W. Scott Jardine, Esq., Secretary
First Trust Exchange-Traded Fund IV
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(Name and Address of Agent for Service)
Index to Exhibits
Exhibits
The Information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
PRELIMINARY PROSPECTUS DATED APRIL 10, 2014
SUBJECT TO COMPLETION
FIRST TRUST EXCHANGE-TRADED FUND IV
PROSPECTUS
First Trust Enhanced Short Maturity ETF
Ticker Symbol: _______
Exchange: NASDAQ(R)
First Trust Enhanced Short Maturity ETF (the "Fund") is a series of First Trust
Exchange-Traded Fund IV (the "Trust") and an exchange-traded fund organized as a
separate series of a registered management investment company.
The Fund will list and principally trade its shares on The NASDAQ(R) Stock
Market LLC ("NASDAQ(R)"). Market prices may differ to some degree from the net
asset value of the shares. Unlike mutual funds, the Fund issues and redeems
shares at net asset value only in large specified blocks each consisting of
50,000 shares (each such block of shares, called a "Creation Unit," and
collectively, the "Creation Units"). The Fund's Creation Units are issued for
securities in which the Fund invests and/or cash, and redeemed for securities
and/or cash, and only to and from broker-dealers and large institutional
investors that have entered into participation agreements.
THE FUND IS AN ACTIVELY MANAGED EXCHANGE-TRADED FUND AND EXCEPT WHEN AGGREGATED
IN CREATION UNITS, THE SHARES ARE NOT REDEEMABLE SECURITIES OF THE FUND.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED OF THESE
SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
_______, 2014
TABLE OF CONTENTS
SUMMARY INFORMATION...........................................................1
ADDITIONAL INFORMATION ON THE FUND'S INVESTMENT OBJECTIVE AND STRATEGIES......9
ADDITIONAL RISKS OF INVESTING IN THE FUND....................................13
FUND ORGANIZATION............................................................21
MANAGEMENT OF THE FUND.......................................................21
HOW TO BUY AND SELL SHARES...................................................22
DIVIDENDS, DISTRIBUTIONS AND TAXES...........................................24
FEDERAL TAX MATTERS..........................................................24
DISTRIBUTION PLAN............................................................28
NET ASSET VALUE..............................................................28
FUND SERVICE PROVIDERS.......................................................30
PREMIUM/DISCOUNT INFORMATION.................................................30
OTHER INFORMATION............................................................30
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SUMMARY INFORMATION
INVESTMENT OBJECTIVE
The Fund's investment objective is to seek current income, consistent with
preservation of capital and daily liquidity.
FEES AND EXPENSES OF THE FUND
The following table describes the fees and expenses you may pay if you buy and
hold shares of the Fund. Investors purchasing and selling shares may be subject
to costs (including customary brokerage commissions) charged by their broker,
which are not reflected in the table below.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum Sales Charge (Load) Imposed on Purchases (as a percentage
of offering price) None
ANNUAL FUND OPERATING EXPENSES (expenses that you pay each year as
a percentage of the value of your investment)
Management Fees 0.__%
Distribution and Service (12b-1) Fees (1) 0.00%
Other Expenses(2) 0.00%
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Total Annual Fund Operating Expenses 0.__%
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EXAMPLE
The example below is intended to help you compare the cost of investing in
the Fund with the cost of investing in other funds. This example does not
take into account customary brokerage commissions that you pay when
purchasing or selling shares of the Fund in the secondary market.
The example assumes that you invest $10,000 in the Fund for the time
periods indicated. The example also assumes that your investment has a 5%
return each year and that the Fund's operating expenses remain at current
levels until ______, 201_, and thereafter at ____% to represent the
imposition of the 12b-1 fee of 0.25% per annum of the Fund's average daily
net assets.1 Although your actual costs may be higher or lower, based on
these assumptions your costs would be:
1 YEAR 3 YEARS
$____ $____
------
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(1) Although the Fund has adopted a 12b-1 plan that permits it to pay up
to 0.25% per annum, it will not pay 12b-1 fees at any time before
___________, 201_.
(2) The Fund had not fully commenced operations as of the date of this
prospectus. "Other Expenses" are estimates based on the expenses the
Fund expects to incur for the current fiscal year.
PORTFOLIO TURNOVER
The Fund pays transaction costs, such as commissions, when it buys and
sells securities (or "turns over" its portfolio). A higher portfolio
turnover rate may indicate higher transaction costs and may result in
higher taxes when Fund shares are held in a taxable account. These costs,
which are not reflected in annual fund operating expenses or in the
example, affect the Fund's performance.
PRINCIPAL INVESTMENT STRATEGIES
Under normal market conditions, the Fund will seek to achieve its investment
objective by investing in a portfolio of U.S. dollar-denominated fixed- and
variable-rate instruments (collectively, "Fixed Income Securities") issued by
U.S. and non-U.S. public and private sector entities. The Fund will hold Fixed
Income Securities of at least 13 non-affiliated issuers.
Fixed Income Securities will include the following types of fixed- and
variable-rate debt securities: corporate and government bonds and notes; agency
securities; instruments of non-U.S. issuers in developed markets; privately
issued securities; asset-backed securities; mortgage-backed securities;
municipal bonds; money market securities; and investment companies, such as
exchange-traded funds ("ETFs"), (including investment companies advised by the
Fund's investment advisor) that invest primarily in the foregoing types of Fixed
Income Securities. At least 80% of the Fund's net assets will be invested in
Fixed Income Securities that are, at the time of purchase, investment grade. For
an unrated security to be considered investment grade, the Fund's investment
advisor will consider, at the time of purchase, whether such security is of
comparable quality based on fundamental credit analysis of the unrated security
and comparable NRSRO-rated securities.
Under normal market conditions, the Fund's duration is expected to be below one
year and the maturity of the Fund's portfolio is expected to be below three
years. Duration is a measure of the expected price volatility of a debt
instrument as a result of changes in market rates of interest, based on, among
other factors, the weighted average timing of the instrument's expected
principal and interest payments. Duration differs from maturity in that it
considers a security's yield, coupon payments, principal payments, call features
and coupon adjustments in addition to the amount of time until the security
finally matures. Maturity is measured relative to the type of security. For
Fixed Income Securities (exclusive of asset-backed securities and
mortgage-backed securities), maturity shall be calculated using dollar-weighted
average maturity, which is calculated by taking the average length of time to
maturity. For asset-backed securities and mortgage-backed securities, maturity
shall be calculated using weighted average life, which is the estimated time to
principal paydown for each underlying instrument held by the Fund, weighted
according to the relative holdings per instrument.
-2-
The Fund invests in asset-backed and mortgage-backed securities. Asset backed
securities are fixed income securities that are backed by a pool of assets,
usually loans such as installment sale contracts or credit card receivables.
Mortgage-backed securities are asset-backed securities based on a particular
type of asset, a mortgage. There are a wide variety of mortgage-backed
securities involving commercial or residential, fixed rate or adjustable rate
mortgages and mortgages issued by banks or government agencies. The Fund intends
to limit its investments in asset-backed securities and non-agency
mortgage-backed securities (in the aggregate) to 20% of its net assets.
The Fund may invest up to 20% of its net assets in floating rate loans. The
floating rate loans in which the Fund will invest will represent amounts
borrowed by companies or other entities from banks and other lenders and a
significant portion of such floating rate loans may be rated below investment
grade or unrated. Floating rate loans held by the Fund may be senior or
subordinate obligations of the borrower and may or may not be secured by
collateral.
The Fund anticipates investing in registered open-end investment companies, such
as ETFs, that generally provide exposure to Fixed Income Securities. The Fund's
may invest in other ETFs, including but not limited to, other ETFs that are
advised by the Fund's advisor. Any other ETFs in which the Fund invests to gain
exposure to Fixed Income Securities may be subject to investment parameters that
differ in certain respects from the Fund's investment parameters.
PRINCIPAL RISKS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency. There can be no
assurance that the Fund's investment objective will be achieved.
ALTERNATIVE MINIMUM TAX RISK. The Fund has no limit as to the amount that can be
invested in alternative minimum tax bonds. Therefore, all or a portion of the
Fund's otherwise exempt-interest dividends may be taxable to those shareholders
subject to the federal alternative minimum tax.
CALL RISK. If an issuer calls higher-yielding debt instruments held by the Fund,
performance could be adversely impacted.
CASH TRANSACTIONS RISK. The Fund will, under most circumstances, effect a
portion of creations and redemptions for cash, rather than in-kind securities.
As a result, an investment in the Fund may be less tax-efficient than an
investment in an ETF that effects its creations and redemption for in-kind
securities. Because the Fund may effect a portion of redemptions for cash, it
may be required to sell portfolio securities in order to obtain the cash needed
to distribute redemption proceeds. A sale of shares may result in capital gains
or losses and may also result in higher brokerage costs.
-3-
CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable
or unwilling to make dividend, interest and/or principal payments when due and
the related risk that the value of a security may decline because of concerns
about the issuer's ability to make such payments.
FLOATING-RATE LOAN RISK. An investment in floating-rate loans subjects the Fund
to credit risk, which is heightened for loans in which the Fund invests because
companies that issue such loans tend to be highly leveraged and thus are more
susceptible to the risks of interest deferral, default and/or bankruptcy. The
loans are usually rated below investment grade but may also be unrated. An
economic downturn would generally lead to a higher non-payment rate, and a loan
may lose significant market value before a default occurs. Moreover, any
specific collateral used to secure a loan may decline in value or become
illiquid, which would adversely affect the loan's value. Unlike the securities
markets, there is no central clearinghouse for loan trades, and the loan market
has not established enforceable settlement standards or remedies for failure to
settle. Therefore, portfolio transactions in loans may have uncertain settlement
time periods. Loans are subject to a number of risks described elsewhere in this
prospectus, including liquidity risk and the risk of investing in below
investment grade debt instruments.
HIGH YIELD SECURITIES RISK. High yield securities, or "junk" bonds, are subject
to greater market fluctuations and risk of loss than securities with higher
ratings, and therefore, may be highly speculative. These securities are issued
by companies that may have limited operating history, narrowly focused
operations, and/or other impediments to the timely payment of periodic interest
and principal at maturity. If the economy slows down or dips into recession, the
issuers of high yield securities may not have sufficient resources to continue
making timely payment of periodic interest and principal at maturity. The market
for high yield securities is generally smaller and less liquid than that for
investment grade securities. High yield securities are generally not listed on a
national securities exchange but trade in the over-the-counter markets. Due to
the smaller, less liquid market for high yield securities, the bid-offer spread
on such securities is generally greater than it is for investment grade
securities and the purchase or sale of such securities may take longer to
complete.
ILLIQUID SECURITIES RISK. Some of the securities held by the Fund may be
illiquid. Illiquid securities involve the risk that the securities will not be
able to be sold at the time desired by the Fund or at prices approximately the
value at which the Fund is carrying the securities on its books.
INCOME RISK. Income from the Fund's fixed income investments could decline
during periods of falling interest rates.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the Fixed
Income Securities in the Fund will decline because of rising market interest
rates. Interest rate risk is generally lower for shorter term investments and
higher for longer term investments. Mortgage-related securities are particularly
subject to the risk that interest rate volatility may adversely impact the
valuation and price of such securities.
INVESTMENT COMPANIES RISK. The Fund may invest in the shares of other investment
companies, and therefore, the Fund's investment performance and risks may be
-4-
related to the investment performance and risks of the underlying funds. In
general, as a shareholder in other investment companies, the Fund bears its
ratable share of the underlying fund's expenses, and would be subject to
duplicative expenses to the extent the Fund invests in other investment
companies.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. The advisor will apply investment techniques and
risk analyses in making investment decisions for the Fund, but there can be no
guarantee that the Fund will meet its investment objective.
MARKET RISK. Market risk is the risk that a particular security owned by the
Fund or shares of the Fund in general may fall in value. Securities are subject
to market fluctuations caused by such factors as economic, political, regulatory
or market developments, changes in interest rates and perceived trends in bond
prices. Also, certain of these factors may affect the liquidity of the bonds in
the Fund's portfolio and make it more difficult for the Fund to sell them.
Overall security values could decline generally or could underperform other
investments.
MORTGAGE SECURITIES RISK. The Fund invests in mortgage-related securities,
including mortgage-backed securities, which may make the Fund more susceptible
to adverse economic, political or regulatory events that affect the value of
real estate. Changes in local, state and federal policies could negatively
impact the mortgage-related securities market, which include various government
initiated and sponsored homeowner assistance programs and eminent domain issues.
Mortgage-related securities are subject to the risk that the rate of mortgage
prepayments decreases, which extends the average life of a security and
increases the interest rate exposure. Mortgage-related securities may also face
liquidity issues when the Fund seeks to sell such securities, but is unable to
find buyers at a bid-ask spread to make the transaction feasible. These
securities are also subject to the risk that the underlying borrowers may
default on their mortgages, resulting in a non-payment of principal and
interest. Finally, the mortgage-related securities market may be negatively
impacted by regulatory changes including those that are related to the mandate
or existence of the government-sponsored enterprises, Fannie Mae, Freddie Mac
and Ginnie Mae.
[MUNICIPAL LEASE OBLIGATIONS RISK. Participation interests in municipal leases
pose special risks because many leases and contracts contain "non-appropriation"
clauses that provide that the governmental issuer has no obligation to make
future payments under the lease or contract unless money is appropriated for
this purpose by the appropriate legislative body.]
NEW FUND RISK. The Fund currently has fewer assets than larger funds, and like
other relatively new funds, large inflows and outflows may impact the Fund's
market exposure for limited periods of time. This impact may be positive or
negative, depending on the direction of market movement during the period
affected. Also, during the initial invest-up period, the Fund may depart from
its principal investment strategies and invest a larger amount or all of its
assets in cash equivalents or it may hold cash.
-5-
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
Investment Company Act of 1940, as amended (the "1940 Act"). As a result, the
Fund is only limited as to the percentage of its assets that may be invested in
the securities of any one issuer by the diversification requirements imposed by
the Internal Revenue Code of 1986, as amended (the "Code"). The Fund may invest
a relatively high percentage of its assets in a limited number of issuers. As a
result, the Fund may be more susceptible to a single adverse economic or
regulatory occurrence affecting one or more of these issuers, experience
increased volatility and be highly concentrated in certain issuers.
NON-U.S. SECURITIES RISK. The Fund invests in securities of non-U.S. issuers.
Non-U.S. securities are subject to higher volatility than securities of domestic
issuers due to possible adverse political, social or economic developments;
restrictions on foreign investment or exchange of securities; lack of liquidity;
currency exchange rates; excessive taxation; government seizure of assets;
different legal or accounting standards and less government supervision and
regulation of exchanges in foreign countries.
POLITICAL AND ECONOMIC RISKS. The values of municipal securities held by the
Fund may be adversely affected by local political and economic conditions and
developments. Adverse conditions in an industry significant to a local economy
could have a correspondingly adverse effect on the financial condition of local
issuers.
PREPAYMENT RISK. Mortgage-related securities are subject to pre-payment risk.
The degree to which borrowers prepay loans, whether as a contractual requirement
or at their election, may be affected by general business conditions, the
financial condition of the borrower and competitive conditions among loan
investors, among others. As such, prepayments cannot be predicted with accuracy.
Upon a prepayment, either in part or in full, the actual outstanding debt on
which the Fund derives interest income will be reduced. The Fund may not be able
to reinvest the proceeds received on terms as favorable as the prepaid loan.
SOVEREIGN DEBT RISK. Investments in debt securities issued by foreign
governments ("Sovereign Debt") involve special risks because the governmental
authority that controls the repayment of the debt may be unwilling or unable to
repay the principal and/or interest when due in accordance with the terms of
such securities; the relative size of the debt service burden to the economy as
a whole; or the government debtor's policy towards the International Monetary
Fund and the political constraints to which a government debtor may be subject.
If an issuer of sovereign debt defaults on payments of principal and/or
interest, the Fund may have limited legal recourse against the issuer and/or
guarantor. In certain cases, remedies must be pursued in the courts of the
defaulting party itself, and the Fund's ability to obtain recourse may be
limited.
TAX RISK. Income from municipal bonds held by the Fund could be declared taxable
because of, among other things, unfavorable changes in tax laws, adverse
interpretations by the Internal Revenue Service or state tax authorities, or
noncompliant conduct of a bond issuer.
-6-
PERFORMANCE
The Fund has not yet commenced operations and, therefore, does not have a
performance history. Once available, the Fund's performance information, and
information that gives some indication of the risks of an investment in the Fund
by comparing the Fund's performance with a broad measure of market performance,
will be available on the Fund's website at www.ftportfolios.com. The Fund's past
performance (before and after taxes) is not necessarily an indication of how the
Fund will perform in the future.
MANAGEMENT
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or "Advisor")
PORTFOLIO MANAGERS
The following persons serve as the portfolio managers of the Fund. Each
has managed the Fund since 2014:
o Todd Larson, CFA, Vice President of First Trust;
o Eric R. Maisel, CFA, Vice President of First Trust;
PURCHASE AND SALE OF FUND SHARES
The Fund issues and redeems shares on a continuous basis, at net asset value,
only in Creation Units consisting of 50,000 shares. The Creation Units are
issued for securities in which the Fund invests and/or cash, and redeemed for
securities and/or cash, and only to and from broker-dealers and large
institutional investors that have entered into participation agreements.
Individual shares may only be purchased and sold on NASDAQ(R) through a
broker-dealer. Shares of the Fund will trade on NASDAQ(R) at market prices
rather than net asset value, which may cause the shares to trade at a price
greater than net asset value (premium) or less than net asset value (discount).
TAX INFORMATION
The Fund's distributions are taxable and will generally be taxed as ordinary
income or capital gains. Distributions on shares held in a tax-deferred account,
while not immediately taxable, will be subject to tax when the shares are no
longer held in a tax-deferred account.
PAYMENTS TO BROKER-DEALERS AND OTHER FINANCIAL INTERMEDIARIES
If you purchase shares of the Fund through a broker-dealer or other financial
intermediary (such as a bank), First Trust and First Trust Portfolios L.P., the
Fund's distributor, may pay the intermediary for the sale of Fund shares and
related services. These payments may create a conflict of interest by
influencing the broker-dealer or other intermediary and your salesperson to
-7-
recommend the Fund over another investment. Ask your salesperson or visit your
financial intermediary's website for more information.
-8-
ADDITIONAL INFORMATION ON THE FUND'S INVESTMENT OBJECTIVE AND STRATEGIES
The Fund's investment objective is fundamental and may only be changed with
shareholder approval. Unless an investment policy is identified as being
fundamental, all investment policies included in this prospectus and the Fund's
Statement of Additional Information ("SAI") are non-fundamental and may be
changed by the Board of Trustees (the "Board") of the First Trust Exchange
Traded Fund IV (the "Trust"), of which the Fund is a series, without shareholder
approval. If there is a material change to the Fund's principal investment
strategies, you should consider whether the Fund remains an appropriate
investment for you. There is no guarantee that the Fund will achieve its
investment objective. During the initial invest-up period, the Fund may depart
from its principal investment strategies and invest a larger amount or all of
its assets in cash equivalents or it may hold cash.
In selecting securities for the Fund, the Advisor's investment strategy is
driven by comprehensive analysis with a goal of investing in securities
representing the best relative value in the market. The Fund is seeking current
income, consistent with preservation of capital and daily liquidity.
FUND INVESTMENTS
CORPORATE BONDS
The Fund may invest in corporate debt securities issued by U.S. and non-U.S.
companies of all kinds, including those with small, mid and large
capitalizations. Corporate debt securities are fixed income securities issued by
businesses to finance their operations. Notes, bonds, debentures and commercial
paper are the most common types of corporate debt securities, with the primary
difference being their maturities and secured or unsecured status. Commercial
paper has the shortest term and is usually unsecured. Corporate debt may be
rated investment grade or below investment grade and may carry fixed or floating
rates of interest.
HIGH YIELD CORPORATE BONDS AND FLOATING RATE LOANS
The Fund may invest in a combination of high yield corporate bonds and floating
rate loans. The high yield corporate bonds in which the Fund invests are rated
below investment grade at the time of purchase or unrated and deemed by the
Advisor to be of comparable quality, commonly referred to as "junk" bonds. For
purposes of determining whether a security is below investment grade, the lowest
available rating will be considered. High yield debt may be issued, for example,
by companies without long track records of sales and earnings or by issuers that
have questionable credit strength. Corporate bonds may carry fixed or floating
rates of interest.
The floating rate loans in which the Fund invests represent amounts borrowed by
companies or other entities from banks and other lenders. In many cases,
floating rate loans are issued in connection with recapitalizations,
acquisitions, leveraged buyouts, and refinancing. A significant portion of the
floating rate loans in which the Fund invests are expected to be rated below
investment grade or unrated. The floating rate loans held by the Fund may be
-9-
senior or subordinate obligations of the borrower. In the event of bankruptcy,
holders of senior floating rate loans are typically paid (to the extent assets
are available) before certain other creditors of the borrower (e.g., bondholders
and stockholders). Holders of subordinate loans may be paid after more senior
bondholders. Loans may or may not be secured by collateral.
Floating rate loans have interest rates that reset periodically. The interest
rates on floating rate loans are generally based on a percentage above the
London Interbank Offered Rate (LIBOR), a U.S. bank's prime or base rate, the
overnight federal funds rate, or another rate. Floating rate loans may be
structured and administered by a financial institution that acts as the agent of
the lenders participating in the floating rate loan. The Fund may acquire
floating rate loans directly from a lender or through the agent, as an
assignment from another lender who holds a floating rate loan, or as a
participation interest in another lender's floating rate loan or portion
thereof. The Advisor does not intend to purchase floating rate loans that are in
default; however, the Fund may hold a floating rate loan that has defaulted
subsequent to the purchase by the Fund.
MUNICIPAL SECURITIES
Municipal securities are debt securities that pay interest that is exempt from
regular federal income taxes. Municipal securities are generally issued by or on
behalf of states, territories or possessions of the United States and the
District of Columbia and their political subdivisions, agencies, authorities and
other instrumentalities. The types of municipal securities in which the Fund may
invest include municipal lease obligations (and certificates of participation in
such obligations), municipal general obligation bonds, municipal revenue bonds,
municipal notes, municipal cash equivalents, private activity bonds (including
without limitation industrial development bonds), and pre-refunded and escrowed
to maturity bonds. In addition, municipal securities include securities issued
by entities whose underlying assets are municipal bonds (for example, tender
option bond (TOB) trusts and custodial receipts trusts).
MORTGAGE-RELATED INVESTMENTS
The Fund invests in mortgage-related debt securities and other mortgage-related
instruments (collectively, "Mortgage-Related Investments").
The Fund generally expects that the Mortgage-Related Investments in which it
invests will primarily consist of investment grade securities (i.e., securities
with credit ratings within the four highest rating categories of a NRSRO at the
time of purchase. The Mortgage-Related Investments in which the Fund invests
include mortgage backed securities (such as residential mortgage backed
securities ("RMBS") and commercial mortgage backed securities ("CMBS")).
Mortgage-backed securities represent an interest in a pool of mortgage loans
made by banks and other financial institutions to finance purchases of homes,
commercial buildings and other real estate. The individual mortgage loans are
packaged or "pooled" together for sale to investors. As the underlying mortgage
loans are paid off, investors receive principal and interest payments.
Mortgage-backed securities may be fixed-rate or adjustable-rate mortgage-backed
securities (ARMS). Certain mortgage-backed securities (including RMBS and CMBS),
where mortgage payments are divided up between paying the loan's principal and
paying the loan's interest, are referred to as stripped mortgage-backed
securities (SMBS). Further, mortgage-backed securities can also be categorized
-10-
as collateralized mortgage obligations (CMOs) or real estate mortgage investment
conduits (REMICs) where they are divided into multiple classes with each class
being entitled to a different share of the principal and/or interest payments
received from the pool of underlying assets.
The mortgage-backed securities in which the Fund invests may be, but are not
required to be, issued or guaranteed by the U.S. government, its agencies or
instrumentalities, such as Ginnie Mae and U.S. government-sponsored entities,
such as Fannie Mae and Freddie Mac. Government agency or instrumentality
securities have different levels of credit support. For example, Ginnie Mae
securities carry a guarantee as to the timely repayment of principal and
interest that is backed by the full faith and credit of the U.S. government.
However, the full faith and credit guarantee does not apply to the market prices
and yields of the Ginnie Mae securities or to the net asset value, trading price
or performance of the Fund, which will vary with changes in interest rates and
other market conditions. Fannie Mae and Freddie Mac pass-through mortgage
certificates are backed by the credit of the respective instrumentality and are
not guaranteed by the U.S. government. Other securities issued by government
agencies or instrumentalities, including government-sponsored entities, may only
be backed by the creditworthiness of the issuing institution, not the U.S.
government, or the issuers may have the right to borrow from the U.S. Treasury
to meet their obligations. Many mortgage-backed securities are pass-through
securities, which means they provide investors with monthly payments consisting
of a pro rata share of both regular interest and principal payments as well as
unscheduled prepayments on the underlying mortgage loans. Because prepayment
rates of individual mortgage pools vary widely, the average life of a particular
pool cannot be predicted accurately. Adjustable-rate mortgage-backed securities
include ARMS and other mortgage-backed securities with interest rates that
adjust periodically to reflect prevailing market rates.
[Additionally, the Fund may invest in mortgage dollar rolls. In a mortgage
dollar roll, the Fund will sell (or buy) mortgage-backed securities for delivery
on a specified date and simultaneously contract to repurchase (or sell)
substantially similar (same type, coupon and maturity) securities on a future
date. During the period between a sale and repurchase, the Fund will forgo
principal and interest paid on the mortgage-backed securities. The Fund will
earn or lose money on a mortgage dollar roll from any difference between the
sale price and the future purchase price. In a sale and repurchase, the Fund
will also earn money on the interest earned on the cash proceeds of the initial
sale. The Fund intends to enter into mortgage dollar rolls only with high
quality securities dealers and banks, as determined by the Advisor.
The Fund may also invest in to-be-announced transactions ("TBA Transactions"). A
TBA Transaction is a method of trading mortgage-backed securities. In a TBA
Transaction, the buyer and the seller agree on general trade parameters such as
agency, settlement date, par amount and price. The actual pools delivered
generally are determined two days prior to the settlement date.]
-11-
GOVERNMENT BONDS
The Fund may invest in U.S. government securities. U.S. government securities
include U.S. Treasury obligations and securities issued or guaranteed by various
agencies of the U.S. government, or by various instrumentalities that have been
established or sponsored by the U.S. government. U.S. Treasury obligations are
backed by the "full faith and credit" of the U.S. government. Securities issued
or guaranteed by federal agencies and U.S. government sponsored
instrumentalities may or may not be backed by the full faith and credit of the
U.S. government.
INTERNATIONAL SOVEREIGN DEBT
The Fund invests in debt securities, [including inflation-linked bonds,] issued
by foreign governments or their subdivisions, agencies and government-sponsored
enterprises. Sovereign Debt may include bonds, notes or other debt obligations
denominated in U.S. dollars issued by foreign governments.
INVESTMENT COMPANIES AND OTHER POOLED INVESTMENT VEHICLES
The Fund may invest in securities of investment companies, including ETFs. The
Fund may invest in the securities of ETFs, and other ETFs may invest in the
Fund, in excess of the limits imposed under the 1940 Act pursuant to exemptive
orders obtained by certain ETFs and their sponsors from the Securities and
Exchange Commission ("SEC"). ETFs trade on a securities exchange and their
shares may, at times, trade at a premium or discount to their net asset value.
As a shareholder in a pooled investment vehicle, the Fund will bear its ratable
share of that vehicle's expenses, and would remain subject to payment of the
fund's advisory and administrative fees with respect to assets so invested.
Shareholders would therefore be subject to duplicative expenses to the extent
the Fund invests in other pooled investment vehicles. In addition, the Fund will
incur brokerage costs when purchasing and selling shares of ETFs and closed-end
investment companies. Securities of other pooled investment vehicles may be
leveraged, in which case the value and/or yield of such securities will tend to
be more volatile than securities of unleveraged vehicles.
ADDITIONAL INVESTMENTS
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Fund may invest up to [10%] of its net assets in short-term debt securities,
money market funds and other cash equivalents, or it may hold cash. The
percentage of the Fund invested in such holdings will vary and will depend on
several factors, including market conditions. For temporary defensive purposes,
during the initial invest-up period and during periods of high cash inflows or
outflows, the Fund may depart from its principal investment strategies and
invest part or all of its assets in these securities or it may hold cash. During
such periods, the Fund may not be able to achieve its investment objective. The
Fund may adopt a defensive strategy when the Advisor believes securities in
which the Fund normally invests have elevated risks due to political or economic
factors and in other extraordinary circumstances.
-12-
Short-term debt securities are securities from issuers having a long-term debt
rating of at least A by S&P Ratings, Moody's or Fitch and having a maturity of
one year or less. The use of temporary investments will not be a part of a
principal investment strategy of the Fund.
Short-term debt securities are defined to include, without limitation, the
following: (i) U.S. government securities, including bills, notes and bonds
differing as to maturity and rates of interest, which are either issued or
guaranteed by the U.S. Treasury or by U.S. government agencies or
instrumentalities; (ii) short-term securities issued or guaranteed by non-U.S.
governments or by their agencies or instrumentalities; (iii) certificates of
deposit issued against funds deposited in a bank or savings and loan
association; (iv) bankers' acceptances, which are short-term credit instruments
used to finance commercial transactions; (v) repurchase agreements, which
involve purchases of debt securities; (vi) bank time deposits, which are monies
kept on deposit with banks or savings and loan associations for a stated period
of time at a fixed rate of interest; and (vii) commercial paper, which is
short-term unsecured promissory notes. The Fund may only invest in commercial
paper rated A-1 or higher by S&P Ratings, Prime-1 or higher by Moody's or F1 or
higher by Fitch.
ILLIQUID SECURITIES
The Fund may hold up to an aggregate amount of 15% of its net assets in illiquid
securities (calculated at the time of investment), including Rule 144A
securities deemed illiquid by the Advisor and/or the applicable Management Team
and variable rate master demand notes. The Fund will monitor its portfolio
liquidity on an ongoing basis to determine whether, in light of current
circumstances, an adequate level of liquidity is being maintained, and will
consider taking appropriate steps in order to maintain adequate liquidity if,
through a change in values, net assets, or other circumstances, more than 15% of
the Fund's net assets are held in illiquid securities. Illiquid securities
include securities subject to contractual or other restrictions on resale and
other instruments that lack readily available markets as determined in
accordance with Commission staff guidance.
DISCLOSURE OF PORTFOLIO HOLDINGS
A description of the policies and procedures with respect to the disclosure of
the Fund's portfolio securities is included in the Fund's SAI and on the Fund's
website at www.ftportfolios.com.
ADDITIONAL RISKS OF INVESTING IN THE FUND
Risk is inherent in all investing. Investing in the Fund involves risk,
including the risk that you may lose all or part of your investment. There can
be no assurance that the Fund will meet its stated objective. Before you invest,
you should consider the following risks in addition to the Principal Risks set
forth above in this prospectus:
BORROWING AND LEVERAGE RISK. When the Fund borrows money, it must pay interest
and other fees, which will reduce the Fund's returns if such costs exceed the
returns on the portfolio securities purchased or retained with such borrowings.
Any such borrowings are intended to be temporary. However, under certain market
-13-
conditions, including periods of low demand or decreased liquidity, such
borrowings might be outstanding for longer periods of time. As prescribed by the
1940 Act, the Fund will be required to maintain specified asset coverage of at
least 300% with respect to any bank borrowing immediately following such
borrowing. The Fund may be required to dispose of assets on unfavorable terms if
market fluctuations or other factors reduce the Fund's asset coverage to less
than the prescribed amount.
CALL RISK. In addition to the risks described above in "Principal Risks -- Call
Risk," many bonds may be redeemed at the option of the issuer, or "called,"
before their stated maturity date. In general, an issuer will call its bonds if
they can be refinanced by issuing new bonds which bear a lower interest rate.
The Fund is subject to the possibility that during periods of falling interest
rates, a bond issuer will call its high yielding bonds. The Fund would then be
forced to invest the unanticipated proceeds at lower interest rates, resulting
in a decline in the Fund's income.
CASH TRANSACTIONS RISK. In addition to the risks described above in "Principal
Risks -- Cash Transactions Risk," the Fund currently intends to effect a
significant portion of creations and redemptions for cash, rather than in-kind
securities. As a result, an investment in the Fund may be less tax-efficient
than an investment in an ETF that effects its creations and redemptions for
in-kind securities. ETFs are able to make in-kind redemptions and avoid being
taxed on gains on the distributed portfolio securities at the fund level.
Because the Fund intends to effect a significant portion of redemptions for
cash, it may be required to sell portfolio securities in order to obtain the
cash needed to distribute redemption proceeds. Any recognized gain on these
sales by the Fund will generally cause the Fund to recognize gain it might not
otherwise have recognized, or to recognize such gain sooner than would otherwise
be required if it were to distribute portfolio securities in-kind. The Fund
generally intends to distribute these gains to shareholders to avoid being taxed
on this gain at the fund level and otherwise comply with the special tax rules
that apply to it. This strategy may cause shareholders to be subject to tax on
gains they would not otherwise be subject to, or at an earlier date than if they
had made an investment in a different ETF. Moreover, cash transactions may have
to be carried out over several days if the securities market is relatively
illiquid and may involve considerable brokerage fees and taxes. These brokerage
fees and taxes, which will be higher than if the Fund sold and redeemed its
shares principally in-kind, will be passed on to purchasers and redeemers of
Creation Units in the form of creation and redemption transaction fees. In
addition, these factors may result in wider spreads between the bid and the
offered prices of the Fund's shares than for ETFs that distribute portfolio
securities in-kind.
CREDIT RISK. In addition to the risks described above in "Principal Risks --
Credit Risk," credit risk is the risk that an issuer of a debt instrument may be
unable or unwilling to make dividend, interest and/or principal payments when
due and the related risk that the value of an instrument may decline because of
concerns about the issuer's ability or unwillingness to make such payments. High
yield and comparable unrated debt securities, while generally offering higher
yields than investment-grade debt with similar maturities, involve greater
risks, including the possibility of dividend or interest deferral, default or
bankruptcy, and are regarded as predominantly speculative with respect to the
issuer's capacity to pay dividends or interest and repay principal. Credit risk
is heightened for loans in which the Fund invests because companies that issue
-14-
such loans tend to be highly leveraged and thus are more susceptible to the
risks of interest deferral, default and/or bankruptcy.
CREDIT RATING AGENCY RISK. Credit ratings are determined by credit rating
agencies such as Moody's Investors Service, Inc., Fitch Inc., or Standard &
Poor's, Inc., and are only the opinions of such entities. Ratings assigned by a
rating agency are not absolute standards of credit quality and do not evaluate
market risk or the liquidity of securities. Any shortcomings or inefficiencies
in credit rating agencies' processes for determining credit ratings may
adversely affect the credit ratings of securities held by the Fund and, as a
result, may adversely affect those securities' perceived or actual credit risk.
FIXED INCOME SECURITIES RISK. An investment in the Fund also involves risk
associated with an investment in fixed income securities including the risk that
certain of the securities in the Fund may not have the benefit of covenants
which would prevent the issuer from engaging in capital restructurings or
borrowing transactions in connection with corporate acquisitions, leveraged
buyouts or restructurings. This could have the effect of reducing the ability of
the issuer to meet its payment obligations and might result in increased credit
risk. In addition, certain of the securities may be redeemed or prepaid by the
issuer, resulting in lower interest payments received by the Fund and reduced
distributions to shareholders.
FLOATING-RATE LOAN RISK. In addition to the risks described above in "Principal
Risks -- Floating-Rate Loan Risk," the loans in which the Fund may invest may
not (i) be rated at the time of investment; (ii) be registered with the SEC;
(iii) be listed on a securities exchange; or (iv) have sufficient collateral
securing the loan or the collateral may not be available in the event of
bankruptcy. In addition, the amount of public information available with respect
to loans may be less extensive than that available for more widely rated,
registered and exchange-listed securities. Because no active trading market may
exist for some of the loans in which the Fund may invest, such loans may be
illiquid and more difficult to value than more liquid instruments for which a
trading market does exist. Unlike the securities markets, there is no central
clearinghouse for loan trades, and the loan market has not established
enforceable settlement standards or remedies for failure to settle. Therefore,
portfolio transactions in loans may have uncertain settlement time periods.
Because the interest rates of loans in which the Fund may invest may reset
frequently, if market interest rates fall, the loans' interest rates will be
reset to lower levels, potentially reducing the Fund's income.
