SOURCE CAPITAL /DE/ — Regulatory Filings 1996

Apr 29, 1996

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U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-2 [x] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [x] Amendment No. 19 Exact Name of Registrant as Specified in Charter SOURCE CAPITAL, INC. Address of Principal Executive Offices (Number, Street, City, State, Zip Code) 11400 West Olympic Boulevard, Suite 1200, Los Angeles, CA 90064 Registrant's Telephone Number, including Area Code (310) 473-0225 Name and Address (Number, Street, City, State, Zip Code) of Agent for Service Julio J. de Puzo, Jr., President 11400 West Olympic Boulevard, Suite 1200, Los Angeles, CA 90064 Copy to: Lawrence J. Sheehan, Esq., O'Melveny & Myers 1999 Avenue of the Stars, Los Angeles, CA 90067 1 of 38 pages 2 SOURCE CAPITAL, INC. CROSS REFERENCE SHEET

2 3 PART A EXPENSE SYNOPSIS

The foregoing information is intended to assist the investor in understanding the various costs and expenses that an investor in the Company will bear directly or indirectly. See Item 9 - Management for a description of the Investment Advisory Agreement and expenses borne by the Company. The example is included to provide a means for the investor to compare expense levels of investment companies with different fee structures over varying investment periods. To facilitate such comparison, all investment companies are required to utilize a five percent annual return assumption. This assumption is unrelated to the Company's prior performance and is not a projection of future performance. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESSER THAN THOSE SHOWN. * Excludes brokerage commissions paid on purchases and sales of shares of the Company. GENERAL DESCRIPTION OF THE COMPANY GENERAL Source Capital, Inc. ("Company") is a publicly traded, closed-end diversified management investment company, organized as a Delaware corporation on June 24, 1968. INVESTMENT OBJECTIVE The Company's investment objective, which cannot be changed without shareholder approval, is to seek maximum total return for Common shareholders from both capital appreciation and investment income to the extent consistent with protection of invested capital and provision of sufficient income to meet the dividend requirements of Preferred shareholders. This means that the Company does not invest in securities offering higher current yields or the greatest opportunities for capital appreciation if it is perceived that such investment would create undue risk of loss of capital. 3 4 INVESTMENT POLICIES The Company presently invests primarily in publicly traded common stocks and securities convertible into such common stocks. The Company also invests in fixed income securities, such as debentures, notes and preferred stocks, which offer attractive yields or are believed to present opportunities for capital appreciation. It also holds U.S. Government obligations, commercial paper, minimum-term investment certificates and cash to the extent that a temporary defensive position or the availability of assets for possible investment opportunities is considered advisable from time to time. Short-term investments also include the purchase of U.S. Government or Government agency debt securities from a bank subject to a Repurchase Agreement obligating the bank to repurchase and the Company to resell such securities on a fixed date (usually within seven days) and at an agreed upon yield to the Company. The Company may write listed call options which are traded on a national securities exchange and may lend its portfolio securities to broker-dealers and other financial institutions as described in further detail below. The Adviser's emphasis on fundamental analysis of an issuer's prospects and the inherent value of its securities may result in a portion of the portfolio being invested in medium or smaller sized companies or companies perceived by the average investor to be unpopular or unfamiliar. This should not imply that values are not available in larger, better known companies. Rather, it is the Adviser's position that value can be found in companies of all sizes. Substantially all common stocks the Company purchases, however, will be either listed on a national securities exchange or included in the National Association of Securities Dealers Automated Quotation ("NASDAQ") National Market System or National List. The Adviser's value-oriented investment approach may result in a portfolio which may not reflect all facets of the national economy and which may differ significantly from the broad market indices. The Adviser's value-oriented investment approach may reduce but does not eliminate the risk of loss from investments in common stocks and other securities since market prices can be expected to fluctuate with changes in the business and prospects of an issuer, as well as with general market conditions. The market price of fixed-income securities held by the Company can be expected to vary inversely to changes in prevailing interest rates. Investments in fixed-income securities with longer maturities generally produce higher yields but are subject to greater market fluctuation. Certain fixed-income securities, including convertible securities in which the Company invests, are rated BB or lower, by Standard & Poor's Corporation ("S&P") or Ba or lower by Moody's Investors Service, Inc. ("Moody's"), which ratings are considered by the rating agencies to be speculative, or are unrated securities considered by the Adviser to be of comparable quality. Debt securities with a rating of BB/Ba or lower are commonly referred to as "junk bonds." See "Risks of Lower-Rated Debt Securities" below. The Company may employ from time to time certain investment techniques which involve additional risks. These investment techniques include purchasing unregistered securities, writing listed call options, effecting short sales against the box, lending portfolio securities, investment in foreign securities and repurchase agreements. Each of these investment techniques and the risks thereof are described under separate subheadings below. As noted above, the Company may invest in Convertible Securities, in debt securities which are not rated in the highest two grades by Moody's and S&P, and in preferred stocks. As used herein, a convertible security is a bond, debenture, or note, that may be converted into or exchanged for, or is accompanied by a warrant or other right to purchase, a specified amount of common stock of the same or a different issuer within a particular period of time at a specified price or formula. A Convertible Security entitles the holder to receive interest paid or accrued on the debt security until the Convertible Security matures or is redeemed, converted or exchanged. Before conversion, Convertible Securities have characteristics similar to non-convertible debt securities in that they ordinarily provide a stable stream of income with generally higher yields than those of common stocks of the same or similar issuers. Convertible Securities rank senior to common stock in a corporation's capital structure and, therefore, generally entail less risk than the corporation's common stock, although the extent to which such risk is reduced depends in large measure upon the degree to which the Convertible Security sells near its value as a fixed-income security. Prices of convertible securities generally fluctuate in response to changes in interest rates as well as to changes in the prices of the underlying common stocks. RISKS OF LOWER-RATED DEBT SECURITIES Convertible Securities are generally not investment grade securities which are those rated within the four highest categories by S&P and Moody's. Investment grade securities rated BBB by S&P or Baa by Moody's are considered to have speculative characteristics. To the extent that Convertible Securities or other debt securities acquired by the Company are rated lower than investment grade or are comparable unrated securities, there is a 4 5 greater risk as to the timely repayment of the principal of, and timely payment of interest on, such securities. The Company may invest up to 30% of its net assets in Convertible Securities and other debt securities rated BB or lower by S&P or Ba or lower by Moody's, and comparable unrated securities. Decisions to purchase and sell these securities are based on the Adviser's evaluation of their investment potential and not on the ratings assigned by credit agencies. Because investment in lower rated securities involves greater investment risk, achievement of the Company's investment objective is more dependent on the Adviser's credit analysis than with respect to the Company's investments in higher rated securities. Lower rated securities may be more susceptible to real or perceived adverse economic and competitive industry conditions than investment grade securities. A projection of an economic downturn, for example, could cause a decline in the prices of lower rated securities because the advent of a recession could lessen the ability of a highly leveraged company to make principal and interest payments on its debt securities. In addition, the secondary trading market for lower rated securities may be less liquid than the market for higher rated securities. Prices of lower rated securities may decline rapidly in the event a significant number of holders decide to sell. Changes in expectations regarding an individual issuer, an industry or lower rated securities generally could reduce market liquidity for such securities and make their sale by the Company more difficult, at least in the absence of price concessions. The lower rated bond market has grown primarily during a period of long economic expansion and it is uncertain how it would perform during an extended economic downturn. An economic downturn or an increase in interest rates could severely disrupt the market for lower rated bonds and adversely affect the value of outstanding bonds and the ability of the issuers to repay principal and interest. The convertible and lower rated securities in which the Company may invest from time to time include debt securities of companies that are financially troubled, in default or are in bankruptcy or reorganization ("Deep Discount Securities"). These securities may be rated C, C1 or D by S&P or C by Moody's or may be unrated. Debt obligations of such companies are usually available at a deep discount from the face value of the instrument. The Company will invest in Deep Discount Securities when the Adviser believes that existing factors are likely to improve the company's financial condition. Such factors include a restructuring of debt, management changes, existence of adequate assets, or other special circumstances. A debt instrument purchased at a deep discount, but prior to default, may currently pay a very high effective yield. In addition, if the financial condition of the issuer improves, the underlying value of the securities may increase, resulting in a capital gain. If the issuer defaults on its obligations or remains in default, or if the plan of reorganization is insufficient for debt-holders, the Deep Discount Securities may stop generating income and lose value or become worthless. The Adviser will balance the benefits of Deep Discount Securities with their risks. While a diversified portfolio may reduce the overall impact of a Deep Discount Security that is in default or loses its value, the risk cannot be eliminated. As of December 31, 1995, the average percentage of the Company's assets invested in fixed income securities (or preferred stocks) within the various rating categories (based on the S&P ratings if the securities are rated by S&P, otherwise based on Moody's ratings), and the nonrated debt securities, determined on a dollar weighted average, were as follows:

