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18.31. Preferred Securities Risk

There are special risks associated with investing in preferred securities, including:

1. Preferred securities may include provisions that permit the issuer, at its discretion, to defer distributions for a stated period without any adverse consequences to the issuer. If any Investment Compartment owns a preferred security that is deferring its distributions, the relevant Investment Compartment may be required to report income for tax purposes although it has not yet received such income.

2. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure in terms of having priority to corporate income and liquidation payments, and therefore will be subject to greater credit risk than debt instruments.

3. Generally, preferred security holders (such as the Investment Compartments) have no voting rights with respect to the issuing company unless preferred dividends have been in arrears for a specified number of periods, at which time the preferred security holders may elect a number of directors to the issuer’s board. Generally, once all the arrearages have been paid, the preferred security holders no longer have voting rights. In the case of any Investment Compartment preferred securities, holders generally have no voting rights, except if (I) the issuer fails to pay dividends for a specified period of time or (ii) a declaration of default occurs and is continuing.

4. In certain varying circumstances, an issuer of preferred securities may redeem the securities prior to a specified date. 

5. Any Investment Compartment preferred securities are typically issued by corporations, generally in the form of interest bearing notes with preferred securities characteristics, or by an affiliated business of the relevant Investment Compartment of a corporation, generally in the form of beneficial interests in subordinated debentures or similarly structured securities. The relevant Investment Compartment preferred securities market consists of both fixed and adjustable coupon rate securities that are either perpetual in nature or have stated maturity dates.

6. The relevant Investment Compartment preferred securities are typically junior and fully subordinated liabilities of an issuer and benefit from a guarantee that is junior and fully subordinated to the other liabilities of the guarantor. In addition, Investment Compartment preferred securities typically permit an issuer to defer the payment of income for five years or more without triggering an event of default. Because of their subordinated position in the capital structure of an issuer, the ability to defer payments for extended periods of time without default consequences to the issuer, and certain other features (such as restrictions on common dividend payments by the issuer or ultimate guarantor when full cumulative payments on the Investment Compartment preferred securities have not been made), this relevant Investment Compartment preferred securities are often treated as close substitutes for traditional preferred securities, both by issuers and investors.

7. The relevant Investment Compartment preferred securities include but are not limited to Investment Compartment originated preferred securities (“TOPRS®”); monthly income preferred securities (“MIPS®”); quarterly income bond securities (“QUIBS®”); quarterly income debt securities (“QUIDS®”); quarterly income preferred securities (“QUIPSSM”); corporate Investment Compartment securities (“CORTS®”); public income notes (“PINES®”); and other Investment Compartment preferred securities.

8. The relevant Investment Compartment preferred securities are typically issued with a final maturity date, although some are perpetual in nature. In certain instances, a final maturity date may be extended and/or the final payment of principal may be deferred at the issuer’s option for a specified time without default. No redemption can typically take place unless all cumulative payment obligations have been met, although issuers may be able to engage in open-market repurchases without regard to whether all payments have been paid.

9. The relevant Investment Compartment preferred securities are issued by the relevant Investment Compartment or other special purpose entities established by operating companies and are not a direct obligation of an operating company. At the time the Investment Compartment or the special purpose entity sells such preferred securities to investors, it purchases debt of the operating company (with terms comparable to those of the Investment Compartment or the special purpose entity securities), which enables the operating company to deduct for tax purposes the interest paid on the debt held by the Investment Compartment or the special purpose entity. The Investment Compartment or the special purpose entity is generally required to be treated as transparent such that the holders of the Investment Compartment, so the preferred securities are treated as owning beneficial interests in the underlying debt of the operating company. Accordingly, payments on the Investment Compartment preferred securities are treated as interest rather than dividends. The Investment Compartment or the special purpose entity in turn would be a holder of the operating company’s debt and would have priority with respect to the operating company’s earnings and profits over the operating company’s common shareholders, but would typically be subordinated to other classes of the operating company’s debt. Typically a preferred share has a rating that is slightly below that of its corresponding operating company’s senior debt securities.

10. From time to time, preferred securities, including Investment Compartment preferred securities, have been, and may in the future be, offered having features other than those described herein. The Investment Compartment reserves the right to invest in these securities if the Manager believes that doing so would be consistent with the Investment Compartment’s investment objectives and policies. Since the market for these instruments would be new, the Investment Compartment may have difficulty disposing of them at a suitable price and time. In addition to limited liquidity, these instruments may present other risks, such as high price volatility.