First Trust or its affiliates may participate in the primary and secondary
market for loans. Because of limitations imposed by applicable law, the presence
of such affiliates in the loan market may restrict the Fund's ability to acquire
some loans or affect the timing or price of loan acquisitions. Also, because
First Trust may wish to invest in the publicly-traded securities of an obligor,
the Fund may not have access to material non-public information regarding the
obligor to which other investors have access.
HIGH YIELD SECURITIES RISK. In addition to the risks described above in
"Principal Risks -- High Yield Securities Risk," the Fund's investment in high
yield, high risk, domestic and foreign obligations, or "junk" securities, may
entail increased credit risks and the risk that the value of Fund's assets will
decline, and may decline precipitously, with increases in interest rates. In
-15-
recent years there have been wide fluctuations in interest rates and thus in the
value of fixed rate obligations generally. Securities such as those included in
the Fund are, under most circumstances, subject to greater market fluctuations
and risk of loss of income and principal than are investments in lower-yielding,
higher-rated securities, and their value may decline precipitously because of
increases in interest rates, not only because the increases in rates generally
decrease values, but also because increased rates may indicate a slowdown in the
economy and a decrease in the value of assets generally that may adversely
affect the credit of issuers of high yield, high risk securities, resulting in a
higher incidence of defaults among high yield, high risk securities. A slowdown
in the economy, or a development adversely affecting an issuer's
creditworthiness, may result in the issuer being unable to maintain earnings or
sell assets at the rate and at the prices, respectively, that are required to
produce sufficient cash flow to meet its interest and principal requirements.
For an issuer that has outstanding both senior commercial bank debt and
subordinated high yield, high risk securities, an increase in interest rates
will increase that issuer's interest expense insofar as the interest rate on the
bank debt is fluctuating. However, many leveraged issuers enter into interest
rate protection agreements to fix or cap the interest rate on a large portion of
their bank debt. This reduces exposure to increasing rates, but reduces the
benefit to the issuer of declining rates. The advisor cannot predict future
economic policies or their consequences or, therefore, the course or extent of
any similar market fluctuations in the future.
High yield debt may be issued by companies without long track records of sales
and earnings, or by issuers that have questionable credit strength. High yield
debt and comparable unrated debt securities: (i) will likely have some quality
and protective characteristics that, in the judgment of the rating agency
evaluating the instrument, are outweighed by large uncertainties or major risk
exposures to adverse conditions; and (ii) are predominantly speculative with
respect to the issuer's capacity to pay dividends or interest and repay
principal in accordance with the terms of the obligation. Many lower-quality
debt securities are subject to legal or contractual restrictions limiting the
Fund's ability to resell the securities to the general public.
ILLIQUID SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Illiquid Securities Risk," an investment in the Fund involves further
risk due to the fact that the Fund may invest a substantial portion of its
assets in lower-quality debt instruments issued by companies that are highly
leveraged. Lower-quality debt tends to be less liquid than higher-quality debt.
If the economy experiences a sudden downturn, or if the debt markets for such
companies become distressed, the Fund may have particular difficulty selling its
assets in sufficient amounts, at reasonable prices and in a sufficiently timely
manner to raise the cash necessary to meet any potentially heavy redemption
requests by Fund shareholders. In such event, there would be a greater chance
that the Fund may be forced to curtail or suspend redemptions, in which case you
might experience a delay or inability to liquidate your investment at the
desired time or in the desired amount.
INCOME RISK. In addition to the risks described above in "Principal Risks --
Income Risk," if interest rates decline, the income earned from the Fund's
portfolio may also decline. This can result because the Fund generally holds
floating rate debt that will adjust lower with falling interest rates. For
loans, interest rates typically reset periodically.
-16-
INFLATION RISK. Inflation risk is the risk that the value of assets or income
from investments will be less in the future as inflation decreases the value of
money. As inflation increases, the value of the Fund's assets can decline as can
the value of the Fund's distributions.
INTEREST RATE RISK. In addition to the risks described above in "Principal Risks
-- Interest Rate Risk," the value of the Fund's fixed-rate income may decline if
market interest rates rise. Interest rate risk is generally lower for
shorter-term investments and higher for longer-term investments. Duration is a
common measure of interest rate risk. Duration measures a bond's expected life
on a present value basis, taking into account the bond's yield, interest
payments and final maturity. Duration is a reasonably accurate measure of a
bond's price sensitivity to changes in interest rates. The longer the duration
of a bond, the greater the bond's price sensitivity is to changes in interest
rates.
INVESTMENT COMPANIES RISK. In addition to the risks described above in
"Principal Risks -- Investment Companies Risk," the Fund may invest in the
shares of other investment companies, including ETFs. An ETF may fail to
accurately track the returns of the market segment or index that it is designed
to track, and the price of an ETF's shares may fluctuate. In addition, because
they, unlike traditional mutual funds, are traded on an exchange, ETFs are
subject to the following risks: (i) the performance of the ETF may not replicate
the performance of the underlying index that it is designed to track; (ii) the
market price of the ETF's shares may trade at a premium or discount to the ETF's
net asset value; (iii) an active trading market for an ETF may not develop or be
maintained; and (iv) there is no assurance that the requirements of the exchange
necessary to maintain the listing of the ETF will continue to be met or remain
unchanged. In the event substantial market or other disruptions affecting ETFs
should occur in the future, the liquidity and value of the Fund's shares could
also be substantially and adversely affected.
ISSUER SPECIFIC CHANGES RISK. The value of an individual security or particular
type of security can be more volatile than the market as a whole and can perform
differently from the value of the market as a whole.
MANAGEMENT RISK. In addition to the risks described above in "Principal Risks --
Management Risk," the Fund is subject to management risk because it has an
actively managed portfolio. The advisor will apply investment techniques and
risk analyses in making investment decisions for the Fund, but there can be no
guarantee that the Fund will achieve its investment objective.
LEGISLATION/LITIGATION RISK. From time to time, various legislative initiatives
are proposed that may have a negative impact on certain securities in which the
Fund invests. In addition, litigation regarding any of the securities owned by
the Fund may negatively impact the value of the Fund's shares. Such legislation
or litigation may cause the Fund to lose value or may result in higher portfolio
turnover if the Advisor determines to sell such a holding.
MARKET RISK. In addition to the risks described above in "Principal
Risks--Market Risk," the market values of the Fund's investments may decline, at
times sharply and unpredictably. Market values of debt securities are affected
-17-
by a number of different factors, including changes in interest rates, the
credit quality of bond issuers, and general economic and market conditions.
MARKET MAKER RISK. If the Fund has lower average daily trading volumes, it may
rely on a small number of third-party market makers to provide a market for the
purchase and sale of shares. Any trading halt or other problem relating to the
trading activity of these market makers could result in a dramatic change in the
spread between the Fund's net asset value and the price at which the Fund's
shares are trading on the Exchange which could result in a decrease in value of
the Fund's shares.
[MUNICIPAL LEASE OBLIGATION RISK. In addition to the risks described above in
"Principal Risks--Municipal Lease Obligations Risk," the Fund may purchase
participation interests in municipal leases. These are undivided interests in a
lease, installment purchase contract, or conditional sale contract entered into
by a state or local government unit to acquire equipment or facilities.
Participation interests in municipal leases pose special risks because many
leases and contracts contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for this purpose by the appropriate
legislative body. Although these kinds of obligations are secured by the leased
equipment or facilities, it might be difficult and time consuming to dispose of
the equipment or facilities in the event of non-appropriation, and the Fund
might not recover the full principal amount of the obligation.]
NON-U.S. SECURITIES RISK. In addition to the risks described above in "Principal
Risks -- Non-U.S. Securities Risk," an investment in securities of non-U.S.
companies involves other risks not associated with domestic issuers. Investment
in non-U.S. securities may involve higher costs than investment in U.S.
securities, including higher transaction and custody costs as well as the
imposition of additional taxes by non-U.S. governments. Non-U.S. investments may
also involve risks associated with the level of currency exchange rates, less
complete financial information about the issuers, less market liquidity, more
market volatility and political instability. Future political and economic
developments, the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of non-U.S. holdings, the possible
establishment of exchange controls or freezes on the convertibility of currency,
or the adoption of other governmental restrictions might adversely affect an
investment in non-U.S. securities. Additionally, non-U.S. issuers may be subject
to less stringent regulation, and to different accounting, auditing and
recordkeeping requirements.
POLITICAL AND ECONOMIC RISKS. In addition to the risks described above in
"Principal Risks--Political and Economic Risks, the values of municipal
securities may be adversely affected by local political and economic conditions
and developments. Adverse conditions in an industry significant to a local
economy could have a correspondingly adverse effect on the financial condition
of local issuers. Other factors that could affect municipal securities include a
change in the local, state, or national economy, demographic factors, ecological
or environmental concerns, statutory limitations on the issuer's ability to
increase taxes, and other developments generally affecting the revenue of
issuers (for example, legislation or court decisions reducing state aid to local
governments or mandating additional services). This risk would be heightened to
-18-
the extent that the Fund invests a substantial portion of the below investment
grade quality portion of its portfolio in the bonds of similar projects (such as
those relating to the education, health care, housing, transportation, or
utilities industries), in industrial development bonds, or in particular types
of municipal securities (such as general obligation bonds, private activity
bonds or moral obligation bonds) that are particularly exposed to specific types
of adverse economic, business or political events.
To the extent that the Fund invests a significant portion of its assets in the
securities of issuers located in a given state or U.S. territory, it will be
disproportionally affected by political and economic conditions and developments
in that state or territory. In addition, economic, political or regulatory
changes in that state or territory could adversely affect municipal bond issuers
in that state or territory and therefore the value of the Fund's investment
portfolio.
PREPAYMENT RISK. In addition to the risks described above in "Principal Risks --
Prepayment Risk," during periods of falling interest rates, an issuer of a loan
may exercise its right to pay principal on an obligation earlier than expected.
This may result in the Fund reinvesting proceeds at lower interest rates,
resulting in a decline in the Fund's income.
SOVEREIGN DEBT RISK. In addition to the risks described above in "Principal
Risks - Sovereign Debt Risk," investments in Sovereign Debt securities involve
special risks, such as the relative size of the debt service burden to the
economy as a whole and the government debtor's policy towards the International
Monetary Fund and the political constraints to which a government debtor may be
subject. The governmental authority that controls the repayment of sovereign
debt may be unwilling or unable to repay the principal and/or interest when due
in accordance with the terms of such securities. If an issuer of Sovereign Debt
defaults on payments of principal and/or interest, the Fund may have limited
legal recourse against the issuer and/or guarantor. In certain cases, remedies
must be pursued in the courts of the defaulting party itself, and the Fund's
ability to obtain recourse may be limited.
Certain issuers of Sovereign Debt may be dependent on disbursements from foreign
governments, multilateral agencies and others abroad to reduce principal and
interest arrearages on their debt. Such disbursements may be conditioned upon a
debtor's implementation of economic reforms and/or economic performance and the
timely service of such debtor's obligations. A failure on the part of the debtor
to implement such reforms, achieve such levels of economic performance or repay
principal or interest when due may result in the cancellation of such third
parties' commitments to lend funds to the government debtor, which may impair
the debtor's ability to service its debts on a timely basis. If the Fund is a
holder of such government debt, the Fund may be requested to participate in the
rescheduling of such debt and to extend further loans to government debtors.
TAX RISK. In addition to the risks described above in "Principal Risks--Tax
Risk, proposals have been introduced in Congress to restrict or eliminate the
federal income tax exemption for interest on municipal securities, and similar
proposals may be introduced in the future. Proposed "flat tax" and "value added
tax" proposals would also have the effect of eliminating the tax preference for
municipal securities. Some of the past proposals would have applied to interest
on municipal securities issued before the date of enactment, which would have
adversely affected their value to a material degree. If such a proposal were
-19-
enacted, the availability of municipal securities for investment by the Fund and
the value of the Fund's portfolio would be adversely affected.
VALUATION RISK. Unlike publicly traded securities that trade on national
exchanges, there is no central place or exchange for fixed income securities
trading. Fixed income securities generally trade on an "over-the-counter" market
which may be anywhere in the world where the buyer and seller can settle on a
price. Due to the lack of centralized information and trading, the valuation of
fixed income securities may carry more uncertainty and risk than that of
publicly traded securities. Accordingly, determinations of the fair value of
fixed income securities may be based on infrequent and dated information. Also,
because the available information is less reliable and more subjective, elements
of judgment may play a greater role in valuation of debt securities than for
other types of securities. Typically, fixed income securities are valued using
information provided by a third party pricing service, which primarily uses
broker quotes to value the securities.
TRADING ISSUES
Although the Fund intends to list and trade its shares on NASDAQ(R), there can
be no assurance that an active trading market for such shares will develop or be
maintained. Trading in shares on NASDAQ(R) may be halted due to market
conditions or for reasons that, in the view of NASDAQ(R), make trading in shares
inadvisable. In addition, trading in shares on NASDAQ(R) is subject to trading
halts caused by extraordinary market volatility pursuant to NASDAQ(R) "circuit
breaker" rules. There can be no assurance that the requirements of NASDAQ(R)
necessary to maintain the listing of the Fund will continue to be met or will
remain unchanged. Due to the initial small asset size of the Fund, it is more
likely to have difficulty maintaining its listing on NASDAQ(R).
FLUCTUATION OF NET ASSET VALUE
The net asset value of shares of the Fund will generally fluctuate with
changes in the market value of the Fund's holdings. The market prices of shares
will generally fluctuate in accordance with changes in net asset value as well
as the relative supply of and demand for shares on NASDAQ(R). The Fund cannot
predict whether shares will trade below, at or above their net asset value.
Price differences may be due, in large part, to the fact that supply and demand
forces at work in the secondary trading market for shares will be closely
related to, but not identical to, the same forces influencing the prices of the
holdings of the Fund trading individually or in the aggregate at any point in
time. However, given that shares can only be purchased and redeemed either
in-kind or for cash in Creation Units (unlike shares of closed-end funds, which
frequently trade at appreciable discounts from, and sometimes at premiums to,
their net asset value), the Fund believes that large discounts or premiums to
the net asset value of shares should not be sustained.
-20-
FUND ORGANIZATION
The Fund is a series of the Trust, an investment company registered under the
1940 Act. The Fund is treated as a separate fund with its own investment
objective and policies. The Trust is organized as a Massachusetts business
trust. Its Board is responsible for the overall management and direction of the
Trust. The Board elects the Trust's officers and approves all significant
agreements, including those with the investment advisor, custodian and fund
administrative and accounting agent.
MANAGEMENT OF THE FUND
First Trust Advisors L.P. ("First Trust" or the "Advisor"), 120 East Liberty
Drive, Wheaton, Illinois 60187, is the investment advisor to the Fund. In this
capacity, First Trust is responsible for the selection and ongoing monitoring of
the securities in the Fund's portfolio and certain other services necessary for
the management of the portfolio.
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. Grace Partners of
DuPage L.P. is a limited partnership with one general partner, The Charger
Corporation, and a number of limited partners. The Charger Corporation is an
Illinois corporation controlled by James A. Bowen, the Chief Executive Officer
of First Trust. First Trust discharges its responsibilities subject to the
policies of the Board.
First Trust serves as advisor or sub-advisor for __ mutual fund portfolios,
seven ETFs consisting of __ series and __ closed-end funds and is also the
portfolio supervisor of certain unit investment trusts sponsored by First Trust
Portfolios L.P. ("FTP"), 120 East Liberty Drive, Wheaton, Illinois 60187. FTP
specializes in the underwriting, trading and distribution of unit investment
trusts and other securities. FTP is the principal underwriter of the shares of
the Fund.
Todd Larson and Eric Maisel are the Fund's portfolio managers and share
responsibilities for the day-to-day management of the Fund's investment
portfolio.
o Mr. Larson has been a Vice President and Fixed Income Portfolio
Manager at First Trust since December 2007. Mr. Larson is
responsible for managing fixed income portfolios for First Trust's
institutional clients. Prior to joining First Trust, Mr. Larson was
a portfolio manager with ABN AMRO Asset Management, Horizon Cash
Management and Van Kampen American Capital.
o Mr. Maisel joined First Trust in March 2011 as a Fixed Income
Portfolio Manager and has 21 years of investment experience, most
reently as Senior Portfolio Manager for the Ascendant Structured
Credit Opportunity Fund.
For additional information concerning First Trust and the portfolio
managers, including a description of the services provided to the Fund, see
"Management of the Fund" in the Fund's SAI. Additional information about the
portfolio managers' compensation, other accounts managed by the portfolio
-21-
managers and the portfolio managers' ownership of securities in the Fund is
provided in the SAI.
MANAGEMENT FEE
Pursuant to the Investment Management Agreement, First Trust will manage the
investment of the Fund's assets and will be responsible for the Fund's expenses,
including the cost of transfer agency, custody, fund administration, legal,
audit and other services, but excluding fee payments under the Investment
Management Agreement, interest, taxes, brokerage commissions and other expenses
connected with the execution of portfolio transactions, distribution and service
fees pursuant to a 12b-1 plan, if any, and extraordinary expenses.
The Fund has agreed to pay First Trust an annual management fee equal to 0.__%
of its average daily net assets. As of the date of this prospectus, the Fund has
neither commenced operations nor paid management fees.
A discussion regarding the Board's approval of the Investment Management
Agreement for the Fund will be available in the Fund's Annual Report to
shareholders for the period ended ___________, 201_.
HOW TO BUY AND SELL SHARES
Most investors will buy and sell shares of the Fund in secondary market
transactions through brokers. Shares of the Fund are expected to be listed for
trading on the secondary market on NASDAQ(R). Shares can be bought and sold
throughout the trading day like other publicly traded shares. There is no
minimum investment when buying shares on NASDAQ(R). Although shares are
generally purchased and sold in "round lots" of 100 shares, brokerage firms
typically permit investors to purchase or sell shares in smaller "odd lots," at
no per-share price differential. When buying or selling shares through a broker,
investors should expect to incur customary brokerage commissions, investors may
receive less than the net asset value of the shares because shares are bought
and sold at market prices rather than net asset value, and investors may pay
some or all of the spread between the bid and the offer price in the secondary
market on each leg of a round trip (purchase and sale) transaction. Share prices
are reported in dollars and cents per share.
For purposes of the 1940 Act, the Fund is treated as a registered investment
company, and the acquisition of shares by other registered investment companies
is subject to the restrictions of Section 12(d)(1) of the 1940 Act. The Trust,
on behalf of the Fund, has received an exemptive order from the SEC that permits
certain registered investment companies to invest in the Fund beyond the limits
set forth in Section 12(d)(1), subject to certain terms and conditions,
including that any such investment companies enter into an agreement with the
Fund regarding the terms of any investment.
-22-
BOOK ENTRY
Shares are held in book-entry form, which means that no share certificates are
issued. The Depository Trust Company ("DTC") or its nominee is the record owner
of all outstanding shares of the Fund and is recognized as the owner of all
shares for all purposes.
Investors owning shares are beneficial owners as shown on the records of DTC or
its participants. DTC serves as the securities depository for all shares.
Participants in DTC include securities brokers and dealers, banks, trust
companies, clearing corporations and other institutions that directly or
indirectly maintain a custodial relationship with DTC. As a beneficial owner of
shares, you are not entitled to receive physical delivery of share certificates
or to have shares registered in your name, and you are not considered a
registered owner of shares. Therefore, to exercise any right as an owner of
shares, you must rely upon the procedures of DTC and its participants. These
procedures are the same as those that apply to any other stocks that you hold in
book-entry or "street name" form.
SHARE TRADING PRICES
The trading prices of shares of the Fund on NASDAQ(R) may differ from the Fund's
daily net asset value and can be affected by market forces of supply and demand,
economic conditions and other factors.
Information regarding the intra-day value of the shares of the Fund, also
referred to as the "indicative optimized portfolio value" ("IOPV"), is
disseminated every 15 seconds throughout the Fund's trading day by the national
securities exchange on which the shares are listed or by market data vendors or
other information providers. The IOPV should not be viewed as a "real-time"
update of the net asset value per share of the Fund because the IOPV may not be
calculated in the same manner as the net asset value, which is computed once a
day, generally at the end of the business day. The price of a non-U.S. security
that is primarily traded on a non-U.S. exchange will be updated, using the last
sale price, every 15 seconds throughout the trading day, provided, that upon the
closing of such non-U.S. exchange, the closing price of the security, after
being converted to U.S. dollars, will be used. Furthermore, in calculating the
IOPV of the Fund's shares, exchange rates may be used throughout the day (9:00
a.m. to 4:15 p.m., Eastern time) that may differ from those used to calculate
the net asset value per share of the Fund and consequently may result in
differences between the net asset value and the IOPV. The Fund is not involved
in, or responsible for, the calculation or dissemination of the IOPV of shares
of the Fund and the Fund does not make any warranty as to its accuracy.
FREQUENT PURCHASES AND REDEMPTIONS OF THE FUND'S SHARES
The Fund imposes no restrictions on the frequency of purchases and redemptions
("market timing"). In determining not to approve a written, established policy,
the Board evaluated the risks of market timing activities by the Fund's
shareholders. The Board considered that the Fund's shares can only be purchased
and redeemed directly from the Fund in Creation Units by broker-dealers and
large institutional investors that have entered into participation agreements
(i.e., authorized participants ("APs"), and that the vast majority of trading in
the Fund's shares occurs on the secondary market. Because the secondary market
-23-
trades do not involve the Fund directly, it is unlikely those trades would cause
many of the harmful effects of market timing, including dilution, disruption of
portfolio management, increases in the Fund's trading costs and the realization
of capital gains. As the Fund may effect the purchase or redemption of Creation
Units in exchange wholly or partially for cash, the Board noted that such trades
could result in dilution to the Fund and increased transaction costs, which
could negatively impact the Fund's ability to achieve its investment objective.
However, the Board noted that direct trading by APs is critical to ensuring that
the shares trade at or close to net asset value. In addition, the Fund imposes
fixed and variable transaction fees on purchases and redemptions of Creation
Units to cover the custodial and other costs incurred by the Fund in effecting
trades. Finally, the Advisor monitors purchase abd redemption orders from APs
for patterns of abusive trading. The Fund reserves the right to reject purchase
and redemption orders from APs that the Advisor has determined may be disruptive
to the management of the Fund, or otherwise not in the Fund's best interests.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Dividends from net investment income, if any, are declared and paid at least
monthly by the Fund. The Fund distributes its net realized capital gains, if
any, to shareholders at least annually.
Distributions in cash may be reinvested automatically in additional whole shares
only if the broker through whom you purchased shares makes such option
available. Such shares will generally be reinvested by the broker based upon the
market price of those shares and investors may be subject to customary brokerage
commissions charged by the broker.
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax consequences of
owning shares of the Fund. This section is current as of the date of this
prospectus. Tax laws and interpretations change frequently, and these summaries
do not describe all of the tax consequences to all taxpayers. For example, these
summaries generally do not describe your situation if you are a corporation, a
non-U.S. person, a broker-dealer, or other investor with special circumstances.
In addition, this section does not describe your state, local or non-U.S. tax
consequences.
This federal income tax summary is based in part on the advice of counsel to the
Fund. The Internal Revenue Service could disagree with any conclusions set forth
in this section. In addition, counsel to the Fund was not asked to review, and
has not reached a conclusion with respect to, the federal income tax treatment
of the assets to be included in the Fund. This may not be sufficient for you to
use for the purpose of avoiding penalties under federal tax law.
As with any investment, you should seek advice based on your individual
circumstances from your own tax advisor.
-24-
FUND STATUS
The Fund intends to qualify as a "regulated investment company" under the
federal tax laws. If the Fund qualifies as a regulated investment company and
distributes its income as required by the tax law, the Fund generally will not
pay federal income taxes.
DISTRIBUTIONS
The Fund's distributions are generally taxable. After the end of each year, you
will receive a tax statement that separates the distributions of the Fund into
two categories, ordinary income distributions and capital gains dividends.
Ordinary income distributions are generally taxed at your ordinary tax rate;
however, as further discussed below, certain ordinary income distributions
received from the Fund may be taxed at the capital gains tax rates. Generally,
you will treat all capital gain dividends as long-term capital gains regardless
of how long you have owned your shares. To determine your actual tax liability
for your capital gains dividends, you must calculate your total net capital gain
or loss for the tax year after considering all of your other taxable
transactions, as described below. In addition, the Fund may make distributions
that represent a return of capital for tax purposes and thus will generally not
be taxable to you; however, such distributions may reduce basis, which could
result in you having to pay higher taxes in the future when shares are sold,
even if you sell the shares at a loss from your original investment. The tax
status of your distributions from the Fund is not affected by whether you
reinvest your distributions in additional shares or receive them in cash. The
income from the Fund that you must take into account for federal income tax
purposes is not reduced by amounts used to pay a deferred sales fee, if any. The
tax laws may require you to treat distributions made to you in January as if you
had received them on December 31 of the previous year.
Under the "Health Care and Education Reconciliation Act of 2010," income from
the Fund may also be subject to a new 3.8% "Medicare tax" imposed for taxable
years beginning after 2012. This tax will generally apply to your net investment
income if your adjusted gross income exceeds certain threshold amounts, which
are $250,000 in the case of married couples filing joint returns and $200,000 in
the case of single individuals.
DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares generally will not be entitled to the dividends
received deduction with respect to many dividends received from the Fund because
the dividends received deduction is generally not available for distributions
from regulated investment companies. However, certain ordinary income dividends
on shares that are attributable to qualifying dividends received by the Fund
from certain corporations may be reported by the Fund as being eligible for the
dividends received deduction.
CAPITAL GAINS AND LOSSES AND CERTAIN ORDINARY INCOME DIVIDENDS
If you are an individual, the maximum marginal federal tax rate for net capital
gain is generally 20% for taxpayers in the 39.6% tax bracket, 15% for taxpayers
-25-
in the 25%, 28%, 33% and 35% tax brackets and 0% for taxpayers in the 10% and
15% tax brackets. Capital gains may also be subject to the Medicare tax
described above.
Net capital gain equals net long-term capital gain minus net short-term capital
loss for the taxable year. Capital gain or loss is long-term if the holding
period for the asset is more than one year and is short-term if the holding
period for the asset is one year or less. You must exclude the date you purchase
your shares to determine your holding period. However, if you receive a capital
gain dividend from the Fund and sell your shares at a loss after holding it for
six months or less, the loss will be recharacterized as long-term capital loss
to the extent of the capital gain dividend received. The tax rates for capital
gains realized from assets held for one year or less are generally the same as
for ordinary income. The Code treats certain capital gains as ordinary income in
special situations.
Ordinary income dividends received by an individual shareholder from a regulated
investment company such as the Fund are generally taxed at the same rates that
apply to net capital gain (as discussed above), provided certain holding period
requirements are satisfied and provided the dividends are attributable to
qualifying dividends received by the Fund itself. The Fund will provide notice
to its shareholders of the amount of any distribution which may be taken into
account as a dividend which is eligible for the capital gains tax rates.
SALE OF SHARES
If you sell or redeem your shares, you will generally recognize a taxable gain
or loss. To determine the amount of this gain or loss, you must subtract your
tax basis in your shares from the amount you receive in the transaction. Your
tax basis in your shares is generally equal to the cost of your shares,
generally including sales charges. In some cases, however, you may have to
adjust your tax basis after you purchase your shares.
TAXES ON PURCHASE AND REDEMPTION OF CREATION UNITS
If you exchange securities for Creation Units you will generally recognize a
gain or a loss. The gain or loss will be equal to the difference between the
market value of the Creation Units at the time and your aggregate basis in the
securities surrendered and the cash component paid. If you exchange Creation
Units for securities, you will generally recognize a gain or loss equal to the
difference between your basis in the Creation Units and the aggregate market
value of the securities received and the cash redemption amount. The Internal
Revenue Service, however, may assert that a loss realized upon an exchange of
securities for Creation Units or Creation Units for securities cannot be
deducted currently under the rules governing "wash sales," or on the basis that
there has been no significant change in economic position.
DEDUCTIBILITY OF FUND EXPENSES
Expenses incurred and deducted by the Fund will generally not be treated as
income taxable to you. In some cases, however, you may be required to treat your
portion of these Fund expenses as income. In these cases you may be able to take
a deduction for these expenses. However, certain miscellaneous itemized
-26-
deductions, such as investment expenses, may be deducted by individuals only to
the extent that all of these deductions exceed 2% of the individual's adjusted
gross income. Some individuals may also be subject to further limitations on the
amount of their itemized deductions, depending on their income.
NON-U.S. TAX CREDIT
Because the Fund invests in non-U.S. securities, the tax statement that you
receive may include an item showing non-U.S. taxes the Fund paid to other
countries. In this case, dividends taxed to you will include your share of the
taxes the Fund paid to other countries. You may be able to deduct or receive a
tax credit for your share of these taxes.
NON-U.S. INVESTORS
If you are a non-U.S. investor (i.e., an investor other than a U.S. citizen or
resident or a U.S. corporation, partnership, estate or trust), you should be
aware that, generally, subject to applicable tax treaties, distributions from
the Fund will be characterized as dividends for federal income tax purposes
(other than dividends which the Fund properly reports as capital gain dividends)
and will be subject to U.S. federal income taxes, including withholding taxes,
subject to certain exceptions described below. However, distributions received
by a non-U.S. investor from the Fund that are properly reported by the Fund as
capital gain dividends may not be subject to U.S. federal income taxes,
including withholding taxes, provided that the Fund makes certain elections and
certain other conditions are met. In the case of dividends with respect to
taxable years of the Trust beginning prior to 2014, distributions from the Trust
that are properly reported by the Trust as an interest-related dividend
attributable to certain interest income received by the Trust or as a short-term
capital gain dividend attributable to certain net short-term capital gain income
received by the Trust may not be subject to U.S. federal income taxes, including
withholding taxes, when received by certain foreign investors, provided that the
Trust makes certain elections and certain other conditions are met.
Distributions after December 31, 2013 may be subject to a U.S. withholding tax
of 30% in the case of distributions to (i) certain non-U.S. financial
institutions that have not entered into an agreement with the U.S. Treasury to
collect and disclose certain information and are not resident in a jurisdiction
that has entered into such an agreement with the U.S. Treasury and (ii) certain
other non-U.S. entities that do not provide certain certifications and
information about the entity's U.S. owners. Dispositions of shares by such
persons may be subject to such withholding after December 31, 2016.
INVESTMENTS IN CERTAIN NON-U.S. CORPORATIONS
If the Fund holds an interest in any passive foreign investment company, which
are generally certain non-U.S. corporations that receive at least 75% of their
annual gross income from passive sources (such as interest, dividends, certain
rents and royalties or capital gains) or that hold at least 50% of their assets
in investments producing such passive income, the Fund could be subject to U.S.
federal income tax and additional interest charges on gains and certain
-27-
distributions with respect to those interests, even if all the income or gain is
timely distributed to its shareholders. The Fund will not be able to pass
through to its shareholders any credit or deduction for such taxes. The Fund may
be able to make an election that could ameliorate these adverse tax
consequences. In this case, the Fund would recognize as ordinary income any
increase in the value of such passive foreign investment company shares, and as
ordinary loss any decrease in such value to the extent it did not exceed prior
increases included in income. Under this election, the Fund might be required to
recognize in a year income in excess of its distributions from passive foreign
investment companies and its proceeds from dispositions of passive foreign
investment company securities during that year, and such income would
nevertheless be subject to the distribution requirement and would be taken into
account for purposes of the 4% excise tax. Dividends paid by passive foreign
investment companies will not be treated as qualified dividend income.
DISTRIBUTION PLAN
FTP serves as the distributor of Creation Units for the Fund on an agency basis.
FTP does not maintain a secondary market in shares.
The Board has adopted a Distribution and Service Plan pursuant to Rule 12b-1
under the 1940 Act. In accordance with its Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse FTP for amounts expended to finance activities primarily
intended to result in the sale of Creation Units or the provision of investor
services. FTP may also use this amount to compensate securities dealers or other
persons that are APs for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional services.
The Fund does not currently pay 12b-1 fees, and pursuant to a contractual
arrangement, the Fund will not pay 12b-1 fees any time before _________.
However, in the event 12b-1 fees are charged in the future, because these fees
are paid out of the Fund's assets, over time these fees will increase the cost
of your investment and may cost you more than certain other types of sales
charges.
NET ASSET VALUE
The Fund's net asset value is determined as of the close of trading (normally
4:00 p.m., Eastern time) on each day the New York Stock Exchange is open for
business. Net asset value is calculated for the Fund by taking the market price
of the Fund's total assets, including interest or dividends accrued but not yet
collected, less all liabilities, and dividing such amount by the total number of
shares outstanding. The result, rounded to the nearest cent, is the net asset
value per share. All valuations are subject to review by the Fund's Board or its
delegate.
The Fund's investments are valued daily in accordance with valuation procedures
adopted by the Trust's Board of Trustees, and in accordance with provisions of
the 1940 Act. Certain securities in which the Fund may invest are not listed on
any securities exchange or board of trade. Such securities are typically bought
and sold by institutional investors in individually negotiated private
-28-
transactions that function in many respects like an over-the-counter secondary
market, although typically no formal market makers exist. Certain securities,
particularly debt securities, have few or no trades, or trade infrequently, and
information regarding a specific security may not be widely available or may be
incomplete. Accordingly, determinations of the fair value of debt securities may
be based on infrequent and dated information. Because there is less reliable,
objective data available, elements of judgment may play a greater role in
valuation of debt securities than for other types of securities. Typically, debt
securities are valued using information provided by a third-party pricing
service. The third-party pricing service primarily uses broker quotes to value
the securities.
The Fund's investments will be valued at market value or, in the absence of
market value with respect to any investment, at fair value in accordance with
valuation procedures adopted by the Fund's Board and in accordance with the 1940
Act. Portfolio securities listed on any exchange other than The NASDAQ National
Market ("NASDAQ") and the London Stock Exchange Alternative Investment Market
("AIM") will be valued at the last sale price on the exchange on which they are
principally traded. Securities listed on the NASDAQ or the AIM will be valued at
the official closing price. Securities traded on more than one securities
exchange will be valued at the last sale price or official closing price, as
applicable, at the close of the exchange representing the principal market for
such securities. Portfolio securities traded in the over-the-counter market are
valued at their closing bid prices. Short-term investments that mature in less
than 60 days when purchased will be valued at cost adjusted for amortization of
premiums and accretion of discount. Net asset value may change on days when
investors may not sell or redeem Fund shares.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board or its delegate at fair
value. The use of fair value pricing by the Fund is governed by valuation
procedures adopted by the Board and in accordance with the provisions of the
1940 Act. These securities generally include, but are not limited to, certain
restricted securities (securities which may not be publicly sold without
registration under the Securities Act of 1933, as amended (the "Securities Act")
for which a pricing service is unable to provide a market price; securities
whose trading has been formally suspended; a security whose market price is not
available from a pre-established pricing source; a security with respect to
which an event has occurred that is likely to materially affect the value of the
security after the market has closed but before the calculation of the Fund's
net asset value or make it difficult or impossible to obtain a reliable market
quotation; and a security whose price, as provided by the pricing service, does
not reflect the security's "fair value." As a general principle, the current
"fair value" of a security would appear to be the amount which the owner might
reasonably expect to receive for the security upon its current sale. The use of
fair value prices by the Fund generally results in the prices used by the Fund
that may differ from current market quotations or official closing prices on the
applicable exchange. A variety of factors may be considered in determining the
fair value of such securities. Valuing the Fund's securities using fair value
pricing will result in using prices for those securities that may differ from
current market valuations. See the Fund's SAI for details.
Because foreign securities exchanges may be open on different days than the days
during which an investor may purchase or sell shares of the Fund, the value of
-29-
the Fund's securities may change on days when investors are not able to purchase
or sell shares of the Fund. The value of securities denominated in foreign
currencies is converted into U.S. dollars at the exchange rates in effect at the
time of valuation.
FUND SERVICE PROVIDERS
_____________ acts as the administrator, accounting agent, custodian and
transfer agent to the Fund. Chapman and Cutler LLP, 111 West Monroe Street,
Chicago, Illinois 60603, serves as legal counsel to the Fund.
PREMIUM/DISCOUNT INFORMATION
The Fund has not yet commenced operations and, therefore, does not have
information about the differences between the Fund's daily market price on
NASDAQ(R) and its net asset value. Once the Fund has commenced operations, this
information will be available on the Fund's website at www.ftportfolios.com.
OTHER INFORMATION
CONTINUOUS OFFERING
The Fund issues, on a continuous offering basis, its shares in one or more
groups of a fixed number of Fund shares (each such group of such specified
number of individual Fund shares, a "Creation Unit Aggregation"). The method by
which Creation Unit Aggregations of Fund shares are created and traded may raise
certain issues under applicable securities laws. Because new Creation Unit
Aggregations of shares are issued and sold by the Fund on an ongoing basis, a
"distribution," as such term is used in the Securities Act, may occur at any
point. Broker-dealers and other persons are cautioned that some activities on
their part may, depending on the circumstances, result in their being deemed
participants in a distribution in a manner that could render them statutory
underwriters and subject them to the prospectus delivery requirement and
liability provisions of the Securities Act.