• The nonrated debt securities as a percentage of total net assets are considered by the Adviser to be comparable to securities rated by S&P as BB - 1.6%. 5 6 SPECIAL CONSIDERATIONS AND RISK FACTORS MARKET PRICE PREMIUM OR DISCOUNT FROM NET ASSET VALUE. Shares of the Company are listed and traded on the New York Stock Exchange. Since the Company is a closed-end investment company, shareholders do not have the right to redeem shares at net asset value. The market price for shares of closed-end investment companies generally varies from per share net asset value and such shares frequently trade at a discount from net asset value. Shares of common stock of the Company have traded at, above and below net asset value since the commencement of operations. See "Share Price Data." During the past three years, the Company's common stock has generally traded at a premium above net asset value. To the extent [that] shares trade at a premium above net asset value, a reduction in such premium or a change from a premium to a discount would adversely affect an investor's return. ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's Certificate of Incorporation may be regarded as "anti-takeover" provisions. These provisions require the affirmative vote or consent of the holders of at least two-thirds of the outstanding shares of the Company for a merger or consolidation of the Company with an open-end investment company, a merger or consolidation of the Company with a closed-end investment company with different voting requirements, dissolution of the Company, a sale of all or substantially all of the assets of the Company or an amendment to the Company's Certificate of Incorporation making the common stock a redeemable security or reducing the two-thirds vote required by the Certificate of Incorporation. See "Capital Stock - Anti-Takeover Provisions of the Certificate of Incorporation." DISTRIBUTIONS. The Company pays quarterly distributions on its common stock approximating, on an annual basis, 10% of the ongoing net asset value of such shares. These distributions require payments substantially in excess of the Company's net investment income. Only the portion of a distribution which equals the Company's current net investment income should be considered a dividend. The remainder constitutes a payment out of the Company's net realized capital gains for each period to the extent available; any excess is from paid-in capital. See "Capital Stock - Common Dividends and Distributions." EFFECTS OF LEVERAGE Based on total net assets at December 31, 1995, approximately 15.0% of the Company's capital structure was represented by the Preferred Stock. The leverage provided by the Preferred Stock increases the potential risk and return on the Common Stock. Dividends on the Preferred Stock are paid at an annual rate of $2.40 per share. Based upon the Company's total net assets at December 31, 1995, the portfolio must experience an annual return of 1.3% in order to cover this dividend. The following table is provided to assist in understanding the effects of leverage. The assumed return figures appearing in the table are hypothetical and actual returns may be greater or less than those shown below.

6 7 SHARE PRICE DATA The following table sets forth the high and low sales price on the New York Stock Exchange ("NYSE") and the volume of trading in such shares during each calendar quarter for the last two years. Also set forth are the related net asset values per share of Common Stock, $1.00 par value ("Common Stock"), as calculated by First Pacific Advisors, Inc., the Company's investment adviser ("Adviser"), and the premium (discount) to net asset value represented by such market prices. The liquidation preference of the $2.40 Cumulative Preferred Stock, $3.00 par value ("Preferred Stock"), is $27.50 per share.

