First Trust RBA American Industrial Renaissance(TM) ETF (the "Fund") is a series
of First Trust Exchange-Traded Fund VI (the "Trust") and an exchange-traded
index fund organized as a separate series of a registered management investment
company.
The Fund lists and principally trades its shares on The NASDAQ(R) Stock
Market LLC ("NASDAQ(R)" or the "Exchange"). 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 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.
STATEMENT OF ADDITIONAL INFORMATION
INVESTMENT COMPANY ACT FILE NO. 811-22717
FIRST TRUST EXCHANGE-TRADED FUND VI
TICKER
FUND NAME SYMBOL EXCHANGE
FIRST TRUST RBA AMERICAN INDUSTRIAL RENAISSANCE(TM) ETF AIRR The NASDAQ(R) Stock Market
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DATED MARCH 11, 2014
This Statement of Additional Information ("SAI") is not a prospectus. It
should be read in conjunction with the prospectus dated March 11, 2014, as it
may be revised from time to time (the "Prospectus"), for First Trust RBA
American Industrial Renaissance(TM) ETF (the "Fund"), a series of the First
Trust Exchange-Traded Fund VI (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.........................................................6
SUBLICENSE AGREEMENTS........................................................17
INVESTMENT RISKS ............................................................17
MANAGEMENT OF THE FUND.......................................................24
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE.....................................37
BROKERAGE ALLOCATIONS........................................................37
CUSTODIAN, TRANSFER AGENT, FUND ACCOUNTING AGENT, DISTRIBUTOR, INDEX
PROVIDER AND EXCHANGE...................................................39
ADDITIONAL INFORMATION.......................................................42
PROXY VOTING POLICIES AND PROCEDURES.........................................43
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS........................44
FEDERAL TAX MATTERS .........................................................53
DETERMINATION OF NET ASSET VALUE.............................................59
DIVIDENDS AND DISTRIBUTIONS..................................................61
MISCELLANEOUS INFORMATION....................................................61
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EXHIBIT A - PROXY VOTING GUIDELINES..........................................62
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GENERAL DESCRIPTION OF THE TRUST AND THE FUND
The Trust was organized as a Massachusetts business trust on June 4, 2012,
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 eight series, including the Fund, 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
making any determination as to whether any person is entitled to the advancement
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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. (the "Advisor" or "First
Trust").
The shares of the Fund list and principally trade on The NASDAQ(R)
Stock Market ("NASDAQ(R)" or the "Exchange"). The shares will trade on the
NASDAQ(R) 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") included in the Fund's Index (as hereinafter defined),
together with the deposit of a specified cash payment (the "Cash Component").
Shares are redeemable only in Creation Unit Aggregations and, generally, in
exchange for portfolio securities and a specified cash payment. 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 NASDAQ(R) necessary
to maintain the listing of shares of the Fund will continue to be met. The
NASDAQ(R) 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; (ii) the
value of the Fund's Index (as defined below) is no longer calculated or
available; or (iii) such other event shall occur or condition exist that, in the
opinion of the NASDAQ(R) makes further dealings on the Exchange inadvisable.
The NASDAQ(R) 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 NASDAQ(R), brokers'
commissions on transactions will be based on negotiated commission rates at
customary levels.
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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
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 of the outstanding
voting securities (as such term is defined in the 1940 Act) 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
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from investing in securities or other instruments backed by physical
commodities).
(7) The Fund may not invest 25% or more of the value of its total
assets in securities of issuers in any one industry or group of
industries, except to the extent that the Index that the Fund is based
upon concentrates in an industry or a group of industries. 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.
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 borrowings 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.
Except for restriction (2), 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).
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 policies and may be changed by the Board of Trustees.
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INVESTMENT STRATEGIES
Under normal circumstances, the Fund will invest at least 90% of its net
assets (plus any borrowings for investment purposes) in U.S. equity securities,
which represent the securities in the Richard Bernstein Advisors American
Industrial Renaissance Index (the "Index"). Fund shareholders are entitled to 60
days' notice prior to any change in this non-fundamental investment policy.
TYPES OF INVESTMENTS
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 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 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, such
descriptions are not all-inclusive. 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.
Equities. To the extent disclosed in the Prospectus, the Fund intends to
invest in equity securities. Equity securities represent an ownership position
in a company. The prices of equity securities fluctuate based on, among other
things, events specific to their issuers and market, economic, and other
conditions. Equity securities in which the Fund invests may include common and
preferred stocks. Common stocks include the common stock of any class or series
of a domestic or foreign corporation or any similar equity interest, such as a
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trust or partnership interest. These investments may or may not pay dividends
and may or may not carry voting rights. Common stock occupies the most junior
position in a company's capital structure. The Funds may also invest in warrants
and rights related to common stocks.
The Fund may also invest in preferred equity securities. Preferred stock,
unlike common stock, offers a stated dividend rate payable from the issuer's
earnings. Preferred stock dividends may be cumulative or non-cumulative,
participating or action rate. If interest rates rise, the fixed dividend on
preferred stocks may be less attractive, causing the price of preferred stocks
to decline. Preferred stock may have mandatory sinking fund provisions, as well
as call/redemption provisions prior to maturity, a negative feature when
interest rates decline.
Fixed Income Investments and Cash Equivalents. Normally, the Fund invests
substantially all of its assets to meet its investment objectives; 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 that 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 FNMA. 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.
(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
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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
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.
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(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 objective 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.
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 the 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, cetain
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 the
Advisor the day-to-day determination of the illiquidity of any equity or
fixed-income security, although it has retained oversight responsibility
for such determinations. With respect to Rule 144A securities, the
Advisor 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
- 9 -
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.
Money Market Funds. The Funds may invest in shares of money market funds
to the extent permitted by the 1940 Act.
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.
LENDING OF PORTFOLIO SECURITIES
In order to generate additional income, as a non-principal investment
strategy, First Trust is authorized to select the Funds, with notice to the
Board of Trustees, to lend portfolio securities representing up to 33 1/3% of
the value of their total assets 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 that First Trust has determined are creditworthy under guidelines
established 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. First Trust
may select the Fund to participate in the securities lending program, at its
discretion with notice to the Board of Trustees.
In these loan arrangements, the Fund will receive collateral in the form
of cash, U.S. government securities or other high grade debt obligations 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
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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 long-term capital gains, even if the actual
dividends would have constituted qualified dividends had the Fund held the
securities.
HEDGING STRATEGIES
General Description of Hedging Strategies
The Fund may engage in hedging activities. First Trust may cause the Fund
to utilize a variety of financial instruments, including options, forward
contracts, futures contracts (hereinafter referred to as "Futures" or "Futures
Contracts"), and options on Futures Contracts to attempt to hedge the Fund's
holdings. The use of Futures is not a part of a principal investment strategy of
the Fund.
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.
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 the Advisor 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 as
currently in effect, the Fund limits its trading activity in Futures, option 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.
The Advisor 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
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organization. The Fund will not enter into Futures Contracts and options
transactions if more than 30% of their net assets would be committed to such
instruments. If the Fund were no longer able to claim the exclusion, the Advisor
would be required to register as a "commodity pool operator," and the Fund and
the Advisor would be subject to regulation under the Commodity Exchange Act (the
"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
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, 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
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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
the 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.
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 equity 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
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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.
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
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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.
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
- 15 -
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,
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.
- 16 -
SUBLICENSE AGREEMENT
The Trust on behalf of the Fund relies on a product license agreement (the
"Product License Agreement") by and between Richard Bernstein Advisors LLC
("RBA" or the "Index Provider") and First Trust and a related sublicense
agreement (the "Sublicense Agreement") with First Trust that grants the Trust,
on behalf of the Fund, a non-exclusive and non-transferable sublicense to use
certain intellectual property of the Index Provider, in connection with the
issuance, distribution, marketing and/or promotion of the Fund. Pursuant to the
Sublicense Agreement, the Fund has agreed to be bound by certain provisions of
the Product License Agreement.
INVESTMENT RISKS
Overview
An investment in the 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 equity securities or the general
condition of the securities market may worsen and the value of the securities
and therefore the value of the Fund may decline. The 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 the Fund is not predictive of
their future performance.
Common Stocks
Equity securities are especially susceptible to general market movements
and to volatile increases and decreases of value as market confidence in and
perceptions of the issuers change. These perceptions are based on unpredictable
factors including expectations regarding government, economic, monetary and
fiscal policies, inflation and interest rates, economic expansion or
contraction, and global or regional political, economic or banking crises. First
Trust cannot predict the direction or scope of any of these factors.
Shareholders of common stocks have rights to receive payments from the issuers
of those common stocks that are generally subordinate to those of creditors of,
or holders of debt obligations or preferred stocks of, such issuers.
Shareholders of common stocks of the type held by the Fund have a right to
receive dividends only when and if, and in the amounts, declared by the issuer's
board of directors and have a right to participate in amounts available for
distribution by the issuer only after all other claims on the issuer have been
paid. Common stocks do not represent an obligation of the issuer and, therefore,
do not offer any assurance of income or provide the same degree of protection of
capital as do debt securities. The issuance of additional debt securities or
preferred stock will create prior claims for payment of principal, interest and
dividends which could adversely affect the ability and inclination of the issuer
to declare or pay dividends on its common stock or the rights of holders of
common stock with respect to assets of the issuer upon liquidation or
bankruptcy. The value of common stocks is subject to market fluctuations for as
- 17 -
long as the common stocks remain outstanding, and thus the value of the equity
securities in the Fund will fluctuate over the life of the Fund and may be more
or less than the price at which they were purchased by the Fund. The equity
securities held in the Fund may appreciate or depreciate in value (or pay
dividends) depending on the full range of economic and market influences
affecting these securities, including the impact of the Fund's purchase and sale
of the equity securities and other factors.
Holders of common stocks incur more risk than holders of preferred stocks
and debt obligations because common stockholders, as owners of the entity, have
generally inferior rights to receive payments from the issuer in comparison with
the rights of creditors of, or holders of debt obligations or preferred stocks
issued by, the issuer. Cumulative preferred stock dividends must be paid before
common stock dividends and any cumulative preferred stock dividend omitted is
added to future dividends payable to the holders of cumulative preferred stock.
Preferred stockholders are also generally entitled to rights on liquidation,
which are senior to those of common stockholders.
Dividends Risk
Shareholders of common stocks have rights to receive payments from the
issuers of those common stocks that are generally subordinate to those of
creditors of, or holders of debt obligations or preferred stocks of, such
issuers. Shareholders of common stocks of the type held by the Fund have a right
to receive dividends only when and if, and in the amounts, declared by the
issuer's board of directors and have a right to participate in amounts available
for distribution by the issuer only after all other claims on the issuer have
been paid or have otherwise been settled. Common stocks do not represent an
obligation of the issuer and, therefore, do not offer any assurance of income or
provide the same degree of protection of capital, as do debt securities. The
issuance of additional debt securities or preferred stock will create prior
claims for payment of principal, interest and dividends which could adversely
affect the ability and inclination of the issuer to declare or pay dividends on
its common stock or the rights of holders of common stock with respect to assets
of the issuer upon liquidation or bankruptcy. Cumulative preferred stock
dividends must be paid before common stock dividends, and any cumulative
preferred stock dividend omitted is added to future dividends payable to the
holders of cumulative preferred stock. Preferred stockholders are also generally
entitled to rights on liquidation that are senior to those of common
stockholders.
Financials Concentration Risk
Major determinants of future earnings of companies in the financial
services sector are the direction of the stock market, investor confidence,
equity transaction volume, the level and direction of long-term and short-term
interest rates, and the outlook for emerging markets. Negative trends in any of
these earnings determinants could have a serious adverse effect on the financial
stability, as well as the stock prices, of these companies. Furthermore, there
can be no assurance that the issuers of the Securities included in the Fund will
be able to respond in a timely manner to compete in the rapidly developing
marketplace. In addition to the foregoing, profit margins of these companies
continue to shrink due to the commoditization of traditional businesses, new
- 18 -
competitors, capital expenditures on new technology and the pressures to compete
globally.
Banks. Banks, thrifts and their holding companies are especially subject
to the adverse effects of economic recession; volatile interest rates; portfolio
concentrations in geographic markets, in commercial and residential real estate
loans or any particular segment or industry; and competition from new entrants
in their fields of business. Banks and thrifts are highly dependent on net
interest margin. Banks and thrifts traditionally receive a significant portion
of their revenues from consumer mortgage fee income because of activity in
mortgage and refinance markets. As home purchasing and refinancing activity has
subsided, this revenue has diminished. Economic conditions in the real estate
markets have deteriorated, leading to asset write-offs and decreased liquidity
in the credit markets, which can have a substantial negative effect upon banks
and thrifts because they generally have a portion of their assets invested in
loans secured by real estate. Difficulties in the mortgage and broader credit
markets have resulted in decreases in the availability of funds. Financial
performance of many banks and thrifts, especially in securities collateralized
by mortgage loans, has deteriorated.
Banks and thrifts, particularly smaller community banks, face increased
competition from nontraditional lending sources and financial services providers
including brokerage firms, broker/dealers, investment banks, mutual fund
companies and other companies that offer various financial products.
Technological advances allow these nontraditional lending sources and financial
services providers to cut overhead and permit the more efficient use of customer
data. These companies compete with banks and thrifts to provide traditional
financial services products in addition to their brokerage and investment
advice.
Banks, thrifts and their holding companies are subject to extensive
federal regulation and, when such institutions are state-chartered, to state
regulation as well. Such regulations impose strict capital requirements and
limitations on the nature and extent of business activities that banks and
thrifts may pursue. Furthermore, bank regulators have a wide range of discretion
in connection with their supervisory and enforcement authority and may
substantially restrict the permissible activities of a particular institution if
deemed to pose significant risks to the soundness of such institution or the
safety of the federal deposit insurance fund. Regulatory actions, such as
increases in the minimum capital requirements applicable to banks and thrifts
and increases in deposit insurance premiums required to be paid by banks and
thrifts to the Federal Deposit Insurance Corporation (the "FDIC"), can
negatively affect earnings and the ability of a company to pay dividends.