For example, a broker-dealer firm or its client may be deemed a statutory
underwriter if it takes Creation Unit Aggregations after placing an order with
FTP, breaks them down into constituent shares and sells such shares directly to
customers, or if it chooses to couple the creation of a supply of new shares
with an active selling effort involving solicitation of secondary market demand
for shares. A determination of whether one is an underwriter for purposes of the
Securities Act must take into account all the facts and circumstances pertaining
to the activities of the broker-dealer or its client in the particular case, and
the examples mentioned above should not be considered a complete description of
all the activities that could lead to a characterization as an underwriter.
Broker-dealer firms should also note that dealers who are not "underwriters" but
are effecting transactions in shares, whether or not participating in the
distribution of shares, are generally required to deliver a prospectus. This is
because the prospectus delivery exemption in Section 4(3) of the Securities Act
-30-
is not available in respect of such transactions as a result of Section 24(d) of
the 1940 Act. As a result, broker-dealer firms should note that dealers who are
not underwriters but are participating in a distribution (as contrasted with
ordinary secondary market transactions) and thus dealing with the shares that
are part of an overallotment within the meaning of Section 4(3)(c) of the
Securities Act would be unable to take advantage of the prospectus delivery
exemption provided by Section 4(3) of the Securities Act. Firms that incur a
prospectus delivery obligation with respect to shares are reminded that, under
the Securities Act Rule 153, a prospectus delivery obligation under Section
5(b)(2) of the Securities Act owed to a broker-dealer in connection with a sale
on NASDAQ(R) is satisfied by the fact that the prospectus is available from
NASDAQ(R) upon request. The prospectus delivery mechanism provided in Rule 153
is available with respect to transactions on a national securities exchange, a
trading facility or an alternative trading system.
-31-
FIRST TRUST EXCHANGE-TRADED FUND IV
FIRST TRUST ENHANCED SHORT MATURITY ETF
FOR MORE INFORMATION
For more detailed information on the Fund, several additional sources of
information are available to you. The SAI, incorporated by reference into this
prospectus, contains detailed information on the Fund's policies and operation.
Additional information about the Fund's investments is available in the annual
and semi-annual reports to shareholders. In the Fund's annual reports, you will
find a discussion of the market conditions and investment strategies that
significantly impacted the Fund's performance during the last fiscal year. The
Fund's most recent SAI, annual or semi-annual reports and certain other
information are available free of charge by calling the Fund at (800) 621-1675,
on the Fund's website at www.ftportfolios.com or through your financial advisor.
Shareholders may call the toll-free number above with any inquiries.
You may obtain this and other information regarding the Fund, including the
Codes of Ethics adopted by First Trust, FTP and the Trust, directly from the
SEC. Information on the SEC's website is free of charge. Visit the SEC's on-line
EDGAR database at www.sec.gov or in person at the SEC's Public Reference Room in
Washington, D.C., or call the SEC at (202) 551-8090 for information on the
Public Reference Room. You may also request information regarding the Fund by
sending a request (along with a duplication fee) to the SEC's Public Reference
Section, 100 F Street, N.E., Washington, D.C. 20549-1520 or by sending an
electronic request to publicinfo@sec.gov.
First Trust Advisors, L.P.
120 East Liberty Drive
Suite 400
Wheaton, Illinois 60187
(800) 621-1675 SEC File #: 333-174332
www.ftportfolios.com 811-22559
Preliminary Statement of Additional Information
Dated April 10, 2014
Subject to Completion
|
The information in this Statement of Additional Information is not complete and
may be changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is effective. This
Statement of Additional Information is not an offer to sell these securities and
it is not soliciting an offer to buy these securities in any state where the
offer of sale is not permitted.
STATEMENT OF ADDITIONAL INFORMATION
INVESTMENT COMPANY ACT FILE NO. 811-22559
FIRST TRUST EXCHANGE-TRADED FUND IV
TICKER
FUND NAME SYMBOL EXCHANGE
FIRST TRUST ENHANCED SHORT MATURITY ETF ______ NASDAQ(R)
DATED _____, 2014
|
This Statement of Additional Information ("SAI") is not a prospectus. It
should be read in conjunction with the prospectus dated _____, 2014, as it may
be revised from time to time (the "Prospectus"), for First Trust Enhanced Short
Maturity ETF (the "Fund"), a series of the First Trust Exchange-Traded Fund IV
(the "Trust"). Capitalized terms used herein that are not defined have the same
meaning as in the Prospectus, unless otherwise noted. A copy of the Prospectus
may be obtained without charge by writing to the Trust's distributor, First
Trust Portfolios L.P., 120 East Liberty Drive, Suite 400, Wheaton, Illinois
60187, or by calling toll free at (800) 621-1675.
TABLE OF CONTENTS
GENERAL DESCRIPTION OF THE TRUST AND THE FUND................................1
EXCHANGE LISTING AND TRADING.................................................3
INVESTMENT OBJECTIVE AND POLICIES............................................4
INVESTMENT STRATEGIES........................................................5
INVESTMENT RISKS............................................................22
MANAGEMENT OF THE FUND......................................................26
BROKERAGE ALLOCATIONS.......................................................38
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT................39
ADDITIONAL INFORMATION......................................................41
PROXY VOTING POLICIES AND PROCEDURES........................................43
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS.......................44
REGULAR HOLIDAYS............................................................51
FEDERAL TAX MATTERS.........................................................56
DETERMINATION OF NET ASSET VALUE............................................62
DIVIDENDS AND DISTRIBUTIONS.................................................63
MISCELLANEOUS INFORMATION...................................................64
APPENDIX A - RATINGS OF INVESTMENTS........................................A-1
APPENDIX B - ISS PROXY VOTING CONCISE GUIDELINES...........................B-1
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- ii -
GENERAL DESCRIPTION OF THE TRUST AND THE FUND
The Trust was organized as a Massachusetts business trust on September 15,
2010, and is authorized to issue an unlimited number of shares in one or more
series or "Funds." The Trust is an open-end management investment company,
registered under the Investment Company Act of 1940, as amended (the "1940
Act"). The Trust currently offers shares in [ ] series, including the First
Trust Enhanced Short Maturity ETF, a non-diversified series.
This SAI relates to the Fund. The Fund, as a series of the Trust,
represents a beneficial interest in a separate portfolio of securities and other
assets, with its own objective and policies.
The Board of Trustees of the Trust (the "Board of Trustees" or the
"Trustees") has the right to establish additional series in the future, to
determine the preferences, voting powers, rights and privileges thereof and to
modify such preferences, voting powers, rights and privileges without
shareholder approval. Shares of any series may also be divided into one or more
classes at the discretion of the Trustees.
The Trust or any series or class thereof may be terminated at any time by
the Board of Trustees upon written notice to the shareholders.
Each share has one vote with respect to matters upon which a shareholder
vote is required consistent with the requirements of the 1940 Act and the rules
promulgated thereunder. Shares of all series of the Trust vote together as a
single class except as otherwise required by the 1940 Act, or if the matter
being voted on affects only a particular series, and, if a matter affects a
particular series differently from other series, the shares of that series will
vote separately on such matter. The Trust's Declaration of Trust (the
"Declaration") requires a shareholder vote only on those matters where the 1940
Act requires a vote of shareholders and otherwise permits the Trustees to take
actions without seeking the consent of shareholders. For example, the
Declaration gives the Trustees broad authority to approve reorganizations
between the Fund and another entity, such as another exchange-traded fund, or
the sale of all or substantially all of the Fund's assets, or the termination of
the Trust or the Fund without shareholder approval if the 1940 Act would not
require such approval.
The Declaration provides that by becoming a shareholder of the Fund, each
shareholder shall be expressly held to have agreed to be bound by the provisions
of the Declaration. The Declaration may, except in limited circumstances, be
amended by the Trustees in any respect without a shareholder vote. The
Declaration provides that the Trustees may establish the number of Trustees and
that vacancies on the Board of Trustees may be filled by the remaining Trustees,
except when election of Trustees by the shareholders is required under the 1940
Act. Trustees are then elected by a plurality of votes cast by shareholders at a
meeting at which a quorum is present. The Declaration also provides that
Trustees may be removed, with or without cause, by a vote of shareholders
holding at least two-thirds of the voting power of the Trust, or by a vote of
two-thirds of the remaining Trustees. The provisions of the Declaration relating
to the election and removal of Trustees may not be amended without the approval
of two-thirds of the Trustees.
The holders of Fund shares are required to disclose information on direct
or indirect ownership of Fund shares as may be required to comply with various
laws applicable to the Fund or as the Trustees may determine, and ownership of
Fund shares may be disclosed by the Fund if so required by law or regulation. In
addition, pursuant to the Declaration, the Trustees may, in their discretion,
require the Trust to redeem shares held by any shareholder for any reason under
terms set by the Trustees. The Declaration provides a detailed process for the
bringing of derivative actions by shareholders in order to permit legitimate
inquiries and claims while avoiding the time, expense, distraction and other
harm that can be caused to the Fund or its shareholders as a result of spurious
shareholder demands and derivative actions. Prior to bringing a derivative
action, a demand must first be made on the Trustees. The Declaration details
various information, certifications, undertakings and acknowledgements that must
be included in the demand. Following receipt of the demand, the Trustees have a
period of 90 days, which may be extended by an additional 60 days, to consider
the demand. If a majority of the Trustees who are considered independent for the
purposes of considering the demand determine that maintaining the suit would not
be in the best interests of the Fund, the Trustees are required to reject the
demand and the complaining shareholder may not proceed with the derivative
action unless the shareholder is able to sustain the burden of proof to a court
that the decision of the Trustees not to pursue the requested action was not a
good faith exercise of their business judgment on behalf of the Fund. In making
such a determination, a Trustee is not considered to have a personal financial
interest by virtue of being compensated for his or her services as a Trustee. If
a demand is rejected, the complaining shareholder will be responsible for the
costs and expenses (including attorneys' fees) incurred by the Fund in
connection with the consideration of the demand under a number of circumstances.
If a derivative action is brought in violation of the Declaration, the
shareholder bringing the action may be responsible for the Fund's costs,
including attorneys' fees. The Declaration also provides that any shareholder
bringing an action against the Fund waives the right to trial by jury to the
fullest extent permitted by law.
The Trust is not required to and does not intend to hold annual meetings
of shareholders.
Under Massachusetts law applicable to Massachusetts business trusts,
shareholders of such a trust may, under certain circumstances, be held
personally liable as partners for its obligations. However, the Declaration
contains an express disclaimer of shareholder liability for acts or obligations
of the Trust and requires that notice of this disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Trust or the
Trustees. The Declaration further provides for indemnification out of the assets
and property of the Trust for all losses and expenses of any shareholder held
personally liable for the obligations of the Trust. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which both inadequate insurance existed and the
Trust or the Fund itself was unable to meet its obligations.
The Declaration further provides that a Trustee acting in his or her
capacity as Trustee is not personally liable to any person other than the Trust
or its shareholders, for any act, omission, or obligation of the Trust. The
Declaration requires the Trust to indemnify any persons who are or who have been
Trustees, officers or employees of the Trust for any liability for actions or
failure to act except to the extent prohibited by applicable federal law. In
2
making any determination as to whether any person is entitled to the advancement
of expenses in connection with a claim for which indemnification is sought, such
person is entitled to a rebuttable presumption that he or she did not engage in
conduct for which indemnification is not available. The Declaration provides
that any Trustee who serves as chair of the Board of Trustees or of a committee
of the Board of Trustees, lead independent Trustee, or audit committee financial
expert, or in any other similar capacity will not be subject to any greater
standard of care or liability because of such position.
The Fund is advised by First Trust Advisors L.P. ("First Trust" or the
"Advisor").
The Fund intends to list and principally trade its shares on The NASDAQ(R)
Stock Market LLC (the "NASDAQ(R)" or the "Exchange"). The shares will trade on
the Exchange at market prices that may be below, at or above net asset value.
The Fund offers and issues shares at net asset value only in aggregations of a
specified number of shares (each a "Creation Unit" or a "Creation Unit
Aggregation"), generally in exchange for a basket of securities (the "Deposit
Securities"), together with the deposit of a specified cash payment (the "Cash
Component") or for cash as specified in the Prospectus. Creation Units are
aggregations of 50,000 shares of the Fund.
The Trust reserves the right to permit creations and redemptions of Fund
shares to be made in whole or in part on a cash basis under certain
circumstances. Fund shares may be issued in advance of receipt of Deposit
Securities subject to various conditions including a requirement to maintain on
deposit with the Fund cash at least equal to 115% of the market value of the
missing Deposit Securities. See the "Creation and Redemption of Creation Unit
Aggregations" section. In each instance of such cash creations or redemptions,
transaction fees may be imposed that will be higher than the transaction fees
associated with in-kind creations or redemptions. In all cases, such fees will
be limited in accordance with the requirements of the Securities and Exchange
Commission (the "SEC") applicable to management investment companies offering
redeemable securities.
EXCHANGE LISTING AND TRADING
There can be no assurance that the requirements of the Exchange necessary
to maintain the listing of shares of the Fund will continue to be met. The
Exchange may, but is not required to, remove the shares of the Fund from listing
if (i) following the initial 12-month period beginning at the commencement of
trading of the Fund, there are fewer than 50 beneficial owners of the shares of
the Fund for 30 or more consecutive trading days; or (ii) such other event shall
occur or condition exist that, in the opinion of the Exchange, makes further
dealings on the Exchange inadvisable. The Exchange will remove the shares of the
Fund from listing and trading upon termination of the Fund.
As in the case of other stocks traded on the Exchange, brokers'
commissions on transactions will be based on negotiated commission rates at
customary levels.
The Fund reserves the right to adjust the price levels of shares in the
future to help maintain convenient trading ranges for investors. Any adjustments
3
would be accomplished through stock splits or reverse stock splits, which would
have no effect on the net assets of the Fund.
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus describes the investment objective and certain policies of
the Fund. The following supplements the information contained in the Prospectus
concerning the investment objective and policies of the Fund.
The Fund is subject to the following fundamental policies, which may not
be changed without approval of the holders of a majority (as such term is
defined in the 1940 Act) of the outstanding voting securities of the Fund:
(1) The Fund may not issue senior securities, except as permitted
under the 1940 Act.
(2) The Fund may not borrow money, except that the Fund may (i)
borrow money from banks for temporary or emergency purposes (but not for
leverage or the purchase of investments); and (ii) engage in other
transactions permissible under the 1940 Act that may involve a borrowing
(such as obtaining short-term credits as are necessary for the clearance
of transactions, engaging in delayed-delivery transactions, or purchasing
certain futures and forward contracts), provided that the combination of
(i) and (ii) shall not exceed 33 1/3% of the value of the Fund's total
assets (including the amount borrowed), less the Fund's liabilities (other
than borrowings).
(3) The Fund will not underwrite the securities of other issuers
except to the extent the Fund may be considered an underwriter under the
Securities Act of 1933, as amended (the "1933 Act"), in connection with
the purchase and sale of portfolio securities.
(4) The Fund will not purchase or sell real estate or interests
therein, unless acquired as a result of ownership of securities or other
instruments (but this shall not prohibit the Fund from purchasing or
selling securities or other instruments backed by real estate or of
issuers engaged in real estate activities).
(5) The Fund may not make loans to other persons, except through
(i) the purchase of debt securities permissible under the Fund's
investment policies; (ii) repurchase agreements; or (iii) the lending of
portfolio securities, provided that no such loan of portfolio securities
may be made by the Fund if, as a result, the aggregate of such loans would
exceed 33 1/3% of the value of the Fund's total assets.
(6) The Fund may not purchase or sell physical commodities unless
acquired as a result of ownership of securities or other instruments (but
this shall not prevent the Fund from purchasing or selling options,
futures contracts, forward contracts or other derivative instruments, or
from investing in securities or other instruments backed by physical
commodities).
4
(7) The Fund may not invest 25% or more of the value of its total
assets in securities of issuers in any one industry. This restriction does
not apply to obligations issued or guaranteed by the U.S. government, its
agencies or instrumentalities, or securities of other investment
companies.
Except for restriction (2) above, if a percentage restriction is adhered
to at the time of investment, a later increase in percentage resulting from a
change in market value of the investment or the total assets will not constitute
a violation of that restriction. With respect to restriction (2), if the
limitations are exceeded as a result of a change in market value then the Fund
will reduce the amount of borrowings within three days thereafter to the extent
necessary to comply with the limitations (not including Sundays and holidays).
For purposes of applying restriction (1) above, under the 1940 Act as
currently in effect, the Fund is not permitted to issue senior securities,
except that the Fund may borrow from any bank if immediately after such
borrowing the value of the Fund's total assets is at least 300% of the principal
amount of all of the Fund's borrowings (i.e., the principal amount of the
borrowings may not exceed 33 1/3% of the Fund's total assets). In the event that
such asset coverage shall at any time fall below 300% the Fund shall, within
three days thereafter (not including Sundays and holidays), reduce the amount of
its borrowings to an extent that the asset coverage of such borrowing shall be
at least 300%. The fundamental investment limitations set forth above limit the
Fund's ability to engage in certain investment practices and purchase securities
or other instruments to the extent permitted by, or consistent with, applicable
law. As such, these limitations will change as the statute, rules, regulations
or orders (or, if applicable, interpretations) change, and no shareholder vote
will be required or sought.
The Fund's investment objective and the foregoing fundamental policies of
the Fund may not be changed without the affirmative vote of the majority of the
outstanding voting securities of the Fund. The 1940 Act defines a majority vote
as the vote of the lesser of (i) 67% or more of the voting securities
represented at a meeting at which more than 50% of the outstanding securities
are represented; or (ii) more than 50% of the outstanding voting securities.
With respect to the submission of a change in an investment policy to the
holders of outstanding voting securities of the Fund, such matter shall be
deemed to have been effectively acted upon with respect to the Fund if a
majority of the outstanding voting securities of the Fund vote for the approval
of such matter, notwithstanding that such matter has not been approved by the
holders of a majority of the outstanding voting securities of any other series
of the Trust affected by such matter.
In addition to the foregoing fundamental policies, the Fund is also
subject to strategies and policies discussed herein which, unless otherwise
noted, are non-fundamental restrictions and policies and may be changed by the
Board of Trustees.
INVESTMENT STRATEGIES
Under normal market conditions, the Fund will seek to achieve its
investment objective by investing in a portfolio of U.S. dollar-denominated
fixed and variable rate instruments (collectively, "Fixed Income Securities")
issued by U.S. and non-U.S. public and private sector entities. Fixed Income
5
Securities will include the following types of fixed and variable rate debt
securities: corporate and government bonds and notes; agency securities;
instruments of non-U.S. issuers in developed markets; privately issued
securities; structured securities; municipal bonds; money market securities; and
investment companies (including investment companies advised by the Fund's
invesmtnet adviser) that invest in such Fixed Income Securities. During the
initial invest-up period, the Fund may depart from its principal investment
strategies and invest a larger amount or all of its assets in cash equivalents
or it may hold cash.
TYPES OF INVESTMENTS
Corporate Bonds. Corporate bonds, also known as fixed-income securities,
are debt obligations issued by corporations. Corporate bonds are generally used
by corporations to borrow money from investors. Corporate bonds may be either
secured or unsecured. Collateral used for secured debt includes, but is not
limited to, real property, machinery, equipment, accounts receivable, stocks,
bonds or notes. If a corporate bond is unsecured, it is known as a debenture.
Holders of corporate bonds, as creditors, have a prior legal claim over common
and preferred stockholders as to both income and assets of the issuer for the
principal and interest due them and may have a prior claim over other creditors
if liens or mortgages are involved. Interest on corporate bonds may be fixed or
floating, or the securities may be zero coupon fixed-income securities which pay
no interest. Interest on corporate bonds is typically paid semi-annually and is
fully taxable to the holder of the bonds. Corporate bonds contain elements of
both interest rate risk and credit risk. The market value of a corporate bond
generally may be expected to rise and fall inversely with changes in interest
rates and may also be affected by the credit rating of the issuer, the issuer's
performance and perceptions of the issuer in the marketplace. Corporate bonds
usually yield more than government or agency bonds due to the presence of credit
risk.
High Yield Securities: The Fund will invest in securities that are rated
below investment grade at the time of purchase. The ratings of a rating agency
represent its opinion as to the quality of securities it undertakes to rate.
Ratings are not absolute standards of quality; consequently, securities with the
same maturity, duration, coupon, and rating may have different yields. For
purposes of determining whether a security is below investment grade, the lowest
available rating will be considered. If a security owned by the Fund is
subsequently downgraded, the Fund will not be required to dispose of such
security. If a downgrade occurs, the Advisor will consider what action,
including the sale of such security, is in the best interests of the Fund. The
Credit Rating Definitions, as published by the three major ratings agencies, are
set forth in Appendix A to this SAI.
Because the risk of default is higher for below investment grade
securities than investment grade securities, the Advisor's research and credit
analysis will be an especially important part of managing securities of this
type. The Advisor will attempt to identify those issuers of below investment
grade securities whose financial condition the Advisor believes are adequate to
meet future obligations or who have improved or are expected to improve in the
future. The Advisor analysis focuses on relative values based on such factors as
interest or dividend coverage, asset coverage, earnings prospects and the
experience and managerial strength of the issuer.
6
Loans. The Fund may invest in fixed and floating rate loans ("Loans").
Loans may include senior floating rate loans ("Senior Loans") and secured and
unsecured loans, second lien or more junior loans and bridge loans ("Junior
Loans"). Loans are typically arranged through private negotiations between
borrowers in the United States or in foreign or emerging markets which may be
corporate issuers or issuers of sovereign debt obligations ("Obligors") and one
or more financial institutions and other lenders ("Lenders"). The Fund may
invest in Loans by purchasing assignments of all or a portion of Loans
("Assignments") or Loan participations ("Participations") from third parties.
The Fund has direct rights against the Obligor on the Loan when it
purchases an Assignment. Assignments are arranged through private negotiations
between potential assignees and potential assignors. With respect to
Participations, typically, the Fund will have a contractual relationship only
with the Lender and not with the Obligor. The agreement governing Participations
may limit the rights of the Fund to vote on certain changes which may be made to
the Loan agreement, such as waiving a breach of a covenant. However, the holder
of a Participation will generally have the right to vote on certain fundamental
issues such as changes in principal amount, payment dates and interest rate.
Participations may entail certain risks relating to the creditworthiness of the
parties from which the participations are obtained.
A Loan is typically originated, negotiated and structured by a U.S. or
foreign commercial bank, insurance company, finance company or other financial
institution (the "Agent") for a group of Loan investors. The Agent typically
administers and enforces the Loan on behalf of the other Loan investors in the
syndicate. The Agent's duties may include responsibility for the collection of
principal and interest payments from the Obligor and the apportionment of these
payments to the credit of all Loan investors. The Agent is also typically
responsible for monitoring compliance with the covenants contained in the Loan
agreement based upon reports prepared by the Obligor. In addition, an
institution, typically but not always the Agent, holds any collateral on behalf
of the Loan investors. In the event of a default by the Obligor, it is possible,
though unlikely, that the Fund could receive a portion of the borrower's
collateral. If the Fund receives collateral other than cash, any proceeds
received from liquidation of such collateral will be available for investment as
part of the Fund's portfolio.
In the process of buying, selling and holding Senior Loans, the Fund may
receive and/or pay certain fees. These fees are in addition to interest payments
received and may include facility fees, commitment fees, commissions and
prepayment penalty fees. When the Fund buys or sells a Loan it may pay a fee. In
certain circumstances, the Fund may receive a prepayment penalty fee upon
prepayment of a Loan.
There may be instances in which the Fund is required to vote upon
amendments to certain of the Loans in which it invests. In these cases, the Fund
will attempt to ensure that such amendments are voted consistently and solely in
the best interests of the Fund.
Additional Information Concerning Senior Loans. Senior Loans typically
hold the most senior position in the capital structure of the Obligor, are
typically secured with specific collateral and have a claim on the assets and/or
stock of the Obligor that is senior to that held by subordinated debtholders and
shareholders of the Obligor. Collateral for Senior Loans may include (i) working
7
capital assets, such as accounts receivable and inventory; (ii) tangible fixed
assets, such as real property, buildings and equipment; (iii) intangible assets,
such as trademarks and patent rights; and/or (iv) security interests in shares
of stock of subsidiaries or affiliates.
Non-U.S. Investments. The Fund may invest in U.S. dollar-denominated
securities issued by non-U.S. companies that are traded over-the-counter ("OTC")
or listed on an exchange. Non-U.S. debt securities in which the Fund may invest
include debt securities issued or guaranteed by companies organized under the
laws of countries other than the United States, debt securities issued or
guaranteed by foreign, national, provincial, state, municipal or other
governments with taxing authority or by their agencies or instrumentalities and
debt obligations of supranational governmental entities such as the World Bank
or European Union.
ADDITIONAL INVESTMENTS
[Additional Information Concerning Synthetic Letters of Credit: Loans may
include synthetic letters of credit. In a synthetic letter of credit
transaction, the lender typically creates a special purpose entity or a
credit-linked deposit account for the purpose of funding a letter of credit to
the borrower. When the Fund invests in a synthetic letter of credit, the Fund is
typically paid a rate based on the lender's borrowing costs and the terms of a
synthetic letter of credit. Synthetic letters of credit are typically structured
as assignments with the Fund acquiring direct rights against the obligor.
Additional Information Concerning Unfunded Commitments: Unfunded
commitments are contractual obligations pursuant to which the Fund agrees to
invest in a loan at a future date. Typically, the Fund receives a commitment fee
for entering into the unfunded commitment.
Credit Linked Notes: Credit linked notes are structured securities
typically issued by banks whose principal and interest payments are contingent
on the performance of a reference issuer. Credit linked notes are created by
embedding a credit default swap in a funded asset to form an investment whose
credit risk and cash flow characteristics resemble those of a bond or loan.
These credit linked notes pay an enhanced coupon to the investor for taking on
the added credit risk of the reference issuer.]
Illiquid Securities: The Fund may invest in illiquid securities (i.e.,
securities that cannot be sold within seven days in the ordinary course of
business at approximately the amount at which a Fund values the securities for
purposes of determining the Fund's net asset value). For purposes of this
restriction, illiquid securities include, but are not limited to, certain
restricted securities (securities the disposition of which is restricted under
the federal securities laws), securities that may only be resold pursuant to
Rule 144A under the 1933 Act but that are deemed to be illiquid; and repurchase
agreements with maturities in excess of seven days. However, the Fund will not
acquire illiquid securities if, as a result, such securities would comprise more
than 15% of the value of the Fund's net assets. The Board of Trustees or its
delegate has the ultimate authority to determine, to the extent permissible
under the federal securities laws, which securities are liquid or illiquid for
purposes of this 15% limitation. The Board of Trustees has delegated to First
Trust the day-to-day determination of the illiquidity of any equity or
8
fixed-income security, although it has retained oversight and ultimate
responsibility for such determinations. Although no definitive liquidity
criteria are used, First Trust looks to factors such as (i) the nature of the
market for a security (including the institutional private resale market), the
frequency of trades and quotes for the security, the number of dealers willing
to purchase or sell the security, the amount of time normally needed to dispose
of the security, the method of soliciting offers and the mechanics of transfer);
(ii) the terms of certain securities or other instruments allowing for the
disposition to a third party or the issuer thereof (e.g., certain repurchase
obligations and demand instruments); and (iii) other permissible relevant
factors.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the 1933 Act. Where registration is required, the
Fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, the Fund might obtain a less favorable price than that which
prevailed when it decided to sell. Illiquid securities will be priced at fair
value as determined in good faith under procedures adopted by the Board of
Trustees. If, through the appreciation of illiquid securities or the
depreciation of liquid securities, the Fund should be in a position where more
than 15% of the value of its net assets are invested in illiquid securities,
including restricted securities which are not readily marketable, the Fund will
take such steps as is deemed advisable, if any, to protect liquidity.
Investment Companies and Pooled Investment Vehicles. The Fund may invest
in other pooled investment vehicles, including open-end or closed-end investment
companies, other exchange-traded funds ("ETFs") and business development
companies that invest primarily in securities of the types in which the Fund may
invest directly. As a shareholder in a pooled investment vehicle, the Fund will
bear its ratable share of that vehicle's expenses, and would remain subject to
payment of the Fund's management fees with respect to assets so invested.
Shareholders would therefore be subject to duplicative expenses to the extent
the Fund invests in other pooled investment vehicles. In addition, the Fund will
incur brokerage costs when purchasing and selling shares of ETFs and closed-end
funds. Other pooled investment vehicles may be leveraged, and the net asset
value and market value of their securities will therefore be more volatile and
the yield to shareholders will tend to fluctuate more than the yield of
unleveraged pooled investment vehicles.
The Fund may invest in the securities of ETFs in excess of the limits
imposed under the 1940 Act pursuant to exemptive orders obtained by certain ETFs
and their sponsors from the SEC. An ETF is a fund that holds a portfolio of
securities and trades on a securities exchange and its shares may, at times,
trade at a premium or discount to their net asset value. Additionally, the Fund
may invest in certain investment companies in excess of the limits imposed under
the 1940 Act, subject to certain terms and conditions, pursuant to an exemptive
order that the SEC has issued to the Trust. The Fund may also invest in shares
of money market funds to the extent permitted by the 1940 Act.
[Other Loans: The loan may invest in secured loans that are not first lien
and loans that are unsecured. These loans have the same characteristics as
9
senior loans except that such loans are not first in priority of repayment
and/or are not secured by collateral. Accordingly, the risks associated with
these loans are higher than the risks for loans with first priority over the
collateral. Because these loans are lower in priority and/or unsecured, they are
subject to the additional risk that the cash flow of the borrower may be
insufficient to meet scheduled payments after giving effect to the secured
obligations of the borrower. In the event of default on such a loan, the first
priority lien holder has first claim to the underlying collateral of the loan.
It is possible that no value would remain for the holders of secured loans that
are not first lien and loans that are unsecured and therefore result in a loss
of investment to the Fund.]
Fixed Income Investments and Cash Equivalents. Normally, the Fund will
invest substantially all of its assets to meet its investment objective;
however, for temporary or defensive purposes, the Fund may invest in fixed
income investments and cash equivalents in order to provide income, liquidity
and preserve capital.
Fixed income investments and cash equivalents held by the Fund may
include, without limitation, the types of investments set forth below:
(1) The Fund may invest in U.S. government securities, including
bills, notes and bonds differing as to maturity and rates of interest,
which are either issued or guaranteed by the U.S. Treasury or by U.S.
government agencies or instrumentalities. U.S. government securities
include securities that are issued or guaranteed by the United States
Treasury, by various agencies of the U.S. government, or by various
instrumentalities which have been established or sponsored by the U.S.
government. U.S. Treasury securities are backed by the "full faith and
credit" of the United States. Securities issued or guaranteed by federal
agencies and U.S. government-sponsored instrumentalities may or may not be
backed by the full faith and credit of the United States. Some of the U.S.
government agencies that issue or guarantee securities include the
Export-Import Bank of the United States, Farmers Home Administration,
Federal Housing Administration, Maritime Administration, Small Business
Administration and The Tennessee Valley Authority. An instrumentality of
the U.S. government is a government agency organized under Federal charter
with government supervision. Instrumentalities issuing or guaranteeing
securities include, among others, Federal Home Loan Banks, the Federal
Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks and Federal National Mortgage Association ("Fannie Mae"). In the
case of those U.S. government securities not backed by the full faith and
credit of the United States, the investor must look principally to the
agency or instrumentality issuing or guaranteeing the security for
ultimate repayment, and may not be able to assert a claim against the
United States itself in the event that the agency or instrumentality does
not meet its commitment. The U.S. government, its agencies and
instrumentalities do not guarantee the market value of their securities,
and consequently, the value of such securities may fluctuate. In addition,
the Fund may invest in sovereign debt obligations of non-U.S. countries. A
sovereign debtor's willingness or ability to repay principal and interest
in a timely manner may be affected by a number of factors, including its
cash flow situation, the extent of its non-U.S. reserves, the availability
of sufficient non-U.S. exchange on the date a payment is due, the relative
size of the debt service burden to the economy as a whole, the sovereign
10
debtor's policy toward principal international lenders and the political
constraints to which it may be subject.
(2) The Fund may invest in certificates of deposit issued against
funds deposited in a bank or savings and loan association. Such
certificates are for a definite period of time, earn a specified rate of
return, and are normally negotiable. If such certificates of deposit are
non-negotiable, they will be considered illiquid securities and be subject
to the Fund's 15% restriction on investments in illiquid securities.
Pursuant to the certificate of deposit, the issuer agrees to pay the
amount deposited plus interest to the bearer of the certificate on the
date specified thereon. Under current FDIC regulations, the maximum
insurance payable as to any one certificate of deposit is $250,000;
therefore, certificates of deposit purchased by the Fund may not be fully
insured. The Fund may only invest in certificates of deposit issued by
U.S. banks with at least $1 billion in assets.
(3) The Fund may invest in bankers' acceptances, which are
short-term credit instruments used to finance commercial transactions.
Generally, an acceptance is a time draft drawn on a bank by an exporter or
an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by a bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
asset or it may be sold in the secondary market at the going rate of
interest for a specific maturity.
(4) The Fund may invest in repurchase agreements, which involve
purchases of debt securities with counterparties that are deemed by the
Advisor to present acceptable credit risks. In such an action, at the time
the Fund purchases the security, it simultaneously agrees to resell and
redeliver the security to the seller, who also simultaneously agrees to
buy back the security at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the Fund
to invest temporarily available cash. The Fund may enter into repurchase
agreements only with respect to obligations of the U.S. government, its
agencies or instrumentalities; certificates of deposit; or bankers'
acceptances in which the Fund may invest. Repurchase agreements may be
considered loans to the seller, collateralized by the underlying
securities. The risk to the Fund is limited to the ability of the seller
to pay the agreed-upon sum on the repurchase date; in the event of
default, the repurchase agreement provides that the Fund is entitled to
sell the underlying collateral. If the value of the collateral declines
after the agreement is entered into, however, and if the seller defaults
under a repurchase agreement when the value of the underlying collateral
is less than the repurchase price, the Fund could incur a loss of both
principal and interest. The portfolio managers monitor the value of the
collateral at the time the action is entered into and at all times during
the term of the repurchase agreement. The portfolio managers do so in an
effort to determine that the value of the collateral always equals or
exceeds the agreed-upon repurchase price to be paid to the Fund. If the
seller were to be subject to a federal bankruptcy proceeding, the ability
11
of the Fund to liquidate the collateral could be delayed or impaired
because of certain provisions of the bankruptcy laws.
(5) The Fund may invest in bank time deposits, which are monies
kept on deposit with banks or savings and loan associations for a stated
period of time at a fixed rate of interest. There may be penalties for the
early withdrawal of such time deposits, in which case the yields of these
investments will be reduced.
(6) The Fund may invest in commercial paper, which are short-term
unsecured promissory notes, including variable rate master demand notes
issued by corporations to finance their current operations. Master demand
notes are direct lending arrangements between the Fund and a corporation.
There is no secondary market for the notes. However, they are redeemable
by the Fund at any time. The portfolio managers will consider the
financial condition of the corporation (e.g., earning power, cash flow and
other liquidity ratios) and will continuously monitor the corporation's
ability to meet all of its financial obligations, because the Fund's
liquidity might be impaired if the corporation were unable to pay
principal and interest on demand. The Fund may invest in commercial paper
only if its has received the highest rating from at least one nationally
recognized statistical rating organization or, if unrated, judged by First
Trust to be of comparable quality.
(7) The Fund may invest in shares of money market funds, as
consistent with its investment objectives and policies. Shares of money
market funds are subject to management fees and other expenses of those
funds. Therefore, investments in money market funds will cause the Fund to
bear proportionately the costs incurred by the money market funds'
operations. At the same time, the Fund will continue to pay its own
management fees and expenses with respect to all of its assets, including
any portion invested in the shares of other investment companies. Although
money market funds that operate in accordance with Rule 2a-7 under the
1940 Act seek to preserve a $1.00 share price, it is possible for the Fund
to lose money by investing in money market funds.
When-Issued or Delayed-Delivery Transactions: The Fund may from time to
time purchase securities on a "when-issued" or other delayed-delivery basis. The
price of securities purchased in such transactions is fixed at the time the
commitment to purchase is made, but delivery and payment for the securities take
place at a later date. During the period between the purchase and settlement,
the Fund does not remit payment to the issuer, no interest is accrued on debt
securities and dividend income is not earned on equity securities.