On April 19, 1996, the last sale price for shares of Common Stock and Preferred Stock on the NYSE was $41.125 and $28.50, respectively. The Common Stock price represented a discount of 5.87% from the net asset value per share as determined on April 19, 1996, of $43.69. Although shares of Common Stock of the Company have generally traded at a premium to net asset value from September 1984 to May 1987, and from June 1990 to November 1994, such shares traded at a discount from net asset value for many years prior to September 1984, and generally traded at a discount from June 1987 to May 1990, and from December 1994 to present. INVESTMENT RESTRICTIONS The Company has adopted the following investment restrictions which cannot be changed without approval by the holders of both a majority of the Preferred Stock and of the Common Stock. Such majority is defined by the Act as (i) 67% or more of the voting securities present in person or by proxy at the meeting, if the holders of more than 50% of the outstanding voting securities are present or represented by proxy, or (ii) more than 50% of the outstanding voting securities, whichever is less. These restrictions provide that the Company shall not: 1. Purchase any security if such purchase would cause less than 75% of the value of its total assets to be represented by cash and cash items (including receivables), Government securities, securities of other investment companies and other securities for the purpose of this calculation limited in respect to any one issuer to an amount not greater in value than 5% of the value of the total assets of the Company and to not more than 10% of the outstanding voting securities of such issuer. 2. Make short sales of securities or maintain a short position unless the Company contemporaneously owns or has the right to obtain at no added cost securities identical to those sold short (short sales "against the box") or unless the securities sold are "when issued" or "when distributed" securities which the Company expects to receive in a recapitalization, reorganization, or other exchange for securities the Company contemporaneously owns or has the right to obtain at no added cost. The Company shall not make short sales or maintain a short position if to do so would cause more than 25% of the Company's total net assets (exclusive of proceeds from short sales) to be allocated to a segregated account in connection with short sales. Purchase securities on margin, but the Company may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. 7 8 3. Purchase or retain the securities of any issuer if those officers and directors of the Company or its Adviser owning individually more than 1/2 of 1% of the securities of such issuer together own more than 5% of the securities of such issuer. 4. Engage in transactions in puts, calls or combinations thereof, but the Company may acquire warrants or other rights to subscribe to securities of companies issuing such warrants or rights, or of parents or subsidiaries of such companies; except that the Company may write listed call options which are traded on a national securities exchange. The Company may write options only on securities which it owns (covered options), and is required to retain ownership of the underlying security as long as the option remains outstanding. The Company may not write any option which would at the time cause outstanding options written by the Company to cover securities comprising more than 10% of the value of the Company's assets. 5. Purchase securities of other investment companies if immediately after such purchase the Company will own (a) more than 3% of the total outstanding voting stock of the acquired company, (b) securities issued by the acquired company having an aggregate value in excess of 5% of the value of the total assets of the Company, or (c) securities issued by all investment companies having an aggregate value in excess of 10% of the value of the total assets of the Company. In addition, the Company may not purchase securities of an open-end investment company. 6. Invest in commodities, commodity contracts, real estate, or interests in real estate, although the Company may purchase securities of companies holding real estate or interests therein. 7. Issue any Senior Securities (as defined by the Act) except the Preferred Stock; or borrow in excess of 5% of the value of its total assets, or pledge its assets to an extent greater than 10% of the value of its total assets; provided that any borrowing must be from banks and must be undertaken only as a temporary measure for extraordinary or emergency purposes. 8. Make any investment which would cause more than 25% of its assets to be invested in securities issued by companies principally engaged in any one industry. 9. Make loans except that the Company may acquire non-publicly offered debt securities (including convertible securities and including Repurchase Agreements) of any company and except that the Company may in an amount not exceeding 10% of its net assets acquire debt securities of any person in connection with the sale or other disposition of securities owned by the Company. The purchase of a portion of an issue of publicly distributed bonds, debentures or other debt securities, whether or not the purchase was made upon the original issue of the securities is not considered to be a loan. The Company may lend its portfolio securities to brokers, dealers and other financial institutions, provided that such loans are callable at any time by the Company, and are at all times secured by cash collateral that is equal to at least the market value, determined daily, of the loaned securities. The Company may make loans of portfolio securities with a market value of up to 20% of the value of the Company's total assets. 10. Invest in securities of issuers that do not have outstanding a class of securities for which market quotations are readily available, except for (i) non-convertible debt securities and (ii) other securities acquired in connection with the sale or other disposition of securities owned by the Company or which are believed will enhance or protect the value of securities owned by the Company. 11. Purchase restricted securities, other than debt securities, from an issuer unless the Company has obtained the contractual right to call upon the issuer to file a registration statement with respect to the restricted securities. The issuer's commitment to register its securities may be for a limited or for an unlimited period of time, but if limited it will encompass a period of at least two years. The Company may purchase restricted securities from a holder without obtaining such a contractual right from the issuer if the value of all such securities does not exceed 10% of the value of the total assets of the Company. 8 9 OPERATING POLICIES The Company has also adopted the following operating policies. The Company may not invest more than 5% of the value of its total assets in securities of companies which (including predecessor companies or operations) have been in business less than three years. The Company may not invest more than 5% of its net assets in warrants or rights valued at the lower of cost or market, nor more than 2% of its net assets in warrants or rights (valued on such basis) which are not listed on the NYSE or American Stock Exchange. Warrants or rights acquired in units or attached to other securities are not subject to the foregoing limitations. The Company may not invest more than 5% of the value of its total assets in securities of foreign issuers under circumstances that would subject it to any federal interest equalization tax then in effect or at prices that reflect any such tax. The Company may not purchase a restricted security, other than a debt security, if the total value of restricted securities, other than debt securities, owned by the Company would exceed 15% of its net assets. The Company may not purchase a restricted debt security if the total value of restricted debt securities owned by the Company would exceed 30% of its total assets. While the Company may invest in securities of an issuer for the purpose of exercising control or management thereof, it is the Company's operating policy not to do so except where necessary to realize the value of a prior investment. The operating policies described in this paragraph may be amended by the Board of Directors without the vote of shareholders. SECURITIES OF FOREIGN ISSUERS Investments in securities of foreign issuers may be affected favorably or unfavorably by changes in currency rates and exchange control regulations. Compared to U.S. companies, there may be less publicly available information about foreign companies and they generally are subject to less stringent accounting, auditing and financial reporting standards and requirements. Securities of some foreign companies may be less liquid or more volatile than those of U.S. companies. Foreign brokerage commissions and custodial fees are generally higher than in the United States. Investments in foreign securities may involve additional risks, including local political or economic developments, expropriation or nationalization of assets and imposition of withholding taxes on dividend or interest payments. In the event of a default on any foreign debt obligation, it may be more difficult for the Company to obtain or enforce a judgment against the issuer. COVERED CALL OPTIONS When the Company writes a listed call option, the purchaser has the right to buy a security from the Company at a fixed exercise price any time before the option contract expires, regardless of changes in the market price of the underlying security. The Company writes options only on securities it owns (covered options) and must retain ownership of the underlying security while the option is outstanding. Until the option expires, the Company cannot profit from a rise in the market price of the underlying security over the exercise price, except insofar as the premium which the Company receives, net of commissions, represents a profit. The premium paid to the Company is the consideration for undertaking this obligation. The Company may not write any option which, at the time, would cause its outstanding options to cover securities comprising more than 10% of its asset value. Writing option contracts is a highly specialized activity and may limit investment flexibility at certain times. The maximum term for listed options exceeds two years, but the Company expects that most options it writes will not exceed six months. SHORT SALES AGAINST THE BOX The Company can make short sales of securities or maintain a short position if the Company contemporaneously owns or has the right to obtain at no added cost securities identical to those sold short (short sales "against the box") or if the securities sold are "when issued" or "when distributed" securities which the Company expects to receive in a recapitalization, reorganization or other exchange for securities the Company contemporaneously owns or has the right to obtain at no added cost. The principal purpose of making short sales is to enable the Company to obtain the current market price of a security which the Company desires to sell but which cannot be currently delivered for settlement. The Company shall not make short sales or maintain a short position if to do so would cause more than 25% of its total net assets (exclusive of proceeds from short sales) to be allocated to a segregated account in connection with short sales. REPURCHASE AGREEMENTS The Company can invest in repurchase agreements with domestic banks or dealers to earn a return on temporarily available cash. A repurchase agreement is a short-term investment in which the purchaser (i.e., the Company) acquires a debt security and the seller agrees to repurchase at a future time and set price, thereby determining the yield during the holding period. Repurchase agreements are collateralized by the underlying debt 9 10 securities and may be considered loans under the 1940 Act. In the event of bankruptcy or other default by the seller, the Company may experience delays and expenses liquidating the underlying security, loss from decline in value of such security and lack of access to income on such security. RESTRICTED SECURITIES Restricted securities are securities that have been sold in the United States without registration under the Securities Act of 1933 (including any securities purchased by the Company pursuant to Rule 144A) and are thus subject to restrictions on resale. Restricted securities generally may be resold only in a privately negotiated transaction with a limited number of purchasers or in a public offering registered under the Securities Act of 1933. Considerable delay could be encountered in either event. These difficulties and delays could result in the Company's inability to realize a favorable price upon disposition of restricted securities, and in some cases, might make disposition of such restricted securities at the time desired by the Company impossible. In those instances where the Company determines to have restricted securities held by it registered prior to sale and the Company does not have a contractual commitment from the issuer or seller to pay the costs of such registration, the gross proceeds from the sale of the securities would be reduced by the registration costs and underwriting discounts in the event of a public offering. Restricted securities of a class which is publicly traded normally may be resold beginning two years following the acquisition, subject to the volume limitations and certain other conditions of Rule 144 under the Securities Act of 1933. Beginning three years after acquisition, such securities ordinarily may be resold without restriction. Rule 144A provides a "safe harbor" for the resale of certain restricted securities among qualified institutional investors without registration under the Securities Act of 1933 and without any holding period requirement. MANAGEMENT OF THE COMPANY GENERAL A board of seven directors is responsible for overseeing the Company's affairs. The Adviser selects investments for the Company, provides administrative services and manages the Company's business. The Adviser, together with its predecessors, has been in the investment advisory business since 1954, serving as investment adviser to the Company since its inception. All officers of the Company are also officers of the Adviser. A number of the directors and officers of the Company are also directors and/or officers of one or more of the four open-end investment companies advised by the Adviser. These investment companies are FPA Capital Fund, Inc. ("Capital"), FPA New Income, Inc. ("New Income"), FPA Paramount Fund, Inc. ("Paramount"), and FPA Perennial Fund, Inc. ("Perennial") (collectively, "FPA Fund Complex"). The directors and officers of the Company and their principal occupations during the past five years are listed below. Unless otherwise indicated, the address for each person is 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064. The Company has no advisory board, executive or investment committee. WESLEY E. BELLWOOD, DIRECTOR 500 North State College Boulevard, Orange, California. Chairman of the Board and director of Wynn's International, Inc. (diversified automotive aftermarket products manufacturer). DAVID REES, DIRECTOR 1601 Country Club Drive, Glendale, California. Private investor. First Vice President and director of the International Institute of Los Angeles. Formerly, until 1995, Senior Editor of Los Angeles Business Journal for more than the preceding five years. LAWRENCE J. SHEEHAN, DIRECTOR 1999 Avenue of the Stars, Los Angeles, California. Of counsel to, and partner (1969 to 1994) of, the law firm of O'Melveny & Myers, legal counsel to the Company. Director of Capital, of New Income, of Perennial, and of TCW Convertible Securities Fund, Inc., a closed- end investment company not advised by the Adviser. CHARLES W. STANTON, DIRECTOR 743-P Avenida Majorca, Laguna Hills, California. Retired. Independent Architectural and Planning Consultant. Formerly head of the New York Office of Welton Becket Associates (architectural and engineering firm). KENNETH L. TREFFTZS, DIRECTOR 11131 Briarcliff Drive, San Diego, California. Private investor. Director of Capital, of New Income, of Perennial, and of Fremont General Corporation (financial service company). Director (or Trustee) of the Pacific Horizon Funds and Horizon Funds, a group of 13 open-end investment company portfolios not advised by the Adviser. Formerly Professor of Finance and Chairman of the Department of Finance and Business Economics, University of Southern California Graduate School of Business. 10 11 JULIO J. DE PUZO, JR., PRESIDENT, TREASURER AND DIRECTOR Principal, since March 1996, Chief Executive Officer since March 1996 and director since October 1995 of the Adviser; and Executive Vice President (since March 1996), Chief Financial Officer (since October 1991) and director (since May 1991) of FPA Fund Distributors, Inc. ("Fund Distributors"). Treasurer of Capital, New Income, Paramount and Perennial. Executive Vice President from October 1995 to March 1996, Chief Administrative Officer from October 1995 to March 1996, Chief Financial Officer from June 1991 to March 1996, Treasurer from June 1991 to March 1996, Senior Vice President from February 1993 to October 1995, and First Vice President from April 1985 to February 1993, of the Adviser; and Senior Vice President (or First Vice President) from October 1991 to March 1996 of Fund Distributors. *ROBERT L. RODRIGUEZ, SENIOR VICE PRESIDENT AND DIRECTOR Principal, Chief Investment Officer and director of the Adviser since March 1996; and director of Fund Distributors since March 1996. President and Chief Investment Officer of Capital and New Income. Executive Vice President from January 1996 to March 1996, Senior Vice President from February 1993 to January 1996, and Vice President from November 1983 to February 1993, of the Adviser. CHRISTOPHER LINDEN, SENIOR VICE PRESIDENT Principal and director of the Adviser since March 1996. Senior Vice President of Capital, New Income, Paramount and Perennial. President from February 1993 to March 1996, Senior Vice President from November 1980 to February 1993, and director and Chief Operating Officer from June 1991 to September 1995, of the Adviser; director of Fund Distributors from May 1991 to September 1995; director and Chairman of the Board from June 1985 to May 1995, and Chief Operating Officer from December 1982 to November 1995, of Paramount; and President and Chief Investment Officer of Perennial from September 1983 to September 1995. ERIC S. ENDE, SENIOR VICE PRESIDENT Senior Vice President (or Vice President) of the Adviser for more than the past five years. President and Chief Investment Officer of Perennial, and Vice President of Capital, New Income and Paramount. Executive Vice President from August 1995 to September 1995, and Vice President from May 1985 to August 1995, of Perennial. STEVEN T. ROMICK, VICE PRESIDENT Senior Vice President of the Adviser since March 1996. Director, Chairman of the Board and Chief Financial Officer of The Crescent Group, Inc. from May 1990 to February 1996. SHERRY SASAKI, SECRETARY Assistant Vice President (since December 1992) and Secretary (or Assistant Secretary) of the Adviser for more than the past five years; and Secretary of Fund Distributors. Secretary of Capital, of New Income, of Paramount, and of Perennial. CHRISTOPHER H. THOMAS, ASSISTANT TREASURER Vice President and Controller of the Adviser and of Fund Distributors since March 1995. Assistant Treasurer of Capital, of New Income, of Paramount, and of Perennial since April 1995. Staff Accountant with the Office of Inspection of the Securities and Exchange Commission from 1994 to March 1995. School Administrator of the Calvary Road Christian Academy from 1988 to 1993. * Indicates a director who is an interested person under the Act. The Company does not pay any salaries to its officers, who are compensated by the Adviser. The following information relates to director compensation. The five directors who are not affiliated with the Adviser received as a group $75,000 for the year ended December 31, 1995. Each such director is also reimbursed for out-of-pocket expenses incurred as a director. During the year ended December 31, 1995, the Company incurred legal fees of $14,373 payable to O'Melveny & Myers, legal counsel for the Company. Lawrence J. Sheehan, a director of the Company, was a partner of that firm. 11 12