Neither federal insurance of deposits nor governmental regulations, however,
insure the solvency or profitability of banks or their holding companies, or
insures against any risk of investment in the securities issued by such
institutions.
In light of the current credit market difficulties, the U.S. Government is
considering changes to the laws and regulatory structure. New legislation and
regulatory changes could cause business disruptions, result in significant loss
of revenue, limit financial firms' ability to pursue business opportunities,
impact the value of business assets and impose additional costs that may
adversely affect business. There can be no assurance as to the actual impact
these laws and their implementing regulations, or any other governmental
program, will have on the financial markets. Currently the Federal Reserve
Board, the FDIC, the SEC, Office of Comptroller of the Currency (a bureau of the
- 19 -
Department of the U.S. Treasury (the "U.S. Treasury") which regulates national
banks), and the CFTC all play a role in the supervision of the financial
markets. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection
Act ("Dodd-Frank Act"), signed into law in 2010, financial firms are subject to
increased scrutiny concerning their capital, liquidity, and risk management
standards. Certain provisions of the Dodd-Frank Act would create a national bank
supervisor to conduct prudential supervision regulation of all federally
chartered depository institutions, and all federal branches and agencies of
foreign banks. This single regulator would oversee the entire banking industry,
thereby leading to potential risks, costs and unknown impacts on the entire
financial sector.
The SEC and the Financial Accounting Standards Board ("FASB") require the
expanded use of market value accounting by banks and have imposed rules
requiring mark-to-market accounting for investment securities held in trading
accounts or available for sale. Adoption of additional rules may result in
increased volatility in the reported health of the industry, and mandated
regulatory intervention to correct such problems. FASB Accounting Standards
Codification 820, "Fair Value Measurement" changed the requirements of
mark-to-market accounting and determining fair value when the volume and level
of activity for the asset or liability has significantly decreased. These
changes and other potential changes in financial accounting rules and valuation
techniques may have a significant impact on the banking and financial services
industries in terms of accurately pricing assets or liabilities.
Insurance. The Fund may invest in companies involved in the insurance
industry, which are engaged in underwriting, reinsuring, selling, distributing
or placing of property and casualty, life or health insurance. Other growth
areas within the insurance industry include brokerage, reciprocals, claims
processors and multi-line insurance companies. Interest rate levels, general
economic conditions and price and marketing competition affect insurance company
profits. Property and casualty insurance profits may also be affected by weather
catastrophes and other disasters. Life and health insurance profits may be
affected by mortality and morbidity rates. Individual companies may be exposed
to material risks including reserve inadequacy and the inability to collect from
reinsurance carriers. Insurance companies are subject to extensive governmental
regulation, including the imposition of maximum rate levels, which may not be
adequate for some lines of business. Proposed or potential tax law changes may
also adversely affect insurance companies' policy sales, tax obligations, and
profitability. In addition to the foregoing, profit margins of these companies
continue to shrink due to the commoditization of traditional businesses, new
competitors, capital expenditures on new technology and the pressures to compete
globally. In addition to the normal risks of business, companies involved in the
insurance industry are subject to significant risk factors, including those
applicable to regulated insurance companies, such as: (i) the inherent
uncertainty in the process of establishing property-liability loss reserves,
particularly reserves for the cost of environmental, asbestos and mass tort
claims, and the fact that ultimate losses could materially exceed established
loss reserves which could have a material adverse effect on results of
operations and financial condition; (ii) the fact that insurance companies have
experienced, and can be expected in the future to experience, catastrophe losses
which could have a material adverse impact on their financial condition, results
of operations and cash flow; (iii) the inherent uncertainty in the process of
establishing property-liability loss reserves due to changes in loss payment
patterns caused by new claims settlement practices; (iv) the need for insurance
- 20 -
companies and their subsidiaries to maintain appropriate levels of statutory
capital and surplus, particularly in light of continuing scrutiny by rating
organizations and state insurance regulatory authorities, and in order to
maintain acceptable financial strength or claims-paying ability rating; (v) the
extensive regulation and supervision to which insurance companies' subsidiaries
are subject, various regulatory initiatives that may affect insurance companies,
and regulatory and other legal actions; (vi) the adverse impact that increases
in interest rates could have on the value of an insurance company's investment
portfolio and on the attractiveness of certain of its products; (vii) the need
to adjust the effective duration of the assets and liabilities of life insurance
operations in order to meet the anticipated cash flow requirements of its
policyholder obligations; (viii) the uncertainty involved in estimating the
availability of reinsurance and the collectability of reinsurance recoverables;
and (ix) proposed legislation that would establish the Office of National
Insurance within the U.S. Treasury. This proposed federal agency would gather
information, develop expertise, negotiate international agreements, and
coordinate policy in the insurance sector. This enhanced oversight into the
insurance industry may pose unknown risks to the sector as a whole.
The state insurance regulatory framework has, during recent years, come
under increased federal scrutiny, and certain state legislatures have considered
or enacted laws that alter and, in many cases, increase state authority to
regulate insurance companies and insurance holding company systems. Further, the
National Association of Insurance Commissioners and state insurance regulators
are re-examining existing laws and regulations, specifically focusing on
insurance companies, interpretations of existing laws and the development of new
laws. In addition, Congress and certain federal agencies have investigated the
condition of the insurance industry in the United States to determine whether to
promulgate additional federal regulation. The Advisor is unable to predict
whether any state or federal legislation will be enacted to change the nature or
scope of regulation of the insurance industry, or what effect, if any, such
legislation would have on the industry.
All insurance companies are subject to state laws and regulations that
require diversification of their investment portfolios and limit the amount of
investments in certain investment categories. Failure to comply with these laws
and regulations would cause non-conforming investments to be treated as
non-admitted assets for purposes of measuring statutory surplus and, in some
instances, would require divestiture.
While current federal income tax law permits the tax-deferred accumulation
of earnings on the premiums paid by an annuity owner and holders of certain
savings-oriented life insurance products, no assurance can be given that future
tax law will continue to allow such tax deferrals. If such deferrals were not
allowed, consumer demand for the affected products would be substantially
reduced. In addition, proposals to lower the federal income tax rates through a
form of flat tax or otherwise could have, if enacted, a negative impact on the
demand for such products.
Investment Banks. The Fund may invest in companies engaged in investment
banking/brokerage and investment management, which include brokerage firms,
broker/dealers, investment banks, finance companies and mutual fund companies.
Earnings and share prices of companies in this industry are quite volatile, and
often exceed the volatility levels of the market as a whole. Negative economic
- 21 -
events in the credit markets have led some firms to declare bankruptcy, forced
short-notice sales to competing firms, or required government intervention by
the FDIC or through an infusion of Troubled Asset Relief Program funds.
Consolidation in the industry and the volatility in the stock market have
negatively affected investors.
Small-Cap Companies
While historically small-cap company stocks have outperformed the stocks
of large companies, the former have customarily involved more investment risk as
well. Small-cap companies may have limited product lines, markets or financial
resources; may lack management depth or experience; and may be more vulnerable
to adverse general market or economic developments than large companies. Some of
these companies may distribute, sell or produce products that have recently been
brought to market and may be dependent on key personnel.
ADDITIONAL RISK OF INVESTING IN THE FUND
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 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.
Liquidity Risk
Whether or not the equity securities in the Fund are listed on a
securities exchange, the principal trading market for certain of the equity
securities in the Fund may be in the over-the-counter ("OTC") market.
As a result, the existence of a liquid trading market for the equity securities
may depend on whether dealers will make a market in the equity securities. There
can be no assurance that a market will be made for any of the equity securities,
that any market for the equity securities will be maintained or that there will
be sufficient liquidity of the equity securities in any markets made. The price
at which the equity securities are held in the Fund will be adversely affected
if trading markets for the equity securities are limited or absent.
RISKS AND SPECIAL CONSIDERATIONS CONCERNING DERIVATIVES
To the extent disclosed in the Prospectus, the Fund may invest in
derivatives. In addition to the foregoing, the use of derivative instruments
involves certain general risks and considerations as described below.
- 22 -
(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 portfolio managers' 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 portfolio managers' 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 portfolio managers 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/Counterparty 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
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.
- 23 -
(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
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
- 24 -
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 IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS 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 111 Portfolios None
120 East Liberty Drive, Board and (December 2010 to
Suite 400 Trustee Present), President (until
Wheaton, IL 60187 o Since inception December 2010), First
D.O.B.: 09/55 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)
Independent Trustees
-------------------------
Richard E. Erickson Trustee o Indefinite term Physician; President, 111 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 111 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), Vice Services
Wheaton, IL 60187 President and Chief International
D.O.B.: 11/57 Financial Officer (1990 to
May 2007), ADM Investor
Services, Inc. (Futures
Commission Merchant)
- 25 -
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS BY TRUSTEE 5 YEARS
Robert F. Keith Trustee o Indefinite term President (2003 to 111 Portfolios Director of
c/o First Trust Advisors Present), Hibs Enterprises Trust Company of
L.P. o Since inception (Financial and Management Illinois
120 East Liberty Drive, Consulting)
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
President and Chief
Niel B. Nielson Trustee o Indefinite term Executive Officer (July 111 Portfolios Director of
c/o First Trust Advisors 2012 to Present), Dew Covenant
L.P. o Since inception Learning LLC (Educational Transport Inc.
120 East Liberty Drive, Products and Services);
Suite 400 President (June 2002 to
Wheaton, IL 60187 June 2012), Covenant
D.O.B.: 03/54 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)
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, (April 2007 to
Wheaton, IL 60187 Chief Accounting Present), First Trust
D.O.B.: 01/66 Officer Advisors L.P. and First
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 and
D.O.B.: 05/60 General Counsel, BondWave
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 (September
Wheaton, IL 60187 2005 to July 2012), First
D.O.B.: 02/70 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 L.P.
Suite 400 Chief Compliance o Since inception and First Trust Portfolios
Wheaton, IL 60187 Officer L.P.
D.O.B.: 12/66
- 26 -
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS BY TRUSTEE 5 YEARS
Roger F. Testin Vice President o Indefinite term Senior Vice President, N/A N/A
120 East Liberty Drive, First Trust Advisors L.P.
Suite 400 o Since inception and First Trust Portfolios
Wheaton, IL 60187 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 September
D.O.B.: 11/70 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 First Defined
Portfolio Fund, LLC, open-end funds with 12 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,
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 IV, First Trust Exchange-Traded Fund V, 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 82
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.
- 27 -
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 Funds' 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 Funds' 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
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 Funds' 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
- 28 -
and its committees meet frequently throughout the year to oversee the Funds'
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 also serves 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
Fund. To submit a recommendation for nomination as a candidate for a position on
the Board of Trustees, shareholders of the 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, 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
- 29 -
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 the FUnd hold the same positions with each fund in the
First Trust Fund Complex (representing 111 portfolios) as they hold with the
Fund.
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
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
- 30 -
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), Chairman of the Audit Committee (2012 - 2013) and Chairman of the
Valuation Committee (June 2006 - 2007 and 2010 - 2011) 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
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) and he currently serves as Lead Independent Trustee and on the
Executive Committee (since January 1, 2014) and on the Executive Committee
(since January 31, 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
- 31 -
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.
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
- 32 -
for one fiscal year and the actual compensation paid by the First Trust Fund
Complex 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 THE TOTAL COMPENSATION FROM
NAME OF TRUSTEE FUND(1) THE FIRST TRUST FUND COMPLEX(2)
Richard E. Erickson $1,457 $306,162
Thomas R. Kadlec $1,492 $299,500
Robert F. Keith $1,457 $310,300
Niel B. Nielson $1,674* $304,334
|
(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 12 portfolios of First
Defined Portfolio Fund, LLC, First Trust Series Fund and First Trust
Variable Insurance Trust, open-end funds, 14 closed-end funds and 79
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 IV, First Trust Exchange-Traded Fund V, 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.
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 February 24, 2014, the Independent Trustees of the Trust and
immediate family members did 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 February 24, 2014, the officers and Trustees, in the aggregate,
owned less than 1% of the shares of the Fund.
- 33 -
As of February 28, 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 December 8, 2013. 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 0.70% of its average
daily net assets. First Trust provides fund reporting services to the Fund for a
flat annual fee in the amount of $9,250, which is included in the annual
management fee.
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 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 is 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
- 34 -
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.
Investment Committee. The Investment Committee of First Trust (the
"Investment Committee") is primarily responsible for the day-to-day management
of the Fund. There are currently five members of the Investment Committee, as
follows:
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
Daniel J. Lindquist Managing Director Since 2004 Managing Director (July 2012
to Present), Senior Vice
President (September 2005 to
July 2012), Vice President
(April 2004 to September
2005), First Trust Advisors
L.P. and First Trust
Portfolios L.P.
Jon C. Erickson Senior Vice President Since 1994 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
David G. McGarel Chief Investment Officer Since 1997 Chief Investment Officer (June
and Managing Director 2012 to Present), Managing
Director (July 2012 to
Present), Senior Vice
President (September 2005 to
July 2012), First Trust
Advisors L.P. and First Trust
Portfolios L.P.
Roger F. Testin Senior Vice President Since 2001 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
Stan Ueland Senior Vice President Since 1997 Senior Vice President
(September 2012 to Present),
Vice President (August 2005 to
September 2012), First Trust
Advisors L.P. and First Trust
Portfolios L.P.
|
- 35 -
Daniel J. Lindquist: Mr. Lindquist is Chairman of the Investment Committee
and presides over Investment Committee meetings. Mr. Lindquist is also
responsible for overseeing the implementation of the Fund's investment strategy.
