for refinancing, in particular, is likely to be less well established. MIG 4: Notes are of adequate quality, carrying specific risk but having protection and not distinctly or predominantly speculative. S&P Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After June 29, 1984, for new municipal note issues due in three years or less, the ratings below will usually be assigned. Notes maturing beyond three years will most likely receive a bond rating of the type recited above. SP-1: Issues carrying this designation have a very strong or strong capacity to pay principal and interest. Issues determined to possess overwhelming safety characteristics will be given a "plus" (+) designation. SP-2: Issues carrying this designation have a satisfactory capacity to pay principal and interest. Short-Term Debt & Commercial Paper Ratings MOODY'S Moody's short-term debt ratings are opinions of the ability of issuers to repay punctually senior debt obligations. These obligations have an original maturity not exceeding one year, unless explicitly noted. Moody's commercial paper ratings, which are also applicable to municipal paper investments, are opinions of the ability of issuers to repay punctually their promissory obligations not having an original maturity in excess of nine months. Moody's employs the following designations for both short-term debt and commercial paper, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: P-1 (Prime-1): Superior capacity for repayment. P-2 (Prime-2): Strong capacity for repayment. S&P S&P's ratings are a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues within the "A" category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety, as follows: A-1: This designation indicates the degree of safety regarding timely payment is very strong. A "plus" (+) designation indicates an even stronger likelihood of timely payment. A-2: Capacity for timely payment on issues with this designation is strong. The relative degree of safety, however, is not as overwhelming as for issues designated A-1. A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. FITCH Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of generally up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. The short-term rating places greater emphasis than a long-term rating on the existence of liquidity necessary to meet the issuer's obligations in a timely manner. F-1+: Exceptionally strong credit quality. Regarded as having the strongest degree of assurance for timely payment. F-1: Very strong credit quality. Reflects an assurance of timely payment only slightly less in degree than issues rated F-1+. F-2: Good credit quality. A satisfactory degree of assurance for timely payment, but the margin of safety is not as great as for issues assigned F-1+ and F-1 ratings. F-3: Fair credit quality. Have characteristics suggesting that the degree of assurance for timely payment is adequate; however, near-term adverse changes could cause these securities to be rated below investment grade. F-5: Weak credit quality. Have characteristics suggesting a minimal degree of assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic conditions. D: Default. Actual or imminent payment default. LOC: The symbol LOC indicates that the rating is based on a letter of credit issued by a commercial bank. STATE TAX TREATMENT - ------------------------------------------------------------------------------- The following information on the state income tax treatment of dividends from the funds is based upon correspondence and sources believed to be reliable. Except where otherwise noted, the information pertains to individual state income taxation only. You may be subject to local taxes on dividends or the value of your shares. Corporations, trusts, estates and other entities may be subject to other taxes and should consult with their tax advisors or their state department of revenue. For some investors, a portion of the dividend income may be subject to the federal and/or state alternative minimum tax. ALABAMA Under Section 40-18-14(3)f of the Alabama Code, interest on obligations of the state of Alabama and any of its counties, municipalities or other political subdivisions is exempt from personal income tax. Section 40-18-14(3)d provides similar tax-exempt treatment for interest on exempt obligations of the U.S. government or its possessions including qualifying obligations of Puerto Rico, Guam and the Virgin Islands. In addition, Regulation Section 810-3-14-.02(4)(b)2 and an administrative ruling of the Alabama Department of Revenue, dated March 1, 1990, both extend the exemption for obligations of the U.S. government or its possessions to distributions from a regulated investment company, such as the Alabama Fund, to the extent that the distributions are paid from interest earned on such exempt obligations. The March 1, 1990, ruling (as well as the instructions to Alabama Form 40) also indicates that the exemption would apply to Alabama municipal obligations. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations or obligations of other states and their political subdivisions. To the extent such investments are made by the fund, distributions from those investments generally will be taxable. Any distributions of capital gains earned by the fund are fully includable in each individual shareholder's Alabama taxable income and are currently taxed at ordinary income tax rates. FLORIDA Although Florida does not impose a personal income tax, it does impose an intangible personal property tax on intangible property having a taxable situs in Florida. This tax is imposed on the value of certain intangible personal property, including shares of a mutual fund. However, according to Florida Statute Section 199.185, there is an exemption for shares of a mutual fund, such as the Florida Fund, that is organized as a business trust, if, on the January 1 assessment date, at least 90% of the net asset value of the portfolio of assets corresponding to such shares consists of exempt property. Exempt property includes notes, bonds and other obligations issued by the state of Florida or its municipalities, counties and other taxing districts or by the U.S. government and its agencies. If, on the date of assessment, the 90% threshold is not met, only that portion, if any, of the value of the mutual fund shares attributable to notes, bonds and obligations of the U.S. government and its agencies will be exempt. GEORGIA Under Section 48-7-27(b)(1)(A) of the Georgia Code, interest on obligations of the state of Georgia and its political subdivisions, which is not otherwise included in federal adjusted gross income, is exempt from the state's individual income tax. Likewise, under Section 48-7-27(b)(2) interest on exempt obligations of the U.S. government, its territories and possessions (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands), or of any authority, commission, or instrumentality of the U.S. government also is exempt from the state's individual income tax. According to the instructions to Georgia's personal income tax return, distributions from the Georgia Fund attributable to interest on obligations of the state of Georgia and its political subdivisions and, apparently, to interest on obligations of the U.S. government, its territories and possessions will be excluded from the Georgia individual income tax. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by a fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Any distributions of capital gains earned by the fund are fully included in each individual shareholder's Georgia taxable income as dividend income and capital gain, respectively, and are currently taxed at ordinary income tax rates. KENTUCKY Pursuant to Kentucky Revised Statute 141.010(10)(a) and (12)(a), interest earned on exempt obligations of the U.S. government, its agencies and instrumentalities, or its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands) and obligations issued by the Commonwealth of Kentucky or its political subdivisions will be exempt from Kentucky's personal income tax. Under Kentucky Income Tax Revenue Policy 42P161 (as revised December 1, 1990), dividends from regulated investment companies, such as the Kentucky Fund, which are derived from such exempt obligations, also will be exempt from state income tax. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Any distributions of net short-term and net long-term capital gains earned by the fund are generally includable in each shareholder's Kentucky adjusted gross income and are taxed at ordinary income tax rates. Kentucky Revenue Circular 40C003 also states that gain from the sale of some U.S. government and Kentucky obligations may be exempt from state income tax, but the availability of the exemption depends upon the specific legislation authorizing the bonds. A specific opinion may be requested from the Kentucky Revenue Cabinet. LOUISIANA Under Section 47:293(g)(b) of Louisiana's individual income tax law, interest earned on exempt obligations of the state of Louisiana or its political subdivisions, is exempt from the Louisiana individual income tax interest earned on obligations which Louisiana is prohibited from taxing by the constitutional laws of the United States is also exempt under Section 47:293, distributions from a regulated investment company, such as the Louisiana Fund, also will be exempt from the Louisiana individual income tax to the extent that they are derived from interest earned on such exempt obligations. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Any distributions of net short-term and net long-term capital gains earned by the fund are included in each shareholder's Louisiana taxable income and are currently taxed at ordinary income tax rates. MARYLAND Distributions from the Maryland Fund attributable to interest on obligations of the state of Maryland and its political subdivisions are excluded from Maryland's personal income tax. Under Section 10-207(c) of the Tax General Article, interest on exempt obligations of the U.S. government and any authority, commission, instrumentality, possession or territory of the U.S. (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands) also is exempt from Maryland's personal income tax. Under Section 10-207(c-1) and Administrative Release No. 11, this exemption is extended to distributions from a regulated investment company, such as the Maryland Fund, to the extent such distributions are paid out of interest earned on exempt obligations of the U.S. government or its agencies and possessions (including Puerto Rico, Guam and the U.S. Virgin Islands). Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Any distributions of capital gains by the fund derived from gain realized from the sale or exchange of obligations issued by the state of Maryland or its political subdivisions also may be tax-exempt to the fund's shareholders. Distributions of capital gains earned by the fund on non-Maryland obligations are includable in each shareholder's Maryland adjusted gross income and are taxed at ordinary income tax rates. MISSOURI Under Section 143.121 of the Revised Statutes of Missouri, interest earned on exempt obligations of the U.S. government, its authorities, commissions, instrumentalities, possessions or territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands), or the state of Missouri, its political subdivisions or authorities are exempt from Missouri personal income tax. Under Missouri's income tax regulations (Title 12, Section 10-2.155), a regulated investment company such as the Missouri Fund may pass the tax-exempt character of such interest through to its shareholders. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Any distributions of net short-term and net long-term capital gains earned by the fund are included in each shareholder's Missouri taxable income and are currently taxed at ordinary income tax rates. NORTH CAROLINA Section 105-134.6(b)(1) of the North Carolina General Statutes provides that interest on exempt obligations of the U.S. government, its possessions, or its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands) and exempt obligations of the state of North Carolina or its political subdivisions are exempt from state income tax. Pursuant to a North Carolina Department of Revenue Information Bulletin dated January 1,2000, dividends received from a regulated investment company, such as the North Carolina Fund, are exempt from personal income tax to the extent that the distributions are derived from interest on such exempt obligations and provided that at the close of each quarter of its taxable year, at least 50 percent of the value of the assets of the regulated investment company consist of state and local bonds, the interest from which from federal income tax. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Distributions of capital gains attributable from the sale of certain North Carolina obligations issued before July 1, 1995, may be exempt from taxation for the fund's shareholders. Distributions of all net short-term capital gain and net long-term capital gain earned by the fund on all other North Carolina obligations and on non-North Carolina obligations are includable in each shareholder's North Carolina taxable income and are currently taxed at ordinary income rates. TEXAS does not presently impose any income tax on individuals, trusts, or estates. VIRGINIA Section 58.1-322 of the Code of Virginia provides that interest and gains on obligations of the state of Virginia, its political subdivisions, and instrumentalities or direct obligations of the U.S. government or its authorities, commission, instrumentalities or territories (including Puerto Rico, Guam and the Virgin Islands) is exempt from personal income tax. Under Title 23, Virginia Administrative Code 10-110-142, distributions from a regulated investment company, such as the Virginia Fund, also will be exempt from personal income tax to the extent attributable to such exempt obligations. Tax-exempt treatment generally is not available for distributions attributable to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other states and their political subdivisions. To the extent such investments are made by the fund, such as for temporary or defensive purposes, such distributions generally will be taxable. Distributions of net short-term and net long-term capital gains earned by the fund from taxable obligations are included in each shareholder's Virginia taxable income and are currently taxed at ordinary income tax rates. Prospectus FRANKLIN TAX-FREE TRUST INVESTMENT STRATEGY TAX-FREE INCOME FRANKLIN ARIZONA TAX-FREE INCOME FUND FRANKLIN COLORADO TAX-FREE INCOME FUND FRANKLIN CONNECTICUT TAX-FREE INCOME FUND FRANKLIN FEDERAL INTERMEDIATE TAX-FREE INCOME FUND FRANKLIN HIGH YIELD TAX-FREE INCOME FUND FRANKLIN NEW JERSEY TAX-FREE INCOME FUND FRANKLIN OREGON TAX-FREE INCOME FUND FRANKLIN PENNSYLVANIA TAX-FREE INCOME FUND FRANKLIN PUERTO RICO TAX-FREE INCOME FUND JULY 1, 2001 [Insert Franklin Templeton Ben Head] THE SEC HAS NOT APPROVED OR DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. CONTENTS THE FUNDS [Begin callout] INFORMATION ABOUT EACH FUND YOU SHOULD KNOW BEFORE INVESTING [End callout] 2 Goals and Strategies 5 Main Risks 9 Performance 18 Fees and Expenses 24 Management 26 Distributions and Taxes 28 Financial Highlights YOUR ACCOUNT [Begin callout] INFORMATION ABOUT SALES CHARGES, ACCOUNT TRANSACTIONS AND SERVICES [End callout] 41 Choosing a Share Class 45 Buying Shares 48 Investor Services 52 Selling Shares 54 Account Policies 58 Questions FOR MORE INFORMATION [Begin callout] Where to learn more about each Fund [End callout] Back Cover THE FUNDS [Insert graphic of bullseye and arrows] GOALS AND STRATEGIES GOALS The Federal Intermediate Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes, including the individual alternative minimum tax, as is consistent with prudent investment management and the preservation of shareholders' capital. The High Yield Fund's principal investment goal is to provide investors with a high current yield exempt from federal income taxes. Its secondary goal is capital appreciation to the extent possible and consistent with the Fund's principal investment goal. The Puerto Rico Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investment management and the preservation of shareholders' capital. The Puerto Rico Fund also seeks to provide a maximum level of income that is free from the personal income taxes of a majority of states, although this policy is not a fundamental investment goal of the Fund and may be changed without shareholder approval. Each state Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes and from personal income taxes, if any, for resident shareholders of that Fund's state as is consistent with prudent investment management and the preservation of shareholders' capital. MAIN INVESTMENT STRATEGIES Under normal market conditions, each Fund invests mainly in municipal securities whose interest is free from federal income taxes, including the federal alternative minimum tax. In addition, each state Fund invests mainly in municipal securities that pay interest free from the personal income taxes, if any, of that Fund's state. The Puerto Rico Fund also normally invests mainly in municipal securities whose interest is free from the personal income taxes of a majority of states. Although each Fund tries to invest all of its assets in tax-free securities, it is possible that up to 20% of its assets may be in tax-free securities that pay interest that may be subject to the federal alternative minimum tax and, although not anticipated, in securities that pay taxable interest. [Begin callout] MUNICIPAL SECURITIES are issued by state and local governments, their agencies and authorities, as well as by the District of Columbia and U.S. territories and possessions, to borrow money for various public and private projects. Municipal securities pay a fixed, floating or variable rate of interest, and require that the amount borrowed (principal) be repaid at maturity. [End callout] Each Fund, except the High Yield Fund, only buys municipal securities rated in the top four ratings by U.S. nationally recognized rating services (or comparable unrated securities). The High Yield Fund may invest in securities rated in any rating category, including defaulted securities, although it currently invests primarily in securities rated BBB/Baa or below (or comparable unrated securities). Each Fund also may invest in municipal lease obligations, which generally are issued to finance the purchase of public property. The property is leased to a state or local government and the lease payments are used to pay the interest on the obligations. These differ from other municipal securities because the money to make the lease payments must be set aside each year or the lease can be cancelled without penalty. If this happens, investors who own the obligations may not be paid. None of the Funds have restrictions on the maturity of the securities they may buy, although the Federal Intermediate Fund seeks to maintain a dollar-weighted average portfolio maturity of three to 10 years. The manager selects securities that it believes will provide the best balance between risk and return within a Fund's range of allowable investments and typically uses a buy and hold strategy. This means it holds securities in the Fund's portfolio for income purposes, rather than trading securities for capital gains, although the manager may sell a security at any time if it believes it could help the Fund meet its goal. When selecting securities for the High Yield Fund's portfolio, the manager may consider existing market conditions, the availability of lower-rated securities, and whether the difference in yields between higher and lower-rated securities justifies the higher risk of lower-rated securities. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of the Fund's assets in a temporary defensive manner by holding all or a substantial portion of its assets in cash, cash equivalents or other high quality short-term investments. Temporary defensive investments generally may include securities that pay taxable interest. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. In these circumstances, a Fund may be unable to achieve its investment goal. [Insert graphic of chart with line going up and down] MAIN RISKS ---------- INTEREST RATE When interest rates rise, municipal security prices fall. The opposite is also true: municipal security prices rise when interest rates fall. In general, securities with longer maturities are more sensitive to these price changes. CREDIT An issuer of municipal securities may be unable to make interest payments and repay principal. Changes in an issuer's financial strength or in a security's credit rating may affect a security's value and, thus, impact Fund performance. Many of each Fund's portfolio securities may be supported by credit enhancements, which may be provided by either U.S. or foreign entities. These securities have the credit risk of the entity providing the credit support. Credit support provided by a foreign entity may be less certain because of the possibility of adverse foreign economic, political or legal developments that may affect the ability of that entity to meet its obligations. To the extent that a Fund holds insured securities, a change in the credit rating of any one or more of the municipal bond insurers that insure securities in the Fund's portfolio may affect the value of the securities they insure, the Fund's share price and Fund performance. A Fund might also be adversely impacted by the inability of an insurer to meet its insurance obligations. LOWER-RATED SECURITIES. Securities rated below the top four ratings, sometimes called "junk bonds", generally have more credit risk than higher-rated securities. The High Yield Fund may invest up to 100% of its assets in lower-rated securities. None of the other Funds invests in securities rated below the top four ratings. The risk of default or price changes due to changes in the issuer's credit quality is greater with lower-rated securities. Issuers of lower-rated securities are typically in weaker financial health than issuers of higher-rated securities, and their ability to make interest payments or repay principal is less certain. These issuers also are more likely to encounter financial difficulties and to be materially affected by these difficulties when they encounter them. The market price of lower-rated securities may fluctuate more than higher-rated securities and may decline significantly in periods of general or regional economic difficulty. Lower-rated securities also may be less liquid than higher-rated securities. [Begin callout] Because interest rates and municipal security prices fluctuate, the amount of a Fund's distributions, its yield, and the value of your investment in that Fund will go up and down. This means you could lose money over short or even extended periods. [End callout] INCOME Since each Fund can only distribute what it earns, the Fund's distributions to shareholders may decline when interest rates fall. CALL A municipal security may be prepaid (called) before maturity. An issuer is more likely to call its securities when interest rates are falling, because the issuer can issue new securities with lower interest payments. If a security is called, a Fund may have to replace it with a lower-yielding security. At any time, each Fund may have a large amount of its assets invested in municipal securities subject to call risk. A call of some or all of these securities may lower that Fund's income and yield and its distributions to shareholders. MARKET A security's value may be reduced by market activity or the results of supply and demand. This is a basic risk associated with all securities. When there are more sellers than buyers, prices tend to fall. Likewise, when there are more buyers than sellers, prices tend to rise. Each Fund may invest more than 25% of its assets in municipal securities that finance similar types of projects, such as hospitals, housing, industrial development, transportation or pollution control. A change that affects one project, such as proposed legislation on the financing of the project, a shortage of the materials needed for the project, or a declining need for the project, would likely affect all similar projects, thereby increasing market risk. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS Municipal securities may be issued on a when-issued or delayed delivery basis, where payment and delivery take place at a future date. Since the market price of the security may fluctuate during the time before payment and delivery, the Fund assumes the risk that the value of the security at delivery may be more or less than the purchase price. DIVERSIFICATION The Connecticut and Federal Intermediate Funds are non-diversified funds. They may invest a greater portion of their assets in the municipal securities of one issuer than a diversified fund. These Funds may be more sensitive to economic, business, political or other changes affecting similar issuers or securities, which may result in greater fluctuation in the value of their shares. The Funds, however, intend to meet certain tax diversification requirements. The other Funds are all diversified funds. The Federal Intermediate and High Yield Funds are diversified nationally. The High Yield Fund will not invest more than 25% of its total assets in the municipal securities of any one state or territory. STATE Since each state Fund invests predominately in municipal securities of its state, events in that state are likely to affect the Fund's investments and its performance. These events may include economic or political policy changes, tax base erosion, state constitutional limits on tax increases, budget deficits and other financial difficulties, and changes in the credit ratings assigned to the state's municipal issuers. A negative change in any one of these or other areas could affect the ability of a state's municipal issuers to meet their obligations. It is important to remember that economic, budget and other conditions within a state are unpredictable and can change at any time. For these reasons, each state Fund and the Puerto Rico Fund may involve more risk than an investment in a fund that does not focus on securities of a single state or territory. To the extent the Federal Intermediate, High Yield or Puerto Rico Funds are invested in a state, events in that state may affect their investments and their performance. U.S. TERRITORIES The Puerto Rico Fund invests predominately in Puerto Rico municipal securities and may invest up to 35% of its total assets in municipal securities issued by other U.S. territories. Each of the other Funds also may invest up to 35% of its total assets in municipal securities issued by U.S. territories. As with state municipal securities, events in any of these territories where a Fund is invested may affect the Fund's investments and its performance. More detailed information about the Funds, their policies and risks and about municipal securities ratings can be found in the Funds' Statement of Additional Information (SAI). [Begin callout] Mutual fund shares are not deposits or obligations of, or guaranteed or endorsed by, any bank, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency of the U.S. government. Mutual fund shares involve investment risks, including the possible loss of principal. [End callout] [Insert graphic of a bull and a bear] PERFORMANCE ----------- The bar charts and tables below show the volatility of each Fund's returns, which is one indicator of the risks of investing in a Fund. The bar charts show changes in each Fund's returns from year to year over the calendar years shown. The tables show how each Fund's average annual total returns compare to those of a broad-based securities market index. Of course, past performance cannot predict or guarantee future results. ARIZONA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 5.83% Worst Quarter: Q1 '94 - -4.32% [End callout] 12.24% 10.02% 11.18% -4.03% 14.59% 4.21% 8.23% 5.44% -3.83% 10.30% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Arizona Fund - Class A/2 5.62% 3.85% 6.19% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Arizona Fund - Class C/2 7.60% 4.00% 4.92% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.51% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. COLORADO FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 6.62% Worst Quarter: Q1 '94 - -5.02% [End callout] 12.35% 10.00% 12.74% -5.43% 16.07% 4.76% 8.82% 5.73% -4.43% 11.56% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Colorado Fund - Class A/2 6.78% 4.23% 6.53% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Colorado Fund - Class C/2 8.91% 4.40% 5.35% Lehman Brothers Municipal Bond Index/3 11.68% 5.84 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.98% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. CONNECTICUT FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 5.54% Worst Quarter: Q1 '94 - -4.73% [End callout] 10.77% 8.33% 12.32% -5.40% 14.32% 4.48% 8.50% 5.96% -4.82% 9.83% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Connecticut Fund - Class A/2 5.19% 3.76% 5.77% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Connecticut Fund - Class C/2 7.17% 3.89% 4.77% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.08% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. FEDERAL INTERMEDIATE FUND ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 5.19% Worst Quarter: Q1 '94 - -3.76% [End callout] 12.68% -2.71% 14.42% 6.68% 5.27% 5.80% -1.84% 7.40% 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 SINCE INCEPTION 1 YEAR 5 YEARS (9/21/92) - -------------------------------------------------------------------------------- Federal Intermediate Fund/2 5.02% 4.14% 5.64% Lehman Brothers 10-Year Municipal Bond Index3 10.76% 5.93% 6.73% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.40% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. HIGH YIELD FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 6.38% Worst Quarter: Q1 '94 - -3.02% [End callout] 12.40% 9.25% 13.27% -2.59% 16.29% 6.16% 10.60% 4.81% -3.13% 5.77% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- High Yield Fund - Class A/2 1.24% 3.84% 6.64% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR (1/01/99) - -------------------------------------------------------------------------------- High Yield Fund - Class B/2 1.29% -0.94% Lehman Brothers Municipal Bond Index/3 11.68% 4.59% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- High Yield Fund - Class C/2 3.18% 3.98 5.05% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.18% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. NEW JERSEY FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 6.44% Worst Quarter: Q1 '94 - -4.79% [End callout] 12.46% 9.19% 10.97% -5.21% 15.58% 4.04% 8.34% 6.11% -3.36% 11.54% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- New Jersey Fund - Class A/2 6.79% 4.31% 6.31% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- New Jersey Fund - Class C/2 8.80% 4.42% 5.37% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.06% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. OREGON FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 6.54% Worst Quarter: Q1 '94 - -4.55% [End callout] 12.63% 8.66% 10.91% -4.93% 15.08% 4.32% 8.24% 5.44% -3.87% 10.98% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Oregon Fund - Class A/2 6.27% 3.99% 6.09% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Oregon Fund - Class C/2 8.21% 4.13% 5.03% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.73% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. PENNSYLVANIA FUND - CLASS A ANNUAL TOTAL RETURNS/1 [Begin callout] Best Quarter: Q1 '95 5.81% Worst Quarter: Q1 '94 - -3.64% [End callout] 13.48% 9.83% 11.66% -3.29% 14.34% 4.50% 8.94% 5.48% -4.08% 10.88% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Pennsylvania Fund - Class A/2 6.12% 4.10% 6.52% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Pennsylvania Fund - Class C/2 8.10% 4.22% 5.10% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 2.31% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. PUERTO RICO FUND - CLASS A ANNUAL TOTAL RETURNS/1 [End callout] Best Quarter: Q1 '95 5.95% Worst Quarter: Q1 '94 - -4.27% [End callout] 12.27% 9.12% 10.99% -4.28% 14.49% 5.08% 8.75% 5.74% -2.34% 10.18% 91 92 93 94 95 96 97 98 99 00 YEAR AVERAGE ANNUAL TOTAL RETURNS For the periods ended December 31, 2000 1 YEAR 5 YEARS 10 YEARS - -------------------------------------------------------------------------------- Puerto Rico Fund - Class A/2 5.49% 4.48% 6.38% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 7.32% SINCE INCEPTION 1 YEAR 5 YEARS (5/1/95) - -------------------------------------------------------------------------------- Puerto Rico Fund - Class C/2 7.51% 4.58% 5.34% Lehman Brothers Municipal Bond Index/3 11.68% 5.84% 6.85% 1. Figures do not reflect sales charges. If they did, returns would be lower. As of March 31, 2001, the Fund's year-to-date return was 1.71% for Class A. 2. Figures reflect sales charges. All Fund performance assumes reinvestment of dividends and capital gains. May 1, 1994, Class A implemented a Rule 12b-1 plan, which affects subsequent performance. 3. Source: Standard & Poor's Micropal. The unmanaged Lehman Brothers Municipal Bond Index includes investment grade bonds issued within the last five years as part of a deal of over $50 million and with a maturity of at least two years. It includes reinvested interest. One cannot invest directly in an index, nor is an index representative of the Fund's portfolio. [Insert graphic of percentage sign] FEES AND EXPENSES ----------------- This table describes the fees and expenses that you may pay if you buy and hold shares of a Fund. SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT) FEDERAL HIGH ARIZONA COLORADO CONNECTICUT INTERMEDIATE YIELD CLASS A FUND FUND FUND FUND FUND - -------------------------------------------------------------------------------- Maximum sales charge 4.25% 4.25% 4.25% 2.25% 4.25% (load) as a percentage of offering price Load imposed on 4.25% 4.25% 4.25% 2.25% 4.25% purchases Maximum deferred None None None None None sales charge (load)/1 CLASS B - -------------------------------------------------------------------------------- Maximum sales charge 4.00% - - - 4.00% (load) as a percentage of offering price Load imposed on None - - - None purchases Maximum deferred 4.00% - - - 4.00% sales charge (load)/2 CLASS C - -------------------------------------------------------------------------------- Maximum sales charge 1.99% 1.99% 1.99% - 1.99% (load) as a percentage of offering price Load imposed on 1.00% 1.00% 1.00% - 1.00% purchases Maximum deferred 0.99% 0.99% 0.99% - 0.99% sales charge (load/3 NEW JERSEY OREGON PENNSYLVANIA PUERTO CLASS A FUND FUND FUND RICO FUND - -------------------------------------------------------------------------------- Maximum sales charge 4.25% 4.25% 4.25% 4.25% (load) as a percentage of offering price Load imposed on purchases 4.25% 4.25% 4.25% 4.25% Maximum deferred sales None None None None charge (load)/1 CLASS B - -------------------------------------------------------------------------------- Maximum sales charge 4.00% - 4.00% - (load) as a percentage of offering price Load imposed on purchases None - None - Maximum deferred sales charge (load)/2 4.00% - 4.00% - CLASS C - -------------------------------------------------------------------------------- Maximum sales charge (load) as a percentage of offering price 1.99% 1.99% 1.99% 1.99% Load imposed on purchases 1.00% 1.00% 1.00% 1.00% Maximum deferred sales charge (load)/3 0.99% 0.99% 0.99% 0.99% Please see "Choosing a Share Class" on page 41 for an explanation of how and when these sales charges apply. ANNUAL FUND OPERATING EXPENSES (EXPENSES DEDUCTED FROM FUND ASSETS) FEDERAL HIGH ARIZONA COLORADO CONNECTICUT INTERMEDIATE YIELD CLASS A FUND FUND FUND FUND FUND - -------------------------------------------------------------------------------- Management fees 0.48% 0.54% 0.56% 0.57% 0.45% Distribution and service (12b-1) fees 0.10% 0.10% 0.10% 0.10% 0.09% Other expenses 0.06% 0.07% 0.07% 0.09% 0.08% --------------------------------------------------------- Total annual Fund operating expenses 0.64% 0.71% 0.73% 0.76 0.62% --------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------- Management fees 0.48% - - - 0.45% Distribution and service (12b-1) fees 0.65% - - - 0.65% Other expenses 0.06% - - - 0.08% --------------------------------------------------------- Total annual Fund operating expenses 1.19% - - - 1.18% --------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------- Management fees 0.48% 0.54% 0.56% - 0.45% Distribution and service (12b-1) fees 0.65% 0.65% 0.65% - 0.65% Other expenses 0.06% 0.07% 0.07% - 0.08% --------------------------------------------------------- Total annual Fund operating expenses 1.19% 1.26% 1.28% - 1.18% --------------------------------------------------------- NEW JERSEY FUND OREGON PENNSYLVANIA PUERTO CLASS A FUND FUND RICO FUND - -------------------------------------------------------------------------------- Management fees 0.49% 0.50% 0.49% 0.56% Distribution and service (12b-1) fees 0.10% 0.10% 0.10% 0.10% Other expenses 0.08% 0.07% 0.08% 0.11% ------------------------------------------------ Total annual Fund operating expenses 0.67% 0.67% 0.67% 0.77% ------------------------------------------------ CLASS B - -------------------------------------------------------------------------------- Management fees 0.49% - 0.49% - Distribution and service (12b-1) fees 0.64% - 0.65% - Other expenses 0.08% - 0.08% - ------------------------------------------------ Total annual Fund operating expenses 1.21% - 1.22% - ------------------------------------------------ CLASS C - -------------------------------------------------------------------------------- Management fees 0.49% 0.50% 0.49% 0.56% Distribution and service (12b-1) fees 0.64% 0.65% 0.65% 0.65% Other expenses 0.08% 0.07% 0.08% 0.11% ------------------------------------------------ Total annual Fund operating expenses 1.21% 1.22% 1.22% 1.32% ------------------------------------------------ 1. There is a 1% contingent deferred sales charge that applies to investments of $1 million or more (see page 41). 2. Declines to zero after six years. 3. This is equivalent to a charge of 1% based on net asset value. EXAMPLE This example can help you compare the cost of investing in a Fund with the cost of investing in other mutual funds. It assumes: o You invest $10,000 for the periods shown; o Your investment has a 5% return each year; and o The Fund's operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions your costs would be: FEDERAL HIGH ARIZONA COLORADO CONNECTICUT INTERMEDIATE YIELD FUND FUND FUND FUND FUND - -------------------------------------------------------------------------------- If you sell your shares at the end of the period: CLASS A 1 Year/1 $488 $494 $496 $301 $486 3 Years $621 $642 $648 $462 $615 5 Years $767 $803 $814 $638 $756 10 Years $1,189 $1,270 $1,293 $1,146 $1,166 CLASS B 1 Year $521 - - - $520 3 Years $678 - - - $675 5 Years $854 - - - $849 10 Years/2 $1,290 - - - $1,276 CLASS C 1 Year $319 $326 $328 - $318 3 Years $474 $496 $502 - $471 5 Years $748 $785 $795 - $743 10 Years $1,529 $1,607 $1,630 - $1,517 If you do not sell your shares: CLASS B 1 Year $121 - - - $120 3 Years $378 - - - $375 5 Years $654 - - - $649 10 Years/2 $1,290 - - - $1,276 CLASS C 1 Year $220 $227 $229 - $219 3 Years $474 $496 $502 - $471 5 Years $748 $785 $795 - $743 10 Years $1,529 $1,607 $1,630 - $1,517 NEW JERSEY OREGON PENNSYLVANIA PUERTO RICO FUND FUND FUND FUND - -------------------------------------------------------------------------------- If you sell your shares at the end of the period: CLASS A 1 Year/1 $491 $491 $491 $500 3 Years $630 $630 $630 $661 5 Years $782 $782 $782 $835 10 Years $1,224 $1,224 $1,224 $1,339 CLASS B 1 Year $523 - $524 - 3 Years $684 - $687 - 5 Years $865 - $870 - 10 Years $1,316 - $1,325 - CLASS C 1 Year $321 $322 $322 $332 3 Years $480 $483 $483 $514 5 Years $758 $764 $764 $816 10 Years $1,551 $1,563 $1,563 $1,674 If you do not sell your shares: CLASS B 1 Year $123 - $124 - 3 Years $384 - $387 - 5 Years $665 - $670 - 10 Years2 $1,316 - $1,325 - CLASS C 1 Year $222 $223 $223 $233 3 Years $480 $483 $483 $514 5 Years $758 $764 $764 $816 10 Years $1,551 $1,563 $1,563 $1,674 1. Assumes a contingent deferred sales charge (CDSC) will not apply. 2. Assumes conversion of Class B shares to Class A shares after eight years, lowering your annual expenses from that time on. [Insert graphic of briefcase] MANAGEMENT ---------- Franklin Advisers, Inc. (Advisers), One Franklin Parkway, San Mateo, CA 94403-1906, is each Fund's investment manager. Together, Advisers and its affiliates manage over $271 billion in assets. Before October 1, 1998, the Connecticut Fund's manager was Franklin Investment Advisory Services, Inc. The terms and conditions of the management services Advisers provides are the same as those of the previous manager. The team responsible for the Funds' management is: SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS Ms. Amoroso has been an analyst or portfolio manager of the Arizona, Colorado, Connecticut, Federal Intermediate, New Jersey and Oregon Funds since their inception and the High Yield, Pennsylvania and Puerto Rico Funds since 1987. She is the co-Director of Franklin's Municipal Bond Department. She joined Franklin Templeton Investments in 1986. JAMES CONN, VICE PRESIDENT OF ADVISERS Mr. Conn has been an analyst or portfolio manager of the Federal Intermediate Fund since December 1999. He joined Franklin Templeton Investments in 1996. Previously, he was a portfolio manager with California Investment Trust. CARRIE HIGGINS, VICE PRESIDENT OF ADVISERS Ms. Higgins has been an analyst or portfolio manager of the Arizona, Colorado, New Jersey, Oregon and Puerto Rico Funds since 1992. She joined Franklin Templeton Investments in 1990. JOHN HOPP, VICE PRESIDENT OF ADVISERS Mr. Hopp has been an analyst or portfolio manager of the High Yield Fund since 1993. He joined Franklin Templeton Investments in 1991. JOHN POMEROY, VICE PRESIDENT OF ADVISERS Mr. Pomeroy has been an analyst or portfolio manager of the Federal Intermediate Fund since its inception and the Connecticut Fund since 1989. He joined Franklin Templeton Investments in 1986. CHRISTOPHER SPERRY, PORTFOLIO MANAGER OF ADVISERS Mr. Sperry has been an analyst or portfolio manager of the Arizona and Oregon Funds since 2000. He joined Franklin Templeton Investments in 1996. JOHN WILEY, VICE PRESIDENT OF ADVISERS Mr. Wiley has been an analyst or portfolio manager of the Arizona, Oregon and Pennsylvania Funds since 1991. He joined Franklin Templeton Investments in 1989. STELLA S. WONG, VICE PRESIDENT OF ADVISERS Ms. Wong has been an analyst or portfolio manager of the Colorado, Connecticut, New Jersey and Pennsylvania Funds since their inception and the Puerto Rico Fund since 1986. She joined Franklin Templeton Investments in 1986. Each Fund pays Advisers a fee for managing the Fund's assets. For the fiscal year ended February 28, 2001, each Fund paid to the manager for its services the following management fees as a percentage of its average monthly net assets: MANAGEMENT FEES (AS A PERCENTAGE OF AVERAGE MONTHLY ASSETS) - -------------------------------------------------------------------------------- Arizona Fund 0.48% Colorado Fund 0.54% Connecticut Fund 0.56% Federal Intermediate Fund 0.57% High Yield Fund 0.45% New Jersey Fund 0.49% Oregon Fund 0.50% Pennsylvania Fund 0.49% Puerto Rico Fund 0.56% [Insert graphic of dollar signs and stacks of coins] DISTRIBUTIONS AND TAXES ----------------------- ON MAY 26, 2001, THE U.S. CONGRESS PASSED AND SENT TO THE PRESIDENT THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001. IT IS EXPECTED THAT THE PRESIDENT WILL SIGN THIS LEGISLATION AND IT WILL BECOME LAW. THE 2001 TAX ACT CONTAINS PROVISIONS THAT WILL REDUCE EFFECTIVE FEDERAL INDIVIDUAL INCOME TAX RATES, PHASED-IN OVER TIME, AND WILL CREATE INVESTMENT, EDUCATIONAL AND RETIREMENT SAVINGS INCENTIVES THROUGH INCREASED CONTRIBUTION LIMITS, INCREASED PHASE-OUT LIMITS, AND OTHER TAX BENEFITS. INVESTORS SHOULD TALK TO THEIR PERSONAL TAX ADVISORS ABOUT THE IMPLICATIONS OF THESE TAX LAW CHANGES ON THEIR INVESTMENT IN A FUND. INCOME AND CAPITAL GAIN DISTRIBUTIONS Each Fund typically declares income dividends each day that its net asset value is calculated and pays them monthly. A Fund does not pay "interest". Your account begins to receive dividends on the day after the Fund receives your investment and continues to receive dividends through the day it receives a request to redeem your shares. Capital gains, if any, may be distributed at least annually. The amount of any distributions will vary, and there is no guarantee a Fund will pay either income dividends or capital gain distributions. AVOID "BUYING A DIVIDEND" If you invest in a Fund shortly before it makes a capital gain distribution, you will receive some of your investment back in the form of a taxable distribution. TAX CONSIDERATIONS You may receive three different types of distributions from the Fund: o EXEMPT-INTEREST DIVIDENDS Most Fund distributions consist of exempt-interest dividends (dividends paid from interest earned on municipal securities). Because of this tax exemption, a tax-free fund may not be a suitable investment for retirement plans and other tax-exempt investors. In general, exempt-interest dividends are exempt from regular federal income tax. Exempt-interest dividends from interest earned on municipal securities of a state, or its political subdivisions, generally are also exempt from that state's personal income tax. Income from municipal securities of other states generally does not qualify as tax-free. Exempt-interest dividends are taken into account when determining the taxable portion of your social security or railroad retirement benefits. Each Fund may invest a portion of its assets in private activity bonds. The income from these bonds is a tax preference item when determining your alternative minimum tax. o TAXABLE INCOME DIVIDENDS Each Fund may invest a portion of its assets in securities that pay income that is not tax-exempt. A Fund may also distribute to you any market discount and net short-term capital gains from the sale of its portfolio securities. If you are a taxable investor, Fund distributions from this income are taxable to you as ordinary income. o CAPITAL GAIN DISTRIBUTIONS Each Fund may also realize net long-term capital gains and distribute these gains to you as capital gain distributions. These distributions will be taxable to you as long-term capital gains no matter how long you have owned your shares. Distributions of ordinary income and capital gains are taxable whether you reinvest your distributions in additional Fund shares or receive them in cash. Every January, you will receive a statement that shows the tax status of distributions you received for the previous year. BACKUP WITHHOLDING By law, a Fund must withhold 31% of your taxable distributions and redemption proceeds unless you: o provide your correct social security or taxpayer identification number, o certify that this number is correct, o certify that you are not subject to backup withholding, and o certify that you are a U.S. person (including a U.S. resident alien). A Fund also must withhold if the IRS instructs it to do so. When you sell your shares in a Fund, you may realize a capital gain or loss. For tax purposes, an exchange of your Fund shares for shares of a different Franklin Templeton fund is the same as a sale. Distributions of ordinary income and capital gains, and gains from the redemption of your Fund shares are generally subject to state and local taxes. Non-U.S. investors may be subject to U.S. withholding or estate tax, and are subject to special U.S. tax certification requirements. You should consult your tax advisor about the federal, state, local or foreign tax consequences of your investment in a Fund. [Insert graphic of dollar bill] FINANCIAL HIGHLIGHTS -------------------- The tables below present each Fund's financial performance for the past five years. Certain information reflects financial results for a simple Fund share. The total returns in the table represent the rate than an investor would have earned or lost on an investment in a Fund assuming reinvestment of dividends and capital gains. This information has been audited by PricewaterhouseCoopers LLP whose report, along with the Fund's financial statements, are included in the annual report, which is available upon request. ARIZONA FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000/3 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.31 11.38 11.44 11.24 11.34 year ------------------------------------------------ Net investment income/1 .57 .57 .59 .61 .62 Net realized and unrealized gains (losses) .52 (1.02) (.01) .29 (.04) ------------------------------------------------ Total from investment 1.09 (.45) .58 .90 .58 operations ------------------------------------------------ Distributions from net investment income (.57) (.58) (.59) (.62) (.63) Distributions from net realized gains - (.04) (.05) (.08) (.05) ------------------------------------------------ Total distributions (.57) (.62) (.64) (.70) (.68) ------------------------------------------------ Net asset value, end of year 10.83 10.31 11.38 11.44 11.24 ------------------------------------------------ Total return (%)/2 10.80 (4.15) 5.17 8.23 5.33 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 777,553 756,274 861,020 810,250 752,335 1,000) Ratios to average net assets: (%) Expenses .64 .62 .63 .63 .62 Net investment income 5.39 5.30 5.11 5.40 5.59 Portfolio turnover rate (%) 24.38 20.55 14.11 20.02 16.57 CLASS B - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.32 10.24 year --------------------- Net investment income/1 .52 .05 Net realized and unrealized gains (losses) .53 .07 --------------------- Total from investment 1.05 .12 operations --------------------- Distributions from net investment income (.51) (.04) Net asset value, end of year 10.86 10.32 --------------------- Total return (%)/2 10.37 1.21 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 3,700 176 Ratios to average net assets: (%) Expenses 1.19 1.184 Net investment income 4.82 5.264 Portfolio turnover rate (%) 24.38 20.55 ARIZONA FUND (CONT.) CLASS C YEAR ENDED FEBRUARY 29, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.38 11.45 11.51 11.30 11.38 year ------------------------------------------------ Net investment income/1 .52 .52 .52 .56 .57 Net realized and unrealized gains (losses) .51 (1.03) (.01) .29 (.03) ------------------------------------------------ Total from investment 1.03 (.51) .51 .85 .54 operations ------------------------------------------------ Distributions from net investment income (.51) (.52) (.52) (.56) (.57) Distributions from net realized gains - (.04) (.05) (.08) (.05) ------------------------------------------------ Total distributions (.51) (.56) (.57) (.64) (.62) ------------------------------------------------ Net asset value, end of year 10.90 10.38 11.45 11.51 11.30 ------------------------------------------------ Total return (%)/2 10.13 (4.65) 4.54 7.67 4.89 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 23,840 22,671 23,871 14,537 5,486 1,000) Ratios to average net assets: (%) Expenses 1.19 1.18 1.19 1.19 1.19 Net investment income 4.84 4.75 4.55 4.82 5.01 Portfolio turnover rate (%) 24.38 20.55 14.11 20.02 16.57 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. Annualized. COLORADO FUND CLASS A YEAR ENDED FEBRUARY 29, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) - ----------------------------- Net asset value, beginning of 10.90 12.05 12.11 11.80 11.84 year - -------------------------------------------------------------------------------- Net investment income/1 .59 .59 .60 .63 .66 - ----------------------------- Net realized and unrealized - ----------------------------- gains (losses) .74 (1.13) .02 .39 (.04) - ----------------------------- ------------------------------------------------ Total from investment 1.33 (.54) .62 1.02 .62 operations - -------------------------------------------------------------------------------- Distributions from net - ----------------------------- investment income (.59) (.60) (.60) (.64) (.66) - ----------------------------- Distributions from net realized gains - (.01) (.08) (.07) - - ----------------------------- ------------------------------------------------ Total distributions (.59) (.61) (.68) (.71) (.66) - ----------------------------- - -------------------------------------------------------------------------------- Net asset value, end of year 11.64 10.90 12.05 12.11 11.80 ------------------------------------------------ Total return (%)/2 12.50 (4.57) 5.24 8.86 5.44 - ----------------------------- - ----------------------------- RATIOS/SUPPLEMENTAL DATA - ----------------------------- Net assets, end of year ($ x 285,169 264,563 301,381 266,599 236,609 1,000) - ----------------------------- Ratios to average net assets: (%) - ----------------------------- Expenses .71 .70 .70 .71 .71 - ----------------------------- Net investment income 5.27 5.18 4.93 5.28 5.59 - ----------------------------- Portfolio turnover rate (%) 50.05 29.30 12.60 22.97 14.13 - ----------------------------- CLASS C - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.96 12.11 12.17 11.84 11.87 year ------------------------------------------------- Net investment income/1 .54 .53 .54 .57 .59 Net realized and unrealized gains (losses) .73 (1.14) .02 .40 (.02) ------------------------------------------------- Total from investment 1.27 (.61) .56 .97 .57 operations ------------------------------------------------- Distributions from net investment income (.53) (.53) (.54) (.57) (.60) Distributions from net realized gains - (.01) (.08) (.07) - ------------------------------------------------ Total distributions (.53) (.54) (.62) (.64) (.60) ------------------------------------------------ Net asset value, end of year 11.70 10.96 12.11 12.17 11.84 ------------------------------------------------ Total return (%)/2 11.83 (5.08) 4.63 8.39 4.93 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 23,450 20,564 21,899 10,855 5,654 1,000) Ratios to average net assets: (%) Expenses 1.26 1.25 1.26 1.27 1.28 Net investment income 4.72 4.63 4.38 4.72 4.99 Portfolio turnover rate (%) 50.05 29.30 12.60 22.97 14.13 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges. CONNECTICUT FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.06 11.27 11.23 10.92 10.96 year ------------------------------------------------ Net investment income/1 .56 .56 .58 .60 .61 Net realized and unrealized gains (losses) .56 (1.21) .04 .32 (.02) ------------------------------------------------ Total from investment 1.12 (.65) .62 .92 .59 operations ------------------------------------------------ Distributions from net investment income (.55) (.56) (.58) (.61) (.63) ------------------------------------------------ Net asset value, end of year 10.63 10.06 11.27 11.23 10.92 ------------------------------------------------ Total return (%)/2 11.43 (5.90) 5.62 8.62 5.52 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 228,844 207,745 245,016 203,643 183,649 1,000) Ratios to average net assets: (%) Expenses .73 .71 .72 .73 .72 Net investment income 5.37 5.26 5.08 5.41 5.62 Portfolio turnover rate (%) 10.11 30.61 5.87 18.54 14.53 CLASS C - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.10 11.30 11.26 10.94 10.97 year ------------------------------------------------ Net investment income/1 .50 .50 .52 .55 .60 Net realized and unrealized gains (losses) .56 (1.20) .03 .31 (.07) ------------------------------------------------ Total from investment 1.06 (.70) .55 .86 .53 operations ------------------------------------------------ Distributions from net investment income (.50) (.50) (.51) (.54) (.56) ------------------------------------------------ Net asset value, end of year 10.66 10.10 11.30 11.26 10.94 ------------------------------------------------ Total return (%)/2 10.69 (6.32) 5.02 8.08 5.03 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 27,256 25,007 23,443 8,636 4,149 1,000) Ratios to average net assets: (%) Expenses 1.28 1.26 1.28 1.29 1.29 Net investment income 4.83 4.73 4.53 4.85 5.01 Portfolio turnover rate (%) 10.11 30.61 5.87 18.54 14.53 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges. FEDERAL INTERMEDIATE FUND YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.52 11.30 11.25 10.94 10.95 year ------------------------------------------------ Net investment income1 .52 .51 .51 .53 .55 Net realized and unrealized gains (losses) .42 (.78) .06 .33 (.01) ------------------------------------------------ Total from investment .94 (.27) .57 .86 .54 operations ----------------------------------------------- Distributions from net investment income (.52) (.51) (.52) (.55) (.55) ------------------------------------------------ Net asset value, end of year 10.94 10.52 11.30 11.25 10.94 ------------------------------------------------ Total return (%)/2 9.10 (2.43) 5.17 8.02 5.12 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 164,450 170,907 195,598 139,545 104,715 1,000) Ratios to average net assets: (%) Expenses .76 .73 .75 .75 .68 Expenses excluding waiver and payments by affiliate .76 .75 .78 .82 .84 Net investment income 4.88 4.72 4.53 4.83 5.16 Portfolio turnover rate (%) 8.87 31.27 16.57 23.32 22.54 1. Based on average shares outstanding effective year ended February 2000. 