(1) Director since March 1996. * No pension or retirement benefits are provided to Directors by the Company or the FPA Fund Complex. ** Includes compensation from the Company and from three open-end investment companies. INVESTMENT ADVISER First Pacific Advisors, Inc. ("Adviser"), a Massachusetts corporation, is the successor to a California corporation of the same name which served as investment adviser to the Company from its organization in 1968 to June 27, 1991. On that date, the Adviser purchased the former adviser's business as a going concern. The Adviser maintains its principal office at 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064. The Adviser and the former adviser are hereinafter sometimes collectively referred to as the "Adviser." The Adviser was organized by, and is an indirect wholly owned subsidiary of, United Asset Management Corporation ("UAM"), which is a holding company principally engaged, through affiliated firms, in providing institutional investment management and acquiring institutional investment management firms. The common stock of UAM is listed on the New York Stock Exchange. No person is known by UAM to own or hold with power to vote 25% or more of the outstanding shares of UAM common stock. The Adviser serves as investment adviser to the following open-end investment companies (mutual funds): FPA Paramount Fund, Inc. (since July 1978), which had net assets of $575,065,069 at December 31, 1995; FPA Perennial Fund, Inc. (since commencement of operations in April 1984), which had net assets of $47,390,332 at December 31, 1995; FPA Capital Fund, Inc. (since July 1984), which had net assets of $353,000,947 at December 31, 1995; and FPA New Income, Inc. (since July 1984), which had net assets of $233,604,691 at December 31, 1995. The Adviser also advises institutional accounts. The Adviser had total assets under management of $3.4 billion at December 31, 1995. PORTFOLIO MANAGEMENT Eric S. Ende, whose occupation is described above, has been primarily responsible for the day-to-day management of the Company's portfolio since March 1996. For more than ten years prior to March 1996, Mr. Ende assisted George H. Michaelis who served as President and portfolio manager of the Company from 1978 until his accidental death in 1996. INVESTMENT ADVISORY AGREEMENT The Adviser provides investment management and advisory services to the Company pursuant to an Investment Advisory Agreement dated June 27, 1991 ("Advisory Agreement"). The continuation of the Advisory Agreement to April 30, 1996, was approved by shareholders of the Company on May 1, 1995. The Advisory Agreement provides that it may be renewed from year to year by (i) the Board of Directors of the Company or by the vote of a majority (as defined in the Act) of the outstanding voting securities of the Company, and (ii) by the vote of a majority of directors who are not interested persons (as defined in the Act) of the Company or of the Adviser cast in person at a meeting called for the purpose of voting on such approval. The renewal of the Advisory Agreement through April 30, 1997, has been approved by the Board of Directors and a majority of the directors who are not interested persons of the Company or of the Adviser. Under the Advisory Agreement, the Adviser provides continuing supervision of the Company's investment portfolio. The Adviser is authorized, subject to the control of the Company's Board of Directors, to determine which 12 13 securities are to be bought or sold and in what amounts. In addition to providing management and investment advisory services, the Adviser furnishes office space, facilities and equipment. The Adviser also compensates all officers and other personnel of the Company except directors who are not affiliated with the Adviser. For providing these services, the Adviser receives a monthly fee equal to 1/12 of the annualized percentage indicated below of total net assets. The annualized percentage is determined by the total net assets of the Company on the last business day of each month, in accordance with the following table: 0.725% for the first $100 million of total net assets; 0.700% for the next $100 million of total net assets; and 0.675% for the total net assets over $200 million. This fee is higher than the fee paid by some other investment companies. For the years ended December 31, 1993, 1994 and 1995, the Adviser received $2,296,999, $2,305,313 and $2,437,373, respectively, in net advisory fees from the Company. The total net assets of the Company were $362,086,804 on December 31, 1995. Other than the expenses specifically assumed by the Adviser under the Advisory Agreement, all expenses incurred in the operation of the Company are borne by the Company. Expenses incurred by the Company include brokerage commissions on portfolio transactions, fees and expenses of directors who are not affiliated with the Adviser, taxes, transfer agent fees, dividend disbursement and reinvestment and custodian fees, auditing and legal fees, the cost of printing and mailing reports and proxy materials to shareholders, expenses of printing and engraving stock certificates, expense of trade association memberships, and advertising and public relations expenses. No advertising or public relations expenses have been incurred by the Company except in connection with shareholder relations and shareholder communications. The Advisory Agreement includes a provision for a reduction in the advisory fees payable to the Adviser in the amount by which certain defined operating expenses of the Company for any year exceed 1.5% of the first $30 million of average total net assets of the Company, plus 1% of the remaining average total net assets. Operating expenses, as defined in the Advisory Agreement, exclude interest, taxes, any expenditures for supplemental statistical and research information, any uncapitalized legal expenses relating to specific portfolio securities or any proposed acquisition or disposition thereof, and extraordinary expenses such as those of litigation, merger, reorganization or recapitalization. All expenditures, including costs incurred in connection with the purchase, holding or sale of portfolio securities, which are capitalized in accordance with generally accepted accounting principles applicable to investment companies, are accounted for as capital items and not as expenses. This expense limitation provision does not require any payment by the Adviser beyond the return of the advisory fees for a year. The Advisory Agreement provides that the Adviser shall have no liability to the Company or any shareholders of the Company for any error of judgment, mistake of law or any loss arising out of any investment, or for any other act or omission in the performance by the Adviser of its duties under the Advisory Agreement, except for liability resulting from willful misfeasance, bad faith or negligence on the part of the Adviser or the reckless disregard of its duties under the Advisory Agreement. The Advisory Agreement may be terminated without penalty by the Board of Directors of the Company or the vote of a majority (as defined in the Act) of the outstanding voting securities of the Company upon 60 days' written notice to the Adviser or by the Adviser upon like notice to the Company. The Advisory Agreement will automatically terminate in the event of its assignment, as that term is defined in the Act. PORTFOLIO TRANSACTIONS AND BROKERAGE Under the Investment Advisory Agreement ("Advisory Agreement"), dated June 27, 1991, the Adviser makes decisions to buy and sell securities for the Company, selects broker-dealers, and negotiates commission rates or net prices. In over-the-counter transactions, orders are placed directly with a principal market maker unless it is believed better prices and executions are available elsewhere. Portfolio transactions are effected with broker-dealers selected for their abilities to give prompt execution at prices which are favorable to the Company. If these primary considerations are met, agency transactions for the Company are typically placed with brokers which provide brokerage and research services to the Company or the Adviser at commission rates considered to be reasonable, although higher than the lowest brokerage rates available. No formula for such allocation exists. The Company thus bears the cost of such services. While research services may be useful to supplement other available investment information, the receipt thereof does not necessarily reduce the expenses of the Adviser. Any solicitation fees which are received by the Adviser in connection with a tender of portfolio securities of the Company in acceptance of an exchange or tender offer are applied to reduce the advisory fees payable by the Company. The Company does not pay any mark-up over the market price of securities acquired in principal transactions with dealers. The Advisory Agreement includes direct authorization for the Adviser to pay commissions on securities transactions to broker-dealers furnishing research services in an amount higher than the lowest available rate, if the Adviser determines in good faith that the amount is reasonable in relation to the brokerage and research services provided (as required by Section 28(e) of the Securities Exchange Act of 1934), viewed in terms of the particular transaction or the Adviser's overall responsibilities with respect to accounts as to which it exercises investment discretion. The term brokerage and research services is defined to include advice as to the value of securities, the advisability of investing in, purchasing or selling securities, the availability of securities or purchasers or sellers of 13 14 securities, furnishing analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy and performance of accounts, and effecting securities transactions, and performing functions incidental thereto, such as clearance, settlement, and custody. The Adviser also places portfolio transactions for other advisory accounts, including other investment companies. Research services furnished by broker-dealers which effect securities transactions for the Company may be used by the Adviser in servicing all of its advisory accounts and not all such research services may be used by the Adviser in the management of the Company's portfolio. Conversely, research services furnished by broker-dealers which effect securities transactions for other advisory accounts may be used by the Adviser in the management of the Company. In the opinion of the Adviser, it is not possible to measure separately the benefits from research services to each advisory account. Because the volume and nature of the trading activities of the advisory accounts are not uniform, the amount of commissions in excess of the lowest available rate paid by each advisory account for brokerage and research services will vary. In the opinion of the Adviser, however, total commissions paid by the Company are not disproportionate to the benefits received by it on a continuing basis. Brokerage commissions paid by the Company on portfolio transactions for the years ended December 31, 1993, 1994 and 1995 totaled approximately $219,763, $252,529 and $317,504, respectively. During the last fiscal year, $278,483 of commissions were paid on transactions having a total value of $142,875,802 to broker-dealers selected because of research services provided to the Adviser. The Adviser seeks to allocate portfolio transactions equitably whenever concurrent decisions are made to purchase or sell securities for the Company and another advisory account. In some cases, this procedure could have an adverse effect on the price or the amount of securities purchased or sold by the Company. In making such allocations, the main factors considered by the Adviser are the respective investment objectives, the relative size of portfolio holdings of the same or comparable securities, the availability of cash for investment, the size of investment commitments generally held and the opinions of the persons responsible for recommending the investment. CUSTODIAN, TRANSFER AGENT, DIVIDEND PAYING AGENT AND REGISTRAR All cash and securities of the Company are held by the custodian, State Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts 02110. Rules adopted under the Investment Company Act of 1940 permit the Company to maintain its foreign securities in the custody of certain eligible foreign banks and securities depositories. Pursuant to these rules, any foreign securities in the Company's portfolio may be held by foreign sub-custodians and securities depositories