Jon C. Erickson: As the head of First Trust's Equity Research Group, Mr.
Erickson is responsible for determining the securities to be purchased and sold
by funds that do not utilize quantitative investment strategies.
David G. McGarel: As First Trust's Chief Investment Officer, Mr. McGarel
consults with the Investment Committee on market conditions and First Trust's
general investment philosophy.
Roger F. Testin: As head of First Trust's Portfolio Management Group, Mr.
Testin is responsible for executing the instructions of the Strategy Research
Group and Equity Research Group in the Fund's portfolio.
Stan Ueland: Mr. Ueland executes the investment strategy of the Fund.
No member of the Investment Committee beneficially owns any shares of the
Fund.
Compensation. The compensation structure for each member of the Investment
Committee 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 members of the Investment
Committee are not based upon criteria such as performance of the Funds or the
value of assets included in the Funds' portfolios. In addition, Mr. Erickson,
Mr. Lindquist, Mr. McGarel and Mr. Ueland also have an indirect ownership stake
in the firm and will therefore receive their allocable share of
ownership-related distributions.
The Investment Committee manages the investment vehicles (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:
- 36 -
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE
REGISTERED INVESTMENT OTHER POOLED INVESTMENT
COMPANIES VEHICLES
NUMBER OF ACCOUNTS NUMBER OF ACCOUNTS OTHER ACCOUNTS NUMBER OF
INVESTMENT COMMITTEE MEMBER ($ ASSETS) ($ ASSETS) ACCOUNTS ($ ASSETS)
Roger F. Testin 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Jon C. Erickson 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
David G. McGarel 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Daniel J. Lindquist 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Stan Ueland 70 ($18,162,457,152) N/A N/A
|
Conflicts. None of the accounts managed by the Investment Committee 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 Investment Committee's management of the Fund's
investments and the investments of the other accounts managed by the Investment
Committee. However, because the investment strategy of the Fund and the
investment strategies of many of the other accounts managed by the Investment
Committee are based on fairly mechanical investment processes, the Investment
Committee 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 Investment Committee 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 Investment
Committee.
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
- 37 -
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
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 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
- 38 -
such allocations between the Fund and other advisory accounts, the main factors
considered by First Trust are the respective investment objectives, 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.
Administrator. Brown Brothers Harriman & Co ("BBH") serves as
Administrator for the Fund. Its principal address is 40 Water Street, Boston,
Massachusetts 02109.
BBH serves as Administrator for the Trust pursuant to a Fund
Administration and Accounting Agreement. Under such agreement, BBH is obligated
on a continuous basis, to provide such administrative services as the Board of
Trustees reasonably deems necessary for the proper administration of the Trust
and the Fund. BBH will generally assist in all aspects of the Trust's and the
Fund's operations; supply and maintain office facilities (which may be in BBH 's
own offices), statistical and research data, data processing services, clerical,
accounting, bookkeeping and record keeping services (including, without
limitation, the maintenance of such books and records as are required under the
1940 Act and the rules thereunder, except as maintained by other agency agents),
internal auditing, executive and administrative services, and stationery and
office supplies; prepare reports to shareholders or investors; prepare and file
tax returns; supply financial information and supporting data for reports to and
filings with the SEC and various state Blue Sky authorities; supply supporting
documentation for meetings of the Board of Trustees; and provide monitoring
reports and assistance regarding compliance with federal and state securities
laws.
Pursuant to the Fund Administration and Accounting 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 BBH
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 BBH in
the performance of its duties. This fee is subject to reduction for assets over
$1 billion.
CUSTODIAN, TRANSFER AGENT, FUND ACCOUNTING AGENT, DISTRIBUTOR, INDEX PROVIDER
AND EXCHANGE
Custodian, Transfer Agent and Accounting Agent. BBH, as custodian for the
Fund pursuant to a Custody Agreement, holds the Fund's assets. BBH also serves
as transfer agent of the Fund pursuant to an Administrative Agency Agreement. As
the Fund's accounting agent, BBH calculates the net asset value of shares and
calculates net income and realized capital gains or losses. BBH may be
reimbursed by the Funds for its out-of-pocket expenses.
- 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 Funds through the Distributor only in
Creation Unit Aggregations, as described below under the heading "Creation and
Redemption of Creation Unit Aggregations."
First Trust 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. First
Trust's available resources to make these payments include profits from advisory
fees received from the Funds. The services First Trust 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 March
31, 2016.
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
Creation Unit Aggregations of Fund shares. Participating Parties defined in
"Procedures for Creation of Creation Unit Aggregations" below shall be DTC
- 40 -
Participants (as defined in "DTC Acts as Securities Depository for Fund Shares"
below.
Index Provider. The Index Provider is not affiliated with the Fund, First
Trust Portfolios or First Trust. The Fund is entitled to use the Index pursuant
to a sublicensing arrangement by and between the Trust, on behalf of the Fund,
and First Trust, which in turn has a license agreement with the Index Provider.
The Fund is not sponsored, endorsed, sold or promoted by RBA. RBA makes no
representation or warranty, express or implied, to the owners of the Fund or any
member of the public regarding the advisability of trading in the Fund. RBA's
only relationship to First Trust is the licensing of certain trademarks and
trade names of RBA and of the Index which is determined, composed and calculated
by RBA without regard to First Trust or the Fund, RBA has no obligation to take
the needs of First Trust or the owners of the Fund into consideration in
determining, composing or calculating the Index. RBA is not responsible for and
has not participated in the determination of the timing of, prices at, or
quantities of the Fund to be listed or in the determination or calculation of
the equation by which shares of the Fund are to be converted into cash. RBA has
no obligation or liability in connection with the administration, marketing or
trading of the Fund.
RBA DOES NOT GUARANTEE OR MAKE ANY REPRESENTATION OR WARRANTY AS TO THE
ACCURACY AND/OR THE COMPLETENESS OF THE INDEX OR ANY DATA INCLUDED THEREIN AND
RBA SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN.
THE INDEX, ANY DATA CONTAINED THEREIN AND ANY OTHER DATA OR INFORMATION SUPPLIED
BY RBA IS PROVIDED ON AN "AS IS" BASIS. RBA MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY FIRST TRUST, OWNERS OF THE FUND, OR ANY
OTHER PERSON OR ENTITY FROM THE USE OF THE INDEX OR ANY DATA INCLUDED THEREIN.
RBA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL
WARRANTIES, OF MERCHANTABILITY, NON-INFRINGEMENT OR FITNESS FOR A PARTICULAR
PURPOSE OR USE WITH RESPECT TO THE INDEX OR ANY DATA INCLUDED THEREIN, OR ANY
WARRANTIES WITH RESPECT TO THE TIMELINESS, SEQUENCE, ACCURACY, COMPLETENESS,
CURRENTNESS, OR QUALITY OF THE INDEX, ANY DATA CONTAINED THEREIN OR ANY DATA OR
INFORMATION SUPPLIED BY RBA. RBA SHALL NOT BE RESPONSIBLE FOR ANY MISDELIVERY OF
ANY DATA RELATED TO OR ASSOCIATED WITH THE INDEX OR ANY DATA CONTAINED THEREIN.
WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL RBA HAVE ANY LIABILITY
FOR ANY LOST PROFITS OR INDIRECT, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
RBA AND ITS RESPECTIVE AFFILIATES AND EACH OF THEIR RESPECTIVE OFFICERS,
DIRECTORS, EMPLOYEES, AGENTS AND SOURCES (THE "RBA PARTIES") SHALL NOT BE LIABLE
TO FIRST TRUST OR ANY THIRD PARTY FOR ANY LOSS OR DAMAGE, DIRECT, INDIRECT OR
CONSEQUENTIAL, ARISING FROM (A) ANY INACCURACY OR INCOMPLETENESS IN, OR DELAYS,
INTERRUPTIONS, ERRORS OR OMISSIONS IN THE DELIVERY OF THE INDEX OR ANY DATA
- 41 -
CONTAINED THEREIN, OR (B) ANY DECISION MADE OR ACTION TAKEN BY FIRST TRUST OR
ANY THIRD PARTY IN RELIANCE UPON THE FUND, INDEX OR ANY DATA CONTAINED THEREIN.
THERE ARE NO THIRD PARTY BENEFICIARIES OF ANY AGREEMENTS OR ARRANGEMENTS BETWEEN
RBA AND FIRST TRUST.
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
lists the shares of the Fund 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.
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
- 42 -
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.
PROXY VOTING POLICIES AND PROCEDURES
The Trust has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently with the best
interests of the Fund.
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.
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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 A.
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 BBH 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 of 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.
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS
Creation. 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, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
- 44 -
Deposit of Securities and Deposit or Delivery of Cash. The consideration
for purchase of Creation Unit Aggregations of the Fund may consist of (i) cash
in lieu of all or a portion of the Deposit Securities, as defined below; and/or
(ii) a designated portfolio of equity securities determined by First Trust--the
"Deposit Securities"--per each Creation Unit Aggregation constituting a
substantial replication of the stocks included in the underlying index and
generally an amount of cash--the "Cash Component"--computed as described below.
Together, the Deposit Securities and the Cash Component (including the cash in
lieu amount) 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 the net asset value of Fund shares (per Creation Unit Aggregation) and
the "Deposit Amount"--an amount equal to the market value of the Deposit
Securities and/or cash in lieu of all or a portion 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 (discussed below), makes available on each
Business Day, prior to the opening of business of the NYSE (currently 9:30 a.m.,
Eastern Time), the list of the names and the required number of shares of each
Deposit Security to be included in the current Fund Deposit (based on
information at the end of the previous Business Day) for the Fund.
Such Fund Deposit is applicable, subject to any adjustments as described
below, in order to effect creations of Creation Unit Aggregations of the Fund
until such time as the next-announced composition of the Deposit Securities is
made available.
The identity and number of shares of the Deposit Securities required for a
Fund Deposit for the Fund change as rebalancing adjustments and corporate action
events are reflected within the Fund from time to time by First Trust with a
view to the investment objective of the Fund. The composition of the Deposit
Securities may also change in response to adjustments to the weighting or
composition of the component stocks of the underlying index. In addition, the
Trust reserves the right to permit or require the substitution of an amount of
cash--i.e., a "cash in lieu" amount--to be added to the Cash Component to
replace any Deposit Security that may not be available, that may not be
available in sufficient quantity for delivery or which might not be eligible for
trading by an Authorized Participant ("AP") or the investor for which it is
acting or other relevant reason. The adjustments described above will reflect
changes known to First Trust on the date of announcement to be in effect by the
time of delivery of the Fund Deposit, in the composition of the underlying index
or resulting from certain corporate actions.
In addition to the list of names and numbers of securities constituting
the current Deposit Securities of a Fund Deposit, the Custodian, through the
NSCC, also makes available on each Business Day, the estimated Cash Component,
- 45 -
effective through and including the previous Business Day, per outstanding
Creation Unit Aggregation of the Fund.
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), and 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 AP.
Investors should contact the Distributor for the names of APs 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 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 each case on
the date such order is placed in order for 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. In
the case of custom orders, the order must be received by the transfer agent no
later than 3:00 p.m. Eastern Time on the trade date. A custom order may be
placed by an AP in the event that the Trust permits or requires the substitution
of an amount of cash to be added to the Cash Component to replace any Deposit
Security which may not be available in sufficient quantity for delivery or which
may not be eligible for trading by such AP or the investor for which it is
acting or other relevant reason. 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 AP by telephone or other transmission method acceptable to
the transfer agent pursuant to procedures set forth in the Participant
Agreement. Severe economic or market disruptions or changes, or telephone or
other communication failure may impede the ability to reach the transfer agent
or an AP.
All orders from investors who are not APs to create Creation Unit
Aggregations shall be placed with an AP, as applicable, in the form required by
such AP. In addition, the AP 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 AP 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.
Placement of Creation Orders. In order to purchase Creation Units of a
Fund, an AP must submit an order to purchase for one or more Creation Units. All
such orders must be received by a Fund's transfer agent in proper form no later
than the close of regular trading on the NYSE (ordinarily 4:00 p.m. Eastern
- 46 -
Time) in order to receive that day's closing net asset value per share. Orders
must be placed in proper form by or through an AP, which is a DTC Participant,
i.e., a subcustodian of the Trust. Deposit Securities must be delivered to the
Trust through DTC or NSCC, and 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. If a Deposit Security is an American Depository Receipt ("ADR")
or similar domestic instrument, it may be delivered to the Custodian. The AP
must also pay on or before the International Contractual Settlement Date
immediately available or same-day funds estimated by the Trust to be sufficient
to pay the Cash Component next determined after acceptance of the creation
order, together with the applicable Creation Transaction Fee and additional
variable amounts, as described below. 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 such Fund
are customarily traded. A custom order may be placed by an AP in the event that
a Fund permits or requires the substitution of an amount of cash to be added to
the Cash Component (if applicable) to replace any Deposit Security which may not
be available in sufficient quantity for delivery or which may not be eligible
for trading by such AP or the investor for which it is acting or any other
relevant reason.
The AP must also make available no later than 2:00 p.m., Eastern Time, on
the International Contractual Settlement Date, by means satisfactory to the
Trust, immediately-available or same-day funds estimated by the Trust to be
sufficient to pay the Cash Component next determined after acceptance of the
purchase order, together with the applicable purchase transaction fee. Any
excess funds will be returned following settlement of the issue of the Creation
Unit Aggregation.