Delayed-delivery commitments involve a risk of loss if the value of the security
to be purchased declines prior to the settlement date, which risk is in addition
to the risk of a decline in value of the Fund's other assets. While securities
purchased in delayed-delivery transactions may be sold prior to the settlement
date, the Fund intends to purchase such securities with the purpose of actually
acquiring them. At the time the Fund makes the commitment to purchase a security
in a delayed-delivery transaction, it will record the transaction and reflect
the value of the security in determining its net asset value. The Fund will
earmark or maintain in a segregated account cash, U.S. government securities,
and high-grade liquid debt securities equal in value to commitments for
delayed-delivery securities. Such earmarked or segregated securities will mature
12
or, if necessary, be sold on or before the settlement date. When the time comes
to pay for delayed-delivery securities, the Fund will meet its obligations from
then-available cash flow, sale of the securities earmarked or held in the
segregated account as described above, sale of other securities, or, although it
would not normally expect to do so, from the sale of the delayed-delivery
securities themselves (which may have a market value greater or less than the
Fund's payment obligation).
Although the Prospectus and this SAI describe certain permitted methods of
segregating assets or otherwise "covering" certain transactions, the Fund may
segregate against or cover such transactions using other methods permitted under
the 1940 Act, the rules and regulations thereunder, or orders issued by the SEC
thereunder. For these purposes, interpretations and guidance provided by the SEC
staff may be taken into account.
PORTFOLIO TURNOVER
The Fund buys and sells portfolio securities in the normal course of its
investment activities. The proportion of the Fund's investment portfolio that is
bought and sold during a year is known as the Fund's portfolio turnover rate. A
turnover rate of 100% would occur, for example, if the Fund bought and sold
securities valued at 100% of its net assets within one year. A high portfolio
turnover rate could result in the payment by the Fund of increased brokerage
costs, expenses and taxes.
HEDGING STRATEGIES
General Description of Hedging Strategies
To the extent disclosed in the Prospectus, the Fund may engage in hedging
activities, or other investment in derivative instruments. The Fund may utilize
a variety of financial instruments, including options, forward contracts,
futures contracts (hereinafter referred to as "Futures" or "Futures Contracts"),
options on Futures Contracts, shorting strategies and swap agreements to attempt
to hedge the Fund's holdings.
Hedging or derivative instruments on securities generally are used to
hedge against price movements in one or more particular securities positions
that the Fund owns or intends to acquire. Such instruments may also be used to
"lock-in" realized but unrecognized gains in the value of portfolio securities.
Hedging instruments on stock indices, in contrast, generally are used to hedge
against price movements in broad equity market sectors in which the Fund has
invested or expects to invest. Hedging strategies, if successful, can reduce the
risk of loss by wholly or partially offsetting the negative effect of
unfavorable price movements in the investments being hedged. However, hedging
strategies can also reduce the opportunity for gain by offsetting the positive
effect of favorable price movements in the hedged investments. The use of
hedging instruments is subject to applicable regulations of the SEC, the several
options and futures exchanges upon which they are traded, the Commodity Futures
Trading Commission (the "CFTC") and various state regulatory authorities. In
addition, the Fund's ability to use hedging instruments may be limited by tax
considerations.
13
General Limitations on Futures and Options Transactions
The Fund limits its direct investments in futures, options on futures and
swaps to the extent necessary for First Trust to claim the exclusion from
regulation as a "commodity pool operator" with respect to the Fund under CFTC
Rule 4.5, as such rule may be amended from time to time. Under Rule 4.5 of the
CEA, as currently in effect, the Fund limits its trading activity in futures,
options on futures and swaps (excluding activity for "bona fide hedging
purposes," as defined by the CFTC) such that it meets one of the following
tests: (i) aggregate initial margin and premiums required to establish its
futures, options on futures and swap positions do not exceed 5% of the
liquidation value of the Fund's portfolio, after taking into account unrealized
profits and losses on such positions; or (ii) aggregate net notional value of
its futures, options on futures and swap positions does not exceed 100% of the
liquidation value of the Fund's portfolio, after taking into account unrealized
profits and losses on such positions.
First Trust has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with respect to the Fund with
the National Futures Association, the Futures industry's self-regulatory
organization. The Fund will not enter into Futures Contracts and options
transactions if more than 30% of its net assets would be committed to such
instruments. If First Trust were no longer able to claim the exclusion for the
Fund, First Trust would be required to register as a "commodity pool operator,"
and the Fund and First Trust would be subject to regulation under the Commodity
Exchange Act ("CEA").
The foregoing limitations are non-fundamental policies of the Fund and may
be changed without shareholder approval as regulatory agencies permit.
Asset Coverage for Futures and Options Positions
The Fund will comply with the regulatory requirements of the SEC and the
CFTC with respect to coverage of options and Futures positions by registered
investment companies and, if the guidelines so require, will earmark or set
aside cash, U.S. government securities, high grade liquid debt securities and/or
other liquid assets permitted by the SEC and CFTC in a segregated custodial
account in the amount prescribed. Securities earmarked or held in a segregated
account cannot be sold while the Futures or options position is outstanding,
unless replaced with other permissible assets, and will be marked-to-market
daily.
Stock Index Options
The Fund may purchase stock index options, sell stock index options in
order to close out existing positions, and/or write covered options on stock
indices for hedging purposes. Stock index options are put options and call
options on various stock indices. In most respects, they are identical to listed
options on common stocks. The primary difference between stock options and index
options occurs when index options are exercised. In the case of stock options,
the underlying security, common stock, is delivered. However, upon the exercise
of an index option, settlement does not occur by delivery of the securities
comprising the stock index. The option holder who exercises the index option
receives an amount of cash if the closing level of the stock index upon which
the option is based is greater than, in the case of a call, or less than, in the
14
case of a put, the exercise price of the option. This amount of cash is equal to
the difference between the closing price of the stock index and the exercise
price of the option expressed in dollars times a specified multiple.
A stock index fluctuates with changes in the market values of the stocks
included in the index. For example, some stock index options are based on a
broad market index, such as the S&P 500 Index or the Value Line(R) Composite
Index or a more narrow market index, such as the S&P 100 Index. Indices may also
be based on an industry or market segment. Options on stock indices are
currently traded on the following exchanges: the Chicago Board Options Exchange,
NYSE Amex Options, The NASDAQ(R) Stock Market LLC ("NASDAQ(R)") and the
Philadelphia Stock Exchange.
The Fund's use of stock index options is subject to certain risks.
Successful use by the Fund of options on stock indices will be subject to the
ability of First Trust to correctly predict movements in the directions of the
stock market. This requires different skills and techniques than predicting
changes in the prices of individual securities. In addition, the Fund's ability
to effectively hedge all or a portion of the securities in its portfolio, in
anticipation of or during a market decline through transactions in put options
on stock indices, depends on the degree to which price movements in the
underlying index correlate with the price movements of the securities held by
the Fund. Inasmuch as the Fund's securities will not duplicate the components of
an index, the correlation will not be perfect. Consequently, the Fund will bear
the risk that the prices of its securities being hedged will not move in the
same amount as the prices of its put options on the stock indices. It is also
possible that there may be a negative correlation between the index and the
Fund's securities, which would result in a loss on both such securities and the
options on stock indices acquired by the Fund.
The hours of trading for options may not conform to the hours during which
the underlying securities are traded. To the extent that the options markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be reflected
in the options markets. The purchase of options is a highly specialized
activity, which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. The purchase of
stock index options involves the risk that the premium and transaction costs
paid by the Fund in purchasing an option will be lost as a result of
unanticipated movements in prices of the securities comprising the stock index
on which the option is based.
Certain Considerations Regarding Options
There is no assurance that a liquid secondary market on an options
exchange will exist for any particular option, or at any particular time, and
for some options no secondary market on an exchange or elsewhere may exist. If
the Fund is unable to close out a call option on securities that it has written
before the option is exercised, the Fund may be required to purchase the
optioned securities in order to satisfy its obligation under the option to
deliver such securities. If the Fund is unable to effect a closing sale
transaction with respect to options on securities that it has purchased, it
would have to exercise the option in order to realize any profit and would incur
transaction costs upon the purchase and sale of the underlying securities.
15
The writing and purchasing of options is a highly specialized activity
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging. Options transactions may result in significantly higher
transaction costs and portfolio turnover for the Fund.
Futures Contracts
The Fund may enter into Futures Contracts, including index Futures as a
hedge against movements in the securities markets, in order to hedge against
changes on securities held or intended to be acquired by the Fund or for other
purposes permissible under the CEA. The Fund's hedging may include sales of
Futures as an offset against the effect of expected declines in stock prices and
purchases of Futures as an offset against the effect of expected increases in
stock prices. The Fund will not enter into Futures Contracts which are
prohibited under the CEA and will, to the extent required by regulatory
authorities, enter only into Futures Contracts that are traded on national
Futures exchanges and are standardized as to maturity date and underlying
financial instrument. The principal interest rate Futures exchanges in the
United States are the Chicago Board of Trade and the Chicago Mercantile
Exchange. Futures exchanges and trading are regulated under the CEA by the CFTC.
An interest rate Futures Contract provides for the future sale by one
party and purchase by another party of a specified amount of a specific
financial instrument (e.g., a debt security) or currency for a specified price
at a designated date, time and place. An index Futures Contract is an agreement
pursuant to which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index Futures
Contract was originally written. Transaction costs are incurred when a Futures
Contract is bought or sold and margin deposits must be maintained. A Futures
Contract may be satisfied by delivery or purchase, as the case may be, of the
instrument or by payment of the change in the cash value of the index. More
commonly, Futures Contracts are closed out prior to delivery by entering into an
offsetting transaction in a matching Futures Contract. Although the value of an
index might be a function of the value of certain specified securities, no
physical delivery of those securities is made. If the offsetting purchase price
is less than the original sale price, a gain will be realized. Conversely, if
the offsetting sale price is more than the original purchase price, a gain will
be realized; if it is less, a loss will be realized. The transaction costs must
also be included in these calculations. There can be no assurance, however, that
the Fund will be able to enter into an offsetting transaction with respect to a
particular Futures Contract at a particular time. If the Fund is not able to
enter into an offsetting transaction, the Fund will continue to be required to
maintain the margin deposits on the Futures Contract.
Margin is the amount of funds that must be deposited by the Fund with its
custodian in a segregated account in the name of the Futures commission merchant
in order to initiate Futures trading and to maintain the Fund's open positions
in Futures Contracts. A margin deposit is intended to ensure the Fund's
performance of the Futures Contract.
16
The margin required for a particular Futures Contract is set by the
exchange on which the Futures Contract is traded and may be significantly
modified from time to time by the exchange during the term of the Futures
Contract. Futures Contracts are customarily purchased and sold on margins that
may range upward from less than 5% of the value of the Futures Contract being
traded.
If the price of an open Futures Contract changes (by increase in the case
of a sale or by decrease in the case of a purchase) so that the loss on the
Futures Contract reaches a point at which the margin on deposit does not satisfy
margin requirements, the broker will require an increase in the margin. However,
if the value of a position increases because of favorable price changes in the
Futures Contract so that the margin deposit exceeds the required margin, the
broker will pay the excess to the Fund. In computing daily net asset value, the
Fund will mark to market the current value of its open Futures Contracts. The
Fund expects to earn interest income on its margin deposits.
Because of the low margin deposits required, Futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a Futures Contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the Futures Contract is deposited as margin, a subsequent 10%
decrease in the value of the Futures Contract would result in a total loss of
the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit, if the Future Contracts were closed out.
Thus, a purchase or sale of a Futures Contract may result in losses in excess of
the amount initially invested in the Futures Contract. However, the Fund would
presumably have sustained comparable losses if, instead of the Futures Contract,
it had invested in the underlying financial instrument and sold it after the
decline.
Most U.S. Futures exchanges limit the amount of fluctuation permitted in
Futures Contract prices during a single trading day. The day limit establishes
the maximum amount that the price of a Futures Contract may vary either up or
down from the previous day's settlement price at the end of a trading session.
Once the daily limit has been reached in a particular type of Futures Contract,
no trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses, because the limit may prevent the liquidation of
unfavorable positions. Futures Contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of Futures positions and subjecting some
investors to substantial losses.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a Futures position. The Fund would continue to be
required to meet margin requirements until the position is closed, possibly
resulting in a decline in the Fund's net asset value. In addition, many of the
contracts discussed above are relatively new instruments without a significant
trading history. As a result, there can be no assurance that an active secondary
market will develop or continue to exist.
17
A public market exists in Futures Contracts covering a number of indices,
including but not limited to, the S&P 500 Index, the S&P 100 Index, the
NASDAQ-100 Index(R), the Value Line(R) Composite Index and the NYSE Composite
Index(R).
Options on Futures
The Fund may also purchase or write put and call options on Futures
Contracts and enter into closing transactions with respect to such options to
terminate an existing position. A Futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a Futures Contract at a specified exercise price prior to the
expiration of the option. Upon exercise of a call option, the holder acquires a
long position in the Futures Contract and the writer is assigned the opposite
short position. In the case of a put option, the opposite is true. Prior to
exercise or expiration, a Futures option may be closed out by an offsetting
purchase or sale of a Futures option of the same series.
The Fund may use options on Futures Contracts in connection with hedging
strategies. Generally, these strategies would be applied under the same market
and market sector conditions in which the Fund uses put and call options on
securities or indices. The purchase of put options on Futures Contracts is
analogous to the purchase of puts on securities or indices so as to hedge the
Fund's securities holdings against the risk of declining market prices. The
writing of a call option or the purchasing of a put option on a Futures Contract
constitutes a partial hedge against declining prices of securities which are
deliverable upon exercise of the Futures Contract. If the price at expiration of
a written call option is below the exercise price, the Fund will retain the full
amount of the option premium which provides a partial hedge against any decline
that may have occurred in the Fund's holdings of securities. If the price when
the option is exercised is above the exercise price, however, the Fund will
incur a loss, which may be offset, in whole or in part, by the increase in the
value of the securities held by the Fund that were being hedged. Writing a put
option or purchasing a call option on a Futures Contract serves as a partial
hedge against an increase in the value of the securities the Fund intends to
acquire.
As with investments in Futures Contracts, the Fund is required to deposit
and maintain margin with respect to put and call options on Futures Contracts
written by them. Such margin deposits will vary depending on the nature of the
underlying Futures Contract (and the related initial margin requirements), the
current market value of the option, and other Futures positions held by the
Fund. The Fund will earmark or set aside in a segregated account at the Fund's
custodian, liquid assets, such as cash, U.S. government securities or other
high-grade liquid debt obligations equal in value to the amount due on the
underlying obligation. Such segregated assets will be marked-to-market daily,
and additional assets will be earmarked or placed in the segregated account
whenever the total value of the earmarked or segregated assets falls below the
amount due on the underlying obligation.
The risks associated with the use of options on Futures Contracts include
the risk that the Fund may close out its position as a writer of an option only
if a liquid secondary market exists for such options, which cannot be assured.
The Fund's successful use of options on Futures Contracts depends on First
Trust's ability to correctly predict the movement in prices of Futures Contracts
and the underlying instruments, which may prove to be incorrect. In addition,
18
there may be imperfect correlation between the instruments being hedged and the
Futures Contract subject to the option. For additional information, see "Futures
Contracts." Certain characteristics of the Futures market might increase the
risk that movements in the prices of Futures Contracts or options on Futures
Contracts might not correlate perfectly with movements in the prices of the
investments being hedged. For example, all participants in the Futures and
options on Futures Contracts markets are subject to daily variation margin calls
and might be compelled to liquidate Futures or options on Futures Contracts
positions whose prices are moving unfavorably to avoid being subject to further
calls. These liquidations could increase the price volatility of the instruments
and distort the normal price relationship between the Futures or options and the
investments being hedged. Also, because of initial margin deposit requirements,
there might be increased participation by speculators in the Futures markets.
This participation also might cause temporary price distortions. In addition,
activities of large traders in both the Futures and securities markets involving
arbitrage, "program trading," and other investment strategies might result in
temporary price distortions.
Swap Agreements
A swap is a financial instrument that typically involves the exchange of
cash flows between two parties on specified dates (settlement dates), where the
cash flows are based on agreed-upon prices, rates, indices, etc. The nominal
amount on which the cash flows are calculated is called the notional amount.
Swaps are individually negotiated and structured to include exposure to a
variety of different types of investments or market factors, such as interest
rates, non-U.S. currency rates, mortgage securities, corporate borrowing rates,
security prices, indexes or inflation rates.
Swap agreements may increase or decrease the overall volatility of the
investments of the Fund and its share price. The performance of swap agreements
may be affected by a change in the specific interest rate, currency, or other
factors that determine the amounts of payments due to and from the Fund. If a
swap agreement calls for payments by the Fund, the Fund must be prepared to make
such payments when due. In addition, if the counterparty's creditworthiness
declines, the value of a swap agreement would be likely to decline, potentially
resulting in losses.
Generally, swap agreements have a fixed maturity date that will be agreed
upon by the parties. The agreement can be terminated before the maturity date
only under limited circumstances, such as default by one of the parties or
insolvency, among others, and can be transferred by a party only with the prior
written consent of the other party. The Fund may be able to eliminate its
exposure under a swap agreement either by assignment or by other disposition, or
by entering into an offsetting swap agreement with the same party or a similarly
creditworthy party. If the counterparty is unable to meet its obligations under
the contract, declares bankruptcy, defaults or becomes insolvent, the Fund may
not be able to recover the money it expected to receive under the contract.
A swap agreement can be a form of leverage, which can magnify the Fund's
gains or losses. In order to reduce the risk associated with leveraging, the
Fund may cover its current obligations under swap agreements according to
guidelines established by the SEC. If the Fund enters into a swap agreement on a
net basis, it will earmark assets with a daily value at least equal to the
19
excess, if any, of the Fund's accrued obligations under the swap agreement over
the accrued amount the Fund is entitled to receive under the agreement. If the
Fund enters into a swap agreement on other than a net basis, it will earmark
assets with a value equal to the full amount of the Fund's accrued obligations
under the agreement.
Equity Swaps. In a typical equity swap, one party agrees to pay another
party the return on a stock, stock index or basket of stocks in return for a
specified interest rate. By entering into an equity index swap, for example, the
index receiver can gain exposure to stocks making up the index of securities
without actually purchasing those stocks. Equity index swaps involve not only
the risk associated with investment in the securities represented in the index,
but also the risk that the performance of such securities, including dividends,
will not exceed the return on the interest rate that the Fund will be committed
to pay.
Interest Rate Swaps. Interest rate swaps are financial instruments that
involve the exchange of one type of interest rate for another type of interest
rate cash flow on specified dates in the future. Some of the different types of
interest rate swaps are "fixed-for floating rate swaps," "termed basis swaps"
and "index amortizing swaps." Fixed-for floating rate swaps involve the exchange
of fixed interest rate cash flows for floating rate cash flows. Termed basis
swaps entail cash flows to both parties based on floating interest rates, where
the interest rate indices are different. Index amortizing swaps are typically
fixed-for floating swaps where the notional amount changes if certain conditions
are met. Like a traditional investment in a debt security, the Fund could lose
money by investing in an interest rate swap if interest rates change adversely.
For example, if the Fund enters into a swap where it agrees to exchange a
floating rate of interest for a fixed rate of interest, the Fund may have to pay
more money than it receives. Similarly, if the Fund enters into a swap where it
agrees to exchange a fixed rate of interest for a floating rate of interest, the
Fund may receive less money than it has agreed to pay.
Currency Swaps. A currency swap is an agreement between two parties in
which one party agrees to make interest rate payments in one currency and the
other promises to make interest rate payments in another currency. The Fund may
enter into a currency swap when it has one currency and desires a different
currency. Typically the interest rates that determine the currency swap payments
are fixed, although occasionally one or both parties may pay a floating rate of
interest. Unlike an interest rate swap, however, the principal amounts are
exchanged at the beginning of the contract and returned at the end of the
contract. Changes in non-U.S. exchange rates and changes in interest rates, as
described above, may negatively affect currency swaps.
Credit Default Swaps. A credit default swap is similar to an insurance
contract in that it provides the buyer with protection against specific risks.
Most often, corporate bond investors buy credit default swaps for protection
against a default by the issuer of the corporate bond, but these flexible
instruments can be used in many ways to customize exposure to corporate credit.
Credit default swap agreements can mitigate risks in bond investing by
transferring a given risk from one party to another without transferring the
underlying bond or other credit asset. In a credit default swap agreement, one
party "sells" risk and the counterparty "buys" that risk. The "seller" of credit
risk, who also tends to own the underlying credit asset, pays a periodic fee to
the risk "buyer." In return, the risk "buyer" agrees to pay the "seller" a set
amount if there is a default, or a credit event.
20
The Fund's use of credit default swap agreements exposes the Fund to
additional risks, including but not limited to, the credit and liquidity risk of
a counterparty. If the credit quality of any such counterparty deteriorates,
such counterparty may default on its obligations to make payments under the swap
agreement. The Fund may also be exposed to liquidity risk because the market for
credit default swaps are relatively illiquid and the Fund will generally not be
permitted to terminate or assign its credit default swaps without the consent of
the related counterparty and accordingly may not be able to terminate or assign
such credit default swaps in a timely fashion and for a fair price, potentially
restricting its ability to take advantage of market opportunities.
Short Sales
The Fund may take short positions in securities, which are often referred
to as "short sales." A short sale is a sale of a security the Fund has borrowed,
with the expectation that the security will underperform the market. To settle
the short sale transaction, the Fund buys the same security at a later date and
returns it to the lender of the security. The Fund makes money on a short
position if the market price of the security goes down after the short sale or
if the market price of the securities it buys with the proceeds of the short
sale increases more than that of the security sold short. Conversely, if the
price of the security sold short goes up after the short sale, the Fund loses
money because it has to pay more to replace the borrowed security than it
received when it sold the security short. Short-selling is considered "leverage"
and may involve substantial risk.
LENDING OF PORTFOLIO SECURITIES
To the extent disclosed in the Prospectus, in order to generate additional
income, as a non-principal investment strategy, the Fund may lend portfolio
securities to broker-dealers, banks or other institutional borrowers of
securities. As with other extensions of credit, there may be risks of delay in
recovery of the securities or even loss of rights in the collateral should the
borrower of the securities fail financially. However, the Fund will only enter
into domestic loan arrangements with broker-dealers, banks or other
institutions, which First Trust has determined are creditworthy under guidelines
approved by the Board of Trustees. The Fund will pay a portion of the income
earned on the lending transaction to the placing broker and may pay
administrative and custodial fees in connection with these loans.
In these loan arrangements, the Fund will receive collateral in the form
of cash or U.S. government securities equal to at least 102% (for domestic
securities) or 105% (for international securities) of the market value of the
securities loaned as determined at the time of loan origination. This collateral
must be valued daily by First Trust or the Fund's lending agent and, if the
market value of the loaned securities increases, the borrower must furnish
additional collateral to the Fund. During the time portfolio securities are on
loan, the borrower pays the Fund any dividends or interest paid on the
securities. Loans are subject to termination at any time by the Fund or the
borrower. While the Fund does not have the right to vote securities on loan, it
would terminate the loan and regain the right to vote if that were considered
important with respect to the investment. When the Fund lends portfolio
securities to a borrower, payments in lieu of dividends made by the borrower to
the Fund will not constitute "qualified dividends" taxable at the same rate as
21
long-term capital gains, even if the actual dividends would have constituted
qualified dividends had the Fund held the securities.
INVESTMENT RISKS
Overview
An investment in a Fund should be made with an understanding of the risks
that an investment in the Fund shares entails, including the risk that the
financial condition of the issuers of the securities or the general condition of
the securities market may worsen and the value of the securities and therefore
the value of a Fund may decline. A Fund may not be an appropriate investment for
those who are unable or unwilling to assume the risks involved generally with
such an investment. The past market and earnings performance of any of the
securities included in a Fund is not predictive of their future performance.
Information Risk
There is typically less publicly available information concerning loans
than other types of fixed income investments. As a result, the Fund generally
will be dependent on reports and other information provided by the obligor,
either directly or through an agent, to evaluate the obligor's creditworthiness
or to determine the obligor's compliance with the covenants and other terms of
the Loan Agreement. Such reliance may make investments in loans more susceptible
to fraud than other types of investments. In addition, because the Advisor may
wish to invest in the publicly traded securities of an obligor, they may not
have access to material non-public information regarding the obligor to which
other loan investors have access.
Liquidity Risk
Although the Fund limits its investments in illiquid securities to no more
than 15% of its net assets at the time of purchase, securities that are deemed
to be liquid at the time of purchase may become illiquid or less liquid. No
active trading market may exist for certain securities and certain securities
may be subject to restrictions on resale or have a limited secondary market.
Certain securities may be subject to irregular trading activity, wide bid/ask
spreads and extended trade settlement periods. The inability to dispose of
certain securities in a timely fashion or at a favorable price could result in
losses to the Fund.
Whether or not the securities held by the Fund are listed on a securities
exchange, the principal trading market for certain of the securities may be in
the OTC market. As a result, the existence of a liquid trading market for such
securities may depend on whether dealers will make a market in the securities.
There can be no assurance that a market will be made for any of the securities,
that any market for such securities will be maintained or that there will be
sufficient liquidity of the securities in any markets made. The price at which
such securities are held by the Fund will be adversely affected if trading
markets for the securities are limited or absent.
22
Non-U.S. Securities Risk
An investment in non-U.S. securities involves risks in addition to the
usual risks inherent in domestic investments. Non-U.S. securities are affected
by the fact that in many countries there is less publicly available information
about issuers than is available in the reports and ratings published about
companies in the United States and companies may not be subject to uniform
accounting, auditing and financial reporting standards. Other risks inherent in
non-U.S. investments may include expropriation; confiscatory taxation;
withholding taxes on dividends and interest; less extensive regulation of
non-U.S. brokers, securities markets and issuers; diplomatic developments; and
political or social instability. Non-U.S. economies may differ favorably or
unfavorably from the U.S. economy in various respects, and many non-U.S.
securities are less liquid and their prices tend to be more volatile than
comparable U.S. securities. From time to time, non-U.S. securities may be
difficult to liquidate rapidly without adverse price effects.
Regulatory Changes
To the extent that legislation or state or federal regulators that
regulate certain financial institutions impose additional requirements or
restrictions with respect to the ability of such institutions to make loans,
particularly in connection with highly leveraged transactions, the availability
of loans for investment may be adversely affected. Furthermore, such legislation
or regulation could depress the market value of loans held by the Fund.
Risk Factors of Loan Assignments and Participations
Loans are subject to the risks associated with debt obligations in general
including interest rate risk, credit risk and market risk. When a loan is
acquired from a lender, the risk includes the credit risk associated with the
obligor of the underlying loan. The Fund may incur additional credit risk when
the Fund acquires a participation in a loan from another lender because the Fund
must assume the risk of insolvency or bankruptcy of the other lender from which
the loan was acquired. To the extent that loans involve obligors in foreign or
emerging markets, such loans are subject to the risks associated with foreign
investments or investments in emerging markets in general.
Tax Law Change Risk
Changes in tax laws or regulations, or interpretations thereof in the
future, could adversely affect the Fund or the assets in which it invests. Any
such changes could negatively impact the Fund and its shareholders.
RISKS AND SPECIAL CONSIDERATIONS CONCERNING DERIVATIVES
Derivatives Risk
To the extent disclosed in the Prospectus, the Fund may invest in
derivatives. The use of derivatives presents risks different from, and possibly
greater than, the risks associated with investing directly in traditional
23
securities. Among the risks presented are market risk, credit risk, management
risk and liquidity risk. The use of derivatives can lead to losses because of
adverse movements in the price or value of the underlying asset, index or rate,
which may be magnified by certain features of the derivatives. In addition, when
the Fund invests in certain derivative securities, including, but not limited
to, when-issued securities, forward commitments, futures contracts and interest
rate swaps, they are effectively leveraging their investments, which could
result in exaggerated changes in the net asset value of the Fund's shares and
can result in losses that exceed the amount originally invested. The success of
the Advisor's derivatives strategies will depend on its ability to assess and
predict the impact of market or economic developments on the underlying asset,
index or rate and the derivative itself, without the benefit of observing the
performance of the derivative under all possible market conditions. Liquidity
risk exists when a security cannot be purchased or sold at the time desired, or
cannot be purchased or sold without adversely affecting the price.
In addition to the foregoing, the use of derivative instruments involves
certain general risks and considerations as described below.
(1) Market Risk. Market risk is the risk that the value of the
underlying assets may go up or down. Adverse movements in the value of an
underlying asset can expose the Fund to losses. Derivative instruments may
include elements of leverage and, accordingly, fluctuations in the value
of the derivative instrument in relation to the underlying asset may be
magnified. The successful use of derivative instruments depends upon a
variety of factors, particularly the Advisor's ability to predict
movements of the securities, currencies, and commodities markets, which
may require different skills than predicting changes in the prices of
individual securities. There can be no assurance that any particular
strategy adopted will succeed. A decision to engage in a derivative
transaction will reflect the Advisor's judgment that the derivative
transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objective, investment limitations, and
operating policies. In making such a judgment, the Advisor will analyze
the benefits and risks of the derivative transactions and weigh them in
the context of the Fund's overall investments and investment objective.
(2) Credit Risk. Credit risk is the risk that a loss may be
sustained as a result of the failure of a counterparty to comply with the
terms of a derivative instrument. The counterparty risk for
exchange-traded derivatives is generally less than for
privately-negotiated or OTC derivatives, since generally a clearing
agency, which is the issuer or counterparty to each exchange-traded
instrument, provides a guarantee of performance. For privately-negotiated
instruments, there is no similar clearing agency guarantee. In all
transactions, the Fund will bear the risk that the counterparty will
default, and this could result in a loss of the expected benefit of the
derivative transactions and possibly other losses to the Fund. The Fund
will enter into transactions in derivative instruments only with
counterparties that First Trust reasonably believes are capable of
performing under the contract.
(3) Correlation Risk. Correlation risk is the risk that there might
be an imperfect correlation, or even no correlation, between price
movements of a derivative instrument and price movements of investments
24
being hedged. When a derivative transaction is used to completely hedge
another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments.
With a perfect hedge, the value of the combined position remains unchanged
with any change in the price of the underlying asset. With an imperfect
hedge, the value of the derivative instrument and its hedge are not
perfectly correlated. For example, if the value of a derivative instrument
used in a short hedge (such as writing a call option, buying a put option
or selling a Futures Contract) increased by less than the decline in value
of the hedged investments, the hedge would not be perfectly correlated.
This might occur due to factors unrelated to the value of the investments
being hedged, such as speculative or other pressures on the markets in
which these instruments are traded. The effectiveness of hedges using
instruments on indices will depend, in part, on the degree of correlation
between price movements in the index and the price movements in the
investments being hedged.
(4) Liquidity Risk. Liquidity risk is the risk that a derivative
instrument cannot be sold, closed out, or replaced quickly at or very
close to its fundamental value. Generally, exchange contracts are very
liquid because the exchange clearinghouse is the counterparty of every
contract. OTC transactions are less liquid than exchange-traded
derivatives since they often can only be closed out with the other party
to the transaction. The Fund might be required by applicable regulatory
requirements to maintain assets as "cover," maintain segregated accounts,
and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments
other than purchase options). If the Fund is unable to close out its
positions in such instruments, it might be required to continue to
maintain such assets or accounts or make such payments until the position
expires, matures, or is closed out. These requirements might impair the
Fund's ability to sell a security or make an investment at a time when it
would otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. The Fund's ability to sell
or close out a position in an instrument prior to expiration or maturity
depends upon the existence of a liquid secondary market or, in the absence
of such a market, the ability and willingness of the counterparty to enter
into a transaction closing out the position. Due to liquidity risk, there
is no assurance that any derivatives position can be sold or closed out at
a time and price that is favorable to the Fund.
(5) Legal Risk. Legal risk is the risk of loss caused by the
unenforceability of a party's obligations under the derivative. While a
party seeking price certainty agrees to surrender the potential upside in
exchange for downside protection, the party taking the risk is looking for
a positive payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a derivative transaction may try to
avoid payment by exploiting various legal uncertainties about certain
derivative products.
(6) Systemic or "Interconnection" Risk. Systemic or interconnection
risk is the risk that a disruption in the financial markets will cause
difficulties for all market participants. In other words, a disruption in
one market will spill over into other markets, perhaps creating a chain
25
reaction. Much of the OTC derivatives market takes place among the OTC
dealers themselves, thus creating a large interconnected web of financial
obligations. This interconnectedness raises the possibility that a default
by one large dealer could create losses for other dealers and destabilize
the entire market for OTC derivative instruments.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The general supervision of the duties performed for the Fund under the
investment management agreement is the responsibility of the Board of Trustees.
There are five Trustees of the Trust, one of whom is an "interested person" (as
the term is defined in the 1940 Act) and four of whom are Trustees who are not
officers or employees of First Trust or any of its affiliates ("Independent
Trustees"). The Trustees set broad policies for the Fund, choose the Trust's
officers and hire the Trust's investment advisor. The officers of the Trust
manage its day-to-day operations and are responsible to the Trust's Board of
Trustees. The following is a list of the Trustees and executive officers of the
Trust and a statement of their present positions and principal occupations
during the past five years, the number of portfolios each Trustee oversees and
the other directorships they have held during the past five years, if
applicable. Each Trustee has been elected for an indefinite term. The officers
of the Trust serve indefinite terms. Each Trustee, except for James A. Bowen, is
an Independent Trustee. Mr. Bowen is deemed an "interested person" (as that term
is defined in the 1940 Act) ("Interested Trustee") of the Trust due to his
position as Chief Executive Officer of First Trust, investment advisor to the
Fund.
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS DIRECTORSHIPS
POSITION AND TERM OF OFFICE AND IN THE FIRST TRUST HELD BY TRUSTEE
NAME, ADDRESS OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS FUND COMPLEX DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE 5 YEARS
Trustee who is an Interested
Person of the Trust
-----------------------------
James A. Bowen(1) Chairman of the o Indefinite term Chief Executive Officer ___ Portfolios None.
120 East Liberty Drive, Board and (December 2010 to
Suite 400 Trustee Present), President
Wheaton, IL 60187 o Since inception (until December 2010),
D.O.B.: 09/55 First Trust Advisors
L.P. and First Trust
Portfolios L.P.;
Chairman of the Board of
Directors, BondWave LLC
(Software Development
Company/Investment
Advisor) and Stonebridge
Advisors LLC (Investment
Advisor)
26
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS DIRECTORSHIPS
POSITION AND TERM OF OFFICE AND IN THE FIRST TRUST HELD BY TRUSTEE
NAME, ADDRESS OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS FUND COMPLEX DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE 5 YEARS
Independent Trustees
-----------------------------
Richard E. Erickson Trustee o Indefinite term Physician; President, _____ Portfolios None.
c/o First Trust Advisors Wheaton Orthopedics;
L.P. Co-owner and Co-Director
120 East Liberty Drive, o Since inception (January 1996 to May
Suite 400 2007), Sports Med Center
Wheaton, IL 60187 for Fitness; Limited
D.O.B.: 04/51 Partner, Gundersen Real
Estate Limited
Partnership; Member,
Sportsmed LLC
Thomas R. Kadlec Trustee o Indefinite term President (March 2010 to _____ Portfolios Director of ADM
c/o First Trust Advisors Present), Senior Vice Investor
L.P. o Since inception President and Chief Services, Inc.
120 East Liberty Drive, Financial Officer (May and ADM Investor
Suite 400 2007 to March 2010), Services
Wheaton, IL 60187 Vice President and Chief International
D.O.B.: 11/57 Financial Officer (1990
to May 2007), ADM
Investor Services, Inc.
(Futures Commission
Merchant)
Robert F. Keith Trustee o Indefinite term President (2003 to _____ Portfolios Director of
c/o First Trust Advisors Present), Hibs Trust Company of
L.P. o Since inception Enterprises (Financial Illinois
120 East Liberty Drive, and Management
Suite 400 Consulting)
Wheaton, IL 60187
D.O.B.: 11/56
Niel B. Nielson Trustee o Indefinite term President and Chief _____ Portfolios Director of
c/o First Trust Advisors Executive Officer (July Covenant
L.P. o Since inception 2012 to Present), Dew Transport Inc.