approved by the directors of the Company in accordance with the regulations of the Securities and Exchange Commission. The transfer agent, dividend disbursing agent and registrar for the Company's shares is Chemical Mellon Shareholder Services, L.L.C., P.O. Box 590, Ridgefield Park, New Jersey 07660. INDEPENDENT AUDITORS Ernst & Young LLP, 515 South Flower Street, Los Angeles, California 90071, performs annual audits of the Company's financial statements. PRINCIPAL SHAREHOLDERS OF THE COMPANY On March 1, 1996, no person owned of record, or, to the knowledge of management, owned beneficially more than 5% of the outstanding Common Stock or more than 5% of the outstanding Preferred Stock, except Cede & Co., which held of record 3,841,977 shares of Common Stock (53.12%) and 1,212,188 shares of Preferred Stock (61.56%), and holds shares as nominee for participants in the Depository Trust Company, P.O. Box 20, Bowling Green Station, New York, New York 10004-9998; and Loriot & Co., which held of record 397,795 shares of Common Stock (5.50%), and holds shares as nominee for participants in the Company's Automatic Reinvestment Plan, c/o Chemical Mellon Shareholder Services, Dividend Reinvestment Department, 4 Station Square, Commerce Court, Pittsburgh, Pennsylvania 15219-1119. On March 1, 1996, all directors and officers as a group owned less than 1% of the Company's outstanding Common Stock and less than 1% of the Company's outstanding Preferred Stock. DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 3,000,000 shares of $2.40 Cumulative Preferred Stock, $3.00 par value ("Preferred Stock"), and 12,000,000 shares of Common Stock, $1.00 par value ("Common Stock"). As of April 19, 1996, 1,969,212 shares of Preferred Stock and 7,232,110 shares of Common Stock were outstanding, no shares of Common and Preferred Stock were held by the Company. The Preferred Stock and the 14 15 Common Stock are fully paid and non-assessable and have no pre-emptive, conversion or exchange rights. The Company has no outstanding debt securities. PREFERRED DIVIDENDS The holders of Preferred Stock are entitled to fixed cumulative dividends, as and when declared by the Board of Directors, at the rate of $2.40 per annum, payable quarterly on the 15th of March, June, September and December. COMMON DIVIDENDS AND DISTRIBUTIONS The Company's distribution policy with respect to the Common Stock provides for regular quarterly distributions which, on an annualized basis, approximate 10% of the net asset value of the Common Stock. The Board of Directors of the Company reviews the amount of the quarterly distribution at least once a year and adjusts such amount after sustained changes in net asset value appear to the Board of Directors reasonably likely to support the new distribution rate on a continuing basis. Since the current distribution policy was adopted in June 1976, at an initial annual rate of $1.40 per share, continued increase in net asset value, despite payments from capital, have permitted 16 subsequent increases to the current rate of $3.70. Maintenance of the current $3.70 annualized rate is dependent upon achieving a total return on the Common Stock from both income and appreciation to sustain a net asset value of $37.00. The distribution policy requires payments substantially in excess of the current net investment income of the Company after provision for dividends on the Preferred Stock. Only the portion of a distribution which equals the Company's current net investment income applicable to the Common Stock should be considered a dividend. The remainder constitutes a payment out of the Company's net realized capital gains for the year to the extent available; any excess will be from paid-in capital. Declaration of distributions on Common Stock is subject to the limitation that the Preferred Stock have an Asset Coverage of at least 200% after deducting the amount of the distribution. For years in which the Company distributes amounts in excess of its net investment income and net realized capital gains, such distributions will decrease the Company's total assets and, therefore, have the likely effect of increasing the Company's expense ratio. In addition, in order to make such distributions, the Company may have to sell a portion of its investment portfolio at a time when independent investment judgment might not dictate such action. Such sales, if they involve assets held for less than three months, could also adversely affect the Company's status as a regulated investment company since, in order for the Company to qualify as a regulated investment company, for each taxable year, less than 30% of the Company's gross income must be derived from gains realized on the sale or other disposition of stocks or securities held for less than three months. Future distribution policy will be influenced by future events, including compliance with tax and legal requirements as they exist from time to time. ASSET COVERAGE As required by the Act, no dividends or distributions may be declared on the Common Stock if dividends on the Preferred Stock are in arrears or if the Preferred Stock would not thereafter have an "Asset Coverage" of at least 200%. The 200% Asset Coverage limitation also applies to any purchase by the Company of its Common Stock. The Asset Coverage of the Preferred Stock is the ratio which the value of the total assets of the Company, less all liabilities and indebtedness not represented by senior securities, bears to the aggregate amount of senior securities representing indebtedness of the Company plus the aggregate of the liquidation preference of the Preferred Stock. Based upon total net assets of $362,086,804 at December 31, 1995, the Asset Coverage of the Preferred Stock at that date was 669%. If dividends cannot be declared on the Common Stock because of the 200% Asset Coverage limitation, the Company expects to pay Special Distributions on the Preferred Stock to the extent necessary to comply with Subchapter M. Any such Special Distribution would have the effect of reducing the amounts due to holders of Preferred Stock upon liquidation of the Company, or upon redemption of the Preferred Stock, but would not affect the amount of the annual $2.40 cumulative dividend to which the holders of Preferred Stock are entitled so long as such shares remain outstanding. Following any Special Distribution the effective yield on the Preferred Stock as a percentage of its liquidation preference would be increased, which would be detrimental to the holders of the Common Stock as long as the Preferred Stock remained outstanding. VOTING RIGHTS Except as noted below, the shares of both classes have equal voting rights of one vote per share and vote together as a single class. In elections of directors, the holders of the Preferred Stock, as a separate class, vote to elect two directors and the holders of the Common Stock as a separate class, vote to elect the remaining directors. The Board of Directors currently consists of six members, but this number may be changed by the Board. As required by the Act, if dividends on the Preferred Stock are in arrears in an amount equal to two full years' dividends, the holders of such shares have the right to elect a majority of the directors until all accrued dividends have been paid or otherwise provided for. Each class of shareholders also is entitled to vote as a class (1) with respect to any reorganization (as defined in the Act) of the Company adversely affecting such securities and (2) with respect to the approval of any action requiring a vote of security holders under Section 13(a) of the Act including, among other 15 16 things, changes in the Company's subclassification as a closed-end investment company, and changes in its investment objective or its fundamental investment policies, including those described under "Investment Restrictions." Both the Preferred Stock and the Common Stock have cumulative voting rights, which means that, in all elections of directors, each shareholder has the right to cast a number of votes equal to the number of shares owned multiplied by the number of directors to be elected by the holders of shares of such class at such election, and each shareholder may cast the whole number of votes for one candidate or distribute such votes among candidates as such shareholder chooses. ANTI-TAKEOVER PROVISIONS OF THE CERTIFICATE OF INCORPORATION The Company has provisions in its Certificate of Incorporation that could have the effect of limiting the ability of other entities or persons to acquire control of the Company, to cause it to engage in certain transactions or to modify its structure. The affirmative vote or consent of the holders of at least two-thirds of the outstanding shares of the Company is required to authorize any of the following actions: (1) merger or consolidation of the Company with an open-end investment company; (2) merger or consolidation with a closed-end investment company, unless such company's charter has the same voting requirements; (3) dissolution of the Company; (4) sale of all or substantially all of the assets of the Company; or (5) amendment to the Certificate of Incorporation of the Company which makes the Common Stock a redeemable security (as such term is defined in the 1940 Act) or which reduces the two-thirds vote required to authorize the actions in (1) through (5) hereof. These two-thirds voting requirements are greater than the minimum requirements under Delaware law or the 1940 Act. Reference is made to the Certificate of Incorporation of the Company, on file with the Securities and Exchange Commission, for the full text of these provisions. These provisions could have the effect of depriving shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Company in a tender offer or similar transaction. REDEMPTION The Preferred Stock may be called for redemption by the Board of Directors of the Company, in whole or in part, at the redemption price of $27.50 per share, plus accrued and unpaid dividends to the redemption date, reduced by the amount, if any, of Special Distributions received with respect to the Preferred Stock prior to the redemption. If less than all outstanding Preferred Stock is to be redeemed, the redemption shall be made by lot, or on a pro rata basis, or in such other manner as will not discriminate unfairly against any holder of Preferred Stock. LIQUIDATION RIGHTS Upon any voluntary or involuntary liquidation of the Company (pursuant to the vote of each class of shares or otherwise), the holders of Preferred Stock are entitled, after satisfaction of outstanding liabilities, and before any distribution may be made on the Common Stock, to an amount equal to $27.50 per share plus accrued and unpaid dividends to the liquidation date, and minus the amount of any Special Distributions. Upon any liquidation, holders of the Common Stock, after required payments on the Preferred Stock, receive the remaining net assets of the Company. REINVESTMENT PLAN Holders of record (other than brokers or nominees of banks and other financial institutions) of Common and Preferred Stock are eligible to participate in the Dividend Reinvestment Plan ("Plan"), pursuant to which distributions to shareholders will be paid in or reinvested in shares of Common Stock of the Company ("Dividend Shares"). Chemical Mellon Shareholder Services, L.L.C. ("Agent"), P.O. Box 590, Ridgefield Park, New Jersey 07660, acts as agent for participants under the Plan. A shareholder may join the Plan by signing and returning an authorization form which may be obtained from the Agent. A shareholder may elect to withdraw from the Plan at any time by written notice to the Agent and thereby elect to receive cash in lieu of Dividend Shares. There is no penalty for withdrawal from the Plan and shareholders who have previously withdrawn from the Plan may rejoin at any time. Purchases of the Company's shares may be made by the Agent, on behalf of the participants in the Plan, promptly after receipt of funds, and in no event later than 30 days from such receipt except when restricted under applicable federal securities laws, from time to time to satisfy dividend reinvestments under the Plan. Such purchases by the Agent may be made when the price plus estimated commissions of the Company's Common Stock on the NYSE is lower than the Company's most recently calculated net asset value per share. If the Agent determines on the dividend payment date that the shares purchased as of such date are insufficient to satisfy the dividend reinvestment requirements, the Agent, on behalf of the participants in the