2. Total return does not include sales charges. HIGH YIELD FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 19993 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.41 11.49 11.68 11.21 11.19 year ------------------------------------------------ Net investment income/1 .62 .65 .66 .69 .71 Net realized and unrealized gains (losses) .09 (1.08) (.18) .47 .04 ------------------------------------------------ Total from investment .71 (.43) .48 1.16 .75 operations ------------------------------------------------ Distributions from net investment income (.62) (.65) (.65) (.69) (.73) Distributions from net realized - -4 (.02) - - gains ------------------------------------------------ Total distributions (.62) (.65) (.67) (.69) (.73) ------------------------------------------------ Net asset value, end of year 10.50 10.41 11.49 11.68 11.21 ------------------------------------------------ Total return (%)/2 6.99 (3.81) 4.21 10.64 7.01 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 4,709,402 5,017 5,988 5,743 4,505 Ratios to average net assets: (%) Expenses .62 .61 .62 .61 .62 Net investment income 5.90 5.92 5.64 5.98 6.41 Portfolio turnover rate (%) 11.08 25.35 18.55 15.84 6.98 CLASS B - -------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.45 11.52 11.51 year ------------------------------ Net investment income/1 .56 .59 .11 Net realized and unrealized gains (losses) .09 (1.07) - ------------------------------ Total from investment .65 (.48) .11 operations ------------------------------ Distributions from net investment income (.56) (.59) (.10) Distribution from net realized - -4 - gains Total distributions (.56) (.59) (.10) ------------------------------ Net asset value, end of year 10.54 10.45 11.52 ------------------------------ Total return (%)/2 6.38 (4.27) .96 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 136,030 92,099 15,487 Ratios to average net assets: (%) Expenses 1.18 1.17 1.185 Net investment income 5.33 5.44 5.065 Portfolio turnover rate (%) 11.08 25.35 18.55 HIGH YIELD FUND (CONT.) CLASS C YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.48 11.56 11.75 11.26 11.24 year ------------------------------------------------ Net investment income/1 .56 .59 .60 .63 .66 Net realized and unrealized gains (losses) .10 (1.08) (.18) .48 .03 ------------------------------------------------ Total from investment .66 (.49) .42 1.11 .69 operations ------------------------------------------------ Distributions from net investment income (.56) (.59) (.59) (.62) (.67) Distributions from net realized gains - -4 (.02) - - ------------------------------------------------ Total distributions (.56) (.59) (.61) (.62) (.67) ------------------------------------------------ Net asset value, end of year 10.58 10.48 11.56 11.75 11.26 ------------------------------------------------ Total return (%)/2 6.45 (4.41) 3.69 10.15 6.36 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 501,372 540,932 631,974 423,264 194,400 1,000) Ratios to average net assets: (%) Expenses 1.18 1.17 1.18 1.18 1.18 Net investment income 5.34 5.35 5.07 5.38 5.78 Portfolio turnover rate (%) 11.08 25.35 18.55 15.84 6.98 1. Based on average shares outstanding effective year ended February 29, 2000. 2. Total return does not include sales charges, and is not annualized. 3. For the period January 1, 1999 (effective date) to February 28, 1999 for Class B. 4. The Fund made a capital gain distribution of $.003. 5. Annualized. NEW JERSEY FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 20003 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.99 11.96 11.92 11.61 11.68 year ------------------------------------------------ Net investment income/1 .59 .60 .61 .63 .64 Net realized and unrealized gains (losses) .71 (.96) .05 .32 (.06) ------------------------------------------------ Total from investment 1.30 (.36) .66 .95 .58 operations ------------------------------------------------ Distributions from net investment income (.59) (.61)/4 (.62) (.64) (.65) ------------------------------------------------ Net asset value, end of year 11.70 10.99 11.96 11.92 11.61 ------------------------------------------------ Total return (%/2 12.16 (3.08) 5.63 8.37 5.13 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 654,709 617,407 681,818 636,929 574,691 1,000) Ratios to average net assets: (%) Expenses .67 .65 .65 .66 .64 Net investment income 5.24 5.23 5.06 5.34 5.58 Portfolio turnover rate (%) 20.19 21.21 5.43 12.77 8.87 CLASS B - ----------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.00 10.89 year --------------------- Net investment income1 .54 .06 Net realized and unrealized gains .73 .10 --------------------- Total from investment 1.27 .16 operations --------------------- Distributions from net investment income (.53) (.05) --------------------- Net asset value, end of year 11.74 11.00 --------------------- Total return (%)/2 11.81 1.44 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 9,798 226 Ratios to average net assets: (%) Expenses 1.21 1.205 Net investment income 4.64 4.665 Portfolio turnover rate (%) 20.19 21.21 NEW JERSEY FUND (CONT.) CLASS C YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 11.05 12.03 11.98 11.66 11.72 year ------------------------------------------------- Net investment income1 .53 .54 .54 .56 .57 Net realized and unrealized gains (losses) .72 (.98) .06 .33 (.05) ------------------------------------------------ Total from investment 1.25 (.44) .60 .89 .52 operations ------------------------------------------------ Distributions from net investment income (.53) (.54)4 (.55) (.57) (.58) ------------------------------------------------ Net asset value, end of year 11.77 11.05 12.03 11.98 11.66 ------------------------------------------------ Total return (%)/2 11.59 (3.69) 5.09 7.84 4.57 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 53,381 46,403 48,715 28,139 13,095 1,000) Ratios to average net assets: (%) Expenses 1.21 1.20 1.21 1.21 1.21 Net investment income 4.69 4.67 4.50 4.77 5.01 Portfolio turnover rate (%) 20.19 21.21 5.43 12.77 8.87 1. Based on average shares outstanding effective year ended February 29,2000. 2. Total return does not include sales charges. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. The Fund made a capital gain distribution of $.003. 5. Annualized. OREGON FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.81 11.83 11.86 11.55 11.60 year ------------------------------------------------ Net investment income/1 .58 .58 .59 .62 .63 Net realized and unrealized gains (losses) .61 (1.02) (.01) .31 (.05) ------------------------------------------------ Total from investment 1.19 (.44) .58 .93 .58 operations ------------------------------------------------ Distributions from net investment income (.58) (.58) (.61) (.62) (.63) ------------------------------------------------ Net asset value, end of year 11.42 10.81 11.83 11.86 11.55 ------------------------------------------------ Total return (%)/2 11.25 (3.76) 5.12 8.21 5.13 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 457,613 432,675 483,664 427,022 384,003 1,000) Ratios to average net assets: (%) Expenses .67 .66 .67 .67 .66 Net investment income 5.20 5.16 5.00 5.33 5.52 Portfolio turnover rate (%) 16.22 24.58 10.65 12.18 4.47 CLASS C PER SHARE DATA ($) Net asset value, beginning of 10.88 11.90 11.92 11.61 11.65 year ------------------------------------------------ Net investment income/1 .52 .52 .53 .56 .56 Net realized and unrealized gains (losses) .62 (1.02) - .31 (.04) ------------------------------------------------ Total from investment 1.14 (.50) .53 .87 .52 operations ------------------------------------------------ Distributions from net investment income (.52) (.52) (.55) (.56) (.56) ------------------------------------------------ Net asset value, end of year 11.50 10.88 11.90 11.92 11.61 ------------------------------------------------ Total return (%)/2 10.58 (4.36) 4.59 7.66 4.59 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 38,733 34,071 32,962 15,946 7,100 1,000) Ratios to average net assets: (%) Expenses 1.22 1.21 1.23 1.22 1.23 Net investment income 4.65 4.62 4.44 4.74 4.93 Portfolio turnover rate (%) 16.22 24.58 10.65 12.18 4.47 1. Based on average shares outstanding effective year ended February 29,2000. 2. Total return does not include sales charges. PENNSYLVANIA FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000/3 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 9.55 10.52 10.56 10.39 10.44 year ------------------------------------------------ Net investment income/1 .53 .53 .55 .58 .60 Net realized and unrealized gains (losses) .56 (.97) (.02) .32 (.04) ------------------------------------------------ Total from investment 1.09 (.44) .53 .90 .56 operations ------------------------------------------------ Distributions from net investment income (.52) (.53) (.56) (.59) (.61) Distributions from net realized gains - -4 (.01) (.14) - ------------------------------------------------ Total distributions (.52) (.53) (.57) (.73) (.61) ------------------------------------------------ Net asset value, end of year 10.12 9.55 10.52 10.56 10.39 ------------------------------------------------ Total return (%)/2 11.73 (4.24) 5.11 8.90 5.53 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 649,603 639,004 758,942 713,141 658,339 1,000) Ratios to average net assets: (%) Expenses .67 .66 .65 .65 .64 Net investment income 5.40 5.32 5.17 5.49 5.84 Portfolio turnover rate (%) 7.56 24.21 11.11 12.74 22.24 CLASS B PER SHARE DATA ($) Net asset value, beginning of 9.55 9.47 year --------------------- Net investment income1 .48 .04 Net realized and unrealized gains (losses) .57 .08 --------------------- Total from investment 1.05 .12 operations --------------------- Distributions from net investment income (.47) (.04) --------------------- Net asset value, end of year 10.13 9.55 --------------------- Total return (%)/2 11.23 1.27 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 1,000) 3,205 186 Ratios to average net assets: (%) Expenses 1.22 1.215 Net investment income 4.85 5.065 Portfolio turnover rate (%) 7.56 24.21 PENNSYLVANIA FUND (CONT.) CLASS C YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 9.60 10.57 10.61 10.43 10.47 year ------------------------------------------------ Net investment income/1 .48 .48 .49 .52 .55 Net realized and unrealized gains (losses) .57 (.97) (.03) .33 (.05) ------------------------------------------------ Total from investment 1.05 (.49) .46 .85 .50 operations ------------------------------------------------ Distributions from net investment income (.47) (.48) (.49) (.53) (.54) Distributions from net realized gains - -4 (.01) (.14) - ------------------------------------------------ Total distributions (.47) (.48) (.50) (.67) (.54) ------------------------------------------------ Net asset value, end of year 10.18 9.60 10.57 10.61 10.43 ------------------------------------------------ Total return (%)/2 11.18 (4.76) 4.50 8.35 4.98 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 43,907 40,973 41,917 25,899 11,935 1,000) Ratios to average net assets: (%) Expenses 1.22 1.21 1.21 1.21 1.21 Net investment income 4.85 4.77 4.61 4.89 5.22 Portfolio turnover rate (%) 7.56 24.21 11.11 12.74 22.24 1. Based on average shares outstanding effective year ended February 29,2000. 2. Total return does not include sales charges. 3. For the period February 1, 2000 (effective date) to February 29, 2000 for Class B. 4. The Fund made a capital gain distribution of $.0002. 5. Annualized. PUERTO RICO FUND CLASS A YEAR ENDED FEBRUARY 28, - -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.95 11.88 11.86 11.51 11.59 year ------------------------------------------------ Net investment income1 .58 .59 .60 .62 .65 Net realized and unrealized gains (losses) .60 (.92) .06 .36 .02 ------------------------------------------------ Total from investment 1.18 (.33) .66 .98 .67 operations ------------------------------------------------ Distributions from net investment income (.58) (.58) (.60) (.62) (.65) Distributions from net realized - (.02) (.04) (.01) (.10) gains ------------------------------------------------ Total distributions (.58) (.60) (.64) (.63) (.75) ------------------------------------------------ Net asset value, end of year 11.55 10.95 11.88 11.86 11.51 ------------------------------------------------ Total return (%)2 11.06 (2.91) 5.68 8.78 6.03 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 205,678 195,157 218,753 210,325 192,525 1,000) Ratios to average net assets: (%) Expenses .77 .74 .74 .75 .73 Net investment income 5.18 5.14 4.98 5.35 5.62 Portfolio turnover rate (%) 42.32 13.41 20.19 7.94 21.09 CLASS C - -------------------------------------------------------------------------------- PER SHARE DATA ($) Net asset value, beginning of 10.97 11.89 11.87 11.53 11.62 year ------------------------------------------------ Net investment income1 .52 .53 .53 .56 .58 Net realized and unrealized gains (losses) .61 (.92) .06 .34 .02 ------------------------------------------------ Total from investment 1.13 (.39) .59 .90 .60 operations ------------------------------------------------ Distributions from net investment income (.52) (.51) (.53) (.55) (.59) Distributions from net realized - (.02) (.04) (.01) (.10) gains ------------------------------------------------ Total distributions (.52) (.53) (.57) (.56) (.69) ------------------------------------------------ Net asset value, end of year 11.58 10.97 11.89 11.87 11.53 ------------------------------------------------ Total return (%)2 10.54 (3.37) 5.09 8.07 5.33 RATIOS/SUPPLEMENTAL DATA Net assets, end of year ($ x 10,413 7,270 7,050 3,615 1,679 1,000) Ratios to average net assets: (%) Expenses 1.32 1.30 1.30 1.31 1.30 Net investment income 4.63 4.60 4.43 4.78 5.04 Portfolio turnover rate (%) 42.32 13.41 20.19 7.94 21.09 1. Based on average shares outstanding effective year ended February 29,2000. 2. Total return does not include sales charges. YOUR ACCOUNT [Insert graphic of pencil marking an X] CHOOSING A SHARE CLASS ---------------------- Each class has its own sales charge and expense structure, allowing you to choose the class that best meets your situation. Your investment representative can help you decide. Class A Class B Class C - -------------------------------------------------------------------------------- o Initial sales charge of o No initial sales charge o Initial sales charge 2.25% or less (Federal of 1% Intermediate Fund) or 4.25% or less (all other Funds) o Deferred sales charge of o Deferred sales charge of o Deferred sales charge 1% on purchases of $1 4% on shares you sell of 1% on shares you million or more sold within the first year, sell within 18 months within 12 months declining to 1% within six years and eliminated after that o Lower annual expenses o Higher annual expenses o Higher annual than Class B or C due than Class A (same as expenses than Class to lower distribution Class C) due to higher A (same as Class B) distribution fees. due to higher Automatic conversion to distribution fees. Class A shares after No conversion to eight years, reducing Class A shares, so future annual expenses. annual expenses do not decrease. SALES CHARGES - CLASS A THE SALES CHARGE MAKES WHICH EQUALS THIS % UP THIS % OF THE OF YOUR NET WHEN YOU INVEST THIS AMOUNT OFFERING PRICE INVESTMENT - -------------------------------------------------------------------------------- ALL FUNDS (EXCEPT FEDERAL INTERMEDIATE) Under $100,000 4.25 4.44 $100,000 but under $250,000 3.50 3.63 $250,000 but under $500,000 2.50 2.56 $500,000 but under $1 million 2.00 2.04 FEDERAL INTERMEDIATE FUND Under $100,000 2.25 2.30 $100,000 but under $250,000 1.75 1.78 $250,000 but under $500,000 1.25 1.26 $500,000 but under $1 million 1.00 1.01 INVESTMENTS OF $1 MILLION OR MORE If you invest $1 million or more, either as a lump sum or through our cumulative quantity discount or letter of intent programs (see page 44), you can buy Class A shares without an initial sales charge. However, there is a 1% contingent deferred sales charge (CDSC) on any shares you sell within 12 months of purchase. The way we calculate the CDSC is the same for each class (please see page 43). The CDSC will not apply to purchases over $250 million in the High Yield Fund. DISTRIBUTION AND SERVICE (12B-1) FEES Class A has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution fees of up to 0.10% per year, to those who sell and distribute Class A shares and provide other services to shareholders. Because these fees are paid out of Class A's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS B IF YOU SELL YOUR SHARES WITHIN THIS % IS DEDUCTED FROM THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC - ------------------------------------------------------------------ 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 With Class B shares, there is no initial sales charge. However, there is a CDSC if you sell your shares within six years, as described in the table above. The way we calculate the CDSC is the same for each class (please see page 43). After 8 years, your Class B shares automatically convert to Class A shares, lowering your annual expenses from that time on. MAXIMUM PURCHASE AMOUNT The maximum amount you may invest in Class B shares at one time is $249,999. We place any investment of $250,000 or more in Class A shares, since a reduced initial sales charge is available and Class A's annual expenses are lower. DISTRIBUTION AND SERVICE (12B-1) FEES Class B has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows each Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class B shares and for services provided to shareholders. Because these fees are paid out of Class B's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. SALES CHARGES - CLASS C THE SALES CHARGE MAKES UP THIS % WHICH EQUALS THIS % WHEN YOU INVEST THIS AMOUNT OF THE OFFERING PRICE OF YOUR NET INVESTMENT Under $1 million 1.00 1.01 WE PLACE ANY INVESTMENT OF $1 MILLION OR MORE IN CLASS A SHARES, SINCE THERE IS NO INITIAL SALES CHARGE AND CLASS A'S ANNUAL EXPENSES ARE LOWER. CDSC There is a 1% contingent deferred sales charge (CDSC) on any Class C shares you sell within 18 months of purchase. The way we calculate the CDSC is the same for each class (please see below). DISTRIBUTION AND SERVICE (12B-1) FEES Class C has a distribution plan, sometimes known as a Rule 12b-1 plan, that allows the Fund to pay distribution and other fees of up to 0.65% per year for the sale of Class C shares and for services provided to shareholders. Because these fees are paid out of Class C's assets on an on-going basis, over time these fees will increase the cost of your investment and may cost you more than paying other types of sales charges. CONTINGENT DEFERRED SALES CHARGE (CDSC) - CLASS A, B & C The CDSC for each class is based on the current value of the shares being sold or their net asset value when purchased, whichever is less. There is no CDSC on shares you acquire by reinvesting your dividends or capital gains distributions. [Begin callout] The HOLDING PERIOD FOR THE CDSC begins on the day you buy your shares. Your shares will age one month on that same date the next month and each following month. For example, if you buy shares on the 18th of the month, they will age one month on the 18th day of the next month and each following month. [End callout] To keep your CDSC as low as possible, each time you place a request to sell shares we will first sell any shares in your account that are not subject to a CDSC. If there are not enough of these to meet your request, we will sell the shares in the order they were purchased. We will use this same method if you exchange your shares into another Franklin Templeton fund (please see page 50 for exchange information). SALES CHARGE REDUCTIONS AND WAIVERS If you qualify for any of the sales charge reductions or waivers below, please let us know at the time you make your investment to help ensure you receive the lower sales charge. QUANTITY DISCOUNTS We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases of Class A shares. [Begin callout] FRANKLIN TEMPLETON FUNDS include all of the U.S. registered mutual funds of Franklin Templeton Investments, except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. [End callout] o CUMULATIVE QUANTITY DISCOUNT - lets you combine all of your shares in Franklin Templeton funds for purposes of calculating the sales charge. You also may combine the shares of your spouse, and your children or grandchildren, if they are under the age of 21. Certain company and retirement plan accounts also may be included. o LETTER OF INTENT (LOI) - expresses your intent to buy a stated dollar amount of shares over a 13-month period and lets you receive the same sales charge as if all shares had been purchased at one time. We will reserve a portion of your shares to cover any additional sales charge that may apply if you do not buy the amount stated in your LOI. TO SIGN UP FOR THESE PROGRAMS, COMPLETE THE APPROPRIATE SECTION OF YOUR ACCOUNT APPLICATION. REINSTATEMENT PRIVILEGE If you sell shares of a Franklin Templeton fund, you may reinvest some or all of the proceeds within 365 days without an initial sales charge. The proceeds must be reinvested within the same share class, except proceeds from the sale of Class B shares will be reinvested in Class A shares. If you paid a CDSC when you sold your Class A or C shares, we will credit your account with the amount of the CDSC paid but a new CDSC will apply. For Class B shares reinvested in Class A, a new CDSC will not apply, although your account will not be credited with the amount of any CDSC paid when you sold your Class B shares. Proceeds immediately placed in a Franklin Bank Certificate of Deposit (CD) also may be reinvested without an initial sales charge if you reinvest them within 365 days from the date the CD matures, including any rollover. This privilege does not apply to shares you buy and sell under our exchange program. Shares purchased with the proceeds from a money fund may be subject to a sales charge. SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales charge or CDSC by various individuals and institutions or by investors who reinvest certain distributions and proceeds within 365 days. Certain investors also may buy Class C shares without an initial sales charge. The CDSC for each class may be waived for certain redemptions and distributions. If you would like information about available sales charge waivers, call your investment representative or call Shareholder Services at 1-800/632-2301. A list of available sales charge waivers also may be found in the Statement of Additional Information (SAI). GROUP INVESTMENT PROGRAM Allows established groups of 11 or more investors to invest as a group. For sales charge purposes, the group's investments are added together. There are certain other requirements and the group must have a purpose other than buying Fund shares at a discount. [Insert graphic of a paper with lines and someone writing] BUYING SHARES ------------- MINIMUM INVESTMENTS - -------------------------------------------------------------------------------- INITIAL ADDITIONAL - -------------------------------------------------------------------------------- Regular accounts $1,000 $50 - -------------------------------------------------------------------------------- Automatic investment plans $50 $50 - -------------------------------------------------------------------------------- UGMA/UTMA accounts $100 $50 - -------------------------------------------------------------------------------- Broker-dealer sponsored wrap account $250 $50 programs - -------------------------------------------------------------------------------- Full-time employees, officers, $100 $50 trustees and directors of Franklin Templeton entities, and their immediate family members - -------------------------------------------------------------------------------- PLEASE NOTE THAT YOU MAY ONLY BUY SHARES OF A FUND ELIGIBLE FOR SALE IN YOUR STATE OR JURISDICTION. ACCOUNT APPLICATION If you are opening a new account, please complete and sign the enclosed account application. Make sure you indicate the share class you have chosen. If you do not indicate a class, we will place your purchase in Class A shares. To save time, you can sign up now for services you may want on your account by completing the appropriate sections of the application (see "Investor Services" on page 48). For example, if you would like to link one of your bank accounts to your Fund account so that you may use electronic funds transfer to and from your bank account to buy and sell shares, please complete the bank information section of the application. We will keep your bank information on file for future purchases and redemptions. BUYING SHARES - -------------------------------------------------------------------------------- OPENING AN ACCOUNT ADDING TO AN ACCOUNT - -------------------------------------------------------------------------------- [Insert graphic of hands shaking] Contact your investment Contact your investment THROUGH YOUR representative representative INVESTMENT REPRESENTATIVE - -------------------------------------------------------------------------------- [Insert graphic of If you have another Before requesting a phone and computer] Franklin Templeton fund telephone or online purchase account with your bank into an existing account, BY PHONE/ONLINE account information on please make sure we have file, you may open a new your bank account (Up to $100,000 per account by phone. At this information on file. If we shareholder per day) time, a new account may do not have this not be opened online. information, you will need 1-800/632-2301 to send written instructions To make a same day with your bank's name and franklintempleton.com investment, your phone address, a voided check or order must be received and savings account deposit NOTE: CERTAIN ACCOUNT accepted by us by 1:00 slip, and a signature TYPES ARE NOT p.m. Pacific time or the guarantee if the bank and AVAILABLE FOR ONLINE close of the New York Fund accounts do not have at ACCOUNT ACCESS Stock Exchange, whichever least one common owner. is earlier. To make a same day investment, your phone or online order must be received and accepted by us by 1:00 p.m. Pacific time or the close of the New York Stock Exchange, whichever is earlier. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Make your check payable to Make your check payable to [Insert graphic of the Fund. the Fund. Include your envelope] account number on the check. Mail the check and your BY MAIL signed application to Fill out the deposit slip Investor Services. from your account statement. If you do not have a slip, include a note with your name, the Fund name, and your account number. Mail the check and deposit slip or note to Investor Services. - -------------------------------------------------------------------------------- [Insert graphic of Call to receive a wire Call to receive a wire three lightning bolts] control number and wire control number and wire instructions. instructions. Wire the funds and mail To make a same day wire BY WIRE your signed application to investment, please call us Investor Services. Please by 1:00 p.m. Pacific time 1-800/632-2301 include the wire control and make sure your wire (or 1-650/312-2000 number or your new account arrives by 3:00 p.m. collect) number on the application. To make a same day wire investment, please call us by 1:00 p.m. Pacific time and make sure your wire arrives by 3:00 p.m. - -------------------------------------------------------------------------------- [Insert graphic of two Call Shareholder Services Call Shareholder Services at arrows pointing in at the number below, or the number below or our directions] send signed written automated TeleFACTS instructions. You also system, or send signed BY EXCHANGE may place an online written instructions. You exchange order. The also may place an online TeleFACTS(R) TeleFACTS system cannot be exchange order. 1-800/247-1753 used to open a new account. (around-the-clock (Please see page 50 for access) (Please see page 50 for information on exchanges.) information on exchanges.) Our Website franklintempleton.com - -------------------------------------------------------------------------------- FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of person with a headset] INVESTOR SERVICES ----------------- AUTOMATIC INVESTMENT PLAN This plan offers a convenient way for you to invest in a Fund by automatically transferring money from your checking or savings account each month to buy shares. To sign up, complete the appropriate section of your account application and mail it to Investor Services. If you are opening a new account, please include the minimum initial investment of $50 with your application. AUTOMATIC PAYROLL DEDUCTION You may invest in a Fund automatically by transferring money from your paycheck to the Fund by electronic funds transfer. If you are interested, indicate on your application that you would like to receive an Automatic Payroll Deduction Program kit. DISTRIBUTION OPTIONS You may reinvest distributions you receive from a Fund in an existing account in the same share class* of Fund or another Franklin Templeton fund. Initial sales charges and CDSCs will not apply if you reinvest your distributions within 365 days. You also can have your distributions deposited in a bank account, or mailed by check. Deposits to a bank account may be made by electronic funds transfer. Please indicate on your application the distribution option you have chosen, otherwise we will reinvest your distributions in the same share class of the Fund. *Class B and C shareholders may reinvest their distributions in Class A shares of any Franklin Templeton money fund. TELEFACTS(R) Our TeleFACTS system offers around-the-clock access to information about your account or any Franklin Templeton fund. This service is available from touch-tone phones at 1-800/247-1753. For a free TeleFACTS brochure, call 1-800/DIAL BEN. FRANKLIN TEMPLETON ONLINE You can visit us online at franklintempleton.com for around-the-clock viewing of information about most Franklin Templeton funds or to register to view your accounts online. You also may register for online transactions that will allow you to buy, sell, or exchange your shares and make certain changes to your account. Some account types may not be able to process any or all transactions online. You also may register online for Franklin Templeton's convenient electronic delivery of your important shareholder documents. This service should be available on our website in July 2001. TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account, allowing you to obtain or view your account information, and conduct a number of transactions by phone or online, including: buy, sell, or exchange shares of most funds; use electronic funds transfer to buy or sell shares of most funds; change your address; request a year-end statement; add or change account services (including distribution options, systematic withdrawals, automatic investment plans). In addition, you may elect to receive your important shareholder documents online and discontinue receiving paper copies. To view your account information or request online transactions, you will first need to register for these services at the shareholder section of our website at franklintempleton.com. You will be asked to accept the terms of an online agreement(s) and establish a password for online services. If you are registered for online services, you may enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most Funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Using our shareholder website means you are consenting to sending and receiving personal financial information over the Internet so you should be sure you are comfortable with the risks. As long as we follow reasonable security procedures and act on instructions we reasonably believe are genuine, we will not be responsible for any losses that may occur from unauthorized requests. We will request passwords or other information, and also may record calls. To help safeguard your account, keep your password confidential, and verify the accuracy of your confirmation statements immediately after you receive them. Contact us immediately if you believe someone has obtained unauthorized access to your account or password. For transactions done over the Internet, we recommend the use of an Internet browser with 128-bit encryption. Certain methods of contacting us (such as by phone or by Internet) may be unavailable or delayed during periods of unusual market activity. OF COURSE, YOU CAN DECLINE TELEPHONE BUY, SELL, OR EXCHANGE PRIVILEGES ON YOUR ACCOUNT APPLICATION, OR CHOOSE NOT TO REGISTER FOR ONLINE PRIVILEGES. IF YOU HAVE TELEPHONE/ONLINE PRIVILEGES ON YOUR ACCOUNT AND WANT TO DISCONTINUE THEM, PLEASE CONTACT US FOR INSTRUCTIONS. You may reinstate these privileges at any time in writing, including online registration with respect to online privileges. NOTE: We discourage you from including confidential or sensitive information in any Internet communication to us. If you do choose to send email (encrypted or not) to us over the Internet, you are accepting the associated risks of lack of confidentiality. EXCHANGE PRIVILEGE You can exchange shares between most Franklin Templeton funds within the same class*, generally without paying any additional sales charges. If you exchange shares held for less than six months, however, you may be charged the difference between the initial sales charge of the two funds if the difference is more than 0.25%. If you exchange shares from a money fund, a sales charge may apply no matter how long you have held the shares. [Begin callout] An EXCHANGE is really two transactions: a sale of one fund and the purchase of another. In general, the same policies that apply to purchases and sales apply to exchanges, including minimum investment amounts. Exchanges also have the same tax consequences as ordinary sales and purchases. [End callout] Generally exchanges may only be made between identically registered accounts, unless you send written instructions with a signature guarantee. Any CDSC will continue to be calculated from the date of your initial investment and will not be charged at the time of the exchange. The purchase price for determining a CDSC on exchanged shares will be the price you paid for the original shares. If you exchange shares subject to a CDSC into a Class A money fund, the time your shares are held in the money fund will not count towards the CDSC holding period. If you exchange your Class B shares for the same class of shares of another Franklin Templeton fund, the time your shares are held in that fund will count towards the eight year period for automatic conversion to Class A shares. Because excessive trading can hurt fund performance, operations and shareholders, each Fund reserves the right to revise or terminate the exchange privilege, limit the amount or number of exchanges, reject any exchange, or restrict or refuse purchases if (i) the Fund or its manager believes the Fund would be harmed or unable to invest effectively, or (ii) the Fund receives or anticipates simultaneous orders that may significantly affect the Fund (please see "Market Timers" on page 56). *Class Z shareholders of Franklin Mutual Series Fund Inc. may exchange into Class A without any sales charge. Advisor Class shareholders of another Franklin Templeton fund also may exchange into Class A without any sales charge. Advisor Class shareholders who exchange their shares for Class A shares and later decide they would like to exchange into another fund that offers Advisor Class may do so. SYSTEMATIC WITHDRAWAL PLAN This plan allows you to automatically sell your shares and receive regular payments from your account. A CDSC may apply to withdrawals that exceed certain amounts. Certain terms and minimums apply. To sign up, complete the appropriate section of your application. [Insert graphic of a certificate] SELLING SHARES -------------- You can sell your shares at any time. Please keep in mind that a contingent deferred sales charge (CDSC) may apply. SELLING SHARES IN WRITING Generally, requests to sell $100,000 or less can be made over the phone, online, or with a simple letter. Sometimes, however, to protect you and the Fund we will need written instructions signed by all registered owners, with a signature guarantee for each owner, if: [Begin callout] A SIGNATURE GUARANTEE helps protect your account against fraud. You can obtain a signature guarantee at most banks and securities dealers. [End callout] A notary public CANNOT provide a signature guarantee. o you are selling more than $100,000 worth of shares o you want your proceeds paid to someone who is not a registered owner o you want to send your proceeds somewhere other than the address of record, or preauthorized bank or brokerage firm account We also may require a signature guarantee on instructions we receive from an agent, not the registered owners, or when we believe it would protect the Fund against potential claims based on the instructions received. SELLING RECENTLY PURCHASED SHARES If you sell shares recently purchased, we may delay sending you the proceeds until your check, draft or wire/electronic funds transfer has cleared, which may take seven business days or more. A certified or cashier's check may clear in less time. REDEMPTION PROCEEDS Your redemption check will be sent within seven days after we receive your request in proper form. We are not able to receive or pay out cash in the form of currency. Redemption proceeds may be delayed if we have not yet received your signed account application. SELLING SHARES - -------------------------------------------------------------------------------- TO SELL SOME OR ALL OF YOUR SHARES - -------------------------------------------------------------------------------- [Insert graphic of hands shaking] Contact your investment representative THROUGH YOUR INVESTMENT REPRESENTATIVE - -------------------------------------------------------------------------------- [Insert graphic of Send written instructions and endorsed share envelope] certificates (if you hold share certificates) to Investor Services. Corporate, partnership BY MAIL or trust accounts may need to send additional documents. Specify the Fund, the account number and the dollar value or number of shares you wish to sell. If you own both Class A and B shares, also specify the class of shares, otherwise we will sell your Class A shares first. Be sure to include all necessary signatures and any additional documents, as well as signature guarantees if required. A check will be mailed to the name(s) and address on the account, or otherwise according to your written instructions. - -------------------------------------------------------------------------------- [Insert graphic of As long as your transaction is for $100,000 or phone and computer] less, you do not hold share certificates and you have not changed your address by phone or BY PHONE/ONLINE online within the last 15 days, you can sell your shares by phone or online. 1-800/632-2301 A check will be mailed to the name(s) and franklintempleton.com address on the account. Written instructions, with a signature guarantee, are required to send the check to another address or to make it payable to another person. (Please see page 48 for more information.) - -------------------------------------------------------------------------------- [Insert graphic of three You can call, write, or visit us online to have bolts] redemption proceeds sent to a bank account. See the policies above for selling shares by mail, phone, or online. BY ELECTRONIC FUNDS TRANSFER (ACH) Before requesting to have redemption proceeds sent to a bank account, please make sure we have your bank account information on file. If we do not have this information, you will need to send written instructions with your bank's name and address, a voided check or savings account deposit slip, and a signature guarantee if the bank and Fund accounts do not have at least one common owner. If we receive your request in proper form by 1:00 p.m. Pacific time, proceeds sent by ACH generally will be available within two to three business days. - -------------------------------------------------------------------------------- [Insert graphic of two Obtain a current prospectus for the fund you arrows pointing in are considering. Prospectuses are available opposite directions] online at franklintempleton.com. BY EXCHANGE Call Shareholder Services at the number below or our automated TeleFACTS system, or send TeleFACTS(R) signed written instructions. You also may 1-800/247-1753 place an exchange order online. See the (around-the-clock policies above for selling shares by mail, access) phone, or online. If you hold share certificates, you will need to return them to the Fund before your exchange can be processed. - -------------------------------------------------------------------------------- FRANKLIN TEMPLETON INVESTOR SERVICES P.O. BOX 997151, SACRAMENTO, CA 95899-9983 CALL TOLL-FREE: 1-800/632-2301 (MONDAY THROUGH FRIDAY 5:30 A.M. TO 5:00 P.M., PACIFIC TIME SATURDAY 6:30 A.M. TO 2:30 P.M., PACIFIC TIME) [Insert graphic of paper and pen] ACCOUNT POLICIES ---------------- CALCULATING SHARE PRICE Each Fund calculates its net asset value per share (NAV) each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). Each class's NAV is calculated by dividing its net assets by the number of its shares outstanding. [Begin callout] When you buy shares, you pay the offering price. The offering price is the NAV plus any applicable sales charge. When you sell shares, you receive the NAV minus any applicable contingent deferred sales charge (CDSC). [End callout] Each Fund's assets are generally valued at their market value. If market prices are unavailable, or if an event occurs after the close of the trading market that materially affects the values, assets may be valued at their fair value. Requests to buy and sell shares are processed at the NAV next calculated after we receive your request in proper form. ACCOUNTS WITH LOW BALANCES If the value of your account falls below $250 ($50 for employee and UGMA/UTMA accounts) because you sell some of your shares, we may mail you a notice asking you to bring the account back up to its applicable minimum investment amount. If you choose not to do so within 30 days, we may close your account and mail the proceeds to the address of record. You will not be charged a CDSC if your account is closed for this reason. STATEMENTS AND REPORTS You will receive quarterly account statements that show all your account transactions during the quarter. You also will receive written notification after each transaction affecting your account (except for distributions and transactions made through automatic investment or withdrawal programs, which will be reported on your quarterly statement). You also will receive the Funds' financial reports every six months. To reduce Fund expenses, we try to identify related shareholders in a household and send only one copy of the financial reports. If you need additional copies, please call 1-800/DIAL BEN. You also can review these documents on our website if you have registered to view your account information online. If you are registered for online services, you may also enroll online in Franklin Templeton's electronic delivery program for your important shareholder documents. This will allow you to receive electronic delivery (through our website) of most funds' prospectuses, annual/semiannual reports to shareholders, and proxy statements, as well as your account(s) statements and trade confirmations, and discontinue receiving your paper copies through the U.S. mail. Visit us online at franklintempleton.com for more information. INVESTMENT REPRESENTATIVE ACCOUNT ACCESS If there is a dealer or other investment representative of record on your account, he or she will be able to obtain your account information, conduct transactions for your account, and also will receive copies of all notifications and statements and other information about your account directly from the Fund. STREET OR NOMINEE ACCOUNTS You may transfer your shares from the street or nominee name account of one dealer to another, as long as both dealers have an agreement with Franklin Templeton Distributors, Inc. We will process the transfer after we receive authorization in proper form from your delivering securities dealer. JOINT ACCOUNTS Unless you specify a different registration, accounts with two or more owners are registered as "joint tenants with rights of survivorship" (shown as "Jt Ten" on your account statement). To make any ownership changes to a joint account, all owners must agree in writing, regardless of the law in your state. JOINT ACCOUNT RISK WITH TELEPHONE/ONLINE PRIVILEGES You will automatically receive telephone/online privileges when you open your account. If your account has more than one registered owner, telephone/online privileges allow the Fund to accept online registration for online services (including electronic delivery of important shareholder documents) and transaction instructions online or by telephone from only one registered owner. This means that ANY ONE REGISTERED OWNER ON YOUR ACCOUNT, ACTING ALONE AND WITHOUT THE CONSENT OF ANY OTHER REGISTERED OWNER, may give the Fund instructions by telephone, online or in writing (subject to any limitations in telephone or online privileges) to: o Exchange shares from a jointly registered Fund account requiring all registered owner signatures into an identically registered money fund account that only requires one registered owner's signature to redeem shares; o Redeem Fund shares and direct the redemption proceeds to a bank account that may or may not be owned by you and, if owned by you jointly with someone else, only requires one person to withdraw funds by check or otherwise; o Change the bank account to which Fund share redemption proceeds may be sent, which bank account may not be owned by you; o Purchase Fund shares by debiting a bank account that may be owned by you; and o Change the bank account that may be debited for Fund share purchases, which new account may be owned by you. If you do NOT want another registered owner on your account to be able to issue these kinds of instructions to the Fund without your consent, you must instruct the Fund to deny/terminate online privileges and the ability to issue such instructions by telephone so that these types of instructions will only be accepted in writing signed by all account owners. This decision will apply to any other fund into which you may exchange your jointly owned Fund shares. Any later decision to permit these types of instructions by telephone and/or online will need to be given to the Fund in a written instruction signed by all registered owners. MARKET TIMERS The Funds do not allow investments by Market Timers. You may be considered a Market Timer if you have (i) requested an exchange out of any of the Franklin Templeton funds within two weeks of an earlier exchange request out of any fund, or (ii) exchanged shares out of any of the Franklin Templeton funds more than twice within a rolling 90 day period, or (iii) otherwise seem to follow a market timing pattern that may adversely affect the Fund. Accounts under common ownership or control with an account that is covered by (i), (ii), or (iii) also are subject to these limits. ADDITIONAL POLICIES Please note that the Funds maintain additional policies and reserve certain rights, including: o The Funds may restrict or refuse any order to buy shares, including any purchase under the exchange privilege. o The Funds may modify, suspend, or terminate telephone/online privileges at any time. o At any time, the Funds may change their investment minimums or waive or lower their minimums for certain purchases. o The Funds may modify or discontinue the exchange privilege on 60 days' notice. o In unusual circumstances, we may temporarily suspend redemptions, or postpone the payment of proceeds, as allowed by federal securities laws. o For redemptions over a certain amount, each Fund reserves the right, in the case of an emergency, to make payments in securities or other assets of the Fund, if the payment of cash proceeds by check, wire or electronic funds transfer would be harmful to existing shareholders. o To permit investors to obtain the current price, dealers are responsible for transmitting all orders to the Funds promptly. DEALER COMPENSATION Qualifying dealers who sell Fund shares may receive sales commissions and other payments. These are paid by Franklin Templeton Distributors, Inc. (Distributors) from sales charges, distribution and service (12b-1) fees and its other resources. ALL FUNDS (EXCEPT FEDERAL INTERMEDIATE) CLASS A CLASS B CLASS C - ------------------------------------------------------------------------------ COMMISSION (%) - 3.00 2.00 Investment under $100,000 4.00 - - $100,000 but under $250,000 3.25 - - $250,000 but under $500,000 2.25 - - $500,000 but under $1 million 1.85 - - $1 million or more up to 0.751 - - 12B-1 FEE TO DEALER 0.10 0.15/2 0.65/3 FEDERAL INTERMEDIATE FUND COMMISSION (%) - Investment under $100,000 2.00 $100,000 but under $250,000 1.50 $250,000 but under $500,000 1.00 $500,000 but under $1 million 0.85 $1 million or more up to 0.75/1 12B-1 FEE TO DEALER 0.10 A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer commission of up to 0.25% may be paid on Class A NAV purchases by certain trust companies and bank trust departments, eligible governmental authorities, and broker-dealers or others on behalf of clients participating in comprehensive fee programs. 1. During the first year after purchase, dealers may not be eligible to receive the 12b-1 fee. 2. Dealers may be eligible to receive up to 0.15% from the date of purchase. After 8 years, Class B shares convert to Class A shares and dealers may then receive the 12b-1 fee applicable to Class A. 3. Dealers may be eligible to receive up to 0.15% during the first year after purchase and may be eligible to receive the full 12b-1 fee starting in the 13th month. [Insert graphic of question mark] QUESTIONS --------- If you have any questions about the Funds or your account, you can write to us at P.O. Box 997151, Sacramento, CA 95899-9983. You also can call us at one of the following numbers. For your protection and to help ensure we provide you with quality service, all calls may be monitored or recorded. HOURS (PACIFIC TIME, DEPARTMENT NAME TELEPHONE NUMBER MONDAY THROUGH FRIDAY) - ---------------------------------------------------------------------------- Shareholder Services 1-800/632-2301 5:30 a.m. to 5:00 p.m. 6:30 a.m. to 2:30 p.m. (Saturday) Fund Information 1-800/DIAL BEN 5:30 a.m. to 5:00 p.m. (1-800/342-5236) 6:30 a.m. to 2:30 p.m. (Saturday) Retirement Services 1-800/527-2020 5:30 a.m. to 5:00 p.m. Advisor Services 1-800/524-4040 5:30 a.m. to 5:00 p.m. Institutional Services 1-800/321-8563 6:00 a.m. to 5:00 p.m. TDD (hearing impaired) 1-800/851-0637 5:30 a.m. to 5:00 p.m. TeleFACTS(R)(automated) 1-800/247-1753 (around-the-clock access) FOR MORE INFORMATION You can learn more about each Fund in the following documents: ANNUAL/SEMIANNUAL REPORT TO SHAREHOLDERS Includes a discussion of recent market conditions and Fund strategies that significantly affected each Fund's performance during its last fiscal year, financial statements, detailed performance information, portfolio holdings and the auditor's report. STATEMENT OF ADDITIONAL INFORMATION (SAI) Contains more information about each Fund, its investments and policies. It is incorporated by reference (is legally a part of this prospectus). For a free copy of the current annual/semiannual report or the SAI, please contact your investment representative or call us at the number below. You also can view the current annual/semiannual report online at franklintempleton.com. FRANKLIN(R)TEMPLETON(R) 1-800/DIAL BEN(R) (1-800/342-5236) TDD (Hearing Impaired) 1-800/851-0637 franklintempleton.com You also can obtain information about each Fund by visiting the SEC's Public Reference Room in Washington, D.C. (phone 1-202/942-8090) or the EDGAR Database on the SEC's Internet site at http://www.sec.gov. You can obtain copies of this information, after paying a duplicating fee, by writing to the SEC's Public Reference Section, Washington, D.C. 20549-0102 or by electronic request at the following e-mail address: publicinfo@sec.gov. Investment Company Act file # 811-4149 TF3 P 07/01 FRANKLIN TAX-FREE TRUST FRANKLIN ARIZONA TAX-FREE INCOME FUND FRANKLIN COLORADO TAX-FREE INCOME FUND FRANKLIN CONNECTICUT TAX-FREE INCOME FUND FRANKLIN FEDERAL INTERMEDIATE-TERM TAX-FREE INCOME FUND FRANKLIN HIGH YIELD TAX-FREE INCOME FUND FRANKLIN NEW JERSEY TAX-FREE INCOME FUND FRANKLIN OREGON TAX-FREE INCOME FUND FRANKLIN PENNSYLVANIA TAX-FREE INCOME FUND FRANKLIN PUERTO RICO TAX-FREE INCOME FUND [INSERT FRANKLIN TEMPLETON BEN HEAD] STATEMENT OF ADDITIONAL INFORMATION JULY 1, 2001 P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R) This Statement of Additional Information (SAI) is not a prospectus. It contains information in addition to the information in the Funds' prospectus. The Funds' prospectus, dated July 1, 2001, which we may amend from time to time, contains the basic information you should know before investing in the Funds. You should read this SAI together with the Funds' prospectus. The audited financial statements and auditor's report in the Funds' Annual Report to Shareholders, for the fiscal year ended February 28, 2001, are incorporated by reference (are legally a part of this SAI). For a free copy of the current prospectus or annual report, contact your investment representative or call 1-800/DIAL BEN (1-800/342-5236). CONTENTS Goals, Strategies and Risks . . . . . . . . . 2 Officers and Trustees . . . . . . . . . . . . 11 Management and Other Services . . . . . . . . 14 Portfolio Transactions . . . . . . . . . . . 15 Distributions and Taxes . . . . . . . . . . . 15 Organization, Voting Rights and Principal Holders . . . . . . . . . . . .17 Buying and Selling Shares . . . . . . . . . . 18 Pricing Shares . . . . . . . . . . . . . . . .23 The Underwriter . . . . . . . . . . . . . . . 24 Performance . . . . . . . . . . . . . . . . . 26 Miscellaneous Information . . . . . . . . . . 30 Description of Ratings . . . . . . . . . . . .30 State Tax Treatment . . . . . . . . . . . . . 