120 East Liberty Drive, Learning LLC
Suite 400 (Educational Products
Wheaton, IL 60187 and Services); President
D.O.B.: 03/54 (June 2002 to June
2012), Covenant College
Officers of the Trust
-----------------------------
Mark R. Bradley President and o Indefinite term Chief Financial Officer, N/A N/A
120 East Liberty Drive, Chief Executive Chief Operating Officer
Suite 400 Officer (December 2010 to
Wheaton, IL 60187 o Since inception Present), First Trust
D.O.B.: 11/57 Advisors L.P. and First
Trust Portfolios L.P.;
Chief Financial Officer,
BondWave LLC (Software
Development
Company/Investment
Advisor) and Stonebridge
Advisors LLC (Investment
Advisor)
27
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS DIRECTORSHIPS
POSITION AND TERM OF OFFICE AND IN THE FIRST TRUST HELD BY TRUSTEE
NAME, ADDRESS OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS FUND COMPLEX DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE 5 YEARS
James M. Dykas Treasurer, Chief o Indefinite term Controller (January 2011 N/A N/A
120 East Liberty Drive, Financial to Present), Senior Vice
Suite 400 Officer and o Since inception President, First Trust
Wheaton, IL 60187 Chief Accounting Advisors L.P. and First
D.O.B.: 01/66 Officer Trust Portfolios L.P.
W. Scott Jardine Secretary and o Indefinite term General Counsel, First N/A N/A
120 East Liberty Drive, Chief Legal Trust Advisors L.P. and
Suite 400 Officer o Since inception First Trust Portfolios
Wheaton, IL 60187 L.P.; Secretary BondWave
D.O.B.: 05/60 LLC (Software
Development
Company/Investment
Advisor); and
Stonebridge Advisors LLC
(Investment Advisor)
Daniel J. Lindquist Vice President o Indefinite term Managing Director (July N/A N/A
120 East Liberty Drive, 2012 to Present), Senior
Suite 400 o Since inception Vice President
Wheaton, IL 60187 (September 2005 to July
D.O.B.: 02/70 2012), First Trust
Advisors L.P. and First
Trust Portfolios L.P.
Kristi A. Maher Assistant o Indefinite term Deputy General Counsel, N/A N/A
120 East Liberty Drive, Secretary and First Trust Advisors
Suite 400 Chief Compliance o Since inception L.P. and First Trust
Wheaton, IL 60187 Officer Portfolios L.P.
D.O.B.: 12/66
Roger F. Testin Vice President o Indefinite term Senior Vice President. N/A N/A
120 East Liberty Drive, First Trust Advisors
Suite 400 o Since inception L.P. and First Trust
Wheaton, IL 60187 Portfolios L.P.
D.O.B.: 06/66
Stan Ueland Vice President o Indefinite term Senior Vice President N/A N/A
120 East Liberty Drive, (September 2012 to
Suite 400 o Since inception Present), Vice President
Wheaton, IL 60187 (August 2005 to
D.O.B.: 11/70 September 2012), First
Trust Advisors L.P. and
First Trust Portfolios
L.P.
|
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust, investment advisor
of the Fund.
UNITARY BOARD LEADERSHIP STRUCTURE
Each Trustee serves as a trustee of all open-end and closed-end funds in
the First Trust Fund Complex (as defined below), which is known as a "unitary"
board leadership structure. Each Trustee currently serves as a trustee of First
Trust Series Fund, First Trust Variable Insurance Trust and of First Defined
Portfolio Fund, LLC, open-end funds with __ portfolios advised by First Trust;
First Trust Senior Floating Rate Income Fund II, Macquarie/First Trust Global
Infrastructure/Utilities Dividend & Income Fund, First Trust Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust Mortgage Income Fund, First Trust
Strategic High Income Fund II, First Trust/Aberdeen Emerging Opportunity Fund,
28
First Trust Specialty Finance and Financial Opportunities Fund, First Trust
Dividend and Income Fund, First Trust High Income Long/Short Fund, First Trust
Energy Infrastructure Fund, First Trust MLP and Energy Income Fund and First
Trust Intermediate Duration Preferred & Income Fund, closed-end funds advised by
First Trust; and the Trust, First Trust Exchange-Traded Fund, First Trust
Exchange-Traded Fund II, First Trust Exchange-Traded Fund III, First Trust
Exchange-Traded Fund V, First Trust Exchange-Traded Fund VI, First Trust
Exchange-Traded Fund VII, First Trust Exchange-Traded AlphaDEX(R) Fund and First
Trust Exchange Traded AlphaDEX(R) Fund II, exchange-traded funds with __
portfolios advised by First Trust (each a "First Trust Fund" and collectively,
the "First Trust Fund Complex"). None of the Trustees who are not "interested
persons" of the Trust, nor any of their immediate family members, has ever been
a director, officer or employee of, or consultant to, First Trust, First Trust
Portfolios L.P. or their affiliates.
The management of the Fund, including general supervision of the duties
performed for the Fund under the investment management agreement between the
Trust, on behalf of the Fund, and the Advisor, is the responsibility of the
Board of Trustees. The Trustees of the Trust set broad policies for the Fund,
choose the Trust's officers, and hire the Fund's investment advisor and other
service providers. The officers of the Trust manage the day to-day operations
and are responsible to the Trust's Board. The Trust's Board is composed of four
Independent Trustees and one Interested Trustee. The Interested Trustee, James
A. Bowen, serves as the Chairman of the Board for each fund in the First Trust
Fund Complex.
The same five persons serve as Trustees on the Trust's Board and on the
Boards of all other First Trust Funds. The unitary board structure was adopted
for the First Trust Funds because of the efficiencies it achieves with respect
to the governance and oversight of the First Trust Funds. Each First Trust Fund
is subject to the rules and regulations of the 1940 Act (and other applicable
securities laws), which means that many of the First Trust Funds face similar
issues with respect to certain of their fundamental activities, including risk
management, portfolio liquidity, portfolio valuation and financial reporting.
Because of the similar and often overlapping issues facing the First Trust
Funds, including among the First Trust exchange-traded funds, the Board of the
First Trust Funds believes that maintaining a unitary board structure promotes
efficiency and consistency in the governance and oversight of all First Trust
Funds and reduces the costs, administrative burdens and possible conflicts that
may result from having multiple boards. In adopting a unitary board structure,
the Trustees seek to provide effective governance through establishing a board
the overall composition of which will, as a body, possesses the appropriate
skills, diversity, independence and experience to oversee the Fund's business.
Annually, the Board reviews its governance structure and the committee
structures, their performance and functions and reviews any processes that would
enhance Board governance over the Fund's business. The Board has determined that
its leadership structure, including the unitary board and committee structure,
is appropriate based on the characteristics of the funds it serves and the
characteristics of the First Trust Fund Complex as a whole.
In order to streamline communication between the Advisor and the
Independent Trustees and create certain efficiencies, the Board has a Lead
Independent Trustee who is responsible for: (i) coordinating activities of the
29
Independent Trustees; (ii) working with the Advisor, Fund counsel and the
independent legal counsel to the Independent Trustees to determine the agenda
for Board meetings; (iii) serving as the principal contact for and facilitating
communication between the Independent Trustees and the Fund's service providers,
particularly the Advisor; and (iv) any other duties that the Independent
Trustees may delegate to the Lead Independent Trustee. The Lead Independent
Trustee is selected by the Independent Trustees and serves a three year term or
until his successor is selected.
The Board has established four standing committees (as described below)
and has delegated certain of its responsibilities to those committees. The Board
and its committees meet frequently throughout the year to oversee the Fund's
activities, review contractual arrangements with and performance of service
providers, oversee compliance with regulatory requirements, and review Fund
performance. The Independent Trustees are represented by independent legal
counsel at all Board and committee meetings (other than meetings of the
Executive Committee). Generally, the Board acts by majority vote of all the
Trustees, including a majority vote of the Independent Trustees if required by
applicable law.
Commencing January 1, 2014, the three Committee Chairmen and the Lead
Independent Trustee rotate every three years in serving as Chairman of the Audit
Committee, the Nominating and Governance Committee or the Valuation Committee,
or as Lead Independent Trustee. The Lead Independent Trustee and immediate past
lead Trustee also serve on the Executive Committee with the Interested Trustee.
The four standing committees of the First Trust Fund Complex are: the
Executive Committee (and Pricing and Dividend Committee), the Nominating and
Governance Committee, the Valuation Committee and the Audit Committee. The
Executive Committee, which meets between Board meetings, is authorized to
exercise all powers of and to act in the place of the Board of Trustees to the
extent permitted by the Trust's Declaration of Trust and By Laws. Such Committee
is also responsible for the declaration and setting of dividends. Mr. Kadlec,
Mr. Bowen and Mr. Keith are members of the Executive Committee.
The Nominating and Governance Committee is responsible for appointing and
nominating non-interested persons to the Trust's Board of Trustees. Messrs.
Erickson, Kadlec, Keith and Nielson are members of the Nominating and Governance
Committee. If there is no vacancy on the Board of Trustees, the Board will not
actively seek recommendations from other parties, including shareholders. The
Board of Trustees adopted a mandatory retirement age of 72 for Trustees, beyond
which age Trustees are ineligible to serve. The Committee will not consider new
trustee candidates who are 72 years of age or older. When a vacancy on the Board
of Trustees of a First Trust Fund occurs and nominations are sought to fill such
vacancy, the Nominating and Governance Committee may seek nominations from those
sources it deems appropriate in its discretion, including shareholders of the
applicable fund. To submit a recommendation for nomination as a candidate for a
position on the Board of Trustees, shareholders of the applicable fund shall
mail such recommendation to W. Scott Jardine, Secretary, at the Trust's address,
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187. Such recommendation
shall include the following information: (i) evidence of fund ownership of the
person or entity recommending the candidate (if a fund shareholder); (ii) a full
description of the proposed candidate's background, including their education,
30
experience, current employment and date of birth; (iii) names and addresses of
at least three professional references for the candidate; (iv) information as to
whether the candidate is an "interested person" in relation to the fund, as such
term is defined in the 1940 Act, and such other information that may be
considered to impair the candidate's independence; and (v) any other information
that may be helpful to the Committee in evaluating the candidate. If a
recommendation is received with satisfactorily completed information regarding a
candidate during a time when a vacancy exists on the Board or during such other
time as the Nominating and Governance Committee is accepting recommendations,
the recommendation will be forwarded to the Chairman of the Nominating and
Governance Committee and the counsel to the Independent Trustees.
Recommendations received at any other time will be kept on file until such time
as the Nominating and Governance Committee is accepting recommendations, at
which point they may be considered for nomination.
The Valuation Committee is responsible for the oversight of the pricing
procedures of the Fund. Messrs. Erickson, Kadlec, Keith and Nielson are members
of the Valuation Committee.
The Audit Committee is responsible for overseeing the Fund's accounting
and financial reporting process, the system of internal controls, audit process
and evaluating and appointing independent auditors (subject also to Board
approval). Messrs. Erickson, Kadlec, Keith and Nielson serve on the Audit
Committee.
EXECUTIVE OFFICERS
The executive officers of each Fund hold the same positions with each fund
in the First trust Fund Complex (representing ___ portfolios) as they hold with
the Funds.
RISK OVERSIGHT
As part of the general oversight of the Fund, the Board is involved in the
risk oversight of the Fund. The Board has adopted and periodically reviews
policies and procedures designed to address the Fund's risks. Oversight of
investment and compliance risk, including oversight of any sub-advisors, is
performed primarily at the Board level in conjunction with the Advisor's
investment oversight group and the Trust's Chief Compliance Officer ("CCO").
Oversight of other risks also occurs at the committee level. The Advisor's
investment oversight group reports to the Board at quarterly meetings regarding,
among other things, Fund performance and the various drivers of such
performance. The Board reviews reports on the Fund's and the service providers'
compliance policies and procedures at each quarterly Board meeting and receives
an annual report from the CCO regarding the operations of the Fund's and the
service providers' compliance program. In addition, the Independent Trustees
meet privately each quarter with the CCO. The Audit Committee reviews with the
Advisor the Fund's major financial risk exposures and the steps the Advisor has
taken to monitor and control these exposures, including the Fund's risk
assessment and risk management policies and guidelines. The Audit Committee
also, as appropriate, reviews in a general manner the processes other Board
committees have in place with respect to risk assessment and risk management.
The Nominating and Governance Committee monitors all matters related to the
corporate governance of the Fund. The Valuation Committee monitors valuation
31
risk and compliance with the Fund's Valuation Procedures and oversees the
pricing services and actions by the Advisor's Pricing Committee with respect to
the valuation of portfolio securities.
Not all risks that may affect the Fund can be identified nor can controls
be developed to eliminate or mitigate their occurrence or effects. It may not be
practical or cost effective to eliminate or mitigate certain risks, the
processes and controls employed to address certain risks may be limited in their
effectiveness, and some risks are simply beyond the reasonable control of the
Fund or the Advisor or other service providers. Moreover, it is necessary to
bear certain risks (such as investment related risks) to achieve the Fund's
goals. As a result of the foregoing and other factors, the Fund's ability to
manage risk is subject to substantial limitations.
BOARD DIVERSIFICATION AND TRUSTEE QUALIFICATIONS
As described above, the Nominating and Governance Committee of the Board
oversees matters related to the nomination of Trustees. The Nominating and
Governance Committee seeks to establish an effective Board with an appropriate
range of skills and diversity, including, as appropriate, differences in
background, professional experience, education, vocations, and other individual
characteristics and traits in the aggregate. Each Trustee must meet certain
basic requirements, including relevant skills and experience, time availability,
and if qualifying as an Independent Trustee, independence from the Advisor,
underwriters or other service providers, including any affiliates of these
entities.
Listed below for each current Trustee are the experiences, qualifications
and attributes that led to the conclusion, as of the date of this SAI, that each
current Trustee should serve as a trustee in light of the Fund's business and
structure.
Richard E. Erickson, M.D., is an orthopedic surgeon and President of
Wheaton Orthopedics. He also has been a co-owner and director of a fitness
center and a limited partner of two real estate companies. Dr. Erickson has
served as a Trustee of each First Trust Fund since its inception. Dr. Erickson
has also served as the Lead Independent Trustee and on the Executive Committee
(2008 - 2009), Chairman of the Nominating and Governance Committee (2003 - 2007)
and Chairman of the Valuation Committee (June 2006 - 2007), Chairman of the
Audit Committee (2012 - 2013) of the First Trust Funds. He currently serves as
Chairman of the Nominating and Governance Committee (since January 1, 2014) of
the First Trust Funds.
Thomas R. Kadlec is President of ADM Investor Services Inc. ("ADMIS"), a
futures commission merchant and wholly-owned subsidiary of the Archer Daniels
Midland Company ("ADM"). Mr. Kadlec has been employed by ADMIS and its
affiliates since 1990 in various accounting, financial, operations and risk
management capacities. Mr. Kadlec serves on the boards of several international
affiliates of ADMIS and is a member of ADM's Integrated Risk Committee, which is
tasked with the duty of implementing and communicating enterprise-wide risk
management. Mr. Kadlec has served as a Trustee of each First Trust Fund, except
First Defined Portfolio Fund, LLC, since its inception. He has served as a
Trustee of First Defined Portfolio Fund, LLC since 2004. Mr. Kadlec also served
on the Executive Committee from the organization of the first First Trust
closed-end fund in 2003 until he was elected as the first Lead Independent
32
Trustee in December 2005, serving as such through 2007. He also served as
Chairman of the Valuation Committee (2008 - 2009), Chairman of the Audit
Committee (2010 - 2011) and Chairman of the Nominating and Governance Committee
(2012 - 2013). He currently serves as Lead Independent Trustee and on the
Executive Committee (since January 1, 2014) of the First Trust Funds.
Robert F. Keith is President of Hibs Enterprises, a financial and
management consulting firm. Mr. Keith has been with Hibs Enterprises since 2003.
Prior thereto, Mr. Keith spent 18 years with ServiceMaster and Aramark,
including three years as President and COO of ServiceMaster Consumer Services,
where he led the initial expansion of certain products overseas, five years as
President and COO of ServiceMaster Management Services and two years as
President of Aramark ServiceMaster Management Services. Mr. Keith is a certified
public accountant and also has held the positions of Treasurer and Chief
Financial Officer of ServiceMaster, at which time he oversaw the financial
aspects of ServiceMaster's expansion of its Management Services division in to
Europe, the Middle East and Asia. Mr. Keith has served as a Trustee of the First
Trust Funds since June 2006. Mr. Keith has also served as the Chairman of the
Audit Committee (2008 - 2009) and Chairman of the Nominating and Governance
Committee (2010 - 2011) of the First Trust Funds. He served as Lead Independent
Trustee and on the Executive Committee (2012 - 2013) and currently serves as
Chairman of the Valuation Committee (since January 1, 2014) and on the Executive
Committee (since January 31, 2014) of the First Trust Funds.
Niel B. Nielson, Ph.D., has served as the President and Chief Executive
Officer of Dew Learning LLC (a global provider of digital and on-line
educational products and services) since 2012. Mr. Nielson formerly served as
President of Covenant College (2002-2012), and as a partner and trader (of
options and Futures Contracts for hedging options) for Ritchie Capital Markets
Group (1996 - 1997), where he held an administrative management position at this
proprietary derivatives trading company. He also held prior positions in new
business development for ServiceMaster Management Services Company, and in
personnel and human resources for NationsBank of North Carolina, N.A. and
Chicago Research and Trading Group, Ltd. ("CRT"). His international experience
includes serving as a director of CRT Europe, Inc. for two years, directing out
of London all aspects of business conducted by the U.K. and European subsidiary
of CRT. Prior to that, Mr. Nielson was a trader and manager at CRT in Chicago.
Mr. Nielson has served as a Trustee of each First Trust Fund since its inception
and of the First Trust Funds since 1999. Mr. Nielson has also served as the
Chairman of the Audit Committee (2003 - 2006), Chairman of the Valuation
Committee (2007 - 2008), Chairman of the Nominating and Governance Committee
(2008 - 2009) and Lead Independent Trustee and a member of the Executive
Committee (2010 - 2011). He currently serves as Chairman of the Audit Committee
(since January 1, 2014) of the First Trust Funds.
James A. Bowen is Chief Executive Officer of First Trust Advisors L.P. and
First Trust Portfolios L.P. Mr. Bowen is involved in the day-to-day management
of the First Trust Funds and serves on the Executive Committee. He has over 26
years of experience in the investment company business in sales, sales
management and executive management. Mr. Bowen has served as a Trustee of each
First Trust Fund since its inception and of the First Trust Funds since 1999.
33
Each Independent Trustee is paid a fixed annual retainer of $125,000 per
year and an annual per fund fee of $4,000 for each closed-end fund or other
actively managed fund and $1,000 for each index fund in the First Trust Fund
Complex. The fixed annual retainer is allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Additionally, the Lead Independent
Trustee is paid $15,000 annually, the Chairman of the Audit Committee is paid
$10,000 annually, and each of the Chairmen of the Nominating and Governance
Committee and the Valuation Committee is paid $5,000 annually to serve in such
capacities, with such compensation allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Trustees are also reimbursed by
the investment companies in the First Trust Fund Complex for travel and
out-of-pocket expenses incurred in connection with all meetings.
The following table sets forth the estimated compensation (including
reimbursement for travel and out-of-pocket expenses) to be paid by the Fund and
the actual compensation paid by the First Trust Fund Complex to each of the
Independent Trustees for one fiscal year and for the calendar year ended
December 31, 2013, respectively. The Trust has no retirement or pension plans.
The officers and Trustee who are "interested persons" as designated above serve
without any compensation from the Trust. The Trust has no employees. Its
officers are compensated by First Trust.
ESTIMATED COMPENSATION FROM TOTAL COMPENSATION FROM
NAME OF TRUSTEE THE FUND(1) THE FIRST TRUST FUND COMPLEX(2)
Richard E. Erickson $____ $306,102
Thomas R. Kadlec $____ $299,500
Robert F. Keith $____ $310,300
Niel B. Nielson $____ $309,334
|
(1) The estimated compensation to be paid by the Fund to the Independent
Trustees for one fiscal year for services to the Fund.
(2) The total compensation paid to the Independent Trustees for the
calendar year ended December 31, 2013, for services to the ___
portfolios of First Defined Portfolio Fund, LLC, First Trust Series
Fund and First Trust Variable Insurance Trust, open-end funds, __
closed-end funds and __ series of the Trust, First Trust
Exchange-Traded Fund, First Trust Exchange-Traded Fund II, First Trust
Exchange-Traded Fund III, First Trust Exchange-Traded Fund V, First
Trust Exchange-Traded Fund VI, First Trust Exchange-Traded Fund VII,
First Trust Exchange-Traded AlphaDEX(R) Fund and First Trust
Exchange-Traded AlphaDEX(R) Fund II, all advised by First Trust.
34
The following table sets forth the dollar range of equity securities
beneficially owned by the Trustees in the Fund and in other funds overseen by
the Trustees in the First Trust Fund Complex as of December 31, 2013:
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN
DOLLAR RANGE OF ALL REGISTERED INVESTMENT COMPANIES
EQUITY SECURITIES OVERSEEN BY TRUSTEE IN [THE] FIRST
IN THE FUND TRUST
TRUSTEE (NUMBER OF SHARES HELD) FUND COMPLEX
Interested Trustee
James A. Bowen None $10,001 - $50,000
Independent Trustees
Richard E. Erickson None Over $100,000
Thomas R. Kadlec None Over $100,000
Robert F. Keith None Over $100,000
Niel B. Nielson None Over $100,000
|
As of _________, 2014, the Independent Trustees of the Trust and immediate
family members do not own beneficially or of record any class of securities of
an investment advisor or principal underwriter of the Fund or any person
directly or indirectly controlling, controlled by, or under common control with
an investment advisor or principal underwriter of the Fund.
As of _________, 2014, the officers and Trustees, in the aggregate, owned
less than 1% of the shares of the Fund.
As of _______, 2014, First Trust Portfolios was the sole shareholder of
the Fund. As sole shareholder, First Trust Portfolios has the ability to control
the outcome of any item presented to shareholders for approval.
Investment Advisor. The Board of Trustees of the Trust, including the
Independent Trustees, approved an investment management agreement (the
"Investment Management Agreement") for the Fund for an initial two-year term at
a meeting held on ___________, 2014. The Board of Trustees determined that the
Investment Management Agreement is in the best interests of the Fund in light of
the services, expenses and such other matters as the Board of Trustees
considered to be relevant in the exercise of its reasonable business judgment.
Pursuant to the Investment Management Agreement between First Trust and
the Trust, First Trust will manage the investment of the Fund's assets and will
be responsible for paying all expenses of the Fund, excluding the fee payments
under the Investment Management Agreement, interest, taxes, brokerage
commissions, acquired fund fees and expenses and other expenses connected with
the execution of portfolio transactions, distribution and service fees payable
pursuant to a Rule 12b-1 plan, if any, and extraordinary expenses. The Fund has
agreed to pay First Trust an annual management fee equal to 0.__% of its average
daily net assets.
35
First Trust, 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187,
is the investment advisor to the Fund. First Trust is a limited partnership with
one limited partner, Grace Partners of DuPage L.P., and one general partner, The
Charger Corporation. Grace Partners of DuPage L.P. is a limited partnership with
one general partner, The Charger Corporation, and a number of limited partners.
The Charger Corporation is an Illinois corporation controlled by James A. Bowen,
the Chief Executive Officer of First Trust. First Trust discharges its
responsibilities to the Fund subject to the policies of the Board of Trustees.
First Trust provides investment tools and portfolios for advisors and
investors. First Trust is committed to theoretically sound portfolio
construction and empirically verifiable investment management approaches. Its
asset management philosophy and investment discipline are deeply rooted in the
application of intuitive factor analysis and model implementation to enhance
investment decisions.
First Trust acts as investment advisor for and manages the investment and
reinvestment of the assets of the Fund. First Trust also administers the Trust's
business affairs, provides office facilities and equipment and certain clerical,
bookkeeping and administrative services, and permits any of its officers or
employees to serve without compensation as Trustees or officers of the Trust if
elected to such positions.
Under the Investment Management Agreement, First Trust shall not be liable
for any loss sustained by reason of the purchase, sale or retention of any
security, whether or not such purchase, sale or retention shall have been based
upon the investigation and research made by any other individual, firm or
corporation, if such recommendation shall have been selected with due care and
in good faith, except loss resulting from willful misfeasance, bad faith, or
gross negligence on the part of First Trust in the performance of its
obligations and duties, or by reason of its reckless disregard of its
obligations and duties. The Investment Management Agreement continues until two
years after the initial issuance of Fund shares, and thereafter only if approved
annually by the Board of Trustees, including a majority of the Independent
Trustees. The Investment Management Agreement terminates automatically upon
assignment and is terminable at any time without penalty as to the Fund by the
Board of Trustees, including a majority of the Independent Trustees, or by vote
of the holders of a majority of the Fund's outstanding voting securities on 60
days' written notice to First Trust, or by First Trust on 60 days' written
notice to the Fund.
Portfolio Managers.
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
Todd Larson Vice President Since 2007 Vice President (2007 to
Present), First Trust Advisors
L.P. and First Trust
Portfolios L.P.; Vice
President, ABN AMRO Asset
Management
36
|
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
Eric R. Maisel Vice President Since 2008 Vice President (2007 to
Present), First Trust Advisors
L.P. and First Trust
Portfolios L.P.
|
Mr. Larson: As head of First Trust's Fixed Income Group, Mr. Larson is
responsible for implementing fixed income investment strategies for First
Trust's institutional clients.
Mr. Maisel: Mr. Maisel serves as a Portfolio Manager for First Trust's
Fixed Income Group.
Compensation. The compensation structure for each portfolio manager is
based upon a fixed salary as well as a discretionary bonus determined by the
management of First Trust. Salaries are determined by management and are based
upon an individual's position and overall value to the firm. Bonuses are also
determined by management and are based upon an individual's overall contribution
to the success of the firm and the profitability of the firm. Salaries and
bonuses for the portfolio manager are not based upon criteria such as Fund
performance or the value of assets included in the Fund's portfolio.
The portfolio managers manage the investment vehicles and accounts
(other than the series of the Trust) with the number of accounts and assets, as
of December 31, 2013 set forth in the table below:
ACCOUNTS MANAGED BY PORTFOLIO MANAGERS
REGISTERED INVESTMENT OTHER POOLED OTHER ACCOUNTS NUMBER OF
PORTFOLIO MANAGER COMPANIES INVESTMENT VEHICLES ACCOUNTS
NUMBER OF ACCOUNTS NUMBER OF ACCOUNTS ($ ASSETS)
($ ASSETS) ($ ASSETS)
Todd Larson
Eric R. Maisel
|
Conflicts. None of the accounts managed by the portfolio managers pay an
advisory fee that is based upon the performance of the account. In addition,
First Trust believes that there are no material conflicts of interest that may
arise in connection with the portfolio managers' management of the Fund's
investments and the investments of the other accounts managed by the portfolio
managers. However, because the investment strategy for the Fund and the
37
investment strategies of many of the other accounts managed by the portfolio
managers are based on fairly mechanical investment processes, the portfolio
managers may recommend that certain clients sell and other clients buy a given
security at the same time. In addition, because the investment strategies of the
Fund and other accounts managed by the portfolio managers generally result in
the clients investing in readily available securities, First Trust believes that
there should not be material conflicts in the allocation of investment
opportunities between the Fund and other accounts managed by the portfolio
managers. None of the portfolio managers own shares in the Fund.
BROKERAGE ALLOCATIONS
First Trust is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's securities business, the
negotiation of the commissions to be paid on brokered transactions, the prices
for principal trades in securities, and the allocation of portfolio brokerage
and principal business. It is the policy of First Trust to seek the best
execution at the best security price available with respect to each transaction,
and with respect to brokered transactions in light of the overall quality of
brokerage and research services provided to First Trust and its clients. The
best price to the Fund means the best net price without regard to the mix
between purchase or sale price and commission, if any. Purchases may be made
from underwriters, dealers, and, on occasion, the issuers. Commissions will be
paid on the Fund's Futures transactions, if any. The purchase price of portfolio
securities purchased from an underwriter or dealer may include underwriting
commissions and dealer spreads. The Fund may pay mark-ups on principal
transactions. In selecting broker/dealers and in negotiating commissions, First
Trust considers, among other things, the firm's reliability, the quality of its
execution services on a continuing basis and its financial condition. Fund
portfolio transactions may be effected with broker/dealers who have assisted
investors in the purchase of shares.
Section 28(e) of the Securities Exchange Act of 1934, as amended (the
"1934 Act") permits an investment advisor, under certain circumstances, to cause
an account to pay a broker or dealer who supplies brokerage and research
services a commission for effecting a transaction in excess of the amount of
commission another broker or dealer would have charged for effecting the
transaction. Brokerage and research services include (i) furnishing advice as to
the value of securities, the advisability of investing, purchasing or selling
securities, and the availability of securities or purchasers or sellers of
securities; (ii) furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy, and the performance
of accounts; and (iii) effecting securities transactions and performing
functions incidental thereto (such as clearance, settlement, and custody). Such
brokerage and research services are often referred to as "soft dollars." First
Trust has advised the Board of Trustees that it does not currently intend to use
soft dollars.
Notwithstanding the foregoing, in selecting brokers, First Trust may in
the future consider investment and market information and other research, such
as economic, securities and performance measurement research, provided by such
brokers, and the quality and reliability of brokerage services, including
execution capability, performance, and financial responsibility. Accordingly,
the commissions charged by any such broker may be greater than the amount
another firm might charge if First Trust determines in good faith that the
amount of such commissions is reasonable in relation to the value of the
research information and brokerage services provided by such broker to First
38
Trust or the Trust. In addition, First Trust must determine that the research
information received in this manner provides the Fund with benefits by
supplementing the research otherwise available to the Fund. The Investment
Management Agreement provides that such higher commissions will not be paid by
the Fund unless the Advisor determines in good faith that the amount is
reasonable in relation to the services provided. The investment advisory fees
paid by the Fund to First Trust under the Investment Management Agreement would
not be reduced as a result of receipt by First Trust of research services.
First Trust places portfolio transactions for other advisory accounts
advised by it, and research services furnished by firms through which the Fund
effects its securities transactions may be used by First Trust in servicing all
of its accounts; not all of such services may be used by First Trust in
connection with the Fund. First Trust believes it is not possible to measure
separately the benefits from research services to each of the accounts
(including the Fund) advised by it. Because the volume and nature of the trading
activities of the accounts are not uniform, the amount of commissions in excess
of those charged by another broker paid by each account for brokerage and
research services will vary. However, First Trust believes such costs to the
Fund will not be disproportionate to the benefits received by the Fund on a
continuing basis. First Trust seeks to allocate portfolio transactions equitably
whenever concurrent decisions are made to purchase or sell securities by the
Fund and another advisory account. In some cases, this procedure could have an
adverse effect on the price or the amount of securities available to the Fund.
In making such allocations between the Fund and other advisory accounts, the
main factors considered by First Trust are the respective investment objective,
the relative size of portfolio holding of the same or comparable securities, the
availability of cash for investment and the size of investment commitments
generally held.
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT, DISTRIBUTOR
Custodian, Administrator, Fund Accountant and Transfer Agent. _________
("_____"), as custodian for the Fund pursuant to a Custodian Agreement, holds
the Fund's assets. Also, pursuant to an Administrative Agency Agreement, ______
provides certain administrative and accounting services to the Fund, including
maintaining the Fund's books of account, records of the Fund's securities
transactions and certain other books and records; acting as liaison with the
Fund's independent registered public accounting firm by providing such
accountant with various audit-related information with respect to the Fund; and
providing other continuous accounting and administrative services. ______ also
serves as the Fund's transfer agent pursuant to a Transfer Agency Agreement.
______ is located at ______.
Pursuant to the Administrative Agency Agreement, the Trust on behalf of
the Fund has agreed to indemnify the Administrator for certain liabilities,
including certain liabilities arising under the federal securities laws, unless
such loss or liability results from negligence or willful misconduct in the
performance of its duties.
Pursuant to the Fund Administration and Accounting Agreement between
______ and the Trust, the Fund has agreed to pay such compensation as is
mutually agreed from time to time and such out-of-pocket expenses as incurred by
______ in the performance of its duties.
39
Distributor. First Trust Portfolios L.P., an affiliate of First Trust, is
the distributor ("FTP" or the "Distributor") and principal underwriter of the
shares of the Fund. Its principal address is 120 East Liberty Drive, Suite 400,
Wheaton, Illinois 60187. The Distributor has entered into a Distribution
Agreement with the Trust pursuant to which it distributes Fund shares. Shares
are continuously offered for sale by the Fund through the Distributor only in
Creation Unit Aggregations, as described below under the heading "Creation and
Redemption of Creation Unit Aggregations."
The advisor may, from time to time and from its own resources, pay, defray
or absorb costs relating to distribution, including payments out of its own
resources to the Distributor, or to otherwise promote the sale of shares. The
Advisor's available resources to make these payments may include profits from
advisory fees received from the Fund. The services the advisor may pay for
include, but are not limited to, advertising and attaining access to certain
conferences and seminars, as well as being presented with the opportunity to
address investors and industry professionals through speeches and written
marketing materials.
12b-1 Plan. The Trust has adopted a Plan of Distribution pursuant to Rule
12b-1 under the 1940 Act (the "Plan") pursuant to which the Fund may reimburse
the Distributor up to a maximum annual rate of 0.25% of its average daily net
assets.
Under the Plan and as required by Rule 12b-1, the Trustees will receive
and review after the end of each calendar quarter a written report provided by
the Distributor of the amounts expended under the Plan and the purpose for which
such expenditures were made. With the exception of the Distributor and its
affiliates, no "interested person" of the Trust (as that term is defined in the
1940 Act) and no Trustee of the Trust has a direct or indirect financial
interest in the operation of the Plan or any related agreement.
No fee is currently paid by the Fund under the Plan, and pursuant to a
contractual agreement, the Fund will not pay 12b-1 fees any time before ______,
2014.
Aggregations. Fund shares in less than Creation Unit Aggregations are not
distributed by the Distributor. The Distributor will deliver the Prospectus and,
upon request, this SAI to persons purchasing Creation Unit Aggregations and will
maintain records of both orders placed with it and confirmations of acceptance
furnished by it. The Distributor is a broker-dealer registered under the 1934
Act and a member of the Financial Industry Regulatory Authority ("FINRA").
The Distribution Agreement provides that it may be terminated at any time,
without the payment of any penalty, on at least 60 days' written notice by the
Trust to the Distributor (i) by vote of a majority of the Independent Trustees;
or (ii) by vote of a majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund. The Distribution Agreement will terminate
automatically in the event of its assignment (as defined in the 1940 Act).
The Distributor may also enter into agreements with participants that
utilize the facilities of the Depository Trust Company (the "DTC Participants"),
which have international, operational, capabilities and place orders for
40
Creation Unit Aggregations of Fund shares. Participating Parties (which are
participants in the Continuous Net Settlement System of the National Securities
Clearing Corporation) shall be DTC Participants.
[Additional Service Provider. First Trust, on behalf of the Fund has
engaged Markit Group Limited or its designee (the "IPV Calculator"), to
calculate the intra-day values for the shares of the Fund.]
Exchange. The only relationship that the Exchange has with First Trust or
the Distributor of the Fund in connection with the Fund is that the Exchange
will list the shares of the Fund and disseminates the intra-day portfolio values
that are calculated by the IPV Calculator pursuant to its listing agreement with
the Trust. The Exchange is not responsible for and has not participated in the
determination of pricing or the timing of the issuance or sale of the shares of
the Fund or in the determination or calculation of the asset value of the Fund.
The Exchange has no obligation or liability in connection with the
administration, marketing or trading of the Fund.
ADDITIONAL INFORMATION
Book Entry Only System. The following information supplements and should
be read in conjunction with the Prospectus.
DTC Acts as Securities Depository for Fund Shares. Shares of the Fund are
represented by securities registered in the name of The Depository Trust Company
("DTC") or its nominee, Cede & Co., and deposited with, or on behalf of, DTC.
DTC, a limited-purpose trust company, was created to hold securities of
its participants (the "DTC Participants") and to facilitate the clearance and
settlement of securities transactions among the DTC Participants in such
securities through electronic book-entry changes in accounts of the DTC
Participants, thereby eliminating the need for physical movement of securities,
certificates. DTC Participants include securities brokers and dealers, banks,
trust companies, clearing corporations and certain other organizations, some of
whom (and/or their representatives) own DTC. More specifically, DTC is owned by
a number of its DTC Participants and by the New York Stock Exchange (the "NYSE")
and FINRA. Access to the DTC system is also available to others such as banks,
brokers, dealers and trust companies that clear through or maintain a custodial
relationship with a DTC Participant, either directly or indirectly (the
"Indirect Participants").