Plan, will obtain the necessary additional shares as follows. To the extent that outstanding shares are not available at a cost of less than per share net asset value, the Agent, on behalf of the participants in the Plan, will accept payment of the dividend, or the remaining portion thereof, in authorized but unissued shares of Common Stock of the Company on the dividend payment date. Such shares will be issued at a per share price equal to the higher of (1) the net asset value per share on the payment date, or (2) 95% 16 17 of the closing market price per share on the payment date. If the closing sale or offer price, plus estimated commissions, of the Common Stock on the NYSE on the payment date is less than the Company's net asset value per share on such day, then the Agent will purchase additional outstanding shares on the NYSE or elsewhere. There are no brokerage charges with respect to shares issued directly by the Company to satisfy the dividend reinvestment requirements. However, each participant will pay a pro rata share of brokerage commissions incurred with respect to the Agent's open market purchases of shares. In each case, the cost per share of shares purchased for each shareholder's account will be the average cost, including brokerage commissions, of any shares purchased in the open market plus the cost of any shares issued by the Company. Shareholders participating in the Plan may receive benefits not available to shareholders not participating in the Plan. If the market price plus commissions of the Company's Common Stock is above the net asset value, participants in the Plan will receive shares of the Company at a discount of up to 5% from the current market value. However, if the market price plus commissions is below the net asset value, participants will receive distributions in shares at prices below the net asset value. Also, since the Company does not redeem its shares, the price on resale may be more or less than the net asset value. In the case of foreign participants whose dividends are subject to United States income tax withholding and in the case of any participants subject to 31% federal backup withholding, the Agent will reinvest dividends after deduction of the amount required to be withheld. Experience under the Plan may indicate that changes are desirable. Accordingly, the Company reserves the right to amend or terminate the plan. There is no direct service charge to participants in the Plan; however, the Company reserves the right to amend the Plan to include a service charge payable by the participants. CASH INVESTMENT PLAN All record holders of Common Stock are offered the opportunity, on a voluntary basis, to send in cash payments of not less than $100 each up to a total of $7,500 per month to purchase additional shares of the Common Stock of the Company through participation in the Cash Investment Plan ("Cash Plan"). The investment date is the 15th of every month. Under the Cash Plan, the Agent each month invests the aggregated funds of all the participants for that month in additional shares of the Company's Common Stock purchased at market price plus brokerage costs and an applicable service charge. Distributions payable on all shares credited to a participant's account are automatically reinvested in additional shares pursuant to the terms of the Reinvestment Plan. Pending investment, a participant's funds held by the Agent will not bear interest. A participant may withdraw his or her entire cash payment by written notice received by the Agent not less than 48 hours before such payment is to be invested. The price at which the Agent is deemed to have acquired shares for a participant's account is the average price (including brokerage commissions and a service charge of $5.00 per transaction) of all shares purchased by it for all participants in the Cash Plan and as Agent for all participants in the Reinvestment Plan, with the aggregate funds of all participants used for such purpose for each investment date. Shares are purchased by the Agent as soon as practicable, but no later than thirty days, after the investment date. A brochure describing the terms and conditions of the Cash Plan is available from the Agent. The Cash Plan may be amended or terminated by the Company. TAXATION GENERAL The Company has qualified, and intends to qualify, each year as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986 ("Code"). In order to qualify as a regulated investment company for any taxable year, the Company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans and gains from the sale or other disposition of stock or securities or foreign currencies or other income derived with respect to its business of investing in such stock, securities or currencies; (2) derive less than 30% of its gross income from the sale or other disposition of stock or securities held for less than three months ("Three-Month Gain Rule"); and (3) distribute at least 90% of its investment company taxable income (net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year. The Company must also diversify its holdings so that, at the close of each quarter of its taxable year, (1) at least 50% of the value of its total assets consists of cash, cash items, Government Securities, and the securities of other regulated investment companies and other securities limited generally with respect to any one issuer to not more than 5% of the total assets of the Company and not more than 10% of the outstanding voting securities of such issuer, and (2) not more than 25% of the value of its total assets is invested in the securities (other than Government Securities or the securities of other regulated investment companies) of any one issuer, or in two or more issuers which the Company controls and which are engaged in the same or similar trades or business ("Asset Diversification Test"). 17 18 As a regulated investment company, the Company is not subject to Federal income tax on its investment company taxable income and net capital gains (any net long-term capital gains in excess of the sum of net short-term capital losses and capital loss carryovers from prior years), if any, that it distributes to its shareholders. The Company intends to distribute to its shareholders all of its investment company taxable income and, to the extent described below, net capital gains. The Company is subject to a nondeductible 4% excise tax measured with respect to certain undistributed amounts of ordinary income and capital gain net income. The Company intends to distribute sufficient amounts to avoid liability for the excise tax. At least a portion of the distributions paid by the Company to shareholders is taxable as dividend income to shareholders. As determined each year, any remainder is taxable to shareholders as long-term capital gains or constitute a return of capital. Any such return of capital payment is taxable to shareholders as dividend income because the Company has accumulated earnings and profits for federal income tax purposes. Net investment income distributed as dividends is generally paid first to the holders of the Preferred Stock. Distributions of net investment income are reportable by shareholders as dividends taxable at ordinary income tax rates. To the extent determined each year, a portion of the Company's distributions from net investment income qualify for the 70% dividends received deduction for corporations. To the extent any net realized capital gains of the Company are included in distributions to shareholders, the portion of any distribution which is equivalent to any net realized short-term capital gains is taxable to shareholders as ordinary income dividends, and the portion which is equivalent to any net realized long-term capital gains is taxable to shareholders as long-term capital gains. This tax result applies whether or not distributions are reinvested under the Company's Reinvestment Plan. Such distributions from net realized long-term capital gains are taxable to a shareholder as long-term capital gains regardless of the length of time shares of Common Stock of the Company have been held by the shareholders, but any loss on the sale of shares held for less than six months is treated as a long-term capital loss to the extent of any long-term capital gain distribution paid on such shares. To the extent the Company realizes net long-term capital gains for any year in excess of the amounts distributed under the Company's distribution policy, such excess may be distributed to shareholders or retained by the Company. To the extent that the Company realizes net long-term capital gains for any year which are not distributed to shareholders, the Company designates such gains as undistributed and, accordingly, pays the capital gains tax at the regular corporate rate (presently 35%) thereon, which payment is available as a tax credit to holders of Common Stock, as described below. Each holder of Common Stock on the last day of any taxable year of the Company for which the Company pays a tax on the undistributed excess of its net long-term capital gain over its net short-term capital loss is treated as if the Company had distributed to such shareholder on such last day a pro rata share (determined without reference to the Preferred Stock) of the long-term gain on which such tax was paid. Accordingly, each such person (1) includes, as long-term gain in the tax return for the taxable year in which the last day of the Company's taxable year falls, a pro rata share (determined without reference to the Preferred Stock) of the Company's long-term gain on which the Company paid a tax, and consequently incurs any taxes payable thereon, (2) is entitled either to a credit on such return for, or a refund of, the tax paid by the Company on the amount so included in such return, and (3) is entitled to increase the tax cost basis of the Common Stock by the difference between their undistributed capital gains and their tax credit. Persons not subject to tax on capital gains, such as charitable and educational organizations described in Section 501(a) of the Code and certain non-resident alien individuals and foreign corporations, are entitled to a refund of their pro rata share of the tax paid by the Company upon filing appropriate returns or claims for refund. The Company sends written statements and notices to shareholders regarding the tax status of all dividends and distributions made during each calendar year. Shareholders who reinvest distributions in shares of the Company's Common Stock will be treated as receiving distributions of an amount equal to the fair market value, determined as of the payment date, of the shares received if the shares are purchased from the Company. Such value may exceed the amount of the cash distribution that would have been paid. If the outstanding shares are purchased in the open market, the taxable distribution will equal the cash distribution that would have been paid. In either event, the cost basis in the shares received will equal the amount recognized as a taxable distribution. DISQUALIFICATION AS A REGULATED INVESTMENT COMPANY If for any taxable year the Company does not qualify as a regulated investment company, all of its taxable income will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the Company's current and accumulated earnings and profits. BACKUP WITHHOLDING The Company generally will be required to withhold tax at the rate of 31% with respect to distributions of investment company taxable income and capital gain distributions payable to a non-corporate shareholder if the shareholder fails to provide a correct taxpayer identification number or is otherwise subject to backup withholding. 18 19 FOREIGN WITHHOLDING TAXES To the extent that the Company invests in foreign securities, dividends and interest received by the Company on such securities may be subject to foreign withholding taxes. The Company will be entitled to claim a deduction for such foreign withholding taxes for U.S. Federal income tax purposes. However, any such taxes will reduce the income available for distribution to the Company's shareholders. OTHER TAXATION Distributions to shareholders who are non-resident aliens may be subject to a 30% United States withholding tax under provisions of the Code applicable to foreign individuals and entities unless a reduced rate of withholding or a withholding exemption is provided under applicable treaty law. Non-resident shareholders are urged to consult their own tax advisers concerning the applicability of the United States withholding tax. 19 20 INDEX TO FINANCIAL STATEMENTS

