SECTION 2. Background

2.1 Certain Auction Rate Preferred Stock

This notice addresses auction rate preferred stock issued by eligible issuers described herein with terms that are described generally herein (“auction rate preferred stock”). In general, auction rate preferred stock is preferred stock in which the dividend rate is reset periodically (typically every seven to 28 days), pursuant to an auction rate-setting process or a similar remarketing agent rate-setting process that is designed to produce the minimum dividend rate necessary to enable all interested sellers to sell the preferred stock to willing buyers at a price equal to the par amount of the applicable “liquidation preference” (typically, $25,000), plus accrued but unpaid dividends. A “failed” auction or remarketing occurs if the auction or remarketing fails to produce buyers for all interested sellers at a dividend rate that is at or below the maximum dividend rate

specified by the terms of the auction rate preferred stock. Upon a failed auction or remarketing, the dividend rate is reset at a prescribed maximum dividend rate until the next auction or remarketing. In addition, in the case of some issues of auction rate preferred stock, the dividend rate may escalate further to prescribed increasing maximum rates based on the continued occurrence of failed auctions or remarketings for increasing periods of time. The auction rate preferred stock generally is perpetual, optionally redeemable by the issuer at any time, and mandatorily redeemable in certain circumstances, such as upon a failure to meet certain asset coverage requirements. All redemptions of auction rate preferred stock are subject to applicable state law restrictions on redemptions of stock.

This notice only addresses auction rate preferred stock issued in the United States by closed-end management companies that are “regulated investment companies” (as defined in § 851 of the Internal Revenue Code) which invest predominantly in debt instruments and whose other investments are incidental to their business of investing in the debt instruments (“Eligible Issuers”).

2.2 Liquidity Facility Presently, money market funds cannot hold auction rate preferred stock because it lacks the requisite liquidity features necessary to enable it to qualify as an eligible security for purchase by such funds under the Security and Exchange Commission’s Rule 2a–7, 17 C.F.R. 270.2a–7, issued under the Investment Company Act of 1940 (“Rule 2a–7”). In order to address liquidity needs in the auction rate securities market in response to recent auction failures, issuers and third parties seek to add liquidity facilities to support auction rate preferred stock and thereby to enable such stock to become eligible for purchase by money market funds under Rule 2a–7. Issuers and other interested parties reasonably expect that adding liquidity facilities to auction rate preferred stock and expanding the investor base for such stock to include money market fund investors will facilitate successful auctions.

The liquidity facilities for the auction rate preferred stock will be provided by

third-party liquidity providers with terms and parameters that are described generally herein (“liquidity facilities” and “liquidity providers,” respectively). In general, the liquidity facilities will have terms intended to make the auction rate preferred stock covered by such liquidity facilities eligible for purchase by money market funds under Rule 2a–7. All current and future holders of auction rate preferred stock covered by a liquidity facility will be designated third-party beneficiaries of the liquidity facility and will have the right to enforce the liquidity facility directly against the liquidity provider.

A liquidity facility on auction rate preferred stock will provide to holders a tender option or right to sell such stock to the liquidity provider at a price equal to the stock’s liquidation preference, plus accrued but unpaid dividends, if one of the following two “trigger events” occurs: (1) a failed auction or remarketing; or (2) a failure to renew, replace, or extend an existing liquidity facility then in place with the same liquidity provider or another liquidity provider by a date that occurs at least two auction or remarketing dates before the termination date of the existing liquidity facility then in place.

In some cases, a liquidity facility for auction rate preferred stock may include an agreement by the issuer of the auction rate preferred stock to redeem the stock purchased by the liquidity provider under the liquidity facility after a minimum holding period of six months and after continuous good faith efforts to resell the stock in the periodic auctions at a price equal to the liquidation preference, plus accrued but unpaid dividends. In other cases, a liquidity facility for auction rate preferred stock may be provided without any contractual rights of the liquidity provider to require the issuer of such stock to redeem or repurchase any such stock purchased by the liquidity provider under the liquidity facility.

Issuers anticipate that liquidity facilities typically, but not necessarily, will have a term of not more than 364 days for regulatory reasons. Issuers expect that they will be required to arrange for renewal, replacement, or extension of such liquidity facilities at least two auction or remarket

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holding period, the liquidity provider must offer such stock for resale at each periodic auction or remarketing duly held under the terms of the stock to set the dividend rate at a price equal to the par amount of the applicable liquidation preference, plus accrued but unpaid dividends. Except for any contractual rights provided to the liquidity provider to require the issuer of the auction rate preferred stock to redeem or repurchase stock purchased by the liquidity provider under the liquidity facility, the liquidity provider and any subsequent holder of such purchased stock otherwise must not have any greater rights with respect to such stock than other holders of the stock under the terms of the liquidity facility, the terms of such stock, or applicable state law.

3.7 Certain Liquidity Facilities With- out Rights of a Liquidity Provider to Re- quire Redemption or Repurchase of Stock by Issuer . In the case of a liquidity facility for auction rate preferred stock in which the liquidity provider has no contractual rights to require the issuer of such stock or a related party to such issuer to redeem or repurchase stock purchased by the liquidity provider under the liquidity facility, any redemption of such stock purchased by the liquidity provider or any subsequent holder of such purchased stock must be limited by applicable state law restrictions on redemptions of stock that apply to any holder of the auction rate preferred stock ( e.g., state law restrictions on redemptions of stock which would impair the issuer’s required capital, surplus, or total assets). The liquidity provider and any subsequent holder of the auction rate preferred stock must not have any greater redemption rights or other rights against the issuer of such stock or a related party to such issuer with respect to such stock than other holders of such stock under the terms of the liquidity facility, the terms of such stock, or applicable state law.

3.8 Certain Liquidating Partnerships That Hold Auction Rate Preferred Stock . The IRS will not challenge the equity characterization of interests in a partnership for Federal income tax purposes as a result of adding a liquidity facility, as described in this § 3.8, to support the variable-rate interests in the partnership, as described in this § 3.8, if the conditions of this § 3.8 are met. The partnership must reasonably expect that at least 95 percent of the assets

ing dates before expiration of existing liquidity facilities so that liquidity facilities will cover the auction rate preferred stock without interruption to facilitate qualification for purchase by money market funds under Rule 2a–7.

Issuers expect that liquidity providers will charge commercially reasonable liquidity fees for liquidity facilities, including commitment fees for the availability of the liquidity facilities and draw fees for draws to purchase stock under the liquidity facilities.