A Creation Unit Aggregation will not be issued until the transfer of good
title to the Trust of the portfolio of Deposit Securities, the payment of the
Cash Component, the payment of any other cash amounts and the Creation
Transaction Fee (as defined below) have been completed. When the required
Deposit Securities which are U.S. securities have been delivered to the Trust
through DTC or NSCC, and Deposit Securities which are non-U.S. securities have
been delivered to the Custodian and each relevant subcustodian confirms to the
Custodian that the required Deposit Securities which are non-U.S. securities
(or, when permitted in the sole discretion of Trust, the cash in lieu thereof)
have been delivered to the account of the relevant subcustodian, the Custodian
shall notify the Distributor and the transfer agent which, acting on behalf of
the Trust, will issue and cause the delivery of the Creation Unit Aggregations.
The Trust may in its sole discretion permit or require the substitution of an
amount of cash (i.e., a "cash in lieu" amount) to be added to the Cash Component
to replace any Deposit Security which may not be available in sufficient
quantity for delivery or for other relevant reasons. If the Distributor, acting
on behalf of the Trust, determines that a "cash in lieu" amount will be
accepted, the Distributor will notify the AP and the transfer agent, and the AP
shall deliver, on behalf of itself or the party on whose behalf it is acting,
the "cash in lieu" amount, with any appropriate adjustments as advised by the
Trust as discussed below.
- 47 -
In the event that an order for a Creation Unit is incomplete on the
International Contractual Settlement Date 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 AP 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. The Trust may permit, in its discretion, the AP to
substitute a different security in lieu of depositing some or all of the Deposit
Securities. Substitution of cash or a different security might be permitted or
required, for example, because one or more Deposit Securities may be unavailable
in the quantity needed or may not be eligible for trading by the AP due to local
trading restrictions or other restrictions.
To the extent contemplated by the applicable Participant Agreement,
Creation Unit Aggregations of the Fund will be issued to such AP notwithstanding
the fact that the corresponding Fund Deposits have not been received in part or
in whole, in reliance on the undertaking of the AP to deliver the missing
Deposit Securities as soon as possible, which undertaking shall be secured by
such AP'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. Such cash collateral must be
delivered no later than 2:00 p.m., Eastern Time, on the contractual settlement
date. The Participant Agreement will permit the Fund to buy the missing Deposit
Securities at any time and will subject the AP 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 Deposit
Securities delivered are not as disseminated for that date by the Custodian, as
described above; (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 counsel, be unlawful; (vi) acceptance of the Fund Deposit
would otherwise, in the discretion of the Trust or First Trust, have an adverse
effect on the Trust, the Fund or the rights of Beneficial Owners; or (vii)
circumstances outside the control of the Trust, the Custodian, the Distributor
and First Trust make it for all practical purposes impossible to process
creation orders. Examples of such circumstances include acts of God; 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, First Trust, the
Distributor, DTC, NSCC, the Custodian or sub-custodian or any other participant
in the creation process, and similar extraordinary events. In addition, an order
may be rejected for practical reasons such as 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 or
systems failures involving computer or other information systems affecting any
relevant sub-custodian. The Distributor shall notify a prospective creator of a
Creation Unit and/or the AP acting on behalf of such prospective creator of its
rejection of the order of such person. The Trust, the Custodian, any
- 48 -
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 number of shares 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 $500. 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 Creation Transaction Fee may increase or decrease as the Fund's
portfolio is adjusted to conform to changes in the composition of the Index. 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 AP to substitute cash or a different
security in lieu of depositing one or more of the requisite Deposit Securities,
the AP may also be assessed an amount to cover the cost of purchasing the
Deposit Securities and/or disposing of the substituted 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 and/or substitute securities.
As discussed above, shares of the Fund may be issued in advance of receipt
of all 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.
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. A redeeming beneficial owner must maintain
appropriate security arrangements with a broker-dealer, bank or other custody
provider in each jurisdiction in which any of the portfolio securities are
customarily traded. If such arrangements cannot be made, or it is not possible
to effect deliveries of the portfolio securities in a particular jurisdiction or
under certain other circumstances (for example, holders may incur unfavorable
tax treatment in some countries if they are entitled to receive "in-kind"
redemption proceeds), Fund shares may be redeemed for cash at the discretion of
First Trust.
- 49 -
With respect to the Fund, the Custodian, through the NSCC, makes available
prior to the opening of business on the NYSE (currently 9:30 a.m. Eastern Time)
on each Business Day, the identity of the Fund Securities (as defined below)
that will be applicable (subject to possible amendment or correction) to
redemption requests received in proper form (as described below) on that day.
Fund Securities (as defined below) received on redemption may not be identical
to Deposit Securities that are applicable to creations of Creation Unit
Aggregations.
Unless cash redemptions are available or specified for the Fund, the
redemption proceeds for a Creation Unit Aggregation generally consist of a
portfolio of securities ("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
being redeemed, as next determined after a receipt of a request in proper form,
and the 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 a value greater than the net asset value of
the Fund shares, 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 AP by the redeeming shareholder.
The right of redemption may be suspended or the date of payment postponed
(i) for any period during which the NYSE is closed (other than customary weekend
and holiday closings); (ii) for any period during which trading on the NYSE 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
$500. The Redemption Transaction Fee is applicable to each redemption
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. The Redemption Transaction Fee may
increase or decrease as the Fund's portfolio is adjusted to conform to changes
in the composition of the Index. The Fund reserves the right to effect
redemptions in cash. A shareholder may request a cash redemption in lieu of
securities; however, the Fund may, in its discretion, reject any such request.
Investors will also bear the costs of transferring the Fund Securities from the
Trust to their account or on their order. Investors who use the services of a
broker or other such intermediary in addition to an AP 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 AP that has executed a Participant
Agreement. Investors other than APs are responsible for making arrangements for
a redemption request to be made through an AP. An order to redeem Creation Unit
Aggregations of the Fund is deemed received by the Trust on the Transmittal Date
if: (i) such order is received by BBH (in its capacity as transfer agent) not
- 50 -
later than the Closing Time on the Transmittal Date; (ii) such order is
accompanied or followed by the requisite number of shares of the Fund specified
in such order, which delivery must be made through DTC to BBH; and (iii) all
other procedures set forth in the Participant Agreement are properly followed.
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. 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 on which the Fund may rely, the Fund's in-kind redemption
proceeds must 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 generally
no later than 12 calendar days following tender of a Creation Unit Aggregation.
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 AP
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 AP's agreement, in the event the AP 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 will nonetheless accept the redemption request in
reliance on the undertaking by the AP to deliver the missing shares as soon as
possible. Such undertaking shall be secured by the AP's delivery and 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 BBH and marked to
market daily, and that the fees of BBH and any sub-custodians in respect of the
delivery, maintenance and redelivery of the cash collateral shall be payable by
the AP. If the AP'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 AP 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 BBH
according to the procedures set forth in this SAI under "Determination of Net
- 51 -
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 BBH 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 BBH prior to the "DTC Cut-Off-Time," then the value of the Fund Securities
and the Cash Redemption Amount to be delivered will be determined by BBH on such
Transmittal Date. If, however, a redemption order is submitted to BBH by a DTC
Participant not later than the Closing Time on the Transmittal Date but either
(i) the requisite number of shares of the Fund are not delivered by the DTC
Cut-Off-Time, as described above, on such Transmittal Date; or (ii) the
redemption order is not submitted in proper form, then the redemption order will
not be deemed received as of the Transmittal Date. In such case, the value of
the Fund Securities and the Cash Redemption Amount to be delivered/received will
be computed on the Business Day that such order is deemed received by the Trust,
i.e., the Business Day on which the shares of the Fund are delivered through DTC
to BBH by the "DTC Cut-Off-Time" on such Business Day pursuant to a properly
submitted redemption order.
If it is not possible to effect deliveries of the Fund Securities, the
Trust may in its discretion exercise its option to redeem such Fund shares in
cash, and the redeeming Beneficial Owner will be required to receive its
redemption proceeds in cash. In addition, an investor may request a redemption
in cash that the Fund may, in its sole discretion, permit. In either case, the
investor will receive a cash payment equal to the net asset value of its Fund
shares based on the net asset value of shares of the relevant Fund next
determined after the redemption request is received in proper form (minus a
redemption transaction fee and additional charge for requested cash redemptions
specified above, to offset the Trust's brokerage and other transaction costs
associated with the disposition of Fund Securities). The Fund may also, in its
sole discretion, upon request of a shareholder, provide such redeemer a
portfolio of securities that differs from the exact composition of the Fund
Securities, or cash in lieu of some securities added to the Cash Component, but
in no event will the total value of the securities delivered and the cash
transmitted differ from the net asset value.
Redemptions of Fund shares for Fund Securities will be subject to
compliance with applicable federal and state securities laws and the Fund
(whether or not it otherwise permits cash redemptions) reserves the right to
redeem Creation Unit Aggregations for cash to the extent that the Trust could
not lawfully deliver specific Fund Securities upon redemptions or could not do
so without first registering the Fund Securities under such laws. An AP or an
investor for which it is acting subject to a legal restriction with respect to a
particular stock included in the Fund Securities applicable to the redemption of
a Creation Unit Aggregation may be paid an equivalent amount of cash. The AP 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.
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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,
(i) 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; (ii) diversify its holdings so that, at the end of each quarter of
the taxable year, (a) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. government
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 (b) 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 (iii) 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.
- 53 -
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. However, certain ordinary income distributions received from the Fund
may be taxed at capital gains tax rates. In particular, 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, provided that certain holding period requirements are satisfied
and provided the dividends are attributable to qualifying dividends received by
the Fund itself. Dividends received by the Fund from foreign corporations and
from REITs are qualifying dividends eligible for this lower tax rate only in
certain circumstances.
The Fund will provide notice to its shareholders of the amount of any
distributions that may be taken into account as a dividend, which is eligible
for the capital gains tax rates. The Fund cannot make any guarantees as to the
amount of any distribution, which will be regarded as a qualifying dividend.
- 54 -
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. However, certain ordinary
income dividends on shares that are attributable to qualifying dividends
received by the Fund from certain domestic corporations may be reported by the
Fund as being eligible for the dividends received deduction.
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 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.
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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 (i) 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 (ii) 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
- 56 -
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
- 57 -
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.
In addition, capital gains distributions attributable to gains from U.S.
real property interests (including certain U.S. real property holding
corporations) will generally be subject to United States withholding tax and
will give rise to an obligation on the part of the foreign shareholder to file a
United States tax return.
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.
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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.
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 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.
- 59 -
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 on an amortized cost basis.
(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, that 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. Use of fair value prices and certain current market valuations could
result in a difference between the prices used to calculate the Fund's net asset
value and the prices used by the Index, which, in turn, could result in a
difference between the Fund's performance and the performance of the Index.
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.
- 60 -
The Fund may suspend the right of redemption for the Fund only under the
following unusual circumstances: (i) when the NYSE is closed (other than
weekends and holidays) or trading is restricted; (ii) 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 (iii) 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."
General Policies. Dividends from net investment income of the Fund, if
any, are declared and paid quarterly. 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.
- 61 -
APPENDIX A - PROXY VOTING GUIDELINES
2014 U.S. Proxy Voting Concise Guidelines
December 19, 2013
Institutional Shareholder Services Inc.
- 62 -
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
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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.
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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
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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.
2. Responsiveness
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.
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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.
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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.
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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
o 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
SHAREHOLDER RIGHTS & DEFENSES
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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
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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.
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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:
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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
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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.
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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:
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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.
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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
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o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
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
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o Recent amendments that incorporate any problematic features (such as
those above) or recent actions (such as extraordinary equity grants)
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;
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o If the company has already responded in an appropriate and sufficient
manner to the issue(s) raised in the proposal;
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.
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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.
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.
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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
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
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STATEMENT OF ADDITIONAL INFORMATION
INVESTMENT COMPANY ACT FILE NO. 811-22717
FIRST TRUST EXCHANGE-TRADED FUND VI
TICKER
FUND NAME SYMBOL EXCHANGE
FIRST TRUST RBA QUALITY INCOME ETF QINC The NASDAQ(R) Stock Market
|
DATED MARCH 11, 2014
This Statement of Additional Information ("SAI") is not a prospectus. It
should be read in conjunction with the prospectus dated March 11, 2014, as it
may be revised from time to time (the "Prospectus"), for First Trust RBA Quality
Income ETF (the "Fund"), a series of the First Trust Exchange-Traded Fund VI
(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..........................................................6
SUBLICENSE AGREEMENTS.........................................................17
INVESTMENT RISKS .............................................................18
FUND MANAGEMENT ..............................................................26
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE......................................39
BROKERAGE ALLOCATIONS.........................................................39
CUSTODIAN, TRANSFER AGENT, FUND ACCOUNTING AGENT, DISTRIBUTOR, INDEX
PROVIDER.................................................................41
ADDITIONAL INFORMATION........................................................44
PROXY VOTING POLICIES AND PROCEDURES..........................................45
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS.........................46
REGULAR HOLIDAYS .............................................................55
FEDERAL TAX MATTERS ..........................................................60
DETERMINATION OF NET ASSET VALUE..............................................66
DIVIDENDS AND DISTRIBUTIONS...................................................68
MISCELLANEOUS INFORMATION.....................................................68
|
EXHIBIT A - PROXY VOTING GUIDELINES...........................................69
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GENERAL DESCRIPTION OF THE TRUST AND THE FUND
The Trust was organized as a Massachusetts business trust on June 4, 2012,
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 eight series, including the Fund, 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. (the "Advisor" or "First
Trust").
The shares of the Fund list and principally trade on The NASDAQ(R)
Stock Market ("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 equity securities (the
"Deposit Securities") included in the Fund's Index (as hereinafter defined),
together with the deposit of a specified cash payment (the "Cash Component").