20 21 REPORT OF INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF SOURCE CAPITAL, INC. We have audited the accompanying statement of assets and liabilities of Source Capital, Inc., including the portfolio of investments, as of December 31, 1995, and the related statements of operations and changes in total net assets for each of the two years in the period then ended, and the financial highlights as it relates to selected data for a share of Common Stock, for each of the five years in the period then ended. These financial statements and financial highlights are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 1995, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Source Capital, Inc. at December 31, 1995, the results of its operations and the changes in total net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP ERNST & YOUNG LLP Los Angeles, California January 26, 1996 21 22 PORTFOLIO OF INVESTMENTS December 31, 1995

22 23 PORTFOLIO OF INVESTMENTS Continued

23 24 PORTFOLIO OF INVESTMENTS Continued

• Non-income producing securities ++ Restricted securities purchased without registration under the Securities Act of 1933 pursuant to Rule 144A, which generally may be resold only to certain institutional investors prior to registration. See notes to financial statements. 24 25 STATEMENT OF ASSETS AND LIABILITIES

See notes to financial statements. 25 26 STATEMENT OF OPERATIONS

See notes to financial statements. 26 27 STATEMENT OF CHANGES IN TOTAL NET ASSETS

See notes to financial statements. - -------------------------------------------------------------------------------- 27 28 FINANCIAL HIGHLIGHTS Selected data for a share of Common Stock outstanding throughout each year

(1) Based on market value per share, adjusted for reinvestment of distributions (2) Based on net asset value per share, adjusted for reinvestment of distributions (3) Information shown as of the end of the year (4) The average of all month-end market values during each year See notes to financial statements. - -------------------------------------------------------------------------------- QUARTERLY RESULTS OF INVESTMENT OPERATIONS (unaudited)