33 - ------------------------------------------------------------------------------- MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS: O ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT; O ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK; O ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. GOALS, STRATEGIES AND RISKS - ------------------------------------------------------------------------------- Generally, the policies and restrictions discussed in this SAI and in the prospectus apply when a Fund makes an investment. In most cases, the Fund is not required to sell a security because circumstances change and the security no longer meets one or more of the Fund's policies or restrictions. If a percentage restriction or limitation is met at the time of investment, a later increase or decrease in the percentage due to a change in the value or liquidity of portfolio securities will not be considered a violation of the restriction or limitation. If a bankruptcy or other extraordinary event occurs concerning a particular security the Fund owns, the Fund may receive stock, real estate, or other investments that the Fund would not, or could not, buy. If this happens, the Fund intends to sell such investments as soon as practicable while trying to maximize the return to shareholders. Each Fund has adopted certain investment restrictions as fundamental and non-fundamental policies. A fundamental policy may only be changed if the change is approved by (i) more than 50% of a Fund's outstanding shares or (ii) 67% or more of a Fund's shares present at a shareholder meeting if more than 50% of a Fund's outstanding shares are represented at the meeting in person or by proxy, whichever is less. A non-fundamental policy may be changed by the board of trustees without the approval of shareholders. FUNDAMENTAL INVESTMENT POLICIES The Federal Intermediate Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes, including the individual alternative minimum tax, as is consistent with prudent investment management and the preservation of shareholders' capital. The High Yield Fund's principal investment goal is to provide investors with a high current yield exempt from federal income taxes. Its secondary goal is capital appreciation to the extent possible and consistent with the Fund's principal investment goal. The Puerto Rico Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes as is consistent with prudent investment management and the preservation of shareholders' capital. The Puerto Rico Fund also seeks to provide a maximum level of income that is free from the personal income taxes of a majority of states, although this policy is not a fundamental investment goal of the Fund and may be changed without shareholder approval. Each state Fund's investment goal is to provide investors with as high a level of income exempt from federal income taxes and from personal income taxes, if any, for resident shareholders of the Fund's state as is consistent with prudent investment management and the preservation of shareholders' capital. Each Fund may not: 1. Borrow money or mortgage or pledge any of its assets, except that borrowings (and a pledge of assets therefore) for temporary or emergency purposes may be made from banks in any amount up to 5% of the total asset value. 2. Buy any securities on "margin" or sell any securities "short," except that it may use such short-term credits as are necessary for the clearance of transactions. 3. Make loans, except through the purchase of readily marketable debt securities which are either publicly distributed or customarily purchased by institutional investors. Although such loans are not presently intended, this prohibition will not preclude the Fund from loaning portfolio securities to broker-dealers or other institutional investors if at least 102% cash collateral is pledged and maintained by the borrower; provided such portfolio security loans may not be made if, as a result, the aggregate of such loans exceeds 10% of the value of the Fund's total assets at the time of the most recent loan. 4. Act as underwriter of securities issued by other persons, except insofar as the Fund may be technically deemed an underwriter under the federal securities laws in connection with the disposition of portfolio securities. 5. Purchase the securities of any issuer which would result in owning more than 10% of the voting securities of such issuer, except with respect to the Connecticut and Federal Intermediate Funds, each of which will not purchase a security, if as a result: i) more than 25% of its total assets would be invested in the securities of a single issuer or ii) with respect to 50% of its total assets, more than 5% of its assets would be invested in the securities of a single issuer. 6. Purchase securities from or sell to the Trust's officers and trustees, or any firm of which any officer or trustee is a member, as principal, or retain securities of any issuer if, to the knowledge of the Trust, one or more of the Trust's officers, trustees, or investment manager own beneficially more than one-half of 1% of the securities of such issuer and all such officers and trustees together own beneficially more than 5% of such securities. 7. Acquire, lease or hold real estate, except such as may be necessary or advisable for the maintenance of its offices and provided that this limitation shall not prohibit the purchase of municipal and other debt securities secured by real estate or interests therein. 8. Invest in commodities and commodity contracts, puts, calls, straddles, spreads or any combination thereof, or interests in oil, gas, or other mineral exploration or development programs, except that it may purchase, hold and dispose of "obligations with puts attached" in accordance with its investment policies. 9. Invest in companies for the purpose of exercising control or management. 10. For each Fund except the Federal Intermediate Fund, purchase securities of other investment companies, except in connection with a merger, consolidation or reorganization, except to the extent the Fund invests its uninvested daily cash balances in shares of the Franklin Tax-Exempt Money Fund and other tax-exempt money market funds in Franklin Templeton Investments provided i) its purchases and redemptions of such money market fund shares may not be subject to any purchase or redemption fees, ii) its investments may not be subject to duplication of management fees, nor to any charge related to the expense of distributing the Fund's shares (as determined under Rule 12b-1, as amended under the federal securities laws) and iii) aggregate investments by the Fund in any such money market fund do not exceed (A) the greater of (i) 5% of the Fund's total net assets or (ii) $2.5 million, or (B) more than 3% of the outstanding shares of any such money market fund. 11. For each Fund except the Federal Intermediate Fund, invest more than 25% of its assets in securities of any industry; although for purposes of this limitation, tax-exempt securities and U.S. government obligations are not considered to be part of any industry. The following investment restrictions only apply to the Federal Intermediate Fund: 12. Purchase securities of other investment companies, except in connection with a merger, consolidation, acquisition or reorganization. To the extent permitted by exemptions which may be granted under the Investment Company Act of 1940, the Federal Intermediate Fund may invest in shares of one or more investment companies, of the type generally referred to as money market funds, managed by Franklin Advisers, Inc. or its affiliates. 13. Purchase securities, in private placements or in other transactions, for which there are legal or contractual restrictions on resale. 14. Invest more than 25% of its assets in securities of any industry. For purposes of this limitation, tax-exempt securities issued by governments or political subdivisions of governments are not considered to be part of any industry. INVESTMENTS, TECHNIQUES, STRATEGIES AND THEIR RISKS As a fundamental policy, each Fund normally invests at least 80% of its total assets in securities that pay interest free from federal income taxes, including the federal alternative minimum tax. Each Fund applies this test to its net assets, except for the Federal Intermediate Fund, which applies this test to its total assets. Each state Fund, as a fundamental policy, also normally invests at least 80% of its net assets in securities that pay interest free from the personal income taxes, if any, of its state. As a nonfundamental policy, the Puerto Rico Fund and each state Fund also normally invests at least and 65% of its total assets in municipal securities of their state or territory. Unlike the state and Puerto Rico Funds, the Federal Intermediate and High Yield Funds are diversified nationally. The High Yield Fund will not invest more than 25% of its total assets in the municipal securities of any one state or territory. Municipal securities issued by a Fund's state or that state's counties, municipalities, authorities, agencies, or other subdivisions, as well as qualifying municipal securities issued by U.S. territories such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands, generally pay interest free from federal income tax and from state personal income taxes, if any, for residents of the Fund's state. Each Fund tries to invest all of its assets in tax-free municipal securities. The issuer's bond counsel generally gives the issuer an opinion on the tax-exempt status of a municipal security when the security is issued. Some states may require a Fund to invest a certain amount of its assets in securities of that state, or in securities that are otherwise tax-free under the laws of that state, in order for any portion of the Fund's distributions to be free from the state's personal income taxes. If a Fund's state requires this, the Fund will try to invest its assets as required so that its distributions will be free from personal income taxes for resident shareholders of the Fund's state. BELOW IS A DESCRIPTION OF VARIOUS TYPES OF MUNICIPAL AND OTHER SECURITIES THAT EACH FUND MAY BUY. OTHER TYPES OF MUNICIPAL SECURITIES MAY BECOME AVAILABLE THAT ARE SIMILAR TO THOSE DESCRIBED BELOW AND IN WHICH EACH FUND ALSO MAY INVEST, IF CONSISTENT WITH ITS INVESTMENT GOAL AND POLICIES. MUNICIPAL BONDS have two principal classifications: general obligation bonds and revenue bonds. GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states, counties, cities, towns and regional districts. The proceeds of these obligations are used to fund a wide range of public projects, including construction or improvement of schools, highways and roads. The basic security behind general obligation bonds is the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. The taxes that can be levied for the payment of debt service may be limited or unlimited as to the rate or amount of special assessments. REVENUE BONDS. The full faith, credit and taxing power of the issuer do not secure revenue bonds. Instead, the principal security for a revenue bond generally is the net revenue derived from a particular facility, group of facilities, or, in some cases, the proceeds of a special excise tax or other specific revenue source. Revenue bonds are issued to finance a wide variety of capital projects, including: electric, gas, water and sewer systems; highways, bridges and tunnels; port and airport facilities; colleges and universities; and hospitals. The principal security behind these bonds may vary. For example, housing finance authorities have a wide range of security, including partially or fully insured mortgages, rent subsidized and/or collateralized mortgages, and/or the net revenues from housing or other public projects. Many bonds provide additional security in the form of a debt service reserve fund that may be used to make principal and interest payments. Some authorities have further security in the form of state assurances (although without obligation) to make up deficiencies in the debt service reserve fund. ANTICIPATION NOTES are issued to provide interim financing of various municipal needs in anticipation of the receipt of other sources of money for repayment of the notes. BOND ANTICIPATION notes are normally issued to provide interim financing until a long-term bond financing can be arranged which provides the money for the repayment of the notes. REVENUE ANTICIPATION notes are issued in expectation of the receipt of revenue sources, other than tax receipts, such as federal revenues available under the Federal Revenue Sharing Program. TAX ANTICIPATION notes are issued to finance the short-term working capital needs of municipalities in anticipation of the receipt of various seasonal tax revenues that are used to repay the notes. They are usually general obligations of the issuer and are secured by the taxing power for the payment of principal and interest. CALLABLE BONDS Each Fund may invest in callable bonds, which allow the issuer to repay some or all of the bonds ahead of schedule. If a bond is called, the Fund will receive the principal amount, the accrued interest, and may receive a small additional payment as a call premium. The manager may sell a callable bond before its call date if it believes the bond is at its maximum premium potential. When pricing callable bonds, the call feature is factored into the price of the bonds and may impact a Fund's net asset value. An issuer is more likely to call its bonds when interest rates are below the rate at which the original bond was issued, because the issuer can issue new bonds with lower interest payments. If a bond is called, the Fund may have to replace it with a lower-yielding security. A call of some or all of these securities may lower a Fund's income, its yield and its distributions to shareholders. If the Fund originally paid a premium for the bond because it had appreciated in value from its original issue price, the Fund also may not be able to recover the full amount it paid for the bond. One way for a Fund to protect itself from call risk is to buy bonds with call protection. Call protection is an assurance that the bond will not be called for a specific time period, typically five to 10 years from when the bond is issued. COMMERCIAL PAPER is a promissory note issued by a corporation to finance its short-term credit needs. Each Fund may invest in taxable commercial paper only for temporary defensive purposes. CONVERTIBLE AND STEP COUPON BONDS Each Fund may each invest a portion of its assets in convertible and step coupon bonds. Convertible bonds are zero-coupon securities until a predetermined date, at which time they convert to a specified coupon security. The coupon on step coupon bonds changes periodically during the life of the security based on predetermined dates chosen when the security is issued. Zero coupon bonds tend to react more sharply to changes in interest rates than traditional bonds. ESCROW-SECURED OR PRE-REFUNDED BONDS are created when an issuer uses the proceeds from a new bond issue to buy high grade, interest bearing debt securities, generally direct obligations of the U.S. government in order to redeem (or pre-refunded), before maturity, an outstanding bond issue that is not immediately callable. These securities are then deposited in an irrevocable escrow account held by a trustee bank to secure all future payments of principal and interest on the pre-refunded bond. Pre-refunded bonds often receive a triple A or equivalent rating. Because pre-refunded bonds still bear the same interest rate, and have a very high credit quality, their price may increase. However, as the original bond approaches its call date, the bond's price will fall to its call price. Each Fund's manager attempts to manage the pre-refunded bonds in its portfolio so that it sells them before this decline in price occurs. MUNICIPAL LEASE OBLIGATIONS are created to finance the purchase of property for public use. The property is then leased to the state or a local government and these leases secure the municipal lease obligations. The lease payments are used to pay the interest on the obligations. However, municipal lease obligations differ from other municipal securities because each year the lessee's governing body must appropriate (set aside) the money to make the lease payments. If the money is not appropriated, the issuer or the lessee can end the lease without penalty. If the lease is cancelled, investors who own the municipal lease obligations may not be paid. Each Fund may invest in municipal lease obligations, including certificates of participation. The board of trustees reviews each Fund's municipal lease obligations to try to assure that they are liquid investments based on various factors reviewed by each Fund's manager. Since annual appropriations are required to make lease payments, municipal lease obligations generally are not subject to constitutional limitations on the issuance of debt, and may allow an issuer to increase government liabilities beyond constitutional debt limits. When faced with increasingly tight budgets, local governments have more discretion to curtail lease payments under a municipal lease obligation than they do to curtail payments on other municipal securities. If not enough money is appropriated to make the lease payments, the leased property may be repossessed as security for holders of the municipal lease obligations. If this happens, there is no assurance that the property's private sector or re-leasing value will be enough to make all outstanding payments on the municipal lease obligations or that the payments will continue to be tax-free. While cancellation risk is inherent to municipal lease obligations, each Fund believes that this risk may be reduced, although not eliminated, by its policies on the quality of municipal lease securities in which it may invest. STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped" form. Stripped municipal securities represent separate ownership of principal and interest payments on municipal securities. TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270 days or less) issued by a municipality to meet working capital needs. TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of public authorities to finance various privately operated facilities which are expected to benefit the municipality and its residents, such as business, manufacturing, housing, sports and pollution control, as well as public facilities such as airports, mass transit systems, ports and parking. The payment of principal and interest is solely dependent on the ability of the facility's user to meet its financial obligations and the pledge, if any, of the facility or other property as security for payment. U.S. GOVERNMENT SECURITIES are issued by the U.S. Treasury or by agencies and instrumentalities of the U.S. government and are backed by the full faith and credit of the U.S. government. They include Treasury bills, notes and bonds. VARIABLE OR FLOATING RATE SECURITIES Each Fund may invest in variable or floating rate securities, including variable rate demand notes, which have interest rates that change either at specific intervals (variable rate), from daily up to monthly, or whenever a benchmark rate changes (floating rate). The interest rate adjustments are designed to help stabilize the security's price. While this feature helps protect against a decline in the security's market price when interest rates rise, it lowers a Fund's income when interest rates fall. Of course, a Fund's income from its variable rate investments also may increase if interest rates rise. Variable or floating rate securities may include a demand feature, which may be unconditional. The demand feature allows the holder to demand prepayment of the principal amount before maturity, generally on one to 30 days' notice. The holder receives the principal amount plus any accrued interest either from the issuer or by drawing on a bank letter of credit, a guarantee or insurance issued with respect to the security. Each Fund generally uses variable or floating rate securities as short-term investments while waiting for long-term investment opportunities. ZERO-COUPON AND DELAYED INTEREST SECURITIES Each Fund may invest in zero-coupon and delayed interest securities. Zero-coupon securities make no periodic interest payments, but are sold at a deep discount from their face value. The buyer recognizes a rate of return determined by the gradual appreciation of the security, which is redeemed at face value on a specified maturity date. The discount varies depending on the time remaining until maturity, as well as market interest rates, liquidity of the security, and the issuer's perceived credit quality. The discount, in the absence of financial difficulties of the issuer, typically decreases as the final maturity date approaches. If the issuer defaults, the Fund may not receive any return on its investment. Because zero-coupon securities bear no interest and compound semiannually at the rate fixed at the time of issuance, their value generally is more volatile than the value of other fixed-income securities. Since zero-coupon bondholders do not receive interest payments, when interest rates rise, zero-coupon securities fall more dramatically in value than bonds paying interest on a current basis. When interest rates fall, zero-coupon securities rise more rapidly in value because the bonds reflect a fixed rate of return. An investment in zero-coupon and delayed interest securities may cause the Fund to recognize income and make distributions to shareholders before it receives any cash payments on its investment. To generate cash to satisfy distribution requirements, the Fund may have to sell portfolio securities that it otherwise would have continued to hold or to use cash flows from other sources such as the sale of Fund shares. IN ADDITION TO STANDARD PURCHASES AND SALES OF VARIOUS MUNICIPAL SECURITIES, EACH FUND'S PORTFOLIO MAY ALSO BE SUBJECT TO CERTAIN OTHER CHARACTERISTICS AND RISKS, AND MAY ALSO ENGAGE IN OTHER STRATEGIES, WHICH, ALONG WITH THESE RISKS, ARE DESCRIBED BELOW. SHOULD OTHER STRATEGIES, NOT SPECIFICALLY DESCRIBED BELOW, BECOME AVAILABLE OR ATTRACTIVE, THE MANAGER MAY ENGAGE IN THEM SO LONG AS THEY ARE CONSISTENT WITH EACH FUND'S GOALS AND OBJECTIVES. CREDIT QUALITY All things being equal, the lower a security's credit quality, the higher the risk and the higher the yield the security generally must pay as compensation to investors for the higher risk. A security's credit quality depends on the issuer's ability to pay interest on the security and, ultimately, to repay the principal. Independent rating agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors Service, Inc. (Moody's), and Standard & Poor's Ratings Group (S&P(R)), often rate municipal securities based on their analysis of the issuer's credit quality. Most rating agencies use a descending alphabet scale to rate long-term securities, and a descending numerical scale to rate short-term securities. Securities in the top four ratings are "investment grade," although securities in the fourth highest rating may have some speculative features. These ratings are described at the end of this SAI under "Description of Ratings." An insurance company, bank or other foreign or domestic entity may provide credit support for a municipal security and enhance its credit quality. For example, some municipal securities are insured, which means they are covered by an insurance policy that guarantees the timely payment of principal and interest. Other municipal securities may be backed by letters of credit, guarantees, or escrow or trust accounts that contain securities backed by the full faith and credit of the U.S. government to secure the payment of principal and interest. As discussed in the prospectus, each Fund has limitations on the credit quality of the securities it may buy. These limitations generally are applied when the Fund makes an investment so that the Fund is not required to sell a security because of a later change in circumstances. In addition to considering ratings in its selection of each Fund's portfolio securities, the manager may consider, among other things, information about the financial history and condition of the issuer, revenue and expense prospects and, in the case of revenue bonds, the financial history and condition of the source of revenue to service the bonds. Securities that depend on the credit of the U.S. government are regarded as having a triple A or equivalent rating. The High Yield Fund invests at least 65% of its assets in high yield securities. The High Yield Fund may invest in securities rated in any rating category, including defaulted securities if the manager believes the issuer may resume making interest payments or other favorable developments seem likely in the near future. The High Yield Fund, however, currently does not intend to invest more than 10% of its assets in defaulted securities. While the Fund tries to invest in lower-rated securities, the manager may consider existing market conditions, the availability of lower-rated securities, and whether the difference in yields between higher- and lower-rated securities justifies the higher risk of lower-rated securities when selecting securities for the High Yield Fund's portfolio. DIVERSIFICATION All of the Funds, except the Connecticut and Federal Intermediate Funds, are diversified funds. The Connecticut and Federal Intermediate Funds are non-diversified. As a fundamental policy, none of the diversified Funds will buy a security if, with respect to 75% of its net assets, more than 5% would be in the securities of any single issuer (with the exception of obligations of the U.S. government). For this purpose, each political subdivision, agency, or instrumentality, each multi-state agency of which a state is a member, and each public authority that issues private activity bonds on behalf of a private entity, is considered a separate issuer. Escrow-secured or defeased bonds are not generally considered an obligation of the original municipality when determining diversification. Each Fund, including the Connecticut and Federal Intermediate Funds, intends to meet certain diversification requirements for tax purposes. Generally, to meet federal tax requirements at the close of each quarter, a Fund may not invest more than 25% of its total assets in any one issuer and, with respect to 50% of total assets, may not invest more than 5% of its total assets in any one issuer. These limitations do not apply to U.S. government securities and may be revised if applicable federal income tax requirements are revised. ILLIQUID INVESTMENTS Each Fund may invest up to 10% of its net assets in illiquid securities. Illiquid securities generally are securities that cannot be sold within seven days in the normal course of business at approximately the amount at which the Fund has valued them. MATURITY Municipal securities are issued with a specific maturity date - the date when the issuer must repay the amount borrowed. Maturities typically range from less than one year (short term) to 30 years (long term). In general, securities with longer maturities are more sensitive to price changes, although they may provide higher yields. The Funds have no restrictions on the maturity of the securities they may buy or on its average portfolio maturity. PORTFOLIO TURNOVER The frequency of portfolio transactions, usually referred to as the portfolio turnover rate, varies for each Fund from year to year, depending on market conditions. While short-term trading increases portfolio turnover and may increase costs, the execution costs for municipal securities are substantially less than for equivalent dollar values of equity securities. TEMPORARY INVESTMENTS When the manager believes market or economic conditions are unusual or unfavorable for investors, the manager may invest up to 100% of a Fund's assets in a temporary defensive manner or hold a substantial portion of its portfolio in cash, cash equivalents or other high quality short-term investments. Unfavorable market or economic conditions may include excessive volatility or a prolonged general decline in the securities markets in the securities in which the Funds' invest or in the economies of the states and territories where the Funds' invest. Temporary defensive investments generally may include securities that pay taxable interest, including (i) for the state Funds, municipal securities issued by a state or local government other than the Fund's state; (ii) high quality commercial paper; or (iii) securities issued by or guaranteed by the full faith and credit of the U.S. government. Each Fund also may invest all of its assets in municipal securities issued by a U.S. territory such as Guam, Puerto Rico, the Mariana Islands or the U.S. Virgin Islands. The manager also may invest in these types of securities or hold cash when securities meeting the Fund's investment criteria are unavailable or to maintain liquidity. WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a "when-issued" basis. When so offered, the price, which is generally expressed in yield terms, is fixed at the time the commitment to buy is made, but delivery and payment take place at a later date. During the time between purchase and settlement, no payment is made by the Fund to the issuer and no interest accrues to the Fund. If the other party to the transaction fails to deliver or pay for the security, the Fund could miss a favorable price or yield opportunity, or could experience a loss. When a Fund makes the commitment to buy a municipal security on a when-issued basis, it records the transaction and includes the value of the security in the calculation of its net asset value. The Fund does not believe that its net asset value or income will be negatively affected by its purchase of municipal securities on a when-issued basis. The Fund will not engage in when-issued transactions for investment leverage purposes. Although a Fund generally will buy municipal securities on a when-issued basis with the intention of acquiring the securities, it may sell the securities before the settlement date if it is considered advisable. When a Fund is the buyer, it will set aside on its books cash or liquid securities, with an aggregate value equal to the amount of its purchase commitments, until payment is made. If assets of a Fund are held in cash pending the settlement of a purchase of securities, the Fund will not earn income on those assets. STATE AND U.S. TERRITORY RISKS - ------------------------------ STATE Since each state Fund mainly invests in the municipal securities of its state, its performance is closely tied to the ability of issuers of municipal securities in its state to continue to make principal and interest payments on their securities. The issuers' ability to do this is in turn dependent on economic, political and other conditions within the state. Below is a discussion of certain conditions that may affect municipal issuers in the Funds' various states. It is not a complete analysis of every material fact that may affect the ability of issuers of municipal securities to meet their debt obligations or the economic or political conditions within any state and is subject to change. The information below is based on data available to the Funds from historically reliable sources, but the Funds have not independently verified it. The ability of issuers of municipal securities to continue to make principal and interest payments is dependent in large part on their ability to raise revenues, primarily through taxes, and to control spending. Many factors can affect a state's revenues including the rate of population growth, unemployment rates, personal income growth, federal aid, and the ability to attract and keep successful businesses. A number of factors can also affect a state's spending including the need for infrastructure improvements, increased costs for education and other services, current debt levels, and the existence of accumulated budget deficits. The following gives more information about the risks of investing in the Funds. Please read this information together with the section "Main Risks" in the Prospectus. ARIZONA. Strong overall employment growth, affordable housing, and an attractive climate have helped Arizona's population grow at a rate four times faster than the national rate during the 1990s. Although population growth is expected to remain strong in the near term, the rate of growth has slowed since 1996 as a result of California's economic recovery and thus reduced migration from that state. Competitive wage rates, low energy costs, corporate tax reductions and an abundance of land also have helped to attract businesses to the state. As a result, Arizona's unemployment rate in 2000 was at its lowest level since the early 1970s. While Arizona's economy, in the past was heavily dependent on its farming, mining and real estate industries, Arizona's economy has continued to diversify. As of 2000, manufacturing accounted for approximately 9.6% of the state's total employment, trade 23.4%, services 31.9%, government 16.3%, construction 7.2%, finance 6.4%, and transportation/utilities, 4.8%. Farming and mining accounted for less than 2% of the total workforce. Approximately 43% of the state's exports have been in the area of high-technology products. Over the past five years the state's GDP has increased to $150 billion in 2000 from $105 billion in 1995. Under its constitution, Arizona cannot issue general obligation debt. Thus, gross state debt levels have remained moderate. The state historically has relied on lease obligations, revenue bonds, and pay-as-you-go financing for its capital needs. Arizona's strong economic growth and higher-than-anticipated tax revenues have allowed the state to post four consecutive operating surpluses and General Fund balance increases. Results from fiscal 2000 show another operating surplus. COLORADO. During the 1980s, Colorado's economy was dependent on its energy sector. As a result, when the energy sector declined in the mid-to-late 1980s, the state suffered a sharp economic downturn. Since 1991, growth in the services, trade and government sectors has improved Colorado's economic diversification. Growth in these areas, as well as in construction and high technology sectors, also has helped to offset job losses caused by military base closings and the decline of the state's mining industry. Population and income levels have also grown since 1991, often exceeding national trends. Colorado has a higher per capita income than the national average. The unemployment rate, 2.7% for 2000, has been consistently below the national average. The recent strength of Colorado's economy has helped to improve the state's financial position. Revenue growth has continued to exceed projections, primarily in the area of income tax collections. Since Colorado's constitution prohibits the issuance of general obligation debt, the state's debt burden has been low. The state has relied primarily on pay-as-you-go and lease financing to meet its capital improvement needs. CONNECTICUT. Connecticut's recovery from the recession of the early 1990s has been slower than the rest of the nation. Over the past three years, however, the state's economic recovery has shown signs of improved strength. Gains in tourism and business services have led to greater economic diversification as the economy has continued to move from manufacturing and defense related industries towards services. Connecticut has sought to further its economic growth with various business and tax incentives such as corporate and sales tax rate cuts, corporate tax credits for research and development and various other business tax credits. Nonetheless, the state's tight labor market, slow population growth and high wages may limit future growth. Additionally, the Governor's proposed budget for FY02 includes several modifications to the state's tax law. The most noteworthy is the repeal of the 5.75% sales tax on hospital services, which will reduce revenues by more than $110 million in FY02. In FY00, Connecticut ran a $73 million deficit, in part as a result of a $892 million transfer out. However, the state still ended the year with a positive fund balance of $555 million as a result of positive financial results built up from prior years. Financial performance has benefited from various fiscal reforms including a constitutional amendment requiring balanced budgets, expenditure caps and the implementation of a personal income tax. These improvements have allowed the state to post a budget reserve of $564 million for FY00. FY01 final numbers will not be available until the end of the fiscal year. Potential areas of financial stress may include increased spending for education, a large, unfunded pension liability, and a relatively high debt burden. NEW JERSEY. Historically, New Jersey's economy, which greatly benefits from the substantial employment opportunities in New York and Pennsylvania, has been one of the most diverse in the nation. Like many other states in the northeast region, New Jersey was hit especially hard by the recession in the early 1990s and has been slower to recover than many other states. In recent years, however, the state's performance has improved. Jobs grew at a rate of 2% in 1998, 1.7% in 1999 and 1.5% in 2000. While these rates were below the national rates of 2.6% in 1998, 2.3% in 1999 and 2.1 in 2000, they led the region. Unemployment levels also have decreased to 3.8% in 2000 from a high of 8.5% in 1992 and are slightly below the national rate of 4.0%. The state ended fiscal 2000 with a surplus and increased its General Fund balance $490 million to $2.7 billion. The state's positive financial performance was aided by strong growth in personal income tax receipts. Much of this growth was from the high-income taxpayer base, which grew due in part to the recent success of the financial services sector. The state's increased reliance on high-income taxpayers and the success of the financial markets may make it more vulnerable to an economic downturn. The state's outstanding debt has grown significantly in recent years. As of May 2000 the state ranked near the top in net tax-supported debt ratio of debt to personal income, and debt per capita. Nonetheless, debt service has remained manageable in light of the state's resources. OREGON. Oregon's economy has experienced strong growth, primarily in its high-tech manufacturing and housing construction sectors. However, due to a general slowing of the national economy in particular a slowing on hi-tech spending. Future growth is likely to be dependent on the strength of the national economy, as well as the strength of the state's high-tech industries, and the performance of Pacific Rim economies. Economic growth may be hampered, however, by the state's rising labor and housing costs, which have lessened Oregon's competitive position in attracting new businesses. The strength of Oregon's economy has helped the state maintain positive financial results. Recently, however, voter initiatives have limited the state's financial flexibility. In November 1990, voters approved Measure 5, which limited local property taxes and required the state to provide replacement revenues to schools. The state has been successful in meeting the requirements of Measure 5, which has increased state spending for schools from 33% of the General Fund budget to more than 50%. On May 20, 1997, voters passed Measure 50, which has placed some pressure on the state's budget. This measure could negatively impact the revenue-raising flexibility of the state and make it more vulnerable to an economic downturn. PENNSYLVANIA. Although improving, the performance of Pennsylvania's economy has continued to lag behind the national average. While Pennsylvania benefits from a highly diverse economy, retail trade, manufacturing, service and construction industries have continued to contract. Unemployment levels have been improving, yet are still higher than the national rate. The cost of doing business in Pennsylvania ranks thirteenth among the fifty states. The state's labor and energy costs remain high. Net migration, population and personal income growth also have remained below national levels. However, on a per capita income basis Pennsylvania is slightly above the national average. To try to improve its economic performance, Pennsylvania recently made economic development a priority. To attract new business, the commonwealth has implemented various business tax cuts and has attempted to ease its regulatory environment. These steps, together with the commonwealth's strong education, health care and transportation systems, could help to provide a positive environment for attracting businesses. Historically, Pennsylvania's financial performance has been tied to fluctuations in both national and regional economic trends. In recent years, improvements in the commonwealth's economy and higher-than-expected tax revenues have helped strengthen the commonwealth's financial position. The commonwealth has posted nine years of budgetary surplus operations with the past six years showing revenues well in excess of projections. Due to the cyclical nature of its economy and financial performance, the commonwealth has been committed to using a portion of its surpluses to build reserves (the Tax Stabilization Fund) in the hope of providing some security against future economic downturns or other uncertainties that could affect the state. The commonwealth is required to transfer 15% of the unappropriated year end surplus to this fund, and in three of the last four years, the commonwealth has transferred more than the required amount. At the end of FY00, the Tax Stabilization Fund reserve stood at $1.1 billion or a healthy 5.4% of revenues in addition to $1.7 billion in unreserved moneys. Some of these unreserved moneys were used to provide business tax relief in the amount of $445 million in FY01. U.S. TERRITORIES Since each Fund may invest up to 35% of its assets in municipal securities issued by U.S. territories, the ability of municipal issuers in U.S. territories to continue to make principal and interest payments also may affect a Fund's performance. As with municipal issuers, the ability to make these payments is dependent on economic, political and other conditions. Below is a discussion of certain conditions within some of the territories where the Funds may invest. It is not a complete analysis of every material fact that may affect the ability of issuers of U.S. territory municipal securities to meet their debt obligations or the economic or political conditions within the territories and is subject to change. It is based on data available to the Funds from historically reliable sources, but it has not been independently verified by the Funds. PUERTO RICO. In recent years, Puerto Rico's financial performance has improved. In April 2001, Moody's changed Puerto Rico's outlook to stable from positive. Relatively strong revenue growth and more aggressive tax collection procedures resulted in a General Fund surplus for fiscal 1999 (audited) of $497 million, including an unreserved balance of $185.4 million. Between fiscal years 1993 and 1999, Puerto Rico has experienced a 4.3% drop in the unemployment rate, a 54% increase in hotel registrations, a 31% in retail sales, a 76% increase in exports, and a 22% decrease in welfare recipients. While Puerto Rico's debt per capita levels are at the higher end of the spectrum compared to American states, that is partly explained by the fact that Puerto Rico generally centralizes its debt issuance at the state level. S&P rates Puerto Rico's general obligation debt at A, with a stable outlook. Moody's rates the island's general obligation debt at Baa1. The Moody's rating has been at Baa1 since 1976 and the S&P A rating has been in place since 1956. Going forward, these debt levels may increase as Puerto Rico attempts to finance significant capital and infrastructure improvements. Puerto Rico also will need to address its large unfunded pension liability of more than $6 billion. Puerto Rico also faces challenges from the 1996 passage of a bill eliminating Section 936 of the Internal Revenue Code. This section has given certain U.S. corporations operating in Puerto Rico significant tax advantages. These incentives have helped considerably with Puerto Rico's economic growth, especially with the development of its manufacturing sector. U.S. firms that have benefited from these incentives have provided a significant portion of Puerto Rico's revenues, employment and deposits in local financial institutions. The section 936 incentives are being phased out over a 10-year period ending in 2006. It is hoped that this long phase-out period will give Puerto Rico sufficient time to lessen the potentially negative effects of section 936's elimination. In the fifth year of this phase-out period, business continues to show interest in Puerto Rico as manufacturing and services/commerce continue to represent the largest sector of employment. Outstanding issues relating to the potential for a transition to statehood also may have broad implications for Puerto Rico and its financial and credit position. GUAM. Guam's economy continues to contract, however there have been some signs of improvement. Guam is heavily dependent on tourism. It has been especially dependent on Japanese tourism, which has made Guam vulnerable to fluctuations in the relationship between the U.S. dollar and the Japanese yen. However, the past two years (1999 and 2000) have seen a improvement in tourism. This increased tourism (particularly Japan and Korea) has helped create job growth in the services and retail trade industries as well. Seventy-five percent of tourism is derived from Japan and in 2000, Guam saw arrivals increase 5.2%. Tourism from Korea, the second largest market, increased 79% in 2000. Despite the pickup in the largest industry, tourism, unemployment still remains high at 15.1%. This is down from 15.6% in 1999. Despite an 11% increase in service employment in 2000, Guam experienced significant declines in construction and government employment levels as the U.S. continues to decrease its military presence. Guam has also seen an improvement in personal income, which grew 4% in 2000 compared to 1.5% in 1999 and negative growth in 1998. This is a positive trend since the highest paid jobs tend to be military jobs, which have been decreasing. In the early to mid-1990s, Guam's financial position deteriorated due to a series of natural disasters that led to increased spending on top of already significant budget gaps. As a result, the government introduced a comprehensive financial plan in June 1995 to help balance the budget and reduce the General Fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21 million deficit and ended the year with a negative unreserved General Fund balance of $158.9 million. The 1998 Asian economic crisis and Typhoon Paka, which hit Guam in December 1997, negatively affected both tourism and other economic activities in Guam and contributed to a decline of 1.8% in gross island product between 1997 and 1998. Additional deficits are expected in 1999 and 2000 when the audited financial reports for those periods become available. While Guam's debt burden has been manageable, Guam's ability to maintain current debt levels may be challenged in the near future. U.S. military downsizing has reduced the federal presence on the island and also may reduce federal support for infrastructure projects. At the same time, Guam has faced increasing pressure to improve its infrastructure to help generate economic development. Overall, as of May 15, 2001, S&P's outlook for Guam was negative due to Guam's continued weak financial position and its inability to meet the goals of the financial plan. MARIANA ISLANDS. The Commonwealth of the Mariana Islands became a U.S. territory in 1975. At that time, the U.S. government agreed to exempt the islands from federal minimum wage and immigration laws in an effort to help stimulate industry and the economy. The islands' minimum wage is more than $2 per hour below the U.S. level and tens of thousands of workers have emigrated from various Asian countries to provide cheap labor for the islands' industries. The islands' tourism and apparel industries combined to help increase gross business receipts from $224 million in 1985 to $2.575 billion in 1997. However, a decline in tourism caused by the 1998 Asian economic crisis caused gross business receipt revenue to decline to $2.24 billion in 1998 and $ 2.21 billion in 1999. The breakdown by sector for 1999 was garment manufacturing 36%, retail trade/gas stations 20%, services 16%, tourism 7%(hotels, restaurants only) and other 21%. Gross business revenue tax collections totaled $54.2 million in fiscal year 1999. Also in fiscal year 1999, General Fund revenues totaled $221 million while expenditures totaled $162 million. In 1999, the General Fund balance had a deficit of $39 million, an improvement from 1998's deficit of $49 million. The population of all the islands combined was 67,212 at FYE 1996 and the estimate for 1999 is 78,425. The average earnings per capita totaled $10,192 in 1998. At FYE 1995, the most recent year available, almost 85% of all persons 16 years and older participated in the labor force, compared to 64% in 1980. U.S. VIRGIN ISLANDS. The U.S. Virgin Islands Government has suffered numerous years of budget imbalances over the past decade. The Government's cash flow problems have created recurring annual General Fund deficits. Although the financial operations of the Government have rarely been audited since fiscal year 1995, the accumulated deficit at June 30, 1999 was estimated to be about $341 million. To help finance this deficit, the government has issued several bond deals. A $300 million bond issued in 1999 allowed the Government to finance working capital needs, pay outstanding obligations to vendors, and make past due income tax refunds. The Virgin Islands' large public sector payroll (approximately 32.8% of employment), relatively small private sector that is dependent on tourism and related services (21% of employment), and heavy reliance on taxes as a revenue source (close to 97% of all revenues), together with the effects of three major hurricanes in the past ten years, have contributed to its financial problems. The U.S. Virgin Islands did not participate in the record economic boom experienced by the mainland U.S. in the late 1990s. The U.S. Virgin Islands continue to experience high unemployment rates and low wealth levels. The Virgin Islands are highly dependent on tourism, which contracted in 1999, but improved in 2000. While the islands have experienced an increase in hotel occupancy, the majority of visitors come via cruise ships (over 1.4 million cruise passengers in 1999). The Government reported a 25% increase in cruise and air visitor arrivals in 2000. In September 1998, the Department of Interior Office of Inspector General issued an audit report on the Virgin Islands. It noted that while the Virgin Islands had made improvements in its financial situation, problems remained in the areas of overall financial management, expenditure control and revenue collections. To help improve its financial position, the Virgin Islands has developed a five-year economic recovery plan. Central to this plan is a reduction in government spending. In June 1999, the governor implemented a strict hiring freeze and mandated a 5% reduction in personnel expenditures each year through fiscal 2004, a 50% reduction in overtime expenses, and various other cost saving initiatives. In October 1999, the government and the Department of Interior entered into a Memorandum of Understanding stipulating that federal grants will be awarded contingent on several financial performance and accountability standards being met that will demonstrate improvement in the economic and financial condition of the islands. Since the plan is new, it is not yet certain whether or to what extent the plan will be successful in helping the Virgin Islands improve its financial condition. OFFICERS AND TRUSTEES - ------------------------------------------------------------------------------- The Trust has a board of trustees. The board is responsible for the overall management of the Trust, including general supervision and review of each Fund's investment activities. The board, in turn, elects the officers of the Trust who are responsible for administering the Trust's day-to-day operations. The board also monitors each Fund to ensure no material conflicts exist among share classes. While none is expected, the board will act appropriately to resolve any material conflict that may arise. The name, age and address of the officers and board members, as well as their affiliations, positions held with the Trust, and principal occupations during the past five years are shown below. Frank H. Abbott, III (80) 1045 Sansome Street, San Francisco, CA 94111 TRUSTEE President and Director, Abbott Corporation (an investment company); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, MotherLode Gold Mines Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food processing) (until 1996). Harris J. Ashton (69) 191 Clapboard Ridge Road, Greenwich, CT 06830 TRUSTEE Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat packing company); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Chairman of the Board, General Host Corporation (nursery and craft centers) (until 1998). S. Joseph Fortunato (68) Park Avenue at Morris County, P.O. Box 1945 Morristown, NJ 07962-1945 TRUSTEE Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee, as the case may be, of 49 of the investment companies in Franklin Templeton Investments. Edith E. Holiday (49) 3239 38th Street, N.W., Washington, DC 20016 TRUSTEE Director, Amerada Hess Corporation (exploration and refining of oil and gas) (1993-present), Hercules Incorporated (chemicals, fibers and resins) (1993-present), Beverly Enterprises, Inc. (health care) (1995-present), H.J. Heinz Company (processed foods and allied products) (1994-present) and RTI International Metals, Inc. (manufacture and distribution of titanium) (1999-present); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, Assistant to the President of the United States and Secretary of the Cabinet (1990-1993), General Counsel to the United States Treasury Department (1989-1990), and Counselor to the Secretary and Assistant Secretary for Public Affairs and Public Liaison-United States Treasury Department (1988-1989). *Charles B. Johnson (68) One Franklin Parkway, San Mateo, CA 94403-1906 CHAIRMAN OF THE BOARD AND TRUSTEE Chairman of the Board, Chief Executive Officer, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President, Franklin Templeton Distributors, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 48 of the investment companies in Franklin Templeton Investments. *Rupert H. Johnson, Jr. (60) One Franklin Parkway, San Mateo, CA 94403-1906 PRESIDENT AND TRUSTEE Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Director, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin Advisory Services, LLC; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Frank W.T. LaHaye (72) 20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014 TRUSTEE Chairman, Peregrine Venture Management Company (venture capital); Director, The California Center for Land Recycling (redevelopment); director or trustee, as the case may be, of 28 of the investment companies in Franklin Templeton Investments; and FORMERLY, General Partner, Miller & LaHaye and Peregrine Associates, the general partners of Peregrine Venture funds. Gordon S. Macklin (73) 8212 Burning Tree Road, Bethesda, MD 20817 TRUSTEE Director, Martek Biosciences Corporation, WorldCom, Inc. (communications services), MedImmune, Inc. (biotechnology), Overstock.com (internet services), White Mountains Insurance Group, Ltd. (holding company) and Spacehab, Inc. (aerospace services); director or trustee, as the case may be, of 48 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chairman, White River Corporation (financial services) (until 1998) and Hambrecht & Quist Group (investment banking) (until 1992), and President, National Association of Securities Dealers, Inc. (until 1987). Sheila Amoroso (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Harmon E. Burns (56) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Vice President and Director, Franklin Templeton Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Director, Franklin Investment Advisory Services, Inc.; and officer and/or director or trustee, as the case may be, of most of the other subsidiaries of Franklin Resources, Inc. and of 51 of the investment companies in Franklin Templeton Investments. Rafael R. Costas, Jr. (36) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. Martin L. Flanagan (41) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND CHIEF FINANCIAL OFFICER President, Member - Office of the President, Chief Financial Officer and Chief Operating Officer, Franklin Resources, Inc.; Executive Vice President, Franklin Templeton Investor Services, LLC; President and Chief Financial Officer, Franklin Mutual Advisers, LLC; Executive Vice President, Chief Financial Officer and Director, Templeton Worldwide, Inc.; Executive Vice President and Chief Operating Officer, Templeton Investment Counsel, LLC; Executive Vice President, Franklin Advisers, Inc. and Franklin Investment Advisory Services, Inc.; Chief Financial Officer, Franklin Advisory Services, LLC; officer and/or director of some of the other subsidiaries of Franklin Resources, Inc.; and officer and/or director or trustee, as the case may be, of 51 of the investment companies in Franklin Templeton Investments. David P. Goss (54) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Associate General Counsel, Franklin Templeton Investments; President, Chief Executive Officer and Director, Franklin Select Realty Trust, Property Resources, Inc., Property Resources Equity Trust, Franklin Real Estate Management, Inc. and Franklin Properties, Inc.; officer and director of some of the other subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, President, Chief Executive Officer and Director, Franklin Real Estate Income Fund and Franklin Advantage Real Estate Income Fund (until 1996). Barbara J. Green (53) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Vice President and Deputy General Counsel, Franklin Resources, Inc.; Senior Vice President, Templeton Worldwide, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Deputy Director, Division of Investment Management, Executive Assistant and Senior Advisor to the Chairman, Counselor to the Chairman, Special Counsel and Attorney Fellow, U.S. Securities and Exchange Commission (1986-1995), Attorney, Rogers & Wells (until 1986), and Judicial Clerk, U.S. District Court (District of Massachusetts) (until 1979). Edward V. McVey (63) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Templeton Distributors, Inc.; officer of one of the other subsidiaries of Franklin Resources, Inc. and of 29 of the investment companies in Franklin Templeton Investments. Kimberley Monasterio (37) One Franklin Parkway, San Mateo, CA 94403-1906 TREASURER AND PRINCIPAL ACCOUNTING OFFICER Senior Vice President, Franklin Templeton Services, LLC; and officer of 33 of the investment companies in Franklin Templeton Investments. Murray L. Simpson (64) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT AND SECRETARY Executive Vice President and General Counsel, Franklin Resources, Inc.; officer and/or director of some of the subsidiaries of Franklin Resources, Inc.; officer of 52 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Executive Officer and Managing Director, Templeton Franklin Investment Services (Asia) Limited (until 2000) and Director, Templeton Asset Management Ltd. (until 1999). Thomas Walsh (39) One Franklin Parkway, San Mateo, CA 94403-1906 VICE PRESIDENT Senior Vice President, Franklin Advisers, Inc.; and officer of eight of the investment companies in Franklin Templeton Investments. *This board member is considered an "interested person" under federal securities laws. Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers. The Trust pays noninterested board members $1,450 per month plus $1,300 per meeting attended. Board members who serve on the audit committee of the Trust and other funds in Franklin Templeton Investments receive a flat fee of $2,000 per committee meeting attended, a portion of which is allocated to the Trust. Members of a committee are not compensated for any committee meeting held on the day of a board meeting. Noninterested board members also may serve as directors or trustees of other funds in Franklin Templeton Investments and may receive fees from these funds for their services. The fees payable to noninterested board members by the Trust are subject to reductions resulting from fee caps limiting the amount of fees payable to board members who serve on other boards within Franklin Templeton Investments. The following table provides the total fees paid to noninterested board members by the Trust and by Franklin Templeton Investments. TOTAL FEES NUMBER OF BOARDS TOTAL FEES RECEIVED FROM IN FRANKLIN RECEIVED FROM FRANKLIN TEMPLETON TEMPLETON NAME THE TRUST/1 INVESTMENTS/2 INVESTMENTS ON ($) ($) WHICH EACH SERVES/3 - -------------------------------------------------------------------------------- Frank H. Abbott, III 23,056 156,953 28 Harris J. Ashton 25,267 359,404 48 S. Joseph Fortunato 23,564 359,629 49 Edith E. Holiday 31,700 248,305 28 Frank W.T. LaHaye 24,356 165,529 28 Gordon S. Macklin 25,267 359,504 48 1. For the fiscal year ended February 28, 2001. 2. For the calendar year ended December 31, 2000. 3. We base the number of boards on the number of registered investment companies in Franklin Templeton Investments. This number does not include the total number of series or funds within each investment company for which the board members are responsible. Franklin Templeton Investments currently includes 52 registered investment companies, with approximately 156 U.S. based funds or series. Noninterested board members are reimbursed for expenses incurred in connection with attending board meetings, paid pro rata by each fund in Franklin Templeton Investments for which they serve as director or trustee. No officer or board member received any other compensation, including pension or retirement benefits, directly or indirectly from the Funds or other funds in Franklin Templeton Investments. Certain officers or board members who are shareholders of Franklin Resources, Inc.(Resources) may be deemed to receive indirect remuneration by virtue of their participation, if any, in the fees paid to its subsidiaries. Board members historically have followed a policy of having substantial investments in one or more of the funds in Franklin Templeton Investments, as is consistent with their individual financial goals. In February 1998, this policy was formalized through adoption of a requirement that each board member invest one-third of fees received for serving as a director or trustee of a Templeton fund in shares of one or more Templeton funds and one-third of fees received for serving as a director or trustee of a Franklin fund in shares of one or more Franklin funds until the value of such investments equals or exceeds five times the annual fees paid such board member. Investments in the name of family members or entities controlled by a board member constitute fund holdings of such board member for purposes of this policy, and a three year phase-in period applies to such investment requirements for newly elected board members. In implementing such policy, a board member's fund holdings existing on February 27, 1998, are valued as of such date with subsequent investments valued at cost. MANAGEMENT AND OTHER SERVICES - ----------------------------- MANAGER AND SERVICES PROVIDED Each Fund's manager is Franklin Advisers, Inc. The manager is a wholly owned subsidiary of Resources, a publicly owned company engaged in the financial services industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal shareholders of Resources. The manager provides investment research and portfolio management services, and selects the securities for each Fund to buy, hold or sell. The manager's extensive research activities include, as appropriate, traveling to meet with issuers and to review project sites. The manager also selects the brokers who execute the Funds' portfolio transactions. The manager provides periodic reports to the board, which reviews and supervises the manager's investment activities. To protect the Funds, the manager and its officers, directors and employees are covered by fidelity insurance. The manager and its affiliates manage numerous other investment companies and accounts. The manager may give advice and take action with respect to any of the other funds it manages, or for its own account, that may differ from action taken by the manager on behalf of each Fund. Similarly, with respect to each Fund, the manager is not obligated to recommend, buy or sell, or to refrain from recommending, buying or selling any security that the manager and access persons, as defined by applicable federal securities laws, may buy or sell for its or their own account or for the accounts of any other fund. The manager is not obligated to refrain from investing in securities held by the Funds or other funds it manages. The Funds, their manager and principal underwriter have each adopted a code of ethics, as required by federal securities laws. Under the code of ethics, employees who are designated as access persons may engage in personal securities transactions, including transactions involving securities that are being considered for a Fund or that are currently held by the Funds, subject to certain general restrictions and procedures. The personal securities transactions of access persons of the Funds, their manager and principal underwriter will be governed by the code of ethics. The code of ethics is on file with, and available from, the U.S. Securities and Exchange Commission (SEC). MANAGEMENT FEES Each Fund pays the manager a fee equal to a monthly rate of: o 5/96 of 1% of the value of its net assets up to and including $100 million; and o 1/24 of 1% of the value of its net assets over $100 million up to and including $250 million; and o 9/240 of 1% of the value of its net assets in excess of $250 million. The fee is computed at the close of business on the last business day of each month according to the terms of the management agreement. Each class of a Fund's shares pays its proportionate share of the fee. For the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the Funds paid the following management fees: MANAGEMENT FEES PAID ($) ------------------------------------------------ 2001 2000 1999 - -------------------------------------------------------------------------------- Arizona Fund 3,785,115 4,051,080 4,124,084 Colorado Fund 1,570,752 1,628,892 1,615,981 Connecticut Fund 1,307,835 1,410,653 1,313,337 Federal Intermediate Fund/1 938,980 1,011,967 901,601 High Yield Fund 25,016,712 28,491,742 29,382,074 New Jersey Fund 3,287,976 3,470,377 3,411,855 Oregon Fund 2,390,932 2,502,386 2,429,095 Pennsylvania Fund 3,325,321 3,602,657 3,734,742 Puerto Rico Fund 1,164,394 1,209,819 1,223,542 1. For the fiscal years ended February 29, 2000 and February 28, 1999, management fees before any advance waiver totaled $1,046,931 and $959,067, respectively. Under an agreement by the manager to limit its fees, the Fund paid the management fees shown. ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, LLC (FT Services) has an agreement with the manager to provide certain administrative services and facilities for each Fund. FT Services is wholly owned by Resources and is an affiliate of the Funds' manager and principal underwriter. The administrative services FT Services provides include preparing and maintaining books, records, and tax and financial reports, and monitoring compliance with regulatory requirements. ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an annual rate of: o 0.15% of each Fund's average daily net assets up to $200 million; o 0.135% of each Fund's average daily net assets over $200 million up to $700 million; o 0.10% of each Fund's average daily net assets over $700 million up to $1.2 billion; and o 0.075% of each Fund's average daily net assets over $1.2 billion. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the manager paid FT Services the following administration fees: ADMINISTRATION FEES PAID ($) ------------------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------------------- Arizona Fund 1,059,667 1,123,413 1,132,869 Colorado Fund 425,022 445,392 436,830 Connecticut Fund 347,897 380,856 347,940 Federal Intermediate Fund 245,545 276,840 246,943 High Yield Fund 4,713,741 5,311,059 5,411,515 New Jersey Fund 937,892 990,633 970,458 Oregon Fund 670,790 708,290 661,993 Pennsylvania Fund 952,137 1,023,651 1,046,296 Puerto Rico Fund 309,929 323,935 325,819 SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin Templeton Investor Services, LLC (Investor Services) is each Fund's shareholder servicing agent and acts as the Fund's transfer agent and dividend-paying agent. Investor Services is located at One Franklin Parkway, San Mateo, CA 94403-1906. Please send all correspondence to Investor Services to P.O. Box 997151, Sacramento, CA 95899-9983. For its services, Investor Services receives a fixed fee per account. Each Fund also will reimburse Investor Services for certain out-of-pocket expenses, which may include payments by Investor Services to entities, including affiliated entities, that provide sub-shareholder services, recordkeeping and/or transfer agency services to beneficial owners of the Fund. The amount of reimbursements for these services per benefit plan participant Fund account per year will not exceed the per account fee payable by a Fund to Investor Services in connection with maintaining shareholder accounts. CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New York, NY 10286, acts as custodian of each Fund's securities and other assets. AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105, is the Funds' independent auditor. The auditor gives an opinion on the financial statements included in the Trust's Annual Report to Shareholders and reviews the Trust's registration statement filed with the SEC. PORTFOLIO TRANSACTIONS - -------------------------------------------------------------------------------- Since most purchases by the Funds are principal transactions at net prices, the Funds incur little or no brokerage costs. Each Fund deals directly with the selling or buying principal or market maker without incurring charges for the services of a broker on its behalf, unless it is determined that a better price or execution may be obtained by using the services of a broker. Purchases of portfolio securities from underwriters will include a commission or concession paid by the issuer to the underwriter, and purchases from dealers will include a spread between the bid and ask prices. As a general rule, the Funds do not buy securities in underwritings where they are given no choice, or only limited choice, in the designation of dealers to receive the commission. The Funds seek to obtain prompt execution of orders at the most favorable net price. Transactions may be directed to dealers in return for research and statistical information, as well as for special services provided by the dealers in the execution of orders. It is not possible to place a dollar value on the special executions or on the research services the manager receives from dealers effecting transactions in portfolio securities. The allocation of transactions to obtain additional research services allows the manager to supplement its own research and analysis activities and to receive the views and information of individuals and research staffs of other securities firms. As long as it is lawful and appropriate to do so, the manager and its affiliates may use this research and data in their investment advisory capacities with other clients. If the Funds' officers are satisfied that the best execution is obtained, the sale of Fund shares, as well as shares of other funds in Franklin Templeton Investments, also may be considered a factor in the selection of broker-dealers to execute the Funds' portfolio transactions. If purchases or sales of securities of the Funds and one or more other investment companies or clients supervised by the manager are considered at or about the same time, transactions in these securities will be allocated among the several investment companies and clients in a manner deemed equitable to all by the manager, taking into account the respective sizes of the funds and the amount of securities to be purchased or sold. In some cases this procedure could have a detrimental effect on the price or volume of the security so far as the Funds are concerned. In other cases it is possible that the ability to participate in volume transactions may improve execution and reduce transaction costs to the Funds. During the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999, the Funds did not pay any brokerage commissions. As of February 28, 2001, the Funds did not own securities of their regular broker-dealers. DISTRIBUTIONS AND TAXES - -------------------------------------------------------------------------------- INCOME AND CAPITAL GAIN DISTRIBUTIONS Each multiclass Fund calculates income dividends and capital gain distributions the same way for each class. The amount of any income dividends per share will differ, however, generally due to the difference in the distribution and service (Rule 12b-1) fees applicable to each class. DISTRIBUTIONS OF NET INVESTMENT INCOME Each Fund receives income generally in the form of interest on its investments. This income, less expenses incurred in the operation of the Fund, constitutes the Fund's net investment income from which dividends may be paid to you. This net investment income may either be tax-exempt or taxable when distributed to you. EXEMPT-INTEREST DIVIDENDS. By meeting certain requirements of the Internal Revenue Code (Code), each Fund qualifies to pay exempt-interest dividends to you. These dividends are derived from interest income exempt from regular federal income tax, and are not subject to regular federal income tax when they are paid to you. In addition, to the extent that exempt-interest dividends are derived from interest on obligations of any state or its political subdivisions, or from interest on qualifying U.S. territorial obligations (including qualifying obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also may be exempt from that state's personal income tax. Income from municipal securities of other states generally does not qualify as tax-free. TAXABLE INCOME DIVIDENDS. Each Fund may earn taxable income from many sources, including temporary investments, the discount on stripped obligations or their coupons, income from securities loans or other taxable transactions, and ordinary income on the sale of market discount bonds. If you are a taxable investor, any income dividends a Fund pays from this income will be taxable to you as ordinary income. DISTRIBUTIONS OF CAPITAL GAINS CAPITAL GAIN DISTRIBUTIONS. Each Fund may realize capital gains and losses on the sale or other disposition of its portfolio securities. Distributions from net short-term capital gains are taxable to you as ordinary income. Distributions from net long-term capital gains are taxable to you as long-term capital gains, regardless of how long you have owned your shares in the Fund. Any net capital gains realized by a Fund generally are distributed once each year, and may be distributed more frequently, if necessary, to reduce or eliminate excise or income taxes on the Fund. FIVE YEAR GAINS. Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), capital gain distributions from a Fund's sale of securities held for more than five years are subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). INFORMATION ON THE AMOUNT AND TAX CHARACTER OF DISTRIBUTIONS Each Fund will inform you of the amount of your income dividends and capital gain distributions at the time they are paid, and will advise you of their tax status for federal income tax purposes shortly after the close of each calendar year. This information will include the portion of the distributions that on average are comprised of taxable income or interest income that is a tax preference item when determining your alternative minimum tax. If you have not owned your Fund shares for a full year, the Fund may designate and distribute to you, as taxable, tax-exempt or tax preference income, a percentage of income that may not be equal to the actual amount of each type of income earned during the period of your investment in the Fund. Taxable distributions declared in December but paid in January are taxable to you as if paid in December. 2001 TAX ACT On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001. This Tax Act includes provisions that will significantly reduce individual income tax rates, provide for marriage penalty relief, eliminate current phase-outs of the standard deduction and personal exemptions, provide for additional savings incentives for individuals through expansion of retirement and education savings programs, and provide for limited estate, gift and generation-skipping tax relief. While these provisions have important tax impacts on individual investors in a Fund, their impact on the taxation of a Fund are limited. See your personal tax advisor for more information. ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each Fund has elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code (Code). It has qualified as a regulated investment company for its most recent fiscal year, and intends to continue to qualify during the current fiscal year. As a regulated investment company, the Fund generally pays no federal income tax on the income and gains it distributes to you. The board reserves the right not to maintain the qualification of a Fund as a regulated investment company if it determines this course of action to be beneficial to shareholders. In that case, the Fund would be subject to federal, and possibly state, corporate taxes on its taxable income and gains, and distributions to you (including dividends from tax-exempt interest) would be taxed as ordinary income dividends to the extent of the Fund's earnings and profits. EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Code requires a Fund to distribute to you by December 31 of each year, at a minimum, the following amounts: o 98% of its taxable ordinary income earned during the calendar year; o 98% of its capital gain net income earned during the twelve month period ending October 31; and o 100% of any undistributed amounts from the prior year. Each Fund intends to declare and pay these distributions in December (or to pay them in January, in which case you must treat them as received in December), but can give no assurances that its distributions will be sufficient to eliminate all taxes. REDEMPTION OF FUND SHARES REDEMPTIONS. Redemptions (including redemptions in kind) and exchanges of Fund shares are taxable transactions for federal and state income tax purposes. If you redeem your Fund shares, or exchange them for shares of a different Franklin Templeton fund, the IRS requires you to report any gain or loss on your redemption or exchange. If you hold your shares as a capital asset, any gain or loss that you realize is a capital gain or loss and is long-term or short-term, generally depending on how long you have owned your shares. FIVE YEAR GAINS. Beginning in the year 2001 for shareholders in the 15% federal income tax bracket (or in the year 2006 for shareholders in the 28% or higher bracket), gain from the redemption of Fund shares held for more than five years may be subject to a maximum rate of tax of 8% (or 18% for shareholders in the 28% or higher bracket). If you are in the 28% or higher tax bracket, you may elect to mark your Fund shares to market as of January 2, 2001. If you make this election, any Fund shares that you acquired before this date will be eligible for the 18% maximum rate of tax, beginning in 2006. However, in making the election, you are required to pay a tax on any appreciation in the value of your Fund shares as of January 2, 2001, and to restart your holding period in the shares as of that date. The election does not apply to Fund shares redeemed on or before January 2, 2002. REDEMPTIONS AT A LOSS WITHIN SIX MONTHS OF PURCHASE. If you redeem or exchange Fund shares held for six months or less: o any loss incurred is disallowed to the extent of any exempt-interest dividends paid to you on your shares, and o any remaining loss is treated as a long-term capital loss to the extent of any long-term capital gains distributed to you by a Fund. WASH SALES. All or a portion of any loss that you realize on the redemption of your Fund shares is disallowed to the extent that you buy other shares in the Fund (through reinvestment of dividends or otherwise) within 30 days before or after your share redemption. Any loss disallowed under these rules is added to your tax basis in the new shares. DEFERRAL OF BASIS. If you redeem some or all of your shares in a Fund, and then reinvest the redemption proceeds in the Fund or in another Franklin Templeton fund within 90 days of buying the original shares, the sales charge that would otherwise apply to your reinvestment may be reduced or eliminated. In reporting any gain or loss on your redemption, all or a portion of the sales charge that you paid for your original shares in the Fund is excluded from your tax basis in the shares sold and added to your tax basis in the new shares. DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because the Fund's income is derived primarily from interest rather than dividends, generally none of its distributions are expected to qualify for the corporate dividends-received deduction. INVESTMENT IN COMPLEX SECURITIES Each Fund may invest in securities issued or purchased at a discount, such as zero coupon, step-up or payment-in-kind (PIK) bonds, that may require it to accrue and distribute income not yet received. In order to generate sufficient cash to make these distributions, a Fund may be required to sell securities in its portfolio that it otherwise might have continued to hold. These rules could affect the amount, timing and tax character of income distributed to you by the Fund. TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity bonds, while exempt from regular federal income tax, is a tax preference item for taxpayers when determining their alternative minimum tax under the Code and under the income tax provisions of several states. Private activity bond interest could subject you to or increase your liability under federal and state alternative minimum taxes, depending on your personal or corporate tax position. Persons defined in the Code as substantial users (or persons related to such users) of facilities financed by private activity bonds should consult their tax advisors before buying Fund shares. ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS - -------------------------------------------------------------------------------- Each Fund is a series of Franklin Tax-Free Trust, an open-end management investment company, commonly called a mutual fund. The Trust was organized as a Massachusetts business trust in September 1984, and is registered with the SEC. As a shareholder of a Massachusetts business trust, you could, under certain circumstances, be held personally liable as a partner for its obligations. The Agreement and Declaration of Trust, however, contains an express disclaimer of shareholder liability for acts or obligations of the Fund. The Declaration of Trust also provides for indemnification and reimbursement of expenses out of the Fund's assets if you are held personally liable for obligations of the Fund. The Declaration of Trust provides that each Fund shall, upon request, assume the defense of any claim made against you for any act or obligation of the Fund and satisfy any judgment thereon. All such rights are limited to the assets of the Fund. The Declaration of Trust further provides that each Fund may maintain appropriate insurance (for example, fidelity bonding and errors and omissions insurance) for the protection of the Fund, its shareholders, trustees, officers, employees and agents to cover possible tort and other liabilities. Furthermore, the activities of the Fund as an investment company, as distinguished from an operating company, would not likely give rise to liabilities in excess of the Fund's total assets. Thus, the risk that you would incur financial loss on account of shareholder liability is limited to the unlikely circumstance in which both inadequate insurance exists and the Fund itself is unable to meet its obligations. The Arizona, High Yield, New Jersey and Pennsylvania Funds currently offer three classes of shares, Class A, Class B and Class C. The Colorado, Connecticut, Oregon and Puerto Rico Funds currently offer two classes of shares, Class A and Class C. The full title of each class is: o Franklin Arizona Tax-Free Income Fund - Class A o Franklin Arizona Tax-Free Income Fund - Class B o Franklin Arizona Tax-Free Income Fund - Class C o Franklin Colorado Tax-Free Income Fund - Class A o Franklin Colorado Tax-Free Income Fund - Class C o Franklin Connecticut Tax-Free Income Fund - Class A o Franklin Connecticut Tax-Free Income Fund - Class C o Franklin High Yield Tax-Free Income Fund - Class A o Franklin High Yield Tax-Free Income Fund - Class B o Franklin High Yield Tax-Free Income Fund - Class C o Franklin New Jersey Tax-Free Income Fund - Class A o Franklin New Jersey Tax-Free Income Fund - Class B o Franklin New Jersey Tax-Free Income Fund - Class C o Franklin Oregon Tax-Free Income Fund - Class A o Franklin Oregon Tax-Free Income Fund - Class C o Franklin Pennsylvania Tax-Free Income Fund - Class A o Franklin Pennsylvania Tax-Free Income Fund - Class B o Franklin Pennsylvania Tax-Free Income Fund - Class C o Franklin Puerto Rico Tax-Free Income Fund - Class A o Franklin Puerto Rico Tax-Free Income Fund - Class C The Federal Intermediate only offers one share class. Because its sales charge structure and Rule 12b-1 plan is similar to those of Class A shares, shares of this Fund are considered Class A shares for redemption, exchange and other purposes. The Funds may offer additional classes of shares in the future. Shares of each class represent proportionate interests in each Fund's assets. On matters that affect a Fund as a whole, each class has the same voting and other rights and preferences as any other class. On matters that affect only one class, only shareholders of that class may vote. Each class votes separately on matters affecting only that class, or expressly required to be voted on separately by state or federal law. Shares of each class of a series have the same voting and other rights and preferences as the other classes and series of the Trust for matters that affect the Trust as a whole. Additional series may be offered in the future. The Trust has noncumulative voting rights. For board member elections, this gives holders of more than 50% of the shares voting the ability to elect all of the members of the board. If this happens, holders of the remaining shares voting will not be able to elect anyone to the board. The Trust does not intend to hold annual shareholder meetings. The Trust or a series of the Trust may hold special meetings, however, for matters requiring shareholder approval. A meeting may be called by the board to consider the removal of a board member if requested in writing by shareholders holding at least 10% of the outstanding shares. In certain circumstances, we are required to help you communicate with other shareholders about the removal of a board member. A special meeting also may be called by the board in its discretion. From time to time, the number of Fund shares held in the "street name" accounts of various securities dealers for the benefit of their clients or in centralized securities depositories may exceed 5% of the total shares outstanding. To the best knowledge of the Fund, no other person holds beneficially or of record more than 5% of the outstanding shares of any class. As of June 1, 2001, the officers and board members, as a group, owned of record and beneficially less than 1% of the outstanding shares of each Fund and class. The board members may own shares in other funds in Franklin Templeton Investments. BUYING AND SELLING SHARES - -------------------------------------------------------------------------------- Each Fund continuously offers its shares through securities dealers who have an agreement with Franklin Templeton Distributors, Inc. (Distributors). A securities dealer includes any financial institution that, either directly or through affiliates, has an agreement with Distributors to handle customer orders and accounts with a Fund. This reference is for convenience only and does not indicate a legal conclusion of capacity. Banks and financial institutions that sell shares of a Fund may be required by state law to register as securities dealers. For investors outside the U.S., the offering of Fund shares may be limited in many jurisdictions. An investor who wishes to buy shares of the Fund should determine, or have a broker-dealer determine, the applicable laws and regulations of the relevant jurisdiction. Investors are responsible for compliance with tax, currency exchange or other regulations applicable to redemption and purchase transactions in any jurisdiction to which they may be subject. Investors should consult appropriate tax and legal advisors to obtain information on the rules applicable to these transactions. All checks, drafts, wires and other payment mediums used to buy or sell shares of the Fund must be denominated in U.S. dollars. We may, in our sole discretion, either (a) reject any order to buy or sell shares denominated in any other currency or (b) honor the transaction or make adjustments to your account for the transaction as of a date and with a foreign currency exchange factor determined by the drawee bank. We may deduct any applicable banking charges imposed by the bank from your account. When you buy shares, if you submit a check or a draft that is returned unpaid to the Fund we may impose a $10 charge against your account for each returned item. INITIAL SALES CHARGES The maximum initial sales charge is 2.25% for the Federal Intermediate Fund. For each of the other Funds, the maximum initial sales charge is 4.25% for Class A and 1% for Class C. There is no initial sales charge for Class B. The initial sales charge for Class A shares may be reduced for certain large purchases, as described in the prospectus. We offer several ways for you to combine your purchases in Franklin Templeton funds to take advantage of the lower sales charges for large purchases. Franklin Templeton funds include the U.S. registered mutual funds in Franklin Templeton Investments except Franklin Templeton Variable Insurance Products Trust and Templeton Capital Accumulator Fund, Inc. CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on Class A shares, you may combine the amount of your current purchase with the cost or current value, whichever is higher, of your existing shares in Franklin Templeton funds. You also may combine the shares of your spouse, children under the age of 21 or grandchildren under the age of 21. If you are the sole owner of a company, you also may add any company accounts, including retirement plan accounts. LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by completing the letter of intent section of your account application. A letter of intent is a commitment by you to invest a specified dollar amount during a 13 month period. The amount you agree to invest determines the sales charge you pay. By completing the letter of intent section of the application, you acknowledge and agree to the following: o You authorize Distributors to reserve 5% of your total intended purchase in Class A shares registered in your name until you fulfill your LOI. Your periodic statements will include the reserved shares in the total shares you own, and we will pay or reinvest dividend and capital gain distributions on the reserved shares according to the distribution option you have chosen. o You give Distributors a security interest in the reserved shares and appoint Distributors as attorney-in-fact. o Distributors may sell any or all of the reserved shares to cover any additional sales charge if you do not fulfill the terms of the LOI. o Although you may exchange your shares, you may not sell reserved shares until you complete the LOI or pay the higher sales charge. After you file your LOI with the Fund, you may buy Class A shares at the sales charge applicable to the amount specified in your LOI. Sales charge reductions based on purchases in more than one Franklin Templeton fund will be effective only after notification to Distributors that the investment qualifies for a discount. Any Class A purchases you made within 90 days before you filed your LOI also may qualify for a retroactive reduction in the sales charge. If you file your LOI with the Fund before a change in the Fund's sales charge, you may complete the LOI at the lower of the new sales charge or the sales charge in effect when the LOI was filed. Your holdings in Franklin Templeton funds acquired more than 90 days before you filed your LOI will be counted towards the completion of the LOI, but they will not be entitled to a retroactive reduction in the sales charge. Any redemptions you make during the 13 month period will be subtracted from the amount of the purchases for purposes of determining whether the terms of the LOI have been completed. If the terms of your LOI are met, the reserved shares will be deposited to an account in your name or delivered to you or as you direct. If the amount of your total purchases, less redemptions, is more than the amount specified in your LOI and is an amount that would qualify for a further sales charge reduction, a retroactive price adjustment will be made by Distributors and the securities dealer through whom purchases were made. The price adjustment will be made on purchases made within 90 days before and on those made after you filed your LOI and will be applied towards the purchase of additional shares at the offering price applicable to a single purchase or the dollar amount of the total purchases. If the amount of your total purchases, less redemptions, is less than the amount specified in your LOI, the sales charge will be adjusted upward, depending on the actual amount purchased (less redemptions) during the period. You will need to send Distributors an amount equal to the difference in the actual dollar amount of sales charge paid and the amount of sales charge that would have applied to the total purchases if the total of the purchases had been made at one time. Upon payment of this amount, the reserved shares held for your account will be deposited to an account in your name or delivered to you or as you direct. If within 20 days after written request the difference in sales charge is not paid, we will redeem an appropriate number of reserved shares to realize the difference. If you redeem the total amount in your account before you fulfill your LOI, we will deduct the additional sales charge due from the sale proceeds and forward the balance to you. GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A shares at a reduced sales charge that applies to the group as a whole. The sales charge is based on the combined dollar value of the group members' existing investments, plus the amount of the current purchase. A qualified group is one that: o Was formed at least six months ago, o Has a purpose other than buying Fund shares at a discount, o Has more than 10 members, o Can arrange for meetings between our representatives and group members, o Agrees to include Franklin Templeton fund sales and other materials in publications and mailings to its members at reduced or no cost to Distributors, o Agrees to arrange for payroll deduction or other bulk transmission of investments to the Fund, and o Meets other uniform criteria that allow Distributors to achieve cost savings in distributing shares. WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased without an initial sales charge or contingent deferred sales charge (CDSC) by investors who reinvest within 365 days: o Dividend and capital gain distributions from any Franklin Templeton fund. The distributions generally must be reinvested in the same share class. Certain exceptions apply, however, to Class C shareholders who chose to reinvest their distributions in Class A shares of the Fund before November 17, 1997, and to Advisor Class or Class Z shareholders of a Franklin Templeton fund who may reinvest their distributions in the Fund's Class A shares. o Annuity payments received under either an annuity option or from death benefit proceeds, if the annuity contract offers as an investment option the Franklin Templeton Variable Insurance Products Trust. You should contact your tax advisor for information on any tax consequences that may apply. o Redemption proceeds from a repurchase of shares of Franklin Floating Rate Trust, if the shares were continuously held for at least 12 months. If you immediately placed your redemption proceeds in a Franklin Bank CD or a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date the CD matures, including any rollover, or the date you redeem your money fund shares. o Redemption proceeds from the sale of Class A shares of any of the Templeton Global Strategy Funds if you are a qualified investor. If you paid a CDSC when you redeemed your Class A shares from a Templeton Global Strategy Fund, a new CDSC will apply to your purchase of Fund shares and the CDSC holding period will begin again. We will, however, credit your Fund account with additional shares based on the CDSC you previously paid and the amount of the redemption proceeds that you reinvest. If you immediately placed your redemption proceeds in a Franklin Templeton money fund, you may reinvest them as described above. The proceeds must be reinvested within 365 days from the date they are redeemed from the money fund. WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without an initial sales charge or CDSC by various individuals and institutions due to anticipated economies in sales efforts and expenses, including: o Trust companies and bank trust departments investing assets held in a fiduciary, agency, advisory, custodial or similar capacity and over which the trust companies and bank trust departments or other plan fiduciaries or participants, in the case of certain retirement plans, have full or shared investment discretion. We may accept orders for these accounts by telephone or other means of electronic data transfer directly from the bank or trust company, with payment by federal funds received by the close of business on the next business day following the order. o Any state or local government or any instrumentality, department, authority or agency thereof that has determined the Fund is a legally permissible investment and that can only buy Fund shares without paying sales charges. Please consult your legal and investment advisors to determine if an investment in the Fund is permissible and suitable for you and the effect, if any, of payments by the Fund on arbitrage rebate calculations. o Broker-dealers, registered investment advisors or certified financial planners who have entered into an agreement with Distributors for clients participating in comprehensive fee programs o Qualified registered investment advisors who buy through a broker-dealer or service agent who has entered into an agreement with Distributors o Registered securities dealers and their affiliates, for their investment accounts only o Current employees of securities dealers and their affiliates and their family members, as allowed by the internal policies of their employer o Officers, trustees, directors and full-time employees of Franklin Templeton Investments, and their family members, consistent with our then-current policies o Any investor who is currently a Class Z shareholder of Franklin Mutual Series Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z shareholder who had an account in any Mutual Series fund on October 31, 1996, or who sold his or her shares of Mutual Series Class Z within the past 365 days o Investment companies exchanging shares or selling assets pursuant to a merger, acquisition or exchange offer o Accounts managed by Franklin Templeton Investments o Certain unit investment trusts and their holders reinvesting distributions from the trusts In addition, Class C shares may be purchased without an initial sales charge by any investor who buys Class C shares through an omnibus account with Merrill Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are sold within 18 months of purchase. DEALER COMPENSATION Securities dealers may at times receive the entire sales charge. A securities dealer who receives 90% or more of the sales charge may be deemed an underwriter under the Securities Act of 1933, as amended. Financial institutions or their affiliated brokers may receive an agency transaction fee in the percentages indicated in the dealer compensation table in the Funds' prospectus. Distributors may pay the following commissions, out of its own resources, to securities dealers who initiate and are responsible for purchases of Class A shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus 0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3 million to $50 million, plus 0.25% on sales over $50 million to $100 million, plus 0.15% on sales over $100 million. These breakpoints are reset every 12 months for purposes of additional purchases. In addition to the payments above, Distributors and/or its affiliates may provide financial support to securities dealers that sell shares of Franklin Templeton Investments. This support is based primarily on the amount of sales of fund shares and/or total assets with Franklin Templeton Investments. The amount of support may be affected by: total sales; net sales; levels of redemptions; the proportion of a securities dealer's sales and marketing efforts in Franklin Templeton Investments; a securities dealer's support of, and participation in, Distributors' marketing programs; a securities dealer's compensation programs for its registered representatives; and the extent of a securities dealer's marketing programs relating to Franklin Templeton Investments. Financial support to securities dealers may be made by payments from Distributors' resources, from Distributors' retention of underwriting concessions and, in the case of funds that have Rule 12b-1 plans, from payments to Distributors under such plans. In addition, certain securities dealers may receive brokerage commissions generated by fund portfolio transactions in accordance with the rules of the National Association of Securities Dealers, Inc. Distributors routinely sponsors due diligence meetings for registered representatives during which they receive updates on various Franklin Templeton funds and are afforded the opportunity to speak with portfolio managers. Invitation to these meetings is not conditioned on selling a specific number of shares. Those who have shown an interest in Franklin Templeton funds, however, are more likely to be considered. To the extent permitted by their firm's policies and procedures, registered representatives' expenses in attending these meetings may be covered by Distributors. CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in Class A shares, either as a lump sum or through our cumulative quantity discount or letter of intent programs, a CDSC may apply on any shares you sell within 12 months of purchase. For Class C shares, a CDSC may apply if you sell your shares within 18 months of purchase. The CDSC is 1% of the value of the shares sold or the net asset value at the time of purchase, whichever is less. A CDSC will not apply to Class A purchases over $250 million in the High Yield Fund. For Class B shares, there is a CDSC if you sell your shares within six years, as described in the table below. The charge is based on the value of the shares sold or the net asset value at the time of purchase, whichever is less. IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC - -------------------------------------------------------------------------------- 1 Year 4 2 Years 4 3 Years 3 4 Years 3 5 Years 2 6 Years 1 7 Years 0 CDSC WAIVERS. The CDSC for any share class generally will be waived for: o Account fees o Redemptions of Class A shares by investors who purchased $1 million or more without an initial sales charge if the securities dealer of record waived its commission in connection with the purchase o Redemptions by a Fund when an account falls below the minimum required account size o Redemptions following the death of the shareholder or beneficial owner o Redemptions through a systematic withdrawal plan set up before February 1, 1995 o Redemptions through a systematic withdrawal plan set up on or after February 1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of your account's net asset value depending on the frequency of your plan EXCHANGE PRIVILEGE If you request the exchange of the total value of your account, accrued but unpaid income dividends and capital gain distributions will be reinvested in the Fund at net asset value on the date of the exchange, and then the entire share balance will be exchanged into the new fund. Backup withholding and information reporting may apply. If a substantial number of shareholders should, within a short period, sell their Fund shares under the exchange privilege, the Fund might have to sell portfolio securities it might otherwise hold and incur the additional costs related to such transactions. On the other hand, increased use of the exchange privilege may result in periodic large inflows of money. If this occurs, it is each Fund's general policy to initially invest this money in short-term, tax-exempt municipal securities, unless it is believed that attractive investment opportunities consistent with the Fund's investment goals exist immediately. This money will then be withdrawn from the short-term, tax-exempt municipal securities and invested in portfolio securities in as orderly a manner as is possible when attractive investment opportunities arise. The proceeds from the sale of shares of an investment company generally are not available until the seventh day following the sale. The funds you are seeking to exchange into may delay issuing shares pursuant to an exchange until that seventh day. The sale of Fund shares to complete an exchange will be effected at net asset value at the close of business on the day the request for exchange is received in proper form. SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell your shares and receive regular payments from your account on a monthly, quarterly, semiannual or annual basis. The value of your account must be at least $5,000 and the minimum payment amount for each withdrawal must be at least $50. There are no service charges for establishing or maintaining a systematic withdrawal plan. Each month in which a payment is scheduled, we will redeem an equivalent amount of shares in your account on the day of the month you have indicated on your account application or, if no day is indicated, on the 20th day of the month. If that day falls on a weekend or holiday, we will process the redemption on the next business day. For plans set up before June 1, 2000, we will continue to process redemptions on the 25th day of the month (or the next business day) unless you instruct us to change the processing date. Available processing dates currently are the 1st, 5th, 10th, 15th, 20th and 25th days of the month. When you sell your shares under a systematic withdrawal plan, it is a taxable transaction. To avoid paying sales charges on money you plan to withdraw within a short period of time, you may not want to set up a systematic withdrawal plan if you plan to buy shares on a regular basis. Shares sold under the plan also may be subject to a CDSC. Redeeming shares through a systematic withdrawal plan may reduce or exhaust the shares in your account if payments exceed distributions received from the Fund. This is especially likely to occur if there is a market decline. If a withdrawal amount exceeds the value of your account, your account will be closed and the remaining balance in your account will be sent to you. Because the amount withdrawn under the plan may be more than your actual yield or income, part of the payment may be a return of your investment. To discontinue a systematic withdrawal plan, change the amount and schedule of withdrawal payments, or suspend one payment, we must receive instructions from you at least three business days before a scheduled payment. A Fund may discontinue a systematic withdrawal plan by notifying you in writing and will discontinue a systematic withdrawal plan automatically if all shares in your account are withdrawn or if the Fund receives notification of the shareholder's death or incapacity. REDEMPTIONS IN KIND Each Fund has committed itself to pay in cash (by check) all requests for redemption by any shareholder of record, limited in amount, however, during any 90-day period to the lesser of $250,000 or 1% of the value of the Fund's net assets at the beginning of the 90-day period. This commitment is irrevocable without the prior approval of the SEC. In the case of redemption requests in excess of these amounts, the board reserves the right to make payments in whole or in part in securities or other assets of the Fund, in case of an emergency, or if the payment of such a redemption in cash would be detrimental to the existing shareholders of the Fund. In these circumstances, the securities distributed would be valued at the price used to compute the Fund's net assets and you may incur brokerage fees in converting the securities to cash. The Funds do not intend to redeem illiquid securities in kind. If this happens, however, you may not be able to recover your investment in a timely manner. SHARE CERTIFICATES We will credit your shares to your Fund account. We do not issue share certificates unless you specifically request them. This eliminates the costly problem of replacing lost, stolen or destroyed certificates. If a certificate is lost, stolen or destroyed, you may have to pay an insurance premium of up to 2% of the value of the certificate to replace it. Any outstanding share certificates must be returned to the Fund if you want to sell or exchange those shares or if you would like to start a systematic withdrawal plan. The certificates should be properly endorsed. You can do this either by signing the back of the certificate or by completing a share assignment form. For your protection, you may prefer to complete a share assignment form and to send the certificate and assignment form in separate envelopes. GENERAL INFORMATION If dividend checks are returned to the Fund marked "unable to forward" by the postal service, we will consider this a request by you to change your dividend option to reinvest all distributions. The proceeds will be reinvested in additional shares at net asset value until we receive new instructions. Distribution or redemption checks sent to you do not earn interest or any other income during the time the checks remain uncashed. Neither the Funds nor their affiliates will be liable for any loss caused by your failure to cash such checks. The Funds are not responsible for tracking down uncashed checks, unless a check is returned as undeliverable. In most cases, if mail is returned as undeliverable we are required to take certain steps to try to find you free of charge. If these attempts are unsuccessful, however, we may deduct the costs of any additional efforts to find you from your account. These costs may include a percentage of the account when a search company charges a percentage fee in exchange for its location services. Sending redemption proceeds by wire or electronic funds transfer (ACH) is a special service that we make available whenever possible. By offering this service to you, the Funds are not bound to meet any redemption request in less than the seven day period prescribed by law. Neither the Funds nor their agents shall be liable to you or any other person if, for any reason, a redemption request by wire or ACH is not processed as described in the prospectus. Franklin Templeton Investor Services, LLC (Investor Services) may pay certain financial institutions that maintain omnibus accounts with the Funds on behalf of numerous beneficial owners for recordkeeping operations performed with respect to such owners. For each beneficial owner in the omnibus account, the Fund may reimburse Investor Services an amount not to exceed the per account fee that the Fund normally pays Investor Services. These financial institutions also may charge a fee for their services directly to their clients. There are special procedures for banks and other institutions that wish to open multiple accounts. An institution may open a single master account by filing one application form with a Fund, signed by personnel authorized to act for the institution. Individual sub-accounts may be opened when the master account is opened by listing them on the application, or by providing instructions to the Fund at a later date. These sub-accounts may be registered either by name or number. Each Fund's investment minimums apply to each sub-account. Each Fund will send confirmation and account statements for the sub-accounts to the institution. If you buy or sell shares through your securities dealer, we use the net asset value next calculated after your securities dealer receives your request, which is promptly transmitted to the Fund. If you sell shares through your securities dealer, it is your dealer's responsibility to transmit the order to the Fund in a timely fashion. Your redemption proceeds will not earn interest between the time we receive the order from your dealer and the time we receive any required documents. Any loss to you resulting from your dealer's failure to transmit your redemption order to the Fund in a timely fashion must be settled between you and your securities dealer. Certain shareholder servicing agents may be authorized to