Beneficial ownership of shares is limited to DTC Participants, Indirect
Participants and persons holding interests through DTC Participants and Indirect
Participants. Ownership of beneficial interests in shares (owners of such
beneficial interests are referred to herein as "Beneficial Owners") is shown on,
and the transfer of ownership is effected only through, records maintained by
DTC (with respect to DTC Participants) and on the records of DTC Participants
(with respect to Indirect Participants and Beneficial Owners that are not DTC
Participants). Beneficial Owners will receive from or through the DTC
Participant a written confirmation relating to their purchase and sale of
shares.
41
Conveyance of all notices, statements and other communications to
Beneficial Owners is effected as follows. Pursuant to a letter agreement between
DTC and the Trust, DTC is required to make available to the Trust upon request
and for a fee to be charged to the Trust a listing of the shares of the Fund
held by each DTC Participant. The Trust shall inquire of each such DTC
Participant as to the number of Beneficial Owners holding shares, directly or
indirectly, through such DTC Participant. The Trust shall provide each such DTC
Participant with copies of such notice, statement or other communication, in
such form, number and at such place as such DTC Participant may reasonably
request, in order that such notice, statement or communication may be
transmitted by such DTC Participant, directly or indirectly, to such Beneficial
Owners. In addition, the Trust shall pay to each such DTC Participants a fair
and reasonable amount as reimbursement for the expenses attendant to such
transmittal, all subject to applicable statutory and regulatory requirements.
Fund distributions shall be made to DTC or its nominee, as the registered
holder of all Fund shares. DTC or its nominee, upon receipt of any such
distributions, shall immediately credit DTC Participants' accounts with payments
in amounts proportionate to their respective beneficial interests in shares of
the Fund as shown on the records of DTC or its nominee. Payments by DTC
Participants to Indirect Participants and Beneficial Owners of shares held
through such DTC Participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts of
customers in bearer form or registered in a "street name," and will be the
responsibility of such DTC Participants.
The Trust has no responsibility or liability for any aspect of the records
relating to or notices to Beneficial Owners, or payments made on account of
beneficial ownership interests in such shares, or for maintaining, supervising
or reviewing any records relating to such beneficial ownership interests, or for
any other aspect of the relationship between DTC and the DTC Participants or the
relationship between such DTC Participants and the Indirect Participants and
Beneficial Owners owning through such DTC Participants.
DTC may decide to discontinue providing its service with respect to shares
at any time by giving reasonable notice to the Trust and discharging its
responsibilities with respect thereto under applicable law. Under such
circumstances, the Trust shall take action to find a replacement for DTC to
perform its functions at a comparable cost.
Intra-Day Portfolio Value. The price of a non-U.S. security that is
primarily traded on a non-U.S. exchange shall be updated every 15 seconds
throughout its trading day, provided, that upon the closing of such non-U.S.
exchange the closing price of the security will be used throughout the remainder
of the business day where the markets remain open. These exchange rates may
differ from those used by First Trust and consequently result in intra-day
portfolio values that may vary. Furthermore, in calculating the intra-day
portfolio values of the Fund's shares, the exchange rates used throughout the
day (9:00 a.m. to 4:15 p.m. Eastern Time) shall be those that are deemed to be
most appropriate.
42
PROXY VOTING POLICIES AND PROCEDURES
The Board has delegated to First Trust the proxy voting responsibilities
for the Fund and has directed First Trust to vote proxies consistent with the
Fund's best interests. First Trust has engaged the services of ISS Governance
Services, a division of RiskMetrics Group, Inc. ("ISS"), to make recommendations
to First Trust on the voting of proxies relating to securities held by the Fund.
If First Trust manages the assets of a company or its pension plan and any of
First Trust's clients hold any securities of that company, First Trust will vote
proxies relating to such company's securities in accordance with the ISS
recommendations to avoid any conflict of interest. While these guidelines are
not intended to be all-inclusive, they do provide guidance on First Trust's
general voting policies.
First Trust has adopted the ISS Proxy Voting Guidelines. While these
guidelines are not intended to be all-inclusive, they do provide guidance on
First Trust's general voting policies. The ISS Proxy Voting Guidelines are
attached hereto as Exhibit B.
Quarterly Portfolio Schedule. The Trust is required to disclose, after its
first and third fiscal quarters, the complete schedule of the Fund's portfolio
holdings with the SEC on Form N-Q. Form N-Q for the Trust is available on the
SEC's website at http://www.sec.gov. The Fund's Form N-Q may also be reviewed
and copied at the SEC's Public Reference Room in Washington, D.C. and
information on the operation of the Public Reference Room may be obtained by
calling 1-800-SEC-0330. The Trust's Forms N-Q are available without charge, upon
request, by calling (800) 621-1675 or by writing to First Trust Portfolios L.P.,
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187.
Policy Regarding Disclosure of Portfolio Holdings. The Trust has adopted a
policy regarding the disclosure of information about the Fund's portfolio
holdings. The Board of Trustees must approve all material amendments to this
policy. The Fund's portfolio holdings are publicly disseminated each day the
Fund is open for business through financial reporting and news services,
including publicly accessible Internet websites. In addition, a basket
composition file, which includes the security names and share quantities to
deliver in exchange for Fund shares, together with estimates and actual cash
components, is publicly disseminated each day the NYSE is open for trading via
the National Securities Clearing Corporation ("NSCC"). The basket represents one
Creation Unit of the Fund. The Fund's portfolio holdings are also available on
the Fund's website at http://www.ftportfolios.com. The Trust, First Trust, FTP
and ______ will not disseminate non-public information concerning the Trust.
Codes of Ethics. In order to mitigate the possibility that the Fund will
be adversely affected by personal trading, the Trust, First Trust and the
Distributor have adopted Codes of Ethics under Rule 17j-1 under the 1940 Act.
These Codes of Ethics contain policies restricting securities trading in
personal accounts of the officers, Trustees and others who normally come into
possession of information on portfolio transactions. Personnel subject to the
Codes of Ethics may invest in securities that may be purchased or held by the
Fund; however, the Codes of Ethics require that each transaction in such
securities be reviewed by the CCO or his or her designee. These Codes of Ethics
are on public file with, and are available from, the SEC.
43
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS
GENERAL
The Trust issues and sells shares of the Fund only in Creation Unit
Aggregations on a continuous basis through the Distributor, without a sales
load, at their net asset values next determined after receipt, on any Business
Day (as defined below), of an order in proper form.
A "Business Day" is any day on which the NYSE is open for business. As of
the date of this SAI, the NYSE observes the following holidays: New Year's Day,
Martin Luther King, Jr. Day, President's Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
PURCHASE AND ISSUANCE OF CREATION UNIT AGGREGATIONS
Fund Deposit. Unless cash purchases are required or permitted for the Fund
under the circumstances described below, the consideration for purchase of a
Creation Unit Aggregation of shares of the Fund generally consists of the
in-kind deposit of a designated portfolio of securities and other instruments
(the "Deposit Securities") generally corresponding pro rata (except in certain
circumstances) to the Fund's portfolio positions (including cash positions) as
of the end of the prior Business Day and an amount of cash computed as described
below (the "Cash Component"). Together, the Deposit Securities (and/or any cash
with respect to cash purchases and cash-in-lieu amounts) and the Cash Component
constitute the "Fund Deposit," which represents the minimum initial and
subsequent investment amount for a Creation Unit Aggregation of the Fund.
The Cash Component is sometimes also referred to as the Balancing Amount.
The Cash Component serves the function of compensating for any differences
between the net asset value per Creation Unit Aggregation and the Deposit Amount
(as defined below). The Cash Component is an amount equal to the difference
between (i) the net asset value of Fund shares (per Creation Unit Aggregation)
and (ii) the "Deposit Amount" -- an amount equal to the aggregate market value
of the Deposit Securities. If the Cash Component is a positive number (i.e., the
net asset value per Creation Unit Aggregation exceeds the Deposit Amount), the
creator will deliver the Cash Component. If the Cash Component is a negative
number (i.e., the net asset value per Creation Unit Aggregation is less than the
Deposit Amount), the creator will receive the Cash Component.
The Custodian, through the NSCC, makes available on each Business Day,
prior to the opening of business of the Exchange (currently 9:30 a.m., Eastern
Time), the list of the names and the required quantity of each Deposit Security,
as well as the estimated Cash Component (if any) that will be applicable to Fund
Deposits for the Fund for that day (subject to correction of any errors). Such
Fund Deposit information is applicable in order to effect creations of Creation
Unit Aggregations of the Fund until the next Business Day.
44
The identities and quantities of the Deposit Securities required for a
Fund Deposit for the Fund change as corporate action events are reflected within
the Fund from time to time by the Advisor with a view to the investment
objective of the Fund.
The Fund reserves the right to require or permit purchases of Creation
Unit Aggregations to be made in whole or in part on a cash basis, rather than
in-kind, under the following circumstances: (i) to the extent there is a Cash
Component; (ii) if, on a given Business Day, the Fund announces before the open
of trading that all purchases on that day will be made entirely in cash; (iii)
if, upon receiving a purchase order from an Authorized Participant (as defined
below), the Fund determines to require the purchase to be made entirely in cash;
(iv) if, on a given Business Day, the Fund requires all Authorized Participants
purchasing shares on that day to deposit cash in lieu of some or all of the
Deposit Securities because: (a) such instruments are not eligible for transfer
through either the Continuous Net Settlement System of the NSCC as such
processes have been enhanced to effect purchases and redemptions of Creation
Unit Aggregations (the "NSCC Process") or through the facilities of DTC (the
"DTC Process"); or (b) in the case of non-U.S. Deposit Securities, such
instruments are not eligible for trading due to local trading restrictions,
local restrictions on securities transfers or other similar circumstances; or
(v) if the Fund permits an Authorized Participant to deposit cash in lieu of
some or all of the Deposit Securities because: (a) such instruments are not
available in sufficient quantity; or (b) such instruments are not eligible for
trading by an Authorized Participant or the investor on whose behalf the
Authorized Participant is acting.
In addition, under the following circumstances, it is possible that
Deposit Securities may not correspond pro rata to the positions in the Fund's
portfolio as of the end of the prior Business Day: (i) in the case of bonds, for
minor differences when it is impossible to break up bonds beyond certain minimum
sizes needed for transfer and settlement; (ii) for minor differences when
rounding is necessary to eliminate fractional shares or lots that are not
tradeable round lots (a tradeable round lot for a security will be the standard
unit of trading in that particular type of security in its primary market); or
(iii) with respect to "to-be-announced" transactions, short positions and other
positions that cannot be transferred in kind (including instruments that can be
transferred in kind only with the consent of the original counterparty to the
extent the Fund does not intend to seek such consents), and they will therefore
be excluded from the Deposit Securities with their value reflected in the
determination of the Cash Component.
Procedures for Creation of Creation Unit Aggregations. In order to be
eligible to place orders with the Distributor and to create a Creation Unit
Aggregation of the Fund, an entity must be a DTC Participant (see the "Book
Entry Only System" section), must have executed an agreement with the
Distributor and transfer agent, with respect to creations and redemptions of
Creation Unit Aggregations ("Participant Agreement") (discussed below), and have
international operational capabilities. A DTC Participant is also referred to as
an "Authorized Participant." Investors should contact the Distributor for the
names of Authorized Participants that have signed a Participant Agreement. All
Fund shares, however created, will be entered on the records of DTC in the name
of Cede & Co. for the account of a DTC Participant.
All standard orders to create Creation Unit Aggregations must be received
by the transfer agent no later than the closing time of the regular trading
session on the NYSE ("Closing Time") (ordinarily 4:00 p.m., Eastern Time) in
45
each case on the date such order is placed in order for the creation of Creation
Unit Aggregations to be effected based on the net asset value of shares of the
Fund as next determined on such date after receipt of the order in proper form.
Subject to the provisions of the applicable Participant Agreement, in the case
of custom orders, the order must generally be received by the transfer agent no
later than 3:00 p.m. Eastern Time on the trade date. The Fund may require custom
orders for the purchase of Creation Unit Aggregations to be placed earlier in
the day (for example, on days when the generally accepted close of the Exchange
or the applicable fixed-income security market occurs earlier than normal (such
as the day before a holiday)). In addition, it is possible that orders to
purchase a Creation Unit Aggregation may not be accepted on any day when the
applicable fixed-income security markets are closed. The date on which an order
to create Creation Unit Aggregations (or an order to redeem Creation Unit
Aggregations, as discussed below) is placed is referred to as the "Transmittal
Date." Orders must be transmitted by an Authorized Participant by telephone or
other transmission method acceptable to the transfer agent pursuant to
procedures set forth in the Participant Agreement. Economic or market
disruptions or changes, or telephone or other communication failure may impede
the ability to reach the transfer agent or an Authorized Participant.
All orders from investors who are not Authorized Participants to create
Creation Unit Aggregations shall be placed with an Authorized Participant, as
applicable, in the form required by such Authorized Participant. In addition,
the Authorized Participant may request the investor to make certain
representations or enter into agreements with respect to the order, e.g., to
provide for payments of cash, when required. Investors should be aware that
their particular broker may not have executed a Participant Agreement and that,
therefore, orders to create Creation Unit Aggregations of the Fund have to be
placed by the investor's broker through an Authorized Participant that has
executed a Participant Agreement. In such cases there may be additional charges
to such investor. At any given time, there may be only a limited number of
broker-dealers that have executed a Participant Agreement. Those persons placing
orders should ascertain the deadlines applicable to DTC and the Federal Reserve
Bank wire system by contacting the operations department of the broker or
depository institution effectuating such transfer of Deposit Securities and Cash
Component.
Deposit Securities must be delivered to the Trust through the applicable
processes set forth in the Participant Agreement. Deposit Securities which are
non-U.S. securities must be delivered to an account maintained at the applicable
local subcustodian of the Trust on or before the International Contractual
Settlement Date (as defined below), all in accordance with the terms of the
Participant Agreement. If a Deposit Security is an ADR or similar domestic
instrument, it may be delivered to the Custodian. The Authorized Participant
must also pay on or before the International Contractual Settlement Date
immediately available or same-day funds estimated by Trust to be sufficient to
pay the Cash Component next determined after acceptance of the creation order,
together with the applicable Creation Transaction Fee (as defined below) and
additional variable amounts, as described below, all in accordance with the
terms of the Participant Agreement. The "International Contractual Settlement
Date" is the earlier of (i) the date upon which all of the required Deposit
Securities, the Cash Component and any other cash amounts which may be due are
delivered to the Fund; or (ii) the latest day for settlement on the customary
settlement cycle in the jurisdiction(s) where any of the securities of the Fund
46
are customarily traded. Any excess funds will be returned following settlement
of the issue of the Creation Unit Aggregation.
Issuance of Creation Unit Aggregations. A Creation Unit Aggregation will
generally not be issued until the transfer of good title to the Trust of the
portfolio of Deposit Securities and the payment of the Cash Component, the
Creation Transaction Fee (as defined below) and any other required cash amounts
have been completed. As described in the next paragraph, in the event that an
order for a Creation Unit is incomplete because certain or all of the Deposit
Securities are missing, the Trust may issue a Creation Unit notwithstanding such
deficiency in reliance on the undertaking of the Authorized Participant to
deliver the missing Deposit Securities as soon as possible, which undertaking
shall be secured by an additional cash deposit (described below) with respect to
the undelivered Deposit Securities.
To the extent contemplated by the applicable Participant Agreement,
Creation Unit Aggregations of the Fund will be issued to such Authorized
Participant notwithstanding the fact that the corresponding Fund Deposits have
not been received in part or in whole, in reliance on the undertaking of the
Authorized Participant to deliver the missing Deposit Securities as soon as
possible, which undertaking shall be secured by such Authorized Participant's
delivery and maintenance of collateral consisting of cash in the form of U.S.
dollars in immediately available funds having a value (marked to market daily)
at least equal to 115% (which First Trust may change from time to time) of the
value of the missing Deposit Securities. The Participant Agreement will permit
the Fund to buy the missing Deposit Securities at any time and will subject the
Authorized Participant to liability for any shortfall between the cost to the
Trust of purchasing such securities and the value of the collateral.
Acceptance of Orders for Creation Unit Aggregations. The Trust reserves
the absolute right to reject a creation order transmitted to it by the
Distributor with respect to the Fund if: (i) the order is not in proper form;
(ii) the investor(s), upon obtaining the Fund shares ordered, would own 80% or
more of the currently outstanding shares of the Fund; (iii) the required Fund
Deposit is not delivered; (iv) acceptance of the Deposit Securities would have
certain adverse tax consequences to the Fund; (v) acceptance of the Fund Deposit
would, in the opinion of the Trust, be unlawful; (vi) acceptance of the Fund
Deposit would otherwise, in the discretion of the Trust or the Distributor, have
an adverse effect on the Trust, the Fund or the rights of Beneficial Owners; or
(vii) circumstances outside the control of the Trust or the Fund make it
impossible to process creation orders for all practical purposes. Examples of
such circumstances include: acts of God or public service or utility problems
such as fires, floods, extreme weather conditions and power outages resulting in
telephone, telecopy and computer failures; market conditions or activities
causing trading halts; systems failures involving computer or other information
systems affecting the Trust, the Fund, First Trust, the Distributor, DTC, NSCC,
the transfer agent, the Custodian, the sub-custodian or any other participant in
the creation process; the imposition by a foreign government or a regulatory
body of controls, or other monetary, currency or trading restrictions that
directly affect the portfolio securities held; and similar extraordinary events.
The Distributor shall notify a prospective creator of a Creation Unit and/or the
Authorized Participant acting on behalf of such prospective creator of its
rejection of the order of such person. The Trust, the Fund, the Custodian, any
47
sub-custodian and the Distributor are under no duty, however, to give
notification of any defects or irregularities in the delivery of Fund Deposits,
nor shall any of them incur any liability for the failure to give any such
notification.
All questions as to the quantity of each security in the Deposit
Securities and the validity, form, eligibility, and acceptance for deposit of
any securities to be delivered shall be determined by the Trust, and the Trust's
determination shall be final and binding.
Creation Transaction Fee. Purchasers of Creation Units must pay a creation
transaction fee (the "Creation Transaction Fee") that is currently $___. The
Creation Transaction Fee is applicable to each purchase transaction regardless
of the number of Creation Units purchased in the transaction. The Creation
Transaction Fee may vary and is based on the composition of the securities
included in the Fund's portfolio and the countries in which the transactions are
settled. The price for each Creation Unit will equal the daily net asset value
per share times the number of shares in a Creation Unit plus the fees described
above and, if applicable, any operational processing and brokerage costs,
transfer fees or stamp taxes. When the Fund permits an Authorized Participant to
substitute cash in lieu of depositing one or more of the requisite Deposit
Securities, the Authorized Participant may also be assessed an amount to cover
the cost of purchasing the Deposit Securities, including operational processing
and brokerage costs, transfer fees, stamp taxes, and part or all of the spread
between the expected bid and offer side of the market related to such Deposit
Securities.
REDEMPTIONS OF CREATION UNIT AGGREGATIONS
Redemption of Fund Shares In Creation Unit Aggregations. Fund shares may
be redeemed only in Creation Unit Aggregations at their net asset value next
determined after receipt of a redemption request in proper form by the Fund
through the transfer agent and only on a Business Day. The Fund will not redeem
shares in amounts less than Creation Unit Aggregations. Beneficial Owners must
accumulate enough shares in the secondary market to constitute a Creation Unit
Aggregation in order to have such shares redeemed by the Trust. There can be no
assurance, however, that there will be sufficient liquidity in the public
trading market at any time to permit assembly of a Creation Unit Aggregation.
Investors should expect to incur customary brokerage and other costs in
connection with assembling a sufficient number of Fund shares to constitute a
redeemable Creation Unit Aggregation.
The Custodian, through the NSCC, makes available on each Business Day,
prior to the opening of business on the Exchange (currently 9:30 a.m. Eastern
Time), the list of the names and the required quantity of the securities and
other instruments ("Fund Securities"), as well as the estimated Cash Redemption
Amount (defined below) (if any), that will be applicable for the Fund for that
day (subject to correction of any errors) to redemption requests received in
proper form (as described below) on that day.
Unless cash redemptions are required or permitted for the Fund under the
circumstances described below, the redemption proceeds for a Creation Unit
Aggregation generally consist of Fund Securities--as announced on the Business
Day of the request for redemption received in proper form--plus or minus cash in
an amount equal to the difference between the net asset value of the Fund shares
(per Creation Unit Aggregation) being redeemed, as next determined after a
48
receipt of a request in proper form, and the aggregate market value of the Fund
Securities (the "Cash Redemption Amount"), less the applicable Redemption
Transaction Fee as listed below and, if applicable, any operational processing
and brokerage costs, transfer fees or stamp taxes. In the event that the Fund
Securities have an aggregate market value greater than the net asset value of
the Fund shares (per Creation Unit Aggregation), a compensating cash payment
equal to the difference plus, the applicable Redemption Transaction Fee and, if
applicable, any operational processing and brokerage costs, transfer fees or
stamp taxes is required to be made by or through an Authorized Participant by
the redeeming shareholder.
The Fund reserves the right to require or permit redemptions of Creation
Unit Aggregations to be made in whole or in part on a cash basis, rather than
in-kind, under the following circumstances: (i) to the extent there is a Cash
Redemption Amount; (ii) if, on a given Business Day, the Fund announces before
the open of trading that all redemptions on that day will be made entirely in
cash; (iii) if, upon receiving a redemption order from an Authorized
Participant, the Fund determines to require the redemption to be made entirely
in cash; (iv) if, on a given Business Day, the Fund requires all Authorized
Participants redeeming shares on that day to receive cash in lieu of some or all
of the Fund Securities because: (a) such instruments are not eligible for
transfer through either the NSCC Process or the DTC Process, or (b) in the case
of non-U.S. Fund Securities, such instruments are not eligible for trading due
to local trading restrictions, local restrictions on securities transfers or
other similar circumstances; or (v) if the Fund permits an Authorized
Participant to receive cash in lieu of some or all of the Fund Securities
because: (a) such instruments are not eligible for trading by an Authorized
Participant or the investor on whose behalf the Authorized Participant is
acting, or (b) with respect to non-U.S. Fund Securities, a holder of shares of
the Fund would be subject to unfavorable income tax treatment if the holder
receives redemption proceeds in kind.
In addition, under the following circumstances, it is possible that Fund
Securities may not correspond pro rata to the positions in the Fund's portfolio
as of the end of the prior Business Day: (i) in the case of bonds, for minor
differences when it is impossible to break up bonds beyond certain minimum sizes
needed for transfer and settlement; (ii) for minor differences when rounding is
necessary to eliminate fractional shares or lots that are not tradeable round
lots; or (iii) with respect to "to-be-announced" transactions, short positions
and other positions that cannot be transferred in kind (including instruments
that can be transferred in kind only with the consent of the original
counterparty to the extent the Fund does not intend to seek such consents), and
they will therefore be excluded from the Fund Securities with their value
reflected in the determination of the Cash Redemption Amount.
The right of redemption may be suspended or the date of payment postponed
(i) for any period during which the _______ is closed (other than customary
weekend and holiday closings); (ii) for any period during which trading on the
_______ is suspended or restricted; (iii) for any period during which an
emergency exists as a result of which disposal of the shares of the Fund or
determination of the Fund's net asset value is not reasonably practicable; or
(iv) in such other circumstances as are permitted by the SEC.
Redemption Transaction Fee. Parties redeeming Creation Units must pay a
redemption transaction fee (the "Redemption Transaction Fee") that is currently
$___. The Redemption Transaction Fee is applicable to each redemption
49
transaction regardless of the number of Creation Units redeemed in the
transaction. The Redemption Transaction Fee may vary and is based on the
composition of the securities included in the Fund's portfolio and the countries
in which the transactions are settled. Investors will also bear the costs of
transferring the Fund Securities from the Trust to their account or on their
order and may also be assessed an amount to cover other costs including
operational processing and brokerage costs, transfer fees, stamp taxes, and part
or all of the spread between the expected bid and offer side of the market
related to such Securities. Investors who use the services of a broker or other
such intermediary in addition to an Authorized Participant to effect a
redemption of a Creation Unit Aggregation may be charged an additional fee for
such services.
Placement of Redemption Orders. Orders to redeem Creation Unit
Aggregations must be delivered through an Authorized Participant that has
executed a Participant Agreement and must comply with the applicable provisions
of such Participant Agreement. Investors other than Authorized Participants are
responsible for making arrangements for a redemption request to be made through
an Authorized Participant.
Deliveries of Fund Securities to investors are generally expected to be
made within three Business Days. Due to the schedule of holidays in certain
countries, however, the delivery of in-kind redemption proceeds for the Fund may
take longer than three Business Days after the day on which the redemption
request is received in proper form. In such cases, the local market settlement
procedures will not commence until the end of the local holiday periods. See
below for a list of the local holidays in the foreign countries relevant to the
Fund. Under the 1940 Act, the Fund would generally be required to make payment
of redemption proceeds within seven days after a security is tendered for
redemption. However, because the settlement of redemptions of Fund shares is
contingent not only on the settlement cycle of the United States securities
markets, but also on delivery cycles of foreign markets, pursuant to an
exemptive order upon which the Fund may rely, the Fund's in-kind redemption
proceeds are permitted to be paid within the maximum number of calendar days
required for such payment or satisfaction in the principal local foreign markets
where transactions in portfolio securities customarily clear and settle, but no
later than 15 calendar days following tender of a Creation Unit Aggregation in
proper form.
In connection with taking delivery of shares of non-U.S. Fund Securities
upon redemption of shares of the Fund, a redeeming Beneficial Owner, or
Authorized Participant acting on behalf of such Beneficial Owner, must maintain
appropriate security arrangements with a qualified broker-dealer, bank or other
custody provider in each jurisdiction in which any of the Fund Securities are
customarily traded, to which account such Fund Securities will be delivered.
To the extent contemplated by an Authorized Participant's agreement, in
the event the Authorized Participant has submitted a redemption request in
proper form but is unable to transfer all or part of the Creation Unit
Aggregation to be redeemed to the Fund's transfer agent, the transfer agent may
nonetheless accept the redemption request in reliance on the undertaking by the
Authorized Participant to deliver the missing shares as soon as possible. Such
undertaking shall be secured by the Authorized Participant's delivery and
50
maintenance of collateral consisting of cash having a value (marked to market
daily) at least equal to 115%, (which First Trust may change from time to time),
of the value of the missing shares.
The current procedures for collateralization of missing shares require,
among other things, that any cash collateral shall be in the form of U.S.
dollars in immediately available funds and shall be held by ______ and marked to
market daily, and that the fees of ______ and any sub-custodians in respect of
the delivery, maintenance and redelivery of the cash collateral shall be payable
by the Authorized Participant. If the Authorized Participant's agreement
provides for collateralization, it will permit the Trust, on behalf of the
affected Fund, to purchase the missing shares at any time and will subject the
Authorized Participant to liability for any shortfall between the cost to the
Trust of purchasing such shares and the value of the collateral.
The calculation of the value of the Fund Securities and the Cash
Redemption Amount to be delivered/received upon redemption will be made by
______ according to the procedures set forth in this SAI under "Determination of
Net Asset Value" computed on the Business Day on which a redemption order is
deemed received by the Trust. Therefore, if a redemption order in proper form is
submitted to ______ by a DTC Participant not later than Closing Time on the
Transmittal Date, and the requisite number of shares of the Fund are delivered
to ______ prior to the specified time, then the value of the Fund Securities and
the Cash Redemption Amount to be delivered will be determined by ______ on such
Transmittal Date. A redemption order must be submitted in proper form.
Redemptions of Fund shares for Fund Securities will be subject to
compliance with applicable federal and state securities laws and the Fund
reserves the right to redeem Creation Unit Aggregations for cash under the
circumstances described above. An Authorized Participant or an investor for
which it is acting may therefore be paid redemption proceeds in cash. The
Authorized Participant may request the redeeming Beneficial Owner of the Fund
shares to complete an order form or to enter into agreements with respect to
such matters as compensating cash payment, beneficial ownership of shares or
delivery instructions.
Because the portfolio securities of the Fund may trade on the relevant
exchange(s) on days that the listing exchange for the Fund is closed or are
otherwise not Business Days for the Fund, shareholders may not be able to redeem
their shares of the Fund, or purchase and sell shares of the Fund on the listing
exchange for the Fund, on days when the net asset value of the Fund could be
significantly affected by events in the relevant foreign markets.
REGULAR HOLIDAYS
The Fund generally intends to effect deliveries of Creation Units and
securities in its portfolio ("Portfolio Securities") on a basis of "T" plus
three Business Days (i.e., days on which the NYSE is open). The Fund may effect
deliveries of Creation Units and portfolio securities on a basis other than "T"
plus three in order to accommodate local holiday schedules, to account for
different treatment among non-U.S. and U.S. markets of dividend record dates and
ex-dividend dates, or under certain other circumstances. The ability of the
Trust to effect in-kind creations and redemptions within three Business Days of
receipt of an order in good form is subject, among other things, to the
condition that, within the time period from the date of the order to the date of
51
delivery of the securities, there are no days that are holidays in the
applicable foreign market. For every occurrence of one or more intervening
holidays in the applicable non-U.S. market that are not holidays observed in the
U.S. equity market, the redemption settlement cycle will be extended by the
number of such intervening holidays. In addition to holidays, other
unforeseeable closings in a non-U.S. market due to emergencies may also prevent
the Trust from delivering securities within the normal settlement period.
The longest redemption cycle for the Fund is a function of the longest
redemption cycle among the countries whose securities comprise the Fund. The
securities delivery cycles currently practicable for transferring Portfolio
Securities to redeeming investors, coupled with non-U.S. market holiday
schedules, will require a delivery process longer than seven calendar days for
the Fund in certain circumstances. It is not expected, however, that the Fund
will take more than twelve calendar days from the date of the tender to deliver
the redemption proceeds. The holidays applicable to the Fund during such periods
are listed below. Certain holidays may occur on different dates in subsequent
years. The proclamation of new holidays, the treatment by market participants of
certain days as "informal holidays" (e.g., days on which no or limited
securities transactions occur, as a result of substantially shortened trading
hours), the elimination of existing holidays, or changes in local securities
delivery practices could affect the information set forth herein at some time in
the future.
The dates of the regular holidays affecting the relevant securities
markets from ______, 2013, through ______, 2014, of the below-listed countries
are as follows: [TO BE UPDATED]
ARGENTINA AUSTRALIA AUSTRIA BELGIUM
--------- --------- ------- -------
July 9 December 25 August 15 July 21
August 19 December 26 October 26 August 15
October 14 January 1 November 1 November 1
November 25 January 27 December 25 November 11
December 8 April 18 December 26 December 25
December 25 April 21 January 1 January 1
January 1 April 25 April 21 April 21
March 3 May 1 May 1
March 4 May 29 May 29
March 24 June 19
April 2
April 18
May 1
June 20
|
52
BRAZIL CANADA CHILE CHINA
------ ------ ----- -----
November 15 July 1 July 16 September 19
December 25 September 2 August 15 September 30
December 31 October 14 September 18 October 1
January 1 December 25 September 19 October 2
March 4 December 26 September 20 October 3
March 5 January 1 October 31 October 8
April 18 April 18 November 1 October 9
April 21 April 21 December 25 October 10
May 1 May 19 January 1 October 11
June 19 July 1 April 18 January 1
May 1 January 30
May 21 January 31
June 29 May 1
June 2
DENMARK FINLAND FRANCE GERMANY
------- ------- ------ -------
December 25 December 6 August 15 October 3
December 26 December 25 November 1 December 25
January 1 December 26 November 11 December 26
April 17 January 1 December 25 January 1
April 18 January 6 January 1 April 18
April 21 April 18 April 21 April 21
May 16 April 21 May 1 May 1
May 29 May 1 May 8 May 29
June 5 May 29 May 29
June 20
|
53
GREECE HONG KONG INDIA IRELAND
------ --------- ----- -------
August 15 July 1 July 10 August 5
October 28 September 20 August 2 October 28
December 25 October 1 August 15 December 25
December 26 October 14 August 20 December 26
January 1 December 25 August 28 January 1
January 6 December 26 September 9 March 17
March 3 January 1 September 16 April 21
March 25 January 31 October 2 May 5
April 18 February 3 October 11 June 2
April 21 April 18 October 16
May 1 April 21 October 18
June 9 May 1 October 22
May 6 November 4
June 2 November 5
November 8
November 14
December 24
December 25
January 1
January 2
January 13
January 14
January 26
February 28
March 17
April 18
April 23
May 1
May 14
ISRAEL ITALY JAPAN MALAYSIA
------ ----- ----- --------
July 16 August 15 July 15 August 8
September 5 November 1 September 16 August 9
September 6 December 25 September 23 September 16
September 19 December 26 October 14 October 15
September 26 January 1 November 4 November 5
November 28 April 21 December 23 December 25
April 15 April 25 January 1 January 1
April 18 May 1 January 13 January 24
April 21 June 2 February 11 January 31
May 5 March 21 May 1
May 6 April 29 June 7
June 4 May 5
May 6
|
54
MEXICO NEW ZEALAND NETHERLANDS NORWAY
------ ----------- ----------- ------
September 16 October 28 December 25 December 25
November 18 December 25 December 26 December 26
November 20 December 26 January 1 January 1
December 25 January 1 April 18 April 17
January 1 January 2 April 21 April 18
March 17 February 6 May 29 April 21
May 1 April 18 May 1
April 21 May 29
April 25
June 2
PORTUGAL SINGAPORE SOUTH AFRICA SOUTH KOREA
-------- --------- ------------ -----------
August 15 August 8 August 9 August 15
December 25 August 9 September 24 September 18
January 1 October 15 December 16 September 19
April 18 November 4 December 25 September 20
April 25 December 25 December 26 October 3
May 1 January 1 January 1 December 25
June 10 January 31 March 13 January 1
April 18 March 21 January 30
May 1 April 18 January 31
April 21 May 5
April 28 May 6
May 1 June 6
June 16
SPAIN SWEDEN SWITZERLAND TAIWAN
----- ------ ----------- ------
November 1 December 25 August 1 September 3
December 6 December 26 August 15 September 19
December 9 January 1 November 1 October 10
December 25 January 6 December 8 January 1
January 1 April 18 December 25 January 30
April 18 April 21 December 26 January 31
May 1 May 1 January 1 Februay 3
May 29 January 2 February 28
June 6 January 6 May 1
April 18 June 2
April 21
May 1
May 29
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55
THAILAND UNITED KINGDOM UNITED STATES
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August 12 December 25 July 4
October 23 December 26 September 2
December 5 January 1 October 14
December 10 April 18 November 11
December 31 May 5 November 28
January 1 May 26 December 25
April 7 January 1
April 14 January 20
April 15 February 17
April 16 May 26
May 5
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FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax
consequences of owning shares of the Fund. This section is current as of the
date of the Prospectus. Tax laws and interpretations change frequently, and
these summaries do not describe all of the tax consequences to all taxpayers.
For example, these summaries generally do not describe your situation if you are
a corporation, a non-U.S. person, a broker-dealer, or other investor with
special circumstances. In addition, this section does not describe your state,
local or foreign tax consequences.
This federal income tax summary is based in part on the advice of counsel
to the Fund. The Internal Revenue Service could disagree with any conclusions
set forth in this section. In addition, our counsel was not asked to review, and
has not reached a conclusion with respect to the federal income tax treatment of
the assets to be deposited in the Fund. This may not be sufficient for
prospective investors to use for the purpose of avoiding penalties under federal
tax law.
As with any investment, prospective investors should seek advice based on
their individual circumstances from their own tax advisor.
The Fund intends to qualify annually and to elect to be treated as a
regulated investment company under the Internal Revenue Code of 1986, as amended
(the "Code").
To qualify for the favorable U.S. federal income tax treatment generally
accorded to regulated investment companies, the Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies or other income
derived with respect to its business of investing in such stock, securities or
currencies, or net income derived from interests in certain publicly traded
partnerships; (b) diversify its holdings so that, at the end of each quarter of
the taxable year, (i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. government
56
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer generally limited for
the purposes of this calculation to an amount not greater than 5% of the value
of the Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. government securities or
the securities of other regulated investment companies) of any one issuer, or
two or more issuers which the Fund controls which are engaged in the same,
similar or related trades or businesses, or the securities of one or more of
certain publicly traded partnerships; and (c) distribute at least 90% of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of net long-term capital
losses) and at least 90% of its net tax-exempt interest income each taxable
year. There are certain exceptions for failure to qualify if the failure is for
reasonable cause or is de minimis, and certain corrective action is taken and
certain tax payments are made by the Fund.