Shares are redeemable only in Creation Unit Aggregations and, generally, in
exchange for portfolio securities and a specified cash payment. 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 NASDAQ(R) necessary
to maintain the listing of shares of the Fund will continue to be met. NASDAQ(R)
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; (ii) the value of the Fund's
Index (as defined below) is no longer calculated or available; or (iii) such
other event shall occur or condition exist that, in the opinion of NASDAQ(R)
makes further dealings on the Exchange inadvisable. NASDAQ(R) 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 NASDAQ(R), brokers'
commissions on transactions will be based on negotiated commission rates at
customary levels.
- 3 -
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
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 of the outstanding
voting securities (as such term is defined in the 1940 Act) 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
- 4 -
from investing in securities or other instruments backed by physical
commodities).
(7) The Fund may not invest 25% or more of the value of its total
assets in securities of issuers in any one industry or group of
industries, except to the extent that the Index that the Fund is based
upon concentrates in an industry or a group of industries. 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.
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 borrowings 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.
Except for restriction (2), 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).
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 policies and may be changed by the Board of Trustees.
- 5 -
INVESTMENT STRATEGIES
Under normal circumstances, the Fund will invest at least 90% of its net
assets (plus any borrowings for investment purposes) in U.S. equity securities,
which represent the securities in the Richard Bernstein Advisors Quality Income
Index (the "Index"). Fund shareholders are entitled to 60 days' notice prior to
any change in this non-fundamental investment policy.
TYPES OF INVESTMENTS
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 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 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, such
descriptions are not all-inclusive. 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.
Equities. To the extent disclosed in the Prospectus, the Fund intends to
invest in equity securities. Equity securities represent an ownership position
in a company. The prices of equity securities fluctuate based on, among other
things, events specific to their issuers and market, economic, and other
conditions. Equity securities in which the Fund invests may include common and
preferred stocks. Common stocks include the common stock of any class or series
of a domestic or foreign corporation or any similar equity interest, such as a
trust or partnership interest. These investments may or may not pay dividends
and may or may not carry voting rights. Common stock occupies the most junior
- 6 -
position in a company's capital structure. The Funds may also invest in warrants
and rights related to common stocks.
The Fund may also invest in preferred equity securities. Preferred stock,
unlike common stock, offers a stated dividend rate payable from the issuer's
earnings. Preferred stock dividends may be cumulative or non-cumulative,
participating or action rate. If interest rates rise, the fixed dividend on
preferred stocks may be less attractive, causing the price of preferred stocks
to decline. Preferred stock may have mandatory sinking fund provisions, as well
as call/redemption provisions prior to maturity, a negative feature when
interest rates decline.
Depositary Receipts. The Funds' investments may include securities of
foreign issuers in the form of sponsored or unsponsored American Depositary
Receipts ("ADRs"), Global Depositary Receipts ("GDRs"), and European Depositary
Receipts ("EDRs"). ADRs are depositary receipts normally issued by a United
States bank or trust company that evidence ownership of underlying securities
issued by a foreign corporation. EDRs and GDRs are typically issued by foreign
banks or trust companies, although they also may be issued by United States
banks or trust companies, and evidence ownership of underlying securities issued
by either a foreign or a United States corporation. Generally, depositary
receipts in registered form are designed for use in the United States securities
market. Depositary receipts in bearer form are designed for use in securities
markets outside the United States. Depositary receipts may not necessarily be
denominated in the same currency as the underlying securities into which they
may be converted. Ownership of unsponsored depositary receipts may not entitle a
Fund to financial or other reports from the issuer of the underlying security,
to which it would be entitled as the owner of sponsored depositary receipts.
Fixed Income Investments and Cash Equivalents. Normally, the Fund invests
substantially all of its assets to meet its investment objectives; 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 that 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
- 7 -
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 FNMA. 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.
(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
- 8 -
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
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 objective 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.
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 the 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
- 9 -
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 the
Advisor the day-to-day determination of the illiquidity of any equity or
fixed-income security, although it has retained oversight and ultimate
responsibility for such determinations. With respect to Rule 144A securities,
First Trust considers 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.
Money Market Funds. The Funds may invest in shares of money market funds
to the extent permitted by the 1940 Act.
Non-U.S. Investments. Non-U.S. securities include securities issued or
guaranteed by companies organized under the laws of countries other than the
United States (including emerging markets), 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.
These securities may be issued by companies domiciled in the United States, U.S.
dollar-denominated depositary receipts, U.S. dollar-denominated foreign
securities. Non-U.S. securities also include U.S. dollar-denominated debt
obligations, such as "Yankee Dollar" obligations, of foreign issuers and of
supra-national government entities. Yankee Dollar obligations are U.S. dollar-
denominated obligations issued in the U.S. capital markets by foreign
corporations, banks and governments. Foreign securities also may be traded on
foreign securities exchanges or in over-the-counter ("OTC") capital markets.
Certain of the Fund's investment in foreign securities may be denominated
in currencies other than the U.S. dollar. To the extent the Fund invests in such
instruments, the value of the assets of the Fund as measured in U.S. dollars
will be affected by changes in exchange rates. Generally, the Fund's currency
exchange transactions will be conducted on a spot (i.e., cash) basis at the spot
- 10 -
rate prevailing in the currency exchange market. The cost of the Fund's currency
exchange transactions will generally be the difference between the bid and offer
spot rate of the currency being purchased or sold. In order to protect against
uncertainty in the level of future currency exchange rates, the Fund is
authorized to enter into various currency exchange transactions.
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.
LENDING OF PORTFOLIO SECURITIES
In order to generate additional income, as a non-principal investment
strategy, First Trust is authorized to select the Funds, with notice to the
Board of Trustees, to lend portfolio securities representing up to 33 1/3% of
the value of their total assets 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 that First Trust has determined are creditworthy under guidelines
established 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. First Trust
may select the Fund to participate in the securities lending program, at its
discretion with notice to the Board of Trustees.
In these loan arrangements, the Fund will receive collateral in the form
of cash, U.S. government securities or other high-grade debt obligations 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 long-term capital gains, even if the actual
dividends would have constituted qualified dividends had the Fund held the
securities.
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HEDGING STRATEGIES
General Description of Hedging Strategies
The Fund may engage in hedging activities. First Trust may cause the Fund
to utilize a variety of financial instruments, including options, forward
contracts, futures contracts (hereinafter referred to as "Futures" or "Futures
Contracts"), and options on Futures Contracts to attempt to hedge the Fund's
holdings. The use of Futures is not a part of a principal investment strategy of
the Fund.
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.
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 the Advisor 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 as
currently in effect, the Fund limits its trading activity in Futures, option 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.
The Advisor 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 their net assets would be committed to such
instruments. If the Fund were no longer able to claim the exclusion, the Advisor
would be required to register as a "commodity pool operator," and the Fund and
the Advisor would be subject to regulation under the Commodity Exchange Act (the
"CEA").
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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
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, 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
the 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
- 13 -
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.
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 equity 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
- 14 -
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.
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
- 15 -
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.
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
- 16 -
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,
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.
SUBLICENSE AGREEMENT
The Trust on behalf of the Fund relies on a product license agreement (the
"Product License Agreement") by and between Richard Bernstein Advisors LLC
("RBA" or the "Index Provider") and First Trust and a related sublicense
agreement (the "Sublicense Agreement") with First Trust that grants the Trust,
on behalf of the Fund, a non-exclusive and non-transferable sublicense to use
certain intellectual property of the Index Provider, in connection with the
issuance, distribution, marketing and/or promotion of the Fund. Pursuant to the
- 17 -
Sublicense Agreement, the Fund has agreed to be bound by certain provisions of
the Product License Agreement.
INVESTMENT RISKS
Overview
An investment in the 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 equity securities or the general
condition of the securities market may worsen and the value of the securities
and therefore the value of the Fund may decline. The 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 the Fund is not predictive of
their future performance.
Common Stocks
Equity securities are especially susceptible to general market movements
and to volatile increases and decreases of value as market confidence in and
perceptions of the issuers change. These perceptions are based on unpredictable
factors including expectations regarding government, economic, monetary and
fiscal policies, inflation and interest rates, economic expansion or
contraction, and global or regional political, economic or banking crises. First
Trust cannot predict the direction or scope of any of these factors.
Shareholders of common stocks have rights to receive payments from the issuers
of those common stocks that are generally subordinate to those of creditors of,
or holders of debt obligations or preferred stocks of, such issuers.
Shareholders of common stocks of the type held by the Fund have a right to
receive dividends only when and if, and in the amounts, declared by the issuer's
board of directors and have a right to participate in amounts available for
distribution by the issuer only after all other claims on the issuer have been
paid. Common stocks do not represent an obligation of the issuer and, therefore,
do not offer any assurance of income or provide the same degree of protection of
capital as do debt securities. The issuance of additional debt securities or
preferred stock will create prior claims for payment of principal, interest and
dividends which could adversely affect the ability and inclination of the issuer
to declare or pay dividends on its common stock or the rights of holders of
common stock with respect to assets of the issuer upon liquidation or
bankruptcy. The value of common stocks is subject to market fluctuations for as
long as the common stocks remain outstanding, and thus the value of the equity
securities in the Fund will fluctuate over the life of the Fund and may be more
or less than the price at which they were purchased by the Fund. The equity
securities held in the Fund may appreciate or depreciate in value (or pay
dividends) depending on the full range of economic and market influences
affecting these securities, including the impact of the Fund's purchase and sale
of the equity securities and other factors.
- 18 -
Holders of common stocks incur more risk than holders of preferred stocks
and debt obligations because common stockholders, as owners of the entity, have
generally inferior rights to receive payments from the issuer in comparison with
the rights of creditors of, or holders of debt obligations or preferred stocks
issued by, the issuer. Cumulative preferred stock dividends must be paid before
common stock dividends and any cumulative preferred stock dividend omitted is
added to future dividends payable to the holders of cumulative preferred stock.
Preferred stockholders are also generally entitled to rights on liquidation,
which are senior to those of common stockholders.
Dividends Risk
Shareholders of common stocks have rights to receive payments from the
issuers of those common stocks that are generally subordinate to those of
creditors of, or holders of debt obligations or preferred stocks of, such
issuers. Shareholders of common stocks of the type held by the Fund have a right
to receive dividends only when and if, and in the amounts, declared by the
issuer's board of directors and have a right to participate in amounts available
for distribution by the issuer only after all other claims on the issuer have
been paid or have otherwise been settled. Common stocks do not represent an
obligation of the issuer and, therefore, do not offer any assurance of income or
provide the same degree of protection of capital, as do debt securities. The
issuance of additional debt securities or preferred stock will create prior
claims for payment of principal, interest and dividends which could adversely
affect the ability and inclination of the issuer to declare or pay dividends on
its common stock or the rights of holders of common stock with respect to assets
of the issuer upon liquidation or bankruptcy. Cumulative preferred stock
dividends must be paid before common stock dividends, and any cumulative
preferred stock dividend omitted is added to future dividends payable to the
holders of cumulative preferred stock. Preferred stockholders are also generally
entitled to rights on liquidation that are senior to those of common
stockholders.
Depositary Receipts Risk
The Fund may hold securities of certain non-U.S. companies in the form of
Depositary Receipts. Depositary Receipts may not necessarily be denominated in
the same currency as the underlying securities into which they may be converted.
ADRs are receipts typically issued by an American bank or trust company that
evidence ownership of underlying securities issued by a foreign corporation.
EDRs are receipts issued by a European bank or trust company evidencing
ownership of securities issued by a foreign corporation. New York shares are
typically issued by a company incorporated in the Netherlands and represent a
direct interest in the company. Unlike traditional, New York share programs
do not involve custody of the Dutch shares of the company. GDRs are
receipts issued throughout the world that evidence a similar arrangement.
ADRs, EDRs and GDRs may trade in foreign currencies that differ from the
currency the underlying security for each ADR, EDR or GDR principally trades in.
Global shares are the actual (ordinary) shares of a non-U.S. company which trade
both in the home market and the United States. Generally, ADRs and New York
shares, in registered form, are designed for use in the U.S. securities markets.
EDRs, in registered form, are used to access European markets. GDRs, in
registered form, are tradable both in the United States and in Europe and are
designed for use throughout the world. Global shares are represented by the same
- 19 -
share certificate in the United States and the home market. Separate registrars
in the United States and the home country are maintained. In most cases,
purchases occurring on a U.S. exchange would be reflected on the U.S. registrar.
Global shares may also be eligible to list on exchanges in addition to the
United States and the home country. The Fund may hold unsponsored Depositary
Receipts. The issuers of unsponsored Depositary Receipts are not obligated to
disclose material information in the United States; therefore, there may be less
information available regarding such issuers and there may not be a correlation
between such information and the market value of the Depositary Receipts.
Financials Concentration Risk
Major determinants of future earnings of companies in the financial
services sector are the direction of the stock market, investor confidence,
equity transaction volume, the level and direction of long-term and short-term
interest rates, and the outlook for emerging markets. Negative trends in any of
these earnings determinants could have a serious adverse effect on the financial
stability, as well as the stock prices, of these companies. Furthermore, there
can be no assurance that the issuers of the Securities included in the Fund will
be able to respond in a timely manner to compete in the rapidly developing
marketplace. In addition to the foregoing, profit margins of these companies
continue to shrink due to the commoditization of traditional businesses, new
competitors, capital expenditures on new technology and the pressures to compete
globally.
Banks. Banks, thrifts and their holding companies are especially subject
to the adverse effects of economic recession; volatile interest rates; portfolio
concentrations in geographic markets, in commercial and residential real estate
loans or any particular segment or industry; and competition from new entrants
in their fields of business. Banks and thrifts are highly dependent on net
interest margin. Banks and thrifts traditionally receive a significant portion
of their revenues from consumer mortgage fee income because of activity in
mortgage and refinance markets. As home purchasing and refinancing activity has
subsided, this revenue has diminished. Economic conditions in the real estate
markets have deteriorated, leading to asset write-offs and decreased liquidity
in the credit markets, which can have a substantial negative effect upon banks
and thrifts because they generally have a portion of their assets invested in
loans secured by real estate. Difficulties in the mortgage and broader credit
markets have resulted in decreases in the availability of funds. Financial
performance of many banks and thrifts, especially in securities collateralized
by mortgage loans, has deteriorated.