28 29 NOTES TO FINANCIAL STATEMENTS NOTE A--SIGNIFICANT ACCOUNTING POLICIES The Company is registered under the Investment Company Act of 1940 as a diversified, closed-end management investment company. The investment objective of the Company is to seek maximum total return for Common shareholders from both capital appreciation and investment income to the extent consistent with protection of invested capital and provision of sufficient income to meet the dividend requirements of Preferred shareholders. The significant accounting policies followed by the Company in the preparation of its financial statements include the following: 1. SECURITIES VALUATION--Securities, including any outstanding call options, listed or traded on a national securities exchange or on the NASDAQ National Market System are valued at the last sale price on the last business day of the year, or, if there was not a sale that day, at the mean between the most recent bid and asked prices. Securities which are unlisted are valued at the mean between the most recent bid and asked prices. Short-term corporate notes with maturities of 60 days or less are valued at cost plus interest earned, which approximates market value. Restricted securities and securities for which market quotations are not readily available are valued at fair value as determined in good faith by, or under the direction of, the Board of Directors. 2. FEDERAL INCOME TAX--No provision for federal taxes on net investment income is considered necessary because the Company has elected to be taxed as a "regulated investment company" under the Internal Revenue Code, and intends to maintain this qualification and to distribute each year all of its taxable net investment income to its shareholders in accordance with the minimum distribution requirements of the Code. 3. OTHER--Securities transactions are accounted for on the date the securities are purchased or sold. Dividend income is recorded on the ex-dividend date. Interest income and expenses are recorded on an accrual basis. Dividends payable by the Company on the Preferred Stock are recorded on an accrual basis and distributions payable on the Common Stock are recorded on the ex-dividend date. NOTE B--CAPITAL STOCK The Preferred Stock is entitled in liquidation to $27.50 per share plus accrued dividends and may be called for redemption, at the discretion of the Company, at $27.50 per share plus accrued dividends. Dividends may not be declared on the Common Stock if Preferred dividends are in arrears or if the Preferred Stock would not thereafter have an asset coverage of 200% or more. During the years ended December 31, 1995 and 1994, the Company issued 86,640 and 126,076 shares of Common Stock under its Reinvestment Plan for Common and Preferred shareholders, respectively. In addition, the Company issued 416,651 shares of Common Stock pursuant to its Common Subscription Offer during the year ended December 31, 1994. NOTE C--ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS Pursuant to an investment advisory agreement, the Company pays First Pacific Advisors, Inc. ("Investment Adviser") monthly investment advisory fees calculated at an annual rate of .725% for the first $100 million of total net assets, .700% for the next $100 million of total net assets, and .675% for any total net assets in excess of $200 million. The Agreement obligates the Investment Adviser to reduce its fee to the extent necessary to reimburse the Company for any annual expenses (exclusive of interest, taxes, the cost of any supplementary statistical and research information, legal expenses related to portfolio securities, and extraordinary expenses such as litigation) in excess of 1 1/2% of the first $30 million and 1% of the remaining average total net assets of the Company for the year. For the years ended December 31, 1995 and 1994, the Company paid aggregate fees of $75,000 and $75,000 respectively, to all Directors who are not affiliated persons of the Investment Adviser. During the years ended December 31, 1995 and 1994, the Company incurred legal fees of $14,373 and $40,851, respectively, payable to O'Melveny & Myers, counsel for the Company. A Director of the Company is of counsel to, and a retired partner of, that firm. NOTE D--PURCHASES AND SALES OF SECURITIES Cost of purchases of investment securities (excluding short-term corporate notes with maturities of 60 days or less) aggregated $161,525,237 and $221,177,865 for the years ended December 31, 1995 and 1994, respectively. Realized gains and losses are based on the specific-certificate identification method. Cost of investment securities owned at December 31, 1995 was $281,220,348 for federal income tax purposes. Gross unrealized appreciation and depreciation for all securities at December 31, 1995 for federal income tax purposes was $61,084,446 and $4,541,708, respectively. NOTE E--QUARTERLY INFORMATION See page 28 for unaudited quarterly results of investment operations. 29 30 PART C. OTHER INFORMATION ITEM 24 - FINANCIAL STATEMENTS AND EXHIBITS (1) Financial Statements (all included in Part A) Report of Independent Auditors Portfolio of Investment Securities, December 31, 1995 Statement of Assets and Liabilities, December 31, 1995 Statement of Operations, Year ended December 31, 1994 Year ended December 31, 1995 Statement of Changes in Total Net Assets, Year ended December 31, 1994 Year ended December 31, 1995 Consent of Independent Auditors (filed as page C-6 in Part C) (2) Exhibits a. The Certificate of Incorporation was filed as Exhibit 1 to Amendment No. 1 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. a.1 Certificate of Amendment, dated May 20, 1981 to Certificate of Incorporation was filed as Exhibit 1.1 to Amendment No. 3 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. a.2 Certificate of Amendment, dated June 1, 1982 to Certificate of Incorporation was filed as Exhibit 1.2 to Amendment No. 4 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. b. By-Laws as amended to date were filed as Exhibit 2 to Amendment No. 1 of the Company's Registration Statement on Form N-2 and are incorporated herein by reference. d.1 Specimen Common Stock certificate was filed as Exhibit 4.1 to Amendment No. 6 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. d.2 Specimen Preferred Stock certificate was filed as Exhibit 4.2 to Amendment No. 6 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. d.3 Subscription Certificate for Rights Offering was filed as Exhibit d.3 to Amendment No. 17 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. d.4 Notice of Guaranteed Delivery was filed as Exhibit d.4 to Amendment No. 17 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. C-1 30 31 e. Source Capital, Inc. Automatic Reinvestment Plan, as amended May 4, 1992, was filed as Exhibit 4 to Post-Effective Amendment No. 1 of the Company's Registration Statement on Form S-3 (Reg. No. 33-46039) and is incorporated herein by reference. g. Investment Advisory Agreement, dated June 27, 1991, between the Company and First Pacific Advisors, Inc. was filed as Exhibit 6 to Amendment No. 13 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.1 Custodian Agreement dated March 1, 1973 between the Company and State Street Bank and Trust Company was filed as Exhibit 1.8 to the Company's Registration Statement No. 2-58956 on Form S-4 and is incorporated herein by reference. j.2 Amendment dated March 22, 1979, to Custodian Agreement between the Company and State Street Bank and Trust Company was filed as Exhibit 9.2 to Amendment No. 1 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.3 Amendment No. 2 dated July 21, 1981, to Custodian Agreement between the Company and State Street Bank and Trust Company was filed as Exhibit 9.3 to Amendment No. 7 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.4 Amendment No. 3 dated September 1, 1985, to Custodian Agreement between the Company and State Street Bank and Trust Company was filed as Exhibit 9.4 to Amendment No. 8 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.5 Amendment No. 4 dated November 1, 1988, to Custodian Agreement between the Company and State Street Bank and Trust Company was filed as Exhibit 9.5 to Amendment No. 10 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.6 Custodian Fee Schedule Addendum for GNMA Securities Traded through Participants Trust Company dated February 14, 1990 was filed as Exhibit 9.6 to Amendment No. 11 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. j.7 Amendment dated February 5, 1996, to Custodian Agreement between the Company and State Street Bank and Trust Company. l. Opinion and consent of O'Melveny & Myers was filed as Exhibit l to Amendment No. 17 of the Company's Registration Statement on Form N-2 and is incorporated herein by reference. n. Consent of Independent Auditors (filed as page C-6). r. Financial Data Schedule. Exhibits c, f, h, i, k, m, and o-q have been omitted because the conditions requiring their filing do not exist. ITEM 25 - MARKETING ARRANGEMENTS Inapplicable ITEM 26 - OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Inapplicable ITEM 27 - PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT None. C-2 31 32 ITEM 28 - NUMBER OF HOLDERS OF SECURITIES As of April 19, 1996:

ITEM 29 - INDEMNIFICATION Section 145 of the General Corporation Law of Delaware empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative by reason of the fact that he is or was a director, officer, employee or agent of the corporation or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or enterprise. Depending on the character of the proceeding, a corporation may indemnify against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in connection with such action, suit or proceeding if the person indemnified acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. In the case of an action by or in the right of the corporation, no indemnification may be made in respect to any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action was brought shall determine that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which such court shall deem proper. Section 145 further provides that to the extent a director, officer, employee or agent of a corporation has been successful in the defense of any action, suit or proceeding referred to above or in the defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. Article VIII of the By-Laws of the Company provide in effect that each director and officer shall be indemnified by the Company against reasonable costs and expenses incurred in connection with any action, suit or proceeding to which such person may be made a party by reason of holding such office, except in the case of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of the office. There is a directors' and officers' liability insurance policy which is presently outstanding insuring directors and officers of the Company; the policy expires in March 1997, and provides limits of $10,000,000 per policy year. The policy covers losses as defined in the policy in excess of the first $5,000 for each director or officer. ITEM 30 - BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER During the last two years, First Pacific Advisors, Inc., the investment adviser to the Company, has not engaged in any other business of a substantial nature except as described under "Investment Adviser" in Part A hereof. During the last two years, no director or officer of First Pacific Advisors, Inc. has engaged for his or her own account or in the capacity of director, officer, employee, partner or trustee, in any other business, profession, vocation or employment of a substantial nature except as described under "Management of the Company - General" in Part A hereof and as set forth below. C-3 32 33

The address of each company named is 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064. ITEM 31 - LOCATION OF ACCOUNTS AND RECORDS The accounts, books and other documents required to be maintained by Section 31(a) of the Investment Company Act of 1940 and the Rules promulgated thereunder are maintained in the physical possession of Mr. Julio J. de Puzo, Jr., Treasurer of the Company*, except as otherwise stated below:

• P.O. Box 590, Ridgefield Park, New Jersey 07660 **11400 W. Olympic Blvd., Suite 1200, Los Angeles, California 90064 C-4 33 34 ITEM 32 - MANAGEMENT SERVICES There is no management-related service contract under which services are provided to the Company which is not discussed in Part A of this Form. ITEM 33 - UNDERTAKINGS Inapplicable. SIGNATURES Pursuant to the requirements of the Investment Company Act of 1940, the Registrant has duly caused this Amendment to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, and State of California, on the 22nd day of April, 1996. SOURCE CAPITAL, INC. By /s/ Julio J. de Puzo, Jr. -------------------------------- Julio J. de Puzo, Jr., President C-5 34 35 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Independent Auditors" and to the use of our report dated January 26, 1996, in Post- Effective Amendment No. 19 to the Registration Statement on Form N-2 of Source Capital, Inc. /s/ Ernst & Young LLP ------------------------------- ERNST & YOUNG LLP Los Angeles, California April 24, 1996 C-6 35 36 EXHIBIT INDEX

All other applicable exhibits are incorporated herein by reference. 36