As a regulated investment company, the Fund generally will not be subject
to U.S. federal income tax on its investment company taxable income (as that
term is defined in the Code, but without regard to the deduction for dividends
paid) and net capital gain (the excess of net long-term capital gain over net
short-term capital loss), if any, that it distributes to shareholders. The Fund
intends to distribute to its shareholders, at least annually, substantially all
of its investment company taxable income and net capital gain. If the Fund
retains any net capital gain or investment company taxable income, it will
generally be subject to federal income tax at regular corporate rates on the
amount retained. In addition, amounts not distributed on a timely basis in
accordance with a calendar year distribution requirement are subject to a
nondeductible 4% excise tax unless, generally, the Fund distributes during each
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
income (not taking into account any capital gains or losses) for the calendar
year; (2) at least 98.2% of its capital gains in excess of its capital losses
(adjusted for certain ordinary losses) for the one-year period ending October 31
of the calendar year; and (3) any ordinary income and capital gains for previous
years that were not distributed during those years. In order to prevent
application of the excise tax, the Fund intends to make its distributions in
accordance with the calendar year distribution requirement. A distribution will
be treated as paid on December 31 of the current calendar year if it is declared
by the Fund in October, November or December with a record date in such a month
and paid by the Fund during January of the following calendar year. Such
distributions will be taxable to shareholders in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received.
Subject to certain reasonable cause and de minimis exceptions, if the Fund
failed to qualify as a regulated investment company or failed to satisfy the 90%
distribution requirement in any taxable year, the Fund would be taxed as an
ordinary corporation on its taxable income (even if such income were distributed
to its shareholders) and all distributions out of earnings and profits would be
taxed to shareholders as ordinary income.
DISTRIBUTIONS
Dividends paid out of the Fund's investment company taxable income are
generally taxable to a shareholder as ordinary income to the extent of the
Fund's earnings and profits, whether paid in cash or reinvested in additional
shares.
57
Under the "Health Care and Education Reconciliation Act of 2010," income
from the Fund may also be subject to a new 3.8% "Medicare tax" imposed for
taxable years beginning after 2012. This tax will generally apply to net
investment income if the taxpayer's adjusted gross income exceeds certain
threshold amounts, which are $250,000 in the case of married couples filing
joint returns and $200,000 in the case of single individuals.
A corporation that owns shares generally will not be entitled to the
dividends received deduction with respect to many dividends received from the
Fund because the dividends received deduction is generally not available for
distributions from regulated investment companies.
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly reported as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. Shareholders
receiving distributions in the form of additional shares, rather than cash,
generally will have a cost basis in each such share equal to the value of a
share of the Fund on the reinvestment date. A distribution of an amount in
excess of the Fund's current and accumulated earnings and profits will be
treated by a shareholder as a return of capital which is applied against and
reduces the shareholder's basis in his or her shares. To the extent that the
amount of any such distribution exceeds the shareholder's basis in his or her
shares, the excess will be treated by the shareholder as gain from a sale or
exchange of the shares.
Shareholders will be notified annually as to the U.S. federal income tax
status of distributions, and shareholders receiving distributions in the form of
additional shares will receive a report as to the value of those shares.
SALE OR EXCHANGE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, such a shareholder may realize a capital
gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for the shares. Generally, a shareholder's gain or
loss will be a long-term gain or loss if the shares have been held for more than
one year.
Any loss realized on a sale or exchange will be disallowed to the extent
that shares disposed of are replaced (including through reinvestment of
dividends) within a period of 61 days beginning 30 days before and ending 30
days after disposition of shares or to the extent that the shareholder, during
such period, acquires or enters into an option or contract to acquire,
substantially identical stock or securities. In such a case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized by a shareholder on a disposition of Fund shares held by the
shareholder for six months or less will be disallowed to the extent of the
exempt-interest dividends the shareholder received, except in the case of a
regular dividend paid by the Fund if the Fund declares exempt-interest dividends
on a daily basis in an amount equal to at least 90 percent of its net tax-exempt
interest and distributes such dividends on a monthly or more frequent basis. To
the extent, if any, it is not disallowed, it will be treated as a long-term
capital loss to the extent of any distributions of long-term capital gain
received by the shareholder with respect to such shares.
58
TAXES ON PURCHASE AND REDEMPTION OF CREATION UNITS
If a shareholder exchanges equity securities for Creation Units the
shareholder will generally recognize a gain or a loss. The gain or loss will be
equal to the difference between the market value of the Creation Units at the
time and the shareholder's aggregate basis in the securities surrendered and the
Cash Component paid. If a shareholder exchanges Creation Units for equity
securities, then the shareholder will generally recognize a gain or loss equal
to the difference between the shareholder's basis in the Creation Units and the
aggregate market value of the securities received and the Cash Redemption
Amount. The Internal Revenue Service, however, may assert that a loss realized
upon an exchange of securities for Creation Units or Creation Units for
securities cannot be deducted currently under the rules governing "wash sales,"
or on the basis that there has been no significant change in economic position.
NATURE OF FUND INVESTMENTS
Certain of the Fund's investment practices are subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions; (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income; (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited); (iv)
cause the Fund to recognize income or gain without a corresponding receipt of
cash; (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur; and (vi) adversely alter the characterization of
certain complex financial transactions.
FUTURES CONTRACTS AND OPTIONS
The Fund's transactions in Futures Contracts and options will be subject
to special provisions of the Code that, among other things, may affect the
character of gains and losses realized by the Fund (i.e., may affect whether
gains or losses are ordinary or capital, or short-term or long-term), may
accelerate recognition of income to the Fund and may defer Fund losses. These
rules could, therefore, affect the character, amount and timing of distributions
to shareholders. These provisions also (a) will require the Fund to
mark-to-market certain types of the positions in its portfolio (i.e., treat them
as if they were closed out); and (b) may cause the Fund to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the 90% distribution requirement for qualifying to be taxed as a
regulated investment company and the distribution requirements for avoiding
excise taxes.
INVESTMENTS IN CERTAIN FOREIGN CORPORATIONS
If the Fund holds an equity interest in any "passive foreign investment
companies" ("PFICs"), which are generally certain foreign corporations that
receive at least 75% of their annual gross income from passive sources (such as
interest, dividends, certain rents and royalties or capital gains) or that hold
at least 50% of their assets in investments producing such passive income, the
Fund could be subject to U.S. federal income tax and additional interest charges
on gains and certain distributions with respect to those equity interests, even
if all the income or gain is timely distributed to its shareholders. The Fund
59
will not be able to pass through to its shareholders any credit or deduction for
such taxes. The Fund may be able to make an election that could ameliorate these
adverse tax consequences. In this case, the Fund would recognize as ordinary
income any increase in the value of such PFIC shares, and as ordinary loss any
decrease in such value to the extent it did not exceed prior increases included
in income. Under this election, the Fund might be required to recognize in a
year income in excess of its distributions from PFICs and its proceeds from
dispositions of PFIC stock during that year, and such income would nevertheless
be subject to the distribution requirement and would be taken into account for
purposes of the 4% excise tax (described above). Dividends paid by PFICs are not
treated as qualified dividend income.
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Fund with their correct taxpayer identification number or to make
required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. Corporate shareholders and
certain other shareholders specified in the Code generally are exempt from such
backup withholding. This withholding is not an additional tax. Any amounts
withheld may be credited against the shareholder's U.S. federal income tax
liability.
NON-U.S. SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ("non-U.S. shareholder") depends on whether the income of
the Fund is "effectively connected" with a U.S. trade or business carried on by
the shareholder.
In addition to the rules described in this section concerning the
potential imposition of withholding on distributions to non-U.S. persons,
distributions after June 30, 2014, to non-U.S. persons that are "financial
institutions" may be subject to a withholding tax of 30% unless an agreement is
in place between the financial institution and the U.S. Treasury to collect and
disclose information about accounts, equity investments, or debt interests in
the financial institution held by one or more U.S. persons or the institution is
resident in a jurisdiction that has entered into such an agreement with the U.S.
Treasury. For these purposes, a "financial institution" means any entity that
(i) accepts deposits in the ordinary course of a banking or similar business,
(ii) holds financial assets for the account of others as a substantial portion
of its business, or (iii) is engaged (or holds itself out as being engaged)
primarily in the business of investing, reinvesting or trading in securities,
partnership interests, commodities or any interest (including a futures contract
or option) in such securities, partnership interests or commodities.
Dispositions of shares by such persons may be subject to such withholding after
December 31, 2016.
Distributions to non-financial non-U.S. entities (other than publicly
traded foreign entities, entities owned by residents of U.S. possessions,
foreign governments, international organizations, or foreign central banks)
after June 30, 2014, will also be subject to a withholding tax of 30% if the
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entity does not certify that the entity does not have any substantial U.S.
owners or provide the name, address and TIN of each substantial U.S. owner.
Dispositions of shares by such persons may be subject to such withholding after
December 31, 2016.
Income Not Effectively Connected. If the income from the Fund is not
"effectively connected" with a U.S. trade or business carried on by the non-U.S.
shareholder, distributions of investment company taxable income will generally
be subject to a U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions.
Distributions of capital gain dividends and any amounts retained by the
Fund which are properly reported by the Fund as undistributed capital gains will
not be subject to U.S. tax at the rate of 30% (or lower treaty rate) unless the
non-U.S. shareholder is a nonresident alien individual and is physically present
in the United States for more than 182 days during the taxable year and meets
certain other requirements. However, this 30% tax on capital gains of
nonresident alien individuals who are physically present in the United States
for more than the 182 day period only applies in exceptional cases because any
individual present in the United States for more than 182 days during the
taxable year is generally treated as a resident for U.S. income tax purposes; in
that case, he or she would be subject to U.S. income tax on his or her worldwide
income at the graduated rates applicable to U.S. citizens, rather than the 30%
U.S. tax. In the case of a non-U.S. shareholder who is a nonresident alien
individual, the Fund may be required to withhold U.S. income tax from
distributions of net capital gain unless the non-U.S. shareholder certifies his
or her non-U.S. status under penalties of perjury or otherwise establishes an
exemption. If a non-U.S. shareholder is a nonresident alien individual, any gain
such shareholder realizes upon the sale or exchange of such shareholder's shares
of the Fund in the United States will ordinarily be exempt from U.S. tax unless
the gain is U.S. source income and such shareholder is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements.
Income Effectively Connected. If the income from the Fund is "effectively
connected" with a U.S. trade or business carried on by a non-U.S. shareholder,
then distributions of investment company taxable income and capital gain
dividends, any amounts retained by the Fund which are properly reported by the
Fund as undistributed capital gains and any gains realized upon the sale or
exchange of shares of the Fund will be subject to U.S. income tax at the
graduated rates applicable to U.S. citizens, residents and domestic
corporations. Non-U.S. corporate shareholders may also be subject to the branch
profits tax imposed by the Code. The tax consequences to a non-U.S. shareholder
entitled to claim the benefits of an applicable tax treaty may differ from those
described herein. Non-U.S. shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Fund.
OTHER TAXATION
Fund shareholders may be subject to state, local and foreign taxes on
their Fund distributions. Shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Fund.
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DETERMINATION OF NET ASSET VALUE
The following information supplements and should be read in conjunction
with the section in the Prospectus entitled "Net Asset Value."
The per share net asset value of the Fund is determined by dividing the
total value of the securities and other assets, less liabilities, by the total
number of shares outstanding. Under normal circumstances, daily calculation of
the net asset value will utilize the last closing sale price of each security
held by the Fund at the close of the market on which such security is
principally listed. In determining net asset value, portfolio securities for the
Fund for which accurate market quotations are readily available will be valued
by the Fund accounting agent as follows:
(1) Common stocks and other equity securities listed on any
national or foreign exchange other than NASDAQ(R) and the London Stock
Exchange Alternative Investment Market ("AIM") will be valued at the last
sale price on the business day as of which such value is being determined.
Securities listed on NASDAQ(R) or AIM are valued at the official closing
price on the business day as of which such value is being determined. If
there has been no sale on such day, or no official closing price in the
case of securities traded on NASDAQ(R) and AIM, the securities are valued
at the mean of the most recent bid and ask prices on such day. Portfolio
securities traded on more than one securities exchange are valued at the
last sale price or official closing price, as applicable, on the business
day as of which such value is being determined at the close of the
exchange representing the principal market for such securities.
(2) Securities traded in the OTC market are valued at the midpoint
between the bid and asked price, if available, and otherwise at their
closing bid prices.
(3) Exchange traded options and Futures Contracts will be valued at
the closing price in the market where such contracts are principally
traded. OTC options and Futures Contracts will be valued at the midpoint
between the bid and asked price, if available, and otherwise at their
closing bid prices.
(4) Forward foreign currency exchange contracts which are traded in
the United States on regulated exchanges will be valued by calculating the
mean between the last bid and asked quotations supplied to a pricing
service by certain independent dealers in such contracts.
In addition, the following types of securities will be valued as follows:
(1) Fixed income securities with a remaining maturity of 60 days or
more will be valued by the fund accounting agent using a pricing service.
When price quotes are not available, fair value is based on prices of
comparable securities.
(2) Fixed income securities maturing within 60 days are valued by
the Fund accounting agent at cost adjusted for amortization premiums and
accretions of discounts.
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(3) Repurchase agreements will be valued as follows. Overnight
repurchase agreements will be valued at cost. Term repurchase agreements
(i.e., those whose maturity exceeds seven days) will be valued by First
Trust at the average of the bid quotations obtained daily from at least
two recognized dealers.
The value of any portfolio security held by the Fund for which market
quotations are not readily available will be determined by First Trust in a
manner that most fairly reflects fair market value of the security on the
valuation date, based on a consideration of all available information.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board of Trustees or its delegate
at fair value. These securities generally include but are not limited to,
restricted securities (securities which may not be publicly sold without
registration under the 1933 Act) for which a pricing service is unable to
provide a market price; securities whose trading has been formally suspended; a
security whose market price is not available from a pre-established pricing
source; a security with respect to which an event has occurred that is likely to
materially affect the value of the security after the market has closed but
before the calculation of Fund net asset value (as may be the case in foreign
markets on which the security is primarily traded) or make it difficult or
impossible to obtain a reliable market quotation; and a security whose price, as
provided by the pricing service, does not reflect the security's "fair value."
As a general principle, the current "fair value" of an issue of securities would
appear to be the amount which the owner might reasonably expect to receive for
them upon their current sale. A variety of factors may be considered in
determining the fair value of such securities.
Valuing the Fund's investments using fair value pricing will result in
using prices for those investments that may differ from current market
valuations.
Because foreign markets may be open on different days than the days during
which a shareholder may purchase the shares of the Fund, the value of the Fund's
investments may change on the days when shareholders are not able to purchase
the shares of the Fund.
The value of assets denominated in foreign currencies is converted into
U.S. dollars using exchange rates in effect at the time of valuation.
The Fund may suspend the right of redemption for the Fund only under the
following unusual circumstances: (a) when the ______ is closed (other than
weekends and holidays) or trading is restricted; (b) when trading in the markets
normally utilized is restricted, or when an emergency exists as determined by
the SEC so that disposal of the Fund's investments or determination of its net
assets is not reasonably practicable; or (c) during any period when the SEC may
permit.
DIVIDENDS AND DISTRIBUTIONS
The following information supplements and should be read in conjunction
with the section in the Prospectus entitled "Dividends, Distributions and
Taxes."
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General Policies. Dividends from net investment income of the Fund, if
any, are declared and paid monthly. Distributions of net realized securities
gains, if any, generally are declared and paid once a year, but the Trust may
make distributions on a more frequent basis. The Trust reserves the right to
declare special distributions if, in its reasonable discretion, such action is
necessary or advisable to preserve the status of the Fund as a regulated
investment company or to avoid imposition of income or excise taxes on
undistributed income.
Dividends and other distributions of Fund shares are distributed, as
described below, on a pro rata basis to Beneficial Owners of such shares.
Dividend payments are made through DTC Participants and Indirect Participants to
Beneficial Owners then of record with proceeds received from the Fund.
Dividend Reinvestment Service. No reinvestment service is provided by the
Trust. Broker-dealers may make available the DTC book-entry Dividend
Reinvestment Service for use by Beneficial Owners of the Fund for reinvestment
of their dividend distributions. Beneficial Owners should contact their brokers
in order to determine the availability and costs of the service and the details
of participation therein. Brokers may require Beneficial Owners to adhere to
specific procedures and timetables. If this service is available and used,
dividend distributions of both income and realized gains will be automatically
reinvested in additional whole shares of the Fund purchased in the secondary
market.
MISCELLANEOUS INFORMATION
Counsel. Chapman and Cutler LLP, 111 West Monroe Street, Chicago, Illinois
60603, is counsel to the Trust.
Independent Registered Public Accounting Firm. Deloitte & Touche LLP, 111
South Wacker Drive, Chicago, Illinois 60606, serves as the Fund's independent
registered public accounting firm. The firm audits the Fund's financial
statements and performs other related audit services.
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APPENDIX A - RATINGS OF INVESTMENTS
STANDARD & POOR'S CREDIT RATING DEFINITIONS
As published by Standard & Poor's
A Standard & Poor's issue credit rating is a forward-looking opinion about
the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program (including ratings on medium-term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The opinion
reflects Standard & Poor's view of the obligor's capacity and willingness to
meet its financial commitments as they come due, and may assess terms, such as
collateral security and subordination, which could affect ultimate payment in
the event of default.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days--including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
Long-Term Issue Credit Ratings
Issue credit ratings are based, in varying degrees, on Standard & Poor's
analysis of the following considerations:
1. Likelihood of payment--capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms of the
obligation;
2. Nature of and provisions of the obligation; and
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
Issue ratings are an assessment of default risk, but may incorporate an
assessment of relative seniority or ultimate recovery in the event of default.
Junior obligations are typically rated lower than senior obligations, to reflect
the lower priority in bankruptcy, as noted above. (Such differentiation may
apply when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
A-1
AAA An obligation rated 'AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated 'AA' differs from the highest-rated obligations only to a
small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A An obligation rated 'A' is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB An obligation rated 'BBB' exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity of the obligor to meet its financial commitment on the
obligation.
Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having
significant speculative characteristics. 'BB' indicates the least degree of
speculation and 'C' the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB An obligation rated 'BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B An obligation rated 'B' is more vulnerable to nonpayment than obligations
rated 'BB', but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC An obligation rated 'CCC' is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC An obligation rated 'CC' is currently highly vulnerable to nonpayment.
C A 'C' rating is assigned to obligations that are currently highly vulnerable
to nonpayment, obligations that have payment arrearages allowed by the terms of
the documents, or obligations of an issuer that is the subject of a bankruptcy
petition or similar action which have not experienced a payment default. Among
others, the 'C' rating may be assigned to subordinated debt, preferred stock or
other obligations on which cash payments have been suspended in accordance with
the instrument's terms or when preferred stock is the subject of a distressed
exchange offer, whereby some or all of the issue is either repurchased for an
amount of cash or replaced by other instruments having a total value that is
less than par.
A-2
D An obligation rated 'D' is in payment default. The 'D' rating category is used
when payments on an obligation are not made on the date due, unless Standard &
Poor's believes that such payments will be made within five business days,
irrespective of any grace period. The 'D' rating also will be used upon the
filing of a bankruptcy petition or the taking of similar action if payments on
an obligation are jeopardized. An obligation's rating is lowered to 'D' upon
completion of a distressed exchange offer, whereby some or all of the issue is
either repurchased for an amount of cash or replaced by other instruments having
a total value that is less than par.
NR This indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor's does not rate a
particular obligation as a matter of policy.
The ratings from 'AA' to 'CCC' may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within the major rating
categories.
Short-Term Issue Credit Ratings
A-1 A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2 A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3 A short-term obligation rated 'A-3' exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
B A short-term obligion rated 'B' is regarded as vulnerable and has significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitments; however, it faces major ongoing uncertainties which could
lead to the obligor's inadequate capacity to meet its financial commitments.
C A short-term obligation rated 'C' is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
A-3
D A short-term obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation are not made on the date due,
unless Standard & Poor's believes that such payments will be made within any
stated grace period. However, any stated grace period longer than five business
days will be treated as five business days. The 'D' rating also will be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
MOODY'S INVESTORS SERVICE, INC.--A BRIEF DESCRIPTION OF THE APPLICABLE
MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") RATING SYMBOLS AND THEIR MEANINGS
(AS PUBLISHED BY MOODY'S) FOLLOWS:
Ratings assigned on Moody's global long-term and short-term rating scales
are forward-looking opinions of the relative credit risks of financial
obligations issued by non-financial corporates, financial institutions,
structured finance vehicles, project finance vehicles, and public sector
entities. Long-term ratings are assigned to issuers or obligations with an
original maturity of one year or more and reflect both on the likelihood of a
default on contractually promised payments and the expected financial loss
suffered in the event of default. Short-term ratings are assigned to obligations
with an original maturity of thirteen months or less and reflect the likelihood
of a default on contractually promised payments.
Long Term Obligation Ratings
Aaa Obligations rated Aaa are judged to be of the highest quality, subject to
the lowest level of credit risk.
Aa Obligations rated Aa are judged to be of high quality and are subject to very
low credit risk.
A Obligations rated A are judged to be upper-medium grade and are subject to low
credit risk.
Baa Obligations rated Baa are judged to be medium-grade and subject to moderate
credit risk and as such may possess certain speculative characteristics.
Ba Obligations rated Ba are judged to be speculative and are subject to
substantial credit risk.
B Obligations rated B are considered speculative and are subject to high credit
risk.
Caa Obligations rated Caa are judged to be speculative of poor standing and are
subject to very high credit risk.
Ca Obligations rated Ca are highly speculative and are likely in, or very near,
default, with some prospect of recovery of principal and interest.
A-4
C Obligations rated C are the lowest rated and are typically in default, with
little prospect for recovery of principal or interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic
rating classification from Aaa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
Short-Term Obligation Ratings
P-1 Issuers (or supporting institutions) rated Prime-1 have a superior ability
to repay short-term debt obligations.
P-2 Issuers (or supporting institutions) rated Prime-2 have a strong ability to
repay short-term debt obligations.
P-3 Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP Issuers (or supporting institutions) rated Not Prime do not fall within any
of the Prime rating categories.
Medium-Term Note Program Ratings
Moody's assigns provisional ratings to medium-term note (MTN) programs and
definitive ratings to the individual debt securities issued from them (referred
to as drawdowns or notes).
MTN program ratings are intended to reflect the ratings likely to be
assigned to drawdowns issued from the program with the specified priority of
claim (e.g., senior or subordinated). To capture the contingent nature of a
program rating, Moody's assigns provisional ratings to MTN programs. A
provisional rating is denoted by a (P) in front of the rating.
The rating assigned to a drawdown from a rated MTN or bank/deposit note
program is definitive in nature, and may differ from the program rating if the
drawdown is exposed to additional credit risks besides the issuer's default,
such as links to the defaults of other issuers, or has other structural features
that warrant a different rating. In some circumstances, no rating may be
assigned to a drawdown.
Moody's encourages market participants to contact Moody's Ratings Desks or
visit www.moodys.com directly if they have questions regarding ratings for
specific notes issued under a medium-term note program. Unrated notes issued
under an MTN program may be assigned an NR (not rated) symbol.
A-5
U.S. Municipal Short-Term Debt and Demand Obligation Ratings
Short-Term Obligation Ratings
The Municipal Investment Grade (MIG) scale is used to rate US municipal
bond anticipation notes of up to three years maturity. Municipal notes rated on
the MIG scale may be secured by either pledged revenues or proceeds of a
take-out financing received prior to note maturity. MIG ratings expire at the
maturity of the obligation, and the issuer's long-term rating is only one
consideration in assigning the MIG rating. MIG ratings are divided into three
levels--MIG 1 through MIG 3--while speculative grade short-term obligations are
designated SG.
MIG 1 This designation denotes superior credit quality. Excellent protection is
afforded by established cash flows, highly reliable liquidity support, or
demonstrated broad-based access to the market for refinancing.
MIG 2 This designation denotes strong credit quality. Margins of protection are
ample, although not as large as in the preceding group.
MIG 3 This designation denotes acceptable credit quality. Liquidity and
cash-flow protection may be narrow, and market access for refinancing is likely
to be less well-established.
SG This designation denotes speculative-grade credit quality. Debt instruments
in this category may lack sufficient margins of protection.
Demand Obligation Ratings
In the case of variable rate demand obligations (VRDOs), a two-component
rating is assigned: a long or short-term debt rating and a demand obligation
rating. The first element represents Moody's evaluation of risk associated with
scheduled principal and interest payments. The second element represents Moody's
evaluation of risk associated with the ability to receive purchase price upon
demand ("demand feature"). The second element uses a rating from a variation of
the MIG scale called the Variable Municipal Investment Grade (VMIG) scale.
VMIG 1 This designation denotes superior credit quality. Excellent protection is
afforded by the superior short-term credit strength of the liquidity provider
and structural and legal protections that ensure the timely payment of purchase
price upon demand.
VMIG 2 This designation denotes strong credit quality. Good protection is
afforded by the strong short-term credit strength of the liquidity provider and
structural and legal protections that ensure the timely payment of purchase
price upon demand.
A-6
VMIG 3 This designation denotes acceptable credit quality. Adequate protection
is afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
SG This designation denotes speculative-grade credit quality. Demand features
rated in this category may be supported by a liquidity provider that does not
have an investment grade short-term rating or may lack the structural and/or
legal protections necessary to ensure the timely payment of purchase price upon
demand.
FITCH RATINGS--A BRIEF DESCRIPTION OF THE APPLICABLE FITCH RATINGS
("FITCH") RATINGS SYMBOLS AND MEANINGS (AS PUBLISHED BY FITCH) FOLLOWS:
Fitch Ratings' credit ratings provide an opinion on the relative ability
of an entity to meet financial commitments, such as interest, preferred
dividends, repayment of principal, insurance claims or counterparty obligations.
Credit ratings are used by investors as indications of the likelihood of
receiving the money owed to them in accordance with the terms on which they
invested. The agency's credit ratings cover the global spectrum of corporate,
sovereign (including supranational and sub-national), financial, bank,
insurance, municipal and other public finance entities and the securities or
other obligations they issue, as well as structured finance securities backed by
receivables or other financial assets.
The terms "investment grade" and "speculative grade" have established
themselves over time as shorthand to describe the categories 'AAA' to 'BBB'
(investment grade) and 'BB' to 'D' (speculative grade). The terms "investment
grade" and "speculative grade" are market conventions, and do not imply any
recommendation or endorsement of a specific security for investment purposes.
"Investment grade" categories indicate relatively low to moderate credit risk,
while ratings in the "speculative" categories either signal a higher level of
credit risk or that a default has already occurred.
A designation of "Not Rated" or "NR" is used to denote securities not
rated by Fitch where Fitch has rated some, but not all, securities comprising an
issuance capital structure.
Credit ratings express risk in relative rank order, which is to say they
are ordinal measures of credit risk and are not predictive of a specific
frequency of default or loss.
Fitch's credit ratings do not directly address any risk other than credit
risk. In particular, ratings do not deal with the risk of a market value loss on
a rated security due to changes in interest rates, liquidity and other market
considerations. However, in terms of payment obligation on the rated liability,
market risk may be considered to the extent that it influences the ability of an
issuer to pay upon a commitment. Ratings nonetheless do not reflect market risk
to the extent that they influence the size or other conditionality of the
obligation to pay upon a commitment (for example, in the case of index-linked
bonds).
In the default components of ratings assigned to individual obligations or
instruments, the agency typically rates to the likelihood of non-payment or
default in accordance with the terms of that instrument's documentation. In
limited cases, Fitch Ratings may include additional considerations (i.e., rate
A-7
to a higher or lower standard than that implied in the obligation's
documentation). In such cases, the agency will make clear the assumptions
underlying the agency's opinion in the accompanying rating commentary.
International Long-Term Ratings
Issuer Credit Rating Scales
AAA Highest credit quality. 'AAA' ratings denote the lowest expectation of
default risk. They are assigned only in cases of exceptionally strong capacity
for payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA Very high credit quality. 'AA' ratings denote expectations of very low
default risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A High credit quality. 'A' ratings denote expectations of low default risk. The
capacity for payment of financial commitments is considered strong. This
capacity may, nevertheless, be more vulnerable to adverse business or economic
conditions than is the case for higher ratings.
BBB Good credit quality. 'BBB' ratings indicate that expectations of default
risk are currently low. The capacity for payment of financial commitments is
considered adequate but adverse business or economic conditions are more likely
to impair this capacity.
BB Speculative. 'BB' ratings indicate an elevated vulnerability to default risk,
particularly in the event of adverse changes in business or economic conditions
over time; however, business or financial flexibility exists which supports the
servicing of financial commitments.
B Highly speculative. 'B' ratings indicate that material default risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is vulnerable to
deterioration in the business and economic environment.
CCC Substantial credit risk. Default is a real possibility.
CC Very high levels of credit risk. Default of some kind appears probable.
C Exceptionally high levels of credit risk. Default is imminent or inevitable,
or the issuer is in standstill. Conditions that are indicative of a 'C' category
rating for an issuer include:
(i) the issuer has entered into a grace or cure period following
non-payment of a material financial obligation;
(ii) the issuer has entered into a temporary negotiated waiver or
standstill agreement following a payment default on a material financial
obligation; or
(iii) Fitch Ratings otherwise believes a condition of 'RD' or 'D' to be
A-8
imminent or inevitable, including through the formal announcement of a
distressed debt exchange.
RD: Restricted default. 'RD' ratings indicate an issuer that in Fitch Ratings'
opinion has experienced an uncured payment default on a bond, loan or other
material financial obligation but which has not entered into bankruptcy filings,
administration, receivership, liquidation or other formal winding-up procedure,
and which has not otherwise ceased operating. This would include:
(i) the selective payment default on a specific class or currency of debt;
(ii) the uncured expiry of any applicable grace period, cure period or
default forbearance period following a payment default on a bank loan, capital
markets security or other material financial obligation;
(iii) the extension of multiple waivers or forbearance periods upon a
payment default on one or more material financial obligations, either in series
or in parallel; or
(iv) execution of a distressed debt exchange on one or more material
financial obligations.
D: Default. 'D' ratings indicate an issuer that in Fitch Ratings' opinion has
entered into bankruptcy filings, administration, receivership, liquidation or
other formal winding-up procedure, or which has otherwise ceased business.
Default ratings are not assigned prospectively to entities or their
obligations; within this context, non-payment on an instrument that contains a
deferral feature or grace period will generally not be considered a default
until after the expiration of the deferral or grace period, unless a default is
otherwise driven by bankruptcy or other similar circumstance, or by a distressed
debt exchange.
"Imminent" default typically refers to the occasion where a payment
default has been intimated by the issuer, and is all but inevitable. This may,
for example, be where an issuer has missed a scheduled payment, but (as is
typical) has a grace period during which it may cure the payment default.
Another alternative would be where an issuer has formally announced a distressed
debt exchange, but the date of the exchange still lies several days or weeks in
the immediate future.
In all cases, the assignment of a default rating reflects the agency's
opinion as to the most appropriate rating category consistent with the rest of
its universe of ratings, and may differ from the definition of default under the
terms of an issuer's financial obligations or local commercial practice.
Note. The modifiers "+" or "-" may be appended to a rating to denote
relative status within major rating categories. Such suffixes are not added to
the 'AAA', or to categories below 'B'.
A-9
International Short-Term Ratings
A short-term issuer or obligation rating is based in all cases on the
short-term vulnerability to default of the rated entity or security stream and
relates to the capacity to meet financial obligations in accordance with the
documentation governing the relevant obligation. Short-Term Ratings are assigned
to obligations whose initial maturity is viewed as "short term" based on market
convention. Typically, this means up to 13 months for corporate, sovereign, and
structured obligations, and up to 36 months for obligations in U.S. public
finance markets.
F1 Highest short-term credit quality. Indicates the strongest intrinsic capacity
for timely payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2 Good short-term credit quality. Good intrinsic capacity for timely payment of
financial commitments.
F3 Fair short-term credit quality. The intrinsic capacity for timely payment of
financial commitments is adequate.
B Speculative short-term credit quality. Minimal capacity for timely payment of
financial commitments, plus heightened vulnerability to near term adverse
changes in financial and economic conditions.
C High short-term default risk. Default is a real possibility.
RD Restricted default. Indicates an entity that has defaulted on one or more of
its financial commitments, although it continues to meet other financial
obligations. Applicable to entity ratings only.
D Default. Indicates a broad-based default event for an entity, or the default
of a short-term obligation.
Notes to Long-term and Short-term ratings:
'WD' indicates that the rating has been withdrawn and the issue or issuer
is no longer rated by Fitch Ratings
Rating Watch: Rating Watches indicate that there is a heightened
probability of a rating change and the likely direction of such a change. These
are designated as "Positive", indicating a potential upgrade, "Negative", for a
potential downgrade, or "Evolving", if ratings may be raised, lowered or
affirmed. However, ratings that are not on Rating Watch can be raised or lowered
without being placed on Rating Watch first, if circumstances warrant such an
action. A Rating Watch is typically event-driven and, as such, it is generally
resolved over a relatively short period.
A-10
APPENDIX B
ISS
An MSCI Brand
Transparency. Inclusiveness. Global Expertise.
2014 U.S. Proxy Voting Concise Guidelines
December 19, 2013
Institutional Shareholder Services Inc.
Copyright (C) 2013 by ISS
B-1
ISS' 2014 U.S. Proxy Voting Concise Guidelines
The policies contained herein are a sampling of select, key proxy voting
guidelines and are not exhaustive. A full listing of ISS' 2014
proxy voting guidelines can be found at:
http://www.issgovernance.com/policy/2014/policy_information
ROUTINE/MISCELLANEOUS
Auditor Ratification
Vote for proposals to ratify auditors unless any of the following apply:
o An auditor has a financial interest in or association with the
company, and is therefore not independent;
o There is reason to believe that the independent auditor has rendered
an opinion that is neither accurate nor indicative of the company's
financial position;
o Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP, or material
weaknesses identified in Section 404 disclosures; or
o Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
o Non-audit ("other") fees > audit fees + audit-related fees + tax
compliance/preparation fees
o o o o o
BOARD OF DIRECTORS:
Voting on Director Nominees in Uncontested Elections
Four fundamental principles apply when determining votes on director nominees:
1. Accountability
2. Responsiveness
3. Composition
4. Independence
Generally vote for director nominees, except under the following circumstances:
1. Accountability
B-2
Vote against(1) or withhold from the entire board of directors (except new
nominees(2), who should be considered case-by-case) for the following:
Problematic Takeover Defenses
Classified Board Structure:
1.1. The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for
election. All appropriate nominees (except new) may be held
accountable.
Director Performance Evaluation:
1.2. The board lacks accountability and oversight, coupled with sustained
poor performance relative to peers. Sustained poor performance is
measured by one- and three-year total shareholder returns in the
bottom half of a company's four-digit GICS industry group (Russell
3000 companies only). Take into consideration the company's
five-year total shareholder return and operational metrics.
Problematic provisions include but are not limited to:
o A classified board structure;
o A supermajority vote requirement;
o Either a plurality vote standard in uncontested director
elections or a majority vote standard with no plurality
carve-out for contested elections;
o The inability of shareholders to call special meetings;
o The inability of shareholders to act by written consent;
o A dual-class capital structure; and/or
o A non-shareholder-approved poison pill.
Poison Pills:
1.3. The company's poison pill has a "dead-hand" or "modified dead-hand"
feature. Vote against or withhold from nominees every year until
this feature is removed;
1.4. The board adopts a poison pill with a term of more than 12 months
("long-term pill"), or renews any existing pill, including any
"short-term" pill (12 months or less), without shareholder approval.
A commitment or policy that puts a newly adopted pill to a binding
shareholder vote may potentially offset an adverse vote
1 In general, companies with a plurality vote standard use "Withhold" as the
contrary vote option in director elections; companies with a majority vote
standard use "Against". However, it will vary by company and the proxy must
be checked to determine the valid contrary vote option for the particular
company.
2 A "new nominee" is any current nominee who has not already been elected by
shareholders and who joined the board after the problematic action in
question transpired. If ISS cannot determine whether the nominee joined the
board before or after the problematic action transpired, the nominee will be
considered a "new nominee" if he or she joined the board within the 12
months prior to the upcoming shareholder meeting.
B-3
recommendation. Review such companies with classified boards every
year, and such companies with annually elected boards at least once
every three years, and vote against or withhold votes from all
nominees if the company still maintains a non-shareholder-approved
poison pill; or
1.5. The board makes a material adverse change to an existing poison pill
without shareholder approval.
Vote case-by-case on all nominees if:
1.6. The board adopts a poison pill with a term of 12 months or less
("short-term pill") without shareholder approval, taking into
account the following factors:
o The date of the pill's adoption relative to the date of the
next meeting of shareholders--i.e., whether the company had
time to put the pill on ballot for shareholder ratification
given the circumstances;
o The issuer's rationale;
o The issuer's governance structure and practices; and
o The issuer's track record of accountability to shareholders.