accept your transaction request. For institutional accounts, there may be additional methods of buying or selling Fund shares than those described in this SAI or in the prospectus. In the event of disputes involving multiple claims of ownership or authority to control your account, the Fund has the right (but has no obligation) to: (a) freeze the account and require the written agreement of all persons deemed by the Fund to have a potential property interest in the account, before executing instructions regarding the account; (b) interplead disputed funds or accounts with a court of competent jurisdiction; or (c) surrender ownership of all or a portion of the account to the IRS in response to a notice of levy. PRICING SHARES - -------------------------------------------------------------------------------- When you buy shares, you pay the offering price. The offering price is the net asset value (NAV) per share plus any applicable sales charge, calculated to two decimal places using standard rounding criteria. When you sell shares, you receive the NAV minus any applicable CDSC. The value of a mutual fund is determined by deducting the fund's liabilities from the total assets of the portfolio. The net asset value per share is determined by dividing the net asset value of the fund by the number of shares outstanding. Each Fund calculates the NAV per share of each class each business day at the close of trading on the New York Stock Exchange (normally 1:00 p.m. Pacific time). The Funds do not calculate the NAV on days the New York Stock Exchange (NYSE) is closed for trading, which include New Year's Day, Martin Luther King Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. When determining its NAV, each Fund values cash and receivables at their realizable amounts, and records interest as accrued. Each Fund values over-the-counter portfolio securities within the range of the most recent quoted bid and ask prices. If portfolio securities trade both in the over-the-counter market and on a stock exchange, each Fund values them according to the broadest and most representative market as determined by the manager. Municipal securities generally trade in the over-the-counter market rather than on a securities exchange. In the absence of a sale or reported bid and ask prices, information with respect to bond and note transactions, quotations from bond dealers, market transactions in comparable securities, and various relationships between securities are used to determine the value of municipal securities. Generally, trading in U.S. government securities and money market instruments is substantially completed each day at various times before the close of the NYSE. The value of these securities used in computing the NAV is determined as of such times. Occasionally, events affecting the values of these securities may occur between the times at which they are determined and the close of the NYSE that will not be reflected in the computation of the NAV. If events materially affecting the values of these securities occur during this period, the securities will be valued at their fair value as determined in good faith by the board. Other securities for which market quotations are readily available are valued at the current market price, which may be obtained from a pricing service, based on a variety of factors including recent trades, institutional size trading in similar types of securities (considering yield, risk and maturity) and/or developments related to specific issues. Securities and other assets for which market prices are not readily available are valued at fair value as determined following procedures approved by the board. With the approval of the board, each Fund may use a pricing service, bank or securities dealer to perform any of the above described functions. THE UNDERWRITER - -------------------------------------------------------------------------------- Franklin Templeton Distributors, Inc. (Distributors) acts as the principal underwriter in the continuous public offering of each Fund's shares. Distributors is located at One Franklin Parkway, San Mateo, CA 94403-1906. Distributors pays the expenses of the distribution of Fund shares, including advertising expenses and the costs of printing sales material and prospectuses used to offer shares to the public. Each Fund pays the expenses of preparing and printing amendments to its registration statements and prospectuses (other than those necessitated by the activities of Distributors) and of sending prospectuses to existing shareholders. The table below shows the aggregate underwriting commissions Distributors received in connection with the offering of the Funds' shares, the net underwriting discounts and commissions Distributors retained after allowances to dealers, and the amounts Distributors received in connection with redemptions or repurchases of shares for the last three fiscal years ended February 28, 2001, February 29, 2000, and February 28, 1999: AMOUNT RECEIVED IN CONNECTION WITH TOTAL AMOUNT REDEMPTIONS COMMISSIONS RETAINED BY AND RECEIVED DISTRIBUTORS REPURCHASES ($) ($) ($) - -------------------------------------------------------------------------------- 2001 Arizona Fund 1,405,763 96,524 14,182 Colorado Fund 577,095 38,270 8,708 Connecticut Fund 620,405 37,944 22,265 Federal Intermediate Fund 158,806 14,344 59,234 High Yield Fund 7,436,614 460,998 600,719 New Jersey Fund 1,397,134 86,045 36,409 Oregon Fund 1,062,709 65,923 26,226 Pennsylvania Fund 1,029,637 64,598 12,462 Puerto Rico Fund 369,060 23,643 1,905 2000 Arizona Fund 1,789,429 116,636 43,769 Colorado Fund 792,171 47,662 26,569 Connecticut Fund 775,626 44,859 27,906 Federal Intermediate Fund 295,096 37,026 34,398 High Yield Fund 12,907,406 797,311 800,953 New Jersey Fund 1,875,772 113,850 68,849 Oregon Fund 1,361,936 80,741 63,487 Pennsylvania Fund 1,641,659 99,014 42,266 Puerto Rico Fund 506,727 32,887 6,957 1999 Arizona Fund 3,109,731 204,136 12,269 Colorado Fund 1,230,170 75,655 8,464 Connecticut Fund 1,280,521 72,556 7,518 Federal Intermediate Fund 408,916 55,742 4,464 High Yield Fund 24,360,736 1,514,537 283,409 New Jersey Fund 2,838,883 169,312 23,450 Oregon Fund 2,294,919 142,478 13,763 Pennsylvania Fund 2,942,369 186,194 16,329 Puerto Rico Fund 703,085 44,229 5,057 Distributors may be entitled to payments from the Funds under the Rule 12b-1 plans, as discussed below. Except as noted, Distributors received no other compensation from the Funds for acting as underwriter. DISTRIBUTION AND SERVICE (12B-1) FEES The board has adopted a separate plan pursuant to Rule 12b-1 for each class. Although the plans differ in some ways for each class, each plan is designed to benefit the Fund and its shareholders. The plans are expected to, among other things, increase advertising of the Fund, encourage sales of the Fund and service to its shareholders, and increase or maintain assets of the Fund so that certain fixed expenses may be spread over a broader asset base, resulting in lower per share expense ratios. In addition, a positive cash flow into the Fund is useful in managing the Fund because the manager has more flexibility in taking advantage of new investment opportunities and handling shareholder redemptions. Under each plan, the Fund pays Distributors or others for the expenses of activities that are primarily intended to sell shares of the class. These expenses also may include service fees paid to securities dealers or others who have executed a servicing agreement with the Fund, Distributors or its affiliates who provide service or account maintenance to shareholders (service fees); the expenses of printing prospectuses and reports used for sales purposes, and of preparing and distributing sales literature and advertisements; and a prorated portion of Distributors' overhead expenses related to these activities. Together, these expenses, including the service fees, are "eligible expenses." The 12b-1 fees charged to each class are based only on the fees attributable to that particular class. THE CLASS A PLAN. Each Fund may pay up to 0.10% per year of Class A's average daily net assets. The Class A plan is a reimbursement plan. It allows the Fund to reimburse Distributors for eligible expenses that Distributors has shown it has incurred. The Fund will not reimburse more than the maximum amount allowed under the plan. Any unreimbursed expenses from one year may not be carried over to or reimbursed in later years. For the fiscal year ended February 28, 2001, the amounts paid by the Funds pursuant to the Class A plan were: FEDERAL ARIZONA COLORADO CONNECTICUT INTERMEDIATE ($) ($) ($) ($) - -------------------------------------------------------------------------------- Advertising 52,721 16,711 12,398 5,227 Printing and mailing prospectuses other than to current shareholders 13,849 4,727 3,531 1,642 Payments to underwriters 16,188 6,901 5,338 2,562 Payments to broker-dealers 578,025 209,991 168,952 148,602 Other 68,959 25,470 18,292 6,290 ------------------------------------------------------- Total 729,742 263,800 208,511 164,323 ------------------------------------------------------- HIGH YIELD NEW JERSEY OREGON PENNSYLVANIA ($) ($) ($) ($) - -------------------------------------------------------------------------------- Advertising 163,106 32,420 23,909 54,310 Printing and mailing prospectuses other than to current shareholders 42,058 10,874 8,403 10,333 Payments to underwriters 54,151 16,608 10,679 10,084 Payments to broker-dealers 3,977,758 479,003 337,107 492,713 Other 231,767 63,980 44,472 53,144 ------------------------------------------------------- Total 4,468,840 602,885 424,570 620,584 ------------------------------------------------------- PUERTO RICO ($) - --------------------------------------- Advertising 9,505 Printing and mailing prospectuses other than to current shareholders 5,515 Payments to underwriters 3,431 Payments to broker dealers 150,617 Other 21,180 -------------- Total 190,248 -------------- THE CLASS B AND C PLANS. Each Fund pays Distributors up to 0.65% per year of the class's average daily net assets, out of which 0.15% may be paid for services to the shareholders (service fees). The Class B and C plans also may be used to pay Distributors for advancing commissions to securities dealers with respect to the initial sale of Class B and C shares. Class B plan fees payable to Distributors are used by Distributors to pay third party financing entities that have provided financing to Distributors in connection with advancing commissions to securities dealers. Resources owns a minority interest in one of the third party financing entities. The Class B and C plans are compensation plans. They allow each Fund to pay a fee to Distributors that may be more than the eligible expenses Distributors has incurred at the time of the payment. Distributors must, however, demonstrate to the board that it has spent or has near-term plans to spend the amount received on eligible expenses. Each Fund will not pay more than the maximum amount allowed under the plans. Under the Class B plan, the amounts paid by the Funds pursuant to the plan for the fiscal year ended February 28, 2001, were: ARIZONA HIGH YIELD NEW JERSEY PENNSYLVANIA ($) ($) ($) ($) - -------------------------------------------------------------------------------- Advertising 126 12,999 265 109 Printing and mailing prospectuses other than to current shareholders 4 1,236 4 4 Payments to underwriters 128 9,669 221 65 Payments to broker-dealers 8,455 680,287 14,924 7,349 Other 196 17,479 347 145 ----------------------------------------------- Total 8,909 721,670 15,761 7,672 ----------------------------------------------- Under the Class C plan, the amounts paid by the Funds pursuant to the plan for the fiscal year ended February 28, 2001, were: FEDERAL ARIZONA COLORADO CONNECTICUT INTERMEDIATE ($) ($) ($) ($) - -------------------------------------------------------------------------------- Advertising 2,678 3,534 2,509 - Printing and mailing - prospectuses other than to current shareholders 472 575 489 Payments to underwriters - 1,148 1,411 1,212 Payments to - broker-dealers 139,743 130,579 147,900 Other 3,289 3,643 3,071 - ------------------------------------------------------- Total 147,330 139,742 155,181 - ------------------------------------------------------- HIGH YIELD NEW JERSEY OREGON PENNSYLVANIA ($) ($) ($) ($) - -------------------------------------------------------------------------------- Advertising 51,345 4,059 4,436 5,396 Printing and mailing prospectuses other than to current shareholders 11,698 740 704 891 Payments to underwriters 18,474 2,069 2,489 1,756 Payments to broker-dealers 3,208,219 290,579 213,279 252,466 Other 67,416 5,564 5,877 5,650 --------------------------------------------------------- Total 3,357,152 303,011 226,785 266,159 --------------------------------------------------------- PUERTO RICO ($) - -------------------------------------------------------- Advertising 1,430 Printing and mailing prospectuses other than to 203 current shareholders Payments to underwriters 670 Payments to broker-dealers 48,901 Other 1,498 ----------------- Total 52,702 ----------------- THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or others are entitled to under each plan, each plan also provides that to the extent the Fund, the manager or Distributors or other parties on behalf of the Fund, the manager or Distributors make payments that are deemed to be for the financing of any activity primarily intended to result in the sale of Fund shares within the context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then such payments shall be deemed to have been made pursuant to the plan. To the extent fees are for distribution or marketing functions, as distinguished from administrative servicing or agency transactions, certain banks may not participate in the plans because of applicable federal law prohibiting certain banks from engaging in the distribution of mutual fund shares. These banks, however, are allowed to receive fees under the plans for administrative servicing or for agency transactions. Distributors must provide written reports to the board at least quarterly on the amounts and purpose of any payment made under the plans and any related agreements, and furnish the board with such other information as the board may reasonably request to enable it to make an informed determination of whether the plans should be continued. Each plan has been approved according to the provisions of Rule 12b-1. The terms and provisions of each plan also are consistent with Rule 12b-1. PERFORMANCE - -------------------------------------------------------------------------------- Performance quotations are subject to SEC rules. These rules require the use of standardized performance quotations or, alternatively, that every non-standardized performance quotation furnished by a Fund be accompanied by certain standardized performance information computed as required by the SEC. Average annual total return and current yield quotations used by the Funds are based on the standardized methods of computing performance mandated by the SEC. Performance figures reflect Rule 12b-1 fees from the date of the plan's implementation. An explanation of these and other methods used by the Funds to compute or express performance follows. Regardless of the method used, past performance does not guarantee future results, and is an indication of the return to shareholders only for the limited historical period used. AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding the average annual rates of return over the periods indicated below that would equate an initial hypothetical $1,000 investment to its ending redeemable value. The calculation assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, and income dividends and capital gain distributions are reinvested at net asset value. The quotation assumes the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. If a change is made to the sales charge structure, historical performance information will be restated to reflect the maximum initial sales charge currently in effect. When considering the average annual total return quotations for Class A and C shares, you should keep in mind that the maximum initial sales charge reflected in each quotation is a one time fee charged on all direct purchases, which will have its greatest impact during the early stages of your investment. This charge will affect actual performance less the longer you retain your investment in the Funds. The average annual total returns for the indicated periods ended February 28, 2001, were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - -------------------------------------------------------------------------------- CLASS A Arizona Fund 9/01/87 6.07 4.05 5.98 6.61 Colorado Fund 9/01/87 7.76 4.42 6.42 6.96 Connecticut Fund 10/03/88 6.66 3.97 5.65 5.99 Federal Intermediate Fund 9/21/92 6.67 4.45 - 5.73 High Yield Fund 3/18/86 2.46 3.98 6.59 7.15 New Jersey Fund 5/12/88 7.38 4.60 6.15 6.94 Oregon Fund 9/01/87 6.52 4.17 5.89 6.41 Pennsylvania Fund 12/01/86 7.02 4.36 6.42 6.29 Puerto Rico Fund 4/03/85 6.30 4.71 6.20 7.06 SINCE INCEPTION 1 YEAR INCEPTION DATE (%) (%) - -------------------------------------------------------------------------------- CLASS B Arizona Fund 02/01/00 6.37 7.13 High Yield Fund 01/01/99 2.38 0.03 New Jersey Fund 02/01/00 7.81 8.71 Pennsylvania Fund 02/01/00 7.23 8.00 SINCE INCEPTION 1 YEAR 5 YEARS INCEPTION DATE (%) (%) (%) - -------------------------------------------------------------------------------- CLASS C Arizona Fund 05/01/95 8.09 4.19 4.89 Colorado Fund 05/01/95 9.73 4.57 5.38 Connecticut Fund 05/01/95 8.62 4.13 4.81 High Yield Fund 05/01/95 4.36 4.13 5.11 New Jersey Fund 05/01/95 9.50 4.74 5.45 Oregon Fund 05/01/95 8.48 4.27 5.02 Pennsylvania Fund 05/01/95 9.04 4.49 5.18 Puerto Rico Fund 05/01/95 8.45 4.81 5.37 The following SEC formula was used to calculate these figures: n P(1+T) = ERV where: P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of each period at the end of each period CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total return assumes the maximum initial sales charge is deducted from the initial $1,000 purchase, income dividends and capital gain distributions are reinvested at net asset value, the account was completely redeemed at the end of each period and the deduction of all applicable charges and fees. Cumulative total return, however, is based on the actual return for a specified period rather than on the average return over the periods indicated above. The cumulative total returns for the indicated periods ended February 28, 2001 were: SINCE INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION DATE (%) (%) (%) (%) - -------------------------------------------------------------------------------- CLASS A Arizona Fund 9/01/87 6.07 21.96 78.75 137.34 Colorado Fund 9/01/87 7.76 24.12 86.33 147.91 Connecticut Fund 10/03/88 6.66 21.51 73.27 105.82 Federal Intermediate Fund 9/21/92 6.67 24.29 - 60.05 High Yield Fund 3/18/86 2.46 21.55 89.31 180.72 New Jersey Fund 5/12/88 7.38 25.23 81.63 135.94 Oregon Fund 9/01/87 6.52 22.64 77.18 131.33 Pennsylvania Fund 12/01/86 7.02 23.78 86.38 138.60 Puerto Rico Fund 4/03/85 6.30 25.89 82.42 196.07 SINCE INCEPTION 1 YEAR INCEPTION DATE (%) (%) - -------------------------------------------------------------------------------- CLASS B Arizona Fund 02/01/00 6.37 7.70 High Yield Fund 01/01/99 2.38 0.06 New Jersey Fund 02/01/00 7.81 9.41 Pennsylvania Fund 02/01/00 7.23 8.64 SINCE INCEPTION 1 YEAR 5 YEARS INCEPTION DATE (%) (%) (%) - -------------------------------------------------------------------------------- CLASS C Arizona Fund 05/01/95 8.09 22.78 32.08 Colorado Fund 05/01/95 9.73 25.05 35.72 Connecticut Fund 05/01/95 8.62 22.42 31.51 High Yield Fund 05/01/95 4.36 22.42 33.71 New Jersey Fund 05/01/95 9.50 26.07 36.24 Oregon Fund 05/01/95 8.48 23.27 33.08 Pennsylvania Fund 05/01/95 9.04 24.55 34.24 Puerto Rico Fund 05/01/95 8.45 26.46 35.67 CURRENT YIELD Current yield shows the income per share earned by a Fund. It is calculated by dividing the net investment income per share earned during a 30-day base period by the applicable maximum offering price per share on the last day of the period and annualizing the result. Expenses accrued for the period include any fees charged to all shareholders of the class during the base period. The yields for the 30-day period ended February 28, 2001, were: CLASS A CLASS B CLASS C (%) (%) (%) - -------------------------------------------------------------------------------- Arizona Fund 4.44 4.09 4.05 Colorado Fund 4.28 - 3.88 Connecticut Fund 4.37 - 3.97 Federal Intermediate Fund 4.12 - - High Yield Fund 5.20 4.88 4.83 New Jersey Fund 4.28 3.91 3.88 Oregon Fund 4.30 - 3.89 Pennsylvania Fund 4.47 4.11 4.07 Puerto Rico Fund 4.15 - 3.74 The following SEC formula was used to calculate these figures: 6 Yield = 2 [(A-B + 1) - 1] --- cd where: a = interest earned during the period b = expenses accrued for the period (net of reimbursements) c = the average daily number of shares outstanding during the period that were entitled to receive dividends d = the maximum offering price per share on the last day of the period TAXABLE-EQUIVALENT YIELD Each Fund also may quote a taxable-equivalent yield that shows the before-tax yield that would have to be earned from a taxable investment to equal the yield. Taxable-equivalent yield is computed by dividing the portion of the yield that is tax-exempt by one minus the highest applicable comDDbined federal and state income tax rate and adding the product to the portion of the yield that is not tax-exempt, if any. The taxable-equivalent yields for the 30-day period ended February 28, 2001, were: CLASS A CLASS B CLASS C (%) (%) (%) - -------------------------------------------------------------------------------- Arizona Fund 7.74 7.13 7.06 Colorado Fund 7.43 - 6.74 Connecticut Fund 7.58 - 6.88 Federal Intermediate Fund 6.82 - - High Yield Fund 8.61 8.08 8.00 New Jersey Fund 7.57 6.91 6.86 Oregon Fund 7.82 - 7.08 Pennsylvania Fund 7.61 7.00 6.93 Puerto Rico Fund 6.87 - 6.19 As of February 28, 2001, the combined federal and state income tax rates upon which the taxable-equivalent yield quotations were based were as follows: COMBINED RATE (%) - -------------------------------------------------------------------------------- Arizona Fund 42.64 Colorado Fund 42.40 Connecticut Fund 42.32 Federal Intermediate Fund 39.60 High Yield Fund 39.60 New Jersey Fund 43.45 Oregon Fund 45.04 Pennsylvania Fund 41.29 Puerto Rico Fund 39.60 From time to time, as any changes to the rates become effective, taxable-equivalent yield quotations advertised by the Funds will be updated to reflect these changes. The Funds expect updates may be necessary as tax rates are changed by federal and state governments. The advantage of tax-free investments, like the Funds, will be enhanced by any tax rate increases. Therefore, the details of specific tax increases may be used in sales material for the Funds. CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are calculated according to a formula prescribed by the SEC, are not indicative of the amounts that were or will be paid to shareholders. Amounts paid to shareholders are reflected in the quoted current distribution rate or taxable-equivalent distribution rate. The current distribution rate is usually computed by annualizing the dividends paid per share by a class during a certain period and dividing that amount by the current maximum offering price. The current distribution rate differs from the current yield computation because it may include distributions to shareholders from sources other than interest, if any, and is calculated over a different period of time. The current distribution rates for the 30-day period ended February 28, 2001, were: CLASS A CLASS B CLASS C (%) (%) (%) - -------------------------------------------------------------------------------- Arizona Fund 5.02 4.64 4.59 Colorado Fund 4.87 - 4.45 Connecticut Fund 4.93 - 4.51 Federal Intermediate 4.61 - - Fund High Yield Fund 5.31 4.93 4.88 New Jersey Fund 4.80 4.41 4.37 Oregon Fund 4.83 - 4.38 Pennsylvania Fund 5.00 4.64 4.58 Puerto Rico Fund 4.83 - 4.42 A taxable-equivalent distribution rate shows the taxable distribution rate equivalent to the current distribution rate. The advertised taxable-equivalent distribution rate will reflect the most current federal and state tax rates available to the Fund. The taxable-equivalent distribution rates for the 30-day period ended February 28, 2001, were: CLASS A CLASS B CLASS C (%) (%) (%) - -------------------------------------------------------------------------------- Arizona Fund 8.75 8.09 8.00 Colorado Fund 8.45 - 7.73 Connecticut Fund 8.55 - 7.82 Federal Intermediate Fund 7.63 - - High Yield Fund 8.79 8.16 8.08 New Jersey Fund 8.49 7.80 7.73 Oregon Fund 8.79 - 7.97 Pennsylvania Fund 8.52 7.90 7.80 Puerto Rico Fund 8.00 - 7.32 VOLATILITY Occasionally statistics may be used to show a Fund's volatility or risk. Measures of volatility or risk are generally used to compare a Fund's net asset value or performance to a market index. One measure of volatility is beta. Beta is the volatility of a fund relative to the total market, as represented by an index considered representative of the types of securities in which the fund invests. A beta of more than 1.00 indicates volatility greater than the market and a beta of less than 1.00 indicates volatility less than the market. Another measure of volatility or risk is standard deviation. Standard deviation is used to measure variability of net asset value or total return around an average over a specified period of time. The idea is that greater volatility means greater risk undertaken in achieving performance. OTHER PERFORMANCE QUOTATIONS Each Fund also may quote the performance of shares without a sales charge. Sales literature and advertising may quote a cumulative total return, average annual total return and other measures of performance with the substitution of net asset value for the public offering price. Each Fund may include in its advertising or sales material information relating to investment goals and performance results of funds belonging to Franklin Templeton Investments. Resources is the parent company of the advisors and underwriter of Franklin Templeton funds. COMPARISONS To help you better evaluate how an investment in a Fund may satisfy your investment goal, advertisements and other materials about the Fund may discuss certain measures of Fund performance as reported by various financial publications. Materials also may compare performance (as calculated above) to performance as reported by other investments, indices, and averages. These comparisons may include, but are not limited to, the following examples: o Salomon Smith Barney Broad Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate and mortgage bonds. o Lehman Brothers Aggregate Bond Index or its component indices - measures yield, price and total return for Treasury, agency, corporate, mortgage and Yankee bonds. o Lehman Brothers Municipal Bond Index or its component indices - measures yield, price and total return for the municipal bond market. o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of 20 general obligation bonds maturing in 20 years. o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds. The index attempts to track the new-issue market as closely as possible, so it changes bonds twice a month, adding all new bonds that meet certain requirements and deleting an equivalent number according to their secondary market trading activity. As a result, the average par call date, average maturity date, and average coupon rate can and have changed over time. The average maturity generally has been about 29-30 years. o Financial publications: The WALL STREET JOURNAL, and BUSINESS WEEK, FINANCIAL WORLD, FORBES, FORTUNE, and MONEY magazines - provide performance statistics over specified time periods. o Salomon Smith Barney Composite High Yield Index or its component indices - measures yield, price and total return for the Long-Term High-Yield Index, Intermediate-Term High-Yield Index and Long-Term Utility High-Yield Index. o Historical data supplied by the research departments of CS First Boston Corporation, J.P. Morgan(R)Chase Co., Salomon Smith Barney Inc., Merrill Lynch, and Lehman Brothers(R). o Morningstar - information published by Morningstar, Inc., including Morningstar proprietary mutual fund ratings. The ratings reflect Morningstar's assessment of the historical risk-adjusted performance of a fund over specified time periods relative to other funds within its category. o Lipper, Inc. - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund Performance Analysis - measure total return and average current yield for the mutual fund industry and rank individual mutual fund performance over specified time periods, assuming reinvestment of all distributions, exclusive of any applicable sales charges. From time to time, advertisements or information for each Fund may include a discussion of certain attributes or benefits to be derived from an investment in the Fund. The advertisements or information may include symbols, headlines, or other material that highlights or summarizes the information discussed in more detail in the communication. Advertisements or sales material issued by each Fund also may discuss or be based upon information in a recent issue of the Special Report on Tax Freedom Day published by the Tax Foundation, a Washington, D.C. based nonprofit research and public education organization. The report illustrates, among other things, the annual amount of time the average taxpayer works to satisfy his or her tax obligations to the federal, state and local taxing authorities. Advertisements or information also may compare each Fund's performance to the return on certificates of deposit (CDs) or other investments. You should be aware, however, that an investment in the Fund involves the risk of fluctuation of principal value, a risk generally not present in an investment in a CD issued by a bank. CDs are frequently insured by an agency of the U.S. government. An investment in a Fund is not insured by any federal, state or private entity. In assessing comparisons of performance, you should keep in mind that the composition of the investments in the reported indices and averages is not identical to any Fund's portfolio, the indices and averages are generally unmanaged, and the items included in the calculations of the averages may not be identical to the formula used by a Fund to calculate its figures. In addition, there can be no assurance that a Fund will continue its performance as compared to these other averages. MISCELLANEOUS INFORMATION - -------------------------------------------------------------------------------- The Funds may help you achieve various investment goals such as accumulating money for retirement, saving for a down payment on a home, college costs and other long-term goals. The Franklin College Costs Planner may help you in determining how much money must be invested on a monthly basis to have a projected amount available in the future to fund a child's college education. (Projected college cost estimates are based upon current costs published by the College Board.) The Franklin Retirement Planning Guide leads you through the steps to start a retirement savings program. Of course, an investment in the Funds cannot guarantee that these goals will be met. The Funds are members of Franklin Templeton Investments, one of the largest mutual fund organizations in the U.S., and may be considered in a program for diversification of assets. Founded in 1947, Franklin is one of the oldest mutual fund organizations and now services approximately 3 million shareholder accounts. In 1992, Franklin, a leader in managing fixed-income mutual funds and an innovator in creating domestic equity funds, joined forces with Templeton, a pioneer in international investing. The Mutual Series team, known for its value-driven approach to domestic equity investing, became part of the organization four years later. In 2001, the Fiduciary Trust team, known for providing global investment management to institutions and high net worth clients worldwide, joined the organization. Together, Franklin Templeton Investments has over $271 billion in assets under management for more than 5 million U.S. based mutual fund shareholder and other accounts. Franklin Templeton Investments offers 107 U.S. based open-end investment companies to the public. Each Fund may identify itself by its Nasdaq symbol or CUSIP number. Franklin is a leader in the tax-free mutual fund industry and manages more than $45 billion in municipal security assets for over three quarters of a million investors. Under current tax laws, municipal securities remain one of the few investments offering the potential for tax-free income. In 2001, taxes could cost $46 on every $100 earned from a fully taxable investment based on the combination of the new 39.1% federal tax rate and the highest state tax rate of 7.2% (after the federal tax deduction). Franklin tax-free funds, however, offer tax relief through a professionally managed portfolio of tax-free securities selected based on their yield, quality and maturity. An investment in a Franklin tax-free fund can provide you with the potential to earn income free of federal taxes and, depending on the fund, state and local taxes as well, while supporting state and local public projects. Franklin tax-free funds also may provide tax-free compounding, when dividends are reinvested. An investment in Franklin's tax-free funds can grow more rapidly than similar taxable investments. Municipal securities are generally considered to be creditworthy, second in quality only to securities issued or guaranteed by the U.S. government and its agencies. The market price of municipal securities, however, may fluctuate. This fluctuation will have a direct impact on the net asset value of the Fund's shares. Currently, there are more mutual funds than there are stocks listed on the New York Stock Exchange. While many of them have similar investment goals, no two are exactly alike. Shares of the Funds are generally sold through securities dealers, whose investment representatives are experienced professionals who can offer advice on the type of investments suitable to your unique goals and needs, as well as the risks associated with such investments. DESCRIPTION OF RATINGS - -------------------------------------------------------------------------------- MUNICIPAL BOND RATINGS MOODY'S INVESTORS SERVICE, INC. (MOODY'S) INVESTMENT GRADE Aaa: Municipal bonds rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt-edged." Interest payments are protected by a large or exceptionally stable margin, and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa: Municipal bonds rated Aa are judged to be high quality by all standards. Together with the Aaa group, they comprise what are generally known as high-grade bonds. They are rated lower than the best bonds because margins of protection may not be as large, fluctuation of protective elements may be of greater amplitude, or there may be other elements present that make the long-term risks appear somewhat larger. A: Municipal bonds rated A possess many favorable investment attributes and are considered upper medium-grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present that suggest a susceptibility to impairment sometime in the future. Baa: Municipal bonds rated Baa are considered medium-grade obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. These bonds lack outstanding investment characteristics and, in fact, have speculative characteristics as well. BELOW INVESTMENT GRADE Ba: Municipal bonds rated Ba are judged to have predominantly speculative elements and their future cannot be considered well assured. Often the protection of interest and principal payments may be very moderate and, thereby, not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Municipal bonds rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Municipal bonds rated Caa are of poor standing. These issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Municipal bonds rated Ca represent obligations that are speculative to a high degree. These issues are often in default or have other marked shortcomings. C: Municipal bonds rated C are the lowest-rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Con.(-): Municipal bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals that begin when facilities are completed, or (d) payments to which some other limiting condition attaches. Parenthetical rating denotes probable credit stature upon the completion of construction or the elimination of the basis of the condition. Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic rating classification from Aa through Caa in its municipal bond ratings. The modifier 1 indicates that the security ranks in the higher end of its generic rating category; modifier 2 indicates a mid-range ranking; and modifier 3 indicates that the issue ranks in the lower end of its generic rating category. STANDARD & POOR'S RATINGS GROUP (S&P/(R)) INVESTMENT GRADE AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess the ultimate degree of protection as to principal and interest. In the market, they move with interest rates and, hence, provide the maximum safety on all counts. AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the majority of instances differ from AAA issues only in a small degree. Here, too, prices move with the long-term money market. A: Municipal bonds rated A are regarded as upper medium-grade. They have considerable investment strength but are not entirely free from adverse effects of changes in economic and trade conditions. Interest and principal are regarded as safe. They predominantly reflect money rates in their market behavior but also, to some extent, economic conditions. BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. BELOW INVESTMENT GRADE BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on balance, as predominantly speculative with respect to the issuer's capacity to pay interest and repay principal in accordance with the terms of the obligations. BB indicates the lowest degree of speculation and CC the highest degree of speculation. While these bonds will likely have some quality and protective characteristics, they are outweighed by large uncertainties or major risk exposures to adverse conditions. C: This rating is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in default and payment of interest and/or repayment of principal is in arrears. Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. FITCH INVESTORS SERVICE, INC. (FITCH) INVESTMENT GRADE AAA: Municipal bonds rated AAA are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal that is unlikely to be affected by reasonably foreseeable events. AA: Municipal bonds rated AA are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong although not quite as strong as bonds rated AAA and not significantly vulnerable to foreseeable future developments. A: Municipal bonds rated A are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB: Municipal bonds rated BBB are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BELOW INVESTMENT GRADE BB: Municipal bonds rated BB are considered speculative. The obligor's ability to pay interest and repay principal may be affected over time by adverse economic changes. Business and financial alternatives can be identified, however, that could assist the obligor in satisfying its debt service requirements. B: Municipal bonds rated B are considered highly speculative. While bonds in this class are currently meeting debt service requirements, the probability of continued timely payment of principal and interest reflects the obligor's limited margin of safety and the need for reasonable business and economic activity throughout the life of the issue. CCC: Municipal bonds rated CCC have certain identifiable characteristics which, if not remedied, may lead to default. The ability to meet obligations requires an advantageous business and economic environment. CC: Municipal bonds rated CC are minimally protected. Default in payment of interest and/or principal seems probable over time. C: Municipal bonds rated C are in imminent default in the payment of interest or principal. DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest and/or principal payments. Such bonds are extremely speculative and should be valued on the basis of their ultimate recovery value in liquidation or reorganization of the obligor. DDD represents the highest potential for recovery while D represents the lowest potential for recovery. Plus (+) or minus (-) signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus or minus signs are not used with the AAA, DDD, DD or D categories. MUNICIPAL NOTE RATINGS MOODY'S Moody's ratings for state, municipal and other short-term obligations will be designated Moody's Investment Grade (MIG). This distinction is in recognition of the differences between short-term credit risk and long-term risk. Factors affecting the liquidity of the borrower are uppermost in importance in short-term borrowing; factors of the first importance in long-term borrowing risk are of lesser importance in the short run. Symbols used will be as follows: MIG 1: Notes are of the best quality enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. MIG 2: Notes are of high quality, with margins of protection ample, although not so large as in the preceding group. MIG 3: Notes are of favorable quality, with all security elements accounted for, but lacking the undeniable strength of the preceding grades. Market access for refinancing, in particular, is likely to be less well established. MIG 4: Notes are of adequate quality, carrying specific risk but having protection and not distinctly or predominantly speculative. S&P Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After June 29, 1984, for new municipal note issues due in three years or less, the ratings below will usually be assigned. Notes maturing beyond three years will most likely receive a bond rating of the type recited above. SP-1: Issues carrying this designation have a very strong or strong capacity to pay principal and interest. Issues determined to possess overwhelming safety characteristics will be given a "plus" (+) designation. SP-2: Issues carrying this designation have a satisfactory capacity to pay principal and interest. SHORT-TERM DEBT & COMMERCIAL PAPER RATINGS MOODY'S Moody's short-term debt ratings are opinions of the ability of issuers to repay punctually senior debt obligations. These obligations have an original maturity not exceeding one year, unless explicitly noted. Moody's commercial paper ratings, which are also applicable to municipal paper investments, are opinions of the ability of issuers to repay punctually their promissory obligations not having an original maturity in excess of nine months. Moody's employs the following designations for both short-term debt and commercial paper, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: P-1 (Prime-1): Superior capacity for repayment. P-2 (Prime-2): Strong capacity for repayment. S&P S&P's ratings are a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues within the "A" category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety, as follows: A-1: This designation indicates the degree of safety regarding timely payment is very strong. A "plus" (+) designation indicates an even stronger likelihood of timely payment. A-2: Capacity for timely payment on issues with this designation is strong. The relative degree of safety, however, is not as overwhelming as for issues designated A-1. A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. FITCH Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of generally up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. The short-term rating places greater emphasis than a long-term rating on the existence of liquidity necessary to meet the issuer's obligations in a timely manner. F-1+: Exceptionally strong credit quality. Regarded as having the strongest degree of assurance for timely payment. F-1: Very strong credit quality. Reflects an assurance of timely payment only slightly less in degree than issues rated F-1+. F-2: Good credit quality. A satisfactory degree of assurance for timely payment, but the margin of safety is not as great as for issues assigned F-1+ and F-1 ratings. F-3: Fair credit quality. Have characteristics suggesting that the degree of assurance for timely payment is adequate; however, near-term adverse changes could cause these securities to be rated below investment grade. F-5: Weak credit quality. Have characteristics suggesting a minimal degree of assurance for timely payment and are vulnerable to near-term adverse changes in financial and economic conditions. D: Default. Actual or imminent payment default. LOC: The symbol LOC indicates that the rating is based on a letter of credit issued by a commercial bank. STATE TAX TREATMENT The following information on the state income tax treatment of dividends from the funds is based upon correspondence and sources believed to be reliable. Except where otherwise noted, the information pertains to individual state income taxation only. You may be subject to local taxes on dividends or the value of your shares. Corporations, trusts, estates and other entities may be subject to other taxes and should consult with their tax advisors or their state department of revenue. For some investors, a portion of the dividend income may be subject to the federal and/or state alternative minimum tax. ARIZONA As a result of Section 43-1021(4) of the Arizona Income Tax Code, interest on obligations of the state of Arizona or its political subdivisions is exempt from the Arizona individual income tax. Section 43-1022(6) provides similar tax-exempt treatment for interest on obligations of the U.S. Pursuant to Arizona Individual Income Tax Ruling 84-10-5, Arizona does not tax dividend income from regulated investment companies, such as the Arizona Fund, to the extent that such income is derived from such exempt obligations. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.), or obligations from other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund, such as for temporary or defensive purposes, the distributions will be taxable. Any distributions of net short-term and net long-term capital gain earned by the fund are included in each shareholder's Arizona taxable income and are taxed at ordinary income tax rates. COLORADO Sections 39-22-104 and 39-22-304 of the Colorado Revised Statutes state that interest on obligations of the state of Colorado or its political subdivisions and direct obligations of the U.S. or its possessions is exempt from personal and corporate income tax. The Colorado Department of Revenue has advised in published guidance that distributions from a regulated investment company, such as the Colorado Fund, also will be exempt from personal and corporate income tax if the fund invests in such exempt obligations. The Colorado Department of Revenue has confirmed in guidance dated September 1993 that this exclusion also applies to territorial obligations of the U.S. (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands). Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of other states and their political subdivisions do not qualify for this exemption. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. Any distributions of capital gains earned by the fund are included in each shareholder's Colorado taxable income as dividend income and capital gain, respectively, and are taxed at ordinary income tax rates. CONNECTICUT Section 12-701(a)(20) of the Connecticut General Statutes states that interest income from obligations issued by or on behalf of the state of Connecticut, its political subdivisions, public instrumentalities, state or local authorities, districts, or similar public entities created under the laws of the state of Connecticut and exempt obligations of the U.S. or its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands) is exempt from state personal income tax. Dividends paid by a regulated investment company, such as the Connecticut Fund, that are derived from such exempt obligations will be exempt from state personal income tax, subject to the limitation below for exempt federal obligations. Corporate shareholders generally are subject to Connecticut corporation income taxes on distributions from the fund. Sections 12-701(a)(20) and 12-718 of the Connecticut General Statutes also states that a fund is qualified to pay exempt dividends derived from exempt U.S. government obligations to its shareholders if, at the close of each quarter of its taxable year, at least 50% of the value of its total assets consists of exempt U.S. government obligations. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of other states and their political subdivisions do not qualify for this exemption. Any distribution of capital gains earned by the fund that are attributable to Connecticut obligations are exempt from Connecticut's individual income tax. All other distributions of capital gains earned by the fund are included in each shareholder's Connecticut taxable income as dividend income and capital gain, respectively, and are taxed at ordinary income rates. NEW JERSEY Section 54A:6-14.1 of the New Jersey Statutes provides that distributions paid by qualified investment funds, such as the New Jersey Fund, are not included in gross income for purposes of the New Jersey gross income tax to the extent the distributions are attributable to interest or gain from obligations issued by or on behalf of the state of New Jersey or its political subdivisions, or obligations free from state or local taxation by any act of the state of New Jersey or laws of the U.S. (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands). In order to qualify as a qualified investment fund, the New Jersey Fund must, among other things, have not less than 80% of its investments (excluding cash, cash items, receivables and certain other financial instruments) invested in the tax exempt obligations described above. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. As a matter of policy, the fund will continue to qualify as a qualified investment fund to try to ensure that the fund continues to qualify to pay distributions that are exempt from the New Jersey gross income tax. Any distributions of net short-term and net long-term capital gain earned by the fund from taxable obligations are included in each shareholder's New Jersey taxable income as dividend income and long-term capital gain, respectively, and are taxed at ordinary income tax rates. OREGON Sections 316.683 and 316-680 of the Oregon Revised Statutes and Oregon Administrative Rule Section 150-316.680-(B) provide that "state exempt-interest dividends" that are paid by a regulated investment company, such as the Oregon Fund, and designated by it as such in a written notice mailed to its shareholders not later than 60 days after the close of its taxable year will be excluded from the shareholders' income for purposes of Oregon's personal income tax. "State exempt-interest dividends" include distributions of interest attributable both to obligations of the state of Oregon and its political subdivisions and to obligations of the U.S., its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands) and possessions of any U.S. authority, commission or instrumentality. Corporate shareholders generally are subject to the Oregon corporation excise and income tax on distributions from the fund. Dividends paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. Any distributions of capital gain earned by the fund are included in each shareholder's Oregon taxable income as dividend income and capital gain, respectively, and are taxed at ordinary income tax rates. However, a shareholder may defer gain on the sale or other disposition of a capital asset by reinvesting in a qualified investment fund within six months. PENNSYLVANIA Sections 301 and 303 of the Tax Reform Code of Pennsylvania states that interest income derived from obligations that are statutorily free from state or local taxation under the laws of the Commonwealth of Pennsylvania or under the laws of the U.S. is exempt from state personal income tax. Such exempt obligations include obligations issued by the Commonwealth of Pennsylvania, any public authority, commission, board or other state agency, any political subdivision of the state or its public authority, and exempt obligations of the U.S. or its territories (including qualifying obligations of Puerto Rico, Guam and the Virgin Islands). Sections 301 and 303 of the Tax Reform Code of Pennsylvania further provide that interest derived by an investment company, such as the Pennsylvania Fund, from such exempt obligations is not subject to state, personal or corporate net income tax. Distributions paid from interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of other states and their political subdivisions are fully taxable. To the extent that such taxable investments are made by the fund for temporary or defensive purposes, the distributions will be taxable. Distributions paid by the fund also are generally exempt from the Philadelphia School District Investment Income Tax to the same extent as the Pennsylvania personal income tax. Any distributions of net short-term and long-term capital gain earned by the fund are included in each shareholder's Pennsylvania taxable income and are taxed at ordinary income tax rates. Shareholders of the fund who are subject to the Pennsylvania personal property tax in their county of residence will be exempt from county personal property tax to the extent that the portfolio of the fund consists of exempt obligations described above on the annual assessment date of January 1. Information regarding the portion of the value of the shares, if any, which is subject to the Pennsylvania personal property tax will be provided to shareholders of the fund. PUERTO RICO For U.S. citizens and residents, exempt-interest dividends received from the Puerto Rico Fund generally are exempt from U.S. federal and state personal income taxation in all states that impose an income tax, pursuant to section 103 of the Internal Revenue Code and 31 U.S.C. section 3124. For Puerto Rico taxpayers, exempt-interest dividends, to the extent derived from Puerto Rico, Guam and Virgin Island obligations, generally will be exempt from Puerto Rico taxation pursuant to a ruling received by the fund dated May 24, 1996. FRANKLIN TAX-FREE TRUST FILE NOS. 02-94222 & 811-4149 FORM N-1A PART C OTHER INFORMATION ITEM 23. EXHIBITS. The following exhibits are incorporated by reference to the previously filed document indicated below, except as noted: (a) Articles of Incorporation (i) Restated Agreement and Declaration of Trust dated October 26, 1984 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Certificate of Amendment of Agreement and Declaration of Trust dated July 16, 1991 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (iii) Certificate of Amendment of Agreement and Declaration of Trust dated April 21, 1992 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (iv) Certificate of Amendment of Agreement and Declaration of Trust dated December 14, 1993 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (v) Certificate of Amendment of Agreement and Declaration of Trust dated March 21, 1995 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (b) By-laws (i) By-Laws Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Certificate of Amendment of By-Laws dated December 8, 1987 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (iii)Amendment to By-Laws dated April 21, 1992 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (iv) Certificate of Amendment of By-Laws dated December 14, 1993 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (v) Amendment to By-Laws dated January 18, 1994 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (c) Instruments Defining Rights of Security Holders Not Applicable (d) Investment Advisory Contracts (i) Management Agreement between Registrant and Franklin Advisers, Inc. dated December 1, 1986 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Amendment to Management Agreement between Registrant and Franklin Advisers, Inc. dated August 1, 1995 Filing: Post-Effective Amendment No. 22 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: March 14, 1996 (iii) Management Agreement between Registrant and Franklin Advisers on behalf of Franklin Connecticut Tax-Free Income Fund dated October 1, 1998 Filing: Post-Effective Amendment No. 28 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: January 28, 2000 (e) Underwriting Contracts (i) Amended and Restated Distribution Agreement between Registrant and Franklin/Templeton Distributors, Inc. dated October 31, 2000 (ii) Form of Dealer Agreements effective as of March 1, 1998 between Franklin/Templeton Distributors, Inc. and Securities Dealers Filing: Post-Effective Amendment No. 26 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: December 23, 1998 (f) Bonus or Profit Sharing Contracts Not Applicable (g) Custodian Agreements (i) Master Custody Agreement between Registrant and Bank of New York dated February 16, 1996 Filing: Post-Effective Amendment No. 22 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: March 14, 1996 (ii) Terminal Link Agreement between Registrant and Bank of New York dated February 16, 1996 Filing: Post-Effective Amendment No. 22 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: March 14, 1996 (iii)Amendment dated May 7, 1997 to Master Custody Agreement between Registrant and Bank of New York dated February 16, 1996 Filing: Post-Effective Amendment No. 25 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 29, 1998 (iv) Amendment dated February 27, 1998 to Master Custody Agreement between Registrant and Bank of New York dated February 16, 1996 Filing: Post-Effective Amendment No. 26 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: December 23, 1998 (v) Amendment dated March 28, 2001 to Exhibit A of the Master Custody Agreement between Registrant and the Bank of New York dated February 16, 1996 (vi) Foreign Custody Manager Agreement made as of July 30, 1998, effective as of February 27, 1998 on behalf of each Investment Company listed on Schedule 1 Filing: Post-Effective Amendment No. 26 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: December 23, 1998 (vii)Amendment dated March 28, 2001, to Schedule 1 of the Foreign Custody Agreement between Registrant and Bank of New York dated July 30, 1998 (viii)Amendment dated November 24, 2000 to Schedule 2 of the Foreign Custody Agreement between Registrant and Bank of New York date July 30, 1998 (h) Other Material Contracts (i) Agreement between Registrant and Financial Guaranty Insurance Company dated March 8, 1985 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Amendment to Agreement between Registrant and Financial Guaranty Insurance Company dated November 24, 1992 Registrant: Franklin New York Tax-Free Trust Filing: Post-Effective Amendment No. 12 to Registration Statement on Form N-1A File No. 33-7785 Filing Date: April 25, 1995 (iii) Mutual Fund Agreement between Registrant and Financial Guaranty Insurance Company dated April 30, 1993 Filing: Post-Effective Amendment No. 25 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 29, 1998 (iv) Subcontract for Fund Administrative Services between Franklin Advisers, Inc. and Franklin Templeton Services, LLC dated January 1, 2001 (i) Legal Opinion (i) Opinion and Consent of Counsel dated April 17, 1998 Filing: Post-Effective Amendment No. 25 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 29, 1998 (j) Other Opinions (i) Consent of Independent Auditors (k) Omitted Financial Statements Not Applicable (l) Initial Capital Agreements (i) Letter of Understanding dated September 21, 1992 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Letter of Understanding dated April 12, 1995 Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (m) Rule 12b-1 Plan (i) Class A shares Distribution Plans pursuant to Rule 12b-1 on behalf of the following funds: Dated July 1, 1993: Franklin Federal Intermediate-Term Tax-Free Income Fund Franklin Florida Insured Tax-Free Income Fund Dated May 1, 1994: Franklin Alabama Tax-Free Income Fund Franklin Arizona Tax-Free Income Fund Franklin Colorado Tax-Free Income Fund Franklin Connecticut Tax-Free Income Fund Franklin Florida Tax-Free Income Fund Franklin Georgia Tax-Free Income Fund Franklin High Yield Tax-Free Income Fund Franklin Insured Tax-Free Income Fund Franklin Kentucky Tax-Free Income Fund Franklin Louisiana Tax-Free Income Fund Franklin Maryland Tax-Free Income Fund Franklin Massachusetts Insured Tax-Free Income Fund Franklin Michigan Insured Tax-Free Income Fund Franklin Minnesota Insured Tax-Free Income Fund Franklin Missouri Tax-Free Income Fund Franklin New Jersey Tax-Free Income Fund Franklin North Carolina Tax-Free Income Fund Franklin Ohio Insured Tax-Free Income Fund Franklin Oregon Tax-Free Income Fund Franklin Pennsylvania Tax-Free Income Fund Franklin Puerto Rico Tax-Free Income Fund Franklin Texas Tax-Free Income Fund Franklin Virginia Tax-Free Income Fund Filing: Post-Effective Amendment No. 21 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 28, 1995 (ii) Class C shares Distribution Plan pursuant to Rule 12b-1 on behalf of the following funds: Dated October 10, 2000: Franklin Alabama Tax-Free Income Fund Franklin Arizona Tax-Free Income Fund Franklin Colorado Tax-Free Income Fund Franklin Connecticut Tax-Free Income Fund Franklin Florida Tax-Free Income Fund Franklin Georgia Tax-Free Income Fund Franklin High Yield Tax-Free Income Fund Franklin Insured Tax-Free Income Fund Franklin Louisiana Tax-Free Income Fund Franklin Maryland Tax-Free Income Fund Franklin Massachusetts Insured Tax-Free Income Fund Franklin Michigan Insured Tax-Free Income Fund Franklin Minnesota Insured Tax-Free Income Fund Franklin Missouri Tax-Free Income Fund Franklin New Jersey Tax-Free Income Fund Franklin North Carolina Tax-Free Income Fund Franklin Ohio Insured Tax-Free Income Fund Franklin Oregon Tax-Free Income Fund Franklin Pennsylvania Tax-Free Income Fund Franklin Puerto Rico Tax-Free Income Fund Franklin Texas Tax-Free Income Fund Franklin Virginia Tax-Free Income Fund (iii) Distribution Plan dated October 16, 1998 pursuant to Rule 12b-1 between the Registrant on behalf of Franklin High Yield Tax-Free Income Fund - Class B and Franklin/Templeton Distributors, Inc. Filing: Post-Effective Amendment No. 26 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: December 23, 1998 (iv) Class B Distribution Plan pursuant to Rule 12b-1 on behalf of the following funds: Franklin Arizona Tax-Free Income Fund - Class B Franklin Florida Tax-Free Income Fund - Class B Franklin Insured Tax-Free Income Fund - Class B Franklin Michigan Insured Tax-Free Income Fund - Class B Franklin New Jersey Tax-Free Income Fund - Class B Franklin Ohio Insured Tax-Free Income Fund - Class B Franklin Pennsylvania Tax-Free Income Fund - Class B Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (o) Rule 18f-3 Plan (i) Multiple Class Plan dated October 19, 1995 Filing: Post-Effective Amendment No. 25 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 29, 1998 (ii) Multiple Class Plan dated March 19, 1998 on behalf of Franklin High Yield Tax-Free Income Fund Filing: Post-Effective Amendment No. 27 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: April 29, 1999 (iii) Multiple Class Plan on behalf of Franklin Arizona Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (iv) Multiple Class Plan on behalf of Franklin Florida Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (v) Multiple Class Plan on behalf of Franklin Insured Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (vi) Multiple Class Plan on behalf of Franklin Michigan Insured Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (vii) Multiple Class Plan on behalf of Franklin New Jersey Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (viii) Multiple Class Plan on behalf of Franklin Ohio Insured Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (ix) Multiple Class Plan on behalf of Franklin Pennsylvania Tax-Free Income Fund Filing: Post-Effective Amendment No. 29 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: June 28, 2000 (p) Power of Attorney (i) Power of Attorney dated January 20, 2000 Filing: Post-Effective Amendment No. 28 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: January 28, 2000 (ii) Certificate of Secretary dated January 27, 2000 Filing: Post-Effective Amendment No. 28 to Registration Statement on Form N-1A File No. 2-94222 Filing Date: January 28, 2000 (q) Code of Ethics (i) Code of Ethics dated June 1, 2001 ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH THE FUND None ITEM 25. INDEMNIFICATION Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to trustees, 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 trustee, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such trustee, officer or controlling person in connection with 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 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 THE INVESTMENT ADVISER The officers and directors of Franklin Advisers, Inc. (advisers), Registrant's manager, also serve as officers and/or directors for (1) Advisers' corporate parent, Franklin Resources, Inc., and/or (2) other investment companies in Franklin Templeton Investments. For additional information please see Part B and Schedules A and D of Form ADV of Advisers (SEC File 801-26292), incorporated herein by reference, which set forth the officers and directors of Advisers and information as to any business, profession, vocation or employment of a substantial nature engages in by those officers and directors during the past two years. ITEM 27. PRINCIPAL UNDERWRITERS a) Franklin/Templeton Distributors, Inc., (Distributors) also acts as principal underwriter of shares of: Franklin California Tax-Free Income Fund, Inc. Franklin California Tax-Free Trust Franklin Custodian Funds, Inc. Franklin Federal Money Fund Franklin Federal Tax-Free Income Fund Franklin Floating Rate Master Trust Franklin Floating Rate Trust Franklin Global Trust Franklin Gold and Precious Metals Fund Franklin Growth and Income Fund Franklin High Income Trust Franklin Investors Securities Trust Franklin Managed Trust Franklin Money Fund Franklin Municipal Securities Trust Franklin Mutual Series Fund Inc. Franklin New York Tax-Free Income Fund Franklin New York Tax-Free Trust Franklin Real Estate Securities Trust Franklin Strategic Mortgage Portfolio Franklin Strategic Series Franklin Tax-Exempt Money Fund Franklin Templeton Fund Allocator Series Franklin Templeton Global Trust Franklin Templeton International Trust Franklin Templeton Money Fund Trust Franklin Value Investors Trust Franklin Templeton Variable Insurance Products Trust Institutional Fiduciary Trust Templeton Capital Accumulator Fund, Inc. Templeton Developing Markets Trust Templeton Funds, Inc. Templeton Global Investment Trust Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund, Inc. Templeton Growth Fund, Inc. Templeton Income Trust Templeton Institutional Funds, Inc. ITEM 28. LOCATION OF ACCOUNTS AND RECORDS The accounts, books or other documents required to be maintained by Section 31 (a) of the Investment Company Act of 1940 are kept by the Registrant or its shareholder services agent, Franklin Templeton Investors Services, LLC both of whose address is One Franklin Parkway, San Mateo, CA. 94403-1906. ITEM 29. MANAGEMENT SERVICES There are no management-related service contracts not discussed in Part A or Part B. ITEM 30. UNDERTAKINGS Not Applicable SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant certifies that it meets all of the requirements for effectiveness of this Registration Statement pursuant to Rule 485(b) under the Securities Act of 1933 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of San Mateo and the State of California, on the 26th day of June, 2001. FRANKLIN TAX-FREE TRUST By: RUPERT H. JOHNSON, JR.* ----------------------- Rupert H. Johnson, Jr. President Pursuant to the requirements of the Securities Act of 1933, this Registration Amendment has been signed below by the following persons in the capacities and on the dates indicated: RUPERT H. JOHNSON, JR.* Trustee and Principal - ----------------------- Rupert H. Johnson, Jr. Executive Officer Dated: June 26, 2001 MARTIN L. FLANAGAN* Principal Financial Officer - ------------------- Martin L. Flanagan Dated: June 26, 2001 KIMBERLEY H. MONASTERIO* Principal Accounting Officer - ------------------------ Kimberley H. Monasterio Dated: June 26, 2001 FRANK H. ABBOTT, III* Trustee - --------------------- Frank H. Abbott, III Dated: June 26, 2001 HARRIS J. ASHTON* Trustee - ----------------- Harris J. Ashton Dated: June 26, 2001 S. JOSEPH FORTUNATO* Trustee - -------------------- S. Joseph Fortunato Dated: June 26, 2001 EDITH E. HOLIDAY* Trustee - ----------------- Edith E. Holiday Dated: June 26, 2001 CHARLES B. JOHNSON* Trustee - ------------------- Charles B. Johnson Dated: June 26, 2001 FRANK W. T. LAHAYE* Trustee - ------------------- Frank W. T. LaHaye Dated: June 26, 2001 GORDON S. MACKLIN* Trustee - ------------------ Gordon S. Macklin Dated: June 26, 2001 *By /s/David P. Goss -------------------------------- David P. Goss, Attorney-in-Fact (Pursuant to Power of Attorney previously filed) FRANKLIN TAX-FREE TRUST REGISTRATION STATEMENT EXHIBITS INDEX EXHIBIT NO. DESCRIPTION LOCATION EX-99.a(i) Restated Agreement and Declaration of * Trust dated October 26, 1984 EX-99.a(ii) Certificate of Amendment of Agreement and * Declaration of Trust dated July 16, 1991 EX-99.a(iii) Certificate of Amendment of Agreement and * Declaration of Trust dated April 21, 1992 EX-99.a(iv) Certificate of Amendment of Agreement and * Declaration of Trust dated December 14, 1993 EX-99.a(v) Certificate of Amendment of Agreement and * Declaration of Trust dated March 21, 1995 EX-99.a(vi) Certificate of Secretary Amendment of * Agreement and Declaration of Trust dated August 31, 1999 EX-99.b(i) By-Laws * EX-99.b(ii) Certificate of Amendment of By-Laws dated * December 8,1987 EX-99.b(iii) Amendment to By-Laws dated April 21, 1992 * EX.99.b(iv) Certificate of Amendment of By-Laws dated * December 14, 1993 EX-99.b(v) Amendment to By-Laws dated January 18, * 1994 EX-99.d(i) Management Agreement between Registrant * and Franklin Advisers, Inc. dated December 1, 1986 EX-99.d(ii) Amendment to Management Agreement between * Registrant and Franklin Advisers, Inc. dated August 1, 1995 EX-99.d(iii) Management Agreement between Registrant * and Franklin Advisers on behalf of Franklin Connecticut Tax-Free Income Fund dated October 1, 1998 EX-99.e(i) Amended and Restated Distribution Attached Agreement between Registrant and Franklin/Templeton Distributors, Inc. dated October 31, 2000 EX-99.e(ii) Dealer Agreements Effective as of March * 1, 1998 between Franklin/Templeton Distributors, Inc. and securities dealers EX-99.g(i) Master Custody Agreement between * Registrant and Bank of New York dated February 16, 1996 EX-99.g(ii) Terminal Link Agreement between * Registrant and Bank of New York dated February 16, 1996 EX-99.g(iii) Amendment dated May 7, 1997 to Master * Custody Agreement between Registrant and Bank of New York dated February 16, 1996 EX-99.g(iv) Amendment dated February 27, 1998 to * Master Custody Agreement between Registrant and Bank of New York dated February 16, 1996 EX-99.g(v) Amendment dated March 28, 2001, to Attached Exhibit A of the Master Custody Agreement between Registrant and the Bank of New York dated February 16, 1996 EX-99.g(vi) Foreign Custody Manager Agreement * made as of July 30, 1998, effective as of February 27, 1998 on behalf of each Investment Company listed on Schedule 1 EX-99.g(vii) Amendment dated March 28, 2001 to Attached Schedule 1 of the Foreign Custody Agreement between Registrant and Bank of New York dated July 30, 1998 EX-99.g(viii) Amendment dated November 24, 2000 to Attached Schedule 2 of the Foreign Custody Agreement between Registrant and Bank of New York dated July 30, 1998 EX-99.h(i) Agreement between Registrant and * Financial Guaranty Insurance Company dated March 8, 1985 EX-99.h(ii) Amendment to Agreement between * Registrant and Financial Guaranty Insurance Company dated November 24, 1992 EX-99.h(iii) Mutual Fund Agreement between Registrant * and Financial Guaranty Insurance Company dated April 30, 1993 EX-99.h(iv) Subcontract for Fund Administrative Attached Services between Franklin Advisers, Inc. and Franklin Templeton Services, LLC EX-99.i(i) Opinion and Consent of Counsel dated * April 17, 1998 EX-99.j(i) Consent of Independent Auditors Attached EX-99.l(i) Letter of Understanding dated * September 21, 1992 EX-99.l(ii) Letter of Understanding dated April 12, * 1994 EX-99.m(i) Class A Shares Distribution Plans * pursuant to Rule 12b-1 dated July 1, 1993 and May 1, 1994 EX-99.m(ii) Class C Shares Distribution Plan pursuant Attached to Rule 12b-1 dated October 10, 2000 EX-99.m(iii) Distribution Plan dated October 16, 1998 * pursuant to Rule 12b-1 between the Registrant on behalf of Franklin High Yield Tax-Free Income Fund - Class B and Franklin/Templeton Distributors, Inc. EX-99.m(iv) Class B Distribution Plan pursuant to * Rule 12b-1 EX-99.o(i) Multiple Class Plan dated October 19, 1995 * EX-99.o(ii) Multiple Class Plan on behalf of Franklin * High Yield Tax-Free Income Fund EX-99.o(iii) Multiple Class Plan on behalf of Franklin * Arizona Tax-Free Income Fund EX-99.o(iv) Multiple Class Plan on behalf of Franklin * Florida Tax-Free Income Fund EX-99.o(v) Multiple Class Plan on behalf of * Franklin Insured Tax-Free Income Fund EX-99.o(vi) Multiple Class Plan on behalf of Franklin * Michigan Insured Tax-Free Income Fund EX-99.o(vii) Multiple Class Plan on behalf of Franklin * New Jersey Tax-Free Income Fund EX-99.o(viii) Multiple Class Plan on behalf of Franklin * Ohio Insured Tax-Free Income Fund EX-99.o(ix) Multiple Class Plan on behalf of Franklin * Pennsylvania Tax-Free Income Fund EX-99.p(i) Power of Attorney dated January 20, 2000 * EX-99.q(i) Code of Ethics Attached *Incorporated by Reference EX-99.E 2 distagree.txt E(I) DISTRIBUTION AGREEMENT FRANKLIN TAX-FREE TRUST 777 Mariners Island Blvd. San Mateo, California 94404 Franklin/Templeton Distributors, Inc. 700 Central Avenue St. Petersburg, Florida 33701-3628 Re: Amended and Restated Distribution Agreement Gentlemen: We, FRANKLIN TAX-FREE TRUST, (the "Fund") are a corporation or business trust operating as an open-end management investment company or "mutual fund", which is registered under the Investment Company Act of 1940 (the "1940 Act") and whose shares are registered under the Securities Act of 1933 (the "1933 Act"). We desire to issue one or more series or classes of our authorized but unissued shares of capital stock or beneficial interest (the "Shares") to authorized persons in accordance with applicable Federal and State securities laws. The Fund's Shares may be made available in one or more separate series, each of which may have one or more classes. You have informed us that your company is registered as a broker-dealer under the provisions of the Securities Exchange Act of 1934 and that your company is a member of the National Association of Securities Dealers, Inc. You have indicated your desire to act as the exclusive selling agent and distributor for the Shares. We have been authorized to execute and deliver this Distribution Agreement ("Agreement") to you by a resolution of our Board of Directors or Trustees ("Board") passed at a meeting at which a majority of Board members, including a majority who are not otherwise interested persons of the Fund and who are not interested persons of our investment adviser, its related organizations or with you or your related organizations, were present and voted in favor of the said resolution approving this Agreement. 1. APPOINTMENT OF UNDERWRITER. Upon the execution of this Agreement and in consideration of the agreements on your part herein expressed and upon the terms and conditions set forth herein, we hereby appoint you as the exclusive sales agent for our Shares and agree that we will deliver such Shares as you may sell. You agree to use your best efforts to promote the sale of Shares, but are not obligated to sell any specific number of Shares. However, the Fund and each series retain the right to make direct sales of its Shares without sales charges consistent with the terms of the then current prospectus and statement of additional information and applicable law, and to engage in other legally authorized transactions in its Shares which do not involve the sale of Shares to the general public. Such other transactions may include, without limitation, transactions between the Fund or any series or class and its shareholders only, transactions involving the reorganization of the Fund or any series, and transactions involving the merger or combination of the Fund or any series with another corporation or trust. 2. INDEPENDENT CONTRACTOR. You will undertake and discharge your obligations hereunder as an independent contractor and shall have no authority or power to obligate or bind us by your actions, conduct or contracts except that you are authorized to promote the sale of Shares. You may appoint sub-agents or distribute through dealers or otherwise as you may determine from time to time, but this Agreement shall not be construed as authorizing any dealer or other person to accept orders for sale or repurchase on our behalf or otherwise act as our agent for any purpose. 3. OFFERING PRICE. Shares shall be offered for sale at a price equivalent to the net asset value per share of that series and class plus any applicable percentage of the public offering price as sales commission or as otherwise set forth in our then current prospectus. On each business day on which the New York Stock Exchange is open for business, we will furnish you with the net asset value of the Shares of each available series and class which shall be determined in accordance with our then effective prospectus. All Shares will be sold in the manner set forth in our then effective prospectus and statement of additional information, and in compliance with applicable law. 4. COMPENSATION. ------------- A. SALES COMMISSION. You shall be entitled to charge a sales commission on the sale or redemption, as appropriate, of each series and class of each Fund's Shares in the amount of any initial, deferred or contingent deferred sales charge as set forth in our then effective prospectus. You may allow any sub-agents or dealers such commissions or discounts from and not exceeding the total sales commission as you shall deem advisable, so long as any such commissions or discounts are set forth in our current prospectus to the extent required by the applicable Federal and State securities laws. You may also make payments to sub-agents or dealers from your own resources, subject to the following conditions: (a) any such payments shall not create any obligation for or recourse against the Fund or any series or class, and (b) the terms and conditions of any such payments are consistent with our prospectus and applicable federal and state securities laws and are disclosed in our prospectus or statement of additional information to the extent such laws may require. B. DISTRIBUTION PLANS. You shall also be entitled to ------------------- compensation for your services as provided in any Distribution Plan adopted as to any series and class of any Fund's Shares pursuant to Rule 12b-1 under the 1940 Act. The compensation provided in the Class B Distribution Plan applicable to Class B Shares (the "Class B Plan") is divided into a distribution fee and a service fee, each of which fees is in compensation for different services to be rendered to the Fund. Subject to the termination provisions in the Class B Plan, the distribution fee with respect to the sale of a Class B Share shall be earned when such Class B Share is sold and shall be payable from time to time as provided in the Class B Plan. The distribution fee payable to you as provided in the Class B Plan shall be payable without offset, defense or counterclaim (it being understood by the parties hereto that nothing in this sentence shall be deemed a waiver by the Fund of any claim the Fund may have against you). You may direct the Fund to cause our custodian to pay such distribution fee to Lightning Finance Company Limited ("LFL") or other persons providing funds to you to cover expenses referred to in Section 2(a) of the Class B Plan and to cause our custodian to pay the service fee to you to cover expenses referred to in Section 2(b) of the Class B Plan. We understand that you intend to assign your right to receive certain distribution fees with respect to Class B Shares to LFL in exchange for funds that you will use to cover expenses referred to in Section 2(a) of the Class B Plan. In recognition that we will benefit from your arrangement with LFL, we agree that, in addition to the provisions of Section 7(iii) of the Class B Plan, we will not pay to any person or entity, other than LFL, any such assigned distribution fees related to Class B Shares sold by you prior to the termination of either the Agreement or the Class B Plan. We agree that the preceding sentence shall survive termination of the Agreement. The compensation provided in the Class C Distribution Plan applicable to Class C Shares (the "Class C Plan") is divided into a distribution fee and a service fee, each of which fees is in compensation for different services to be rendered to the Fund. Subject to the termination provisions in the Class C Plan, the distribution fee with respect to the sale of a Class C Share shall be earned when such Class C Share is sold and shall be payable from time to time as provided in the Class C Plan shall be payable without offset, defense or counterclaim (it being understood by the parties hereto that nothing in this sentence shall be deemed a waiver by the Fund of any claim the Fund may have against you). You may direct the Fund to cause our custodian to pay such distribution fee to Lightning Finance Company Limited ("LFL") or other persons providing funds to you to cover expenses referred to in Section 2(a) of the Class C Plan and to cause our custodian to pay the service fee to you to cover expenses referred to in Section 2(b) of the Class C Plan. We understand that you intend to assign your right to receive certain distribution fees with respect to Class C Shares to LFL in exchange for funds that you will use to cover expenses referred to in Section 2(a) of the Class C Plan. In recognition that we will benefit from your arrangement with LFL, we agree that, in addition to the provisions of Section 7(iii) of the Class C Plan, we will not pay to any person or entity, other than LFL, any such assigned distribution fees related to Class C Shares sold by you prior to the termination of either the Agreement or the Class C Plan. We agree that the preceding sentence shall survive termination of the Agreement. C. With respect to the sales commission on the redemption of Shares of each series and class of Fund as provided in Subsection 4.A. above, we will cause our shareholder services agent (the "Transfer Agent") to withhold from redemption proceeds payable to holders of the Shares all contingent deferred sales charges properly payable by such holders in accordance with the terms of our then current prospectuses and statements of additional information (each such sales charge, a "CDSC"). Upon receipt of an order for redemption, the Transfer Agent shall direct our custodian to transfer such redemption proceeds to a general trust account. We shall then cause the Transfer Agent to pay over to you or your assigns from the general trust account such CDSCs properly payable by such holders as promptly as possible after the settlement date for each such redemption of Shares. CDSCs shall be payable without offset, defense or counterclaim (it being understood that nothing in this sentence shall be deemed a waiver by us of any claim we may have against you.) You may direct that the CDSCs payable to you be paid to any other person. 5. TERMS AND CONDITIONS OF SALES. Shares shall be offered for sale only in those jurisdictions where they have been properly registered or are exempt from registration, and only to those groups of people which the Board may from time to time determine to be eligible to purchase such shares. 6. ORDERS AND PAYMENT FOR SHARES. Orders for Shares shall be directed to the Fund's shareholder services agent, for acceptance on behalf of the Fund. At or prior to the time of delivery of any of our Shares you will pay or cause to be paid to the custodian of the Fund's assets, for our account, an amount in cash equal to the net asset value of such Shares. Sales of Shares shall be deemed to be made when and where accepted by the Fund's shareholder services agent. The Fund's custodian and shareholder services agent shall be identified in its prospectus. 7. PURCHASES FOR YOUR OWN ACCOUNT. You shall not purchase our Shares for your own account for purposes of resale to the public, but you may purchase Shares for your own investment account upon your written assurance that the purchase is for investment purposes and that the Shares will not be resold except through redemption by us. 8. SALE OF SHARES TO AFFILIATES. You may sell our Shares at net asset value to certain of your and our affiliated persons pursuant to the applicable provisions of the federal securities statutes and rules or regulations thereunder (the "Rules and Regulations"), including Rule 22d-1 under the 1940 Act, as amended from time to time. 9. ALLOCATION OF EXPENSES. We will pay the expenses: ----------------------- (a) Of the preparation of the audited and certified financial statements of our company to be included in any Post-Effective Amendments ("Amendments") to our Registration Statement under the 1933 Act or 1940 Act, including the prospectus and statement of additional information included therein; (b) Of the preparation, including legal fees, and printing of all Amendments or supplements filed with the Securities and Exchange Commission, including the copies of the prospectuses included in the Amendments and the first 10 copies of the definitive prospectuses or supplements thereto, other than those necessitated by your (including your "Parent's") activities or Rules and Regulations related to your activities where such Amendments or supplements result in expenses which we would not otherwise have incurred; (c) Of the preparation, printing and distribution of any reports or communications which we send to our existing shareholders; and (d) Of filing and other fees to Federal and State securities regulatory authorities necessary to continue offering our Shares. You will pay the expenses: (a) Of printing the copies of the prospectuses and any supplements thereto and statements of additional information which are necessary to continue to offer our Shares; (b) Of the preparation, excluding legal fees, and printing of all Amendments and supplements to our prospectuses and statements of additional information if the Amendment or supplement arises from your (including your "Parent's") activities or Rules and Regulations related to your activities and those expenses would not otherwise have been incurred by us; (c) Of printing additional copies, for use by you as sales literature, of reports or other communications which we have prepared for distribution to our existing shareholders; and (d) Incurred by you in advertising, promoting and selling our Shares. 10. FURNISHING OF INFORMATION. We will furnish to you such information with respect to each series and class of Shares, in such form and signed by such of our officers as you may reasonably request, and we warrant that the statements therein contained, when so signed, will be true and correct. We will also furnish you with such information and will take such action as you may reasonably request in order to qualify our Shares for sale to the public under the Blue Sky Laws of jurisdictions in which you may wish to offer them. We will furnish you with annual audited financial statements of our books and accounts certified by independent public accountants, with semi-annual financial statements prepared by us, with registration statements and, from time to time, with such additional information regarding our financial condition as you may reasonably request. 11. CONDUCT OF BUSINESS. Other than our currently effective prospectus, you will not issue any sales material or statements except literature or advertising which conforms to the requirements of Federal and State securities laws and regulations and which have been filed, where necessary, with the appropriate regulatory authorities. You will furnish us with copies of all such materials prior to their use and no such material shall be published if we shall reasonably and promptly object. You shall comply with the applicable Federal and State laws and regulations where our Shares are offered for sale and conduct your affairs with us and with dealers, brokers or investors in accordance with the Conduct Rules of the National Association of Securities Dealers, Inc. 12. REDEMPTION OR REPURCHASE WITHIN SEVEN DAYS. If Shares are tendered to us for redemption or repurchase by us within seven business days after your acceptance of the original purchase order for such Shares, you will immediately refund to us the full sales commission (net of allowances to dealers or brokers) allowed to you on the original sale, and will promptly, upon receipt thereof, pay to us any refunds from dealers or brokers of the balance of sales commissions reallowed by you. We shall notify you of such tender for redemption within 10 days of the day on which notice of such tender for redemption is received by us. 13. OTHER ACTIVITIES. Your services pursuant to this Agreement shall ------------------ not be deemed to be exclusive, and you may render similar services and act as an underwriter, distributor or dealer for other investment companies in the offering of their shares. 14. TERM OF AGREEMENT. This Agreement shall become effective on the date of its execution, and shall remain in effect for a period of two (2) years. The Agreement is renewable annually thereafter, with respect to the Fund or, if the Fund has more than one series, with respect to each series, for successive periods not to exceed one year (i) by a vote of (a) a majority of the outstanding voting securities of the Fund or, if the Fund has more than one series, of each series, or (b) by a vote of the Board, AND (ii) by a vote of a majority of the members of the Board who are not parties to the Agreement or interested persons of any parties to the Agreement (other than as members of the Board), cast in person at a meeting called for the purpose of voting on the Agreement. This Agreement may at any time be terminated by the Fund or by any series without the payment of any penalty, (i) either by vote of the Board or by vote of a majority of the outstanding voting securities of the Fund or any series on 90 days' written notice to you; or (ii) by you on 90 days' written notice to the Fund; and shall immediately terminate with respect to the Fund and each series in the event of its assignment. 15. SUSPENSION OF SALES. We reserve the right at all times to suspend --------------------- or limit the public offering of Shares upon two days' written notice to you. 16. MISCELLANEOUS. This Agreement shall be subject to the laws of the State of California and shall be interpreted and construed to further promote the operation of the Fund as an open-end investment company. This Agreement shall supersede all Distribution Agreements and Amendments previously in effect between the parties. As used herein, the terms "net asset value," "offering price," "investment company," "open-end investment company," "principal underwriter," "interested person," "Parent," "affiliated person," and "majority of the outstanding voting securities" shall have the meanings set forth in the 1933 Act or the 1940 Act and the Rules and Regulations thereunder and the term "assignment" shall have the meaning as set forth in the 1940 Act and the Rules and Regulations thereunder. Nothing herein shall be deemed to protect you against any liability to us or to our securities holders to which you would otherwise be subject by reason of willful misfeasance, bad faith or gross negligence in the performance of your duties hereunder, or by reason of your reckless disregard of your obligations and duties hereunder. If the foregoing meets with your approval, please acknowledge your acceptance by signing each of the enclosed copies, whereupon this will become a binding agreement as of the date set forth below. Very truly yours, FRANKLIN TAX-FREE TRUST By: /s/David P. Goss ---------------- David P. Goss Vice President & Assistant Secretary Accepted: FRANKLIN/TEMPLETON DISTRIBUTORS, INC. By: /s/Charles E. Johnson ---------------------- Charles E. Johnson Senior Vice President Dated as of: October 31, 2000 EX-99.G 3 exhibita.txt G(V) MASTER CUSTODY AGREEMENT EXHIBIT A MASTER CUSTODY AGREEMENT EXHIBIT A
The following is a list of the Investment Companies and their respective Series for which the Custodian shall serve under the Master Custody Agreement dated as of February 16, 1996. - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Adjustable Rate Securities Portfolios Delaware Business Trust U.S. Government Adjustable Rate Mortgage Portfolio Franklin California Tax-Free Maryland Corporation Income Fund, Inc. Franklin California Tax-Free Trust Massachusetts Business Trust Franklin California Insured Tax-Free Income Fund Franklin California Tax-Exempt Money Fund Franklin California Intermediate-Term Tax-Free Income Fund Franklin Custodian Funds, Inc. Maryland Corporation Growth Series Utilities Series Dynatech Series Income Series U.S. Government Securities Series Franklin Growth and Income Fund Delaware Business Trust Franklin Federal Money Fund California Corporation Franklin Federal Tax- Free California Corporation Income Fund - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Gold & Precious Metals Fund Delaware Business Trust Franklin High Income Trust Delaware Business Trust AGE High Income Fund Franklin Investors Securities Trust Massachusetts Business Trust Franklin Global Government Income Fund Franklin Short-Intermediate U.S. Govt Securities Fund Franklin Convertible Securities Fund Franklin Adjustable U.S. Government Securities Fund Franklin Equity Income Fund Franklin Total Return Fund Franklin Managed Trust Delaware Business Trust Franklin Rising Dividends Fund Franklin Money Fund California Corporation Franklin Municipal Securities Delaware Business Trust Franklin California High Yield Municipal Fund Trust Franklin Tennessee Municipal Bond Fund Franklin Mutual Series Fund Inc. Maryland Corporation Mutual Shares Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Discovery Fund Mutual European Fund Mutual Financial Services Fund - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Franklin New York Tax-Free Delaware Business Trust Income Fund Franklin New York Tax-Free Trust Massachusetts Business Trust Franklin New York Tax-Exempt Money Fund Franklin New York Intermediate-Term Tax-Free Income Fund Franklin New York Insured Tax-Free Income Fund Franklin Real Estate Securities Trust Delaware Business Trust Franklin Real Estate Securities Fund Franklin Strategic Mortgage Portfolio Delaware Business Trust Franklin Strategic Series Delaware Business Trust Franklin California Growth Fund Franklin Strategic Income Fund Franklin Global Communications Fund Franklin Small Cap Growth Fund I Franklin Global Health Care Fund Franklin Natural Resources Fund Franklin Blue Chip Fund Franklin Biotechnology Discovery Fund Franklin U.S. Long-Short Fund Franklin Large Cap Growth Fund Franklin Aggressive Growth Fund Franklin Small Cap Growth Fund II Franklin Technology Fund Franklin Tax-Exempt Money Fund California Corporation - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Tax-Free Trust Massachusetts Business Trust Franklin Massachusetts Insured Tax-Free Income Fund Franklin Michigan Insured Tax-Free Income Fund Franklin Minnesota Insured Tax-Free Income Fund Franklin Insured Tax-Free Income Fund Franklin Ohio Insured Tax-Free Income Fund Franklin Puerto Rico Tax-Free Income Fund Franklin Arizona Tax-Free Income Fund Franklin Colorado Tax-Free Income Fund Franklin Georgia Tax-Free Income Fund Franklin Pennsylvania Tax-Free Income Fund Franklin High Yield Tax-Free Income Fund Franklin Missouri Tax-Free Income Fund Franklin Oregon Tax-Free Income Fund Franklin Texas Tax-Free Income Fund Franklin Virginia Tax-Free Income Fund Franklin Alabama Tax-Free Income Fun Franklin Florida Tax-Free Income Fund Franklin Connecticut Tax-Free Income Fund Franklin Louisiana Tax-Free Income Fund Franklin Maryland Tax-Free Income Fund Franklin North Carolina Tax-Free Income Fund Franklin New Jersey Tax-Free Income Fund Franklin Kentucky Tax-Free Income Fund Franklin Federal Intermediate-Term Tax-Free Income Fund Franklin Florida Insured Tax-Free IncomeFund - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Templeton Fund Delaware Business Trust Franklin Templeton Conservative Target Fund Allocator Series Franklin Templeton Moderate Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Global Trust Delaware Business Trust Franklin Templeton Global Currency Fund Franklin Templeton Hard Currency Fund Franklin Templeton International Trust Delaware Business Trust Templeton Pacific Growth Fund Templeton Foreign Smaller Companies Fund Franklin Templeton Money Fund Trust Delaware Business Trust Franklin Templeton Money Fund Franklin Value Investors Trust Massachusetts Business Trust Franklin Balance Sheet Investment Fund Franklin MicroCap Value Fund Franklin Value Fund Franklin Large Cap Value Fund Franklin Templeton Variable Massachusetts Business Trust Franklin Money Market Fund Insurance Products Trust Franklin Growth and Income Fund Franklin Natural Resources Securities Fund Franklin Real Estate Fund Franklin Global Communications Securities Fund Franklin High Income Fund Templeton Global Income Securities Fund Franklin Income Securities Fund Franklin U.S. Government Fund Franklin Zero Coupon Fund - 2005 Franklin Zero Coupon Fund - 2010 Franklin Rising Dividends Securities Fund Templeton Pacific Growth Securities Fund Templeton International Securities Fund Templeton Developing Markets Securities Fund Templeton Growth Securities Fund Templeton Asset Strategy Fund Franklin Small Cap Fund Franklin Larg Cap Growth Securities Fund Templeton International Smaller Companies Fund Mutual Discovery Securities Fund Mutual Shares Securities Fund Franklin Global Health Care Securities Fund Franklin Value Securities Fund Franklin Aggressive Growth Securities Fund Franklin S&P 500 Index Fund Franklin Strategic Income Securities Fund Franklin Technology Securities Fund - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES ---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Institutional Fiduciary Trust Massachusetts Business Trust Money Market Portfolio Franklin U.S. Government Securities Money Market Portfolio Franklin Cash Reserves Fund The Money Market Portfolios Delaware Business Trust The Money Market Portfolio The U.S. Government Securities Money Market Portfolio - ------------------------------------------------------------------------------------------------------------------------------------ INVESTMENT COMPANY ORGANIZATION SERIES---(if applicable) - ------------------------------------------------------------------------------------------------------------------------------------ Franklin Floating Rate Master Trust Delaware Business Franklin Floating Rate Master Series Trust CLOSED END FUNDS: Franklin Multi-Income Trust Massachusetts Business Trust Franklin Universal Trust Massachusetts Business Trust Franklin Floating Rate Trust Delaware Business Trust - ------------------------------------------------------------------------------------------------------------------------------------
Revised: 3-28-01 EX-99.G 4 sche1.txt G(VII) FOREIGN CUSTODY AGREEMENT SCHEDULE 1 SCHEDULE 1
INVESTMENT COMPANY SERIES Franklin Gold & Precious Metals Fund Franklin Growth and Income Fund Franklin High Income Trust AGE High Income Fund Franklin Custodian Funds, Inc. Growth Series Utilities Series DynaTech Series Income Series Franklin Investors Securities Trust Franklin Global Government Income Fund Franklin Convertible Securities Fund Franklin Equity Income Fund Franklin Total Return Fund Franklin Value Investors Trust Franklin Balance Sheet Investment Franklin MicroCap Value Fund Franklin Value Fund Franklin Large Cap Value Fund Franklin Strategic Mortgage Portfolio Franklin Managed Trust Franklin Rising Dividends Fund Franklin Strategic Series Franklin Strategic Income Fund Franklin Global Communications Fund Franklin Small Cap Growth Fund I Franklin Global Health Care Fund Franklin Natural Resources Fund Franklin Blue Chip Fund Franklin Biotechnology Discovery Fund Franklin U.S. Long-Short Fund Franklin Aggressive Growth Securities Fund Franklin Large Cap Growth Fund Franklin Small Cap Growth Fund II Franklin Technology Fund Franklin Templeton International Trust Templeton Pacific Growth Fund Franklin Real Estate Securities Trust Fund Franklin Real Estate Securities Franklin Templeton Variable Insurance Products Trust Franklin Money Market Fund Franklin Growth and Income Fund Franklin Natural Resources Securities Fund Franklin Real Estate Fund Franklin Global Communications Securities Fund Franklin High Income Fund Templeton Global Income Securities Fund Franklin Income Securities Fund Franklin U.S. Government Securities Fund Franklin Zero Coupon Fund - 2005 Franklin Zero Coupon Fund - 2010 Franklin Rising Dividends Securities Fund Templeton Pacific Growth Fund Templeton International Equity Fund Franklin Small Cap Fund Franklin Large Cap Growth Securities Fund Mutual Discovery Securities Fund Mutual Shares Securities Fund Franklin Global Health Care Securities Fund Franklin Value Securities Fund Franklin Aggressive Growth Securities Fund Franklin S&P 500 Index Fund Franklin Strategic Income Securities Fund Franklin Technology Securities Fund Franklin Universal Trust Franklin Multi-Income Trust Franklin Floating Rate Trust Franklin Templeton Fund Allocator Series Franklin Templeton Conservative Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton Growth Target Fund Franklin Floating Rate Master Trust Franklin Floating Rate Master Series
Revised 03-28-01 EX-99.G 5 sche2.txt G(VIII) FOREIGN CUSTODY AGREEMENT SHCEDULE 2 SCHEDULE 2 WORLDWIDE NETWORK OF SUBCUSTODIANS
COUNTRY SUBCUSTODIAN Argentina Banco Rio de La Plata Australia National Australia Bank Limited Austria Bank Austria AG Bahrain HSBC Bank Middle East Bangladesh Standard Chartered Bank PLC Belgium Banque Bruxelles Lambert Benin Societe Generale de Banques en Cote d'lvoire Bermuda Bank of Bermuda Limited Bolivia Citibank, N.A. Botswana Barclays Bank of Botswana Ltd. Brazil BankBoston, N.A. Bulgaria ING Bank Burkina Faso Societe Generale de Banques en Cote d'lvoire Canada Royal Bank of Canada Chile BankBoston, N.A. China The Standard Chartered Bank Colombia Cititrust Colombia S.A. Costa Rica Banco BCT Croatia Privredna Banka Zabreb d.d. Cyprus Bank of Cyprus Czech Republic Ceskoslovenska Obchodni Banka A.S. Denmark Danske Bank EASDAQ Banque Bruxelles Lambert Ecuador Citibank, N.A. Egypt Citibank, N.A. Estonia Hansabank, Ltd. Euromarket Clearstream Euromarket Euroclear Finland Merita Bank plc France BNP PARIBAS/Credit Agricole Indosuez Germany Dresdner Bank AG Ghana Barclays Bank of Ghana Ltd. Greece BNP PARIBAS Guinea Bissau Societe Generale de Banques en Cote d'lvoire Hong Kong The Hongkong and Shanghai Banking Corporation Limited Hungary Citibank Budapest Rt. Iceland Landsbanki Islands India The Hongkong and Shanghai Banking Corporation Limited/Deutsche Bank Indonesia The Hongkong and Shanghai Banking Corporation Limited COUNTRY SUBCUSTODIAN Ireland Allied Irish Banks plc Israel Bank Leumi Le-Israel B.M. Italy Banca Commerciale Italiana/BNP PARIBAS Ivory Coast Societe Generale de Banques en Cote d'lvoire Jamaica CIBC Trust & Merchant Bank Jamaica Ltd. Japan The Bank of Tokyo-Mitsubishi Limited/The Fuji Bank, Limited Jordan HSBC Bank Middle East Kazakhstan ABN/AMRO Kenya Barclays Bank of Kenya Limited Latvia Hansabanka Limited Lebanon HSBC Bank Middle East Lithuania Vilniaus Bankas Luxembourg Banque et Caisse d'Epargne de L'Etat Malaysia HSBC Bank Malaysia Berhad Mali Societe Generale de Banques en Cote d'lvoire Malta HSBC Bank Malta p.l.c. Mauritius Hongkong and Shanghai Banking Corp. Mexico Banco Nacional de Mexico Morocco Banque Commerciale du Maroc Namibia Stanbic Bank Namibia Limited Netherlands Fortis Bank (Nederland) N.V. New Zealand National Nominees Limited Niger Societe Generale de Banques en Cote d'lvoire Nigeria Stanbic Merchant Bank Nigeria Limited Norway Den norske Bank ASA Oman HSBC Bank Middle East Pakistan Standard Chartered Bank Palestinian Autonomous Area HSBC Bank Middle East, Ramallah Panama BankBoston, N.A. Peru Citibank, N.A. Philippines The Hongkong and Shanghai Banking Corporation, Limited Poland Bank Handlowy w Warszawie S.A. Portugal Banco Comercial Portugues, S.A. Qatar HSBC Bank Middle East, Doha Romania ING Bank Russia Credit Suisse First Boston AO/Vneshtorgbanke (Min Fin Bonds only) Senegal Societe Generale de Banques en Cote d'lvoire Singapore United Overseas Bank Limited/Development Bank of Singapore Slovakia Ceskoslovenska Obchodni Banka, A.S. Bratislava Slovenia Bank Austria Creditanstalt d.d. Ljubljana South Africa Standard Bank of South Africa Limited /Societe Generale, Johannesburg Branch South Korea Standard Chartered Bank Spain Banco Bilbao Vizcaya Argentaria SA/Banco Santander Central Hispano COUNTRY SUBCUSTODIAN Sri Lanka Standard Chartered Bank Swaziland Stanbic Bank Swaziland Limited Sweden Skandinaviska Enskilda Banken Switzerland Credit Suisse First Boston Taiwan The Hongkong and Shanghai Banking Corporation,Limited Thailand Standard Chartered Bank/Bangkok Bank Public Company Ltd. Togo Societe Generale de Banques en Cote d'lvoire Trinidad & Tobago Republic Bank Limited Tunisia Banque Internationale Arabe de Tunisie Turkey Osmanli Bankasi A.S.(Ottoman Bank) Ukraine ING Bank United Kingdom The Bank of New York/The Depository & Clearing Centre (DCC) United States The Bank of New York Uruguay BankBoston, N.A. Venezuela Citibank, N.A. Zambia Barclays Bank of Zambia Limited Zimbabwe Barclays Bank of Zimbabwe Limited