Banks, thrifts and their holding companies are subject to extensive
federal regulation and, when such institutions are state-chartered, to state
regulation as well. Such regulations impose strict capital requirements and
limitations on the nature and extent of business activities that banks and
thrifts may pursue. Furthermore, bank regulators have a wide range of discretion
in connection with their supervisory and enforcement authority and may
substantially restrict the permissible activities of a particular institution if
deemed to pose significant risks to the soundness of such institution or the
safety of the federal deposit insurance fund. Regulatory actions, such as
increases in the minimum capital requirements applicable to banks and thrifts
and increases in deposit insurance premiums required to be paid by banks and
thrifts to the Federal Deposit Insurance Corporation (the "FDIC"), can
- 20 -
negatively affect earnings and the ability of a company to pay dividends.
Neither federal insurance of deposits nor governmental regulations, however,
insure the solvency or profitability of banks or their holding companies, or
insures against any risk of investment in the securities issued by such
institutions.
In light of the current credit market difficulties, the U.S. Government is
considering changes to the laws and regulatory structure. New legislation and
regulatory changes could cause business disruptions, result in significant loss
of revenue, limit financial firms' ability to pursue business opportunities,
impact the value of business assets and impose additional costs that may
adversely affect business. There can be no assurance as to the actual impact
these laws and their implementing regulations, or any other governmental
program, will have on the financial markets. Currently the Federal Reserve
Board, the FDIC, the SEC, Office of Comptroller of the Currency (a bureau of the
Department of the U.S. Treasury (the "U.S. Treasury") which regulates national
banks), and the CFTC all play a role in the supervision of the financial
markets. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection
Act ("Dodd-Frank Act"), signed into law in 2010, financial firms are subject to
increased scrutiny concerning their capital, liquidity, and risk management
standards. Certain provisions of the Dodd-Frank Act would create a national bank
supervisor to conduct prudential supervision regulation of all federally
chartered depository institutions, and all federal branches and agencies of
foreign banks. This single regulator would oversee the entire banking industry,
thereby leading to potential risks, costs and unknown impacts on the entire
financial sector.
The SEC and the Financial Accounting Standards Board ("FASB") require the
expanded use of market value accounting by banks and have imposed rules
requiring mark-to-market accounting for investment securities held in trading
accounts or available for sale. Adoption of additional rules may result in
increased volatility in the reported health of the industry, and mandated
regulatory intervention to correct such problems. FASB Accounting Standards
Codification 820, "Fair Value Measurement" changed the requirements of
mark-to-market accounting and determining fair value when the volume and level
of activity for the asset or liability has significantly decreased. These
changes and other potential changes in financial accounting rules and valuation
techniques may have a significant impact on the banking and financial services
industries in terms of accurately pricing assets or liabilities.
Insurance. The Fund may invest in companies involved in the insurance
industry, which are engaged in underwriting, reinsuring, selling, distributing
or placing of property and casualty, life or health insurance. Other growth
areas within the insurance industry include brokerage, reciprocals, claims
processors and multi-line insurance companies. Interest rate levels, general
economic conditions and price and marketing competition affect insurance company
profits. Property and casualty insurance profits may also be affected by weather
catastrophes and other disasters. Life and health insurance profits may be
affected by mortality and morbidity rates. Individual companies may be exposed
to material risks including reserve inadequacy and the inability to collect from
reinsurance carriers. Insurance companies are subject to extensive governmental
regulation, including the imposition of maximum rate levels, which may not be
adequate for some lines of business. Proposed or potential tax law changes may
also adversely affect insurance companies' policy sales, tax obligations, and
profitability. In addition to the foregoing, profit margins of these companies
continue to shrink due to the commoditization of traditional businesses, new
competitors, capital expenditures on new technology and the pressures to compete
- 21 -
globally. In addition to the normal risks of business, companies involved in the
insurance industry are subject to significant risk factors, including those
applicable to regulated insurance companies, such as: (i) the inherent
uncertainty in the process of establishing property-liability loss reserves,
particularly reserves for the cost of environmental, asbestos and mass tort
claims, and the fact that ultimate losses could materially exceed established
loss reserves which could have a material adverse effect on results of
operations and financial condition; (ii) the fact that insurance companies have
experienced, and can be expected in the future to experience, catastrophe losses
which could have a material adverse impact on their financial condition, results
of operations and cash flow; (iii) the inherent uncertainty in the process of
establishing property-liability loss reserves due to changes in loss payment
patterns caused by new claims settlement practices; (iv) the need for insurance
companies and their subsidiaries to maintain appropriate levels of statutory
capital and surplus, particularly in light of continuing scrutiny by rating
organizations and state insurance regulatory authorities, and in order to
maintain acceptable financial strength or claims-paying ability rating; (v) the
extensive regulation and supervision to which insurance companies' subsidiaries
are subject, various regulatory initiatives that may affect insurance companies,
and regulatory and other legal actions; (vi) the adverse impact that increases
in interest rates could have on the value of an insurance company's investment
portfolio and on the attractiveness of certain of its products; (vii) the need
to adjust the effective duration of the assets and liabilities of life insurance
operations in order to meet the anticipated cash flow requirements of its
policyholder obligations; (viii) the uncertainty involved in estimating the
availability of reinsurance and the collectability of reinsurance recoverables;
and (ix) proposed legislation that would establish the Office of National
Insurance within the U.S. Treasury. This proposed federal agency would gather
information, develop expertise, negotiate international agreements, and
coordinate policy in the insurance sector. This enhanced oversight into the
insurance industry may pose unknown risks to the sector as a whole.
The state insurance regulatory framework has, during recent years, come
under increased federal scrutiny, and certain state legislatures have considered
or enacted laws that alter and, in many cases, increase state authority to
regulate insurance companies and insurance holding company systems. Further, the
National Association of Insurance Commissioners and state insurance regulators
are re-examining existing laws and regulations, specifically focusing on
insurance companies, interpretations of existing laws and the development of new
laws. In addition, Congress and certain federal agencies have investigated the
condition of the insurance industry in the United States to determine whether to
promulgate additional federal regulation. The Advisor is unable to predict
whether any state or federal legislation will be enacted to change the nature or
scope of regulation of the insurance industry, or what effect, if any, such
legislation would have on the industry.
All insurance companies are subject to state laws and regulations that
require diversification of their investment portfolios and limit the amount of
investments in certain investment categories. Failure to comply with these laws
and regulations would cause non-conforming investments to be treated as
non-admitted assets for purposes of measuring statutory surplus and, in some
instances, would require divestiture.
While current federal income tax law permits the tax-deferred accumulation
of earnings on the premiums paid by an annuity owner and holders of certain
- 22 -
savings-oriented life insurance products, no assurance can be given that future
tax law will continue to allow such tax deferrals. If such deferrals were not
allowed, consumer demand for the affected products would be substantially
reduced. In addition, proposals to lower the federal income tax rates through a
form of flat tax or otherwise could have, if enacted, a negative impact on the
demand for such products.
Investment Banks. The Fund may invest in companies engaged in investment
banking/brokerage and investment management, which include brokerage firms,
broker/dealers, investment banks, finance companies and mutual fund companies.
Earnings and share prices of companies in this industry are quite volatile, and
often exceed the volatility levels of the market as a whole. Negative economic
events in the credit markets have led some firms to declare bankruptcy, forced
short-notice sales to competing firms, or required government intervention by
the FDIC or through an infusion of Troubled Asset Relief Program funds.
Consolidation in the industry and the volatility in the stock market have
negatively affected investors.
Non-U.S. Securities Risk
An investment in non-U.S. securities involves risks in addition to the
usual risks inherent in domestic investments, including currency risk. The value
of a non-U.S. security in U.S. dollars tends to decrease when the value of the
U.S. dollar rises against the non-U.S. currency in which the security is
denominated and tends to increase when the value of the U.S. dollar falls
against such currency. 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.
Passive Foreign Investment Companies Risk.
The Fund may invest in companies that are considered to be "passive
foreign investment companies" ("PFICs"), 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. Therefore, 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 distributed to its
shareholders in a timely manner. The Fund will not be able to pass through to
its shareholders any credit or deduction for such taxes.
- 23 -
Small-Cap Companies
While historically small-cap company stocks have outperformed the stocks
of large companies, the former have customarily involved more investment risk as
well. Small-cap companies may have limited product lines, markets or financial
resources; may lack management depth or experience; and may be more vulnerable
to adverse general market or economic developments than large companies. Some of
these companies may distribute, sell or produce products that have recently been
brought to market and may be dependent on key personnel.
ADDITIONAL RISK OF INVESTING IN THE FUND
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 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.
Liquidity Risk
Whether or not the equity securities in the Fund are listed on a
securities exchange, the principal trading market for certain of the equity
securities in the Fund may be in the OTC market. As a result, the existence of a
liquid trading market for the equity securities may depend on whether dealers
will make a market in the equity securities. There can be no assurance that a
market will be made for any of the equity securities, that any market for the
equity securities will be maintained or that there will be sufficient liquidity
of the equity securities in any markets made. The price at which the equity
securities are held in the Fund will be adversely affected if trading markets
for the equity securities are limited or absent.
RISKS AND SPECIAL CONSIDERATIONS CONCERNING DERIVATIVES
To the extent disclosed in the Prospectus, the Fund may invest in
derivatives. 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
- 24 -
variety of factors, particularly the portfolio managers' 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 portfolio managers' 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 portfolio managers 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/Counterparty 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
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
- 25 -
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
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
- 26 -
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 IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS 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 111 Portfolios None
120 East Liberty Drive, Board and (December 2010 to
Suite 400 Trustee Present), President (until
Wheaton, IL 60187 o Since inception December 2010), First
D.O.B.: 09/55 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)
Independent Trustees
-------------------------
Richard E. Erickson Trustee o Indefinite term Physician; President, 111 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 111 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), Vice Services
Wheaton, IL 60187 President and Chief International
D.O.B.: 11/57 Financial Officer (1990 to
May 2007), ADM Investor
Services, Inc. (Futures
Commission Merchant)
- 27 -
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS BY TRUSTEE 5 YEARS
Robert F. Keith Trustee o Indefinite term President (2003 to 111 Portfolios Director of
c/o First Trust Advisors Present), Hibs Enterprises Trust Company of
L.P. o Since inception (Financial and Management Illinois
120 East Liberty Drive, Consulting)
Suite 400
Wheaton, IL 60187
D.O.B.: 11/56
President and Chief
Niel B. Nielson Trustee o Indefinite term Executive Officer (July 111 Portfolios Director of
c/o First Trust Advisors 2012 to Present), Dew Covenant
L.P. o Since inception Learning LLC (Educational Transport Inc.
120 East Liberty Drive, Products and Services);
Suite 400 President (June 2002 to
Wheaton, IL 60187 June 2012), Covenant
D.O.B.: 03/54 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)
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, (April 2007
Wheaton, IL 60187 Chief Accounting to Present) First Trust
D.O.B.: 01/66 Officer Advisors L.P. and First
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 and
D.O.B.: 05/60 General Counsel, BondWave
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 (September
Wheaton, IL 60187 2005 to July 2012), First
D.O.B.: 02/70 Trust Advisors L.P. and
First Trust Portfolios
L.P.
- 28 -
|
OTHER
NUMBER OF TRUSTEESHIPS OR
PORTFOLIOS IN THE DIRECTORSHIPS
POSITION TERM OF OFFICE AND FIRST TRUST FUND HELD BY TRUSTEE
NAME, ADDRESS AND OFFICES YEAR FIRST ELECTED PRINCIPAL OCCUPATIONS COMPLEX OVERSEEN DURING THE PAST
AND DATE OF BIRTH WITH TRUST OR APPOINTED DURING PAST 5 YEARS BY TRUSTEE 5 YEARS
Kristi A. Maher Assistant o Indefinite term Deputy General Counsel, N/A N/A
120 East Liberty Drive, Secretary and First Trust Advisors L.P.
Suite 400 Chief Compliance o Since inception and First Trust Portfolios
Wheaton, IL 60187 Officer 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 L.P.
Suite 400 o Since inception and First Trust Portfolios
Wheaton, IL 60187 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 September
D.O.B.: 11/70 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 First Defined
Portfolio Fund, LLC, open-end funds with 12 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,
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 IV, First Trust Exchange-Traded Fund V, 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 82
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.
- 29 -
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 First Trust 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 Funds' 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 Funds' 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
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 Funds' 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 Funds'
- 30 -
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 also serves 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
Fund. To submit a recommendation for nomination as a candidate for a position on
the Board of Trustees, shareholders of the 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, 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.
- 31 -
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 the FUnd hold the same positions with each fund in the
First Trust Fund Complex (representing 111 portfolios) as they hold with the
Fund.
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
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
- 32 -
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), Chairman of the Audit Committee (2012 - 2013) and Chairman of the
Valuation Committee (June 2006 - 2007 and 2010 - 2011) 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
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) and he currently serves as Lead Independent Trustee and on the
Executive Committee (since January 1, 2014) and on the Executive Committee
(since January 31, 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
- 33 -
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.