Problematic Audit-Related Practices
Generally vote against or withhold from the members of the Audit Committee if:
1.7. The non-audit fees paid to the auditor are excessive (see discussion
under "Auditor Ratification");
1.8. The company receives an adverse opinion on the company's financial
statements from its auditor; or
1.9. There is persuasive evidence that the Audit Committee entered into
an inappropriate indemnification agreement with its auditor that
limits the ability of the company, or its shareholders, to pursue
legitimate legal recourse against the audit firm.
Vote case-by-case on members of the Audit Committee, and potentially the full
board, if:
1.10. Poor accounting practices are identified that rise to a level of
serious concern, such as: fraud, misapplication of GAA; and material
weaknesses identified in Section 404 disclosures. Examine the
severity, breadth, chronological sequence, and duration, as well as
the company's efforts at remediation or corrective actions, in
determining whether withhold/against votes are warranted.
Problematic Compensation Practices/Pay for Performance Misalignment
B-4
In the absence of an Advisory Vote on Executive Compensation ballot item or in
egregious situations, vote against or withhold from the members of the
Compensation Committee, and potentially the full board, if:
1.11. There is a significant misalignment between CEO pay and company
performance (pay for performance);
1.12. The company maintains significant problematic pay practices;
1.13. The board exhibits a significant level of poor communication and
responsiveness to shareholders;
1.14. The company fails to submit one-time transfers of stock options to a
shareholder vote; or
1.15. The company fails to fulfill the terms of a burn rate commitment
made to shareholders.
Vote case-by-case on Compensation Committee members (or, in exceptional cases,
the full board) and the Management Say-on-Pay proposal if:
1.16. The company's previous say-on-pay proposal received the support of
less than 70 percent of votes cast, taking into account:
o The company's response, including:
- Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
- Specific actions taken to address the issues that
contributed to the low level of support;
- Other recent compensation actions taken by the company;
o Whether the issues raised are recurring or isolated;
o The company's ownership structure; and
o Whether the support level was less than 50 percent, which
would warrant the highest degree of responsiveness.
Governance Failures
Under extraordinary circumstances, vote against or withhold from directors
individually, committee members, or the entire board, due to:
1.17. Material failures of governance, stewardship, risk oversight(3), or
fiduciary responsibilities at the company;
1.18. Failure to replace management as appropriate; or
1.19. Egregious actions related to a director's service on other boards
that raise substantial doubt about his or her ability to effectively
oversee management and serve the best interests of shareholders at
any company.
3 Examples of failure of risk oversight include, but are not limited to:
bribery; large or serial fines or sanctions from regulatory bodies;
significant adverse legal judgments or settlements; hedging of company
stock; or significant pledging of company stock.
B-5
2. Responsiveness
Vote case-by-case on individual directors, committee members, or the entire
board of directors, as appropriate, if:
2.1. The board failed to act on a shareholder proposal that received the
support of a majority of the shares cast in the previous year.
Factors that will be considered are:
o Disclosed outreach efforts by the board to shareholders in the
wake of the vote;
o Rationale provided in the proxy statement for the level of
implementation;
o The subject matter of the proposal;
o The level of support for and opposition to the resolution in
past meetings;
o Actions taken by the board in response to the majority vote
and its engagement with shareholders;
o The continuation of the underlying issue as a voting item on
the ballot (as either shareholder or management proposals);
and
o Other factors as appropriate.
2.2. The board failed to act on takeover offers where the majority of
shares are tendered;
2.3. At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company
has failed to address the issue(s) that caused the high
withhold/against vote;
2.4. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received the majority of
votes cast at the most recent shareholder meeting at which
shareholders voted on the say-on-pay frequency; or
2.5. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received a plurality,
but not a majority, of the votes cast at the most recent shareholder
meeting at which shareholders voted on the say-on-pay frequency,
taking into account:
o The board's rationale for selecting a frequency that is
different from the frequency that received a plurality;
o The company's ownership structure and vote results;
o ISS' analysis of whether there are compensation concerns or a
history of problematic compensation practices; and
o The previous year's support level on the company's say-on-pay
proposal.
B-6
3. Composition
Attendance at Board and Committee Meetings:
3.1. Generally vote against or withhold from directors (except new
nominees, who should be considered case-by-case(4)) who attend less
than 75 percent of the aggregate of their board and committee
meetings for the period for which they served, unless an acceptable
reason for absences is disclosed in the proxy or another SEC filing.
Acceptable reasons for director absences are generally limited to
the following:
o Medical issues/illness;
o Family emergencies; and
o Missing only one meeting (when the total of all meetings is
three or fewer).
3.2. If the proxy disclosure is unclear and insufficient to determine
whether a director attended at least 75 percent of the aggregate of
his/her board and committee meetings during his/her period of
service, vote against or withhold from the director(s) in question.
Overboarded Directors:
Vote against or withhold from individual directors who:
3.3. Sit on more than six public company boards; or
3.4. Are CEOs of public companies who sit on the boards of more than two
public companies besides their own--withhold only at their outside
boards(5).
4. Independence
Vote against or withhold from Inside Directors and Affiliated Outside Directors
when:
4.1. The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
4.2. The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
4.3. The company lacks a formal nominating committee, even if the board
attests that the independent directors fulfill the functions of such
a committee; or
4.4. Independent directors make up less than a majority of the directors.
4 For new nominees only, schedule conflicts due to commitments made prior to
their appointment to the board are considered if disclosed in the proxy or
another SEC filing.
5 Although all of a CEO's subsidiary boards will be counted as separate
boards, ISS will not recommend a withhold vote from the CEO of a parent
company board or any of the controlled (>50 percent ownership) subsidiaries
of that parent, but will do so at subsidiaries that are less than 50 percent
controlled and boards outside the parent/subsidiary relationships.
B-7
o o o o o
Proxy Access
ISS supports proxy access as an important shareholder right, one that is
complementary to other best-practice corporate governance features. However, in
the absence of a uniform standard, proposals to enact proxy access may vary
widely; as such, ISS is not setting forth specific parameters at this time and
will take a case-by-case approach in evaluating these proposals.
Vote case-by-case on proposals to enact proxy access, taking into account, among
other factors:
o Company-specific factors; and
- Proposal-specific factors, including:
- The ownership thresholds proposed in the resolution (i.e.,
percentage and duration);
- The maximum proportion of directors that shareholders may
nominate each year; and
- The method of determining which nominations should appear
on the ballot if multiple shareholders submit nominations.
o o o o o
Proxy Contests--Voting for Director Nominees in Contested Elections
Vote case-by-case on the election of directors in contested elections,
considering the following factors:
o Long-term financial performance of the target company relative to its
industry;
o Management's track record;
o Background to the proxy contest;
o Qualifications of director nominees (both slates);
o Strategic plan of dissident slate and quality of critique against
management;
o Likelihood that the proposed goals and objectives can be achieved
(both slates);
o Stock ownership positions.
When the addition of shareholder nominees to the management card ("proxy access
nominees") results in a number of nominees on the management card which exceeds
the number of seats available for election, vote case-by-case considering the
same factors listed above.
o o o o o
B-8
SHAREHOLDER RIGHTS & DEFENSES
Poison Pills- Management Proposals to Ratify Poison Pill
Vote case-by-case on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
o No lower than a 20% trigger, flip-in or flip-over;
o A term of no more than three years;
o No dead-hand, slow-hand, no-hand or similar feature that limits the
ability of a future board to redeem the pill;
o Shareholder redemption feature (qualifying offer clause); if the board
refuses to redeem the pill 90 days after a qualifying offer is
announced, 10 percent of the shares may call a special meeting or seek
a written consent to vote on rescinding the pill.
In addition, the rationale for adopting the pill should be thoroughly explained
by the company. In examining the request for the pill, take into consideration
the company's existing governance structure, including: board independence,
existing takeover defenses, and any problematic governance concerns.
o o o o o
Poison Pills- Management Proposals to Ratify a Pill to Preserve Net Operating
Losses (NOLs)
Vote against proposals to adopt a poison pill for the stated purpose of
protecting a company's net operating losses (NOL) if the term of the pill would
exceed the shorter of three years and the exhaustion of the NOL.
Vote case-by-case on management proposals for poison pill ratification,
considering the following factors, if the term of the pill would be the shorter
of three years (or less) and the exhaustion of the NOL:
o The ownership threshold to transfer (NOL pills generally have a
trigger slightly below 5 percent);
o The value of the NOLs;
o Shareholder protection mechanisms (sunset provision, or commitment to
cause expiration of the pill upon exhaustion or expiration of NOLs);
o The company's existing governance structure including: board
independence, existing takeover defenses, track record of
responsiveness to shareholders, and any other problematic governance
concerns; and
o Any other factors that may be applicable.
o o o o o
B-9
Shareholder Ability to Act by Written Consent
Generally vote against management and shareholder proposals to restrict or
prohibit shareholders' ability to act by written consent.
Generally vote for management and shareholder proposals that provide
shareholders with the ability to act by written consent, taking into account the
following factors:
o Shareholders' current right to act by written consent;
o The consent threshold;
o The inclusion of exclusionary or prohibitive language;
o Investor ownership structure; and
o Shareholder support of, and management's response to, previous
shareholder proposals.
Vote case-by-case on shareholder proposals if, in addition to the considerations
above, the company has the following governance and antitakeover provisions:
o An unfettered(6) right for shareholders to call special meetings at a
10 percent threshold;
o A majority vote standard in uncontested director elections;
o No non-shareholder-approved pill; and
o An annually elected board.
o o o o o
CAPITAL/RESTRUCTURING
Common Stock Authorization
Vote for proposals to increase the number of authorized common shares where the
primary purpose of the increase is to issue shares in connection with a
transaction on the same ballot that warrants support.
Vote against proposals at companies with more than one class of common stock to
increase the number of authorized shares of the class of common stock that has
superior voting rights.
Vote against proposals to increase the number of authorized common shares if a
vote for a reverse stock split on the same ballot is warranted despite the fact
that the authorized shares would not be reduced proportionally.
6 "Unfettered" means no restrictions on agenda items, no restrictions on the
number of shareholders who can group together to reach the 10 percent
threshold, and only reasonable limits on when a meeting can be called: no
greater than 30 days after the last annual meeting and no greater than 90
prior to the next annual meeting.
B-10
Vote case-by-case on all other proposals to increase the number of shares of
common stock authorized for issuance. Take into account company-specific factors
that include, at a minimum, the following:
o Past Board Performance:
- The company's use of authorized shares during the last three years
o The Current Request:
- Disclosure in the proxy statement of the specific purposes of the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request; and
- The dilutive impact of the request as determined by an allowable
increase calculated by ISS (typically 100 percent of existing
authorized shares) that reflects the company's need for shares and
total shareholder returns.
o o o o o
Dual Class Structure
Generally vote against proposals to create a new class of common stock, unless:
o The company discloses a compelling rationale for the dual-class
capital structure, such as:
o The company's auditor has concluded that there is substantial doubt
about the company's ability to continue as a going concern; or
o The new class of shares will be transitory;
o The new class is intended for financing purposes with minimal or no
dilution to current shareholders in both the short term and long term;
and
o The new class is not designed to preserve or increase the voting power
of an insider or significant shareholder.
o o o o o
Preferred Stock Authorization
Vote for proposals to increase the number of authorized preferred shares where
the primary purpose of the increase is to issue shares in connection with a
transaction on the same ballot that warrants support.
Vote against proposals at companies with more than one class or series of
preferred stock to increase the number of authorized shares of the class or
series of preferred stock that has superior voting rights.
Vote case-by-case on all other proposals to increase the number of shares of
preferred stock authorized for issuance. Take into account company-specific
factors that include, at a minimum, the following:
B-11
o Past Board Performance:
- The company's use of authorized preferred shares during the last
three years;
o The Current Request:
- Disclosure in the proxy statement of the specific purposes for the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request;
- In cases where the company has existing authorized preferred
stock, the dilutive impact of the request as determined by an
allowable increase calculated by ISS (typically 100 percent of
existing authorized shares) that reflects the company's need for
shares and total shareholder returns; and
- Whether the shares requested are blank check preferred shares that
can be used for antitakeover purposes.
o o o o o
Mergers and Acquisitions
Vote case-by-case on mergers and acquisitions. Review and evaluate the merits
and drawbacks of the proposed transaction, balancing various and sometimes
countervailing factors including:
o Valuation - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
o Market reaction - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
o Strategic rationale - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
o Negotiations and process - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
o Conflicts of interest - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and
officers of the company may be more likely to vote to approve a merger
than if they did not hold these interests. Consider whether these
interests may have influenced these directors and officers to support
or recommend the merger. The CIC figure presented in the "ISS
Transaction Summary" section of this report is an aggregate figure
that can in certain cases be a misleading indicator of the true value
transfer from shareholders to insiders. Where such figure appears to
be excessive, analyze the underlying assumptions to determine whether
a potential conflict exists.
o Governance - Will the combined company have a better or worse
governance profile than the current governance profiles of the
B-12
respective parties to the transaction? If the governance profile is to
change for the worse, the burden is on the company to prove that other
issues (such as valuation) outweigh any deterioration in governance.
o o o o o
COMPENSATION
Executive Pay Evaluation
Underlying all evaluations are five global principles that most investors expect
corporations to adhere to in designing and administering executive and director
compensation programs:
1. Maintain appropriate pay-for-performance alignment, with emphasis on
long-term shareholder value: This principle encompasses overall
executive pay practices, which must be designed to attract, retain,
and appropriately motivate the key employees who drive shareholder
value creation over the long term. It will take into consideration,
among other factors, the link between pay and performance; the mix
between fixed and variable pay; performance goals; and equity-based
plan costs;
2. Avoid arrangements that risk "pay for failure": This principle
addresses the appropriateness of long or indefinite contracts,
excessive severance packages, and guaranteed compensation;
3. Maintain an independent and effective compensation committee: This
principle promotes oversight of executive pay programs by directors
with appropriate skills, knowledge, experience, and a sound process
for compensation decision-making (e.g., including access to
independent expertise and advice when needed);
4. Provide shareholders with clear, comprehensive compensation
disclosures: This principle underscores the importance of informative
and timely disclosures that enable shareholders to evaluate executive
pay practices fully and fairly;
5. Avoid inappropriate pay to non-executive directors: This principle
recognizes the interests of shareholders in ensuring that compensation
to outside directors does not compromise their independence and
ability to make appropriate judgments in overseeing managers' pay and
performance. At the market level, it may incorporate a variety of
generally accepted best practices.
Advisory Votes on Executive Compensation--Management Proposals (Management
Say-on-Pay)
Vote case-by-case on ballot items related to executive pay and practices, as
well as certain aspects of outside director compensation.
B-13
Vote against Advisory Votes on Executive Compensation (Management
Say-on-Pay--MSOP) if:
o There is a significant misalignment between CEO pay and company
performance (pay for performance);
o The company maintains significant problematic pay practices;
o The board exhibits a significant level of poor communication and
responsiveness to shareholders.
Vote against or withhold from the members of the Compensation Committee and
potentially the full board if:
o There is no MSOP on the ballot, and an against vote on an MSOP is
warranted due to a pay for performance misalignment, problematic pay
practices, or the lack of adequate responsiveness on compensation
issues raised previously, or a combination thereof;
o The board fails to respond adequately to a previous MSOP proposal that
received less than 70 percent support of votes cast;
o The company has recently practiced or approved problematic pay
practices, including option repricing or option backdating; or
o The situation is egregious.
Vote against an equity plan on the ballot if:
o A pay for performance misalignment is found, and a significant portion
of the CEO's misaligned pay is attributed to non-performance-based
equity awards, taking into consideration:
- Magnitude of pay misalignment;
- Contribution of non-performance-based equity grants to overall
pay; and
- the proportion of equity awards granted in the last three fiscal
years concentrated at the named executive officer (NEO) level.
Primary Evaluation Factors for Executive Pay
Pay-for-Performance Evaluation
ISS annually conducts a pay-for-performance analysis to identify strong or
satisfactory alignment between pay and performance over a sustained period. With
respect to companies in the Russell 3000 index, this analysis considers the
following:
B-14
1. Peer Group(7) Alignment:
o The degree of alignment between the company's annualized TSR
rank and the CEO's annualized total pay rank within a peer
group, each measured over a three-year period.
o The multiple of the CEO's total pay relative to the peer group
median.
2. Absolute Alignment - the absolute alignment between the trend in CEO
pay and company TSR over the prior five fiscal years - i.e., the
difference between the trend in annual pay changes and the trend in
annualized TSR during the period.
If the above analysis demonstrates significant unsatisfactory long-term
pay-for-performance alignment or, in the case of non-Russell 3000 index
companies, misaligned pay and performance are otherwise suggested, our analysis
may include any of the following qualitative factors, if they are relevant to
the analysis to determine how various pay elements may work to encourage or to
undermine long-term value creation and alignment with shareholder interests:
o The ratio of performance- to time-based equity awards;
o The overall ratio of performance-based compensation;
o The completeness of disclosure and rigor of performance goals;
o The company's peer group benchmarking practices;
o Actual results of financial/operational metrics, such as growth in
revenue, profit, cash flow, etc., both absolute and relative to peers;
o Special circumstances related to, for example, a new CEO in the prior
FY or anomalous equity grant practices (e.g., bi-annual awards);
o Realizable pay(8) compared to grant pay; and
o Any other factors deemed relevant.
Problematic Pay Practices
The focus is on executive compensation practices that contravene the global pay
principles, including:
o Problematic practices related to non-performance-based compensation
elements;
o Incentives that may motivate excessive risk-taking; and
o Options Backdating.
7 The revised peer group is generally comprised of 14-24 companies that are
selected using market cap, revenue (or assets for certain financial firms),
GICS industry group and company's selected peers' GICS industry group with
size constraints, via a process designed to select peers that are closest to
the subject company in terms of revenue/assets and industry and also within
a market cap bucket that is reflective of the company's.
8 ISS research reports will include realizable pay for S&P1500 companies.
B-15
Problematic Pay Practices related to Non-Performance-Based Compensation Elements
Pay elements that are not directly based on performance are generally evaluated
case-by-case considering the context of a company's overall pay program and
demonstrated pay-for-performance philosophy. Please refer to ISS' Compensation
FAQ document for detail on specific pay practices that have been identified as
potentially problematic and may lead to negative recommendations if they are
deemed to be inappropriate or unjustified relative to executive pay best
practices. The list below highlights the problematic practices that carry
significant weight in this overall consideration and may result in adverse vote
recommendations:
o Repricing or replacing of underwater stock options/SARS without prior
shareholder approval (including cash buyouts and voluntary surrender
of underwater options);
o Excessive perquisites or tax gross-ups, including any gross-up related
to a secular trust or restricted stock vesting;
o New or extended agreements that provide for:
- CIC payments exceeding 3 times base salary and average/target/most
recent bonus;
- CIC severance payments without involuntary job loss or substantial
diminution of duties ("single" or "modified single" triggers);
- CIC payments with excise tax gross-ups (including "modified"
gross-ups).
Incentives that may Motivate Excessive Risk-Taking
o Multi-year guaranteed bonuses;
o A single or common performance metric used for short- and long-term
plans;
o Lucrative severance packages;
o High pay opportunities relative to industry peers;
o Disproportionate supplemental pensions; or
o Mega annual equity grants that provide unlimited upside with no
downside risk.
Factors that potentially mitigate the impact of risky incentives include
rigorous claw-back provisions and robust stock ownership/holding guidelines.
Options Backdating
The following factors should be examined case-by-case to allow for distinctions
to be made between "sloppy" plan administration versus deliberate action or
fraud:
o Reason and motive for the options backdating issue, such as
inadvertent vs. deliberate grant date changes;
o Duration of options backdating;
o Size of restatement due to options backdating;
o Corrective actions taken by the board or compensation committee, such
as canceling or re-pricing backdated options, the recouping of option
gains on backdated grants; and
o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
B-16
Board Communications and Responsiveness
Consider the following factors case-by-case when evaluating ballot items related
to executive pay on the board's responsiveness to investor input and engagement
on compensation issues:
o Failure to respond to majority-supported shareholder proposals on
executive pay topics; or
o Failure to adequately respond to the company's previous say-on-pay
proposal that received the support of less than 70 percent of votes
cast, taking into account:
- The company's response, including:
o Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
o Specific actions taken to address the issues that contributed
to the low level of support;
o Other recent compensation actions taken by the company;
- Whether the issues raised are recurring or isolated;
- The company's ownership structure; and
- Whether the support level was less than 50 percent, which would
warrant the highest degree of responsiveness.
o o o o o
Frequency of Advisory Vote on Executive Compensation ("Say When on Pay")
Vote for annual advisory votes on compensation, which provide the most
consistent and clear communication channel for shareholder concerns about
companies' executive pay programs.
o o o o o
Voting on Golden Parachutes in an Acquisition, Merger, Consolidation, or
Proposed Sale
Vote case-by-case on say on Golden Parachute proposals, including consideration
of existing change-in-control arrangements maintained with named executive
officers rather than focusing primarily on new or extended arrangements.
Features that may result in an against recommendation include one or more of the
following, depending on the number, magnitude, and/or timing of issue(s):
o Single- or modified-single-trigger cash severance;
o Single-trigger acceleration of unvested equity awards;
o Excessive cash severance (>3x base salary and bonus);
o Excise tax gross-ups triggered and payable (as opposed to a provision
to provide excise tax gross-ups);
o Excessive golden parachute payments (on an absolute basis or as a
percentage of transaction equity value); or
o Recent amendments that incorporate any problematic features (such as
those above) or recent actions (such as extraordinary equity grants)
B-17
that may make packages so attractive as to influence merger agreements
that may not be in the best interests of shareholders; or
o The company's assertion that a proposed transaction is conditioned on
shareholder approval of the golden parachute advisory vote.
Recent amendment(s) that incorporate problematic features will tend to carry
more weight on the overall analysis. However, the presence of multiple legacy
problematic features will also be closely scrutinized.
In cases where the golden parachute vote is incorporated into a company's
advisory vote on compensation (management say-on-pay), ISS will evaluate the
say-on-pay proposal in accordance with these guidelines, which may give higher
weight to that component of the overall evaluation.
o o o o o
Equity-Based and Other Incentive Plans
Vote case-by-case on equity-based compensation plans. Vote against the equity
plan if any of the following factors apply:
o The total cost of the company's equity plans is unreasonable;
o The plan expressly permits repricing;
o A pay-for-performance misalignment is found;
o The company's three year burn rate exceeds the burn rate cap of its
industry group;
o The plan has a liberal change-of-control definition; or
o The plan is a vehicle for problematic pay practices.
SOCIAL/ENVIRONMENTAL ISSUES
Global Approach
Issues covered under the policy include a wide range of topics, including
consumer and product safety, environment and energy, labor standards and human
rights, workplace and board diversity, and corporate political issues. While a
variety of factors goes into each analysis, the overall principle guiding all
vote recommendations focuses on how the proposal may enhance or protect
shareholder value in either the short or long term.
Generally vote case-by-case, taking into consideration whether implementation of
the proposal is likely to enhance or protect shareholder value, and, in
addition, the following will also be considered:
o If the issues presented in the proposal are more appropriately or
effectively dealt with through legislation or government regulation;
o If the company has already responded in an appropriate and sufficient
manner to the issue(s) raised in the proposal;
B-18
o Whether the proposal's request is unduly burdensome (scope or
timeframe) or overly prescriptive;
o The company's approach compared with any industry standard practices
for addressing the issue(s) raised by the proposal;
o If the proposal requests increased disclosure or greater transparency,
whether or not reasonable and sufficient information is currently
available to shareholders from the company or from other publicly
available sources; and
o If the proposal requests increased disclosure or greater transparency,
whether or not implementation would reveal proprietary or confidential
information that could place the company at a competitive
disadvantage.
o o o o o
Political Activities
Lobbying
Vote case-by-case on proposals requesting information on a company's lobbying
(including direct, indirect, and grassroots lobbying) activities, policies, or
procedures, considering:
o The company's current disclosure of relevant lobbying policies, and
management and board oversight;
o The company's disclosure regarding trade associations or other groups
that it supports, or is a member of, that engage in lobbying
activities; and
o Recent significant controversies, fines, or litigation regarding the
company's lobbying-related activities.
o o o o o
Political Contributions
Generally vote for proposals requesting greater disclosure of a company's
political contributions and trade association spending policies and activities,
considering:
o The company's current disclosure of policies and oversight mechanisms
related to its direct political contributions and payments to trade
associations or other groups that may be used for political purposes,
including information on the types of organizations supported and the
business rationale for supporting these organizations; and
o Recent significant controversies, fines, or litigation related to the
company's political contributions or political activities.
Vote against proposals barring a company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level;
barring political contributions can put the company at a competitive
disadvantage.
B-19
Vote against proposals to publish in newspapers and other media a company's
political contributions. Such publications could present significant cost to the
company without providing commensurate value to shareholders.
o o o o o
Political Ties
Generally vote against proposals asking a company to affirm political
nonpartisanship in the workplace, so long as:
o There are no recent, significant controversies, fines, or litigation
regarding the company's political contributions or trade association
spending; and
o The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and prohibit coercion.
Vote against proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
o o o o o
8. Foreign Private Issuers Listed on U.S. Exchanges
Vote against (or withhold from) non-independent director nominees at companies
which fail to meet the following criteria: a majority-independent board, and the
presence of an audit, a compensation, and a nomination committee, each of which
is entirely composed of independent directors.
Where the design and disclosure levels of equity compensation plans are
comparable to those seen at U.S. companies, U.S. compensation policy will be
used to evaluate the compensation plan proposals. Otherwise, they, and all other
voting items, will be evaluated using the relevant ISS regional or market proxy
voting guidelines.
o o o o o
DISCLOSURE/DISCLAIMER
This document and all of the information contained in it, including without
limitation all text, data, graphs, and charts (collectively, the "Information")
is the property of Institutional Shareholder Services Inc. (ISS), its
subsidiaries, or, in some cases third party suppliers.
The Information has not been submitted to, nor received approval from, the
United States Securities and Exchange Commission or any other regulatory body.
None of the Information constitutes an offer to sell (or a solicitation of an
B-20
offer to buy), or a promotion or recommendation of, any security, financial
product or other investment vehicle or any trading strategy, and ISS does not
endorse, approve, or otherwise express any opinion regarding any issuer,
securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk of any use it may make or
permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO
THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS,
NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS for A PARTICULAR
PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by
law, in no event shall ISS have any liability regarding any of the Information
for any direct, indirect, special, punitive, consequential (including lost
profits), or any other damages even if notified of the possibility of such
damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
o o o o o
B-21
First Trust Exchange-Traded Fund IV
PART C - OTHER INFORMATION
ITEM 28. EXHIBITS
EXHIBIT NO. DESCRIPTION
(a) (1) Declaration of Trust of the Registrant and Establishment and
Designation of Series Attached Thereto as Schedule A. (1)
(2) Amended and Restated Establishment and Designation of Series
dated December 18, 2013. (4)
(b) By-Laws of the Registrant. (1)
(c) Not applicable.
(d) (1) Sub-Advisory Agreement. (2)
(2) Investment Management Agreement. (3)
(e) (1) Distribution Agreement. (3)
(2) Exhibit A to Distribution Agreement. (5)
(f) Not applicable.
(g) (1) Custody Agreement between the Registrant and The Bank of New
York Mellon. (3)
(2) Schedule A to Custody Agreement. (5)
(h) (1) Form of Subscription Agreement. (2)
(2) Transfer Agency Agreement. (3)
(3) Administration and Accounting Agreement. (3)
(4) Amended Exhibit A to the Transfer Agency Agreement. (4)
(i) (1) Opinion and Consent of Bingham McCutchen LLP. (5)
(2) Opinion and Consent of Chapman and Cutler LLP. (5)
(j) Not Applicable.
(k) Not applicable.
(l) Not applicable.
(m) (1) 12b-1 Distribution and Service Plan. (2)
(2) Amended Exhibit A to 12b-1 Distribution and Service Plan. (3)
(n) Not Applicable.
(o) Not Applicable.
(p) (1) First Trust Advisors L.P., First Trust Portfolios L.P. Code of
Ethics, amended on July 1, 2013. (5)
(2) First Trust Funds Code of Ethics, amended on October 30,
2013. (5)
(q) Powers of Attorney for Messrs. Bowen, Erickson, Kadlec and Keith
authorizing James A. Bowen, Mark R. Bradley, W. Scott Jardine,
Kristi A. Maher and Eric F. Fess to execute the Registration
Statement. (1)
(1) Incorporated by reference to the Registrant's Registration Statement on
Form N-1A (File No. 333-174332) filed on May 19, 2011.
(2) Incorporated by reference to the Registrant's Registration Statement on
Form N-1A (File No. 333-174332) filed on June 14, 2012.
(3) Incorporated by reference to the Registrant's Registration Statement on
Form N-1A (File No. 333-174332) filed on March 21, 2013.
(4) Incorporated by reference to the Registrant's Registration Statement on
Form N-1A (File No. 333-174332) filed on February 28, 2014.
(5) To be filed by amendment.
ITEM 29. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Not Applicable.
ITEM 30. INDEMNIFICATION
Section 9.5 of the Registrant's Declaration of Trust provides as follows:
Section 9.5. Indemnification and Advancement of Expenses. Subject to the
exceptions and limitations contained in this Section 9.5, every person who is,
or has been, a Trustee, officer, or employee of the Trust, including persons who
serve at the request of the Trust as directors, trustees, officers, employees or
agents of another organization in which the Trust has an interest as a
shareholder, creditor or otherwise (hereinafter referred to as a "Covered
Person"), shall be indemnified by the Trust to the fullest extent permitted by
law against liability and against all expenses reasonably incurred or paid by
him or in connection with any claim, action, suit or proceeding in which he
becomes involved as a party or otherwise by virtue of his being or having been
such a Trustee, director, officer, employee or agent and against amounts paid or
incurred by him in settlement thereof.
No indemnification shall be provided hereunder to a Covered Person to the
extent such indemnification is prohibited by applicable federal law.
The rights of indemnification herein provided may be insured against by
policies maintained by the Trust, shall be severable, shall not affect any other
rights to which any Covered Person may now or hereafter be entitled, shall
continue as to a person who has ceased to be such a Covered Person and shall
inure to the benefit of the heirs, executors and administrators of such a
person.
Subject to applicable federal law, expenses of preparation and
presentation of a defense to any claim, action, suit or proceeding subject to a
claim for indemnification under this Section 9.5 shall be advanced by the Trust
prior to final disposition thereof upon receipt of an undertaking by or on
behalf of the recipient to repay such amount if it is ultimately determined that
he is not entitled to indemnification under this Section 9.5.
To the extent that any determination is required to be made as to whether
a Covered Person engaged in conduct for which indemnification is not provided as
described herein, or as to whether there is reason to believe that a Covered
Person ultimately will be found entitled to indemnification, the Person or
Persons making the determination shall afford the Covered Person a rebuttable
presumption that the Covered Person has not engaged in such conduct and that
there is reason to believe that the Covered Person ultimately will be found
entitled to indemnification.
As used in this Section 9.5, the words "claim," "action," "suit" or
"proceeding" shall apply to all claims, demands, actions, suits, investigations,
regulatory inquiries, proceedings or any other occurrence of a similar nature,
whether actual or threatened and whether civil, criminal, administrative or
other, including appeals, and the words "liability" and "expenses" shall include
without limitation, attorneys' fees, costs, judgments, amounts paid in
settlement, fines, penalties and other liabilities.
ITEM 31. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER
First Trust Advisors L.P. ("First Trust"), investment adviser to the
Registrant, serves as adviser or sub-adviser to various other open-end and
closed-end management investment companies and is the portfolio supervisor of
certain unit investment trusts. The principal business of certain of First
Trust's principal executive officers involves various activities in connection
with the family of unit investment trusts sponsored by First Trust Portfolios
L.P. ("FTP"). The principal address for all these investment companies, First
Trust, FTP and the persons below is 120 East Liberty Drive, Suite 400, Wheaton,
Illinois 60187.
A description of any business, profession, vocation or employment of a
substantial nature in which the officers of First Trust who serve as officers or
trustees of the Registrant have engaged during the last two years for his or her
account or in the capacity of director, officer, employee, partner or trustee
appears under "Management of the Fund" in the Statement of Additional
Information. Such information for the remaining senior officers of First Trust
appears below:
NAME AND POSITION WITH FIRST TRUST EMPLOYMENT DURING PAST TWO YEARS
Andrew S. Roggensack, President Managing Director and President, First Trust
R. Scott Hall, Managing Director Managing Director, First Trust
Ronald D. McAlister, Managing Director Managing Director, First Trust
David G. McGarel, Chief Investment Officer Managing Director (since July 2012); Senior Vice
and Managing Director President, First Trust
Kathleen Brown, Chief Compliance Officer and Chief Compliance Officer and Senior Vice President,
Senior Vice President First Trust
Brian Wesbury, Chief Economist and Chief Economist and Senior Vice President, First Trust
Senior Vice President
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ITEM 32. PRINCIPAL UNDERWRITER
(a) FTP serves as principal underwriter of the shares of the Registrant,
First Trust Exchange-Traded Fund, First Trust Exchange-Traded Fund II, First
Trust Exchange-Traded Fund III, First Trust Exchange-Traded Fund V, First Trust
Exchange Traded Fund VI, First Trust Exchange-Traded Fund VII, First Trust
Exchange-Traded AlphaDEX(R) Fund, First Trust Exchange-Traded AlphaDEX(R) Fund
II, First Trust Variable Insurance Trust, First Trust Series Fund and First
Defined Portfolio Fund LLC. FTP serves as principal underwriter and depositor of
the following investment companies registered as unit investment trusts: the
First Trust Combined Series, FT Series (formerly known as the First Trust
Special Situations Trust), the First Trust Insured Corporate Trust, the First
Trust of Insured Municipal Bonds and the First Trust GNMA.
(b)
NAME AND PRINCIPAL POSITIONS AND OFFICES POSITIONS AND
BUSINESS ADDRESS* WITH UNDERWRITER OFFICES WITH FUND
The Charger Corporation General Partner None
Grace Partners of DuPage L.P. Limited Partner None
James A. Bowen Chief Executive Officer and Trustee and Chairman of the Board
Managing Director
Mark R. Bradley Chief Financial Officer, Chief President and Chief Executive
Operating Officer and Managing Officer
Director
Frank L. Fichera Managing Director None
Russell J. Graham Managing Director None
R. Scott Hall Managing Director None
W. Scott Jardine General Counsel, Secretary and Secretary
Managing Director
Daniel J. Lindquist Managing Director Vice President
Ronald D. McAlister Managing Director None
David G. McGarel Managing Director None
Richard A. Olson Managing Director None
Maria Prestigiacomo Managing Director None
Andrew S. Roggensack President and Managing Director None
Kristi A. Maher Deputy General Counsel Chief Compliance Officer and
Assistant Secretary
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* All addresses are
120 East Liberty Drive,
Wheaton, Illinois 60187.
(c) Not Applicable.
ITEM 33. LOCATION OF ACCOUNTS AND RECORDS
First Trust, 120 East Liberty Drive, Wheaton, Illinois 60187, maintains
the Registrant's organizational documents, minutes of meetings, contracts of the
Registrant and all advisory material of the investment adviser.
ITEM 34. MANAGEMENT SERVICES
Not Applicable.
ITEM 35. UNDERTAKINGS
Not Applicable.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, duly authorized in the
City of Wheaton, and State of Illinois, on the 10th day of April, 2014.
FIRST TRUST EXCHANGE-TRADED FUND IV
By: /s/ Mark R. Bradley
-----------------------------------
Mark R. Bradley, President and
Chief Executive Officer
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Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated:
SIGNATURE TITLE DATE
President and Chief April 10, 2014
/s/ Mark R. Bradley Executive Officer
-----------------------------
Mark R. Bradley
Treasurer, Chief Financial April 10, 2014
Officer and Chief
/s/ James M. Dykas Accounting Officer
-----------------------------
James M. Dykas
)
James A. Bowen* Trustee )
)
)
Richard E. Erickson* Trustee )
)
)
Thomas R. Kadlec* Trustee ) BY: /s/ W. Scott Jardine
) ---------------------
) W. Scott Jardine
Robert F. Keith* Trustee ) Attorney-In-Fact
) April 10, 2014
)
Niel B. Nielson* Trustee )
)
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* Original powers of attorney authorizing James A. Bowen, W. Scott
Jardine, Mark R. Bradley, Eric F. Fess and Kristi A. Maher to execute
Registrant's Registration Statement, and Amendments thereto, for each of
the trustees of the Registrant on whose behalf this Registration
Statement is filed, were previously executed, filed as an exhibit and
are incorporated by reference herein.
INDEX TO EXHIBITS