Revised 11-24-00 EX-99.H 6 subcont.txt H(IV) SUBCONTRACT FOR FUND ADMINISTRATIVE SERVICES SUBCONTRACT FOR FUND ADMINISTRATIVE SERVICES This Subcontract for Fund Administrative Services ("Subcontract") is made as of January 1, 2001 between FRANKLIN ADVISERS, INC., a California corporation, hereinafter called the "Investment Manager," and FRANKLIN TEMPLETON SERVICES, LLC (the "Administrator"). In consideration of the mutual agreements herein made, the Administrator and the Investment Manager understand and agree as follows: I. Prime Contract. This Subcontract is made in order to assist the Investment Manager in fulfilling certain of the Investment Manager's obligations under each investment management and investment advisory agreement ("Agreement") between the Investment Manager and each Investment Company listed on Exhibit A, ("Investment Company") for itself or on behalf of each of its series listed on Exhibit A (each, a "Fund"). This Subcontract is subject to the terms of each Agreement, which is incorporated herein by reference. II. Subcontractual Provisions. (1) The Administrator agrees, during the life of this Agreement, to provide the following services to each Fund: (a) providing office space, telephone, office equipment and supplies for the Fund; (b) providing trading desk facilities for the Fund, unless these facilities are provided by the Fund's investment adviser; (c) authorizing expenditures and approving bills for payment on behalf of the Fund; (d) supervising preparation of periodic reports to shareholders, notices of dividends, capital gains distributions and tax credits; and attending to routine correspondence and other communications with individual shareholders when asked to do so by the Fund's shareholder servicing agent or other agents of the Fund; (e) coordinating the daily pricing of the Fund's investment portfolio, including collecting quotations from pricing services engaged by the Fund; providing fund accounting services, including preparing and supervising publication of daily net asset value quotations, periodic earnings reports and other financial data; and coordinating trade settlements; (f) monitoring relationships with organizations serving the Fund, including custodians, transfer agents, public accounting firms, law firms, printers and other third party service providers; (g) supervising compliance by the Fund with recordkeeping requirements under the federal securities laws, including the 1940 Act and the rules and regulations thereunder, and under other applicable state and federal laws; and maintaining books and records for the Fund (other than those maintained by the custodian and transfer agent); (h) preparing and filing of tax reports including the Fund's income tax returns, and monitoring the Fund's compliance with subchapter M of the Internal Revenue Code, as amended, and other applicable tax laws and regulations; (i) monitoring the Fund's compliance with: 1940 Act and other federal securities laws, and rules and regulations thereunder; state and foreign laws and regulations applicable to the operation of investment companies; the Fund's investment objectives, policies and restrictions; and the Code of Ethics and other policies adopted by the Investment Company's Board of Trustees or Directors ("Board") or by the Fund's investment adviser and applicable to the Fund; (j) providing executive, clerical and secretarial personnel needed to carry out the above responsibilities; (k) preparing and filing regulatory reports, including without limitation Forms N-1A and NSAR, proxy statements, information statements and U.S. and foreign ownership reports; and (l) providing support services incidental to carrying out these duties. Nothing in this Agreement shall obligate the Investment Company or any Fund to pay any compensation to the officers of the Investment Company. Nothing in this Agreement shall obligate the Administrator to pay for the services of third parties, including attorneys, auditors, printers, pricing services or others, engaged directly by the Fund to perform services on behalf of the Fund. (2) The Investment Manager agrees to pay to the Administrator as compensation for such services a monthly fee equal on an annual basis to 0.15% of the first $200 million of the average daily net assets of each Fund during the month preceding each payment, reduced as follows: on such net assets in excess of $200 million up to $700 million, a monthly fee equal on an annual basis to 0.135%; on such net assets in excess of $700 million up to $1.2 billion, a monthly fee equal on an annual basis to 0.1%; and on such net assets in excess of $1.2 billion, a monthly fee equal on an annual basis to 0.075%. From time to time, the Administrator may waive all or a portion of its fees provided for hereunder and such waiver shall be treated as a reduction in the purchase price of its services. The Administrator shall be contractually bound hereunder by the terms of any publicly announced waiver of its fee, or any limitation of each affected Fund's expenses, as if such waiver or limitation were fully set forth herein. (3) This Subcontract shall become effective on the date written above and shall continue in effect as to each Investment Company and each Fund so long as (1) the Agreement applicable to the Investment Company or Fund is in effect and (2) this Subcontract is not terminated. This Subcontract will terminate as to any Investment Company or Fund immediately upon the termination of the Agreement applicable to the Investment Company or Fund, and may in addition be terminated by either party at any time, without the payment of any penalty, on sixty (60) days' written notice to the other party. (4) In the absence of willful misfeasance, bad faith or gross negligence on the part of the Administrator, or of reckless disregard of its duties and obligations hereunder, the Administrator shall not be subject to liability for any act or omission in the course of, or connected with, rendering services hereunder. IN WITNESS WHEREOF, the parties hereto have caused this Subcontract to be executed by their duly authorized officers. FRANKLIN ADVISERS, INC. By: /s/ Charles E. Johnson ----------------------- Charles E. Johnson President FRANKLIN TEMPLETON SERVICES, LLC By: /s/Leslie M. Kratte -------------------- Leslie M. Kratter Senior Vice President SUBCONTRACT FOR FUND ADMINISTRATIVE SERVICES BETWEEN FRANKLIN ADVISERS, INC. AND FRANKLIN TEMPLETON SERVICES, LLC EXHIBIT A - ------------------------------------------------------------------------- INVESTMENT COMPANY SERIES ---(IF APPLICABLE) - ------------------------------------------------------------------------- Franklin High Income Trust AGE High Income Fund Franklin Asset Allocation Fund Franklin California Tax-Free Income Fund, Inc. Franklin California Tax-Free Franklin California Insured Tax-Free Trust Income Fund Franklin California Tax-Exempt Money Fund Franklin California Intermediate-Term Tax-Free Income Fund Franklin Custodian Funds, Inc. Utilities Series Dynatech Series Income Series U.S. Government Securities Series Franklin Growth and Income Fund Franklin Federal Tax- Free Income Fund Franklin Gold and Precious Metals Fund Franklin Investors Securities Franklin Global Government Income Fund Trust Franklin Short-Intermediate U.S. Government Securities Fund Franklin Convertible Securities Fund Franklin Equity Income Fund - ------------------------------------------------------------------------- - ------------------------------------------------------------------------- INVESTMENT COMPANY SERIES ---(IF APPLICABLE) - ------------------------------------------------------------------------- Franklin Municipal Securities Franklin California High Yield Trust Municipal Fund Franklin Tennessee Municipal Bond Fund Franklin New York Tax-Free Franklin New York Tax-Exempt Money Fund Trust Franklin New York Insured Tax-Free Income Fund Franklin New York Intermediate-Term Tax-Free Income Fund Franklin Real Estate Franklin Real Estate Securities Fund Securities Trust Franklin Strategic Mortgage Portfolio Franklin Strategic Series Franklin California Growth Fund Franklin Strategic Income Fund Franklin Global Communications Fund Franklin Small Cap Growth Fund I Franklin Global Health Care Fund Franklin Natural Resources Fund Franklin Blue Chip Fund Franklin Tax-Exempt Money Fund - ------------------------------------------------------------------------- - ------------------------------------------------------------------------- INVESTMENT COMPANY SERIES ---(IF APPLICABLE) - ------------------------------------------------------------------------- Franklin Tax-Free Trust Franklin Massachusetts Insured Tax-Free Income Fund Franklin Michigan Insured Tax-Free Income Fund Franklin Minnesota Insured Tax-Free Income Fund Franklin Insured Tax-Free Income Fund Franklin Ohio Insured Tax-Free Income Fund Franklin Puerto Rico Tax-Free Income Fund Franklin Arizona Tax-Free Income Fund Franklin Colorado Tax-Free Income Fund Franklin Georgia Tax-Free Income Fund Franklin Pennsylvania Tax-Free Income Fund Franklin High Yield Tax-Free Income Fund Franklin Missouri Tax-Free Income Fund Franklin Oregon Tax-Free Income Fund Franklin Texas Tax-Free Income Fund Franklin Virginia Tax-Free Income Fund Franklin Alabama Tax-Free Income Fund Franklin Florida Tax-Free Income Fund Franklin Connecticut Tax-Free Income Fund Franklin Louisiana Tax-Free Income Fund Franklin Maryland Tax-Free Income Fund Franklin North Carolina Tax-Free Income Fund Franklin New Jersey Tax-Free Income Fund Franklin Kentucky Tax-Free Income Fund Franklin Federal Intermediate-Term Tax-Free Income Fund Franklin Arizona Insured Tax-Free Income Fund Franklin Florida Insured Tax-Free Income Fund Franklin Templeton Templeton Pacific Growth Fund International Trust Templeton Foreign Smaller Companies Fund Franklin Templeton Global Trust Franklin Templeton Global Currency Fund Franklin Templeton Hard Currency Fund CLOSED END FUNDS: Franklin Multi-Income Trust Franklin Universal Trust - ------------------------------------------------------------------------- EX-99.J 7 consent.txt J(I) CONSENT OF INDEPENDENT AUDITORS CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in Post-Effective Amendment No. 30 to the Registration Statement of Franklin Tax-Free Trust on Form N-1A, File No. 2-94222, of our report dated April 4, 2001, on our audit of the financial statements and financial highlights of Franklin Tax-Free Trust, which report is included in the Annual Report to Shareholders for the year ended February 28, 2001 filed with the Securities and Exchange Commission pursuant to section 30(d) of the Investment Company Act of 1940, which is incorporated by reference in the Registration Statement. We also consent to the reference to our firm under the captions "Financial Highlights" and "Independent Auditors." /s/PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP San Francisco, California June 27, 2001 EX-99.M 8 classc.txt M(II) CLASS C SHARES DISTRIBUTION PLAN CLASS C DISTRIBUTION PLAN I. Investment Company: FRANKLIN TAX-FREE TRUST II. Fund: FRANKLIN ALABAMA TAX-FREE INCOME FUND - CLASS C FRANKLIN ARIZONA TAX-FREE INCOME FUND - CLASS C FRANKLIN COLORADO TAX-FREE INCOME FUND - CLASS C FRANKLIN CONNECTICUT TAX-FREE INCOME FUND - CLASS C FRANKLIN FLORIDA TAX-FREE INCOME FUND - CLASS C FRANKLIN GEORGIA TAX-FREE INCOME FUND - CLASS C FRANKLIN HIGH YIELD TAX-FREE INCOME FUND - CLASS C FRANKLIN INSURED TAX-FREE INCOME FUND - CLASS C FRANKLIN LOUISIANA TAX-FREE INCOME FUND - CLASS C FRANKLIN MARYLAND TAX-FREE INCOME FUND - CLASS C FRANKLIN MASSACHUSETTS INSURED TAX-FREE INCOME FUND - CLASS C FRANKLIN MICHIGAN INSURED TAX-FREE INCOME FUND - CLASS C FRANKLIN MINNESOTA INSURED TAX-FREE INCOME FUND - CLASS C FRANKLIN MISSOURI TAX-FREE INCOME FUND - CLASS C FRANKLIN NEW JERSEY TAX-FREE INCOME FUND - CLASS C FRANKLIN NORTH CAROLINA TAX-FREE INCOME FUND - CLASS C FRANKLIN OHIO INSURED TAX-FREE INCOME FUND - CLASS C FRANKLIN OREGON TAX-FREE INCOME FUND - CLASS C FRANKLIN PENNSYLVANIA TAX-FREE INCOME FUND - CLASS C FRANKLIN PUERTO RICO TAX-FREE INCOME FUND - CLASS C FRANKLIN TEXAS TAX-FREE INCOME FUND - CLASS C FRANKLIN VIRGINIA TAX-FREE INCOME FUND - CLASS C III. Maximum Per Annum Rule 12b-1 Fees for Class C Shares (as a percentage of average daily net assets of the class) A. Distribution Fee: 0.50% B. Service Fee: 0.15% PREAMBLE TO CLASS C DISTRIBUTION PLAN The following Distribution Plan (the "Plan") has been adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940 (the "Act") by the Investment Company named above ("Investment Company") for the Class C shares (the "Class") of each Fund named above ("Fund"), which Plan shall take effect as of the date Class C shares are first offered (the "Effective Date of the Plan"). The Plan has been approved by a majority of the Board of Directors or Trustees of the Investment Company (the "Board"), including a majority of the Board members who are not interested persons of the Investment Company and who have no direct, or indirect financial interest in the operation of the Plan (the "non-interested Board members"), cast in person at a meeting called for the purpose of voting on such Plan. In reviewing the Plan, the Board considered the schedule and nature of payments and terms of the Management Agreement between the Investment Company and Franklin Advisers, Inc. ("Advisers") and the terms of the Underwriting Agreement between the Investment Company and Franklin/Templeton Distributors, Inc. ("Distributors"). The Board concluded that the compensation of Advisers, under the Management Agreement, and of Distributors, under the Underwriting Agreement, was fair and not excessive. The approval of the Plan included a determination that in the exercise of their reasonable business judgment and in light of their fiduciary duties, there is a reasonable likelihood that the Plan will benefit the Fund and its shareholders. The Board recognizes that Distributors has entered into an arrangement with a third party in order to pay for the distribution activities of the Class pursuant to which Distributors may sell, transfer, convey and assign its rights to the fees payable hereunder to such third party. The Board further recognizes that it has an obligation to act in good faith and in the best interests of the Fund and its shareholders when considering the continuation or termination of the Plan and any payments to be made thereunder. DISTRIBUTION PLAN 1. (a) The Fund shall pay to Distributors a quarterly fee not to exceed the above-stated maximum distribution fee per annum of the Class' average daily net assets represented by shares of the Class, as may be determined by the Board from time to time. (b) In addition to the amounts described in (a) above, the Fund shall pay (i) to Distributors for payment to dealers or others, or (ii) directly to others, an amount not to exceed the above-stated maximum service fee per annum of the Class' average daily net assets represented by shares of the Class, as may be determined by the Investment Company's Board from time to time, as a service fee pursuant to servicing agreements which have been approved from time to time by the Board, including the non-interested Board members. 2. (a) The monies paid to Distributors pursuant to Paragraph 1(a) above shall be treated as compensation for Distributors' distribution-related services including compensation for amounts advanced to securities dealers or their firms or others selling shares of the Class who have executed an agreement with the Investment Company, Distributors or its affiliates, which form of agreement has been approved from time to time by the Board, including the non-interested Board members, with respect to the sale of Class shares. In addition, Distributors may use such monies paid to it pursuant to Paragraph 1(a) above to assist in the distribution and promotion of shares of the Class. Payments made to Distributors under the Plan may be used for, among other things, the printing of prospectuses and reports used for sales purposes, expenses of preparing and distributing sales literature and related expenses, advertisements, and other distribution-related expenses, including a pro-rated portion of Distributors' overhead expenses attributable to the distribution of Class shares, as well as for additional distribution fees paid to securities dealers or their firms or others who have executed agreements with the Investment Company, Distributors or its affiliates, or for certain promotional distribution charges paid to broker-dealer firms or others, or for participation in certain distribution channels. (b) The monies to be paid pursuant to paragraph 1(b) above shall be used to pay dealers or others for, among other things, furnishing personal services and maintaining shareholder accounts, which services include, among other things, assisting in establishing and maintaining customer accounts and records; assisting with purchase and redemption requests; arranging for bank wires; monitoring dividend payments from the Fund on behalf of customers; forwarding certain shareholder communications from the Fund to customers; receiving and answering correspondence; and aiding in maintaining the investment of their respective customers in the Class. Any amounts paid under this paragraph 2(b) shall be paid pursuant to a servicing or other agreement, which form of agreement has been approved from time to time by the Board. 3. In addition to the payments which the Fund is authorized to make pursuant to paragraphs 1 and 2 hereof, to the extent that the Fund, Advisers, Distributors or other parties on behalf of the Fund, Advisers or Distributors make payments that are deemed to be payments by the Fund for the financing of any activity primarily intended to result in the sale of Class shares issued by the Fund within the context of Rule 12b-1 under the Act, then such payments shall be deemed to have been made pursuant to the Plan. In no event shall the aggregate asset-based sales charges which include payments specified in paragraphs 1 and 2, plus any other payments deemed to be made pursuant to the Plan under this paragraph, exceed the amount permitted to be paid pursuant to Rule 2830(d) of the Conduct Rules of the National Association of Securities Dealers, Inc. 4. Distributors shall furnish to the Board, for its review, on a quarterly basis, a written report of the monies paid to it and to others under the Plan, and shall furnish the Board with such other information as the Board may reasonably request in connection with the payments made under the Plan in order to enable the Board to make an informed determination of whether the Plan should be continued. 5. (a) Distributors may assign, transfer or pledge ("Transfer") to one or more designees (each an "Assignee"), its rights to all or a designated portion of the fees to which it is entitled under paragraph 1 of this Plan from time to time (but not Distributors' duties and obligations pursuant hereto or pursuant to any distribution agreement in effect from time to time, if any, between Distributors and the Fund), free and clear of any offsets or claims the Fund may have against Distributors. Each such Assignee's ownership interest in a Transfer of a specific designated portion of the fees to which Distributors is entitled is hereafter referred to as an "Assignee's 12b-1 Portion." A Transfer pursuant to this Section 5(a) shall not reduce or extinguish any claims of the Fund against Distributors. (b) Distributors shall promptly notify the Fund in writing of each such Transfer by providing the Fund with the name and address of each such Assignee. (c) Distributors may direct the Fund to pay any Assignee's 12b-1 Portion directly to each Assignee. In such event, Distributors shall provide the Fund with a monthly calculation of the amount to which each Assignee is entitled (the "Monthly Calculation"). In such event, the Fund shall, upon receipt of such notice and Monthly Calculation from Distributors, make all payments required directly to the Assignee in accordance with the information provided in such notice and Monthly Calculation upon the same terms and conditions as if such payments were to be paid to Distributors. (d) Alternatively, in connection with a Transfer, Distributors may direct the Fund to pay all or a portion of the fees to which Distributors is entitled from time to time to a depository or collection agent designated by any Assignee, which depository or collection agent may be delegated the duty of dividing such fees between the Assignee's 12b-1 Portion and the balance (such balance, when distributed to Distributors by the depository or collection agent, the "Distributors' 12b-1 Portion"), in which case only Distributors' 12b-1 Portion may be subject to offsets or claims the Fund may have against Distributors. 6. The Plan shall continue in effect for a period of more than one year only so long as such continuance is specifically approved at least annually by the Board, including the non-interested Board members, cast in person at a meeting called for the purpose of voting on the Plan. In determining whether there is a reasonable likelihood that the continuation of the Plan will benefit the Fund and its shareholders, the Board may, but is not obligated to, consider that Distributors has incurred substantial costs and has entered into an arrangement with a third party which third party has agreed to purchase from Distributors the entitlement of Distributors to receive the payments described in Paragraph 1(a) above, which purchase will generate the cash flow needed to pay for the distribution activities for the Class. 7. The Plan, and any agreements entered into pursuant to this Plan, may be terminated with respect to the shares of the Class at any time, without penalty, by vote of a majority of the outstanding voting securities of such Class or by vote of a majority of the non-interested Board members of the Investment Company, on not more than sixty (60) days' written notice, and shall terminate automatically in the event of any act that constitutes an assignment of the Management Agreement between the Fund and the Adviser. Upon termination of this Plan with respect to the Class, the obligation of the Fund to make payments pursuant to this Plan with respect to such Class shall terminate, and the Fund shall not be required to make payments hereunder beyond such termination date with respect to expenses incurred in connection with Class shares sold prior to such termination date, provided, in each case that each of the requirements of a Complete Termination of this Plan in respect of such Class, as defined below, are met. For purposes of this Section 7, a "Complete Termination" of this Plan in respect of the Class shall mean a termination of this Plan in respect of such Class, provided that: (i) the non-interested Board members of the Investment Company shall have acted in good faith and shall have determined that such termination is in the best interest of the Investment Company and the shareholders of the Fund and the Class; (ii) the Investment Company does not alter the terms of the contingent deferred sales charges applicable to Class shares outstanding at the time of such termination; and (iii) unless Distributors at the time of such termination was in material breach under the distribution agreement in respect of the Fund, the Fund shall not, in respect of such Fund, pay to any person or entity, other than Distributors or its designee, the payments described in either paragraph 1(a) or 1(b) in respect of the Class shares sold by Distributors prior to such termination. 8. The Plan, and any agreements entered into pursuant to this Plan, may not be amended to increase materially the amount to be spent for distribution pursuant to Paragraph 1 hereof without approval by a majority of the outstanding voting securities of the Class of the Fund. 9. All material amendments to the Plan, or any agreements entered into pursuant to this Plan, shall be approved by the non-interested Board members cast in person at a meeting called for the purpose of voting on any such amendment. 10. So long as the Plan is in effect, the selection and nomination of the Fund's non-interested Board members shall be committed to the discretion of such non-interested Board members. This Plan and the terms and provisions thereof are hereby accepted and agreed to by the Investment Company and Distributors as evidenced by their execution hereof. Dated as of: October 31, 2000 FRANKLIN TAX-FREE TRUST By: /s/ David P. Goss ------------------ David P. Goss Vice President & Assistant Secretary Franklin/Templeton Distributors, Inc. By: /s/Charles E. Johnson ---------------------- Charles E. Johnson Senior Vice President EX-99.Q 9 codeofethics.txt Q(I) CODE OF ETHICS THE FRANKLIN TEMPLETON GROUP CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING TABLE OF CONTENTS THE FRANKLIN TEMPLETON GROUP CODE OF ETHICS..................................1 - ------------------------------------------- PART 1 - STATEMENT OF PRINCIPLES.............................................1 PART 2 - PURPOSES, AND CONSEQUENCES OF NON-COMPLIANCE........................2 PART 3 - COMPLIANCE REQUIREMENTS FOR ALL ACCESS PERSONS......................3 PART 4 - ADDITIONAL COMPLIANCE REQUIREMENTS APPLICABLE TO PORTFOLIO PERSONS...............................................10 PART 5 - REPORTING REQUIREMENTS FOR ALL ACCESS PERSONS......................13 PART 6 - PRE-CLEARANCE REQUIREMENTS.........................................17 PART 7 - PENALTIES FOR VIOLATIONS OF THE CODE..............................23 PART 8 - A REMINDER ABOUT THE FRANKLIN TEMPLETON GROUP INSIDER TRADING POLICY.............................................24 APPENDIX A: COMPLIANCE PROCEDURES, DEFINITIONS, AND OTHER ITEMS.............25 - ---------- --------------------------------------------------- I. RESPONSIBILITIES OF EACH DESIGNATED COMPLIANCE OFFICER................26 II. COMPILATION OF DEFINITIONS OF IMPORTANT TERMS.........................32 III. SECURITIES EXEMPT FROM THE PROHIBITED, REPORTING, AND PRE-CLEARANCE PROVISIONS..........................................33 IV. LEGAL REQUIREMENT.....................................................34 APPENDIX B: FORMS AND SCHEDULES.............................................35 - ---------- ------------------- ACKNOWLEDGMENT FORM.........................................................36 SCHEDULE A: LEGAL AND COMPLIANCE OFFICERS AND --------------------------------- PRECLEARANCE DESK TELEPHONE & FAX NUMBERS.......................37 ----------------------------------------- SCHEDULE B: SECURITIES TRANSACTION REPORT...................................39 ----------------------------- SCHEDULE C: INITIAL, ANNUAL & UPDATED DISCLOSURE OF ACCESS PERSONS ------------------------------------------------------- SECURITIES HOLDINGS... .........................................39 ------------------- SCHEDULE D: NOTIFICATION OF SECURITIES ACCOUNT OPENING......................41 ------------------------------------------ SCHEDULE E: NOTIFICATION OF DIRECT OR INDIRECT BENEFICIAL INTEREST..........42 ------------------------------------------------------ SCHEDULE F: INITIAL, ANNUAL & UPDATED DISCLOSURE OF SECURITIES ACCOUNTS.....43 ----------------------------------------------------------- SCHEDULE G: INITIAL AND ANNUAL CERTIFICATION OF DISCRETIONARY AUTHORITY.....45 ----------------------------------------------------------- SCHEDULE H: CHECKLIST FOR INVESTMENTS IN PARTNERSHIPS AND --------------------------------------------- SECURITIES ISSUED IN PRIVATE PLACEMENTS.........................47 --------------------------------------- APPENDIX C: INVESTMENT ADVISOR AND BROKER-DEALER AND OTHER ---------------------------------------------- SUBSIDIARIES OF FRANKLIN RESOURCES, INC. - FEBRUARY 2001......49 --------------------------------------------------------- THE FRANKLIN TEMPLETON GROUP POLICY STATEMENT ON INSIDER TRADING.............1 - ---------------------------------------------------------------- A. LEGAL REQUIREMENT......................................................1 B. WHO IS AN INSIDER?.....................................................2 C. WHAT IS MATERIAL INFORMATION?..........................................2 D. WHAT IS NON-PUBLIC INFORMATION?........................................2 E. BASIS FOR LIABILITY....................................................3 F. PENALTIES FOR INSIDER TRADING..........................................3 G. INSIDER TRADING PROCEDURES.............................................4 THE FRANKLIN TEMPLETON GROUP CODE OF ETHICS Franklin Resources, Inc. and all of its subsidiaries, and the funds in the Franklin Templeton Group of Funds (the "Funds") (collectively, the "Franklin Templeton Group") will follow this Code of Ethics (the "Code") and Policy Statement on Insider Trading (the "Insider Trading Policy"). Additionally, the subsidiaries listed in Appendix C of this Code, together with Franklin Resources, Inc., the Funds, the Fund's investment advisers and principal underwriter, have adopted the Code and Insider Trading Policy. PART 1 - STATEMENT OF PRINCIPLES The Franklin Templeton Group's policy is that the interests of shareholders and clients are paramount and come before the interests of any director, officer or employee of the Franklin Templeton Group/1/. Personal investing activities of ALL directors, officers and employees of the Franklin Templeton Group should be conducted in a manner to avoid actual OR potential conflicts of interest with the Franklin Templeton Group, Fund shareholders, and other clients of any Franklin Templeton adviser. Directors, officers and employees of the Franklin Templeton Group shall use their positions with the Franklin Templeton Group, and any investment opportunities they learn of because of their positions with the Franklin Templeton Group, in a manner consistent with their fiduciary duties for the benefit of Fund shareholders, and clients. - ------- 1 "Director" includes trustee. - ------- PART 2 - PURPOSES, AND CONSEQUENCES OF NON-COMPLIANCE It is important that you read and understand this document, because its overall purpose is to help all of us comply with the law and to preserve and protect the outstanding reputation of the Franklin Templeton Group. This document was adopted to comply with Securities and Exchange Commission rules under the Investment Company Act of 1940 ("1940 Act"), the Investment Advisers Act of 1940 ("Advisers Act"), the Insider Trading and Securities Fraud Enforcement Act of 1988 ("ITSFEA"), industry practice and the recommendations contained in the ICI's REPORT OF THE ADVISORY GROUP ON PERSONAL INVESTING. Any violation of the Code or Insider Trading Policy, including engaging in a prohibited transaction or failing to file required reports, may result in disciplinary action, and, when appropriate, termination of employment and/or referral to appropriate governmental agencies. PART 3 - COMPLIANCE REQUIREMENTS FOR ALL ACCESS PERSONS 3.1 WHO IS COVERED BY THE CODE AND HOW DOES IT WORK? The principles contained in the Code must be observed by ALL directors, officers and employees/2/ of the Franklin Templeton Group. However, there are different categories of restrictions on personal investing activities. The category in which you have been placed generally depends on your job function, although unique circumstances may result in you being placed in a different category. The Code covers the following categories of employees who are described below: (1) ACCESS PERSONS: Access Persons are those employees who have "ACCESS TO INFORMATION" concerning recommendations made to a Fund or client with regard to the purchase or sale of a security. Examples of "ACCESS TO INFORMATION" would include having access to trading systems, portfolio accounting systems, research data bases or settlement information. Access Persons would typically include employees, ncluding Management Trainees, in the following departments: o fund accounting; o investment operations; o information services & technology; o product management; o legal and legal compliance o and anyone else designated by the Director of Compliance In addition, you are an Access Person if you are any of the following: o an officer or and directors of funds; o an officer or director of an investment advisor or broker-dealer subsidiary in the Franklin Templeton Group; o a person that controls those entities; and o any Franklin Resources' Proprietary Account ("Proprietary Account")/3/. (2) PORTFOLIO PERSONS: Portfolio Persons are a subset of Access Persons and are those employees of the Franklin Templeton Group, who, in connection with his or her regular functions or duties, makes or participates in the decision to purchase or sell a security by a Fund in the Franklin Templeton Group, or any other client or if his or her functions relate to the making of any recommendations about those purchases or sales. Portfolio Persons include: - ------- 2 The term "employee or employees" includes management trainees, as well as regular employees of the Franklin Templeton Group. 3 See Appendix A. II., for definition of "Proprietary Accounts." - ------- o portfolio managers; o research analysts; o traders; o employees serving in equivalent capacities (such as Management Trainees); o employees supervising the activities of Portfolio Persons; and o anyone else designated by the Director of Compliance (3) NON-ACCESS PERSONS: If you are an employee in the Franklin Templeton Group AND you do not fit into any of the above categories, you are a Non-Access Person. Because you do not normally receive confidential information about Fund portfolios, you are subject only to the prohibited transaction provisions described in 3.4 of this Code and the Franklin Resources, Inc.'s Standards of Business Conduct contained in the Employee Handbook. Please contact the Legal Compliance Department if you are unsure as to what category you fall in or whether you should be considered to be an Access Person or Portfolio Person. The Code works by prohibiting some transactions and requiring pre-clearance and reporting of most others. NON-ACCESS PERSONS do not have to pre-clear their security transactions, and, in most cases, do not have to report their transactions. "INDEPENDENT DIRECTORS" need not report any securities transaction unless you knew, or should have known that, during the 15-day period before or after the transaction, the security was purchased or sold or considered for purchase or sale by a Fund or Franklin Resources for a Fund. (SEE Section 5.2.B below.) HOWEVER, PERSONAL INVESTING ACTIVITIES OF ALL EMPLOYEES AND INDEPENDENT DIRECTORS ARE TO BE CONDUCTED IN COMPLIANCE WITH THE PROHIBITED TRANSACTIONS PROVISIONS CONTAINED IN 3.4 BELOW. If you have any questions regarding your personal securities activity, contact the Legal Compliance Department. 3.2 WHAT ACCOUNTS AND TRANSACTIONS ARE COVERED? The Code covers all of your personal securities accounts and transactions, as well as transactions by any of Franklin Resource's Proprietary Accounts. It also covers all securities and accounts in which you have "beneficial ownership/4/". A transaction by or for the account of your spouse, or any other family member living in your home is considered to be the same as a transaction by you. Also, a transaction for any account in which you have any economic interest (other than the account of an unrelated client for which advisory fees are received) and have or share investment control is generally considered the same as a transaction by you. For example, if you invest in a corporation that invests in securities and you have or share control over its investments, that corporation's securities transactions are considered yours. However, you are not deemed to have a pecuniary interest in any securities held by a partnership, corporation, trust or similar entity unless you control, or share control of such entity, or have, or share control over its investments. For example, securities transactions of a trust or foundation in which you do not have an economic interest (i.e., you are not the trustor or beneficiary) but of which you are a trustee are not considered yours unless you have voting or investment control of its assets. Accordingly, each time the words "you" or "your" are used in this document, they apply not only to your personal transactions and accounts, but also to all transactions and accounts in which you have any direct or indirect beneficial interest. If it is not clear whether a particular account or transaction is covered, ask a Preclearance Officer for guidance. - ------- 4 Generally, a person has "beneficial ownership" in a security if he or she, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares a direct or indirect - ------- 3.3 WHAT SECURITIES ARE EXEMPT FROM THE CODE OF ETHICS? You do not need to pre-clear OR report transactions of the following -- securities: (1) securities that are direct obligations of the U. S. Government (i.e., issued or guaranteed by the U.S. Government, such as Treasury bills, notes and bonds, including U.S. Savings Bonds and derivatives thereof); (2) high quality short-term instruments, including but not limited to bankers' acceptances, bank certificates of deposit, commercial paper and repurchase agreements; (3) shares of registered open-end investment companies ("mutual funds"); and (4) commodity futures, currencies, currency forwards and derivatives thereof. Such transactions are also exempt from: (i) the prohibited transaction provisions contained in Part 3.4 such as front-running; (ii) the additional compliance requirements applicable to portfolio persons contained in Part 4; and (iii) the applicable reporting requirements contained in Part 5. 3.4 PROHIBITED TRANSACTIONS FOR ALL ACCESS PERSONS A. "INTENT" IS IMPORTANT --------------------- Certain transactions described below have been determined by the courts and the SEC to be prohibited by law. The Code reiterates that these types of transactions are a violation of the Statement of Principals and are prohibited. Preclearance, which is a cornerstone of our compliance efforts, cannot detect transactions which are dependent upon INTENT, or which by their nature, occur before any order has been placed for a fund or client. A Preclearance Officer, who is there to assist you with compliance with the Code, CANNOT guarantee any transaction or transactions comply with the Code or the law. The fact that your transaction receives preclearance, shows evidence of good faith, but depending upon all the facts, may not provide a full and complete defense to any accusation of violation of the Code or of the law. For example, if you executed a transaction for which you received approval, or if the transaction was exempt from preclearance (e.g., a transaction for 100 shares or less), would not preclude a subsequent finding that front-running or scalping occurred because such activity are dependent upon your intent. Intent cannot be detected during preclearance, but only after a review of all the facts. In the final analysis, compliance remains the responsibility of EACH individual effecting personal securities transactions. B. FRONT-RUNNING: TRADING AHEAD OF A FUND OR CLIENT ------------------------------------------------- You cannot front-run any trade of a Fund or client. The term "front-run" means knowingly trading before a contemplated transaction by a Fund or client of any Franklin Templeton adviser, whether or not your trade and the Fund's or client's trade take place in the same market. Thus, you may not: (1) purchase a security if you intend, or know of Franklin Templeton Group's intention, to purchase that security or a related security on behalf of a Fund or client, or (2) sell a security if you intend, or know of Franklin Templeton Group's intention, to sell that security or a related security on behalf of a Fund or client. C. SCALPING. --------- You cannot purchase a security (or its economic equivalent) with the intention of recommending that the security be purchased for a Fund, or client, or sell short a security (or its economic equivalent) with the intention of recommending that the security be sold for a Fund or client. Scalping is prohibited whether or not you realize a profit from such transaction. D. TRADING PARALLEL TO A FUND OR CLIENT ------------------------------------ You cannot buy a security if you know that the same or a related security is being bought contemporaneously by a Fund or client, or sell a security if you know that the same or a related security is being sold contemporaneously by a Fund or client. E. TRADING AGAINST A FUND OR CLIENT -------------------------------- You cannot: (1) buy a security if you know that a Fund or client is selling the same or a related security, or has sold the security, until seven (7) calendar days after the Fund's or client's order has either been executed or withdrawn, or (2) sell a security if you know that a Fund or client is buying the same or a related security, or has bought the security until seven (7) calendar days after the Fund's or client's order has either been executed or withdrawn. Refer to Section I.A., "Pre-Clearance Standards," of Appendix A of the Code for more details regarding the preclearance of personal securities transactions. F. USING PROPRIETARY INFORMATION FOR PERSONAL TRANSACTIONS ------------------------------------------------------- You cannot buy or sell a security based on Proprietary Information/5/ without disclosing the information and receiving written authorization. If you wish to purchase or sell a security about which you obtained such information, you must report all of the information you obtained regarding the security to the Appropriate Analyst(s)/6/, or to the Director of Compliance for dissemination to the Appropriate Analyst(s). - ------- 5 Proprietary Information: Information that is obtained or developed during the ordinary course of employment with the Franklin Templeton Group, whether by you or someone else, and is not available to persons outside the Franklin Templeton Group. Examples of such Proprietary Information include, among other things, internal research reports, research materials supplied to the Franklin Templeton Group by vendors and broker-dealers not generally available to the public, minutes of departmental/research meetings and conference calls, and communications with company officers (including confidentiality agreements). Examples of non-Proprietary Information include mass media publications (e.g., The Wall Street Journal, Forbes, and Fortune), certain specialized publications available to the public (e.g., Morningstar, Value Line, Standard and Poors), and research reports available to the general public. 6 The Director of Compliance is designated on Schedule A. The "Appropriate Analyst" means any securities analyst or portfolio manager, other than you, making recommendations or investing funds on behalf of any associated client, who may be reasonably expected to recommend or consider the purchase or sale of the security in question. - ------- You will be permitted to purchase or sell such security if the Appropriate Analyst(s) confirms to the Preclearance Desk that there is no intention to engage in a transaction regarding the security within seven (7) calendar days on behalf of an Associated Client/7/ and you subsequently preclear such security in accordance with Part 6 below. G. CERTAIN TRANSACTIONS IN SECURITIES OF FRANKLIN RESOURCES, INC., AND ------------------------------------------------------------------- AFFILIATED CLOSED-END FUNDS, AND REAL ESTATE INVESTMENT TRUSTS -------------------------------------------------------------- If you are an employee of Franklin Resources, Inc. or any of its affiliates, including the Franklin Templeton Group, you cannot effect a short sale of the securities, including "short sales against the box" of Franklin Resources, Inc., or any of the Franklin or Templeton closed-end funds, Franklin real estate investment trusts or any other security issued by Franklin Resources, Inc. or its affiliates. This prohibition would also apply to effecting economically equivalent transactions, including, but not limited to sales of any option to buy (i.e., a call option) or purchases of any option to sell (i.e., a put option) and "swap" transactions or other derivatives. Officers and directors of the Franklin Templeton Group who may be covered by Section 16 of the Securities Exchange Act of 1934, are reminded that their obligations under that section are in addition to their obligations under this Code. - ------- 7 Associated Client: A Fund or client whose trading information would be available to the access person during the course of his or her regular functions or duties. - ------- PART 4 - ADDITIONAL COMPLIANCE REQUIREMENTS APPLICABLE TO PORTFOLIO PERSONS/8/ 4.1 REQUIREMENT TO DISCLOSE INTEREST AND METHOD OF DISCLOSURE As a Portfolio Person, you must promptly disclose your direct or indirect beneficial interest in a security whenever you learn that the security is under consideration for purchase or sale by an Associated Client in the Franklin Templeton Group and you; (1) Have or share investment control of the Associated Client; (2) Make any recommendation or participate in the determination of which recommendation shall be made on behalf of the Associated Client; or (3) Have functions or duties that relate to the determination of which recommendation shall be made to the Associated Client. In such instances, you must initially disclose that beneficial interest orally to the primary portfolio manager (or other Appropriate Analyst) of the Associated Client(s) considering the security, the Director of Research and Trading or the Director of Compliance. Following that oral disclosure, you must send a written acknowledgment of that interest on Schedule E (or on a form containing substantially similar information) to the primary portfolio manager (or other Appropriate Analyst), with a copy to the Legal Compliance Department. 4.2 SHORT SALES OF SECURITIES You cannot sell short ANY security held by your Associated Clients, including "short sales against the box". Additionally, Portfolio Persons associated with the Templeton Group of Funds and clients cannot sell short any security on the Templeton "Bargain List". This prohibition would also apply to effecting economically equivalent transactions, including, but not limited to, sales of uncovered call options, purchases of put options while not owning the underlying security and short sales of bonds that are convertible into equity positions. - ------- 8 You are a "Portfolio Person" if you are an employee of the Franklin Templeton Group, and, in connection with your regular functions or duties, make or participate in the decision to purchase or sell a security by a Fund in the Franklin Templeton Group, or any other client or if your functions relate to the making of any recommendations about those purchases or sales. Portfolio Persons include portfolio managers, research analysts, traders, persons serving in equivalent capacities (such as Management Trainees), persons supervising the activities of Portfolio Persons, and anyone else so designated by the Compliance Officer. - ------- 4.3 SHORT SWING TRADING Portfolio Persons cannot profit from the purchase and sale or sale and purchase within sixty calendar days of any security, including derivatives. Portfolio Persons are responsible for transactions that may occur in margin and option accounts and all such transactions must comply with this restriction/9/. This restriction does NOT apply to: (1) trading within a shorter period if you do not realize a profit and if you do not violate any other provisions of this Code; AND --- (2) profiting on the purchase and sale or sale and purchase within sixty calendar days of the following securities: o securities that are direct obligations of the U.S. Government, such as Treasury bills, notes and bonds, and U.S. Savings Bonds and derivatives thereof; o high quality short-term instruments ("money market instruments") including but not limited to (i) bankers' acceptances, (ii) U.S. bank certificates of deposit; (iii) commercial paper; and (iv) repurchase agreements; o shares of registered open-end investment companies; and o commodity futures, currencies, currency forwards and derivatives thereof. Calculation of profits during the 60 calendar day holding period generally will be based on "last-in, first-out" ("LIFO"). Portfolio Persons may elect to calculate their 60 calendar day profits on either a LIFO or FIFO ("first-in, first-out") basis when there has not been any activity in such security by their Associated Clients during the previous 60 calendar days. 9 This restriction applies equally to transactions occurring in margin and option accounts which may not be due to direct actions by the Portfolio Person. For example, a stock held less than 60 days that is sold to meet a margin call or the underlying stock of a covered call option held less than 60 days that is called away, would be a violation of this restriction if these transactions resulted in a profit for the Portfolio Person. 4.4 SERVICE AS A DIRECTOR As a Portfolio Person, you cannot serve as a director, trustee, or in a similar capacity for any company (excluding not-for-profit companies, charitable groups, and eleemosynary organizations) unless you receive approval from the Chief Executive Officer of the principal investment adviser to the Fund(s) of which you are a Portfolio Person and he/she determines that your service is consistent with the interests of the Fund(s) and its shareholders. 4.5 SECURITIES SOLD IN A PUBLIC OFFERING Portfolio Persons cannot buy securities in any initial public offering, or a secondary offering by an issuer, INCLUDING initial public offerings of securities made by closed-end funds and real estate investment trusts advised by the Franklin Templeton Group. Purchases of open-end mutual funds are excluded from this prohibition. 4.6 INTERESTS IN PARTNERSHIPS AND SECURITIES ISSUED IN PRIVATE PLACEMENTS Portfolio Persons cannot acquire limited partnership interests or other securities in private placements unless they: (1) complete the Private Placement Checklist (Schedule H); (2) provide supporting documentation (e.g., a copy of the offering memorandum); and (3) obtain approval of the appropriate Chief Investment Officer; and (4) submit all documents to the Legal Compliance Department Approval will only be granted after the Director of Compliance consults with an executive officer of Franklin Resources, Inc. PART 5 - REPORTING REQUIREMENTS FOR ALL ACCESS PERSONS 5.1 REPORTING OF BENEFICIAL OWNERSHIP AND SECURITIES TRANSACTIONS Compliance with the following personal securities transaction reporting procedures is essential to enable us to meet our responsibilities to Funds and other clients and to comply with regulatory requirements. You are expected to comply with both the letter and spirit of these requirements, including completing and filing all reports required under the Code in a timely manner. 5.2 INITIAL HOLDINGS AND BROKERAGE ACCOUNT REPORTS A. ALL ACCESS PERSONS (EXCEPT INDEPENDENT DIRECTORS) Every employee (new or transfer) of the Franklin Templeton Group who becomes an Access Person, must file: (1) An Acknowledgement Form; (2) Schedule C: Initial, Annual & Updated Disclosure of Securities Holdings; and (3) Schedule F: Initial, Annual & Updated Disclosure of Securities Accounts The Acknowledgement Form, Schedule C and Schedule F MUST be completed and returned to the Legal Compliance Department within 10 CALENDAR DAYS of the date the employee becomes an access person. 5.3 QUARTERLY TRANSACTION REPORTS A. ALL ACCESS PERSONS (EXCEPT INDEPENDENT DIRECTORS) You MUST report ALL securities transactions by; (i) providing the Legal Compliance Department with copies of ALL broker's confirmations and statements within 10 calendar days after the end of the calendar quarter (which may be sent under separate cover by the broker) showing ALL transactions and holdings in securities AND (ii) certifying by January 30th of each year that you have disclosed all such brokerage accounts on Schedule F to the Legal Compliance Department. The brokerage statements and confirmations must include all transactions in securities in which you have, or by reason of the transaction acquire any direct or indirect beneficial ownership, including transactions in a discretionary account and transactions for any account in which you have any economic interest AND have or share investment control. Also, if you acquire securities by any other method which is not being reported to the Legal Compliance Department by a duplicate confirmation statement at or near the time of the acquisition, you must report that acquisition to the Legal Compliance Department on Schedule B within 10 calendar days after you are notified of the acquisition. Such acquisitions include, among other things, securities acquired by gift, inheritance, vesting/10/, stock splits, merger or reorganization of the issuer of the security. You must file these documents with the Legal Compliance Department not later than 10 calendar days after the end of each quarter, but you need not show or report transactions for any account over which you had no direct or indirect influence or control/11/. Failure to timely report transactions is a violation of Rule 17j-1 as well as the Code, and may be reported to the Fund's Board of Directors and may also result, among other things, in denial of future personal security transaction requests. B. INDEPENDENT DIRECTORS If you are a director of the Franklin Templeton Group but you are not an "interested person" of the Fund, you are not required to file transaction reports unless you knew or should have known that, during the 15-day period before or after a transaction, the security was purchased or sold, or considered for purchase or sale, by a Fund or by Franklin Resources on behalf of a Fund. - ------- 10 You are not required to separately report the vesting of shares or options of Franklin Resources, Inc., received pursuant to a deferred compensation plan as such information is already maintained. 11 See Sections 3.2 and 4.6 of the Code. Also, confirmations and statements of transactions in open-end mutual funds, including mutual funds sponsored by the Franklin Templeton Group are not required. See Section 3.3 above for a list of other securities that need not be reported. If you have any beneficial ownership in a discretionary account, transactions in that account are treated as yours and must be reported by the manager of that account (see Section 6.1.C below). - ------- 5.4 ANNUAL REPORTS - ALL ACCESS PERSONS A. SECURITIES ACCOUNTS REPORTS (EXCEPT INDEPENDENT DIRECTORS) ---------------------------------------------------------- As an access person, you must file a report of all personal securities accounts on Schedule F, with the Legal Compliance Department, annually by January 30th. You must report the name and description of each securities account in which you have a direct or indirect beneficial interest, including securities accounts of a spouse and minor children. You must also report any account in which you have any economic interest AND have or share investment control (e.g., trusts, foundations, etc.) other than an account for a Fund in, or a client of, the Franklin Templeton Group. B. SECURITIES HOLDINGS REPORTS (EXCEPT INDEPENDENT DIRECTORS) ---------------------------------------------------------- You must file a report of personal securities holdings on Schedule C, with the Legal Compliance Department, by January 30th of each year. This report should include ALL of your securities holdings, including any security acquired by a transaction, gift, inheritance, vesting, merger or reorganization of the issuer of the security, in which you have any direct or indirect beneficial ownership, including securities holdings in a discretionary account and for any account in which you have any economic interest AND have or share investment control. Your securities holding information must be current as of a date no more than 30 days before the report is submitted. You may attach copies of year-end brokerage statements to the Schedule C in lieu of listing each security position on the schedule. C. CERTIFICATION OF COMPLIANCE WITH THE CODE OF ETHICS (INCLUDING INDEPENDENT DIRECTORS) All access persons, including independent directors, will be asked to certify that they will comply with the FRANKLIN TEMPLETON GROUP'S CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING by filing the Acknowledgment Form with the Legal Compliance Department within 10 business days of receipt of the Code. Thereafter, you will be asked to certify that you have complied with the Code during the preceding year by filing a similar Acknowledgment Form by January 30 of each year. 5.5 BROKERAGE ACCOUNTS AND CONFIRMATIONS OF SECURITIES TRANSACTIONS (EXCEPT INDEPENDENT DIRECTORS) If you are an access person , in the Franklin Templeton Group, before or at a time contemporaneous with opening a brokerage account with a registered broker-dealer, or a bank, or placing an initial order for the purchase or sale of securities with that broker-dealer or bank, you must: (1) notify the Legal Compliance Department, in writing, by completing Schedule D or by providing substantially similar information; and (2) notify the institution with which the account is opened, in writing, of your association with the Franklin Templeton Group. The Compliance Department will request the institution in writing to send to it duplicate copies of confirmations and statements for all transactions effected in the account simultaneously with their mailing to you. If you have an existing account on the effective date of this Code or upon becoming an access person, you must comply within 10 days with conditions (1) and (2) above. PART 6 - PRE-CLEARANCE REQUIREMENTS 6.1 PRIOR APPROVAL OF SECURITIES TRANSACTIONS A. LENGTH OF APPROVAL Unless you are covered by Paragraph D below, you cannot buy or sell any security, without first contacting a Preclearance Officer by fax, phone, or e-mail and obtaining his or her approval. A clearance is good until the close of the business day following the day clearance is granted but may be extended in special circumstances, shortened or rescinded, as explained in Appendix A. B. SECURITIES NOT REQUIRING PRECLEARANCE The securities enumerated below do not require preclearance under the Code. However, all other provisions of the Code apply, including, but not limited to: (i) the prohibited transaction provisions contained in Part 3.4 such as front-running; (ii) the additional compliance requirements applicable to portfolio persons contained in Part 4, (iii) the applicable reporting requirements contained in Part 5; and (iv) insider trading prohibitions. You need NOT pre-clear transactions in the following securities: (1) MUTUAL FUNDS. Transactions in shares of any registered open-end mutual fund; (2) FRANKLIN RESOURCES, INC., AND ITS AFFILIATES. Purchases and sales of securities of Franklin Resources, Inc., closed-end funds of the Franklin Templeton Group, or real estate investment trusts advised by Franklin Properties Inc., as these securities cannot be purchased on behalf of our advisory clients/12/. (3) SMALL QUANTITIES. o Transactions that do not result in purchases or sales of more than 100 shares of any one security, regardless of where it is traded, in any 30 day period; or o Transactions of 500 shares or less of any security listed on the NYSE or NASDAQ NMS in any 30 day period; or - ------- 12 Officers, directors and certain other key management personnel who perform significant policy-making functions of Franklin Resources, Inc., the closed-end funds, and/or real estate investment trusts may have ownership reporting requirements in addition to these reporting requirements. Contact the Legal Compliance Department for additional information. See also the "Insider Trading Policy" attached. - ------- o Transactions of 1000 shares or less of the top 50 securities by volume during the previous calendar quarter on the NYSE or NASDAQ NMS in any 30 day period. HOWEVER, YOU MAY NOT EXECUTE ANY TRANSACTION, REGARDLESS OF QUANTITY, IF YOU LEARN THAT THE FUNDS ARE ACTIVE IN THE SECURITY. IT WILL BE PRESUMED THAT YOU HAVE KNOWLEDGE OF FUND ACTIVITY IN THE SECURITY IF, AMONG OTHER THINGS, YOU ARE DENIED APPROVAL TO GO FORWARD WITH A TRANSACTION REQUEST. Transactions made pursuant to dividend reinvestment plans ("DRIPs") do not require preclearance regardless of quantity or Fund activity. (4) GOVERNMENT OBLIGATIONS. Transactions in securities issued or guaranteed by the governments of the United States, Canada, the United Kingdom, France, Germany, Switzerland, Italy and Japan, or their agencies or instrumentalities, or derivatives thereof; (5) PAYROLL DEDUCTION PLANS. Securities purchased by an employee's spouse pursuant to a payroll deduction program, provided the Compliance Department has been previously notified in writing by the access person that the spouse will be participating in the payroll deduction program. (6) EMPLOYER STOCK OPTION PROGRAMS. Transactions involving the exercise and/or purchase by an access person or an access person's spouse of securities pursuant to a program sponsored by a corporation employing the access person or spouse. (7) PRO RATA DISTRIBUTIONS. Purchases effected by the exercise of rights issued pro rata to all holders of a class of securities or the sale of rights so received. (8) TENDER OFFERS. Transactions in securities pursuant to a bona fide tender offer made for any and all such securities to all similarly situated shareholders in conjunction with mergers, acquisitions, reorganizations and/or similar corporate actions. However, tenders pursuant to offers for less than all outstanding securities of a class of securities of an issuer must be precleared. (9) NOT ELIGIBLE FOR FUNDS AND CLIENTS. Transactions in any securities that are prohibited investments for all Funds and clients advised by the entity employing the access person. (10) NO INVESTMENT CONTROL. Transactions effected for an account or entity over which you do not have or share investment control (i.e., an account where someone else exercises complete investment control). (11) NO BENEFICIAL OWNERSHIP. Transactions in which you do not acquire or dispose of direct or indirect beneficial ownership (i.e., an account where in you have no financial interest). Although an access person's securities transaction may be exempt from pre-clearing, such transactions must comply with the prohibited transaction provisions of Section 3.4 above. Additionally, you may not trade any securities as to which you have "inside information" (see attached THE FRANKLIN TEMPLETON GROUP POLICY STATEMENT ON INSIDER TRADING). If you have any questions, contact a Preclearance Officer before engaging in the transaction. If you have any doubt whether you have or might acquire direct or indirect beneficial ownership or have or share investment control over an account or entity in a particular transaction, or whether a transaction involves a security covered by the Code, you should consult with a Preclearance Officer before engaging in the transaction. C. DISCRETIONARY ACCOUNTS You need not pre-clear transactions in any discretionary account for which a registered broker-dealer, a registered investment adviser, or other investment manager acting in a similar fiduciary capacity, which is not affiliated with the Franklin Templeton Group, exercises sole investment discretion, if the following conditions are met/13/: (1) The terms of each account relationship ("Agreement") must be in writing and filed with a Preclearance Officer prior to any transactions. (2) Any amendment to each Agreement must be filed with aPreclearance Officer prior to its effective date. (3) The Portfolio Person certifies to the Compliance Department at the time such account relationship commences, and annually thereafter, as contained in Schedule G of the Code that such Portfolio Person does not have direct or indirect influence or control over the account, other than the right to terminate the account. (4) Additionally, any discretionary account that you open or maintain with a registered broker-dealer, a registered investment adviser, or other investment manager acting in a similar fiduciary capacity must provide duplicate copies of confirmations and statements for all transactions effected in the account simultaneously with their delivery to you., If your discretionary account acquires securities which are not reported to a Preclearance Officer by a duplicate confirmation, such transaction must be reported to a Preclearance Officer on Schedule B within 10 days after you are notified of the acquisition/14/. - ------- 13 Please note that these conditions apply to any discretionary account in existence prior to the effective date of this Code or prior to your becoming an access person. Also, the conditions apply to transactions in any discretionary account, including pre-existing accounts, in which you have any direct or indirect beneficial ownership, even if it is not in your name. 14 Any pre-existing agreement must be promptly amended to comply with this condition. The required reports may be made in the form of an account statement if they are filed by the applicable deadline. - ------- However, if you make ANY request that the discretionary account manager enter into or refrain from a specific transaction or class of transactions, you must first consult with aPreclearance Officer and obtain approval prior to making such request. D. DIRECTORS WHO ARE NOT ADVISORY PERSONS OR ADVISORY REPRESENTATIVES ------------------------------------------------------------------ You need not pre-clear any securities if: (1) You are a director of a Fund in the Franklin Templeton Group and a director of the fund's advisor; (2) You are not an "advisory person"/15/ of a Fund in the Franklin Templeton Group; and (3) You are not an employee of any Fund, or (1) You are a director of a Fund in the Franklin Templeton Group; (2) You are not an "advisory representative"/16/ of Franklin Resources or any subsidiary; and - ------- 15 An "advisory person" of a registered investment company or an investment adviser is any employee, who in connection with his or her regular functions or duties, makes, participates in, or obtains information regarding the purchase or sale of a security by an advisory client , or whose functions relate to the making of any recommendations with respect to such purchases or sales. Advisory person also includes any natural person in a control relationship to such company or investment adviser who obtains information concerning recommendations made to such company with regard to the purchase or sale of a security. 