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 for
one fiscal year and the actual compensation paid by the First Trust Fund Complex
for the calendar year ended December 31, 2013, respectively. The Trust has no
retirement or pension plans. The officers and Trustee who are "interested
- 34 -
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 THE TOTAL COMPENSATION FROM
NAME OF TRUSTEE FUND(1) THE FIRST TRUST FUND COMPLEX(2)
Richard E. Erickson $1,457 $306,162
Thomas R. Kadlec $1,492 $299,500
Robert F. Keith $1,457 $310,300
Niel B. Nielson $1,674* $304,334
|
(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 12 portfolios
of First Defined Portfolio Fund, LLC, First Trust Series Fund and
First Trust Variable Insurance Trust, open-end funds, 14 closed-end
funds and 79 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 IV, First Trust Exchange-Traded
Fund V, 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.
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
TRUSTEE IN THE FUND TRUST 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 February 24, 2014, the Independent Trustees of the Trust and
immediate family members did 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 February 24, 2014, the officers and Trustees, in the aggregate,
owned less than 1% of the shares of the Fund.
- 35 -
As of February 28, 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 December 8, 2013. 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 0.70% of its average
daily net assets. First Trust provides fund reporting services to the Fund for a
flat annual fee in the amount of $9,250, which is included in the annual
management fee.
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 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 is 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
- 36 -
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.
Investment Committee. The Investment Committee of First Trust (the
"Investment Committee") is primarily responsible for the day-to-day management
of the Fund. There are currently five members of the Investment Committee, as
follows:
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
Daniel J. Lindquist Managing Director Since 2004 Managing Director (July 2012
to Present), Senior Vice
President (September 2005 to
July 2012), Vice President
(April 2004 to September
2005), First Trust Advisors
L.P. and First Trust
Portfolios L.P.
Jon C. Erickson Senior Vice President Since 1994 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
David G. McGarel Chief Investment Officer Since 1997 Chief Investment Officer (June
and Managing Director 2012 to Present), Managing
Director (July 2012 to
Present), Senior Vice
President (September 2005 to
July 2012), First Trust
Advisors L.P. and First Trust
Portfolios L.P.
Roger F. Testin Senior Vice President Since 2001 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
Stan Ueland Senior Vice President Since 1997 Senior Vice President
(September 2012 to Present),
Vice President (August 2005 to
September 2012), First Trust
Advisors L.P. and First Trust
Portfolios L.P.
|
- 37 -
Daniel J. Lindquist: Mr. Lindquist is Chairman of the Investment Committee
and presides over Investment Committee meetings. Mr. Lindquist is also
responsible for overseeing the implementation of the Fund's investment strategy.
Jon C. Erickson: As the head of First Trust's Equity Research Group, Mr.
Erickson is responsible for determining the securities to be purchased and sold
by funds that do not utilize quantitative investment strategies.
David G. McGarel: As First Trust's Chief Investment Officer, Mr. McGarel
consults with the Investment Committee on market conditions and First Trust's
general investment philosophy.
Roger F. Testin: As head of First Trust's Portfolio Management Group, Mr.
Testin is responsible for executing the instructions of the Strategy Research
Group and Equity Research Group in the Fund's portfolio.
Stan Ueland: Mr. Ueland executes the investment strategy of the Fund.
No member of the Investment Committee beneficially owns any shares of the
Fund.
Compensation. The compensation structure for each member of the Investment
Committee 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 members of the Investment
Committee are not based upon criteria such as performance of the Funds or the
value of assets included in the Funds' portfolios. In addition, Mr. Erickson,
Mr. Lindquist, Mr. McGarel and Mr. Ueland also have an indirect ownership stake
in the firm and will therefore receive their allocable share of
ownership-related distributions.
The Investment Committee manages the investment vehicles (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:
- 38 -
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE
REGISTERED INVESTMENT OTHER POOLED INVESTMENT
COMPANIES VEHICLES
NUMBER OF ACCOUNTS NUMBER OF ACCOUNTS OTHER ACCOUNTS NUMBER OF
INVESTMENT COMMITTEE MEMBER ($ ASSETS) ($ ASSETS) ACCOUNTS ($ ASSETS)
Roger F. Testin 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Jon C. Erickson 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
David G. McGarel 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Daniel J. Lindquist 83 ($23,465,710,810) 8 ($138,646,923) 2,411 ($760,225,152)
Stan Ueland 70 ($18,162,457,152) N/A N/A
|
Conflicts. None of the accounts managed by the Investment Committee 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 Investment Committee's management of the Fund's
investments and the investments of the other accounts managed by the Investment
Committee. However, because the investment strategy of the Fund and the
investment strategies of many of the other accounts managed by the Investment
Committee are based on fairly mechanical investment processes, the Investment
Committee 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 Investment Committee 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 Investment
Committee.
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
- 39 -
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
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 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
- 40 -
such allocations between the Fund and other advisory accounts, the main factors
considered by First Trust are the respective investment objectives, 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.
Administrator. Brown Brothers Harriman & Co ("BBH") serves as
Administrator for the Fund. Its principal address is 40 Water Street, Boston,
Massachusetts 02109.
BBH serves as Administrator for the Trust pursuant to a Fund
Administration and Accounting Agreement. Under such agreement, BBH is obligated
on a continuous basis, to provide such administrative services as the Board of
Trustees reasonably deems necessary for the proper administration of the Trust
and the Fund. BBH will generally assist in all aspects of the Trust's and the
Fund's operations; supply and maintain office facilities (which may be in BBH 's
own offices), statistical and research data, data processing services, clerical,
accounting, bookkeeping and record keeping services (including, without
limitation, the maintenance of such books and records as are required under the
1940 Act and the rules thereunder, except as maintained by other agency agents),
internal auditing, executive and administrative services, and stationery and
office supplies; prepare reports to shareholders or investors; prepare and file
tax returns; supply financial information and supporting data for reports to and
filings with the SEC and various state Blue Sky authorities; supply supporting
documentation for meetings of the Board of Trustees; and provide monitoring
reports and assistance regarding compliance with federal and state securities
laws.
Pursuant to the Fund Administration and Accounting 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 BBH
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 BBH in
the performance of its duties. This fee is subject to reduction for assets over
$1 billion.
CUSTODIAN, TRANSFER AGENT, FUND ACCOUNTING AGENT, DISTRIBUTOR, INDEX
PROVIDER AND EXCHANGE
Custodian, Transfer Agent and Accounting Agent. BBH, as custodian for the
Fund pursuant to a Custody Agreement, holds the Fund's assets. BBH also serves
as transfer agent of the Fund pursuant to an Administrative Agency Agreement. As
the Fund's accounting agent, BBH calculates the net asset value of shares and
calculates net income and realized capital gains or losses. BBH may be
reimbursed by the Funds for its out-of-pocket expenses.
- 41 -
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 Funds through the Distributor only in
Creation Unit Aggregations, as described below under the heading "Creation and
Redemption of Creation Unit Aggregations."
First Trust 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. First
Trust's available resources to make these payments include profits from advisory
fees received from the Funds. The services First Trust 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 March
31, 2016.
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
Creation Unit Aggregations of Fund shares. Participating Parties as defined in
"Procedures for Creation of Creation Unit Aggregations" below shall be DTC
- 42 -
Participants (as defined in "DTC Acts as Securities Depository for Fund Shares"
below.
Index Provider. The Index Provider is not affiliated with the Fund, First
Trust Portfolios or First Trust. The Fund is entitled to use the Index pursuant
to a sublicensing arrangement by and between the Trust, on behalf of the Fund,
and First Trust, which in turn has a license agreement with the Index Provider.
The Fund is not sponsored, endorsed, sold or promoted by RBA. RBA makes no
representation or warranty, express or implied, to the owners of the Fund or any
member of the public regarding the advisability of trading in the Fund. RBA's
only relationship to First Trust is the licensing of certain trademarks and
trade names of RBA and of the Index which is determined, composed and calculated
by RBA without regard to First Trust or the Fund, RBA has no obligation to take
the needs of First Trust or the owners of the Fund into consideration in
determining, composing or calculating the Index. RBA is not responsible for and
has not participated in the determination of the timing of, prices at, or
quantities of the Fund to be listed or in the determination or calculation of
the equation by which shares of the Fund are to be converted into cash. RBA has
no obligation or liability in connection with the administration, marketing or
trading of the Fund.
RBA DOES NOT GUARANTEE OR MAKE ANY REPRESENTATION OR WARRANTY AS TO THE
ACCURACY AND/OR THE COMPLETENESS OF THE INDEX OR ANY DATA INCLUDED THEREIN AND
RBA SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN.
THE INDEX, ANY DATA CONTAINED THEREIN AND ANY OTHER DATA OR INFORMATION SUPPLIED
BY RBA IS PROVIDED ON AN "AS IS" BASIS. RBA MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY FIRST TRUST, OWNERS OF THE FUND, OR ANY
OTHER PERSON OR ENTITY FROM THE USE OF THE INDEX OR ANY DATA INCLUDED THEREIN.
RBA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL
WARRANTIES, OF MERCHANTABILITY, NON-INFRINGEMENT OR FITNESS FOR A PARTICULAR
PURPOSE OR USE WITH RESPECT TO THE INDEX OR ANY DATA INCLUDED THEREIN, OR ANY
WARRANTIES WITH RESPECT TO THE TIMELINESS, SEQUENCE, ACCURACY, COMPLETENESS,
CURRENTNESS, OR QUALITY OF THE INDEX, ANY DATA CONTAINED THEREIN OR ANY DATA OR
INFORMATION SUPPLIED BY RBA. RBA SHALL NOT BE RESPONSIBLE FOR ANY MISDELIVERY OF
ANY DATA RELATED TO OR ASSOCIATED WITH THE INDEX OR ANY DATA CONTAINED THEREIN.
WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL RBA HAVE ANY LIABILITY
FOR ANY LOST PROFITS OR INDIRECT, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
RBA AND ITS RESPECTIVE AFFILIATES AND EACH OF THEIR RESPECTIVE OFFICERS,
DIRECTORS, EMPLOYEES, AGENTS AND SOURCES (THE "RBA PARTIES") SHALL NOT BE LIABLE
TO FIRST TRUST OR ANY THIRD PARTY FOR ANY LOSS OR DAMAGE, DIRECT, INDIRECT OR
CONSEQUENTIAL, ARISING FROM (A) ANY INACCURACY OR INCOMPLETENESS IN, OR DELAYS,
INTERRUPTIONS, ERRORS OR OMISSIONS IN THE DELIVERY OF THE INDEX OR ANY DATA
- 43 -
CONTAINED THEREIN, OR (B) ANY DECISION MADE OR ACTION TAKEN BY FIRST TRUST OR
ANY THIRD PARTY IN RELIANCE UPON THE FUND, INDEX OR ANY DATA CONTAINED THEREIN.
THERE ARE NO THIRD PARTY BENEFICIARIES OF ANY AGREEMENTS OR ARRANGEMENTS BETWEEN
RBA AND FIRST TRUST.
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
lists the shares of the Fund 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.
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
- 44 -
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.
PROXY VOTING POLICIES AND PROCEDURES
The Trust has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently with the best
interests of the Fund.
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
- 45 -
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 A.
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 BBH 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 of 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.
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS
Creation. The Trust issues and sells shares of the Fund only in Creation
Unit Aggregations on a continuous basis through the Distributor, without a sales
- 46 -
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, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Deposit of Securities and Deposit or Delivery of Cash. The consideration
for purchase of Creation Unit Aggregations of the Fund may consist of (i) cash
in lieu of all or a portion of the Deposit Securities, as defined below; and/or
(ii) a designated portfolio of equity securities determined by First Trust--the
"Deposit Securities"--per each Creation Unit Aggregation constituting a
substantial replication of the stocks included in the underlying index and
generally an amount of cash--the "Cash Component"--computed as described below.
Together, the Deposit Securities and the Cash Component (including the cash in
lieu amount) 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 the net asset value of Fund shares (per Creation Unit Aggregation) and
the "Deposit Amount"--an amount equal to the market value of the Deposit
Securities and/or cash in lieu of all or a portion 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 (discussed below), makes available on each
Business Day, prior to the opening of business of the NYSE (currently 9:30 a.m.,
Eastern Time), the list of the names and the required number of shares of each
Deposit Security to be included in the current Fund Deposit (based on
information at the end of the previous Business Day) for the Fund.
Such Fund Deposit is applicable, subject to any adjustments as described
below, in order to effect creations of Creation Unit Aggregations of the Fund
until such time as the next-announced composition of the Deposit Securities is
made available.
The identity and number of shares of the Deposit Securities required for a
Fund Deposit for the Fund change as rebalancing adjustments and corporate action
events are reflected within the Fund from time to time by First Trust with a
view to the investment objective of the Fund. The composition of the Deposit
Securities may also change in response to adjustments to the weighting or
composition of the component stocks of the underlying index. In addition, the
Trust reserves the right to permit or require the substitution of an amount of
cash--i.e., a "cash in lieu" amount--to be added to the Cash Component to
replace any Deposit Security that may not be available, that may not be
- 47 -
available in sufficient quantity for delivery or which might not be eligible for
trading by an Authorized Participant ("AP") or the investor for which it is
acting or other relevant reason. The adjustments described above will reflect
changes known to First Trust on the date of announcement to be in effect by the
time of delivery of the Fund Deposit, in the composition of the underlying index
or resulting from certain corporate actions.
In addition to the list of names and numbers of securities constituting
the current Deposit Securities of a Fund Deposit, the Custodian, through the
NSCC, also makes available on each Business Day, the estimated Cash Component,
effective through and including the previous Business Day, per outstanding
Creation Unit Aggregation of the Fund.
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), and 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 AP.
Investors should contact the Distributor for the names of APs 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 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 each case on
the date such order is placed in order for 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. In
the case of custom orders, the order must be received by the transfer agent no
later than 3:00 p.m. Eastern Time on the trade date. A custom order may be
placed by an AP in the event that the Trust permits or requires the substitution
of an amount of cash to be added to the Cash Component to replace any Deposit
Security which may not be available in sufficient quantity for delivery or which
may not be eligible for trading by such AP or the investor for which it is
acting or other relevant reason. 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 AP by telephone or other transmission method acceptable to
the transfer agent pursuant to procedures set forth in the Participant
Agreement. Severe economic or market disruptions or changes, or telephone or
other communication failure may impede the ability to reach the transfer agent
or an AP.