16 Generally, an "advisory representative" is any person who makes any recommendation, who participates in the determination of which recommendation shall be made, or whose functions or duties relate to the determination of which recommendation shall be made, or who, in connection with his duties, obtains any information concerning which securities are being recommended prior to the effective dissemination of such recommendations or of the information concerning such recommendations. See Section II of Appendix A for the legal definition of "Advisory Representative." - ------- (3) You are not an employee of any Fund, unless you know or should know that, during the 15-day period before the transaction, the security was purchased or sold, or considered for purchase or sale, by a Fund or by Franklin Resources on behalf of a Fund or other client. Directors, other than independent Directors, qualifying under this paragraph are required to comply with all applicable provisions of the Code including reporting their initial holdings and brokerage accounts in accordance with 5.2, personal securities transactions and accounts in accordance with 5.3 and 5.5, and annual reports in accordance with 5.4 of the Code. PART 7 - PENALTIES FOR VIOLATIONS OF THE CODE The Code is designed to assure compliance with applicable law and to maintain shareholder confidence in the Franklin Templeton Group. In adopting this Code, it is the intention of the Boards of Directors/Trustees, to attempt to achieve 100% compliance with all requirements of the Code - but it is recognized that this may not be possible. Incidental failures to comply with the Code are not necessarily a violation of the law or the Franklin Templeton Group's Statement of Principles. Such isolated or inadvertent violations of the Code not resulting in a violation of law or the Statement of Principles will be referred to the Director of Compliance and/or management personnel, and disciplinary action commensurate with the violation, if warranted, will be imposed. However, if you violate any of the enumerated prohibited transactions contained in Parts 3 and 4 of the Code, you will be expected to give up ANY profits realized from these transactions to Franklin Resources for the benefit of the affected Funds or other clients. If Franklin Resources cannot determine which Fund(s) or client(s) were affected, the proceeds will be donated to a charity chosen by Franklin Resources. Failure to disgorge profits when requested may result in additional disciplinary action, including termination of employment. Further, a pattern of violations that individually do not violate the law or Statement of Principles, but which taken together demonstrate a lack of respect for the Code of Ethics, may result in disciplinary action including termination of employment. A violation of the Code resulting in a violation of the law will be severely sanctioned, with disciplinary action including, but not limited to, referral of the matter to the board of directors of the affected Fund, termination of employment or referral of the matter to the appropriate regulatory agency for civil and/or criminal investigation. PART 8 - A REMINDER ABOUT THE FRANKLIN TEMPLETON GROUP INSIDER TRADING POLICY The Code of Ethics is primarily concerned with transactions in securities held or to be acquired by any of the Funds or Franklin Resources' clients, regardless of whether those transactions are based on inside information or actually harm a Fund or a client. The Insider Trading Policy (attached to this document) deals with the problem of insider trading in securities that could result in harm to a Fund, a client, or members of the public, and applies to all directors, officers and employees of any entity in the Franklin Templeton Group. Although the requirements of the Code and the Insider Trading Policy are similar, you must comply with both. APPENDIX A: COMPLIANCE PROCEDURES, DEFINITIONS, AND OTHER ITEMS - ---------------------------------------------------------------- This appendix sets forth the additional responsibilities and obligations of Compliance Officers, and the Legal/Administration and Legal/Compliance Departments, under the Franklin Templeton Group Code of Ethics and Policy Statement on Insider Trading. I. RESPONSIBILITIES OF EACH DESIGNATED COMPLIANCE OFFICER A. PRE-CLEARANCE STANDARDS 1. GENERAL PRINCIPLES The Director of Compliance, or a Preclearance Officer, shall only permit an access person to go forward with a proposed security/17/ transaction if he or she determines that, considering all of the facts and circumstances, the transaction does not violate the provisions of Rule 17j-1, or of this Code and there is no likelihood of harm to a client. 2. ASSOCIATED CLIENTS Unless there are special circumstances that make it appropriate to disapprove a personal securities transaction request, a Preclearance Officer shall consider only those securities transactions of the "Associated Clients" of the access person, including open and executed orders and recommendations, in determining whether to approve such a request. "Associated Clients" are those Funds or clients whose trading information would be available to the access person during the course of his or her regular functions or duties. Currently, there are three groups of Associated Clients: (i) the Franklin Mutual Series Funds and clients advised by Franklin Mutual Advisers, LLC ("Mutual Clients"); (ii) the Franklin Group of Funds and the clients advised by the various Franklin investment advisers ("Franklin Clients"); and (iii) the Templeton Group of Funds and the clients advised by the various Templeton investment advisers ("Templeton Clients"). Thus, persons who have access to the trading information of Mutual Clients generally will be precleared solely against the securities transactions of the Mutual Clients, including open and executed orders and recommendations. Similarly, persons who have access to the trading information of Franklin Clients or Templeton Clients generally will be precleared solely against the securities transactions of Franklin Clients or Templeton Clients, as appropriate. Certain officers of Franklin Resources, as well as legal, compliance, fund accounting, investment operations and other personnel who generally have access to trading information of the funds and clients of the Franklin Templeton Group during the course of their regular functions and duties, will have their personal securities transactions precleared against executed transactions, open orders and recommendations of the entire Franklin Templeton Group. - -------- 17 Security includes any option to purchase or sell, and any security that is exchangeable for or convertible into, any security that is held or to be acquired by a fund. - -------- 3. SPECIFIC STANDARDS (a) SECURITIES TRANSACTIONS BY FUNDS OR CLIENTS ------------------------------------------- No clearance shall be given for any transaction in any security on any day during which an Associated Client of the access person has executed a buy or sell order in that security, until seven (7) calendar days after the order has been executed. Notwithstanding a transaction in the previous seven days, clearance may be granted to sell if the security has been disposed of by all Associated Clients. (b) SECURITIES UNDER CONSIDERATION OPEN ORDERS No clearance shall be given for any transaction in any security on any day which an Associated Client of the access person has a pending buy or sell order for such security, until seven (7) calendar days after the order has been executed. RECOMMENDATIONS No clearance shall be given for any transaction in any security on any day on which a recommendation for such security was made by a Portfolio Person, until seven (7) calendar days after the recommendation was made and no orders have subsequently been executed or are pending. (c) PRIVATE PLACEMENTS In considering requests by Portfolio Personnel for approval of limited partnerships and other private placement securities transactions, the Director of Compliance shall consult with an executive officer of Franklin Resources, Inc. In deciding whether to approve the transaction, the Director of Compliance and the executive officer shall take into account, among other factors, whether the investment opportunity should be reserved for a Fund or other client, and whether the investment opportunity is being offered to the Portfolio Person by virtue of his or her position with the Franklin Templeton Group. If the Portfolio Person receives clearance for the transaction, an investment in the same issuer may only be made for a Fund or client if an executive officer of Franklin Resources, Inc., who has been informed of the Portfolio Person's pre-existing investment and who has no interest in the issuer, approves the transaction. (d) DURATION OF CLEARANCE If a Preclearance Officer approves a proposed securities transaction, the order for the transaction must be placed and effected by the close of the next business day following the day approval was granted. The Director of Compliance may, in his or her discretion, extend the clearance period up to seven calendar days, beginning on the date of the approval, for a securities transaction of any access person who demonstrates that special circumstances make the extended clearance period necessary and appropriate/18/. The Director of Compliance may, in his or her discretion, after consultation with a member of senior management for Franklin Resources, Inc., renew the approval for a particular transaction for up to an additional seven calendar days upon a similar showing of special circumstances by the access person. The Director of Compliance may shorten or rescind any approval or renewal of approval under this paragraph if he or she determines it is appropriate to do so. - ----- 18 Special circumstances include but are not limited to, for example, differences in time zones, delays due to travel, and the unusual size of proposed trades or limit orders. Limit orders must expire within the applicable clearance period. - ----- B. WAIVERS BY THE DIRECTOR OF COMPLIANCE The Director of Compliance may, in his or her discretion, after consultation with an executive officer of Franklin Resources, Inc., waive compliance by any access person with the provisions of the Code, if he or she finds that such a waiver: (1) is necessary to alleviate undue hardship or in view of unforeseen circumstances or is otherwise appropriate under all the relevant facts and circumstances; (2) will not be inconsistent with the purposes and objectives of the Code; (3) will not adversely affect the interests of advisory clients of the Franklin Templeton Group, the interests of the Franklin Templeton Group or its affiliates; and (4) will not result in a transaction or conduct that would violate provisions of applicable laws or regulations. Any waiver shall be in writing, shall contain a statement of the basis for it, and a copy shall be promptly sent by the Director of Compliance to the General Counsel of Franklin Resources, Inc. C. CONTINUING RESPONSIBILITIES OF THE LEGAL COMPLIANCE DEPARTMENT A Preclearance Officer shall make a record of all requests for pre-clearance regarding the purchase or sale of a security, including the date of the request, the name of the access person, the details of the proposed transaction, and whether the request was approved or denied. APreclearance Officer shall keep a record of any waivers given, including the reasons for each exception and a description of any potentially conflicting Fund or client transactions. A Preclearance Officer shall also collect the signed initial acknowledgments of receipt and the annual acknowledgments from each access person of receipt of a copy of the Code and Insider Trading Policy, as well as reports, as applicable, on Schedules B, C, D, E and F of the Code. In addition, a Preclearance Officer shall request copies of all confirmations, and other information with respect to an account opened and maintained with the broker-dealer by any access person of the Franklin Templeton Group. A Preclearance Officer shall preserve those acknowledgments and reports, the records of consultations and waivers, and the confirmations, and other information for the period required by applicable regulation. A Preclearance Officer shall review brokerage transaction confirmations, account statements, Schedules B, C, D, E, F and Private Placement Checklists of Access Persons for compliance with the Code. The reviews shall include, but are not limited to; (1) Comparison of brokerage confirmations, Schedule Bs, and/or brokerage statements to preclearance request worksheets or, if a private placement, the Private Placement Checklist; (2) Comparison of brokerage statements and/or Schedule Fs to current securities holding information; (3) Comparison of Schedule C to current securities account information; (4) Conducting periodic "back-testing" of access person transactions, Schedule Es and/or Schedule Gs in comparison to fund and client transactions; A Preclearance Officer shall evidence review by initialing and dating the appropriate document. Any apparent violations of the Code detected by a Preclearance Officer during his or her review shall be promptly brought to the attention of the Director of Compliance. D. PERIODIC RESPONSIBILITIES OF THE LEGAL COMPLIANCE DEPARTMENT The Legal Compliance Department shall consult with the General Counsel and the Human Resources Department, as the case may be, to assure that: (1) Adequate reviews and audits are conducted to monitor compliance with the reporting, pre-clearance, prohibited transaction and other requirements of the Code. (2) Adequate reviews and audits are conducted to monitor compliance with the reporting, pre-clearance, prohibited transaction and other requirements of the Code. (3) All access persons and new employees of the Franklin Templeton Group are adequately informed and receive appropriate education and training as to their duties and obligations under the Code. (4) There are adequate educational, informational and monitoring efforts to ensure that reasonable steps are taken to prevent and detect unlawful insider trading by access persons and to control access to inside information. (5) Written compliance reports are submitted to the Board of Directors of Franklin Resources, Inc., and the Board of each relevant Fund at least annually. Such reports will describe any issues arising under the Code or procedures since the last report, including, but not limited to, information about material violations of the Code or procedures and sanctions imposed in response to the material violations. (6) The Legal Compliance Department will certify at least annually to the Fund's board of directors that the Franklin Templeton Group has adopted procedures reasonably necessary to prevent Access Persons from violating the Code, and (7) Appropriate records are kept for the periods required by law. E. APPROVAL BY FUND'S BOARD OF DIRECTORS (1) Basis for Approval The Board of Directors/Trustees must base its approval of the Code' on a determination that the Code contains provisions reasonably necessary to prevent access persons from engaging in any conduct prohibited by rule 17j-1. (2) New Funds At the time a new fund is organized, the Legal Compliance Department will provide the Fund's board of directors, a certification that the investment adviser and principal underwriter have adopted procedures reasonably necessary to prevent Access Persons from violating the Code. Such certification will state that the Code contains provisions reasonably necessary to prevent Access Persons from violating the Code. (3) Material Changes to the Code of Ethics The Legal Compliance Department will provide the Fund's board of directors a written description of all material changes to the Code no later than six months after adoption of the material change by the Franklin Templeton Group. II. COMPILATION OF DEFINITIONS OF IMPORTANT TERMS For purposes of the Code of Ethics and Insider Trading Policy, the terms below have the following meanings: 1934 ACT - The Securities Exchange Act of 1934, as amended. 1940 ACT - The Investment Company Act of 1940, as amended. ACCESSPERSON - Each director, trustee, general partner or officer, and any other person that directly or indirectly controls (within the meaning of Section 2(a)(9) of the 1940 Act) the Franklin Templeton Group or a person, including an Advisory Representative, who has access to information concerning recommendations made to a Fund or client with regard to the purchase or sale of a security. ADVISORY REPRESENTATIVE - Any officer or director of Franklin Resources; any employee who makes any recommendation, who participates in the determination of which recommendation shall be made, or whose functions or duties relate to the determination of which recommendation shall be made; any employee who, in connection with his or her duties, obtains any information concerning which securities are being recommended prior to the effective dissemination of such recommendations or of the information concerning such recommendations; and any of the following persons who obtain information concerning securities recommendations being made by Franklin Resources prior to the effective dissemination of such recommendations or of the information concerning such recommendations: (i) any person in a control relationship to Franklin Resources, (ii) any affiliated person of such controlling person, and (iii) any affiliated person of such affiliated person. AFFILIATED PERSON - same meaning as Section 2(a)(3) of the Investment Company Act of 1940. An "affiliated person" of an investment company includes directors, officers, employees, and the investment adviser. In addition, it includes any person owning 5% of the company's voting securities, any person in which the investment company owns 5% or more of the voting securities, and any person directly or indirectly controlling, controlled by, or under common control with the company. APPROPRIATE ANALYST - With respect to any access person, any securities analyst or portfolio manager making investment recommendations or investing funds on behalf of an Associated Client and who may be reasonably expected to recommend or consider the purchase or sale of a security. ASSOCIATED CLIENT - A Fund or client whose trading information would be available to the access person during the course of his or her regular functions or duties. BENEFICIAL OWNERSHIP - Has the same meaning as in Rule 16a-1(a)(2) under the 1934 Act. Generally, a person has a beneficial ownership in a security if he or she, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares a direct or indirect pecuniary interest in the security. There is a presumption of a pecuniary interest in a security held or acquired by a member of a person's immediate family sharing the same household. FUNDS - Investment companies in the Franklin Templeton Group of Funds. HELD OR TO BE ACQUIRED - A security is "held or to be acquired" if within the most recent 15 days it (i) is or has been held by a Fund, or (ii) is being or has been considered by a Fund or its investment adviser for purchase by the Fund. PORTFOLIO PERSON - Any employee of the Franklin Templeton Group, who, in connection with his or her regular functions or duties, makes or participates in the decision to purchase or sell a security by a Fund in the Franklin Templeton Group, or any other client or if his or her functions relate to the making of any recommendations about those purchases or sales. Portfolio Persons include portfolio managers, research analysts, traders, persons serving in equivalent capacities (such as Management Trainees), persons supervising the activities of Portfolio Persons, and anyone else designated by the Director of Compliance PROPRIETARY ACCOUNTS - Any corporate account or other account including, but not limited to, a limited partnership, a corporate hedge fund, a limited liability company or any other pooled investment vehicle in which Franklin Resources or its affiliates, owns 5 percent or more of the outstanding capital or is entitled to 25% or more of the profits or losses in the account (excluding any asset based investment management fees based on average periodic net assets in accounts). SECURITY - Any stock, note, bond, evidence of indebtedness, participation or interest in any profit-sharing plan or limited or general partnership, investment contract, certificate of deposit for a security, fractional undivided interest in oil or gas or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of deposit), guarantee of, or warrant or right to subscribe for or purchase any of the foregoing, and in general any interest or instrument commonly known as a security, except commodity futures, currency and currency forwards. For the purpose of this Code, "security" does not include: (1) Direct obligations of the Government of the United States; (2) Bankers' acceptances, bank certificates of deposit, commercial paper and high quality short-term debt instruments, including repurchase agreements; and (3) Shares issued by open-end funds. SEE Section III of Appendix A for a summary of different requirements for different types of securities. III. SECURITIES EXEMPT FROM THE PROHIBITED , REPORTING, AND PRE-CLEARANCE PROVISIONS A. PROHIBITED TRANSACTIONS Securities that are EXEMPT from the prohibited transaction provisions of Section 3.4 include: (1) securities that are direct obligations of the U.S. Government, such as Treasury bills, notes and bonds, and U.S. Savings Bonds and derivatives thereof; (2) high quality short-term instruments ("money market instruments") including but not limited to (i) bankers' acceptances, (ii) U.S. bank certificates of deposit; (iii) commercial paper; and (iv) repurchase agreements; (3) shares of registered open-end investment companies; (4) commodity futures, currencies, currency forwards and derivatives thereof; (5) securities that are prohibited investments for all Funds and clients advised by the entity employing the access person; and (6) transactions in securities issued or guaranteed by the governments or their agencies or instrumentalities of Canada, the United Kingdom, France, Germany, Switzerland, Italy and Japan and derivatives thereof. B. REPORTING AND PRECLEARANCE Securities that are EXEMPT from both the reporting requirements of Section 5 and preclearance requirements of Section 6 of the Code include: (1) securities that are direct obligations of the U.S. Government, such Treasury bills, notes and bonds, and U.S. Savings Bonds and as derivatives thereof; (2) high quality short-term instruments ("money market instruments") including but not limited to (i) bankers' acceptances, (ii) U.S. bank certificates of deposit; (iii) commercial paper; and (iv) repurchase agreements; (3) shares of registered open-end investment companies; and (4) commodity futures, currencies, currency forwards and derivatives thereof. IV. LEGAL REQUIREMENT Rule 17j-1 under the Investment Company Act of 1940 ("1940 Act") makes it unlawful for any affiliated person of the Franklin Templeton Group in connection with the purchase or sale of a security, including any option to purchase or sell, and any security convertible into or exchangeable for, any security that is "held or to be acquired" by a Fund in the Franklin Templeton Group: A. To employ any device, scheme or artifice to defraud a Fund; B. To make to a Fund any untrue statement of a material fact or omit to state to a Fund a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading; C. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon a Fund; or D. To engage in any manipulative practice with respect to a Fund. A security is "held or to be acquired" if within the most recent 15 days it (i) is or has been held by a Fund, or (ii) is being or has been considered by a Fund or its investment adviser for purchase by the Fund. APPENDIX B: FORMS AND SCHEDULES ACKNOWLEDGMENT FORM CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING To: DIRECTOR OF COMPLIANCE, LEGAL COMPLIANCE DEPARTMENT I hereby acknowledge receipt of a copy of the Franklin Templeton Group's CODE OF ETHICS AND POLICY STATEMENT ON INSIDER TRADING, AMENDED AND RESTATED, FEBRUARY 2000, which I have read and understand. I will comply fully with all provisions of the Code and the Insider Trading Policy to the extent they apply to me during the period of my employment. Additionally, I authorize any broker-dealer, bank or investment adviser with whom I have securities accounts and accounts in which I have beneficial ownership, to provide brokerage confirmations and statements as required for compliance with the Code. I further understand and acknowledge that any violation of the Code or Insider Trading Policy, including engaging in a prohibited transaction or failure to file reports as required (see Schedules B, C, D, E, F and G), may subject me to disciplinary action, including termination of employment. SIGNATURE: ________________________________________ PRINT NAME: ________________________________________ TITLE: ________________________________________ DEPARTMENT: ________________________________________ LOCATION: ________________________________________ DATE ACKNOWLEDGMENT WAS SIGNED: ________________________________________ RETURN TO: LEGAL COMPLIANCE DEPARTMENT, FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 SCHEDULE A: LEGAL AND COMPLIANCE OFFICERS AND PRECLEARANCE DESK TELEPHONE & FAX NUMBERS/19/ LEGAL OFFICER MURRAY SIMPSON EXECUTIVE VICE PRESIDENT & GENERAL COUNSEL FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY SAN MATEO, CA 94403-1906 (650) 525 -7331 COMPLIANCE OFFICERS - ------------------------------------------------------------------------------ DIRECTOR OF COMPLIANCE PRECLEARANCE OFFICERS James M. Davis Stephanie Harwood, Franklin Templeton Investments Supervisor One Franklin Parkway Monique Glowinak San Mateo, CA 94403-1906 Legal Compliance Department (650) 312-2832 Franklin Templeton Investments One Franklin Parkway San Mateo, CA 94403-1906 (650) 312-3693 (telephone) (650) 312-5646 (facsimile) Preclear, Legal (internal e-mail address) Lpreclear@frk.com(externale-mail address) - ------------------------------------------------------------------------------ - ------- 19 As of June 01, 2001 - ------- SCHEDULE B: SECURITIES TRANSACTION REPORT This report of personal securities transactions NOT reported by duplicate confirmations and brokerage statements pursuant to Section 5.3 of the Code is required pursuant to Rule 204-2(a) of the Investment Advisers Act of 1940 or Rule 17j-1(c) of the Investment Company Act of 1940. The report must be completed and submitted to the Compliance Department no later than 10 calendar days after the end of the calendar quarter.. Refer to Section 5.3 of the Code of Ethics for further instructions.
- ---------------------------------------------------------------------------------------------------------------------------------- Trade Buy, Sell Security Description, including Type of Quantity or Price Broker-Dealer Date Date or Other interest rate and maturity Security Principal or Bank Preclearance (if appropriate) (Stock, Amount obtained Bond, from Option, Compliance etc) Dept. - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- THE REPORT OR RECORDING OF ANY TRANSACTION ABOVE SHALL NOT BE CONSTRUED AS AN ADMISSION THAT I HAVE ANY DIRECT OR INDIRECT OWNERSHIP IN THE SECURITIES. - --------------------------- ------------------------- ----------------- ---------------------- (PRINT NAME) (SIGNATURE) (DATE) (QUARTER ENDING) RETURN TO: LEGAL COMPLIANCE DEPARTMENT, FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906
SCHEDULE C: INITIAL, ANNUAL & UPDATED DISCLOSURE OF ACCESS PERSONS SECURITIES HOLDINGS This report shall set forth the security name or description and security class of each security holding in which you have a direct or indirect beneficial interest, including holdings by a spouse, minor children, trusts, foundations, and any account for which trading authority has been delegated to you, other than authority to trade for a Fund in or a client of the Franklin Templeton Group. In lieu of listing each security position below, you may instead attach copies of brokerage statements, sign below and return Schedule C and brokerage statements to the Legal Compliance Department within 10 days if an initial report or by January 30th of each year if an annual report. Refer to Sections 5.2.A and 5.4.A of the Code for additional filing instructions.
- ---------------------------------------------------------------------------------------------------------------------------------- Security Description including interest Type of Security Quantity or Name of rate and maturity (Stock, Bond, Principal Broker-Dealer (if appropriate) Option, etc.) Amount or Bank Account Number - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- [ ] I DID NOT HAVE ANY PERSONAL SECURITIES HOLDINGS FOR YEAR ENDED __________________ [ ] I HAVE ATTACHED STATEMENTS CONTAINING ALL MY PERSONAL SECURITIES HOLDINGS FOR THE YEAR ENDED _____________ TO THE BEST OF MY KNOWLEDGE I HAVE DISCLOSED ALL OF MY SECURITIES ACCOUNTS AND/OR INVESTMENTS IN WHICH I HAVE A DIRECT OR INDIRECT BENEFICIAL INTEREST, INCLUDING SECURITY ACCOUNTS OF A SPOUSE, MINOR CHILDREN, TRUSTS, FOUNDATIONS, AND ANY ACCOUNT FOR WHICH TRADING AUTHORITY HAS BEEN DELEGATED AN UNAFFILIATED PARTY. - --------------------------- ------------------------- ----------------- ---------------------- PRINT NAME SIGNATURE DATE YEAR ENDED
* Securities that are EXEMPT from being reported on Schedule C include: (i) securities that are direct obligations of the U.S. Government, such as Treasury bills, notes and bonds, and U.S. Savings Bonds and derivatives thereof; (ii) high quality short-term instruments ("money market instruments") including but not limited to bankers' acceptances, U.S. bank certificates of deposit; commercial paper; and repurchase agreements; (iii) shares of registered open-end investment companies; and (iv) commodity futures, currencies, currency forwards and derivatives thereof. SCHEDULE D: NOTIFICATION OF SECURITIES ACCOUNT OPENING DATE: _____________________ TO: Preclearance Desk Legal Compliance Department One Franklin Parkway San Mateo, CA 94403-1906 (650) 312-3693 FAX: (650) 312-5646 FROM: NAME: ________________________ DEPARTMENT: ________________________ LOCATION: ________________________ EXTENSION: ________________________ ARE YOU A REG. REPRESENTATIVE? YES [ ] NO [ ] ARE YOU AN ACCESS PERSON? YES [ ] NO [ ] This is to advise you that I will be opening or have opened a securities account with the following firm: PLEASE FILL OUT COMPLETELY TO EXPEDITE PROCESSING NAME ON ACCOUNT: _________________________________________________________ (If other than employee, please state relationship i.e., spouse, son, daughter, trust, etc.) ACCT # OR SSN #: _________________________________________________________ NAME OF FIRM: _________________________________________________________ ATTN: _________________________________________________________ ADDRESS OF FIRM: _________________________________________________________ CITY/STATE/ZIP: _________________________________________________________ * All Franklin registered representatives and Access Persons, PRIOR TO OPENING A BROKERAGE ACCOUNT OR PLACING AN INITIAL ORDER, are required to notify the Legal Compliance Department and the executing broker-dealer in writing. This includes accounts in which the registered representative or access person has or will have a financial interest (e.g., a spouse's account) or discretionary authority (e.g., a trust account for a minor child). Upon receipt of the NOTIFICATION OF SECURITIES ACCOUNT OPENING form, the Legal Compliance Department will contact the broker-dealer identified above and request that it receive duplicate confirmations and statements of your brokerage account. SCHEDULE E: NOTIFICATION OF DIRECT OR INDIRECT BENEFICIAL INTEREST If you have any beneficial ownership in a security and you recommend to the Appropriate Analyst that the security be considered for purchase or sale by an Associated Client, or if you carry out a purchase or sale of that security for an Associated Client, you must disclose your beneficial ownership to the Legal Compliance Department and the Appropriate Analyst in writing on Schedule E (or an equivalent form containing similar information) before the purchase or sale, or before or simultaneously with the recommendation.
- ---------------------------------------------------------------------------------------------------------------------------------- Date and Method Primary Method of Learned that Portfolio Ownership Acquisition Security Under Manager or Date of Security Type (Direct Year (Purch/ Consideration Approriate Name of Person Verbal Description or Indirect) Acquired Gift/Other) by Funds Analyst Notified Notification - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- ____________________________ _____________________________ _________________________ (PRINT NAME) (SIGNATURE) (DATE)
RETURN TO: LEGAL COMPLIANCE DEPARTMENT, FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 SCHEDULE F: INITIAL, ANNUAL & UPDATED DISCLOSURE OF SECURITIES ACCOUNTS ----------------------------------------------------------- This report shall set forth the name and description of each securities account in which you have a direct or indirect beneficial interest, including securities accounts of a spouse, minor children, trusts, foundations, and any account for which trading authority has been delegated to you, other than authority to trade for a Fund in, or a client of, the Franklin Templeton Group. In lieu of listing each securities account below, you may instead attach copies of the brokerage statements, sign below and return Schedule F and brokerage statements to the Compliance Department.
- ---------------------------------------------------------------------------------------------------------------------------------- NAME OF BROKERAGE ADDRESS OF BROKERAGE FIRM, NAME OF NAME(S) ON ACCOUNT FIRM, BANK OR BANK OR INVEST. ADVISER ACCOUNT (REGISTRATION SHOWN INVESTMENT (STREET, CITY , STATE ACCOUNT EXECUTIVE/ ON STATEMENT) ADVISER AND ZIP CODE) NUMBER REPRESENTATIVE - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- TO THE BEST OF MY KNOWLEDGE I HAVE DISCLOSED ALL OF MY SECURITIES ACCOUNTS IN WHICH I HAVE A DIRECT OR INDIRECT BENEFICIAL INTEREST, INCLUDING SECURITY ACCOUNTS OF A SPOUSE, MINOR CHILDREN, TRUSTS, FOUNDATIONS, AND ANY ACCOUNT FOR WHICH TRADING AUTHORITY HAS BEEN DELEGATED TO ME. - --------------------------- ----------------------- ---------------- -------------------- PRINT NAME SIGNATURE DATE YEAR ENDED
RETURN TO: LEGAL COMPLIANCE DEPARTMENT, FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906 SCHEDULE G: INITIAL AND ANNUAL CERTIFICATION OF DISCRETIONARY AUTHORITY This report shall set forth the account name or description in which you have a direct or indirect beneficial interest, including holdings by a spouse, minor children, trusts, foundations, and as to which trading authority has been delegated by you to an unaffiliated registered broker-dealer, registered investment adviser, or other investment manager acting in a similar fiduciary capacity, who exercises sole investment discretion.
- ---------------------------------------------------------------------------------------------------------------------------------- TYPE OF OWNERSHIP NAME(S) AS SHOWN ON NAME/DESCRIPTION OF BROKERAGE FIRM, DIRECT OWNERSHIP (DO) ACCOUNT NUMBER ACCOUNT OR INVESTMENT BANK, INVESTMENT ADVISER OR INVESTMENT INDIRECT OWNERSHIP (IO) (IF APPLICABLE) - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- TO THE BEST OF MY KNOWLEDGE I HAVE DISCLOSED ALL OF MY SECURITIES ACCOUNTS AND/OR INVESTMENTS IN WHICH I HAVE A DIRECT OR INDIRECT BENEFICIAL INTEREST, INCLUDING SECURITY ACCOUNTS OF A SPOUSE, MINOR CHILDREN, TRUSTS, FOUNDATIONS, AND ANY ACCOUNT FOR WHICH TRADING AUTHORITY HAS BEEN DELEGATED AN UNAFFILIATED PARTY. FURTHER, I CERTIFY THAT I DO NOT HAVE ANY DIRECT OR INDIRECT INFLUENCE OR CONTROL OVER THE ACCOUNTS LISTED ABOVE. - ------------------------- -------------------------- ---------------------- --------------------- PRINT NAME SIGNATURE DATE YEAR ENDED
RETURN TO: LEGAL COMPLIANCE DEPARTMENT, FRANKLIN TEMPLETON INVESTMENTS ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-190 SCHEDULE H: CHECKLIST FOR INVESTMENTS IN PARTNERSHIPS AND SECURITIES ISSUED IN PRIVATE PLACEMENTS GENERAL INSTRUCTIONS: In considering requests by Access Persons for approval of limited partnerships and other private placement securities transactions, the Director of Compliance shall consult with an executive officer of Franklin Resources, Inc. In deciding whether to approve the transaction, the Director of Compliance and the executive officer shall take into account, among other factors, whether the investment opportunity should be reserved for a Fund or other client, and whether the investment opportunity is being offered to the access person by virtue of his or her position with the Franklin Templeton Group. IF THE ACCESS PERSON RECEIVES CLEARANCE FOR THE TRANSACTION, AN INVESTMENT IN THE SAME ISSUER MAY ONLY BE MADE FOR A FUND OR CLIENT IF AN EXECUTIVE OFFICER OF FRANKLIN RESOURCES, INC., WHO HAS BEEN INFORMED OF THE ACCESS PERSON'S PRE-EXISTING INVESTMENT AND WHO HAS NO INTEREST IN THE ISSUER, APPROVES THE TRANSACTION. IN ORDER TO PROCESS YOUR REQUEST, PLEASE PROVIDE THE FOLLOWING INFORMATION: 1) Name/Description of proposed investment: ______________________________ 2) Proposed Investment Amount: ______________________________ 3) Please attach pages of the offering memorandum (or other documents) summarizing the investment opportunity, including: a) Name of the partnership/hedge fund/issuer; b) Name of the general partner, location & telephone number; c) Summary of the offering; including the total amount the offering/issuer; d) Percentage your investment will represent of the total offering; e) Plan of distribution; and f) Investment objective and strategy, PLEASE RESPOND TO THE FOLLOWING QUESTIONS: 4) Was this investment opportunity presented to you in your capacity as a portfolio manager, trader or research analyst? If no, please explain the relationship, if any, you have to the issuer or principals of the issuer. 5) Is this investment opportunity suitable for any fund/client that you advise? If yes, why isn't the investment being made on behalf of the fund/client? If no, why isn't the investment opportunity suitable for the fund/clients? 6) Do any of the fund/clients that you advise presently hold securities of the issuer of this proposed investment (e.g., common stock, preferred stock, corporate debt, loan participations, partnership interests, etc)? If yes, please provide the names of the funds/clients and security description. 7) Do you presently have or will you have any managerial role with the company/issuer as a result of your investment? If yes, please explain in detail your responsibilities, including any compensation you will receive. 8) Will you have any investment control or input to the investment decision making process? 9) If applicable, will you receive reports of portfolio holdings? If yes, when and how frequently will these be provided? Reminder: Personal securities transactions that do not generate brokerage confirmations must be reported to the Legal Compliance Department on Schedule B within 10 calendar days after you are notified. _______________________________ Name of Access Person _______________________________ ________________________ Access Person Signature Date Approved by: __________________________________ ________________________ Chief Investment Officer Signature Date - ------------------------------------------------------------------------------ LEGAL COMPLIANCE USE ONLY - ------------------------------------------------------------------------------ DATE RECEIVED: ___________________ DATE ENTERED IN LOTUS NOTES: ___________________ DATE FORWARDED FRI EXECUTIVE OFFICER: _____________________ PRECLEARED: YES [ ] NO [ ] (ATTACHED E-MAIL) DATE: _____________ DATE ENTERED IN APII: ____________________ - ------------------------------------------------------------------------------ APPENDIX C: INVESTMENT ADVISOR AND BROKER-DEALER AND OTHER SUBSIDIARIES OF --------------------------------------------------------------------------- FRANKLIN RESOURCES, INC. - FEBRUARY 2001 ----------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------- Franklin Advisers, Inc. IA Franklin Templeton Investment Corp. (Canada) IA Franklin Advisory Services, LLC IA Templeton/Franklin Investment Services, Inc. IA/BD Franklin Investment Advisory Services, Inc. IA Templeton Investment Counsel, LLC IA Franklin Management, Inc. IA Templeton Asset Management, Ltd. IA/FIA Franklin Mutual Advisers, LLC IA Franklin Templeton Investments Japan Ltd. FIA Franklin Properties, Inc. REA Closed Joint-Stock Company Tempelton (Russia) FIA Franklin/Templeton Distributors, Inc. IA/BD Templeton Unit Trust Management Ltd. (UK) FBD Franklin Assets Management (Propriety Ltd.) IA Orion Fund Management Ltd. FIA Templeton (Switzerland), Ltd. FBD Templeton Global Advisors Ltd. (Bahamas) IA Franklin Templeton Investments (Asia) Ltd. FBD Tempelton Asset Management (India) Pvt. Ltd. FIA/FBD Franklin Templeton Investments Corp. (UK) IA/FIA Templeton Italia SIM S.p.A. (Italy) FBD Franklin Templeton International Services S.A. (Luxembourg) FBD Franklin Templeton Investment Services GmbH Franklin Templeton Investments (Australia) Limited FIA (Germany) FBD Franklin/Templeton Investor Services, LLC TA Templeton Funds Annuity Company INS Franklin Templeton Services, LLC BM FTTrust Company Trust - ----------------------------------------------------------------------------------------------------------------------------------
Codes: IA: US registered investment adviser BD: US registered broker-dealer FIA: Foreign equivalent investment adviser FBD: Foreign equivalent broker-dealer TA: US registered transfer agent BM: Business manager to the funds REA: Real estate adviser INS: Insurance company Trust: Trust company THE FRANKLIN TEMPLETON GROUP POLICY STATEMENT ON INSIDER TRADING A. LEGAL REQUIREMENT Pursuant to the Insider Trading and Securities Fraud Enforcement Act of 1988, it is the policy of the Franklin Templeton Group to forbid any officer, director, employee, consultant acting in a similar capacity, or other person associated with the Franklin Templeton Group from trading, either personally or on behalf of clients, including all client assets managed by the entities in the Franklin Templeton Group, on material non-public information or communicating material non-public information to others in violation of the law. This conduct is frequently referred to as "insider trading." The Franklin Templeton Group's Policy Statement on Insider Trading applies to every officer, director, employee or other person associated with the Franklin Templeton Group and extends to activities within and outside their duties with the Franklin Templeton Group. Every officer, director and employee must read and retain this policy statement. Any questions regarding the Franklin Templeton Group's Policy Statement on Insider Trading or the Compliance Procedures should be referred to the Legal Department. The term "insider trading" is not defined in the federal securities laws, but generally is used to refer to the use of material non-public information to trade in securities (whether or not one is an "insider") or to communications of material non-public information to others. While the law concerning insider trading is not static, it is generally understood that the law prohibits: (1) trading by an insider, while in possession of material non-public information; or (2) trading by a non-insider, while in possession of material non-public information, where the information either was disclosed to the non-insider in violation of an insider's duty to keep it confidential or was misappropriated; or (3) communicating material non-public information to others. The elements of insider trading and the penalties for such unlawful conduct are discussed below. If, after reviewing this policy statement, you have any questions, you should consult the Legal Department. POLICY STATEMENT ON INSIDER TRADING B. WHO IS AN INSIDER? The concept of "insider" is broad. It includes officers, directors and employees of a company. In addition, a person can be a "temporary insider" if he or she enters into a special confidential relationship in the conduct of a company's affairs and as a result is given access to information solely for the company's purposes. A temporary insider can include, among others, a company's outside attorneys, accountants, consultants, bank lending officers, and the employees of such organizations. In addition, an investment adviser may become a temporary insider of a company it advises or for which it performs other services. According to the U.S. Supreme Court, the company must expect the outsider to keep the disclosed non-public information confidential and the relationship must at least imply such a duty before the outsider will be considered an insider. C. WHAT IS MATERIAL INFORMATION? Trading on inside information is not a basis for liability unless the information is material. "Material information" generally is defined as information for which there is a substantial likelihood that a reasonable investor would consider it important in making his or her investment decisions, or information that is reasonably certain to have a substantial effect on the price of the company's securities. Information that officers, directors and employees should consider material includes, but is not limited to: dividend changes, earnings estimates, changes in previously released earnings estimates, significant merger or acquisition proposals or agreements, major litigation, liquidation problems, and extraordinary management developments. Material information does not have to relate to a company's business. For example, in CARPENTER V. U.S., 108 U.S. 316 (1987), the Supreme Court considered as material certain information about the contents of a forthcoming newspaper column that was expected to affect the market price of a security. In that case, a WALL STREET JOURNAL reporter was found criminally liable for disclosing to others the dates that reports on various companies would appear in the WALL STREET JOURNAL and whether those reports would be favorable or not. D. WHAT IS NON-PUBLIC INFORMATION? Information is non-public until it has been effectively communicated to the marketplace. One must be able to point to some fact to show that the information is generally public. For example, information found in a report filed with the Securities and Exchange Commission ("SEC"), or appearing in Dow Jones, Reuters Economic Services, THE WALL STREET JOURNAL or other publications of general circulation would be considered public. E. BASIS FOR LIABILITY 1. FIDUCIARY DUTY THEORY In 1980, the Supreme Court found that there is no general duty to disclose before trading on material non-public information, but that such a duty arises only where there is a fiduciary relationship. That is, there must be a relationship between the parties to the transaction such that one party has a right to expect that the other party will not disclose any material non-public information or refrain from trading. CHIARELLA V. U.S., 445 U.S. 22 (1980). In DIRKS V. SEC, 463 U.S. 646 (1983), the Supreme Court stated alternate theories under which non-insiders can acquire the fiduciary duties of insiders. They can enter into a confidential relationship with the company through which they gain information (E.G., attorneys, accountants), or they can acquire a fiduciary duty to the company's shareholders as "tippees" if they are aware or should have been aware that they have been given confidential information by an insider who has violated his fiduciary duty to the company's shareholders. However, in the "tippee" situation, a breach of duty occurs only if the insider personally benefits, directly or indirectly, from the disclosure. The benefit does not have to be pecuniary but can be a gift, a reputational benefit that will translate into future earnings, or even evidence of a relationship that suggests a quid pro quo. 2. MISAPPROPRIATION THEORY Another basis for insider trading liability is the "misappropriation" theory, under which liability is established when trading occurs on material non-public information that was stolen or misappropriated from any other person. In U.S. V. CARPENTER, SUPRA, the Court found, in 1987, a columnist defrauded THE WALL STREET JOURNAL when he stole information from the WALL STREET JOURNAL and used it for trading in the securities markets. It should be noted that the misappropriation theory can be used to reach a variety of individuals not previously thought to be encompassed under the fiduciary duty theory. F. PENALTIES FOR INSIDER TRADING Penalties for trading on or communicating material non-public information are severe, both for individuals involved in such unlawful conduct and their employers. A person can be subject to some or all of the penalties below even if he or she does not personally benefit from the violation. Penalties include: o civil injunctions; o treble damages; o disgorgement of profits; o jail sentences; o fines for the person who committed the violation of up to three times the profit gained or loss avoided, whether or not the person actually benefited; and o fines for the employer or other controlling person of up to the greater of $1,000,000 or three times the amount of the profit gained or loss avoided. In addition, any violation of this policy statement can result in serious sanctions by the Franklin Templeton Group, including dismissal of any person involved. G. INSIDER TRADING PROCEDURES Each access person, Compliance Officer, the Risk Management Department, and the Legal Department, as the case may be, shall comply with the following procedures. 1. IDENTIFYING INSIDE INFORMATION Before trading for yourself or others, including investment companies or private accounts managed by the Franklin Templeton Group, in the securities of a company about which you may have potential inside information, ask yourself the following questions: o Is the information material? o Is this information that an investor would consider important in making his or her investment decisions? o Is this information that would substantially affect the market price of the securities if generally disclosed? o Is the information non-public? o To whom has this information been provided? o Has the information been effectively communicated to the marketplace (e.g., published in REUTERS, THE WALL STREET JOURNAL or other publications of general circulation)? If, after consideration of these questions, you believe that the information may be material and non-public, or if you have questions as to whether the information is material and non-public, you should take the following steps: (i) Report the matter immediately to the designated Compliance Officer, or if he or she is not available, to the Legal Department. (ii) Do not purchase or sell the securities on behalf of yourself or others, including investment companies or private accounts managed by the Franklin Templeton Group. (iii) Do not communicate the information inside or outside the Franklin Templeton Group, other than to the Compliance Officer or the Legal Department. (iv) The Compliance Officer shall immediately contact the Legal Department for advice concerning any possible material, non-public information. (v) After the Legal Department has reviewed the issue and consulted with the Compliance Officer, you will be instructed either to continue the prohibitions against trading and communication noted in (ii) and (iii), or you will be allowed to trade and communicate the information. (vi) In the event the information in your possession is determined by the Legal Department or the Compliance Officer to be material and non-public, it may not be communicated to anyone, including persons within the Franklin Templeton Group, except as provided in (i) above. In addition, care should be taken so that the information is secure. For example, files containing the information should be sealed and access to computer files containing material non-public information should be restricted to the extent practicable. 2. RESTRICTING ACCESS TO OTHER SENSITIVE INFORMATION All Franklin Templeton Group personnel also are reminded of the need to be careful to protect from disclosure other types of sensitive information that they may obtain or have access to as a result of their employment or association with the Franklin Templeton Group. (I) GENERAL ACCESS CONTROL PROCEDURES The Franklin Templeton Group has established a process by which access to company files that may contain sensitive or non-public information such as the Bargain List and the Source of Funds List is carefully limited. Since most of the Franklin Templeton Group files which contain sensitive information are stored in computers, personal identification numbers, passwords and/or code access numbers are distributed to Franklin Templeton Group computer access persons only. This activity is monitored on an ongoing basis. In addition, access to certain areas likely to contain sensitive information is normally restricted by access codes. -----END PRIVACY-ENHANCED MESSAGE-----