All orders from investors who are not APs to create Creation Unit
Aggregations shall be placed with an AP, as applicable, in the form required by
such AP. In addition, the AP 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 AP 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
- 48 -
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.
Placement of Creation Orders. In order to purchase Creation Units of a
Fund, an AP must submit an order to purchase for one or more Creation Units. All
such orders must be received by a Fund's transfer agent in proper form no later
than the close of regular trading on the NYSE (ordinarily 4:00 p.m. Eastern
Time) in order to receive that day's closing net asset value per share. Orders
must be placed in proper form by or through an AP, which is a DTC Participant,
i.e., a subcustodian of the Trust. Deposit Securities must be delivered to the
Trust through DTC or NSCC, and 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. If a Deposit Security is an ADR or similar domestic instrument,
it may be delivered to the Custodian. The AP must also pay on or before the
International Contractual Settlement Date immediately available or same-day
funds estimated by the Trust to be sufficient to pay the Cash Component next
determined after acceptance of the creation order, together with the applicable
Creation Transaction Fee and additional variable amounts, as described below.
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 such Fund are customarily traded.
A custom order may be placed by an AP in the event that a Fund permits or
requires the substitution of an amount of cash to be added to the Cash Component
(if applicable) to replace any Deposit Security which may not be available in
sufficient quantity for delivery or which may not be eligible for trading by
such AP or the investor for which it is acting or any other relevant reason.
The AP must also make available no later than 2:00 p.m., Eastern Time, on
the International Contractual Settlement Date, by means satisfactory to the
Trust, immediately-available or same-day funds estimated by the Trust to be
sufficient to pay the Cash Component next determined after acceptance of the
purchase order, together with the applicable purchase transaction fee. Any
excess funds will be returned following settlement of the issue of the Creation
Unit Aggregation.
A Creation Unit Aggregation will not be issued until the transfer of good
title to the Trust of the portfolio of Deposit Securities, the payment of the
Cash Component, the payment of any other cash amounts and the Creation
Transaction Fee (as defined below) have been completed. When the required
Deposit Securities which are U.S. securities have been delivered to the Trust
through DTC or NSCC, and Deposit Securities which are non-U.S. securities have
been delivered to the Custodian and each relevant subcustodian confirms to the
Custodian that the required Deposit Securities which are non-U.S. securities
(or, when permitted in the sole discretion of Trust, the cash in lieu thereof)
have been delivered to the account of the relevant subcustodian, the Custodian
shall notify the Distributor and the transfer agent which, acting on behalf of
the Trust, will issue and cause the delivery of the Creation Unit Aggregations.
The Trust may in its sole discretion permit or require the substitution of an
amount of cash (i.e., a "cash in lieu" amount) to be added to the Cash Component
- 49 -
to replace any Deposit Security which may not be available in sufficient
quantity for delivery or for other relevant reasons. If the Distributor, acting
on behalf of the Trust, determines that a "cash in lieu" amount will be
accepted, the Distributor will notify the AP and the transfer agent, and the AP
shall deliver, on behalf of itself or the party on whose behalf it is acting,
the "cash in lieu" amount, with any appropriate adjustments as advised by the
Trust as discussed below.
In the event that an order for a Creation Unit is incomplete on the
International Contractual Settlement Date 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 AP 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. The Trust may permit, in its discretion, the AP to
substitute a different security in lieu of depositing some or all of the Deposit
Securities. Substitution of cash or a different security might be permitted or
required, for example, because one or more Deposit Securities may be unavailable
in the quantity needed or may not be eligible for trading by the AP due to local
trading restrictions or other restrictions.
To the extent contemplated by the applicable Participant Agreement,
Creation Unit Aggregations of the Fund will be issued to such AP notwithstanding
the fact that the corresponding Fund Deposits have not been received in part or
in whole, in reliance on the undertaking of the AP to deliver the missing
Deposit Securities as soon as possible, which undertaking shall be secured by
such AP'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. Such cash collateral must be
delivered no later than 2:00 p.m., Eastern Time, on the contractual settlement
date. The Participant Agreement will permit the Fund to buy the missing Deposit
Securities at any time and will subject the AP 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 Deposit
Securities delivered are not as disseminated for that date by the Custodian, as
described above; (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 counsel, be unlawful; (vi) acceptance of the Fund Deposit
would otherwise, in the discretion of the Trust or First Trust, have an adverse
effect on the Trust, the Fund or the rights of Beneficial Owners; or (vii)
circumstances outside the control of the Trust, the Custodian, the Distributor
and First Trust make it for all practical purposes impossible to process
creation orders. Examples of such circumstances include acts of God; 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, First Trust, the
Distributor, DTC, NSCC, the Custodian or sub-custodian or any other participant
- 50 -
in the creation process, and similar extraordinary events. In addition, an order
may be rejected for practical reasons such as 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 or
systems failures involving computer or other information systems affecting any
relevant sub-custodian. The Distributor shall notify a prospective creator of a
Creation Unit and/or the AP acting on behalf of such prospective creator of its
rejection of the order of such person. The Trust, the Custodian, any
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 number of shares 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 $500. 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 Creation Transaction Fee may increase or decrease as the Fund's
portfolio is adjusted to conform to changes in the composition of the Index. 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 AP to substitute cash or a different
security in lieu of depositing one or more of the requisite Deposit Securities,
the AP may also be assessed an amount to cover the cost of purchasing the
Deposit Securities and/or disposing of the substituted 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 and/or substitute securities.
As discussed above, shares of the Fund may be issued in advance of receipt
of all 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.
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. A redeeming beneficial owner must maintain
appropriate security arrangements with a broker-dealer, bank or other custody
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provider in each jurisdiction in which any of the portfolio securities are
customarily traded. If such arrangements cannot be made, or it is not possible
to effect deliveries of the portfolio securities in a particular jurisdiction or
under certain other circumstances (for example, holders may incur unfavorable
tax treatment in some countries if they are entitled to receive "in-kind"
redemption proceeds), Fund shares may be redeemed for cash at the discretion of
First Trust.
With respect to the Fund, the Custodian, through the NSCC, makes available
prior to the opening of business on the NYSE (currently 9:30 a.m. Eastern Time)
on each Business Day, the identity of the Fund Securities (as defined below)
that will be applicable (subject to possible amendment or correction) to
redemption requests received in proper form (as described below) on that day.
Fund Securities (as defined below) received on redemption may not be identical
to Deposit Securities that are applicable to creations of Creation Unit
Aggregations.
Unless cash redemptions are available or specified for the Fund, the
redemption proceeds for a Creation Unit Aggregation generally consist of a
portfolio of securities ("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
being redeemed, as next determined after a receipt of a request in proper form,
and the 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 a value greater than the net asset value of
the Fund shares, 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 AP by the redeeming shareholder.
The right of redemption may be suspended or the date of payment postponed
(i) for any period during which the NYSE is closed (other than customary weekend
and holiday closings); (ii) for any period during which trading on the NYSE 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
$500. The Redemption Transaction Fee is applicable to each redemption
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. The Redemption Transaction Fee may
increase or decrease as the Fund's portfolio is adjusted to conform to changes
in the composition of the Index. The Fund reserves the right to effect
redemptions in cash. A shareholder may request a cash redemption in lieu of
securities; however, the Fund may, in its discretion, reject any such request.
Investors will also bear the costs of transferring the Fund Securities from the
Trust to their account or on their order. Investors who use the services of a
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broker or other such intermediary in addition to an AP 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 AP that has executed a Participant
Agreement. Investors other than APs are responsible for making arrangements for
a redemption request to be made through an AP. An order to redeem Creation Unit
Aggregations of the Fund is deemed received by the Trust on the Transmittal Date
if: (i) such order is received by BBH (in its capacity as transfer agent) not
later than the Closing Time on the Transmittal Date; (ii) such order is
accompanied or followed by the requisite number of shares of the Fund specified
in such order, which delivery must be made through DTC to BBH; and (iii) all
other procedures set forth in the Participant Agreement are properly followed.
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.
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 on which the Fund may rely, the Fund's in-kind redemption
proceeds must 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 generally
no later than 12 calendar days following tender of a Creation Unit Aggregation.
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 AP
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 AP's agreement, in the event the AP 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 will nonetheless accept the redemption request in
reliance on the undertaking by the AP to deliver the missing shares as soon as
possible. Such undertaking shall be secured by the AP's delivery and 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 BBH and marked to
market daily, and that the fees of BBH and any sub-custodians in respect of the
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delivery, maintenance and redelivery of the cash collateral shall be payable by
the AP. If the AP'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 AP 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 BBH
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 BBH 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 BBH prior to the "DTC Cut-Off-Time," then the value of the Fund Securities
and the Cash Redemption Amount to be delivered will be determined by BBH on such
Transmittal Date. If, however, a redemption order is submitted to BBH by a DTC
Participant not later than the Closing Time on the Transmittal Date but either
(i) the requisite number of shares of the Fund are not delivered by the DTC
Cut-Off-Time, as described above, on such Transmittal Date; or (ii) the
redemption order is not submitted in proper form, then the redemption order will
not be deemed received as of the Transmittal Date. In such case, the value of
the Fund Securities and the Cash Redemption Amount to be delivered/received will
be computed on the Business Day that such order is deemed received by the Trust,
i.e., the Business Day on which the shares of the Fund are delivered through DTC
to BBH by the "DTC Cut-Off-Time" on such Business Day pursuant to a properly
submitted redemption order.
If it is not possible to effect deliveries of the Fund Securities, the
Trust may in its discretion exercise its option to redeem such Fund shares in
cash, and the redeeming Beneficial Owner will be required to receive its
redemption proceeds in cash. In addition, an investor may request a redemption
in cash that the Fund may, in its sole discretion, permit. In either case, the
investor will receive a cash payment equal to the net asset value of its Fund
shares based on the net asset value of shares of the relevant Fund next
determined after the redemption request is received in proper form (minus a
redemption transaction fee and additional charge for requested cash redemptions
specified above, to offset the Trust's brokerage and other transaction costs
associated with the disposition of Fund Securities). The Fund may also, in its
sole discretion, upon request of a shareholder, provide such redeemer a
portfolio of securities that differs from the exact composition of the Fund
Securities, or cash in lieu of some securities added to the Cash Component, but
in no event will the total value of the securities delivered and the cash
transmitted differ from the net asset value.
Redemptions of Fund shares for Fund Securities will be subject to
compliance with applicable federal and state securities laws and the Fund
(whether or not it otherwise permits cash redemptions) reserves the right to
redeem Creation Unit Aggregations for cash to the extent that the Trust could
not lawfully deliver specific Fund Securities upon redemptions or could not do
so without first registering the Fund Securities under such laws. An AP or an
investor for which it is acting subject to a legal restriction with respect to a
particular stock included in the Fund Securities applicable to the redemption of
a Creation Unit Aggregation may be paid an equivalent amount of cash. The AP may
request the redeeming Beneficial Owner of the Fund shares to complete an order
- 54 -
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.
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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,
(i) 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; (ii) diversify its holdings so that, at the end of each quarter of
the taxable year, (a) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. government
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 (b) 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 (iii) 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.
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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. However, certain ordinary income distributions received from the Fund
may be taxed at capital gains tax rates. In particular, 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, provided that certain holding period requirements are satisfied
and provided the dividends are attributable to qualifying dividends received by
the Fund itself. Dividends received by the Fund from REITs and foreign
corporations are qualifying dividends eligible for this lower tax rate only in
certain circumstances. The Fund will provide notice to its shareholders of the
amount of any distributions that may be taken into account as a dividend that is
eligible for the capital gains tax rates. The Fund cannot make any guarantees as
to the amount of any distribution that will be regarded as a qualifying
dividend.
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
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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. However, certain ordinary
income dividends on shares that are attributable to qualifying dividends
received by the Fund from certain domestic corporations may be reported by the
Fund as being eligible for the dividends received deduction.
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. Some capital gains
dividends may be taxed at a maximum stated rate of 25% or 28%. 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 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.
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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 (i) 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 (ii) 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 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 will not be able to
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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
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.
- 64 -
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.
In addition, capital gains distributions attributable to gains from U.S.
real property interests (including certain U.S. real property holding
corporations) will generally be subject to United States withholding tax and
will give rise to an obligation on the part of the foreign shareholder to file a
United States tax return.
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.
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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.
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 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.
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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 on an amortized cost basis.
(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, that 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. Use of fair value prices and certain current market valuations could
result in a difference between the prices used to calculate the Fund's net asset
value and the prices used by the Index, which, in turn, could result in a
difference between the Fund's performance and the performance of the Index.
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.
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The Fund may suspend the right of redemption for the Fund only under the
following unusual circumstances: (i) when the NYSE is closed (other than
weekends and holidays) or trading is restricted; (ii) 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 (iii) 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."
General Policies. Dividends from net investment income of the Fund, if
any, are declared and paid quarterly. 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 - PROXY VOTING GUIDELINES
2014 U.S. Proxy Voting Concise Guidelines
December 19, 2013
Institutional Shareholder Services Inc.
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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
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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.
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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
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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.
2. Responsiveness
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.
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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.
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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.
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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
o 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
SHAREHOLDER RIGHTS & DEFENSES
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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
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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.
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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:
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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
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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.
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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:
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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.
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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
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o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
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
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o Recent amendments that incorporate any problematic features (such as
those above) or recent actions (such as extraordinary equity grants)
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;
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o If the company has already responded in an appropriate and sufficient
manner to the issue(s) raised in the proposal;
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.
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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.
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.
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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
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
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